How Retailers are Using Behavioral Economics to Understand Customer Behavior


With the advancement of technology, retailers now have access to in-store data that maps the movements and decision processes of customers, which helps retailers to increase sales and deliver superior customer experience. However, data by itself does not create any value for retailers. How retailers interpret the data is critical for generating actionable insights and improving their business. Viewing data through the lens of behavioral economics is a powerful means to understand customer behavior.

What is Behavioral Economics?

Classical economic theorists assume that individuals make decisions based on a rational thought process. However, retailers have long been aware that irrationality shapes customer behavior. A study by Gallup shows that emotions dominate economic decision making (70% emotional and 30% rational). Behavioral economics attempts to combine human nature and classical economics to understand how irrationality shapes customer behavior in a predictable direction.

Retailers should consider applying the following behavioral economics principles to understand better how their customers make purchasing decisions.

“FREE” is the Magic Word

The word “FREE” extraordinarily evokes positive feelings in customers, rendering them to behave differently from how perfectly rational customers will behave. Dan Ariely, professor of psychology and behavioral economics at Duke University, outlines in his book, Predictably Irrational, about “Hershey’s Kiss” experiment, which explains people’s favoritism towards “free” products. In the “Hershey’s Kiss” experiment, his research team sold a Lindt Truffle for 26 cents and a Hershey’s Kisses for 1 cent on campus. At this stage, a near equal number of participants bought each candy. However, when the price of each candy was reduced by 1 cent each, 90% of participants went for the free Hershey’s Kisses. According to traditional economics, reducing the price of two different products by the same amount should not have affected customer’s preferences, but the power of free caused customers to behave irrationally.

How does this principle play out in the real retail word? The phrases “Buy one, get one free” and “50% discount on two purchases of the same item” offer the same economic benefit to customers, but the latter just does not capture customers’ attention like the word “FREE” does. When retailers are planning to implement discounts and promotions, they should take into consideration how different phrasing appeals to customers.

More Options Do Not Mean More Sales

Many retailers believe that customers enjoy the situation in which they have many options to choose from. It turns out that reducing the number of choices available to customers may actually increase sales. In a study to prove this point, researchers observed two different groups of customers in a supermarket with bottles of jam on display: one group had six different options to choose from, and the other group had 24 different options. Although more customers stopped by when they saw 24 different bottles of jam, the number of customers that ended up purchasing was ten times less than the case of 6 bottles (3% vs. 30%).

Customers are often overwhelmed and encounter choice paralysis when they are bombarded with an excessive number of options. At the heart of this phenomenon is people’s inability to process too much information simultaneously. Even when they do make a choice, they are generally less satisfied with their selection because they tend to raise doubts about the decision they made in the process of comparing multiple options. To encourage purchases and increase customer satisfaction, retailers, therefore, must provide an optimal number of choices. Luckily, researchers have shown there is a magic number: 7 (+/- 2).

People Favor What They See, Hear, or Feel

Although customers may think they make informed purchases based on their needs, they are easily swayed by how retailers market and display their products. In one study, researchers approached customers planning to purchase laptops in an electronics store. To half of the customers, researchers asked about their memory needs. To the other half, researchers asked about their processor speed needs. Researchers ensured that the conversation with customers was not leading or steering in any way. Interestingly, results showed that the group that was asked about memory needs ended up buying laptops with larger memory. In contrast, the group that was asked about processer speeds purchased laptops with higher processor speeds.

This simple study showed how just getting the customers to think about a specific attribute affects their purchasing decision in favor of the attribute. Subtle cues in the shopping environment, such as pictures, texts, and sound, can subconsciously affect how customers respond to a marketing message. Retailers need to consider choice presentation or framing to incentivize customers to behave in a way that they would like them to.

The lesson that can be learned from these behavioral economics principles is simple:

In today’s’ competitive retail landscape, understanding why your customers behave in the way they do and leveraging the knowledge to nudge your customers into making choices that you want them to make is the key to survival.

Cyclops is a retail analytics system that can help retailers generate insights into how their customers shop inside their stores. To understand more about how Cyclops can help retailers digitally transform their stores amid the COVID-19 pandemic, visit our website: https://dayta.ai

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