[extropy-chat] Inside Vs. Outside Forecasts

[Max More]

Excellent discussion.

Below is a commentary I wrote on a piece by 
Kahneman and a co-author, along with a piece of 
my own that drew on their work. Do go to the URLs 
if you want to read the actual articles, as well 
as find plenty of links to related work.

Max


Outside Looking In: Maximize Project Success Rates with Premortem Strategy
by Max More,
ManyWorlds, 04/09/2004
http://www.manyworlds.com/index2.aspx?from=/exploreCO.aspx&coid=CO490411554857

Why do highly intelligent and capable business 
leaders, backed by an army of talent and a flood 
of information, make so many extremely expensive 
mistakes? This article looks at the role of 
mental models in decision making and forecasting 
and suggests effective and efficient methods for 
improving. “Premortem strategy” reverses the 
effects of incentives that typically bias 
thinking, encouraging project planners and 
forecasters to check their assumptions. The 
premortem strategy raises awareness of 
assumptions made and ignored while coming to a 
conclusion, making it far easier to give due 
attention to alternatives that might avoid a costly failure.

This premortem method works especially well, 
argues Max More, when combined with what Lovallo 
and Kahneman have called “the outside view”. 
Technically known as “reference-class 
forecasting”, taking the outside view counters 
excessive optimism, being especially valuable 
when it comes to projects or initiatives that 
companies have never attempted before, whether 
entering a new market or implementing an 
unfamiliar process technology. Reference-class 
forecasting works by having you reevaluate your 
conclusion in the objective context of a class of 
similar projects, initiatives, or forecasts.

The article concludes by noting intriguing 
parallels and complementarities of premortem 
strategy and the outside view with role playing 
as a forecasting tool and some uses of scenario 
planning. Despite Ed Harris’ stirring words in 
Apollo 13, failure always is an option. Use these 
methods to minimize failure and to improve the 
odds of selecting the optimal choice.


Delusions of Success: How Optimism Undermines Executives' Decisions
by Dan Lovallo, Daniel Kahneman
Harvard Business Review, published on 07/01/2003
http://www.manyworlds.com/exploreCO.aspx?coid=CO77031947495

If you strode into your office today, feeling 
especially eager and optimistic, this is just the 
article to deflate your balloon. According to 
authors Dan Lovallo and Nobel-Prize winner Daniel 
Kahneman, letting out some of the pressurized 
optimism will probably save you and your company 
much grief in the future. That’s an enormous 
simplification of the message of this excellent 
paper applying cognitive psychology to 
forecasting and strategic decision-making. In 
reality, you may not need to change your extremely can-do ways.

Near the end of the article, Lovallo and Kahneman 
make a particularly useful point. The pervasive 
human tendency for over-optimism – with all its 
costly consequences in business decisions – can 
be highly beneficial when confined to the right 
places. To the extent that your company can 
cleanly separate functions and positions that 
involve or shape decision-making and those that 
promote or guide action, optimism can be left 
untouched in the latter but not the former. As 
the authors note, an optimistic CFO is a disaster 
waiting to happen, but optimism in a sales force 
or in some aspects of R&D should be healthy.

Business writers and analysts have made us all 
well aware of the high rate of failure, disaster, 
and debacle when it comes to mergers and 
acquisitions, entering new markets, and large 
capital investment projects. Because we naturally 
adopt an “inside view” of the situation and 
decision to be made, we nevertheless greatly 
overestimate our chances of success. Economists 
are no help; those not well versed in the dark 
arts of behavioral finance will only feed our 
optimism with academic cocaine that explains all 
those hugely costly mistakes as risky but rational decisions.

Lovallo and Kahneman will have none of this 
exculpatory nonsense. They locate the problem in 
several factors: A combination of cognitive 
biases including attribution errors, anchoring 
and competitor neglect, along with organizational 
pressures including stretch goals, discouragement 
of “disloyal” pessimism, and the pressure to 
present proposals in the best possible light in 
order to secure funding and support.

All is not lost. Lovallo and Kahneman explain how 
taking “the outside view” can counter endemic 
over-optimism. They show how to apply an outside 
perspective to planning and forecasting processes 
in five steps. This involves using an objective, 
external “reference class” to correct your 
intuitive estimate. The research demonstrates 
that “reference-class forecasting”, though 
ignoring the details of the current project, 
greatly improves realism and reliability. As we 
have suggested in “Rationality: The Next 
Competitive Advantage”, mastering these cognitive 
and emotional aspects of business decision-making 
and realigning organizational culture and 
processes accordingly could become a prime competitive differentiator.



_______________________________________________________
Max More, Ph.D.
max at maxmore.com or more at extropy.org
http://www.maxmore.com
Strategic Philosopher
Chairman, Extropy Institute. http://www.extropy.org <more at extropy.org>
________________________________________________________________
Director of Content Solutions, ManyWorlds Inc.: http://www.manyworlds.com
--- Thought leadership in the innovation economy
m.more at manyworlds.com
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