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Predictably Irrational Customers
 

Predictably Irrational Customers

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Optimizing Choices for How People Really Buy,

Optimizing Choices for How People Really Buy,
Not How We Think They Buy - Behavioral economics white paper developed while at Diamond Consultants

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    Predictably Irrational Customers Predictably Irrational Customers Document Transcript

    • insight Predictably Irrational Customers Optimizing Choices for How People Really Buy, Not How We Think They Buy Bill Abbott, Alex Mannella, Kyle McNamara, and Amaresh Tripathy The Internet has a huge influence on consumer behavior worldwide. Millions of customers use the Web, as well as cell phones and in-store kiosks, to compare, contrast, and purchase products. Once a nascent “marketspace,” the Internet is now an established shopping environment in which even the smallest features can cause shifts in buyer behavior. In spite of the new opportunity arising from online channels, most companies do not test their e-commerce interfaces for revenue maximization. Those that do, often fail to leverage the science of behavioral economics, which documents how people really think, as opposed to how they are supposed to think (as suggested by rational economic theory). Companies that deploy behavioral economics to improve their e-commerce interfaces can garner short-term profits and long-term competitive advantage, because they are in a position to learn faster than their competition about what really works. Diamond thanks Dan Ariely, the Alfred P. Sloan Professor of Behavioral Economics, Massachusetts Institute of Technology, for his contributions to this paper. Diamond Partners Paul Blase, Anand Rao, and John Sviokla, and Senior Associate Eric Siegmann, also contributed to this report.
    • Executive Targeting consumers with behavioral shopping cart abandonment rates remain Summary economics principles clearly has wide- high and conversion rates remain low. ranging impacts beyond online channels. One reason for this is that few companies The Internet, however, provides us with carefully address all the subtle levers in the necessary flexibility for testing purposes the sales cycle—from offer presentation as well as the ability to mine an abundance through order execution—that can influence of data. Once analyzed, the results can consumer purchase behavior. As a result, be scaled to optimize online marketing efforts consumers often face a confusing array and also be cascaded through brick-and- of product combinations and uncertainty Measuring Value Through a mortar storefronts and other channels. around the online purchase process, Structured Testing Approach causing them to turn to higher-cost channels, Based on our marketing and e-commerce migrate to a competitor, or delay the project experience, and our partnership with purchase entirely. 5. Prof. Dan Ariely, a highly respected behavioral Tracking and 1. economist from MIT and a Diamond Valuable insights into consumers’ decision- Analysis Hypotheses Generation Fellow, we believe firms can begin to drive up making behavior can be gained from conversion rates by designing and testing new the field of behavioral economics. Behavioral 4. 6. models fast and frequently (Figure 1). economics brings together insights from Test Solution Execution 2. psychology and economics, as they relate to Targeting Simple factors can have profound impact human judgment and decision-making. on success rates. In Europe, countries that 3. The central premise is that when confronted Offer and had an “opt-out” organ donor strategy saw Creative Design with limited resources (e.g., ability, time, a seven-fold increase in donor participation; information), human beings are not “rational” firms that offered fewer 401(k) investment and do not make the same economic Figure 1 options radically improved participation decisions as if complete and certain information in retirement plans; a magazine that framed were available. purchase choice with three options rather than two more than doubled the uptake of In collaboration with Prof. Ariely and the pricier—and more profitable—option. through independent research, our findings Details matter. It is necessary to employ have led us to propose a set of ideas and a scientific approach to truly know what an approach to apply behavioral economics to offer: If you don’t test your strategy, you principles to improve online marketing. won’t learn what really works. We refer to the use of behavioral economics to improve online marketing and sales as While companies continue to spend heavily “Choice Optimization.” table of contents on online marketing and sales, online Executive Summary . . . . . . . . . 2 Current State of Online Marketing . . . . 4 Common Pitfalls Companies Encounter . . 6 Applying Behavioral Economic Concepts Online . . . . . . . . . . 9 Getting Started . . . . . . . . . . 12 About the Authors . . . . . . . . . 15 For more information contact: Bill Abbott, Partner bill.abbott@diamondconsultants.com 2
