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THINKING ABOUT...
I In making decisions, your own mind may be your worst enemy.
M AKING DECISIONS iS the most important job of any executive.
It's also the toughest and the riskiest. Bad deci- sions can damage a business and a career, sometimes irreparably.
So where do bad decisions come from?
In many cases, they can be traced back to the way the decisions were made-tbe alternatives were not clearly defined, the right information was not collected, the costs and benefits were not accurately weighed. But some- times the fault lies not in tbe decision-making process but rather in tbe mind of the decision maker. The way the human brain works can sabotage our decisions.
Researchers have been studying the way our minds function in mak- ing decisions for half a century. This research, in the laboratory and in the field, has revealed that we use un- conscious routines to cope with tbe complexity inherent in most deci- sions.
These routines, known as heuristics, serve us well in most sit- uations.
In judging distance, for ex- ample, our minds frequently rely on a heuristic that equates clarity with proximity. The clearer an object ap- pears, the closer we judge it to be.
The fuzzier it appears, the farther away we assume it must be. This simple mental sbortcut helps us to make the continuous stream of dis- tance judgments required to navi- gate the world.
Yet, like most heuristics, it is not foolproof.
On days that are hazier than normal, our eyes will tend to trick our minds into thinking that things are more distant tban tbey actually are. Because the resulting distortion poses few dangers for most of us, we can safely ignore it.
For airline pilots, though, tbe distor- tion can be cata- strophic. Tbat's why pilots are HIDDEN TRAPS IN DECISION MAKING by ]ohn S.
Hammond, Ralph L Keeney, and Howard Raiffa S. Hammond is a consultant on decision making and a former professor at the Harvard Business School in Boston, Massachusetts.
Ralph L.
Keeney is a professor at the Marshall School of Business and the School of Engineering at the Univer- sity of Southern California in Los Angeles. Howard Raiffa is the Frank Plumpton Ramsey Professor of Man- agerial Economics Emeritus at the Harvard Business School. Their book. Smart Choices:
A Practical Guide to Making Better Decisions, will be published in October by the Harvard Business School Press.
trained to use objective measures of distance in addition to their vision.
Researchers have identified a whole series of sucb flaws in the way we think in making decisions. Some, like the heuristic for clarity, are sen- sory misperceptions. Others take the form of hiases.
Others appear simply as irrational anomalies in our think- ing. What makes all these traps so dangerous is their invisi- bility. Because they are hardwired into our think- ing process, we fail to rec- ognize them-even as we fall right into them.
For executives, whose success hinges on the many day-to-day decisions they make or approve, the psychological traps are especially dangerous. They ean undermine everything from new- produet development to acquisition and divestiture strategy to succes- sion planning. While no one can rid his or her mind of these ingrained flaws, anyone ean follow the lead of airline pilots and learn to understand the traps and compensate for them.
In this article, we examine a num- ber of well-documented psycholog- ical traps that are particularly likely to undermine business decisions. In addition to reviewing the causes and manifestations of these traps, we offer some specific ways man- agers can guard against them.
It's important to remember, tbough, that the hest defense is always aware- ness.
Executives who attempt to familiarize themselves with these traps and tbe diverse forms they take will be better able to ensure that tbe decisions they make are HARVARD BUSINESS REVIEW September-October 1998 THINKING ABOUT...
THE HIDDEN TRAPS IN DECISION MAKING sound and that the recommenda- tions proposed by subprdii^tes .or associates are reliable.
The Anchoring Trap How would you answer these two questions?
Is the population of Turkey greater than 35 millioni What's your best estimate of Turkey's population} If you're like most people, the figure of 35 million cited in the first ques- tion (a figure we chose arbitrarily) infiuenced your answer to the sec- ond question. Over the years, we've Decision makers display a strong bias toward alternatives that perpetuate the status quo.
posed those questions to many groups of people.
In half the cases, we used 35 million in the first question; in the other half, we used 100 mil- lion. Without fail, the answers to the second question increase by many millions when the larger figure is used in the first question. This sim- ple test illustrates the common and often pernicious mental phenome- non known as anchoring.
