I’ve always been fascinated by the mysterious ways of the human mind. Why we do what we do in certain situations and why we act sometimes totally irrationally. Dan Ariely’s book, Predictably Irrational, attempts to explore this question. He investigates irrationality from different aspects such as market dynamics, human relationships and government policy, but the implications may be valid in any field that involves human decision making.
The book makes for an exciting read. However, if you wanted to be mean, you could say it’s no more than the detailed description of a series of experiments. In addition, all the experiments were performed at a few of the top US universities, which means the samples are not representative of the whole country, let alone other countries and different demographics.
Put that aside, some of the results are thought provoking and could give most of us ideas that could potentially improve our lives.
This is not a review or a critique of the book, but a highly subjective summary of its takeaways and is obviously full of spoilers. Feel free to use it for your own purposes, and buy the book if you want to get the details.
If you’re looking for a more objective summary, you’ll find it here.
1. The Truth about Relativity
The Economist wanted to offer these subscription options:
1. Internet-only subscription for $59.
2. Print-only subscription for $125.
But they realized that very few people would pay that much for print so they added a twist.
1. Internet-only subscription for $59.
2. Print-only subscription for $125.
3. Print-and-Internet subscription for $125.
By adding this third option for the same price as the second, they changed the basis for comparison. In this new setup, you essentially get the online for free (which doesn’t cost them much anyway) if you pay for the print, which makes the 3rd option much more attractive. Also, you’ve got two options for the same price, which makes it easy to compare those two and choose the better one, and disregard the first option even if it’s half the price.
The proportion of people (students in an experiment) who went for different options when presented with these choices:
1. Internet-only subscription for $59. – 68%
2. Print-only subscription for $125. – 32%
1. Internet-only subscription for $59. – 16%
2. Print-only subscription for $125. – 0%
3. Print-and-Internet subscription for $125. – 84%
The logic behind this is that we have no idea about the real value of each option (and of most products in general for that matter). The best we can do is compare the cost and benefit related to each one.
The same thing happens if we are in the market for a house and are presented with three options.
3. Colonial with damaged roof for lower price
You are much more likely to buy number two, because you can compare it to another one, which is similar, but worse over all. Number one is difficult to compare, so you won’t even consider it. Chances are your agent wants you to buy number two and put the other two in there to make sure you do.
Another example: you are shopping for a trip. Your agent shows you a trip to Rome and a similar one to Paris for the same price. You have no idea which one to choose. Then your agent changes the package. Rome comes with breakfast, Paris doesn’t. Now it’s easy to decide.
The most frightening place to catch this phenomena in the act is dating. There are three options again:
1. A good looking person
2. Another good looking person
3. A slightly less good looking person, similar to number 2
75% of people will choose number 2. Again, because it’s easy to compare 2 to 3 and 2 is clearly better. 1 never stood a chance.
2. The fallacy of supply and demand
The point this chapter makes is that most of the time we have no idea of the inherent value of a certain product and what we’re willing to pay for it depends on lots of things, but the first price tag associated with that product has a decisive role. Turning this around, if you are launching a product don’t necessarily base your pricing on your costs or the competition’s prices, but take into account your potential buyers perception of your product. Going one step further, create a perception that supports your pricing policy. This is how some people can get away with charging ten times the price for the same thing as others.
Or, as Mark Twain once noted about Tom Sawyer, “Tom had discovered a great law of human action, namely, that in order to make a man covet a thing, it is only necessary to make the thing difficult to attain.”
Two interesting concepts:
1. Arbitrary coherence.
This one refers to a situation in which our judgement is initially influenced by often random anchors, but our following decisions will be coherent and logical. So if we start bidding low for a product for whatever reason in a series of bids, our following bids are likely to be lower, coherent with our first one. We compare our decisions to the first one we made.
