How the endowment effect works in marketing

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?

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.

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 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.