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Posts Tagged ‘Daniel Kahneman’

Marketing Psychology: Price Framing

January 30, 2015 2 comments

Price framing is one of those topics that everyone seems to have heard of, but every person you ask will give you a different definition of what it is and how it works. Yet if you’re managing a web store with thousands of products, for example, understanding how to present prices and products in the most optimal way can make an enormous revenue difference.

Let’s take a moment to talk about how price framing works and why it has an effect on consumers.

First of all, when we talk about price framing, we’re talking about changing the context of a price presentation – without substantially changing the price itself – in order to encourage more purchases. This is the reason you’re charged $39.99 rather than $40.00 for iPhone earbuds. But that’s just the tip of the iceberg.

What Do You Mean I’m Not Being Rational?!

One of the most amazing things about how price framing works is that it shouldn’t work at all. Up until a few decades ago, economic theory took utilitarianism as a given. When making a choice whether or not to buy an iPhone, both economists and psychologists assumed that you made a rational calculation of the pros and cons of the choice, and selected the outcome that, to the best of your knowledge, would be most useful or advantageous to you.

So it shouldn’t matter at all how a price is presented to you. The price is the price, and you should make the same calculation of advantages regardless of context.

Except that the rational action theory of economics turns out to be mostly bullshit.

If rational action theory were true, your tendency to purchase a $39.99 item (when you would not have purchased a $40 item) would be based solely on the utility of the one-cent savings. I think we can all agree that something else is at work here. This is an example of how marketers have always been decades ahead of economists.

The first people who noticed that people don’t make explicitly rational outcome choices were psychologists Daniel Kahneman and the late Amos Tversky. They are the grandfathers of what’s now called behavioral economics. They discovered through controlled experiments that people use cognitive shortcuts, called biases, to help make choices. These shortcuts don’t always produce rational decisions.

For example, Kahneman and Tversky discovered that, when people are given a choice of losing $10 for sure, or having a 50-50 chance of losing $25, they tend to avoid the certain loss even though rationally speaking it’s the worse choice.

Other pioneers have significantly advanced the study of these cognitive shortcuts. Two of the most prominent are Richard Thaler (author of Nudge), and Dan Ariely (author of Predictably Irrational).

So, what affect can these biases have on consumer behavior (and specific to us, on price presentation)?

Here are three major principles that may be helpful:

1. People evaluate prices relative to a reference point

Up until recently we believed that, when evaluating a potential purchase, people made comparisons to absolutes. Is this iPhone worth the 400 units of currency that I will part with?

Well, it turns out that we evaluate purchases on relative terms. We’re looking for the value that’s reasonable. But what’s reasonable can be determined by many things.

In a Psychology Today article called “Pricing and Framing: When Are We Likely to Pay More For Products,” Dr. Gizem Saka gives us the scenario of the bread maker:

…You have two options. A standard quality break maker is for sale for $80; and a higher quality bread maker is sold at $120. You compare and contrast the two machines. You tell yourself you are not an expert maker, and you go with the $80 one.

[…]

Now when you go to the shop, you have 3 options. You can spend $80, or $120 or $475. Rationally speaking, adding an irrelevant option should not change your decision between the $80 and the $120 ones. The pros and cons did not change; quality of the bread makers remained the same, and you are making the same salary. You know that you are never going to spend $475 on a break maker…

But the thing is, now you do would feel more comfortable buying the $120 one. After all, you are not buying the most expensive alternative. You have found the middle ground, and you are probably happier, compared to someone who buys the cheaper version with only two options.

This is a form of psychological anchoring that Saka describes is widely known as the irrelevant third option, or in business terms, the loss leader. It is a super-premium product that may not be profitable in its own right but makes the next option down seem more attractive.

This is the most famous use of the principle that the attractiveness of an option will change depending on what’s presented with it. But this is only one example of the effect one can have by introducing or removing options.

2. People evaluate price differences relative to the level of the initial price.

The scientific name for this is the Weber-Fechner Law, if you want to Google it.

You will tend to be more motivated if a $20 price is lowered to $10, than if a $120 price were lowered to $110. Again, there’s no good reason for this. The economic advantage to you is the same in both scenarios.

Ernst Weber was a 19th century scientists who discovered that the stronger a stimulus is, the more change you have to make to it before we can perceive the change. If you’re carrying three pounds of stuff and I add a pound, you will notice the change much more easily than if you’re carrying 30 lbs and I add one.

Fechner improved on this idea by figuring out the mathematical relationship between intensity and perceived change (it’s a simple logarithm, if you care).

The Weber-Fechner law is why you have a hard time paying $5.00 for a Starbucks Sugar-coma Mocha, but you have an easier time coming down $5,000 on the asking price for the house you’re selling. This is especially important when studying price elasticity – the variation in dollar amount that people are willing to pay for the same item.

