Executive Summary
Decision making is a crucial activity in any business organisation. Decisions are mostly made by the managers and leaders of the organisation. In case, an organisation has invested in a certain project, it is possible for the management to reach a decision to escalate the organisational commitment to the project.
The considerations that drive the organisation into reaching such a decision may include the amount of money that it has invested in the project as well as the time spent on it.
As a result, the organisation may decide to escalate its commitment despite information indicating that the project is failing. Oil drilling is a project that needs a lot of capital and money to undertake. If the project fails, the managers are likely not to accept the failure and escalate commitment.
This article focuses on escalation and, precisely, escalation by an oil company that has drilled oil for three years with no success yet the chief executive has decided to continue drilling.
Psychological aspects of decision making
Introduction
Decision making involves a process whereby someone selects an action that needs to be taken to counter a given problem. The action is usually picked from among a number of alternatives.
Decision making is a mental, cognitive process. It is a process that involves the mind, imagination and creativity (Drummond, 2012).
When making a decision, managers should be extremely careful since the decisions they make will have an effect on the organization’s performance. It will be crucial for them to make consultations before they reach a final decision (Bazerman & Moore, 2009).
This is the case for a company based in Greenland that has been drilling oil for the last three years and no oil has been found, and the CEO maintains that he has promising data.
This article focuses on the dangers associated with escalation of commitment and how these can be averted. It is a report addressed to the chief executive officer of the oil company.
Escalation
It is important for the chief executive officer to understand the meaning of the term escalation. The term is used by decision makers to justify their reasons for arriving at a decision to invest in a certain project. The term is used in instances where the anticipated benefits are less than the losses to be incurred.
The term escalation refers to an increase in number, volume, amount, scope or intensity. It has various meanings depending on the context in which it is being used (Morgan, Project Air Force (U.S.) & United States, 2008).
For instance, in a business environment, escalation occurs when the cost of goods and services rises as a result of inflation (Kahn, 2010).
Escalation can be driven by factors such as changes in technology as well as changes to the balance of supply and demand relating to an item or class of items or even services (Morgan, Project Air Force (U.S.) & United States, 2008). Cost escalation is likely to cause a projected cost overrun.
According to Wu (2011), “Escalation of commitment refers to the phenomenon of unpromising projects that have already been invested by accepting several resources permitted to be continued.
The extra investment is still chosen by the decision makers…..” (p. 37). Therefore, the CEO has the option of either escalating commitment or not to escalate.
The escalation of commitment to a certain project usually increases due to consideration of the past cumulative cost of the investment (Ackert & Deaves, 2010).
He is expected to assess the loss experience in the project. His decision to continue with the project can be described by the proverb “Throwing good money after bad” (Wu, 201, p. 37).
Escalation theory
When one is making a decision about an issue that is uncertain, there is a lot of risk involved (Drummond & Hodgson, 2011). Under escalation theory, the CEO will be tempted to continue with the drilling especially after considering the resources that have already been invested.
Some of the most important aspects of escalation theory are; descriptive, normative, as well as tactical aspects. There are many misunderstandings that arise from the escalation theory.
The descriptive aspects focus on the explanation of the dynamics and choices that are available for a given project (Kahn, 2010). The CEO has to look for all the alternatives that are best for the company to ensure it does not make losses.
This will help in generating all the possibilities. Normative aspect on the other hand is about the rules that exist about the situation (Kahn, 2010).
In this case, if the chief executive officer continues with the escalation, there is a probability that the company will incur losses. Therefore, the data relied on might be misleading and he should shun it.
As the CEO, one has a difficult situation when choosing a certain course of action which later shows signs of failure (Drummond & Hodgson, 2011). There is an option of deciding to pull out and invest in another venture.
The company can stick to its goals and continue pursuing the initial goals in the hope that it will pay off. Chief executive officers and decision makers have the tendency to escalate commitment, even after the previous course of action has proved not to be viable, and the decision appears unwise.
Prospect Theory
Prospect theory is an economic theory which deals with decision making. The theory involves decisions with high risks. It is based on the ways of averting losses in the decision making process. It is applicable where the outcome is foreseeable.
Based on the prospect theory, he can weigh between the losses that the company can incur from escalation and the gains that are likely to result and then make an informed decision. He can review the data and its reliability.
The decision he makes should not be based on the final outcome. Since there has been no signs of oil for the last three years, based on the prospect theory, the company is likely to incur a loss and, therefore, I would advise that the company does not escalate (Wakker, 2010)
Why escalation is necessary
It is imperative to note that the problems associated with the escalation directly affect the chief executive officer’s decision making. When a project seems not to work out, it is likely that a solution will be found for the problem.
It might take time before a solution is found. This is uncertain since the chief executive officer is not sure whether a favourable decision will be reached in the long run.
This stresses the importance of escalation. Instead of just giving up on a project, he should persist and find a solution to the problem (Clegg, Hardy & Nord, 1999).
