Before deciding on a course of action, prudent managers evaluate the situation c

Question

Before deciding on a course of action, prudent managers evaluate the situation confrontingthem. Unfortunately, some managers are cautious to a fault–taking costly steps to defendagainst unlikely outcomes. Others are overcondent–underestimating the range of potentialoutcomes. And still others are highly impressionable–allowing memorable events in the pastto dictate their view of what might be possible now.These are just three of the well-documented psychological traps that afict most manag-ers at some point, assert authors John S. Hammond, Ralph L. Keeney, and Howard Raiffa intheir 1998 article. Still more pitfalls distort reasoning ability or cater to our own biases. Exam-ples of the latter include the tendencies to stick with the status quo, to look for evidenceconrming one’s preferences, and to throw good money after bad because it’s hard to admitmaking a mistake.Techniques exist to overcome each one of these problems. For instance, since the waya problem is posed can inuence how you think about it, try to reframe the question in variousways and ask yourself how your thinking might change for each version. Even if we can’t erad-icate the distortions ingrained in the way our minds work, we can build tests like this into ourdecision-making processes to improve the quality of the choices we make.
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DECISION MAKING >> BEST OF HBRBY JOHN S. HAMMOND, RALPH L. KEENEY, AND HOWARD RAIFFA
In making decisions,you may be at the mercyof your mind’s strangeworkings. Here’s howto catch thinking trapsbefore they becomejudgment disasters.
lies not in the decision-making processbut rather in the mind of the decisionmaker.The way the human brain workscan sabotage our decisions.Researchers have been studying theway our minds function in making de-cisions for half a century. This research,in the laboratory and in the eld, hasrevealed that we use unconscious rou-tines to cope with the complexity in-herent in most decisions. These rou-tines, known as heuristics, serve us well
The Hidden
Traps
in Decision
Making
M
AKING DECISIONS is the most
important job of any executive. It’s alsothe toughest and the riskiest. Bad deci-sions can damage a business and a ca-reer, sometimes irreparably. So wheredo bad decisions come from? In manycases, they can be traced back to theway the decisions were made–the alter-natives were not clearly dened, theright information was not collected,the costs and benets were not accu-rately weighed.But sometimes the fault
in most situations. In judging distance,for example, our minds frequently relyon a heuristic that equates clarity withproximity. The clearer an object ap-pears, the closer we judge it to be. Thefuzzier it appears, the farther away weassume it must be. This simple mentalshortcut helps us to make the continu-ous stream of distance judgments re-quired to navigate the world.Yet, like most heuristics, it is not fool-proof. On days that are hazier than nor-mal, our eyes will tend to trick ourminds into thinking that things aremore distant than they actually are. Be-cause the resulting distortion posesfew dangers for most of us,we can safelyignore it. For airline pilots, though, thedistortion can be catastrophic. That’swhy pilots are trained to use objectivemeasures of distance in addition totheir vision.Researchers have identied a wholeseries of such aws in the way we thinkin making decisions. Some, like theheuristic for clarity, are sensory mis-perceptions. Others take the form ofbiases. Others appear simply as irra-tional anomalies in our thinking. Whatmakes all these traps so dangerous istheir invisibility.Because they are hard-wired into our thinking process, wefail to recognize them–even as we fallright into them.For executives, whose success hingeson the many day-to-day decisions theymake or approve, the psychologicaltraps are especially dangerous. Theycan undermine everything from new-product development to acquisitionand divestiture strategy to successionplanning. While no one can rid his orher mind of these ingrained aws, any-one can follow the lead of airline pilotsand learn to understand the traps andcompensate for them.In this article, we examine a numberof well-documented psychological trapsthat are particularly likely to underminebusiness decisions.In addition to review-
ing the causes and manifestations ofthese traps, we offer some specic waysmanagers can guard against them. It’simportant to remember, though, thatthe best defense is always awareness.Executives who attempt to familiarizethemselves with these traps and the di-verse forms they take will be better ableto ensure that the decisions they makeare sound and that the recommenda-tions proposed by subordinates or asso-ciates are reliable.
The Anchoring Trap
How would you answer these twoquestions?
Is the population of Turkey greaterthan 35 million?What’s your best estimate of Turkey’spopulation?
If you’re like most people, the gureof 35 million cited in the rst question(a gure we chose arbitrarily) inu-enced your answer to the second ques-tion. Over the years, we’ve posed thosequestions to many groups of people. Inhalf the cases, we used 35 million in therst question; in the other half, we used100 million.Without fail,the answers tothe second question increase by manymillions when the larger gure is used inthe rst question. This simple test illus-trates the common and often perniciousmental phenomenon known as anchor-ing. When considering a decision, the
