Friday, January 21, 2011

Behavioral Distortions in Strategy

Behavioral economics focuses on the irrationalities of so called ‘Homo Economicus’. Though a relatively new branch of economics that has evolved over close to four decades, behavioural economics has gained currency in our understanding of what goes on behind economic decision making process. Executives shaping the strategy of corporations recognise the importance of introducing the concepts of behavioural economics into the strategic decision making process. There have been significant volume of academic and empirical research that show that there are cognitive biases- systematic tendencies to deviate from rational calculations,  influencing our decision making process at an individual level and consequently at a broad corporate level. Some of these biases creep into the ‘system’ even when we are aware of its presence. There are tools prescribed by researchers and academicians that can help eliminate these biases to a great extent and render decision processes robust if not error free. The impact of behavioural economics on the strategic positioning of a company and the strategic choices that it makes is not fully understood though currently as a research area it enjoys a lot of attention. Cognitive biases apply to issues like resource allocation, market entry or exit decisions, mergers and acquisitions, a key technological choice, a new product launch.  The strategic positioning of a company is the outcome of such decisions. Therefore, at one level behavioural economics impacts the strategy and competitive positioning of a company in a very direct manner. Understanding and measuring that impact would allow executives to take improved strategic decisions.

Strategic decisions involve some fact gathering and analysis. It relies on the insights and judgment of a number of executives (a number sometimes as small as one). And it is reached after a process—sometimes very formal, sometimes completely informal—turning the data and judgment into a decision. Though companies vary in processes - there are some key elements in robust decision making processes generally observed. These elements are:-
1.      1. Assessment: forecasting demand and competitor reaction, assessing own capabilities, and tailoring the evaluation approach to the specific decision etc.
2.     2. Process: Gathering all critical information for the decision makers, giving floor to dissenting voices, comments from people from unrelated fields etc.
3.       3. Focus on targets: Resource allocation, aligning targets and incentives, fixing short term and long term goals etc.

However, such well-crafted strategy is often found wanting in terms of delivery of satisfactory outcome. Such failures result in loss of initiative and resources. It would be a worthwhile exercise to explore the biases in executive decisions and its impact on overall strategy of the firm. And also quantify the financial benefits of processes that ‘debias’ strategic decisions and help corporations to strategically position themselves more accurately and effectively.

Strategy is often the game changer; right strategy taking a corporation to a position of eminence and the wrong one causing downfall. It can be safely said that strategy is a result of a complex decision making process fraught with irrationality and biases. Understanding and correcting these biases will have enormous impact on the competitive positioning and success of a corporation. 

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