The Hidden Traps in Decision Making

by John S. Hammond, Ralph L. Keeney, and Howard Raiffa

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thomas w. malone androbert j. laubacher

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john s. hammond,ralph l. keeney, and HOWARD RAIFFA

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greg brenneman

SEPTEMBER – OCTOBER 1998

Reprint Number

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than normal, our eyes will tend totrick our minds into thinking thatthings are more distant than theyactually are. Because the resultingdistortion poses few dangers formost of us, we can safely ignore it.For airline pilots, though, the distor-

tion can be cata-strophic. That’swhy pilots are

aking decis ions is themost important job of anyexecutive. It’s also the

toughest and the riskiest. Bad deci-sions can damage a business and acareer, sometimes irreparably. Sowhere do bad decisions come from?In many cases, they can be tracedback to the way the decisions weremade – the alternatives were notclearly defined, theright informationwas not collected,the costs and benefitswere not accuratelyweighed. But some-times the fault lies notin the decision-makingprocess but rather in the mind ofthe decision maker. The way thehuman brain works can sabotageour decisions.

Researchers have been studyingthe way our minds function in mak-ing decisions for half a century. Thisresearch, in the laboratory and in thefield, has revealed that we use un-conscious routines to cope with thecomplexity inherent in most deci-sions. These routines, known asheuristics, serve us well in most sit-uations. In judging distance, for ex-ample, our minds frequently rely ona heuristic that equates clarity withproximity. The clearer an object ap-pears, the closer we judge it to be.The fuzzier it appears, the fartheraway we assume it must be. Thissimple mental shortcut helps us tomake the continuous stream of dis-tance judgments required to navi-gate the world.

Yet, like most heuristics, it is notfoolproof. On days that are hazier

trained to use objective measures ofdistance in addition to their vision.

Researchers have identified awhole series of such flaws in the waywe think in making decisions. Some,like the heuristic for clarity, are sen-sory misperceptions. Others take theform of biases. Others appear simplyas irrational anomalies in our think-ing. What makes all these traps so

dangerous is their invisi-bility. Because they arehardwired into our think-ing process, we fail to rec-ognize them – even as wefall right into them.

For executives, whosesuccess hinges on the manyday-to-day decisions they make

or approve, the psychological trapsare especially dangerous. They canundermine everything from new-product development to acquisitionand divestiture strategy to succes-sion planning. While no one can ridhis or her mind of these ingrainedflaws, anyone can follow the lead ofairline pilots and learn to understandthe traps and compensate for them.

In this article, we examine a num-ber of well-documented psycholog-ical traps that are particularly likelyto undermine business decisions. Inaddition to reviewing the causesand manifestations of these traps,we offer some specific ways man-agers can guard against them. It’simportant to remember, though, thatthe best defense is always aware-ness. Executives who attempt to familiarize themselves with thesetraps and the diverse forms theytake will be better able to ensurethat the decisions they make are

John S. Hammond is a consultanton decision making and a formerprofessor at the Harvard BusinessSchool in Boston, Massachusetts.Ralph L. Keeney is a professor at theMarshall School of Business and theSchool of Engineering at the Univer-sity of Southern California in LosAngeles. Howard Raiffa is the FrankPlumpton Ramsey Professor of Man-agerial Economics Emeritus at theHarvard Business School. Theirbook, Smart Choices: A PracticalGuide to Making Better Decisions,will be published in October by theHarvard Business School Press.

In making decisions, your own mindmay be your worst enemy.

M

THEHIDDEN TRAPSIN DECISION

MAKINGby John S. Hammond,Ralph L. Keeney,and Howard Raiffa

T H I N K I N G A B O U T …

Copyright © 1998 by the President and Fellows of Harvard College. All rights reserved. 3

4 harvard business review September–October 1998

the hidden traps in decis ion makingT H I N K I N G A B O U T …

sound and that the recommenda-tions proposed by subordinates orassociates are reliable.

The Anchoring TrapHow would you answer these twoquestions?

