Congratulations! You’ve Won Russian Roulette Alternative Paths

You arrange to meet with a Russian oligarch in a forest just outside your city. He arrives shortly after you, carrying a suitcase and a gun. Placing the suitcase on the hood of his car, he opens it so you can see it is filled to the brim with stacks of money—$10 million in total. “Want to play Russian roulette?” he asks. “Pull the trigger once, and all this is yours.” The revolver contains a single bullet; the other five chambers are empty. You consider your options. Ten million dollars would change your life. You would never have to work again. You could finally move from collecting stamps to collecting sports cars!

You accept the challenge. You put the revolver to your temple and squeeze the trigger. You hear a faint click and feel adrenaline flood your body. Nothing happens. The chamber was empty! You have survived. You take the money, move to the most beautiful city you know, and upset the locals by building a luxurious villa there.

        One of these neighbors, whose home now stands in the shadow of yours, is a prominent lawyer. He works twelve hours a day, three hundred days a year. His rates are impressive, but not unusual: $500 per hour. Each year he can put aside half a million dollars net after taxes and living expenses. From time to time, you wave to him from your driveway, laughing on the inside: He will have to work for twenty years to catch up with you.

Suppose that, after twenty years, your hardworking neighbor has saved up $10 million. A journalist comes along one day and puts together a piece on the more affluent residents in the area—complete with photos of the magnificent buildings and the beautiful second wives that you and your neighbor have accrued. He comments on the interior design and the exquisite landscaping. However, the crucial difference between the two of you remains hidden from view: the risk that lurks behind each of the $10 million. For this he would need to recognize the alternative paths.

But not only journalists are underachievers at this skill. We all are.

Alternative paths are all the outcomes that could have happened but did not. With the game of Russian roulette, four alternative paths would have led to the same result (winning the $10 million) and the fifth alternative to your death. A huge difference. In the case of the lawyer, the possible paths lie much more closely together. In a village, he would have earned perhaps just $200 per hour. In the heart of New York working for one of the major investment banks, maybe it would have been $600 per hour. But, unlike you, he risked no alternative path that would have cost him his fortune—or his life.

Alternative paths are invisible, so we contemplate them very rarely. Those who speculate on junk bonds, options, and credit default swaps, thus making millions, should never forget that they flirt with many alternative paths that lead straight to ruin. To a rational mind, $10 million that comes about through a huge risk is worth less than the same sum earned by years of drudgery. (An accountant might disagree, though.)

Recently, I was at a dinner with an American friend who suggested tossing a coin to decide who should pay the bill. He lost. The situation was uncomfortable for me, since he was my guest in Switzerland. “Next time I’ll pay, whether here or in New York,” I promised. He thought for a moment and said, “Considering the alternative paths, you’ve actually already paid for half of this dinner.”

In conclusion: Risk is not directly visible. Therefore, always consider what the alternatives paths are. Success that comes about through risky dealings is, to a rational mind, of less worth than success achieved the “boring” way (for example, with laborious work as a lawyer, a dentist, a ski instructor, a pilot, a hairdresser, or a consultant). Yes, looking at alternative paths from the outside is a difficult task, looking at them from the inside an almost impossible task. Your brain will do everything to convince you that your success is warranted—no matter how risky your dealings are—and will obscure any thought of paths other than the one you are on. 

Why Attractive People Climb the Career Ladder More Quickly Halo Effect

Cisco, the Silicon Valley firm, was once a darling of the new economy. Business journalists gushed about its success in every discipline: its wonderful customer service, perfect strategy, skillful acquisitions, unique corporate culture, and charismatic CEO. In March 2000, it was the most valuable company in the world.

When Cisco’s stock plummeted 80 percent the following year, the journalists changed their tune. Suddenly the company’s competitive advantages were reframed as destructive shortcomings: poor customer service, a woolly strategy, clumsy acquisitions, a lame corporate culture, and an insipid CEO. All this—and yet neither the strategy nor the CEO had changed. What had changed, in the wake of the dot-com crash, was demand for Cisco’s product—and that was through no fault of the firm.

The halo effect occurs when a single aspect dazzles us and affects how we see the full picture. In the case of Cisco, its halo shone particularly bright. Journalists were astounded by its stock prices and assumed the entire business was just as brilliant—without closer investigation.

The halo effect always works the same way: We take a simple-to-obtain or remarkable fact or detail, such as a company’s financial situation, and extrapolate conclusions from there that are harder to nail down, such as the merit of its management or the feasibility of its strategy. We often ascribe success and superiority where little is due, such as when we favor products from a manufacturer simply because of its good reputation. Another example of the halo effect: We believe that CEOs who are successful in one industry will thrive in any sector—and furthermore that they are heroes in their private lives, too.

The psychologist Edward Lee Thorndike discovered the halo effect nearly one hundred years ago. His conclusion was that a single quality (e.g., beauty, social status, age) produces a positive or negative impression that outshines everything else, and the overall effect is disproportionate. Beauty is the best-studied example. Dozens of studies have shown that we automatically regard good-looking people as more pleasant, honest, and intelligent. Attractive people also have it easier in their professional lives—and that has nothing to do with the myth of (women) “sleeping their way to the top.” The effect can even be detected in schools, where teachers unconsciously give good-looking students better grades.

Advertising has found an ally in the halo effect: Just look at the number of celebrities smiling at us from TV ads, billboards, and magazines. What makes a professional tennis player like Roger Federer a coffee machine expert is still open for debate, but this hasn’t detracted from the success of the campaign. We are so used to seeing celebrities promoting arbitrary products that we never stop to consider why their support should be of any importance to us. But this is exactly the sneaky part of the halo effect: It works on a subconscious level. All that needs to register is the attractive face, dream lifestyle—and that product.

