How does the pervasiveness of optimistic bias in life impact on the ability of executives, entrepreneurs and organisations to make successful market-entry decisions?
RESEARCH
How does the pervasiveness of optimistic bias in life impact on the ability of executives, entrepreneurs and organisations to make successful market-entry decisions?
The pitfalls of ptimism o
COGNITIVE ANALYSIS of risk taking finds that decision-makers have a strong tendency to consider problems as unique. They isolate the current choice from future opportunities and neglect the statistics of the past in evaluating current plans. 1 By treating problems as unique, people tend to be overly optimistic when making large infrequent decisions. They also exhibit what the AGSM’ s Dan Lovallo calls Reference Group Neglect( RGN) when making decisions in a competitive environment. He talks to consultant Chris Manning about its impact and related inside- versus outside-view thinking on business entry. 2
DL: RGN theory is a fundamental aspect of my research into the psychology of competition and optimistic bias. It has been shown to be a contributor to overly optimistic entry decisions. It is also part of a broader psychological phenomenon known as‘ inside-view’ thinking. When people take the inside view in a competitive situation they tend to place too much emphasis on information relating to their own abilities, traits or plans, rather than carefully examining the competition.
Optimism plays a significant part in this because studies show that it can be quite impervious to all kinds of feedback. One of my favourite studies of this is one on driving, where people were asked to rate their driving ability. There were two groups of 50 people and they gave largely identical ratings. The surprising factor was that one of the groups was comprised of people who were all in the hospital because they had been in traffic accidents and, incredibly, two-thirds of them had actually caused the accident.
CM: What’ s important from a management practice perspective is that your work highlights something that probably happens more frequently than it should and, therefore, it is important to understand the drivers behind it. I do think there’ s a risk that as managers become more specialised, they’ re more prone to becoming the optimist you’ re concerned about in your writing. You could call it a‘ king of the castle’ syndrome where the specialist says they know all the statistical evidence, the trends of the past and where the market is headed. They give advice thinking that they’ re the only one who really knows, and that’ s a trap.
The challenge for everyone is to continually look around and take a helicopter view [ outside view ] of the experiences of competitors while, internally, assessing how the organisation has learnt through past investment decisions. It’ s crucial to understand and assess, statistically or through another form of evaluation, what might be the competitive response if, for example, you enter the market.
A classic example of the importance of asking,‘ What will be the impact of my decision?’ is the case of Rupert Murdoch and the New York Post( which competed with the Daily News). Murdoch decided to put the price of the paper up to make it more profitable, figuring the Daily News would follow. The Daily News didn’ t follow so instead Murdoch dropped the price of the paper on Staten Island below the initial price, forcing the Daily News to focus on the issue. The Daily News then put the price of its paper up to the level that Murdoch had originally set.
DL: As consultants, do you often find companies doing a good job of taking decision audits – assessing what they have done right and wrong and asking what they can learn?
CM: In terms of most due diligence procedures and risk management processes that leading companies deploy now, most will review investment decisions at key milestones. They will ask:‘ To what extent have we achieved the stated objectives of this project; have we met hurdle rates and if not, what has driven variation?’. Good learning organisations use that experience to
MARKET ENTRY PERSPECTIVES
Dr Dan Lovallo( top right) is a senior lecturer in general management at the AGSM. Chris Manning is a principal at Booz • Allen & Hamilton.
18 | AGSM ISSUE 1 • 2001