Business

The Anchoring Effect: First impressions count in more ways than one

Phil Whitby  

Do you weigh up all the options before making a decision? Do you consider all angles, facts and measurements and only then take the plunge? Even if you believe this, you can still be susceptible to the anchoring effect: your final decision is merely an adjustment of an initial perception.


To drop the price, drop the anchor

When buying a car a sensible person would look at the mpg, bhp, emissions, depreciation, insurance group etc. to find the best model, but is that all the relevant information required when looking for a good deal?

To achieve the best possible price it could be prudent to look at the financial situation of the car dealer, their selling history, profit/loss records, stock price, the price of steel…

What usually happens is that a consumer will head to a dealership after seeing the retail price on an advert and see if they can get a significant discount off that number. A 10-15% discount from a retail price of £20,000 is a significant amount in absolute terms, and would certainly lead to a feeling of accomplishment in most buyers.

Unfortunately, the dealers are well aware of this and have priced accordingly to maintain healthy profits.


The house of ‘Honest John’ always wins

Most purveyors of any retail product hitch your initial perception to a number that acts as an anchor around which all bartering gravitates(either internally with yourself, or with a sales representative). If you have ever been part of a tie-breaker in a quiz -or observed one - you will notice that the second person to guess will usually use the first persons guess as an anchor: even if it is a wild over-estimate. Retail prices act like this initial ‘guess’: they are generally huge over-estimates are only ever listed for the legally required time (usually for as long as any discounted or sale price will be maintained), and then deeply discounted thereafter.

Laws are in place to prevent retailers inflating the retail price in the sale as it is perceived as fundamentally dishonest to exploit this bias without giving consumers sufficient time to actually buy the product at the ridiculous retail price! Presumably, the law is there to prevent the retailers over-inflating to a price that would mean it would never sell, and therefore cost the retailer in terms of potential earnings.

We need laws to protect us from the effects of anchoring as there is a huge volume of evidence demonstrating that we are vulnerable. Tversky and Kahnemann first demonstrated the effect with some rather cunning experiments.

In the first experiment, the subjects were asked to estimate the number of African countries in the United Nations, but only after they had spun a ‘Wheel of Fortune’. The Wheel was rigged to give either the number 10 or 65, thus anchoring the individual to a high or low number. The groups of subjects anchored to the number 10 returned a median estimate of African countries in the U.N. as 25, whereas the higher number group returned a median estimate of 45.

The effect of anchoring was also observed when subjects were asked to estimate in the middle of a computation. Students were given 5 seconds to calculate the product of either of the following:

8 x 7 x 6 x 5 x 4 x 3 x 2 x 1   and   1 x 2 x 3 x 4 x 5 x 6 x 7 x 8

The insufficient time meant that the students would stop in the middle and be asked to estimate: the first calculation would leave a higher number when the first few steps are performed than the second calculation, and their estimates would also be significantly higher. The actual answer for both questions is 40,320 but the first groups median estimate was 2,250 versus the second groups estimate of 512.


The price is right (or High Precise)

Now consider when you are calculating your costs for the new house/car or phone, are you really meticulously calculating all your prospective costs? Have you ever signed up for a new mobile contract because the initial cost of the shiny new phone was acceptable but then discovered that picture messaging, or additional data, was surprisingly exorbitant? Retailers are aware that you will be estimating a relatively large computation based on the initial costs that they present to you, and that any later numbers introduced will not be factored in.

A fascinating study by Cardella and Seiler from 2016 outlines how different pricing strategies in real estate lead to different outcomes for sellers. The four strategies are listed below:

Rounded Price (R): pl = $200,000.
Just Below Price (JB): pl = $199,000.
High Precise Price (HP): pl = $201,326.
Low Precise Price (LP): pl = $198,674.

The best outcomes for the sellers came when the high precise price (HP) was employed: the discount was the smallest and the final price would be the highest, while the just below price (JB) lead to the highest discount. The list prices would alter the nature of the negotiations too: buyers would make the lowest initial offer when the price was rounded(R), whereas HP would lead to higher and more precise counter offers (presumably as the precise price suggest the seller is adamant and determined, while the rounded price suggests the seller has a vague and flexible notion of the value ).

Expertise in the area can help attenuate the effect of anchoring, but only to a small degree. Even judicial sentencing has demonstrated susceptibility to anchoring effects which may explain the huge apparent lack of consistency in sentencing decisions.

Any football fans will also notice that referees can be much more reluctant to send off players for blatant red card offences if they have already sent off one or more players in the match already. This may be due in part to anchoring to an inferred number of ‘acceptable’ red cards. Any more than 1 or 2 cards is therefore indicative of a lack of control by the referee rather than reasonable application of the rules of the game. Even when study participants were told they were being given ‘anchors’ to distort their estimate, anchoring effects were still observed in their results.


How to adjust for adjustment

When confronted with a tense negotiation, remember that anchoring will be happening to you and the opposite party. If presented with a number that is too far away from any middle ground that would be acceptable to you, the best recourse is to leave negotiations altogether and return another time. Remember that any remotely experienced negotiator will have anchoring in mind, and that a compromise will almost always be possible, and it is not offensive to submit a ‘low-ball’ counter-offer - you just increase the risk of the opposite party leaving the table!