Saturday, May 15, 2010

The Primate School of Management

I often think that business students would be better served if they had to take more courses on social sciences--sociology and anthropology. They'd have a better grasp of how businesses actually operate and consumers actually think. Homo Sapiens are primates. We're not computers.

Most economists view humans as rational beings who will always make decisions that are in their best interest. The reality is much more animal-like. Humans make emotional decisions and then rationalize them. There's no better example of this than the automobile industry. If humans truly were rational beings, there would be only a handful of car models available, and people would buy the model with the lowest overall cost that best suits their needs. They'd keep their cars until the exact point that it would cost less to buy a new one than to continue to fix and insure their existing one. But, if that were the case, we'd have no auto industry to speak of.

People buy cars because they like how they look, or they "fit their lifestyle", or they project some attribute of their personality that they have (or wish they had.) There's nothing rational about those decisions; they're driven by emotion. People regularly trade in cars that have years of life left, even if they'd be thousands of dollars ahead by keeping the car rather than trading it in, because they have "new car fever."

If people are that emotional about a simple appliance, a device that enables them to get from Point A to Point B, why do we assume that they make purely rational decisions about their investments? What statistical model validates the concept that when you group thousands or millions of emotionally-based transactions together, they become rational?

Companies are groups of people. They constitute societies with mores and values. There are in-groups and out-groups. And, like people, they act emotionally and then rationalize their decisions. How else do you explain the thousands of bad decisions that are made by companies, large and small, every day? Is it that they don't have "perfect information?" No one does, yet they'll spend millions of dollars trying to get it. How do you justify spending months working on annual business plans that everyone knows will be obsolete before they're completed?

Expecting rational behavior to spontaneously emerge from groups of emotionally-driven individuals is itself irrational. We'd be better off if we assume, and allow for, emotionally-driven decision making, instead of assuming that economic decisions are always rational and then being shocked when we find out that they're not.

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