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Three Second Rule

GreenWood Investors – The Three Second Rule

Our first quarter letter’s discussion on paying more attention to the whims and fancies of Mr. Market’s focus spurred a few friends to recommend some great psychological summer reads.

Q2 2020 hedge fund letters, conferences and more

To quickly summarize the quarterly letter, System 1 thinking, the fast and often emotional parts of our brains, drives the stock market on a day to day and week to week basis. System 1 also drives most purchase considerations in the commercial marketplace, and as we’ll see, even drives voting outcomes.

While the nomenclature of System 1 and System 2 is modern, the concept of having separate minds is ancient. The distinction began with Buddha and even formed the core of Adam Smith’s Theory of Moral Sentiments, which laid the groundwork for our understanding of economic behaviors. He wrote, “I divide myself, as it were, into two persons; and that I, the examiner and judge, represent a different character from that other I, the person whose conduct is examined into and judged of.”

Although psychologists over the past few decades have advised us all to not trust the judgement of System 1, it is there to ensure our survival. While it’s not good at creativity, cooperation, collaboration, or rational thinking, it’s very good at fighting or flighting. And surprisingly, in this era of cooperation and collaboration, we still use it frequently.

Advertisers have long known, if subconsciously, that appealing to the System 1 was key to highly successful commercial campaigns. And it just so happens that a highly enjoyable read from some ad guys, System 1 – Unlocking Profitable Growth, by Kearon, Ewing & Wood came along right as a few managers at CTT have been working on launching a completely new commercial offering for our network. While I encourage any interested to read the book, as it was highly enjoyable, with multiple illustrations, I’d like to summarize some of the key findings in this post. And I’ll add a few of my own examples to help illustrate the points made in System 1.

System 1, The TimeSaver

In their highly enjoyable work, the authors start off by reviewing known biases and heuristics that psychologists and marketers have profiled on our System 1.

These psychological biases are largely only relevant to our fast-thinking, and fast-talking parts of our brains. The right pre-frontal cortex, which is pivotal for greater understanding and our sense of self, is not affected by the biases and shortcuts of the rest of the brain. While using System 2 and the pre-frontal cortex is highly enjoyable (as gamers well know), it’s also taxing. You are consuming a very heavy amount of calories when you’re using System 2. Think of it a bit like when you’re using your computer’s resources heavily, the fan turns on, and sometimes it goes turbo. That’s what our System 2 does to us. When it’s in control, we often do our best thinking, imagining, and understanding, often through feeling and intuition, as the right brain doesn’t bother itself with the limitations of language and speech.

As the authors point out on page 26:

“The psychologist Sendhil Mullainathan studied decision-making among those in poverty. He found that a shortage of money leads to a state of constant cognitive depletion. Every day, you have to work out how much you have, what you can afford, how to allocate resources within your family, and so on. Because your System, 2 is under such pressure, you rely on System 1 even more. Trouble is, this can make you more susceptible to impulsive decision-making, and tempted by products, packaging and offers that provide instant gratification. But System 1 is vital because it saves time and energy, two things that poverty can seriously reduce.

If we go back to Ice Age humans, they often had to make life-or-death decisions very quickly. The ability to do this by instinctively processing past experience was vital. If they relied on the slow, considered, System 2 in every situation, they would not have survived. So fast and frugal decision-making isn’t a mere substitute for ‘real’ thinking. It is the real thinking – an evolutionary marvel that’s kept our species alive.”

Even on seemingly complex tasks, we tend to try to revert to using the System 1 part of our minds as frequently as possible. Malcolm Gladwell’s high profile 10,000 hour rule he introduced in The Outliers was describing the typically long period required for System 1 to achieve mastery of a complex subject. But if you don’t have 10,000 hours, turning on System 2 is a great way to operate at a very capable level. Still, it would be great if you’re well-rested and well-fed the moment you need your System 2 the most.

Could this notion perhaps describe beginners’ luck? Surely it would be an interesting study, as beginners are clearly using System 2 on turbo mode. As the authors point out, “the fact that System 2 can sometimes make better decisions doesn’t mean we always give it the chance… Shortage of time, tiredness, hunger and sexual arousal can also make System 1 even more dominant.”

