Opening Keynote address, TIE entrepreneurial summit, 2011 – Part 1

Dear Friends,

It is a matter of great pleasure and privilege for me to address such an august gathering as this. I would like to sincerely thank the organizers of TIE Entrepreneurial Summit 2011, for giving me this great opportunity to share some of my views, with the very successful entrepreneurs that have gathered here today.

I have always been fascinated by the complexity of human behavior, which I find some times very predictable, other times so irrational and many a times completely enigmatic. This fascination led me, at a very early stage in my career, to try my own little experiments to glean better insights into Human Behavior.

It was in the year 1965, when I was working as an Electrical Engineer, in a Hydroelectric Generating Station, that I tried my little experiment to figure out the scope and power of incentives.  I had, at that time, very little authority to offer any sort of monetary incentives and therefore thought of the idea of allowing the maintenance staff to leave home two hours early, if only they could complete their work on time with the condition that the quality of work needed to be better than usual. I was really happy to find that this simple incentive did turn out to be effective, as the staff not only did their work energetically, but did a very clean and good quality job not seen for many years in that place. But, the very next day, I was pulled up by my boss for not adhering to governmental norms that stipulated minimum number of hours of work per day, that every employee was expected to put in.

It was only in the year 2000, soon after my voluntary retirement from Infosys, that I really started probing deeply into the amazing research that was being carried out in the area of brain sciences. What excited me most was the extraordinary insights into human behavior that this research has been throwing up in the last two decades. Research work in Neuro-biology and the two disciplines of Neuro-economics and Behavioral Economics is of particular relevance to business professionals and bulk of my talk today, will focus on some interesting research findings in these areas.

Economists and brain scientists have come together and created a new discipline called “Neuroeconomics” that engages both neurobiology and economics.  Neuroeconomists are attempting to get better insights into what happens in the human brain when we are involved in economic decision-making.  Neuroeconomists use an array of cutting-edge technology tools like Functional Magnetic Resonance Imaging, Positron Emission Tomography, Multichannel Electroencephalography, Near Infrared Spectroscopic Imaging etc. to study and understand the neurological underpinnings of decision-making.

Scientists have been questioning, for many years, the standard economic models of human behavior that anchor around the three traits of unbounded rationality, unbounded willpower and unbounded selfishness. Behavioral Economists have challenged this unbounded nature of human rationality, willpower and self-interest and have successfully demonstrated that these boundaries are broken by social, cognitive and emotional factors which play a significant role in economic decisions of both individuals and institutions.

The field of Behavioral Economics has been gaining immense importance as can be gauged from the following facts. Cass Sunstein one of the authors of the best selling Behavioral Economics book called “Nudge”, currently runs the Office of Information and Regulatory Affairs for Barack Obama, and his co-author Richard Thaler has been advising Britain’s David Cameron’s new Behavioral Insight Team, based in the Cabinet Office.

If you need any further proof, let me quote from the article  “Applying Behavioral Economics to Drive Growth and Profitability” published by Gallup Consulting.

Gallup says

“To make sense of how employees and customers behave, leaders must first begin to understand human nature and will need to accept that human beings do not always act in rational ways.

Taking a cue from behavioral economics, scientists at Gallup developed a method to measure — reliably and accurately — the emotional connections between customers and the organizations that serve them. Our research has also sought to demonstrate the linkages between the measure of customer engagement and crucial business performance metrics like customer retention, cross-sell, share of wallet, frequency of purchase, profitability and relationship growth.”

Ladies and Gentlemen,

While brain research on human behavior covers a very large canvas, I will restrict my talk to two broad topics. First, I will take you through the findings of brain research that clearly brings out the critical role that fairness and equity play when you attempt to emotionally engage your people, be it your employees or be it your customers. Then, I will introduce you to the very intriguing and interesting range of irrational behaviors that we all exhibit and many of these behaviors, incidentally happen without our explicit awareness. I will also highlight some interesting manifestations of human biases, particularly those that drive customer behavior, which I believe, as enterprising business professionals, you have a great potential to exploit.

If you just look around you and try to observe, you cannot but notice the ubiquitous presence of unfairness in a variety of manifestations with all its devastating effects. Political clashes by and large tend to be driven by fairness issues. If you turn on the news channel on TV you are immediately confronted with passionate and violent mass uprisings in one country or another against unfair treatment meted out to them. Newspapers and magazines are replete with all sorts of conflicts and violence mainly anchored on feeling of unfairness.

It is pertinent here to point out that even very mundane situations of unfairness can generate strong emotions in us. The feeling, for example, of being “taken advantage of” by a taxi driver taking a longer route, can spoil an otherwise great day, despite the fact that the money involved is relatively small. In these emotional situations, it is the principle that counts. It is therefore not surprising that some people spend enormous sums of money to “right the wrongs” in court, with no obvious economic advantage other than “justice”.  We, as human beings, ladies and gentlemen, crave for fairness, and there are enough examples of people who risk their life savings and even their lives to obtain their perceived fairness.

