Investors’ Behavioral Biases: Part IX – The Planning Fallacy
In 1957, it was estimated that the Sydney Opera House would cost $7 million and be completed in 1963. In reality, a scaled-down version cost $102 million and did not open until 1973. This is an extreme example of Planning Fallacy. But it is just one of many examples from governments, corporations and individuals.
This fallacy is the human tendency to underestimate time, costs, and risks of future outcomes. It arises from an optimistic outlook which leads to an underestimation of problems, and an overestimation of benefits, along the way to the expected outcome. The more complex a project, the more likely it will suffer from cost, time and risk blow-outs.
Hofstadter’s Law: “It always takes longer than you expect, even when you take into account Hofstadter’s Law”. Rather neatly recursive.
Image Courtesy Scott Miller
And here’s an image that says it all really.
Image Courtesy suggest-keywords.com
Planning Fallacy trips up investors time and again, generally the listed corporation is at fault, but investors are not without blame either.
I will conclude with one recent Australian example that decimated portfolios. Bellamy’s Australia Limited (ASX: BAL) is a leading provider of organic baby/toddler food such as milk powders and cereals. In brief, demand has fallen for its important infant milk powder, particularly in China.
The company had been expecting continued strong growth in sales and had negotiated sizeable offtake agreements with suppliers. Now the lower demand has led to increased inventory, excess supplies and shortfall payments to suppliers. Further, it outsources production and these contracts have minimum volume commitments which cannot be met. There is much more detail, but the picture is clear.
The CEO has been sacked and management are seeking to reduce costs. And so on. But none of this helps the investor. The company had regularly stated that the growth path was very strong, particularly penetration of the Chinese market. But it is not.
The investor has paid dearly. When the company released a negative business update on 2 December 2016 the stock was trading at $12.13. It closed that day at $6.85. A few days later the stock was suspended until a second, more detailed announcement on 11 January 2017. The stock last closed at $4.01. All as a result of the company being way too optimistic about future prospects – a great but painful example of the Planning Fallacy.
Today, 23 January 2017, IMF Bentham has announced that it proposes to fund a class action against the company for “alleged misleading or deceptive conduct”, among other claims.