Why irrelevant facts and numbers can affect your judgement
By Narayan Sharalaya
The anchoring effect is a cognitive bias that describes the human tendency to rely too heavily on the first piece of information they receive (anchor) while making judgements. This can happen even if the anchor provided has little or no relevance in the decision making process. A classic example of this is a study where people were divided into two groups and asked the following questions:
|Group 1||Group 2|
The results of the study showed that the participants in Group 1 tended to give a mean age of 80 years as compared to 50 years by the participants in group 2. The first question acted as a suggestion towards describing Gandhi’s age. While no one really believed that he had lived for 144 years, or less than 9, the associative memory produced a picture of an ancient man or a young man based on the question they got.
Anchoring effects are not unknown and are used by salesmen and marketeers all the time. Flipkart came under the spotlight last October when it was found that it had jacked up the prices of all its products leading up to its big billion day sale.The increased price acted as an anchor price making the discount look bigger.
The use of anchoring is not limited to retail businesses only. Anchoring and framing also affect how objectively we look at news presented to us.
The above headline comes in the wake of the recent ban on Maggi by regulators. By using an anchor of Rs 445 crore, the article looks to show the lack of quality testing by Nestle on its food products. But, judging the adequacy of spending on quality testing by comparing it to advertisement expenditure is a clear case of a cognitive bias. Testing expenditure is an outcome of factors like shelf life, research costs, equipment costs, etc. while advertisement expenses are dependent on market size, differences, competition and so on. To compare the two is akin to comparing apples and oranges. The article even mentions later on that this spending was consistent with the other noodle brands.
Anchors are also a useful tool during the negotiation process. Sellers are often advised to move first during a negotiation. When the seller opens negotiations, he subtly manages to decide the price by using the anchoring effect. Even if the seller receives a lower amount than his offer, he still receives an amount close to his asking price.
Anchoring Effects on Financial Markets
Recent studies on behavioural finance show a strong tendency of anchoring effect by analysts and experts. The anchors used by investors fall into quantitative and psychological anchors. Quantitative anchors lie in the form of past prices, industry averages and indexes or price earning ratios of other companies. Psychological anchors take the form of stories or antecedents that influence stock prices. It is often found that those who sell stocks to the public often use vivid stories about the history of the company, nature of the product and its demand rather than relevant statistical data about the stock. These serve as moral anchors to the public and decide the share prices.
Resisting the Anchoring Effect
Anchors serve as a useful tool to decision making in many cases where information is not easily available and decisions are hard to arrive at. The problem arises when the anchor used has little or no implication towards the decision being made. Successfully avoiding anchoring bias requires the identification of the anchors or situations where anchoring bias could prevail. People are less likely to be influenced by an anchor when making a decision if they have knowledge of it. However, recognising anchors requires an impressive amount of intelligence and self-awareness; the problem with anchoring is that it is like an invisible phenomenon that operates outside our consciousness. Resisting the anchoring bias is an exceedingly hard task because the anchors we use are often subtle and random cues from the environment.
Narayan Sharalaya is an intern at Takshashila Institution and is currently doing his Bachelors in Economics at NMIMS, Mumbai.