Lecture 1,2,3 - What Is Behavioral Science & Why Management Students Need To Learn This (Autosaved) (Autosaved)

Behavioral Economics for Manager: The Leader as
Decision Architect
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Instructor: Dr. Amrita Kamalini Bhatt acharyya
E-mail: ambhatt acharyy@imt.edu
Mobile: 9432943856
Insti tute Of Management Technology, Ghaziabad
Marking System Allocated Marks
Quiz 20 Marks
Class Participation 20 Marks
Group Projects 20 Marks
End Term 40 Marks
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Behavioral Economics for Manager: The Leader as Decision Architect
However beautiful the strategy, you should occasionally look at the results.
Sir Winston Churchilll
 What is Economics?
 What does Economics Study?
 What does ‘micro’ and ‘macro’ economics study?
‘optimal allocation’
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Allocation addresses the method of producing goods and services as well as to whom the
goods are allocated and how much each person consumes.
A central theme of economics is to understand people’s individual behavior and interactions
which form the basis for the entire allocation process.
When we understand the allocation process then we can understand the effects of government
economic policies on the final allocation of resources.
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Economics studies potential policies, evaluates them and attempts to understand which
policies are desirable.
Garnering the ability to evaluate economic policies to a certain degree is obligatory for any
voter in a democratic nation who has completed a college level education.
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 What is Behavioral Economics?
In traditional economics main actor is an imaginary character called ‘economic man’ or
‘Home economicus’. He is a selfish and rational maximizer of his own personal utility.
In actual humans, ‘Homo sapiens’ are not completely selfish is the way an ‘economic man’ is,
nor are they perfectly rational and often allow her emotions to affect the economic decision.
Behavioral Economics can be defined as ‘study of economics that does not rely on the
assumption of the rational, selfish economic man.’
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Behavioral Economics employs theories and results from psychology, sociology, anthropology,
neurology and other disciplines, and makes use of empirical studies including experimental
ones to demonstrate the inconsistency between the assumption of an economic man and
actual economic decision making.
Rational Man: Traditional economics makes this assumption that all economic agents are
‘rational’ and makes economic decision keeping in mind their individual gains.
Behavioral Economics breaks this assumption and tries to understand economic decision of
humans, human behavior and interactions. How they behave individually and in groups.
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 Economics and psychology are the two most influential disciplines that underlie marketing and
finance.
 Both disciplines are used to develop models and established facts in order to better understand
how firms and customers actually behave in markets and to give advice to managers.
 As both of these disciplines have the common goal of understanding human behavior relatively
few marketing studies have integrated ideas from the two disciplines.
 All too often business management theorists, fail to engage in debate, examine and re-examine
their theories and rather continue to advocate for management behaviors based on a time and
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place that no longer resemble today’s market conditions. Behavioral Economics for Manager: The Leader as Decision Architect
 Behavioral economics has revealed a variety of systematic ways in which people deviate from
being perfectly selfish, rational, optimizing agents.
 These findings have important implications for government policy and firm behavior. This
course will explore these implications by answering two main questions:
(1) what does behavioral economics imply for when and how the government should intervene
in markets?
(2) What does behavioral economics imply for firms' pricing and production decisions?
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 The course will present the standard economic approaches to answering these questions and
then explore how answers change when we consider that people act in behavioral ways.
 Towards the end of the course, we will investigate specific policy questions, allowing us to
debate solutions while hearing from policy makers operating in a world of behavioral agents.
 Other than that Behavioral economics can be used in marketing applications, to link the
psychological approach of consumer behavior to the economic models of consumer choice and
market activity.
 In one word let us replace ‘Homo Economicus’ by ‘Homo Sapiens’

