In my last blog, I introduced the concept of “heuristics” and promised I would provide more insight from The Undoing Project, the latest book by Michael Lewis.
So, here’s a brief overview: In the 1950s, Nobel Prize-winning psychologist Herbert Simon suggested that while people strive to make rational choices, human judgment is subject to cognitive limitations, and people are limited by the amount of time they have to make choices/decisions. In the 1970s, Amos Tversky and Daniel Kahneman introduced and labeled the specific ways of thinking people rely on to simplify decision-making.
As I mentioned in my previous blog, this topic is quite technical, but it’s very important for business owners and senior executives to be aware of the practical implications present in the decisions they make every day. For that reason, I would highly recommend reading The Undoing Project.
To whet your appetite, I’ll share two basic examples of the impact of heuristic biases from the book.
Belief in the Law of Small Numbers: The power of this belief can be seen in the way people think of totally random patterns — like, say, those created by a flipped coin. People know that a flipped coin is equally likely to come up heads as it is tails, but they also think the tendency for a coin that’s flipped a great many times to land on heads half the time would also express itself if it were flipped only a few times — an error known as “the gambler’s fallacy.” If I flipped a coin a few times in a row and it landed on heads every time, what do you think it would land on on the next flip? Most people would say it will land on tails, as if the coin itself could even things out. Tversky and Kahneman would say this is a glitch in human behavior. In reality, if you were to flip a coin a thousand times, you would be more likely to end up with heads or tails roughly half the time than you would if you only flipped it 10 times.
Framing–Sensitivity to Negative Outcomes: If I gave you $1,000 and then gave you a choice between another gift of $500 and a 50/50 shot at winning $1,000, what would you pick? Most people pick $500, because it’s the sure thing. Now, how about if I gave you $2,000 and then gave you a choice between losing $500 for sure and a 50/50 risk of losing $1,000? Most people would take the bet. The bottom line is that the two questions are effectively identical. In both cases, if you decide to gamble, you’d wind up with a 50/50 shot at being worth $2,000. And in both cases, if you chose the sure thing, you’d wind up being worth $1,500. When the sure thing is framed as a loss, people choose the gamble. However, when you frame it as a gain, people choose the sure thing.
Hopefully these two examples give you a brief glimpse into heuristics. When you reflect on your business, think about those times when you’re quoting on new work or evaluating your team members. Are you basing your conclusions on objective data, or intuition? As a seasoned businessman, I realize more and more each day how many biases, rules of thumb, and gut feelings I have that are wrong.
Give the book a chance.