Last time we introduced the EAST model of change – If you want to make the change work, it must be Easy, Attractive, Social and Timely – this time we focus on Easy. Humans are purpose built to save energy to always have a strong reserve for the challenging and often changing environment. So, if you want someone to change something, you want to make it easy for them – take away all the actual AND perceived effort, discomfort and stumbling blocks in their way. Here are three strategies, that you may use:
Opt out: In every situation, there is a default outcome. In most cases that is to stick with status quo and to change it we would need to take action to opt in. So not only do we prefer status quo twice that of change, but if we are exhausted, hungry or missing sleep then we typically do not want to change anything, so it is almost impossible. For example, if you ask people whether they want a pension fund, green energy or organ donation, almost everyone agrees. But almost none acts. Instead of asking people to opt in, ask them to opt out, if they do not want to do it – conformity increases from 5-10% to 90-95% with just that trick!
Quick steps: If you have ever been to any old-fashioned company or government agency, you have probably tried death by form – a ton of stuff to fill out, most of it without any real need and all of it filled out countless times before. I always imagine some evil administrator with a lifetime of disappointments concocting new ways to make my life a living hell when I am there. Instead cut the steps, simplify the forms, collect the data yourself, reorder the process, so you only need a small percentage of people to fill out something – and for Pete’s sake save it! Think of Amazon’s one click to buy button – I would love it if it did not cost me so much…😊
Priming: All right all right, I have said it before. But seriously, I promise to stop as soon as you stop dropping sudden-town-hall-strategy-transformation-meetings on poor unsuspecting employees. Just tell them what you are going to tell them. Then tell them. And then tell them what you told them. But not in one meeting. There is nothing wrong in you telling them that when you are looking into the annual strategy update, that you are – drum roll! – looking into the annual strategy update. They will appreciate it. After all it is your job. And once you have given them these updates a few times with just a bit more meat on it every time, they will be wondering why, nothing has been done yet instead of fighting it.
MAKE – IT – EASY!
I hope you enjoyed this short introduction to the first dimension in the EAST model – next time we will talk about attractiveness, but if you cannot wait… well you know what to do. email@example.com or +45-23103206.
Our irrational behaviors are neither random nor senseless – they are systematic and predictable. We all make the same types of mistakes over and over, because of the basic wiring of our brains
Dan Ariely, Behavioural Economics Professor
Let’s play pretend. Let’s pretend that your company has managed to develop just the right culture and design just the perfect change program again and again. That should be enough, right? Afraid not – you will still encounter the entire Zoo of Irrationality – the six bias groups.
We tend to have tunnel vision and thus miss all the largest opportunities, search for data confirming our preconceived notions and overlook warning signs, be overconfident about what it takes, take decisions based on how happy we are and not least stick with losing ideas for waaay too long.
So, if the culture is your perfect highway and the change program is your perfect race car, then all of us not so perfect drivers will still manage to drive you in the ground with all our biases. But there is hope! To capture all of their insight, tools and methods from years of UK government interventions, the Behavioural Insights Team developed a model called EAST. Basically, if you want to change anything in the world, you need to make it Easy, Attractive, Social and Timely.
Easy – take away stumbling blocks
Some consider this the mother of all change resistance, and although there is no solid research supporting that, you would do well to not forget this one!
Humans are purpose built to save energy. Not too many years ago, the world was full of sudden changes in the environment that required immediate bursts of energy to fight or flee. Today the biggest surprises are when our daily commute is interrupted by a train delay, because someone forgot that winter tends to bring snow on the tracks (really?), but our brain is not so easily un-hardwired.
So, if you want someone to change something, you want to make it easy for them – take away all the actual AND perceived effort, discomfort and stumbling blocks in their way. Instead of a series of steps, make it just one. Instead of complex decisions, simplify it for them. Instead of letting them find their own way, light up the fast track.
In short – Make it easy!
Attractive – build a driving force
It is obvious that if you want someone to move somewhere, that somewhere must be more attractive than the current location. Typically, some sort of unbalanced combination of carrot and whip is applied. Hey, if it works on animals, it should work on humans, right?
Well let’s take a slightly different view on motivation – the intrinsic vs extrinsic perspective. Intrinsic motivation is when you want something of your own accord – extrinsic is when it must be enforced from the outside on you. Both the carrot and the stick belong to the extrinsic perspective, which requires continuous monitoring and upgrading (the stick must always be a present danger to work – the one carrot will quickly become insufficient to motivate), so it is not a particularly powerful motivation approach.
Intrinsic on the other hand works all by itself and refuels automatically – and the fuel is the type you use for supersonic jets – not old tanker vessels. There are lots of different things you can do here, but you can briefly categorize them into attractive destinations vs attractive journeys and being something vs being a part of something.
In short – make it exciting!
Social – show everyone else doing it
If a hotel writes that most people reuse their towels at least once during their stay, the likelihood of you reusing your towels increase by 26%. But if they write that most people who have stayed in this room reuse their towels at least once during their stay, the likelihood increase by 33%. People you feel closer to has a much larger impact on you.
This closeness can take many shapes. If somebody does something for you, you feel obligated to return the favor – even if you don’t like them or their gift. If somebody is nice to you, you automatically like them and is willing to do a lot to keep the relation in good shape. If somebody seemingly is in an authoritative position, then you want to stay on their good side.
In short – follow the herd!
Timely – help each person change in their own time
The timing of change cannot be overstated. People react very differently to requests based on when they happen. At a high level we may be in different life stages, where people are more likely to change, if they are already in the middle of a transition whether changing company, role or something more private.
At a low level what happened just a day, an hour or a minute ago will affect our response. For example, if you had an argument at home before coming to work and you did not have much sleep, you are very likely to reject all requests, as your negative energy level and mood will make you defensive – that is stick with status quo.
One of my favorite examples is the study done on parole hearings in the US, where three judges sit down for an entire day and review parole applications. In the beginning of the day applications have a decent chance, but it quickly falls to the floor – then rise again before falling – and then once more. What happens? Lunch and afternoon snacks – that is the difference between looking at the bars from the inside or the outside.
In short – timing is everything!
This should get you started on thinking in behavioral terms and in the coming articles we will dive into some tools from each dimension in the EAST model – if you cannot wait, you are welcome to contact me at firstname.lastname@example.org or +45-23103206.
