Cognitive Biases and Their Impact on Dealing With Conflicting Objective Functions

8/7/2019 Cognitive Biases and Their Impact on Dealing With Conflicting Objective Functions

1/9

Chapter4

CognitiveBiasesandtheirimpactondealingwithconflictingObjectiveFunctions

By:ProcyonMukherjee

Zurich,1stMarch2011

InChapterthreeIhadlightlytouchedontheaspectofbiaseswhenPlannerstrytosidewithcertain

decisionsasopposedtoothers,thispredilectionforcertainoutcomesisnotwithoutanyreasonandit

pervadeseveryorganizationalinterfaceandinfluencesresults.Weshallseeinthelimitedspaceof

supplychainshowsuchbiasesimpededecisionmakinginadirectionthatmayormaynotbetheideal

oneandtakingcognizanceofthisearlyenoughisanimportantwaythatsomemitigationeffortscould

beattempted.

WhilepsychologistshavetheorizedonBiastheories,theyhavelookedatindividualandsocialbiases

muchmoredeeplywhileorganizationalbiasisasubjectstillinitsinfancyandIwouldtakethelibertyof

usingsomeofmyexperiencesinexplainingthesebiases.

Whydovariousconstituenciesholdcertainperspectivesinpreferencetootherequallyvalid

perspectives?Firstofallwemustthereforedefineunderwhatconditionssuchpreferenceisdesiredand

thefirstconditionis:

1.WhenthereisonetochoosefrommanywhilenoobviouschoiceisavailableThisisaverygeneralconditionofchoices,butitisthefundamentalcondition.Unlesswehavea

situationwhenanobviouschoiceisavailablethepresenceofbiasdoesnotcreepin,howeverthere

couldbeasocialbiasoranindividualbiasoraculturalbiastowardscertainchoicesalthoughanobvious

choiceisavailable.Weshallignorethisbiasasthiscouldbemoredifficulttohandleinthecontextof

organizationalpuzzlesthatwewanttodealwith.Soweshallsimplifythestructureasoneinwhichno

mathematicallytruestatementisavailabletomakeaparticularchoiceobvious,wehavetheincidence

ofaBiastocreepin.

Letusexploreagivenconditionthatafirmhasthreechoicestoincreaseprofitsanditneedstoselect

one:

IncreaseSales IncreaseMargins ReduceCosts

Letusassumethateachcouldequallybeeffectivetoresultinahigherprofit,whatwouldthefirm

choose?Perhapsinthiscasetherecouldbeanincidenceofabiastowardseithersalesormarginsor

costsdependingonwhatispredominantinthefirmscollectivethinking.Mostfirmstrytoeliminatethis


2/9

biasbyfocusingonmorethanoneobjectivefunctionbydesigningcertainincentivesthatservevarious

aspectsoftheoriginalobjectivefunction.

2.Whenfunctionsarealignedtocommonincentives,theymirrorspecificbiasesinsteadofreducingit

Letusgobacktotheearlierexampleandassumethatthefirmputsinplaceincentivestoensurethatall

threeobjectivefunctionsarepursued,whichmeansthatincreasingsales,reducingcostsandincreasing

marginsarealltakenupbyvariousarmsofthefirmsothatwedonotmisstheopportunitytoimprove

oneachofthesepotentialgainspossibletobederivedforincreasingprofits.

Inordertoavoidthatthesalesfunctionsinglemindedlypursuestheobjectivefunctionofincreasing

sales,whiletheproductionfunctionwouldpursuethereductionofcosts,andthecommongroupof

peopledrawnfromsalesandplanttopursuethecommonobjectivefunctionofincreasingmarginsas

thatcouldbedonebyproducingmoreofthehighmarginproductsormovetowardsincreasingpricesof

someproductsbydeliveringhighervaluetothecustomers,wecouldhaveonesingleincentivedirected

towardsprofitwhichistobeachievedbytheoptimizationofallthreeobjectivefunctions.

