If the emerging science of behavioral finance has taught us anything, it's this: Humans are pre-wired to make some really dumb financial decisions.
Do you know your weak points?
There's loss aversion, where we find that the urge to avoid a loss is much more powerful than the urge to seek a gain. Some studies suggest that a loss is twice as powerful, psychologically, than an equivalent gain. (Put another way, losing $50 feels as bad as gaining $100 feels good.)
Related to that, there's the sunk-cost fallacy -- the need to feel that lost money, also known as sunk costs, counts for something. If you've already lost $300 at a slot machine, you're unlikely to move to another one or stop playing. After all, you've already put $300 into this one, you're bound to hit eventually if you keep playing, right? (Except that, as we all know when we step back and think about it, the chances of winning on the next play are, for all intents and purposes, the same as they were on the last play -- and the 299 plays before that.)
There's also every advertiser's favorite, confirmation bias, which is the tendency of people to look for evidence to support their pre-existing preferences and to discount contradictory input. And related to that, anchoring -- where we focus on one particular number and lose track of the larger picture.
Now, what if there were a business designed to take advantage of the weaknesses in our wiring? That may sound silly, but I recently looked at one that might qualify -- and it's pretty interesting.
So this business is what, a casino?
It's not exactly a casino. I'd better explain. The business I'm talking about is Swoopo.com. Swoopo, if you haven't seen it, looks like an eBay
Under the hood
Here's how it works: All kinds of cool consumer goodies -- computers, GPS devices, bicycles, smartphones -- are offered in short-duration auctions by Swoopo. (You and I can't sell on Swoopo, only buy.) All of those auctions start at the same price -- $0.12 -- with no reserve, and each bid raises the price of the item by a fixed, small amount, normally $0.12, though there are exceptions.
That may sound crazy, but there are two catches: First, placing a bid isn't free. You have to pay a small fee -- they vary by auction, but $0.60 is typical -- each time you bid. Second, if there's a bid in the last 20 seconds, the auction timer resets. And it will reset over and over and over again, as long as there are bids.
So sure, you might see a bike with a MSRP of $500 "sell" for $80. But how much did that winning bidder spend on all the bids he made along the way? I'm sure Swoopo loses money on some auctions, when all things are considered. But a lot of the time, the losing bids more than pay for any discount the winner gets.
Yes, they are inside your head
So here's how Swoopo is taking advantage of our brains' wiring: First, the closing prices of past auctions look like absolute steals. A recent research paper that looked at Swoopo said that "the median auction closes with a final price that is 18.9% of the retail price." If you see someone win a brand-new $1,700 Macbook Pro for $81.64 -- which actually happened as I was writing this article -- it's hard to resist being drawn in. We all love a bargain, right? In fact, we anchor on those low prices, and the site's design helps to confirm our new bias: Here be bargains!
So you get drawn in, and you bid, and you bid, and you bid some more, and on a hotly contested high-ticket item you could spend a couple hundred dollars on bid fees and still need to keep bidding. And many folks will keep bidding in that situation -- there's the "sunk-cost fallacy." It seems like the money you've already spent without winning will "count" if you win and go to waste if you don't.
In one sense, it does count. Even if you lose the auction, Swoopo lets you buy the item at full retail price less whatever you spent on bids. But apart from that, if the auction is still running, the money you've spent in the past has done exactly nothing to improve your chances of winning.
It's like the whole thing is carefully constructed to push our cash-surrendering buttons. Of course, it probably is.
One Fool's "entertainment" is another Fool's ...
Swoopo refers to itself as "entertainment shopping." Here's my take: It's "entertainment" in the same sense that casino operators are entertainment companies.
Now, it's true that casino operators like MGM Mirage
While bidding on Swoopo isn't exactly gambling, it's a lot like gambling. And while I have no idea how profitable the company is, I think it's a great example of applied behavioral economics. And that's why I think I'll hold off on actually bidding on anything for the time being.
Have you checked out Swoopo? Scroll down this page and leave me a comment and let me know what you think.
Fool contributor John Rosevear has no position in the companies mentioned. eBay is a Motley Fool Stock Advisor recommendation and a Motley Fool Inside Value pick. PepsiCo is a Motley Fool Income Investor recommendation. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.