‘Before you make that big decision…’ by Daniel Kahneman, Dan Lovallo and Olivier Sibony, Harvard Business Review, June 2011

In the last blog I reviewed an article by Olivier Sibony in the McKinsey Quarterly, covering the ways in which Chief Financial Officers can and should remove bias from major business decisions. This article builds on this coverage in two ways; by involving two academics from Princeton and Sydney Universities (thus helping to get placed in the HBR) and by extending the responsibility for removing bias to all senior management.

The article starts by introducing some of the different types of bias that we at MTP have found to be powerful for our coverage of business case decisions:

• Confirmation bias, ignoring evidence that contradicts their prior view
• Anchoring bias, weighing too heavily the information that justifies that view
• Loss aversion, an overly cautious approach caused by fear of failure

I was however surprised that motivational bias was not highlighted early on, because we find this to be the most common distorting factor in project decisions; the way in which managers fall in love with an idea and lose all sense of objectivity. This is particularly common among those involved in acquisitions and a typical feature is zero tolerance of more pessimistic voices.
The article claims that the removal of bias in decisions makes companies’ return on investment 7% higher, based on McKinsey research of 1,000 businesses. One wonders about the validity of the research and the other factors that impact ROI but the presence of two respected academics presumably means that this is a true correlation. There is then a sweeping assertion that business executives are incapable of recognising and removing their biases, therefore they must look to others and to the use of suitable tools. I wonder how many CEOs would agree with this assertion and how difficult it must be to make them believe it of themselves. They are almost certain to be biased about their own biases!

The argument that bias cannot be removed is based around the division of thinking into ‘System One and System Two’ elements; System One is the intuitive reflex way of seeing the world, System Two is when we adopt rule based reasoning. The authors’ view is that System One determines most of our thoughts and is the inbuilt source of bias; we cannot, on our own, change what is instinctive. Therefore the solution has to be at the organisational level and must involve more than one person, an interesting challenge for CEOs of an autocratic disposition.

The article then introduces three scenarios as examples of major decisions; a radical pricing change, a large capital outlay and a major acquisition. Though it is good to see practical examples, these are anonymous and seem to be fictitious, which makes them less than convincing; they also seem to add little to the argument.

More useful was the checklist of 12 questions which are intended to question for bias and lead the way to it being removed, looking particularly for self-interest, excessive love for the project and dissenting opinions. There is not space to repeat all 12 questions but the following are among the best and should provide a flavour:

• Is diagnosis influenced by salient analogies? (a rather pretentious way of saying, ‘has a recent success made you think you can do it again?’)
• Is there a halo effect, are we attributing past successes to the personalities of those involved?
• Is there an atmosphere of over confidence which causes us to underrate competitors?

The process of asking and answering these questions is inevitably time consuming and disruptive and the article suggest that this approach is only for the big decisions. It is also important that the review and final decision should be organisationally separate from the team that makes the recommendation; it would have been good to hear more about this, in particular the role of the CFO in making sure it is fully objective.

It is good to see such an important and practical topic being aired in the HBR but I was still left wondering how many CEOs would accept the logic and the process when that next vital acquisition target becomes available.

Click here to read the article in full:

http://hbr.org/2011/06/the-big-idea-before-you-make-that-big-decision/ar/1