The upside of irrationality – Loss Aversion bias

“If there is a 50-50 chance that something will go wrong, then 9 times out of ten it will.”

Paul Harvey, Journalist

If someone approaches you with a bet of USD 100 at a flip of a coin – if you win you get 100 and if you lose you pay 100, then you are not going to take it. Whether it takes increasing your winning option to 150 or 250 depends on your specific risk appetite, but on average you need twice as much back as you have in risk. Twice!

Daniel Kahneman – the nobel price winner and author of Thinking Fast & Slow – calls this the most significant contribution of psychology to behavioural economics. The applications in all business, negotiations and not least stock trading cannot be overestimated – any place there is anything less than perfect information on both sides of a deal, there will be manipulation (consciously or not).

Here is Dan Ariely – one of the most popular authors and professors in behavioural economics – giving you some really sharp pointers and tricks on loss aversion:

If you enjoyed this you will love next time, where your own emotional bias will be tested if you dare… And if you have too much of an appetite, then contact me at brian@behaviouralstrategygroup.com or +45-23103206.

None of your decisions are rational

I had the pleasure of my first live Linkedin interview on behavioural economics and why none – yes none – of your decisions are rational a few weeks ago with national Linkedin celebrity Giovanni Niese.

Giovanni managed to make me look both smart and funny most of the time, when speaking about the six main bias problems all humans face and the secret tricks to avoid them before disaster strikes, so sit back and enjoy (in Danish)!

I hope you had just half as much fun watching as Giovanni and I did making this video for you. If you want to learn more about how to avoid irrational business disasters, feel free to contact me at +45-23103206 or brian@behaviouralstrategygroup.com.

The upside of irrationality – Overconfidence bias

“A very disturbing feature of overconfidence is that it often appears to be poorly associated with knowledge – that is, the more ignorant the individual, the more confident he or she might be.”

Robert Trivers, Sociobioligist

Duke University has been asking CFOs of large companies over a number of years to assess the return on Standard & Poor’s stock index over the coming year. Over time, the researchers collected 11,600 projections and thus had a good basis for assessing whether the CFOs were able to predict developments. Their conclusion was that CFOs of large companies have no idea about the development of the stock market a year ahead. In fact, the correlation between their estimates and price was in fact less than 0. This means that when they said, for example, that the shares would fall, the shares were more likely to rise. But the surprising thing was that CFOs were not aware that their forecasts were complete rubbish. This discrepancy between the CFOs self-perception and their real abilities is a good example of overconfidence.

Can overconfidence be a good thing? Well your tendency towards overconfidence damages your learning process and the quality of your decisions. Positive illusions and overconfidence lead to and escalate conflicts, reinforce arrogant and careless behavior, take undue credit for successes and blame others for failures, plan projects and set goals out of step with reality. Otherwise it is a great thing.

Here is a fun video with a very interesting hypothesis at the end about why you do all that:

Next up is Emotional bias – if you liked this, you will love that!

If you want to learn more about how to avoid this in your business, contact me at brian@behaviouralstrategygroup.com.

The upside of irrationality – Confirmation bias

“If you torture the data long enough, it will confess to anything.”

Ronald Coase, Professor in Economics at Chicago Business School

The power of your brain never ceases to amaze me.

You make snap decisions on very little real content and instead respond disproportionally to authoritativeness and approachability. You jump to superficial and quite stable conclusions such as when you have started to favor one prime minister candidate over another, no amount of evidence will change your opinion. This is the reason that televised political debates are pretty much a waste of time.

But how far can you actually take it? That was the question that spawned this hilarious video – watch it to the end for the big surprise:

Normally, you would hear something like: “dont try this at home – we are trained professionals”. Well firstly I guess this is why behavioural economics is the funniest profession and these vidoes are the upside of irrationality – and secondly why not give it a try at home? Let me know how it works out!

Next up is Overconfidence bias, where I have yet to find a great video, so feel free to hit me with ideas at brian@behaviouralstrategygroup.com – stay tuned!

