Resource plays are characterized by large acquisitions of properties, as well as mergers and acquisitions. How do you maintain scientific objectivity? How are do you become aware of when / how / where bias might creep in?
As in the case of any big decision, the major flaw in most decision-making processes is the fact that they are marred by overconfidence (Lovallo, etal, 2007, p. 95). One of the major strategies used to grow in times of technological innovation is to acquire the company that has new technologies rather than trying to develop the technologies internally, or to grow organically by expanding existing technologies. In the case of disruptive technologies, survival may require one to acquire a technology because clinging to one’s existing technology could result in the ultimate (and surprisingly quick) death of the organization.
However, in the case of mergers and acquisitions, there are a few specific biases that can be very toxic to the decision-making process. So, Dan Lovallo, building on the work of Daniel Kahneman and A. Tversky, has proposed a procedure to overcome bias. While many of the recommendations seem self-evident, the key is to institute them in a systematic way in the organization in order to avoid internalization of bias and the rigidification of blind spots. More importantly, a culture of rational questioning and inquiry, coupled with a deep respect for an “outside view” can counter the development of a culture of reinforced delusion or a shared “folie a deux” delusion that characterizes irrational partners and doomsday cults.
The companies that have a long history of acquiring companies, such as GE, Johnson & Johnson, Google, and Cisco, take past experience into consideration. However, if your company does not have a history of acquiring companies or merging with them, it’s important follow the “Overcoming Biases” process and procedure carefully, and it’s worthwhile to hire an outside consultant to help you make sure that you’re not reintroducing bias by skewing the analysis to favor your own predilections.
Phase One: Investigation of Facts
1. Confirmation bias: To eliminate confirmation bias, try to find evidence that debunks or unconfirms your case.
2. Overconfidence: To deflate overconfidence, try to develop a reference class of prior deals / acquisitions and compare them.
3. Underestimation of culture difference: Pinpoint the prevailing values, cultural beliefs, ideas, attitudes, and insights that inform each of the cultures. What are the stories that they like to tell about themselves and their organization? What are the behaviors that are rewarded? What are punished? Who are the “cultural heroes”? Any “cultural dogs”?
4. Planning fallacy: Look at your analogues in the reference class and take a long, hard, realistic look at how much time it really took for the companies to merge, or for the acquisition to be completely realized. How much time did it take? How much money? What were the casualties? Where did they occur? How many employees resigned rather than recombining in the new organization?
5. Conflict of interest: Who may benefit from the actual situation? Are the main beneficiaries the ones who are in charge of the merger or acquisition? Who are the real champions?
Market Phase: Negotiation
Winner’s Curse: Be sure to avoid getting into a bidding war. Bidding wars are notoriously emotional and may lead to irrational decisions – some may bid the price up too high, but others may drop out too early due to distaste for the entire bidding situation.
Final Phase: Make sure you have total access to all records, accounting, books.
Anchoring bias: Avoid getting stuck in your mindset by bringing in independent analysts.
Sunk cost fallacy: Avoid believing it’s too late to turn back because you’ve already put too much money in it to bail out. You can avoid the “sunk cost” fallacy by having a set of contingency plans and alternative options for each stage of the game.
Following the steps will help you avoid potential disasters. However, it’s also possible that you’ll still need a few new additional vantage points. Here are a few red flags in the M&A process that could indicate that something is fundamentally wrong with the proposal on the table:
• The merger or acquisition has only one champion, which is either the CEO or the Chairman of the Board.
• The proposal focuses only on new revenues or cost savings / efficiencies, without having a combination of both revenue generation and enhanced efficiencies.
• Inadequate investigation of cultural differences.
• There are several bidders for the company and the limit price changes.
• Members of the team start saying things like “we can’t turn back now – we have too much invested” or “we have to see this out because we’ve sunk so much into it.”
• You’re passionate about the deal – it’s “do or die” with you.
M&A Aversion? Hidden bias
Just because your organization may be proposing an M&A does not mean that everyone is enthralled by the process, or that they believe in it. It is very useful to look at some of the biases may make executives uncomfortable with mergers and acquisitions.
Loss aversion: Much M&A aversion comes from the belief that acquiring a business is much riskier than achieving growth organically. Many times when someone does not want to take on risk, they mask it with stalling tactics – endless studies, white papers, and decision avoidance. When that happens, it’s possible to lose opportunities for real growth. To avoid loss aversion, try aggregating an M&A decision within a larger array of strategic decisions.
Comparative ignorance: Not knowing the facts about similar deals leads to ignorance of the comparisons and it allows one to judge the proposal emotionally rather than on actual statistics / results from the experiences of others. The way to overcome a few of uncertainty is to look at a potential range of outcomes (based on an analysis of at least eight analogous cases), and to make sure that the worst-case scenario will not jeopardize the viability of the company.
Mergers and acquisitions are complex, costly, and risky. However, when considered within the context of overall growth strategies, it is often not possible to grow without acquisitions particularly in areas of high competition and established brands.
De-risking the M&A process by eliminating bias in a systematic and consistent manner has been demonstrated to be effective for organizations seeking to grow, especially in times of radical technological change and innovation.
Kahneman, D. (2003). A perspective on judgment and choice: mapping bounded rationality. The American Psychologist, 58(9), 697-720.
Kahneman, D., & Klein, G. (2009). Conditions for intuitive expertise: a failure to disagree. The American Psychologist, 64(6), 515-526.
Kahneman, D., Lovallo, D., & Sibony, O. (2011). Before you make that big decision. Harvard Business Review, 89(6), 50-60.
Kahneman, D.; Tversky, A. (1979). “Prospect theory: An analysis of decisions under risk”. Econometrica 47 (2): 263–291. doi:10.2307/1914185. JSTOR 1914185.
Lovallo, D., & Kahneman, D. (2003). Delusions of success. How optimism undermines executives’ decisions. Harvard Business Review, 81(7), 56.
Thaler, R.; Sunstein, C. (2008). Nudge: Improving Decisions About Health, Wealth, and Happiness. NY: Caravan.
Tversky, A.; Kahneman, D. (1973). “Availability: A heuristic for judging frequency and probability”. Cognitive Psychology 5 (2): 207–232. doi:10.1016/0010-0285(73)90033-9.
Last 5 posts by Susan Nash
- Concepts, Models, and Case Studies of Dolomitization – with Applications to Hydrocarbon Exploration and Development - March 10th, 2014
- Applied Concepts in Naturally Fractured Reservoirs - March 7th, 2014
- Getting Started in Fluvial Stratigraphy - March 7th, 2014
- Basinal to Local Scale Stratigraphy and Facies Architecture of the Jackfork Group Turbidites, Arkansas - March 6th, 2014
- Unlocking the Deep HPHT Oligocene Fairway in the Nile Delta and the 20K Technology Promise - March 6th, 2014