Monday, October 29, 2012

No matter who wins presidential race, voters pessimistic on health care’s future

By Editorial Staff

October 29, 2012

It may not be exactly an October surprise, but it appears the public has low expectations for the future of the American health care, regardless of who sits in the Oval Office after inauguration day. Though many views fall along voters’ party lines, a new survey form TeleVox indicates that neither Republicans nor Democrats are filled with optimism when it comes to health care reform.

The survey, out this month, was conducted by Kelton Research and TeleVox, which reports that 78% of respondents believe the country’s health care system will stay the same or worsen if the White House changes hands. Meanwhile some 72% also believe it will stay the same or worsen if it doesn’t.

Not all of the dismal views are bipartisan. Eighty-seven percent of Democrats think a change in leadership will cause the nation’s health issues to worsen, according to the survey; 93% of Republicans think problems will grow if the Democrats remain in power.

Only 9% of Republicans believe four more years will bring the costs of preventive care down, versus 27% of Democrats. Some 24% of Democrats and 64% of Republicans think reelection will bring these costs up, TeleVox reports. Two-fifths of respondents think preventive costs will rise no matter who carries the day on Nov. 6.

One good thing both sides agree on about preventive care: it matters. More than 95% across the board say preventive medicine is important, with 93% agreeing with statement “it’s less expensive to prevent a serious condition or disease than it is to treat it.” To American voters, an ounce of prevention is worth a pound of cure.

Around 30% of both parties report feeling unknowledgeable about what preventive services their health plan offers. Fifty-seven percent of Republicans and 59% of Democrats tell TeleVox that a doctor recommendation is the No. 1 motivator to take a preventive care measure. Forty percent of Democrats and just one percentage point more of Republicans say cost is the biggest reason they have not utilized preventive care.

Thursday, October 18, 2012

6 Books for the Well-Rounded Entrepreneur

Starting a business, personal productivity, marketing skills--these good reads cover the essentials an entrepreneur needs to master.
Man readingmohammada/Flickr

… Here are six books that at least partially cover the entrepreneurial gamut: starting a business, personal productivity, marketing, improving skills, operations--even health and fitness.

Each will leave you feeling challenged, inspired, motivated, and ready to take your professional life to new heights.

Starting and Sustaining a Business
Part research, part science, and part introspection exercise, Heart, Smarts, Guts and Luck does help you understand your personality and decision-making traits--useful in itself--but more importantly is filled with cool insights and tips any entrepreneur can benefit from.

One is the Three-Minute Rule, based on the premise that what your customers do in the three minutes just before and just after they use your product or service tells you a lot about their needs and how they actually use what you sell.

For example, studies show customers buy less when their arms are full--which is why placing empty shopping baskets or carts in the middle of a retail store can dramatically increase sales per customer….

Personal Productivity

Cover of "Getting Things Done: The Art of...
Cover via Amazon
… David Allen's Getting Things Done … Yes, his process is comprehensive. Yes, you might think, "Wait... I have to do all that?"

And yes, maybe you won't adopt his entire system. I haven't.

But you will find ways to waste less time, be more productive, and focus more on what truly drives the results you want in your business and personal life. …

Improving Skills
… The subtitle of Practice Perfect is "42 Rules for Getting Better at Getting Better." It's like the "teach a man to fish" principle: Instead of describing how to improve one specific skill, Practice Perfect provides practical tools for practicing, modeling, using feedback, and making those new skills stick.

Best of all it's a guide to not only improving your own skills but also your employees' skills. …

The Hidden Agenda lays out a blueprint for determining the hidden agendas of decision makers--and in the process transcend persuasion and create connections.

… As a consumer, I have needs. I have wants. And I have beliefs. Connect your products, services, or ideas with my needs, wants, and beliefs and then you don't have to sell me.

I'm already with you.

American Icon, the story of Ford's turnaround, without a government bailout, is outstanding.
And it reads like a novel--although in this case a "novel" that will help you lead and run your own business better.

Health and Fitness

Physical Fitness
Physical Fitness (Photo credit: Justin Liew)
Guess what: Most people drink too much during and after exercise; for most of us drinking when we get thirsty is fine. Stretching before we exercise doesn't seem to prevent injury and can actually decrease our performance. Chocolate milk is an awesome post-workout drink. Sitting too much is slowly killing us.
And exercise can make us smarter.

The First 20 Minutes debunks a number of health and fitness myths and lays out a simple blueprint for getting the most out of exercise--without all the conventional wisdom and marketing b.s. that tends to lead us astray.

