NOTE: This is the third in an ongoing series of stories that explain complex behavioral economics ideas in simple was, and use them to your advantage in everyday life. READ there entire Everyday Econ series.
There’s a car dealer outside New York City who aggressively advertises $7,500 discounts for buyers who show up for a “sale.” The sale is, of course, temporarily permanent, and offered for every Hallmark holiday. How can he do it?
Listen carefully to the ad, and you’ll hear the phrase discounted … from the posted dealer price. Unless you were born yesterday, you know exactly what’s going on. The dealer increases the price, then offers the $7,500 discount on that higher price. So if we all know what’s going on, does that old saw really work?
You bet it does. The phenomenon is called “anchoring.” And we fall for it all the time. But understand how anchoring works, and you can at least save yourself a lot of wasted time the next time you negotiate to buy a car. And you might even save some money.
Behaviorists use the word anchoring to describe the basic human tendency to attribute out-weighted importance to the first piece of information you receive in a situation. Anchoring happens in many aspects of life, but let’s stick with money. If a car dealer tells you the price of a car is $20,000, but then offers to sell it to you for $15,000, you will be convinced you are getting a much better deal than if he straight-up offered to sell it for $15,000. That first number thrown out there, the $20,000, serves as an anchor — a first reference point. Every other price becomes an adjustment of that price. Buyers can’t help but see the $15,000 offer as a $5,000 discount — hence the New York City salesman’s tactic.
Right about now, you are probably thinking this is hogwash, and that you know better. Everybody knows that a typical car dealer move is to negotiate from a high price. And if you know that, you are immune from the tactic, right?
Not only are you mistaken, but it’s this level of overconfidence that salespeople prey on most. The only thing more dangerous than an under-informed consumer is an arrogant one.
Numerous studies show anchoring at work. Behavioral economics legend Daniel Kahneman conducted some of the first research into anchoring back in the 1970s. He asked subjects to quickly guess at the solution for one of two math problems — 8x7x6x5x4x3x2x1 or 1x2x3x4x5x6x7x8. Those given the series of numbers starting from 8 guessed, on average, 2,250. Those who started from 1 guessed 512. (The right answer is at the end of this column).
Now if you think you are above anchoring, here’s a key result for you. Even when subjects are told about anchoring, and warned not to let it influence their opinions on the price of things, it does. One study asked participants when Gandhi died – they were then told he might have died at either 9 years old or 140 years old. The group initially told 140 guessed nearly 20 years older (57) than the other group (40).
Back to negotiation. Real estate agents sometimes have outsized confidence in their ability to “price” homes that are put on the market, or to assess whether a price is too high or too low. In his great book “The Two-Headed Quarter: How to see through deceptive numbers,” Loyola professor Joseph Ganem described a study which proved that. Real estate agents were asked to appraise a home based on a 10-page packet of information where the only variance was the list price. When it was $119,000, the average appraisal was $114,000. When the list price was $149,000, the average appraisal was $128,700. In other words, simply changing the first price suggestion made agents raise their perceived value of a home by more than $14,000 (corrected).
Worse yet, the agents were blissfully unaware of the influence the list price had on their appraisal.
“Only 10 percent of the agents mentioned listing price as one of their top three considerations,” Ganem writes. “It is interesting that anchoring effects influence experts without their being aware of, or at the very least, willing to admit the influence.”
The only thing more dangerous than an uninformed consumer is an arrogant one.
So, how can you use the anchoring effect to your advantage? Believe it or not, despite what many negotiators say, it’s often smart to be the first person to name a dollar figure when negotiating a price or a salary. And you might as well be a little like the car dealer at the beginning of this story. If you want a $1,000 raise, ask for $1,500 … or even $2,000. If you want to buy a car for $20,000, offer $16,000. The dealer will probably laugh, but that’s OK — you laughed at the advertisement, didn’t you?
(The correct answer is 40,320).