Heuristics and Decision-Making
What Is A Heuristic And Why Heuristics Matter In Business
Business / By Gennaro Cuofano / May 1, 2024
As highlighted by German psychologist Gerd Gigerenzer in the paper “Heuristic Decision Making,” the term heuristic is of Greek origin, meaning “serving to find out or discover.” More precisely, a heuristic is a fast and accurate way to make decisions in the real world, which is driven by uncertainty.
AspectExplanationDefinitionA heuristic is a mental shortcut or a simplified strategy that individuals use to make judgments, decisions, or solve problems efficiently. It’s a rule or guideline that simplifies complex tasks.PurposeThe primary purpose of heuristics is to speed up decision-making and problem-solving processes by reducing the cognitive load. They provide quick and practical solutions in situations where in-depth analysis may be time-consuming or impractical.Types of HeuristicsThere are several types of heuristics commonly used:
– Availability Heuristic: People judge the likelihood of events based on their availability in memory. If something is more easily recalled, it’s perceived as more common or likely.
– Representativeness Heuristic: This involves categorizing something based on how similar it is to a prototype. If an object or event closely resembles a known prototype, it’s judged as more representative.
– Anchoring and Adjustment Heuristic: People tend to rely on initial information (the anchor) and adjust from there when making judgments.
– Satisficing Heuristic: Rather than seeking the best solution, individuals settle for a satisfactory one.
– Confirmation Bias: People seek information that confirms their existing beliefs or decisions.ProsHeuristics offer several advantages:
– Speed: They allow for quick decision-making and problem-solving.
– Cognitive Efficiency: Heuristics reduce mental effort and simplify complex tasks.
– Adaptability: They can be applied in various situations.
– Simplicity: Heuristics are easy to understand and apply.ConsDespite their benefits, heuristics have limitations:
– Biases: They can lead to cognitive biases, causing errors in judgment.
– Inaccuracy: Heuristics may not always yield accurate or optimal solutions.
– Oversimplification: They can oversimplify complex problems, leading to suboptimal decisions.Common ExamplesEveryday examples of heuristics include:
– Choosing the shortest line at the grocery store checkout.
– Making snap judgments based on first impressions.
– Relying on past experience to make decisions.
– Using stereotypes to assess people or situations.In Decision-MakingHeuristics play a significant role in decision-making processes. They help individuals make choices in situations with limited time and information. However, they can also lead to biases, such as confirmation bias or overconfidence.In Problem-SolvingHeuristics simplify complex problem-solving tasks by breaking them down into manageable steps or focusing on the most relevant information. While this speeds up the process, it may result in suboptimal solutions.Bounded RationalityHeuristics are closely linked to bounded rationality, a concept that suggests that individuals make decisions within the limits of their knowledge, cognitive resources, and time. Heuristics are used to cope with these limitations.CriticismsCritics argue that heuristics can lead to systematic errors and irrational judgments, especially when individuals rely on them excessively. They may not always lead to the best or most rational decisions.ImprovementTo mitigate the potential drawbacks of heuristics, individuals can:
– Be aware of cognitive biases associated with heuristics. – Seek additional information and consider multiple perspectives.
– Use heuristics as a starting point and then engage in more thorough analysis when necessary.In Artificial IntelligenceHeuristics are also used in artificial intelligence and computer science to create algorithms and search strategies that solve problems more efficiently. They help computers make decisions and navigate complex tasks.
Table of Contents
What is a Heuristic? Beyond biases and the prevailing narrowed vision of the mind
In a 1996 paper entitled “Reasoning the Fast and Frugal Way: Models of Bounded Rationality” psychologists Gerd Gigerenzer and Daniel G. Goldstein highlighted:
Humans and animals make inferences about the world under limited time and knowledge. In contrast, many models of rational inference treat the mind as a Laplacean Demon, equipped with unlimited time, knowledge, and computational might.
This is a very important concept to start with. Where modern psychologists and theorists of mind manufacture experiments in the lab, those experiments are tied to specific scenarios, that are hardly replicable in the real world.
Why is that? It all starts with a narrow theory of mind.
A narrow definition of rationality
Experiments are manufactured and often based on assumptions around how our minds work. For instance, if a psychologist will label rationality as the ability to optimize during a decision-making process (just like a machine would do) this requires the mind to gather all the possible information to come to a logical decision.
However, in the real world, decisions are made with incomplete information, a high degree of uncertainty and little to no understanding of what’s coming next. Therefore, when the psychologist mutters about the inability of the human brain to understand statistics or logic. In the real world, that means survival.
If surviving means losing some efficiency or avoiding optimization to prevent massive failure, our mind is working as it should.
Risk vs. Uncertainty
Another component that the conventional or prevailing school of thought is the lack of understanding of the domain in which the human mind is operating. That’s a key point to understand the difference between risk and uncertainty.
Risk is computable
Risk is a concept that analysts love. Why? It’s something that can be modeled. Thus, circumscribed to scenarios that have definite rules, like games. You often see in business books how game theory helped businessmen to be successful.
But that is a story crafted in hindsight. Game theory or your skills as a chess player might help you (in impressing others) in normal circumstances (assuming those exist) but they won’t help you much in the real world. Unless you have an alternative toolbox made of heuristics.
