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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
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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:
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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.
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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
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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?
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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
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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
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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
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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