mind gives disproportionate weight tothe rst information it receives. Initialimpressions, estimates, or data anchorsubsequent thoughts and judgments.Anchors take many guises. They canbe as simple and seemingly innocuousas a comment offered by a colleague ora statistic appearing in the morningnewspaper. They can be as insidious as
a stereotype about a person’s skin color,accent, or dress. In business, one of themost common types of anchors is a pastevent or trend. A marketer attemptingto project the sales of a product for thecoming year often begins by looking atthe sales volumes for past years.The oldnumbers become anchors, which theforecaster then adjusts based on otherfactors. This approach, while it maylead to a reasonably accurate estimate,tends to give too much weight to pastevents and not enough weight to otherfactors. In situations characterized byrapid changes in the marketplace, his-torical anchors can lead to poor fore-casts and, in turn, misguided choices.Because anchors can establish theterms on which a decision will be made,they are often used as a bargaining tac-tic by savvy negotiators. Consider theexperience of a large consulting rmthat was searching for new ofce spacein San Francisco. Working with a com-mercial real-estate broker, the rm’spartners identied a building that metall their criteria,and they set up a meet-ing with the building’s owners.The own-ers opened the meeting by laying outthe terms of a proposed contract: a ten-year lease; an initial monthly price of$2.50 per square foot; annual price in-creases at the prevailing ination rate;all interior improvements to be the ten-ant’s responsibility; an option for the
tenant to extend the lease for ten addi-tional years under the same terms. Al-though the price was at the high endof current market rates, the consult-ants made a relatively modest coun-teroffer. They proposed an initial pricein the midrange of market rates andasked the owners to share in the renova-tion expenses, but they accepted all the
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John S.Hammond is a consultant on decision making and a former professor of Harvard Business School in Boston.Ralph L.Keeney
is a professor at Duke University’s Fuqua School of Business in Durham,North Carolina.Howard Raiffa is the Frank Plumpton Ram-sey Professor of Managerial Economics (Emeritus) at Harvard Business School. They are the authors of Smart Choices: A PracticalGuide to Making Better Decisions (Harvard Business School Press, 1998).
Decision makers display a strong bias towardalternatives that perpetuate the status quo.
other terms.The consultants could havebeen much more aggressive and creativein their counterproposal–reducing theinitial price to the low end of marketrates, adjusting rates biennially ratherthan annually, putting a cap on the in-creases, dening different terms for ex-tending the lease,and so forth–but theirthinking was guided by the owners’initial proposal. The consultants hadfallen into the anchoring trap, and as aresult, they ended up paying a lot morefor the space than they had to.>> What can you do about it? Theeffect of anchors in decision makinghas been documented in thousands ofexperiments. Anchors inuence the de-cisions not only of managers, but alsoof accountants and engineers, bankersand lawyers, consultants and stock an-alysts. No one can avoid their inu-ence; they’re just too widespread. Butmanagers who are aware of the dangersof anchors can reduce their impact byusing the following techniques:
• Always view a problem from differ-
ent perspectives. Try using alternativestarting points and approaches ratherthan sticking with the rst line ofthought that occurs to you.
• Think about the problem on your
own before consulting others to avoidbecoming anchored by their ideas.
• Be open-minded. Seek information
and opinions from a variety of peopleto widen your frame of reference and topush your mind in fresh directions.
• Be careful to avoid anchoring your
advisers, consultants, and others fromwhom you solicit information and coun-sel. Tell them as little as possible aboutyour own ideas,estimates,and tentativedecisions. If you reveal too much, yourown preconceptions may simply comeback to you.
• Be particularly wary of anchors in
negotiations. Think through your posi-tion before any negotiation begins inorder to avoid being anchored by theother party’s initial proposal. At thesame time, look for opportunities touse anchors to your own advantage–ifyou’re the seller, for example, suggesta high, but defensible, price as an open-ing gambit.
The Status-Quo Trap
We all like to believe that we make de-cisions rationally and objectively. Butthe fact is, we all carry biases, and thosebiases inuence the choices we make.Decision makers display, for example,a strong bias toward alternatives thatperpetuate the status quo. On a broadscale, we can see this tendency when-ever a radically new product is intro-duced.The rst automobiles,revealinglycalled “horseless carriages,”looked verymuch like the buggies they replaced.The rst “electronic newspapers” ap-pearing on the World Wide Web lookedvery much like their print precursors.On a more familiar level, you mayhave succumbed to this bias in yourpersonal nancial decisions. Peoplesometimes, for example, inherit sharesof stock that they would never havebought themselves. Although it wouldbe a straightforward, inexpensive prop-osition to sell those shares and put themoney into a different investment, asurprising number of people don’t sell.They nd the status quo comfortable,and they avoid taking action that wouldupset it.“Maybe I’ll rethink it later,”theysay. But “later”is usually never.
