chrisadas.com

The Winner’s Curse

The question is, what causes spending to expand well beyond initial projections? Explanations range from subtle psychological impulses when numbers are involved, to the economic phenomenon known as the winner's curse, to outright lying.

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Economists and behavioral scientists say the pattern of budget excess echoes findings in other areas where people allow their best hopes to dominate the planning process. Irrational optimism afflicts even individuals who have experience with a given situation, and should know better. Researchers have linked it to business analysts' earnings forecasts and to students predicting when they will finish assignments. Irrational optimism, for example, is at work when a commuter is consistently late for work because she estimates her travel time based on the assumption that traffic and transit always will run smoothly.

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Prof. J?rgensen and other researchers say another factor exacerbates the effects of irrational optimism: Projects planned most optimistically will look more attractive to funders than those that are planned realistically. So even if not every planner is optimistic, those who are have the best shot of moving forward, but will have to cope with a form of the winner's curse: the consequences of rosy estimates.

This article mentions infrastructure/construction projects and software development as examples of where winner's curse strikes often. I think most people will agree this happens in many other disciplines that include multiple parties bidding on project, and consulting projects are no exception.

Wikipedia describes the winner's curse as phenomenon that occurs in common value auctions with incomplete information. So, in fact, consulting may suffer even more severely from the winner's curse because we face a more severe case of incomplete information compared to, say, construction. This is especially true for works on strategy, framework, and other types of work where it is not possible to always clearly define the required effort.

A picture is worth quite a few words. Here is a chart from a study on this phenomena on Srilankan construction projects, conducted in 2005. Hardly no explanation need to accompany the chart, don't you think?