— The Art and Science of Decision-Making for Entrepreneurs
Yogi Berra once famously quipped, “When you come to a fork in the road, take it.” As perplexing as this advice may initially seem, it serves as a fitting reminder of the many decisions we face throughout our careers and lives. Each choice, whether made intuitively or deliberately, shapes our journey and defines our path.
The importance of data-driven decision-making is well-established; however, as an entrepreneur turned investor, I often encountered situations where decisions had to be made in times of uncertainty, without sufficient data.
Sometimes our gut makes the call. All these experiences led me to reflect on the wisdom imparted in Daniel Kahneman’s groundbreaking book: “Thinking, Fast and Slow.“
In his book, Daniel Kahneman, the Nobel Prize-winning psychologist and economist, introduces a dual-system framework of human cognition:
- System 1: Fast, intuitive, and emotionally driven, this system relies on heuristics (mental shortcuts) to simplify complex information and generate quick judgments, often contains cognitive biases
- System 2: Slow, deliberate, and more analytical, focused attention and mental efforts, such as solving complex problems, and evaluating data and evidence, sometimes lead to decision paralysis, causing missed windows of opportunity.
These two cognitive systems have evolved to help humans survive complex environments, with System 1 enabling rapid decisions based on limited information, and System 2 providing more deliberate and logical analysis when dealing with unfamiliar situations. By examining these cognitive systems, we can learn how to adapt our decision-making strategies when faced with varying amounts of data, from scarcity to abundance. The following analysis applies Kahneman’s wisdom to different scenarios in the context of business decision-making: data scarcity, incomplete data, and abundant data.
Data Scarcity, Mental Shortcuts
In situations where there is data scarcity, business leaders often rely on their intuitive System 1. This fast, automatic cognitive process can achieve quick assessment and guide decision-making in the absence of comprehensive information. However, it is crucial to recognize the potential pitfalls of relying solely on intuition, as cognitive biases often lead to errors in judgment.
One of those cognitive biases is the role of heuristics in human decision-making. Heuristics are mental shortcuts that help individuals make decisions quickly and efficiently, while System 1 is highly efficient in many situations, after all, in the ancestral environment, rapid decision-making was often essential for survival, especially in situations involving threats or opportunities, but its reliance on System 1 can easily lead to these cognitive biases and errors:
- Anchoring bias: The tendency to rely heavily on the first piece of information encountered (the “anchor”) when making decisions. This can lead to biased judgments, as subsequent information may not be weighted appropriately.
- Availability heuristic: The tendency to overestimate the likelihood of events based on their availability in memory. People may judge the frequency or probability of an event based on how easily they can recall similar instances, which can lead to biased assessments.
- Confirmation bias: The tendency to search for, interpret, and remember information in a way that confirms one’s preexisting beliefs or hypotheses. This can result in overlooking or dismissing contradictory evidence and can reinforce existing beliefs, even if they are incorrect.
- Hindsight bias: The inclination to see past events as more predictable than they were at the time they occurred. This can lead to overconfidence in one’s ability to predict future events and an underestimation of uncertainty.
- Overconfidence bias: The tendency for people to overestimate their own abilities, knowledge, and the accuracy of their predictions. This can result in taking unnecessary risks or making suboptimal decisions.
In situations with data scarcity, it is crucial to exercise patience and postpone making critical decisions, instead focusing on prioritizing data collection. Hastily jumping to “intuitive” conclusions that may lead us to fall victim to cognitive biases, we should take a step back and avoid relying on these unreliable mental shortcuts. Gathering more data before making critical decisions leads to improved outcomes and helps avoid potential pitfalls even in data-scarce situations.
Incomplete Data, the Art of Decision Making
In a dynamic business environment at the forefront of innovation, all decisions are inherently made with imperfect information.
Your ability to make decisions using intuition holds great value, as the saying goes, “Trust your hunches. They’re usually based on facts filed away just below the conscious level”. That’s why decision-making is also an art.
However, there are plenty of instances when the most prudent course of action is to put more effort into analyzing the available data, rather than succumbing to the habit of making “instinctive” decisions.
You can also experiment with various models to analyze the available data and consider alternative explanations to challenge your initial hypothesis. Oftentimes, better analysis can compensate for incomplete data, allowing you to see the big picture with only limited puzzle pieces in place.
According to Daniel Kahneman, when faced with incomplete data, our cognitive systems need to collaborate effectively, making it essential to engage both our intuitive System 1 and analytical System 2. This approach involves tapping into our instincts and intuitions, while also verifying and refining them with the available data at hand. The art of decision-making lies in striking a balance between these two Systems.
By combining the power of our intuitions with the insights gleaned from data analysis, we create a more well-rounded and informed decision-making framework. This synergy between intuition and analysis allows us to navigate uncertain situations more confidently, making the best possible decisions even when operating with incomplete data.
