This article appeared in September 2020 in Wall-Street.ro (Romanian version).
Man is a rational animal. That’s what Aristotle says, so it must be true. And, taking the “manager” as the archetype of the modern man, we get to the classical economics paradigm of the manager who only decides analytically, who considers all available information, who brilliantly ignores his instinct, and who is driven exclusively by profit maximization.
Should we open a new store in Piteşti? We do a SWOT and we find out. Should we hire a sales manager who has worked for a competitor? We do a pros and cons analysis. Should we continue, where possible, with working from home, after the pandemic is over? We open an excel and do a cost-benefit analysis. Should we continue with the old marketing plan or make a new one? A decision tree. How do we choose a supplier in a new market? Obviously, a weighted criteria matrix.
However, in reality, managers don’t make decisions like that. In any case, not entirely. We prefer to do business with partners we know, not with anyone who offers a better price. We follow our instinct and intuition, especially in uncertain situations. If we have too many options, we get stuck, through a counter-intuitive mechanism discovered by the psychologist Barry Schwartz, the paradox of choice. Also, the plans and the budgets already approved are very difficult to change.
When I deliver Critical Thinking or Decision-Making workshops for managers, I start by asking them to what extent they use their reason when making important business or career decisions. (By the way, how do you make decisions? How many of them are based on reason and analysis?). Most of the respondents identify themselves with the image of the rational manager described above and answer “between 70-90 percent”.
Then I ask them to give me an example of important decisions in their lives and to describe the decision-making process. One question, for example, is how they chose the company they work for. After a few very interesting answers, we realize that we often build our destiny based on how much we like the style of a building or the good coffee in the office where a friend works. Thus, I sometimes succeed to lower the way participants estimate their own rationality. Why am I doing this? Because when we think we are predominantly rational, we can no longer improve the way we think and decide. How (and why) should we improve something that already works great? That is why I dedicate the first class to dismantling the myth that we predominantly make rational choices.
This difference between the rational way in which classical economics says that we can and should decide and the way in which people decide in real life gave rise in the 1970s to a new science, behavioral economics, which studies how people actually decide and maps from a rather psychological perspective the influence of the irrational in our lives.
The champions of this field, Amos Tverski, Daniel Kahneman, Dan Ariely, Richard Thaler, have shown that, far from being rational, we are systematically influenced by irrational mechanisms. They have identified a series of behavioral traps (cognitive biases) that make us act irrationally. For example, the sunk cost trap makes us unable to close a project that turns out to be unprofitable, but in which we invested a lot of time, effort, money, or other resources. I am sure that each of us has at least one such project. Which one is yours? Loss aversion makes us care much more about a loss than about a gain of the same value. If we have our salary increased by 100 euros, the joy is much less than the annoyance in case our salary decreases by the same amount, 100 euros. We want more of what is in short supply: the scarcity effect. The platforms through which we book hotels or plane tickets know this all too well when they show us only two seats left at the current price.
The Robin Hood aura of this new science which challenges the rigid truths of classical economics has made it very popular. Its popularity was also heightened by the writing talent of its promoters (some best-sellers: Thinking Fast and Slow by Kahneman, Nudge and Misbehaving by Thaler and Predictably Irrational by Ariely), and by two Nobel prizes (Kahneman, 2002, Thaler, 2017).
This new paradigm, according to which our behavior is often instinctively subjected to irrational unconscious forces which we cannot control and which lead to wrong decisions has built a significant followership. I recognize lecture participants who have read about cognitive biases. They answer that their decisions are only 10-20% rational. By asking this question I get samples which, generalized, show that, at least in the population of managers, some consider themselves 80% rational and the others 20% rational.
Doesn’t that sound a little weird? This distribution is not normal at all. Where is the middle? As you probably guessed from my tone, I choose in this article the philosophical triad: thesis – antithesis – synthesis. The thesis would be that man is, or at least can and should be, rather rational. Which, in business, translates into the classical economics paradigm whose superhero is the perfectly rational economic agent. The antithesis is that we often make the wrong decision because of irrational mechanisms. Which, in business, translates into the paradigm of behavioral economics whose protagonist is the manager subject to cognitive biases.
What’s the synthesis, then? To use both reason and instinct. Recent research on the dual way our minds work shows that, in fact, type I processing (fast and reflex), and type II processing (slow and analytical), cooperate successfully in all our decisions. An example of how we can put this in practice would be the combination of managerial intuition with rational algorithms.
Although it’s still considered a kind of voodoo (I’m curious what CEO would admit in front of the shareholders or the organization that s/he decided on a major project based on intuition), a lot of studies have confirmed the accuracy of managerial intuition, especially in areas in which decision-makers are experienced and in complex situations for which there are no clear and measurable solutions (for example decisions concerning team members, M&A decisions, or problems arising in the context of uncertainty or crisis). It is good to listen to our intuition and even to encourage our team members to develop it.
But, for strategic decisions, we must always run a parallel rational mechanism to guide our decision-making. A practical way to combine reason and intuition would be, when we have to choose between several options (projects, suppliers, scaling methods), to establish clear criteria based on which to decide, to give each one a different weight and then to add an additional criterion, intuition, with a greater or lesser weight, depending on how much we trust it. Another one would be to use analysis and hard criteria for selecting a shortlist of two or three final options and then use our intuition to pinpoint the winning strategy.
In short, we should be aware of and accept our instinct, but then to incorporate it into a rational analysis. And one last thing: managerial intuition is a useful tool, but I’m not sure that the procurement department agrees on that, so it is not mandatory to keep this criterion in your excel once you have made your decision.
Radu Atanasiu teaches Thinking and Deciding in Business at Bucharest International School of Management (BISM, former MSM Romania) and Critical Thinking at The Entrepreneurship Academy, is a business angel and founded the volunteering platform DeBunavoie.ro.
BISM opened the registrations for the 12th Executive MBA generation (one and a half years, starting in November 2021) and for the 14th Fast Track generation (short program – 4 months, in Romanian, starting in September ir 2021). More details on bism.ro.