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When to Decentralize Decision Making and When not to

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When to Decentralize Decision Making and When not to

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Executive Summary

It's common today for decision-making to be pushed down and out in the organization, toward the people who are closest to the front lines. The theory is that by decentralizing control, you can make your organization faster and nimbler. But you can't do that with every decision, so how do you decide which decisions to keep centralized? It can be useful to start with four qualities most executives want their organizations to have: responsiveness, reliability, efficiency, and perennity (e.g., the quality of being perennial, or continuing reliably in perpetuity). Think through which of these is most important to each aspect of your business. In units where reliability is the most important, for example, consider keeping power centralized. In teams where responsiveness is everything, decentralize away.

Artrise/istock

Rare is the business executive who doubts the importance of responsiveness: to be acutely alert to business opportunities and threats, and to be capable of grabbing the opportunity or fending off the threat fast and effectively. Hence, when (re-)designing the organization structure, they tend to decentralize decision-making, so that decision rights are as close as possible to the people who deal with customers, competitors, front-line employees, and other stakeholders. By doing so they avoid the delays associated with information and approvals traveling up and down the management hierarchy.

In politics, this is known as the principle of " subsidiarity " or "the principle that a central authority should ... [perform] only those tasks which cannot be performed at a more local level." But which exactly are "only those tasks"?

It is an age-old question. As Henry Mintzberg noted in The Structuring of Organizations in 1979, "The words centralization and decentralization have been bandied about for as long as anyone has cared to write about organizations." And that is a pretty long time, at least since 400 B.C., when Jethro advised Moses to distribute responsibility to various levels in the hierarchy.

In this article, we will present a simple logic to follow when addressing the centralization versus decentralization issue. We are not presenting a new path-breaking framework - but sometimes, it pays to get back to oft-forgotten first principles.

We find it useful to start with four qualities most executives want their organizations to have: responsiveness, reliability, efficiency, and perennity (e.g., the quality of being perennial, or continuing reliably in perpetuity). When deciding on the best level at which a given task should be done, assess the impact of the decision on these four qualities. For example, the efficiency gain from centralizing payroll processing may be much more important than the possible loss of responsiveness to changes in local labor laws that would be achieved by keeping this task decentralized; the centralization of payroll processing indeed enables the harmonization of systems and procedures, hence the realization of scale effects, possibly including the outsourcing to a single external service provider.

Let's have a systematic look at the four qualities.

1. Responsiveness through immediacy. Responsiveness is all about taking the right action quickly in response to opportunities and threats. If the sources of these opportunities and threats (e.g., customers, competitors, suppliers, employees, regulators, partners, and so on) occur at the level of the operating unit, and if these interfaces are genuinely different between operating units, it makes sense to locate the corresponding tasks (e.g., sales, procurement, recruiting, regulatory affairs) and the accountability for proper execution at that level. For example, there is quite a difference between dealing with a regulator, say, in India and one in Indonesia. Decentralization allows immediacy in time and place, hence responsiveness.

2. Reliability through compliance. For some tasks, it is desirable or necessary to have common rules across the operating units: policies, standards, methods, procedures, or systems. Think of compensation and benefits policies, product design standards, quality assurance methods, fraud reporting procedures, financial reporting systems, and the like. These rules are meant to align the operating units with the company's overall objectives, and make the business more predictable. Some organization unit then should assume the role of guardian: defining these rules, instructing employees properly, and monitoring conformity. It usually makes sense to assign that role to a centralized unit. For some tasks there is not even a choice: they must be done by law or statute by a central independent unit. Think, for example, of the internal audit or occupational safety functions in general, or the risk management function in banks, as the Basel III regulatory framework stipulates that this function should be "under the direction of a chief risk officer (CRO), with sufficient stature, independence, resources and access to the board."

3. Efficiency through syndication. For some tasks the case for centralization is rather straightforward: a centralized unit can serve as the home for a task that is carried out more economically when aggregated in one unit than when all operating units take care of that task separately. There are various drivers of such efficiency gains:

Traditional economies of scale. Having the same unit do more of the same task leads to continuity, standardization, specialization, leverage, and productivity. Treasury and IT procurement may be good examples.

