For the past 20 years, I have been exploring how people change their behavior. This exploration has led me down many different paths and lines of inquiry. One of the most fascinating areas of research that I’ve investigated surrounds the now hot topic of behavioral economics.
I often describe behavioral economics as the “fusion of psychology and economics in order to gain a better understanding of human behavior and decision making.”
So what do we find out when we fuse psychology and economics together?
“Humans often act in very irrational ways.”
Now that is not ground breaking news for most of us. Even when I graduated with an economics degree, I knew that people didn’t always act in rational ways – or at least I didn’t (otherwise why would I stay up watching bad T.V. until 2:30 AM when I knew I had to get up by 7:00 AM for a meeting or why would I spend a hundred dollars on a dinner out but fret over buying a steak that was over $10 at the grocery store?).
However, for many economists, that statement was hearsay. Many economic models are based on the fact that people act in rational ways to maximize their own utility (i.e., happiness). These theories stated that we might make irrational choices in the short-term, or when we don’t have enough information, or that at least your irrational behavior would be vastly different than mine so that on average, we would be rational.
The truth discovered by behavioral economics is that is not often the case. We don’t act rationally – in fact, we sometimes act exactly opposite of how an economist would think we should act.
For example, research has shown that we will judge the value of an unknown item using totally irrelevant data to help us in that decision. Dan Ariely ran a wonderful study where he asked people to bid on a wireless keyboard (something that they were not very familiar with at the time), but before they answered, they had to write down the last two digits of their social security number (a totally irrelevant piece of data). The results of the bid were fascinating (top 20% being SSN that ended in 80 or above, the bottom 20% being SSN that ended in 20 or below):
This is a significant difference in how much they bid – entirely based on the last two digits of the SSN.
Here’s another one.
Would you work harder for a set amount (say $10) or for an uncertain amount (say 50% chance of $10 or 50% chance of $5)? Most rational people would say that they would work harder for the guaranteed payout of $10…that isn’t the case.
In a study that looked at drinking a large amount of water in two minutes – some people were offered a $2 fixed amount for finishing it – the other group was told they would earn either $1 or $2 (random chance of either). So what was the result?
43% completion rate for the certain award versus 70% completion rate for the variable? Not what you would think right?
Note – that this doesn’t apply to people choosing to participate – existing research suggests that we prefer certainty over uncertainty when deciding if we should opt-in for a goal. However, uncertainty is more powerful in boosting motivation en-route to a goal.
So what does any of this have to do with change?
We so often want to drive change in ourselves or our organizations and think through the process of this – in a rational and systematic manner. I’ve worked with companies who are baffled that they don’t see a long-term increase in employee productivity and satisfaction after they increase their wage (Hedonic Treadmill Effect). I know people who have mapped out their exercise routine for the next day, only to hit the snooze button instead of getting up and going for their morning run (Hyperbolic Discounting).
Too often we try to implement a change program based on a belief that we are rational beings.
Behavioral economics highlights that this just isn’t the case.
For the past two years, in addition to my regular day job, I’ve been researching what it takes for people to make meaningful and purposeful change.
It has been fascinating.
I’ve talked with a number of people about their change journeys. I’ve read countless books and journal articles on change. I’ve been introduced to a number of new insights from neuroscience, motivational theory, behavioral economics and habit formation that, when brought together, can have a huge impact on how people can effectively change. I have identified what I think are six major components that help drive successful change.
I’ve lived this, breathed it, and dreamed it…
I’ve not been able to keep my own change habits going.
At the beginning of the year I had set out to write five pages a week on change (not quite a New Years resolution, but very close). I thought that would be a manageable goal and one that would allow me have enough material for a book on change by the end of the year.
Five pages a week isn’t even a page a day – how hard could that be?
There was a recent blog from HRZone UK that claimed, “Blog: Most employers spend more on office cleaning than staff motivation.” I cannot vouch for the accuracy of this statement or info in the article.
That being said, accuracy is not the point. The point is, you get what you pay for – right? So what is it that your organization is paying for?
How is your company spending its money? Is it on it’s people or on systems? Is it on sales or is it on customer support? R&D or discounts to suppliers? The money often points to where the focus is for your company?
