Director: Corporate-911
We are living in uncertain times. The level of disruption that companies have experienced in the last two years (2020 and 2021) is unprecedented and has taken many companies by surprise. This disruption has also never been experienced by most of the business leaders who are currently at the helm of companies; the result of this is that they are uncertain about how they can address the current challenges that they are facing in the best possible way.
The future outlook of addressing this disruption is not getting any better. The war between Russia and the Ukraine is starting to apply a significant strangle hold on industries. Who would have thought that pubs in the UK would be facing financial distress because of the energy crisis that the country is currently experiencing?
How do companies plan for the future when faced with this disruption? CEOs are facing increasing pressure from boards and company shareholders to increase profitability. This needs to be done off the back of extensive market research and meticulous planning. Uncertain projections is something CEOs do not want to face.
I recently read an article on the Harvard Business Review (HBR) website which discusses this in more detail.
Think in Expected Values
The article points out that the essence of rationality is selecting the course of action with the highest expected value. Computing expected value is as easy as multiplying the value by its probability. For example, the expected value of a gamble that pays $20 with 50% probability is $10. If you could play this gamble every day of your life at a cost of $9, you would come out ahead in the long run. You should take the chance every day, even though half the time you would lose $9. On losing days, you may feel sad that you got unlucky, but you need not regret your choice to play; it was a good choice, given what you knew at the time you made the choice.
Jeff Bezos pitched early investment in Amazon.com using the logic of expected value. He saw a large potential upside of his online retail business, but also acknowledged substantial risk. He warned early investors that there was a 70% chance he would fail and their investment would become worthless. But the potential rewards attached to that 30% chance of success, he argued, was enough to outweigh the 70% chance of failure. In fact, a dollar invested in Amazon.com when the company went public in 1997 would be worth $1,840 today. Let’s say that, at the time of the IPO, there was a 70% chance of failure and a 30% chance of a return of $1,840 for a dollar’s investment. That would give a dollar’s investment an expected value of $552 (which is $1,870 multiplied by 30%). That expected value makes investment a good idea.
The logic underlying expected values acknowledges that the future is uncertain and our decisions should reflect that. Some of the uncertainty in the world is simply irreducible. It is folly, for instance, to pretend you can predict the coin flip or the roulette wheel. Likewise, many of the social and economic systems in which we operate are sufficiently complex that it is functionally impossible to predict their operations perfectly.
The article adds that history is replete with confident forecasts from smart people that, in retrospect, look ridiculous. Take, for example, Apple Computer co-founder Steve Wozniak’s pessimistic prediction in 1985: “the home computer may be going the way of video games, which are a dying fad. For most personal tasks…paper works just as well as a computer, and costs less.” Or consider Stanford Professor Paul Ehrlich’s gloomy forecast in his 1968 best-seller, The Population Bomb, that the world would run out of food and “hundreds of millions of people are going to starve to death” in the 1970s. In a complex world, we should forecast with humility. Give up on the pretense that you can anticipate precisely what will happen. Usually, though, the answer isn’t to just shrug your shoulders and say “I have no idea what will happen.” Instead, think about the range of possibilities and the likelihoods of each. Explicitly considering how you might be wrong can help you be more humble.
We often ask participants in our studies to report their confidence in different ways. One matches the way we are most often invited to forecast the future: They report a best guess and their confidence in it. For instance, we ask them to estimate the high temperature, one month out, in the city where they live. When asked this way, across studies, people on average claim to be about 70% confident that the actual temperature will be within 5 degrees of their guess, even though they are only right 30% of the time.
A second way to forecast is to estimate the likelihood of each of several possibilities. For instance, I can break the range of likely temperatures into a set of ranges, each 10 degrees wide. When people estimate these likelihoods, the highest probability assigned to any 10-degree range is lower — typically a bit below 50%. Now that’s still overconfident relative to their 30% hit rate, but it’s a lot better.