In fact, my business partner, Adam Day, at Golden Section advocates that one of the key qualities of a potentially successful founder is his or her ability to make sound decisions with limited information under a high level of uncertainty.
Abundant Data, the Science of Decision Making
With the widespread adoption of B2B SaaS applications in enterprises, there is a growing amount of data at your disposal. In situations with abundant data, the challenge lies in sifting through the vast amounts of information to determine what is relevant and valuable for decision-making. The sheer volume of data can introduce a cacophony of noise, making it essential to filter out extraneous details and focus on uncovering meaningful correlations and causation. It’s crucial to guard against information overload and prevent decision paralysis.
The abundance of data empowers us to fully engage our analytical System 2. By concentrating on key metrics and essential information, we can make more informed decisions tailored to our unique circumstances. To further enhance decision-making processes, it’s vital to adopt industry-specific best practices in analytics, ensuring that we fully leverage the wealth of available data.
To effectively engage System 2 when faced with abundant data, consider these methods:
- Slow down and deliberate: Thoroughly analyze the data, using your business data model, avoiding the temptation to jump to conclusions or rely on intuition alone.
- Challenge assumptions: Question your initial thoughts and beliefs, and consider alternative explanations supported by the available data, differentiate correlation from causation.
- Break down complex problems: Divide complicated issues into smaller, more manageable components for easier analysis.
- Engage in critical thinking: Assess the data’s quality and reliability, looking for potential biases, inconsistencies, or limitations.
- Utilize AI tools to help you analyze a vast amount of data, turn raw data into information, and turn information into intelligence.
By incorporating these methods into your decision-making process, you can more effectively engage your analytical System 2, ensuring that you make well-informed decisions based on the wealth of data available in today’s complex business environment.
Avoid Cognitive Biases and Fallacies
A deliberate, analytical approach, along with data-driven decision-making as exemplified by System 2, serves as the most effective antidote to counter cognitive biases and fallacies.
- Prospect Theory: A central concept in behavioral economics. It posits that people make decisions based on the potential value of gains and losses (Huan De Huan Shi 患得患失), rather than the final outcome. Moreover, they are more sensitive to losses than to gains of the same magnitude, a phenomenon known as loss aversion.
- The Planning Fallacy: Our tendency to underestimate the time, resources, and effort required to complete a task or project. Kahneman emphasizes the importance of learning from past experiences and considering the reference class when making predictions.
- The Sunk Cost Fallacy: Our inclination to continue investing in projects or decisions based on the amount of resources we have already committed, rather than evaluating their current or future value. This fallacy can lead to poor decision-making and wasted resources.
To counteract the Prospect Theory and loss aversion, we should consciously focus on the overall potential outcome and consider a broader perspective when evaluating gains and losses. To overcome the Planning Fallacy, it is crucial to implement a method known as reference class forecasting, which involves comparing similar projects or tasks and using their average performance as a basis for estimation. This approach helps provide a more realistic timeframe and resource allocation. Finally, to avoid the Sunk Cost Fallacy, we must learn to dispassionately evaluate the present and future value of projects and decisions, rather than being influenced by the resources already invested. By being aware of these biases and applying these System 2 strategies, we can minimize the influence of these common fallacies.
The Art and Science of Decision Making
The art and science of decision-making requires the interaction between System 1 and System 2. Many entrepreneurs are making decisions with imperfect data and intel each day, some of the decisions are consequential, and even decide the fate of the company. it is essential to apply the insights found in Daniel Kahneman’s work and continuously guard against cognitive biases.
We need to leverage the interplay between these two systems, highlighting that they often work in tandem, with System 1 generating intuitive judgments that are then evaluated and adjusted by System 2. The cooperation between the two systems can be highly effective, but it can also lead to biases and errors when System 2 fails to adequately scrutinize or override the judgments generated by System 1.
While System 2 is more objective, System 1 is subjective to the individual. Therefore, candid discussions and debates between team members can help bridge the judgment gap, as each person has a slightly different System 1 due to their different life experiences and professional expertise. By maintaining open and effective communication channels and sharing insights with decision-makers (such as Board, Management Team, or Investment Committee), we draw on the life experience of each team member to check and balance one another’s intuitions.
As we journey through our careers and lives, we come to recognize that we are the culmination of countless decisions we’ve made along the way. Sometimes those decisions are made intuitively, and sometimes more deliberately; in either case, we can never go back to remake those decisions. However, the decisions we make now are consequential and have the power to shape the trajectory of our businesses and our futures. As business leaders and company founders, you cannot simply recuse yourself; you have to rise to the occasion to make those tough calls.
While we may not have control over the ultimate outcomes of these critical decisions, we do have control over the habits and methods by which we arrive at them — in business, as well as in life, that’s good enough, that’s all we can ask for. At least you shall have peace knowing the fact that you’ve utilized the best mental efforts and analytical methods to make those decisions; that’s the best we can do when we come to a fork in the road.