MBA 564 - 01 - 2004:
Chapter OneBusiness Turnaround Situations: Concepts, Definitions
and IllustrationsOzzie Mascarenhas S. J.; Ph.D.At some time or
other in their organizational life, most corporations experience
downturns in performance. Most corporations fight the downturn and
get on high-growth tracks. We call this process, a business
transformation. Some corporations, however, remain stagnant and are
caught in a vicious status quo, while a significant few fail in the
competitive combat and start declining and distressing; they soon
degenerate into a cash crisis mode, eventually becoming insolvent,
file for bankruptcy, and some die. The process of reviving these
corporations and making them viable again is traditionally called a
business turnaround. In this introductory chapter, we will examine
several events that lead to corporate failure, and therefore, that
precede typical business turnarounds. Sequentially, these events
may occur as follows:
Organizational underperformance
Organizational decline
Organizational downturn
Organizational crisis
Organizational sickness
Organizational distress
Organizational failure
Organizational insolvency
Organizational bankruptcy
Organizational death We will define and illustrate these
sequenced concepts and events. These are not mutually exclusive and
collectively exhaustive (MECE) concepts or stages, but are
interconnected and overlapping, dynamic and turbulent,
unpredictable and uncontrollable events. They are often
consequences of organizational, industrial, national or
international turmoil or domestic market failures. Global
competition, technological intensity, forced product obsolescence,
fast changing customer loyalties and lifestyles, offshore
outsourcing, wage (cum expensive benefits) inflation, and
relatively flat demand are some of the forces that cause
organizations to decline. Each stage, however, calls for some form
of business turnaround that would lead to the survival, revival,
rescue, restructure and eventually, the transformation of a failing
business.
The Relevance of Business Turnarounds Business turnarounds are
of increasing relevance today. Corporate losses have been enormous
and steadily increasing. In 1998, 120 public companies went
bankrupt with a loss of $28.94 billion in assets.
In 1999, 145 public companies (20.83 percent over 1998) sought
Chapter 11 protection with a total loss of $58.76 billion (103
percent over 1998) in assets.
In 2000, 176 public companies (21.38 percent over 1999) declared
bankruptcy with a total loss of $94.79 billions (61.3 percent over
1999) in assets.
In 2001, that number rose by 46.02 percent to 257 public
companies with a total loss of $258 billions assets (172 percent
over 2000).
Several of these companies were among the Fortune 500
enterprises for which failure had been a rarity (Hartman 2004: 5).
Once considered a rare event, corporate restructuring has become an
important part of everyday business practice. Every business day
brings new announcements of corporate bankruptcy reorganizations,
equity spin-offs and carve-outs, tracking stock issues,
divestitures, buyouts, mergers, acquisitions, downsizing,
outsourcing and other corporate cost-cutting programs.
Restructuring has now become a commonplace strategy to improve
financial performance, exploit new strategic opportunities, and
gain credibility with the capital market. When the competitive
stakes are high, restructuring can make the difference in whether a
company survives or dies (Gilson 2001: vii).
During the past two decades, a record number of companies have
sought corporate restructuring in an effort to cut costs, increase
revenues, improve internal incentives and regain their domestic or
global market advantage. Over the past four decades, year-to-year
volatility in the earnings growth rate of S&P 500 companies has
increased by nearly 50 percent, despite vigorous efforts to manage
earnings. Performance slumps are proliferating. Some thirty years
ago, specifically during 1973-77, an average of 37 Fortune 500
companies experienced a 50 percent five-year decline in net income.
During 1993-1997, that number doubled to more than 84 percent each
year, right in the middle of the longest economic boom in modern
times (Hamel and Vlikangas 2003).
With the globalization of communications and the digitization of
countless products and services, global out-sourcing has become a
cost-reduction opportunity and a turnaround strategy to corporate
executives but a nightmare to the unemployed and underemployed of
the developed world. Large pools of capital now flow easily through
the worlds financial markets, seeking the highest return. Radical
innovations and revolutionary advances in technology have
dramatically reduced the costs of producing goods and services. In
this highly competitive world, however, corporate executives find
themselves under ever-increasing pressure to deliver superior
performance and value for their shareholders (Prahalad and
Ramaswamy 2000).
Basic Problems that Precede Business Turnarounds
As stated in the Prologue of this Book, in general, a failing
business poses two main operational problems:
1. How to resolve the day-to-day operational problems of cash
flow management and
2. How to restructure the debt and equity of the business until
the corporation is back on its feet again.
Turnaround is the term that is used to refer to the process of
solving both these operational problems in a business decline.
Turnaround-rescue strategies deal with the first problem that
primarily relates to cash flow management, and turnaround
debt-equity-restructuring strategies deal with the second problem.
Typically, business turnarounds deal with both rescue and
restructuring strategies in relation to failing corporations. Under
both strategies, turnaround management means improving the position
of a given business as a low-cost provider of increasingly
differentiated products and services in a highly competitive world
(Zimmerman 1991:111). Restructuring is the term used to describe
the process of developing a financial structure that will provide a
basis for a turnaround (Gilson 2001).
