In For A Penny, In for A Pound: How "Staying The Course" Can Ruin Your Business
”If at first you don’t succeed, try, try, again. Then quit. No use being a damn fool about it.” – C. Fields
Consider these examples:
- You have invested 100 million dollars in a larger housing project, but six months into the project it is clear that you will have to invest 20 million more for the project to a success. Would you pull the plug on the project or allocate the remaining money?
- You work as a venture capitalist and have previously invested 5 million dollars in a promising start-up company. A year later, the company is about to run out of money and will definitely go bankrupt without an additional investment of 2 million. Would you choose to invest again?
- You took a job in a leading consultancy firm earning you employee shares, bonuses and the promise of rapid career advancement. You put in a lot of overtime and managed to pull in larger projects, but several years later your career expectations have still not been met. If you leave the company, you lose the employee shares and the many years you've investmented. What do you do?
Although these decisions are all different, they share a number of common characteristics: First, you must make a decision on the basis of a previous decision - you invested the money or that you took the job. And secondly, you dedicated hours, resources, and effort into your original choice and now it is not going as you had hoped for.
Our instinct often convinces us to stay with our chosen course, especially as we often feel we have invested too much to stop. We're struck by sunk cost fallacy, dreading if we acknowledge defeat and pull the plug all that investment is lost! So we justify major investments of money, time and resources based on a previous decision to invest, even when it is clear that the extra costs exceed our expected gains.
So how do you know when to stop? At which point does it become irrational to continue down the same path? Why do we so persistently stick with decision paths that only results in a waste of time, energy and money? And why is this behaviour so widespread when it is irrational?
Don't Want To Rock The Boat!
Many of our critical management decisions concern a series of choices rather than an isolated decision and here we are often vulnerable to the escalation of commitment bias - also called irrational escalation - meaning that we have a tendency to escalate commitment to our original decision rather than change course, even when we witness an increase in negative outcomes.
While the escalation of commitment is an individual bias, it is markedly exaggerated in groups and competitive situations.
As individuals and in groups, we escalate our commitment to previous decisions beyond the point a rational decision model would advise us. We fail to realise that the time and money spent is gone - they are all in the past, are irreversible and therefore should not be considered in relation to future actions.
From Irrational To Rational Commitment
So how do we remove the irrational escalation from decisions? First and foremost, we have to realise that the key to good decisions is to be able to distinguish between when persistence pays off and when we are holding on past the decision expiration date.
Second, we need to realise that our reference point can only be based on our current situation and not past actions and decisions - like spilled milk, they are irreversible and in the past.
Third, we need to evaluate our next decision based on future costs and benefits. So if you want to invest in the startup or the housing project - or quit your job - you need to consider your future benefits, gains and costs. It is irrelevant whether you have invested 5 mill., 20 mill. or years of time and resources. The only relevant consideration is your future costs and benefits of continuing or stopping.
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