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Markets’ very own climate change

Posted on: Friday 19th of August 2011



For many years now, our view of human decision making has been that we are ‘rational’ creatures, assiduously collecting all the facts, sifting and weighing their relevance and relative importance, carefully assembling them into alternative options which we can evaluate in order to make a final decision that ‘maximises our utility’ (which can be defined by some sort of objective criteria).


20th century economists based their theories on such assumptions, and businesses and Governments believed what the economists told them. We now know this view has about as much credibility as other folk wisdoms such as the earth is flat, and the sun orbits the earth. We were in thrall to witchdoctors, not scientists, and science has moved on: the picture it reveals is almost the exact opposite of what the economists taught.


Human decision-making is primarily emotional. Our decisions are driven by what we want and avoiding what we don’t want. These likes (for food, security, sex, status) and dislikes (fear of danger) are highly emotional drives and largely instinctive, built into the most primeval parts of our brains. If the relevant parts of the brain is damaged, we find it close to impossible to make the simplest of decisions. Reasoning – the ability to stop and think, to consider alternative scenarios, to plan and strategise – came later as an add-on; a sophistication to help make the original instincts work better.



The emotional costs of choice


There is now a massive amount of ongoing research into how humans actually make decisions as opposed to how, theoretically speaking, we should make decisions.


We now know, for example, that the simple fact of having a choice has huge psychological benefits. With choice, you are empowered. Without choice, you are disempowered – helpless. People who feel they have no choice tend to get depressed.


On the other hand, choice can bring its own psychological costs. In his famous book The Paradox of Choice psychologist Barry Schwartz enumerated many of these costs. They include:


  • a sense of loss (when we forgo the benefits of the option not chosen. This leads many people to procrastinate)
  • decision anxiety (fear of making the wrong decision)
  • decision regret (“Damn! I did make wrong decision!”)
  • fear of decision-regret (sometimes, we’re so worried about making the wrong decision that we end up making no decision at all. Tragically, the bigger the decision the more likely this is to happen – such as ‘which pension should I choose?’).



Behavioural economics


On top of this are the findings of behavioural economics which charts the many ways in which we process information in ‘predictably irrational’ ways. These include:


  • Mere familiarity – preferring things you’ve heard about it, not because they are better but simply because you’ve heard of them. (This is how lots of advertising works.)
  • Framing – being overly influenced by the context in which information is presented
  • Priming – look for things you’ve been ‘told’ to look for, rather than approaching them with a fresh, open mind
  • Loss aversion – losing £1 hurts more than gaining £1.50
  • Hyperbolic discounting – a bird in the hand today is worth two in the bush tomorrow
  • Salience – being overly influenced by the last piece of information you came across (even if it’s irrelevant)
  • Norms and peer pressure – liking what others like, because you feel you should
  • Obedience – doing what an authority tells you
  • Inertia – letting the initial cost of doing something outweigh bigger, longer-term benefits of doing it



Short cuts and rules of thumb


Faced with the high information and emotional costs of making decisions, and ‘biased’ by their many predictable ‘irrationalities’, consumers have adopted a host of different coping strategies. Most boil down to a simple short cut or rule of thumb that gets them to a good enough decision, quickly and easily. Here are some of them:

  • Buy the one I know I like (decisions based on experience)
  • Buy what I bought last time (reduce research costs and risk)
  • Buy the one I always buy (habit + research and risk reduction)
  • Buy the one I’ve heard of (risk reduction)
  • Buy the ones my friends recommend (research and risk reduction + peer pressure)
  • Buy the cheapest (value and/or necessity)
  • Buy the most expensive (quality, status seeking, special occasion)
  • Buy somewhere in between (‘hedge my bets’)
  • Buy the one that’s easiest to buy (convenience, hassle reduction)
  • Buy the one with the biggest discount (value, bargain hunting)
  • Buy the one I like the look of (impulse, aesthetics)



As shoppers, most of us will be familiar with these coping strategies. Depending on the situation, we switch effortlessly from one to another, mixing them up, changing tack, and so on. Most of the time, however, we also know that to some degree or other the results will be unsatisfactory. Yes, we’re always on the look-out for a better deal, it’s just that the cost and hassle of searching for it is too high. Life is too short.




Marketing’s Persuasion Paradigm


So far, I’ve talked only about what buyers do. But what about sellers? Here, there is a sorry story to tell. In mass markets’ early days, companies believed and acted upon economists’ theories of human rationality. This told them that if they made the best possible product and sold it at the best possible price, more people would buy this product, and they would flourish in the marketplace.


