What is the ‘Anchoring Effect’?

5 mins read
by Angel One

‘The Anchoring Effect’ is a cognitive heuristic wherein human beings tend to rely heavily on the very first piece of information offered to them, known as ‘the anchor’, when making decisions. Since this habit distorts our judgment, anchoring is considered a type of cognitive bias. It comes into use in cases of negotiation, since it can help us make as well as respond to first offers a lot more effectively. Anchoring is particularly useful when it comes to negotiations in price. The party who puts forth the first offer often gets the lion’s share of the value.

This usually is due to our tendency to ‘anchor’ the bargaining that follows in its direction, even in cases where the recipient might think that the offer is out of line. Depending on how it’s used, the anchoring effect can be more or less helpful. As an anchoring effect example, researchers of negotiation strategies have found that numerical first offers that are precise are much more effective than rounder offers. For instance, a house with a list price of $255,500 will most likely bring in higher bids than houses that have list prices of $256,000 or $255,000.

Another way in which the anchoring effect can negatively impact decision-making is when one is presented with an overly aggressive offer. These kinds of offers risk derailing negotiations, to begin with, particularly when they cause the other side to question one’s credibility such that one wonders if a negotiated agreement is even possible. What will happen in case the other side makes the first offer? You can counter the impact of the anchoring effect by simply recognizing when somebody is attempting it.

In this case, avoid making the common error of responding with a counteroffer before you choose to defuse the other side’s anchor. AS an anchoring example, let’s say somebody chooses to open with $100, and you wish to counter that offer with $50. Before you present your number it is important to make clear that starting at $100 is simply unacceptable. In case you avoid defusing the anchor first, you are subconsciously suggesting that $100 is the zone for bargaining.

The Advantage of Precision

It’s no surprise that the anchoring effect is heavily involved in negotiation. When making an opening in a negotiation, our main focus is usually how low or high it should be. The latest research on negotiating makes clear that the precision of your offer, in other words, how detailed your listing price is, are much more important. In general, the fewer zeros you have at the end of your offer price, the more precise it is said to be.

Generally speaking, the more precise your listing offer, the stronger of an anchor it is likely to create. Offers that are precise tend to convey that you have a clear sense of the value of the commodity you are selling, and also that you are unlikely to be flexible on your price. Accordingly, counterparts tend to cave in. However, there is a catch to this.

Prior studies have demonstrated a precision-related advantage operates under the premise that the parties involved have already decided to negotiate. In contrast to this, in many real-world negotiations, first offers are often presented before the parties involved even start their negotiations. In these cases, research has shown that offers that are highly precise often risk scaring away potential negotiators by conveying a sense of inflexibility.

These results suggest that the past advice that advocates high precision in offers needs some modification. Going for a rounder offer will likely entice more bidders, who see an opportunity for negotiation. However, once the negotiation is in progress, you will likely benefit from increasing the precision of your counteroffers which convey that you do not have a lot of wiggle room on the price.

The Phantom Anchor

Another aspect of the anchoring effect that one should factor in is known as the phantom anchor. A phantom anchor is a figure that is not actually being offered on the surface but is mentioned in passing and is perceived as an anchor nonetheless. For example, consider a car seller who says that he was going to ask for ₹1.5 lakhs for your car but is letting you have it for the price of ₹1 lakh. In this case, ₹ 1.5 lakhs becomes the phantom anchor, since it might not be the actual offer but it carries the weight of being one.

Since past research has shown that even irrelevant or arbitrary numbers can become powerful anchors in negotiation, researchers have looked at how much of a difference adding a phantom anchor to the mix can make. Does phantom anchoring make a difference to one’s negotiating abilities? The answer has been a resounding yes.

Across a host of experiments, negotiators who chose to frame their offer relative to a separate phantom anchor (for example, ₹10,000 rather than ₹12,000 for a refrigerator) were likely to achieve better outcomes than negotiators making the same offer (₹10,000) without having a phantom anchor as reference. Although it is not actually on the table, referencing a phantom anchor pulls the expectations of a bidder of how well they can do in its direction.

The Bottom line

Anchoring is a powerful cognitive bias that can be used to one’s advantage in situations that require negotiation. Prior research has demonstrated how powerful being precise can be when it comes to creating an anchor in the minds of others. However, too much precision can ward off potential buyers due to giving the illusion of inflexibility. Another key aspect of anchoring that can be used to one’s advantage is a phantom anchor. Although not officially on the table, referencing a price one ‘could’ have sold at creates a sense of a phantom anchor, pulling the buyer’s expectations in its direction, giving sellers the upper hand. Of course, as a potential buyer, being aware of these strategies is the best way to avoid getting swayed by them.