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 Within marketing science, the analysis of brand choices for fast-moving consumer goods, based on
aggregate data, shows that most individuals tend to purchase a variety of brands within a product
category.
 In a steady-state market:
(a) only a small portion of consumers buy just one brand on consecutive shopping occasions, that is,
few consumers remain 100% loyal to one brand;
(b) each brand attracts a small group of 100%-loyal consumers;
(c) the majority of consumers buy several different brands, selected apparently randomly from a
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(d) existing brands usually differ widely with respect to penetration level and not so much in terms of
average buying frequency (i.e., how often consumers buy it during the analysis period); and
(e) brands with smaller penetration levels (or market shares) also tend to show smaller average buying
frequency and smaller percentages of 100%-loyal consumers (i.e., “double jeopardy”).
These results have been replicated for some 30 food and drink products (from cookies to beer), 20 cleaning
and personal care products (from cosmetics to heavy cleaning liquids), gasoline, aviation fuel,
automobiles, some medicines and pharmaceutical prescriptions, television channels and shows, shopping
trips, store chains, individual stores, and attitudes toward brands (Foxalla , 2007)
This behavior can be described with the help the theory of ‘Nudge’ developed by Richard Thaler 13
The Role of a Manager
 Is shifting in profound ways as market complexities continue to present newfound challenges to
the management of people in the workplace.
 Today’s dominant management perspectives focus on the behaviors associated with planning,
controlling, organizing, and directing resources within organizations, which arise from a rational
economic understanding of human behavior.
 Utilizing behavioral sciences creates an opportunity to bring humanity back to the forefront of
management decision-making.
 In addition, recent behavioral science sheds light on the complexity andirrationality that arise in
human decision-making, which necessitates a new understanding on how to manage people in

the workplace. 14
 Within the fictional superhero comic book series, Ben Parker advises the young and struggling
Spiderman, “With much power comes much responsibility.” Entering into the management
profession brings a greater sense of responsibility for organizational outcomes.
 Management, while filled with many opportunities, also presents challenges unfounded at
other levels within the organization.
 Pew Research Center (2014) study found that only 39% of employed adults wanted to become
a boss or top manager some day. It is not a position that all employed individuals strive toward.
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 The role of manager today is as instrumental to organizational outcomes as it was at its
inception. Getting the management role right is necessary for firm survival.
 The usefulness of many of today’s dominant assumptions that underpin leading management
behaviors and practices have proven to be antiquated at best, and at worse, harmful to longer
term value creation.
 The traditional management discourse subscribes to the activities proposed in the theory of
business administration, which is largely based on rational economic assumptions of how
people make decisions and behave in organizations.

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 As discovered, rational economic theory is less helpful to inform our understanding of the way
people actually behave within real organizations.
 The lack of usefulness in ‘rational economics’ informing management theory is partly based on
the complexity and unpredictable markets firms seek to compete in today, and in part, based
on the fact that people are not as self-seeking as many of the rational models presume.
 The behavioral sciences are leveraged to form a new paradigm on the role of management in
today’s firms which gives a departure from in environments that relied on efficiency, routine
and low cognitive skills.

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 The role of manager has moved from one who administers tangible resources in a predictable
and controllable fashion to the one who adapts to the complexity of both the environment and
people they manage.
 Rather than relying on command and control styles of leadership to mitigate agency costs,
today’s managers may be better off leveraging the inherent desire for people to grow, develop,
and belong by building social capital to lower the costs of doing business and align interests.
 As result, the role of manager departs from one who plans, organizes, controls and directs
tangible resources to one who connects, coaches, empowers, and adapts to people and
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 The manager is free from engaging in the command and control style of leadership, which is
averse to the development of knowledge and people in today’s workplaces.
 This new behavioral paradigm of management also requires a newfound understanding of
human behavior and the irrationalities, such as implicit assumptions or the power paradox,
which can mitigate one’s ability to effectively build social capital in the workplace.
 Social capital is built upon a manager connecting employees to shared objectives during the
hiring process, coaching with and toward expertise during goal-setting and performance
management activities, empowering through reciprocal relationships to foster employee

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 The manager’s newfound role in organizations consists of both highly cognitive, emotional and
relational activities.
 Scott (2017) commented many of today’s leading management theorists undervalue the
emotional toil and labor managers face each day working with people.
 Managers are not immune to the many heuristics that impede rational decision-making in the
workplace.
 It is also important to consider how managers can create their own time and space for
development, growth, and a sense of belonging to the broader organizational narrative.

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Behavioral economics and policy
 By its nature, economics is an applied subject. It should inform on how to alleviate poverty,
avoid unemployment, regulate industry and so on.
 But lately there has built a frustration amongst non economist people that economics often
fails to provide good answers to important policy questions or rather predict future, an
economic future.
Ex-Ante v/s ex-post
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Problems with ‘Standard Economic Model’
 Standard economic model suggests that intervention is needed only when markets fail because
of things such as and externalities, imperfect information or imperfect competition;
 If markets work, then people make the rational decision.
 So if people do not save for retirement then that clearly want to end their life in poverty.
 If someone buys a mortgage that they cannot afford them they knowingly gambled everything
on house prices rising.