The upside of irrationality – Availability bias

“I confine my exercise to sidestepping responsibility, jumping to conclusions, pushing my luck, flying off the handle, running up bills and stretching the truth.”

Unknown author

If a picture is worth a thousand words, then a video must be… well better. The upside of all this irrationality in your biases is that all researchers have been “forced” to make fun videos to illustrate their learnings. Now you have been through Dilberts guided safari tour through uncharted decision making territory and a ton of other exciting stuff, but let’s mix it up: You will get a hilarious video and a razor sharp quote the next six week to illustrate, why you – yes you – are irrational all the time!

We will go through all your six core bias groups of (the avid reader will notice how they perfectly conform to the quote above):

  • Availability bias – why you focus too narrowly
  • Confirmation bias – why you jump to conclusions
  • Overconfidence bias – why you overrate your own importance
  • Emotional bias – why you live by your feelings
  • Loss Aversion bias – why you hold on to things too long
  • Bounded Ethicality bias – why you lie all the time.

Lets kick it off with one my favorite videos and quotes about Availability bias:

“Our comforting conviction that the world makes sense rests on a secure foundation: our almost unlimited ability to ignore our ignorance.”

Daniel Kahneman, Nobel Price Winner & author of Thinking Fast & Slow

Now almost no one gets this video, but of course you did, so pass it on to a friend to test them – after all it is good to laugh at yourself, but more fun to laugh at others… (sorry Danish irony may interrupt core messages here from time to time). Next week you will see, why you jump to conclusions all the time – stay tuned!

If you want to explore more or learn how to save you or your company from these every day mistakes, when you are making big decisions, please contact me at brian@behaviouralstrategygroup.com or +45-23103206.

Strategy from board perspective featured in nBoard

Strategy is the most important job for the board of directors, but what role should you play in the different process steps and how do you avoid the most dangerous mistakes?

I have written a short article in the professional board network nBoard for the board members in my network based on my experience from strategy projects (no paywall and in Danish).

Strategy from board perspective

If you want to discuss how to set up strategy right or just learn more, contact me at +45-23103206 or brian@behaviouralstrategygroup.com.

Innovative project approach recognized

metaphor-lightbulbs_unique

Behavioural Strategy Group was just featured in the Comatch newsletter to more than 1,000 strategically minded businesses with an article on our next practice strategy as an innovative project approach!

Originally planned for November last year we had a bit of over-the-holidays-corona confusion, but now it is there and of course you should not be cheated of the article so here is the link – enjoy reading:

Next practice strategy

If you want to learn more, then contact me at brian@behaviouralstrategygroup.com or +45-23103206.

Dilbert does Bounded Ethicality bias

http://www.dilbert.com

Welcome to the end of the safari through uncharted decision-making territory with your guide Dilbert. You have encountered the Big Five animals that kill off 70% of all strategy – now get ready to meet their black sheep sibling…

Bounded ethicality is your systematic and predictable tendency to act dishonestly because you only see the parts of the animal that you want to see. You might cheat on taxes, lie about your exciting life, take credit for your colleagues results or steal pencils from work without ever really questioning your self-image. Yes, there are also the big ones out there like Dick Fuld, who as the CEO of now bankrupt Lehman Brothers was a key player in the largest financial crisis in almost a century. But most people just engage in everyday dishonesty – and the combined value of that has been proven in studies by behavioral economics professor Dan Ariely to greatly outnumber the big bad villains!

Now, how do you recognize the black among the sheep in the wild? Well, firstly you need to understand that most people actually want to behave – out of a strong sense of fairness or simply because dishonesty is punished in society. Consider this experiment: You are standing on a train station next to another commuter, when you are both approached by an elderly gentleman with a proposal. He will give your fellow commuter USD 1,000, if she can agree with you to share some of it. She proposes USD 20 for you and USD 980 for herself – what do you do? If you are like most people you say no because it is unfair, and the experiment almost always concludes close to 50/50 sharing. So, you want to behave – but you also want to maximize your own utility – and whenever these two things are at odds, you can be sure to find trouble.

