Why Good Leaders Make Bad Decisions

Bad business decisions rarely attract the attention they are getting this week, as
four UK bank bosses face the House of Commons Treasury Select Committee to explain how they arrived at decisions that nearly ruined the banks they were heading up.

Among those present will be former Royal Bank of Scotland boss Sir Fred ("the Shred") Goodwin, who made the fateful decision to acquire ABN Amro for cash just as the credit markets are imploding. In the US, President Obama recently had to admit "I screwed up" when it was revealed that his nominees for a couple of important posts had not paid their taxes. But bad decisions are nothing new -- nor do they happen only to other people. Bad decisions are something we all need to guard against.

When bad decisions hit the press, the first reponse is to call for more regulation, more oversight and more bureaucracy. But that kills innovation and motivation -- and is often ineffective. Is there anything that you can do to reduce the risk of a bad decision, without adding layers of heavy-handed process?

We think so. Our recent study of flawed decisions suggests that they are much more likely to occur under what we call "red flag conditions". Forewarned is forearmed. If you can spot one of the four red flags, you can take steps to reduce the risk of screwing up.

By identifying the decision maker's potential red flags it is possible to identify their potential bias. But it can be difficult toelf-diagnose, so the analysis is best done by people who know the decision-maker -- this is what a good chairman does of their CEO.

1. Misleading experiences This occurs when we are faced with an unfamiliar situation-- especially if it appears familiar. Under these conditions we may think we recognize something when we do not. William D Smithburg became CEO of Quaker Oats, the global food and drinks business, in 1981 and executed the successful acquisition of Gatorade, the sports drink company in 1983. In 1994, the expanding company sought to repeat the success by acquiring another successful but underexploited drinks company -- Snapple.
   What Smithburg failed to recognize was that, whereas Gatorade was promoted and distributed in a traditional fashion and was a rising star in its market, Snapple was a quirky, entrepreneurial organisation producing an image drink that was already losing market share. The acquisition was disastrous, leading to the downfall of both Smithburg and Quaker itself. The lesson: Identify the main uncertainties involved in a strategic decision and ask whether the decision-maker's experience might distort their thinking.
2. Misleading pre-judgements This is when our thinking has been primed before we begin to evaluate the situation, by previous judgements or decisions we have made that connect with the current situation. Steve Russell, when CEO of Boots between 2000 and 2004, had a potentially misleading and strong prejudgement that Boots's growth potential lay in health-care services. In his own words, "I had been formulating this ambition for Boots since I was merchandising director of Boots the Chemist in the late 1980s. So, when I became CEO, I was determined to make it happen."
   With hindsight, he commented: "We did not have the know-how to make these services work. We should not have tried to do so much of it ourselves." Other managers suggested that many of the services Boots tried to enter were inherently low-margin businesses. A turbulent trading period ensued and Russell resigned in 2004. The lesson: Consider whether the decision-maker is prejudicing a decision -- could it distort their thinking and cause them to behave in a blinkered manner?
3. Inappropriate self-interest This can be a powerful and often unconscious influence, even among professionals who are highly ethical. There are suspicions that doctors allow their prescription choices to be influenced by drug company favours and freebies. Credit ratings agencies likely underestimated the credit risk of many of the derivative products they rated because they were paid by the issuer of the derivative product. The lesson: Don't assume that even the most ethical decision-maker will be able to escape the influence of their personal interests -- and be aware of where they may be susceptible to influence.
4. Inappropriate attachments When CEO of retailer Marks and Spencer in the 1980s, Sir Derek Rayner proved a canny and capable business leader. Yet, he shelled out $750m for US clothing brand Brooks Brothers even though his team felt it was worth considerably less. M&S's share price fell sharply. Why did he do it?
   In "The Rise and Fall of Marks & Spencer",author Judi Bevan says Sir Derek "was enamored" of the clothing, which fitted his age and style. He allowed his choice of acquisition target to be unduly influenced by his personal opinion. The lesson: Don't underestimate the effect of powerful emotions of affection or hatred -- however objective a decision-maker says they are, they could be swayed.

(Photo: Dan Alford, CC2.0)