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Behavioral economics make us question the purpose of policy-
 This is because the emphasis turns more towards measuring happiness than measuring rational choice.
 In fact we shall see that choice can be influenced by all kinds of context effects; such as a ‘50% off’
sticker for a TV advert on the consequences of evading tax; this makes the very notion of rational
choice become somewhat meaningless.
 Suppose for instance Annika loves a bargain and cannot resist buying a handbag that she has absolutely
no need for because the prices is reduced 50%.
 We might call this a mistake because I know was only won over by the 50% of sticker but if buying
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handbag makes you happy then was it a mistake? Behavioral Economics for Manager: The Leader as Decision Architect
 Is Annika going to be happier if we point out to her that she has just been duped into buying a
handbag she does not need?
 Will she be any happier if the government bans misleading price offers?
 Similarly, suppose and are always pays her taxes because she overestimates the probability of
being caught evading tax.
 Will she be any happier if we point out to her that she has been duped by the advertising of the
tax authorities?
 Clever policy should make people happier, and behavioral economics gives us a better picture of
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But, what is Rationality?
 The definition of rationality has been much debated but there is general agreement that
rational choices should satisfy some elementary requirements of consistency and coherence.
 Tversky and Kahneman(1981) wrote a paper where they describe decision problems in which
people systematically violate the requirements of consistency and coherence
 And trace these violations to the psychological principles that govern the perception of decision
problems and the valuation of options.
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 Similarly if someone become addicted to heroin then they choose to do so taking into account
their financial constraints.
 To anyone other than economics these kind of statement sound weird, they also sound weird to
a behavioral economist.
 But it is important to realise that behavioral economics does not prescribe ‘big government’
rather it prescribes clever government.
 As behavioral economics tries to give fresh insight into what policies will work and what will
not; a clever government is call of the day.

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The Anatomy of a decision
The term judgment refers to the cognitive aspects of the decision-making process, to fully
understand judgment, we must first identify the components of the decision-making process that
require it.
 Let us consider the following circumstances:
You are finishing your MBA at a well-known school. Your credentials are quite good, and you
expect to obtain job offers from a number of consulting firms. How are you going to select the
right job?
As the owner of a venture capital firm, you have a number of proposals that meet your
preliminary considerations but only a limited budget with which to fund new projects. Which
projects will you fund? 27
 What do these scenarios have in common?
Each one proposes a problem, and
Each problem has a number of alternative solutions.
 Let’s look at six steps you should take, either implicitly or explicitly, when applying a
‘‘rational’’ decision-making process to each scenario.
 Define the problem
 Identify the criteria
 Weight the criteria
 Generate Alternatives
 Rate each alternative at each criteria

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 Behavioral Economics for Manager: The Leader as Decision Architect
Which is the longer table?
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How much is 17×39?
What is the emotion do you see in this picture?

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 Even the brightest people make judgmental errors on a regular basis.
 These errors, or biases, are much more likely to occur in System 1 thinking than in System 2
thinking.
 At the same time, any methodical System 2 process will use some intuitive System 1 shortcuts.
In fact, the two systems frequently work in tandem, with modification of the quick, initial
response of System 1 thinking after more in-depth consideration by the System 2 mind.
 Sometimes, however, System 2 thinking does not fully adjust. For example, most people have a
sensible aversion to eating from a container labeled as containing the poison cyanide.
 However, they have trouble overcoming this impulse even when they themselves were the
ones to write ‘‘cyanide’’ on an otherwise clean container.

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System 1 & System 2 Thinking (Cognitive Functioning)
Do people actually reason in the logical manner described above? Sometimes they do, but not most of
the time.
 System 1 thinking refers to our intuitive system, which is typically fast, automatic, effortless,
implicit, and emotional. We make most decisions in life using System 1 thinking. For instance,
we usually decide how to interpret verbal language or visual information automatically and
unconsciously.
 System 2 refers to reasoning that is slower, conscious, effortful, explicit, and logical.
In most situations, our System 1 thinking is quite sufficient; it would be impractical, for example, to
logically reason through every choice we make while shopping for groceries.
But System 2 logic should preferably influence our most important decisions. The busier and more rushed
people are, the more they have on their minds, and the more likely they are to rely on System 1 thinking.
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Let’s Play a game
 Bread and ?
 The automatic activities that is attributed to System 1 thinking:
1. Understand simple sentences.