Is the population of Turkeygreater than 35 million?

What’s your best estimate of Turkey’s population?

If you’re like most people, the figureof 35 million cited in the first ques-tion (a figure we chose arbitrarily)influenced your answer to the sec-ond question. Over the years, we’ve

posed those questions to manygroups of people. In half the cases, weused 35 million in the first question;in the other half, we used 100 mil-lion. Without fail, the answers to thesecond question increase by manymillions when the larger figure isused in the first question. This sim-ple test illustrates the common andoften pernicious mental phenome-non known as anchoring. When con-sidering a decision, the mind givesdisproportionate weight to the firstinformation it receives. Initial im-pressions, estimates, or data anchorsubsequent thoughts and judgments.

Anchors take many guises. Theycan be as simple and seemingly in-nocuous as a comment offered by acolleague or a statistic appearing inthe morning newspaper. They can beas insidious as a stereotype about aperson’s skin color, accent, or dress.In business, one of the most commontypes of anchors is a past event ortrend. A marketer attempting to pro-ject the sales of a product for thecoming year often begins by lookingat the sales volumes for past years.The old numbers become anchors,which the forecaster then adjustsbased on other factors. This ap-proach, while it may lead to a reason-ably accurate estimate, tends to givetoo much weight to past events and

not enough weight to other factors.In situations characterized by rapidchanges in the marketplace, histori-cal anchors can lead to poor forecastsand, in turn, misguided choices.

Because anchors can establish theterms on which a decision will bemade, they are often used as a bar-gaining tactic by savvy negotiators.Consider the experience of a largeconsulting firm that was searchingfor new office space in San Francisco.Working with a commercial real-estate broker, the firm’s partnersidentified a building that met alltheir criteria, and they set up a meet-ing with the building’s owners. The

owners opened the meet-ing by laying out theterms of a proposed con-tract: a ten-year lease; aninitial monthly price of$2.50 per square foot; an-nual price increases atthe prevailing inflation

rate; all interior improvements to bethe tenant’s responsibility; an optionfor the tenant to extend the lease forten additional years under the sameterms. Although the price was at thehigh end of current market rates,the consultants made a relativelymodest counteroffer. They proposedan initial price in the midrange ofmarket rates and asked the ownersto share in the renovation expenses,but they accepted all the other terms.The consultants could have beenmuch more aggressive and creativein their counterproposal – reducingthe initial price to the low end ofmarket rates, adjusting rates bienni-ally rather than annually, putting acap on the increases, defining differ-ent terms for extending the lease,and so forth – but their thinking wasguided by the owners’ initial pro-posal. The consultants had falleninto the anchoring trap, and as a re-sult, they ended up paying a lot morefor the space than they had to.

What can you do about it?The effect of anchors in decision

making has been documented inthousands of experiments. Anchorsinfluence the decisions not only ofmanagers, but also of accountantsand engineers, bankers and lawyers,consultants and stock analysts. Noone can avoid their influence; they’re

just too widespread. But managerswho are aware of the dangers of an-chors can reduce their impact by us-ing the following techniques:o Always view a problem from dif-ferent perspectives. Try using alter-native starting points and approachesrather than sticking with the firstline of thought that occurs to you. o Think about the problem on yourown before consulting others in or-der to avoid becoming anchored bytheir ideas.o Be open minded. Seek informa-tion and opinions from a variety ofpeople to widen your frame of refer-ence and to push your mind in freshdirections. o Be careful to avoid anchoring youradvisers, consultants, and othersfrom whom you solicit informationand counsel. Tell them as little aspossible about your own ideas, esti-mates, and tentative decisions. Ifyou reveal too much, your own pre-conceptions may simply come backto you.o Be particularly wary of anchors innegotiations. Think through yourposition before any negotiation be-gins in order to avoid being anchoredby the other party’s initial proposal.At the same time, look for opportu-nities to use anchors to your own advantage – if you’re the seller, forexample, suggest a high, but defen-sible, price as an opening gambit.