Sticking with negative effects, the halo effect can lead to great injustice and even stereotyping when nationality, gender, or race becomes the all-encompassing feature. One need be neither racist nor sexist to fall victim to this. The halo effect clouds our view, just as it does journalists, educators, and consumers.

Occasionally, this effect has pleasant consequences—at least in the short term. Have you ever been head over heels in love? If so, you know how flawless a person can appear. Your Mr. or Ms. Perfect seems to be the whole package: attractive, intelligent, likable, and warm. Even when your friends might point out obvious failings, you see nothing but endearing quirks.

The halo effect obstructs our view of true characteristics. To counteract this, go beyond face value. Factor out the most striking features. World-class orchestras achieve this by making candidates play behind a screen, so that sex, race, age, and appearance play no part in their decision. To business journalists I warmly recommend judging a company by something other than its easily obtainable quarterly figures (the stock market already delivers that). Dig deeper. Invest the time to do serious research. What emerges is not always pretty, but almost always educational. 

Why You Shouldn’t Believe in the Stork False Causality

For the inhabitants of the Hebrides, a chain of islands north of Scotland, head lice were a part of life. If the lice left their host, he became sick and feverish. Therefore, to dispel the fever, sick people had lice put in their hair intentionally. There was a method to their madness: As soon as the lice had settled in again, the patient improved.

In one city, a study revealed that in each blaze, the more firefighters called out to fight it, the greater the fire damage. The mayor imposed an immediate hiring freeze and cut the firefighting budget.

Both stories come from German physics professors Hans-Peter Beck-Bornholdt and Hans-Hermann Dubben. In their book (unfortunately there is no English version), they illustrate the muddling of cause and effect. If the lice leave the invalid, it is because he has a fever and they simply get hot feet. When the fever breaks, they return. And the bigger the blaze, the more firefighters were called out—not, of course, vice versa.

                  We may smirk at these stories, but false causality leads us astray practically every day. Consider the headline: “Employee Motivation Leads to Higher Corporate Profits.” Does it? Maybe people are simply more motivated because the company is doing well. Another headline touts that the more women on a corporate board, the more profitable the firm is. But is that really how it works? Or do highly profitable firms simply tend to recruit more women to their boards? Business book authors and consultants often operate with similar false—or at least fuzzy—causalities.

In the ’90s, there was no one holier than the then-head of the Federal Reserve, Alan Greenspan. His obscure remarks gave monetary policy the aura of a secret science that kept the country on the secure path of prosperity. Politicians, journalists, and business leaders idolized Greenspan. Today we know that these commentators fell victim to false causality. America’s symbiosis with China, the globe’s low-cost producer and eager buyer of U.S. debt, played a much more important role. In other words, Greenspan was simply lucky that the economy did so well during his tenure.

A further example: Scientists found that long periods in the hospital affected patients adversely. This was music to health insurers’ ears, who, of course, are keen to make stays as brief as possible. But, clearly, patients who are discharged immediately are healthier than those who must stay on for treatment. This hardly makes long stays detrimental.

Or, take this headline: “Fact: Women Who Use Shampoo XYZ Every Day Have Stronger Hair.” Though the context can be substantiated scientifically, this statement says very little—least of all, that the shampoo makes your hair stronger. It might simply be the other way round: Women with strong hair tend to use shampoo XYZ—and perhaps that’s because it says “especially for thick hair” on the bottle.

            Recently I read that students get better grades at school if their homes contain a lot of books. This study was surely a shot in the arm for booksellers, but it is another fine example of false causality. The simple truth is that educated parents tend to value their children’s education more than uneducated ones do. Plus, educated parents often have more books at home. In short, a dust-covered copy of War and Peace alone isn’t going to influence anyone’s grades; what counts is parents’ education levels, as well as their genes.

The best example of false causality was the supposed relationship between the birth rate and the numbers of stork pairs in Germany. Both were in decline, and if you plot them on a graph, the two lines of development from 1965 to 1987 appeared almost identical. Does this mean the stork actually does bring babies? Obviously not, since this was a purely coincidental correlation.

In conclusion: Correlation is not causality. Take a closer look at linked events: Sometimes what is presented as the cause turns out to be the effect, and vice versa. And sometimes there is no link at all—just like with the storks and babies.

You Like Me, You Really, Really Like Me Liking Bias

Kevin has just bought two boxes of fine Margaux. He rarely drinks wine—not even Bordeaux—but the sales assistant was so nice, not fake or pushy, just really likable. So he bought them.

Joe Girard is considered the most successful car salesman in the world. His tip for success: “There’s nothing more effective in selling anything than getting the customer to believe, really believe, that you like him and care about him.” Girard doesn’t just talk the talk: His secret weapon is sending a card to his customers each month. Just one sentence salutes them: “I like you.”

The liking bias is startlingly simple to understand and yet we continually fall prey to it. It means this: The more we like someone, the more inclined we are to buy from or help that person. Still, the question remains: What does “likable” even mean? According to research, we see people as pleasant, if (a) they are outwardly attractive, (b) they are similar to us in terms of origin, personality, or interests, and (c) they like us. Consequently, advertising is full of attractive people. Ugly people seem unfriendly and don’t even make it into the background (see A). In addition to engaging super-attractive types, advertising also employs “people like you and me” (see B)—those who are similar in appearance, accent, or background. In short, the more similar, the better. Mirroring is a standard technique in sales to get exactly this effect. Here, the salesperson tries to copy the gestures, language, and facial expressions of his prospective client. If the buyer speaks very slowly and quietly, often scratching his head, it makes sense for the seller to speak slowly and quietly, and to scratch his head now and then, too. That makes him likable in the eyes of the buyer, and thus a business deal is more likely. Finally, it’s not unheard of for advertisers to pay us compliments: How many times have you bought something “because you’re worth it”? Here factor C comes into play: We find people appealing if they like us. Compliments work wonders, even if they ring hollow as a drum.

