Sticky Decisions – Anchoring and Adjusting

It’s the end of a long day of Saturday shopping. You’re at the big box appliance store, looking to replace that old refrigerator. After several rounds of negotiating with your salesperson, you relent, agreeing to his latest offer. Heck – it seems like a good deal, it’s $200 off of the original price!

This scene probably feels familiar to you. Often, when purchasing an item, we have a difficult time determining if we have done an adequate job of negotiating. Marketing and sales professionals, with insights into human behavior, do a good job “stacking the deck” against the buyer. One technique that is common is to exploit a flaw in human reasoning known as anchoring and adjusting.

Anchoring and adjusting is a heuristic, or rule-of-thumb, used for rapid, intuitive judgements. Unfortunately, it can lead to inaccurate judgments and estimations across a wide range of domains. In addition to our price negotiation example, the effect of anchoring and adjusting is seen in contract negotiating, project planning, budgeting and forecasting. It is a well studied phenomenon that should be understood by any professional interested in improving their decision making and prediction skills. A particularly insidious nature of anchoring and adjusting is that it can be influenced by subconscious exposure to irrelevant data. This enables unscrupulous actors to exploit unwitting counterparties.

The research team of Kahneman and Tversky first coined the term anchoring and adjusting  in a seminal 1974 paper entitled Judgment under uncertainty: Heuristics and biases. They described a consistent two-stage process by which people estimated values. First, an individual establishes a reference point, based on an initial value. This starting point is known as the anchor. In the case of our refrigerator example above, it would be the list price of the item. Next, people will make one, or a series of, revisions (i.e. adjustments) to the anchor to arrive at a final estimation. In our example, this would be represented by the rounds of negotiation that involved changes to the list price of the item.

Kahneman and Tversky noted that the initial values that people were exposed to had a dramatic effect, influencing subsequent revisions. Their “adjustments” were typically too small, resulting in inaccurate final estimations. In one study, subjects were given five seconds to estimate the total of a mathematical equation. One group was presented with the following problem:

1 x 2 x 3 x 4 x 5 x 6 x 7 x 8

Another group saw the same equation, but in reverse:

8 x 7 x 6 x 5 x 4 x 3 x 2 x 1

The median estimate for the first group was 512. The second group had a median estimate over four times as high at 2,250. The correct value was 40,320. Kahneman and Tversky concluded that the subjects were demonstrating the anchoring and adjustment heuristic. Given limited time, the subjects needed to perform some quick multiplication (i.e. establish an anchor value) and then extrapolate (i.e. adjust to) a final estimate. The folks presented with the first sequence were starting with lower values, and arrived at a lower anchor value. But both groups did insufficient adjusting; the correct value was almost 20 times the median estimate of the second group.

In a second study described in the paper, Kahneman and Tversky rigged a wheel of fortune to always land on either 10 or 65. Subjects were asked two questions:

  • Was the percentage of African countries in the United Nations higher or lower than the number from the wheel of fortune?
  • What percentage of  African countries are in the United Nations?

Subjects presented with the number 10 from the wheel had an average guess of 25%. Amazingly, subjects presented with the number 65 had an average guess of 45%. The only difference between the two groups was the “random” spin of a wheel, producing what should have been an irrelevant “cue”. However, as with the order of the math problem, the wheel spin acted as an anchor, serving to limit the effects of future adjustments.

Numerous follow-up studies have confirmed the pervasive effect of the anchoring and adjustment heuristic.  In another experiment, similar to the wheel of fortune example, subjects were asked to estimate Mahatma Gandhi’s age of death. However, first they were asked if it was higher or lower than  an anchoring value (9 or 150). Both of these anchor values were clearly irrelevant, yet influenced the subject’s estimates. The first group averaged a guess of 50 while the second group averaged 67.

