When it comes to money, even the well-informed can find it difficult to make optimal choices. Looking at the entire UK population, more than half are saving inadequately for their retirement. According to the FCA over 3 million hold persistent credit card debt 1. And one in three working families may be as little as a pay cheque away from being unable to pay for their homes2.
There are many reasons why people may find it difficult to manage their finances well, and research increasingly shows that we often fail to make decisions that best serve our fiscal aspirations. One such research discipline is behavioural economics - an emerging field at the intersection of economics, psychology and sociology that we believe can be used for developing practical tools to help people manage their money better.
The cost of poor financial decision-making is considerable, from retiring without adequate economic resources to high interest payments on debt or losing out on long-term investment growth. The latter, also known as ‘reckless conservatism’, is to a large extent attributed to perceived complexity of choice, lack of clear guidance and aversion to experiencing short-term fluctuation in the value of funds. As a result, it can lead to an expensive inertia, where capital is eroded by inflation and consumers fail to capture the extra return on equity they can get over and above saving accounts.
Behavioural economics is a relatively new science, which examines the behavioural factors that influence decision-making. In the past two decades, behavioural economics has gathered momentum as a result of successful application to changing people’s behaviours for the better in real world settings, and attracting attention via popular books such as Freakonomics; Thinking, Fast and Slow; Nudge and Predictably Irrational.
Governments, regulators and businesses are interested in behavioural economics because it can assist with re-evaluating attitudes to customer behaviour. Moving away from entrenched rational paradigms, this science can provide a framework for assessing how customers respond in different situations, and then support better outcomes.
To bring scientific knowledge and business application closer together, last year we initiated the first joint London Business School and Lloyds Banking Group Behavioural Economics challenge. Part of the Behavioural Economics and Decision-Making course, more than 100 students collaborated with Lloyds over several months to help the bank improve customer behaviour.
These projects addressed how the discipline could be applied to areas such as helping customers to save more, helping them manage their spending better with smart in-app nudges, or boosting digital skills and use of technology such as mobile banking app alerts in the small business sector.
Many people have a complex relationship with money, and evidence suggests a large number of customers would value their bank offering more assistance in making good decisions. Knowing their customers through often long-standing and comprehensive relationships, banks are uniquely positioned with the knowledge and resources to help customers where needed.
It is in the long-term interest of both regulators and banks to reduce customer financial mismanagement. By knowing their customers better, banks could do more to be aware of who, for example, is likely to become overdrawn, overspend or miss savings targets. By rethinking accepted rational paradigms governing consumer behaviour and drawing on Behavioural Economics, banks can research implementing preventative measures to help customers avoid overdrafts, missing payments, or neglecting savings plans and pension contributions.
Lloyds Banking Group, a UK retail bank, is investing several billion pounds in transforming its operations, with the ambition to be the best bank for customers. Behavioural economics, along with other data and customer-focused disciplines, is a central element of this ambition, driving more efficient use of data to give customers greater value, and developing more human-centric design to improve customer experience.
“It’s amazing to see the difference our work can make to the bank in a short space of time,” says Abhijit Akerkar, head of the Behavioural Science Lab at Lloyds, and himself an alumnus of London Business School.
It is necessary to remember that avenues for involvement in modifying decisions are governed by ethical and regulatory constraints. Behavioural Economics has much promise, but applying initiatives in a consistent, credible and effective way to a wide cross-section of the population, without overstepping personal or legal boundaries or alienating consumers, is more difficult than might first appear.
During the challenge, students developed projects which addressed a number of business problems in retail banking, and generated ideas for tackling them effectively at opportune moments. Scientifically robust platforms were necessary for testing hypotheses and evaluating efficacy when applied to real situations, while acknowledging barriers to implementation.
“I enjoyed the course, and as a scientist I really liked that there was an experimental element of gathering data, combined with behaviour you see in real life,” said Raquel Velasco, a student with a background in physics who worked on a project investigating how to help young people save more effectively for retirement.
In developing their projects, students had freedom to pursue ideas, hypotheses and insights in areas such as customer research or models for interaction with customers. The Lloyds team briefed the students, and as the challenge sponsors, were then available for further discussion and feedback.
For LBS faculty and students, collaborating on these projects was an exciting opportunity to explore behavioural economics concepts that incorporated robust testing in conjunction with learning from their sponsors. This learning included valuable experience in conducting real world research and responding to the needs and expectations of real world clients. The challenge also presented a setting for making contacts, fostering client liaison skills and gaining focused exposure to the corporate environment. “We want to take what we learn out of business school and apply it, and working on the project was similar to real world activity and the kind of job we might have in the future,” Velasco says.
In setting up the projects, the students consulted with LBS faculty and Lloyds executives to examine the integration of behavioural economics into formal, systematic frameworks for understanding the behaviours of customers better. The original project topics were formulated from problems relating to customer behaviour and anchored in the value and feasibility of the research, though closer examination of possible topics frequently revealed other aspects to be considered.
