“Prospect Theory” was first published in 1979 by Kahneman and Tversky, and though many would think it was about finding new business, it is instead, a theory that looks at how people make choices between alternatives. The purpose of this article is to explore how people make choices and how you can apply this knowledge in your pursuit of persuading people, whether they are your clients, your staff or your manager.
How do most people make decisions? Do they start with logical arguments or do they make gut calls and then back those decisions up with rationalizations? To get the good or to avoid the bad is the interesting question. Here’s a simple test to see where you stand when it comes to making choices when presented with alternatives.
In Scenario One, choose one of the two gambles:
Gamble A: A 100% chance of receiving $2000.
Gamble B: Toss a coin with a 50% chance of receiving $4000, and a 50% chance of receiving nothing.
Make your choice before you read on.
In Scenario 2, choose between:
Gamble C: A 100% chance of losing $2000.
Gamble D: Toss a coin with a 50% chance of paying $4000, and a 50% chance of paying nothing.
Curious how your answers compare to others? Keep reading.
In their study on Prospect Theory, Kahnemann and Tversky found that while a strong majority of people choose A, almost all of those people also choose D, thus illustrating a proclivity to avoid risk. When I ask clients the first set of questions, I often hear, “I’ll take Gamble A, it’s safer,” while others will add, “I know it’s the same expected value, but I’m conservative by nature.”
When I ask the clients the second set of questions, they usually recognize the paradox, but still, rationalize the emotional decision to choose D because, as they tell me, “If there is a chance though, how can you pass it up?”
People avoid risk when it comes to getting good things, but embrace risk when it comes to avoiding bad things. No wonder sales people will reply to all RFQ’s – even the ones they have almost no chance of winning (scenario 2) – instead of prospecting their target market (scenario 1). No wonder some companies go to the brink of bankruptcy before they will change how they operate versus proactively ensuring profitability. We know the odds are stacked against us but if there is a chance…we’ll risk the loss to avoid pain yet fail to act when pursuing the good.
Getting the Good
Your products and services provide a wide array of benefits to your customers. If they didn’t, you wouldn’t be in business. But what is the most effective way of explaining this to those customers? Prospect theory argues that explaining the “good” about your product is a substantially weaker argument than explaining how your product helps “avoid the bad.”
When buying a TV at an electronics store, which argument would resonate more with you? “If you buy the extended warranty, it will save you some money if you encounter a problem with the TV.” Or, “If you don’t buy the extended warranty you could end up paying twice the price when the TV breaks.” Which one tugs at the emotions first and the rational mind later?
But what if your competitors have figured this out? This “new” theory might be exactly what they are working with right now. They may take this different approach and instead of focusing on benefits of what they offer, they begin to focus on risks of people not buying what they offer. What could your company lose? What would be at stake? The ways in which you frame your offering can be the difference between getting the order and being rationalized away.