For a long time, economics was perceived as a pragmatic science, asserting that people are rational beings who approach each decision in a rational way – thinking about the benefits first. Thus, everything depends on how much a person already has, rather than what they actually want. Centuries of economic research were based on this model. Conventional economics dominated academia and market strategies since the late 18th century. However, a different economic perspective has surfaced in recent years, stating that most people make a decision first and assess its benefits after. This new concept presumes that most people are not as economically rational as once perceived.
To build a new economic theory based on the presumption that people make faulty decisions, is a difficult task. But it is possible and apparently, you can get a Nobel Prize for doing so.
Before starring in “The Big Short”, a film explaining the economic laws that lead to the Great Recession, Richard Thaler was a professor at the University of Chicago Booth School of Business and an advisor to former President Barack Obama. It was Thaler who received the Nobel Prize for exploring the idea of “behavioral economics”.
Before Thaler, economists used to perceive the decision making of consumers and the “consumer journey” as a rational, mathematically measurable process. Thaler came up with the concept known as the “dictatorship game” for economists. In this game, one player has to divide $20 with a random and anonymous rival in one of two ways: there is the option to take $18 out of $20 for yourself or to divide it equally – at $10 each. You would expect that a rational person without hesitation must take the $18 dollars. But during the initial experiments, 76% of students shared the money equally. On average, only about a third of the players behaved like a “rational person” and took as much money as possible.
Science in progress
Since the time of Adam Smith, classical economic theorists believed that daily human decision making was based strictly on rationality. Although we now know that this isn’t true, a long transition to the behavioral studies was yet to be made. The neoclassics were the first to step on the path of rethinking.
Take, for example, the concept of “expected utility” in the Neumann-Morgenstern theory: the buyer makes a choice in favor of goods that provide the most benefit. Neoclassics started rethinking the consumer journey at this point. This theory was accepted for about five years until 1953, when French economist Maurice Allais discovered that a person, being in a situation of risk and uncertainty, will try not to maximize the benefit but to achieve a sense of security. This phenomenon became known as the Allais paradox which also earned Maurice Allais a Nobel Prize.
The next landmark discovery was achieved through the work of Daniel Kahneman and Amos Tversky. They endeavored to compare the cognitive models of decision-making in psychological studies with the economic models of a rational person. Having found many inconsistencies, they crashed the postulates of neoclassical economic theory step-by-step. The pioneers of behavioral economics proved that our decisions do not obey the laws of ratio, but follow the laws of subjective social reality that each of us creates from our own experience. In 2002, Kahneman was awarded the Nobel Prize for these works (Tversky, unfortunately, did not live to see it).
On the brink of a new economic theory
The term neuromarketing was introduced in 2002 by the BrightHouse Institute, an Atlanta company that was the first to incorporate an MRI scan with marketing research. Roger Dooley’s blog (in this case – a much more valid source than Wikipedia) defines neuromarketing as a type of marketing research in which tools for neuroscience, like fMRI, EEG, etc., are used to attain a deeper understanding of consumer behavior. Google Scholar defines “neuromarketing” as a section of neurobiology responsible for decision making. Thus, for neurobiologists, it is a branch of science; for classic marketers – a type of research.
Neuromarketing has become extremely popular in the business world because the tools for analyzing neurobiological data and recording brain activity is now available at almost any research institution. Electroencephalography, eye movement registration and measuring galvanic skin response have become relatively cheap and applicable methods for testing marketing viability. The need for a deeper understanding of the motivations behind human decision making is constantly evolving. In fact, we can thank for Walkman players to the results of the neuromarketing research that showed, “consumers do not want to carry a tape recorder with them.”
The most significant examples of neuromarketing in Action
In many respects, a series of studies based around the “Coca-Cola vs. Pepsi” battle became the cornerstone for an entire marketing industry. At the end of the twentieth century, Coca-Cola retained the dominant market share, ahead of Pepsi. The blind tests (participants didn’t know which brand they had been drinking) showed that many consumers preferred Pepsi. However, when they knew the name of the drink before tasting it, the winner was usually Coca-Cola.
Similar tests were performed while scanning participants’ brain reactions using an MRI. The studies revealed that subjects who were likely to choose Coca-Cola over Pepsi subconsciously activated the hippocampus and dorsolateral prefrontal cortex – brain zones associated with brand memory and preferences. This effect was called “marketing-placebo”, proving that the strength of the brand itself can have a significant impact on its product perception. Tests demonstrated that evoking emotions from seeing the product may be even more important than its actual taste.
To better evaluate the strength of a brand, as well as to create an advertisement that would be emotional, memorable and involving, more than 200 new research labs began to conduct their own neuromarketing research between 2003 and 2010. One of the pioneers in this field was the NeuroFocus company, absorbed by Nielsen in 2010. The acquisition of a small lab by a marketing giant illustrated a strong demand for neuromarketing research among enterprise corporations. There was no doubt that neuromarketing studies had the potential to bear tangible benefits.
Since then, technologies for neuromarketing research have advanced by leaps and bounds. The client lists of neuromarketing companies were more or less made up of all the major players of the Fortune-500 list. Suddenly, leading research companies began to open their own neuromarketing offices. This led to the creation of the NeuroMarketing Science and Business Association, which unites more than 180 companies from all over the world. According to Transparency Market Research, the market for neuromarketing in 2016 was $960 million; by 2025, it is expected to grow to $2.2 billion.
