Tag: Anchoring

A Simple Checklist to Improve Decisions

We owe thanks to the publishing industry. Their ability to take a concept and fill an entire category with a shotgun approach is the reason that more people are talking about biases.

Unfortunately, talk alone will not eliminate them but it is possible to take steps to counteract them. Reducing biases can make a huge difference in the quality of any decision and it is easier than you think.

In a recent article for Harvard Business Review, Daniel Kahneman (and others) describe a simple way to detect bias and minimize its effects in the most common type of decisions people make: determining whether to accept, reject, or pass on a recommendation.

The Munger two-step process for making decisions is a more complete framework, but Kahneman's approach is a good way to help reduce biases in our decision-making.

If you're short on time here is a simple checklist that will get you started on the path towards improving your decisions:

Preliminary Questions: Ask yourself

1. Check for Self-interested Biases

  • Is there any reason to suspect the team making the recommendation of errors motivated by self-interest?
  • Review the proposal with extra care, especially for overoptimism.

2. Check for the Affect Heuristic

  • Has the team fallen in love with its proposal?
  • Rigorously apply all the quality controls on the checklist.

3. Check for Groupthink

  • Were there dissenting opinions within the team?
  • Were they explored adequately?
  • Solicit dissenting views, discreetly if necessary.
  • Challenge Questions: Ask the recommenders

4. Check for Saliency Bias

  • Could the diagnosis be overly influenced by an analogy to a memorable success?
  • Ask for more analogies, and rigorously analyze their similarity to the current situation.

5. Check for Confirmation Bias

  • Are credible alternatives included along with the recommendation?
  • Request additional options.

6. Check for Availability Bias

  • If you had to make this decision again in a year’s time, what information would you want, and can you get more of it now?
  • Use checklists of the data needed for each kind of decision.

7. Check for Anchoring Bias

  • Do you know where the numbers came from? Can there be
  • …unsubstantiated numbers?
  • …extrapolation from history?
  • …a motivation to use a certain anchor?
  • Reanchor with figures generated by other models or benchmarks, and request new analysis.

8. Check for Halo Effect

  • Is the team assuming that a person, organization, or approach that is successful in one area will be just as successful in another?
  • Eliminate false inferences, and ask the team to seek additional comparable examples.

9. Check for Sunk-Cost Fallacy, Endowment Effect

  • Are the recommenders overly attached to a history of past decisions?
  • Consider the issue as if you were a new CEO.
  • Evaluation Questions: Ask about the proposal

10. Check for Overconfidence, Planning Fallacy, Optimistic Biases, Competitor Neglect

  • Is the base case overly optimistic?
  • Have the team build a case taking an outside view; use war games.

11. Check for Disaster Neglect

  • Is the worst case bad enough?
  • Have the team conduct a premortem: Imagine that the worst has happened, and develop a story about the causes.

12. Check for Loss Aversion

  • Is the recommending team overly cautious?
  • Realign incentives to share responsibility for the risk or to remove risk.

If you're looking to dramatically improve your decision making here is a great list of books to get started:

Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard H. Thaler and Cass R. Sunstein

Think Twice: Harnessing the Power of Counterintuition by Michael J. Mauboussin

Think Again: Why Good Leaders Make Bad Decisions and How to Keep It from Happening to You by Sydney Finkelstein, Jo Whitehead, and Andrew Campbell

Predictably Irrational: The Hidden Forces That Shape Our Decisions by Dan Ariely

Thinking, Fast and Slow by Daniel Kahneman

Judgment and Managerial Decision Making by Max Bazerman

Dan Ariely: Real Negotiation at the Grand Bazaar

I thought the merchant's use of a calculator was ingenious.

[email protected] Bazaar from mervelous on Vimeo.

Dan Ariely is the best-selling author of The Upside of Irrationality: The Unexpected Benefits of Defying Logic at Work and at Home and Predictably Irrational, Revised and Expanded Edition: The Hidden Forces That Shape Our Decisions.

