Series 2, Episode 6: Loss Aversion
Loss aversion is our tendency, our natural desire, to prefer avoiding a loss when compared with acquiring an equivalent gain.
What this basically means is that we would feel losing £10 more than we would feel gaining £10. So, if you are walking down the street and find a £10 note on the floor - brilliant. Of course you’d feel happy and chuffed that you’ve found money. But equally, if you put your hand in your pocket and realise you lost £10, that feeling, the sinking feeling you get in your stomach, this is loss aversion being played out.
Something that happened to me recently, and I’m absolutely certain it would’ve happened to many of the people listening to this podcast, is that I lost my wallet. At first, I was looking around not necessarily feeling any anxiety or worry that I’d lost my wallet. However, as time moved on, that anxiety, that sinking feeling in my stomach, grew to the point of it being very noticeable.
I kept on looking - everywhere - for what felt like an eternity, getting more and more frantic, until I put my hand down the side of the couch, and found a few coins, some popcorn, and my wallet. I didn’t really find any popcorn by the way, although that would have been a bonus if I had!
Now, yes, I was relieved, yes I was happy that I found my wallet again, but that feeling really was insignificant compared to the feeling I had when I realised I’d lost it in the first place.
How we feel about a loss compared to an equivalent gain is different, it’s more noticeable.
And if we look closer, we can see loss aversion playing out in many other walks of life.
When you are working on a project for example you tend to feel, and focus on, the setbacks in that project more than you feel, or focus on, the progress that you are making. When you receive criticism from people, it feels stronger than when someone praises you.
Basically, negative emotions have a much stronger impact than positive emotions. It’s why we get upset more when we lose £10 than we are happy when we find £10.
BUT IT CAN ALSO BE POSITIVE
But loss aversion can also be used in a very positive way, if used correctly. For example, in 2003 the Italian government introduced a new points based penalty system for drivers based on the principles of loss aversion.
So, unlike other countries around the world, where you receive points for traffic offences, the Italian government decided to give every driver 20 points and take points away from them based on the severity of the offence. Once you have lost all 20 points, you are not only banned from driving, but you have to take your driving test again.
And what is amazing about this, is that the statistics show that it has had a positive impact on the number of offences recorded. It seems (and it’s obvious really) that drivers don’t like losing points, and will change their behaviour in order to protect them.
And it’s not just law-enforcement agencies that understand the power of loss aversion.
Retailers have understood, and exploited, this behaviour for years. For example, one way in which it’s exploited by retailers is to create the feeling of scarcity. In other words put prominent signs on their websites that say things like “buy this item now as there is only five left in stock.”... Knowing that as a consumer we don’t want to be left without, or we don’t want to feel the anxiety of missing out, so creating a sense of urgency and scarcity, is more likely to make us buy.
But one of the most amazing ways in which retailers exploit this behaviour, and this really is quite staggering, is by giving away a free gift with a product. Let me explain.
So, say you went into a shop to buy a bottle of perfume that you know costs £30. When you look on the shelf, you see that there are two separate offers available. The first is your perfume, available with a discount of 30%... 30% off the normal price. In other words, your perfume is available today for only £21. What a deal!
The second offer is your perfume - available at its normal price of £30, but it comes with two free gifts; a luxurious body scrub and a small cosmetics bag. I have no idea where I plucked those two items from, by the way… I blame growing up with four sisters!
Now, what will most likely happen, and here is where it gets really strange, is because you don’t want to lose the free gifts on offer, you will be more inclined to buy the perfume that comes with a free gifts even if the value of those gifts are less than the discount available on the bottle of perfume itself.
What I mean by that is if the luxurious body scrub and the cosmetic bag only cost £8, it would be cheaper for you to buy the perfume on discount, without the free gifts, and buy those two items separately, as you would’ve only spent a total of £29.
But the draw of the free gifts… the power of not wanting to lose free gifts, it’s too much, and all logic goes out of the window. We walk up to the shelf, pick up the perfume with the free gifts and walk to the cashier to pay.
We need to remember that loss aversion is really powerful, and if we don’t keep it in check, or slow down to consider its effects when making decisions, we could end up in a place where we are doing everything we can to not lose something, but actually end up losing something else.
So don’t let loss aversion take control, making you miss out on new opportunities, or new experiences, simply based on a fear of losing. We take risks all the time. Just getting out of bed today and getting dressed carried a degree of risk, so don’t let your aversion to loss become too dominant in your life. Don’t ignore it, but don’t let it control you either.
In essence, harness loss aversion at the right time, the right place, and when it’s genuinely for your benefit. Try and take a balanced approach.
That’s it for this episode. Join me next time on Bitesize Behaviours when we explore the battle between the present and the future.
See you next time on bitesize behaviour.