When you’re shopping for something special or unique, how do you know what a fair price is? If you’re like most people, the first piece of price information you encounter acts as an anchor, influencing all your future judgments about the price you should pay. This happens even if you disagree with the initial price or try not to let it influence your judgement.
A price anchor is just what the name implies – the initial asking price weighs heavily, creating a reference point which is hard to fully escape. Essentially, once we encounter any kind of price guide, we tend to base assessments of the “fair” price by adjusting away from that anchor. The problem is that these adjustments may not go far enough, meaning our final assessment of a fair price ends up closer to the anchor than it would otherwise be.
In many situations, including where price is negotiable, the price guide set out by the seller is the first anchor point. This sets the scene for the negotiation, and the final price will often be within striking distance of that initial anchor. Amateurs and professionals alike are susceptive to this type of anchor.
A great study by Northcraft and Neale shows the impact of anchors in real estate. Both amateurs (students) and professionals (real estate agents) toured and made judgments about a realistic selling price for real estate properties. Each participant had access to a 10-page information booklet, containing all the information usually used by agents to set a list price. Although agents denied they were influenced by the list price, the authors found that both groups were equally influenced by the list price anchor.
Haggling in a market is another classic situation where price anchors come into play. Nobel Prize winning psychologist Daniel Kahneman has some advice if you find yourself facing an outrageous proposed selling price: “you should not come back with an equally outrageous counteroffer, creating a gap that will be difficult to bridge in further negotiations. Instead you should make a scene, storm out or threaten to do so, and make it clear – to yourself as well as to the other side – that you will not continue the negotiation with that number on the table.”
And what about anchors in auctions? As this blog previously alluded , prices and anchors are a little more complicated in auction situations. As a starting point, a publicly known reserve acts like a typical anchor, influencing potential bidders to value the good at or above the reserve price.
What about the starting price or first bid? This is where things get tricky. Although a low starting price can sometimes lead to a low final price, things often turn out the other way – where a low starting price leads to a high final price. There are a few factors at play here:
- First, lower starting prices allow more potential bidders to feel they have a real chance of winning at the outset;
- Second, lower starting prices entice bidders to invest time and energy in the auction. This can create a feeling of ownership causing bidders to escalate their commitments; and
- Third, more potential bidders means more interest, and more interest leads bidders to infer a higher value. Because the “right” price for a good under auction is unknown, bidders often look to other bidders for information about how to behave. So if a low price entices one bid, the chance of a second (and third, and fourth…) bid dramatically increases.
For the savvy buyer looking to minimise the impact of anchors, there are a few things to keep in mind. The first step is to recognise price anchors where they exist. Searching for an argument against the anchor is a good way to protect yourself from being caught out. Don’t be fooled by auctions with a high number of bids – new bidders often gravitate towards auctions with a high number of bids, ignoring comparable auctions with no bids. And finally, remember Daniel Kahneman’s advice - be prepared to walk away if you encounter a price anchor that’s deliberately outrageous.
Further reading
- Tversky, A., & Kahneman, D. (1992). Advances in prospect theory: Cumulative representation of uncertainty. Journal of Risk and uncertainty, 5(4), 297-323.
- Northcraft, G. B., & Neale, M. A. (1987). Experts, amateurs, and real estate: An anchoring-and-adjustment perspective on property pricing decisions. Organizational behavior and human decision processes, 39(1), 84-97.
- Kahneman, D. (2011). Thinking, fast and slow. Macmillan. p126
- Kamins, M. A., Dreze, X., & Folkes, V. S. (2004). Effects of seller-supplied prices on buyers' product evaluations: Reference prices in an Internet auction context. Journal of Consumer Research, 30(4), 622-628.
- Kamins, M. A., Dreze, X., & Folkes, V. S. (2004). Effects of seller-supplied prices on buyers' product evaluations: Reference prices in an Internet auction context. Journal of Consumer Research, 30(4), 622-628.
- Ku, G., Galinsky, A. D., & Murnighan, J. K. (2006). Starting low but ending high: A reversal of the anchoring effect in auctions. Journal of Personality and social Psychology, 90(6), 975.
- Dholakia, U. M., & Soltysinski, K. (2001). Coveted or overlooked? The psychology of bidding for comparable listings in digital auctions. Marketing Letters, 12(3), 225-237.
- Galinsky, A. D., & Mussweiler, T. (2001). First offers as anchors: the role of perspective-taking and negotiator focus. Journal of personality and social psychology, 81(4), 657.