Endowment Effect User Experience (UX) topic overview/definition

What is Endowment Effect?

The endowment effect refers to how humans tend to prefer objects they already possess over those they do not, thereby placing a higher value on an object they are asked to give up than on a similar object they are asked to obtain. Designers apply the effect to product and web design so as to influence user behavior.

The term emerged in the field of behavioral economics, where the empirical research of psychologists Richard Thaler, Daniel Kahnerman, and Jack Knetsch has shown considerable differences between buying and selling prices of consumption goods, even when strategic considerations (for making a profit) are excluded. The effect is generally interpreted as a manifestation of the “loss-aversion” principle, which states that humans weigh losses more heavily than they do gains.

When designing a user experience, designers can apply the endowment effect as something that will enhance the prospects of customer retention. For example, having accepted an offer for an initial free trial period for a digital product, users might start to consider the product as being something they “own.” Consequently, they might be more willing to pay a fair price for continuing to “own” it. This is opposed to the users approaching that item without having had the chance to sample it (in which case, lacking the warmth of an owner’s perspective, they would be far less prepared to pay that price for it). Naturally, the product has to prove itself to be of value to users; otherwise, they will not continue to use it. This effect can likewise account for why convincing customers to “switch” from a product they already find satisfactory to another is difficult—clearly the new product will have to offer considerably more, and at a lesser price, to convince a user to adopt it.

Literature on Endowment Effect

Here’s the entire UX literature on Endowment Effect by the Interaction Design Foundation, collated in one place:

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Endowment Effect - The Economics of Design

Endowment Effect - The Economics of Design

The Endowment Effect is a contradiction of the classical economic idea that people always behave rationally within an economic system. It is the surprising idea that we are prepared to pay more money to retain something that we already own than we would pay for the item if we did not own it. It is often also shown that we are unwilling to trade something that we already own in exchange for something of equal value (regardless of whether that item is more or less desirable than the item we already own).

Daniel Kahneman, the Nobel Prize winning economist, Jack Knetsch and Richard Thaler, who are also highly respected economists, in their 1990 paper; “Experimental Tests of the Endowment Effect and the Coarse Theorem” showed the Endowment Effect in action.

Experimental Evidence of the Endowment Effect

They conducted a series of experiments in which participants were offered the chance to buy a mug. They were asked to assign a value that they would be willing to pay for the mug. Then they were given (they did not have to pay for it) the mug.

They were then asked if they wanted to trade their mug for objects of equal value, pens. They were invited to decide how many pens they wanted in exchange for their mug. They determined that on average participants wanted twice as many pens for their mug. That is, they valued the mug twice as much when it was already theirs than they valued it when it wasn’t theirs.

Author/Copyright holder: Pixabay. Copyright terms and licence: Free to Use.

Why Does the Endowment Effect Exist?

There are many explanations for the endowment effect. Daniel Kahneman’s own research offers 3 possible explanations: that it involves loss aversion (the idea that we feel the pain of loss twice as strongly as we feel pleasure at an equal gain), reference-dependence (the idea that we weigh a loss before a gain and thus weigh it more heavily than the gain), and a neoclassical effect (the idea that we are indifferent to the change and thus expect to be compensated more highly for the effort involved).

There are other theories that involve psychological concepts and others still that believe this is an evolutionary effect.

Whichever, explanation we accept – it is fairly certain that the endowment effect exists. However, it is worth noting that there are criticisms of the idea too. And that in particular, Michael Hanemann (pictured below) in 1991, demonstrated that the endowment effect only appears to be present when exchanges of similar goods of equal value are being considered.

Author/Copyright holder: Xlouteiro. Copyright terms and licence: CC BY-SA 4.0

Why Does the Endowment Effect Matter to Designers?

If you know that someone feels the loss of something they own more severely than they anticipate the gain of something of equal value and you know that this is likely to make them pay more to retain what they own – you can increase product adoption and user retention.

For example, if you have a digital product such as an app or a magazine subscription. You can offer a free-trial for that product. This reduces the initial cost, and thus initial risk, of the decision making process to zero. Someone is more likely to become a user of your product when there is no risk to doing so. And don’t forget people like free stuff too – Sandra Bullock, the Oscar winning actress says; “I’ll do anything for free stuff.”

However, it also makes it less likely that when the free-trial is over that the user will give up the product. The endowment effect means that they are going to feel some pain about surrendering the product.

Interestingly, the endowment effect also suggests that because we value a product about twice as much when it is ours than when it is not – someone may be willing to pay more for a product following a free-trial than they would if they had to pay for the product without such a trial.

Author/Copyright holder: Pramod Patil. Copyright terms and licence: Fair Use.

The endowment effect is also invoked by offering a money back guarantee. While this requires that the user adopts the product and takes some risk when they do so – it offers security that they can, for a period of time, reverse that decision.

Yet again, the endowment effect suggests that once the person owns the product they would pay twice as much to keep it than they would have paid for it originally. Thus they are unlikely to take advantage of the money back offer because the money back is only worth what they have originally paid for it.

There are many other ways, in theory, to manipulate the endowment effect but these are the two most commonly used to encourage product adoption and then retention of that product.

It is worth noting that the endowment effect, in these instances, is only likely to apply if the product is perceived to have value to the user in the first place. If you product is a buggy, frustrating mess – users are still going to return it.

The Take Away

The endowment effect is the idea that we value something we already own more highly than something of equivalent that we do not. This effect can be exploited by designers looking to increase adoption and retention of use with products for example by offering a free-trial or a money back guarantee.

References

Daniel Kahneman, Jack L. Knetsch and Richard H. Thaler (1990). "Experimental Tests of the Endowment Effect and the Coase Theorem". Journal of Political Economy 98 (6): 1325–1348.

Hanemann, W. Michael (1991). "Willingness To Pay and Willingness To Accept: How Much Can They Differ? Reply". American Economic Review 81 (3): 635–647.

Kahneman, Daniel; Tversky, Amos (1979). "Prospect Theory: An Analysis of Decision under Risk".Econometrica 47 (2): 263.


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Learn more about Endowment Effect

Take a deep dive into Endowment Effect with our course Get Your Product Used: Adoption and Appropriation.

Designing for user experience and usability is not enough. If products are not used—and it doesn’t matter how good they are—they will be consigned to the trash can of history.

Sony’s Betamax, Coca-Cola’s New Coke, Pepsi’s Crystal Pepsi, and McDonald’s Arch Deluxe are among the most famous products which made it into production but failed to wow their audiences, according to Business Insider. In fact, Harvard Business Review dedicated a long piece to “Why most product launches fail”—so it’s not just big brands that aren’t getting their design process right but a lot of businesses and individuals, too.

So, what is the way forward? Well, once you’re sure that the user experience and usability of your product work the way you want them to, you’ve got to get your designs adopted by users (i.e., they have to start using them). Ideally, you want them to appropriate your designs, too; you want the users to start using your designs in ways you didn’t intend or foresee. How do we get our designs adopted and appropriated? We design for adoption and appropriation.

This course is presented by Alan Dix, a former professor at Lancaster University in the UK and a world-renowned authority in Human-Computer Interaction. Alan is also the author the university-level textbook “Human-Computer Interaction.” It is a short course designed to help you master the concepts and practice of designing for adoption and appropriation. It contains all the basics to get you started on this path and the practical tips to implement the ideas. Alan blends theory and practice to ensure you get to grips with these essential design processes.

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