Your mind is a categorization machine, busy all the time taking in voluminous amounts of messy data and then simplifying and structuring it so that you can make sense of the world.
For a categorization to have value, two things must be true: First, it must be valid. You can’t just arbitrarily divide a homogeneous group. Second, it must be useful. The categories must behave differently in some way you care about. But in business we often create and rely on categories that are invalid, not useful or both — and this can lead to major errors in decision-making.
Categorical thinking can be dangerous in four important ways. It can lead you to compress the members of a category, treating them as if they were more alike than they are; amplify differences between members of different categories; discriminate, favoring certain categories over others; and fossilize, treating the categorical structure you’ve imposed as if it were static.
COMPRESSION
When you categorize, you think in terms of prototypes. But that makes it easy to forget the multitude of variations that exist within the category you’ve established.
THE MYTH OF THE TARGET CUSTOMER: Consider what happens in segmentation studies — one of the most common tools used by marketing departments. The goal of a segmentation study is to separate customers into categories and then identify target customers — that is, the category that deserves special attention and strategic focus.
Segmentation studies typically begin by asking customers about their behavior, desires and demographic characteristics. A clustering algorithm then divides respondents into groups according to similarities in how they answered. This kind of analysis rarely yields highly differentiated categories. But instead of seriously evaluating whether the clusters are valid, marketers just move on to the next steps in the segmentation process: determining average values, profiling and creating personas. This is how “minivan moms” and other such categories are born.
However, the segments that most businesses work with are not as clear-cut as they seem. Customers in a segment often behave very differently. To resist the effects of compression, analysts and managers might ask, How likely is it that two customers from different clusters are more similar than two customers from the same cluster? AMPLIFICATION
Categorical thinking encourages you to exaggerate differences across category boundaries. That can lead you to stereotype people from other groups, set arbitrary thresholds for decisions and draw inaccurate conclusions.
GROUP DYNAMICS: Success often hinges on creating interdepartmental synergies. But categorical thinking may cause you to seriously underestimate how well your teams can do cross-silo work together. If, say, you assume that your data scientists have lots of technical expertise but little understanding of how the business works, and that your marketing managers have the domain knowledge but can’t wrangle data, you might rarely think about having them team up.
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DECISION-MAKING: Whenever you make a decision using a cutoff along some continuous dimension, you’re likely to amplify small differences. After the financial crisis in 2008, the Belgian government bailed out Fortis, a subsidiary of BNP Paribas. As a result, the government owned millions of shares of BNP Paribas. According to the Belgian newspaper De Standaard, at the end of January 2018, when the stock price was a little over 67 euros, the government decided that it would sell its shares if they reached 68 euros again. But they never did; instead the price plummeted, and those shares are now worth only 44 euros.
Nobody in the Belgian government could have predicted that the stock price would fall so much. But the government’s mistake was to make selling its shares an all-ornothing affair.
DISCRIMINATION
Once you’ve imposed a categorical structure, you tend to favor certain categories over others. But insufficiently attending to other categories can be harmful.
OVERTARGETING: Targeting online ads broadly often yields a higher return on investment than targeting narrowly. Researchers have found that online ads tend to increase purchase probability by only a small fraction of a percent. If the chance that someone will buy your product without seeing an ad is 0.10%, exposure to an ad might move the probability up to 0.13%. The positive impact of the ad may be a bit greater for target customers, but in many cases it won’t compensate for the additional cost per click. Marketers, however, get obsessed with their target customers, ignoring the value that can be extracted from everyone else. FOSSILIZATION
Categories lead to a fixed worldview. They give us a sense that this is how things are, rather than how someone decided to organize the world.
INNOVATION: Innovation is about breaking the tendency to think categorically. Many businesses aim to increase the efficiency of their operations through categorization. They assign tasks to people, and people to departments. Such disciplinary boundaries serve a purpose, but they also come at a cost. Future business problems don’t fall neatly within the boundaries that were created to help solve past problems. And thinking only within existing categories can slow down the creation of knowledge, because it interferes with people’s ability to combine elements in new ways.
LIMITING THE DANGERS OF CATEGORICAL THINKING
So how can a thoughtful leader avoid the harm that comes from categorical thinking? We propose a four-step process:
1. INCREASE AWARENESS. Anybody who makes decisions needs to be aware of the oversimplifications that categorical thinking encourages and the invisible biases it creates. Companies should help their employees be more comfortable with uncertainty, nuance and complexity. “Is a categorization valid?” is a question that should be part of the decisionmaking mantra.
2. DEVELOP CAPABILITIES TO ANALYZE DATA CONTINUOUSLY. Any company that uses segmentation studies as a major part of its marketing research or strategic planning should employ well-established metrics offer and develop in-house expertise for interpreting the data.
3. AUDIT DECISION CRITERIA. Many companies decide they will act only after they pass some arbitrary threshold on a continuum. This increases risk and can impede learning. To avoid these problems, we recommend that you perform an audit of decision-making criteria throughout your organization.
4. SCHEDULE REGULAR ‘ DEFOSSILIZATION’ MEETINGS. Even if you follow the three steps above, fossilization is still a danger. To avoid it, hold regular brainstorming meetings at which you scrutinize your most basic beliefs about what is happening in your industry.
Categories are how we make sense of the world and communicate our ideas to others. But when we see categories where none exist, it warps our view of the world, and our decision-making suffers. Today, as the data revolution progresses, a key to success will be learning to mitigate the consequences of categorical thinking.
