The Anchoring Effect
What we believe. When we make a decision, we collect all the necessary information and analyze all the parameters that factor in before we reach a conclusion. In the end, we choose correctly, or at least we have very good reasons supporting our choice.
What is the reality: The initial information we receive, relevant or irrelevant, subconsciously plays a significant role in our decision-making process, severely affecting our thoughts, beliefs, and final course of action.
This unintended first-information influence is known as “the anchoring effect.”
Anchoring is to be affected too much by a piece of information we receive early in the decision-making process, most often the very first piece of information we become aware of. This is called the “anchor”. A lot of times this piece of information could be completely irrelevant to the subject and the decision we are about to make. Although some adjustments could be done, the point is that the final decision is profoundly influenced by and most probably is estimated around the initial anchor.
Anchoring is very common in product selling, in the stock market, and in real estate. In all these cases, the first price offering for a product, stock, or a house sets the standard for all further negotiation.
Suppose you are looking to a buy a pair of jeans. You manage to find one of your liking, you try it on, then you discreetly peek at the price tag. The pair costs 400€. You think about leaving, but then the salesperson approaches you, mentioning that this pair of jeans just went on a 70% discount, and so the final price is now 120€. You think that this is an excellent deal because the initial price was 400€ and you buy it. But what if I were to tell you that the original price was 150€, or maybe even 100€? Well, you’ve been anchored. The discount price (the 120$) works in this case as an anchor, as the yardstick by which we measure any further judgement about the price of the jeans being high or low.The same goes with house pricing, car (specially used) pricing, and stock pricing.
Some Interesting experiments about Anchoring Effect
Anchoring was first mentioned by Daniel Kahneman and Amos Tversky. Speaking about the adjustment theory, which states that people use the anchor as a starting point for their estimations, and then they only make adjustments around that anchor. This happens to correct their initial evaluation, adjustments that most of the times do not dramatically change the result. The first experiment they used was to ask students to estimate in 5 seconds the result of the following : 1 X 2 X 3 X 4 X 5 X 6 X 7 X 8 and the reverse 8 X 7 X 6 X 5 X 4 X 3 X 2 X 1. In the first case, students estimated the result to be 512, and in the second case, 2,250. The right answer is 40,320. This is a typical example of how the first information we get affects our estimation. The time given for calculations is too limited to actually produce a correct answer, so people eventually have to make a guess. When starting to count from a low number (in this case, number 1), most tend to calculate a smaller number (512) than in the second case, where people start estimating from a bigger number.
Another interesting example from those two showing that, even though we are aware that the information we are given is false, yet it still affects us, is the following: Students were asked to estimate at what age Gandhi died. Before that, half the participants were asked whether Gandhi died before or after the age of 9, the other half whether he died before or after the age of 140. Both questions didn’t even approach the correct answer (Gandhi was 78 years old when he died). Still, the first group gave an average age of 50, while the second an age of 67.
Kahneman and Tversky also conducted the following experiment, in which the participants were asked to watch a roulette wheel that was supposed to stop in either 10 or 65. After that, they have been invited to estimate what percentage of the United Nations were African countries. Participants who saw the roulette wheel stop on 10 estimated that around 25% percent of UN were African countries, and those whose wheel stopped on 65 estimated 45% This a huge difference. The important part here is that those two groups were affected by an entirely irrelevant piece of information.
Another example proving that was conducted by Dan Ariely. Dan asked the people participating in his experiment to write down the last two digits of their social security number. He separated them into two groups, those whose social security number last digits were lower than 50 and those from 50 to 99. Afterwards, these groups were asked to estimate the cost of some products like wine and chocolates, whose value they didn’t know. The group with higher social security numbers estimated the cost to be around 60-120% percent greater than those with lower social security numbers. Now Imagine how we are affected in our everyday life.
*(Actually, we are conducting the last three experiments, and we are relly eager to publish the results next week)
During the Strategic Negotiation Process Workshops, another test was conducted, proving the impact of anchoring. Divided into buyers and sellers, each party’s participants received the same information about the other party. In the end, it was noted that the success rate of the participants who anchored their offers was greater than the ones who did not (source: Wikipedia).
A lot of people tend to negotiate around an anchored price, the initial price and tend to ignore other parameters or avoid making some further analysis of the object they are going to purchase. That ranges from a pair of jeans to a car, or even a house.
