The IKEA Effect

The IKEA effect is a fascinating cognitive bias whereby consumers place a (sometimes disproportionately) higher value on things that they have either made themselves, or to which they’ve contributed towards making. Researchers writing in the Journal of Consumer Psychology describe it as a clear case of effort justification, a process rooted in cognitive dissonance, in which people convert intellectual labour and physical sweat into perceived worth. This tendency can be so strong that experiment participants often form true beliefs about the superior quality of their own creations, even when objective measures suggest otherwise. In behavioural finance, similar mechanisms drive sub-optimal trading decisions and panic selling, as investors cling to built portfolios that they have personally curated, despite mounting evidence that rebalancing would be rationally permissible. This substantial causal contribution of self-assembly to perceived value explains why people might value imperfect things they’ve helped create more than they would value the equivalent, perfect, but ready-made, product. Those who have pained memories of tussling with Allan keys, recalcitrant IKEA furniture and occasionally incomprehensible schematics will no doubt have raised eyebrows. Of course, the effect only applies to items that are successfully assembled, of course. If people fail to build an item using the instructions provided, or it takes too long or is too difficult, due either to the complexity of the instructions or the inexperience of the user, then they do not ascribe the same value to the item.

According to researchers, there are a number of possible reasons for this effect. There’s the obvious investment of time and effort, which leads people to incorporate the value of their labour into the finished item. Behavioural scientists such as Marc Oliver Petersen of Oxford University Press note that loss aversion amplifies this attachment, because abandoning a half-built coffee table feels like admitting defeat. For the more creative types, or those seeking a more customised solution, there’s also the value of personalisation and of meeting their bespoke, individual requirements. However, what’s interesting is that some research has shown that the IKEA effect can apply even when no customisation is involved, and where the consumer has only followed fairly simple and straightforward instructions in assembling an item. The theory is that participation in the construction and assembly process fulfils a deep-rooted need for self-efficacy – “people derive satisfaction from the feeling that they are able to influence their surroundings, for example, by creating objects.” Scholars such as Amin Zokaei Ashtiani list this motivation among a cluster of praxical epistemic values that govern how true belief and intellectual performance interact while we manipulate the world around us.

There’s an apocryphal tale associated with an early iteration of the IKEA effect (having its origin long before the advent of IKEA). When the first instant cake mixes were produced, in the 1950s, they required nothing more than the addition of water before mixing and baking. And they were not particularly popular. In desperation, the manufacturer turned to a psychologist for help, and they suggested that the problem lay in the simplicity of the cake mix: it was undermining the value of the cake baker’s role in the process. Make it more complicated, he suggested, and they will flock to it. So the recipe was amended to remove dried egg powder, and instant cake mixes began to require the addition of fresh eggs, and sure enough, they began flying off the shelves. (Of course, it’s entirely possible that this was primarily driven by a consumer preference for cakes made with fresh eggs, over then-mysterious ingredients such as dried egg powder, but it does illustrate the power of the IKEA effect). Behavioural economists now cite this classic instant cake example in international journal articles on process building, effort justification and family vegetable intake, noting that even simple culinary tweaks can change how people internalise a causal contribution to the outcome.

At this stage, you’d be forgiven for asking yourself the question, “Well this is all very interesting, but why is a trading technology company writing about the IKEA effect and instant cake mix?”. Well, it’s because of our reaction when we first found out about it. We realised that a lot of what we do, at Chronicle, leverages and builds on the same psychological factors behind the IKEA effect. Furthermore, it’s what makes our model so successful as well. Of course, we’re not asking our clients to self-assemble a trading system out of components we provide in a box, given a few schematics and an Allan key. But nor are we delivering a full and perfect product to which our clients have had no input, other than picking it off the shelf. Our model sits squarely in between, and offers the best of both worlds. In volatile financial markets where loss aversion, conspiracy theorists on social media and the ever-present risk of panic selling can derail even the most carefully built portfolios, we give clients a framework that reinforces epistemic values and mitigates cognitive bias.

When clients sign up for a Chronicle product, they’re not just asking us to come in and assemble our software components to their specification. We enter into a partnership that’s about customisation and ownership. We help to define and implement the customisations that need to be made, using a framework that can be tailored to specific needs. Our unique selling point, however, is about knowledge transfer: collaborating with our client’s teams to implement our products and embed best practices and ways of working, and giving development teams a safe environment in which to be creative in producing the best business solutions. This partnership echoes the praxical thesis advanced in recent Rev Financ Stud papers, namely that people value systems more when they can trace a clear, substantial causal contribution of their own to the final outcome. By the end of our time on an integration project, our clients genuinely don’t need us any more, because they know how to maintain and adapt the system themselves. This is possible for us, because Chronicle’s business model does not rely on us being indispensable and embedding ourselves within a client organisation for the long term, as do so many of our competitors. Instead, our business model is about scaling up and increasing the breadth of our client base, expanding to address new markets in a fast-paced and increasingly digital landscape. In short, we help trading desks construct a technological equivalent of the Sears Tower—robust, modular and future-proof—without forcing them to live perpetually on the construction site.

Does this all sound far too good to be true? It’s not – we designed our Chronicle Platform specifically to address the challenges faced by trading firms when contemplating the question of build vs. buy. We’ve solved all the problems of failover, high availability, performance and scalability, so that your developers can focus on those pieces of the puzzle that solve the business problem and take your trading performance to the next level. We give your teams the support and guidance on structuring and testing our components, and our ongoing technical support ensures that you always experience the highest levels of service. Unlike other vendors, our emphasis is on enabling and empowering the talented people within your organisation, and building their capabilities around our products. This reduces your dependency on us to make enhancements and to implement new requirements, while still giving you peace of mind that we will be there to support you when you need it. Your teams will also benefit from any software updates and enhancements that become available. The end result is a thoughtfully built portfolio of trading applications whose architecture embeds true belief in best practice, yet remains flexible enough to evolve as market microstructure, stock market regulations and client expectations continue to change.