When con- sidering a decision, the mind gives disproportionate weight to the first information it receives. Initial im- pressions, estimates, or data anchor subsequent thoughts and judgments.
Anchors take many guises. They can be as simple and seemingly in- nocuous as a comment offered by a colleague or a statistic appearing in the morning newspaper. They can be as insidious as a stereotype about a person's skin color, accent, or dress.
In business, one of the most common types of anchors is a past event or trend.
A marketer attempting to pro- ject the sales of a product for the coming year often begins by looking at the sales volumes for past years.
The old numbers become anchors, which the forecaster then adjusts based on other factors. This ap- proach, while it may lead to a reason- ably accurate estimate, tends to give too much weight to past events and not enough weight to other factors.
In situations characterized by rapid changes in the marketplace, histori- cal anchors can lead to poor forecasts and, in turn, misguided choices.
Because anchors can establish the terms on which a decision will be made, they are often used as a bar- gaining tactic by savvy negotiators.
Consider the experience of a large consulting firm that was searching for new office space in San Francisco.
Working with a commercial real- estate broker, the firm's partners identified a building that met all their criteria, and they set up a meet- ing with the building's owners. The owners opened the meet- ing by laying out the terms of a proposed con- tract:
a ten-year lease; an initial monthly price of $2.50 per square foot; an- nual price increases at the prevailing inflation rate; all interior improvements to be the tenant's responsibility,- an option for the tenant to extend the lease for ten additional years under the same terms.
Although the price was at the high end of current market rates, the consultants made a relatively modest counteroffer. They proposed an initial price in the midrange of market rates and asked the owners to share in the renovation expenses, but they accepted all the other terms.
The consultants could have been much more aggressive and creative in their counterproposal-reducing the initial price to the low end of market rates, adjusting rates bienni- ally rather than annually, putting a cap on the increases, defining differ- ent terms for extending the lease, and so forth-hut their thinking was guided by the owners' initial pro- posal.
The consultants had fallen into the anchoring trap, and as a re- sult, they ended up paying a lot more for the space than they had to.
What can you do about it?
The effect of anchors in decision making has been documented in thousands of experiments. Anchors influence the decisions not only of managers, but also of accountants and engineers, bankers and lawyers, consultants and stock analysts.
No one can avoid their infiuence; they're just too widespread.
But managers who are aware of the dangers of an- chors can reduce their impact hy us- ing the following techniques:
a Always view a problem from dif- ferent perspectives. Try using alter- native starting points and approaches rather than sticking with the first line of thought that occurs to you.
Q Think about the problem on your own before consulting others in or- der to avoid becoming anchored by their ideas.
a Be open minded. Seek informa- tion and opinions from a variety of people to widen your frame of refer- ence and to push your mind in fresh directions.
a Be careful to avoid anchoring your advisers, consultants, and others from whom you solicit information and counsel. Tell them as little as possible about your own ideas, esti- mates, and tentative decisions.
If you reveal too much, your own pre- conceptions may simply come back to you.
a Be particularly wary of anchors in negotiations. Think through your position before any negotiation he- gins in order to avoid being anchored by the other party's initial proposal.
At the same time, look for opportu- nities to use anchors to your own advantage-if you're the seller, for example, suggest a high, but defen- sible, price as an opening gambit.
The Status-Quo Trap We all like to believe that we make decisions rationally and objectively.
But the fact is, we all carry biases, and those biases influence the choices we make. Decision makers display, for example, a strong bias to- ward alternatives that perpetuate the status quo. On a broad scale, we can see this tendency whenever a radically new product is introduced.
The first automobiles, revealingly called "horseless carriages," looked very much like the buggies they re- placed.
The first "electronic news- papers" appearing on the World Wide Weh looked very much like their print precursors.
On a more familiar level, you may have succumbed to this bias in your personal financial decisions. People sometimes, for example, inherit 48 HARVARD BUSINESS REVIEW September-October 1998 THINKING ABOUT...
