Behavioral economics is the science of "nudging" communities to make rational choices in their own best interest. Discover how you can harness this methodology for business transformation.
Behavioral economics is a methodology that leverages the study of human behavior in order to better predict and influence the outcomes of transformation within an economic system. In microcosm, this supports business transformation by empowering change management.
Understanding how your employees will respond to change allows you to frame your business transformation in a way that they will support. Let's explore behavioral economics and how it applies to business transformation.
To find out more about how SAP LeanIX supports change management in business transformation, read our white paper:
WHITE PAPER: Insight, Communication, Engagement - How EA Supports Change Management
What Is Behavioral Economics?
Behavioral economics is a scientific framework designed to encourage large communities to make the right decisions to promote the wellbeing of the group. It normally applies to consumers within an economy, but it's easy to see how this methodology can be applied to the operations of your organization.
Behavioral economics was first developed by economist Richard Thaler in the 2000s. Thaler hoped to use prospect theory, developed by Daniel Kahneman and Amos Tversky, to enhance traditional economics.
Economic analysis of consumer behavior was historically based on the idea that people make rational decisions in their own self-interest. Yet, prospect theory shows us that people do not act rationally.
Kahneman and Tversky considered people's choice in two situations:
- when offered the choice between 100% chance to win $450 or a 50% to win $1,000
- when offered the choice between 100% chance to lose $500 or a 50% to lose $1,100
In situation 1, people tended to choose the safe option of winning $450. In situation 2, they preferred to take the 50% chance of losing nothing.
In terms of probability, the two situations above are identical and someone acting rationally would make the same choice in each. Yet, our perceptions of the situations lead us to make irrational choices.
Thaler hoped to use Kahneman and Tversky's work on understanding why people make imperfect choices to create a better framework for predicting and guiding consumer behavior. Thus, behavioral economics was born.
The methodology is based on providing "nudges" to consumers to use their perceptions to persuade them to make the right decisions. By ensuring correct choices require the least effort to make, Thaler theorized that people will be more likely to act as positive forces in the system.
An example might be to nudge consumers to pay for items with a debit card by offering interest-free overdrafts or cashback schemes. This will make people less likely to get themselves into credit card debt.
Likewise, a government may nudge consumers by reducing taxes on contributions to pension funds. By making it more expensive to not pay into a pension, fewer people will find themselves without support when they reach retirement age.
Leveraging Behavioral Economics In Your Organization
Behavioral economics is, of course, aimed at the wider economy, rather than enterprise. Taking its principles into account, however, you can help gain support for a business transformation from your stakeholders.
Say you want your employees to use a new software application, rather than a legacy tool that they're used to. If you remotely install the new application on their devices and put a link to it on their desktop, they're much more likely to start using it than if you ask them to download and install the application themselves.
Equally, if you want to nudge employees to change over to your new process, you could give them a document that covers hundreds of reasons why the change is a great idea, but few of them will take the time to read it. You're far more likely to persuade people by only showing the top three reasons why the change is necessary, even though this gives them less incentive.
By considering a range of concepts like these from behavioral economics, we can make our business transformation initiatives more likely to win over our stakeholders. These concepts include:
Bounded Rationality
Behavioral economics suggests that people have "limited cognitive ability". This isn't an insult, but simply the fact that people aren't always able to understand what the best course of action is, so it's important for us to show our employees why following our procedures benefits them.
Bounded Self-Interest
People may not always understand the best course of action, but they also aren't completely selfish. If we explain to our employees that following our process will benefit their colleagues throughout the company, they are more likely to see the value of it.
Bounded Willpower
People prefer short-term benefits over long-term ones. As such, it's important to highlight the immediate value of a business transformation, rather than just the eventual benefits.
Loss Aversion
Under prospect theory, as we explained above, people will generally prefer not to lose something more than they would like to gain something. Thus, showing the negative consequences of not completing a business transformation will likely be more persuasive than listing the benefits.
Sunk-Cost Fallacy
People will often continue to invest in a failing project to avoid having to admit that what they have invested so far has been wasted. As such, it can help a business transformation to take time to celebrate the achievements your organization made using a legacy system, before framing the new system as an evolution, rather than a new start.
Mental Accounting
If an item goes down in price, people are more likely to spend more on it, losing the benefit of the price reduction. If you make the necessary steps of a business transformation easy to complete, employees will be more likely to take the time to complete them, even if it's extra work.
How SAP LeanIX Supports Business Transformation
Behavioral economics is a vital part of change management that can enable your business transformations by winning stakeholder buy-in and collaboration. This is key for ensuring your transformation doesn't miss out the human element of your organization.
Managing a transformation and ensuring a clear overview of the project, and regular communication and engagement with your stakeholders, requires leveraging the right tool to handle all your information. SAP LeanIX is the meeting point between enterprise architecture and change management, and drives success in business transformation.
To find out more about how SAP LeanIX supports change management in business transformation, read our white paper:
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