A few weeks ago, I read an article in the Wall Street Journal about people who had opened up their very first investment accounts just to get in on the Facebook IPO. One man they profiled had purchased $10,000 worth of stock, borrowing $5,000 from his mother. Clearly, for him this was a major investment, so it seems likely he felt this was a sure bet. It also seems likely that he’s kicking himself today, as the value of the stock has dropped almost 25 percent since its May 17 IPO.
This poor soul, like so many others, failed to judge risk accurately, and no doubt there are myriad reasons for that. But I’d like to suggest that one critically important factor in this story is Facebook’s ubiquity and its starring role in so many people’s personal lives — what psychologists might term the “availability bias.”
Availability bias is the mental rule of thumb whereby we call to mind our personal knowledge of a topic in order to work out how important it is. It’s the reason so many people overestimate the danger of flying in airplanes or of having their children abducted, and underestimate the risk of getting cancer from lack of sunscreen or getting in a car accident. Airplane accidents and abductions are big news; they are memorable and easy to call to mind, so we overestimate their importance.
Facebook is likewise vividly top of mind for many people who use it so frequently and so very personally. This meant that Face- book loomed larger in investors’ minds than it deserved to, given the facts. Rather than compare the benefits of a wide set of possible investments — like other individual stocks, bonds, or index and other exchange-traded funds — people selected among the much smaller set of highly familiar investment choices.
Availability bias distorts business investments in the same way, particularly when corporations seek new growth. In deciding where to allocate new product or new business development funds, they all too often view their core or high-profile markets as the safest bets only because they are familiar. Sure, they’ve been told “invest in what you understand.” But is what’s familiar really what they understand?
Consider, for example, the tablet market over the last few years, which has seen a glut of undifferentiated and ultimately unsuccessful me-too products. In the wake of the sexy, media-grabbing iPad, every- one wanted to get into the game, and so for many companies creating a tablet felt like a no-brainer, low-risk decision. But was that so? Creating and marketing a tab-let is quite expensive. So unless you have some evidence that you’ll be putting out a strong, differentiated product, this is in reality quite a risky decision. Just think of HP’s TouchPad, Lenovo’s IdeaPad Tablet, or BlackBerry’s PlayBook.
The alternative to constraining your decisions to the familiar (or the famous) is to ground your investments in a decision- making process that is deliberate, not reactive.
Focus on discovering customers’ needs. When you discover unmet customer needs, you naturally create a differentiated offering with true market value. Easy to say, but the trick here is to make sure you really are looking for customers’ needs — not just convincing yourself that customers need what you, or everyone else, want to make.
Pursue a long-term strategy. In an effective strategy, short-term moves should be leading you toward a desired outcome in the long term. A collection of opportunistic bets, no matter how sure they seem in the moment, is not a strategy. Would any solid personal financial plan have advocated liquidating mutual and bond funds to bet the farm on Facebook?
Don’t follow the herd. We’re all human, and there’s emotional comfort in doing what everyone else is doing. Recognize that feeling — and then make sure that you’re not letting it cloud your judgment. Be vigilant and actually evaluate each investment opportunity on its merits, not on its media profile.
Following such a process will help protect against the risk that comes with the availability bias. And if you still sense that your organization is sliding into that trap, use the bias to your own advantage: remind everyone — frequently — of the story of the Facebook investor you never want to become.
NOTE: Originally published by Harvard Business Review in 2012. Copyright 2012 Harvard Business Review. All rights reserved. Reprinted by permission.
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