The Art of Thinking Clearly: Better Thinking, Better Decisions

See also Contrast Effect (ch. 10); Fear of Regret (ch. 82); House-Money Effect (ch. 84)

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28
WHEN YOU HEAR HOOFBEATS, DON’T EXPECT A ZEBRA
Base-Rate Neglect
Mark is a thin man from Germany with glasses who likes to listen to Mozart.
Which is more likely? That Mark is A) a truck driver or B) a professor of literature
in Frankfurt. Most will bet on B, which is wrong. Germany has 10,000 times more
truck drivers than Frankfurt has literature professors. Therefore, it is more likely
that Mark is a truck driver. So what just happened? The detailed description
enticed us to overlook the statistical reality. Scientists call this fallacy 
base-rate
neglect
: a disregard of fundamental distribution levels. It is one of the most
common errors in reasoning. Virtually all journalists, economists and politicians
fall for it on a regular basis.
Here is a second example: a young man is stabbed and fatally injured. Which
of these is more likely? A) The attacker is a Russian immigrant and imports
combat knives illegally, or B) the attacker is a middle-class American. You know
the drill now: option B is much more likely because there are a million times more
middle-class Americans than there are Russian knife importers.
In medicine, 
base-rate neglect
plays an important role. For example, migraines
can point (among others) to a viral infection or a brain tumour. However, viral
infections are much more common (in other words, they have a higher base rate),
so doctors assess patients for these first before testing for tumours. This is very
reasonable. In medical school, residents spend a lot of time purging 
base-rate
neglect
. The motto drummed into any prospective doctor in the United States is:
‘When you hear hoofbeats behind you, don’t expect to see a zebra.’ Which
means: investigate the most likely ailments before you start diagnosing exotic
diseases, even if you are a specialist in that.
Doctors are the only professionals who enjoy this base-rate training.
Regrettably, few people in business are exposed to it. Now and then I see high-
flying entrepreneurs’ business plans and get very excited by their products, ideas
and personalities. I often catch myself thinking: this could be the next Google! But
a glance at the base rate brings me back down to earth. The probability that a firm
will survive the first five years is 20%. So what then is the probability that they will

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grow into a global corporation? Almost zero. Warren Buffett once explained why
he does not invest in biotech companies: ‘How many of these companies make a
turnover of several hundred million dollars? It simply does not happen?. . .?The
most likely scenario is that these firms will just hover somewhere in the middle.’
This is clear base-rate thinking. For most people, 
survivorship bias
(chapter 1) is
one of the causes for their 
base-rate neglect
. They tend to see only the successful
individuals and companies, because the unsuccessful cases are not reported (or
are under-reported). This makes them neglect the large part of the ‘invisible’
cases.
Imagine you are sampling wine in a restaurant and have to guess from which
country it comes. The label of the bottle is covered. If, like me, you are not a wine
connoisseur, the only lifeline you have is the base rate. You know from
experience that about three-quarters of the wines on the menu are of French
origin, so reasonably, you guess France, even if you suspect a Chilean or
Californian twist.
Sometimes I have the dubious honour of speaking in front of students of elite
business schools. When I ask them about their career prospects, most answer
that in the medium term, they see themselves on the boards of global companies.
Years ago, both my fellow students and I gave the same answer. The way I see it,
my role is to give students a base-rate crash course: ‘With a degree from this
school, the chance of you landing a spot on the board of a Fortune 500 company
is less than 0.1%. No matter how smart and ambitious you are, the most likely
scenario is that you will end up in middle management.’ With this, I earn shocked
looks, and tell myself that I have made a small contribution toward mitigating their
future mid-life crises.