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

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.  


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Getting ripped not ripped off at the gym: Price anchoring at work

I walked away.  Her best offer was $16.50 a week for gym membership, better than the $18 I was already spending as a casual member, and yet I turned down the offer. Why? 

Pricing psychology is such an important part of every business and behavioural economics can go along way towards understanding why customers react to deals the way they do.  Here are eight lessons from how my gym botched the deal.

Over the past few months the gym had sent me text messages offering $18 a week memberships, the same price as my weekly Zumba class.  This was their attempt at winning me over by saying "you may as well because that's what you're spending anyway".  Why didn't it work? Commitment to 12 months. Lesson 1. Don't ask your customer for a commitment without rewarding them beyond what a 'casual' customer would receive.  And because the offer was texted to my phone, any other benefits of membership (better change rooms for instance) were not explained.  If using this strategy, parcel the benefits with the price in each and every communication. A text saying "Unlimited Zumba plus full access to pool, yoga + sauna no add cost" might have been better.

So now $18 was anchored as my membership price expectation.  Lesson 2. Whatever deal your customer first sees is vital because it is the offer against which all others will be judged.  This of course can work very well for a savvy business because it sets an upper limit against which you can offer discounts. 

The other important aspect here is that $18 anchored the price in context.  The $18 for gym membership was seen as relatively expensive and yet I have spent more on that in yogurt in the last 2 weeks. When I was later comparing a cheaper deal to that anchored price, I was judging them relative to gym prices only, not other lifestyle costs. Lesson 3. Take the opportunity to broaden your customer's frame of reference with other price anchors to influence how your pricing is perceived.  And the other anchors don't even have to be relevant! Duke University's Dan Ariely has demonstrated that numbers as random as the last four digits of a social security number can influence the price people are willing to pay for wine. My gym could have cited average costs per week of Internet, train travel or something else just to broaden the context in which I was judging the value of the membership.

The gym next texted me a deal for $16 per week.  Hmmm, that was getting more like it; I would be saving on my Zumba!   Note how I thought about it as saving money rather than spending less money; this is the concept of sunk cost where people fixate on the incremental change (saving $2) rather than the outlay (paying $16).  Lesson 4. Sunk cost is extremely powerful because your customer's mind will be busy calculating the differential value rather than worrying about the actual cost. 

But another week elapsed before I took action and the offer reverted to $18. So I now had an upper price anchor of $18 and a lower price anchor of $16.  This is another useful technique for savvy businesses because you can help your customer understand that the deals are not forever, and they need to act when one crops up.  The concept at play here is loss aversion, where it hurts to lose a potential discount.  Lesson 5. Sequencing favourable and less favourable deals can help drive take up.  Petrol pricing is typical of this behaviour where we rush to buy petrol at its low ebb during a particular day of the week.

So then it came to my next offer. A rep from the gym called me and offered $13 per week.  Well, that was too good to refuse.  I had rejected $18, so this saved me $5, and I had missed out on the great value $16 offer, so I was ready to sign. And the fact that a rep called me rather than texted probably didn't hurt either because it distinguished the deal from others.  Lesson 6. Make sure killer offers cut through as special and close the deal.

Having arranged to meet the rep at a specific time and had that confirmed by him via text that day, I was a bit confused when told he had gone home for the day.  Lesson 7. Customers hate being bounced and it can jolt them from a future focus (I'm going to me a gym member) to current focus (if this is how they treat prospective customers...). Confirming an appointment only to sub in a colleague who does not have full background information gets your customer in a negative frame of mind when you want them to be thinking "yes!".

Fifteen minutes later his colleague met with me with the latest offer.  Here's how our conversation went;

• Gym rep - "For a commitment-free membership we can offer $22 a week. Otherwise, you can take our special deal of $16.50 per week for 12 months"  (Note nice use of anchoring at higher casual rate before mentioning contract rate)
• Me with puzzled expression - "I'm confused. Your colleague offered me $13"
• Gym rep - "I'm sorry, that deal has expired"
• Me - "I wasn't told it would expire, and had arranged with your colleague to sign up for that"
• Gym rep - "As I say, that deal expired and the best I can offer is $16.50."
• Me - "Ummm. Can I think about it?" (when confused, delay)
• Gym rep - "Well unfortunately I can only offer that price tonight"  (Nice pressure. Tapping into my loss aversion") 
• Me -"I'm going to have to think about it" (preparedness to walk away because I felt that I has been lured to sign through misleading representations, but also because I had previously 'walked away' from $16 by not acting on that deal, so I knew I could live without it.)

