The Potency of Shortcuts in Decision-Making
A growing body of research suggests that CEOs who use heuristics can make more effective decisions than those who take a more comprehensive approach.
Sebastian Kruse, David Bendig, and Malte Brettel
September 06, 2023
How do CEOs make good decisions? At a time when senior leaders have access to more data and sophisticated analytics tools than ever before, the central challenge of making good decisions about hiring, product development, and resource allocation is increasingly not a lack of information. Rather, it is knowing how much information is enough, and how to use it.
Scholars of decision-making have long recommended that CEOs and managers gather and analyze comprehensive information before making choices. This advice is based on two assumptions: (1) More information leads to better understanding of the decision at hand and possible consequences, and (2) an emphasis on gathering information rather than relying primarily on one’s own knowledge may reduce harmful biases.
However, a growing body of research shows that CEOs may often be better off putting more trust in the simple rules of thumb known as heuristics. These usually spring from a leader’s direct experience, are applied deliberately, and frequently result in superior decision outcomes. Our recent study, published in the Journal of Management Studies, suggests that CEOs who use more heuristics in making decisions can accelerate the speed of new product development in their organizations and achieve greater overall business performance. Another study, by Christopher Bingham et al. in Strategic Entrepreneurship Journal, suggests that using heuristics for international expansion decisions can lead to higher sales and revenue growth from those initiatives.
When (and Why) Heuristics
Research finds that heuristics work best under three conditions.
When the decision environment is noisy. In such an environment, more information is unlikely to lead to a better understanding of a specific decision problem. For example, when executives make choices about which innovation projects to invest in based on estimated market size, feasibility, or timeline, these data points often reflect the subjective evaluations of potential project leaders rather than objective facts. Using heuristics under such conditions filters out noise in the decision-making process.
Heuristics can be particularly effective when the decision environment is noisy, where more information is unlikely to lead to a better understanding of a specific decision problem.
Research shows that simple heuristics, such as “invest in projects with the most advantages” or “invest in the project that the most experienced team member prefers,” can be as accurate in selecting successful innovation projects as comprehensive decision-making while also accelerating the speed of decision-making.
When decision-makers face a highly dynamic environment. In this case, information becomes outdated quickly, and using outdated information can diminish decision quality. For instance, when selecting target customers for new marketing initiatives, it can be more effective to use simple heuristics rather than relying on past, possibly outdated customer data. The simple rule “target customers who have bought from us in the past six months” can predict future purchasing behavior more accurately than complex models trained on large amounts of older data.
When obtaining large amounts of information is difficult. In the case of hiring, for example, it’s impractical or costly to obtain extensive information on every potential candidate. Employers instead have to rely on a few pieces of information, such as a candidate’s CV and their impression of a candidate’s performance in an interview.
Research suggests that using heuristics in such situations can forecast future job performance more precisely than analyzing detailed information obtained in structured interviews. For example, managers might ask themselves three simple questions when considering a job candidate: Does the candidate have exceptional ability? Do I admire the candidate’s track record? And will the candidate raise the level of performance within the team? They might choose to hire a candidate only if the answer to all three questions is “yes.” However, heuristics used in hiring must focus on performance-related criteria and not have the effect of unfairly discriminating against individuals or reinforcing social biases.
In short, heuristics work best in environments that are noisy and dynamic, and where information is scarce.
How Heuristics Can Clarify Thinking
To understand how using heuristics can help in practice, let’s consider how they help leaders address four fundamental questions in new product development.
On which opportunities should we focus in new product development? Comprehensive decision-making in this regard would involve instructing development teams to analyze a wide variety of market segments and technologies to identify the most promising opportunities. Alternatively, CEOs can use heuristics to focus their efforts on certain customer types (“develop products only for end customers”) or specific product types (“develop only software products”). Such heuristics enable a narrower focus for new product development and a higher likelihood of generating more innovative ideas. CEOs can also use heuristics to limit the number of projects that can be developed in parallel, ensuring that sufficient resources are available for each project.
How do we choose among competing projects? Heuristics can also help CEOs effectively choose among projects within a specified search field. Many factors can influence the attractiveness of a new project, such as future profitability, risk, product advantage, feasibility, market size, competition, and length of payback period. When using comprehensive decision-making, CEOs carefully analyze and weigh each of these factors. However, simple heuristics are often faster and more effective when deciding which projects to move forward with and which to drop. CEOs can assign positive and negative scores (+1 / -1) to each factor for each project, tally these scores, and select the project with the highest total. Or they can eliminate all projects that score poorly on the factors they consider the most important, a heuristic called elimination by aspects. Research shows that these two heuristics can identify which projects are likely to fail and which are likely to succeed in the vast majority of cases.
