Why Are People More Concerned About Potential Losses Than Winnings?

  • As anyone who bought stocks at the height of the dot.com bubble will probably understand, making a quick profit is great, but making a loss is difficult to stomach!  Behavioural scientists call this loss aversion. People are intrinsically afraid of losses. When compared against each other people hate losing more than they enjoy winning. Thus losses loom larger than gains even though the value in monetary terms may be identical.
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  • Research by Daniel Kahneman and Amos Tversky  into the psychological value of losses and gains indicated that people may have a loss aversion ratio of between 1.5 and 2.5. This means a loss that is identical in money terms to a gain may be valued up to 2.5 times more than the gain. This is an average as some people are more or less loss averse than others.

 

  • For example professional gamblers are more tolerant of losses. This seems to be because they are less emotionally involved in individual bets than the amateur gambler. The key for any risk taking behaviour appears to be to think like a professional trader or gambler. Don’t get emotional about a purchase or a bet. Think of it as purely a transaction.

Image of 888.com poker table

IMPLICATIONS OF LOSS AVERSION

Loss aversion is one of the most important drivers of human decision making. This is because it inevitably leads to risk aversion and a number of predictable behaviours in certain situations:

Threat to lifestyle:

 

image of playing cards and chips in a casino

  • Where a loss could be ruinous or would threaten their lifestyle, people will normally dismiss the option completely. This is one reason why spread betting companies force customers to set automatic stop losses on most of their accounts. This protects customers from their bad bets by limiting potential losses. If there was no such stop loss in place most people would never consider this type of betting.

Winners and losers:

  • Where people are presented with a situation where both a gain and a loss is possible there is a tendency to make extreme risk averse choices. For instance a person is given the choice between a small but certain gain and a chance for a large gain that also has a low chance of a large loss. People have a tendency to focus on the potential for a large loss and often select the former, more certain option. This is why people are drawn to guaranteed returns and even a small probability of a large loss is enough to make people shy away from certain types of investments.

 Bad choices:

  • Where the choice is between a certain loss and a larger loss that is just a probability (i.e. there is a chance of no loss), diminishing sensitivity can result in  excessive risk taking. This helps explain why people will sometimes throw more money at a loss making venture in the hope that they can turn the business around. Gamblers are also prone to putting more money at risk after making substantial losses. Their mind set is focused on the potential for their next gamble to win the jackpot and wipe out their losses. People become so emotionally involved in trying to avoid a loss that they fail to see they are just making the situation worse.

Image of New York stock market

Power of ownership:

  • Where a person buys something with the intention of consuming or using it the minimum price that they are prepared to sell the item for is often higher than the maximum price they would be prepared to pay themselves. This is called the endowment effect. The ownership of goods appears to increase the perceived value of an item, particularly for goods that are not  frequently traded.
  • This is the result of our reluctance to give up an item that we already own. Such behaviour can be seen in the housing market where sellers often have to lower their initial asking price as buyers frequently are not prepared to pay the price sellers value their homes at. The endowment effect is most prominent for new goods, such as cars, where owners value their goods much closer to the original purchase price than potential buyers do.

Status quo bias:

  • Loss aversion is also powerful force in preventing change. People have a general preference towards the current state of affairs (e.g. their existing supplier) over changing to a better alternative. This is often attributed to a combination of loss aversion and the endowment effect. However, fear of regret in making a wrong decision can also play a part in inertia.
  • This is why it is important to understand the effect of loss aversion and emotional factors when researching how to encourage switching. Money back guarantees and free trials are often used by companies to reduce the perceived risk of loss and regret that stops people switching away from what they know. However, the fear of loss and feeling regret are such powerful emotions that these activities often fall on deaf ears. Loss aversion is probably the most effective loyalty program most companies have on their side.


“Loss aversion is a powerful conservative force that favors minimal changes from the status quo in the lives of both institutions and individuals.” Daniel Kahneman, Thinking, fast and slow.