THE HIDDEN TRAPS IN DECISION MAKING shares of stock that they would never have bought themselves. Although it would he a straightforward, inexpen- sive proposition to sell those shares and put the money into a different investment, a surprising number of people don't sell.
They find the status quo comfortable, and they avoid tak- ing action that would upset it.
"Maybe I'll rethink it later," they say.
But "later" is usually never.
The source of the status-quo trap lies deep within our psyches, in our desire to protect our egos from dam- age.
Breaking from the status quo means taking action, and when we take action, we take responsihility, thus opening ourselves to criticism and to regret. Not surprisingly, we naturally look for reasons to do nothing. Sticking with the status quo represents, in m,ost cases, the safer course because it puts us at less psychological risk.
Many experiments have shown the magnetic attraction of the status quo.
In one, a group of people were randomly given one of two gifts of approximately the same value-half received a mug, the other half a Swiss chocolate bar. They were then told that they could easily exchange the gift they received for the other gift.
While you might expect that about half would have wanted to make the exchange, only one in ten actually did. The status quo exerted its power even though it had been arbitrarily established only minutes before.
Other experiments have shown that the more choices you are given, the more pull the status quo has.
More people will, for instance, choose the status quo when there are two alternatives to it rather than one:
A and B instead of just A.
Why?
Choosing hetween A and B requires additional effort; selecting the status quo avoids that effort.
In business, where sins of com- mission (doing something) tend to be punished much more severely than sins of omission (doing noth- ing), the status quo holds a particu- larly strong attraction. Many merg- ers, for example, founder because the acquiring company avoids tak- ing swift action to impose a new, more appropriate management structure on the acquired company.
"Let's not rock the hoat right now," the typical reasoning goes. "Let's wait until the situation stabilizes." But as time passes, the existing structure becomes more entrenched, and altering it becomes harder, not easier. Having failed to seize the oc- casion when change would have been expected, management finds itself stuck with the status quo.
What can you do about it?
First of all, remember that in any given decision, maintaining the sta- tus quo may indeed be the best choice, but you don't want to choose it just because it is comfortable.
Once you become aware of the sta- tus-quo trap, you can use these tech- niques to lessen its pull:
D Always remind yourself of your objectives and examine how they would be served by the status quo.
You may find that elements of the current situation act as barriers to your goals.
n Never think of the status quo as your only alternative. Identify other options and use them as counter- balances, carefully evaluating all the pluses and minuses.
a Ask yourself whether you would choose the status-quo alternative if, in fact, it weren't the status quo.
a Avoid exaggerating the effort or cost involved in switching from the status quo.
a Remember that the desirability of the status quo will change over time.
When comparing alternatives, al- ways evaluate them in terms of the future as well as the present.
D If you have several alternatives that are superior to the status quo, don't default to the status quo just hecause you're having a hard time picking the best alternative. Force yourself to choose.
The Sunk-Cost Trap Another of our deep-seated biases is to make choices in a way that justi- fies past choices, even when the past choices no longer seem valid. Most of us have fallen into this trap. We may have refused, for example, to sell a stock or a mutual fund at a loss, forgoing other, more attractive investments.
Or we may have poured enormous effort into improv- ing the performance of an employee whom we knew we shouldn't have hired in the first place. Our past de- cisions hecome what economists term sunk costs-old investments of time or money that are now irrecov- erable. We know, rationally, that sunk costs are irrelevant to the pres- ent decision, but nevertheless they prey on our minds, leading us to make inappropriate decisions.
Why can't people free themselves from past decisions? Frequently, it's because they are unwilling, con- sciously or not, to admit to a mis- take.
Acknowledging a poor decision in one's personal life may be purely a private matter, involving only one's self-esteem, but in business, a bad decision is often a very public mat- ter, inviting critical comments from colleagues or bosses.
If you fire a poor performer whom you hired, you're making a public admission of poor judgment. It seems psychologi- cally safer to let him or her stay on, even though that choice only com- pounds the error.
