Posted by: Patrick Lefler | February 11, 2010

Loss aversion…and why it matters

Loss aversion refers to the tendency of people to strongly prefer avoiding losses as opposed to acquiring gains. And this emotional difference between gains and losses is so strong that some studies suggest that losses can be twice as powerful as gains.  Psychological researchers Daniel Kahneman and Amos Tversky were the first to document this tendency in their 1979 research article titled, “Prospect Theory: An Analysis of Decision Under Risk”.

As highlighted in the 2008 book “Yes – 50 Scientifically Proven Ways to Be Persuasive”, loss aversion explains quite a bit of human behavior in a number of different areas.

Take the case of investors who prematurely sell stocks that have gained in value because they simply don’t want to lose what they’ve already gained. It is the complete opposite of what rational investors are taught – ride your gains for the long run but cut your losses early. And while personally, none of us would even put ourselves in that “inexperienced investor” category, I don’t think there isn’t one of us who hasn’t said over the past year, “Even though I hate the market, I’m not selling my “xyz” stock until it reaches my break-even level.” We like to think that we’re rational investors, but as soon as our portfolio reaches some psychological (or real) “break-even” point, we can’t sell quick enough. We won’t admit it, but there is a bit of loss aversion in each of us.

Insurance is another area where the concept of loss aversion hits home. Insurance companies don’t frame their marketing message in terms of what customers have to gain by buying their product, but rather they focus their message strictly on what will happen (the loss) if you don’t buy the policy. Insurance policies mitigate losses – whether it’s for your auto, your home or your life – it’s how they sell so many policies. And on a personal level, I find that the really good insurance agents are masters at this technique – they are relentless at it…and in my case, it worked.

So why does this matter? It matters because most businesses today fail to incorporate loss aversion techniques into their sales and marketing messages. Most are really good at crafting messages that highlight what prospects have to gain from buying their product. Far fewer take that next powerful step and also highlight the losses that could occur if that same product is not purchased. It could be as simple as changing your message from: “If you buy this product, you could save 50 thousand dollars” to “If you fail to buy this product, you could lose 50 thousand dollars.” To an economist, the two messages are identical. To a psychologist familiar with loss aversion theory, the messages couldn’t be any more different.

Here’s the takeaway. Loss aversion is a powerful and proven concept. When you market your product or services, you need to incorporate the psychological aspects of loss aversion into your message (when appropriate). If done correctly, the gains can be significant…or said a bit differently, if you fail to incorporate loss aversion into your message, your revenue losses can be significant.

More on this and other topics next time…

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