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Too Early to Execute the Strategic Scenario Planning: Hyperbolic Discounting and Psychological Biases ofIndonesian SMEs Managers

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Rayenda BrahmanaSchool of ManagementUniversiti Sains MalaysiaMindenP.PenangMalaysia

Widyana Verawaty SiregarFaculty of EconomicsUniversitas MalikussalehLhoseumaweNADIndonesia

Arnawan HsbFaculty of EngineeringUniversitas MalikussalehLhoseumaweNADIndonesia

Corresponding author: Rayenda Brahmana Corresponding Author’s Email: [email protected]

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Acknowledgments ( if applicable):

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Structured Abstract:

PurposeUsing the Hyperbolic Discounting approach in qualitative manner, this article aims to explore the linkage of the timepreference bias towards the too early execution of strategic focused planning. We also investigate the role ofpsychological bias in explaining the early execution.

Design/methodology/approachThis research use qualitative methods to explore the role of hyperbolic discounting in driving thepsychological bias towards too early strategic scenario planning, and its rationalization. We conductedface-to-face survey by door-to-door of the SME. The samples in this research are Indonesia Northernpart of Sumatran Small and Medium Enterprises.



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FindingsThis research found most of the SMEs managers are time preference bias due to hyperbolic discounting. Thishyperbolic discounting awoke manager’s psychological bias and resulted too early decision making. This psychologicalbias might be due to the mental of prospect theory, or the representative effect, or Framing Bias, or the adaptive bias.

Research limitations/implicationsThe sample is only taken from Northern part of Indonesia. To have a robust generalization, the research should beconducted in the entire part of Indonesia.

Practical implicationsThis paper can be used by practitioner to understand their behaviour towards strategic decision making. Further,practitioner will know that if their time preference bias will not generate better result.

Keywords: SMEs, Indonesia, strategy, hyperbolic discounting, psychological bias, strategic focused planning

Article Classification: Research paper

For internal production use onlyRunning Heads:



Too Early to Execute the Strategic Scenario Planning: Hyperbolic

Discounting and Psychological Biases of Indonesian SMEs Managers1. IntroductionTo survive in a turbulent environment, the firm manager develops a strategy by assessing theenvironment which includes scenario planning to tackle unpredictable events based oninformation gathering, analysis, and planning activity (Wright, 2000). This scenario planningassists the organization to anticipate anomalous conditions, understand the risk and awarenessof alternate future possibilities. Indeed scenario planning must follow the utility function andeconomics motive. However, because building a strategy is fully subjective in nature, the roleof psychology might influence the strategic decision making process (Schwartz, 1996); anissue which is commonly overlooked by academicians and practitioners.

The standard tenet in decision science is agents (or in our case firm managers) are assumed to be time-consistent following their utility function. This assumption addresses that a contrasttime preference such as short run and long run never arises; or so-called exponentialdiscounting. However, a growing body of literature has challenged this traditional view andallows firm managers to be time inconsistent by modeling their discount function ashyperbolic. This is the contrasting view that this study will enrich, where firm managers donot always follow their utility function in making strategic decisions.

Firm managers with hyperbolic discount 1 functions demonstrate a high degree of discountingin the short run but a relatively low degree of discounting in the long run (Rubinstein, 2003).Therefore, hyperbolic firm managers are likely to delay tasks with immediate costs anddelayed benefits, whereas they would choose to perform the same task if both costs and

benefits were to occur in the future.

