Articles Tagged with: behavioral economics

What is Loss Aversion?

Let’s talk about loss aversion, why the pain of loss results in irrational decisions, and how marketers are taking advantage of this.

Loss aversion is perfectly summed up by FOMO or the Fear of Missing Out.

It’s the irrational fear of loss. In psychology, loss aversion explains why people, too often, focus on setbacks instead of gains—it explains why the pain of losing is seen to be more powerful than the pleasure of gaining something. In their Prospect Theory study, Daniel Kahneman and Amos Tversky said, “losses loom larger than gains.”

About twice as large!

What makes loss aversion so influential?

Simply put, we hate loss. Receiving something is great, sure—but we don’t love it as much as we hate losing.

If you received a $200 jacket for your birthday, you’d be happy. However, if your dog chewed a giant hole in it the next day, the unhappiness you’d feel would be twice as powerful.  

Losing something or downgrading is psychologically distressing, so we do what we can to avoid it (even if it makes absolutely no sense).

It’s not completely our fault, though. There are intense cultural, socioeconomic, and neurological factors at play when it comes to the power of loss aversion.

Loss triggers a reaction from the same part of the brain that processes fear and risk. Our brains also associate loss with prediction errors and disgust. We’re trained to detest loss.  

We’re extremely vulnerable to loss aversion when it comes to making decisions because as soon as we imagine a choice, we’re emotionally invested and attached.  

People will go to incredible lengths to avoid a perceived loss.

Example: waiting in absurdly long lines to get something for free.

In December of last year, Starbucks created a holiday-themed travel mug that you would get for free if you ordered a Grande holiday beverage. They claimed they would keep the promo going until they ran out of mugs. Nobody knew how many they had on hand, so there were lines around blocks at Starbucks stores across the country. It didn’t matter that the travel mug was valued at less than $5 and made from thin plastic. They had already latched on to the idea of getting a free holiday treat, so not receiving that mug would be considered a significant loss.

People are also likely to make purchases they weren’t necessarily planning on making if you provide them with a free shipping coupon. They’ll recognize that this opportunity doesn’t come along all time, and the thought of losing out on it will persuade them to make a purchase.  

Businesses use loss aversion marketing strategies all the time.

A perfectly executed “flash deal” is a big moneymaker. When a product is deeply discounted for a very limited time, the consumer’s brain focuses on the ticking timer and the amount of savings rather than on the product itself. You probably don’t need another sweater or another cordless vacuum cleaner—but at 70% off, that’s a GREAT deal, right? I can’t miss out on that!

It’s also why pre-orders, coupons, and VIP exclusives work. With pre-orders, it’s an early bird discount—the discount is the prize for ordering early. With coupons, it’s a lot like being given free money. Why would anyone throw free money away, right? With VIP exclusives, all you needed to get VIP status was probably to sign up for a newsletter, and voila! It’s too easy. Why risk missing out on the action?

Free trial periods show people exactly what their life would look like with the product or service, making it exponentially harder for them to end it when the trial is over. They’ve experienced the benefits and identified with that life, so they don’t want to lose it.  

Insurance companies usually have a mile-long list of extremely unfortunate things that could happen to you and how you’ll be negatively affected if you don’t have the proper coverage. No matter how unlikely these events are, they’ve successfully set you up to view them as losses, and you’re more likely to focus on those than the regular payments required to avoid them.

If your business needs to avoid giving people more than necessary, loss aversion tactics can help you sidestep that waste. Studies have shown that when options are presented as addable rather than retractable, people will only take what they want (toppings on a salad, ingredients in a sandwich, etc.).

You can maximize the effects of loss aversion marketing in your small business, too.

The success of your offer entirely depends on your messaging.

Understanding your target audience and their fears is crucial to connecting with them. You need to clearly explain what their life would be like if they don’t purchase your product or service, and they won’t care unless you speak directly to their pain points and experiences. It’s about showing them what they’ll miss out on if they don’t participate soon and painting a picture they can’t ignore.

