What is Behavioral Economics? And Why Should IT Leaders Care?
You’re not perfect.
You’re not alone. Ever feel torn between making a sensible decision and immediate gratification? We like to believe that we’re rational and intelligent, making decisions in our best interest. Reality shows otherwise.
You might have noticed the term “Behavioral Economics” in conversation. Maybe you heard Richard Thaler won the 2017 Nobel Memorial Prize in Economic Sciences this past October. Or maybe you viewed our recent design thinking webinar with Damco and ADP.
What is behavioral economics?
Behavioral economics can help people make better decisions and habits—ones that lead to happier, healthier lives. By blending psychology and economics, it provides insights into why we don’t act in our own best interests. It exposes the flaws and biases that influence our actions.
Thaler’s research helped pioneer the field. Thaler and Cass Sutton published Nudge: Improving Decisions about Health, Wealth and Happiness in 2008. They explained that subtle nudges can encourage better decisions, especially when planning long term. They also outlined other ways we betray ourselves.
These are some of the main ways we sabotage ourselves when making decisions:
Endowment Effect and Loss Aversion
We tend to value things more when we own them. Thaler described this as the Endowment Effect. This bias occurs when we overvalue a good that we own, regardless of its market value. Symbolic, experiential, or emotional values come into play here. You’re more likely to sell something you own at a higher price than what you would be willing to pay to buy the same thing.
The Endowment Effect links to another important concept of behavioral economics: Loss Aversion.
Would you rather get a $5 discount, or avoid a $5 surcharge? The pain of losing can be psychologically twice as powerful as the pleasure of gaining. People are more willing to take risks to avoid a loss than to take one for a similar gain. Trial offers are another embodiment of this. Once accustomed to having something, you’re more likely to pay to keep it than to pay for it from the beginning.
Status Quo Bias
People are more likely to stick with the status quo, even if big potential gains involve little cost. Many prefer things to stay the same by doing nothing or by sticking with a previous decision.
Loss aversion comes into play, but changing defaults can have a huge effect. You’re less likely to enroll in a retirement plan if you need to choose to do it. If you are automatically enrolled in a retirement savings plan, you’re less likely to opt out. Status Quo Bias means once you’re in, you’re less likely to leave.
The easier it is to remember something, the greater its importance is perceived to be. People tend to weigh their judgments toward more recent information. It leads people towards making opinions based on the latest news heard.
The Availability heuristic is a notion that often comes into play with marketing. Put something in front of people often enough so that it stays readily in their mind. Need car insurance? Who are you going to check first?
Coming back to feeling torn between making sensible decisions and immediate gratification, it’s an internal struggle described as being between your “planning” and “doing” selves. This is where nudges come in.
Thaler and Sunstein pioneered the idea of using nudges to promote good long-term decision making while maintaining freedom of choice. One method of doing this is changing the default option, like switching users from opt-in to opt-out. This has become a factor in public policy. Over 50 countries have centralized “nudge units” influenced by behavioral sciences. They’ve made strides in areas like retirement savings and organ donation.
Be mindful that if misused, nudges can be manipulative and be a detriment to individuals. They should benefit both parties involved. That is the use Thaler and Sunstein argue for in their book Nudge. They should be transparent and never misleading. It should be easy to opt out. Nudges should be driven by the belief that the behavior encouraged will improve the welfare of those being nudged.
Following the rise of human-centered design and design thinking into the general consciousness, it’s not surprising to see interest in behavioral economics grow. Like those concepts, behavioral economics brings the focus back to people. It attempts to integrate psychologists’ understanding of human behavior into economic analysis. It can guide toward more healthy behaviors by correcting cognitive and emotional barriers.
It acknowledges that we often make errors and need a nudge to make decisions that are in our own best interest. By understanding where we go wrong, we can better help ourselves go right.
Transferring nudges to the digital space allow us to test designs and conduct research faster to see what works best. We can get results from that testing much faster too. Results come in days or weeks instead of waiting years. Digital offers an unprecedented scale to test and interact with users, whether it’s optimizing email or notification messaging, web pages, or app screens. Even small changes can have a large impact.
For instance, ADP introduced the practice of behavioral economics into their product design. It helped put human experience at the center of their process. Using the Mendix platform in conjunction with a design thinking approach, ADP built a leadership development solution called Compass that increased internal engagement from less than 10 percent to over 80 percent. It was such a success that ADP commercialized the solution based on customer requests. Building upon agile and design thinking, and applying these concepts responsibly, allow you to better help your users and drive positive outcomes for both your users and your product.