"Whenever I go into a restaurant, I order both a chicken and an egg to see which comes first"

Wednesday, September 19, 2012

Innovation At No Cost

Most innovations have a significant cost.  R&D budgets for the biggest companies are significant, launching new products or services requires significant marketing and advertising.  Some innovations cost nothing, and they are the holy grail of management.  Most fall into the category of “Why didn’t I think of that?” – that is, they are obvious in retrospect, are genius in their simplicity and ability to reduce costs, generate profits, or improve performance.  There are two examples which come immediately to mind.

First is eliminating both-way tolls on Manhattan bridges and tunnels.  Up until relatively recently, travellers had to sit in endless lines in each direction, going in to New York City and back out again.  Until someone asked the question: “Why don’t we eliminate the outbound tolls and charge double on the inbound?”.  That would eliminate half the bottlenecks that occur every day with no negative impact on revenue.  Ninety percent of cars that enter Manhattan have to exit at one time or another (it is an island), and most will do so as daily commuters. Brilliant.

The second example is the university which decided to eliminate trays from the school cafeteria.  If students had to return to the steam trays to get refills, they would be likely to eat less, helping to keep the famous ‘sophomore spread’ under control, and reducing plate waste.  Eliminating trays would eliminate the cost of the trays, would significantly reduce the labor costs of washing them, and would avoid releasing dishwashing chemicals into the environment.  All at no cost.  Brilliant.

Along comes the idea of ‘loss aversion’:

In economics and decision theory, loss aversion refers to people's tendency to strongly prefer avoiding losses to acquiring gains. Some studies suggest that losses are twice as powerful, psychologically, as gains. (Wikipedia).

Loss aversion theory is frequently applied to marketing.  Sellers take advantage of the general tendency of buyers to retain (not lose) what they have purchased and offer rebates and trial periods.

A related theory is called The Endowment Effect: The value of a good increases when it becomes a part of a persons endowment. The person demands more to give up an object then they would be willing to pay to acquire it.

In simple terms, you will do more to keep a good obtained, then invest in efforts to attain it.

Shankar Vedantam of NPR reported on a study to apply loss aversion theory to teacher performance.

Economist John List at the University of Chicago recently conducted an unusual field experiment in [a poorly-performing] a school district near Chicago.

List and his colleagues divided 150 teachers into three groups. One group got no incentive; they just went about their school year as usual. A second group was promised a bonus if their students did well at math.

The third group is where the psychology came in: The teachers were given a bonus of $4,000 upfront — but it had a catch. If student math performance didn't improve, teachers had to sign a contract promising to return some or all of the money.

The experiment showed that the give-back group performed two to three times higher than that which received the incentive amount at the end of the performance period.

What we found is strong evidence in favor of loss aversion," he said. "Teachers who were paid in advance and [were] asked to give the money back if their students did not perform — their [students'] test scores were actually out of the roof: two to three times higher than the gains of the teachers in the traditional bonus group."

To change performance incentives from the back-end to the front-end of an educational cycle costs nothing, and the rewards are significant.  Brilliant.

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