It would be nice to think managers always make the best decisions possible for their firms, given the circumstances, acting rationally using all the information at their disposal. However, people are far from perfect, and their decision making is inevitably biased in one way or another. Unfortunately, this bias can have a negative impact on an organisation’s profit
A recent research paper by Marco Bertini and Oded Koenigsberg of London Business School, and Daniel Halbheer of the University of St Gallen, offers some comfort for senior executives. The authors suggest that, in the context of price and quality related decisions, senior managers armed with a degree of foresight can take action to alleviate the effects of biased decisions by their managerial reports.
Numerous research studies suggest that people are over-confident about their ability to influence events positively. Individuals tend to take responsibility for good outcomes, while attributing bad outcomes to the actions of others. One poll, for example, reported that 95 per cent of managers in Europe blamed price competition on the irresponsible actions of rivals rather than on their own behaviour.
Bertini and his co-authors, conducted a number of studies to investigate managers’ opinions about firm performance in relation to price and quality. For example, they asked a group of senior executives to imagine that their company recently launched a new product with first-year sales at £25 expected to reach 10,000 units. The executives were split into two sub-groups. One sub-group was told that actual sales outperformed the forecast by 25 per cent. The other subgroup was told sales lagged the forecast by 25 per cent. Both sub-groups were asked to choose between price and quality as the most likely reason for the sales performance. For the successful executives, 67 per cent selected quality; while 63 per cent of executives who experienced failure opted for price.
When actual profits outperform expected profits, managers are happy to take responsibility. They attribute the outperformance to the quality of products of the firm. It is easy for a manager to link product quality to their own actions and those of the firm that they belong to. From the manager’s perspective, the manager plays an important role in creating products and delivering them to consumers. Note that managers do not assume good profits are down to attractively priced products. Pricing is seen more as a product of external factors beyond the manager’s control. When profit performance is lower than expected, managers are more likely to blame pricing than poor quality products.
This self-serving behaviour determines the response to different profit performance scenarios. Given good profit performance managers continue to increase quality, with poor profit performance they cut prices. This tends to be bad for future firm profitability. Neither response, on average, outperforms a rational manager acting on the actual information available about the firm’s price-quality margins, and those of its rivals.
But all is not lost. Despite this tendency to make self-serving decisions, firms can remain competitive and produce profits in excess of those achievable by a rational manager. Senior managers must have the foresight to take quality and pricing decisions that account for the predicted consequences of a manager’s self-serving bias. Helpfully, the authors construct a model that shows how to do this, given various competitive permutations. In doing so, the senior manager can even produce greater profits than if a rational manager had been making the decisions. And then, presumably, claim the credit.
Marco Bertini, Daniel Halbheer and Oded Koenigsburg, 'Self-Serving Behavior in Price-Quality Competition' (Marketing Science, 2013)