Cognitive biases and strategic decision-making

Daniel Kahneman's book "Thinking, Fast and Slow" synthesizes a great deal of research over the past several decades about the brain's thinking and decision-making processes. It's a great book, well worth reading. But it's pretty long. This article from McKinsey classics, "Hidden Flaws in Strategy," is nearly 10 years old, but is worth reading for its still-valid insights. (It's free after registration.) The article looks at common cognitive biases in decision making and suggests ways to avoid them.

1. Overconfidence/overoptimism - we tend to look at the bright side, and wildly overestimate our abilities to predict. To counter this tendency, the authors advise testing strategies under a wide range of scenarios, taking the most pessimistic scenario and making it worse, and ensuring that you have the capacity to be flexible as uncertainties resolve.

2. Mental accounting - we all put some spending into categories that saves us from having to look at it too closely. The authors recommend adherence to "a basic rule: that every . . . dollar . . . is worth exactly that, whatever the category. In this way, you will make sure that all investments are judged on consistent criteria . . . "

3. Don't be too wedded to the status quo, but be prepared to stick with it when it's the better choice. How to tell? The authors recommend two approaches: a) Take a radical view of your entire portfolio of programs and consider closing or changing all of them; and then b) Analyze your status quo options the same way you would change options. "Most strategists are good at identifying the risks of new strategies but less good at seeing the risks of failing to change."

4. Anchoring - Our brains tend to stick with, or anchor, to a suggested number, whether it is relevant to whatever we've been asked about or not. Sellers might use the tendency to their advantage during negotiations or advertising. But the tendency can impair decisions. Put comparisons in a larger context: 20-30 years, for example.

5. The sunk-cost fallacy - loss aversion and anchoring often lead us to continue an investment even after it has turned sour. To avoid it, the authors say, look at each incremental investment separately, with a fully analysis. Be ready to end experiments early. And condition further funds on meeting certain targets.

6. Know when to follow the herd - and when to go your own way. Good strategies often break away from a trend, the authors say. Combined with the principle of ending experiments early, it's can be smart to disregard the received wisdom.

7. Know when to get excited. OK, the authors don't quite put it this way, but a wise woman I once worked for did. Sometimes waiting and seeing is the best policy.

8. Make sure your consensus, when you have one, is real. False consensus can be reached when a strong leader thinks she has sought and received objective counsel but for whatever reason (they can include pressure to agree, selective recall, confirmation bias, or a biased evaluation) the consensus is a false one. To minimize the risk, the authors say, make sure your culture values challenges and open criticism. In addition, make sure the strong players have checks and balances so that they can't simply dismiss challenges to their proposals without reviewing them. And, as I said yesterday, make sure you search for as many reasons not to do something as you can come up with for a reason to do it.

Admitting cognitive mistakes

In case you missed it over the weekend, here is a link to the NY Times story about how Dr. Robert Spitzer, author of a 2001 study that supposedly showed that self-reports of change in sexual orientation after therapy were credible, has now changed his mind. More than that, in a letter to the editor of the journal that published the initial study, he says, "I believe I owe the gay community an apology for my study making unproven claims of the efficacy of reparative therapy." You can read the text of the letter here.

In its exploration of a scientist's decision to admit he'd made a mistake it's quite a moving story. It's also a nice illustration of substitution, one of the shortcuts in thinking Daniel Kahneman describes in his fascinating book "Thinking Fast and Slow." As Kahneman puts it, "If a satisfactory answer to a hard question is not found quickly . . . [we] find a related question that is easier and will answer it." According to Spitzer's letter, he substituted an easier question (how do individuals undergoing reparative therapy describe changes in sexual orientation) for the hard one (can some version of reparative therapy enable individuals to change their sexual  orientation from homosexual to heterosexual).

Spitzer then compounded the study's flaws by persuading himself that the self-reports in the studies were credible. In Kahneman's terms, he "focuse[d] on existing evidence and ignore[d] absent evidence." We all make these kinds of mistakes, and Kahneman not only shows how, he offers some useful correctives. I highly recommend the book.