1. It's harder to part with something than to acquire it

The term ‘switching costs’ sounds like a dry calculation better left to the financial or accounting teams. But switching costs have a powerful psychological side, as the Situation 12.1 demonstrates.

The endowment effect therefore has several consequences for a sales negotiation, depending on whether the seller is the incumbent or the challenger. First, incumbent salespeople need to have up-to-date and honest answers to these segmentation questions we posed in Chapter 11. Only then can they determine the extent to which they can use their standing to their advantage in their negotiations. Second, the endowment effect can work in the incumbent's favour if they succeed in establishing and perpetuating a legacy in the customer organization, rather than merely a history.

The difference between legacy and history is that a legacy is a living history, as the next example shows. A large company developed and launched a new product in collaboration with a trusted supplier, but the product ran into severe technical difficulties that escalated to such an extent that observers started using the word ‘scandal’. The original supplier was unable to solve the underlying problem, so the customer turned to a competing firm that ramped up quickly and solved the problem, albeit at a slightly higher price.⁵ When the next round of negotiations with that ‘heroic’ supplier took place, the endowment effect ran deep. The customer was reluctant to give up on that supplier, even though it cost more to work with them.

The onus is now on the supplier to make sure that the endowment effect remains healthy. It is in the supplier's interest to turn that history into a legacy by incorporating it into its selling story and ensuring that the memory doesn't fade.

In general, you should keep the memory of joint victories and co-developed solutions alive in your regular interactions with clients and also make sure that these stories are used to help onboard new personnel. Make them campfire stories to be told from time to time so that everyone in the community – on both sides – can relate to the proud common past.

We cannot give incumbents a hard-and-fast rule on what the endowment effect and legacies mean in terms of prices. But you should think twice about reflexively granting a discount to an existing client – especially one with a strong legacy – simply because they ask. Loyalty discounts, for example, are not obligatory, although they can serve as good rewards when offered as small, unexpected gifts, as we will discuss in Chapter 15.

You may even want to play offence and look for ways to move your prices incrementally higher. In terms of making price increases or price adjustments, you could think of incorporating a slight ‘friendship premium’ and support it by showing how smoothly the business is running and your commitment to keeping it that way. Just don't use the phrase ‘friendship premium’ within earshot of your customers.

If you are the challenger, the odds are good that you will need to provide the customer a perceived benefit that is subjectively large enough to overcome the endowment effect and make them comfortable moving away from their existing supplier. This can mean providing credible assurances instead of money. This is where a strong brand can play a role. This essential reassurance strategy can include extra inventory, extra quality control, or having your service people on-premise during the initial changeover. You could also offer to monitor their customers' acceptance of a new formulation or new product that is using your materials or services. You can also show how your offering can help the customer acquire more customers for themselves. In any case, a lower price should be the last resort to overcome the endowment effect.

2. It's hard to stop throwing good money after bad

Imagine that you paid $800 six months ago to go on a trip next week. You planned to go with two friends, but you and your friends have drifted apart since you made the payment. To make matters worse, you are not feeling well at the moment, and you face some tight deadlines at work.

Would you still go on the trip?

The interesting finding is not how many people say they would still go. What is far more interesting is that significantly fewer people would go if they had won the trip in a raffle instead of paying $800.

This is one illustration of the sunk-cost fallacy. In a seminal paper on the topic, Ohio University researchers Hal Arkes and Catherine Blumer described the sunk-cost fallacy as, ‘a greater tendency to continue an endeavor once an investment in money, effort, or time has been made’.⁶ They also found that people ‘who had incurred a sunk cost inflated their estimate of how likely a project was to succeed compared to the estimates of the same project by those who had not incurred a sunk cost’.⁷

In a business context, the sunk-cost fallacy means that people have a tendency to throw good money after bad, even if they have classic ‘System 2’ training or education that warns them they should know better. One challenge posed by Arkes and Blumer in their research demonstrates how pronounced this tendency is. They asked respondents to assume that they had just invested $10 million in a plane that radar cannot detect. As that project was 90% complete, the company learned that a competitor had started to market a new plane that is not only invisible to radar, but also much faster and more economical than the plane the respondents are developing. Nonetheless, some 82% of respondents said they would still invest to complete the original project, despite the recent news about its disadvantages.⁸

