What Brings a Consumer Back for More? Evidence from Quantifiable Gain and Loss Experiences in Penny Auctions

Evidence increasingly points to the importance of reference-dependence in predicting consumer behavior. We utilize detailed data from penny auctions, which first appeared as an internet phenomenon in the late 2000’s, to uncover how consumers’ prior experiences predict their willingness to try a new experience again. The penny auction setting allows us to concretely quantify consumers’ positive and negative experiences, which avoids the measurement challenges typical in other settings. We find the following empirical patterns, which bear intuitive resemblance to reference-dependent behavior: First, consumers’ tendency to return is at least weakly increasing in the outcome from their prior experience; Second, consumers’ return rate on marginal loss experiences drops more steeply than it increases for marginal gain experiences; Third, consumers have an aversion to losing at any level, which makes them discontinuously less likely to return after any loss compared to after a gain. We derive the conditions on utility functions and reference point updating needed in order to account for our empirical findings. Finally, we examine the bracketing tendencies of consumers in calculating their gains and losses after repeated experiences, and find that consumers tend to bracket narrowly, with the aforementioned patterns appearing most strongly as a function of their most recent experience. This is consistent with the intuition that consumers have short memories, and that a recent bad experience is likely to drive them away permanently, in spite of previous positive experiences. JEL Codes: D03, D11, D12