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Overconfidence Eventually
Leads To Failure in Business
New research reveals big-headed business people are more likely
to jump into new ventures with little regard for competition and
market size. The results, detailed in the recent issue of the
journal Experimental Psychology, shed light on why many
ventures fail in the first few years.
In 2006, nearly 650,000 new businesses with employees opened
their doors in the United States, while nearly 565,000 firms closed,
according to the U.S. Small Business Administration. More than
99 percent of the nearly 27 million businesses in the U.S. in
2006 were small firms with fewer than 500 employees.
"Market entry decisions tend to be overoptimistic,"
said lead researcher Briony Pulford, a psychologist at the University
of Leicester in England, "with the inevitable result that
new business startups tend to exceed market capacity, and many
new businesses fail within a few years."
Pulford and her colleagues set up a game that simulated market
conditions. Participants stood to gain capital or see a loss based
on their decisions on whether to open restaurants given different
market scenarios.
"Our results showed that when success depended on skill,
overconfidence tended to cause excess entry into a market place,"
Pulford said.
The self-sure participants tended to venture into markets that
were too small to accommodate another profitable business. "Excess
entry was much more frequent when market capacity was small,"
Pulford said, "suggesting that entrepreneurs do not take
sufficient account of market capacity."
The individuals most likely to make overoptimistic decisions
were those with absolute confidence in their own abilities. So
the cockiness didn't arise from comparisons with others.
Some advice for eager entrepreneurs: "They should beware
of overconfidence," Pulford said, "and they should be
especially wary when entering small markets or markets that seem
to present easy business opportunities, because over-entry seems
most likely in these circumstances."
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