People run into difficulty with the sunk-cost fallacy, because System 1 longs for completion once we have made an investment into an idea or a project. The greater the prior investment is, the greater difficulties we will have to let go or move on if the future success of the project starts to look doubtful. One motivation for succumbing to the sunk-cost fallacy and continuing to invest is a reluctance to appear wasteful or to have one's name attached to failure. Another related factor is known as the planning fallacy, something nearly everyone experiences at some point. People tend to be exuberantly optimistic about how quickly they can complete a particular project, even when fully aware that they have often failed to complete similar projects on time in the past.

For some companies, the hardest question to answer is not ‘What should we do?’ but rather ‘What should we stop doing?’ Research into the sunk-cost fallacy and the planning fallacy show that the presence of a devil's advocate can help someone overcome their biases and stop throwing good money after bad.

Salespeople can start the devil's advocate process by viewing the market through the eyes of their customers' customers. Where is that market heading? Incumbents can offer alternatives to help the customer redirect resources in order to improve success chances of other existing projects or invest in different solutions. Depending on the stakes, approaching a customer can require either extreme boldness or extreme honesty. It can also involve finding other trusted allies within the buyer's organization and staging a friendly intervention to convince them to shift resources away from the quicksand of sunk-cost projects.

The sunk-cost fallacy has several consequences for a salesperson. The first is the fact that buyers – as representatives of their companies – will inevitably ask for some wasteful and unwise investments in projects. There is a reason why these investments are often called ‘pet projects’. Their appeal is emotional and the desire for them to succeed is hard-wired into us.

Salespeople also need to be wary of the risk of the sunk-cost fallacy in their own work. It is not uncommon for salespeople to justify a lower price or discount by citing a buyer's promise of some future commitment: higher volumes, better terms, inside tracks to new projects, and so on. One could thus view a discount as an investment in a buyer's promise. Without outside guidance or a devil's advocate, a salesperson can find it challenging to abandon such decisions, even though most have little or no chance of working in the salesperson's favour. In some cases, it can even make sense to let a customer go. Salespeople need to recognize this and have the courage to know when to stop investing in false promises.

3. Price thresholds are personal, subjective, and often higher than you think

In a sales environment, salespeople and buyers may describe prices and price thresholds in terms of pain. Whether it is bluff or not, a buyer might greet a price quote with a wince or a shudder or say ‘that will hurt’ when confronted with a price they perceive as too high or when they want to create the impression that the price is too high.

Are these thresholds real? Is the sensation of pain real? The answer lies within our brains. Studies of the price-quality heuristic, which we introduced at the beginning of Part II, have revealed that prices can cause perceptible pleasant sensations in our brains. The work that Kai did in the Starbucks study and subsequent experiments showed the existence of a feel-good price in our brains, which is technically a threshold. The price that elicits the strongest feeling in our minds might be significantly higher than the price we would consciously admit to in an open question or in another form of research.

Our answer is that real thresholds exist, but they rarely lie where our System 2 mind thinks they do. Sometimes we let the ghost of homo economicus whisper in our ears and tell us where various mathematical thresholds exist, such as maximum willingness to pay, the highest price that ‘the market will bear’, the profit-optimal selling price, or the floor price for a given negotiation. This is useful information, but it is only one set of guidance. The following story – adapted from a study that the neuroscience research agency Neurensics conducted – illustrates the deeper power that perceived thresholds exert.⁹

An insurance company relied on the broker model to sell policies and financial products despite the growth of direct-to-customer business models. Product management struggled in an internal discussion with upper management about whether the insurance should be priced above €99 per year for certain risk profiles. The stakeholders were split on whether a threshold existed at €100.¹⁰

Classic marketing research could not resolve the matter. In traditional pricing research, study participants are either explicitly asked to name a price, evaluate a given price, or select a product in a price choice architecture designed by the researcher. In all cases, the participants are aware of the goals of the study. Hence, all standard pricing research methods suffer from significant biases.¹¹

Now think back to the wine and coffee experiments with brain wave testing at the start of Part II. The insurance company asked Neurensics to apply the same approach in order to understand the perceived value of their customers. Neurensics tested 40 typical customers and found – to their initial surprise – that there was no threshold in the minds of the customers. In the corresponding demand model, a substantial proportion of customers buy at prices of €105 or even up to €110 and beyond.

