Dangers of Escalation of Commitment in Accounting

This report analyses the issue of escalation of commitment to a course of action from the perspective of the pharmaceutical industry. Escalation can be defined as a situation where a failing venture is supplied with additional resources beyond the point of feasibility. As such, escalation carries substantial dangers for organisations by generating avoidable economic losses. The report inquiries into the generic causes of escalation by examining subject literature. Accordingly psychological, social, organisational and project-specific factors are identified as common escalation activators. Exploration into the particulars of the said industry categorises profitability issues, market performance concerns, maturing products portfolio alongside development pipeline conditions as features amplifying pharma companies’ vulnerability to escalation. The point is supported by real-life case examples located in the appendix.

Appreciation of escalation causes allows for development of effective prevention policies. The report suggests preventive measures aimed at reducing the occurrence of escalation triggers, such as challenging the individual and social causes. Approaches for reducing other factors’ impact on decision-making are outlined in the form of strategy alteration as well as process management policies. The report finalises with suggestions on escalating situations management.

Statement of Reference

The aim of this 2000-word report is to inquiry the causes and dangers of escalation of commitment to a course of action from the perspective of pharmaceutical companies.

This report is to assess the dangers of escalation of commitment to a chosen course of action through the perspective of pharmaceutical companies. In order to achieve the aim set, the paper first analyses the definition and threats arising from the phenomenon of escalation.

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Next, following the framework proposed by Ross & Staw (1993) generic causes of escalation are summarised. Subsequently, the report looks at industry- and drug development-specific escalation triggers in an attempt to identify why the pharmaceutical companies are particularly vulnerable to the dangers of escalation of commitment.

Then, escalation prevention provisions organised around tackling previously identified triggers are outlined. The report concludes with suggestions concerning the issue of escalating situation management.

Escalation of commitment: Definition and dangers

Escalation can be defined as a situation where an individual over-commits resources to a failing venture after receiving negative feedback on its performance. Having an option to discontinue, the decision-maker forgoes rational behaviour and devotes more money, time or effort in a false belief that greater involvement will bring the project to successful completion (Staw, 1981).

Some examination suggests that escalation as such should not be automatically assigned negative connotation. Low level of employee commitment is also damaging to organisational performance; background factors might justify over-commitment (Heath, 1995). Another view assumes escalation to be a natural feature of the business decision-making that should be treated as an unavoidable expense (Bowen, 1987). The dominant notion supported by extensive research suggests that escalation of commitment should be acted against (Brockner, 1992) because of carrying dangers of:

• Ultimately leading to multiplication of avoidable losses;
• Introducing irrational decision-making;
• Undermining the basic premise of business activity: to maximise gains with minimal costs;
• Generating substantial opportunity costs
• Consuming unrecoverable resources, such as time.

Appreciation of escalation triggers allows for development of efficient prevention methods aimed at reducing the occurrence of such factors, subsequently protecting the company from the aforementioned detriments.

Generic causes of escalation

Psychological

Initial research suggested that escalation arises primarily from the natural incline of the human being to self-justify behaviour. Supplying the course of action with additional resources serves as unconscious defence technique: the individual reassures him/herself that the original decision made was rational (Staw, 1976). Self-justification need is heightened if the decision-maker holds responsibility for the resource allocation (Staw, 1981), which is typical for investment decision setting.

Prospect theory applied to escalation suggests that self-justification is not vital prerequisite for its occurrence. Escalation is induced by the decision-maker using a ‘frame’ to make decisions under conditions of uncertainty of results. The decision-maker views subsequent decisions in reference to outcomes of initial judgements in order to produce a coherent frame. The negative feedback on the initial resource allocation results in the subsequent distribution being viewed as a choice between definite and possible loss, or a negative frame. Subsequently individuals are prone to escalation by becoming risk-seeking: failing to accept a definite loss even at the cost of incurring greater in the future (Whyte, 1986).

How the decision-maker perceives incurred costs, constitutes another escalation trigger (Garland & Newport, 1991). Following prospects theory, the ‘sunk costs effect’ suggests that costs incurred viewed in relation to the total expenditure induce a negative frame, leading to escalating behaviour. Linked with that, the dislike of waste provides another motivation to supply the course of action further, rather than face a definite loss (Arkes& Blumer, 1985). Interestingly, excitement about the project outcomes (Schmidt& Calantone, 2002), and ‘sunk-time effect’­ (Navarro& Fantino, 2009) aid escalation occurrence.

Social

Importantly, the aforementioned need to justify the correctness of behaviour is not limited to the individual and applies to the wider social context (Staw, 1976). Maintaining an image of a consistent decision-maker among peers proves equally, or more, important to meeting self-justification needs.

