#15 Strategic decisions or pure chance?
This episode was recorded in German.
In the new episode of Hope Is Not a Strategy, strategy call #15 "Strategic decisions or pure chance?", strategy consultant Christian Underwood and Professor Dr. Jürgen Weigand, Deputy Dean of WHU (Otto Beisheim School of Management), talk about strategic decision-making in theory and in day-to-day business.
Every day, we make 20,000 to 30,000 decisions. Some have only a short-term effect, like the coffee in the morning. Others last much longer, like moving in with your partner. But how exactly do you make a decision? And when is a decision tactical or operational, and when are you acting strategically?
In theory, making decisions based on the rationality principle isn't all that hard. But what does it look like in professional practice? That's where cognitive biases, noise, personal value systems and blind reliance on your own experience come into play.
In this episode, Jürgen and Christian take on all the big questions around strategic decision-making. Can people decide purely rationally at all, or does that take a machine? Which factors influence the decision-making process, and does anyone ever have all the information they need to decide? You'll find out all of that and more in the new episode of Hope Is Not a Strategy #15 "Strategic decisions or pure chance?"
Detailed episode description:
How many decisions we make every day
We make between 20,000 and 30,000 decisions a day. Between 90 and 95% of them run automatically. That includes things like deciding whether to actually get up or what to have for breakfast. Routines form in the subconscious and are practiced over long periods, but at their core they're still decisions. Alongside these automatic decisions, there are also the strategic decisions that have to be made.
Defining the strategic decision
Strategy, and strategic decisions along with it, comes mostly from the military world. The term differs from tactical or operational decisions. Operational decisions can be reversed in the short term. Whether you drink a coffee or not is something you can still decide when the coffee machine is already running or the hot cup is sitting in front of you. Strategic decisions, by contrast, cannot be reversed in the short term.
Strategic decisions have consequences that play out over a certain period of time, and if you don't like those consequences, you can't simply undo them.
An example: a man and a woman decide to move in together. They sign a lease, but a few weeks later they realize the relationship has no future. Getting out of that lease is no longer easy. There are notice periods to observe, whether they like it or not. In other words: they have to think ahead about how stable the relationship is and whether it will hold up. Does it make sense to move in together and sign a lease at this point? Even if the consequences in this example last only three months, they're still longer-term consequences that can't be reversed right away.
Decisions in theory: the rationality principle
Decision-makers in companies will never have all the relevant information they need to make a decision, which means you can never be aware of all the consequences in advance.
Economists work with the rationality principle. It assumes that decision-makers have all relevant information at any given moment and are able to identify different options, compare them and pick the best one. In theory, this is a very useful principle, because it allows you to draw certain conclusions that can then be compared and measured against reality.
In reality, though, decisions are rarely rational, and all the information relevant to a decision is never available.
Too many options make deciding harder
Normally there's a rule of thumb: you have two or three options to choose from and pick one. The more options on the table, the harder it becomes to make a decision. Empirical studies show that people, especially when buying consumer goods, tend to be overwhelmed by more than three options. It gets too complex, and in many cases that overload means the purchase decision is abandoned altogether.
Experience shapes tomorrow's decisions
Past experience shapes and influences today's experiences and decisions, which in turn will affect the future. Managers are often hired because they did good work at a previous company and are expected to do it the same way again at the new one. And that's usually exactly what they do.
It's worth noting here that over the course of evolution, humans developed certain routines in order to survive. One of those routines is to take positive past experience, extrapolate it and project it into the future. People fundamentally think in a very linear way, even when the relationships in reality aren't linear at all. Based on experience gathered from the few observations they've made themselves, people assume that if they just add one more point, it will work, which often isn't the case.
Extrapolation is especially difficult in disruptive times
In disruptive times in particular, as we're seeing right now, it's difficult to simply project past experience forward. There are exponential processes, and those are not linear.
The COVID-19 pandemic is a good example. People learned that with more infections, events unfold faster. That's exponential growth. And that's where the heuristic used to simplify decision-making, namely linear thinking, hits its limits and leads to mistakes.
So when people fail to recognize that something is exponential, they're more likely to make the wrong decision. That's called cognitive bias.
Assuming that the future will look much like today or the past is a major risk for strategic decision-making
Building the future on past experience is a classic problem rooted in how the brain selects information. People are natural little egotists: they enjoy hearing themselves talk and they like their own decisions, especially when those decisions turned out well. The brain then selects exactly that kind of information, instead of considering that the future might look completely different from the past. The real question to ask is which deviations exist and which pieces of information differ. But those are exactly the pieces of information that often get ignored and dismissed as a "random result," while people keep working their way along the linear trend.
Personal values shape decision-making
Biases and value systems can influence decision-making too.
An example: behind conscious decisions, like going fully vegan and no longer buying food wrapped in plastic, there's a conscious value. It might be that someone wants to protect the environment or contribute to keeping the planet livable for people in the future. These personal values shape decision-making as well. When several options are on the table and one of them matches an individual's value system, that person will always favor that option, even if another one might be more economical or simply better.
