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Dangers of Escalation of Commitment
Accounting and Finance
Birmingham City University
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Dangers of Escalation of Commitment 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. 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 decisionmaking 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. 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, 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 overlyoptimistically 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 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, 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 and $6bn in compensation costs (FT, 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, 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, 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, 1999).
Dangers of Escalation of Commitment
Kurs: Accounting and Finance
Universitet: Birmingham City University
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