Two things that I often do when working with companies trying to improve their employee motivation is 1) interview key leaders to understand what the key drivers of the businessare and 2) conduct a total rewards audit. I use step one of this process to get at the underlying drivers of the business. This often isn’t the first thing that comes out of leaders mouths. In fact, it usually requires me to probe with them to really get at the root cause. This understanding of the key drivers is vital to being able to motivate the appropriate behaviors and performance. What we find in step two of this process is that the company’s Total Rewards are NOT in alignment with the key drivers. In other words, companies are often spending their money on things that are not key to driving their success (similar to the clean office analogy in the HR Zone article).
This is not a good way to spend money.
Hopefully your company isn’t doing this. But a simple way of finding out is to look at where you are spending money and then seeing if that aligns with the key drivers of the business. If it aligns, you are doing well, if not, you have a problem.
The following is the final blog of 3 posts from our guest blogger Paul Schoening, President of Plan C. He is bringing a unique perspective on what it takes for a small business to survive. In his first two posts (here and here) he talked about the difficulty of starting a business based on passion and how that passion is both good and bad. He discussed how entrepreneurs need to look at building a sustainability plan and not a business plan. In this blog are his final two tips. Let us know what you think. Enjoy!
4. Continually learn: I’ve mentioned education already but I need to stress how it’s important to stay ahead of the competition. To do that, you need to carve out time to learn. It doesn’t matter how you learn, but you must be constantly learning. I’m not saying that you need to take classes – but you do need to keep up on things.
Read, attend conferences, sit through webinars, go to the library (I know – old fashioned but it works), find a mentor, network and learn more about your business than you think you will ever use. Using the internet to learn is easier than ever – enter a topic in google and you have thousands of links to explore. Subscribe to websites that help you learn and stay up on leading thought in your industry. University sites offer a lot of free classes via the web (see here). Apple even has iTunesU that you can get on your iPhone or iPad and learn while you are on the go.
When you are starting a business, finding time to learn can feel like you are taking away from other important aspects of the business – but it is key to long term survival. You’ll need to prioritize your time and make critical choices which will allow you to learn and grown your business at the same time…including how to more efficiently sweep the floors! Engaging your new employees through continuous learning is also a key factor in retaining the talent you need to succeed. Rick Osborn, president of the Association for Continuing Higher Education says, that’s a mistake.
“It doesn’t make sense,” said Osborn. I understand that when businesses are looking to make cuts, these are the kinds of programs that are the first to go. In the short term, those kinds of cuts might work for a business. But, in the long run, you’re going to have to restore the cuts.”
Businesses that offer professional development often have a strong track record for employee retention. In fact, employees cite continuing education programs as the No. 2 reason they stay in their jobs, said Susan Porter Robinson of the Washington, D.C.-based American Council on Education.
5. Connect, connect, and connect some more: Get connected with people in your industry, other small business people, and anybody else that could potentially be of benefit to your business. Do this so you can understand the challenges, opportunities and resources available to be successful. Research by the IBM T. J. Watson Research Center indicated that the effects of networking and connecting with other people have a long term positive impact. The research found that 9-months after a networking “mixer” event, participants rated the top five benefits as
Being networked professionally
Feeling energized by the interaction
Gained a business insight
Established a collaboration opportunity and
Had found professional inspiration
Source: Enhanced Professional Networking and its Impact on Personal Development and Business Success, 2006
While every social engagement is not a sales call, it can be a potential opportunity to talk about your business and what you do. Join Linked-In groups, start a channel on You-Tube, expand your twitter accounts. Utilize your network of friends, family and acquaintances. Make the effort. You never know where the next sale is going to come from. Don’t leave anything on the table, this is your livelihood!
Let us know what you think – leave a comment below. Join in the discussion!
The following is the second of 3 posts from our guest blogger Paul Schoening, President of Plan C. He is bringing a unique perspective on what it takes for a small business to survive. In his first post (here) he talked about the difficulty of starting a business based on passion and how that passion is both good and bad. He discussed how entrepreneurs need to look at building a sustainability plan and not a business plan. In this blog are his next two tips. Over the next few weeks, the final post will outline the final two survival tips. Enjoy!
