Recently there was a very interesting Horizon documentary on the BBC dealing with how we make decisions.
There has been a great deal of research on the subject and apparently, whilst we truly believe we make rational, considered decisions all the time, in reality the complete opposite is true. For the majority of the time, we make a quick decision based on what are called cognitive biases. This is particularly true when it comes to decisions concerning money. And one of the most powerful biases we are subject to is loss aversion.
Loss aversion was demonstrated with a deceptively simple experiment; a person in the street was offered £10, which was theirs to keep. They were then offered a ‘safe’ option of receiving an additional £5, or the ‘risky’ option to gamble on the toss of a coin. If it came up heads they would receive an additional £10, if it came up tails they would receive nothing extra. Either way the initial £10 was theirs. Not surprisingly, the majority people choose to take the ‘safe’ £5.
Then the experiment was changed; people now received £20 and were again given the choice of two options. Take the ‘safe’ option and hand back £5, or take a gamble on the toss of a coin - heads, they hand back nothing, but tails they hand back £10.
In both instances, the ‘safe’ option resulting in them taking away £15 and the ‘risky’ option left them with £10. Identical results.
The surprising outcome, is that faced with the possibility of ‘losing’ money, the majority of people will take the gamble. We don’t like to lose things, particularly money, and perversely we then take risk to avoid this loss.
There were many further examples and similar experiments have also been done with monkeys with identical results. If this cognitive bias of loss aversion goes this far back in our evolutionary development, then we are simply incapable of switching it off - it will dominate our decision making.
All this made me wonder just how rational we are when making buying decisions for our businesses. We presumably would make a very different decision if we were faced with the possibility of losing all our company data due to bad backups, than if we thinking of updating IT hardware to improve efficiency. One would appear, rationally speaking, to be a more compelling prospect, but perhaps we are more driven by loss aversion. Maybe it all comes back to our having to identify a ‘pain’ before we act to resolve it.