How does psychology affect business decisions?

I have an interest in reading psychology – it is a subject I have never studied but one that I find fascinating. I am by no means an authority on the subject, but I do find the workings of the mind incredibly intoxicating.

Two books in particular have fundamentally changed my outlook on life, work, family and relationships with people – the first is: I’m OK – You’re OK by Thomas A Harris; the second is Thinking, Fast and Slow by notable psychologist and Nobel Prize in Economics winner, Daniel Kahneman.

In the latter, Prof Kahneman talks about two systems that influence and govern how we make intuitive judgements:

• System 1 is an automatic operation that we have no sense of voluntary control over, for instance how we can look at someone and formulate an instant opinion of them.
• System 2 is more effortful and conscious, e.g. undertaking complex calculations.

(See pages 20-21 for in-depth definitions of System 1 and System 2.)

I have been reading this book with absolute fascination (and a certain amount of introspection also, I may add). The author talks about the concept of substitution – the operation of answering one question (usually an easier one) in place of another (the original harder) question. And also the affect heuristic – where people let their likes and dislikes determine their beliefs about the world (the term was first proposed by the psychologist Paul Slovic).

At the end of this Chapter (page 104), Daniel Kahneman states the following example:

“He likes the project, so he thinks its costs are low and its benefits are high. Nice example of the affect heuristic.”

Is this what we see when presenting business cases for approval? Increasingly, projects are having to compete for budget approval – most likely caused by the current economic climate causing increased focus on minimizing unqualified spending and maximizing return on investment (benefits realization) – and having to satisfy certain investment criteria before funds are allocated to them. In essence, portfolio management.

When creating business cases, are we guilty of the combined influence of substitution and the affect heuristic? If the original (harder) question being asked from the business case is: “Is this a worthwhile project?”, is the author of the business case actually guilty of answering the following (easier) question: “Do I like this project?” If the answer is yes, this is the manifestation of the affect heuristic in the business case.

If the individual likes the project, there may (dare I say: will) be a tendency to overstate the benefits and understate the costs. But is the opposite true? That is, “He dislikes the project, so he thinks its costs are high and its benefits are low.” My gut feeling says no (opinions welcomed)!

Would anyone write a business case that says: “Don’t invest – this project is not worthwhile”? We all know theory and best practice says the business case is there to justify (or not) the investment, but it could be that it is worthwhile, but not as worthwhile as other proposals and is, therefore, rejected. This is not the same as saying, “Don’t invest – this project is not worthwhile,” it is saying, “Now is not the right time to invest.”

From what I understand (my apologies to Prof Kahneman if my understanding is incorrect), substitution and the affect heuristic are functions of System 1. So if System 1 has involuntary control, are we pre-disposed to create ineffectual business cases with unerring optimism or pessimism? Absolutely not! System 2 is in charge – with the ability to resist the suggestions of System 1.

But in a lot of people, System 2 is lazy and it becomes an ‘endorser’ rather than an ‘enforcer’ of the emotions of System 1 (as Daniel Kahneman states on page 103).

A couple of suggestions to help overcome these System 1 tendencies:

1. The use of project assurance (independent or otherwise) should help overcome the effects of substitution and the affect heuristic – and ensure that our business cases are robust and accurate. That is assuming, of course, that project assurance can themselves resist these effects!

2. Historical data is extremely useful as a means of increasing accuracy of estimates (project costs and benefits). Of course, it depends on having historical data to use – if there is none, start collecting some now!

Well, that’s my take on things! I find all of this fascinating – is it just me? (You can leave a comment below.)

To find out more about how QA can help build your capability and capacity in project management, drop me a line at QAL.OrganisationalConsultancy@qa.com.

[This article was first published on pmtoday.co.uk on 08/08/19]