Article Summary:
What leaders need to know about risk and cognitive biases. Assessing and managing risk is hard enough on its own for leaders, but it’s made even more difficult by cognitive biases. Examples of several cognitive biases and how they can challenge leaders and organizations, plus two techniques for addressing them.
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When it comes to risk-taking and risk mitigation, leaders need to be aware of the dangers of cognitive biases on decision-making.
Esteemed psychologist Daniel Kahneman and his long-time collaborator, Amos Tversky, highlight that humans often have what they call “severe and systematic errors” in their thinking due to the inherent workings of their brains. These cognitive biases are flaws in thinking that can impair decision-making.
Think about civic leaders who underestimate the likelihood or severity of natural disasters, resulting in inadequate response plans. Without a clear and accurate sense of the risks, they may not allocate sufficient resources, conduct effective training, or communicate with the community properly, putting lives at risk.
Consider Mt. Everest climbing expeditions in which leaders underestimate the hazards of the ascent. Even seasoned climbers might convince themselves they can reach the summit despite ominous and worsening weather conditions. They push forward despite clear signs of danger, putting everyone in jeopardy.
“Unfortunately, the sort of individual who is programmed to ignore personal distress and keep pushing for the top is frequently programmed to disregard signs of grave and imminent danger as well. This forms the nub of a dilemma that every Everest climber eventually comes up against: in order to succeed you must be exceedingly driven, but if you’re too driven you’re likely to die. Above 26,000 feet, moreover, the line between appropriate zeal and reckless summit fever becomes grievously thin.
Thus the slopes of Everest are littered with corpses.”
-Jon Krakauer, Into Thin Air
Below, we examine eight common cognitive biases—including confirmation bias, groupthink, the planning fallacy, and overconfidence bias—and how they can degrade leaders’ ability to assess and manage risk.
1. Confirmation Bias
When you’re suffering from confirmation bias, you tend to favor information that confirms your pre-existing beliefs and to ignore information that contradicts them. It’s a double-whammy with major downsides.
Example: While planning a new highway, a transportation agency focuses on reports highlighting the benefits of the project, especially economic growth. Meanwhile, they downplay research pointing to potential traffic congestion and environmental damage. Ultimately, the project attracts major public opposition, causing headaches, delays, and unanticipated expenses for the agency.
“Confirmation bias is probably the single biggest problem in business, because even the most sophisticated people get it wrong. People go out and they’re collecting the data, and they don’t realize they’re cooking the books.”
-Dan Lovallo, decision-making researcher and professor
2. Overconfidence Bias
You suffer from overconfidence bias when your belief in your own knowledge or abilities surpasses your actual skill level.
“There’s no chance that the iPhone is going to get any significant market share. No chance.”
-Steve Ballmer, then-CEO of Microsoft
Example: When expanding into a new country, a large consumer goods company underestimates the complexity of the competitive dynamics, cultural differences, and local regulations Their faith in their brand strength and business processes causes them to overlook those critical factors, resulting in cultural missteps and poor market reception.
Overconfidence bias is a big problem for company founders. According to researchers, overconfident entrepreneurs tend to: introduce riskier products with lower success rates, ignore competitors and their strengths, under-resource their ventures, and rely less on external networks for needed resources. All of these, of course, are important for firm survival. (1)
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3. Planning Fallacy
You’re suffering from the planning fallacy when you’re underestimating the time, costs, and/or risks of future actions and overestimating their benefits. It’s why so many projections badly miss their mark.
Example: A small business owner has a nagging feeling about a new business opportunity that a colleague brought him. Though it pays well, the work is out of his usual scope and will require a big lift in terms of research, planning, and delivery. Since the project is so specialized, it won’t have spillover benefits on other accounts. But the money is enticing, especially since revenues are unpredictable in the business. The project ends up taking twice as long as expected and requires extra support from three outside contractors. In the end, he regrets taking the project due to all the added hassles.
4. Groupthink
According to Yale research psychologist Irving Janis, groupthink occurs when people “are deeply involved in a cohesive in-group” and their “strivings for unanimity override their motivation to realistically appraise alternative courses of action.” People stifle their own beliefs in order to maintain harmony in the group.
Example: In a company operating senior living centers, executives downplay concerns about staff shortages and inadequate care as they focus on revenue growth. As they focus on cost-cutting measures and decide to limit hiring without critically evaluating the cascading impacts on resident care, they’re setting the stage for problems down the road. The desire to achieve milestones quickly and maintain team harmony leads them to neglect important conversations and alternative viewpoints. Ultimately, they’re inviting health problems among residents and risking damage to the company’s reputation.
5. Illusion of Control
The illusion of control is a problem for you if you’re overestimating your ability to control events.
Example: A global company hungry for faster growth initiates a big and complex merger. They’re confident that their meticulous planning will ensure smooth integration of the firms. They soon discover, though, that they’ve underestimated the prevalence and impact of cultural clashes, integration challenges, and unforeseen financial issues. As a result, they’re left with significant service disruptions and worker dissatisfaction.
6. Loss Aversion
Loss aversion is the human tendency to prefer avoiding losses rather than acquiring equivalent gains. In a nutshell, the psychological pain of losing something eclipses the pleasure of gaining something of equal value. Loss aversion can result in overly conservative choices and a persistent reluctance to pursue new ventures or bold innovations.
Example: In a nonprofit organization serving disadvantaged youth, the senior management team avoids shutting down an underperforming summer camp program because they worry about backlash from funders and volunteers who value tradition. As a result, they’re missing the opportunity to implement more effective initiatives like financial literacy and entrepreneurship programs that respond creatively to the evolving needs and interests of the people they serve.
