“If something is built to show, it’s built to grow.” – Jonah Berger
When a marketing professor from the Wharton Business School writes a book on making things catch on, you read it. In his New York Times best-selling book, Contagious, Jonah Berger explores why things catch on. For more than a decade, Berger has been researching why certain products sell more than others and why some products leave behavioral residue while others immediately leave our thoughts. Berger claims that “Virality isn’t born, it’s made.”
In Contagious, Berger introduces Daniel Kahneman, a Nobel Prize winner in Economics, who is famous for his research on a concept called “prospect theory”. Simply put, prospect theory is the idea that the way people actually make decisions is different from how they should make decisions. While this may seem intuitive to some, it runs juxtapose to key assumptions in economics. One of the basic assumptions of economics is that people make decisions that are rational and optimal. In contrast to this, Kahneman’s prospect theory suggests that we often do the exact opposite.
In fact, his theory becomes amplified when we are dealing with large numbers and high dollar purchases (think car or home purchase). What we know from Kahneman’s research is that people do not always evaluate things in absolute terms. Here is an example. Let’s say you are in the market to buy a new alarm clock. You walk into a store and are about to buy the perfect alarm clock for $35. Right before you swipe your card someone in line tells you that you can buy the same alarm clock for only $20 if you go to a store right down the street. What would you do? Most people would immediately head to the other store. Now, let’s say you were at Costco about to buy a $700 TV. But right before you swipe your card, someone tells you that you can buy the same TV for only $685 if you go to a store right down the street. What would you do? Most people would proceed with their check out at Costco. In other words, forego the $15 in savings. But why does our behavior differ over the same $15 in absolute savings? Because how we actually make decisions about purchases is not always economically optimal, even when the absolute dollars are the same.
One of the key messages from Kahneman’s research is that people don’t always think about purchases in absolute terms ($15) but rather we evaluate purchases by a “reference point”. In both scenarios described above, the reference point is zero dollars. But the further away we get from zero, the less inclined we are to feel the impact of absolute dollars. The $15 seems more significant savings when purchasing a $35 alarm clock. But not so much when purchasing a $700 TV.
This is why people get into trouble when it comes to big purchases. We tend to lose sight of absolute terms. For example, if you are looking to buy a house, and are mentally prepared to spend $200,000 (roughly the national average) to purchase the house, sliding several thousand dollars up in price becomes less painful. At the end of the day, what’s really the difference between $200,000 and $240,000? When signing for the mortgage, it won’t feel like that much. But in absolute terms, you are spending a difference of $40,000! As a stand-alone number, $40,000 becomes more pronounced. In order to protect yourself from your natural inclination to purchase more than you should, it is imperative to create budgets and stick to them. Decide what you are going to pay before you walk into any major purchase and use prospect theory to your advantage.
As professor Berger points out, “Practical value is about helping.” If we arm ourselves with knowledge about how we actually make purchases, perhaps we can make better decisions and spread the word along the way.