The problem with sunk costs

Many of you are familiar with the idea of sunk costs — those costs that are unrecoverable. Economics teaches us we should ignore sunk costs if we want to make the best decision going forward. After all, we cannot change the sunk costs so why even think about them for the next decision.

Ignoring sunk costs for future decisions makes perfect sense on paper and in classroom activities. However, it’s easier said than done. Here are some common things I hear when I lead sessions on sunk costs:

  • Sunk costs can inform us if they are representative of recurring costs. For instance, I know after I’ve trained someone that time/money spent is a sunk cost, so I should not add that into my cost/benefit analysis when deciding if someone needs to be moved into a different role or let go. The issue is that I’ll have to spend the same time/money training a new person if I don’t keep this person. It seems like the sunk costs are relevant to deciding what to do.
  • There’s a psychological component to sunk costs. Imagine saying to a customer, “let’s not even talk about last year’s contract because those are sunk costs to you.” That’s just not how most people are wired to think. Instead, we have a psychological tie to what we paid last year or the last time we bought it.
  • There’s an emotional piece of sunk costs. The old joke is to not to come to an economist for relationship advice because if you say something like, “But we’ve had four good years together,” the economist will say, “ehh, just ignore those years, they’re just sunk costs.” (Economics is the dismal science after all.) While the economist is absolutely right, memories and shared experiences are a fundamental human condition. Asking someone to totally ignore that is a tall order.
  • The dollar part of sunk costs are often written down, so they’re in our faces when we’re trying to make decisions. There’s something about seeing a big minus sign in the ledger that is just tough to ignore.

What this all adds up to is that sunk costs are often easy to identify and hard to ignore for decision making. What have some of your experiences with sunk costs been? What are some good ways that we can make sure we’re thinking about and acting appropriately when it comes to sunk costs?

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I’ve started to realize how powerful “rules” can be. “Rules” are the artificial constraints individuals put on themselves even when there isn’t anything really in the way. Here are some common examples of how “rules” creep into the day-to-day activities:

  • “I thought about sending this proposal to Jane, but proposals have to have a 12% return rate for her to even think about approving them.”
  • “We’re having trouble filling this role because have to hire someone with 10 years of industry experience and knowledge about this niche area.”
  • “I really think that Joe deserves an extraordinary raise this year, but I know that type of thing will go under heavy scrutiny and get widdled away to a more typical level.”
  • “I can’t ask to work from home tomorrow – no one does that in our group right now.”

“Rules” can arise from many different places — a leader who has a pattern of behavior that is not intended to be a rule but becomes one, a past job/experience that had an explicit rule that you can’t let go of, an offhanded comment that gets turned into a detailed rule or an example that turns into the “rule”.

I think MBM organizations are particularly susceptible to “rules” because we tend to use general principles to guide our behavior, which leads to ambiguity. Yet, most people crave clarity, so they start making “rules” to help them guide their behavior. It doesn’t take long for a best practice to turn into a “rule.” What are some of the risks we run with “rules”?

  • “Rules” suffer from some of the same downsides as explicit rules, except you have the added problem of they aren’t written down anywhere. So the clarity you get in the short run degrades over the long haul.
  • “Rules” can quickly become part of the culture and it’s much harder to change culture than it is to change a written rule.
  • “Rules” can be unconscious. This means that individuals may not be aware they are following the “rules.” This can also lead to people not seeing opportunities because they don’t even realize they have the blinders on.

I know there’s more to this “rules” thing than I can write in a few hundred words, but hopefully this gives you a flavor for what I’m thinking about. Now I turn it over to you. What can we do to help people break away from the “rules”? What aspects of MBM help us to prevent “rules” from becoming major constraints to what we do?

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Interesting Articles

Over the past several weeks, I’ve come across or been sent some interesting articles. Some of these explicitly connect with MBM and some of them are more interesting management or economics articles that may spark some good conversation.