Uncertainty is not computable
When financial analysts evaluate risks they fall into the trap of thinking that we can understand the real world by modeling it. The modern approaches to entrepreneurship try to bring this same logic to the business world, with nefast consequences.
When there is a high variability of outcomes, it’s impossible to model the risk. If at all you need a simple set of rules of thumb to avoid the worst-case scenario because if that materializes that will be no risk-model that will help with that.
Indeed the consequences of an uncertain scenario might be too bad for you to actually even see its outcome because survival is at stake.
Unmodeling the real world
When psychological experiments are made in the lab, often times the psychologist starts with a preconceived idea of the human mind and she works her way back to prove it with an experiment.
When that happens experiments are “manufactured” (in many cases unconsciously) to produce a certain result (in short, biases are more a domain applicable to psychologists than of laypeople dealing with real-world uncertainty).
This has come up recently with what is called a Replication Crisis, which as highlighted on Wikipedia:
The replication crisis (or replicability crisis or reproducibility crisis) is, as of 2019, an ongoing methodological crisis in which it has been found that many scientific studies are difficult or impossible to replicate or reproduce. The replication crisis affects the social sciences and medicine most severely.
Part of this trend is in the use of statistical tools that are not proper for real-world analyses, and the fact that research sometimes turns into an attention-driven activity. As pointed out by Noah Smith in Bloombergs’ “Why ‘Statistical Significance’ Is Often Insignificant:”
In psychology, in medicine, and in some fields of economics, large and systematic searches are discovering that many findings in the literature are spurious. John Ioannidis, professor of medicine and health research at Stanford University, goes so far as to say that “most published research findings are false,” including those in economics. The tendency research journals have of publishing anything with p-values lower than 5 percent — the arbitrary value referred to as “statistical significance” — is widely suspected as a culprit.
To be sure, this is not to say those experiments aren’t valid. Worse than that, in some instances, they carry from the beginning assumptions about the psyche of the subjects that are biased themselves.
In short, the biases that we all talk about nowadays, especially in the business world, in reality, might easily be explained with a theory of mind that goes beyond the conventional definition of rationality.
This definition starts by thinking of our mind as an easily tricked machine, that due to its survival mechanisms isn’t well-adapted anymore to modern times. Thus, it can easily fall prey to dozens if not hundreds of biases that affect our daily lives.
That is we see anywhere today in business publications massive lists of cognitive biases that make us more “aware.”
Heuristics: dirt and quick? Not really!
As highlighted in “Heuristic Decision Making:”
The goal of making judgments more accurately by ignoring information is new. It goes beyond the classical assumption that a heuristic trades off some accuracy for less effort.
The main perspective for which heuristics have been studied and communicated to a mass business audience is through the fact that by definition a heuristic is quick and dirty. In short, our error-prone mind generates biases because we use heuristics that made us sacrifice efficiency for speed in the face of a sort la lazy mechanism of the mind.
According to this view, the mind might ignore important information in an efficiency-driven way, almost like it was optimizing for computing power.
In reality, the mind might have learned that ignoring useless information is a more effective survival mechanism in that specific context. Therefore, focusing on one key data point is way more reliable than taking more information. This completely changes the paradigm.
Where a lazy-driven mind avoids too much information because it’s not computably able to process it (thus sacrificing efficiency for speed almost like it was a computer). In a new paradigm, where heuristics and rules of thumbs become central as a necessary filtering mechanism of the mind that learns ho to ignore useless and irrelevant information.
In short, what matters is the outcome of the action, not the process neither the motivation that drives the process.
Conflict of interests, marketing, and manipulation
New media have enabled companies to communicate at large scale. When this communication is done right we can call it marketing. When that’s done wrong we can call it a conflict of interest or at worst manipulation.
Thus, many of what we call biases are also the consequence of the way the message gets framed to us. In short, it’s like playing a game where one player has to trick the other. As the other player learns the tricks of the first player, new strategies need to be found.
One there is a gap between the trickster and the tricked a bias might emerge as a better ability of the trickster.
Blind faith in technology
While planning a trip back to the city I live in, I was thinking to postpone the trip due to bad weather. While consulting my GPS which optimizes for shorter routes (not certainly for the beauty of the landscape or chances of survival) I risked to get to the end of the trip underwater.
In short, the GPS was giving me the time to destination with a bit of delay but without necessarily mentioning that I was getting there by risking to be flooded!
This blind faith in technology isn’t due to our inability to deal with it. Rather with the way these technologies are framed. When technology is built to optimize, and when it is marketed so that you believe that optimization is what matters in any context (optimization works in narrow ordinary situations) you end up relying too much on it.
The central problem with a two-system thinking model
Theories proposed by psychologists like Kahneman and Tversky have become central in the business world. The book Thinking, Fast And Slow has become a business bible and indeed that is a great read.
Yet the assumptions underlying these theories stand on a hypothetical optimization process humans should follow when making a decision. As highlighted in the paper “Heuristic Decision Making:”
As Kahneman (2003) explained in his Nobel Memorial Lecture: “Our research attempted to obtain a map of bounded rationality, by exploring the systematic biases that separate the beliefs that people have and the choices they make from the optimal beliefs and choices assumed in rational-agent models”
This view might start with a wrong definition and interpretation of bounded rationality formulated by Simon. Bounded rationality is not about systematic biases, it’s about decision-making in the real world, which is unpredictable.
