Suppose you’re down to your last cent and decide to take a walk.
While walking, you find two N$100 notes on the ground. You happily pick up the notes, put them in your pocket and quickly walk to the shop to buy some much-needed items.
You fill your basket with goods, but when you get to the till, you realise you’ve lost one note and only have N$100.
Question: Does the pain of losing N$100 exceed the joy of discovering N$200?
Your individual answer to that speaks to your aversion to loss in prospect theory.
Prospect theory seeks to explain how our decisions are influenced by our attitudes toward risk, uncertainty, loss, and gain.
When developing strategy and plans, you must be personally aware of your individual inclination towards loss aversion. In other words, you must not allow your over-conservativeness as an individual to make your plans too safe.
In the same way, you must not allow your appetite for uncertainty and risk as an individual to overextend into your organisational planning.
Prospect theory tells us we often make decisions based on whether we fear loss more than we expect gain and to what extent we think something is certain or uncertain.
Over-conservative people fear loss and tend to regard most things as uncertain. That is not healthy.
On the other hand, over-optimistic people only think of the gain without factoring in possible losses and tend to regard everything as 100% certain. That is not healthy either.
These are called irrational biases. Instead, we must depersonalise choices by having neutral perspectives and must clearly separate risk from reward by evaluating probabilities and likelihoods separately.
Every decision, no matter how personal or complex, has a neutral mathematical or statistical balance between loss and gain, risk and reward and statistical probability.
Your job is to find it.
