What could be more rational than the way managers make decisions? Many years of research and deep thinking has sought out the most robust techniques for controlling and even removing risk from strategic thinking and investment plans. Generations of analysts and gurus have worked long hours to build matrices, frameworks, templates and checklists that they assure us – and we are willing to believe – will guarantee rigour inresource allocation decisions.
And yet …
We are all – still - human. The bias that is deep within us influences how we work, how we think, how we make decisions whether they are personal or professional. Behavioural economics is not simply a matter of directing consumer buying habits or allowing governments to nudge the average citizen along. We are all seeking to find our way in the imperfect world that the behavioural economists portray. Our imperfections and failures to conform to abstract models are innate, and possibly part of the pleasure of being: even Cass Sunstein, co-author of best-selling behavioural economics text, Nudge, accepts the wisdom of establishing a cap on the number of economists at a dinner party.
Oddly, perhaps, it’s accepted that decisions about people may be influenced by unconscious awareness or stereotyped assumptions about gender, age, sexuality, class, ethnicity;by and large, most of us work hard to avoid those effects, perhaps because we acknowledge that there is both scope and prior evidence of irrationality.
We are less keen, however, to accept that our strategic and leadership decisions may be subject to bias. And that we may not be as rational as we believe ourselves to be in our strategic planning and resource allocation, despite the training and development, system driven budgeting and other efforts.
The evidence? Take business cases for major investment. Reports (such as Do You KnowYour Cost of Capital? Michael T. Jacobs and Anil Shivdasani) point to the impact of the assumptions made by managers on the outcome. Small changes in these may generate a big difference in the outcome, but assumptions are, by definition, based on belief more than hard fact.
At The Red Thread Partnership, we have many years of experience in working with, and advising at, board level. Here are some examples of behaviours we have witnessed, placed in a behavioural economics framework.
|What we saw||Behavioural Economics Bias|
|Failing to invest in innovation because this year has seen strong sales and margin growth after many years of poor performance||Present bias|
|Chasing after every possible sales opportunity rather than focusing on the strategic priorities (or focusing at all)||Loss aversion|
|Retaining a failing business (product, channel) despite poor performance because it has been successful in the past, or investing more in such failures than the business commits to new ventures||Endowment effect|
|Believing that because the board has been successful in the past it will continue to be so, and can therefore work on instinct rather than due process||Over-confidence|
|Assuming that the trend for the first six months’ sales (of a new product, channel, business) will extend upwards for years to come||Over-extrapolation|
|Making a large investment in expansion after one year of strong performance assuming that the trend will continue||Projection bias|
|Assuming that because the target market is large, the sales potential must also be large. Or thinking that all market gaps are opportunities rather than ‘holes’ in demand||Salience and limited attention|
|Making decisions on a product by product or market by market basis, failing to map the entire customer landscape of alternatives and substitutes||Narrow framing|
|Working to the same anticipated ROI across all business cases or investment plans, instead of devising a range of appropriate hurdle rates||Rules of thumb|
|Constantly seeking to match competitors, follow market leaders and meet the requirements of prospects, however costly||Social influence|
Of course, there are other pressures on decisions such as these. Shareholders may apply pressure to invest, divest or cut costs, with an eye on dividends or short term share price gains.Regulators may force similar actions for the supposed benefit of society or at the urging of interest groups.And there is always the possible influence of the pure, unbiased self-interest of individual managers and directors looking to maximise their career opportunities and personal wealth!
Even while they contend with these pressures, a great opportunity exists for directors and managers to take a long, cool look at how they work together and how they make decisions. Bias cannot be avoided but it can be recognised, managed and even used to empower processes.
Ask yourselves these questions:
So think about it – it’s not complicated, it’s hard.