The Application of Behavioral Science in Decision Making

Behavioral Science has changed the way managers approach questions of human behavior, by going beyond asking what the logical thing to be done to asking what the psychological realities of the situation. Thanks to Professor Daylian Cain of Yale school of Management for the insightful perspective on negotiating mindset in decision making during the just concluded Global Network Week. It is not sufficient to understand what you want or figure out the other party’s sheet to know the best price they are willing to pay before and during a negotiation. The smart trader combines the sheet efficiently through joint problem-solving skills to come to an effective deal by identifying what is valuable to one side and cheap to the other.

Know Your Reservation Value and The Pie

The Reservation Value is the walkaway price at which you do not care if the bid is accepted or not. This is the maximum a buyer would be willing to pay or the lowest, a seller would be willing to accept. It requires skills to figure out the reservation value of the other party. The strength of a smart negotiator is how much you can beat your reservation value. The goal of the buyer is to pay less than the Reservation Value while the Sell’s goal is to get more above the reservation value.

When two parties negotiate, the Pie is the differential value between the result of the aggregated individual efforts and the outcome of their joint efforts. Your goal is how much you can share from the Pie. For example, Paul and Janet are negotiating a deal to partner to deliver a project with Return-on-Investment worth $2 million. If the negotiation fails, Paul can invest his fund to generate $400,000 while Janet could earn $700,000. They both need the synergetic effect of their joint effort to earn the $2M. What is at stake is $900k. The Pie is $900,000! Figuring out their sheet through information gathering, either from competitors or websites is the goal of identifying the Pie. Your aim is to optimize the proportion of your share of the Pie, not just the absolute figure.

Be skillful to allow them to go first in a negotiation. Put all the issues on the table first before you haggle over them.

Making Better Decisions Using Behavioral Science

The application of behavioral science is reshaping how risk management in decision-making is assessed. The outside view draws an analogy from the past performance and not just the current situation. It is the best perspective! Behavioral science encourages taking a good risk that has a positive expected value. The outcome does not necessarily reflect the quality of the decision, rather, look at the process that culminates into the decision. If you can take all the small risks with the positive expected value, you should be prepared to take a good, aggregated risk.

Understanding behavioral science in decision-making has further stressed the need to be cautious with big risks; be risk-averse when considering a big risk that can sink the ship.

The reality in many organizations is that top management are being rewarded for taking big risks, ideally, they should be risk-averse at this level. At the bottom of the ladder, research has shown that folks are not rewarded for taking risks with a bad outcome, meanwhile, they should be risk-seeking at this level to promote the organization’s success. Do not confuse an outcome with a decision. Look at the process!