TL;DR:

Loss aversion drives our decision-making. Combat it through awareness when picking profit margins.

A lot of human evolutionary history has been spent in the hunter-gatherer environment, where we lived in groups of about 150 people, foraging for food to survive. This environment shaped our evolution and led to common biases that drive our behavior today. One of these biases is called loss aversion.

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We hate losing money more than we enjoy winning money.

A study by Daniel Kahneman and Amos Tversky revealed that people experience losses more intensely than gains of the same magnitude, a phenomenon they termed loss aversion.

In one key study, participants were asked to choose between guaranteed amounts of money or gambles. The study showed that people tend to prefer avoiding losses rather than acquiring equivalent gains. For example, when faced with a choice between:

• A certain gain of $500, or
• A 50% chance of winning $1,000 or nothing,

many people prefer the certain gain of $500. However, when the scenario was framed as:

• A certain loss of $500, or
• A 50% chance of losing $1,000 or losing nothing, people were more likely to take the gamble, trying to avoid the certain loss, even though the expected value in both scenarios is the same ($500).

This study demonstrated that losses loom larger than gains in people's minds, leading to risk-averse behavior when it comes to gains and risk-seeking behavior when it comes to losses. The emotional impact of losing money is more significant than the pleasure of gaining an equivalent amount, which is a key insight from Kahneman and Tversky’s research on prospect theory.

Loss aversion is heightened by our natural tendency to avoid pain and fear.

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Here are some irrational thoughts I’ve experienced when picking profit margins on competitive bids:

“If we miss this one, we’re toast for next year.”

I don’t know a single contractor who has gone out of business because they missed one bid. Not a single one. Everyone I know who has missed a significant bid said things ended up working out: they got other work they didn’t know was coming, they shifted resources, etc.

“I cannot let ‘them’ have it.”

In my head, I’m picturing my main competitor’s equipment parked along the road I drive by every day on my way to work, and how frustrating that will feel. This impacts my pride, and therefore I can’t let that happen.

“Remember that bid from 3 years ago?”

We lost that $15M job by $18K a few years ago, and I don’t want to feel as foolish now as I did then. So, I’ll cut a couple of points out of this one. Mind you, that bid from the past wasn’t even against the same competition or a similar type of job. The market is completely different now.

It takes courage to be objective on bid day. And it takes even more courage to add profit to a bid than to cut it. Cutting is easy. Adding money isn’t always the right move either. The key is to stay objective.

3 simple strategies:

Historical Spread Data

Compare recent past bids (margins and spreads) of similar types and against this competitive lineup. Calculate the optimal profit margin for this bid. (For won bids, what gross profit could you have had and still been low? For lost bids, what gross profit would it have taken to be low?)

Competitive Analysis

Analyze the competition and see who is realistically capable of handling this job.

Backlog Fitting

Evaluate what winning or losing this bid would truly do to your bottom line: revenue, profit, tonnage, plant transfer, and overhead. Large assets (plant, equipment, trucks, people) must be paid for and knowing the quantifiable impact of a bid removes doubt.

In summary, recognize that we’re all subject to loss aversion. A 2% margin expansion for any paving contractor represents a significant amount of potential profit that could stay in your pocket instead of being given back to the market. Being aware of this bias is a win in itself!

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