I have read this really nice article in McKinsey Quarterly Distortions and Deceptions in Strategic Decisions which uncovers two types of human mind traps in strategic thinking: “distortions” and “deceptions”. I have combined the lessons from McKinsey with several lessons from The Black Swan (Taleb, 2007), The Harvard Business Review (Hammond et al, 2006) and other sources cited within and you will see that they show similar conclusions. Very interesting; but I bet that even if you will find these findings very interesting (like I did), you will forget them by the time you close the browser. Because they are SO into our human nature!

Distortions and biases

Distortions are flaws of thinking that prevent us to perceive correctly the reality (you can’t see clearly). Biases are flaws of thinking which make it difficult for us to assess the reality (you can’t judge clearly).

1. Optimism and overconfidence in unknown: if you do not have the possibility to measure or otherwise determine the probability of an event, you will tend to estimate that probability in a more optimistic or overconfident fashion. This is what we usually do when we launch a completely new product and try to predict revenues, or when we plan for large projects (planning fallacy). The same when we take a decision for which we cannot measure the probability of the output (for instance investment in a new market).

To prevent overoptimism bias for your executive employees, reward realism and require independent estimations. If you need your plan to be approved, create several wide scenarios to test the strategy: optimistic and pessimistic scenarios, Wack (1985) recommends 2 or 4 options and your managers will choose from them (otherwise, if you create 3 alternatives like many others, managers will tend to choose the middle ground). Add some buffer to the pessimistic scenarios; you need that because your brain is meant to work in a overconfidence way and therefore you tend to underestimate your chances for disaster. Build the company flexible, such that it can adapt its scale easily as operations fluctuate. Inevitably, there will be periods or boom and periods of recession. These periods require different strategies from companies, and in order to cope with the changes the company must be flexible. This flexibility is the adaptability to uncertain changes.

Trap: people tend to be more optimistic when they can’t calculate the odds.

When comes to loosing, people tend to disregard the chances of high impact improbable events happen, events for which no history exist (“that will never happen”). For instance, if someone tells you that a large, stable, insurance company with triple A ratings (e.g. AIG) will go bankrupt and lose all your money, you will not believe him because in your mind, there is no real reason to perceive that as a possibility. HOWEVER, when loosing involves events for which you have a history (e.g. dice, coin flip, blackjack), even if chances are quantifiable, you tend to maximize the risks of loss (more on that in point 2).

Trap: people don’t see the risks when experience doesn’t show casualties.

2. Loss aversion: when probability is known (for instance you possess a method to measure it, or you have a track record that allows you to calculate it), you will tend to feel loss more painfully than success. For instance, given 50-50% chances, you will have a stronger feeling against loosing 1000 EUR than winning 1000. The feeling gets more intense as the exposure gets higher. Think about it: would you flip the coin for your house given the 50-50% chance to win another one of the same value?

The loss aversion gets worse generally if the decision is a one time event (e.g flip the coin on your house) and by the fact that you usually get punished for taking a decision that has lead to a loss (the flip of the coin above) but you do not (usually) get punished for loss of opportunity. In this instance, loss aversion generates the gravitation towards the status quo, coupled with the tendency to avoid the efforts of change (Hammond et al, 2006). An example of opportunity: invest in the stock market when you have some information that there is a high chance to win. If you decide not to invest to avoid the risk of loosing, and the stock market bounces, you will support less criticism than if you would have invested and would have lost.

To avoid loss aversion bias you can establish small ventures inside the organization and appraise on long term contribution, not short term successes. New products or new initiatives may not be successful in short term but may prove highly successful after a few years. You need to give them a break to learn, develop and catch on; otherwise, as with too many companies, running for quick money may leave you shortsighted and out of the future.

Trap: when they know the odds, people fear failure more than they crave for success.