Prof Golnaz Tabibnia of Carnegie Mellon University who has done extensive research on fairness has an explanation. He says that the tendency to resist and fight against unfair outcomes is some thing that is deeply rooted in all human beings.

Neuroeconomics experiments endorse this view that the human brain is tuned to aggressively punish those who violate fairness norms.

Let me first take you through the now famous Ultimatum Game, which for the first time clearly and conclusively established that the brain is hardwired to handle some economic problems through emotion rather than number crunching and also showed that human brains respond with special emotional vehemence to social cheating.

In the Ultimatum Game, two people are involved in an economic transaction over a resource of value to both, let us say $1000 of cash. In this game, only one person, let us call him the proposer, controls this cash of $1000. The structure of the game is such that, the proposer will offer some portion of this cash to the other person and If the specific offer is accepted by the responder, then both people get to keep their portions. On the other hand, If the offer is rejected, then both proposer and responder get nothing.

Let us analyze this game from the traditional perspective of the rational economic man, which holds that a normal person ranks potential outcomes and takes decisions, that will “maximize some utility function”—in this case, taking as much of the $1000 cash as possible. From this economic perspective, the proposer should make the smallest offer that he believes the responder is likely to accept, trying to maximize the amount of cash that will remain with him. The responder should accept whatever offer he receives, simply because he will then at least get whatever the proposer has offered. On the other hand, thinking that the offer is unfair, if he rejects the offer, he gets nothing.

Yet the results of this Ultimatum Game tell another story. It is found that if the offer is not at least half of the resource, the responder, most of the times, rejects the offer, even though by doing so he ends up with nothing.

Alan Sanfey, and his colleagues at Princeton University examined the Ultimatum Game with 19 subjects in the role of responders and used fMRI to observe their brain activity. They found that when unfair offers, defined as those of less than half the resource, were made, responders often rejected them.

As they did so, the area of their brains associated with negative emotional states, the bilateral anterior insula, rather than those associated with complex cognition, the dorsolateral prefrontal cortex were most active. The more the offer deviated from what is considered fair, the more active was the emotional part of the brain when such an offer was rejected. Anger at being treated unfairly by other players appeared to override rational economic reasoning. Interestingly, in the minority of cases, when the unfair offers was still accepted, the reasoning part of the brain was most active.

Sanfey and his team took their experiment one step further. They had the same subjects play the Ultimatum Game against a computer that did exactly what the proposing human partner did. In a testament to the remarkable fine-scale social distinctions that we humans make, Sanfey and his colleagues found that the responders were more likely to accept an unfair offer from a computer than from a human partner, and activation of emotional brain was lower when unfair offers were made by the computer. In other words, the responders were much more likely to view an unfair offer from another human as a violation of social norms, and hence responded emotionally.

The importance of fairness was forcefully driven home to me when I was a youngster who just took over as head of electrical dept of a sugar factory way back in 1967. It was less than two weeks since I took my new job and found my small office fully surrounded by a large contingent of slogan shouting workers, called Gherao those days, and their leader walked in to my office. He first tried to calm my nerves saying that I need not be alarmed by the presence of large number of workers. He went on to advise me that as I was new to the factory and was unaware of the trade union rivalries, he wished to update me on my immediate supervisor who was a senior member of INTUC which was a rival to his own trade union AITUC. He claimed that the worker that I took to task the previous day, based on the biased supervisor’s words, belonged to the supervisor’s rival union. His parting advice was that I should verify the facts a little more diligently in future before taking any action, to avoid getting caught in cross trade union politics.

It was a sane advice, even though it came with a pointed gun. It forced me to investigate with lot more thoroughness any issue, before deciding on the action to be taken. More importantly, it encouraged me to embrace fairness, equity and transparency as critical values in all my future decision-making processes as this had the great advantage of freeing me from worrying about the affiliations of the affected constituents. The simple logic was that “what is fair is fair” independent of who the participants were. Adherence to these principles has worked very well for me not only in that factory but in all my later experiences. The factory, during my stay had experienced labor strikes, lock outs and lot of labor unrest. The gratification for me, however, was that when I left the organization, I had the unique distinction of having commanded respect from all employees independent of their affiliations.

Many years later, I had the extra-ordinary privilege of steering the Human Capital Management strategies at Infosys Technologies for better part of the first twenty years of its growth period. Justifying the Infosys tag line “Powered by Intellect and Driven by Values” put an enormous responsibility on all of us at Infosys, to build high capability human resource teams and concurrently develop and nurture a value-driven organization culture.