The source of the status-quo trap liesdeep within our psyches,in our desire toprotect our egos from damage.Breakingfrom the status quo means taking ac-tion, and when we take action, we takeresponsibility,thus opening ourselves tocriticism and to regret.Not surprisingly,we naturally look for reasons to do noth-ing. Sticking with the status quo repre-sents, in most cases, the safer course be-cause it puts us at less psychological risk.Many experiments have shown themagnetic attraction of the status quo.In one, a group of people were ran-domly given one of two gifts of approx-imately the same value – half receiveda mug, the other half a Swiss chocolatebar.They were then told that they couldeasily exchange the gift they receivedfor the other gift. While you might ex-pect that about half would have wantedto make the exchange, only one in tenactually did. The status quo exerted itspower even though it had been arbitrar-ily established only minutes before.Other experiments have shown thatthe more choices you are given, themore pull the status quo has. More peo-ple will, for instance, choose the statusquo when there are two alternatives to
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it rather than one: A and B instead ofjust A.Why? Choosing between A and Brequires additional effort; selecting thestatus quo avoids that effort.In business,where sins of commission(doing something) tend to be punishedmuch more severely than sins of omis-sion (doing nothing), the status quoholds a particularly strong attraction.Many mergers, for example, founderbecause the acquiring company avoidstaking swift action to impose a new,more appropriate management struc-ture on the acquired company.“Let’s notrock the boat right now,”the typical rea-soning goes. “Let’s wait until the situ-ation stabilizes.”But as time passes, theexisting structure becomes more en-trenched,and altering it becomes harder,not easier. Having failed to seize the oc-casion when change would have beenexpected,management nds itself stuckwith the status quo.>> What can you do about it? Firstof all, remember that in any given deci-sion,maintaining the status quo may in-deed be the best choice, but you don’twant to choose it just because it is com-fortable.Once you become aware of thestatus-quo trap, you can use these tech-niques to lessen its pull:
• Always remind yourself of your ob-
jectives and examine how they would beserved by the status quo. You may ndthat elements of the current situationact as barriers to your goals.
• Never think of the status quo as
your only alternative.Identify other op-tions and use them as counterbalances,carefully evaluating all the pluses andminuses.
• Ask yourself whether you would
choose the status-quo alternative if, infact, it weren’t the status quo.
• Avoid exaggerating the effort or
cost involved in switching from the sta-tus quo.
• Remember that the desirability of
the status quo will change over time.When comparing alternatives, alwaysevaluate them in terms of the future aswell as the present.
• If you have several alternatives that
are superior to the status quo, don’t de-fault to the status quo just because you’re
having a hard time picking the best al-ternative. Force yourself to choose.
The Sunk-Cost Trap
Another of our deep-seated biases is tomake choices in a way that justies pastchoices, even when the past choices nolonger seem valid.Most of us have falleninto this trap. We may have refused, forexample,to sell a stock or a mutual fundat a loss, forgoing other, more attractiveinvestments. Or we may have pouredenormous effort into improving theperformance of an employee whom we
knew we shouldn’t have hired in therst place. Our past decisions becomewhat economists term sunk costs–old in-vestments of time or money that arenow irrecoverable. We know, rationally,that sunk costs are irrelevant to thepresent decision, but nevertheless theyprey on our minds, leading us to makeinappropriate decisions.Why can’t people free themselvesfrom past decisions? Frequently, it’s be-cause they are unwilling, consciously ornot,to admit to a mistake.Acknowledg-ing a poor decision in one’s personal lifemay be purely a private matter, involv-ing only one’s self-esteem, but in busi-ness, a bad decision is often a very pub-lic matter, inviting critical commentsfrom colleagues or bosses. If you re apoor performer whom you hired,you’remaking a public admission of poor judg-ment. It seems psychologically safer tolet him or her stay on, even though thatchoice only compounds the error.The sunk-cost bias shows up with dis-turbing regularity in banking, where itcan have particularly dire consequences.When a borrower’s business runs intotrouble, a lender will often advance ad-ditional funds in hopes of providing thebusiness with some breathing room torecover.If the business does have a goodchance of coming back, that’s a wise in-vestment. Otherwise, it’s just throwinggood money after bad.