The Status-Quo TrapWe all like to believe that we makedecisions rationally and objectively.But the fact is, we all carry biases,and those biases influence the choices we make. Decision makersdisplay, for example, a strong bias to-ward alternatives that perpetuatethe status quo. On a broad scale, wecan see this tendency whenever aradically new product is introduced.The first automobiles, revealinglycalled “horseless carriages,” lookedvery much like the buggies they re-placed. The first “electronic news-papers” appearing on the WorldWide Web looked very much liketheir print precursors.

On a more familiar level, you mayhave succumbed to this bias in yourpersonal financial decisions. Peoplesometimes, for example, inherit

Decision makers display astrong bias toward alternativesthat perpetuate the status quo.

shares of stock that they would neverhave bought themselves. Although itwould be a straightforward, inexpen-sive proposition to sell those sharesand put the money into a differentinvestment, a surprising number ofpeople don’t sell. They find the statusquo comfortable, and they avoid tak-ing action that would upset it.“Maybe I’ll rethink it later,” theysay. But “later” is usually never.

The source of the status-quo traplies deep within our psyches, in ourdesire to protect our egos from dam-age. Breaking from the status quomeans taking action, and when wetake action, we take responsibility,thus opening ourselves to criticismand to regret. Not surprisingly, wenaturally look for reasons to donothing. Sticking with the statusquo represents, in most cases, thesafer course because it puts us at lesspsychological risk.

Many experiments have shownthe magnetic attraction of the statusquo. In one, a group of people wererandomly given one of two gifts ofapproximately the same value – halfreceived a mug, the other half a Swisschocolate bar. They were then toldthat they could easily exchange thegift they received for the other gift.While you might expect that abouthalf would have wanted to make theexchange, only one in ten actuallydid. The status quo exerted its powereven though it had been arbitrarilyestablished only minutes before.

Other experiments have shownthat the more choices you are given,the more pull the status quo has.More people will, for instance,choose the status quo when there aretwo alternatives to it rather thanone: A and B instead of just A. Why?Choosing between A and B requiresadditional effort; selecting the statusquo avoids that effort.

In business, where sins of com-mission (doing something) tend tobe punished much more severelythan sins of omission (doing noth-ing), the status quo holds a particu-larly strong attraction. Many merg-ers, for example, founder becausethe acquiring company avoids tak-ing swift action to impose a new,more appropriate managementstructure on the acquired company.

“Let’s not rock the boat right now,”the typical reasoning goes. “Let’swait until the situation stabilizes.”But as time passes, the existingstructure becomes more entrenched,and altering it becomes harder, noteasier. Having failed to seize the oc-casion when change would havebeen expected, management finds itself stuck with the status quo.

What can you do about it?First of all, remember that in any

given decision, maintaining the sta-tus quo may indeed be the bestchoice, but you don’t want to chooseit just because it is comfortable.Once you become aware of the sta-tus-quo trap, you can use these tech-niques to lessen its pull:o Always remind yourself of yourobjectives and examine how theywould be served by the status quo.You may find that elements of thecurrent situation act as barriers toyour goals.o Never think of the status quo asyour only alternative. Identify otheroptions and use them as counter-balances, carefully evaluating all thepluses and minuses.o Ask yourself whether you wouldchoose the status-quo alternative if,in fact, it weren’t the status quo.o Avoid exaggerating the effort orcost involved in switching from thestatus quo.o Remember that the desirability ofthe status quo will change over time.When comparing alternatives, al-ways evaluate them in terms of thefuture as well as the present.o If you have several alternativesthat are superior to the status quo,don’t default to the status quo justbecause you’re having a hard timepicking the best alternative. Forceyourself to choose.

The Sunk-Cost TrapAnother of our deep-seated biases isto make choices in a way that justi-fies past choices, even when the pastchoices no longer seem valid. Mostof us have fallen into this trap. Wemay have refused, for example, tosell a stock or a mutual fund at aloss, forgoing other, more attractiveinvestments. Or we may havepoured enormous effort into improv-ing the performance of an employee

whom we knew we shouldn’t havehired in the first place. Our past de-cisions become what economiststerm sunk costs – old investments oftime or money that are now irrecov-erable. We know, rationally, thatsunk costs are irrelevant to the pres-ent decision, but nevertheless theyprey on our minds, leading us tomake inappropriate decisions.

