The CEO Game

Oh, Black Friday. The notorious day of sweat, tears, and unfortunately, blood. In order to get the fabled rock-bottom prices that are available in stores in the wee hours of the morning the Friday after Thanksgiving, shoppers have camped outside, gotten into fistfights and last year, in Long Island, an unfortunate security guards was trampled to death by a mob. But this article is not about the horror that his behavior reveals about today’s American culture. This article is about whether there is any point at all to participated in Black Friday, to the truly shopping-savvy.

Black Friday.

The answer seems to be more. More and more retailers are offering deals before and after Black Friday, and an increasing number are offering online deals. Traditionally, lower-market retailers have participated in Black Friday, selling older products that they would have to mark the prices down on anyway. But now higher-end retailers like Saks, Barneys, and Nordstrom had started their online sales the Wednesday before Thanksgiving, thus avoiding seeming low-brow while still being able to appeal to customers who, especially in these economic times, are always looking for a deal. And now Cyber Monday has begun to take hold. Based on the idea that people go back to work on Monday and therefore obviously begin shopping online, many retailers offer great deals online after Black Friday. Heck, JC Penny and Staples begin their Cyber Monday deals on Sunday!

So what is the point of this article? The first, most obvious point is that you and your spiked shoes should have stayed home this Friday. But the more important point is that everyone should take note that the world is changing. Traditional business models become obsolete with new technologies, and both producers and consumers who pick up on these changes will benefit. In-store shopping is not only less and less reasonable on Black Friday — any day of the week, convenient websites, sometimes even with free shipping (and free return shipping) make the hassle of wandering through the zoo that is IKEA or Victoria’s Secret less and less appealing. New interactive tools available while e-shopping, including recommendation agents and comparison matrices, simply cannot be matched in person. Businesses are now learning how to become what is called “brick-and-click”, existing both in real life and online. In tough economic times, the ability to become this type of amphibian, I believe, will determine the survival of the retailers.

Tamar

The CEO Game.

A field that is closely related to behavioral economics and aiding its development is Neuroeconomics. Neuroeconomics uses the insights and methodologies of neuroscience, the study of the brain, in order to deepen our understanding of economics. Neuroscience has both been able to augment some of the traditional assumptions of classical economics (termed the “incremental approach”) and to force economics to completely rethink classical economic constructs (termed the “radical approach”). Classical economics evolved based on a system of revealed preferences — the idea that people’s preferences can indicated correctly through their actions, such as through their purchases. Now that a neuroscience technique allows measurement of actual thoughts and feelings, the link between feelings and actions is being broken down.

Understanding The Brain.

What neuroscience doing, perhaps most importantly, is illuminating the difference between controlled and automatic responses and between the affective and cognitive systems. Classical economics mostly deals with controlled responses and the cognitive system. It presumes that people always can and do fully take the time to weigh all of their options, think of all of the ramifications, and pick the option that maximizes their utility. Some responses, however, are automatic. People have little control over these processes and even very little introspective access. Therefore, the usual utility-maximizing behavior cannot apply. Furthermore, some responses, whether or not there are automatic, are drive by the affective system. This includes not only emotions, but also drives, such as arousal, pain, and craving.

What tools does Neuroeconomics employ? Firstly, Neuroeconomics employs neural imaging techniques, such as MRIs, PET scans, and EEGs. But the field has a number of other tools at its disposal, including single-neuron imaging (used only on animals, thus far), electrical brain stimulation (EBS), the examination of brain damage and its effect on humans, Transcranial magnetic stimulation (TMS), diffusion tensor imaging (DTI) and the monitoring of physiological indicators.

The use of neuroscience techniques to inform economics is Neuroeconomics. So what have these techniques told economists? Firstly, it challenges many of the basic constructs we now use, such as risk aversion and time preferences. For instance, classical economics assumes that people have consistent discount rates across different activities. However, neuroscience shows us that different parts of the brain are used when contemplating or doing different activities. Thus, the discounting involved overeating may be completely different than the discounting involved in properly storing your shoes. Secondly, brain scans suggest that people react similarly to the gain or loss of money as do the gain or loss of food. This implies that money itself has utility, as opposed to being an indirect measure of utility as something than can be used to obtain other things. Thirdly, the distinction in the brain between pleasure and motivation system shows that people do not always pursue the most that is that they want the most, which is a basic assumption of classical economic theory. This is just a sampling of the findings of neuroeconomics.

The implications of neuroeconomics are staggering. With the brain more accessible than ever before, assumptions that were made before economics could know how people thought have to be rethought. Though it is too early to tell exactly how and if economics will integrate this field, it is certainly promising to change the way many of us think.

Tamar.

The CEO Game.

Traditional microeconomics teaches us that we should make decisions on the margin. That is, we should ignore sunk costs. Sunk costs are costs we have already been incurred and cannot be recovered regardless of your next time. In order to optimize revenue, theory of the firm states that, in perfect competition, marginal revenue should be equal to marginal cost. That is, how much you earn for selling the last unit of a product should be how much it costs you to produce that product (in this perfect world, that would also be the price on every unit). This also applies for people and their utility. You should assess both costs and benefits on the margin, in the next time period, on the next purchase, without thinking of everything that came before.

Logic In, Emotions Out.

Most of us, of course, don’t do this. How many times have you sat through a movie you hated because you paid for the ticket already? How many times have you waited for the subway an extra 20 minutes instead of just walking because you have already waited for 20 minutes? And how many times you have eaten that last slice of pie even though you were really incredibly full because you already heated up the whole thing and you didn’t want to throw it away? Enough times, I am sure, that you are aware of the phenomenon of, at the end of the movie, wait, or pie, being incredibly bored, late, or nauseous, and wondering why you just did that.

The reason you just did whatever irrational behavior it was that I just described (or a host of others) is that, unfortunately, you’re human. And that, as always, is the lesson from behavioral economics. Humans aren’t irrational! So why treat them that way? Now we come back to our good friend prospect theory, which was mentioned in the first article I wrote about behavioral economics. In addition to valuable insights on reference points, prospect theory states that people are inherently loss averse. Not only that, but they did to weigh losses twice as heavily as gains — that is, a loss of $1 is twice as painful as a gain of $1. The combination of a non-neutral reference point and loss aversion is what leads to irrational behavior.

Once you have decided to see the movie, wait for the subway, or eat that piece of pie, your reference point account for your doing those things. That is your neutral position. Not achieving these goals is a loss. This sort of mental accounting, as it is called, commits you to decisions that are less than ideal.

A good businessman, either online in a serious game such as The CEO Game or in real life, doesn’t let a misplaced sense of regret and loss stop him from making proper economic decisions. Recognize when you’re including sunk costs in your decision-making and put an end to it. Live life on the edge, or margin. You’ll be happier, and wealthier, for it.

Tamar.

The CEO Game.