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No doubt about it - a foolish decision can ruin an agreement. If you have ever done that, you might want to know some of most common mind freezes that can lead to unwise decisions and costly results. This article speaks to that issue, includes a case study to illustrate it, and provides better ways to approach a decision before you make it, especially if it will affect important outcomes.

When managing the contracting process your decisions can mean the difference between success and failure!  Sometimes our own biases and resulting delusions obstruct successful results all parties to the contract believe they deserve.   How do you keep from unwittingly making that mistake?

First, don’t expect one answer to this challenge, because no two organizations or individuals think or act alike.   Even so, much insight today has evolved to reveal how we form our decisions and push our cherished biases into them.   The point is we can eliminate erroneous thinking by influencing all parties to act objectivity within the contracting process -- no matter the mental obstacles we too often carry.

Biases and delusions hurt all parties

We need to be transparently honest when deciding on an action plan based on data available.  In working with that data, we must be aware of any illusion of making a profit when the project has obviously failed. Also, we need to be aware of any reciprocity a counterparty to the contract may use to force us to sign a deal that is obviously not in our best interest.

Relying on data alone for executing the contract?  Not smart!

As stated, our decisions arise from available data plus our human psychological responses to it, and that habit can lead to an unhealthy result. Maybe tragic!  For example, when given a statistic about the consumer trend towards a particular product or service, often we focus on the content as opposed to the reliability of the information like sample size, demographics, conditions, consumer backgrounds, seasonality issues, etc.  The downside is we give ourselves a world view that is simpler and more coherent than the data, but the data itself too often fails to justify our world view.

It happens, unfortunately, because most numbers are collections of randomness and do not necessarily tell an all-encompassing story, such as, the reality or consistency of the facts in an ever-changing unpredictable environment. Numbers alone produce observations that are due to chance, and chance events are rarely reliable. “Causal explanations of chance events are inevitably wrong,” says Daniel Kahneman, winner of Nobel prize, in his bestseller Thinking, Fast and Slow.1 

Big technology unicorns2 like Google and Facebook that rose to billion-dollar organizations do not enable any tech start-up to automatically become the next in line for major success.  And no matter how interesting this concept might be, a high profile, award-winning chief executive officer (CEO) does not make the company more successful than its competitors.

Likewise, even if a supplier has good performance track records, it does not mean the supplier is risk-free in any current contract. Historical events do not constitute future results; and the success of any company is a separate issue from the fame and accolades received by its CEO.  And don’t forget -- the number of unsuccessful start-ups that outweigh the successful ones often reflected the same success stories of start-ups that have been successful.  

False gains never work

It’s foolish to rush in to implement a new system or to overhaul the infrastructure altogether based on the euphoria pushed by “experts” who expect high profitability returns. Organizations that practice that take risks because they too often fear forfeiting imagined gains.

Companies that benefitted from adopting technology that produced stellar results usually did so only by implementing good organizational building structures that preceded their success stories.  Specifically, their culture and adaptability to change was in place and their people and partners were prepared to evolve. Companies lacking these attributes often find themselves flat lining -- unable to move forward after spending huge dollars on their system implementations. 

Sunk-cost fallacy3

The unwillingness to close out a project that is creating losses and to continue investing more resources on your failing project when better options are available -- that is we call a “sunk-cost fallacy.” This costly mistake pins people to a plateau and they are unable to break out. If you have such a delusion, you not only will be blind to your real loss, but you could also destroy the prospect of an alternate investment growth potential where resources can be channelled and put to better use. 

Reciprocity

It is risky to close a deal with a vendor who has done a favor for you or who has made a promise to reward you.  Unless a first right of refusal is explicitly given as a commitment in an earlier contract, a deal out of a reciprocal act will rob us of what could have been a better option. 

For example, a breach of purchasing policy occurred when three quotes in the solicitation were made without any intention of considering alternate vendors.  Inevitably, if we become overconfident in what was presented to us, our own blind trust will usually result in an unfavorable decision.

For instance, when people favor a technology, product, or company, they think only of its large benefit offerings and assume little risk will result. And when the market is down, those who plunge their life savings into certain companies or ventures hoping to gain high returns when the market recovers often underestimate the risk they face.

Somehow our minds tend to jump to conclusions when they believe a false narrative as expressed by Daniel Kahneman when he wrote “Rationality is logical coherence - reasonable or not.”4

Business collapse – a case study

Not long ago, a newly opened retail store was quickly gaining traction as its first-year revenue hit $5M. Owners opened 18 more stores soon after its founder had won an entrepreneur award. Revenue soon exceeded $20M. Its outstanding performance had attracted companies eager to do business with him. 