HOW PEOPLE REACT TO RISK OR PROBABILITIES:

  • As I’ve mentioned, loss aversion and risk are intrinsically linked. Research into the psychological value (i.e the weight) that people give to different probabilities has identified two key biases that influence human decision making in the face of uncertainty.
  • The possibility effect results in highly unlikely (low probability) events being given more weight than they justify.  People naturally overestimate the probability that these events occur and so are more willing than they should be to respond to offers that tap into these perceptions.
  • This helps to explain the attractiveness of betting on unlikely outcomes (e.g. a horse with odds of 100 to 1) and insurance policies that cover uncommon events (e.g. extended warranties). If people assessed odds rationally they wouldn’t gamble on such unlikely events as they would over time be better off keeping their money in their pocket.
  • In market research this means that people tend to express more concern about low probability events such as crime or freak accidents than we might expect them to. This may also explain certain risk averse behaviours that give the impression that the chance of an event is higher than it is in reality.
  • The certainty effect leads to events that are almost certain being given less weight than their probability justifies. Due to loss aversion it is human nature to want to eliminate risk rather then reduce it. In horse racing this means people place fewer bets on the favourite than we would expect if they were totally rational. Instead the possibility effect encourages people to bet on rank outsiders when the odds don’t justify it.
  • In retail, rather than offering 4 for the price of 3, people respond better to 1 free with every 3 purchased. The latter is more compelling because the zero price has more certainty. For websites it also means that if visitors are slightly unsure about how genuine or secure a website is they will have a tendency to magnify the risk. This may lead to visitors abandoning a transaction. It also explains why we are so responsive to guarantees. A guarantee eliminates any uncertainty about the situation, whether it’s about an application being accepted or getting the advertised offer/rate. People are often unsure if they will qualify for offers so a guarantee removes this concern.
  • A study carried out by Kahneman and Tversky for their Prospect theory indicated that unlikely events (1% to 2% probability) are over weighted by a factor of 4. However, for an almost certain event the difference is even larger. In experiments a 2% chance of not winning was given a weighting of 13% (or an 87.1% chance of winning).

THE RISK OF A RARE EVENT:

  • Where the odds of an event are very small (e.g. around 0.001% or less) people become almost completely indifferent to variations in levels of risk. Rather emotional factors and how a risk is framed are the key drivers of how people react to these levels of risk. This helps to explain why people are often too willing to bet on extreme events happening or why they buy multiple lottery tickets when there is a large jackpot.
“When the top prize is very large, ticket buyers appear indifferent to the fact that their chance of winning is minuscule.” Daniel Khaneman, Thinking, fast and slow
  • Research has also found evidence that rich and vivid descriptions of an outcome (e.g. fantasies about your lifestyle as a lottery winner) help to reduce the impact of probabilities. In particular people are more heavily influenced (in terms of weighting of probabilities) if an event is described by using frequencies (e.g. the number of people) than by using standard indicators  of probability or risk.
  • This is why gaming sites tend to promote the number of winners rather than the chance of winning. From a marketing perspective it suggests using rich media to bring events to life and avoid using abstract concepts of probability that people struggle to understand.

So, loss aversion and related biases are a key driver of human decision making in many situations. It explains how uncertainty skews surveys that ask respondents direct questions about risk and uncertainty. If there is any uncertainty about an outcome people are likely to exaggerate the potential risk and respond accordingly. For this reason more value is likely to be gained from observing consumer behaviour and analysing the choices they make (e.g. through conjoint analysis or online experiments).

Thank you for reading my post and I hope it has generated some ideas for future research and experiments.

You can view my full Digital Marketing and Optimization Toolbox here.

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Further reading:

 

  • About the author:  Neal provides digital optimisation consultancy services and has worked for  brands such as Deezer.comFoxybingo.com, Very.co.uk and partypoker.com.  He identifies areas for improvement using a combination of approaches including web analytics, heuristic analysis, customer journey mapping, usability testing, and Voice of Customer feedback.
  • Neal has had articles published on website optimisation on Usabilla.com  and as an ex-research and insight manager on the GreenBook Blog research website.  If you wish to contact Neal please send an email to neal.cole@conversion-uplift.co.uk. You can follow Neal on Twitter @northresearch, see his LinkedIn profile or connect on Facebook.

Why Should You Use Video Mystery Shopping To Protect Your Brand?

 

Using Research To Protect Brand Equity:

Rarely does a month go by and it seems we hear about another mis-selling scandal in financial services. Given the ramifications of the 2008 financial crisis you would expect more monitoring of firms behaviour. This is especially important in retail financial services where poor advice can be very costly to customers and may have long term consequences on their lifestyle.

Given reputation and good will is critical in all businesses it is essential that your customers have confidence that you have the right controls in place to identify when service levels and advice are consistently below expected standards.

