Tuesday, July 3, 2012

Why business is like piracy and needs more irrational thought

This is a guest post by Jim Prior, CEO of brand consultancy The Partners. You can follow him on Twitter on @jim_prior

In the study of economic decision-making the Ultimatum Game is an illustration of the unpredictability of human behaviour, value judgement, and the role and importance, therein, of morality.

The Ultimatum Game is a two-person scenario in which the first player is given a sum of money, say 100 coins, and told to propose a division of it with the second player. If the second player accepts the proposal then the coins are split according to the proposal. However, if the second player rejects, then neither player receives anything. The game is played only once. The question is: what should the first player propose?

Across widespread experiments (using real people) a vast range of different outcomes has been observed. Different cultures, different social conditions, different neurological profiles, yield different and unpredictable results. And whilst there are some general patterns -- 50/50 splits are common in the industrialised world and offers worse than 80/20 are rarely accepted -- the variations in results cannot be rationally explained by anything other than the presence of non-rational factors heavily influencing the human mind. Indeed, the most logical outcome, a 99/1 split, is one of the least observed of all. Whilst not everyone acts altruistically in the Ultimatum Game, I certainly find it reassuring that a good number do.

But there is an extension of the Ultimatum Game that gives a twist to this finding. This one is called Five Pirates and it goes like this: five equally and exceptionally greedy, ruthless and logical pirates have a treasure chest containing 100 gold coins. The eldest pirate (Pirate A) must propose a division of the coins amongst the group. If at least half the pirates (including the proposer) accept the division then the share is made. But if more than half reject it, the proposer is made to walk the plank, and the task of proposing a division amongst the remaining four then falls to the next eldest pirate (Pirate B) and the same conditions apply. This goes on, through Pirates C, D and E, unless at least half the remaining pirates agree at some point.

So, what division should Pirate A propose? This puzzle is a little different to the Ultimatum Game in that it is not positioned as a human behaviour study but as an exercise in logic -- more specifically, critical thinking. If you want to try and solve the problem, then take a break from the rest of this article because I'm going to give the answer in the next paragraph.

The trick is to solve the problem using backwards induction: consider what would happen if there were only two pirates left and then add back the earlier pirates one by one, each time considering what they would have to offer to improve the situation for a sufficient number of pirates to secure enough votes in favour. The answer for what Pirate A should propose, and the one that the majority must logically accept, turns out to be A.98, B.0, C.1, D.0, E.1. The controlling pirate maximises his return, gives the bare minimum to some others, and leaves some with nothing. Under the rules of Five Pirates, there can be no dispute that this is the right and only answer. There's no room for empathy or morality here; it's an entirely rational business decision.

And it's the kind of business decision that we see all too much of in reality (such as might be made by a bank wanting to manipulate the Libor rate for example). Too many businesses behave too much like Five Pirates and not enough like the Ultimatum Game. Too selfish, insufficiently altruistic; giving the minimum away that they need to because their priority is to maximise what they keep for themself. If Pirate A had shareholders, they would be feeling mighty proud.

Yet this seems to be a dilemma. If people's instinct, as illustrated by the Ultimatum Game, is to act more altruistically than logic dictates then why should this not follow through into the behaviour of business which, after all, is simply another human system? In the face of complexity, why do empathy and human understanding get sacrificed for logic and strictly rational thought? Well the fact is this: logic is not only intellectually satisfying (I confess to taking great pleasure in the Five Pirates solution) but it is easy to justify to your boss or your shareholder. Human emotion is not. And that is wrong.

Business needs to get comfortable with more emotionally-led decision-making and become more comfortable with following human instincts around fairness, altruism and simply doing the right thing. The reason we know this is true is because, even for the most hardened professional in the most cut-throat of businesses, we all ultimately revert to being the individual human beings of the Ultimatum Game who understand there's a big difference between logical and emotional sense.

Of course, in reality, there are no such things as equally and exceptionally greedy, ruthless and logical pirates. But it is my belief that there's some hard work, and some irrational thinking, for business leaders to do to ensure that they don't continue to be perceived as such.

There's an important added dimension to this story too. In the Five Pirates game remember that there are five ruthless pirates not just the one who makes the proposal, and all of them are complicit in accepting the logical deal. And so it is in business too. Too many "deals" get accepted by shareholders, staff, customers, and legislators that are rationally sound but not in the best human interest. The conclusion we should draw from this is that it doesn't just fall on business leaders to change their practises, it falls on all of us to start thinking differently too.

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