How Biases Can Color Entrepreneurial Decision-Making
0 min read
Innovation and entrepreneurship can be synonymous with uncertainty, and an environment of uncertainty is often the perfect atmosphere for biases to come into play. One of the most pivotal decisions that entrepreneurs have to face is whether or not to pivot (pun intended). Succumbing to certain cognitive biases during such decisions can be costly.
In the startup world, pivoting means shifting to a new strategy. During pivots, the ultimate goal remains the same: to solve a specific problem in society. The methodology used to ultimately address this problem, however, changes. Pivots can take a variety forms. Here are some examples:
- Changing the platform of your product. For example, moving from mobile technology to a web-based platform.
- Utilizing a different revenue model and/or moving to a different target market. For example, shifting from a B2C (Business-to-Customer) model to a B2B (Business-to-Business) model.
- Adding (or removing) a significant feature to (or from) your product.
Pivoting can help increase a business’s growth, evade large challenges, diversify market reach, and improve customer reach. Embracing the pivot is key to finding success in the world of entrepreneurship. After all, a product idea will rarely have the perfect business model or product market fit from the beginning. The flexibility to pivot is essential for any true entrepreneur.
At the same time, the decision to pivot should be backed by extensive planning. This article won’t necessarily help you determine if it is the appropriate time for your startup to pivot. Instead, it will discuss the different biases that may affect your ability to make a sound decision. Knowing these biases can help you avoid common decision-making pitfalls, and potentially protect your startup.
Behavioral Science, Democratized
We make 35,000 decisions each day, often in environments that aren’t conducive to making sound choices.
At TDL, we work with organizations in the public and private sectors—from new startups, to governments, to established players like the Gates Foundation—to debias decision-making and create better outcomes for everyone.
Biases that can influence the decision to pivot
Survivorship bias is the heuristic of focusing on a successful subgroup and believing it to be representative of the entire group, often due to the failed subgroup’s lack of visibility.1 Survivorship bias is especially prominent in the startup world. It is widely known that nearly 90% of startups fail.2 Nevertheless, a majority of entrepreneurs are confident that their venture and entrepreneurial journey will be successful. Oftentimes, these bold statements are backed by references to stories of successful startup founders such as Mark Zuckerberg or Bill Gates (a.k.a. the survivors). What does not cross people’s minds so easily, however, is the number of failed founders. In a sense, survivorship bias is a form of the availability heuristic, which describes our tendency to rely more heavily on information that comes to mind quickly and easily when making decisions about the future.3
Survivorship bias affects decisions to pivot in a similar way. There are several startups became successful as the result of a major pivot: some notable examples include Slack, Twitter, and Instagram. Such stories can misrepresent the success rate of radical pivots. As a result, founders may be inclined to pivot, even when doing so is more of a last-ditch effort rather than a sound business strategy.
Hard pivots are often only a means of stalling failure for many companies.4 Therefore, it is important to recognize when the urge to pivot may only be a reflection of deeper underlying problems with your startup. Understanding survivorship bias can help you navigate this decision with less unrealistic optimism and more sound reasoning, as focusing a bit more on the failures can paint a more holistic picture. And that picture is sobering: One study found that approximately ~10% of startups fail due to an unsuccessful pivot.5
Of course, successful pivots are indeed inspiring. Just remember: pivots are not always successful.
Sunk Cost Fallacy
The sunk cost fallacy describes our tendency to consider past investments of resources when making decisions, often resulting in the decision to continue the behavior at hand.6 While virtually everyone succumbs to the sunk cost fallacy, it can be especially common among entrepreneurs, who invest great amounts of time, energy, and capital into their projects with hopes of seeing their vision materialize. This fallacy can be costly, as it can bias entrepreneurs towards executing a strategy or operating their business well beyond the point where they should have given up. Why? They don’t want their “sunk costs” to go to waste. As a result, they continue to waste more resources.
Sunk costs can make it very difficult to decide to pivot. This relates to the concept of “psychological ownership” in entrepreneurship, which describes entrepreneurs’ tendencies to become one with their ideas, both internally and externally.7 Prior investment can cause entrepreneurs to develop a personal attachment to their product or strategy, which can contribute to the risk aversion associated with pivoting.8 It is important that entrepreneurs do not get too attached to their original or present business model. By avoiding doing so, they can be more open-minded when approaching alternative strategies that could indeed put them on the path to success. It can also help to frame projects in the context of future utility, by thinking and talking about your business in the future tense.
Entrepreneurs are passionate about the business they are building. Their commitment and unwavering belief in their startup is often what helps them transform their idea into actuality. However, this can be a double-edged sword, as entrepreneurs’ faith in themselves can affect their ability to notice that their idea may not actually be viable. This is often referred to as overconfidence bias, which describes people’s tendency to overestimate their abilities to perform a task or the probability of success in comparison to an objective evaluation.
