Did you know that an offer of low fees could actually result in a potential client turning down your services? That people are much more motivated by the prospect of losses than they are by the hope of gains? It may seem counterintuitive but, according to Jordan Birnbaum, vice president of ADP, they are the truths at the heart of behavioral economics.

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By: Bill Hayes, Pennsylvania CPA Journal Managing Editor

Podcast Transcript

What's the best way for a CPA firm to land new clients? Well, it seems like a simple equation. Tout your advantages over the competition and keep the pricing low. However, according to our guest Jordan Birnbaum, vice president for ADP, it may not be that simple due to the concept of behavioral economics.

I mentioned that you're a VP at ADP, but you have another role as well. You're also the chief behavioral economist. For the uninitiated among our audience here, what is behavioral economics?

[Birnbaum] Oh, so many fun ways to answer that question. I'll start with the shortest. Behavioral economics is the study of how people behave, and if you take that one step further, it's the study of how people make decisions. And then if you take that one step even further, it's the study of human irrationality, because when you study human decision-making, you are confronted with the reality that human beings are quite often very irrational, so long as rationality is being defined as making a decision that's in our own best interests.

One of the reasons that behavioral economics feels so new is because it contrasts in a very important way from classical economics, which is how most people grew up thinking about economics. So classical economics is essentially about making predictions, and economists will build models that they can input data and out will come these predictions. For example, if you know the supply of lumber and the demand for lumber, you can predict the price at which lumber will trade. But for those models to work, they have to make some very weighty assumptions, and one of those assumptions is that all people in a given market are perfectly rational actors, which if you take a moment to think about is, of course, hilarious.

So we find ourselves in a situation where, with classical economics, it's crucially important that we map out how self-interested people would make choices, and that we build models to understand what that framework looks like. But when it comes to describing how people actually are, it requires a great deal of nuance because it doesn't take a lot of work to figure out that people are incredibly capable of making decisions that we would otherwise classify as irrational.

So that's what behavioral economics is all about. It's about understanding what factors contribute to human decision-making, what kinds of things can lead us astray, and then finally, if we can understand that, how might we be able to use that knowledge to help people? How can we create interventions, often called nudges, to help people make better decisions in their own best interests?

Looking at your piece for AccountingWEB on this topic, a bunch of lines jumped out, and one such line was, and I quote, "Your prospects will likely be more motivated to avoid losses than to secure gains." Can you explain a bit about the topic of loss aversion and why it's important in these circumstances?

[Birnbaum] I can, and it's actually, just by way of providing an example of what we mean by human irrationality, it's the perfect thing to explore. So for what it's worth, the idea of loss aversion emerges from something that I think a lot of people have heard of but aren't exactly sure what it is, and what I'm talking about is something called prospect theory, and it was created and put out in the late 1970s by two celebrities in my world, Amos Tversky and Daniel Kahneman. In prospect theory, they were essentially taking a look at how human attitudes toward risk would change given various circumstances such as being up or down. If you think about it through the perspective of poker, if you're having a good night or a bad night, how might that affect your decision-making in the moment? In many ways, this was the birth of behavioral economics because we were no longer going to assume that people were going to behave rationally and start looking for evidence of that irrationality.

But what emerged from all these different studies was one tendency that seemed to hold constant in just about every place that they looked. And what they uncovered was this idea of loss aversion. So generally speaking, human beings are twice as motivated to avoid losses as we are to secure gains. Here's another way to think about that. Let's say you lost $50, and you experienced the pain of that loss, and you said to yourself, "Well, I want to have the same intensity experience, but in the opposite direction." You'd think that you would then need to go out and find $50 to get that same boost, but you wouldn't. You would actually have to gain $100 for it to equal the power of the emotion of the $50 loss. So losses hit us twice as hard as wins or gains do.

And you know, just anecdotally, I know in my life, anytime I've ever heard an athlete or a coach interviewed and asked, "What's bigger? Your desire to win or your hatred of losing?" I think it's 100% they've all said, "I hate losing more than I like winning."

So when I learned of this, that's the first thing I thought of, and you can really ... by the way, this is a really interesting dinner time conversation. Talk about loss aversion over dinner. You'll be amazed at where the conversation goes. But if you take a step back for a moment and you think about human evolution and how risk played a role in our lives back when we were living in caves, you can actually start to intuitively understand how those people who were less inclined to take risks were more likely to survive and thrive as a result. So you may find the origin of this in something that is just fundamental to the human evolution in history, but the relevance of it today can be found and applied in all sorts of ways.

I'll give this one example. It's my go-to example, just because I think it surprises people how far afield something like loss aversion can be relevant. What I talk about is, I work a lot in leadership development, and when you're trying to get leaders to improve, the hardest part and the first thing that you have to do is to get them to care, to get them to want to get better. I could say to a leader, "Think of all the career advancements and promotions that you stand to gain by improving as a leader." Or I could say, "Think about all the career advancements and promotions that you stand to lose by not improving as a leader." And that second statement is twice as motivating to people, just by changing two little words. By understanding how the prospects of wins and losses affect human motivation, without assuming that it will be rational, we can uncover this insight into human behavior and then start using it for good.

