Executives learn that counting on irrational buying behavior can improve business performance.

Why would more test subjects report more pain relief from a pill priced at $2.50 than from the same medication priced at just 10 cents? Why do people who opt-in to savings plans at work save much less money than those who opt-out?

According to Dan Ariely, behavioral economist and best-selling author of "Predictably Irrational: The Hidden Force That Shape Our Decisions," consumer purchasing decisions are guided by expectations, emotions, and context that are not accounted for in traditional economic theory. Big decisions and large effects can be swayed by small changes.

"Whether marketing to eager children or hard-nosed CFOs, don't ignore the seemingly irrelevant influences that drive consumers to make irrational choices," said Ariely, speaking at the Exchange, sponsored by Diamond Management & Technology Consultants, Inc.

Ariely, the Alfred P. Sloan Professor of Behavioral Economics at MIT and a Diamond Fellow, presented the results of numerous experiments that show how people behave far less rationally than standard economic theory assumes.

The implications are endless and we feel they will have a profound implication for every industry," said John Sviokla, Managing Director of Innovation and Research at Diamond. The feedback we've gotten at the Exchange and from other client conversations suggest that informed management teams will be applying the principles of behavioral economics in their products, services, and processes."

Prof. Ariely's new book, "Predictably Irrational: The Hidden Forces That Shape Our Decisions," reveals ways in which consumers--contrary to popular belief--do not make rational decisions. Released Feb. 19, the book has garnered rave reviews and is currently a New York Times bestseller.

For example, to test the effects of discounting, Ariely asked students to drink a beverage that promised to "elevate your game" and provide "energy for your mind" before taking a word puzzle test. Half the students were charged full price for the beverage; half a discounted price. Students who paid full price experienced a 28 percent improvement in performance than those who paid a lower price. Furthermore, the students who took the word puzzle test without first drinking the beverage performed the same as those who paid full price.

"If people rely on their irrational instincts every time they see a discounted item they will instinctively assume its quality is less than that of a full-price item," Ariely said. "The effect of discounts is largely an unconscious reaction to lower prices."

Sviokla added, "Frankly, it is irrational for companies to ignore the findings of behavioral economics. Its implications are so profound that management teams need to rethink how they interact with customers, how they present offers in the marketplace, how they motivate employees, even how they think about supply and demand. Moreover, the results are as relevant to insurance companies and banks, as they are to consumer products firms. "

Predicting Irrational Behavior Requires 5-Step Approach

Because it is such a new field of study, Sviokla recommends that management take a five-step approach.

"This science has such counter-intuitive implications that we recommend a five-step process for adoption of these notions: education, contextualization, experimentation, implementation and institutionalization," Sviokla explained. "Those firms that jumped straight to implementation--without taking the time to get buy in and prove the concepts in the context of their own firms-- - simply rejected the notions because they are so radical to 'normal' management thinking.

For example, if you simply put the price on office supplies in the supply closet, people are less likely to take them home because when they see pens as "money" they are less likely to steal.

If you give people fewer 401(k) plan choices they are more likely to participate, because too many choices freeze decision-making.

"Once they see the evidence," Sviokla said, "management starts recognizing opportunities and conducts the analysis required to understand how irrational customer behavior affects their business."