ObjectiveFunctionSales=S

ObjectiveFunctionCost=C

ObjectiveFunctionMargin=M

Conventionallogicwouldsuggestthatunderclearmethodsofcalculationwecouldactuallypinpoint

howeachdeltachangecouldimpactthefinalresultwhichisprofit,thus:

Profit=f(deltaS,deltaC,deltaM)

DoesthismeanthatthecommonincentiveonprofitcouldeliminatethebiastowardseitherofS,Cor

M?

Ifthiswastruethenthesalesfunctionwouldhavehadnobiastowardssales,themanufacturing

functionwouldnothavehadanybiastowardscostandthecommonfunctionwouldhavehadnobias

towardsanyoneofthethreeatall.Thetruthissomewhereinbetween,wedoseesuchbiasesalthough

commonincentivestrytoeliminatesuchbiases.Whyisthisso?

Thereasonissteepedintheconceptofinformationasymmetryandinwhatwehavealreadyseena

glimpseintheearlierchapter,Boundedrationalityunderuncertainty.Letusdealwitheachofthe

conceptsfirst.

KahnemannandTverskyresearchedoncognitivebiasesandhaveproposedthreekindsofheuristicsin

playfordecisionmakingunderuncertainty:


3/9

A.RepresentativeHeuristicBias:SupposewestartwithasetofdatathatrepresentsTypeAandletusassumethatsomecharacteristicsofthisdataisrelatedwithafunctionB.Forexamplelet

ustakethetypicalexamplethatKahnemannandTverskyproposed;thereisalistcontaining

namesofprominentStatesmen(TypeAdata).Therearesomewithinthiswhoaremore

prominentthantheothers(FunctionB:Popularity).IftheTypeAlistisreadoutthenitismost

likelythatthemorepopularnameswouldberememberedandthelessforgotten,thereforeitis

morelikelythatattributescorrespondingtothemorepopularoneswouldinfluencethedecision

onwhatistherepresentativeattributefortheType1data.Forexampleifmorepopular

Statesmenaremeninthatlist,itcouldwellbeinterpretedthatthelistofTypeAhasmoremen,

regardlessoftheactualcomposition.Oradifferentexamplecouldbethatifthenamesof

popularStatesmenhappentobefromAsia,itcouldbeinterpretedthatthelisthasmore

proportionofAsianStatesmen.

B.AvailabilityHeuristicBias:Inthiscaseattributionisgiventoamorefamiliarandresonantpieceofinformationinthepuzzlethatiseasytodecipher,thanthemorecomplexoneandismore

likelytobesequestered.Theclassicalexampleisthebatandtheballpuzzle,whichwasgivento

theHarvardUniversityMBAstudentsinwhichmorethansixtypercentgavethewronganswer:

Ifabatandballtogethercosts$1.20andifthebatiscostlierthantheballby$1,whatisthecostof

thebat?

Theavailabilityheuristichasthebiggestconnectionintheworldofbusiness.Investorsfindinthetrend

chartsofthepastperformanceofvariouscompaniesaleadingindicatoroffinancialhealthofasectorof

businessortheeconomyingeneral,whereastheactualdatacouldbesimplyrandom.Theavailability

heuristicsaremorecommonlyusedbythefinancialcommunitytolookatthedataofthenearby

quarterstoframetheprojectionforthenextquarters,whichinabsenceofanyotherinformationisthe

only

way

to

project

future

performance.

The

problem

is

that

there

are

a

myriad

of

other

extraneous

factorsthatcouldhaveinfluencedthemorecurrentquartersandwhethertheycouldinfluencethe

futureneedstobeascertainedbeforesuchananalogycouldbedrawn.

