Sway: Loss Aversion and the Power of Commitment

While most of us think of ourselves as rational human beings, we are much more prone to irrational behaviour than we actually realise.

Our behaviour and our decision making are influenced by an array of psychological undercurrents that are powerful and persuasive. Even more startling, when they converge, they become even more powerful, and can have far reaching impacts on the decisions we make.

Ori Brafman and Ron Brafman outline a number of these undercurrents in their excellent book 'Sway: The Irresistible Pull of Irrational Behaviour'.

This post explores the first two undercurrents, Loss Aversion and the Power of Commitment.

Loss Aversion

Human beings experience the pain associated with loss much more vividly than the joy of experiencing a gain. What this means is that humans are more often motivated by avoiding loss (and pain) than pleasure, and can overreact to perceived losses.

Marketers have been exploiting this undercurrent for a long time. Think about phone companies or car rentals, and the types of plans they offer.

From the book:

"The word loss alone, in fact, elicits a surprisingly powerful reaction in us. Companies like Avis and Hertz, facing the challenge of selling a product that is both useless and overpriced, have capitalised on this powerful effect. When we rent cars, our credit cards - not to mention our own car insurance - automatically covers us should anything go wrong with the vehicle. But the rental companies push additional coverage that not only is redundant but would cost a whopping $5,000 on an annual basis. Normally, we'd scoff at such a waste of money. But then, as the sales rep behind the counter is about to hand over the keys to that newish Ford Taurus, he asks whether we'd like to buy the loss damage waiver.     
When we hear those words, our minds begin to whir: What if I have bad luck and end up a wreck? What if, for some reason, my credit card won't cover me after all? Normally, we'd never dream of taking out an extra policy at an astronomical rate just to be doubly safe, but the threat of a loss makes us reconsider."

In other words, the more there is on line, the easier it is to get swept up in an irrational decision.

Another example is in stock trading. Investors have a term called "chasing the loss" that touches on this - when we don't cash out on a high, and continue to ignore the current data, put on blinders, and proceed with singular purpose to recover as much of their loss as possible. This can often result in losing everything as a result of this poor decision making.

Commitment

Commitment as an undercurrent is closely linked to loss aversion.

Commitment manifests itself as an inability to let go when things are clearly not working. Think about times you have invested a huge amount of time and effort in a project or poured a lot of energy in a doomed relationship. It can be incredibly hard to move on or admit defeat, however staying the course because we have been committed invariably hurts you more in the long run.

So when linked to loss aversion, this creates a dangerous mix. We can create situations where we try to avoid potential losses (so become averse to risk taking), and stay committed to the things we have been doing for years (so blinded by commitment), and therefore implement inferior strategies.

A great example in the book of this is the Twenty-Dollar Auction, an experiment run by Professor Bazerman at Harvard.

The twenty-dollar auction is simple. Students are able to bet in dollar increments starting from zero to win a twenty-dollar bill. The catch is that whoever comes in second place needs to honour their bet and fork out the money they bet.

In almost all cases when the experiment is run, it follows the same pattern - bids rapidly increase to the $12 - $16 mark, and then all players drop off except for two.

This is the critical moment when commitment sets in - no one wants to be seen as a sucker, so they keep betting. Eventually bids invariably tip over the $20 mark - with the all time record being a bet setting at $204.

The analysis - the deeper the hole they dig themselves into, the more they continue to dig, losing all site of the original goal. The most interesting point again is the $12 - $16 mark - this is the moment where loss aversion and commitment meet together to sway people into an irrational situation.

Some other examples outlined in the book are the Vietnam and Iraq wars (both of which eerily mirror each other in terms of a build up of loss aversion and commitment). We are not just talking a few dollars here, but potentially a huge number of human lives being swept up in irrationality.

How to Avoid Them

When it comes to psychological undercurrents, the best ways to counter them is often to avoid following our natural instincts. This can be hugely hard, so its good to keep these strategies in mind.

Avoiding Loss Aversion

Our natural tendency to avoid the pain of loss is more likely to distort our thinking when we place too much importance on short-term goals. A long-term view makes any immediate potential losses not seem as menacing. In other words, trade "band aid" solutions for longer-term planning.

An example is if someone stops in front of you at a green light. Your natural instinct may be to pull your car out into the oncoming car lane to go around them (and probably quite aggressively) as a means to avoid the pain of being late. But is this worth the risk of smashing into another vehicle?

Avoiding Commitment

Strategies to avoid commitment undercurrents revolve around adopting a Zen Buddist approach. Let go of the past, what's done is done, so shift direction rather than digging a deeper hole.

Think about marketing managers who are supporting a failed campaign or strategy because they don't want to be seen as a quitter, or as someone who is rocking the boat. Invariably this will only compound negative results long-term.

Ask yourself the following litany:

"If I were just arriving on the scene and were given the choice to either jump into this project as it stands now or pass on it, would I choose to jump in?"

If the answer is no, then chances are you have been swayed by the hidden force of commitment. Making a clean break may be uncomfortable, but it could be in our best interests.

Grab the book for some interesting case studies and research that delves deeper into this topic.


This continues my post on mental models.