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Complexity, Cognitive Biases, and Decision Making in an Uncertain World of Technology Sung Joo Bae Assistant Professor Operations and Technology Management School of Business Yonsei University

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  • Complexity, Cognitive Biases, and Decision Making in an Uncertain World of TechnologySung Joo Bae

    Assistant ProfessorOperations and Technology Management

    School of BusinessYonsei University

  • Class Logistics Team Wikis security & creating a new page, team formation!!! Participation: 30% Attendance Case/Class discussion Wiki Participation (extra points) PREPAREDNESS Five written case report: 30% Final Project: 40% New concept of Product/Svc/Biz Model

  • Project plan presentation Aug 2, 2011 5 minute SHARP Get feedbacks afterwards (approximately 5 minutes)

  • Quiz: The following video shows 6 people making passes (3 in white shirts and 3 in black shirts). Your task is to count the total number of AIR PASSES that people wearing WHITE shirts pass.- Do NOT count passes by the players in black. - Do not count the bounce passes only direct air passes.

  • VIDEO

  • Inattentional Blindness When people are engaged in an attention-demanding task they often fail to notice unexpected objects or events.

    In an experiment setting, 50% have failed to notice the gorilla.

  • Case Study Kodak & the Digital Revolution

  • Kodak in Rochester

  • Q: These companies have something in common. What is it?

    ICI (chemicals)IBM (personal computers)Kodak (photography)Sears (retailing)General Motors (automobiles)Ampex (video recorders)Winchester (disk drives)US Steel (steel)Syntex (pharmaceuticals)Philips (electronics)SSIH (watches)Polaroid (photography)Fuji Xerox (copiers)Zenith (TVs)

  • ICI (chemicals)IBM (personal computers)Kodak (photography)Sears (retailing)General Motors (automobiles)Ampex (video recorders)Winchester (disk drives)US Steel (steel)Syntex (pharmaceuticals)Philips (electronics)SSIH (watches)Polaroid (photography)Fuji Xerox (copiers)Zenith (TVs)

    They are the product class winners who fall victims to their success..then, what in the world has happened to them?

  • Changes from the OutsideFirm

  • Changes from the OutsideFirm

  • Changes from the OutsideAdaptation& Reorientation

  • InertiaChanges from the Outside

  • Learning MyopiaEfforts in Short Term SuccessInertia in Long Term Failure

  • Industry Life-cycle as an S-Curve

    t

    Performance

    Source: Foster (1986)Discontinuity

    Ferment

    Takeoff

    Maturity

  • The S-Curve Maps Major Transitions

    t

    Performance

    Source: Foster (1986)Discontinuity

    Ferment

    Takeoff

    Maturity

  • Dominant Design

    Product Innovation ProcessInnovationDominant Design

    # of Innovations

    t(Abernathy & Utterback, 1975)Era of Ferment

  • The Nature of Technical Work Changes

    t

    Performance

    DiscontinuityTakeoff

    Maturity

    Will it work? Exploration, Fun, Creativity

    Can we make 100,000 and service them?

    We need to be responsive & flexible but controlled

    Will it work? Exploration, Fun, Creativity

    Source: MITs Tech Strategy

  • The Basis for Competition Changes

    t

    Performance

    Discontinuity

    Product DifferentiationIntellectual PropertySpeedFrontier Performance

    Price, Quality, Incremental Features

    Product DifferentiationIntellectual PropertySpeedFrontier Performance

    Source: MITs Tech Strategy

  • The Organizational Dynamics Changes

    t

    Performance

    Discontinuity

    Entrepreneurial Energy Critical

    Coordination and Control Critical

    Entrepreneurial Energy Critical

    Source: MITs Tech Strategy

  • Technical Change

    IncrementalInnovation ModularInnovationRadicalInnovationArchitecturalInnovation

    Core Concepts

    Linkages betweenCore Concepts & ComponentsUnchanged

    Changed

    Reinforced Overturned

    (Henderson & Clark, 1990)innovations that change the way in which the components of a product are linked together, while leaving the core design concepts (and thus the basic knowledge underlying the components) untouched

  • Design Structure Matrix (DSM)

    Source: Design rules (2000)

  • Design Parameters & Tasks

    Source: Design rules (2000)

  • Possible relationships between tasks

    Source: Design rules (2000)

  • Simplified TSM for IBM Laptop design

    Source: Design rules (2000)

  • Modularization of IBM Laptop design

    Source: Design rules (2000)

  • Taxonomy of DSM

  • Source: Design rules (2000)

  • Exercise: iPod and iTunes Store on iPhone

  • Technical Change

    IncrementalInnovation ModularInnovationRadicalInnovationArchitecturalInnovation

    Core Concepts

    Linkages betweenCore Concepts & ComponentsUnchanged

    Changed

    Reinforced Overturned

    (Henderson & Clark, 1990)innovations that change the way in which the components of a product are linked together, while leaving the core design concepts (and thus the basic knowledge underlying the components) untouched

  • Transitions often challenge existing organizations severely

    Cumulate share of sales of photolithographic alignment equipment, 1962-1986, by generation Contact Proximity Scanner S&R (1) S&R (2) Cobilt 44

  • Inertia in Organizational Mechanisms Filters (Cognitive Framework) Channels (Information Flow) Problem-Solving Strategies (Learning Trajectory) Structures, culture, disciplined processes, control mechanism, individual knowledge? Anything else?