Daniel Kahneman, the master of studying the psychological biases of System 1, even observed in a famous study of Israeli judges that the single biggest factor that influenced the longevity of prison sentences was how recently they had taken a break.

Emotion: The Ultimate Hack

So clearly System 1 is a time and energy saver – something we all highly value. But it’s also highly affected by emotions. System 1 is as old as animal consciousness. It is housed in the oldest segment of the human brain. Deeper within the limbic system is the most ancient part of our brains, the stem and cerebellum, often called the “reptilian” brain. It contains the amygdala, or the fight or flight segment of our brains, but it also has many other parts of our brains that lead to both positive and negative emotions.

An emotion is simply a hack. Just like a picture is worth a thousand words, an emotion is worth a novel of instructions. In a millisecond, it informs us if we want more of something or if we need to avoid it. It’s a very effective time saver. But as Daniel Kahneman and Amos Tversky have pointed out, these emotions, particularly in the modern society, are often ill-informed. Stimulating someone’s emotions will pigeon-hole them into using their System 1, whether intentionally or not.

That’s why the most effective advertisements and brands elicit emotional reactions in us. As the authors stated very simply as a precept, “the more people feel, the more people will buy.” Even in an era of digital advertising, “the most effective medium for creating happiness is still film,” helping to explain why video formats on Twitter are by far the most popular ad type (well over half of its ad formats), and the entire industry is hyper-focused on connected TVs and video advertising.

Interestingly, Daniel Kahneman’s peak-end rule, helps predict how well our System 1 will receive an advertisement. What we remember is a function of the average of the emotional peak and the end. So advertisements that have a climax early keep our attention and memory focused throughout. This helps explain why so many great films and books start with an action-oriented foreshadowing of the climax only to fall back into a background explanation after the introductory action peaks our brains.

Source: UI Patterns

Fame, Feeling & Fluency

When introducing brands, products, services or concepts to others, we would do well to remember the 3 Fs: fame, fluency and feeling. Fame is relatively straightforward, and also helps to explain why in a world of digitalized and targeted direct-response ad formats, they haven’t taken the entire industry. Companies that only spend their advertising dollars on direct-response formats are not playing the long game. Brand advertising is highly important to augment the “top of mind” performance for products. In The Long And Short Of It, Les Binet and Peter Field concluded that a good rule of thumb for the division of the advertising budget should be 60% spent on brand advertising and only 40% on direct response and sales activations.

System 1 works rapidly, and doesn’t have time to access our memory banks, so famous brands and products have a virtuous circle of success when it comes to influencing System 1.

One thing I found interesting was the two different results marketing experts received when conducting customer surveys. New products that are rationally better than the older, more tested products, require us to access System 2 to appreciate the merits. Under untimed tests of consumer choices, System 2 prevailed and the newer and better products won more often.

But that’s not what’s driving most of our decisions, particularly at a supermarket filled with tens of thousands of SKUs. The marketing measurers got completely different results when applying a 3-second time limit to consumer choice surveys. And those correlated much more strongly to actual real-world commercial performance. Measuring consumer preference under time constraints, a three second limit, is a much more accurate predictor of commercial success than a slow and deliberate process.

Fame, feeling and fluency help inform rapid System 1 decisions, and hence, drive adoption. We’ve covered the importance of fame and feeling, but what does fluency mean? Fluency is essentially making something easy to understand. “Fluency is about being distinctive – easy to recognize, easy to understand, easy to mentally process.”

Every successful movement or product has a high sense of fluency. Think of the Catholic Church adopting most pagan holidays, names, days, and customs. It made adoption much more possible than introducing a completely new religion to a society. Darwin even used this concept in his Origin of Species by first devoting considerable time “to re-iterating conventional knowledge on the cross-breeding of dogs and birds before going into uncharted territory.”

The authors conclude that introducing new concepts, products, services or innovations require that innovation to be 80% familiar and only 20% new. The element of “surprise” is best optimized to comprise no more than 20% of the emotion one feels when seeing or hearing about that item of focus. More surprise will then require System 2, which normally makes us move onto less demanding, and safer, choices.

