Business decisions are frequently flawed. A KPMG study of corporate mergers and acquisitions – some of the highest-stakes decisions that executives make – showed that 83 percent failed to create any value for shareholders. What are the greatest cognitive and psychological pitfalls that lead to such bad decisions and how can you avoid these?
Many businesses put their faith in careful analysis for important decisions, such as whether to launch a new product or service, change the structure of the organisation, enter a new country or market, or acquire another firm.
While there is nothing wrong with a rigorous analysis, what companies often neglect is going through a thorough decision-making process.
Researchers Lovallo and Sibony found that process is more important than analysis in producing a good decision - one that increases revenue, profit or market share by a factor of six. A typical decision-making process in a company is organised as follows: they have a team arguing only one side of a case and it falls to the final decision-maker to be both the challenger and ultimate judge. Building a good decision-making process is largely ensuring that flaws like these do not happen. In their book 'Decisive', bestselling authors Chip and Dan Heath describe the process managers should follow in order to avoid the four main villains of decision-making.
1. Narrow framing
Famous psychologist Daniel Kahneman (author 'Thinking, Fast and Slow') said that we are often too quick to jump to conclusions because we give too much weight to the information that is right in front of us, while failing to consider the information that is just offstage. And that, in essence, is the core difficulty in decision-making: What is in the spotlight will rarely be everything we need to make a good decision.
Narrow framing is the tendency to define our choices too narrowly. Asking the question: 'Should I fire Shannon or not?' is an example of a narrow frame because it spotlights one alternative at the expense of all others.
How to overcome this?
The first step is recognising the narrow frame. "Whether or not" choices are rarely a good idea. A 1993 study by Paul Nutt of Ohio State University analysed 168 decisions and found that of the teams he studied, only 29 considered more than one alternative. He also found that "whether or not" decisions failed 52 percent of the time over the long term versus 32 percent of the decisions with two or more alternatives. Nutt argues this is to be expected because when a manager pursues a single option, she spends most of her time asking: "How can I make this work?" rather than finding better ways to do it. Adding options (legitimate alternatives, not sham options) leads to better and also faster decisions, research shows. A good way to generate new options is to find someone else who has already solved your problem. Joining the CFO community is good place to start finding that someone else.
What makes narrow framing remarkable is how easy it is to correct - the lightest prick often bursts the bubble. There are a number of ways for doing that. The Vanishing Options Test: what if you couldn't do any of the things you're considering - what else might you try? Multitracking - thinking "AND" not "OR" - is another effective technique to compare options.
2. Confirmation bias
Our normal habit in life is to develop a quick belief about a situation and then seek out information that bolsters our belief. This problematic habit, called the 'confirmation bias', is the second villain of decision-making. Data that supports what you think and data that contradicts what you think. Guess which one gets cited at the board meeting? Researchers have found this result again and again. When people have the opportunity to collect information from the world, they are more likely to select information that supports their pre-existing attitudes, beliefs and actions.
The tricky thing about confirmation bias is that it can look very scientific. After all, we're collecting data. Dan Lovallo, professor and decision-making researcher, said: "Confirmation bias is probably the single biggest problem in business because even the most sophistic people get it wrong. People go out and they're collecting the data, and they don't realise they're cooking the books."
How to overcome this?
First reality-test your assumptions by finding more trustworthy information. Be diligent about the way you collect information, asking disconfirming questions and considering the opposite. Go talk to your customers to find out their biggest problems. Try your competitors' products. Specifically, look for the outside view because this is always more accurate than your own inside view. It is a summary of real-world experiences, rather than a single person's impressions. Furthermore, go talk to an expert. However, do not ask for predictions but rather, for an assessment of the base rate. In the case of a lawsuit, for example, ask, "What kind of evidence can tip the verdict one way or the other?" Or, "How many cases get settled before trial?". Do not ask, "Will we win this trial?"
A wise CEO might also assign a team to make a case against a certain decision. It puts the team members in the role of protecting the organisation and licenses their scepticism. This is thus a very good idea, especially with a high-stakes decision, such as an acquisition or large investment. Finally, experiment rather than predict. One survey found that 60 percent of Inc. 500 CEOs had not even written business plans before launching their companies.
3. Short-term emotion
In the early 1980s, Intel had two main products: memory and microprocessors. Memory, the company's original business line, was still the dominant source of the company's revenue, but in the early 1980s, the company's competitive position in the memory business came under threat from Japanese companies. In the years that followed, Intel's position was getting worse and the memory products were becoming a drag on profits. In 1985, president Andy Grove was discussing the problem with Intel's chairman and CEO, Gordon Moore. Grove asked him, "If the board kicked us out and brought in a new CEO, what do you think he would do?" Moore answered without hesitation, "He would get us out of memories." Grove stared at him, numb, and said, "Why shouldn't you and I walk out the door, come back in, and do it ourselves?"
This decision was so hard for Grove and Moore because they felt conflicted. The short-term pressures and political wrangling clouded their minds and obscured the long-term need to exit the memory business. By switching their perspectives - "what would our successors do?" - Moore and Grove suddenly saw the picture clearly.
How to overcome this?
You can overcome short-term emotion by creating distance between yourself and the decision, like Grove and Moore did. A tool to do this is called 10/10/10. It makes us think about our decisions on three different time frames: how will we feel about it in 10 minutes, 10 months and 10 years? This helps to level the emotional playing field. We should also seek the advice of others. Psychologists have found that when we are giving advice, we find it easier to focus on the most important factors. Ask yourself the question: what would I tell my best friend to do in this situation?
4. Overconfidence
In January 1962, a four-man rock 'n roll group was invited to audition in London for one of the two major British record labels, Decca Records. After the audition, they received the verdict: Decca had decided to pass. In a letter to the band's manager, Dick Rowe, a prominent talent scout at Decca Records, wrote, "We don't like your boys' sound. Groups are out: four-piece groups with guitars, particularly, are finished." By now you probably guessed the band that Rowe rejected was the Beatles. He had learned the hard way that the fourth villain of decision-making is overconfidence.
People think they know more than they do about how the future will unfold.
For example, a study showed that when doctors reckoned themselves "completely certain" about a diagnosis, they were wrong 40 percent of the time. When a group of students made estimates that they believed had only a 1 percent chance of being wrong, they were actually wrong 27 percent of the time. We have too much confidence in our own predictions.
How to overcome this?
Never be too sure because the future is uncertain. Always prepare to be wrong. Also, rather than make predictions - at which humans are generally very bad - consider the range of possible outcomes, both positive and negative. When we think about the extremes, we stretch our sense of what is possible, and that expanded range better reflects reality. Another well-known technique is the premortem. We are one year into the future and the idea went horribly wrong. What happened? The premortem stops people focusing on a single, usually optimistic, guess about how the world will unfold and instead compels them to pay attention to the uncertainty surrounding the guess. Also focus on the opposite of the premortem: a terrific success. Is your company ready for it?
Our decisions will never be perfect but they can be better. The right process can help to navigate even the thorniest decisions and help to avoid the dangers along the way.
By Jeppe Kleyngeld
