I really find ABC's new reality TV show "Shark Tank" amusing. If you're not familiar with it, it's produced by Mark Burnett, who is also the producer of a number of hit shows including "Survivor" and "The Apprentice." On the show, five self-made millionaires (the sharks) hear presentations from entrepreneurs who need money to grow their business. The idea that self-made millionaires would decide to invest hundreds of thousands of dollars in a person they just met - based on a two minute interview, no less - seems a little ridiculous. But for the entrepreneurs on the show who need the money, it is indeed very serious.

If the shark "bites" and makes an offer, the entrepreneurs have to make a decision almost immediately. This is what makes the show so interesting; you can see all types of decision biases on display.

In last Sunday's episode, commitment bias was on full display. Paul Watts, one of the entrepreneur contestants, had a graffiti removal business that was grossing $230,000 per year. He wanted to franchise the business but had no experience in that area. Two of the shark judges, Kevin, the venture capitalist, and Robert, the technology guru, were willing to give Paul $350,000 for 75% of the business. It seemed to me this was a great deal for Paul - he would get two new partners that could help him sell franchises, plus get a large cash payment. Yet he turned the offer down flat.

Dan Claffey, owner of Coffee Brand Gifts (a business in which he puts names associated with coffee on novelty items like teddy bears), claimed he had invested $400,000 of his own money in his business, but he had no sales to show for it. He wanted a $400,000 investment for 40% of his company. The sharks told him he had a worthless patent. Yet the fact that he had spent so much of his own money without any sales did not seem to deter him at all. Continuing on a erroneous path because of sunk costs is a common decision-making error. Claffey apparently will continue to pursue a flawed business strategy rather than stop and cut his losses.

Gina Catroneo, however, had to be the night's biggest victim of commitment bias. Her company Souls Calling sells products with a positive message, like umbrellas (rather, "inspirellas") featuring greeting card-like words of inspriation and sandals that literally stamp happy words in the sand when you walk. She wanted $150,000 for 25% of her company, but her sales were less than $20,000 per year. She said she had invested over $100,000 of her own money into the business, but the sharks told her she needed to get a job and forget the fantasy. Still, she hung on. At the exit interview, she said as long as people needed happy thoughts, Souls Calling would be there to meet the need. Like I said, the show was amusing.

Decision-Making Best Practice #17: Yogi Berra once said, "You can observe a lot just by watching." Even though "Shark Tank" seems contrived, you really can learn a lot about decision-making by paying close attention.

Labels: commitment bias, decision-making, entrepreneurs

We're always getting "expert" advice. Yet the fallibility of so-called experts is legendary. Here is a quick tool you can use to determine which experts you can trust, and which experts you should view with a healthy dose of skepticism.

In his brilliant and disturbing book House of Cards: Psychology and Psychotherapy Built on Myth, author Robyn Dawes discusses how we learn. "Two conditions are important for experiential learning: One, a clear understanding of what constitutes an incorrect response or error in judgment, and two, immediate, unambiguous and consistent feedback when such errors are made," Dawes says.

Experiential learning is how we learn to walk, talk, and drive a car, for example. With learning to drive a car, there is a clear expectation: you must drive between the lines on the correct side of the road. And we get immediate feedback when we do it wrong as we try to correct the direction of the car by making adjustments to the steering wheel. 99.9% of us are not expert drivers coming out the gate. It can take months - even years - to become a skilled driver. Examples of bona fide experts we can trust are chemists , engineers, and chess masters - those who have loads of empirical, scientific data they have tested for themselves and on which they base their findings and skill. Chemists, for example, consistently produce the same results from experiments. Engineers can predict with a high degree of accuracy when a structure will fail, and chess masters will consistently beat you. Experience is a great way to learn chemistry, engineering, or chess.

Many experts learned their craft without the benefit of either a clear expectation of what success is, nor the benefit of receiving immediate feedback about the results of their efforts. Walter Freeman is an example of someone considered to be an "expert" at one time. A graduate from two of the most prestigious schools in the country - Yale and the University of Pennsylvania Medical School - he was president of the American Association of Neuropathologists, president of the American Board of Psychiatry and Neurology, and a member of the American Psychiatric Association.

Freeman developed a theory that a specific procedure - the lobotomy - would be beneficial for mentally ill patients. Unlike the experts above, Freeman's theory was not easily falsifiable. He did not conduct double-blind tests where post-procedure results were compared to a control group. Instead, Freeman relied on his observations of the patients and his clinical judgment (training, experience, and education) to judge whether the treatment helped the patient. (Click here to watch a clip from PBS's "The Lobotomist" that shows how Freeman ignored the failures of his procedures, or watch another clip below.)

