Predictably Irrational: The Hidden Forces that Shape Our Decisions

Business Book Review

If you haven’t read this one already, read it now.  This is as insightful a look at why humans do the dumb shit that we do as anything Kahneman has put out there and I loved his book: Thinking, Fast and Slow.  Ariely takes us through, step by step, all of the major irrationalities that we buy into every day.  The beauty of this book is that we know that we are irrational but this book will show that this irrationality is actually predictable.  Or as Ariely puts it, “our irrationality happens the same way, again and again.”

All of the theories in the book are backed up by empirical experimentation.  While sample size always needs to be considered, having real numbers trumps gut feel every day of the week.  The way he runs each experiment is telling.  He always sets out to answer a question that bothers him then comes up with a data driven answer.  Curiosity coupled with experiment makes for great reading.

There are so many lessons to pull from this book that it would be a shame not to list them all here for a Cliff Notes review at the very least.  That is the purpose of a lot of these business book reviews, to make sure that the lessons are extracted for future reference.  They also help me distill what I took as the most important nuggets from a particular author’s teaching.  So without further ado, let’s dive in.

The first lesson is about the cycle of relativity.  This starts with our author’s fundamental observation: “most people don’t know what they want unless they see it in context.”  You didn’t know that you wanted that Tesla until you saw it next to your crappy 1994 Toyota Carola.  This makes sense, right?  The discovery that the author puts in front of us is that every marketer in the world knows this and uses it to their advantage.  My favorite example of this, “…people generally won’t buy the most expensive dish on the menu, they will order the second most expensive dish.  Thus, by creating an expensive dish, a restaurateur can lure customers in to ordering the second most expensive choice.”  He calls this the decoy effect.  The opposite of offering the most expensive item is by offering a clearly inferior option, either at the same price or at a negligibly cheaper price, to make the more expensive option look far more appealing.  This decoy effect “is the secret agent in more decisions than we could imagine.”

He next dives into the fallacies of supply and demand and how easily these forces can be manipulated.  There were two big lessons I pulled from this, price anchoring and creating demand.  Price anchoring comes about by something called arbitrary coherence.  “Initial prices are largely ‘arbitrary’ and can be influenced by responses to random questions; but once those prices are established in our minds, they shape not only what we are willing to pay for an item, but also how much we are willing to pay for related products (this makes them coherent).”  The message here is be very careful with your pricing strategies, especially if you are defining a market.  The other side of this is that if prices in your model are already anchored, then you have to change the experience to change the pricing.  This is what Starbucks did with coffee.  They turned buying coffee into a new, exotic experience then were able to charge a lot more for it.  In creation of demand he quotes Mark Twain, “Tom had discovered a great law of human action, namely, that in order to make a man covet a thing, it is only necessary to make the thing difficult to attain.”  This can be seen everywhere but I believe my brother describes it best when he says that ‘people love to wait in line.’  The reason for this is what Ariely calls behavior herding.  “It happens when we assume that something is good (or bad) on the basis of other people’s previous behavior, and our own actions follow suit.”

His next experiment dives into why we find “FREE!” so exciting.  His theory is that something free gives us such a charge because, “…humans are intrinsically afraid of loss.  The real allure of FREE! is tied to this fear.  There’s no visible possibility of loss when we choose a FREE! Item (it’s free). But suppose we choose the item that’s not free.  Uh-oh, now there’s a risk of having made a poor decision – the possibility of loss.  And so, given the choice, we go for what is free.”  Removing this risk of a ‘poor decision’ drives us to make all sorts of poor decisions like buying two for one deals of items that you never would have bought one of in the first place.  I have an uncle that is famous for this, he once bought a case of Italian salad dressing, even though he doesn’t like Italian salad dressing, just because it was ‘such a good deal’.

He then dives into the dichotomy of social norms vs. market norms.  “The social norms include the friendly requests that people make of one another.  Could you help me move this couch? … Social norms are wrapped up in our social nature and our need for community.  They are usually warm and fuzzy.  Instant paybacks are not required.  …market norms, is very different.  There’s nothing warm and fuzzy about it.  The exchanges are sharp-edged: wages, prices, rents, interest, and costs-and-benefits.”  He uses two great examples here, imagine offering to pay grandma for the cost of the Thanksgiving dinner she put out for everyone or explaining to a date the amount you are shelling out for the last three dates you took her out on.  Both of these cases, even if well meant, are a serious violation of the social contract!  Sadly, “when a social norm collides with a market norm, the social norm goes away for a long time.  In other words, social relationships are not easy to reestablish.”

