Exploiting Consumer Irrationality

January 9, 2016

 

A fundamental assumption underlying economic theory is that the market, through consumer choice, represents the most efficient mechanism through which to satisfy societal needs and interests.  The notion of a free market is often combined with the notion of freedom because consumers have the power to address social needs through their purchasing decisions.  But a fundamental assumption underlying this assertion is that consumers make choices rationally.

 

In 1974, two economists published an article that has had profound implications for our understanding of how people make decisions in their everyday lives.  Nobel Prize winners Amos Tversky and Daniel Kahneman presented strong evidence to suggest that when faced with a decision, people do not engage in what many believed to be a rational, calculated process where they collect all relevant information, evaluate that information, devise alternatives, evaluate those alternatives against criteria and then make a decision.   Instead they found that, due to bounded rationality, people use heuristics or mental shortcuts that supplant this time-consuming and arduous process.  Bounded rationality simply means that decision makers do not have the ability or resources to process all available information and alternatives to make what rational thinking would suggest is an optimal decision.  Therefore, their rationality is by default bounded in its reach.  We therefore use these shortcuts all the time without even knowing it.  As economist Dan Ariely said in his TED talk, “We wake up in the morning and we think that we made decisions.  But many of these decisions do not reside within us”. 

 

In the last decade or so, consumer psychologists have become a highly valuable resource for business because they can help develop marketing strategies that exploit consumer irrationality.  As a consequence, business can avoid having to respond to consumers as independent actors who voice needs freely and instead shape those needs by tapping into their psychological vulnerabilities.  Many of these strategies have become so commonplace that they represent an expected consumer-corporation battleground.  Consider the compliance heuristics where, for example, consumers will be more apt to purchase a product (like a cigarette) if it complies with recommendations coming from authority figures (like a doctor). The social validation heuristic, which suggests that people feel pressured to comply with something that many of their peers have done, is often exploited through messages meant to make consumers feel isolated if they don’t purchase a product that a high number of people already have.  And we’ve all experienced the scarcity heuristic where marketers emphasize the scarcity of a product because irrational decision-makers have a greater tendency to want something that they can’t have. 

 

Studies have also shown the power of persuasion heuristics where, for example, people have a greater tendency to perceive an advertisement to be of higher quality if it is longer in length and full of lots of facts and figures.  Marketers also know that consumers are more likely to agree with people they like, which explains why many strategies use actors who are more attractive, share similar challenges on a daily basis or possess more general likable habits.  What is more, consumers are often persuaded to think that something is correct when there is consensus among a group of people.  It comes as no surprise then that many ads start off by saying that many experts share the opinion even though that opinion is not supported by fact. 

 

But the above tactics, while effective, are relatively old and a growing number of consumers have pushed back on these tactics.  In response, marketers have grown quite sophisticated in their efforts to exploit consumer vulnerabilities by focusing on subtler decision-making biases.  One of the most common is representative bias where decisions are based on anecdotal information that people believe is representative of all situations.  For instance, many of us have likely generalized a couple of instances of bad customer service by suggesting that this bad service is endemic in all situations.  If consumers didn’t naturally have this bias, it is unlikely that the insurance industry would be as profitable as it is today.  Insurance is quite dependent on exploiting consumer belief that, although statistically, the probability of a particular event occurring is extremely low, it could still, however remote, happen to them.  Buying insurance essentially means that one is betting that this extremely low probability event will happen.  As a consequence, if consumers behaved rationality, they would calculate that the cost of a premium far outweighs the cost of this event occurring, once you factor in the probability.  This means that the greater the irrational behaviour of the consumer, the greater the premium and profitability.  It is no surprise then that advertisements for insurance do not highlight the benefits of spreading risk across multiple consumers and instead focus on instilling fear that the remote is possible and worth a high price to avoid.

