Book Reviews

Nassim Nicholas Taleb introduced a new term into the lexicon of business forecasting, the “black swan event.”  The metaphor comes from the apparent fact that, for some reason, black swans should not exist, but they sometimes do.  In THE BLACK SWAN:  The Impact of the Highly Improbably, Taleb expounds for  366 pages on what is, for the most part, a single idea:  the normal (bell-shaped) distribution is pretty much worthless for predicting the likelihood of any random occurrence.  Taleb augments this idea in various, occasionally entertaining ways, acquaints the reader with power law and “fat tail” distributions, and takes excursions through fractal geometry and chaos theory.

Taleb tells us he aspires to erudition, and he introduces the reader to plenty of “great thinkers” that history has failed to credit.  You can come away from this book feeling that it is mostly about showing us how erudite Taleb is.  For me, one of the key shortcomings is Taleb’s tendency, via style, to claim that we should accept his arguments on faith.  There are plenty of concepts, especially involving numbers, that would benefit from concrete examples.  There’s just a little too much “Take my word for it” in his writing.  Still, if you’ve got time to kill, this is not an unrewarding read.

David Orrell tackles the very same subject–our inability to predict the future–in The Future of Everything:  The Science of Prediction (which has a sub-sub title: “From Wealth and Weather to Chaos and Complexity”).  For a mathematician, Orrel has an entertaining style and writes with clarity.  This book is far more focused than THE BLACK SWAN, which is sort of meandering.  The book is divided into three main parts: past, present and future.  The past provides a history of forecasting, beginning with the Greeks and the Oracle at Delphi.  The present considers the challenges of prediction in three key areas: weather, health (via genetics), and finance.  Orrel did his dissertation research on weather forecasting, and after reading this book, I think you’ll agree that it’s a great case study for revealing everything we think we know about the “science of prediction.”

Orrel’s main point is that a key problem in prediction is model error (the basis of his dissertation), which far outweighs the influence of chaos and other random disturbances.  In a nutshell, the complexity of these systems exceeds our ability to specify and parameterize models (models are subject to specification error, parameter error, and stochastic error).  Weather is a great example.  While there are only a few components to the system (temperature, humidity, air pressure, and such), the interactions between these components are almost impossible to predict.  Another problem is the resolution of the model; conditions are extremely local, but it it very difficult to develop a model that resolves to a volume small enough to predict local conditions.

Orrell educates.  The reader comes away with an understanding of the logic and mechanics of forecasting, as well as the seemingly intractable challenges.  Orrell provides clear explanations of many important forecasting concepts and does a good job of making the math accessible to a general reader.  There are a couple of shortcomings.  Orrell gives only passing notice to agent-based simulation and similar computational approaches to complexity.  And, in the third part of the book (the “future”), after spending the preceding two parts on the near futility of prediction (but for different reasons than Taleb), Orrell offers his “best guesses” for the future in areas such as climate change.

While I embrace the basic premises of these books, some new developments are cause for optimism.  Economists using an agent-based model of credit markets were able to simulate the fall off the cliff that we’ve experienced in the real world, as just one example.  While not truly “predictive,” these models can help us understand the conditions that are likely to produce extreme outcomes.

THE BLACK SWAN has its rewards, but The Future of Everything has far more value for the forecasting professional.  As a chaser, you might try Why Most Things Fail:  Evolution, Extinction and Economics by Paul Ormerod.

Copyright 2010 by David G. Bakken.  All rights reservcd.


buy-ology:  Truth and Lies About Why We Buy by Martin Lindstrom, Doubleday, 2008

The author bio on the inside of the jacket describes Martin Lindstrom as “one of the world’s most respected marketing gurus” and claims that he has a “global audience of over a million people.”   Even so, until this book was published I’d never heard of Martin Lindstrom in my many years as a marketing consultant.  More than anything, my ignorance points to the fragmented nature of the marketing world, where it’s entirely possible for an individual to be known to a relatively small group of clients until he or she publishes a book that makes the New York Times best-seller list.

Lindstrom’s book is, sort of, about the application of cognitive neuroscience to marketing and, more specifically, to branding. Technological advances have given neuroscientists new tools for localizing and measuring the level of activity in different areas of the brain, and these tools are being applied to marketing and other areas of economic behavior.  The technology that is getting the most attention is functional magnetic resonance imaging, or fMRI.  In the typical diagnostic MRI, a series of images are captured  that reflect “snapshots” of an area that, taken together, paint a detailed internal picture of some part of the body.  fMRI improves upon this (at least from the neuroscientist’s perspective) by creating a sequence of images over time. Because the fMRI can detect changes in blood flow to different parts of the brain, this effectively allows a researcher to map the areas of the brain that are “engaged” in different cognitive tasks.  Like a patient undergoing a diagnostic MRI, a subject in an experiment that employs fMRI must lie inside the MRI machine.  Any external stimulus (such as an advertisement or task instructions) must either be auditory or presented to the subject by reflecting it onto a small mirror above the subject’s face.  If you’ve ever experienced an MRI, you know that there is loud and frequent banging during the test.  Most fMRI studies are conducted on small samples of consumers (fewer than thirty, in many cases).

