Michael Sherman is a business strategist and lawyer who advises some of Canada’s largest corporations on the implications and applications of behavioural economics.
Visit the lunchroom at Google headquarters and you’ll witness behavioural economics in action.
There’s a salad bar at the front of the cafeteria, encouraging people to fill their plates with healthy foods first. A sign is posted next to a stack of plates, reminding customers that people who use larger plates tend to eat more. Vegetable dishes are tagged with green labels, signifying healthy choices, while desserts are tagged with red ones, cautioning moderation. Desserts, if you can find them, are relegated to the sidelines and come in tiny three-bite portions.
Subtle cues like these – nudges – have proven remarkably successful in coaxing people to eat healthier and make smarter choices, without telling them what to do.
These days, a growing number of businesses are applying behavioural economics to better understand and influence the way people make personal decisions. Along with Google, companies such as JPMorgan, Merrill Lynch and Barclays Bank are actively employing BE principles.
In Canada, Canadian Tire, Proctor & Gamble and major Canadian banks are also integrating BE principles into the way they engage consumers.
It’s no surprise that many companies are jumping on the behavioural economics bandwagon. A recent U.S. Gallup study showed that firms employing BE principles have outperformed their peers by 85 per cent in sales growth and by more than 25 per cent in gross profitability.
BE first rose to prominence in 2002, when a team of Princeton psychologists led by Daniel Kahneman was awarded the Nobel Prize in economics for showing how the human brain is hard-wired to make irrational decisions over and over again in predictable ways.
Unlike traditional economics, which assumes that people make decisions with the logic and rationality of Mr. Spock, BE combines psychology and economics to show how people make decisions in real life. When faced with complex financial choices, people tend to act more like Homer Simpson than Mr. Spock. They get swept away by emotion, they rely on intuition and hunches, and they take mental shortcuts that lead them astray.
Over time, Prof. Kahneman and his team discovered the existence of dozens of mental blind spots, known as cognitive biases, that cause people to make irrational decisions. Examples of these cognitive biases include:
- Status quo bias. When faced with difficult decisions, inertia sets in and people tend to stick with the status quo.
- Loss aversion. People dislike losing twice as much as they like winning, and they avoid selling items at a loss.
- Present bias. People tend to prefer to receive smaller payments now than significantly larger payments in the future.
- Choice overload. When faced with too many choices, people tend to become overwhelmed and freeze.
In 2008, University of Chicago professors Richard Thaler and Cass Sunstein published their groundbreaking book Nudge, outlining how consumers could be encouraged to overcome these cognitive biases and make better choices.
Nudges are a means of altering behaviour in predictable ways by making subtle suggestions, using indirect incentives and by framing choices in ways that will encourage better decision making. Nudges should be easy and cheap to avoid, without making any choice mandatory.
Nudges can be simple. Travel websites encourage consumers to purchase add-on products, such as travel insurance, by preselecting items once a trip is booked. They know that once a default option is established, it tends to stick.
Nudges can help people save for retirement. Some companies automatically enroll employees in retirement savings plans and set the default contribution rates at levels that encourage long-term saving. While these programs are optional and employees can reduce their contribution rate or opt out entirely, this approach helps overcome present bias and encourages saving for the future.
When government officials in Quebec send out notices of speeding violations caught on roadside cameras, they include photographs of the owner’s car and a close-up of the licence plate. They know that vivid pictures of drivers flaunting social norms will nudge speeders toward throwing in the towel and admitting guilt.
What’s more, marketers know that people tend to follow the herd, so they label products as “most popular” or “top seller” to nudge people to jump on the bandwagon and make a purchase.
Governments were some of the first organizations to adopt and apply BE in practical ways. In 2009, U.S. President Barack Obama appointed Prof. Sunstein as the White House’s “regulatory czar” and began integrating BE insights into the way the U.S. government operates. Last September, Mr. Obama signed a landmark executive order directing federal agencies to use behavioural science insights whenever possible, essentially embedding BE as a cornerstone of U.S. policy making.
In 2010, British Prime Minister David Cameron recruited Prof. Thaler to establish a Cabinet Office Behavioural Insights Team, otherwise known as the “nudge unit.”
Inspired by the remarkable success of the British experience, the Canadian government recently introduced the Innovation Hub, a team providing BE-related advice to federal departments. In early 2015, Ontario Finance Minister Charles Sousa announced the formation of a new Behavioural Insights Unit in his province, which is now using BE principles to experiment with more than a dozen different organ donation forms to see what works best.
The Canadian government strengthened its commitment to BE with the recent appointment of Prof. Dilip Soman as policy adviser and scholar in residence at the Privy Council Office. Prof. Soman, who is on leave from the University of Toronto’s Rotman School of Management, is one of Canada’s leading thinkers in behavioural economics.
“Governments have done a good job of looking through a BE lens when evaluating policies – and the appetite is growing,” he says. “Yet this is an area where business has lagged government.”
One of the reasons businesses have been slow to adopt BE strategies is that many business leaders have studied traditional economics theory and continue to believe consumers always act rationally. While traditional economics theory provides an excellent framework on how people are supposed to make decisions, behavioural economists caution that it shouldn’t be used to predict how consumers really think.
“The more you train managers in economics and rational thinking, the less they empathize with consumers,” Prof. Soman adds.
Although the shift toward BE in the corporate context is not as advanced as it has been in government, a growing number of companies are currently using BE to map their customers’ journey to uncover when cognitive biases might arise and distort the decision-making process. Marketers are using BE to examine how customers select products, how they consume them, and what features, prices and designs could be improved to enhance the way consumers make choices.
Advanced users of BE are conducting experiments on how customers evaluate and use products or services. Some companies have established research labs to conduct tests to assess the effectiveness of ads, websites, store layouts or products from a BE perspective. Others have gone a step further and are testing the effectiveness of nudges in the marketplace.
Nudges come in different forms in different places.
“I find it fascinating that Canadians are the biggest collectors of loyalty points in the world,” says Dan Ariely, a professor of psychology and behavioural economics at Duke University. “After all, loyalty points nudge you to focus less on product quality and service, and encourage you to behave in a different way.”
Meanwhile, business schools in Canada are supplying a robust pipeline of able graduates to fill the expected demand for future behaviouralists. Prof. Soman said the Rotman School of Management has 150 undergraduate business students enrolled in courses about behavioural economics and there are an additional 75 MBA students taking BE-related courses each year.
While the application of BE theory is still in the early stages of acceptance in Corporate Canada, it’s on the rise and there’s good reason to believe that nudges are becoming an integral part of the way businesses engage with consumers.Report Typo/Error