One vendor offered the store an opportunity for growth in home furnishing business and invited the store partnership in a warehouse for storing large inventory at a highly discounted rate. The offer was accepted. 

But within the year the business failed. They tried moving to a more prominent location and they picked up at first but suddenly stopped again due to unfavourable regulatory changes.  More collapses kept occurring until the business finally declared bankruptcy. 

What caused this?

Adverse market conditions?  Something beyond their control?  No, instead the business was overly confident.  At the end of the day, the owner knew that the business was losing money every year but did nothing to change it. Instead, unrealistic ambition to recharge the business led to total loss!  Their naive beliefs assumed that what they heard about present market conditions were true.  The business unwittingly took on high debts to pay for ambitious expansion plans that included penetrating into an unfamiliar marketing territory.  Then the losses started mounting up.

Know what you want, your objective, mission, and purpose.

Any decision spawned by fear of losing out is dangerous.  It derails our vision so that we fail to align with our business’s original objective.  Our illusion of false gain steers us into what we never intended. In his book, Better Decisions Fewer Regrets5, Andy Stanley encouraged audiences to ask questions like: “Why am I doing this?” “What story do I want to tell?” before committing on a decision. And even as you make your decision, question the diagnosis of that decision to reaffirm your thoughts. 

You could label this as making a premortem procedure.  In fact, Gary Klein, a psychologist, proposed doing a premortem exercise6 for any critical decision you plan to make.  He suggested finding experts to help you – people who are knowledgeable about the decision.  In the exercise, ask the experts to imagine your team agreeing to a specific decision.  Define the decision and then imagine the decision failing a year later.  Then ask them to imagine various reasons why the decision failed, what could be done differently, and what was wrongly assumed.

Doing this teamwork premortem exercise helps to unleash possible threats that were not previously thought of and legitimizes doubts that raise a deeper look on its risk management.  You should then be able to restructure the decision or plan or to reconsider it altogether if that does not make sense to the business’s objective. 

When making your decision or plan, take time to continue discussing it with your team in case you discover that you must detour into a new direction. Any project that involves huge investment costs with high vested interest in time and effort often makes investors unwilling to abort the plan even when it starts to collapse. Their “sunk-cost” fallacy (delusion of success) is costly and leads headlong into risk-taking.  Then, as time passes, the loss perpetrates into greater losses with more resources foolishly invested. 

Evaluate other options

Responding to a favor by committing to a deal is often emotional and prevents rational decision-making. Bazerman and colleagues in the HKS Faculty Research Working Paper Series Joint versus separate evaluation,7 suggests that by seeking and evaluating multiple options jointly and simultaneously helps to combat emotion that creates judgmental bias.  By doing this you will get clarity on all possible alternatives that would lead to better and more ethical decisions.

Interviewing known experts who have the facts on the various options available will give you a deeper understanding about what’s happening in the marketplace. Some scholars advocate justifying a decision before committing to it. This reduces the likelihood of acting on emotions that we will later regret.

Often people want you to see them as collaborative, but, when collaborating, be careful. You don’t want to commit to something you cannot sustain. If something is too good to be true it probably is.  So, let’s err on the side of caution!

END NOTES

  1. Daniel Kahneman, winner of Nobel prize https://www.nobelprize.org/prizes/economic-sciences/2002/kahneman/facts/
  2. The Complete List of Unicorn Companies, CB Insights
  3. Sunk-cost fallacy https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/sunk-cost-fallacy/ and https://en.wikipedia.org/wiki/Sunk_cost
  4. Thinking, Fast and Slow by Daniel Kahneman: Summary and Notes
  5. Better Decisions Fewer Regrets, by Andy Stanley https://www.amazon.com/Better-Decisions-Fewer-Regrets-Questions/dp/1713528126
  6. Performing a project premortem, by Gary Klein, Harvard Business Review, from the September 2007 Issue. https://hbr.org/2007/09/performing-a-project-premortem
  7. Bohnet, Iris, Alexandra van Geen, and Max Bazerman. "When Performance Trumps Gender Bias: Joint Versus Separate Evaluation." Management Science 62, no. 5 (May 2016): 1225–1234. https://dash.harvard.edu/handle/1/8506867

REFERENCES

ABOUT THE AUTHOR

Yvonne Sophia Low has been a professional in strategic sourcing procurement and vendor partnerships for 15 years, during which she added significant value to various multinational corporations (MNCs) in transformative projects focusing on cost and contract optimization, excellence and effectiveness, processes, and risk mitigation. Recently she dedicated her time to humanitarian initiatives by writing two books for the underprivileged community. She can be contacted via https://www.linkedin.com/in/yvonne-sophia-low.

 

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Yvonne Sophia Low, Business Partner, Negotiator, Certified Procurement, LLM


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