Relating back to business strategy formulation, firm managers are assumed not to follow their personal preferences, be rational, and time-consistent in making decision. In terms ofscenario planning of business strategy formulation, its strength lies in the value ofinterpreting the environment (Raspin and Terjesen, 2007). The well-formulated scenariosassist managers to develop their sense-making skills (Weick, 1995) by framing and reframingthe business environment. As it is based on the intuition of managers, the role of psychologymight affect the decision making; a situation that has implication for organization

performance.Our interest in this study is to revisit the psychological influence on the early implementationof business strategy scenario planning moderated by hyperbolic discounting. Instead ofconfirming the previous literature about strategic management, we choose to focus on findinganother explanation beyond decision making. We do believe the existing literatureempirically argue the decision making under the utility function circumstance. Meanwhile, inthe real world, decision making does not always follow the rational assumption. Mainly in theSmall and Medium enterprises (hereafter SME), whereas the literature suggest they are moreirrational in crafting strategy compared to larger companies (see Gagnon, Sicotte, and

1 Hyperbolic Discounting means people tend to choose to have a reward in the nearest date if it is only shortterm, but can wait the reward for long run. i.e. we will choose USD1 reward in tomorrow rather than USD3reward in the next three days. But we will choose USD3 reward in 63 days rather than USD1 reward in 60 days.



Posada, 2000; Johnsen and McMahon, 2005; Carneiro, 2006). In short, we propose anotherexplanation beyond the strategy making of SMEs by gauging the hyperbolic discounting (seeFigure 1).

Figure 1 Black Box framework of Decision Making

The case in our study is the behavior of firm managers in facing the 2government plan toincrease the electricity tariff. Logically, firm managers should establish a strategic plan ofcost reduction to overcome potential future problems. Following the utility function, thedecision should be post the event because the government has not made any announcements.Interestingly, Indonesian SMEs implemented their strategy scenario planning before the planof increases of electricity tariff was implemented. Borrowing Rispen and Terjesen (2007)term, this is what we called as the too early strategic Focused planning. It means the firmmanagers execute the strategic focused planning sooner than its schedule. We found the link

between too early strategic focused planning execution and the hyperbolic discounting because of their psychological biases effect. If this is the case, the irrational prevention actionwhich taken by a firm manager might be because of their time preference bias. Therefore, weexplore their behavior towards the stimulants, and relate it with their strategy decisionmaking.

To deliver the idea in a proper manner, we set our study as follows: Section 2 presents theData and Methodology. The results of first experiment, second experiment, third experiment,and in-depth interview are delivered in section 3, 4, 5, and 6 consecutively. Section 7discusses the result to form the hypothesis. Section 8, the last section, remarks the propositionwith its framework.

2. Data and MethodologyWe used qualitative methods to explore the role of hyperbolic discounting in driving the

psychological bias towards too early strategic scenario planning, and its rationalization. Thesamples in this research are Indonesia Northern part of Sumatran Small and Medium

2 When the study conducted, the government planned to increase the electricity tariff due to Oil Pricefluctuation. The data collection had been conducted 4 months after the government proposal. 4 month after thedata collection, the government increased the electricity tariff.



Enterprises. As this is a qualitative research, the number of samples is not an issue. Nevertheless, we have an adequate number of respondents.

We conducted face-to-face surveys by door-to-door contact with the SME. It was conductedin 2009. At first, we asked them to fill the questionnaire, and thereafter we conducted theinterview. The SMEs included in this study are the small class enterprise and medium classenterprise. Indonesian SME ministries; the small enterprise SMEs, are those firms with anAsset not to exceed Rp 200 Million (approximately equal to USD 20,000). Meanwhile, a firmthat has asset in the range of Rp200 Million up to Rp 10 billion (approximately equal to USD20,000 – USD 1 Million) is classified as Medium enterprise SME (please see Decree ofFinance Minister: Keputusan Menteri Keuangan No 316/KMK.016/1994 tanggal 27 Juni1994). There are 98 SMEs in total. This is described in detail in Table 1.

Table 1: The Profile of SMEs

< 10 6 2.33

10 25 19 4.84 26 50 11 7.73

50 15 9.27

51

< 50 15 7.47

50 100 14 11.79 101 200 10 15.30

200 8 18.38 47

This study follows the Rubinstein (2003) hyperbolic discounting experiments. Meanwhile,

the interview was made using our self-constructed guideline which is a plausible applicationof the hyperbolic discounting hypothesis. The results of these mentioned methodologies areretrieved as our fundamental to propose the proposition regarding the linkage between time

preference bias (hyperbolic discounting and strategic scenario planning implementation).

