Tuesday, July 1, 2008

McKinsey’s Four Biases of Failure

According to a new McKinsey Quarterly study, faced with a failing product or division, companies tend to hang on too long. Common psychological biases help explain why executives downplay evidence of failure and put off the tough decision to bail out. Executives can learn to identify those biases and to understand when they are likely to hinder an objective evaluation of the prospects of a product, a business unit, or even an entire industry.

A few examples:

Smitten by the popularity of small Japanese cars in the 1980s, General Motors launched Saturn as a “new kind of car company.” Sales peaked in 1994, but GM held on, sinking billions into the brand that has yet to turn a profit.

Brewers of Schlitz beer decided to use a cheaper process in making the beer in the early 1970s. Schlitz had been the No. 3 brands in the U.S., but its loyal beer-drinking fans hated the new taste. Schlitz went into declined and was bought by Stroh.

Polaroid had been an extremely popular brand since its cameras produced nearly-instant images. Then the digital camera came along in the 1980s as management stubbornly stuck to its technology and business plan. Polaroid went bankrupt in 2001.

Authors John T. Horn, Dan P. Lovallo and S. Patrick Viguerie say that four biases affected bad decisions such as these. The biases are:

The confirmation bias. Companies fail to confirm that a new product or strategy is actually working and meeting goals.

The sunk-cost fallacy. Once an idea is not living up to expectations, management doesn’t want to consider dumping it arguing that they put too much money in developing it.

The escalation of commitment. If a product is a bummer, management holds on to it, thinking that someday it will be profitable.

The anchoring and adjustment bias: If the company does decide to exit a product, it has to make savvy decisions about how to get rid of it, such as finding the right new owner and at the right sales price.

I've seem management give up on a product or business too soon and hang on too long; these four biases may help explain why it's so hard to admit defeat and retreat.


Dwain said...

I think another commonality is the fear of being seen as a failure. They don't want to be the person that calls a Spade a Spade and gives up. Sometimes their ego gets in the way thinking that they can fix the problem and when they finally realize that it is a losing battle, it is much too late to quit at that point.

I think some of the best leaders are those that can admit that they made a mistake or made the wrong decision and can move forward. Learn from your mistakes, but more importantly admit you made a mistake to begin with.

Dan McCarthy said...

Dwain –
Right, business leaders tend to be pretty competitive bunch, and just hate to “lose”.

Dwain said...

Which sometimes isn't such a bad thing. However, when their ego gets in the way of their business sense, then it becomes a problem.