Some corporations in financial difficulty are able to solve
their operational and debt-equity problems by issuing stock,
especially if the company is over-leveraged by debt. Other failing
firms are able to regain profitability by improving cost margins
through the reduction of manufacturing costs and the elimination of
unprofitable products and services. Other firms even do better:
they generate more revenues and income by increasing sales, market
share, and expanding markets. That is, they can turnaround failing
companies by themselves - with internal skills for turnaround and
restructuring or transformation. When by themselves they cannot
execute a timely internal turnaround, the failing companies bring
in either turnaround experts or courts, or both, depending upon the
severity of the corporate sickness or disease. [See Turnaround
Executive Exercise 1.1].Lack of Management Theory on Business
TurnaroundsIn strategic management, an impressive body of
literature on turnaround management has accumulated over the last
three decades (1975-2005). The topic, however, remains largely
idiosyncratic, descriptive, anecdotal, open-ended and
non-cumulative with hardly any conceptual and theoretical
developments (Pearce and Robbins 1993). This is primarily because
every turnaround deals with reversing a specific organizational
underperformance and, hence, has a unique content and context.
Moreover, because it deals with the survival of organizations, a
business turnaround is viewed as a performance issue (and not a
conceptual or theoretical one) in strategic management (Chowdhurry
2002). Every turnaround involves a process - how firms move away
from crippling deterioration in performance to enduring success or
eventual death. A deep appreciation of the process of turnarounds
is essential for developing a theory of turnarounds.
Even though most organizations, at some time or other in their
corporate life, experience downturns in performance, yet
organizational decline and turnaround are only recently emerging as
subjects of systematic research (Ford 1985; also see References at
the end of this chapter). Since Whettens (1980a) call for increased
research on organizational decline, theoretical and empirical work
on this important phenomenon has grown rapidly.
Analyzing corporate failure has been a major activity in
management literature. The first stream of analyses was primarily
restricted to large public-sector firms (reviewed by Whetten 1980b,
1987 and inventoried by Zammuto 1983). Analysis of large or small
private sector firms, however, has been steadily increasing. We
will be discussing the findings of these studies in this and the
next chapter. First, we like to situate business turnarounds in the
context of the product life cycle and the corporate business cycle.
[See Turnaround Executive Exercise 1.2].The Product Life Cycle and
the Corporate Business Cycle
In the tough and rough competitive world of today, almost all
dynamic, innovative and well-planned businesses takeoff and head
toward prosperity, while stagnant, non-innovative and poorly
planned businesses downturn and head toward insolvency. Figure 1.1
captures this phenomenon. In Figure1.1, when the Y-axis represents
the sales of a given product and X-axis represents time in fixed
interval periods, it is the traditional product life cycle. On the
same X-axis, when the Y-axis depicts profits (losses) corresponding
to sales revenues, it is the traditional corporate business
cycle.
Figure 1.1: Product and Business Cycles of Prosperity and
Insolvency
New Product Development
StagesIntro-ductionMaturityPene-trationMarket
SaturationDeclinePhase out
Producer Cycle or Market
StructureMonopolyDuopolyOligopolyPolypoly or
competitionOligopolyDuopoly or monopoly
Customer CycleInnovatorsEarly adoptersLate
AdoptersLaggardsTrailersStatus Quo Inactive customers
Pricing
CyclePremiumPenetrationSkimmingFire-fightingDiscountsClearance
pricing
Promotion CycleSelective advertisingMass advertisingMassive
advertisingReduced advertisingLean advertisingClearance-house
advertising
Placing CycleHigh UpscaleUpscaleMidscaleDiscount storesDeep
discountClearance Houses
Product CycleBrand new personalized productProduct bundlingPrice
bundlingProduct-price bundlingStandar-dizingCommoditizing
Profit CycleVery HighHighMediumNegligibleLosingHeavy losses
Inventory CycleLowModerateHighHighestModerateClearance House
Consumer Credit CycleNone: Pay Cash fullLimited: Pay more;
Credit lessModerate:Pay half; Credit halfGenerous:Carry now; pay
laterModerate:Pay less; credit moreLimited:Clearance credit
Receivables CycleVery lowMinimumMediumVery highHighHigh
Payables CycleVery HighHighMediumLowLowestVery low
Business Cycle StagesA Successful BusinessA Failing Business
Start-up phaseAA': Start-up costs
AB : Early lucky but planned beginnings
A'B': Pre-breakeven period: no profits yetAA': Start-up
costs
AB: Early lucky serendipity-based beginnings
A'B': Longer pre-breakeven period
Early take-offs: first inflection point: BBC: Early progress
when forging into new and high-risk markets
B'C': Early harvest of increasing profitsBC: Early progress and
forging into new and risky marketsB'C': Early harvest of profits if
any
Competition BCD: Strategizing against increasing competition:
Planning attackC'D': Profits are flat but certain.BCD: Firefighting
tough and increasing competition: StagnancyC'D': Profits are slim
and uncertain.
Turning pointD: Transformation: market and/or technological
breakthrough or radical innovationDE*: Sales start increasing.D:
Underperformance: no market or technological breakthroughsDE: Sales
continue to decrease.
Turnaround ManagementDE*F*: Transformation management
salesD'E**F**: Transformation management profitsDEF : Unsuccessful
turnaround management salesD'E'F' : Unsuccessful turnaround
profits/losses
FH : Delayed turnaround management
F'H': Delayed turnaround management profits
DestinyE*F*: Prosperity, expansion, growth.
