Behavioural economics

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Behavioural economics is the combination of human psychology, decision science, and economics. It is an innovative and scientific approach to understanding how humans make decisions.

Uygar Kilic
Uygar Kilic, Behavioural Economist, Cronus Business Consultancy

You may have heard of behavioural economics, read 'Nudge', or seen the cover of 'Thinking, fast and slow'. While behavioural economics became famous with the 'Nudge' book (2009), British economist Adam Smith in fact discussed the impact of human behaviour on economic decisions in his first book, 'The Theory of Moral Sentiments', in 1759.

Existing economics models, such as neo-classic, assume that we are always rational with our decisions and make the perfect choice with the perfect information.

You might be wondering, “What is the relationship between behavioural economics and startups?" Corporations are already using behavioural economics principles for their marketing, internal relations, and even for investment purposes. However, behavioural economics is not only for corporations; it is for startups like yours.

Unfortunately, the reality is entirely different. Our brains are not capable of analysing every single piece of information for each decision in order to make the perfect choice. It is nearly impossible to gather all of the information about what could influence our decisions and to analyse this information quickly. We usually use a heuristic process, which gives good results most of the time.

Our decision-making system works quite simply: there is a problem, we need a solution, and we need to reach a goal or satisfy an expectation. Solving a problem may not help you sell your product or get investment.

People don't really buy a Starbucks coffee because they want to have a coffee and reduce their thirst. Their initial goal to get that caffeine hit could be achieved at any coffee shop. It is their secondary goal that makes the difference and shows how irrationally we behave. People buy Starbucks coffee to reach their secondary goal; this could be demonstrating wealth, being part of a social community, enjoying the experience of buying a coffee, or other things.

EMOTIONS

Eighty-five percent of our decisions pass through the emotional side of our brain, as demonstrated by the Nobel-winning psychologist and economist Daniel Kahneman (2002). Scientific evidence shows the importance of turning your idea into an emotional story. Storytelling is as old as human life on this planet. People who reject a new idea also do storytelling, to show that they are right. Therefore, a new idea cannot be accepted without turning to storytelling. Unfortunately, we tend to reject new ideas and stick with our own beliefs. We are more defence lawyer than scientist. The solution to this problem is to create an emotional story to deliver the idea.

You might be starting to see the connection between behavioural economics and startups. A startup idea is something new to people's minds; people may resist your ground-breaking idea, so they can keep doing things how they did in the 'good old days'. For many people, a Blackberry smartphone was the best smartphone on the market in 2007; people were telling stories of how they sent an email so easily or how they searched the web with a full keyboard. However, at the time they did not realise that they don't use all the buttons all the time, unlike the screen, and that the keyboard was consuming a large portion of potential screen space.

When you watch the first-gen iPhone press conference (2007), you can see how Steve Jobs turned the touch screen into an emotional story, and we accepted his new idea to ditch the keyboard.

Funding is a very important part of the startup world; some products or services may not create profit as soon as they are released to the market. Funding rounds, meetings with investors or venture capitals, or any type of activity concerned with getting money into your business is directly related to behavioural economics. In order to change the perception of the investors, you must turn your idea and product into a story.

PRINCIPLES OF BEHAVIOURAL ECONOMICS

Let's start with some of the behavioural economics principles. Firstly, framing: our brain interprets information depending on how it is presented. For example, the brain does not see '75% fat free' and '25% fat' as equal. The fat-free product sounds healthier and therefore seems a better choice. Unfortunately, our brain does not have the capability to process all of the information, as I mentioned before. We make decisions through both conscious and subconscious choices. How you present your data to investors is important. Consider how people can reach their goals by using your products; this is what will help you to frame your product and show a distinctive character.

Secondly, the priming effect is useful when asking for additional funding. Scientific studies show that we are influenced by small cues while making a decision. A website with too many missing images may lose credibility. These small cues do not really represent the product or the service. Our brain just makes a quick heuristic decision and makes an assumption. In most cases, it is wrong. Missing website photos do not mean that the company will take your money and not send their product. However, this is how our brain works. For funding, it is important to pay attention to details and to avoid any small cues that may cause subconscious biases. For startups, your first impression is very important, from PowerPoint slides to your website. Investors won't be expecting high-end quality but cutting corners will not help you to win.

Thirdly, loss aversion: we are 3.5 times more loss sensitive to things than our gains. This comes from our ancestors; when food was limited, they had to act fast to get enough to survive. We still have the same behaviour, but it takes a different shape. Uber, Facebook, Apple, and many other firms began as a startup and changed the world. People who hesitated to invest lost a big return for their investment. Early stage investors would be happy to hear your ideas and future plans; however, in order to use loss aversion, you must show how you are going to execute the plan. Your team and background experiences play critical roles here. You need to rationalise or justify your ideas through your team's ability and expertise. This will prove that you will execute your plans and will show them what they will lose if they don't invest.

FINALLY

Behavioural economics is a very rich scientific area. Investors have limited time to analyse your product and make a decision. Therefore, it is important to think about how you can change their perception towards your product in order to be seen as a promising investment. Even in a short discussion about your product, how you frame it can change how worthy of investment they deem it to be. Unlike computers, we do not process information in isolation. Everything in our mind is interconnected and that's how we make our decisions. In many cases, we don't even realise our decisions are influenced by subconscious cues. This is why startups can gain so much by harnessing the power of behavioural economics.