McKinsey: A marketer’s guide to applying behavioral economics

TakeAway: Marketers have been applying behavioral economics—often unknowingly—for years. A more systematic approach can unlock significant value.

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Excerpted from McKinsey Online: A marketer’s guide to behavioral economics, Feb. 2010

Long before behavioral economics had a name, marketers were using it.

“Three for the price of two” offers and extended-payment layaway plans became widespread because they worked — not because marketers had run scientific studies showing that people prefer a supposedly free incentive to an equivalent price discount or that people often behave irrationally when thinking about future consequences.

Here are four practical techniques that should be part of every marketer’s tool kit.

1. Make a product’s cost less painful 
In marketing practice, many factors influence the way consumers value a dollar and how much pain they feel upon spending it.

Retailers know that allowing consumers to delay payment can dramatically increase their willingness to buy.

One reason delayed payments work is perfectly logical: the time value of money makes future payments less costly than immediate ones. But there is a second, less rational basis for this phenomenon. Payments, like all losses, are viscerally unpleasant. Even small delays in payment can soften the immediate sting of parting with your money and remove an important barrier to purchase.

Consumers use different mental accounts for money they obtain from different sources.

Commonly observed mental accounts include windfall gains, pocket money, income, and savings. Windfall gains and pocket money are usually the easiest for consumers to spend. Income is less easy to relinquish, and savings the most difficult of all.

2. Harness the power of a default option
The evidence is overwhelming that presenting one option as a default increases the chance it will be chosen.

Defaults — what you get if you don’t actively make a choice — work partly by instilling a perception of ownership before any purchase takes place, because the pleasure we derive from gains is less intense than the pain from equivalent losses. When we’re “given” something by default, it becomes more valued than it would have been otherwise — and we are more loath to part with it.

An Italian telecom company, for example, increased the acceptance rate of an offer made to customers when they called to cancel their service. Originally, a script informed them that they would receive 100 free calls if they kept their plan. The script was reworded to say, “We have already credited your account with 100 calls—how could you use those?” Many customers did not want to give up free talk time they felt they already owned.

Defaults work best when decision makers are too indifferent, confused, or conflicted to consider their options.

That principle is particularly relevant in a world that’s increasingly awash with choices — a default eliminates the need to make a decision.

3. Don’t overwhelm consumers with choice
When a default option isn’t possible, marketers must be wary of generating “choice overload,” which makes consumers less likely to purchase.

Large in-store assortments work against marketers in at least two ways.

First, these choices make consumers work harder to find their preferred option, a potential barrier to purchase.

Second, large assortments increase the likelihood that each choice will become imbued with a “negative halo” — a heightened awareness that every option requires you to forgo desirable features available in some other product.

Reducing the number of options makes people likelier not only to reach a decision but also to feel more satisfied with their choice.

4. Position your preferred option carefully
Economists assume that everything has a price: your willingness to pay may be higher than mine, but each of us has a maximum price we’d be willing to pay.

How marketers position a product, though, can change the equation.

Marketers sometimes benefit from offering a few clearly inferior options. Even if they don’t sell, they may increase sales of slightly better products the store really wants to move.

Similarly, many restaurants find that the second-most-expensive bottle of wine is very popular — and so is the second-cheapest.

Customers who buy the former feel they are getting something special but not going over the top.

Those who buy the latter feel they are getting a bargain but not being cheap.

Sony found the same thing with headphones: consumers buy them at a given price if there is a more expensive option — but not if they are the most expensive option on offer.

Marketers have long been aware that irrationality helps shape consumer behavior. Behavioral economics can make that irrationality more predictable.

Understanding exactly how small changes to the details of an offer can influence the way people react to it is crucial to unlocking significant value—often at very low cost.

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