Don Sull's blog

In turbulent markets, firms must disinvest from under-performing units to free resources necessary to exploit new opportunities. Most firms are better at getting into new things than getting out of established ones. In a recent survey, respondents cited their firm’s lack of a “well-defined processes to exit declining businesses and kill unsuccessful initiatives” as the second biggest obstacle to agility (out of a total of thirty possible factors). My last post summarized data suggesting that firms typically delay exit beyond the optimal point, and in the process deplete resources to invest in growth opportunities.

Why do firms struggle to kill failing initiatives? There are many sound reasons to delay exit, including uncertainty about the payoff to persistence, closing costs, and interdependencies among units that prevent a clean severing of ties. In many cases, however, executives fail to exit even as evidence mounts that the costs of persistence outweigh the benefits of staying the course.  Instead they double down, and increase their investment rather than pulling back to revisit their ingoing assumptions, and make mid-course corrections or pull the plug.

Management scholars refer to this tendency as “escalating commitment to a failed course of action,” and have documented that both individuals and organizations often increase their investment despite negative feedback. Several factors contribute to this tendency, but the most important is the decision maker’s desire to save face. Rather than admit their earlier decision was mistaken, people often increase their investment in the hopes that more resources will produce a favorable outcome.

This explanation, in my view, rightly highlights the importance of saving face in delayed exit, but misses some of the organizational realities that prevent disinvestment in complex organizations. My doctoral dissertation advisor Joseph Bower along with several of his doctoral students, including Clay Christensen, have provided a more nuanced view of how resources are allocated in large, complex organizations, and one that sheds more light on the dynamics of exit.

Bower shows that in most large, complex organizations, resources are allocated through a bottom-up process. Frontline employees closest to the market identify and experiment with potential opportunities at little cost to the organization. To secure the significant resources required to scale a promising opportunity, a well-regarded middle manager must sponsor the project, take responsibility for its execution, and vouch for its ultimate success to the senior executives who allocate funds. The middle manager stakes her reputation on the success of the initiative, providing a strong incentive for her to advance only the most promising projects and make sure they succeed. Repeated success increases a manager’s reputation for competence in picking good projects and making them work, and boosts her ability to secure resources in the future.

My own work in this stream of research found that the bottom-up process of resource allocation can stall in reverse because it fails to trigger disinvestment from opportunities that are not panning out. Managers rarely recommend killing a project they have endorsed, because it could jeopardize their reputation. Their reluctance to exit is often aggravated by concern for the team and employees who would be hurt by disinvestment. Instead, these executives often seek more resources, hoping (against hope) that further investment will reverse the situation.

Executives are slow to exit from legacy businesses in decline, but they also fail to kill new initiatives that consume significant resources as they scale. Because opportunities in the scaling stage devour so many resources, they live in the corporate spotlight, increasing the reputational damage their management champions incur if they pull the plug. Managers can smother start-up projects, but killing a project burning resources to scale often ends in a public execution.

One financial services firm tackled this problem head on. When the CEO appointed an executive to scale an exciting opportunity in Eastern Europe, he also built in checks to ensure it would be possible to kill the initiative if necessary. He insisted the team include senior members from the risk and finance functions to oversee performance against plan. He refused to authorize the expenditures until the group articulated a handful of deal-killer indicators that would constitute clear grounds for terminating the business.

He also structured the business as a separate legal entity, even though the firm owned all the shares. This legal structure allowed him to appoint a board of directors, which the CEO staffed with outsiders detached from the business as well as a director who had scaled a service business and could distinguish typical growing pains from serious problems. When the risks of the new opportunity proved to outweigh the rewards, the CEO orchestrated a face-saving exit for the executive, promoting him to a significant position in the core business and praising his willingness to take on the scaling of a venture in an unfamiliar market.