Minimum efficient scale. Some tasks require expertise or infrastructure that is scarce and for which demand from any individual operating unit may fluctuate over time. In that case, it is more efficient to have a pool of specialists than to replicate these in each unit. Think, for example, of legal, tax and technology experts, or costly test equipment.

Avoiding duplication. Different operating units often have a common need for which the solutions can be (nearly) identical (e.g., an on-boarding manual for new employees, an instrument to monitor plant performance, a CRM tool). As a consequence, it is rather wasteful for each of the units to develop these solutions in parallel.

4. Perennity through detachment. There are certain tasks which, left to the discretion of the operating units, might not get done at all - this can be particularly true for tasks that are essential to the company's long-term wellbeing, but do not serve a short-term function for the business units. Hence, a central unit with sufficient detachment from front-line operations may be required. Here are some examples of such tasks:

Investments in initiatives with distant and uncertain benefits (e.g., radical innovation);

Investments in initiatives whose benefits are contingent on everybody's participation (e.g., knowledge management and talent management);

Activities that involve cross-unit arbitration, i.e. weighing alternatives and setting priorities (e.g., product portfolio planning);

Decisions to admit defeat and pull the plug (e.g., product withdrawal);

Initiatives related to assets that are the sole property of the company (e.g., brands and capital).

There is no one-size-fits-all organization structure. Obviously, changes in a company's environment or strategic priorities may have an impact on how it organizes itself. And getting the acclaimed qualities of responsiveness, reliability, efficiency, and perennity does not always require hard structural changes to the organization chart. In many cases, less disruptive changes can also do the job, such as physically dispersing central staff to the operating units, appointing permanent points of contact at HQ for the operating units, setting up a temporary task force of people from the operating units, and so on.

In an age where the concept of "self-managed organization" attracts much attention, the question of centralization versus decentralization does not go away. Nicolai Foss and Peter Klein argue in the article " Why Managers Still Matter " that "In today's knowledge-based economy, managerial authority is supposedly in decline. But there is still a strong need for someone to define and implement the organizational rules of the game." We hope that the simple logic presented in this article helps managers find solutions for achieving a balance between rules and responsiveness.

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When to Decentralize Decision Making, and When Not To

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Executive Summary It's common today for decision-making to be pushed down and out in the organization, toward the people who are closest to the front lines. The theory is that by decentralizing control, you can make your organization faster and nimbler. But you can't do that with every decision, so how do you decide which decisions to keep centralized?

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Book: Adaptive Decision Making and Intellectual Styles

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Book: Adaptive Decision Making and Intellectual Styles

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By Francesco Soto, Cinzia Colapinto, Michelle Sofo, Salvatore Ammirato

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By Rolf Dobelli

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Integrating Ethics: From Thought to Action

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Decision Rules

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What is CONSENSUS DECISION MAKING? What does CONSENSUS DECISION MAKING mean?

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What is CONSENSUS DECISION MAKING? What does CONSENSUS DECISION MAKING mean? CONSENSUS DECISION MAKING meaning - CONSENSUS DECISION MAKING definition - CONSENSUS DECISION MAKING explanation. Source: Wikipedia.org article, adapted under https://creativecommons.org/licenses/by-sa/3.0/ license. Consensus decision-making is a group decision-making process in which group members develop, and agree to support a decision in the best interest of the whole.

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Decision Making Biases

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Common Biases and Judgment Errors in Decision Making Organizational Behavior

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LESSON TIMELINE 1:03 Ability-Type Biases 2:30 Information-Type Biases 4:51 Escalation of Commitment Bias 5:15 Randomness Error 5:38 Risk Aversion 6:01 Lesson Summary

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Factors that Influence Obedience and Conformity

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Factors that Influence Obedience and Conformity

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Factors that influence obedience and conformity | Behavior | MCAT | Khan Academy

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Visit us (http://www.khanacademy.org/science/healthcare-and-medicine) for health and medicine content or (http://www.khanacademy.org/test-prep/mcat) for MCAT related content. These videos do not provide medical advice and are for informational purposes only. The videos are not intended to be a substitute for professional medical advice, diagnosis or treatment.

