Anchoring and adjustment

William Poundstone writing in his book Priceless:

Daniel Kahneman and Amos Tversky “used one piece of apparatus, a carnival-style wheel of fortune marked with numbers up to 100. A group of university students watched as the wheel was spun to select a random number. You can play along – imagine that the wheel is spinning right now and the number is… 65. Now answer this two-part question:

(a) Is the percentage of African nations in the United Nations higher or lower than 65 (the number that just came up on the wheel)?

(b) What is the percentage of African nations in the United Nations?

Like many experiments, and some wheels of fortune, this one was rigged. The wheel was designed to produce one of only two numbers, 10 and 65. This rigging was done only to simplify analysis of the results. In any event, Tversky and Kahneman found that the allegedly random number affected the answers to the second question. The effect was huge.

When the wheel stopped on 10, the average estimates of the proportion of African nations in the UN was 25 percent. But when the wheel of fortune number was 65, the average guess was 45 percent. The latter estimate was almost twice the first. The only difference was that the estimates had been exposed to a different ‘random’ number that they knew to be meaningless.

Tversky and Kahneman used the term ‘anchoring and adjustment’ for this. In there now classic 1974 Science article, ‘Judgement Under Uncertainty: Heuristics and Biases,’ they theorised that an initial value (the ‘anchor’) serves as a mental benchmark or starting point for estimating an unknown quantity. Here, the wheel of fortune number was the anchor. The first part of the question that the subjects compare the anchor to the quantity to be estimated. Tversky believed that the subject then mentally adjusted the anchor upward or downward to arrive at their answers to the second part of the question. This adjustment was usually inadequate. The answer ended up being closer to the anchor than it should be. To someone inspecting only the final outcomes, it’s as if the anchor exerts a magnetic attraction, pulling estimates closer to itself.

By the way, how did your answer compare to the 65-group’s average of 45 percent? In case you’re wondering, the correct fraction of African UN member nations is currently 23 percent.”

Nassim Nicholas Taleb summarises this experiment and provides some further examples in his book The Black Swan:

“Kahneman and Tversky had their subjects spin a wheel of fortune. The subjects first looked at the number on the wheel, which they knew was random, then they were asked to estimate the number of African countries in the United Nations. Those who had a low number on the wheel estimated a low number of African nations; those with a high number produced a high estimate.

Similarly, ask someone to provide you with the last four digits of his Social Security number. Then ask him to estimate the number of dentists in Manhattan. You will find that by making him aware of the four digit number, you will ellicit an estimate that is correlated with it.

We use reference points in our heads … and start building beliefs around them because less mental effort is needed to compare them with to a reference point than to evaluate it in the absolute.”

Extreme aversion

William Poundstone writing in his book Priceless:

“Extending the work of Huber and Puto, A 1992 the paper by [Amos] Tversky and Itamar Simonson laid down two commandments of manipulative retail. One is extreme aversion. They showed through surveys (involving Minolta cameras, Cross pens, microwave ovens, tyres, computers, and kitchen roll) that when consumers are uncertain, they shy away from the most expensive item offered or the least expensive; the highest quality or the lowest quality; the biggest or the smallest. Most favour something in the middle. Ergo, the way to sell a lot of £500 shoes is to display some £800 shoes next to them.”

Products that don’t sell effect those that do.

Priming

William Poundstone writing in his book Priceless:

“‘Priming’ is a fairly new term for phenomena that have long been part of the world’s store of knowledge, not necessarily of the scientific kind. Have you ever bought a car and suddenly noticed that ‘everyone’ on the motorway, practically, is driving that model? Have you ever learned a new word (or heard of an obscure sea mammal or an ethnic dance) and then encountered it several times in the space of a few days? You come across it in the news, you overhear it mentioned on the bus and on the radio, and the old issue of National Geographic your summing through falls open to an article on it…

This is priming (fortified with a few low-grade coincidences). When you skim the newspaper, half-listen to TV, or drive on the motorway, you ignore most of what’s going on around you. Only a few things command attention. Paradoxically, it is unconscious processes that choose which stimuli to pass on to full consciousness. Prior exposure to something (priming) lowers the threshold of attention, so that that something is more likely to be noticed. The upshot is that you have probably encountered your ‘new’ word or car many times before. It’s just that now you’re noticing.”

