TCS Daily


More Making Great Decisions

By David R. Henderson - March 20, 2006 12:00 AM

In a recent article, I laid out some of the important ways of thinking that my co-author, Charles Hooper, and I discuss in our book, Making Great Decisions in Business and Life. Here are a few more.

Many people are familiar with Pareto's Law of income distribution, named after Italian economist Vilfredo Pareto. The law, which states that 20 percent of the population earns 80 percent of the income, is now called the 80/20 rule. We point in our book that this rule applies to far more than income distribution.

For example, it will often be the case that 20 percent of your customers cause 80 percent of your problems and that another 20 percent of your customers (possibly overlapping the first 20 percent) give you 80 percent of your business. We derive a straightforward mathematical implication of this rule to get what we call "Factor 16." It states: "The individuals in the 20-percent group are 16 times as important as those in the 80-percent group."

This simple fact can be very powerful. What if you could single out the 20 percent of your customers who give you the most difficulty and -- assuming that they're not also the ones who give you 80 percent of your business -- quit dealing with them or even just reduce your dealings substantially? Or what if you could figure out the 20 percent who give you the most business and figure out how to cater to them better? This is what Best Buy is doing. Best Buy has categorized its customers into angels and devils, which is self-explanatory, and is figuring out how to discourage the devils and cater to the angels. And what if this relationship also applied to employees and you could figure out which is which? In the extreme, you could fire the 80 percent who are less productive and give a 1500-percent raise to the high performers.

Another of our insights is on the distinction between good decisions and good outcomes. Naturally, you want to achieve good outcomes, and the best way to get there is to make good decisions. That's obvious -- to us. But you've probably heard people say, "I'd rather be lucky than good." That statement is nonsensical. You can choose to be good, but you can't choose to be lucky -- which is why it's called luck.

So the good decision is not the one that gave you the good outcome by luck but, rather, the one that you would (should) choose again given the circumstances. In our book, we give a simple example of a teacher telling two students to choose a number between 1 and 10 and promising a special treat to the one who comes closer to the teacher's hidden number. Addie picks 2 and then Greer picks 1. The teacher announces that Greer won. Should Greer choose 1 the next time? No. He was lucky this time. If Addie picks 2, he has the best odds of winning if he picks 3: he will win as long as the teacher has chosen any number but 1 or 2. And, by the way, whoever goes first next time should choose 5 or 6.

This might all seem obvious to you. But consider a professional basketball coach faced with a decision that just might cost him his job. In a sense, he took Greer's approach above -- and lost.

Twice.

Twice this season, Mike Montgomery's Golden State Warriors (unofficial motto: they'll break your heart) were up by 3 points with less than 4 seconds left and the other side having possession: first in a game against Houston and then in a game against Utah. Consider two strategies. The first is to have one of his players foul on the inbound pass. Then the other team's only realistic strategy for tying the game would have been to attempt the following: make one free throw, try to miss on the second free throw but hit the rim, grab the rebound, and then make a two-pointer to put the game into overtime. Think of the odds of all that happening. Let's say the probability of hitting the first free throw is 80 percent. (I'm overstating all probabilities to bias it against my conclusion.) Hitting the rim on purpose is tough, but let's say it's as high as 90 percent. Then come two really tough parts. The shooting team has to rebound off the rim: let's put that probability at 50 percent given that the Warriors have their rebounders closer to the rim. Then, once they rebound, they have to make a basket in less than 3 seconds. The probability of a successful shot under those circumstances must be less than 50 percent. When you put all these events together, you multiply probabilities. So you get 80% times 90% times 50% times 50%, which is 14 percent or one in 7.

Montgomery's second possible strategy is let the opposing team attempt a 3-point shot to tie the game, but to make it difficult without fouling. Montgomery chose the second strategy. The other team's odds, even for a lousy 3-point-shooting team, are about 30 percent. Both times, the opposing team made the three-pointer unmolested, forced the game into overtime, and beat the dispirited Warriors.

Interviewed about his strategy, Montgomery defended it, saying, "I believe as long as I've coached that you don't stop the clock and you don't give people free points." In other words, Montgomery had formulated a rule but failed to adapt to the context. During the Utah game, having laid out the case for the first strategy and seeing Montgomery err by trying the second strategy, one of the two FSN Bay Area television announcers put it well: "We're going to overtime -- but why?"

And Montgomery's decision-making gets even worse. In the same interview, Montgomery continued, "But since that's not worked twice, I owe it to try something different." But he reached a correct conclusion on faulty reasoning. In a fundamental sense, he had still failed to think clearly. The reason Montgomery should have tried something different is not that his strategy didn't work twice. A sample size of two is incredibly small and not a good guide to probabilities. The reason he should rethink his strategy is that the probabilities are against his strategy versus the other one.

I know this is "just" basketball. But we're talking about a serious high-stakes business. It's not hard to imagine a CEO making similar mistakes based on rigid rules or a President doing the same with even bigger stakes.

David R. Henderson is an associate professor of economics at the Naval Postgraduate School in Monterey, California and a research fellow with the Hoover Institution. He is co-author of Making Great Decisions in Business and Life. (Chicago Park Press, 2006.)

