Sommersemester 2021: Tobias Zehetner
"Gains and losses are relative to some neutral reference point".1 This statement is a central part of the coding within Kahneman and Tversky's Prospect Theory and aims to illustrate, that we, as humans, typically perceive results as being either a loss or a gain, rather than an ultimate condition.1 What might sound abstract becomes graspable in financial situations, where gaining a certain amount of money might be less useful than losing the same amount hurts. But can such behavioral take-aways also be applied to a field of study, that is different from finance, such as marketing? In other words: Can Prospect Theory tell us more about the relationship between customers and brands? The simple answer is “Yes, it can”, as the same aversion for losses can be seen for consumer behavior.2
Putting it into context, the reference point of Prospect Theory is equated with the expectation of the consumer.2 To make this idea more tangible let us establish the example of buying a Porsche. Imagine you want to buy a sports car and have a specific amount of money that you are willing to spend. If you do in fact buy, for example, a Porsche 911, that costs the same amount as you were willing to spend, you will, most likely, not assess this expenditure as a loss. However, if it turns out, that your local dealership does not have any 911 in stock, and the production of the model has been discontinued, the pure failure of purchasing the car counts as a loss.2 Similarly, imagining the 911, in the end, turns out to be more expensive as expected, as the discontinuation of the production raised prices, one might also evaluate it as a loss. This dependency on references seems very intuitive up to this point, however, it gives even more interesting insights into customer behavior, under uncertainty.
In this case, a customers' or decision-makers' preferences regarding consumption are significantly influenced by the customers' environment.2
Therefore, the willingness to pay depends on a) the probability with which one is expecting to buy a product, also known as the attachment effect, and b) the expected price itself, often referred to as the comparison effect.2 In this aspect, the attachment effect tells us, that if the probability of buying a product increases, it automatically increases the loss perception should the purchase, for whatever reason, fail. Thus, an increasing attachment effect boosts willingness to pay.2 In other words, the more people are expecting to be able to enjoy a certain product or offering, the less likely they are to accept a loss. This moreover is congeneric to the concept of the Endowment effect, as an increased contemplation of buying a product, or a well thought-out plan of purchase, leads to stronger loss perceptions if purchases are not made.3 Moreover, the comparison effect shows, that the lower the price one is expecting to pay for a product is, the more will higher prices be considered as a loss.2 Thus, low expected prices correspond to a low willingness to pay. Conversely, a customer's willingness to pay rises, if the expected price increases, as one expects to pay more.2 Should prices unexpectedly be higher, a higher expected price means overpaying a product hurts less.
References
1 Kahneman, D. & Tversky, A. (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica, 47(2), 263–291. https://doi.org/10.2307/1914185
2 Koszegi, B. & Rabin, M. (2006). A Model of Reference-Dependent Preferences. The Quarterly Journal of Economics, 121(4), 1133–1165. https://doi.org/10.1093/qje/121.4.1133
3 Kahneman, D., Knetsch, J. L. & Thaler, R. H. (1991). Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias. Journal of Economic Perspectives, 5(1), 193–206. https://doi.org/10.1257/jep.5.1.193