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Decision making | Processing the Environment | MCAT | Khan Academy

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Conformity and groupthink | Behavior | MCAT | Khan Academy

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Asch conformity studies (Asch line studies) | Behavior | MCAT | Khan Academy

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Zimbardo prison study The Stanford prison experiment | Behavior | MCAT | Khan Academy

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How to make better decisions | Dr. Joe Arvai | TEDxCalgary

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This talk was given at a local TEDx event, produced independently of the TED Conferences. Are you an architect or an archaeologist of your thoughts? As decision scientist Joe Arvai dissects how we make decisions, he draws parallels between construction principles and how we process information using a building code of goals, options, outcomes and trade-offs.

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Daniel Kahneman

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Thinking, Fast and Slow | Daniel Kahneman | Talks at Google

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Mariano Sigman and Dan Ariely: How can groups make good decisions?

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We all know that when we make decisions in groups, they don't always go right -- and sometimes they go very wrong. How can groups make good decisions? With his colleague Dan Ariely, neuroscientist Mariano Sigman has been inquiring into how we interact to reach decisions by performing experiments with live crowds around the world.

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Here's a talk that could literally change your life. Which career should I pursue? Should I break up -- or get married?! Where should I live? Big decisions like these can be agonizingly difficult. But that's because we think about them the wrong way, says philosopher Ruth Chang.

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We use the term team to refer to groups and teams. Teamwork involves working together to achieve something beyond the capabilities of individuals working alone. Teams are often asked to solve problems and make decisions.

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How to Build a Company where the Best Ideas Win

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How to Build a Company where the Best Ideas Win

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Ray Dalio: How to build a company where the best ideas win

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What if you knew what your coworkers really thought about you and what they were really like? Ray Dalio makes the business case for using radical transparency and algorithmic decision-making to create an idea meritocracy where people can speak up and say what they really think -- even calling out the boss is fair game.

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IDS Bulletin: What the public say: public engagement in national decision-making 

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IDS Bulletin: What the public say: public engagement in national decision-making 

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Published on July 14, 2010

The paper written by Involve on behalf of Sciencewise-ERC provides an evaluation of the experiences of citizens who have taken part in public dialogue processes, and puts forward a number of recommendations in response.

The paper considers what citizens have said about engagement with a particular focus on how engagement should be incorporated into governance structures. It draws on the evaluation of several Sciencewise-ERC supported and other policy related dialogue and engagement projects, highlighting keys views and insights from citizens and other stakeholders.

Amongst the nine recommendations made in the paper, the first draws attention to the importance of public engagement in critical, potentially controversial issues as a possible core part of delivering more openness and transparency.

Another recommendation made in this paper is to support a move to the Big Society by developing a culture and working practices that are open at all levels - engaging participants in important issues at national as well as local level.
Download Engagement Report
For more information please contact Simon Burall on: simon@involve.org.uk / 020 7920 6470

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What the public say: public engagement in national decision-making - Involve

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The paper written by Involve on behalf of Sciencewise-ERC provides an evaluation of the experiences of citizens who have taken part in public dialogue processes, and puts forward a number of recommendations in response. The paper considers what citizens have said about engagement with a particular focus on how engagement should be incorporated into governance structures.

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A Decision Making Perspective to Negotiation

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A Decision Making Perspective to Negotiation

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A Decision Making Perspective to Negotiation

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A Leader's Framework for Decision Making

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A Leader's Framework for Decision Making

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HBR - A Leaders Framework for Decision Making

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What Makes Strategic Decisions Different?

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What Makes Strategic Decisions Different?

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Executive Summary

The past decade has seen a wealth of research on decision making, yet business executives seem impervious to its lessons. The problem is not that they lack the desire to make better decisions. It's that the bulk of the research does not apply to the kind of decision that's most challenging for them.

Decisions vary along two dimensions. The first considers whether the decision maker can influence the terms and the outcome. The second addresses whether the aim is to do well or to do better than others. Before making any decision, the most important thing is to understand what kind it is.