Other Cases of the Anchoring Effect
The focusing effect is somehow related to the anchoring effect. This is what happens when something, a piece of information or an event, succeeds in correctly predicting the outcome of an event.
We tend to pay attention to ordinary things and those that pop first into mind, and not those that are less obvious, (e.g. when we make a prediction about whether a person is happy or sad. In such cases, we tend to determine the happiness/sadness percentage by the most predictable, recognizable factors. -Surely, somebody who makes a lot of money must be very happy – not taking into account other factors just as relevant, that may be influencing the happy/sad analogy even more – health, marital status, etc.).
In a case study, people were informed about two employees, one working under strict supervision in his job, the other with no none supervision. When asked which one of them is happier in his life, most people answered the one who works unsupervised. This is not the case. The data given (the level of supervision) hardly suffice to reach a safe conclusion about either employee’s emotional state. There are other parameters that affect the sadness/happiness balance, like how many hours each person works, or how many vacation days they got etc. Another point mentioned by David Kahneman is that people tend to overestimate the income increase in association with the happiness it provides
Anchoring Effect in negotiation
When negotiating, anchoring initially sets the main framework within which the offers will range, then focuses on what the subject of the negotiation is worth. Other than the Tversky and Kahneman study, several additional experiments have proven that an object’s value is significantly affected by anchoring. For example, instead of judging an offer’s aspects and traits, negotiators usually zero in only one characteristic. As a result, a calculated first offer substantially influences all following offers. The offer/counteroffer scheme results in a satisfactory arrangement for all negotiating parties. Still, several studies have proven that the following offers have a much smaller impact on the result of the negotiation than first offer (source: wikipedia).
Facts and applications of Anchoring Effect
Another interesting fact about anchoring is that both experienced and inexperienced people are affected by anchoring. Anchoring is irrelevant with factors such as intelligence or experience. Investigators Northcraft and Neale asked both real-estate agents and students to estimate a house’s value. Despite them denying it, the experiment proved that even the real-estate agents were affected by the anchor of the initial price (source: Wikipedia).
Anchoring is not limited to an object’s value as a whole, but may also affect the scale, i.e. the adjustment made to each prediction about the object’s worth. Janiszewski and Uy conducted a relevant experiment, giving the participants an initial price for a beach house, then asking them to estimate the home’s real value. They were given either a generic anchor (e.g. $800,000) or a more accurate one (e.g. $799,800). The general anchor participants lowered their estimation more than the particular anchor participants did ($751,867 vs $784,671). The researchers ascribe this to a difference in scale, meaning that the anchor influences both the starting value and the starting level. If the anchor is more rounded, people adjust their predictions in a larger scale ($19, $21, etc.), but when the anchor resembles something like $19.85, then predictions revolve around $19.75, $19.95, etc, i.e. they adjust in a lower scale. As a result, the final price of an object is settled on an offer closer to the initial offer, when said offer is a more specific one (source: Wikipedia).
A further interesting “use” of the anchoring effect refers to encouraging people to do some volunteer work, or generally influencing them to do good. Researchers Catalan, Lewis, Vincent, and Wheeler conducted an experiment in 1975, asking some students to work voluntarily as camp counselors, dedicating two hours of their time per week, in a two-year period. All students refused. Interestingly enough, when the researchers then asked if the students would volunteer only once, for a trip lasting only for two hours, about half agreed. The researchers entirely omitting initial two-year proposal, only 17% of the students agreed. This is an important bargaining technique, beginning the negotiations with an offer much higher than what you are actually aiming at.
How to benefit from the Anchoring Effect
Knowing how anchoring effect works, we can use it in a negotiation about selling something we own; a car, a house or something else. Remember to propose a price near you liking, or higher than the actual price, and try to sell as high as possible. Keep in mind that other part might seek to change the anchor so that might not work. Try to use the pricing experiment I gave with the financial times subscription when pricing, this could lead your customers to buy the service you want. You can apply this in other situations, remember an uglier version of what you want to sell, can help you actually sell it.
How to Avoid it
One important thing is that it is tough to avoid anchoring even if we realize the falsity of the information. The previous example we mentioned about Gandhi is a fascinating example.
We should be aware that, in the most probable cases we are going to come across an anchor, i.e., Negotiations and pricing, we must try not to be affected by the initial price offering and figure out the actual cost by doing some research.
Do not immediately give in to your inner voice saying “this is a deal,” think about it again.