Tuesday, July 26, 2011

Will the carbon tax change business behaviour?

Thank you to those who emailed me about how the Australian Federal Government's proposed carbon tax would be viewed by behavioural economics. Political views aside, here's the run down;

Is a tax on emitters better than an incentive to drive behavioural change?
Absolutely.  We are more driven to avoid pain than seek gain, so in this case an incentive such as a rebate for organisations who reduce emissions (gain) would be less likely to change behaviour than the introduction of a penalty (pain).  The behavioural principle at play is loss aversion, where we are motivated to avoid a situation where we lose something.  The government is hoping to stimulate the large emitters to change their behaviour because otherwise those businesses will face significant cost.   As a more personal example, think of the following. Would you be more likely to join up to health insurance if you were paid an incentive of $400 to do so, or were taxed $400 if you did not? The proof is in the fact that in Australia we have compulsory health insurance because too few of us were taking proactive action to insure our health.

If the tax is simply passed on to consumers, is it really changing emitter behaviour?
Yes.  Whilst many businesses may adjust their pricing to pass on the cost of the carbon tax, we are all motivated by margin.  Just as with any tax, businesses will be motivated to reduce the amount payable because that helps the bottom line.   Again, it is loss aversion that motivates businesses to take steps to eliminate costs, and now emissions are part of that equation.

Can the carbon tax be used to charge higher prices?
Invariably the tax will be used to adjust pricing, and consumers will expect that. But here is the opportunity for you; by resetting expectations and having a publicly justifiable reason to change, new price levels will be anchored in the market.  Think back to when petrol was under $1 per litre.  Whilst  that now seems like a dream, as consumers we have had our expectations reframed and have been able to adapt to the new pricing levels. What about bananas? With supply of bananas contracting after Cyclone Yasi and the Queensland Floods, prices have skyrocketed ($13/kg in Melbourne). Whilst not everyone can afford to buy bananas now, once supply returns you can be sure that the normal average cost per kilo will be higher than it was before expectations were anchored at the higher price.

A side note on price anchoring. The federal Opposition and the Greens both played a role in helping the Government gain psychological acceptance of the carbon price of $23 per tonne. How? The Greens had asked for a $40/tonne price and the Opposition had jumped on Treasury modelling at $30/tonne.  This meant that by the time $23/tonne was determined, it hardly raised a whimper.

So in sum, the carbon tax will change the behaviour of businesses, but so too would any new impost.  No surprise that it will force businesses to look for new ways to reduce cost and improve margin, but it just so happens that this may help the planet in the process.

As always, let me know if you have an issue on which you would like a behavioural economics perspective. Email peoplepatterns@gmail.com or tweet @peoplepatterns. Until next time, happy taxing.

This post also appeared in http://www.smartcompany.com.au/blogs/20110726-will-the-carbon-tax-change-business-behaviour.html

Saturday, July 23, 2011

Are you the next News of the World?