 So I walked away. 

The gym almost had me, and had used different anchoring techniques to finally get me to a position of commitment. Spooking me with a more expensive deal was a mistake they could have easily avoided by clarifying the deadline for the $13 offer.  

However, the most surprising part of this is that had they come back and offered me a deal somewhere between $16.50 and $13 I would have signed.  Whilst $14 or $15 was more than their best deal, I could have worn the fact that that offer was for a limited time and I was still doing better than $16.50.  What's going on here?  Think back to sunk cost. By turning up ready to sign, I had psychologically 'spent' $13, so anything that was closer to my end of the pricing spectrum ($13) than the gym's ($16.50), was acceptable. Lesson 8. Just because you've anchored the price low doesn't mean you necessarily have to go there to win the business.

In actual fact they called and honoured the $13 deal so I am now a paid up, committed member. Fair to say there were some bumps and turns in how the local gym influenced my decision to do business with them, and it didn't need to be so clumsy. I trust you will be able to apply these eight lessons to engage your potential customers.

1. Don't ask your customer for a commitment without rewarding them beyond what a 'casual' customer would
2. Whatever deal your customer first sees is vital because it is the offer against which all others will be judged
3. Take the opportunity to broaden your customer's frame of reference with other price anchors to influence how your pricing is perceived 
4. Sunk cost is extremely powerful because your customer's mind will be busy calculating the differential value rather than worrying about the actual cost 
5. Sequencing favourable and less favourable deals can help drive take up
6. Make sure killer offers cut through as special and close the deal
7. Customers hate being bounced and it can jolt them from a future focus to current focus
8. Just because you've anchored the price low doesn't mean you necessarily have to go there to win the business

Image from Foster City, and no it's not me!

Gender differences in bottle shop behaviour

An article on the gender difference in booze buying behaviour grabbed my attention the other week. "Cheap Booze for him" headlined a story about some Roy Morgan research that identified that blokes were driven by bargains, whereas women sought helpful customer service ("Cheap Booze for him" by Inga Gilchrist, MXNews 4/7/11).  The article quoted bar duty manager David Dearlove as explaining that emotions were the difference, where "females want more from a situation, so they want to be waited on. Whereas guys just say 'Give me my beer' and they're done."  Very hunter-gatherer!

Devising your customer engagement plan
As this snippet of research indicates, businesses have a lot of decisions to make when structuring the optimal customer engagement plan (*refer caveat below).  In this case, "beer on sale" would likely stimulate male foot traffic and you would tend to up-weight staff at the registers.  A promotion on "wine matching" may instead stimulate more female custom, and you would need to ensure you had staff available in the aisles to direct purchase decisions.

At what point can you influence the purchase decision?
The interesting point here I think is that men in this scenario are making the decision before entering the store - indeed it is the reason they visit the store.   Women, on the other hand, visit the store in order to make a decision, and in fact be helped to make it.  This means the retailer has different opportunities to influence what the customer walks away with.

To make the most of male customers, the retailer should place high margin wine or champagne near the beer on special, suggesting the guy keep in sweet with his lady by coming home bearing gifts.  This is a technique used in grocery where nappies sell well with beer!  This opportunity for the retailer centers around the behavioural principles of sunk cost and mental accounting. The guy has already 'spent' the amount of money for the beer before he arrives in store (sunk cost), and that means that it should be easier to up-sell because any other purchase comes out of another mental bank account.

To make the most of female customers, the retailer can of course use direct customer service, but the other opportunity is to help the decision making by noting which wines are most popular, best value, match with particular foods and so on.  You have probably seen these techniques applied on point of sale, like "staff picks" or "popular seller", and these work because they use the behavioural economics principle of herding - we go where others go.  If you know other people like the wine, then there is less chance of making a poor choice.  Use of a rating system can also help to frame the decision, so a rating system for value or taste can help influence customer purchases.

Behavioural Economics can influence both genders
Whilst I do enjoy little snippets on gender differences, more important to your business is how you can influence the behaviour demonstrated by the sexes.  Male or female, your customer can be greatly influenced by strategies to get them in the door, and then again whilst in store so it may be worth you considering what Behavioural Economics can offer at each decision point.  Until next time, happy boozing.

(*Note, whilst the article on the research pointed to some gender differences which I have used in this post, there are doubtless many exceptions and qualifiers that you would need to consider before applying carte blanche to your business. Start with accessing the source research through Roy Morgan if you are interested.)

Image from http://www.bargaineering.com/images/in_posts/wine-shop-aisle.jpg

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