For many retailers, 4th quarter represents up to half of their annual revenue – traditionally with focus on Christmas followed by a discounted January to empty the shelves again. Black Friday has changed all of that – originally a US phenomenon right after Thanksgiving, countries across all continents have embraced the concept, where retailers are dumping prices anywhere between 5% and 90%.
That is some discount – which is interesting because while the supply chain and production variance is costly, then +40% will not buy anything regardless of discount and +50% will only buy if discounted 50-90%. And just like classic airline loyalty programs, a major part of this would have sold anyways, so many are basically giving away money.
Now the business case is on average iffy for the retailers – but as a consumer it is great right? Well, if you are purely buying stuff, you truly need, at a truly discounted price and in a truly high quality, it is great. But is that the case? Lets look at some of the marketing tricks you should be wary about (whether you are a consumer or a retailer).
Firstly, Black Friday is all about creating scarcity – one of our most powerful psychological triggers. There is the scarcity of time (limited time offers – some accelerating this with countdown clocks or early bird offers) and the scarcity of product as many retailers offer exclusivity to certain segments or only stock a limited number of the discounted products to lure you in for a classic game of bait and switch. Either way you are likely to buy stuff you don’t really need, unless you have a clear picture of exactly what you want up front. This approach comes from a method known as committing to core priorities.
Secondly, many retailers before Black Friday hike up their prices to create an artificially large discount – make sure to check prices ideally in a price portal with historical price levels – comparing different futures tend to increase your rationality substantially. As a clue remember if the discount is relative (the percentage saved), then the amount saved is often low – and if mentioned in absolute terms (the amount saved), then the relative is often low. Be sure to read the fine print – as a discount may depend on you opening a credit line. But surely a gift card cannot go wrong? Well +5% of all gift cards are never redeemed, so it is basically free to give you a discount of 5%. All of this is designed around your limited attention span, which is further reduced with fatigue, so make sure to fuel up!
Finally, buying something that lasts and thus has lower environmental impact is of course a matter of quality, where some offers look like what you want, sounds like what you want and feel like what you want – but is reality a dumped down version of the TV that you originally dreamed of. In general, it is very difficult for people to assess the quality of a product and thus we go by simple cues. The freshness of the green section of a supermarket, the cleanliness of the car repair shop and of course price. But just as important as quality, the actual utilization is critical. +10% of all Black Friday shoppers do it out of boredom – not out of need. And bundling products for higher sales and average margin will get you stuff that you did not really need and eventually becomes waste. Confirmation bias will be in full overdrive now, so maybe assign a friend to the Devils Advocate role to help you avoid all those plastic trinkets.
Remember the Chinese proverb: “The more you own – the more it owns you”. Make my Christmas and buy only what you truly need by following the simple tricks above (commit to core priorities, compare futures, fuel up and Devils Advocate) – or if you prefer go nuts and make the retailers’ Christmas. It is all up to you – and you are rational decision maker right😉?
If you want to help more customers buy the right things from you, contact brian@behaviouralstrategygroup or +45-23103206
Last week we looked at building the highway of transformations and this week the focus is on the racecar – the change initiative. Obviously if the highway is uneven or the race car is not tuned, the outcome can be disastrous. But what are the key components of a change race car? Any change requires three components:
Solving the business problem – the actual reason for the change and the ongoing problem solving throughout the process
Facilitating the organizational change – the project management from past state to a desirable future
Ensuring the individual transition – moving people from awareness to action at individual speeds
Solving the business problem
Have you ever wondered why some people are extremely effective at solving thorny problems and others are… well… not? 50 years ago, McKinsey noticed that some of their engagements were highly successful, while others failed even with the same teams or clients. This started a revolution in problem solving and today all top tier strategy consultants use the McKinsey 7 step method.
The approach starts by really nailing the problem definition. As Lewis Carroll said: “If you don’t know where you are going, any road will take you there”. The next step is breaking down the problem into a mutually exclusive and collectively exhaustive set of logical components. For example, if you wanted to buy a more expensive house, what could you do? Well, you would either need to reduce your costs or increase your income – in the next level of break down, you would then look at possible new or improved income streams. After this you prioritize the most potent ideas to speed up, build an effective work plan, have the best people conduct the analyses, and synthesize the whole thing (and no synthesis is not the same as summary😊) before building your presentation for maximum impact.
Sounds easy right? When I joined Qvartz (now Bain) – I was lucky to get the best mentor in the company – the one who trained everyone else. I will never forget the first thing he told me: “I have been doing this for 25 years, and I will never be good enough”. This is the most powerful business toolbox, but it requires discipline.
Facilitating the organizational change
Once a problem has been solved, it involves a change in one or several of the 6S model components. Each of these warrants their own article (or books), but the focus here is on the project management.
Anyone who has been through Prince2 certification will probably agree that this is also an area of its own, but once you have completed some of the biggest and most complex cutting edge technology projects on time and budget, you realize that coordination and filling out endless forms is really not the point. It is a bit like taking a classic board education with focus on duties, controlling, recruitment, finance and press. You might think you are ready, but this will never get you selected.
Sure, you need to nail the project definition, manage your risks, budget the project and plan your activities, but by far the most important thing is your stakeholders. And no amount of coordination and form filling will prepare you for that. This is all about leadership – listening, involving, influencing and driving the initiatives forward.
Ensuring the individual transition
Some people prefer ADKAR, but either way it is just a model of the transition that you want the organization to go through (ACCA is originally developed for advertising communication). The key insight is that it cannot be completed in one sitting and is individual. But how do you create a unified program that is also individual? There are two key approaches that work in tandem:
As it cannot be completed in one sitting, you need to build several touch points. It makes no sense to save it all for that infamous town hall meeting. Instead prime your organization with small bits of information even as you start building your new strategy or business approach. Your organization can handle that you in the beginning of a development process writes everyone to let them know, that you have just started on an exciting strategy review. They want you to do that. It is your job. In fact, it is a bit scary when management does not seem to be worried about a strategy gone off tangent. Keep the information flowing in various well planned time slots and touch points to get everyone used to it.
