Exercising judgment How behavioral economics can help midsize companies become more agile

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Learn how midsize companies seeking to outmaneuver larger competitors can use key tenets of behavioral economics to their advantage. 

Introduction

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Navigating an era of mobile technology, cybersecurity, and “big data” can overwhelm any organization. Midsize companies in the United States, which produce between $10 million to $1 billion in annual revenues, can be particularly challenged by these trends.1 How can they compete against larger rivals that can write off several billion-dollar wrong turns and live to tell the tale?2 For almost any midsize company, the sheer size and resources that these larger competitors have at their disposal can be intimidating.

Cumulatively, US midsize companies total more than 200,000 and make up 34 percent of the United States workforce, which would equal the world’s fourth largest global economy.3 Of these organizations, 98 percent are privately held.4 As such, they tend not to be beholden to short-term pressures as publicly held companies are, such as reporting quarterly earnings. In hard times, we can see this play out. For example, during the 2008 recession, 82 percent of midsize companies not only survived but added jobs when larger companies were forced to lay off thousands of workers.5

As a number of business publications will tell you, one way these organizations can survive and flourish against larger competition is through agility.6 Rather than try to outspend the competition, private midsize firms can take advantage of their ability to move more quickly than larger, publicly held organizations often can. For this reason, they are often better positioned to adjust their strategies, enter new markets, and quickly modify internal policies to keep up with the rapidly evolving business environment.

A Deloitte series on behavioral economics and management

Behavioral economics is the examination of how psychological, social, and emotional factors often conflict with and override economic incentives when individuals or groups make decisions. This article is part of a series that examines the influence and consequences of behavioral principles on the choices people make related to their work. Collectively, these articles, interviews, and reports illustrate how understanding biases and cognitive limitations should be a first step to developing countermeasures that can limit their impact on an organization. For more information visit http://dupress.com/collection/behavioral-insights/.

The promise of agility will likely not be realized, however, if leaders fail to explore and fully understand the connection between people and performance; focusing on how people make decisions and what motivates them to work most effectively (and, conversely, what doesn’t) can be critical. In any organization, no matter where an employee sits on the org chart, he or she is typically subject to the same human biases that influence decision making. Decades of research in the field of behavioral science suggests that these biases are universal and deeply ingrained in all of us. (See the sidebar, “A Deloitte series on behavioral economics and management” for more details.) As behavioral scientist Dan Ariely coined it, humans are “predictably irrational.”7 This may explain why we fear change, get overwhelmed by too many decisions, and prefer short-term, small payoffs over long-term, larger rewards.

While these biases can manifest almost anywhere in corporate decision making, we focus on three highly relevant issues to private, midsize firms as identified in Deloitte’s Private company issues and opportunities: What to consider in 2017 report:8

  1. Change management. Why is change so difficult? First, people tend to naturally gravitate to the status quo. It’s familiar, there’s a comfort level associated with it, and so it feels “right.” Second, change can challenge people’s beliefs about their core strengths. Consider that many knowledge workers have spent years honing a particular skill or set of skills. When new technologies create opportunities or a large-scale change initiative is implemented and employees are asked to change course and do their jobs differently, it can be a challenge.
  2. Cybersecurity. Implementing new technology doesn’t stop at the change-management process. It also exposes organizations to greater cyber risk. Though cybersecurity may seem like a technology issue, most cyber breaches derive from human error, such as an employee falling victim to a phishing scheme.9 When managing any number of responsibilities and distractions, it can be easy for anyone to click on the wrong link or respond to a fake email.
  3. Talent management. Making the right hire can be a struggle for organizational leaders. We now know that our biases can often get in the way of making the “right” hiring decision. For instance, one study showed that whether we have 10 seconds or one hour with a candidate, we often come to the same conclusions.10 And in a tight market for talent, it’s important to reduce the impact biases can have and make the right talent decisions.

Understanding and addressing biases such as these can help midsize organizations realize greater agility when competing in today’s rapidly evolving markets.

Though biases can manifest both internally within organizations and externally among their customers (for example, in matters of pricing and product choice), this article specifically focuses on the internal operational issues relevant to private, midsize firms. (See the note, “Organizational biases are everywhere” for more background.) The reason: Leaders of mid-market firms are well aware that larger organizations will almost always have more resources than they will. They also are likely aware that leveraging agility as a competitive differentiator is somewhat contingent on having efficient processes in place and smart decision making. For these organizations to fully capitalize on the ability to adapt more quickly (and hopefully more intelligently), they likely need to circumvent the biases that often keep them stuck repeating unproductive patterns and therefore, hinder the competitive advantage their size may afford them.

