Behavioral economists know that because people struggle to think about money and risk in a systematic way, they may make irrational, counterproductive financial decisions for themselves and their organizations. The world of personal financial advice provides an example: Most people estimate that they'll need 75% of their current salary in retirement-because that's the benchmark they've heard from financial advisers. But when they describe how they expect to live, it turns out they'll actually need 135%.
The idea of making a deal with a handshake-what we generally call an incomplete contract-makes most of us uncomfortable. A handshake is fine between friends, but when it comes to vendors, partners, advisers, employees, or customers, we believe that incomplete contracts are a reckless way to do business. Indeed, firms try to make contracts as airtight as possible-specifying outcomes and contingencies in advance, thus lowering the chances for misunderstanding and uncertainty. But complete contracts have their own flaws, and business's increasing dependence on absurdly detailed contracts in every situation comes with its own downside.
HBR asked top management thinkers to share what they were resolved to accomplish in 2011. Here are their answers: Joseph E. Stiglitz will be crafting a new postcrisis paradigm for macroeconomics whereby rational individuals interact with imperfect and asymmetric information. Herminia Ibarra will be looking for hard evidence of how "soft" leadership creates value. Eric Schmidt will be planning to scale mobile technology by developing fast networks and providing low-cost smartphones in the poorest parts of the world. Michael Porter will be using modern cost accounting to uncover-and lower-the real costs of health care. Vijay Govindarajan will be trying to prototype a $300 house to replace the world's poorest slums, provide healthy living, and foster education. Dan Ariely will be investigating consumers' distaste for genetically modified salmon, synthetic pharmaceuticals, and other products that aren't "natural." Laura D. Tyson will be promoting the establishment of a national infrastructure investment bank. Esther Duflo will be striving to increase full immunization in poor areas of India. Clay Shirky will be studying how to design internet platforms that foster civility. Klaus Schwab will be undertaking to create a Risk Response Network through which decision makers around the world can pool knowledge about the risks they face. Jack Ma will be working to instill a strong set of values in his 19,000 young employees and to help clean up China's environment. Thomas H. Davenport will be researching big judgment calls that turned out well and how organizations arrived at them. A.G. Lafley will be proselytizing to make company boards take leadership succession seriously. Eleven additional contributors to the Agenda, along with special audio and video features, can be found at hbr.org/2011-agenda.
Managers attempt to make sense of their environment and predict what will result from their decisions. The problem is that there's plenty of random noise in competitive environments, so rewarding or penalizing managers on the basis of outcomes is a mistake. This column offers four ways companies can create more effective reward systems, helping managers to make better decisions.
Companies pay amazing amounts of money to get answers from consultants or rely on focus groups, a dozen people riffing on something they know little about, to set strategies. What companies won't do is experiment to find evidence of the right way forward. Why? One reason is that experiments require short-term sacrifices for long-term gains. Companies (and people) are notoriously bad at making those trade-offs. Another is that there's the false sense of security that heeding experts provides. When we pay consultants, we want an answer from them and not a proposal for what experiment to conduct. As human beings, we tend to value answers over questions because answers allow us to take action, while questions mean that we need to keep thinking to work things out.
Standard economic theory assumes that human beings are capable of making rational decisions and that markets and institutions, in the aggregate, are healthily self-regulating. But the global economic crisis, argues Ariely, has shattered these two articles of faith and forced us to confront our false assumptions about the way markets, companies, and people work. So where do corporate managers - who are schooled in rational assumptions but run messy, often unpredictable businesses - go from here? In this lively article, the author, a professor of behavioral economics at Duke University, shows how the emerging discipline of behavioral economics can help businesses better defend against foolishness and waste. Smart organizations will develop a behavioral economics capability by hiring qualified experimenters and conducting small trials that build on one another, revealing a radically different view of how people make decisions. Revenge and cheating are only two of the irrational behaviors that companies will find underlying their employees' and customers' actions. Once an understanding of irrationality is embedded in the fabric of an organization, a behavioral economics approach can be applied to virtually every area of the business, from governance and employee relations to marketing and customer service.
Duke behavioral economist Ariely and Harvard Business School professor Norton explore how our consumption of concepts influences physical consumption, both positively and negatively.
The authors argue that consumer valuations of goods and services are a lot more arbitrary than we may think, and are affected by several 'arbitrary' components and biases. They describe the phenomenon of 'Tom's Law', whereby Mark Twain's Tom Sawyer discovered a great law of human behavior: that in order to make a person covet a thing, it is only necessary to make the thing difficult to attain. They introduce the concept of 'coherent arbitrariness' and show how arbitrariness is enhanced by ambiguity in a good or bad experience.
Our annual survey of ideas and trends that will make an impact on business: Stan Stalnaker heralds a peer-to-peer economy in which consumers become consumer-producers. Tamara J. Erickson dissects the expectations of Gen Y workers. Dr. Jerome Groopman writes a prescription for avoiding misdiagnoses in decision making. Michael Sheehan warns not to resort to the tools of competition when it's really opposition that threatens your company. John J. Medina conceives of a brain-friendly workplace that applies modern science to daily performance. Dan Ariely studies the minds of "honest" people when they cheat. Paul Root Wolpe and Daniel D. Langleben share truths about technologically sophisticated lie detection. Scott Berinato shines a light on the cybercrime service economy. Mark Kuznicki, Eli Singer, and Jay Goldman showcase Toronto, where a technology-driven event led to real social change. John Seely Brown and Douglas Thomas argue that online games are preparing the twenty-first-century workforce. Jane McGonigal calls alternate reality games the promising new operating systems for real-world business. Miklos Sarvary mines the history of broadcasting for wisdom about competing in the metaverses of the internet. Judith Donath asks how true to yourself you'll be in the virtual world. Jan Chipchase surveys the soon-to-be-charted territory of metadata trails. Lew McCreary points a finger at people who blame technology for their bad behavior. Jaime Lerner sees the city of the future in a turtle's shell. David Vogel catalogs the advantages of socially responsible lobbying. George Pohle lets the numbers prove the mass-market promise of China's second-tier cities. Aamir A. Rehman and S. Nazim Ali discuss the boom in sharia-compliant finance. Michael J. Mauboussin identifies the shrinking domain in which experts are the best problem solvers. Garrett Gruener reveals his list of sustainable and unsustainable trends.