We are all susceptible to what has happened at News of the World, a UK newspaper that has been shut down on the back of alleged phone tapping.  We are susceptible because each of us is faced with moral, ethical and legal challenges through the course of our work lives, and these challenges are often so iterative, so imperceptible that little by little, the line falls behind us and we may not even realise.  Behavioural economics can help us understand a couple of the forces at play so that we can better withstand these challenges to our personal and professional integrity.
We tend to follow decisions we have made before because it is more efficient, so that if a situation arises that is similar to one we have previously encountered, we default to the road travelled.  The first time a compromised action is taken, it may have been discussed, agonized over and been made reluctantly. But we don’t cope well with cognitive dissonance – trying to hold conflicting views simultaneously – and we are therefore very good at justifying to ourselves the actions we’ve taken.  The seal has been broken and from this point on, we tend to follow our decisions again and again.  Aside from never crossing the line, what can you do to stop the self-herding cycle?  Two things.
First, you need a circuit breaker and this will often come from outside the work culture in which you are operating (after all, that’s where the behavior began).  A mentor, friend, confidante will help you by giving you fresh perspective on your situation and your options, one of which may very well being changing your employment circumstance. 
And second, take yourself back to the first time you made the decision. What were your choices and how do they compare to subsequent decisions?  We can easily fall into the trap of thinking situations are the same because we have a tendency to apply unconscious short-cuts and rules of thumb to fast track decision making, so by forcing our decision-making back to conscious deliberation we can interrupt self-herding.  
As for cognitive dissonance, recognise why you made the first decision and why it made you uncomfortable. Use the sick feeling in your stomach as mental fortitude to not take the action again.
Whereas self-herding tackles our propensity to replicate decisions we have taken, herding is about following the actions/decisions/values of others.  This is where the culture of an organisation can become absolutely toxic if morally ambiguous behavior is tolerated (let alone encouraged) within a business because more and more staff will be swayed to act in the same way.
What can you do if you want to change a toxic culture?  Get up to speed with the principles of change management. Chip and Dan Heath have written an excellent book, “Switch: How to Change When Change is Hard” which covers the need to appeal to both conscious and unconscious motivations within people to encourage change.  Outlining the penalties of inappropriate behavior (such as phone tapping) in a policy document, may appeal to the rational mind, but not prevent the behavior if it is otherwise condoned. When employees see for example that dubiously sourced articles are published, or that commission is paid on sales made in breach of policy, then those behaviours will continue and spread through the organisation.  The herd is a very powerful force to harness – your challenge is to ensure that the herd is pointing in the right direction for your business objectives.
Always remember that organisations do not cross the line, people do. Therefore understanding two key influencers of behaviour – our own prior decisions and those of the herd – is central to operating ethically, legally and morally, and ensuring we don’t become the latest news of the world.   
As always, if you have a business issue for which you would like a behavioural economics perspective, drop me an email at peoplepatterns@gmail.com. Until next week, happy herding.

Tuesday, July 19, 2011

Tour De France or World Cup; what type of organisation is yours?

Two big sporting events have been underway this week, the Tour De France and the Women's World Cup football, and they've got me thinking about a couple of different organisational cultures I have encountered. So here's something to ponder; is your organisation more like the Tour De France or World Cup football?

 A Tour De France type organisation is structured around the individual who will ultimately deliver the result, most usually, the sales consultant.  Just like the Tour, the individual can only succeed with the help of both the peloton (marketing, product and other in field functions) and the support crew (finance, HR, production, IT).  Whilst the pressure rests on the shoulders of the lead rider, it is the team members who shape their activities around the performance of the lead rider, varying their pace and protecting their man from competitor activity. Team strategy is devised around the lead rider's performance at every stage and all team members subordinate their individual aspirations of glory to the greater good. History records the individual as the winner, and the individual is in this sense, bigger than the team.

A World Cup football type organisation on the other hand, celebrates and records success as a collective. It is the team that is bigger than the individual.  Whilst players have specialist roles (sales, marketing, product), and off field support is essential (finance, HR, IT) and star performers invariably emerge, the team can only succeed if the ball is won by defence and goals kicked by those forward.  History records the team rather than an individual as the victor and the spoils are shared.

So which is the better type of organisation? Does it depend on the type of business you are in? And when should the individual be bigger than the team?  I'd love to hear your thoughts so drop a comment (lycra jokes most welcome).

Monday, July 11, 2011

Firing a customer, what holds us back?

Having recently devoured Timothy Ferriss' "The 4-Hour Work Week", I have been contemplating one of the suggestions he makes for optimising your time; firing some customers.  Comes as a bit of a jolt, doesn't it?  Most of us spend our time and energy on attracting new customers and serving existing, so deliberately getting rid of a customer seems so...crazy.

The central tenet of Ferriss' book is that you need to place a value on your time, and knowing which customers are your most profitable and create the biggest return for your time is a big part of managing your business.  In Ferriss' case, "out of more than 120 wholesale customers, a mere 5 were bringing in 95% of the revenue.  I was`spending 98% of my time chasing the remainder...". So Ferris fired 2% of his customers.

