Day: January 9, 2018

In 2017, Richard Thaler won the Nobel Prize in Economic Science, and it validated one of the areas that could benefit social game companies highly. Thaler is one of the leaders in Behavioral Economics, where Daniel Kahneman previously won a Nobel Prize and the field Dan Ariely popularized in books including Predictably Irrational. The underlying idea in Behavioral Economics is that people do not always act rationally but their irrationally is consistent and can be modeled.

In traditional economics, economists make simplifying assumptions, with one of the most common being that people are perfectly rational. This simplification allows economists to build powerful models to analyze a multitude of different economic issues and markets. Nevertheless, economists and psychologists have documented systematic deviations from the rational behavior assumed in standard economics. By incorporating new insights from human psychology into economic analysis, Thaler provided a valuable set of analytical and experimental tools for understanding and predicting human behavior.

Many of the concepts and findings that Thaler identified are particularly relevant for game companies, particularly free-to-play gaming, and the broader technology space. By reviewing his primary findings, you can make your products more appealing and successful.

Endowment effect

The endowment effect is how people value items they own more than they would if they objectively viewed the item. Somebody might not accept $10,000 for their used car, but if a car dealer offered the same car to them they would not pay $8,000 for it. This leads to sub-optimal solutions but is also a tool for keeping people engaged with your product, potentially by giving them something they may lose if they do not remain active.

Thaler also showed that the endowment effect implies a difference between out-of-pocket costs and opportunity costs. People tend to view out-of-pocket costs as losses, weighted more heavily, while opportunity costs are considered foregone gains, weighted less heavily.

Mental accounting

Mental accounting is a psychological theory of how limited cognition affects spending, saving, and other household behavior. One motivation driven by mental accounting is that people group their expenditures into different categories (housing, food, clothes, etc.), with each category corresponding to a separate mental account. Thaler found that mental accounts are used more generally as a way for rational individuals to simplify their financial decision-making. Each account has its own budget and its own separate reference point, which results in restricted movement between the accounts.

In addition, advance purchases (e.g., buying a billion chips) are typically thought of as investments rather than purchases. At the same time, consumption of a good purchased earlier and used as planned (using the chips you bought last week for a new virtual item when it is released) is often coded as “free,” or even as savings. Decoupling spending and consumption in this way reduces the pain of buying.

Mental accounting is potentially important in three ways to social game companies. First, players might group their purchases by different areas, they may be willing to spend X for chips and Y for new content. Second, customers may have a total budget for social gaming and your priority is getting a larger share of the pie rather than increasing the pie. Finally, by getting people to purchase a large amount at once and then use it over time, they are less likely to feel pain from their consumption.

Diminishing sensitivity

Thaler’s theory of diminishing sensitivity predicts that compound outcomes will be added together or separated before being evaluated. If customers try to edit outcomes to maximize their pleasure, they will try to segregate gains and integrate losses, to cancel small losses against larger gains, and (under some conditions) to segregate small gains (“silver linings”) from large losses. This is particularly relevant when structuring the pay-outs and volatility of social casino offierings.

Planner-doer model

In the planner-doer model, an individual is assumed to be both a narrow-minded doer, who evaluates options just for their current value, and a farsighted planner, who is concerned with lifetime utility. By appealing to both the planner and the doer, you can increase long term engagement of customers.

Social preferences

Perceived fairness is a strong determinant of behavior. People are more likely to accept a price increase if they feel the company needs to in order to remain profitable or to keep employees. People, however, feel it is unfair to increase prices due to rising demand. People who think they are being treated unfairly are likely to look for alternative products. This is particularly a problem in the digital world, where customers face different prices and AB tests and often consider it unfair that other players are getting a better value.

Further reading required

Since I have not earned a Nobel Prize (yet), I recommend you read Thaler’s work directly, including his book Nudge. There are many lessons that will make you both more effective individually and potentially make your products perform better.

Key takeaways

• Richard Thaler won the Nobel Prize for Economics last year, by showing that people do not always act rationally but their irrationally is consistent and can be modeled
• One of the key theories Thaler drove was the Endowment Effect, where people value goods they own more than the same good objectively.
• His insights into mental accounting are also quite useful, as Thaler demonstrates that people bucket goods into different categories and have budgets for each category. Related, they treat advance purchases differently, looking at consumption as consumption of a free good rather than spending money.