Loss Aversion Bias

Loss Aversion Bias

Numerous studies have shown that people feel losses more deeply than gains of the same value (Kahneman and Tversky 1979, Tversky and Kahneman 1991).
Goldberg and von Nitzsch (1999) pages 97-98

A friend of mine, we’ll call him Joe so I can feel free to ridicule him publicly, complained to me the other day about a kit he bought called the “Robot Builder’s Bonanza”—it’s a beginning robotics kit. He bought it from some off brand electronics site for around $20. So he thought.

The kit arrived, but after checking his bank statements Joe noticed the charge had gone through for $31.02.

I asked him what he did about it. He e-mailed the company about the problem, and got a bullshit boilerplate response back. He did a few backflips, I guess by looking at the domain’s whois information to find a number, and eventually got on the line with someone at the company who, he reported, was rude and told him to piss off, in not so many words.

Joe is nothing if not tenacious. He called his credit card company to initiate a chargeback for the transaction. Since it wasn’t cut and dry—he had received the thing he bought, he was just charged the wrong price for it—he had to download a form, fill it out and fax in a signed copy.

After about three and a half weeks he got the difference of $11.14 refunded.

I know this because as Joe was relating this story I was totally fascinated, and I asked him for more and more detail. I knew this was a textbook case of the Loss Aversion Bias, and I wanted the full scoop to share with you.

He spent 4 hours to get an $11 refund

In all, Joe had gone through considerable effort to find an e-mail address, all the relevant transaction data, even more hassle to find a number and call it, waited on the phone with his credit card company for almost an hour, then printed, filled out, and faxed a form. All told, he had spent four hours or so over the course of a few days getting his refund. His $11 refund.

So I proposed a business deal for Joe. I said to him, listen, I have these bitchy customer service people I don’t want to deal with. You’ll have to do a little a sniffing to find the right people to contact. You’ll need to call them, figure out some paper work they’ll need, and send it all in. Shouldn’t take more than half a day’s work, I said. I’ll give you $11 to do it.

For some reason, Joe told me to fuck off.

Why Loss Aversion Bias is Dangerous

Loss aversion is a error in our brains that makes us fight like a rabid animal to avoid a small loss, while chewing our cud stupidly when it comes to getting what we want. Data from Kahneman and Tversky suggests we prefer avoiding loss about twice as much as acquiring gains.

That’s a trap.

It’s counter productive because it’s rare to find a slam dunk in life. You can find a job that’s a little better—in fact, getting better job often leads to getting an even better job. You can achieve “100% better.” The problem is that you’ll rarely achieve 100% better in one move. That’s why loss aversion tends to “stick” you exactly where you are unless you get a lucky break with a job that is twice as good.

Consider also that whatever you have, you’ll work twice as hard to keep it than you would to acquire it in the first place. If your husband is sort of a shit, you’ll fight to “make it work.” If you had just started dating him though, you’d only work half that hard to get the same guy. Again, loss aversion tends to “stick” you exactly where you are.

How to Short Circuit the Loss Aversion Bias

When you realize you’re choosing between something you’re attached to and something that’s potentially better, the easiest way to short circuit the loss aversion bias is to turn it on its head.

  • To Joe it made perfect sense to spend the time and energy to make sure he didn’t unfairly lose his $11.14, but when I reversed the question and asked him to spend equivalent time and energy in order to gain $11, he knew intuitively that it was a crappy deal.
  • If you’re working massive overtime to get a promotion, ask yourself: would I work a 40 hour week at a job paying what I make now, plus another 40 hours a week without pay for a whole year in order to make 10% more than I make now?
  • If you’re with someone who doesn’t make your heart sing, ask yourself: would I fight to acquire the companionship of a person who I know is dull and and kind of annoying?

Can you think of a situation where reversing your thinking would make it clear that you’re fighting tooth and nail for a crappy deal?

Responses

  1. Pingback: Brain Hack: turn loss aversion bias on its head

  2. Chris ()

    Is it really though? Isn’t more a case that Joe felt that the company had stolen $11 from him? And that it was the principal of not letting them get away with it that drove him to fight for 4 hours? (Reply)

  3. Elliott ()

    can’t Joe’s actions also be accreddited to the human trait of not wanting to be ripped off? (which is demonstrated by the ‘ultimatum game’ and people generally refusing offers of below 20% of the money)

    surely Joe was not acting purely for the $11, he probably felt slighted and was pissed off, and if he was asked about it he might have responded he did it “for the principle” which can’t be ignored. (Reply)

  4. David K. Park ()

    I’m a big fan of prospect theory and the current work in behavioral economics. Here’s a great Ted Talk by Dan Gilbert who discusses our mistaken expectations – http://bit.ly/11onmh.

