Is intuition good or bad for business? This question has supporters and detractors. Latest research by ESADE Professor Bart De Langhe published in Harvard Business Review shows that intuition-based decisions are not always the best for business. ESADE Knowledge: Should managers trust their intuition? Bart De Langhe: The power of intuition is incredible. Our intuitions are very fast and they largely drive decision-making so it is important for managers to understand what their intuitions are and how their intuitive system works. In psychology, there is this idea that people can use two ways of information processing to make decisions. The first is quick and based on intuition. The second requires analytical effort and is much slower. Quite often we make decisions based on our intuition because they provide 'instant' answers to problems yet we often fail to check the accuracy of our intuitions. One characteristic of our intuitive system is that it assumes that problems are linear. That leads us into trouble because a lot of relationships in business are non-linear. EK: Is linear thinking bad for business? De Langhe: Linear thinking has limitations for business. I am teaching Executive MBA students and we often talk about this topic in class. I ask them this question: Suppose you have 2 customer segments, one with a retention rate of 20% and another with 60%. Almost everyone automatically assumes that increasing retention rates from 20 to 40% is better than from 60 to 70% because the first option implies an increase of 20% and the second one only 10%. EK: So, this assumption is wrong? De Langhe: It is more often wrong than it is right. The relationship between the retention rate of a customer and the value of that customer for the firm is highly non-linear. Moving the needle on a customer that is likely to stay has a greater impact on firm profitability than moving the needle on a customer that is likely to defect. Yet most companies are trying to do exactly the opposite. They try to identify customers with low retention rates and try to make them less likely to churn, for instance by offering a discount. However, if you can identify customers with high retention rates and make those even more likely to stay, the returns will be much higher. EK: Can you give us another example? De Langhe:  A similar thing happens with customer satisfaction and profitability. Imagine a manager who runs a monthly customer survey and results show that 50% of customers that previously gave 3 points on a scale from 1 to 5 now give 4 points. That seems like a major accomplishment and management may want to crack open the champagne. EK: What is wrong with it? De Langhe:  The relationship between customer satisfaction and the outcome that companies ultimately care about, such as customer loyalty or profitability, is not a straight line between two points. In many industries, it makes a big difference whether a customer is completely satisfied (5) or just satisfied (4), but it makes very little difference whether a customer gives you a 3 or a 2. EK: Many managers may think that linear thinking is the right choice. De Langhe:  What often happens is that managers in companies choose a number of metrics to measure and optimize but they do not think clearly about the outcome they want to achieve -- which for most companies is profitability. Managers should focus on this ultimate outcome without assuming linear relationships between the thing that they are measuring and the result they hope to obtain. EK: Is linear thinking more common than we think in business? De Langhe:  It is hard to say but based on my experience, this bias is extremely pervasive and maybe close on 100% of managers use it one way or another. It takes thought and systematic analysis to overrule intuition and many managers are not doing this on a daily basis. Managers need to realize that many relationships are non-linear and so metrics based on linear thinking are often inaccurate. EK: Why do you think people have this tendency to think linearly? De Langhe:  I guess the short answer is that intuition is a reasonable approximation that allows quick action but it is just not going to be the optimal solution nor lead to the best decisions. EK: How can managers retrain their brains to be aware of this linear bias? De Langhe:  There are several things companies can do. The most critical step is the moment of reflection that most people do not have when they think about a problem. Managers need to be aware of the way their mind works and its tendency to assume linearity while many problems in real life are non-linear. Awareness is the first step to realizing that you should not be trusting your judgement to the extent that you currently do. Business schools have an important role to play here. You cannot expect business students to achieve their true potential if you do not teach them about the mechanisms of their own minds and those of others. Business schools should place greater importance on fine-tuning people's intuitions. This is absolutely critical across all business disciplines. EK: What is the second step? De Langhe:  Once you realize the world is non-linear and your mind works linearly, then you need to think about what exactly your goal is and figure out what the optimal solution is to a problem. For instance, imagine you're a manager at Starbucks. If your ultimate goal is to maximize profits by increasing the number of customers that repeatedly use your services, you need to understand that the relationship between customer satisfaction and customer retention is likely to be highly non-linear. So instead of wasting time and energy on dissatisfied customers, you should focus your efforts on trying to delight satisfied customers. EK: Are there any tools managers can use to speed up their optimal decision-making? De Langhe:  Sometimes it is hard to figure out what the analytical solution to a problem is but it gets much easier when you can see a visual representation of the challenge. There is a lot of opportunity with developments in artificial intelligence and big data to visualize non-linearities on the fly. If companies were to invest in these visual tools, managers could speed up their decision-making process and find optimal solutions much faster. Business schools have an important responsibility here as well. This is why ESADE recently launched an MSc in Business Analytics. Business Analytics is not only about the data, it is also about the mind. The first and most important step in analytics is to ask the right questions, hence the need to understand the limitations of one's intuition.

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Why linear intuitions hinder your decisions as a manager

10/2017

Is intuition good or bad for business? This question has supporters and detractors. Latest research by ESADE Professor Bart De Langhe published in Harvard Business Review shows that intuition-based decisions are not always the best for business.


