Note: This article originally published by my colleague David Tang.
It’s a common business problem faced by any size company, big and small.
The situation is you’ve developed a brilliant product. Compared to the incumbent or existing way of doing things, your product is more feature-packed, is easier to use, and is more economical to the customer.
The problem is your sales suck. Why aren’t customers banging down the door?
Are customers irrational?
The answer is “yes.” Numerous studies have showed that consumer behavior is irrational. If you assume otherwise, then you are also behaving irrationally.
To understand why people aren’t buying your product, it is imperative to understand some key concepts in behavioral economics. Here are three important principles to be cognizant of.
Principle 1. Losses Loom Larger than Gains
Every new product provides perceived gains and losses for the customer. These gains and losses need not be financial. For example, let’s say you are starting an online grocery store for your municipality. With the promise of groceries delivered to the door, the perceived gains could be convenience, time savings, and effort savings. On the other hand, you are altering the way the customer performs a certain process–buying groceries. This change will translate to perceived losses (i.e. financial and non-financial costs), which can include the inability to handpick produce and meat, delivery fees, and having to be home during the delivery window.
When we look at this objectively, online groceries is a clear superior choice. Convenience, time savings, and effort savings are great value propositions, after all.
However, when the customer evaluates options subjectively, it becomes unclear whether online groceries is the still better choice. In fact, it is likely the customer views online grocery shopping as the poorer choice. This is because losses loom larger than gains.
A consumer has an inherent Consumer Bias. This bias weighs a loss three times that of a benefit. To put it another way, the objective value of a gain needs to exceed the objective value of a loss by three times for the customer to perceive the new product as better than the existing.
Principle 2. Reference Points Matter
The second principle to understand is different people have different reference points. These reference points matter. The reference point simply refers to the person’s current state of being.
Continuing our online grocer example, the reference point of a typical customer is someone who currently goes to the physical supermarket to pick up groceries. This process may already be part of the customer’s weekly routine. Gains and losses are relative to this state of being.
For two people with different reference points, a gain for one person may be perceived as a loss for the other. To illustrate this concept, let’s look at the price of gas. Assume the average price for a gallon of gas in the US is $3, whereas it’s $10 in the UK. If a US customer came upon a gas station charging $6.50/gallon, she would be furious. If a UK customer came upon the same situation, she would be ecstatic. (Also, note that even though the objective difference is the same for both customers, the US customer’s sentiment would be more affected than that of the UK customer, because losses loom greater than gains.)
The Value Function Illustrates Objective vs. Subjective Values
By understanding your customer’s reference point, you can determine her perceived gains and losses. In most cases, your reference point is different from that of your customer’s. This is because you have already used and experienced your product, whereas your customer has not. Your product has become part of your state of being. This disparity in judgment is captured in the concept known as the Innovator’s Curse.
Principle 3. Endowment Effect
According to the Endowment Effect, people value items in their possession (i.e. part of their endowment) more than items not in their possession. This is because people are loss averse.
This behavior sheds some light on why losses loom larger than gains. If a customer is already accustomed to an existing product or existing way of doing things, it becomes hard for her to give that up and change–even if the alternative presents greater benefits.
Are any of these principles hindering your sales?
Recognizing and understanding these three principles of behavioral economics is crucial. It allows us to develop product strategies that specifically counter consumer adoption barriers at play and leverage behavioral tendencies.
Now, let’s look at three such strategies–one for each principle.
The 10X Rule
If losses loom larger than gains, then we need to create a product where the gains greatly dwarf the losses. Create one where the benefits are 10X that of the losses, so that all economic and psychological switching costs are overcome. This is also known as Andy Grove’s 10X Rule. Andy Grove, Intel’s third employee and former CEO, had stated, for widespread adoption, a new product has to offer a 10X improvement over the incumbent product.
Of course, this strategy is easier said than done.
Reference Point Pivot
Since reference points dictate how customers perceive gains and losses, it makes sense to seek out customers with favorable reference points. Think about it this way. In one market, your product may have fulfill the 10X Rule. In another, your same product may be perceived as 10X worse!
During its earlier years, Walmart opened stores only in rural areas to compete against local mom and pops. Compared with these incumbent retailers, Walmart was a clear 10X improvement. If Walmart had started off launching stores in metropolitan areas instead, where large department store chains were already established, Walmart’s growth would have been hindered.
Ideal markets are ones filled with first time buyers. For the first time buyer, her reference point is neutral. She doesn’t have any preconceived biases over existing benefits lost and new costs incurred, because she doesn’t currently use the incumbent solution. Thus, for many products, it is easiest to launch in emerging markets. This is because emerging markets (e.g. BRICS nations) are filled with first time buyers. Read more about entering emerging markets here.
The Endowment Effect has an interesting implication. It implies the customer will spend more–mo’ money, mo’ time, and mo’ effort–to keep something she has than to obtain something for the first time.
With this insight into consumer psychology, many companies offer free samples to get customers hooked on their products. Once the customer begins using the product, she will appreciate the benefits it offers and is likely to spend money to retain these benefits. This is, in essence, an example of Reference Point Pivot.
Similarly, a popular business model adopted by many Internet SaaS companies is the “freemium” model. In the freemium model, the customer is first presented with a free version of the product. Then, the customer is offered (or forced) to a premium version.
For a more in depth discussion on product adoption, consumer psychology, and product strategies, take a look at this business document: The Psychology of Product Adoption.
Still no dice?
Of course, if your product is awesome–you think so and your customers agree–then lack of sales could be due to poor marketing. Ramp up your marketing, sales, and biz dev efforts.
Interested in business strategy? Check out Flevy’s collection of business frameworks, most created by former consultants of top tier consulting firms.
EDIT: I have just published a new article, The Complete Guide to Product Adoption. This article analyzes product adoption on the market level, product level, consumer level, and tactical level; and is based on a number of established business strategy frameworks.
Please also share your thoughts, experiences, and advice in the comments. Thanks!
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