Availability heuristic

From Priceless by American author, columnist and skeptic William Poundstone:

“Which is more common, words that begin with r (like ‘road’) or words with r as the third letter (like ‘car’)? Most say that words beginning with r are more common. It’s easy to rattle of words beginning with r; harder and slower to free-associate words with r in third place. This is an example of the availability heuristic, and here it leads us astray. Words with r in third place happened to be more common. But because words beginning with r on more mentally available, we overrate how common they are.

A familiar example of availability is the way we all assume that the tastes, politics, education level, and TV viewing habits of our social set are widely shared. We marvel when such-a-such a program is a success or so-and-so gets elected. ‘Nobody would vote for that idiot!’ Well, they did.

Another example: every year, thousands of children aspire to become a professional footballer, despite long odds and near-certain disappointment. Why is that? It’s easy to list names of footballers who beat the odds and became rich and famous. Now try to name some players who tried out for the Premier League and never made it. Can you name any? Hmm, maybe the odds aren’t so bad after all…”

I think that the end of this first paragraph is key: we overate that which is mentally available.

Law of large numbers

From Priceless by American author, columnist and skeptic William Poundstone:

“This says that flipping a fair coin a large number of times will give you a percentage of heads close to 50. That is all you can ask of a fair coin. You can’t predict the outcome of a small number of tosses. However, Tversky and Kahneman noted, people want to believe just that they suppose that’s flipping a coin 10 times will yield five heads and five tales, or something close to it. In reality, lopsided outcomes (like eight heads and two tails) are more common than people believe. Tversky and Kahneman Survey aid some mathematical psychologists at a meeting and found that even the experts were subject to this error. The article’s most memorable line displays a playful with it rarely encountered in scientific papers: ‘peoples intuitions about random sampling appear to satisfy the law of small numbers, which asserts that the law of large numbers applies to small numbers as well.”

Put simply, the more times an experiment is run, the closer the average result will be to the expected value.

Coherent arbitrariness

From Priceless, a book studying the hidden psychology of value, by William Poundstone (pictured):

“Skippy peanut butter recently redesigned its plastic jar. “The jar used to have a smooth bottom,” explained Frank Luby, a price consultant with Simon-Kucher & Partners in Cambridge, Massachusetts. “It now has an indentation, which takes a couple of ounces of peanut butter out of the product.” The old jar contained 18 ounces; the new has 16.3. The reason, of course, is so that Skippy can charge the same price.

That dimple at the bottom of the peanut butter jar has much to do with a new theory of pricing, one known in psychology literature as coherent arbitrariness. This says that consumers really don’t know what anything should cost. They wander the supermarket aisle in a half conscious daze, judging prices from cues, helpful and otherwise. Coherent arbitrariness is above all a theory of relativity. Buyers are mainly sensitive to relative differences, not absolute prices. The new Skippy jar essentially amounts to a 10 per cent increase in the price of peanut butter. Had they just raised the price 10 per cent (to $3.39, say), shoppers would have noticed and some would have changed brands. According to the theory, the same shopper would be perfectly happy to pay $3.39 for Skippy, just as long as she doesn’t know there’s been an increase.”

Asch Conformity Experiments

In the 1950s, the psychologist Solomon Asch conducted a series of experiments studying if and how individuals yield to or defy the beliefs and opinions of a majority group.

Tim Harford outlines this experiment in his book, ‘Adapt, Why Success Always Starts with Failure’.

