Week 8 - Behavioural Strategy

• Prospect Theory:


  Losses and gains are valued differently
• Daniel Kahneman (2011); Thinking Fast and Slow

  System 1: fast, heuristic, unconscious decisions

  System 2; slow, thought-out decisions
• Thaler and Sunstein (2008); Nudge, Improving decisions about health, wealth and happiness

  Nudge: Any change in the choice architecture that results in a predictable change in behaviour, without foregoing any options or changing the economic incentivesEngelen (2020); Nudging is unethical
• Powell, Lovallo, Fox (2011); Behavioural Strategy

  Behavioural Strategy: “Behavioural strategy merges cognitive and social psychology with strategic management theory and practice. Behavioural strategy aims to bring realistic assumptions about human cognition, emotion, and social behaviour to the strategic management of organisations”
• Powell, Lovallo, Fox (2011); Behavioural Strategy

  Three schools to behavioural strategy:

  1. Reductionist
  2. Pluralist
  3. Contextualist
• Reductionist View

  Relies on positivist, realist, and objectivist philosophies of science

  • Favours quantitative methodology and mathematical modelling
  • Bounded rationalist, prospect theory, heuristics and biases
  • Moral Hazard (Akerlof), Bounded rationality (Simon), Utility (Von-Neumann)
• Pluralist View


  Evolutionary philosophies of science. Less concerned with individual decision-making and more concerned with the overall decision environment of the firm. • Intergroup bargaining, conflict resolution, resource allocationOrganisationally situated managers / groups
• Contextualist View

  • Sensemaking, perception, social construction of reality, critical theory
  • Shared ideologies, cognitive frames matter more than decisions, which seldom correspond with what people actually do anyway
  • Cognitive Maps

  Management perception and language
• Powell, Lovallo, Fox (2011); Behavioural Strategy

  How does individual cognition scale to collective behaviour?

  There is a gap between individual cognition and collective strategt

  Strategic actions: Not solely reflective of top management cognition

  Mode of aggregation of individual opinions depends on market conditions; strategic substitutes vs strategic complements
• Powell, Lovallo, Fox (2011); Behavioural Strategy

  How does individual cognition scale to collective behaviour?

  • Carnegie Model: Organisational strategy is largely a political process, involving coalition building bargaining, and conflict resolution. CEOs must then take this and try and reconcile firm beliefs with their own personal goals

  Groupthink, Psychology of organisation, conflit-resolution
• Powell, Lovallo, Fox (2011); Behavioural Strategy

  What are the psychological underpinnings of strategic management theory?

  No Rules for Riches

  • Heterogeneity amongst firms could be to do with firm failure, not just immobile factors, causal ambiguity, or inimitable goods

  Bounded rationality, biases, and heuristics can lead to failures
• Powell, Lovallo, Fox (2011)

  Can behavioural strategy explain complex executive judgements?

  Organisational Decisions:

  1. Logical
  2. Judgement

  CEO Hubris
• Powell, Lovallo, Fox (2011)

  Can we improve the psychological architecture of the firm?

  • Devil’s advocacy
  • Scenario analysis
  • ‘Post-mortum’ analysis ex ante
  • Introducing checklists reduced errors in healthcare management Nudging: Thaler and Sunstein (2008)
  • Display constant running costs of machinery
  • Design work spaces that encourage group discussionFirms should create choice architecture for dealing with known decision-biases in the form
• Pfeffer (2006); Hard Facts, profiting from evidence-based management

  70-80% of all mergers vail to deliver their intended benefits, and destroy economic value in the process Cisco’s Success:

  • Used evidence-based management data on acquisitions, both others’ and its own
  • Uncovered the importance of organisational culture compatibility for merger successCasual Benchmarking: Big mistake.
• Powell and Lovallo (2017); Strategic Decision Architecture of the Firm

  Reductionism does not solve the main strategy problems that executives face

  Strategic Processes can be used to distort biases: Green-lighting

  Strategic Decision Processes:

  1. Investment: large commitments, Degree of Risk
  2. Resource Allocation: Degree of Agility
  3. Blue Sky: High uncertainty, Degree of Innovaqtion
• Powell and Lovallo (2017); Strategic Decision Architecture of the Firm

  • Organisational decisions are not the sum of the biases of individuals, nor do they mimic the biases of one individual, but they effectuate arange of socio-cultural and behavioural forces
  • Decision-makers are subject to confirmation bias
• Liu et al (2017); Strategizing with Biases

  9 effective behavioural interventions grounded in public policy applications

  1. Messenger

  2. Incentives 3. Norms

  4. Defaults

  5. Salience

  6. Priming

  7. Affect

  8. Commitments

  9. Ego
• Wernerfelt (1987); Competitive Strategy under Uncertainty

  Firms who focus should base their choice of where to focus on the relative profitability if they are strong, and what others will do if they are weak
• Bromiley and Papenhausen (2003); Assumptions of rationality in strategy research

  • The overwhelming thrust of convention strategic theory has been to say that agents are intelligent utility-maximisers over all feasible alternatives
  • Barney - argues that it is because of resources that management do not understand, and bounded rationality stops competitors from pricing it away
• Powell (2017); Strategy as Diligence

  • Pace of competition means analysing industries, choosing scale and scope, positioning for competitive advantage, and seekingdifferentiated resources and capabilities have outlived their usefulness
  • Executives no longer believe in sustainable CA as a concept
• Bromiley (2005); Behavioural Foundations of Strategic Management


  Barney (2001): “If the application of a theory to a firm without any special resources can be used to create strategic advantage for that firm, then the actions undertaken by any one of these firms would not be a sustained source of competitive advantage”

  • However, this comes from the assumptions of rationality and equilibrium

  • people suffer from many biases or systematic patterns that result in them making sub-optimal decisions
• Time Series and Endogeneity:

  “Firm performance influences firm behaviour”
• Kahneman and Tversky (1974); Endowment Effct, Loss aversion, and the status quo bias


  Endowment Effect

  Loss Aversion

  Status Quo Bias
• Barney (1986); Strategic Factor Markets. Expectations, Luck, and Business Strategy

  • Success is driven by information, expectations of value, and luck
  • The greater the uncertainty of the firm is in this market, the greater part luck plays
  • Strategic factor markets are incomplete and imperfect

  1. Expected value
  2. Lack of separation
  3. Uniqueness
  4. Lack of entry
  5. Lack of understanding

  Resources must be acquired efficiently before they can be used: luck plays a role!
• Karl Weick (1995); Sensemaking

  How we structure the unknown as to be able to act in it”• Enables leaders to have a better grasp of their environments