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Applying principles of behavioural economics to save money!

  If you think you are immune to making irrational decisions, you are suffering from what is known as ‘Bias Blind Spot’, a type of cognitive bias where one recognises the impact of biases on the judgement of others, while failing to see the impact of biases on one’s own judgement. Wondering what the correlation is between cognitive bias and saving money? Read on!  

Do you often wonder how so many people are just plain irrational?
But you are not one of them!
You make completely logical decisions based on facts.  Right?
In reality, human beings are incredibly irrational creatures. We make innumerable illogical decisions every day, and don’t even realise it.  To make matters worse, we also convince ourselves that these decisions were the correct ones to make.
Well, it all comes down to cognitive biases.  What are they?  Cognitive bias is a systematic error in thinking that affects our decisions and judgements.  These biases may arise due to memories, attention or simply through the evolution process, but they exist and influence the way we see and think about the world.
Let me give you examples that might help you save money and help you make sound choices!  Let us start with a small example.
Let’s say you worked very hard during the entire year for the Common Aptitude Test (CAT), and took the test on 25th November.  I present you with two outcomes –
A: You received a 99th percentile rank.  How would you react?  Without doubt you would attribute it to your own awesomeness – you worked hard, and you are intelligent!  Isn’t it?
B: Unfortunately, you ended up with only 80th percentile rank.  How would you react? More often than not, the blame would be on other factors – bad luck, the test centre was too cold, the faculty did not explain the subject correctly, or your roommate kept you up all night before the test. 
While, the excuses given could be true, they don’t paint the complete picture of all the circumstances that led to your performance in the test.  This phenomenon is known as the Self Serving Bias, a tendency to attribute positive outcomes to our own character, but attribute negative events to external factors.
Yes, I do remember that I promised to give you examples on how you are making irrational decisions every day, and how you can save money.  There is no arguing that e-commerce now is ubiquitous.  So, why don’t we try to save some money there? I am going to give you 5 examples of cognitive biases (there are just too many!) and how your favourite e-commerce company exploits them to make money.  Hopefully, when you become aware of these biases, you can make more informed choices. Sounds great, right? Here we go!

The Bandwagon Effect
The Bandwagon Effect is extremely common. Simply put, it is the general tendency for people to congregate to an idea / action / belief just because there are many other people already buying into it.  It encourages popularity simply by riding the already-existing popularity. 
There are several great applications where the Bandwagon Effect plays a role in driving sales. Do you remember your last purchase online?  Did you look at the product’s ‘rating’ before making that purchase?  There you go – you too have joined the bandwagon!  In e-commerce, reviews and ratings can have a significant influence on conversion (purchase).  A ‘5 Star’ review by itself means nothing, but an average 4/5 Stars from 1,000 reviewers can easily sway your purchase decisions, because you assume these rating to be the much needed ‘social proof’ in the absence of any experience with that product or service.
The problem with social reviews and ratings is that it can be manipulated.  The case in point is a restaurant called, “The Shed at Dulwich”, which really is an entirely fake restaurant but was at one point the top-rated restaurant on TripAdvisor. The listing on TripAdvisor has been removed since, but there still is a Facebook page, where it is rated 4.9/5 based on 355 people (bottom image)!

The Framing Effect
We often react based on the manner in which various options are presented to us.  This can happen even when the information is essentially the same.  This is known as the Framing Effect! 
Let me give you one example – suppose, you are taking a family member to a doctor for a critical operation.  You know that the doctor has 90% success rate in performing that operation.  Just before you are leaving, a relative meets you and tells you that the doctor is not that skilful, as about 10 out of 100 of his patients have perished.  Will you change your decision in the light of this new information?  If your answer is yes, then explain, why?  Look carefully again: the information that you have, and one that your relative has, are essentially the same.  Aren’t they?
Booking.com is known to effectively utilize the Framing Effect and sway how users view booking hotels on its portal.  Normally, users might not think that other people want the same room, but Booking.com makes it very clear how many other people do (image above).

Loss Aversion
How many times have you received emails or SMSes regarding the “Limited time offer!”?  Do check your inbox – if you receive any newsletters for any brand—you are sure to have received some “Last Chance to Buy” emails in there.  In fact, these communications are making you acutely aware of the fact that you are ‘missing out on something amazing’.  
It is pretty interesting how e-commerce companies imply to the customers that they already have something (their money), but that by not buying their products or services, they are actually losing their money to a choice that has less value.  How do customers perceive these messages?  They think that it really is not about saving money, but preventing the loss by purchasing another option!
Another way of using loss aversion is by offering customers an opportunity to use your products or services for free or at discount for a limited time.  If they really like what they received, and they get used to using the product, they will not want to give it up when the trial period ends, because that would be a loss.  The customers are more likely to pay for subsequent use.

The Decoy Effect
A consumer’s preferences for either option A or option B changes in favour of option B, when option C is presented, which is similar to option B but in no way better. It works well when option C is completely inferior to option A, but on par with option B.  When option C is present, it makes option A more attractive than if the options were merely A and B.  Here, option
C works as a decoy in favour of option B!
Mobile phone manufacturers and software services providers are known to use this strategy.  You can see in the image (bottom), the F-Secure antivirus gives 3 options to home users – Total, Safe and Freedom VPN.  The last one is a decoy.  Usually, the Safe bundle would sell most.

The Isolation Effect
When multiple similar objects are present, the one that differs from the rest is most likely to be remembered, and this phenomenon is known as the Isolation Effect. In practice, people value a thing differently depending on whether it is placed in isolation and whether it is placed next to an alternative.  So, a certain product can be made to look more attractive if it is placed next to an alternative, relative to which it is distinctively better in some respect.
When I put the query ‘men dress’ on Google, I got these results shown in the image above.  Which one did you notice first?  I noticed the last one, because it is worn by a man, over a white tee, and it really stands out because of the background!
Finally, a few parting words that I must share. Please do not confuse cognitive biases with logical fallacies.  These two arise for completely different reasons.  A logical fallacy stems from an error in a logical argument, whereas a cognitive bias is rooted in errors in thought process, often arising from problems with memory, attention, attribution, and other mental mistakes.  The good news is that biases can be controlled, and the first step is to be informed about them.  By reading this article, you have already started the process! So, try to learn more about the topic, which will prepare you to think objectively in situations when bias threatens your rationality.