  • Component (incremental) vs. Architectural Innovation?

    t

    Performance

    Source: Foster (1986)Discontinuity

    Ferment

    Takeoff

    Maturity

  • Disruptive Innovation;

    High-End MktDemand

    Low-End MktDemand

    Performance

    t

    Disruptive Innovation

    Source: Christensen (1997)

    Technologies that disrupt an established trajectory of performance improvement

    Mid-End MktDemand

  • Disruptive Innovation

  • Inertia in Organizational Mechanisms Resource Dependence in this case, customers Resource Allocation

  • Competence-enhancing vs. competence-destroying

    Competence-destroying Innovation; Innovations which render the existing resources and capabilities of the firm obsoleteCompetence-enhancing Innovation;Innovations which are compatible with the existing resources and capabilities of the firm obsolete

  • How do these two tables compare in size and shape?

  • (Shepard, 1990)

  • Quiz: QUICKLY answer the following questions.1. A bat and ball cost $1.10 in total. The bat costs $1.00 more than the ball. How much does the ball cost?

    2. If it takes 5 machines 5 minutes to make 5 widgets, how long would it take 100 machines to make 100 widgets?

  • Two Cognitive Systems - Automatic & Reflective

    Automatic Uncontrolled Effortless Associative Fast Unconscious Skilled

    Reflective Controlled Effortful Deductive Slow Self-aware Rule-followingSource: Thaler & Sunstein (2009)

  • Automatic System Rules of Thumb Very effective in time-constrained situation But very often systemically-biased Systematic biases Anchoring : Start from the known (familiar) fact and adjust in the direction that seems right (e.g. Size of Hong Kong Island) Availability: Assess the likelihood of events based on how readily examples come to mind (e.g. insurance surge after earthquakes) Representativeness: Stereotype based on personal experience (e.g. Hot Hands, Bombs on Thames)Source: Thaler & Sunstein (2009)

  • Map of London showing V-1 rocket strikes (Gilovich, 1991)

    River Thames

    Regents Park

    Cumberland

  • Map of London showing V-1 rocket strikes (Gilovich, 1991)

    River Thames

    Regents Park

    Cumberland

  • Map of London showing V-1 rocket strikes (Gilovich, 1991)

    River Thames

    Regents Park

    Cumberland

  • Automatic System Rules of Thumb

    Optimism & Over-confidence: People are over-confident in their abilities e.g. Entrepreneurs answers to two questions 1) Chance of success of businesses like yours: 50%2) Chance of success of your business: 90% Loss Aversion: People do not assign specific values to objects. When they give up something, they hurt more than they are pleased when they acquire the same thing e.g. Heads to win $X, tails to lose $100 Usually X is about $200. Status Quo Bias: People tends to stick with their current situation E.g. Same seat for every class? Opt-in much more effective than Opt-out in subscription-based business

  • Cognitive Inertia vs. Action InertiaCognitive Inertia Locking into habitual ways of thinking about their industry and firms position Framing lock-ins Dangerous analogies Emotional traps

    Action Inertia Resistance that a given strategic option is likely to meet when it is executed Will discuss this in detail..

  • Framing (Mental model) lock-ins Rationality is constrained Managers develop and use simplified representations of their strategic problems Three things matter in this business: A,B, & C This business is all about the relationship between X & Y We are a technology company! Yahoo is in the media business! (Then CEO Tim Koogle) pervasive consequences for Yahoos Strategy and organization Stickiness and resistance to negative feedback (confirmation bias) look for evidence to support current thinking

  • PolaroidFar superior digital camera technology in 1991 Filed for bankruptcyBefore we start, let me premise that there is one thing about photography that not everyone understands but that is crucial to it. In the photography business, all the money is in the software, in the consumables. There is no money in the hardware. This has been and will always be a fundamental truth.- Former Polaroid CEO

  • SimilarityMapping

    Dangerous Analogies Most powerful form of reasoning in high complex and ambiguous decision setting

    Intels Celeron Processor, Circuit Citys CarMax Enrons (gas & electricity) attempts in broadband industry: Analogy fragmented demand, capital intensive distribution, rapid change by deregulation and technical change

    Target Problem

    SourceProblem

    Candidatesolution Transfer

  • Emotions Emotional attachment to a certain way of thinking Usually come from years of experience, culture, identification of oneself with it (Polaroid, Kodak, etc.) Results Threat looks way larger! Escalation of Commitment Familiar patterns of thinking replicated Think about Kodaks response to the Sonys first digital camera fear, enormous R&D with razor/blade model in mind

  • A Way Out of the Cognitive Inertia Mapping assumptions: what assumptions am I making? Generating alternatives: what alternatives are there? Analysis: Lay out the alternatives and compare to choose the best one.