  • California’s Water Shortage” gives a prime lesson on what can happen when you start interfering with prices. We associate prices with our Knowledge Process Dimension because they convey the knowledge people need to make good decisions as individuals, which often adds up to better overall societal outcomes.
  • How to Validate Your Business Idea So you Don’t Lose $82,000 Like Noah Kagan” gives one example (not the example) of how doing some low cost experimentation of your value proposition can help avoid making a major mistake. Thanks to Gary for sending along this story. As Gary pointed out in his message to me, “The thought behind it lines up very well with several of our Guiding Principles, including Value Creation, Principled Entrepreneurship, Customer Focus, Knowledge and Change.”
  • Jimmy John’s Serves Up Lessons on Terrible Management” is an article about a fast food chain who has required every employee to sign a rigid non-compete. The author of the article isn’t fundamentally anti-non-compete. Instead, she points that just because something is legal it doesn’t mean it creates value and when management is done in order to exert power for power’s sake, it almost always comes off as mean and wasteful.
  • A key mental model in MBM is the economic means versus the political means. “Rent Seeking: America’s New Past Time” gives one example of a form the political means of profiting can take (note: economics often use the term rent seeking to describe political profit that comes through the use/abuse of government powers).
  • While I cannot vouch for these programs (I haven’t been through them), here are 33 online economics courses. Many of them are through reputable universities and can be taken on your own timeline.

Have you come across any interesting MBM-related articles lately? Leave us a link or two in the comments.

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2014 Economic Freedom of the World Report

The 2014 Economic Freedom of the World Report was released earlier this month. As many of you know, this annual report includes some of the research that grounds very foundations of MBM. One of our key mental models is that economic freedom unleashes individuals’ productivity and it’s productivity that brings prosperity. As in all the years past, we continue to see that countries with more economic freedom tend to have more prosperity.

According to the authors of the report, “Individuals have economic freedom when property they acquire without the use of force, fraud, or theft is protected from physical invasion by others and they are free to use, exchange, or give their property as long as their actions do not violate the identical rights of others. An index of economic freedom should measure the extent to which rightly acquired property is protected and individuals are engaged in voluntary transactions.” When a person enjoys economic freedom she lives in a country where she has reasonable control over her time, talent, and resources.

Here are some things of note from this year’s Economic Freedom of the World Report:

  • Hong Kong and Singapore remain the in the top two positions for economic freedom.
  • Venezuela remains as the least free country they studied. Note: countries like Syria, Somalia, North Korea and others are not measured because of lack of data or mistrust of data.
  • The U.S. jumped from 17th to tied for 12th. This was a result of a combination of factors — including some positive increases for the US and some countries near the US losing economic freedom, which makes the relative position go up.
  • The US had increases in 4/5 categories in the Index, including size of government (remember, this a relative measure of size of government versus the economy. This does not mean the government has actually decreased in size), legal system and property rights, sound money, and regulation. Only freedom to trade internationally dropped.
  • China’s economic freedom increased, but it still in the bottom quartile (least free) of the 152 countries ranked.

The link above will take you to the full report. The authors make transparency a priority. Anyone can download the data, use it in their own studies and have access to the report online free of change. The same website includes a country-by-country data snapshot if you just want to check out a country or two.

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Authentic Change

During a recent conversation with a colleague who is attempting to apply MBM in an organization of about 600 people the topic of authentic change came up. The reality is that many clever people can take the language of MBM, slap it onto the things they are doing and sound really proficient. But how do you get authentic change? Here are a few things I’ve found about organization who honestly embrace MBM over the long haul:

  • It takes time. Of course there are certain things an organization may already be doing that are very consistent with MBM — finding ways to keep those, using the appropriate language and tweaking where necessary is a big, but often doable job. Changing the big things that are inconsistent with MBM is like changing a personal habit, like trying to exercise everyday or quit smoking. Except that it’s even harder because you’re trying to get hundreds of people to change the habit all at once. Authentic change doesn’t happen in the burst of energy right after making a New Year’s Resolution. It’s the day-in and day-out stuff over months or years that make it part of an organization’s DNA.
  • It takes all three conditions of human action — but for some reason people are really focus on discomfort instead of a vision of a better state. The three conditions of human actions (the things that have to be there for a human to take action) are a sense of discomfort, a vision of a better state and a belief that one can accomplish that vision. For many of us, the default setting is the discomfort. We want someone to change, we try to make that sense of unease real. My experience is that most people who want to change already feel the discomfort. It’s not all that unusual for me to hear people say, “But I don’t even know what applying MBM looks like!” or “Before I worked here for awhile, I didn’t understand why it was important.” This makes me think that there are a lot of folks out there who don’t have a vision of the better state.
  • Leaders make the difference. Having an outside person (like an MBM consultant) can only do so much. Unless leaders hold people accountable for change, it’s a waste of time.
  • Taking the long term view means treating honest mistakes appropriately. If we want people to try new things, mistakes will happen. ”Appropriate” will look different depending on the circumstances. If the organization starts to believe that any mistake will result in severe punishment, why would they try a new method of doing things?

These are just some high level things I’ve noticed when organizations start asking employees to apply MBM. What have you learned about authentic change?

