Pivot or Perish? When does it make sense to pull the plug?

by Jocelyn Whittenburg

The lean startup philosophy recognizes the high likelihood that an original idea will not be perfect and may need major adjustments as a startup grows. Recognizing that pivoting is often necessary allows many startups and their investors to view pivoting positively and encourage healthy changes to the direction of the business. However, pivoting is not always the right answer. Startups sometimes pivot when they should have pulled the plug. Inherent human biases dictate that we naturally lean towards pivoting instead of perishing. There are four types of biases that can lead to a tendency to pivot instead of pull the plug (from HBS Note - Hypothesis-Drive Entrepreneurship: The Lean Startup):

Optimism bias: People have a systematic tendency to overestimate the likelihood of positive events and underestimate the likelihood of negative events. This bias is likely to lead the entrepreneur to be overly optimistic regarding the likelihood of a successful pivot.

Planning fallacy: People also have a tendency to overestimate the benefits of a task and to underestimate the time and money required to complete that task. This bias can be particularly harmful when an entrepreneur is evaluating the pivot opportunity. A pivot can easily be attractive given the entrepreneur’s estimate of the benefit, time, and costs required by the pivot. If, however, the entrepreneur is suffering from planning fallacy (and many are), the benefits are likely to be lower and the time and money required likely to be higher, which will significantly reduce the attractiveness of the pivot.

Confirmation bias: People have a tendency to interpret information in ways that validate their hypotheses. Therefore, when evaluating an MVP test, an entrepreneur may be more likely to interpret the information as favorable to pivoting instead of as a signal to pull the plug.

Sunk cost fallacy: People tend to consider expenses that have been incurred and cannot be recovered when making business decisions. This may lead an entrepreneur to lean towards pivoting and persisting (in order not to waste the time and money already poured into the company) instead of evaluating the business going forward and pulling the plug.

Given these biases, entrepreneurs need to be careful when evaluating the decisions to pivot or perish. In my opinion, an entrepreneur should pivot if:
- MVP hypothesis test results indicate a viable pivot option. The option must hold up under scrutiny (what if the rewards are lower? what if more time and money are required than initially expected?)
- The entrepreneur has enough current funding to pivot or can raise more funding on reasonable terms.
In short, the entrepreneur must identify a specific opportunity, think through the viability of the potential pivot, and test the pivot for robustness against natural cognitive biases. Additionally, the entrepreneur must maintain employee motivation by ensuring that the financing terms for new money mean that the employee will still realize upside upon the success of the company.

On the other hand, the entrepreneur should pull the plug if:
- The MVP hypothesis test did not reveal any viable pivot options or if the pivot options do not stand up to scrutiny.
- Financing cannot be raised on acceptable terms.
- Employees will be in a worse position if they stay on for a pivot than if the company pulls the plug.
Basically, if the entrepreneur does not have a specific viable pivot option, cannot preserve the upside for employees in terms for new financing, and could put his employees in a worse position by pivoting; the entrepreneur should resist the temptations of cognitive biases and pull the plug.

Some entrepreneurs would argue that there is value in pivoting even if the company will ultimately fail. It’s a signal to future investors that the entrepreneur does not give up easily and will remain dedicated to his / her company. Although it is clear that reputation is paramount as an entrepreneur, founders should remember that they are playing with people’s hard-earned money and should think carefully about pouring money into a poorly conceived pivot instead of failing gracefully. There are as many reputational dangers in not knowing when to quit as there are in quitting too quickly.

Comments

Popular posts from this blog

Quiz Time 129

TCS IT Wiz 2013 Bhubaneswar Prelims

The 5 hour start-up: BrownBagBrain