How to Make Better Business Decisions: Avoid the Hidden Traps! (Part II), by Urs Koenig, MBA, PhD, Principal, Redpoint Coaching

jsw_sunk_cost_imageMaking decisions is one of the most important jobs of leaders. It is also the toughest and the riskiest. Bad decisions can ruin your business or career.

In a previous edition of ChangeAbility,  I examined two, well-documented psychological traps and told you what you can do about them in order to make better decisions.  These two traps were:

THE ANCHORING TRAP & THE STATUS-QUO TRAP

In this edition, I am discussing the following two traps:

THE SUNK-COST TRAP & THE CONFIRMING EVIDENCE TRAP

THE SUNK-COST TRAP

We all sometimes make choices in a way that justifies past choices, even when the past choices are no longer valid.

Imagine you have been standing in line at the post office for 15 minutes. You have a meeting with an important client coming up, and you run the risk of being late to the meeting if you keep standing in line. What do you do?

For many of us the thinking goes something like this, “Well, dam#$^%! I have already been standing in line for 15 minutes; it would be really stupid to give up my space now, so I will stand in line even if I end up being late to the important meeting.” We just fell into the sunk-cost trap.  How so?

It’s simple: we are justifying our decision to keep standing in line by what we have done in the past (i.e. standing in line for 15 minutes already) and not by what is best going forward. Even if you have been standing in line for hours, you need to leave the line if your client meeting is more important than mailing those packages. As economists would say: it’s all about maximizing your utility going forward!

Other examples of the sunk-cost trap include business owners who pour enormous effort into improving the performance of an employee whom they should not have hired in the first place. It is also very common in banking. When a borrower’s business runs into trouble, a lender often advances additional funds in the hope that the business can turn around. If the business does have a good chance to do that, this is wise; otherwise it’s just throwing good money after bad.

Why can we not free ourselves from past decisions? Frequently, it is because we are unwilling to admit mistakes. If you, for example, fire a poor performer who you hired, you are making a public admission of poor judgment. It seems psychologically safer to let him or her stay on, even though that choice only compounds the error.

Sometimes a corporate culture reinforces the sunk-cost trap. If the penalties for making a decision that leads to poor outcome are overly severe, managers will be motivated to let failed projects drag on forever – in the vain hope that they will somehow turn around.

WHAT CAN YOU DO ABOUT THE SUNK-COST TRAP?

Make a conscious effort to set aside any sunk cost – whether psychological or economic – that will muddy your thinking about the choices at hand:

  • Seek out and listen carefully to the views of people who were uninvolved with the earlier decision
  • Examine why admitting earlier mistakes distresses you. If it’s your wounded self-esteem, deal with it head-on. Remind yourself that even smart choices can have bad consequences and that even the best and most experienced executives are not immune to errors in judgment
  • Don’t cultivate a failure-fearing culture that makes employees perpetuate their mistakes. Lead by example by admitting your own mistakes
  • Remember: “If you are in a hole, stop digging.” – Warren Buffet 

THE CONFIRMING-EVIDENCE TRAP

Imagine you are the president of a successful, mid-size, Italian shoe manufacturer, considering whether to call off a planned plant expansion. For a while you have been concerned that your company won’t be able to sustain the rapid pace of growth of its exports. You fear that the value of the Euro will strengthen in coming months, making your goods more costly for overseas consumers. But before you put the brakes on the plant expansion, you decide to call up an old business school classmate, the CEO of a similar company that recently cancelled plans for a new factory, to check her reasoning. She presents a strong case that other currencies are about to weaken against the Euro. What do you do?

You’d better not let this conversation be the clincher because you’ve probably just fallen victim to the confirming-evidence trap. This bias leads us to seek out information that supports our existing instincts or points of view while avoiding information that contradicts it. What, after all, did you expect your acquaintance to give, other than a strong argument in favor of her decision?

Two fundamental psychological forces are at work here:

  • We subconsciously decide what we want to do before we figure out why we want to do it.
  • Our inclination is to be more engaged by things we like than by things we dislike – a tendency well documented even in babies. Naturally, we are drawn to information that supports our subconscious leanings.

WHAT YOU CAN DO ABOUT THE CONFIRMING EVIDENCE TRAP?

It’s not that you should not make the choice you are subconsciously drawn to. It’s just that you want to make sure it’s the smart choice. Here is how you put it to the test:

  • Get someone you respect to play the devil’s advocate to argue against the decision you are contemplating. Better yet, build the counter-argument yourself. What are the strongest reasons to do something else?
  • Be honest with yourself about your motives. Are you really gathering information to help you make a smart choice, or are you just looking for evidence confirming what you think you’d like to do?
  • In seeking the advice of others, don’t ask leading questions that invite confirming evidence. If you find that an advisor always seems to support your point of view, find a new advisor. Do not surround yourself with yes-men (and women).

