Phil Rosenzweig on “The benefits—and limits—of decision models”

Posted on: February 27th, 2014 by bobmorris

Credit: Pierre-Antoine-Grisoni

Credit: Pierre-Antoine-Grisoni

Here is a brief excerpt from an article written by Phil Rosenzweig for the McKinsey Quarterly, published by McKinsey & Company. To read the complete article, check out a wealth of other resources, learn more about the firm, and register for email alerts, please click here.

To learn more about the McKinsey Quarterly, please click here.

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Big data and models help overcome biases that cloud judgment, but many executive decisions also require bold action inspired by self-confidence. Here’s how to take charge in a clear-headed way.

The growing power of decision models has captured plenty of C-suite attention in recent years. Combining vast amounts of data and increasingly sophisticated algorithms, modeling has opened up new pathways for improving corporate performance. Models can be immensely useful, often making very accurate predictions or guiding knotty optimization choices and, in the process, can help companies to avoid some of the common biases that at times undermine leaders’ judgments.

Yet when organizations embrace decision models, they sometimes overlook the need to use them well. In this article, I’ll address an important distinction between outcomes leaders can influence and those they cannot. For things that executives cannot directly influence, accurate judgments are paramount and the new modeling tools can be valuable. However, when a senior manager can have a direct influence over the outcome of a decision, the challenge is quite different. In this case, the task isn’t to predict what will happen but to make it happen. Here, positive thinking—indeed, a healthy dose of management confidence—can make the difference between success and failure.

Where models work well

Examples of successful decision models are numerous and growing. Retailers gather real-time information about customer behavior by monitoring preferences and spending patterns. They can also run experiments to test the impact of changes in pricing or packaging and then rapidly observe the quantities sold. Banks approve loans and insurance companies extend coverage, basing their decisions on models that are continually updated, factoring in the most information to make the best decisions.

Some recent applications are truly dazzling. Certain companies analyze masses of financial transactions in real time to detect fraudulent credit-card use. A number of companies are gathering years of data about temperature and rainfall across the United States to run weather simulations and help farmers decide what to plant and when. Better risk management and improved crop yields are the result.

Other examples of decision models border on the humorous. Garth Sundem and John Tierney devised a model to shed light on what they described, tongues firmly in cheek, as one of the world’s great unsolved mysteries: how long will a celebrity marriage last? They came up with the Sundem/Tierney Unified Celebrity Theory, which predicted the length of a marriage based on the couple’s combined age (older was better), whether either had tied the knot before (failed marriages were not a good sign), and how long they had dated (the longer the better). The model also took into account fame (measured by hits on a Google search) and sex appeal (the share of those Google hits that came up with images of the wife scantily clad). With only a handful of variables, the model did a very good job of predicting the fate of celebrity marriages over the next few years.

Models have also shown remarkable power in fields that are usually considered the domain of experts. With data from France’s premier wine-producing regions, Bordeaux and Burgundy, Princeton economist Orley Ashenfelter devised a model that used just three variables to predict the quality of a vintage: winter rainfall, harvest rainfall, and average growing-season temperature. To the surprise of many, the model outperformed wine connoisseurs.

Why do decision models perform so well? In part because they can gather vast quantities of data, but also because they avoid common biases that undermine human judgment.2People tend to be overly precise, believing that their estimates will be more accurate than they really are. They suffer from the recency bias, placing too much weight on the most immediate information. They are also unreliable: ask someone the same question on two different occasions and you may get two different answers. Decision models have none of these drawbacks; they weigh all data objectively and evenly. No wonder they do better than humans.

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Here is a direct link to the complete article.

Phil Rosenzweig is a professor of strategy and international business at the International Institute for Management Development (IMD), in Lausanne, Switzerland. This article is adapted from his new book, Left Brain, Right Stuff: How Leaders Make Winning Decisions (PublicAffairs, January 2014). To read my review of that book, please click here.

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