Noah Lim

Modeling the Psychology of Consumer and Firm Behavior with Behavioral Economics

Marketing is an applied science that tries to explain and influence how firms and consumers behave in markets. Marketing models are usually applications of standard economic theories, which rely on strong assumptions of rationality of consumers and firms. Behavioral economics explores the implications of the limits of rationality, with the goal of making economic theories more plausible by explaining and predicting behavior more accurately while maintaining formal power. This article reviews six behavioral economics models that are useful to marketing. Three models generalize standard preference structures to allow for sensitivity to reference points and loss aversion, social preferences toward outcomes of others, and preference for instant gratification. The other three models generalize the concept of game-theoretic equilibrium, allowing decision makers to make mistakes, encounter limits on the depth of strategic thinking, and equilibrate by learning from feedback. The authors also discuss a specific marketing application for each of these six models. The goal of this article is to encourage marketing researchers to apply these models. Doing so will raise technical challenges for modelers and will require thoughtful input from psychologists who study consumer behavior. Consequently, such models could create a common language both for modelers who prize formality and for psychologists who prize realism.

Designing Sales Contests: Does the Prize Structure Matter?

Sales contests are short-term incentives that managers use to raise sales effort. The extant marketing theory predicts that the optimal prize structure should have two characteristics: (1) The number of prizewinners should be greater than one, and (2) prize values should be unique and rank ordered. However, this theory has not been empirically examined. This article presents two empirical studies that examine whether the prize structure of a sales contest affects sales performance. In each study, the authors investigate the incremental effects of introducing multiple prizewinners and unique rank-ordered prizes into a sales contest. The first study consists of two laboratory experiments in which participants make decisions that closely reflect the decision trade-offs in the theoretical model of sales contests. The second study consists of two field economic experiments in which trained salespeople sell fundraising sponsorships to companies. The results across the experiments are remarkably consistent: The number of prizewinners in a sales contest should indeed be greater than one. However, introducing rank-ordered prizes into contests with multiple prizewinners does not boost sales effort and revenues.

Social Loss Aversion and Optimal Contest Design

When managers are designing a contest to motivate effort by salespeople, service employees, franchisees, or product development teams, a key question is, What should the optimal proportion of winners and losers be? Prevailing marketing theory predicts that the proportion of winners in a contest should always be lower than the proportion of losers. Not only has this theory not been empirically tested, but it is also based on the assumption that contestants care solely about the value of the prizes they receive. This self-interested assumption has been increasingly challenged in marketing and economics. This article uses a behavioral economics model to formalize the idea that if contestants also care about their contest outcomes relative to other contestants, changing the proportion of winners in a contest can alter the reference points contestants use to make these social comparisons. Consequently, a contest with a higher proportion of winners than losers can yield greater effort than one with fewer winners than losers if the degree of social loss aversion in the contestants is sufficiently strong. Two incentive-aligned experiments show that this prediction can be valid in situations with public announcements of contest outcomes.

Designing Multiperson Tournaments with Asymmetric Contestants: An Experimental Study

Is the right amount of effort exerted in multiperson tournaments where contestants have two different levels of initial endowments (termed “favorites” and “underdogs”)? We develop theoretical predictions for the level of effort and the effect of varying the prize structure. We test these predictions for three-person tournaments using an economic experiment in a social environment where contest outcomes are publicly announced. We find that both favorites and underdogs overexert effort relative to the theoretical point predictions. Moreover, in the treatment with two favorites and one underdog, favorites increase their effort when the number of prizes is increased from one to two, contrary to the theory prediction. We show that a generalized model that allows for psychological losses from losing for favorites and psychological gains from winning for underdogs because of social comparisons tracks the experimental results better than the standard theoretical model. This paper was accepted by Peter Wakker, decision analysis.

How "Psychological" Should Economic and Marketing Models Be?

The authors discuss the potential of making the recently developed behavioral economics models even more “psychological” by (1) increasing their context specificity, (2) allowing different people to have different model parameters, and (3) capturing the underlying psychological processes more explicitly. They show that some of these models already make room for understanding context specificity and heterogeneity, and they discuss new ways to enrich the models along those two dimensions. The task of adding process details is more challenging in simple mathematical forms because these models must serve as building blocks for aggregate market models.

When Do Group Incentives for Salespeople Work

When should sales managers employ group incentives rather than individual incentives to motivate their sales force? Using economic experiments, the authors show that two-person group incentives can outperform individual incentives and that the relative efficacy of group incentives depends on three important factors. First, the strength of social ties among the group members matters. Effort decisions in group-based incentives increase significantly when members socialize briefly before committing effort. Second, the design of the group incentive matters. For the group incentive to work better than the individual incentive, the group-based component (i.e., how much the payment scheme weights the contribution of others) in the former cannot be too large. Third, the informational feedback that group members receive matters. When socialized group members can observe one anothers true effort, rather than only their output, effort surprisingly decreases. The authors show that a model that accounts for social preferences and the psychological loss that occurs when teammates underestimate ones effort can explain salesperson behavior in group incentives well.

Relationship Organization and Price Delegation: An Experimental Study

Price delegation to the salesforce is a practice widely adopted by firms. This paper examines the relationship between price delegation and managerial profits using a laboratory economics experiment. A novel feature of our experiment is that we study how varying the relationship organization of the sales manager and salesperson to allow for 1 requests by the salesperson for the manager to choose price delegation, and for 2 the manager to award a small bonus after observing the salespersons decisions, can affect behavior. The results show that, contrary to the theoretical prediction, managers choose price delegation frequently and salespeople respond reciprocally, leading to higher manager profits under price delegation. Moreover, this behavior increases when requests and bonuses are allowed. We show that a behavioral economics model that incorporates positive reciprocity can explain these results well. Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2013.1778 . This paper was accepted by Pradeep Chintagunta, marketing.

How Does Team Composition Affect Effort in Contests? A Theoretical and Experimental Analysis

When companies organize salespeople into teams to compete with one another, how does the ability composition of team members affect effort? And how may the effect of team composition on effort depend on the type of contest the teams are competing in? Using a game-theoretic model, we derive the very sharp predictions that when winning the contest depends on the average team sales, the ability composition of a team has no effect on team effort, and the stronger and weaker members will expend identical effort levels. However, when the contest winner is determined by the minimum or maximum output contribution within the team, heterogeneity in team composition exerts a deleterious effect on team effort, with the stronger and weaker members expending unequal effort. Our model also shows that in a contest between two symmetric teams, when team members are homogeneous, all three contest metrics yield identical team effort; however, when team members are heterogeneous, the average metric elicits the highest team effort. We also discuss cases when the minimum and maximum metrics are optimal. We test the models empirical validity using two incentive-aligned experiments in which participants make effort decisions strategically. The experimental results exhibit broad support for the theoretical predictions.