So-called multilevel marketing (selling through personal networks) works solely because of the liking bias. Though there are excellent plastic containers in the supermarket for a quarter of the price, Tupperware generates annual revenues of $2 billion. Why? The friends who hold the Tupperware parties meet the second and third congeniality standard perfectly.

Aid agencies employ the liking bias to great effect. Their campaigns use beaming children or women almost exclusively. Never will you see a stone-faced, wounded guerrilla fighter staring at you from billboards—even though he also needs your support. Conservation organizations also carefully select who gets the starring role in their advertisements. Have you ever seen a World Wildlife Fund brochure filled with spiders, worms, algae, or bacteria? They are perhaps just as endangered as pandas, gorillas, koalas, and seals—and even more important for the ecosystem. But we feel nothing for them. The more human a creature acts, the more similar it is to us, the more we like it. The bone skipper fly is extinct? Too bad.

Politicians, too, are maestros of the liking bias. Depending on the makeup and interests of an audience, they emphasize different topics, such as residential area, social background, or economic issues. And they flatter us: Each potential voter is made to feel like an indispensable member of the team: “Your vote counts!” Of course your vote counts, but only by the tiniest of fractions, bordering on the irrelevant.

A friend who deals in oil pumps told me how he once closed an eight-figure deal for a pipeline in Russia. “Bribery?” I inquired. He shook his head. “We were chatting, and suddenly we got on to the topic of sailing. It turned out that both of us—the buyer and me—were die-hard 470 dinghy fans. From that moment on, he liked me; I was a friend. So the deal was sealed. Amiability works better than bribery.”

So, if you are a salesperson, make buyers think you like them, even if this means outright flattery. And if you are a consumer, always judge a product independent of who is selling it. Banish the salespeople from your mind or, rather, pretend you don’t like them. 

Why Speed Demons Appear to Be Safer Drivers Intention-to-Treat Error

You’ll find it hard to believe, but speed demons drive more safely than so-called careful drivers. Why? Well, consider this: The distance from Miami to West Palm Beach is around seventy-five miles. Drivers who cover the distance in an hour or less we’ll categorize as “reckless drivers” because they’re traveling at an average of 75 mph or more. All others we put into the group of careful drivers. Which group experiences fewer accidents? Without a doubt, it is the “reckless drivers.” They all completed the journey in less than an hour, so they could not have been involved in any accidents. This automatically puts all drivers who end up in accidents in the slower drivers’ category. This example illustrates a treacherous fallacy, the so-called intention-to-treat error. Unfortunately, there is no catchier term for it.

This might sound to you like the survivorship bias (chapter 1), but it’s different. In the survivorship bias you see only the survivors, not the failed projects or cars involved in accidents. In the intention-to-treat error, the failed projects or cars with accidents prominently show up, just in the wrong category.

A banker showed me an interesting study recently. Its conclusion: Companies with debt on their balance sheets are significantly more profitable than firms with no debt (equity only). The banker vehemently insisted that every company should borrow at will, and, of course, his bank is the best place to do it. I examined the study more closely. How could that be? Indeed, from one thousand randomly selected firms, those with large loans displayed higher returns not only on their equity but also on their total capital. They were in every respect more successful than the independently financed firms. Then the penny dropped: Unprofitable companies don’t get corporate loans. Thus, they form part of the “equity-only” group. The other firms that make up this set have bigger cash cushions, stay afloat longer, and, no matter how sickly they are, remain part of the study. On the other side, firms that have borrowed a lot go bankrupt more quickly. Once they cannot pay back the interest, the bank takes over, and the companies are sold off—thus disappearing from the sample. The ones that remain in the “debt group” are relatively healthy, regardless of how much debt they have amassed on their balance sheets.

If you’re thinking, “Okay, got it,” watch out. The intention-to-treat error is not easy to recognize. A fictional example from medicine: A pharmaceutical company has developed a new drug to fight heart disease. A study “proves” that it significantly reduces patients’ mortality rates. The data speaks for itself: Among patients who have taken the drug regularly, the five-year mortality rate is 15 percent. For those who have swallowed placebo pills, it is about the same, indicating that the pill doesn’t work. However—and this is crucial—the mortality rate of patients who have taken the drug at irregular intervals is 30 percent—twice as high!

       A big difference between regular and irregular intake. So, the pill is a complete success. Or is it?

Here’s the snag: The pill is probably not the decisive factor; rather, it is the patients’ behavior. Perhaps patients discontinued the pill following severe side effects and thus landed in the “irregular intake” category. Maybe they were so ill that there was no way to continue it on a regular basis. Either way, only relatively healthy patients remain in the “regular” group, which makes the drug look a lot more effective than it really is. The really sick patients who, for this very reason, couldn’t take the drug on a regular basis ended up populating the “irregular intake” group.

In reputable studies, medical researchers evaluate the data of all patients whom they originally intend to treat (hence the title); it doesn’t matter if they take part in the trial or they drop out. Unfortunately, many studies flout this rule. Whether this is intentional or accidental remains to be seen. Therefore, be on your guard: Always check whether test subjects—drivers who end up in accidents, bankrupt companies, critically ill patients—have, for whatever reason, vanished from the sample. If so, you should file the study where it belongs: in the trash can. 

