Behavioral Economics, Marketing, Loyalty and the Customer Experience

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Conversations about consumer buying decisions invariably turn to behavioral economics. Behavioral economics essentially is the study of the impact of non-economic factors on economic decision making. Homo Economicus – consumers as rational, information processors making optimal decisions that maximize their economic well-being – has been declared dead. So what else is new?

Other than in the mental laboratory of classical economists, no one in the real world has ever paid any attention to this idealized version of the consumer as an engine of micro-economic efficiency. Economists may have been lost in this unrealistic picture of reality, but economists are the people who solve the problem of “how do you open a can if you are stranded on a desert island with no tools?” by assuming you have a can opener. Business people and marketers, on the other hand, I would argue, always have practiced behavioral economics.

Regardless of any text book or AMA gobbledygook definitions, the Laxtionary defines marketing as:

Every aspect of marketing tactics and strategy – from advertising, branding, messaging, promotions and placement to pricing, product features, distribution, packaging and distribution – ultimately is aimed at influencing the purchase behavior of consumers based on behavioral economics. I doubt very much that Adam Smith would disagree.

Consumers as IRrational?

While I guess this puts me firmly in the camp of behavioral economists, I take extreme exception with those who categorize consumer behavior as irrational in their failure to make decisions that maximize their economic gains. We live in a world of “bounded rationality” in which we are constrained by limited and imperfect information, as well as highly variable but always imperfect information processing capabilities. Equally important, we attach “value” to a spectrum of individual needs and desires – from time, ease, safety and convenience to self-fulfillment, emotional satisfaction, social recognition and status – that extend well beyond simple economic priorities.

Rather than characterize our “failure” to make decisions based on maximizing economic outcomes as irrational, I would argue that consumers make spectacularly rational decisions based on their ability to process the information they have (and the information they want), their perceptions and understanding, and the calculus of the multiplicity of things they value. The seemingly endless array of decisions that economists might classify as irrational are quite rational given the constraints of bounded rationality, perceptions and personal values.

  1. Does it make sense to buy new, unproven technology products or cars with no track record; to shop in expensive stores for products available for less elsewhere; to buy early in the season rather than wait for sales; to pay more for a specific brand instead of buying a knock-off? It all comes down to the individual consumer’s set of values: if they are an early adopter technophile or a “car guy/girl;” prefer the status/service/what-ever of more expensive stores; want to enjoy something now rather than wait; or appreciate being identified with a particular brand, all of these decisions are perfectly rational reflections of the tradeoffs between economic maximizing and other values that consumers have. 
  2. Are the tens-of-millions of Americans who buy lottery tickets irrational because the likelihood of winning is so astronomically small that you probably would net a higher rate of return by handing out dollar bills to strangers in the hope that one of them is a wealthy altruist who reciprocates by giving you a million in return? While characterized by homo economicus as a tax on stupidity, lottery tickets are dreams, not investments.
  3. There are countless varieties of onerous loans that make “no sense,” from payday, subprime, rent-to-own, pawn shop and tax refund loans to the type that are illegal. But for consumers faced with limited resources, the need for immediate cash and, very often, a poor understanding of the alternative or consequences of their decisions, their use of these financial “instruments” is rational.

The list is endless.

As researchers, we strive to understand consumer preferences across the spectrum of things to which people attach value and the conditions under which they make purchase decisions. As marketers, we strive to use this understanding to maximize our influence over those purchase decisions. This is the world of behavioral economics.

Loyalty and Customer Experience

When it comes to research and implementation in customer loyalty and experience, companies have two “rational” options (which are not mutually exclusive):

  • Strive to understand and deliver on those experiences and aspects of the relationship that build loyalty – or at least convince customers the company is delivering on these promises
  • Try to understand other ways in which the company can create unique experiences and aspects that customer will truly enjoy and desire;  and work to convince customers that these are things they should value highly and aggressively seek out in the future.

While the latter approach is the ever-sexy domain of innovation and inspiration – with legendary success stories like Disney and Apple – the former is the arena in which the overwhelming majority of companies compete for customer attention and loyalty.

