You know the saying – Time flies when you are in mortal danger on uncharted decision-making territory and Dilbert will now guide you painstakingly close to the last of the Big Five – Loss Aversion bias. Together with Availability, Confirmation, Overconfidence and Emotional biases they make up a whopping 70% risk of failure in strategy. When is the last time you spent a few years on something that you knew would likely fail?
Loss Aversion is a tricky animal. It makes you fear losses much more than similar size rewards attract you. If someone offers you a bet on a flip of a coin, where you gain USD 100 on heads and lose USD 100 on tails, then no one will take it, although the gain and loss multiplied by the probability are exactly equal. In fact, research shows that you need to get about twice the amount in gains on average before you take it!
The good part is that it is easy to recognize in the wild. Whenever you own something, you can be sure it is lurking in the dark, and this is one of the reasons that imperfect markets like private houses can sometimes take long to close a deal – when you are about to sell the house, where you spent your life and raised your children your valuation simply goes through the roof. But professional players and “perfect” markets are highly susceptible as well. When you are selling off part of your business, changing your strategy or divesting assets of any kind, that you have personally acquired, then you are simply more committed to what you have than what you can gain and thus demand inordinate compensation for letting it go. This is one of the reasons that when large changes are required, it can be a good idea to bring in a new CEO. But beware Loss Aversion quickly takes hold – if you are somehow able to get your product in the hands of a customer for just a few seconds, it increases the purchase likelihood by about 80%…
Like the other Big Five biases, Loss Aversion has a dangerous family of its own – teeth, claws and all: Scarcity, Escalation of Commitment, Sunk Cost, Ownership Effect, The Framing Effect (Changing how people react to a situation based on whether you frame it as a loss or a gain: Did you have to let 30% of the staff go or did you manage to retain 70%?) and Mental Accounting (Your tendency to create different mental accounts – for example one for regular income sub-allocated into different spending accounts, but if you have a sudden windfall that is of course completely different and should be burnt immediately on something useless). All these siblings affect how you value different options just like traditional car companies considering whether to move away from a century old engine technology. Just saying.
Now how do you fight such a powerful beast? The last part of Dilbert’s strip is scarily insightful – once you understand that you are influenced by biases, you will quickly do… nothing. At least not without some tricks, so if we are talking assets or projects, you might need sell-by-prices or close-by-dates, where you have pre-committed publicly and in writing to a certain action – thereby using your fear of losing status to combat your Loss Aversion bias. Ask yourself would you rehire that person or reinvest in that idea to test your Sunk Cost bias. It can be difficult to assess what is common sense and what is just general Loss Aversion, when looking at a number of strategic options and you deselect the riskiest ones – make sure to really do your due diligence on both probability and reward, because like Venture Capitalists you only need one of the low probability/high reward options to work out.
Congratulations! You survived meeting the Big Five and your Certification of Bias Tracking is in the mail (no really…). But last time I did promise a little surprise – because although you have met the Big Five biases that make up the 70% risk of strategy failure, there is in fact another bias group, which is just a little different – maybe like black sheep. You have had ample opportunity to study this animal in it’s natural habitat – I am of course talking about Bounded Ethicality for example in financial institutions…
Now if you cannot wait for the bonus safari trip or you want to safeguard your strategy against these animals, then contact me now at firstname.lastname@example.org or +45-23103206.