Heuristics, biases, and other things that go bump in the night – What should we do?

John Roberts

1

Paper presented to the Behavioural Insights in Business and Policy Roundtable,

University of New South Wales CBD Campus, Sydney, November 2016

An historical view of research in consumer response

Qualitative What is Psychologists

happening? Sociologists

Why? How? Anthropologists

Quantitative How much is Statisticians

happening? Economists

When? How much? Econometricians

The starting point

3

From Gigi

1. Economics has provided some

insights into the marketplace and

its social environment

2. However, there are many missing

pieces that we don’t quite

understand

3. Behavioural economics may

throw some insight on those

From Andreas

1. In applying behavioural economics

there are a number of potential

pitfalls:

• Mixed findings, spotty

performance, 2nd order effects

2. Therefore, we should be careful in

looking for, understanding, and

harnessing the insights from

behavioural economics

I would like to close with some thoughts about the where, when and how

Existence

We know that there are departures from “rationality”

• Framing risks choices as lives lost versus lives saved

(Tversky and Kanhnemann 1985)

• Price of a beer at the beach(Thaler 1985)

• Effectiveness of defaults

(Johnson & Goldstein 2003)

4

We know that these effects can be fleeting

• Iyengar and Lepper (2000)

Choosing between 6 and 24 varieties of jam

5

Is the famous

‘paradox of

choice’ a myth?BY BARRY SCHWARTZ January

29, 2014 at 12:43 PM EST

2. The influenced

and their responses

The environment and

its rules

1. The actors and

their actions

Measuring marketing effectiveness

The Marketing Mix

To make our actions effective, we need to understand three elements

Framework for understanding the locus of action

This provides us with three areas of focus:

How customers and other subjects behave (The marketplace place phenomena)

Dimensions of management action (Decisions managers take based on analysis)

The rules and context of the environment (Regulation and market characteristics)

So where does behavioural economics come in?

“Behavioural economics is the study of where our representations of consumer evaluation and decision making departs from the phenomena we observe in the marketplace.”

• Consumer departures from those that our axiomatic representations of choice would predict are not always usefully described as “irrational.”

• Some choices may just be due to omitted variables (e.g., Shugan JCR 1980 “The cost of thinking”) while others may lead to inconsistent choices.

• For public policy purposes we need to be very careful in defining what is in the consumer’s interests.

7

Economic models of consumer behaviourThe workhorses of marketing science

• Utility (e.g., Lancaster 1966)

A product’s utility is constituted by the value of its component attributes

• Choice (e.g., McFadden 1974)

The probability of an option being selected is a function of

its utility

• Budget allocation (e.g., Thaler 1985)

8

Improving our representations of consumer evaluation and choice processes

Separability Biases, recency and priors

Kayande et al. (Mkt Sc 2007) Chylinski, Roberts and Hardie (Mkt Sc 2013)

Consideration Emotions with cognitions

Roberts and Lattin (JMR 1991) Roberts et al. (Mkt Sc 2015)9http://www.youtube.com/watch?v=yPAfA84A290

http://www.youtube.com/watch?v=sJzRS_LfalU

Classifying departures from “rationality”

• Heuristics and biases (Tversky and Kahneman 1975)– Representativeness, availability and anchoring

• Framing– Defaults (Johnson and Goldstein Science 2003) – Losses and gains (Armstrong et al. 2002)

• Estimation errors and bounded rationality– Intertemporal discount rates (Loewenstein and Prelac QJE 1992)– Inconsistent treatment of uncertainty– Prospect Theory (Kahneman and Tversky 1979)

• Other criteria, aggregation rules– Mental accounting (Thaler Mkt Sc 1993)Fairness: https://www.youtube.com/watch?v=3XXQMDGErL0

10

When our simple models break down

• When consumers have little familiarity with the task

– High technology

– House purchase

• When consumers have incomplete information

– New product purchase

– Credence products (e.g., doctors, wine merchants)

• When consumers have non-comparable options

– Lack of attribute alignability (Johnson JCR 1984)

11

Implications of a failure of consumer heuristics % % Inert

Inept Not enough No Real % Non

Unacceptable Information Need Consider

Crunchy Nut

Flakes

36.0 10.0 21.0 67.0

Fruit Loops 78.5 1.5 2.5 82.5

Frosties 76.0 1.5 10.0 87.5

Kelloggs

Corn Flakes

6.0 1.5 12.5 20.0

Komplete

Muesli

8.5 26.5 19.0 54.0

Nutrigrain 16.5 2.5 6.0 35.0

Ready

Wheats

22.0 29.0 19.0 70.0

Skippy Corn

Flakes

12.0 4.0 41.5 57.5

Sultana Bran 3.5 2.5 35.0 41.0

Brands in the Australian Ready to Eat Cereal Market

Weetbix takes on Nutrigrain

13

Decisions marketing managers make

• What managers do: The marketing mix– Product: Design features (anxiety and regret)

– Price: “9” endings as a signal of bargains

– Promotion: Choosing a battleground

– Place: Healthy food at eye level

• To whom managers do it: Customer management– Acquisition: Moments of truth (Sainsbury and Safeway)

– Retention: Customer recovery strategies

– Account maximization: Avoiding “bad profits”

14

Implications for action: Managers

• Understand (and manage) the benchmarks (anchors) against which your products will be judged. (e.g., Prada stores do not have high sales.)

• Provide context so that consumer inferencing will work in your favour (Avis “We try harder.)

• Turn high involvement decisions to low involvement decisions (e.g., automatic payments)

15

Decisions regulators make

• What is misleading and deceptive conduct?– Incorrect claims (“Australians prefer Visa”: True?)

– Inappropriate inferences (Malboro Mild, Low tar)

– The reasonable man

– Heterogeneity: The old and the young

• Fair and open markets– Deceptive barriers to entry

– Maximizing and crimping capture of consumer surplus

– Information transparency; availability and distribution

16

Implications for action: Regulators• Understand where consumers are likely to be

misled (e.g., Bunnings “Where lowest prices are just the beginning. Find a lower price on a stocked item and we will beat it by 10%.”)

• Understand consumer inference processes (for example, low fat low calorie in consumer’s mind; energy is good but calories are bad.)

• Look for sources of heterogeneity

17

Discussion questions

To be able to harness the ideas of behavioural economics we need to be able to answer the following questions:

1. What are the different types of departure from homo economicus that offer threats and opportunities?

2. When would we expect these departures to be present and to be important?

3. How do we establish the limits, boundaries, domains of these phenomena (external validity)?

4. Given the insights from observing heuristics and biases, what are the actions that the consumer, the decision maker, and the regulator can take to further their objectives?

18