Data-driven decision making

In my first post about Pangea Formazione (PangeaF in the following), I have mentioned a few times that our company has set its mission as to help other companies to make good use of the data they own, in order to move towards data-driven decision process.

Is this really something useful and/or needed? In fact, it is. 

Since the late 70s there have been plenty of studies which revealed the huge impact that bias and heuristics can have on our quantitative decisions, not because of lack of expertise or just ignorance, but due to the actual evolution process of the human brain through centuries. A typical example is the so called “framing effect”, studied by Kahneman and Tversky in the early 80s [1].

Daniel Kahneman (picture from: wikipedia.org)

Two separate groups of participants are presented with a different scenario, related to the outbreak of an Asian epidemic who would affect six thousand people. Participants are asked to choose among two possible courses of actions, based on their rational preferences. The first group was presented with the following choices:

  • with plan A, 2000 persons will be saved;
  • with plan B, we have 1/3 of probability to save 6000 persons (everybody), and 2/3 of probability that no people are saved.

The second group was presented with the following choices:

  • with plan C, 4000 persons will die;
  • with plan D, we have 1/3 of probability that no people die, and 2/3 of probability that 6000 persons (everybody) die.

PLAN A
2000 saved

PLAN B
A 33% chance of saving all 6000 people,
66% possibility of saving no one.
PLAN C
4000 dead

PLAN D
A 33% chance that no people will die,
66% possibility that all 6000 will die.

What has been observed both in the original experiment and in many replications is that in the first case around 70% of the participants prefer plan A, while in the second case almost 80% of the participants prefer plan D. But plan A is the same as plan C, and plan B is the same of plan D! The only change is in the frame which is used to present the decision making problem, that affects the choice much more than any rational decision making theory would allow. [*]
The problem is that the description of the experiment in the two settings triggers different areas of our brain: when presenting the choice in terms of gains (first group) mechanisms of risk-aversion take precedence, while when presenting the choice in terms of losses (second group) we are much more propense to choose a risky option because of loss-aversion. 

Other examples can be found in Kahneman’s book “Thinking, fast and slow” [2], that the famous psychologist and 2002 Nobel laureate for Economic Sciences wrote to present the results of decades of experiments on the psychology of judgment and decision-making, as well as behavioral economics. 

And this is not just an example taken from some psychological study to “push our agenda”, with no true impact on the business world: it is something that is continuously seen in action. A 20+ years monitoring research on public, private and no-profit companies throughout USA, Europe and Canada [3] has shown that typically 50% of the business decisions ends up in failure, 33% of all decisions made are never implemented, and half of the decisions which get implemented are discontinued after 2 years. One of the causes of such (depressing) trend is the fact that in two cases out of three, choices are taken based either on failure-prone methods or on fads that are popular but not based on actual evidences.
In several cases it has also been shown that failure-prone methods are still followed because of difficulties to deal correctly with uncertainties that are intrinsic with decision making processes in strategic and business contexts.

There exist several types of uncertainties which can affect a decision making process: factors that there is no time or money to monitor effectively, factors that our outside our control capabilities like competitors’ moves or other stakeholders’ decisions, factors that are truly random and unexpected and that can lead the same decision towards very different results. Uncertainty assessment is a critical element in such scenario and we always find surprising to see how often it is underestimated: typically, it is only considered when assessing the global risk level of a productive process or “a posteriori” when a decision has undesired outcomes.

The described difficulties in evaluating quantitatively uncertainties are absolutely in line with the psychological researches we mentioned above, but there seems to be an additional inertia towards adoption of software-based tools that could provide with more coherent and consistent probability evaluations in different scenarios. 

What can be done to address such problems? How can we improve our skills in dealing with uncertainties? We will provide a possible answer in the next post, which shall complete the overview of the main points of the approach followed by PangeaF when implementing software solutions to support decision making processes.

Stay tuned!

[*] On a side note, you might want to notice that the expected value of each plan is always the same, so that assuming human choices follow a model based on perfect information, and defining rationality along the lines of von Neumann & Morgenstern’s game theory, we shall conclude that any “rational” decision maker would be indifferent among the four possible plans.

Bibliography

[1] A. Tversky & D. Kahneman, The Framing of decisions and the psychology of choice, Science. 211 (4481), 453?458 (1981). doi:10.1126/science.7455683.

[2] D. Kahneman. Thinking, Fast and Slow. Farrar, Straus and Giroux, New York, 2011. ISBN: 0374533555

[3] P. C. Nutt. Why Decisions Fail. Berrett-Koehler Publishers, Oakland, California, 2002. ISBN: 1576751503

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