anchoring-effect

What Is The Anchoring Effect And Why It Matters In Business

The anchoring effect describes the human tendency to rely on an initial piece of information (the “anchor”) to make subsequent judgments or decisions. Price anchoring, then, is the process of establishing a price point that customers can reference when making a buying decision.

Understanding the anchoring effect

The anchoring effect is part of an entire field of study researching how the brain determines value. Dubbed neuroeconomics, the field is a mixture of economics, psychology, and neuroscience and how these disciplines play a role in human decision making.

Indeed, the anchoring effect is a powerful strategy that businesses can and do use to influence consumer behavior. 

When a price anchor is established, it gives the consumer a frame of reference for valuing the product. In a $100 pair of shoes that is discounted to $75, the original asking price of $100 is the anchor point. It allows the consumer to deduce that the shoes have been discounted by 25%. More importantly, it leads them to believe that they are receiving a good deal.

Perception

Within reason, the definition of a “cheap” or “expensive” product is open to interpretation. In other words, price is always relative and judged after comparison to similar products. Since consumers tend to desire the highest reward for the least amount of money or effort, marketers can use this to their advantage. 

For example, a cloud storage company could offer a premium plan of $1,000 per month with unlimited storage and a standard plan of $200 per month offering 750 gigabytes of storage. Most consumers will sign up for the standard plan because they don’t need unlimited storage. Because of the $1,000 price anchor, they’ll also believe they are saving $800 a month. The business, on the other hand, deliberately created the premium plan to make the standard plan look more attractive in comparison. In this scenario, it is a win-win for both parties.

The power of suggestion

Price anchoring is also effective when there are a large variety of products. With such variety, some consumers have difficulty making decisions on what to buy. Their decision anxiety is such that they might walk away from the purchase altogether. 

Businesses can use the bandwagon effect and price anchoring to relieve this anxiety. For example, a bookstore may feature a bestseller section with popular books and an anchor price of $20. Here, the anchor price provides a frame of reference for the consumer who may have only wanted to spend $15. But since many other consumers are buying books at this price, it must represent value for money. This in turn reduces decision-anxiety because the consumer assures themselves that the $20 price anchor is a good one.

A tendency to avoid extremes

As a general rule, consumers like to avoid extremes. Most will order a medium coffee in a cafe instead of a small or large one. This tendency to sit in the middle is something that businesses exploit through price anchoring. 

Consider the example of a hosting company that offers three levels of hosting – basic, premium, and professional. Here, the company effectively uses the price of the basic and professional level packages as an anchor to push consumers to the premium level. Regardless of industry, businesses that offer a complete range of products can take advantage of this tendency to avoid extremities. Instead, the consumer is directed to the product that the business wants them to purchase.

Key takeaways:

  • The anchoring effect is a basic human tendency to rely on initial information (the “anchor”) to make future decisions. Price anchoring is therefore the process of using an initial price to influence consumer purchasing decisions.
  • Businesses can use the anchoring effect to influence consumer buying behavior through exploiting cognitive biases and tendencies.
  • The anchoring effect allows businesses to direct consumers to a target product. This is achieved through perception, suggestion, and avoiding extremes.

Other business concepts

Biases

biases
The concept of cognitive biases was introduced and popularized by the work of Amos Tversky and Daniel Kahneman since 1972. Biases are seen as systematic errors and flaws that make humans deviate from the standards of rationality, thus making us inept at making good decisions under uncertainty.

Bounded Rationality

bounded-rationality
Bounded rationality is a concept attributed to Herbert Simon, an economist and political scientist interested in decision-making and how we make decisions in the real world. In fact, he believed that rather than optimizing (which was the mainstream view in the past decades) humans follow what he called satisficing.

Dunning-Kruger Effect

dunning-kruger-effect
The Dunning-Kruger effect describes a cognitive bias where people with low ability in a task overestimate their ability to perform that task well. Consumers or businesses that do not possess the requisite knowledge make bad decisions. What’s more, knowledge gaps prevent the person or business from seeing their mistakes.

Occam’s Razor

occams-razor
Occam’s Razor states that one should not increase (beyond reason) the number of entities required to explain anything. All things being equal, the simplest solution is often the best one. The principle is attributed to 14th-century English theologian William of Ockham.

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Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which target is to reach over two million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get in touch with Gennaro here