#4 Endowment Effect: Why we always sit in the same damn seat

Cars, homes, pens, mugs - it doesn’t matter what it is - if it’s ours, chances are we'll think it's more valuable than it really is. In this episode, Mel and Dan look at why we're always going to be disappointed when we sell something second hand, and how marketers can make their products irrationally valuable in the eyes of consumers.

Dan: 00:17 Hey, I'm Dan Monheit, Co-founder of Hardhat.

Mel: 00:20 And I'm Dr Mel Weinberg, a performance psychologist.

Dan: 00:23 And if you're listening to this, it's because you're interested in why we choose what we choose ...

Mel: 00:27 ... why we think what we think ...

Dan: 00:28 ... and how to exploit this stuff for fun and commercial gain.

Mel: 00:28 Here we go again.

Dan: 00:32 Yeah, here we go again.

Hey, Mel?

Mel: 00:47 Yeah, Dan.

Dan: 00:49 I couldn't help but notice, this is our, I don't know, third, fourth episode now, and every time we come in here, being the gentleman that I am, I always let you in first, and for some reason you always sit in that exact seat. I was just wondering why that is?

Mel: 01:01 This spot?

Dan: 01:02 Yeah.

Mel: 01:03 It's my spot.

Dan: 01:03 Yeah, I know. I know you say it's your spot, but what makes it your spot?

Mel: 01:08 It's the one that I always sit in.

Dan: 01:11 It's your spot, because it's the one you always sit in, because it's your spot ...

Mel: 01:14 Because it's my spot.

Dan: 01:15 Right.

Mel: 01:15 Are you calling me out for circular logic here?

Dan: 01:18 I mean, it just seems weird, right? Like, we had the first show, we recorded it in, I don't know, 20 minutes, 30 minutes. So you sat on that piece of fabric once for 20 minutes, and now it's yours until, I don't know, the end of time, until somebody demolishes the studio and builds a new one, and then maybe I can sit on that side.

Mel: 01:32 You want my spot.

Dan: 01:33 Well, I don't really want it, but I just think it's interesting that you have somehow assigned value to that, I guess in the same way that when we go to sell our cars, we always seem to, for some reason, think that they're worth a hell of a lot more than the people who want to buy them. The same is probably true for our houses, as well. For some reason, the person selling the house always seems to think they're going to get more for it ... unless you happen to live in Melbourne ... than people seem to think they're going to be paying for it.

Mel: 01:58 I think what I'm hearing is that you're sort of describing what's known as the Endowment Effect. It's one of those heuristics that we talk about often. It's the idea that we tend to ascribe more value to something simply because we own it. Like the reason that my spot is obviously better than your spot is because it's mine, and so basically, the more that I feel a sense of ownership over this piece of real estate, here on this couch, the more important it is to me and the less willing I am to give it up for anything.

Dan: 02:30 That's interesting that the longer you have it for, the less willing you are to give it up, which I guess, if we think about things like our cars, which we spend a lot of time in and we probably have all these wonderful memories of going on road trips on and have got these sort of parts of ourselves assigned to these objects.

Mel: 02:45 And you name ... some people name their cars.

Dan: 02:48 Some people name their cars. That'd be weird but people do it, right. I guess the longer something is part of us, and the more it becomes part of our identity, and that place on the couch is clearly a key part of your identity now, the more value we tend to ascribe to these things, even if they're just inanimate objects.

Mel: 03:05 Yeah, so hey, let me tell you about some research. Guess what-

Dan: 03:08 Dr Mel coming with the research.

Mel: 03:10 I've got a study for you, would you believe it?

Dan: 03:12 Out of your back pocket.

Mel: 03:13 It's a study from the back pocket of the jeans I was wearing back in 1990, by some of our favourites, including good old Danny Kahneman. It was a study involving Cornell undergraduate students, and what they did was they gave half of them some mugs, okay.

Dan: 03:31 Mugs? Like drinking mugs?

Mel: 03:32 Yeah, like coffee mugs. Yeah.

So they gave mugs to half of them, and the other half didn't get any mugs. Then they asked both groups to place a value on how much these mugs were worth. So we're making a bit of a contrast here between what people perhaps are willing to pay for the mugs, and for people with the mugs, it's about how much they're willing to accept for the mugs. What they found was that the people who actually were given the mugs placed a much higher cost estimate on the value of those mugs than people who weren't given the mugs.

Dan: 04:06 Okay, let me break this down. So you and I are both in this course, Cornell undergrads. You're in the lucky group of people that get a mug. I'm in the unlucky group of people that don't get mugs. Then they're like, "How much do you reckon these mugs are worth?"

Mel: 04:16 Yeah. I say, "This is a nice mug and I'm holding it, and actually, I mean, it's my mug. So it's probably worth about five bucks."

Dan: 04:26 Right, and I'm like, "Well, I don't really see any value in that mug. Who cares? I reckon it's maybe worth, I don't know, $2.50, $3.00."

