Loss Aversion Theory is a complicated way of saying something pretty simple: we hate to lose what we have more than we like gaining something new.
This idea has been around long enough to be encoded into old wives’ tales: a bird in the hand is worth two in the bush. However, this simple insight has noticeable consequences. That being many aspects of digital marketing, growth marketing, social proof techniques, and even writing marketing proposals.
In this article, we’ll explain what loss aversion theory is, how it can be used in marketing and what it’s limitations are.
What is Loss Aversion Theory?
This idea was first acknowledged by Daniel Kahneman and Amos Tversky in 1979. Its basic premise has been repeated in hundreds of experiments. Kahneman says that he often explains it with a coin flip bet. Tails means the player loses $10, he’ll say. He’ll inquire what heads would have to be worth for them to play the game. In most cases, the proposal is around $20. In other words, losses hurt about twice as much as wins thrill.
This result has been repeated in many experiments over the past 50 years. Some of this research has been conducted in extremely risky situations, and some in less serious circumstances. In one experiment, two groups of patients received almost identical brochures on breast self-examinations. For the first group, the content emphasized the gains of performing self-exams. While the second group received a negatively-framed brochure, highlighting the losses of not performing the self-exams. Scared by the possible losses, the second group indicated higher positive attitudes and behaviors related to the exams.
The results of this kind of research are invariably similar: we are not the rational decision makers we think we are. When making decisions, we use a baseline as reference. That being, we don’t want to lose what we already have.
Loss Aversion in Marketing
Let’s take a look at how loss aversion applies in the real world.
An easy way to implement the key insight of loss aversion theory is in your digital marketing. Instead of framing a special offer as a present you are giving to your customers, frame this as an offer they have already earned. Unless acting quickly, this offer is going to become unavailable.
Research suggests that this kind of approach can be extremely successful. In research studies conducted by Daugirdas Jankus at the ISM University of Management and Economics, loss aversion approaches of this kind outperformed the counterparts. It reaches the highest increase in conversions and the highest mean scores for maximizing page views.
In practice, this indicates that increasing conversions on your website can be done by adopting approaches that make use of three key principles:
- Frame the offer in terms of loss.
- Make it risky.
- Offer a referent to base the comparison.
Now, it’s possible to take this further and to personalize this type of offer based on the prior behavior of a customer. If they don’t have the tracking option activated on their favorite ad blocker (which is a coin flip in itself), you can collect information on what they have purchased to date, and offer similar items in time-constrained deals. By doing this, you combine two of the most effective marketing tools available: loss aversion and website personalization.
The same principle can be applied in your social proof mechanisms. It’s possible to frame testimonials and reviews in a way that induces a fear that customers will lose out. This can be achieved by stressing that your company is growing fast and can only take on a limited number of exclusive new customers.
Despite many pieces of research, loss aversion theory does have some detractors. They claim that the kind of behavior seen in the research mentioned above is not irrational at all. Rather, it’s a rational response to the loss of valued goods. In this context, much research has been devoted to working out whether loss aversion bias can be mitigated. Especially given that investors fall prey to this bias. They tend to view their investments under short-term lenses. That larger gain accumulated within a year gets easily overlooked. A recent minor loss over the last month can produce the thought that this leads to significant inefficiencies in our economy.
Marketers are less concerned on constructing eternal theories about human psychology and more focused on what works. For whatever reason, loss aversion theory appears to work.
The Bottom Line
For this reason, no marketer today can afford to be ignorant about loss aversion theory. Study after study has shown that offers that are framed in terms of losing an existing possession, rather than gaining a previously unknown one performs better. In addition, loss aversion theory is now so mainstream that it’s basic knowledge. It will greatly help marketers in collaborating with their peers and in designing growth strategies that managers understand the value.
Here at UseProof, we’ve long been aware of the theory behind loss aversion, and have designed our platform so that you can easily implement it on your own website.