We translated the Rubinstein’s survey (2003) into the Indonesian language, and thenIndonesian to English by using a professional translator. If the meaning has much variance,we will do the translation again. Luckily, the survey that was constructed by Rubinstein(2003) is not a difficult and complicated form of English. We translated it in one round withinsignificant differences.



3. Experiments IBased on Rubinstein (2003), we derived 6 questions which break down into 3 subsections ofthe experiment. The purpose of the subsection is to check the rigor and robustness of thesurvey in revealing the hyperbolic discounting behavior of the SME’s manager. Please notethat the word “manager” here is referring to the owner. As we know, the manager in a SME isactually the owner of the organization. The first subsection consists of Question 1 (Q1) andQuestion 2 (2). The detail is:

Q1 Imagine you have to choose between the following options:A) The Government increases the Electricity Tariff one month after today by 7%B) The Government increases the Electricity Tariff three months after today by 8%What will be your choice?

Q2 Imagine you have to choose between the following options:A) The Government Increases the Electricity Tariff twelve months after today by 7%B) The Government Increases the Electricity Tariff fifteen months after today by 8%

What will be your choice?Table 2 depicts the results of hyperbolic discounting where we found it interesting. Weremark this hyperbolic discounting because many of respondents chose B in Q1 and thenchose A in Q2. It violates the utility function exponentially. Let us look to the table. 67% ofrespondents prefer the government not to apply the new tariff as soon as possible. For them,one month and three months have significant impacts. It might be related to their limitedcash reserves. However, if we gave them a different scenario, they chose twelve months aftertoday by 7% compared to 8% fifteen months after today. This result shows their hyperbolicdiscounting. In other words, Indonesian SME’s managers exhibit the time preference bias.

Table 2: The Result of Experiment 1

1 33% 67% 2 59% 41%

4. Experiments IIThe second subsection consists of Question 3 (Q3) and Question 4 (Q4). The detail is:

Q3 You can pay your electricity bill in installment manner. If there are two options, whichone do you prefer?

1 1 1 1 97,000 97,000 97,000 97,000

1 1 1 1 100,000 100,000 100,000 100,000

Q4 Which one do you prefer?A) Payment of Rp 97,000 on 1 st Dec

B)

Payment of Rp 100,000 on 1st

of Nov



If following the hyperbolic discounting theorem, every manager choosing A in Q4 willchoose A in Q3. Again, consider the general function of the hyperbolic discounting, of

∑ ∏= =+

,...2,1 ,...,10 )()(0(t s t s x x υ δ υ , where ( s

δ ) is a weakly increasing sequence. If a manager

chooses B in Q4, it means he/she is ready to sacrifice 3% in order to advance payment due byone month. Therefore, based on Table 3 result, we can surmise that the firm manager did time

preference bias by its hyperbolic discounting.

Table 3: The Result of Experiment II

3 54% 46%

4 57% 43%

Table 3 depicts that 54% of respondents chose A. It means that firm manager prefers to delaytheir payment to receive discount. The 57% who chose A in Q4 confirms this result. It is inline with the inverse hyperbolic discounting where in term of payment people try to avoid it.Therefore, we can surmise the experiment II shows the hyperbolic discounting preference ofIndonesian SME’s firm manager.

5. Experiments IIIIn hyperbolic discounting manner, a firm manager shows a preference for one that arrives

sooner rather than later. The discounting words come to this term as he/she values therewards exaggeratedly in short run, but then values the rewards deflatedly in long run.Indeed, it is different if we want to do a payment like Experiment 1 and Experiment 2. We dothe third experiment to test whether the hyperbolic discounting of the manager is consistentor not.

