Keystrokes of the ‘faint-hearted’ closet economist: The advertising ‘nudge’

There’s a quiet revolution playing out amidst the advertising fraternity. The advertisers are attracted by the new possibilities that emerge when the world is viewed through the behavioural economics lens: the study, if you like, of how people actually behave rather than how more theoretical models declare that they should. They are looking to behavioural economics to help find new ways to influence the decisions we take, as consumers.

Many behavioural economists describe their discipline as a complement to the world of classical economics: an alternative framework to the centuries-old view that economic agents behave consistently and rationally, choosing the best outcome in every situation, making the right decisions in a world of perfect information.

In fact, it is a much more direct challenge to the old orthodoxy than this suggests.

To the layman at least their observation and experiment-rich brand of psychology (a worldview that accepts that humans are irrational, inconsistent and don’t always act in their best interests) explains far better the world around us: be it stock market bubbles or conspicuous consumption.

The advertising industry, of course, instinctively understands this ‘new’ economic startpoint. It has long understood that decisions are often made habitually, emotionally and on the basis of what others think or will think; at odds, in other words, with the classical economist’s predictions.

Although you will still hear the term ‘USP’ lazily bandied about, it long ago enlarged its mental model of ‘how advertising works’ from one where the unadorned statement of a product’s unique advantage would coerce the attentive and rational consumer into forming a preference for it.

A behavioural economics perspective is not, then, a bolt from the blue for advertising folk.

At its broadest, behavioural economics reminds us of the ‘status quo bias’ that keeps most markets stable (because we crave the familiar, and are adverse to the potential loss that attaches to a ‘new’ decision) and the ‘heuristics’, or rules of thumb, that we use to aid decision-making.

Brands, of course, are the ultimate heuristic: mental shortcuts that make potentially complex decisions simple for consumers. They speak to the ‘cognitive miser’ in all of us. Behavioural economics gives us also the notion of ‘anchoring’: that brand (and other) decisions are typically made in relation to other options, rather than in isolation.
This alone should provide food for thought and an obvious action plan for those advertisers and brand-owners who spend too much time staring at their own brand or campaign, and not enough understanding their competitors’. (Marketing history is littered with brands that were effectively repositioned by others while brand managers fiddled).

But whether or not the advertising fraternity has a long-lasting love affair with behavioural economoics – by its very nature, its focus on what people actually do – brings with it an overdue challenge to the implicit assumption in some corners of our industry that ‘brand’ and ‘brand image’ are the exclusive levers of marketing success.

Our impulse to understand behavioural economics, then, is a helpful corrective to lazy or narrow thinking; a reminder that attitudes to a brand will often follow rather than lead behaviour change and that an advertising campaign is one answer, not always the answer.

We would all do well to make the assumptions with which we market and advertise more explicit, a kind of ‘contract’ with our organisation and others that makes concrete our underlying beliefs. Meanwhile let’s remember that what people say about brands and what brands say about themselves is, in the end, less important than what people (and brands) actually do.

There’s always been this long-drawn debate about whether advertising is strongly persuasive or nudging?

And see how Haagen-Dazs used salience to create an all new product.

A version of this article appeared in Bangalore Mirror last month.

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Keystrokes of the ‘faint-hearted’ closet economist: Group-buying

About a year and a half ago, group buying was a phenomenon unheard of. Groupon did not exist. Today it has some 700 million odd members in 500 different countries making (perhaps) more than a billion dollars a year . India alone has some 30-odd group buying portals now. There’s obviously something clever and innovative behind group buying. Given that customers with coupons or deals are saving lots of money on goods and services, how can this possibly be a win-win for all?

There are significant network effects at play here: the more people sign up on a group buying site, the more targeted its deals can be. A product or a service displays positive network effects when more usage of the product by any user increases the product’s value for other users (and sometimes all users). The microstructure of an underlying network of connections often influences how much network effects matter. For example, a good displays local network effects when rather than being influenced by an increase in the size of a product’s user base in general, each consumer is influenced directly by the decisions of only a typically small subset of other consumers, for instance those he or she is “connected” to via an underlying social or business network (instant messaging is a great example of a product that displays local network effects).

The idea that the deals or coupons only become activated once a certain minimum number of people have signed up for them; This is essentially a guarantee for the merchant that the needle will be moved, that their effort won’t be wasted. That kind of guaranteed engagement is hugely valuable, and more or less unprecedented in the world of marketing and advertising. Then there’s the twist in the “coupon” or “deal” part of the name. No longer do merchants pay money for the privilege of giving coupons away for free in newspapers. Instead, they receive money. There’s something extremely gratifying about being paid to offer discounts to new customers.

Also, the most important aspect of a deal is probably that it’s local. Before group-buying sites came along, there was no effective way for merchants to reach consumers in their area, while excluding everybody else. If you’re a neighborhood restaurant, you don’t want to entice people who live miles away: you want to reach locals. And while group-buying sites aren’t quite there yet — it’s orders of magnitude better at targeting than anything which came before it. And it’s improving every day.