Where our well-being is concerned, astray is the last place we want to be.
Read more:
  • Start a Small Business in a Few Hours
  • 6 Ways to Spoil Great PR Opportunities
  • 9 People to Remove From Your Inner Circle

  • Jeff Haden learned much of what he knows about business and technology as he worked his way up in the manufacturing industry. Everything else he picks up from ghostwriting books for some of the smartest leaders he knows in business. @jeff_haden
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    Thursday, October 11, 2012

    When Banks Won’t Touch Your Company

    Alternative financing firms take on credit risks that financial institutions don’t want.
    Vincent Ryan

    When commercial bank lending rises on a sustained basis as it has the past year, it’s hard to fathom some companies being denied credit. … [There] are always companies (and industries) that are just not bankable. … Among them: firms that are cash-flow negative, start-ups with intellectual property but no customers, and young industrial companies that need to finance fixed assets before entering production phase.

    Loans (Photo credit: zingbot)
    The situation for the have-nots could get worse in the next few years: pieces of the new Basel III bank capital rules may force banks to be more selective with their capital commitments, especially to companies of marginal creditworthiness.

    But there are some alternative financing sources that are hungry to deploy money and willing to finance higher-risk projects. … “There’s not a lot of yield to be gotten in the public bond markets. Private capital providers need yield in their portfolios,” says Allen Weaver, senior managing director at Prudential Capital Group, which invests long-term money from insurance companies and pension funds.

    Take Deep Eddy Vodka. When demand was outstripping the capacity of its bottling line equipment last year, the two-year-old spirits start-up called on many banks but found its business model didn’t line up with their idea of creditworthiness. Deep Eddy spends a lot on sales and marketing to build its brand and grow its topline fast, paying less attention to profits for now, says John Scarborough, the company’s vice president of finance. Once bankers saw the business’s operating losses, they said they needed personal guarantees from Deep Eddy’s principals.

    Image representing Fountain Partners as depict...
    Image via CrunchBase
    After searching, Deep Eddy found Fountain Partners, a provider of lease lines of credit for capital equipment. “Fountain was willing to look at the business model, peel back the onion a bit, and see that there was a fundamentally strong business underneath,” says Scarborough. Deep Eddy landed a $250,000, 36-month lease to buy its new high-capacity bottling line, as well as a sale-leaseback of existing equipment to generate additional working capital.

    There is a knock on alternative financing, though. A nonbank financier’s cost of capital is higher than a traditional bank, ... Since its cost of capital is higher, the borrower pays a higher rate.
    “With the funds we are running right now, we are looking for rates of return that are double-digit, and we are very clear about our willingness to take large-scale risks that make that [rate] deserving and fair,” says Tom Carter, founder of Fountain Partners and a former CFO.

    Also taking those credit risks are business development corporations (BDCs), which are publicly held investment companies that must distribute 90% of their profits to shareholders. By leveraging their balance sheets, BDCs can get their cost of capital down, says Manuel Henriquez, CEO of BDC Hercules Technology Growth Capital. Hercules originates senior secured loans, often collateralized with intellectual property, and has a cost of capital of 5% to 7%, compared with 2% to 3% for a bank.

    The real advantage of alternative financing is not in the hard costs, though. Henriquez says his clients … can place their deposits and operating accounts into any bank. … [The] financing agreements are a lot less covenant-driven. And in the event a company gets into trouble, “the loan doesn’t get passed to a workout group whose sole purpose is to get the bank’s money back at whatever cost, because regulators are breathing down its neck,” Henriquez says.
    “Because we are not regulated like a bank and have permanent capital on our balance sheet, we can work with a company through difficult times,” he adds. “We expect our companies to stumble, like a little kid on a bike.”

    Not that borrowers shouldn’t pay attention to the cost of alternative financing. In lease deals, notes Scarborough, sometimes the actual interest rate is buried in a bunch of numbers. …
    While monthly payments with interest rates higher than a typical bank loan may scare finance executives, nonbank debt lets some companies save expensive equity capital for strategic uses. It doesn’t make sense for a start-up to buy furniture, servers, and routers or fund working capital with equity dollars, Henriquez says: …

    Understanding Financial Leverage
    Understanding Financial Leverage (Photo credit: Wikipedia)
    “In consumer packaged goods, value is created by the brand,” says Scarborough. “We have a finite amount of capital and the highest-return, best use of capital is to invest in marketing programs and a world-class sales team, not equipment.”

    But alternative financing firms don’t have an infinite appetite for risk, either. Fountain Partners looked at several deals in the solar industry between 2006 and 2011, Carter says, but never extended credit to one. His reasoning: basic science and execution risk around the companies’ manufacturing plans, and the fact that many of the solar companies didn’t have enough venture money to reach production phase.

    Still, in general, firms like Fountain take a more expansive view of a borrower’s prospects. “We take risk that large-scale financial institutions shy away from,” says Carter.