Use the Wisdom of the Crowd
the HBR article points out that even experts tend to have too much confidence in their estimates, and most of us have too much confidence that we can find the right expert. The Wall Street Journal asks expert economists to predict key economic outcomes for the upcoming year. There is huge variation in their predictions. How should you use the distribution of expert forecasts? Many would use the advice of the top expert. That’s basically what the ancient Greek philosopher Socrates advocated:
First of all, ask whether there is any one of us who has knowledge of that about which we are deliberating? If there is, let us take his advice, though he be one only, and not mind the rest.
A different approach relies on the wisdom of crowds. In his 2004 book on popularizing that idea, James Surowiecki argued that simple rules of aggregating judgments within a group — including using a mean or median, or majority vote for yes/no decisions — typically outperform more complex decision-making strategies. Business professor Rick Larrick and his colleagues show the benefits of a “select-crowd” strategy, which consists of choosing a small number of expert individuals and averaging their opinions. Averaging the estimates of all of the economists in the WSJ survey is a better strategy than selecting the estimate of the best predictor from the previous year. But averaging the top five predictors from the previous year outperforms a simple average all of the economists’ opinions.
The article adds that it is our craving for certainty that leads us to chase a single expert, the one who can make perfect predictions. And this craving also makes us vulnerable to charlatans who lie to us and pretend they know; or worse yet, those megalomaniacs so overconfident that they sincerely believe they know. Beware the leader, entrepreneur, or political candidate who claims certainty about an uncertain future. They reveal more arrogance than insight.
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Calibrate Your Confidence
The article points out that many self-help and business books could leave you with the impression that your challenge in life is to maximize your confidence. Shouldn’t you want to be optimistic? “One of the most important qualities of a good leader is optimism,” Disney CEO Robert Iger wrote in his 2019 memoir, The Ride of a Lifetime. “People are not motivated or energized by pessimists.” Our advice to accept uncertainty could make you look indecisive or, worse yet, pessimistic. Good leaders should strive for confidence, right?
Wrong. Striving for maximum confidence can lead to all sorts of bad decisions. Overconfidence about your future earnings could lead you to spend more than you have. Overconfidence about your invincibility might lead you to take risks that could shorten your life expectancy. Overconfidence about your popularity can lead you to behave in annoying and offensive ways. Overconfidence about your success can undermine investment in the effort required to achieve it.
Good expected value calculations require accurate estimates of both the probability and the payoff of different options. That is not easy when wishful thinking leads you to overestimate the probability of desirable outcomes. Conversely, if you are a defensive pessimist, you may be tempted to overestimate the risk of disaster, so as to motivate yourself to avoid it. Both are biases you should try to banish from your expected value calculations. You want accuracy. Once you have calculated both value and probability as faithfully as possible, then you can consider your attitude toward risk. If you are risk averse, then you will require that uncertainty be offset by higher expected values. On the other hand, risk seekers will be willing to accept lower expected values in return for the chance at a jackpot.
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Decision Analyst and former professional poker player Annie Duke, in her book, Thinking in Bets, describes how gamblers help calibrate each other’s confidence by challenging implausible forecasts with the question, “Wanna bet?” This can be a fun game to play with your colleagues if you disagree about something. Instead of arguing, bet on your beliefs. Write down everyone’s forecasts and resolve the bets later.
The article adds that this can be a useful way to get better at calibrating your confidence: keep track and keep score. Get in the habit of making probabilistic forecasts of uncertain events. Then go back and see how often you were right. When you claimed 90% confidence you would meet a particular deadline, how often did you do it? If your confidence is perfectly “calibrated” you’d have met that deadline 9 out of 10 times.
Managers can help others in their organizations get better at calibrating their confidence by collecting predictions and scoring them later. Will a development project stay on schedule? Will the project stay on budget? Record everyone’s estimates of these probabilities and then score them and publicize them later. Share the results so that people are aware of their own accuracy. Encourage those who report to you to honestly report their uncertainty. Don’t be like Serena’s boss, who, by demanding certainty, encouraged inaccurate and overconfident forecasts.
The above information is very interesting and provides many insightful tools that Turnaround Professionals can use to help their clients navigate the current uncertainty that they are facing. We will round off the discussion next week.
Robin Nicholson is the Director of Corporate-911 and is a Senior Business Rescue Practitioner.
