Decision Making: Framing Risk and Opportunity

From the lecture series: The Art of Critical Decision Making

By Michael A. Roberto, D.B.A., Bryant University

Could the way that we present and define a problem for people actually shape the solution that they select? Does the way that a leader frames a problem actually narrow the range of alternatives that their advisors might consider and discuss?

image of a man framing with this fingers

Frames are mental models that we use that simplify our understanding of the complex world around us. In other words, frames are mental models that help us make sense of the world around us.

Previously, we talked about cognitive bias. Today, we’ll talk about the distortions that could be created based on how problems are framed or defined for us. Moreover, we’ll look specifically at the relationship between how we frame problems and the level of risk that we take. What is a frame? Frames are mental models that we use that simplify our understanding of the complex world around us. In other words, frames are mental models that help us make sense of the world around us. They involve our assumptions—often taken-for-granted assumptions—about how things work. How we frame a problem often shapes the solution at which we arrive. Let’s think for a moment about how economists think about choice, and we’ve gone back to that a number of times in this course, because economists have some pretty sophisticated models of how we make decisions. In particular, they’re interested in the decisions we make about purchasing goods, for example.

For years, economists believed that we estimate expected values when confronted with risky situations, and that framing the situation in one way or the other really shouldn’t matter. Economists would argue that basically we weight different possible outcomes with probabilities, and when faced with a risky situation, we then determine what the expected value will be. In other words, we take the probability of outcome A times the result of outcome A, plus the probability of outcome B, times the result of outcome B, and that yields some expected value. Most of us are slightly risk averse, meaning we would rather take an amount slightly less than that expected value if it was given to us with certainty, rather than take the risk of a high or low outcome. In other words, we like that certainty equivalent rather than the gamble—most of us, not all of us; some of us love risk. In the field of business we often look at entrepreneurs and say, they seem like they enjoy taking risk, they’re more risk-seeking than the average person; they’re tolerant of the fact that they’re going to face a lot of ambiguity that they might fail. Most entrepreneurial ventures do fail, and most entrepreneurs go into it understanding that, and they’re willing to take the risk, but most of us are risk averse.

Economists for many years didn’t believe that how we framed a situation, the language we used in presenting a problem to someone, they didn’t believe that mattered in terms of the decision-making we would undertake in risky situations. It turns out that wasn’t correct. Tversky and Kahneman, two scholars we’ve mentioned before, experts in decision-making, put forth an interesting theory some years ago; they called it prospect theory, and their theory suggests that framing matters. In fact, even small changes in wording have a substantial effect on our propensity to take risks. According to prospect theory, framing does matter a great deal, and if we frame a situation in terms of a potential gain, we act differently than if we frame it in terms of a potential loss. So this notion, then, of loss versus gain turns out to have a great impact on our risk-seeking or risk aversion. Tversky and Kahneman argue that framing situations in terms of a loss is what causes us to take more risks, much more risks than if we frame it in terms of a potential gain.

image of a nurse checking someone's blood pressure
A useful thought experiment for framing in economics entails two possible responses to a medical disaster.

How did they show this? Interestingly, they conducted some experiments that I’d like to actually walk through with you. Let me paint a scenario for you, and then I actually want you to answer, as the subjects in Tversky and Kahneman’s experiments were asked to answer. Here’s the scenario: Imagine that the United States is preparing for the outbreak of an unusual Asian disease that is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. Assume that the exact scientific estimate of the consequences of the program are as follows: If program A is adopted, 200 people will be saved. If program B is adopted, there is a one-third probability that 600 people will be saved and a two-thirds probability that no one will be saved. Which of these two programs do you favor? And I would ask you right now to sort of take a mental note of which program, A or B, you favor. If you have a paper and pencil, write it down because I’m about to present you a second scenario, and I’m going to compare your answer to that situation to the answer you just gave in this situation about program A and B.

This is a transcript from the video series The Art of Critical Decision Making. Watch it now, on The Great Courses Plus.

Okay, let’s turn to that other scenario. Once again, imagine that the United States is preparing for the outbreak of an unusual Asian disease expected to kill 600 people. Again, we have two alternative programs to combat the disease, and assume again that we know the exact scientific estimates of the consequences of these two programs. Here they are—in this case, we have program C and program D. If program C is adopted, 400 people will die; we know that with certainty. If program D is adopted, there is a one-third probability that nobody will die; however, there’s a two-thirds probability that 600 people will die. In comparing programs C and D, which of these two programs do you favor? Please make a mental note of your response, or again, if you have a pencil and a pad, write down which program you favor.

