When you are entering negotiations, is it better to offer a number first, or wait for the other side to do it? Although many books and seminars on negotiations suggest you should wait for the other side to offer a number, I disagree. I have been asked that question a few times, and my answer is put your number out first and take advantage of the anchoring effect.
Daniel Kahneman wrote about the anchoring effect in Thinking Fast and Slow. The idea is when trying to estimate something, people will consider a recent value they have seen, and that value will influence their estimate. As an example, Kahneman and Amos Tversky rigged a roulette wheel to land on either 10 or 65. They spun it and the people who saw the result wrote down the number they saw. Not long after, those same people were asked to estimate the percentage of African nations that were members of the UN. The people who saw the roulette wheel land on 10 guessed on average 25% of the African nations were members. The people who saw 65 on the wheel guessed on average 45% of those nations were members. Clearly the numbers they saw were suggestive and influenced their estimates. In his book, Kahneman provided several more examples of this anchoring effect.
I understand that games and unrelated estimating of unknown numbers are not the same as negotiating to buy or sell something, but the principles apply. We once ran a small exercise for a client where their employees were required to estimate the value of a certain piece of property, and then either buy it or sell it. Some of the employees only learned that the property had been purchased for $300,000 a few years ago. Others learned that a nearby company could generate an estimated $2 million in annual income from an expansion there. All the employees were told that there was no other industrial property available in the area. Predictably, those who only knew the previous price paid for the property estimate the value at an average of $350,000. Those who had only learned about the expansion opportunity valued the property at close to $2 million. The employees were influenced by the anchor numbers they had seen.
In most buying and selling situations, the negotiators will have more information than the employees in our client exercise or the participants in the Kahneman and Tversky studies, but they never have perfect information. There are always unknowns. In negotiations, each participant is always trying to estimate the value to the other participant. Since the other participant’s value is unknown, the first number they give you is highly likely to influence your estimate.
Consider the last time you bought or sold a home. The home seller listed an asking price first. How far below the asking price was the first offer? In tight markets where not many homes are available, the first offers tend to be very close to the asking price. In markets with more inventory, first offers tend to be lower. However, it is pretty rare to see initial offers 20% below the asking price. Now notwithstanding the anchoring effect, real estate also shows the downside of trying to anchor on a number that is well outside the appropriate range. A property that is priced too high, does not receive any offers. When there are plenty of alternatives, potential buyers simply assume the seller is anchored to that high number and they never try to negotiate.
One thing negotiation books and seminars suggest which is consistent with anchoring is to move in small increments. To take an extreme example, let’s say you are offered 25% less than your stated price for something. That offer is meant to try to get you to question whether your price is a real reflection of value. It is meant to get you to anchor on a new lower number. Your challenge is to reestablish the anchor at or near your initial price. Even if you question your own value estimate, a substantial downward move by you communicates to your counterparty that you are going to get much closer to their number. In that case, the anchoring effect will have cost you money. On the other hand, if you make a very small move, you communicate to the other party that you are confident in your number, and you get them to question their own.
There are many things that go into successful negotiating, and I am not trying to oversimplify it. However, it is clear from a rich body of behavioral economics work that we are all affected by anchors. So, while trying to understand how your counterparty thinks, doing your homework on how your product or service adds value, and trying to find a win-win solution, try to also take advantage of the anchoring effect. Go ahead and quote a number first to set the anchor, and if you do make moves, do so in small increments.