Saturday, March 13, 2010

Influence: Chapter 2

Value investors believe that Mr. Market's mood swings offer them excellent opportunities to buy low and sell high. But how does an investor avoid becoming Mr. Market rather than taking advantage of him? Influence, by Robert Cialdini, helps us understand the factors that influence us, which are exploited by, among others, the news media, our brokers, and research analysts, and thereby puts us in a position to protect ourselves from our own, hard-coded biases that we wouldn't otherwise know have been triggered.

This chapter contains a discussion of the reciprocity and perceptual contrast theories, and how they are successfully used against unsuspecting individuals in order to derive abnormal profits. The human concept of reciprocation makes us more likely to do something for someone when they have done something for us. "Perceptual contrast" makes us more willing to agree to something when presented in comparison with something that appears worse.

We've already seen both of these human tendencies (here and here) when we looked at Charlie Munger's discussion of human tendencies, but in Influence, Cialdini demonstrates them a bit more clearly with examples and shows more thoroughly how they are used as weapons against us by those who exploit these tendencies.

The concept of reciprocity is deeply ingrained in all human cultures. Cialdini argues that this trait has been a major contributor to human evolution, as it has allowed humans to give favours and resources to others with the knowledge that they will be returned. This has created a "network of obligation" that has allowed humans to share goods and services in a manner that has allowed the group to prosper.

Cialdini delves into a large number of odd historical occurrences and purposeful psychological experiments that demonstrate how powerful these tendencies are. Under ordinary circumstances, there is a strong correlation between how much we like a person, and what favours we are willing to do for them. But once a favour has been done for us, the correlation between how much we like a person and what we'll do for them goes out the window: Cialdini shows that whether we like a person or not, we will do a favour for them if we have accepted one from them.

Furthermore, the favours do not have to be of the same magnitude, and the receiver of the initial favour need not even want the favour in order to feel the sense of obligation. This is a powerful tool that is exploited by salespeople, charities, and religions, all of whom offer gifts in order to instill a sense of obligation in the receiver. In this way, the initiator is choosing the gift, and then asking for a larger return, also of the choosing of the initiator, resulting in a very profitable outcome!

Exploiters achieve the highest profits, however, when reciprocity is combined with perceptual contrast. For example, if one is asked to volunteer one hour per week for a year, one may see a high rejection rate. But following this question, if one is asked to volunteer just once for one hour, one is likely to see much higher acceptance rates than if the first question was never asked. This is because the second request is seen as much more reasonable than the first request (perceptual contrast), and because the initiator has accepted the initial rejection, thereby instilling a sense of obligation in the subject.

Everyone from politicians (accepting campaign financing and then returning favours to the donors, voting for bills because they are sponsored by members to whom favours are owed) to consumers (receiving small gifts which lead to purchases, trying out samples which instill an obligation to purchase) to scientists (receiving funding from special interests that tend to influence experiment conclusions) are susceptible to being influenced by these factors. Understanding how these tendencies are being used is the best defense to feeling a sense of obligation to the exploiter.

6 comments:

Anonymous said...

hi barel,
i really like the condensed snapshot like presentation of the books chapter by chapter.
is there any book by mr.munger worth reviewing?
also u never tell us hows the INVESTA" LIFESTYLE like?
lol

Saj Karsan said...

Hi Anon,

The investa' lifestyle includes a lot of reading. Regarding Munger, I'm not sure he's written more than a couple of books so I don't think there's a lot of selection. One of them is already reviewed.

Anonymous said...

i know this sounds a bit dull but how do u guys u know form ur" own radar for undervalued stocks?"
is it like spending the day on the net reading reports, learning bout the company etc or is there something more to it?
psst... hows the fund in q4(yeah yeah i know this is a bit short termist but cant help it)?
did u join that arbitrage guy who wanted to team up with u?
thx 4 replying

Saj Karsan said...

Hi Anon,

I tend to hear about stocks from other value investors, other like-minded sites, stock screens, and in general just a lot of reading.

The fund's results will be out in a few weeks; you'll have to wait till then I'm afraid!

I'm not sure I know what you mean by 'join' nor do I know which 'arbitrage guy' you refer to.

Anonymous said...

got it! so value investing is fun hard work
i meant the holy grail to investing guy (saw his comment on an earlier post)

Saj Karsan said...

Hi Anon,

No I haven't joined him

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