Definition 

The endowment effect describes buyers' tendency to value a good higher once they own it. Therefore, people demand more money for giving up an object than they would be willing to pay for the object (Kahneman et al., 1991). 

Explanation

In a study, participants were offered either a lottery ticket or $2. Later, they were introduced with an option to exchange the money for the lottery ticket, or the other way. Most of the participants did not want to trade. This was the case even though the money had a higher and risk-free value than the lottery ticket (Knetsch and Sinden, 1984). Once the participants acquired a sense of attachment and belonging to the object, they were unwilling to give it up since the loss of selling it (loss aversion) was more important than the actual selling price.

How to use it? 

Several strategies can foster a sense of ownership or attachment among prospective customers for your products. Probably the most common tactic is a free trial (for a subscription, or a free sample of your product). Recently, buy-now-pay-later services use a similar approach to give consumers the sense that they already "owned" a specific product in the past. Lastly, trying out products like clothes or phones allows customers to imagine themselves owning your product much more than merely seeing it on the shelf. 

What to watch out for 

Find the right time span for the free trial offer: If you endow your customers for a long period of time, you lose revenue. However, if the time period is not long enough, the attachment might not become strong and customers can still decide to leave your product. Therefore, it is crucial to find the right time span.

Difficult to get customers to switch to your product: It can be difficult to convince customers to change to your product if they have already fostered attachment to the competitor's product.

Be aware that the endowment effect also applies to sellers and remember that when you will be setting up your pricing strategy.

Sources & further reading

What Your Customer Wants and Can’t Tell You: Unlocking Consumer Decisions with the Science of Behavioral Economics - Melanie Palmer: https://www.amazon.com/What-Your-Customer-Wants-Cant/dp/1642505625

 

Why Buyers and Sellers Inherently Disagree on What Things Are Worth - Carey K. Morewedge:

https://hbr.org/2016/05/why-buyers-and-sellers-inherently-disagree-on-what-things-are-worth

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"Key Behavioral Pricing Effects"