Categories:

8 Comments

Absolutelly wrong statment
I completely deny your conclusion. it depend on mathmatics. This is very worng system of reaseach in western philosophy. In this system you count man as a machine behave just like robot. this system is very dangerious and harmful to mankind, How dare to predicate that man alway behave logically. man is by nature irrational animal. no one can predicate his action,mathmatics is very useful in science but it is completely hopeless in human behavour

useless commentary, and wrong
For several intricate reasons, the 80% causes the 20%. If it weren't for the 80% there wouldn't be a 20%. And that is not what Best Buy is doing. The fact is, if you squash the 80%, provided you can identify them on any given day, and understand why they belong to that group and why you failed to convert them and why the 20% is the way it is, all you will be left with is a new 20% and 80% both one-fifth the size of the original. Useless commentary, and wrong.

Making Great Decisions
David, 20% of the people who disagree with you will cause 80% of your dissapointment.In your arguments, was the coach wrong both times, incorrect on two separate occasions, or did he fail to choose the obvious because it was a double negative?
This past Sunday during the NCAA basketball tournament,
Connecticut beat Kentucky under the exact same scenario. Three straight fouls, 6 straight foul shots made, and Kentucky lost by the same 3 points. Kentucky ran out of time and Connecticut made each foul shot. Kentucky still had the ball when time ran out; Connecticut made all their shots, which I found unusual with that much pressure.

Need for Probability and Statistics
Shows the need for education in probability and statistics.
Of course, states don't want people to really now how hopeless it is to win the lottery.

Human behaviour
Physics cannot determine the what a single molecule of nitrogen will do, but it can predict the behaviour of billions of them.
It is precisely the reason humans behave irrationally that the 80/20 rule can apply.

Decision to Choice: Earth's Choicemaker
The missing element in every human 'solution' is
an accurate definition of the creature.

The way we define 'human' determines our view
of self, others, relationships, institutions, life, and
future. Important? Only the Creator who made us
in His own image is qualified to define us accurately.
Choose wisely...there are results.

Each individual human being possesses a unique, highly
developed, and sensitive perception of diversity. Thus
aware, man is endowed with a natural capability for enact-
ing internal mental and external physical selectivity.
Quantitative and qualitative choice-making thus lends
itself as the superior basis of an active intelligence.

Human is earth's Choicemaker. His title describes
his definitive and typifying characteristic. Recall
that his other features are but vehicles of experi-
ence intent on the development of perceptive
awareness and the following acts of decision and
choice. Note that the products of man cannot define
him for they are the fruit of the discerning choice-
making process and include the cognition of self,
the utility of experience, the development of value-
measuring systems and language, and the accultur-
ation of civilization.

The arts and the sciences of man, as with his habits,
customs, and traditions, are the creative harvest of
his perceptive and selective powers. Creativity, the
creative process, is a choice-making process. His
articles, constructs, and commodities, however
marvelous to behold, deserve neither awe nor idol-
atry, for man, not his contrivance, is earth's own
highest expression of the creative process.

Human is earth's Choicemaker. The sublime and
significant act of choosing is, itself, the Archimedean
fulcrum upon which man levers and redirects the
forces of cause and effect to an elected level of qual-
ity and diversity. Further, it orients him toward a
natural environmental opportunity, freedom, and
bestows earth's title, The Choicemaker, on his
singular and plural brow.

Human is earth's Choicemaker. Psalm 25:12 He is by
nature and nature's God a creature of Choice - and of
Criteria. Psalm 119:30,173 His unique and definitive
characteristic is, and of Right ought to be, the natural
foundation of his environments, institutions, and re-
spectful relations to his fellow-man. Thus, he is orien-
ted to a Freedom whose roots are in the Order of the
universe.

Let us proclaim it. Behold!
The Season of Generation-Choicemaker Joel 3:14 KJV

- from The HUMAN PARADIGM




















Interesting
Well, Ramesh, you can decry the use of mathematics in the West, but by my assessment, the West far outranks the rest of the world in just about everything (economics, living standards, freedom, etc.). Thus, maybe, just maybe, attitudes like yours are what is keeping the rest of the world playing catch-up with the West. Just a thought.

By the way, you can wag your finger all you want and cry "how dare you", but if it works, who is the fool??

-Bob

Useful and Correct
Cleary, objectoriented just does not understand what is being proposed in the article. If 20% of the people(customers, employees, volunteers, etc.) are responsible for 80% of a benefit, eliminating the 80% who are responsible for only 20% of the benefit makes a lot of sense, if one's goal is to maximize profits. For example, if I can do 80% of the work with only 20% of the employees, then I cut out all the costs related to those 80% by firing them, greatly increasing the profit margin, and maybe even total profits.

What BestBuy is doing is saying let's get rid of the customers who complain but purchase little, and focus on the customer who purchases a lot. That makes their job easier, and also allows them to pay more attention to the customers who actually purchase things! It's a pretty smart way of doing business, and I think that it will be quite profitable.

Furthermore, although it is true that you will have a new 20/80, you cannot compare the NEW 20/80 to the old 20/80, as the new 80 will be far better than the old 80. But eventually, you will, indeed, have to do the process all over again to weed out the bad apples.

-Bob

TCS Daily Archives