The sunk-cost bias shows up with disturbing regularity in banking, where it can have particularly dire consequences. When a borrower's husiness runs into trouble, a lender will often advance additional funds in hopes of providing the business with some breathing room to recover.
If the business does have a good chance of coming back, tbat's a wise investment. Otherwise, it's just throwing good money after had.
One of us helped a major U.S.
bank recover after it made many bad loans to foreign businesses. We found that the bankers responsible for originating the problem loans were far more likely to advance addi- tional funds-repeatedly, in many cases-than were bankers who took over the accounts after the original loans were made.
Too often, the orig- inal bankers' strategy-and loans- ended in failure. Having been trapped by an escalation of commitment, they had tried, consciously or un- consciously, to protect their earlier, flawed decisions. They had fallen victim to the sunk-cost bias. The bank finally solved the problem by instituting a policy requiring that a loan be immediately reassigned to another banker as soon as any prob- 50 HARVARD BUSINESS REVIEW September-October 1998 THINKING ABOUT...
THE HIDDEN TRAPS IN DECISION MAKING lem arose. The new banker was able to take a fresh, unbiased look at the merit of offering more funds.
Sometimes a corporate culture reinforces the sunk-cost trap. If the penalties for making a decision that leads to an unfavorable outcome are overly severe, managers will be mo- tivated to let failed projects drag on endlessly-in the vain hope that they'll somehow be able to transform them into successes. Executives should recognize that, in an uncertain world where unforeseeable events are common, good decisions can We tend to subconsciously decide what to do before figuring out why we want to do it.
sometimes lead to bad outcomes. By acknowledging that some good ideas will end in failure, executives will encourage people to cut their losses rather than let them mount.
What can you do about it?
For all decisions with a history, you will need to make a conscious effort to set aside any sunk costs- whether psychological or economic - that will muddy your thinking about the choice at hand. Try these techniques:
a Seek out and listen carefully to the views of people wbo were unin- volved with the earlier decisions and who are hence unlikely to be com- mitted to them.
D Examine wby admitting to an ear- lier mistake distresses you. If the prohlem lies in your own wounded self-esteem, deal with it bead-on.
Remind yourself tbat even smart choices can have bad consequences, through no fault of tbe original deci- sion maker, and tbat even tbe best and most experienced managers are not immune to errors in judgment.
Remember the wise words of Warren Buffet: "When you find yourself in a hole, the best thing you can do is stop digging." n Be on the lookout for the influence of sunk-cost biases in the decisions and recommendations made by your suhordinates. Reassign responsibili- ties when necessary.
n Don't cultivate a failure-fearing culture that leads employees to per- petuate their mistakes. In rewarding people^ look at the quality of their decision making (taking into ac- count what was known at the time their decisions were made), not just the quality of the outcomes.
The Confirming-Evidence Trap Imagine that you're the president of a successful midsized U.S. manufac- turer considering whether to call off a planned plant expansion. For a while you've been concerned that your company won't he able to sustain tbe rapid pace of growtb of its exports. You fear tbat the value of tbe U.S. dollar will strengthen in coming months, mak- ing your goods more costly for over- seas consumers and dampening de- mand. But before you put the brakes on the plant expansion, you decide to call up an acquaintance, the chief executive of a similar company that recently mothballed a new factory, to check her reasoning. Sbe presents a strong case that other currencies are about to weaken significantly against tbe dollar. What do you do?
You'd better not let that conversa- tion be tbe clincher, because you've probably just fallen victim to the confirming-evidence bias. This bias leads us to seek out information that supports our existing instinct or point of view while avoiding infor- mation that contradicts it. What, after all, did you expect your ac- quaintance to give, other than a strong argument in favor of her own decision? The confirming-evidence bias not only affects wbere we go to collect evidence but also how we in- terpret the evidence we do receive, leading us to give too much weight to supporting information and too little to conflicting information.
In one psychological study of tbis pbenomenon, two groups-one op- posed to and one supporting capital punishment-each read two reports of carefully conducted research on the effectiveness of the death penalty as a deterrent to crime. One report concluded that the death penalty was effective; the other concluded it was not. Despite being exposed to solid scientific information support- ing counterarguments, the memhers of both groups became even more convinced of the validity of their own position after reading both re- ports.