Why You Shouldn’t Read the News News Illusion

Earthquake in Sumatra. Plane crash in Russia. Man holds daughter captive in cellar for thirty years. Heidi Klum separates from Seal. Record salaries at Bank of America. Attack in Pakistan. Resignation of Mali’s president. New world record in shot put.

Do you really need to know all these things?

We are incredibly well informed, yet we know incredibly little. Why? Because two centuries ago, we invented a toxic form of knowledge called “news.” News is to the mind what sugar is to the body: appetizing, easy to digest—and highly destructive in the long run.

Three years ago, I began an experiment. I stopped reading and listening to the news. I canceled all newspaper and magazine subscriptions. Television and radio were disposed of. I deleted the news apps from my iPhone. I didn’t touch a single free newspaper and deliberately looked the other way when someone on a plane tried to offer me any such reading material. The first weeks were hard. Very hard. I was constantly afraid of missing something. But after a while, I had a new outlook. The result after three years: clearer thoughts, more valuable insights, better decisions, and much more time. And the best thing? I haven’t missed anything important. My social network—not Facebook, the one that exists in the real world consisting of flesh-and-blood friends and acquaintances—works as a news filter and keeps me in the loop.

A dozen reasons exist to give news a wide berth. Here are the top three: First, our brains react disproportionately to different types of information. Scandalous, shocking, people-based, loud, fast-changing details all stimulate us, whereas abstract, complex, and unprocessed information sedates us. News producers capitalize on this. Gripping stories, garish images, and sensational “facts” capture our attention. Recall for a moment their business models: Advertisers buy space and thus finance the news circus on the condition that their ads will be seen. The result: Everything subtle, complex, abstract, and profound must be systematically filtered out, even though such stories are much more relevant to our lives and to our understanding of the world. As a result of news consumption, we walk around with a distorted mental map of the risks and threats we actually face.

Second, news is irrelevant. In the past twelve months, you have probably consumed about ten thousand news snippets—perhaps as many as thirty per day. Be very honest: Name one of them, just one that helped you make a better decision—for your life, your career, or your business—compared with not having this piece of news. No one I have asked has been able to name more than two useful news stories—out of ten thousand. A miserable result. News organizations assert that their information gives you a competitive advantage. Too many fall for this. In reality, news consumption represents a competitive disadvantage. If news really helped people advance, journalists would be at the top of the income pyramid. They aren’t—quite the opposite.

Third, news is a waste of time. An average human being squanders half a day each week on reading about current affairs. In global terms, this is an immense loss of productivity. Take the 2008 terror attacks in Mumbai. Out of sheer thirst for recognition, terrorists murdered two hundred people. Let’s say a billion people devoted an hour of their time to following the aftermath: They viewed the minute-by-minute updates and listened to the inane chatter of a few “experts” and “commentators.” This is a very realistic “guesstimate” since India has more than a billion inhabitants. Thus our conservative calculation: One billion people multiplied by an hour’s distraction equals one billion hours of work stoppage. If we convert this, we learn that news consumption wasted around two thousand lives—ten times more than the attack. A sarcastic but accurate observation.

I would predict that turning your back on news will benefit you as much as purging any of the other ninety-eight flaws we have covered in the pages of this book. Kick the habit—completely. Instead, read long background articles and books. Yes, nothing beats books for understanding the world. 

Curb Your Enthusiasm Winner’s Curse

Texas in the 1950s. A piece of land is being auctioned. Ten oil companies are vying for it. Each has made an estimate of how much the site is worth. The lowest assessment is $10 million, and the highest is $100 million. The higher the price climbs during the auction, the more firms exit the bidding. Finally, one company submits the highest bid and wins. Champagne corks pop.

The winner’s curse suggests that the winner of an auction often turns out to be the loser. Industry analysts have noted that companies that regularly emerged as winning bidders from these oil field auctions systematically paid too much and years later went under. This is understandable. If the estimates vary between $10 million and $100 million, the actual value most likely lies somewhere in the middle. The highest bid at an auction is often much too high—unless these bidders have critical information others are not privy to. This was not the case in Texas. The oil managers actually celebrated a Pyrrhic victory.

         Today, this phenomenon affects us all. From eBay to Groupon to Google AdWords, prices are consistently set by auction. Bidding wars for cell-phone frequencies drive telecom companies to the brink of bankruptcy. Airports rent out their commercial spaces to the highest bidder. And if Walmart plans to introduce a new detergent and asks for tenders from five suppliers, that’s nothing more than an auction—with the risk of the winner’s curse.

The auctioning of everyday life has now reached tradesmen, too, thanks to the Internet. When my walls needed a new lick of paint, instead of tracking down the handiest painter, I advertised the job online. Thirty painters from more than three hundred miles away competed for the job. The best offer was so low that, out of compassion, I could not accept it—to spare the poor painter the winner’s curse.

Initial public offerings (IPOs) are also examples of auctions. And when companies buy other companies—the infamous mergers and acquisitions—the winner’s curse is present more often than not. Astoundingly, more than half of all acquisitions destroy value, according to a McKinsey study.

So why do we fall victim to the winner’s curse? First, the real value of many things is uncertain. Additionally, the more interested parties, the greater the likelihood of an overly enthusiastic bid. Second, we want to outdo competitors. A friend owns a micro-antenna factory and told me about the cutthroat bidding war that Apple instigated during the development of the iPhone. Everyone wants to be the official supplier to Apple, even though whoever gets the contract is likely to lose money.

