We’ve written extensively about the potential of behavioral economics for explaining patients’ motivations and encouraging the sorts of behaviors — diet, exercise, drug adherence — that are needed to contain an emerging epidemic of chronic diseases. But patients aren’t the only ones who need to change. It is becoming equally important for pharma companies to change their behaviors in significant ways — embracing greater transparency before it’s forced on them, investing outside the comfort zone of their traditional business models before they are disrupted, and more. To succeed in this endeavor, however, it’s important to recognize some of the ways in which the motivations and behaviors of large companies are different from those of individuals.
In some ways, companies are more rational than people. They are much more efficient than individuals, for instance, at solving optimization challenges such as managing tax liabilities or accounts receivable. While an individual taxpayer might fail to take advantage of all available deductions and credits (perhaps because of status-quo bias), large companies — with legions of employees and advisors whose very jobs depend on identifying tax-efficient solutions — are much less likely to make such mistakes.
But in other spheres, large companies can be very irrational. They might focus inordinately on meeting quarterly earnings targets, even at the expense of longer-term interests. And in numerous industries, large companies have failed to respond adequately to disruptive innovation, frequently at the expense of their very survival.
The sources of corporate irrationality are somewhat different from the drivers of irrational behavior in individuals. While it’s true that company managers are every bit as human as the rest of us, and therefore subject to many of the biases that behavioral economists have catalogued, their decision-making is also influenced by the structural characteristics and incentives of large organizations. As a result, individual cognitive biases are often compounded by institutional structures and incentives.
For instance, the human tendency to excessively discount future benefits or risks (what behavioral economists call “hyperbolic time discounting”) is compounded by structural factors. These include investors’ quarterly performance expectations (which make it difficult to make decisions that create long-term benefit but short-term pain) and the limited tenure of senior leaders (which reduces their motivation to make investments that would exact costs during their years in office and deliver payback for their successors).
Similarly, another cognitive bias, loss aversion, might be compounded by asymmetric incentives, wherein some stakeholders at large companies (e.g., corporate counsel, regulatory compliance, risk) perceive greater gain from minimizing downside risk than from encouraging appropriate risk-taking in areas that could be essential for the company’s long-term relevance and survival.
Projection bias — the tendency to inappropriately extrapolate the current situation to the future — is the reason that convertibles and homes sell better during the spring and summer months. At big pharma companies, this bias is manifested in comparisons using an inappropriate baseline, e.g., evaluating investments in new business models against companies’ current performance, rather than against what their situation might be if they fail to respond to significant health care reforms that alter the market for their products.
Changing corporate behavior at big pharma companies will therefore require incentives and initiatives that address both the human cognitive biases and the structural factors involved. Scenario planning exercises, for instance, could encourage executives to consider alternate baselines, while changing the metrics on which employees are measured could help combat loss aversion.
What structural factors do you see biasing the behavior of large pharmaceutical companies? What approaches might make a difference? These are important questions, because one way in which corporations are like people is that their long-term health and survival depends on the behaviors they undertake today.