2. Orient to the source of a sudden sound.
3. Make a “disgust face” when shown a horrible picture.
4. Detect hostility in a voice.
5. Answer to 2 + 2 = ?
6. Drive a car on an empty road.
7. Find a strong move in chess (if you are a chess master).
This system 1 thinking shares character traits which are innate to our nature which we share with
animals.
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The highly diverse operations of System 2 have one feature in common: they require attention
and are disrupted when attention is drawn away.
 Here are some examples:
1. Brace for the starter gun in a race.

2. Focus on the voice of a particular person in a crowded and noisy room.
3. Search memory to identify a surprising sound.
4. Maintain a faster walking speed than is natural for you.
5. Monitor the appropriateness of your behavior in a social situation.
6. Tell someone your phone number.
7. Fill out any form.
8. Check the validity of a complex logical argument.
The issue comes down to the question of ‘paying attention’.
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 System 2 has some ability to change the way System 1 works, by programming the normally
automatic functions of attention and memory.
 Everyone has some awareness of the limited capacity of attention, and our social behavior
makes allowances for these limitations.
 Intense focusing on a task can make people effectively blind, even to stimuli that normally
attract attention.
 Systems 1 and 2 are both active whenever we are awake.
 System 1 runs automatically and System 2 is normally in a comfortable low-effort mode, in
which only a fraction of its capacity is engaged.
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 System 1 continuously generates suggestions for System 2: Impressions, Intuitions, Intentions,
and feelings.
 If endorsed by System 2, impressions and intuitions turn into beliefs, and impulses turn into
voluntary actions. When all goes smoothly, which is most of the time, System 2 adopts the
suggestions of System 1 with little or no modification. You generally believe your impressions
and act on your desires, and that is fine usually.
 When System 1 runs into difficulty, it calls on System 2 to support more detailed and specific
processing that may solve the problem of the moment. System 2 is mobilized when a question
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 The division of labor between System 1 and System 2 is highly efficient: it minimizes effort and
optimizes performance. The arrangement works well most of the time because System 1 is
generally very good at what it does: its models of familiar situations are accurate, its short-term
predictions are usually accurate as well, and its initial reactions to challenges are swift and
generally appropriate.
 System 1 has biases, however, systematic errors that it is prone to make in specified
circumstances. One further limitation of System 1 is that it cannot be turned off. If you are
shown a word on the screen in a language you know, you will read it—unless your attention is
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totally focused elsewhere. Behavioral Economics for Manager: The Leader as Decision Architect
The Bounds Of Human Rationality
 The term ‘rationality’ refers to the decision-making process that is logically expected to lead to
the optimal result, given an accurate assessment of the decision maker’s values and risk
preferences.
 The rational model is based on a set of assumptions that prescribe how a decision should be
made rather than describing how a decision is made.
 In his Nobel Prize– winning work, Herbert Simon (March & Simon, 1958; Simon, 1957)
suggested that individual judgment is bounded in its rationality and that we can better
understand decision making by describing and explaining actual decisions, rather than by
focusing solely on prescriptive (‘‘what would rationally be done’’) decision analysis.
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 The term ‘bounded rationality’ is commonly reserved for work in which the constraints people
face are explicitly modeled.
 The approach is thus one of solving for what a rational person will do if they have, say, limited
memory. For instance, what password should Anna use on her computer if she knows she might
forget it? With this approach it is still assumed that people can be approximated by a selfish and
rational Homo economicus; just one with a bit less memory and mathematical ability.
 Such an approach is prone to something called the infinite regress problem, but it does give us
an idea of how a person can optimally cope with their limitations, or bounded rationality.
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Debate and Controversy
The standard economic model predicts well only what experienced people do – i.e. people familiar
with a task or decision?
 This turns out to be a tough question to answer. The problem is that in many instances we find that
the standard economic model gives a poor prediction of what happens the first time someone faces
a particular situation, but a much better prediction the fourth, fifth, sixth time they face the same
situation.
 This is the discovered preference hypothesis, that the standard economic model is a good
predictor if people have had ample opportunity to learn from experience.
 There is debate over the validity of the discovered preference hypothesis, and we shall see
situations in which no amount of experience helps the standard economic model predict well. This
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 More interesting is to ask what we should conclude if the discovered preference hypothesis is
correct.
 This will depend on whether people have ample opportunity to learn from experience in most
of the things we are interested in. Arguably, they do not because there are many important
things that a person does only once or a few times in their life, such as retiring, choosing a
career, buying a house, and so on.
 We want to be able to predict what will happen in these situations too, so maybe the standard
economic model is not so great after all? We shall conveniently avoid that question and finish
with a much easier one.
 Should behavioral economics look to rewrite economics from a psychological perspective, or
adapt the standard economic model to take account of psychological insight? 41