    • Key Behavioral Economics Principles The field of behavioral economics addresses how consumers • Risk Transfer. People are willing to pay premiums to insure use heuristics, or personal rules, to assist their decision- themselves from risk and uncertain outcomes. making process. It further examines how heuristics combine with • Likelihood. Consumers often have a difficult time assessing risk. alternatives in information presentation to affect the ultimate They tend to purchase warranties to protect against long-shot choices of consumers. An online marketing strategy that maximizes failures while underestimating the likelihood of near-certainties. consumers’ willingness to buy will carefully consider how consumers • Happiness. Segregating windfalls (e.g., annuities) and pooling approach the decision-making process. Further, understanding how setbacks (e.g., credit card balances) minimizes unhappiness and the framing and placement of products influence that process allows maximizes happiness. companies to tailor their strategies to reap the most benefits. To compensate for this behavior, companies must help lower The three key behavioral economics principles that should inform the risk associated with consumers giving up what they have in any online marketing strategy are purchase paralysis, risk aversion, exchange for the product being sold. and framing. 1. Purchase Paralysis 3. Framing People draw inferences about a decision based on the way they frame When consumers are offered an exhaustive variety of options, they are the question or their response to it. They also evaluate options on relative often paralyzed by their inability to choose. If they ultimately choose one rather than absolute terms. The implication is that framing comparisons of the options, they will be left less satisfied with their selection relative can influence purchase decisions. Thus, configuring product or service to the others (Schwartz, 2004). Causes of purchase paralysis include: offerings online can guide a consumer’s current and future perception • Regret. Too many choices might cause consumers to regret or and decisions. Actual reversals of preference are demonstrated in anticipate regret for the possibility of having made the wrong choice. choices regarding money, both hypothetical and real, and in questions • Opportunity Cost. It is difficult for consumers to assess trade-offs pertaining to chance (Tversky, 1981). between what would be received and foregone. For example: • Escalation of Expectations. Comparing options relative to each • Faulty Discounting. Customers are impatient with decisions that other increases expectations, which can raise doubt that the involve benefits received in the future. This leads to inconsistent choice was correct post-purchase. and often incorrect discounting of the future benefits. Instead, they • Blame. Consumers will blame themselves and retailers for errors prefer to be presented with near-term savings, even if long-term in judgment and selection. benefits are considerably more valuable. When deciding on the number and variety of products to offer • Loss Aversion. Consumers tend to prefer gains over losses, even consumers, companies must optimize the number of available if the values of the gain and loss are equal. choices to encourage browsing and purchasing, and to minimize • Irrelevant Benchmarks. Consumers’ perceptions of a product consumer regret that could damage the brand. can be influenced by providing comparisons to more expensive 2. Risk Aversion or premium-priced products. Consumers tend to think differently about benefits and disadvantages • Priming. Consumers remember an item best in the form and when considering alternatives. Using mental accounting, they keep context in which they first learned about it. This can be shaped track of and evaluate transactions individually. They also tend to through advertising and product placement. assess specific risks in isolation, rather than consider the broader Companies can improve acceptance and purchase rates by perspective of overall or long-term gains (Rabin, 2001). carefully designing product value propositions that focus on the • Mental Budgets. Consumers behave differently with respect to product’s immediate benefits. Adding frames of reference also money that is allocated to accounts (e.g., savings for a car). Once helps consumers understand the relative value of the product, and consumers mentally allocate money to such accounts, it is no shapes consumer perceptions of the product. longer “free” for consumption. 3
    • Current State of Online channels continue to grow in importance. functionality and effectiveness of their Web Online Marketing Sales through online channels accounted sites. More than half of large companies for almost 3% of overall sales in 2006, and are increasing their Web site operations this rate is growing at more than 25 percent budgets by more than 5 percent annually annually (Figure 2). Forrester Research (Figure 4). Increasing usability, strengthening estimates that almost $400 billion of store customer satisfaction, and demonstrating sales—or 16 percent of total retail sales— ROI are among the top five challenges these are directly influenced by the Web, as companies report. consumers research products online and Despite all this investment, a significant purchase them offline (Forrester Research, Inc., gap exists between the share of consumers The Web’s Impact on In-Store Sales, May 2007). who want to shop online and those who These “cross-channel” shoppers migrate from actually follow through with purchases. The online channels for several reasons, including: percentage of customers who click through a site all the way to conversion remains steady • Desire for immediate gratification at 3 percent, and e-commerce shopping cart • Need to physically inspect or try on the abandonment rates range between 15 percent item before buying and 90 percent, with an average of 60 percent • Concern about online security and (Brinker, 2007; Baxter, 2007). identity theft The keys to improving the success rate of Behavioral economics is These will likely remain significant factors, but these investments are: 1) employ a rigorous concerned with the ways over the next five years, the value of retail sales approach to designing product presentation influenced by the Web will increase by 63 percent, and the end-to-end purchase process, and in which the actual decision- 2) evaluate and refine product offers over time. and cross-channel sales will experience a making process influences 17% CAGR to over $1 trillion in 2012 (Figure 3). Unfortunately, today we see a daunting and loosely connected array of offers from companies decisions that are made As this market grows, companies continue that are not consistently applying controlled in practice. to spend significantly on improving the tests to their offers or the purchase process. E-Commerce Sales as a Percentage of Total Sales 140 120 100 E-Commerce Sales ($B) 80 60 40 20 0 2000 2001 2002 2003 2004 2005 2006 2007 Source: U.S. Census Bureau Figure 2 4