3. Losses hurt more than gains give pleasure.

This is part of what’s called the Endowment Effect, for you Googlers. People tend to ascribe more value to that which they own. Therefore people try to avoid losses more than achieve gains. People want to avoid late fees more than they care to take advantage of early-bird discounts, even if the value is the same.

One working paper from a USM student described how this effect was studied on the “discount for cash” gasoline consumers in the 80’s.

It’s illegal to do so now, but it used to be that gas stations would charge you a special surcharge if you wanted to pay with a credit card (trying to recoup their extra processing fees). The credit card companies, fearing backlash insisted that any such price difference had to be termed a “cash discount” rather than a “credit surcharge.”

It turns out they were right to fear: those paying for gas by credit card had a significantly more negative reaction to the transaction if they “paid a surcharge” rather than simply missing out on a “discount.”

Further Research

Research is still young in this field, fleshing out the details of principles like these. The results are fascinating. For example, one working paper from the Harvard Business School found that it makes a big difference in preference depending on whether a price is “all-inclusive” or “partitioned.”

If you split out a price into line items, the way budget airlines are more prone to do, people will tend to prefer the deal if the secondary item is top-notch for the price (incredible in-flight service, full-service meal, etc), and oppose the deal if the secondary item is lackluster (one movie option, snackbox, etc.).

Why is this? because the secondary item is easier to evaluate compared to its price than the primary item (the plane trip itself). It’s easier to see if you’re getting a deal or not. So if your secondary items aren’t that high-quality for the money, all-inclusive is the way to go.

I’m excited to see what new principles we’ll be able to add to these three as research develops. If you have some to add (and can cite your source), please use the comments to let people know!

 

Understanding and Mastering Willpower

March 30, 2014 4 comments

Willpower, by Roy Baumeister and John Tierney

There is a growing community of psychologists and neurologists who are shedding new light on the concept of willpower. If you’re interested in the topic, a great place to start is a book by Dr. Roy Baumeister, a leader in this field, called Willpower: Rediscovering the Greatest Human Strength. Baumeister’s lab at Florida State specializes in the psychology of willpower. Other prominent scientists in this community have studied or commented on this phenomenon, including Daniel Kahneman, Baba Shiv, Sasha Fedorikhin, and Dan Ariely. It was recently popularized in a TED Talk by Dr. Kelly McGonigal.

Baumeister calls it a “rediscovery” because willpower is a concept that has been understood with varying degrees of accuracy through the years. Since ancient times, it was cursorily understood as a “power” unto itself; something to be harnessed and exercised. This is called the “energy model” of willpower. The energy model was incorporated by Freud into the “superego”.

The energy model fell out of fashion when Freud did, until very recently when psychologists started comparing notes with biologists. They noticed patterns in body rhythms and nutrition that corresponded with the psychological ability to self-regulate. It turns out that our ancient understanding of willpower as an energy unto itself was closer to the truth than we thought.

Willpower 101: How It Works

Here’s a synopsis of what scientists know so far: Read more…

Does Advertising Content Work? Let’s Find Out…

September 30, 2013 Leave a comment
English: Portrait of Milton Friedman

English: Portrait of Milton Friedman (Photo credit: Wikipedia)

One of the great advances in economics to emerge in recent decades is the field of behavioral economics. The preceding generation of economists, including Milton Friedman and others, believed that humans were entirely rational consumers. When they made a purchase decision, it was as a result of a neat mental weighing of opportunities costs verses actual costs and other factors.

Now we are starting to understand the enormous hubris of our own assumed rationality. First Kahneman and Tversky came along and pointed out that human cognition is effected by its own limitations, and that we are susceptible to errors in judgement based on these limitations. Dan Airely noted that human irrationality follows predictable patterns. Then Richard Thaler famously pronounced that you could effect (“nudge”) social and economic outcomes by changing decision contexts. This acceptance and exploration of human irrationality and cognitive bias is giving us a richer understanding of the way we work.

So, let’s see this effect in a true marketing context. Professors Marianne Bertrand (Chicago Booth) and Dean Karlan (Yale), together with their team, designed a field experiment in South Africa. They partnered with a cash loan lender to send direct mail advertisements to potential loan customers. The customers were offered rates selected at random, but that were more favorable than the current market. Some of the mailings only represented the interest rate. Other mailings (randomly) included any of a number of psychological manipulations (in other words, “marketing”). These manipulations included elements like competitive comparisons, promotional giveaways, suggested loan uses, pictures of demographically similar people on the mailer, deadlines and other suggestive priming.

