Dollars & Sense

Loss > Gain

Daniel Kahneman, the celebrated economist, passed away last month. The Nobel Prize and Presidential Medal of Freedom winner gave us insights into the economics of the mind, such as people fearing loss more than gain, making short sighted decisions, and overly relying on feelings. 

We can often use Mr. Kahneman's insights in our business's daily operations.

Risk Assessment
Jason Zweig’s The Wall St. Journal profile on him shares an insight about calculating risk.  

“Ask people if they want to take a risk with an 80% chance of success, and most say yes. Ask instead if they’d incur the same risk with a 20% chance of failure, and many say no.”

Our company may charge clients a small commission when they receive an order. Instead of us explaining to prospects that we take 5%, using Mr. Kahneman's finding it's better to say they keep 95%. 

Loss Aversion
“Losses feel at least twice as painful as gains feel pleasant,” shares The Wall St. Journal article. As such, we want to lead with the pain and loss that we help a merchant avoid—instead of leading with that we gain for them. 

Let’s look at two examples. Our original email to a retailer asking it to add a link on their parent site promoted selling more. (Please see example screen shot.). We then updated this email to instead focus on their store's loss if it didn't add the link.  (Please see example screen shot.).

If you were a retailer and received an email from us, which email would you respond to?

Base Jumping
Kahneman promoted watching the larger data set (the base) to see what may happen vs. using one’s own smaller set.   Article excerpt:

.....

“The most important question to ask before making a decision,” he told me, “is ‘What is the base rate?’”
He meant you should begin every major decision by figuring out the objective odds of success, given the historical range of outcomes in similar situations.

If you’re thinking of starting a new business, your gut might tell you there’s no way you can fail. According to the Bureau of Labor Statistics, however, half of new businesses die within the first five years. That base rate comes from millions of startups, each of which also expected to succeed. You, on the other hand, are a sample of one.
Knowing that the base rate is 50/50 shouldn’t deter you from trying, but it should prevent you from being unrealistically optimistic.

.....

We, too, have to pay attention to base rates. We can’t swim against them. In the book $100m Offers, Alex Hormozi refers to base rates when we share an anecdote about a friend starting a service that helps newspaper companies. (It won’t work well because it’s a shrinking industry).  We have to keep in mind in objective facts: 1. Indie stores, which we service, are not growing quickly in number, and 2. People are getting married less. (We generate a notable amount of business of wedding registries.) We would be wise to invest in a sector that is growing quickly and grow our non-registry services.

Kahneman also was known for continually asking why (questioning norms) and pivoting quickly. “I have no sunk costs,” he said. We want to operate similarly. 

Homework

• What base rates (larger trends) do you have to keep on your radar?
• How can you use Kahneman’s insights about risk and loss version? 

Read the full article by Jason Zweig about Daniel Kahneman: https://www.wsj.com/finance/investing/daniel-kahneman-behavioral-economics-270c9797?reflink=desktopwebshare_permalink
 

Tags:
wsj kahneman loss aversion risk

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