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Individuals Versus Groups: “The Millennials”

One of the most deeply embedded mental models in MBM is the idea of individuals versus groups. The vast majority of MBM starts with the individual. This is in sharp contrast to thinking about groups (here are some examples – mentoring, career development, and RR&Es).

Recently, I’ve been leading many sessions about career development and it seems to be a place where letting go of the group mentality is difficult. Often, the hot topic is around “Millennials.” I put “Millennials” in quotes because I don’t exactly know who is even in the group we broadly describe as “Millennials.” Just a quick internet search will tell you that even the people who use this term don’t always agree.

I think it’s easy to default to thinking about “Millennials” for many of the reasons in this article. There are certain things that people who are new to the workforce have a tendency to struggle with because they’ve never done it before. It’s certainly not a new thing only today’s recent college graduates experience. In fact, if we are intellectually honest with ourselves, each and every one of us could probably think of something our past selves did that falls into the common complaints about newly minted employees.

The article linked above makes a good business case about why we shouldn’t group employees as “Mellennials.” From an MBM standpoint, it’s even more important that we shouldn’t group people. Ultimately, if we make it a practice of grouping people to make decisions, we erode the MBM culture. Here are some ways we risk eroding our culture when we start grouping folks, instead of thinking about each person as an individual:

  • We miss out on a chance to optimize RR&Es, decision rights, and compensation. These are key components of MBM that we enable us to create more value. Imagine the potential missed opportunities if we get it in our heads that everyone with a certain amount of experience would prefer vacation over a bonus. Or what could happen if we decided someone needs to be of a certain group to do certain types of work? (See next bullet points).
  • We don’t live up to the Guiding Principle of Respect. It’s disrespectful to group people based on any arbitrary factory (like race, age, etc.) instead of treating them as individuals. It’s like when I tell people I’m a football fan and live in Atlanta, they assume I’m a Georgia Bulldog. Little do they know I’m more of a pro-football fan, and the Cincinnati Bengals are my team! That was a superficial example, but imagine the number of times grouping people can turn disrespectful. Stereotyping is a natural outcropping of grouping people. Many of us are wise enough to know the fundamental problems that can happen when we stereotype others.
  • In this particular instance, we could run into discrimination laws (note: this is outside my expertise, so I’m going to keep it general). The idea of the “Mellennial” generation is based on age. Building employment strategies (intended or subconscious) based on age is a bad idea. Actions are directly contrary to MBM when they do not comply with all laws and regulations.

What’s your take on grouping people based on generation? Do you see other common ways that we often fall into the trap of looking at groups instead of individuals?

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I Don’t Like to Read — How Can I Learn More about the Foundations of MBM?

If you ask a typical MBM Team member what you can do to learn more about the foundations of MBM, there’s usually a few things that come up over and over. One of those is reading a book, essay or article. I believe reading is one of the core answers because in the past that was one of the few ways a person could learn about three key topics: economics, government, and philosophy.

First, I don’t think you can get completely away from reading. Part of the job of the MBM Team is to articulate key aspects of MBM through writing and talking. By writing things down we can get challenge, share it more easily, and preserve things for the future. However, once you get the basics of MBM, I do think you can do quite a bit to learn some of the foundational material without reading big tomes.

Here are a few thoughts about how you can learn more:

  • Free and open online courses: I’m currently watching a Yale Open Course about Political Philosophy. There’s no sweet graphics. It’s basically a professor just teaching a class. Since I’m more of an audio learner than and I a visual learner, this appeals to my style. Plus, I don’t have to read all of Plato’s Republic in order to know about it.
  • Videos on the basics: Some of the mental models in MBM are pulled directly from other disciplines. For instance, opportunity cost is a mental model pulled directly from economics. If you search for videos about opportunity cost and find someone reputable (economics professors, MBA programs, etc), chances are you’ve got the gist of the mental model. [Please note: this is not true of all mental models. For instance, if you search for CPV Triangle, I bet you get little/nothing. Our ABC Process is different than say Jack Welch's ABC stuff. One way you can tell is to cross-reference with the Science of Success. If the basics seem on track, chances are you've got something worth watching.]
  • Seek out someone in the organization that studied these things and ask them to teach you. It doesn’t have to be anything fancy. An added bonus to this is that most people learn even more by teaching.
  • Feed your intellectual curiosity: don’t study the things you hate (at least not at first). Out of the foundational topics, philosophy is my least favorite. I’ve learned that if I study things that bump up against philosophy (like some political science topics), I’m more likely to absorb. Like any discipline — dieting, working out, you name it — you have to do things that make it fun enough to keep doing it over the long-haul.

