In my last post on Economic Theory vs Human Nature, I discussed ideas about loss aversion from Daniel Kahneman’s great book, Thinking, Fast and Slow. In this post, we’ll look at another concept from the book: how regret, or, more accurately, fear of regret, can distort decisions.

Kahneman cites 2 examples that illustrate this problem.

In the first:

You have been exposed to a disease which if contracted leads to a quick and painless death within a week. The probability that you have the disease is 1/1,000. There is a vaccine that is effective only before any symptoms appear. What is the maximum price you would be willing to pay for the vaccine?

Think about your answer for a moment, then consider the other variation of this scenario:

Volunteers are needed for research on the above disease. All that is required is that you expose yourself to a 1/1,000 chance of contracting the disease. What is the minimum you would ask to be paid in order to volunteer for the program? (You would not be allowed to purchase the vaccine.)

Respondents typically require a much higher price for the second scenario than they would be willing to pay in the first, approximately 50 times more. This is primarily because in the second scenario, you actively made a choice, and you would feel more responsible for the consequences, even though the scenarios are logically identical.

In another example, surveyed parents estimated how much of a discount they would need to switch from an insecticide that caused 15 cases of child poisoning per 10,000 bottles to a brand that caused 16. The vast majority were unwilling to switch for any price.

These examples illustrate that simple economic theory cannot account for the way people make decisions. There are psychological and ethical components, as well. We care not just about the end results, but how and why we got there.

This thinking can have a huge impact on corporate projects. Failing to act may be bad, but actively doing something which then fails feels worse. And once we act, we are prone to stick with failures rather than admit being wrong and moving on. We spend bad money after good, falling prey to the sunk costs fallacy. We make extreme demands in some areas, beyond their economic value, and ignore other issues of critical economic importance. This is one reason ROI calculators often don’t help. They don’t address the asymmetry between doing something and doing “nothing.” (They also don’t account very well for loss aversion.)

A lot of proposals get rejected not because of competition, but because of the dreaded “no decision.” Everything seems right to you, the numbers add up, but you get a bad feeling that your prospect has a bad feeling. When you create a proposal, your prospect needs a clear path to success and a reason to regret sticking with the status quo. (IBM had a great way to handle this– “no one gets fired for buying IBM”, which both highlighted IBM’s reputation, and cast doubt, and possible reason for regret, if you went with an alternative.)

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