The Misconception: You rationally analyze all factors before making a choice or determining value.

The Truth: Your first perception lingers in your mind, affecting later perceptions and decisions.

You walk into a clothing store and see what is probably the most bad ass leather jacket you’ve ever seen.

You try it on, look in the mirror and decide you must have it. While wearing this item, you imagine onlookers will clutch their chests and gasp every time you walk into a room or cross a street. You lift the sleeve to check the price – $1,000.

Well, that’s that, you think. You start to head back to the hanger when a salesperson stops you.

“You like it?”

“I love it, but it’s just too much.”

“No, that jacket is on sale right now for $400.”

It’s expensive, and you don’t need it really, but $600 off the price seems like a great deal for a coat which will increase your cool by a factor of 11. You put it on the card, unaware you’ve been tricked by the oldest retail con in the business.

One of my first jobs was selling leather coats, and I depended on the anchoring effect to earn commission. Each time, I figured it was obvious to customers the company I worked for marked up the prices to unrealistic extremes. Yet, over and over, when people heard the sale price, they smiled and wrestled with their better judgment.

The prices you expect to pay, where did those expectations originate?

To figure out how those channels were dug, those paths were beaten, answer this:

Is the population of Venezuela greater or fewer than 65 million? Go ahead and guess. Ok, another question, how many people do you think live Venezuela?Come up with a figure and keep it in your head. We’ll come back to this in a few paragraphs.

In 1974, Amos Tversky and Daniel Kahneman conducted a study asking a similar question. They asked people to estimate how many African countries were part of the United Nations, but first they spun a wheel of fortune. The wheel was painted with numbers from 0 to 100, but rigged to always land on 10 or 65. When the arrow stopped spinning, they asked the person in the experiment to say if they believed the percentage of countries was higher or lower than the number on the wheel. Next, they asked people to estimate what they thought was the actual percentage. They that found people who landed on 10 in the first half of the experiment guessed around 25 percent of Africa was part of the U.N. Those who landed on 65 said around 45 percent. The subjects had been locked in place by a psychological phenomenon known as the anchoring effect.

The trick here is no one really knew the true answer. They had to guess, yet it didn’t feel like a guess. As far as they knew, the wheel was a random number generator, but it produced something concrete to work from. When they adjusted their estimates, they couldn’t avoid the anchor.

The populations of South American countries probably aren’t numbers you have memorized. You need some sort of cue, a point of reference. You searched your mental assets for something of value concerning Venezuela – the flag, the language, Hugo Chavez – but the population figures aren’t in your head. What is in your head is the figure I gave you, 65 million, and it’s right there up front influencing how you answer the second question. When you have nothing else to go on, you fixate on the information at hand.

The population of Venezuela is 28 million people. How far away was your answer? If you are like most people you assumed something much higher.

The numbers generated by the wheel of fortune, the number I gave you and the $1,000 price tag are all anchors, unwanted guests in the mind which change the mood of the party. Anchors can make big numbers seem small, throw estimates out of whack and lead you into decisions which, in the long view, seem silly.

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 partial computation. In either case, adjustments are typically insufficient…that is, different starting points yield different estimates, which are biased toward the initial values. – “Judgment Under Uncertainty” by Kahneman, Slovic and Tversky

You depend on anchoring every day to predict the outcome of events, to estimate how much time something will take or how much money something will cost. When you need to choose between options, or estimate a value, you need footing to stand on. How much should you be paying for cable? How much should your electricity bill be each month? What is a good price for rent in this neighborhood? You need an anchor from which to compare, and when someone is trying to sell you something they are more than happy to provide one. The problem is, even when you know this, you can’t ignore it.

When shopping for a car, you know it isn’t a completely honest transaction. The real price is probably lower than what they are asking for on the window sticker, yet the anchor price is still going to affect your decision. As you look over the vehicle, you don’t consider how many factories the company owns, how many employees they pay. You don’t pore over engineering diagrams or profit reports. You don’t consider the price of iron or the expensive investments the manufacturer is making into safety testing. The price you are willing to pay has little to do with these considerations because they are as far from you at the point of purchase as the population of Venezuela.

Even if you’ve done some research online, you don’t know for sure exactly what the car is worth, or what the dealer paid for it. The focus instead is the manufacturer’s suggested retail price, and no matter how unrealistic it is, you can’t help but be tethered to it. When you haggle over the price, you are pulling away from the anchor, and both you and the dealer know this.