One of us helped a major U.S. bankrecover after it made many bad loans toforeign businesses. We found that thebankers responsible for originating theproblem loans were far more likely toadvance additional funds – repeatedly,in many cases–than were bankers whotook over the accounts after the originalloans were made.Too often,the originalbankers’ strategy–and loans–ended infailure.Having been trapped by an esca-lation of commitment, they had tried,consciously or unconsciously,to protecttheir earlier, awed decisions. They had
fallen victim to the sunk-cost bias. Thebank nally solved the problem by in-stituting a policy requiring that a loanbe immediately reassigned to anotherbanker as soon as any problem arose.The new banker was able to take a fresh,unbiased look at the merit of offeringmore funds.Sometimes a corporate culture rein-forces the sunk-cost trap.If the penaltiesfor making a decision that leads to anunfavorable outcome are overly severe,managers will be motivated to let failedprojects drag on endlessly – in the vainhope that they’ll somehow be able totransform them into successes. Execu-tives should recognize that,in an uncer-tain world where unforeseeable eventsare common, good decisions can some-times lead to bad outcomes.By acknowl-edging that some good ideas will endin failure, executives will encouragepeople to cut their losses rather than letthem mount.>> What can you do about it? Forall decisions with a history, you willneed to make a conscious effort to setaside any sunk costs – whether psycho-logical or economic – that will muddyyour thinking about the choice at hand.Try these techniques:
• Seek out and listen carefully to the
views of people who were uninvolvedwith the earlier decisions and who arehence unlikely to be committed to them.
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We tend to subconsciously decide what to dobefore guring out why we want to do it.
• Examine why admitting to an earlier
mistake distresses you. If the problemlies in your own wounded self-esteem,deal with it head-on. Remind yourselfthat even smart choices can have badconsequences, through no fault of theoriginal decision maker, and that eventhe best and most experienced manag-ers are not immune to errors in judg-ment. Remember the wise words ofWarren Buffett: “When you nd yourselfin a hole, the best thing you can do isstop digging.”
• Be on the lookout for the inuence
of sunk-cost biases in the decisions andrecommendations made by your subor-dinates. Reassign responsibilities whennecessary.
• Don’t cultivate a failure-fearing
culture that leads employees to perpet-uate their mistakes. In rewarding peo-ple, look at the quality of their deci-sion making (taking into account whatwas known at the time their decisionswere made), not just the quality of theoutcomes.
The Conrming-Evidence Trap
Imagine that you’re the president ofa successful midsize U.S. manufacturerconsidering whether to call off aplanned plant expansion. For a whileyou’ve been concerned that your com-pany won’t be able to sustain the rapidpace of growth of its exports. You fearthat the value of the U.S. dollar willstrengthen in coming months, makingyour goods more costly for overseasconsumers and dampening demand.But before you put the brakes on theplant expansion, you decide to call upan acquaintance, the chief executive ofa similar company that recently moth-balled a new factory, to check her rea-soning. She presents a strong case thatother currencies are about to weakensignicantly against the dollar.What doyou do?You’d better not let that conversationbe the clincher, because you’ve proba-bly just fallen victim to the conrming-evidence bias. This bias leads us to seekout information that supports our ex-isting instinct or point of view whileavoiding information that contradicts
it. What, after all, did you expect youracquaintance to give, other than astrong argument in favor of her owndecision? The conrming-evidence biasnot only affects where we go to collectevidence but also how we interpret theevidence we do receive, leading us togive too much weight to supporting in-formation and too little to conictinginformation.In one psychological study of thisphenomenon,two groups–one opposedto and one supporting capital punish-ment–each read two reports of carefullyconducted research on the effectivenessof the death penalty as a deterrent tocrime. One report concluded that thedeath penalty was effective; the otherconcluded it was not. Despite being ex-posed to solid scientic informationsupporting counterarguments,the mem-bers of both groups became even moreconvinced of the validity of their ownposition after reading both reports.They automatically accepted the sup-porting information and dismissed theconicting information.There are two fundamental psycho-logical forces at work here. The rst isour tendency to subconsciously decide
what we want to do before we gureout why we want to do it. The second isour inclination to be more engaged bythings we like than by things we dis-like–a tendency well documented evenin babies. Naturally, then, we are drawnto information that supports our sub-conscious leanings.>> What can you do about it? It’snot that you shouldn’t make the choiceyou’re subconsciously drawn to. It’s justthat you want to be sure it’s the smartchoice. You need to put it to the test.Here’s how:
• Always check to see whether you are
examining all the evidence with equalrigor. Avoid the tendency to accept con-rming evidence without question.
• Get someone you respect to play