Read more about the loss aversion framing. Also, Thaler (1980) suggests that the loss aversion effect exists also in risk free environments stating that the intensity with which people people feel bad about loosing an good is higher than the intensity of the joy felt about receiving it due to the Endowment effect, which was further studied by many others with the same conclusions. Of course, loss aversion depends on many circumstances such as available funds, attachment to the goods, value attributed to goods etc… Novemsky and Kahneman (2005) go further explaining that loss aversion is present in goods exchange or buying and selling where the loss aversion is directly linked to the benefits that the goods offer to buyers or perceived by sellers. Also, they suggest that buyers are generally more sensitive to price increases than price decreases in consumption (food for thought for sellers), and state that frequent buyers pay the price for fear of loosing consumption while new buyers pay the price when they feel that the item is worth loosing part of their budget. Savvy sellers can increase consumption by re-framing the budget under which an item falls such that the buyer does not feel loss averse with the respective spending (framed into the health budget, buyers will allocate budget for a new brand of lime and water drink even if in reality they do not really need it or they could find cheaper alternatives). A related approach (used for durable goods exchange) is to offer buyers to exchange their old goods for a new item plus cash. This practice can really increase buyouts since owners of durable goods feel are being re-framed from buying an item with several extra benefits and replacing the old item that still performed satisfactory (therefore buyers feel they loose value this way) to a framing where buyers feel they win something in exchange for the old good and get a new one instead (so the frame is more closely linked to exchange of goods where you end up with more value).

To protect yourself from re-framing (as a buyer) always break up the transaction in two separate transactions: how much would you ask for the old good if you were selling it separately and how much would you pay for the new good if you would buy it separately.

In a similar note, Thaler (1997) describes how frequent feedback (especially negative experience) encourages loss aversion which in turn makes people more risk adverse. If you take a look at the stock market, 1 USD invested in 1926 in S&P 500 was worth 1100 USD in 1995 while risk free investment (T-bills) worth 12.87 USD. And the stock market outperformed by much more the risk free instruments through 2005. Nevertheless, there are no investors which obtain these returns mainly because of their risk averse attitude which makes them take wrong decisions. However, frequent positive feedback diminishes loss aversion and encourages riskier investments. That is why in periods of economic growth where the stock market rises investors are repeateadly re-enforced by positive returns and tend to invest much more of their portfolios into the stock markets.

3. Experience: people use their past experience to make quick decisions. This is the most common and the fastest way to take a decision. The mechanism is fast but also prone to error. Two phenomenas are occurring: heuristics (trial and error creates shortcuts in our thinking; when seeing a situation that resembles one in the past, we _think_ we know the outcome and therefore we know what to do) and bias (tendency to lean toward something but with no logical reasoning). For instance, if you lost a lot of money in a recent investment, you tend to be more pessimistic; if you won a lot of money in a recent deal you become suddenly an optimistic. But none of the recent events may be directly linked with what will happen in the future: you may have lots of losses in the past month and gain much more in the next one. The “experiential” method is believed to be linked to our emotions and residing in the limbic part of the brain. The limbic system is a characteristic of mammals thus it may be very old and encrusted deep down in our nature; it is the system that told our ancestors how to behave in near of wild animals, how to look for pray, basic instincts (Taleb, 2007).

To avoid past experience bias, require executives to explain the grounds for decisions; if these are based on past experience, make sure they can reason the decision given the current situation.

Trap: people place allot of weight in their past experience when they take a decision. Sometimes they don’t see the reality ahead.

4. Cognition (information bias): the logical thinking process, whereby one looks for facts, learns the rules and then draws the appropriate conclusions in a logical manner. This system is less prone to error. According to biologists, the cogitative acting is the result of our cortical part of the brain. The cortical part of the brain is what makes us distinct from other mammals.

HOWEVER, if you acquire too much information in order to make a decision the chances are that a) you will either delay the decision too much up to the point when it will become irrelevant (even if correct), b) you will be incapable to take the decision (can’t see the forest from the trees) or c) you will take the wrong one. You need to obtain the relevant information and obtain if as fast as possible (Taleb, 2007).

To balance correctly experience, intuition and cognition in a decision require your executives to support decisions by presenting the key decision factors. Avoid grid type of decisions tools like “decision matrix”, criteria or methods that are too academic or business plans that span over more than 20 pages. In general, the higher the decision level, the more you need to rely on abstract thinking and you find analytical thinking less useful.

Trap: some people are just too analytical. These people get easily lost in the data and find themselves not able to take a decision.

