Latticework of Mental Models: Scarcity Bias

In 1999, on being introduced to the Internet for the very first time, do you know what I did? Like many others, I created a dozen new email accounts. But once I realised the futility of having so many email addresses I discarded almost all of them and stuck to my Yahoo mail. It stayed that way until Gmail arrived.

Some of the Gmail features were quite attractive as compared to Yahoo but what made the former very tempting was its policy of invite-only registrations. You couldn’t get a Gmail account unless someone with Gmail invited you. This made me want it even more. But why?

Folks at Google certainly understood human behaviour better than anyone else. They used the principle of Scarcity Bias to make their product more appealing.

Scarcity principle states that people assign more value to opportunities when they are less available. In other words, things seem more valuable to us when their availability is limited. This bias stems from the basic human tendency to shun losses.

Daniel Kahneman, who is known for his pioneering work in the field of behavioural economics, came up with the Loss Aversion theory, which explains the root of many of the human psychological biases. The theory says that human beings are motivated more by the thought of losing something than by the thought of gaining something of equal value. This is especially true under conditions of risk and uncertainty.

Put simply, the threat of potential loss plays a powerful role in human decision making.

In his book, The Art Of Thinking Clearly, Rolf Dobelli writes –

“Only while the stocks last,” the adverts alert. “Today Only,“ warns the posters. Gallery owners take advantage of the scarcity error by placing red “sold” dots under most of their paintings, transforming the remaining few works into rare item that must be snatched up quickly. We collect stamps, coins, vintage cars even when they serve no practical purpose. The post office doesn’t accept the old stamps, the banks don’t take old coins, and the vintage cars are no longer allowed on the road. These are all side issues; the attraction is that they are in short supply.

Quoting Mark Twain and French philosopher Montaigne, Peter Bevelin in his book Seeking Wisdom, writes –

Michel de Montaigne said: “To forbid us something is to make us want it.” We want what we can’t have. Forbidden fruit tastes best. Mark Twain said, “It was not that Adam ate the apple for the apple’s sake, but because it was forbidden. It would have been better for us – oh infinitely better for us – if the serpent had been forbidden.” Forbid someone to do something and they find it more attractive than they did before it was forbidden.

Before we dig deeper into scarcity bias, it would help to understand its connection with economics.

Scarcity and Economics

Economics is essentially defined as the study of how goods and services are produced, distributed, and consumed by society. The principle of scarcity holds a special place in the world of economics. In 1935, English economist Lionel Robbins described economics as the science of scarcity. That’s because many resources are usually assumed to be in short supply, i.e., scarce or limited.

So now you know what occupies an economist’s mind. They are busy thinking about scarce resources which have alternative uses. In other words, their primary job is to figure out how to optimise and conserve the use of scarce resources.

Even for hunter gatherers, our ancestors living in African savanna, survival was an economic problem. Fortunately, they didn’t have to worry about too many things except to think about food, water, security and reproduction. Unlike us, phone battery running out or missing a flight was not their concern. If they lived near a river, water was an abundant resource but if the river had no fish, food became a scarce resource for them. So they developed instincts to associate scarcity with desirability.

Economists traditionally focus on scarcity because abundant resources are cheap enough to be ignored. Every economic era has different set of key abundances and scarcities. We saw what a scarce resource meant for a stone age economist. In pre-industrial era, energy was scarce (thus expensive) and land was abundant but in industrial era energy became much cheaper and land became scarce.

Similarly, few decades back, computing power was exorbitantly expensive and manpower was dime a dozen. Today, the trend has reversed. Computing power is becoming dirt cheap and manpower is expensive.

So we see that when a critical resource or technology expands in production and its price plummets rapidly, it becomes available virtually for free as compared to some other critical resources for which it can be substituted. But abundances in turn create new type of scarcities. For example, cheap fuel created a dearth of new roads and need for pollution control.

What do you think is a scarce resource in the modern day of information technology? Here’s a hint – A wealth of information creates a poverty of attention. When all the world’s information is available at the click of a button (or touch on a smartphone), wisdom becomes scarce.

Scarcity can also be created artificially. Not just by means of restricting the supply of resources but also by manipulating the perception of people about certain resources which may not really be scarce. That’s where psychology of scarcity bias comes into picture.

Scarcity Bias in Action

The most crucial question that people try to answer in the world of business is how to create a product that satisfies the demand in market. And the second most important question they puzzle over is how to create demand for the product that they already have? The second question is more interesting and the answer to it is – create competition.

Make people perceive there is a huge competition for the item and limit the number of people that can participate in the bidding, writes Bevelin, “If others want what’s scarce, we want it even more. When we can get something that others don’t want, we don’t want it either.”

Innocent (and gullible) consumers fall for limited offers all the time. I am sure you have seen promotions which say “The offer ends at midnight” or “We only have a few left” or even “This is your last chance.” By making things less available, clever marketing people make their products seem more valuable. The tendency to rush and buy things we do not need in discount sales that will end in a few hours is the result of scarcity bias.