 Some would probably like to start from scratch, and scrap the standard economic model.
Maybe that is what you expected of behavioral economics.
 This is not, however, what behavioral economics is about.
 Behavioral economics is very much about working with the standard economic model, whether
it is a good predictor or not.
 That’s because, as mentioned earlier, it is the natural starting point.
 Daniel Kahneman (2003: 1449), for example, writes about his work with Amos Tversky: ‘The
rational agent model was our starting point and the main source of our null hypotheses.’
 To quote from two other leading behavioral economists, Colin Camerer and George
Loewenstein (2004: 3):

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 ‘At the core of behavioral economics is the conviction that increasing the realism of the psychological
underpinnings of economic analysis will improve economics on its own terms.’
Too far or not far enough
 The biggest concern is that behavioral economics is too much like the standard economic model.
 As behavioral economics takes the standard economic model as its starting point. In practice, this
means that behavioral models are almost always the standard economic model plus something new.
 That ‘something new’ might be a reference point, loss aversion, greater weight on the present than the
future, a desire to earn no less than others, and so on. The basic assumptions of the standard economic
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model are retained, however. Behavioral Economics for Manager: The Leader as Decision Architect
 This means that behavioral models retain many non- psychologically grounded assumptions. Put another
way, behavioral economics is firmly based on the methodology of positive economics. Some suggest that
a more radical approach is needed.
 Let us turn now to those who criticize behavioral economics for going too far.
 If behavioral economics is the standard economic model plus something else, then it is no surprise that we
can get a better fit.
 The danger is one of over- fitting. The basic critique goes something like this. The behavioral economist
observes behavior that ‘should not happen’, according to the standard economic model, such as Alisha
borrowing at a high interest rate on a credit card while simultaneously saving for retirement at a low
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 We then come up with something that can ‘explain’ this anomaly, such as an impulsive desire to
buy expensive handbags while out shopping.
 We then congratulate ourselves on a better fit.
 The field of decision making can be roughly divided into two parts: the study of prescriptive
models and the study of descriptive models.
 Prescriptive decision scientists develop methods for making optimal decisions. For example,
they might suggest a mathematical model to help a decision maker act more rationally.
 Descriptive decision researchers consider how decisions are actually made. In this course we
are going to take a descriptive approach, but why?

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 First, understanding our own decision-making processes helps clarify where we are likely to
make mistakes and therefore when better decision strategies are needed.
 Second, the optimal decision in a given situation often depends on the behavior of others.
Understanding how others will act or react to your behavior is critical to making the right
choice.
 Third, plenty of good advice about making decisions is available, but most people do not follow
it. Why not? Because they do not understand how they actually make decisions, they do not
appreciate the need to improve their decision making.
 Satisficing is a decision-making strategy or cognitive heuristic that entails searching through the
available alternatives until an acceptability threshold is met.

