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Behavioural Economics

Use a calculator, not your heart, to assess risk

This article of ours first appeared in Mint on 6th Dec, 2017.

It has taken millions of years for humans to evolve into the species we are today. But it’s been only a few decades of living with rapid technological and economic development. We have lived among and survived snakes, spiders and other species that could have led to our extinction. That’s probably why our brain has developed parts like the amygdala, which acts as an alarm system, generating fast emotions like fear when we notice anything that’s out of place or scary. The amygdala that induces the fear reflex has helped our ancestors survive and it continues to remain a vital tool in today’s daily life. When we see a face that’s scared, we take cues and act instantly; or, if we smell smoke, the amygdala floods the body with fear signals even before we are consciously aware of being afraid.

However, today, life has been changed dramatically due to money and technology. A potential economic threat makes us panic. When our investments take a sudden drop, we react and sell our investments; making ourselves poorer, not richer. But we feel more comfortable to invest when markets are rising. We do the opposite of what common sense shows us—we need to buy low and sell high to make a profit, but we buy high and sell low. In other circumstances, people avoid investing in the stock markets because they are afraid that the stock market might crash, but have no idea how rising prices eat up their savings and cause a loss of money. We are not good at assessing risk—monetary and non-monetary.

The more vivid and imaginable a risk is, the scarier it feels. Behavioural scientist, Paul Slovic, says people will pay twice as much for an insurance policy that covers hospitalization for ‘any disease’ than one that covers hospitalization for ‘any reason’. Any reason covers any disease, but ‘any reason’ seems vague, while ‘any disease’ is vivid. The vividness fills us with fear. It’s not logical. Decades of behavioural science is proving than we don’t always make rational decisions. On the contrary, we often make decisions based on emotion and therefore the decisions sometimes tend to be not rational. For example, people are scared of flying because a plane crash is vivid. Tons of people, including myself, buy air travel insurance, but if we take probability of a plane crash into account, we will find the air travel insurance not worthwhile. At the same time, driving a car without wearing a seat belt feels perfectly safe for a lot of people in India. Let’s see what the numbers have to say. Last year, no one died in India due to a plane crash compared to more than 1,50,000 people who died in road accidents in 2016. So what’s safer—flying by plane or driving on roads? Here’s another example: terrorism. Terrorism creates images of violence, gun shots, bombs, bloodshed. We feel that the risk of terrorism is uncontrollable. But did you know that only 178 civilians died due to terrorism in India this year. On the other hand, smoking kills 1 million people every year in India. Yet we feel more scared of terrorists than cigarettes. But smokers feel they are in charge and understand the consequences, that’s why the risks seem lower than they truly are.

Says Nobel-winning behavioural scientist, Daniel Kahneman, “We tend to judge the probability of an event by the ease with which we can call it to our mind. The more recently an event has occurred, or the more vivid our memory of something like it in the past, the more available an event will be in our minds and the more probable it will seem to happen again.” Clearly that’s not the right way to assess risk because the event does not become more probable just because it occurred recently. In fact, the best time to ‘value invest’ is when the markets are depressed. That’s likely to be a time when there is more bad news than good news, when corporate performances don’t look that good and when analysts don’t have nice things to say. In other words: when markets are low. However, people judge such times to be risky and stay away from stock markets, and when the markets are rising, people hear positive news all around and most investors find comfort in positive statements made by analysts. Due to this positivity and euphoria, people invest at high levels only to find that the trend doesn’t hold true for long.

Understanding risk is critical to managing money. So when you think about risk, it’s better to use a calculator instead of your heart.

Potential loss can make us behave irrationally

There are many instances where a perceived loss makes us behave irrationally. Here’s one of the many stories – of Captain Jacob Van Zanten – in connection to loss aversion.

Captain Van Zanten was regarded as one of the most experienced and accomplished pilots in the world. He was head of KLM’s safety program, known for his attention to detail, methodical approach and a spotless record. He even featured in KLM’s ad which said KLM – the people who made punctuality possible.