E**F**: Transformation prosperity profitsG: Insolvency,
bankruptcy
G': Insolvency losses
Product life cycleABCDE*F*ABCDEFG
Business life cycleA'B'C'D'E**F**A'B'C'D'E'F'G'
Business performance is usually measured by sales revenue in
weeks, months, quarters or years. A business cycle has a starting
point (A' in Figure 1.1) when investments are made, start-up costs
(AA' in Figure 1.1) are undertaken, and when the new product
designing and development process starts. When the product is
nationally launched (after due design testing, ad testing and test
marketing), a start-up sale-revenues phase (AB) of planned or
unplanned beginnings commences, and profits start streaming in
proportionately. AB is the early take-off phase of forging into new
or risk-prone markets. During the sales-phase AB, assuming the
product is just what the target market wants and can afford,
product sales will increase increasingly and so do corresponding
profits. Until a point is reached (point B in Figure 1.1) when
competition catches up with the new brand or product and enters the
market with competing brands, thus, eroding your sales revenues,
market share and brand profits. This is the stage of the first
inflection point (B in Figure 1.1), where revenues shift from an
increasingly increasing status to a decreasingly increasing status.
Theoretically, any point beyond (or right of) B in Figure 1.1 is a
turnaround situation. That is, corporate executives need not delay
turning around a firm until sales are flat (phase CD) or declining
(phases DE, EF and FG) when it may be too late to bring about
positive change. The best time to plan and execute turnaround
strategies is when sales begin to increase decreasingly (i.e.,
after the inflection point B).
During the stage BC, when sales revenues continue to increase,
but increase decreasingly, your competition has presumably
penetrated the market and is steadily eroding your brand, product
or market advantage, and thus, becoming a serious threat. At this
stage, either you strategize your fight against competition, ignore
it (Kim and Mauborgne 2005), or succumb to it. The resulting next
phase is both a successful combat and market breakthrough for a
successful company venture (DE*F*) or a phase of continued
underperformance and lack of innovativeness (DEFG) resulting in a
failing company. The successful company hits a second inflection
point (F*) where technological and market breakthroughs coupled
with radical innovations empower the corporation to harvest
increasingly increasing sales revenues (E*F*), market share and
profits (E**F**).
At point A, the product is launched and, given a production
start-up phase (AA), normally, a sales revenue path (AB) of
increasingly increasing revenues results up to the inflection point
B. Usually, by this time most of the start-up or sunk costs (AA')
incurred during the new product development phase are met and a
breakeven point (B) in profits is reached. In addition, by this
time one should expect one or more competitors to enter the market
(duopoly, oligopoly) who will try to penetrate the market of the
first mover, forcing the latters sales to decrease or increase
decreasingly (phase BC). During BC, profits may continue to
increase increasingly (BC) depending upon the first movers
sustainable competitive advantage. During the phase CD, sales are
flat as tough competition sets in from multiple entrants, while
profits may still increase but decreasingly reaping spillover
effects of the prime movers initial competitive advantage.
Point D is the turning point. The company either forges into
hitherto unexplored or new risk-prone markets (market
breakthroughs) or looks for major technological improvement of the
original product (technological breakthrough) or just takes-off by
venturing into radical innovations relative to the original product
(Chandy and Tellis 1998; 2000). During this phase, the company also
may negotiate major acquisitions, mergers, joint ventures or
strategic alliances that significantly affect performance (Homburg
and Bucerius 2005; Prabhu, Chandy and Ellis 2005). This is the
phase of transformation management represented as DE*F* in Figure
1.1, with a corresponding profit path D'E**F**.
Lack of planning, dynamism, energy and innovation at the turning
point D may precipitate both sales (DE) and profits (D'E')
downwards unless delayed turnaround management causes a reversal of
both sales (FH) and profits (F'H'). Delayed turnarounds that
takeoff after some periods of sales decline are possible
(represented by the sales curve FH and the dotted profits curve
F'H' in Figure 1.1), but they are more difficult to manage and with
limited results (Slatter and Lovett 1999). [See Turnaround
Executive Exercise 1.3].
The business performance cycle is composed of at least three
sets of variables with several quantitative measures of performance
pertaining to each variable:
Marketing performance: [e.g., sales revenues, changes in sales
revenues, change of change in sales, market share, relative market
share, and return on sales (ROS) and returns on promotions
(ROP)].
Marketing-finance performance: [e.g., returns on quality (ROQ),
returns on salespersons, returns on retail outlets, economic valued
added (EVA), cash value added (CVA), and in general, return on
marketing (ROM)]. Financial performance: [e.g., gross margins,
operating margins, net earnings, return on investment (ROI),
returns on assets (ROA) and its subset measures, return on net
assets (RONA), return on business assets (ROBA), return on invested
capital (ROIC), and return on capital employed (ROCE), return on
equity (ROE), earnings per share (EPS), price earnings (P/E) ratio,
market valuation (MVA), and Tobins Q].
Proven return on investments (ROI) is now a main concern for
companies because such investments take funding priority over those
made on faith (Lehman 2002; Narayanan, Desiraju and Chintagunta
2004). Returns on quality (ROQ) explicitly project financial
returns from prospective product or service improvements (Rust,
Zahorik and Keiningham 1995; Rust, Moorman and Dickson 2002). EVA
and CVA are measures of economic profit that are influenced both by
marketing and finance variables. ROM chooses the marketing strategy
options based on the basis of projected financial returns,
operationalized as the change in the firms customer equity related
to the incremental marketing expenditure necessary to produce that
change (Rust, Lemon and Zeithaml 2003). Similarly, companies devote
considerable time and money to managing their sales force while
very few focus on how the sales force needs to change over the life
cycle of the a product or business. Shifts in the sales force
structure (e.g., their roles, their size, their degree of
specialization, their product-customer portfolio in terms of time
and effort) are essential if a company must keep winning the race
for its customers (Zoltners, Sinha and Lorimer 2006: 82).The value
of a company is the net present value of its future cash flows
(Sudarsanam 2003). Managers concerned about delivering value to
shareholders have been focusing for a long time on earnings per
share (EPS). However, currently, overwhelming evidence makes it
clear that what the market really pays attention to are long-term
cash flows; nave attention to EPS will lead to value-destruction
and hostile takeover attacks (Copeland, Koller and Murrin 1996;
Dobbs and Koller 1998). [See Turnaround Executive Exercise
1.4].