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 The term satisficing, a portmanteau of satisfy and suffice was introduced by Herbert A.
Simon in 1956 although the concept was first posted in his 1947 book Administrative Behavior.
 Simon used satisficing to explain the behavior of decision makers under circumstances in which
an optimal solution cannot be determined. He maintained that many natural problems are
characterized by computational intractability or a lack of information, both of which preclude
the use of mathematical optimization procedures.
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 In his Nobel Prize in Economics speech that "decision makers can satisfice either by finding
optimum solutions for a simplified world, or by finding satisfactory solutions for a more realistic
world. Neither approach, in general, dominates the other, and both have continued to co-exist
in the world of management science".
Why we ‘‘satisfice’’?
 While Simon’s bounded-rationality framework views individuals as attempting to make rational
decisions, it acknowledges that they often lack important information that would help define
the problem, the relevant criteria, and so on.
 Time and cost constraints limit the quantity and quality of available information.
 Furthermore, decision makers retain only a relatively small amount of information in their
usable memory. 48
 Finally, intelligence limitations and perceptual errors constrain the ability of decision makers to
accurately ‘‘calculate’’ the optimal choice from the universe of available alternatives.
 Together, these limitations prevent decision makers from making the optimal decisions
assumed by the rational model.
 The decisions that result typically overlook the full range of possible consequences.
 Decision makers will forgo the best solution in favor of one that is acceptable or reasonable.
 That is, we satisfice: rather than examining all possible alternatives, we simply search until we
find a satisfactory solution that will suffice because it achieves an acceptable level of
performance.
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Some background on experiments
 Behavioral economics involves both theory and experiment.
 To run an experiment we need people who are willing to take part. Those who do are given the
title subject or participant.
 Each subject are asked to come to a particular experimental session, and researchers ran
multiple sessions.
 All the sessions took place in a computer lab.
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 Let us describe one such experiments-
 When the subjects arrived to the computer lab after a brief introduction they were each
allocated to a computer and signed a consent form.
 After this there was no talking until the experiment ended, and a subject could see only their
own computer screen. Things were, therefore, completely anonymous, and subjects were
reassured this would be the case.
 Beside their computer each subject would find an instruction sheet, which read something like
this:
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 In this experiment you will make decisions, and earn an amount of money that depends on
what you and others choose. The money will be given to you at the end of the experiment in an
envelope. Only you will know how much money you earned.
 You have been organised into groups of five. Each group will consist of the same five people for
the duration of the experiment. The experiment will last for 25 rounds. In each period you will
be required to make a decision, and your total earnings will depend on your decisions in all
rounds.
 At the beginning of every round you, and all other members of your group, will receive 55
tokens. Each of you must decide, on your own, how many of the 55 tokens to allocate to a
group account.
 If the total number of tokens allocated to the group account is 125 or more then you will each
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 If the total number of tokens allocated to the group account is less than 125 then you will receive no additional
tokens but will get back any tokens you allocated to the group account.
 So, at the end of the round:
 If the total number of tokens allocated to the group account ≥ 125, your earnings = initial 55 tokens − tokens
allocated to group account + additional 50 tokens.
 If the total number of tokens allocated to the group account < 125, your earnings = initial 55 tokens.
 At the end of the session, you will be asked to fill in a short questionnaire. You will be paid in cash the total
amount that you earned for all rounds in the session plus ₹100. Each token will be worth ₹ 10.
 Once all the subjects had read the instructions the experiment would commence, with everything taking place on
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computer Behavioral Economics for Manager: The Leader as Decision Architect
 So, the first thing that would happen is each subject was asked to input how many tokens they
wanted to allocate to the group account. To illustrate, in group one, subject one input 25,
subject two input zero and subjects three to five input 50, 25 and 10.
 The total number allocated was, therefore, 110, which was short of the 125 target. The subjects
were told this and told their earnings were 55. That was the end of round one.
 The total number of tokens allocated in round two went up to 161, well above the target. As
you may have seen by now, the term round keeps track of how far subjects have progressed
through the experiment.
 This is a threshold public good game.
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Changing Nature of Job
 Complexity And Irrationality Influence Markets, Firms, And Individual Behavior
 Management is the driving force inside an organization and the complexity and pressures they
face competing in today’s marketplace are profound, e.g. the average lifespan of an S&P 500
company has diminished by more than 50 years.
 In the 1920s, firm survival time was 67 years, while today few firms expect to survive for more
than 15 years on the S&P 500.
 Simply put, a firm’s chance of long-term survival is quite bleak in today’s environment.
 Only a manager is able to strengthen the diffusion of knowledge in a firm through effective
talent management and increase the chance of a firm’s survival rate in today’s complex
economic climate. Behavioral Economics for Manager: The Leader as Decision Architect
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 You are the director of the marketing division of a rapidly expanding consumer
company. You need to hire a product manager for a new ‘‘secret’’ product that the
company plans to introduce to the market in fifteen months. How will you go about
hiring the appropriate individual?
 You are on the corporate acquisition staff of a large conglomerate that is interested in
acquiring a small-to-moderate-sized firm in the oil industry. What firm, if any, will you
advise the company to acquire?
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No Data, No Drama: How Behavioral Science Can Help the Banking Industry
When Data Plays Hard to Get…
 Since “Machine Learning” and “Big data” have become hot topics, data appears, in the eyes of many, as
a requisite for businesses to improve their customers’ online experience and reach sales targets.
 Data is indeed one of the most valuable resources of our time. Although researchers, engineers and
marketers always used some kind of data in their work, new technologies, such as Next Best
Offer/Action/Product systems, leverage data, at scale, in ways never done before.
 Algorithms can enable brands to offer customers what they need, when they need it, and maybe
even before they realize it.
 In banking in particular, people have a very strong emotional reaction to money and finances.
Even if they think they are making an entirely rational decision, there are always emotions 57
 Therefore banks should be aware of those feelings in order to assist people in making better
decisions with their money .
 We cannot change human nature - that’s impossible, but we can change the environment which
changes human behavior and influences decisions. Often companies design products and hope
they will change human nature, but it’s always the other way around. We should create digital
banking products based on a deeper understanding of human behavior.
 For instance, HSBC has used customer data to predict how they might redeem their credit card
points. In turn, the algorithm’s output was used to send customers personalized reward offers
(e.g. cash or travel points) based on that prediction.
Behavioral Economics for Manager: The Leader as Decision Architect 58

