Musings on Entrepreneurship and Innovation
Friday, May 26, 2006Throwing Good Money After Bad
Why do inventors, entrepreneurs, investors, and corporate managers throw good money (and time and social capital) after bad?
Consider the case of Jerry Wesley, the inventor of the "EZ-X Portable Gym" and a contestant in this season's American Inventor TV show. From the ABC website:
The EZ-X is a passion project for him, so much so that it caused the break-up of his first marriage. He has devoted countless hours and resources to developing the product, which he hopes will make it easy for anyone to get a complete workout anywhere, anytime.
It came as no surprise that Mr. Wesley's invention didn't win the $1 million prize. After all, there seemed little evidence that the invention offered compelling and differentiated value. If that's true, why would Mr. Wesley have pursued the development of the EZ-X in spite of high personal cost? There had to be a point in those "countless hours" at which Mr. Wesley confronted evidence that his invention was really not that promising.
While it may be tempting to write Mr. Wesley off as yet another crazy inventor, I think that would be unfair. I suspect that Mr. Wesley is no crazier than you or me. So, how might you and I avoid Mr. Wesley's fate?
Initial Belief and Escalation of Commitment
In a post titled Cognitive Bias in New Product Development, Businesspundit points to an interesting study authored in April 2000 titled "Stuck in the Past: Why Managers Persist With New Product Failures." The paper examines the causes of escalation of commitment - the tendency to continue to invest in a losing course of action in the face of negative information. Based upon their analysis of direct experimental data, the authors conclude, "the escalation of commitment phenomenon is due to the person's initial summary belief and subsequent confirmation bias in updating those beliefs, rather than commitment to an initial decision."
In other words, if we are initially favorably disposed toward the viability of a venture, we tend to don rose colored glasses:
- We tend to view all new information relatively favorably.
- We overweight positive surprises and underweight negative surprises.
- Even when we adjust our prior beliefs, we do so slowly.
So, the virtues of optimism and commitment can turn against us in a manner that wastes resources and destroys value (as well as marriages and credit ratings).
Avoiding Over-investment in Bad Ideas
Apparently, the moment we embrace an idea, we set ourselves up for a potential fall. How might we mitigate the bias that leads to commitment escalation? According to the aforementioned paper's authors, access to more and better information has little, if any, effect. Instead, they suggest the following:
- Use a decision-maker to make the stop-continue decision who a) was not involved in the initial evaluation of the project and b) was not involved in the previous investment decision.
- Utilize pre-determined stopping rules.
The idea is to de-couple investment decisions from initial beliefs in order to mitigate the risk of destructive path dependency.
Engagement Matters
Of course, as Businesspundit notes, there ain't no free lunch:
There is a minimum level of contextual understanding necessary to make a good decision, and moving people around so that decision makers are always fresh faces risks pulling in someone that doesn't understand the full context of the situation.
Furthermore, the uncertainties that define the new and different rarely resolve themselves. The development and validation of an idea takes work. I don't know about you, but I find it difficult to do hard work unless I believe in the prospects for success. So, it would seem that strong positive beliefs are both necessary and potentially distorting.
A Structural Approach
Dynamically balancing the virtues of passion with the need for objective investment may often be too much for a single organization, much less an individual inventor, when initial uncertainty is high. Consequently, there seems to be a valuable role for a chain of involvement in which:
- An inventor shapes an insight into a product idea and then an invention
- An innovation capitalists evaluates, developes, and validates the invention, and
- A corporate manager evaluates the prospects of commercializing the invention.
Such a structure makes room for the favorable initial belief required to motivate each player to actually do work while ensuring that the escalation of investment is predicated upon a decision by a player who is de-coupled from prior evaluations and investments. On balance, this kind of approach may lead to more economic investment decisions without sucking the life out of the process of innovation.
