Decision-Making Under Uncertainty
“Judge a man by his questions rather than by his answers.” ― Voltaire
“Judge a man by his questions rather than by his answers.” ― Voltaire
We value confidence over uncertainty. We want answers to our questions and we expect them to be right. Google (and Alexa and Siri) don’t just organize information for us. They are expected to point us to the “right” answer. Turn on the televisions to any news channel whether business (CNBC) or news (CNN). Most shows feature “experts” who are asked repeatedly about what is going to happen.
“Will the stock market go up or down for the rest of 2020? How many people will die from COVID-19? When can people get back to their normal lives?”
I have never heard anyone answer, “I don’t know.” If they have, they probably were not invited back to be interviewed on future shows.
It is ok to say you don’t know the answer. And then to pose important questions on the path to greater wisdom. Questions are important. They open us to new perspectives not previously considered and can lead to more creative solutions. Encourage the asking of questions.
“The future cannot be seen even with the most powerful telescopes.” ― Marty Rubin
In a memorable job interview, I was told by a CEO what skills they were looking for in a prospective CFO. One of them was the ability to predict the future; it was phrased as the ability to “look around corners.” I took a deep breath before replying. I said that I could not predict the future; no one could. And if I miraculously actually could, I would not be sitting here in a job interview.
I offered an alternative approach. My philosophy is to create a range of possible future scenarios with regard to business outcomes. And then, based on the company’s historical performance coupled with performance data from comparable companies, to attach probabilities or weights to each outcome.
Scenario analysis with probabilities allows for the CEO, Leadership Team and Board to discuss the risks the organization feels comfortable taking.
The question then becomes: “What risk does the organization want to reduce — the risk of losses or the risk of missing out on gains?” I subscribe to the belief that you can’t do both at the same time, unless there are significant existing operating inefficiencies.
“In any moment of decision, the best thing you can do is the right thing, the next best thing is the wrong thing, and the worst thing you can do is nothing.” ― Theodore Roosevelt
Even though the future is unknowable we still need to take actions.
Most times when we make decisions, especially important decisions, we have to pick a path forward with imperfect information.
Doing nothing, by deferring a decision, is just another form of “making a decision”. The opportunity cost of any decision is the “cost” of the next best alternative to the one selected. Remember to assign an opportunity cost even when simply deferring a decision to a future date.
In my experience as a growth capital investor when we had an opportunity to sell an asset, the managing partner always required us to compare the expected value today with the expected future value. And then we discussed, what must we believe about the future (company performance and market environment) to be confident that we would earn more than our risk-adjusted cost of capital by remaining an investor.
Be intentional and conscious when making decisions. Even if the decision is to not change anything at this point.
“The whole problem with the world is that fools and fanatics are always so certain of themselves, and wiser people so full of doubts.” ― Bertrand Russell
As humans we have evolved to see patterns — even if none exist — and create a story around these patterns which is believable (to us and hopefully to others). This bias to pattern recognition drives our decisions. And, we all tend to be overconfident about our decisions. Many psychologists, including Daniel Kahneman, call overconfidence “the most significant of the cognitive biases.”
Optimism is a form of overconfidence. Optimism is a good thing. Multiple research studies show positive health benefits accruing to those who have a more optimistic view on life.
To offset the overconfidence bias when making decisions, I like one of Jeff Bezos’ principles on decision-making. He is famous for advising that decisions be split into two categories — (i) high cost, consequential ones (he calls these “one-way doors”) and, (ii) low cost, reversible ones (he calls these “two-way doors”.)
And when it comes to decisions that appear to be “one-way doors”, he recommends asking a lot of questions and taking time in reaching a judgment.
Some of the questions worth asking include why might this decision by wrong or what would need to happen for the outcome to be negative.
“Taking risks is really the only way to consistently achieve above-average returns.” ― Sam Zell
In most businesses, when the shareholders’ are sufficiently diversified, they demand above average returns. And experienced business leaders and investors understand that all strategies involve risk.
The objective is to minimize the risk when the decision is consequential. A few different ways to minimize risk include:
Adopting the “outside view”. Think about how you might give advice to a friend who asks about a personal issue when you approach the matter with emotional detachment. And with business issues, research what others facing similar challenges in the past have done.
Testing. If possible, test major changes on a small scale (i.e. A/B test) before implementing across the entire business.
Defining success upfront. Set up parameters to define success or acceptable outcomes upfront, akin to a checklist or algorithm. This process will reduce human bias when making a decision in the future.
Dividing large decisions into stages. If possible, divide investment decisions into stages. And only make the subsequent investment if and when the prior stage has been successfully completed.
Buying options. Pay something upfront — options function as insurance and have a cost. Options offer the ability to walk away from a decision when things don’t work out as hoped for with a smaller loss. An example would be paying more on a monthly basis for a short term lease with many fewer tenant improvements as compared with the typical 10-year lease for office space. The upside is avoiding owning a large contingent liability.
“Judge a man by his questions rather than by his answers.”
― Voltaire
We value confidence over uncertainty. We want answers to our questions and we expect them to be right. Google (and Alexa and Siri) don’t just organize information for us. They are expected to point us to the “right” answer. Turn on the televisions to any news channel, whether business (CNBC) or news (CNN). Most shows feature “experts” who are asked repeatedly about what is going to happen.
“Will the stock market go up or down for the rest of 2020? How many people will die from COVID-19? When can people get back to their normal lives?”
