Anyone who buys a wardrobe from IKEA knows they’ll need a hammer and screwdriver to assemble it once they get home. This not only lowers the sale price, but also has a rather surprising effect on customers, which psychologists have baptized the “IKEA effect”. If used correctly, this phenomenon can help companies in almost every sector improve their marketing and boost sales.The IKEA effect: Why you should include DIY elements in your products
The endowment effect describes how people assess the value of their possessions. The effect causes us to determine the value of a good (e.g. a purchased good) to be higher simply because we (temporarily) own that good. While it seems irrational, it makes sense from an evolutionary standpoint. How does the endowment effect impact marketing?
What is the endowment effect?
The endowment effect is a type of cognitive distortion which describes how we subconsciously assess the value of our own possessions. Studies have shown that people place more value on goods that belong to them than on other comparable products, which could be because of cognitive bias.
The endowment effect has been verified in repeated experiments and is a type of cognitive distortion that people contend with in their everyday lives. A cognitive distortion is a systematic error people make which has been demonstrated in multiple studies as a repeatable effect or bias (i.e. distortion).
People do not always behave in a rationally objective or economically efficient way in marketing situations. Instead, various subconscious effects drive their behavior. For example, the endowment effect shows that we assess our possessions to be of a higher value than they actually are according to the market. The American economist Richard Thaler first described the endowment effect in his article, “Toward a Positive Theory of Consumer Choice.” Thaler further developed ideas outlined in the prospect theory proposed by Daniel Kahneman and Amos Tversky. In this theory, another well-known cognitive distortion called loss aversion plays a key role.
The endowment effect is particularly influential when it comes to possessions that have a sentimental value, which adds to the monetary value of the good. Even goods without an objectively measurable value are given a quantifiable market value by this type of cognitive distortion.
Examples of the endowment effect in practice
A good example of the endowment effect is what happens when share prices fall: The overall negative situation is further exacerbated by the cognitive distortion posed by loss aversion. When prices fall, shareholders hold on to their shares for too long because they are afraid of incurring losses. As a result, the shareholders place a higher value on the shares they own simply because they own them. The economically rational decision would be to sell as soon as possible to minimize losses and then possibly buy new shares later.
In marketing, merchants use coupons to harness the endowment effect. Since the consumer already owns a part of the product or service (e.g., in the form of a $10 discount), they will be more willing to continue investing money in the brand. Promotional gifts are also used to produce this effect.
All examples of the endowment effect can be summed up in this short statement: “ownership creates value.” In more detail, the endowment effect characterizes the difference between the willingness to accept and the willingness to pay. The same person can place two different values on an identical product depending on whether or not they own the product. In practice, this often results in a significant difference in value and thus in price.
Therefore, it makes sense to take advantage of the endowment effect in the area of marketing. A brief scientific look at our evolutionary past has revealed that people with a strong endowment effect have been more successful when trading goods in the past. This is because they were less willing to give up something they owned (e.g. products, money, or other trade goods) than someone with a weaker endowment effect.
The endowment effect in marketing
The endowment effect is important because it affects so many different areas. However, it is particularly significant in marketing and sales concerning buying, selling, and valuation in general. Classic examples of how to use the endowment effect include test drives, trial months, trial subscriptions, and other product samples. Indeed, the endowment effect does apply to things that we only own temporarily or do not yet own. This fact can and should be used in marketing. But does this also work in e-marketing and e-commerce in which there may not be any goods that can be physically owned?
The endowment effect is weaker when it comes to digital products, virtual samples, and products that only consist of an app or software as a service. It is thus recommended to provide the customer with something they can “own” whenever possible and as soon as possible. So, when it comes to digital goods, it makes sense to design the marketing structure in such a way that the users interact with the product as much and as intensively as possible during a free trial phase.
E-commerce is simpler when it deals with physical products. Just by delivering the good to the customer, it is possible to attain significant price increases due to the customers experiencing the value themselves and not wanting to lose possession afterward. This also makes it clear why words like “my” and “your” are used so much in marketing. Before actually owning something, the customer needs to be able to imagine owning it. It is useful to provide visuals and examples that can give customers an impression of their future products in advance. For example, this can include videos, images, and texts which give information about the product’s manufacturing process and history.
In contrast, you are more likely to succeed in realistically assessing market values (e.g., for real estate or motor vehicles) if you also understand the psychological impact of the endowment effect. Additionally, the extent to which the endowment effect is quantified is often not entirely apparent. There is a clear tendency for possessions to be overvalued. This is also one of the reasons why it is important to hire experts or appraisers for valuations. This allows you to avoid incorrect assessments due to the endowment effect. After all, external experts are in a position to make a more objective assessment of value than the owner since they do not own the asset.