Fast, frugal, yet accurate
Another key concept to internalize to deeply understand this alternative view of bounded rationality is the concept of ecological rationality. Ecological rationality looks for strategies that are better suited for a specific environment and context.
The key point here is that there is no best strategy, or optimization strategy because that would not be possible in a large world made of uncertainty.
Therefore, the rules of thumb we might be able to use for each circumstance will help us take advantage of the structure of the environment we operate within.
Thus in this sort of decision-making process, it is like we do create a small world but highly adapted to context and circumstance, which is the opposite of what classic theories of rationality do, assuming that our mind works in a vacuum, or in a sort of free-context reality.
The two sides of Bounded rationality
Bounded rationality is a concept attributed to Herbert Simon, an economist and political scientist interested in decision-making and how we make decisions in the real world. In fact, he believed that rather than optimizing (which was the mainstream view in the past decades) humans follow what he called satisficing.
Based on what we have said so far, let’s look again at the concept of bounded rationality. According to the definition given by his father, Simon, bounded rationality has two main sides:
ecological
and cognitive
It’s ecological because “the mind is adapted for real-world environments.” Therefore, on the one side, the mind makes decisions based on the structure of the environment. And on the other side, there is the computational capability of the decision-maker (cognitive side).
As highlighted by Gerd Gigerenzer and Wolfgang Gaissmaier in “Heuristic Decision Making modern psychologists have focused their attention on the latter (the cognitive side).
More precisely, the focus on the cognitive side has produced the misunderstanding that as the human mind has limited ability to process information, it produces a set of irreparable biases.
Part of this misunderstanding might be given by the fact that those presumably simple heuristics that the mind uses to solve real-world problems are not sophisticated enough to look interesting to the norms of classical rationality.
The importance of Ecological Rationality
Once you understand the other side of rationality, not the cognitive, but the ecological, it changes everything.
In an ecological rationality sense, less-is-more becomes a powerful heuristic to rely on in many of the real-world scenarios.
Less-is-more is about ignoring cues that not only make us worse decision-makers. It also means that after a certain point more information leads to worse decisions, even when the costs of acquiring that information are zero.
Redefining biases
In the conventional view, a bias is a cognitive error the mind makes, which is due to our lack of understanding of the real world driven by classic rationality. In the alternative way to look at bounded rationality in a decision-making process, it needs to balance out bias and flexibility to produce overall an inference which is more effective than a system that has no biases at all!
In that scenario, less information, ignoring a big chunk of noisy information and make “biased decisions” might lead to better decision-making.
Building an adaptive toolbox for entrepreneurs
Once you understand all the principles highlighted above, you start tinkering with simple algorithms, that we can call heuristics, extremely useful for the businessman who doesn’t want to fall trap of complex thinking for the sake of it.
The FourWeekMBA analysis and study into this adaptive toolbox has just started, and we’ll be looking more and more into a set of simple heuristics to use in different contexts, by starting from when it makes sense to use them in the first place.
There are a few contexts in the business world where gathering more information, data and complex models can indeed help build a successful company (like at an operational level). But there are many other places (strategy and vision) where those complex systems not only do not work but are harmful.
For the sake of having a better toolbox for directing your business in the right direction, we’ll continue our investigation!
Case Studies
Recognition Heuristic: This is a simple rule: If one of two objects is recognized and the other is not, then infer that the recognized object has the higher value with respect to the criterion. For example, if someone has to pick a city to visit and recognizes one city but not the other, they might choose the recognized city assuming it’s more popular or significant.
Take-the-Best Heuristic: When making a decision, this heuristic prompts individuals to select the option that scores highest on the most important criterion, ignoring all others. For instance, when choosing a car, if fuel efficiency is the most important criterion, one might select the car with the best fuel efficiency without considering other factors like price or safety.
Satisficing: This term, coined by Herbert Simon, means searching through available options until an acceptability threshold is met. It’s the middle ground between settling for the first acceptable option and holding out for the best possible option. For instance, when hungry, someone might choose a restaurant that’s “good enough” rather than spending hours looking for the best one.
Anchoring and Adjustment: When making decisions, we often start from an initial value (the anchor) and then adjust away from that anchor. For example, if you’re negotiating a salary and the employer offers $50,000, that number becomes the anchor. You might counter with $55,000, adjusting from the initial anchor, rather than asking for, say, $70,000.
Framing Effect: Decisions can be influenced by how choices are presented. For example, meat labeled “75% lean” is more likely to be chosen than meat labeled “25% fat,” even though they mean the same thing.
Endowment Effect: People tend to overvalue things simply because they own them. For instance, someone trying to sell a used car might price it higher than its market value just because it’s theirs.
Default Effect: People are more likely to choose a default option when one is provided. This is why many software installations come with certain options pre-selected, or why organ donation rates are higher in countries with opt-out systems.
