Decision-making in companies is often poor, with the result that sub-optimal to simply bad decisions are made. Many studies of mergers and acquisitions – decisions with enormous interests – show that about 75 percent create no value for the shareholders. What are the main cognitive and psychological pitfalls that lead to bad decisions and how do you avoid them?
Many companies rely on analysis to make important decisions about new products or services, investments, organizational changes and acquisitions. There is nothing wrong with good analyzes, absolutely not even, but what is often missing is a solid decision-making process. Researchers discovered that the process is as much as six times more important than the analysis to make a good decision, one that leads to growth in turnover, profit or market share. The typical decision-making process in a company is structured as follows: a team puts forward arguments for or against a decision and the ultimate decision-maker are both the challenger and the one who takes the plunge. These types of processes easily lead to errors. The process managers should follow to avoid the four biggest enemies of good decisions.
1. Too Narrow Field of View
We often jump to conclusions far too quickly because we attach too much weight to the information in front of us and we outside our field of vision is not to take. This cognitive illusion is known as ‘narrow framing’ and is the first major difficulty in decision making. What is in the spotlight will rarely be all that is necessary for the best possible decision. An example of such a narrow field of view is asking the question; “should I fire Peter or not?” In doing so, the questioner highlights one option at the expense of all possible alternatives.
2. Preference for Confirmation
A typical habit that people have in everyday life is to quickly form a judgment about a situation and then gather information that confirms that picture. This problematic habit is called ‘confirmation bias’, our preference to have our suspicions confirmed. Suppose you have data that confirms your idea and data that contradicts your idea, which will you share with your management team during the meeting? Researchers have shown time and again that when people have an opportunity to gather information, they choose information that supports their existing ideas and beliefs.
The tricky thing about this confirmation preference is that it can look very scientific. After all, you are collecting data. The preference for confirmation is probably the biggest problem in companies because even the sharpest thinkers fall for it. They are going to collect data and do not even realize that they are manipulating a lot. A smart CEO should also assemble a team to gather arguments against important decisions, such as acquisitions. This is an ideal role for the controller and financial manager. It puts the team members in the position of protectors of the organization and gives them permission to be skeptical. Finally, experimenting works better than predicting.
3. Short-term Emotion
In the early 1980s, Intel had two product categories: memory and microprocessors. The memory branch, which the company had grown into, was still the main source of income for the company, but this turnover was jeopardized in the mid-1980s due to Japanese competitors with superior products. Intel’s position in the memory market continued to deteriorate until these products started to erode profitability.
In 1985, President Andy Grove discussed the problem with President and CEO Gordon Moore. Grove asked him; “What if the board kicked us out and brought in a new CEO, what would he do?” Moore looked at him and replied without a doubt, “He would withdraw the company from the memory market.” Grove stared at him, then said; “Why can’t you and I step outside, come back in and do it yourself?”
The decision was so difficult for Grove and Moore because they were in conflict. They had grown up in memory products and the internal pressures and politics clouded their minds when it came to this market. In their subconscious they knew they had to get out of that market, but their emotions made that knowledge obscure. By changing perspective and wondering what their successors would do, they suddenly saw clearly what had to be done.
4. Excessive Self-Confidence
In January 1962, a young four-piece rock & roll group was invited to audition in London with one of the major British record companies, Decca Records. After the audition, the manager of the band got the verdict: Decca waived a contract. In a letter to the manager, Dick Rowe, a prominent talent scout at Decca, wrote, “We don’t like the sound of you guys. Groups are out, especially four-piece groups with guitars. ”
Rowe had learned the hard way about the fourth villain of decision-making: excessive self-confidence. People think they know better how the future will take place than they can know. For example, one study found that when doctors said they were completely sure about a diagnosis, they were found to be wrong about 40 percent of the time. And when a group of students had to estimate the probability of being wrong with an estimate, they believed they had only a 1 percent chance of being wrong. This turned out to be 27 percent. We are too confident in our own predictions.