Poker, coffee mugs and overvalued opportunities: How the endowment effect gets in the way of hitting your sales quota
If you play poker, you have probably heard something along the lines of:
The person who wins is the one who wins the hand.
The runner-up is the one who folds first.
It’s a pretty straight forward concept — if you’ve been dealt a bad hand, you should fold your cards and wait for a better draw. Most often than not however, players will over commit, hoping that their fortune will turn on the flop…
then the middle…
the river...
until it’s too late.
This is true not only for rookies, but also for professional players. In a game of odds, you would expect pros to be cold, clean and rational individuals, acting with the sole objective to maximise their welfare (the very definition of the economic man, or Homo economicus). And that’s often the case — we are all great at calling a bad hand. Until it’s our bad hand. The reason for this is a psychological bias, known as the Endowment Effect, that is very likely to inflate the perceived strength of our own hands, just because they’re ours.
The endowment effect occurs because of two psychological biases:
- Loss aversion — we feel the pain of loss roughly twice as strongly as we feel the pleasure of an equal gain.
- Ownership — we fall in love with what we already have and we are prepared to pay more to retain something that we already own than we would pay to acquire the same item.
In one of the most famous studies of the endowment effect, Pros. Kahneman, Knetsch & Thaler conducted an experiment to see how the endowment effect influences our decision making.
The scientists randomly divided a group of students into buyers and sellers and gave the sellers coffee mugs as a gift. They then asked the sellers how much they’d be willing to sell the mug for and asked the buyers how much they’d pay for it.
The results showed that the sellers (the students who had been endowed with mugs) placed a significantly higher value on the mugs than the buyers did. They were willing to sell a mug for $7.12, while buyers were willing to pay only $2.87 (a 2.5 times difference).
If you think you’re immuned from the endowment effect, because you know better than those students, who “clearly lacked real world experience”, than think again. In an experiment pretty much identical to the above, but with car salespeople and estate agents instead of students (participants you’d expect know a thing or two about buying and selling), researches discovered an overvaluation of owned goods of about 2.5 times that of unowned goods.
How the endowment effect gets in the way of hitting your sales quota (and what you can do to fix this)
To answer this question, we looked at a sample of 11,889 deals (lost: 6,298, won: 5,591) closed on Heresy by 105 teams.
Looking at the density histogram, with the no. of days until close along the x-axis and the frequency of occurrence on the y, we can clearly see that won deals are skewed to the left, showing deals are often closed quicker when they’re won than when they are declared lost.
In order to get a sense of the magnitude of this discrepancy, we look at the median days to win a deal vs to lose a deal:
Time To Win (TTW) = The median days to win a deal = 24
Time To Loss (TTL) = The median days to lose a deal = 65
So, TTL = TTW x 2.7 — a multiplier almost identical to the one discovered by the studies we looked at earlier.
In the case of sales however, what’s worse, is that this trend exacerbates as deals increase in size — i.e. the larger a deal, the longer you’re likely to hold on to it, before dealcealring it “closed lost” (bad news for those of you in enterprise sales).
Taking the log of the deal amount, it makes it clear that as the size of a deal increases, the time taken for a deal to be declared lost also increases.
So how do you fix this?
Know your numbers, to hit your numbers!
The good news is that with reliable data (and strong discipline), you can massively improve your sales performance. Here’s how:
- Be sure to track your average TTW as well as your average TTL.
- Be sure that your TTL is smaller or equals 2.7 times your TTW.
- Be ruthless when it comes to declaring deals closed lost — drop any deal that’s been live longer that your TTL and move on. Think this is harsh? Then check out next month’s episode of the Heresy podcast with Tom Castley from Apptio.
- Know you’re pipeline tenancy and stay on top of your delinquent deals. Time kills deals — knowing when a deal is stuck and being able to move it further down the funnel (before it’s too late), is crucial!
Originally published by Dimitar Stanimiroff at blog.heresy.io on February 22, 2018.