So how much would you pay for $100? Imagine that you and an opponent are invited to take part in such an auction. The rules: Whoever makes the highest offer gets the $100 bill, and—most important—when this happens, both bidders have to pay their final offer. How high will you go? From your perspective, it makes sense to pay $20, $30, or $40. Your opponent does the same. Even $99 seems like a reasonable offer for a $100 bill. Now, your competitor offers $100. If this remains the highest bid, he will come away breaking even (paying $100 for $100), whereas you will simply have to cough up $99. So you continue to bid. At $110, you have a guaranteed loss of $10, but your opponent would have to shell out $109 (his last bid). So he will continue playing. When do you stop? When will your competitor give up? Try it out with friends.

In conclusion: Accept this piece of wisdom about auctions from Warren Buffett: “Don’t go.” If you happen to work in an industry where they are inevitable, set a maximum price and deduct 20 percent from this to offset the winner’s curse. Write this number on a piece of paper and don’t go a cent over it. 

Why Teams Are Lazy Social Loafing

Maximilian Ringelmann, a French engineer, studied the performance of horses in 1913. He concluded that the power of two animals pulling a coach did not equal twice the power of a single horse. Surprised by this result, he extended his research to humans. He had several men pull a rope and measured the force applied by each individual. On average, if two people were pulling together, each invested just 93 percent of his individual strength, when three pulled together, it was 85 percent, and with eight people, just 49 percent.

Science calls this the social loafing effect. It occurs when individual performance is not directly visible; it blends into the group effort. It occurs among rowers, but not in relay races, because here, individual contributions are evident. Social loafing is rational behavior: Why invest all of your energy when half will do—especially when this little shortcut goes unnoticed? Quite simply, social loafing is a form of cheating of which we are all guilty even if it takes place unconsciously, just as it does with the horses.

When people work together, individual performances decrease. This isn’t surprising. What is noteworthy, however, is that our input doesn’t grind to a complete halt. So what stops us from putting our feet up and letting the others do the hard work? The consequences. Zero performance would be noticed, and it brings with it weighty punishments, such as exclusion from the group or vilification. Evolution has led us to develop many fine-tuned senses, including how much idleness we can get away with and how to recognize it in others.

Social loafing does not occur solely in physical performance. We slack off mentally, too. For example, in meetings, the larger the team, the weaker our individual participation. However, once a certain number of participants are involved, our performance plateaus. Whether the group consists of twenty or one hundred people is not important—maximum inertia has been achieved.

One question remains: Who came up with the much-vaunted idea that teams achieve more than individual workers? Maybe the Japanese. Thirty years ago, they flooded global markets with their products. Business economists looked more closely at the industrial miracle and saw that Japanese factories were organized into teams. This model was copied—with mixed success. What worked very well in Japan could not be replicated with the Americans and Europeans—perhaps because social loafing rarely happens there. In the West, teams function better if and only if they are small and consist of diverse, specialized people. This makes sense because, within such groups, individual performances can be traced back to each specialist.

Social loafing has interesting implications. In groups, we tend to hold back not only in terms of participation but also in terms of accountability. Nobody wants to take the rap for the misdeeds or poor decisions of the whole group. A glaring example is the prosecution of the Nazis at the Nuremberg trials or, less controversially, any board or management team. We hide behind team decisions. The technical term for this is “diffusion of responsibility.” For the same reason, teams tend to take bigger risks than their members would take on their own. The individual group members reason that they are not the only ones who will be blamed if things go wrong. This effect is called “risky shift” and is especially hazardous among company and pension-fund strategists, where billions are at stake, or in the Defense Department, where groups decide on the use of nuclear weapons.

In conclusion: People behave differently in groups than when alone (otherwise there would be no groups). The disadvantages of groups can be mitigated by making individual performances as visible as possible. Long live meritocracy! Long live the performance society! 

Why Evil Is More Striking Than Good Loss Aversion

On a scale of 1 to 10, how good do you feel today? Now consider what would bring you up to a perfect 10. That vacation in the Caribbean you’ve always dreamed of? A step up the career ladder, maybe? Next question: What would make you drop down by the same number of points? Paralysis, Alzheimer’s, cancer, depression, war, hunger, torture, financial ruin, damage to your reputation, losing your best friend, your children getting kidnapped, blindness, death? The long list of possibilities makes us realize just how many obstacles to happiness exist; in short, there are more bad things than good—and they are far more consequential.

In our evolutionary past, this was even more the case. One stupid mistake and you were dead. Everything could lead to your rapid departure from the game of life—carelessness on the hunt, an inflamed tendon, exclusion from the group, and so on. People who were reckless or gung ho died before they could pass their genes on to the next generation. Those who remained, the cautious, survived. We are their descendants.

So, no wonder we fear loss more than we value gain. Losing $100 costs you a greater amount of happiness than the delight you would feel if I gave you $100. In fact, it has been proven that, emotionally, a loss “weighs” about twice that of a similar gain. Social scientists call this loss aversion.

For this reason, if you want to convince someone about something, don’t focus on the advantages; instead highlight how it helps them dodge the disadvantages. Here is an example from a campaign promoting breast self-examination (BSE): Two different leaflets were handed out to women. Pamphlet A urged: “Research shows that women who do BSE have an increased chance of finding a tumor in the early, more treatable state of the disease.” Pamphlet B said: Research shows that women who do not do BSE have a decreased chance of finding a tumor in the early, more treatable state of the disease.” The study revealed that pamphlet B (written in a “loss frame”) generated significantly more awareness and BSE behavior than pamphlet A (written in a “gain frame”).

The fear of losing something motivates people more than the prospect of gaining something of equal value. Suppose your business is home insulation. The most effective way of encouraging customers to purchase your product is to tell them how much money they are losing without insulation—as opposed to how much money they would save with it, even though the amount is exactly the same.