People must believe there’s something to lose for loss aversion to work properly. If you post an offer for 20% off and claim that it’s only available for the next two days and then post a 25% off coupon the following week, you’ve given people a reason put off making their decision. Even worse, they’ll notice that you contradicted yourself, and any trust they had in you and your brand will start to fade.  

You’re working hard to convert all the “I’ll just buy it tomorrow” shoppers into “I feel good about committing to this now” shoppers. Keep that goal in mind, and you’ll notice a positive trend in your conversion rates.

How about you? How do you leverage on loss aversion? Got a question? Don’t forget to COMMENT below and SHARE your thoughts.

Sources:

https://www.psychologytoday.com/us/blog/science-choice/201803/what-is-loss-aversion

https://www.activecampaign.com/blog/loss-aversion-marketing

https://thedecisionlab.com/biases/loss-aversion/


Do You Know the Power of FREE?

Let’s talk about the power of free stuff. Why does the word FREE have such an emotional pull? What do brands get in return when they give something for free? More importantly, how can you use the power of free to your advantage?

Dan Ariely, author of Predictably Irrational (2008), showed that nothing is more motivating than getting something for free.  

He set up a table with two bowls: a bowl of Lindt Truffles that he sold for 15 cents and another bowl of Hershey’s Kisses for 1 cent. At the end of the experiment, he found that 73% of the students chose Lindt over Hershey’s. It seemed like students preferred Lindt over Hershey’s even if the cost was 15X higher.

Next, he set up two bowls again, this time selling Lindt Truffles for 14 cents while the Hershey’s Kisses were free. Guess what? 69% of the students chose Hershey’s this time.

This is the power of free or the zero-price effect, and it threatens to turn traditional cost-benefit models on their heads. These models don’t account for the fact that getting something for free has a psychological effect that trumps conventional economic theory.  

Enter behavioral economics: the umbrella term under which the power of free falls. This covers the study of economic decision-making through emotional, cognitive, psychological, social, and cultural factors.  

Why is FREE so powerful?

It’s not just a price indicator but an emotional trigger.

We tend to make decisions based on how they make us feel. Free things make us happy, and we’ll make decisions that make us happy. It sounds simple, but a decision made in the name of a free thing is often irrational.  

That’s largely due to perceived value. We place an unreasonably high value on free things merely because they’re FREE. It’s an option with no downside. There’s no risk involved. We have everything to gain and absolutely nothing to lose.  

We’ve all taken promotional shirts, pens, stickers, koozies, frisbees, bottle openers, keychains, and water bottles from companies we don’t even care about. Do we need them? No. But we felt a pull toward them – saying no didn’t feel like an option.

Surprise! It’s because they were free.  

Let’s look at an even stronger pull: free food. It’s nearly impossible to turn down free food. It doesn’t even matter if we’ve just eaten, are saving our appetite for something later, or aren’t that crazy about the food being offered. If it’s free and right in front of us, we’re likely to take it.

Most of us don’t consider time or even extra money to be lost when exchanging them for a free item or service.  

That’s why we’ll happily wait in a line for multiple hours if Starbucks is offering a free drink when, instead, we could stop by the next day, pay less than $10 for the same drink and be on our way in a matter of seconds.  

Another example is paying for additional products that we don’t need to receive free shipping. We could run out of shampoo and go to Ulta’s website to buy a new bottle but end up buying 4 because we didn’t want to pay for shipping. The shipping cost would be much less than those extra three bottles of shampoo, but we want it to be free.  

Paying for shipping feels like a waste, but paying for more products to get free shipping feels like a deal. It makes us feel like we’ve worked the system and are coming out on top.

While it may seem beneficial for companies to have free shipping minimums so that we’ll buy more to reach it, studies have shown that we’ll buy more things more often if free shipping is a constant offer.

When Amazon first started offering free shipping, they implemented it everywhere except for France but still lowered France’s shipping cost to 20 cents. Sales across the globe increased dramatically, but the sales in France stayed the same. After a while, they announced free shipping in France as well. Their sales there quickly climbed to match those of the rest of the world.  

