When do you exit a failing venture?

There is an interesting little piece in the McKinsey Newsletter on this today:

Standard economic theory treats human beings as rational, calculating machines, but behavioral economics holds that the machine often breaks down. Business people, no less than others, are subject to cognitive biases that can undermine their objectivity—particularly in emotionally traumatic and potentially career-destroying decisions to exit foundering businesses or cancel struggling projects.

Having been on all sides of this one, its interesting to see the McK thinking. They see cognitive biases in 3 key areas:

1. In analyzing the probable future of a project, they see a confirmation bias in those involved - ie seeking data that confirms their view. The proposed solutions are either (i) getting rid of existing management and/or (ii) adding extra accountability.

2. In the Exit/Invest stage, they see two problems, viz:

- Sunk cost thinking - ie counting costs that are irrecoverable
- Escalating Commitment - aka throwing good money after bad

The solutions are to use zero based budgeting and set up contingent roadmaps respectively (I think they got it the wrong way round in the chart)

3. In Proceeding with the Exit, the risk is that people become anchored around previous higher valuations and are unable to make the adjustment. The proposed solution is to use caretaker managers and/or independent evaluators

All very valid, but this does still rather sound like the Rational Calculating Machine approach though - my experience is that these things are much messier, much harder to discern at the time when you can do something about it - ie by the time it is clear, its too late.

For example, analyzing the future is often done in the context of a few deals that if they do come off can be shape changing, what is usually unclear is the probability / time / cost equation - which is of course what drives the "good money after bad". Changing and/or burdeining the management can be unhelpful here and (i) the New Manager has to get up to speed - wastes time at a critical point, plus (ii) turkeys don't, by and large, vote for Xmas no matter when they are drafted in.

Likewise, that price at Exit can be driven as much by the financial (or reputational) impact of the Funding body having to write it off, or the fear that signals sent to the market by bringing in caretaker managers will drastically reduce valuation.

In hindsight, I'd say there are another set of pointers one could use to see things at the time when changes can still be made:

1. Analyzing the future - Rate of change of sales in the industry segment and rate of change of sales of the business as a % - either of these slowing down is a signal that life is going to be harder - both turning down means it will get hard, fast. Customer defections can be a lead indicator as well.

2. Exit/Invest - When the above occurs, consolidation is the emerging game in town, so be consolidatable - you are still of value as you have customers/revenues/reputation etc etc. (i.e. there are probably still greater fools out there)

3. The "F*ck Off" price you receive today will usually be better than the "f*ck off" price you receive later when you, the market and your buyers are all (i) more clear on your situation, (ii) more clear on the market's (reducing) potential, so any optimism is gone, and (iii) capital can be put to use elsewhere sooner.

(And an old and very veteran friend once told me this one - decide who the biggest sleazeball in your org is...when they jump ship, you know its time to think of exit)

Be very interested in others' "early indicator" thoughts.