Thereisadifferentconnotationtothisproblem.Investorsdonothavethefullpictureinapresentation,

whattheycouldhaveinabalancesheetoradetailedearningsstatementwithsupportingcharts.Whata

presentationconveysisaviewpointandhowthisgetspresentedcreatestheavailabilityheuristicasitis

neverpossiblefortheinvestortodiscernabarrageofinformationsteepedindatatables.Thusthe

guidancegiveninapresentationincaseitisbiasedtowardsasetoftrends,ithelpstocreateastronger

impressionforaparticulardecisiontobemade.Humanmindsneverwanttomakecomplexcalculations

togettodecisionsandthenormalbiasistowardsknownandtestedwaysoftakingdecisionswhichis

basedonsimpleheuristicjudgments.

Intheworldofplanningavailabilityheuristicplayshavocwithdecisionmakingasproblemsareso

complexthatplannersdonothavethefullpictureinabsenceofdataandtakesintoaccountthosethat

aresimpletocomprehend.Algorithmsaretheonlylogicalwaytolookatmorethanoneconflicting

objectivefunctionandcreatepropercomputationallogictodealwithoptimizingofeachagainstthe

otherortheoverall.


4/9

C.AnchoringandInsufficientadjustment:Inthiscasethefocusshiftstowardsaparticularinitialstartingpointandthenworksbackwardsorforwardsaroundthatstartingpointtoarriveatthe

bestestimate.Sotheinitialstartingpointinfluencesthedecisionsconsiderablyasthemind

cannotmakeasufficientadjustmentinabsenceofnewinformation.IfweaskwhatyearMan

landedonthemoon,onewouldprobablystartwiththetenureofKennedytostartwithorhis

assassinationdate,ifknown,asthereisastrongassociationofKennedywiththelaunchofthe

firstmannedaircraft.

Inthefieldofbusinessthishaswideramificationasinmostbusinesspresentationsonewouldseethis

biasrampant.Thestartingpointofperiodunderrevieworthecomparatorused,orthechoiceofmetric

itselfinfluencesthedecisions,whichisbasedontheanchoringthathappensinourminds.Forexample

ifaperiodunderreviewisshortenedwiththestartingpointasoneyearbackversusfiveyearsback,

changestheperspectivecompletely.AlargedeltaVsasmalldeltacouldbesimplybecauseofthe

startingpointandinfluencestheanchoringandthesubsequentinsufficientadjustment.

LetmenowtrytousetheseconceptsintheproblemthatIreferredinthecontextofacommon

incentiveapproachwiththreeobjectivefunctionsplayingtothefore.Butthereisanadditionalbiasto

bedealtwith,whichisthebiasofthemindset.

Whilethegeneralconceptofmindsetisaboutparadigmsthatgivegroupsofpeopletheircomfortzones

todealwithproblems,towhichtheyhavefamiliarityintermsofsolutions,thereisthetypicalcaseof

theEinstellungeffect,whichcreatesthefunctionalfixednesstoproblems.Ifasalesmanhasspenthis

timemorewithcustomersinthefield,hewouldnotseetheinternalperspectiveofanoperations

functiontodealwithaproblemthatcouldhavelittletodowiththemarketandviceversa.

Ifprofitcomesfromthesummationofeffortsinsales,operationsandstrategy/planning,butifthe

specificcomponentscouldnotbedissectedtodeconstructtheprofitfunction,itisafertilegroundfor

cognitivebiasestotakeover.Ontopofthistherecouldbeotherobjectivefunctionslikegrowththat

couldfurthervitiatethedynamics.Onewouldhaveexpecteddetailedmathematicstotakecareofsuch

problemsbutmanagersdonothavetimewithcomplexMathematics,infacttheydetestthem.Rather

theyworkwithsimplisticstructuresthatsimplifytheproblemandusesaidstofacilitatedecisionmaking

bytrialanderrors.

Thethreefunctionalgroupsinquestionclearlyhavetodealwiththeirmindsetsandalsothe

organizationreportingtothem.Whattypicallyhappensinacommonincentivestructureisthatthesales

functionmaximizessales,theoperationsfunctiontriestominimizecostandthestrategy/planningcell

given

the

directive

on

growth

looks

at

investments

that

could

create

growth,

which

may

or

may

not

be

accretivetothebottomlineinabsenceofgoodqualityofdata.