  • A Way Out of the Cognitive Inertia From Mental Models to Transformation (Reading) Bringing in the radicals Challenge assumptions Explore new ideas (traveling) Zoon in and zoom out Destroy your brand Create interdisciplinary diversity Idealized design Scenario planning Experimentation What else?

  • Cognitive Inertia vs. Action InertiaCognitive Inertia Locking into habitual ways of thinking about their industry and firms position Framing lock-ins Dangerous analogies Emotional traps

    Action Inertia Resistance that a given strategic option is likely to meet when it is executed Will discuss this in detail..

  • Action Inertia Sticky Routines: McDonalds success in Standard Operating Procedures (Manual) Difficult to change into more customized, diverse menus according to the preference change Ingrained Culture: A system of values (what really matters to the firm, priorities) & norms (appropriate behaviors) Leadership Failures: Take care of misalignment between desired behavior and incentives, attachment to the status quo, and ego-involvement

  • Change challenges every aspect of the organization

    Leadership & Strategy

    Structure &Process

    Incentives

    Culture & Mental Models

    Individuals becomeInvested in old approaches

    Strategic/competitive problems may provide an

    excuse for inertia

    Existing incentives often work against significant

    change, and new incentives take time and work

    Whole scale changes to structure and process are

    very disruptive: Two years of lost time?

    Strong cultures & deeplyrooted mental models areextraordinarily resistant

    to change

  • The Problem of Mental Models

  • Mental models & the evolution of knowledge: The Era of Ferment: A premium on flexible competence: deep integration across functions and boundaries Dominant design established -- enables An Era of Incremental innovation Allows the fragmentation of knowledge Component knowledge -- knowledge about the pieces Architectural knowledge -- knowledge about the relationship between the pieces -- about

    what everybody else knows

  • Architectural knowledge becomes embedded in mental models... Information channels

    If I have a question about customer needs I can always call Fred.. Communication filters

    The only thing I need to worry about in this report is Section 8.. Problem solving strategies

    The easiest way to increase speed while reducing noise is to...

  • And in the Deep Structure of the Organization

    Leadership

    Formal Structure/Process

    Incentives/Political Structure

    Culture/Mental Models

  • Where it is a source of STRENGTH! It allows the organization to get things done! Minimizes meeting time Allows for clear responsibilities And quick response Embedded architectural knowledge is a key organizational competence

  • And of weakness: Problems in recognition: Denial Problems in response: Panic Overload & the recreation of old solutions

  • Control & Coordination

    The Organizational Challenge:

    EntrepreneurialDrive,Freedom from the old ways

    Successful growth unites entrepreneurial insight with

    effective coordination

    StartupsStartups

    B as UB as U

  • In summary: I see, he said, youre suggesting that we invest

    millions of dollars in a market that may or may not exist but that is certainly smaller than our existing market, to develop a product that customers may or may not want, using a business model that will almost certainly give us lower margins than our existing product lines. Youre warning us that well run into serious organizational problems as we make this investment, and our current business is screaming for resources. Tell me again just why we should make this investment?

    - Divisional Manager, Telecommunications Equipment Provider

  • What can be done?

  • Make sure youve fixed (or are at least aware of)the strategic problem

  • What can be done? Lead: Build the ambidextrous senior team: communicate the strategy, allocate resources Structure: Explore transitional and intermediate forms Incent: Explain just whats in this for me? Build: Lay the foundations for a new culture, new expectations

  • What can be done? Lead: Develop a clear strategy Generate energy Build an ambidextrous senior team Make decisions

  • Develop a clear strategy

    How will we Create value?

    How will weCapture value?

    How will weDeliver value?

  • And allocate resources to it!

    How will we Create value?

    How will weCapture value?

    How will weDeliver value?