Twenty-cent shipping wasn’t even close enough to free to be worth it to consumers.   

Lots of companies have figured out how to use the power of free to their advantage.

Various restaurants and retailers will send out freebies to people who have downloaded and made an account on their app.

Their FREE app.

They figure that you’ll come in to get your freebie and end up buying more while you’re at it. They got you into their store when you weren’t necessarily planning on it and made a sale, proving that freebie more than worth it to them.

Many restaurants also utilize a buy-one-get-one-free strategy to get us to come in and spend money. You’re excited to go in and share a discounted meal with a friend, riding the high of the free offer. The benefit for the restaurant is that you’re likely to buy more than what the coupon is for, such as drinks, appetizers, desserts, etc.  

A slightly different approach is giving away something for free that will, in turn, create a demand for something costly. Cell phone companies do this by bringing in customers with a free phone offer and then charging them for the necessary plan.  

The original user of this tactic was the founder of Gillette Razors and Blades. He was having trouble selling his disposable razor blades, so he started giving away the razor for free in various marketing partnerships with other brands. This created the demand for disposable razor blades and is what ultimately got his sales off the ground.

Increasing digital capabilities has had a significant impact on the ability to distribute free things.

Distributing free things online has little to no cost and gives businesses the freedom to reach people they would otherwise be struggling to connect with. 

This is one of the best ways for small businesses to utilize the power of free. 

Whether it’s a webinar, podcast, workshop, newsletter, or blog, small businesses can give away free things online that will gain them mass exposure at little to no cost while establishing themselves as an expert in their field.  

Especially this past year, as even more aspects of running a business have moved online, small businesses are offering free consultations. If they invest a small bit of time into sharing their expertise with a potential customer, that customer is likely to come back to them when they need a paid service.  

The key to gaining a return on these types of freebies is to provide value. 

While the FREE label will pique interest, small businesses aren’t going to gain loyal followers unless they provide a reason for them to stay.  

First, understand your ideal target audience.  

Then put yourself in their shoes and identify the type of content they would want or be interested in.  

What are their frustrations? What do they face day-to-day? Moreover, what are their aspirations?

Create your freebie around what would be useful to them and deliver a value-packed gift they can’t walk away from. Make it so beneficial to them that you and your business will occupy a part of their memory from that point on. 

Small businesses also create positivity in these difficult times by offering their free thing as a celebration.

What do people want on National Margarita Day? A free margarita! Perhaps with the purchase of an entrée.  

National Pi Day brings a flock of hungry shoppers to the internet, hoping to find deals on pizza and bakery pies. This is an excellent opportunity for a buy-one-get-one-free deal to increase business at your restaurant.

Free birthday items are another celebratory way to make someone feel special and get them into your shop.

Will some of us only pick up our free birthday treat? Yes. Will a good number of us buy other things while we’re there? Definitely.

Adding on a free item to something that has already been purchased is also an effective way to gain returning customers.

Going back to the fact that free things make us happy, you have associated yourself with that happiness. You gave us a gift that we didn’t ask for, and you made us happy.  

The other side to that strategy is that your freebie may be something that we’ve never heard of or used before. You’ve just opened our minds to a new product, increasing the chances that we’ll come back to make a purchase.  

The power of free isn’t something that should be overlooked.

There’s more than enough proof that this psychological wonder affects people everywhere.

However, it’s essential to take away that this marketing strategy shouldn’t be used to trick people into spending exorbitant amounts of money.  

Doing good business is about harnessing deep, genuine connections with people, and sneaky gimmicks will not get you there.

The best way to use this gold nugget of human behavior is to understand it, embrace it, and use it in the most ethical way possible.  

How about you? How are you harnessing the power of free? Got a question? Don’t forget to COMMENT below and SHARE your thoughts.

Sources:

https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/zero-price-effect/

https://avgjoefinance.com/power-of-free/

https://www.forentrepreneurs.com/power-of-free/

https://thedecisionlab.com/insights/business/impact-free-consumer-decision-making/

https://www.wired.com/2008/02/ff-free/


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