The Psychology of Loss Aversion

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Why do people suffer from loss aversion?

  • As anyone who has bought stocks during a bull market will know, 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.
  • 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, a gain may be 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.

Loss aversion influences how we take gambles

Implications of Loss Aversion

Loss aversion is one of the most important drivers of human decision making. It is a powerful technique often used in conversion rate optimisation. This is because it inevitably leads to risk aversion and a number of predictable behaviours in certain situations:

Threat to lifestyle:

Risks that threaten our lifestyle are normally avoided due to loss aversion

  • 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:

  • When people are given a situation where both a gain and a loss is possible there is a tendency to make extreme risk averse choices. For instance 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. They will often select the former, more certain option. Even a small probability of a large loss is enough to make people shy away from certain types of investments.

 Bad choices and loss aversion:

  • 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. Hoping that they can turn the business around. Gamblers are also prone to putting more money at risk after making substantial losses. They focus 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. They fail to see they are just making the situation worse.

When faced with all bad choices we are prone to excessive risk taking

Power of ownership:

  • Where a person buys something with the intention of consuming or using it. The minimum price that they sell the item for is often higher than the maximum price they want to pay themselves. This is called the endowment effect. The ownership of goods appears to increase the value of an item, particularly for goods that are not frequently trading.
  • 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. This because buyers do not want to pay the price sellers value their homes at. The endowment effect is most prominent for new goods, such as cars. 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 a combination of loss aversion and the endowment effect. However, fear of regret in making a wrong decision can also play a part in status quo bias.
  • 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. This reduces the 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:

  • 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. They 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. 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.

More About How People React to Risk or Probabilities:

  • 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 Rare Events:

  • 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 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.

Conclusion:

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).

Further reading:

Thinking Fast and Slow

17 Psychological Conversion Optimisation Tips

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Conversion rate optimisation is about persuading visitors to convert. Persuasive content that utilises psychological triggers can help you significantly improve your conversion rate. Outlined below are 17 conversion optimisation tips and techniques to effectively engage your visitors and increase your conversions.

1. Ownership focuses our attention on what we might lose!

Image of Amazon Prime 30-day free trial offer
Source: Amazon Prime 30-day free trial offer

Even partial ownership (e.g. a trial subscription) tends to make people more attached to what they have and make them focus on what they may lose rather than what they may gain (see endowment effect). Ownership changes our perception of things and loss aversion makes it difficult for us to give it up.

A great example of this is Amazon Prime which offers a 30-day free for unlimited streaming of moves and TV shows. This combines the power of FREE, that we cover later, with a limited trial that makes customers focus on what they will lose if they cancel their subscription. Try testing different trial promotions, or give more prominence to money-back guarantees, cooling-off periods (for financial services) and ease of returns for large or expensive items. Ownership is a powerful weapon in conversion optimisation.

2. We are motivated by meaningful tasks and acknowledgement of our effort!

Image pop-up for when Buffer is full for free plan - conversion optimisation tips
Source: buffer

None of us like to think our effort is meaningless and we all appreciate positive feedback (see purpose). Visitors want to know that any information you request from them is essential and not just for your benefit. People also like feedback to confirm they have successfully completed tasks (e.g. registration or add to basket). This reassures and motivates them to continue.

Buffer congratulates you when you you’ve completely filled your free plan with posts. But it also uses it as an opportunity to promote upgrading to Awesome subscription plan.

For registration and sign-up forms remove any fields that are not absolutely necessary. Try different words or phrases to explain why each piece of information is required. Also test different ways or congratulating customers when they have completed a task as this can help conversion optimisation. journey.

3. Everything is relative!

Image of Hotjar.com pricing options
Source: Hotjar.com pricing options

People find it difficult to make new decisions and like to compare things that are simple to compare (e.g. one LED TV against another LED TV). Until a person has made such a comparison they often don’t understand there own preferences or know what they want. Giving just two very different options will make it difficult for people to choose. They have nothing to compare either option with and they may not select your preferred option.

This is why sales people will often show you a premium option, a medium option and a value option that appears inferior. They know most people will choose the middle option. So by testing different alternatives on a given page may allow you to nudge visitors towards your preferred option. This could be different subscription options or alternative targeted content (e.g. recently viewed/wish list items etc).

4. The first time we go to purchase is critical for the price we are willing to pay! 

Image of Survata's plans with prices
Image of Survata’s plans with prices

Once a price has been established in our minds it will largely determine our perception of current and future prices (see anchor price). Sensitivity to price changes is heavily influenced by our memory of the prices we have previously paid or seen.