They automatically accepted the supporting information and dis- missed the conflicting information.
There are two fundamental psy- chological forces at work here. The first is our tendency to subcon- sciously decide what we want to do before we figure out why we want to do it. The second is our inclina- tion to be more engaged by tbings we like than hy things we dislike - a ten- dency well documented even in ba- hies.
Naturally, then, we are drawn to information that supports our subconscious leanings.
What can you do about it?
It's not that you shouldn't make the choice you're subconsciously drawn to. It's just tbat you want to he sure it's the smart choice. You need to put it to the test. Here's bow:
n Always check to see whether you are examining all the evidence with equal rigor. Avoid the tendency to accept confirming evidence without question.
n Get someone you respect to play devil's advocate, to argue against the decision you're contemplating. Bet- ter yet, build tbe counterarguments yourself.
What's the strongest reason to do something else? The second strongest reason? Tbe tbird? Con- sider the position with an open mind, n Be honest with yourself ahout your motives. Are you really gather- ing information to help you make a smart choice, or are you just looking for evidence confirming what you think you'd like to do?
D In seeking the advice of others, don't ask leading questions tbat invite confirming evidence. And if you find that an adviser always seems to support your point of view, find a new adviser. Don't surround yourself with yes-men.
The Framing Trap The first step in making a decision is to frame the question. It's also one of the most dangerous steps. The way a 52 HARVARD BUSINESS REVIEW September-October 1998 THINKING ABOUT...
THE HIDDEN TRAPS IN DECISION MAKING problem is framed can profoundly influence the choices you make. In a case involving automobile insur- ance, for example, framing made a $200 million difference. To reduce insurance costs, two neighboring states.
New Jersey and Pennsylvania, made similar changes in their laws.
Each state gave drivers a new option:
by accepting a limited right to sue, they could lower their premiums.
But the two states framed the choice in very different ways:
in New Jersey, you automatically got the limited right to sue unless you specified oth- erwise; in Pennsylvania, you got the full right to sue unless you specified otherwise. The different frames es- tablished different status quos, and, not surprisingly, most consumers de- faulted to the status quo. As a result, in New Jersey about 80% of drivers chose the limited right to sue, but in Pennsylvania only 25 % chose it. Be- cause of the way it framed the choice, Pennsylvania failed to gain approxi- mately $200 million in expected in- surance and litigation savings.
The framing trap can take many forms, and as the insurance example shows, it is often closely related to other psychological traps. A frame can establish the status quo or in- troduce an anchor. It can highlight sunk costs or lead you toward con- firming evidence. Decision research- ers have documented two types of frames that distort decision making with particular frequency:
Flames as Gains Versus Losses.
In a study patterned after a classic experi- ment by decision researchers Daniel Kahneman and Amos Tversky, one of us posed the following problem to a group of insurance professionals:
You are a marine property ad- juster charged with minimizing the loss of cargo on three insuxed barges that sank yesterday off the coast of Alaska. Each barge holds $200,000 worth of cargo, which will be lost if not salvaged within j2 hours. The owner of a local marine-salvage company gives you two options, both of which will cost the same:
Plan A: This plan will save the cargo of one of the three barges, worth $200,000.
Plan B: This plan has a one- third probability of saving the cargo on all three barges, worth $600,000, but has a two-thirds probability of saving nothing.
Which plan would you choose^ If you are like 7r% of the respon- dents in the study, you chose the "less risky" Plan A, which will save one barge for sure. Another group in the study, however, was asked to choose between alternatives C andD:
Plan C: This plan will result in the loss of two of the three car- goes, worth $400,000.
Plan D: This plan has a two- thirds probability of resulting in the loss of all three cargoes and the entire $600,000 but has a one-third probability of losing no cargo.
Faced with this choice, 80% of these respondents preferred Plan D.