Informationasymmetryinthiscontextisamoreinterestingphenomenon.Ifwegobacktotheusedcar

problemfirstreferencedbyAkerlof,weseethatthebuyerhasnoideawhetherthecarisalemon

(defective)whilethepriceisfixedleavingnoroomfornegotiation.Ifweassumethatthereare20%

lemonsitcouldwellbethattheusedcarsalesmansetsthepriceinsuchawaythathemaximizeshis


5/9

utilitybythesuperiorknowledgethathecarriesrelatedtothequalityofthecarsagainsttheinferior

knowledgethatthebuyercarries.Thesolutiontothisproblemissignaling.

Therearemanystunningexamplesofinformationasymmetryproblemslikemanagersversusinvestors

intheknowledgeoftheearningsprojectionsandthequalityoftheseprojectionsorthemoreextreme

caseofthecostofcapitalitselfasthebidaskspreadscouldexpandduetoonesidenothavingthereal

picturewhiletheothersidecouldhave.

Themoreblatantmarketexampleisthecaseofinstitutionalinvestorshavingfarbetterinformation

thanthenormalindividualmarginalinvestorandcouldsignificantlygainfrominformationasymmetries

(shortsellinghasbeenfoundtobeaninstitutionalphenomenonwhichhasdisproportionategainsand

losses).

Letmegobacktomyexampleofthespecificbiasesinthecontextofthecommonincentiveprogram.

Thereareactuallymanypossibilities,soletmedrawthedecisionmatrixasfollows:

DecisionMatrixinthecontextofObjectivefunctions

SALES

OPERATIONS

5%

Sales

Growth

Change

inMix

withno

growth

Change

inMix

with

growth

New

Product

Introducti

ns at5%

Improve

ment of

service

conditions

5%cost

reduction

Efficiency

improvementFixedcost

reduction

Investmentsfor

growth(hard)

Soft

Investments

TwobyTwo(2x2)

Onewouldnoticethatthisisfairlysimpleinatwobytwobutinactualorganizationalcontextthisisa

multipleofXbyY,wherequiteanumberofobjectivefunctionshavetocompetewitheachother.

Itisalittledifficulttoexactlyframetheentirematrixwhentherearemorethantwotobelookedata

time.Buthowdoestheorganizationdwellonthecommonfringeareaswhereoneconflictswiththe

other?Isthemerecommonincentiveforonecommonobjectiveagoodenoughmechanismtotakecare

oftheproblem?Doesleadershiphavetoplaytheroleofinterveningtosettherightpriorities,butbased

onwhatinformationanddatawouldtheleadershipact?


6/9

Inmostcasescomplexityindatastructuresactuallyforcesbiasestoactandinthiscaseallthethree

biases,includingthemindsetactsandactuallyimpedestheprocessofachievingthecommonobjective

asconflictsareresolvednotbasedonwhattheproblemrequiresasasolution,butbyoneormore

biasesthatactmorepowerfullyovertheother.

3.WhentheOwnersoftheProcesscomefromspecificfunctionsandexpertise,theprocesschangesreflectpredilectionoftheowner

Thinkofadepartmentbeingrunbyanengineerorasciencegraduateasopposedtoanaccountant.

RecentlyinaconclaveinZurich,thisexamplewascitedasnootherthanAzimPremji,theChairmanof

Wipro,andhesaidthefirstthingthatanaccountantwoulddoifheseessomenumbersonapieceof

paperagainstcertainattributes,hewilladdthemup;theengineerwouldnot.

