The Planning Fallacy and the Innovator’s Dilemma
“You have to deliver $300 million in incremental growth by 2015,” the business unit head told the leader of his innovation team. “That’s less than 5 percent of our revenues, so that should be quite doable.”
While $300 million might sound like a ridiculously large number to small business owners or entrepreneurs, leaders in many global giants consider the amount a drop in the bucket. But anyone with near-term innovation targets with nine (or six or even four) digits in them should ensure they are familiar with the concept of “planning fallacy.”
The basic concept, first presented by Nobel Laureate Daniel Kahneman and his partner Amos Tversky in an influential 1979 paper, is that human beings are astonishingly bad at estimating how long it will take to complete tasks. As recounted in Kahneman’s recent book, Thinking, Fast and Slow, one study found that the typical homeowner expected their home improvement projects to cost about $19,000. The average actual cost? $39,000. Despite ample available information, 90 percent of high-speed railroad projects have missed budget and passenger estimates, with an average overestimation of passengers of about 100 percent and underestimation of budget of about 50 percent.
Entrepreneurs often underestimate how long it will take them to produce revenues, and wildly miss how much they will have to invest to commercialize their idea. As investor and pundit Guy Kawasaki notes, “As a rule of thumb, when I see a projection, I add one year to delivery time and multiply revenues by 0.1.”
The same challenge makes it difficult for companies to escape the innovator’s dilemma. To get through the corporate approval gauntlet you have to project big numbers. Then early results disappoint. Often projects or even divisions get shut down. And the company is staring at an even bigger growth gap. (Innosight cofounder Clayton Christensen memorably termed this the “growth-gap death spiral” in his 2003 book The Innovator’s Solution).
One way to avoid planning fallacy is to get — and use — data from comparable efforts. A simple starting point can be historical projects.
Scott D. Anthony is managing director of Innosight Asia-Pacific.