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By Olga Kandinskaia
As someone with a keen interest in the business management science, I always keep an eye on the latest decision-making theories. Simply speaking, making a decision is rarely easy. Or at least if we are talking of a good decision. To make a good decision, we need to be able to collect, interpret and analyse a load of information, and at the same time not to lose track of our goals. Management education is dedicated to this purpose of improving real life management decisions, applying the principles of management science to the current business challenges. Behavioural science has proven that people are often irrational when making their choices. Is there a way to prompt people to make better decisions? Yes, and one of the latest theories here, which is increasingly being embraced both in the public sector and in the corporate world abroad, is the Nudge theory. Understanding this theory and applying it in your business will help you succeed.
What is a Nudge?
Generally speaking, a nudge is a light touch or push, which is used to attract attention or to point someone in the right direction. The Nudge theory is a way of offering small clues that support decision-making. It’s not about penalising people financially or limiting their freedom if they don’t act in a certain way. Instead, it is about making it easier for them to make a certain decision. Simple real life examples would be footprints painted on the floor leading to recycling bins, or putting a few euros in the collection plate before passing it around. Placing fruit at the eye level at a school canteen has proven to bring much better results than the direct instruction to children to eat more fruit.
The Nudge theory existed from the mid-1990s, but became famous after the 2008 book by Richard Thaler and Cass Sunstein “Nudge: Improving Decisions about Health, Wealth and Happiness”, where they wrote: “By knowing how people think, we can make it easier for them to choose what is best for them, their families and society.” The Nudge theory is one of the latest developments in the field of behavioural economics. The latter aims to bring psychology back into economics. It was born in the mid-1980s in response to the economists’ claim that all people behave rationally when it comes to economic decisions. Behavioural economics tries to identify patterns and circumstances where our choices aren't perfect – when they are irrational or inconsistent.
For example, we are loss averse: we fear losing money or status more than we enjoy gaining them. We tend to rationalise our opinions, looking for evidence to confirm pre-existing views rather than threaten them. We imagine we are more competent – better informed and more skilled – than we actually are. These are examples of what we call cognitive errors. They mean we make worse decisions than we would if we were meticulously rational.
Nudging in Public Policy
Thaler and Sunstein, two prominent behavioural economists, argued in their book that policymakers should alter the environment in which we make decisions in order to help us make better choices. Not eliminate bad choices, but just gently direct (i.e. nudge) us into making less bad ones. Nudging involves such actions like rearranging choice hierarchies and changing defaults so that better choices are more prominent.
In 2010, Richard Thaler was an adviser on the creation of the Behavioural Insights Team in the UK government, which became known as “nudge unit”. The unit was initially focused on public health issues such as obesity, alcohol intake and organ donation, but promptly its scope has changed to cover everything from pensions and taxes to mobile phone theft and e-cigarettes. The Team’s motto is that “government policy can better be executed by employing small, clever prompts.” The team worked with HMRC (Her Majesty’s Revenue and Customs — the U.K.’s version of the IRS) to change wording in collections letters in an effort to get more people to pay their bills on time without resorting to threats or new legislation. They edited the letters to say that most people in the recipient’s area had paid on time, implying that the reader was the only one doing it wrong. Apparently, this tiny change increased payments by 5%.
Another recent example is the UK pension policy. In order to increase worryingly low pension saving rates among private sector workers, the UK government mandated employers to establish an “automatic enrolment” scheme in 2012. This meant that workers would be automatically placed into a firm’s scheme, and contributions would be deducted from their pay packet, unless they formally requested to be exempted. The theory was that many people actually wanted to put more money aside for retirement, but they were put off by what they feared would be a complicated procedure. The idea was that auto enrolment would make saving the default for employees, and thus make it easier for them to do what they really wanted to do and push up savings rates. It worked well. Since auto enrolment was introduced in 2012, active membership of private sector pension schemes has increased from 2.7 million to 7.7 million in 2016.
Applying Nudging in Business Management
In 2017, Richard Thaler, one of the founding ‘fathers’ of the Nudge theory, received the Nobel prize in economics, and this boosted the active application of the Nudge theory in the corporate world. It concerns all four key aspects of business management: managing people, managing sales, managing operations and managing finances.
The HMRC example above is an example of social proof. It plays on our innate desire to not stand out from the crowd. While social proofs come in many forms, the most straightforward is the method saying “Everyone else is doing it.” In the office, we can use this to help manage employee compliance. For example, when introducing a new training program that you want everyone to complete. Most employees will do it if you ask them, but a portion will always delay. Resorting to some kind of threats, even mild, may have negative side effects, so consider going with this non-threatening and encouraging message instead: “Almost everyone has already completed the training, please make sure you do as well.” You may be surprised that it will be more effective than direct threats.
There is a huge potential when applying the Nudge theory in sales and marketing. The way we describe something has a bearing on whether it is desirable or not. For example, consider a recent smart invention by Philips – the Air Fryer, which cooks food with 75% less fat. But because they called it a ‘fryer’, health-conscious consumers are somewhat suspicious.
Another example of a frequently encountered nudge is the “Most Popular” label. For instance, if you offer on your web site several different subscription packages to customers, you may mark one of them as “Most Popular Plan”. While it doesn’t force your customers’ hand or changes their ability to choose any option, it catches their eye and makes a subtle suggestion by claiming that a specific option is the one everyone else likes.
In the area of finance, organisations such as Lendwithcare, a UK microfinance lending site, have got nudging right. They provide instant feedback to encourage people to donate microloans to small businesses in less developed countries. By showing people where their money went and the good it’s doing, they encourage people to lend a lot more.
Bottom line: nudges are essentially small clues that support decision-making. Use them wisely in your advertising and watch your product fly off the shelves. Fail to understand how people really behave, and your business will struggle – even when doing everything logically right.
Dr Olga Kandinskaia is Assistant Professor of Finance and Director of the MBM – MSc in Business Management at the Cyprus International Institute of Management CIIM