2. Show me the money: When starting a new business, oftentimes entrepreneurs focus on sales revenue or profit figures to assess how they are doing. I know I did. In fact, we had record sales in our final quarter as a business and yet we couldn’t make it last.
While it is good to be profitable and increase sales – it is absolutely critical to have a positive cash flow! You need to have enough cash flow to give yourself time to get off the ground and pay your ongoing bills. Fast growth and increased sales are great, but this can create a sense of overconfidence that can skew your decision-making especially with early business success. Conversely, when times are challenging and a business owner is under pressure we can easily make rash decisions fueled by emotion, not logic (i.e., “how the hell am I going to pay for this?”).
One example of cash flow issues was custom cabinet seller M&J Kitchens – who had survived the Great Recession even when its revenue from homeowners and builders dropped by more than half in 2009. They weathered the storm. Then, late in 2011, with sales almost 42 percent higher than the prior year, they were unable to pay their bills and owner Drew Davies was forced to shut the 26-year-old company down. What happened? M&J highlights how important cash flow is. The issue was a “cash-flow crisis precipitated by his bank and trading partners, who Davies says, abandoned payment agreements that had been in place for decades.” M&J’s cash inflows were coming in slower and it’s payments still needed to be made. In this instance “M&J had to float their customers—builders, architects, and home remodelers—who had slowed their payments, typically from 30 days to 60 or 90. At the same time, his own suppliers changed agreements that had been in place for decades by cutting credit lines or requiring deposits, which Davies says could tie up between $60,000 and $120,000 per month.” After more than 25 years of business, the company was forced out of business, not because sales were down, but because it couldn’t cover its cash flow.
Source: Businessweek.com February, 2011
What happened to M&J is not atypical. It can happen to all of us. Which is why we need to have cash flow plan. One way of looking at this to think about how much cash is required to make payroll, pay suppliers, and cover other expenses each month – then figure how many months of cash reserve you will need to have if things don’t go smoothly. In my case with the bike business, I usually looked out 3 to 4 months. I should have been looking out 6 to 9 months. Each business is different – so think hard about what a downturn or change in situation would mean to you. How fast do your customers pay? How long can you push out your own payments.
One way to avoid these mistakes is by finding a great accountant or financial consultant and using them to map out a plan for this. Look at ways you can collect money faster by offering discounts for payments early or requiring a deposit. See how you can restructure payments on goods and services that you use. Look at payroll differently – offset high bi-weekly pay by using quarterly or annual bonuses that provide flexibility for you and rewards your employees for great work. If you can’t afford to hire an accountant full-time, there are many firms that you can outsource part of the accounting of the business to or hire in for consulting. The voice of reality (a shrewd accountant) will keep you in check.
3. Double the time you think it will take: Time is a resource that is often underestimated when starting a new adventure. In the passion of developing out this great new idea, we forget about how long things can take. Particularly the little things. You can celebrate that you are the President or CEO of your business and be very happy to have the title. But you are also the janitor, the sales person, marketer and customer service rep. You need time to handle all of these responsibilities, take time to do research and to ensure that you are continuing your education and staying on top of the latest trends and facets of the marketplace.
Here are a few examples of some rough time estimates that an entrepreneurial friend put together for me for some of the things that he does that are not part of his core business.
Accounts payable: 2 hours per week
Accounts receivable: 1 hour per week
Payroll: 1 hour per week
Social Media Outreach: 3 hours per week
Developing marketing campaign: 2 hours per week (varies, but this is an average)
HR: 1 hour a week (up to 8 hours a week when issues arise with employees or when hiring)
Scheduling: 1 hour per week
Responding to sales requests: 1 hour per week
Networking: 2-4 hours per week
Miscellaneous (IT trouble shooting, equipment purchase/repair, responding to solicitations, etc..): 2 hours per week
This totals up to over a day and a half out of the week for work doesn’t even include business development, sales, or anything that has to do with the work that drives value for his customers (granted, he could probably reduce his Social Media Outreach – I mean really, 3 hours on Twitter, Linked-In and Facebook?).
