A recent HBR article from January 2008 Harvard Business Review has a provocative piece by innovation guru Clay Christensen and a couple of colleagues called "Innovation Killers: How financial tools destroy your capacity to do new things." I have the greatest of respect for Clay Christenson who does hit the nail on the head every time with his analysis of business. His critique of the limitations of DCF analysis is applicable to private equity deals, hence my interest.
Since my MBA and time at Deloitte, I have always been skeptical toward financial analysis and the reverence to which it is held.
While DCF analysis has its place, its limitations should be recognized. One problem is that fact that most DCF models are built on status quo assumptions (or growth projections) that don't account for the strategic and competitive curve balls. I would add that there is also the issue of garbage-in, garbage-out: the less you know about what's likely to happen (as is the case with new lines of business), the less reliable the output of your DCF model becomes.
I see the problem to be that instead of acknowledging this limitation, many finance geeks embrace the modeled output as Holy Writ. Besides being a false data crutch, it squeezes out consideration of other "softer" factors (like my favourite - non-quantifiable synergies)that are every bit as worthy of consideration. Pick up my book, Money Magnet, which deals with all of this in far greater detail.
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