    100%

    80%

    60%

    40%

    0%

    20%

    65431 2

  • Generate Energy Position the discontinuity as an urgent threat: Flirt with bankruptcy Make vivid the idea that the firm might flirt with bankruptcy Position the discontinuity as an opportunity Generate some small successes: build enthusiasm and infect the organization Leap boldly into the future

  • Build an Ambidextrous Senior Team Ambidextrous senior teams must manage both more mature, operationally focused businesses and higher growth, emerging businesses High performing senior teams show: High conflict, high respect decision making capabilities High levels of trust and truth telling The ability to manage divergent incentive systems and career paths Coupled with processes that support the divergent management of quite different business units E.g. Resource allocation processes that allow for different time horizons, milestones, rates of return

  • Average

    Value-Added

    Time on

    Engineering

    Tasks

    Number of Projects per Engineer

    100%

    80%

    60%

    40%

    0%

    20%

    65431 2

    Source: IBM Development Efficiency Study

    Make Decisions

  • What can be done? Lead: Structure: Implement appropriately Choose the right people Manage linkages

  • Control & Coordination

    Balance entrepreneurial energy and coordination

    EntrepreneurialEnergy Successful disruptive

    innovation unites entrepreneurial insight with

    effective coordination

    StartupsStartups

    B as UB as U

  • Control & Coordination

    Choose a structure that fits the firms strategic positioning and skills

    Jointventure/alliance

    EntrepreneurialEnergy

    Internalventure

    Build insideexisting unit

    Acquire/Partner

  • Control & Coordination

    Manage it using every lever that you have

    Acquire/Partner

    Build inside existing units

    Jointventure/alliance

    ?EntrepreneurialDrive,Freedom from the old ways

    Internalventure

    Build insideexisting unit

  • Exercise:Best Practice in Building Growth Choose one of the alternative organizational forms with which you have some experience: Building growth inside an existing unit Separate division Spin off Joint venture Acquisition In retrospect, what are the critical factors that needed to be in place to make it successful?

  • Acquisitions: Pros and Cons Pros Brings in a new culture with an established set of skills a sure bet? Cons Is the market efficient? Will the shareholders of the acquired firm capture all the value? Should you worry about the winners curse? Will you pay too much? Once acquired, will the new firm simply be assimilated into the existing firm?

  • The Winners Curse may mean that you pay too much

    Perceivedvalue

    No. of firms

    True value

    Winners valuation

  • Once acquired, acquisitions must be managed

    Control & Coordination

    Buy anInnovative

    firm?

    EntrepreneurialDrive,Freedom from the old ways

    Assimilate it ?

  • Key Considerations: How easy is it to write contracts? How tight is the IP regime? How much uncertainty is there? Specificity of the asset how thick is the market?

    What will happen to entrepreneurial energy? What will be the key complementary assets going forward?

  • What can be done? Lead Structure: Incent Explain just whats in this for me? Manage the balance between: Individual outcomes and team/firm outcomes Objective and subjective measures

  • Control & Coordination

    The incentive problem is an inherently difficult one

    EntrepreneurialDrive,Freedom from the old ways

    StartupsStartups

    B as UB as U

  • Control & Coordination

    Using high powered incentives may reduce coordination

    Acquire/Partner

    Build inside existing units

    Jointventure/alliance

    EntrepreneurialDrive,Freedom from the old ways

    Internalventure

    Build insideexisting unit

    ?

  • What can be done? Lead Structure Incent Transform the culture: Build on core values Practice thinking in new ways Manage from the heart

  • Summary

  • Remember what youre dealing with: I see, he said, youre suggesting that we invest

    millions of dollars in a market that may or may not exist but that is certainly smaller than our existing market, to develop a product that customers may or may not want, using a business model that will almost certainly give us lower margins than our existing product lines. Youre warning us that well run into serious organizational problems as we make this investment, and our current business is screaming for resources. Tell me again just why we should make this investment?

    - Divisional Manager, Telecommunications Equipment Provider

  • Make sure youve fixed (or are at least aware of)the strategic problem

  • Control & Coordination

    Manage the organizational issues aggressively

    Acquire

    Build inside existing units

    Jointventure/alliance

    ?EntrepreneurialDrive,Freedom from the old ways

    Internalventure

    Build insideexisting unit

  • Takeaways When the technological change comes, there are different types of cognitive inertia and action inertia to overcome. We should be fully aware of the cognitive biases we may face. understand the nature of these biases and try to counteract. Open-minded about generating and accepting new models

  • Generating New Models Bring in the radicals Challenge assumptions Travel and explore new ideas Zoom in and zoom out Destroy your brand Create interdisciplinary diversity Idealized designs: reinvent from the blank state eBay and Craigslist Scenario planning Experimentation: 20% time?Source: HBR piece, Wind & Crook

  • For Session 5 Questions posted on the class wiki Link your favorite product design with a bit of explanation & story Feel the creativity section State your name please! (or change your name in account) Use the commenting tool below to link. By 11 pm on Saturday (Oct 17) Count towards participation points