5 Biases That Lead to Bad Decisions (Part 2 of 4)

(If you missed the introduction of this series, please click here.)

Each of us is susceptible to irrational behavior’s irresistible pull. Only when we gain insight into our irrationality can we see the extent to which it affects our work and personal lives. Fascinating patterns emerge, and we can master our behaviors and decisions when we connect the dots.

Loss Aversion

We experience the pain associated with loss much more vividly than we do the joy of experiencing a gain.

For example, if egg prices go down, sales go up. But if egg prices rise proportionately, sales dip by 250 percent. Consumers stop buying them because the price has increased. This response flies in the face of traditional economic theory, which dictates that people should react to price fluctuations with equal intensity, regardless of whether price rises or falls. In reality, we illogically overreact to perceived losses.

This also explains why people are much more likely to buy meat when it’s labeled 85 percent lean instead of 15 percent fat. Similarly, twice as many patients opt for surgery when told there’s an 80 percent chance of survival, as opposed to a 20 percent chance of dying.

The same irrational force entices us to pay for a loss damage waiver on a rental car, even though we’re already insured by our credit cards and car insurance. Normally, we’d scoff at wasting money on double insurance coverage, but the feelings associated with the word loss stir our emotional brains and influence action.

Commitment

We’ve all experienced the pull of commitment. We have a tendency to stick with the status quo. We’re predisposed to perpetuating more of the same. It’s an inherent part of our thinking. Deep within our psyches, we are self-protective and risk-aversive.

When we’ve invested our time and money in a project, it’s difficult to let go – even when things clearly aren’t working.

In business, sins of commission tend to be punished more severely than sins of omission, as the status quo holds a particularly magnetic position. Independently, the forces of commitment and aversion to loss have a powerful effect on us; when combined, we find it much harder to break free and do something different.

History shows us how hard it was for Lyndon B. Johnson and George W. Bush to find solutions to the wars in Vietnam and Iraq, respectively. They were strongly influenced by the forces of commitment and aversion to loss.

Kahneman, with his colleague Amos Tversky, first discovered and chronicled the phenomenon of loss aversion.

“To withdraw now is to accept a sure loss, and that option is deeply unattractive,” he wrote. “The option of hanging on will therefore be relatively attractive, even if the chances of success are small and the cost of delaying failure is high.”

When CEOs and boards of directors are charged with making critical strategy decisions, determining the best outcomes often proves challenging when strong egos and competitive personalities are added to the mix.

Over the next few blog posts, we will discuss each of these currents and forces. This was the first two or five.  Bookmark us and come back tomorrow!