Let's take a minute then to consider how two principles of Behavioural Economics can help us understand why we hold on to unnecessary customers, and how to change things.

Sunk cost
Knowing what it takes to get a customer means we are loathe to walk away once we have them.  It's a bit like those shoes you hunted everywhere for.  Oh the joy when you brought them home! But then upon first wearing they sent stabbing pain up your shins and you haven't worn them since. So have you thrown them out? No, chances are they are still in your closet, mocking you. You cannot bring yourself to bin them because you invested so much time, effort and expense in getting them. Sunk cost applies as readily to shoes as it does customers.  If you have customers who are more pain than they are worth, fire them.

Loss aversion
We are driven to avoid loss even more than we are to seek gain.  "A bird in the hand is worth two in the bush" comes to mind.  We often put up with customers that we should not because of two common reasons;
  • we are terrified we will never replace them.  And, guess what? If you continue to invest your time and resources in unprofitable customers, you won't have those resources available to source new customers.  To reduce your loss aversion, do some number crunching. Add up all the hours and stress that your painful customers create, multiply it by your hourly rate and compare it to the revenue those customers generate for you.  Now contrast that with the hours, stress and revenue generated by your top customers. Feeling less scared of ditching the bad apples?
  • we are terrified that our competitors will grab them. We are scared that if we fire a customer, then our competitor will move in and all of a sudden, ruin our market share.  It's possible.  But remember why you wanted to rid yourself of these customers in the first place - they were not making you enough money for the effort involved.  Let your competitors wear the albatross around their neck, bogged down with customers who are overly demanding and unrelenting whilst you swoop in on the profitable targets.
And for those who work in a small market where there are not many customers, and loss of one will dramatically impact your business, here's the tip. You still need to understand your return on investment from these customers. If you do not want to go as far as firing them, look to changing the service mix (from face to face to telesales for example, or weekly to quarterly visits), and establish new rules of engagement.  Consider criteria for which you offer premium-end service, and let them know what they need to do to qualify. They then have the opportunity to either improve their behaviour and spend or be satisfied with a less-resource intensive resource model from your end.

As always, let me know if you have a business issue for which you would like a Behavioural Economics perspective by emailing peoplepatterns@gmail.com. Until next week, happy firing.

This article also appeared in Smartcompany magazine.
Image from: http://cdn.thegloss.com/files/2011/02/fired.jpg

Tuesday, July 5, 2011

Three price rise tips from Behavioural Economics

The Australian financial year has clicked over to FY2011/12, and with it no doubt some tweaks to the profit and loss.  Your opportunity now is to use Behavioural Economics to rethink one of the most common activities associated with this time of year; introducing a price rise.
Whilst common place, introducing a price rise doesn’t necessarily mean it will be well received. Three behavioural principles of which you should be mindful;
1.       Relativity – we judge one thing relative to another, so in this case your pricing will be compared with inflation, competitor prices and value.  How do you stack up? The best course of action is undoubtedly to increase the value at the same time you increase your price, but let’s be honest, sometimes you just want a healthier profit line. Here you will need to do some homework. With what can you compare your pricing favourably?  Guide the relativity judgement by providing cues (eg last year’s rise, overpriced competitors, allied industries etc) otherwise your customers will do it by themselves.
2.       Adaptation – if it’s bad news, get it over quickly. The principle of adaptation has proven that we adapt more readily to news if we are not constantly reminded of it. “Quick like a band aid” springs to mind.  For a price rise, communicate it as you need (ie appropriate and legal disclosure) but don’t keep reminding your customers!  Even if you are increasing the price in increments (eg every quarter), communicate at the first rise, not every time. 
3.       Status Quo Bias – This is one to help you feel better about your decision!  We have a strong status quo bias, tending to stick with what we know.  Still scared that your price rise will result in customer attrition?   Sure, it may happen. But take heart from banks. Remember when one of the big banks raised interest rates above the RBA’s cash rate increase?  Outrage followed by mass exit? Well, no.  Same goes every time the health insurers raise their fees. Of course, exit fees and other penalties for changing provider may have helped, but what is really at play is inertia. Oftentimes we just can’t be bothered taking our business elsewhere.
Have a business issue on which you would like a Behavioural Economics perspective?  Let me know by emailing peoplepatterns@gmail.com.  Until next week, happy pricing.

