Understanding Consumer Behavior through the Lens of Behavioral Economics
In a fast-changing world where organizations struggle to understand and anticipate the behavior of customers, the domain of consumer behavior is gaining prominence. With the emergence of cutting-edge economic models, consumer behavior has evolved to blend behavioral economics, behavioral psychology, and marketing theory into an interdisciplinary field, helping companies comprehend consumer behavior in depth. Amid fluid economic conditions, companies across industries are also looking for ways to mitigate their costs and increase the efficacy of their workforces. To achieve efficiency and higher profit margins, organizations require new insights to guide them in their decision making. However, many of the classical economic models that can be used to predict consumer behavior can be quite limited in effectiveness, because they assume perfect self-interested rationality in decision-making. Behavioral economics—which is making inroads into the commercial world, especially the CPG space—addresses these challenges by equipping market researchers with new insights to more accurately predict consumer behavior in multiple markets, precisely because they incorporate predictions of irrationality in decision-making.
Trends and Challenges in the CPG Industry
Behavioral economics is such an intriguing discipline that it is garnering global attention, primarily because of its ability to provide insights into unconscious psychological factors that influence consumer behavior. Classical economics is premised on the idea that human beings are perfectly rational and that people’s decision-making capability is based on self-interest. However, behavioral economics abandons those assumptions and instead reliably anticipates how behaviors might be influenced by irrationality and imperfect decision-making. By drawing on insights from human psychology, behavioral economists have achieved better success rates in predicting human reactions to a broad range of circumstances. Regardless of the intended outcomes, organizations can significantly improve predictions of consumer behavior by incorporating concepts from behavioral economics.
Compared to extrinsic motivation, intrinsic motivation is far more potent. Applied to the workplace, it makes an employee treat a job like a hobby, experiencing inherent joy and thereby investing more time ensuring success
Consumer behavior encompasses several useful elements that can be incorporated into market research and data analysis to effectively communicate the value of products/services. For instance, Robert Cialdini, the author of the seminal work ‘Influence,’ outlines several factors that disproportionately influence consumer behavior including (among others) reciprocity, social proof, and scarcity. Borrowing these ideas can drive buying decisions and increase customer loyalty to a greater degree. The concepts can be tested in randomized controlled trials to measure their impact in the marketing of CPG.
In a famous experiment, Cialdini himself tried to determine the most impactful communication techniques to encourage consumers to decrease their electricity consumption. The author placed banners at random houses with messages such as “use less energy to save the environment,” “use less energy to save it for future generations” and “use less energy because your neighbors use less energy.” Not surprisingly to Cialdini, only the last message moved the needle, based on the power of social proof. The experiment points to the fact that anticipating rationality as the driving force behind consumer behavior can be a flawed approach.
In a professional capacity, the challenge lies in encouraging employees to care about their job and be dedicated to the success of the organization. At ADP, we have the opportunity to examine at all the different areas of HCM in which we play a pivotal role across industries, and we are trying to understand how behavioral economics can be applied to design better and more effective products and services. Moreover, behavioral economics may help us achieve outcomes that were otherwise impossible in the past.
Having graduated college with a BS in consumer economics, I was trained as a classical economist to build models based on the assumption that people’s behavior is driven by rational self-interest. In receiving my Master’s degree in Industrial/ Organizational Psychology, I gained far more insights into non-rational drivers of human behavior. Subsequently, I design behavioral models considering various organizational scenarios relative to actual, as opposed to rational, human behavior. In other words, I prioritize the “would” over the “should.” As an example, consider employee motivation. Motivation can be categorized into two types: intrinsic and extrinsic. Extrinsic motivation is driven by external factors and rewards and punishments. These might include promotions, commissions, professional recognition, or demotions and demerits. Intrinsic motivation is driven by internal factors. In other words, doing something simply because someone wants to. Compared to extrinsic motivation, intrinsic motivation is far more potent. Applied to the workplace, it makes an employee treat a job like a hobby, experiencing inherent joy and thereby investing more time ensuring success. Unfortunately, intrinsic motivation is something that most employees lack in the workplace.
The Real Motivation
Organizations can trigger intrinsic motivation by focusing on three essential elements identified by Deci and Ryan in their seminal Self-Determination Theory: autonomy, mastery, and relatedness. In the business world, autonomy is the freedom to determine how to perform the job, while mastery refers to the ability to demonstrate expertise and achievement in that performance. Relatedness refers to the ability to connect professionally with other people, such as colleagues, customers, and clients. By designing jobs and workplaces that enable and empower these elements, organizations can drive the intrinsic motivation of employees, leading to sustained excellent performance.
In behavioral economics, framing explains how an identical piece of information presented differently, can induce wildly divergent reactions. For example, consider a doctor counseling a patient. The doctor could tell a patient about having contracted a disease with a 90 percent survival rate, or with a 10 percent mortality rate. Although the information is the same, people will have widely different reactions.
At ADP, we wanted to put this technique into practice around feedback and leadership development. Let’s consider a leader who received feedback that he/she is not providing sufficient recognition to the team. We found that when the feedback was presented in terms of deficiencies of the leader, it triggered a defensive reaction. Leaders receiving feedback this way tended to discount and discredit it, thereby not using it as the basis for future development work. When the feedback was presented in terms of team needs, it led to much more productive reactions. When leaders heard, “Your team has high needs for recognition,” they were much more likely to embrace the feedback than if they heard, “You don’t give your team enough recognition.” We baked this insight into a product called Compass, and it is leading to extraordinary results. It’s a great example of how using behavioral economics can help us to be more impactful in our efforts to positively influence our clients, customers and employees.