No surprise: these psychological factors, when considered as a whole, had a significant effect on loan take-up. The demand increased by as much as a 25% reduction in the interest rate. This effect should not be possible under traditional economic thought.

There were a few interesting subtleties to the results. First, the psychologically-loaded marketing was generally more effective when the interest rate is high (i.e. the loan is more expensive). In other words, as consumers were influenced more by price, they were influenced less by psychological factors.

Also, there were no subgroups of customers who were more or less susceptible to psychological factors than any other. Many have hypothesized that psychological marketing has a greater effect on the less educated and less wealthy. This does not seem to be the case.

Much of new classical research was conducted a...

The University of Chicago, home to Professors Richard Thaler and Marianne Bertrand. (Photo credit: Wikipedia)

Finally, the psychologically-loaded marketing did not seem to attract a poorer class of borrowers. Normally to increase demand for loans one lowers the interest rate, but in so doing one risks attracting borrowers who are less likely to repay. Therefore there is a certain market equilibrium that exists regardless of the present interest rate. Psychologically-loaded marketing increased demand for loans without changing the risk profile of the borrowing pool. That is, it changed the equilibrium of the market on its own. This means that psychological marketing could be seen as its own competitive dimension, particularly in areas of low price sensitivity.

Quora Questions: Overcoming Procrastination

July 9, 2013 1 comment
English: Basal Ganglia and Related Structures ...

English: Basal Ganglia and Related Structures of the Brain (Photo credit: Wikipedia)

While trolling through Quora, I came across a question that I have asked myself over and over: “How do I get over my bad habit of procrastinating?”

The first answer to this question caught my eye. It was written by Oliver Emberton, who keeps a blog called Leading a Better Life. He gives us a readable and entertaining explanation of how different parts of the brain interact to either create or overcome procrastination.

Emberton creates two characters: Albert, a rational character representing the activity of the pre-frontal cortex, and Rex, a baby reptile who represents the musing of the more reptilian parts of our brain (the basal ganglia, located at the stem). While Albert is the only one capable of complex, rational thought, it is Rex who is, interestingly enough, in charge of the final decisions on everything we do. So while our decisions may be influenced by rational thought, we are not rational creatures; ultimately we make decisions based on associations and habits etched within the lower levels of our brain.

The story of these two characters draws from the intellectual playground of authors like Charles Duhigg (“The Power of Habit”), and academics such as Daniel Kahneman (“Thinking, Fast and Slow“), and Roy Baumeister who study willpower, decision mechanisms, and the evolution of the human brain.

I encourage you to read his answer for yourself, but I will say that Emberton keys in on an insightful metaphor: the basal ganglia (the baby reptile Rex) acts much like a small child would. I’m about to welcome my first child into the world, so his take seems interesting to me.

The Basal Ganglia, he argues, does not speak the language of rationality, it speaks the language of primal emotion: “Hunger. Fear. Love. Lust. Rex’s thoughts are primitive and without language.” So, this part of the brain – the part that ultimately drives action – cannot be reasoned with. It must be spoken to on an emotional rather than a logical level. Like a child, it must be bribed and cajoled. Habits must be set up with reward and punishment mechanisms.Discipline must be cultivated.

With all the advanced psychological and neuroscience research available today, it’s funny to me that the most intuitive way of dealing with the decision-oriented aspects of the brain is to regard them as you would a child. But the comparison seems to hold up.

Blink and You’ll Miss It: Intuitive Thought, Decision and Action

March 24, 2013 6 comments

David Brooks is a columnist for the New York Times, and (in my opinion) an acute social and political observer. He is not an academic, but is very well read in psychology and sociology. He wrote a book in 2011 called The Social Animal which deals in part with the role of subconscious mental processes in decision making. This is a fascinating area of emerging science, and not without controversy.

That same year, Brooks gave a talk in front of a panel at Harvard, and opened himself to criticism. I’m going to take that talk and discussion as a starting point. It’s not necessary to watch the whole session to follow the thesis, but I’m including it for reference.

As far as I can remember, there has always been a fascination about unconscious processes and intuitive thought. I remember self-help product commercials from the late eighties that would use the power of “subliminal communication” to speak directly to your unconscious mind. Fundamentally we all understand that the brain holds mysterious processes yielding incredible creative and intuitive results; everything from a poet’s sudden inspiration in the middle of the night to a second baseman’s flawless turn of a 6-4-3 double play.

For mainstream readers, this fascination culminated in Malcolm Gladwell‘s book Blink, which further detailed the seemingly limitless intelligence of intuitive thought. After closing that book, one is left with the sense that many problems would be solved by trusting our unconscious impulses at the expense of rational decision making. You can see how, for many, this could be an incredibly seductive thought.