Why can’t people free themselvesfrom past decisions? Frequently, it’sbecause they are unwilling, con-sciously or not, to admit to a mis-take. Acknowledging a poor decisionin one’s personal life may be purely aprivate matter, involving only one’sself-esteem, but in business, a baddecision is often a very public mat-ter, inviting critical comments fromcolleagues or bosses. If you fire apoor performer whom you hired,you’re making a public admission ofpoor judgment. It seems psychologi-cally safer to let him or her stay on,even though that choice only com-pounds the error.

The sunk-cost bias shows up withdisturbing regularity in banking,where it can have particularly direconsequences. When a borrower’sbusiness runs into trouble, a lenderwill often advance additional fundsin hopes of providing the businesswith some breathing room to recover.If the business does have a goodchance of coming back, that’s a wiseinvestment. Otherwise, it’s justthrowing good money after bad.

One of us helped a major U.S.bank recover after it made many badloans to foreign businesses. Wefound that the bankers responsiblefor originating the problem loanswere far more likely to advance addi-tional funds – repeatedly, in manycases – than were bankers who tookover the accounts after the originalloans were made. Too often, the orig-inal bankers’ strategy – and loans –ended in failure. Having been trappedby an escalation of commitment,they had tried, consciously or un-consciously, to protect their earlier,flawed decisions. They had fallenvictim to the sunk-cost bias. Thebank finally solved the problem byinstituting a policy requiring that aloan be immediately reassigned toanother banker as soon as any prob-

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lem arose. The new banker was ableto take a fresh, unbiased look at themerit of offering more funds.

Sometimes a corporate culture reinforces the sunk-cost trap. If thepenalties for making a decision thatleads to an unfavorable outcome areoverly severe, managers will be mo-tivated to let failed projects drag onendlessly – in the vain hope thatthey’ll somehow be able to transformthem into successes. Executivesshould recognize that, in an uncertainworld where unforeseeable eventsare common, good decisions can

sometimes lead to bad outcomes. Byacknowledging that some good ideaswill end in failure, executives willencourage people to cut their lossesrather than let them mount.

What can you do about it?For all decisions with a history,

you will need to make a consciouseffort to set aside any sunk costs –whether psychological or economic –that will muddy your thinkingabout the choice at hand. Try thesetechniques:o Seek out and listen carefully to theviews of people who were unin-volved with the earlier decisions andwho are hence unlikely to be com-mitted to them. o Examine why admitting to an ear-lier mistake distresses you. If theproblem lies in your own woundedself-esteem, deal with it head-on.Remind yourself that even smartchoices can have bad consequences,through no fault of the original deci-sion maker, and that even the bestand most experienced managers arenot immune to errors in judgment.Remember the wise words of WarrenBuffet: “When you find yourself in ahole, the best thing you can do isstop digging.”o Be on the lookout for the influenceof sunk-cost biases in the decisionsand recommendations made by yoursubordinates. Reassign responsibili-ties when necessary.

o Don’t cultivate a failure-fearingculture that leads employees to per-petuate their mistakes. In rewardingpeople, look at the quality of theirdecision making (taking into ac-count what was known at the timetheir decisions were made), not justthe quality of the outcomes.

The Confirming-EvidenceTrapImagine that you’re the president ofa successful midsized U.S. manufac-turer considering whether to call offa planned plant expansion. For a

while you’ve beenconcerned that yourcompany won’t beable to sustain therapid pace of growthof its exports. Youfear that the value ofthe U.S. dollar will

strengthen in coming months, mak-ing your goods more costly for over-seas consumers and dampening de-mand. But before you put the brakeson the plant expansion, you decideto call up an acquaintance, the chiefexecutive of a similar company thatrecently mothballed a new factory,to check her reasoning. She presentsa strong case that other currenciesare about to weaken significantlyagainst the dollar. What do you do?

