Dan Lovallo

Who they are

Lovallo is Professor of Strategy, Innovation and Decision Sciences at the University of Sydney Business School. He holds a PhD from the Haas School of Business at the University of California, Berkeley, and is a senior research fellow at the Institute for Business Innovation there. His university profile describes his research as concerning the psychological aspects of strategic decisions, and records publications in the American Economic Review, Management Science and the Harvard Business Review. He sits on the editorial boards of Strategy Science and McKinsey on Finance.

Kahneman describes the collaboration in Thinking, Fast and Slow. Almost fifteen years after he first reported on the planning fallacy with Amos Tversky, he writes, he and Lovallo sketched a theory in which optimistic bias is a significant source of risk taking, as an alternative to the standard rational model in which risk is taken because the odds are favourable.

Key papers

The 1993 paper in Management Science, "Timid choices and bold forecasts: A cognitive perspective on risk taking" (volume 39, issue 1, pages 17-31), is where Kahneman and Lovallo drew the line between the inside view and the outside view. The inside view builds a forecast from the specifics of the case in hand. The outside view treats the case as one member of a class and asks what happened to the rest.

The 2003 article in the Harvard Business Review, "Delusions of success: How optimism undermines executives' decisions", appeared in July 2003 on pages 56 to 63. Its record describes the argument briefly: when planning major initiatives, executives tend to overstate benefits and underestimate costs, which sets them up for failure, and the article offers ways to make forecasting more realistic. Flyvbjerg's published comment, in the December 2003 issue, describes the article's subjects as overoptimism, anchoring, competitor neglect and the outside view, and its cures as including outside forecasters and the outside view.

Key ideas

Three ideas are associated with Lovallo in Kahneman's account. The first is the pairing of bold forecasts with timid decisions. Kahneman reports that risk takers show no unusual appetite for high-stakes gambles; they are merely less aware of risks than more timid people are.

The second is competition neglect, a term Kahneman credits to Colin Camerer and Lovallo. People focus on what they want to do and can do, and neglect the plans and skills of others, which can lead to excess entry into markets, so that more competitors enter than the market can profitably sustain and their average outcome is a loss. Kahneman also cites Dosi and Lovallo on entrepreneurial firms that do not survive but signal new markets to better-qualified competitors, which they call optimistic martyrs: good for the economy and bad for their investors.

The third is the difference of view with Bent Flyvbjerg over cause. Flyvbjerg accepted much of the 2003 analysis and argued that it underweights deliberate manipulation of forecasts. The experimental evidence from Roger Buehler's 1994 studies, in which students with no incentive to shade their estimates still ran late, supports the optimism account, and Flyvbjerg's 258-project record, in which estimates did not improve over 70 years, supports his. The two are not mutually exclusive.

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