Nine Lessons for Innovators from a Nobel Prize-Winning Psychologist

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random guesses. For example, data from a firm of wealth advisors with whom Kahneman consulted showed zero year-to-year correlation in the success of individual advisors, meaning that the supposed talents for which these advisors were rewarded in their annual bonuses was entirely illusory. But when Kahneman presented these findings to the firm, he was politely ignored. “The illusion of skill is not only an individual aberration; it is deeply ingrained in the culture of the industry,” Kahneman concludes.

6. The optimistic bias: Entrepreneurs know that the chances of success for a new business are low—only 35 percent of small businesses in the U.S. survive for five years. But they don’t seem to think the statistics apply to them, or they’d probably never start. Closely related to this is the planning fallacy, which leads decision makers to neglect historical data and rely on forecasts that are really more like best-case scenarios. The optimistic bias may also explain why so many corporate mergers and acquisitions go bad: the leaders of the acquiring firm overestimate their own competence and “make huge bets…acting on the mistaken belief that they can manage the assets of another company better than its current owners do.”

7. Overconfidence: The illusion of validity leads decision-makers to undertake bold programs based mostly on their insularity. “Declarations of high confidence mainly tell you that an individual has constructed a coherent story in his mind, not necessarily that the story is true,” Kahneman writes. But he also sees an institutional bias at work. Organizations and markets reward leaders who act with blind confidence. “An unbiased appreciation of uncertainty is a cornerstone of rationality—but it is not what people and organizations want,” he writes. “Acting on pretended knowledge is often the preferred solution.”

8. Competition neglect: Entrepreneurs usually act as if their companies will rise or fall based on their own efforts, while ignoring what their competitors are up to. “These bold people think their fate is almost entirely in their own hands,” Kahneman says. “They are almost surely wrong: the outcome of a startup depends as much on the achievements of its competitors and on changes in the market as on its own efforts. However, WYSIATI plays its part, and entrepreneurs naturally focus on what they know best—their plans and actions and the immediate threats and opportunities, such as the availability of funding. They know less about their competitors and therefore find it natural to imagine a future in which the competition plays little part.”

9. The focusing illusion: Business leaders are prone to many biases, but so are consumers—the people who ultimately buy the stuff entrepreneurs are selling. One is the focusing illusion, which can be reduced to the observation that, in Kahneman’s words, “nothing in life is as important as you think it is when you are thinking about it.” This illusion leads early adopters—and I count myself in this group—to spend lots of money on heavily hyped products that, in reality, are either off the wall (Google Glass) or only marginally better than what came before (the iPhone 5 vs. the iPhone 4S). “The focusing illusion creates a bias in favor of goods and experiences that are initially exciting, even if they will eventually lose their appeal,” Kahneman writes. This leads us to make bad choices based on overly optimistic forecasts of our future happiness—a pattern that Kahneman’s colleagues Daniel Gilbert and Timothy Wilson call “miswanting.”

These nine biases are just the beginning. The litany of thinking errors that Kahneman and others in his field have documented is so long it’s a wonder anything gets accomplished in the business world.

In fact, the farther I got into Kahneman’s book, the clearer it became that there’s a strange paradox at work. Kahneman says he wrote Thinking, Fast and Slow partly to help readers identify the biases in their own thinking and sidestep them in cases where they may lead to worse outcomes. He doesn’t argue that biases can be rooted out altogether—since, to a large extent, they’re neurologically hard-wired—but he thinks they can be mitigated through greater awareness.

The paradox is this: the whole world of venture-backed innovation is structured to reward people who take irrational gambles. In fact, you can argue that technological and economic disruptions of the sort that the tech ecosystem celebrates only come from people who display delusional levels of self-confidence and risk-taking. If every entrepreneur and investor were to read Kahneman’s book and become fully cognizant of the flaws in their thinking and the statistical realities they’re up against, Silicon Valley would have to put out a permanent “Gone Fishing” sign.

By the same token, if the people who donate money to startups on Kickstarter and buy Fitbits and Pebble watches and iPhones were to lose the conviction that each new gadget will make them incrementally happier, there’d be nobody to pave the way for wider adoption—and many genuinely worthy technologies might never see the light of day.

Kahneman himself seems to be aware of the contradictions. “I believe that someone who lacks a delusional sense of significance will wilt in the face of repeated experiences of multiple small failures and rare successes,” he writes. So the answer to the paradox may be that there are sectors of the economy where bias is not just desirable, but indispensable. Entrepreneurs are delusional. They’re looking at examples like Larry Page and Sergey Brin and Mark Zuckerberg and Kevin Systrom (Instagram’s founder) and—like buyers of Powerball tickets—fixating on a hyper-optimistic scenario in which they’re just as lucky.

But you know what? God bless ‘em all for for their obvious overconfidence. If the traitorous eight engineers hadn’t had the pluck to leave good jobs at Shockley Semiconductor Laboratory in 1957 to start Fairchild Semiconductor, hundreds of subsequent Fairchild spinoffs, including Intel and AMD, would never have been formed—and Silicon Valley as we know it would not exist. And if today’s young entrepreneurs weren’t taking equivalent gambles with their careers, we tech journalists wouldn’t have anything to write about.

As T.S. Eliot wrote, “Only those who will risk going too far can possibly find out how far it is possible to go.” Kahneman and the behavioral economists didn’t need to prove that humans are irrational: the tech world did that long ago.

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The Author

Wade Roush is a contributing editor at Xconomy.

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  • JerryA

    Great summary, and in my view, a brilliantly insightful analogy to the paradox with the tech world in general.

    The only thing I take issue with is the belittling of Freakonomics and Dan Ariely up front. Arguably Freakonomics has had a far greater impact on the world than Kahneman has, and continues to be more accessible with their very popular podcast. Ariely is brilliant too, bridging academia with Joe Public well. Dan is still relatively young, so expect much more from him. (Dan’s podcast, “Arming the Donkeys” is also good)

    This takes nothing away from the greatness of Kahneman, who’s book is based on his and others’ research. From a purely academic sense though, I would argue that Scott Plous’s 1993 book “The psychology of judgement and decision making” is just as good. (and a much shorter read)

    As an decision making “freak”, I prefer Plous and Kahneman, but I respect and difference, and support the far greater impact that Freakonmics and Dan Ariely make to society.