MONEYMAX.PH
AS a follow-up to my previous column about Stage-Gate® as a way to structure our innovation processes, I would like to discuss some struggles this structure will face by design. Limitations in our capabilities to approach decisions as fully rational beings will inadvertently take their toll when we use this approach. Though unable to avoid these psychological effects, knowing the situations of such decision-making in which their occurrence is probable can help get us one step closer to rationality.
Prospect Theory
Our judgments are not stable, but they depend on ourselves, the given situation, and how the question at hand is framed, making them susceptible to changes and manipulation. This is founded in what is known as “Prospect Theory.” This widely accepted decision-making model was developed by psychologists Daniel Kahneman and Amos Tversky, for which Kahneman was awarded the Nobel Prize for Economics in 2002.
Prospect Theory breaks with the widespread expected utility theory, which assumes decision makers will always choose the option with the highest expected outcome. But it realizes that our actual behavior deviates from these rational solutions, with such deviations stemming from our inability to deal with uncertainties. This comes together in the core item of Prospect Theory, the S-shaped value function, with its famous kink.
Status quo – a mobile item of our decision process
The value function is a brilliant illustration of our irrationalities when facing decisions in uncertainty. It shows how we value different possible outcomes. The difference between two options – a gain or loss in value – is exposed as the true driving force behind our decisions. Close to our current state, the status quo, a gain will cause a much stronger increase in value as opposed to the same gain further away from the status quo, thus affecting how we make our decisions.
This can lead to interesting effects on how we spend our money. For example, when buying a watch with a mean price of about P5,000, we may be reluctant to consider an option that is priced at P6,000. But when we are looking at buying a car for P600,000, we will hardly reject a different offer for P601,000. Even though in both cases the monetary difference is P1,000, we value the loss in the latter case to be less, which lowers the boundaries for us to accept it.
Similar effects can be seen when dealing with the timing the losses are realized. We are more willing to accept a gamble, for which we may have to pay in the case of a loss if the payment is due in one year, as opposed to right now – a reason why many nations have appropriately. Furthermore, and most importantly, the status quo This is important, as we have a strong aversion toward losses that greatly influence our decisionmaking.
Behavioral dangers in Stage-Gate® decisions
In deciding to use a staged approach to projects, we willfully submit ourselves to a continuous repositioning of the status quo. Entering each decision-making point, the gates, we will review the information provided not from an overhead point of view, nor from the perspective that we had after the previous gate. We will have become fully accustomed to the situation our project has moved into, affecting our judgment of the project’s development and forecast.
Thus, we might undervalue additional costs from a project’s continuation, weighing them against a now larger total expenditure. Furthermore, we may overrate possible gains we hope to receive from the project, which is now closer to its completion.
One possible effect stands out. In shifting the status quo, the costs of the previous stages are not as available, causing us to misjudge their impact – just like with the gamble mentioned above. We have accepted them, after all, what is done is done. However, this makes us unable to properly value them, and weigh them against possible