The Flaw of Averages: Why We Underestimate Risk in the Face of Uncertainty

CHAPTER 11 CHAPTER

Mindle 4: Terri Dial and the Drunk in the Road

“Consider a drunk staggering down the middle of a busy highway,” I told a group of Wells Fargo bank executives in 1995, “and assume that his average position is the centerline. Then the state of the drunk at his average position is alive, but on average he’s dead.”¹

Practically before the words were out of my mouth, one of the bankers exclaimed: “Why that’s the reason we always blow the budget on our incentive plan!”

I wasn’t yet sure what she meant by this, but I knew that Terri Dial had just detected a case of the Strong Form of the Flaw of Averages. Terri had started her banking career as a teller in the 1970s, had worked her way up to executive vice president, and was two years away from being the chief executive of the retail banking division of Wells Fargo. The bank had difficulty in forecasting the total paid out in incentive bonuses, and Terri was looking for new perspectives on the problem.

She explained her insight with a simplified example, as follows. Suppose the number of checking accounts sold per year by employees varied widely but averaged 200. To increase performance, you decide to reward everyone with above-average sales (201 or more), with a $1,000 bonus, while everyone else gets zero. I have heard some in the industry refer to such a hurdle as a “champagne moment.” On average how much do you need ...