You’d better not let that conversa-tion be the clincher, because you’veprobably just fallen victim to theconfirming-evidence bias. This biasleads us to seek out information thatsupports our existing instinct orpoint of view while avoiding infor-mation that contradicts it. What, after all, did you expect your ac-quaintance to give, other than astrong argument in favor of her owndecision? The confirming-evidencebias not only affects where we go tocollect evidence but also how we in-terpret the evidence we do receive,leading us to give too much weightto supporting information and toolittle to conflicting information.

In one psychological study of thisphenomenon, two groups – one op-posed to and one supporting capitalpunishment – each read two reportsof carefully conducted research onthe effectiveness of the death penaltyas a deterrent to crime. One report

concluded that the death penaltywas effective; the other concluded it was not. Despite being exposed tosolid scientific information support-ing counterarguments, the membersof both groups became even moreconvinced of the validity of theirown position after reading both re-ports. They automatically acceptedthe supporting information and dis-missed the conflicting information.

There are two fundamental psy-chological forces at work here. Thefirst is our tendency to subcon-sciously decide what we want to dobefore we figure out why we wantto do it. The second is our inclina-tion to be more engaged by things welike than by things we dislike – a ten-dency well documented even in ba-bies. Naturally, then, we are drawnto information that supports oursubconscious leanings.

What can you do about it?It’s not that you shouldn’t make

the choice you’re subconsciouslydrawn to. It’s just that you want tobe sure it’s the smart choice. Youneed to put it to the test. Here’s how:o Always check to see whether youare examining all the evidence withequal rigor. Avoid the tendency toaccept confirming evidence withoutquestion.o Get someone you respect to playdevil’s advocate, to argue against thedecision you’re contemplating. Bet-ter yet, build the counterargumentsyourself. What’s the strongest reasonto do something else? The secondstrongest reason? The third? Con-sider the position with an open mind.o Be honest with yourself aboutyour motives. Are you really gather-ing information to help you make asmart choice, or are you just lookingfor evidence confirming what youthink you’d like to do?o In seeking the advice of others,don’t ask leading questions thatinvite confirming evidence. And ifyou find that an adviser alwaysseems to support your point of view,find a new adviser. Don’t surroundyourself with yes-men.

The Framing TrapThe first step in making a decision isto frame the question. It’s also one ofthe most dangerous steps. The way a

We tend to subconsciously decidewhat to do before figuring outwhy we want to do it.

problem is framed can profoundlyinfluence the choices you make. In a case involving automobile insur-ance, for example, framing made a$200 million difference. To reduceinsurance costs, two neighboringstates, New Jersey and Pennsylvania,made similar changes in their laws.Each state gave drivers a new option:by accepting a limited right to sue,they could lower their premiums.But the two states framed the choicein very different ways: in New Jersey,you automatically got the limitedright to sue unless you specified oth-erwise; in Pennsylvania, you got thefull right to sue unless you specifiedotherwise. The different frames es-tablished different status quos, and,not surprisingly, most consumers de-faulted to the status quo. As a result,in New Jersey about 80% of driverschose the limited right to sue, but inPennsylvania only 25% chose it. Be-cause of the way it framed the choice,Pennsylvania failed to gain approxi-mately $200 million in expected in-surance and litigation savings.

The framing trap can take manyforms, and as the insurance exampleshows, it is often closely related toother psychological traps. A framecan establish the status quo or in-troduce an anchor. It can highlightsunk costs or lead you toward con-firming evidence. Decision research-ers have documented two types offrames that distort decision makingwith particular frequency:

Frames as Gains Versus Losses. In astudy patterned after a classic experi-ment by decision researchers DanielKahneman and Amos Tversky, one ofus posed the following problem to agroup of insurance professionals:

You are a marine property ad-juster charged with minimizingthe loss of cargo on three insuredbarges that sank yesterday offthe coast of Alaska. Each bargeholds $200,000 worth of cargo,which will be lost if not salvagedwithin 72 hours. The owner of alocal marine-salvage companygives you two options, both ofwhich will cost the same:

Plan A: This plan will save thecargo of one of the three barges,worth $200,000.

