Even the best leaders make the occasional bad call, but in hard times such mistakes can be fatal. The key to minimising the risk of flawed decision-making lies in knowing your limitations, and having just enough process in place to balance inevitable subconscious bias. Jo Whitehead, Andrew Campbell and Sydney Finkelstein explain their 'red flags and safeguards' approach.
Strategic decision-making is not for the faint-hearted, and the mettle of every executive from novice to old hand will be acutely tested over the coming months. There's nothing like the pressure of a severe economic downturn to sort the managerial wheat from the chaff. Companies have been broken by bad decisions, even when they were accompanied by analysis and review. The quality of a decision often depends on the judgment of one person, or a few at most.
Flawed decisions - those that were not just unlucky or poorly called - have at their root the distorted judgment of one or more of these decision-makers. Take the example of Steve Russell, who became CEO of Boots in 2000 and resigned just four years later. For years, Boots was a household name, boasting dominant market share, high margins and prime retail sites on every British high street. But the company's dominant position left it little opportunity for further growth. More worryingly, supermarkets such as Tesco were expanding their range of pharmacy products and services and eating into its market share.
Boots had tried a number of different ways to grow. One was to acquire other UK retail businesses with growth potential, but this proved unsuccessful. Another was to take the business model to other countries, but this didn't show much promise either. 'For at least 10 years I had believed that Boots ought to be able to go from being a pharmacist into healthcare,' explained Russell. 'I could see Boots becoming the healthcare provider to the nation. All my research told me that there was a huge latent desire for additional health provision in Britain. I had been formulating this ambition for Boots since I was its merchandising director in the late 1980s. So, when I became CEO, I was determined to make it happen.'
Russell's plan was to build on Boots' positioning in health and beauty. He discontinued some unrelated lines, expanded the health range, and launched additional health and wellbeing services, such as dentistry, chiropody and travel inoculations. Russell's strategy of expanding into services did not succeed. 'It was an execution problem,' said Russell. 'We did not have the know-how to make these services work.'
Other managers suggested that many of the new services Boots sought to provide were inherently low-margin, and that it did not have the skills required to manage traditionally independent professionals such as dentists.
Russell isn't the only seasoned executive to have made a flawed decision. Sir Clive Thompson of Rentokil and Sir Derek Rayner of Marks & Spencer both suffered in this respect, and the current economic crisis will no doubt reveal many more mistakes made not only by hubristic business superheroes but by ordinary managers. In hiring, promoting, investing and acquiring, no-one is immune to the dangers of making flawed decisions.
So why do experienced and smart managers make bad calls? The root causes lie deep in the human mind and the way it makes decisions. Researchers in a range of disciplines - including neuroscience, behavioural economics and evolutionary psychology - are making rapid progress in uncovering how our brain works, shedding light on how we make decisions. Many of their findings will feel familiar to experienced managers: we use our intuition; we are influenced by emotions - often described as 'gut feelings'; and our judgment is affected by our personal interests and the impact that the decision might have on those we care about.
One of the primary insights is how few of our decision processes we are able consciously to audit, and how incapable we are of spotting the distortions in our own thinking. For example, decision-makers may be aware that they are basing their decision on a gut feeling. They may even be able to articulate a possible source for that feeling - perhaps their past experience in making similar decisions. But they are typically unable to say how well they are counterbalancing these gut feelings with the facts of the situation or with rational thought.
A great deal of decision-making occurs below our level of consciousness. The extent to which we are unconscious of how much our intuition and emotions influence our choices creates great risk.
Most leaders recognise that they can make mistakes, which is why most organisations have standard safeguards in place. The typical decision process requires data-gathering and analysis, a decision group to discuss the pros and cons, a governance group to approve the decision, and close monitoring of what happens so that errors can be reversed. The problem with such standard processes is that they are often too heavy-handed or too interfering. Many companies strain under the burden of governance processes, approval levels and decision-making forms and formats. This can impose a heavy cost on the firm and dampen initiative and experimentation: many good decisions can fail to get through the system.
At the other extreme, elaborate standard processes can fail to weed out bad decisions. At Boots, Russell hired consultants to collect extra data, debated the strategy with his top team, was supported by a high-quality strategy director and challenged by a sceptical board, and monitored results as the strategy progressed. Yet he still made a bad decision and was slow to recognise that it was not working.
So, if more bad decisions are to be cut out of an organisation without strangling it with bureaucracy, we need to be able to design safeguards that are fit for purpose. If the potential distortion is strong and in the head of the CEO, we need powerful safeguards to protect the decision. If there are no obvious distortions, we can strip away bureaucracy and rely on the good judgment of wise managers. The key is 'just enough' process to counterbalance the most likely distortions of the decision-maker, but not so much process that we sap the entrepreneurial lifeblood of the company.
Fine in theory, but are there any tools that can help do this in practice? We suggest a two-step process. First, identify the 'red-flag conditions'. These are specific to the decision and the individual, and are likely to lead to distortions in the decision-maker's judgment. Such conditions can make the intuition, feelings and experience of the decision-maker a liability rather than an asset. The second step is to counterbalance these red-flag conditions with carefully chosen safeguards (diagram below or click here for large version).