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    Tuesday, October 9, 2012

    Want to Build Resilience? Kill the Complexity

    Harvard Business Review
    by Andrew Zolli  |   8:00 AM September 26, 2012

    Air France A330-200 F-GZCP lands at Paris-Char...
    Air France A330-200 F-GZCP lands at Paris-Charles de Gaulle Airport. – The aircraft was destroyed in Air France Flight 447. (Photo credit: Wikipedia)
    This July, aviation officials released their final report on one of the most puzzling and grim episodes in French aviation history: the 2009 crash of Air France Flight 447, en route from Rio de Janeiro to Paris. The plane had mysteriously plummeted from an altitude of thirty-five thousand feet for three and a half minutes, before colliding explosively with the vast, two-mile-deep waters of the south Atlantic. Two hundred and twenty eight people lost their lives;…

    What — or who — was to blame? French investigators …  singled out one all-too-common culprit: human error. Their report found that the pilots, although well-trained, had fatally misdiagnosed the reasons that the plane had gone into a stall, and that their subsequent errors, based on this initial mistake, led directly to the catastrophe.

    English: Pitot tube
    English: Pitot tube (Photo credit: Wikipedia)
    Yet it was complexity, as much as any factor, which doomed Flight 447. Prior the crash, the plane had flown through a series of storms, causing a buildup of ice that disabled several of its airspeed sensors — a moderate, but not catastrophic failure. As a safety precaution, the autopilot automatically disengaged, returning control to the human pilots, while flashing them a cryptic "invalid data" alert that revealed little about the underlying problem. Confronting this ambiguity, the pilots appear to have reverted to rote training procedures that likely made the situation worse: they banked into a climb designed to avoid further danger, which also slowed the plane's airspeed and sent it into a stall.

    Confusingly, at the height of the danger, a blaring alarm in the cockpit indicating the stall went silent — suggesting exactly the opposite of what was actually happening. The plane's cockpit voice recorder captured the pilots' last, bewildered exchange:

    Recife - The frigate Constituição arrives at t...
    Recife - The frigate Constituição arrives at the Port of Recife, transporting wreckage of the Air France Airbus A330 that was involved in an accident on 31 May 2009. (Photo credit: Wikipedia)
    (Pilot 1) Damn it, we're going to crash... This can't be happening!
    (Pilot 2) But what's happening?

    Less than two seconds later, they were dead.

    Researchers find … circumstances where adding safety-enhancements to systems actually makes crisis situations more dangerous, not less so. The reasons are rooted partly in the pernicious nature of complexity, and partly in the way that human beings psychologically respond to risk.

    We rightfully add safety systems to things … in an effort to encourage them to run safely yet ever-more efficiently. Each of these safety features, however, also increases the complexity of the whole. Add enough of them, and soon these otherwise beneficial features become potential sources of risk themselves, as the number of possible interactions — both anticipated and unanticipated — between various components becomes incomprehensibly large.

    This, in turn, amplifies uncertainty when things go wrong, making crises harder to correct: … Imagine facing a dozen … alerts simultaneously, and having to decide what's true and false … at the same time. Imagine further that, if you choose incorrectly, you will push the system into an unrecoverable catastrophe. Now, give yourself just a few seconds to make the right choice. …

    CalTech system scientist John Doyle has coined a term for such systems: … Robust-Yet-Fragile — and one of their hallmark features is that they are good at dealing with anticipated threats, but terrible at dealing with unanticipated ones. As the complexity of these systems grow, both the sources and severity of possible disruptions increases, even as the size required for potential 'triggering events' decreases — it can take only a tiny event, at the wrong place or at the wrong time, to spark a calamity.

    Variations of such "complexity risk" contributed to JP Morgan's recent multibillion-dollar hedging fiasco, as well as to the challenge of rebooting the US economy in the wake of the 2008 financial crisis. (Some of the derivatives contracts that banks had previously signed with each other were up to a million pages long, … Untangling the resulting counterparty risk — determining who was on the hook to whom — was rendered all but impossible. This in turn made hoarding money, not lending it, the sanest thing for the banks to do after the crash.)

    Complexity is a clear and present danger to both firms and the global financial system: it makes both much harder to manage, govern, audit, regulate and support effectively in times of crisis. Without taming complexity, greater transparency and fuller disclosures don't necessarily help, …: making lots of raw data available just makes a bigger pile of hay in which to try and find the needle.

    Unfortunately, human beings' psychological responses to risk often makes the situation worse, through twin phenomena called risk compensation and risk homeostasis. … [As] we add safety features to a system, people will often change their behavior to act in a riskier way, betting (often subconsciously) that the system will be able to save them. People wearing seatbelts in cars with airbags and antilock brakes drive faster than those who don't, because they feel more protected … And we don't just adjust perceptions of our own safety, but of others' as well: for example, motorists have been found to pass more closely to bicyclists wearing helmets than those that don't, betting (incorrectly) that helmets make cyclists safer than they actually do.