Mel: 04:34 That's exactly what happened, yeah.

Dan: 04:34 And that's what happened.

Mel: 04:34 Yeah.

Dan: 04:36 So you thought it was worth more just because you had it?

Mel: 04:38 Same-looking mug, the only difference was that I was given one and you weren't.

Dan: 04:42 Right. Look, this seems weird, right. This seems weird that we would be somehow wired to assign value to something just because it's in our possession. It sounds like it would make us do kind of wacky things, but I guess if you take a long term historical perspective on this, coming from a world of finite resources ... You know I like to talk about caveman Dan ... If we had to go out and hunt for something and kill it and bring it home, there's probably a lot of work in that, so it probably makes sense that we would have evolved to overvalue the stuff that we have, over the things that we don't.

Mel: 05:14 Yeah, and in the same vein, so one of the ways that we can explain this is through the concept of loss aversion, which is also very popular in the behavioural economics field, and it's the idea that once we have something, we really, really don't want to lose it. We're more motivated by the idea of not losing something than we are by the idea of actually gaining something.

Dan: 05:35 Right, it's the old, like, bird in the hand is worth two in the bush.

Mel: 05:38 Something like that, yeah. Yeah, so the idea is that if we have it, we don't want to let it go, and if we don't have it, we don't actually care that much for it.

Dan: 05:46 Okay, that's interesting.

Mel: 05:48 It comes back to our motivation around ... and sort of how emotions play into the way that we think. So all of this stuff is about how we feel, rather than how we think, at the end of the day. One example of loss aversion is that if you lose $10 out of your pocket, you're going to be pretty upset, right.

Dan: 06:12 Mm-hmm (affirmative).

Mel: 06:13 Everybody knows that feeling where you've just lost 10 bucks, right.

Dan: 06:15 “I'm such an idiot!”

Mel: 06:17 And logically, you'd think, well, if you get 10 bucks back, all right, we're good, I'm even. Even though your bank account might be even, emotionally you're not. Emotionally you've gone out of whack because that loss of $10 was actually a lot stronger than finding it again. So what you actually need, to come out emotionally even, is actually to find 20 bucks.

Dan: 06:40 Right, to compensate for the lost 10.

Mel: 06:43 That's right.

Dan: 06:44 Wow. That's a recipe for disaster for mankind, surely.

Mel: 06:44 Can be. Yeah.

Dan: 06:49 Okay, so if we're going to just really put a ribbon around this, what we're saying is, if we own a thing, actually or even just perceptually, even just that we happen to sit on that chair for five minutes, if we feel some sense of ownership towards something, we are going to ascribe more value to it than if we never owned it at all.

Mel: 07:08 Yeah. Can you give me an example of how this might work in your world?

Dan: 07:13 I'm so glad you asked. Obviously, academically or just intuitively, instinctively, businesses have realised this for a long, long time, that the quicker you can get somebody to feel like this thing is theirs, the better chance you've got of them actually buying it. So if you look at things like real estate, right, we have open for inspections for a reason. We want people to come in and see the house. You know you go to an open for inspection and they take away all the photos of the family that live there. Firstly because it's kind of weird, but also it's much easier for you to imagine yourself in that home.

Same thing when you go to buy a car, the first thing the sales guys wants to do, right, is give you an experience. He wants to get you in the car, going for a test drive, so you can start imagining yourself driving to work or driving home or cruising around with your friends in this exact car. Even if you've only driven it for two or three minutes, 15 minutes, whatever it is, it's started to weld itself to you, and you start feeling some degree of ownership. You've imagined your future life together.

Mel: 08:11 It's pretty amazing how strong our imagination is for things like this. Back in the day, I used to work at Sportsco.

Dan: 08:18 Let's go Sportsco?

Mel: 08:20 That's the one. I used to sell running shoes, used to sell sneakers. That might have been where part of the obsession started. But what I used to do would be to get the customer to try them on, right, and if you can get a customer to try it on, you've basically made the sale, because what happens when they try it on is that they start to walk around the store in it, and as they're walking around the store in it, they're imagining their future life with these shoes.

Dan: 08:42 “My life is so good with these shoes.”

Mel: 08:46 And they're imagining all the other outfits they can wear with these shoes. They're imagining what events they're going to wear these shoes to. So then, for them to actually not make that purchase, that not only deprives them of the shoes, but of all those future dreams that they had with this fantastic new pair of Air Force Ones.

Dan: 09:00 Got you. So that's one. The second way businesses try to use this is with the process of co-creation, so knowing that if they can get consumers to feel like they're actually contributing to the end product, they're going to ascribe ownership to it, and therefore they're going to value it more. There's a couple of really great examples of this.

