Influence of behavioral economics on project management

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THEORETICAL ESSAY

SANTOS, Durval dos [1]

SANTOS, Durval dos. Influence of behavioral economics on project management. Revista Científica Multidisciplinar Núcleo do Conhecimento. Year. 06, Ed. 12, Vol. 02, pp. 66-74. December 2021. ISSN: 2448-0959, Access link: https://www.nucleodoconhecimento.com.br/business-administration/behavioral-economics ‎

ABSTRACT

Methods, processes and practices in the area of ​​project management are based on the principles of traditional economics, which considers managers to be rational beings capable of always making the best decisions. However, human beings show limited rationality and let their more intuitive and emotional side influence many decisions, incurring systematic errors of logic. Given this context, the following research question arises: How do cognitive biases that influence decision making affect tools used in project management? In view of the question posed, the article aims to explore the impact of cognitive biases in two important tools in project management: the management of added value and the management of costs to be incurred. To achieve this research objective, a theoretical essay was carried out on concepts of behavioral economics and project management. The main results were a detailed elaboration of the decision biases that influence these important tools and a reflection on ways to deal with them. This article contributes to the project management literature by drawing attention to the importance of using behavioral economics concepts to improve managers’ decisions. From a practical point of view, the article offers ideas on how to avoid pitfalls linked to behavioral aspects during the decision-making process.

Keywords: Behavioral Economics, Cognitive Biases, Projects, Results.

1. INTRODUCTION

The literature on project management is in its state of the art (ROWE, 2020). However, its main tools, such as the Project Management Body of Knowledge (PMBOK) PMI Guide, the Earned Value Management (EVM) methods, Lean, Scrum and Agile Project Management, combined with the most participatory and employee-centered human resource management models (AGUDA et al., 2021), are not being enough to reduce the erosion of profit margins, in which many projects continue to be delivered late and above the planned cost. These methods or management guides are based on traditional economy models.

On the other hand, Thaler (2019) shows through different experiments that humans differ from the creatures of the traditional economy (homo-economicus-Econs). Human beings make mistakes and have limited rationality. Kahneman (2012), in his book “Rápido e Devagar: duas formas de pensar” also points out that, in addition to optical illusions, there are illusions of thought, which give rise to cognitive biases, such as overconfidence, which directly influence people’s decision-making. According to these authors, behavioral aspects of human beings should be taken into account. This is the only way to design policies and procedures to increase the number of hits in public or private administration.

Despite the knowledge brought by behavioral economics (THALER, 2019), the literature on the use of project management tools devotes little attention to the aspect of bounded rationality and the influence of cognitive biases on decisions. In this context, this article argues that project management needs to take these biases into account to promote improvement in the decisions made. Based on this premise, the following research question arises: How do cognitive biases that influence decision making affect tools used in project management? To answer this question, the article specifically aims to explore the impact of cognitive biases in two important tools in project management: the management of added value and the management of costs to be incurred. Once this question is answered, the article explores ways of dealing with these biases. The aspects discussed here can contribute to improving the application of these tools. The article then elaborates on central ideas of behavioral economics, then discusses techniques that take this logic into account, and finally concludes with reflections on the implications of the points raised.

2. THEORETICAL ELABORATION

2.1 BEHAVIORAL ECONOMICS

Personal or managerial decisions, even of highly qualified people, do not presuppose the absence of errors, since these decisions are influenced by the references that individuals have on the subject in question and on factors related to their behavior. For example, overconfidence and exaggerated optimism can contribute to incurring simple errors and difficulty predicting factors. Thus, to improve the decisions to be made in any activity in family or business life, it is necessary to try to understand human behaviors.

In 1970, Robert H. Thaler began studies on behavior, associating traditional economics with social sciences and psychology, in order to publish his book “Misbehaving – A construção da engenharia comportamental” in 2019. The central premise of traditional economic theory is that people choose optimization within their possessions, assuming that the beliefs that motivate their choices are impartial and based on rational expectations.

Thaler (2019) questions these premises and uses knowledge of psychology to adapt and improve behavior in decision-making processes. The author does not seek to demonstrate the irrationality of human beings or deny the traditional economy, but worries about the need to introduce psychological aspects to conventional economic models. He refers to writers who addressed the subject of behavior, such as Irish economist and psychologist Adam Smith, who talks about self-control in his book “A Teoria dos Sentimentos Morais” and Kurt Lewin, who in 1935 wrote about how the same object can be interpreted in different ways by different individuals. Thaler (2019) is also based on Daniel Kahneman’s work on the two ways of thinking of human beings.

According to Kahneman (2012), humans have two ways of thinking, because the human brain works as a set of two systems. The “Fast” system operates automatically and generates surprisingly complex patterns of ideas with little or no effort and no sense of voluntary control. The “Slow” system focuses attention on activities that require mental effort as complex calculations and is often associated with subjective experiences such as choosing and concentrating. For example, the “Fast” system calculates 2+2, calculates whether an object is far or near, and drives a car on an empty road. But calculating 17×23, finding a blond-haired woman in the crowd and filing income tax is the task of the “Slow” system. These systems format the way individuals think with the fast side, always being able to contribute to the origin of biases.

