Did you check out Safari 3 or Intype? How about the newest version of Navicat? If you answered yes, then you’re probably a techie who absolutely loves trying out new software. You love to discard the old, and you welcome new ideas and products with open arms. You download new browsers, try out new JavaScript libraries, and read Engadget. You do this because you’re constantly in search of the faster, more stable, and just flat out better goodies. And while there is nothing inherently wrong with this behavior, there can be a problem when you try to create software for an audience much wider than the Techcrunch 500k.

Unfortunately, you can be in for a world of hurt if you assume the average person will even try out your software just because it is groundbreaking, has a slicker interface, or sports a few more features than the next guy. Your friends might think you’re a genius, and tech insiders may give you rave reviews, but you’ll end up in the deadpool if your product doesn’t provide customers with much more value than their current software. There are a number of reasons for why this happens, but one worth learning about is the endowment effect.

Endowment Effect

As Wikipedia puts it:

The endowment effect (or divestiture aversion) is a hypothesis that people value a good or service more once their property right to it has been established. In other words, people place a higher value on objects they own relative to objects they do not. In one experiment, people demanded a higher price for a coffee mug that had been given to them but put a lower price on one they did not yet own. The endowment effect was described as inconsistent with standard economic theory which asserts that a person’s willingness to pay (WTP) for a good should be equal to their willingness to accept (WTA) compensation to be deprived of the good. This hypothesis underlies consumer theory and indifference curves.

The endowment effect is closely tied to loss aversion, which is the theory that we’d rather avoid losses than potential gains, and the status quo bias or the believe that people just like things how they are. We overvalue what we have, and we undervalue what we can gain. This behavior is irrational, and it feels like the mainstream culture is extra resistant when it comes trying and buying software. It’s why there is a first mover advantage, IE6 is still around, and nobody cares that your application has some AJAX and a few more features. It’s one of the reasons why so many products lack the steam required to climb the adoption curve.

What Can You Do

You can get a sense of just how irrational buyer behavior really is now that you understand why people are afraid to leave their overvalued software. This doesn’t mean that you have no shot at hitting the mainstream market, but it does mean that “me-too” products and one-upping the competition are going to leave you broke. Instead of entering an arms race, you’re going to have to get creative and make something that people will really value. There is a large body of knowledge on how to go about doing this, and if you’re interested in learning more, I’d recommend reading Blue Ocean Strategy, and John T. Gourville’s article in the Harvard Business Reveiw on Eager Sellers and Stony Buyers: Understanding the Psychology of New-Product Adoption.

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Chris Campbell

The Endowment Effect by Chris Campbell

This entry was posted 3 years ago and was filed under Notebooks.
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  1. Joe Rawlinson · 3 years ago

    Great points Chris. Just because we build it doesn’t mean the customers will start buying. The Blue Ocean strategy is a wise one because you are essentially creating a market where there wasn’t one before. Your potential customers are thus less likely to have to ditch their current product or service in favor of yours.

  2. star · 3 years ago

    Agree with you.

  3. Shanti · 3 years ago

    This reminds me of a conversation I had in college once, re: this awesome teeny tiny red t-shirt that said “Bally Boy” on it. It was classic.

    One of my floormates liked it as well and I jokingly said I’d sell it to him for $10. (which I would, actually) And of course some smart ass, being serious I think, chimes in that I should just give it to him. People are always saying this kinds of stuff but when it comes to their own property — forget about it!

  4. Elad · 3 years ago

    There are two strategies that can be used to counter this effect: 1. Build something entirely new - so people can’t place value on the thing they own already, because they don’t own anything like what you’re offering. Of course, you’ll have to offer something that’s both new and extremely useful for enough people to decide to try it, but that’s another story. 2. One-up the competition, but do that at the core feature of the product, the one that actually causes people to use it. Google wasn’t the first search engine, but it did search so much better.