713 escalation

8/12/2019 713 Escalation

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E S C A L A T I O N O F C O M M I T M E N T

GETTING OUT BEFORE ITS

TOO LATE


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ESCALATION DEFINED

Escalation refers to persistence with a course ofaction beyond a rationally defensible point.


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EXAMPLES OF ESCALATION

You dont go into business to give in

Last year was bad, year before was very bad, thisyear is disaster

If this goes on I shall have to do a runner


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ESCALATION

Preconditions Costs are incurred

Feedback is negative

Opportunity to quit or

continue Consequences of quitting

or continuing areunknown


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CAUSES OF ESCALATION

Psychological

Social

Economic

Organizational


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PSYCHOLOGICAL CAUSES

How does escalation start?


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ORIGINS OF ESCALATION

Bright promises entrepreneurs allow their enthusiasmto over-ride their judgement.

Consequently they may fail to do sufficient reality testingto check their plans are realistic.

They may be so determined to set up in business that theyscale up possible sales so that the business plan makessense on paper.


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PLANS

Fail to take full account of costs, rent, rates, cost ofsupplies, staffing costs.

Failure to compute a proper cash flow analysis.

Overly optimistic estimates of level and rate ofreturns likely to be generated by the business.

Inadequate knowledge of the nature of the business


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ESCALTION

Ego-defensiveness need to appear rational

Framing effects

Sunk costs

Dislike of waste


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EGO

Refers to fear of failure.

Reluctance to admit to making a mistake.

Overly inflated view of ones capabilities recall

illusion of control. Desire to be proved right.


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EGO AND INFORMATION

When decision-makers ego are at stake they may notadjust their views to keep up with new information.

This typically means decision-makers pay moreattention to feedback that supports their views.

Downplay or even ignore information suggestingpersistence is futile as expectations cannot be met.


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FRAMING

Prospect theory predicts that decision-makers areinfluenced by how a problem is expressed(framed).

When a business fails decisions are likely to benegatively framed, that is, as a choice betweenlosses.

Negative framing results in risk seeking behaviour.

To be risk seeking is to take a bigger risk thanobjective conditions warrant.


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FRAMING

In practice:

Closing a venture meansaccepting a definitelosswhereas persisting offers thechance of avoiding that lossaltogether but at the risk ofsubsequently incurring a much

bigger one. Prospect theory predicts that a

loss that is merely probable ispreferable to one that isdefinite.

Escalation enables decisionmakers to avoid a definite loss.


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MONEY SUNK AND LOST

Sunk costs refer to investments made in anticipationof revenue streams.

Strictly speaking they should usually be ignored in

deciding how to invest resources in future becausethey cannot influence outcomes.


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FOR EXAMPLE..

1. Cost of converting house to corner shop = 40 000(sunk cost).

2. Shop generates income of 100 a week.

3. Stocking supermarket shelves = 300 a week.

Note, in deciding between 2 and 3, sunk costs make nodifference.


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TO PUT IT ANOTHER WAY

The choice is between: Earning 100 a week inshop.

Earning 300 a week insupermarket.


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PSYCHOLOGY OF SUNK COSTS

What we can accept intellectually we cannot alwaysaccept emotionally.

We may persist out of psychological attachment to

sunk costs and because we dislike waste.


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FOR EXAMPLE

Holding on to old stock.

Refusing to sell a business because of all the timeand effort invested.

Even when closing down, throwing things awayrather than accept a small sum of money.


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SOCIAL CAUSES OF ESCALATION

Escalation may be fuelled by the presence of anaudience.

Audience effects can drive escalation even though

decision-makers have begun to recognise thatpersistence is most probably futile because it isalready clear that expectations cannot be met.


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SOCIAL CAUSES OF ESCALATION

Competition the dollar auction.

Needing to look good in public

Perceived need to be consistent

Valuing leaders who appear strong and decisive


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ECONOMIC CAUSES OF ESCALATION

It can be as expensive to quit as to continue

Low salvage value

High closing costs, e.g., tied in to a lease on

premises, redundancy costs Project may be nearing completion


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ESCALATION

Politics vested interests may try to concealfailure and/or perpetuate project.

Sheer weight of institutions as project gainsmomentum whole departments may have beencreated to support it.

Project closely identified with values and purposesof organization.

Administrative inertia - just too much trouble tointervene.

NOTE: these usually only apply in large businesses


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AVOIDING ESCALATION

Be careful what you get into: remember the planningfallacy

Monitor projects carefully Set clear expectations and compare results against those

expectations Set limits Change the project managers Separate authorization from evaluation Set quitting points Real options thinking see separate slides Think of projects as a series of investments beginning

now


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AVOIDING ESCALATION CONTd

What are the marginal costs of completion?

What are the marginal benefits?

Pay attention to the opportunity costs of persistence What are the alternatives?

What are the reputational costs of switching?

Base decisions on net gain

If an opportunity offering bigger gains becomesavailable, it makes economic sense to quit even asuccessfulventure.

713 escalation

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