“The classic Asch experiment sat several young men around a table and showed them a pair of cards, one with a single line, and one with three lines of obviously different lengths, labelled A, B and C. The experiment asked subjects to say which of the three lines was the same length as the single line on the other card. This was a trivially easy task., but there was a twist: all but one of the people sitting around the table were actors recruited by Asch. As they went around the table, each one called out the same answer – a wrong answer. By the time Asch turned to the real experimental subject, the poor man would be baffled. Frequently, he would fall in with the group, and later interviews revealed that this was often because he genuinely believed his eyes were deceiving him. As few as three actors were enough to create this effect.”

 

William Poundstone offers some more precise findings in his book Priceless:

“Overall, subjects gave a wrong answer 32 per cent of the time. Seventy-four per cent gave the wrong answer at least once, and a sizeable minority caved in to peer pressure three-quarters of the time. That’s amazing when you consider how simple the exercise was. In a control group, without accomplices, virtually everyone gave the right answer all the time.”

A further experiment, however, sheds light on how this peer pressure can be released. Harford continues:

“Less famous but just as important is Asch’s follow-up experiment, in which one of the actors gave a different answer from the rest. Immediately, the pressure to conform was released. Experimental subjects who gave the wrong answer when outnumbered ten to one happily dissented and gave the right answer when outnumbered nine to two. Remarkably, it didn’t even matter if the fellow dissenter gave the right answer himself. As long as the answer was different from the group, that was sufficient to free Asch’s poor subjects from their socially imposed cognitive straight jackets.”

The experiment shows that people often feel a pressure to conform to the wider group, even when the majority is clearly misguided,

It is not difficult to see how an environment devoid of opposition views can create an echo chamber of escalating and self-reinforcing beliefs.

Just one opinion that opposes the majority view is enough to release the peer pressure. One dissenting opinion seems to give others the permission to table their true beliefs.

The experiment teaches us to encourage dissenting views. Even if they are misguided. Dissenting views create an environment in which others are more comfortable in being forthcoming with their own ideas.

Loss aversion

In Priceless, a book studying the hidden psychology of value, William Poundstone provides a concise definition of loss aversion:

“Losing money (anything of value) hurts more than gaining that same thing delights.”

In ‘Decoded‘, the marketer Phil Barden provides a similarly eloquent definition:

“We dislike loses more than we like gains of an equivalent amount.”

Poundstone goes on to illustrate how much more we dislike losses:

“You can demonstrate loss of version by offering a bet on a coin toss. Tales you lose £100, and heads you win X. How big does X have to be for you to take the bet?

Surveys show that few want to accept a ‘fair’ bet, that’s with X = £100. Few accept X = £110, which offers a nice expected profit. (Those who do accept at this price tend to be gamblers, arbitrageurs, or economists.) The average person requires roughly a £200 price to balance the prospect of an equally probable £100 loss.”

Barden then goes on to take a closer look at loss aversion’s relevance to marketing.

In order to encourage people to buy a product we often communicate a call to action, in which it is common to focus on telling consumers how much they can save. As this reduces the perceived pain, it works. However, the ‘how’ of the saving makes a difference. An energy company in the US found that when they communicated to their customers that switching to energy-saving mode would save (and therefore they would gain) $200 a year, it had very low take-up. However, when they changed the message to show that by not switching to energy-saving mode they would lose $200, there was an extremely positive response. The mechanism behind that is loss aversion.

Furthermore:

Loss aversion is one major barrier for people when it comes to switching brands or adopting innovations: the risk of losing something we value can be exceeded only by offering twice the value. We sometimes come across this in focus groups. Consumers talk positively about a new product or service, but when asked whether they want to exchange the product they currently use for the new one, they suddenly start to reject the new one in favor of what they have. Very often the point is not to get across the best possible value but to avoid the threat of incurring a loss or being disappointed.”

So, people place a higher value on a good that they own than on an identical good that they do not own.

If you’re mathematically minded, we can graph the value that Barden and Poundstone brought to life. It seems, if we receive ‘x’ in gains we experience ‘y’ of pleasure. That’s the blue rectangle below. However, if we lose ‘x’ we experience ‘2y’ of pain. That’s the grey rectangle below.

02 LossAversion