If we move beyond loyalty as a concept to loyalty as an expression of customer preferences made tangible in the form of Loyalty Behaviors, the connection to behavioral economics is obvious: it’s not about the delivery of some idealized “best product at the best price;” it’s about understanding what “drives” customer behaviors and then wowing customers by exceeding their expectations on those things they most value, while satisfying their expectations on their more basic needs. After they have redefined the customer experience, even the Disneys and the Apples must turn to understanding the expectations customers have regarding the experiences the companies created so the firms can continue to delight customers and deliver against the very expectations they helped to fashion.

So while the debate over behavioral economics may rage on between theorists, those of us in the applied world of marketing and customer experience and loyalty will continue to focus on what we have known has been the keystone all along. That is, trying to understand what consumers value most and then influencing how people think about a product or a company with the objective of capturing, retaining and growing customer spend.

10 COMMENTS

  1. Thanks Howard – for the Laxplanation! While I love the insights Behavioral Economists can derive, I sit firmly in the “Irrational” buyer category. You’ve helped to describe why and provided a road-map to my pocketbook if anyone wanted to encourage my spending.
    Thanks!

  2. While much of what Howard says makes sense (dare I say, “is rational”?), the first half of his piece is much ado about nothing. It comes across as his defining “rational” to be a quality that is characteristic of any decision that the consumer makes simply by virtue of the fact that the consumer makes it, regardless of how irrational it may seem. That may be how it’s defined in the Laxtionary, but it’s not the definition in more conventional dictionaries (not to mention the textbooks or AMA material that Howard so blatantly disdains).

    Still, the loyalty part of the piece was worth the read.

  3. Bob –

    Thanks for your comment – or at least that part which doesn't take me to the woodshed.

    While the Laxionary may not be authoritative, I would argue that my definition of marketing is more practical and meaningful than that offered by the AMA, which says that "Marketing is the activity, set of institutions, and processes for creating, communicating, delivering, and exchanging offerings that have value for customers, clients, partners, and society at large.”

    Definitional repartees aside, I don't think that any decision is rational simply because the consumer made a decision. But equating rational with economic optimization – the central assumption of the economic model of decision making – seems misguided. It ignores other outcomes or "goods” – such as time, convenience, simplicity, conflict avoidance, ego gratification or even being altruistic – that people may rationally seek. More importantly, the economic model ignores problems of imperfect information, the cost of information and our imperfect ability to process information.

    Perhaps I cast too wide a net, but I would argue that a consumer's decision is rational if they consider the information they have available and make a decision that they think is the best for them given their situation and the outcomes they seek.

  4. Howard,

    Thanks for taking the time to respond.

    I agree that equating rational with economic optimization is misguided. No argument from me on that score. But then to go on and say that the decision is rational because it includes all of the “other outcomes or ‘goods'” strikes me as verging on the tautological. In other words, if a consumer’s decision seems irrational, it is only because we are failing to take into consideration some “other outcome or ‘good'” that they obviously must have taken into consideration when they made their decision.

    I think we are in agreement with your basic premise. I only take issue with your use of the term “rational” in this context. Perhaps my mother, who ironically was married to a marketing professor (and AMA member), said it best: “There’s no accounting for taste.”

  5. Yes, Bob, I think we agree for the most part.

    I may be skating on thin ice in my desire simultaneously to expand the scope of what is "rational” without breaking through the ice into the tautological problem of defining any act as rational by definition. Without trying to parse words too much and get lost in semantics, I think that in almost any instance where someone makes an active decision to do or buy something, that decision is rational.

    Businessdictionary.com defines a decision as "a choice made between alternative courses of action in a situation of uncertainty.” (I deliberately went to a "formal” source for the definition instead of retreating to the Laxtionary.) While I make no claim to be a psychologist, a "choice,” to me, implies weighing options to come to a conclusion. This definition also explicitly incorporates the concept of uncertainty, which I think would be a close parallel to my point of limited information and imperfect ability to process information.

    Taking this one step further, I would argue that
    • A random choice is non-rational, in that it makes no effort at an informed decision. "Decisions” in games of chance, for example, are non-rational.
    • Any choice in which the consumer makes a decision that they think is best in which they try to understand their situation, the alternatives and the expected consequences of alternative choices , I would argue, is rational.
    • It seems to me that a decision is irrational only if the person explicitly ignores information (that they have, understand and can process) in making their decision, if they lack the cognitive skills to evaluate alternatives, or if they intentionally make a decision that they think is not best under the circumstances.