Human Traits Essential to Capitalism

Yale economist Robert Shiller argues that rising inequality in the US was a major cause of the recent crisis, and little is being done to address it. He recommends reading Adam Smith's Theory of Moral Sentiments, The Passions and The Interests: Political Arguments for Capitalism Before its Triumph, Nudge, Fault Lines: How Hidden Fractures Still Threaten the World Economy, and Winner-Take-All Politics: How Washington Made the Rich Richer and Turned its Back on the Middle Class.

If you did try to summarise it, what would you say you're trying to get at with these book choices?

I think that our economic system reflects our understanding of humankind, and that understanding has been developing, with especial rapidity lately. You have to understand people first before you can understand how to devise an economic system for them. And I think our understanding of people has been accelerating over the last century, or even half-century.

…On The Passions and The Interests: Political Arguments for Capitalism Before its Triumph, by the great Albert O Hirschman.

This is a great book. It traces the history of an idea – an idea that is central to our whole civilisation today. The idea is that human nature is basically unruly and destructive, or has the potential to become so, but that we've designed a society that sets a space for this kind of impulse, where it's acted out in a civilized manner – and that's capitalism. So when we reflect on some of the horrors of capitalism, we have to consider that things could have been much worse if we didn't have this system. Our fights would have been on real battlefields, rather than economic battlefields. That's a theory, that's an idea that really led to the adoption of capitalism, or the free enterprise system, around the world.

…Tell me about Nudge.

We're now coming up to 2008, when Richard Thaler and Cass Sunstein published this book. It looks quite a bit different from the first two in that it reflects much more modern psychology. I admired Adam Smith for his personal observations, but there was no experimentation, there was no real modern psychology in it. What Sunstein and Thaler emphasise is a lot of principles of psychology that can only be understood with regard to actual experiments. So they talk about things like anchoring, availability, representativeness, heuristic optimism, overconfidence, asymmetry of appreciation of gains versus losses, status quo bias, framing, self-control mechanisms – all the things that we've learned about.

We're way ahead of Adam Smith now in our understanding of people, and that suggests a different model for our economy. Nudge doesn't present itself in a grandiose way at all, but it's a very important book. It really is a different model of our economy, and how government should be involved.

What was the ultimate cause of the crisis, in Fault Line's view?

The title of his book is Fault Lines – so it's plural. He notes that it's not one cause; he actually has several different classes of causes.

The first of them is political, and the politics that lead to rising inequality. That's been a trend in recent years in most nations of the world. Inequality has been getting worse, particularly in the US, but also in Europe and Asia and many other places. One thing that this has done is it has encouraged governments, who are aware of the resentment caused by the rising inequality, to try to take some kind of steps to make it more politically acceptable. He gives other examples as well, but historically, that has often taken the form of stimulating credit: instead of fixing the problems of the poor, lending money to them. He has a chapter entitled ‘Let them eat credit’.

Continue Reading.

Scientifically Proven Ways to Increase Tips in the Service Industry

Tipping is a $40 billion dollar industry in the United States. Yet from the traditional economic perspective, which sees us as rational agents operating in our own interest, tipping waiters, barbers, taxi drivers and other service workers is crazy.

Many food servers depend on tips to make their living. Understanding the variables that affect tipping behavior can make a huge difference on income. Of course, a lot of the variables that influence tipping behavior are outside the servers's control. For example, customers tend to leave larger tips when the weather is pleasant, when there is desirable background music, and when the restaurant is elegant or in an urban area. Food quality has a large impact. Research also suggests that tipping behavior is affected by customers’ characteristics, including size of the dining party, amount of alcohol consumed, customers’ gender and ethnic background, and method of payment.

However, research also indicates that servers can control some variables that influence tipping behavior.

