If loyalty programs aim to positively influence consumer behaviour, then understanding how consumers make decisions and the factors that influence decision making is an important area of research in loyalty psychology.
I’ve seized the gift of time that isolation has dealt in order to deep dive into the biases which impact consumer thinking patterns and determine how loyalty programs can design specific elements of their program to appeal to specific consumer biases.
The Endowment Effect and Loss Aversion biases are the most applicable to a wide number of loyalty program design frameworks. Their effects have loyalty program members flying across the world for no reason or spending larger sums of money for fear of losing a small discount.
This article explains these biases, how they’ve developed and how loyalty programs are benefiting from them.
What is the Endowment Effect and Loss Aversion bias?
An endowment effect bias (as illustrated by the image above) occurs when people irrationally overvalue an object they own, regardless of its objective market value, whereby ‘people often demand much more to give up an object than they would be willing to pay to acquire it.’(Thaler, 1980)[1].
Kahneman et al (1991)[2] ran a series of experiments to test the endowment effect. In one experiment, 77 students were randomly assigned roles as buyers or sellers, with sellers provided with university-branded coffee mugs. Few trades ensued, with sellers asking for an average $7.12 for a mug, while buyers only wanted to pay an average $2.87. The experience suggested that the low volume of trade was primarily produced by the seller’s reluctance to give up their endowment, rather than by buyers’ unwillingness to spend their cash.
Endowment affect is closely related to loss aversion.
Kahneman & Tversky (1979)[3] then conducted a series of experiments where subjects were asked to choose between more or less risky propositions which provided the potential to win or lose money (e.g. an equal chance of winning or losing $100). They found ‘the aggravation that one experiences in losing a sum of money appears to be greater than the pleasure associated with gaining the same amount,’ and that most people find symmetric bets of that form to be distinctly unattractive.
These findings have led to the development of strategies whereby workers and students have been motivated by penalties rather than rewards. Hossain & List (2012)[4] determined that framing outcomes as penalties resulted in improved performance in a Chinese production factory. Fryer et al (2012)[5] demonstrated that exploiting the power of loss aversion, where teachers were paid in advance and asked to give back the money if their students do not improve sufficiently, increased math test scores by more than one standard deviation. People are more willing to take risks or behave dishonestly to avoid a loss than to make a gain. A study by Schindler & Pfattheicher (2016)[6] used a die-under-the-cup game and a coin-toss task, with the opportunity for participants to engage in dishonest behaviour either to avoid a loss (loss condition) or to approach an equivalent gain. Their results found that people show more dishonest behaviour to avoid a loss.
According to Ries (2012)[7], some private fitness centres allow people to invest their own money in weight-loss incentives, for example, by putting in $200 and receiving a portion back as they achieve incremental weight-loss goals. Websites like www.stickK.com operate on the same basis in the online environment. They help people achieve goals via a ‘Commitment Contract’; a binding agreement which involves putting money on the table to ensure the user follows through with their intentions using loss aversion.
How loyalty programs appeal to the Endowment Effect and Loss Aversion bias:
Loss aversion is used extensively in loyalty programs (and marketing strategies more widely) to stimulate member engagement. Programs can provide members with something which they feel ownership for and value, and then establish conditions whereby they might have ownership removed. This can act as a motivational force to compel the member to continue. This includes the threat of status tier members losing their benefits if they fail to earn enough status credits, members suffering their points to expire if they do not engage with the program on a regular enough basis (or redeem them in time) and members not being able to access desirable rewards (reward seats, hotel rooms, etc) or having to spend a greater amount of points if they do not book early enough.
Two examples of companies benefiting from these biases include:
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Qantas Frequent Flyer (the status tier framework)
A ‘status run’ involves members of a frequent flyer program taking a flight with the soul purpose of earning enough status credits to ensure their status tier is maintained. A nice destination or the number of frequent flyer points earned for the trip are secondary considerations.
If a member has not flown enough in a calendar year to qualify or re-qualify for a premium status, sometimes there is a business case for a status run to make sense to the member due to the high value placed on the benefits they stand to lose. Qantas is considered the leader of the pack for members taking status runs, given the need for Australians to travel long haul and the desire for the process to be as comfortable as possible.[1]
Australian Frequent Flyer[2] (among other websites) have put together a list of best Qantas status run paths of 2020 where members could pick up a flight with the necessary status credits for the lowest cost. They also advise readers to keep a lookout for the double status credit promotions run by Qantas which are becoming increasingly more frequent – Qantas have recognised the patterns of ‘status runners’ and have adjusted their promotions to appeal to them by offering regular status credit promotions on certain routes rather than offering sale prices.
Thus, the status run has been formed by members actively avoiding losing access to their tier benefits or losing the progress they’ve made towards the next tier and subsequent promotions have been built off the back of this.
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Modern Market Rewards (the delayed credit framework)
The credit program framework is where members earn credit to their account for future spend on the company’s products.
As a join bonus, customers who sign up to Modern Market Rewards receive $2 credit into their account aimed at immediately encouraging them to spend at Modern Market to take advantage of their credit. Every time the member dines at Modern Market they progress towards earning their next $10 credit. A $10 credit is triggered ready for redemption each time a $100 spend threshold is reached, encouraging continuous earn activity to progress towards more credits. An expiry is also placed on the credits to generate FOMO, feeding into the endowment effect and loss aversion biases.
Summary
Loyalty programs have consumers making decisions to act in a way which seems completely irrational (i.e flying across the world for status credits or spending large sums to avoid losing a discount). But this is the exact nature of biases. They frame our thinking patterns and cause us to make judgments and decisions without looking at the bigger picture. Programs who have been successful in understanding and appealing to consumer biases have made a rational decision to realise the benefits.
[1] Thaler, Richard, “Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization, 1980, 1, 39-60.
[2] Kahneman, D., Knetsch, J. L., & Thaler, R. H. (1991). Anomalies: The endowment effect, loss aversion, and status quo bias. Journal of Economic Perspectives, 5(1), 193-206.
[3] Kahneman, D. and Tversky, A. (1979). Prospect Theory: An Analysis of Decision under Risk, Econometrica, vol. 47, issue 2, 263-91
[4] Hossain, Tanjim & List, John. (2009). The Behavioralist Visits the Factory: Increasing Productivity Using Simple Framing Manipulations. National Bureau of Economic Research, Inc, NBER Working Papers. 58
[5] Fryer, R. G., Levitt, S. D., List, J. and Sadoff, S. 2012. “Enhancing the Efficacy of Teacher Incentives through Loss Aversion: A Field Experiment,” NBER Working Papers 18237, National Bureau of Economic Research, Inc.
[6] Schindler, S., & Pfattheicher, S. (2017). The frame of the game: Loss-framing increases dishonest behavior. Journal of Experimental Social Psychology, 69, 172-177.
[7] Ries N. M. (2012). Financial incentives for weight loss and healthy behaviours. Healthcare policy = Politiques de sante, 7(3), 23–28.
[8] Financial Review, ‘How to make those airline ‘status runs’ count’, 4th April 2019, https://www.afr.com/work-and-careers/management/how-to-make-those-airline-status-runs-count-20190327-h1cvpr, accessed 11th May 2020
[9] Australian Frequent Flyer, ‘The Best Qantas Status Runs in 2020’, 15th February 2020, https://www.australianfrequentflyer.com.au/qantas-status-runs/, accessed 8th May 2020
