Missing the Mark on A Project? Here's a Way to Get Back on Track.

In our research on project management, we've observed that leaders frequently face critical decisions under uncertainty. From determining budgets to revising project scopes, the stakes are high. But how do behavioral biases influence these decisions? Our recent study, with Woonam Hwang of the University of Utah, sheds light on this important question by exploring the concept of managerial mental accounting and its impact on project outcomes.

Understanding Managerial Mental Accounting

At its core, managerial mental accounting refers to the cognitive processes project leaders use to evaluate costs, scope and progress. These processes often involve comparing the project’s current state to a set of reference points or benchmarks. Leaders use these comparisons to assess performance and make decisions about adjustments. Three key types of comparisons often occur:

1. Baseline Comparisons: Leaders compare actual costs and achieved scope against the original project plan to determine whether they are over or under budget and on or behind schedule.
2. Progressive Adjustments: As new information becomes available, leaders update their expectations and evaluate progress against revised benchmarks. This includes comparing expected future costs and outcomes to current achievements.
3. Outcome Trade-offs: Leaders weigh potential losses in one dimension (e.g., increased costs) against gains in another (e.g., improved scope or quality).

These comparisons are deeply influenced by biases such as:

1. Loss Aversion: The tendency to weigh potential losses more heavily than equivalent gains.
2. Reference Point Updating: Adjusting expectations based on new information, which may lead to overly conservative or optimistic decisions.
3. Narrow Framing: A focus on immediate metrics without considering the broader project context.

Consider a real estate developer planning to flip a house: the project begins with a well-defined budget and timeline. However, unforeseen circumstances — like rising material costs or a cooling market — can necessitate mid-project adjustments. How the leader perceives progress and updates expectations in light of these changes is often guided by mental accounting.

The Impact on Downstream Decisions

We developed a behavioral model to predict how these biases affect project revisions. Our findings reveal that mental accounting often results in insufficient adjustments to scope and cost, reducing financial profit. For instance:

• Leaders may anchor too strongly to the original plan, failing to scale up or down appropriately in response to changes.
• Cost overruns can occur as leaders attempt to mitigate perceived losses in scope, even when additional spending is unjustified.
• Reluctance to abandon projects can lead to continued investment in ventures with diminishing returns.

For example, reducing the initial scope may be painful, even if new information recommends doing so. On the flip side, increasing the scope when new information suggests it is profitable may fail to happen because increasing the cost feels too painful. In the first case, loss aversion strikes on the scope dimension, whereas in the second case, it strikes on the cost dimension. As a result, managers tend to anchor too much on the initial plan and not react sufficiently to news that may justify larger changes in the project.

Progress Measures: A Double-Edged Sword

One of the study's key insights is the role of progress measures in shaping decisions. Measures like planned scope, actual cost and earned value provide reference points that influence how leaders perceive progress and adjust expectations. The researchers found that:

• Using planned scope as a measure is often advantageous, as it sets realistic anchors for adjustments. In other words, it tends to reduce the influence of loss aversion.
• Conversely, earned value as a cost measure is rarely advisable, as it tends to make comparisons more vulnerable to loss aversion, hence distort perceptions and lead to poor decisions.

Practical Implications for Leaders

To counteract the effects of mental accounting biases, organizations can implement strategies such as:

1. Optimizing Progress Measures: Tailor measures to align with project goals and mitigate biases. For example, using planned scope for scope evaluation and actual cost for cost tracking.
2. Training for Awareness: Equip leaders with tools to recognize and counteract their biases, enabling more rational decision-making.

The role of technology also cannot be overlooked. Advanced project management tools can integrate behavioral insights, providing leaders with data-driven recommendations that account for potential biases. For instance, software could flag when a project is trending toward excessive cost overruns or when scope adjustments appear insufficient.

A Behavioral Lens on Abandonment Decisions

Another striking finding from the study is the reluctance of project leaders to abandon failing projects. This tendency, driven by loss aversion, often results in the infamous "sunk cost fallacy," where additional resources are invested despite diminishing returns.

The research suggests that such reluctance stems from a psychological resistance to acknowledging failure. Abandoning a project not only represents a loss in scope but also challenges the leader's sense of accomplishment. By designing governance structures that de-emphasize sunk costs and focus on future profitability, organizations can help leaders make more objective decisions.

For example, consider a tech startup investing in a new product. If market feedback indicates limited demand, the rational choice might be to cut losses and pivot. However, mental accounting biases could lead the team to double down on development, hoping to "recoup" perceived losses. By adopting clearer metrics and fostering a culture that views pivoting as strategic rather than as a failure, companies can mitigate this risk.

Looking Ahead: Bridging Theory and Practice

Our research on managerial mental accounting provides a compelling framework for understanding the behavioral dimensions of project management. We demonstrate the importance of integrating rational project management models with behavioral insights. By acknowledging and addressing these biases, leaders can make more informed decisions, improve project outcomes and navigate the complexities of today’s business environment.

Our findings show that the key lies in balancing rational models with behavioral insights — a strategy that can turn challenges into opportunities for success. Whether through smarter progress measures, robust governance structures, or enhanced training, the tools to mitigate biases are within reach. Leaders who embrace this approach will not only drive better project outcomes but also foster a culture of resilience and adaptability within their organizations.

Manel Baucells and Yael Grushka-Cockayne are co-authors of “Managerial Mental Accounting and Downstream Project Decisions” with Woonam Hwang of University of Utah’s David Eccles School of Business.