Kahnemann’s Prospect Theory: a summary in one graphic

Human behaviour isn’t that hard to understand if you do the work. And my favourite theory of it involves Cognitive Biases: the core emotionally-led behaviours that drive the decisions we actually make, rather than the decisions that might be more rational.

Cognitive Biases are rooted in Kahneman and Tversky’s Prospect Theory, which was crucial to my MBA thesis some years back. (Nice of him to summarise his life’s work AFTER I’d ploughed through the academic literature.) Basically, it’s an add-on to Expected Utility Theory (where we take risks based on the outcome we expect) that draws in Cognitive Biases (the emotional factors that govern what we actually do.)

While the concepts aren’t hard, there are around a hundred Cognitive Biases recognised in human psychology, making it hard to summarise with any rigour. But there’s a great diagram in Thinking, Fast and Slow that brings its three key points together.

prospect-theory

First, note the y-axis, “Psychological value”. That takes account of the human factor Expected Utility doesn’t: £500 has different perceived value to a pauper and a millionaire, so setting this axis for your audience – the  “base rate” on which they make decisions – is key.

Second, note it’s S-shaped. If you’re winning, it takes a lot more wins to get the same flush of excitement you did on your first win. (Diminishing returns are what keep sensible adults at slot machines for hours at a time.) The perceived utility depends on how much utility you’ve got already.

Third, note it’s not symmetrical. This illustrates the biggest Cognitive Bias of all: Loss Aversion. (We tend to resist losing a lot more than we accept winning; it’s why investors ride their losing stocks down, while selling their winners while they’re still rising.) Loss Aversion is at the core of much human behaviour.

And that’s it. In tune with my theory that you only need one good book to understand 90% of any field, that’s all any marketer needs to know about Cognitive Biases and how useful they can be in understanding customers. If you’d like some of these principles applied to your own marketing, contact me.

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