How we regularly make poor strategic decisions without even realising, and what to do about it (2/4)

In the first post of this series, we explained how "cognitive traps" trick us into making irrational, and potentially harmful, decisions without realising it. We explained traps one and two, and their damaging business and financial consequences. We will cover ten such traps in this series, and conclude the series with some suggested methods of staying rational, and countering what seems an inevitability of falling into the traps.

In this post, we cover traps three to six, and their consequences.

Trap 3: “Availability bias”

This trap causes people to base decisions on information that is to hand, usually in their memories, versus the information that they actually need, like the car driver who loses his keys at night and only looks for them under lamp posts.

We see this at its most dangerous in Board or management workshops where the day is being run on the basis that all of the important knowledge is in the room. We have even heard facilitators use this we-have-everything-in-our-heads-already as a key premise for the entire strategy that emerges.

This cognitive trap also biases us to recency and proximity – we don’t look back far enough for similar patterns or warning signs, and we don’t look far afield enough for analogous evidence of failure or success.

Trap 4: “Confirmation bias”

This trap causes people look for evidence to prove what they believe to be true, rather than looking for evidence to challenge it: why Tories read the Telegraph and Socialists read the Guardian.

We see this bias at its most damaging in investment cases for acquisitions and in business cases for investment of money and time into new ventures or projects. Even when employing a third party professional to assess the acquisition, venture or project, the investor or business manager will actually ask for affirmation or substantiation – “I’m just looking for confirmation of my hypothesis” - rather than “Challenge me and tell me where I’m wrong”.

Trap 5: “The affect heuristic”

This trap causes people to allow their beliefs and value judgements to interfere with a rational assessment of costs and benefits.

We find this most dangerous at either of two extremes: on the one hand where the decision maker is very passionate about a subject, or on the other where he is once-bitten-twice-shy.

In the former case, whilst we find it critical that managers be passionate about their products or services, this passion can blind the person to reality, and can be impossible to address without introducing a very senior individual with authority to challenge assertions with information.

In the once-bitten-twice-shy case, we have seen private equity companies abandon entire sectors following one painful loss, and refuse to entertain the most solid business case that shares even the remotest common characteristics of historic loss-makers.

Trap 6: “The problem of induction”

Induction is the process of generating a general rule from a series of observations. In the absence of clear indisputable deductive relationships, induction can be all a person has to go on. The problem of induction is that the brain will look for neat patterns and will try to create a general rule even if it is based on insufficient information.

In acquisitions, people can over-estimate the performance and prospects of a company by seeing how satisfied its customers are. This creates an overly-positive pattern from what is essentially a self-selecting group: non-customers and disgruntled ex-customers need including for the full picture. Another example of poor induction is where management projects forward on the basis of a new product’s first year’s sales and forget to consider that this first year was a golden year, where everyone without the product bought one and would never need another.

A very common area where induction knows no bounds is in the practice of regression: correlating one factor against another to create what superficially appears to be a causal relationship. For example, it is possible to infer high price sensitivity when analysing price-volume relationships, and miss the over-riding effect of heavily marketed promotions that commonly coincide with lower prices. I was humbled to the limitations of correlation when an analyst working for me at my former company determined an almost 100% correlation between pallet demand and GDP. We started to doubt the causality when the analyst realised that she had used the wrong source data and correlated UK pallet demand with Polish GDP numbers. Our confidence in the causality was damaged further when the correlation with the "correct" driver, UK GDP, was about 30% lower.

In our next post, four more cognitive traps, after which we will conclude the series with some suggested counter-measures.


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For the full text of this series email steve@latitude.co.uk