By: Dan Ariely

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Have you ever wondered why people make the decisions they do? Given the data rich world we live in, you would expect that we would make rational decisions. Not so.

In his book “Predictably Irrational” Dan Ariely provides us with a number of examples of why we just don’t act as we should. The analysis behind many of these ideas can be used to help us grow our business so spend the next ten minutes with us in finding out why the only thing that is predictable is our irrationality.

Humans rarely choose things in absolute terms. We don’t have an internal value meter that tells us how much things are worth. Rather, we focus on the relative advantage of one thing over another, and estimate value accordingly. Take Ariely’s example of TV’s in an electronics warehouse. Three sets are available for sale. One is priced high, one is priced low and one is priced somewhere in the middle.

Example 1: The Middle Makes Money

Now setting aside brand loyalty (and Plasma versus LCD), one TV is pretty much the same as another. So how do we decide which to choose? Who really knows if the Panasonic at $690 is a better deal than the Philips at $1,480? But given three choices, most people will take the middle choice. So guess which television the store prices as the middle option? That’s right, the one they want to sell!

We not only tend to compare things with one another but also tend to focus on comparing things that are easily comparable and avoid comparing things that cannot be compared easily. In essence, introducing set C, the cheaper version and decoy, creates a simple relative comparison with set B (the one the store wants you to buy), and hence makes set B look better, not just relative to set C, but overall as well.

As a consequence, the inclusion of C, even if no one ever selects it, makes people more likely to make B their final choice. The same twisted logic applies for the expensive option but in reverse. After all why pay more for something that you can get at a lower price! This is the problem of relativity we look at our decisions in a relative way and compare them locally to the available alternative.

Example 2: Anchoring - First Impressions Last

We’ve all seen the cartoon. The egg hatches and the chick identifies the first live thing it sees as its mother. Ariely wanted to explore if the human brain is wired like that of a gosling. Do our first impressions and decisions become imprinted? And if so, how does this imprinting play out in our lives? When we encounter a new product, for instance, do we accept the first price that comes before our eyes? And more importantly, does that price (which in academic lingo is called an anchor) have a long-term effect on our willingness to pay for the product from then on?

What Ariely set out to prove (described in detail in the book) was the existence of arbitrary coherence. The basic idea of arbitrary coherence is this: although initial prices are “arbitrary” once those prices are established in our minds they will shape not only present prices but also future prices (this makes them “coherent”).

In other words once consumers are willing to pay a certain price for one product, their willingness to pay for other items in the same product category is judged relative to that first price (the anchor). So take care when setting out charges for your products or services.

While initial prices are largely “arbitrary”, once those prices are established in our minds, they shape not only what we are willing to pay for an item, but also how much we are willing to pay for related products. Price tags by themselves are not necessarily anchors but they become anchors when we contemplate buying a product or service at that particular price.

Example 3: Self Herding: In with the In Crowd.

You’re walking past a restaurant, and you see two people standing in line, waiting to get in. “This must be a good restaurant” you think to yourself. “People are standing in line”. So you stand behind these people. Another person walks by. He sees three people standing in line and thinks, “this must be a fantastic restaurant” and joins the line. Others join.

Ariely describes this type of behaviour as herding. It happens when we assume that something is good (or bad) on the basis of other people’s previous behaviour, and our own actions follow suit.

When Howard Shultz created Starbucks, he latched on to this concept. He worked diligently to separate Starbucks from other coffee shops, not through price but through ambience.

Accordingly, he designed Starbucks from the very beginning to feel like a continental coffee house. Starbucks did everything in its power to make the experience feel different, so different that we would not use the prices at Dunkin’ Donuts as an anchor, but instead would be open to the new anchor that Starbucks was preparing for us. The third place.

Ariely takes this further and introduces the concept of self-herding. This happens when we believe something is good (or bad) on the basis of our own previous behaviour. You’ve already made the same decision many times in the past, so you’ve “brainwashed” yourself that this is the way you want to spend your money.

You’ve herded yourself, lining up behind your initial experience and now you’re part of the crowd. Where else can we see this effect? Clearly with Apple. From the “must have” appeal of the latest gadget, owned by the in crowd, to personally replacing that gadget with the latest upgrade, self-herding has been key to their success.

