Although there are many folks who would argue that finance and quant courses are the only big value lessons that one learns in business school, I personally have a large place in my heart for organizational behavior courses taught in the business schools.
One of the most valuable lessons and core theories in this vein is a theory known as prospect theory (developed by psychologists Daniel Kahneman and Amos Tversky).
I remember the essence of this theory via the saying "losses loom larger than gains".
Some things that fall out directly from this (note that the aspects of bundling and unbundling potentially should be attributed to my wife’s PhD advisor, Richard Thaler):
- A $2 loss hurts more than a $2 gain feels good (loss aversion)
- Bundling losses together reduces pain
- Unbundling gains increases good feelings.
Some areas where I have used this concept in managerial and entrepreneurial settings:
- If I want to rub salt in the wound of a supplier who has let me down (perhaps for me to make a point), I may break out the failings into multiple parts and multiple sessions. Unbundling "losses" in effect increases the pain. (Steve, you sick-o.)
- If I want to reward salespeople or reps with bonuses, I may break an $X bonus into two parts (say 50% each) and deliver one part on contract signing and the other on project start. The bonus feels like more than $X dollars.
- If I need to deliver bad news to my own team (e.g., letting people go), I try to do this all in one sitting (and depending on the type of news, sometimes on a Friday where the bad feeling does not linger in the office).
- In non-profit settings where budgets may be tight and membership assessments or fee assessments need to be made mid-fiscal year, try to get them all in one fell swoop as opposed to nickel and diming the community. Each nickel and dime hurts more as an individual hit than in aggregate.
A notable one that has been used on me:
- An imploding sign-on bonus – You get $X if you accept the offer now, but the bonus shrinks by $Y every month that you delay.
While I’m no PhD in the subject matter, although the term, "theory" in "prospect theory" makes the concept sound far out there in terms of practical use, the phenomena has experimentally been demonstrated to hold true in many different settings. Settings go beyond finance (and mental accounting concepts) and even extend to physical sensation experiments. It’s worthwhile to try to apply the concepts surrounding prospect theory in real life.