Paralysis by Analysis: Having too much information can lead to decision paralysis, where the individual becomes overwhelmed and struggles to make a choice. This is where the “less-is-more” heuristic can come in handy, prompting one to make a decision based on fewer, more critical factors.
Escalation of Commitment: Sometimes, people continue a behavior or endeavor as a result of previously invested resources (time, money, or effort), even if it’s not the best decision. Recognizing this bias can help individuals avoid throwing good money after bad.
Authority Heuristic: We often trust the judgment of experts or authority figures, even if we haven’t critically evaluated their advice. For instance, someone might buy a product because a celebrity endorsed it.
Consistency Heuristic: People prefer to be consistent in their attitudes and choices. If someone publicly commits to a goal (like losing weight), they’re more likely to stick to it to remain consistent with their commitment.
Contrast Effect: Our perception of a decision can be altered based on a comparison. For example, if you see a shirt for $100 and then see a similar one for $50, the second one seems cheap by contrast.
Mood and Decision Making: Our emotional state can influence our decisions. When happy, people may be more prone to take risks. Recognizing this can help in ensuring decisions aren’t purely emotion-driven.
Key Highlights:
Heuristics are fast and accurate decision-making strategies used in the real world to cope with uncertainty and limited time and knowledge.
The prevailing narrow theory of mind in traditional psychological experiments leads to a narrow definition of rationality, assuming unlimited time, knowledge, and computational capabilities.
In the real world, decisions are made with incomplete information, high uncertainty, and little understanding of future outcomes, which is crucial for survival.
The conventional view distinguishes risk (computable) from uncertainty (uncomputable), but in uncertain scenarios, heuristics become more reliable than attempting to optimize.
Psychological experiments may be influenced by preconceived ideas of how the human mind works, leading to the replication crisis where many scientific studies are difficult to reproduce.
Heuristics are not just quick and dirty shortcuts but can be effective ways of decision-making in specific contexts, following the concept of ecological rationality.
Less-is-more is an important heuristic that suggests ignoring useless information can lead to better decision-making in uncertain environments.
Biases and heuristics can balance out to produce overall better decision-making, challenging the notion that biases are solely cognitive errors.
Building an adaptive toolbox of simple heuristics can help entrepreneurs make effective decisions in various business contexts.
Blind faith in technology can be problematic, as relying solely on optimization-oriented technologies may lead to suboptimal outcomes in uncertain situations.
Bounded rationality has two main sides: ecological (mind adapted for real-world environments) and cognitive (computational capability of the decision-maker).
Understanding ecological rationality allows for better decision-making by relying on heuristics suited for specific environments and contexts.
The alternative view of bounded rationality emphasizes the use of simple heuristics as a necessary filtering mechanism of the mind to ignore useless and irrelevant information.
The mind’s ability to ignore information can be an effective survival mechanism and lead to better decision-making in uncertain situations.
By adopting heuristics and simple rules of thumb, entrepreneurs can develop a more effective decision-making approach in the face of uncertainty.
Recognizing biases and heuristics in communication and marketing can help avoid manipulation and conflict of interests.
Heuristics provide an adaptive toolbox for decision-making that is better suited for uncertain environments than complex models and optimization-oriented approaches.
List of Heuristics
HeuristicExplanationImplicationsPrevention StrategiesWhen to LeverageExamplesAnchoringRelying on the first piece of information encountered (the “anchor”) when making decisions.May lead to biased judgments if the anchor is arbitrary.Be aware of anchoring effects and consider multiple anchors.In negotiations, set the initial offer.Setting a high price for a product before discounting.AvailabilityJudging likelihood based on ease of recall or availability of related examples in memory.Overestimating the probability of events that receive more media coverage.Be critical of media influence and seek diverse sources of information.When assessing personal experiences.Believing a plane crash is more common after hearing about one on the news.Confirmation BiasSeeking information that confirms existing beliefs while ignoring contradictory information.Can reinforce stereotypes and hinder objective decision-making.Actively seek out opposing viewpoints and diverse sources of information.When conducting research or analyzing data.Believing a diet works because you only read success stories.Sunk Cost FallacyContinuing an endeavor based on prior investments (e.g., time, money), even when not rational.Can lead to wasteful decisions and perpetuate failing projects.Evaluate decisions based on future costs and benefits, not past investments.When considering whether to continue a project.Staying in a failing business to “recoup” losses.Hindsight BiasBelieving an event was predictable or expected after it has already occurred.Hinders learning from past mistakes and impacts decision-making.Reflect on decisions without the benefit of hindsight when evaluating outcomes.During post-project reviews.Thinking that a stock market crash was predictable after it happens.Loss AversionPreferring to avoid losses over acquiring equivalent gains, leading to risk aversion.May lead to missed opportunities and conservative decision-making.Recognize loss aversion tendencies and assess risks objectively.When considering investment decisions.Avoiding stock market investments due to fear of losing money.OverconfidenceOverestimating one’s abilities, knowledge, or the accuracy of one’s beliefs and predictions.The tendency to overestimate one’s own abilities or the accuracy of one’s beliefs and predictions.Encourage critical self-assessment and seek external feedback.When planning and assessing personal skills.Believing you’re a better