Endowment Effect: Definition, Examples, Uses In Marketing And Economics

Cognitive biases influence our decision-making abilities subtly. One such bias, which has implications in economics and marketing, is the endowment effect. Since it operates on people subconsciously, it is important to understand the irrational behavior it causes in us. And to learn how to use it to persuade others ethically.

What Is The Endowment Effect?

The endowment effect is defined as our tendency to ascribe higher value to something merely because we own it. Also known as divestiture aversion, it was a term first coined by Richard Thaler, a behavioral economist. Thaler’s study, done with Daniel Kahneman and Jack Knetsch, was one of the first to show this effect experimentally.

Now, some modern cognitive behaviors proposed by social psychologists can be somewhat dubious. Mostly observed in their “controlled” undergraduate subjects. But not very useful in the real world because of additional complexities.

A way to test if certain biases and heuristics, like the endowment effect, are in fact valid is to look for ancient proof. Essentially, an observation of the concept going back in history will validate the current theory.

The good news is that for the endowment effect, we do find historic evidence of this. Listen to what a famous ancient Greek philosopher and polymath had to say about this cognitive quirk:

“For most things are differently valued by those who have them and by those who wish to get them: what belongs to us, and what we give away, always seems very precious to us.” — Aristotle.

When you see modern scholars like Thaler and Kahneman re-discover what was commonly known centuries ago, you should pay attention to their findings. It is a real effect and plays an important role in human decision making.

How The Endowment Effect Works

The endowment effect was initially hypothesized to be related to loss aversion — another cognitive sciences quirk humans are prone to. Once we own something, giving it away seems like a loss. Thus, we mentally overvalue our possessions to avoid feeling dissatisfied from losing them.

But new findings in social psychology and behavioral economics show that ownership, and not loss aversion, causes the endowment effect. In other words, the mere fact of possessing something makes us irrationally assign a higher value to it.

Endowment Effect Examples In Sales And Marketing

Unbeknownst to most of us, the endowment effect, or slight variations of it, have been used quite successfully in marketing for quite a while now. In some cases, it is deliberate. While in others these retailers have accidently stumbled up on its good fortune. It is also possible that some salespeople are, even now, not aware of its fortuitous effects on their bottom lines. Let’s go through some examples to learn more.

The Endowment Effect In Department Store Changing Rooms

Department stores and clothing stores in malls have been using a variation of the endowment effect for decades now. The changing rooms they provide are there to let customers check the fit of the clothes. And decide if it looks good on them and/or pick out the right size.

But for that short time, in the privacy of the change room, that garment is yours. It is on you and you see yourself in the mirror. People now visualize themselves going places in it. And imagining what others might say or think about the outfit.

Through the endowment effect, you will view the clothes more favorably and increase the chances that you will buy it. This is probably a case where retailers have accidently hit on an element of the endowment effect in helping them with sales.

Online Retailers Persuading Us To Buy More Through The Endowment Effect

Several online retailers have now started a new feature. They allow customers who want to buy clothing or shoes to “take home” several sizes around the customers estimated size for no charge. They then get seven days to try out the items. You can then either return everything or keep the size that fits best. Only after seven days are they charged for things they keep.

With their past models, you would need to purchase a few sizes and then mail back the undesired ones for a refund. So, this is definitely a beneficial feature for an online store to offer.

However, they will also rarely pass on an opportunity to also take advantage of our weakness for subconscious tricks. Here again, the merchandise is yours for 7 days. And this makes the endowment effect kick in. You are now less likely to return everything. Your divesture aversion will trick you into keeping at least one item.

How The Endowment Effect Persuades Us To Buy More

If you asked people why they decided to make the final purchase, they’ll say they thought it looked good on them or that they liked the color. But a big driver in their choice would simply have been that they were reluctant to let go of something their subconscious previously viewed as belonging to them.

The online stores are subconsciously letting you believe that you own the item for seven days. Even though the item is not yet paid for, the endowment effect still plays a role and gets us to overvalue it. Thus, we are more likely to end up keeping at least one of the sizes we have tried out.

Now contrast this to their previous approach in which people would get the item shipped, try it and then have to quickly make a decision whether to keep or return it. The sense of ownership for seven days shifts us towards liking it more than with their past model.

Additionally, we are reminded of the generosity of the online stores in giving us many sizes to try out and additional days to decide. And all the items were sent to us for free, so it plays on our need to reciprocate — by agreeing to the purchase it.

The Endowment Effect Of Free Trials

Free trials (or initial lower prices) that the likes of online streaming services, cable TV/internet providers, and magazine subscriptions provide to potential customers is a somewhat obvious example of the endowment effect.

But we know they are successful in driving sign ups to their services. When you have their service for a few months, they become your provider and brand. You own their service. When the initial free term comes up and you have to choose whether to continue with them, you are likely to judge them more favorably than you would have before. Simply having this service and viewing it as yours, will tilt the decision towards staying with it.

Engaging The Endowment Effect In Virtual Reality And Augmented Reality Shopping Experiences

If you are shopping for large furniture, art, and decorative home items, new augmented reality apps let you “insert” the item virtually in your living space. This essentially triggers your mind to imagine the item in your home. If you see something clearly fitting in to your living space, it is half as if you already own it. While the endowment effect may not play a big role here, it still factors in to some of the decision making and eventual yes/no to the purchase.

How To Use The Endowment Effect To Persuade Others In The Workplace

Being aware of the power of the endowment effect will help you calibrate some of your ideas and proposals at work. You will start to realize that you might be assigning a greater value to their utility than they are worth because you came up with the ideas. We sometimes give our own ideas more credit than they may deserve.

You can also use the endowment effect to give your ideas and proposals at work more chances of success. Find a way to get people to try out for a few days (without cost or risk) what you are trying to sell them (physical things or ideas). Then, they will start to feel like they own the item. In their mind, this will now be worth much more than before they had this sense of ownership

Related Cognitive Biases

While the endowment effect is about us ascribing increased value due to mere ownership, there is a related cognitive bias called the IKEA effect. This is a tendency to overvalue an item because we have provided some of the labor that went into its building or final form. Just like many of us do with IKEA furniture that comes ready-to-assemble. Since we take the pieces and “construct” the eventual furniture, we view it as more attractive or desirable.

Additional Reading On The Endowment Effect

If you want to discover new ways to persuade others, the next time you visit an online website, pay close attention to any of the latest features they are promoting. There is a good chance they are using some new psychological trick to drive up sales. If you develop the ability to find these hidden gems, you will be able to use them to your benefit when you influence and persuade people.

A good book that discusses the endowment effect and other cognitive biases is Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard Thaler and Cass Sunstein, Penguin Group, New York, NY 2009.

Keywords

Endowment Effect; Marketing; Behavioral Economics; Cognitive Bias; Decision Making; Persuasion; Mental Accounting; Divestiture Aversion

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