Tips for small business: 7 biases that can effect your decision making Mike | October 18th, 2010
Einstein once said, “Common sense is the collection of prejudices acquired by age eighteen.” Common sense, Einstein was arguing, can often be the enemy of rationality, science, and fact-based decision-making. We are all guilty of this; every day our decisions are tinged by favoritism, rules of thumb, partiality, heuristics, predilection; call it what you will but our biases come into play with every decision we make and every tactic we execute. The trick is to recognize our own biases, question them every day, and be constantly aware of their often pernicious influence on our decision making.
Here are my 7 favorite cognitive biases, each of which has the ability to impact on your decision-making process, and some thoughts on how they can be leveraged and ways counteract their influence in your quest for wise determination.
Humans have a tendency to rely very heavily on one specific piece of information in their decision-making. This can happen in everyday life decisions, or in important negotiations. For instance, when looking at a new house a buyer may notice that the roof needs work, and may be prone to focus on that alone, while ignoring the fact that the seller has recently installed a new HVAC system, upgraded the electricity, and refinished all of the hardwood floors. The same seller, during negotiations, may wisely make a low (but not ridiculously low) offer to the buyer in the hopes of “anchoring” the negotiation around that lower number. Studies (most famously Tversky and Kahneman) have shown that when asked to estimate a number or percentage, if the researcher suggested a low number, the participant’s estimates would skew lower, and when a high number was suggested, the result would be the opposite.
How can small business owners leverage this bias? Be aware of the “lock-in” effect, and assess all information critically. Remember that your counterpart in any negotiation may present information that is self-serving, so look skeptically at the particulars. Anchoring can also be used to your advantage – remember that your negotiating partner is equally susceptible to this bias.
2. Bandwagon effect.
We are prone to believe that if lots of other people are doing something that we can or should do the same. We see this every day with people buying products, attending movies, and even joining political movements. Just because others do or believe something, does not necessarily mean that it is the best course of action, or the most valuable philosophy. Herd behavior and conformity can have a negative impact on your business decisions and can impact your ability to consider alternatives and define problems.
How can small business owners leverage this bias? If everyone else is onboard with a plan or proposal, there may be good reason to question why. Seek out alternatives and remember that groupthink can destroy a team’s effectiveness and limit a manager’s ability to choose between viable options.
3. Confirmation bias.
Closely related to the Bandwagon effect, is the confirmation bias. This is a predisposition to look for or information that confirms something we already believe. In other words, we prefer to see data that supports what we already “know,” so if you are politically conservative, chances are good that you prefer the information you get from Fox News. On the other hand, if you are a liberal, you would probably be more comfortable consuming your news via the Huffington Post.
How can small business owners leverage this bias? Actively seek out disconfirming information; ask others, “Why will this not work? What is wrong with my idea?” Recognize that you are a writhing mass of pre-conceived notions and make every effort to fiercely debate each of those.
4. Availability heuristic.
When we have a vivid memory of an event or outcome, we are prone to believe that event or outcome is more probable than other equally likely events. In other words, if you can easily bring something to mind, you will likely believe that is what will happen again. For instance, even though all data clearly demonstrates that airline travel is one of the safest forms of transportation, the memory of a recent air disaster will make us believe that air travel is risky; as the memory of the event fades, our belief in the safety of the 747 increases.
How can small business owners leverage this bias? Beware the influence that comes of suggestions or anecdotes not based in fact – we have a tendency to remember the stories we hear and, because certain memories are easily available to us, we allow those to influence our decisions.
5. Gambler’s fallacy.
Many addicted gamblers will tell you that they lost all of their money because they sincerely believed that they would be able to win it back because “the odds were in my favor.” This belief led to them playing the game just “one more” time. The belief that because you just lost 10 spins of the roulette wheel in a row, odds are that you will win on the 11th is a dangerous fallacy; in a game of chance, each new spin of the wheel has the exact same chances as the last spin, no more, no less. In other words, each time you flip a coin, the odds are exactly the same 50-50 as they were on the last flip, so the belief that future probabilities are changed by the events that proceeded is a dangerous trap.
How can small business owners leverage this bias? It’s simple – don’t do it! As tempting as it may be to continue a losing effort, recognize that you are throwing “good money after bad” and base your decision-making on rational factors and mathematical certainty, not on a false belief that somehow the world will tip your way of you play “just one more time.”.
6. The “sunk cost” effect.
Related to the gambler’s fallacy, and equally dangerous, is the belief that because you have already “invested” time or money in an endeavor this is reason enough to pursue that effort. Past costs, whether an investment of time or money, should never be used in evaluating a decision. In economic valuation, past cost can never be a factor for arriving at a value, and formulas such as NPV (net present value) will never take into account money which has already been spent. A great illustration of sunk cost? Let’s say you paid $100 to go to a football game. After the first half, your team is getting killed; the score stands at 53-0 and you are having a rotten time. You have a choice here: should you leave and go do something that you will enjoy more than watching your team go down to abject defeat? Or should you staying and justify your suffering because you already spent the $100. The answer? Ignore the money you spent – it is gone already, down the tubes – and LEAVE!
How can small business owners leverage this bias? Make your decisions based not on what you have already done, or how much you have already invested; ask yourself this: “From today forward, how much effort and money will I need to invest to make ____ happen?” Fill in the blank, then assess the value to your business based only on that information, and you are on your way down the road to rationality.
7. Hindsight bias.
“I knew it!” After the fact we often see occurrences as having been predictable. That football game? You “knew” that your team was going to be slaughtered, as a matter of fact you could have predicted it. But, truthfully before the game your hopes were high; it’s only after the game that you remember your prediction of certain defeat so clearly. This is the hindsight bias, and this incorrect appraisal of reality can often cloud your judgement and influence how you will make decisions on future events.
How can small business owners leverage this bias? Don’t let a successful outcome influence your analysis of a future decision. If you convince yourself of your predictive powers, you will be doing a disservice to your business and arriving at decisions that are based not on the data available but on your “hunch.”