2. Self Herding
We’ve all heard about the herd behaviour. But as it turns out something like that happens without a crowd. Take someone who hates Starbucks, but has no choice but to have a coffee in there one day. Next time he sees Starbucks, he remembers that it wasn’t as bad as he had expected so he gives it another go. By the third time he’s familiar with the different names and the ambience so he goes in again. Soon our man is happy to pay $5 for a coffee, although he resented that idea a while ago. The point is, we look back at our past decisions and experiences and see them much the same way we see a long queue of people in front of a restaurant. If so many people want to get that lunch, it must be good. If I’ve been to this place so many times, it must be good. The initial experience must of course be better than awful for this to work.
3. The cost of zero cost
The point Dan Ariely is making in this chapter is that free is an emotional hot point. If you lower the price from 10 to 9 cents, or from 1 to 0, the difference is just 1 cent in both cases. And yet your “sales” will go through the roof only in the second case.
This isn’t so surprising to me, since getting something for free changes everything. There is no transaction, you don’t need to make a decision. You just take it whatever it is and throw it away if you don’t need it after all.
Dan’s suggestions for decision and policy makers is more noteworthy. Governments as well as businesses work hard in many cases to get the masses to do something, for instance go to regular health checks. They run massive campaigns and even reduce the price of the check. What they should do to achieve a breakthrough is make it free. The cost of the awareness campaigns could be spent on making the check itself free for instance.
The same applies to businesses that want to quickly acquire millions of users – think online services.
This chapter leaves lots of questions unanswered, for instance the fact that we associate smaller value with products that are free.
If you’re interested in diving deeper into the topic, read Chris Anderson’s book titled Free.
4. The cost of social norms
The norms of the market and our social life are different and we live in both worlds at the same time. Sometimes these norms get mixed up which can lead to problems.
Two important points:
1. When people work for a cause or do a favour they make more of an effort than when they are paid.
2. When people get mixed messages, get a gift, but know the price, they work less hard.
If the deal is based on market norms (a job), but social norms are also introduced (benefits), it will increase productivity. Doing it the other way is a bad idea. If a relationship or project is based on social norms and we try to put a price tag to one’s efforts or give them a gift but accentuate the price (especially if low), we destroy the social quality of the agreement and are likely to get worse results.
5. The Influence of arousal
The statement this chapter makes is that we become a different person in a sexually aroused or emotionally excited state of mind.
In our normal state of mind we underestimate the likelihood of engaging in morally wrong, or risky activities in an emotionally heightened state. But as a matter of fact, we do give in to all kinds of temptations when excited. Hence our normal state of being doesn’t know this other kind of highly impulsive and careless person we become in a state of arousal.
To make better decisions, we must prepare for the hot state while we are cool. We have to make arrangements that will prevent us from making a bad decision when excited.
6. The Problem of Procrastination and Self-Control
The key concept of the chapter is precommitment.
As the experiments with self imposed and compulsory deadlines suggest, we procrastinate less if our deadlines are clear and we know them in advance. Complete flexibility doesn’t seem to help, but being able to set our own deadlines does.
Guidance and transparency are also important as the Honda/Ford service case study shows. Honda had these extremely simple and transparent servicing bundles after a certain number of years or milage, which worked so well (people had their cars serviced when they were supposed to) that Ford applied the same principle, which skyrocketed the utilization of their service bay.
Precommitment can be very helpful if we set things up in a way that we can’t change them when we want to. There are certain spending limits we can set on our credit cards, but a smart card that would allow preset budgets for different categories, would be really cool. The key thing is to make the good decision in advance with a cool head and make sure we can’t change it later.
7. The High Price of Ownership
We are all familiar with the IKEA effect to some extent. A piece of furniture we put together is worth a lot more to us than another one we bought complete. We have a difficult time selling the house we built, because we want a higher price for the little quirks that made our lives so much better. However, in the eyes of a potential new owner, these might just be things to get rid of, hence a the gap between the asking price and what the buyer is willing to pay widens.
The experiment in this chapter that highlights this highly irrational behaviour is fascinating. Or rather the results of it are. There is this basketball match at the university that every student wants to get into, but only a limited number actually can. They have to go through havoc and mayhem to get tickets and even an element of luck is involved. So when the happy owners of tickets are offered an opportunity to sell their tickets, it’s no wonder their price is in thousands of dollars. What’s more surprising is that people who didn’t get the tickets, would not pay more than a few hundred dollars for one. So there is a magnitude of difference between the asking price and the offer, which means no sale is ever going to happen. Not exactly an efficient market.