The main alternative technology for “brain imaging” is electro-encephalography (EEG).  Much like an electrocardiogram that measures electrical activity in the heart, EEG measures electrical activity in the brain. Over the years, technological refinements have made EEG measurements more precise, leading to an ability to isolate the activity in different regions of the brain.  Whereas the increase in blood flow detected by fMRI has a small delay (e.g. one to three seconds), the responses detected by EEG are instantaneous.  EEG is therefore very good at detecting what we are paying attention to.  And, because the sensors for EEG can be embedded in something like a baseball cap, it’s possible to monitor brain activity while subjects are, for example, watching television programs in a group.  The form of EEG monitoring used in most neuromarketing studies, steady state topography (SST), is also less expensive than fMRI.  A new EEG technology, magneto-encephalography (MEG), is, like fMRI, not portable and at this early stage, relatively expensive.

Most “neuromarketing” brain imaging research relies on correlating brain activity that occurs in response to some relevant stimulus (which could be viewing a television program, watching an advertisement, or making a choice from a simulated shelf, as examples) with what we know about localization of function in the brain.  If different stimuli or cognitive tasks lead to activity in different regions of the brain we can make inferences based on what we know about the functions performed by those areas of the brain.

Our understanding of localization of brain function is based on anatomy, on behavioral changes or impairments that result from injury or damage to some part of the brain, on studies with direct measurement of neural activity (by inserting electrodes into individual neurons), and on brain imaging studies.  Some functions are clearly localized in specific parts of the brain, particularly sensory and motor functions.  For example, the areas of the brain that process visual and auditory stimuli are distinct and, except in rare cases of synesthesia, there is a one-to-one correspondence between sensory input and the area of the brain that is activated.  When it comes to processing complex information, the picture is not so clear cut.  We may know which areas are involved in, say, emotion, but we cannot precisely determine the form of that involvement.  Thus, it’s one thing to observe that areas of the brain believed to involve emotion and reward “light up” when we are exposed to an advertisement, and quite another to conclude that a brand message must activate particular areas of the brain in order to create loyalty to the brand.

According to Mr. Lindstrom, the basis for this book is a research study involving about 2,000 individuals that he conducted over a three-year period with the help of Richard Silberstein of the Brain Sciences Institute at Swinburne University in Melbourne, Australia, and Gemma Calvert, Managing Director of Neurosense, a UK consultancy specializing in the application of neuroscience to consumer marketing.  About 90% of the subjects participated in studies employing SST/EEG to measure brain activity.  The remainder took part in fMRI measurements.  The $7 million (US) or so that Mr. Lindstrom claims the research cost was provided by a few client companies.  Mr. Lindstrom reminds us repeatedly (4 times in the first 11 pages of the book) that this is the “most extensive study of its kind ever conducted” (and “twenty-five times larger than any marketing study ever conducted”).

Unfortunately, the book fails to deliver the goods promised in the subtitle, “Truth and Lies About Why We Buy.”  It may be that Mr. Lindstrom kept all the good stuff for the clients who kicked in to fund his study.  Instead of an informative report on a comprehensive program of research, we get only the sketchiest details of the neuroscience experiments (and when we do, the results are usually “shocking”).  Mr. Lindstrom has received some attention for his finding that warning labels on cigarette packs and advertisements may actually trigger a craving for the product.  He tries to extend this finding to broader areas of marketing, but I’m not sure that physically addictive products are the best neuroscience model for other consumer goods.  His general technique is to toss out a proposition about some underlying, presumably unconscious process that determines our marketplace choices, provide a number of anecdotes as examples of this proposition and, finally–in some but not all cases–share some finding or other from his study that proves what he’s telling us.

In a paper presented at the ESOMAR Congress 2006 (title “Cognitive Neuroscience, Marketing and Research:  Separating Fact from Fiction”), Jane Raymond, a neuroscientist at Bangor University in Wales, and Graham Page of Millward Brown note that “a great many papers have been written and presented on cognitive neuroscience in recent years–some by neuroscientists, some by enthusiastic amateurs, some by start-ups with a product to sell.”  By the way, this paper is an excellent introduction to cognitive neuroscience and it’s potential relevance for marketers.  I’m not sure if it’s available anywhere except in the conference proceedings.