driver than others despite data to the contrary.Recency EffectGiving more importance to recent events or information when making decisions.May lead to overlooking long-term trends and making impulsive choices.Balance recent data with historical context and trends.In investment decisions, consider long-term performance.Buying a stock because it performed well recently.Framing EffectDecisions can be influenced by how information is presented or framed.Different framings can lead to varying perceptions and choices.Be aware of framing effects and consider different perspectives.When crafting persuasive messages.A health campaign emphasizing “90% fat-free” vs. “10% fat” yogurt.Prospect TheoryEvaluating potential outcomes based on perceived gains and losses rather than final states.People evaluate potential outcomes based on perceived gains and losses rather than final states.Use objective data and consider outcomes in terms of overall utility.When designing incentive programs.Offering insurance with a focus on avoiding potential losses.Status Quo BiasThe preference for the current state of affairs and the resistance to change.Can lead to missed opportunities for improvement and innovation.Encourage regular evaluation and a willingness to consider change.When assessing organizational processes.Sticking to an old software system despite better alternatives.GroupthinkThe tendency of a group to make decisions without critical evaluation due to a desire for consensus and conformity.Can lead to poor decisions when diverse perspectives are not considered.Encourage open and dissenting opinions within group discussions.During team decision-making processes.Going along with a group’s decision to maintain harmony.Availability CascadeA self-reinforcing process where a belief or idea becomes more credible and influential simply because it’s repeated frequently.Can lead to the spread of misinformation and irrational beliefs.Encourage critical thinking and fact-checking in the face of widely repeated claims.When evaluating the credibility of information.Believing a false rumor because it’s widely shared on social media.Anchoring and AdjustmentPeople start with an initial estimate (the anchor) and then adjust it to reach a final decision.Anchors can bias judgment, leading to inaccurate estimates.Be aware of the anchor’s influence and adjust away from it if necessary.In negotiations and pricing decisions.Offering a high-priced item as a starting point for negotiation.The Planning FallacyThe tendency to underestimate the time, costs, and risks of future actions and overestimate the benefits.Can lead to project delays, budget overruns, and disappointment.Use historical data and consider potential risks when planning projects.When estimating project timelines and budgets.Underestimating the time needed to complete a construction project.Regression to the MeanThe tendency for extreme events or measurements to return to a more average state over time.Can lead to misinterpretation of natural fluctuations as trends or interventions.Recognize that extreme results are often followed by more typical ones.When analyzing performance data.Assuming a sports team will continue winning after a streak of victories.Cognitive DissonanceThe discomfort people feel when they hold conflicting beliefs or engage in actions that are inconsistent with their beliefs.Can lead to rationalization and resistance to changing beliefs or behaviors.Encourage reflection and openness to adjusting beliefs or behaviors.When promoting behavior change or diversity of thought.Smoking despite knowing the health risks because quitting is difficult.Representativeness HeuristicJudging the probability of an event based on how similar it is to a prototype.Can lead to stereotyping and misjudgments if prototypes are not representative.Use statistical information in addition to resemblance when making judgments.When making predictions based on patterns.Assuming a person is a good programmer because they fit the “nerd” stereotype.Fundamental Attribution ErrorThe tendency to attribute the behavior of others to their character while attributing our own behavior to external factors.Can lead to misjudgments about the motivations and intentions of others.Practice empathy and consider situational factors when judging others.When evaluating the actions of individuals or groups.Blaming a coworker for a mistake while attributing your own mistakes to external pressures.Illusory CorrelationPerceiving a relationship between two variables when none exists or overestimating the strength of a real but weak relationship.Can lead to superstitions and inaccurate beliefs about cause and effect.Encourage objective analysis and critical thinking when evaluating correlations.When interpreting data or research findings.Believing that a lucky charm improves sports performance based on anecdotal evidence.The Endowment EffectThe tendency to overvalue items simply because you own them.Can lead to inflated valuations and resistance to selling or exchanging possessions.Recognize the bias and consider the objective value of items when making decisions.When pricing personal belongings for sale.Valuing a used car much higher just because it’s yours.Hyperbolic DiscountingThe tendency to prioritize immediate rewards over larger, delayed rewards.Can lead to impulsive decision-making and neglecting long-term goals.Implement strategies like pre-commitment to make future rewards more salient.When setting savings or investment goals.Choosing to spend money on entertainment rather than saving for retirement.The Curse of KnowledgeAssuming that others have the same level of knowledge or understanding as oneself.Can lead to ineffective communication and difficulty teaching or explaining concepts.Practice empathy and adapt your communication to the audience’s level of knowledge.When explaining complex ideas or concepts.Using jargon when explaining a technical concept to a non-expert.Escalation of CommitmentThe tendency to continue investing in a decision or project, despite evidence of failure.Can lead to persistent, irrational investment of resources.Establish clear criteria for success and be willing to cut losses when those criteria aren’t met.When managing a failing project.Pouring more money into a failing business despite declining performance.The Curse of Sunk CostsThe inability to ignore past costs when making decisions.Can lead to irrational decisions to justify past investments.Evaluate decisions