    • We believe companies can increase the make. Traditional economics suggests that their chances of obtaining this goal. In reality, effectiveness of their online marketing efforts consumers make rational, consistent however, too much choice can become and sales channels by applying behavioral choices to obtain products or services that a barrier in the consumer’s decision-making economics concepts. Behavioral economics best meet their needs at the least possible process, along with other obstacles such as provides insight into how the decision-making cost. This suggests that presenting consumers increased complexity, uncertainty, and limited process influences the decisions consumers with a wide range of choices increases information around a selection’s future value. Forecast: U.S. Cross-Channel Sales, 2006–2012 $3,500 Total U.S. Retail Sales Total Cross-Channel Sales $3,000 Total eCommerce Sales $2,500 $2,000 Sales ($B) $1,500 $1,000 $500 0 2006 2007 2008 2009 2010 2011 2012 Source: Forrester Research, Inc., The Web’s Impact on In-Store Sales, 2007 Figure 3 Change in Site Operations Budgets from 2006 to 2007 Decrease (4%) Increase More than 20% Stay the Same (14%) (26%) Increase by 11% to 20% (18%) Increase by 1% to 5% (16%) Increase by 6% to 10% (22%) Source: JupiterResearch, Web Site Spending, 2007 Figure 4 5
    • Common Pitfalls Companies can drive higher conversion motivation to purchase the product Companies Encounter rates by applying Choice Optimization. But (Iyengar, 2000). These studies imply that before tapping into these strategies, companies can determine an ideal companies need to understand how offers number of choices that will optimize the might negatively impact consumers. behavior of certain segments, and we We believe there are three main reasons believe these core concepts can be applied for suboptimal online sales performance: effectively to online marketing. 1. Too many choices. If an e-commerce To examine the impact of choice on product site requires that customers choose satisfaction, researchers conducted between a myriad of product options or a study where participants selected from configurations, customers might fail either a limited assortment or an extensive to complete the decision process. Adding array of chocolates. Participants then options also increases the risk that sampled their selections and were given consumers will regret their purchases or the option to receive cash compensation have unreasonably high expectations about or an equivalent value of the chocolate they the value of their purchases. chose. Participants with the extensive array found the decision-making process more Research has found that increasing the Choice Optimization is the enjoyable than those with the limited number of mutual funds available to array, but were later more dissatisfied application of behavioral employees in their 401(k) plans can result and regretful of their choice and in lower participation rates. One economics principles in online were considerably less likely to choose employer found that for every 10 mutual chocolates over money as compensation. marketing to simplify the funds included in its program, participation (Iyengar, 2000). Having a greater number dropped 2 percent, even though opting out decision-making process and of options to choose from ultimately of the plan meant passing up the opportunity forced these consumers to abandon the increase conversion rates. to receive up to $5,000 in employer product altogether. matching funds (Schwartz, 2004). In another study, researchers set up tables in an upscale grocery store that Too much choice leads featured a line of exotic jams. Consumers to purchase paralysis who stopped could taste samples and they received a $1 coupon if they bought Conversion Rates from Jam Presentation a jar. Consumers were presented 100 with either six or 24 jam varieties. When 6 Jams 24 Jams 24 varieties were available, more 80 people stopped at the table than when 60% six were available, but only 3 percent 60 of people examining the 24 varieties made 40% a purchase, compared with 30 percent 40 30% of those exposed to the six varieties 20 12% (Figure 5). The researchers concluded that 3% 2% an extensive array of options can be 0 appealing at first glance, but a wide variety Approach Buy Conversion also can subsequently reduce consumers’ Source: Iyengar, 2000; Diamond analysis Figure 5 6
    • 2. Process uncertainty. Customers may Companies are starting to incorporate reaffirmed this strategy, citing the free be dissuaded from completing a transaction tools to make the purchase process more shipping offers “as an effective worldwide if a Web site does not clearly help them predictable and secure. Google Checkout, marketing tool” that the company intends place an order, determine when they will for example, integrates with merchant Web to continue offer indefinitely. receive it, understand when and how sites, allowing customers to use their Google Each of these three factors represents an much they will be billed, or feel that their accounts to complete a purchase instead of area of increased risk for not acquiring information is secure. creating a separate account at each merchant. potential online customers. Ignoring these Other companies are letting consumers use The average e-commerce shopping cart factors has serious consequences: PayPal in addition to credit and debit cards. abandonment rate is around 60 percent. Offering a third-party payment mechanism • Lost or delayed sales due to consumer Of this figure, 48 percent of carts are with built-in security features and consumer indecisiveness or anxiety; abandoned during the checkout process. familiarity reduces risk and uncertainty in Many of the factors contributing to • Migration to higher-cost channels due the purchase process. abandonment are related to uncertainty to