Number one is IKEA. IKEA know that the fact people spend whatever it is, 89 bucks on a Billy bookshelf, they bring it home and then they invest two or three hours of themselves, their own time and effort, and cursing and tears if you're me, in putting together your Billy bookshelf, you are just going to be so much more proud of it, and you're going to value it so much more highly than if you'd just gone and bought a ready-made thing off the shelf. It results in people doing all sorts of crazy stuff, like selling Billy bookshelves on Ebay for hundreds of dollars, which makes no sense at all. I was even speaking to somebody last week who's being relocated overseas and they are taking their Billy bookshelf with them. The thing cost under 100 bucks and they probably sell them wherever the person's moving. Makes no sense at all.

The other great example of co-creation is the guys at Betty Crocker. You guys know the cake people, and Betty Crocker know that if they can get people to feel like we are really creating the cake with them, and not just putting together a bunch of things they have assembled for us, we're going to be so much more proud of it. They've realised that the minimum threshold for us feeling like we're contributing is cracking an egg. So even if everything else is in the box, if we crack the egg, we mix it in there, we are baking, and now it feels like it's ours, and man, this cake tastes so good, and I'm so proud of it because I made that thing. I cracked that egg by hand.

Mel: 10:38 So another example, it's reminding me of customising products and personalising shoes. We'll go back to the good old Nike kicks as an example, because one day, one day we'll get Phil Knight in the store, in the studio, and then we'll get in his door. But the idea is that if you can personalise a pair of shoes, right, everybody's got shoes, and they come in all different colours, but if you can actually co-design them, if you can actually contribute to what colour those shoes are, what colour the swoosh is going to be, what colour every little piece of it is going to be, what colour the shoelaces are going to be, it's going to feel like yours. And if at the end, you can chuck your initials on it and a number, then those shoes are ultimately yours.

Dan: 11:24 I guess we're seeing that proliferate out everywhere, from websites where you can spec up your own car and put your own wheels on, and you can change the different tint of the windows, through to even just being able to put your initials on a phone case or a bag or a wallet.

Mel: 11:40 Yeah, that's it. It's happening everywhere now, so I think we can move onto the next ... the last one, which was the idea of a money-back guarantee.

Dan: 11:49 Uh-huh (affirmative).

Mel: 11:49 Yeah, so we know all sorts of companies offer a money-back guarantee these days, for all sorts of things, and what they're really doing there, rather than giving you a sense of ownership or allowing you to co-create, they're actually feeding into this idea of loss aversion. So knowing that we don't like to lose out on anything, for example our money to buy something, what they do is offer a money-back guarantee which says, "You don't actually need to worry about losing anything of yours to obtain this product. In fact, we're going to, if you're unhappy, you can have all of your money back. There's absolutely no reason to worry or to feel anything in respect to loss, at all."

Dan: 12:26 You've basically just described every infomercial ever made.

Mel: 12:29 That's it.

Dan: 12:30 All right, so the three ways I guess companies are using this is, one is around giving people an experience to get a sense of ownership, you know, free trial of the product, test drive, try it on, walk around, describe your life in this thing. The second is around co-creation. If we can get them to build it, they're going to value it more, they're going to love it. And the third is around de-risking the potential loss with things like money-back guarantees.

Mel: 12:53 Yeah. Don't take my spot.

Dan: 12:55 I would not take your spot, and now I understand how much you value it, I don't even think I could afford to take that spot if I ever wanted to.

Mel: 13:02 No, I'm not selling it to you for anything.

Dan: 13:03 But to you guys, dear listeners, I mean, look, this show would be nothing without you all. You have contributed so much and you should all be so proud of yourselves for the show that you've helped create here.

Mel: 13:12 Yeah, I mean, it really is their show. I mean, we do it for everybody, don't we?

Dan: 13:18 Yeah.

Mel: 13:19 It's fun for us, but it's really-

Dan: 13:21 Mainly for the people.

Mel: 13:22 It's all for them.

Dan: 13:23 Yeah. So if you've got more questions about the endowment effect or loss aversion, you can hit us on Twitter. If you want the airy-fairy academic stuff, you can get Mel. What's your handle, Mel?

Mel: 13:32 Airy-fairy ... @DrMelW.

Dan: 13:34 Sorry, well-researched.

Mel: 13:36 Scientifically credible.

Dan: 13:37 Scientifically proven. She's wearing a lab coat right now, @DrMelW. Is that D-R Mel W?

Mel: 13:44 That's the one.

Dan: 13:45 Got you. Or if you want to know the hard hitting business side of this stuff and how to actually use sell more products and services, you can get me on Twitter as well, I'm @danmonheit, M-O-N-H-E-I-T.

Mel: 13:56 And just in case you were wondering, that was Dan trying to sneak everybody into co-creating the show.

Dan: 14:02 No, it's not sneaky at all.

Mel: 14:04 You told me, again. I'm going to put my ethical police hat on.

Dan: 14:07 Call the fun police.

Mel: 14:09 Show's over. We're out.

Dan: 14:10 All right, we're done.