based on future costs and benefits, not past investments.When deciding whether to continue a project.Continuing to attend an expensive, unenjoyable event to “get your money’s worth.”Anchoring to Initial BeliefsThe tendency to anchor one’s beliefs or judgments to initial information, even if it’s inaccurate.Can lead to stubbornness and resistance to changing one’s mind when presented with new evidence.Encourage open-mindedness and a willingness to adjust beliefs based on new information.When engaged in debates or discussions.Holding onto a political belief despite evidence to the contrary because it was your initial stance.The Just-World HypothesisThe belief that the world is inherently fair, and people get what they deserve.Can lead to victim-blaming and insensitivity to the struggles of others.Recognize that the world is complex, and circumstances often play a significant role in outcomes.When discussing social justice issues.Blaming a homeless person for their situation based on the assumption that they must have done something to deserve it.The Availability HeuristicEstimating the likelihood of an event based on its ease of recall from memory.Can lead to misjudgments if memorable events don’t accurately represent probabilities.Cross-reference information with objective data to reduce reliance on memory alone.When assessing risk or probabilities.Overestimating the risk of shark attacks after seeing a news story about one.The Dunning-Kruger EffectThe cognitive bias where people with low ability at a task overestimate their ability, while those with high ability underestimate their ability.Can lead to overconfidence and incompetence in some cases.Encourage self-awareness and humility in assessing one’s own skills and knowledge.When seeking self-improvement or providing feedback.Someone with limited knowledge about a subject believing they are an expert.The Zeigarnik EffectThe tendency to remember uncompleted tasks or interrupted activities better than completed tasks.Can lead to intrusive thoughts and decreased focus on current tasks.Use task management strategies to reduce the mental load of unfinished tasks.When organizing your work or managing your to-do list.Remembering to buy groceries that you left off your last shopping trip.
References:
Reasoning the Fast and Frugal Way: Models of Bounded Rationality, Gerd Gigerenzer and Daniel G. Goldstein, Max Planck Institute for Psychological Research and University of Chicago, Psychological Review Copyright 1996 by the American Psychological Association, Inc. 1996, Vol. 103. No. 4, 650-669
Heuristic Decision Making, Gerd Gigerenzer and Wolfgang Gaissmaier, Annu. Rev. Psychol. 2011. 62:451–82
Simon, Herbert, 1983. “On the Behavioral and Rational Foundation of Economic Theory,” Working Paper Series 115, Research Institute of Industrial Economics.
Simon, Herbert A., 1978. “Rational Decision-Making in Business Organizations,” Nobel Prize in Economics documents 1978-1, Nobel Prize Committee.
Read Next: Heuristics, Biases.
Other business resources:
Read Next: Heuristics, Biases.
Connected Thinking Frameworks
Convergent vs. Divergent Thinking
Convergent thinking occurs when the solution to a problem can be found by applying established rules and logical reasoning. Whereas divergent thinking is an unstructured problem-solving method where participants are encouraged to develop many innovative ideas or solutions to a given problem. Where convergent thinking might work for larger, mature organizations where divergent thinking is more suited for startups and innovative companies.
Critical thinking involves analyzing observations, facts, evidence, and arguments to form a judgment about what someone reads, hears, says, or writes.
The concept of cognitive biases was introduced and popularized by the work of Amos Tversky and Daniel Kahneman in 1972. Biases are seen as systematic errors and flaws that make humans deviate from the standards of rationality, thus making us inept at making good decisions under uncertainty.
Second-order thinking is a means of assessing the implications of our decisions by considering future consequences. Second-order thinking is a mental model that considers all future possibilities. It encourages individuals to think outside of the box so that they can prepare for every and eventuality. It also discourages the tendency for individuals to default to the most obvious choice.
Lateral thinking is a business strategy that involves approaching a problem from a different direction. The strategy attempts to remove traditionally formulaic and routine approaches to problem-solving by advocating creative thinking, therefore finding unconventional ways to solve a known problem. This sort of non-linear approach to problem-solving, can at times, create a big impact.
Bounded rationality is a concept attributed to Herbert Simon, an economist and political scientist interested in decision-making and how we make decisions in the real world. In fact, he believed that rather than optimizing (which was the mainstream view in the past decades) humans follow what he called satisficing.
The Dunning-Kruger effect describes a cognitive bias where people with low ability in a task overestimate their ability to perform that task well. Consumers or businesses that do not possess the requisite knowledge make bad decisions. What’s more, knowledge gaps prevent the person or business from seeing their mistakes.
Occam’s Razor states that one should not increase (beyond reason) the number of entities required to explain anything. All things being equal, the simplest solution is often the best one. The principle is attributed to 14th-century English theologian William of Ockham.
The Lindy Effect is a theory about the ageing of non-perishable things, like technology or ideas. Popularized by author Nicholas Nassim Taleb, the Lindy Effect states that non-perishable things like technology age – linearly – in reverse. Therefore, the older an idea or a technology, the same will be its life expectancy.
Antifragility was first coined as a term by author, and options trader Nassim Nicholas Taleb. Antifragility is a characteristic of systems that thrive as a result of stressors, volatility, and randomness. Therefore, Antifragile is the opposite of fragile. Where a fragile thing breaks up to volatility; a robust thing resists volatility. An antifragile thing gets stronger from volatility (provided the level of stressors and randomness doesn’t pass a certain threshold).