devil’s advocate,to argue against the de-cision you’re contemplating. Better yet,build the counterarguments yourself.What’s the strongest reason to do some-thing else? The second strongest rea-son? The third? Consider the positionwith an open mind.
• Be honest with yourself about your
motives. Are you really gathering in-formation to help you make a smartchoice, or are you just looking for evi-
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dence conrming what you think you’dlike to do?
• In seeking the advice of others,don’t
ask leading questions that invite con-rming evidence.And if you nd that anadviser always seems to support yourpoint of view, nd a new adviser. Don’tsurround yourself with yes-men.
The Framing Trap
The rst step in making a decision is toframe the question. It’s also one of themost dangerous steps. The way a prob-lem is framed can profoundly inuencethe choices you make. In a case involv-ing automobile insurance, for example,framing made a $200 million difference.To reduce insurance costs, two neigh-boring states, New Jersey and Pennsyl-vania, made similar changes in theirlaws. Each state gave drivers a new op-tion: By accepting a limited right to sue,they could lower their premiums. Butthe two states framed the choice in verydifferent ways: In New Jersey, you auto-matically got the limited right to sueunless you specied otherwise; in Penn-sylvania,you got the full right to sue un-less you specied otherwise. The differ-ent frames established different statusquos, and, not surprisingly, most con-sumers defaulted to the status quo. Asa result,in New Jersey about 80% of driv-ers chose the limited right to sue, butin Pennsylvania only 25% chose it. Be-cause of the way it framed the choice,Pennsylvania failed to gain approxi-mately $200 million in expected insur-ance and litigation savings.The framing trap can take manyforms, and as the insurance exampleshows,it is often closely related to otherpsychological traps. A frame can estab-lish the status quo or introduce an an-chor. It can highlight sunk costs or leadyou toward conrming evidence. Deci-sion researchers have documented twotypes of frames that distort decisionmaking with particular frequency:Frames as gains versus losses. Ina study patterned after a classic experi-ment by decision researchers DanielKahneman and Amos Tversky,one of usposed the following problem to a groupof insurance professionals:
You are a marine property adjustercharged with minimizing the loss ofcargo on three insured barges that sankyesterday off the coast of Alaska. Eachbarge holds $200,000 worth of cargo,which will be lost if not salvaged within72 hours. The owner of a local marine-salvage company gives you two options,both of which will cost the same:Plan A: This plan will save the cargo ofone of the three barges,worth $200,000.Plan B: This plan has a one-third prob-ability of saving the cargo on all threebarges, worth $600,000, but has a two-thirds probability of saving nothing.Which plan would you choose?
If you are like 71% of the respondentsin the study, you chose the “less risky”Plan A, which will save one barge forsure. Another group in the study, how-ever,was asked to choose between alter-natives C and D:
Plan C: This plan will result in the lossof two of the three cargoes, worth
$400,000.
Plan D:This plan has a two-thirds prob-ability of resulting in the loss of all threecargoes and the entire $600,000 but hasa one-third probability of losing no cargo.
Faced with this choice, 80% of theserespondents preferred Plan D.The pairs of alternatives are,of course,precisely equivalent–Plan A is the sameas Plan C,and Plan B is the same as PlanD–they’ve just been framed in differentways. The strikingly different responsesreveal that people are risk averse whena problem is posed in terms of gains(barges saved) but risk seeking when aproblem is posed in terms of avoidinglosses (barges lost). Furthermore, theytend to adopt the frame as it is pre-sented to them rather than restating theproblem in their own way.
Framing with different referencepoints. The same problem can alsoelicit very different responses whenframes use different reference points.Let’s say you have $2,000 in your check-ing account and you are asked the fol-lowing question:
Would you accept a fty-fty chanceof either losing $300 or winning $500?
Would you accept the chance? Whatif you were asked this question:
Would you prefer to keep your check-ing account balance of $2,000 or to ac-cept a fty-fty chance of having either
$1,700 or $2,500 in your account?
Once again, the two questions posethe same problem. While your answersto both questions should, rationallyspeaking, be the same, studies haveshown that many people would refusethe fty-fty chance in the rst ques-tion but accept it in the second. Theirdifferent reactions result from the dif-ferent reference points presented in
the two frames. The rst frame, with itsreference point of zero, emphasizes in-cremental gains and losses, and thethought of losing triggers a conserva-tive response in many people’s minds.The second frame, with its referencepoint of $2,000, puts things into per-spective by emphasizing the real nan-cial impact of the decision.>> What can you do about it? Apoorly framed problem can under-mine even the best-considered deci-sion. But any adverse effect of framingcan be limited by taking the followingprecautions:
• Don’t automatically accept the ini-
tial frame, whether it was formulatedby you or by someone else. Always tryto reframe the problem in various ways.Look for distortions caused by theframes.
