Monday, February 16, 2009

From "Think Again," a book about decisionmaking gone wrong - Marc's mistake story

"Think Again" is a great new business book in which authors Sydney Finkelstein of Dartmouth University and Jo Whitehead and Andrew Campbell of Ashbridge Business School describe research in cognitive science and behavioral economics to explain how the decisionmaking process goes awry and, even more importantly, how our minds obscure the mistakes we make and keep us from understanding the weaknesses in our decision processes. [The authors also have a website for the book, including pointers to some of the underlying research and other goodies.]

The book is full of great storytelling, and this one in particular, about an executive named Marc, seemed very appropriate for the Mistake Bank:

Marc was the managing director of the French subsidiary of an international manufacturer of packaging machinery. He was considering whether or not to acquire a company that had a near-monopoly on manufacturing a specialized type of food packaging machine. While the company had a strong position in the market, there were several warning signs that it was a risky investment. The business was highly dependent on sales to one large meat processing company. Because the machinery was a form of capital investment, sales tended to be highly cyclical. The management team had recently lost some of its more talented designers and marketers, and performance was flagging. The current owners of the business were keen to sell.

These risks were particularly an issue because Marc had committed to his head office that he would deliver relatively stable performance. The previous year, Marc had personally persuaded the head office to provide additional investment to his subsidiary for low-risk acquisitions, and so his reputation was at stake.

As the transaction progressed, some members of Marc's supervisory board voiced their concerns about the proposed acquisition. Despte this, Marc went ahead. A few months later, following the discovery of bovine spongiform encephalopathy (BSE), or mad cow disease, in French cattle, the meat-processing customer announced that it was putting discretionary capital expenditure, including the packaging machines manufactured by Marc's company, on hold. The management team was unable to deal with the dramatic drop-off in demand. Profits plunged into the red. Marc's superiors were shocked, and Marc's career received a large black mark.

Marc described why he thought he had made a flawed decision. "I was under pressure to do this deal for my own interest. If I went ahead, then the costs incurred in auditing and due diligence of the company would be capitalized and added to the cost of the investment. If I backed out, then they would all be charged to my office as an expense. Because we had been pursuing this company for a while, those costs were quite significant--and I guess I was influenced by that. I had an annual target to hit--and the charge-off would occur at the end of the financial year, leaving me no time to find a way to avoid a big loss. Of course, in the end, doing a bad deal was much worse for my position. I guess self-interest clouded my judgment."

Reprinted with permission from Harvard Business Press. Copyright 2008 Sydney Finkelstein, Jo Whitehead, and Andrew Campbell. All Rights Reserved.

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