How Behavioral Anomalies Affect Your Strategy


I recently read an excellent paper called "Incorporating Behavioral Anomalies in Strategic Models." The paper explores the idea that if our strategic models are based on assumptions of rational behavior, and behavioral economics has shown that rationality cannot always be assumed, what does that mean for strategy? Here is an excerpt from the paper.

In many decision-making situations, decision makers begin with a set of beliefs and subsequently gather additional information to update their prior beliefs before making decisions. Confirmatory bias is the tendency of decision makers to favor their prior beliefs (or working hypotheses) much more than normative models would dictate. Most of the traditional models in marketing, statistics and economics model the decision makers as engaging in optimal data collection and employing Bayes' Rule to update the prior beliefs in the light of new data. For example, in models of search (e.g. Weitzman, 1979), consumers use Bayes' rule to revise their priors about other stores' prices after finding the price at a store, and then decide whether to search further.

However, a large literature in psychology has accumulated a substantial body of evidence
that decision-makers tend to overweigh their prior beliefs or existing hypotheses.

The paper suggests some directions for future research. I've said before that I think b-schools will someday have a basic course in neuroscience as part of the curriculum. Until that happens, think about it this way… worry less about the details of economic theory and more about the real behavior you can observe through experimentation in different areas of your business.