I have never heard anyone answer, “I don’t know.” If they have, they probably were not invited back to future shows.
It is ok to say you don’t know the answer. And then to pose important questions on the path to greater wisdom. Questions are important. They open us to new perspectives not previously considered and can lead to more creative solutions. Encourage the asking of questions.
“The future cannot be seen even with the most powerful telescopes.”
― Marty Rubin
In a memorable job interview, I was told by a CEO what skills they were looking for in a prospective CFO. One of them was the ability to predict the future; it was phrased as the ability to “look around corners.” I took a deep breath before replying. I said that I could not predict the future; no one could. And if I miraculously actually could, I would not be sitting here in a job interview.
I offered an alternative approach. My philosophy is to create a range of possible future scenarios with regard to business outcomes. And then, based on the company’s historical performance coupled with performance data from comparable companies, to attach probabilities or weights to each outcome.
Scenario analysis with probabilities allows for the CEO, Leadership Team and Board to discuss the risks the organization feels comfortable taking.
The question then becomes: “What risk does the organization want to reduce — the risk of losses or the risk of missing out on gains?” I subscribe to the belief that you can’t do both at the same time, unless there are significant existing operating inefficiencies.
“In any moment of decision, the best thing you can do is the right thing, the next best thing is the wrong thing, and the worst thing you can do is nothing.”
― Theodore Roosevelt
Even though the future is unknowable we still need to take actions.
Most times when we make decisions, especially important decisions, we have to pick a path forward with imperfect information.
Doing nothing, by deferring a decision, is just another form of “making a decision”. The opportunity cost of any decision is the “cost” of the next best alternative to the one selected. Remember to assign an opportunity cost even when simply deferring a decision to a future date.
In my experience as a growth capital investor when we had an opportunity to sell an asset, the managing partner always required us to compare the expected value today with the expected future value. And then we discussed, what must we believe about the future (company performance and market environment) to be confident that we would earn more than our risk-adjusted cost of capital by remaining an investor.
Be intentional and conscious when making decisions. Even if the decision is to not change anything at this point.
“The whole problem with the world is that fools and fanatics are always so certain of themselves, and wiser people so full of doubts.”
― Bertrand Russell
As humans we have evolved to see patterns — even if none exist — and create a story around these patterns which is believable (to us and hopefully to others). This bias to pattern recognition drives our decisions. And, we all tend to be overconfident about our decisions. Many psychologists, including Daniel Kahneman, call overconfidence “the most significant of the cognitive biases.”
Optimism is a form of overconfidence. Optimism is a good thing. Multiple research studies show positive health benefits accruing to those who have a more optimistic view on life.
To offset the overconfidence bias when making decisions, I like one of Jeff Bezos’ principles on decision-making. He is famous for advising that decisions be split into two categories — (i) high cost, consequential ones (he calls these “one-way doors”) and, (ii) low cost, reversible ones (he calls these “two-way doors”).
And when it comes to decisions that appear to be “one-way doors”, he recommends asking a lot of questions and taking time in reaching a judgment.
Some of the questions worth asking include why might this decision by wrong or what would need to happen for the outcome to be negative
“Taking risks is really the only way to consistently achieve above-average returns.”
― Sam Zell
In most businesses, when the shareholders’ are sufficiently diversified, they demand above average returns. And experienced business leaders and investors understand that all strategies involve risk.
The objective is to minimize the risk when the decision is consequential. A few different ways to minimize risk include:
Adopting the “outside view”. Think about how you might give advice to a friend who asks about a personal issue when you approach the matter with emotional detachment. And with business issues, research what others facing similar challenges in the past have done.
Testing. If possible, test major changes on a small scale (i.e. A/B test) before implementing across the entire business.
Defining success upfront. Set up parameters to define success or acceptable outcomes upfront, akin to a checklist or algorithm. This process will reduce human bias when making a decision in the future.
Dividing large decisions into stages. If possible, divide investment decisions into stages. And only make the subsequent investment if and when the prior stage has been successfully completed.
Buying options. Pay something upfront — options function as insurance and have a cost. Options offer the ability to walk away from a decision when things don’t work out as hoped for with a smaller loss. An example would be paying more on a monthly basis for a short term lease with many fewer tenant improvements as compared with the typical 10-year lease for office space. The upside is avoiding owning a large contingent liability.
“The only thing that is constant is change.” ― Heraclitus
This was a quote I first came across in high school. It struck me powerfully then and still does today. I remind myself regularly to accept and embrace change acknowledging that change is hard.
Uncertainty about the future seems greater now because there is no analog in our lifetimes to the current COVID-19 pandemic. The causes of disruption to the global economy and the second-order impacts are different from the prior financial and economic crises we’ve lived through.
One result is a very broad range of views about the future. Some prognosticators are quite optimistic while others are very pessimistic. The broad divergence in forecasts means the distribution of possible outcomes has much fatter tails. Venture capital investors are quite familiar with fat-tailed distributions as their portfolios mirror that type of distribution — in their fat- tailed distribution many investments are losers and a few are very sizable winners.
We are likely to see this play out in the next few years as businesses adjust to the new realities (yet unknown) caused by COVID.
I want to end with a few words of hope from the stoic Roman emperor Marcus Aurelius.
“Never let the future disturb you. You will meet it, if you have to, with the same weapons of reason which today arm you against the present.” ― Marcus Aurelius