A business cycle, however, is not merely the flow of sales and
profits. We also need to know what happens within the company. For
instance, we need to examine how cash is generated, how it is
spent, what is the cash flow, what are the cash inflow and outflow
variables or activities. We need to know what happens within the
organization that can stimulate or depress sales: e.g., innovation
and production performance, cash flow and profit performance. These
are not merely finance questions but, as we shall see, are
marketing-finance interface questions that we must address (see
Chapters 3 & 6). Given that sales performance is easily
measured from time to time, Figure 1.1 based on sales performance
provides a rough idea of regular business cycles. The model assumes
that most businesses start well, continue to do well as long as
there is dynamism, energy, innovation and good planning to support
them. The firms that fail to provide such supports begin to
under-perform, decline, become insolvent and die. In this sense,
most corporate business death cycles are management failures
(Blayney 2002; Kaplan and Norton 1996). Planning and monitoring
dynamism, energy, innovation and good business planning are
important turnaround tasks that one should start much before
distress or insolvency sets in. In fact, one should galvanize these
corporate tasks at least as soon as symptoms of significant
corporate underperformance appear in the day-to-day functions of
the organization. Organizational Underperformance
We focus now on organizational underperformance, its content,
process and symptoms. Presumably, corporate underperformance is an
antecedent to corporate decline, downturn, distress, crisis,
insolvency, bankruptcy and death. Hence, we need first to
understand corporate underperformance in all its relevant
dimensions, situations, antecedents, concomitants, determinants,
causes and effects.
We can best situate and examine the question of organizational
underperformance against what is more obvious and studied -
organizational high performance. We can derive the definition,
process and measures of underperformance from high performance as a
contrasting phenomenon.
What is Organizational High Performance?
What is a high-performance company? Why did Sam Waltons small
chain of dime stores of 1964 become the greatest retailer in the
world, Wal-Mart, by 2000 and continues to do so in 2008?
Conversely, why did K-Mart, the greatest discount store in 1992 go
bankrupt in 2000? Why was Thomas J. Watson, Sr. able to take the
small Computing Tabulating Recording Company (CTRC) to the giant
International Business Machines (IBM) Corporation it became? How
did a band of renegade entrepreneurs in a bombed-out building in
Tokyo in 1945 rise to become the Sony Corporation? These were high
achievers marked with organizational super performance (Collins and
Porras 1994; Collins 2001).
We do not know everything about organizational high performance.
For one thing, we do not have the benefit of an agreed-upon high
performance scorecard whereby we can decide who stands tallest
among competing businesses (Kirby 2005: 30). Much would depend upon
which benchmark or yardstick we choose to measure high performance.
For the most part, however, there is agreement that success shows
up in cash and that cash comes to businesses in various forms
(Kirby 2005:36). Nevertheless, there is disagreement on other
criteria of success. For instance, are the winners with the highest
market capitalization the ones with the greatest sales growth, with
the highest profits, or with the highest Tobins Q? Are you better
if you boomed in bust years or if you really boomed in boom years?
Different authors come up with different high-performance formulae
and determinant causes.
For example, the best business practices such as the principles
of scientific management, statistical quality control (SQC), total
quality management (TQM), six-sigma, management by objectives
(MBO), reengineering, retrobranding, decentralization, customer
relationship management (CRM), supply chain management (SCM),
retail partners relationship management (PRM), employee
relationship management (ERM) and strategic planning tend to spread
across all major companies. Yet, why do some companies become truly
great and others do not? In other words, how to identify the
principles that separate iconic institutions, those that weave
themselves successfully and permanently into the very fabric of our
society and change our world, from the mass of mediocre enterprises
(Collins and Porras 1994)? How among companies born in the same
era, with the same market opportunities, facing the same
demographic and technology shifts and socioeconomic trends, some
corporations (e.g., Dell, GE, IBM, Johnson & Johnson, and
Microsoft) succeed and rise to phenomenal greatness while others
(e.g., corresponding and contemporary competitors such as, Gateway,
Westinghouse, Burroughs, Bristol-Myers and Netscape) last but did
not become industrial icons?Apparently, the question did not occur
to anybody until then in the history of business (Kirby 2005). As
management consultants strategically positioned at the intersection
of academic scholarship and business practice, Peters and Waterman
(1982) asked the same question differently: what separates winners
from losers? Their original sample of 62 great companies was drawn
from an analysis of McKinseys Reports to which they applied six
different financial metrics or quantitative criteria and pared it
down to forty-three. The winners consistently beat competitors over
a 20-year period on six financial yardsticks: compound asset
growth, compound equity growth, ratio of market value to book
value, return on capital, return on equity (ROE), and return on
sales (ROS). Peters and Waterman (1982) attributed winning
performance to the companys bias for action, staying close to the
customer, fostering autonomy and entrepreneurship within the
company, gaining productivity through people, hands-on and
value-driven management, and lean enterprise management. At a later
stage in the research, Peters and Waterman (1982) added other
non-financial criteria such as managerial attitudes, courage,
risk-proneness, and ethics, believing there is more to a great
company than money. For instance, GE made the first the list of
sixty-two but did not make the cut at forty-three. The final sample
investigated 43 companies such as 3M, Atari, Boeing, Data General,
DEC, Delta Airlines, HP, IBM, Lanier, McDonalds, NCR, United
Technologies, and Wang. Collins and Porras (1994) in their Built to
Last looked for companies that had risen to iconic stature and held
it for five, ten or fifteen decades. Accordingly, the companies
they selected for their study included American Express, Boeing,
Citicorp, Ford, GE, HP, IBM, Johnson & Johnson, Marriott,
Merck, Motorola, Nordstrom, Philip Morris, P&G, Sony, 3M,
Wal-Mart, and Walt Disney. Collins and Porras (1994) challenged
managers by claiming that various managerial actions and attitudes
account for the difference between winners and losers in business.