Mr. Lindstrom’s enthusiasm for his topic is evident throughout the book and despite the fact that he comes up short with respect to practical information or to my standards for research-based books, it’s still a fun read.  One thing that annoys–almost all of the notes are presented in the form of URL’s rather than bibliographic citations, and almost all of them are from secondary sources rather than the original research reports or articles.

So, by all means read this book if you like, but don’t take it as the final word on the way our brains govern our marketplace choices.

Copyright 2009 by David G. Bakken.  All rights reservcd.

I heard Dan Ariely speak at the AMA Research Conference in Boston last September before I read this book (Predictably Irrational: The Hidden Forces That Shape Our Decisions, Harper, 2008).  He gave the audience a riveting account of his experience recovering from burns caused by the explosion of a magnesium flare.  You can read the account for yourself in the introductory chapter to this book (“How an Injury Led Me to Irrationality and to the Research Described Here”).  In a nutshell, Ariely questioned the conventional wisdom of the nursing staff that it was less painful overall to remove the bandages covering his burns quickly rather than gradually.  Ariely eventually put this to the test with experiments involving various sources of pain and concluded that the nurses, despite the best intentions, were wrong.

In the subsequent chapters, Ariely systematically dissects our decision processes, showing again and again that most of the time we are not the rational, utility maximizing creatures found in contemporary economic theory.  Ariely’s speech at the AMA conference (as I remember it) focused on asymmetric dominance.  Choosing between two different but attractive alternatives is very difficult for most people.  Ariely gave the example of choosing between a luxury vacation in Paris and a similar vacation in Rome.  But… if we throw another alternative into the mix–say a less luxurious package in Rome–the choice suddenly becomes much easier, and a majority of people will choose the more luxurious Rome vacation.  This is asymmetric dominance.  The luxurious Rome vacation becomes more attractive because we can more easily compare it to the lesser package for Rome.  We might not know whether the Paris package is better than the Rome package, but we definitely know that the more luxurious Rome package is better than the less luxurious package.  In effect, the introduction of the inferior Roman alternative has bumped Paris out of the choice process.  This topic is covered in the first chapter of the book, “The Truth About Relativity.”

This is important stuff for market researchers and marketers.  Asymmetric dominance can come into play in market research studies that rely on choice-based conjoint (CBC).  I’m pretty sure that I’ve designed a few CBC studies over the years where asymmetric dominance may have been at work (inadvertently, of course!).  

Other chapters are equally valuable.  In Chapter 5, “The Influence of Arousal,” we learn how decisions change as a function of the state of arousal.  Market researchers often ask consumer how likely they are to purchase some good or service in the future.  After reading this chapter, you’ll question whether the “cold” survey question can ever accurately capture what consumers will do in the “hot” purchase situation.  A practical implication–consumers are more likely to give “accurate” information about what they will do when they are immersed in the buying process.  There’s plenty more food for thought in chapters with titles like “Keeping Doors Open (Why Options Distract Us from Our Main Objective),” “The Effect of Expectations (Why the Mind Gets What It Expects)” and “The Power of Price (Why a 50-Cent Aspirin Can Do What a Penny Aspirin Can’t).”

Ariely writes in a personal, conversational style–you’ll not only learn something about irrationality, you’ll learn about Ariely, his family, his collaborators and students.  The subjects in his experiments also get the personal treatment.  Ariely describes his experiments in just enough detail to convey the systematic nature of his efforts, but not quite enough detail to convey the rigor required for sound psychological research.  Taking Ariely’s accounts at face value, it’s not clear that controls such as counterbalancing for order of presentation and similar procedures for assuring internal validity were employed.  Many of the experiments are conducted in natural settings.  We have to take Ariely’s word for the magnitude of the effects he observes, since we don’t get enough information to assess statistical conclusion validity.

The experiments described in this book are part of a long tradition of research in cognitive and social psychological processes that goes back at least as far as Fritz Heider (The Psychology of Interpersonal Relations, John Wiley & Sons, 1958).  I’m a little unsettled by the way in which this book seems to suggest that the investigation of irrationality is relatively recent and more or less exclusive to behavioral economics.  Ariely has every right to focus on his own research–there’s lots of fascinating stuff here–but psychologists have been studying these processes for a long time.  For some classic examples, see The Social Animal by Elliot Aronson and Mistakes Were Made (But Not by Me):  Why We Justify Foolish Beliefs, Bad Decisions and Hurtful Acts by Carol Tavris and Elliot Aronson.  The contribution of the behavioral economists is to extend those themes to areas involving monetary transactions.

Bottom line:  this is an enjoyable, thought-provoking read.  

Copyright 2009 by David G. Bakken

Why Popcorn Costs So Much at the Movies and Other Pricing Puzzles, Richard B. McKenzie, Copernicus Books/Springer, 2008.