If you're a food server try—and if you're a customer watch out for—the following:

Have your restaurant prime the customer with examples of what a tip would be at 20%
This study examined the role of gratuity guidelines on tipping behavior in restaurants. When diners were finished with their meals, they were given checks that either did or did not include calculated examples informing them what various percentages of their bill would amount to. Results indicated that parties who received the gratuity examples left significantly higher tips than did those receiving no examples. These results and their implications are discussed.

Introduce yourself by name
…wait staff who introduced themselves by name received an average tip of $5.44, or 23 percent of the total bill, and those who used no name were tipped on average about $3.49, or 15 percent of the total bill.

Squat when you first get to the table
Walters should squat down next to the table upon their first trip to the station, Lynn recommended, based on his study at an unnamed casual Mexican restaurant in Houston. Those who squatted received an average tip that was 20 percent higher — $6.40 as compared with $5.18 — than those who stood on their initial visit to the station.

Smile
Servers should give their customers a large smile — with mouth open and teeth showing — while they work.

Approach The Table Often
Walt staff should visit their tables more often, Lynn suggested as another technique, based on a study conducted in the 1970s at a Chicago steak house. Those who approached their tables — just to check up on the customers and not to deliver anything — two times or more received average tips that were 15.6 percent of the total bill, while those who approached the table only to deliver something or take something away received tips that were on average 13.8 percent of the total bill.

Touch your customers
He recommend they touch them lightly on their shoulders when delivering the bill or when returning with change or a credit card. His study for the technique was conducted at a Bennigan's in Houston. Those who touched their customers for an average of two to four seconds received an average tip of 18 percent, or $3.20, of the total bill, and those who didn't received a 12-percent average tip, or $2.52.

Give your customers something extra, like a mint
Another controversial technique Lynn recommended is for wait staff to give their customers after-dinner mints, based on his study at a Philadelphia restaurant. Servers who left their customers mints received tips that were on average about 28 percent, or $5.98, of the total bill, and those who left no mints received average tips of 19 percent, or $4.64, of the total bill.

“The technique didn't work at steak houses with a [per-person] check average over $30,” Lynn said. He added that leaving mints for customers at upscale restaurants seems to have no impact on tips. “But at casual restaurants, it does increase tips,” he insisted. “It works because customers got something free, so they want to repay their servers.”

Compliment your customers
The present study examined the role of ingratiation on tipping behavior in restau- rants. In the study, 2 female food servers waited on 94 couples eating dinner, and either complimented or did not compliment the couples on their dinner selections. Results indicated that food servers received significantly higher tips when complimenting their customers than when not complimenting them. These results and their implications are discussed.

Other ideas? Write “thank-you” or simply draw a smily-face on the bill (to create a likeable impression); Print a picture of someone smiling on the bill, or the American Flag (something most people would associate with happiness); Make paying by Visa the default; If you're a guy give the bill to the woman and if you're a woman give the bill a guy; and Tell customers the weather is supposed to be nice tomorrow (take away a subconscious worry).

If you're interested in learning more about gratuity's try reading Keep the Change: A Clueless Tipper's Quest to Become the Guru of the Gratuity. The best book out there on working in a restaurant is Kitchen Confidential.

Sources
– Ingratiation and Gratuity: The Effect of Complimenting Customers on Tipping Behavior in Restaurants
– Tip gratuity scale in server's favor with simple techniques
– http://www.allacademic.com/meta/p_mla_apa_research_citation/3/0/7/3/0/p307300_index.html

How Williams Sonoma Inadvertently Sold More Bread Machines

Paying attention to what your customers and clients see can be a very effective way to increase your influence and, subsequently, your business.

Steve Martin, co-author of Yes! 50 Secrets from the Science of Persuasion, tells the story:

A few years ago a well-known US kitchen retailer released its latest bread-making machine. Like any company bringing a new and improved product to market, it was excited about the extra sales revenues the product might deliver. And, like most companies, it was a little nervous about whether it had done everything to get its product launch right.

