Competition Neglect

COMPETITION NEGLECT

It is tempting to explain entrepreneurial optimism by wishful thinking, but emotion is only part of the story. Cognitive biases play an important role, notably the System 1 feature WYSIATI: what you see is all there is.

• We focus on our goal, anchor on our plan, and neglect relevant base rates, exposing ourselves to the planning fallacy.

• We focus on what we want to do and can do, neglecting the plans and skills of others.

• Both in explaining the past and in predicting the future, we focus on the causal role of skill and neglect the role of luck. We are therefore prone to an illusion of control.

• We focus on what we know and neglect what we do not know, which makes us overly confident in our beliefs.

The observation that “90% of drivers believe they are better than average” is a well-established psychological finding that has become part of the culture, and it often comes up as a prime example of a more general above-average effect. A cognitive interpretation offers an alternative to explaining the finding through self-aggrandizement. Consider these two questions:

Are you a good driver?

Are you better than average as a driver?

The first question is easy and the answer comes quickly: most drivers say yes. The second question is much harder and for most respondents almost impossible to answer seriously and correctly, because it requires an assessment of the average quality of drivers. People can respond to a difficult question by answering an easier one. They compare themselves to the average without ever thinking about the average. The evidence for the cognitive interpretation of the above-average effect is that when people are asked about a task they find difficult (for many of us this could be “Are you better than average in starting conversations with strangers?”), they readily rate themselves as below average. The upshot is that people tend to be overly optimistic about their relative standing on any activity in which they do moderately well.

I have had several occasions to ask founders and participants in innovative start-ups a question: To what extent will the outcome of your effort depend on what you do in your firm? This is evidently an easy question; the answer comes quickly and in my small sample it has never been less than 80%. Even when they are not sure they will succeed, these bold people think their fate is almost entirely in their own hands. They are surely wrong: the outcome of a start-up depends as much on the achievements of its competitors and on changes in the market as on its own efforts. However, WYSIATI plays its part, and entrepreneurs naturally focus on what they know best—their plans and actions and the most immediate threats and opportunities, such as the availability of funding. They know less about their competitors and therefore find it natural to imagine a future in which the competition plays little part.

Colin Camerer and Dan Lovallo, who coined the concept of competition neglect, illustrated it with a quote from the then chairman of Disney Studios. Asked why so many expensive big-budget movies are released on the same days (such as Memorial Day and Independence Day), he replied:

Hubris. Hubris. If you only think about your own business, you think, “I’ve got a good story department, I’ve got a good marketing department, we’re going to go out and do this.” And you don’t think that everybody else is thinking the same way. In a given weekend in a year you’ll have five movies open, and there’s certainly not enough people to go around.

The candid answer refers to hubris, but it displays no arrogance, no conceit of superiority to competing studios. The competition is simply not part of the decision, in which a difficult question has again been replaced by an easier one. The question that needs an answer is this: Considering what others will do, how many people will see our film? The question the studio executives considered is simpler and refers to knowledge that is most easily available to them: Do we have a good film and a good organization to market it? The familiar System 1 processes of WYSIATI and substitution produce both competition neglect and the above-average effect. The consequence of competition neglect is excess entry: more competitors enter the market than the market can profitably sustain, so their average outcome is a loss. The outcome is disappointing for the typical entrant in the market, but the effect on the economy as a whole could well be positive. In fact, Giovanni Dosi and Dan Lovallo call entrepreneurial firms that fail but signal new markets to more qualified competitors “optimistic martyrs”—good for the economy but bad for their investors.