The Fudge Factor Theory
by Yasushi Kusume
'People tend to believe their own exaggerated stories..
The Honest Truth about Dishonesty, Dan Ariely
You’re planning a project. You start by listing the actions you need to take. You calculate the resources required and the costs involved. You produce a schedule. And then, because you know you can’t predict all the unexpected costs and events bound to come into play, you add an arbitrary amount – say 20% – to your budget. This is what’s called the ‘fudge factor’. Because you’re ‘fudging’ the figures; making allowances for the absence of accurate information. Where does this amount come from? A lot of people would argue it’s based on experience or past data. That it’s a fully rational choice. But is that really true?
The honourable cheat
Dan Ariely, a professor of Behavioural Economics at Duke University and MIT, has made a study of the way we make decisions. In particular, the way we make irrationally ‘bad’ decisions. For example, you’re driving through town. The speed limit is 30 mph. Yet it’s absolutely not uncommon to drive a little faster. To exceed the limit. What’s more, it’s not just us, we tell ourselves. Almost everyone does it. It’s a social norm. And so we end up believing our own exaggerations.
We can behave like this because, as humans, we possess what’s known as cognitive flexibility. It means we can balance the conflicting motivations that drive our behaviour. So on the one hand, we want to see ourselves as honest and honourable. On the other, we’re often happy to benefit from bending the rules. Cheating a little, as we do when we exceed the speed limit ‘a tiny bit’. Cognitive flexibility lets us tell ourselves that as long as we only cheat a little, we can still consider ourselves honest and honourable. Dan Ariely has dubbed this mental balancing act the Fudge Factor Theory.
At which point you may be asking yourself: what does all this have to do with a brand? I’d answer with another question. Can a brand bend the rules to gain an advantage from a situation without losing its brand reputation and loyalty?
Price gouging
In his book Misbehaving, economist and behavioural scientist Richard Thaler touches on the term ‘price gouging’: the practice of increasing prices to take advantage of a situation. For example, charging more for snow shovels after a snowstorm. Everybody knows that snow will fall. There are snow shovels in the shops. But because snow has fallen and people need shovels, the shop owner feels justified in charging more for them.
(Just to be clear, price gouging is different from inflation. Inflation can be caused by high demand or cost increases. Price gouging is opportunistic and localized, exploiting specific situations rather than broader economic trends.)
Or take Uber. The price of an Uber ride can increase significantly during peak hours; sometimes up to 10 times the usual rate. Uber argues that such a price hike helps increase supply because it encourages more drivers to start working. But, as Thaler points out, this is a fallacious argument: higher prices don’t result in an increase in the number of drivers, and the prices don’t come down quickly. When it comes to the Fudge Factor Theory, Uber’s ‘more drivers’ proposal lands on the side of dishonesty.
Damaging the brand
Thaler, who also teaches economics at the University of Chicago, has written that a majority of MBA students believe it’s fair to increase the price of snow shovels after a storm. For them, such 'market fundamentalism’ ensures that the balance of supply and demand determines prices, and guarantees the best allocation of resources.
But such thinking can damage a brand. Chasing short, rather than long-term profits risks damaging customer loyalty and trust. And once customers lose faith in a brand, it’s extremely difficult to win it back. If your brand wants to be seen as honest and honourable, it should avoid making extra profit by taking unfair advantage of its customers.
Dynamic pricing
So is there another, fairer, way to handle increased demand? Although it has its opponents – some consumers view it as price gouging under a new name – many businesses have begun to make use of ‘dynamic pricing’: airlines, hotels and train companies, for example, and such brands as Uber, Amazon, Airbnb and Disney. They offer higher prices at peak periods, while also encouraging consumers to make cheaper purchases during periods of low demand.
It can go wrong. Bruce Springsteen fans recently found themselves in what amounted to an auction for tickets. Because demand was so high, the prices for his concert kept increasing, and some tickets ended up selling for as much as $5,000! Yet for all that, dynamic pricing does bring a new approach to business beyond just discounting or lowering margins.
The disadvantage as I see it is that, sooner or later, every business will start using it, and it will become a standard offer. As a result, pricing will become more complex, requiring several levels of value-price combination offers, each needing to be competitive in different ways.
Food for creative thinking
I want to finish by returning to Dan Ariely’s opening observation, about people tending to believe their own exaggerated stories. A brand is no different from people. And when it starts fabricating excuses to justify extra profits, it’s believing its own stories. And this, as the Uber experience shows, can backfire. Trust will be lost.
Consumers understand that a successful brand needs to maintain a profit and pay its employees, and they’re willing to pay for the value they receive. What they won’t put up with is a brand giving in to the Fudge Factor Theory, trying to balance right and wrong for its own benefit. That’s why a brand should always remain transparent and honest with its customers. Because the only additional thing they seek from it, beyond its products, is honesty.
Nothing more.