It needn’t have worried. Within a few weeks, sales had almost doubled. Surprisingly, though, it wasn’t the new product that generated the huge sales growth but an older model.

Yet there was no doubt about the role that its brand new product had played in persuading customers to buy its older and cheaper version.

Persuasion researchers suggest that when people consider a particular set of choices, they often favour alternatives that are ‘compromise choices’. That is, choices that compromise between what is needed at a minimum and what they could possibly spend at a maximum.

A key factor that often drives compromise choices is price. In the case of the bread-making machine, when customers saw the newer, more expensive product, the original, cheaper product immediately seemed a wiser, more economical and attractive choice in comparison.

Paying attention to what your customers and clients see first can be a very effective way to increase your influence and, subsequently, your business. It is useful to remember that high- end and high-priced products provide two crucial benefits. Firstly, they often serve to meet the needs of customers who are attracted to high-price offerings. A second, and perhaps less recognised benefit is that the next-highest options are often seen as more attractively priced.

Bars and hotels often present wine lists in the order of their cheapest (most often the house wine) first. But doing so might mean that customers may never consider some of the more expensive and potentially more profitable wines towards the end of the list. The ‘compromise’ approach suggests that reversing the order and placing more expensive wines at the top of the list would immediately make the next most expensive wines a more attractive choice — potentially increasing sales.

Original source: http://www.babusinesslife.com/Tools/Persuasion/How-compromise-choices-can-make-you-money.html

Michael Mauboussin: Getting More out of Your Brain

As Warren Buffett says, temperament is more important that IQ, because otherwise you take all the horsepower of your brain and dramatically reduce it. “A lot of people start out with 400-horsepower motors but only get a hundred horsepower of output,” he said. “It’s way better to have a 200-horsepower motor and get it all into output.”

With that in mind, Michael Mauboussin, the very first guest on our podcast, writes about five pitfalls to avoid that reduce the horsepower of your brain.

Five Pitfalls to Avoid

1. Overconfidence

The first pitfall that Mauboussin mentions is overconfidence. Acting as though you are smarter than you are is a recipe for disaster.

Researchers have found that people consistently overrate their abilities, knowledge, and skill. This is especially true in areas outside of their expertise. For example, professional securities analysts and money managers were presented with ten requests for information that they were unlikely to know (e.g., total area of Lake Michigan in square miles). They were asked to respond to each question with both an answer and a “confidence range”—high and low boundaries within which they were 90% certain that the true number resides. On average, the analysts choose ranges wide enough to accommodate the correct answer only 64% of the time. Money managers were even less successful at 50%.

Edward Russo and Paul Schoemaker, in their book “Managing Overconfidence,” argue that this confidence quiz measures how well we recognize the gap between what we think we know and what we do know. They point out that good decision-making means knowing the limits of your knowledge. Warren Buffett echoes the point with his circle of competence concept. He argues that investors should define their circle of competence, or area of expertise, and stay within it. Overconfidence in our expertise can lead to poor decisions. In the words of Will Rogers, “It’s not what we don’t know that gets us into trouble, it’s what we know that ain’t so.”

Mauboussin suggests you know your circle of competence and not over-estimate your abilities. To compensate for inevitable error in this, he suggests adding a margin of safety. Another idea is to do the work necessary to have an opinion and test it with other people by seeking feedback.

2. Anchoring and Adjustment

This is when we are influenced by data or information, even if it's not relevant, that impacts our future judgments. “In considering a decision,” Mauboussin writes, “we often give disproportionate weight to the first information we receive. As a result, initial impressions, ideas, estimates, or data anchor our subsequent thoughts.”

A good decision process helps counter this by ensuring you look at decisions from various angles, consider a wide variety of sources, start from zero, and adapt to reality.

3. Improper Framing

I'll let Mauboussin explain this before I take over.

