He split his presentation into two sections. The first half focused on the main ways in which we don’t understand money as well as we may think. While the second half looked into the field of behavioural economics and what it aims to achieve.
We deal with money numerous times a day, almost every day. Most people would say they understand the concept of money well, but in reality we make a lot of poor decisions when parting with our cash.
Each time you buy a good or pay for a service, your thought process ought to think about the opportunity cost. What trade-off do you make when you buy your morning coffee for £2.80? Will you be better off with your flat white?
Ariely argues very few people think in these terms. And it’s not exclusive to inexpensive goods. He conducted a survey in a Toyota garage, and no-one could explain what they would not be able to buy if they went through with the purchase of their new car. “A Honda” was the best he got…
In most walks of life humans have evolved well. Our physical world is full of innovation and development, but we need to work harder to overcome our mental challenges.
Our lives are complex, and this does not help us when it comes to money. If we were given a daily budget of £50 the chances are we would be more rational. If you spent more on breakfast, it’s clear that you would have less for lunch and then dinner for example. However, we are paid monthly, with a diverse set of outgoings – mortgage, utility bills, council tax, phone bill, school fees etc. This structure makes the trade-off between what we want and what is best far more blurry.
Our instincts do not help us either, and there are three main ways our minds conspire against us.
Our instincts mean we instinctively think about the relative value of money.
Example:
Scenario A. Imagine you are in a shop and are about to buy a pen for £15. When you go to purchase the pen, the cashier tells you they have another shop 250 meters down the road. In that shop, they currently have a sale on the exact same pen and it will only cost you £8.
Outcome. It’s a nice sunny day, most people walk to the other shop to buy the pen. It’s almost half-price!
Scenario B. Imagine you are in a luxury retailer about to buy a new suit for £1015. When you go to purchase the suit, the cashier tells you they have another shop 250 meters down the road. In that shop, they currently have a sale on the exact same suit in your size and it will only cost you £1008.
Outcome. Even though it is still a nice sunny day, most people will just buy the suit for £1015. The discount is just not worth it.
Lesson. As humans, we are very vulnerable when spending large amounts of money. Our bank accounts don’t mind where the hypothetical £8 saving comes from but our instincts turn the decision into a relative concept.
When we part with our money, we feel differently depending on how and when it’s done.
Example
Scenario A. Imagine you’ve booked a luxury 10-day cruise and you’re asked to pay for it online 6-months before the cruise takes place.
Scenario B. Imagine you’ve booked a luxury 10-day cruise and you’re asked to pay in cash the moment you get off the boat at the end of your holiday.
Outcome. The rationale holiday goer would opt for Scenario B. But few would choose this option, and it would impact your enjoyment of the trip.
Example
A study was conducted into the way in which households pay their electricity bills. Energy firms moved a section of their consumer base to monthly direct debits, from handwritten cheques. Over the course of the study, they found households who began paying by direct debit used 4% more electricity on average.
Lesson. The direction of travel for payments is likely to make us worse at making good decisions with money. Credit cards, contactless, one-click etc. are all conspiring to make paying for goods easy. By taking the pain away, technology is likely to make us more irrational.
We don’t appreciate goods for themselves. We appreciate them for what has gone into producing them.
Example
There are a number of businesses which are very good at showing their effort to ensure customers appreciate their service and pay their wages.
Some businesses are terrible for showing their effort.
Lesson. As a business, you must show/describe the effort you go to in order to generate more appreciation for the service you offer and justification for the cost. I think this is important to remember for HL.
Behavioural economics seeks to help people make better decisions. To do so, first you must reduce friction and then increase motivation.
There is a difference between what people want and what they do. This difference is explained by friction. There are many instances where we choose the path of least resistance. Not because it is what we prefer, but because it is easier. If you can alleviate friction, you give yourself access to untapped demand.
So, as a business the question we should be asking ourselves is “where is the ideal behaviour not the easiest one?” if you find these questions, and make them easier, you unlock opportunities.
From there, you have to add extra motivation.
A good example for us is household saving. We know the savings rate has fallen significantly in the UK, but why?
We live in an asymmetric world, where saving is invisible and spending is very visible. It’s unlikely you know how much your neighbour is saving each month but you probably have a better idea of what their spending is like. Equally, there is little positive reinforcement from your family if you save £200 a month because they may not know, nor will they feel the immediate benefit. Whereas, if you brought home a £200 present each month, you will receive instant appreciation.
People know they should save more but we must help give them the motivation to do so. At HL we have a history of reducing friction. I think we could be better at providing added motivation.
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