Consequences: Thinking Through Second and Third Order Effects

There are many situations in business and in our personal lives that invite an immediate decision without reference to their consequences. This is known as a first order effect where we are responding to events we hadn’t planned for. For example, we need to act when threats are immediate, and safety is at stake or when we decide that the risk associated with a bad decision is easily contained. For prevaricators, not making a decision can also been seen as a first order effect although waiting for more information can sometimes turn out to be prudent!

Unexpected risks to people and property drive reactions in the moment but thinking through and planning for these scenarios - rare or not - can provide a much better response. The second and third order effects require us to look beyond the immediate decision, using skill and experience, to predict potential consequences of those decisions we make in the moment. Sometimes this is referred to as scenario planning.

For most of us, when we think of second and third order thinking we almost always relate it to gaming, from chess or other strategic games: understanding the moves open to our opponents places us in a better position to act and respond as the game unfolds. Similarly, scenarios are often used by organizations to plan for the upcoming year or even a five-year outlook, yet once the strategy is in play, those scenarios are rarely revisited to inform our decision making as the period unfolds, or even reviewed in the next planning cycle - we tend to look at what happened rather than the quality of our predictions.

We are increasingly surrounded by intense prompts for first-order thinking. For example, social media drives reactive responses, opinions are formed in the moment and then traded as statements of fact; businesses are driven more by competitive response than the strengths of their own organization; and by our general lack of empathetic analysis. The problem for stakeholders with first-order responses is the confidence with which they are delivered, they broker no dissent, are forthright and firm, and they are delivered quickly. These reactive responses can haunt and damage us.

The Dunning-Kruger Effect reflects cognitive bias where individuals tend to overrate their decision making because they do not recognize any qualitative difference between their own knowledge and the abilities of other people. Their misplaced confidence can also give them a first order mindset, where they don’t stop to consider the wider impact of their direction.

This graph shows a comparison between actual and perceived performance over a range of competences. As competence increases, perception of performance reduces as knowledge and experience tempers blind confidence.

First order thinkers respond quickly, which in the moment is popular - especially when paired with a Dunning-Kruger level of confidence. This is the person who jumps in feet first to ‘take charge’ with a ‘can-do’ attitude without truly understanding the situation. Second order thinkers live by a mantra closer to “act in haste and repent at leisure”, but their reaction time can be longer and because they tend to look towards hurdles and barriers to ensure they are avoided, they can be seen to be negative.

Howard Marks the investment strategist is often quoted when second order effects are discussed, which is not surprising as financial futures are dependent on predicting (or influencing) future events. It is touted that the smart investor always looks to the second order by considering how the actions of many may create opportunities for the second order thinker. Yet, much of what Marks advises is simply contrarian or counter-cyclic, even if the evidence doesn’t support the conclusion. Being the salmon in a fast-moving stream of investment opportunity but perhaps swimming up the wrong stream entirely. 

This isn’t second order thinking at all, but merely looking to buck a trend, and requires little examination of the consequences down the line. Investing drives these kinds of responses because markets are hard to interpret. Just like the casino gambler, their loyalty to their strategy - no matter how tenuous its relationship to the game - is justification for continuing to rail against losses by sticking to a plan whose odds never really change. A second order thinker doesn’t go to a casino unless they are counting cards at Blackjack, but a third order thinker would advise them of the real probability of ending your night in an uncomfortable position in a dark alley when the House uncovers your cunning plan. 

Looking beyond the obvious, seeking out broader trends and consequences as guides to actions, are second and third order effects that give us a wider appreciation of the risks involved in a decision. They may not affect the decision itself for all the other reasons that can drive a decision, yet being informed of possible consequences gives us a planning. Risk-response planning informs us of the richness of the challenges and opportunities that might emerge, placing us in a better position for lean thinking, organizational structuring and skills acquisition, amongst others.

Business and personal decisions seem increasingly complex, influenced in great part by ecological impacts and the increasingly interdependent macro-economic environment we find ourselves in. We have new threats to our strategies from the actions of bad actors or poorly designed systems, and the fiscal uncertainty of governmental decision making in a changing energy environment, for instance. All of this is enough for us to review how we map and plan for risks to our business and our people, but there are other factors at play too...