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Tuesday, January 17, 2012

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Monday, November 29, 2010

Distortions and deceptions in strategic decisions

Companies are vulnerable to misconceptions, biases, and plain old lies. But not hopelessly vulnerable.
Dan P. Lovallo and Olivier Sibony
2006 Number 1
The chief executive of a large multinational was trying to decide whether to undertake an enormous merger-one that would not only change the direction of his company but also transform its whole industry. He had gathered his top team for a final discussion. The most vocal proponent of the deal-the executive in charge of the company's largest division-extolled its purported strategic advantages, perhaps not coincidentally because if it were to go through he would run an even larger division and thereby be able to position himself as the CEO's undisputed successor. The CFO, by contrast, argued that the underlying forecasts were highly uncertain and that the merger's strategic rationale wasn't financially convincing. Other members of the top team said very little. Given more time to make the decision and less worry that news of the deal might leak out, the CEO doubtless would have requested additional analysis and opinion. Time, however, was tight, and in the end the CEO sided with the division head, a longtime protégé, and proposed the deal to his board, which approved it. The result was a massive destruction of value when the strategic synergies failed to materialize.
Does this composite of several real-life examples sound familiar? These circumstances certainly were not ideal for basing a strategic decision on objective data and sound business judgment. 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. Much of the time such big decisions depend, in no small part, on the CEO's trust in the people making the proposals.
Strategic decisions are never simple to make, and they sometimes go wrong because of human shortcomings. Behavioral economics teaches us that a host of universal human biases, such as over optimism about the likelihood of success, can affect strategic decisions. Such decisions are also vulnerable to what economists call the "principal-agent problem": when the incentives of certain employees are misaligned with the interests of their companies, they tend to look out for themselves in deceptive ways.
Most companies know about these pitfalls. Yet few realize that principal-agent problems often compound cognitive imperfections to form intertwined and harmful patterns of distortion and deception throughout the organization. Two distinct approaches can help companies come to grips with these patterns. First, managers can become more aware of how biases can affect their own decision making and then endeavor to counter those biases. Second, companies can better avoid distortions and deceptions by reviewing the way they make decisions and embedding safeguards into their formal decision-making processes and corporate culture.
Distortions and deceptions
Errors in strategic decision making can arise from the cognitive biases we all have as human beings.

These biases, which distort the way people collect and process information, can also arise from interactions in organizational settings, where judgment may be colored by self-interest that leads employees to perpetrate more or less conscious deceptions (Exhibit 1).
Distortions
Of all the documented cognitive distortions, over optimism and loss aversion (the human tendency to experience losses more acutely than gains) are the most likely to lead people who make strategic decisions astray, because decisions with an element of risk-all strategic ones-have two essential components. The first is a judgment about the likelihood of a given outcome, the second a value or utility placed on it.
When judging the likelihood of potentially positive outcomes, human beings have an overwhelming tendency to be overoptimistic or overconfident: they think that the future will be great, especially for them. Almost all of us believe ourselves to be in the top 20 percent of the population when it comes to driving, pleasing a partner, or managing a business. In the making of strategic decisions, optimism not only generates unrealistic forecasts but also leads managers to underestimate future challenges more subtly-for instance, by ignoring the risk of a clash between corporate cultures after a merger.
When probabilities are based on repeated events and can therefore often be well defined, optimism is less of a factor. But loss aversion is still a concern. Research shows that if a 50-50 gamble could cost the gambler $1,000, most people, given an objective assessment of the odds, would demand an upside of $2,000 to $2,500.

Over optimism affects judgments of probability and tends to produce over commitment. Loss aversion influences outcome preferences and leads to inaction and under commitment. But the fact that over optimism and loss aversion represent opposing tendencies doesn't mean that they always counteract each other. Over optimism and loss aversion, though opposing tendencies, don't always counteract each other
Loss aversion wouldn't have such a large effect on decisions made in times of uncertainty if people viewed each gamble not in isolation but as one of many taken during their own lives or the life of an organization. But executives, like all of us, 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. From the latter perspective, it makes sense to take more risks. Most of the phenomena commonly grouped under the label of risk aversion actually reflect loss aversion, for if we integrated most gambles into a broader set, we would end up risk neutral for all but the largest risks. This truth has important implications for strategic decision making.
Deceptions
The strategic decisions that companies make result from interactions among their executives: a manager proposes an investment, for example, and an executive committee reviews and evaluates it. In this kind of setting, a conflict of interest often arises between an "agent" (in this case, the manager) and the "principal" (the corporation) on whose behalf the agent acts.

