The Endowment Effect
[Last Updated January 21st 2024]
The endowment effect describes how individuals tend to attribute a greater value to an owned item, than to the same item if unowned. Kahneman et al. (1990) describe this in detail by using the concepts of “willingness to pay” and “willingness to accept” alongside indifference curves (which you’ll be familiar with if you ever studied microeconomics). To put it simply, if we own an item, our willingness to pay (how much we would buy the item for) tends to be lower than our willingness to accept (how much we would sell the item for). In turn, this suggests that we overvalue items that we own. Similarly, Kahneman et al. (1991) demonstrated that individuals are less likely to trade a good they already received for another good of equal value (arguably, even if they prefer the other good). Importantly, this suggests that owning an item enhances its perceived value. Further, it is important to note that the endowment effect seems to apply to both tangible products like clothing and intangible products like services or healthcare (Jaeger et al., 2020).
There are a surprising number of different explanations for why the endowment effect occurs. The most popular explanation is rooted in loss aversion (and subsequently negativity bias). When we trade away something we own, we view it as a loss. In this respect, framing something as a loss or a gain would likely matter. For example, someone may be less willing to “trade” an item (as they overvalue the item they own) than if they were asked to “trade-up” (which implies they are trading for something explicitly better and thus making a gain). For a technical explanation of this, see Kahneman et al. (1991). Gal (2006) suggests that the endowment effect may result from psychological inertia to remain at the status quo (as seen in the status quo bias). Within this paradigm, we have an unclear sense of the value of items, and thus there is a lack of motivation to move away from the status quo (ownership of an existing item) unless there is clear evidence that an alternative is a better choice. For a visual representation of this concept, see figure 1 in Gal (2006). There is debate as to whether or not the status quo bias requires loss aversion as an explanation. Additionally, Huck et al. (2005) suggest there may be evolutionary reasons for the endowment effect. They argue that individuals who adopted the endowment effect were able to bargain better in bilateral trades, gain more resources, and thus be more likely to pass on genes.
There are also various other explanations that are a bit more technical in nature, and succinctly covered by Morewedge & Giblin (2015). Recent evidence from Achtypi et al. (2021) suggests that rather than a bias from ownership, the endowment effect may simply reflect a belief-driven negotiation strategy and a desire to attain a good deal. However, as of the start of 2024 we were unable to find any replication of this research.
Beggan (1992) examined the endowment effect from a social psychology perspective, relabeling it the mere ownership effect, and arguing that rather than loss aversion, individuals create a psychological connection between an owned item and their self-concept, and then overvalue it to preserve or enhance their self-esteem. Barone et al. (1997) criticized the research methodology behind the mere ownership effect, but a more recent meta-analysis by Białek et al. (2022) found a moderate mere ownership effect across studies. As the mere ownership effect relies on a different set of fundamental assumptions, it will be considered as a separate strategy and not covered in the examples on this page (you can read about it here). However, when considering strategies involving the endowment effect, the mere ownership effect should also be taken into account.
Assuming that ownership of an item leads an individual to overvalue said item, you should focus on strategies that lead to temporary ownership or the illusion of ownership. Following this, you can take advantage of the endowment effect by exposing individuals to the potential loss of said item. This can also be extended to services rather than just material goods.
If you are a SaaS startup, or offer a service with various tiers and pricing, you can offer free trials for premium/advanced tiers. If an individual experiences a free trial for a limited period of time, they will feel some sense of ownership. As such, they might overvalue the additional services they are receiving, and in turn be more willing to pay for the additional services when the trial ends. To enhance conversions to higher tiers, you can frame the end of the trial as a loss. For example, you might send an email that prompts the user to “act now” or lose access to features (which you should list out). You can further take advantage of loss aversion in this situation by offering the customer a limited deal (e.g. 10% off if you switch to the premium tier before the trial ends).
One of the issues of launching a new product/service is that individuals may not be interested in switching away from existing brands (e.g. due to the status quo bias). As such, many companies providing services offer timed trials, or limited trials, in order to entice users to try their new service. Rather than a trial, it might be wise to offer a select number of users the service for free. For example, you might offer one-year free of premium SaaS. Combined with reciprocity, this may lead to enhanced reviews from those who perceive a sense of ownership due to the free gift. If you use this strategy, make sure you plan out how you will request reviews. Many companies offer a small reward (e.g. $5) to leave a review, which adds another level of social pressure through reciprocity. This can be a great way to create quick social proof that your service is competitive and liked by others. And while you might lose out on profit from the free gifts, the positive attention you get can outweigh the losses, if it helps drive growth. In respect to products, you can send new items as a bonus to customers who are ordering from your store, and include a short request for a review. By providing them with the item, you engage the endowment effect and increase the chance they will like the item, and you also engage reciprocity. This is great for clothing brands that use social media as a way to market their products. And it also has the added effect of eliciting repeat customers.