The essence of the behavioral economics
Thaler explored behavioral economics working within a British research team that analyzed the habits of taxpayers and their decision making. During these studies he worked out several methods of dealing with “defaulters” – individuals who do not file declarations and do not pay taxes. He also discovered how to prevent economic “bubbles” that lead to economic crises and distortions (ideas that won him a cameo in the major motion picture “The Big Short”).
Within the framework of behavioral economics, Thaler attempted to answer the question of how to demonstrate consumer behavior in a more rational way. To do so, he used the typical example of an individual choosing to build up a pension fund or striving for other effective monetary goals. Thaler showed how character traits systematically influence individual decisions and market outcomes.
One of the most common examples of behavioral economics in action was a case study conducted with General Motors. A group of scientists were sent to a local GM location with the sole task of tuning up illumination for the workers. Productivity increased significantly and the experiment progressed. Later, the brightness of the lighting was reduced to even lower than the initial level. Surprisingly, productivity increased again. Finally, the light was adjusted back its original level and again, productivity skyrocketed.
This is the simplest example of behavioral economics at work. Why did productivity increase? Because of the change in attitude towards the workers. The researchers came, turning the lights on and off, tracking indicators and asking questions. The GM staff appreciated that somebody was paying attention to them, giving them reason to change.
The principles of neuromarketing
One of the most interesting lessons that neuromarketing has taught us is that a decision is formed deep inside your brain 7 seconds before your consciousness even realizes you’ve made it. Marketers are more or less ready for this and have tools for influencing consumer’s way of thinking in the long run. Here are a couple working examples that demonstrate the use of neuromarketing and Thaler’s research:
The fewer steps, the better. Say, you’re booking an airplane ticket. Suddenly a hint on the website pops up: hurry up and pay via credit card. But you could just as easily pay via cash or credit card at the airport, so why does the company advise you to pay by card right now? As a consumer, you shouldn’t get distracted from “the main thing” – transferring the funds.
Basic emotions always work: fear, desire, guilt. Especially fear and guilt. Consumers are instantly ready to write negative reviews if they do not like a service or product. But when they are satisfied, chances are there will be no positive feedback whatsoever. Is it the laziness? Turns out human brain is tuned to the negative outcomes more than to the positive ones. That is why the fear of loss often works better in advertising than the satisfaction of acquisition.
Booking.com makes excellent use of this principle. On almost every offer, they will show the message “we have only 1 room left”, or “10 people are currently viewing this offer”, or “80% of the numbers are already occupied”, etc. Suddenly, we don’t have time to lose $200.
The Campbell’s case from the book “Hacking Marketing” by Phil Barden. The Campbell’s Soup Company once decided to experiment with discounts to increase sales. Here’s what they got out of it:
Situation 1. Soup was sold with the announcement “Discount – 12%.” Sales amounted to 3.3 cans per buyer.
Situation 2. Soup was sold with the announcement “12% discount. Maximum of 4 cans per customer.”
Sales amounted to 3.5 cans per buyer.
Situation 3. “12% discount. A maximum of 12 cans per hand.”
Sales amounted to an average of 7 cans per customer.
Results: the number 12 served as an anchor and the effect of the deficit drew buyer’s attention to the offer.
Inverted depreciation of goods/services. Lots of price offers appear already with discounts. A discount drags a customer into an illusion of getting a “freebie” raising the chances of a purchase. Out of two posters, “$200 already with a discount” and “-50%, for just $200”, the second announcement gets more feedback. Although the price is the same, the implied depreciation wins the game.
Phil Barden gives another example of this effect. A car washing company decided to start a customer loyalty program. Drivers who had their cars washed for 8 times got the ninth wash for free. They made 2 types of discount-cards for the clients that needed to be filled:
- An 8-point card
- A card of ten points with two points checked in advance “at the expense of the company”.
Results: the second type of card was twice more effective. Two free points placed in advance engaged the customer in “the chase”: the cardholders took the filled out fields as the beginning of the quest where they had to check all eight points as fast as possible. This small and seemingly worthless change in card design had a significant impact on sales.
The principle of relativity is best shown for The Economist Case – the favorite case of every marketer in the world from Dan Ariely’s “Behavioral Economics. Why people behave irrationally and how to make money on this”. The Economist offered three types of subscriptions for its digital edition:
- Subscription to the digital edition for $59
- Subscription to the printed edition for $125
- Subscription to both printed and digital versions for $125
He gave these options to 100 students at the Sloan School of Management, they voted as follows:
- Subscription to the digital edition for 59 dollars – 16 students
- Subscription to the printed edition of the magazine for $125 – 0 students
- Subscription to printed and digital editions for $125 – 84 students
If the second option is removed (nobody voted for it at all), then that leaves the following types of subscriptions:
- Subscription to the online version of The Economist – $59
- Subscription to printed and digital editions – $125
The once-so-desired digital and printed edition this time was preferred by only 32 students out of 100.
This experiment illustrates the principle of relativity: people are predisposed to compare similar things to each other, deliberately ignoring the poorly matched features of the goods. On The Economist’s website the second option was a bait, prompting readers to choose a double subscription.
Next time you create marketing anchors, discounts, or subscription plans for your business, remember the principle of relativity and include a bait in the plan. Also don’t forget to make one of the options look like a gift, and tell your leads upfront that there’s only one left.
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