    A related concept, risk homeostasis, suggests that, … we each have an internal, preferred level of risk tolerance — if one path for expressing one's innate appetite for risk is blocked, we will find another. In skydiving, this phenomenon gave rise, famously, to Booth's Rule #2, which states that "The safer skydiving gear becomes, the more chances skydivers will take, in order to keep the fatality rate constant."

    Organizations also have a measure of risk homeostasis, expressed through their culture.

    People who are naturally more risk-averse or more risk tolerant than the culture of their organizations find themselves pressured, often covertly, to "get in line" or "get packing."

    Ridiculous Risk Aversion - Lawyer Bollocks!
    Ridiculous Risk Aversion - Lawyer Bollocks! (Photo credit: Danny McL)
    This was well in evidence at BP, for example, long before their devastating spill in the Gulf — the company actually had a major accident somewhere in the world roughly every other year for a decade prior to the Deep Water Horizon catastrophe. During that period, fines and admonitions from governments came to be seen by BP's executive management as the cost of growth in the high-stakes world of energy extraction — and this acceptance sent a powerful signal through the rank-and-file. According to former employees at the company, BP's lower-level managers would instead focus excessively on things like the dangers of not having a lid on a cup of coffee, rather than the risk and expense of capping a well with inferior material.

    Deepwater Horizon Oil Spill Site
    Deepwater Horizon Oil Spill Site (Photo credit: Green Fire Productions)
    Combine complex, Robust-Yet-Fragile systems, risk-compensating human psyches, and risk-homeostatic organizational cultures, and you inevitably get catastrophes of all kinds: ... That observation is driving increasing interest in the new field of resilience — how to build systems that can better accommodate disruptions when they inevitably occur. …

    Consider the problem of complexity and financial regulation. The elements of Dodd-Frank that have been written so far have drawn scorn … for doing little about the problem of too-big-to-fail banks; but they've done even less about the more serious problem of too-complex-to-manage institutions, …

    Banks' advocates are quick to point out that many of the new regulations are contradictory, confusing and actually make things worse, …: adding too-complex regulation on top of a too-complex financial system could put us all, … in the cockpit of a doomed plane.

    … [To} be explored here: to encourage the reduction in the complexity of both firms and the financial system as a whole, in exchange for reducing the number and complexity of regulations with which the banks have to comply. … Such a system would be easier to police and tougher to game.

    Efforts at simplification also have to deal urgently with the problem of dense overconnection … In 2006, the Federal Reserve invited a group of researchers to study the connections between banks … What they discovered was shocking: Just sixty-six banks — out of thousands — accounted for 75 percent of all the transfers. And twenty five of these were completely interconnected to one another, …

    Little has been done about this dense structural overconnection since the crash, … Over the past two decades, the links between financial hubs like London, New York and Hong Kong have grown at least sixfold. By reintroducing simplicity and modularity back into the system, a crisis somewhere doesn't always have to become a crisis everywhere.

    … [Taking] steps to tame complexity of a system are meaningless without also addressing incentives and culture, since people will inevitably drive a safer car more dangerously. To tackle this, organizations must learn to improve the "cognitive diversity" of their people and teams — getting people to think more broadly and diversely about the systems they inhabit. One of the pioneers in this effort is, … the U.S. Army.

    human-shield-gaza (Photo credit: ` ³ok_qa³ `)
    Today's armed forces confront circumstances of enormous ambiguity — theatres of operation with many different kinds of actors — … without a "front line." In such an environment, the cultural nuances of every interaction matter, and the opportunities for misunderstanding signals is extremely high. In the face of such complexity, it can be powerfully tempting for tight-knit groups of soldiers to fall back on rote training, …

    Making one kind of mistake might get you killed, making another might prolong a war.

    To combat this, retired army colonel Greg Fontenot and his colleagues at Fort Leavenworth, Kansas, started the University of Foreign Military and Cultural Studies, more commonly known by its nickname, Red Team University. The school is the hub of an effort to train … field operatives who bring critical thinking to the battlefield and help commanding officers avoid the perils of overconfidence, strategic brittleness, and groupthink. The goal is to respectfully help leaders in complex situations unearth untested assumptions, consider alternative interpretations and "think like the other" without sapping unit cohesion or morale, and while retaining their values.

    Flight path of Air France Flight 447 on 31 May...
    Flight path of Air France Flight 447 on 31 May/1 June. The solid red line shows actual route, the dashed line is the planned route after the last transmission heard. (Photo credit: Wikipedia)
    More than 300 of these professional skeptics have since graduated from the program, and have fanned out through the Army's ranks. Their effects have been transformational — not only shaping a broad array of decisions and tactics, but also spreading a form of cultural change appropriate for both the institution and the complex times in which it now both fights and keeps the peace.

