Behavioral Economics and Product Management: Enhancing Decision-Making and User Experience

For the past few years, I've been studying economics. This spring, I focused on Behavioral Economics and Behavioral Design.

Both areas have a lot in common with my primary profession, Product Management. I've decided to dig deeper into these fields and share the fundamental principles and processes here. I'll also provide resources below for those interested in a more thorough exploration of the subject.

Let's start with definitions:

• Behavioral Economics: this is a scientific discipline within economics that studies the influence of psychological, cognitive, emotional, and social factors on the economic decisions made by individual persons and institutions, as well as their implications for market prices, returns, and resource allocation.

  
  

• Behavioral Design: this involves the application of insights from human behavior (derived from Behavioral Economics) to design products, services, systems, or spaces that help people to make better decisions and act in their own best interests.

Behavioral Economics

The traditional schools of economics - that we all studied in schools and universities - are built on the premise that humans make decisions rationally and act in their personal interests (homo economicus). Adam Smith laid the foundation for classical economics in his work “An Inquiry into the Nature and Causes of the Wealth of Nations” (1776), introducing the idea of the “invisible hand” that regulates the market and promotes societal well-being through individual actions aimed at personal gain.

That's all well and good. But there's a catch. While we all aspire to exercise, read books, buy healthy products, and avoid sugar, Coca-Cola's annual revenue stands at $44.140B, with a growth of 6.82% year-over-year.

Unlike the theoretical homo economicus, real people:

• Process information imperfectly
• Are emotional
• Are influenced by context and environment
• Are short-sighted
• Are inconsistent
• Are mentally lazy

All of this leads to the Intention — Action Gap: a disparity between intention and action.

“I have three main flaws — 1) lack of willpower, 2) irritability, and 3) laziness, which I need to get rid of.”

— Leo Tolstoy, 1854

Context Effect

Let's now examine how, for example, the Context Effect influences choice and decision-making.

The Compromise Effect

Options are more often chosen when they give us a compromise among a set of alternatives. A middle-of-the-road choice appears to be a good compromise between options that might be perceived as too extreme. For instance, if a local store sells bicycles priced between $50 and $75, the average buyer who's not looking for a luxury bike will typically choose a $60 bicycle, as it's moderate and matches their expertise level. However, if a $100 bicycle is added to the mix, most average buyers will opt for the more expensive $75 bicycle. This demonstrates the compromise effect on bicycle choice, which aligns with their expectations about average prices.

The Attractiveness Effect

The second contextual effect on consumer behavior claims that one item will enhance the appeal of another one that is similar but superior. By showing that one item surpasses a similar one, the likability and potential purchasing power of the superior item can be increased.

The Similarity Effect

The third contextual effect on consumer behavior states that a product will do more damage to the sales of a similar product than to a dissimilar one. When two or more products, that are alike, compete for consumer attention, they will only diminish interest in each other in the market.

Default Effect

A no-action default is the outcome when an individual fails to make a decision. E. Johnson and D. Goldstein (2003), Science. The Default Effect explains an agent's tendency to typically accept the default option.

Endogenous Default Effects

The likelihood of selecting an option is higher when it is set as the standard or default. For example, different countries have various rules regarding organ donor registration. In those with a donor opt-in policy, all citizens are automatically considered non-donors unless they are registered as such. In countries with an opt-out system, all citizens are automatically deemed donors unless they actively choose to be excluded from the registry. It's argued that this policy difference is the main reason for the huge disparity in donor rates among these nations.

Exogenous Default Effects

Normative choice (what others do) might unconsciously be adopted as a social default effect. Thus, people are more likely to choose what they perceive as the choice of others, even if they don't view the other person as more competent. People also tend to consider options that require less justification as defaults. For example, the standard procedure in parole hearings is to decline to release inmates (we all want to be the good guys and press the blue button).

The Allais paradox

The paradox demonstrates the inapplicability of the expected utility maximization theory under real-world conditions of risk and uncertainty. From a mathematical standpoint, the author shows that a real economic agent doesn't maximize expected utility but strives for maximum reliability. Allais, a well-known French economist, conducted a psychological experiment described below and got paradoxical results. Individuals were offered a choice between one decision out of two sets of risky decisions.

In the first set, there was situation A, where there was a 100% certainty of winning 1 million francs, and situation B, where there was a 10% chance of winning 5 million francs, an 89% chance of winning 1 million francs, and a 1% chance of winning nothing.

Here, X is an unknown amount to the chooser. Let's make a choice too. Which option seems better to you? Most people choose option A. But which choice would be optimal in reality? Will the result remain the same if the “unknown amount” X changes from zero to 100 million?