Plan B: This plan has a one-third probability of saving thecargo on all three barges, worth$600,000, but has a two-thirdsprobability of saving nothing.

Which plan would you choose?

If you are like 71% of the respon-dents in the study, you chose the“less risky” Plan A, which will saveone barge for sure. Another groupin the study, however, was asked to choose between alternatives Cand D:

Plan C: This plan will result inthe loss of two of the three car-goes, worth $400,000.

Plan D: This plan has a two-thirds probability of resultingin the loss of all three cargoesand the entire $600,000 but hasa one-third probability of losingno cargo.

Faced with this choice, 80% of theserespondents preferred Plan D.

The pairs of alternatives are, ofcourse, precisely equivalent – PlanA is the same as Plan C, and Plan Bis the same as Plan D – they’ve justbeen framed in different ways. Thestrikingly different responses revealthat people are risk averse when aproblem is posed in terms of gains(barges saved) but risk seeking whena problem is posed in terms of avoid-ing losses (barges lost). Further-more, they tend to adopt the frameas it is presented to them ratherthan restating the problem in theirown way.

Framing with Different ReferencePoints. The same problem can alsoelicit very different responses whenframes use different referencepoints. Let’s say you have $2,000 inyour checking account and you areasked the following question:

Would you accept a fifty-fiftychance of either losing $300 orwinning $500?

Would you accept the chance? Whatif you were asked this question:

Would you prefer to keep yourchecking account balance of$2,000 or to accept a fifty-fiftychance of having either $1,700or $2,500 in your account?

Once again, the two questions posethe same problem. While youranswers to both questions should,rationally speaking, be the same,studies have shown that many peo-ple would refuse the fifty-fifty chancein the first question but accept it inthe second. Their different reactionsresult from the different referencepoints presented in the two frames.The first frame, with its referencepoint of zero, emphasizes incremen-tal gains and losses, and the thoughtof losing triggers a conservative re-sponse in many people’s minds. Thesecond frame, with its referencepoint of $2,000, puts things into per-spective by emphasizing the real financial impact of the decision.

What can you do about it?A poorly framed problem can un-

dermine even the best-considereddecision. But any adverse effect offraming can be limited by taking thefollowing precautions:o Don’t automatically accept theinitial frame, whether it was formu-lated by you or by someone else. Al-ways try to reframe the problem invarious ways. Look for distortionscaused by the frames.o Try posing problems in a neutral,redundant way that combines gainsand losses or embraces different ref-erence points. For example: Wouldyou accept a fifty-fifty chance ofeither losing $300, resulting in abank balance of $1,700, or winning$500, resulting in a bank balanceof $2,500?o Think hard throughout your de-cision-making process about theframing of the problem. At pointsthroughout the process, particularlynear the end, ask yourself how yourthinking might change if the fram-ing changed. o When others recommend deci-sions, examine the way they framedthe problem. Challenge them withdifferent frames.

Estimating and ForecastingTrapsMost of us are adept at making esti-mates about time, distance, weight,and volume. That’s because we’reconstantly making judgments aboutthese variables and getting quickfeedback about the accuracy of those

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judgments. Through daily practice,our minds become finely calibrated.

Making estimates or forecastsabout uncertain events, however, isa different matter. While managerscontinually make such estimates

and forecasts, they rarely get clearfeedback about their accuracy. If youjudge, for example, that the like-lihood of the price of oil falling toless than $15 a barrel one year henceis about 40% and the price does in-deed fall to that level, you can’t tellwhether you were right or wrongabout the probability you estimated.The only way to gauge your accuracywould be to keep track of many,many similar judgments to see if, after the fact, the events you thoughthad a 40% chance of occurring actu-ally did occur 40% of the time. Thatwould require a great deal of data,carefully tracked over a long periodof time. Weather forecasters andbookmakers have the opportunitiesand incentives to maintain suchrecords, but the rest of us don’t. As aresult, our minds never become cali-brated for making estimates in theface of uncertainty.