One way to overcome this time crunch is to look at outsourcing some of the functions of your business so you can focus on the areas of which you have immediate control and greatest value-add. This might require you to increase your outflow of cash (which can be troublesome – see #2) but if it can allow you the time to focus on the important things for success, then it is worth it. Another option is to think outside of the “box” and look at creating partnerships and alliance where you can trade services or leverage each others core competencies.
My 5-year old son is starting to become afraid of “monsters” in our house. This has not been a problem until just a few days ago – but now he is reluctant to go anywhere in the house alone. It culminated last night, when he wanted a specific book read to him before going to bed. That book was located in our 3rd floor attic bedroom. We were on the 2nd floor when the 5-year old requested this book.
“Ok. Go get it and I’ll read it to you” I said.
“I can’t” he said very quickly.
“Why not? Do your legs not work?” I asked teasingly.
“I’m scared – I don’t like being alone” he replied seriously.
“But I’m right here and you just have to go up the stairs that are right over there” I said pointing to the stairs just 20 feet away.
“Can you come with me?”
“No – I’m right here and you’ll be fine.”
“But I need you to come with me.”
After 10-minutes of this back and forth conversation that included discussions on what type of monster it was, the fact that monsters were imaginary, and the fact that he would be no more than 50 feet away from me at any point in his under 60-second journey and within easy calling distance, he was still firmly planted on the couch not willing to go get the book by himself. I even tried my best motivation and psychology tactics to get him to go up by himself (incentives, peer pressure, challenge, etc..) – to no avail. Then he said this most insightful statement:
“Just because its imaginary doesn’t mean that I’m still not scared.”
Wow…that’s when it hit me, I wouldn’t be able to rationally talk him into going upstairs to get the book. No matter how many facts we agreed on. No matter how well reasoned my arguments were. No matter how simple the solution was. He was going to still be scared.
I needed to respond to him on an emotional level. I needed to make him “feel” safe. I needed to hold his hand or walk halfway up the attic stairs or go up first and clear the attic of any monsters before he was ever going to go up in the attic alone.
And sometimes we and our employees are the same way. We make up monsters.
We extrapolate all the bad things that could happen and they get blown out of proportion. We understand all the rational discourse on why the company needs to change, but in our guts we are scared by that. We get caught up in the emotion of how we feel about what somebody said to us and not about what they actually said or meant. We spin our wheels in the mud worrying about not getting a project done instead of just working on it.
And no matter how rationale the argument is against this imaginary thing – we are still scared. When people are scared – we don’t work well. We don’t go up the stairs to get the book. Instead we sit in our cubes and wait. We spread rumors and try to get others to believe in our imaginary monsters too. We worry and fret and stress.
We are emotional beings. Our imaginary fears and worries are not going to dissipate with rational discourse or well reasoned arguments or even facts. Sometimes the only way over it is to have someone figuratively hold our hand, or walk halfway up the stairs or go chase out all the monsters first.
Too often as leaders we miss this fact!
The Not So Shining Knight
As leaders we want to be the shining knight that comes in and vanquishes all the monsters. So what do we do – we focus on the facts. We layout well reasoned arguments. We rationally explain away all the potential downfalls.
Our communications highlight all the great benefits of the new program – but don’t address the emotional side of things. We discuss program rules and miss out on leading people through an example of what it is going to be like. We provide all the facts on a new change initiative but don’t go out and show them how we have to change as well.
We don’t bring in the human side of things.
We need to get better at holding hands. We need to work on our empathy. Communication, no matter how good, won’t solve all our problems. As leaders, we need to lead. We need to go up the stairs first. We need to put skin in the game. We need to feel the pain too.
We can’t always talk people out of being scared – even when they are scared about imaginary monsters. As a leader it is not about being right or getting the facts straight. It is about emphasizing with what your team is going through and being there for them. It means that we have to start thinking and acting with our more with our heart and less with our head.
That’s what makes great leaders.
Let us know what type of imaginary monsters you face…leave a comment.
Here is a little bit of psychology that most of us know intuitively. People hate vacuums. No not the kind that you use for cleaning your carpets…the kind that exist when there is an information void.