Sometimes the limited-number information is true, like it happens in Safal Niveshak workshops 🙂 where the seats are limited because the venue has limited seating capacity and conveying that information isn’t with an intention to exploit scarcity bias.

But we can’t deny the fact that ‘limited number’ and ‘deadline’ tactics are standard techniques employed by persuasion experts to drive profits. They try to convince us that access to what they are offering is restricted by amount or time. It’s ironical (and paradoxical) to find companies manufacture millions of pieces of a so called limited edition smartphone (or any other product) and still manage to sell out in no time. So don’t be surprised to find out that the guy standing next to you in the traffic light is wearing the same limited edition watch that you bought yesterday.

Robert Cialdini, in his masterpiece (a must read) Influence: The Psychology of Persuasion, writes –

A home vacuum-cleaner operation I infiltrated instructed its sales trainees to claim, “I have so many other people to see that I have the time to visit a family only once. It’s company policy that even if you decide later that you want this machine, I can’t come back and sell it to you.” …As the company sales manager impressed on his trainees, the true purpose of the can’t-come-back claim has nothing to do with reducing overburdened sales schedules. It is to “keep the prospects from taking the time to think the deal over by scaring them into believing they can’t have it later, which makes them want it now.”

Scarcity principle is one of the six weapons of influence that Cialdini has described in his book.

Open outcry auctions are another place where scarcity bias lures people into overpaying for things. In auctions, items are scarce in that they are unique (only one person can have it), and scarce in time (after the bids are finished, you’ve lost your chance). When the auctioneer starts the countdown, scarcity bias kicks in and people can’t resist the urge to outbid others. This is what Charlie Munger has to say on auctions –

…open-outcry auction is just made to turn the brain into mush: you’ve got social proof, the other guy is bidding, you get reciprocation tendency, you get deprival super-reaction syndrome, the thing is going away. I mean it just absolutely is designed to manipulate people into idiotic behavior.

As far as Warren Buffett is concerned, he has just two words of advice for auctions – Don’t Go!

There are two important things to understand about scarcity bias. First, we value those things that have become recently restricted more than those that were restricted all along. And second, we are more attracted to scarce resources when we compete with others for them.

In Investing

One of the avenues in stock market where scarcity bias comes into play is IPOs. Because of the limited availability of new issues, people covet them even more. Remember the Reliance Power IPO? Everyone wanted it. Many of my friends who had never invested in stock market before, opened their demat accounts just so they could apply for Reliance Power IPO.

When Buffett issued Class-B shares of Berkshire, he made sure that it wasn’t a typical IPO. He wrote in his 1997 letter…

Our issuance of the B shares not only arrested the sale of the trusts, but provided a low-cost way for people to invest in Berkshire if they still wished to after hearing the warnings we issued. To blunt the enthusiasm that brokers normally have for pushing new issues—because that’s where the money is—we arranged for our offering to carry a commission of only 1½%, the lowest payoff that we have ever seen in common stock underwriting. Additionally, we made the amount of the offering open-ended, thereby repelling the typical IPO buyer who looks for a short-term price spurt arising from a combination of hype and scarcity.

Insider information is something hard to get. Just because it’s forbidden, many investors seek it actively despite knowing that insider trading is illegal. Sometimes people make buy-sell decisions only because they have access to insider information, disregarding the relevance of that information to stock price or to the underlying business. In the heat of scarcity bias, people put a high value on useless information only because it’s censored. Similarly, when certain investment opportunities aren’t available to other, they appear more valuable to us.

When investors are in the middle of a bull run, you know what’s scarce? Common sense. And do you know what’s scarce during bear markets? Again, common sense. It’s so ironic and sad that a supposedly abundant and common thing becomes scarce right when everyone needs it.

Conclusion

The crux of scarcity bias is we want and value more what is scarce or unique. We want what is, or appears to be, less available. The less available it is, the more we desire it.

Let me speculate a bit about how scarcity bias lowers our day to day happiness. For large number of people (including many of those who are pretty rich), thoughts about lack of money occupies the mind for most of the waking hours. And I was also one of them. I still am, but thankfully those hours of worry have reduced drastically.

What I have realised is this – If I don’t take my financial life so seriously, I can learn to enjoy the process of shifting from a mindset of scarcity to one of abundance. The day one stops focusing on scarcity of money and starts being grateful for all the abundance (family, friends, good health, etc.) he or she will experience a sea change in daily happiness.

No matter which economic era we live in, the only thing that can’t be made abundant is time. In fact, the only real scarce thing in this world is time. At the age of 35 today, I’ve already covered more than half of my expected life span. So if at all I should allow myself to indulge in scarcity bias, it should be about the scarcity of time and most of my efforts should be directed on spending this scarce resource on things that matter to me.

Learning and becoming a better thinker is one such thing. Sharing with others is another. What about you?

Take care and keep learning.