From Rationality to Irrationality: How Behavioural Economics works in E-commerce?

How often do you find yourself clearing your mailbox off the emails received from online shopping platforms asking you to complete the purchase of the items you left in your shopping cart?

In the most straight forward terms, Behavioural economics helps ruthless corporations make you purchase products you don’t really want in quantities you absolutely do not need for the money you probably don’t have to impress people you don’t really like. How application of some basic behavioural economics tools can trick any consumer into spending money is explained in the subsequent paragraphs:

I.  The Decoy Effect:

This is most prominent pricing strategy used by the big corporations like Apple, Starbucks and even McDonalds. We cannot judge things in absolute terms, we can only judge them in comparison. This effect was first pointed out by Huber (1982), and then subsequently studied by an MIT Professor, Dan Ariely (1995), who noticed something strange in The Economist subscription. He stated that- people tend to change their original preference between two choices when they are presented with a third choice that is relatively worse than the first two products in terms of quality, price or both.

 The subscription offer of The Economist was:

a. Economist.com Subscription (Group 1): USD 59/year

b. Print Subscription (Group 2): USD 125/year

c. Print & Web Subscription (Group 3): USD 125/year^1A

Dan spilt his students into two groups and then asked them to pick a choice. The results were:

Ø  When only first two options were presented: 68% of students chose Group 1; 32% chose Group 2

Ø  When third option was added:  16% chose Group 1; 0% chose Group 2; 84% chose Group 3

The results were astonishing and it led to the conclusion that, the third option, known as the decoy is to guide people towards picking the most beneficial option for The Economist, but not necessarily the most beneficial to its subscriber¹ . According to Hendricks (2018), Decoy works best when there are three options to choose, namely a target, a competitor, and a decoy. Target is the choice that the company wants you to make, Competitor is up against the Target, and Decoy is what will influence consumer’s choice from Competitor to Target.

II. The Endowment Effect:

According to Rolf Dobelli, author of ‘The art of thinking clearly’, If we own something, we value it more. If we are selling something we own, then we would charge for it more than we would even spend on it ourselves. Professor Dan Ariely tested this effect yet again with his students by presenting them with a lucky draw to a big baseball game. He then pulled the students to see what the tickets were worth- those who didn’t win, guessed the ticket to be priced at around $170 and those who won wouldn’t sell the ticket for less than $2400. The simple fact of ownership can make us overvalue what we have.

Conversely, people are often willing to pay more to keep something they already own and at the same time, new customers will be less inclined to pay the same price. Endowment effect is the reason why we are better at collecting things than casting them off. It is the reason why we fill our homes with junk and hardly ever part with it; the reason why we cling to investments in stocks and other assets even when they no longer seem profitable.

III. Scarcity Principle in Marketing:

The difficult it is to obtain a particular product or a deal, the more valuable it becomes in the eyes of the consumer. This is the reason Companies never show the quantity of stock available for a product in the description. By doing this, marketers create artificial scarcity for their product and make it exclusive, in order to generate demand for it. Corporations like Amazon, eBay, etc., use this tool to create limited price deals and time bound offers on their products.

Product scarcity increases arousal, limiting a consumer’s ability to process information and encouraging more heuristic processing². The “Out of Stock” tactic plays nicely with the principle of social proof that a particular product has been bought by many people and must be the best available.

IV.  Decision Paralysis:

In common parlance, it is also known as “Choice overload”. It is a situation when a customer experiences “paralysis of analysis” (Kurien, 2013) when presented with too many detailed options to choose from. In such a situation, in order to make the best optimal decision, the consumer never really makes a decision and postpones buying the product.

Consumers are known to postpone their buying decisions when they are spoilt for choices, while they close deals quicker when there have been less options to choose from (Kurien, 2013). This is more evident for FMCG products. Customer generally thinks that they have a sea of products to choose from, which will guarantee them maximum satisfaction, but on the contrary, the opposite may happen. This is called Illusion of Control as stated by Power Retail³.

To overcome this, companies usually reduce the number of lines or products they carry, which allows them to manage the logistics in a healthy manner while at the same time helping the consumer narrow down to that one single choice he wants to make.

V.  Zipf’s Law:

Also known as The Law of Least Effort, this principle was first discovered in 1894 by a French philosopher Guillaume Ferrero, and then later by Harvard University professor George Kingsley Zipf. The crux of this theory is that if something does not require thinking about it, then most people will not.

However, it was not until when Daniel Kahneman in his book Thinking Fast and Slow (2011) beautifully pointed out the Behavioural cost that a consumer undergoes while making a purchase. It refers to both the physical and mental effort while making a purchase (excluding the monetary cost). Kahneman noted that higher the behavioural cost, less is the probability of consumer buying that product.

Thus, in the marketing arena, if a customer cannot easily find a way to reach out to a buyer, he will take the path of least resistance and move to a competitor or another option. This is the reason e-commerce websites have to maintain one-click-away customer care helplines and a robust grievance redressal system.

VI. Anchoring Effect:

People tend to rely heavily on the information they receive at first while making any decision. This is used widely by marketers in fixing and stating the price of a product to the customer. While buying a car, for example, the first price that is quoted to us by the retailer becomes the anchor for us and from there on, we compare that price with the subsequent model of cars that we see⁴.

A study conducted in this arena- Gandhi and the Anchoring Effect (Strack and Mussweiler, 1997)⁵ in which two groups of participants were asked to estimate the age of Mahatma Gandhi when he was assassinated. The first group was given the anchor of 9 years or older, and the second group was given the anchor of 140 years older or younger. Participants with higher anchor guessed the age to be 67 years old, while with the lower anchor guessed he was 50 years old at the time of his assassination. This study demonstrated how our anchors shape our bias, even if the information seems implausible.

VII. Loss Aversion and the Nudge Theory:

Loss aversion is our tendency to prefer avoiding losses to acquiring gains. You might forget the little profit you had in the stock market, but you will never forget even the miniscule loss you incurred. People detest losses twice as much as they enjoy gains (Prentice, 2019). Loss aversion is also related to The Prospect Theory (Kahneman & Tversky, 1979)- which states that people will be willing to take much bigger risks to avoid losing what they have then they would have taken to gain them in the first place.

How do companies monetize on this fear? By showing “Only few left in stock! Hurry!” next to a product. This feeds our loss-averse mindset to take an impulsive decision to add that commodity in the cart and purchase it. Another example could be, displaying the new discounted price in bold above the old price⁶.

Richard Thaler, in his book, Nudge (2008), that won him the Nobel Prize in Economics (2017) stated that people can be “nudged” to make the right choice without coercing them or restricting their freedom of choice. Hence, compliance is achieved while maintain the individual’s freedom. Nudging in digital space is used through persuasion techniques like showcasing feedback from the customers, or showcasing how many times a particular product was bought in the last few hours, or IKEA showcasing IKEA Family Price below its products, etc.

All the above concepts together form the Choice architecture (Thaler, 2008) and are used extensively over the web. If used unethically, these models may completely downplay the consumers’ skills and rationality. Nudging is an extremely non-consumer centric phenomenon. Once the purchase has taken place, Nudging does nothing to promote healthy consumer behaviour (Sanghi, et. al, 2018).

In the recent years, motivational psychology in the field of Behavioural Economics has sought to lay out a system that help customers perform healthy behaviours like financial wisdom to help achieve long-term goals. Behavioural economics can also be used to promote positive climate sensitive behaviour- that are sustainable for the planet and at the same time eliminate the hazards of the darker side of influencing consumer choices. Behavioural economics coupled rationally with technology can play an instrumental role in creating a better future for generations to come.