Countering Biases in Business Decision Making

CoverThis e-book is a guide to the behavioural biases and fallacies of logic that distort business decision-making.  In addition to identifying these biases, ed it provides suggestions for countering them.  And rather than classifying by bias type, as has traditionally been the case for books on the subject, its structure is situational.  The biases have been grouped according to the business circumstances in which they typically arise. 

Over the past few years, several books focusing on the intersection of behavioural science and economics have made the best seller lists.  These include The Black Swan by Nassim Nicholas Taleb; Nudge by Richard Thaler and Cass Sunstein; Predictably Irrational by Dan Ariely; and most recently Thinking, Fast and Slow by Daniel Kahneman – the father of behavioural economics and a Nobel Laureate for his work on the subject. 

Around ten years ago, insights from behavioural research started to influence management thinking.  In July 2003 the Harvard Business Review (HBR) published an article by Kahneman and Dan Lovallo called Delusions of Success: How optimism undermines executives’ decisions.  At the same time, and identifying many of the same factors, Charles Roxburgh wrote an article in the McKinsey Quarterly called Hidden Flaws in Strategy.  In February 2009 Andrew Campbell, Jo Whitehead & Sydney Finkelstein wrote an HBR article called Why Good Leaders Make Bad Decisions seeking to prune the biases previously identified into an even more select subset.   And in 2011 HBR published an article by Kahneman, Lovallo and Olivier Sibony called Before you make that big decision that focused on how to counteract some of the biases identified by Kahneman and Lovallo in their original article.

These articles have helped bring insights from behavioural economics to a wider audience.  But in the process they have focused on a small set of heuristic biases.  It is our view that this concentration of attention misses some of the most significant biases that strategists face, such as those introduced by the way strategic objectives and challenges are framed.  (This omission was acknowledged by Kahneman in a Q&A session on the Freakonomics web site  – see his answer to the last question.)  In addition there are a number of other cognitive distortions – outcome bias, omission bias and the narrative fallacy to name just three – that have received limited attention but have a major impact on how we learn about and practice strategy development.

This guide seeks to rectify this gap.  The books on behavioural economics described above focus on making the case that we are not as rational as we think.  By contrast, this guide focuses wholly on the situational implications.  (Those needing to be convinced or wanting to delve more into the research should explore the books mentioned above, particularly Thinking, Fast and Slow; also Inevitable Illusions by Massimo Piatelli-Palmerini which is an excellent primer on our cognitive deficiencies.)   

This book starts with an overview of why the insights from behavioural economics fundamentally challenge prevailing practices in strategy development, what we have called the Old Rules of Strategy.  In particular it outlines why the analytical paradigm of strategy development doesn’t effectively counter the biases that arise from the uncertainty inherent in long term decision-making.  It goes on to suggest an alternative approach – the New Rules of Strategy – for better dealing with the challenges that uncertainty presents, thereby reducing the susceptibility of strategic decision-making to the range of biases outlined in the sections that follow. 

There are five of these sections, each focusing on a particular business challenge and the biases that can arise in each one.  Each section ends with suggestions as to how the biases described can be counteracted.   

The first section describes the prejudices that both limit the validity of predictions about how the business environment will unfold and result in excessive confidence being placed in the accuracy of these forecasts to the detriment of good decision-making.

The errors that can arise in risk and opportunity evaluations are covered in the second section.  This section highlights the difficulties we have in making accurate probabilistic assessments, a critical element in such evaluations.

In the third, the distortions that can occur when setting the direction for a business are outlined.  Direction setting encompasses everything from establishing objectives, identifying the key challenges that the business faces and defining how these will be overcome.  Biases that intervene in these processes lead to sub-optimal paths being followed. 

The fourth part describes the cognitive traps that managers can fall into when defining, designing and delivering transformational initiatives.  These initiatives translate decisions into action.  This is where significant funds are invested so mistakes here are also costly. 

Alongside decisions about strategic direction, decisions about individuals – who will fill what roles – are the most important a business leader makes.  The misjudgments that arise when assessing people (e.g. as part of performance appraisals or when recruiting) and performing self-evaluations are covered in the final section. 

As the overview section suggests, this book has particular relevance to those responsible for long-term strategic thinking in their organizations.  By definition strategy decisions must be based on assumptions about what will happen in the future rather than facts and that makes them fertile territory for rationality to be compromised. 

It is not that strategists are particularly susceptible to bias – arguably the sensibilities of those drawn to such roles make them less prone to distorted thinking.  But if the leaders responsible for making major decisions assume they are immune to irrationality, the risk of flawed moves and costly write-offs is much increased. 

In our view, the strategy development process in a behavioural age – where there is much greater awareness of the biases and prejudices that can distort decision making – should differ markedly from what it looked like in the age of assumed rationality.  Significant transformations in approach, mindset and method are required; but the need for such a wholesale change has been missed in the books and articles written so far on the business relevance of behavioural economics. 

The narrow focus their authors have taken has encouraged the view that bias can be mitigated through incremental improvements to current processes.  But once a holistic view is taken and an extended range of biases is considered, the questionable validity of the assumptions inherent in the existing paradigm becomes clear; and with it, why radical reform rather than minor modification is necessary.

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