On one flight en route from Amsterdam to Las Palmas airport in Canary Islands, Spain, Van Zanten got an urgent message that a terrorist bomb had exploded at the Las Palmas airport. He was now made to land at nearby Tenerife’s tiny airport along with many other re-directed flights.

He safely parked the plane. But he wanted to take off before the mandatory rest period got underway, because there was no replacement crew at Tenerife, the airline would have to find passengers a place to stay, the delay would initiate a cascade of flight cancellations throughout KLM and he of course had thoughts about his own reputation on line.

Two hours had already passed by. So Van Zanten decided to refuel at Tenerife thinking that he would shave an hour off the turnaround at Las Palmas. But soon thereafter, word came from Las Palmas that the airport had finally reopened. But it was too late to stop the refuel.

Finally just when it looked like he could take off, a thick layer of fog descended upon the runway – visibility dropped to just 300m. Nevertheless he revved up the engines and lurched down the runway. When the co-pilot alerted him that they didn’t get ATC clearance, he hit the brakes and asked him to get the approval. The co-pilot received the airway clearance but not the takeoff clearance. Completely out of character, Van Zanten again turned the throttle to full power and roared down the runway.

To his nightmare he saw a Pan Am 747 parked across the runway while he was approaching full speed. He managed to pull the aircraft’s nose desperately, but the underside of the fuselage ripped through the top of Pan Am. The KLM plane burst into flames killing all crew and passengers, 584 in all, including Van Zanten.

The aeronautical community was stunned. The experts concluded that it wasn’t a mechanical failure or terrorist attack. Pan Am missed a taxiway turnoff and wasn’t supposed to be on the runway. Because of the fog Van Zanten couldn’t see Pan Am. Pan Am pilot couldn’t see KLM. The under staffed tower controllers couldn’t see either. But why did a seasoned pilot, the head of safety at KLM make such a rash and irresponsible decision?

The best explanation the investigators came up with was that Van Zanten was feeling frustrated. But how could he cast aside every bit of training and protocol when the stakes were so high?

Turns out the investigators were right. We’re all susceptible to a tendency to go to great lengths to avoid possible losses. We’re loss averse. Van Zanten’s desire to avoid a delay started small. But as the delay grew longer, the potential loss seemed almost inevitable. He got so focused on avoiding the loss, that he tuned out of his common sense and years of training.

As Columbia business school professor, Eric Johnson says, “the more meaningful a potential loss is, the more loss averse we become. In other words, the more there is on line, the easier it is to get swept into an irrational decision.”

Source

Employee performance and happiness talk (Gartner)

Our latest talk was on applying behavioural science for improving employee performance and happiness at the Gartner Symposium ITXPO, Goa for India’s Top 300 CIOs.

Behavioural science experiments on employee performance and happiness show that businesses often operate in ways that are not aligned to principles of human psychology, leading to engagement and motivation levels that are disappointing.

For example, when performance appraisals are done annually, employees are also given feedback on improvement and learning. But behavioural science shows that the focus of employees at that stage is on earning, while learning shuts down. Companies can benefit to a great extent if the ‘scope of improvement’ conversation is done as a separate exercise at a separate time than the performance review and appraisal.

The talk covered behavioural science findings on rewards, recognition, incentives – monetary, non-monetary, experiential; performance appraisal, feedback, teams, collaboration, workplace design, change management, productivity, culture and core values.

Like we always do, the talk focussed on simple but innovative and practical Behavioural Design nudges that could make a big difference in employee performance and happiness.

 

How a teacher changed lives of school kids

Her name is Molly Howard, a teacher who taught at a school in Georgia, US, where 80% of the kids lived in poverty and only 15% of the kids went on to study in colleges. Many teachers had a defeatist attitude – some children can and some children can’t.

But Molly challenged that view. Once she joined she abolished the school’s two-track system that separated the college bound students from the vocational students. She beefed up assessments and tutorial programs. She matched students with teachers who would be their on-campus advisors. But the biggest impact came from how she graded the students – A, B, C and Not Yet. No D-F.

