Behavioral Economics and Sustainability
Incentivize People for the Common Good
In recent months, large corporations are incorporating sustainable products into their portfolios, which provide environmental, social and economic benefits while protecting public health and the environment throughout their entire life cycle, from the extraction of the raw materials and manufacturing to final disposal to the customer. How do behavioral aspects influence people’s sustainability decisions?
Sustainability is not just a buzzword, but a concept that must be addressed by each of us — both from a personal and professional level — to have a better world. It is evident that, more and more, companies are incorporating sustainability as an added value within their portfolio, but how can we encourage the consumption of this type of products or services? How can behavioral aspects influence the sustainability decisions of our employees, consumers and other stakeholders? What is the relationship between these behavioral elements and the decision-making process as it relates to sustainability?
Behavioral Economics is a science of psychology that can help to better understand economic decision-making processes by individuals and institutions with respect to sustainability and other issues relevant to humanity today. This discipline combines the principles of psychology, sociology and economics, with the aim of better understanding how we make financial decisions.
Not all customers are the same or behave in the same way in the same scenarios
To understand what the fundamentals of Behavioral Economics are, let’s take a simple example. Typically, when a meat-based main dish is served at one of these large events, 5–10% of diners will request a vegetarian alternative. However, at the 2009 edition of the Behavior, Energy and Climate Change Conference, the organizers reversed the options and offered a vegetarian dish as the default option, and meat as an alternative. So, 80% of the 700 people who attended the conference opted for the vegetarian option. The conclusion is that this change occurred due to the different presentation or formulation (framing) of the alternatives presented.
This is another example with which you can see how, by using Behavioral Economics, it is possible to incentivize people to buy renewable energy instead of conventional energy (from fossil fuels and the main contributors to carbon emissions).
It must be assumed that there is a clear difference between the intention and the action of the consumers and, normally, people tend to stick to the default option and prefer not to change the current state due to cost and aversion to losses. In this context, for example, we inform people that their city is supplied up of 50% by renewable energy and 50% by conventional energy, but the default contract is based on the use of renewable energy. Since people are less likely to proactively make a switch, they will mostly stick to the default contract and use renewable energy.
Behavioral Economics can be used to solve some of the great challenges of fighting climate change
Behavioral Economics can be used to solve some of the great challenges in the fight against climate change, especially in reducing carbon emissions. In this sense, it is necessary to understand why some people make decisions so differently from others when choosing similar products and services. In fact, small and large companies, financial institutions and other service providers are making use of this science (Behavioral Economics) to better position their services.
CARBON EMISSIONS ACCOUNTING
The shift towards sustainable business practices is something that society is actively pushing for. Customers are increasingly demanding more visibility into the carbon footprint of the products they purchase. But, regardless of the impact that this level of transparency may have with respect to consumers, it is likely that in the future it will become an obligation to provide information about the environmental impact on product labels.
Within the Climate 21 program, ‘SAP Product Carbon Footprint Analytics’ is a tool that provides information on the carbon emissions of a product throughout the entire value chain, including production, raw materials, energy use and transport. In addition, it allows integration with information on third-party products and solutions, to be able to analyze and understand the breakdowns of emissions, or even to obtain comparisons of each of the activities that make up this value chain.
It is clear that behavioral economics has become fashionable and, in fact, in recent months it has been applied to different areas of our daily lives. For example, governments incorporate this concept to define public policies and use it to better understand user perceptions and improve educational outcomes at low cost. Regarding the private sphere, companies use it to get closer to their customers and promote better decision-making.
These are just a few examples of its application.
PROMOTING SUSTAINABLE PRACTICES
Some of the metrics that influence the decision-making process are those related to CSR (Corporate Social Responsibility), ESG (Environmental, Social and Governance) or sustainability in general. We can think of the idea that if a company is more socially responsible and makes better decisions about sustainability and climate change, the customer may choose it instead of other “less sustainable” alternatives.
How can we make the benefit more attractive and attractive to end consumers?
But how can we build and develop this whole connected concept of behavioral economics and sustainability to differentiate ourselves from competitors while building an attractive offering for customers? How can we make the benefit more attractive and attractive to end consumers?
First, not all customers are the same or behave in the same way under the same scenarios, therefore, it is important to segment the current customer base and create a specific offer and actions for each of these segments. Furthermore, it must be taken into account that there is a significant divergence between millennials (between 18 and 39 years old) and adults (over 50 years old) in relation to the perception of sustainability. With sustainable investing, for example, we see that a certain lack of awareness and interest in the social investment space impacts on your retirement planning considerations.
Behavioral Economics can help us understand how people make decisions and therefore influence them to achieve desired change by defining an architecture of choice and the use of stimuli (or nudges).
INCENTIVES AND LOSS AVERSION
One of the challenges of behavioral economics is how to deal with cognitive biases and difficulties in the decision-making process. One solution is to generate small incentives, stimuli or “nudges” that help people to make the expected decisions.