Such "agency problems," which occur when the agent's incentives aren't perfectly aligned with the principal's interests, can lead to more or less intentional deceptions-misleading information provided to others-that compound the problem of the agent's unintentional distortions. Recall the CEO who was grappling with the big merger decision: trusting the protégé (the head of the largest division) exposed the CEO to the risk that the merger's proponent was not only over optimistic but also attempting to further his own career by exaggerating the deal's upside or underestimating its risks.
When companies evaluate strategic decisions, three conditions frequently create agency problems. One is the misalignment of time horizons between individuals and corporations. Several consumer goods companies, for example, have noted that brand managers who rotate quickly in and out of their jobs tend to favor initiatives (such as introducing new product variants) with a short-term payback. These managers' deception, intentional or not, is to advance only certain projects-those aligned with their interests. The development of radically new products or other important projects with longer payback times can rarely succeed without a senior sponsor who is likely to be around longer.
Another problem that can generate harmful deceptions is the differing risk profiles of individuals and organizations. Consider a real-life example. A midlevel executive at a large manufacturing company decided not to propose a capital investment that had a 50-50 chance of either losing the entire $2 million investment or returning $10 million. Despite his natural loss aversion, the chance of a 5:1 gain should have enticed him into accepting the bet, and his superiors, for the same reasons, would have deemed it attractive. Instead, he worried that if the investment failed, his reputation and career prospects would take a blow, though he didn't anticipate being punished if the investment was forgone. As a result, he decided not to recommend it and thus in effect acted deceptively by not promoting an attractive investment. This asymmetry between results based on action and inaction is called the "omission bias," and here it magnified the executive's loss aversion.
The final agency issue arises from the likelihood that a subordinate knows much more than a superior does about a given issue. Higher-ranking executives must therefore make judgments about not just the merits of a proposal but also their trust in the person advancing it. This is unavoidable and usually acceptable: after all, what more important decision do CEOs make than choosing their closest associates? The tendency, however, is to rely too much on signals based on a person's reputation when they are least likely to be predictive: novel, uncertain environments such as that of the multinational that went ahead with the megamerger. We call the tendency to place too much weight on a person's reputation-and thus increase the exposure to deception-the "champion bias."
Furthermore, the multinational's merger decision exhibited an element of "sunflower management": the inclination of people in organizations to align themselves with the leader's real or assumed viewpoint. The CEO had expected to find dissenting voices among his senior executives. But except for the CFO, they believed that the CEO favored the deal and that the merger would proceed no matter what they said and thus kept their doubts to themselves for fear of harming their careers. In effect, they misled the CEO by suppressing what they really thought about the deal.
Improving individual decisions
Knowing that human nature may lead decision making astray, wise executives can use this insight to fortify their judgment when they make important decisions. To do so, however, they must know which bias is most likely to affect the decision at hand. Exhibit 2 offers a road map for the types of decisions where over optimism or excessive risk aversion will probably be the determining factor.
In general, the key to reducing over optimism is to improve the learning environment by generating frequent, rapid, and unambiguous feedback. In the absence of such an environment-for instance, when companies face rare and unusual decisions, which, unfortunately, are the most important ones-there is a bias toward optimistic judgments of the odds. The size of a decision determines the appropriate degree of risk aversion. For major ones, a certain amount of it makes sense-nobody wants to bet the farm. For smaller ones, it doesn't, though it often prevails for reasons we'll soon explore. Companies should see minor decisions as part of a long-term, diversified (and thus risk-mitigating) strategy.
As Exhibit 2 shows, companies don't always rationally factor risk into their decisions. In the large, infrequent ones
(for instance, the industry-transforming merger that went horribly wrong) represented in the exhibit's upper-left quadrant there is a tendency to take an overly optimistic view. In essence, faulty judgments lead executives to take risks they would have avoided if they had had an accurate judgment of the odds. Since executives facing such a rare decision can't benefit from their own experience, they should learn from the experience of other companies by collecting case studies of similar decisions to provide a class of reference cases for comparison.

