Fair warning this is a piece about “pricing models” so how exciting can it be? But maybe you should give it a chance.
As easily molded individuals we are susceptible to accepting most “prices” in the market as normal. But what is normal? Where did the guiding mechanism that we perceive to be normal originally come from and who set that price? A recent MIT study published in the book Predictably Irrational shows the power of that original “anchor” price.
Here’s what happened to a group of MBA students at MIT a few years ago.
“Now here we have a nice 1998 Cotes du Rhone Jaboulet Parallel,” said Drazen Prelec, a professor at MIT’s Sloan School of Management, as he lifted a bottle admiringly. Sitting before him were the 55 students from his marketing research class. On this day, Prelec, professor George Loewenstein of Carnegie Mellon University and I had an unusual request for this group of future marketing pros. We asked them to jot down the last two digits of their Social Security numbers and tell us whether they would pay that amount for a number of products, including the wine. Then we asked them to actually bid on these items in an auction.
What were we trying to prove? The existence of what we called arbitrary coherence. The basic idea of arbitrary coherence is this: Although initial prices can be “arbitrary,” once those prices are established in our minds, they will shape not only present prices but also future ones (thus making them “coherent”). So would thinking about one’s Social Security number be enough to create an anchor? And would that initial anchor have a long-term influence? That’s what we wanted to find out…
Prelec held up four other items one by one: a cordless trackball, a cordless keyboard and mouse, a design book, and a one-pound box of Belgian chocolates. He passed out forms that listed all the items. “Now I want you to write the last two digits of your Social Security number at the top of the page,” he instructed. “And then write them again next to each of the items in the form of a price. In other words, if the last two digits are 23, write $23. Now when you’re finished with that,” he added, “I want you to indicate on your sheets whether you would pay that amount for each of the products.”
When the students had finished, Prelec asked them to write down the maximum amount they were willing to pay for each of the products (their bids). Then they passed the sheets up to me, and I announced the winners. The students enjoyed this exercise, but when I asked them whether they felt that writing down the last two digits of their Social Security numbers had influenced their final bids, they dismissed my suggestion. No way!
Did the digits from the Social Security numbers serve as anchors? Remarkably, they did: The students with the highest-ending Social Security digits bid highest, while those with the lowest-ending numbers bid lowest. The top 20 percent, for instance, bid an average of $56 for the cordless keyboard; the bottom 20 percent bid an average of $16. In the end, students with Social Security numbers ending in the upper 20 percent placed bids that were 216 to 346 percent higher than those of the students with Social Security numbers ending in the lowest 20 percent.
