The Behavioural Economics of Melbourne Cup Day

You have spent hours hunting for the right frock, shoes, bag and hat. You've been primped, plucked and spray tanned, waxed and blow dried.  You have dieted, exercised and cleansed. You've been up since the early hours, battled traffic snarls and endless queues. And now here you are.  Standing in the car park which has been claimed by heels rather than wheels, crammed in amongst sweaty strangers, sipping sour bubbles and nibbling soggy sandwiches. Ahhh, Melbourne Cup Day...proof irrefutable that we are not entirely rational beings.

In celebration of the famous Melbourne Cup, let's take a sneaky peek at the behavioural economics at play.

Overconfidence bias: 
We can be too confident in our abilities which leads to risk taking.
"I've studied the form and of course I know more than the Bookies."  

Illusion of control: We think we can control events that we can't.
"My horse always/never wins."

Actor-observer bias: 
We attribute our own positive behaviour to our character, and the behaviour of others to the situation.
"When I get drunk it's the mix of wine and bubbles that did it; when you get drunk it's because you drank too much!" or "When I win it's because I am super talented in selecting winners; when you win it's luck."

Endowment effect: 
Don't get too excited guys, endowment is about us overvaluing what we own.
"Sure I randomly drew that horse out of the hat, but it's mine and you can't have it."

Restraint bias: 
We underestimate our ability to avoid temptation.
"It's ok, I'll only have a couple of drinks."  

Remembering self: 
Our memories of an experience rather than the experience itself is what persuades us.
I remember the fun of previous Cup days rather than the reality of sore feet, sun burn and expense.

Mental accounting: 
Money is allocated to different 'mental' bank accounts.
I paid for my outfit out of a different 'mental account' than my power bill. Any money I win will be 'free' money to be used on fun stuff.

Focusing illusion:
Whatever we focus on has more importance at that moment than any other time.
"What, there's a race after the Cup??"

Clustering illusion:
We see patterns where none exist.
"The jockey is wearing my lucky colours."

Hindsight bias:
We knew it all along.
"I knew it was going to win!  I just didn't get around to placing a bet."

Sunk cost fallacy:
Once resources have been invested, we find it hard to walk away.
"I better just finish this last drink. Can't let it go to waste" or "Of course I'll wear that fascinator again!"

Sounds like fun doesn't it?  And one for the road, 

Hedonic framing:
Separate, smaller gains over a stretch of time are more pleasurable than one large win of equal value, but smaller separate losses hurt more than a once off.  In other words, the more times we are interrupted by good or bad news, the better/worse it is.
"This is the best day of my life!" or...

No. Don't worry. Your horse always wins.  Have a good one.

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Image from http://www.rgbstock.com/images/horses/2

Loading the dice in the game of business

Last week, together with around 100 others I rolled the dice as part of Leverage: The Game of Business, a facilitated business fundamentals board game.  Yes, a board game.  I'd never heard of this product before, and it struck me as a novel way of educating small business operators about key concepts like conversion, average sales value, turnover and margin as well as expanding thinking about what strategies are possible.

Game time
Tables of 5-6 people sat around a board game that resembled many others in that we moved our pieces in a clockwise direction according to our roll of the dice.  When we passed the square called "Profit" we collected money from the bank, and our objective was to invest in business strategies that would increase this amount.  Our other objective was to invest in business leverage strategies that enabled the business to function without our involvement, such as developing a recruitment strategy to ensure attraction and retention of talent and securing a robust and accurate bank transfer system to optimise cash flow.


Yours to own
Each player was randomly given a business to run, for instance mine was a menswear retailer, another was an engineering firm.  This is a great idea because it taps into what is know as the "endowment effect" - in other words, we try harder if we feel we are invested in something.  Sure, they could make this more effective by getting each player to write a slogan or choose their business rather than having it assigned, but it is much better than not characterising what you were playing for.

By the way, if you've ever been frustrated that no one, staff included, is as passionate about your business as you are, get over it.  You can't expect others to feel like you do unless they have been deeply involved in developing the character of the business and feel they have skin in the game.

Distorted reality

The game's chief objective is to educate business people about key business concepts, getting used to the language and mathematics involved, so my next point might be a little harsh.  A shortcoming of the game is that is predicated in the positive, so every strategy - from an advertising catalogue to product line extension - resulted in either an increase (1-10% gains), or at worst, status quo.  You couldn't fail.  

This is far removed from the reality faced by every business owner, where it’s our fear of what we stand to lose that holds us back.  Where does this fear come from? Uncertainty about what our customers, our suppliers and our staff will do in response to our decisions. Yes, I can run a campaign to existing customers to grow sales but what if I stuff it up and annoy them so much they churn?  What if I raise my prices and my customers turn to my cheaper competitor?  How do I find the time to document every system and process when my major concern is keeping the lights on?