    Structural simplification and cultural change efforts like these will never eliminate every surprise, of course, but undertaken together they just might ensure greater resilience — for everyone — in their aftermath.

    Otherwise, like the pilots of Flight 447, we're just flying blind.

    More blog posts by Andrew Zolli
    More on: Decision making, Risk management
    Andrew Zolli
    Andrew Zolli
    Andrew Zolli is the Executive Director of the global innovation network PopTech, and the co-author of Resilience: Why Things Bounce Back, published by Free Press.
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    Wednesday, October 3, 2012

    As fiscal cliff looms, Americans face hefty tax hike

    CBS News MoneyWatch October 1, 2012, 2:17 PM


    Play VIDEO What is the "fiscal cliff?"

    (MoneyWatch) Taxes for nearly 9 of 10 Americans will rise by an average of $3,500 a year if Congress and the White House fail to reach a deal that avoids the so-called fiscal cliff.

    Income Tax Cocktail
    Income Tax Cocktail (Photo credit: Kenn Wilson)
    The Brookings-Urban Institute Tax Policy Center, a Washington research group, said in a new report that the planned elimination of tax breaks at the end of the year would affect 88 percent of U.S. taxpayers, with most seeing tax hike in 2013 of 5 percent. It would also boost federal tax receipts by a total of $536 billion, or 20 percent, next year.

    Most of the increase would come from the scheduled expiration of tax cuts enacted in 2001 and 2003 during the George W. Bush administration. The expiration of President Obama's payroll tax holiday, which shaves 2 percentage points off payments to Social Security, would also contribute to the rise.

    … "It's just a huge, huge number," said Eric Toder, an Urban Institute scholar, in a conference call to discuss the report.

    The top 20 percent of income-earners -- those with mean annual earnings of more than $170,000 -- would experience the highest tax increase, at 5.8 percent (see chart at bottom). That would push the average federal income tax rate for taxpayers in this bracket to 30.9 percent. As a result, they would end up paying 60 percent, or $300 billion, of the additional revenue from the rise in rates.

    A middle-class household, with income between $40,000 and $64,000, would see its taxes rise by about $2,000. The bottom 20 percent of earners -- those with mean income of less than $15,900 -- would pay the least in total dollars, at $16.1 billion.

    Earned Income Tax Credit (EITC)35
    Earned Income Tax Credit (EITC)35 (Photo credit: Antonio Villaraigosa)
    But low-income earners would see the largest increase in the percent of their income they pay in taxes, with that figure slated to rise to 4.3 percent, from the current average of 0.6 percent. Specifically, they would feel the greatest financial impact of expiring tax breaks that were part of Obama's 2009 economic stimulus package, the Institute found. They would lose an expansion of the earned income tax credit and the child tax credit for working families. A $2,500 credit for college tuition also would shrink to $1,800 and be available for only two years, instead of the current four.

    US taxes as a percent of income in 2008.
    US taxes as a percent of income in 2008. (Photo credit: Wikipedia)
    … The number of people subject to the alternative minimum tax also would increase to 21.7 million households, up from 4 million this year.

    Although most lawmakers say they favor extending the income tax cuts, there is bitter partisan dispute over for whom. Republicans generally want to preserve all the income and estate tax cuts for 2013, including for top income-earners, arguing that the resulting decline in government revenue can be plugged by eliminating tax loopholes. Democrats, including President Obama, want to let most of of the tax cuts lapse for the top 2 percent of households, or individuals making more than $200,000 a year and married couples making more than $250,000.

    English: Plot of top bracket from U.S. Federal...
    English: Plot of top bracket from U.S. Federal Marginal Income Tax Rates for 1913 to 2009. Data are from (Photo credit: Wikipedia)
    According to the Tax Policy Center, households at the top of the income range are most affected by the income taxes and the tax increases on unearned income, such as capital gains that were enacted under the 2010 health care law and that take effect in January.

    Another potential side effect of the fiscal cliff: Growing skepticism that Congress will reach an agreement on taxes and spending could lead to a large sell-off of stocks and other financial assets later this year as people try to avoid the higher capital gains rate.

    "If investors really believe that the tax rate they face on capital gains is about to go up significantly, some of them will choose to realize accumulated gains this year rather than next year," said Donald Marron, one of the authors of the study.

    © 2012 CBS Interactive Inc.. All Rights Reserved.
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    Monday, October 1, 2012

    Failing business divisions: Making better exit decisions

    Psychological biases can make it difficult to get out of an ailing business.