Ergodicity is one of the most important concepts in statistics. Ergodicity is a mathematical concept suggesting that a point of a moving system will eventually visit all parts of the space the system moves in. On the opposite side, non-ergodic means that a system doesn’t visit all the possible parts, as there are absorbing barriers
Systems thinking is a holistic means of investigating the factors and interactions that could contribute to a potential outcome. It is about thinking non-linearly, and understanding the second-order consequences of actions and input into the system.
Vertical thinking, on the other hand, is a problem-solving approach that favors a selective, analytical, structured, and sequential mindset. The focus of vertical thinking is to arrive at a reasoned, defined solution.
Metaphorical thinking describes a mental process in which comparisons are made between qualities of objects usually considered to be separate classifications. Metaphorical thinking is a mental process connecting two different universes of meaning and is the result of the mind looking for similarities.
Maslow’s Hammer, otherwise known as the law of the instrument or the Einstellung effect, is a cognitive bias causing an over-reliance on a familiar tool. This can be expressed as the tendency to overuse a known tool (perhaps a hammer) to solve issues that might require a different tool. This problem is persistent in the business world where perhaps known tools or frameworks might be used in the wrong context (like business plans used as planning tools instead of only investors’ pitches).
The Peter Principle was first described by Canadian sociologist Lawrence J. Peter in his 1969 book The Peter Principle. The Peter Principle states that people are continually promoted within an organization until they reach their level of incompetence.
The straw man fallacy describes an argument that misrepresents an opponent’s stance to make rebuttal more convenient. The straw man fallacy is a type of informal logical fallacy, defined as a flaw in the structure of an argument that renders it invalid.
The Google effect is a tendency for individuals to forget information that is readily available through search engines. During the Google effect – sometimes called digital amnesia – individuals have an excessive reliance on digital information as a form of memory recall.
The Streisand Effect is a paradoxical phenomenon where the act of suppressing information to reduce visibility causes it to become more visible. In 2003, Streisand attempted to suppress aerial photographs of her Californian home by suing photographer Kenneth Adelman for an invasion of privacy. Adelman, who Streisand assumed was paparazzi, was instead taking photographs to document and study coastal erosion. In her quest for more privacy, Streisand’s efforts had the opposite effect.
Single-attribute choices – such as choosing the apartment with the lowest rent – are relatively simple. However, most of the decisions consumers make are based on multiple attributes which complicate the decision-making process. The compromise effect states that a consumer is more likely to choose the middle option of a set of products over more extreme options.
In business, the butterfly effect describes the phenomenon where the simplest actions yield the largest rewards. The butterfly effect was coined by meteorologist Edward Lorenz in 1960 and as a result, it is most often associated with weather in pop culture. Lorenz noted that the small action of a butterfly fluttering its wings had the potential to cause progressively larger actions resulting in a typhoon.
The IKEA effect is a cognitive bias that describes consumers’ tendency to value something more if they have made it themselves. That is why brands often use the IKEA effect to have customizations for final products, as they help the consumer relate to it more and therefore appending to it more value.
The Ringelmann effect describes the tendency for individuals within a group to become less productive as the group size increases.
The overview effect is a cognitive shift reported by some astronauts when they look back at the Earth from space. The shift occurs because of the impressive visual spectacle of the Earth and tends to be characterized by a state of awe and increased self-transcendence.
The house money effect was first described by researchers Richard Thaler and Eric Johnson in a 1990 study entitled Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice. The house money effect is a cognitive bias where investors take higher risks on reinvested capital than they would on an initial investment.
As highlighted by German psychologist Gerd Gigerenzer in the paper “Heuristic Decision Making,” the term heuristic is of Greek origin, meaning “serving to find out or discover.” More precisely, a heuristic is a fast and accurate way to make decisions in the real world, which is driven by uncertainty.
The recognition heuristic is a psychological model of judgment and decision making. It is part of a suite of simple and economical heuristics proposed by psychologists Daniel Goldstein and Gerd Gigerenzer. The recognition heuristic argues that inferences are made about an object based on whether it is recognized or not.
The representativeness heuristic was first described by psychologists Daniel Kahneman and Amos Tversky. The representativeness heuristic judges the probability of an event according to the degree to which that event resembles a broader class. When queried, most will choose the first option because the description of John matches the stereotype we may hold for an archaeologist.
The take-the-best heuristic is a decision-making shortcut that helps an individual choose between several alternatives. The take-the-best (TTB) heuristic decides between two or more alternatives based on a single good attribute, otherwise known as a cue. In the process, less desirable attributes are ignored.
The bundling bias is a cognitive bias in e-commerce where a consumer tends not to use all of the products bought as a group, or bundle. Bundling occurs when individual products or services are sold together as a bundle. Common examples are tickets and experiences. The bundling bias dictates that consumers are less likely to use each item in the bundle. This means that the value of the bundle and indeed the value of each item in the bundle is decreased.
The Barnum Effect is a cognitive bias where individuals believe that generic information – which applies to most people – is specifically tailored for themselves.
The anchoring effect describes the human tendency to rely on an initial piece of information (the “anchor”) to make subsequent judgments or decisions. Price anchoring, then, is the process of establishing a price point that customers can reference when making a buying decision.