customer impatience or uncertainty; and in the process, including hidden charges 3. Faulty discounting. If a Web site over- at the checkout, lack of clear delivery emphasizes the long-term benefits of • Inconsistent expectations of the product’s details, and discomfort with the buying a product relative to its short-term appeal, future value which may lead to increased process (Baxter, 2007). consumers might be dissuaded from downstream support, churn, and damage purchasing because they tend to incorrectly to the brand. To reduce uncertainty, companies can and inconsistently discount future add cues within the checkout process that benefits. Consumers value current over future guide customers through the process. For Companies with Complex consumption, even when that future example, Esurance, an insurance company Products at Risk consumption is considerably more valuable. with a heavy online presence, developed Companies in several key industries are a simple, three-step process to purchase In one study, the subjects were told that vulnerable to these risks, due to the insurance, and adopted it as their slogan they had won $15 in a lottery and that they complexity and breadth of their product (“Quote. Buy. Print.”). This process could take the money now or wait until and service offerings: is prominently displayed as the consumer later. Participants were asked how much • Wireless Carriers. Wireless companies progresses from obtaining a quote to they would require to make waiting just as are offering a wider variety of handsets printing a policy, providing a simple visual cue attractive as getting the money now. The (e.g., clamshell, candy bar, camera, as to progress through the transaction. median responses were $20 in one month, 3G, smart phones) along with an array Additionally, companies such as Dell and $50 in one year, and $100 in 10 years. of voice and data plans (e.g., local, Amazon provide estimated shipment These figures imply a compound discount national, 3G data) and additional services and delivery dates throughout the process rate of 345% over the one-month period, (e.g., text and picture messaging). to properly set consumer expectations. 120% over the one-year period, and 19% Many of these options also have variants, over the 10-year period (Thaler, 1981). The risks of credit card theft and identity theft including handset color; inclusion of a The large discount rate seen in the short- also deter some customers from completing camera; and number of allowable minutes, term periods illustrates consumers’ online purchases. Among consumers who messages, or kilobytes of data per preferences for short-term gains. have never shopped online, the top reason month. When choosing a plan, Web sites they cite for not doing so is the fear of Offers of short-term gains can also influence do not effectively segment customers providing their financial information online. consumers into buying products. For example, or provide historical usage data that might Among consumers who have shopped online, Amazon.com offers free shipping on orders be available from a representative in 17 percent have stopped buying online over $25, which may encourage consumers the store or on the customer support line. altogether because of fears of identity theft to buy more than they intended to order Potential areas of segmentation could (Forrester Research, Inc., Checkout Tools to meet the threshold for free shipping. In include average minutes per month, roaming That Boost eBusiness, January 2007). a July 25, 2006, press release, Amazon patterns, and international calls. 7
    • • Cable and Internet Providers. Cable • Financial Services Firms. Credit card • Insurance Companies. Insurance policies and high-speed Internet providers are cross- companies offer a complex array of are based on a complex set of factors (e.g., selling tiers of core products along with services, including cards linked to checking the item being insured, the coverage levels telephone service, packaging them into accounts, cards with branded rewards, sought, and the discounts for which the bundles to save customers money. However, and cards with unique payment options. To insured is eligible). Many companies allow each of these products has a number of prevent the risk of overwhelming customers consumers to obtain rate quotes online, variants, including a wide range of premium with options, many companies leverage but there are many options from which to channels and Internet connection speeds. self-segmentation questioning to narrow select. The initial quote is generally based This diversity of choice places a large the list of choices. on a default set of coverage options and burden on consumers to research and find discounts, but it is left to consumers to adjust the ideal plan. coverage based on their preferences. Testing Online Marketing Efforts for Maximum Impact Diamond uses the following structured testing approach to generate insights, provide value, and improve customer profitability: 5. 1. Hypotheses Generation. Review background data to develop Tracking and 1. Analysis Hypotheses hypotheses around the types of offers desired by each segment. Generation Leverage segmentation schemes to ensure targeting of the right customers. 6. 2. Targeting. Identify the targeting criteria based on hypotheses. 4. Solution Test Determine to whom and to which channel the offer will be Execution 2. presented. Size both target and control groups. Targeting 3. Offer and Creative Design. Develop a compelling offer based 3. on hypotheses, channels, and segments. Offer and Creative Design 4. Test Execution. Test multiple options at the same time, using a multivariate test design, and execute the marketing campaign. 5. Tracking & Analysis. Analyze offer effectiveness by collecting responder data. Calculate response rates for target and control cells and evaluate the test economics to decide whether the test offer should be rolled out or not. Finally, gather learnings from the test cycle to refine hypotheses. 6. Solution. Roll out successful offers to the broader population. This new offer becomes the control for future campaigns. 8
