It happens pretty much every time I go to a restaurant with my daughter. I open the menu and scan the options. Then I take a look at the children’s menu. Often the menu is quite similar, with the same pasta and tomato sauce. But the dishes from the children’s menu are generally cheaper, and I say to myself: Wow, good deal.
If I think about it for a moment, however, the deal isn’t really a deal. After all, I estimated the cost of the pasta based on the adult menu, not the actual cost of making butterfly noodles and serving them with a red-tinted sauce.
My faulty reasoning is the product of anchoring, a cognitive bias that can undermine our critical thinking. According to the researchers, anchoring occurs when people rely on irrelevant but readily available facts to make judgments. Our minds place too much weight on initial impressions or numbers that influence our later thoughts. In my case, adult menu prices shaped – or anchored – my judgment of the value of children’s menu dishes.
In the 1970s, psychologists Amos Tversky and Daniel Kahneman showed the power of the anchoring effect. In a landmark study, researchers found that spinning a wheel of fortune in front of participants and anchoring them with random numbers influenced their answers to simple questions, such as “what percentage of UN countries are in Africa?”
Studies show that anchoring effects persist, regardless of how weak the connection between anchoring and the actual decision. One study found that “an athlete’s performance ratings were influenced by the number on their jersey.” In other words, people believed that an athlete with a higher jersey number was better than an athlete with a lower number, all else being equal.
Anchoring affects all kinds of decisions, even those made by experts who should know more. In particular, recent research shows that pegging is much more prevalent in the financial world than previously thought, with substantial pegging effects influencing stock market performance. Led by a team from Ghent University, the study showed that investors valued companies more if the companies had higher stock prices. This happened even after controlling for factors such as the number of shares available and other corporate governance issues.
So, if two companies have the same financial profile, except that company X has fewer shares at a higher price than company Y, then the shares of company X will sell better in the long run than those of company Y. . Why? Because the stock price – the anchor – improves the perceived value of the company.
While anchoring can lead to serious and costly mistakes, there are also ways to use bias to your advantage. Here are three strategies that can help ensure that your thinking is clear and grounded, but not grounded.
Don’t let the anchors drag you down
The anchor is everywhere in the retail world. It’s a way of making customers feel like they’re getting a good deal. One of my favorites is the big box stores that offer huge “discounts” on grossly inflated “original” prices that have little to do with the actual value of the item.
So, for example, I’ll see an “originally” budget sofa priced at $800 that was discounted to $200 to make the sofa seem like a bargain. Companies often perform such “markdowns,” even if there’s no reason the sofa was sold for $800 in the first place.
There are ways to get out of the anchor. The first step is to clarify the data. When we are clearer about the evidence, we are less likely to be deceived. When it comes to a big decision, for example, I often write down all the factors involved. Recording information helps me assess its reliability and eliminate anchor points that are not relevant.
Talking about decisions can serve the same purpose. I find that when I seek advice from my friends and peers and force myself to be explicit about my reasoning, it can help expose an anchor.
The key questions to answer are: What information am I using to make this decision or judgment? Is it accurate and relevant? Am I correctly weighing its importance?
If you find that you lack strong evidence, that’s a sign that you may be engaging in grounding. It’s also a sign that you need to do more research, which brings us to our next takeaway.
Do your research to escape prejudice
I have already consulted Shark, a French company that creates high-end motorcycle helmets. The company was considering whether or not to move its production line from Portugal to Thailand. At first glance, it looked like the move would make good business sense. After all, production costs are generally lower in Thailand.
But my team realized that there was an anchoring problem. Shark’s team had factored in the cost of producing a standardized helmet, but the company’s product offering was generally custom helmets. In other words, the Shark team had relied on the cost of producing a type of helmet rather than the cost of customizing each helmet.
So we called in a group with stopwatches to determine the exact production cost of the different categories of helmets. The results showed that it was better to keep more than 70% of the production in Portugal.
Anchoring to the beat of what happened at Shark is always the result of misinformation or misinformation. Too often, the human brain becomes fixated on outdated or irrelevant information and fails to see things clearly.
That’s why, for budgets, I often recommend zero-based budgeting, which forces companies to assess costs with a fresh eye. Under a zero-based budget process, the company must clear previous budgets and re-justify all recurring expenses. This process forces companies to leave their anchors and thus find new opportunities for savings and growth. This is particularly relevant with current supply chain issues and inflation.
It’s not always possible to get outside help, but you can always do more research. If you think a number or piece of information may be an anchor, try to refute or confirm it by researching other sources. Collect the opinions of colleagues who have not yet been exposed to the anchor. Interview experts who can inform you about the relevance or lack of relevance of the anchor.
Use anchors to your advantage
My friend Alex Clavel, head of corporate strategy at Softbank, recognizes the value of anchoring in negotiations. He encourages his team “to use the anchor proactively to convince other parties at the negotiating table that somehow our ‘anchor’ should be the basis of the talks. If successful, this type of anchoring can “keep the discussion on your terms as much as possible,” making a favorable outcome more likely.
Conversely, it is vital to resist this type of anchor when the other side tries to deploy it. Alex tells me that he recently worked to remove the anchor of a counterparty whose business valuation had declined due to due diligence issues. The counterparty has always insisted on referring to the initial valuation of $500 million during negotiations. But Alex reminded them that the figure was no longer relevant and could no longer be used as a basis for negotiations.
Likewise, I will sometimes use anchors to swing a negotiation in my favor. For example, during a negotiation session, I can start by talking about a part of the contract that has already been settled in favor of my opponents. With this “victory” in mind, my opponents may be more willing to make concessions once we move on to outstanding issues. As Cecile Ferrie-Davies, Managing Director of Pimco, argues, “anchoring can more often influence the context of a transaction than specific analysis.”
In the end, the anchoring phenomenon shows that if we think of ourselves as rational and logical beings, extraneous details can have a disproportionate influence on our reasoning. The best solution is a mixture of vigilance and humility and improving critical thinking skills. Otherwise, you could fall victim to an anchor, being dragged down through you whether you notice it or not.