Why People make Irrational Decisions every single day?
From the book Predictably Irrational by Dan Ariely
Predictably Irrational explains why people make irrational decisions every single day. The answer is tied to human instincts, but Dan Ariely provides in-depth explanations of how you can avoid these irrational decisions yourself. We struggle to eradicate these irrational behaviors ourselves as we attach them to rational thoughts and reason. However, Dan Ariely outlines why these rational thoughts are better attached to other behaviors and how we can apply these changes to help our businesses succeed.
Dan Ariely’s Perspective
Dan Ariely is an Israeli-American Professor of Psychology and Behavioral Economics at Duke University. He is also a founder of the research institution The Center for Advanced Hindsight. Dan’s research focuses on the irrational ways people behave, especially concerning economics. He is the writer of three New York Times bestsellers. Additionally, his TED talks have over 15 million views, and he is the co-founder of five successful companies.
Freebies Evoke Emotional Irrationality
We all have an emotional reaction to the word ‘free’. Even if we only need one of an item, buy two get one free encourages us to overbuy rather than rationally buy one. Additionally, it is not uncommon for people to carry useless free pens, notepads, and post-it notes back from conferences.
Dan explains that ‘free’ is not just a price, but is also a powerful emotional trigger. This emotional trigger has the potential to warp our rationality. For example, studies have been conducted into people choosing between tasty Lindt truffles for 15 cents each and Hershey’s Kisses for one cent. The vast majority (73%) would happily pay the extra money for the Lindt truffles. However, if you then offer the Hershey kisses for free and the Lindt truffles for 14 cents (the same difference as the first experiment), 69% of people choose Hershey’s kisses. The difference in price is the same in the two experiments. Still, the presence of something that is ‘free’ warps people’s rationality. Dan describes this as the ‘power of free.’
The Zero Price Effect
Humans struggle with any circumstances where there is the potential to lose things. However, if something is free, then there is no potential downside. Hence, the lack of risk makes us perceive these items as more valuable than they are. Dan encourages people to avoid being dragged into this effect themselves, but instead utilize it to benefit their business. If you offer something free, as part of your business, then you will start drawing a crowd. Additionally, if you want to start selling more of a particular product, you should make part of the purchase free.
The First Price We Hear Impacts Our Future Negotiations
Dan explains that the way we decide what we are willing to pay for products is far more irrational than we realize. The most rational approach to pricing would be to consider supply and demand and the utility of the item. However, Dan explains that we instead use arbitrary coherence. Essentially, no matter how arbitrary the first price we are provided, we will take this price as being coherent. Hence, this first price provides an anchor for determining a reasonable price in our future purchases.
For example, when a new type of technology hits the market, it is challenging for us to independently work out the predicted price of this technology. In this instance, we start looking for an anchor. Say we find the first pricing of this piece of technology on Amazon for $800. $800 now becomes our anchor, and any websites which are selling this technology for $750 will look like a fair price. Additionally, another website selling it at $850 will seem like a rip-off.
Interestingly, this anchoring effect can even be impacted by numbers that are not relevant to products. A study asked people to write down the last two digits of their social security number. Then, they were asked to bid on products in an auction. Those whose numbers were high, such as 96, paid much higher prices for items. In contrast, if the person’s last two digits formed a low number, such as 21, they were unwilling to bid on items unless they were bargains.
By themselves, price tags are not necessarily anchors, but they become anchors when we contemplate buying a product or service at that particular price.
We Overvalue Our Own
Dan explains that we think more fondly of things that we own. Once we own something, we start thinking of all the positive things we have done and could do with it. Therefore, we value these items more highly than other people’s items. Additionally, people have a disproportionate focus on what they are losing rather than gaining. Hence, we struggle to part with what we already own, meaning we heavily overvalue our possessions. Finally, as well as overvaluing what we own, we are unaware that we do this. Therefore, we expect other people to value the things we own in the same way. For this, Dan provides an example of people selling a house. Their house will be full of the quirky designs they like, and they will overvalue the aesthetic beauty of these designs. Hence, they will see these designs as a reason that buyers should pay more for the property. However, buyers will likely expect a discount on the house because of the flashy interiors.
At Duke University, basketball games are in incredibly high demand. Students will camp for days outside the stadium so that they can participate in a ticket lottery. The interesting part arises, though, when students win tickets and then look to sell them. Even though each student stands an equal chance of winnings and presumably initially valued the tickets in the same way, as soon as possession is involved, the pricing is warped. Those who win the tickets try to sell them for $2,400, as they value them so highly. In contrast, those who did not win the tickets are only willing to pay $170. These students started with the same valuation; the only change was their ownership of the tickets.