 

Unlike applying the representative heuristic to advocate for the necessity of your product or service, it can also be applied to the way in which people are objectified into particular categories often based on one or two characteristics that become representative of that person. Wearing a backpack and using a skateboard will generate a particular stereotype while coming out of a limousine taxi in a business suit will generate another.  Because it is our nature as human beings to feel accepted by broader society, we behave in ways that validate and reinforce these stereotypes.  In other words, to gain acceptance, people work to excel in that stereotype. Naomi Klein’s No Logo explained the strong impact of identity marketing where companies establish (or draw on) particular role identities or stereotypes and then market behaviors associated with those role identities.  For instance, marketers can prey on a woman’s desire to be a wonderful grandmother by validating this stereotype through a child’s appreciation for a toy.  Similarly, marketers aim to associate the drinking of Gatorade with top athletic accomplishments so that aspiring athletes associate success with the consumption of this product.  The survival of the jewelry industry – and perhaps the diamond industry – is highly dependent on reinforcing the socially constructed notion that a man’s symbol of commitment and love towards a woman is dependent on purchasing her a diamond ring. These examples surround us daily but only became a popular marketing strategy in the 1990s when marketers realized that consumers behave irrationality when they think purchasing a product/service helps them conform to a particular identity they have in society. 

 

Closely related to representative bias is sample size bias where decision makers often succumb to the results of a small sample.  In a small sample, the odds that results will stray away from the mean is much greater than with a large sample.  Flip a coin 10 times and there is a greater chance that the frequency of ‘heads’ will stray away from 50%. But flip the coin 1000 times and the number of times ‘heads’ emerges will be much closer to 50%.  Casinos are very effective at exploiting sample size bias when they advertise that a particular slot machine produced an exceptionally high number of wins in a given time period.  An irrational consumer will think that their chances are greater at this machine when in fact the casino simply chose a short time period (sample size) that happened to produce a high number of winnings.  Increase the time period and this machine will be no different than others.  As a similar example, consumers are often strong-armed into purchasing warranties for electronics. Salespeople often refer to multiple instances of malfunction of a very small sample size of products to convince consumers that they should get a warranty.  One cannot help but balk at the contradiction associated with a retailer’s promise of quality products on the one hand and the very strong recommendation to buy a warranty that bets that it will break down on the other.

 

Another important heuristic is availability.  The availability heuristic is a tendency for people to base their judgments on information that is readily available to them or easier to gather regardless of whether that information is relevant or not.  How many of us have researched a symptom of an illness by googling the symptom, which presents completely inaccurate and alarmist information that in most cases is not grounded in any scientific research?  Food and beverage companies have often been accused of commissioning studies that demonstrate health benefits associated with a novel combination of nutrients.  The publication of the results of the study in the media exploits the availability heuristic as consumers eagerly search for the new product with those stated nutrient combinations.  Then the food producer makes sure that they are on the shelf as these consumers search for the product. 

 

Perhaps a more egregious example of exploiting the availability heuristic is Target’s use of predictive analytics.  Unfortunately, when the media caught on to the story, the debate about its use was whether this was effective analytics or simply something creepy.  Very seldom do we hear a debate about whether these sorts of initiatives have a fundamental impact on how we perceive reality.  Consider the example.  Target tracks purchasing decisions of women so that they can predict, based on particular purchases at time 0, that they will be delivering a baby 9 months later.  Because the expectant mother is going to be more sensitive to these messages at around the 8-month mark, Target can tap into her availability bias by presenting her with information that is not necessarily in her best interests but in the best interests of Target.  A rational woman would be able to assess the merits of such an advertising scheme to ascertain whether this is something she really needs.  But because of the availability heuristic, her determination of what is or is not appropriate or necessary to consume at 8 months is no longer driven by genuine market needs but instead by her increased sensitivity to these messages that appear nicely timed, almost fate-like.  This notion that consumers are more apt to purchase products and services they otherwise would not when they are presented at what seems like a serendipitous coincidence is well established in research. In such a situation, consumers convince themselves that the product/service is needed because of its association with their present condition/stage of life. Most consumers don’t realize that this was planted for the purpose of exploiting this vulnerability. 

