How Anchoring Affects Everything

How often do you think you make decisions on a daily basis? It’s likely more often than we think. Where you want to go for lunch, what movie you want to see, whether you should get the complementary Parmesan cheese added to your soup or entree at Olive Garden. All of these are harmless decisions that require very minimal negotiating. But what happens if you’re in a situation where negotiating is a must, such as negotiating the price of the car you like or a bump in salary? For negotiations that involve a quantifiable amount, it’s a different story.

When it comes to negotiating, whether it be salary or the nice car at the dealership, it’s commonly said that you should never give the first number. Other times, it’s said that you should give the first number to set the range. In either scenario, when the first number is given, it sets the stage for a cognitive bias known as the anchoring effect. This causes people to rely too heavily on the first piece of information that’s given. Once that detail is acknowledged, all discussions tend to center around it. This is most evident in situations where people don’t have the right amount of context or knowledge around that piece of information (e.g., not knowing the average price for the car you like or how much your current role is actually paying). Like most other cognitive biases, the anchoring effect occurs across almost all kinds of situations.

For early-stage startup founders, or even people thinking of starting a company, looking at certain metrics can take you down the wrong path. If you’re researching the Total Addressable Market and you see that the number is eye-popping, it doesn’t mean you’ve found a potential market. Not at all. Being tempted by a metric like this is a prime example of being hooked in by the anchoring effect – seeing this piece of information dictating your future thoughts around whether you have a viable market for your product or service. That’s why you research the Serviceable Available Market and Serviceable Obtainable Market to get a better idea.

From the investing side, it’s easy to fall in love with a startup if you hear that the team worked at a Big Tech company or the startup is backed by a big-name VC firm. Although those things have merit and can be used as possible screeners when looking for companies to put capital in, it doesn’t guarantee that the startup will make it out alive. That’s why due diligence is so important and a critical part of how VC firms make their returns. Basically those who don’t get tied down by a tempting statistic or fact are those who survive longer.

Next time you’re negotiating or deciding between two options, always keep everything in mind. Never base your choice on the first piece of information you hear – that’s only one piece of the puzzle. Research how much that car is worth or how much your role is really worth. Conducting proper due diligence can pretty much cure this, whether it’s an everyday occurence or something big like deciding whether to invest in a company or not. As long as you’re aware of the anchoring effect, you’re one step closer to making a much smarter bet.