We like to think we are smarter than we are. As Daniel Kahneman famously said, "Our comforting conviction that the world makes sense rests on a secure foundation: our unlimited ability to ignore our ignorance."
We like to think that we are above being caught out by 'gimmicks' and 'tricks', but in truth, the very structure of our minds makes us susceptible to bias. With that in mind, I have decided to do a series of posts on cognitive biases, or heuristics, as Daniel Kahneman and Amos Tversky referred to them.
I thought I'd start with anchoring. I was recently having a conversation with a solicitor friend of mine. We were discussing the pricing and value of things, more specifically the pricing and value of professional services and how one goes about valuing what is, in essence, time and experience. I can't recall what the catalyst was, but at some point we had made the leap in the conversation to prices signalling value and the concept of anchoring.
Anchoring (or associative coherence) is the tendency to rely on a single piece of information in the decision-making process. It is one of the most well-known cognitive biases and we see it everywhere.
The Bargain Hunt effect
During lockdown, my family and I would often watch BBC's Bargain Hunt during our lunchtime break, and to me it is one of the best illustrations of anchoring. The premise of the show is that two couples compete against each other to make the most profit. They are each given £300 and an expert, and given one hour at an antiques fair to procure 3 items. These items are sold in a general auction several weeks later and the biggest profit — or, as is most often the case, the smallest loss — wins.
Most items are marked with a price tag. The amateur Bargain Hunters haggle with the seller to get a better price and, almost always, succeed in getting the trader to accept a significantly lower price. They walk away chuffed with their deal and proud of their negotiating skills. When the hammer drops, weeks later at the auction, we get an idea of the actual value of the item and, the vast majority of the time, it is less than the 'bargain' price paid.
By anchoring on the original price tag, the Bargain Hunters believe that they are getting a really good deal; that with their smooth talking and expert negotiating skills, the poor stall owner never stood a chance. The truth, though, is that the stall holder saw them coming!
The wheel of fortune
In the early 1970s, Kahneman and Tversky ran a series of experiments. They rigged a wheel marked from 1 to 100 so that it would only ever stop at 10 or 65. They asked the participants to spin the wheel and write down the number it landed on. They then asked them: is the percentage of African countries among UN members larger or smaller than the number you wrote? And, what is your best guess of the percentage of African nations in the UN?
The outcome of a wheel of fortune (even a rigged one) cannot possibly yield any useful information on African countries in the UN, and rational, logical people should not even consider it in answering the subsequent question. But they do. The average estimate for participants who spun "10" was 25%, and for participants who spun "65" was 45%. Clearly a material difference.
In similar exercises, participants were asked: was Gandhi more or less than 144 years old when he died? And, how old was Gandhi when he died? One hundred and forty-four is an absurdly high number, so almost no one would plump for 'over', yet the 144 still has a bearing on the answer to the second question. It primes us, and although we are not consciously aware of it, our estimate is an adjustment down from that prime. This adjustment, and particularly how we adjust insufficiently, was the subject of a 1973 paper by Messrs Kahneman and Tversky, "On the Psychology of Prediction".
Arbitrary coherence
As the above study shows, an anchor can be any piece of information; it doesn't have to be a price. In a study carried out by Drazen Prelec, George Loewenstein and Dan Ariely, participants were asked to write the last 2 digits of their social security numbers at the top of a piece of paper and then submit sealed bids for 5 separate items in an auction.
Analysis of the bids revealed that those with high ending social security numbers (80–99) bid the highest, and those with low ending social security numbers (01–20) bid the lowest. For one particular item, a bottle of 1998 Côtes du Rhône, the bottom 20% bid an average of $9, whereas the top 20% bid an average of $28.
Unlike associative coherence, where a price tag or RRP can have a bearing on our opinion of value, these studies showed that arbitrary coherence — where an arbitrary, non-related piece of data can influence our judgement — is a very real phenomenon.
Although we may have the "ability to ignore our ignorance", being aware of these biases and understanding them can give us an advantage and help us to avoid suboptimal decisions. It goes without saying that doing more research and gathering more data will lead to better decision making.
