Daniel Kahneman shared the Nobel Prize for Economics in 2002 for his work in behavioral economics and decision-analysis. For much of his career, Kahneman partnered with Amos Tversky, who unfortunately passed away before he too could with the Nobel Prize. Sadly, this prestigious award is not granted posthumously. Kahneman’s book, Thinking Fast and Slow, summarizes their and his life-long work. It contains many fundamental insights about decision-making, but I have chosen my five favorite lessons for small private businesses and not-for-profit organizations. They are:
- Rationality–Yes, human beings are generally rational, but sometimes their decisions are influenced by factors other than the calculus of profitability and gain. Decision-makers can be fatigued or hungry or deceived by biases in their cognitive processes. Everyone has limited cognitive processing abilities, easily overwhelmed in the decision-making process. Remember that when you are trying to convince your manager of something important to you and she is simply not listening or understanding!
- Ranking–Many managers say the hiring decision is the most important action they undertake. An organization is a collection of individuals fulfilling certain roles. What could be more important than making sure the organization has top notch people? Despite what managers say, Kahmenman believes they often approach interviewing unprepared and in a non-structured manner. His solution is to set up a scorecard and rank candidates on the individual attributes the position requires. Studies have shown the results of ranking candidates have superior results to just hiring on a wing and a prayer. (This is a poor pun as Kahneman did work with the Israeli Air Force.) He further advises don’t deviate from the ranking process even if your intuition tells you to hire someone else.
- Risk— Every decision is filled with risk and uncertainty. Kahneman and Tversky found people were generally risk averse. Take the possibility of a coin flip. If it comes up heads, you win $125. If it is tails you lose $100. Sounds like a good deal, right? Most people would not take this gamble, realizing one flip of the coin could go either way. However, if you start increasing the return on heads, more people would take the gamble. Generally, people feel a loss twice as much as an equivalent amount of gain.
- Regression to the Mean– If someone performs a task brilliantly the first time, we tend to expect the same level of accomplishment again. This is highly unrealistic due to the regression to the mean. In actuality, the person will probably perform closer to their average the second time. This is a vivid lesson for me. I had never golfed before and I was forced to play in the company golf outing. After taking a few lessons, I arrived at the golf course with a newfound determination. I teed off on the first hole and hit a beautiful shot down the middle of the fairway. Dropping the club, I said to my manager, “I quit. It can only go downhill from here.” I was right. I was terrible the rest of the way as I regressed to my mean. The same thing happens with baseball players who are in a batting streak. My father is fond of saying, “they will come back to earth. They always do.” He is right. They always do.