So how could all this be applied in real life other than not overpricing second hand items for sale?
As Dan points out, there is a widespread application of this phenomenon in marketing. Smart marketers know that once we own something, we have a hard time letting it go. That’s why they give us stuff for free to try or give us back the money if we don’t like it, because unless the product is awful and adds no value to our lives whatsoever, we’ll want to keep it. Our aversion to loss and feel of ownership dictates that we hang on to it.
So if you buy things, think twice about taking something for free. If you sell things, don’t even sell them. Give them away for free and charge when people don’t want to return them.
Look at a practical example (This one isn’t in the book). You are looking for kitchen knives, but you are not an expert of knives, you don’t really know what you need. You’re presented with three sets. They all look pretty much the same, but one set is priced significantly higher than the others and it also comes with a lifetime guarantee. Take it home and if you don’t like it, bring it back get your money back. Anytime. Which set are you going to buy?
8. Keeping Doors Open
Don’t keep all your eggs in one basket – goes the well known saying. At first sight it reflects the wisdom of many generations. But is our inherent inclination to maximize the number of our options really wise?
My first attempt at college was a disaster. I wanted to be a computer programmer, because it seemed like a profession in demand. The possibility that I might not have the skills and capabilities to do that didn’t cross my mind. It didn’t take more than a few months for the truth to be revealed: I was never going to make it.
I tried again and chose a less geeky, Economics combined with IT course. This time, it was accountancy that I struggled with. After 3 semesters, I applied for another course (Human Resources Management) so that I would not lose more time if I dropped out of the first one (I was almost certain I would). Despite all the odds, I didn’t drop out of the IT course so I ended up doing two colleges and working at the same time.
When I saw that I was going to make the IT course after all, I should have stopped the HR one immediately, but I didn’t. My reasoning was that having two degrees is always better than one and that it would greatly improve my chances of landing a good job.
It’s been a good few years now that I graduated, but I’ve never used my HR degree, and I’m almost certain I never will.
The price I paid for keeping this particular door open was extremely high. Years of sleep deprivation, missed opportunities, neglected relationships and a fortune spent on tuition fees.
That’s just one personal example for the phenomenon that this chapter examines.
The experiment Dan conducted established that we can’t tolerate the loss of options even if keeping all of them open is in no way beneficial to us.
For some reason, we are wired to always prefer more options to fewer. I can see how that makes sense from the viewpoint of the survival of the species. But this wiring was implanted in us in a world with a very limited number of options.
The cavemen had essentially two options. He could choose to hunt and eat meat or to gather plants. It was wise to do both and resort to one when the other wasn’t available.
On the other hand, living in the 21 century, it’s not a wise thing to aspire to keep all options open all the time, because there are too many. For the lucky people who are happy to be specialists of a certain field, this may not sound like much of a challenge. But for the multipotentialite type closing doors can be extremely painful.
Being indecisive in the dating scene is also ubiquitous. Having seemingly unlimited number of options to choose a mate, makes it very difficult to stay committed in a relationship. The remarkably high number of single people indicates that having more options doesn’t really help to make a final choice.
9. The effect of expectations
“WHEN WE BELIEVE beforehand that something will be good, therefore, it generally will be good—and when we think it will be bad, it will bad.”
That’s the hypothesis that this chapter succeeds in proving. The evidence is overwhelming. Beer with vinegar tastes better provided that you are not told that it has it before drinking it. Coffee tastes better drunk from fancy cups. A sports car feels better if you had high expectations before the test drive and so on.
The real interesting thing is that it’s not just perception. Expectations change the actual experience we have. So we don’t just imagine that beer with vinegar tastes bad, it actually does (but only if we know it’s in the beer in advance). How is that possible? How can information change the physicality of our experience?