As a CEO, he should be able to manage the escalation. Proper management of escalation will bring order to the company. Informed decision on whether to put resources on the project at the same times will lead to customer satisfaction (Hofmann, 2007).
Escalation of commitment has an influence on decision making by the management. Decision makers make a choice of the course of action, and they spend so much time being committed to the actions suggested by the decision despite the fact the decision might be wrong (Griffin, 2012).
If the management decides to escalate commitment in holding the stock, the economic situation may improve in the future, and the business organization may sell the stock at a profit. On the other hand, the decision makers may decide not to escalate commitment and sell the items at a loss.
He should take time to read an escalation report, so that he gathers enough information that will enable him make the right decision on whether to escalate commitment or not.
Psychological dangers of escalation
The chief executive officer should appreciate the psychological dangers of escalation and the steps involved. The first psychological cause of escalation is the fact that human beings have a tendency to believe in their own decisions.
They will try any means to prove that their decision is right even if there is evidence of the decision being wrong. This belief leads to what can be referred to as a perceptional bias. They will always perceive their decision as being right (Sylvan & Voss, 1998).
The second psychological cause of escalation is they will never judge their decisions as wrong. It is psychological that human beings will always filter out evidence to prove that their decisions are right. The bias can be referred to as a judgmental bias.
The third cause is that human beings fear to accept failure. It can be said that human beings will escalate commitment since they want to manage other peoples’ impressions. The fourth psychological cause of escalation is that human beings like to exhibit competitive rationality.
Human beings are usually not aware of what impact their decisions will bring. The chief executive officer of the company has the control, and negative impacts of the escalation can be averted through practical decision making (Cornwall, Vang & Hartman, 2009).
Social dangers of escalation
Managers, as well as decision makers, may decide to escalate their actions as a result of social factors. Among the social factors that can lead to escalation, include the fear of accounting to others for the decision or for the action they take (Drummond & Hodgson, 2011).
When the chief executive officer of the company makes a certain decision, the society will look up for the results of the company’s decision, and they expect the company to be accountable for the decisions they take.
If he drops or changes the course of action, he will be required to explain the basis of the action. In Greenland oil exploration, his decision will prevent financial losses by the company (Chell, 2004).
Economic dangers of escalation
In most cases, it is the economic reasons that will make chief executive officers change their initial decisions to invest in a certain project. One of the economic factors that causes escalation is the economics related to the investment decision that is associated with a given project.
In the Greenland case, the company might have spent so much money and time on the project. This makes the decision exceedingly difficult to be reached.
The company will be on the verge of making one significant loss if it quits the project. Economic losses may motivate the company to escalation (Bercovitch & Jackson, 2009).
Organisational causes of escalation
Among the organisational factors, there are those associated with the escalation of commitment. The institution or the company may not be willing to give up on the project due to considerations of the resources used and the time spent on the project.
The other factor is the contextual factors that might influence the activities of the organisation. These might include government policies as well as key firms, which work in partnership with the organisation.
The chief executive officer should rely on the dangers of escalation to arrive at a fruitful decision on how escalation can be averted (Nicholas & Steyn, 2012).
How to avert the dangers of escalation
The psychological dangers can be averted by encouraging a consultative mode of arriving at a decision. The CEO has the responsibility to facilitate the said process. Secondly, he can reduce the social dangers by initiating a strong support on the decisions reached.
Thirdly, the economic pressures in the company on profit making should be lowered. Finally, partners in the escalation process should be free to weigh the reasons for the company’s withdraw from the venture (Caldwell & William, 2012).
Why oil exploration may be vulnerable to escalation
The oil industry is one of the industries that require a lot of capital. As a result of many resources spent on this venture, it becomes difficult for the CEO to compromise giving up the project (Caldwell & William, 2012).
For instance, in Cuba, there have been efforts to drill oil with data indicating that there is oil in the region. Their second oil well-Catoche-1 proved to be unsuccessful. The reason given for the failure is a geological formation that is said to be extremely tightly compacted (Reuters, 2012).
Since data indicates that there is oil, it is likely that there would be an escalation in the project. The theory of escalation indicates that it is difficult for a company to give up on the project that is promising, bearing in mind the resources spent on it (Brocas & Carrillo, 2003).
Recommendations and conclusion
Escalation leads to the allocation of resources to areas which they should not be allocated since there is evidence that the project is failing. Among the recommended ways, which reduce escalation are activities that can overcome the perception threshold.
These are activities that will enable the management to generate active decision making. The other aspect that can reduce escalation is the activities to reduce selective perception. There are activities that will help in reduction of self justification.
The other recommendation that the management should engage in is the activities that will help them reduce the sunk cost effect as well as activities to reduce the unquestioned decision making (Mahlendorf, 2007).
The measures, which are likely to be most effective in the case of the oil company in Greenland, is that you should consider the dangers that are likely to result from the escalation.
If the result is a loss, it will be advisable that the company gives up on the project. Therefore, as the CEO should first review the data he has to ascertain its reliability and take an informed decision from there.
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