Assume you are at a store looking at an item, and the salesman comes over and tells you it is a great deal, do you believe him?
The answer may astonish you.
Basic economic theory informs us that prices are set by a persons willingness to pay. But, what is behind a persons willingness to pay? Are there factors that influence perception of value? How does someone know how much they should pay for something?
The power of anchoring
The fact is, there are invisible forces at work in establishing what people think is a “good price.” And the funny thing is that these perceptions on “good price” can be relatively arbitrary.
Jack and Jill have been dating for two years. Every week, at the same time, they sit down together in front of their 30″ television to watch The Walking Dead. They value this time together. As their anniversary approaches, both of them want to do something special for the other.
Jack decides to go out to the store and buy a top-of-the-line large flatscreen for Jill. He knows nothing about television prices; he only knows that he wants something that would bring The Walking Dead to life. This could only make Jill happy, right? He goes to the store to look at televisions and finds a 60″ that would fit perfectly in their living room. The price tag reads $2499; however, it is on sale for $999. Jack is psyched and buys the television because he feels he is getting a deal he can’t pass up.
Unbeknownst to Jack, Jill also goes out to buy a large flatscreen for Jack. She reasons that it will make their time together even better. More importantly, she knows that Jack has wanted a new television for awhile. She knows nothing about television prices. She goes to a different store and looks at the exact same 60″ model that Jack looked at. She sees the price tag of $2499. However, in her store, the television is not for sale. As she is getting ready to leave, a salesman approaches and tells her he will take 20% off if she leaves with the television today. She pays the the $1999 because she feels she got a great deal.
What gives? How can Jack and Jill both feel they got a great deal, despite the fact that they spent dramatically different amounts? How can they both feel great about their purchases? How would they feel if they shared the amounts they spent with each other?
The answer lies in what behavioral economists and cognitive psychologists call an anchor. Since Jack and Jill both entered the sales process without expectation on price, they needed a reference or starting point. Some sort of cue to help them evaluate the item or price in context.
Both Jack and Jill were given the original price of the television – $2499. That became the anchor. It became the reference point that guided all other decisions about the purchase.
It is why Jack and Jill both thought they were getting a great deal, despite the deals being dramatically different.
How does anchoring work?
By definition, anchoring is a heuristic where initial exposure to a number serves as a reference point. This number then influences later judgments about value. Simply stated, once an anchor is set, other judgments are made in reference to the anchor.
In 1974, behavioral economists Amos Tversky and Daniel Kahneman conducted a study. They asked a group of people to estimate how many African countries were part of the United Nations. Before they began, the research participants had to spin a “wheel of fortune” with numbers from 0 to 100. As part of the experiment, the wheel was rigged to always land on 10 or 65.
When the wheel stopped spinning, the researcher asked the test subject if they believed the percentage of countries was higher or lower than the number on the wheel. Next, they asked people to estimate what they thought was the actual percentage.
They that found people who landed on 10 in the first half of the experiment guessed around 25 percent of Africa was part of the U.N. Those who landed on 65 said around 45 percent.
The subjects answers to the question were informed by the anchor, i.e. the number from the wheel.
People like a point of reference and comparison; anchors provide that. Also, the value people place on items is dynamic and dictated by perception. This perception is guided by anchors. So perception of value is set by the very people selling you the goods and services.
In the end, merchants are telling you that you are getting a good deal… and you believe them.