Optimal starting prices for negotiations and auctions

An article in the latest edition of Current Directions in Psychological Science reviews studies on the best starting points to increase the final price in either negotiations or auctions. In general, start high in negotiations, start low in auctions.

It turns out that negotiations, where several parties are invited to discuss a price, and auctions, where people can include themselves by jumping in when they want, are quite different psychologically.

The article, by business psychologist Adam Gilinsky and colleagues, notes that starting prices are a form of ‘anchor‘ – a piece of information which is known to affect subsequent decisions. As the authors note, anchoring has a powerful influence on our reasoning:

An anchor is a numeric value that influences subsequent numeric estimates and outcomes. When people make judgments, their final estimates are often assimilated to—that is, become more similar to—the initial anchor value (Tversky & Kahneman, 1974).

For example, in one of the best-known anchoring studies (Tversky & Kahneman, 1974), participants were exposed to an arbitrary number between 0 and 100 from the spin of a roulette wheel and then asked to estimate the percentage of African nations in the United Nations: Participants whose roulette wheel landed on a relatively high number gave higher absolute estimates than did participants whose wheel landed on a lower number.

Even outside of trivia questions, few psychological phenomena are as robust as the anchoring effect; it influences public policy assessments, judicial verdicts, economic transactions, and a variety of psychological phenomena.

The evidence suggests that in negotiations, a high starting price most often leads to a high final price, as the anchoring effect seems to work in a relatively undiluted way (with the caveat that completely ridiculous starting prices could prevent any deal being reached).

There’s an interesting aside in the article, mentioning that you can protect yourself from high anchor points from other people by focusing on your own ideal price or your opponents weaknesses, as found by a 2001 study, or by considering why the suggested price might be inaccurate, as found by another study published in the same year.

It also turns out that, contrary to conventional wisdom, making the first offer is also a good strategy:

Many negotiation books recommend waiting for the other side to offer first. However, existing empirical research contradicts this conventional wisdom: The final outcome in single and multi-issue negotiations, both in the United States and Thailand, often depends on whether the buyer or the seller makes the first offer. Indeed, the final price tends to be higher when a seller (who wants a higher price and thus sets a high first offer) makes the first offer than when the buyer (who offers a low first offer to achieve a low final price) goes first.

In contrast, for auctions, starting with a low price is generally more likely to lead to a higher final price. The researchers note this is likely due to three factors: price rise in auctions seems to be driven by social competition and so starting with a low entry point encourages more people to join in; once someone has bid, they have made a commitment which is likely to encourage them to continue; and finally, more bids leads us to infer that the item has a higher value.

It’s not a huge article so is worth reading in full if you’re interested in economic reasoning. Luckily, the full text is available as a pdf pre-print if you don’t have access to the journal.

Link to DOI entry for study.
pdf of full text.

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