The Benefits of Private-Sector 'Nudging'

Behavioral economics has increased dramatically in popularity over the last decade. Not surprisingly, academic researchers have expressed significant interest in this (relatively) new line of inquiry, but behavioral economics has also received a disproportionate amount of attention from outside of the academic community. For example, policymakers have embraced behavioral economics as a way to understand how people’s actions deviate from their long-term best interests and, as a result, how governments can mandate changes to consumers’ choice architectures in order to “nudge” them (in a libertarian paternalism sense) toward greater long-term happiness. In addition, marketers have (knowingly or unknowingly) embraced behavioral economics as a way to exploit consumers’ decision-making biases in order to increase profitability.

As behavioral economists uncover and document more ways in which individuals are biased in their decision making, both marketers and policymakers get more ways to nudge consumers in various directions. One common perception is that policy makers nudge consumers toward their long-term best interests and marketers nudge consumers away from their long-term best interests, usually by manipulating consumers into buying more than they would if they were being economically rational. But is this always the case? 

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The Incentives for Nudging

There are obviously significant incentives for private producers (i.e. companies selling goods and services to consumers) to implement nudges that improve their profit. These nudges that are profitable for producers could, in turn, either be good or bad for consumers, or they could even be good for some consumers and bad for others. Furthermore, there is some opportunity for entrepreneurs to either “sell” nudges directly to consumers or to get into the business of helping producers implement effective nudges. That said, it’s important to recognize that there are limitations on the ability (or, perhaps more accurately, willingness) of private markets to provide nudges that are helpful for consumers and, conversely, to refrain from providing nudges that are harmful to consumers.

For now, let's explore some examples of private-sector nudges that are beneficial to consumers.

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Examples of Beneficial Private-Sector Nudging

Despite the popular conception that there is a universal tension between the incentives of marketers and the well-being of consumers, it’s not actually that difficult to find examples where companies use the principles of behavioral economics to not only enhance their profitability but also better align consumers with their long-term best interests.  Let’s examine a few examples of such nudges in order to understand how they work and in what contexts they tend to appear.

Around 2005, in order to generate demand for savings accounts and debit card transactions, Bank of America introduced a program called “Keep the Change.” This program rounds consumers’ debit card transactions up to the next dollar and then deposits the “change” into consumers’ savings accounts. To sweeten the deal, Bank of America matches consumers’ savings deposits 100 percent for the first three months and then 5 percent thereafter, up to $250 per year. Since then, other banks have followed suit with similar programs.

In its first two years, Bank of America customers saved $400 million via the Keep the Change program. (Note, however, that some of this amount could have replaced other amounts that the consumers would have saved, but it’s likely still a net increase overall.) 

This market-based nudge appears to be pretty solidly in the best interests of consumers, especially since the program requires consumers to actively sign up for the program.  (One drawback worth noting, however, is that some consumers have experienced issues with overdraft fees that they attribute to the program.) The downside of this active sign-up requirement, of course, is that consumers need to be self-aware regarding their need to be nudged (or have enough desire for the match incentive) in order to take the trouble to sign up, and the choice architecture of the decision of whether or not to enroll is  biased in favor of not enrolling since that is the default option for the consumer.  (This, of course, could be changed, and many consumers would likely benefit, but that doesn’t mean that they won’t complain in the short term.)  Fortunately, the presence of the match incentive likely gets at least some consumers to sign up for non-nudge-related reasons.

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Examples of Beneficial Private-Sector Nudging

Much has been made in academia, in the media, and in business of the effects of defaults on employee 401(k) participation.  In one landmark field study (as well as several follow-up studies), employee 401(k) participation was shown to increase from less than 50 percent to almost 90 percent as a result of simply switching from a system where employees had to actively opt into the 401(k) program (via a short process that was not intended to be burdensome) to a system where employers were enrolled in the program by default but could opt out by completing a short form.  In another analysis, 401(k) participation rates were shown to be higher when employees are given fewer choices of plans to pick from.  (Note that this is technically more than a nudge if consumers’ choices are forcibly limited, which is why some organizations present a few choices as the default but have more options available for those who want to consider all of them.) 

Programs of this type appear to be both in the best interests of the companies offering them (as evidenced by their revealed preference for undertaking the expense and effort to implement them) and beneficial in the long-term to consumers.  Though we technically can’t be entirely certain, it’s fairly difficult to envision a common scenario where the default nudge leads to enrollment when it’s actually optimal for a consumer to not enroll in a 401(k) program (mainly because it’s pretty rare that people save “too much” for retirement!).

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Examples of Beneficial Private-Sector Nudging

Behavioral economists have also thought about how to help people overcome their time inconsistency and biases toward immediate gratification that lead to procrastination in saving decisions. For example, Shlomo Benartzi and Richard Thaler lay out a plan entitled “Save More Tomorrow” in which participants are encouraged not to put more money away today but instead to commit a portion of future pay increases to savings.  These plans, when implemented in pilot organizations, were accepted by almost 80 percent of participants, and, of those participants, 80 percent remained in the program after four pay-raise cycles.

One of the interesting aspects of this program is that consumers could choose to implement this strategy themselves via a traditional retirement plan, so the increase in participation is either due to the power of suggestion or the fact that consumers hadn’t thought of this strategy until it was presented to them.  Again, given that most consumers report wanting to save more than their short-term selves will allow, this nudge is most likely a nudge that is good for both producers and consumers.

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Examples of Beneficial Private-Sector Nudging

If you are in charge of your household’s utility bills, you have likely noticed a recent phenomenon whereby your utility bill now includes information on your energy usage as compared to that of your neighbors and then suggests some ways of conserving energy.  Since conserving energy really means buying less of the product that the company is trying to sell you, these nudges may seem a little perplexing.  Is it really the case that your utilities have the proper incentives to encourage energy conservation?

In many cases, this answer is yes, for two reasons.  First, the government agencies that regulate the utilities often give either mandates or incentives to the companies in order to get them to encourage conservation.  Second, because the utilities are charged with serving what often seems to be an ever-expanding universe of energy demand, it is sometimes more cost effective to encourage customers to use less energy than it is to either buy energy externally on wholesale markets in order to meet demand or incur the fixed costs of expanding one’s own facilities. These two observations imply that it’s pretty safe to conclude that the nudges put out by the utilities are going to encourage less rather than more energy usage.  What is less clear is whether consumers’ long-term selves really care all that much about using less energy or whether the negative externalities generated by energy usage give society a reason to care even when individuals don’t.  (Economically speaking, both of these reasons give valid justification for putting a nudge in place, but it’s important to recognize that the reasons are not one and the same and may affect the effectiveness of the nudge.)

Previous attempts at encouraging conservation have included the use of subsidies for energy-efficient light bulbs and household products, but the nudge-based approaches appear to generate an effect at least as large with lower cost to the company (and, as a result in some cases, lower cost to the taxpayer).  Does the nudge make consumers better off?  After all, the descriptive norm by itself can cause some households to increase their energy consumption, and not everyone necessarily has energy conservation as a long-term goal.  (In fact, the effects of such a nudge are much stronger for liberals than for conservatives, and conservatives disproportionately report not liking the messages and choose to opt out of such mailings.  Narrowly speaking, it’s unclear whether this nudge as typically enacted makes consumers better off, but there is opportunity to provide a more targeted nudge that will reach a largely receptive audience and mitigate perverse effects.  From a broader societal perspective, the nudge is good for both consumers and producers because it does reduce their energy costs on average (eliminating some production that is sold at an inefficiently low price) and reduces the externalities generated by energy consumption, which benefits consumers overall as a group.