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7. Selective Recall
You’re suffering from selective recall when you more accurately remember things that align with your interests, values, and beliefs than those that go against them.
Example: If a therapist has had great results with cognitive-behavioral therapy, she may become overly reliant on using it, overlooking cases in which clients might need different interventions.
8. WYSIATI
In his book, Thinking, Fast and Slow, Daniel Kahneman talked about “WYSIATI”: “What You See Is All There Is.” It happens when you make decisions based on the information that’s have readily available to you, neglecting other relevant data or possibilities. Essentially, you’re failing to account for the possibility that there’s missing information that might be important in the situation.
Example: As a company is considering entering a new geographic market, the management team commissions market research that projects strong expected consumer demand. Unfortunately, the research didn’t account for emerging local competitors and changing local regulations. The firm ends up saddled with regulatory compliance issues and a market environment more contested than expected, jeopardizing their expansion efforts.
Ways to Mitigate Cognitive Biases When Taking Risks
Clearly, there are many ways that cognitive biases can cause problems for leaders when it comes to taking and managing risks. Fortunately, there are things you can do to address them. Here are two of my favorites:
“Pre-Mortem”
You may have heard about a “post-mortem” exercise: it’s a process conducted after a project concludes (particularly if it fails), aimed at analyzing what went wrong and extracting lessons for future initiatives. The term comes from the medical field and refers to autopsies to determine causes of death. The idea is to foster greater understanding and continuous improvement. It’s akin to what military units call an “after-action review.”
In a “pre-mortem,” by contrast, a team imagines at the outset of a project that the initiative has failed. It then works backward to determine what could lead to the failure.
Example: The senior management team at a medical device company is considering offering services related to their devices for the first time, including patient engagement programs as well as consulting, training, maintenance, and data analytics services for hospitals and clinics. As they gather to envision the project’s hypothetical collapse a year after launch, they brainstorm possible reasons for failure, such as:
- their marketing strategies didn’t resonate with healthcare providers regarding the new services, leading to low adoption rates
- they didn’t hire enough trained nurses and technicians to deliver these services, resulting in poor service quality and long wait times for patients
- their business model didn’t generate enough cash to support ongoing service operations
- the sales team lacked the necessary skills to communicate the value proposition of the new services effectively, leading to client dissatisfaction and loss of trust
- the transition created internal resistance, with workers unsure of how to adapt to the new business model, resulting in greater staff attrition
By identifying these challenges, the team can develop targeted strategies to mitigate the major risks. This proactive approach can significantly boost the odds of a successful launch.
Leadership Derailers Assessment
Take this assessment to identify what’s inhibiting your leadership effectiveness. It will help you develop self-awareness and identify ways to improve your leadership.
“Kill-Thrill”
In their book, Business Model Generation, Alexander Osterwalder and Yves Pigneur popularized a powerful innovation method called the “kill-thrill” exercise. Here’s how it works:
- In a team meeting (ideally with people from different backgrounds and functional areas), one person shares an idea for a new product, service, or venture.
- Then the group moves into “kill” mode by brainstorming all the possible flaws or challenges with the idea and the reasons why it might not work. Here, it’s important to go for quantity (e.g., at least 50 flaws or concerns) and not analyze them at this point.
- Next, the team moves into “thrill” mode by generating ideas for how to salvage the idea, addressing the problems raised earlier. Essentially, they see if they can bring it back from the dead. (2)
Conclusion
When it comes to taking and managing risks, cognitive biases are an underappreciated part of the story. Leaders are wise to make sure their colleagues are aware of them and equipped with effective tools to address them.
Tools for You
- Leadership Derailers Assessment to help you identify what’s inhibiting your leadership effectiveness
- Personal Values Exercise to help you determine and clarify what’s most important to you
- Alignment Scorecard to help you assess your organization’s level of alignment
Related Articles & Resources
- “A Painful Leadership Lesson in Managing Risk”
- “How Leaders Today Should Approach Risk”
- Daniel Kahneman, Thinking, Fast and Slow
- Alexander Osterwalder and Yves Pigneur, Business Model Generation
(1) According to researchers, “overconfidence increases the risk of non-survival among entrepreneurial firms: entrepreneurs clearly overestimate their accuracy and control of situations, and underestimate risks.” Source: Simon, M., Houghton, S. M., & Aquino, K. (2000). Cognitive biases, risk perception, and venture formation: How individuals decide to start companies. Journal of Business Venturing, 14(5), 113–134.
(2) Merck has used a version of this kill-thrill exercise for a long time. Note also note the technique of “creative abrasion,” in which teams question each other and try to destroy each other’s ideas but must then articulate the other side of the argument. Such intellectual duels can sharpen thinking and lead to innovation. Bob Taylor used this technique successfully at Xerox’s Palo Alto Research Center (PARC) in the development of the ARPAnet, the network that became the basis for the Internet. Source: Walter Isaacson, The Innovators: How a Group of Hackers, Geniuses, and Geeks Created the Digital Revolution (Simon & Schuster, 2014).
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Gregg Vanourek is a writer, teacher, and TEDx speaker on personal development and leadership. He is co-author of three books, including Triple Crown Leadership: Building Excellent, Ethical, and Enduring Organizations (a winner of the International Book Awards, written with his father, Bob Vanourek) and LIFE Entrepreneurs (a manifesto for living with purpose and passion). Check out their Leadership Derailers Assessment or get their monthly newsletter. If you found value in this, please forward it to a friend. Every little bit helps!