5. We just cannot predict our future! A specialist that makes a prediction about the future is actually thinking inside the box, because inevitably he tries to predict the future by looking at the past; a non-specialist trying to predict the future makes a guess that has nothing to do with the reality.
Trying to predict the future is trying to guess something when you have too little information (for instance the number of dears in Yellowstone park). If you give the last values of a stock to a taxi driver it is quite possible for him to predict the future price with the same accuracy as a trained professional (there are a lot of experiments proving this affirmation).

Nassim (Taleb, 2007) considers that when you predict for planning you also need to take into consideration the worse case scenario and he illustrates this need with a metaphor – let’s exemplify with a similar shorter example: if you prepare to go into a trip and I tell you that there are 25% chances it is going to rain, 75% chances it is going to be sunny and 5% it is going to snow heavy, would you take your winter boots along? Even if most of the people answer yes to this question, the (sad) reality is that most of the companies do not plan for worse case scenarios…

Trap: people can’t predict, and sadly they don’t plan for failure.

I have written a new post on predictions, which fills in several points in this article: Do predictions make sense?

6. Estimations (still Taleb, 2007): people think that they have higher chances to win when the stake is higher than when the sake is lower. For instance, given a 1:1,000,000 probability of success (lottery), people feel luckier when the prize is 2,000,000 EUR than if the prize were 1,000 EUR.

Trap: people like to aim high.

7. Confirmation bias: the process of taking a decision involves analyzing the situation, weighting the probable outcomes and choosing the best way forward. Simple, right? NO. Because the analysis of the situation requires a theory that would indicate the probable outcomes based on the present facts. Decision makers have to figure out the theory which would support the analysis and they need to make sure that the theory is correct. In order to validate the theory, decision makers verify it by checking it against several scenarios in real life or in simulations (in general, the only way to validate a theory is to check the theory in a set of scenarios where the predicted outcomes are verified against real outcomes). HOWEVER, most of the time decision makers validate the theory with scenarios that confirm it, and they think that positive results strongly suggest that the theory is correct. WRONG. Let’s take an example.

P. C. Wason (psychologist) made an experiment where he asked a number of subjects to determine the rule that he used to create the following sequence of numbers: 2, 4, 6. Since there are a number of mathematical rules that could generate such a series, he allowed participants to verify their theories by presenting 3 numbers generated based on the “suspected” rule and Wason would validate or invalidate the numbers (by saying “yes” or “no”). Based on these validations or invalidations subjects would know (after a number of trials) whether the rule they have created is correct or not. The subjects decided when they would stop the validations and decide on their rule, basically when they felt comfortable with the verifications that the suspected rule went through. The result: none of the test subjects managed to guess Wason’s rule since the rule was “any number in an ascending order”. The easies rule to think of would seem to be that the series is built from even numbers. But the reason why nobody figured this out, was that everybody created a rule and then asked questions that would validate that rule rather than questions that would invalidate it. Nobody asked if the next number in the series could be lower than 6! Everybody asked about confirmatory evidence, not contradictory evidence. Everybody tested numbers that - if Wason would say they are correct - would validate the rule they were verifying. What they should have done, after creating the rule, they should have also tested numbers that - if Wason would say they are correct - would invalidate the rule they were verifying. The inner-works of human mind that are trying to find confirmation in our theories is due to human ego. Most of humans want to believe and see that they are right, very few actually also search for to see if they are wrong. This phenomena is the Confirmation bias. Confirmation bias is also due to the fact that humans know exactly what they like or what they want but cannot clearly show why (Hammond et al, 2006).

In order to avoid the confirmation bias, look for evidence that, if found, confirms your theory but also look for evidence that, if found, would infirm your theory. Avoid yes-men and have a moderate critical discussion in the decision making process (moderate because team members which are overly critical can dry up the team resources, enthusiasm or optimism and become counter productive).

Trap: people look for confirmation when they verify their theories, but do not look for evidence that, if found, would infirm their theories.

8. Heuristic simplification: means finding a solution to a problem by using methods which are not quite accurate but because time and information is limited it is sufficient to make a trial and error with different approximative methods and see which one gives the best results. For instance, you can approximate distance up to a point in the horizon by observing the clarity with which you can see the objects there (Hammond et al, 2006). While heuristic simplification works for most of our day to day perceptions of the reality, the process is not always sufficient accurate for important decisions. In an analogy with the distance estimations, plane pilots are always trained to trust the on board equipment more than their perceptions.

