Chapter 12 of PSYCHOMarketing by Roger Nichols
A man walks up to a stockbroker to get some information about a particular stock that is currently on public offer. After the stockbroker highlights the tremendous benefits the man can enjoy a few years after buying the stock, and the variety of opportunities the stock can offer his generation, he tells him that the stock price will slide down in the first few years to a worthless value before sliding up. After a few hours of the stockbroker’s lucid explanation of the pros and cons of the stock, the man decides not to invest in the stock because of fear of loss, in spite of the financial gains he can ultimately enjoy.
One might be forced to ask why a man would give up so good a stock just because of fear of loss. The brutal truth is many of you would do the same, and moreover, some are already doing that. Please don’t be too hard on yourself; this phenomenon of being too sensitive to losses, no matter how small, compared to the benefits, is what experts refer to as “Loss Aversion.”
Loss aversion is the tendency of people to prefer limited or avoided losses altogether in obtaining gains of equivalent proportions. I’m very sure you have, at some point, been invited to join a Ponzi scheme, where you would invest $20,000 and end up gaining $100,000. If everyone invested in these schemes, most of them would still be around now. The truth is that only less than 15% will be willing to partake in the risk of placing their $20,000 on the line. Most generally do not like to take a financial risk if they can lose it all.
This is perfectly normal, and that is why it is important for a manufacturer not to suggest customers take unnecessary risk. This is why some companies tell customers they will refund part or all of their payment if they use their product for a while. They know the thought of getting money back will encourage a consumer to try out their product. Marketers are aware of the human tendency to be struck by the Loss Aversion phenomena, and they exploit it to their advantage. Likewise, as consumers, we make smart moves by leaning toward a brand we find reliable, in order to avoid regretting our choices.
Kahneman and Tversky (p. 35) were the first to identify this phenomenon, and they came up with different explanations for the behavior. One thing that is common in most research is that gender, age, contextual conditions, information, the need for a product, and, of course, the sales pitch have been associated in patterns of behavior for this phenomenon.
Loss Aversion Marketing Implications
The core implication of the loss aversion theory of marketing is that consumers obtain “gains” and “losses” which are measured according to a reference point. That can make it difficult, in any given situation, to know what gain or loss actually entails, since both gains and losses are highly subjective to consumers. For instance, if you, as a marketer, want to invest in some products, the first thing you will most likely do is try to find out the benefits that will accrue to you from your investment, as well as the losses you can incur from investing in the product. You will also most likely consider whether there is a ready market, along with your projected expenditure and profit. In short, you will try to minimize all losses as much as possible.
Applying Loss Aversion Theory
According to this theory, the price of a commodity has been linked to utility losses for buyers, while the reduction in the cost of a commodity is closely linked with utility gains. A resultant effect of this is that the losses incurred in participating in a venture, or buying a product, are weighted more heavily than the benefits of equal magnitude. This will make the demand responses more elastic to upsurge in the price of the commodity than a decrease in price. Having this in mind, marketers should lower the price of their commodity and the cost of production to encourage more buyers to buy their products.