Posts Tagged ‘Behavioral economics’

IACCM, Regression to the mean, and other topics of the week

May 17, 2013

NASA Sunspot Number Predictions for Solar cycl...

  • The humble founder of TPS planet – Captain TPS?…*running to the shower* – will be making an appearance on the, in this case inappropriately named, ‘Ask the Expert’ IACCM webinar series on June 6. I’ll be blathering on about prediction markets, crowdsourcing, and how they can be applied to procurement and the supply chain. You can register here. You have to be a member, but if you sign up close enough to the event, you can attend this one for free. Log in, listen, add your own thoughts, heckle me…just make sure you are there. You’ll either learn something, or watch me publicly embarrass myself, but either way, it’s a win for you.
  • While I’m on the topic, friend of the blog (and author) and CEO of IACCM, Tim Cummins writes a very informative blog on contracting that can be found here.
  • Least surprising, yet concerning, news of the week; the IRS scandal. So you mean that people with a substantial amount of power over other people’s lives have used that in a power in a biased way? Someone get Kahneman on the phone…
  • ‘The Un’ (of the Kim Family) has either gone quiet or the world’s news media has moved on to something more interesting. I wouldn’t be totally shocked to learn that his dad left him a script…’During the annual South Korean and USA joint military exercises, you shall take the following steps…’
  • Key quote from Thinking, Fast and Slow ‘We will not learn to understand regression [to the mean] from experience.’ (My note: among many other areas in which creative thought/problem solving/rationality is required). To put the quote in context, Kahneman is talking about the fact that most people base predictions of the future on a relatively small sample of readily available evidence without accounting for the fact that the correlation between that small piece of evidence and predictions of an uncertain future are less than 100%. We then take that evidence, and develop causal interpretations that are completely inaccurate.
  • Regarding job performance, I have witnessed this phenomenon more times than I care to remember. A couple random (or worse, influenced by selection bias) comments are taken as a proxy for overall performance (both good and bad). I would even go as far as to say that our visceral feelings about someone then bias overconfident people even further to selectively look for evidence of strong or weak performance. The good news is, if you are in a business environment, you can focus on looking good when an overconfident exec is watching and don’t worry much about the day to day (unless it results in a problem that then gains attention that can be pinned on you). The bad news? Well, if you do a great job everyday, but a random poor performance happens to be noted by someone influential, then you have a steep hill to climb. Ridiculous? Uh-huh.
  • Re-reading the stuff you have written in the past is always scary, but I went ahead and gave it a shot. I did not make the connection at the time between my article in The Journal of Prediction Markets and behavioral economics, but I now believe there is a link.  Our tendency is to predict more extreme outcomes than are truly likely based on our lack of understanding of regression to the mean (see discussion above). Prediction markets remove those errors by combining them with the errors of lots of other people, thus mitigating the extremeness of individual predictions. (If you can tell me what assumption I’m making here in the comments, you will win a free annual subscription to the TPS Report.)  Still think this is not having an effect on the information flow in your supply chain?

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Did Anyone Notice That…

May 7, 2013
English: Christiane Amanpour at the Vanity Fai...

The queen of news reporting…Christiane Amanpour!

In my last post, I was fooled by randomness, or more specifically, by my System 1 thinking. I had hoped that a couple Kahneman fans would call me out in the comments section – though that is not to imply that my rush to judgement was intended as a test (it wasn’t)!

What am I talking about? Well, in my last post, I called out Bangladeshi Prime Minister Hasina based solely on her appearance on Christiane Amanpour’s excellent show. Now, if we think about it, it makes zero sense to base our entire judgement of her ability to govern on one appearance on one news show. I don’t know if we have any experts on Bangladeshi government  residing here on TPS Planet, but I am certainly not one. I would need a great deal more information on her regime, their policies, and their effectiveness in managing change before making even the slightest judgement in this regard.