Behavioral economics is increasingly being used to understand the functioning of different areas, such as product development, operations management (CROSON et al., 2013), and behavioral finance (HIRSHLEIFER, 2015). This last field of knowledge, for example, is based on behavioral economics to explain why many people sell profitable stocks, but hold them down, and make superfluous purchases even if it means indebtedness. The application of behavioral economics to project management can substantially facilitate the understanding of how cognitive biases affect the work of project managers. The following article explores some tools used in the management of projects and the biases to which they are exposed.

2.2 VALUE-ADDED MANAGEMENT AND STATUS QUO BIAS

The Earned Value Management (EVM) tool was developed in the 1960s by NASA and the U.S. Department of Defense. It is considered the most effective method to monitor and control projects, aiming at reducing the incidence of overcost and delays (KIM et al., 2003).

EVM integrates technique, cost and schedule. With risk management, it allows you to measure and quantify performance, helping to predict the future performance of the project based on its trend (NASA, 2018). It shows the manager the real situation of the project, comparing what was done with what should have been done in relation to the costs and deadlines of the project. With this, it provides accurate data for the correction of the course of the project, aiming to bring it back to its original cost and term objectives (MEREDITH et al., 2017).

The EVM is based on three variables: Cost incurred up to measurement (CA), Planned Value to measurement (PV) and Added Value up to the date of measurement (EV), which is equal to the physical advance multiplied by the planned value. In the following simple example, you plan to build a house in ten months for $100,000. A measurement in the fifth month indicated that only 40% of the house was built at a cost of $55,000.

In this case, CA is equal to $55,000, the actual expense up to the fifth month. PV is equal to $50,000, the amount that should have been spent by the fifth month. And the EV is $40,000, because only 40% of the total is built. Thus, the EV is below the PV, which was the one planned showing a delay in the project. On the other hand, the CA is above the PV, showing that the project has already spent more than should have been spent by the fifth week of the project. You can also calculate the cost performance indices – CPI (EV/AC) – and term performance – SPI (EV/PV). In the example, the CPI is 1.27 and points to an overcost of 27%. The SPI is 0.8 and shows a delay of 20%.

The use of the EVM tool is essential, however, the resistance to its use is attributed to some behavioral aspects. Managers usually refute performance measurement indices because they feel measured all the time, while in reality measurements help the manager (TERRIBILI FILHO, 2011).

The Status Quo bias leads managers to maintain the tools they have always used, even when they have enough information to choose something more advantageous or a better tool. For human beings it is difficult to change the mentality in relation to what is being eated for breakfast, imagine in relation to the problems that are faced in a lifetime (THALER, 2019). Thus, project managers tend to manage without the performance indices provided by the EVM methodology. Without this measurement, it becomes difficult to identify deviations and the need to change the course of the project to recover delays and avoid extra costs.

In their research, Feitosa et al. (2014) corroborate the idea that project managers are influenced by different biases. By studying project management in a large Brazilian construction company, they concluded that the profile of the company’s managers is at odds with pure rationality. These were overly confident in their estimates, seem more optimistic than other groups of economic agents, and were largely influenced by anchors in their estimates.

2.3 COST MANAGEMENT TO BE INCURRING, MYOPIA OF EVALUATIONS AND THE BIAS OF ANCHORING

The result of the project is found by deducting from the revenue the costs incurred up to the date of measurement, the costs to be incurred until delivery and the costs to be incurred after delivery (MEREDITH et al., 2017). The costs incurred are well controlled by the project manager and the company managers via ERP (Enterprise Resource Planning) systems. However, the costs to be incurs are not always well evaluated and are sometimes even unknown, which can substantially modify operating results. Thus, behavioral economics associates the low importance attributed to the costs to incur some behavioral factors.

In his book “A Teoria dos Sentimentos Morais”, Adam Smith (1759) writes about self-control and portrays the conflict between passions, characterizing them as short-sighted. He argues that the human being tends to see only what is close. The pleasure that can be enjoyed five years from now, for example, is of very little interest, especially when compared to what can be enjoyed today.

Myopia is more pronounced when it comes to evaluating future problems such as the costs to be incurred that can nullify or bring the margin of a project to negative extremes. So humans tend to pay attention to what’s happening right now, without worrying about what might come up front, people prefer to spend now forgetting the future. Thus, project managers tend to think about the costs present, without giving importance to the costs being incurable, especially those that may appear after the end of the project, due to management failure.

The anchoring bias, which is the tendency to rely on first impressions or information (anchor), also leads managers to rely on the information received for the beginning of the project, often without a more adequate analysis or even a review, thus providing costs to incur. Once the biases that influence each project management tool have been presented, it is possible to deal with them, a theme explored in the next section.

