Making Big Decisions: Don’t Let Your Brain Be The Flaw In The Thinking - Part I

Author: Christian Bamber
Posted: Monday 19th September, 2011. 10:27:22

Having worked at Board level for a number of years I’ve seen some really good decisions made and inevitably I’ve seen some really terrible decisions made which have had considerable consequences for the organisation.

Anyone in a position of responsibility naturally hopes to make the best decision they can in the light of the available information, yet there are times when we may all have been at least partly responsible for decisions resulting in a less than optimal outcome!

But why do we still struggle to make the right strategic decisions when for decades the theory of business strategy has been so well developed by the likes of Porter, Mintzberg and Drucker to name just a few? Of course, poor analysis, greed, excessive ambition and other corporate evils are sometimes to blame. However, this article doesn’t aim to examine these but rather to summarise a past McKinsey Quarterly article (Roxburgh, 2003) on the subject of behavioural economics, more precisely the role our brains play in each and every decision we make.

Although a bafflingly incredible organ, the brain is certainly not the rational calculating machine we sometimes expect. Through evolution, it has developed a series of shortcuts, simplifications and biases that we could call bad habits. In addition, some bad habits will have resulted from the shorter timeframes of social factors and the influences of those around us.

The upshot is that social scientists and behavioural economists have managed to explain some of the bad decision-making that has taken place in history and linked them to one of a number of brain-related flaws.

Interestingly, the original article by McKinsey was written in May 2003 and cited several examples of bad decisions made in the late 1990s eventually leading to the dot-com collapse. The author, Charles Roxburgh, also had the following to say:

“…don’t make the mistake of thinking that [the 1990s] was an era of unrepeatable strategic madness. Behavioural economics tells us that the mistakes made in the late 1990s were exactly the sorts of errors our brains are programmed to make – and will probably make again.”

…and again, and again…

Let’s look at the eight flaws Roxburgh highlighted in more detail:

Flaw 1: Overconfidence

Our brains are programmed to make us feel overconfident. This is not always a bad thing since we need this confidence to embark on certain life-changing ventures such as, for example, starting up a new business or emigrating abroad to live and work.

But it’s not always a good thing: the brain is particularly overconfident of its ability to make accurate estimates. Behavioural economists have illustrated this point with simple quizzes such as “how long is the river Amazon?” Participants only need to answer with a range, not a precise figure, which they feel 90% confident in.

Instead of giving a safe, wide ranging estimate such as “between 2,000 and 10,000km long”, participants time and again choose a much narrower range such as between “9,000 and 10,000km”, and get it wrong (the answer being roughly 6,500km).

The reason? Because most of us are unwilling to reveal our ignorance by specifying a wide range: we prefer being precisely wrong than being vaguely right!

Similar to overconfidence is the problem of over-optimism. Our forecasts generally tend towards the rosier end of the spectrum and, coupled with overconfidence, we give unrealistically precise and over-optimistic estimates of uncertainties.

However, there are ways of trying to counter these problems:

• Test strategies under a much wider range of scenarios including more pessimistic outcomes. For example, what happens if my client base drops by 25% overnight?
• After you’ve done the above, add 20% to 25% more downside to the most pessimistic scenario as the risk of getting pessimistic scenarios wrong is greater than that of getting the upside wrong. For example, what happens if my client base drops by (25%+25% = ) 50% over night?
• Build more flexibility and options into your strategy to allow the organisation to scale up or cut back as uncertainties unfold. For example, have a pre-formulated strategic plan that is triggered when the client base drops by, say, 3%, and another plan that is triggered if the drop isn’t halted and hits 5% and so on.
• Be sceptical of strategies based on certainty. For example, don’t assume the dog and cat population will always be at the ratio it is at now, or that the population of dogs will always be the size it is now. What if the population drops by 10% due to some outbreak of a particularly virulent virus? Fanciful, maybe, but you can bet your bottom dollar that the most forward-thinking pharmaceutical companies have factored this in to their strategic plans so why aren’t we?

Flaw 2: Mental Accounting

The behavioural economist Richard Thaler coined the term “mental accounting” and defined it as “the inclination to treat money differently depending on where it comes from, where it is kept, and how it is spent.”

For example, gamblers who lose all of their winnings often feel that they haven’t really lost anything as they didn’t have this money before, even though clearly they would have been richer if they had quit whilst they were ahead.

Mental accounting has permeated the boardrooms of even the most conservative organisations. One classic manifestation of this is being less concerned with the value of money when it is from a separate category of spending even within the same budget. For example, “innovation spend” versus “consumables spend” where the former is spent freely and the latter is scrutinised more closely.