There are four red-flag conditions. The first is 'misleading experiences', and occurs when we are faced with an unfamiliar situation, especially if it seems familiar. We can think we recognise something when we do not. For example, Russell may have been misled by his experience of working in Boots. The high street chemist chain had enjoyed a scale advantage in retail pharmacy and he may have presumed that a similar advantage could be gained in healthcare services. These service businesses turned out to be less sensitive to scale economics.
Another example of misleading experiences is that of Sir Clive Thompson, who had led Rentokil to success through the 1980s and '90s. He later embarked on a series of major acquisitions that led to a collapse in Rentokil's share price. Rentokil had been successful by acquiring more than a hundred relatively small companies, on which it imposed tight controls through a decentralised management structure. Yet none of Thompson's previous deals had involved public companies of the size of Securiguard or BET - the acquisitions that triggered Rentokil's decline.
When Thompson talked to classrooms of managers at the time of the BET deal and soon after, he was often confronted with scepticism. Students were concerned that he was taking too much risk. He explained that Rentokil had made more than a hundred acquisitions and that he needed to provide additional deals to keep his aggressive management team in work: 'I need to give my lions more red meat.'
He seemed to underplay the difference between acquiring and integrating a small company into the Rentokil way of doing business and taking on a major company such as BET, which was not only in rather different businesses but also had a strong culture of its own that could not easily be transformed. The acquisitions proved difficult to integrate and, worse, destroyed the common culture that bound managers at Rentokil. The lesson to be learned? That when we have been very successful in the past, we often presume that our actions will be successful again, and we find it hard to question ourselves and correct our error.
The second red-flag condition occurs when our thinking has been primed by previous judgments or decisions that connect with the current situation, even before we begin to evaluate the new situation. These are 'misleading prejudgments'. The third red-flag condition is the familiar 'inappropriate self-interest'. For Russell, a growth option such as expanding into a range of healthcare services was more personally attractive to him than options such as sticking to the core business or selling the company. As he explained: 'Frankly, if the board had wanted to follow a cash strategy, they would have had to do it without me.'
The fourth is 'inappropriate attachments', such as the one we might feel to colleagues or a business when considering cost reductions. A striking example is that of Sir Derek Rayner, who acquired Brooks Brothers - the US retail chain famous for its button-down shirts - when he was CEO of Marks & Spencer in the 1980s. In the four years of his leadership from 1984 to '88, M&S had modernised and transformed itself from a family-run company, doubled earnings per share and grown revenues from £2.9bn to £4.6bn. And yet he paid $750m for Brooks Brothers, even though his team told him it was worth only $450m. When he announced the deal, M&S's share price fell sharply. Why did he do it?
As Judi Bevan describes in her book The Rise and Fall of Marks & Spencer (Profile Books 2002, updated 2007), Rayner 'was enamoured of Brooks Brothers clothing, which was in large part aimed at men of Rayner's age and taste'. Although his advisers had presented six possible acquisition targets, Rayner ignored all the others and 'went straight for the preppy upmarket Brooks Brothers chain'.
Rayner could have justified the acquisition with the argument that a quality company with a quality product would surely be a good fit with M&S. This would have made it almost impossible for him to appreciate the extent to which he was being influenced by the emotional attachments of which he was only partly conscious. Difficult too for him to see why Brooks Brothers was worth only half of what he paid.
After identifying red flags, the second step is to select what we call process safeguards - that is, the particular additions to any standard decision process that are most likely to counteract distortions. It's helpful to think through four categories (see diagram). The first safeguard is experience, data and analysis. In business, there are many ways data can be collected and experience broadened. A discussion with a key customer can provide valuable feedback on a proposed new product or service. Market research might evaluate the risks of entering a new market. Consultants can be brought in, partly for their expertise and readily available manpower, but also because they are relatively objective.
Second is debate and challenge. Creating a debate that challenges biases need not involve an elaborate process. It could mean chatting through an issue with a friend or colleague. In large organisations, a typical approach is to form a decision group. While many of these operate with simple guidelines, there are a host of more elaborate approaches - splitting the proposer, evaluator and authoriser roles, allocating 'hats' to different people (as lateral thinker Edward de Bono suggests), role-playing, or the devil's-advocate method (in which a subgroup attacks the proposed option).
Third is governance. Someone with power and strong prejudgments may be resistant to new analysis or a group process. If so, it may be necessary to strengthen the governance process - say, by setting up a special subcommittee of the board to review the proposal in detail.
Fourth and final is monitoring what happens after the decision, particularly when there is a risk that all the safeguards are still insufficient.
We are not claiming that it is possible to spot every red flag or to find an effective safeguard against every source of bias. But 'red flags and safeguards' thinking can, we believe, help any board or any management group improve its hit rate. We also recognise that safeguards have negative consequences - they can slow the decision down or demotivate the team driving the decision. But better to be explicit about the tradeoffs involved in selecting safeguards than to reject them on the basis of a gut feeling that 'it wouldn't work here'.
Becoming an effective decision-maker is not just about being an expert and having good judgment. It's also about taking steps to guard against the inevitable distortions that can lead to a flawed decision. You could never eliminate all flawed decisions, but the 'red flags and safeguards' approach helps to reduce the risk.
Think Again: Why good leaders make bad decisions and how to keep it from happening to you is published by Harvard Business Press. To order the book (RRP £17.99) at the discounted price of £14.99 (incl p&p), phone McGraw-Hill on 01628 502720 and quote 'TA09MT'. Offer ends 31 March '09.