The HiddenTrapsin DecisionMaking
BY JOHN S. HAMMOND, RALPH L. KEENEY, AND HOWARD RAIFFA
Harvard Business Review, 1998
Before deciding on a course of action, prudent managers evaluate the situation confrontingthem. Unfortunately, some managers are cautious to a fault –taking costly steps to defend against unlikely outcomes. Others are overconfident –underestimating the range of potential outcomes. And still others are highly impressionable –allowing memorable events in the past to dictate their view of what might be possible now.
These are just three of the well-documented psychological traps that afflict most managers at some point. Still more pitfalls distort reasoning ability or cater to our own biases. Examples of the latter include the tendencies to stick with the status quo, to look for evidence confirming one’s preferences, and to throw good money after bad because it’s hard to admit making a mistake.
Techniques exist to overcome each one of these problems. For instance, since the way a problem is posed can influence how you think about it, try to reframe the question in various ways and ask yourself how your thinking might change for each version. Even if we can’t eradicate the distortions ingrained in the way our minds work, we can build tests like this into our decision-making processes to improve the quality of the choices we make.
In making decisions, you may be at the mercy of your mind’s strange workings. Here’s how to catch thinking traps before they becomejudgment disasters.
MAKING DECISIONS is the mostimportant job of any executive. It’s alsothe toughest and the riskiest. Bad decisionscan damage a business and a career,sometimes irreparably. So wheredo bad decisions come from? In manycases, they can be traced back to theway the decisions were made–the alternativeswere not clearly defined, theright information was not collected,the costs and benefits were not accuratelyweighed. But sometimes the faultlies not in the decision-making processbut rather in the mind of the decisionmaker. The way the human brain workscan sabotage our decisions.
Researchers have been studying theway our minds function in making decisionsfor half a century. This research,in the laboratory and in the field, hasrevealed that we use unconscious routinesto cope with the complexity inherentin most decisions. These routines,known as heuristics, serve us wellin most situations. In judging distance,for example, our minds frequently relyon a heuristic that equates clarity withproximity. The clearer an object appears,the closer we judge it to be. Thefuzzier it appears, the farther away weassume it must be. This simple mentalshortcut helps us to make the continuousstream of distance judgments requiredto navigate the world.
Yet, like most heuristics, it is not foolproof.On days that are hazier than normal,our eyes will tend to trick ourminds into thinking that things aremore distant than they actually are. Becausethe resulting distortion posesfew dangers for most of us, we can safelyignore it. For airline pilots, though, thedistortion can be catastrophic. That’swhy pilots are trained to use objectivemeasures of distance in addition totheir vision.
Researchers have identified a wholeseries of such flaws in the way we thinkin making decisions. Some, like theheuristic for clarity, are sensory misperceptions.Others take the form ofbiases. Others appear simply as irrationalanomalies in our thinking. Whatmakes all these traps so dangerous istheir invisibility. Because they are hardwiredinto our thinking process, wefail to recognize them–even as we fallright into them.For executives, whose success hingeson the many day-to-day decisions theymake or approve, the psychologicaltraps are especially dangerous. Theycan undermine everything from newproductdevelopment to acquisitionand divestiture strategy to successionplanning. While no one can rid his orher mind of these ingrained flaws, anyonecan follow the lead of airline pilotsand learn to understand the traps andcompensate for them.
In this article, we examine a numberof well-documented psychological trapsthat are particularly likely to underminebusiness decisions. In addition to reviewingthe causes and manifestations ofthese traps, we offer some specific waysmanagers can guard against them. It’simportant to remember, though, thatthe best defense is always awareness.Executives who attempt to familiarizethemselves with these traps and the diverseforms they take will be better ableto ensure that the decisions they makeare sound and that the recommendationsproposed by subordinates or associatesare reliable.
The Anchoring Trap
How would you answer these twoquestions?
Is the population of Turkey greaterthan 35 million?
What’s your best estimate of Turkey’spopulation?
If you’re like most people, the figureof 35 million cited in the first question(a figure we chose arbitrarily) influencedyour answer to the second question.
Over the years, we’ve posed thosequestions to many groups of people. Inhalf the cases, we used 35 million in thefirst question; in the other half, we used100 million.Without fail, the answers tothe second question increase by manymillions when the larger figure is used inthe first question. This simple test illustratesthe common and often perniciousmental phenomenon known as anchoring.
When considering a decision, themind gives disproportionate weight tothe first information it receives. Initialimpressions, estimates, or data anchorsubsequent thoughts and judgments.
