I attended a very interesting keynote address at Predictive Analytics World in San Francisco, February 2009, entitled The Unrealized Power of Data by Andreas Weigend, former Chief Scientist of Amazon.com. As noted in an earlier blog, Weigend's a big proponent of applying scientific principals to facilitate business learning. He's also keen on social or viral marketing, the end goal of which is to evolve CRM to CMR – customer managed relationships. When asked at the end of his talk to recommend a source for BI inspiration, Weigend didn't hesitate, touting Dan Ariely's best-selling book on behavioral economics: Predictably Irrational, The Hidden Forces That Shape Our Decisions. Weigend also enthused on the possibilities of predictably irrational meeting social data in a blog opinion

In Predictably Irrational (PI), Ariely deftly shows the workings of  behavioral economics in controlled laboratory settings. I was particularly impressed with chapters detailing clever experiments on the fallacy of supply and demand, the cost of zero cost, and the power of price. PI's simple experiments around free and zero certainly resonated. I'll often take a less than rational exchange when one side involves something for free. After similar reactions from a half dozen chapters, it began to seem almost too easy to formulate behavioral economics-driven hypotheses: first construct a laboratory situation for which rational and efficient self interest predict obvious behavior. Then, come up with alternatives that show the brain's “ability” to short-circuit optimal decisions. Voila! I must admit, though, I was underwhelmed by PI's experiments on decision-making under sexual stimulation in the influence of arousal. To think my blue collar Dad was actually practicing behavioral economics when he sat me down for the discussion nearly 40 years ago!

I'm also a bit reluctant to just blithely accept Ariely's method of laboratory experiments with MIT students as a foundation for behavioral economics knowledge-building. With this approach, Ariely optimizes internal validity of his designs at the expense of generalizability or external validity. As he notes: “...(laboratory) experiments are like microscopes or strobe lights. They help us slow human behavior to a frame-by-frame narration of events, isolate individual forces, and examine those forces carefully and in more detail.” All well and good. My own preference is to combine the control of the lab with a healthy dose of field investigations that offer more real world credibility for a slight premium in validity.

Ariely does migrate from his laboratory academic world to business operations in a thought-provoking July-August 2009 HBR article, The New Economics, Count on Irrational Decision Making. He contrasts the differences between behavioral experiments that focus on foundational human behavior with business experiments that seek to optimize an aspect of operations. The former is science or laboratory research; the latter is engineering or field inquiry. Both are necessary to successfully deploy behavioral economics findings in business. Ariely offers several interesting business applications, including methods to minimize lying and cheating by prospects, approaches to promote optimal pricing, and ways to mitigate revenge of aggrieved customers. Finally, he argues for basic corporate behavioral economics experimentation competency to abet business learning.

There's no shortage of other applied predictably irrational analyses making the rounds in behavioral and economics worlds either. A personal favorite is Nudge, Improving Decisions About Health, Wealth, and Happiness, by Richard Thaler and Cass Sunstein. The authors advocate a new movement, libertarian paternalism, that uses the findings of behavioral economics research to nudge the populace to make better decisions, all the while preserving their ultimate freedom of choice. Look for Harvard law scholar Sunstein to join President Obama's staff as head of the powerful Office of Information and Regulatory Affairs any day now, bringing the tools of behavioral economics to the highest levels of government.

There are even defections to the behavioral economics world from the prominent economics mainstream. Berkeley Nobel laureate George Akerloff and Yale Irrational Exuberance author Robert Shiller have written a compelling new book, Animal Spirits, How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism, that uses principles of behavioral economics to both explain the current financial crisis and offer prescriptions for the return to macroeconomic prosperity going forward. Finally, Ori and Rom Brafman have authored  an engaging gem of a book, Sway, The Irresistible Pull of Irrational Behavior, that offers cogent but predictably irrational explanations for a variety of historical events.

I'm a big fan of behavioral economics (and its investment science cousin, behavioral finance) that reject the rationality of traditional economic thinking for imperfect but predictable human decision making. At the same time, I don't think the field necessarily represents a paradigm shift to the study of behavior. Psychologists, historians, political scientists, sociologists, and educators have long posited imperfect human decision making and deployed experimental approaches to formulate and test their theories. The ascendance of behavioral economics is nevertheless a boon to the study of behavior – and a field that business should progressively turn to for help with the development of strategies and experimental approaches to learning.

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