Introduction to Anchoring and Adjustment
Anchoring and adjustment is a cognitive heuristic that profoundly affects decisions. It begins when an individual relies heavily on an initial point of information, known as an anchor, and then makes adjustments based on this starting point. Unfortunately, these adjustments often remain too close to the initial anchor, especially when the anchor significantly deviates from the true value.
Key Takeaways
- Powerful Heuristic: Anchoring and adjustment is a mental shortcut where initial ideas heavily influence subsequent beliefs and decisions.
- Potential Pitfalls: When the starting anchor deviates significantly from reality, it can lead to erroneous results.
- Influencing Factors: Awareness, incentives, broad consideration of various ideas, expertise, experience, personality traits, and mood can all modify the effects of anchoring.
- Practical Applications: In business and negotiation settings, strategically using an anchor can shape outcomes in your favor.
Overcoming Anchoring Bias
Anchoring is a form of cognitive bias where individuals latch onto an initial number or value—usually the first value they encounter, such as expected prices or economic forecasts. Unlike conservatism bias, which deals with assimilating new information incrementally, anchoring skews decisions around an initial anchor. Adjustments made from this anchor can often be systematically biased if the anchor is inaccurate.
Real-World Implications
Imagine you’re shown a random number before being asked an unrelated question that requires an estimated value. Even though the random number is irrelevant, it might act as an anchor impacting your subsequent response. Anchors can be self-generated, derived from models or forecasts, or proposed by external sources.
Influence and Mitigation
Although awareness of anchoring can reduce—but not entirely eliminate—its bias, strategies like increasing expertise, approaching decisions with multiple perspectives, or incorporating diverse models can help. For example, forecasters leveraging many data sources and perspectives tend to produce more accurate predictions than those relying on a single source.
Business and Finance Applications
Strategic Negotiation Tactics
In business scenarios like sales, price, and wage negotiations, anchoring can be a formidable tool. Setting a high initial price can influence the final agreement terms more than the subsequent negotiation dynamics. For instance, a used car salesperson might initially propose a price significantly above the car’s fair value. This high anchor shapes the direction and range of negotiation, often resulting in a higher final agreed price.
Financial Models and Forecasting
In financial analysis, the output from pricing models or economic forecasting tools can become an anchor for analysts. To counteract this, diversifying the analytical approach by considering multiple models and different strands of evidence can mitigate the anchoring effect. Social psychology research by Phillip Tetlock suggests that analysts who integrate various perspectives (‘foxes’) provide more accurate forecasts compared to those fixated on a single or limited such models (‘hedgehogs’).
Related Terms: heuristic, cognitive bias, behavioral finance, forecasting, pricing model.
References
- Adrian Furnham and Hua Chu Boo. “A Literature Review of the Anchoring Effect”, Page 39. The Journal of Socio-Economics, 2011.
- Harvard Law School Program on Negotiation. “The Anchoring Effect and How it Can Impact Your Negotiation”.
- Princeton University Press. “Expert Political Judgment: How Good Is It? How Can We Know?”
