Three years ago, I bought myself a PlayStation Portable (PSP) at Sim Lim Square. Prior to the actual buy, I compared the prices at more than five different outlets and realized that they were all selling it at $290. With the assurance that they had done away with the price war that was prevalent years before, I decided to buy it from the very first shop I had gone to.
As I was about to purchase the PSP, the owner of the store started pushing some add-ons to me: first a memory card, then a protective case, and finally a pair of earphones. For some reason unbeknownst to me then, I barely hesitated. Before I realized it, I was $550 down. I had spent almost twice of what I had intended. Two months later, I found out from my friends that I had been cheated. The owner had charged me three times the market prices for both the case and the earphones.
How is it that I allowed myself to be cheated so spectacularly? How could I have paid so little attention to the prices? Those add-ons did not come cheap. If I had given more consideration to their prices, I might very well have realized that they were grossly inflated. More importantly, why did I buy the add-ons when, on a separate day, I would never have considered them at those prices?
In 1974, Tversky and Kahneman presented the anchoring and adjustment heuristic to account for how people estimate quantities. In the classic study, participants were asked to estimate the percentage of African countries that belonged to the UN. Before making their estimates, half of the participants were asked if it was more or less than 10% (an anchor), while the other half were asked if it was more or less than 65%. Those that were presented with the lower anchor of 10% reported significantly lower estimates (25% on average) than those presented with the higher anchor of 65% (65% on average). Ariely, Loewenstein, and Prelec (2003) carried out a similar experiment in which participants were allowed to bid for items in an auction, but only after writing down their Social Security numbers and asked if they would pay an amount equal to it for the items. Those who had higher Social Security numbers ended up bidding significantly more for the items. These experiments showed that arbitrarily selected anchors could in fact skew the subjects’ judgment considerably.
This was the same anchoring and adjustment heuristic I unconsciously used and fell prey to: I was fixated on the irrelevant price of the PSP (which served as the anchor), and adjusted downward to decide what would have been a reasonable price to pay for the add-ons. However, I failed to adjust downward sufficiently from the high anchor, resulting in a much higher willingness to pay than usual. Since the add-ons were cheaper than the maximum I was willing to pay, they appeared like a bargain to me and I went ahead with the purchases. The result? I ended up paying much more than I really should have. The anchoring and adjustment heuristic led me to think of the values of the add-ons in relative terms; I determined my willingness to pay for them based solely on the price of the PSP.
Having explored the cognitive underpinnings of my irrational behavior, what can we do to avoid making the same mistake? I have found two strategies to be particularly useful. The first is to be constantly aware of the anchoring and adjustment heuristic in daily situations. As with most cognitive heuristics, we often use it without being aware of it. Suppose you are having dinner at a posh restaurant. You aren’t feeling too hungry, so you decide that a beefsteak is just enough for you. You place your order, and the waiter says to you, “ would you like to add on the soup of the day for just three dollars?” Would you? Most people would, since $3 for soup isn’t much compared to $30 for beefsteak. But as you struggle to finish your steak, you catch yourself wondering if this was really a good decision. If we can recognize the prevalence of this cognitive bias in our everyday transactions, we can overcome this temporally heightened willingness to pay and avoid buying what we don’t really need. In my case, I would have paid more attention to the intrinsic worth of the add-ons, instead of simply anchoring on the price of the PSP.
The second strategy requires us to ask ourselves two questions before we commit ourselves to an add-on. First, would the utility you derive from your purchase be at least equal to what you pay for? If so, it may be a good buy. The second and overriding question is, would you be able to better spend that money elsewhere? If so, then it would be a bad buy.Adopting a broad perspective by considering alternative uses of the money serves as an excellent reminder of what we are giving up when we purchase an add-on, and thus forces us to assess it for what it is really worth.
1] The opportunity cost of the add-on is a better decision criterion. An add-on may still be a bad buy if it passes the first test but not the second.