Opening keynote address – TIE Entrepreneurial Summit, 2011 – Part 2

Ladies and gentlemen,

There is enough research evidence to show that all of us without exceptions have naturally in-built biases and I would like to touch upon a few of them.

Let me take up the irrational bias called “Optimism Bias”, which all of you, particularly as entrepreneurs, need to appreciate.

The belief that the future will be much better than either the past or the present, is core to the optimism bias.

Research indicates that unrealistic optimism is a pervasive human trait and this bias influences diverse domains ranging from personal relationships to politics to finance. What is more puzzling, however, is that people continue to maintain such unrealistic optimism, despite frequently encountering credible information that challenges their undue optimism.

Behavioral Economics professor Dan Ariely, author of New York Times bestseller “Upside of Irrationality”, points out that the value of an asset is lot higher in the minds of the owners compared to the value placed on it by people who don’t have the asset. This optimism bias explains the reason why it is so hard to get a business buyer to offer you a price for your company that you think reflects its real value or why it is difficult to get an investor to value your business at what you think is its real worth.

Interestingly, a survey found that 68 percent of startup entrepreneurs believe their company is more likely to succeed than similar companies, while in reality only 50 percent of startup companies even survive beyond the first three years of activity.

At the macroeconomic level, Robert Shiller, in his book Irrational Exuberance makes the case that irrational exuberance contributes to the generation of bubbles in the financial markets. Harvard economist Ed Glaeser when asked to explain his failure to foresee the housing market bubble had this to say. “ I grossly underestimated the human capacity to think rosy thoughts about the value of house”.

Let me now take you through another human bias called Reference Bias or Anchoring Effect.

We are all familiar with auctions. Let me take the example where people enter an auction for several items, such as cordless phones, books, chocolates, bottles of wine etc.  The bidders write down for each of the items, the maximum amount of money that they are willing to pay.  Whoever submits the highest bid for an item, wins that item and pays the amount. People who are keen to buy a specific item are expected to enter higher bids than others, because they place higher value for the item at that point of time.

But here’s the ingenious twist introduced by Behavioral Economist Dan Ariely.  Before people entered their bids for each item, they were asked first to write down the last two digits of their Social Security number and then write down their bids for various items.

Ariely’s experiment threw up surprising positive correlation between the last two digits of the Social Security numbers and the entered bids of people. In other words, bidders whose last two digits of the Social Security numbers were larger in numerical value, for some reason, were driven to enter higher bids for a given item than those whose last two digits of social security numbers were smaller.  For example, those whose last two digits were between 00-19 were willing to pay $8.64 for a cordless trackball on an average.  In sharp contrast, those whose last two digits of the Social Security number were between 80-99 were willing to pay $26.18 for the same item, more than three times as much. The question to ask is how the last two digits of bidders’ Social Security numbers, by any stretch of imagination, can possibly affect how much they are actually willing to pay for a whole host of items?

Daniel Kahneman, the psychologist who won the Nobel Prize in economics and considered the “father” of behavioral economics, has an explanation. He says that when people are thinking about quantities, the first number that gets their full attention has enormous impact in all future numbers.

I will leave it your innovative imagination to come up with creative ways of priming your customers’ brains to exploit this anchoring effect.

Marketers also exploit another bias termed as “Relative Positioning Bias” by offering certain additional options to customers that they do not really intend to sell. Many wine shops, for instance, have realized that the second-most-expensive bottle of wine is the most popular with maximum sales—and so is the second- cheapest. The innovative part is that the most expensive as well as the cheapest options are simply offered to boost the sales of their adjacent products.

The explanation for this peculiar behavior is that customers who buy the second highest priced product feel that they are getting something of special value without going over the top. Similarly those who buy the second cheapest product feel that they are getting a good bargain without going cheap.

Sony, in fact, encountered this bias while pricing their headphones. Consumers were inclined to buy a headphone model at a given price only if they saw a more expensive Sony model available —but not if the model itself is the most expensive option on offer.

There is another manifestation of this human frailty.

In an interesting experiment, the researchers offered a set of people two subscription options for the magazine “The Economist”.

