Behavioral Economics
and Disruptive Innovation
Jonathan Zinman
Professor of Economics, Dartmouth College
Scientific Director, U.S. Household Finance Initiative
July 12, 2014
Smoketree Roundtable
What is Behavioral Economics (BE)?
• At its best it melds:
– Psychologist’s rich understanding of decision making
(complexity, biases, and fallability)
– Economist’s rich understanding of markets
• At its worst…
– Rejects homo economicus without offering
constructive alternative
• “People are irrational”… how/when/where/why?
• “Context matters?”… how/when/where/why?
– Used to justify prescriptions that far outstrip evidence
How is BE being applied
in consumer finance?
• Communications
– Marketing
– Reminders
– Feedback
• Pricing
• Process
– “on-ramping”
– Default options (opt-out 401k’s)
• Product development
– SMaRT
– (Harder savings commitments)
– (Spending controls)
Long history of BE-like applications
for ill
A few examples:
• “Monthly payments” marketing
• Teaser pricing
• Rebates
• Bundling add-ons
• Etc.
Can BE be harnessed to improve
outcomes?
• Probably, but the jury is still out
• Mounting evidence on how to apply BE for
behavior change
• Much less evidence on if/when behavior
change actually makes people better off
Outcomes-based measurement:
Which outcomes?
Personal Balance Sheet
Assets
Liabilities
Deposit Accounts
$6,102
First Mortgage
CDs
$3,783
Second Mortgage
Stocks
$4,983
Vehicle Loans
$5,242
Bonds
$4,534
Credit Cards
$6,503
Mutual Funds
$3,549
Student Loans
IRAs
$15,004
Margin Loans
$0
401(k)
$32,765
Payday Loans
$0
Automobiles
$12,186
Other Installment Debt
Real Estate
Other Property
Total Assets
$220,800
Other Lines of Credit
$170,400
$18,300
$12,987
$3,210
$0
$14,222
$317,928
Total Liabilities
$216,642
Net Worth
$101,286
Can BE be harnessed for good, in a
game-changing way?
• I’m optimistic
• Will illustrate with 4 high-level ideas
– 2 for policy and 2 practice
BE-informed disruptive innovation:
Information policy
Old approach: point-of-sale disclosure
BE-approach:
– Rethink timing: decision point of pre-POS
– Rethink content (amount, density, framing, etc.)
• Including meta-information (build “wariness”)
• Including the possibility of persuasive content
– Rethink channels
– Rethink sender
Examples: CFPB Office of Engagement, Smart
Disclosure, ??
BE-informed disruptive innovation:
Principles-based regulation
BE opens possibility that some
products/transactions harmful even if not
deceptive, fraudulent per se.
But… how define and measure harm?
Are we moving toward a regulatory environment
where it will make sense for more firms to turn
“compliance” on its head?
BE and disruptive innovation:
BE as a discipline
Methods for applying BE:
1. Assume you know enough to write RXs
– Many cautionary tales here
2. Throw out a bunch of stuff and see what sticks
(a lot of AB testing uses this approach)
*3. Use BE to innovate more efficiently
– What to test?
– What do test results tell us about promising
approaches to future innovations?
• Subsequent rounds of testing
• In other functions/units of the business
BE and disruptive innovation:
BE -> new products, industries?
Example: “Liability Management”
Consumer pain points (high-level):
• How do I find the best loan for me?
– Many overpay, a lot
•
Whom can I trust to help me?
– Advice market fragmented, lots of low-quality providers
Business case premise:
• Huge asset management industry
• But debt is where the money is for most consumers
– Hundreds of basis points on trillion of dollars
Bottleneck: “consumers won’t pay”
• BE helps us see this is, very likely, utter nonsense
From BE to a new business model
“People won’t pay out-of-pocket for value-added financial services…” But:
People do pay for credit report management, identity protection, tax prep, etc.
People will pay when they are liquid (tipping the teller at the check-cashing window;
tax-refund frenzy)
Pricing/business models often succeed in convincing people to buy something they
(don’t know they) want. Examples from other contexts:
–
–
–
–
Fee bundled in/extracted from a lump-sum disbursement
Monthly subscription, often starting with a teaser
Money management fees
Pay-for-performance
BE can help bridge contexts and build-out from pricing -> business model
– Timing the offer
– Framing the offer
– On-ramping from offer to take-up
Discussion…
Some BE-informed Design Principles
• Simplify
• Streamline (on-ramping)
• Just-in-time (reach people at decision point)
• Meet people where they’re at
– Facilitating, nudging more effective than felt-change
• Diagnose, treat, and measure success or failure
• Be humble: we still have a lot to learn
– Mixed and limited evidence, especially outside the lab
– A premise of behavioral social science is that context matters
Messaging for rainy day savings
Test 1. Which works better at encouraging regular savings
deposits?
1. “If you make… deposits, you will receive [small yield incentive]”
2. “If you miss a deposit, you will lose [small yield incentive]”
3. “If you make… deposits, you will receive [small yield incentive] that
4.
you can use to reach your saving goal of [client’s goal]”
“If you miss a deposit, you will lose [small yield incentive] that you
could use to reach your saving goal of [client’s goal]”
Results:
1 and 2 push
3 and 4 push
3 and 4 >> 1 and 2
Messaging for financial resiliency
Test 2. Which works better at controlling discretionary spending
among a sample of active HelloWallet users?
1. Email every Friday re: the budget for that weekend
2. Same as #1, but every other week
3. Same as #1, but don’t start until 4 weeks after enrollment
Results:
3>2>1
Diagnoses
•
•
•
•
•
•
Struggles in Managing Desires
Bandwidth constraints (e.g., limited attention)
Biased forecasting (e.g., excessive optimism)
Getting the math wrong (low numeracy, math biases)
Getting basic facts wrong (low financial literacy)
Limited/biased learning (about oneself, about finance)
Treatments (Levers)
Commitment (hard and soft)
Default options
Automation
Reminders
Framing
Cuing
Priming
Information