I walk up to you and say: flip this coin. If you get “heads”, I’ll give you $100 – if you get “tails”, you’ll give me $100.
Would you do it?
Psychologists have performed countless similar studies on the decision-making behavior, and the vast majority (beyond 80%) would opt NOT to take part of the coin toss I describe above.
The decision not to take part in the coin toss is statistically flawed: if you were to calculate your “net gain/loss” from this experiment, you should be INDIFFERENT:
- There is a 50% chance of getting heads or tails.
- So your net gain/loss would be: (50% x (+$100)) + (50% x (-$100)) = +$50-$50 = $0.
But you still wouldn’t take “the risk”.
Psychologists call this: “LOSS AVERSION”: the fear of losing something you already have is MUCH more powerful than the potential gain.
Let’s use another example - I walk up to you and say:
- You have a 95% chance of winning $100,000,
- And a 5% chance of losing $300,000.
Statistically, your net gain/loss would be:
(95% x $100,000) + (5% x (-$300,000)) = +$95,000-$15,000 = $80,000!
So you should definitely take the risk! However, most people DON’T: Loss Aversion at play.
So how can you use that to your advantage?
The simplest way would be during negotiations: one of the most common negotiation tactics we all use is to “highlight the positives” of a deal, sale, etc. You’re highlighting what the other party would “gain” from making the deal happen.
But if you really want to get a deal done quickly and on the best terms possible, you should indirectly highlight the “loss that they would incur by NOT getting a deal done”.
Let’s take an example:
Scenario: I’m advising a client on selling his company, and we’re in the middle of negotiations with a buyer. The buyer wants to pay $300m, and I want him to pay $350m.
Normally, an advisor would highlight to the buyer the “unique opportunity” for them to acquire this company: “you immediately get a working platform”, “it will add $xxx to your profits in months”, you will get amazing management”, “you will immediately gain x% market share”, etc.
This is all well and good, but if the buyer is like 80-90% of people, he/she would respond better to the “Loss Aversion” argument. As such, I would take the buyer aside for an “informal” chat and mention things like: “don’t miss this opportunity because if you do, it will be harder for you to defend your position in the market!”, “I really want to help you close this deal but my client is on the edge of walking out, you don’t want to lose all the hard work you’ve put into this!”, etc.
It’s a much more powerful approach to negotiation.
But let’s look at it in a non-work / social context:
There is a new acronym floating around in social media these days: “FOMO”. It means “Fear of Missing Out”. The fact that it became such a trending hashtag in social media is in itself a clear indication of the power of Loss Aversion.
So the next time you’re having a hard time convincing your friend/partner/significant other to a social outing, don’t argue that “he/she will have so much fun”, but rather think of something that they might lose by not going. For example, you can say: “ “. Yes I’m leaving this one blank, I don’t’ want to get in trouble at home! But you get my point!
I’ll leave you with one more:
- A lottery ticket costs $10, and you have 1 in 10 million chance of winning $10m.
- 100% chance of losing $10
- 0.00001% chance of winning $10 million
You net gain/loss would be: (0.00001% x $10m) + (100% x (-$10)) = +$1-$10 = MINUS $9.
You are virtually guaranteed to lose $9, but because the amount is so small, the Loss Aversion is insignificant, and so people still buy lottery tickets!