Imagine this: 20 minutes into a movie with big name stars, you realize that it should probably rank in the 5 worst movies ever made. Will you leave – if the ticket cost you $10?
Welcome to the world of cognitive biases.
The scenarios listed above are examples of the sunk-cost fallacy or bias, one of the four, that a McKinsey Quarterly article argues prevents companies from getting out when they should – out of unprofitable divisions, businesses or even industries.
The other biases cited in the article are equally pernicious and can waste money and destroy value:
Could some of this have happened at GM with its Volt electric car? Surely they knew that demand for it would be far below what was needed to drive down costs with massive economies of scale?
The example from the article illustrating both these biases:
The Vancouver Expo 86 is a classic example. 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. During those seven years, the expo received several cash infusions because of the provincial government’s commitment to the project. 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—six times early estimates—and the 1976 Montreal Olympics lost more than CAN $1 billion, though no deficit had been expected.
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. Customers complained of slow service and began defecting to Yahoo! and other rivals. 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.
The full, long article talks in more detail about these biases and how to overcome them, along with other examples.