In her view the students had accepted a culture of failure. These students didn’t used to do their homework or turned in shoddy work. They behaved as though they were complete failures. Getting a D or F seemed to be an easy way out for not trying enough.

In her new system of ‘Not Yet’ if the students did substandard work the teachers were made to say ‘Not Yet’. The students said to themselves, “My teacher thinks I could do better.”

Molly Howard had transformed her students with a simple Behavioural Design nudge. Test scores went up. The graduation rate increased dramatically. Howard was given the U.S. Principal of the year award in 2008.

Let’s not give up on North Korea, not yet.

What it takes to be an innovator

Most of us tend to think that innovators are born geniuses. It’s in their blood. Either you have it or you don’t. But reality is anything but that. Innovation like anything else is a habit that can be designed. Just the way a company called Brasilata has done.

Brasilata is a US$ 170 million manufacturing firm from Brazil that makes various kinds of steel cans. Manufacturing may seem boring but Brasilata is one of the most innovating companies in Latin America. For example in 2012, employees submitted 1,71,916 ideas – an average of 170.4 ideas per employee! Many of the suggestions led to the development of new products. The decision regarding approval and implementation of these ideas is made most of the time by the front line.

For instance, Brasilata came up with a new approach for steel cans designed to carry flammable liquids to meet UN standards. These cans needed to withstand a drop from 4 feet. Most manufacturers did this by thickening the metal layers, which ended up using more raw material. But Brasilata’s employees created a new steel can inspired by car bumpers that collapse on impact. The new steel can be deformed on impact, reducing stress on critical seam. This also reduced the amount of steel used.

In another instance, when the Brazil government rationed energy in 2001 due to severe energy crisis, Brasilata’s employees reduced its energy consumption by 35% and even resold extra energy saved to other companies.

Innovation is so embedded in the employees that two employees came up with a suggestion of eliminating their own jobs! Beat that.

Is innovation in their blood? Are they born with it or has been it designed?

Let’s see what their founders put in place for this to happen. To begin with the employees are called ‘inventors’. It isn’t simply feel good language. When they join the company they are asked to sign an innovation contract. It challenges them to come up with ideas for better products, improve production processes and squeeze costs out of the system. Procedures have been made for them to submit their ideas. Brasilata distributes 15% of its net profits amongst its inventors.

I have no doubt that the journey would have been a difficult one. It probably took a while for employees to become good at inventing. And initially employees might have even felt like imposters with themselves being called inventors. The founders would have created an expectation of failure – not the failure of the mission, but of failure on route.

And yes I forgot to mention that the idea of the two employees of eliminating their job was accepted. Their explanation was that they had eliminated their job positions to increase company profitability and this would in turn be distributed to all; as mentioned previously 15% of Brasilata net profits are shared by the employees. But the two were placed in a new roles because Brasilata has a no dismissal policy. In the opinion of the chief executive officer “job security functions as a safety net which enables the trapeze artist to perform to his best ability without risking his life.”

Source: Brasilata

To overcome big problems, think small

Most of the times, when we think of big problems, for example, bad hygiene habits of a nation, we tend to believe that the solution also needs to be as big. But it may not require lots of resources to overcome the big problem. Time and again Behavioural Design has proven that the solution needn’t be big in terms of budgets, effort and resources. Here’s one more nudge/ intervention of Behavioural Design that illustrates the same.

In 1990, Jerry Sternin used to work for Save the Children and was sent to Vietnam to fight malnutrition amongst children. Sternin had read a lot about malnutrition and conventional wisdom indicated that malnutrition was a result of intertwined problems like sanitation, poverty, lack of access to clean water and lack of awareness about nutrition.

Sternin instead chose not to be overwhelmed with such theoretical knowledge. Rather, he traveled to rural villages to find out if there were any very poor kids who were big and healthy than the typical kid in Vietnam. He thought that if these kids were staying healthy against the odds, why couldn’t every kid be healthy?