All of the traps we’ve discussed sofar can influence the way we makedecisions when confronted with un-certainty. But there’s another set oftraps that can have a particularlydistorting effect in uncertain situa-tions because they cloud our abilityto assess probabilities. Let’s look atthree of the most common of theseuncertainty traps:

The Overconfidence Trap. Eventhough most of us are not very goodat making estimates or forecasts, weactually tend to be overconfidentabout our accuracy. That can lead toerrors in judgment and, in turn, baddecisions. In one series of tests, peo-ple were asked to forecast the nextweek’s closing value for the Dow

Jones Industrial Average. To accountfor uncertainty, they were thenasked to estimate a range withinwhich the closing value would likelyfall. In picking the top number of therange, they were asked to choose a

high estimate theythought had only a 1%chance of being ex-ceeded by the closingvalue. Similarly, forthe bottom end, theywere told to pick a lowestimate for whichthey thought therewould be only a 1%chance of the closing

value falling below it. If they weregood at judging their forecasting accuracy, you’d expect the partici-pants to be wrong only about 2% ofthe time. But hundreds of tests haveshown that the actual Dow Jones averages fell outside the forecastranges 20% to 30% of the time.Overly confident about the accuracyof their predictions, most people settoo narrow a range of possibilities.

Think of the implications for busi-ness decisions, in which major ini-tiatives and investments often hingeon ranges of estimates. If managersunderestimate the high end or over-estimate the low end of a crucialvariable, they may miss attractiveopportunities or expose themselvesto far greater risk than they realize.Much money has been wasted on ill-fated product-development projectsbecause managers did not accuratelyaccount for the possibility of marketfailure.

The Prudence Trap. Another trapfor forecasters takes the form of over-cautiousness, or prudence. Whenfaced with high-stakes decisions, we tend to adjust our esti-mates or forecasts “just to beon the safe side.” Many yearsago, for example, one of the Big Three U.S. automakerswas deciding how many of anew-model car to produce inanticipation of its busiest salesseason. The market-planning de-partment, responsible for the deci-sion, asked other departments tosupply forecasts of key variablessuch as anticipated sales, dealer in-ventories, competitor actions, and

costs. Knowing the purpose of theestimates, each department slantedits forecast to favor building morecars – “just to be safe.” But the mar-ket planners took the numbers atface value and then made their own“just to be safe” adjustments. Notsurprisingly, the number of cars pro-duced far exceeded demand, and thecompany took six months to sell offthe surplus, resorting in the end topromotional pricing.

Policymakers have gone so far asto codify overcautiousness in formaldecision procedures. An extreme ex-ample is the methodology of “worst-case analysis,” which was once popu-lar in the design of weapons systemsand is still used in certain engineer-ing and regulatory settings. Usingthis approach, engineers designedweapons to operate under the worstpossible combination of circum-stances, even though the odds ofthose circumstances actually com-ing to pass were infinitesimal. Worst-case analysis added enormous costswith no practical benefit (in fact, itoften backfired by touching off anarms race), proving that too muchprudence can sometimes be as dan-gerous as too little.

The Recallability Trap. Even if weare neither overly confident nor un-duly prudent, we can still fall into atrap when making estimates or fore-casts. Because we frequently baseour predictions about future eventson our memory of past events, wecan be overly influenced by dramaticevents – those that leave a strong im-pression on our memory. We all, forexample, exaggerate the probabilityof rare but catastrophic occurrencessuch as plane crashes because theyget disproportionate attention in the

media. A dramatic or traumaticevent in your own life can also dis-tort your thinking. You will assign ahigher probability to traffic acci-dents if you have passed one on theway to work, and you will assign a

Even though most of us are notvery good at making estimates,we tend to be overconfidentabout our accuracy–which canlead to bad decisions.