    If you really wanted to test the theory of loss aversion shouldn’t your deal have been $22 for 2 hrs of work? (Reply)

  5. Björn ()

    I don’t think it is a very good example. There was another psychological experiment showing people were prepared to pay to punish freeloaders in a group. That is not just stupidity, it is an important social mechanism to curb freeloading in society.

    Most online purchases we make go through well because other people paid the extra price (in time and effort) to punish and weed out the bad businesses. So if you spend more effort than the pure money’s worth, you are paying back your part to society.

    In this particular example, I would probably have gone one step further and dropped the credit card company for providing bad service. Then maybe Twitter about it and what not…

    That said, you can of course still argue that it is stupid to contribute to society for free. That would then make you a freeloader, without an immediate backlash. I don’t have an answer to that ready, just saying that the whole “game theoretic setup” might be a bit more complicated than what at first meets the eye. You have to consider evolution theory, too. I suppose for starters if you decided to freeload, prices would generally go up for you. Other people seeing you might become less bothered, too, and as a result more often you won’t read a warning about a shady company than before, resulting in more broken deals. (Reply)

  6. CustDevGuy ()

    Interesting post.

    One should note, however, that in certain contexts loss aversion bias makes perfect sense even if it doesn’t mathematically/rationally.

    Taking your example, a situation where one is taken advantage of, and to rectify or balance the damage, it costs more than the original damage may be completely rational if repuational effects need to taken into account.

    If this happened to Joe in a large-scale business deal, say in a real estate, and the word got out in the local real estate community that Joe was a sucker and wouldn’t object to getting rolled — Joe could expect to get rolled more often. Therefore, it is in his interest to short-term pay more to regain his damages/costs, if long-term it serves his interests.

    It may be true that ‘we prefer avoiding loss about twice as much as acquiring gains’, but I don’t see why our biases towards losses and gains should be symmetrical.

    Lastly, I would guess that loss aversion bias was evolutionarily adaptive in the EEA (Environment of Evolutionary Adaptedness) and still maybe in certain situations.

    BTW If you’re interested in biases, I wrote a post about cognitive biases and startup success here:

    http://market-by-numbers.com/2010/01/cognitive-biases-positive-black-swan-events-and-startups/ (Reply)

  7. crash ()

    This is a great post. In most circumstances, I get around this problem by thinking I can do more damage by posting about in my blog about my horrible experience, get it listed on DIGG, post it on every single social media property I use and then tell all my friends about getting screwed.

    I would figure it would take about $11 worth of effort and in the end, wreck more damage than than what your friend went through. Plus, it would put a smile on my face for several days.

    In todays world, you have immense power at your disposal to make companies think twice about screwing its customers – either on purpose or by mistake. (Reply)

  8. Richard ()

    This is great, I totally use that logic to friends buying things too.

    When a friend bought a new car they were choosing between luxury car A and economical car b. They couldn’t decide because the playing field wasn’t level.

    So we played a thought game, Lets say luxury “A” costs 10,000 and economy “b” costs 8,000. If you already owned luxury car “A”, and someone offered to trade you that car for economy “B” and 2,000 would you take the deal? If the answer is yes, then they should obviously buy the economy car.

    It may be a little confusing but its a great way to evaluate the worth you place on two comparative items.
    .-= Richard´s last blog ..Take a Note =-. (Reply)

  9. Erick ()

    Not the best example. I have one. A friend I had would spend days looking for the best deal on everything he purchased. I would explain to him over and over that the best course would be to buy from a local retailer, provided their price wasn’t obscene. Failing that, find a better price elsewhere. Instead, he’d spend hours each day trying to save pennies, overlooking the fact that those hours spent were quite costly. So, on a $100 item, attempting to save himself $5, he would pass on literally double-digit billable hours. And the moron did this with everything he bought. (Reply)

  10. Steve ()

    I think commenters above hit it — it’s more than the $11, it’s about fighting back when you’ve been taken advantage of. We all get jerked around by faceless bureaucracies, crooks and sheisters who deliver a little less than they promise for a little more than they deserve. Some of us, when taken advantage of, have an intense need to demonstrate that we have control and we will not be taken. Advantage. Of. Dammit.

    AT&T once screwed me over for about $350 on a cell phone bill when I was nearly broke. So later on, I made sure that when my IT customers were buying T1s, they heard my horror story. And to a client, they went with other vendors. AT&T got their $350, but I made sure they lost many, many tens of thousands of dollars.

    Seriously, you can’t beat that feeling! :-D (Reply)

  11. de-aversioning ()

    Thanks for this post! It just helped me understand the cost of a project I’m working on for about 10 hours each week. When I multiply by an hourly rate over the course of a year, it’s clearly not a good use of my time. I’ll hand off this work to someone else.