Option one was an electronic-only subscription package for $59/year

Option two was the combination of print and electronic subscriptions for $125/year, a little more than double of the first option.

Given these two choices, 68% of people chose the former option, while 32% chose the latter.  In standard economic terms, it meant that a majority of people considered buying an electronic-only subscription for the reduced cost of $59 to be “better value” than having to pay more than twice as much for a combination of print and electronic subscriptions. This is some thing we can all understand.

But then the researchers repeated the experiment with a modification. An extra option was introduced to make in all, three options to choose.

The first option was the same, electronic-only subscription for $59/year.

The print plus electronic subscriptions option was again the same for $125/year but was given as the third option.

The additional option was juxtaposed as the second option and was the print-only subscription for $125/year.

Given these three options, not unsurprisingly 0% of people chose the print-only option.

However this time, only 16% of people as opposed to 68% chose the electronics only first option.

And a preponderant 84% of people as opposed to earlier 32% chose the electronics and print combination.

Why did throwing in a third option of print only, which nobody chose any way, entirely reverse the preferences?

That is how irrational we are.

My wife always accuses me of having a bias towards more expensive goods even though the cheaper versions may be equally good both in terms of functionality and quality. Fortunately neuroscientists have come to my rescue by rationalizing this kind of bias.

There is enough research to show that people generally believe that things that cost more are likely to be of better quality than things that cost less. Enterprising businesses are exploiting this human irrationality through innovative pricing strategies.

There is research suggesting that this bias towards higher-priced goods may have something to do with the way the brain links price with pleasure — and thus leads people to make assumptions about quality.

Researchers from the California Institute of Technology and Stanford University asked 20 volunteers to taste and evaluate five wine samples, which were labeled according to price: $5, $10, $35, $45 and $90 a bottle. All the volunteers identified themselves as moderate wine drinkers and not experts.

At the end of the experiment, the volunteers said they liked the more expensive wines best. And brain scans taken as the volunteers sipped and rated the wines showed that the higher-priced wines indeed, did generate more activity in the medial orbitofrontal cortex, an area of the brain that responds to certain pleasurable experiences.

But there was a catch. Although subjects were told that they were tasting five different wines, in fact, they sampled only three. The $90 wine was presented twice, once at its real price and the other time as a $10 wine; the $5 wine was also presented as a $45 wine. The interesting finding was that when the cheaper wine of $5 was offered at the higher price of $45 the participants preferred them — and their brains did register greater pleasure.

Similarly, when they sampled the $90 wine which was presented as $10 wine, the subjects did not like them as much, their brains registering lesser pleasure from the experience. It was clear that what the volunteers really liked was the price tag, not the product. The pleasure we derive from any product or service, ladies and gentlemen, depends less on the product or service and more on our expectations from the product or service.

Here is another example of how people make inferences about quality based on price tag.

Consider the experience of the jewelry storeowner whose consignment of turquoise jewelry wasn’t selling. Displaying it more prominently did not achieve any improvement in sales either. The increased efforts by her sales staff also did not yield any results. Exasperated, the storeowner gave her sales manager instructions to mark the lot down “x1⁄2” and departed on a buying trip. On her return, the store owner was pleasantly surprised to find that the manager misread her note and had mistakenly doubled the price of the items—and as a result sold the whole stock. So, dear friends, next time you price your product or service, please keep this bias in mind.

You do not know what you can really get away with, till you try.

My dear friends,

As one intimately involved with HR strategies for more than two decades, I can not but talk a little about employee motivation and what Neuroscience has to say about this.

We are all familiar with bonuses and incentives that are extensively used in the corporate world as powerful tools for motivating staff for superior performance. Behavioral Economists are criticizing this overemphasis on financial and cash incentives & bonuses. They are questioning the effectiveness of these incentives in the absence of Intrinsic Motivation which they advocate is lot more critical to deliver results.

Social scientists talk of two types of motivation, the intrinsic motivation, which makes us indulge in activities for their own inherent satisfaction and then the extrinsic motivation that makes us do things for some external reasons including financial rewards and recognitions.