Why should banks be interested in behavioral economics?
 Banks have always been a trusted touchpoint for people. When people make an important
decision, like buying a home for example, they have many doubts, questions and lots of missing
information. Those decisions contain so many invisible emotions and internal biases - doubts,
worries, excitement, confusion, fear of loss. Being a trusted partner and understanding how
your customers react to these important life decisions is essential for giving good, and helpful
advice.
What about the role of Chief Behavioral Officer with the bank? Is it necessary?
 The role of Chief Behavioral Officer is key for any growing institution. It is particularly important
in banking and investment arenas, because the industry is driven by numbers in its nature.
However, there needs to be a person that looks at things from a bigger perspective, beyond59
 The Chief Behavioral Officer understands both the business concerns and the science, and is
able to draw conclusions from both disciplines. Truth is there are no off-the-rack solutions for
applying all the insights, financial data, inputs from multiple sources. The key is to experiment.
Try things. Having someone who leads these experiments is going to be crucial - especially in
traditional industries like banking.
60
How do people generally think about money?
 People, in general, have a difficult time evaluating financial decisions or measuring opportunity
costs.
 If you make a financial decision now, it impacts what you could potentially do with that same
money in the future. That's tough to think about.
 So the way we end up thinking about money is based on uncertainty and our inability to
measure what something is worth, the assess its value. Therefore we tend to take shortcuts,
and find little tricks - that consciously or subconsciously convince us that we know the value of
61
 People tend to create mental accounts, just like we do within our online banking budgets- with
saving, checking, retirement accounts.
 Sometimes we think about the money we spend on rent, on food or on bills in separate
categories. In many senses it can help- budgeting is important-, but it is also irrational because
all our money is the same, all part of one account, whether we spend it on food, leisure or
something else.
 What also happens, is that we often break our mental accounting rules, like when one day we
decide we want to go out with friends, we momentarily forget about our categories to justify a
night out when we really shouldn’t.