Anchors take many guises. They canbe as simple and seemingly innocuousas a comment offered by a colleague ora statistic appearing in the morningnewspaper. They can be as insidious asa stereotype about a person’s skin color,accent, or dress. In business, one of themost common types of anchors is a pastevent or trend. A marketer attemptingto project the sales of a product for thecoming year often begins by looking atthe sales volumes for past years. The oldnumbers become anchors, which theforecaster then adjusts based on otherfactors. This approach, while it maylead to a reasonably accurate estimate,tends to give too much weight to pastevents and not enough weight to otherfactors. In situations characterized byrapid changes in the marketplace, historicalanchors can lead to poor forecastsand, in turn, misguided choices.Because anchors can establish theterms on which a decision will be made,they are often used as a bargaining tacticby savvy negotiators. Consider theexperience of a large consulting firmthat was searching for new office spacein San Francisco. Working with a commercialreal-estate broker, the firm’spartners identified a building that metall their criteria, and they set up a meetingwith the building’s owners. The ownersopened the meeting by laying outthe terms of a proposed contract: a ten-yearlease; an initial monthly price of$2.50 per square foot; annual price increasesat the prevailing inflation rate;all interior improvements to be the tenant’sresponsibility; an option for thetenant to extend the lease for ten additionalyears under the same terms. Althoughthe price was at the high endof current market rates, the consultantsmade a relatively modest counteroffer.They proposed an initial pricein the midrange of market rates andasked the owners to share in the renovationexpenses, but they accepted all theother terms. The consultants could havebeen much more aggressive and creativein their counterproposal –reducing theinitial price to the low end of marketrates, adjusting rates biennially ratherthan annually, putting a cap on the increases,defining different terms for extendingthe lease, and so forth–but theirthinking was guided by the owners’initial proposal. The consultants hadfallen into the anchoring trap, and as aresult, they ended up paying a lot morefor the space than they had to.
What can you do about it? Theeffect of anchors in decision makinghas been documented in thousands ofexperiments. Anchors influence the decisionsnot only of managers, but alsoof accountants and engineers, bankersand lawyers, consultants and stock analysts.
No one can avoid their influence;they’re just too widespread. Butmanagers who are aware of the dangersof anchors can reduce their impact byusing the following techniques:
•Always view a problem from differentperspectives. Try using alternativestarting points and approaches ratherthan sticking with the first line ofthought that occurs to you.
•Think about the problem on yourown before consulting others to avoidbecoming anchored by their ideas.
•Be open-minded. Seek informationand opinions from a variety of peopleto widen your frame of reference and topush your mind in fresh directions.
•Be careful to avoid anchoring youradvisers, consultants, and others fromwhom you solicit information and counsel.
Tell them as little as possible aboutyour own ideas, estimates, and tentativedecisions. If you reveal too much, yourown preconceptions may simply comeback to you.
•Be particularly wary of anchors innegotiations. Think through your positionbefore any negotiation begins inorder to avoid being anchored by theother party’s initial proposal. At thesame time, look for opportunities touse anchors to your own advantage –ifyou’re the seller, for example, suggesta high, but defensible, price as an openinggambit.
The Status-Quo Trap
We all like to believe that we make decisionsrationally and objectively. Butthe fact is, we all carry biases, and thosebiases influence the choices we make.
Decision makers display, for example,a strong bias toward alternatives thatperpetuate the status quo. On a broadscale, we can see this tendency whenevera radically new product is introduced.
The first automobiles, revealinglycalled “horseless carriages,”looked verymuch like the buggies they replaced.
The first “electronic newspapers”appearingon the World Wide Web lookedvery much like their print precursors.
On a more familiar level, you mayhave succumbed to this bias in yourpersonal financial decisions. Peoplesometimes, for example; inherit sharesof stock that they would never havebought themselves. Although it wouldbe a straightforward, inexpensive propositionto sell those shares and put themoney into a different investment, asurprising number of people don’t sell.
They find the status quo comfortable,and they avoid taking action that wouldupset it.“Maybe I’ll rethink it later,”theysay. But “later”is usually never.
The source of the status-quo trap liesdeep within our psyches, in our desire toprotect our egos from damage. Breakingfrom the status quo means taking action,and when we take action, we takeresponsibility, thus opening ourselves tocriticism and to regret. Not surprisingly,we naturally look for reasons to do nothing.
Sticking with the status quo represents,in most cases, the safer course becauseit puts us at less psychological risk.
Many experiments have shown themagnetic attraction of the status quo.
In one, a group of people were randomlygiven one of two gifts of approximatelythe same value –half receiveda mug, the other half a Swiss chocolatebar.They were then told that they couldeasily exchange the gift they receivedfor the other gift. While you might expectthat about half would have wantedto make the exchange, only one in tenactually did. The status quo exerted itspower even though it had been arbitrarilyestablished only minutes before.
Other experiments have shown thatthe more choices you are given, themore pull the status quo has. More peoplewill, for instance, choose the statusquo when there are two alternatives toit rather than one: A and B instead ofjust A.Why? Choosing between A and Brequires additional effort; selecting thestatus quo avoids that effort.
In business, where sins of commission (doing something) tend to be punished much more severely than sins of omission (doing nothing), the status quo holds a particularly strong attraction.
