Loss aversion

In Priceless, a book studying the hidden psychology of value, William Poundstone provides a concise definition of loss aversion:

“Losing money (anything of value) hurts more than gaining that same thing delights.”

In ‘Decoded‘, the marketer Phil Barden provides a similarly eloquent definition:

“We dislike loses more than we like gains of an equivalent amount.”

Poundstone goes on to illustrate how much more we dislike losses:

“You can demonstrate loss of version by offering a bet on a coin toss. Tales you lose £100, and heads you win X. How big does X have to be for you to take the bet?

Surveys show that few want to accept a ‘fair’ bet, that’s with X = £100. Few accept X = £110, which offers a nice expected profit. (Those who do accept at this price tend to be gamblers, arbitrageurs, or economists.) The average person requires roughly a £200 price to balance the prospect of an equally probable £100 loss.”

Barden then goes on to take a closer look at loss aversion’s relevance to marketing.

In order to encourage people to buy a product we often communicate a call to action, in which it is common to focus on telling consumers how much they can save. As this reduces the perceived pain, it works. However, the ‘how’ of the saving makes a difference. An energy company in the US found that when they communicated to their customers that switching to energy-saving mode would save (and therefore they would gain) $200 a year, it had very low take-up. However, when they changed the message to show that by not switching to energy-saving mode they would lose $200, there was an extremely positive response. The mechanism behind that is loss aversion.

Furthermore:

Loss aversion is one major barrier for people when it comes to switching brands or adopting innovations: the risk of losing something we value can be exceeded only by offering twice the value. We sometimes come across this in focus groups. Consumers talk positively about a new product or service, but when asked whether they want to exchange the product they currently use for the new one, they suddenly start to reject the new one in favor of what they have. Very often the point is not to get across the best possible value but to avoid the threat of incurring a loss or being disappointed.”

So, people place a higher value on a good that they own than on an identical good that they do not own.

If you’re mathematically minded, we can graph the value that Barden and Poundstone brought to life. It seems, if we receive ‘x’ in gains we experience ‘y’ of pleasure. That’s the blue rectangle below. However, if we lose ‘x’ we experience ‘2y’ of pain. That’s the grey rectangle below.

02 LossAversion

Hey. I’m Alex Murrell. I'm a Planner at Epoch Design in Bristol where I help deliver highly creative, innovative and effective pack, instore and online communications for some of the world’s biggest FMCG brands. Want to know more? You can find me on Twitter or LinkedIn.

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