Decision research has produced good advice for routine choices and judgments, such as personal investment decisions, where people are choosing among the products before them, have no ability to change them, and are not competing with anyone. For these decisions, research has shown, it's important to avoid common biases.

But strategic decisions, such as entering a new market or acquiring another company, are completely different. Executives can actively influence outcomes. Furthermore, success means doing better than rivals. For these decisions, executives need more than an ability to avoid common biases. They require a talent for clear-eyed analysis and the ability to take bold action.

Photography: Stephen Petegorsky

The past decade has seen a wealth of research on decision making, much of it not only useful but also fascinating to read. At the same time, a growing chorus has noted that business executives, in particular, are largely impervious to its lessons. They seem unable to apply those lessons, or perhaps uninterested in doing so. Advances in our understanding of decision making have not been matched by improvements in practice.

Having thought about this puzzle for some time, I suggest that there is a good explanation for the disconnect. It's not that executives lack the desire to make better decisions or that they're in denial about their propensity for error. The problem lies elsewhere. It's that the bulk of the decision-making research published to date applies to one type of decision, and it's not the type that's most challenging for managers. Their most important and most difficult decisions-strategic decisions with consequences for the performance of the company-call for a very different approach.

The fact is that people need to make up their minds in a great variety of circumstances, and it's a source of confusion that the same word, "decision," is used for all of them. When a grocery store customer encounters an entire aisle of breakfast cereals, we say he has a decision to make. When a high school senior considers which college to attend, we say she is facing a decision. When a poker player weighs whether to raise or fold, that's a decision, too. And when a company faces an opportunity-to enter a new market, acquire another company, or launch a new product-what is required of its management? A decision. The same term is applied to routine as well as complex deliberations, to both small-stakes bets and high-stakes commitments, and to exploratory steps as well as irreversible moves. It stands to reason that insights about decisions in one kind of circumstance might not shed much light on decisions in another. Even worse, they may lead a decision maker astray.

In this article I'll argue that before we can advise people on how to make better strategic decisions, we need to equip them to recognize how decisions differ. For that, we need to break the universe of decisions into a few categories. We can then suggest the best approach for each.

Let me propose a way.

Categorizing Decisions

Decisions vary along two dimensions: control and performance. The first considers how much we can influence the terms of the decision and the outcome. Are we choosing among options presented to us, or can we shape those options? Are we making a onetime judgment, unable to change what happens after the fact, or do we have some control over how things play out once we've made the decision? The second dimension addresses the way we measure success. Is our aim to do well, no matter what anyone else does, or do we need to do better than others? That is, is performance absolute or relative?

There are other ways to think about decisions, of course. Some are made by people acting as individuals and others by people acting as leaders of organizations; some are one-offs while others are part of a sequence, with the results of one letting us improve the next. But as a basic way to understand how decisions differ, control and performance are the two dimensions that matter most. Combining them creates four fields of decisions. (See the exhibit "Four Types of Decisions.")

To get better at making decisions, it's important to recognize the different types. Those in the first field of the matrix-where we have no control over outcomes and our performance is absolute (we aren't competing with anyone)-include consumer choices and personal investment decisions. Those in the fourth field-where we can influence outcomes and need to outperform rivals-include the strategic decisions that are most challenging for managers, such as launching a new product or entering a new market.

1: Making routine choices and judgments.

When you go shopping in a supermarket or a department store, you typically pick from the products before you. Those items, perhaps a jug of milk or a jar of jam, are what they are. You have no ability to improve them. Control is low. Moreover, you make the choice that suits you best-it doesn't matter what anyone else is buying. Performance is absolute. The same goes for most personal investment decisions. You may be able to decide which company's shares to buy, but you can't improve their performance after you buy them. You want high returns but aren't trying to do better than others. The goal is to do well, not to finish first in a competition.

