Because it can be applied to both pricing and negotiations, the anchoring bias has the potential to boost your company’s revenue and help you cut costs. Identify how anchoring works and you’ll be better positioned to charge more for your product or service, while paying less for your business expenses.
How Anchoring Works
Behavioral finance examines the way emotions and other psychological factors influence our monetary choices. It’s most often applied to understanding how people arrive at their investment decisions, but the same influences – including the anchoring bias – are responsible for the way we evaluate most pricing as consumers and entrepreneurs.
Anchoring is essentially what happens when we rely too heavily on a historical value or preliminary piece of information (one that’s often irrelevant) to help make a decision or judgement.
Any time you need to decide whether a price is reasonable for example, and therefore represents good value in your eyes, your subconscious roots around for some way to make that analysis easier. In many cases, the psychological benchmark it relies on is the first pricing data it's exposed to.
Anchoring is usually at work when someone goes to buy a used car and discovers a sticker price of $15,000. They may have left home knowing they could get a decent vehicle for a lot less, but talking the sales person down from $15,000 to $13,000 makes them feel like they got a great deal.
We’re all susceptible to the effects of anchoring, though we’re often unaware that it’s happening. And even when the existence of an anchor is pointed out to us, we can still have trouble ignoring the first impression it creates when deciding whether something is worth the price being asked.
Using Anchoring Techniques in Your Business
So how can understanding the anchoring bias help your business maximize prices and minimize costs? Anchors make it easier for people to deal with uncertainty and complexity in a world bursting with information. As a result, your customers use them to make purchase decisions. And you can use them to seek better rates from your suppliers or service providers.
Let’s take a look at how anchoring can help make your business more profitable.
Boost Your Revenue
Sales drive your revenue. So it only stands to reason that the more you can charge for your product or service – while remaining competitive, of course – the more income you’ll earn. There are many pricing strategies you can and should take advantage of as a business owner, but anchoring is one of the most effective.
We know that historical values serve as common anchor points when it comes to our purchasing decisions. That’s what makes discounts, flash sales, and other price-reduction offers so effective.
When a customer is presented with the “sale” price for a product or service, along with the original or “regular” rate, they tend to think more favorably about buying that item – even if the new price is still more than they would normally have been willing to pay.
Anchoring can also be used to encourage sales where higher-priced alternatives are offered to customers first. Introducing a more economical version of your product or service after the costlier option – especially one that’s equal in quality - immediately increases its purchase appeal by virtue of simple comparison.
Cut Your Costs
Many of the costs associated with running a business are tied to fees that frequently offer some wiggle room. If you can negotiate lower rates for services, supplies – even the interest on your loans – it will help reduce your monthly expenses.
Like historical values, we know that the pricing information we’re first introduced to in certain situations can act as an anchor. So any time you enter into negotiations with a supplier, financial institution, or service provider, it’s important that you go in prepared.
Setting the base or anchor price in a negotiation by making the first offer can give you a distinct advantage. If, for example, you’re hoping to pay someone $40 an hour to clean your office - and they’re hoping for something closer to $75 an hour – offering $30 an hour in your initial discussion will give you a better chance of getting the rate you want.
Because, according to Harvard Law School’s Program on Negotiation, extending a lower offer upfront reduces the other person’s expectation that they’ll be able to reach an agreement skewed in their favor. This essentially leaves them more open to the idea of accepting a lower rate.
Naturally, using this kind of strategy successfully hinges on the person you’re negotiating with having less of a working knowledge about anchoring than you do. But as a basic bargaining tactic, it’s well worth exploring for the potential it holds to reduce your business expenses.
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