Wednesday, September 16, 2009

Strategic Planning Analogy #276: Bias to Stop

Ford invented the minivan, but refused to build them. Why? First, Ford was #1 in the sales of station wagons at that time. Ford feared that the minivan would cannibalize the sales on all those station wagons. Second, the truck division thought it might cannibalize some truck sales, as well.

Ford saw little benefit in spending all the money needed to gear up production for a new vehicle (the minivan) if all it was going to is steal business from their other profitable lines. Therefore, they did not introduce the minivan. It seemed like a wise financial move at the time. Why needlessly spend all that extra capital to get sales you already had?

Of course, when Lee Iacocca left Ford and went to Chrysler, he found himself at a company that was weak in the station wagon and truck businesses. There wasn’t much at Chrysler to be cannibalized by the minivan. Therefore, Chrysler introduced the minivan. It was a huge success, mostly at Ford’s expense.

Ford was correct about one thing. The minivan did make the station wagon obsolete. Ford lost nearly all of its station wagon sales. Too bad Ford did not factor in a competitive introduction of the minivan into their business model. In the end, Ford did not save the expense of introducing a minivan (as they had hoped). They had to do it anyway, as a response to Chrysler. However, because they let Chrysler get a head start, Chrysler got most of the benefit of the minivan.

As this story illustrates, one can create logical arguments to kill a new project, as Ford did with the minivan. One can even back up that argument with solid financials. However, that does not always mean that the new project should be killed.

Logical arguments and financial models can be flawed. A natural bias to kill new initiatives can exist in an organization. This bias can cloud one’s judgment, leading to a flawed analysis.

Due to a bias towards past success, Ford failed to take into account the inevitability that station wagons would eventually become passé. By not proactively planning for their replacement, they allowed Chrysler to replace them.

Businesses need to be aware of the potential for this bias, so that they do not fall into the trap which hurt Ford.

In the last blog, we looked at how a bias to “go” on new ventures can hurt a company. In this blog, we will look at how a bias to “no go” on new ventures can also hurt a company. We will look at the causes of the “no go” bias, how it can distort our analysis, and questions to ask ourselves in order to keep the bias from causing us to make the wrong decision.

1. Bias Source #1: Avoiding the Hammer
The old saying is that the hammer hits the tallest nail. If you stand out too much, you are vulnerable to attack. New ventures have high visibility and stand out. If they fail, you run the risk of being attacked. Their failure becomes your failure. By contrast, it is easier to hide in the bureaucracy of the established businesses.

2. Bias Source #2: Avoiding Accountability
If you say “go” and the new business fails, there is hell to pay, because a highly visible loss is right there on the books for all to see. However, if you say “no go” and the business would have been great, there is less of a backlash, because it is all subjective. Hence, if you want to avoid accountability for your decision, it is easier if you say “no go.”

3. Bias Source #3: New Game Threatens My Game
You’ve been working yourself up the corporate ladder playing by the old rules associated with the old way of doing things. The new ways could make your “game” obsolete. To protect your personal future, you need to protect the ways of the past.

4. Bias Source #4: Short-Term Pressure
There tends to be more pressure on hitting the targets for the current month or current quarter than for long-term profits. Since new initiatives usually have a near-term drain on profits, there is a tendency to put them off, so they won’t hurt near-term earnings.

5. Bias Source #5: Not on My Watch
The remaining tenure for most CEOs is relatively short—shorter than the time for a new initiate to have a positive impact. The leaders may be retired or have moved on by the time the new initiative pans out. As one CEO put it, “Why should I invest in something that hurts earnings on my watch, but provides benefits for my successor that he will take credit for?”

6. Bias Source #5: Fear of Cannibalization
As we saw in the story, new projects often cannibalize older businesses. The thought is that by avoiding the new businesses, we can protect the old ones while at the same time avoiding all that new investment.

These factors can cause a bias to say “no go” to projects which should move forward. They can even distort the financial analysis, to make “no go” look better than it should.

1. Distortion #1: Old Cash Flow Will Go On Forever
New initiatives are often compared to the status quo. If you assume the status quo will always be strong and healthy, then it is hard to justify change. However, it is a fact of life that all strategic initiatives eventually fail. Customer desires change and innovations from others change demand. Product lifecycles eventually reach maturity and decline. The “next big thing” eventually becomes “that obsolete thing.” 8-Track players were once the rage in music. Now they are junk.

The cash flow on the old business will not go on forever. If you don’t replace it, another company will. Either way, there is inevitable decline. Make sure you put it in the model.

2. Distortion #2: Things Won’t Change if I Don’t Change
Ford thought that if they didn’t build the minivan, the minivan would not be built. This, as we saw, was not the case. Innovation is going on all over the place in your industry. If you can see the potential in the new venture, so can others. Just because you like the status quo and don’t want change (because right now you are the leader) does not mean that everyone likes the status quo (especially the non-leaders). Change is inevitable. Either you can take advantage of it (by action) or be hurt by it (through inaction). Therefore, your modeling should assume changing conditions caused by others.

3. Distortion #3: Old Beasts don’t Need to be Fed
To keep older businesses vital, one needs to reinvest in them. For example, I know of a retailer who built a lot of stores in the 1970s and 1980s and then hardly ever reinvested in those locations. Eventually the stores looked rather shabby. In addition, over the next 30 years, those neighborhoods changed and became less desirable locations for stores. People wanted to shop the newer, nicer stores of the competition which were closer to their new homes, rather than drive into the dangerous inner-city locations where these old shabby stores were. By not reinvesting in the old business and refusing to relocate those stores to better locations, the company eventually went bankrupt. In the near term, those relocations looked more expensive than staying in the older locations. Over time, however, the lack of reinvestment killed the old business. Does your business model include reinvestments in the status quo? The old beasts still need to be fed, or they will die.

So how can we avoid this bias and resulting distortions? If helps if we ask ourselves the following questions before making a decision.

1. If you were assured of a promotion regardless of the success or failure of the new initiative would you still want to kill it? (This unlinks your fate from the fate of the project, so that you can look at it more objectively)

2. If near-term pressures were eliminated, what would you do? (near-term is biased towards status quo) Keep in mind that astute investors value your firm based on future cash flow potential, not history. If you can convince them that these are good long term investments, they will support you. It helps if incentive programs de-emphasize near-term and also reward good long-term decisions.

3. What if another company says “go” to your “no go” decision? Can you survive the impact to your core businesses? (This provides a more realistic way to evaluate cannibalization)

4. In your model, are you adequately feeding the old beast to keep it relevant or are you choking it? Either the modeling needs to include lots of cash to invigorate the old, or the future prospects for the status quo need to be significantly reduced. Make sure the residual value on the status quo does not overstate its potential.

Since all current initiatives will eventually fail, there is a need to continually reinvent a firm with new initiatives. Otherwise, your company will fail when all the current initiatives fail. Unfortunately, it is often difficult to justify the cost of reinvention while the old initiatives are still cranking out healthy cash flows. This creates a bias to kill off new initiatives. The more we are aware of this bias, the more we can avoid its disastrous consequences.

Just as the station wagon did not live forever, it appears that the minivan is now in decline. Crossover vehicles are starting to take its place. And guess what? Ford has aggressively gone after the crossover business, because they do not have many minivan sales to cannibalize. By contrast, Chrysler has been slow to get into the crossover business, in large part due to not wanting to cannibalize the most profitable piece of their portfolio (the minivan). Times may change, but the mistaken logic appears to live on.

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