Each individual touch point can be made flexible either in time (for example by video or eLearning that can be viewed when there is time) or in content (for example leader led mini workshops), where different types of concerns can be handled related to the what, why and how of the change. The what and why is often about hitting the right amount and type of detail for the specific audience, thus leader led solutions are often powerful. The how is more about helping people pre-plan for the change. What will this mean for their job, what kind of obstacles will come from that and how will they handle it. Research shows significant difference in meeting problems prepared instead of having to think on the spot – both in terms of individual experience but also how everyone else around are affected.
Now all of this is manipulation – and next time you will see quite a lot more of that. But keep in mind that you cannot not manipulate – but you can control whether you manipulate towards something universally desirable and how massively you do it. Ethics are key.
It is great to see all the people contacting with questions, comments and potential projects – you can also do that at brian@behaviouralstrategygroup or +45-23103206.
Every organization is doing a balancing act between using precious time, resources and talent on identifying the next big thing in their industry – and minimizing the time, resources and talent on delivering the current value proposition to their target segments.
Some go to one extreme and some go to the other – whether that is the right approach depends on how close they are to the beginning and the end of their product life cycle. So if you just invented a 100% co2 neutral jet fuel, you should focus on minimizing risks and cost to serve and produce (80% co2 neutral jet fuel currently costs 8 times that of traditional fuel). Vice versa if you are a world leader in pumping oil up from the underground, you need to switch your focus from execution to innovation.
Now this is strategy – but as Peter Drucker famously said: “Culture eats strategy for breakfast”. Meaning when 5-10 people in top management decides to go right and the entire organization is hardwired to go left, then the organization wins the tuck of war. Unless you do something. Unless you identify and implement effective levers to align the culture.
In 2010 we developed this model to create one simple picture of the workable change research and practice (There is still quite a lot of unworkable material). The external levers represent the interaction between the organization and the owners, customers and larger ecosystem to fund and obtain insights and technologies to drive the next big thing. The CxO levers represent the main tools that top management apply to lead the organization towards that next big thing – agreeing on goals, structuring for success and driving change in every dialogue. Finally, the role of HR in placing the right people in the right roles, continuously developing strong leaders and experts in a world fast changing competencies as well as engaging the organization on performance and execution. All three sets of levers affect the leaders, employees, processes and finally results.
The levers do not change – but the tools do. For example in 2010 employee engagement surveys were still mostly focused on the job of the employee, while a few organizations like Maersk had inserted a module as leadership feedback. Postnord went further and implemented a strategy execution module, where you at any given time could see, where in the organization strategy was failing and in which way, so you could quickly remedy it (disclaimer: I helped both companies do that:).
The three sets of levers represent an entire book of course, so here we will just focus in a few critical points from each. While the external lever of owners is very much about setting business expectations, and customers is about truly understanding their needs through powerful market research, then the ecosystem is about value innovation – like Proctor & Gamble scanning the market for innovations and connecting with relevant scientists, experts and alumni or GlaxoSmithKline opening up their patents pools in less studied diseases.
Communication is a field of its own, but we will in the next articles dive into how to use behavioral economic insight to remove irrational resistance. There is an entire science around goal setting, but a few things must be adhered to – simple and realistic connection from top to bottom and a translation at each level of what that means in terms of activities. Structure often goes wrong, because management starts with their most critical people and then build an organization around them. Very irrational – also very human.
Instead we designed a full process for a large global pharma client, where you start by diagnosing the issue, identifying the objectives and selecting the most relevant design criteria as the first three steps in the model below. Then to design your optimal structure you pick the most relevant structural building blocks based on the criteria, combine them into full design options and select based on your design criteria. Only now can you start considering your current team, so at least you have the right target structure and you know where you have made compromises.
Direct HR levers
Placing people is about getting people in, up and out of organizations, so this is a dramatic area. Lots can be said about recruitment not least on debiasing the selection, but a powerful trick if you have an attractive company and you are looking to fill a critical but not abnormal role is to avoid selecting and just let interested parties deselect themselves against tough criteria – providing references, ticking off simple but hard questions like appraisal scores, psychometric tests etc. It needs to be done respectfully and transparently though!
Placing the right people in the right roles is typically left to organic change, but this cannot stand alone – typically when running an organizational review we find that about 20% of the most important roles are not filled by the best players – and many of the best players have unimportant roles leaving them unutilized at best and ready to leave at worst.
Development is a whole other ballgame and luckily has come far from the days of pure knowledge dumps in lecture style. Today you need several development vehicles attacking different learning styles at the right time preferably in a coherent concept, so the brain has an easier time to recall it. One of my still favorite concepts is the leadership pipeline – although the book requires some updating to modern leadership – because of the focus it puts on work values over skills. That is truly embracing the why of a behavior over the how of the behavior. It is not difficult to build a great team, set objectives, delegate smartly, coach people or manage performance – the skills are easy. But getting people to value it and to do it – now that is the key to any development.
The idea of focus on work values instead of skills or behavior is not important alone in leadership development – it is a core principle in change. You might have read about true change requires new artifacts, behaviors and values – sounds difficult right? The point is that if you can change values, then behaviors and artifacts follows.
The three sets of levers above represent the places you can set in to align your culture with strategy – but the effectiveness of the tools is equally important. These are just a few of the examples and even they need updating as the wider culture changes – the expectations to work from home, digitalization, diversity or sustainability to mention a few. If you are missing one of the two you will either be crawling towards your goal or going nowhere in a hurry.
But with those in place you have a solid foundation – the highway if you like. Next time time you will see the racecar – how to build a high level change initiative with respect to problem solving, project management and change stages. Finally, you will meet the driver – with all the irrational biases – and some of the most powerful tools to circumvent them. Stay tuned!
If you are in a hurry, contact email@example.com or +45-23103206.
Why do organizations struggle so much with change despite the obvious truth of the quote from Heraclitus? In BSG we work with this every day – in some ways it is all we do. After more than 25 years experience with strategic problem solving, international project management, organizational culture and behavioural change, we have recognized some fundamental rules:
Some cultures are good at change, some at consistent improvements and some are in limbo – avoid the last and go all in on the most relevant for your industry and positioning
Change is individual – you cannot change an organization – but you can organize a change without coaching each and everyone
There is irrational and there is rational resistance – learn how to treat them differently by recognizing each and applying the right tool
Stop me if you heard this one before: We were working with a large global manufacturer of machinery and they had just bought a CRM system. They were now designing and configuring the system, but they were slowly realizing that they were getting massive resistance, as they started involving their sales organization. Visually their process looked a bit like this:
Identify & buy
Design & configure
Communicate & train
The first line is what they did – the second line is the translation of their actions into the 3I innovation process – but in exactly the wrong order (you first want to talk to the users to get insight, then ideate for the design and finally implement by in this case buying the most relevant system)!
