As entrepreneurs, we have to deal with a lot of uncertainty. It is very important to remember not to fall victim to our own minds and biases.
As a product of evolutionary development, our brains follow certain patterns that were useful to us in the past. However, some of these no longer serve us well in the modern world.
For example, 200,000 years ago people worked hard to ensure they were consuming enough calories. Thus it was important to favour foods that were high in sugar and fats. You know, fast food.
With the introduction of McDonald’s, Doritos, and my favourite, the Mars Bar into our daily diets, it is now easier than ever to chew down on half of our recommended daily caloric intake in 10 minutes. The mechanisms that allowed us to survive centuries ago are still present, and contribute to the current rise in obesity worldwide.
In a similar fashion, our brains developed to be best suited for life in small groups. 10,000 years ago the largest city in the world was Mureybet, located in modern day Syria, with a population of 500 people.
In the 1990s, Robin Dunbar, a British anthropologist, proposed what is now known as Dunbar’s number. Dunbar posited that humans could at most maintain 150 stable relationships at any given time. In other words, there is a reason why keeping up with updates from 500 friends on Facebook feels impossible.
As we are presented with this information, we should be cognizant of the influence that this evolutionary baggage may have on us.
Some of the features of our brain have a high impact on our business activities. Awareness of these biases can prove valuable, helping us identify scenarios where someone may gain leverage over us, or assisting us in gaining an edge ourselves.
Without further ado, here are the top 5 cognitive biases that everyone building a business should be aware of.
1) Priming Effect
Let me ask you two questions. Don’t look up the answers on Google, give yourself a chance to experience the effect - it’ll be worth it.
Is the population of the Netherlands larger or smaller than 500,000? Think about it and write the answer down.
Now, what you think the actual population of the Netherlands is? Write it down.
Got it? Now, look up the exact figure. Chances are you lowballed.
The most common answer that I encounter is ‘5 million people’. Everyone knows it’s a small country, but not everyone knows that the population of the Netherlands is actually 17 million.
In short, our mind gets ‘primed’ or ‘anchored’ to whatever the first number it encounters is, influencing our perception of the situation. That is the priming effect in its essence. I still get the population wrong every time I’m anchored to the initial 500,000.
It’s very easy to see how this tactic applied to business and negotiations can put anyone in a disadvantageous position. Someone throws out a ridiculously large or a ridiculously small number; your mind is now primed.
The good news is that knowing about the effect may reduce its impact. Be cautious when you are presented with specific numbers. Don’t take them on faith and check them independently before making any commitments.
2) Confirmation Bias
On the political spectrum, do you consider yourself more right or left leaning? If you consider yourself more liberal than conservative, chances are you enjoy CNN more than Fox News. The opposite goes for your right-wing counterparts.
We actively seek out information that confirms our pre-existing beliefs. The reason is simple, really. We are motivated by wishful thinking, and would prefer to be correct rather than incorrect.
In its extreme, confirmation bias leads to people ignoring any information that contradicts their personal opinion and focusing instead on anything that supports it. This self-deception can lead to overconfidence and poor decision making.
In your day-to-day encounters, try to cast away your preconceived notions of a topic and approach it with an open mind. Listen critically to the ideas of others. Oftentimes, even if you end up disagreeing, the exchange of perspective and new information can prove invaluable.
Confirmation bias has caused many entrepreneurs to incorrectly evaluate the popularity of their idea. This bias goes against the idea of failing fast. To defeat confirmation bias try to poke holes in your idea and conduct user research and user testing. Take a scientific approach.
An alternative explanation of confirmation bias is that people use heuristics to simplify complex tasks like deciding on the reliability of data. Our ability as humans to effectively scrutinize new information is lacking, so we tend to use the frequency at which we’ve been exposed to a piece of information as an approximation of reliability. This heuristic, known as the Availability Heuristic is our third cognitive bias:
3) Availability Heuristic
You are more likely to say something like ‘React Native is really popular’ or ‘PHP is still going strong’ if you are surrounded by people that use React Native or PHP respectively.
We should all know about it by now, yet so many times we fall victim to the availability heuristic. We naturally tend to think that if it is easy to recall something, it must be important or true.
People that watch local news with their unending stream of burglary and murder reports tend to think that murders and burglaries happen more frequently than they actually do.