Example 4: Zero don’t mean nothing.

It’s no secret that getting something free feels very good. Ariel suggests ZERO is not just another price. He claims ZERO is an emotional hot button a source of irrational excitement. Would you buy something if it were discounted from 50 cents to 20 cents? Maybe. Would you buy it if it were discounted from 50 cents to 2 cents? Maybe. Would you grab it if it were discounted from 50 cents to ZERO? You bet!

Most transactions have an upside and a downside, but when something is FREE we forget the downside, FREE gives us such an emotional charge that we perceive what is being offered as immensely more valuable than it really is. Why? Ariel suggests it’s because humans are intrinsically afraid of loss. The real allure of FREE is tied to this fear.

There’s no visible possibility of loss when we choose a FREE item (it’s free). But suppose we choose the item that’s not free. Uh-oh, now there’s a risk of having made a poor decision, the possibility of a loss.

Zero is not just another discount. Zero is a different place. The difference between two cents and one cent is small. But the difference between one cent and zero is huge! If you are in business, and understand that, you can do some marvellous things. Want to draw a crowd? Make something FREE! Want to sell more products? Make part of the purchase FREE!

Example 5: Ownership creates a false perspective.

Ownership pervades our lives and, in a strange way, shapes many of the things we do. Much of our life story can be told by describing the ebb and flow of our particular possessions, what we get and what we give up. Ariel asks: Since so much of our lives is dedicated to ownership, wouldn’t it be nice to make the best decisions about this?

Wouldn’t it be nice, for instance, to know exactly how much we would enjoy a new home, a new car, a different sofa, and an Armani suit, so that we could make accurate decisions about owning them? In his research he identifies three “quirks” of ownership.

The first quirk is that we fall in love with what we already have. Ariel postulates: Suppose you decide to sell your old VW bus. What do you start doing? Even before you’ve put a FOR SALE sign in the window, you begin to recall trips you took. You were much younger, of course; the kids hadn’t sprouted into teenagers. A warm glow of remembrance washes over you. This applies not only to VW buses, of course, but to everything else. And it can happen fast.

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 as we do. We somehow expect the buyer of our VW to share our feelings, emotions, and memories. Unfortunately, the buyer of the VW is more likely to notice the puff of smoke that is emitted as you shift from first into second. So where does this apply in business? We must look at the world through our customer’s lens. We must make sure we see it from their perspective and not to get upset if they call our baby ugly.

Example 6: Options are Costly.

In the context of today’s world, we work feverishly to keep all our options open. We buy the expandable computer system, just in case we need all those high-tech bells and whistles. We buy the insurance policies that are offered with the plasma high definition television, just in case the big screen goes blank.

Ariel speculates whilst we might not always be aware of it, in every case we give something up for options. We end up with a computer that has more functions than we need, or a stereo with an unnecessarily expensive warranty.

We are continually reminded that we can do anything and be anything we want to be. The problem is in living up to this dream. We must develop ourselves in every way possible; must taste every aspect of life; must make sure that of the 1,000 things to see before dying, we have not stopped at number 999. But then comes a problem are we spreading ourselves too thin?

Doors of opportunity open regularly and running from door to door is a strange human activity. But even stranger is our compulsion to chase after doors of little worth opportunities that are nearly dead, or that hold little interest for us. What we need is to consciously start closing some of our doors. Small doors, of course, are rather easy to close.

But the bigger doors (or those that seem bigger) are harder to close. Doors that just might lead to a new career or to 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 things that are similarly attractive is one of the most difficult decisions we can make. This is a situation not just of keeping options open for too long, but of being indecisive to the point of paying for our indecision in the end.

Ariel 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 important we fail to take into consideration the relatively minor differences that would have come with either one of the decisions. So what’s the relevance to business?

If we offer every bell and every whistle to our client we are presenting them with options to evaluate. Options that will detract from the decision to purchase. Information overload. Let’s make it easy to make a decision. Take 37 Signals for example. A highly successful technology company but one that offers stripped down solutions. Solutions that meet the key needs and key needs alone. Is your service or product a gilded lily?

These are only a few examples of our irrational decision making. The book has so many more that I suggest you make a rational decision and go out and buy a copy. If you do you’ll find many more ways that understanding our predictably irrational behaviour can help your business grow.