For instance, these great corporations became clock builders and
not time tellers, they chose ventures A and B, and not A or B, and
they preserved the core business and values while stimulating
progress and seeking consistent alignment. Great executives of the
world aspired to create something bigger and more lasting than what
they were. They found and sustained an ongoing institution rooted
in a set of timeless core values. Their organizations espoused a
purpose beyond just growing large and making money. They stood the
test of time by virtue of their ability continually to renew
themselves from within (Collins and Porras 1994: xviii).As a sequel
to this study, Jim Collins (2001) wrote Good to Great. This time,
he drew his winners circle using a qualifying metric: cumulative
investor returns relative to the general stock market. The
fundamental thesis in both books was - great and built to last
companies stood by timeless core values and enduring purpose while
dramatically adapting to a changing world. This is the trademark of
organizational high performance.
Katzenbach (2000) studied 25 enterprises, including Avon
Products, BMC Software, Hambrecht and Quist, Hills Pet Nutrition,
Home Depot, KFC, Marriott International, NASA, Southwest Airlines,
and the U.S. Marine Corps. The author based the choice on proven
financial and market superiority over several years, and found that
these companies consistently pursued one or more of five distinct
paths: mission, values and pride; process and metrics;
entrepreneurial spirit; individual achievement, and recognition and
celebration.
Foster and Kaplan (2001) investigated Corning, Enron, General
Electric, Johnson & Johnson, Kleiner Perkins, Caufield &
Byers, Kohlberg Kravis Roberts, and LOral. These companies did the
virtually impossible - sustained market-beating performance for
more than 15 years. These companies radically transformed their
operations by creating new businesses, selling or closing
slow-growth businesses or divisions, abandoning outdated structures
and rules, and adopting new decision-making processes, control
systems, and mental models.
Zook and Allen (2001) identified high performance companies such
as Anheuser-Busch, Biogen, Coca-Cola, Dell, EMC, Hilti
International, Intel, Microsoft, and Nokia, among others, because
of their sustained growth in both revenues and profits over
extended periods, while generating total shareholder returns in
excess of the cost of capital. The authors argued that these
companies built unique strength in a core business and mined that
core for its full growth potential by expanding into logical
directions.
Recently, Joyce, Nohria and Roberson (2003) studied 160
companies across 40 different industries, including Dollar General,
Flowers Industries, Home Depot, Nucor, Schering-Plough, Target, and
Wal-Mart. They based their choice on total shareholder returns over
a ten-year period, as this criterion separated the winners that
outperformed rivals, losers that underperformed, climbers that
improved over time, and tumblers that deteriorated over time. They
used a 4+2 formula, involving simultaneous superior performance in
four primary areas (strategy, execution, culture, and structure)
and in any two of four secondary areas (talent, leadership,
innovation, and mergers and partnerships).
Based on these seminal studies of organizational high
performance, we may now draw a profile, by contrast, of
organizational underperformance. Table 1.1 profiles corporate high
performance traits against corresponding underperformance symptoms.
In general, organizational underperformance occurs for the opposite
reasons: No clear definition of vision and mission
No timeless core values No enduring purpose Compromising
standards for the sake of expediency No well-planned long-term
strategies
Mostly ruled by tactics to make quick money Short-term gains at
the expense of long-term losses
Expansion into non-core business areas Over-diffusion of
expertise and talent No great innovations or market breakthroughs
Do not have a strong social mission or identityThese companies do
not positively impact the world around them. According to Collins
and Porras (1994), visionary companies do not ask, how should we
change? Rather they ask, who are we? What do we stand for and why
do we exist? Where are we going? Collins and Porras (1994) offer
the answer: preserve the core but stimulate progress. What the
organization is and what it stands for are timeless core values and
enduring purpose that should never change. Whereas, operating
practices and business strategies should change constantly in
response to a fast changing world. [See Turnaround Executive
Exercise 1.5]. It was Hewlett-Packards enduring character that
guided the company through decades of changing technologies and
evolving markets. Johnson & Johnson used this concept to
challenge its entire organization structure and revamp its
processes while preserving the core ideals it enshrined in its
Credo. The Minnesota-based 3M Company divested substantial chunks
of its fixed assets that offered little opportunity for innovation
and focused on its enduring purpose of solving unsolved problems
innovatively.
