Few weeks back when we discussed the Variable Reinforcement mental model, there was a brief mention about casino slot machines. Let me pull out that text for you –
Now that we are talking about slot machines, it’s worth mentioning another extremely intelligent aspect of slot machine design called calibrated near misses, which exploits another behavioural quirk called Deprival Super Reaction Tendency. But let me save that story for some other day.
Well, I was saving that story for today. 🙂
If you buy a ticket for the lottery that has the number 49 on it and the number 48 is drawn, you think, “I was so close…” BUT were you really? No you weren’t. If you have read the basics of statistics, you would know that the numbers in lottery are supposed to be random and the probability of each number is ideally same. So you weren’t anymore closer (or farther) from winning as you would have been if the number you got was 1.
However, that’s not how the gambling systems are designed.
In casinos, some slot machines receive better results (for the casino owner, not the gambler) than other machines based on the same payouts, same locations, same design, etc. How come?
The difference between the two slot machines is this – even though the overall probability of winning or losing is the same in both, one machine has a lot more “near misses” than the other one. This keeps gamblers hooked because it makes them think, “Oh! I was so close to winning. How could I miss it. Let me try again.”
The gambler tends to play more, which translates into more collections for the casino from the “doctored” machine.
Psychology of the near miss is particularly well known in the casino industry. The “near miss” potential is very reinforcing and makes people want to try again. In fact, gaming commissions, the regulatory bodies which control the casinos, are aware about this irregularity and they even allow slot machines to have unusually large number of “near misses” calibrated in the design.
Here’s another interesting video where a slot machine designer explains how intelligent design and human psychology is used to make the activity an addiction…
So much for the honesty in gambling. 🙂
Now, why am I discussing gambling and slot machines? Because I want to tell you about …
Deprival Super Reaction Tendency
This irrational response to “near miss” or “almost there” is what Charlie Munger has dubbed as “Deprival Super Reaction Tendency”. It’s another super critical mental model from the field of psychology.
Let’s use the acronym DSRT because it saves screen space, computer memory, internet congestion, and my keyboard strokes. I know I have said this before but the real reason for using acronyms is that it creates an impression in reader’s mind that the author is smart. 😉
You can call DSRT a flavour of loss aversion bias, which states that the quantity of man’s pleasure from a ten-rupee gain is significantly lower than the quantity of his displeasure from a ten-rupee loss. However, the irrational reaction to loss in this scenario (taking away the almost possessed reward) is little more intense.
Peter Kaufman writes in Poor Charlie’s Almanack –
If a man almost gets something he greatly wants and has it jerked away from him at the last moment, he will react much as if he had long owned the reward and had it jerked away. I include the natural human reactions to both kinds of loss experience – the loss of the possessed reward and the loss of the almost-possessed reward – under one description, Deprival Super Reaction Tendency.
It’s no wonder that this tendency isn’t just limited to humans. Evolution has ingrained this anomaly in animals also. Kaufman adds –
The Mungers once owned a tame and good-natured dog…There was only one way to get bitten by this dog. And that was to try and take some food away from him after he already had it in his mouth. If you did that, this friendly dog would automatically bite. He couldn’t help it. Nothing could be more stupid than for the dog to bite his master. But the dog couldn’t help being foolish…He had an automatic Deprival-Superreaction tendency in his nature.
You should read about Prof. Sanjay Bakshi’s tryst with DSRT, in his own words.
DSRT in Real World
It’s not just money that triggers the DSRT.
Taking away people’s freedom, status, love, friendship, opportunity, dominated territory or anything they value will results in DSRT.
Charlie Munger explains –
Deprival-Superreaction Tendency often protects ideological or religious views by triggering dislike and hatred directed toward vocal non-believers…because the ideas of nonbelievers, if they spread, will diminish the influence of views that are now supported by a comfortable environment including a strong belief-maintenance system…University liberal arts departments, law schools, and business organizations all display plenty of such ideology-based groupthink that rejects almost all conflicting inputs.
Centuries ago, DSRT was so strong that it wasn’t uncommon to subject the heretics to extreme torture and brutal death.
Coca Cola, one of the most celebrated and profitable brands in the world, was almost brought down to its knees by DSRT. In 1985, they launched a ‘New Coke’ which had different taste from the original Coke. The response was something they didn’t expect at all.
Coke was a birthright that everyone, from farmers to presidents enjoyed, together, and had for generations. Consumers felt that something had been taken away from them and replaced with something they didn’t ask for and didn’t like.
The ‘New Coke’ was a colossal failure. Coca Cola had to recall the new product and immediately bring back the original Coke.
Don’t underestimate the power of DSRT!
DSRT and Lollapalooza
One of the places where DSRT has ghastly effects is open-outcry auctions.
