Decisions can benefit from a little understanding
Experiments show that when people place a bet on the flip of a coin, they prefer to do so before the coin is tossed. People believe they ca n influence the future - an illusion sometimes echoed in business decisions which defy all logic. The stampede of investors into dot coms demonstrates this.
Authorities on decision-making claim these "illusions of control" distort managerial decisions. A good start in learning to avoid them is an understanding of how judgment may be adversely affected.
Anchoring: We tend to give disproportionate influence to the first piece of information we receive about a decision. First impressions become anchors and unduly sway subsequent judgments. For example, a high guide price for a house is likely to inflate auction bids, while low guide prices bring more bargain-hunters into the market.
Another form of anchoring occurs when problem-solvers accept conventional wisdom or the first idea that presents itself. They fixate on the one idea, may fail to solve the problem, perhaps creating more difficulties later.
Mental models: Unconscious assumptions, or mental models, may intensify anchoring. Among these is the inclination toward the status quo. People cling to standard ideas, thus avoiding the criticism and regret should they strike out and fail. Also, if the status quo has worked, mental inertia creates misguided complacency, so we repeat past decisions.
Even when we don't opt for the first obvious alternative, we might still adopt the first decision that meets some minimum criterion - "satisficing". Time pressures and an inability to pursue innovation that might improve choice produce this "that'll do" approach. While satisficing may be efficient for minor decisions, when it comes to strategic decisions with long-term implications and significant investment, this will not do.
Over-confidence: This may distort forecasts on costs and benefits of the choices being considered leading to the wrong decision. Tests confirm that most people overestimate the accuracy of their forecasts, implying that managers may overestimate or underestimate returns from projects, thus perhaps engaging in unproductive ventures or missing attractive ones.
An overdependence on modelling techniques to predict the future can give false confidence. Despite the shortcomings, decision-makers frequently treat findings from models as gospel. For instance, recruiters applying scoring grids to evaluate job candidates can make the wrong choice if they rely excessively on numbers. The totality of grid scores usually does not capture the totality of the candidates, especially for senior jobs, where subtle or multidimensional characteristics such as leadership are involved.
People highlight their positive characteristics and discount their negatives, thereby producing overconfidence. They can be unrealistically optimistic about their future relative to others, believing they are less susceptible to misfortune and that they can control events. Thus, executives may take chances, based on unwarranted optimism and the "illusion of control". Ironically, an overly positive self-image may make a person less prone to recognise false illusions.
Restricted choices: Inaccuracies in predicting outcomes of alternative decisions can arise from a fixation on a sole consequence rather than multiple outcomes. We may focus on more immediate results because we tend to discount the future. Thus, those involved in mergers concentrate on finalising the deal, as opposed to making the arrangement work. They also overlook numerous responses to the announcement, as stakeholders, internal and external, adopt positions that can affect the deal.
The implications of different choices are not adequately evaluated if knock-on effects are ignored. A company may decide to enter a market but forget that incumbent rivals will not stand idly by. Freddie Laker learned this when he provoked the established transatlantic airlines into a price war that Laker Airlines could not hope to survive. Laker should have considered this before choosing his strategy.
Just as the immediate future can unduly influence decisions, so can the immediate past. Since we often base our predictions on memories, we use what is most memorable, thereby distorting our decisions. Good or bad earnings quarters will often be reflected in an extreme move - up or down - in share price.
Evaluating risks: Over-confidence, unrealistically positive self assessments and emotional preferences can result in underestimating the risks of some alternatives. On the other hand, people may plan for the worst case scenario, erring on the side of caution. Hence a risk-averse company pessimistic about its sales forecasts may undershoot production levels and leave customers with unfilled orders to buy from a competitor. Next season, it may raise its production based on the last order levels (recent memory), but find a shortfall in orders because it had not considered knock-on effects of unsatisfied customers migrating to competitors.
Escalation and entrapment: Frequently, good money is thrown after bad. When a decision fails, we may justify it by investing to fix it. Banks lending large sums to customers who default may lend more to the same customers, hoping they can rescue the borrower who will then pay them back.
So the way we think and our emotional needs can lead to poor decisions. Understanding these psychological propensities should help the decision-maker avoid their worst effects - inadequate generation and evaluation of alternative choices. This can be achieved by making an effort to expose oneself to a variety of experiences and perspectives, to be open minded, especially to those likely to have a different viewpoint, to seek views of people not involved in earlier decisions, and to make underlying assumptions explicit, subjecting them to examination.
Dr Eleanor O'Higgins is a lecturer in strategic management and business ethics at UCD graduate business school