When losses are more motivating than wins
Four ways loss aversion has been used to shape behavior.
The principle of loss aversion, or the finding that people are far more sensitive to losses than proportional gains, has been known and studied extensively for many years (Tversky & Kahneman, 1991). The original academic study has over 4937 citations according to Google Scholar, a figure that testifies to the importance of the effect. Although we have known about the phenomenon of loss aversion for decades, practitioners are still finding innovative ways to leverage the effect in order to promote desired behavior. In this article, I want to go over some of the ways in which loss aversion has been used to affect people’s behavior.
- Savings behavior:
Perhaps one of the most obvious ways in which loss aversion can be applied to behavior is through people’s money. Just as people experience gains and losses in fixed amounts (e.g. winning a lottery or an unforeseen expense), they can also experience it in rates of income (i.e. pay cuts and raises). Building on this, researchers from the University of Chicago developed a program that, among other features, increased participants’ savings rates immediately following a raise (Thaler & Benartzi, 2004). Their reasoning was that if the increased savings was synchronized with a raise, participants would be no longer experience the increased savings rate as a loss (i.e. less take-home pay), as the raise would allow them to maintain (or even increase) their current spending rate while increasing their savings. The program was a resounding success, increasing savings rates by as much as 10%, much of which was attributable to this clever recognition of loss aversion.
The evidence for using financial incentives in the domain of exercise is mixed. In a review of studies that explored incentives for exercise, only eight of eleven studies demonstrated effectiveness (Mitchell et al., 2013). Moreover, it is questioned whether long-term effects can be realized from paying people to work out. Again, loss aversion provided a potential solution to this difficulty. In an innovative study, obese adults were assigned to one of three exercise conditions (Patel et al., 2016). In the first two incentive conditions, participants were either paid or entered into a lottery each time they completed an exercise goal (7000 steps). But another group of participants was given something different. Instead, they were given a flat pay at the beginning of the month which amounted to the total they would earn were they to exercise every day of the month. Then, their money was reduced for each day they chose not to exercise. Consistent with predictions, this condition proved to be the most effective, showing significant increases in exercise compared to the other two conditions (who were equal to each other in terms of performance).
What about using loss aversion in the domain of performance? One district-wide experiment looked at how financial incentives can increase teacher performance (Fryer Jr., Levitt, List, & Sadoff, 2012). Teachers in a Chicago school district were given the option of enrolling in an experiment, which randomly assigned participants to multiple conditions. In the standard ‘gain’ condition, teachers were told that they would be rewarded based on the improvement of their students’ math test scores, with a variable reward of 0 to 8000 dollars (with an average bonus of 4000 dollars). Critically, in the ‘loss’ condition teachers were given the average expected value of 4000 dollars at the beginning of the school year, with the stipulation that they would return some or all of the money should they fail to raise the test scores (and that they would get additional compensation if they exceeded the 4000 dollar mark). Thus, teachers in both the gain and loss conditions were still being effectively rewarded for the same performance, but framed in different ways. As in the previous implementations, the loss condition was far more effective at motivating teachers to raise math scores, resulting in an estimated one standard deviation increase in teacher quality. Similar effects have been observed in the industry, such as in a Chinese manufacturing plant that saw an increase in productivity of one percent when bonuses were framed as losses rather than gains (Hossain & List, 2009).
- PRODUCT RETURNS:
While the previous three examples looked at how loss aversion can encourage positive behaviors (financial responsibility, physical exercise, and teacher performance), the effect can also be put towards less benevolent purposes. There is probably no domain more relevant for loss aversion in marketing than that of product returns. It doesn’t take much for people to feel as though they own something (some psychology research indicates that touch can often be sufficient to promote feelings of possession; Peck & Shu, 2009), and ordering products can often trigger this. In a review of research on return policies, researchers have found that lenient policies (e.g. increasing the time window of allowable returns) were shown to actually decrease returns (Janakiraman, Syrdal, & Freling, 2016). The authors reasoned that this effect likely stems from, as you guessed, feelings of ownership and loss. The longer an item is a person’s house, the greater the likelihood they will begin to feel a sense of ownership, and the lower the likelihood they will return it.
Loss aversion can also be used to reduce return inclinations another way. In a recent article featured in Psychology and Marketing (Li & Yi, 2017), researchers explored how bundling purchases with a ‘free’ gift actually functioned to reduce product returns. The theoretical reasoning for this effect lies with loss aversion. By forcing people to return something that they have acquired (the free gift), firms are causing people to experience a loss of something they feel they own. This prospect is so unpleasant that it likely causes people to second-guess their return intention. To test these predictions, the authors ran a series of scenario-based studies where they asked participants to imagine that they had ordered a product that they were unsatisfied with. Critically, half of the participants were told they had also received a free gift as a promotion, but would be required to forfeit the gift should they return the main purchase. Sure enough, the authors found that participants in the promotion condition reported greater feelings of loss were they to return the product, which in turn drove reduced return intentions.
Fryer Jr, R. G., Levitt, S. D., List, J., & Sadoff, S. (2012). Enhancing the efficacy of teacher incentives through loss aversion: A field experiment (No. w18237). National Bureau of Economic Research.
Hossain, T., & List, J. A. (2012). The behavioralist visits the factory: Increasing productivity using simple framing manipulations. Management Science, 58(12), 2151–2167.
Janakiraman, N., Syrdal, H. A., & Freling, R. (2016). The Effect of Return Policy Leniency on Consumer Purchase and Return Decisions: A Meta-analytic Review. Journal of Retailing, 92(2), 226–235.
Lee, S., & Yi, Y. (2017). “Seize the Deal, or Return It Losing Your Free Gift”: The Effect of a Gift‐With‐Purchase Promotion on Product Return Intention. Psychology & Marketing, 34(3), 249–263.
Mitchell, M. S., Goodman, J. M., Alter, D. A., John, L. K., Oh, P. I., Pakosh, M. T., & Faulkner, G. E. (2013). Financial incentives for exercise adherence in adults: systematic review and meta-analysis. American journal of preventive medicine, 45(5), 658–667.
Patel, M. S., Asch, D. A., Rosin, M. R., Small, D. S., Bellamy, S. L., Heuer, J., & Volpp, K. G. (2016). Framing financial incentives to increase physical activity among overweight and obese adults. Ann Intern Med, 164, 385–394.
Peck, J., & Shu, S. B. (2009). The effect of mere touch on perceived ownership. Journal of consumer Research, 36(3), 434–447.
Thaler, R. H., & Benartzi, S. (2004). Save more tomorrow™: Using behavioral economics to increase employee saving. Journal of political Economy, 112(S1), S164-S187.
Tversky, A., & Kahneman, D. (1991). Loss aversion in riskless choice: A reference-dependent model. The quarterly journal of economics, 106(4), 1039–1061.