According to prospect theory, framing does matter a great deal, and if we frame a situation in terms of a potential gain, we act differently than if we frame it in terms of a potential loss.

Let’s think about your responses. What happens when this is done with a large group of subjects? Here’s what Tversky and Kahneman found: With regard to problem number one, comparing programs A and B, people tend to be risk averse. The average person, at least in their response, tends to be risk averse. In problem two, people exhibit risk-taking tendencies. What’s going on there? I mean, the two situations are identical; the only difference is that the first problem focuses on the number of lives that can be saved, while the second one focuses on the number of lives that can be lost, and what happens is when we frame it in terms of a loss, we see people engaging in risk-seeking or risk-taking behavior. When we frame it in terms of a gain, we see people being much more risk averse—on average, not everyone, of course. The point is that we see people flipping from risk aversion to risk-seeking behavior just because we define the problem a different way, and that’s quite interesting because, in fact, most studies found, of course, that people are pretty consistent; they edither tend to be in terms of their personality and character sort of risk averse or not. That’s what we thought at least, but now here, Tversky and Kahneman are showing us that language matters—how we define the problem actually dictates the choices that we make, and this is really an amazing conclusion. Small changes in wording matter a great deal—language matters. Definition of problems dictates, or at least drives towards, the kind of solutions we come up with, with regard to those problems.

Learn more about the myth that bad decisions are most often made by bad leaders

image of two Vietnam-era helicopters
The Vietnam War can be seen as a classic case of escalation due to sunk-cost effect.

We talked several lectures ago about the sunk-cost effect, the escalation of commitment. Prospect theory may be one explanation for the escalation of commitment that occurs when there are high sunk costs. Let’s take an example. You know, tragically, the Vietnam War may be an example of the escalation of commitment. As you might recall, or you might have read about in the history books, the Vietnam War was not an instance where we sort of went in completely into a battle, into a war, all at once. Instead, we sort of dipped our toe in. We started out by sending advisors to South Vietnam; we then begin to introduce troops into combat there, and over time we added more and more troops and escalated our commitment. We gradually kept increasing our involvement, despite a series of very poor results. One would argue, drawing on prospect theory, that perhaps we kept pouring more resources into the war because we framed the situation in terms of a loss. Thus, we had a propensity to take more and more risk to try to dig out of the loss position.

There was this sort of so-called domino theory that if we lost the state, the country, of South Vietnam to communism, then other nation-states in South Asia and East Asia might fall like dominos to Soviet expansionism into communism. So, we had framed this as sort of this loss, this potential loss, and maybe that led us to take a number of risks and to escalate our commitment to what was a failing course of action.

That framing of the situation as a loss really started way back at the beginning when the whole thing was sort of defined or put forth for the American people and for the president as “we don’t want to lose South Vietnam to the communists.” It wasn’t about sort of gaining a victory to accomplishing objectives; it was sort of this defensive posture that said we’re very worried about the Soviet threat. We’re very worried about Soviet expansionism. We don’t want to see communism run rampant in various parts of the world—so we need to sort of draw a line in the sand. We want to sort of avoid the loss of another nation-state, of another region, to communism. In fact, there was this sort of so-called domino theory that if we lost the state, the country, of South Vietnam to communism, then other nation-states in South Asia and East Asia might fall like dominos to Soviet expansionism into communism. So, we had framed this as sort of this loss, this potential loss, and maybe that led us to take a number of risks and to escalate our commitment to what was a failing course of action—a very sad circumstance where prospect theory might help us explain the behavior of our leaders in that case.

From this body of work, this early body of work, largely laboratory studies looking at framing and its impact on decision-making, we have management scholars who extended the research by arguing that we act differently when situations are framed as opportunities versus threats, and now they’re making an interesting dichotomy, and in the field of management and business we often do think about what might happen to the firm, as there may be a threat coming from the external environment from a competitor, or from a regulatory change, or from a change or shift in consumer tastes, or there might be an opportunity.

photograph of chocolate
A chocolate manufacturer can treat the trend towards healthy living as both a threat and an opportunity.

So, if you’re a chocolate manufacturer, then all of this emphasis on health and wellness might be framed as a serious threat; people are worried about obesity, and they’re going to consume less candy and chocolate—that could harm our business. Or that same issue of health and wellness could be framed as an opportunity. There’s some scientific research showing that, for example, there’s some health benefits to dark chocolate, and so as a management team you might look at the health and wellness trend and say, here is an opportunity for us to actually bring out a line of products that have some health benefits that play into that trend, that play into that growing consumer preference. So this notion that managers all the time are sort of framing things in terms of this sort of dichotomy of opportunities and threats seems quite real.

