Kahneman, Tversky and cognitive biases

Posted: 02/06/2014 - 17:41

Nobel laureate Daniel Kahneman, professor emeritus of Psychology at Princeton University, famed for his psychological research into economic science and behavioral economics, laid the foundation for the field of research known as cognitive biases.

His work has been popularised recently in a TED talk, “The riddle of experience vs. memory”. Kahneman and his colleague Amos Tversky (who died in 1996) challenged traditional economic theory that dates to Adam Smith: that people make rational choices based on their self-interest. Their research showed that people frequently fail to fully analyse situations where they must make complex judgments. Instead, people and organisations often make decisions using rules of thumb rather than rational analysis, and they base those decisions on factors economists traditionally don’t consider, such as fairness, past events and aversion to loss.

As I dug deeper into Kahneman’s work, I was struck by just how many cognitive biases there are! The list is literally from A-to-Z: from the “ambiguity effect” to “zero risk bias.” These “cognitive traps” make it virtually impossible to think clearly in our personal – and business – lives.

Kahneman and Tversky found that people’s decisions can be swayed by how a given situation is framed. For example, they asked people to hypothetically decide what procedure to take to cure a disease, and most preferred a procedure that saved 80 per cent of people to one that killed 20 per cent.

While their examples are numerous and widespread, it is the business examples that interest me the most. In a 2008 video interview with McKinsey Kahneman asked, “Are the talents of the people that surround the decision-making utilised effectively? In many cases the answer is no.” That’s because there is an “enormous amount of resistance to improving the quality of the decision-making process – people feel threatened.”

That resonates with me. I can definitely testify that all too often businesses get stuck in a rut because they fear change – and their decisions are based on their own cognitive biases. In short, they are afraid to move forward because Vested is different – and cling to why they need to continue doing things the same old same way they have always done them.

Vested’s 10 Ailments that can plague business and outsource deals come to mind. There’s the Junkyard Dog Factor, where after a decision to outsource is made, employees hunker down and stake territorial claims to processes that “absolutely must” stay in house. The Zero-Sum Game occurs when companies believe that if something is good for the service provider, then it is automatically bad for them. Measurement Minutiae is another, where companies get bogged in a sea of metrics – they must measure everything that move! – most of which are not used in a meaningful way.

The idea of cognitive biases in business also resonates with Jim Taylor, an adjunct professor at the University of San Francisco. Taylor picked up on Kahneman’s and Tversky’s themes last year in a Psychology Today article, ‘Cognitive Biases are Bad for Business‘.

He said their work shows that “humans make decisions and act in ways that are anything but rational.” Cognitive biases can be broadly placed in two categories, he continued:

  • Information biases that include the use of heuristics, or information-processing shortcuts, can “produce fast and efficient, though not necessarily accurate, decisions.”
  • Ego biases include emotional motivations, such as fear, anger, or worry, and social influences such as peer pressure, the desire for acceptance, and doubt that other people can be wrong.

When cognitive biases influence individuals, real problems can arise. But when cognitive biases impact a business, then the problems can be exponentially worse. Just think of the Edsel and the Microsoft Kin.

Taylor identified 12 cognitive biases that appear to be most harmful to business decision-making. (He noted that some of these cognitive biases were developed and empirically validated by Kahneman and Tversky.) Taylor’s 12 biases include:

  • Knee-jerk bias: fast and intuitive decisions when slow and deliberate decisions are necessary.
  • Occam’s razor bias: assume the most obvious decision is the best decision.
  • Silo effect: use too narrow an approach in making a decision.
  • Confirmation bias: focus on information that affirms beliefs and assumptions.
  • Inertia bias: think, feel, and act in ways that are familiar, comfortable, predictable, and controllable.
  • Myopia bias: see and interpret the world through the narrow lens of your own experiences, baggage, beliefs, and assumptions.

Ego biases include:

  • Shock-and-awe bias: belief that intellectual firepower alone is enough to make complex decisions.
  • Overconfidence effect: excessive confidence in beliefs, knowledge, and abilities.
  • Optimism bias: overly optimistic, overestimating favorable outcomes and underestimating unfavorable outcomes.
  • Homecoming queen/king bias: act in ways that will increase acceptance, liking, and popularity.
  • Force field bias: think, feel, and act in ways that reduce a perceived threat, anxiety, or fear.
  • Planning fallacy: underestimate the time and costs needed to complete a task.

Taylor sums up his article matter-of-factly. “Clearly, cognitive biases are bad for business…(they) are most problematic because they cause business people to make bad decisions.”

Outsourcing decisions in today’s volatile global economic climate are highly complex and uncertain, especially where one side or the other acts with self-interest, inflexibility and/or incomplete knowledge of the enterprise or problems. Irrational or at least ineffective behaviour – and outcomes – is almost guaranteed in those instances.

So what can you do about cognitive biases that inflect your organisation? How often have you sat in meetings where some, or all, of those biases were on display?  Taylor says there are ways to fight through the bias thicket.  His tips include:

  • Be aware that cognitive biases exist; use your understanding of them to ask the right questions.
  • Collaboration: the best way to recognise and mitigate cognitive biases.
  • Turn on the cognitive bias radar.
  • Establish a trusting, disciplined and consistent framework and process for making decisions.

I agree with Taylor’s tips. As I like to teach – don’t be afraid to point out the elephants in the room! In fact, you might enjoy this opinion piece I recently wrote for Information Week on this topic.

Region: 

About The Author

Kate Vitasek's picture

Kate Vitasek is an international authority for her award-winning research and Vested® business model for highly collaborative relationships.   Vitasek, a Faculty member at the University of Tennessee, has been lauded by World Trade Magazine as one of the “Fabulous 50+1” most influential people impacting global commerce.    Her work has led to 6 books, including: Vested Outsourcing: Five Rules That Will Transform Outsourcing, Vested: How P&G, McDonald’s and Microsoft Are Redefining Winning in Business Relationships and Getting to We: Negotiating Agreements for Highly Collaborative Relationships.

Vitasek is known for her practical and research-based advice for driving transformation and innovation through highly-collaborative and strategic partnerships.   She has been appeared on CNN International, Bloomberg, NPR, and on Fox Business News.  Her work has been featured in over 300 articles in publications like Forbes, Chief Executive Magazine, CIO Magazine, The Wall Street Journal, Journal of Commerce, World Trade Magazine and Future of Sourcing.