Introduction

Imagine that you are given $1000 and asked to choose between a 50% chance of winning another $1000 or a 100% chance of winning another $500. Which do you choose? Now instead, imagine that you are given $2000 and asked to choose between a 50% chance of losing $1000 or a 100% chance of losing $500. What do you choose now? Although these problems have equivalent outcomes, most people choose the second option in the first situation (100% chance of getting another $500) but the first option in the second situation (50% chance of losing $1000).

Kahneman & Tversky (1979) suggest that individuals are typically risk-averse in the domain of gains preferring certain gains to mere chance of gains but risk-seeking in the domain of losses, preferring the chance of losses to certain ones. This pattern can be explained by Prospect Theory according to which individuals make decisions by weighing the value of gains and losses relative to their current reference state. An important aspect of Prospect Theory is Loss Aversion which is the tendency for the impact of losses from one reference state to be greater than the impact of equivalent gains. Simply said, during the decision-making process, losses loom larger than gains. This theory can explain a range of behavior and choices, including consumer behavior.

A key prediction stemming from Loss Aversion is that framing options in ways that shift individuals’ reference points can alter their decisions. For instance, in one study participants were asked to imagine purchasing a car. Half of the participants were presented with the fully loaded car model, along with a list of all the additional features that this model had above the base model and asked which features they would like to remove. The other half of the participants were presented with the base model, and given the same list of additional features, but were asked which ones they would like to add. Participants who started with the fully loaded model chose more features and spent more as compared to those who started with the base model. For those who started with the base model, the value of gaining additional features was often not worth the monetary costs. However, for those who started with the fully loaded model, the potential of loss of some features (which they likely perceived as already owned) was not worth the financial gain associated with removing them.

Loss Aversion is also an essential factor in determining if and when individuals are willing to switch to lower or higher quality. Fogel et al. (2004) conducted an experiment where they gave participants a list of 25 beers with their current retail price and asked which they were most likely to buy. Based on participants’ preferences, their reference beer cost about $4 and was rated as moderate quality. When asked to imagine that all prices fell, participants happily switched to a better-quality beer, and still spent about $4. However, participants were less willing to downgrade the quality when asked to imagine that prices of beer rose. At higher prices, they still chose beers of moderate quality but spent almost $5 on them. This suggests that individuals are more loss averse to quality than money, and it may be easier to get individuals to switch up in quality than down. As a result, brand builders should consider using price promotions to encourage their customers to buy higher-quality products. In future purchase trips, consumers should be less willing to switch down in quality when prices return to normal.

Applications to Brand Building

At Hotspex, we help brands identify consumer reference products and prices. We can examine the effect of various communication and pricing strategies on consumer behavior. There are several things to consider when applying Loss Aversion to brand-building:

1. Framing communications and promotions around loss: Instead of just focusing on the benefits of your products, highlight what customers are losing out on if they don’t purchase your product, such as unique features, lifestyle benefits, savings etc. For subscription-based models, brands should consider reminding customers what they stand to lose if they cancel their subscription.

2. Creating a sense of urgency: You can drive behavior by creating a sense of urgency of purchasing the product at the very moment. For example, Amazon does this with its countdown timers on deals of the day that make customers feel the need to purchase the product before the time runs out and they miss out on the deal. Brands can also do that by sending cart abandonment reminders.

3. Own it now, pay later: Brand builders can leverage Loss Aversion by creating scenarios where individuals are paying to avoid losing a product/service instead of paying to obtain it. For instance, Brick provides financing options that allow customers to purchase a product without making payments for the first year or two. Consistent with the Endowment Effect, once the product is brought home and tried, it is less likely that people will be willing to lose it, as they will value it more highly.

4. Consider how your customers perceive product changes: Changes which are perceived as a loss by consumers may have unintended negative consequences. For instance, in 1985, when Coca-Cola released a new formula and rebranded as New Coke, there was a considerable backlash and outpouring of demands to bring the original one back. One reason for this unforeseen response was that the change was perceived as the loss of a loved brand that consumers felt a sense of ownership over. At Hotspex, we can help you test planned product changes and rebranding strategies to help ensure that they elicit the intended response from customers.

Conclusion

To conclude, we weigh losses more heavily than gains while making purchase decisions. Brand builders can leverage Loss Aversion by framing messages to highlight the cost of not choosing a particular option and by creating a sense of urgency through limited offers or sales. Additionally, brands should consider how product changes may be perceived by their customers and determine the best way to implement them, all of which Hotspex can help you with.

Sources: Biswas, D., & Grau, S. L. (2008). Consumer choices under product option framing: loss aversion principles or sensitivity to price differentials?. Psychology & Marketing, 25(5), 399-415.

Fogel, S., Lovallo, D., & Caringal, C. (2004). Loss aversion for quality in Consumer Choice. Australian Journal of Management, 29(1), 45-63.

Hjorth, K., & Fosgerau, M. (2011). Loss Aversion and Individual Characteristics. Environmental and Resource Economics, 49(4), 573-596.

Kahneman, D. and A. Tversky. (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica 47, 263–291.