Why business is addicted to habits

06 May, 2013

Habits are good for business. In fact, many industries could not survive without them. The incentive systems and business models of the companies that make habit-forming products require someone gets hooked. Without consumer habits, these enterprises would go bust.

While most of us think of cigarettes or gambling as habit-forming products, the fact is, a much wider swath of industries rely on consumer’s using their products without thought or deliberation.

These companies have no secret agenda or nefarious ambitions. They are in business to give people what they want, even if at times, what the consumer wants isn’t necessarily good for them.

But like every other company, habit-forming businesses are run by well-intentioned people. Hard-working folks with families and dreams of their own. So how then can these two realities coexist? How can companies seek to hook their customers, while also being run by decent people who have just as visceral of an aversion to manipulation as the rest of us?

The habit business

The answer lies in the business imperative. An enterprises’ worth is the sum of the future profits it will generate. MBAs are taught to calculate the value of an enterprise this way and it is the benchmark investors use to determine the fair price of a company’s shares.

CEOs and their management teams are evaluated by their ability to increase the value of their stock. Their job is to implement strategies to grow future cash flow by some combination of increasing revenues and decreasing expenses.

Creating consumer habits is an effective way to drive share price by increasing what companies call “customer lifetime value.” CLTV is the amount of money made from a customer before they switch to a competitor, stop using the product, or die.

Some products have a very high CLTV. Credit card customers for example, tend to stay loyal for a very long time and are worth a bundle.

Someone must get hooked

Acquiring customers is expensive and time consuming. Ensuring customers are habituated to using a product decreases these expenses, thereby increasing enterprise value.

It’s worth noting that a surprising number of businesses follow a negative binomial distribution, also known as a Pareto concentration. Typically thought of as the 80/20 rule, the phenomenon occurs wherever a few buyers account for the vast majority of revenue. However, at times that split can be much more skewed than one might think.

While for most consumer goods, the concentration tends to be 60/20, for online gaming companies like Zynga, 100% of the revenue comes from just 2% of players.

In most consumer-facing businesses the Pareto Law applies. These customers are obviously very important to the company because without them, the enterprise could not survive, their profit margins simply would not allow it.

The combination of a business imperative to drive shareholder value by increasing CLTV along with the identification of the most loyal customers, means companies spend significant resources competing for a small set of “heavy users.” Companies are therefore highly motivated to hook customers – and keep them using their products for as long as possible.

Nir’s Note: Let me know what you think in the comments section below or send me an email. Do you have any supporting stories to share? Do you know of any relevant studies or examples? Read any good books on the topic? Please let me know.

(Nir Eyal is a Lecturer in Marketing at the Stanford Graduate School of Business and the author of the forthcoming book “Hooked: How to Drive Engagement by Creating User Habits.” Nir blogs about the intersection of psychology, technology, and business at NirAndFar.com. Follow Nir on Twitter @nireyal)

To become a guest contributor with VCCircle, write to shrija@vccircle.com.


Leave Your Comment
Businesses need to understand consumers better than they know themselves: Nir Eyal

Businesses need to understand consumers better than they know themselves: Nir Eyal

TEAM VCC 1 year ago
Creating customer habits around products is a constant challenge for businesses, both big and small. In his book Hooked: How to Build Habit-Forming Products, Nir...
Getting your product into the habit zone

Getting your product into the habit zone

Nir Eyal 5 years ago
As the web becomes an increasingly crowded place, users are desperate for solutions to sort through the online clutter. The Internet has become a giant...
Habit startups

Habit startups

Ryan Hoover 1 year ago
In case you haven’t noticed, habits are a big deal, becoming increasingly important in technology products and in many cases, a necessity to compete. Many...
No Comments

Why business is addicted to habits

Powered by WordPress.com VIP