Behavioural economics - lessons from an ad man

Some of the most interesting academic work comes from collisions and overlaps between diverse fields and disciplines. As the dust begins to settle from the financial crisis Economics IMO needs to listen and draw more from Psychology, History and Biology. We need less Maths and more humanity and we can do much from approaching knotty policy dilemmas from different points of view.

In this spirit, Rory Sutherland the “Fat bloke at Ogilvy” gave a fascinating and illuminating talk on some of the lessons of behavioural economics applied to the world of advertising and marketing in his talk at the LSE this afternoon - it was totally worth the train journey into London to hear a speaker whose positive engagement with his audience put others to shame. How refreshing it was to hear from a speaker undaunted and unaffected by the doctrines of classical economic thinking.

Here is a snapshot of Rory’s journey through some great microeconomics!

1/ Pricing and value. Tesco is not really appreciated by people for what they do - which is to drive prices down for household basics - but do lower prices for basic models actually make people any happier? Not really - because there is little intangible value in a Tescos product, it doesn’t make the heart beat faster.

2/ Rarity value and the environment: It is human nature to attach rarity value to items that are scarce relative to demand (diamonds, blue-fin tuna, truffles, leather seats in vehicles) but this can be a catastrophe for the environment. Whereas Coca Cola or pizza (products with largely synthetic value) are ultra efficient to manufacture and distribute and their environmental footprint in the long run is smaller.

3/ Advertising tinkers with perceptions but this is not necessarily a bad thing - especially when it comes to marketing premium brands where money has been invested in the reputation attached to the product. Brands are an insurance against rip-offs - a form of signalling to consumers. Why are tourist restaurants invariably crap compared to local diners? Because of the importance of consumer feedback and because tourist joints have no commercial interest in recurring business (this may be changing a little with the explosion of social networking and sites such as Trip Advisor).

4/ Why do so many people eat pizza? - There are some good demand and supply-side explanations

* Most people quite like it (it has some of the characteristics of a universal blood group)
* It is suitable for people of varying appetites (how many of you eat a whole one? how many of you are happy to share even in a restaurant?)
* Easy to mash up / customise (bland, spicy et al)
* Ability to reuse the next day (something to do with the tomatoes?
* Cheap ingredients
* Cheap to transport
* Low overhead costs
* An affordable web 2.0 food! (lots of user generated content!)

5/ Asymmetric information - most of the purchases we make are massively asymmetrical because we pay for it before we consume it. we can only see whether something was good value after the event with the benefit of hindsight. Partly because of this more consumers than economists are prepared to admit are engaged in a constant war of ‘risk reduction’ when they make buying decisions. Crap avoidance rather than an orgy of optimisation. This is one reason why McDonald’s is so successful despite being loathed by people who then go and eat in one of their outlets. In most towns and cities in the world McDonald’s is the least-worst option when hungry and there is less chance of a disaster than almost anywhere else!

6/ Persuasion rather than compulsion: Advertising is an under-rated means of changing outcomes and can do so in a highly efficient way. TV commercials explaining how to reduce the risk of house fires, hard-hitting adverts on drink driving, commercials on smoke alarms. Too often we look for expensive engineering solutions to problems rather than using the power of persuasion. Rearranging neurons and neural pathways is an under-used art. A gentle nudge or a piece of timely information can be more effective than traditional views about using taxation and other financial ploys to change incentives.

* Allowing young people to donate to charity by text message has changed the dynamics of giving by the young
* Level crossings that have a timer telling motorists how long they will wait before driving off again
* Adding new distribution channels to familiar products creates huge opportunities for increased demand (a reason why there are so many vending machines outside shops in Japan!)

7/ Marketing is drawing heavily on behavioural traits to become more effective

* Banner ads trying to sell £800 flat screen TVs target people looking for £3000 holidays
* Staged tasks (known as chunking) increase the chances of consumers achieving desired outcomes

Most of all, here is value from getting people to look at things differently. Most economic growth comes from lots of small ideas that bring about small but positive changes in people’s daily lives. Intangible value matters and should be cherished. A wonderfully simple lesson from a presentation that was a cut above the rest I have heard this year!