Prospect Theory and Framing
1
G. Masino - University of Ferrara
Prospect Theory
2
Tversky e Khaneman (Nobel prize)
PT explains how human decision makers deviate
from normative utility theory
PT assumes that we decide according to “something”
similar to a “subjective” probability, and that we
assess outcomes according to something similar to a
“perceived” utility
Thus, the “weight” of a certain decision alternative
depends on “perceived probability” and “perceived
utility”
G. Masino - University of Ferrara
Ex 2A
3
Do you prefer:
A)
to have 50% probability to win 20k euros?
OR
B) to be sure at 100% prob. to win 10k euros?
G. Masino - University of Ferrara
Ex 2B
4
Do you prefer:
C) to have 50% probability to lose 20k euros?
OR
D) to be sure at 100% prob. to lose 8k euros?
G. Masino - University of Ferrara
Prospect Theory and Risk
5
We tend to be risk takers when we expect a loss (in relation
to a reference point)
Even small negative variations (losses) are perceived as very
significant
We desperately try to avoid losses. Thus, we prefer uncertain (risky)
situations as long as we have a chance to avoid the loss
We tend to be risk avoiders when we expect a gain (in
relation to a reference point)
When expected gain increases, its perceived value decreases
Thus, if higher gain is associated with lower probabilities, we prefer a
lower gain with higher probability
G. Masino - University of Ferrara
Prospect Theory and Utility
6
G. Masino - University of Ferrara
Reference Points
7
Reference points are crucial not just in terms of what
they are and what is their value, but also in terms of how
they are described
You have to decide wether to pay with credit card or cash
for a certain purchase. When the extra cost (for the use of
the credit card) is described as “surcharge for credit
card payment”, people are less likely to use the credit
card, as compared to situations where the same cost is
described as “discount for cash payment”
In the FIRST case, the option is desribed in terms of an
additional loss. In the SECOND case, the option is
described as a missed gain.
Remember: we are loss avoiders !!!!
G. Masino - University of Ferrara
Ex 3A
8
You are an oncologist. You have to choose the best cure to treat
liver tumor. Actual, reliable statistics show that:
Out of 100 people subjected to surgery, 10 die during the
operation, 32 die within 1 year, and 66 die within five years.
Out of 100 people subjected to radiations, no one dies during the
treatment, 23 die within 1 years, 78 die within five years.
What do you suggest to your patients?
SURGERY
G. Masino - University of Ferrara
RADIATIONS
Ex 3B
9
You are an oncologist. You have to choose the best cure to treat a
liver tumor. Actual, reliable statistics data show that:
Out of 100 people subjected to surgery, 90 survive the operation,
68 survive for at least 1 year, and 34 survive for at least five
years.
Out of 100 people subjected to radiations, all of them survive the
treatment, 77 survive for at least 1 year, 22 survive for at least
five years.
What do you suggest to your patients?
SURGERY
G. Masino - University of Ferrara
RADIATIONS
Results
10
A: 50 % of physicians answer SURGERY
B: 84 % of physicians answer SURGERY
… BUT THE QUESTIONS ARE THE SAME!!!
(that is, they provide the SAME information and they ask to take the
SAME decision in the SAME situation)
WHY ???
G. Masino - University of Ferrara
FRAMING
11
The way we FRAME the problem – for example, the way we
describe the reference points (success or failure of a
decision, loss or gain ...) deeply influence our judgment and
choice
It’s a mental scheme / framework that we use in
order to simplify complex situations
The way we describe a problem, the words we use, the
references and the parameters with which we define success or
failure, gain or loss, the measurement units that we use, the
metaphors, what we consider relevant or irrelevant for our
decision, etc.
It is a way to make efficient use our limited mental resources
(attention, information processing, etc.)
G. Masino - University of Ferrara
Framing managerial decisions
12
A change or a new constraint can be framed as a
“threat” or as an “opportunity”
very common frames in managerial decisions
research shows that
when organizations use the “threat” frame, they tend to react in a
more robust way, but also more rigidly, insisting on current
procedures and routines
when organizations use the “opportunity” frame, they tend to react
in a less robust way, but also in a more flexible and creative way,
by taking new actions and initiatives
Neither one or the other is necessarily “right” or “wrong”
e.g. Gilbert’s research on american newspapers
G. Masino - University of Ferrara
Gilbert’s research on newspapers and
the rise of the internet
13
Newspapers that framed the web as a threat, they invested many
resources on web initiatives, but the replicated on-line what they
were already doing in paper
eg. pdf versions of the newspaper, selling ads in a very similar
way to the paper version, etc.
Newspapers that framed the problem as an opportunity, they
reacted in a more creative way, but they didn’t invest enough
resources
es: blogs, forums, etc. but they had little impact on business
Most effective reactions came from Newspapers that framed the
problem initially as a threat (which created a lot of alert and
“readiness” to invest), but then they switched to an opportunity
frame, which allowed them to invest those resources in a more
creative and business-effective way
eg., they separated traditional activities from online activities
eg. NYT: special online ads targeted to specific customer groups
G. Masino - University of Ferrara
Framing and Business Strategy
14
J. O’Toole research on General Motors’ frame in the 70s
1. GM “is in the business of making money, not cars”
2. Success do not come from tecnological leadership, but from quickly
adopting innovations developed by others
3. Cars are status symbols. Style is more important than quality. Users
trade up well before quality becomes a problem
4. US market is isolated. No foreign competitor will never be able to
acquire more than 15% of the US market
5. Energy will always be abundant and cheap
6. Labor does not have a significant impact on production quality
7. Social and environmental concerns are not relevant in the US market
8. Central governement is an enemy
9. Tight central control is the secret of good organization
10. Managers should be trained internally
G. Masino - University of Ferrara
Framing and Business Strategy
15
How GM reacted to dramatic changes in the auto
industry (eg. Toyota’s arrival into the Us market)?
First, by ignoring it
Then, as a threat. They held on tight to their current beliefs,
identity and actions
Eventually, they became incapable of sustaining the
competition of Toyota and other new competitors, and changes
in society and the market
G. Masino - University of Ferrara
Framing and Communication
16
“It’s not often you get good news instead of a bill, but
we’ve got some for you. If you’ve heard all those
rumors about your basic cable rate going uo to $10
or more a month, you can relax: it’s not going to
happen!
The great news is [....] the rate for basic cable is
increasing only $2 a month
Storer Cable Communications,
Louisville, Kentucky
G. Masino - University of Ferrara
How to improve our decision making?
17
Explicitely consider alternative frames:
1. Challenge your own opinions and habits
2. Look for other points of view
3. Role play your competitors
4. Look for diversity
5. Brainstorming
6. Think using different perspectives
7. Think by analogy
8. Think using different metaphors
9. Investigate about how others solved similar problems
10. Monitor external changes and trends
G. Masino - University of Ferrara
How to improve our decision making?
18
Especially leaders should be very careful about how
they frame problems for others
remember Carol !!!
Try to use more than one frame at a time
Look for “robust” solutions
the Royal Shell Dutch example
Be careful about the terms we use, the reference
points, the measurement units, the metaphors, etc.
Always challenge our beliefs, especially the ones we take for
granted!
G. Masino - University of Ferrara
To Sum Up
19
We always frame, in one way or another, our decisions
This is not only unavoidable, it is also useful, as it
helps us to reduce the complexity of choices
So, we have to be very careful about how we frame,
because the frame we choose may have a large
influence on our decisions
In general, we have to consider our «natural»
predisposition to avoid losses and to evaluate
probabilities in a biased way
G. Masino - University of Ferrara