“Where all think alike, no one thinks very much.”
— Walter Lippmann
The five most dangerous words in business are: “Everybody else is doing it.”
— Warren Buffett
The principle of social proof derives from social comparison and conformity. We naturally compare our behavior to what others are doing. If we notice a difference we feel some pressure to change our behavior.
Consider laugh tracks while watching TV. I suspect at one point or another you've been watching TV while a laugh track came on and encouraged you to laugh at a joke that you didn't think was all that funny.
Advertisers love to exploit social proof. Rather than convince us directly that a product is good, often ad-copy will use terms like “fastest-growing” or “largest-selling.” Unconsciously our brains think all of these other people can't be wrong.
Another everyday example of social proof is how baristas at your local coffee shop have adopted the principle of salting the collection plate from churches. Ushers used to salt the collection plate by placing several different bills onto the collection plate before it was passed around. Even a little ‘salt' helps and research demonstrates that salting with higher bills yields higher collections (possibly because of the combination of social proof and anchoring). Baristas, clever as they are, often salt the tip plate with “large change” and quickly remove pennies and nickels.
In his best-selling book, Influence: Science and Practice, Robert Cialdini writes:
(The principle of social influence) states that we determine what is correct by finding out what other people think is correct. The principle applies especially to the way we decide what constitutes correct behavior. We view a behavior as correct in a given situation to the degree that we see others performing it. Whether the question is what to do with an empty popcorn box in a movie theater, how fast to drive on a certain stretch of highway, or how to eat the chicken at a dinner party, the actions of those around us will be important guides in defining the answer.
The tendency to see an action as appropriate when others are doing it works quite well normally. As a rule, we will make fewer mistakes by acting in accord with social evidence than by acting contrary to it. Usually, when a lot of people are doing something, it is the right thing to do. This feature principle of social proof is simultaneously its major strength and its major weakness.
From the 1990 Wesco Annual report
Granting the presence of perverse incentive, what are the operating mechanics that cause widespread bad loans (where the higher interest rates do not adequately cover increased risk of loss) under our present system? After all, the bad lending, while it has a surface plausibility to bankers under cost pressure, is, by definition, not rational, at least for the lending banks and the wider civilization. How then does bad lending occur?
It occurs (partly) because there are predictable irrationalities among people as social animals. It is now pretty clear (in experimental social psychology) that people on the horns of a dilemma, which is where our system has placed our bankers, are extra likely to react unwisely to the example of other peoples’ conduct, now widely called “social proof”. So, once some banker has apparently (but not really) solved his cost-pressure problem by unwise lending, a considerable amount of imitative “crowd folly,” relying on the “social proof,” is the natural consequence. Additional massive irrational lending is caused by “reinforcement” of foolish behavior, caused by unwise accounting convention in a manner discussed later in this letter. It is hard to be wise when the messages which drive you are wrong messages provided by a mal-designed system.
In Managing With Power Jeffrey Pfeffer offers:
There are many examples of the effects of social proof in organizations, some almost as compelling as the lack of bystander interventions in stabbings. In some instances, social proof was used intentionally to obtain and exercise interpersonal influences; in others, social proof occurred almost accidentally, but still can help us understand what happened and why. The fraudulent transactions of OPM Leasing are a case in point. Some of OPM's victims were among the leading banks and investment bankers in the United States. And though this fact inspires amazement, it also helps explain how such massive fraud could have persisted for so long and on such a scale.
As Gandossy noted, OPM began as a legitimate business, and over the years engaged in thousands of legitimate leasing transactions, many times the number of fraudulent transactions. Thus, many of their associations were totally honest, and those associations may have caused those who suspected fraud to question their own judgment. Moreover, they intentionally used social proof as a strategy.
Like most executives, Goodman and Weissman were concerned about OPM's corporate image, and they did several things to elevate their standing with outsiders.
First they associated with elite, well-known corporations, correctly believing that by doing so, outsiders would see them as bigger and better than they actually were. In their first few years they hired Big Eight accounting firms, and, later, venerable investment banking houses (Goldman, Sachs) to arrange credit. They didn't employ such firms merely to obtain improved service but simply to establish legitimacy in the marketplace. Whenever possible they exploited their elite associations … in meetings and correspondence with prospective lessees and lenders, Goodman was quick to mention OPM's relationship with Goldman, Sachs and Lehman.
OPM used its associations to promote the belief it was engaged in legitimate business. With no one questioning its operations—after all, many of the firms were receiving handsome fees—it was difficult for any individual or organization to violate the social consensus and question what was going on. And the longer it went on, the harder it was to question, for there was now a larger set of relationships, and a history of commitment, which made uncovering and disclosing the fraud increasingly unlikely.