Organizational biases are everywhere

Firm-wide biases can manifest in organizations of any size, big or small. This is a product of us being human. These pertain to matters of change management, cybersecurity, and talent management. For this reason, our research throughout the paper pulls examples from organizations of all sizes, rather than just midsize businesses. Our hope is that by identifying issues especially relevant to private, midsize organizations, we provide a line of sight into how other groups are able to circumvent their biases and achieve new levels of productivity.

Change management: Manage the process, change the people

Consider a few important trends highlighted in Deloitte’s 2016 technology survey of mid-market organizations.11 First, the most-cited reason mid-market executives invest in cloud infrastructure, big data, and analytics is that they hope to achieve new levels of productivity. But greater technology spending does not always result in immediately higher productivity. The survey also revealed that, for a vast majority of mid-market organizations, at least 40 percent of technology spending is earmarked for implementation initiatives.12

Why is so much money reserved for implementation? Because the speed at which organizations can yield greater productivity often depends upon how well the business integrates these new technologies and processes with the people tasked with leveraging them.13 And as the behavioral sciences suggest, it is no easy endeavor to change people’s behavior—even when it would be in their best interest to do so.

Break through the status quo bias

Decision making isn’t always made in absolute terms; often, it is viewed in terms of how it impacts our status quo. Committing to a path that may yield higher payoffs but with the cost of greater uncertainty can be intimidating for anyone. This fear of uncertainty is often fueled by the behavioral concept of loss aversion: We hate losses so much that we would prefer to stay put and forgo new opportunities rather than expose ourselves to greater risk.

For example, engineers who may be weighing the merits of transitioning from a traditional manufacturing process to additive manufacturing (also known as 3D printing) have been known to have difficulty making this transition. Switching to this new technology could threaten their status as subject matter experts or deviate away from a career’s worth of knowledge and success garnered in traditional methods.14 In this case—and many others like it—we are expecting people to pivot their mental model of how their organization, and consequently, their role should be performed. Without lending an assisting hand, asking people to change how they see the world can be an ambitious endeavor.

To facilitate these changes, the behavioral sciences suggest we should provide individuals with tools to make new courses of action easier. We discuss a few of these tools, known as behavioral nudges, which can help people make changes now that would benefit them in the future. When used effectively, nudges can remove cognitive barriers and offer people more confidence in taking on the unknown.

Commit to change with confidence

When committing to a new endeavor, many of us can benefit from even a small amount of assistance. Commitment devices strive to help people achieve success by clearly outlining the steps they should take to accomplish their goals—and a road map to get there. Psychology suggests that when someone explicitly makes a commitment to acting differently, they tend to be both more willing and confident in their ability to act differently.

In Norway, the social security administration asked people who were out on medical leave for more than six months to create a formalized plan for how they would return to work. By holding a meeting between the employee, employer, and physician to outline plans and discuss issues, employees returned to work sooner—20 days sooner for part-time work, and 10 days sooner for full-time.15

Even simply having someone fill out a consequence free “commitment card” has produced promising results. In 2012, President Obama’s reelection campaign asked would-be voters to fill out a commitment card that pledged that they would go to their local polling station to vote. They also asked these voters to explicitly state how and when they would get to the polls.16

Organizations can leverage these same commitment strategies in their own change management projects. Walking people through small, predetermined steps can help remove uncertainty and make change feel less overwhelming. Covering the last mile of change by requesting that people fill out their own commitment plans can engender a change environment that goes with the grain of human psychology rather than against it.

Provide meaning through social change

Taking cues from our peers is a powerful means to invoke change. People often feel more empowered when they know how their peers behaved under similar circumstances.

In an effort to reduce improper payments in unemployment insurance, the New Mexico Department of Workforce Solutions embedded social messaging that explained how others filled out forms. For a subset of the claimants filling out their weekly earnings report, a message prompted them stating, truthfully, that “9 out of 10 people in <your county> accurately report earnings each week.” This little social cue resulted in a 25 percent increase in earnings reported vs. the control group, who did not receive the message.17

By using commitment devices, organizations can highlight peer performance for each step of the change process while explicitly communicating expectations and allowing employees to commit to stated goals.

