How decisions are made
If struggling to make a business case ask ‘Why are we doing this?’ If the answer is ‘strategic reasons’, you’re going to have to hack the numbers to make the discounted cash flow turn positive. ‘Strategic reasons’ is the scariest justification for any business decision. If you see these words in a business case or corporate prospectus, know that the management can’t make the numbers work.
Note the grammar in the question ‘Why are we doing this’. The decision has already been made. Your job is to fix the numbers to justify the decision for some internal investment case. Does that sound wrong? If it does, I don’t apologise. Financial analysis is a good way of preventing bad decisions being made but it won’t help you make good decisions. Everyone can run the same numbers. It is unlikely your competitors will blunder into a bad decision you just ruled out. In other words, there’s little competitive advantage to be gained from financial analysis. By contrast, there’s plenty of competitive advantage to be gained from individual judgement.
Individual judgement or, to give it some other names, intuition, hope, gamble or assertion, is how decisions are actually made. This is how it should be. Why? Because decisions are about the future, and the future is uncertain. This sounds a dangerously circular argument. I’m not suggesting that you don’t do any analysis; only that it there are limits to its usefulness. To repeat, analysis should stop the obviously bad judgements, but it can’t tell you which ones are good because it will never be obvious.
If this is how decisions are actually made, why are ‘strategic reasons’ such a red flag in any business case? Principally because they are very difficult to quantify in a credible way. Take an example of a new corporate headquarters. Try building a business case to justify the huge capital investment of a new headquarters. Unless your old building is about to fall down around your ears, it’s difficult, and sometimes not even then. Yet, would you really expect a large, successful business to headquarter in some Portacabin next to an airport, which is probably the best financial case? You wouldn’t, would you. But try quantifying the reasons why not. It’s part of your corporate brand; your headquarters attracts people to your organisation, inspires loyalty, and embodies the values you admire. It connects with your staff, suppliers and competitors at a deep, personal level. It’s part of your corporate brand equity. Try valuing that!
What other popular ‘strategic reasons’ are there? Mergers and acquisitions are a good source. Financial analysts can cook up any number of plausible-sounding strategic benefits: synergy, cross-marketing, global reach, market power or defence, and procurement savings are among the most popular. Sometimes though you can’t escape the sense that it is just plain vanity, or even worse, displacement activity on a grand scale.
Must there always be a financial benefit for every decision? Logically there must because the opposite means a deliberate choice to destroy value. If strategic reasons are difficult to quantify it just shows the limits of discounted cash flow as a decision-support tool. It relies on cash in and cash out. Failing to attract a star employee because he or she felt your shabby headquarters was a metaphor for your business does not translate into cash in or cash out; not in a primary way anyway.
That’s why strategic reasons are so frightening, you have no way of knowing whether the management judgement behind them is sound or not. It’s dangerous to take it on trust and financial analysis won’t help. You need to use your own judgement.