So obviously this was an organization that was not experienced in managing change – thus breaking rule 1. They also took the classic one size fits all communication approach and thus breaking rule 2. Finally, the resistance because of that approach was equally rational and irrational (it did not make sense what they did, so it was rational to resist – the sales organization was also super pissed, so it quickly turned irrational as well😊) – getting 100% perfect rule breaking score. There is another way with a three sided approach to respect the fundamental rules:
The cultural problem
Culture is typically developed as a side product of the founders behavior and then over time through organizational growth adjusted with each new senior manager. Or to quote Steve Gruenert and Todd Whitaker: “The Culture of any organization is shaped by the worst behavior the leader is willing to tolerate.”
Now many organizations do not have a consistent nor effective approach to strategy, structure and change or how people are recruited, rewarded and developed. There is rarely one vision of the culture guiding every lever affecting the organization – and powerful tools applied in each lever. Without that consistency it is difficult to expect for example a fast moving and innovative organization.
The change problem
Here is the classic approach. The management team goes offsite to finalize the main outline of the new strategy, that they worked on for a few months, before announcing the surprise town hall meeting, where they spring their brilliant concept formulated as “3 key points” on their poor organization. What is wrong with that? I mean is that not exactly what the management team is paid for (among other things)?
The problem is of course that this is not how people work regardless of what we are paid to do. We do not mind change – many actually love it – but people change at different speeds and only when they can convince themselves that the vision is about twice as good as the current approach. Imagine you have been a successful sales manager for ten years, when you are told that you need to change everything and align your approach with the “3 key points” (pause for dramatic effect). Will you a) forget everything that made you successful for ten years or will you b) continue as before until you recognize tangible improvements in your everyday challenges? Building your change program to ensure tangible and individual interaction is critical.
The bias problem
Even if you have developed the right culture and designed a great change program rationally, you will still encounter the entire Zoo of Irrationality – the six bias groups. We tend to have tunnel vision and thus miss all the largest opportunities, search for data confirming our preconceived notions and overlook warning signs, be overconfident about what it takes, take decisions based on how happy we are and not least stick with losing ideas.
Now if some organizations has nailed the culture and thus build an effective highway for their change programs to drive on, a few have created effective change programs and thus built fast race cars to drive their vision, then almost no one have managed to debias their change efforts and thus avoid the driver swerving back and forth. To be clear you need to bring the people with you to succeed.
We will dive into the details of how to use these three very different toolboxes in the next articles. If you cannot wait, then contact firstname.lastname@example.org or +45-23103206
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 email@example.com for more information.
It takes twenty years to build a reputation and five minutes to ruin it. If you think about that, you do things differently
The financial world was shaken to its core, when the fourth largest US investment bank, Lehman Brothers, filed for bankruptcy in September 2008. With $ 639 billion in assets and $ 619 billion in debt, Lehman’s bankruptcy petition not only surpassed other bankruptcy giants like WorldCom or Enron by a factor 10, it also came after repeated assurances that finances were sound.
Lehman Brothers had a humble beginning as a grocery business in Alabama in 1844 by German immigrant Henry Lehman, who was eventually joined by his two brothers. The business boomed and managed to survive massive challenges like railway company bankruptcies, the Great Depression, two world wars and capital suffocation from various owners, but it was the breakdown of the American housing market that finally killed it. The seed was sowed when Washington in 1999 removed the Glass-Steagall law, which separated commercial and investment banks, so the former handled capital-intensive portfolios like real estate and the latter focused on liquid assets. In 2001 CEO Dick Fuld received an investment plan from a group of math PhDs, showing how the bank would always profit, if it invested in the housing market, and he was so impressed, that he immediately borrowed billions to invest in the housing market.
Fuld was feared and admired as the Gorilla of Wall Street due to his aggressive style and lived for Lehman Brothers, where he started at 23 and quickly became the longest serving CEO on Wall Street. In 2003 and 2004 Lehman bought five housing loan businesses including two subprime services specialized in Alt-A loans for borrowers without documentation, which at first sight was ingenious – the following three years, they grew by 56% annually ending with USD 4.2bn profit in 2007 and a market value of USD 60bn. But the assumptions in the PhDs investment proposal was falling apart. The stock market had its largest correction in five years in just one day, the number of sub prime loan defaults reached the highest share in a decade and Bear Stearns had two housing funds go bankrupt. Lehmans CFO assured the market that the risks were well insured, so the strategy was not changed, and they geared their investment with a factor 44, while the five other large investment banks stayed around a factor 20-30.
The warning signs kept pouring in with Bear Stearns having a near breakdown early 2008, hedge fund managers were questioning the value of Lehmans housing loan portfolio and Lehman had the first quarterly loss in more than a decade, leading to one double-digit drop-in stock price after another. The final blow came, when Korea Development Bank withdrew from negotiations to take an active share in Lehman. Hedgefund clients left, creditors cut off loan facilities, Lehman had a second quarterly loss and Moodys Investor Service stated that Lehman had to sell the majority of its shares to avoid a rating reduction. Lehman was now losing USD 8m every minute with little cash left and made one last desperate attempt to find a buyer in Barclays to no avail. 15th September Fuld declared bankruptcy, eliminating USD 46bn in market value or 93% in just three days, and Barclays bought the scraps for USD 1bn.
Bounded Ethics were rampant in Lehman Brothers
Bankruptcies are full of learning, but what was particularly interesting here was despite Fulds clear ethics in private, then his business ethic was more “anything goes”. As bankruptcy lawyer Valukas started unravelling the events, an enormous number of lies were discovered. Whenever danger was noted, everything was covered up. Maybe to avoid showing weakness or maybe Fuld believed so much in his strategy, but the many problems and attempts to finder buyers indicated more that he was feeling the ropes tightening around his neck. So, he did what everyone else does in a high pressure situation: He lied. Maybe on purpose to mislead, maybe because he was caught in his story, maybe his pride could not handle it or maybe he would not accept his back was against the wall. The problem with the lies was that they led to more problems, less trust and wasted precious time in dealing with the very real challenges. Stopping the bleeding early and giving potential buyers enough time to consider how to integrate the acquisition might have saved Lehmans – because as we saw in chapter 7, when we are faced with a high-risk situation and short time, we stick to status quo. We all fear losing face, but that need to protect our self image can become the very reason we fail.