Beyond that, there’s an uncommonly large number of ways in which participating in a deal can benefit a restaurant or other merchant. For one thing, the offer will go out to a targeted group of people in exactly your neighborhood or a specific area in the city — which means that even if none of them sign up for the deal, they’ll still have seen customized advertising for you, from a company (group-buying site) which they trust. And when a few hundred people have signed up for your deal, you get a huge amount of mindshare from them. Many will redeem the deals or coupons very quickly, but a lot of them will wait a while, thinking about you in the back of their minds all the time. If a friend asks whether they know a good local restaurant, they might well think of your name even if they haven’t been yet. And after they’ve been, they know exactly where you are and what you serve — information which you want locals to know but which can be very hard to broadcast.

More generally, of course, it provide an important nudge to jolt people out of their day-to-day habits and try something new. A lot of us might see a new place open up and think to ourselves that we should try it some time; a group-buying site turns that vague sense into something we really must do if we don’t want to lose the money we spent on the deal or coupon. By forcing people to pay for their coupon or deal, restaurants lock in new customers in a way that old-fashioned coupons never could.

In that sense, from the consumer’s perspective, group buying is a commitment device: it’s a way of forcing yourself to do something you really want to try at some point, but know that you might otherwise never get around to. The merchant persuades the consumer to make that commitment right now by making sure that the offer only lasts a very short time — usually only a day or two. The consumer knows that if they don’t buy the deal now, they’ve missed their chance.

Deals and coupons can very good at driving traffic during slow periods. For any kind of business which needs a certain amount of volume to keep ticking over in fallow times, group buying can be exactly what the doctor ordered.

In the popular imagination, then, the idea behind group-buying is that it attracts new customers to a restaurant, some of whom become regulars and therefore very profitable. Long-term profits from the few, in this model, make up for short-term losses from the many who will never return.

And that is indeed a central part of how group buying works — it’s just not the only way that restaurants get value from the site. In that sense, restaurants are much like a discount deal or coupon itself. It makes money on every sale — but it will only see its margins start to rise impressively if and when its merchants start coming back on a regular basis. At that point, the cost of setting up and selling a new deal comes down dramatically, and the site’s profits on the deal — after accounting for the cost of their salesperson’s time — rise substantially. The group buying site itself, as much as its merchants, is counting on repeat business. And that comes from having a positive reputation which can spread like wildfire over social networks.

PS: A shorter version of this article appeared in Bangalore Mirror last month.

Keystrokes of the ‘faint-hearted’ closet economist: Why Kindle will soon be available for ‘free’?

The economics of free. Extolling the virtues of Chris Anderson, free is the future of business. And of course, this is not news. Google giving off Nexus Ones for free at TED, Radiohead offering ‘as you wish, you may pay’ music download off the internet and Kindle bringing the price down consistently so much so that it is predicted that by November it may be available for FREE.

It must cost something to make?

The trick is in figuring out how Amazon can bundle the free Kindle and still make money.

The wonderful feature of a non-scarce, or infinite, good that it is effectively a free resource. Once created, it costs nothing to give to someone else, and you still retain the original. In fact, economists have finally realized that this is the very key to economic growth and progress. The infinite resource known as an “idea” that improves what was already there is what increases the size of a market. Or, putting it another way, that infinite resource of a new idea makes an existing scarce resource more valuable.

The way it works is actually quite easy and fits in with the same basic economics that’s always been in place. Knocking down the barriers of artificial scarcity opens up tremendous new opportunities — just as knocking down the artificial scarcity known as “protectionism” helps to grow markets by creating new opportunities. In this case, those new opportunities have only increased in number as we’ve gone digital, making more content infinite in nature.

So, the very simple way to go about this is to:

1. Redefine the market based on the benefits based on the benefits of what you’re providing, rather than the specific product you’re selling. If you’re focused on selling the benefits, then discovering a better way to sell those benefits is seen as a good thing, rather than a threat.

2. Break the benefits down into scarce and infinite components. In fact, if you look closely enough, you realize that any scarce product you buy actually has infinite components while any infinite good you see also tends to have scarce components.

3. Set the infinite components free, syndicate them, make them easy to get – all to increase the value of the scarce components.

4. Charge for the scarce components that are tied to infinite components. And, yet, all the while, you know exactly what scarce resources those non-scarce goods are tied to, and you’re ready to sell those scarce resources, recognizing that the more people who are consuming the infinite goods, the more valuable your scarce resource is.

So while, ebooks may be the scare resource, Kindle is the infinite one and giving it for free may just get more people to hop onto ebooks.

Courtesy Wikipedia: The Grateful Dead have constantly toured throughout their career, playing more than 2300 concerts. They promoted a sense of community among their fans, who became known as Deadheads, many of whom followed their tours for months or years on end. In their early career, the band also dedicated their time and talents to their community, the Haight-Ashbury area of San Francisco, making available free food, lodging, music and health care to all comers; they were the “first among equals in giving unselfishly of themselves to hippie culture, performing ‘more free concerts than any band in the history of music’.

