Do we work to win or to avoid losing?

Fear of defeat is a normal human feeling, tied as it is to the natural instinct for self-preservation. So it becomes automatic to rely on these instinctive mechanisms for our decisions at work as well. In that setting, however, it means that our fear of losing usually outweighs our pleasure in winning. The ability to take risks is one of the fundamental traits of a successful entrepreneur, provided the risk is calculated and properly managed.

At the organizational level, this tendency increases exponentially. In complex structures, made up of many people at different levels, risk aversion is amplified and leads to organizational inertia.

Let’s look at an example that shows how this mechanism works:

Professor Max H. Bazerman teaches a negotiation course at Harvard University. He opens the first day of every course the same way: he takes a 20-dollar bill and puts it up for auction (it is a variant of the “dollar auction” studied by the economist Martin Shubik in 1971). In the title of his article, Shubik (1971) presents it as a paradox in noncooperative behavior and escalation. There are only two simple rules:

1) bids must be made in increments of 1 dollar

2) the runner-up still has to pay their last bid, and gets nothing in return

The bidding starts and gradually all the participants but two drop out; the two who remain know that the loser will have to pay and get nothing, and they keep bidding.

At this point the strategy of the two is no longer aimed at winning but at escaping defeat (behavioral economics – loss aversion http://en.wikipedia.org/wiki/Loss_aversion). Studies of the psychological value of losses and gains have identified a loss aversion ratio of around 2. This means that the motivation to avoid a loss is about twice as strong as the motivation to seek a gain. A meta-analysis of 607 estimates drawn from 150 articles puts the mean coefficient at 1.955, with a 95% interval between 1.820 and 2.102 (Brown, Imai, Vieider and Camerer, 2024).

Bazerman has repeated this game many times, and the $20 bill has regularly sold for more than its face value; in some cases it has reached substantial sums (over $200).

The fear of accepting losses drives people (and organizations) to pursue ideas that have proved outdated, because they feel bound by earlier decisions. The loss aversion ratio shows how hard it is to let go of one project in order to start another that may be better.

The effect is that we carry on with a project, treating the costs already incurred as a reason to continue, and end up with a result shaped too heavily by past choices. Organization scholars call this escalation of commitment and have been investigating it for decades: a meta-analysis has reviewed the many determinants identified in the literature (Sleesman and colleagues, 2012).

The “winner’s curse” occurs in competitive situations, when a successful buyer finds that they have paid too much for an asset of uncertain value (http://www.cs.princeton.edu/courses/archive/spr10/cos444/papers/BazermanSamuelson83.pdf).

This situation applies in every industry and involves measurable costs, but also organizational and strategic costs and the cost of slower decisions, which are hard to measure.

People who work in sales, especially when the product or service is complex and the sales cycle is long, often find themselves in this situation. To deliver the expected results, a salesperson has to manage their time. The more time and effort they have devoted to a given sales cycle, the stronger their motivation and emotional involvement will be. This in turn leads them to overestimate the chances of success and to play down the risks, and there are three possible outcomes:

1) a sale: at the expense of margins and time, and by accepting and concealing possible risks.

2) a lost deal, with the material and emotional investment hard to recover

3) an endless cycle (the worst case): unable to accept the loss, the salesperson keeps alive the illusion that the opportunity is still open.

The more involved the person is, the harder it is for them to realize it; pressure and emotion increase the risk of serious forecasting errors.

Organizations are often unwitting accomplices, encouraging expectations that have a negative effect on the final result. Better formalization of forecasts and activity, more careful training at every level and particular attention to how employees are motivated (keeping the loss aversion ratio in mind) can minimize these risks.

Alberto Viotto