How a Lesson in Behavioral Economics Can Help Business Analysts
A good business analyst is expected to be rational — someone who can logically collate and dissect data to come up with objective metrics and facts; an ability best demonstrated by Spock from Star Trek. But if reading Daniel Kahneman’s ‘Thinking Fast and Slow’ has taught me anything, it is that analysts, and most human beings for that matter, are far from rational decision-makers and are prone to biases and heuristics.
Enter behavioral economics, a field of study that discusses how individuals and communities make decisions, and upends the conventional wisdom that we make decisions based on our own long-term best interests. While most attribute this unique discipline’s rise to two Israeli scientists Kahneman and Amos Tversky, the foundational principles were in-fact stated by Aristotle over 2000 years ago in his list of logical fallacies. One of my favorites is noncausa pro causa, which contemporary scientists understand as mistaking correlation for causation or type 1 error. For example, whenever a new president is elected and soon after, the economic landscape improves as seen through a decrease in the unemployment rate or a boom in the stock market, people tend to attribute these economic shifts to the newly elected government, when often it is simply a periodic expansion of the economic cycle after a contraction phase. An awareness of how people interpret various phenomena can help understand the inner workings of the business landscape. Now, such discussions have entered the mainstream especially after scholars like Kahneman, Robert Shiller, and Richard Thaler have won Nobel Prizes for their work in this field.
I believe behavioral economics is more than just an academic discipline; it is a way of thinking — a lifestyle choice. It offers us practical, actionable insights on how we can make our lives better. On learning about how our payment patterns can affect our perceived experience, I uninstalled my Uber app and purchased a bicycle to commute to the office. The rationale is that people are much happier paying a lump sum upfront before enjoying an experience, rather than paying in increments periodically. Also, by doing this, I had essentially signed a ‘Ulysses contract’ with myself to exercise every day.
Similarly, behavioral economics has also changed the way I look at data and results from statistical analyses. Whenever I read a headline like, “The percentage of millionaires in state A has doubled over the past year”, I make sure to enquire about the base rates involved. An increase from 0.1% to 0.2% is not as significant as an increase from 25% to 50%. Now, consider this fact: highly intelligent women tend to marry men who are less intelligent than they are. A lot can be inferred from this, and many would come up with witty reasons on why this is the case. In truth, this is a mere mathematical inevitability. In any phenomenon where some combination of skill and chance is involved, extreme outcomes are often followed by moderate ones on successive measurements — the ‘regression to the mean’ phenomenon. So, knowing that the correlation of spouses’ intelligence is less than perfect, one shouldn’t be too surprised at this finding. It is the reason share prices fluctuate in the short run — high prices are immediately followed by low and vice versa — but tend to revert to the mean trend over longer periods of time.
Many organizations have applied behavioral principles to help achieve their goals in different ways. The ‘Nudge Unit’ was created to use these principles to improve the efficacy of the UK government’s policies. Among their success stories is one where they increased organ donation participation by simply modifying the application form from an opt-in format, where people had to tick a box if they wanted to participate, to an opt-out format, where people were enrolled by default and had to tick the box to unenroll. This simple shift increased organ donations manifold with zero investment. Other companies have used psychological tricks to grow their businesses. For example, Uber sends targeted messages to drivers reminding them of how close they are to reaching their daily targets, and hence allows the ‘Zeigarnik effect’ to prompt drivers to work longer hours. An understanding of behavioral science can throw light on many strategies used by businesses and explain many results in ways numbers alone cannot.
Accepting the fact that we are not entirely in control of our choices is a humbling realization. Behavioral economics has changed the way I think about how people react to different economic stimuli. Coupling psychological insights with numerical analyses has added a new dimension to my work. At the root level, businesses are communities of people, and if you understand people, you understand business.
