Overcome These 5 Biases to Unlock Sustainable Growth
Author: Joshua Seedman
Introduction
Exhibit 1 (Click to Enlarge)
Poor decision-making is oftentimes the number one culprit for why companies fail and/or see stagnant growth. While there are many factors that contribute to poor corporate decision-making, often the number one culprit are biases that unknowingly guide value erosive decisions. Simply, left unchecked, subconscious biases (1) undermine corporate decision-making, (2) create a toxic culture, (3) lead to stagnant growth, and (4) drive negative ROI. For example, companies exhibiting a greater number of biases are 32 percent more likely to pass up good investments (See Exhibit 1). In addition, biases can decrease the returns on a company’s investments by 31 percent (See Exhibit 1). On the opposite side of this spectrum, those that improve their decision-making via debiasing efforts can witness substantial growth, including ROI increases of 7 percent and greater (Exhibit 2). Simply, decision-making can either be value erosive or value maximizing.
Exhibit 2 (Click to Enlarge)
In a recent McKinsey survey of 772 board members, including over 200 chairmen, respondents ranked "reducing decision biases" as their number one aspiration for how to improve their performance. Furthermore, in a recent McKinsey Quarterly survey of ~2,200 executives, only 28 percent said that the quality of strategic decisions, due to prevailing biases, was generally good.[1] Finally, another McKinsey survey of over 1,000 executives illustrated that raising a company’s decision-making from the bottom to the top quartile improved its ROI by 6.9 percentage points (See Exhibit 2 and 3). Consequently, instead of relying on gut decision-making the same level of rigor leveraged across enterprise initiatives such as analytics, sales & marketing, R&D, operations, and financial forecasting should be employed for unbiased decision-making.
Exhibit 3 (Click to Enlarge)
In strategic decision-making leaders need to look inwardly as much as within their own organization to identify and put a stop to biases. Such a self-reflective system is not only admissibly challenging but one that also takes time to harness. Quite simply, transforming decision-making from value erosive to value unlocking requires implementing an appropriate debiasing program that will identify, confront, and implement guard rails for ensuring appropriate change. This is without question a daunting transformation that requires a significant mindset shift. However, when one looks at the value eroding biases so prevalent in organizations such change, no matter how challenging, is of the utmost importance to enterprise health. For example, a majority of mergers (50 to 75 percent) destroy acquirer shareholder value, in large part, because synergies are over-estimated due to biases. In addition, biases often equate to (1) strategic plans that ignore competitive responses, (2) groupthink that destroys innovation, (3) poor culture that lacks engagement, (4) large investment projects that are over budget and over time, and (5) transformations that end up using an enormous amount of capital with little to no financial benefit.
Simply, biases often undermine decision-making more often than not. Behavioral economics indicate we are often not rational as decision makers. As Dan Ariely notes “… we are really far less rational than standard economic theory assumes. Moreover, these irrational behaviors are neither random nor senseless. They are systematic, and since we repeat them again and again, predictable.” However, such irrationality can be combatted by tools and countermeasures. As Daniel Kahneman states, “[when it comes to debiasing] I’m much more optimistic about organizations than individuals as organizations can put systems in place to help.”
Such pre-defined systems are not only necessary to safeguard against pre-installed human biases but to also help mitigate the strain of decision-making paralysis. For example, the average individual makes ~10,000 decisions a day – each of which requires brainpower. The greater number of decisions made equates to decreased mental reserves for sound decision-making; and thus, the greater likelihood that one will use heuristics (i.e., rules of thumb biases) to guide their decisions. Quite simply, humans all have finite decision-making capacity and in order to avoid decision-making paralysis one must either prioritize the decisions on which to focus our attention - indeed, not always practical - or have a structured decision-making system in place that helps guide one through the maze of decision-making heuristics and biases.
Five Biases That Hold Back Growth
Exhibit 4 (Click to Enlarge)
There are many factors that contribute to poor corporate decision-making. However, there are generally five reoccurring biases that unknowingly guide value erosive decisions, specifically, (1) anchoring, (2) confirmation bias | group think, (3) prospect theory, (4) misaligned incentives, and (5) overconfidence bias (See Exhibit 4). This article will dive into each of these five value erosive biases as well as provide methods to mitigate them across the enterprise. Ultimately, concentrating on overcoming these five biases will significantly help transform a company's decision-making protocols, ensuring greater growth and ROI across the enterprise.