Ihavetriedtothinkhowmentalpredilectionsworkinagivensituation.Itisdifferentfrombias,

althoughtherecouldbesomecommonelementsinboth.Imagineasalesfunctionbeingexecutedbyan

Engineer,hewouldinvariablybringinatechnicalaspectinselling,trytounderstandthecustomers

processfromthetechnicalprocessstandpoint,orcommunicatewithhisinternaloperations

organizationwithatechnicallinkageinordertoimprovetheprocessflowwiththecustomer.Thissame

functionwouldlookdifferentwhensteeredbyasalesmanwhoiscomingfromanaccounting

backgroundorapurelysellingbackground.

Whensuchownerscombineinamatrixsetuptodealwithchallengesthatstretchbeyondtheirareas,it

isonlytobeexpectedthatpredilectionsdoplayaroleinbothframing,understandingandthefinal

solutiontotheproblem.

LetmenowgobacktotheoriginalSupplyChainproblemwithmultiplayersituation.Isthereawayto

dealwiththepushpullthatonewouldexpectrelatedtobiasandpredilections?Andhowdowedeal

withthat?

TheOrganization

Theorganizationisthecenterpieceofthepuzzleandwhatistheorganization?Itisjustnotthe

structure,butthepeoplewhomanthisstructureandtherelativeimportanceofwhattheydeliveror

theirfunctionsdeliveragainsteachotherandagainsttheobjectivesofthefirm.Whiledesigninga

supplychainsolution,thequestionoftheorganizationcanneverbeleftout.

Everypartoftheorganizationhasitscoreobjectivesandgoalsandintodaysworldofincentives,they

haveassumedfarmoreimportanceasthevariablepaycomponenthasincreased.Infirmswhere

incentivesaresodesignedtomaximizeeachindividualfunctionsgoalsortargets,theproblemisonly


7/9

compoundedtothatextentasoveralloptimizationcanonlybedoneatahigherlevel.Buthowhighis

thehigherlevelthatisthecriticalquestion.Thelowerthebetterasbettercoordinationcanonly

happenifobjectivescanbecommonlydenominated.

Asupplychainhasmanyplayersstartingwith:

1.Procurementofinputs,whohavetonegotiateagainsttoughconditionsandhavetheirownKPIslikereducingtransactioncost,procurementcostorimprovingcashflowsthroughbetter

paymentterms.Inaglobalorganizationsuchplayershavetobegloballycoordinatedasthey

havetodealwithglobalplayersasrivalsaswell.

2.Sales:Inaworldwheredemandisconstrainedtheybehavequitedifferentlytoaplacewhichissupplyconstrained.ThesalesfunctionhastodealwithamyriadoffactorswhichIwillcoverin

thenextsection.

3.SupplyChainPlanner:Thesupplychainplannerworksunderthenarrowinfluenceofhisplanninghorizonandhavetodependonmanyotherconstituenciesonwhomtheyhavelittle

influenceintermsofdrivingdecisions,likeproduction,maintenance,etc,whomayhaveother

KPIs.

4.Production&Maintenancefunction:Theoperationsfunctionoutsideofplanningactuallyinfluencesresultsmostprominentlyonceaplanhasbeenfrozenastheytakedecisionsoutside

oftheplannersviewpointandsometimesthesedecisionshavebearingontheresults.

5.GeneralManagement:TheGeneralmanagementisnotanextrinsicplayerbutthemostintrinsicandhecouldtaketheultimatedecisionswhichmaynottouchbasewiththeplannerorits

knowledge.Whilethesedecisionsareimportantandcouldbeabsolutelyrationalegiventhe

natureoftheKPIs,someofthesedecisionscouldalterthewaytheresultsaresupposedtobe

derived.

Thereareanumberofprocessesthathavetobefollowedthroughtomakeaplanningprocesswork.Let

mehighlightthekeyones:

1.BusinessPlanningandAnnualBudgetingExercise2.DeterminationofDynamicsalesandProductionPlan3.CapacityAllocationandSupplierQuotaAllocation4.MonthlyForecastingprocess5.OrderEntryandOrderManagement6.SupplyDemandmatching7.ConversionofFlexiorderstoFixedorders8.Executionofplan9.Midcoursecorrectionandadjustmentofmasterparameters10.Expeditinganddeviationmanagement11.Negativefeedbackloop


8/9

Howtheorganizationworksinalltheseplanningdomainsisanimportantsteptobeseenanddebated.