Another example is imposing “cost caps” on the core business whilst a new venture has an uncapped and ever-increasing budget. Perhaps you are closely monitoring the running costs of your practice and running a very tight ship, yet the new branch practice you are building seems to have a “flexible”, ever-increasing budget.

These are all examples of real cost but are treated differently due to the way they are categorised.

The solution is to adhere to this basic rule: every pound is worth exactly one pound, whatever category of spend it is in.

Flaw 3: The status quo bias

A classic experiment involved students being asked how they would invest a hypothetical inheritance. The inheritance came in the form of several million dollars of low-risk, low-return bonds for half of the students, and several million dollars in high-risk, high-return securities for the remaining half of the students. Both groups left most of their money alone.

It was the initial allocation of the inheritance that determined what the students did with the money, not their attitude towards risk. One explanation for the “status quo bias” is an aversion to loss. We are more concerned about the risk of loss than we are excited by the chance of gain. The rational choice, of course, would have been to re-balance the portfolios.

Another example concerning Cornell students involved selling university-branded coffee mugs. If given a mug, the student would not sell it for less than $5.25 on average, whereas a student without a mug wouldn’t buy one for more than $2.75. The difference in price implies a value of $2.50 just from owning the mug.

The status quo bias and aversion to loss have been shown to be causative factors in poor strategic decisions. It makes decision-makers reluctant to sell businesses and yet such divestments are a major source of value creation. I’ve certainly witnessed a number of situations where selling off part of a business or even closing down a failing aspect of one would have created far more value in the long run but for the irrational reluctance of key decision makers to “let go”.

And what about shifting the allocation of resources to a new and potentially lucrative service offering but for it to meet resistance because “we’ve always done it like this”?

I suspect for smaller businesses and practices there are emotional reasons for not wanting, for example, to sell off part of a business you have created over many decades to the next corporate group that comes along. However, to achieve the maximum value from what you do, you may wish to follow these two rules:

• View all businesses as “up for sale” – view divestment not as a failure but as a healthy renewal of your overall portfolio.
• Subject any status quo options to a thorough risk analysis focussing on both the risk of new strategies and the risk of failing to change.

Flaw 4: Anchoring

One of the most curious wiring flaws in the brain is known as anchoring. Present a number to the brain and then ask it to estimate a value of something totally unrelated and it will anchor its estimate on the original number.

Roxburgh illustrates this point with the Genghis Kahn date test. Ask a group of people to write down the last three digits of their phone numbers and then ask them to estimate the date of Genghis Kahn’s death. The results always show a correlation between the two sets of numbers; people assume that he lived in the first millennium (i.e. a 3-figure date) whereas he actually lived from1162 to 1227.

Anchoring can be a handy tool for strategists and decision-makers alike. For example, in negotiating the sale price of a business, starting with a high sale price will often result in a good outcome for the seller as the buyer’s offer will be anchored around the original figure.

However, anchoring can be dangerous, particularly when one becomes anchored to the past. Our recent banking crisis no doubt had anchoring amongst its long list of flaws and mistakes. Similarly, anyone looking at trends should take a long historical perspective, not just the last two or three years.

There are many practical uses for counter-anchoring not least when it comes to annual budgeting. It’s easy to create the next annual budget by assuming similar figures to the previous year and maybe adding or deducting a bit more. But don’t become anchored to those figures without thinking about any impending external or internal factors that may affect the year’s outcome, and looking at historical trends may reveal something you hadn’t considered.

In summary, breaking away from anchoring can prevent catastrophic decisions being made in addition to being used to one’s advantage in the right situation.


At this point, I find myself guilty of flaw 1: overconfidence. That’s because I thought I could squeeze an illustration of all eight flaws into this week’s article. If I had taken Roxburgh’s advice, I would have been more pessimistic about what I could achieve and then added another 25% to that and realised that four flaws were the maximum I could cover.

But then being too pessimistic makes the world a dull place since now you have flaws 5 to 8 to look forward to next week!

Click here to read part II


Roxburgh, C. (2003) Hidden flaws in strategy. McKinsey Quarterly, May.

Christian Bamber is Principal Consultant and Director of Approach Strategy, a consulting firm specialising in strategy services to service industries and not-for-profit organisations. For more information, please contact Approach Strategy at christian@approachstrategy.co.uk. Tel: 01225 722 654 or visit their website www.approachstrategy.co.uk

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