Q5 Imagine that you have to choose between the following two options:A) Receiving Rp700,000 on Dec 1 st 2010.B) Receiving Rp1,000,000 on Dec 1 st 2011.What will be your choice?

Q6 Imagine that you have to choose between the following two options:A) Receiving Rp970,000 on Dec 1 st 2010.B) Receiving Rp1,270,000 on Dec 2 nd 2010.What will be your choice?

Choosing “delay” in Q5 and “no delay” in Q6 will show the time preferences bias. It

indicates the hyperbolic discounting the utility function of ∑ ∏= =+

,...2,1 ,...,10 )()(0(t s t s x x υ δ υ ,

where ( sδ ) is a weakly increasing sequence. If a subject choose A in Q5, then he/she is ready

to sacrifice Rp300,000 or 30% discount in order to advance the payment due in December byone month. The hyperbolic discounting theory predicts that he would find the 30% discountsacrifice worthwhile in order to advance any of the other scheduled payments by one month.



Table 4: The Result of Experiment III

1 38% 62% 2 57% 43%

Our result is consistently supporting the hyperbolic discounting theory. We found that themanagers have time preference biases. Firm managers have a strong tendency to makechoices that are inconsistent over time. They make a decision today that their future selfwould prefer not to make, despite using same the justification. In other words, firm managershave tendency in self-control bias as having time preference biases. The results depicted onTable 4 supports this tendency.

6. In-Depth InterviewThe interviews were conducted by 11 field researchers. It was recorded, fully transcribedwith accompanying notes, and run into NVIVO software. We coded and thematicallyanalysed the data sets using an interpretive approach. We reconfirmed our result with expertsin behavioural economics and strategic management. We discussed the results with the fieldresearcher to ensure a robust result. In the end, we found six keywords for the strategy actionof SME in facing the Government plan of electricity tariff increases, and five keywords as the

reasoning beyond the strategy action.

The strategy taken by the SMEs to face the increase of electricity tariff plan is depicted inTable 5. Most of the SMEs have already begun to do electricity efficiency campaign.Moreover, most of them also have begun to increase the price of their products. Interestingly,59% of SMEs did employee rationalization. It means they cut off the number of employee

before the government plan to increase the electricity tariff was implemented. We also foundthat only small numbers of SME (7%) have not applied anything because of waiting for theimplementation. 18% of SMEs stated that they will not do any strategic action or planning infacing the electricity tariff increase plan. Those who will not change everything or waiting forimplementation argue that the increase of electricity tariff does not change anything. Thereasoning of those who already applied strategy action is addressed in Table 5.

Table 5: The Strategy Action that Have Been Taken By SME

74 76%

63 64%

58 59%

18 18%

14 14% 7 7%



They gave the adaptation before the implementation as the main reason why they have toimplement the strategy action. 88% of the SMEs believed that the strategic action needs timeto adjust in the organization if the government increases the electricity tariff. Therefore, it isnecessary to conduct the strategic action before the electricity tariff increases. 69% of theSMEs addressed the increase of raw material as their reason. They argued that by announcingthe plan to increase the electricity tariff, the price of the raw material will increaseautomatically; an occasion that is called as reactive inflation in economics. This reactiveinflation also brought 62% and 59% of SMEs to implement their strategic action before the

plan was implemented because it will increase the total cost and decrease the demand. Inother words, these SME managers applied their strategic action to anticipate the reactiveinflation during the increases of electricity tariff. Some more, there is 34% of SMEs statedthe price increase by competitor as their reason. The discussion of these findings is discussedcomprehensively in next section.

