Business leaders must become aware of their cognitive biases in how they make and execute on their decisions. These decisions can affect their teams, the growth of their organizations, and the future potential gains, and losses, that the business receives.
Loss aversion is the cognitive bias where people naturally lose a more significant amount of satisfaction from a loss than they receive from a similarly valued gain. This bias manifests in two distinct patterns, in anticipation, and in framing a particular loss or gain.
Anticipation can become a crucial component of this bias, and affect decision makers based on how they have experienced gains or losses in the past. Decision-makers who have historically faced a weighty loss may become more hesitant to enter similar situations. This hesitation can lead to lost opportunities or undue delay in moving forward on projects. For example, hiring managers who have felt that a number of their poor hires have come from a particular generation may be hesitant in hiring similar candidates. Just the same, those decision-makers who have beaten the odds in the past may have a skewed sense of their success and take more significant risks in the future. Every financial prospectus explains this flawlessly, “Past performance is no guarantee of future results.”
Framing the risk, and explaining the loss in different terms may also affect how decision-makers approach a solution. Objectively, gaining a discount or avoiding a surcharge is the same. However, both situations elicit different emotional responses. Based on their past deals, and how they approach situations, this opt-in versus opt-out can skew behavior and allow for poor decision making towards critical business matters. Managers who are facing cutting expenses from a budget may overlook opportunities to raise revenue because their focus is only on the expense column.
Ultimately business leaders must remain objective in their decisions.
Extensive subjectivity or emotional involvement in the subject matter can allow for leaders to become irrational and not make the best decisions with the data and information present. Business leaders must be able to look past the data and see it in context. One data point, however it may be framed, is still a single data point. The more considerable power of data is in being able to view it in context, either to other similar points, or trends over time.
Similarly, managers must be able to see the upside of choices and understand that the most significant gains lie in the outliers. If all of our decisions must be satisfied within six standard deviations, then it will become impossible to progress and make the necessary leaps for remaining competitive in today’s dynamic market environment.
Every day business leaders are forced to expand their comfort zones. Remaining knowledgeable on this common cognitive bias can help ensure that they are making the best decisions in leaving their safe space and exploring how they can expand, especially in incremental ways.