Before you take advantage of the alternative learning methods out there, I think you need to have some of the following skills:

  • Critical thinking skills to recognize that even topics and people that are very consistent with MBM may have aspects that aren’t exactly on target. In other words, don’t believe everything you hear or see. Even when you’re reading MBM Team generated material, put your critical thinking skills to use. We need employees who are thinking and challenging us about the ideas.
  • Have a sense of if something seems to fit with MBM or not. There’s no way one person is going to catch every nuance of a lecture or recording. However, having a high level sense of if something is generally consistent or not is key to learning more, whether it’s reading a book or watching a video.
  • Find a learning partner who you feel assured you can have safe conversations with. By safe, I mean that person you can ask the “dumb questions” to — even if they don’t have the answers, sometimes asking the questions can be just as useful as trying to answering them.

Have you found ways to learn more about the foundations of MBM that don’t involve reading? What’s worked for you in the past?


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Working the land

Today in the US, we are celebrating Labor Day. Labor Day is a holiday intended to be a tribute to the workers who have contributed to making the US a prosperous country. (Note: I say intended because I think most people just enjoy a day off with a cook-out.) While I agree that it is people who do the work that result in prosperity, it’s not people working alone. I hate the idea of toiling for no reward.

Yet, there’s been a picture from outer space that has been circulating lately that paints a stark picture of what laboring in one set of circumstances looks like compared to another. Click here to see “Where China and Kazakhstan Meet.” The difference from space is astounding.

I’ve had the pleasure of knowing people from both countries. From what I can tell of my friends, both countries have people who are willing to work hard to improve their lives and want to do the right thing. Yet, when you just take a glance (from outer space), something doesn’t seem to be going well in Kazakhstan. If you read the article attached to the picture, it states that this area of Kazakhstan still seems to run like it did during Soviet times.

So today if you’re thinking about the laborers who worked hard to build whatever country it is you live in, don’t forget about other things that mattered too: economic freedom, rule of law, capital, risk-taking entrepreneurs, and a culture that looks a lot like our Guiding Principles.

For those of you celebrating Labor Day, have a safe and happy day off! 

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Work-Life Balance

I bet many of you were surprised by the title of this post. Work-life balance is something that has gotten a lot of press for the last decade or so. If you search the right terms, you’ll get all sorts of articles that make you feel really good or really bad about your work-life balance.

What does MBM have to do with work-life balance? What’s funny is if you comb MBM materials, chances are you won’t find that phrase anywhere. If you work in an MBM organization like I do, chances are you don’t even hear that phrase often (if at all). I bet if you talk to a typical person, they care a great deal about work-life balance.

What (if any) mental models can help us think through the implications of work-life balance in an MBM context? Here are a few of my ideas, leave your thoughts in the comments:

  • Subjective value: What a “good” work-life balance looks like for one employee is not going to be the same for another. In fact, one employee may have very different ideas about what an optimal work-life balance is over his/her career. In MBM, we embrace subjective value and the uniqueness of each person. Often, there are tools at our disposal to help make things happen if we feel it creates value.
  • Self-interest: We understand that each person is self-interested. This means that each and every employee is working for us not out altruism, but because this current work arrangement appeals to their self-interest. My personal experience is that it is usually a bundle of things that make a job in someone self-interest (a combination of salary, benefits, type of work, location, etc.). We don’t shy away from this.
  • Competitive Advantage: We have to find ways to bring together the subjective value and self-interest of each employee with the needs of the organization. Organizations have to keep their competitive edges if they’re going to be successful.

When you put these three mental models together, there’s no blanket answer to the work-life balance question. It might make sense in one situation to allow part time or seasonal work, while in others it just won’t do. In some roles, great flexibility and working from home can be a possibility and other roles just can’t have that. Because we approach each situation as a unique opportunity to create value, there is a great deal of flexibility can be used to help make the situation into a win-win situation.

So what are some practical things you can do if you work in an MBM organization and you’re not happy with your work-life balance?

  • 1st and foremost — talk to your supervisor! If your supervisor doesn’t know how frustrated you are because you’ve been working 80 hour weeks or that you’d like to work more hours whenever possible, how can s/he help when the opportunity arises?
  • Be entrepreneurial: Can you find ways to create more value AND get closer to the work-life balance you want? Perhaps this is finding new projects that can get you more hours (or the type of work you want). Maybe it’s finding a way to shape your role (or find a different role) that lets you work remotely for a day or two a week. Maybe it’s talking to your colleagues and seeing if someone is interested in working on the project you’re sick of.
  • Focus on contribution. The more you contribute to value creation, the more valuable you are to an organization. Many supervisors view getting closer to optimal work-life balance as an incentive (and in some cases a more powerful incentive than straight financial incentives). Supervisors are on the look out for win-win situations. The more you add to the organization, the more opportunity there is for a supervisor to help you get what you want.