Dissecting global trends: An example from Italy

Research in Brief
Dissecting global trends: An example from Italy
Executives should examine the impact of trends on sub industries, segments, categories, and micro markets before placing their bets.
Stefano Proverbio, Sven Smit, and S. Patrick Viguerie, March 2008
Executives know they must incorporate social and environmental trends into their strategies, but few act on trends in ways that would allow them to ride the waves successfully. Our experience, backed by recent research, suggests that companies should navigate important trends by first studying their impact on sub industries, segments, categories, and micro markets. That kind of analysis breaks down megatrends into micro trends that companies can invest in with confidence. When they do, they are applying an approach similar to the one they should use when targeting growth opportunities in any market.
Indeed, we find that the importance of taking a granular view of where to compete can hardly be overestimated. We compared the global growth rates of industries with those of an international sample of 416 large companies, from 1999 to 2005. We found that we could explain why some companies grew faster than others only by measuring their exposure to sub industries and product categories.

To show what that approach looks like in practice, we analyzed the market impact that an important trend-aging populations in developed economies-will have in Italy, which has one of the world's most rapidly aging populations, because of low birth rates and a high life expectancy. The starting point for a granular growth and trend analysis is to break down market information into increasingly fine-grained levels (Exhibit 1)-from the world market (which we call G0); to 24 broad industry groups, such as health care equipment and services (G1); to 151 individual industries (G2). These, in turn, can be divided

  • G0. At the world-market level, we estimate that aging populations will reduce global GDP by 0.1 percent a year until 2020. In Italy, the impact will be virtually neutral-lowering GDP by just 0.03 percent a year. This gap offers no useful information for an executive considering whether to ride Italy's trend to aging.
  • G1 and G2. At the level of industry groups and individual industries, the impact of aging clearly varies across the Italian economy (Exhibit 2). We estimate that changes in the age mix will increase demand for health care, housing, energy, and food and beverages by 0.15 percent (food and beverages) to 0.30 percent (health care) between now and 2020. Conversely, industries such as apparel, furniture, and automobiles are all likely to suffer a drop in demand of around 0.15 percent a year over that period. Games, toys, and sports will likely be hardest hit, with an annual decline of 0.4 percent. Aging will therefore have a positive impact on some Italian industries and a negative one on others. But industry averages don't tell executives enough to make specific decisions about where to compete.

DETERMINATON

In 1883, a creative engineer named John Roebling was inspired by an idea to build a spectacular bridge connecting New York with the Long Island. However bridge building experts throughout the world thought that this was an impossible feat and told Roebling to forget the idea. It just could not be done. It was not practical. It had never been done before.

Roebling could not ignore the vision he had in his mind of this bridge. He thought about it all the time and he knew deep in his heart that it could be done. He just had to share the dream with someone else. After much discussion and persuasion he managed to convince his son Washington, an up and coming engineer, that the
bridge in fact could be built.

Working together for the first time, the father and son developed concepts of how it could be accomplished and how the obstacles could be overcome. With great excitement and inspiration, and the headiness of a wild challenge before them, they hired their crew and began to build their dream bridge.

The project started well, but when it was only a few months underway a tragic accident on the site took the life of John Roebling. Washington was injured and left with a certain amount of brain damage, which resulted in him not being able to walk or talk or even move.

"We told them so."
"Crazy men and their crazy dreams."
"It`s foolish to chase wild visions."

Everyone had a negative comment to make and felt that the project should be scrapped since the Roeblings were the only ones who knew how the bridge could be built. In spite of his handicap Washington was never discouraged and still had a burning desire to complete the bridge and his mind was still as sharp as ever.

He tried to inspire and pass on his enthusiasm to some of his friends, but they were too daunted by the task. As he lay on his bed in his hospital room, with the sunlight streaming through the windows, a gentle breeze blew the flimsy white curtains apart and he was able to see the sky and the tops of the trees outside for just a moment.

It seemed that there was a message for him not to give up. Suddenly an idea hit him. All he could do was move one finger and he decided to make the best use of it. By moving this, he slowly developed a code of communication with his wife.

He touched his wife's arm with that finger, indicating to her that he wanted her to call the engineers again. Then he used the same method of tapping her arm to tell the engineers what to do. It seemed foolish but the project was under way again.

For 13 years Washington tapped out his instructions with his finger on his wife's arm, until the bridge was finally completed. Today the spectacular Brooklyn Bridge stands in all its glory as a tribute to the triumph of one man's indomitable spirit and his determination not to be defeated by circumstances. It is also a tribute to the
engineers and their team work, and to their faith in a man who was considered mad by half the world. It stands too as a tangible monument to the love and devotion of his wife who for 13 long years patiently decoded the messages of her husband and told the engineers what to do.