Surprisingly, black sheep comes in flocks and they have an extended family to watch out for: Everyday dishonesty, indirect unethical behavior (you overlook or hide unethical behavior for example by outsourcing unsustainable production practices to third party businesses), motivated blindness (classic impartiality issue like accounting firms watching over their clients), in-group favoritism (for example you give board roles to your network), implicit attitudes (your stereotypical opinions about different demographic groups – a whole training industry has sprung up around just this one bias – and no, training does not help), experience of fairness (your tendency to be willing to lose out yourself in order to punish unfair behavior). Recognize any of these in recent business scandals?

As you can probably imagine it is much easier to recognize bounded ethicality in others than in yourself, so fixing it is difficult. Start by identifying risks of motivated blindness in departments and reward systems – for example investment teams in pension funds often assess their own performance, and somehow they deserve exuberant bonuses every year… A great trick is to continuously remind the organization about your ethical code – it might sound too easy, but this simple act can drive enormous impact as proven in many studies for example with theft – not least because the first unethical behavior is typically small but shapes the future view on fairness. On a grander scale build simplicity, transparency, diversity and impartial control into organization, processes, and systems to create an environment without shady spaces for bounded ethicality.

This time I mean it. This is the end of the Dilbert guided safari through uncharted decision-making territory. The Big Five of Availability, Confirmation, Overconfidence, Emotional and Loss Aversion biases kill 70% of your strategies – and their black sheep sibling Bounded Ethicality can burn down the global economy – so a formidable foe to beat. When you want to safeguard your strategy against these animals, contact me at brian@behaviouralstrategygroup.com or +45-23103206.

Stay safe. And don’t play with the animals.

Dilbert does Loss Aversion bias

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 brian@behaviouralstrategygroup.com or +45-23103206.

Stay safe.

BSG nugget: Incentives do work…

…but probably not in the way that you expect!

And since you have just passed New Years, it probably means that this is last chance for your organization to finalize your bonus schemes despite a whole body of work from motivational theorists over psychologists and latest behavioral economists has been pointing out that monetary incentives are challenging in most organizational settings:

Firstly, as Daniel Kahneman points out in his landmark book, Thinking Fast & Slow, money drives individualism over team work: “The general theme of these findings is that the idea of money primes individualism: a reluctance to be involved with others, to depend on others, or to accept demands from others”. Your company is more likely than not a highly integrated organism, where the whole is greater than the sum of the parts and your departments depend on each other for success: finance depends on operations, which depends on sales, which depends on marketing, which depends product development and vice versa.

Secondly, as Dan Ariely, another key behavioral economics player, has described again and again, money tends to take you away from focusing on the overall purpose of an organization and towards maximizing your own benefits – and they are often difficult to align. Sales is good, so more sales is better – except of course when sold below profit, above available inventory, in a way that compromises future sales etc. And sales is actually the easiest to measure and align!

Thirdly, as shown by Daniel Pink in the video above, money as an incentive even in relatively basic jobs tend to reduce rather than increase your performance. You need to pay a fair compensation to avoid demotivation, but what actually works is focus on building your autonomy, mastery and purpose into your job – so being able to decide within your working area, being able to develop strong skills in your working area and finally connecting your working area with a higher purpose.

Clearly incentives work, but not in the way that you want, so what to do? Well, here are three quick tips:

  1. When individual rewards do not work, try to think of a team approach – this both helps before AND after the reward, as it is part of a shared experience, win and celebration.
  2. When money in itself primes a focus on your own financial benefit at the expense of the organization look for less direct monetary rewards such as an experience or invest in strong purpose organizations with employee ownership.
  3. When money as a direct incentive actually reduces performance then why not simply remove it. Pay fair compensation, build fantastic jobs and maybe build in a profit sharing approach, so you can be sure that both your organization and your company wins at the same time.

And yes, most of the rules and tools on what, when and how to measure and reward still needs to be considered. If you want to design your organization, metrics and change programs, so they fit how real humans think and behave, contact me at brian@behaviouralstrategygroup.com or +45-23103206.