The story is a great illustration of how our minds work, though. Our system 1 makes rapid judgements about individuals. When there is little evidence of a particular trait available, we fill in those gaps in information with what we do know – substituting good qualities when we have an overall good feeling about someone and vice versa. On a blog post meant to entertain, the consequences are not dire. In other cases – negotiation involving known suppliers being one – we need to take steps to avoid that bias.

We’ll explore those in greater detail in the days, weeks or months that follow…whenever my lazy System 2 gets itself motivated again.

Taleb, Kahneman, and…Rajakovich?

April 4, 2013

Ok, so the headline might be a bit deceptive. I was not actually, physically present

Nassim Nicholas Taleb

when these two scholars met. But if we take the meta-universe as our context, then I could…oh, I’ll just move along.

Check out this discussion between Daniel Kahneman and Nassim Nicholas Taleb. Trying to summarize an 80-minute discussion would make me an even larger fool of randomness than I was before, so I’ll just subject you to some of it instead! Cha-ching.

A key point of the discussion centered around the following theme: Size means fragility. In percentage terms, the larger the project, the greater the overruns; the larger the organization, the more susceptible they are to risk of bankruptcy; generally, the greater the degree of centralization, the more susceptible we are to extreme negative outcomes.

Most people will understand this point at some level. Taleb used the example of government, the economy, and large banks. I’ll use the example of decision-making in just about any context. Where one person or a small group of people make decisions from on high without a very good knowledge of the details of a situation, they may make small gains in terms of continuity. They may also cause large problems.

The effect is even worse when the person or group is focused on things that will have little impact, instead of those that will have a large one.

Procurement’s role – a behavioral economist’s perspective

March 25, 2013

Regions of the cerebral cortex associated with...

Procurement’s role in a modern, giant corporation – discounted by many – is to promote ‘decision efficiency.’ ‘Decision efficiency’ may sound like some piece of business jargon, but it is actually the fundamental reason why procurement is absolutely necessary to an organization. Here’s why:

When people spend money on something, there is some amount of pain associated with that purchase. For some of my tightwad friends, this pain is almost unbearable. Spendthrifts, on the other hand, are particularly good at fooling themselves – i.e. shutting it out of their minds.

I hear the procurement naysayer crowd now…’that’s great for individuals, but what about organizations.’ Ok, maybe you weren’t saying that, but I’ll go ahead and refute it anyway.

People experience the pain of paying to the degree to which they feel directly affected by it. So, while a budget holder may feel mildly connected to the pain of spending some of her budget, the next layer removed will feel even less. By the time we get to the maintenance supervisor that runs out to Home Depot/B&Q on a regular basis, he may actually look forward to some time away from the plant.

Even the budget-holder, however, will be much more in tune with the utility (pleasure/usefulness) derived from an expense or ‘investment’ than the pain. After all, it is one line of expenditure, and the only incentive is to stay within the budget. This phenomenon is called ‘hedonic efficiency.’ I.e. the budget holder wants the benefit and to sweep the expense out of mind as quickly as possible.

What does that mean in practical terms. A). Ownership – i.e. to be able to control the good or service purchased B) Prepayment – i.e. get the money out of there and forget about it.

So, where does procurement come in? We promote decision efficiency. In practical terms this may mean leasing or renting, paying only for what we use (avoiding the prepayment bias), and making opportunity costs explicit. To the extent that we show the utility the business receives against the costs involved, we become an effective conscience for the business. We are there to prevent bias.

Companies – specifically executives – must first be cognizant of the biases that impact them. At that point, they will recognize the need for procurement to be there to counteract those biases.

Procurement has a responsibility here too. We must present the case as clearly and rationally as possible. There is an interdependency present as well. If the business continually shows they do not want to be inconvenienced with the facts, procurement receives the implicit message that their lives will be easier if they just remain quiet.

CEO’s – yep, pointing directly at you – take note.

Branson’s conditioning

February 22, 2012
English: Sir Richard Branson at the eTalk Fest...

Good work, Richard. Image via Wikipedia

I recently received a two pieces of communication from Virgin media, who does my internet, phone, and cable TV. The first one celebrated the fact that I will be receiving up to 100 Mb/s in internet speed 18 months from now.

