Contributed by Dr. Gleb Tsipursky.
One of the biggest dangers for entrepreneurs comes when their enterprise grows from being a small shop of 10 people to a midsized company of 100 or more. Entrepreneurial decision-making must change to account for this growth, but it often doesn’t due to our desire to avoid losses.
To illustrate why, let me tell you a story.
It’s your lucky day! You meet a kind stranger who offers you something for nothing. No tricks, really: You’re getting a free lunch.
She gives you US$45. Then she asks if you want to keep that money or give it to her in exchange for a coin flip. If it lands heads up, she’ll give you US$100. If it’s tails, you get nothing.
Which do you choose? Do you want US$45 cash in your pocket or are you willing to take a chance with the coin flip? Decide before reading further.
When I present this scenario in my speeches to business audiences, about 80 percent say they’ll take the money from the kind stranger. I made that choice when I first learned about this scenario and so do most people in studies of similar choices.
After all, the US$45 is a sure thing. Wouldn’t I feel foolish if I took a risk and lost it all for just a chance at getting US$100? My gut reaction was to avoid losing out. After all, who wants to be a loser, right?
Well, let’s run the numbers. The chance of getting heads is 50 percent, so in half of all cases you’ll win US$100 and in the rest, you won’t win anything. That’s equivalent to US$50 on average, versus US$45.
Imagine you flipped a coin 10 times, 100 times, 1,000 times, 10,000 times, and then 100,000 times. At 100,000, on average you would get US$5 million if you chose the coin flip for US$100 each time, versus US$4.5 million if you chose US$45 each time. The difference? A cool US$500,000.
Thus, unfortunately, choosing US$45 as my gift ultimately results in losing out. The right choice—the one most likely to not cause me to be a loser—is to choose the coin flip as the gift. Otherwise, over multiple coin flips, you’re pretty much guaranteed to lose.
Read more from Octane about entrepreneurial decision-making.
But wait, you might be thinking, I presented this as a one-time deal, not a repeating opportunity. Maybe if I told you it was a repeating scenario, you’d have thought about it differently.
Here’s the problem. Research shows that our gut treats each individual scenario we see as a one-off. In reality, we face a multitude of such choices daily. Our intuition is to treat each one as a separate situation. Yet, these choices form part of a broader repeating pattern where our intuition tends to steer us toward losing money.
This gut reaction is called loss aversion, one of the many dangerous judgment errors that result from how our brains are wired, what scholars in cognitive neuroscience and behavioral economics call cognitive biases.
Fortunately, recent research in these fields shows how you can use pragmatic strategies to address these dangerous judgment errors in your professional life.
First, evaluate where cognitive biases are hurting you and others in your team and organization. Then, you can use structured decision-making methods to make “good enough” daily decisions quickly and more thorough ones for important choices, and formulate truly effective long-term strategic plans. In addition, you can develop mental habits and skills to notice cognitive biases and prevent yourself from slipping into them.
Your professional life—anyone’s professional life—is made of 100,000 coin flips. The stranger’s gift represents the series of opportunities we face in our work, and we can either win US$5 million or US$4.5 million, depending on the choices we make for each one.
The same applies at an organizational level. Let’s say your enterprise has an annual revenue of US$5 million and a healthy profit of US$750 thousand. Regardless of the choices you’re making, if other employees in your organization are going with their gut to avoid losses and the company loses 10 percent of its revenue or US$500 thousand per year, then two-thirds of your profit will be wiped out, leaving only US$250 thousand.
As an entrepreneur, you need to account for the choices of others in your enterprise as your company grows. They are likely to be much less entrepreneurial than you and may make poor choices.
To prevent your— and their—intuition from leading the company astray, adopt a policy of letting the data lead you, instead of relying on intuitions. For each decision the company faces, prompt your team to envision it as a repeating pattern, instead of a one-time decision: Run the numbers, account for the role of uncertainty and take the course most likely to lead to the biggest profit.
Treating each choice as part of a broader pattern might feel counterintuitive, uncomfortable or unsafe. Yet the course that feels most safe—avoiding losses—is actually much more dangerous for your bottom line.
Dr. Gleb Tsipursky is on a mission to protect leaders from dangerous judgment errors known as cognitive biases by developing the most effective decision-making strategies. With over 20 years of experience as CEO of the training, coaching, and consulting firm Disaster Avoidance Experts, he also spent over 15 years in academia as a cognitive neuroscientist and behavioral economist. He’s an EO speaker, a recent EO 360° podcast guest and author of Never Go With Your Gut (2019), The Blindspots Between Us (2020) and The Truth Seeker’s Handbook (2017).