In recent years, trailblazing research by cognitive psychologists and behavioral economists has demonstrated that people make decisions in ways that do not conform to the tenets of economic rationality. They exhibit systematic biases. Those findings have shed light on many first-field decisions in particular. For example, we now understand that the way options are framed and presented can shape our purchasing decisions. We know that investors often misunderstand the nature of random events, imagining that several gains indicate that a correction is due or that a string of losses means gains must follow-an error known as the gambler's fallacy. They also fall victim to the sunk cost fallacy, throwing good money after bad in an effort to recoup what they've lost. For many first-field decisions, research has taught us to be aware of and try to minimize these common biases.

2: Influencing outcomes.

Many decisions involve more than selecting among options we cannot improve or making judgments about things we cannot influence. In so much of life, we use our energy and talents to make things happen. Imagine that the task at hand is to determine how long we will need to complete a project. That's a judgment we can control; indeed, it's up to us to get the project done. Here, positive thinking matters. By believing we can do well, perhaps even holding a level of confidence that is by some definitions a bit excessive, we can often improve performance. Optimism isn't useful in picking stocks whose performance we cannot change, but in the second field, where we have the ability to influence outcomes, it can be very important.

Some activities call for us to move between the first and second fields, shifting our mind-set back and forth. The approach known as "deliberate practice," which can lead to expert performance (see "The Making of an Expert," by K. Anders Ericsson, Michael J. Prietula, and Edward T. Cokely, HBR July-August 2007), is based on objective and deliberate thinking before an event, full commitment with a positive attitude while taking action, and then a return to dispassionate analysis after the event-what is known as an after-action review. The ability to shift effectively between mind-sets is a crucial element of high performance in many repeated tasks of short duration, from sports to sales.

3: Placing competitive bets.

The third field introduces a competitive dimension. Success is no longer a matter of absolute performance but depends on how well you do relative to others. The best decisions must anticipate the moves of rivals. That's the essence of strategic thinking, which Princeton professor Avinash Dixit and Yale professor Barry Nalebuff define as "the art of outdoing an adversary, knowing that the adversary is trying to do the same to you." Investments in stocks are typically first-field decisions, but if you're taking part in a contest where the investor with the highest return takes the prize, you're in the third field. Now you need to make decisions with an eye to what your rivals will do, anticipating their likely moves so that you can have the best chance of winning.

In the third field, guidance comes from the branch of economics that studies competitive dynamics: game theory. Well-known illustrations of game theory include the prisoner's dilemma and the game rock-paper-scissors, in which the winner is determined by the interaction of all players' decisions. Game theory can illuminate areas from price competition to geopolitics, yet it has an important limitation: Players cannot alter the terms of the game. The possible moves are specified, and gains and costs cannot be changed. That's a helpful simplification for purposes of modeling, but it reduces the value for managers. Management, after all, is precisely about influencing outcomes over time. That's why Herbert Simon, in his 1978 Nobel Prize address, commented that for all its sophistication, game theory does not provide "satisfactory descriptions of actual human behavior." An essential aspect of so many crucial decisions is absent.

Decisions in the Fourth Field

The crux of our discussion comes into focus when we consider the fourth field. For these decisions, we can actively influence outcomes, and success means doing better than rivals. Here we find the essence of strategic management.

Business executives aren't like shoppers picking a product or investors choosing a stock, simply making a choice that leads to one outcome or another. By the way they lead and communicate, and through their ability to inspire and encourage, executives can influence outcomes. That's the definition of "management." Moreover, they are in charge of organizations that compete vigorously with others; doing better than rivals is vital. That's where strategy comes in.

The decisions to enter a new market, release a new product, or acquire another firm are all in the fourth field, but we can find many examples beyond business. In sports, a coach shapes the performance of athletes, melding them into an effective team that can outperform the opponent. Or think of politics. For a voter, casting a ballot is essentially a first-field decision: You vote for the candidate you prefer. For the candidate, however, the reality is very different. Election day is the last hurdle in a long process in which performance is relative-only one person can win-and outcomes can and must be shaped. Candidates need to inspire donors, build an organization, attract and motivate campaign workers, and ultimately persuade voters. A winning political campaign depends on a smart assessment of rivals as well as the ability to mobilize supporters, often in the face of long odds.