 

Image of New York stock market

 

MONITORING CUSTOMER INTERACTIONS:

In one of my research roles I came across a company who assured me that they could measure real customer interactions be sitting next to advisers and recording their telephone conversation with customers. I was advised that this would not influence their behaviour because the advisers were dealing with business transactions. Sales management were also comfortable with this approach.

This is clearly a fallacy. There is plenty of research that indicates it is human nature to behave differently when we know we are being observed. People are more careful to follow standard procedures and want to portray themselves in a good light with everyone concerned.

Indeed, a number of years ago I was asked to establish a programme of research to monitor service standards and identify training needs for an insurance company’s direct sales force. Each sales person was already evaluated on a regular basis by being accompanied and assessed during a normal sales visit. The vast majority of sales people passed these assessments without much trouble. The question was whether these observations were a true reflection of their normal behaviour.

 

EVALUATING FACE-TO-FACE SERVICE & ADVICE:

  • To ensure an accurate and detailed evaluation of service standards and behaviour I established a program of regular mystery customer surveys. We recruited people who met the basic customer profile and gave them a very simple scenario (customer need) to follow. This allowed the customer to use their own details as much as possible. They also collected any documents or leaflets they were given during the process.

THE RESULTS:

  • Sales management and Legal were shocked by the findings. There was a total lack of consistency in how the sales process was followed and most advisers did not perform to expected standards. This was valuable feedback though and a great deal of effort was employed to improve the customer experience and the standard of advice provided.

IMPLICATIONS FOR RESEARCH:

  • Only video mystery shopping (using a hidden camera) can accurately capture every element of customer interactions to ensure there is no disagreement about what was said and done. Where traditional pen and paper mystery shopping was used I believe this was a false economy. The sales process in FS is too long and complex to be able to rely on the memory of a mystery shopper.

 

  • It is difficult for anyone to ignore a video of poor or misleading advice in FS. This is partly because video evidence can capture the whole sales experience. But also regulators will normally be given access to such material when they visit companies and they will expect to see evidence of corrective action.
  • There was no correlation between customer satisfaction with the advice given and the adviser’s compliance with basic standards for advice giving. This is perhaps not surprising as why should a customer understand details of the advice process. But it does confirm that Voice of the Customer research should not be used as an indicator of the quality of advice provided.
  • Videos of customer interactions are a powerful aid to change. They allow advisers to see the interaction from the customer’s point of view that encourages changes in behaviour that would otherwise be difficult to achieve. Each adviser was able to view their video with their manager and agree a detailed personal development plan to address any issues identified.
  • In FS you need fully trained advisers or trainers to assess the customer interactions. Each company has its own standards and you need a good understanding of regulatory requirements to accurately evaluate a service and advice.

OVERALL CONCLUSION:

  • The findings suggested to me that the regulatory framework is too complex and prescriptive. The focus should be on giving customers good service and advice rather than ticking boxes and following set procedures.
  • People need to be able to trust  advisers, particularly when dealing with money issues. However, a minority of people will always have a tendency to cheat or cut corners unless there are controls in place to spot such rogue behaviours. It is human nature and it happens in every sector. Video mystery shopping is an excellent tool that can be employed to capture the reality of the customer experience and the nature of advice given. With the correct controls in place it can be a catalyst for positive change in an organisation and a means for identifying potential mis-selling.

Thank you reading my post. If you found this useful please share with the social media icons on the page.

You can view my full Digital Marketing and Optimization Toolbox here.

To browse links to all my posts on one page please click here.

 

  • About the author:  Neal provides digital optimisation consultancy services and has worked for  brands such as Deezer.comFoxybingo.com, Very.co.uk and partypoker.com.  He identifies areas for improvement using a combination of approaches including web analytics, heuristic analysis, customer journey mapping, usability testing, and Voice of Customer feedback.  By  aligning each stage of the customer journey  with the organisation’s business goals this helps to improve conversion rates and revenues significantly as almost all websites benefit from a review of customer touch points and user journeys.
  • Neal has had articles published on website optimisation on Usabilla.com  and as an ex-research and insight manager on the GreenBook Blog research website.  If you wish to contact Neal please send an email to neal.cole@outlook.com. You can follow Neal on Twitter @northresearch and view his LinkedIn profile.