The second ethical break down is a more gradual erosion of ethical conduct, where a small step away from a high ethical standard sets us on downward trend towards faster and larger ethical lapses, which we may not even notice due to our blindness to change. Lehman used an increasing number of accounting tricks to make their gearing and liquidity look favorable for example by selling to ghost companies and rebuying them at a higher price thus avoiding sales of assets with losses.
The third ethical break down happened as outside auditors Ernest & Young knew about the activities and failed to report it despite direct questioning. Lehman was a huge and profitable client for them, where motivated blindness indicates that when we are incentivized to avoid certain data, then we tend to overlook it.
You see Bounded Ethics every day
Nobody is in doubt about the dramatic unethical behaviour of Enron’s Jeff Skilling, Italy’s Silvio Berlusconi or IT Factory’s Stein Bagger. The business scandals of the last 20 years have led media, politicians and academics to look for the underlying reasons for ethical breaks and the most popular approach is identifying a few evil people or systems – like Dick Fuld in Lehman, Arthur Andersen in Enron or poor regulations. But the latest research shows that most unethical behaviour happens without a conscioius choice. Of course there are people, who act unethically on purpose, but the argument here is that our ability to understand and change unethical behaviour in people rests on appreciating that we are systematically biased in certain ways:
Everyday dishonesty: The human tendency to lie up to the point, where you feel your integrity is at risk – further enhanced by your self serving bias. For example high earners will find a reason to justify why they save their money in tax havens.
Indirect unethical behaviour: This tendency to avoid seeing or even hiding exploiting or unethical behaviour by having third parties do the job for you. For example some global companies like H&M or Apple have had questionable production facilitites run by third parties.
Motivated blindness: The tendency to avoid noticing unethical behaviour, when it is against your own interests to notice them. For example classic inhability cases like the researcher, politician or leader cannot see the problem in their close relations with certain interest organizations.
In-group favoritism: Also known as in-group bias, it describes your tendency to favor members of the group you belong to over members of groups you do not belong to. For example, we tend to provide possible board positions, jobs or other opportunities to people in our network, without thinking about whether they are also objectively the best to solve the task.
Implicit attitudes: When you meet someone, you immediately activate stereotypes about the person’s race, gender, and age. For example, when we meet a female dealer and are more surprised by an aggressive negotiating behavior than if it were a male dealer.
Experience of Fairness: Your tendency to value fairness to an extent that you are willing to sacrifice your financial well-being to enforce it. For example, if a business partner offers a very unfair deal in a negotiation, we can let the whole deal fall through to teach the other party a lesson, even when it may have financial consequences for ourselves.
You cheat because you deserve it
Sometimes you lie or cheat because it is self serving, but other times you might do it, because you can – or because you cannot help it, as you are running out of the energy required to ensure proper self control. And our brains are flexible enough to change our mind after cheating to make us believe that we in fact deserved it – even worse if there is some distance between the unethical behaviour and the reward. For example 10% of professional golf players are willing to pick up the ball to place it more favourably, but 23% are willing to do the same with the club.
The creative class is special and is treated as such, which makes creatives feel more important and deserving in US studies. The trouble with that is they are more willing to steal or lie than other groups. And this is not only the natural creatives – if you prime people to believe they belong to the creative class, they steal 6 times more than the control group. So the creatives issue may be a US challenge, but priming people to feel more deserving for whatever reason is the a problem. Now how important is that? Well the typical organization loses about 5% of annual revenue to cheating and fraud, losing about USD 2.9bn in 2010.
You are about to enter a pedestrian crossing, when an aggressive driver races past you inches away. Shocked you yell at the driver, but the car is already gone. Do you think the car was an brand new Aston Martin or and old Toyota Corolla? Research shows that drivers in expensive cars are much more aggressive and selfish in traffic than those in cheaper cars. Also known as the asshole effect, American psychologist Paul Piff researched whether assholes often became rich – or if being rich in itself drove the asshole tendency. It turned out that mere thought of feeling rich or just being near money symbols would make you more antisocial, self sufficient and unwilling to help others.
In a small classroom at the University of California, Berkeley, two students are playing Monopoly, one of whom has no earthly chance of winning. The Monopoly game is rigged, so the other player is more privileged during the game. Hundreds of Monopoly games with different players show the same – winning brings out the worst in the player who is unfairly privileged to win – arrogant, dominant, entitled to his victory and even eats more of the common candy. But there are some completely different unforeseen effects of winning: When we win in a competition, we subsequently have a greater tendency to cheat others to continue to win. In short, winning leads to more unethical behavior – even in an unimportant game. Now imagine what you would do, if billions were at stake.
6S Model – ensuring transparency
It is easy to identify unethical behaviour in others but very difficult in our selves. So to combat this bias group, you might want to start by ensuring that individuals are not making decisions about cases, where they have a personal interest and then picking some of these tricks:
Structure: You need transparency and simplicity everywhere – not least in your structure and to avoid ethical breaks. A flat organization with a stringent logic and large span of control is preferable – possibly coupled with internal audit, whistleblowers and external unbiased support.
Steps: Just like structure transparency and simplicity is key. A strong process management approach can by virtue of its rationality and simplicity identify off activities and prune them. But it cannot stand alone – the Enron case was well known for their use of standardized processes, where a customer claim was passed from department A to B to C and back to A with no way of communicating between them.
Style: Some of the best options to combat limited ethics are to ensure diversity, broad compensation structures and a code of ethics that is constantly repeated and permeates the organization. Diversity means that we are not as easily talked into unfortunate actions as when we are surrounded by people who are similar to us. The compensation structure should reward groups instead of individuals, as cheating requires a larger coalition to make sense. The code of ethics may seem weak at first glance, but Ariely’s research shows that people take it very seriously if they are just reminded that there is a code of ethics.
