“Endowment Effect”
by David Merrill on September 28, 2009
Late last month, I read an article in the Financial Times entitled Prisoners of Inertia. Among other things, it mentioned an economic principle called the Endowment Effect, which describes how cost and uncertainty deter change. The article goes on to say that until consumers become dissatisfied with savings and start spending again, the global economy may not get back on track.
Another aspect of the endowment effect is that people place a higher value on objects they own than objects that they do not. This is a certain fact in the IT world where spending has been curtailed, and people desire to sweat their existing assets to maximize the investments, defer additional capital expenses and “hunker-down” to ride out an economic and capex-sensitive storm. Some of the observable results can be seen as more and more IT shops are turning to server and storage virtualization to extend useful life of large assets, and to squeeze out every opportunity for capacity. When you have servers and storage running at 20-40% of capacity, there are compelling reasons to place a high value on these sunk assets and to make a small incremental investment to unlock stranded or unused capacity within the servers or storage arrays.
I have noticed medium and large clients taking a very proactive approach to asset utilization, because in part they value these assets that they own and are not in a position to get new assets. Moving from thick to thin volumes, changing RAID levels, virtualizing older arrays can produce some very impressive results with reclamation of 30-60% of capacity being very common. When we work with a client and help them reclaim enough capacity to run the operations “in growth mode” for an additional 12-15 months, then the assets get worked harder and a positive ROA measurement can be presented to management. As a vendor, we are always asked to lower our purchase price (and will always be a customer request), but our options now to help reclaim and better utilize existing assets is a stronger and more relevant approach in today’s climate.
I always thought it was our charm and wit that persuaded people in this way, but the endowment effect tells me that we are all economic creatures and that behaviors can be observed and measured (in part) with business or finance theories.
Comments (1)
josephmartins on 28 Sep 2009 at 4:36 pm
There’s an another explanation that has little, if anything, to do with the endowment effect.
While the endowment effect tells us that individuals place greater value on that which they own, there is a hard cost attached to obtaining that which they do not yet own.
Cheap capital enables and even masks mismanagement.
When capital is available cheaply, companies often spend more than is truly necessary for whatever objective they might have at the time. We know they overspend on some areas of IT (esp. storage) though many will never admit it.
When capital becomes “too expensive”, or dries up completely, spending goes down. Economic downturns force individuals and businesses to do what they should have been doing all along…prudent money management. They are forced to ask themselves, “Do we really need this?, and “Is there a more affordable alternative?”
The reality is that a proactive approach to asset utilization is the right thing to do in good times and bad. Unfortunately, many of the lessons learned (about optimization and efficiency) are seemingly abandoned when good times return.
Fortunately, I don’t rely on technology buyers for my income. So rather than beat around the bush and tell them what they might want to hear, I can tell them what they need to hear. And what they need to hear is that many of them simply poorly manage the resources that they have and throw more money at the problems enabled by their own behavior.