9. Anchoring (Hammond et al, 2006): when you don’t know anything about a subject, you cling to each information you get when you make estimations no matter how irrelevant the information is. For instance, let’s assume a question for which you don’t know the answer: how many lovers did Caterina II of Russia had? This is a question used frequently by Taleb (2007) when he wants to illustrate prediction, so we will adapt this question for the purpose of our demonstration. If you were asked “Did Caterina II of Russia had more than 30 lovers? How many lovers did Caterina have?”, then you most probably would estimate a number somewhere around 30. But if you were asked “Did Caterina II of Russia had more than 4 lovers? How many lovers did Caterina have?” then you would have answered somewhere below 10. Anchoring means that your brain is influenced by recent information or information from proximity when portraying reality.

People anchor on first impressions, recent data (even if incomplete or inaccurate), statistics, stereotypes (like accent, dress), a past event or recent trends (Hammond et al, 2006).

Why are anchors bad? Because they limit your analysis to factors that are not fully relevant. Most sales persons, when estimating sales, first look at the previous year results and adjust it by various factors (like dynamics of the economy, advertising efforts). When actually they should start from scratch to determine the factors that would affect sales and try to determine these factors for the next year.

In order to avoid anchoring yourself, you can try to analyze the problem from different perspectives and diversify the information that you hold (get information from different sources and people on the same matter). Also try to understand how important is the information that you hold. To avoid anchoring in other’s opinions try to analyze the information yourself first and afterwards ask for opinions.

To avoid team anchoring, try to limit the opinions which you transmit to your team members, employees or consultants before you get input from them.

Trap: in the absence of solid evidence, people get anchored in first impressions, unverified information or subjective opinions when they take decisions.

10. Status quo: the choice of doing noting. Why? Because it is easier, because of the above mentioned loss aversion or resistance to change (Bateman et al, 1997). An experiment (Roxburgh, 2003) whereby students were asked to choose a destination for a large inheritance, showed that most of the students left the investment as they received it, although they should have balanced the portfolio (in order to diversify against risk). Therefore, if they received risk free bonds, they left the money in bonds. If they received the inheritance in stocks, most of the students left the money in stocks. They were affected by the status quo, which is a powerful reason for delaying a change - “because it has always been this way”.

To avoid the status quo trap always look for and be open to alternatives, critically analyze the current situation and its impact on your objectives and determine optimum costs of change (Hammond et al, 2006). You might be emotionally involved into the current choice (situation) especially if you participated to it. But always look at this problem from an outsider point of view: challenge. If some other manager would be hired to replace you, would he challenge your choice? Also, if you would make a fresh new start, would you make the same choice again? These questions have to be taken seriously; you need to really assess the alternatives, determine costs, quotations from suppliers, start negotiations etc… before drawing the conclusions. You are not required to take action, but you have to treat this questioning serious, to be prepared to make a change, the only thing that would prevent you to make the change would be the fact that the status quo is actually better and needs to be maintained. You must understand that the current situation is not an asset in itself, rather the opportunities that you currently have are the real assets to successfully go forward. Therefore, the best decision that you can make in your choice as to whether you should remain to the status quo or change the current situation is to think about your current business value as money and think about what you would like to do with that money. For instance, if you have 100 stocks invested in the stock market, and want to decide whether to stick with the current portfolio or invest in new opportunities, you can determine the present value of your portfolio (how much you could get if you would sell today) and decide as if you were in front of a blank paper what would be the best investment opportunity to go forward. With regards to risk, you need to identify both the risks of staying with the status quo and the risks of changing.

Trap: it is easier to keep status quo - but most often the wrong choice. Change is good.