The decoy effect is a psychological phenomenon where inferior – or decoy – options influence consumer preferences. Businesses use the decoy effect to nudge potential customers toward the desired target product. The decoy effect is staged by placing a competitor product and a decoy product, which is primarily used to nudge the customer toward the target product.
Commitment bias describes the tendency of an individual to remain committed to past behaviors – even if they result in undesirable outcomes. The bias is particularly pronounced when such behaviors are performed publicly. Commitment bias is also known as escalation of commitment.
First-principles thinking – sometimes called reasoning from first principles – is used to reverse-engineer complex problems and encourage creativity. It involves breaking down problems into basic elements and reassembling them from the ground up. Elon Musk is among the strongest proponents of this way of thinking.
The ladder of inference is a conscious or subconscious thinking process where an individual moves from a fact to a decision or action. The ladder of inference was created by academic Chris Argyris to illustrate how people form and then use mental models to make decisions.
Goodhart’s Law is named after British monetary policy theorist and economist Charles Goodhart. Speaking at a conference in Sydney in 1975, Goodhart said that “any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.” Goodhart’s Law states that when a measure becomes a target, it ceases to be a good measure.
The Six Thinking Hats model was created by psychologist Edward de Bono in 1986, who noted that personality type was a key driver of how people approached problem-solving. For example, optimists view situations differently from pessimists. Analytical individuals may generate ideas that a more emotional person would not, and vice versa.
The Mandela effect is a phenomenon where a large group of people remembers an event differently from how it occurred. The Mandela effect was first described in relation to Fiona Broome, who believed that former South African President Nelson Mandela died in prison during the 1980s. While Mandela was released from prison in 1990 and died 23 years later, Broome remembered news coverage of his death in prison and even a speech from his widow. Of course, neither event occurred in reality. But Broome was later to discover that she was not the only one with the same recollection of events.
The crowding-out effect occurs when public sector spending reduces spending in the private sector.
The bandwagon effect tells us that the more a belief or idea has been adopted by more people within a group, the more the individual adoption of that idea might increase within the same group. This is the psychological effect that leads to herd mentality. What in marketing can be associated with social proof.
Moore’s law states that the number of transistors on a microchip doubles approximately every two years. This observation was made by Intel co-founder Gordon Moore in 1965 and it become a guiding principle for the semiconductor industry and has had far-reaching implications for technology as a whole.
Disruptive innovation as a term was first described by Clayton M. Christensen, an American academic and business consultant whom The Economist called “the most influential management thinker of his time.” Disruptive innovation describes the process by which a product or service takes hold at the bottom of a market and eventually displaces established competitors, products, firms, or alliances.
Value migration was first described by author Adrian Slywotzky in his 1996 book Value Migration – How to Think Several Moves Ahead of the Competition. Value migration is the transferal of value-creating forces from outdated business modelsto something better able to satisfy consumer demands.
The bye-now effect describes the tendency for consumers to think of the word “buy” when they read the word “bye”. In a study that tracked diners at a name-your-own-price restaurant, each diner was asked to read one of two phrases before ordering their meal. The first phrase, “so long”, resulted in diners paying an average of $32 per meal. But when diners recited the phrase “bye bye” before ordering, the average price per meal rose to $45.
Groupthink occurs when well-intentioned individuals make non-optimal or irrational decisions based on a belief that dissent is impossible or on a motivation to conform. Groupthink occurs when members of a group reach a consensus without critical reasoning or evaluation of the alternatives and their consequences.
A stereotype is a fixed and over-generalized belief about a particular group or class of people. These beliefs are based on the false assumption that certain characteristics are common to every individual residing in that group. Many stereotypes have a long and sometimes controversial history and are a direct consequence of various political, social, or economic events. Stereotyping is the process of making assumptions about a person or group of people based on various attributes, including gender, race, religion, or physical traits.
Murphy’s Law states that if anything can go wrong, it will go wrong. Murphy’s Law was named after aerospace engineer Edward A. Murphy. During his time working at Edwards Air Force Base in 1949, Murphy cursed a technician who had improperly wired an electrical component and said, “If there is any way to do it wrong, he’ll find it.”
Law of Unintended Consequences
The law of unintended consequences was first mentioned by British philosopher John Locke when writing to parliament about the unintended effects of interest rate rises. However, it was popularized in 1936 by American sociologist Robert K. Merton who looked at unexpected, unanticipated, and unintended consequences and their impact on society.
Fundamental attribution error is a bias people display when judging the behavior of others. The tendency is to over-emphasize personal characteristics and under-emphasize environmental and situational factors.
Outcome bias describes a tendency to evaluate a decision based on its outcome and not on the process by which the decision was reached. In other words, the quality of a decision is only determined once the outcome is known. Outcome bias occurs when a decision is based on the outcome of previous events without regard for how those events developed.
Hindsight bias is the tendency for people to perceive past events as more predictable than they actually were. The result of a presidential election, for example, seems more obvious when the winner is announced. The same can also be said for the avid sports fan who predicted the correct outcome of a match regardless of whether their team won or lost. Hindsight bias, therefore, is the tendency for an individual to convince themselves that they accurately predicted an event before it happened.