Recently I read an enlightening book by Daniel Kahneman, a Nobel-prize-winning economist: Thinking, Fast and Slow. The book is filled with rigorous economic and psychological studies of how our instincts and reason mislead us, especially when we are dealing with statistics. His goal in writing was to improve our ability to identify and understand errors of judgment and choice, in others and ourselves. Much of the book, a bestseller since 2011, has great relevance both for entrepreneurs and people like us who coach them. What I plan to do is walk you through some common mistakes Kahneman and others describe and then suggest some solutions.
OUTCOME BIAS
Most of the stories we tell media entrepreneurs are success stories, and my own research is full of such examples. Our goal is to try to identify some common elements among these success stories that entrepreneurs can use in charting a path forward. The old business models don’t work, so we have to try to identify new ones. There is a problem with this approach, Kahneman says, “The explanatory stories that people find compelling are simple; are concrete rather than abstract; assign a larger role to talent, stupidity, and intentions than to luck; and focus on a few striking events that happened rather than on the countless events that failed to happen.”
For example, the story that is told about Google’s founders, Larry Page and Sergey Brin, is one of plucky entrepreneurs who outsmarted everyone and built a trillion-dollar company from a startup in a garage. However, Kahneman reminds us that a year after founding the company, they were willing to sell it for less than $1 million. “But the buyer said the price was too high.” By focusing on the outcome, Google’s global dominance, we tend to ignore how the story might have been different if the founders had sold the company in its early days. No one would be celebrating them today as brilliant entrepreneurial geniuses.
OPTIMISM HELPS ENTREPRENEURS
Another way the entrepreneurial community misleads itself is with excessive optimism, Kahneman says. But it has its upside, “Because they misread the risks, optimistic entrepre- neurs often believe they are prudent, even when they are not. Their confidence in their future success sustains a positive mood that helps them obtain resources from others, raise the morale of their employees, and enhance their prospects of prevailing. When action is needed, optimism, even of the mildly delusional variety, may be a good thing.” When he chats with entrepreneurs, Kahneman finds that they never estimate their chances of success as less than 80%. They think their fate is almost entirely in their own hands. “They are surely wrong: the outcome of a startup depends as much on the achievements of its competitors and on changes in the market as on its own efforts,” Kahneman writes.
HOW BIASES MISLEAD ENTREPRENEURS
The mental errors of entrepreneurs are laid out in detail by Stephen X. Zhang and Javier Cueto, who draw heavily on Kahneman’s research in their paper, “The Study of Bias in Entrepreneurship.” They point out that several aspects of startups contribute to mistakes in judgment: the uncertainty of outcomes, the speed in which they have to make decisions, and information overload. Some of the mental biases they describe:
• Overconfidence: They place more importance on possible positive outcomes than negative ones. It can lead to excessive risk-taking.
• Illusion of control: They overemphasize how much skill, rather than chance, is the reason for improved performance.
• The law of small numbers: They reach conclusions about a large set of cases using a limited sample.
• Availability bias: They make judgments about the proba- bility of events based on how easy it is to think of examples.
• Escalation of commitment: They persist unduly with un- successful initiatives or courses of action.
Sometimes the best decision might be to move on and try something else. Many successful entrepreneurs have a history of failed ventures. That’s how they learned what it takes to make their big idea work.
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