Eddielogic

– Thoughts on Strategy and Management

Strategies and their problems in practice – the sunk cost dilemma

| 2 Comments

It is really hard to execute a good strategy? There is no ultimate answer in terms of “yes” or “no”, but we can consider a lot of issues in order to ensure strategy implementation. Before considering this, it is essential to understand that success of strategy implementation is not related to “magic” and requires the acceptance of “typical” managerial weak points. The following statements illustrate the difference between strategy development and strategy implementation

  • “Organizations often fail at strategy execution. Various sources have reported implementation failure rates between 60 and 90 percent.” (Kaplan, Norton (2005))
  • “Most companies invest a significant amount of time and effort in a formal, annual strategic planning process – but many executives see little benefit from the investment.” (S. Kaplan, Beinhocker (2003))
  • “After more than 30 years of hard thinking about strategy, consultants and scholars have provided an abundance of frameworks for analyzing strategic situations. Missing, however, has been any guidance as to what the product of these tools should be…” (Donald C. Hambrick and J.W. Fredrickson (2001))

An issue, which can be observed in practice, can be described as “sunk cost dilemma”. It is actually an investment problem, which is sometimes also known as “throwing good money after bad (money)”. It occurs when large / financially heavy projects do not meet the schedules and budgets. Often these projects have been very important to the business model of the organisation (e.g. installation of a new business processing system). As a result the planned business case no longer works and the financial projections are out of control. However, since of the invested capital so far is huge, the organisation can not turn back the time and has to keep investing to complete the project. At this point it can be argued that the organisation and their executives have been felled into a sunk-cost trap. Unfortunately there is no easy way out. What can be lessons learned?

  • Be careful and realistic when assessing projects and organisational capacities to run large projects. Try to avoid over-optimism. Set up a list of “project risks” and decide, if you are prepared to accept these risks.
  • Use the entire tool set to analyse those heavy investments and set up a worst case scenario. Define a PSR (point of safe return). Look also only at incremental costs and revenues.
  • Prepare the organisation to stop and to kill strategic projects early when they are not able to meet milestones.
  • Employ a gated funding strategy: Set up certain small milestones, which have to be met. If the project overrun these milestones, stop it.
LIKE WHAT YOU'VE READ? If so, subscribe to our mailing list. Just enter your best mail address and press the Subscribe button!

2 Comments

  1. Oliver

    I did some research and had disussions with others on the Sunk cost dilemma. I think it is sometimes confused with the Sunk cost fallacy.

    The SC fallacy describes a situation where people make bad decisions because of a misconception of the meaning of sunk costs. They do “not want to loose their investment”, whatever that may mean.

    The SC dilemma describes a situation with a sequence of good decisions. nevertheless the result is a loss.

    I believe, a strategy avoiding the SC dilemma should focus on risk awareness, avoiding beautification and political cost estimates, and having good communications on the progress of an investment.

    Kind regards

    Frances

  2. Pingback: Sticky factors | Eddielogic

Leave a Reply

Required fields are marked *.