The desire to obtain social approval is exacerbated under insecurity of the social status in the group, or in a presence of an adverse crowd (Staw, 1976). In such instances the individual is likely to model his/her behaviour to reproduce the model endorsed by the audience (Brockner, 1992). As the group replicates leader stereotypes that emphasize the need for decision-makers to be consistent in actions in order to be perceived as competent (Staw& Ross, 1980), the individual aspiring to achieve consistency with the stereotypical image will over-commit not to distort others’ belief in their leadership potential, and to reaffirm position in the group structure.

Intra- or inter- group competition can indicate escalation. The focus is shifted away from objective assessment of the possible outcomes of a chosen decision onto the motivation to win. The need to do whatever it takes to get a step ahead of the competitors introduces scope for irrationality and escalation as such irrational behaviour is common to both of the parties involved (Bazerman, 2006).

Organisational

Projects receiving strong organisational support are prone to escalation (Pfeffer, 1981 in Ross& Staw, 1993), as the decision-makers identify them with the existence of organisation itself. Furthermore, the centrality of the project to organisational values and its entrenchment in the organisational structure account for the projects being continued despite reservations (Goodman et al., 1980 in Ross& Staw, 1993). Unwinding the supporting infrastructure might threaten the very basis of working organisational structure; induce change that is often associated with risks and dangers. The costs of acceptance of status quo are perceived as minor to the potential dangers of modified environment.

Maintaining reputation and consistency between values and actions prove to constitute forces inducing over-commitment from organisational perspective (Ross& Staw, 1993). Companies having publicly announced success might be more hesitant to admit failure and discontinue with the course of action.

Project-specific

High development costs and risky market performance of the finished product, the acceptance of failures and losses as a feature of the R&D process, and reluctance of decision-makers to emotionally detach from the prolonged projects account for greater escalation exposure of R&D projects (Schmidt& Calantone, 2002).

Low potential reusability (Staw& Ross, 1993) of the generated output results in reluctance to discontinue the venture in order to avoid waste. Negative framing induces the perception of exit costs, such as compensation packages as definite waste, leading to escalation.

The advancement of the project on a timeline constitutes another threat due to sunk-cost effect (Navarro& Fantino, 2009). Projects reaching advanced stages of development would be discontinued reluctantly because of accumulation of used resources, including time, and the perception of imminent availability of the anticipated gains.

Industry-specific Escalation Triggers

Profitability issues

Recent data suggests that pharmaceutical companies are to face decline in profit figures in forthcoming years (Datamonitor, 2010). This can be attributed to steadily increasing drug development costs: the costs producing the final product exceed $1 billion, with as few as 20% of successful product entries achieving the break-even point (Innovation.org, 2010). Estimates suggest that pharmaceutical companies should launch two to four drugs annually to maintain steady profit margins (Gassmann& Reepmeyer, 2005). However, due to high attrition rates the overall success of organisations’ strategy is often reliant on the success of a single project (Kola& Landis, 2004). These factors pressurise the companies to continue with projects and disregard arising reservations to maintain profitability.

Maturing product portfolio

The reduction in new component approvals can be partially attributed to strengthening drug registration requirements. Other explanation lies in the controversial ‘innovation deficit’ experienced by the industry (Schmid& Smith, 2004). Lower innovation figures account for pharmaceutical companies’ being faced with maturing product portfolio. Consequently, the companies engage in a variety of innovative projects overly-optimistically assessing their revenue potential, failing to discontinue when reservations arise. Eventually, the companies face greater losses as the projects fail to generate anticipated revenues, but incurring avoidable losses (Appendix: Dimebon case).

Concerns for market performance

The pressure to persist is further reinforced by the need to be consistent with company’s vision (Ross& Staw, 1993). Endorsing the projects demonstrates consistence with the mission statement; reaffirms the reputation as well as reassures the market and investors on following the profitable trail. However, forgoing ethical and safety aspects of drug delivery over concerns for market performance and cost-cutting proves detrimental (Appendix: GSK Puerto Rico Plant).

Development pipeline conditions

The specificity of the drug development pipeline further adds to the vulnerability to the dangers of escalation of commitment. The drug development time is estimated to surpass 10 years, with the costs amplifying as the project progresses (Accenture, 2007). This suggests heightened emotional attachment and excitement towards results, as well as existence of supporting infrastructure as powerful motivators of escalation. Attrition figures reveal that escalation is common in the industry as the most projects are withdrawn after reaching the most cost intensive stage of advanced clinical trials that precedes the registration process; or are recalled after reaching the patient due to safety concerns that have been ignored earlier on (Kola& Landis, 2004) (Appendix: Avandia case).

Escalation: how to prevent it?

Tackling individual and social causes

Perhaps introduce appraisal procedures emphasizing one’s ability to build on past actions, rather than progression of the project. This will reduce managers’ fear of negative consequences if the project fails. Confidential treatment of sensitive matters, such as personal failures, will reduce the reputation retention motivation for escalation (Simonson& Staw, 1992).