Many mergers, for example, founderbecause the acquiring company avoidstaking swift action to impose a new,more appropriate management structureon the acquired company.“Let’s notrock the boat right now,”the typical reasoninggoes. “Let’s wait until the situationstabilizes.”But as time passes, theexisting structure becomes more entrenched,and altering it becomes harder,not easier.Having failed to seize the occasionwhen change would have beenexpected, management finds itself stuckwith the status quo.
What can you do about it? Firstof all, remember that in any given decision,maintaining the status quo may indeedbe the best choice, but you don’twant to choose it just because it is comfortable.
Once you become aware of thestatus-quo trap, you can use these techniquesto lessen its pull:
•Always remind yourself of your objectivesand examine how they would beserved by the status quo. You may findthat elements of the current situationact as barriers to your goals.
•Never think of the status quo asyour only alternative. Identify other optionsand use them as counterbalances,carefully evaluating all the pluses andminuses.
•Ask yourself whether you wouldchoose the status-quo alternative if, infact, it weren’t the status quo.
•Avoid exaggerating the effort orcost involved in switching from the statusquo.
•Remember that the desirability ofthe status quo will change over time.
When comparing alternatives, alwaysevaluate them in terms of the future aswell as the present.
•If you have several alternatives thatare superior to the status quo, don’t defaultto the status quo just because you’rehaving a hard time picking the best alternative.
Force yourself to choose.
The Sunk-Cost Trap
Another of our deep-seated biases is tomake choices in a way that justifies pastchoices, even when the past choices nolonger seem valid. Most of us have falleninto this trap.We may have refused, forexample, to sell a stock or a mutual fundat a loss, forgoing other, more attractiveinvestments. Or we may have pouredenormous effort into improving theperformance of an employee whom weknew we shouldn’t have hired in thefirst place. Our past decisions becomewhat economists term sunk costs–old investmentsof time or money that arenow irrecoverable.We know, rationally,that sunk costs are irrelevant to thepresent decision, but nevertheless theyprey on our minds, leading us to makeinappropriate decisions.
Why can’t people free themselvesfrom past decisions? Frequently, it’s becausethey are unwilling, consciously ornot, to admit to a mistake.Acknowledginga poor decision in one’s personal lifemay be purely a private matter, involvingonly one’s self-esteem, but in business,a bad decision is often a very publicmatter, inviting critical commentsfrom colleagues or bosses. If you fire apoor performer whom you hired, you’remaking a public admission of poor judgment.
It seems psychologically safer tolet him or her stay on, even though thatchoice only compounds the error.
The sunk-cost bias shows up with disturbingregularity in banking, where itcan have particularly dire consequences.
When a borrower’s business runs intotrouble, a lender will often advance additionalfunds in hopes of providing thebusiness with some breathing room torecover. If the business does have a goodchance of coming back, that’s a wise investment.
Otherwise, it’s just throwinggood money after bad.
One of us helped a major U.S. bankrecover after it made many bad loans toforeign businesses. We found that thebankers responsible for originating theproblem loans were far more likely toadvance additional funds –repeatedly,in many cases –than were bankers whotook over the accounts after the originalloans were made.Too often, the originalbankers’strategy –and loans –ended infailure.Having been trapped by an escalationof commitment, they had tried,consciously or unconsciously, to protecttheir earlier, flawed decisions. They hadfallen victim to the sunk-cost bias. Thebank finally solved the problem by institutinga policy requiring that a loanbe immediately reassigned to anotherbanker as soon as any problem arose.
The new banker was able to take a fresh,unbiased look at the merit of offeringmore funds.
Sometimes a corporate culture reinforcesthe sunk-cost trap. If the penaltiesfor making a decision that leads to anunfavorable outcome are overly severe,managers will be motivated to let failedprojects drag on endlessly –in the vainhope that they’ll somehow be able totransform them into successes. Executivesshould recognize that, in an uncertainworld where unforeseeable eventsare common, good decisions can sometimeslead to bad outcomes. By acknowledgingthat some good ideas will endin failure, executives will encouragepeople to cut their losses rather than letthem mount.
What can you do about it? Forall decisions with a history, you willneed to make a conscious effort to setaside any sunk costs –whether psychologicalor economic –that will muddy your thinking about the choice at hand.
Try these techniques:
•Seek out and listen carefully to theviews of people who were uninvolvedwith the earlier decisions and who arehence unlikely to be committed to them.
•Examine why admitting to an earliermistake distresses you. If the problemlies in your own wounded self-esteem,deal with it head-on. Remind yourselfthat even smart choices can have badconsequences, through no fault of theoriginal decision maker, and that eventhe best and most experienced managersare not immune to errors in judgment.Remember the wise words ofWarren Buffett: “When you find yourselfin a hole, the best thing you can do isstop digging.”