When launching a new product if you can associate it with a premium category you are more likely to be able to charge a premium price. You should always show your most expensive plan first as this helps create the highest possible anchor price. Test different ways of presenting prices, change the location of the price, and see if by offering a premium alternative you can boost sales without having to make large price reductions.

5. The power of FREE!

Image of Neflix free for a month offer
Source: Netflix – “Join free for a month” offer

The impact of offering something for FREE is often underestimated in conversion optimisation. People are afraid of loss and because of this FREE is a powerful motivator. As a result consumers will often perceive a FREE offer as substantially more valuable than it really is.

This can result in the cost of offering something for FREE being easily outweighed by the benefit from an uplift in conversion. Alternatively, if you offer a free benefit as part of your proposition that perhaps your competitors don’t, then try testing the impact of promoting this as a FREE benefit of your service. Whatever you do don’t mention how much it actually costs.

6. Scarcity makes us value things more!

Image of Booking.com with scarcity indicators
Source: Booking.com scarcity indicators include “Booked x times today” and “Only x rooms left”.

People value things that are scarce partly because they are loss averse. We are particularly motivated if we believe that we are in competition with other people to purchase a scarce item. This is why eBay auctions can get out of hand and we end up paying far more than we originally planned for an item.

Stock level indicators (e.g. number of rooms left, low stock, number of items remaining, bids etc) are a powerful tactic for conversion optimisation. Scarcity is used everywhere online. Including hotel and flight booking sites, flash sales, exclusive pre-sale registration, offer ending soon, and limited edition item.

Booking.com is especially good at using scarcity. As well as showing the number of rooms left, the site also shows the number of times a room has been booked today and for locations with high demand a further message is displayed (see below). The key to conversion optimisation is to test, test and test!

Image from Booking.com showing location has high demand
Source: Booking.com

7. We are more motivated by a cause than by money! 

Image of Tesco.com communities - conversion optimisation tips
Source: Tesco.com Communities including Cancer Research UK Race for Life food partner

People are much more willing to spend time and effort for a cause than for money. This is because social norms are much more powerful motivators than cash. Research has shown that focusing on money can result in more independent and selfish behaviour and a reluctance to be help others. People who believe in cause are much more passionate and more willing to offer to help others.

It can be advantageous to align your brand or site with relevant good causes as it helps to build loyalty. However, taking such an approach often needs to be part of a long-term commitment to a cause as people can react negatively if you chop and change according to short-term business needs. If you do go down this route focus on the material benefits to the good cause (e.g. Computers for Schools vouchers) rather than the actual value. Test different methods of giving to good causes to understand which most engage with your customers and help with conversion optimisation.

8. The power reciprocation!

image of Copyblogger.com site and free resources
Source: Copyblogger.com

We feel obliged to the future repayment of favours, gifts, good deeds and the like. Organisations can use the social norm of reciprocation to their advantage for conversion optimisation. Try offering help, free resources (e.g. White papers), advice or samples without obligation.

Online video guides are becoming the norm, but other ways to benefit from this rule include online tools and planners, free smartphone Apps, money off coupons and how to guides. The skill here is to find something that really catches the imagination of your customers so that they value it so much that they almost feel obliged to maintain their relationship with you.

9. Sex sells?

Image of beautiful woman on Beaverbrooks.co.uk
Source: Beaverbrooks.co.uk

Great images of beautiful people grab attention and can help to sell product. Sex can sell because we respond to material differently when we are in a state of arousal. Neuroscience indicates that this is because it engages the pleasurable reward centre of our brain. Research has found that men are more willing to take risks when they are aroused by beautiful women. People also automatically assign positive traits to attractive looking people.

Try testing models of different age, gender or family groups on high converting pages to see if aligning the images more closely with your target audience improves conversion. People are naturally drawn to looking at eyes so this could also be incorporated in your tests.

10. Customers will procrastinate if you give them a chance!

Image of incentive to open a Very,co.uk account
Source: very.co.uk

People like to put decisions off until the last minute and avoid doing things that they don’t enjoy. To avoid visitors procrastinating use different strategies to motivate them to convert now!

Online only discount can be used to encourage visitors to sign up. Also have you considered using gamification techniques to make a recruitment email or registration process more interesting and enjoyable. You can also test different incentives (e.g. money off vouchers or prize draw entry) to see what attracts new customers the most.