11. Mental accounting: there are periods in the life of each one of us when we feel that our health becomes very important. This is usually linked to a recent suffering which affected us a bit more than usual. In that period, we feel that health is so important that it really worths paying anything for this type of expense. We start buying different products which are marketed as being “healthy”, “improving health”. And we feel happy about it. I think some of the worse examples are those of massage, UV or fitness devices which we usually buy, use several times and then abandon in a corner of the house. At work, we see different examples on a similar note. “Our strategy is to improve our market share in the X business line or Y market segment”. And all of a sudden, all projects that serve that goal get approved even if they don’t bring returns, while perfectly profitable projects get sided. People have a mental budget which is much simpler than the company budget, and it is organized by very large domains and each domain has a certain importance. Shelter, food, health, fun, comfort, social life, learning etc… The entire income of a person is allocated to the appropriate budget and the spending is performed accordingly. Budget is limited and usually allocated to highly important domains (like shelter, food, health), so whatever surpasses the budget is discarded if money is limited. But if you manage to convince a person that buying a fridge which purifies the air inside and keeps vegetables fresh is in the health rather than comfort category, that person will allocate budget for this expense even in limited resources. Otherwise, he might not have bought the item for comfort. Mental accounting is a flaw that makes us judge poorly the allocation of resources.

Prevention: have a clear and uniform way to assess proposals. All proposals should be assessed based on the same criteria. Be skeptic when you are advised to invest in “strategic” projects.

Trap: the value of money depends on where the money comes from and what we spend them on. We are subjective in assessing the value of the same revenue or expense depending on how our mind categorizes the respective item. But the categorization is not always rational, because we do not assess using the same efficiency criteria all these items, and sometimes we allocate exaggerate (useless) amounts on a category (health, food) while we ignore relevant expenses on categories we prioritize less (education).

12. Other biases:

Selective recall bias: when you remember only the things that re-enforce your beliefs.

Biased evaluation: the acceptance of praises without questioning while rejecting criticism immediately (e.g. someone criticizes your idea).

Deformation Professionelle: the profession of a person affects the way this person thinks. A lawyer tends to analyze things from a legal point of view, a doctor diagnoses everything and a teacher behaves as if he is still in the classroom.

Deceptions

Deceptions are systemic flaws in trust and interest.

1. Principal (company) – agent (executive) theory, whereby the corporation objectives conflict with personal objectives of decision factors:

“misalignment of time horizons” – e.g. the interests of the agent are short term and the interests of the principal is long term

“misalignment of risk profiles” - e.g. the manager looks for short term less risky profit because the figures look good in the yearly appraisal

The key to managing time horizon and risk profile misalignment is in the way performance is assessed and rewarded. You must carefully balance short term with long term and weight the risk that your company really needs.

“champion bias: - e.g. an executive takes a decision based on the subordinate reputation and not on facts

“sunflower management” – e.g. subordinates trust management in decision and do not challenge these decisions

To avoid champion bias and sunflower management encourage reasonably open debate. Separate the scope of the discussions: to reach a decision, to support a champion, to increase group commitment etc…

2. Decision and guilt: when you make a mistake that leads to problems, it helps if you can create a story that explains what happened and where you were not at fault (Taleb, 2007). This is what the human brain does. In reality, argues Nassim, in the professions where there is a high degree of randomness (such as trading), there is no such thing as a wrong decision. If you read his book (The Black Swan) you will understand better why he tells us this: because he really believes that some events are UNPREDICTABLE. If you have an unpredictable event, and you take a bad decision, how can you be blamed for it when there is no chance that you could have seen it? Nevertheless, there are many people out there that operate in unpredictable environments yet they think that they understand how to deal with it and they have the illusion that they can understand and predict their environment (Nassim studies deeply this fallacy in his book Fooled by randomness). This theory can be applied also to general to decisions (in less random environments), since most of the decisions are made with at least a degree of uncertainty. If the conditions could be 100% predictable then it would not be a decision rather a choice. So DON’T feel bad about BAD decisions. If you act in good faith, if you put soul in it, if you cogitate (in balance with the experience) the decision, chances are you did everything possible to nail it.

3. Sunk cost effect (Hammond et al, 2006): this trap is closely related to bad decisions. People who take bad decisions which are visible to other peers tend to further support the decision even if it is counter productive because they do not want to publicly acknowledge the initial mistake.

Sunk cost means that you should consider all the costs incurred so far as unrecoverable costs, and if it is feasible to change your decision do it as soon as possible.