    • Applying Behavioral Research in behavioral economics has shown But results also must be filtered to prevent Economic Concepts that conversion rates can be affected by recommending items that the consumer seemingly subtle presentation factors. For has already purchased. Netflix employs Online example, an online publisher tested a collaborative filtering approach that two offers on its Web site. The first offered leverages user ratings, movie genre “7 Days Free,” and the second “7 Days frequency, and cross-sell likelihood. As a Risk-Free.” The words “Free” and “Risk-Free” result, the online movie rental service is were bolded to highlight the key benefit, and able to quickly filter through thousands of the second example resulted in a 12 percent movie titles to show consumers one title higher conversion rate than the first option. they can have collaborative faith in renting. In a separate experiment, the same publisher • Explicit filtering (also known as “self- tested two different page layouts, the segmentation”) requires consumers to first containing two columns of text and the select or rate their preferences in order second containing only one. Simplifying the to narrow the number of options presented. layout by combining two columns of text into Citibank and U.S. Bank allow customers one produced an 88 percent improvement in to self-segment by identifying the credit conversion rates (McGlaughlin, 2006). card features most important to them. The application of Based on our work with Prof. Ariely, as well as U.S. Bank asks its customers to select up our own research, we believe there are three to seven key features (e.g., traditional seemingly subtle specific ways companies can use core behavioral cards, student cards, travel or cash rewards), presentation factors economics principles to improve online sales: in order to present them with cards that match those preferences. Since this data can significantly 1. Choice Filter. Offering customers directly reflects consumer choices, it can excessive options can overwhelm them affect conversion rates. be especially useful in understanding their with a fear of making the wrong choice, preferences. However, since providing this or cause them to anticipate regret, which information requires consumers to expend can lead to postponing a purchase. effort, companies often have less data The ability to properly filter through an than what they desire. In addition, this exhaustive list of products or services process indicates to customers that there can help consumers complete the purchase are additional options available to which process. Companies can provide collaborative, they are not being exposed. Also, explicit explicit, or implicit filters—either filtering still introduces the risk of regret. individually or in combination—to help customers narrow their choices. • Implicit filtering involves identifying consumer preferences based on their • Collaborative filtering examines the actions (e.g., items viewed or purchased), preferences of many users to make or on the demographic information predictions about the interests of any they provide. Data on items viewed one user. Web sites such as Amazon and purchased during a session gives and Netflix use this technique to make insight into preferences, and information recommendations to their users. The such as customer billing zip codes can relevance of recommendations can vary, be matched to databases from vendors but they tend to improve the collection of such as Claritas and Acxiom to obtain larger amounts of data. These techniques socioeconomic characteristics. For the are good for categories with large numbers most part, data collection is automatic and of products (e.g., books, music) because largely independent from the consumer, a single person cannot view all of the items. 9
    • Companies across industries can benefit from applying behavioral economics principles to their online sales channels. A Sampling of How Behavioral Economics Principles Can Impact Consumers Industry Too Many Choices Process Uncertainty Faulty Discounting Wireless 1,900 Combinations1 • A four-step process is presented to choose • A trial period allows customers to cancel a phone and plan followed by a separate within a few weeks, but they must pay service four-step process to complete the purchase. charges. A shorter, risk-free trial period Presenting one process to guide the might attract more customers because it consumer through the full transaction could reduce current consumption in favor would reduce uncertainty about next steps. of long-term benefits. • The activation fee is described in small print • Free 2–4 day shipping is offered for online at the bottom of the page, where customers purchases, forcing customers to delay might not see it. Displaying the fee more benefits. Free overnight shipping reduces clearly as part of “one-time charges” helps the delay before benefits are realized and avoid surprises. might avoid delayed decisions or migration to a higher-cost sales channel. Cable 64 Combinations2 • The site indicates that a limited package • Savings resulting from choosing a package selection is available online, but full instead of individual services are not range is available via phone. Customers consistently indicated. Displaying the specific are likely to call Customer Service, a higher- savings will lead customers to focus on the cost sales channel, to understand all options. product’s near-term value. Credit Cards 34 Unique Options3 • Sites do not contain a timeline to help • The annual fee to earn rewards in effect customers understand their progress promises customers future rewards in through the application process. Including exchange for current consumption. timing elements helps customers reduce Customers may incorrectly value the benefits uncertainty about next steps. received over time. Insurance 65 Combinations4 • Sites do not contain timing elements to • Many companies add a service charge for help customers understand their progress the option to pay premiums monthly. toward obtaining an online quote. Including Framing this fee instead as a discount details about timing helps reduce customers’ for payment in full helps customers realize uncertainty about next steps. the near-term value of their choice, instead of having to value it into the future. 