Anchor Away, Negotiators

In a negotiation, an “anchor” is the first offer made by each side. It could be a specific price, payment terms, or a bundle of equipment or services. It is called an anchor because it “anchors” the negotiation around a specific point. Much like a ship will drift around its anchor due to winds or tides, so will a negotiation drift around a first offer. Most of us are not even aware of anchors in our daily lives. Yet, anyone who’s shopped for a car or a house has been “anchored” by the window sticker on the car or the listing price on the house. We know the price on these items is rarely firm, and will often be adjusted based on our skill in handling the negotiation, the relative scarcity of the item, and how badly we need the item.

An interesting experiment conducted in 1974 by psychologists Amos Tversky and Daniel Kahneman¹ proves that we are all influenced by anchors, especially when we are unfamiliar with a particular situation. In the experiment, a roulette wheel was spun, landing randomly on a number. Then participants were asked to estimate the percentage of African countries belonging to the United Nations. When a 10 appeared on the roulette wheel, participants gave a median answer of 25 countries. When 65 appeared on the wheel, participants gave a median answer of 45 countries. The experiment points out that when we lack knowledge about a
particular situation we are often “anchored” by whatever data is available, however irrelevant the data might be.

When faced with starting a negotiation, should you anchor “high” if you are a seller and “low” if you’re a buyer? In general, the answer is yes. However, here are two things to consider.

• First, consider how much of a commodity the item is. For example, if the item for sale is 100 tons of wheat, your ability to anchor higher (as a seller) or lower (as a buyer) is limited since there are many comparable sales made every day (as reported on the commodity exchanges). However, if the item is more unique, such as an antique Rolls-Royce, there is far less data available on comparable sales for exactly the same item. Additionally, if there is an emotional content to the purchase (as there might be for a collector of antique Rolls-Royces) your ability to anchor “high” as a seller is actually enhanced.
   
• Second, consider the long-term relationship you have with the party on the other side of the transaction. In the case of the 100 tons of wheat, there is probably no long-term relationship between buyer and seller. However, for the antique Rolls, the marketplace is small and the buyers and sellers are often known to one another. Anchoring extremely high or low in this case might damage the long-term relationship. 

So, how do you avoid being taken in by the power of anchors? First, research comparable sales data, either for deals that have been done within your company or for comparable deals done by your competitors. Then decide, based on the data (not your emotions) what you believe is a reasonable price for your solution, regardless of where the buyer has set their anchor. Second, as a seller, if you are faced with an anchor price
that seems too low, ask the buyer what the basis is for their price. We often find that the buyer has very little factual basis for their offer, and they simply picked the lowest possible number they can imagine someone paying. They might say “this is all we want to pay” or “the economy is hurting, and we just want to pay less.” While these are probably true statements, they are not nearly as persuasive as true market data-based offers.

If the buyer cannot provide a plausible, market data-based reason for their price, consider making your counter offer as high as you possibly can, and base your offer on verifiable, comparable data. Then, ask the buyer “why should I sell my product for less?” Or, you can ask them “would you sell my product for less if you were me, based on this data?”

Avoid splitting the difference between their price and yours. When a buyer is faced with the pricing facts behind your offer, they sometimes offer to “split the difference” between your market-based price and their emotion-based price. But why would you want to split the difference between a number they have randomly or emotionally chosen and your factual, market-based number? Instead, be firm on your price and remind them of the comparable sales prices you have based your offer on. Then, ask them to persuade you as to why their price is the correct price (a task they will find hard to do without resorting to emotional responses such as “I just think it’s worth that much.”)

Finally, as a seller, your negotiating effectiveness is enhanced if you have built a strong pipeline of demand for your goods and services. You can maintain higher prices if you have multiple potential customers to sell your products to. But what if you are the sales person on a single large corporation? You may feel that they can easily say “take it or leave it.” In this case, consider basing your deals not only on market prices, but also tie in other terms, such as quantity discounts, early shipping, financing, and so forth. Explain any decrease from your anchor price in terms such as “Yes, I can lower my price, but only if you take a quantity of X and have them shipped by Y.” Avoid simply lowering your offering price due to pressure. You’ll only get more pressure!

¹Washington Post, Oct. 23, 2006, In a Sea of Uncertainty, Shankar Vedantam

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