Example of sunk costs: buying an inappropriate server which performs poorly; you do not want to admit you made a mistake and buy another server because you will loose face in front of your colleagues or boss.

To avoid the sunk cost trap you can shift periodically the responsibility for decisions inside the organization. A fresh view with no emotional ties will make it easier to break from the past. The failure of a decision does not imply failure of oneself (there are good decisions which gone bad due to circumstances). The organization culture is very important: employees must not fear making bad decisions. There are hardly long term good decisions, the best organizations are the ones that make quick decisions, assess the incremental decision rather than the current investment (Roxburgh, 2003) and shift the right direction fast. Assessment of the employees should be made also on the quality of the decisions not only on the results.

4. Overconfidence in own skills (Lovallo and Kahneman, 2003): in 1970, 1 million students from the college board were surveyed to discover how people feel about themselves compared to others. 70% of the students saw themselves as being above the average, while only 2% saw themselves below the average. In sports, and in social ability to get along with each other, 60% of the students saw themselves as above the average. If you make a survey amongst drivers (especially men), you will see that most of the drivers rate themselves as above average drivers and enough of them in the top decile. Now with a small bit of statistical knowledge we understand that it is not possible for 60-70 percent of people to be above the average since, in order to make that average, you need to have a sufficient number of people below and equally above the average. If you take any series of numbers from 1 to 10 (considering the rating of a person’s driving skills, 10 being the best driver) and calculate the average, you will see that most of the drivers are distributed almost evenly above and below the average.

If people would be able to objectively rather themselves, about 50% will be above average and about 50% will be below average.

Further reading (if you have time): Lake Wobegon effect and Downing effect.

Trap: people actually see themselves as above the average on many traits and skills. This causes people to overestimate their abilities. However, research shows that people with above the average intelligence most of the times underestimate themselves because they can understand how intelligent are others and overestimate other peers intelligence.

Lovallo and Kahneman think that the root of this delusion is linked to the self serving bias, the characteristic of people to attribute success to their own skills and failure to external factors. A study of annual shareholder reports found out that in general, positive results achieved by the companies were attributed to executives while failures to external factors such as inflation, weather, economic decline, market conditions etc…

Further reading (if you have time): Self serving bias, Attribution theory and Choice supportive bias.

I mean this is only natural and you don’t need a theory to explain you this deception since we are betrayed by our own self esteem and you can see that every day around you. People need to feel successful, they need to feel that they do not make mistakes and they need to remain positive so that they can go on (and not enter depression).

Trap: people attribute the successes to them and failures to external factors.

To avoid this trap you should understand that successes and failures depend only in part on your actions, and you should understand that your decisions are sometimes biased. There is no such thing as a good or bad decision, there is favorable decision and unfavorable decision within the context of the external factors. The best you can do is understand biases, deceptions in your thinking, understand the environment and decide for what you think is best under those circumstances. But be ready to change your decision if needed.

5. Organizational pressure (Lovallo and Kahneman, 2003): due to the fact that projects and budgets compete with each other inside an organization, managers tend to skew positively the implications of a project: higher budget, lower costs, lower time to market etc… Of course this depends from manager to manager, but there are organizational cultures which encourage such practice. If the managers observe that their projects are dumped in favor of other projects where authors present better conditions, they will be at least tempted to sweeten the deals.

Organizational pressure lays in how projects are approved, how business plans, managers and results are judged inside the organization. Besides financial results and time to market, the criteria used for judgment must include strategic alignment with the organization strategic goals, customer satisfaction, retention or acquisition or market position consolidation.

Trap: organizational culture, the way in which projects and results are judged may influence the way business plans and estimations are mad (both overly optimism or overly pessimism).

6. Inside and outside view (Lovallo and Kahneman, 2003): when you undertake a project, especially as a manager, you have to produce some estimations (time to market, project budget, financial plan etc…). Your first reaction is to look for as many details as possible about the project, assess each and then put it all together to construct the big plan (this is the inside view). In this effort, you are assisted by your project team members and you make use of your skills as much as possible. After all, as a manager you “should know everything about the project you are running” thus you should be able to approximate in good confidence (at least this is what your manager thinks or it is what you would like your manager to think). In order to be seen as an expert, you should be able to provide accurate estimations required for planning. Right? WRONG! Many studies show that estimations based on the inside view for which the organization has no experience (for instance new products, or large investments never made before) are so optimistic that in average projects tend to cost twice as expected and finalize in twice more time.