This celebratory letter spoke of the massive investment Virgin was making in me, and painted a clear picture of how wonderful life will be with all this speed. Richard Branson, the CEO of Virgin, was prominently featured…it was as if he reached into his own pocket and decided to help me out. What a guy!

Two days later I received a second letter telling me that there would be a price increase in my service bundle. No mention of Mr. Branson to be found. But I thought ol’ Richard was my benevolent, rich friend?!

This, ladies and gentleman, is called conditioning. In this particular case, Branson and staff played on how our minds are wired as it relates to gifts. We receive a gift (free extra internet speed), and are then hit with a price increase. Since we just received the gift (even one we didn’t ask for), we connect this to the price increase and the increase isn’t so bad. Fair is fair. And Virgin gets to win market share while having us pay for it.

The worst part is, it works. And there is nothing unethical or problematic about it.

The reality is that we’re just not as complex as we think we are.

Related articles

Omission bias

February 1, 2012

The omission bias is one that I find particularly common, both in sports and in business. It is even encoded in the Army’s tried and true mantra – “never volunteer for anything!”

Check out this article by Tobias Moskowitz passed along by our friends at Freakonomics. Of particular note is the costs we incur by not doing something that are recognized much less than those of doing something wrong. It is very much related to the concept of opportunity cost, which I always feel a bit ridiculous in raising in a business setting.

The likelihood is that those words simply bring back unpleasant memories of a long-forgotten economics class.

Negotiation – a look at empirical evidence

January 1, 2012
Löwenstein

Random pic from a guy with a similar name to Loewenstein. Image by matthiashn via Flickr

Academics can be both frustrating and refreshing all at once. They do a great job – George Loewenstein is one of the best – of providing empirical evidence of how things are. Often, however, they don’t express strong opinions on the implications of their findings. They leave that sort of thing to hacks like me. Hooray?

Loewenstein hops into the world of negotiation in an article called “Explaining the bargaining impasse.” I won’t do a full review or try to explain his points in detail. I’ll leave that to people with even more boring lives than mine. I will, however, offer some opinions where Loewenstein leaves off. I’m sure he would agree with everything I’m about to say…if only off the record.

The most interesting finding that he presents is that when people are asked to write down the weaknesses in their own position, they are able, to some extent, overcome the self-serving bias (processing information that supports one’s own position more readily than opposing information).

The question that he leaves unanswered is whether this activity is a good one, or whether the self-serving bias actually helps us achieve a better result. My answer is that it depends on the type of negotiation.

In a one-off deal, do the self-serving thing. In a long term relationship, write down the weaknesses in your position. It will help you understand the other side. I’d also use this knowledge when developing a contract. What risks are you foisting on the other side, and will this damage trust? I’ve seen people talk a good game with relationships, but then go out and dictate a position that suppliers will outwardly accept. However, under this veneer, the lack of trust percolates and we are no longer united by a common objective.

The same principle can work in interpersonal relationships, both professional and private. I have seen people always complain about others not taking responsibility for things, and then proceed to not take responsibility for anything. Before behaving like a politician complaining about the deterioration of ethical standards, think about what the other person could realistically have accomplished given the circumstances. You’ll find that your ability to solve problems rises while the time spent blaming people falls dramatically.

This way of thinking can dramatically improve our lives. I have seen a small number of people in which conflict is truly a part of almost every relationship they have whether professional or private (this is the default, but even these people are able to overcome this state with conscious effort). They may not even recognize themselves in this portrait, because it is simply viewed as the way things are – i.e. you are not getting as much stuff as you potentially could if you are not in conflict with everyone who could potentially give you more stuff (curiously, kids are the only ones left out). It is as if their world is defined by the conflicts they have.

I have also seen people who seem to live in harmony with just about everyone. It is rare, but I believe that it is a glimpse our future. Collective action is the next frontier. More on all of this to follow, unless I catch the laziness bug that’s been going around.

