If all of economics is supposed to be a study of human behavior, how is behavioral economics different? Economics traditionally conceptualizes a world populated by calculating, unemotional utility maximizers that famed economist Richard Thaler has cleverly dubbed Homo economicus, or Econs for short. Behavioral economics disputes three unrealistic traits of Econs: boundless rationality, willpower and selfishness. Simply put, behavioral economics recognizes that people are human, and humans are not quite perfect and sometimes downright irrational.
Luckily, marketers aren’t economists and have been using behavioral economics principles – albeit unknowingly – for years. From 2-for-1 specials to Alka-Seltzer's Plop, Plop, Fizz, Fizz, there are potentially endless applications. These two concepts apply especially well: Mental Accounting (specifically Loss Aversion) and Transaction Utility.
Mental Accounting and Loss Aversion: Accounting is essentially a system of recording and summarizing business and financial transactions and analyzing, verifying, and reporting the results. Individuals and households also need to record, summarize, analyze and report their transaction history. They do so for the same reason businesses do: to keep track of how they spend their money and to manage their spending. Mental accounting is an explanation of how they do this.
Mental accounting also explains that people account for losses and gains differently. Loss aversion states that people strongly prefer avoiding losses than acquiring gains. In other words, a $50 parking ticket is more painful than finding $50 on the street is enjoyable. Some studies go so far as to say that losses hurt twice as much, or a $25 parking ticket is more painful than finding $50 on the street is enjoyable. This is something marketers can take advantage of by trying to make a product's cost as painless as possible.
Consumers always have the choice to save their money for another day, so marketers not only have to be better than competitors, but also convince consumers to spend money in the first place. So although a 15% off deal gives consumers some transaction utility (more on that later), a better strategy might be to give them $15 upfront. By ‘giving’ a customer $15, marketers leverage loss aversion. In customer’s minds, that $15 is now theirs; by not using it, they lose the $15.
This is even better than giving customers $15 at checkout, because that is accounted for as a $15 gain at checkout, which, as discussed above, isn’t as enjoyable as it is painful to lose the $15 you gave them.
Power of Price, Transaction Utility and Framing: Positioning your preferred option is very important. The classic example is from the magazine The Economist. They offered two subscription options: online only for $59, or a print and online subscription for $125. Most people chose the online only subscription - after all, it was much cheaper and served up the same content. Was it really worth the extra $66 to receive it in print? The marketers at The Economist then added a third option – print only for $125. Who in their right mind would buy print only for the same price as print and online? The answer is no one, as you’d expect. But then a majority of people began purchasing the print and online subscription instead of online only. Why? Because consumers viewed the web subscription as a bonus. By offering the print-only option, the people at The Economist, intentionally or not, had made consumers think the value of the print subscription was $125. Rather than paying an extra $66 for the print version, they were now getting the $59 web subscription for free. As a result, consumers thought they scored a great deal.
This demonstrates transaction utility. Separate from the utility derived from actually using the product, this is the satisfaction of getting a good deal. It is the same reason you bought that shirt you kind of liked once you realized it was 50% off. (Ok, maybe that was me.)