This was the short version of the last chapter on the 6 major bias groups in 5th best management book of 2016. Next up is the final conclusion. If you cannot wait contact firstname.lastname@example.org or +45-23103206.
It is useless to attempt to reason a man out of a thing he was never reasoned into
At the end of the 1970ies a genious entrepreneur decided to beat IBM as the world leading tech company within the next decade. You will be forgiven thinking it was Steve Jobs, but it was actually Chinese inventor Dr. An Wang. Wang Labs was one of the first tech companies to advertise on TV and their first add showed Wang Labs as David and IBM as Goliath. From there on a series of “Giant Killer” stories were aired with the grand finale of a Wang helichopter shooting the smug IBM CEO.
Wang was as known for his butterflys as his ingenioius inventions based on 40 patents and 23 honorable degrees. He was born in Shangai in 1920 and entered the Chinese version of MIT at 16. During his studies Japan invaded China and young Wang lost his entire family, but he finalized with top marks and immigrated dirt poor to the US, where he got a PhD from Harvard. He opened up a one-man company and invented memory core, which revolutionized pocket calculators and later mini computers including word processers to replace type writers. His company grew 60% annually in the 1980ies into a USD 2bn Fortune 500 company with 80% of the 2000 largest US companies as clients, but disaster was lurking.
Until now Wang had capably foreseen technological developments, but now the company was against all trends pouring all resources into the competitive word processing market – in fact only IBM was spending more on marketing. Meanwhile the personal computer market was booming, where Wang held several critical patents, but he refused to change course: “personal computers is the dumbest thing ever!”. Wang loved word processing. His feelings went far beyond pride and commercial interest – he was emotional and protective like a parent. When he finally saw the writing on the wall it was last shot and he blew it on a proprietary operating system, when everybody else used IBM compatible systems. Sales nose dived and Wang Labs was bankrupt in 1990.
Wang’s problems were self inflicted and more personal than business related. Wang hated IBM after the company according to his own biography had cheated and humiliated him, when he sold his memory-core patent to IBM as a young man. He was determined to beat IBM, even if it would cost him everything. And so, it did.
Emotional bias – your emotions decide for you
A leading neuroscientist conducted an experiment on the role of emotions in decision making – the Iowa Gambling Task. Particpants sat down at tables with four decks of cards and were given USD 2000 to try to grow. They were told that some cards would pay say USD 100 and others would cost say USD 100. What they did not know was that half the decks were stacked to create a surplus and the other half a deficit. As the players started drawing good and bad cards, their emotions were measured, and they were asked about their feelings. In the beginning they drew random cards and just made notes, but as soon as they started drawing the cards that cost something, their emotions were activated, heart and pulse beating faster. After a while it was possible to observe higher emotional activity BEFORE picking from the bad decks. In fact, they started going after the good decks without being able to articulate why.
It might seem strange, that we can have emotions that make our decisions without us realizing it, but this is exactly what happens. Many scientists believe that our brains store memories of actions and associate emotions with that – known as emotional tagging. When we encounter similar situations, we recall our last action and our emotions – the emotions will then promote or warn us against these actions and thereby drive our decision – exactly like Wang. Until recently behavioral economics focused only on cognitive decision processes, but now researchers have found that not only do emotions drive our decisions directly through emotional tagging and enhance our existing cognitive biases like confirmation bias, but we also have a whole host of individual emotional biases:
Status quo bias is our irrational preference for the current situation – any change from that feels like a loss and shows why some companies never innovate or change. In fact, according to McKinsey the best way to predict your competitors strategy is to look at what they have done recently. As you run out of energy from making decisions in a day, then your tendency to stay with status quo also increases.
Avoidance of regret describes how it is more painful to make a change and be wrong, than stick with current actions and then be wrong – it can be seen when leaders stick with poor decisions, but a version of it also exist in competitive sports: Everybody prefers the gold medal, but silver medalists are actually more dissatisfied than bronze winners – they are just happy they got something, but silver is soooo close to gold.
Insensitivity to numbers shows that we are for example less focused on savings human lives as the number of people in danger grows. Saving one life can seem huge, but saving 88 vs 87 lives seem relatively unimportant, which is the reason that news outlets focus on stories and not statistics: people relate to people and not to numbers.
Hyperbolic discounting means that we prefer to get a reward earlier rather than later to the extent that even small delays cause us to discount the value of the reward substantially, whereas a much longer delay does not discount much more. So, if you are offered the choice between USD 100 now or USD 200 in 1 year, most take the money now, although you could earn the equivalent of 100% interest. But if you are offered USD 100 in 1 year or USD 200 in two years (also 100% interest), you would normally pick the USD 200.
Multiple selves are our tendency to have two opposite preferences for both immediate satisfaction and future rewards. On the one hand you want to stay healthy and accelerate your career – on the other hand pizza and some easy work tasks sound great. On the one hand you want to watch that new French intelligent drama – on the other hand Rocky 5000 sounds so alluring.
Self serving bias attribute positive events to our own personality or effort, while negative events are attributed to external factors. For example, if your project goes well, then of course it is because of you – but if it goes wrong, then the reason is external like poor partners or too few resources. If you are sued and win, then 85% of you will expect the plaintiff to pay trial costs – but if you sue someone and lose, then only 44% of you believe you should pay trial costs.
6S model – building checks and balances
Management literature has recently gone through a theoretical discussion about whether employees should park their emotions at the office front door. Our opinion is that you cannot be split in two. Not only is it physically impossible, but it is probably incredibly difficult to make any decisions at all without emotions to guide you and nothing great has ever come without passion. But we all have our strengths and weaknesses, where even strengths can backfire, and we need to keep it under control. Generally, you want to create checks and balances between different actors and activities in the organization and here are a few examples:
Strategy: When planning for an emotional organization, there are three things that are particularly critical: First, you need to look broadly to minimize the chance of falling in love with a specific scenario. Second, the process must be fact-based specifically on critical areas that determine the direction of the company. Finally, your processes must be coherent so that decisions somewhere in the process are followed up with changes elsewhere. Thus, you avoid an emotional decision about sub-elements instead of the overall strategy. In practice, this can be done with qualitative and quantitative megatrend analyzes, where the status quo can be challenged through assessment of alternatives. Coupled with the overall Playing to Win process, which just excels with its cohesiveness, this is a powerful solution.
