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When a Discount, Isn’t Really a Discount.

by J. Money on Thursday, May 26, 2011

hank negotiation(Guest Post by Pop)

Cairo. City of the living. And home to some of the greatest negotiators on Earth. I visited the city a couple years ago and had the pleasure of stopping by its main market, Khan el-Khalili. It’s a big tourist trap now. Filled with colorful, embroidered robes that no one but foreigners buy and homemade toy camels stuffed with sand.

But if you ever find yourself in the area and are willing to part with a couple bucks, the markets in Egypt will give you a first-class education in the art of negotiation.

I watched a twenty-something couple from Australia try to buy a Hard Rock Cairo t-shirt (don’t ask me why). Here’s a brief summary of the conversation:

Tourist: How much for the shirt?
Vendor: 100 Egyptian pounds.
Tourist: I’ll pay you 50. (My guidebook had similar advice to offer half of his initial offer.)
Vendor (after much pondering): How about 60? 10 pounds is only two American dollars. It’s nothing to you.
Tourist: Ok, 60. (Tourist leaves happy. Vendor is happy.)

Another tourist bought the same shirt a few minutes later for 30 Egyptian pounds. There was more haggling, but the coup de grace was the tourist showing the vendor that he literally only had 30 pounds on him.

So what happened? The first tourist took 50% off the seller’s price, and he still didn’t get as low as he could have.

Making the first offer to “anchor” the negotiation

The vendor knows what he’s doing. By setting the first price, he set the benchmark by which all discounts would be judged. The tourist could have asked for up to a 70% discount, and he’d still come out on top. Psychologists call it “anchoring”, and believe me, it’s not a tactic used solely in a far away land. Don’t think you suffer from it? How would you answer this series of questions?

Are there more or fewer than 10 African countries in the United Nations?
Let’s say you answered, “more.”

How many do you think there are?
If you were like the test subjects in an experiment run by professors Daniel Kahneman and Amos Tversky, you probably guessed somewhere around “25″.

But let’s say my first question was this: Are there more or fewer than 45 African countries in the United Nations? And you still answered “more.” What would you guess now? (Actually, you see where this is going so you’d ruin my experiment. Just play along, please.) If you were a typical subject, you’d guess somewhere around “65″.

Now, you’re not a moron. You know that the first question shouldn’t influence the second one. But it does. You use that first number as a reference point and are reluctant to adjust up or down from it too far, no matter where it was.

Marketers use this all the time. How do you think Macy’s gets away with a constant flow of 20% off Friends & Family discount coupons? Or why is there a store next to Rockefeller Center in New York that’s been holding a 50%-off going out of business sale for three years running?

The key is the starting price. Once somebody tells you a Hugo Boss suit is worth $800, you think you’re getting a great deal when the price drops to $600, no matter what you would have offered had you just been asked out of the blue what you’d pay for it.

But given that you read blogs like this one, you’re probably quite a frugaliste. Maybe you don’t fall for those “sales” tricks. Thing is, anchoring isn’t just a marketing trick. It’s used in pretty much every negotiation you’ll ever encounter.

Using anchoring to your advantage

Let’s say you’re selling a house. Your list price is $700,000. The first offer comes in at $500,000. You probably think that’s a completely unreasonable offer. Perhaps you’re willing to go as low as $650,000, but if you counter with that immediately, the buyer is going to protest that you’re not meeting him anywhere close to the middle of your two offers.

Instead, what if you just said “no” and told them their offer was unreasonable? If he really wants the house, the buyer might come back with an offer of $600k, and your counter (say, $650k), suddenly looks much more reasonable than it did under the previous scenario. (And in case you don’t want to take an anonymous cartoon character’s word for it, I pretty much ripped off that strategy from a Stanford management professor.)

In some scenarios, you might be hesitant to make the first offer. If you’re new to the job market, for example, you might not know how much money to ask for in a salary negotiation. Guess too low, and you’ve left money on the table without the hiring manager having to lift a finger.

But even if you can’t use anchoring to your advantage, at least now I hope you won’t let someone use it to take advantage of you. You’ve got to ask friends, professors, mentors or whomever what kind of market price your skills have, and stick to your research no matter how low the initial offer comes in.

If you don’t, you’ve essentially fallen for that sketchy suit store’s 50%-off, going out of business sale.

——–
Pop writes about the intersection of our brains, our money, and the economy at Pop Economics. There, you’ll find stories that go way beyond Personal Finance 101 and deep into the psychology that drives your money decisions–not to mention some killer pop art! You can follow Pop on Twitter at @PopEconomics.


{ 8 comments… read them below or add one }

1 No Debt MBA May 26, 2011 at 8:53 am

I went to Khan el-Khalili a few times when I was living in Egypt and it was pretty fun. Vendors there name ridiculously high prices (for reference a doctor’s starting salary is 220 Egyptian pounds a month and I think the average was like 500 Egyptian pounds) so we would go and name what seemed like ridiculously low prices compared to the starting price. So if something was listed at 20 Egyptian pounds I’d offer two. In Arabic. The vendor talks about how his price is $4 USD and how I’m starving his children etc etc, but you hold your ground, walk away a few times, and only give slight increases. The vendor won’t sell it to you if it’s a loss but I’d end up getting 20 Egyptian pound items for about 3-4 Egyptian pounds.