If there is a Ford dealership right next to a person’s workplace, they will be much more inclined to report that Ford is having a successful year.
As a software engineer, I encounter new and upcoming technologies and frameworks all the time. We need to recognize when a technology is a fad or a revolution. As an example, I think blockchain is a great technology and has excellent applications, but it’s been very over-hyped by the media, the explosive rise in the values of bitcoin/other alt-coins, and the flood of Initial Coin Offerings (ICO’s).
Avoid bandwagons. I understand it is very time-consuming to double check every incoming bit of information. Go with the reasonable intuition and when it matters, check the facts.
4) The Endowment Effect
I am offering to sell you my five-year-old gaming PC that I built after weeks of research. This machine was worth $1,500 when I built it. I custom built the case. I played Mass Effect 3, Far Cry 3, Assassin’s Creed 3, & Diablo 3 on it with my friends that same year. I’ll be lucky if you’re willing to pay me a few hundred dollars for it.
Now, what if the situation was reversed?
People tend to appraise things in their possession as more valuable than the same objects that are offered to them by someone else. Often this is due to some emotional attachment that the owner feels towards his goods.
It has been posited by economists that there may be an evolutionary explanation to the endowment effect. They suggest that a seller who adopts the endowment effect may bargain more aggressively, leading to a larger payoff for their goods.
While you may be proud of your product, it may not be worth quite as much as you think. Just because you’re convinced that your iteration of the wheel is superior to all others, doesn’t mean the market will agree.
Through the lens of colder and more measured evaluation, some of the offers that you receive may not seem as unfair as you first thought.
5) Sunk Cost Fallacy
A buddy of mine used to refuse to buy rechargeable batteries for his portable CD player because he ‘had spent too much money on regular batteries and couldn’t stop now’. That was one of the most ridiculous things I’d ever heard, but on an emotional level, I could still empathize. I didn’t even argue.
I learned my first lessons about the sunk cost fallacy when I started playing poker. ‘The money you put in the pot is no longer yours’ they say. The ability to ‘detach’ from your previously invested money is invaluable in ensuring that you don’t lose even more playing the weaker hand simply because you’ve already pushed some of your chips to the middle.
It is probably the one mistake that’s hurting startups the most. Big companies still struggle with it, but for a young company, prolonged investment into ideas that are ultimately not going to pan out can be a much bigger deal. I’ve seen it numerous times over my career and so have you, I am sure.
Some economists have hypothesized that honouring sunk costs may be evolutionarily advantageous in certain situations. We as humans sometimes struggle to reconcile our short-term desires with our long-term ambitions. Maybe the sunk cost of paying for a gym membership should incentivize you to lead a more active lifestyle.
While two-sided, the takeaway is actually quite simple. ‘We’ve been doing this for a long time’ is not enough of a justification to continue practices that are ultimately costing you productivity or money. But don't abandon your initial ideas just for the sake of 'switching things up'.
Evaluate your initial reasoning and approach. Examine it within the context of your current results. As entrepreneurs, we must be ready to make a change and pivot, especially if the predictions don’t match the outcomes. The approaches we choose in the beginning are based on our initial limited information. With furthering our understanding of the problems we are trying to solve, comes an opportunity to make a change. This is how we find product-market fit.
This goes contrary to the popular belief that one should ‘never give up’. There is a world of difference between giving up on your dream of building your company exactly as you initially envisioned and being open to pivoting when the opportunity arises.
We like to think of ourselves as rational thinkers because we are. Sometimes.
When approaching problems logically the human brain has the capacity to solve incredibly complex problems.
On the other hand, emotional or instinctive thinking allows us to read people’s facial expressions to better understand their emotions, amongst many other useful things.
This disconnect is identified as ‘fast’ and ‘slow’ thinking and can be seen as:
- fast, automatic, subconscious, almost instinctual
- slow, calculating, conscious, and deliberate actions.
Our ‘fast’ thinking often feeds our ’slow’ thinking which presents a risk. We need to be aware of the typical mistakes we are capable of making to not let the emotional thinking overtake our rational side.
Recognizing the discussed cognitive biases and understanding their effects are especially important in business and product development as the choices we make have lingering effects and long-lasting consequences.
If you’d like to read further about cognitive biases, click here for an expansive list.