The pairs of alternatives are, of course, precisely equivalent - Plan A is the same as Plan C, and Plan B is the same as Plan D-they've just been framed in different ways. The strikingly different responses reveal that people are risk averse when a problem is posed in terms of gains (barges saved) but risk seeking when a problem is posed in terms of avoid- ing losses (barges lost). Further- more, they tend to adopt the frame as it is presented to them rather than restating the problem in their own way.
Framing with Different Reference Points. The same problem can also elicit very different responses when frames use different reference points. Let's say you have $2,000 in your checking account and you are asked the following question:
Would you accept a fifty-fifty chance of either losing $300 or winning $5001 Would you accept the chance? What if you were asked this question:
Would you prefer to keep yom checking account balance of $2,000 or to accept a fifty-fifty chance of having either $i,joo or $2,500 in your account} Once again, the two questions pose the same problem. While your answers to both questions should, rationally speaking, be the same, studies have shown that many peo- ple would refuse the fifty-fifty chance in the first question hut accept it in the second. Their different reactions result from the different reference points presented in the two frames.
The first frame, with its reference point of zero, emphasizes incremen- tal gains and losses, and the thought of losing triggers a conservative re- sponse in many people's minds. The second frame, with its reference point of $2,000, puts things into per- spective by emphasizing the real financial impact of the decision.
What can you do about it?
A poorly framed problem can un- dermine even the best-considered decision. But any adverse effect of framing can be limited by taking the following precautions:
a Don't automatically accept the initial frame, whether it was formu- lated by you or by someone else. Al- ways try to reframe the problem in various ways. Look for distortions caused by the frames.
a Try posing problems in a neutral, redundant way that combines gains and losses or embraces different ref- erence points. For example: Would you accept a fifty-fifty chance of either losing $300, resulting in a bank balance of $1,700, or winning $500, resulting in a bank balance o Think hard throughout your de- cision-making process about the framing of the problem. At points throughout the process, particularly near the end, ask yourself how your thinking might change if the fram- ing changed.
a When others recommend deci- sions, examine the way they framed the problem. Challenge them with different frames.
Estimating and Forecasting Traps Most of us are adept at making esti- mates about time, distance, weight, and volume. That's because we're constantly making judgments about these variables and getting quick feedback about the accuracy of those 54 HARVARD BUSINESS REVIEW September-October 1998 THINKING ABOUT...
THE HIDDEN TRAPS IN DECISION MAKING judgments. Through daily practice, our minds become finely calibrated.
Making estimates or forecasts about uncertain events, however, is a different matter. While managers continually make such estimates Even though most of us are not very good at making estimates, we tend to be overconfident about our accuracy-which can lead to bad decisions.
and forecasts, they rarely get clear feedback about their accuracy. If you judge, for example, that the like- lihood of the price of oil falling to less than $ 15 a harrel one year hence is about 40% and the price does in- deed fall to that level, you can't tell whether you were right or wrong about the probability you estimated.
Tbe only way to gauge your accuracy would be to keep track of many, many similar judgments to see if, after tbe fact, tbe events you thought had a 40% chance of occurring actu- ally did occur 40% of the time. That would require a great deal of data, carefully tracked over a long period of time. Weather forecasters and bookmakers have the opportunities and incentives to maintain such records, but the rest of us don't. As a result, our minds never become cali- brated for making estimates in the face of uncertainty.
All of the traps we've discussed so far can influence the way we make decisions when confronted with un- certainty. But there's another set of traps that can have a particularly distorting effect in uncertain situa- tions because they cloud our ability to assess probabilities. Let's look at three of the most common of these uncertainty traps:
The Overconfidence Trap. Even though most of us are not very good at making estimates or forecasts, we actually tend to he overconfident about our accuracy. Tbat can lead to errors in judgment and, in turn, bad decisions, hi one series of tests, peo- ple were asked to forecast tbe next week's closing value for the Dow Jones Industrial Average. To account for uncertainty, they were then asked to estimate a range within which the closing value would hkely fall.