Organizations act very rigidly when they’re faced with threats, and they act much more flexibly and adaptively if they frame those same situations as opportunities.

According to this theory, organizations act very rigidly when they’re faced with threats, and they act much more flexibly and adaptively if they frame those same situations as opportunities—very different behavior depending on how they’ve defined the problem, how they’ve defined the situation. In particular, scholars have argued that we tend to simply “try harder” using well-established routines and procedures when we frame something as a threat. However, we may not think differently. We may not find new ways of working very effectively if we frame it as a threat. We may be doing more of what already got us in trouble in the first place. That’s threat rigidity, and it can be a real problem.

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What’s interesting about this work is it has been extended by various scholars who began to dig into this in more detail, and one of those scholars is named Clark Gilbert, a former colleague of mine at the Harvard Business School. He was doing his graduate work in the field of management around the time the web really started to take off, and he became very interested in what was going on in the newspaper industry at the time. We all know that the newspaper industry has been seriously disrupted by the web. Circulations are down across the board, newspapers in the United States. Advertising revenue has dried up dramatically with the emergence of things like Craigslist, and Monster.com, and all sorts of other online advertising avenues—Google search ads, et cetera. So he became very interested in how will traditional newspapers react to the emergence of the web, and what he did here is say, might it matter how they frame the situation, how they define what is going on with regard to the web. His work suggests that framing a situation as a threat may actually have some usefulness. Why? Because if we frame it as a threat, we may actually allocate more resources to the problem; it may sort of wake us up and say, we have to do something. But we might need to frame it as an opportunity to use those resources effectively, because framing as an opportunity leads to more divergent thinking, less rigidity in our behavior, more openness to new ideas. In other words, what Gilbert is saying is it’s not as simple as: Opportunity framing is better than threat framing. In fact, what the best organizations do is balance two competing frames, and this is what he looked at in the context of the newspaper industry and its response to the Internet. His study found that those newspapers who exclusively examine the web as a threat responded by pouring dollars at their websites. However, they tended to simply replicate their hard copy online. Their paper copy became a PDF that was posted on a URL, on a website that people could download and read—not a very creative use of the technology—in fact, a use of the technology that bore a striking resemblance to what already existed, not fully taking advantage of what the web had to offer.

Those who framed it as an opportunity did respond more adaptively, but they didn’t necessarily allocate enough resources to the situation to implement their strategy as well. Here’s what those organizations did. They, by framing it as an opportunity, they saw the web as a chance to do things you can’t do with a hard copy of a newspaper that gets dropped at someone’s door at 6 am. These are the kinds of organizations (those who framed it as an opportunity) who started blogs, podcasts, who had forums for discussion and bulletin boards, who started doing things with their website that they couldn’t do with their hard copy. This was much more divergent thinking, more creative, more open to new ideas—so there are the benefits of the opportunity framing, but they didn’t allocate enough resources to really fully capitalize on the technology and on the opportunity. The most effective organizations in the study initially assessed the web as a threat, and in response to that they woke up—they sort of jostled the organization out of its slumber, and they poured some resources at it. They often set up a separate organization, a unit that was told, go get this thing, go study it, go figure out what’s going on, but then they quickly reframed the web as an opportunity and they said wait, wait, wait, the web isn’t going to just destroy our business, there might be an opportunity to really grow new streams of revenue, to do exciting new things, and so the best organizations were able to sort of manage these competing frames—a very interesting body of work that’s shown us not just the power of framing, but how we might use framing to our advantage as leaders in organizations.

Framing is a general phenomenon, not just a binary thing. Framing is not always about sort of A versus B, threat versus opportunity, loss versus gain. We have always adopted mental models that shape our way of looking at situations. Now sometimes, though, those mental models become outdated. Let’s take the case of the September 11 terrorist attacks. What the 9/11 Commission found in their report on these attacks is that many government agencies were still operating, in 2001, with a “Cold War” mindset, with a Cold War framing of the world and the threats around them. The Cold War mindset viewed threats as emanating primarily from other nation-states. The Cold War frame emphasized conventional warfare and arming ourselves to protect against military attacks by the armies of other nations. The various arms of the federal government were all still organized based on this Cold War model of national security. They weren’t organized to defend against these so-called asymmetric threats (i.e., threats that came from things other than nation-states, threats that came from things other than conventional armies, threats that involved networks of people in various places—not world leaders of countries, threats that involved different kinds of ways of attacking people—and not attacking their armies, but perhaps attacking its civilians). The government and its various agencies were not organized. Their mental model caused them—because they were in that Cold War mind frame, that Cold War mindset—to be sort of predisposed to a very different set of defensive tactics than were called for to be able to be prepared to defend against something like the terrorist attacks of 9/11. So what we see here is that a mindset that worked quite well for 40 or 50 years after World War II became outdated. New kinds of issues arose in the environment, and new kinds of threats arose, and a certain model, certain frame of the world, still persisted in the organization in its culture and structure, and that meant that when new threats and new things emerged, they were still operating in a sort of old model.

