Book Review: Predictably Irrational

Dan Ariely’s story is a fascinating one. As an 18 year-old growing up in Israel, he was caught up in an explosion that left 70 percent of his body covered with third degree burns. His three year recuperation period in hospital involved daily disinfectant baths and bandage changes that even sound excruciatingly painful. But the experience led him to reflect on how the world works, why we do what we do and ultimately to a career in the study of behavioural economics.

Predictably Irrational is a highly readable and fascinating account of research conducted by Ariely and those of like mind. It examines a variety of important questions about human behaviour. Why are we susceptible to the word – free? Do men (particularly) think differently when aroused? No prizes for guessing the answer to that one. Why do we all suffer from problems of procrastination which characterises everything from missing project deadlines to failing to look after our health and save for retirement? Why do we overvalue what we have? Think of how the prices of houses diverge between sellers and buyers. Why are we prone to keeping our options open? Why are we less likely to steal cash than products of the same value? Experimental research findings are presented to demonstrate the existence of these and a variety of other irrational behaviours.

So this book challenges the basic economic notion that we are rational – that is, the simple idea that in everyday life we compute the value of all the options open to us and follow the best course of action. Ariely argues that not only are we irrational but rather that we do it again and again – we are predictably irrational. And it has profound implications for many aspects of marketing and decision making. For example, relativity plays a huge part in how we evaluate options. Given a choice of three prices, most people will tend to go for the middle one. High priced items on a restaurant menu boost revenues even if no one actually buys them because customers tend to go for the second highest one. Not rational but consistent! When we consider buying new products, the first price we see becomes an anchor which is why many luxury items can command prices that are off the scale. Add to that, the finding that the higher the price of the drug, the better we perceive it will make us feel and we begin to appreciate the power of one of the key weapons in the marketing arsenal.

First published in 2008 and revised and updated in 2009 in the wake of the global financial crisis, the book is a must read. It tells us a great deal about ourselves and why we are far less in control than we like to think.

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Book Review: Basic Instincts

This was my first sortie into the world of behavioural economics and it has been a very worthwhile one. Basic Instincts by Pete Lunn is a lucidly written, well researched and highly accessible overview of a growing field. The book’s primary audience is students of economics as it takes hold of many of the disciplines core tenets such as equilibrium, profit maximisation, rationality and so on and demonstrates in a compelling fashion that the world we live in does not always conform to these theoretical models. The implications are wide ranging, impacting on everything from consumer behaviour to labour markets to the ‘theory of the firm’.

For those involved in marketing, the book is a fascinating read as well. By devoting a full chapter to how marketing calls into question much economic orthodoxy, it certainly gives marketers a chance to feel a little smug and be grateful that they didn’t pay too much attention during those early microeconomics lectures. A footnote to this chapter describes Kotler’s classic book as a horror story but for reasons you will only understand when you know where Lunn is coming from. For businesses of all sizes though, this chapter provides further evidence of the power of marketing, based not on intuition, but on economic reasoning and supporting evidence. Consumers struggling with uncertainty have a motivation to ‘trust’ brands. Our instinctive desire to be part of a group means that we are susceptible to appeals that attach brands to personalities, lifestyles and social classes. Advertising, though it may be wasteful from society’s point of view, clearly works and one of the most persistent findings in industrial economics is a link between profitability and marketing.

Against this background, marketing’s failure to pack a bigger punch in corporate boardrooms all over the world remains hard to fathom. Paradoxically, the discipline has done a bad job of marketing itself. Perhaps, instead of seeking to learn the language of finance, it should be adopting the logic of behavioural economics. Consumers are not rational, selfish beings operating in an environment of perfect information. As Lunn points out , a prime example of this is the iPhone for which many consumers shelled out $599 only to see the price drop to $399 just two months later. Basic Instincts explains that there are a variety of ways in which we can be MISLED. Consequently, we have developed a capacity to trade with each other which has evolved through many generations. But this capacity contains many ‘sub-optimals’ such as a propensity to value what we have and know, to value fairness in exchanges and that we are highly influenced by social context and engage in herding behaviour. Marketers need to demonstrate more powerfully why customers behave in the many unprecedented ways that they do. Behavioural economics along with evolutionary psychology and neuro-marketing is helping to do this. These fields are teaching both marketers and consumers a lot about themselves.

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