book.chapter Common decision making errors and solutions

Believing problems are unique Corporate mergers and acquisitions, a multi-trillion-dollar industry, often fail to create shareholder value despite the high costs and intentions behind them. Executives, driven by optimism and an inside perspective, believe in the synergies of combining companies, overlooking the frequent reality that these deals don't meet expectations. To counteract this, a three-step process is advised: preparing by learning from others' experiences, recognizing the influence of optimism, and applying a decision-making framework based on comprehensive data and statistical analysis. Incorporating an outside view involves selecting relevant data, analyzing outcomes to identify success patterns, making informed forecasts while acknowledging potential biases, and continuously refining predictions with new information. Emphasizing the importance of leveraging similarities rather than focusing solely on unique aspects, this approach encourages making informed, effective decisions by drawing on a broader spectrum of comparable experiences. Ignoring alternative options Anchoring is a cognitive bias where an initial piece of information serves as a reference point for subsequent judgments and decisions. This often leads to tunnel vision, limiting our ability to consider a wider range of possibilities. For example, when estimating the freezing point of vodka, many might start with water's freezing point as a reference, leading to inaccurate estimates. Similarly, real estate agents given different listing prices for the same house tend to appraise its value based on the initial price provided, demonstrating how anchors can influence our perception of value. In negotiations, the first offer can significantly shape the outcome, especially in ambiguous situations. To combat tunnel vision, it's crucial to actively seek out and consider a broad spectrum of alternatives, encourage and listen to dissenting opinions, keep a record of decisions to understand biases, avoid making decisions in emotional states, and be mindful of how incentives might influence decisions. By being aware of these biases and taking steps to mitigate them, we can make more informed and objective decisions. Overvaluing expert opinions Experts and computers each have their roles in decision-making. Experts excel in navigating uncertain situations with multiple outcomes, establishing the rules. Once these rules are clear, computers can efficiently apply them. The wisdom of crowds, aggregated by computers, often surpasses individual expert predictions. However, neither experts nor collective wisdom should be solely relied upon. Decisions should be evaluated on their own merits, sometimes requiring expert insight, other times benefiting from the crowd's perspective, or a combination of both. To effectively use experts, one should match the problem to the solution, seek diverse perspectives, and leverage technology for repetitive tasks. Recognizing when to go beyond experts is crucial, as they maintain advantages in certain areas despite our reservations about computer-generated outcomes. The challenge lies in knowing when and how to utilize experts or the collective wisdom for better decision-making outcomes. Influenced by others' actions Decision-making is often swayed by social pressures and environmental factors, such as the desire to align with influential peers, the influence of recent events, or the framing of choices. Emotional states and group dynamics can also affect our choices. Additionally, organizational inertia, with a mindset of "we've always done it this way," can lead to poor decisions. To improve decision-making, one should be aware of these influences and strive to create a positive environment that encourages good processes and stress management. It's crucial to analyze the situation before considering individual motives, challenging the western focus on individualism. Beware of the "institutional imperative," where organizations mimic peers, often seen in hasty mergers. Decisions should be made for the organization's benefit, not just to follow trends. Regularly reevaluate processes to ensure they remain relevant and avoid being trapped by outdated habits. Acknowledging the social nature of decision-making and managing its influences is key to making better choices. Simplifying complex systems Humans often seek to simplify complex systems into models they can understand, leading to errors in judgment and decision-making. For instance, when evaluating what drives a company's stock price, focusing solely on earnings per share or overall cash flow can lead to narrow perspectives. Earnings per share might lead one to obsess over daily financial news, while a focus on cash flow could result in broader market trend analyses. Similarly, hiring superstar ceos based on past performance without considering the support systems that contributed to their success can result in disappointment. These examples highlight the pitfalls of isolating parts of a system without understanding the whole. To make better decisions, it's advised to view systems at the appropriate level, recognize the degree of system coupling, and use simulations for complex scenarios. Understanding complex adaptive systems requires careful goal setting and cautious implementation of changes to avoid unintended consequences. Michael mauboussin emphasizes the importance of thoughtful decision-making to minimize mistakes and capitalize on opportunities, while keith stanovich notes that intelligent performance depends on clear directives. Misjudging cause and effect In business, actions are based on underlying theories believed to be true. When adopting new practices, it's in the hope that a different theory will yield better results. However, theories must be tested against real-world data and refined over time. A prime example is boeing's 787 dreamliner project, which suffered from an unsuccessful outsourcing strategy. While outsourcing can reduce costs, it proved disastrous for boeing due to misinterpretations of blueprints by suppliers, leading to integration issues, delays, and budget overruns. This underscores the importance of applying business theories in the right context and being cautious of misleading correlations, like the super bowl indicator in stock markets. Effective business decision-making requires acknowledging the dynamic nature of circumstances, being skeptical of universal rules or "best practices," and focusing on adapting to changing conditions rather than relying on past successes or supposed success formulas. Unaware of tipping points Water freezing into ice at its freezing point exemplifies a phase transition, a phenomenon where a minor change in temperature triggers a significant transformation. This concept extends beyond physical states, influencing complex systems like financial markets. The 2007-2009 financial crisis serves as a prime example, initiated by a flawed formula developed by statistician david li. This formula, intended to measure default correlations among financial assets, underpinned the burgeoning financial derivatives market. However, it failed to account for dynamic correlations, leading to widespread underestimation of risk and a cascade of defaults when markets moved in unison. To navigate such unpredictable phase transitions, several strategies are recommended. Understanding the full range of potential outcomes, including extreme events, is crucial. Recognizing signs of impending phase transitions, where minor changes could have disproportionate effects, can offer insights into systemic risks. Skepticism towards precise forecasts, especially those spanning multiple domains, is advised due to the inherent complexity and unpredictability of such systems. Lastly, balancing risk and reward by preparing for negative outcomes while seeking positive opportunities can mitigate the impact of unforeseen changes. These approaches underscore the importance of caution and preparedness in the face of systems characterized by abrupt and significant changes. Misattributing success to skill Distinguishing between skill and luck in success is challenging for humans, often leading to errors in judgment. People may mistakenly believe in the exceptionalism of individuals or organizations, attributing their above-average performance to skill alone and overlooking the significant role of luck. This misconception can lead to poor investment decisions and unrealistic expectations. Additionally, the tendency to misinterpret data can cause observers to expect sustained excellence, ignoring the inevitable reversion to the mean. Feedback based on outcomes without differentiating between skill and luck is unproductive. The halo effect further complicates matters by attributing success to specific attributes without recognizing luck's influence, leading to disappointment when performance normalizes. To avoid these pitfalls, it's crucial to realistically assess luck's role, consider larger data samples, monitor system changes, and be skeptical of simple solutions promising guaranteed success. Recognizing the balance between skill and luck, and preparing for average outcomes after periods of exceptional luck, is essential for accurate evaluation and decision-making.