Dan provides an intricate example of how each of these biases can be incorporated into our decisions. The first quirk is that we fall in love with what we already have. Suppose you decide to sell your old VW van. Even before you’ve put a ‘for sale’ sign in the window, you begin to recall the trips you took in it. You were much younger, and the warm glow of remembrance washes over you. This impacts on your pricing. Then, the second quirk he identifies is that we focus on what we may lose, rather than what we may gain. When we price that beloved VW, we think more about what we will lose (the use of the bus) than what we will gain (money to buy something else). As soon as we begin thinking about giving up our valued possessions, we are already mourning the loss. Finally, his third quirk is that we assume other people will see the transaction from the same perspective. We somehow expect the buyer of our VW to share our feelings, emotions, and memories. Unfortunately, the VW buyer is more likely to notice the puff of smoke that is emitted as you shift from first into second. So, how does this apply to business? We must look at the world through our customers’ lenses. We must make sure we see it from their perspective.
Expectations Shape Our Experiences
Our expectations, based on our previous experiences, radically influence how we experience things. Dan provides an example of how Pepsi and Coke both say that consumers prefer their cola’s taste. They make this argument as consumers say they prefer Coke’s taste if the branding is on view. However, in a blind taste test, Pepsi comes out on top. Therefore, people’s mental image of Coke as a brand alters their experience of the cola.
A similar example is movies that have outstanding reviews. We are more likely to enjoy a movie if it has won multiple awards and received critical acclaim. We can even see this effect with medical interventions. Specifically, the placebo effect. Those who are more open to the idea of medication working have better medical outcomes. Similarly, more expensive medicine has been found to have a greater impact on people, even if it is not any different than a cheaper alternative. Finally, those who paid more for an energy drink performed better on a puzzle than those who had paid less for the same energy drink.
In essence, our expectations have a significant impact on our behaviors and significantly impact our genuine experiences. We should be applying these norms depending on the given situation. The norms will impact our expectations we are using.
Responses Are Either Dependent on Social or Market Norms
Dan explains that there are two types of norms in the world: social norms and market norms. Social norms are relevant to friendly requests and favors, while market norms relate to resources being exchanged. There are certain circumstances where using the wrong norm will have detrimental results. For example, you would not want to offer your co-worker a hug goodbye at the end of the day. Similarly, you wouldn’t want to offer your mother money for a meal she has cooked for you, or a girl/boy money for going on a first date with you. Therefore, we have to understand that certain norms apply to certain situations.
Dan outlines that market norms are generally more selfish. It is possible to benefit economically from invoking requests relevant to specific norms at the right time. Dan provides the example of lawyers. If you ask a lawyer to offer cheaper services to needy individuals, they, more often than not, will say no. The issue with this request is that it relates to market norms, which are cold, calculated, and about exchanging resources. However, if you instead ask lawyers for pro bono work for needy individuals, you are far more likely to succeed. Hence, Dan suggests that you think about the occasions when you should mention money. Mentioning money will almost always activate people’s market norms. It is impossible to revert people to social norms when market norms have been activated. Therefore, consider encouraging warm and unselfish social norms by choosing your requests wisely.
We Are All a Little Bit Dishonest
Dan explains that several studies suggest that most people are a little bit dishonest. One of these studies included a math quiz that incorporated small rewards (money). This study found that most people would cheat by exaggerating their performance if given the opportunity of marking their work. Interestingly, even if the chances of being caught became almost impossible, people did not cheat more than they did in the first condition. These results suggest that we only tend to cheat/lie a little bit, rather than a lot.
As well as dishonesty reaching a limit, we are more likely to be dishonest about the smaller things in life. For example, we are more likely to steal a pen or coffee mug from work than money. In fact, Dan explains that we are generally more dishonest when money isn’t involved. It is easier to rationalize dishonesty with items rather than money. The majority of people accept that dishonesty is wrong, so we are generally unwilling to be dishonest unless we can rationalize it. Hence, we tend only to lie a little bit and only lie if we can rationalize it.
Despite these tendencies, Dan explains that we can reduce the likelihood of others and ourselves being dishonest. If we encourage others to think about honesty before a task, they are much less likely to cheat or lie. Dan provides the same example of a quiz for monetary prizes where cheating is possible; however, participants have to read the ten commandments beforehand with this example. In this condition, nobody cheated at all. Just priming people before a task can help prevent us from being a little bit dishonest.