Table 6: The SMEs Rationalization Beyond their Strategy Action

65 88%

51 69%

46 62%

44 59%

25 34%

7. DiscussionAccording to Rispen and Terjesen (2007) there are 3 type of planning in business strategy,which are: (1) Formal Forecasting, (2) Focused Forecasting, and (3) Intuitive Forecasting.The formality and the breadth are the dimensions that distinguished one planning approach toanother planning approach. The formality means the way in retrieving the information.Meanwhile, the breadth means the broadness in gathering the information. Figure 2 depictsthe differences.After conducting the survey in Indonesian SMEs, we observed that the firm managers utilizefocused forecasting. They dedicate their resources to short term plan that are issue driven.Moreover, this type of planner often makes decision with in regards to a significant current

business environment whereas in our case the issue is the government plan to increase theelectricity tariff. Focused forecasting strategy expects to overcome the problems when itsurfaces. This behavior can be seen in our result where most of Indonesian SMEs firmmanagers already sketched a program to surmount the issue of electricity tariff.



Figure 2: Three Forecasting Modes (Raspin and Terjesen, 2007)

If we already found that the firm managers of Indonesia SMEs adopt focused forecasting,what is the role of hyperbolic discounting into their decision? Hyperbolic discounting

behavior is the easy way to see whether the firm manager is time preference biased or not. In

our case, most of the Indonesian SMEs firm managers exhibit time preference bias (refer tothe experimental results). The decision maker’s (in this case is the SMEs manager) preferences alter over time implying the inconsistency in executing their preferences. Thistime preference bias has played a role on shifting the preference period. For example, if themanagers should buy a machine in the next three months according to budget plan, they will

buy it earlier because of a stimulant affecting their decision. They will make justification andrationalization to overcome their bias. Back to our research, it is also found in the. As mostIndonesian SME firm managers have time preference bias (hyperbolic discounting problem),they “discounted” their plan in the future to the present. Indeed, it will affect the performanceof the organization. Depicted in table 7, their company performance has no changes after they

discounted their future plan. In a nutshell, the hyperbolic discounting plays role on thedecision taken by the SMEs firm managers.

Table 7: Result of the Implementation after Three Months

%

47 47.96%

23 23.47%

11 11.22%

17 17.35%



If the hyperbolic discounting affects the bias strategic action of Indonesian SMEs firmmanagers, what is the driver of this kind of behavior? This is the key and the importance ofthis study. We explore and propose the determinant of a discounted plan that did not result inany consequence. Hence, we propose psychological biases as the determinant of discountedfocused forecasting.In general, there are 4 main schools of thought that offered different psychological biases forthis matter, which are: (1) Behaviorist, (2) Gestalt, (3) Cognitive, and (4) Social Psychology(see Table 8). We compiled from Tvede (2002) and link it with our result.

Table 8: Psychology Bias Description

Source: Compiled from Tvede (2002)

In term of the behaviorist school of thought, there is a decision making bias called ProspectTheory. In this psychological bias, people tend to be less eager to gamble with profits thanwith losses. Prospect theory means decision maker gives more value to a gain of a given sizethan to an equal loss (Kahneman and Tversky, 1979). This theory can be used to reveal why

people tend to gamble much in achieving gaining rather than in reducing loss. Clarke, Krase,and Statman (1994) addressed regret and loss aversion as the reasoning behind this behavior.People cannot bear to face the reality of loss and thereby make irrational decisions. In our

study, it was vividly portrayed by the behavior of firm managers. Firm managers were afraidthat the raw material and total cost will be increased. They cannot face this problem as it willresult in a loss to them. Thereby, they did hyperbolic discounting by present value of theirfocused planned. In the end, this action did not result in any advantage for them (see table 6).

In summary, people make decision for psychological reasons. Their behaviour is affected bythe hyperbolic discounting attitude. SMEs in Indonesia try to avoid the pain of regret byimplementing the plan sooner than expected. They were afraid that the electricity tariff willinterrupt their financial performance. In brief, the hyperbolic discounting of decision makersin SMEs creates a psychological bias, so-called as Regret and Loss Aversion. This

psychological bias brought SMEs firm managers to execute their focused plan much earlierthan planned.