Consider developing positive leader stereotypes supported by convergent organisational values emphasizing the rationality of decision-making. Furthermore, introducing panel decision-making procedures contribute to preventing escalation by reducing individual responsibility for the decision taken (Simonson& Staw, 1992; Schmidt& Calantone, 2002). Inviting members of relevant departments allows for assessing the project’s success potential from a variety of angles limiting scope for escalation to arise.

Ponder developing neutral decision frames by rotating managers in charge of the project so that different individuals held responsibility for initial and subsequent resources allocations (Simonson& Staw, 1992). Additionally, foster for emotional detachment from sunk costs by introducing training in mental budgeting (Heath, 1995).

Project evaluation and management

Clear and achievable targets should be set out at the project initiation alongside exit points at various stages of progression (Schmid& Smith, 2004). Measuring project’s performance against set aims; assessing the efficiency with which resources yield results at the selected points allows for early estimation whether the project is following the anticipated pathway, thus allowing to avoid greater losses. Consider adopting ‘attrite early’ strategy (Schmid& Smith, 2004) as company’s motto.

Consider participation in multi-stakeholder analysis projects evaluating the potential value of innovative drug projects at early stages of development such as the consultations conducted within the European Healthcare Innovation Leadership Network (AstraZeneca, 2010).

Ponder involving external parties in the project (Schmidt& Calantone, 2002). Perhaps engage auditors to assess the success project’s success potential at its outset or to devise effective contingency planning. This will ensure objectivity and independence of organisational politics. Consider outsourcing the project to subcontractors to avoid its institutionalisation in the organisational structure.

Alternating middle-to-long-term strategy

Consider renewing existing product portfolio and engagement in ‘me-too’ drug developments. This ensures steady revenue generation from inelastic demand segments (Ganuza et al., 2009) and carries less risk comparing to reliance on anticipated gains from innovative compounds. Estimations suggest that involvement in drug-related sectors or focusing on advancement in licensed compounds constitute a potentially profitable alternative (Schmid& Smith, 2004). Consider GSK’s involvement in healthcare brands as an example.

Managing Escalation

Suppose the escalating situation arises, consider replacing the project manager or establishing panel assessment in order to remove the negative thinking frame, rid off the potential self-justification needs and assess realistically project’s success potential (Simonson & Staw, 1992). Consequently, ponder engaging external consultants to develop plausible solutions and introduce other point of view independent of the political and organisational influence. Otherwise, evaluate potential salvage value of the project towards establishing uses other than the initial one anticipated (Appendix: Viagra case).

Furthermore, consider whether external financial support for advanced research is available; and if is feasible to use towards accomplishment of the project’s aims. Otherwise, ponder engaging in partnership with a company undertaking research in similar compound in order to combine knowhow and reduce costs.

Appendix

Avandia case

Recent withdrawal of GSK’s highly innovative and best-selling diabetes drug, Avandia, in EU was caused by the linkages with deaths by heart failures among the patients on the medication (FT.com, 2010b). Allegedly, the company was aware of the severity of adverse effects, however launched the drug to the market (Avandia Recall News, 2010). Estimations suggest that GSK could face between $1.1bn and $6bn in compensation costs (FT.com, 2010a) that could have been avoided had the company ceased the project when safety concerns were brought to light. Additionally, bad publicity incurred after the allegations surfaced resulted in fall of GSK share prices, and the company facing negative profit accounts (FT.com, 2010c).

Dimebon case

Pfizer has recently withdrawn from advanced clinical trials (undertaken in partnership with Medivation) of highly anticipated Alzheimer’s disease cure, Dimebon, after the drug exhibited no promising therapeutic results (MedScape Medical News, 2010). The reservations about the curative properties of the compound have been raised at early stages of the process. It is assumed that the logic behind Dimebon’s miraculous effects was never properly investigated. Furthermore, similar compounds failed in previous trials (ABC News online, 2010). Escalating behaviour in such case could be linked to Pfizer losing patent rights the currently marketed Alzheimer’s treatment, Aricept and was in need of a profitable replacement. As a result of failure to investigate and evaluate promptly, Pfizer has incurred $725 million in R&D costs (the Economist.com, 2010).

GSK Puerto Rico Plant case

GSK is reported to pay $750m in penalty payment to US government and other claimants following allegations on manufacturing malpractice and failure to adhere to safety standards in production plant in Puerto Rico. The allegations regarding mal-adjusted doses of active ingredients and ineffectiveness of drugs submitted to government programmes were revealed by a former employee and resulted in the company being charged with a criminal offence (Wall Street Journal Law Blog, 2010).

Viagra case

Initially Viagra was developed as a cordial drug aimed at decreasing blood pressure and preventing cardiac arrests. Clinical trials unexpectedly revealed potentially exploitable and marketable properties of the drug: high effectiveness in fighting erectile dysfunction in men.

In the six months following its launch as a revolutionary treatment, in 1998 Viagra worldwide sales have exceeded £300 million (BBCnews.com, 1999).