Perhaps this is one of the best examples of a never-say-die attitude that overcomes a terrible physical handicap and achieves an impossible goal.

Often when we face obstacles in our day-to-day life, our hurdles seem very small in comparison to what many others have to face. The Brooklyn Bridge shows us that dreams that seem impossible can be realised with determination and persistence, no matter what the odds are.

Even the most distant dream can be realized with determination and persistence.

George L. Hanbury
Dawgen Public Accountants
5 Melmac Avenue, Kingston 5 Jamaica

Controlling Negative Thoughts

Athletes regularly carry on an inner dialogue—this is called self-talk. Your self-talk can be negative and self-destructive to confidence or it can be positive and help you remain confident in challenging situations. If you want to be negative with yourself, you have plenty of opportunity to do so in sports. However, I do not think you will perform your best nor have much fun. The key point is that you have control over what you say to yourself and have to work on staying positive.

It is easy to forget someone else's criticism of you, but it's not easy to forget your own criticism of yourself. I ask the athletes I work with to monitor what they say to themselves. If you get negative with your own self-talk and cut yourself down, you have to recognize this behavior and make an effort to change. When you say to yourself "I can't win this fight," "you are the worst", or "Don't lose another match", you are hurting your own confidence. Negative thoughts lead to low self-confidence and negative outcomes. You are the only person who knows when you being negative and the only one who can turn it around.

The first step is to pay attention to what you say to yourself and notice when you begin to have negative thoughts. The goal is to quickly identifying your negative self-talk. After you finish a match, go back and think about when you were negative with yourself. Write down the negative statements and in what situations they occurred. If you have more negative than positive self-talk during a match, this indicates that you need to work on changing your self-talk.

The next step is to modify your typical negative thoughts or doubt. Write down the negative self-statements from the previous exercise. Next to each self-statement, change the negative thought to a positive statement. For example, the negative self-statement: "I can't believe he fooled you on that move, you are the worst fighter in the world" change to "You are human and will make mistakes, next time you will know better". Practice changing your negative thoughts to positive thoughts on paper.

The final step is to apply what you have done on paper to your matches. The next time you become aware of a negative thought or doubt, you will have a positive response ready to put into place and apply. Make the choice to keep your self-talk positive and confidence enhancing.