We talked a little bit earlier about irrationality and how it's often common in people. So another line from the piece that you did for AccountingWEB, "Irrationality does not mean the same thing as unpredictability." What are some of the factors that make irrationality predictable?

[Birnbaum] One of the reasons that I have lots of confidence in the future of behavioral economics is that the answer to that question is “Infinity.” We will never run out of factors that can influence behavior. Just to give you a sense, I'm trying to think of a broad sampling. What are other people doing around you in the moment? That will have a huge impact on your decision-making. How much sleep did you get last night? What kind of weather is it outside today? How hungry are you, and what did you have for your last meal? What kind of childhood did you have? How tall are you? The number of factors that are all combining in any given moment to influence how we're perceiving the world and the choices that we make are literally infinite. It's uncountable, but it does encompass certainly what's happening around you in the moment. Physical factors, contextual factors. Are you under pressure? Are you relaxed? Are you laughing? Are you neutral? There is just too much to be able to account for in any given situation.

However, we do know that there are certain environmental or contextual trends that emerge in human behavior and tendencies, and what's happening is that the field is getting quite good at identifying what these things are, these certain biases or heuristics, which I'll explain what those are in a moment.

Then being able to create experiments that induce them to prove their existence. Once they're able to do that and then they put it out into the literature, the entire community learns about these new biases, heuristics, techniques, what have you, and start experimenting with them, and oftentimes that work will happen in a sort of academic environment. There are a lot of great nonprofits that work on the application of behavioral economics towards public health, public safety issues, but more and more private industry is now using this as well to take on challenges like, "How do we keep our employee base engaged? How do we keep our clients feeling a greater sense of brand loyalty?" So there's really no end to where the application of behavioral economics will go because every time we get a new insight into a factor that is shaping motivation and shaping decision-making in an irrational way, we can then start to account for it, predict it, and then stage or create an intervention to help people overcome it.

When pitching prospective clients, a practitioner might think the best thing for them to do is go in the room and you give them the lowest price, right? That's a very sort of common way to think, but that might actually not be the best approach. Why is that, according to behavioral economics?

[Birnbaum] So the first answer is, not only might you be costing yourself money, but you might even be costing yourself the sale. Because certainly, yes, a rational consumer is always going to go for the lowest price, but as we have just identified, rationality is not actually what's driving all of our decisions, and perhaps not even most of our decisions.

With pricing, when you come in at a low price, what you might be communicating is that your service, the quality of your service, is not that strong. So if you go in right away assuming that price is the place for you to move to try to lock down a deal, you actually might be making a deal less likely by signaling desperation, by signaling that you're not sufficiently valuing the worth of what you can contribute. So what I would say is that I think that there needs to be both an analysis of sort of who you are in the market, what kinds of services you're providing, and what would be pricing that would be consistent with that perception, and then the other is to really try to understand your client and what matters to your client, and what might be getting in the way of them taking a next step with you, and trying very hard to identify what that thing is instead of assuming that price is the way to solve the problem.

A lot of practitioners, a lot of people, that are listening to this, they probably don't have a behavioral economist on staff, and maybe not have the resources to procure one. Are there resources that they can leverage to learn more about this topic and put the information to use?

Oh, yes. I have really good news on this topic, too. Not only are there resources, they're fun. Part of what I think is making behavioral economics explode like it is, is that it doesn't necessarily feel like work when you're learning about it. There are a few books that are classics in our field that I would recommend, and then there are a couple of hubs to go to for ongoing articles and the like, but certainly I think that if you're starting with an introduction to behavioral economics, you have to start with the book Nudge. It's written by Richard Thaler and Cass Sunstein. Thaler won the Nobel Prize a few years ago. It's fabulous. It is an incredible book, and not only does it describe behavioral economics, but I think it really triggers the imagination on how you can use this stuff, and it feels like a playbook for how to think about creating nudges in any environment and how to understand what levers you can pull and what best practices that you can put into place to try to take something that is virtually free, and can have groundbreaking transformative results.

I want to give, actually, before I continue telling more of the resources, there's one last story that I'm going to fill you in with because I'll feel guilty if I don't get this out there so people can understand the scope of what's possible for us. We're going to take a very quick look, and this, by the way, I learned from Nudge. We're going to take a very quick look at organ donation in Germany and Austria, and the reason this is a good thing to do is because Germany and Austria have very similar cultures, so it would be surprising to learn that they have wildly divergent attitudes about something like organ donation.

But they do one thing very differently. In Germany, they have an opt-in process in order to become an organ donor. If you go to their version of the DMV or you try to apply online, whatever it might be, you'll come up to a section on the form and it will say, "Check this box if you want to become an organ donor." And if you don't check the box, if you do nothing, you are not an organ donor. So in Germany, organ donation rates are, I believe, around 12%. Austria does the exact opposite. In Austria, you go to the DMV or to register and you get to a section and it says, "Check this box if you do not want to become an organ donor." So now if you do nothing, you're an organ donor. Any guesses for the organ donation rate in Austria?