11. If uncertainty exists people look to the actions of others to guide them!

Image of social proof on Dropbox.com
Source: Dropbox.com

People naturally follow a crowd (see Herd instinct) as it provides us with reassurance about our decisions, especially when we are in a new or uncertain situation. Sometimes we also consciously copy others we want to associate with or admire to project a certain image to the outside world.

If your site has built up a sizable number of subscribers ensure this is clear on your landing pages. Inform visitors about what is most popular on your site and include testimonials from existing customers.

12 People respond more positively to someone they know and like!

Image of testimonial on Google Analytics homepage
Source: google analytics

People want to like organizations that they buy from and they respond positively to indications that you have similar values and attitudes to them. Companies that have a clear vision and strong customer centric culture can project this through their online presence to their advantage.

Market research can help you understand your prospects life style, values, interests and motivations. This can help you avoid having policies or promoting causes that conflict with your visitors’ vales and interests. Having photographs of real people who work for an organisation in relevant posts can improve how visitors relate to a website and have been known to significantly improve conversion rates. Further, the perceived age of a model on a page can also affect the conversion rate if they are too young or old compared to your visitor profile.

Sites that are perceived to use deception or trick customers into decisions (see dark UX) may benefit from short-term gains in conversion but this is likely to be more than off-set by a loss from life-time customer value. Experiments have found that even a low level of irritation can make people irritated and act vengeful towards companies that annoy them.

13. People don’t like closing doors!

Image of a closed door - conversion optimisation tips
Source: Freeimages.com

People like to keep their options open as it gives them a sense of control over their own destiny. Autonomy is an important human motivation. Even when people are at the last stage of a transaction having a get out option (e.g. back to shopping) may be more motivating than than if you make it difficult to abandon or change items in the basket. Otherwise customers can feel trapped and out of control.

Test different sign-posting at each stage of checkout as it is important to communicate to customers where they are in the process and give them clear options. Try testing more prominent ‘Return to shopping’ or ‘Back’ buttons in checkout to see if it actually improves rather than decreases conversion.

14. The power of the written word!

Image of a pen lying on paper which has writing on it
Source: Freeimages.com

People like to be perceived to be consistent and it is an important motivator of our behaviour. Inconsistency is perceived to be an undesirable personal trait. Commitment is the key to consistency and is the reason why Amway Corporation ask their members to record sales goals on paper. Similarly, just writing something positive about a subject can cause a shift in a person’s attitude and behaviour towards the views they express.

Commitment and consistency is one of the most powerful methods of social influence to help conversion optimisation

Reviews and testimonials are great for conversion optimisation as they provide evidence that other people trust you. But they also help reinforce attitudes and behaviour of those who write them. Have you analysed the value of customers after they have written a review? Test different ways of promoting testimonials and reviews and see if you can obtain permission to use them on landing pages.

15. Obedience to authority!

Image of meaning of Never Knowingly Undersold means from John Lewis
Source: John Lewis

People often have a compulsion to comply with the commands of someone in authority. Even the appearance of authority can be enough to influence our behaviour. Some brands also are so well respected in their market that they have a certain authority that their competitors lack. This can be a powerful technique for conversion optimisation.

For many years in the US an actor who played a doctor in a popular TV series successfully promoted caffeine-free coffee. It’s success was partly explained by his association with being an MD on TV. Personalities associated with your category or service can be powerful symbols of authority.

Other sources of authority include independent surveys that benchmark your service. John Lewis (above) is well known for high service standards and a “Never knowingly Undersold” strapline. Awards, and testimonials from recognized experts can also add to your credibility. Try testing different ways of indicating your authority to see what works best on your site.

16. Don’t underestimate the importance of presentation!

Image of Haikudeck.com homepage
Source: Haikudeck.com

Expectations affect every aspect of our life and how you present your value proposition will influence how visitors respond to your site now and in the future. The same goes for conversion optimisation – visitors respond better if you serve up what they are expecting.

Research can help you identify your potential customers’ expectations. If you understand new visitor expectations you can test aligning your key messages and presentation accordingly. For landing pages test different benefits for signing up and see if aligning content and imagery to reflect new visitor search activity help with conversion optimisation.

17. We put greater value on things that we have helped create!

Image of Customize option on Converse trainers website - conversion optimisation tips
Source: Converse

The ability to customise a product by investing our own time and effort often leads us to value it more than something we buy off the shelf (see IKEA effect). Converse allows visitors to customise casual shoes and Moonpig.com enables customers to create their own greetings cards.

Where people value the ability to personalise a product this can be a great way of improving the perceived value of your product or service. Try testing in different categories or the level of personalisation to see what catches your customer’s imagination.

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