Dan Lovallo

Rational entrepreneurs or optimistic martyrs? Some considerations on technological regimes, corporate entries, and the evolutionary role of decision biases.

Introduction This is a rather conjectural report on the evolutionary role of decision biases— at both the level of individuals and of organizations—and, in particular, on their importance to the processes of corporate entry and the evolution of industrial structures. A growing and quite robust body of evidence highlights the pervasiveness of various types of biases in individual decision making, which accounts for systematic departures from predictions of the canonical model of rational choice (see, for example, Kahneman & Tversky, 1973, 1986, Shafir & Tversky, 1992). For our purposes, we will mainly concern ourselves with overconfidence or optimism, which frequently leads to bold forecasts of the consequences of ones own actions. Also, by way of example, we will examine risk seeking in the domain of losses, which often yields escalating commitments in the face of failures. Interestingly, these biases appear to carry over from the level of individuals to that of groups and organizations and, indeed, might even be amplified in the latter circumstances (see, for example, Kahneman & Lovallo, 1993, Lovallo, 1996a, and the literature discussed there). In this respect, a challenging domain of investigation – with vast ramifications into the analyses of the nature of entrepreneurship, technological change, and industrial dynamics – is that of corporate entry into an industry.

To Review or Not to Review? Limited Strategic Thinking at the Movie Box Office

Film studios occasionally withhold movies from critics before their release. These cold openings provide a natural setting to apply laboratory-developed models of limited strategic thinking to the field. In a set of 1,303 widely released movies, cold opening is correlated with a 10-30 percent increase in domestic box-office revenue, and a pattern of fan disappointment, consistent with the hypothesis that some moviegoers do not infer low quality from cold opening. While selection and endogeneity may play a role in these regressions, the full pattern of results is consistent with level-k and cognitive hierarchy behavioral-game-theoretic models. (JEL D12, D82, L82, M37)

Living with uncertainty: attractiveness and resolution timing

This study extends Loewensteins (1987) notions of savoring and dread to the domain of uncertainty. Measures of attractiveness and of willingness to delay the resolution of uncertainty were obtained for 16 two-outcome gambles with expected value of

Looking Inside Psychological Influences on Structuring a Firm’s Portfolio of Resources

1000 and for reflected versions of the same gambles. In both sets, the correlation between the means of the two measures was almost perfect. Positively skewed gambles were most attractive, and associated with the highest tolerance for delayed resolution. A measure of willingness to pay for early resolution showed a similar pattern. Copyright (C) 2000 John Wiley & Sons, Ltd. Language: en

Estimating Structural Models of Equilibrium and Cognitive Hierarchy Thinking in the Field: The Case of Withheld Movie Critic Reviews

This article explores ways that behavioral decision theory can predict and explain patterns of decisions that managers make in their efforts to maximize the economic value and scarcity potential of a firm’s portfolio of resources. The authors argue that psychology can offer a deeper and more nuanced look “inside” resource-based theory (RBT) as an efficiency-oriented, resource-focused analytical tool for discerning firm performance differences. The authors focus their inquiry on the resource acquisition, accumulation, and divestment processes that determine the components of a firm’s resource portfolio, developing a two-dimension framework to facilitate and extend the implementation of a decision-based approach to RBT. The first dimension describes three key psychological contexts of decisions, distinguishing among (a) perceptions of a firm’s existing resources, (b) the experience or competence of the decision makers, and (c) the framing of how alternatives are presented to decision makers. The second dimension captures the psychologically meaningful distinction between single choices made in isolation and simultaneous choices. Drawing on experimental and field research, the authors develop six testable propositions and explore potential for future theoretical and empirical contributions. The framework can help scholars specify the psychological foundations of a firm’s resource portfolio’s economic value and scarcity potential while helping managers delineate relevant considerations they must adopt to enhance a firm’s profitability.

Loss Aversion for Quality in Consumer Choice

Film studios occasionally withhold movies from critics before their release. Because the unreviewed movies tend to be below average in quality, this practice provides a useful setting in which to test models of limited strategic thinking: Do moviegoers seem to realize that no review is a sign of low quality? A companion paper showed that in a set of all widely released movies in 2000--2009, cold opening produces a significant 20%--30% increase in domestic box office revenue, which is consistent with moviegoers overestimating quality of unreviewed movies perhaps due to limited strategic thinking. This paper reviews those findings and provides two models to analyze this data: an equilibrium model and a behavioral cognitive hierarchy model that allows for differing levels of strategic thinking between moviegoers and movie studios. The behavioral model fits the data better, because moviegoer parameters are relatively close to those observed in experimental subjects. These results suggests that limited strategic thinking rather than equilibrium reasoning may be a better explanation for naive moviegoer behavior. This paper was accepted by Brad Barber, behavioral economics.

Generative Sensing: A design perspective on the microfoundations of sensing capabilities

A reference price is an internal price that consumers are believed to use to compare actual prices. Reference effects for price have been demonstrated in many settings. Reference effects for quality also have been demonstrated using scanner data. Here we present experimental evidence. Firstly, it is shown that high quality goods will be valued more by consumers who consider trading down in quality than by those who consider trading up in quality. Secondly, we show that when all prices fall, more switching up in quality from the reference brand will occur than switching down in quality when all prices rise, and that when all prices fall, consumers will switch to higher quality up to, but not beyond, the price regularly paid.

Behavioral Strategy and the Strategic Decision Architecture of the Firm

The ability to sense valuable strategic options and then to organize effectively and efficiently to embrace them is at the core of a companys dynamic capabilities. This article identifies and discusses a specific type of sensing that we call “generative sensing.” Companies and executives that display generative sensing capabilities proactively generate hypotheses about observed events and then test these hypotheses to generate new data in a recursive process. Borrowing from design cognition research, we discuss the two microfoundations of these capabilities—framing and abduction – and provide examples of how they are embedded in companies to enhance option generation.

A Design Cognition Perspective on Strategic Option Generation

This special issue explores the impacts of behavioral strategy on management practice. Behavioral strategy can best contribute to management practice by shifting its focus from individual decision biases to the design of behaviorally informed decision processes at the level of the firm. This introduction identifies three types of organizational decision processes, shows how they interact with individual and group biases, and proposes a model showing how managers can design and deploy these processes to shape the strategy of the firm. It then introduces the articles in this special issue and discusses their contributions to the future of behavioral strategy.

Robust Design Review Conversations

Abstract Strategic option generation is a fundamental step in strategy formulation. Several lenses have been proposed to explain its foundations, including the microeconomics positioning school, and the resource and capabilities based view of the firm. These approaches are largely based on inductive and deductive logics, which are not the logics that provide strategic options that are potentially novel, profitable, and largely differentiated from competitive offerings. In this chapter, we propose a unifying framework of the cognitive foundations of strategic option generation. Building on five fundamental cognitive acts – imitation, framing, analogical reasoning, abductive reasoning, and mental simulation, this proposed model both synthesizes the extant literature and provides guidance about promising avenues for future theoretical and empirical research.