Governance, Leadership and Sunk Costs

Scene: Board Meeting

Director 1: Thanks for providing these numbers. I see we continue to lose money on the prevention program – what can we do about it?

Director 2: The problem is nobody knows about this program. I was speaking with a local last week who had never heard of it! Are we doing anything to get the word out?

Staff member: Two years ago we paid for a marketing consultant. Last year we hired an assistant for Stan to free him up to get out in the community and promote it. Just last month we bought Google ad words for $5500.

Director 2: Great – how are the results?

Executive Director: Client numbers are down and the program’s deficit keeps climbing – although less steeply than last year. We were discussing this in the management team and we think there are a couple of key donors who would really get behind strengthening the program with both a city-wide billboard campaign and an additional full time counselor to finally enable us to offer wrap around services. So we’d like to propose…

New Director (interrupting): You mean this program has had continually increasing investments over the last three years, continually declining client numbers, increasing deficits and you want to add 50% more to the funding and hit on two major donors to support this?! I’d much rather propose we eliminate it and focus these resources somewhere more productive.

Chorus: Are you crazy?! We have invested in the high six figures in this program – we can’t let that investment go to waste! (This is the attachment theory of management and governance – i.e. emotionally attached to past investments)

Haven’t you been through a milder version (hopefully) of this in a staff meeting, board meeting and in your own mind? Don’t be too sure your organization isn’t falling prey. We get very attached to what we have invested in (think marriage and kids). A sunk cost is an unrecoverable cost for which you are already liable. Sunk costs have been or will be paid regardless of the decision whether or not to proceed with the project. Therefore they are irrelevant to the current decision and should not be included in the analysis (tell this to the emotions and values you have invested heavily in a project over some years).

Here is a famous example from Robert H. Frank which shows how the sunk cost fallacy can sneak up on you.

Cornell University has two sets of faculty tennis courts, one outdoor and the other indoor. Membership in the outdoor facility is available for a fixed fee per season. There is no additional charge based on actual court use. The indoor facility, by contrast, has not only a seasonal fee, but also a $12 per hour charge for court time. The higher charges of the indoor facility reflect the additional costs of heat, electricity and building maintenance. The indoor facility opens in early October, a time when the Ithaca weather can be anything from bright sunshine and mild temperatures to blowing sleet and snow. The outdoor courts remain open, weather permitting, until early November. During good weather, almost everyone prefers to play on the outdoor courts, which are nestled in one of Ithaca’s scenic gorges.
Demand on the indoor facility is intense, and people who want to play regularly must commit themselves to buy a specific hour each week. Having done so, they must pay for the hour whether they use it or not. Here is the problem: You are committed to an indoor court at 3:00PM on Saturday, October 20 (you have paid for it-sunk cost), the only hour you are free to play that day. It is a warm, sunny autumn afternoon. Where should you play, indoors or out?

You’ve probably guessed by now that you should enjoy the outdoor court with a clean conscience. Here are two common examples of sunk costs:

Fixed overhead expenses. Overhead expenses are associated with activities that are not directly attributable to a single business activity but instead affect many different areas of the organization. They are often allocated to the different business activities for accounting purposes, for cost analysis or for reporting to grant makers. To the extent that these overhead costs are fixed and will be incurred in any case, they are not incremental to the decision and should not be included in analysis.

Past R&D expenditures. When you have already devoted significant resources to develop a new program, there will be a tendency to continue investing even if market conditions have changed or otherwise demonstrated it is unlikely to be viable. That rationale that is sometimes given is that if the program is abandoned the money that has already been invested will be “wasted.” In other cases, a decision is made to abandon the project because it cannot possibly recoup the investment that has already been made in it. Neither argument is correct: Any money that has already been spent is a sunk cost and therefore irrelevant to the future.

