Sunday, February 13, 2011

Winner's Curse and the Cost of Ownership

Consider yourself in the shoes of Siddharth Mallya. Your team fared reasonably well in the last season of IPL, finished third overall, smelt blood but couldn’t quite make a kill. This time you are hungry for the trophy and you don’t want to take a chance. Pack in firepower in your arsenal, no matter what it takes. You want to retain that Virat Kohli; he rocked with his willow last summer wearing your shirt, you want him real bad this time too. So as the auction progresses in salubrious Bangalore, you fork out $1.8 million, an amount other bidders think preposterous, and you bag Kohli with the fall of hammer. Even though you have retained Kohli in the auction, you probably have ended up overpaying for him. Clearly the market (the other bidders) didn’t see Kohli’s value at your price. So your win was rather costly. Economists have a name for this phenomenon – ‘winner’s curse

Now move over Siddharth Mallya. Let’s get closer to ourselves. Think about the last time you entered an e-bay auction. Suppose you make your first bid on Friday morning, for a wristwatch, and at this point you are the highest bidder. That night you log on, and you are still the top dog. Ditto the next night. You start thinking about that elegant watch. You imagine it on your wrist; you imagine the compliments you will get. And then you go online again an hour before the end of the auction. Some dog has topped your bid! Someone else will take your watch! So you increase your bid beyond what you had originally planned.

Let me tell you, auctions are not the only time when we end up paying more than we want to pay for something. In daily life we miscalculate the value of transactions very often. We do it as a buyer as well as a seller. These miscalculations can be explained by invoking a mental faculty that we have – a sense of ownership. Much of our life story can be described by the arrival and departure of ‘things’ that we own or relinquish ownership of. We buy clothes and food, cars and homes, for instance. And we sell things as well- homes and cars, and in the course of our careers, our time.

Since so much of our lives is dedicated to ownership, wouldn’t it be nice to make the best decisions about this? Wouldn’t it be nice, for instance, to exactly how much we would enjoy a new fancy mobile phone, a 4wd SUV or a Prada shoe, so that we could make accurate decisions about owning them? Unfortunately, this is rarely the case. We are mostly fumbling in the dark.

Lets look at a very common situation of selling a car. Even before you put your ad or contact a dealer, you begin to recall trips you took. You were younger, of course; you just started your married life. The memories of those romantic drives wash over you and you feel an ache in your heart every time you look at the old faithful. You set a price that is high but reasonable to you as your heartache can’t be just for nothing. However, the prospective buyer during his inspection tends to only notice the dent in the bumper and the black smoke from the exhaust! He quotes a ridiculously low price for your beloved.

When it comes to buying we are no better. Often we start owning things before we actually do so. We see M S Dhoni sitting in front of an Amrapali Villa with lush greenery all around him, and we imagine ourselves there. We imagine our kids running around in the carpet grass lawn right in front of our dream house. The trap is set, and we willingly walk in. We become partial owners even before we own anything. Companies know this concept too well and advertisers use it as a mainspring.

There is another way that we can get drawn into ownership. Often companies have ‘trial’ promotions. For example dishtv offers a free premium platinum package for new customers for the first three months (it’s not actually free though- the rental is cleverly built into the initial price). We like the television experience and tell ourselves, we can always go back to a downgrade because at the end of the day we only watch channels that we can count on our fingers. But once we try the platinum package, of course, we claim ownership of it. Will we really be able to downgrade? Doubtful. Most likely we won’t be able to deal with the idea of letting go of something that we got used to. Letting go is often harder than we can imagine.

Another example of the same hook is the ’30-day money back guarantee’. If we are not sure whether or not we should get a dinner set, the guarantee of being able to change our mind later may push us over the hump so that we end up getting it. We fail to appreciate how our perspective will shift once we have it at home and how we will start viewing the dinner set – as ours. It’s difficult to imagine how a dinner set can ignite an emotion of ownership in us!

The bad news is there is no known cure of ownership bias. Only thing is to try to view all transactions as if we were non-owners, putting some distance between ourselves and the item of interest.

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