The Anchoring Effect, Cognitive Biases & Thinking about Thinking.
Many years ago, whilst on a gap year, we were in a market Bangkok with some Thai friends. I saw a beautiful piece of Jade that I thought would be a great gift. It was truly beautiful and I fell in love with it, so I asked the price. I don’t remember the exact price the market stall owner said but let’s say $100.
That was way beyond what I could afford to pay, I was very disappointed. As I walked away, The owner caught up with me and said that this was the normal price but it was discounted today and he could let me have it for $40.
A bargain! But I was going to be clever, I thought, and negotiated a bit more and finally purchased for $35. I was so pleased with myself!
I showed it to my Thai friends who let me know that I had paid way over the odds and I should have paid no more than $10. I was gutted!
I had fallen for the oldest sales trick in the world. The Anchoring Effect!
Why do we all fall for this?
We all believe that we act rationally and can evaluate the situation carefully before we make a decision, particularly about value. This is a misconception. The seller had exploited the cultural difference in values and the ability to distort my perception by giving me a very high starting point.
The truth is that, no matter what you do, the first perception lingers in your mind and affects all later perceptions and decisions. When taken to extremes it affects your judgment about value and meaning, particularly when reinforced by a story, authority, and branding.
Let me explain by asking you this…
What is the value of all the gold in the world? Is it more or less than $45 trillion? (don’t google the answer!).
Decide what you think and keep that number in mind. I’ll let you know a little further down the page.
In 1974 Tversky and Kahneman asked a very similar question. They asked people to estimate how many African countries were part of the United Nations. However, before they asked the question they spun a wheel of fortune. The wheel had numbers from 0 to 100 but was rigged so that it would land on 10 or 65. They spun the arrow and when it stopped spinning, at either 10 or 65 they asked people to say if there were a higher or lower percentage of African countries in the UN than the number on the wheel. Then they asked the people to estimate what they thought the percentage might be.
What they found was that people who were shown the number 10 on the wheel guessed, on average, that there were 25% of African countries were part of the UN.
Those who were shown the number 65, estimated, on average 45%.
This is the anchoring effect in action.
The thing here is that no one knew the correct answer, they had to make a guess. As far as they were told the wheel of fortune was a random number generator that produced something to work from. The people could not avoid the anchor.
You probably don’t know the value of all the gold in the world, but I gave you a point of reference, $45 trillion. With that in mind, you applied everything you knew about Gold, Foort Knox, Carats, value, preciousness, etc. but the actual amount isn’t in your head, but you did read $45 trillion and with nothing else (I hope) to work with you probably (most likely) used my value as a benchmark. This was the only information at hand.
The actual value is estimated, according to google, as nearer $8 trillion.
“In many situations, people make estimates by starting from an initial value that is adjusted to yield the final answer. The initial value, or starting point, may be suggested by the formulation of the problem, or it may be the result of a partial computation. In either case, adjustments are typically insufficient…that is, different starting points yield different estimates, which are biased towards initial values.”
Judgment under uncertainty by Kahneman, Slovic, and Tversky.
Everything we do, every day depends on anchoring which is part of our assumptions. This is partly due to our desire and need to make predictions about the future. How long and how much all need reference points. We can often feel we are getting value if a high starting point is reduced.
We see this all the time in internet marketing with a technique called (by Russel Brunson in Expert secrets) “The Stack”.
The Stack is where the bundle of your purchase is firstly priced at a very high value and then reduced drastically, often to 10% of the stated value. If that wasn’t enough, then the bonuses are “stacked” into the deal, to give still further value to the purchase.
Even if you know you are the subject of an anchoring effect, it is very difficult to avoid or ignore it and the psychological feeling it produces.
For instance, when you go to buy a car you’re fairly sure that the price shown is not the price.
Market stall traders will tell you what they’re not going to sell their product for in order to anchor you to a point of reference. When they finally get to the price they are selling for, you feel you’ve got a bargain.
Dan Ariely in his book, Predictably Irrational, quotes an experiment carried out at MIT in 2006 where students had to bod on items in an unusual auction.
They described to the students, a bottle of wine, a textbook and a cordless trackball as awesome. Each student was asked to write down the last two digits of their social security number as if it was the price of the item. So, if the last digits were 09, then the price was $9, if it was 79 then the price was $79. After they wrote the pretend price, they were asked to bid on each item.
The anchoring effect distorted their ability to judge the value of the items. Students with a high social security number paid up to 346% more than those with low numbers.
The social security numbers became an anchor, only because the researchers requested them. They could have asked for anything, any question would create an anchor.
A similar effect can be seen in luxury goods. We get anchored to whatever we use as a reference point. An example given by David McRaney is of an $800 Louis Vuitton bag (he could easily have chosen a more expensive handbag) compared to a $25 bag from Walmart. We set our own anchors by what we are used to or what we believe will give us “social” value. Both bags serve the same purpose, but the value we assign to an object, its provenance, story, and status anchor the pleasure and value we attribute to the object. You just wouldn’t pay $800 for a bag at Walmart.
Irrational Baseline
Anchoring can and is used to manipulate people's behavior. Buying in a “sale” or at a “discount” encourages us to believe that the normal price is high and we are getting a bargain, but only if it imparts the right values. This is often called the irrational baseline.
Another form of anchoring is something known as “Bracketing”.
Bracketing.
Bracketing prepares a client for higher prices by creating two options and implying that there are no other choices.
For instance; a salesperson may say; “would you say your budget is within the $8 - $12k or $12 – $16k range?” By framing the question in this way the purchaser feels that these are the only options and will probably go for the lower bracket (which may be more than they had intended). This is often used to get people to increase their maximum budget.
The High-Low reference point.
Imagine you are going to buy a piece of furniture and you’ve set yourself a budget of $1000. The salesperson asks you, “is your budget higher or lower than $4350?” The $4000 represents the higher end of prices and the $350 adds specificity. The salesperson has set the anchor without explicitly stating it. Even if you come back with $2000, the salesperson has already got you to extend your budget without a hard-sell.
At the end of the day, the anchoring effect isn’t the only cognitive bias that gets us to shift our benchmarks, there are many others. Even if we know that this is how our brains naturally work, and it’s not always to our advantage, there is very little we can do about it.
What we can do though, is ask ourselves, when we’re parting with our money, what drives these choices? Are old anchors and assumptions controlling the choices we make? However, if you know that the person selling to you is depending on an anchoring effect, you can at least be aware of what is going on and let your rational brain take control of the situation.
