The wealth of information within academia and doesn’t get used by business is amazing. I blame their naming. Academics have great information, but a terrible naming skills.
Take Hyperbolic Discounting (please!), a significant psychological concept that plays into many decisions we make, that we discussed on a recent podcast. You might think the term describes super-exaggerated markdowns, but it doesn’t.
Hyperbolic Discounting is what happens when we have the choice between a reward now and a reward later. It describes how we disregard the value of something when we have to wait for the benefits of it over time. In other words, we would rather have an immediate reward than one in the future, even if the future reward is higher than the one today. Moreover, Hyperbolic Discounting is why we expect a much higher reward when we have to wait for something.
For example, if I were to offer you the choice between giving you $100 now, or you could wait a week, and I would give you $100 then. Which of those two options would you want?
My guess is you want it now, and why wouldn’t you? Logic dictates that you could spend or invest it now. If you wait, there is no benefit. It’s still $100, but now you had to wait.
To make this a real choice, I would have to add a benefit to waiting a week, like a higher amount. That is the “discount” in the name, as in disregarding the value of $100 because you had to wait for it. This part of the term is not the problem; rationally speaking, there is a “right” answer. The benefit I add should be how much you could earn by investing that money in the week that I keep it. It would be a small amount of money.
Where Hyperbolic Discounting gets problematic is when you talk about the amount it would take to make you willing to wait a week for it. It would not be a small amount of money.
People end up wanting way more money than they rationally should for delaying a week. This part is the “hyperbolic” of Hyperbolic Discounting.
See what I mean about the name? I just explained it and I feel a little confused. But, I digress. For what it’s worth, academics chose the word hyperbolic because it describes the shape of the discounting curve. So, mapping this model mathematically, the line represents the amount of compensation you would require for me to keep the $100 for a week. Hyperbolic Discounting dictates that the line in the model would be at a steep angle.
Semantics aside, what Hyperbolic Discounting means is that we overvalue immediacy. We have an immediacy bias. We want it now, like a bunch of Veruca Salts, stamping our feet for our $100.
It’s funny how much of behavioral economics is rediscovering idioms. For example, you have likely heard the term, “A bird in the hand is worth two in the bush.” This phrase is the psychology behind hyperbolic discounting. We might even recognize that the two birds in the bush would be better to have. However, we don’t see how it would be that much better than the bird we have now.
The Marshmallow Experiment
You might have seen or heard of the famous set of 1960s-era experiments done in developmental psychology with children and marshmallows. Known as the “Marshmallow Test,” researchers at Stanford presented the child with a marshmallow and said, “You can eat this if you want to, but if you can wait to eat it until I get back, then I’ll give you two marshmallows.”
Here is a video that demonstrates how it worked:
To a child, the marshmallow is the monetary equivalent of the Hyperbolic Discount we feel about the $100. The researchers were asking children to put off the immediate reward to get a higher reward later. If you watched the video, then you see how the kids struggle with self-control, except for a couple, who unapologetically ate the first marshmallow.
Interestingly, follow-up research found that the “Marshmallow Test” predicted a lot of things later in life, like financial success and higher test scores for those children who were able to resist the temptation to eat the first marshmallow.
I struggle with weight loss. I know if I eat less and exercise more, I am going to be thinner and more fit tomorrow. However, this knowledge means little to me when I am holding a cookie in my hand. I choose the short-term reward of a tasty treat and give up the long-term reward of improved health.
Gambling is another example of how we participate in Hyperbolic Discounting. If you invest $100 in an investment vehicle that yields compound interest, in a few decades, it would be worth substantially more than if you bet it on a horse. Moreover, many investments of that $100 would also have a guaranteed return. However, sometimes we choose the immediate pleasure of a risky outcome where we’re almost certainly going to lose all of that money on a horse.
So What Does This Mean to You?
Understanding the irrational way that people discount things and how time plays into value will help you succeed with customer-driven growth. People value immediate gratification more than future benefits. If there is a delay, we demand a high relative return for that. Moreover, we have an over-inflated sense of what justifies our waiting for that gratification. It is a bias that we all have and something you should be aware of if you sell things to people.
The good news is we are all more or less on the same page with this one, so, unlike some psychological concepts, Hyperbolic Discounting is easier to anticipate. Anytime you incorporate time into the sales process, Hyperbolic Discounting makes people feel hesitant to buy. Motivating them to act will demand a significant return.
Also, you could make our love of immediacy work in your favor. For example, Amazon has a real advantage in the marketplace because they invested in the infrastructure to get orders out quickly. Now, it is difficult for many people, including me, to shop online anywhere else because I know I have to wait an extra few days to get what I want.
Also, you need to understand Hyperbolic Discounting and how to get around it if your product or service involves delayed gratification. Pensions, life insurance, financial products all struggle against Hyperbolic Discounting behavior from their customers. It might help to offer some immediate satisfaction for your customers at the beginning of the interaction. Also, focus on educating customers on the benefits of investing now for what they will get back later and how that looks will help them overcome their hesitancy to forgo immediate gratification.
Finally, there are always degrees in these types of concepts. All people might participate in Hyperbolic Discounting, but the dollar amounts or time investments will be different. Moreover, the levels of motivation might have to be different depending on who you are trying to motivate to act. When you make those offers, they need to be different for different groups of people. Therefore understanding your customers and grouping them by their behavior is essential to your success.
To hear more about The Secrets of Pricing in more detail, listen to the complete podcast here.
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Colin Shaw is the founder and CEO of Beyond Philosophy, one of the world’s leading Customer experience consultancy & training organizations. Colin is an international author of six bestselling books and an engaging keynote speaker.
Follow Colin Shaw on Twitter @ColinShaw_CX