    McKinsey Quarterly
    MAY 2006 • John T. Horn, Dan P. Lovallo, and S. Patrick Viguerie

    failing business divisions article, underperforming business units, Strategy

    English: Logo of General Motors Corporation. S...
    English: Logo of General Motors Corporation. Source: 2007_business_choice_bro_en.pdf (on GM website). (Photo credit: Wikipedia)
    When General Motors launched Saturn, in 1985, the small-car division was GM's response to surging demand for Japanese brands. At first, consumers were very receptive to what was billed as "a new kind of car company," but sales peaked in 1994 and then drifted steadily downward. GM reorganized the division, taking away some of its autonomy in order to leverage the parent company's economies of scale, and in 2004 GM agreed to invest a further $3 billion to rejuvenate the brand. But 21 years and billions of dollars after its founding, it has yet to earn a profit.1 Similarly, Polaroid, the pioneer of instant photography and the employer of more than 10,000 people in the 1980s, failed to find a niche in the digital market. A series of layoffs and restructurings culminated in bankruptcy, in October 2001.

    These stories illustrate a common business problem: staying too long with a losing venture. … Indeed, when companies do finally exit, the spur is often the arrival of a new senior executive or a crisis, such as a seriously downgraded credit rating.

    polaroid freak
    polaroid freak (Photo credit: speechlessson)
    … One study showed that as a business ages, the average total return to shareholders tends to decline.2 For most of the divestitures in the sample, the seller would have received a higher price had it sold earlier. According to our analysis of a broad cross-section of US companies from 1993 to 2004, the probability that a failing business will grow appreciably or become profitable within three years was less than 35 percent. Finally, researchers who studied the entry and exit patterns of businesses across industries found that companies are more likely to exit at the troughs of business cycles—usually the worst time to sell.3

    Why is it so difficult to divest a business at the right time or to exit a failing project and redirect corporate resources? Many factors play a role, … Yet a primary reason is the psychological biases that affect human decision making and lead executives astray when they confront an unsuccessful enterprise or initiative. Such biases routinely cause companies to ignore danger signs, to refrain from adjusting goals in the face of new information, and to throw good money after bad.

    Decision Making Chart
    Decision Making Chart (Photo credit: West Virginia Blue)
    … An awareness of this fact should make it easier to avoid errors—and does, if companies identify the biases at play, determine where in the decision-making process they crop up, and then adopt mechanisms to minimize their impact. Techniques such as contingent road maps and tools borrowed from private equity firms can help companies to decide objectively whether they should halt a failing project or business and to navigate the complexities of the exit.
    The psychological biases at play
    The decision-making process for exiting a project, business, or industry has three steps. First, a well-run company routinely assesses whether its products, internal projects, and business units are meeting expectations. If they aren't, the second step is the difficult decision about whether to shut them down or divest if they can't be improved. Finally, executives tackle the nitty-gritty details of exiting.

    Each step of this process is vulnerable to cognitive biases that can undermine objective decision making. Four biases have significant impact: the confirmation bias, the sunk-cost fallacy, escalation of commitment, and anchoring and adjustment. We explore the psychology behind each one, as well as its influence on decisions (Exhibit 1).

      Analyzing the project
      Let's start with a brief test of a person's ability to analyze hypotheses. Imagine that someone deals four cards from a deck, each with a number printed on one side and a letter on the other.4 Which pair would you choose given an opportunity to flip over just two cards to test the assertion, "If a card has a vowel on one side, then there must be an odd number on the other side"?

      Most people correctly choose the U but then incorrectly select 7. This pattern illustrates the confirmation bias: people tend to seek information that supports their point of view and to discount information that doesn't. An odd number opposite U confirms the statement, while an even number refutes it. But the 7 doesn't provide any new information—a vowel on the other side confirms the assertion, but a consonant doesn't reveal anything, since consonants can have even or odd numbers on their flip sides. The correct choice is the 8 because it could reveal something: if there is a vowel on the other side, the statement is false.

      Now imagine a group of executives evaluating a project to see if it meets performance hurdles and if its revenues and costs match the initial estimates. Just as most people choose cards that support a statement rather than those that could contradict it, business evaluators rarely seek data to disprove the contention that a troubled project or business will eventually come around. Instead, they seek market research trumpeting a successful launch, quality control estimates predicting that a product will be reliable, or forecasts of production costs and start-up times that would confirm the success of the turnaround effort. Indeed, …[negative reports] often give rise to additional reports that contradict the negative ones.

