Wednesday, May 6th, 2020
By Gideon Grunfeld
The decisions made by human beings are subject to numerous logical flaws and idiosyncrasies. Unfortunately, COVID-19 and our individual and collective responses to it require us to make prudent decisions despite our flawed reasoning.
There is a lot of research showing that we tend to underestimate risks associated with low-probability but catastrophic events. For example, humans can’t easily distinguish between bad outcomes that are likely to happen one in twenty times and those that take place one in two hundred, two thousand, or two million. This flaw in our thinking is linked to an even more general and systematic one – overconfidence. Whether it’s business owners estimating the chances of their business surviving five years or experts assessing the chance of a rare event, we tend to overestimate what we know. And this can be a particularly severe problem in cultures that encourage positive thinking and ostracize those who are deemed to be “negative” people.
As a business owner or manager, some anxiety under the present circumstances is a sign of intelligence. But anxiety without some analysis is not useful. So, where should the analysis of your business start?
In our experience consulting with law firms and other professional services companies, two areas of risk tend to get overlooked during a crisis. The first relates to low probability events involving cash flow. For example, business owners tend to underestimate the chances that typically reliable clients will stop paying. We understandably focus on those clients who have a history of paying us inconsistently or who have said something to alert us to the threat of non-payment. That’s why businesses tend to get blindsided when a dependable client suddenly changes course. You should, therefore, run revenue scenarios that include non-payment by some of your best clients. That will help you decide what to do before such an event takes place and how to react once it does.
The second area of balky risk assessment involves relationship management. In a crisis, we tend to shrink our focus to those who are closest to us, and that is true of both personal and business relationships. But weaker relationships have been found to be especially helpful in creating new opportunities and finding new clients. Excessive reliance on your strongest relationships often results in you knowing the same people. And when you know and rely on a relatively narrow circle of people, you are at risk of something happening to a key relationship. That is why you should evaluate your systems and identify key relationships and alternative ways of receiving certain services. For example, if you are entirely dependent on a single person to provide your IT support, consider what will happen if that person falls ill or otherwise becomes unavailable to you.
The list of human logical flaws is long and varied. Papers like Eliezer Yudkowsky’s “Cognitive Biases Potentially Affecting Judgment of Global Risks” have done a good job of cataloging these. But even without delving into the academic literature, you can help your business and the people you care about by being aware that our ability to assess risks is impaired during a pandemic and we should be wary of overconfidence.
This is a time for humility.