Social psychology experiments show that bidders in auctions often get carried away and end up bidding far more than underlying value of the objects being auctioned. Such outcomes are almost always caused by a combination of multiple forces working in the same direction. In auctions, these include greed, envy, bias from commitment (every bid is a public endorsement of the bidder’s belief that value exceeds his bid), social proof (last price from another bidder was reasonable), low contrast (every successive bid is only a tiny increment over the previous one), and DSRT.
So the best antidote to saving yourself from auctions is Warren Buffett’s advice – “Don’t go.”
And Charlie Munger says in his Psychology of Human Misjudgment lecture –
…the 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.
Another area where DSRT, along with other behavioural biases, creates lollapalooza is the field of negotiations. In labour negotiations, the last thing negotiators want is the proposal to reduce wages. That’s because such decisions receive a disproportionately intense reaction from the unions due to DSRT triggered by the threat to take away something (wages, benefits etc.).
Many corporate salary structures include sign-on bonus (or retention bonus) which is given upfront with the condition that it will be recovered in case the employee leaves the organisation early. That’s a neat trick to exploit DSRT to keep the employees from quitting early.
In fact, persuasion experts (salespeople and marketing professionals) know it very well that the easiest way to convince people is to take their focus on what they will lose rather than what they might gain if they don’t use the promoted product/service.
DSRT in Investing
Peter Bevelin writes in his book Seeking Wisdom –
We hate to admin we’ve lost money…we hate to sell losing stocks. It is the same as admitting to others and ourselves that we’ve made a mistake. We therefore hold on to our losers too long and sell our winners too soon. A realized loss feels worse than suffering the same loss on paper.
In fact the paper loss sometime drives people to such levels of irrationality that without questioning the quality of the business they buy more and try to average down their cost.
Loss-aversion combined with ego, writes Peter Bernstein in his book Against The Gods…
…leads investors to gamble by clinging to their mistakes in the fond hope that someday the market will vindicate their judgment and make them whole.
Sadly the market doesn’t know that you’re holding on to a loser and neither does the losing stock.
Antidote to DSRT
We’ve already seen the most effective antidote against DSRT, under specific situation of auctions, is to avoid going to such places.
How do you save yourselves from the vicious design of slot machines? I suggest – “Don’t go to the casino!” But if you must, set aside a small amount of money marked as “sin money” and use that.
What to do when it comes to saving ourselves from DSRT arising out of conventional thinking? How do you deal with it at personal level and at organizational level in general?
Answer is – invite a “Devil’s Advocate”. Deliberately bring in able and articulate disbelievers of your ideas, people who hold contrary views. Make them your “adversarial collaborators”, a term introduced by Daniel Kahneman in his book Thinking, Fast and Slow.
To avoid falling for DSRT while investing in stocks, don’t focus on your purchase price. Ask: Suppose I hadn’t made the investment, would I make this investment today at current price? Don’t throwing good money after the bad money. Charlie Munger advises –
People go broke that way – because they can’t stop, rethink and say, “I can afford to write this one off and live to fight again. I don’t have to pursue this thing as an obsession – in a way that will break me.” Part of what you must learn is how to handle mistakes and new facts that change the odds. Life, in part, is like a poker game, wherein you have to learn to quit sometimes when holding a much-loved hand.
Now you know what to do when you hear the relationship manager from your bank tells you, “You will miss a 3X return if you don’t invest in our scheme.” Don’t panic. Remind yourself that it’s the DSRT play.
Knowing that our loss aversion makes us more sensitive to information that has negative implications for us, can we make use of DSRT to create positive results for us?
Here is an idea – Extending the persuasion argument about DSRT, we can motivate ourselves to adopt good habits by focusing on the information emphasizing the possible negative consequences (loss of good health, longevity) of not performing certain activities.
From coke to dogs, from stock market to open auctions, DSRT rules our lives.
It should be pretty obvious by now that DSRT plays an important role in understanding the human behaviour.
Awareness about behavioural biases doesn’t necessarily make us immune to them, however what we can attempt to do is to minimize their effect and increasingly make better choices.
Becoming a sensible investor is a byproduct of learning to make better decisions. Learning a new mental model today, we have added another instrument in our latticework toolbox.
As a closing thought, let me rehash what many wise men have said before – acquisition of knowledge at first may seem like a daunting task, but it’s amazing what you can achieve with a slow and steady progress – one idea at a time.
And before you realize the snowball of knowledge will start paving the path to an immensely satisfying life.
It’s said that the best gift you could ever give someone is your time, because you’re giving them something that you will never get back. So, thanks for investing your precious time with me today. I will always cherish this gift.
Take care and keep learning.