devoish (98.78)

Predictable Irrational

July 31, 2009 – Comments (6) | RELATED TICKERS: UPS , E , LL

I stumbled upon this little excerpt from the book of the same title by Dan Ariely, and thought you all might find it interesting;

Consider this: if I asked you for the last two
digits of your social security number (mine are 79), then asked you whether you
would pay this number in dollars (for me this would be $79) for a particular
bottle of Côtes du Rhône 1998, would the mere suggestion of that number
influence how much you would be willing to spend on wine? Sounds preposterous,
doesn’t it? Well, wait until you see what happened to a group of MBA students
at MIT a few years ago.

“Now here we have
a nice Côtes du Rhône Jaboulet Parallel,” said Drazen Prelec, a professor at
MIT’s Sloan School of Management,
as he lifted a bottle admiringly. “It’s a 1998.”

At the time, sitting before him were the 55
students from his marketing research class. On this day, Drazen, George
Loewenstein (a professor at Carnegie
Mellon
University),
and I would have an unusual request for this group of future marketing pros. We
would ask them to jot down the last two digits of their social security numbers
and tell us whether they would pay this amount for a number of products,
including the bottle of wine. Then, we would ask 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 are “arbitrary,”
once those prices are established in our minds they will shape not only present
prices but also future prices (this makes 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 see.

“For those of you who don’t know much about
wines,” Drazen continued, “this bottle received eighty- six points from Wine Spectator. It has the flavor of red
berry, mocha, and black chocolate; it’s a medium- bodied, medium- intensity,
nicely balanced red, and it makes for delightful drinking.” Drazen held up
another bottle. This was a Hermitage Jaboulet La Chapelle, 1996, with a 92-
point rating from the Wine Advocate magazine.
“The finest La Chapelle since 1990,” Drazen intoned, while the students looked
up curiously. “Only 8,100 cases made . . .”

In turn, Drazen held up four other items: a
cordless trackball (TrackMan Marble FX by Logitech); a cordless keyboard and
mouse (iTouch by Logitech); a design book (The
Perfect Package: How to Add Value through Graphic Design); and a one- pound
box of Belgian chocolates by Neuhaus.

Drazen 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 twenty- three, write twenty- three dollars.”

“Now when you’re finished with that,” he
added, “I want you to indicate on your sheets-with a simple yes or no- whether
you would pay that amount for each of the products.”

When the students had finished answering yes
or no to each item, Drazen asked them to write down the maximum amount they
were willing to pay for each of the products (their bids). Once they had
written down their bids, the students passed the sheets up to me and I entered
their responses into my laptop and announced the winners. One by one the
student who had made the highest bid for each of the products would step up to
the front of the class, pay for the product, and take it with them.

The students enjoyed this class exercise, but
when I asked them if they felt that writing down the last two digits of their
social security numbers had influenced their final bids, they quickly dismissed
my suggestion. No way!

When I got back to my office, I analyzed the data. Did the
digits from the social security numbers serve as anchors? Remarkably, they did:
the students with the highest- ending social security digits (from 80 to 99)
bid highest, while those with the lowest- ending numbers (1 to 20) 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, we could see
that 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.