2.4 DEALING WITH BIASES

According to Kahneman (2012), about improving personal judgments and decisions from cognitive biases, there is little that can be done without considerable effort, because intuitive thinking —”the Fast” — is not easily educated and prone to overconfidence, extreme predictions, planning errors, and others. The most effective way to block these intuitive system errors is to seek to recognize it as a mined cognitive field and ask the rational system for help —”the Slow”. Thus, systematic strategies are needed to prevent each type of bias. For example, people with overconfidence bias do not go to the trouble of documenting their wrong predictions and may become victims of another bias —that of confirmation, looking only for evidence to confirm their hypotheses. Thus, the only protection against overconfidence is to collect data systematically, especially data that proves it wrong (THALER, 2019).

Seeking to mitigate the myopia of cost assessment to be incurring, it is suggested to grant managers the signing of remuneration contracts, committing to return the money received when the goals are not met. This compensation model makes future failures more tangible and leads professionals to worry about future results. This suggestion is based on the article by Fryer et al. (2018) on improving the efficiency of teaching. According to these authors, professionals with this remuneration model present better results in relation to the efficiency of teaching. Finally, behavioral analyses of the employees of organizations carried out by behavior specialists will allow guiding the decision-making process of their managers reducing the risk of decisions.

3. FINAL CONSIDERATIONS

This article sought to answer: How do cognitive biases that influence decision making affect tools used in project management? Given this, we explored how decision biases affect tools used in project management. For this, a reflection was made on the status quo bias on the use of the value-added method and on how the management of costs to be incurred is influenced by the myopia of assessments and the anchoring bias.

After this reflection, the article presented how project managers can deal with these biases, proposing suggestions on how to minimize their impacts. With the knowledge of the different behaviors and biases, it is possible to mediate conflicts and remove barriers, facilitating the implementation and use of management tools, such as EVM, the evaluation of costs to be incurred, among other processes and practices mentioned in the PMBOK Guide (PMBOK GUIDE, 2021).

The incorporation of behavioral economics into existing project management practices with the mitigation of key cost control risks can contribute substantially to project performance, also improving the work environment in organizations.

REFERENCES

AGUDA, R. et al. Challenges and Opportunities in Developing Project Management Decision-Making Tools. Journal of Engineering, Project & Production Management, v. 11, n. 2, 2021.

CROSON, R. et al. Behavioral operations: the state of the field. Journal of Operations Management, v. 31, n. 1-2, p. 1-5, 2013.

FEITOSA, A. B. et al. A influência de vieses cognitivos e motivacionais na tomada de decisão gerencial: Evidências empíricas em uma empresa de construção civil brasileira. Revista de Negócios, v. 19, n. 3, p. 3-22, 2014.

FRYER, R. G. et al. Enhancing the efficacy of teacher incentives through framing: A field experiment. NBER Working Paper, 2018. Disponível em: https://rady.ucsd.edu/docs/Fryer_et_al_Teacher_Incentives_Framing_2019.pdf. Acesso em: 26 de out. de 2021.

HIRSHLEIFER, D. Behavioral finance. Annual Review of Financial Economics, v. 7, p. 133-159, 2015

KAHNEMAN, D. Rápido e devagar: duas formas de pensar. Objetiva, 2012.

KIM, E. et al. A model for effective implementation of Earned Value Management methodologyInternational Journal of Project Management, v. 21, n. 5, p. 375-382, 2003.

LEWIN, K. Teoria de campo em ciências sociais. São Paulo: Biblioteca Pioneira de Ciências, 1965.

MEREDITH, J. R. et al. Project management: a strategic managerial approach. Hoboken, NJ: John Wiley & Sons, 2017.

NASA. Earned value management (EVM) implementation handbook. Washington, DC: NASA. 2018. Disponível em: https://ntrs.nasa.gov/api/citations/20180001499/downloads/20180001499.pdf. Acesso em: 26 de out. de 2021

PROJECT MANAGEMENT INSTITUTE. A Guide to the Project Management Body of Knowledge. 7. Ed. USA, 2021.

ROWE, S. F. Project management for small projects. Oakland, CA: Berrett-Koehler Publishers, 2020.

SMITH, A. Teoria dos sentimentos morais. São Paulo: Martins Fontes, 1999.

TERRIBILI FILHO, A. Gerenciamento de projetos em 7 passos: uma abordagem prática. São Paulo, SP: M. books, 2011.

THALER, R. H. Misbehaving: a construção da engenharia comportamental. Rio de Janeiro: Intrinseca, 2019.

VARGAS, R. V. Gerenciamento de Projetos: estabelecendo diferenciais competitivos. 6. ed. Rio de Janeiro, RJ: Brasport, 2005.

[1] Electrical Engineer at the Federal University of Uberlândia and Post-Graduation Industrial Administration at the Mauá School of Engineering.

Posted: September, 2019.

Approved: December, 2021.

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