Understanding Loss Aversion: 4 Tips to Drive Better Decision-Making

I’m fortunate enough to live very close to work. Most days, I walk to and from the Intelliware Development office. However, on the rare occasions that I take public transit, I often wait much longer at the bus stop than it would have taken me to walk the distance. The longer I wait, the less likely I am to start walking.

This sort of behaviour makes very little sense if you think about it, but we make these decisions over and over again in our lives: staying in an unfulfilling job, holding a bad investment, or postponing a doctor’s appointment. Our inability to walk away or change our course of action can be attributed to a theory calledloss aversion.

Loss aversion states that human beings have a strong preference for avoiding losses over acquiring gains. In other words, we hate losing things a lot more than we like getting new things. In the earlier example, I know I can’t get back the time I’ve already lost – it is a sunk cost but I can save time if I begin walking. Yet I chose to wait.

Source: http://www.variginlondon.co.uk/2012/03/hunger-games.html

 

At Intelliware, many of our clients come to us after they’ve sunk a lot of money into an off-the-shelf product that doesn’t work for their business. That decision is hard, and deserves to be recognized. It means acknowledging the loss (the cost of the product, and the time and effort that went into it) and evaluating new options independent of past investments—in this case: custom software development.

Loss aversion also explains why the Agile process works so well. Delivering value early and often encourages us to constantly validate that we’re heading in the right direction because even the smallest loss causes us to respond in surprising ways.

For example, take this natural experiment in the United States. In 2012, Montgomery County introduced a five cent tax on grocery bags and experienced a 42% decrease in the use of grocery bags. Meanwhile, store chains in the Washington Metropolitan Area offered a five cent incentive on reusable grocery bags, but saw no change in consumer behaviour.[1]

Now that you understand how this quality governs a lot of our daily decisions, what does this mean for your business?

  • Give out promotions.
    Instead of making your customers buy the product outright, consider giving them a free trial or a promotional price. Of course, the product itself must be compelling. Having it brings joy, and losing it would be awful. Furthermore, continuing the trial justifies the time and effort a user would have already invested into the product. The idea of losing out on a great deal is much stronger than getting the discount itself.
  • Re-think incentives.
    A common engagement technique in gamification is rewarding the user for actions and achievements. These digital tokens can be points or badges. The theory is that the user will actively seek these rewards and therefore engage with the application more. A potentially more addicting strategy would be to give out the reward first. Then, if the user fails to accomplish some task within a certain timeframe, he runs the risk of losing it.
  • Use effective copy.
    Think about how you word your value proposition so it can be framed as either a gain or a loss. For example, “Save time with our expense tracking software” vs. “How much time are you wasting filing expenses by hand?” On one hand, you’re asking your customers to evaluate something they’ve yet to gain. In the latter, your customers are reflecting on time they’ve already lost. The emotion of loss will drive them towards action.
  • Defer registration.
    When possible, defer registration until the user has already invested some time with you. For example, enable them to complete activities until they need to save their work. At that point, walking away would mean losing that investment. Rearrange a form so the comment field is first and the name and email fields are placed last. Or, allow your customers to apply for a quote and give them the opportunity to save it. The rationale is giving them the opportunity to sign up to not to lose the work they’ve already done, as opposed to evaluate what they can gain by signing up. This also works because of fairness and reciprocity: giving your customers value before asking for information in return.

As a final takeaway, evaluate your own decision-making. Are you sacrificing opportunities because of sunk costs? Are you taking calculated risks? Overcome loss aversion by identifying what it is that you’re scared of, and make a move forward. Shift loss aversion to the goal you can’t afford not to attain.

[1] http://persuasive-patterns.com/patterns/Loss-aversion

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