Think you're a rationale thinker? Think again.
Turns out, your brain is more inadequate at making logical decisions than you may realize. And the reasons make shock you.
In an article in the May 2013 issue of McKinsey Quarterly, Charles Roxburgh writes that the common assumptions about modern economics – that people are, or can be, rationale decision makers – doesn’t stack up with the evidence. And while this has been known by behavioural economists for some time, the idea hasn’t yet influenced how business strategies are formed.
So why do good executives make bad strategies? Roxburgh has 8 theories.
Your cocky and overconfidence, or at least your brain thinks you are. The human brain is programmed to be overconfident. In many cases, this is a good thing. The world would be a dull place if people weren’t confident that could could build, say, a horseless carriage or a better tablet computer. But as Roxburgh writes, it can also cause you to have an unrealistic view of your abilities. This is a particular problem with making accurate estimates. It also has the nasty side effect of causing you to be overly optimistic.
You know that feeling when you win $100 in a game of cards, but then lose it? You don’t feel that you’ve actually lost anything because it was “free” money in the first place. That’s your brain’s twisted mental accounting system at work.
Mental account describes how people treat money differently based on where it come from, where it’s kept, and how it is spent. This type of spending is less scrutinized by your brain, but it’s real money that’s being spent.
The status quo bias
Most people like to leave things as they are. We have an innate aversion to loss. How does this impact business strategy? It makes executives reluctant to sell businesses or assets, and divesting a business unlocks a major source of value.
This brain bias is a strange one. Chalk it up to a wiring flaw, if you will, but your brain has a tendency to anchor itself to information that it is first presented with. For example, write down the last 3 digits of your phone number. Now, tell me the date that Genghis Khan dies. Chances are, you’re likely to incorporate some digits from your phone number in your estimate.
This flaw can doom your expectations, particularly when dealing with past performance of the stock market in predicting equity returns. But you can use this flaw to your advantage. For example, if you’re negotiating the sale of your business, naming a high price can help peg the ballpark offer at the range you want.