It makes perfect sense. In this era of ‘demonstrable product superiority’ and ‘unique selling propositions’ many of today’s great brands were built. But then marketers discovered that people didn’t always act as rationally as they ‘should’. To their delight and surprise, marketers also began to discover short cuts … to improved profitability.


For example, they discovered that if they advertised a product a lot, more people would buy it even it wasn’t any better than its competitor. They put this down to the ‘persuasive powers’ of their advertising and became obsessed with the benefits more ‘effective’ persuasion could bring – the quest to influence consumers’ decisions now took root next to the original quest of ‘identify and meet customer needs’.


Marketers also discovered how to game consumers’ decision-making short cuts. If inertia discourages switching, lure them in with an unbeatable offer and then hike up the rates over time. If consumers believe higher prices are a signal of quality, why not just put up the price without bothering to improve the quality? They’ll buy it anyway, without our having to spend money on product improvements! Then, now and again, we can ‘discount’ the price back to what it was before and the stupid clots will believe they’re getting a fantastic bargain!


The net result was that over the decades, companies took on a janus-faced position with customers. On the one hand, they still espoused the original marketing mantra of “identify and meet your customer’s needs”: it made them look good and, despite consumers’ many predictable irrationalities, markets did tend to sort good from bad over time.


On the other hand however, they also pursued marketing’s persuasion and influence paradigm as hard as they could. They believed they had hard evidence of its ‘effectiveness’ (look at the way advertising increases sales), though in many cases the evidence they had was actually evidence of something else entirely. * For example, a lot of advertising is ‘effective’ not because it ‘persuades’ people that a product is better or more attractive, but because of the behavioural economists’ mere exposure effect.



A new market emerges


Markets (and marketing) didn’t, therefore, evolve in the ways economists predicted. Consumers didn’t always behave rationally. Marketers learned to adapt to, respond and sometimes game consumers’ ‘predictable irrationalities’, and consumers developed responses to these responses, and so on. (For example, ‘if brands are always trying to charge a price premium, wherever possible I will opt for the retailer own label version’.)


Over time, this cat-and-mouse game between marketers and consumers has grown increasingly complex. But in the meantime, something else has happened.


First, companies’ adoption of the persuasion paradigm created a gap in the market – a market for information, tools and services that ‘help me make better decisions’. This market for decision support services is completely different to the market for better products and services. It works in its own ways. It has its own dynamics, with its own business models. It’s also multi-dimensional: about reducing the information and emotional costs of decision-making, avoiding the risks and pitfalls of ‘predictable irrationalities’ and decision-making rules of thumb, while improving decision-making outcomes for the individuals concerned.


As I’ll explain later, I think this market for ‘making and implementing better decisions’ is set to become the biggest consumer market in the world. Yet, bizarrely, most companies still can’t even see that it exists. If you see yourself as being in the business of influencing consumer decisions, how can you play in the market for better decisions? It simply doesn’t compute.


Second, the harder companies try to influence and persuade, the more they drive a long-term and catastrophic loss of trust. Every time a marketer tries to influence a consumer’s decision in the marketer’s rather than the consumer’s favour, it generates a small toxic emission of mistrust. The product might get consumed and forgotten. But the toxic emissions remain, accumulating in the atmosphere to create an overall change in the climate – to create a climate of mistrust. **


This manifests itself in many different ways: hostile pressure groups, a sceptical and critical media, suspicious and controlling regulators, unengaged and cynical customers. But underneath these manifestations lies a huge economic problem: low levels of trust are the biggest single obstacle to trust-based information sharing between individuals and organisations, and that’s what we desperately need for the next big leap forward in economic and social development.


I’ve outlined a little of the scale, economic importance and implications of today’s consumer decision making revolution. The next question is: ‘so what’s changing?’


Alan Mitchell




* A recent piece of research examined the content of marketing text books from 1929 to 1989. A trawl through these textbooks collected 566 claimed ‘principles’ of effective marketing. Four independent raters agreed that only 20 of these principles were actually meaningful. Twenty marketing professors were then asked to rate these principles according to a range of criteria: are they correct, supported by empirical evidence, useful. None of these principles met all the criteria. In a further twist, the professors were then asked to judge the same 20 principles, except that this time their meaning was reversed. Nine of these principles were judged by the professors to be equally correct. (Persuasive Advertising: Evidence Based Principles, J. Scott Armstrong, Palgrave Macmillan, 2010)



** Just one small example. A recent review of research into consumer attitudes towards advertising tracked responses to questions such as ‘how believable/truthful/useful/informative are ads?’ Up to the mid-1950s the public’s response was overwhelmingly positive, scoring 8 on a nine-point scale. By the 1970s these responses plummeted to below 3, and have remained below 3 ever since.