Most people like to think of themselves as rational creatures. In order to arrive at a decision, they carefully consider and analyze relevant facts. They are “truth seeking” animals, simply looking to determine a correct conclusion. Unfortunately, a large body of scientific research has shown that people can be led askew by random, irrelevant data. Therefore, decisions that an individual believes are fact based can actually be incorrect and counterproductive.
Since the 1970’s, there has been a large amount of research in an area of behavioral psychology known as cognitive biases. Cognitive biases are the inherent tendencies that humans have to arrive at judgments and decisions that are irrational and out of step with objective reality. Many cognitive biases stem from humans being hard wired to use short cuts in analyzing facts and arriving at conclusions. While these short cuts may have been useful in our evolutionary past (e.g. quickly determining friend from foe), they can create dysfunctional behavior in a complex, modern society.
One particular cognitive bias that has been significantly studied is known as anchoring and adjusting. It was first highlighted by the Nobel prize winning research team Kahneman and Tversky in a 1974 paper. Anchoring and adjusting is seen when people make estimates from an initial starting value and then make insufficient adjustments towards a final answer. An example from Kahneman and Tversky’s research provides a helpful illustration of the bias in action.
In a classic study, a wheel was spun producing a random number between 0 and 100. The subject was then asked whether the percentage of countries in the United Nations from Africa was higher or lower than that random number. In a followup question, the subject was asked to now guess specifically what percentage of United Nations countries were in Africa. Groups that had been shown 10 as the random number gave an average guess of 25% to the followup question. Groups receiving the number 65 had an average guess of 45%. Remember that the initial number was entirely random and had nothing to do with any relevant fact about geography or politics! Kahneman and Tversky concluded that the random number was subconsciously used as an anchor, limiting the adjustment that would be made towards an ultimate conclusion.
In another interesting study, subjects were asked to guess the age at which Gandhi died. First, one group was asked whether Gandhi was older than 9 before passing away. This group subsequently estimated his lifespan at 50. A second group was initially asked whether Gandhi lived to the age of 140. This group subsequently estimated that Gandhi passed away at the age of 67! Bear in mind that the anchor values of 9 and 140 were just as useless as random data.
While the two studies mentioned above relate to trivia and seem hypothetical in nature, additional studies have focused on real world business decisions. One series of studies looked at how a listing price could influence the appraisal of a home by experienced real estate agents. In these studies, the agents were given significant information about the home, including a standard MLS listing sheet and sales figures for comparable homes in the area. They were also allowed to tour the homes. The twist was that the agents were split into four groups, with each group seeing a different listing price. Sure enough, the listing price had a significant effect on the appraisal prices. Even more interestingly, the agents didn’t believe that the listing price affected their judgement. When asked to list the factors that were important to them in pricing the property, only 8% said that listing price was one of their top three considerations.
The real estate pricing studies are a great example of the insidious impact that anchoring and adjustment can have on standard business transactions. A common example in everyday corporate life is the use of list prices. In many cases, these prices are far from a real offer that a selling party would accept. They act, however, as an anchor, convincing a buyer that they have a bargain when getting some level of discount. Anchoring is also at play in a number of common business processes such as budgeting. Typically, a department looks at a current budget or spending level and makes that the anchor. Adjustments are often only a fine gradient away from the anchor.
Anchor and adjusting is a dangerous phenomonen that takes place below our conscious awareness. It can even be triggered by subliminal cues. It can lead us to make inaccurate and suboptimal judgements, projections, estimates and decisions. To be more effective professionals, we need to have defensive mechanisms in place to combat its pernicious effects.
Neutralizing the effects of anchoring and adjusting starts with an understanding of its mechanics and recognizing scenarios where it may be at play. Any situation where a value must be estimated or negotiated can be influenced by an anchor. One simple way to defend against anchoring is to eliminate the contagion of an anchor value. As an example, citing the real estate study mentioned, the agents should have done an appraisal without being aware of a listing price. Another way to try to neutralize the contagion is to use a zero-based scheme for new values. As an example when doing budgeting, build a new budget from the ground up as opposed to using last year’s figure as a starting point.
Another useful tactic is to use benchmarking information to establish your estimate or guide point. For example, let’s say an organization is trying to decide if they spend an appropriate amount on technology. Typically, the current spend becomes the anchor, with minor adjustments made depending on the prevailing mood (i.e. need to cut back vs. need greater investment). Utilizing a benchmark allows an organization to see how far they are from a normal range of spend, diminishing the impact of the anchor.
Frequently anchoring can be seen during the initial pricing and subsequent negotiation for purchasing goods and services. This can be combatted through two mechanisms. First, having an understanding of actual as opposed to list prices is valuable intelligence. In the consumer sector, we’ve seen how sources such as Edmunds, allow car buyers to ignore list prices quoted by dealers. Similar information can be provided in the corporate space through advisory services. An additional weapon is the use of a competitive bid process. Whether this is via a formal RFP or comparing best offers from multiple competitors, this can again neutralize the effect of the anchor.
Anchoring and adjusting is truly an invisible law, impacting our decision making, outside of our conscious awareness. As with all cognitive biases, having an awareness and a proactive strategy is the only way to combat its insidious effects.