The MRI experiment they did with giving people Pepsi and Coke revealed that when people were told they got their favourite brand, not only the areas of the brain responsible for feeling the pleasure of the sugar doze, but those associated with higher level thinking (memory, brand associations) also became active.
So the information we have about a certain experience beforehand is responsible for the quality of the actual experience to a large part.
It’s easy to dismiss this as nothing new and go like every marketer knows this. But I think the implications are far-reaching. Not only does this explain why the same event seen by two people may be interpreted in two very different ways (they essentially see different things), it also reminds us once again of the importance of presentation.
I’ve just read a proposal for website redesign. It was 20 pages, very well composed, including every detail the client might be interested in and more. It implies reliability, an aura of seriousness and competence. What’s behind the proposal is a very different matter.
The importance of presentation in the digital era is paramount.
I’m not advocating overmarketing and under delivering. Far from it. What I do see very often however is that great services, great products and even great people go undiscovered, because their presentation does not live up to the awesome value they ship.
10. The power of price
While the previous chapter essentially discussed a facet of the placebo effect without mentioning the word itself, this chapter is full on about the placebo effect.
Beyond listing a number of cases, experiments and studies that are still impossible to fully explain scientifically (like making people believe they’ve been operated on and their parkinsons disease goes away and stuff like that), Dan explores the role of price in this chapter.
The experiments suggest that more expensive things (higher perceived value) have a better placebo effect. The most solid proof seems to be the experiment where people drank some energy drink, and those who had the more expensive version did better in a puzzle. Also, the group who had the drink whose bottle specifically said that it helps people do better in puzzles, they actually did better than the group with the blank bottle.
It is fascinating how our brain creates our reality.
And again, it’s good to keep in mind that what we expect from a product or service (based on its price and packaging) determines what we experience to a great extent.
11. The Context of Our Character, Part I
When we think about honesty and morals, we tend to think that there are good people and bad people. This chapter suggests that reality is slightly different.
As it turns out, people in general are fairly honest, and only cheat a little even if they have a blatant opportunity to do so. But that little, they will cheat. So it’s not like a few people cheat big time which brings down the average. Most people cheat a little if given the opportunity.
The most exciting finding of this chapter is that people cheat much less if they are reminded of morals and honesty. This works by just making them think of the ten commandments or signing a code of honor or something similar.
12. The Context of Our Character, Part II
Having grown up in Hungary just a few years after the collapse of socialism, I have hands on experience about the point this chapter is making. The socialist society was built on this great idea of equality, which in practical terms meant that everybody had some kind of a job (the notion of productivity wasn’t included in the soviet socialist dictionary), and everyone was paid pretty much the same, low wages. To increase the perceived quality of life, the system tolerated a bit of dishonesty here and there. For instance, workers were allowed to take some of what they produced in the factory home. Some greedy people went too far of course and stole half the factory and opened up their own businesses after the collapse of the system. But the point is that it was part of the culture to take stuff home (it wouldn’t be considered stealing) from work.
Similarly, this chapter argues that while we will take bits and pieces of stuff that don’t belong to us without having second thoughts, we don’t do the same with cash. For some reason, cash is something that we’re very honest about in general. In the advent of digital money, that’s not too encouraging.
13. Beer and Free Lunches
While this last chapter doesn’t really reveal much new information, it provides a summary and a criticism of standard economics, which I believe is well deserved.
Summary – Key Takeaways
- We have no idea of the real value of things. We can only make choices in comparison to similar options.
- The old supply and demand theory explains only a fraction of what happens in the marketplace.
- When appropriate, giving things away for free can make all the difference.
- Social and marketplace norms don’t always mix well.
- The only way to make sure we don’t give in to temptation is to make it impossible before the temptation arises.
- Do not try to get the sentimental value for an item you’re selling and you’ll make a quicker sale.
- Keeping too many doors open often has a higher cost than what those opportunities are actually worth.
- Our experience is largely determined by our prior beliefs, perhaps more so than the quality of the actual product.
- People are generally honest and will be even more so when reminded of honesty.
- People easily steal things, but not cash.