    I know my definition of rational may be more expansive than most, but I am reluctant to categorize a decision (or person) as irrational because their decision making calculus is different than what we have come to expect.

  6. I read an interesting book by Dan Ariely — Predictably Irrational — which gave a lot of examples where consumers make decisions that don’t appear to make much sense.

    One example: we tend to overreact to anything that is “free.”

    I think there is some truth in the notion that people make decisions for emotional and other reasons they can’t (or won’t) articulate, and then after the fact justify those decisions with rational explanation.

    If you’re unaware of the deep-down reasons why you chose one thing over another, does that make it rational, irrational, or just unconscious?

  7. Good point, Bob. Virtually all of the well-thought out models of loyalty and satisfaction include emotional dimensions as both part of the concept and as possible “drivers.”

    I know we are drifting into ever murkier terrain, but aren’t emotions, in many respects, another category of needs that are perfectly rational to satisfy? In fact, aren’t many emotional needs simply the unconscious, simplified shorthand for previously made decisions and experiences?

    Take brand preference, for example. Instead of reading every label on every product to evaluate the relative merits of all competitive products when we go into the supermarket (or any store or e-tailer site, for that matter), we subconsciously rely on our previous experiences and gravitate to brands and products that we trust and with which we identify.

    It seems to me that psychologists would defend satisfying "normal” emotional needs as perfectly reasonable that is, rational), even if we make such decisions subconsciously. Of course, I have hedged a bit, as "abnormal” emotional needs opens up a Pandora's Box of problems and contradictions. Maybe you'll cut me some slack on that point?

    (Oh, BTW, “Predictably Irrational” is next in line on my Kindle.)

  8. Howard, your argument seems to be that every decision is rational. Because any decision is made on either logic or emotion, conscious or subconscious.

    In my mind, rational means logical. With reasons that you could explain to another, disinterested 3rd party. Saying to someone else, “I decided to make that decision because it felt like the right thing to do” wouldn’t be recognized as “rational” by most people.

    And the dictionary seems to agree with me. Rational means:

    1. agreeable to reason; reasonable; sensible: a rational plan for economic development.
    2. having or exercising reason, sound judgment, or good sense: a calm and rational negotiator.
    3. being in or characterized by full possession of one’s reason; sane; lucid: The patient appeared perfectly rational.
    4. endowed with the faculty of reason: rational beings.
    5. of, pertaining to, or constituting reasoning powers: the rational faculty.

    Nothing here suggests that a decision made for emotional reasons is “rational” — although it still may be a good decision!

  9. I will accept that rational essentially means logical – but in the face of time constraints and limited, inaccurate or un-understandable information, our ability to exercise logic is, as I put it in my original post, "bounded.”

    While I wasn't basing my view on the work done by Daniel Kahneman (“Thinking Fast and Slow”), I will invoke some of his ideas in my defense. Kahneman argues that there are two "systems” of thinking. System 1 is the "fast” side, relying on intuition, assumptions, habits – and emotions.
    Most thinking, he argues, is driven by the quick, unconscious thinking done by System 1. System 2, by contrast, is for more conscious, deliberate, intentional reasoning.

    System 1 thinking meets all of the definitional criteria you present. The "economic man” assumptions of rationality, however, are 100% in the domain of System 2. But our decisions and behaviors are far more often driven by System 1 thinking, which does incorporate an emotional dimension.

  10. Yes, I completely agree that good decisions are based on logic and intuition. I just don’t think redefining “rational” is going to help people understand this. Unless your Laxtionary is more widely adopted!

    Perhaps the problem here is that being “irrational” is considered a bad thing in business. And no wonder. According to Wikipedia:

    Irrationality is cognition, thinking, talking or acting without inclusion of rationality. It is more specifically described as an action or opinion given through inadequate using reason , emotional distress, or cognitive deficiency. The term is used, usually pejoratively, to describe thinking and actions that are, or appear to be, less useful or more illogical than other more rational alternatives.

    Let’s hope Kahneman’s ideas are more widely adopted, along with a better language to describe decisions made for logical and “other” reasons hard to describe.

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