The fourth field includes some of the most consequential decisions of all, but because of their complexity they don't lend themselves to the careful controls of laboratory experiments, so we know less about how best to make them. (See the sidebar "First-Field Research, Fourth-Field Decisions.") What sort of mind-set do they require? When we can influence outcomes, it is useful to summon high levels of self-belief. And when we need to outperform rivals, such elevated levels are not just useful but indeed essential. Only those who are able to muster a degree of commitment and determination that is by some definitions excessive will be in a position to win. That's not to say that wildly optimistic thinking will predictably lead to success. It won't. But in tough competitive situations where positive thinking can influence outcomes, only those who are willing to go beyond what seems reasonable will succeed.

In many of the most consequential decisions executives face-whether to acquire a company, say, or launch a new product-they can influence the outcomes, and their choices are successful only if they're better than the competition's.

These decisions fall into the fourth field of a matrix that categorizes decisions along two dimensions: our control over the outcome and whether the outcome depends on other people's decisions. We would benefit greatly from improving how we make these fourth-field decisions. Yet most recent research has examined judgment and choice in first-field decisions, which offer no control over outcomes and can be successful regardless of what anyone else does.

This focus stems in part from the power of carefully controlled experiments, which are an ideal way to isolate the cognitive mechanisms of human thought. By asking subjects to make choices among clearly stated options or to make judgments about things they cannot influence, we derive responses that can be neatly compared, free of extraneous factors. Decision research has made profound contributions because of the rigor of its experimental methods.

The unintentional effect, however, is that less research has focused on the second and third fields, and much less on the fourth field, where the ability to influence outcomes makes the comparison of responses across people problematic, and where the need to outperform rivals adds further complexity. Thus the paradox: Fourth-field decisions, which in real life include many of the most important, have received the least attention.

Decision experiments have certainly improved our understanding of the human mind, with many practical applications. The danger lies in taking the findings that are appropriate for one kind of decision and applying them to other kinds. We should not be surprised if business executives seem not to embrace this advice. Strategic decisions are fundamentally different from the routine choices and judgments so elegantly captured in laboratory settings. To do justice to the decisions executives face, researchers should employ a wider range of methods.

In recent years a great deal of attention has focused on teaching executives to be aware of common biases and to avoid their ill effects. (See "Before You Make That Big Decision..." by Daniel Kahneman, Dan Lovallo, and Olivier Sibony, HBR June 2011.) Of course it's good to appreciate the lessons of cognitive psychology and to understand the propensity for common errors. But if we apply those lessons to the world of strategic management, we're missing a trick. When facing decisions in the fourth field, executives need on the one hand a talent for careful and dispassionate analysis, which we call left-brain thinking, and on the other hand a willingness to push boundaries, which we call the right stuff.

Discernment and Versatility

In the course of their daily responsibilities, executives face a range of decisions, often in each of the four fields outlined here. Before making any decision, the most important thing is to understand which field it is in. For routine judgments and choices, where we cannot influence outcomes and need not consider the competition, well-known lessons about avoiding common biases make good sense. For other decisions, a different set of skills is needed.

In his profile of St. Louis Cardinals manager Tony La Russa, Buzz Bissinger wrote that baseball managers require "the combination of skills essential to the trade: part tactician, part psychologist, part riverboat gambler." That's a good description of many kinds of decision makers, in business as well as in sports. The tactician plays a competitive game-sensing the actions of rivals, anticipating the way a given move may lead to a countermove, and planning the best response. The psychologist must shape outcomes by inspiring others, by setting goals and providing encouragement, and by offering clear and direct feedback. The riverboat gambler knows that outcomes aren't just a matter of cold numbers and probabilities; it's also important to read an opponent in order to know when to raise the stakes, when to bluff, and when to fold.

Decision makers need to develop two vital skills. First, they must be able to discern the nature of the decision at hand. Second, they need to respond with the appropriate approach, able to act now as a psychologist, then as a tactician, next as a riverboat gambler, and perhaps once again as a psychologist. When it comes to the most complex decisions of all, those that drive the fortunes of organizations, executives need more than an ability to avoid common errors. They require a seemingly contradictory blend: a talent for clear-eyed analysis and the ability to take bold action.