This article originally appeared in Smartcompany for whom I am contributing articles on how Behavioural Economics can be applied to common business issues.

Friday, July 1, 2011

Why the chicken crossed the road? The Behavioural Economist knows

You might have read a bit about “Behavioural Economics” on this blog and around the traps and wondered whether it is worth knowing more.  The answer is yes.  And to make it come to life, let's use the age old question "why did the chicken cross the road?" to illustrate how Behavioural Economics can help us understand why customers do what they do.  The story goes a little like this… 

Development of a highway was being delayed by protesters who were demanding protection of a known avian crossing point.  That’s right, a section of road where chickens crossed from one paddock to another.
 To move things along, three firms were contracted by the road construction firm Total Tarmac* to shed light on why the chickens crossed the road.  If they could stop the crossing without negatively affecting the chickens, they could expand the highway.

Firm 1 Qualitative Researchers R Us
The first firm specialised in qualitative research.

“It’s simple; we’ll run some focus groups with a sample of the chickens and have the chickens do homework before they come along. The chickens will take photos of each stage of their trip and describe their feelings in a journal”.

The focus group was a resounding success, with high energy and lots of eager participation (a sample transcript is available in a separate blog "Chicken talk")  The research firm presented its conclusions to Total Tarmac.

“Total Tarmac, the reason the chickens cross the road is multifaceted. For some chickens, they are motivated by self development. For others, it is a functional experience. It would be our recommendation to run some quantitative analysis on the willingness of chickens to cross the road made of marble, which was brainstormed as a preferred road surface.”

Firm 2 Economists for You
The second firm was a group of economists.
“It’s simple; we’ll build a model that compares the economic benefit of paddock one to paddock two. Chickens, seeking to maximise their economic return, will cross the road to the paddock with greatest value. Ergo by eliminating value of paddock two whilst inversely increasing the value of paddock one, the chickens will of course stay where they maximise their benefit”

The firm went away and developed its model, presenting their findings to Total Tarmac with a dazzling array of charts, propensity models and road crossing projections.
“Total Tarmac, the reason the chickens cross the road is clear. Paddock two (the side to which they migrate) is 20% more abundant with feed and contains 30% more water.  Therefore, maintaining optimal value conditions will stimulate chicken crossing.  On the other hand, reducing value conditions will reduce chicken propensity to cross the road.”

Firm 3 Behavioural Actions Now
The third firm comprised a group of behavioural economists.
“It’s simple; we are not interested in 'why' the chickens cross the road. We are interested in the fact that they do, and in what can influence this behaviour according to your objectives. If you want to prevent chickens from crossing the road, what can inhibit the road-crossing behaviour?

The behavioural economists set up a number of experimental conditions and tested what the chickens did.  The outcomes of these tests were explained to the client.

“Total Tarmac, chickens cross the road until they stop crossing the road.  There are many ways you can change their behaviour, but we must first understand that the chickens themselves may not even know why they cross the road.  If asked, the chickens can proffer a rationalised explanation (more feed, I was bored, change of scenery, I prefer marble), but this won’t help you change their behaviour. To change their behaviour, know that behaviour is not always rational and that we are subject to deeply ingrained biases of which we are not even aware.  To know what will change their behaviour, we ran a battery (poor choice of words) of behavioural tests with the chickens.   We found the following;

Herd behaviour: Chickens flock and in experimental condition A, when the leaders crossed the road, the other chickens followed. To prevent this, influence the leaders to stay in Paddock One.

Heuristic: The chickens have over the years developed a rule of thumb. After two days of heavy rain, they cross to the other Paddock to seek shelter.  Paddock One becomes too soggy. In experimental condition C, shelter and additional drainage was provided in Paddock One which stopped the chickens from crossing the road.

