Businesses need to put more cognitive effort into the decision-making process to avoid costly errors says Joep Steffes
Any business is subject to the myriad of forces seemingly set against it to prevent it from succeeding.
In fact, much of your ultimate success as a business leader is based on how you are able to deal with the inevitable problems that come along in the course of a business’s growth and development, and how you can plan to address those issues when they come up. But perhaps the hardest problems to overcome are the seemingly innocuous bad decisions that you can’t recognise, often until it’s too late.
I found that more than most strategic decisions made by directors turn out to be wrong and I wanted to find out why leaders are making bad decisions in order to provide some practical steps to help make better decisions.
The reality is that bad decisions are made due to a variety of factors, including time constraints, lack of information, and bias which often causes directors to make important decisions that are not based on reason but ‘gut’.
These decisions, which could be deciding whether or not to enter a new market or to pursue a merger, require more thought than the average decision, and this means that a director can’t simply rely on automatic actions or intuition.
An important task
Good decision making requires more than speed and a ‘gut feeling’. After all, these things don’t always lead to the best outcome. This was evident in cases like the banking crisis, the demise of Kodak and the downfall of Nokia as market leader in the mobile phone sector.
Time constraints, group dynamics, incomplete information and excessive optimism often cause leaders to make decisions that are not sufficiently based on reason, which takes more time and effort.
People are not naturally inclined to correct themselves, so this is an important task for the supervisory authority or supervisory directors or anyone or anyone overseeing the quality of decision-making in organisations
In fact, according to research from former Professor Clayton Christensen at Harvard Business School, each year more than 30,000 new products are launched but 80% of these fail as a result of poor decision making. This is a shame, especially since a carefully thought-out decision can save a lot of time, money and manpower.
Why do mistakes happen?
I wanted to find out more, to try and understand why so many bad decisions are made and how we can help improve them. To do this I analysed an in-depth case study at DSB Bank, a Dutch Bank and insurance company that failed in 2009.
At that time the company was still owned and run by its founder Dirk Scheringa. After a very successful and profitable period, DSB Bank found itself in an increasing mismatch between its commission-based business model, the demands of an external supervisor, and the changing social and consumer requirements of the financial landscape in the Netherlands.
The decision under investigation was the choice of developing a new business model for DSB Bank.
I discovered that biases were found during all phases of the decision-making process. The main findings were amongst the role of dominant logic within DSB Bank. The mindset of the founder and management of DSB Bank was based on entrepreneurship and being in control. Risk-management, on the other hand, was not part of the mindset of decision makers.
The dominant logic at DSB Bank was strengthened by the profitability of its business, by political reinforcement, but also by external and internal supervisors who lacked the means and willingness to take corrective actions. Together with signs of strategic inertia many small moments of stress in the history of DSB led them to organisational fatigue that resulted in decisions of insufficient adjustment in the business model. Subsequently DSB filed bankruptcy in October 2009.
I also discovered that it seems that in times of increasing urgency or the perception of a crisis, the perception of board involvement in strategic decision-making changes from passive and control focus to active and advice or even pro-active.
As part of the research, I conducted interviews with supervisory and executive directors which revealed some additional information.
First, supervisory directors focus their attention more on the new strategic decision than the decision which involves ‘housekeeping’. They might avoid choices which require more time and resources. They will avoid engagement in decision making which is not concerned with on the new. It’s ‘not sexy’ to be engaged in housekeeping decisions.
The internal context of organisations consists of several factors explaining bounded rationality. It seems that none of them is leading. However, this part of the research remains inconclusive.
The external environmental factor has a limited influence on bounded rationality. This is contradictory with behavioural decision science research on ‘biases and heuristics’.
Group dynamics and personality of the director are an import factor in explaining how people make decisions.
Leadership, personal motivation, and urgency of the decision are determinants of the moment of involvement of boards at decision making. The level of involvement ranges from ‘informing’, ‘probing’ to ‘co-decision’.
Unfortunately, I also found evidence that there is limited effort to removed bias in decision making.
How to defend your company from biases
But how can you defend your company from bias? I came up with five lines of defence which a supervisory director or supervisory authority can use to ensure that directors make better-informed decisions and rely less on their gut feeling.
Depending on the role of the supervisory board (employer, advisor, monitor or supervisory authority), my strategy consists of five steps that should be taken in the following order. These lines of defence encapsulate the effects of bounded rationality.
‘Motivating’ decision makers to put more cognitive effort into the decision making takes through incentives and accountability. Managers need to make sure they are incentivised to follow these strategies and achieve results as well as accountability for the decisions they make. –
In the next step, it is important to strengthen directors’ thinking skills so that they can look at the matter from a different angle and not only focus on shareholder value, for example.
This is called ‘enabling’, decision makers to deploy more cognitive capital towards decision-making tasks through cognitive debiasing techniques, critical thinking, group decision making and organised contradiction, decision modelling and IT support. This means strengthening directors’ thinking skills so that they can look at the matter from a different angle.
If the first two steps don’t work, the next step involves making agreements regarding the way in which decisions are made through rules and governance structures.
This is called ‘agreeing’ between decision makers and supervisory boards on how a decision should be made through procedures, protocols, committees, supervisory teams, and other governance mechanisms. This means that lots of opinions and professional comments are taken into account, rather than just one director. This is vital in improving current procedures and making real change.
This is followed by ‘monitoring’, which in the advisory role would involve creating scenarios. Monitoring the outcomes and progress of decisions by post-audit and review teams and applying ‘stage-gate’ of ‘optional’ decision making methodologies. This means there will be room for improvement and help.
Finally, the last step is to ‘change the context’ in order to look at a decision in a different way. This can lead to a different choice.
Moving forward
It should be noted that poor decision making among directors could be as a result of the ‘old boys’ network’ where these jobs were given rather than earned. This is often due to non-diverse thinking as a result of homogeneous boards. This is a particularly prevalent issue in a world where technology is constantly changing, and it’s no longer possible to just patent something that can last for years.
To keep up, companies need to re-invent themselves constantly, and recognizing where to go next requires a diverse talent pool with varied perspectives. This means steering away from things that fester inclusivity.
For example, the position of director would often be passed on to those in the ‘old boys’ network’ . Or other qualifications that don’t match the need of the company (like age, ethnicity, etc.) rather than a candidate who is more qualified. For example, the ‘Old Boys’ Club’ is dominated by white male culture and from those from elite backgrounds.
However, this doesn’t cut it anymore.
Directors need to have real knowledge and expertise to be able to do this role, they need to fully understand how the behavioural and decision-making process works.
If a company is more responsive to the behaviour of directors in this capacity, it leads to better decisions which can not only be of value to shareholders and the organisation but can bring social benefits too.
This is such a big issue, so businesses need to ensure that their directors are making fully-informed decisions by selecting directors based on cognitive capabilities and critical thinking skills. They simply have to put more cognitive effort in the decision-making process. They need to have decision governance structures and responsibilities in place which effects how decisions are made and that monitor the decision-making process.
If businesses can successfully follow these steps that I have outlined, it should cause a reduction in the costly errors they make.
Joep Steffes is a PHD student at Nyenrode Business University