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The Federal Aviation Administration also had this sort of issue as they sort of experienced the 9/11 terrorist attacks. The Federal Aviation Administration had developed a lot of procedures to try to sort of promote and preserve aviation security. Many of those procedures were born during the ’60s and ’70s, during a time when there were two main concerns to aviation security. One was hijacking, of course. There were a number of very prominent hijackings, particularly in the 1970s, and the second threat they were worried about was someone somehow putting a bomb in checked luggage and that bomb going off in the cargo bay of a plane and taking it from the sky. They weren’t at all sort of considering the notion of someone being a suicide bomber, in a way, on a plane and killing themselves and taking the plane down with them—so their frame, sort of their whole model of security, was based on the fact that they had this deep experience in an era in the ’70s where hijackings and bombings were sort of the norm for terrorists. So again, we can get caught in a way of framing the situation and a certain mental model, and it can become outdated, and it’s hard to shake it.

image of a GMC truck
General Motors was the largest and most profitable company in the world in 1972.

Speaking of hard to shake mental models, mental models ultimately come down to our taken-for-granted assumptions about how the world works. These assumptions can easily get outdated, and yet, we don’t make them explicit and challenge them in our organizations. Let me ask you a question: What was the most successful (the largest and most profitable) company in the world in 1972? General Motors. General Motors, with more than 50 percent market share in the United States in the automobile market, with incredible profits, with revenue growing every year; on top of the world. USC Professor James O’Toole once identified the core assumptions of the management team at General Motors in the 1970s, when they were on top of the world. He developed a list of sort of the 10 fundamental shared basic assumptions at General Motors, c. 1972. It’s a bit of a stylized list, it may be a little extreme. I’m sure that some of the managers at General Motors would quibble with some of these, but it’s illustrative. He said,

  1. GM is in the business of making money, not cars. In his belief that was sort of one of the fundamental shared basic assumptions, one of the fundamental facets of the mental model-driving behavior and decision-making at GM.

  2. Success comes not from technological leadership but from being able to quickly adopt innovations successfully introduced by others.

  3. Cars are primarily status symbols. Styling is, therefore, more important than quality to customers, who, after all, are going to trade up every other year anyway. That was the model in the automobile industry in the ’60s and ’70s: Get people to trade up as incomes rose in the post-World War II era.

  4. The U.S. car market is isolated from the rest of the world. Foreign competitors will never gain more than 15 percent of our domestic market.

  5. Energy will always be abundant and cheap—the fifth poor assumption (1972 note, just before the first OPEC embargo, the first dramatic spike in oil prices that occurred during the 1970s).

  6. Workers have no important impact on production or product quality—that’s the purview of inspectors, of engineers.

  7. Consumer, environmental, and other social concerns are unimportant to the U.S. public.

  8. Government is the enemy. It should be fought tooth and nail every inch of the way.

  9. Strict, centralized financial controls are the secret to good administration.

  10. Managers should always be developed from the inside; managers should be promoted from within.

Those were the 10 assumptions O’Toole identified in looking back at the management team at GM; that was their mental model in 1972. His analysis suggested GM was unable to recognize how and when these assumptions had become outdated. Many of them became outdated right then in 1973, like the assumption about energy prices. Some took more years, even a decade or more, to fundamentally become flawed and outdated. When the threat of Japanese imports really began to build steam during the 1970s and early ’80s, General Motors first dismissed it. Then they framed it primarily as a threat, and they acted very rigidly in response. It’s very interesting to watch how calcified mental models can become—how hard it can be for a team to shake itself from that model, from that frame of a situation, and that becomes even harder when there’s very little turnover in that management team, when everyone has worked in the industry for a long period of time and in that particular company for a long period of time. That lack of exposure to other ideas and outside perspectives can make it hard to sort of frame it in any other way than the way it has always been framed by a particular organization and its leaders.

In some situations, leaders might want to hold back on offering their assessment of a situation, because their framing of a situation may constrict the range of advice and the range of options brought forth by their team. That’s an important lesson with regard to framing that every leader should heed.