Overconfidence bias can affect the decision to pivot in both ways. For example, an entrepreneur may have great faith in their current strategy, and thus avoid a pivot. On the other hand, they may be inclined to execute a hard pivot, and may do so carelessly due to their overestimation of the likelihood of success.
The biases described above all contribute to confirmation bias, which is our tendency to more frequently notice and absorb information that supports our underlying beliefs. Biases such as survivorship bias, sunk cost fallacy, confirmation bias, and even overconfidence bias can exacerbate confirmation bias. Entrepreneurs may find themselves selectively focusing on feedback that supports their original idea, and ignoring feedback that suggests otherwise. This, of course, applies to decisions regarding pivots as well.9
For example, an entrepreneur who just developed their minimum viable product (MVP) may begin to conduct pilot testing. It is likely that the entrepreneur has some hypotheses going into the testing phase. As a result, the entrepreneur may interpret the results of the pilot testing in ways that validate their original hypotheses. As a result, he or she may miss crucial signs that indicate a pivot in strategy is necessary.
To pivot, or to persevere—it can be the most difficult decision for entrepreneurs to make, and a crucial one at that. Upon reviewing the various biases that can affect this decision, we also notice a third option quietly lurking: to pull the plug. While pivots are quite common among successful startups, it is important to realize when you are pivoting only to put off admitting failure. Realizing this saves time, effort, and resources down the road. At the same time, it is essential that entrepreneurs are able to recognize when their present strategy is not working, and a pivot is necessary. Understanding the biases described in this article can help entrepreneurs approach the decision to pivot more rationally.
One final recommendation comes from Eric Ries, entrepreneur and author of The Lean Startup: to seek the “perspectives of outside advisors who can help us see past our preconceptions and interpret data in new ways.”10 While being aware of the aforementioned biases can be helpful, it is often not enough to escape them. Third-parties have the ability to more objectively assess the state of your startup, as they personally haven’t invested their own resources.
- Survivorship Bias. [cited 19 Oct 2020]. Available: https://corporatefinanceinstitute.com/resources/knowledge/other/survivorship-bias/
- Forbes. [cited 19 Oct 2020]. Available: Patel, N. (2015, September 02). 90% Of Startups Fail: Here’s What You Need To Know About The 10%. Retrieved July 27, 2020, from https://www.forbes.com/sites/neilpatel/2015/01/16/90-of-startups-will-fail-heres-what-you-need-to-know-about-the-10/
- Availability Heuristic – Biases & Heuristics. [cited 19 Oct 2020]. Available: https://thedecisionlab.com/biases/availability-heuristic/
- The Road to $100M — Reforge. [cited 19 Oct 2020]. Available: https://www.reforge.com/the-road-to-100m
- CB Insights. Why Startups Fail: Top 20 Reasons l CB Insights. CB Insights; 6 Nov 2019 [cited 19 Oct 2020]. Available: https://www.cbinsights.com/research/startup-failure-reasons-top/
- Domeier M, Sachse P, Schäfer B. Motivational Reasons for Biased Decisions: The Sunk-Cost Effect’s Instrumental Rationality. Front Psychol. 2018;9. doi:10.3389/fpsyg.2018.00815
- Pierce JL, Kostova T, Dirks KT. The State of Psychological Ownership: Integrating and Extending a Century of Research. Review of General Psychology. 2003. pp. 84–107. doi:10.1037/1089-26188.8.131.52
- Viswanathan VK, Linsey JS. Role of Sunk Cost in Engineering Idea Generation: An Experimental Investigation. Journal of Mechanical Design. 2013. doi:10.1115/1.4025290
- Baer M, Brown G. Blind in one eye: How psychological ownership of ideas affects the types of suggestions people adopt. Organizational Behavior and Human Decision Processes. 2012. pp. 60–71. doi:10.1016/j.obhdp.2012.01.003
- Ries E. The Lean Startup: How Today’s Entrepreneurs Use Continuous Innovation to Create Radically Successful Businesses. Currency; 2011.
About the Author
Sanketh is an undergraduate student at the University of Maryland: College Park studying Health Decision Sciences (individual studies degree) and Biology. He is the co-Founder and co-CEO of Vitalize, a digital wellness platform for healthcare workers, and has published research on topics related to clinical decision-making, neurology, and emergency medicine and critical care. He is also currently leading business development for a new AI innovation at PediaMetrix, a pediatric health startup, and previously founded STEPS, an education nonprofit. Sanketh is interested in the applications of behavioral and decision sciences to improve medical decision-making, and how digital health and health policy serve as a scalable channel to do so.