What’s the right pace of new product development? Heuristics can assist CEOs and managers in establishing a sense of rhythm and pace for new product development. For example, Apple uses the simple rule of “release a new version of the iPhone every 24 months” to structure its development activities. This rule promotes efficiency by providing employees with a continuous and predictable sense of urgency, facilitates the integration of external suppliers, and smooths the transition of employees from one project to the next. Similarly, some CEOs set the rule that all new-product projects must be finished within 18 months to provide a steady rhythm and pace. Other CEOs set the rule that new B2B product releases must be synchronized with customer release cycles, forcing development teams to reduce their project scopes to deliver projects within customer deadlines.
How can we balance efficiency and flexibility? Development groups must be efficient (that is, streamline processes to deliver products under time and resource constraints), and they must also have the flexibility to explore and experiment, but focusing on one often comes at the expense of the other. Heuristics can help CEOs effectively balance this trade-off. For instance, 3M famously uses the rule of thumb that all developers can spend 15% of their time working on projects based on their own ideas. This simple rule balances efficiency and flexibility by determining the time available for independent exploration, in order to foster innovation while effectively managing resources. Similarly, CEOs have the option to stipulate that a specific number of projects must embrace high experimentation (such as “one-fifth of all projects should be radically innovative”) or set limits on the resources allocated each year for entirely novel projects (“10% of the budget is reserved for new-to-the-world ideas”). Research has shown that such simple rules can empower companies to develop highly innovative products despite limited resources.
Getting the Most Value From Rules of Thumb
In order to gain the advantages of speedier decision-making with heuristics and still maintain decision quality, CEOs who employ them should consider the following actions:
Use heuristics in the right context. Heuristics are effective in environments that are noisy and dynamic and where information is hard to obtain, whereas comprehensive decision-making is more effective in stable environments where large amounts of objective information are readily available. CEOs should thus adapt their decision-making style to the characteristics of the environment.
For example, when making decisions on which companies to acquire in mature markets, comprehensive decision-making can be effective because objective information on acquisition targets is readily available. In contrast, when CEOs acquire companies in highly dynamic markets experiencing rapid technological development, heuristics may be more effective, since more information often does not necessarily lead to better predictions of a target’s value.
Develop and refine your own heuristics. Effective heuristics are not arbitrary — they are developed through careful reflection and an understanding of difficult business problems. Heuristics are reliable when they capture causal regularities in a simple rule, but they can introduce bias when they do not capture a causal link. Reserving space for careful reflection when generating heuristics may therefore be time well spent for CEOs.
Developing one’s own heuristics is crucial because the insights captured in a heuristic developed by someone else may not transfer to a different decision context.
Heuristics also become more effective when CEOs put them into practice, observe their outcomes,and refine them over time. Research finds that a simple heuristic for international expansion for a supplier to the pharmaceutical industry, such as “enter countries that have a lot of pharma activity,” can, with experience, be refined into the more complex and effective heuristic of “enter countries that have lots of pharma activity and are home to the headquarters of a large pharmaceutical company.”Share and explain the story behind a heuristic.
The heuristics developed by CEOs will serve as decision guidelines for many members of an organization, who will themselves apply rules such as those defining what kinds of international markets may be of interest or what kinds of development projects to pursue. However, because heuristics are very short and simple by nature, they don’t convey the logic behind them.
Sharing the story about why a heuristic was created increases the chances that employees will remember and apply it. Recent advances in data analytics — and many organizations’ success at gaining useful insights from these tools — suggest that analyzing large amounts of information using complex algorithms may be the most effective way to make decisions. However, many managerial decisions need to be made in noisy and dynamic environments, where quality information can be hard to obtain and evaluate.
In such environments, simple rules of thumb can lead to faster and better choices than complex analyses based on large amounts of information. We encourage CEOs and managers to understand the value of heuristics and learn how to develop and use them as a complement to thorough information gathering and analysis in decision-making.
AABOUT THE AUTHORS
Sebastian Kruse is an assistant professor in the Innovation and Entrepreneurship (WIN) group within the TIME research area at RWTH Aachen University in Germany. David Bendig is a full professor at the School of Business and Economics at the University of Muenster in Germany. Malte Brettel is a full professor at WIN and adjunct professor for entrepreneurship at WHU-Otto Beisheim School of Management.