Tag: prospect theory

• Why pessimism sounds so smart

  Tom Gardner and Morgan Housel (The Motley Fool) recently published a LinkedIn article called, Why Does Pessimism Sound So Smart? (Especially When Things Are So Good.)

  Here is the gist of it:

  If you say the world has been getting better you may get away with being called naïve and insensitive. If you say the world is going to go on getting better, you are considered embarrassingly mad. If, on the other hand, you say catastrophe is imminent, you may expect a McArthur genius award or even the Nobel Peace Prize.

  Part of the reason for this is that we, as humans, respond more strongly to losses:

  There’s clearly more at stake with pessimism. Daniel Kahneman won the Nobel Prize for showing that people respond more strongly to loss than gain. It’s an evolutionary shield: “Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce,” Kahneman once wrote.

  The behavioural economic theory being referred to above is called Prospect Theory. I wrote about this back in the fall of 2013 and made the argument that Prospect Theory might explain why NIMBYISM is so common in city building. 

  Change to our communities is perceived as risky. And in the face of these uncertain situations, we tend to place more emphasis on the potential losses (traffic, congestion, shadowing, and so on) rather than the potential gains (increased vibrancy, improved streetscape, creation of more housing, and so on). It’s human nature.

  Having said all this, I show up here every day and try to make this blog a positive place on the internet. Sure, I make suggestions about things I think we should do, but I generally focus on them as opportunities. Hopefully that comes through, because I’m a big fan of optimism.

  2016.03.28

• Yes In My Back Yard

  Last week I called somebody a NIMBY. And though I probably shouldn’t have, it stems from the fact that I make a concerted effort to be the exact opposite: a YIMBY (Yes In My Back Yard, as opposed to Not In My Back Yard).

  I appreciate that change can be difficult for a lot of people. In fact, behavioral economic theory (specifically Prospect Theory) suggests that when people are faced with probabilistic alternatives involving risk, they tend to put more weight on the potential losses. This means that the potential benefits have to be, not just marginally better, but hugely more beneficial before people will make the change.

  Because I know I’m equipped with this bias, I try and constantly remind myself that change and motion are good and that oftentimes the potential losses or negatives aren’t going to be as bad as I might initially think.

  However, I also have a counter acting bias. I recently did a personality assessment (called the DiSC assessment) and I was found to be a creator. I would agree with this. What it means is that I prefer “to live in a world of possibilities.” I’m interested not in the way things are done today, but how they could be done in the future.

  And when I think about all the things I’m passionate about—architecture, design, real estate development, cities and tech—there’s a common thread: each one is about imagining something new. Whether you’re designing a building or building a new internet platform, it’s all about possibilities. I believe that the future will be better than today. I’m an optimist.

  But I recognize that this is a distinct personality type. I’m an early adopter. And not all people are like this. That’s why the adoption curve looks the way it does. 

  What would you say is your personality type?

  2014.02.11

• Prospect Theory

  I just read an interesting chapter from Tim Smith’s book, “Pricing Strategy: Setting Price Levels, Managing Price Discounts and Establishing Price Structures.” It’s Chapter 5: Psychological Influences on Price Sensitivity.

  The chapter covers a number of pricing phenomenons, such as why prices ending in .99 tend to convey a discount and why whole prices ending in 0 tend to speak more to quality. It’s for this reason that art work is typically priced using simple round numbers.

  But one of most interesting theories from the chapter is that of Prospect Theory. Not only because of its impact on pricing strategies, but because, I think, it also applies to the real estate development business.

  Prospect Theory essentially describes the way people make decisions in the face of uncertainty. The two big takeaways for me are (1) that potential losses carry more weight than potential gains and (2) that both losses and gains experience diminishing returns.

  What this effectively means is that people, when faced with risk, tend to focus more on the negatives, and the potential losses, than on the positives. This means that the gains just can’t match the losses, they have to be significantly greater if you’re going to inspire action (a purchasing decision, a change in behaviour, or whatever).

  The second point basically means that these gains and losses become muted after a certain point. If you hit someone with enough of either, eventually they reach a point where they become desensitized in a way. Each additional amount of gain or loss produces less and less impact.

  Besides the obvious point of making sure that your product or service results in lots of gain for your customer, there are a couple of other things you can do to respond to this theory.

  The first is to “bundle losses” and “unbundle gains”. In other words, hit people with all the losses at once and then spread out the gains. What this does is maximize the psychological perception of gains and minimize the perception of losses because, remember, after a while people start to discount the losses.

  The other thing you can do is transfer losses, which is often just the cost itself, from direct to indirect. Big box stores, as an example, are great at this. They offer low prices (a direct cost) in exchange for greater indirect costs: higher transportation costs to the user, greater environmental impact, and so on. Studies show that people feel direct costs much more than indirect costs.

  There are a bunch of things you can do based on this theory, but again, one of the most fascinating things for me was how it also applies to the real estate industry. There’s a well known acronym in the industry called NIMBY. It stands for Not In My Back Yard, and it’s used pejoratively to refer to people who oppose development in their community.

  However, if you look at NIMBY’ism through the lens of Prospect Theory, you realize that it’s almost an innate human reaction. Development and construction is disruptive and the end result is change in somebody’s community. And I suspect that most residents view it as a risky and uncertain situation. Therefore, it’s no wonder that they’re first reaction is opposition. They’re weighing the potential losses more than the potential gains.

  So maybe we developers just need to apply a little Prospect Theory. We need to get better at producing and communicating gains.

  2013.10.29