WAYNE BORCHARDT: Woolworths blunder a lesson in being too bold about decisions

Do you think you are an above-average driver? About 90% of those reading this will think so. But of course that is statistically impossible. About half of you will be wrong. So where does this overconfidence in your ability come from? It is a common cognitive trap we are all susceptible to. Familiarising yourself with what it means, and what to do about it, will undoubtedly improve your decision-making.

Good decision-making is a defining skill for business leaders. It is along this metric that they will ultimately be judged, because good decision-making will not only shape a firm’s profit margins but also its future sustainability. Business leaders are in effect the drivers of very big cars, worth a lot of money, with dozens and sometimes hundreds or even thousands of people in the back seat — all dependent on the safety of the vehicle they are in. If these corporate drivers get things wrong it can end in disaster.

One such example of a strategic business decision gone wrong comes from a company all South Africans are familiar with. At the end of August, Woolworths made headlines after releasing its financial results. The company was able to slash its debt and reduce net borrowings by 91% due largely to selling significant properties of David Jones, an upmarket department store in Australia that Woolworths bought in 2014. Back then, the decision was believed to be a good one by those in the driving seat — but the market didn’t see things quite the same way.

When the acquisition was announced, the Woolworths share price took a huge knock. This was because the company had paid a 25% premium for David Jones, which was not exactly shooting the lights out in Australia. It raised alarm bells at the time, which have since been justified — hence the market is now reacting positively to Woolworths selling off debt in the region.

Excessive faith

So what are the lessons to be learnt? Warren Buffett, famed for his savvy investment principles, once said many corporate acquirers think of themselves as magical princesses, confident their special kisses can transform toads into handsome princes. However, in all his time he says he has seen many kisses — and few miracles. This is backed up by a significant study by Hayward and Hambrink that revealed CEO hubris is often associated with acquisition premiums — paying more to acquire a company than otherwise should be.

Looking back, the decision to pay big bucks for David Jones was a function of overconfidence. On this occasion, such overconfidence was a result of overestimation (Woolworths management falsely believing their call would deliver returns beyond what the evidence suggested) and overprecision — excessive faith that they knew the real truth, believing the market was missing something. This was borne out by their forecasts for the expected earnings from their acquisition: they predicted returns more than three times greater than what materialised.

The decisionmakers at Woolworths couldn’t see the true worth of the Australian retailer through their excessive overconfidence. It resulted in the company having to write off billions — more than half of the overall deal value. It was the corporate equivalent of a car crash.

The Woolworths board should have asked the management team the following questions at the time:

• What other growth strategies have you considered besides the David Jones acquisition?
• What uncertainties have you considered about the strategy you are promoting?
• How did you model those uncertainties?
• How robust is your strategy against those uncertainties?

These kinds of questions can fundamentally improve the robustness of strategic decision-making — recognising that overconfidence biases are real, and through that realisation bringing in measures to mitigate them.

It is impossible to show why overconfidence may lead to the wrong decision if we are unable to clearly define what qualifies as a “good” decision. But evaluating a good decision is a difficult task as each one rests on the context in which it is made. Carl Spetzler, Hannah Winter and Jennifer Meyer offer a valuable framework in their book, Decision Quality. They define the following dimensions for evaluating the quality of a strategic decision:

• Appropriate framing  comprises properly defining the decision problem.
• Shaping creative, executable alternatives —— not just entertaining other options for the sake of it, but truly exploring viable alternatives.
• Assessing those strategic alternatives using meaningful and reliable information — ensuring the information most relevant to making that decision has been considered and the uncertainties regarding it assessed.
• Clear values and trade-offs refers to how the alternatives are considered in light of what you care most about.
• A sound rationale for how the decision was made, effectively weighing up the different alternatives and assessing what will likely yield the greatest value.
• A commitment to action.

According to Don Moore, a lead researcher in this field, cognitive bias is the “mother of all biases”. It is often the root cause behind other mental traps that limit your ability to see reality for what it is. In my research at the University of Cape Town’s Graduate School of Business — one of only three triple-crown-accredited African business schools — evidence suggests specific pessimists substantially outperform vague optimists. This is because a little pessimism goes far in making you question the beliefs underpinning your decisions. This can only help those decisions be more robust.

So, the next time you feel especially emboldened when making a big decision, reflect a little more, try to see the downside and remember, if you think you are smarter than everyone else, you are statistically likely to be wrong about that.

• Borchardt is adjunct senior lecturer at the University of Cape Town Graduate School of Business and founder and CEO of The Decision Advisory Group.