In picking the top number of the range, they were asked to choose a high estimate they thought had only a i % chance of being ex- ceeded by tbe closing value. Similarly, for the bottom end, they were told to pick a low estimate for which they thought there would be only a 1% chance of the closing value falling helow it. If they were good at judging their forecasting accuracy, you'd expect the partici- pants to be wrong only about 2 % of the time. But hundreds of tests have shown that the actual Dow Jones averages fell outside the forecast ranges 20% to 30% of the time.
Overly confident about the accuracy of their predictions, most people set too narrow a range of possibilities.
Think of the implications for busi- ness decisions, in which major ini- tiatives and investments often hinge on ranges of estimates. If managers underestimate the high end or over- estimate the low end of a crucial variable, they may miss attractive opportunities or expose themselves to far greater risk than they realize.
Much money has been wasted on ill- fated product-development projects because managers did not accurately account for the possibility of market failure.
The Prudence Trap. Another trap for forecasters takes the form of over- cautiousness, or prudence. When faced with high-stakes decisions, we tend to adjust our esti- mates or forecasts "just to be on the safe side." Many years ago, for example, one of the Big Three U.S. automakers was deciding how many of a new-model car to produce in anticipation of its busiest sales season. The market-planning de- partment, responsible for the deci- sion, asked other departments to supply forecasts of key variables such as anticipated sales, dealer in- ventories, competitor actions, and costs.
Knowing the purpose of the estimates, each department slanted its forecast to favor building more cars-"just to he safe." But the mar- ket planners took the numhers at face value and then made their own "just to be safe" adjustments. Not surprisingly, the number of cars pro- duced far exceeded demand, and the company took six months to sell off the surplus, resorting in the end to promotional pricing.
Policymakers have gone so far as to codify overcautiousness in formal decision procedures. An extreme ex- ample is the methodology of "worst- case analysis," which was once popu- lar in the design of weapons systems and is still used in certain engineer- ing and regulatory settings. Using this approach, engineers designed weapons to operate under the worst possible combination of circum- stances, even though the odds of those circumstances actually com- ing to pass were infinitesimal. Worst- case analysis added enormous costs with no practical benefit (in fact, it often backfired by touching off an arms race), proving that too much prudence can sometimes be as dan- gerous as too little.
The Recallabiiity Trap. Even if we are neither overly confident nor un- duly prudent, we can still fall into a trap when making estimates or fore- casts.
Because we frequently base our predictions about future events on our memory of past events, we can be overly influenced by dramatic events - tbose that leave a strong im- pression on our memory. We all, for example, exaggerate the probability of rare but catastrophic occurrences such as plane crashes because they get disproportionate attention in the A dramatic or traumatic event in your own life can also distort your thinking.
media. A dramatic or traumatic event in your own life can also dis- tort your thinking. You will assign a higher probability to traffic acci- dents if you bave passed one on the way to work, and you will assign a 56 HARVARD BUSINESS REVIEW September-October 1998 higher chance of someday dying of cancer yourself if a close friend has died of the disease.
In fact, anything that distorts your ability to recall events in a balanced way will distort your probability as- sessments. In one experiment, lists of well-known men and women were read to different groups of people.
Unbeknownst to the subjects, eacb list had an equal number of men and women, but on some lists tbe men were more famous than the women while on others the women were more famous. Afterward, the partici- pants were asked to estimate the per- centages of men and women on each list. Those who had heard the list with the more famous men thought there were more men on the list, while those who had heard the one with the more famous women thought there were more women.
Corporate lawyers often get caught in the recallabiiity trap wben defending liability suits. Their deci- sions about whetber to settle a claim or take it to court usually binge on their assessments of the possihle outcomes of a trial. Because the me- dia tend to aggressively publicize massive damage awards (wbile ig- noring other, far more common trial outcomes), lawyers can overesti- mate the probability of a large award for the plaintiff.
As a result, they of- fer larger settlements than are actu- ally warranted.
What can you do about it?
The best way to avoid the estimat- ing and forecasting traps is to take a very disciplined approach to making forecasts and judging probabilities.
