Absolute or Relative

As humans, we’re not good at absolutes.  We can’t look at a colour and tell the exact hue.  We can’t life a bag and say exactly how heavy it is.  We can’t hear a sound and tell how loud it is. Our brains are just not programmed to allow us to do that. We are experts at comparisons though.  We can see two colours and say which is the most red.  We can lift two bags and say easily which is the heaviest.  We can hear two sounds and immediately we know which is louder. We love to compare.  The same is true with pricing.  We can’t see something and immediately know what it’s worth.  We can tell if something is worth more or less to us than something else, but not in absolute terms.  Sometimes we can gauge value by remembering what we paid before, but that’s just remembering. I have been helping bookkeepers with pricing for years now, and I’m truly fascinated by it.  I’m amazed how much we all feel that we are able to assign values to things and then something else is thrown into the mix and we can.  Most of the time we don’t realise that these seemingly unrelated items are manipulating our thoughts in the way they are, As an example, how much impact could a random number have on our understanding of value?  Not much you would think, but you’d be wrong. Tversky and Kahneman are legendary Israeli American psychologists.  They specialised in Behavioural Decision Theory, or how we make decisions. In an experiment they took a group of students and a carnival wheel of fortune.  The wheel was spun to a seemingly random number and the students asked:

1. Is the percentage of African nations in the United Nations higher or lower than the number on the wheel?
2. What is the percentage of African nations in the United Nations?

The wheel was rigged.  The wheel only randomly stopped on 10 or 65 for ease of analysis.  When it stopped on 10, the average estimate of the percentage of African nations in the UN was 25%, and when it stopped on 65 it was 45%.  The only difference was that the students were exposed to different random numbers. Numbers they knew to be meaningless. One year ago, I carried out a similar experiment on bookkeepers.  They were asked:

1. What are the last two digits on your national insurance number?
2. Would you pay that amount for a bottle of wine?
3. What is the most you would pay for a bottle of wine?

Those with NI numbers ending in the range from 10-40 were prepared to pay on average £10.41, while those with an NI number ending in the range 71-99 would pay on average £25.12.  More than twice the amount. If we can anchor prices to random numbers, how easy would it be to anchor prices to other prices of similar products.  This week I carried out another short experiment. Everyone was shown a wireless HP mouse with a very short description.  One half of participants were shown this next to a similar mouse priced at £16.17. The second group were shown it next to a similar mouse costing £78.32. I asked everyone what they would be willing to pay for the HP mouse.  Would the price of the item that it was sitting next to impact on the amount they were willing to pay.  Unsurprisingly, it did. The group shown the cheaper mouse were prepared to pay an average of £15.41. hshown the more expensive mouse were prepared to pay £23.52. This sort of price anchoring is used everywhere in life from high street shops, to online retailers, the service industry and even travel.  The experiments here have been repeated again and again over the years. It’s even been found that when people know of this and it’s possible existence they still find it difficult not to be unconsciously swayed by the presence of an anchor. An experiment was carried out by Timothy Wilson of the University of Virginia.  He found that even putting a warning on the sheet had no impact at all. It’s like telling someone not to think of a pink elephant.