Here is a facinating conversation between Shane Parish of Farnam Street and Rory Sutherland, the Vice Chairman of Ogilvy & Mather Group, one of the largest advertising companies in the world.
Rory started the behavioral insights team at OM and spends his days applying behavioral economics and evolutionary psychology to solve problems for their clients.
The conversation is broad ranging and long (Rory certainly likes the sound of his own voice) but it is littered with hundreds of nuggets of mental models and insights that are applicable to both running a business, investing and understanding trends in the world today including political trends and technological trends like Artificial Intelligence. So well worth a listen.
A few of my takeaways (my own thoughts in italics)
“The problem with (traditional) economics isn’t only that it’s wrong, it’s that it is very creatively limiting, it posits a very one dimensional view of human nature, entirely driven by monetary utility.”
Different consumers respond differently to different distribution channels
Did you know that advertisers have exploited double-blind testing of what works in adverts since the 1800’s, often running different printing presses with different variants of adverts to test which were more successful! The medical world only caught onto this is the mid 1900’s.
In an example he gives an advert in the pre internet era is run in three different forms: an option of responding by mail only, an option responding by telephone only, or an option where both channels were available. In their example the first mail option had a 2.5% response rate, the telephone advert had a 3.5% response rate. The interesting thing is that the combined option had a response rate of around 5.8%, ie. the two different channels for the same thing accessed almost completely different non overlapping groups of consumers. So how you sell something is as important as what you sell.
The value of unpredictability, emotion and irrationality
“It’s impossible for anything completely rational to successfully evolve, because a byproduct of being optimally rational is being completely predictable and if you were completely predictable you would be dead.” In evolutionary terms other aninals would take advantage of you due to your predictability. So there is a danger in looking at everything as an optimisation problem. Our psychology has evolved to be a bit random and unpredictable.
People will take advantage of driverless cars because they are programmed to be safe, pedestrians will walk in front of them or mess around with them to have some fun. Driverless cars will not only have to cope with the normal unpredictability of human drivers but with also how humans will evolve their driving because of how they know driverless cars will behave!
Anger is a useful emotion for humans because the potential to provoke it prevents someone from taking advantage you. They know at some point they will get a reaction and that basically keeps most of us well behaved.
A connected though from me is: Will general artificial intelligence have to develop the same evolutionary mechanisms to operate in our world or survive in a world with other GAIs? Like genetic algorithms will it have to have random mutations or like humans have to evolve emotion to create unpredictability to be able to survive and evolve? What are the implications of that?
Some societies have a cultural tilt towards being tolerant of ambiguity, and have more of an attitude to “give the benefit of the doubt” to someone else compared to those who are more rules driven “this is my right so I will assume I can do this and not make for any allowance for others” – the former (Sweden, Ireland, Netherlands) have lower road accident rates than the latter (Germany, the US). People who are less reliant on rules operate more carefully to avoid costly mistakes.
Contextual biases and value signalling
He explores how the value we place on either a good or service is incredibly contextual. For example we will have a bias towards paying more for the same service or good from one provider or another depending on our sense of the brand of the provider. eg we will pay more for a beer from a boutique hotel than for the same beer sold by a pop-up stand even if we take away all of the “other benefits” like the location and atmosphere. In a financial context think of this as a “boutique hedge fund” versus a lowley long only manager with the same alpha! How does this effect how you market your business?
Other insights into human behaviour from Robert Trivers: his work on Reciprocal altruism (another behavioral trait, that we feel obliged to reciprocate towards someone who is altruistic to us) and work on self deception: Self deception is evolutionarily advantageous, as the best way to deceive others is to believe your own deceits.
Our desire for artificial certainty justified by rational models
Beauracrats, business men (and many investors) love a formula because of the artificial sense of certainty that it creates for then when making a decision. That prevents them from having to exercise judgement for which they might be blamed. Avoidance of blame is a key driver in many businesses.
And that creates herding behaviours because of the asymmetry of reward to getting something right (often a small bonus) versus consequence of getting something wrong (getting fired). The “rational boring norm” is the safe place for most businesses and most peopke working for a big business. Most businesses and people are focused on avoiding bad outcomes rather than maximising the opportunity.
This creates bogus rationality where we try to use simple, understandable algorithns to prove that the decision was logical rather than take a risk of complex judgement demanded in understanding a more complex system: like the financial markets. Does this have potential consequences for the current trend towards “smart beta” algorithms in investing?
This leads on to the role of imagination vs reasoning in decision making. It usually takes takes imagination to formulate an insight or hypothesis and then logic to prove whether it is true. The role of imagination is often downplayed because afterwards we present the thinking as if the linear sequence of the logic led us to the conclusion. Science and insights are very seldom arrived the linear way.
He highlights three different forms of reasoning
Forward reasoning: what will happen next because I know of what has happened so far, based on our heuristics of how the world works. We then can test out model or heuristic by seeing if the outcome matched our expectation. If not we need imagination to hypothesise how to change our models or heuristics.
Reverse reasoning: like a detective, I observe an outcome and then I hypothesise what preconditions could lead to it and like a detective I sift through possibilities. This requires a lot of imagination to hypothesise what could lead to the outcome.
Post-rational reasoning: what we usually do when we come to a conclusion: our emotional limbic system reacts very quickly resulting in a conclusion or action using its heuristic systems in a situation, afterwards we justify the outcome by coming up with a narrative or logic that justifies the decision (fitting the facts to what we want the answer to be). We are post-rational creatures rather than rational creatures. Most of our reasoning happens after we feel an emotion, to justify why we feel the emotion.
The psychology of choices and value.
On a menu we can use the price of different items to signal worth or quality. The menu context pushes people towards selecting certain options, for example seldom choosing the most expensive or cheapest option on the menu, or the more expensive options being indicative of higher quality.
Game theory and the difference between one-off games vs repeat games.
In a repeat game you don’t just optimise your outcome for the next move but for many moves into the future. For example in selling to someone, you don’t just want this sale but future sales to the same customer, so you had better make sure that this experience is a good one for the customer even if that does not maximise your short term profit. In long term games you have to be tustworthy and reputation is incredibly important. Consumers make many choices based on their intuitive understanding of service providers trustworthiness and alignment. The bigger the upfront cost of committing to a decision that takes a long time to see results the more the long term alignment will matter.
There are many practical applications in every day business. For example the focus by many large businesses incentivised by stock market behaviour towards short term earnings results is a bias toward “one time games” to make themselves rich. Think of the contrast between hedge funds with annual performance fees, private equity with 5 or 7 year incentivisation and Amazon with a very long horizon strategy for growing the business through reinvestment.
The value of experimentation.
In business you don’t have to be right all the time, you can be experimental and see what works and what doesnt (provided the cost to testing is low). It is important to test some counterintuitive or imaginative ideas because as its much more valuable when they pay off as your competitors won’t or are unlikely to have tested them.
In the case of the financial markets the payoff of a contrarian bet may be large as it is counter to expectations with little downside if the crowd is already pricing in the consensus scenario.
So have a listen here