Prospect theory applied to corporate innovation – interesting

Lessons to Be Learned from Prospect Theory

Prospect theory, when applied to innovation, suggests that managers in profitable companies are likely to be risk averse and therefore are psychologically likely to reject potentially innovative ideas, particularly new product and service ideas that offer an opportunity to increase income. However, potentially innovative ideas which reduce loss, are more likely to be implemented. Thus, in an established firm, process efficiency ideas, which reduce costs, are more attractive to the typical human than are product ideas. And this is true in my experience, anyway.

Likewise, loss making companies such as new start-ups or companies facing economic difficulties are more likely to embrace new product and service ideas as they offer the opportunity to reduce loss. However, start-ups with a young not-yet-defined corporate culture would seem more likely to innovate effectively than established companies that are suddenly losing money and need to innovate themselves out of trouble.

I really enjoyed Jeffrey Baumgartner’s thought experiment linking prospect theory (imbalance of risk assessment for gains versus losses) with corporate interest in innovation (more at http://www.jpb.com/report103/archive.php?issue_no=20090519). Not the whole story, but certainly an insightful generalization.

Other important related ideas include the ‘Innovators Dilemma’ (http://en.wikipedia.org/wiki/Disruptive_technology) and the notion of punctuated equilibrium applied to social institutions http://en.wikipedia.org/wiki/Punctuated_equilibrium_in_social_theory

More on this to come over time.

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