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Common biases that affect an entrepreneur’s decision-making

HUSTLE
By Pauline Muindi | April 7th 2021
[Courtesy]

Humans are not as rational as they love to assume.

Everybody has cognitive biases that affect their thinking, memory, and judgement. Cognitive biases form as a result of the brain attempting to simplify information processing. In the book Thinking, Fast and Slow, Daniel Kahneman explains that humans employ a small number of simple and quick rules of thumb in many different situations in order to take a decision as quick as possible under uncertainty.

Biases are influenced by factors such as past experiences, individual motivations, social pressures, internal beliefs, emotions, past experiences, and one’s ability to process information. Depending on the context or situation, cognitive biases can be either beneficial or problematic. For entrepreneurs, biases, especially when based on erroneous inferences or assumptions, can lead to severe and systematic errors in critical decision-making.

With entrepreneurs juggling multiple tasks that require rapid decision-making throughout their day, it is no surprise that they’re especially susceptible to certain cognitive biases. In addition, some behavioural psychologists suggest that entrepreneurship attracts people with certain personality traits, which makes them more inclined to follow their “hunches” when making decisions. Often, these hunches are informed by cognitive biases.

Regardless of the reason for susceptibility to cognitive biases, here’s a brief list of common entrepreneurial biases and how to avoid them

Optimism

Most motivational speakers, books, videos, and quotes agree on one thing: a positive attitude is a necessary ingredient for success. However, only focusing on the positive side, known as the optimism bias, when making decisions can be something of a double-edged sword.

No one can deny the power of having a positive attitude. It can boost your energy, heighten your inner strength, and inspire the people around you. The contagious nature of a positive attitude makes for a great entrepreneurial leader who inspires morale in both partners and employees. Conversely, optimism bias can blind you to potential pitfalls and make you over-estimate the likelihood of positive outcomes. Entrepreneurs with optimism bias are likely to engage in excessively risky decision-making behaviours than can ultimately kill their start-ups.

The Fix: Accept the fact that you are not exempt from failure or facing negative consequences of making certain decisions. Before making critical decisions for your business, think about the potential pitfalls and various possible outcomes. This forces you to consider your decision more objectively. If your decision can’t withstand the exercise, it is probably not the best bet. If you see a high likelihood of success despite the potential pitfalls, you can implement the decision and take steps to protect against failure.

Overconfidence

Relative to the optimism bias, overconfidence bias occurs when confidence in your skills, judgements, inferences or predictions is too high compared to the corresponding accuracy.

Entrepreneurs can be influenced by overconfidence bias when they overestimate their abilities, overlooking the need to hire experts for certain tasks.

The Fix: You can overcome confidence bias by admitting when you don’t have the skills needed to complete certain tasks effectively. In simple words, know your limitations. Be open to hiring someone else with the necessary skills when needed.

Planning Fallacy

“I can do this faster than the average person,” an entrepreneur clouded by the planning fallacy is likely to think. Under the influence of the planning fallacy bias, entrepreneurs generally underestimate the amount of time, skill, and resources needed to accomplish a project or task. This bias can lead to running out of funding or other resources required to achieve critical business milestones. An entrepreneur with this bias is also unlikely to have a “Plan B”, compromising the well-being of their business venture.

The Fix: The first step in overcoming the planning fallacy is to take a keen look at the available data. For instance, you can research how much time and resources it has taken to accomplish similar projects. Analyse the potential risks and come up with a realistic plan to avoid them. Additionally, set realistic deadlines to inspire you to follow through and complete tasks in time.

Confirmation Bias

People making decisions under the influence of confirmation bias search, interpret, and remember information in a way that corresponds with prior hypotheses, regardless of the reality.  Simply put, they latch onto information that confirms their pre-existing beliefs, no matter how tenuous. This can lead to ignoring highly important information, making success more difficult to achieve. For instance, an entrepreneur who has convinced themselves that SEO isn’t a beneficial strategy to market their products will seek out information that confirms this bias, regardless of what data shows.

The Fix: Play “the devil’s advocate” to your own ideas before implementing them. If you find it depressing to shoot down your own ideas, appoint someone in your team or network to play the role. Regardless of their personal opinions, their role will be to come up with arguments against your idea. This isn’t to dissuade you from thinking big and implementing innovative ideas but to help you strengthen your ideas and make them more likely to succeed.

Sunk-Cost Fallacy

After working on an idea for a long time and investing lots of money, it is understandable to feel emotionally attached to making it work. You are likely to ignore signs that the idea is doomed to fail. “I’ve already come this far, why quit now?” you tell yourself.

Let’s say you invest Sh5 million to launch a restaurant and in a couple of months you realise you’re losing money with no signs of a turnaround in the horizon. In such a situation, a prudent entrepreneur would cut their losses and close the business. However, someone operating under the sunk-cost fallacy is likely to continue operating and even invest more money into the business.

The Fix: Understand that success is not always achievable through sheer determination and continued investment of time, money, and resources. While the “never give up” approach is admirable, sometimes it is wiser to accept defeat and save your resources for a more viable idea. Regularly re-evaluate your ideas to ensure that the potential payoff is worth the continued effort.

 

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