This type of aversion is also found on the stock market, where investors tend to simply ignore losses on paper. After all, an unrealized loss isn’t as painful as a realized one. So they sit on the stock, even if the chance of recovery is small and the probability of further decline is large. I once met a man, a multimillionaire, who was terribly upset because he had lost a $100 bill. What a waste of emotion! I pointed out that the value of his portfolio fluctuated by at least $100 every second.

Management gurus push employees in large companies to be bolder and more entrepreneurial. The reality is: Employees tend to be risk averse. From their perspective, this aversion makes perfect sense: Why risk something that brings them, at best, a nice bonus, and at worst, a pink slip? The downside is larger than the upside. In almost all companies and situations, safeguarding your career trumps any potential reward. So, if you’ve been scratching your head about the lack of risk taking among your employees, you now know why. (However, if employees do take big risks, it is often when they can hide behind group decisions. Learn more in chapter 33 on social loafing.)

We can’t fight it: Evil is more powerful and more plentiful than good. We are more sensitive to negative than to positive things. On the street, scary faces stand out more than smiling ones. We remember bad behavior longer than good—except, of course, when it comes to ourselves. 

How to Relieve People of Their Millions Induction

A farmer feeds a goose. At first, the shy animal is hesitant, wondering: “What’s going on here? Why is he feeding me?” This continues for a few more weeks until, eventually, the goose’s skepticism gives way. After a few months, the goose is sure: “The farmer has my best interests at heart.” Each additional day’s feeding confirms this. Fully convinced of the man’s benevolence, the goose is amazed when he takes it out of its enclosure on Christmas Day—and slaughters it. The Christmas goose fell victim to inductive thinking, the inclination to draw universal certainties from individual observations. Philosopher David Hume used this allegory back in the eighteenth century to warn of its pitfalls. However, it’s not just geese that are susceptible to it.

An investor buys shares in stock X. The share price rockets, and at first he is wary. “Probably a bubble,” he suspects. As the stock continues to rise, even after months, his apprehension turns into excitement: “This stock may never come down,” especially since every day this is the case. After half a year, he invests his life savings in it, turning a blind eye to the huge cluster risk this poses. Later, the man will pay for his foolish investment. He has fallen hook, line, and sinker for induction.

Inductive thinking doesn’t have to be a road to ruin, though. In fact, you can make a fortune with it by sending a few e-mails. Here’s how: Put together two stock market forecasts—one predicting that prices will rise next month and one warning of a drop. Send the first mail to fifty thousand people and the second mail to a different set of fifty thousand. Suppose that after one month, the indices have fallen. Now you can send another e-mail, but this time only to the fifty thousand people who received a correct prediction. These fifty thousand you divide into two groups: The first half learns that prices will increase next month, and the second half discovers they will fall. Continue doing this. After ten months, around a hundred people will remain, all of whom you have advised impeccably. From their perspective, you are a genius. You have proven that you are truly in possession of prophetic powers. Some of these people will trust you with their money. Take it and start a new life in Brazil.

However, it’s not just naive strangers who get deceived in this way; we constantly trick ourselves, too. For example, people who are rarely ill consider themselves immortal. CEOs who announce increased profits in consecutive quarters deem themselves infallible—their employees and shareholders do, too. I once had a friend who was a base jumper. He jumped off cliffs, antennae, and buildings, pulling the rip cord only at the last minute. One day, I brought up how risky his chosen sport is. He replied quite matter-of-factly: “I’ve over a thousand jumps under my belt, and nothing has ever happened to me.” Two months later, he was dead. It happened when he jumped from a particularly dangerous ous cliff in South Africa. This single event was enough to eradicate a theory confirmed a thousand times over.

Inductive thinking can have devastating results. Yet we cannot do without it. We trust that, when we board a plane, aerodynamic laws will still be valid. We imagine that we will not be randomly beaten up on the street. We expect that our hearts will still be beating tomorrow. These are confidences without which we could not live, but we must remember that certainties are always provisional. As Benjamin Franklin said, “Nothing is certain but death and taxes.”

Induction seduces us and leads us to conclusions such as: “Mankind has always survived, so we will be able to tackle any future challenges, too.” Sounds good in theory, but what we fail to realize is that such a statement can only come from a species that has lasted until now. To assume that our existence to date is an indication of our future survival is a serious flaw in reasoning. Probably the most serious of all. 

Don’t Cling to Things Endowment Effect

The BMW gleamed in the parking lot of the used-car dealership. Although it had a few miles on the odometer, it looked in perfect condition. I know a little about used cars, and to me, it was worth around $40,000. However, the salesman was pushing for $50,000 and wouldn’t budge a dime. When he called the next week to say he would accept $40,000 after all, I went for it. The next day, I took it out for a spin and stopped at a gas station. The owner came out to admire the car—and proceeded to offer me $53,000 in cash on the spot. I politely declined. Only on the way home did I realize how ridiculous I was to have said no. Something that I considered worth $40,000 had passed into my possession and suddenly taken on a value of more than $53,000. If I were thinking purely rationally, I would have sold the car immediately. But, alas, I’d fallen under the influence of the endowment effect. We consider things to be more valuable the moment we own them. In other words, if we are selling something, we charge more for it than what we ourselves would be willing to spend.

To probe this, psychologist Dan Ariely conducted the following experiment: In one of his classes, he raffled tickets to a major basketball game, then polled the students to see how much they thought the tickets were worth. The empty-handed students estimated around $170, whereas the winning students would not sell it below an average of $2,400. The simple fact of ownership makes us add zeros to the selling price.

In real estate, the endowment effect is palpable. Sellers become emotionally attached to their houses and thus systematically overestimate their value. They balk at the market price, expecting buyers to pay more—which is completely absurd since this excess is little more than sentimental value.