• Try posing problems in a neutral,
redundant way that combines gains andlosses or embraces different referencepoints. For example: Would you accepta fty-fty chance of either losing $300,resulting in a bank balance of $1,700, orwinning $500, resulting in a bank bal-ance of $2,500?
• Think hard throughout your deci-
sion-making process about the framingof the problem. At points throughoutthe process, particularly near the end,ask yourself how your thinking mightchange if the framing changed.
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A dramatic or traumaticevent in your own life canalso distort your thinking.
• When others recommend decisions,
examine the way they framed the prob-lem. Challenge them with differentframes.
The Estimating and ForecastingTraps
Most of us are adept at making esti-mates about time, distance, weight,and volume. That’s because we’re con-stantly making judgments about thesevariables and getting quick feedbackabout the accuracy of those judgments.Through daily practice, our minds be-come nely calibrated.Making estimates or forecasts aboutuncertain events,however,is a differentmatter. While managers continuallymake such estimates and forecasts,theyrarely get clear feedback about their ac-curacy. If you judge, for example, thatthe likelihood of the price of oil fallingto less than $15 a barrel one year henceis about 40% and the price does indeedfall to that level, you can’t tell whetheryou were right or wrong about the prob-ability you estimated. The only way togauge your accuracy would be to keeptrack of many, many similar judgmentsto see if, after the fact, the events youthought had a 40% chance of occurringactually did occur 40% of the time. Thatwould require a great deal of data, care-fully tracked over a long period of time.Weather forecasters and bookmakershave the opportunities and incentivesto maintain such records,but the rest ofus don’t. As a result, our minds neverbecome calibrated for making estimatesin the face of uncertainty.All of the traps we’ve discussed so farcan inuence the way we make deci-sions when confronted with uncer-tainty. But there’s another set of trapsthat can have a particularly distortingeffect in uncertain situations becausethey cloud our ability to assess probabil-ities.Let’s look at three of the most com-mon of these uncertainty traps:The overcondence trap. Eventhough most of us are not very good atmaking estimates or forecasts, we actu-ally tend to be overcondent about ouraccuracy.That can lead to errors in judg-ment and, in turn, bad decisions. In one
series of tests,people were asked to fore-cast the next week’s closing value forthe Dow Jones Industrial Average. Toaccount for uncertainty, they were thenasked to estimate a range within whichthe closing value would likely fall. Inpicking the top number of the range,they were asked to choose a high esti-mate they thought had only a 1% chanceof being exceeded by the closing value.Similarly,for the bottom end,they weretold to pick a low estimate for whichthey thought there would be only a 1%
chance of the closing value falling belowit. If they were good at judging theirforecasting accuracy, you’d expect theparticipants to be wrong only about 2%
of the time. But hundreds of tests haveshown that the actual Dow Jones aver-ages fell outside the forecast ranges 20%
to 30% of the time. Overly condentabout the accuracy of their predictions,most people set too narrow a range ofpossibilities.Think of the implications for busi-ness decisions, in which major initia-tives and investments often hinge onranges of estimates. If managers under-estimate the high end or overestimatethe low end of a crucial variable, they
may miss attractive opportunities orexpose themselves to far greater riskthan they realize.Much money has beenwasted on ill-fated product-developmentprojects because managers did not accu-rately account for the possibility of mar-ket failure.The prudence trap. Another trapfor forecasters takes the form of over-cautiousness, or prudence. When facedwith high-stakes decisions, we tend toadjust our estimates or forecasts “justto be on the safe side.”Many years ago,for example, one of the Big Three U.S.automakers was deciding how manyof a new-model car to produce in antic-ipation of its busiest sales season. Themarket-planning department, responsi-ble for the decision,asked other depart-ments to supply forecasts of key vari-ables such as anticipated sales, dealerinventories, competitor actions, andcosts. Knowing the purpose of the esti-mates,each department slanted its fore-cast to favor building more cars –“justto be safe.” But the market plannerstook the numbers at face value and thenmade their own “just to be safe”adjust-ments. Not surprisingly, the numberof cars produced far exceeded demand,
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The Hidden Traps in Decision Making >> BEST OF HBR
