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How to Save a Billion Dollars

Guy Kawasaki Co-Founder, Alltop Recent Posts

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September 10, 2008

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As a small business owner, how'd you like to get a billion dollar lesson for the price of a book? Paul Carroll and Chunka Mui provide this gift in their new book, Billion-Dollar Lessons: What You Can Learn from the Most Inexcusable Business Failures of the Last 25 Years. Carroll and Mui examine some of the great business fiascos to provide help you avoid the same fate. I caught up with Chunka recently and asked him to explain the lessons of their research.

Question: What are the primary causes of failure for mergers and acquisitions?

Answer: The short answer is bad strategy. Some 46% of the 750 failures we studied in detail occurred because of a strategy that could have been seen as ill-conceived at the time--in other words, not because of crummy luck or bad execution, even though conventional wisdom seems to be that good execution can make any idea work. If you dig a little deeper, here are the main issues:

Companies overestimate the power that comes with additional size. We cringe every time we see a press release that says a company will achieve "critical mass." Let's say a company goes from supplying half a percent of the world's iron ore to supplying one percent. That looks like a doubling in size to them, but the market doesn't care. That company has gone from being a gnat to being a mosquito--or at most a fly.

Companies underestimate the complexity that comes with additional size. In the 1980s, US Air bought two airlines of about its size and saw just about every system break down. Because the IT systems were overwhelmed, teams of secretaries often had to manually type thousands of checks on payday. US Air went from being one of the most consistently profitable airlines to a decade of losses.

Companies overestimate their hold on customers. An electric utility in Florida looked at its base of nice, elderly folks and thought it could sell insurance to them. Nope. The folks didn't even relate the two--electricity and insurance--even though they generally liked the utility. A study found that something like 80% of executives think their products are better than the competition--and that 8% of customers agree.

Companies play semantic games to convince themselves that they have something that matters in a new market. Avon decided in the 1980s that its "culture of caring" equipped it to operate retirement homes. Not even close. We blame this phenomenon partly on all the talk that the railroads fell by the wayside way back when because they thought of themselves as being in the railroad business, that the railroads could have captured the nascent automobile industry if they'd thought of themselves more broadly as being in the "transportation" business. We think the railroads would have lost their shirts if they'd gotten into cars. Railroads and cars had nothing at all in common.

Companies don't consider all their options. Everyone wants to be the buyer, even though it would often make sense--at least for investors--if a company decided to be the seller.

People routinely overpay for acquisitions. But you already knew that.

Question: What does it take to make a merger, acquisition, and other bold moves work?

Answer: A lot, actually, but we pretty much leave this question to others. We try to help people avoid the catchable errors in strategy, so they have better odds of succeeding. So we'd say that if you avoid overestimating the benefits of scale, avoid underestimating the complexity, etc., you have a much better chance.

Question: Why do seemingly smart people and companies make such blunders?

Answer: It turns out that we're wired to be overconfident, to come to conclusions too quickly, and to not learn from mistakes. There are also all sorts of institutional issues. People are afraid to challenge the CEO. They don't want to be too harsh lest they destroy the carefully cultivated camaraderie of an executive team.

The CEO is in a tough spot because he can't bounce ideas off much of anyone. He can seem indecisive if he talks out loud in front of his executive team. The same holds true for the board. Besides, the board may not be an incredibly knowledgeable group. It's made up of some corporate insiders, plus outsiders who, by definition, can't be from the relevant industry. They're surely smart and experienced, but they may not have the right experience. The CEO can really let his hair down in front of investment bankers and high-level management consultants, but they have financial incentives that color their own judgment.

When it comes time to do a big deal, the CEO is probably new at that game. These guys, if they're really active, may get to make two or three major strategy moves while in the top job. So, when the time comes, they're relatively inexperienced and have to rely on people who may not have their best interests at heart. The difficulty of the position is why we recommend a series of ways for companies to increase disagreement--so bad ideas can be caught before investors lose hundreds of millions or billions of dollars and before the CEO loses his job.

Question: When, if ever, is there true synergy?