Social cues can also go well beyond messaging alone. Research shows that work feels more meaningful when employees feel that the activities they undertake can improve the well-being of others.18 The Deloitte Review article, “Humanizing change: Developing more effective change management strategies,” featured a story about how one manufacturer revamped its inventory process by making the initiative more human:19

A core group of engineers deemed the new process cumbersome and saw little value in adopting these new procedures, so they didn’t. Their noncompliance negatively affected the accounts payable department, who found themselves staying late to reconcile the variances. Rather than host another training session, company leaders had a better idea, drawing on the power of storytelling and social experiences. They invited employees from engineering and from accounts payable to an off-site location and used whiteboards to visually represent the new process, pinpointing the highs and lows of what employees were experiencing. As the engineers began to put faces to names, leaders could see mental models shifting. The motivation to adopt the process was no longer based on the organization becoming more efficient—it was so their colleagues from the accounts payable department could go home on time.

Smaller organizations may hold a relative advantage in deploying these insights. Given their size, they may find it easier to bring seemingly unrelated groups together to “humanize” the change.

Cybersecurity: With greater technology comes greater responsibility

As midsize companies are integrating more technology into their organizations, change management is likely not the only operational focus that can benefit from implementing behavioral economics strategies and tools. The No. 1 IT challenge cited by mid-market businesses is managing information security.20

One might assume that better cyber threat technology holds the key to prevention, but the data suggest it really starts with the people.21 A recent Deloitte report, Private company issues and opportunities: What to consider in 2017, stresses the importance of educating employees on how to cut through everyday distractions and remain vigilant to cyber threats.22

But education may only be the beginning. We live in a fast-paced world, filled with distractions. Instead, behavioral science tells us that a more consistent way to protect information security is to consider people’s “behaviors, motivations, and habits.”23 By doing so, we can link employee culture to strategies and actions that can better protect company information.

Design a secure culture through choice architecture and social cues

Modifying culture in general and specifically to be more cyber-vigilant is no easy feat. As the Deloitte University Press article, Toeing the line, explains, in order to change culture, businesses often need to align policies, individual and group learnings, and the tools employees are expected to interact with.24

Policies alone typically do not engender compliance. Like the change management case, however, peer interaction can be a powerful way to build a secure culture. Consider these tactics:

  • Leverage peer mentors. Carefully assigned onboarding coaches can help new employees understand and embrace the values of an organization. Coaching has a long history of influencing behavior: Research has shown that strong coaching environments are tied to strong business performance and engagement.25
  • Make the group image the self-image. A West Point Army study shows the power of group belonging. From the first day of training, cadets receive the same uniforms, haircuts, and routine—all in the spirit of espousing the same values across the group. With repetition, cadets internalize these values and they become integral to their own self-image.26 This can be akin to corporate environments that provide new employees with laptop locks and employee badge lanyards that prominently display the company logo.

At the individual and group levels, security-minded behaviors also can be reinforced simply through example. From simple activities like locking up an unattended laptop to always wearing an employee badge in a highly visible location, how our peers behave signals how we should behave, and over time, what our peers believe can become what we believe.

Deliver better choice architecture for office tools

A hallmark of a good choice architecture is about designing an environment that, despite the many distractions, makes it easy for people to make choices in the short term that align with their long-term interests and, where necessary, are also in line with an organization’s cybersecurity requirements.

For example, many organizations now offer an auto-escalation option to 401(k) plans whenever an employee receives a raise. By making the choice once, employees can easily increase their retirement contributions without having to make a “new” decision every time. Similarly, companies can provide default permissions for sharing information or helpful pop-up messages whenever sending data to external parties to increase compliant behavior. With relatively fewer stakeholders to consider and manage, determining these permissions and defaults may be easier for midsize firms to execute.

Talent management: Behavioral insights for your human resources department

With unemployment rates below 5 percent, many midsize businesses are finding it increasingly difficult to find and retain quality employees.27 Already competing with larger organizations with deeper pockets, these organizations may feel they are disadvantaged in areas such as recruitment and employee well-being programs.

Despite these realities, midsize companies have an opportunity to redesign hiring practices and human resources infrastructure to better align with human psychology, thus enabling greater agility when seeking to fill emerging talent gaps.28 Here, their smaller size could be an asset; without the layers of bureaucracy some larger human resources departments may have, these more nimble HR departments could get right to work revamping policies so that they more explicitly speak to employees’ intrinsic motivations.

Decrease your bias, increase your talent pool

Behavioral science shows us that people tend to rely too much on mental heuristics (“rules of thumb”) to make decisions. Although heuristics often guide us through our daily life to help us make quick, effortless decisions, they are also systematically biased. As Daniel Kahneman explains in Thinking, Fast and Slow, this is because we often generalize our assumptions based on small amounts of data and seek out patterns where none exist.29 Consequently, humans tend to be awful at making predictions—such as, who would make for a good hire.

