Imagine you are confronted with the following proposition: you can either accept $1,800 with no strings attached, or you can opt for a 90% chance to win $2,000, which means you have a 10% chance of coming away empty handed. Which option would you prefer?

Now let's flip things around. This time, your two options are either to lose $1,800, or to have a 90% chance of losing $2,000, which means you have a 10% chance of suffering no loss at all. Which option would you prefer?

If you are like most people, your chosen option in both cases would reflect the natural human tendencies toward risk aversion. Humans are risk-averse when it comes to gains, but risk-seeking when it comes to losses. The usual response to the first question is to take the money and run, rather than risk that money for a somewhat larger gain. If you have spent time watching game shows, you have seen contestants wrestle with that question and have probably implored them to ‘Take the money!’ But in the second situation, people want to avoid the certain loss, and take their chances – however slight – that they might lose nothing at all. These sharp preferences hold true even though – purely mathematically speaking – there was no difference between any of the options above. Players either had an expected loss or an expected gain of $1,800.

This example derives from prospect theory, which we introduced briefly in Chapter 8, when we demonstrated with a practical example that losing hurts more than winning excites, even when the spoils are equal. What is even more fascinating about prospect theory is that risk aversion guides our thinking even when the stakes are unequal. In his seminal paper with Tversky, Kahneman cites a similar example: respondents need to choose between an 80% chance of losing $4,000 or a certain loss of $3,000. They write that ‘the majority of subjects were willing to accept a risk of .80 to lose 4,000, in preference to a sure loss of 3,000, although the gamble has a lower expected value.’¹

Do these experiments into basic human-decision science have any practical value for sales negotiations in the twenty-first century? Yes, they do!

Prospect theory – which summarizes the breadth of these findings so neatly – has three basic tenets:

• Small values in gains and losses have a disproportionately high psychological impact.
• High values in gains and losses have a disproportionately low psychological impact.
• People suffer from losses more than they enjoy gains.

According to prospect theory, people feel that the negative utility of a loss outweighs the positive utility of a gain of the same magnitude. If the stakes are equal, we emphasize loss avoidance over the pursuit of gain. This validates the age-old cliché that a bird in the hand is worth two in the bush. These insights culminate in a graph plotting ‘real financial value’ (expressed as dollar amounts) on the x axis and ‘psychological value’ on the y axis, as shown in Figure 15.1.

The first thing to note in Figure 15.1 is that the ghost of homo economicus would disagree with the shape of the curve. The ghost would consider anything but a straight line to be perplexing. After all, logic demands that $100 is $100. But this is not the case, because $100 doesn't always feel like $100.

The first $100 you pay hurt a lot, but at higher values, there is little psychological impact. For instance, most people would be extremely frustrated if they dropped a $100 dollar bill in a storm drain and could not recover it. Yet those very same people would worry to the same extent over a 5% fee for a real estate broker when buying a house. Humans perceive money as relative. Paying $315,000 instead of $300,000 for a house appears to be of a comparable psychological magnitude as losing that $100 bill in the storm drain.

Financial gains are also disproportionately valued, in the sense that small gains are valued relatively more than large gains. This is why the curve in Figure 15.1 is S-shaped. Furthermore, the S-shaped curve is asymmetric. For a better understanding we have added two stars to the original graph. Take the little star in the lower-left quadrant: losing $100 feels like losing $300. Check out the star in the upper-right quadrant: winning $200 feels like winning $280. That is more than the $200 face value, but still less than the perceived loss of $300. That is why most people would reject a random coin-flipping match with a 2:1 payoff with a random stranger on the street.

So how specifically can prospect theory help change the course of a sales negotiation? As you can imagine, insights into how people assess risks and perceive gains and losses have powerful practical applications. The theory offers clear guidance on some eternal questions that don't seem to have an answer that everyone can agree on: should we deliver bad news or good news first? Should we emphasize the language of hope, which means that we highlight the benefits of our offering? Or should we use the language of fear and highlight the customer's pain points? Should we dangle the promise of a big gain down the road or give our customer a smaller reward now? Situations 15.1 and 15.2 explore these questions.

The asymmetric S-shaped curve of prospect theory comes with a further complication that is highly relevant for the sales relationship: the zero-point is adjustable. Different scenarios tested by Kahneman and Tversky showed that our expectations shift the zero point. Practically speaking, this means that unexpected gains have a greater impact than expected benefits. Surprising a loyal long-term client with small free shipment of goods can make them very happy and strengthen the relationship disproportionately.

Now let’s take a look at a situation when someone has good news to deliver. How do you expect the approach to differ in this situation?

The previous two situations focused on how to deliver good news and bad news. The next two situations, in Chapter 16, show how prospect theory can affect how an organization sets its priorities, embraces new ideas, and plans for the future. Organizations, like people, have several strengths and weaknesses. Is it better for an organization to invest in enhancing a strength or overcoming a weakness? Perhaps even more important for planning and priorities: is it easier for an organization to enhance a strength or overcome a weakness?

Thanks to conventional training and the business media, suppliers and their salespeople are so laser-focused on adding value that they overlook opportunities to subtract pain. The phrase ‘pain point’ is a business buzzword, but it is also a strong behavioural driver. Given a choice between getting better at something good (enhancing a strength) or becoming ‘less bad’ at something you aren't as good at (overcoming a weakness), the latter can have the stronger psychological impact. You'll notice that the steepest part of the curve in Figure 15.1 – the place where the psychological impact is greatest relative to the change that caused it – is in the area of small losses. Sometimes addition by subtraction is an attractive approach.