Steps: Facts, facts, facts. That’s how easy it can be said. And yet not, because you can use Wisdom of Crowds to remove yourself from an emotional and towards a factual estimate. Many studies show that our bias can be balanced in groups so that we get close to the right solution, and this is what Wisdom of Crowds is about: When you want to learn about past facts, you ask an expert, but if you want to forecast the future, experts are as bad a chimp throwing darts – instead take the average opinion of 20 average people. This does not mean that intuitive and emotional decisions have to be parked, they are actually very important as long as they are connected to fact-based systems, and you choose from both – the best way is maybe a 50-50 average of your intuitive estimate and what comes out of a model.
Skills: There are two competencies that are critical here. On the one hand, key people must be trained in classical problem solving with the ability to razor-sharply define the problem, break it down into smaller parts, develop solution trees, priorities, analyses, and pyramid-structured presentations. On the other hand, people responsible for change must be well versed in behavioral change management and not least think in implementation solutions as soon as the analysis phase starts.
I hope you enjoyed this short version of chapter 7 in 5th best management book of 2016. Next up is Bounded Ethics – a scary look at the dark side of business and people. Contact email@example.com or +45-23103206 if you are too concerned to wait.
If there is a 50-50 chance that something can go wrong, then 9 times out of ten it will.
In the 1980s, Coca-Cola CEO Robert Goizueta was deeply concerned about the future. Had time run out from Coca-Cola that Dr. John Pemberton back in 1886 had brewed together in his three-legged brass pot? In recent years, Coca-Cola had lost significant ground to arch-rival Pepsi despite Coca-Cola had much broader distribution and spent at least $100 million more annually on marketing. At this difficult time, Pepsi was smearing salt in Coca-Cola’s wounds with its national TV commercials, the Pepsi Challenge, where in a blind test dedicated Cola drinkers always preferred Pepsi. Coca-Cola’s immediate reaction to the Pepsi Challenge commercials was blatantly rejecting the results in public, but the internal concern was growing.
Coca-Cola’s mystery had always been about the famous secret recipe that had not changed in 99 years since Dr. Pemberton developed it. In a world where it was customary to change popular products to “new and improved” versions, the unique thing about Coca-Cola was that it was never new. But Goizueta was not called “President of Change” for nothing. Early in his tenure, he promised that there would be “no sacred cows including the recipe for our products.” He began to shake up the company’s traditions and introduced Diet Coke, Cherry Coke and more. Now Coca-Cola embarked on systematic market research that confirmed the Pepsi blind tests and Coca-Cola scientists began fiddling with the legendary secret recipe, making it more like Pepsi. Instantly, Coca-Cola’s market researchers saw improvements in the blind tests.
In September 1984, they tested what ended up being the final version of New Coke followed by one of the most expensive market research studies in history including 200,000 blind tests across North America. Here, New Coke beat Pepsi by 6-8 percentage points with only 10-12 percent of the taste test participants strongly opposed to changing the Coca-Cola recipe, so Goizueta gave the green light. In the launch press conference, Goizueta called New Coke “the safest move the company had ever made.” Yet New Coke became a disaster. Angry Cola drinkers demonstrated throughout the United States and began hoarding boxes of the old cola. A black market for Old Coke emerged, where a box went for $ 30 and more began to find ways to import it from abroad. Coca-Cola customer service received over 60,000 angry calls from Cola drinkers, while a group of Cola drinkers in the United States sued Coca-Cola. Their reasoning was that “when [Coca-Cola] took Old Coke off the market, they violated my freedom of choice. It is as basic as the Magna Charta, the Declaration of Independence. We went to war in Japan to defend this freedom”. Just 79 days after launch Goizueta was forced to withdraw New Coke and reintroduce the original recipe as “Coca-Cola Classic”. Despite an inferior product Coca Cola is still the dominant soft drink in the world and this marketing blunder of the century shows how difficult it is to understand what people actually think.
Loss aversion – prefer to avoid loss over gain
From the stocks we invest in over the projects we own to the special variety of Coke that we always drank; once we have something, we value it much higher than we did when we first encountered it regardless of objective value. It is called the ownership effect bias and stems from loss aversion, first publicized about 30 years ago by Richard Thaler in the bestseller “Nudge” and subsequently recorded in hundreds of studies. In the most famous, Daniel Kahneman conducted a simple experiment, where students’ incentive to swap two identically priced products was tested. One group was given a coffee cup, while the other group was given a chocolate bar, where after each group was offered the opportunity to swap with the other. Before receiving one or the other, about half had preferred the coffee cup and half preferred the chocolate bar, but now only 10% of each group was willing to swap their newly acquired product. The ownership effect means that after having received something – however temporary it may be – we attach ourselves to it and protest against changes that threaten to remove it. For example, marketers know that it takes oceans of work and money to get people to try something new even if it is better – let alone change their habit. In that context, the whole idea of a Pepsi versus Coca-Cola blind test gets a little silly, because no one drinks their Coca-Cola blind.
But how could Coca-Cola’s extensive research overlook the information they had right under their noses? This is because of the way in which losses affect our judgment. Let’s say you are faced with a choice. You can get 1 million kroner now, or you can get a 50-50 chance to win 2 million kroner or nothing. Which one do you choose? Most of us have a preference for a sure win rather than a bigger but more uncertain reward. But conversely, if you get the choice between definitely losing 10,000 kroner – or a 50-50 chance of losing 20,000 kroner or nothing, then most people will actually take the chance despite the potentially bigger loss. This phenomenon is known as loss aversion, which was originally described in Daniel Kahneman and Amos Tversky’s landmark article from 1979, The Prospect Theory. When Coca Cola faced losing its market position, they bet big. But would they have shown the same willingness to take risks at the prospect of a gain? 99 years of history where Coca-Cola dominated the soda market without making a single change in their recipe indicates that they probably would not. In fact people are about twice as loss averse as they are attracted to the same gain, but that is not all – loss aversion is a group of several biases:
Ownership effects – my house is above market
Also known as divestment aversion we attribute more value to things simply because we own them, as seen above. Most people in the business world have already seen the light in the ownership effect when it comes to enticing you to buy their products. For example, when you buy a computer from Dell, you get a 90-day trial period on an anti-virus program from Norton. This means that we as a computer user are more likely to purchase the software at the end of the free trial period than if it were not offered. The ownership effect will be further strengthened if we at the same time put a lot of energy into making the project into something – also known as the “IKEA effect”. In a variety of experiments, participants were set to assemble IKEA products or build things from Lego, after which they felt that their amateur projects had similar value as if they were made by experts.
