Entrepreneurship may be a highly risky endeavor, which requires not only the knowledge of business processes and market players but also the ability to make balanced choices. The latter, however, may be quite complex due to various biases and pitfalls awaiting senior managers and business owners daily. The present study focuses on identifying the most common errors in business decision-making based on the four cases of questionable managerial choices and elaborating ways to avoid them in the future as well as discussing the most serious type of biases.
Case Number One: the Investment in Marketing
The first case represents a clear example of an anchoring bias. According to the research by Hammond, Keeney, and Raiffa (1998, p. 48), when a choice is to be made, a human brain tends to base the decision on the information that was received first. The CFO has relied on the first piece of information she gained about whether or not spending on marketing affects the sales, started acting according to that information without properly examining other sources. Moreover, when confronted with the negative results of her decision, she still refuses to believe that the reason for the poor sales was connected with the idea that she used as a ground for her actions. Such a commitment to a particular theory and the eagerness to defend it against the obvious facts demonstrates a deep anchoring. One of the best ways to avoid it is to review a critical issue from multiple sides weighing and considering all opinions and facts before making a decision. Another possible solution to this problem may be isolating yourself from advice and trying to resolve an issue or make a decision using your knowledge (Hammond et al., 1998, p. 48). Finally, the very awareness of such pitfall’s existence may already make an individual question the information, on which he or she relies when making decisions.
Case Number Two: the Costly Merger
The next situation exhibits clear signs of an overconfidence bias. As suggested by Lombardo (2014), overconfidence stands for a state of mind, when a belief in one’s powers exceeds the actual limit of those powers. Despite the logical reasons against the acquisition of a rival company, the CEO decides to do it regardless of the difficulties it may bring. Such behavior may be the result of an excess conviction in the ability to resolve any kind of issues based on either past successes or inner self-trust. The neglect of the reasonable argument, devotion to the ultimate goal, and desire to act despite the highly probable dire consequences speak further for the CEO’s overconfidence issue. Finally, the idea of expansion generally comes to the companies, which have been successfully operating in the market for a certain period, giving yet another reason to believe the case to be connected with overconfidence. Such a dangerous pitfall may be avoided by having a consultant, who can reasonably object to overly confident ideas (Bolland & Fletcher, 2012, p. 54). However, in this particular case, the CEO refuses to listen to viable arguments and desires to act at his own risk. In that situation, the probable solution may involve changing the company’s regulations to organize the process of decision-making in a way that requires important choices to be made based on facts supporting them.
Case Number Three: Factory Purchase
In this case, the CEO made a mistake due to a framing effect. While factory A underlined the positive side of the issue, factory B stressed its drawback, which gave the senior manager a false reason to believe, that the first company is better than the second. According to Kourdi (2011, p. 51), people tend to follow certain paths in assessing particular kinds of information, and reversing such paths could lead to errors in decision-making. Here, the senior manager, who is accustomed to positive ways of describing a product, automatically preferred the one that he deemed best presented without noticing the fact that the numbers speak for factory B. Moreover, the latter may also indicate the presence of the confirmation bias, which is displayed by the fact that the CEO presented the information about the factories quoting the 94% success rate of the first one while omitting the 95% rate of the other. The answer to that could be exercising attention to detail and facts of performance. Additionally, a leader could organize such proposal hearings in the presence of a specialists group that can ascertain all positive and negative sides of a decision better than a single individual, which could lower the chance of a mistake.
Case Number Four: Factory Purchase
The fourth case vividly represents a sunk cost trap – the notion that the resources, which have once been spent, are not relevant anymore but continue to arouse unpleasant feelings in an individual (Hammond et al., 1998, p. 52). The efforts and money that had been invested in the development and advertising of a hybrid car, which, eventually, did not bring profit, made it have a mostly sentimental value other than a material one, which is, in turn, became the reason for continuous support. What is more, the refusal to mark the whole enterprise as a failure even facing the facts of it may indicate the anchoring bias as well, which is similar to case number one. One way of dealing with the problem may involve a conscious effort of admitting a mistake and abandoning a burdening enterprise. Additionally, it may be worth trying not to “cultivate a failure-fearing culture that leads employees to perpetuate their mistakes” (Hammond et al., 1998, p. 52).
Overconfidence – the Scourge of Decision Making
However grave the other traps may seem, the underlying reason for many unsuccessful startups, business agreements, and choices of companies is a wrong assessment of one’s strengths and weaknesses. According to the statistical data provided by Gudmundsson and Lechner (2013, p. 278), around 70–80% of the newly created firms are either close or do not generate the expected profit. Such a state of events can not only severely damage the inflow of new products to the market but also discourage the unfortunate businesspersons to organize firms again. A good example of the harmful effects of overconfidence can be the recent failure of a crowd-funded startup Zano that gathered three and a half million dollars to create a polyfunctional mini-drone but has failed to produce what they promised to their backers.
The examined cases indicate that many poor choices may be avoided, provided the company’s head is aware of possible biases and pitfalls and knows how to tackle them. On the whole, among other things, a successful leader needs to deal with anchoring bias by either having a good consultant or altering the company’s structure, be conscious of framing paying attention to facts, have a will to reconcile himself or herself with sunk costs and, most importantly, be a reasonable person, who is not easily overwhelmed with success.
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Gudmundsson, S. V., & Lechner, C. (2013). Cognitive biases, organization, and entrepreneurial firm survival. European Management Journal, 31(3), 278-294.
Hammond, J. S., Keeney, R. L., & Raiffa, H. (1998). The hidden traps in decision-making. Harvard Business Review, 76(5), 47-58.
Lombardo, J. (2014). Common biases and judgment errors in decision making organizational behavior. Web.
Kourdi, J. (2011). Business solutions: Effective decision making. Singapore: Marshall Cavendish International.