Enlightened business leaders around the globe intuitively
understand the importance of timeless core values and enduring
purpose beyond just minting money. They exhibit relentless drive
for progress, but along core values they stand for. These
executives did not invent new core values and purpose, they
discovered a core they had already had and built in common. Often
such core values might be obscured by misalignments and lack of
dialogue. Best executives were willing to forego business
opportunities that would force them to compromise or abandon their
core values and principles. They never compromised values and
standards for the sake of expediency. They were driven by a sense
of social vision and mission while adapting to the dramatic changes
and increasing competitiveness of the world around them.
Visionary companies are organizations, legendry institutions,
not just visionary and charismatic leaders or visionary products
and services. Visionary leaders die and innovative products
obsolesce, but the visionary and missionary institutions they leave
behind last. Successful visionary companies prosper over long
periods, through multiple product and business lifecycles and
multiple generations of active leaders (Collins and Porras 1994:
1-2). Table 1.2 summarizes this discussion by recapturing what
separates winners from losers. [See Turnaround Executive Exercise
1.6].
Table 1.1: Contrasting Organizational High Performance with
Underperformance Measures
[See also Kirby (2005)]AuthorsStudy SamplesChoice CriteriaProven
High Performance MeasuresPredicted Underperformance Measures
Peters and Waterman (1982)3M, Atari, Boeing, Data General, DEC,
Delta Airlines, HP, IBM, Lanier, McDonalds, NCR, United
Technologies, and WangConsistent beating of competitors over a
20-year period on compound asset growth, compound equity growth,
ratio of market value to book value, return on capital, ROE and
ROS. Bias for action, staying close to the customer, fostering
autonomy and entrepreneurship, gaining productivity through people,
hands-on and value-driven management, and lean management
Bias for inaction or status quo
Distancing from the customer
Tight hierarchy and bureaucracy
Lack of entrepreneurship
Gaining productivity independent of people
Lack of value-driven management
Collins and Porras (1994)3M, American Express, Boeing, Citicorp,
Ford, GE, HP, IBM, J & J, Marriott, Merck, Motorola, Nordstrom,
Philip Morris, P&G, Sony, Wal-Mart, Walt DisneyIconic stature
and stellar performance for five to 15 decadesClock builders and
not time tellers; choosing A and B and not A or B; preserving the
core and stimulating progress, and seeking consistent alignment
Overdependence on time and seasons; excluding alternatives;not
preserving the core business;undue expansion into non-core
territories; non-consistent alignment with the environment
Katzenbach (2000)Avon Products, BMC Software, Hambrecht and
Quist, Hills Pet Nutrition, Home Depot, KFC, Marriott
International, NASA, Southwest Airlines, U.S. Marine CorpsProven
financial and market superiority over several years.Consistently
pursued one or more of five distinct paths:
a) mission, values and pride; b) process and metrics;
c) entrepreneurial spirit;
d) individual achievement, & e) recognition &
celebration
Lack of focus on mission and value; no rigorous process and
metrics; low entrepreneurial spirit; low individual achievement;
low recognition and celebration
Foster and Kaplan (2001)Corning, Enron, General Electric,
Johnson & Johnson, Kleiner Perkins, Caufield & Byers,
Kohlberg Kravis Roberts, and LOralSustained market-beating
performance for more than 15 yearsRadically transformed their
operations by creating new businesses, selling or closing
slow-growth businesses or divisions, abandoning outdated structures
and rules, and adopting new decision-making processes, control
systems, and mental modelsNo creation of new
businesses;perpetuating slow-growth businesses and
divisions;adhering to outdated structures and rules; old
decision-making processes and mental models,and no control
systems
Zook and Allen (2001)Anheuser-Busch, Biogen, Coca-Cola, Dell,
EMC, Hilti International, Intel, Microsoft, and Nokia among
othersSustained long-term growth in revenues and profits while
generating total shareholder returns Built unique strength in a
core business and mined that core for its full growth potential by
expanding into logical directions. No seeking strength in the core
business; poor mining of the core business to achieve full growth
potential; expanding into non-core businesses
Joyce, Nohria and Roberson (2003)160 companies across 40
different industries, including Dollar General, Flowers Industries,
Home Depot, Nucor, Schering-Plough, Target, and Wal-Mart.Total
shareholder returns over a ten-year period. The 4+2 formula,
involving simultaneous superior perfor-mance in 4 primary areas
(strategy, execution, culture, & structure) and in any 2 of 4
areas (talent, leadership, inno-vation, mergers/ partnerships).
Poor strategy; poor execution;Low corporate culture;Lack of
effective structure;Low talent and leadership;Low
innovativeness;Ineffective mergers and acquisitions.
Hidden Traps of Decision Making and Underperformance Making
decisions is the most important job of an executive, but it is also
the toughest and the riskiest. Bad decisions can damage a business
and a career, sometimes irreparably. Bad decisions come from many
sources: the problem was ill defined, the controllable and
uncontrollable variables were not fully identified, the relations
between uncontrollable and controllable variables not fully
specified, the alternatives to problem-resolutions were not clearly
defined, the right information was not collected, or the costs and
benefits of each alternative solution were not accurately weighed.