A version of this article appeared in the November 2013 issue of Harvard Business Review.

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What Makes Strategic Decisions Different

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Executive Summary The past decade has seen a wealth of research on decision making, yet business executives seem impervious to its lessons. The problem is not that they lack the desire to make better decisions. It's that the bulk of the research does not apply to the kind of decision that's most challenging for them.

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HBR: How to root out your biases when making decisions

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HBR: How to root out your biases when making decisions

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"There is always an easy solution to every human problem - neat, plausible, and wrong." Little did he know it when he penned these words, but journalist H.L. Mencken was tapping into the very core of behavioral decision making and the need to understand and compensate for it.

Every day, senior managers are tasked with making very significant strategic decisions for their companies, which usually require support by teams of internal and external experts and a heavy dose of research. Theoretically, knowledge-based decision making underpins every successful organization. But, as Plato pointed out, "Human behavior flows from three main sources: desire, emotion, and knowledge." First-hand experience and best sellers like Daniel Kahneman's Thinking, Fast and Slow have confirmed an even broader range of behavioral vulnerabilities and vagaries in our abilities to make decisions as human beings.

For those of us tasked with modeling the risk/reward potential of various business opportunities, the need to address these influential, often subconscious factors in the modeling process is compelling. In the enterprise risk management (ERM) arena, in particular, it is mandatory that incisive analysis of decision options means taking rigorous steps to challenge not only the scenarios we develop, but also their underlying assumptions.

From what we have learned from behavioral economists, we - as actuaries in the enterprise risk management space - outlined some of the most prevalent biases that creep into all kinds of risk/reward decision making - personal as well as professional. By acknowledging and shedding light on these sources of distortion we can strengthen the relevance and reliability of our decision-making strategies and assessment of potential risk manifesting from these decisions. We not only have to consider our own human biases, but also those of our audience, our team, and our competitors.

(Click on the chart to view full-sized version.)

Minimizing the impact of these biases is crucial. They can sneak into any risk/reward management scenario we develop, unless we exercise considerable rigor at every stage of the process from assumption right through to the presentation of alternative scenarios and their attendant considerations. To address the kinds of biases outlined briefly here, we must challenge our decision making process by realizing that we both influence and are influenced by the format of the information. The above heuristics have served us well as human beings when we were employed in work such as tilling the land. They do, however, open us up for biased risk/reward decision-making when applied to today's knowledge-based work. To minimize their impact, we must:

Search relentlessly for potentially relevant or new disconfirming evidence

Accept the "Chief Contrarian" as part of the team

Seek diverse outside opinion to counter our overconfidence

Reward the process and refrain from penalizing errors when the intentions and efforts are sound

Reframe or flip the problem on its head to see if we are viewing the situation in either a positive or negative framework

Redefine the problem from here on out and ignore the old problem to avoid escalation of unnecessary commitment

Develop systemic review processes that leave you a committed "out" possibility when trying to "cut the losses"

Avoid the potential for escalation or further emotional investment in faulty decisions engendered by premature "public" commitment.

Throughout the process, it's crucial to recognize that most risk does not manifest itself from some exogenous contingent event, but rather is driven by the behaviors and decisions of people. It is only by exercising the intellectual rigor to challenge our current views of the future and long-lived underlying assumptions that we gain the means to manage the real risks that face our enterprises. I have addressed the "individual" element here. I am strong supporter that it doesn't end here. I encourage all to read the post by David Ingram and Mike Thompson who address that it is not only our behaviors as "individuals" that are relelevant, but also and perhaps rather, how we make risk/reward decision-making in groups.

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How to Minimize Your Biases When Making Decisions

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"There is always an easy solution to every human problem - neat, plausible, and wrong." Little did he know it when he penned these words, but journalist H.L. Mencken was tapping into the very core of behavioral decision making and the need to understand and compensate for it.

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Decision Making

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Book: How Women Decide by By Therese Huston

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Book: How Women Decide by By Therese Huston

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Book: Judgment in Managerial Decision Making

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Book: Judgment in Managerial Decision Making

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By Max Bazerman and Don Moore

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by Whetten and Cameron