1 Examination of a national wireless carrier’s consumer Web site revealed 41 handset models available for purchase (excluding color variations), eight plan types with six levels of minutes within each. Total number of phone/plan combinations available is 1,968 (41 x 8 x 6). 2 Examination of services available from a national cable provider’s Web site revealed seven choices for cable service, three for Internet, and one for phone. Consumers have the option of only choosing one or two of the services (e.g., cable and Internet, cable and phone, Internet and phone), so each category also has an “opt-out” option. Total number of combinations available is 64 (8 x 4 x 2). 3 Examination of consumer cards available on a major carrier’s Web site revealed 34 unique options. 4 Examination of options required to obtain an auto insurance quote on a national carrier’s Web site revealed that consumers must choose coverage levels within 10 categories, along with up to nine discounts for which they are eligible. Each of the 10 coverage categories (e.g., property damage, collision deductible) contains between two and nine coverage levels (e.g.,$25–50, $500–1000), for a total of 56 combinations. The nine discounts offered a “Yes/No” option. Total coverage/discount combinations is 65 (56 + 9). 10
    • meaning that much more data is or comparable products at other only two choices were presented available. Behavioral data, however, does companies to help consumers choose (“Online Only” and “Online and Print,” not necessarily provide an accurate to buy their products. at $59 and $125, respectively), the representation of a user’s true opinion number of customers choosing the lower- • Satisfaction risk often results when of an item. For example, some purchases priced “Online Only” product increased consumers are faced with too many will be given as gifts and do not to 68 percent, while the percentage choices. For many consumers, examining necessarily reflect the consumer’s own of subscribers choosing “Online and Print” a wider array of product options raises preferences. Companies such as Best dropped to 32 percent. While no one their expectations because they search Buy and Target use both types of implicit chose the “Print Only” option, having it for a product that contains many filtering through a consumer’s account available made the more expensive of the most desired attributes. This also information, viewing history, and “Online and Print” option appear to be increases the chance that consumers purchase history. By using algorithms, a bargain, and this drove a higher will regret their ultimate choice because these retailers then present the percentage of customers to select it. another option might have better met customer with better-defined product Amazon.com effectively cross-sells their needs. Verizon Wireless reduces or service options. additional products to consumers by this risk by offering a 30-day return highlighting the remaining amount of a 2. Risk. In theory, people are willing to pay policy. When the fear of satisfaction is balance required for free shipping. The a premium to avoid risk. Eliminating any a deal-breaker in completing the relative framing of additional purchases as perceived risks in the purchase process can purchase of a phone and plan, consumers savings in shipping costs helps consumers help increase consumer conversion rates. can feel reassured that they have overcome the reality of a higher total 30 days to return the phone and cancel • Process risk is introduced when consumers price after additional items are added. their contract at limited or no cost. do not understand the steps in the • Constructed framing allows companies purchase process, such as when their 3. Framing. The way in which choices are to position a preferred product for items will be shipped, or when their presented can influence a consumer’s maximum exposure. For example, T-Mobile credit cards will be charged. Hewlett- decision to purchase a product. Effective strategically highlights one of its most Packard helps eliminate process risk frames give consumers points of popular plans in a list of other options. by presenting a clear purchase process, reference to understand the relative value While the highlighted plan is not providing estimated shipping and of a product compared to alternatives. the most expensive, its price is above the delivery dates, telling the consumer when Understanding the impact of framing can average. Emphasizing this plan begins their credit card will be charged, help companies cross-sell, up-sell, or steer to set customer expectations about cost. and allowing the customer to click on a customers toward more profitable options. By steering the consumer selection previous step in the process to review • Relative framing highlights the positive this way, the carrier is positioned to sell or revise the information they provided. value of a decision compared with a more expensive plan than it might • Price risk arises when consumers an alternative. The Economist magazine have sold without constructed framing. delay or forgo a purchase because once offered three subscription options • Priming allows companies to make they think that a better price might on its Web site: consumers more receptive to their be available from another retailer or 1. Online Only for $59 products by creating associations with channel. Bed Bath and Beyond items that consumers value. Fidelity’s has significantly reduced price risk 2. Print Only for $125 Web site allows consumers free access for its customers through the use 3. Online and Print for $125 to tools for financial planning and of price matching. Consumers feel they investment research. As consumers use are getting the lowest price available Sixteen percent of customers chose the these tools, they increasingly get the since the retailer advertises the price “Online Only” option and 84 percent impression that Fidelity has a wealth of matching policy. Other companies, selected the “Online and Print” option. No knowledge and would make the financial such as Progressive Insurance and customer chose the “Print Only” option, planning experience easy. Buy.com, display prices of the same so the company removed it. However, when 11