The final project list was modified as issues were clarified and defined. Expressing some of the challenges in clear, non-technical language was a challenge in itself which required intense analysis. The students assessed a number of opportunities and possible actions, including leveraging the effects of social norms, effective methods of boosting digital training and using choice architecture to influence decision-making. Their findings included the impact of techniques such as gain or loss framing, reducing cognitive load and digital alerts. “Knowing that the work we did would actually be used was very motivational, and made us work harder,” says Velasco. “It really focused us, as we had a specific challenge with a clear end-customer in mind.”
The Lloyds sponsors were very positive about the collaboration, reporting that the students’ broad spectrum of experience generated material that could be used in further project development. While the projects reinforced some factors that were already known, fresh perspectives and insights from a diverse and highly skilled group provided different contexts for viewing problems which can be extremely useful in repositioning the way Lloyds looks at customer issues, and assisting the bank holistically.
External expertise and evidence-based data are a key part of ensuring Lloyds can develop a fully nuanced and realistic way of thinking about consumer, customer, and even employee issues, which can then be translated into strategies to facilitate best practice. “We got a fresh scientific perspective on various customer problems, e.g. linking impulsive spending to savings habits to create a positive association,” a Lloyds sponsor says.
Future plans at Lloyds include refining customer experience by looking at what customers need, and their experiences in achieving goals such as securing their financial future. Turning the way the bank has traditionally served customers on its head, it has divided transformation ambition into over 50 ‘customer journeys’, with customer goals as the guiding principle.
These journeys are being shaped by adopting good practice from multiple disciplines, and collaborating with the students has inspired ‘stepping stones’ for exploring new ideas and ways of working. “From the students we learned the different possible ways of applying Behavioural Economics, including how solution ideas are generated,” a Lloyds sponsor says.
Students participating in the challenge gained knowledge in the applications of behavioural economics and expanded their skills in testing hypotheses. Collaborating with Lloyds also gave them an understanding of the complexities of investigating issues that can affect millions of consumers within the context of a large corporate entity. Velasco agrees, saying: “It was really useful for us to apply the course material to something concrete that affects all of us in very tangible ways.”
It was rewarding to bring Lloyds personnel and students together in developing behaviourally informed approaches to guide decision-making. Solutions built applying behavioural economics offer little practical value until their efficacy is tested and validated with real consumers, and these projects offered everyone involved a way of investigating problems and using innovative techniques to generate relevant data and solutions.
David Faro is Associate Professor of Marketing at London Business School. He is Academic Director of the Strategic Branding programme and the Decision Making Strategies for Leaders programme at LBS. Redis Zaliauskas is Behavioural Economist, Applied Science, Lloyds Banking Group
What our students did
The student projects targeted behavioural problems identified as potentially beneficial for consumers, consistent with the bank's purpose and values, and suitable for the application of concepts from behavioural economics. For example:
Several groups worked on projects aimed at increasing saving by the UK population. One group noted a potential link between saving and addictive behaviours, such as gambling or impulsive shopping. The group proposed to introduce simple changes to apps and the way they access their money to promote saving and better money management. It also proposed to make saving apps visually attractive and easy to use, enabling consumers to add to their savings pot at any given moment with the press of a button. A second group proposed to focus on finding a solution for women, who tend to save less than men. The group identified that women on average had lower confidence in own financial literacy than men and that this was an important behavioural barrier. It proposed to overcome this barrier by providing encouraging information about their peers who are saving, introducing role models, and offering practical information on how to save.
Another set of groups worked on proposals aims to increase the digital skills of UK population. Many small businesses in the UK have limited digital skills, foregoing the benefits of digital tools. One problem the groups identified is a sense of choice and information overload: people feel that there are too many choices and too much information for them to make a decision that they would feel confident about. To overcome this barrier, one group designed an intervention based on the “attraction effect”. Prior research has found that introducing to the choice set a dominated (inferior) alternative can make another alternative seem relatively more attractive, and thus give the decision-maker a justifiable “reason” to pick that choice. For example, the group proposed to include in the list of food-sector specific tools such as “Online reservation system” and “Online grocery ordering system” the generic tool “Business webpage”. The group predicted that “Online reservation system” option would garner greater interest when presented along with the generic “Business webpage” option. Another group proposed to trigger a growth mindset to encourage the use of digital tools. Instead of the standard “yes” and “no” answer options, the group proposed to use “yes” and “not yet” response options, mentally keeping the door open for the use of digital tools in the future.
Freakonomics: A Rogue Economist Explores the Hidden Side of Everything by Steven D. Levitt
Predictably Irrational: The Hidden Forces that Shape Our Decisions by Dan Ariely
Nudge: Improving Decisions About Health, Wealth and Happiness by Richard H. Thaler and Cass R. Sunstein
Thinking, Fast and Slow by Daniel Kahneman