Decision Tips
Be aware that initial values bias subsequent information.
The more you ask for, the more you get.
—Anonymous
Brian and Rhonda had been looking for a home for several months. Then they came across the perfect place. The seller was asking $295,000 for it. Brian, always the smart negotiator, began doing his homework. He got a report listing all recent home sales in the area. He found ones that were similar to the one he wanted. He compared them on lot size; number of rooms; square footage; and quality of construction, age, condition, and similar factors. After this careful analysis, Brian concluded the fair market value for this house was $255,000. Now came the challenge. If Brian allowed the seller to focus on the $295,000 asking price, Brian was on the defensive. He would have to explain why he was offering $40,000 less. However, if Brian could get the seller to focus on Brian’s $255,000 offer—that is, to get the seller to justify why the house isn’t correctly priced at $255,000 when compared with other recent sales—he’d have a much better chance of buying the house for something close to $255,000. In essence, Brian was attempting to switch the point of negotiation from the asking price to his offer price.
Brian understood the anchoring effect. He realized that the initial starting point of a negotiation plays a major part in determining the final outcome. In this chapter, you see how the anchoring effect shapes a number of decisions—from negotiations to jury verdicts—and what you can do to lessen its influence.
The anchoring effect is a tendency to fixate on initial information as a starting point. Once set, we then fail to adequately adjust for subsequent information.1 Why does this occur? Our mind appears to give a disproportionate amount of emphasis to the first information it receives. So initial impressions, ideas, prices, and estimates carry undue weight relative to information received later.2
Anchors are widely used by people in the persuasion professions such as advertisers, politicians, real estate agents, and lawyers. For instance, in a mock jury trial, one set of jurors was asked by the plaintiff’s attorney to make an award in the range of $15 million to $50 million. Another set of jurors was asked for an award in the range of $50 million to $150 million. Consistent with the anchoring effect, the median awards were $15 million versus $50 million in the two conditions.3
Negotiations aren’t limited to the persuasion professions, however. All of us are involved in bargaining. We buy a car. We buy or sell a home or business. We create a prenuptial contract or negotiate a starting salary. And any time a negotiation takes place, so does anchoring. As soon as someone states a number, your ability to objectively ignore that number has been compromised. For instance, when a prospective employer asks how much you were making in your prior job, your answer typically anchors the employer’s offer. Most of us understand this and upwardly “adjust” our previous salary in the hope that it will encourage our new employer to offer us more.
Any time a negotiation takes place, so does anchoring.
Let’s look again at home prices because, for most of us, buying or selling a home is one of the biggest financial decisions we make. The evidence indicates that not only is the typical buyer anchored by a property’s initial price, so are the “experts.”4 An experiment with experienced real estate agents in Tucson, Arizona, illustrates this point. The agents were given a detailed ten-page packet describing a number of homes and then taken on a tour of these properties. The packet contained standard Multiple Listing Service listing sheets, recent housing sales data for the city and the neighborhoods, and data about current homes for sale on the market. The agents were then asked to assess “fair market values” and predict selling prices for these homes. The catch in this experiment was that the listed selling price on the summary sheets was manipulated. The homes had been independently valued by appraisers, but different agents were given different listing prices—ranging from 12 percent higher than the actual appraisal to 12 percent lower. Consistent with the power of anchors, the higher the listing price, the higher the agents’ valuation and estimated selling price.
The anchoring effect is most potent when there is a lack of objective information to compare against. Why is a new Patek Philippe watch “worth” $60,000? Because its manufacturer says so? Have you ever gone shopping for a diamond? Did you buy one? How do you know if you got a good deal? Is a wonderful painting by an unknown artist worth $50 or $5,000? Purchases of jewelry and art are particularly vulnerable to anchoring effects because most of us have a great deal of difficulty assessing true value. We are heavily influenced by the initial price set by the seller.
In ambiguous situations, we need to be particularly cautious of trivial factors because they can have a profound effect on anchoring us to an initial position that is hard to deviate from. And implausible anchors can produce large effects.5 For instance, a television infomercial that promises that you could make $300,000 in the first year of selling a certain product is more likely to motivate you to sign up than one that offered a more realistic $25,000. Because we’re unlikely to have any valid reference point to challenge the $300,000 claim, it’s easy for shady entrepreneurs to suck in people with outrageous statements.
You can do a couple of things to make yourself less susceptible to anchoring effects. First, be aware of the anchoring bias. Recognize that we’re all vulnerable to first impressions, so we have to be vigilant when we receive initial information. You need to particularly scrutinize initial values that seem unusually high or low.6 Also, you should be cautious when confronted with best- or worst-case scenarios. This is because extreme anchor values produce the largest anchoring effects. “For instance, after considering the probability of a business venture under ideal conditions, it is difficult to arrive at a realistic projection.”7 Finally, use your knowledge of the anchoring effect to improve your negotiation skills. As a buyer, pay little attention to initial offers. Although everyone must have a starting position, these initial offers tend to be extreme and idealistic. Don’t let them limit your focus or narrow your options. Conversely, as a seller, you want to do just the opposite. Try to take the initiative by defining an initial price and focus the negotiations around that initial number.8
Be aware that initial values bias subsequent information.
Be vigilant to initial values that appear unusually high or low as well as best- and worst-case scenarios.
As a buyer, pay little attention to initial offers.
As a seller, try to take the initiative by defining an initial price.