It was a relatively simple procedure. A hammer was used to drive an ice pick through the back of the eye socket to perform a transorbital lobotomy. Freeman performed over 3000 of these procedures, including on 23-year-old Rosemary Kennedy who along with many other people, was permanently disabled as a result. Freeman even performed the operation on children, including an eighteen-month-old infant and a twelve-year-old boy named Howard Dully who wrote a book called My Lobotomy about how the procedure ruined his life. It was not until a drug called Thorazine was developed that the practice fell out of favor. Freeman continued to perform lobotomies despite the fact that several of his patients died. His license, however, was ultimately revoked.

Unfortunately, many "experts" are no more scientific in their approach than Freeman was. They base their expertise on years of experience, training, and education, even their professional affiliations. Yet they have no empirical data to support their theories. Freeman had all the credentials of the "expert." He graduated from the best schools, had years of experience, and was president of the leading professional groups of his day. But was indeed no expert at all.

Decision-Making Best Practice #16: Trust those experts who predictions and theories are testable and falsifiable. Experts who base their expertise on their education, training, and experience rather than empirical results should be viewed with a high degree of suspicion.

This blog, like my book The Naked Portfolio Manager, is designed to help readers think better and make better decisions. I thought to myself "What could be a better blog topic than to study the first great decision that mankind ever made?"

I am referring, of course, to the decision Eve made in the Garden of Eden when she chose to eat the forbidden fruit. When Eve ate the fruit she disobeyed God. We have been taught this was the original sign and was the cause of all of mankind's hardships. Having read the story many times, let me say I believe almost every biblical scholar has interpreted this event incorrectly and the original sin was not Eve's disobedience to God. Her act of sharing the fruit with Adam was the original sin. Examining the story critically without the constraints of religious dogma yields a much different interpretation of the acts in the garden than we have been taught. And it can lead us to important lessons and decision-making rules we can apply today.

Consider that Eve may have lived in the garden for a relatively short time when she encountered the talking serpent. The Bible tells us that Eve was very beautiful and she and Adam wore no clothes and Adam loved Eve very much. The implication is that Adam and Eve were having normal marital relations, but she had not yet had time to conceive a child when she encountered the serpent. So perhaps she was only a few months old when this occurred. The Bible does not make it clear how old Eve was, but it is clear that the serpent had been in the garden longer since God had created the animals before he had created Eve. So Eve encounters a talking serpent; this must have been an extraordinary event since other than God, Eve, and Adam, no other personages speak in the garden. The talking serpent suggests she eat from the tree of life. Eve says no, since God has told her she will die if she eats from the tree. The serpent says God is not correct and she will be omnipotent if she eats from the tree. Eve now becomes the first human to make a decision under uncertainty. Clearly, both God and the serpent cannot be correct. She must decide if she should risk death in order to have the chance to become omnipotent.

Eve, carried away by the dream of becoming God-like, ignores the risk and eats the forbidden fruit. We know the rest of the story.

Many scholars, parents, and school children have been critical of Eve's decision, but I think they are unfair to her. The normal ways that people make decisions under uncertainty today were not available to her then. Let's remember, Eve never took a course on logic. Neither probability theory nor utility theory had been developed yet either so there was no way to analyze the risk/reward relationship. She could not consult her Bible to see what had happened to people in the past who had disobeyed God. It simply hadn't been written yet. How was she to make this decision?

What is more, it seems almost impossible to believe she fully understood the risks, since no one had ever died in the Garden of Eden. Eve's concept of death had to be fairly abstract. I have asked Biblical scholars this question and I always get the same answer: Eve should have known to obey God. But how was she to know this? She really had no basis for making this decision.

Eve's decision had bad consequences for her as it meant she had to leave the garden and ultimately die, but we cannot call it a bad decision. Rather it was a decision with bad results. Given what she knew at the time, she simply gambled and lost. The original sin was to give the fruit to her husband. She gave it to him knowing full well it would cause his death and she did this because she did not want to face this by herself.

So what are the lessons from this story for today's decision-makers? Decision-Making Best Practices #11-15:
#11 - Challenge dogma. We are told thousands of things in life and many of them prove to be untrue.
#12 - Assign appropriate weight to obscure or poorly understood risks. Eve, like many decision-makers today, clearly underweighed the risks of dying when she made her choice.
#13 - Be careful when criticizing the decision-making of others, especially if you have the benefit of information that those people did not have at the time they made their decision.
#14 - Remember the difference between decisions and results and evaluate decisions on the quality of the thinking employed rather than the result of the decision.
#15 - Delay a critical decision if you can, especially if you will likely be able to get more information later that will allow you to make a better choice.