Brooks shares this fascination with unconscious mental processes, although he makes finer distinctions. His interest in the subject came from his political observations, where he noticed that policymakers and economists tend to assume that humans are thoroughly rational actors, and legislate accordingly. His thesis is that we need to better understand and appreciate our unconscious mental processes, which seem also to be very intelligent and might add a context and richness missing from policy and cultural discussion.

The Social Animal (David Brooks book)

The Social Animal (David Brooks book) (Photo credit: Wikipedia)

He notes, for example, that humans tend to emphasize things that can be measured: test scores, income, performance indicators, etc. We therefore, he says, have a rich vocabulary for discussing the tangible. We are much worse at articulating that which is based on the intangible: emotional health, character aspects, biases, and other abstractions that are based in emotion or intuitive thought. He argues that our emotions (an intuitive process), far from acting against reason as the classicists thought, are part of our advanced mental apparatus for ascribing meaning and value, and therefore an integral part of rational decision making. We therefore lose a great deal when we marginalize the roles of emotion and intuition.

Brooks’ argument is interesting, and I would like to begin my commentary by sharing what I believe to be the best first principles of psychology. In a way, I am lucky that I haven’t been exploring the field for all that long, because we are typically most influenced by the thoughts that we absorb early on, and I had the great good fortune to start this blog right about the time that Daniel Kahneman published his excellent research retrospective Thinking, Fast and Slow. Read more…

The Anti-motivational Speech – A Top 10 List

December 10, 2012 5 comments

When I was 11 years old, I saw a speech by 80’s-era motivational speaker Joe Charbonneau. I thought it was the coolest thing ever, and from that day forward wanted to be a public speaker of some kind.

That star faded a little bit as I got older, and I could peek behind the curtain of the tropes and platitudes that seemed so brilliant at the time (no disrespect to the late Mr. Charbonneau). This kind of speaking is now (rightly) considered more self-parody than serious boost to personal development. I wish I could say that the genre is no longer taken seriously, but speakers like Tony Robbins are now giving mega-concerts to thousands of their faithful. There is, when you think about it, no substantive difference between Tony Robbins and Joel Osteen or Rick Warren. They deal in the trade of temporary ecstasy.

I was looking through YouTube for examples of good modern motivational speakers, just to see if there was anyone out there with some substance. The exercise was depressing. The field has not changed much from the 80’s; the most successful speakers are still blow-dried white guys talking about getting you to change your state of mind. Many are hired by their fellow blow-dried, white corporate managers who believe that their workforce is unmotivated because of some attitudinal flaw that only affects the middle class.

What’s worse, the content is mostly schlock. Many famous systems are based on Neuro-linguistic Programming, a controversial, unproven form of hypnosis. Recently, on an international flight, I saw a BBC documentary called  “Money” about the proliferation of wealth creation seminars in England. It was about how poor and middle-income people would pay thousands of pounds for materials about attitude transformation. They would be instructed to meditate in strange ways several times a day, visualizing themselves with tons of cash. It was sickening, like an Amway seminar had slept with a Baptist revival.

I still want to be a speaker, and after having listened to a lot of modern motivational speeches, I think I have a useful trial theme. I call it, “The Anti-motivational Speech: How To Motivate Yourself and Those Around You By No Longer Being a Fucking Idiot.” I think it’s really going to save the world. It turns out, even smart people get themselves into really stupid habits, and transform into idiots slowly over time. You might be behaving like a total idiot and not even know it! I have ten points so far that I’m thinking about including, and I invite you to submit suggestions if I’ve missed anything important. Read more…

Michael J. Muldoon, Teacher and Coach, 1948-2012

July 20, 2012 8 comments

Michael J. Muldoon

Anyone can talk a good game about emotional intelligence. But when they pass away, and the line for their wake goes out the door and around the building, it’s a sign that they knew a little something about the subject.

Mike Muldoon was a marketer, corporate leadership coach and one of my professors at Lake Forest Graduate School of Management. He died this past Saturday, aged 63. He was an insightful and demanding instructor, with an irrepressible sense of humor drier than the Mojave. He famously talked through a set of clenched teeth about the things that fashinated him. His students performed loving imitations of his mannerisms. He signed his emails with the tag line: “Don’t tell me the sky’s the limit when I know there are footprints on the moon.” Confidentially, I always thought it was a touch cheesy until now.

He talked about his family constantly, and I met them for the first time at the service. They instantly gave the impression of a warm, close-knit, church-going midwestern family. His son, a tall man with a strong presence, was just married the previous weekend. His daughters, both lovely people, were bearing the receiving line duties with poise. One of them is to be married in less than a month. They had the support of an endless host of friends, family, and well-wishers. Read more…