Common Biases in Decision Making

Knowing and avoiding existing decision-making traps is essential, regardless of the model you use. Daniel Kahnemann (another Nobel Prize winner) and Amos Tversky spent decades studying how people make decisions. They found that individuals are influenced by overconfidence bias, hindsight bias, anchoring bias, framing bias, and escalation of commitment.

Overconfidence bias occurs when individuals overestimate their ability to predict future events. Many people exhibit signs of overconfidence. For example, 82% of the drivers surveyed feel they are in the top 30% of safe drivers, 86% of students at the Harvard Business School say they are better looking than their peers, and doctors consistently overestimate their ability to detect problems (Tilson, 1999). Much like friends who are 100% sure they can pick the winners of this week’s football games despite evidence to the contrary, these individuals are suffering from overconfidence bias. Similarly, in 2008, the French bank Société Générale lost over $7 billion due to the rogue actions of a single trader. Jérôme Kerviel, a junior trader at the bank, had extensive knowledge of the bank’s control mechanisms and exploited this knowledge to circumvent the system. Interestingly, he did not make any money from these transactions, and his sole motive was success. He secretly started making risky moves while hiding the evidence. He generated a significant profit for the company early on and became overly confident in his ability to make even more. In his defense, he could merely say that he got “carried away” (The Rogue Rebuttal, 2008). People who purchase lottery tickets as a means to make money are likely suffering from the overconfidence bias. It is three times more likely for a person driving 10 miles to buy a lottery ticket to be killed in a car accident than to win the jackpot (Orkin, 1991). Further, research shows that overconfidence leads to less successful negotiations (Neale & Bazerman, 1985). To avoid this bias, take the time to stop and ask yourself if you are being realistic in your judgments.

Hindsight bias is the opposite of overconfidence bias, as it occurs when looking backward in time and mistakes seem obvious after they have already occurred. In other words, after a surprising event, many individuals are likely to think they already knew the event would happen. This bias may occur because they are selectively reconstructing the events. Hindsight bias tends to become a problem when judging someone else’s decisions. For example, a company driver hears the engine making unusual sounds before starting the morning routine. Being familiar with this car, the driver may conclude that the probability of a serious problem is small and continues to drive the vehicle. During the day, the car malfunctions and stops miles away from the office. It would be easy to criticize the decision to continue driving the car because, in hindsight, the noises heard in the morning would lead us to believe that the driver should have known something was wrong and taken the car in for service. However, the driver in question may have heard similar sounds before with no consequences, so continuing the routine may have been a reasonable choice given the available information. Therefore, decision-makers must be aware of this bias before judging others’ actions.

Anchoring refers to the tendency for individuals to rely too heavily on a single piece of information. Job seekers often fall into this trap by focusing solely on a desired salary while overlooking other key aspects of the job offer, such as additional benefits, job fit, and working environment. Similarly, but more dramatically, lives were lost in the Great Bear Wilderness Disaster when the coroner, within 5 minutes of arriving at the accident scene, declared all five passengers of a small plane dead, which halted the search effort for potential survivors. The next day, two survivors who had been declared dead walked out of the forest. How could a mistake like this have been made? One theory is that decision biases played a significant role in this grave error, and anchoring on the fact that flames had consumed the plane led the coroner to call off the search for any possible survivors (Becker, 2007).

Framing bias is another concern for decision makers. Framing bias refers to the tendency of decision makers to be influenced by how a situation or problem is presented. For example, when purchasing, customers find it easier to let go of a discount than accept a surcharge, even though they might cost the person the same amount of money. Similarly, customers tend to prefer a statement such as “85% lean beef” over “15% fat” (Li, Sun, & Wang, 2007). It is essential to be aware of this tendency because, depending on how a problem is presented, we might choose a disadvantageous alternative simply because of how it is framed.

Escalation of commitment occurs when individuals continue on a failing course of action after information reveals it may be a poor path to follow. It is sometimes called the “sunk costs fallacy” because continuation is often based on the idea that one has already invested in the course of action. For example, imagine a person who purchases a used car that requires repairs every few weeks. An effective way to deal with this situation might be to sell the vehicle without incurring further losses, donate the car, or use it until it becomes unusable. However, many people would spend hours of their time and hundreds, if not thousands, of dollars repairing the car in the hopes of recovering their initial investment. Thus, rather than cutting their losses, they waste time and energy while trying to justify their purchase of the car.

A classic example of escalation of commitment from the corporate world is Motorola Inc.’s Iridium project. In the 1980s, global phone coverage was limited. For example, dealing with a chain of telephone operators in several countries could take hours to get a call from Cleveland to Calcutta. There was a genuine need within the business community to enhance global phone access. Motorola envisioned solving this problem by using 66 low-orbiting satellites, enabling users to make direct calls to any location worldwide. At the time of idea development, the project was technologically advanced, sophisticated, and financially viable. Motorola spun off Iridium as a separate company in 1991. It took researchers 15 years to develop the product from idea to market release. However, in the 1990s, the landscape for cell phone technology was dramatically different from that in the 1980s, and the widespread cell phone coverage worldwide eliminated most of the projected customer base for Iridium. Had they been paying attention to these developments, the decision makers could have abandoned the project in the early 1990s. Instead, they released the Iridium phone to the market in 1998. The phone cost $3,000, which was the size of a brick. Moreover, using the phone to move cars or inside buildings was impossible. Not surprisingly, the launch failed, and Iridium filed for bankruptcy in 1999 (Finkelstein & Sanford, 2000). In the end, the company was purchased for $25 million by a group of investors (whereas it cost the company $5 billion to develop its product), scaled down its operations, and modified it for use by the Department of Defense to connect soldiers in remote areas not served by land lines or cell phones.

Why does escalation of commitment occur? There may be many reasons, but two are particularly important. First, decision makers may not want to admit that they were wrong. This may be due to personal pride or fear of the consequences of such an admission. Second, decision-makers may incorrectly believe that spending more time and energy will help them recover their losses. Effective decision-makers avoid the escalation of commitment by distinguishing between when persistence may pay off and when it might lead to escalation of commitment. You might consider having strict turning back points to prevent the escalation of commitment. For example, you might determine up front that you will not spend more than $500 trying to repair the car and will sell it when you reach that point. You may also consider assigning separate decision-makers for the initial buying and subsequent selling decisions. Periodic evaluations of an initially sound decision to determine whether it remains sensible are another way to prevent the escalation of commitment. This type of review becomes particularly important in projects such as the Iridium phone, where the initial decision is not immediately implemented but requires a lengthy development process. In such cases, it is essential to periodically reassess the soundness of the initial decision in light of changing market conditions. Finally, creating an organizational climate in which individuals do not fear admitting that their initial decision no longer makes economic sense would go a long way in preventing the escalation of commitment, as it could lower the regret the decision maker may experience (Wong & Kwong, 2007).

So far, we have focused on how individuals make decisions and how to avoid decision traps. Next, we will shift our focus to the group level, examining the similarities and differences between individual and group decision-making. Many factors influence group dynamics and also impact the group decision-making process.