Prospect theory is a type of behavioral economics that can also be used in
marketing
. By utilizing prospect theory, you can increase your marketing strategies and expect to increase sales and retain regular customers.
This article provides an overview of prospect theory, the meanings of its terms, examples of its use in marketing, and points to note. If you want to learn about prospect theory or apply it to marketing, please refer to this article.
What is prospect theory?
Prospect theory is an economic theory that analyzes the decision-making process when people make risky choices, and was proposed in 1979 by Daniel Kahneman and Amos Zversky.
Prospect theory proposes the “loss aversion principle,” which states that even if losses and gains are equal, people feel more motivated to avoid losses. It has greatly contributed to the development of behavioral economics and is applied in many fields such as marketing, finance, and policy.
Prospect theory and the law of loss aversion
Prospect theory is a theory that explains the psychology behind how humans make risk-related choices. A particularly important aspect of prospect theory is the law of loss aversion.
Suppose we have the following situation.
I received my favorite cake as a gift for my birthday.
Then a friend shows up and says, “I’ll toss a coin, and if it comes up heads, I’ll buy more cake, and I’ll have two more cakes.But if the coin comes up tails, I’ll eat all of this cake.” If asked, many people will decline the offer.
If you accept the invitation, you may not be able to eat your favorite cake.
In other words, the law of loss aversion expresses the psychological characteristic that humans tend to perceive losses more strongly than gains of equal value and tend to avoid them.
The law of loss aversion has important applications that influence many business choices, including marketing strategies, product pricing, and investment decisions. Prospect theory and the law of loss aversion are very useful tools for predicting human actions and choices, and for predicting outcomes.
Elements of Prospect Theory
Prospect theory consists of two elements:
I will explain each in detail.
probability weighted variable
Probability-weighted variables, simply put, is the idea that people view the probability as high, no matter how low the probability. The lottery example is often used to illustrate probability-weighted variables.
Although the probability of winning the jackpot with a lottery ticket is very low, people buy lottery tickets thinking that they might win.
The above is a clear example of the characteristics of probability-weighted variables: over-expecting low probabilities and underestimating high probabilities. Prospect theory’s “probability weighted variables” play an important role in understanding human risk judgment and behavior.
value function
Values are an important concept for understanding how humans make judgments and choices regarding risks. For example, some people feel happy when they find 100 yen, but losing 100 yen feels more like a loss than finding 100 yen, which is also related to the number of values.
Values provide important clues to how people make choices regarding risks.
3 psychology related to prospect theory
There are three psychological effects related to prospect theory:
I will explain each in detail.
loss aversion
Loss aversion, as mentioned earlier, means that you react more strongly to losing something than to gaining something. For example, if you imagine the joy of finding 500 yen and the regret of losing 500 yen, the latter will feel bigger.
We naturally avoid risks and make choices to avoid losses, which we apply to a variety of things, including marketing.
Reference point dependence
Reference point dependence is the idea that when people make decisions, they evaluate gains and losses based on a certain “reference point,” or reference point. For example, when eating at a restaurant, the reference points for evaluating the deliciousness of the food are the food you have eaten in the past and the taste you expect.
The reason why some people find the same dish “delicious” and others find it “average” depending on their reference point is because they evaluate it based on their expected reference points. The idea of reference point dependence also works when buying things.
If a product that costs 1,000 yen is sold for 800 yen, many people think that it’s a 200 yen savings. However, if a product that originally cost 800 yen were raised to 1,000 yen, it would feel like it was 200 yen more expensive. Even if the difference is the same 200 yen, people’s perceptions will change depending on which reference point they use.
Diminishing sensitivity
Desensitization refers to the phenomenon in which the sense of value of money and things becomes weaker as the value increases. For example, many people would be happy if they got 500 yen even though they didn’t have any money.
However, if you had 500 yen and got another 500 yen, your level of joy would be lower than the happiness you would feel if you got 500 yen when you had nothing. Similarly, the first time you lose 500 yen, you feel very disappointed, but if you have already lost 500 yen and lose another 500 yen, you won’t feel as bad as the first time you lost 500 yen. There shouldn’t be.
Sensitivity reduction is deeply related to consumer behavior and decision-making processes.
How to use prospect theory in marketing
By utilizing prospect theory in marketing, you can increase your chances of increasing sales by taking advantage of consumer psychology. Examples of how prospect theory can be used in marketing include:
I will explain each in detail.
provide a money-back guarantee
When purchasing a product or service, consumers feel the risk that they may not be satisfied with the purchase. Consumers may view the risk of regretting the product as a loss and try to avoid purchasing it.
However, a money-back guarantee gives you peace of mind knowing that even if something goes wrong, you will get your money back. If there is a money-back guarantee, the risk for consumers becomes zero, and by making them think that there is no risk in purchasing, it lowers the hurdle for consumers to purchase the product.
Hold a free campaign
Free campaigns give consumers a chance to try a product or service, eliminating the risk that the product may not be suitable for them. For example, when purchasing expensive basic cosmetics, we hesitate to purchase them because we feel that “what if they don’t suit my skin type?”
However, if you distribute samples during a free campaign, you can check whether the product suits your skin and if there are no problems with the product, you will consider purchasing it. By running a free campaign, consumers can be sure that the product is right for them, reducing the risk of purchasing.
Hold a limited-time event
Limited-time events have the role of making consumers feel like they might miss out on an opportunity, and as a result increase their interest in products and services. For example, let’s say a store is holding a limited-time event: “We’re having a 30% off sale today only.”
Consumers will feel that they don’t want to miss out on a special opportunity that only exists today. They may decide to buy the item sooner so they don’t miss out on a special occasion. In addition, limited-time events can create a sense of risk of loss, as “time may run out.”
This prevents customers from procrastinating in making decisions by making them feel like there is a risk that if they don’t buy now, they may not get the chance again.
Provide points and membership services
If points are given for purchasing products through the introduction of point giving or membership services, consumers will think that they will be able to earn those points. On the other hand, if your points expire if you don’t use them within the time limit, you can think of it as a loss of points that you could have kept.
Consumers are more likely to consider making further purchases to secure points that could otherwise be lost. Also, in the case of membership-based services, you can get benefits by becoming a member, but if you are not a member, you may feel that you cannot enjoy the benefits.
Therefore, to avoid “losing” benefits, customers may consider signing up for membership. By tapping into the consumer’s “don’t want to lose” or “don’t want to lose” psychology, you can guide them toward purchasing the product.
Points to note about prospect theory
When using prospect theory in marketing, keep the following points in mind:
When offering product discounts or special services, it’s important to ensure that all customers have equal access. If you give special treatment to certain customers, other consumers may become distrustful of you and your brand image may deteriorate.
Also, let’s say you offer a limited-time discount or special offer to make consumers feel like they might be missing out if they don’t buy now. However, if it is actually a benefit that can be received all the time, rather than a limited time or special benefit, you will feel “cheated”.
Prospect theory is
a marketing strategy that
makes good use of consumer psychology, but if used incorrectly, it may give consumers a negative impression.
summary
In this article, we have provided an overview of prospect theory, the meanings of its terms, examples of its use in marketing, and points to note.
If you understand prospect theory correctly and use it in marketing, it may lead to increased sales and customer retention.
However, if used incorrectly, there is a risk that consumers will turn away from you, so you need to be careful. Please use this article to your advantage in marketing.