Optimism bias – the term coined by Kahneman refers to the human tendency to exaggerate one’s own ability and underestimate potential difficulties. As Time magazine rightly puts it, Human brain is wired for hope. Both neuroscience and social science suggests that humans in general are more optimistic than realistic. In general, this is excellent, but when it comes to project estimations, it could throw up a few challenges. Budget planners could underestimate the impact of uncertainties or risks and at the same time overestimate the benefits to be derived from outcomes. Optimism bias could be categorized as the unintentional way the rosy picture was created. It is similar to wearing rose colored glasses. In a budgeting landscape, this results in facts being not represented accurately and leading to incorrect plans- mainly underestimation of efforts and/or timeline.
Optimism bias, though widely recognized and more understood is not the only bias that could lead to skewed estimations though. There are a few more:
Self serving bias, which is the tendency to take the credit for success and/or blame external factors for failure. This could lead to ignoring of lessons learned from previous projects and hoping that the external factors influencing failure that time were an isolated incident and everything will work out fine this time. The project team fails to add contingency to cover these valid risks.
False consensus effect is another one and means the tendency to believe that most people share one’s opinions. Key decision makers under influence of this bias may take certain assumptions without full consultation and/or review which may later on be proved to be incorrect or insufficient leading to higher costs or delays.
Illusion of control is the tendency to exaggerate the degree of one’s control over external events. This is an extension to the self serving bias where teams or key stakeholders assume that external factors may be managed to their satisfaction. This might not always be based on facts and data and is a potential for overruns and delays in future.
Strategic misrepresentation on the other hand – the uglier one – is clearly the intentional one – where facts are present but overlooked for ulterior motives.
It is the planned, systematic distortion or misstatement of fact—lying—in response to incentives in the budget process.
Jones and Euske in their studies have highlighted several factors that stimulate strategic misrepresentation in public projects. A lot of them are valid in general for other projects as well:
Uncertainty regarding cause and effect relationships – In case of uncertainty, it is preferred by budgeting teams to err on the higher side. There is little or no penalty at this stage for requesting too much but much higher penalty and related fear if little was requested. There is a flip side to this too. As there are budget planners, so there are budget cutters who assume that estimates have buffers in them and will reduce them. Such reductions if not done carefully and with valid data/facts, could lead to underestimated projects.
Information asymmetry – Stakeholders in the program have varying levels of information which they chose to withhold or share based on their strategy and expected outcome of the budget process. Inflation of demand for the project, overstatement of benefits, understatement of costs, over assessment of the severity of the clients problems are few examples of tactics used.
Absolute constraints on resources and benefits – The budget estimates can be misrepresented so that they achieve the objectives of one or more stakeholders (which may be in line or in conflict to the overall organizational objective for that project). Such misrepresentation is often substantiated with seemingly logical arguments and/or data.
Making budgetary decisions in a highly accelerated time frame – The compulsions of business mean many times several key assumptions are taken without thorough analysis and/or sufficient data points. This could lead to skewed estimates.
Short term versus long term perspective – The “foot in the door” technique is many times used to justify unprofitable projects – termed as strategic projects. The estimate is lowered on purpose to “win the bid” or “sanction the project” with assumptions that the adjustments made now will be recovered in the long run. This is a kind of optimism bias where long term benefits are assumed to justify the near term compromises.
There are several techniques used to control optimism bias more notably – reference class forecasting based on the Nobel prize winning work of Daniel Kahneman and Amos Tversky. Techniques like reference class forecasting would work very well in public projects where historical data is more easily available and there is incentive to not get caught in the “lowest bidder” syndrome. But would it apply in a similar manner to the cut throat competitive world of business as well. The fact of the matter is that these techniques more often than not are going to increases the estimates. Would a seller who is already struggling to meet the competition’s bid be willing to consider such an approach and go for a higher cost. Maybe he will lose the project if he does.
There have to be real incentives or deterrents for sellers in today’s corporate environment to justify the additional effort that would be required to have counter checks to minimize the effects of optimism bias and /or strategic misrepresentation. On the other side, who would a buyer choose from when his competition is planned to roll out similar services soon and time to market is crucial. More often than not the seller who promises to do the project in the fastest timeline at the least cost possible will win the bid.
As can be seen from the Levi Strauss example, the negative impact for the lost business was much severe for the buyer than any potential penalties that could have been imposed on the seller considering the size of the project that was envisaged. So the responsibility to ensure an accurate and real representation of the effort required to do a project is as much on the buyer as is on the sellers who are bidding. Especially in critical business transformation projects like rolling out of a completely overhauled IT infrastructure the cost of the project is not just the cost of implementing the system. The overall cost/risk analysis needs to be done to find out what could be the cost to company if the said objectives of project are not met.