Doallpartsoftheorganizationhaveacommonobjectivewhileworkingineachplanningstep?Howdo

wetakeguardthatanymisalignmentcouldberemovedateverystep?Canthisbedonesimplythrough

KPImonitoring?

Whendeviationstoplanhappennotbecauseofrandomcausesbutassignablecauseshowdothe

systemandalltheconstituenciescometoknowofit?Howdoestheinformationflowwork?Canthisbe

donethroughRuleadherencematrixonly?

Thesearesomekeyquestionstobeasked.

TheSellingMindset

WhyIhavesingledoutthesellingfunctionasaseparatesection,needssomeclarification.Thisiswhere

thepeoplewhomakestuffstarttheprocessofvaluecreationinanyfirm.Withoutanordernothing

canstart,withoutaperceiveddemand,nootherideacanhaveanymeaning.Whileitthesignificant

sourceofvaluecreation,itisalsoasourceofcostcreationasmuchofthecostsstartstoaccrueoncethe

packageofdeliveryisconceived,ornegotiatedandfinallyagreedwiththecustomer.Nomatterwhat

wetrytodointermsofdesigningasupplysolution,thestartingofthecontractualagreementwiththe

customeristherealstartingpointofhowthecustomerwouldexpectthesupplytolooklike.The

expectationsweimbibeinthecustomermusttakeintoaccounttheinherentnatureofthesupplychain

capabilitythatwehave,whichiseasiersaidthandone,asthesellingfunctionhastodealwithalarge

numberofotherfactorsthatcometothefore.Theseare:

Competitionandcompetitiveofferings

Natureofthemarket

Natureofthebusiness

Timingoftheboombustcycles

Objectivesofthefirmvisvisgrowthandstrategyinspecificsegments

Powerofthecustomer


9/9

Thenatureofofferingsandthecapabilitytodeliverisasubjectofdebatewithinthefirm;itisnever

concludedassellingpartoftheorganizationsideswiththecustomerinmanyaspectsofthedebateand

therestoftheorganizationmustsuccumbtotherealizationthatthecustomermusthaveitsway.There

isnothingwronginthisbelief,otherthanthefacttherearelimitstocapabilityanditscostsandmore

oftenthannotetheofferingisastepabovewhatthecostscanbearandthisfactisneverinblackand

white,whiletheofferingscontinuetobe.

Theplanningmindsetontheotherhandmustdealwithoptimizationpuzzlesthateithermaximizesor

minimizesagivenobjectivefunction;therearenoabsolutetruthstobepursued,astherearentany.

Theoperationsmindsettomaximizeefficiencycomeinsharpconflictandthereforetheneedforoverall

leadershipisofparamountimportance.

InthecontextofPlanningthereforeIwouldask,thattheorganizationmusttrytoimproveitsprocesses,

butitshouldnotstartwithapromisethathasembeddedinitsemblanceofawishfulthinkingthatcan

onlybefulfilledthroughaseriesofinitiatives.Ratheritshouldstartwithwhattheorganizationis

capableofdoingandthenstarttoimproveonitthroughcarefullyorchestratedstepsoveraperiodof

time.Sometimesthisaspectisignoredwhiledesigningasupplychainprocessandwemixupbetween

preparingtosupplythebestofourpromisewithaninadequatecapabilitytoorganizeourinputsorour

capabilitytoproduce.Tofindadecentbalancetothispuzzleneedsorganizationalcollaborationand

removalofbiasesonwhichthechapterisdedicated.

ProcyonMukherjee

Zurich,

1stMarch2011

Documents

Cognitive Biases and Their Impact on Dealing With Conflicting Objective Functions