Behavioral Economics and Purchasing

November 19, 2011

I am currently reading a collection of scholarly articles by George Lowenstein. Who is George Loewenstein? Why, only one of the pioneers in the field of behavioral economics! If you did know who he was, well, neither of our lives are very exciting.

Ol’ George is also a man after my own heart. He’s taken concepts from psychology, and applied them to economics.

Painless Saving

Some of you out there will think you are very rational decision-makers when it comes to buying stuff. You are the ones that are especially dangerous…biased but in denial.

The funny thing is that humans make irrational decisions in systematic ways. For instance people fear loss more than appreciate the joy from a gain. We create stories by making sense out of random events. We predict that we’ll be more disciplined in the future than we act today, and inevitably don’t deliver.

It just so happens that in the day job, I advise on purchasing decisions, except in the realm of big corporate decisions rather than on an individual level. The question I get to, then, is whether behavioral economics is applicable at the organizational level. My hunch is that it is, but my next hunch is that “powerful” people will be uncomfortable with this notion…until 20-30 years from now when behavioral economics goes mainstream.

The other issue is the “So What?” factor…i.e. what do we do about it. Going through a process involving multiple viewpoints is a start, but the fundamental challenge is the fact that people who are, in fact, wildly biased are often those most convinced that they are perfectly rational. And, if perfectly rational, what need would there be to account for any biases? Compound all that by those same people surrounding themselves with those who either think the same as they do, or those that will realize it is much more profitable to fly under the radar without saying a word, and the problem is obvious.

All this may sound a bit cynical. However, I prefer to look at it the other way. Those who are open to this new knowledge will have an advantage over the rest.

Negotiation – a look at some empirical evidence

January 1, 2011
Löwenstein

Random pic by a guy with a similar name to George Loewenstein. Image by matthiashn via Flickr

Academics can be both frustrating and refreshing all at once. They do a great job – George Loewenstein is one of the best – of providing empirical evidence of how things are. Often, however, they don’t express strong opinions on the implications of their findings. They leave that sort of thing to hacks like me. Hooray?

Loewenstein hops into the world of negotiation in an article called “Explaining the bargaining impasse.” I won’t do a full review or try to explain his points in detail. I’ll leave that to people with even more boring lives than mine. I will, however, offer some opinions where Loewenstein leaves off. I’m sure he would agree with everything I’m about to say…if only off the record.

The most interesting finding that he presents is that when people are asked to write down the weaknesses in their own position, they are able, to some extent, overcome the self-serving bias (processing information that supports one’s own position more readily than opposing information).

The question that he leaves unanswered is whether this activity is a good one, or whether the self-serving bias actually helps us achieve a better result. My answer is that it depends on the type of negotiation.

In a one-off deal, do the self-serving thing. In a long term relationship, write down the weaknesses in your position. It will help you understand the other side. I’d also use this knowledge when developing a contract. What risks are you foisting on the other side, and will this damage trust? I’ve seen people talk a good game with relationships, but then go out and dictate a position that suppliers will outwardly accept. However, under this veneer, the lack of trust percolates and we are no longer united by a common objective.

The same principle can work in interpersonal relationships, both professional and private. I have seen people always complain about others not taking responsibility for things, and then proceed to not take responsibility for anything. Before behaving like a politician complaining about the deterioration of ethical standards, think about what the other person could realistically have accomplished given the circumstances. You’ll find that your ability to solve problems rises while the time spent blaming people falls dramatically.

This way of thinking can dramatically improve our lives. I have seen a small number of people in which conflict is truly a part of almost every relationship they have whether professional or private (this is the default, but even these people are able to overcome this state with conscious effort). They may not even recognize themselves in this portrait, because it is simply viewed as the way things are – i.e. you are not getting as much stuff as you potentially could if you are not in conflict with everyone who could potentially give you more stuff (curiously, kids are the only ones left out). It is as if their world is defined by the conflicts they have.

I have also seen people who seem to live in harmony with just about everyone. It is rare, but I believe that it is a glimpse our future. Collective action is the next frontier. More on all of this to follow, unless I catch the laziness bug that’s been going around.


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