‘How CFOs can keep strategic decisions on track’ by Bill Huyett and Tim Koller, McKinsey Quarterly, March 2011

McKinsey have the knack of writing about practical issues that impact those who run the finance functions of major companies, which is very much in line with MTP’s coverage on our finance programmes. This time the relevant topic is the avoidance of bias in strategic decision making and the CFO’s responsibility for identifying and overcoming biased thinking.

It could be argued that the finance team should overcome bias by the production of objective quantitative information. But it is rarely as simple as that because hard information is not always taken into account when decisions are made and research indicates that there are many causes of bias, including overconfidence, team motivation, CEO pressure and the risk profiles of the people involved.

The authors make their points through a conversation in Q& A style with the Director of their Paris office Olivier Sibony, who has apparently written many articles on the topic of bias. I would have been rather more impressed if the conversation had included a real life CFO but the article nevertheless has a convincing and practical flavour. The emphasis is on the importance of establishing an effective decision making process, involving the judgment and insights of a number of people, rather than being driven by one biased party.

Sibony is of the view that, in successful companies, over-confidence is ‘hard-wired’ and many managers fail to learn from their mistakes; it is also very difficult to change this mindset, there is a view that ‘next time it will be different’. It is however possible for a multi-person process, that involves structured questioning and challenging, to overcome these built in biases. This can reduce the reliance on financial evaluations that may be driven by biased assumptions; the article quotes the all too common practice whereby M & A evaluations are driven by the answer that is wanted and not by the likely risks and outcomes.

The authors’ suggestion is that decision making meetings should be more like courts of law with for and against arguments, rather than a one way presentation by the project champion. McKinsey’s research of decision making processes indicates that the latter is the normal practice, usually accompanied by the underlying assumption that the project will go through, one way or the other. Instead McKinsey recommends that someone takes the role of devil’s advocate, looking for uncertainties and downside risks to counter the natural biases of the champion. There is even a suggestion that for acquisitions there should be two deal teams, one arguing for and one against. It was here that I began to have some reservations about the practicality because factors of urgency and cost would be sure to arise.

There is also a suggestion that teams should use the concept of the ‘pre-mortem’; each of the key players has to think of several reasons why the deal is going to fail and then discuss what has been done or can be done to overcome the potential problems. At this stage I wondered if maybe this is taking the question of balance too far to the negative side. There would be a danger of changing to a different, pessimistic form of bias that ensures that no decision is ever taken.

The article is interesting but falls short on specific quantitative analysis tools to help in the removal of bias, for instance sensitivity, range and probability analysis. The only techniques quoted are around the analysis of past projects and the discussion of lessons learned. It seems that this thinking is driven much more by the softer behavioural arm of McKinsey than by their harder financial side. But it still provides excellent food for thought.

Click here to read the article in full:
http://www.mckinseyquarterly.com/How_CFOs_can_keep_strategic_decisions_on_track_2750