After observing lots of such families for deviations between healthy kid families and unhealthy kid families, he discovered that mothers of healthy kids were feeding them the same amount of food as mothers of unhealthy kids, but were spreading it across four meals rather than two. Second difference was in the style of feeding – mothers who hand-fed the kids had healthy kids vs the norm of kids feeding themselves. Third most interesting finding was that healthy kids were fed tiny shrimp and crabs, considered appropriate food only for adults by most mothers. The mothers of healthy kids also tossed in sweet-potato greens, considered a low-class food.

Conventionally one would tend to believe that if somehow all the mothers would get to know about these 3 healthy ways of feeding their kids, malnutrition could be eliminated. But Sternin knew that mere awareness does not change behavior. So instead of building an awareness program, Sternin created a community program, in which fifty malnourished families in groups of ten, would meet at a nearby hut each day and prepare food with shrimps, crabs and sweet-potato greens.

Mothers got first hand experience of keeping their sons and daughters healthy. Soon neighboring mothers were convinced by the power of social proof. Within 6 months 65% of the kids were better nourished in that village. The experiment moved to other villages. The community cooking program reached 2.2 million Vietnamese people in 265 villages. A big dent in malnutrition done with a small team and a shoestring budget!

Source: David Dorsey, Fast company, Dec 2000. Jerry Sternin’s presentation at Boston College Center for CSR in April 2008

Investor biases and behaviour

We were in Goa over the weekend for delivering a talk on investor biases and behaviour for SBI Mutual Fund’s financial advisors. We spoke about several biases and how advisors need to be aware of them for handling their own portfolio as well as for managing their client’s expectations and behaviour. Biases like action bias, loss aversion, mental accounting, choice paradox, social proof, etc. make people their own worst enemies in investing. That’s why markets multiply money by hundred times but investors don’t get such returns. It was also fun interacting with fund managers and understanding their perspective on investing. Since these are commissioned talks they can’t be shared. However you can read all about investor behaviour and how to not make investing mistakes by clicking ‘Investor Behaviour’ in ‘Click on your topic of interest’ on the homepage right hand column. Happy reading, learning and investing!

Post-edit: The second round of the talk happened in Hyderabad.

Why we need a label for 'Climate Change'

This article of ours first appeared in Huffington Post on 17th July, 2017.

Nineteen of the G20 countries have affirmed their commitment to the Paris climate agreement, which sets guidelines for each participating country to mitigate global warming. Sponsored by the United Nations, it aims to slow the rise in global temperatures. The US is the lone outlier on climate change while India remains committed on the issue of climate change “as per its own values and requirements.”

On the face of it, climate change seems like a problem that may be happening but is still some time away in the future. So perhaps it can be handled sometime in the future. After all there are so many urgent problems facing our country—poverty, malnutrition, black money, terrorism, lack of infrastructure, etc. Plus, there is this diffused sense of responsibility because it’s affecting almost every country in the world. So the question arises, why should India take the lead to tackle climate change? After all it’s the developed countries that are responsible for much of the industrialisation that’s causing global warming and climate change. But what really matters is which countries are facing and will continue to face the maximum harm from climate change. And India is right on top of that list according to research by the Notre Dame Global Adaptation Initiative. The group measures vulnerability by considering the potential impact of climate change on six areas: food, water, health, ecosystem service, human habitat and infrastructure.

Climate change is a wicked problem. As this New Scientist article points out:

“It provides us with no defining qualities that would give it a clear identity: no deadlines, no geographic location, no single cause or solution and, critically, no obvious enemy. Our brains scan it for the usual cues that we use to process and evaluate information about the world, but find none. And so we impose our own.

It is wide open for interpretation causing constant uncertainty. Climate scientists say people don’t get the science about the environment. Environmentalists say political will is being corrupted by vested commercial interests. Commercial interests deny climate change. Individual minds are left confused.