Bias #1
- Anchoring-
Anchoring, or the idea of grounding one's opponent to an initial value (e.g., giving the first offer), can lead to improper adjustments and major implications for who captures most of the bargaining zone. Studies at MIT found that anchoring can produce a ~43 percent swing in revenues. As Adam Galinsky found, “[i]n situations of great ambiguity and uncertainty, first offers have a strong anchoring effect — they exert a strong pull throughout the rest of the negotiation . . . [and] [e]ven when people know that a particular anchor should not influence their judgments, they are often incapable of resisting its influence.”[6]
For example, higher real estate listing prices typically lead to higher final selling prices.[7] Indeed, much research has illustrated just how important aggressive first offers (i.e., anchoring) are to achieving better outcomes in a negotiation.[8, 9] Countermeasures include: (1) ensuring that one makes the first aggressive offer, (2) re-anchoring by defensively combatting an aggressive first offer with an even more aggressive counter-offer, and (3) presenting multiple equivalent simultaneous offers (MESOs - explained below).
Bias #2
- Confirmation Bias | Group Think -
Confirmation bias has been called “the single biggest problem in business.” As Professor Dan Lovallo notes, "[c]onfirmation bias is probably the single biggest problem in business, because even the most sophisticated people get it wrong. People go out and they're collecting the data, and they don't realise they're cooking the books." Confirmation bias, where individuals either follow the leader (“yes” employees that are afraid to dissent) or “first mover” (follow the majority with no grounding for rationale), pervades many organizations and their accompanying decision-making. Research shows the herd effect and group think is a significant factor for irrational moves. Indeed, the dotcom bubble is a prime example of the ramifications of herd instinct. In addition, studies have found that humans are more than twice as likely to favor confirming information over disconfirming information.[10] For example, Quaker’s disastrous purchase of Snapple was a particularly expensive illustration of confirmation bias among others, costing the company billions of dollars.
Such outcomes occur because companies often get so focused on the potential end prize that groupthink, poor leadership and employee empowerment leading to “yes” people, emotional escalation, egos, tunnel-vision, cultural misalignment, data gaps, and biases get in the way of sound, value maximizing decision-making across the entire decision lifecycle. Countermeasures include (1) implementing pre-mortem protocols, (2) running reference based forecasting, (3) initiating red team – blue team protocols, and (4) assigning a devil’s advocate during war-room negotiation training.
Bias #3
- Prospect Theory -
Daniel Kahneman’s and Amos Tversky’s immense work on prospect theory sheds light on the fact that framing topics around losses instead of gains can trigger a large emotional bias. After all, the human mind is programmed to place a priority on losses instead of gains because humans are naturally bred to be somewhat risk averse. Simply, losses are more painful and gains are more pleasurable. This leaves the risk adverseness of the human mind to gravitate to the option that will ensure minimal losses, even if in the process such a decision destroys immense value.
For example, studies show that companies were willing to only accept a risk of loss between 1 and 20 percent, although the net present value would be positive up to a 75% risk of loss. Obviously, a company can successfully frame a negotiated offer as losses versus gains to trigger an emotional response to their opponent, thus gaining an upper hand in a high-stakes negotiation such as an M&A deal. Appropriate countermeasures include (1) reframing a received offer as a “gain” instead of a loss to ensure mitigation of a gut, risk averse response and (2) performing a net present value analysis to ensure any initial emotionally inbred trigger is not guiding an irrational, value erosive decision.
Bias #4
- Misaligned Incentives -
Across enterprise decision-making, silos can form that often negatively impact value unlocking capabilities. For example, leaders and/or business units can often unknowingly adopt views or seek outcomes favorable to themselves or their business units. Research has shown that even well intentioned professionals, such as doctors and auditors, are unable to prevent self-interest from biasing their judgments. Countermeasures include (1) implementing a formal vetting process before deciding on any key decision, (2) running brain-writing exercises, (3) creating two teams - one to confirm and one to disprove a certain hypothesis, (4) running pre-mortem techniques to uncover potential pain points along the way that may prove value erosive, and (5) assigning a devil’s advocate to help draw out other views and/or hidden ulterior motives.
Bias #5
- Overconfidence Bias -
Many decision-makers and leaders often rely on gut and past experience to drive their decision-making. Such a tactic easily allows an overconfidence bias to take root, which often destroys value. For example, such a bias ensures the company will likely plan without factoring in competitive responses due to overestimating their own ability to drive success. Indeed, surveys show that 93% of US drivers put themselves in the top 50% of all drivers. In addition, 25% of individuals put themselves in the top 1% with their "ability to get on well with others." Finally, another example illustrates this same bias with 87% of Stanford MBA students rating their performance as above the median. Simply, we as humans often overvalue our ability because of an unknowing overconfidence bias.