Closing the Gap between Success and Significance

Think of the person you most admire. This might be a teacher, a business associate, an inspirational leader, a mentor or friend who made a significant impact on your life. You remember them for what they did for you at a time when you needed their direction.
Contrast this person with the college professor who said, "You can interpret this story two ways, my way and the wrong way."
In the past, accepted business leadership styles resembled the college professor's attitude. Using a command style, executives demanded better, faster, cheaper, more efficient strategies, pushing employees to higher standards and criticizing rather than praising.
As a result, the driver leader struggled, employees refused to make an emotional commitment, the management team did not work in a unified fashion and the organization suffered.
The Changing World
Today's business leaders face a world undergoing change such as we have never seen before. New technology, international competition, lightning information availability, and new legal accountability challenge leaders to make not just directional but transformational changes to remain competitive.
In this environment, it is difficult for a CEO, President, or leader to drive an organization to realize its vision and to deliver sustainable results.
The Changing Leadership Model
Many leaders forget a basic adage of leadership. Their success depends on the success of their employees and co-workers. High level leaders understand that they contribute to this success by making it easier for their employees to do their jobs, by making them feel that their jobs have significant value and by treating them as individuals with valid opinions and suggestions.
Research shows that the organizational climate, the way people think about working for an organization, has a significant impact on human performance. The way employees perceive the leader and his management team drives the organizational climate and employee performance.
In today's world-class organization, people at every level must have a personal stake in the vision of the business. The world-class leader understands that the most important part of his job is to develop an organization where people want to work and want to do their best.
Like the person you admire the most, today's effective business leaders develop significance with their associates. They enjoy continued long-term professional and personal success. They leave an indelible impact on their employees, customers and suppliers because of what they do and continue to do for them.
Becoming a Significant Leader
Turn this around and ask yourself who sees you as their mentor, as their inspiration, as memorable in their life. This may be difficult at first since we seldom see ourselves as making a significant impact on others.
Ask yourself how many people in your life want to help you? How many people have you dedicated your time and energy to help this year? If the answer to both questions is "a handful", you may lead a comfortable life, but you will not develop significance in your relationships.
To create significance, you must develop the attitude of the "Servant's Heart". You must ask how you can help people.
This requires you to shift your focus. You develop a Servant's Heart by dedicating yourself to the success of those who help you achieve your success. A self-centered driver has fleeting success because he builds on too small a foundation.
People walk around with the letters MMFA - Make Me Feel Appreciated – as a figurative imprint on their foreheads. You, as a leader with a Servant's Heart, must ask how you can help these people become more effective and feel more important. You must make your customers, employees and suppliers understand that you have their best interests at heart and that your commitment is unconditional.
All of us aspire to reach our dreams and goals. The leader with a "Servant's Heart" inspires others who realize that he cares about them and wants them to succeed at a personal level. When people realize that they can reach their personal goals through helping the organization reach its goals, they make impressive results possible.
Important Attitudes That Lead to Significance
Empathy, defined as the understanding of others, is the fundamental trait that leads to significance. The three levels of empathy are:
1. Being able to read another's emotions
2. Sensing and responding to a person's unspoken concerns or feelings
3. Understanding the issues or concerns that lie behind another's feelings
People with this ability notice emotional cues, listen well, show sensitivity, and understand others' perspectives.
You, as an empathetic leader, sense others' needs and bolster their abilities by looking past the obvious. You see the next step and how to get there. You want to help subordinates and co-workers build their personal identity and their self-image so they can become more successful and you want them to realize that you too are doing the same thing.
You, as the authentic leader with empathy, give advice that serves the person's best interests. When people understand that you have a sincere desire that they succeed, they respond with great enthusiasm. In an organization where people want to be and do their best, you can obtain great results.
Making Personal Changes Is Not Easy
You can use several proven steps to assist you to become an empathetic leader.
First, you must acknowledge your current attitudes before you can change them. People with strong self-awareness understand emotions, strengths, limitations, values and motives at a deep level. They are honest with themselves and about themselves. They know the direction they want their life to take and why.
Second, to make personal changes you must practice the new actions and thoughts you want to develop. In sports, athletes spend far more time practicing than performing. Tiger Woods hits hundreds of practice shots for every tournament shot. In contrast, we in the business world perform but never practice. To be more successful we must practice skills and attitudes that will further our success.
As you practice building empathy and the other skills you need to become significant in others' lives, you must track your new skills. Busy lives make it is easy to delay doing uncomfortable tasks. However, when you hold yourself accountable you will stay on target and make progress towards your goals.
Finally, use a coach or mentor. At the times when you get cranky, a trusted friend, colleague or coach can give you an unbiased perspective. By helping you through rough times, they help you stay focused on your goal.
A Caveat
To build a business culture where employees have a say in the direction of the organization, you do not need to give up leadership. The effective leader understands the importance of building a culture where accountability is expected.
Some might object that working through others as opposed to giving firm direction leads to pressure to lower performance standards, tempting us to make accommodations to personal interests.
Effective leaders understand the importance of building a culture that expects accountability. They hold individuals and the organization accountable every step of the way to reaching the future they envision.
Effective leaders work with individuals without compromising performance. Under such leaders, employees understand and accept the importance of meeting objectives they have helped establish. They understand that when they help the organization meet its goals they meet their own goals. This dynamic has a substantial positive effect on performance by both the organization and the individual.
Successful leaders insist on involving their employees in the planning process as a way to build personal commitment. With a "Servant's Heart," significant leaders have their employees' best interests at heart and will commit to their personal development.
Successful leaders insist on a continuous process of planning and development, of accountability and results, and build the culture of the organization around these cornerstones.
Significance Is a Timeless Concept
People want to feel appreciated. You remember the people you most admire for what they did and do for you. As an empathetic leader, you leave an indelible impact on the lives of others. You accomplish this by developing a "Servant's Heart", helping them become more successful.
In a healthy organization people have a personal stake in the vision of the business. The effective leader develops an organization where people want to work and want to do their best. At the same time he does not sacrifice performance. He builds accountability into the culture of the organization. Everyone understands the performance imperative and this mutual understanding brings great results.
Gaining personal success through helping others is timeless. William Shakespeare said, "The more I give to thee, the more I have."
And to quote Ralph Waldo Emerson, "A man cannot help another without helping himself even more."
To become an extraordinary leader and develop sustainable success, become significant. Make an indelible impact on the lives of others.