    • Getting Applying behavioral economics principles of improvements. Useful baseline metrics Started to improve online marketing and sales requires for defining and measuring the progress companies to take a careful look at where of improvements to online sales channels they currently stand. It also requires creative include the following: thinking about applying the principles, and • Number of available product a rigorous process to test and measure their combinations; impact (Figure 6). • Number of clicks to purchase; 1. Define the Focus. Commercial Web sites • Cart-abandonment rate; typically have multiple purposes, including consumer education, prospect development, • Number of steps completed before lifecycle management (acquisition, abandonment; stimulation, cross-sell, up-sell, retention, • Conversion rates; winback), and self-service. Key consumer • Customer satisfaction scores; and decision points will vary across companies and industries, and each company has its • Cost per transaction. own pain points. Choice Optimization efforts As choice optimization efforts are being should focus on areas likely to produce implemented, monitoring progress a high return on investment. For example, against the baseline helps determine consumers visit a car company’s Web site whether the efforts are truly improving primarily to learn about a car before buying processes. Tools that track Web site one at a dealer. The focus here should activity, such as Omniture and Google be providing a rich, targeted education on Analytics, can also be useful in identifying features, options, and pricing, then helping pain points in the purchase process, the customer find a dealer. On the other hand, including the stage at which customers consumers who visit Amazon.com are more abandon their carts. likely to complete an online purchase, so the focus should be on helping customers 3. Identify and Prioritize Improvement narrow down their options and quickly Opportunities. One of the most effective complete the purchase. ways to determine where behavioral economics principles can deliver superior 2. Establish Baseline and Improvement results is to examine the process from Targets. Establishing a baseline is crucial the consumer perspective. Documenting for identifying areas where behavioral the processes used by customers in economics principles can have the most searching for product information uncovers impact, for preparing a convincing business opportunities for improvement. Such case, and for measuring the effectiveness opportunities may include framing options Diamond’s Choice Optimization Approach 2. Establish 3. Identify 4. Test and 1. Define Baseline and and Prioritize Implement the Focus Improvement Improvement Improvement Targets Opportunities Opportunities Figure 6 12
    • more strategically, articulating next steps analyze offers, such as the one outlined 1. Optimize the number of choices available more clearly, or eliminating underperforming in “Testing Online Marketing Efforts to encourage browsing and purchasing, choices. Further hypotheses can come for Maximum Impact” on page 8, helps and to minimize customer regret. from brainstorming workshops, root-cause deliver the right products to the right 2. Help lower the risk consumers associate analysis of Web data, customer surveys, customers. This works because it teaches with completing an online transaction. and industry research. Quantifying and companies to understand the profit drivers prioritizing the costs and benefits of each for each segment, identify characteristics 3. Focus more heavily on their products’ improvement maintains the focus of the of effective offers within each segment, and immediate benefits (and discount future Choice Optimization efforts. document lessons learned that can be benefits to compensate for consumers’ applied to the development of future offers. inability to correctly value them). 4. Test and Implement Improvement Opportunities. Continuous hypothesis- Choice Optimization applies these behavioral based testing, in which multiple versions Conclusion economics principles to improve product framing of an offer are tested using statistical Incorporating key elements of the consumer with the goal of positively influencing consumer techniques, improves profitability by decision-making process into the development decisions for improved online marketing. allowing companies to choose the offers of an online sales and marketing strategy with the highest success rates. Using can help maximize the effectiveness of that an approach to segment customers and strategy. Specifically, companies must: Additional Diamond insights on behavioral economics and marketing are available at www.diamondconsultants.com: “Behavioral Economics Comes to the Rescue of Retirement Savings,” 2007 “Rapid Market Segmentation: Collaborate and Conquer,” 2007 “Word-of-Mouth Marketing: How to Harness the Power of Consumer Influence,” 2007 “Curing Customer Churn,” 2006 The following papers provide good insight into key behavioral economics principles and their application: “Placebo Effects of Marketing Actions: Consumers May Get What they Pay For.” Dan Ariely et al, 2005. “Amazon.com Recommendations. Item-to-Item Collaborative Filtering.” Greg Linden et al, 2003. “The Paradox of Choice: Why More is Less.” Barry Schwartz, 2005. “The Winner’s Curse.” Richard Thaler, 1994. “Why the Soy Milk King Still Reigns.” G. Pascal Zachary, 2004. 13