Your Take-Away:

  • When facing major decisions in your business or life, be sure to use the above techniques to avoid falling into the Sunk-Cost Trap and the Confirming Evidence Trap.

This article is based on: “Hammond, Ralph & Raiffa: The Hidden Traps in Decision Making,” Harvard Business Review, January 2006.

 

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How To Make Better Decisions: Avoid The Hidden Traps! by Urs Koenig, Redpoint Succession and Leadership Coaching

Making decisions is the most important job of business owners and executives. It is also the toughest and the riskiest. Bad decisions can ruin your business or career.

So where do bad decisions come from?

In many cases they can be traced back to a flawed decision-making process – the alternatives were not clearly defined or the right information was not collected. However, more often than not, the fault lies not in the decision-making process but rather in our mind. The way the human brain works can sabotage decision-making.

Over the course of this and the next edition of ChangeAbility, I will examine four, well-documented psychological traps and tell you what you can do about them in order to make better decisions. These four traps are:

  • The Anchoring Trap
  • The Status Quo Trap
  • The Sunk Cost Trap
  • The Confirming Evidence Trap

The Anchoring Trap

How would you answer these two questions?

  • Is the population of Turkey greater than 35 million?
  • What is your best estimate of Turkey’s population?

If you are like most people, the figure of 35 million cited in the first question influenced your answer to the second question. Studies show that if you use, for example, “100 million” in the first question, the answer to the second question increases by many millions.

This simple test illustrates the common mental phenomena of anchoring: When considering a decision, the mind gives disproportional weight to the first information it receives. Initial impressions, estimates, or data anchor subsequent thoughts and judgments.

Because anchors can establish the terms on which a decision will be made, they are often used by savvy negotiators. The first offer in any negotiation will serve as an anchor. Therefore, it is important to really understand your position before any negotiation in order to avoid being anchored by the other party’s initial offer.

 What Can You Do About the Anchoring Trap?

No one can avoid the influence of anchors. They are too wide spread. However, by being aware of the dangers of anchors and using the following techniques, you can reduce their impact:

Think about the problem on your own before consulting others to avoid becoming anchored by their ideas. When consulting others, seek information and opinions from a wide variety of people.

Be careful to avoid anchoring advisors, consultants and others from whom you solicit counsel. Tell them as little as possible about your own ideas or tentative decisions. If you reveal too much, you might simply anchor their thinking.

Think through your position before any negotiation begins in order to avoid being anchored by the other party’s initial proposal. At the same time, use anchors to your own advantage. If you are a seller, for example, suggest a high but defendable price as a first offer.

The Status Quo Trap

When faced with a decision, we all display a strong bias towards the status quo. The source of the status-quo trap lies deep within our psyches, in our desire to protect our egos from damage. Breaking from the status quo means taking action. When we take action, we take responsibility; thus we open ourselves to criticism and regret.

Many experiments have shown the magnetic attraction of the status quo. In one, a group of people were randomly given one of two gifts of the same value: half received a mug, the other a Swiss chocolate bar. They were told they could easily exchange the gift they had received for the other. While you might expect that about half would have wanted to make the exchange, only one in ten actually did. The status quo exerted its power even though it had been arbitrarily established only minutes before.

In business, where the sins of doing something tend to be punished much more severely than the sins of doing nothing, the status quo holds a particularly strong attraction. In merger situations, for example, the acquiring company often fails to take swift action to impose a new, more appropriate management structure early on. “Let’s not rock the boat; let’s wait until things stabilize,” goes the reasoning. However, as time goes on, the existing structure becomes more entrenched and changing the structure becomes harder, not easier. The acquiring company has fallen into the Status-Quo Trap.

What Can You Do About the Status Quo Trap?

Remember that in any given decision, maintaining the status quo may indeed be the best choice, but you do not want to choose it just because it is comfortable. Once you are aware of the status quo trap, you can use the following techniques to mitigate its influence:

  • Ask yourself whether you would choose the status-quo alternative if, in fact, it weren’t the status quo.
  • Always remind yourself of your objectives and examine how they are served by the status quo. You might find that elements of the status quo are detrimental and prevent you from achieving your goals.
  • If you have several alternatives that are superior to the status-quo, don’t default to the status-quo simply because you’re having a hard time picking the best alternative. Force yourself to choose.

Your Take-Away:

When facing major decisions in your business or life, be sure to use the above techniques to avoid falling into the Anchoring Trap and the Status-Quo Trap. In the next ChangeAbility, I will discuss the Sunk Cost Trap and the Confirming Evidence Trap.

This article is based on: “Hammond, Ralph & Raiffa: The Hidden Traps in Decision Making,” Harvard Business Review, January 2006.