Optimism: The Enemy Of Successful Acquisitions
I attended an excellent talk by Mr. Rich Hartley, Deputy Assistant Secretary of the Air Force (Cost and Economics) last week. There were many interesting and informative points. And the one that struck me the most were his observations regarding optimism. He referred to a Harvard Business Review article ”Delusions of Success How Optimism Undermines Executives’ Decisions“ He summarized the findings related to cost estimating and analysis as follow:
When planning major initiatives
- Routinely exaggerate benefits and discount costs when projecting risky project
- Sets up project for failure; psychologists “planning fallacy”–spin success scenarios and overlook potential for mistakes
Optimism traced to cognitive biases and organizational pressures
- People highly optimistic most of the time –exaggerate talents and degree of control; attribute negative consequences to external factors
- Competition ($, time) for new projects –incentive to accentuate the positive
- Anchoring magnifies optimism –initial plan accentuates positive, skews subsequent analysis
- Most pronounced for initiatives companies have never attempted before
Temper w/ “outside view”
- Supplements traditional forecasting w/ statistical analysis of analogous efforts –reality check on initiative inside view
- Don’t remove optimism, but temper effects –balance between optimism and realism -goals (motivate) and forecasts (decide whether to make commitment in the first place)
The abstract, from the HBR website follows:
The evidence is disturbingly clear: Most major business initiatives–mergers and acquisitions, capital investments, market entries–fail to pay off. Economists would argue that the low success rate reflects a rational assessment of risk, with the returns from a few successes outweighing the losses of many failures. But two distinguished scholars of decision making, Dan Lovallo of the University of New South Wales and Nobel laureate Daniel Kahneman of Princeton University, provide a very different explanation. They show that a combination of cognitive biases (including anchoring and competitor neglect) and organizational pressures lead managers to make overly optimistic forecasts in analyzing proposals for major investments. By exaggerating the likely benefits of a project and ignoring the potential pitfalls, they lead their organizations into initiatives that are doomed to fall well short of expectations. The biases and pressures cannot be escaped, the authors argue, but they can be tempered by applying a very different method of forecasting–one that takes a much more objective “outside view” of an initiative’s likely outcome. This outside view, also known as reference-class forecasting, completely ignores the details of the project at hand; instead, it encourages managers to examine the experiences of a class of similar projects, to lay out a rough distribution of outcomes for this reference class, and then to position the current project in that distribution.
I recommend spending the $6.50 and purchasing the article if you haven’t seen it.
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