Key-strokes of the ‘faint-hearted’ closet economist: Auction & Clicks

The number of ads that the search engine can show to a user is limited, and different positions on the search results page have different desirabilities for advertisers: an ad shown at the top of a page is more likely to be clicked than an ad shown at the bottom. Hence, search engines need a system for allocating the positions to advertisers, and auctions are a natural choice. Currently, the mechanisms most widely used by search engines are based on auctions.

In the simplest such auction, for a specific keyword, advertisers submit bids stating their maximum willingness to pay for a click. When a user enters a keyword, he receives search results along with sponsored links, the latter shown in decreasing order of bids. In particular, the ad with the highest bid is displayed at the top, the ad with the next highest bid is displayed in the second position, and so on. If a user subsequently clicks on an ad in position p, that advertiser is charged by the search engine an amount equal to the next highest bid, i.e., the bid of an advertiser in position p + 1.

A combination of several features makes the market for Internet advertising unique.

First, bidding takes place continuously. For example, the advertiser with the second highest bid on a given keyword at some instant will be listed as the second sponsored link at that instant. But any other advertiser can revise his bid at any time, and the order of sponsored links and prices will change accordingly. These changes can be very rapid because advertisers can employ automated robots, including commercially available software, in responding to others’ bids.

Second, the search engines effectively sell flows of perishable advertising services rather than storable objects: if there are no ads for a particular search term during some period of time, the “capacity” is wasted, much like in electricity markets.

Over time, the search algorithms undergo multiple iterations to reflect the changing consumer perceptions and the landscape. At the same time technology has empowered consumers and businesses to preempt information and beat the machine. As things come a full circle, the information loops back making the system stronger and better. Search engines of the future will be better in part because they will understand more about the individual user. Maybe the search engines of the future will know where one is located, maybe they will know what one knows already or maybe they will fully understand our preferences and hence, throwing up information which is more needed and advertising which is more relevant.

Keystrokes of the ‘faint-hearted’ closet economist: Signalling & Brands

The concept of signalling has to do with the transfer of information from one party to another, often in order to achieve some sort of mutual satisfaction or arrangement. When explaining the way that signalling occurs, the party that is transmitting the information is often referred to as the agent. The party that receives and evaluates the information is usually understood to be the principal.

One of the classic illustrations of how signalling works involves an individual who is seeking employment. In order to attract the attention of an employer, the prospective employee may choose to engage in signalling as a means of gaining the attention of the employer. This segment of the process often begins with the crafting of the resume. If the information on the resume generates sufficient interest, then the employer will often schedule an interview and seek to broaden his or her knowledge base about the prospective employee.

At the interview, the prospect assumes the role of agent and seeks to build on the rapport already established through the resume. This will involve emphasizing certain facts that are relevant to the position and the general goals of the company. Essentially, the agent is taking true data and presenting it in the most attractive manner possible.

In turn, the employer assumes the role of principal and receives the information. As the information is received, principals assimilate and evaluate the data. At the end of this process, the principal can extend an offer of employment to one agent, as well as inform other agents that there is no need for further information and the position is now filled.

One of the key components of ethical signalling is that only true and correct information is provided by an agent to a principal. While the agent may choose to downplay some data while spotlighting other information that he or she believes is of more interest to the principal, honesty is essential if the conveyance or signal of information is to be considered successful.

When a person buys a used car from a stranger, the buyer knows that the purchase involves risks. The seller may tell him that the car has always worked well, but the buyer cannot be sure that the seller is truthful. It is in the interests of the seller to say these things, whether or not they are true. The seller of a “lemon” could say the same thing as the seller of a quality item. Economists say that markets in which one side of the transaction has better knowledge than the other, as in this case, have asymmetric information. In this example sellers of quality items need a way of communicating information to buyers so that only truthful information will be transmitted.

How do sellers convince buyers of the attractive qualities of their products? Or how do buyers seek to filter out erroneous information? Sellers of high-quality items must find a way to signal information about their products, and these signals must be difficult for those selling low-quality products to duplicate.

The way firms signal quality is by building a brand. A brand is valuable only if consumers associate it with quality, and the firm can build this association only with time and resources. Once a brand is established, it is in the interests of the firm to protect it by not offering a poor-quality product.

When consumers are uncertain about product attributes, firms use brands to inform consumers about product positions and to ensure that their product claims are credible(and that there is no information asymmetry.) Brands as market signals improve consumers’ perceptions about brand attribute levels and increase confidence in brands’ claims. The reduced uncertainty lowers information costs and the risks perceived by consumers thus increasing consumers’ expected utility.

What makes a brand?

So the battle over brands will go on. Do not be fooled into thinking it is really about mobile phones, cars or shampoos. It is all about information. And it will continue for as long as buyers need and want information.

PS: Signalling is one of the most seminal works of the economist, George Akerlof who spent a considerable amount of time in India while working on his various theses.

Signalling has been widely used by marketing researchers to understand brand equity and building brand extensions using an umbrella brand as a linchpin.

NEXT POST -> The economic principle that fuels the multi-billion dollar internet advertising industry.