Our brains work overtime to fill in any vacuums that they encounter.
This is a good thing mostly since it has helped us survive, such as when one of our ancestors filled in this unknown, “hmmm….I’m not sure what the growling noise is, but I bet it’s not good so I better run.”
We fill in these blanks all the time – often at a subconscious level. In the 1930’s, Gestalt psychologist conducted a number of experiments that focused perception and filling in missing information. They named this phenomena “the law of closure” famously demonstrated by the Kanizsa Triangle where there are no triangles or circles in the image – yet that is what we see.
While filling in missing information has often helped us, it can also be very detrimental. Take for instance what would occur if your company made a statement to employees such as “we are going through some difficult times and some changes will be announced next week.”
Not knowing what those “changes” are, people will automatically tend to fill in the blank…and what do you think they will fill it in with? Positive thoughts on the future…probably not.
In fact, we can pretty much guarantee that different people will interpret this differently. Some positive, some negative, and others not even registering on their radar. Psychology shows us that ambiguous stimulus will most likely be translated into multiple perceptions by different people – based on their current emotions, past experience, personality make-up, and a variety of other factors.
People will also fill in the blanks based on information they can gather – thus, the “changes” are associated with “difficult times” so the conclusions they will draw will probably be focused on what they have seen or been part of with other changes in difficult times.
But what a company wants is to make sure that a large proportion of people are not filling in the information with negative or wrong information. For instance, the above statement probably would cause a number of people to go back and start talking about the “layoffs” that will probably occur next week – even though nothing of the sort was said.
So what does one do?
While we can never fully make sure that everything is 100% clear and absolutely understood – we can do things to mitigate the negative aspects of this:
1. Eliminate as much ambiguous information as possible – be as clear and complete as you can in both verbal and written communication
Dan Airely, Richard Thaley, Cass Sunstein, Daniel Kahneman, Ran Kivitz, and many more psychology and behavioral economics researchers have shown that while we like to think of ourselves as rational, thinking human beings who are out to optimize our well being, we aren’t.
In fact, we are very far from it.
Sharon Begley at Newsweek wrote this interesting blog “The Limits of Reason” in it, she states, “But as psychologists have been documenting since the 1960s, humans are really, really bad at reasoning. It’s not just that we follow our emotions so often, in contexts from voting to ethics. No, even when we intend to deploy the full force of our rational faculties, we are often as ineffectual as eunuchs at an orgy.”
We see this all the time. I wrote about it in my earlier post from today “5 Lessons from the Maze.” We tend to act and behave in very non-rational ways. There are lots of irrational types of behavior and thinking and lots of theory’s about them (i.e., Loss Aversion, Status Quo Bias, Gambler’s Fallacy, Hedonistic Bias, Anchoring, Reciprocity, Inequity Aversion, etc…).
Here is what is interesting – we tend to still design our incentive programs and our motivational strategies based on believing that people act in a rational manner. We create programs that have 10 different ways to earn, with multipliers, qualifiers, and ratchet effects. We create programs with multiple components and factors that we think will drive specific behaviors and elicit particular performance results. We believe we know what people want and use only extrinsic rewards to drive our results.
This is a true story of what happened to me and one client.
It began in August. I was contracted to conduct an analysis for a company that will remain unnamed. The analysis looked at some specific aspects around a new product launch and involved interviewing a number of executives and sales people from across the organization. In all I did over 40 hours of interviews. I spent twice that amount of time analyzing the interview responses, finding patterns and insights that applied to their specific situation, assessing linkages and developing insights.
I created a comprehensive report that included an executive summary, detailed findings, recommendations for success, and a large section with selected verbatim comments from the interviews.
I thought it was pretty good. We uncovered a lot of useful information regarding the launch process, the sales force readiness, and the work that needed to happen leading up to the launch that could really help the company be more successful. We had taken the pulse of the organization and reported it back in a clear and informative manner.
I’m not just tooting my own horn – the client was very pleased with the content and the findings also. No really he was. In fact, he stated in an e-mail, “I’m very happy with the content and findings and I’m glad I used your services…”
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