Shippers are often surprised when I suggest setting targets for service providers in transportation sourcing events. Economists refer to this concept as "anchoring". Many, if not most, shippers simply take a portfolio of business out to the market and allow the bidders to set the eventual price through a self-selection process; the best proposed value, or combination of price and service determines the eventual price. While this is a strategy that has been employed successfully by many shippers, it does leave a lot to chance and it assumes the carriers will naturally arrive at the "right price".
Before we go further we should probably define anchoring. While the definitions provided in Economics textbooks and journals can be a bit technical, for our purposes we can use the following as a working definition:
Anchoring is a cognitive bias instilled by the setting of a target price, concession, or condition whereby a person relies too heavily on a single piece of information when formulating decisions.
Several studies point to the fact that people will make estimates starting from an initial known value and make adjustments to that value to reflect their beliefs. However, research also points to the fact that the adjustments made are almost always too small. This phenomenon has been well established and time tested. A nearly forty year old study in Science magazine notes an experiment where subjects were asked to estimate the number of African countries in the United Nations. Before the subjects guessed a wheel of fortune was spun with numbered spaces 0-100. Rather than simply guessing a discrete number, subjects were asked to whether the actual number was higher or lower than the wheel's number, and then to guess the discrete number itself. The effects were dramatic and show people's propensity to agree with reference points we are given: ". . . the median estimates of the percentage of African countries in the United Nations were 25 and 45 for groups that received 10 and 65, respectively, as starting points."
Another, more real-world, example can be seen in the retail pricing of consumer electronics. In the 1980s and 1990s personal electronics (radios, tape players, CD players, etc.) were typically priced in the $20-$30 range. In the 2000s consumer electronics companies appear to have embraced price anchoring. Manufacturers priced newly-released products at $300, $400, in some instances as high as $600, and then quickly dropped the price. This served to not only allow for excess profits from early adopters, but more importantly it set a price anchor in consumer's mind so that the products were seen as premium- high-value items. When the prices were then dropped the perceived value was increased.
The most common use of anchoring has got to be negotiation. We've all heard the saying that the first person to name a number in a negotiation typically comes out the loser, but this is not always, or even often, the case. By establishing targets (anchors) with the person across the table you are effectively framing the discussion in terms of those targets. While negotiating downward from those numbers may be an unavoidable reality, the discussion at least begins and is framed around the (higher) target. There are a number of key to knowing how (and when) to use anchoring.
• Communicate the anchors early and reinforce them often — Perception is heavily influenced by the earliest anchors on any given situation. Our later beliefs are typically the results of stimulus based adjustments of our early anchors. Similarly, the depth of our belief in perceptions is highly correlated to the number of times we are exposed to the perception. Therefore, the earlier the anchor is communicated, and the more frequently it is reinforced the greater the impact on the outcome.
• Be specific — Your anchors must be explicit and clearly understood to be effective. Provide specific targets for all primary and secondary cost drivers. Remember, you want to paint a picture in the target's mind of your optimal state, so that they will naturally attempt to build that picture. If the picture is fuzzy the result will be suboptimal.
• Don't be timid — Remember, anchoring only works if the anchors are aggressive. Make sure that achieving the anchor points would translate into a best-in-class agreement.
• Own your anchors — If you don't believe in your anchors neither will anyone else. Assert your belief that your anchors are valid and justifiable with confidence.
• Know when to take another approach — Anchoring only works if you have the knowledge, experience, and market insight to know where to set the anchors. If you are at all uncertain of your targets, it is better to allow the vendors to self-select.
Otherwise you could be leaving money on the table.
Of course anchoring is just one tool in a sourcing professional's toolbox. Knowing when to use it (and when to abandon it) is at least as important as knowing how best to implement it. However, we have found it be an effective was to optimize carrier costs in an increasingly opaque market.
Before we go further we should probably define anchoring. While the definitions provided in Economics textbooks and journals can be a bit technical, for our purposes we can use the following as a working definition:
Anchoring is a cognitive bias instilled by the setting of a target price, concession, or condition whereby a person relies too heavily on a single piece of information when formulating decisions.
Several studies point to the fact that people will make estimates starting from an initial known value and make adjustments to that value to reflect their beliefs. However, research also points to the fact that the adjustments made are almost always too small. This phenomenon has been well established and time tested. A nearly forty year old study in Science magazine notes an experiment where subjects were asked to estimate the number of African countries in the United Nations. Before the subjects guessed a wheel of fortune was spun with numbered spaces 0-100. Rather than simply guessing a discrete number, subjects were asked to whether the actual number was higher or lower than the wheel's number, and then to guess the discrete number itself. The effects were dramatic and show people's propensity to agree with reference points we are given: ". . . the median estimates of the percentage of African countries in the United Nations were 25 and 45 for groups that received 10 and 65, respectively, as starting points."
Another, more real-world, example can be seen in the retail pricing of consumer electronics. In the 1980s and 1990s personal electronics (radios, tape players, CD players, etc.) were typically priced in the $20-$30 range. In the 2000s consumer electronics companies appear to have embraced price anchoring. Manufacturers priced newly-released products at $300, $400, in some instances as high as $600, and then quickly dropped the price. This served to not only allow for excess profits from early adopters, but more importantly it set a price anchor in consumer's mind so that the products were seen as premium- high-value items. When the prices were then dropped the perceived value was increased.
The most common use of anchoring has got to be negotiation. We've all heard the saying that the first person to name a number in a negotiation typically comes out the loser, but this is not always, or even often, the case. By establishing targets (anchors) with the person across the table you are effectively framing the discussion in terms of those targets. While negotiating downward from those numbers may be an unavoidable reality, the discussion at least begins and is framed around the (higher) target. There are a number of key to knowing how (and when) to use anchoring.
• Communicate the anchors early and reinforce them often — Perception is heavily influenced by the earliest anchors on any given situation. Our later beliefs are typically the results of stimulus based adjustments of our early anchors. Similarly, the depth of our belief in perceptions is highly correlated to the number of times we are exposed to the perception. Therefore, the earlier the anchor is communicated, and the more frequently it is reinforced the greater the impact on the outcome.
• Be specific — Your anchors must be explicit and clearly understood to be effective. Provide specific targets for all primary and secondary cost drivers. Remember, you want to paint a picture in the target's mind of your optimal state, so that they will naturally attempt to build that picture. If the picture is fuzzy the result will be suboptimal.
• Don't be timid — Remember, anchoring only works if the anchors are aggressive. Make sure that achieving the anchor points would translate into a best-in-class agreement.
• Own your anchors — If you don't believe in your anchors neither will anyone else. Assert your belief that your anchors are valid and justifiable with confidence.
• Know when to take another approach — Anchoring only works if you have the knowledge, experience, and market insight to know where to set the anchors. If you are at all uncertain of your targets, it is better to allow the vendors to self-select.
Otherwise you could be leaving money on the table.
Of course anchoring is just one tool in a sourcing professional's toolbox. Knowing when to use it (and when to abandon it) is at least as important as knowing how best to implement it. However, we have found it be an effective was to optimize carrier costs in an increasingly opaque market.