In his famous speech, The Psychology of Human Misjudgment, Charlie Munger offers:
If you think about the doctrines I've talked about, namely, one, the power of reinforcement—after all you do something and the market goes up and you get paid and rewarded and applauded and what have you, meaning a lot of reinforcement, if you make a bet on a market and the market goes with you. Also, there's social proof. I mean the prices on the market are the ultimate form of social proof, reflecting what other people think, and so the combination is very powerful. Why would you expect general market levels to always be totally efficient, say even in 1973-74 at the pit, or in 1972 or whatever it was when the Nifty 50 were in their heyday? If these psychological notions are correct, you would expect some waves of irrationality, which carry general levels, so they're inconsistent with reason.
Finally, the open-outcry auction. Well the open-outcry auction is just made to turn the brain into mush: you've got social proof, the other guy is bidding, you get reciprocation tendency, you get deprival super-reaction syndrome, the thing is going away… I mean it just absolutely is designed to manipulate people into idiotic behavior.
From Janet Lowe's Damn Right:
Social Proof, imitative consumption triggered by the mere sight of consumption, will not only help induce trial of our beverage (referring to Coca-Cola). It will also bolster perceived rewards from consumption. We will always take this powerful social-proof factor into account as we design advertising and sales promotions as we forgo present profit to enhance present and future consumption.
Warren Buffett penned the following memo to Berkshire Hathaway Managers:
The five most dangerous words in business may be “Everybody else is doing it.” A lot of banks and insurance companies have suffered earnings disasters after relying on that rationale.
Even worse have been the consequences from using that phrase to justify the morality of proposed actions. More than 100 companies so far have been drawn into the stock option backdating scandal and the number is sure to go higher. My guess is that a great many of the people involved would not have behaved in the manner they did except for the fact that they felt others were doing so as well. The same goes for all of the accounting gimmicks to manipulate earnings – and deceive investors – that has taken place in recent years.
You would have been happy to have as an executor of your will or your son-in-law most of the people who engaged in these ill-conceived activities. But somewhere along the line they picked up the notion – perhaps suggested to them by their auditor or consultant – that a number of well-respected managers were engaging in such practices and therefore it must be OK to do so. It’s a seductive argument.
But it couldn’t be more wrong. In fact, every time you hear the phrase “Everybody else is doing it” it should raise a huge red flag. Why would somebody offer such a rationale for an act if there were a good reason available? Clearly the advocate harbors at least a small doubt about the act if he utilizes this verbal crutch.
So, at Berkshire, let’s start with what is legal, but always go on to what we would feel comfortable about being printed on the front page of our local paper, and never proceed forward simply on the basis of the fact that other people are doing it.
A final note: Somebody is doing something today at Berkshire that you and I would be unhappy about if we knew of it. That’s inevitable: We now employ well over 200,000 people and the chances of that number getting through the day without any bad behavior occurring is nil. But we can have a huge effect in minimizing such activities by jumping on anything immediately when there is the slightest odor of impropriety. Your attitude on such matters, expressed by behavior as well as words, will be the most important factor in how the culture of your business develops. And culture, more than rule books, determines how an organization behaves.
Thanks for your help on this. Berkshire’s reputation is in your hands.
“Big-shot businessmen get into these waves of social proof. Do you remember some years ago when one oil company bought a fertilizer company, and every other major oil company practically ran out and bought a fertilizer company? And there was no more damned reason for all these oil companies to buy fertilizer companies, but they didn't know exactly what to do, and if Exxon was doing it, it was good enough for Mobil, and vice versa. I think they're all gone now, but it was a total disaster.”
— Charlie Munger
From: A Room with a Viewpoint: Using Social Norms to Motivate Environmental Conservation in Hotels:
When consumers learn that seven out of 10 people choose one brand of automobile over another, that teeth-whitening toothpaste has become more popular than its less functional counterpart, and that nearly everyone at the local cafeteria steers clear of the “spamburger surprise” entree, they are getting information about social norms. Specifically, they are getting information about descriptive norms, which refer to how most people behave in a situation. Descriptive norms motivate both private and public actions by informing individuals of what is likely to be effective or adaptive behavior in that situation. A wide variety of research shows that the behavior of others in the social environment shapes individuals’ interpretations of, and responses to, the situation, especially in novel, ambiguous, or uncertain situations.
In Situations Matter, Sam Sommers writes:
Situations, even emergencies, can be ambiguous. At the time, we often don't know they are emergencies. So we use the people around us as guides. We gauge their reactions so that we may calibrate our own responses. If no one else seems alarmed by what's going on—when everyone goes about business as usual—we assume that all is well. We see no reason to forsake inaction for action.
…conformity is an internal process by which we sense a group's norm and adjust accordingly.
Social Proof is in the Farnam Street Latticework of Mental Models.