How can we improve the way we frame things? What should individuals do about the fact that framing can have such a powerful effect on our decision-making? First, leaders need to be careful about imposing their frame on their management team. In some situations, leaders might want to hold back on offering their assessment of a situation, because their framing of a situation may constrict the range of advice and the range of options brought forth by their team. That’s an important lesson with regard to framing that every leader should heed. How else can we improve the way we frame? We should consider adopting multiple frames or multiple definitions of any particular situation. In other words, we ought to define our problems in several different ways—some more broad than others—because each definition naturally tilts us toward one kind of solutions, toward one range of options. We need to think about our metaphors, too. We use them all the time. We make metaphors in our speech and in the way we sort of describe situations to others, and those metaphors are very powerful, but metaphors can also constrict our thinking; they’re part of how we frame problems and situations. We need to surface our implicit assumptions, what are those taken-for-granted assumptions that are part of these mental models that we take around with us. We need to probe, and validate, and test those very carefully.

And finally, we need to think about the reference points and yardsticks that we use when we define problems. Let me give you an example. Prior to Jack Welch becoming CEO of General Electric in 1981, GE looked at each of its business units and said: Is it growing its revenue; is it growing its profit; how’s it doing relative to last year? Is it doing better? If it’s doing better than last year, then, hey, that’s a good thing. If it’s doing worse, then that’s a bad thing, and that’s a pretty basic way of looking at their businesses. Welch took over and said we need a different reference point and a different yardstick because all we’re doing is comparing ourselves to ourselves, to our past, and hey, the Japanese are coming, and all kinds of other challenges are coming in our markets, and this inward focus and self-comparison will do us harm. So he established new reference points and yardsticks. He said we want to be number one or number two in the markets we serve, and if we’re not number one or number two, we ought to fix it, sell it, or shut it down. Wow, all of a sudden the benchmark, the yardstick, the reference point became how we’re doing relative to all these competitors. It no longer became an internal reference point. He’s providing a whole different frame on performance of his business units, and in so doing he unlocked all kinds of opportunities for the company. They did divest some units. They shut some things down, but they also realized what their real gems were, and they grew those businesses very aggressively, and Welch went on and GE went on to great success during his two-decade tenure at the company.

We have to remember throughout this that frames are models. Models are, by definition, simplified abstractions of reality. These models aren’t “right” in the sense that they don’t capture all the complexities of reality, but they can be useful to us. They help us cope with all that complexity and ambiguity in the world around us. They help us make decisions, but we have to be careful of oversimplification, and that’s one of the things that we often do. We do oversimplify situations as we sort of model them, as we sort of come up with a way of defining or framing a situation in order to help us make decisions.

Through it all, we have to remember this notion that better off we will be if we have competing frames, if we have multiple ways of defining the problems we face, so that we don’t sort of force ourselves down one path by virtue of the definition we’ve started with of a problem or situation. F. Scott Fitzgerald, author of The Great Gatsby, once said, “The test of a first-rate intelligence is the ability to hold two opposite ideas in mind at the same time and still retain the ability to function.” The power of competing frames, it’s hard to do, but a first-rate intelligence has the ability to do it—that’s what Fitzgerald said, and I think it’s true. I think the ability to hold those multiple frames in our mind and not allow one definition of a situation to constrict the range of options we consider is absolutely critical. Now where are we going from here? At this point we’ve talked about how our cognitive limitations can distort our decisionmaking, but we don’t want to make it seem like we always get it wrong due to bounded rationality, that we always fall into traps. We want to understand the power of the human mind—and particularly, the power of intuition. We don’t have to do tons of formal analysis to get the right answer to tough problems. We can use our instincts, and our instincts are often correct.

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Common Questions About Framing Risk

Q: What is framing in decision making?

Framing is a tool employed by marketers. It relies on the fact that people will take different actions based on the same set of information, depending on whether the information is framed in a positive or negative light.

Q: Why is the framing effect important?

When information is provided in a favorable light, emphasizing the gains rather than the losses, people are more likely to avoid risks. Conversely, if the losses are emphasized, people will be inclined to take a risk in order to avoid the loss, even if the information is exactly the same.

Q: What is an example of framing in psychology?

The framing effect was introduced in psychology based on a study by Amos Tversky and Daniel Kahnemann. The study demonstrated that in advertising, people will react differently to a product based on how it is framed. For instance, customers will have a more positive perception of a shampoo advertised as having 90% natural ingredients than a shampoo that’s stated as having 10% artificial ingredients, even though both add up to the same outcome.

Q: What is framing a question?

Framing a question means setting up a question in a way that is intended to get the type of answer you are looking for.

This article was updated on 8/19/2010

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