Venerable Detroit automaker Atida Motors has a new call center in Bangalore that the company hopes will raise its reputation for customer service. But it doesn't appear to be doing so yet. Complaints about the Andromeda XL--the hip new model Atida hopes will capture the imagination of Wall Street--are flooding the call center. Call backlogs are building, and letters of complaint are piling up. One loyal Atida customer is so upset about getting the brush-off that he's not only talking to a lawyer but threatening to go on YouTube and take his case to the court of public opinion. In the Internet age, does Atida need a new way to deal with unhappy customers? Tom Farmer, the creator of the unintentionally viral PowerPoint presentation "Yours Is a Very Bad Hotel," says that Atida needs to stop defining customer service solely as a response to bad news and nip problems in the bud by making online dialogue intrinsic to the brand experience. Nate Bennett, of Georgia Tech, and Chris Martin, of Centenary College, observe that Atida has violated its customers' sense of fairness within three dimensions--distributive, procedural, and interactional--thus increasing their desire for revenge. Lexus Vice President for Customer Service Nancy Fein thinks Atida isn't even in the ballpark when it comes to world-class customer service. She offers as an example a Lexus rep who drove 80 miles to deliver $1,000 to a stranded Lexus owner whose purse had been stolen. Barak Libai, of Tel Aviv University and MIT's Sloan School, suggests that Atida invest in a CRM system so that it can determine which customers have enough purchasing and referral value to be given the red carpet treatment and which should be gently let go.
Venerable Detroit automaker Atida Motors has a new call center in Bangalore that the company hopes will raise its reputation for customer service. But it doesn't appear to be doing so yet. Complaints about the Andromeda XL--the hip new model Atida hopes will capture the imagination of Wall Street--are flooding the call center. Call backlogs are building, and letters of complaint are piling up. One loyal Atida customer is so upset about getting the brush-off that he's not only talking to a lawyer but threatening to go on YouTube and take his case to the court of public opinion. In the Internet age, does Atida need a new way to deal with unhappy customers? Tom Farmer, the creator of the unintentionally viral PowerPoint presentation "Yours Is a Very Bad Hotel," says that Atida needs to stop defining customer service solely as a response to bad news and nip problems in the bud by making online dialogue intrinsic to the brand experience. Nate Bennett, of Georgia Tech, and Chris Martin, of Centenary College, observe that Atida has violated its customers' sense of fairness within three dimensions--distributive, procedural, and interactional--thus increasing their desire for revenge. Lexus Vice President for Customer Service Nancy Fein thinks Atida isn't even in the ballpark when it comes to world-class customer service. She offers as an example a Lexus rep who drove 80 miles to deliver $1,000 to a stranded Lexus owner whose purse had been stolen. Barak Libai, of Tel Aviv University and MIT's Sloan School, suggests that Atida invest in a CRM system so that it can determine which customers have enough purchasing and referral value to be given the red carpet treatment and which should be gently let go.
Venerable Detroit automaker Atida Motors has a new call center in Bangalore that the company hopes will raise its reputation for customer service. But it doesn't appear to be doing so yet. Complaints about the Andromeda XL--the hip new model Atida hopes will capture the imagination of Wall Street--are flooding the call center. Call backlogs are building, and letters of complaint are piling up. One loyal Atida customer is so upset about getting the brush-off that he's not only talking to a lawyer but threatening to go on YouTube and take his case to the court of public opinion. In the Internet age, does Atida need a new way to deal with unhappy customers? Tom Farmer, the creator of the unintentionally viral PowerPoint presentation "Yours Is a Very Bad Hotel," says that Atida needs to stop defining customer service solely as a response to bad news and nip problems in the bud by making online dialogue intrinsic to the brand experience. Nate Bennett, of Georgia Tech, and Chris Martin, of Centenary College, observe that Atida has violated its customers' sense of fairness within three dimensions--distributive, procedural, and interactional--thus increasing their desire for revenge. Lexus Vice President for Customer Service Nancy Fein thinks Atida isn't even in the ballpark when it comes to world-class customer service. She offers as an example a Lexus rep who drove 80 miles to deliver $1,000 to a stranded Lexus owner whose purse had been stolen. Barak Libai, of Tel Aviv University and MIT's Sloan School, suggests that Atida invest in a CRM system so that it can determine which customers have enough purchasing and referral value to be given the red carpet treatment and which should be gently let go.
The typical approach to reducing dishonesty - increasing the probability of being caught or the magnitude of punishment - isn't very effective. The authors argue that a psychologically-focused approach may be more effective. Whereas the standard economic perspective considers one cause for dishonesty - external reward mechanisms - and thus emphasizes the probability of being caught and the magnitude of punishment as the sole ways to overcome it, the authors uncover three other causes: they not only examine dishonest behavior caused by external rewards, but dishonest behavior caused by a lack of internalized social norms, by a lack of self-awareness, and by self-deception.