Just how do we make business decisions and are the basis for these decisions always founded in reason? Ed Charles takes a look at decision-making processes.
Henry Mintzberg has spent his career trying to understand how managers make decisions. The Cleghorn Professor of Management Studies at McGill University in Montreal has found that the best way to improve decision making is to admit that decisions are not made in logical steps.
While we’d all like to think we apply reason, the reality is that many of a managers’ best decisions are made in some other way – a flash of inspiration, trial and error, and simply by sticking to what works. Much of Mintzberg’s work shows that managers don’t actually make that many decisions, according to Robert Spillane, Professor of Management at the Macquarie Graduate School of Management.
Spillane, who teaches philosophy and psychology in management, says there is no study that shows that Australia’s one million managers know more about decision making than any other group – lorry drivers or housewives, for example.
He says: “That means a lot of money is going to a lot of people on the assumption that a fair proportion of them know how to make decisions.”
Tim van Gelder, a former academic and Principal of consultancy Austhink says it is difficult to determine how good management decision making is because of a lack of objective measures.
“We can’t get them to play off against each other like tennis or chess to see how good they are. What we have to do is make inferences using information from elsewhere.”
He says there are fields, such as investment, where human judgement can be measured. Classic texts such as Charles Mackay’s Extraordinary Delusions and the Madness of Crowds, written in 1841, detail the madness of investors who poured money into the South Sea Bubble and Tulipomania. A parallel can be drawn with the dotcom boom and bust where managers made the same misjudgements as investors.
Tim van Gelder says: “Humans do tend to get gripped by these selective fantasies and start making rapid decisions without careful reflection on the foundations for those decisions. And, of course, there is the fear of missing out; that was a powerful driver there.”
Traditionally, economics has relied on the notion that people act rationally. More realistically the field of behavioural finance shows people continually make the same errors of judgement.
Dr Daniel Kahneman, Eugene Higgins Professor of Psychology and Professor of Public Affairs in the Woodrow Wilson School of Public and International Affairs at Princeton University, won the Nobel prize for economics in 2002 for the work he had done in this area with the late Amos Tversky. While their work is being applied to investment the same rules of behavior apply to managers.
Kahneman’s and Tversky’s work on prospect theory found that people consistently take short cuts and oversimplify situations. They found people behave differently depending how a situation is framed in relation to taking losses and gains. Typically people are willing to take more risks to avoid losses than to make profits. In plain language people hurt more from losing $100 than the pleasure they can get from winning $100. The difference between $50 and $100 appears to be bigger than $1000 and $1050.
Similarly people are irrational about sunk costs. On a trip to the theatre people will often sit through to the end of an awful production simply because they paid to see it. Managers will stick with an investment simply because of the sunk costs rather than walk away.
Dr Peter Slezak, Director of the Program in Cognitive Science in the School of History and Philosophy of Science at the University of NSW, says that the problem is that human brains are hard wired to make decisions in a certain way. He says: “You can’t actually calculate the optimal solution to a problem every time. You haven’t got the time or the energy or the brains to do it.”
And so you make what he calls “satificing” decisions. You make satisfactory decisions under the circumstances given the constraints of your time.”
Vivek Chaudhri, Associate Professor, Economics and Strategy at the Melbourne Business School, says there is growing interest in behavioural economics being applied to business decisions. He says: “What we really need to do is to start to understand that link between psychology, sociology and economics, and we are only just starting to look at it. At the end of the day, decision making at CEO and other levels is a human process.”
One of the first things Chaudhri tells MBA students is that financial models such as net present value or real options calculations can come up with a number but not an answer. He says: “More often than not you don’t even know what the questions are. There isn’t going to be an answer out there, but if we can start to ask the right sets of questions, then this is where I think the importance of behavioural finance and economics is starting to take shape in management.”
Most management decisions are deliberative, according to van Gelder. He says: “They are made on the basis of an informal consideration of the pros and the cons – the various arguments around the issue. Our abilities and practices for handling those kinds of deliberative judgements are actually fairly primitive. And we know that humans are not good at it and we are not aware of how bad we are at it.”