ESADE Knowledge: Should managers trust their intuition?


Bart De Langhe: The power of intuition is incredible. Our intuitions are very fast and they largely drive decision-making so it is important for managers to understand what their intuitions are and how their intuitive system works. In psychology, there is this idea that people can use two ways of information processing to make decisions.


The first is quick and based on intuition. The second requires analytical effort and is much slower. Quite often we make decisions based on our intuition because they provide 'instant' answers to problems yet we often fail to check the accuracy of our intuitions. One characteristic of our intuitive system is that it assumes that problems are linear. That leads us into trouble because a lot of relationships in business are non-linear.

EK: Is linear thinking bad for business?


De Langhe: Linear thinking has limitations for business. I am teaching Executive MBA students and we often talk about this topic in class. I ask them this question: Suppose you have 2 customer segments, one with a retention rate of 20% and another with 60%. Almost everyone automatically assumes that increasing retention rates from 20 to 40% is better than from 60 to 70% because the first option implies an increase of 20% and the second one only 10%.


EK: So, this assumption is wrong?


De Langhe: It is more often wrong than it is right. The relationship between the retention rate of a customer and the value of that customer for the firm is highly non-linear. Moving the needle on a customer that is likely to stay has a greater impact on firm profitability than moving the needle on a customer that is likely to defect. Yet most companies are trying to do exactly the opposite. They try to identify customers with low retention rates and try to make them less likely to churn, for instance by offering a discount. However, if you can identify customers with high retention rates and make those even more likely to stay, the returns will be much higher.


EK: Can you give us another example?


De Langhe:  A similar thing happens with customer satisfaction and profitability. Imagine a manager who runs a monthly customer survey and results show that 50% of customers that previously gave 3 points on a scale from 1 to 5 now give 4 points. That seems like a major accomplishment and management may want to crack open the champagne.


EK: What is wrong with it?


De Langhe:  The relationship between customer satisfaction and the outcome that companies ultimately care about, such as customer loyalty or profitability, is not a straight line between two points. In many industries, it makes a big difference whether a customer is completely satisfied (5) or just satisfied (4), but it makes very little difference whether a customer gives you a 3 or a 2.


EK: Many managers may think that linear thinking is the right choice.


De Langhe:  What often happens is that managers in companies choose a number of metrics to measure and optimize but they do not think clearly about the outcome they want to achieve -- which for most companies is profitability. Managers should focus on this ultimate outcome without assuming linear relationships between the thing that they are measuring and the result they hope to obtain.

EK: Is linear thinking more common than we think in business?


De Langhe:  It is hard to say but based on my experience, this bias is extremely pervasive and maybe close on 100% of managers use it one way or another. It takes thought and systematic analysis to overrule intuition and many managers are not doing this on a daily basis. Managers need to realize that many relationships are non-linear and so metrics based on linear thinking are often inaccurate.


EK: Why do you think people have this tendency to think linearly?


De Langhe:  I guess the short answer is that intuition is a reasonable approximation that allows quick action but it is just not going to be the optimal solution nor lead to the best decisions.


EK: How can managers retrain their brains to be aware of this linear bias?


De Langhe:  There are several things companies can do. The most critical step is the moment of reflection that most people do not have when they think about a problem. Managers need to be aware of the way their mind works and its tendency to assume linearity while many problems in real life are non-linear. Awareness is the first step to realizing that you should not be trusting your judgement to the extent that you currently do. Business schools have an important role to play here. You cannot expect business students to achieve their true potential if you do not teach them about the mechanisms of their own minds and those of others. Business schools should place greater importance on fine-tuning people's intuitions. This is absolutely critical across all business disciplines.


EK: What is the second step?


De Langhe:  Once you realize the world is non-linear and your mind works linearly, then you need to think about what exactly your goal is and figure out what the optimal solution is to a problem. For instance, imagine you're a manager at Starbucks. If your ultimate goal is to maximize profits by increasing the number of customers that repeatedly use your services, you need to understand that the relationship between customer satisfaction and customer retention is likely to be highly non-linear. So instead of wasting time and energy on dissatisfied customers, you should focus your efforts on trying to delight satisfied customers.


EK: Are there any tools managers can use to speed up their optimal decision-making?


De Langhe:  Sometimes it is hard to figure out what the analytical solution to a problem is but it gets much easier when you can see a visual representation of the challenge. There is a lot of opportunity with developments in artificial intelligence and big data to visualize non-linearities on the fly. If companies were to invest in these visual tools, managers could speed up their decision-making process and find optimal solutions much faster. Business schools have an important responsibility here as well. This is why ESADE recently launched an MSc in Business Analytics. Business Analytics is not only about the data, it is also about the mind. The first and most important step in analytics is to ask the right questions, hence the need to understand the limitations of one's intuition.

More Knowledge
Linear thinking in a nonlinear world
De Langhe, Bart; Puntoni , Stefano; Larrick , Richard
Harvard Business Review
Vol. 95, n 3, 05/2017, p. 130 - 139
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