Anchoring Effect

Anchoring is a cognitive bias, when we rely too heavily on "anchor", also referred as initial piece of information offered when making decisions. Let's discuss a little about curbing your anchoring bias in pricing your product/services.

Case study

In 2008 when recession was at its peak, Microsoft offered Yahoo USD 44.6 billion in cash & stock in a friendly takeover bid. Yahoo's co-founder Jerry Yang declined the offer. He believed Steve Ballmer, CEO Microsoft could do something more better for his side, a little 10.50% extra perhaps?

Microsoft mentioned it was a friendly gesture and an amicable takeover and things can work for both organizations. Since number USD 44.6 billion was out, Yahoo "anchored" on that number and kept pestering for more. The Microsoft deal fell through. Finally in 2017, Yahoo was bought over by Verizon for just 5 billion USD,  almost 10% of Microsoft's offer.

A real life example

Say, you wanted to sell your home. Say, the property is worth USD 700k by your local guideline estimates. But you have bought the home for USD 2,000k. You go online and check for the price of properties with the same locality, same region, year of construction, floor size, carpet area & city registration.

Let's assume you had additionally spent 400k on making your property better, maintenance, patchwork, cleaning, tiles, roofing, amenities, interior decoration etc. You start hunting for a buyer and put the rate as USD 1,000k on property listings all over the area. It so happens, no one bothers calling you.

You speak to some local property agents, real estate consultants, home sellers, and they all provide you a rate which is closer to USD 550k.  Although, you spend time explaining your money spent on maintenance is steep, no one pays heed to your argument and  finally, you change your asking price for your home to USD 725k.

Yes, the hard part is selling your home. Let's assume no one bids for your home for at-least a week.  And, one fine morning, one potential buyer calls and wants to visit the property. He does a walk through and offers you cash down payment of USD 600k.

Will you take the offer or, leave it?

Dear readers, since you are not in the situation, stress of getting a sale, and comfortably just reading this piece of writing, you will obviously tend to think “I will wait and try to get a better price”. Yes?

But, In reality, the seller will haggle for another USD 5k and give away the property. One big reason – Finding a buyer is hard.

More importantly, the seller's mind was already "anchored" when property dealers gave quotes of approximate USD 550k, and believes he successfully can hustle a 55k extra. In sales, more often our buying/selling decisions are based on first piece of intelligence which may or may not be even relevant in making decisions.

Curbing the BIAS

Consider you decide to invest in metals. The first few months, you invest some money in Gold, and its prices increases by 20%. This makes you feel excited, and you start considering of booking profits by diversifying your portfolio. Excited with your recent success, you decide to invest in Silver, which has been low, and still dropping. Don't you think you'd have fallen into a trap of value buying at low, and selling at high. Yes?

Let's assume a few years later, the prices of Gold which you had sold earlier is up by another 30% and you curse yourself and stay away from it. While the prices for Silver, which you have bought continues to fall steeply and you continue holding hoping to making money.

Nobody can ascertain if Gold is good, or Silver is profitable. Since you have anchored the price of Gold and have sold it in profit, you will never buy Gold again at a higher price. In your mind Gold will always remain expensive, while you are ready to add more money in Silver as it has fallen far below your price.

Since you have chosen to invest in Gold, based on first piece of information, which could be relevant, or not relevant, in making a decision, you have "anchored" to that first price. So, you value anything as profit only beyond that initial success.

That sometimes is a mental boundary. You curb all possibilities of improvement and self-direction. But, you really don't know if you could have done better for the next stock - Silver.  It’s natural as you believe your wisdom, but when prices of Silver continue to fall, your self-doubt increases. It questions your intelligence, and quant.

In other words, its high time you must curb your anchoring bias, and not be a victim of bad pricing. Making a mistake in pricing your products, could be really disastrous for your business, and could impact your returning clients in the long run. Many companies, after tasting their initial success, soon bump up their subscription fees.

Avoid steep pricing at all costs. It brings a bad precedence, and causes excessive reputation issues to the people who refer, and endorse the brand for you. Your sales team will obviously be under excessive pressure when you roll-back your offers, or increase you product pricing.

Keep hustling folks.