Overcoming the divestment trauma

Why do so many firms have unfocused business portfolios? Too often, firms pay more attention to adding new businesses to accelerate growth than to divesting existing activities that do not provide the desired results. It is (apparently) easier to add another product category than to gain market share in an existing category. Many managers find it hard to turn down creative ideas, so they let colleagues continue to develop them. At some point – without a deliberate, informed decision – the ideas become too big to stop. On the contrary, it seems to be impossible to build a reputation, a career by identifying and executing divestments.

Companies often have low awareness about the strategic importance of divestitures, often considered a last resort. They also miss the psychological and behavioural dynamics behind these moves. Therefore, the majority of divestitures are reactive at best, tardy at worst, and thus, value-destroyers. Of course, it may be helpful to create a position within a firm based on the identification and execution of divestment opportunities.

However, not all firms value quick divestment from businesses that underperform or no longer fit into the portfolio. That is unfortunate. Instead, divestment should be a pre-condition of investment and acquisitions. Divestment allows a dynamic re-allocation of resources – and it should be a voluntary, planned and deliberate procedure aimed at creating or enhancing the competitive advantage of the divesting company. The figure below depicts the main phases of the divestment process.

Awareness and evaluation gaps in divestiture decisions

The first step in the divestment process is to understand whether there are divestment opportunities to evaluate. There are many reasons why firms have difficulties in questioning the right of a business unit to remain in a firm’s portfolio. The awareness gap is mainly created by informational barriers, such as ineffective reporting systems, the use of short-term indicators without scenario analysis, or low attention to early warning signals that can inform about trends and changes in the market. There are several tools and approaches to support management teams as they attempt to overcome the awareness gap: dedicated divestiture teams, formal portfolio reviews and clear resource allocation rules.

Bridging the awareness gap is a necessary step towards the implementation of a divestiture, but it is not enough. Although managers may be aware of the presence of a problem, they may decide to wait or to hold on instead of phasing out the business. This evaluation gap has roots in managers’ escalation of commitment – or sunk cost fallacy: i.e., individuals or groups stick with a previous decision, investment or investment even though increasingly negative outcomes result from that behaviour. The boundary between awareness and the evaluation gap is often blurred, since an ingrained resistant to divestiture is likely to lead managers to ignore negative signals or minimize the magnitude or urgency of the problem. Even in presence of effective reporting systems, top management might engage in what is defined a “deaf effect”. In other words, they might - consciously or unconsciously - discount information in order to avoid ending up in uncomfortable situations.

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