The Newsletter of Redpoint Coaching
Volume 6, No. 1, January 2007
You are reading ChangeAbility, a newsletter from Urs Koenig, PhD, MBA, of Redpoint Business Coaching.
ChangeAbility is a bimonthly newsletter bringing you hands-on tips and cool resources for building your business and becoming a more effective leader.
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IN THIS ISSUE:
- How to Make Better Decisions: Avoid the Hidden Traps! (Part II)
- Management Concepts Explained: Barriers to Entry and Exit
- Urs's Ultracycling Plans for 2007
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Making decisions is the most important job of business owners and executives. It is also the toughest and the riskiest. Bad decisions can ruin your business or career.
In the last edition of ChangeAbility, I examined two, well-documented psychological traps and told you what you can do about them in order to make better decisions. These two traps were:
++THE ANCHORING TRAP++
++THE STATUS-QUO TRAP++
In this edition, I am discussing the following two traps:
++THE SUNK-COST TRAP++
++THE CONFIRMING EVIDENCE TRAP++
++THE SUNK-COST TRAP++
We all sometimes make choices in a way that justifies past choices, even when the past choices are no longer valid.
Imagine you have been standing in line at the post office for 15 minutes. You have a meeting with an important client coming up, and you run the risk of being late to the meeting if you keep standing in line. What do you do?
For many of us the thinking goes something like this, “Well, dam%$^%! I have already been standing in line for 15 minutes; it would be really stupid to give up my space now, so I will stand in line even if I end up being late to the important meeting.” We just fell into the sunk-cost trap. How so?
It’s simple: we are justifying our decision to keep standing in line by what we have done in the past (i.e. standing in line for 15 minutes already) and not by what is best going forward. Even if you have been standing in line for hours, you need to leave the line if your client meeting is more important than mailing those packages. As economists would say: it’s all about maximizing your utility going forward!
Other examples of the sunk-cost trap include business owners who pour enormous effort into improving the performance of an employee whom they should not have hired in the first place. It is also very common in banking. When a borrower’s business runs into trouble, a lender often advances additional funds in the hope that the business can turn around. If the business does have a good chance to do that, this is wise; otherwise it’s just throwing good money after bad.
Why can we not free ourselves from past decisions? Frequently, it is because we are unwilling to admit mistakes. If you, for example, fire a poor performer who you hired, you are making a public admission of poor judgment. It seems psychologically safer to let him or her stay on, even though that choice only compounds the error.
Sometimes a corporate culture reinforces the sunk-cost trap. If the penalties for making a decision that leads to poor outcome are overly severe, managers will be motivated to let failed projects drag on forever – in the vain hope that they will somehow turn around.
WHAT CAN YOU DO ABOUT THE SUNK-COST TRAP?
Make a conscious effort to set aside any sunk cost – whether psychological or economic – that will muddy your thinking about the choices at hand:
- Seek out and listen carefully to the views of people who were uninvolved with the earlier decision
- Examine why admitting earlier mistakes distresses you. If it’s your wounded self-esteem, deal with it head-on. Remind yourself that even smart choices can have bad consequences and that even the best and most experienced executives are not immune to errors in judgment
- Don’t cultivate a failure-fearing culture that makes employees perpetuate their mistakes. Lead by example by admitting your own mistakes
- Remember: “If you are in a hole, stop digging.” – Warren Buffet
THE CONFIRMING-EVIDENCE TRAP
Imagine you are the president of a successful, mid-size, Italian shoe manufacturer, considering whether to call off a planned plant expansion. For a while you have been concerned that your company won’t be able to sustain the rapid pace of growth of its exports. You fear that the value of the Euro will strengthen in coming months, making your goods more costly for overseas consumers. But before you put the brakes on the plant expansion, you decide to call up an old business school classmate, the CEO of a similar company that recently cancelled plans for a new factory, to check her reasoning. She presents a strong case that other currencies are about to weaken against the Euro. What do you do?
