A private equity firm decided to grow one its companies a retail chain, by buying another chain. This promised a dramatic increase in revenue and should have achieved savings via synergies. The amount and depth of financial analysis done for this deal was stunning. Yet the attention paid to the management talent, supply chain and organizational culture was so slight it was practically nonexistent. Not that they were ignored entirely. Rather the methods, skill and vigor used were vastly inferior to those brought to bear on the financial analysis. Three years later the company was broke, jobs were lost and reputations tarnished.
Quentin Tarantino talks about how often movies are directed by someone who is not in the same room where the acting is occurring. His advice is “don’t go to video-land.” My advice is don’t buy a business you have examined in only one way.
The retail deal happened without a sincere look at the target. At a high level, it looked good and strategically it made all the sense in the world. At this point the investors became committed to the deal. Only then did they begin to look more deeply. By this time, they were psychologically invested, making it nearly impossible to admit that they had spent great effort looking at a deal with many holes. It was easier to ignore the holes.
Why? Human beings have a strong tendency towards the confirmation bias. This bias leads people to view information that supports our beliefs or decisions as more valid, more significant or more voluminous than data that challenges our position.
How could the investors in this case have made a mistake of such proportion? How could their analysis have led them astray? Their analysis didn’t, they went to video-land, or in this case, spreadsheet-land. The projections of future profits were blindingly bright, and they were blinded.
What can you do to make sure you aren’t similarly blinded?
- Make major decisions in the right sequence. Write down the decision you need or want to make. Then ask yourself, “do I already know what I will do?”
If yes, and the decision is a major one, slow yourself down!
If no, then proceed. - Ask others what information you should consider in your decision and don’t just ask your buddies.
- Think about the relative importance of the information you are gathering and its source. Not all data is equal.
- Get out of video-land! If you are buying a retail business, shop there a few times. Priceless information will emerge.
- Estimate the range of upside, not a number, a range. Humans are terrible predictors no matter how educated, why swim against a strong current?
- Estimate the range of downside. Same reason as number 4. Look at the magnitude (literal numbers) of the upside and downside and the range.Is the range of the downside greater than the range of the upside? Is the lower part of the range of the downside so low that it looks like a kamikaze mission?
This should prompt valuable conversation, as it does with our clients. Especially if you use it as a opportunity to realize earlier mistakes in thinking, missing data, or unreasonable exuberance.