The mathematical expectation for the first option equals:

For the second option, it is:

Thus, mathematically, option B is more profitable regardless of the value of X. However, people fear the zero outcome in option B and therefore often choose A.

Alright, we understand that people make irrational decisions. What next? How can we help ourselves and others narrow this Intention — Action Gap? This is where the practical aspect of behavioral economics comes into play — Behavioral Design.

Behavioral Design

4 strategies of Behavioral Design

As you can see, we've mentioned Nudging for the first time, but it's worth noting that it's just one of the strategies and not necessarily the dominant one.

Who decides what choice is correct in the development of Behavioral Design?

• The highest authority — the government, non-profit organizations (for example, a cancer-fighting foundation), or expert councils on a specific topic (like the WHO).
• Social norms and socially acceptable outcomes.
• The person.

  
  

White Behavioral Design planning, especially when using Nudging, it's important to remember that we shouldn't change what people want. Instead, we should help them achieve their goals. An alternative to Nudging is the toxic Sludge. The New York Times has a neat test to check it out for yourself.

Stages of Behavioral Design

1. Behavior. At this stage, we study and describe the current behavior of a group of people and identify the target behavior. For example, we are concerned that people are not inclined to save, posing risks for themselves (like not being able to cover emergency medical expenses or future educational expenses for their kids) and contributing to broader economic issues (increased budget for social subsidies, less educated population, etc). The target behavior is for people to save for their children's education and have reserves for emergency expenses.

   
   

2. Obstacles. We analyze why people act in a particular way. We identify cognitive biases that affect monthly decisions to avoid saving money in deposit accounts. These may be a combination of biases, some of which could include:

In this example, we see Cognitive Load (too busy to figure out types of saving accounts), Overconfidence (thinking they will save in the future or earn more soon), and Present Bias (the desire to buy a new phone now outweighs hypothetical future problems).

3. Design. We identify potential tools (Constraints, Monetary Incentives, Information, and Persuasion, Nudging) that could offset the biases identified in the previous stage's research. We end up with a prioritized set of tools for further testing. Prioritizing in Behavioral Design is quite similar to product prioritization. Operational costs of implementation must also be considered, along with:

• Choosing interventions that address problems at earlier stages of the decision-making process.
• Reach: Individual choices have less reach than default options, for example.
• Long-term effectiveness in forming new, better habits.

So, in our example, potential tools might include:

• Simplifying banking products with fewer or no options. One-click online deposit opening. Default saving goals like “Education”, “Retirement”, “Travel” (addressing the Cognitive Load issue).
• Auto-deductions from each paycheck into a deposit account (addressing Overconfidence and the Present Bias).

4. Testing. We test our hypotheses on a subset of the target group. While I won't go into details on how to conduct randomized studies, select test groups, or calculate statistical significance, the goal is to find the most cost-effective combination of tools that lead to the target behavior.

   
   

5. Scaling. We roll out the chosen strategies to the entire target group and monitor the results.

Behavioral Design and Product Management

We’ve already got an overview of what Behavioral Design entails, and its similarities to the tasks of product management are evident, particularly in stages 2 to 5 (from Obstacles to Scaling).

The main differences I see are these:

The choice of target behavior in Behavioral Design implies improving the quality of life of research participants (users). In Product Management, it's about generating profit for a commercial organization. Sometimes the objectives align, but more often, they don't. Even services from EdTech / HealthTech, which aim to help people with their habits and motivation, mainly focus on optimizing purchase conversion because retention in these services often doesn't allow for commercial success in the market without Sludging.

Professionalism and expertise. Scientists working in Behavioral Design focus on a deep understanding of the problem and finding suitable solutions. In contrast, Product Managers explore market-known options and conduct many tests: quickly and, often, under pressure

Courses on Behavioral Economics & Design

Courses on Behavioral Design:

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Courses on Behavioral Economics:

• (Materials from the courses Behavioral Economics in Action and Designing Nudges were used in this article.)

  
  

Useful Impactually Articles:

• Behavioral Science Reading List —<//impactually.se/your-essential-behavioral-economics-reading-list/](//impactually.se/your-essential-behavioral-economics-reading-list/)
• Where to get started in your organization —<//impactually.se/where-to-start-nudging-in-your-organization/](//impactually.se/where-to-start-nudging-in-your-organization/)
• Don’t trust your gut! Why data is king —<//impactually.se/dont_trust_your_gut/](//impactually.se/dont_trust_your_gut/)