Status quo bias:  In experimental condition D we improved conditions in Paddock One, making it too comfortable to leave.  This stopped the chickens from crossing to the other side because their natural state is status quo.

Confirmation bias: Every time the chickens cross the road, they are met with abundant feed and water. Once it runs out, they cross back to the other paddock, being rewarded once more with abundant feed and water. To prevent crossings, in experimental condition E we removed feed and water from Paddock Two so that the benefit of crossing was not confirmed. The chickens crossed the road twice to Paddock Two looking for the feed, after which they ceased trying.

Loss aversion: When it became apparent to the chickens in experimental condition E that they could not rely on food and water in Paddock Two but could in Paddock One, the chickens in experimental condition E became loss averse. They did not cross the road because to do so would risk what they had.

Adaptation: Experimental Condition F proved that chickens adapted faster to not crossing the road if they are not reminded of the change. Once conditions are improved in Paddock One and the chickens are properly advised of the benefits, do not keep talking to them about how they used to cross the road. 

The behavioural economists went on to explain how anchoring and framing, sunk cost and other behavioural principles were evidenced through their experiments and how Total Tarmac could modify and influence chicken behaviour in small but meaningful ways.

And the winner is...
The team at Total Tarmac listened intently to all three presentations. The qualitative researchers who suggested further quantitative research on marble roads; the economists who suggested reducing the value of Paddock Two to remove the economic benefit, and the behavioural economists who provided insights into the behaviour of chickens and clear actions to take to modify chicken crossings.

If you were Total Tarmac, which approach best met your business requirements?

The power of Behavioural Economics
Behavioural Economics is a powerful methodology to get to answers for your business and the beauty of it is that you can make positive changes to every aspect of how you run your business without massive investment or reengineering. It is about tweaking existing touch points you have with humans (not chickens) like staff, customers, suppliers and stakeholders.  The other great news? There are resources widely available to understand more - you don't even have to run experimental conditions to make a difference.  To find out more about Behavioural Economics, you can;
In the meantime, let me know if you have a particular business issue on which you would like a Behavioural Economics perspective.  Simply email peoplepatterns@gmail.com.

* This is a fictitious case study and any similarity to a real business or chicken is purely coincidental.

"Chicken talk"; an extract from a Qualitative Research session

The following is an extract from the focus group session conducted by Qualitative Researchers R Us* who had been commissioned by Total Tarmac to understand why the chickens crossed the road

The focus group was a resounding success, with high energy and lots of eager participation. 

Facilitator: “Chickens, I want us to consider the question, why do you cross the road? There are no right or wrong answers, we are simply interested in your experience and thoughts. Chicken 1, why do you cross the road?” 
Chicken 1: Well, I’ve always wanted to cross the road since I was a chick.  So I said to myself, today’s the day!  You can do it! I was a bit scared at first, but I knew it was important to my family.
Facilitator: “OK, thanks Chicken 1. Chicken 2, why do you cross the road?”
Chicken 2: “Goodness, I’ve never really thought about why I cross the road.  Umm, I guess because I see other chickens doing it?  No, no, now that I think about it, I cross the road because there is greener grass on the other side. Yes, that’s why.”
Facilitator: “I see. Thanks Chicken 2. Chicken 3, why do you cross the road?”
Chicken 3: "I didn’t cross the road. I don’t like bitumen. I would if the road was made of marble. I like marble. Can the road be made of marble?"
Chicken 1: "Yes, I like that idea. Can the road be made of marble?"
Facilitator: "Thanks for that suggestion. Let me put that up on our brainstorming page!"

The research firm presented its conclusions to Total Tarmac.
“Total Tarmac, the reason the chickens cross the road is multifaceted. For some chickens, they are motivated by self development. For others, it is a functional experience. It would be our recommendation to run some quantitative analysis on the willingness of chickens to cross the road made of marble.”

To find out more, return to the post "Why the Chicken Crossed the Road: The Behavioural Economist knows" on this blog site.

*All businesses and chickens are fictitious and any resemblance is purely coincidental.