One of the rituals of high school is the senior picture.  Nowadays, that often means a trip to a professional studio for a shoot involving multiple outfits, poses and backgrounds.  The student is not obligated to buy any photos–the yearbook photo is provided for free–but the studios hope to sell a package of prints to the student and his or her family.  When one of my children went through this a few years ago, we were presented with a confusing array of packages that varied in the number of poses, the sizes of the prints, and the number of prints of each size that were included.  Say you want to have a more formal pose for the yearbook (that counts as one pose, even though that picture is “free”) and an informal pose for wallet-size prints–you’ll have to buy a package that includes two poses.  That’s not all–in order to get those two poses and a certain number of wallet-size prints, you may be forced to take so many 5x7s and a couple of 10x12s or some other mix of sizes.  And don’t think you’ll be able to figure out the individual prices for wallet-size, 5×7, and 10×12 prints.  There likely is no a la carte offering.

When I went through this with one of my children a few years ago, I wondered how the studio arrived at this particular bundling strategy.  This is precisely the kind of pricing “puzzle” that Richard McKenzie, the Walter B. Gerken Professor of Enterprise and Society in the Paul Merage School of Business at the University of California, Irvine, dissects in this intriguing but (at least for me) occasionally frustrating book.

Pricing makes the economy go ’round.  Pricing is also complex, and economic theory can leave us wanting when it comes to understanding the way that prices work in the “real” world.  Professor McKenzie does a good job of tackling this complexity head on, and anyone whose job is remotely connected to pricing will benefit from reading this book.  Consumers who are curious about the prices they pay (or don’t, for “free” goods) and how they got that way are likely to enjoy this book as well.

McKenzie has given a lot of thought to a wide range of pricing anomalies.  In addition to the title’s question about the high price of popcorn at the movies, here’s a sampling of the puzzles McKenzie ponders:  why there are reduced price sales, why there are so many discount coupons, why some goods are free, why printers are cheap and ink cartridges are expensive, why ticket prices are the same for all movies, why so many prices end with “9,” and why manufacturers offer rebates.

The underlying economic principle in many of these chapters is price discrimination.  In other words, these pricing anomalies arise as a way to distinguish customers who are more price sensitive from those less price sensitive with respect to a given category of goods or services.  A classic example of price discrimination can be found in discount airline fares that require a Saturday night stay in the destination city (thus selecting out the less price sensitive business travelers).  However, this book is nothing if not comprehensive, and McKenzie covers other pricing effects, including distortions introduced by market interventions.

McKenzie’s writing is engaging and readable.  The typical chapter begins with an exploration of the common sense or “obvious” explanation for a pricing anomaly (popcorn costs more at the movies because the consumers are captive, allowing the theater owners to exploit their desire for popcorn) and works his way through competing plausible explanations.  As in, maybe popcorn costs more at the movies in order to keep ticket prices lower.

Maybe it’s just McKenzie’s style, but all too often the explanations for these pricing puzzles come across as speculative hypotheses awaiting empirical verification.  When evidence is offered, as with data on the prices of printers and ink cartridges, it is usually consistent with McKenzie’s explanation, but not necessarily conclusive.  McKenzie gives much more weight to the consumer (demand) side of the pricing problem than he does to the producer (supply) side.  In my experience, manufacturers struggle with a host of cost considerations in setting prices that McKenzie barely touches on.

The chapter titled “Why movie ticket prices are all the same” exemplifies the things I really like about this book, as well as some of the things I found a bit frustrating.  McKenzie provides a fairly rich picture of the relevant economics of the motion picture industry as he explains the apparent anomaly that prices for the most popular movies are the same as those for the least popular. According to McKenzie, this pricing makes sense given that, prior to release there is a lot of uncertainty surrounding the potential popularity of a particular film.  Moreover, there are other pricing “mechanisms” that provide greater returns to the most popular films.  For example, less popular films disappear from first-run theaters fairly quickly, perhaps moving to second and third run screens with lower ticket prices, resulting in higher average ticket prices for the most popular films.

In the case of movie ticket prices, as with some of the other pricing anomalies covered in this book, McKenzie omits or is perhaps unaware of information that might favor alternative explanations.  For example, theater owners do exert some price differentiation for films that are expected to be more popular.  When I went to see “Star Trek” last week, there was a notice at the box office that discount coupons offered by the theater would not be accepted for that movie (at least for the opening weekend). Another nit–there’s no mention of the impact of the multiplex theater configuration on uniform ticket prices.  In the multiplex setting, charging different prices for different films likely would require additional staff to police admittance to the individual movies, thus raising the theater owner’s costs. For a another take on the economics of movie ticket pricing, see The Economic Naturalist:  In Search of Explanations for Everyday Enigmas by Robert H. Frank of Cornell University (Basic Books, 2007).  Frank covers some of the same territory as McKenzie, and I recommend his book as well.

Final verdict–this is a must read book for anyone who deals with pricing.