Our phenomenon also can be analyzed by using Representative effects. It can be simplydescribed as a tendency to think that the trends we observe are likely to continue (Kahnemanand Riepe, 1998). Psychologists use Representativeness for a common error where weestimate the likelihood of something to be true or to happen by how much it resemblessomething similar or something that has already happened (Tvede, 2002). In our case, theSMEs firm managers had experienced the effects of rising electricity tariffs. They “felt” theraw material and total cost will increase. They thought the demand will decrease due toinflation. Further, they thought the competitors will also increase the price. By having thetime preference bias (hyperbolic discounting), it is not a surprise if they employed theirfocused planned earlier than the time schedule. The hyperbolic discounting or time

preference bias inside the firm manager’s cognition moderated this psychological bias. In brief, for a focused forecasting strategic decision maker, the hyperbolic discounting mighthave an effect on awaking the psychological bias; resulting in discounted decision.

The cognitive psychology addresses the behavior of Indonesian SMEs as Framing. Framingmeans the process of decision making influenced by input that seems to suggest the correctanswer. The result of framing is a dependent opinion into certain input. In our case, if wefollow the cognitive psychology, the firm manager of SMEs could have framing bias in theirdecision making. The firm manager relies on the issue of the economic catastrophe if theelectricity tariff is increasing from media reports. They stacked their cognition that the rawmaterial and the total cost will increase and cause difficulties for them. With their hyperbolicdiscounting preference, they implemented their strategy earlier irrationally. It can be seenafter they implement their strategy, actually nothing happens after the increase of electricity

tariff. This framing bias can cause the firm manager to “discount” their strategic planningschedule. In a short, we remark that the hyperbolic discounting (time preference bias) affectsthe cognition of decision maker (firm manager) to be a framing bias; resulting inimplementing the strategic planning earlier than schedule.Another school of thought that can explain this psychological bias is social psychology. Inthis theorem, they address adaptive bias as the explanation on the discounted planned ofSME’s manager. Adaptive bias means the decision maker develops a decision by followingthe others who they associate with. In this case, the firm managers associates their decisionmaking plan to their competitors. As depicted in table 6, 34% of firm managers stated theyimplemented the strategic action earlier because the competitors will increase their price,even though in reality is not the case. In other words, these managers have psychological

biases towards their decision. The hyperbolic discounting is the moderating effect on this behavior and cause the early implementation of strategic action in facing the increase ofelectricity tariff plan.

8. PropositionTherefore, based on our results, we develop our results through a proposition, which is:

Proposition : Firm managers who are stimulated by issue (Forecasted Planner) might have psychological biases in their decision if there is a moderating effect of hyperbolicdiscounting; and resulting discounted planned.

Our proposition offers that the hyperbolic discounting of the firm managers give a

psychological bias. This psychological bias generated an early execution of strategic planning. Indeed, this behavior is an irrational decision and resulting in nothing. As depicted



in Table 7, nothing changes in the firm after they executed the strategic action earlier thusstrengthening our postulation regarding the irrational decision. To prove the applicability ofthis proposition, future studies need to examine it empirically. It is noteworthy that requiresmore psychological explanation to open the black box of decision making. Future researchshould adopt the psychology perspective to reveal the role of hyperbolic discounting onforecasted strategic planning. Figure 3 shows the linkages from the stimulants, moderated bytime preferences bias (Hyperbolic Discounting), until the bad strategic planning.

Figure 3: The Proposed Framework

Let us therefore conclude this study by stating that in the case of Indonesian SMEs, most ofthe firm managers exhibit psychological biases on their decision-making because of thehyperbolic discounting effect.The Irrational decision making of firm manager leads to the formulation of poor strategic

plans. This irrationality is the consequences of the personal attitude belief or value which iscalled as Self-Control bias. The Time preference bias or known as hyperbolic discountingtriggers the self-control bias of firm manager. In the end, we can remark that the hyperbolicdiscounting is the driver of the bad decision making.



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