Stop Doubling Down on Your Failing Strategy

8 November, 2017 / Articles

By the end of the 1990s the British music company HMV was on top of the world. Its business model—operating Main Street stores in which customers could browse through a wide collection and listen to tracks with an in-store headset before they decided whether to buy a CD—had delivered the company an enviable 40% market share in Britain.

HMV’s rise started with the pop music revolution of the 1960s, when the company began expanding its retail operations in London. It doubled in size in the 1970s and had established itself as the country’s leading specialist music retailer by the early 1980s. It opened stores in Ireland and Canada in 1986 and in the United States, France, Germany, and Japan soon afterward. By the 1990s it had more than 320 stores, about 100 of them in the United Kingdom. In 2002 HMV floated on the London Stock Exchange, valued at about £1 billion.

By then, however, some employees and analysts had started to express doubts about the long-term sustainability of HMV’s business model. Although the arrival of DVDs and computer games initially boosted store profits, supermarket chains had begun selling popular CDs at a discount, and in early 1998 Amazon had started selling CDs online. A few years later downloadable music appeared on the internet, culminating in the launch of Apple’s iTunes store in 2003.

But HMV’s top management doggedly stuck to its strategy. In 2004 the company opened its 200th store in the UK and began acquiring rival chain stores, sometimes out of bankruptcy. By 2008 the company was running a global network of more than 600 outlets. As early as 2002 its advertising agency had tried to alert the board to pending dangers—online retailers, downloadable music, and supermarket discounting—but HMV’s managing director, Steve Knott, had angrily rejected the warning: “I have never heard such rubbish. I accept that supermarkets are a thorn in our side, but not for the serious music…buyer, and as for the other two, I don’t ever see them being a real threat; downloadable music is just a fad.”

Not until 2010 did HMV open a digital music store. By then, of course, the company was far too late to the party, and in January 2013 it went into receivership.

HMV’s story is a classic example of what is known in the management literature as an escalation of commitment: holding on too long to a strategy that was once successful. Of course, many factors can contribute to the failure of a specific company, but in nearly every academic case study on the demise of a former leader in its industry, escalation was shown to play a major role. Nokia’s failure, for example, which has been well documented, was to a large extent caused by the company’s continued investment in its proprietary operating system even as Android and iOS were dominating the market.

Once escalation takes hold, it can be difficult to reverse, but you can reduce the chances of falling into that trap. The psychological and sociological dynamics underlying escalation have been researched by one of us (Sivanathan) and countless other scholars from many academic perspectives; in the following pages we draw on this rich body of work to offer tried and proven organizational rules to help managers design their decision-making processes. But first we’ll look at the causes of escalation.

Why It Happens

Escalation of commitment is deeply rooted in the human brain. In a classic experiment, two groups of participants were asked whether they would be willing to invest $1 million to develop a stealth bomber. The first group was asked to assume that the project had not yet been launched and that a rival company had already developed a successful (and superior) product. Unsurprisingly, only 16.7% of those participants opted to commit to the funding.

The second group was asked to assume that the project was already 90% complete. Its members, too, were told that a competitor had developed a superior product. This time 85% opted to commit the resources to complete the project.

These results underscore the fact that people tend to stick to an existing course of action, no matter how irrational. The project’s likely outcome was identical for both groups. Because a competitor had beaten the company to the market with a superior product, the new product was almost bound to fail. The only difference between the two situations was the timing of the question: before commitment to the project versus when it was nearing completion.

What exactly is going on? Research has identified a number of mutually reinforcing biases that collectively explain why people’s judgment may be swayed by a prior commitment to a course of action. The six most important are:

The sunk cost fallacy.

This bias is well known in management literature. When making investment decisions, people often factor in costs they have already incurred. If they abandon a project, those costs won’t be recovered. Their hope is that if the project continues, the costs can be recouped, vindicating earlier decisions to invest. But a rational decision maker will look only at future costs, not at past ones.

Loss aversion.

This bias, too, is well established. If withdrawing from a course of action implies certain and immediate losses, decision makers often prefer to allocate more resources to continue with it—despite low expected returns—if they see any chance of turning the situation around.

The illusion of control.

This bias clearly reinforces the previous two: People habitually overestimate their ability to control the future. In one experiment two groups of participants bought lottery tickets for $1. One group was assigned random lottery numbers and asked at what price they would be prepared to sell their tickets. The average answer was $1.96. The second group, whose members were allowed to pick their numbers, wanted at least $8.67. Prior success—as in HMV’s case—tends to amplify the illusion; people are quick to take credit for the outcomes of decisions and also confuse having correctly predicted the future with having made it happen.

Preference for completion.

A wealth of psychological experimentation suggests that people have an inherent bias toward completing tasks—whether that means finishing a plate of food or seeing a project through.

The science man and innovator, Fernando Fischmann, founder of Crystal Lagoons, recommends this article.

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