Despite their best intentions, executives fall prey to cognitive and organizational biases that get in the way of good decision making. In this series, we highlight some of them and offer a few effective ways to address them.
Our topic this time?
When the crowd isn’t necessarily wise
The dilemma
Another year, another proposal, another processing plant. The CFO at a large chemical company has a sense of déjà vu. The CEO and the board are making noise about building out capacity in the southern half of the United States and allocating more resources to the modular build and design of two more big, new plants in that region. It isn’t an entirely unexpected proposal: most of the company’s competitors follow this same continuous-development model, which can make it easier to raise money and get buy-in for large construction projects. No question, the pursuit of such projects can burnish everyone’s reputation—especially the company that can boast the newest, shiniest facility. But the CFO also knows that there are financial concerns associated with following the crowd. If a group of new plants all come online at the same time, for instance, and create excess capacity, prices across the industry could collapse. How can the CFO convince the CEO, the board, and others to look differently at both the opportunities and the opportunity costs of this proposed build-out?
The research
The CFO is battling against herd mentality, which is a common bias in the worlds of corporate strategy, finance, innovation, and investing. It was first observed by the journalist Charles Mackay in his 1841 study of crowd psychology, Extraordinary Popular Delusions and the Madness of Crowds, which presages the rise of economic bubbles. Herd mentality generally happens when information that’s available to the group is deemed more useful than privately held knowledge, regardless of the source or quality of that information. Individuals buy into the collective wisdom, sometimes even ignoring evidence to the contrary—especially when their reputations are on the line.1 If a chemical company builds a new processing plant when all its competitors do, and that strategy fails, the company’s CEO, board, and other stakeholders can’t be singled out for ridicule because the other companies made the same mistake. But if the company follows an approach that’s different from the crowd and is wrong, its strategy may be criticized, and executives may lose their jobs.
There is safety in the herd. But if no one on an executive team explores a contrarian view, their company may miss opportunities to build competitive advantage, launch new business models or industries, or otherwise position itself for long-term success.
The remedy
A company may never fully bend the herd’s will in its direction, but business leaders who take a contrarian stance can use the herd’s thinking to pressure-test their own information before making critical business decisions. Taking a page from the activist investor playbook, business leaders can engage in a teardown exercise. They can use red teams and blue teams, scenarios, advanced analytics, and role-playing to identify how the herd might react to a decision and to ensure that they can refute public perceptions with detailed analyses.
In the case of the plant build-out proposal, for instance, the CFO and CEO could tap a team of operations heads within relevant business units to review data and build formal cases for and against the new plant’s construction. The CFO and CEO would encourage that team to look at the long-term strategic, operating, and financial implications of the construction and the company’s competitors’ and investors’ possible reactions. For instance, what could chemical demand look like two and five years out? What would be the cash-flow projections two and five years out? When would the project break even? Just how deep could prices drop in the case of excess capacity?
That teardown exercise would generate the evidence that the CFO needs to assuage the CEO, the board, and others’ fears about possibly breaking from pack behaviors. It would also prompt those important stakeholders to acknowledge explicitly the reputational and other risks associated with not following industry-standard approaches to development—and give them the foundation to pursue potentially more effective paths to growth.
Going against the crowd can be daunting in any context; when careers and reputations are on the line, it can be downright paralyzing. But to make a big difference within companies and industries, business leaders may have to make bold moves—even when the crowd disagrees.