The book gives a few iconic examples. When designing an espresso maker for at-home use, Alfonso Bialetti borrowed from the design of the already very popular coffee service trays, which were already heavily used in Italy in the 1930s. The octagonal espresso maker is today a globally recognized design, and it was an instant success in Italy, where 9 in 10 households own at least one, and most have a very high number of Mokas. I think my nonna must have had over 10 to ensure no matter how many people were over, there would be a perfect amount of fresh espresso to serve them.

Another example is the Maclaren umbrella stroller (or push chair). In 1966, when introducing the ingenious design that has since saved a lot of traveling parents’ backs, Owen Maclaren used the same fabric that a seaside deck chair would use. What better way to subconsciously appeal to traveling parents than by using the very fabric they’d be sitting on in the South of Spain?

Donald Trump: The Walking System 1

Using the 3Fs, the authors also interestingly showed how the election of Donald Trump was predicted nearly a year before the actual victory. But in making their point, they did miss one thing: he is a walking amygdala. It appears that the US president is unable to form long-term plans, and instead prefers to think on his feet, where his strongest performances come. Already in the United States, democrats, republicans and independents are excited to watch the debates between the two presidential contenders, which will be must-watch television. This is largely because we know the walking System 1 is inherently unpredictable and provides some entertainment value, depending on your political affiliation.

But being a walking System 1, Donald Trump is great at appealing to others’ System 1. It takes one to know one. His “build the wall” campaign was one of the most recognizable policy positions, and in three words adequately summarized a complex issue such as immigration, while also evoking emotions – either positive or negative – depending on which side you were on.

Even prior to the last four years of shock after shock, Trump never elicited positive emotions in the population. In fact, very few politicians do. He had fame in spades, as did Hillary Clinton and as does Joe Biden. But neither democrats have quite the knack to summarize their candidacy the same way “Make America Great Again,” has been able to do – with globally recognized merchandize nonetheless.

As a friend mentioned to me yesterday, the UK version of the System 1 expert is Boris Johnson’s Chief Advisor Dominic Cummings, who came up with the “Take back control,” mantra which saw the pro-Brexit vote win marginally. The three-word mantra was a brilliant and emotional appeal to System 1’s loss-aversion instincts. Now that everyone in the UK is fed up with hearing about it, he came up with another zinger to gain political momentum to “Get Brexit Done.” These highly fluent phrases are a powerful influencer of our System 1 and surely have influenced UK politics permanently.

Surely a vote for multi-decade international agreements or for one of the most powerful positions on the planet, if not the most, should require some of System 2, right? I think for most people reading this, the answer is a clear and definitive yes. But as the authors point out, “we think much less than we think we think.”

Conclusion

The whole reason I wrote this was to provide additional ammo to our managers at CTT who are busy upgrading the customer experience while also laying the groundwork to launch new innovations. Given it is a 500 year old brand, fame is clearly not a question. Feeling can be improved upon, as abruptly changed quality criteria for regulatory purposes hide the actual underlying improvement in the quality of service. But we’re encouraged that newer services, like BancoCTT, have very high NPS scores.

The company is a location where people come to “get things done,” and the quicker, the better for everyone all around. CTT has made significant investments in shortening the time it takes to send things from here to there, while also cross-selling to the highly valuable traffic that comes to stores daily.

For the newest innovations and services to be launched successfully, they need to carry a high degree of fluency. They need to have a high degree of familiarity, recognizability, and we need them to be a natural fit for that product or service to successfully sell well. There are a lot of great ideas germinating, and some of the press coverage from the latest store opening would lay some hints about the direction the company’s locations are heading (some photos here and here). We believe they will help improve the “feeling” while also increasing the relevance for people in their daily lives. Fame + fluency + feeling is the trifecta for market-share conquering firms.

Most intellectual people often try to shun System 1. As the permanent scowl on President Trumps’ face confirms, it’s not really a happy place to live. It’s the world of Mr. Market, the world of fight or flight, or of greed and fear. It’s not easy to do so, but ignoring this voice most of the time is key to happiness. This ignoring of System 1 is why so many were stunned when Donald Trump won rustbelt states, helping him secure the electoral college and win the presidency. Those operating in System 2, where most value-creators do, would do well to remember that what drives choices in the commercial market, the stock market and the political market, is that old ancient friend, System 1.

Article by GreenWood Investors


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