Quoted and edited from “What Management Is”by Joan Magretta, page 186-189.
14 November 2014
Pulling the plug on an existing activity can be a wrenching experience. Such decisions are necessary since they are the only way to liberate resources from yesterday’s priorities. Peter F. Drucker, an always astute observer of human behavior, noted repeatedly that the greatest obstacle to innovation in organizations is the unwillingness to let go of yesterday’s success, and to free up resources that no longer contribute to results. He once referred to the products and businesses we cling to most tenaciously, despite their mediocre performance, as “investments in managerial ego”. The solution, says Drucker, is the discipline of “systematic abandonment” – as this is how he called it. We needed to ask very tough question, “If you weren’t already in the business, would you enter it today?” And if the answer is no, face that second difficult question, “What are you going to do about it?”
People hate to lose turf, to lose face, to lose, period! They get stuck in a mental trap that economist call sunk cost. A sunk cost is an investment of time or money that can no longer be recovered or put to another use. In plain English, it’s money down the drain. This concept is covered early in any basic finance course, and the lesson is an important one: When you are evaluating whether to invest today, you have to ignore what you’ve already invested. Instead you must ask, will I get a good return on the money and time I’m going to invest from this moment forward?
This lesson has to be taught because it’s not how most people are wired emotionally. Psychologists have known for years that people hate to walk away from decisions they have already made. This finding has been borne out anew by studies in the field of behavioral finance, which focuses on the psychology of investing. It makes little difference whether the mistake involves buying a stock, or developing a new product or hiring an employee: People much prefer to carry on in the hopes that their earlier decisions will be vindicated. The discipline of sunk costs helps managers avoid this trap, and can deter them from throwing good money after bad.
As the pace of competition has quickened, businesses must be more disciplined than ever about letting go, or they will squander resources they need to build tomorrow.