Optimism bias, strategic misinterpretation and reference class forecasting

Multi-National corporations completing large-scale projects face potential high cost overruns and possible overestimations on initial budgets. Through these, sometimes unrealized setbacks, the corporations are not operating at maximum possible efficiency. This can happen through a number of factors such as a poor allocation of resources, lacking a sufficient standard of managerial skills, Optimism Bias and Strategic Misinterpretation.

A Danish geographer by name of Bent Flyvbjerg did extensive research into cost overrun and benefit shortfall of major projects, with additional studies into hypothetical solutions. Through his investigation, Flyvbjerg realised that the cost and benefit shortfall of major projects could be better understood by filtering the wide topic into two sub-topics, Optimism Bias and Strategic Misrepresentation. Through further analysis into the study area, a possible solution to this problem was first found through the use of the Reference Class Forecasting approach (RCF). RCF approach helps by providing a less skewed and opinionated view on a specific subject by using the 'Outside View' instead of the commonly applied 'Inside View'. The over-arching goal is to reduce cost overrun and benefit shortfall by engaging all aspects to increase forecasting accuracy[2].

Through reading this article, a clear and succinct explanation of the strategies and ideas mentioned above will be discussed. A brief analysis will be given on how it is used in business practice to increase efficiency and a detailed paragraph of the studies' limitations as a theory will also be covered.

Optimism Bias

Optimism bias by definition is a form of cognitive bias. This bias refers to the belief that there are reduced negative externalities about a specific situation. Factors that contribute to Optimism bias is if an individual or corporation has a more informative view of the desired end state of the project, the cognitive mechanisms in use, the information the individual or company has to begin with and the overall mood of the project scope. All these factors significantly contribute to the bias, potentially skewing judgement on a project. Optimism bias can be both positive and negative, for example, an overoptimistic overall outcome of a project's benefits can lead to poor planning, budgeting and other factors in the early stages of the project portfolio. However, an increased Optimism Bias can be seen as quite a positive aspect of a business plan. An over-confidence in the desired outcome would increase expectations of an individual or company as it is falsely made to look that it is easier to achieve.

Although this sounds negative if not met, increased expectations help people in a corporation and the business its self, grow considerably as the company will continuously strive for potential new feats. Not only are potential higher target reached, but self-satisfaction is drastically increased no matter the outcome as noted by Psychologists Margaret Marshall and John Brown's theory of Optimism Bias presented by Associate Professor of Cognitive Neuroscience Tali Sharot in a TED talk