Method to Madness?

Anybody might make an irrational decision now and then, right?

For example, anyone might occasionally spend more on something than it is worth, become too attached to a particular investment, make an employment decision based on gut feel when the facts are against it. But in his book, Predictably Irrational, Dan Ariely asserts that in addition to being vulnerable to an occasional random bad call, we human beings are predictably irrational. There is, it seems, some method in our madness.

Remember those supply/demand curves in Economics class that have us neatly arriving at a price where supply and demand are in perfect equilibrium? Hogwash!

Ariely cites a number of experiments that show that that the prices at which people are willing to buy or to sell are influenced by factors that have absolutely nothing to do with the intrinsic value of the object or service. Decisions humans make about the price at which to buy or sell are influenced by factors that are, in fact, quite irrational – but predictably so!

For example, in one experiment, Ariely passes out to his class a sheet of items he intends to auction off. But first he asks the group to write down the last two digits of their social security numbers next to each item and also to note whether they would, hypothetically, be willing to pay that price for the item. Then they are allowed to bid on any of the items they would like. When asked if the silly exercise with the social security numbers had influenced their bids, the participants said “no way!” – yet those who wrote social security digits between 80 to 99 placed bids that were 2-3 times higher than those students whose last two social security digits were between 00 and 20.  Ariely concludes that market decisions can be greatly influenced simply by having considered whether an item was a good deal at a certain price – even if that price was obviously randomly selected.

Ariely presents other experiments designed to identify the hidden forces that affect our decisions, many of which are irrational in a strictly economical sense. What are the implications for business if buying and selling decisions are so strongly influenced by irrelevant factors? Can a better understanding of your customers’ decision making process help you sell more and grow?

Pricing is not the only way that human decisions are influenced in a predictably irrational way. In other experiments, Ariely tests the forces that affect honesty and the willingness to cheat to make a buck. In these experiments, he found that people were predictably less likely to cheat if they were reminded of an obligation for honesty (unenforceable though it was) immediately before the opportunity to cheat presented itself. Interesting.

Even without the toothless exhortation for honesty, participants refrained from wholesale cheating for cash rewards — even when they could feel sure of getting away with it. There was some cheating to be sure, but not nearly as much as the opportunity deliberately allowed. But when the rewards were provided in the form of tokens instead of cash, the amount of cheating soared. The tokens could be exchanged for cold, hard cash at a table just a few feet away, so they were nearly the same as cash. Nonetheless, the scruples that prevented people from dishonestly acquiring actual cash lost their efficacy when those people were faced with an opportunity to dishonestly acquire a cash-equivalent!

If scruples lose their power and influence over people as they become removed from actual cash currency, what are the implications in our increasingly cashless economy? What are the implications for the contingency compensation packages that have become so commonplace? Could this phenomenon have led to some of the previous decade’s egregious instances of ‘cooking the books’ from Enron to Madoff?

Predictably Irrational illustrates interesting facets of human decision making. Understanding the patterns of the irrational biases and influences might help us anticipate and avoid unintended consequences of the decisions we make.

What do you think? Do you see any signs of this behavior in your experience?