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Flaw and Order

Are you apt to make mistakes? You're not alone. Find out how to avoid these 8 common pitfalls.
September 1, 2004
URL: http://www.entrepreneur.com/article/72230

Businesspeople don't necessarily follow flawed strategies because they're greedy, arrogant or careless. Our brains are wired in ways that tend to prevent us from following tried-and-true strategic principles.

That's the view of Charles Roxburgh, a London director of consulting firm McKinsey & Co. who cites behavioral economics studies that show decision-makers commit similar mistakes in ways that suggest irrational behavior is innate. Below are the eight hidden strategy flaws Roxburgh has identified and strategies to help you overcome them.

1. Overconfidence: We often exaggerate our own abilities, Roxburgh says. Overconfidence and its sibling, overoptimism, lead firms to tackle jobs they can't finish or count on overly rosy forecasts. Temper overconfidence by adding 20 to 25 percent more downside to pessimistic planning scenarios, he suggests, and be wary of strategies based on certainty.

2. Mental accounting: This describes the inclination to treat money differently according to its source, allocation or use. It occurs when companies slap cost controls on a vital core business while spending freely on a risky new initiative. Overcome it by sticking to the rule that a dollar is a dollar, no matter where it came from or where it's going.

3. The status quo bias: It's the tendency to leave things alone and may keep you from dropping a product that once was profitable but now loses money. Avoid it by viewing every business, product or market as constantly in play and taking note of the risks of doing nothing as well as making changes.

4. Anchoring: This occurs when you hear a number such as the sale price for a business you want to buy and unknowingly anchor your bid on that figure. Overreliance on past performance data can also anchor you. Avoid anchoring by looking at long-term trends and disregarding others' attempts to anchor you.

5. The sunk-cost effect: If you've ever thrown good money after bad, you've experienced the sunk-cost effect. This is why businesses keep investing in incomplete projects despite changed conditions that make it unwise to pursue completion. Control sunk-cost effects by evaluating incremental investments as if they were new projects, and be ready to kill experiments quickly.

6. The herding instinct: It's the urge to be like everyone else and clearly offers no competitive advantage. Be different by breaking away from the pack and cutting losses by quickly axing innovations that fall short of expectations.

7. Misestimating future hedonic states: This is Roxburgh's name for the propensity to make bad forecasts of how much something will help or hurt. For instance, founders may see selling the company as worse than death when a sale may actually be the best move. Avoiding overreaction, taking a long-term view, and keeping things in perspective will help.

8. False consensus: It happens when you overestimate how much others share your views. We create this effect by seeking facts and opinions that support our beliefs. Limit damage by encouraging open debate and seeking contrary views.

You can use knowledge of common strategy flaws to predict mistakes competitors are likely to make. "These flaws can be insight into effective competitive strategy," says Roxburgh. "For instance, you may see areas where your competitor will be trapped by status quo bias into not reacting fast enough to a new threat."

So far, no one has identified worrying too much about brain limitations as a possible strategy flaw. But rather than aiming to pinpoint all of them, you may be better off by simply realizing that you have built-in strategic limitations. "Only the paranoid survive," says Roxburgh, quoting longtime Intel leader Andrew Grove. "In this phrase, Grove summed up a good way to counter our natural tendency to be overconfident about the future."


Mark Henricks writes on business and technology for leading publications and is author of Not Just a Living.