      Schlitz (Photo credit: reallyboring)
      Consider the fate of a US beer maker, Joseph Schlitz Brewing. In the early 1970s, executives at the company decided to use a cheaper brewing process, citing market research suggesting that consumers couldn't tell beers apart. Although they received constant evidence, in the form of lower sales, that customers found the taste of the beer brewed with the new process noticeably worse, the executives stuck with their low-cost strategy too long. Schlitz, … went into decline and was acquired by rival Stroh in 1982. Like-wise, when Unilever launched a new Persil laundry detergent in the United Kingdom, in 1994, the company tested the formula on new clothes successfully but didn't seek disconfirming evidence, such as whether it would damage older clothing or react negatively to common clothing dyes. Consumers discovered that it did, and Unilever eventually had to return to the old formula.

      Deciding which projects to exit

      At this stage, the sunk-cost fallacy is the key bias affecting the decision-making process. In deciding whether to exit, executives often focus on the unrecoverable money already spent or on the project-specific know-how and capabilities already developed. A related bias is the escalation of commitment: yet more resources are invested, even when all indicators point to failure. This misstep, … often goes hand in hand with the sunk-cost fallacy, since large investments can induce the people who make them to spend more in an effort to justify the original costs, no matter how bleak the outlook. When anyone in a meeting justifies future costs by pointing to past ones, red flags should go up; what's required instead is a levelheaded assessment of the future prospects of a project or business.

      The Vancouver Expo 86 is a classic example.5 The initial budget, CAN $78 million in 1978, ballooned to CAN $1.5 billion by 1985, with a deficit of more than CAN $300 million. … Outrageous attendance estimates were used to justify the added expense (the confirmation bias at play). Predictions of 12.5 million visitors, which would have stressed Vancouver's infrastructure, grew at one point to 28 million—roughly Canada's population at the time. Moreover, Canadians had seen budget deficits for big events before: the 1967 Montreal Exposition lost CAN $285 million—… and the 1976 Montreal Olympics lost more than CAN $1 billion ...

      Contrast that with the story of the Cincinnati subway. Construction began in 1920. When the $6 million budget ran out, in 1927, the leaders of the city decided that it no longer needed the subway, a point suggested by studies from independent experts. Further construction was stopped, though crews had finished building the tunnels.6 The idea for the subway had been conceived in 1884, and the project was supported by Republicans and Democrats alike, … World War I and shifting demographic needs had altered the equation. Fortunately for Cincinnatians, during the past 80 years, referendums to raise funds for completion have all failed.
      Sunk Costs
      Sunk Costs (Photo credit: Shiny Things)

      Proceeding with the cancellation

      The final bias is anchoring and adjustment: decision makers don't sufficiently adjust future estimates away from an initial value. Early estimates can influence decisions in many business situations,7 and this bias is particularly relevant in divestment decisions. There are three possible anchors. One is tied to the sunk cost, … Another is a previous valuation, … The third—the price paid previously for other businesses in the same industry—often comes up during merger waves, …

      The sale of PointCast, which in the 1990s was one of the earliest providers of personalized news and information over the Internet, shows this bias at work. The company had 1.5 million users and $5 million in annual advertising revenue when Rupert Murdoch's News Corporation (NewsCorp) offered $450 million to acquire it. The deal was never finalized, however, and shortly thereafter problems arose. … In the next two years, a number of companies considered buying PointCast, but the offer prices kept dropping. In the end, it was sold to Infogate for $7 million. PointCast's executives may well have anchored their expectations on the first figure, making them reluctant to accept subsequent lower offers.8
      Axing a project that flops is relatively straight-forward, but exiting a business or an industry is more complex:

      … The anguish executives often feel when they must fire colleagues also partially explains why many closures don't occur until after a change in the executive suite. Divestiture, however, is easier because of the possibility of selling the business to another owner. Selling a project to another company is much more difficult, if it is possible at all.

      When a company decides to exit an entire business, the characteristics of the company and the industry can influence the decision-making process. If a flagging division is the only problematic unit in an otherwise healthy company, for instance, all else being equal, managers can sell or close it more easily than they could if it were the core business, where exit would likely mean the company's death. … It sometimes (though rarely) does make sense to hang on in a declining industry—for instance, if rivals are likely to exit soon, leaving the remaining company with a monopoly.

      Becoming unbiased

      Several techniques can mitigate the effects of the human biases that confound exit decision making. One way of overcoming the confirmation bias, for instance, is to assign someone new from the management team to assess a project. … Making executives responsible for the estimates of other people is a powerful check: managers are unlikely to agree to a target they cannot reach or to overestimate the chances that a project will be profitable. The likely result is more honest opinions.