A dramatic or traumaticevent in your own life canalso distort your thinking.

higher chance of someday dying ofcancer yourself if a close friend hasdied of the disease.

In fact, anything that distorts yourability to recall events in a balancedway will distort your probability as-sessments. In one experiment, listsof well-known men and women wereread to different groups of people.Unbeknownst to the subjects, eachlist had an equal number of men andwomen, but on some lists the menwere more famous than the womenwhile on others the women weremore famous. Afterward, the partici-pants were asked to estimate the per-centages of men and women on eachlist. Those who had heard the listwith the more famous men thoughtthere were more men on the list,while those who had heard the onewith the more famous womenthought there were more women.

Corporate lawyers often getcaught in the recallability trap whendefending liability suits. Their deci-sions about whether to settle a claimor take it to court usually hinge ontheir assessments of the possibleoutcomes of a trial. Because the me-dia tend to aggressively publicizemassive damage awards (while ig-noring other, far more common trialoutcomes), lawyers can overesti-mate the probability of a large awardfor the plaintiff. As a result, they of-fer larger settlements than are actu-ally warranted.

What can you do about it?The best way to avoid the estimat-

ing and forecasting traps is to take avery disciplined approach to makingforecasts and judging probabilities.For each of the three traps, some ad-ditional precautions can be taken:o To reduce the effects of overconfi-dence in making estimates, always

start by considering the extremes,the low and high ends of the possiblerange of values. This will help youavoid being anchored by an initialestimate. Then challenge your esti-mates of the extremes. Try to imag-ine circumstances where the actualfigure would fall below your low orabove your high, and adjust yourrange accordingly. Challenge the estimates of your subordinates andadvisers in a similar fashion. They’realso susceptible to overconfidence.o To avoid the prudence trap, al-ways state your estimates honestlyand explain to anyone who will beusing them that they have not beenadjusted. Emphasize the need forhonest input to anyone who will besupplying you with estimates. Testestimates over a reasonable range toassess their impact. Take a secondlook at the more sensitive estimates.o To minimize the distortioncaused by variations in recallability,carefully examine all your assump-tions to ensure they’re not undulyinfluenced by your memory. Get ac-tual statistics whenever possible.Try not to be guided by impressions.

Forewarned Is ForearmedWhen it comes to business deci-sions, there’s rarely such a thing as ano-brainer. Our brains are always atwork, sometimes, unfortunately, inways that hinder rather than helpus. At every stage of the decision-making process, misperceptions, bi-ases, and other tricks of the mindcan influence the choices we make.Highly complex and important deci-sions are the most prone to distor-tion because they tend to involvethe most assumptions, the most es-timates, and the most inputs fromthe most people. The higher the

stakes, the higher the risk of beingcaught in a psychological trap.

The traps we’ve reviewed can allwork in isolation. But, even moredangerous, they can work in concert,amplifying one another. A dramaticfirst impression might anchor ourthinking, and then we might selec-tively seek out confirming evidenceto justify our initial inclination. Wemake a hasty decision, and that deci-sion establishes a new status quo. Asour sunk costs mount, we becometrapped, unable to find a propitioustime to seek out a new and possiblybetter course. The psychologicalmiscues cascade, making it harderand harder to choose wisely.

As we said at the outset, the bestprotection against all psychologicaltraps – in isolation or in combina-tion – is awareness. Forewarned isforearmed. Even if you can’t eradi-cate the distortions ingrained intothe way your mind works, you canbuild tests and disciplines into yourdecision-making process that canuncover errors in thinking beforethey become errors in judgment.And taking action to understand andavoid psychological traps can havethe added benefit of increasing yourconfidence in the choices you make.

For further discussions of decisiontraps, see: J. Edward Russo and PaulJ. H. Schoemaker, Decision Traps:The Ten Barriers to Brilliant Deci-sion Making and How to OvercomeThem (New York: Simon & Schuster,1989) and Max Bazerman, Judgmentin Managerial Decision Making(New York: John Wiley & Sons,fourth edition, 1998).

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