Companies deciding in favor of sustainability
Sustainability is a topic that's moving the business world in a big way right now. And it leads to different decisions, for example about the product portfolio.
Example, a food manufacturer:
A sausage maker decides to offer vegetarian product lines under the same brand. That, of course, carries a lot of explosive force, and it's felt inside the company as well. When meat is the company's DNA and a vegetarian product range is suddenly added, that's an issue with an outward effect too. Decisions are then no longer made purely on a factual or rational level.
Many human decisions are driven by emotion
Rationality is often equated with objectivity. But people are emotional too, and many decisions are guided by human emotion, even when the decision-maker doesn't notice it in that moment.
Companies have to follow what customers want. If customer preferences shift in a way that makes following them economically viable, why wouldn't you pursue that?
Back to the sausage example: a company like that obviously has both the production capacity and the capabilities to offer a range of vegetarian products. So if demand is big enough, if you can cover your costs and turn a profit, then a change like that makes a lot of sense.
The next generation's values shape decision-making in family businesses
The personal values of the next generation of owners shape a company's decision-making and ownership strategy.
Example: winemakers
A lot of people currently want sustainably produced products.
Among winemakers there are many family-run businesses now in their third, fourth or fifth generation. They deliberately say they only produce small batches, but organically and sustainably. There's strong demand for exactly that, which makes it the right approach. Companies should develop an understanding of this in general.
Based on their business model, their business idea and their value system, companies should be able to adapt to demand, and then take it on and get it done.
Values, biases and emotions influence decisions considerably.
Decisions and noise
In his recent book "Noise," Nobel laureate Daniel Kahneman describes noise as a decision factor alongside biases and values.
Christian and Jürgen are sitting in a recording studio, shielded from noise.
Noise here would be things like everyday distractions or a ringing phone.
When you're in the middle of thinking something through or finishing a plan and the phone rings, you could ignore it, but as a rule you don't. That kind of noise distracts you, and whatever happens in a phone call like that can hit you emotionally. When the call ends, the emotion isn't over and the noise is still there. It gets carried into the decision-making process. Noise, in other words, is anything that pulls us away from what we actually want to focus on.
Studies show that people arrive at completely different outcomes when deciding on identical sets of facts.
That's a combination of noise and cognitive bias. You look at the same set of facts, you have the same data, but your brains select different pieces of information. When there's a preconceived opinion, the human brain will select the information that supports it, even if you try to ignore that. And the more external noise there is, the worse it gets. There's an interdependence between what happens externally, the noise, and what happens in your head as information is perceived and processed.
Can people make good decisions, or do we need machines?
People can make good decisions. Whether they make the best possible decision is another question.
The rationality principle used in economic theory is an ideal state that is never reached. The ideal would be complete certainty, where you have all decision-relevant information and know the quantitative consequences. In reality, you usually don't. So you have to look at what that means for you, how far away from it you are, and which factors are influencing your decision-making behavior.
Support from outside critics
To support the decision-making process in a company and get a fresh perspective, get outside advice: lay out your own set of options and ask how the other person would decide. It's especially useful with people who are highly critical, who like to put a finger in the wound and question optimistic scenarios. That gives you a sounding board, and you can define for yourself where you stand and what the consequences of certain decisions would be.
In science, you use peer review. In business, that's harder to organize. Once a new strategy is in place, you can turn to consultants or other strategy experts.
Jürgen shares an example where a larger company brought him in. Two big consulting firms were competing with each other, and both had presented proposed solutions. Management reviewed them and brought Jürgen on board as a sounding board. There was enough material to make a decision. In a case like that, Jürgen puts those decision papers through their paces with his economic and strategic expertise. Based on what the consultancies had done and how he saw things, management made the final call. Those intense discussions across the entire executive board, going through every single detail one more time, are extremely important.
Openness, self-criticism and outside perspectives as success factors
Openness and self-criticism are key factors in successful decision-making. Everyone makes thinking errors they can't identify on their own. The more self-critical board members and decision-makers are, the more transparency you find in the company. You learn what the conviction behind individual elements is, or how the situation is being interpreted. That helps, and it matters a great deal.
Neutral parties like consulting firms or individual consultants may ask entirely different questions, ones you'd never have come up with in your own context because you may be stuck in your ways. Even executive boards with a great deal of experience aren't immune to this (and as we said earlier, experience itself can be dangerous).
Every decision-making phase should end with a decision, of course. The goal is to have integrated many perspectives and considered everything in a 360-degree view. Applied to the strategy process, that's the 360-degree view of the strategy: what was discussed, which decisions need to be made, and why they should be made the way they're on the table.
SHOW NOTES:
WHU - Otto Beisheim School of Management
WHU Strategic decision making programContact: Need help planning your strategy process? Send an email to christian@underwood.de.
Thanks for your interest, and see you in the next episode…
…because HOPE IS NOT A STRATEGY.