    • Sources Baxter, Mike. Online Retail 2007. Special Report: Checkout. 2007. London: E-Consultancy. <http://www.e-consultancy.com/publications/online-retail-checkout-2007/>. Brinker, Scott. Minding the Gap Between Click and Conversion. 20 February 2007. Encino, California: E-Commerce Times, 22 May 2007. <http://www.ecommercetimes.com/ rsstory/55826.html/>. Drèze, Xavier, Stephen Hoch, and Mary Purk. Shelf Management and Space Elasticity. Diss. Graduate School of Business, The Univ. of Chicago, 1994. 25 May 2007 <http://www.xdreze.org/Publications/Shelf.html>. Forrester Research, Inc. The Checkout Tools That Boost eBusiness. January 2007. Forrester Research, Inc. The Web’s Impact on In-Store Sales: US Cross-Channel Sales Forecast, 2006 To 2012. May 2007. Iyengar, Sheena S. and Mark R. Lepper. “When Choice is Demotivating: Can One Desire Too Much of a Good Thing?” Journal of Personality and Social Psychology. 2000, Vol. 79, No. 6, 995-1006. JupiterResearch, LLC. Web Site Spending, 2007. 17 April 2007. McGlaughlin, Flint. “The Power of Small Changes Tested.” 21 March 2006. Marketing Experiments Journal. 23 May 2007. <http://www.marketingexperiments.com/improving- website-conversion/power-small-change.html>. Rabin, Matthew, and Richard H. Thaler. “Anomalies: Risk Aversion.” Journal of Economic Perspectives. 15 (2001): 219-232. Rayport, Jeffrey F., and John Sviokla. “Managing in the Marketspace.” Harvard Business Review. November–December, 1994, pp. 141–150. Schwartz, Barry. The Paradox of Choice. New York: HarperCollins, 2004. Thaler, Richard H. 1981. Some empirical evidence on dynamic inconsistency. Economic Letters, 8, pp. 201-07. Tversky, Amos, and Daniel Kahneman. “The Framing of Decisions and the Psychology of Choice.” Science. 1981, Vol. 211, No. 4481, 453-458. United States Census Bureau. Quarterly Retail E-Commerce Sales. 16 May 2007. Washington, D.C. 18 July 2007 <http://www.census.gov/mrts/www/ecomm.html>. 14
    • About the Authors Bill Abbott is a Partner in Diamond’s Telecom & High Tech practice and co-leader of the firm’s information and analytics services. Bill has significant experience in the communications and media, consumer packaged goods, and insurance industries, collaborating with clients to successfully address challenges in the areas of channel optimization and marketing strategy, organization and process design, including system design and implementation, financial and operational modeling, and activity-based process and product costing. Dan Ariely, the Alfred P. Sloan Professor of Behavioral Economics at Massachusetts Institute of Technology, is a Diamond Fellow whose projects include examinations of online auction behaviors, personal health monitoring, the effects of different pricing mechanisms, and the development of systems to overcome day-to-day irrationality. Prof. Ariely holds a joint appointment between MIT’s Program in Media Arts and Sciences and the Sloan School of Management. Alex Mannella, a partner in Diamond’s Telecom & High Tech practice, is an expert on the issues of customer value management, response modeling, database marketing, and data mining. He has extensive experience developing response and segmentation algorithms, and using artificial intelligence for data mining studies. Mannella, who is also skilled in database development, currently helps lead the Diamond Information and Analytics Center located in Mumbai, India. Kyle McNamara is a Manager in Diamond’s Telecom & High Tech practice who has significant experience in the areas of organization and process design, operations management, revenue assurance, and Web analytics. He has served a variety of clients in the telecommunications, electric utility, financial services, and manufacturing industries. Amaresh Tripathy is a Manager in Diamond’s Telecom & High Tech practice and a thought leader in the area of information and analytics. He has a wealth of experience in the areas of customer value management, channel optimization, competitive analysis, and operations management. Amaresh has supported opportunity strategy and implementation initiatives for companies in the telecom technology, logistics, education, and entertainment industries. Diamond Partners Paul Blase, Anand Rao, and John Sviokla, and Senior Associate Eric Siegmann, also contributed to this report. Diamond thanks Dan Ariely for the title of this paper, also the title of his upcoming book on behavioral economics. 15
    • About Diamond Diamond (NASDAQ: DTPI) is a premier global management consulting firm that helps leading organizations develop and implement growth strategies, improve operations, and capitalize on technology. Mobilizing multidisciplinary teams from our highly skilled strategy, technology, and operations professionals worldwide, Diamond works collaboratively with clients, unleashing the power within their own organizations to achieve sustainable business advantage. To learn more visit www.diamondconsultants.com. Diamond has extensive experience in helping clients improve customer profitability by implementing marketing strategies, retention campaigns, and loyalty programs. We generate value for our clients by integrating disparate data, identifying opportunities for profitability improvement based on customer-level analysis, and using the results to optimize marketing campaigns and enable real-time decision making. To assist in these efforts, Diamond has created an Information and Analytics center of excellence (www.diamondconsultants.com/dias) that provides fast, insightful analysis of complex marketing and operational issues, where intelligent use of data holds the key to better decisions and actions. Diamond Suite 3000 John Hancock Center 875 North Michigan Ave. Chicago, IL 60611 T (312) 255 5000 F (312) 255 6000 www.diamondconsultants.com © 2007 Diamond Management & Technology Consultants, Inc. All rights reserved. C H I C A G O • H A R T F O R D • L O N D O N • M U M B A I • N E W Y O R K • W A S H I N G T O N , D . C .