Richard Thaler performed an interesting classroom experiment at Cornell University to measure the endowment effect. He distributed coffee mugs to half of the students and told them they could either take the mug home or sell it at a price they could specify. The other half of the students who didn’t get a mug were asked how much they would be willing to pay for a mug. In other words, Thaler set up a market for coffee mugs. One would expect that roughly 50 percent of the students would be willing to trade—to either sell or buy a mug. But the result was much lower than that. Why? Because the average owner would not sell below $5.25, and the average buyer would not pay more than $2.25 for a mug.

We can safely say that we are better at collecting things than at casting them off. Not only does this explain why we fill our homes with junk, but also why lovers of stamps, watches, and pieces of art part with them so seldomly.

Amazingly, the endowment effect affects not only possession, but also near ownership. Auction houses like Christie’s and Sotheby’s thrive on this. A person who bids until the end of an auction gets the feeling that the object is practically theirs, thus increasing its value. The would-be owner is suddenly willing to pay much more than planned, and any withdrawal from the bidding is perceived as a loss—which defies all logic. In large auctions, such as those for mining rights or mobile radio frequencies, we often observe the winner’s curse: Here, the successful bidder turns out to be the economic loser when he gets caught up in the fervor and overbids. I’ll offer more insight on the winner’s curse in chapter 35.

There’s a similar effect in the job market. If you are applying for a job and don’t get a call back, you have every reason to be disappointed. However, if you make it to the final stages of the selection process and then receive the rejection, the disappointment can be much bigger—irrationally. Either you get the job or you don’t; nothing else should matter.

In conclusion: Don’t cling to things. Consider your property something that the “universe” (whatever you believe this to be) has bestowed to you temporarily. Keep in mind that it can recoup this (or more) in the blink of an eye. 

Curb Your Enthusiasm Winner’s Curse

Texas in the 1950s. A piece of land is being auctioned. Ten oil companies are vying for it. Each has made an estimate of how much the site is worth. The lowest assessment is $10 million, and the highest is $100 million. The higher the price climbs during the auction, the more firms exit the bidding. Finally, one company submits the highest bid and wins. Champagne corks pop.

The winner’s curse suggests that the winner of an auction often turns out to be the loser. Industry analysts have noted that companies that regularly emerged as winning bidders from these oil field auctions systematically paid too much and years later went under. This is understandable. If the estimates vary between $10 million and $100 million, the actual value most likely lies somewhere in the middle. The highest bid at an auction is often much too high—unless these bidders have critical information others are not privy to. This was not the case in Texas. The oil managers actually celebrated a Pyrrhic victory.

          Today, this phenomenon affects us all. From eBay to Groupon to Google AdWords, prices are consistently set by auction. Bidding wars for cell-phone frequencies drive telecom companies to the brink of bankruptcy. Airports rent out their commercial spaces to the highest bidder. And if Walmart plans to introduce a new detergent and asks for tenders from five suppliers, that’s nothing more than an auction—with the risk of the winner’s curse.

The auctioning of everyday life has now reached tradesmen, too, thanks to the Internet. When my walls needed a new lick of paint, instead of tracking down the handiest painter, I advertised the job online. Thirty painters from more than three hundred miles away competed for the job. The best offer was so low that, out of compassion, I could not accept it—to spare the poor painter the winner’s curse.

Initial public offerings (IPOs) are also examples of auctions. And when companies buy other companies—the infamous mergers and acquisitions—the winner’s curse are present more often than not. Astoundingly, more than half of all acquisitions destroy value, according to a McKinsey study.

So why do we fall victim to the winner’s curse? First, the real value of many things is uncertain. Additionally, the more interested parties, the greater the likelihood of an overly enthusiastic bid. Second, we want to outdo competitors. A friend owns a micro-antenna factory and told me about the cutthroat bidding war that Apple instigated during the development of the iPhone. Everyone wants to be the official supplier to Apple, even though whoever gets the contract is likely to lose money.

So how much would you pay for $100? Imagine that you and an opponent are invited to take part in such an auction. The rules: Whoever makes the highest offer gets the $100 bill, and—most important—when this happens, both bidders have to pay their final offer. How high will you go? From your perspective, it makes sense to pay $20, $30, or $40. Your opponent does the same. Even $99 seems like a reasonable offer for a $100 bill. Now, your competitor offers $100. If this remains the highest bid, he will come away breaking even (paying $100 for $100), whereas you will simply have to cough up $99. So you continue to bid. At $110, you have a guaranteed loss of $10, but your opponent would have to shell out $109 (his last bid). So he will continue playing. When do you stop? When will your competitor give up? Try it out with friends.

In conclusion: Accept this piece of wisdom about auctions from Warren Buffett: “Don’t go.” If you happen to work in an industry where they are inevitable, set a maximum price and deduct 20 percent from this to offset the winner’s curse. Write this number on a piece of paper and don’t go a cent over it.

Why the Last Cookie in the Jar Makes Your Mouth Water

Coffee at a friend’s house. We sat trying to make conversation while her three children grappled with one another on the floor. Suddenly I remembered that I had brought some glass marbles with me—a whole bag full. I spilled them out on the floor, in the hope that the little angels would play with them in peace. Far from it: A heated argument ensued. I didn’t understand what was happening until I looked more closely. Apparently, among the countless marbles, there was just one blue one, and the children scrambled for it. All the marbles were exactly the same size and shiny and bright. But the blue one had an advantage over the others—it was one of a kind. I had to laugh at how childish children are!

In August 2005, when I heard that Google would launch its own e-mail service, I was dead-set on getting an account. (In the end I did.) At the time, new accounts were very restricted and were given out only by invitation. This made me want one even more. But why? Certainly not because I needed another e-mail account (back then, I already had four), or because Gmail was better than the competition, but simply because not everyone had access to it. Looking back, I have to laugh at how childish adults are!