For each of the three traps, some ad- ditional precautions can be taken:
To reduce the effects of overconfi- dence in making estimates, always start by considering tbe extremes, the low and high ends of the possible range of values. This will help you avoid being anchored by an initial estimate. Tben challenge your esti- mates of the extremes. Try to imag- ine circumstances where the actual figure would fall below your low or above your high, and adjust your range accordingly. Challenge the estimates of your subordinates and advisers in a similar fashion. They're also susceptible to overeonfidence.
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Executive Jducation.
GSB.Stanford.edu Web Site:
http://www-gsb.stanford.edu/eep naiiieo programs dit Risk Modeling for Financial titutions New tober 25' 29, 1998 (in London) •gotiation and Influence Strategies ivember 1 -6, 1998; ifil 18 -23, Oct. 31 - Nov.
5, 1999 Ivanced Negotiation Program January 19 - 23,1999 Leading and Managing Change January 24 - February S, )une20-)uly2, 1999 Managing Technology and Strategic Innovation Febfuary 14 - 19, 1999 Market and Credit Risk for Financial Institutions Fet)ruary 21 - 25, 1999 Managing Teams for Innovation and Success March 22-27, 1999 Strategic tJses of Information Technology May 2-7, 1999 Financial Management Program July 4 -16, 1999 Product Development and Manufacturing Strategy July 4- 16, 1999 Executive Program in Strategy and Organization August 1 -13, 1999 Marketing Management:
A Strategic Perspective August 1 - 13, 1999 Human Resource Executive Program Seplembci 12 - 17, 1999 THiNKING ABOUT...
THE HIDDEN TRAPS IN DECISION MAKING D To avoid the prudence trap, al- ways state your estimates honestly and explain to anyone who will be using them that they have not been adjusted. Emphasize the need for honest input to anyone who will be supplying you with estimates. Test estimates over a reasonable range to assess their impact. Take a second look at the more sensitive estimates.
° To minimize the distortion caused by variations in recallability, carefully examine all your assump- tions to ensure they're not unduly influenced by your memory. Get ac- tual statistics whenever possible.
Try not to be guided by impressions.
Forewarned Is Forearmed When it comes to business deci- sions, there's rarely such a thing as a no-brainer. Our brains are always at work, sometimes, unfortunately, in ways that hinder rather than help us.
At every stage of the decision- making process, misperceptions, bi- ases, and other tricks of the mind can influence the choices we make.
Highly complex and important deci- sions are the most prone to distor- tion because they tend to involve the most assumptions, the most es- timates, and the most inputs from the most people. The higher the stakes, the higher the risk of being caught in a psychological trap.
The traps we've reviewed can all work in isolation. But, even more dangerous, they can work in concert, amplifying one another. A dramatic first impression might anchor our thinking, and then we might selec- tively seek out confirming evidence to justify our initial inclination. We make a hasty decision, and that deci- sion establishes a new status quo.
As our sunk costs mount, we become trapped, unable to find a propitious time to seek out a new and possibly better course. The psychological miscues cascade, making it harder and harder to choose wisely.
As we said at the outset, the best protection against all psychological traps-in isolation or in combina- tion-is awareness. Forewarned is forearmed. Even if you can't eradi- cate the distortions ingrained into the way your mind works, you can build tests and disciplines into your decision-making process that can uncover errors in thinking before they become errors in judgment.
And taking action to understand and avoid psychological traps can have the added benefit of increasing your confidence in the choices you make.
FoT further discussions of decision traps, see:
J.
Edward Russo and Paul J- H. Schoemaker, Decision Traps:
The Ten Barriers to Brilliant Deci- sion Making and How to Overcome Them (New York:
Simon &) Schuster, 1989) and Max Bazerman.
Judgment in Managerial Decision Making (New York:
John Wiley &) Sons, fourth edition, 1998).
Reprint 98505 To Older r^rints, see the last page of this issue.
"Sorry, but I don't discuss my financial portfolio on a first date.
58 HARVARD BUSINESS REVIEW September-October 1998