and the company took six months to selloff the surplus, resorting in the end topromotional pricing.Policy makers have gone so far asto codify overcautiousness in formaldecision procedures. An extreme exam-ple is the methodology of “worst-caseanalysis,” which was once popular inthe design of weapons systems and isstill used in certain engineering and reg-ulatory settings. Using this approach,engineers designed weapons to oper-ate under the worst possible combina-tion of circumstances, even though theodds of those circumstances actuallycoming to pass were innitesimal.Worst-case analysis added enormouscosts with no practical benet (in fact,it often backred by touching off anarms race), proving that too much pru-dence can sometimes be as dangerousas too little.The recallability trap. Even if weare neither overly condent nor undulyprudent, we can still fall into a trapwhen making estimates or forecasts.Because we frequently base our pre-dictions about future events on ourmemory of past events,we can be overlyinuenced by dramatic events – thosethat leave a strong impression on ourmemory. We all, for example, exagger-ate the probability of rare but cata-strophic occurrences such as planecrashes because they get dispropor-tionate attention in the media. A dra-matic or traumatic event in your ownlife can also distort your thinking. Youwill assign a higher probability to traf-c accidents if you have passed one onthe way to work, and you will assigna higher chance of someday dying ofcancer yourself if a close friend hasdied of the disease.In fact, anything that distorts yourability to recall events in a balancedway will distort your probability assess-ments. In one experiment, lists of well-known men and women were read to dif-ferent groups of people. Unbeknownstto the subjects, each list had an equalnumber of men and women, but onsome lists the men were more famousthan the women while on others thewomen were more famous. Afterward,
the participants were asked to estimatethe percentages of men and women oneach list. Those who had heard the listwith the more famous men thoughtthere were more men on the list, whilethose who had heard the one with themore famous women thought therewere more women.Corporate lawyers often get caughtin the recallability trap when defend-ing liability suits. Their decisions aboutwhether to settle a claim or take it tocourt usually hinge on their assessmentsof the possible outcomes of a trial. Be-cause the media tend to aggressivelypublicize massive damage awards(while ignoring other, far more com-mon trial outcomes), lawyers can over-estimate the probability of a large awardfor the plaintiff. As a result, they offerlarger settlements than are actuallywarranted.>> What can you do about it? Thebest way to avoid the estimating andforecasting traps is to take a very disci-plined approach to making forecastsand judging probabilities. For each ofthe three traps,some additional precau-tions can be taken:
• To reduce the effects of overcon-
dence in making estimates, always startby considering the extremes, the lowand high ends of the possible range ofvalues. This will help you avoid beinganchored by an initial estimate. Thenchallenge your estimates of the extremes.Try to imagine circumstances where theactual gure would fall below your lowor above your high, and adjust yourrange accordingly. Challenge the esti-mates of your subordinates and advisersin a similar fashion.They’re also suscep-tible to overcondence.
• To avoid the prudence trap, always
state your estimates honestly and ex-plain to anyone who will be usingthem that they have not been adjusted.Emphasize the need for honest inputto anyone who will be supplying youwith estimates.Test estimates over a rea-sonable range to assess their impact.Take a second look at the more sensitiveestimates.
• To minimize the distortion caused
by variations in recallability, carefully
examine all your assumptions to en-sure they’re not unduly inuenced byyour memory. Get actual statisticswhenever possible.Try not to be guidedby impressions.
Forewarned Is Forearmed
When it comes to business decisions,there’s rarely such a thing as a no-brainer. Our brains are always at work,sometimes, unfortunately, in ways thathinder rather than help us. At everystage of the decision-making process,misperceptions, biases, and other tricksof the mind can inuence the choiceswe make. Highly complex and impor-tant decisions are the most prone todistortion because they tend to involvethe most assumptions, the most esti-mates, and the most inputs from themost people. The higher the stakes, thehigher the risk of being caught in a psy-chological trap.The traps we’ve reviewed can all workin isolation. But, even more dangerous,they can work in concert, amplifyingone another.A dramatic rst impressionmight anchor our thinking, and thenwe might selectively seek out conrm-ing evidence to justify our initial incli-nation. We make a hasty decision, andthat decision establishes a new statusquo. As our sunk costs mount, we be-come trapped, unable to nd a propi-tious time to seek out a new and possi-bly better course. The psychologicalmiscues cascade, making it harder andharder to choose wisely.As we said at the outset, the best pro-tection against all psychological traps–in isolation or in combination–is aware-ness. Forewarned is forearmed. Even ifyou can’t eradicate the distortions in-grained into the way your mind works,you can build tests and disciplines intoyour decision-making process that canuncover errors in thinking before theybecome errors in judgment. And takingaction to understand and avoid psycho-logical traps can have the added benetof increasing your condence in thechoices you make.
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DECISION MAKING
Summary of the article"The Hidden Traps in Decision Making" harvard business review. critique the arguments given in the readings, illustrate the points with examples drawn from your own experience, bring in other articles or books you have read.

