PoS Feb 2014 | Averting a risky decision

Dear friend,

On a warm February day in Chennai seven Directors and three top managers of Spectrum Softech sat down to discuss a bold idea: to acquire Bristol Software, an English private software firm. The purpose was to agree on an action plan.

It didn’t quite end that way.

The joy of thinking big

Spectrum, a privately held, rapidly growing, $12 million company provided ERP implementation services to mid-sized US companies. Bristol, $45 million in revenue and $2.5 million in after tax profits, sold business intelligence (BI) software to British companies.

Their founders – Sathyaprakash and Andrew had become friends since they had met in a technology convention in Las Vegas four years ago.

Spectrum was profitable though not flush with cash, while Bristol had been struggling for the last four years. Andrew was tired of the everyday battles of a services business. He had approached Spectrum to buy him out. Sathya was excited.

The meeting began by Sathya pointing out how the acquisition would provide access to lucrative European markets. The combined entity will sell a broader portfolio of services in US and Europe. Bristol would be able to reduce cost of software development by moving software development from Ireland to Chennai. Together the two companies would be more profitable. It was a golden opportunity.

True, Spectrum didn’t have the cash, but they could borrow $12 – 15 million – the expected price – against stocks of the combined entity, as collateral. It should be possible, he felt, to pay back the loan in five to seven years.

Audacious or wise?

Most participants agreed the plan was audacious and sounded good. One or two advised caution; what if the acquisition failed to generate rapid growth and better profits? Would it be possible to make money after servicing the big loan? Would Spectrum managers be able to integrate the much larger Bristol? An agreement was emerging on the need to mitigate risk.

That’s when Narahari the quiet self-effacing CFO, better known as Nari, broke his silence. He said it wasn’t a good idea at all. He pointed out that the financial burden would be too great. If the loan was not serviced according to the bank’s terms, the plot could unravel irretrievably. Integration would consume top management time and could affect Spectrum’s operations. Would the acquisition sink both companies?

Not vote; but merit

The impassioned plea made an impact but discussion veered to risk mitigation and not whether to pursue the idea. Sathya suggested they vote on it. Nari interjected that a matter of such gravity should not be decided by vote but on merit.

At Narahari’s insistence the Board appointed three people to study the acquisition rigorously. They would assess:

– Costs, benefits and pitfalls
– Opportunities and challenges
– Likelihood of success, and
– Consequence of failure.

One member of the task force would focus solely on why the acquisition should not be pursued. Spectrum narrowly averted a risky and hasty decision.

Moral of the story

Behind the seemingly innocuous story there are several powerful lessons for managers. Most of us do not wish to oppose a daring plan because we would appear pessimistic. Research has shown that we routinely overestimate our ability to succeed. Overconfidence bias leads to systematic underestimation of risk.

We rarely challenge the wisdom of majority. Unconsciously, we adopt arguments of vocal and respected members of a group as our own and become susceptible to confirmation bias. In this state we avoid, indeed refuse to deal with contradictory evidence.

Cognitive bias makes human judgement fallible. It leads individuals and groups, novices and experts alike to grave errors. It is imperative that human systems neutralise bias and decide on major issues after rigorous and objective assessment, not consensus. That is why organisations should encourage dissent.

Eight weeks later the task force recommended they should not acquire Bristol. The Board endorsed it. Spectrum averted a risky choice that could have sunk both companies. They were lucky they had Nari.

For more on the subject read ‘How to sharpen strategic thinking’