However, there is hope. Always take into account the outside view. Find similar undertakings even if such projects do not exist in your line of activity. You can look into other industries and find out how projects of similar size were completed. Also look at the history since large projects tend to span over different economic cycles.

Trap: estimations are not always benchmarked, which, for large projects, takes them way off reality due to the overconfidence trap or simply due to failure to take into account complexity.

Famous large project with bad estimation: Sydney Opera House.

In my personal view there is a question that we would ask ourselves. Making estimations too realistic tends to de-motivate your personnel and may have an effect that you do not want: pessimism and underperformance. That is why it generally helps if the organization is a bit more optimistic, but in order to compensate for possible losses it helps to have a higher capitalization. The higher capitalization though makes the company less attractive to investors who seek leverage.

In order to manage motivation and over optimism you can separate the persons which work at starting the project and take the decision to go forward (e.g. product managers and senior management) from the persons which implement the project (e.g. sales). Once the decision to go forward is taken, unless there is reason to exit, you should avoid re-evaluating your decision to start the project and rather focus (in an optimistic fashion) on the success of the project.

7. Herding (Roxburgh, 2003): this flaw is caused by the tendency to conform to others opinions and beliefs. Human individuals are social beings and the social aspect is deeply embedded into the human fabric. People cannot survive on their own therefore they formed groups and societies tens of thousands of years ago. And while each person inside a group is different and these differences are very important, surviving in a group means that these persons need to conform to certain values of that group. But we (humans) cannot rationally identify where the conformity starts and where it ends, we can not clearly delimit where our beliefs start and where the group beliefs come into place, therefore people tend to herd with others in actions (sometimes identifying group beliefs as their own, and really believing in them). Fashion, trends, cars, houses, music, films, investments, jobs - all are prone to herding. This is the reason why some artists make it big time, or some markets create bubbles (technology, dot com, sub prime etc…).

For some people, herding is a skilled method to avoid being publicly humiliated. If you make the same mistake as many others, then it is OK - your ego will not be hurt. But if you are the only “idiot” that went the other way and failed then you become the black sheep of the entire group.

Judge opportunities on your own. Follow the trend only if it makes sense and if not, break away from the trend. Trend breakers will likely be criticized at first, and if the criticism turns out to be true then you should rapidly change your strategy; however, if criticism is wrong, time will tell and others will soon follow you.

Trap: people conform to rules accepted by the members of the social groups they live in and they imitate each other in preferences or decisions. They act like a herd.

8. Failure to estimate future hedonic states: do you remember the last time when something unexpected has happened? I, for example, remember the last time when I heard that my boss got promoted and had to leave, so that implied that a new person would take its place. Now, as a first reaction (status quo bias) I was upset, or at least felt uneasy. But there was nothing that I could do, and plus, I did not know if my next boss would be better or worse than the one that left. So I knew nothing, but on top of that was also incapable of understanding what that change would imply for my state of happiness. In changes where you do not know the precise outcome, you are incapable of assessing your future state of happiness. But how can that be bad? Well, first of all it alters our capacity to take action, and the way we take action. Sometimes we respond with pessimism in front of uncertainty even if in the end it turns out everything will be OK.

It helps to modulate the expectancies: do not get over-excited on good news and do not get too pessimistic on bad news (Roxburgh, 2003). Being reserved helps in avoiding disappointment if not everything goes well, or misjudgment for when the outcome is better than you imagined it at first. Imagine that people tend to over-react to news (both to good and bad news) and when over-reaction is chained, huge over- and under-estimations occur. This phenomena makes people take bad decisions and leads to mass movements with disastrous consequences: stock market crashes, strikes, protests, wars etc…

Trap: when changes happen for which no history exists, people are incapable of estimating their future hedonistic state (happiness or sadness). This is when they overshoot or under-react to these changes and that makes them take bad actions.

References

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