Explanation / Answer

In this article the different traps which we all fall while taking a decision are clearly explained. It is because of these traps which we are not aware of that led to bad decision making.

Some of the traps were:-

Of all the trap given here the Anchoring trap is the most common one, it is in fact known to all the good negotiators. In the current situation it’s like everyone has the weapon, the one who knows to use it better wins.

The Status-Quo Trap has to do with our ego which we all know is bad for everything.

The Sunk Cost Trap, we rely too much on the past.

Also we have seen that all these traps are related to one another, it like a chain reaction.

Most importantly the framing trap can take many forms, and it is often closely related to other psychological traps. A frame can establish the status quo or introduce an anchor. It can highlight sunk costs or lead one toward conrming evidence.

Thus one has to be very care in making decision, they should apply disciplines to their personal and professional life, so that they could easily prevent themselves from falling into such trap.

Apart from these trap, there is also the trap called the Scarcity fallacy:

It is fear of scarcity that lies deep inside all of us. Human Beings always believed in savings, storing etc, it’s because of these fear.

The best example for such fear is the industry of diamond, in the diamond industry a monopoly has formed which keeps the supply of diamond limited to make it look like scarce and subsequently, the price of diamond doesn’t fall.

In this case it has worked but sometimes this fear may lead to bad decision making as the fear of scarcity may lead us to the Framing trap.

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