Framing effects – 90% fat free trumps 10% fat
People react to a particular choice in different ways depending on how the choice is presented; as a loss or as a gain. People tend to avoid risk when a positive framework is presented, but seek risks when a negative framework is presented. For example, it feels mentally more dramatic if you, as the leader of a merger, communicate “we unfortunately had to fire 30% of the employees” instead of “we succeeded in saving 70% of the jobs”. The math is basically the same, but the first sounds like a loss, the second like a win.
Sunk cost & escalate commitment – say no more
We tend to invest money, time and resources based on past investment decisions where we cannot get our investment back and which therefore should not be part of our decisions about the future. For example, if we have once invested in a startup, we will have an easier time investing a second, third and fourth time in the same company, as we do not want to risk our previous investment being “lost” – even if previous investments cannot be regained and thus should not enter into considerations about future investments. We escalate the commitment to our initial decision instead of changing course, even when we get more and more negative outcomes from continuing the course. It is related to sunk cost and occurs, for example, when we have chosen to engage time and resources in hiring an employee who turns out to be incompetent, a new factory that does not give the results we had hoped, or a new product that fails to perform as we had hoped.
Mental bookkeeping – easy come easy go
Also known as the two-pocket theory occurs when we place our money in separate categories or mental accounts, based on where the money comes from or what it is intended for. For example, every month we have allocated our salary to a number of fixed expenses and have a sober approach to our money, but if we suddenly get an unexpected windfall, we can just blow it off because it feels like a different kind of money. In fact, the adage “easy come easy go” is an example of this kind of mental bookkeeping.
Scarcity trap – last shirt is most valuable
When we experience scarcity – for example of time, money, relationships, calories – we tend to concentrate our thoughts on the scarce good – something that actually makes us better able to to assess what the good is worth. But it also means that we tend to become short-sighted, weak-willed, and get tunnel vision because we spend so much mental bandwidth dealing with our thoughts about this scarce resource that we have less mental IQ for other important decisions. Marketing experts work to match supply to demand, but by using the illusion of scarcity, they can accelerate demand. Excellent examples of this effect are the launch of iPhones or Harry Potter books, where the pre-launch was designed not only to increase demand but at the same time to create the illusion that supply would be limited. In many situations, the mere thought of scarcity can actually reduce our intelligence significantly. In several tests among shoppers in shopping malls in the United States and in the fields of Bangladesh, participants were asked about their income and then discreetly classified as either poor or rich. Then they were asked the question: “Your car needs a repair. The insurance covers $150, but it will cost you $150 in deductible. You can choose to take out a loan, pay in full or defer service. What do you choose?” After the test subjects had the answer, they had their fluid intelligence and self-control measured in a Raven test. When it was only about $150, the poor and rich did just as well on the intelligence and self-control test. But when the researchers changed $150 for the repair to $1,500, something significant happened: Rich participants passed the intelligence and self-control test just as well as before, but poor participants did not. The mere thought of facing a $1,500 extra expense put so much pressure on their bandwidth that their floating intelligence score dropped 13-14 IQ percentage points. To put it in perspective, a loss of 13 IQ points can move you from ‘normal intelligent’ to the category of ‘deficient’ or the 5-7 percent least intelligent in society.
6S model – think expected benefits
A simple but effective rule for optimized decisions is that we should always base our decision on the option with the highest expected benefit. In economics, game theory and decision theory, the expected utility hypothesis is a theory of people’s preferences when faced with choices with uncertain outcomes, i.e. bets. You arrive at the expected benefit of an uncertain choice by multiplying the expected outcome of the choice by its probability. The expected benefit model says that 1 million kroner is worth twice as much and provides twice as much benefit as 500,000 kroner. On paper, it seems very true, but people do not feel twice as much pleasure from a gain that is twice as great. This is due to the “declining marginal utility of gains”, which means that the more we get from something, the less joy it gives us. As this is unnatural to us, it should be incorporated in the organization’s levers – here are some examples:
Strategy: We might be tempted to believe that strategy in the risk-averse organization will be the opposite of the over-optimistic one. But risk aversion is not a bias. It is a risk preference that is not about ‘overcoming’ our propensity, but instead comparing value and risks at different options so that we do not stumble into the accompanying biases such as framing, ownership effect, etc. A good place to start strategy analysis is to move beyond the expected scenario and include both best/worst-case scenarios and Wild Cards in the analysis, so that they get a thorough processing and not just “analyzed” superficially in the risk averse leader’s head. A later important step is to go into detail with the Playing to Win strategy, where you investigate how you can win on the game board you are betting on – and not least what it requires of you as an organization. It can also take the form of a series of high risk/high return investment projects versus some low risk/low return investment projects, as long as the options are easy to compare on relatively objective criteria.
Systems: One of the things that can go really wrong here is the feeling of insecurity that leads us to constantly seek more information to be completely sure of the decision. It is difficult to predict the future, so at some point the analysis must stop and the management must show why it is there. If this approach with more and more information is allowed to slip into system design, then you are quickly faced with a very complex and heavy system that pulls the energy completely out of the organization. Therefore, it is important to think simplification and reduce information retrieval to the absolutely critical issues as well as maintain this approach over the time the system is developed.
Skills: In risk-averse organizations it can be difficult to attract people with the opposite approach, but that is exactly what you need: inspiration from creative thinkers, innovators and entrepreneurs as well as over-optimistic people from e.g. the management of role model and innovative companies in similar industries. It will be like getting a necessary vitamin injection and giving your organization a significant boost for a period of time. To make the period last, you can start by getting these people in for inspiration workshops, later for longer strategy projects and finally in protected units – in the same way as when you want to establish a business unit that is very different from the core business. When you are ready, put the protected unit together with the core business.
This was the abbreviated version of chapter 6 in our awarded book Decision Strategy. Next week we will focus on emotional biases – maybe the most challenging of all the bias groups. If you cant wait… contact firstname.lastname@example.org or +45-23103206.