He says the reality is that humans are deeply emotionally involved. “It’s just that our brains weren’t designed to make decisions that systematically integrate a large number of detailed arguments. We are just not very good at it.”
Macquarie’s Spillane is concerned about the quality of – or lack of – argument in decision making. To make a good decision, according to Spillane, managers need to turn to philosophy and understand what it is to reason. He says: “It is generally assumed that reasoning is part of decision making. Because if it isn’t, people are relying on such notions as intuition or gut feel, which often Australian managers are inclined to quote.”
Spillane remembers sitting in on a board meeting with the idea of evaluating its decision making. After an hour the chairman had a break and asked his opinion on the arguments. “I said ‘I can’t answer you because there hasn’t been any’ and he was angry and said ‘what do you think we’ve been doing’ and I said ‘psychotherapy’.”
The point Spillane was making was that they were talking about their feelings rather than having a good argument.
Spillane has tapes of boards in action. He says someone will say: “I think the Adelaide branch should be closed”. “We are waiting for the reason and it doesn’t come. Somebody says ‘I feel it should be left open’. Now, they are not arguments. They are just assertions.”
Ed Charles is a Melbourne-based freelance writer.
Diversity in decision making
The Melbourne Business School’s Vivek Chaudhri says people, particularly males, will overestimate their true ability in any positive attribute. He says managers should recognise the value of diversity in decision making. “You don’t want all your senior managers to be that alpha type male in their 60s.”
The decision you are making
Austhink’s Tim van Gelder says most major decisions are deliberative not technical. He says: “They [managers] don’t understand in even the most basic way what it is to make such a decision. Just as it is that most people who ride a bike don’t understand what it is to ride a bike. They can’t tell you how to turn a corner they just know that they can do it.”
Study rational decision making
The University of NSW’s Dr Peter Slezak says that when you study logic you also have to learn the sophisms or fallacies. “When you understand how the fallacies come up you become alert to them; you become sensitive to the situations where your reasoning is going to let you down. You are fighting against your natural instincts to make the mistakes.”
Every philosopher begins with Socrates, according to the UNSW’s Dr Peter Slezak. Part of his philosophy was to provoke arguments with people. “The reason is that there are rules to arguing well and reasoning well… people just can’t think clearly.”
The correct information
Vivek Chaudhri (MBS) says that companies that are good at decision making tend to have flat structures and good information. “What you want to do from an organisational perspective is try and get those information flows right, and the decisions right in the first place,” he explains.
Watch out for bias
According to a paper by Dr Paul Monk of Austhink, we commonly cling to an opinion, ignoring evidence which conflicts with it. Known as “belief preservation” it is the default for human beings. Another tendency is “confirmation bias”. We select information that supports fixed ideas. “We all have a propensity to seek to confirm our hunches or hypotheses, rather than seek to test and refute them. Our brains simply work that way by default. In cases where the data we have to analyse are complex, and allow more than one possible interpretation, this has real, practical consequences. It plainly has implications for both intelligence and risk management.”
Don’t get personal
Macquarie’s Robert Spillane says it is important to understand the difference between logic and rhetoric, and to argue without getting personal.
What is the truth?
The postmodern concept of truth is that there is no such thing as truth. There is no such thing as truth because what is true for one person may not be true for another. The easiest example of this is in religion in which what is true for a Catholic may not be true for an Anglican, Jew, Muslim, Buddhist or anyone from any other faith. Macquarie’s Spillane says that managers tend to believe in American pragmatism – the truth is what works. “Once you start thinking like that there’s no point in arguing. Because if you believe the truth is what works then all the religions are truth. So what’s the point in arguing as a Christian against a Buddhist. You are wasting your time.”
Helping your decision making
There are a number of simple processes that can help you make decisions. The first is Edward de Bono’s Six Thinking Hats. This allows you to look at a problem from a number of different approaches. Each of the Thinking Hats represents a different style of thinking. It’s not new, but it allows a manager to stop and think about the decision-making process. Go to www.sixhats.com for details.
The Pareto Analysis helps you to decide what are the most important changes to make in the decision-making process. This “80:20 rule” technique helps you to identify the most important problem to solve, it will also give you a score showing how severe the problem is. Go to www.mindtools.com for more information.