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Make It Easier to Cut Your Losses

Company leaders often allocate manpower and money to projects long after it’s become clear that they are failing, digging a deeper hole rather than trying to climb their way out of it. We recognize this foolishness immediately in others, but that doesn’t stop us from making the same mistake ourselves. Why?

New Coke

Sometimes, we don’t know when to throw in the towel. As a project unfolds, it becomes clear that things aren’t working out as planned, that it will cost too much or take too long, or that a rival company will beat you to the punch. But instead of moving on to new opportunities, we all too often simply stay the course.

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Company leaders continue to allocate manpower and money to projects long after it’s become clear that they are obviously failing, digging a deeper hole rather than trying to climb their way out of it (Remember how long it took to get rid of New Coke?)

The costs to the company, in terms of both resources and lost opportunities, can be enormous. For the leader who refuses to see reason, it can be career-ending. We recognize this foolishness immediately in others, but that doesn’t stop us from making the same mistake ourselves. Why?

There are several powerful and largely unconscious psychological forces at work here. We may throw good money after bad because we haven’t come up with an alternative, or because we don’t want to admit to our colleagues, or ourselves, that we were wrong. But the most likely culprit is our overwhelming aversion to sunk costs.

Sunk costs are the resources that you’ve put into an endeavor that you can’t get back out. Once you’ve realized that you won’t succeed, it shouldn’t matter how much time and effort you’ve already spent on something. A bad idea is a bad idea, no matter how much money you’ve already thrown at it.

The problem is that it doesn’t feel that way. Putting in a lot only to end up with nothing to show for it is just too awful for most of us to seriously consider. We worry far too much about what we’ll lose if we just move on, and not nearly enough about the costs of not moving on–more wasted resources, and more missed opportunities.

Companies have developed ways of trying to deal with this problem, but they usually involve extensive external monitoring of decision-making that is both costly and labor-intensive. But thanks to recent research by Northwestern University psychologists Daniel Molden and Chin Ming Hui, there is a far simpler and inexpensive way to be sure you are making the best decisions when a project goes awry: focus on what you have to gain, rather than what you have to lose.

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As I’ve written about before, psychologists call this adopting a promotion focus. When we think about our goals in terms of potential gains, we automatically (often without realizing it) become more comfortable with making mistakes and accepting the losses we may have to incur along the way. When we adopt a prevention focus, on the other hand, and think about our goals in terms of what we could lose if we don’t succeed, we become much more sensitive to sunk costs.

For example, in one of their studies, Molden and Hui put participants into either a promotion or prevention mindset by having them spend five minutes writing about their “personal hopes and aspirations” (promotion) or “duties and obligations” (prevention). They also included a control group with no manipulation of mindset.

Next, each participant was told to imagine that he or she was president of an aviation company that had committed $10 million to developing a “radar-blank” plane. With the project near completion and $9 million already spent, a rival company announces the availability of their own radar-blank plane, which is both superior in performance and lower in cost. The question put to participants was simple–do you invest the remaining $1 million and finish your company’s (inferior and more expensive) plane, or cut your losses and move on?

Molden and Hui found that participants who had been put in a prevention mindset (focused on avoiding loss) stayed the course and invested the remaining $1 million roughly 80% of the time. The control group, included to provide a sense of how people would respond without any changes to their mindset, was virtually identical to the prevention group. This suggests that when a project is failing and sunk costs are high, most of us naturally become prevention-minded, and more likely to try to keep waging a losing battle.

The odds of making that mistake were significantly reduced by the simple act of adopting a promotion mindset (focused on potential gain)–those participants invested the remaining $1 million less than 60% of the time.*

When we think about our goals in terms of going for a win, rather than avoiding a failure, we are more likely to see a doomed project for what it is, and try to make the most of a bad situation.

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It’s not difficult to achieve greater clarity if you make a deliberate effort to refocus yourself prior to making your decision. Stop and reflect on what you have to gain by cutting your losses now–the opportunities for progress and innovation. If you do, you’ll find it much easier to make the right choice.

*Why not a bigger drop? Good question. Remember that promotion focus was manipulated very indirectly through a totally unrelated writing task. If you adopt a promotion focus directly with respect to the decision itself, considering what you could gain by moving on from your failure, the effects should be even stronger.

Follow me on Twitter @hghalvorson.