      Well-run private equity firms adopt these practices too. … Although the process can't eliminate the possibility that the partners' collective judgment will be biased, the reviews not only make biases less likely but also make it more likely that underperforming companies will be sold before they drain the firm's equity.
      Another tool that can help executives overcome biases and make more objective decisions is a contingent road map that lays out signposts to guide decision makers through their options at predetermined checkpoints over the life of a project or business. Signposts mark the points when key uncertainties must be resolved, as well as the ensuing decisions and possible outcomes. For a contingent road map to be effective, specific choices must be assigned to each signpost before the project begins (or at least well before the project approaches the signpost). This system in effect supplies a precommitment that helps mitigate biases when the time to make the decision arrives.

      One petrochemical company, for instance, created a road map for an unprofitable business unit that proposed a new catalyst technology in an attempt to turn itself around (Exhibit 2). The road map established specific targets—a tight range of outcomes—that the new technology had to achieve at a series of checkpoints over several years. It also set up exit rules if the business missed these targets.

      Road maps can also help to isolate the specific biases that may affect the corporate decision-making process. If a signpost suggests, for example, that a project or business should be shut down but executives decide that the company has invested too much time and money to stop, the sunk-cost fallacy and escalation-of-commitment bias are quite likely at work. Of course, the initial road map might have to be adjusted as new information arrives, but the changes, if any, should always be made solely to future signposts, not to the current one.

      Contingent road maps prevent executives from changing the decision criteria in midstream unless there is a valid, objective reason. They help decision makers to focus on future expectations (rather than past performance) and to recognize uncertainty in an explicit way through the use of multiple potential paths. They limit the impact of the emotional sunk costs of executives in projects and businesses. And they help decision makers by removing the blame for unfavorable outcomes that have been specified in advance: the explicit recognition of problems gives an organization a chance to adapt, while a failure to recognize problems beforehand requires a change in strategy that is often psychologically and politically difficult to justify. …

      When companies are finally ready to sell a business, the decision makers can overcome any lingering anchoring and adjustment biases by using independent evaluators who have never seen the initial projections of its value. Uninfluenced by these earlier estimates, the reviews of such people will take into account nothing but the project's actual experience, such as the evolution of market share, competition, and costs. …

      There are ways to ease the emotional pain of shutting down or selling projects or businesses. If a company has several flagging ones, for example, they can be bundled together and exited all at once or at least in quick succession—the business equivalent of ripping a bandage off quickly. Such moves ensure that the psychological sense of failure that often accompanies an exit isn't revisited several times. A onetime disappointment is also easier to sell to stakeholders and capital markets, especially for a new CEO with a restructuring agenda.

      In addition, companies can focus on exiting businesses with products and capabilities that are far from their core activities, as P&G did in 2002, when it divested and spun off certain products in order to focus on others with stronger growth prospects and a more central position in its corporate portfolio.9

      Although canceling a project or exiting a business may often be regarded as a sign of failure, such moves are really a perfectly normal part of the creative-destruction process. Companies need to realize that in this way they can free up their resources and improve their ability to embrace new market opportunities.

      Cognitive Dissonance
      Cognitive Dissonance (Photo credit: Mark Klotz)
      By neutralizing the cognitive biases that make it harder for executives to evaluate struggling ventures objectively, companies have a considerably better shot at making investments in ventures with strong growth prospects. The unacceptable alternative is to gamble away the company's resources on endeavors that are likely to fail in the long run no matter how much is invested in them.

      About the Authors
      John Horn is a consultant in McKinsey's Washington, DC, office; Dan Lovallo is a professor at the Australian Graduate School of Management (of the University of New South Wales) as well as an adviser to the firm; Patrick Viguerie is a director in the Atlanta office.
      1 Alex Taylor III, "GM's Saturn problem," Fortune, December 13, 2004.
      2 Richard Foster and Sarah Kaplan, Creative Destruction: Why Companies That Are Built to Last Underperform the Market—and How to Successfully Transform Them, New York: Currency, 2001.
      3 Richard E. Caves, "Industrial organization and new findings on the turnover and mobility of firms," Journal of Economic Literature, 1998, Volume 36, Number 4, pp. 1947–82.
      4 This example comes from P. C. Wason, "Reasoning," in B. M. Foss, ed., New Horizons in Psychology I, Harmondsworth, United Kingdom: Penguin, 1966, pp. 135–51.
      5 Jerry Ross and Barry M. Staw, "Expo 86: An escalation prototype," Administrative Science Quarterly, Volume 31, Number 2, pp. 274–97.
      6 Allen Singer, The Cincinnati Subway: History of Rapid Transit, Chicago: Arcadia Publishing, 2003.
      7 John T. Horn, Dan P. Lovallo, and S. Patrick Viguerie, "Beating the odds in market entry," The McKinsey Quarterly, 2005 Number 4, pp. 34–45.
      8 Linda Himelstein, "Dusting cobwebs off a Web staple," Business Week, July 14, 2003.
      9 Procter & Gamble annual report, 2002.
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