I'm going to say it's higher.

[Birnbaum] 99% of Austrians are organ donors.

They just don't want to check that box.

[Birnbaum] But that's the point, is that it's not a conscious decision about checking the box.

Absolutely.

[Birnbaum] It's that something that small can be the difference between 12% and 99%, because we're not rational decision makers. So when I talk about having the motivation to try to employ this stuff, those are the kinds of results that a book like Nudge will teach you are very available to you with a little bit of creative thought and some experimentation.

After Nudge, two more books that I would say are classics, one is called Influence by Robert Cialdini, and this is looking at six principles that tend to have outsized influence on human decision-making. This is really fun. I would say that this should be a must-read for all sales and marketers. And what also is great about this book is that it is a foundation of behavioral economics, and yet it came out probably 25 years before the term behavioral economics even existed.

Then a third, and just because we've been borrowing his words in this call, Dan Ariely wrote a book called Predictably Irrational, which couldn't be better considering the words of your question, and what he's talking about are, "What are the factors that systematically produce irrationality? That we can know that in all likelihood, unaided, a human being is going to make an irrational decision in this particular instance? What can we do to help?"

I would say that if you read those three books, you would have a strong understanding of what the field is, how it works, and how to think about it, and then after that there are so many great blogs coming up virtually every day. Three associations I can tell you about I think are terrific. One is ideas42, and they have a newsletter. Another is The Decision Lab. They are in Toronto and they also have a terrific newsletter. And then lastly, there's the Behavioral Science & Policy Association, or BSPA. Those are three resources that you can go to to stay up to date on what's happening and learn about current trends, but really just Googling behavioral economics will send you down a wonderfully enriching path that really will never end, so long as human beings are involved.

Since you threw out the Germany-Austria story, I figured I'd throw something out that just came to me as we were talking here that might be an example of behavioral economics on a small scale. When I'm looking to buy sneakers, let's say, whenever I go on and I'm looking for them, if I see a pair that's $29.99 or something like that, and one that's $39.99, one that's $49.99, I never end up going for the $29.99 because I always figured it might be cheaper or not well made. I guess that's sort of a small scale example of what we're talking about here.

[Birnbaum] Oh, that is unquestionably an example. In fact, I think there's a chapter in Ariely's book about exactly that. I will tell you that most restaurants at this point have had a behavioral designer look at their menus, and when you go to your next restaurant, if you scan, in all likelihood, you will see one item that is substantially more expensive than anything else on the menu, and the reason that item is there is not to make you order it. It's to make you order the second most expensive item on the menu because comparatively it looks like a better deal, and that's exactly what you just explained.

Whether it's through behavioral economics or other means, how important is it for a CPA firm's growth strategy at this point to be data-driven in general?

It's so funny. I think it's such a great question around behavioral economics, in part because it validates the importance of data on two sides, right? So all of behavioral economics is teaching us that we're silly to trust ourselves implicitly and explicitly. We don't have an unfiltered, objective view of the world, and we will make biased decisions. So data is one of the primary tools that we have to protect us against that, and so the very existence of behavioral economics validates the crucial importance of data, because it tells us, "Do not trust your gut. In fact, it's full of crap." That it's appealing to think that you can trust your intuition because it's easy and it requires very little work, and we all inherently like that, and so we feel a tremendous urge to go with our gut. But our gut is actually not nearly as accurate as we like to think.

When we are evaluating our own intuition, we will only think of the instances that we got right, and we will forget all of the instances that we got wrong. So we'll feel like it's trustworthy, but I promise it isn't. There have been brilliant social scientists for over 100 years documenting evidence that it isn't. If nothing else, the fact that our field exists means data is everything.

Then on the flip side, the other wonderful thing about behavioral economics is that you can't do it without data. Everything in behavioral economics has to be validated a million times over from the strictest statistical approaches to make sure that what we're talking about is real. You can't get away with fluff in the behavioral economics community. I would say both in its existence and in its practice, the crucial importance of data cannot be overstated, and so with regard to the accounting profession, I realize that people have been talking about this need to transform for a really long time, and it feels like it's just as relevant today, and yet it still hasn't happened yet. But I also suspect that people don't believe that smoking will kill them because it never has before, so it's going to have to be some kind of balance between not overreacting to the boy who cried wolf, but also realizing that it's not real until it is.

Toward that end, what I would say is that it would seem to me that data and skills with big data are a really natural evolutionary point for the accounting profession, and that if machines are going to be able to start doing the execution that humans currently do, then what the humans can do is start thinking of new ways to leverage the machines for new kinds of insights. So in that regard as well, I think that data to support decision-making, but also data as an end unto itself, is incredibly relevant to the accounting profession.