The problem is that as a tourist your mental accounting is in dollars and you have some preset notion of what things should cost in USD. So when the vendor, experienced in the ways of tourists, converts his prices to USD or euros people fall over themselves to pay what are outrageous prices in Egypt (or were when I was there). Guide books won’t tell you how to get a good deal because the vendor will give you a hard time about it which is not much fun for your vacation and there are many places where prices aren’t 80% tourist inflated and offering 10% of their asking would be incredibly rude. I guess it’s just really important to know the market if you want to get a good deal.

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2 Katie May 26, 2011 at 12:56 pm

Just had an interview last night for a position. At the end of the hour long interview, I asked what the salary range was for the position. The person interviewing me told me a number and said if I wanted to negotiate, now was the time to lay on the table what I thought I should get. I had done some research (And the position is within my current organization as well, which helps) – so I upped it by a couple dollars an hour.

I know what the person in the position previously made, without a college degree, so I am going to be damned if I take the job at a salary lower than that benchmark just because I am trying to move up in the corporate world.

We’ll see how it goes….

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3 retirebyforty May 26, 2011 at 1:11 pm

Ahh.. yes, the tourist tax. In Thailand, they have Thai and non Thai pricing for all the tourist destinations. For Thai people to go see the Palace, it cost 5 bath, but for foreigner, it cost 40 bath. That’s still only about $1.25. I think that’s fair because local people make very little money. Of course it helps that Thai has their own numeric characters so foreigners can’t tell how much less they get charged.
Yeah, everyone love a discount, that’s why anchor price works.

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4 Hassan from Bank On LA May 26, 2011 at 1:14 pm

Cool article. I introduced this topic in a financial education workshop using the iPod as an example, but I like the examples used in this article as well. It can be a pretty powerful tool for negotiation and business.

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5 Financial Success for Young Adutls May 26, 2011 at 3:53 pm

Anchoring is a great way to ‘set up’ a successful sale. I only wish I were better at negotiating. My thoughts are that every price I hear is set in stone.

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6 Pop May 26, 2011 at 7:10 pm

@NoDebtMBA – Agreed. Or maybe just not to care so much whether or not you’re getting a good deal. While Khan el Khalili was a good lesson in negotiating, in the end it IS only one or two American dollars you’re talking about, probably. And in the end, both the buyer and seller are happy.

@Katie – That’s great that you asked for more. So many people don’t even bother. Not asking is the only sure way that you won’t get as much as you could, and employers expect that you will. Good luck!

@retirebyforty – There are tourist taxes in the U.S. too. I’m pretty sure Florida residents pay at least 10% to 20% less than non-Floridians to visit Disney World, for example.

@Financial Success – Yeah, it’s a Western world mindset. We only expect to negotiate at car dealerships or on homes. As long as you can afford to pay a price, though, don’t kick yourself too much about not negotiating on small stuff. That nervousness/pushiness/sense of confrontation you feel when you negotiate might not be worth the $10 or whatever you save.

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7 Paula @ AffordAnything.org May 28, 2011 at 12:01 pm

A few years ago I went to Australia, bought a 4×4, drove it into the Outback and camped in a tent for 10 months. When I would complain about the hefty costs associated with the car — the repairs, the maintenance, the “foreigner” insurance premium, extremely high fuel costs — people used to say, “But think about how much money you saved by camping with your 4×4 instead of staying in hotels every night!” That was totally a false comparison. The cost of staying in hotels every night for 10 months would be so high that I would never consider doing it. If hotels were my only option, I simply wouldn’t have gone to Australia. But by implanting this “comparison” into my mind, people tried to make the cost of maintaining my vehicle seem smaller.

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8 J. Money May 28, 2011 at 5:28 pm

Thanks again for guest posting while I was out of town, Pop — This was a great one :) Appreciate you responding to comments too. Have a few of my own:

@No Debt MBA – Dang, that is so CRAZY! I bet it’s like that in Greece too… I always bargained but never to that extreme. If something was 20 of whatever, I’d try for 15… but I’m sure even then I got ripped off ;) Even though whatever I bought was still worth it to me. So really, everyone wins.
@Katie – Good for you! And good luck! Let us know how it goes :)
@retirebyforty – I guess that does make sense… sometimes I actually feel bad getting a super good deal so I’ll give extra to local sellers. Even here in the US.
@Paula @ AffordAnything.org – YUP!! That pisses me off a lot actually. Like if a friend says something only costs $1,000 down from $5,000 and I still say no to flying wherever they want me to fly. Yes, it’s a bargain of course but it’s still $1,000! If I don’t want to spend it, it doesn’t matter where the hell it gets me ;) Kinda a bad example cuz I love flying and adventuring, but you get the point. Gotta compare fairly.

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