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  • Are Cognitive Biases and Reality Distortion Damaging Your Small Business Decisions?

    We view the world through a range of prisms and distorting “googles”. All of us. In turn we make decisions everyday that affect our lives and small businesses. However we all suffer from cognitive biases that can throw our decision-making off due to reality distortion that we all engage in.

    Tom, The Optimistic Laundry Guy

    Let’s consider Tom, who decided to open up a laundry and dry cleaning shop in his smallish town. He planned well, so he thought, and calculated how much capital he would need to run his business for the first three months. His notion was that it would take three months to establish a large enough loyal clientele to make the business cash flow in in a sustainable way.

    Tom suffers from the OPTIMISM BIAS which, unsurprisingly, results in Tom having an over positive expectation and set of beliefs about his business. Tom is also optimistic in terms of what it will take to develop his clientele, so he invests little in marketing and advertising.

    Normally, optimism, particularly when it is accompanied by determination, and a strong sense of self, can be a valuable state for any entrepreneur.? The problem with Tom’s bias, though is that it’s based on a DISTORTED REALITY, or a reality that could be accurate, but could as easily be wrong.

    And, in Tom’s case it was wrong. His shop suffered through 3 months of poor sales and revenue. Then another month and another month. Eventually Tom closed up his shop, having lost all of his business capital, and had to go back to working in another dry cleaning establishment just to put food on the table.

    Why? Because his optimism bias caused him to plan badly. He failed to market properly or ensure he could weather the storms from poor initial sales. If he planned properly and was not mislead by….well, himself, he could very well have gone on to succeed in spite of initial poor revenue.

    Randy’s Curse of Knowledge Bias

    Randy opened up her own flower shop, and unlike Tom, she didn’t suffer from the optimism bias. She anticipated slow growth by ensuring she had a year’s worth of capital to get her started….maybe a little pessimistic (another bias type), but in the case of working capital better to be conservative.

    Randy needed to hire staff, of course, to help with deliveries, flower arrangements, and other semi-skilled and skilled flower related tasks. She hired several people based on their experience, and then “trained them” to do their jobs the way she wanted. Or so she thought.

    Randy’s problem is called The Curse of Knowledge Bias. She knows her flowers, and is highly skilled in horticulture and flower arranging, and while she hired experienced staff, they didn’t have the breadth and depth of knowledge that she, herself, had. Which wouldn’t have been a problem if Randy realized that her staff weren’t as knowledgable or skilled as she was.

    The result was that the arrangements done by her staff, even though they had been trained a little bit, were sub-standard. Randy wanted to build a reputation of providing arrangements that were both beautiful and cost-effective, but she didn’t realize her staff didn’t really know what that meant. Or at least they didn’t know what Randy meant.

    This slowed her business growth, and lost her a fair number of customers, until she finally figured out that what was easy for her was not easy for everyone. That’s the Curse of Knowledge Bias.

    Her remedy was to double the amount of time training staff, and making sure they actually DID understand what it was she wanted — in other words not to take for granted that their skills and abilities were equivalent to her own.

    The Challenges Of Cognitive Biases and Reality Distortion.

    These biases are universal. We may? not all share the exact same ones, but we all apply these biases to the world around us, and the decisions we make in virtually any context, including how we run our businesses. So, it’s not easy to counter them. Here’s a few of the challenges.

    1. Cognitive biases and distortion are unconscious.
      By and large our biases operate below our thresholds of awareness. We usually do not realize that we are distorting reality according to our biases, and of course, that results in poor decisions, and often puzzlement as to why some of our decisions that seemed so right ended up with disastrous consequences. That said, we can bring our biases into consciousness and challenge them, and as you’ll find in later posts on the topic, that’s critical to improving our decision-making.
    2. There are a lot of cognitive biases.
      Depending on what you count, there are at least 25-30 different cognitive biases that affect our thinking processes. That’s a lot. It’s a lot to monitor, and a lot to track to ensure our own biases are not contaminating our conclusions and decision-making.
    3. Our Biases May Not Be Consistent Across Situations
      You’d think that our biases would operate across situations. It’s “common sense” to think that Optimistic Tom would be optimistic in all things. Or that Randy believes everyone has the same skills, knowledge and understanding across subjects. That would be wrong. It’s entirely possible to be optimistic about some business things, while being pessimistic about relationship things. This makes it harder for us to discern our bias patterns, because they are inconsistent.

    A General Bias Fighting Strategy

    Making better decisions by moving around our cognitive biases involves many of the steps one finds in CRITICAL THINKING models or strategies, so you can’t go wrong by looking at a few of those via Google. Keep in mind that defeating our biases requires a change in mindset, and a change in how we think, away from an unchallenging faith in what we believe to a perspective of understanding that our beliefs can be, and often are going to be somewhat skewed and inaccurate.

    Here are a few things to try.

    1. Challenge Your Assumptions
      We base decisions on a variety of assumptions which we believe are reality. For example, Tom the Optimist believed that he would become self-sustaining within three months, but he really wasn’t basing this on any data or research. It’s just an assumption he made, and one that caused his downfall. Ask yourself: Why do I believe this? Could I be wrong?
    2. Gather Data
      The reason why our assumptions are so dangerous is that they are easily influenced by our biases, rather than being based on data, verifiable information, etc. The more data you have on which to base your decision, the less likely bias would contaminate the decision. So, first identify the kinds of data you need to confirm or disconfirm your assumptions, then go out and find data.
    3. Work To Disconfirm Your Assumptions – Prove Yourself Wrong
      An essential part of a bias fighting strategy is to try hard to disprove your own assumptions and beliefs. We all tend to have a bias towards looking for data that confirms our existing beliefs, so you need to counter-act this bias by trying extra hard to prove that your assumptions are wrong.
    4. Consider Alternative Possibilities
      When you accept that your underlying assumptions for a decision could very easily be wrong, it allows you to look for alternative “truths” that may be more suited to your situation. For example, if Optimistic Tom realized he could be wrong, he could have played out some “what if” scenarios and realized he was walking into trouble.
    5. Consider Consequences of Being Wrong
      Making decisions in business often involves a risk-reward situation. In other words, it’s important to ask: What are the consequences if my assumptions underlying this situation are wrong? Optimistic Tom clearly didn’t do that, being so convinced that he would be self-financing within three months. The consequence? The death of his business, and perhaps his dream.
    6. Get Input From Others With Different Points of View
      When it comes to small business, the owner/executives need to take ownership of their decisions, so its easy feel that its weak to ask others for their opinions. Entrepreneurs tend to be independent sorts who want to make their own decisions, but this it’s risky to rely only on oneself. Asking others for information and opinions can be useful provided you keep an open mind and listen to those opinions. You need not accept them as offered, of course, and remember that others will have their biases, but you may find that advisors’ biases will balance yours.

    What’s Next In Learning To Combat Your Cognitive Biases?

    So far we’ve only discussed a few biases (optimism, and curse of wisdom), but there are many more, and it’s best if you learn about the others.

    In the section (coming soon) on biases, we’ll present to you an explanation of many of the most common cognitive biases along with some examples of how each bias can impact on a small business. Each bias discussion will also include some suggestions regarding how to counter-act that particular bias.

     

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