There is research finding that certain types of extrinsic motivation tools like financial rewards, deadlines, and the threat of punishment may actually turn out to be counter productive as the following case will illustrate.

A nursery school in Israel, to curb the tendency of parents coming late to pick up their wards, introduced small fines for parents who arrived late to collect their children. To the surprise of the school management, the fines, in fact, had an opposite effect as the number of late arrivals actually doubled. It appeared that by paying the fines, the parents no longer experienced the feeling of guilt about arriving late. The intrinsic motivation that compelled them to come on time was gone as they could now rationalize that they were paying a certain amount of money as a cost for their late coming.

We need to appreciate that we are naturally motivated to ‘do the right things’ and when we fail to do so, we feel bad and have a guilty conscience. This guilt can be offset if we receive a punishment, in this case a fine, because after being punished or after paying the fine we feel that we have paid for our misdeed and we have a clean conscience.

Let me now touch upon a very significant research finding which as leaders, you need to take note of. It has been drilled into us through the years that as leaders we have the critical responsibility to “Lead by Example”. Neuroscience fully endorses this sane advice by demonstrating that good and bad behaviors, especially by leaders, are contagious.

That bad behavior begets bad behavior is well proven by a series of “field experiments” in Groningen in the Netherlands designed to test this “broken window” theory. The theory posits that If someone sees, say, graffiti scrawled on a building, he or she will be tempted to do the same or commit some other illegal or mischievous act.

In fact, sociologists often cite this theory as a possible reason that petty or small crimes in New York City dropped substantially in the 1990s after the city scrubbed its buildings, trains, buses, walls etc. clean of graffiti.

Similarly, merely observing a leader publicly blaming an individual in an organization for a problem, greatly increases the odds that the practice of blaming others will spread with the tenacity of an epidemic, according to research from the USC Marshall School of Business and Stanford University.

Nathanael J. Fast and Larissa Tiedens conducted four different experiments and found that publicly blaming others dramatically increases the likelihood that the practice will become viral. The reason they cite for this is that blame spreads quickly since it triggers the perception that one’s self-image is under assault and must be protected.

Similarly leaders are well advised to demonstrate self-control as self-control or lack of self-control is equally contagious.

Researcher Michelle vanDellen shows that picking social influences that are positive can improve your own self-control and by exhibiting self-control, you are also helping others around you to do the same.

While it is generally known that people tend to mimic the behavior of those around them what vanDellen’s study shows for the first time is that self-control is contagious across all behaviors.

What this signifies is that thinking about someone who exhibits good self-control by regularly exercising, for example, can make you improve your own self-control in many other areas like sticking to your financial goals, or attending to your self-improvement programs, or working on your behavioral modification plans etc.

The effect is so powerful, that seeing the name of someone with good or bad self-control flashing on a screen for just 10 milliseconds changed the behavior of volunteers in an experiment.

Similarly, researchers have found that kindness is also contagious and good acts by a handful of individuals can really make a big difference.

Professor James Fowler, lead researcher of joint project by Universities of California and Harvard, claims that co-operative behavior is contagious and will spread quickly from person to person to person. When people benefit from kindness from some one, they tend to “pay it forward” by helping others who were not originally involved, and this creates a cascading effect of co-operation that influences many more in the social network.

Ladies and gentlemen,

By now you must have realized that Human Behavior and Neuroscience excite me a lot and I can go on and on talking about the fascinating findings of Brain Research.

I would have loved to cover the stranglehold that our belief systems have on us and how Leon Festinger’s theory of cognitive dissonance shows the existence of confirmation bias which while forcing us to search and find evidence that supports our existing beliefs ensures that we discredit or discount or completely avoid any information that challenges these beliefs.

I would also have liked to talk about our false memories which make us honestly believe-in and strongly hold-on to our remembrance of certain past events which are quite contradictory to actual recorded evidence and this aspect is being seriously investigated by neurolaw for assessing the reliability of evidence from eye witnesses. There are so many fascinating topics to cover.

But I will stop here as I do not want to stand between you and the wonderful and exciting events that are slated to follow this talk.

Thank you for your patient hearing.


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