The insurance company then adjusted its software to present the brokers out in the field with some prices below €99 and some prices above. Analysing this dataset, it turned out that – as another unexpected surprise – the insurance sales dropped drastically at prices in the three-digit range. That means, out in the field there clearly was a threshold when increasing the price from €99 to €100.

What could explain this apparent contradiction? The insurance company wanted to know, so it commissioned another study, this time using the brokers on-site as study participants, not the customers. The brokers’ brain responses were measured and their match-mismatch signals with respect to the pricing of the insurance were assessed. The results are depicted in Figure 12.1.

The brain signals revealed the threshold at €100 in the brokers’ minds, corresponding remarkably well to the observation of the actual market data. The broker's value perception was lower than the typical customer's value perception of the financial product. This was a self-inflicted stress factor. Price discomfort is often at its peak when a price approaches a threshold and emotions create artificial barriers. People shy away from the risk of getting too close to a real or imagined threshold. In this case, the brokers feared the consequences of crossing a threshold more than their customers did. These findings imply that many organizations fall short of achieving the feel-good price because their salespeople are standing in their own way.

Using a combination of in-person coaching and media material, the insurance company coached the brokers to trust in the high value perception of the end customer, which was substantially reinforced by the brain data. This led to significantly improved sales numbers.

4. There really is room under someone's personal ‘radar’

How much is $15 worth to you?

The ghost of homo economicus would whisper in your ear that ‘$15 is worth $15’, perhaps followed with a ‘duh!’ for emphasis. It seems hard to argue with that logic, but Kahneman and Tversky nonetheless gave it a try in a thought experiment, which we have adapted for presentation here.

Let's say that you want to buy a package of pens for $30, but on the way to the store, you notice that another retailer is selling the same pack of branded pens for $15. Most customers would turn around and walk or drive a reasonable distance to buy the less expensive pens at the other store. Now let's say that you are going to buy a suit or a dress for $500 and then you realize that a nearby shop sells the outfit for $485. In that case, you are much less likely to walk or drive the same reasonable distance to the other store to buy the product there.

Why are some people willing to invest some effort to save $15 in one situation, but refuse to expend the same exact effort to save $15 in a different situation? For the explanation, we turn not to Kahneman and Tversky, but to a pair of nineteenth-century German scientists named Ernst Weber and Gustav Fechner. They discovered that in order for someone to perceive a difference between two stimuli, there needs to be a minimum difference between them.¹² If you lift two items, there has to be a minimum variation of 2% between the weights for you to perceive them as different. Weber also formulated a law that says that this ratio remains constant within reasonable ranges. In other words, the larger the weight, the larger the absolute difference needs to be for someone to notice. In the case of the $15 difference above, a 50% discount on a box of pens is clearly noticeable, but a 3% difference on the price of an outfit does not exert enough pull to entice someone to buy.¹³

These percentages differ by sense. The minimum difference for saltiness is as high as 8%, meaning you need 8% more salt to taste a difference between two soups or sausages. If there is less variation, the saltier product lies below what is known as the ‘just noticeable difference’. The additional level of salt goes unnoticed.¹⁴

In terms of prices, one could refer to these differences as the ‘just actionable difference’ instead of ‘just noticeable difference’. It implies that buyers have a certain radar that defines their sensitivity to price changes, whether up or down. If the magnitude of a price increase remains below the buyer's radar, the chances are higher that you can implement the change with less effort. The same thinking applies to discounts. A discount that is small may be the equivalent of the proverbial tree falling in the forest. If no one notices, did the falling tree (or falling price) really make a sound?

If you find yourself in a situation when a discount or lower price could make strategic or tactical sense, you need to make sure that the amount is sufficiently high to have the intended effect, or even have any effect at all. Ask yourself: Will this move really turn the situation to my favour? How will that happen? Offering a small discount that is ‘below the radar’ is tantamount to discreetly slipping money into their buyers' pockets when they aren't looking.