In both the wheel of fortune example, and the Gandhi study, researchers were demonstrating an element of the anchoring and adjusting process known as priming. The initial number, while completely irrelevant, acted as a primer, and as an anchor to the estimating process. In both these cases, the primer was presented directly to the subjects. Further research has shown that the primer can actually be presented subliminally, or outside of conscious perception.

In a 2005 study in by Mussweiler et al. at a German university, students were asked to estimate the average price of a midsize car. However, prior to being asked for their estimate, they were told to stare at a computer screen. The screen appeared to contain a series of nonsense strings such as “$§?#ß#”. Periodically, subliminal priming information would replace the nonsense string, appearing for 33 milliseconds, below the level of conscious awareness. One group was presented with a subliminal “low” anchor number of 10,000 while the second group was presented with the number 30,000. The average estimate for the low group was 17,150 euros, while the high group estimated 21,219. A third group that received no priming provided a mean estimate of 18,312.

These are but a few of the studies that have consistently demonstrated the robust nature of the anchoring and adjustment heuristic. It is a reasoning flaw that is very hard to extinguish, even when people are explicitly aware of its dynamics. In the workplace it can have profound implications across a number of common functions:

Project Planning – A common practice amongst project planners is to create an initial estimate of duration and cost. This first “cut” is arrived at by adding together estimates for each phase or task of the project. These estimates typically represent best case or normal timeframes for completion of the individual items. As a next step, the planner adds a “fudge factor” or padding, to account for unexpected complications. However, the initial estimate acts as an anchor, and the fudge factor typically represents an insufficient adjustment to that anchor. This problem is so common, that it has its own name, the planning fallacy. A method for countering this issue involves utilizing historical information for estimations. Instead of attempting to guess the completion time and costs for tasks/phases, a planner should use actual historical data from similar projects.

Budgeting – A common budgeting practice involves taking the previous period’s budget and adjusting it to reflect the goals and requirements of the current cycle. Similar to our project plan example, this causes budgets to be anchored to the previous cycle’s number, with adjustments that are not reflective of current realities. A way to counter the effects of anchor and adjusting in the budgeting process is to utilize a zero-based approach. Rather than starting with last cycle’s number, a budget proposal should be built from the ground up, with no reference to previous budgets.

Contract Negotiations – As we saw with our refrigerator example, anytime we are negotiating over the pricing or terms of a deal, anchor and adjusting can effect the outcome. Whether the topic is cost, or cancellation terms, the first figure that is aired will serve as a “stake in the ground”. All negotiations from that point forward will be anchored to the “stake”, typically with adjustments that don’t adequately reflect market realities. There are a couple of good practices that one can use to counter this problem:

  • Ignore list pricing! Use your own research (e.g advisory services, historical deal pricing, competitor pricing) to establish market pricing.
  • Use an RFP or bidding process to force the provider to submit honest pricing
  • Be the first mover. Offer your own pricing or terms first, to create your own anchor.

As mentioned previously, anchoring and adjusting is an insidious reasoning flaw that is difficult to counteract. Here are two general ideas that can give you a fighting chance:

  • Awareness – Understand the mechanics and hallmarks of anchoring and adjusting so that you can spot situations where it is in play. Utilize a standard defense (e.g. attaining market pricing data) to eliminate anchors from the picture.
  • Standardized Processes – Employ a disciplined, standardized approach to vulnerable  processes — such as the ones highlighted above — that enables you to sidestep the effects of anchoring and adjusting.

 

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One Response to Sticky Decisions – Anchoring and Adjusting

  1. An example of the strength of anchoring in negotiations was tested in a study conducted by Northcraft and Neale. The purpose of the study was to measure the difference in the estimated value of a house between students and real-estate agents. In this experiment, both groups were shown a house and then given different listing prices. After making their offer, each group was then asked to discuss what factors influenced their decisions. In the follow-up interviews, (although the real-estate agents denied being influenced by the anchor) the results showed that both groups were equally influenced by the “anchor” of the listing price.

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