Behavioural strategy to load the dice

Running a business is undeniably challenging, and like the board game illustrated, you have to keep dozens of plates spinning in the air.  The good news is that by using behavioural science in your business, you can reduce your uncertainty about what people will do in response to your choice, increasing your odds of success no matter what you do. In a way, you can make your life more like the game's distorted reality.  Every choice you make - an ad campaign, recruitment strategy, customer service policy, pricing decision - can be tweaked in your favour simply by using behavioural economics. Time you loaded the dice in your favour?

More information about Leverage: The Game of Business is available http://www.actioncoach.com/games


PS Why not join the People Patterns mailing list?  Every month you'll receive a short wrap-up of top news from the behavioural sciences and other nuggets of goodness from me. Click here to sign-up.

Lessons in behavioural economics from a small business owner

"Find your happy place" is what my photographer kept telling me as he snapped away for my website head shots. Well, I want you to find a happy place too by learning about how my photographer Con intuitively used behavioural economics to persuade me to buy his services.


1. Present services as clustered packages
Con offers three packages for professionals, Start-Up, Professional and Entrepreneur.  By packaging up the options Con was doing a couple of things.  First, he was creating a perceived value gap between them to support the price ladder, and second he was reducing the complexity of the decision. Contrast this with a longwinded and overwhelming conversation where the customer has to define their requirements such as number of shots and intended use - packaging options is a much smarter play. 


2. Include special offer pricing

Con uses anchoring in his package pricing.  Anchoring is where we fixate on the pricing information first presented, and then judge other prices in relation to that.  Every business can and should use anchoring to help their customers contextualise value. In fact as the price tag image showcases, retailers use this technique all the time to make the sale price seem like great value compared with the Recommended Retail Price (RRP).


In this case, the most expensive package was presented first on the page to anchor me with the other two below, helping to persuade me that they were reasonable.  


Then, under each package was quoted the "Regular Price" followed on the next line by a "Special Offer" price in larger font.  As an added bonus the amount saved also specified.   Now not only was I anchored to differences between packages, I was primed to work out how to qualify for the significant savings.  By this stage, I had mentally accounted for the Special Offer price, triggering my behavioural intent to avoid paying full price before even knowing how to qualify for the discount.


Whatever you do with your pricing, do not underestimate the power of the pain your customers will feel by missing out on the discount.  Intellectually I know that the RRP and the 'amount saved' is a fabrication, but that doesn't mean it does not persuade me.  


3. Use payment terms to your advantage
The Special Offer price was related to the payment options. The first option was to pay 50% on booking with the balance on the day. The second option and "by far the most popular" according to the collateral was to qualify for the special offer by paying 100% upfront at the time of booking.  Cash flow is king for small businesses, so locking in payment ahead of the work is a great strategy.  Note the "most popular" is a clever way of using social norming to influence adherence to Con's preferred option.


4. Up sell once the cost is sunk
Having elected for the most frugal package before the shoot, I was then caught when the number of photos I liked exceeded my allocation.  No problem, I could pay extra on the day.  This is a great way for businesses to drive some extra revenue for two reasons. One, I had already worn the cost of the initial outlay so it was a 'sunk' cost, and two, I had by that stage engaged in the process and so it was harder to walk away. Known as the 'endowment effect', we find it harder to let something go when we've had a hand in creating it.


So there you go. As a small business operator Con was effectively using behavioural principles such as anchoring, social norming, loss aversion, endowment effect and choice architecture to guide buying behaviour.  Con's found his happy place, so you can too.  


PS Why not join the People Patterns mailing list?  Every month you'll receive a short wrap-up of top news from the behavioural sciences and other nuggets of goodness from me. Click here to sign-up.

It's not me it's you: Dropping a customer who doesn't spend enough

We've all been there. That customer who soaks up an inordinate amount of time and energy without spending enough for you to justify the level of resourcing.  And now it's crunch time - how should you move a customer who had face to face sales representation to a less frequent cycle and/or telesales account management without losing their business?  Here are some pointers from behavioural economics to change your service mix.

You don't know what you've got till it's gone...aka "Endowment effect"
You can be sure that the customer took face to face (F2F) representation for granted when they had it - but now that it might be taken away it's seen as a catastrophe. Endowment effect is our tendency to overvalue what we own - in your customer's case, they "own" the level of service they have been used to.

Tell them they can have F2F representation again...but they need to meet the criteria and to do that they can work with their very smart new telesales account manager who will help them get there. Will they like it? Most possibly not because it will be seen as personal affront. But guess what, you're in business and are entitled to treat customers who spend more differently. 

Business Class vs Economy, it's your choice
Procedural fairness explains our tendency to accept a judgment if it has been fairly considered and you know the rules.  If you've ever flown Business Class and then had to go back to Economy, you will know which you prefer, but you also know what it takes to get back to Business Class - money.  Do your customers know what it takes to get F2F representation?  Share the decision and the objective criteria (eg spend more than $5,000 pa...) to help them understand that they are actually in control of their servicing - all it takes is increased spend. 

