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Perspectives

Behavioral economics in 2016

Private company issues and opportunities

It’s hard for companies to recognize human behaviors holding the business back. This can be even more difficult for private companies, who typically have fewer external stakeholders challenging management. But private companies also have an advantage: since their employees believe that their contributions have a direct impact on the company’s results, they tend to be more receptive to change. Smart companies are using behavioral economics and data as an incentive for employees, customers, and other stakeholders to achieve their desired outcomes.

Trend to watch: Behavioral economics

People are the lifeblood of any business. People also can be “predictably irrational,” according to behavioral economist Dan Ariely.1 More often than not, our decisions are informed by our own natural biases and tendencies in addition to the facts at hand.

Where once organizations relied on fully rational, always-calculating employees, they are now turning to behavioral economics and newly available streams of data to point employees, customers and other stakeholders to desired outcomes. A branch of study that blends economics with psychology, behavioral economics has gained prominence in recent years due to books such as Daniel Kahneman’s Thinking, Fast and Slow, and the widespread sharing of success stories involving the application of behavioral economic theories. In many cases, it is the proliferation of massive amounts of data in recent years that has made these applications possible.

Today, businesses are awash in information that helps explain the behavior of their customers, employers and other key stakeholders.

- Tim Murphy, research manager, Deloitte Services LP

Across a range of business disciplines—from inventory management to supply chain optimization to cyber security—private companies often spend a lot of money to get their processes just right but may neglect the people element. Humans have innate biases or proclivities that influence the decisions they make or the behaviors they exhibit on a daily basis. “Sometimes these tendencies can undermine even the most efficient processes,” Murphy says.

One of the most entrenched human behaviors is the tendency to overweight the present state and fail to make changes that would boost competitiveness in the future. Without the right incentives, it can be difficult to get employees to break from the well-worn cognitive track of the status quo.2 Aversion to loss contributes to this challenge, Murphy says. “Employees might worry that a change in business strategy or the adoption of a new technology solution will render their skills obsolete,” he says.

How companies incentivize their employees to innovate is one telling example of how behavioral economics can inspire change. Truly innovative companies don’t typically order their employees to innovate more. Even when companies pay workers more to innovate beyond their day jobs, such efforts may in fact be counterproductive as they crowd out those naturally interested in innovating. Behavioral economics reveals that non-monetary awards, such as simple recognition, can be far more influential for spurring innovation. Some of the most innovative companies in the world today have offered inducements such as innovation contests, achievement awards, and even failure awards that encourage employees to take risks.3

Perhaps, one of the hardest things for many companies to do is to recognize human behaviors that are holding the business back. This may be a greater challenge for private companies that have fewer external stakeholders critiquing business leaders’ decisions and generally pushing them to be better. While a lack of bureaucracy helps family-owned and other private companies be more nimble and responsive to changes in their respective markets, fewer checks and balances can contribute to strategy that looks decisive but could turn out to be impulsive and misguided because of the absence of careful deliberation.

The good news is that behavior is often easier to change at private companies once a problem has been identified. “While it might be tougher to detect bias or negative tendencies at such organizations, it’s easier to engender behavioral change once they do,” Murphy says. This advantage is as much about the ease with which private companies can change their policies as it is about how they are perceived by employees. Employees at private companies often feel that their contributions have a direct impact on their company’s results and attainment of strategic objectives, and this makes them more receptive to changes in their routines.

Sometimes, the smallest nudges can affect the greatest results. For instance, some government agencies in Europe, recognizing people’s resistance to change, started asking citizens to opt out rather than opt in to organ donation programs.4 US companies have used this same strategy to boost enrollment in 401(k) and other retirement plans that are underutilized when employees have to sign up on their own.5

Private company leaders can employ behavioral economics to address their own natural biases. One way is to resist the temptation to “trust their gut” by helping to ensure that every strategic decision, especially the seemingly obvious ones, receives adequate deliberation.6 Murphy says some smaller companies can be vulnerable to confusing impulsiveness with nimbleness. “They may be able to act fast but sometimes it’s not in their best interest to do so,” he says.

Senior leaders should consider multiple options and making them real substitutes, not straw men. Murphy suggests putting the decision on a timeline or calendar. “Before that date arrives, focus on deepening your understanding of the issue at hand rather than a simple ‘go/no-go’ decision,” he says.

Adopting such a deliberative mindset can be particularly useful when exploring a potential acquisition. The CFO and M&A team might look at many potential targets, considering their capabilities, corporate cultures and prices. Similarly, when facing a key hiring decision, a deliberative leader will weigh how all of the candidates’ experiences and skills stack up and evaluate their potential fit with current team members.

Private company leaders can employ behavioral economics to address their own natural biases. One way is to resist the temptation to “trust their gut” by helping to ensure that every strategic decision, especially the seemingly obvious ones, receives adequate deliberation.

Visit the Private company issues and opportunities homepage to view a list of additional topics.

References

1 Dan Ariely, “Are we in control of our own decisions?,” Ted Talk, filmed in December 2008, accessed February 16, 2016, http://www.ted.com/talks/dan_ariely_asks_are_we_in_control_of_our_own_decisions.
2 William Samuelson and Richard Zeckhauser, “Status Quo Bias in Decision Making,” Journal of Risk and Uncertainty, 1988, http://www.hks.harvard.edu/fs/rzeckhau/SQBDM.pdf.
3 Nicolai Andersen, Timothy Murphy, and Dr. Alexander Börsch, “Nothing for money: A behavioral perspective on innovation and motivation,” Deloitte Review, Issue 18, January 25, 2016, http://dupress.com/articles/cultivating-innovation-at-work/.
4 Richard Thaler, “Opting in vs. Opting Out,” New York Times, Sept. 27, 2009, http://www.nytimes.com/2009/09/27/business/economy/27view.html?_r=0.
5 James Guszcza, “The last-mile problem: How data science and behavioral science can work together,” Deloitte Review, Issue 16, January 25, 2015, http://dupress.com/articles/behavioral-economics-predictive-analytics/.
6 Derek M. Pankratz and Michael A. Roberto, “Crossing the mental Rubicon: Don’t let decisiveness backfire,” Deloitte Review, Issue 18, January 25, 2016, http://dupress.com/articles/dont-let-decisiveness-in-leadership-backfire/.

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