Hubris & Overpaying

Introduction

Of the seven deadly sins, perhaps none are as relevant to mergers & acquisitions as hubris. More than a simple case of inflated self-confidence, hubris is the overwhelming pride that has taken down great leaders, armies, and companies throughout history. These days, as psychologists, economists, and business strategists look more closely at the phenomenon, hubris is much better understood. And what they’ve learned is particularly interesting when it comes to acquisitions:

– Executive and corporate hubris is a real phenomenon, brought upon by some predictable circumstances
– Executives who exhibit hubris objectively overpay in deals, and increase the risk of a failed acquisition
– Examples are plenty showing the effects of hubris in recent transactions
– Good advisors can make a difference, and with the right advice and humility, hubris and its consequences are not inevitable

What is hubris, anyway, and where does it come from?

According to psychiatrists, hubris is defined by an exaggerated pride or self-confidence; disregard for the rules; a sense of invincibility.

Dr. Steven Berglas, a former psychiatrist and Harvard Medical School professor turned executive coach, points out that hubris is a reactive behavior, behavior that emerges in response to external forces (such as continual praise from outside admirers or observers). In other words, hubris often starts because there is a deserved sense of success. But once it hits, it’s extremely dangerous.

What do we know about how hubris affects dealmakers (and deal outcomes)?

Overwhelming pride can be damaging in lots of ways. Enron’s pride famously preceded its fall; Napoleon’s disastrous Russian invasions left a trail of death and destruction in its wake. But in the particular environment that is the acquisition process (especially where a competitive bidding process takes place), an ego-driven sense of inflated importance can really kick in, and often leads to overpaying.

An academic study in 2014, conducted by researchers at the University of Lille Nord de France, SKEMA Business School, and the California Institute of Technology, took this anecdotal observation (that hubris leads to inflated purchase prices) and found plenty of empirical evidence to back it up. Developing tests to identify hubristic behavior, they found a strong correlation between it and overpaying for acquisitions.

Nobody wants to overpay for an acquisition, of course. Then again, it happens – and can happen for a variety of reasons. But the downside of hubris on M&A extends beyond the risk of overpaying. Acquisitions are notoriously prone to failure during and after integration, and hubris is just as dangerous for an integration as it is for a bidding environment.

Examples

Given the dramatic successes the software industry has seen over the past three decades, it’s not surprising that there are plenty of examples of M&A driven by ego and exaggerated confidence – and unfortunately, it’s not surprising that many of them have not gone well.

Novell’s $1.4bn purchase of WordPerfect in 1994, in an attempt to counter Microsoft’s dominance, ended in disaster just two years later as the company let WordPerfect go for just over $120M. Overconfident Novell execs, flush with the success of having built the NetWare operating system that redefined enterprise networking, thought they could repeat their success, but the ensuing clash of cultures led to a mass exodus of WordPerfect leadership and a collapse of the very business they had bought.

Marissa Mayer, the poster child of successful Google executives, took the CEO spot at Yahoo! with a mandate to breathe new life into the once-great portal. Her first major act was the $1.1bn purchase of Tumblr in 2013. Within three years, the move was almost unanimously considered to have been a failure, and Yahoo! continues its decline.

Maybe most extreme, Google announced it would put Boston Dynamics, the robotics division it acquired for $500M in late 2013 up for sale – less than three years after acquisition. All of these failed acquisitions, from the outside, exhibit patterns of hubris at work: proven industry leaders, buoyed by previous success, make big-ticket purchases that end up failing spectacularly in just a few years.

Of course, not all expensive IT industry acquisitions have ended in failure. Facebook’s $1bn purchase of Instagram has yielded a business that analysts suspect is already worth multiples of its purchase price. Google’s purchase of YouTube has added a segment that is so important to Google that it lives alongside core search as a central part of the Google ecosystem. And Facebook and Google are known for their charismatic (and constantly-praised) founders. So what’s the difference?

Protecting against hubris – and how a good advisor can help

First off, like most personality traits, hubris is not something everyone suffers from equally. Some executives have the self-awareness and control to guard against hubris intuitively. Others have the prescience to bring strong advisors around them. In either case, a lack of hubris is primarily marked by recognizing where patterns don’t quite repeat themselves; where a new situation is not the same as one in the past that led to great success. No matter how smart or self-controlled you are, this is rarely easy. The “availability heuristic,” a mental shortcut successful people use to make decisions, is the phenomenon whereby the mind draws heavily on recent examples to decide what’s important or how to proceed. Daniel Kahneman, the psychologist/economist who coined the term, has spent decades observing that, when people readily remember losses, not just wins, their behavior will be significantly more conservative. The emerging field of evidence-based decision making and management (already common in healthcare and public policy) works off of this principle, and uses data and analysis to prioritize finding the evidence that might make an argument or initial opinion incorrect.

For executives intent on a big deal, this means that the easier it is to recall examples of less-than-successful translations, the more likely they are not to overpay dramatically. But not all successful executives have such a reservoir of experiences – and that’s where good advisors can come in. A good advisor is someone who actually understands technical aspects and fundamental drivers of an acquisition, and sees the differences between business models and fundamentals of the acquirer and acquisition. Good advisors are also those advisors who are willing to speak frankly and directly. Whether it’s holding “pre mortem” meetings – where companies or consultants discuss what could kill a deal/initiative before proceeding – or simply have a strong enough voice at the table to add value, good advisors can add a dose of reality without being seen as a drag.

A Greenwood example

Not long ago, we were working with a leading PE firm as they considered purchasing a carve-out from a global manufacturing company. The carve out division would have included nearly 40 warehouses across nearly as many countries – and critically, each warehouse had an independent ERP setup. Integrating ERPs is always a challenge. Integrating so many ERPs (especially across so many currencies, and with differing chart of accounts) would be a Herculean task. By our estimate, the work and time required (nearly $40M-$60M over three to five years) would dramatically reduce the attractiveness of the deal.

Our PE clients had done ERP integration before – and they had done it well, but on a completely different, much smaller, scale. Once we looked at the reality of what would be required, it became clear that this wasn’t the right transaction for our client to pursue. They dropped their bid before the second round – and in the process, avoided overpaying for a deal that on the surface might have looked like something they “had done before.” A little humility, and complementary advisors, went a long way.

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