neil woodcock’s marketing blog

Now is the time to take behavioural economics more seriously. Surely the recent financial market collapse is another nail in the coffin of traditional economics, where rational self interest is the primary motivation that is considered. Behavioural economics, the combination of economics, sociology and psychology will prove much more capable of explaining and predicting economic behaviour which traditional economics never did. Behavioural economists often concentrate on cases where people’s actions depart from the systematic, rational strategies Professor John Forbes Nash Jr and his counterparts envisioned in the early 1990s. Despite Nobel recognition for Daniel Kannebahn (prize winner) and Amos Tversky (cited, now deceased), two of the most well known behavioural economists, it appears that the field still does not have much prestige in academic institutions other than as a topic of interest.

Human behaviour, sometimes rational and sometimes not, was always an important factor in financial decisions and has a much bigger impact on economics than traditional economists, and the models that they use, have recognised. The Wall St journal published an article on 10 November 2008 discussing the collapse of AIG. The final statement was that their most senior advisor could see ‘no fundamental reason’ why AIG’s customers panicked“! The article went on to say that “The turmoil at AIG is likely to fan scepticism about the complicated, computer-driven modeling systems that many financial giants rely on to minimise risk”. Warren Buffett, chief executive of Berkshire Hathaway, which owns insurance companies, has been sounding the alarm about the issue for years. Recently, he told US TV interviewer Charlie Rose: “All I can say is, beware of geeks…bearing formulas.” As Tom Davenport said in his blog about the AIG advisor’s comment; ‘if there was ever a better story where traditional econometric models could bring down a company and perhaps even an economy I haven’t read it’.

Why do people buy and sell rationally or irrationally, be that shares, products or services? We have an advantage in the customer management world in that we have for a long time had to understand how events and attitudes drive customer behaviour. But behavioural economic theory can help develop our understanding.  For instance, Kannebahn’s work has an impact on how customer experience is designed. The ‘peak-end’ theory, as he described it, says memorable customer experiences are achieved through a combination of the peak of the emotion felt during the experience (good or bad) and the end experience. The whole experience does not have to be memorable and this knowledge can be useful in designing how you deal with customers over time.

We need to develop further this understanding of behavioural economics and its impact on customer management. We believe that just as there is confusion between traditional economics and behavioural economics in achieving the macro-economic performance, there is a similar confusion over how to generate business performance in a business – i.e. from customers. Economic value from customers is obtained not just through focusing on increasing revenues and decreasing costs, but on the system that influences the customers’ rational and irrational behaviour. This system will be based around the four stakeholder or ‘interest’ groups in corporate life; shareholders, customers, employees and the local community. We write more on this elsewhere. Let me know if you are interested!