Cognitive Bias in Strategic Decision Making picked up on a fantastic McKinsey article about cognitive biases in strategic thinking. I have been writing about the importance of neuroscience and cognitive research on business for as long as this blog has been around. It still doesn't get the attention from the mainstream media it deserves, and it isn't even touched on in most business school programs. I think it is worthy of a class by itself.

Why is this so important? I will let the article explain it.

When judging the likelihood of potentially positive outcomes, human beings have an overwhelming tendency to be overoptimistic or overconfident: they think that the future will be great, especially for them. Almost all of us believe ourselves to be in the top 20 percent of the population when it comes to driving, pleasing a partner, or managing a business. In the making of strategic decisions, optimism not only generates unrealistic forecasts but also leads managers to underestimate future challenges more subtly – for instance, by ignoring the risk of a clash between corporate cultures after a merger.

The article points out that one way to become a better decision making company is to objectively analyze past decisions. Have you consistently made overly optimistic projections? Have you systematically misunderstood the levels of risk involved? If so, you can work on making your assessments more accurate. (I've only heard of a handful of companies ever doing this type of review. If any of you have a formalized process for reviewing past corporate decisions, please share it.)

The chart below if from the article, and highlights some common problems (a clearer version is here).
My own suggestions for combating cognitive biases are to learn as much about them as possible, and foster a culture of open discussion. The first is difficult because people never seem to think they are subject to these biases (which is a bias in itself). The second is difficult because some people don't respond well to criticism or debate about their ideas, even when it is presented in a non-threatening way.

These ideas are important because many more aspects of business are becoming commoditized. Competitive advantages can be replicated, and thus made irrelevant, faster than ever before. Better decision making is an area that can still keep you at the head of the pack, but you have to use it and improve on it as you would any other corporate asset.

  • Do you have data to back up your claim that “For entrepreneurs, over-confidence is a good thing?”

    How can it be that “there is no such a thing as over-estimation of future demand or growth opportunities?” If a store buys too many original Ipods (to use your anecdote) they had no money to take advantage of the Ipod nano surge this last Christmas season.

  • Jason

    I think overconfidence CAN be a good thing for entrepeneurs. The statistics are intimidating (the vast majority of business fail within the first 5 years). Usually you have to deal with a withering barrage of criticism from co-workers, experts, and the man on the street. You need to deal with an overwhelming number of pRoblems, not just getting a good product out.

    This requires overconfidence and a willful ignorance of survivorship bias. I suppose it also involves an underestimation of the difficulties you’ll face. I’ve done it once before, and it looks like I’ll be trying again. As they say, its better to be lucky then smart, but its even better to know the difference. Guess we’ll see how long my luck holds out.

  • J

    “Fostering a culture of open discussion” would be wonderful, but how on earth do you do that? For some things, putting the idea out there and allowing all employees to take anonymous pot shots at it would work, but for major strategic decisions, not enough people are going to know enough about what’s being to proposed to make any comment at all.

    I do wish B-schools would have some program that fought the “champion effect”, but is it rocket science to understand that some managers, no matter how gifted they are, are going to be self interested and/or simply not know what they’re talking about at times? An ethics class that taught grads that it’s pRobably not right to expect an eight figure severance package after destroying billions of dollars in shareholder value and the careers of thousands of people would be nice too.

  • Rob

    I guess it depends on your perspective. On the one hand, if you are overconfident and think your chances are better than they really are, you might work harder because you have more hope and higher expectations. But on the flip side, if you have a more realistic expectation you will realize how everything is stacked against you and you will work harder to compensate.

    So you could say you work hard either way, and working hard is really the most important thing when you are starting up.

  • What’s the value of knowing “what to do” versus being overconfident in your abilities? I can think of some recent examples like the dud(e) who opened the coffee bar (you blogged about it a few weeks ago).

    Honestly if we’ve learned anything from our experiences it’s the value of practical wisdom in entrepreneurship.

  • Rob

    Agreed that most managers are looking for champions, and not figuring out if they are good workers, lucky, or whatever else.

    That’s a good point, about the coffee guy.

    I guess I am contrasting it with being underconfident. It’s sort of like sports – there is always a luck aspect and even an unranked team might, on rare occasion, knock off the top dog. That is why they play the game. Some people may not even play the game unless they are overconfident.

  • J

    I’m not saying “champions” are just lucky, but that they may have an extemely narrow range of competence, and a senior mgr/CEO needs to assess the value of (or, more honestly, ignore) their advice outside that range (the CEO needs to assess himself in the same light). I don’t know where in your career path you got your MBA, but a friend of mine who spent the last few years getting his while running a business expressed surprise several times at the things his classmates didn’t know. Would/did you have the same reaction if you got your MBA after being a COO?