Friday, November 9, 2018

Understanding Your Customers (Lottery Edition)

A billion dollar lottery recently happened and there was a lot of talk about buying lottery tickets. What would you do if you win?

But I want to point on one specific argument that I heard regarding buying lottery tickets. It comes from the guy who thinks he is a bit more clever then the rest. They might say something like "The lottery is a tax on people who are bad at math" or "Playing the lottery is for suckers because it is -EV (expected value)".

If you don't like math, just skip this paragraph. Its not absolutely necessary you understand this to get the picture. Let me explain first what the person is trying to point out. EV stand for expected value and it is the amount of gain or loss you are expected based on real probabilities. So for example if you and your friend flipped quarters, and the loser paid the winner money after each flip, then your expected value would be 0. Since we know that the probability of a coin flip landing heads or tails is 50%. Then you could expect to win half the time and lose half the time. You would be expected to net out. Note that although your EV is 0, what actually happens may be drastically different than the expected value. Your friend may win 5 coin-flips in a row and take all your money. However, based on the law of large numbers, the more you play, the more likely the results will be close to the EV.

The true expected value of the lottery is actually tricky because it depends on the number of people playing and factoring in taxes. There are cases where the lottery can actually be +EV (but due to game theory this usually doesn't last for long). So in general, your friend is correct in saying that it is a losing proposition to buy lottery tickets. For each dollar you put in you are expected to get much less back.

And we could leave it there. But that's not the point. What that person is really missing is the reason why people by lottery tickets. And it isn't to make money. That's right, most people do not buy lottery tickets to make money. If you asked them about their odds of winning or at least if they believe they will make money, I'd think that nearly all of them would understand that they will likely lose money. So why do they buy? They are buying the experience of owning a lottery ticket. To be in the game. To dream and talk to their friends about all the things they will do and buy and how their life will change. They are happy to be in the game rather than be left out. There are a so many reasons for buying a lottery ticket, "making money" is probably one of the least common reasons.

And I'm certain The Lottery (the company) understands this well as their commercials are perfectly aligned. They show a couple frolicking in their newly bought mansion next to the beach and ask "What would you do if you won?"

Another lesson in understanding why customers buy a product and those who say "People are stupid, playing the lottery is -EV" just don't get it.