You’d better not let this conversation be the clincher because you’ve probably just fallen victim to the confirming-evidence trap. This bias leads us to seek out information that supports our existing instincts or points of view while avoiding information that contradicts it. What, after all, did you expect your acquaintance to give, other than a strong argument in favor of her decision?
Two fundamental psychological forces are at work here:
- We subconsciously decide what we want to do before we figure out why we want to do it.
- Our inclination is to be more engaged by things we like than by things we dislike – a tendency well documented even in babies. Naturally, we are drawn to information that supports our subconscious leanings.
WHAT YOU CAN DO ABOUT THE CONFIRMING EVIDENCE TRAP?
It’s not that you should not make the choice you are subconsciously drawn to. It’s just that you want to make sure it’s the smart choice. Here is how you put it to the test:
- Get someone you respect to play the devil’s advocate to argue against the decision you are contemplating. Better yet, build the counter-argument yourself. What are the strongest reasons to do something else?
- Be honest with yourself about your motives. Are you really gathering information to help you make a smart choice, or are you just looking for evidence confirming what you think you’d like to do?
- In seeking the advice of others, don’t ask leading questions that invite confirming evidence. If you find that an advisor always seems to support your point of view, find a new advisor. Do not surround yourself with yes-men (and women).
- When facing major decisions in your business or life, be sure to use the above techniques to avoid falling into the Sunk-Cost Trap and the Confirming Evidence Trap.
This article is based on: “Hammond, Ralph & Raiffa: The Hidden Traps in Decision Making,” Harvard Business Review, January 2006.
Many of the most successful business owners and executives I meet have never attended business school. They were busy building the business while you MBAs sat in class ;-).
Over the course of the next few ChangeAbilities, I will therefore explain popular but often misunderstood management concepts. This month I will start with ‘Barriers to Entry and Exit.’
Barriers to entry are those obstacles that keep new companies from gaining a foothold in a particular market. These barriers may be constructed by existing companies in that market (patent protection, licensing agreements, price manipulation to keep upstarts from being competitive); they may be a result of governmental action (regulations or trade or zoning), or they may be the result of economies of scale (the need to produce at large volumes to be competitive).
Barriers to exit are the realities that make it challenging for companies to get out of a market: among these may be the high cost of laying off staff, contractual obligations such as a lease, or the high cost of offloading existing real estate or equipment.
A brief history:
E-commerce and the evolution of the Internet have changed old ideas about barriers by providing new avenues for firms to enter a market. For example, companies may not face the problems of economies of scale if they sell products over the Internet.
Deregulation in the 1980s and 90s were intended to reduce barriers and allow more players to enter certain markets. A 1996 study of airlines found that barriers were more complex, were “woven into the fabric of an industry.” These barriers included such things as major airlines hoarding the limited take-off and landing slots at major airports and the long-term leases on airport gates. Also, rules prohibiting flights under a certain distance didn’t hinder major airlines who had arrangements with commuter airlines but were a major entry barrier to new airlines.
Other established customs – travel agents’ commissions, frequent flier plans, etc – further excluded new airlines from competing. However, utilizing secondary airports and selling tickets via the Internet has allowed a few smaller carriers to enter the market.
- What are the barriers of entry and exit in my industry?
- How can I erect new barriers of entry/increase the size of the existing barriers to protect me from potential new entrants in my market?
- Am I using barriers of exit as an excuse for not making the changes I need to make?
This article based on Tim Hindle’s Guide to Management Ideas, London: Profile Books, 2003.
In 2007 I will focus on only one race: The 534 mile Race Across Oregon (RAO) http://www.raceacrossoregon.com/. RAO has more than 40,000 feet of climbing.
On July 21, my friend and riding partner Chris Ragsdale and I will attempt to set a new course record in the team-of-two category. The current record stands at 28 hrs and 58 minutes (18.5 miles/hr).
We are currently in base training and doing a lot of hours indoors working on strength, drills and some base miles.
ME KNOW WHAT YOU THINK+++++
Send an email to firstname.lastname@example.org. I welcome your feedback!
Copyright Redpoint Business Coaching, 2006. All rights reserved
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