The anchoring effect can also slip in unannounced. Drazen Prelec and Dan Ariely conducted an experiment at MIT in 2006 where they had students bid on items in a bizarre auction. Ariely explains in his book, Predictably Irrational, that the researchers would hold up a bottle of wine, or a textbook, or a cordless trackball and then describe in detail how awesome it was. Then, each student had to write down the last two digits of their social security number as if it was the price of the item. If the last two digits were 11, then the bottle of wine was priced at $11. If the two numbers were 88, the cordless trackball was $88. After they wrote down the pretend price, they bid. Sure enough, the anchoring effect scrambled their ability to judge the value of the items. People with high social security numbers paid up to 346 percent more than those with low numbers. People with numbers from 80 to 99 paid on average $26 for the trackball, while those with 00 to 19 paid around $9.

Social security numbers were the anchor in this experiment only because we requested them. We could have just as well asked for the current temperature or the manufacturer’s suggested retail price. Any question, in fact, would have created the anchor. Does that seem rational? Of course not. – Dan Ariely from his book, “Predictably Irrational”

The auction experimenters conducted another study in which they asked people to listen to annoying sounds for money. The researchers initially offered either 90 cents or 10 cents for a blast of awful electronic screaming, and then they asked the subjects how much would be the lowest possible price they would need to be paid to listen to the sound again. People who were offered 10 cents said it would take about 33 cents to continue. People offered 90 said it would take 73. They repeated the experiment in other ways, but no matter how they messed with the sounds or the payouts, those who were first offered a low payment consistently agreed to lower amounts than those used to better wages. People who got more money at first were unwilling to accept lower payments later.

If you move up to a nice car or a big house, a nice computer or an expensive smartphone, you become anchored and find it difficult to back move down later, even if you should. Those who buy expensive purses know they are being hornswoggled, at least at some level, yet the anchoring effect still reaches into their bank account.

Does a $800 Louis Vuitton purse function better than a $25 handbag from Wal-Mart? No, not even if it was hand made from giraffe leather and stitched by real, magical leprechauns. It’s just a purse. But the anchor is set. Louis Vuitton bags are expensive, and that in itself has social value. People still buy them and are happy with their purchase. If Wal-Mart offered a purse at $800 it would live out its life on the shelf. The price would be so far from the anchors already set by the store it would seem like a bad deal.

Like most psychological phenomenon, anchoring can be used to manipulate people to do good. The best example is the door-in-the-face technique. In a 1975 study by Catalan, Lewis, Vincent and Wheeler, researchers asked a group of students to volunteer as camp counselors two hours per week for two years. They all said no. The researchers followed up by asking if they would volunteer to supervise a single two-hour trip. Half said yes. Without first asking for the two-year commitment, only 17 percent agreed. Remember this study if you are ever in a negotiation – make your initial request far too high.

You have to start somewhere, and your initial decision or calculation greatly influences all the choices which follow, cascading out, each tethered to the anchors set before. Many of the choices you make every day are reruns of past decisions, like channels dug into a dirt road by a wagon train of selections, you follow the path created by your former self. External anchors, like prices before a sale or ridiculous requests, are obvious enough you can sidestep the actual price, the real appeal. Internal, self-generated anchors, are not so easy to bypass.

You visit the same circuit of websites everyday, eat basically the same few breakfasts. When it comes time to buy new cat food or take your car in for repairs, you have old favorites. Come election time, you pretty much already know who will and will not get your vote. These choices, so predictable, ask yourself what drives them. Are old anchors controlling your current decisions? When you are parting with your money, know the person on the other side of the deal thinks you are not so smart and is depending on the anchoring effect when they tell you how much you are about to save.

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Links:

The African nation study

African nations in the U.N.

Door in Face Study

Social Security numbers study

Sources:

• African nations in the U.N. Retrieved December 2010 from http://en.wikipedia.org/wiki/File:UN_Member_Countries_World.svg.

• Ariely, D., Loewenstein, G., & Prelec, D. (2006). Tom Sawyer and the construction of value. Journal of Economic Behavior & Organization 60, 1–10. Cialdini, R. B., Vincent, J. E., Lewis, S. K., Catalan, J., Wheeler, D., & Darby, B. L. (1975).

• Reciprocal concessions procedure for inducing compliance: The door-in the face technique. Journal of Personality and Social Psychology 31(2), 206–215. Kahneman, D., Slovic, P., & Tversky, A. (1982).

• Judgment under uncertainty: heuristics and biases. Cambridge: Cambridge University Press.

• Ariely, Dan. Predictably Irrational: The Hidden Forces That Shape Our Decisions. New York, NY: HarperCollins, 2008. Print.