Answer: There are actually quite a few examples of synergy. They seem to come when you have a company that's experienced in looking for them and that has real strengths to bring to the party--as opposed to looking to buy those strengths.

Maybe the best example is Cisco, which at least for a long time was able to buy companies with small revenues and amplify those sales enormously by pumping them through Cisco's sales operation. The problems come because companies often overestimate the synergies, especially on the revenue side. They also underestimate the costs that will be incurred to get those synergies. And, of course, companies can get deal fever and overpay as they shoot for those ephemeral synergies.

Question: How can people be so stupid as to believe they'll get away with financial engineering?

Answer: You got us. We think people don't initially intend to do anything terribly wrong. They think they're just smoothing the edges on the numbers. Then they find that they've convinced Wall Street, so now the Street wants a little more. Then a little more. Eventually, things get out of control, and people wind up in orange suits.

Question: How does one choose between "staying the course in the face of doubt" and "embracing change"?

Answer: That's a tough question. We know it's possible to give up a market too soon, but we can tell you that the really big failures came from staying with an existing strategy too long. Kodak tried to hold onto the traditional market for film, chemicals and paper so long that it's riding that one into the ground, while its main competitors, Agfa and Fuji, saw the change soon enough that they fared much better.

You also saw this sort of behavior from your old rival IBM, when they decided to milk the market for 286-based PCs in the late 1980s and delayed introducing machines based on the 386--only to have Compaq and then others take that market from IBM. There are lots of red flags that can indicate that you're staying the course too long. Probably the best exercise is to make a set of predictions toward the beginning of a possible change.

These have to be very detailed--dots per square inch, pixels, price per unit of processing power, etc., at least in the case of technology changes--so you can't go back and fuzz things over and make your predictions look better than they were. Then you track your predictions. If the world is changing slower than you think or as fast as you think, you may be okay. If change is faster than you expect, you should head for the hills.

Question: Can you point to one example of a company with institutionalized devil's advocacy that works?

Answer: Under Jack Welch, GE did a great job of integrating devil's advocacy into its day-to-day dealings. An executive who joined GE when it bought RCA once told Welch that "what passes for conversation at GE would be considered a mugging at RCA."Before GE, IBM under Tom Watson Jr. produced decades of success based on what he called its "contention" system--basically an institutionalized form of devil's advocacy. We're actually working with a few clients to do this now. We hope they will be shining examples in our sequel.

Question: How can a company ensure that there is a healthy level of disagreement?

Answer: The ancient Persians used to make decisions twice--first when they were drunk, then when they were sober. Only if they agreed in both circumstances would they act on the decision. The process worked. The Persians ruled much of world for three centuries.We think companies need to imitate the Persians. As you might imagine, we get a chuckle any time we say this to an audience. People want to retire to the bar to continue the discussion.

What people miss is that most corporations make major decisions in a state that, while not drunk, is certainly emotional. Companies don't need to have executives pop a few martinis and reconsider their thinking. Executives need to find a thoroughly sober, dispassionate environment in which to give their emotional decisions a second look. That need is the genesis for our approach to devil's advocacy.

Question: Doesn't Steve Jobs disprove your point about disagreements and devil's advocates being good things?

Answer: We like Steve Jobs. We think he did an incredibly smart thing by selling Pixar to Disney when he did--even though conventional wisdom is still that Disney got a deal. We think even Steve would benefit from having someone stand up to him from time to time--although it would take a mighty strong person. Guy? [Don't hold your breath, Chunka.]

Question: What should Yahoo! do?

Answer: It's not clear what they should do now, but it's very clear that they should have snapped up the Microsoft offer the instant it was made. If Yahoo! had, our sequel would have covered Microsoft's and Steve Ballmer's multibillion-dollar mistake. As it is, we'll surely be writing about Jerry Yang and asking, "What was he thinking?"

As your organization grows, you will encounter these kinds of opportunities and pitfalls. Try to remember Chunka's insights so that you are a positive "billion-dollar lesson." You can learn much more by reading Chunka's book, so click here to get it. Also, if you want more news and information about leadership, click here.