But I'm special!  I'm an important account!
This type of change reminds the customer that they are one of many, upsetting their sense of uniqueness. Talk to the customer about what makes their business special and why you see a continuing relationship with them, albeit through a different channel.

Don't think about it as losing something
We hate to lose more than we love to win. In this case, the customer may react badly if they perceive the service mix as losing something so do everything you can to frame the change as a gain. Can they get more frequent attention via the phone for example? Do they get the resourcing support of a whole team rather than one individual? Will shorter appointments save them time?  Mark out potential reasons why F2F may not have been the best method of contact from that customer's perspective and consider how to use it in your justification. A word of caution though, the change will most probably be seen as cost cutting, so don't go too heavy on the "it's better for you" angle unless you can actually prove a better service level.

Quick like a bandaid
With unpleasant news, get it over quickly because we adapt more readily if we are not constantly reminded of what has changed. Handover the accounts (and do this properly by thoroughly briefing the new rep and telling the customer) and move on so the healing can begin. 

Still scared to act?
If you are still procrastinating about making the changes, know that you are falling into the trap of loss aversion - you are more fearful of losing the business of some difficult customers than motivated by the gains you can make by having your F2F sales reps concentrate on the accounts with most potential.  And you may well lose some customers.  So to get over this mental hurdle, do some number crunching. How much does it cost you to service those accounts, what's your margin, and what's the opportunity cost between these accounts and the potential accounts your rep could be growing?  Overcome your reticence with a good dose of fear busting.

By no means is changing service mix an easy thing to do, but it is an important aspect of managing your business. If you want to take it a step further and fire a customer, you may want to check out "Firing a Customer - what holds us back?".  Until next time, happy dropping!

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5 Tips for better customer service from Behavioural Economics

This weekend I visited a café famous for being one of the first to bring real coffee to Melbourne.  But in my estimation, that business is surviving on its heritage alone. Both the product and, more strikingly, the service left a lot to be desired.  A sneering barista who barely grunted to acknowledge our orders and practically threw change at my friend made us feel that we were not living up to his expectations.  Needless to say, I won’t be back.  This got me thinking about five principles of Behavioural Economics that can help businesses (well, at least, those who think customer retention is important), improve areas of poor customer service.

Framing

In Behavioural Economics framing refers to the language and context you use when interacting with a customer.  It has been shown that using language like “can’t”, “won’t” and “that’s our policy” inflames the customer experience.  Offering to “take you through the steps…” is much more constructive than “you can’t do that before you do this” because you have framed it in the affirmative. 

Drop in the Bucket Effect

In environments like call centres where the sheer volume of customer inquiries can be overwhelming, it can be difficult for your staff to feel they can make a difference – the drop in the bucket effect.  The knack is to think of the one rather than the many.  Metrics like “How many customers you helped” is better at motivating staff than measurements like call handling time because it takes performance back to the one-to-one relationship.  Likewise, celebrate the success stories where a staff member has helped a customer – noting it doesn’t have to always be ‘going above and beyond’, it should be the goal of every interaction. 

Procedural Fairness

We cope better with outcomes when we feel that we have been treated fairly through the process. To this end, inform your customers of the process that will be used to evaluate their request to help them understand what happens and why.  “I’ll have to speak with my manager” is not as effective as setting up the interaction by outlining the steps and escalation points. “Just before I ask you to go into detail about your concern, I would like to explain my role in this process.  I will…then…and finally…Do you have any questions before we start?”

Uniqueness

Just as we cope better when we know what the evaluation process will be, we also want to be treated as unique individuals. As Dan Ariely writes in Predictably Irrational, we have a “need for uniqueness”.  But whilst of course we are not unique in thinking we are unique (we all do), the lesson here is never to tell a customer they are one of many because that will diminish their sense of individuality. “My issue”… “My situation”. I once had a spat with my car manufacturer because they were interested in their policy whereas I was interested in the inconvenience the car break down meant to my life. 

Endowment effect

The endowment effect means we tend to overvalue what we own.  That’s why you think your car is worth more on trade-in than the dealer. In a customer service setting, this can help explain why customers can be all consumed by their issue, which to your organisation may seem trivial. Again in my car manufacturer’s case, they saw my car breakdown as an isolated issue to be resolved through their usual process. I saw it as a failed new car purchase that stranded me for a whole weekend.  To deal with this you need to see the issue from the customer’s perspective and work with them to understand what it would take to have the concern resolved.

Customer service undoubtedly one of the trickiest areas of business management.  The good news? Whilst the challenge of balancing your organisation’s policies, procedures and resourcing with the expectations of individual customers seems to be in constant flux, there actually consistent and predictable behavioural reasons why customers react in the way they do. An understanding of Behavioural Economics can mean more effective, efficient and satisfying customer service models, so why not get started?  Until next time, happy serving. 

This article also appeared in Smartcompany http://www.smartcompany.com.au/blogs/20110822-5-tips-for-better-customer-service.html

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