You can take advantage of money back guarantees to increase trust, knowing that most people will not return products because of the endowment effect. A money-back guarantee tells a customer that you are confident your product (or service) will satisfy them. And because of the endowment effect, customers may overvalue the items they receive and be unwilling to send them back for the original value. If selling products online, send follow-up emails that prime the customer to believe they made a good purchase, which in turn may increase the effectiveness of the endowment effect. On top of this, even if people dislike the product, they are often lazy and won’t return it. That can result in cognitive dissonance, whereby customers self-justify why they didn’t return the product, by subconsciously assuming they must actually like the product. And in turn, this may lead to positive beliefs about your brand and future purchases. The mere ownership effect would enhance this process, as it posits that individuals overvalue the products/services they purchase to protect their self-concept and maintain their self-esteem. In other words, they would tell themselves that the product must be good, because they chose it.
Carmon and Ariely (2000) surveyed 93 random students who had entered a lottery for NCAA Final Four men’s basketball tournament tickets, and asked them how much they would pay for a ticket if they didn’t have one (buying price), and how much they would be willing to sell a ticket for if they did have one (selling price). The 10% trimmed mean for selling price was $2,411, whereas it was only $166 for buying price, and similarly, the median selling price was $1500 whereas it was only $150 for buying price. Thus, on average, participants suggested they would only part with the tickets for 14 times the value they were willing to pay for them. Further, Carmon and Ariely (2000) found that these results were mostly the same for those who owned tickets and those who were told to imagine owning tickets. This is in line with neuroscientific evidence from Kim & Johnson (2014) that analyzed imagined ownership under a mere ownership effect paradigm.
Achtypi, E., Ashby, N. J. S., Brown, G. D. A., Walasek, L., & Yechiam, E. (2021). The endowment effect and beliefs about the market.
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https://doi.org/10.1037/dec0000143
Barone, M. J., Shimp, T. A., & Sprott, D. E. (1997). Mere ownership revisited: A robust effect?
Journal of Consumer Psychology, 6(3), 257-284.
https://doi.org/10.1207/s15327663jcp0603_03
Beggan, J. K. (1992). On the social nature of nonsocial perception: The mere ownership effect.
Journal of Personality and Social Psychology, 62(2), 229-237.
https://doi.org/10.1037/0022-3514.62.2.229
Białek, M., Gao, Y., Yao, D., & Feldman, G. (2022). Owning leads to valuing: Meta-analysis of the mere ownership effect.
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https://doi.org/10.1002/ejsp.2889
Carmon, Z., & Ariely, D. (2000). Focusing on the forgone: How value can appear so different to buyers and sellers.
Journal of Consumer Research, 27(3), 360-270.
https://doi.org/10.1086/317590
Gal, D. (2006). A psychological law of inertia and the illusion of loss aversion.
Judgment and Decision Making, 1(1), 23-32.
https://doi.org/10.1017/S1930297500000322
Huck, S., Kirchsteiger, G., & Oechssler, J. (2005). Learning to like what you have – Explaining the endowment effect.
The Economic Journal, 115(505), 689-702.
https://doi.org/10.1111/j.1468-0297.2005.01015.x
Jaeger, C. B., Brosnan, S. F., Levin, D. T., & Jones, O. D. (2020). Predicting variation in endowment effect magnitudes.
Evolution and Human Behavior, 41(3), 253-259.
https://doi.org/10.1016/j.evolhumbehav.2020.04.002
Kahneman, D., Knetsch, J. L., & Thaler, R. H. (1990). Experimental tests of the endowment effect and the coase theorem.
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https://doi.org/10.1086/261737
Kahneman, D., Knetsche, J. L., & Thaler, R. H. (1991). Anomalies: The endowment effect, loss aversion, and status quo bias.
The Journal of Economic Perspectives, 5(1), 193-206.
https://doi.org/10.1257/jep.5.1.193
Kim, K., & Johnson, M. K. (2014). Extended self: Spontaneous activation of medial prefrontal cortex by objects that are ‘mine’.
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https://doi.org/10.1093%2Fscan%2Fnst082
Morewedge, C. K., & Giblin, C. E. (2015). Explanations of the endowment effect: An integrative review.
Trends in Cognitive Science, 19(6), 339-348.
https://doi.org/10.1016/j.tics.2015.04.004
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