Strategy & Leadership

Making Better Decisions

September 28, 2017
betere-keuzes

Recently, a good friend of mine was diagnosed with a severe illness. In one of our conversations, he used the following well known words: 'Give me the serenity to accept the things I cannot change, the courage to change the things I can, and the wisdom to know the difference.'

These words – also known as the Serenity Prayer – were written down by the American theologian Reinhold Niebuhr somewhere in the 1930s. Most of us know these words. But really, how well do we know the difference between the things we can and cannot change?

In recent years, several books have been written about decision-making (e.g. Winning Decisions (Russo & Schoemaker 2002), Think Again (Finkelstein, Whitehead & Campbell 2008), Thinking, Fast and Slow (Kahneman 2011), Decisive (Heath & Heath 2013))

Human beings – we’ve learned – seldom behave like the rational actors we’ve read about in our economics textbooks. In real life, we often make mistakes. Over the years, a wide variety of experiments have been developed as researchers have tried to identify the different cognitive biases influencing how we make decisions.

In these experiments, two fundamental assumptions are made (Rosenzweig, 2014).[1] First, subjects typically don’t have the ability to exert control over outcomes. For example, when given the choice between products A, B or C, the prices of these products will be fixed. The decision-maker cannot influence these prices nor can (s)he decide to introduce a fourth product ‘D’.

Second, in most decision-making experiments, there is no need to outperform rivals. In a typical experiment, you are asked to make a decision that is best for you. You don’t have to think about what others will do. Given the absence of a competitive dimension, the only thing that matters is absolute performance (not relative performance).

'There’s a good reason that experiments about choice are designed this way. If you could alter the options, it would be much more difficult to compare answers. We could wind up with many different answers to a wide range of options, rather than a neatly comparable set of data.' (Rosenzweig, 2014, p. 11).

While most experiments have been very effective in isolating the processes of judgement and choice, we should be very careful when applying these findings to other – such as managerial – situations. Are these findings still relevant when we can (or should) control outcomes? Similarly, are these findings still relevant when it is important to outperform rivals, i.e. when performance is relative?

Outcome Control

One important approach to making better decisions is to make a clear distinction between decisions for which we cannot control outcomes and those for which we can (remember Niebuhr?). Trying to influence outcomes over which we don’t have any control is simply a waste of time and effort. We are suffering from an illusion of control when we are trying to influence outcomes that are beyond our control.

Consider, for example, the dice game known as craps. To improve their luck when throwing the dice, players will shake the dice, they will blow on them, and sometimes even talk to them. Clearly, these dice players are suffering from an illusion of control. Blowing will not influence the outcome of a throw.

'For decades researchers have told us that people have a pervasive tendency to overestimate control. We have been admonished to recognize that we can control less than we imagine. […] By running experiments that only looked at instances of low or no control (like throwing dice) […] researchers could only observe the tendency to overestimate control, not the reverse.' (Rosenzweig, 2014, pp. 35-36)

Indeed, sometimes the bigger problem is not an illusion of control. In many real live decision-making situations, we often have more control over outcomes than we think we have. Here, the more common error is not an illusion of control, but rather the reverse: a failure to recognize the extent of control we have.

In a managerial context – unlike most of the decision-making experiments – we can (and should) influence performance outcomes. The greater danger is that we think that a particular situation is outside of our control. Whenever we can take action to influence outcomes, the more serious error is to underestimate our level of control.

Going back to Niebuhr’ Serenity Prayer, unfortunately, we don’t always know the difference between the things we can change and those we cannot change. But if we don’t know for sure, it’s actually always best to err on the side of thinking you can get things done. The upside is nearly always greater than the downside.

Performance: Absolute or Relative?

Decision-making is also often studied without regard to competition. When people are asked to make decisions, they don’t have to worry about the actions of others. Implicitly then, in much of the decision-making literature, the focus is on absolute performance (i.e. you simply have to try to do well). In business however, the objective is to outperform rivals.  Success is measured relative to the performance of your rivals. Performance is relative not absolute. Importantly, in a competitive setting, even a small increase in absolute performance can lead to a decisive increase in relative performance.

Knowing whether performance is absolute or relative is important. However, another key point is the distribution of payoffs. Are payoffs evenly distributed across rivals or does the winner get a payoff which is much higher than that of its rivals?

Competitive situations differ in the way payoffs are allocated across rivals.

Sometimes, the winner earns just a little bit more than the others (low skewness). Here, competition will not be very fierce. When payoffs are highly skewed – i.e. the winner earns a lot more than rivals – competition will become much more intense. The most extreme distribution of payoffs is that where the winner takes all. Under these circumstances, competition will be extremely fierce and very risk-seeking. Here, you need to go for broke. You take outsized risks. Playing it safe will almost certainly guarantee failure.

As a rule then, the higher the skewness of payoffs, the more important it is to outperform rivals. This, in turn, calls for making bold strategic moves.

Conclusion

Most managerial decisions are different from those that have been studied in much of the decision-making literature in two ways: i) managers most often can   (and need to) control outcomes, and ii) managers need to outperform rivals i.e. performance is relative.

When you think you can control outcomes, it pays off to err on the side of thinking you can get things done. The upside is always greater than the downside. When you have to outperform rivals, strategic thinking matters (especially when payoffs are highly skewed).

All of the experiments in the decision-making literature have been very effective in isolating the principles governing how we make decisions, how we make choices. However, we should be very careful when applying these findings to the decision-making situations confronting managers.


[1] The following discussion is based on Rosenzweig (2014), Chapters 1-4 (pp. 1-79).

Bibliography

Finkelstein, S., J. Whitehead en A. Campbell (2009), Think Again: Why Good Leaders Make Bad Decisions and How to Keep it From Happening to You, Harvard Business Press, Boston, MA.

Heath C. en D. Heath (2013), Decisive: How to Make Better Choices in Life and Work, Crown Publishing, Random House, NY.

Kahneman, D. (2011), Thinking Fast and Slow, Farrar, Straus and Giroux, NY

Rosenzweig, Ph (2014), Left Brain, Right Stuff: How Leaders Make Winning Decisions, Public Affairs, Perseus Books, NY.

Russo, J.E. en P.J.H. Schoemaker (2002), Winning Decisions: Getting it Right the First Time, Currency Doubleday, Random House, NY.

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Comments
  1. Lucile de Godoy | October 16, 2017

    Dear Filip, 

    This is a brilliant post, which I greatly enjoyed. Your rationale is very clear and well articulated and the conclusion is one that every business manager should pay attention to. 

    Reading books on decision-making science is not a recipe for managerial decision, as you very well pointed out, as it only focus on how we make decisions, so we should not apply it blindly.

    Thank you.