The fault of bad decisions, however, may not always lie in the
decision-making process, but rather in the mind of the decision
maker. This is because we use unconscious routines or heuristics to
cope with the complexity inherent in most decisions. Some of these
heuristics are hidden psychological traps that are hardwired into
our thinking process. They can undermine everything from new
product development to acquisition and divestiture strategy to
succession planning.According to Hammond, Keeney and Raiffa (2006),
underperforming firms find themselves in various hidden traps of
decision-making such as: The Anchoring Trap: When considering a
decision, the mind gives disproportionate weight to the first
information it receives. That is, initial impressions, estimates,
or data anchor subsequent thoughts and judgments. Anchors are often
guises or stereotypes we draw from a persons color, looks, accent,
nationality, age or even dress. In business, past sales and
forecasts become our anchor when predicting the future. In
negotiations, the initial proposal by one party with all its terms
and conditions can anchor counter bargaining and paralyze creative
counter-proposals. Underperformers can fight the anchoring trap by:
Reviewing a problem from different perspectives, alternative
starting points and approaches rather than stuck by the first line
of thought that occurs to you; Thinking about the problem on your
own before consulting others lest you should be anchored by their
biases; and
Being open-minded, transparent, and seeking information and
opinions from a variety of people to widen your frame of reference
and suggest fresh directions. The Status Quo Trap: Decision makers
display a strong bias toward alternatives that perpetuate the
status quo. The source of the status-quo trap lies deep within our
psyches, in our unconscious desire to protect our egos from damage.
Status quo puts us on less psychological risk. The first
automobiles called horseless carriages looked very much like the
buggies they replaced. The first electronic newspapers on the World
Wide Web looked very much like their print precursors. People who
inherit stocks rarely sell them to make new investments. In
general, the more choices you have, the more the influence of the
status quo. This is because additional alternatives imply
additional processing efforts and risk, and we instinctually tend
to the status quo. In organizations where sins of commission get
punished more severely than sins of omission, status quo holds much
sway. Most mergers flounder because both firms seek individual
status quo. Turnaround managers can combat status quo by: Changing
the status quo especially if it fails to achieve your current goals
and objectives; Identifying other alternatives as counterbalances
with all their positives and negatives; Avoid exaggerating the
effort or cost of switching from the status quo, and By daring to
rock the boat if need be.
Table 1.2: What Characterizes Winner from Loser
CorporationsDimensionLoser Corporations
(Sustained marginal or decreasing performance= industrial
mediocrities)Winner Corporations
(Sustained super-performance = industrial icons)
ExamplesK-Mart, Westinghouse, Burroughs, Bristol-Myers,
Motorola, Gateway, .Wal-Mart, GE, IBM, Johnson & Johnson, Sony,
Dell, .
Economic
SituationSame era, same market opportunities, same demographic
shifts, technological shifts, socioeconomic trendsSame era, same
market opportunities, same demographic shifts, technological
shifts, socioeconomic trends
Primary questsHow to increase sales revenues, market share and
profitability? How to exploit market opportunities?Who are we? What
do we do or should do? Where are we going? Where should we go? How
to benefit the largest numbers in a great way?
Core Mission and ValuesMake money, profits, and create
wealth.
Fight competition; bar market entry.
Enter and exploit new markets.Create ongoing institutions that
last, benefit humankind, serve human needs and aspirations, foster
human dignity, and diffuse technologies and innovations for global
development. Preserving the core mission and values but stimulating
progress.
Success meansRoutine efficient or expedient business operations,
tactics and strategies such as incremental innovations,
cost-cutting, plant closing, massive layoffs, reckless outsourcing,
hostile takeovers, buy-outs, tax write-offs, market opportunism and
expansions unconnected with core mission, and seeking bankruptcy
protection.Enduring purpose and well planned effective business
operations, tactics and strategies such as revenue generation,
setting standards, market breakthroughs, technological
breakthroughs, radical innovations and new product/service
development. Timeless self-renewing core values such as human
dignity, corporate social responsibility, stakeholder stewardship,
social ecology, environmental protection, executive integrity,
ethics, worker morale, courage and risk-proneness. Optimal SCM,
ERM, PRM and CRM.
StrategiesReactive, inactive, temporary, random, haphazard,
exploitative and opportunisticVision-mission driven, proactive,
interactive, well-planned and organized, consistent and persistent,
dramatically adapting to a changing world of technologies and
lifestyles, and responsive to the needs, wants and aspirations of
the developing countries.
Success CriteriaIncreasing sales, market share, profits, ROS,
ROA, ROE, ROI, ROM, EPS and P/E.Increasing value, quality,
benefits, total customer experience (TCE), market value added
(MVA), net worth (NW), return on quality (ROQ), total and
cumulative ROE, and Tobins Q.
OutcomesLocal market success, and leadership, profitability at
the expense of others win-loss status, often ending in
organizational decline, distress, insolvency and failureLasting
global market success, visionary leadership, humanizing products
and services, creation of global wealth and opportunity
The Sunk Cost Trap: This is another version of the status-quo
trap. Sunk costs represent old investments of time and money that
are currently irrecoverable. While we rationally believe that sunk
costs are irrelevant to the present decision, they, nevertheless,
prey on our minds, leading us to make inappropriate decisions. We
use the sunk-cost bias to defend our previous decisions even though
they currently reveal to be errors or mistakes, and admitting
mistakes is painful. Often, we continue to invest into wrong
choices hoping to be lucky or recover, but thereby, we throw good
money into bad, and drag failing projects endlessly.