People’s decisions are affected by how a problem, or set of circumstances, is presented. Even the same problem framed in different—and objectively equal—ways can cause people to make different choices. One example is what Richard Thaler calls “mental accounting.” Say an investor buys a stock at $50 per share that surges to $100. Many investors divide the value of the stock into two distinct parts—the initial investment and the quick profit. And each is treated differently—the original investment with caution and the profit portion with considerably less discipline. Thaler and Eric Johnson call this “the house money effect.”

This effect is not limited to individuals. Hersh Shefrin documents how the committee in charge of Santa Clara University’s endowment portfolio succumbed to this effect. Because of strong market performance, the endowment crossed a preordained absolute level (the frame) ahead of the time line set by the university president. The result? The university took some of the “house money” and added riskier investment classes to its portfolio, including venture capital, hedge funds, and private placements. Classic economic theory assumes frame independence: all money is treated the same. But empirical evidence shows that the frame indeed shapes decisions.

One of the most significant insights from prospect theory is that people exhibit significant aversion to losses when making choices between risky outcomes, no matter how small the stakes. In fact, Kahneman and Tversky find that a loss has about two and a half times the impact of the gain the same size. In other words, people feel a lot worse about losses of given size than they feel good about a gain of similar magnitude. This leads to loss aversion.

To describe this loss aversion, Shefrin and Meir Statman coined the term “disposition effect,” which they amusingly suggest is shorthand for “predisposition toward get-evenitis.” Since it is difficult for investors to make peace with their losses, they tend to sell their winners too soon and hold on to their losers too long. This is because they don’t want to take a loss on a stock. They want to at least get even despite the fact that the original rationale for purchasing the stock no longer appears valid. This is an important insight for all investors, including those that adopt the expectations investing approach.

This is often influenced by incentives as well, because we tend to see the world through our incentives and not how it really is.

Consider this example from Charlie Munger of how Lloyd's Insurance rewarded people:

They were paid a percentage of the gross volume that went through. And paying everybody a percentage of the gross, when what you're really interested in is the net, is a system — given the natural bias of human beings toward doing what's in their own interest even though it has terrible consequences for other people — that really did Lloyd's in.

People were rewarded for doing stupid things because from their frame of reference they acted rationally. It's hard to see the reality of a system you are a part of. To counter this bias, you need to step outside the system. This can be done by adjusting time frames (thinking about the long term and short term), considering second and third order effects, looking at the issue in different ways, and seeking out conflicting opinions.

4. Irrational Escalation of a Commitment

Sometimes we just keep digging when the best thing to do is cut our losses. Past decisions create what economists call sunk costs, which are past investments that cannot be recovered. And if we're the ones who made the decisions for those investments, we're likely to rationalize that the future is brighter. Otherwise, we'd have to admit that we were wrong and that's painful.

While the irrational escalation of a commitment can sometimes pay off, it's not a probabilistic way to think about things.

Sticking to a good decision process is a good way to avoid irrational escalation of a commitment. Other ideas include considering only future benefits and looking inside yourself to see if you're trying to avoid admitting a mistake. As Daniel Dennett says, “you should become a connoisseur of your own mistakes.”

5. Confirmation Trap

This comes from justifying your point of view and is one we can easily observe in others and fail to see in ourselves (again, this comes down to relativity.)

Mauboussin writes:

Investors tend to seek out information that supports their existing point of view while avoiding information that contradicts their opinion. This trap not only affects where investors go for information but also how they interpret the information they receive—too much weight is given to confirming evidence and not enough to disconfirming evidence. Investors often fall into the confirmation trap after making an investment decision. For example, once investors purchase a stock, they seek evidence that confirms their thesis and dismiss or discount information that disconfirms it. This leads to a loss of objectivity.

It's this loss of objectivity that kills us. The way to counter this is to “ask questions and conduct analysis that challenges your most cherished and firmly held beliefs” and seek out disconfirming evidence, something Charles Darwin mastered.

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Still Curious? Follow your brain over to Grey Thinking.

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