Labels: Adam, Eve, God, logic, results, risk, sin

I was amazed to read in The New York Times Saturday that President Obama is crediting the stimulus package with the slowing rate of job loss that was reported by the Bureau of Labor Statistics. For the month of July, employers eliminated 247,000 jobs. This is much less than the 741,000 jobs scrapped in January. Speaking in the Rose Garden, the President said his administration had "rescued our economy from catastrophe."

Did the stimulus package really cause the rate of job loss to slow? Well, it's possible. But it's also possible job loss would have slowed without spending billions of dollars on the stimulus package. After all, when corporate America cuts jobs, they cut the least essential people first. After a few rounds of job cutting, you are left with mission essential people that you just can't get rid if you want to continue to operate. So maybe this is why the rate of job loss slowed.

Or it could be that corporate America has been doing so much belt tightening over the past year that profits are starting to turn up and there is less pressure on managers to reduce headcount.

My point is there are many possible explanations for the slowing of the job loss rate. It's way too early to credit the stimulus plan for causing this. For the administration to take credit at this time shows a lack of critical thinking.

What if the job loss numbers had skyrocketed last month to over a million? Would the President be in the Rose Garden saying, "The stimulus plan has failed and I have taken the country in the wrong direction."? Of course not!

In fairness to the Democrats, critical thinking seemed to be in short supply during the previous administration as well. Confirmation bias is a thinking error in which the decision-maker searches only for facts and ideas that support his preconceived ideas and ignores facts and evidence to the contrary. Many people think George W. Bush fell victim to this same type of thinking in his decision to go into Iraq.

In a "60 Minutes" interview, former CIA Director George Tenet said that on September, 12th 2001, Richard Pearl, the Chairman of the Defense Policy Board Advisory Committee, told him Iraq would have to pay for their role in the 9-11 attacks. Tenet said he was shocked, and made it clear there was no evidence that Iraq had anything to do with Al Qaeda. Some think Bush ignored reports and data suggesting Iraq was not involved with the 9-11 attacks and did not have weapons of mass destruction, preferring to look only at the intelligence that supported going to war.



With so much at stake, why don't our elected officials think better?

Decision-Making Best Practice #10: Challenge your beliefs. Search fo other explanations and never except the first idea without searching for alternative explanation.

Labels: Bush, confirmation bias, Obama

The true connoisseur of eggs knows the perfect soft boiled egg has a warm, runny yoke and a firm egg white. Cooked just ten seconds too long and the yoke will start to harden. Cooked ten seconds too little and you end up with unappetizing, drippy egg whites. The reason cooks so seldomly prepare this dish properly is because of a lack of attention to detail. In my kitchen, I have conducted a series of experiments to determine the formulae for producing the perfect soft boiled egg. To be able to consistently produce the perfect egg, it's necessary to control as many variables as possible. So remember this:

1. Always use the same pan.
2. Measure the amount of water you put into the pan.
3. Always use the same burner.
4. Ensure the initial water temperature is the same each time.
5. Always place the eggs in the water before you turn on the burner.
6. Never, ever mix different sized eggs.
7. Calculate the amount of water displaced by the eggs to adjust for different sizes.
8. Adjust the cooking time based on the amount of water displaced by the eggs.



In my kitchen, I have determined that if I use the same small metal sauce pan with 40 ounces of cold water placed on the front left burner, the correct cooking time for the perfect soft boiled egg can be calculated based on the formulae below:

Time = 9.2 minutes + EV/K.

. . . where "EV" is the amount of water displaced by the egg and "K" is a constant 30 milliliters. Thus, for an extra large egg that displaces 120 milliliters of water, the cooking time is 13 minutes and 12 seconds. For a medium egg that displaces 80 milliliters of water, the formulae predicts an optimal cooking time of 11 minutes and 52 seconds. Of course, this formulae works for me in my kitchen with the small metal pan. In your kitchen you will have to apply the eight points above and develop your own mathematical formulae.

When most people soft boil eggs, they don't use a scientific approach. They simple guess when they think the egg is ready. This "guessing method" results in very inconsistent results. Unfortunately, those who guess sometimes apply this same haphazard approach to investing.

The Naked Portfolio Manager argues that an empirical, disciplined, consistent process will not only generate better results in the kitchen, but in the long run will help improve your decision-making on much more important things (like investing) as well.

Decision-Making Best Practice #9: If it is a really important decision, don’t trust your intuition. Get the data.

Labels: data, empirical, formula, investing