25 March 2009 Andrew Campbell
In an exclusive extract excerpt from their new book Think Again, authors Sydney Finkelstein, Jo Whitehead, and Andrew Campbell examine how good leaders are always capable of making bad decisions.
In the 1980s and 1990s, Sir Clive Thompson was chief executive of one of the most successful companies in Europe: Rentokil. Thompson was lauded—nominated as the best CEO in Britain on more than one occasion—and Rentokil had been voted the UK’s best-run company.
Thompson created a uniquely disciplined, yet entrepreneurial culture at Rentokil and focused on markets, such as pest control and office plants, where there were opportunities to earn exceptional margins. He became known as ‘Mr 20%’, the man who succeeded in delivering annual profit increases of 20% every year.
By the early 1990s, Thompson had been in charge of Rentokil for more than ten years. Growth had come from a relentless combination of margin improvement, market share gains, and small ad-on acquisitions. He was operating in fragmented markets where most competitors were small and many were for sale. In ten years, the company had made 130 acquisitions.
Then, under pressure to continue the company’s growth trajectory, he started looking for larger deals. Add-on acquisitions simply could not deliver the 20% increases of previous years. He acquired Securiguard in 1994, increasing the size of Rentokil by 30%, and followed it by acquiring BET in 1996, more than doubling the company’s size again. The BET deal led to a new name: Rentokil Initial.
Unfortunately the new deals proved unsuccessful. Mr. 20% tumbled off his perch. Shares halved in value then halved again. Thompson tried to recover by selling some of the things he had bought and going back to basics. Too late. The culture he had so carefully created was undermined and diluted. It proved impossible to go back. He tried passing the baton and taking a lesser role as chairman. In the end Thompson was asked to step out of a board meeting so that the directors could discuss his position. When he returned he was asked to resign.
What caused Thompson to change a successful strategy? What was he thinking? He was well advised. He would have been told that there were risks. He would have had tough questions from his shareholders. In fact, during the acquisition battle, the management team of BET produced a well-argued defence document pointing our most of the risks that subsequently proved to be real. Why wasn’t Thompson able to see the risks he was taking with everything he had created?
Driven by experience
This example, as with many of our flawed strategy cases, has multiple potential explanations. Thompson could have made a prejudgment that the 20% target was vital and that he needed to take high risks to achieve it. Thompson could also have been influenced by self-interest. Maybe his stock options were structured to encourage him to take too much risk. However, the explanation that seems to fit best with Thompson’s own reflections is that he was misled by his experience: his pattern-recognition caused him to see the big acquisitions as being similar to the many small successful acquisitions he had made over the last ten years. Instead of fish and fowl, he simply saw larger fish. And he had strong positive emotions about doing deals and taking acquisition-oriented risks.
When Thompson talked to classrooms of managers at the time of the BET deal and soon after, he was often confronted with some skepticism. Students were concerned that he was taking too much risk.
In response, he explained that Rentokil had made more than 100 acquisitions and that he needed to provide additional deals to keep his aggressive management team in work: "I need to give my lions more red meat," he said. He would also share some of his thinking about the risks and benefits, concluding that the risks were worth taking. But, to the listener, the explanation felt partial or insufficient, and Thompson felt only partly engaged in the question. He seemed to be making his judgment through some process other than a careful assessment of the risks and benefits. He appeared to be comparing the big acquisitions with the previous 130 deals and concluding that success was likely.
But it was not a case purely of flawed pattern recognition. Thompson was also drawing on some strong emotional connections. He came alive when he was switched on to telling stories. One story was about risk. Thompson had been given shares in two companies during his teens. One of them, Slater Walker, was the darling of the market. The company acquired businesses and improved them, like today’s private equity funds. Then the company collapsed, and Thompson lost all his money.
The other company, Trust House Forte, was an ambitious hotel company. The founder, Charles Forte, made a number of bold acquisitions of hotel and catering businesses and succeeded. The stock quadrupled in value. Thompson said this experience stimulated his interest in acquisitions and in risk.
He also liked to tell assembled groups about the excitement of the deal process: the early morning meetings; the discussions about bid tactics with investment bankers; the dangers of letting bankers take too much control; the development of arguments for bid documents; the knowledge that the defending company was going through the same processes at the same moment but probably with less experience.
He also recalled the excitement of waiting for the result of the shareholder votes. In the BET case, Rentokil won the day minutes before the deadline, when an aging clerk hobbled into the counting office and handed over a large bundle of votes in Rentokil’s favour. Those votes tipped the balance. It was a very close-run fight. Thompson was standing by the counting desk, watching the clerk arrive. He liked to speculate about what might have happened to him personally if this clerk had lost his way or been taken ill. The votes would have missed the deadline and, as Thompson liked to speculate, the Rentokil board would have probably asked him to resign.
At the end of these stories, with his eyes alight, Thompson would comment, "Better to live like a lion for a day than a lifetime as a lamb." In other words, Thompson was motivated by strong positive feelings about risk, the excitement of the chase and the thrill of winning. His previous experiences had given him emotional tags that may have contributed to misleading him over these big acquisitions deals. He knew he was taking a significant risk, but because of his previous experience with acquisitions, he probably underestimated the risk, and because of the strong positive emotions for doing deals, he readily concluded that the risks were worth taking.
Rentokil provides an illustration of our first red flag condition: misleading experiences. When our memory contains an experience that has some similarities to the situation, but also some important differences, we can be misled into forming a view of the situation or choosing a course of action that is misguided. For example, none of Thompson’s previous acquisitions were public companies the size of Securiguard or BET. We make these kinds of errors quite frequently, and most of the time we catch the error as we look more closely at the situation, imagine how our actions will play out, or get additional information. However, particularly when we have been very successful in the past, as Thompson had been, we can often presume that our actions will be successful and we will find it hard to question ourselves and correct our error.
So how do we know that Sir Clive Thompson was influenced by misleading experiences? We don’t. In fact the tricky part is that Thompson would not know either. These processes are unconscious. Moreover, the rational part of our brain is so inventive that it will, if challenged, produce a rational explanation for a decision that has been made intuitively. It may not be an explanation that will convince an objective listener. But it will convince the person giving the explanation. In other words, the person whose decision is influenced by pattern recognition and emotional tags will not believe that it was.
Reprinted by permission of Harvard Business Press. Copyright 2009 Sydney Finkelstein , Jo Whitehead, and Andrew Campbell. All rights reserved.