Let’s take another close example to better understand this push concept. Knowing what my neighbors are doing can also influence what I do. For example, some utilities and energy companies include a happy face on the bill if the customer is using less energy than the average of their neighbors, graphically persuading consumers to keep doing things right.
This comparative report makes people think more and makes them more proactive towards energy sustainability. Just having your household consumption information doesn’t seem to have much of an impact if you don’t have anything to compare it to. Adding this information is inexpensive and has a great effect.
“Not losing” makes us happier than “winning”. This is the central concept of the prospect theory of Daniel Kahneman
Another concept that can help us in some sustainability challenges is loss aversion: “not losing” makes us happier than “winning”. This is the central concept of Daniel Kahneman’s prospect theory.
To better illustrate this, we can use as an example the use of thermos or reusable containers when ordering coffee “to go” in coffee shops. In some places they give you a discount if you bring your own container. However, this practice does not change behavior efficiently. The most effective way to generate impact would be to introduce the discount in the price of coffee, and charge an extra to those who want a disposable cup. In general, saving is not a very strong incentive, so people’s reaction is very different if they feel that they are paying too much, compared to the feeling that they are saving.
These are just small examples that show that the way we present information can be used to create sustainable change without much financial effort. But Behavioral Economics addresses many more concepts and research that can help small and large companies in the challenges that the fight against climate change and sustainability brings us.
ARE YOU RATIONAL?
One area or sub-discipline that is part of this behavioral economics is that of Behavioral Finance, which studies the influence of psychology on the behavior of investors or financial analysts, also including subsequent effects on markets. According to Daniel Kahneman, Nobel Laureate in Economics in 2002, there are various factors (biases and heuristics) that influence our decision-making process and that lead us to make mistakes.
This science starts from the basis that humans are not 100% rational beings and that our behavior is subject to the stimulation of multiple factors, internal and external, which often lead us to make irrational decisions.
People are unable to fully analyze and distinguish the various options and scenarios that are presented to them, so they employ shortcuts and heuristic thinking. Given this, the mind creates response mechanisms that, unconsciously, help to simplify the decision-making process. This process is influenced by prejudices, emotions, tendencies and other elements, in such a way that, many times, these decisions have a negative impact on people’s finances.
SUSTAINABILITY AND INNOVATION
At SAP we are promoting sustainability with some key initiatives, such as the implementation of the United Nations Sustainable Development Goals (UN SDG’s), the monitoring and reduction of CO2 emissions, programs to combat climate change, promotion of the circular economy, waste management and recycling, or disposal of plastics, among others.
Sustainability aims to protect our natural environment, but it is also a great driver of innovation
Sustainability aims to protect our natural environment, human and ecological health, but it is also a great driver of innovation. In fact, one of the objectives that we have to define in companies is to manage innovation under sustainable structures at the social, environmental and government levels.
At SAP we are working on a cross-cutting sustainability program for the South EMEA region: SAP Cares (Climate Action RESponse). In terms of promoting corporate sustainability habits and behavioral economics, the program is based on three fundamental pillars:
- Measure and understand. First, we need a sophisticated and transparent way of tracking the CO2 footprint throughout our customers’ value chain, and of accounting and managing accumulated carbon credits and taxes in real time. This will allow us to understand how the different actions of our clients are impacting the CO2 footprint and suggest specific actions and stimuli to change behaviors.
- Lead by example. Second, you have to be able to raise awareness that small actions and gestures, such as using a train instead of an airplane, can positively impact our environment. In addition, we also define compensation actions to reduce these emissions, such as, for example, planting a tree for each purchase in the SAP Store.
- Create impact. Lastly, we need a strong community to generate impact and a sense of purpose for our employees, customers, and stakeholders. At SAP we are leading by example and serving as catalysts with many actions such as the Zero Waste Economy program, the SHiFT Platform, for the elimination of plastics, or Climate21.
Now the challenge is to create new interactive experiences that motivate a change in consumer choices, leading to reducing CO2 emissions, eliminating plastics from the ocean, increasing waste recycling or promoting water savings.
It’s a fact: promoting and implementing principles and standards of responsible business behavior can help us create an investment environment that is based on well-accepted economic, social and environmental principles.
The current coronavirus outbreak has exponentially amplified the demand for a robust infrastructure that can operate efficiently during difficult times. This represents a great opportunity for the business world to find a way to provide a technologically advanced, resilient but also sustainable infrastructure.
Incentives like this one are needed to accelerate the planet’s sustainable development goals, and Behavioral Economics can be a great ally to better understand people’s behavior when it comes to sustainability.
Written by Ernesto Rincón. Head of Innovation South Europe at SAP. Associate Professor at University Carlos III Madrid. https://ernestorincon.com