But not only do vested economic interests inhibit reforms, our individual brains are not geared to deal with the problem. Climate change is global, complex, somewhat abstract problem, and occurs in a time frame of decades, all of which make it difficult for people to respond appropriately. Costs are short term, benefits are long term and perceived as uncertain, though in fact benefits are massively greater than the costs of action now. Take survival, for instance. But people suffer from loss aversion—the tendency to fear losses more than we love gains. So it’s challenging for us to give up our aspirations to consume and enjoy the pleasures of consumption now, in order to reap the benefits of reversing climate change.

According to the National Oceanic and Atmospheric Association, US Department of Commerce, January 2017’s average global temperature was the third highest for January in the 1880-2017 record, behind 2016 (highest) and 2007 (second highest). The extent of polar sea ice on 4 December, 2016 was about 3.84 million square kilometers (1.48 million square miles) below the 1981-2010 average, according to U.S. National Snow and Ice Data Center satellite measurements. That’s roughly the size of India melted away because of rising global temperatures. The increase in temperature, heatwaves, storms, floods and disruption of weather patterns is being felt by everyone, but it’s still somehow not enough to get everyone to take the necessary desired action. Why?

To begin with, climate change is a soft term, moderate and fuzzy. It could do with re-labeling as “climate disaster”. Climate disaster creates a stronger sense of threat and generates a greater sense of urgency. It brings up vivid images to the mind of typical disasters—storms, floods, wildfires, droughts, etc. So people are more likely see it as harming them and their family, and more likely to see it happening now. Several behavioural science studies have shown evidence that when words are re-labeled it makes a huge difference in people’s behaviour. Imagine 3G, 4G and wifi being reworded as “radiation”.

However, education on “climate disaster” is not enough. It needs to be made more tangible for everyone to act upon it. We need to create behavioural design nudges in our everyday lives that enable everyone to effectively contribute in reducing climate disaster in a tangible, concrete way. For example, just like the Bureau of Energy Efficiency has created an energy saving star rating system for household appliances like air conditioners, refrigerators and washing machines, we need to have an encompassing “climate disaster” star rating system for each and every product and service we consume. Fewer the stars, more the damage caused to the planet. Higher the stars, the better it is for the planet. For example, amongst food items, chicken would get a higher star rating than beef because cows let out methane as they digest food, a potent greenhouse gas, 25 times as powerful as carbon dioxide. And beef requires 28 times more land to produce than chicken and 11 times more water. Vegetarian plant-based food would get the highest star rating in comparison. The “climate disaster” star rating system will, in turn, nudge manufacturers to ensure their products and services have a high star rating. That means relying on renewable sources of energy, efficient use of resources, efficient emissions and better waste management. Sure it can be complicated to work out such a rating for all products and services, but if done, we could have a shot at surviving ‘climate disaster’.

Consumer and Employee behaviour (Bajaj Finance)

Last week we spoke at Bajaj Finance on applying behavioural science to improve sales conversions, new product adoption, product portfolio, choice architecture, pricing strategies, employee behaviour change, productivity, performance management systems, learning and team collaboration.

One of the questions asked during the Q&A was what’s the difference between data science and behavioural science and what’s the role of both in business. We answered the question with the example of Uber. To make sure you can hire an Uber within couple of minutes of booking one and to make sure the cab arrives at the exact location around the time promised, Uber must be applying incredible amount of data science – matching user’s data with driver’s data and of course so much more we don’t understand as behavioural scientists. When Uber would use surge-pricing too, they would apply data science to incentivise drivers to reduce customer’s waiting time. But it didn’t go down well with anyone. So Uber changed its tactic from surge-pricing (1.8x) to upfront-pricing (Rs. 167). With upfront-pricing customers no longer feel its unfair because they are informed about the exact fare at the time of booking prior to the trip, which is a certain fixed amount and that puts customers at ease, even though in peak times Uber indicates that fares are higher due to higher demand. On the other hand, surge-pricing (1.8x) pinched people a lot more. But now with upfront-pricing, Uber is still able to charge a surcharge, but without pinching people as much, thereby improving customer experience. Uber’s upfront-pricing is an example of Behavioural Design.

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