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Second-Order Thinking: Reasoning Through Different Business Outcomes

September 25, 2020 / by Ben Cohen, FSA, MAAA

In 1985, the Chicago Tribune reported on a Cheez Whiz advertising campaign that went wrong. The campaign, created by account planners at J. Walter Thompson, released a campaign entitled, “Real Cheese Made Easy.” The planners had conducted consumer research performing focus group studies and asked a simple question: why don’t you buy Cheez Whiz?

The answers all circulated around the single idea that Cheez Whiz wasn’t made with real cheese. When the facilitator then listed the ingredients and explained how Cheez Whiz was made, the participants generally felt better and were reported to have positive feelings about Cheez Whiz. 

Thus, the advertising campaign was born. However, upon its launch in test markets, it was met with a series of backlashes and complaints to the FTC regarding truth in advertising. The brand was hurt in those test markets, and they had to go back to the drawing board.

Why did the campaign fail even though the research indicated it would do well? The advertising executives only considered first-order outcomes, and had they employed second-order thinking, they would have made different decisions. 

First-order thinking says, “We need to correct people’s thinking about Cheez Whiz, then they’ll buy from us.” Second-order thinking says, “If we correct people’s thinking, how will they respond?” They would have come to two main responses:

  • If we try to correct people’s thinking, they won’t believe us.
  • If we try to correct people’s thinking, they might believe we're calling them stupid.

Incidentally, both of those things happened, and Cheez Whiz suffered for it. By employing second-order thinking, a business can improve their decision making and avoid adverse outcomes. 

“Failing to consider second- and third-order consequences are the cause of a lot of painfully bad decisions. It is especially deadly when the first inferior option confirms your own biases. Never seize on the first available option, no matter how good it seems, before you’ve asked questions and explored.” - Ray Dalio, from his book Principles

What is second-order thinking, and how does it help make better decisions?

Second-order thinking is a mental model and part of our actuarial toolkit and concepts such as Occam's Razor and Inversion Thinking. Howard Marks in his book, The Most Important Thing, describes what he calls second-level thinking.

“First-level thinking is simplistic and superficial, and just about everyone can do it (a bad sign for anything involving an attempt at superiority). All the first-level thinker needs is an opinion about the future, as in 'The outlook for the company is favorable, meaning the stock will go up.' Second-level thinking is deep, complex and convoluted.”

First-level thinking is natural. It seeks to solve immediate problems but fails to consider any unintended consequences of our decisions. The first-order consequences might provide immediate results in the short-term, but the second-order consequences might have negative effects.

Second-order thinking weighs decisions for their long-term effects. Second-order thinkers are continually asking themselves, “And then what?” They create feedback loops, document their decision-making process, and check back weeks and months to understand the first-order effects and second-order effects.

Why Actuaries are Second Level Thinkers

Actuaries must constantly consider the impact down the road of decisions made today.  These situations often occur when we assist with product development.  Most actuaries are conservative by nature and tend to look at minimizing the possibility of an adverse financial result.  However, taken too far to the extreme, a new product can become out of touch with the market, causing it to be unsellable by agents and unsuitable for customers.  We must remember that if the company never sells a policy, then it can't stay in business.  A short term decision that balances key assumptions could result in lower short term profits, but this result is much better than never selling a policy at all!

On the opposite extreme, a company can sell too much as well.  We have been asked to help remediate companies that didn't consider the strain associated with sales and the compounded impact over many years.  Even though profits were expected down the road, the upfront cost of underwriting and commissions put the company into a dangerous cash flow situation.  This could have been solved by using a reinsurer.  While this means splitting profits, it also prevents a potentially disastrous situation from lack of capital.

 Due to the long-term nature of insurance, incorporating second- and third-order thinking into our processes helps us make better decisions for our clients.

Make Better Decisions with Second-Order Thinking

  1. Always ask, “And then what?”
  2. Map out first, second, third, and even fourth-level consequences. 
  3. Determine results over time. What if a week, month, year, or decade passes? What happens?

 

Topics: Insights

Ben Cohen, FSA, MAAA

Written by Ben Cohen, FSA, MAAA

Ben serves as Wakely Actuarial’s President & Consulting Actuary. He joined Wakely in 2002 and enjoys the variety in the day-to-day of his current role.

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