He also goes in to how valuable social norms can be in the business world.  Take open source software for example.  Who would have ever thought Linux or Wikipedia would have been so popular?  He gives another example of a group of lawyers that were approached to help out a retirement community.  The community asked if they could help and offered to pay them well below their normal fee.  The firm said absolutely not.  They asked again but this time if they would consider doing it for free.  The firm readily agreed.  They had gone from a market norm to a social norm.  He also examines the social contract in modern day business.  Businesses used to take care of their employees with pensions and, at the very least, solid benefits.  Nowadays, these things have been cut and businesses bemoan that they can’t find loyal employees anywhere anymore.  You can’t have it both ways.  Loyalty comes from social norms not market norms.

One more example worth mentioning is why, when you are dining out, taking the last hors d’oeuvre is such a big deal.  The answer, “the communal plate transforms the food into a shared resource, and once something is port of the social good, it leads us into the realm of social norms, and with that the rules for sharing with others.”

He devotes a whole chapter to the fact that we are incredibly stupid when we are sexually aroused.  Well duh.

He dives into procrastination and self-control.  The best example here was with how we are all addicted to our devices especially e-mail.  “I think e-mail addiction has something to do with what the behavioral psychologist B.F. Skinner called ‘schedules of reinforcement’. … “On the face of it, one might expect that the fixed schedules of reinforcement would be more motivating and rewarding because the rat can learn to predict the outcome of his work.  Instead, Skinner found that the variable schedules were actually more motivating.  The most telling result was that when the rewards ceased, the rats ho were under the fixed schedules stopped working almost immediately, but those under the variable schedules kept working for a very long time.”  This is why gambling is so popular.  “If you think about it, e-mail is very much like gambling.  Most of it is junk and equivalent to pulling the lever of a slot machine and losing, but every so often we receive a message that we really want.”

I loved his study on the high price of ownership and the “Ikea effect.”  He has a great line in there, “In fact, I can with a fair amount of certainty say that pride of ownership is inversely proportional to the ease with which ones assembles the furniture.”  You spend time on something, you add a value of ownership to it.  This ownership effect is another cause for irrationality.   This can be summed up in the maxim, “‘One man’s ceiling is another man’s floor. ‘ Well when you’re the owner, you’re at the ceiling; and when you’re the buyer, you’re at the floor.”  According to Ariely, this irrationality is propelled by three quirks: 1) we fall in love with what we already have 2) we focus on what we may lose, rather than what we may gain and 3) we assume other people will see the transaction from the same perspective as we do.

It’s stunning to see his experiments around the effect of expectations.  The general idea here is that if we expect that something is going to be good or bad, that expectation greatly impacts the experience.  He has a great quote on this, “As it turns out, positive expectations allow us to enjoy things more and improve our perception of the world around us.  The danger of expecting nothing is that, in the end, it might be all we’ll get.”

He’s fascinated by the study of the placebo effect and rightfully so.  The placebo effect is an amazing way that our mind controls our body.  What was most fascinating about his study though was how big of an impact price has on the placebo effect.  When study participants were given placebo drugs, they did far better in their treatment when they found out that the placebo drug was very expensive.

This leads into a nice segue on the cycle of distrust.  When marketers abuse things like the placebo effect or any other of irrationalities we believe them, but only for a time.  He presents two morals, “The first is that people are willing to forgive a bit of lying.  But the second, more important moral-one that we are just beginning to understand-is that trust, once eroded, is very hard to restore.”

He then dives into all of the experiments he ran on cheating.  This stuff was fascinating.  “when given the opportunity, many honest people will cheat.  In fact, rather than finding that a few bad apples weighted the averages, we discovered that the majority of people cheated, and that they cheated just a little.  The second, and more counter-intuitive, result was even more impressive: once tempted to cheat, the participants didn’t seem to be as influenced by the risk of being caught as one might think…This means that even when we have no chance of getting caught, we still don’t become wildly dishonest.”  He then primed the pump in his experiments by having folks recall the Ten Commandments before the experiment and, “the students who had been asked to recall the Ten Commandments had not cheated at all.”  So there is definitely something to these honor code things.

Finally, what he found out is that “cheating is a lot easier when it’s a step removed from money.”  Any time they ran their experiments on tokens that were worth a certain amount of money, cheating went up dramatically.  This means cheating on things like airline miles is far easier to do because it’s not linked directly to money.  He cautions banks not to get to far away from real money because of this effect.

As a closer, he offers a plan of action.  “although irrationally is commonplace, it does not necessarily mean that we are helpless.  Once we understand when and where we may make erroneous decisions, we can try to be more vigilant, force ourselves to think differently about these decisions, or use technology to overcome our inherent shortcomings.”  Very cool stuff and a ton of lessons to take away from this book.