Google found that the use of brainteaser questions during the hiring process held no predictive value and that they were putting too much credence on degrees from top-tier universities.30 And perhaps the most well-known example of an organization overcoming systematic bias in hiring is found in Michael Lewis’s Moneyball. Rather than rely on the intuitions of baseball scouts to identify top players, the Oakland A’s used data analytics to reduce bias and pick players based solely upon measurable attributes that lead to better team performance.

The good news is that with the proliferation of data analytics capabilities, almost any size organization can emulate the success of the Oakland A’s and cut through biases in the hiring process. For instance, one movie theater chain used data analytics to study the characteristics of their highest-performing work teams. Based on the findings, the company altered its hiring practices to find people who shared the same qualities as those found in these team members.31

Look toward intrinsic motivations to influence employees

All human resources departments grapple with one core, fundamental question: “What motivates employees?” Assuming that money, benefits, and prestige (extrinsic motivations) are what people want most, traditional HR policies are littered with year-end bonuses and top-down assessments. While this “carrots and sticks” approach has its place, psychology tells us that most people are much more complex than that. They care about organizational recognition, finding meaning in their work, and having the ability to make decisions autonomously. These are all qualities of being intrinsically motivated—and they are often the most powerful drivers of performance and engagement. Knowing this, midsize company leaders have an opportunity to evaluate and, if necessary, retool their policies to speak to these motivations in a more deliberate and holistic way. (For a list of methods to intrinsically motivate employees, see the sidebar, “Intrinsically motivated: Examples from the field”.)

Intrinsically motivated: Examples from the field (adapted from “HR for Humans: How behavioral economics can reinvent HR”)32

Mastery: Some organizations make active efforts to inculcate a learning culture. For example, Google holds a celebrated Tech Talks series attracting prominent thinkers to share leading-edge thinking with its community. Deloitte Consulting LLP holds an annual data science summit at which the firm’s data scientists can bond with, and learn from, each other. Beyond the economic efficiency of self-training rather than paying for external trainers, enabling employees to gain recognition as teachers who are masters of their domains is a powerful motivator.

Autonomy: Give people opportunity for creativity and innovation in their jobs. One of 3M’s scientists developed the post-it note during his “15 percent time.”33 Google’s Gmail and AdSense are credited to the company’s similar “20 percent time” program, in which employees were allowed a day each week to work on side projects.34 In The Good Jobs Strategy, Zeynep Ton argues that retailers who give employees more training, freedom, and flexibility outperform higher-paying peers.35 Zappos, known for excellent customer service, does not monitor its customer representatives’ call times or assign them scripts to read. The company simply instructs the reps to serve its customers well.36

Purpose: Netflix’s influential 124-page culture slide deck starts out with a clear statement that its corporate values are not words on a page but, rather, the behaviors and skills that colleagues value.37 In Work Rules!, Laszlo Bock comments on the ability of Google’s concise mission statement—“to organize the world’s information and make it universally accessible and useful”38—to help give individuals’ work meaning.39 And the need to give work intrinsic meaning is hardly restricted to professional jobs.

The fast lane to agility

For leaders looking to increase their organization’s agility by influencing employee behavior and removing restrictive biases, consider the following methods to support the core operational areas of change management, cybersecurity, and talent management:

Identify employee motivations. Implementing a new technology? Think of how that could alter the employee’s status quo. Will they feel like their skills are obsolete or will they regard it as a skill-building opportunity? Whether protecting your data assets or launching a new process, consider demonstrating why their behavior is meaningful to themselves, to their peers, and to the organization.

Provide psychology-backed tools. Commitment devices help break down new behaviors into manageable activities. The more social you can design them, the better.

Gather data, test, and learn. Fully leverage your ability to change course quickly by developing a test-and-learn environment. Consider instilling data insights across your organization, test the efficacy of changes and new initiatives, analyze the results, and react accordingly.

For any business, the speed and efficiency in which they master these dimensions will likely depend upon how they manage the people behind them. (See table 1 for a summary of the behavioral considerations behind each area of influence.)

 Behavioral considerations for midsize organizations

Whether big or small, the organization that best understands the people behind it is often the one most equipped to innovate faster and more effectively and capitalize on new opportunities. Implementing behavioral science principles can help midsize companies use size to their advantage—and realize the benefits of being a truly agile organization.