 Yet, there are still a number of hurdles preventing businesses and customers to really seize the
power of data. And that is assuming data is easily accessible.
 HSBC wants to give its U.S. credit card customers a better shopping experience.
 The London-based bank is working on creating a rewards program that reads customer data to
predict how they might redeem their credit card points so it can market the offerings of a certain
category — travel, merchandise, gift cards or cash — more actively.
 It’s a little bit like online retailers that push certain products to consumers based on their
preferences and previous activity.
 The bank has partnered with Maritz Motivation Solutions, a provider of loyalty programs to U.S.
and global companies whose technology suggests a redemption category to promote to each
credit cardholder and calculates the percentage of customers likely to redeem in different 63
 More than 90 percent of credit general purpose card spending by consumers with super prime
scores in 2016 was on a rewards card, according to Consumer Financial Protection Bureau’s
Consumer Credit Card Market Report, published in December.
 HSBC banks “international and affluent” customers and operates 229 bank branches on the
east and west coasts of the U.S., more than half of which are in New York. Most of its cards are
tied to a rewards scheme.
 But beyond the interchange, interest and annual fees HSBC makes on each card, competition
among issuers in the rewards credit card market has increased significantly over the past two
years and HSBC is looking to create more meaningful customer interactions in a business that
historically has been difficult or simply arduous to navigate.
64
Does this mean that banks cannot do anything to better serve their clients online?
Of course not.
… Insights from Behavioral Science Can Save Your User Experience
 These three simple steps will help you improve customer experience using behavioral science:
1. Define your goal (you don’t need much data)
 Business objectives drive R&D in the industry, and that holds in banking too.
 Whether it’s encouraging people to save more, having customers engage more with your site to
sustain the online relationship, or motivating them to try on a recently integrated payment solution,
these objectives can be turned into actual research questions.
 The question itself, or the specific business goal you aim for, will delimit the research area to set up a
behavioral intervention. Having data from your customers, like web navigation, drop-off points or
65
even customer profiles will help of course, but it is not required to move on to step 2.
2. Delve into the body of knowledge
 Before starting to plan on how to address business objectives, take the time to catch up on the
latest related behavioral insights from academia or private research reports. This will put you on
the right path to design a customer centric experience.
 In retail banking for example, there is a tremendous amount of evidence from behavioral
economics regarding how people make savings decisions, handle debt, how emotions drive buying
decisions, etc.
3. Test, using a control group
 Testing is key to any worthy behavioral intervention for at least two reasons. First, even if much
research has already been conducted on the topic, you will certainly need to validate your
intervention. Indeed, the solution you implement to improve your customers’ experience might
66
 Testing will allow you to measure the impact of the intervention before applying it for all
customers. This will save you the cost of implementing a bad intervention in case it did not
work as planned.
 These three simple steps can help you leverage your customer experience without any detailed
customer data, just by adapting existing knowledge on human behavior with the appropriate
methodology.
This is called Behavioral banking

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Behavioral Economics for Manager: The Leader as

Class Participation 20 Marks

Group Projects 20 Marks

End Term 40 Marks

Sir Winston Churchilll

 What does Economics Study?

 What does ‘micro’ and ‘macro’ economics study?

goods are allocated and how much each person consumes.

A central theme of economics is to understand people’s individual behavior and interactions

which form the basis for the entire allocation process.

economic policies on the final allocation of resources.

policies are desirable.

voter in a democratic nation who has completed a college level education.

assumption of the rational, selfish economic man.’

actual economic decision making.

being perfectly selfish, rational, optimizing agents.

course will explore these implications by answering two main questions:

 In one word let us replace ‘Homo Economicus’ by ‘Homo Sapiens’

few consumers remain 100% loyal to one brand;

(b) each brand attracts a small group of 100%-loyal consumers;

frequency and smaller percentages of 100%-loyal consumers (i.e., “double jeopardy”).

 Is shifting in profound ways as market complexities continue to present newfound challenges to

the management of people in the workplace.

human decision-making, which necessitates a new understanding on how to manage people in

profession brings a greater sense of responsibility for organizational outcomes.

other levels within the organization.

term value creation.

business administration, which is largely based on rational economic assumptions of how

people make decisions and behave in organizations.

people actually behave within real organizations.

and low cognitive skills.

people they manage.

averse to the development of knowledge and people in today’s workplaces.

 This new behavioral paradigm of management also requires a newfound understanding of

management activities, empowering through reciprocal relationships to foster employee

development, growth, and a sense of belonging to the broader organizational narrative.

avoid unemployment, regulate industry and so on.

Ex-Ante v/s ex-post

of things such as and externalities, imperfect information or imperfect competition;

 If markets work, then people make the rational decision.

on house prices rising.

choice become somewhat meaningless.

no need for because the prices is reduced 50%.

handbag she does not need?

being caught evading tax.

people systematically violate the requirements of consistency and coherence

problems and the valuation of options.

their financial constraints.

rather it prescribes clever government.

not; a clever government is call of the day.

 Let us consider the following circumstances:

Each one proposes a problem, and

Each problem has a number of alternative solutions.

 Identify the criteria

 Weight the criteria

 Rate each alternative at each criteria

What is the emotion do you see in this picture?

ones to write ‘‘cyanide’’ on an otherwise clean container.

1. Understand simple sentences.

1. Brace for the starter gun in a race.

automatic functions of attention and memory.

makes allowances for these limitations.

 Systems 1 and 2 are both active whenever we are awake.