Shifts Happen – Leadership Transitions

Your CEO of 14 years just gave four weeks’ notice. If you speak with people whose roles put them in touch with multiple nonprofits (senior staff at nonprofit associations and networks, leaders at Community Foundations, nonprofit centers, United Way leaders, serial board members, and consultants) you will hear an oft repeated tale: “CEO/executive director turnover is debilitating and borders on epidemic”. These anecdotal reports are backed up by the research (Daring to Lead 2011 report shows 67% of nonprofit CEO’s plan to depart within a five year time frame). One third of incoming leaders are following a predecessor that has been fired. So many transitions appear fraught with “collateral damage” and more drag on organizational momentum, relationships and credibility than necessary.

Does it have to be this way? Sorry to bear bad tidings but certain specific portions of the transition story are inconveniently wired at this time. These wires have to do with the quantity of transition. There is a lot of it and three big factors (among others) suggest this will continue for some time. First; there is a generational leadership shift that continues as baby boomer leaders retire or are forced out having over stayed their welcome, second; there are simply too many sub-scale organizations that are structured for fiscal and talent struggles and high turnover, and third; if the economy continues to ever so slowly inch towards old labor market norms, the current slight drag on transition rates (“Will I find something else?”) will diminish.

The potential good news is around making these leadership transitions less debilitating and even opportunities for realignment and excellence. The potential good news is not about whipping out your garden variety succession plan. Where these exist they tend to be too narrowly conceived (identifying interim leadership, a few points about the search process, maybe identifying a transition committee). Good research exists on robust succession planning but is rarely utilized. Utilizing good succession planning templates is important but let’s be a bit more creative and identify a few critical elements, which, If you are able to implement, will both reduce the likelihood of unwanted transitions, reduce the sting when they happen, and increase the likelihood of discovering positive opportunities in the process. This is not a comprehensive succession planning document.

1.    Get smart about the inherent tensions and dynamics of the CEO and board roles (see nice post from Al Cantor written as to the CEO). All organizations need a mutual accountability tool to be used as a two way scorecard/performance metrics between the CEO and the board. Not just the board evaluating the CEO! This ignores too many realities of what is needed for success (namely a working relationship) especially in small and medium size nonprofits. This tool will be adjusted for the context of each organization but at its core needs to include a two way (ongoing – not crisis) communication plan; two way metrics around CEO and board performance as ambassadors for the organization, as fundraisers, as developers of a talent and leadership pipeline, as financial stewards, and as guardians of the purpose/mission and current strategic plan. Each organization will create its own specific performance metrics in these areas.

2.    Once you are inside the intensity of a transition process do not lose sight of the human relationship risks and opportunities. This means other senior staff can be wounded and even lost due to inattention or perceived slights; donor, board and external partner relationships can rapidly flip from understandable anxiety to lost credibility; depending on your business even clients may be lost if a crisis of confidence ensues. Minimizing these risks requires a communication plan that is sensitive to all key constituents and rapid communication amongst the transition committee. It requires a large heart and some patience for the emotional issues that often surface in these situations.

3.    Do not let your organization skip the step of rigorously reviewing the role to see if smaller or larger adjustments are needed. Make sure these changes arise in an active relationship to the current strategic plan and organizational priorities. This gets forgotten in crises.  This step is especially critical if the departing CEO is the founder. Depending on your specific situation and context a more fully fledged organizational assessment may be in order. In some situations this is not the right thing to do.

4.    Do not let the board abandon ship once a new hire is made! Your new leader absolutely needs close accompaniment in the first 90 days. This takes skill, sensitivity and in my view usually needs help to set up a guiding framework. Ciampa and Watkins well researched work (Right from the Start: Taking Charge in a New Leadership Role) provides helpful guidance: lay a foundation, build credibility, secure early wins, get oriented etc. If you already have consulting help with the process this can also be an important step to find guidance for and is frequently neglected.

Get these four areas right and you have dramatically reduced your risks and dramatically increased your chances for a positive transition. Next Post: So You want to be the new Development Director…