One finds limits by pushing them

Herbert Simon

Omaha – with 450,000 inhabitants located in the state of Nebraska and designed in classic American grid to allow you to quickly move on – is no global metropolis. Still, every year for 40 years on the first Saturday in May 30,000 people from all over the world travel there for a 6 hour event also known as the “Woodstock for Capitalism”. On stage, two old men are sitting. For 6 hours Warren Buffett and Charlie Munger entertain with stories and jokes about the past year. They are both on Forbes shortlist of richest people in the world and the 30,000 people are investors in Berkshire Hathaway, which the two men made the most successful investment company in the 20th century. If you in 1964 invested USD 1,000 in S&P500 – the stock index for the 500 largest American stocks – you would in 2015 have USD 112,000. If you instead had gone with Buffett you would have had USD 18,000,000. That is a factor 160. Imagine retiring with USD 112,000 – and then imagine retiring with USD 18,000,000. Exactly this difference explains the mood in the room. Euphoric.

So how did they do it? Munger summarises it in one word: “Rationality”. Does that mean a giant head office filled to the brink with the brightest minds and biggest computers ever seen to surgically analyze any investment opportunity? No, Berkshire Hathaway is run from the 4th floor of a boring office complex in Omaha by about 12 people. There is no computer in Buffetts office – just a phone. And they are quick to admit that they make lots of mistakes. In other words faced with the immense complexity of investment opportunities, they have not invented an equally complex method. The previous chapters have shown how our decision processes are systematically flawed, but we never aimed at bringing us back to the unemotional Homo Economicus machine. All in all there is probably more good than bad in our biases – it kept us alive throughout evolution. What Munger and Buffett have done is to learn the secret behind how biases strike and how to avoid the worst effects.

Munger calls the ability to navigate a complex reality for”Practical Worldly Wisdom” also known as the infamous ”if you have a hammer, then everything looks like a nail”. The sciences have each a set of problems, which they handle well – physics how matter acts, psychology how people act, economics how markets act and so on. But most problems are complex. They hold elements from several sciences. Are you buying a competitor? Financial, legal, commercial, operational, organizational and digital consequences. If you want to excel at decision making, you need to accept that most real problems are entangled in complexity that cannot just be reduced to one rational equation and this is where “Wisdom” comes in for three reasons, recognizing:
1) it is not about reducing large problems to less complex ones, but it is our ability to handle complexity that must be improved
2) problems are complex and not ”well shaped”, so engineers cannot construct a mathematical formula to solve it
3) problem solving is a scale, so a 1,000 answers to a problem does not mean 999 wrong and 1 right, but more like a group of some obviously idiotic, some decent ones and a few truly wise

“You need to recognize the great ideas in the large disciplines and use them regularly” said Charlie Munger. His recipe is to learn the mental models of how things work in the world and then apply that to problems. Each mental model may be a simple insight in a science like critical mass in physics, compound interest in math or biases in psychology. Together they bring wisdom. This is an attractive thesis, because it has been developed by an extremely successful practitioner, it offers a solution for problems too complex for traditional analysis, the many angles will per definition minimize biases – and it can be trained. Of course not overnight and to start you up, we developed a simple problem review model:

1) Select the decisions that deserve the effort. Either rare decisions with a large effect like company strategy or repeated decisions that compound over time like ongoing capital allocation – this is why green field budgeting is so powerful.

2) Identify the mental models that explain the effect. Over time you will develop a catalogue of mental models, but for now use this short cut: Consider how the problem is constructed. What are the main factors that explain the effect given the possible actions. What are the most important things you can do to ensure success. Which factors depend on each other and how? Finally use the Negative Rule and turn the problem upside down. What happens if everything fails? Where do we NOT want to end up and how would we get there? Who should we not talk to, what should we avoid doing, what top 5 things should we do to ensure failure? Finally, write it down. There is nothing like text to reveal unclear thinking.

3) Identify the biases most likely to affect critical decisions. You now have a problem that is important and you know how it functions. To identify the likely biases you can take an open discussion about previous or observe current decisions around stakeholder interests, project overconfidence, data refuting our analysis etc. You can also use the overview of biases in the previous chapters like a check list. but be aware of the “Lollapalooza effect”, where two or more biases work together towards a certain behavior.

4) Pick the right solution. By now you are well versed in the 6S model and we will here summarize some of the most powerful tools across the bias groups. In STRATEGY we often use scenario planning, because it handles most biases in the beginning of strategic processes by creating a roughly right picture of the world and the opportunities. We typically add the Playing To Win method, because it is coherent, iterative and manages all the biases in the decision making part of the strategy process. In STRUCTURE you want to start with organizational objectives, identify the relevant standard structures and combine before considering any individuals. We have developed this method for a C25 client to avoid the Lollapalooza effect in this complex and biased field. In STEPS we primarily focus on process management combined with Wisdom of Crowds and the infamous check list. In SYSTEMS there is no single method, but there are a few themes like Early Warning Systems for critical risks, ultra simple processes or automated reflection timeouts. In SKILLS you firstly need the competencies matching the organizational processes mentioned above, the capability to “think outside the box” to avoid availability and confirmation biases as well as a rigorous problem solving approach to ensure a rational basis for decisions. In STYLE focus is on diversity of knowledge, perspective and attitudes as well as a careful design of reward systems, because you get what you pay for – generally high level team outcomes are better than individual process goals.

5) Formalize the approach in your processes. Execution is a book on its own with it’s poor track record – not least because of the many biases like status quo bias, emotional bias and planning fallacies. The most critical thing about execution is that it does NOT come after strategy. You need to start the execution process before any strategic decisions are made ideally through involvement to the extent stakeholders start saying no. It is not necessarily the involvement that is important, but the fact that they feel that you made a serious effort in listening. Generally, you want to make the experienced – not necessarily the actual – change feel easy, attractive, timely and socially accepted for example by signing on role models. Keep the list of overconfidence biases top of mind, because it is here that scarcity of time and money is created – over time you will learn what level of risk to apply to different types of plans and budgets.

”This is the beginning of a beautiful friendship”, concluded Humphrey Bogart at the end of the classic movie Casablanca and in the same way we hope this is the beginning of a new journey for you. It would be overconfident to imagine that you by now have integrated knowledge and practice from behavioral economics into your organization with amazing results. You are done when it is second nature and that takes time. In conclusion we have two key points for you. The first is to be wary of your intuition. Our mental systems are formidable at solving the problems they were developed to handle but not the ones that we meet in our modern world – think twice and thoroughly with the tools here. The second and more positive point is that you can make much better decisions if you are conscious about how your cognitive processes may undermine you. You may miss important information right in front of you, throw yourself overconfidently at a business venture without any safety belt and avoid important decisions due to complexity. Of course the behavioral strategic journey takes effort, but the benefits – better decisions and results – will make this is one of the most valuable strategic investments that your organization can make.

This was the last chapter in our awarded book Decision Strategy. Contact brian@behaviouralstrategygroup.com for more information.