My own cursory understanding of human nature and behavior drove many of my HR initiatives at Infosys. My earlier experiences had fully convinced me that in any organization, perceived unfairness could strongly demotivate employees. I must admit, however, that I was not aware at that time, of the research finding that when people perceive that they might compare unfavorably with someone else, the evolutionary threat response kicks in, releasing cortisol and other stress-related hormones. I was, however, convinced that perceptions of unfairness among employees can be best mitigated by making significant improvements in transparency levels, by ensuring open and frequent communications and by deeply engaging employees in various decision making processes. Accordingly, I made it a point to visit all Infosys campuses in April every year, which happened to be the annual pay revision period when there was maximum scope for misinterpretation of employee related decisions. I was there to personally explain the rationale behind the salary revisions, the promotions, the loan policies, ESOP allocations etc. To reinforce our commitment to fairness and to demonstrate our genuine interest in employee feedback, I made it a point to incorporate many good suggestions from employees into the policy framework.

I remember that in one year I made a marginal improvement in the remuneration of software professionals with Computer Science degrees. This move was mainly to address the long standing grouse that Infosys was unfair in treating Computer Science specialists with four years of relevant education on par with, say, a Civil Engineer who had no such background and hence needed to be fully trained at Infosys. I therefore decided to give a token additional remuneration to the Computer Science graduates that year. However, I was surprised to receive a strong negative feedback from all non-Computer Science graduates, many of who were rank holders from their universities. They were very unhappy that the commitment I had made in the campuses that all graduates will be treated equal is being broken, albeit in a small way. This parity was what made many top rank holders in other disciplines to consider the switch to software career at Infosys. It was the principle of honoring the commitment, that they were insisting on and not the amounts involved. I accepted the fairness of the argument and immediately converted the small extra payment into an extra allowance and restricted this payment just for that year.

Ladies and gentlemen,

Before I take you through the amazing and, some times, amusing manifestations of irrational behavior in humans, I would like to salute Bertrand Russel who had the wisdom to appreciate this behavioral underpinning in human beings, when he remarked “It has been said that man is a rational animal. All my life I have been searching for evidence which could support this”.

It should therefore not come as a surprise that the only two non-economists who have won Nobel Prizes in Economics did their pioneering research in the field of Behavioral Economics. As early as in 1940s, Herbert Simon of Carnegie Mellon put forward the concept of “bounded rationality,” arguing that rational thought alone did not explain human decision-making. Traditional economists disliked and in fact, ignored Simon’s research, and when he won the Nobel Prize in 1978, many in the field of Economics were very unhappy about it.

Then, in 1979, psychologists Daniel Kahneman of Princeton and Amos Tversky of Stanford published a breakthrough paper called “Prospect Theory: An Analysis of Decision under Risk,” on how people think about and handle uncertain rewards and corresponding risks. In the ensuing decades, this seminal paper in Behavioral Economics became one of the most widely cited papers in Economics. The authors argued that the ways in which alternatives are framed had strong influence on the decisions that people made.

In their paper, “The Framing of Decisions and the Psychology of Choice,” Tversky and Kahneman presented an illuminating example. Imagine that U.S. is preparing plans to manage outbreak of an unusual Asian disease that is expected to kill 600 people.

To combat the disease, two alternative programs were proposed for selection. If Program A were to be implemented, it was projected that 200 people will be saved whereas if Program B were to be implemented, there was one-third probability that all 600 people will be saved, and a two-thirds probability that none will be saved.

The researchers reported that an overwhelming 72 percent of respondents chose Program A which guaranteed saving of at least 200 people.

The researchers then restated the program outcomes: this time, with Program C in which 400 people will die and with Program D, there is a one-third probability that no one will die, and a two-thirds probability that all 600 people will die.

Surprisingly this time, 78 percent chose Program D the riskier option that was identical to earlier program B of saving all 600 with one-third probability.

When the options that were initially framed in terms of “lives saved” were changed and restated in terms of deaths, referred to as loss frame, people completely reversed their choice.

This mental defect is called Loss Aversion.

The brain is programmed to avoid any option associated with loss and we can clearly observe from the Asian Disease example the ridiculously large shift in preference due to ‘loss aversion’. This aversion to loss made the respondents to reject a guaranteed saving of 200 lives in preference to gambling for one-third probability of saving all 600 lives.

Let me explain this framing bias and loss aversion with a simpler example.

Imagine yourself as a patient with a health problem and your medical consultant suggested that you undergo a surgical procedure. You ask the consultant to give you an idea of success rate of these procedures. If your consultant told you that in the past, out of all the patients who have undergone this procedure, 10 per cent died after five years, my hunch is that many of you will want to avoid the operation.

On the other hand if the consultant had framed the reply as “out of all the patients who have undergone this procedure in the past, 90 per cent are alive after five years”, you are more likely to consider taking the procedure.

Donald Redelmeier, who did the research found that more people, including more doctors were lot more comfortable to undertake the risky procedure when the option was positively framed. It would appear that the prospect of a 90 per cent chance of living is, for most people, more comfortable than a 10 per cent chance of dying, even though both meant the same.

The strategic implication of this psychology of loss aversion for businesses is that when you are pitching a proposition to your employees or to your customers or to any other stakeholders for that matter, you need to take special care to frame the proposal in positive terms ensuring at the same time that you minimize any potential feeling of loss.

Click here to read Part 2 of the speech.