Make Long-Term Goals but Also Fight Your Short-Term Urges
Dan describes our lives as being like a combination of Dr. Jekyll and Mr. Hyde. We are continually looking to better ourselves and make more rational and reasonable long-term goals. This is our Dr. Jekyll side. Despite this, we also have a Mr. Hyde side that impinges on these long-term goals. Mr. Hyde is impulsive and uncontrollable, taking over and doing the opposite of what Dr. Jekyll suggests.
For children, this is why they understand and plan to practice safe sex, but their rational side can be overcome during the passion of arousal. For adults, we make the same mistakes. We create long-term goals for our careers and life. However, instead of attaining these goals, our rationality is often overcome by procrastination.
Despite this, Dan suggests that we can reduce our likelihood of procrastinating. He provides the example of a study conducted with university students, who are notorious procrastinators. This experiment showed that students were able to acknowledge their weaknesses if able to set their deadlines. Accepting their weaknesses allowed them to set small, evenly-spaced deadlines throughout the course rather than being given deadlines and procrastinating until the last minute. Those students who were able to acknowledge their weaknesses and adapt their goals accordingly were able to prevent procrastination. Subsequently, they received far better grades than the students who had one big deadline at the end of the course.
These are the tips that Dan provides on preventing procrastination:
Pre-commit to deadlines and restrictions
Attach a short-term gratification to unpleasant actions, such as eating your favorite food while working on something that you find incredibly boring
Keeping Your Options Open Will Hurt You in the Long Run
Many people believe that leaving your options open is the best approach to take in an uncertain world. We buy the latest piece of technology to have the option of every high-tech action, even if we will never use them. We then buy insurance policies that come with this technology, just in case you change your mind. In the end, we are left with technology that has more functions than we need and high insurance costs that we will never actually use. Keeping your options open is an expensive choice, and multiple studies and historic examples support this.
Dan provides a historical example of the Chinese commander, Xiang Yu. Xiang Yu was a leader in 210BC and had the task of ferrying his army across the Yangtze River. After doing this, he set fire to his ships. Although extreme, this was an example of a leader closing down options so his army could focus on one thing: fighting. His army was then fully motivated to fight, as there was no other option, and they won nine battles in a row.
Some studies support this idea. Dan describes a study where people were offered real money when playing a computer game. Participants were able to earn this money by letting options close. Alternatively, they could lose money to keep options open. Even in a game setting, with money to be gained, the desire to irrationally keep options open is too strong. The majority of participants decided to keep their options open and obtain no real money.
Dan explains that we have to close options in our lives to focus on one goal that is the most important to us. We are repeatedly told that we can do whatever we want in life and be whoever we want to be. The problem with this way of living is that we keep our options open to change our minds, but we then never achieve any of our long-term goals. We are spreading ourselves too thin. Hence, Dan recommends we start consciously start closing some of our doors. The small doors in our lives will be easy to close, but the bigger ones will be much harder. For example, doors that might lead to a new career or a better job might be hard to close. Doors that are tied to our dreams are also hard to close. So are relationships with certain people, even if they seem to be going nowhere.
Choosing between two similarly attractive things is one of the most challenging decisions we can make. This is a situation of being indecisive to the point of paying for our indecision.
Dan believes what we fail to do when focusing on the similarities and minor differences between two things is to take into account the consequences of not deciding. More importantly, we fail to consider the relatively minor differences that would have come with either one of the decisions.
These indecisions have a considerable impact in the business world. If we offer every bell and whistle to our client, we present them with options to evaluate. These options will detract from the decision to purchase. Therefore, we should be aiming to make it easy to make a decision.
The Middle Makes Money
When deciding between items, there is often very little that sets them apart. We might think that people would then go for the cheapest option. However, the reality is that when given three options, people typically choose the middle option. Hence, companies put the item they most want to sell as their middle-priced item.
This effect is created as we tend to focus on comparing things that are easily comparable and avoid comparing things that cannot be compared easily. In essence, set C is the cheaper version and acts as a decoy. Set C creates a simple relative comparison with set B (the one the store wants you to buy) and makes set B look more premium. However, set A is also included as a more expensive option; making set B also look like a bargain. We look at our decisions in a relative way and compare them locally to the available alternative. This is a tactic that can be adopted when choosing how to price services in your business.