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EDITORIAL
Identifying and Avoiding a Common Decision Trap
By Ira Smolowitz, Ph.D.
__________________________________________________________________________
For the typical supermarket shopper a reduction in the price of
an item from $3.94 to $3.93 has virtually no impact. However, a
penny reduction from $2.00 to $1.99 has a disproportionate impact.
The typical consumer focuses disproportionately on the first digit
of the new price vs. the first digit of the old price. As a consequence,
the penny reduction from $2.00 to $1.99 will trigger a favorable
reaction from the consumer. Psychologists call this decision behavior
- anchoring.
Consider the following anchoring trap. "The average home business
has a 75% chance of success. What do you estimate as your chance
of success? What if I had told you the average home business has
a 25% chance of success? Does your estimate change?" 1
The pioneering work in behavioral finance was conducted by the Nobel
Laureates Daniel Kahneman and Amos Tversky.
Kahneman and Tversky contended that people frequently
form estimates by starting with a given, easily available reference
value - which could be arbitrary - and adjusting from that value.
An estimate, therefore, would be "anchored" to that value. (Think
of auto salespeople starting negotiations at the manufacturer's
suggested retail price.)
To demonstrate this heuristic, Dan Ariely, professor of management
science at MIT Sloan School of Management, conducted a mock auction
with his MBA students. He asked students to write down the last
two digits of their Social Security numbers, and then submit bids
on such item as bottles of wine and chocolate. The half of the
group with higher two-digit numbers bid "between 60 percent and
120 percent more" on the items, says Ariely. 2
Here is another example of the anchoring trap as demonstrated by
Hammond, Keeney and Raiffa:
How would you answer these two questions?
Is the population of Turkey greater than 35 million?
What's your best estimate of Turkey's population? If you're like
most people, the figure of 35 million cited in the first question
(a figure we chose arbitrarily) influenced your answer to the
second question. Over the years, we've posed those questions to
many groups of people. In half the cases, we used 35 million in
the first question; in the other half, we used 100 million. Without
fail, the answers to the second question increase by many millions
when the larger figure is used in the first question. This simple
test illustrates the common and often pernicious mental phenomenon
known as anchoring. When considering a decision, the mind gives
disproportionate weight to the first information it receives.
Initial impressions, estimates, or data anchor subsequent thoughts
and judgments. Anchors take many guises. They can be as simple
and seemingly innocuous as a comment offered by a colleague or
a statistic appearing in the morning newspaper. They can be as
insidious as a stereotype about a person's skin color, accent,
or dress. In business, one of the most common types of anchors
is a past event or trend. A marketer attempting to project the
sales of a product for the coming year often begins by looking
at the sales volumes for past years. The old numbers become anchors,
which the forecaster then adjusts based on other factors. This
approach, while it may lead to a reasonably accurate estimate,
tends to give too much weight to past events and not enough weight
to other factors. In situations characterized by rapid changes
in the marketplace, historical anchors can lead to poor forecasts
and, in turn, misguided choices. 3
The authors of the above article indicate that to avoid the anchoring
trap, the decision maker should: "pursue other lines of thought
in addition to your first one." "Seek information from a variety
of people and sources after thinking through the problem on your
own. 4.
In the fast-paced, 24/7 work-place, anchoring, it seems to me, will
become a more pervasive problem. It is a problem that decision makers
must vigilantly strive to avoid. To conclude with a pun - in nautical
terms it's 'anchors aweigh', in decision making it's 'anchors away'.
References
1. Merriman, K.K. "Better Business Through Better Judgment" Home
Business Journal published January 05, 2006 - downloaded 5/3/2006
from www.homebizjour.com/articles p. 1.
2. Teach, Edward "Avoiding Decision Traps" CFO Magazine, June 01,
2004 - downloaded 5/4/2006 from www.cfo.com/printable/article.cfm
p. 1.
3. Hammond, John S., Keeney, Ralph L. and Raifa, Howard "The Hidden
Traps In Decision Making" Harvard Business Review, January 2006,
p. 120.
4. Downloaded from Harvard Business Review, On Point, May, 2006,
p. 1.
_________________________________________________________________________________
Articles printed with the permission of Dr. Ira Smolowitz,
Professor of Finance and Dean, Bureau of Business Research and Program
Development at American International College, Springfield, MA.
_________________________________________________________________________________
Page updated: May 21, 2007 7:53 AM |
All
contents © 2007. All rights reserved.