• by Gord Hotchkiss , Featured Contributor, April 1, 2010

Last week, I talked about the work of Daniel Kahneman, Amos Tversky, Herbert Simon and George Akerlof, key figures in helping define the foundations of consumer behavior, both rational and irrational, that dictate the realities of the marketplace. Today, I want to talk about how these emotional and cognitive biases and limitations play out online, but first, a quick recap is in order:

Prospect Theory - The role of psychological framing and emotional biases in determining human behavior in risky economic decisions. For example, how we're more sensitive about loss than we are about gain.

Bounded Rationality - How we cannot endlessly consider all alternatives for the optimal behavior, but rather rely on "gut instincts" to help sort through the available alternatives.

Information Asymmetry - Why the marketplace has traditionally been unbalanced, with the seller almost always having more information about the product than the buyer.

This is Nothing New...

As I said last week, these are all hardwired human conditions that have been present for hundreds of generations, even though it's only been recently that we've learned enough about human behavior to recognize them. And it's these inherent tendencies that have changed the marketplace since the introduction of the Internet. The huge volume of information available online allowed us to shift the balance of the marketplace to be more equitably distributed between sellers and buyers. Let's explore how each of these occurrences drove the behavioral change, which was enabled, not caused, by the introduction of the Net.

We understand that risk is present in almost all consumer transactions. This fact brings Prospect Theory into the picture. We will unconsciously employ our emotional biases to deal with the risk inherent in each purchase: the greater the risk, the greater the degree of bias.

The Risk/Reward Balance

Consumer motivation relies on us mentally balancing risk and reward. The balance between these opposing forces will dictate how we deal with risk mitigation. If there is a high reward -- for example, buying our mid-life crisis sports car or taking our dream vacation -- our emotional biases will be tilted towards maximizing this reward. Consumer research is really more about wish fulfillment than it is about risk mitigation.

But if there is little or no reward, our research takes a much different path. Think about how we approach the purchase of life insurance, for example. There is no inherent reward here, just risk -- or rather, mitigation of risk. And insurance salespeople mercilessly exploit the emotional bias of loss by getting you to picture your family's future without you in it.

Informed Does Not Always Equal Rational

This risk/reward balance will dictate what our online research will look like. And this is where Akerlof's Information Asymmetry comes in. One of the ways we mitigate risk is by educating ourselves about our purchase. We look up consumer ratings, read reviews and pore over feature sheets.

Today, consumers are much more informed than they were a generation ago. But all that information does not necessarily mean we will make a more logical decision. We humans tend to look at information to support our emotional biases, rather than refute them. So, the balancing of information asymmetry is still done through the lens of our emotional and psychological frames, as shown by Kahneman and Tversky. We have access to information online, but each of us may walk away with different messages, depending on the lens we're seeing that information through.

All This Information, All These Choices...

And that, finally, brings us to Simon's concept of Bounded Rationality. We have more information than ever to sift through. As I said a few columns back, we can employ different strategies to make decisions. Some of us embrace bounded rationality, or satisficing, making us more decisive. It's important to note here that the fact we're trusting our gut to make these satisficing calls means that we may be trusting emotion rather than logic. Others try to optimize each decision, weighing all the variables. While this is perhaps a more rational approach, it can tax our cognitive limits, leading to frustration and often abandonment of the optimal path, resulting in a decision that ends up being a "gut" call anyway.

Our need to access information to mitigate risk has lead to the behavioral changes in consumer behavior. The Internet enabled this. It wasn't technology that changed our behavior; it was just that technology opened the door to allow us to pursue our hardwired tendencies.