So these are my initial thoughts about work-life balance. I’ll admit this isn’t a topic I’ve studied in depth, so I turn to you for more thoughts. Use the comments to add mental models or ideas for action when it comes to work-life balance. And last but not least, I wish you the best of luck in finding the work-life balance that best suits your subjective value!

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MBM and Ambiguity

Once you’ve been in an MBM organization for a bit, you’ll notice there’s a level of ambiguity that comes along with MBM. Here are some examples:

  • The flexibility of RR&Es can result in an ever-evolving day-to-day. I have a job that has tended to have significantly different responsibilities every 6-12 months. While this isn’t true for everyone, it’s a possibility since we’re not restricted to rigid job descriptions.
  • Compensation isn’t constrained by pay ranges or formulas (unless required by law or contract). Unlike some professions/companies where employees know exactly what their bonuses will be at the beginning of the year, there is much more flexibility in the amounts and types of compensation an MBM organization can use.
  • Visions tend to continually evolve in an MBM organization because we’re constantly looking for ways to create value. Sometimes this evolution is smooth and steady. Sometimes it is a major shift.
  • Using principles instead of detailed rules means there isn’t going to be an employee handbook for every situation that comes our way. We deliberately coach supervisors not to tell direct reports exactly what to do or how to do when they can instead ask questions and build the employees’ capability up to do it for themselves. This can lead to frustration for some.

Above are just a few examples. I’ve been kicking around MBM organizations long enough to know that not everyone likes the ambiguity. Employees have left because they wanted to work somewhere with a very clear career ladder. We’ve lost employees because they prefer to know their exact bonuses every year from day 1. In my opinion, these folks are giving up some serious upside in order to have a bit more certainty in their lives — it’s simply a preference to have less ambiguity.

Some employees love the ambiguity. They have a bring-it-on attitude. They want to swing for the fences and love that they work in a place that doesn’t put ceilings on what an employee can contribute or earn.

However, most employees (like me) fall somewhere in the middle. There are times when I love the ambiguity. Sometimes I like that I may have a new responsibility that could totally shift my day-to-day. Sometimes I wish there was more clarity, especially in instances where I work on a project and it just doesn’t seem to pan out.

So if you’re more like me and kind of go back-and-forth on the ambiguity thing, is there anything you can do to get more comfortable with the ambiguity that comes along with applying MBM? Here are some thoughts, and I hope the readers add more in the comments:

  • Work hard to truly understand your team’s vision and how you personally create value. A firm understanding of how what your team does day-to-day to create value can make some of the organizational changes easier to understand and embrace.
  • Use the tools as your disposal. The RR&E Process is a great tool to help employees raise questions and concerns about what is going on around them. I find most employees don’t use this tool enough.
  • Get to know your supervisor and make sure s/he knows you. In an MBM organization, supervisors do more than more traditional organizations. Supervisor develop RR&Es and performance reviews, are expected to coach employees day-to-day, and initiate the compensation review process. The more confidence you have in your supervisor’s character and ability — and the more s/he knows about you — the more comfortable you’ll start to get with some of the ambiguity.
  • Give it a little time. It was some where around the 3 year mark for me (and it’s different for everyone), where I truly felt a trust develop. The trust was that the leaders I work under were doing their best to apply MBM. This isn’t to say mistakes aren’t made, but genuinely trying to apply MBM has a certain feel to it that makes the ambiguity not feel pointless. I firmly believe that leaders make all the difference in if MBM is a part of an organization culture or is just buzzwords. If you don’t trust your leaders, chances are the ambiguity is always going to be scary.
  • Make friends with someone in HR. This one sounds funny, but in most MBM organizations, the HR folks are in a good position to answer questions and help others apply MBM. Personally, I do a lot of work with the HR community where  I work and if they are any reflection of other MBM organizations, it’s these folks who can help you when there are questions or sticky situations.

Last but not least, I think a big component of this is knowing yourself. I do believe there are people out there would never get used to this type of ambiguity. I don’t think it’s worth your health, personal relationships, or general well-being to work at a place that gives you ulcers. Each employee has to determine for himself or herself if they can put up with the ambiguity.

Okay readers, let’s hear from you. What are your thoughts on ambiguity? Please leave any additional tips in the comments.

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