The most important, critical activity of strategy making is that of diagnosing the situation. A mistake in diagnosis will lead to poor strategy and results. This article describes three shortcomings that get in the way of good strategic diagnosis. I found them in Daniel Kahneman’s closing remarks in his book, Thinking Fast and Slow.

Anchoring – We’ve all experienced anchoring when in bargaining over price. Someone offers a price, and the agreement settles someplace near that price. Anchoring is common in establishing project due dates and budgets; those initial anchors may be totally infeasible! The mind gives disproportionate weight to the first information it receives, regardless of the realism of that information.

Here’s an example from earlier in my career. My employer had experienced two very good years of growth, and the prior year our sales were up 35% over the previous year. The CEO entered into a planning meeting and said this, “We grew 35% last year, so our target growth for this year is 35%.” Anchors like this are intuitive, and ignore relevant factors like industry growth rate, competitive responses, and the state of the economy.

Here’s another example. At the time of Wal-Mart’s founding, the conventional wisdom was that a full-line department store needed a population base of at least 100,000. Sam Walton was able to buck this conventional wisdom by redefining the business as a network of stores with an integrated supply chain. Related to conventional wisdom is the concept of a “best practice,” which leads to thoughtless copying of others. Seldom does a good strategy arise from copying the practices of others.

Narrow framing – Humans put boundaries on problems, whether they recognize it or not. When a person frames narrowly, they bring their attention to an isolated part of a situation. When people narrow frame, they tend to look at their own situation fail to appreciate their interactions with others. Narrow framing is the opposite of holding a big picture.

As an example, Kahneman described the experience of his colleague Richard Thaler, who was meeting with a group top managers of 25 divisions of a large company.

He asked them to consider a risky option in which, with equal probabilities, they could lose a large amount of the capital they controlled or earn double that amount. None of the executives was swilling to take such a dangerous gamble. Thaler then turned to the CEO, who was also present, and asked for his opinion. Without hesitation, the CEO answered, “I would like all of them to accept their risks.”

The CEO’s broader frame allowed him to make a decision that implicitly understood that the gains would cancel out the losses and shareholders would do better. The division managers naturally had a risk-adverse mindset; the problem came when each narrow framed on their own condition instead of elevating their perspective.

Many incumbent organizations have stagnated. This is because localized decisions lead to conservative decisions. Opportunities are missed.

By contrast, competent strategic thinkers are aware of the difference between narrow and broad framing and strive to continually analyzed decisions through risk policy that benefits the whole. Strategy itself can be thought of a centralization of certain policies that create impact across the entire organizational system.

Excessive coherence – The idea that strategy is a plan is another way to say that the various elements of a strategy “make sense.” Coherence is the characteristic of a story that indicates that it “hangs together” in the memory so that it seems natural and logical. Excessive coherence is when a person reads too much into a situation, finding causes and relationships where none exist. Excessive coherence explains the halo effect where jump to conclusion that a particular person has extraordinary powers because of their affiliations or past successes.

Most people are familiar with the concept of groupthink where an entire group convinces themselves of the correctness of a strategy. Group social norms – a kind of social coherence – provides reinforcement to the story.

Overconfidence is one of the biggest flaws in strategic thinking. Excessive coherence, that is, belief in the story, leads to overconfidence.

Instead, competent strategic thinkers look for disconfirming evidence and alternative explanations for those signals that are ignored by others.

What are shortcomings should we be aware of?