Joesph Wilkinson, Senior Consultant
Do you believe that most people are naturally predisposed to avoid risk? This is the main thrust of a complex behavioural model known as prospect theory. Daniel Kahneman, who won a Nobel Prize for his work on the theory, explained:
‘For an organism operating close to the edge, the loss of a day’s food could amount to death, while the gain of an extra day’s food could lead to increased comfort but (unless it could be costlessly stored) would not lead to a corresponding increase in life expectancy.’
In short, it makes sense for us to be twice as keen to avoid losses as to achieve gains.
However when the theory is applied to business, some ‘losses’, such as process inefficiencies and poor decisions made on the basis of bad information, can often be overlooked or quantified as unrealised gains. This may be excusable in days of plenty, but in today’s challenging environment, if a company wants to stay relevant, inefficiencies of any kind must be viewed as losses.
Simple Business 101, I hear you say. And so it is. But how do successful companies make the right decisions to minimise losses and maximise gains?
Here are the essential steps:
1) Defining the problem – Identifying the issue that needs to be solved and the decisions that need to be made in the process.
2) Gathering the right information – Identifying the information that needs to be taken into account to solve each aspect of the problem and how to source it. Collating the information.
3) Processing the information – Identifying which aspects of the information collected will be relevant and what additional information is needed. Presenting the information in the best way to facilitate decision-making.
4) Deciding – Involving all concerned parties in making decisions on the basis of the information collected. Assessing whether the decisions taken have solved the problem at hand. Confirming that the views of all the relevant parties have been taken into account. Refining or modifying the decisions to meet changing circumstances, if appropriate.
This may all sound like common sense, but history has taught us that, for many failed companies, common business sense was in short supply.
Did these companies understand their hidden losses and identify their root causes? Were they measuring the right metrics? Could they have handled the crisis better if they had taken information they didn’t know they had access to into account? Or even information they didn’t know they needed – Donald Rumsfeld’s famous unknown unknowns? It is likely that a combination of some or all of these factors was at play.
So what helps a company stay on top of its hidden losses and ahead of the competition? As a starting point, the majority of well-run companies have a robust, integrated and well-oiled management control system in place. This allows them to understand all facets of their business, where their losses come from and why they exist, and helps them make the best decisions to maximise profit.
At Renoir Consulting we have decades of experience across the globe of installing, refining and updating management control systems to deliver outstanding and quantifiable results. Our bespoke solutions, developed together with each company’s managers and their staff, help businesses fix themselves and improve efficiency by giving teams the tools to understand where losses are hidden so they can address them.
If you feel that your company could benefit from a Renoir check-up, please get in touch. Take your cue from prospect theory and hate your losses more than you love potential gains!
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