Rara stunt care, said the Romans. Rarely is valuable. In fact, the scarcity error is as old as mankind. My friend with the three children is a part-time real estate agent. Whenever she has an interested buyer who cannot decide, she calls and says: “A doctor from London saw the plot of land yesterday. He liked it a lot. What about you? Are you still interested?” The doctor from London—sometimes it’s a professor or a banker—is, of course, fictitious. The effect is very real, though: It causes prospects to see the opportunity disappearing before their eyes, so they act and close the deal. Why? This is the potential shortage of supply, yet again. Objectively, this situation is incomprehensible: Either the prospect wants the land for the set price or he does not—regardless of any doctors from London.

     To assess the quality of cookies, Professor Stephen Worchel split participants into two groups. The first group received an entire box of cookies, and the second group just two. In the end, the subjects with just two cookies rated the quality much higher than the first group did. The experiment was repeated several times and always showed the same result.

“Only while stocks last,” the ads alert. “Today only,” warn the posters. Gallery owners take advantage of the scarcity error by placing red “sold” dots under most of their paintings, transforming the remaining few works into rare items that must be snatched up quickly. We collect stamps, coins, vintage cars even when they serve no practical purpose. The post office doesn’t accept the old stamps, the banks don’t take old coins, and the vintage cars are no longer allowed on the road. These are all side issues; the attraction is that they are in short supply.

In one study, students were asked to arrange ten posters in order of attractiveness—with the agreement that afterward they could keep one poster as a reward for their participation. Five minutes later, they were told that the poster with the third-highest rating was no longer available. Then they were asked to judge all ten from scratch. The poster that was no longer available was suddenly classified as the most beautiful. In psychology, this phenomenon is called “reactance”: When we are deprived of an option, we suddenly deem it more attractive. It is a kind of act of defiance. It is also known as the “Romeo and Juliet effect”: Because the love between the tragic Shakespearean teenagers is forbidden, it knows no bounds. This yearning must not necessarily be in a romantic way. In the United States, student parties are often littered with desperately drunk teenagers. In Europe, where the age limit is eighteen, you don’t witness this type of behavior.

                    In conclusion: The typical response to scarcity is a lapse in clear thinking. Assess products and services solely on the basis of their price and benefits. It should be of no importance if an item is disappearing fast or if any doctors from London take an interest.

The Inevitability of Unlikely Events

At 7:15 p.m. on March 1, 1950, the fifteen members of the church choir in Beatrice, Nebraska, were scheduled to meet for rehearsal. For various reasons, they were all running late. The minister’s family was delayed because his wife still had to iron their daughter’s dress. One couple was held back when their car wouldn’t start. The pianist wanted to be there thirty minutes early, but he fell into a deep sleep after dinner. And so on. At 7:25 p.m., the church exploded. The blast was heard all around the village. It blew out the walls and sent the roof crashing to the ground. Miraculously, nobody was killed. The fire chief traced the explosion back to a gas leak, even though members of the choir were convinced they had received a sign from God. Hand of God or coincidence?

Something last week made me think of my old school friend, Andy, whom I hadn’t spoken to in a long time. Suddenly the phone rang. I picked it up, and, loand behold, it was Andy. “I must be telepathic!” I exclaimed excitedly. But telepathy or coincidence?

On October 5, 1990, the San Francisco Examiner reported that Intel would take its rival, AMD, to court. Intel found out that the company was planning to launch a computer chip named AM386, a term that clearly referred to Intel’s 386 chip. How Intel came upon the information is remarkable: By pure coincidence, both companies had hired someone named Mike Webb. Both men were staying in the same hotel in California and checked out on the same day. After they had left, the hotel accepted a package for Mike Webb at reception. It contained confidential documents about the AM386 chip, and the hotel mistakenly sent it to Mike Webb of Intel, who promptly forwarded the contents to the legal department.

How likely are stories like that? The Swiss psychiatrist C. G. Jung saw in them the work of an unknown force, which he called synchronicity. But how should a rationally minded thinker approach these accounts? Preferably with a piece of paper and a pencil. Consider the first case, the explosion of the church. Draw four boxes to represent each of the potential events. The first possibility is what actually took place: “choir delayed and church exploded.” But there are three other options: “choir delayed and church did not explode,” “choir on time and church exploded,” and “choir on time and church did not explode.” Estimate the frequencies of these events and write them in the corresponding box. Pay special attention to how often the last case has happened: Every day, millions of choirs gather for scheduled rehearsals and their churches don’t blow up. Suddenly, the story has lost its unimaginable quality. For all these millions of churches, it would be improbable if something like what happened in Beatrice, Nebraska, didn’t take place at least once a century. So, no hand of God. (And anyway, why would God want to blow a church to smithereens?)

                  Let’s apply the same thinking to the phone call. Keep in mind the many occasions when “Andy” thinks of you but doesn’t call; when you think of him and he doesn’t call; when you don’t think of him and he calls; when he doesn’t think of you and you call. . . . There is an almost infinite number of occasions when you don’t think of him and he doesn’t call. But since people spend about 90 percent of their time thinking about others, it is not unlikely that, eventually, two people will think of each other and one of them will pick up the phone. And it must not be just Andy: If you have a hundred other friends, the probability of this happening increases manifold.

We tend to stumble when estimating probabilities. If someone says “never,” I usually register this as a minuscule probability greater than zero since “never” cannot be compensated by a negative probability.

In sum: Let’s not get too excited. Improbable coincidences are precisely that: rare but very possible events. It’s not surprising when they finally happen. What would be more surprising is if they never came to be.