    It’s interesting because I’ve read about the loss aversion principle before, but never applied it to my own life.

    Some people are good at managing time/money instinctively, but for others (like me) it’s necessary to really work at it. (Reply)

  12. Mr. Natural ()

    It’s really quite simple, just figure in your brain the amount of effort expended for the amount of reward reaped. Think you need more bling in your life? Remember the hours you will have to turn in at the mill/factory/office/workplace in exchange for it.
    THEN there is calculating one’s carbon footprint…another important personal kettle of fish to deal with.

    Peace, eh?
    .-= Mr. Natural´s last blog ..Here’s the newest in the "Small Guys" series:TIMELESS SOJOURN: =-. (Reply)

  13. Karilee ()

    To some of the commentors – it’s not either/or. You can avoid “Joe’s” strategy of punishing himself further, and still follow “Crash’s” strategy of making sure others are warned and the company that screwed you is the one financially (most) punished in the end.

    Nothing wrong with standing for a principle if you CHOOSE to, but do it intelligently and effectively, not by reflex.

    Don’t miss the important part of this post for you: “You’ll rarely achieve 100% better in one move”. Don’t let this programming limit your opportunities – make conscious choices and benefit.
    .-= Karilee´s last blog ..Three Words For The New Year =-. (Reply)

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  15. Matt ()

    At least in the way this is presented, this isn’t an obvious case of loss aversion bias at all (unless your friend told you that was his motivation). I don’t think you’re making a convincing argument for this being a textbook case as there are too many other factors which could motivate your friend’s behavior. In my opinion you drew a particular psychological conclusion purely from hearing a set of actions alone, vs. having additional information such as your friend’s state of mind at the time. (Reply)

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  17. Deborah Channing ()

    Let me start by saying I have been a longtime fan, but this is my first comment. I figured I should probably say thanks for posting this piece (and all your others), and I’ll be back! (Reply)

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  19. Marcus ()

    With all due respect, this is a rather shallow analysis of loss aversion.

    What you propose, that your friend should not have spent so much time getting back his $11, is not what is called in game theory an evolutionarily stable strategy. In other words, a society composed of such individuals cannot work.

    In game theory there is a classic game called hawks and doves. You should read about it and understand how it applies to the situation you have described concerning your friend.

    All your analysis boils down to is that there is a payoff to being a dove. Of course there is. But a society of doves cannot exist because there is a payoff to being a hawk too.

    If everybody just rolled over like you suggest your friend should do then the hawks would proliferate.

    In fact, the only evolutionarily stable strategy is to be a dove when acquiring resources and to be a hawk when protecting a resource. Precisely the behavior your friend exhibited.

    Loss aversion bias is not a flaw in human behavior. It is certainly possible that in such a society it can be profitable to be a pure dove (which is essentially the gist of your post) but only because most people are not pure doves. As a couple of people above have noted, it is basically freeloading. (Reply)

    • Pete ()

      Thanks for the thoughtful reply Marcus. I’m well aware of game theory, hawks, doves, and all.

      This strategy wasn’t suggested in ignorance of evolutionary stability. Actually, it’s the result of an insight I had in recent years that I wrote about in my Hack the World essay which can be summarized as: fuck evolutionary stability.

      You have abstraction disease.

      You’re making perfectly reasonable arguments about a hypothetical, abstract game. About how things might be if “agents” (like doves and hawks) worked a certain way, and made certain decisions en masse. You’re arguing from the premise that what you should do is predicated on whatever the universal axiom is, like Kant argued (I like Kant, but his arguments are pretty outdated these days).

      My point, which I didn’t articulate in this essay, but I have elsewhere, is that that’s an old line of thinking that’s not optimal for you as an individual… it’s only optimal for the “evolutionary structure”, which is a theoretical construct over which you, Marcus, have no control.

      I’ve gotten enough flak over that example though, to realize I could’ve chosen a better one. Any ideas? (Reply)

  20. Arf Epstein ()

    This is not an example of loss aversion. It is an example of how highly Joe, and most of us, value justice. (Reply)

  21. Vince ()

    Great post, but marriage is probably a bad analogy. As in, to many people, it’s a religious sacrament and divorce is wrong. Also, what if you have kids? Is it worth it to try to make marriage work for your kids? Also, if you’re dating, it sucks when you have to say you’re divorced.

    I also agree with Arf – http://www.petermichaud.com/essays/loss-aversion-bias/comment-page-1/#comment-1036 that justice also has value, and doing this kind of thing could prevent it from happening to others in the future. (Reply)

  22. Michael Grafl ()

    Agree with others here: it’s not about the money, but about finding justice, which in itself is a big motivator.

    I would have told you to fuck off as well. (Reply)

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