Dan Ariely is one of the world’s foremost experts in behavioral economics, the study of how people truly behave when making business and financial decisions. His research has proven time and again that we all are not the sensible decision makers that we might like to think we are, and his recent book on the topic, “Predictably Irrational: The Hidden Forces That Shape Our Decisions” (HarperCollins, 2008), debuted on The New York Times Best Seller list when it was released earlier this year. Ariely is a professor of behavioral economics at Duke University and former Alfred P. Sloan Professor of Behavioral Economics at MIT, and through his Web site (www.predictablyirrational.com) he provides updates of his fascinating experiments and invites readers to participate in them.
The leading question
Behavioral economics is revealing surprising new understandings of consumers. What should managers know?
- Offering customers too many choices can easily confuse them, but sometimes a product monopoly can also be confusing.
- If managers want to hire the best people in the future, they must be willing to hire candidates whom they think will fail.
- To increase an employee’s motivation, give him a vacation to the Bahamas instead of the cash equivalent of the trip.
Ariely’s insights should make executives think twice about the wisdom of the decisions they regularly make — as well as the inner processes they rely on to make those decisions. Why, for example, will managers veto a 10% cost increase for a $1 million project while thinking nothing of a 1% overrun on a $10 million budget — even though the actual amount is the same? Why will they often agonize trying to choose between two close candidates for a job when they’re frequently better off just flipping a coin? Why do they try to dominate a market when, in fact, a product monopoly sometimes leads only to consumer confusion, resulting in slow sales?
Recently, Ariely sat down with Alden M. Hayashi, a senior editor with MIT Sloan Management Review. Their conversation begins with a discussion of the implications of behavioral economics for product pricing. Specifically, Ariely explains why a product’s price must take into account various irrational human behaviors, including the principles of anchoring (when the initial price of something has undue influence on our future decisions) and relativity (when we infer the value of a product from the prices of similar offerings).