Business is a mystery, not a puzzle – information overload and judgment

Photo by Jorge Franganillo

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Umair Haque, a fascinating writer (which I quoted in my No More Rules! Presentation), wrote a captivating piece in HBR.org the other day. He discussed the famous Efficient Market Hypothesis (definition from Investopeida):

An investment theory that states it is impossible to “beat the market” because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments.

Haque, who constantly writes about the need for a new economy based on value creation instead of the old one that was consternated on creating money for itself, offers a new idea:

I’d like to advance a hypothesis. Call it the Efficient Community Hypothesis. It says: where efficient markets incorporate “all known information,” efficient communities incorporate “the best known information.” An efficient market is a tool for sorting the largest quantity of info. But an efficient community is a tool for sorting the highest quality info. On its own, the EMH is simply about informational efficiency: that prices incorporate “all known information.” Where it falls down is in terms of informational productivity: whether prices incorporate accurate, valid, and reliable information — high quality knowledge, instead of low-quality noise. Incorporating all known information doesn’t mean incorporating good information.

Haque deals with a very important point. Let’s assume for a minute that when the EMH was originally hypothesized it was correct (even though there is a debate about that). Well, there is no doubt today that the world has changed dramatically. Just think about the differences in quantities between the information that was available, let’s say, 30 years ago, and the quantities available today. There must be a law of diminishing returns at work here. At some point, the more information we put in, the less we gain from it. And sometimes when we abundance of information happens, just as Malcolm Gladwell tries to convince us in Blink: The Power of Thinking Without Thinking, decisions become worse, not better.

But it is even deeper than that. The EMH assumes that information is the only thing we need in order to interpret the market. If we only have all the information, we can come with the right answer – the price. It is kind of a puzzle. Give me all the information and I will give you the answer. But the stock market represents companies that work in the real world. And the real world is, well, uncertain. And yes, it is also more uncertain then it used to be 30 years ago. Even if you do give me all the information, I still need to use judgment in order to give you an answer. And it might be right, but it might not. In an article called “Open Secrets”, that is now part of his book, What the Dog Saw, Gladwell writes:

The national-security expert Gregory Treverton has famously made a distinction between puzzles and mysteries. Osama bin Laden’s whereabouts are a puzzle. We can’t find him because we don’t have enough information. The key to the puzzle will probably come from someone close to bin Laden, and until we can find that source bin Laden will remain at large.

The problem of what would happen in Iraq after the toppling of Saddam Hussein was, by contrast, a mystery. It wasn’t a question that had a simple, factual answer. Mysteries require judgments and the assessment of uncertainty, and the hard part is not that we have too little information but that we have too much.

So what Haque rightly calls for is judgment and trust and expertise on a more common basis. Knowing that we have a lot of information, that a lot of it is irrelevant and that the future is unpredictable, we need two things. First, just like in the case of the doctors described in Blink trying to decide if a patient is a risk for a heart attack, simplify our decision making process. As Gladwell says, they are swimming in knowledge, but lacking in understanding. The simplification helps their judgment. Second, we need people with more practical wisdom, ability to infer judgment and to make decisions that accept the uncertainty.

And that second issue throws me back to my point about rules. In my presentation, No More Rules! I claim that the wide spread use of rules is killing people’s practical wisdom. It is killing their judgment. Just when we have more information than ever and when we need simple good judgment more than ever, we are creating cogs that follow automated rules and formulas that treat the world like a puzzle. Life and business, is mystery, isn’t it time we face up to it?

Elad

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Decision tools

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This is the third post in a series of post I am writing after reading Blink: The Power of Thinking Without Thinking by Malcolm Gladwell (for former post see 1, 2).

One of the sentences that struck me as the most important in Blink comes from the afterword. This is it:

The key to good decision-making is not knowledge. It is understanding. We are swimming in the former. We are desperately lacking the latter.

This sentence is built upon a number of stories in the book (and connects to other writings by Gladwell about the perils of too much information). One of the leading stories it refers to is the story of how Cook County Hospital improved the decision-making of its doctors by telling them to focus only on three pieces of information in the entire sea of details they had about patient in order to make a decision whether he was a risk for heart attack. Even though all doctors felt that this was the wrong way to go, as they were ignoring precious information, it turned out that by focusing only on three issues, doctors made much better decisions that not only saved money, but more importantly, saved lives.

I have written before about the dangers of using the information and measurements we have just because we have them. As we continue to develop in terms of technology, we will have more and more data and information. As Gladwell says in Blink:

We take it, as a given, that the more information decision makers have, the better off they are. If the specialist we are seeing says she needs to do more tests or examine us in more detail, few of us think that’s a bad idea… extra information isn’t actually an advantage at all; that, in fact, you need to know very little to find the underlying signature of a complex phenomenon.

In my mind this connects perfectly with the idea of Vital Signs. This is what I wrote almost a year and a half ago:

I believe the challenge of managers in the next few years, especially in the more subtle fields that are hard to measure will be to create the right vital signs.

I am I the process of reading Switch: How to Change Things When Change Is Hard by the Heath brothers and one of the main concepts of the book is about scripting change. They describe the importance of making people aware of the basic decision principles to guide their specific behavior. They give example of major changes accomplished by ordinary people who harnessed the power of simplifying the decision-making. How? By creating scripted concepts that help decide what is important and what is not.

Reading Blink and Switch just strengthened my understanding of this concept. People are cognitive misers. They are not able and do not want to deal with large amounts of information. As Blink (and Switch) show, when they are faced with so much information it actually affects their judgment, usually in a negative way. The most successful people are not going to be those who can master and absorb large amounts of information. It will be those who will know how to distill this information into a few major signs that help guide decision-making. Thus, our rule as managers is to find the vital signs and make them crystal clear. We need to make sure that we are tackling the right issue. Not lack of information. Lack of decision tools.

Elad