Cognitive biases kill startups – aware, awake and free yourself
India has about 50,000 startups. 1300 new startups were born in 2019. This is quite encouraging but 90% of Indian startups fail within the first five years. There are several reasons for failure- inappropriate products and inappropriate business models are major reasons apart from lack of finance. In other words, startups offer solutions to the problem which either the society does not have or the solution is inappropriate, and, the assumptions behind the design of the business model is not correct. Research suggests assumptions are highly affected by the cognitive biases of the decision makers. Research also suggests that the decision-making environment for the entrepreneurs is highly uncertain and complex as a result the entrepreneurs get influenced more by the biases than the general population. Another important observation from the research on entrepreneurship is the desire to start a business is must to start a business. At the same time if the desire is too high then the decision-making process gets influenced more by the cognitive biases. Evidence suggests that the major biases the entrepreneurs show are: optimism bias, overconfidence bias, availability bias, confirmation bias, planning fallacy, sunk - cost fallacy and hindsight bias.
We will briefly discuss each of the biases that we have mentioned above.
Optimism bias (Planning fallacy)
The optimism bias is defined as “the difference between a person's expectation and the outcome that follows. If expectations are better than reality, the bias is optimistic; if reality is better than expected, the bias is pessimistic'' (Tali Sharot). In other words, over optimism ignores the possibility of negative outcomes. This is very prominent among project managers. Most of the projects are optimistically scheduled and this contributes to time and cost overruns.
How to fix it: There are two proven ways to fix the optimism bias: try to easily retrieve past bad events and the associated likelihood of losses due to these bad events, from memory. Try to appropriately use a loss aversion attitude.
Overconfidence bias
Overconfidence bias is the tendency to overestimate one’s abilities and talent. Overconfidence leads to overoptimism also. It is common knowledge that the majority of us evaluate ourselves as above average during self-appraisal. While we know statistically 50% will be higher than average!
How to fix it: First we have to acknowledge that we all have overconfidence bias. In a decision-making context we have to identify and validate our assumptions as decisions are based on assumptions. We have to challenge our assumptions and the best thing to do is to involve others as devil’s advocate or at least be our own devil’s advocate, which is very difficult. Take feedback seriously. Reflect on daily events and be watchful of daily events to identify signs of overconfidence.
In the case of startups, one should remember that 90% of the startups fail. This realisation will help us avoid optimism and overconfidence bias.
Availability bias
Most of my students who desired to go for startups have thought of app-based business. This is so, because app-based startups are in plenty and it is easy to get more information on app-based startups. This is an example of availability bias. According to Marx and Weber (2012), “availability bias or the availability heuristic refers to the human tendency to judge an event by the ease with which examples of the event can be retrieved from your memory or constructed anew.” People will overestimate the probability of an event happening if something similar they have experienced recently.
How to fix it
The only way to fix it is be aware of it and critically examine the facts that we have and seek more information. Take time to make a choice. Explore more options.
Sunk-Cost Fallacy
To stick to your plan and getting emotionally involved with your idea is good for its success. But the problem is even when an entrepreneur gets a feel that the idea will most likely not work the founders often think, having spent so much resources and time why to abandon it now? The phrase “never give up” may not be wise enough in case of startup. Founders often waste time and capital pursuing something not worth the effort. More one works on such an idea more is the waste of resources. According to Hal Arkes and Catherine Blumer, “when we continue a behaviour or work because of our previous investments of time, money, or effort, we fall victim to what has become known as the sunk cost fallacy.”
How to fix it
It is always advisable that one should work on his idea wholeheartedly to see its success. At the same time a founder must continuously review the business environment, competition and customers’ choice and realistically evaluate the progress of the project. It is not uncommon to see that the goal is just not achievable or worth keeping it alive. If such a situation arises it makes sense to come out of the project at an appropriate time.
Confirmation bias
A person with confirmation bias will always favour information that confirms his existing beliefs while at the same time ignore the information that challenges his belief. This type of bias will prevent us from looking at the situations objectively leading to poor quality decisions as the existing beliefs may be wrong.
How to fix
Acknowledge the bias in you as everybody has it. Once you acknowledge you may be wrong it will be easy to be open and will be ready to take different views positively. Try to look for more information. A good prescription is to test your hypothesis by searching for evidence against that hypothesis.
Hindsight bias
Hindsight bias makes people believe that they can predict past events more accurately than it actually was. This leads people to conclude that they can predict other events too. As a result, they give more importance to intuition than the data. Research suggests that those who fail to develop their startup activity into a real business demonstrate substantial hindsight bias. This happens as the individuals fail to identify the real cause of the failure and think they have the necessary capabilities to undertake successful venturing. Hindsight bias gives birth to overconfidence bias. People influenced by hindsight bias are at risk of overestimating their chances of success when starting a new venture. What is more dangerous is that entrepreneurs with hindsight bias will not learn proper lessons from experience.
How to fix it
Like any other bias, first to acknowledge the bias within you. Once you admit, the job is half done. Try to collect more information and make predictions from the information analysis. Compare it with your gut feeling prediction. Compare actual output with your predicted output. From the gap between the two you will realise the true picture and come out from your bias.
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