Tuesday, September 11, 2007

It Depends

One day, when I was a young boy, my Dad came to me and said, “Let’s go to the police auction and get you a bicycle.”

I was really excited.

As it turns out, the local police department had collected a lot of stuff from raids, robberies and abandonment. If they didn’t know who the property belonged to, the police kept it. When they got too much stuff to store, the police would hold an auction to get rid of the property. One of the items they claimed to have a lot of was bicycles. My Dad figured we could get a pretty good bike fairly cheap at the auction.

When we got to the auction, I saw a huge selection of bikes. They all looked great to me. I would have been happy to come home with pretty much any one of them (although a couple of them looked rather beat up).

After a couple of hours at the auction, my Dad said, “Let’s go home.”

I replied, “But Dad, we didn’t get a bicycle.”

My father responded, “These people are going crazy with their bidding. They are bidding up the prices higher than what the bikes would cost new in the store. I’m not paying those kinds of prices for a used bike.”

So, sadly, I did not get a bike that day.

Business strategy involves making a lot of decisions. Should I invest in “project x”? Should I acquire “company y”? Should I move in the direction of “competency z”?

We would like the answer to be a simple “yes” or “no”. Unfortunately, the answer often should be “it depends.” In the story above, I looked at those bicycles at the auction and I thought they were great. If someone asked me if we should buy one of them, I would have said “yes”. By contrast, by Dad looked at those bikes and saw what people were willing to pay for them and said “no”, because he thought it was a bad value.

So were the bikes worth buying? It depends. They were functionally sound, so they had value. I would have enjoyed owning one. However, when the price became higher than the value of a new bike, they were not worth the price. So, the bikes were worth buying until the bidding got too high.

One cannot universally say that under every circumstance the bikes were worth buying or not worth buying. It depended upon the price. Similarly, one cannot look at most strategic decisions in isolation and say they are universally good or universally bad. They may be good for some companies and bad for others due to differences in competencies or synergies or cultural fit. They may be good at one price but bad at another price. They may be good if you put the right manager in charge but bad if you put the wrong manager in charge.

Therefore, when evaluating a strategic option, one must not automatically assume that the option is universally good or universally bad. Instead, it must be evaluated in light of all the variables which impact its value specifically for your business.

We are going to look at two examples which illustrate this principle.

#1) The Horse Race Track
Many years ago, a businessman thought it would be a good idea to bring horse racing to a city in the Midwest. He spent a small fortune to build a grand place to watch horses race and bet on them. Unfortunately, the revenues were not enough to cover the investment. The businessman was losing large sums of money rapidly.

To solve his problem, he sold the business at a huge discount to another investor. The new investor believed that at the lower price he paid for the assets, he could make a positive return. Alas, he could not. Therefore, this investor sold the business to a third investor at a huge loss.

This cycle went on for awhile until finally somebody paid so little for the assets that he was able to make a profit.

So the question is this: Was building the racetrack a good investment? Initially, one might say no, because it would never in its life provide an adequate return on the original investment. However, if you asked the final investor, he would say he was getting a fair return on HIS investment. So, in reality the answer is “it depends,” and in this case it depended on how much you invested in the venture.

The point is this—instead of looking at something and automatically assuming it is a bad investment or a bad strategic choice, first ask yourself this question: Is there anything I can do or change in order to make what initially looks bad into something good? Can I pay a different price for the investment? Can I repurpose the assets into something else which is more valuable? Is there a way I can combine these assets with my own assets and create something more valuable combined than what they are worth alone? Can I manage the assets better?

Start by answering “it depends,” and then look for the necessary set of circumstances which would make it a good choice. Then see if it is possible for you to make that set of circumstances come to life.

#2) The Acquisition
One time I was making a speech to the top management of a firm and was pointing out all of the strategic benefits they could have if they acquired a particular company and used those assets in a particular way. The executives got excited and concluded that this would be a “great” acquisition.

Along the way, the executives got so carried away with the “greatness” of the idea that they decided to pay whatever price it took to get the deal done. Then they put someone in charge of the project who was not committed to using the assets in the strategic manner I had originally suggested. However, since this was seen as a “great” acquisition, the quality of the management did not seem all that crucial.

As you have probably guessed by now, the company paid too much for the firm and then did not realize the strategic benefits due to the way it was mis-managed. The acquisition turned out to be a failure.

The problem was that the executives convinced themselves that the acquisition was universally good, so the details were not as important. They should have approached the acquisition by saying its success depended upon certain events taking place, such as getting it at a good price and using the assets in a certain strategic manner. Had they made the success appear conditional rather than universal, the company would have done a better job of making sure those conditions existed.

So was this acquisition a good idea? The answer is “it depends.” It is like the example of the bicycle. The acquisition target added value to a point, but not if you overpay. The acquisition’s full value could only be realized if the assets were used in a particular manner. By not using them in this manner, the company turned a good acquisition into a bad one.

So the point here is to not assume a universality of goodness around a particular strategic option. Make an effort at the beginning of the process to determine what conditions could exist to make the option go from good to bad and then put in place safeguards to keep those conditions from occurring. And if they occur anyway, have the strength to pull back from the option and abandon it early, if necessary.

Although we would like simple yesses or no’s to our strategic evaluations, it is often more likely the case that the true answer should be “it depends.” If we approach all of our decisions with an “it depends” mindset, then we are more likely to be able to discover the conditions which will create success and then take the steps to ensure that those conditions exist before moving forward. Or, if we cannot make those conditions exist, we can have the fortitude to back off.

On the old game show “Let’s Make a Deal” contestants would trade one item for something else. The problem was that there was an unknown in the equation. Either they knew what they had but didn’t know what they were trading for, or they didn’t know what they had, but they knew what they were trading for. When you make a deal, it’s a good idea to fully understand what you are giving up and fully understand what you are trying to get. It is only then that you can know if it is a good deal.

No comments:

Post a Comment