Intelligent Economy

In the Intelligent Economy, the single most important factor separating success from failure is how we make, implement and learn from decisions. The key unit of analysis in this forum is the decision itself. So the question is: How do we make, implement and learn from decisions more effectively? Companies that excel in the Intelligent Economy are, de facto, great decision-makers, implementers and learners.

That's why I was fascinated to come across the recent article "Distortions and Deceptions in Strategic Decisions" by McKinsey consultants Dan Lovallo and Olivier Sibony. In the piece, they note that top decision-makers often do not base their decisions on "objective data and sound business judgment," particularly when the decisions are of an unusual or infrequent nature (like a large corporate M&A decision, for instance).

"Despite the enormous resources that corporations devote to strategic planning and other decision-making processes, CEOs must often make judgments they cannot reduce to indisputable financial calculations," the authors write. "Much of the time such big decisions depend, in no small part, on the CEO's trust in the people making the proposals...Behavioral economics teaches us that a host of human biases, such as overoptimism about the likelihood of success, can affect strategic decisions."

The authors go on to sketch out a series of "distortions" (overoptimism, loss aversion, overconfidence) and "deceptions" (misaligned time horizons between managers and corporations, career risk aversion issues that encourage managers to be too conservative in their decisions, executive bias toward trusted associates). Loss aversion (the tendency to "experience losses more acutely than gains") is particularly interesting. Behavioral research suggests that managers often won't invest in initatives or projects that might make sense for an organization (which carries a larger portfolio of projects) because they fear personal risks heavily and "tend to evaluate every option as a change from a reference point -- usually the status quo -- not as one of many possibilities for gains and losses over time across the organization."

Lovallo and Sibony propose that companies "come to grip with these patterns" by 1) becoming more aware of their predispositions toward biased decision-making and 2) implementing safeguards in their decision-making processes and corporate cultures that address these biases. Ultimately, the authors point out, it is critical to have a "culture of reasonably open and objective debate" and offer several approaches toward creating such an environment. The CEO's worst case is when his or her fellow decision-makers feel too restrained to speak their minds and fully engage in the discussion. That's a foundation for stupid and costly decisions.