Are We Rational Decision-Makers, Indeed?
Do we really make rational business decisions?
Usually, the business decision-making process is analytical and rational and includes extensive
information-gathering and detailed analyses.
Therefore, it portrays the decision-maker as "homo economics," capable of rational decisions and driven by ambition to obtain the highest possible outcome for predetermined goals.
Is it really so?
The Paradox of Rationality
We have already touched upon the theory of bounded rationality by Herbert A. Simon.
Classical economics is based on two cornerstone assumptions:
- the economic actor has a particular goal, e.g., profit or asset utilization;
- the economic actor is substantively rational.
Such considerations narrow economic analysis tools to mathematics only, as any rational activity can be explained by numbers.
Simon added psychology to the equation and introduced the notion of "bounded rationality," which results in seemingly irrational choice outcomes by individuals due to
- their limited information processing capacity,
- competence gaps,
- the counter-intuitive nature of probabilistic processes.
Simon also assumed that rationality depends on the process that generated it.
Thus, he defined "procedural rationality" as the process of searching for efficient procedures to find reasonable solutions, not searching for answers themselves.
The model of predictable behavior in decision-making
The research by Simon has been summarized by Ronald A. Heiner, who developed a model of predictable behavior.
According to this model, economic agents often must make decisions in complex environments in which the difficulty of the problem and complexity of the available information exceeds their abilities to process this information correctly and to react to it "optimally."
Then, the economic agent becomes increasingly reluctant to react to new information and leans toward a rule-governed behavior that the agent could easily handle.
The benefits of procedural rationality
Procedural rationality could still be perceived as the brighter side of rationality. The thorough evaluation of information gathered on individual suppliers, particularly on overall supply and demand market developments, helps form a comprehensive view of the decision context.
Therefore, procedural rationality is more likely to prevent the counter-productive reactions and cognitive biases that can lead to selecting an underperforming supplier.
Experience and emotions in decision-making
Two more elements of the decision-making process are experience and emotions.
Since the 1960s, researchers have been examining "emotional buying in industrial markets," "industrial source loyalty," and "stereotype perceptions."
Let's see what drives us to employ stereotypes and gut feelings while making business-critical decisions (e.g., supplier selection and not only those.)
The increasing dynamism and complexity in selecting the most efficient business scenario can lead to limitations in analytical processing, including gathering, assessing, and interpreting relevant facts.
Specifically, experience-based and emotional processing is frequently used in environments with high degrees of uncertainty.
Managers must deal with increasingly disruptive megatrends, e.g., pandemics, technological change, global supply disruption risks, etc. Further, they need to consider multiple criteria when making a selection decision.
When confronted with complex, risky, and volatile situations in their judgment, managers face new problems for which stored patterns from experience might not be readily available or fitting.
Therefore, a predominant reliance on gut feelings might appear and lead to decision-making biases and poor choices.
Decision readiness
Before discussing the nature and effects of decision biases, we need to introduce the notion of decision readiness, which is the general capacity of a person to make sound judgments and choices.
Intense emotional states, fatigue, and poor decision-related skills (e.g., being innumerate) can all contribute to a lack of decision readiness.
You might've noticed how often people tend to make decisions not being ready or fit for that.
The definition and taxonomy of decision biases
Assuming the decision-maker is ready, they are still subjected to biases - systemic deviations from normative standards.
Researchers classified 76 (!!!) types of decision biases that can be grouped as follows:
- An availability cognition bias occurs when a decision-maker judges information more easily remembered as probable.
- A base rate bias assumes the selective use of unreliable base data and omits more relevant additional data.
- A commitment bias tends to follow or escalate a previous, unsatisfactory course of action.
- A confirmatory bias is a tendency to search for or interpret information to confirm the decision-maker's preconceptions.
- A control illusion bias occurs when a sequence of random events or non-representative samples can be mistaken as an essential characteristic of a process, leading to unrealistic confidence in judgment.
- An output evaluation bias occurs when failure is associated with bad luck and success with the decision-maker's abilities.
- A persistence bias assumes that an alternative is chosen simply because it has been selected in the past.
- Presentation bias occurs when data is presented in a way customized to fit the presenter's opinion. This leads to the omission of critical facts and misrepresentation of the subject's actual state.
- A reference point bias occurs when the comparison value or a reference point is biased to fit a specific judgment.
This is how the biases can be mapped to the decision-making processes.
Debiasing decision-making
Fast and slow thinking: System 1 and System 2
In 1982, Fischhoff suggested that standard debiasing techniques - alerting about the possible bias and pointing at its occurrence, providing feedback, and training on objective judgment - hardly yield any results.
Therefore, scientists researched our cognitive processes further and assumed that our mind employs two distinct sets of functions.
One set is fast, effortless, and mostly unconscious. Another one is slow, laborious, conscious, and sequential. These sets of processes have been called System 1 and System 2.
System 1 is our autopilot, responsible for immediate decisions and ensuring our survival. Despite its immense importance, System 1 is the source of biases due to over-reliance on intuitive reactions.
The primary function of System 2 is to control System 1, rectify its mistakes, and implement corrective actions.
The rather obvious debiasing technique trains System 1 to generate better intuitions, i.e., quickly assess situations and develop correct responses based on expertise.
Secondly, people can be taught normative standards based on natural sciences, so System 2 will more likely generate a good response.
Thirdly, System 1's monitoring can be improved, either by sharpening System 2's oversight function or through environmental modifications that help provide oversight.
Procedural rationality as a debiasing technique
To summarize all of the above, managers should realize these biases:
- may result from limited decision readiness;
- are cognitive processes to which decision-makers are vulnerable when they attempt to cope with uncertainty in decision-making;
- can occur inside and outside of their organization;
- usually have negative consequences on decision-making effectiveness (i.e., incorrect or distorted decisions) and positive effects on decision-making efficiency (i.e., savings of time and effort in decision-making).
The application of debiasing techniques is an area that still requires extensive research by cognitive scientists.
Some of those techniques are readily available, e.g., procedural rationality. The well-designed, live-tested, and continuously improved decision-making process could mitigate the effect of cognitive biases.
Another solution could involve cross-functional teams, as diverse views and interests may compensate for individual biases.
The return of rational decision-making
Ideally, as some behavioral economics studies suggest, rationality could return as the organizational decision-making basis by the combination of three methods:
- Coventionalizing, i.e., teaching and embracing it as a part of the corporate culture.
- Commodifying, i.e., studying it from academics or buying it from consultants.
- Engineering, i.e., using it as a tool.
Perhaps the first step to debiasing would be acknowledging and being aware of the decision-maker's possible suboptimal behavior. Sometimes, even this is one giant leap.
More information on this and other exciting topics can be found in "The Technology Procurement Handbook." It represents 23 years of experience, billions of dollars worth of successful sourcing projects, and 1000s of hours spent on research, analysis, and content creation for the most demanding professional readers.
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