 

Another very powerful heuristic is anchoring. It suggests that people will rely too heavily, or anchor, on one trait or piece of information when making decisions.  Anchoring could fall under the availability bias but is more specific in that it provides a reference point that severely skews a person’s evaluation and decision even if that reference point has very little to do with the decision itself.  A very simple example was illuminated in a powerful experiment where subjects were asked to estimate the percentage of African countries in the United Nations (UN).  Prior to the subject’s guess, the subject spun a wheel to reveal a number.  The median answer of the number of countries in the UN varied substantially depending on the number that was spun.  Subjects that spun a lower number like 10 had a mean guess of 25 African countries in the UN while subjects that spun a higher number of 65 had a mean guess of 45 countries.  As another example, when real estate appraisers were tested on their appraised value of a given house, there was a statistically significant difference between those appraisers that were exposed to price lists prior to the appraisal and those who were not.  Several scholars have replicated this and other experiments demonstrating how anchoring can heavily influence a decision-maker’s analysis. Anchoring is the fundamental pricing strategy of Hudson Bay Company.  Walking into any The Bay store, consumers are bombarded with red “sales” signs that give the illusion of immense savings but only when anchored by an inflated regular price. 

 

Another bias is the fallacy of regression where people confuse exceptionally good or exceptionally poor results to continue as if they were average.  A rational decision-maker would recognize that after a particularly good or poor result, the next result will more than likely be closer to the average.  Instructors of a flight simulator couldn’t explain why students performed so poorly relative to previous exceptional student performances.  They didn’t realize that what caused the change was not that top performers simply prepared less or that the second time around was harder but that they simply regressed to the mean their second time.  As an example closer to home, students often think that what explained a poorer grade after an exceptionally good test grade was that they were simply less prepared or the test was much harder the second time around.  This is the fallacy of regression because the more likely reason is that students simply regressed closer to the mean the second time. 

 

Years ago a flurry of companies produced amber beads as an alternative medicine for teething infants.  One company claimed that:

 

“Baltic amber offers a natural, drug-free alternative to the relief of teething pain in children using analgesic and anti-inflammatory properties”

 

There is no scientific evidence to suggest that the components of amber beads are associated with pain relief of infants who are teething.  So then why do these products still exist?  Parents take action with alternatives like amber beads when their infant’s pain is at its peak; that is, when it is particularly exceptional.  So when parents resort to the amber beads, they subsequently see a reduction in pain exhibited by their infant.  But the reason wasn’t the amber beads but that the pain, once at a peak level, simply regressed back to the average level.  Using this as an illustration, there are many advertisements that position a product/service as the savior in times of desperation to ultimately exploit this consumer fallacy.  

 

Finally, scholars have found that people make very different decisions based on how a problem or situation is presented to them.  For instance, marketers have learned that people respond very differently based on which of the following two statements are used following an online purchase:

 

  1. Check the box below if you would prefer not to receive emails with special offers and promotions

  2. Check the box below if you would prefer to receive emails with special offers and promotions

 

Which of the two statements elicited more consumer willingness to receive special offers and promotions?  Turns out that whether the consumer wants to receive special offers or promotions is less important than whether they have to physically check a box, meaning that using the first statement elicited substantially more consumers willing to receive these promotions.  As another example, meat sales were substantially higher when they were advertised as 75% lean rather than 25% fat.  A golf course found that golfers responded much more favourably if they charged a regular price for ‘prime time’ shots and a 20% discount for other times compared with charging a premium for ‘prime time’ shots and a regular price at other times.  Even though the two sets of prices were identical, the way it was presented or framed severely impacted the consumers’ perception of what was fair. 

 

The above mentioned 1974 paper that illuminated some of these biases was so powerful that it remains one of the top cited articles in the social sciences today with an army of researchers confirming and reconfirming that people use these shortcuts to make decisions and thus make decisions that are likely not in their best interests.  This is a very powerful notion, one that many students of business struggle with.  After all, it’s hard to accept that one’s decisions are not made objectively but are in fact reflecting efforts to social engineer society into a particular and rather narrow construction of reality. 

 

Now imagine the implications for business if marketers are aware that consumers do not make calculated decisions when purchasing products or services but instead base their decisions on these aforementioned heuristics.  The goal of business is no longer to meet the needs and wants of society but instead to exploit these decision-making biases to create and shape needs/wants in ways that better align with profitability. 

 

Consider a recent article, in which the author ultimately prescribes how marketers could take advantage of the heuristics of consumers to increase sales.  In other words, rather than work to better meet the needs of consumers, the idea is to exploit the limitations consumers have in making decisions so that companies can sell products/services that have higher margins.  Understanding the real needs of consumers plays second fiddle to exploiting their cognitive limitations to manipulate and shape those needs so that they want/need those products and services that better align with financial goals.  

 

 

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