Habit Forming Products

More than 40% of actions people perform each day aren’t actual decisions but habits.

Charles Duhigg opens “The power of habit” with a fascinating story to explain how our brain is composed of layer upon layer of cells, the outside cells, closer to the scalp, are generally the most recent addition from an evolutionary perspective, at the hearth of it you find the primitive part of our brain (basal ganglia).

Why does it matter? Because as much as we believe we are sophisticated animals, we (all) carry the legacy of our evolution.

Habits for instance emerge because the brain is constantly looking for ways to save efforts, think it back when being “low power” at the wrong moment might lead to extinction (i.e. failing to notice a predator)

Experiments have showed how habits can reduce drastically the brain activity by removing the cognitive load to make decisions of which we already know the outcome. (and leave buffer for other potential tasks like scanning for a predator).

Our Brain ( or system 2 as defined by D. Kahneman) is no longer involved in the decision making and the basal ganglia (system 1) ensure that everything unfolds as planned (pattern) once a cue offers a hint as to which pattern should be used to have the desired reward.

An example could be a sense of craving which make us stand up and go in the kitchen without making an conscious decision to do so. (or an Ad…)

The Habit Loop

which is what triggers the system/pattern
a well establish pattern that we are comfortable delegating to our System 1
a reward at the end of the routine (i.e. eating, or a pleasant sensation)
a craving (i.e. willingness) sensation that fuels the above three steps

It has been shown that the above can be pushed one step further. Over time our brain is discounting the reward even before the reward actually arrives…to the point that the cue itself (the start of the habit loop) results in a physical response.

An interesting application of these concepts can be seen on our everyday life, lets take for example Apple Mail in our iPhone. How many times do we open to check our emails? How many times we feel excited by seeing that red dot on the icon?

See in that case the habit loop is even more interesting, because we cannot discount for sure a good outcome from that red dot in our icon (chances are it will just be an advertisement or spam), but once in a blue moon a good message comes in, and having a variable reward is even more powerful, is addictive. Plus, as behavioural finance teaches us, we are predisposed for overpaying/overestimating lottery tickets & insurances. (i.e. our assessment of a non linear outcome function gets a bit wanky towards the tails)

There are many examples in the past where having habit forming products has resulted in great successes. Pepsodent marketing strategy in the 30s when dental hygiene was a nation security risk (less than 10% was doing it) was to create a fresh and tingling sensation after brushing your teeth which was arguably not required for the purpuse of a toothpaste (i.e. cleaning your teeth) but was the key to close the habit loop around the product.

I believe if correctly specified (cue and reward) and executed properly and for the right reasons, the habit loop or the “stickiness” of certain product categories makes them very interesting from an investment perspective.

An habit forming product (HFP) is by definition low beta (anti cyclical)  given its idiosyncratic nature ( you crave it no matter what), by the same reasons, an HFP is also less elastic to pricing changes. It would be interesting to rank or at least assess the level of “HFP’ness” of new ventures, its difficult to forecast demand at an early stage but having a stickiness factor to a revenue stream (i.e. returning costumers) is a key ingredient for a successful company.

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