One of the most important methods of mitigating this overconfidence bias is to ensure the right people are involved in both the preparation and actual decision-making process. Thus, contributions should not be based on rank but rather on expertise, diversity of background, risk aversion profiles, and ability to dissent via substantive disagreements.[5] Other countermeasures include (1) running pre-mortem and prospective hindsight analysis, (2) performing anonymous/impartial voting to guide decision-making problem solving, and (3) creating a dynamic scoring system to ensure data is driving decisions, in real-time if necessary, instead of gut.
Steps To Mitigating Biases
Any company can take a very structured three-step process to mitigating decision-making biases.
Diagnostics: Identify existing decision-making biases by mapping out how decisions are made, using observed facts and behaviors to identify business outcomes and analyzing their root-causes.
Countermeasures and Playbook: Redesign the decision-making system through selection of relevant countermeasures and creation of playbooks to mitigate identified biases.
Capability Building: Institutionalized the revised decision-making system through (1) creating trainings and war room capability building, (2) implementing feedback mechanisms, (3) producing scoring models to ensure data is driving decision-making instead of gut, heuristics, and biases, and (4) driving continuous audits of the revised system to ensure success and enterprise adoption.
Conclusion
Poor decision-making plaques even the world's best companies. Over time this equates to (1) strategic plans that ignore competitive responses, (2) groupthink that destroys innovation, (3) poor culture that lacks engagement, (4) large investment projects that are over budget and over time, and (5) transformations that end up using enormous amount of capital with little to no financial benefit. In order to keep up with the ever-quickening innovation cycles, organizations must make decisions and roll out new initiatives more quickly than ever. For many organizations, a three to five-year strategic plan represents an antiquated methodology. Thus, in this dynamic and fast-paced environment, a competitive advantage will accrue to companies that have a structured decision-making framework in place, allowing for quick, flexible and sound decision-making that is free of value erosive biases. While the behavioral-strategy journey requires a serious commitment from senior leadership on down, the payoff makes it one of the most valuable strategic investments organizations can make.
About the Author
Joshua Seedman is the founder and chairman of PNI Consulting, a management consulting firm that specializes in global transformations. He has over 20 years of operating and general management experience with expertise in organizational transformations, customer experience, employee engagement, digital transformations, sales & marketing, operational turnarounds, culture/change management, and high-stakes negotiations. His experience includes executive roles within F500 companies, top-tier consulting leadership (McKinsey & Company), over 10 years of global P&L responsibility, and corporate lawyer (Davis Polk & Wardwell). He received his MBA from Kellogg School of Management and his J.D. (cum laude) from Northwestern University School of Law.
Client Examples
Exhibit 5 (Click to Enlarge)
Exhibit 6 (Click to Enlarge)
References
See Flaws in strategic decision making: McKinsey Global Survey Results, mckinseyquarterly.com, January 2009.
See Dan Lovallo, Patrick Viguerie, Robert Uhlaner, and John Horn, Deals without delusions, Harvard Business Review, December 2007, Volume 85, Number 12, pp. 92–99.
See John T. Horn, Dan P. Lovallo, and S. Patrick Viguerie, Beating the odds in market entry, mckinseyquarterly.com, November 2005.
See Bent Flyvbjerg, Dan Lovallo, and Massimo Garbuio, Delusion and deception in large infrastructure projects, California Management Review, 2009, Volume 52, Number 1, pp. 170–93.
The Case for Behavioral Strategy, McKinsey Quarterly March 2010, Dan Lovallo and Olivier Sibony.
Adam D. Galinsky, Should You Make the First Offer?, Negotiation, 7, 1-4 (2004).
Id.
Adam D. Galinsky and T. Mussweiler, First Offers As Anchors: The Role of Perspective-Taking and Negotiator Focus, Journal of Personality and Social Psychology, 81, 657–669 (2001).
Amos Tversky and Daniel Kahneman, Judgment Under Uncertainty: Heuristics and Biases (Vol. 13), Oxford, England: Oregon Research Institute (1974).
William Hart et al (2009) Feeling Validated Versus Being Correct: A Meta-analysis of Selected Exposure to Information, Psychological Bulletin 135: 555-5 – examined over 8,000 participants.