Underperformers can resolve the sunk-cost bias by: Seeking out and
listening carefully to the views of the people who were uninvolved
with the earlier bad decisions; Examining why admitting past
mistakes distresses you and encounter the distress (e.g.,
sunk-self-esteem, loosing face); Remembering warren buffets advice:
when you find yourself in a hole, the best thing you can do is to
stop digging, and Reassess past decisions not only by the quality
of the outcomes but also by the decision-making process (i.e.,
taking into account what information and alternatives you had
then). The Confirming-Evidence Trap: This is a more subtle version
of the status-quo trap. This bias leads us to seek out information
that supports our existing instinct or point of view while avoiding
information that contradicts it. This bias affects us not only
where and when we go to collect information but also in
interpreting the evidence. We automatically accept the supporting
information and dismiss the conflicting information. Two
fundamental psychological forces entrap us here: a) our tendency to
subconsciously decide what we want to do before we figure out why
we want to do it; b) we are inclined to be more engaged by things
we like than by things we dislike. Underperformers can circumvent
the confirming-evidence bias by: Examining all the evidence with
equal vigor, and by avoiding to accept confirming evidence without
question;
Building counterarguments yourself or by a devils advocate; that
is, identify the strongest reasons for doing something else;
Being honest with yourself about your motives; look for smarter
choices and stop collecting evidence to perpetuate old choices;
and
Do not surround yourself with yes-people as consultants. If
there are too many that support your point of view, change your
consultants. The Framing Trap: This is a combination of all the
previous traps. The first step in making a decision is to frame
your problem or question. However, framing can also be very
dangerous: the way you frame a problem can profoundly influence the
choices you make. A frame is often closely related to other
psychological traps. For instance, your frame can establish a
status quo or introduce an anchor; it can highlight sunk costs or
lead you toward confirming evidence. Our frames are often affected
by possible gains or losses. People are risk-averse when a problem
is posed in terms of gains, but are risk-prone when a problem is
posed in terms of losses. Losing triggers a conservative response
in many peoples minds. Frames are also affected by different
reference points: for instance, the same problem impacts you
differently whether you have a $2,000 balance in your checking
account versus zero. Underperformers can reduce the framing bias
by: Reframing the problem in various ways (i.e., do not
automatically accept your initial frame or those of others);
Re-position the problem with different trade-offs of gains and
losses or different reference points;
Checking your frame and framing strategy; ask yourself how your
thinking might change if the framing changed; and
When others offer solutions, check and challenge their frame.
The Prudence Trap: Some managers are just overcautious or
over-prudent in their forecasts, estimates, and budgets. Policy
makers often go by worst case scenario analysis and get
overcautious. When faced with high-stake decisions, managers tend
to adjust their estimates and forecasts just to be on the safer
side. For instance, the Big Three Auto Companies have periodically
produced more millions of cars just to be on the safer side,
despite less anticipated sales, higher dealer inventories, and more
aggressive competitive action. Large accumulated stocks cost
billions of dollars to the domestic auto companies. Underperformers
can avoid the prudence trap: Avoid overcautious or overconfident
forecasting traps by considering the extremes, the low and the high
ends of the possible range of values, and challenge your estimates
of the both extremes; Avoid the prudence trap by honestly stating
your estimates to third parties who will be using them unadjusted;
and
Examine your assumptions and impressions of the past, and get
statistics to back them.Most of these traps work in concert with
others, amplifying one another. For instance, a dramatic first
impression might anchor our thinking, which in turn might look for
confirming evidence to justify our initial bias or status quo. As
our sunk costs mount, we become trapped, disabled to find an
effective escape. The psychological miscues cascade, making it
harder and harder to choose wisely, and we continue to
underperform. The best advice against all traps is, forewarned is
forearmed (Hammond, Keeney and Raiffa 2006: 126). Table 1.3
summarizes the discussion on Organizational Underperformance as
related to the various psychological and economic traps discussed
above. [See Turnaround Executive Exercise 1.7].
Avoiding Smart Mistakes and Organizational Underperformance
According to Schoemaker and Gunther (2006), even avoiding
deliberate mistakes can lead to organizational under-performance.
Several great companies have arisen from what perceptive people
once considered as bad mistakes. Examples include:
1. The FedEx distribution system - the bankers rejected the idea
as impractical and risky.2. The Enterprise - the experts considered
it foolish to offer rental cars off airports and city centers. 3.
Giving credit cards to college students (without using adult
co-signers) was a radical idea proposed by Citibank in the 1980s
but violently opposed by the then financial experts.
4. At Procter & Gamble, which operates in a market where
very few product introductions succeed, their operating philosophy
was based on the assumption that all innovations should come from
inside the company. P&G changed it and turned to outside
partners (customers, suppliers, distributors, retailers) for new
product ideas, even though these sources could be highly risky.
Their rapid learning slogan was Fail often, fast, and cheap - it
requires deliberate mistakes.
5. Whole Foods Market had little experience in organic foods and
yet ventured its first small store in Austin, TX, in 1980. Today,
it has more than 180 stores in North America and the UK, with $4.7
billion in fiscal 2000 sales, and most traditional supermarkets are
now expanding their organic food sections. U. S. Congress mandated
Pentagons DARPA (Defense Advanced Research Project Agency) to
target one-third of the U. S. Military ground vehicles to be
autonomous (i.e., unmanned and remote controlled) by 2015. Faced
with this deadline, DARPA did not seek experienced people and
companies in the world to contract for this job, but deliberately
chose in 2004 college students from premier U. S. Universities to
design, run and test an un-manned vehicle race across the 132-mile
California-Nevada desert. The project was successful in the second
year,
6. Table 1.3: Organizational Underperformance as a Function of
Psychological and Economic Traps in Decision Making
[See Hammond, Keeney and Raiffa (2006)]
Trap TypeTrap Type DefinitionTrap Type SymptomsCombating Trap
Type
SymptomsOrganization Examples
Anchoring TrapWhen considering a decision, the mind gives
disproportio-nate weight to the first information it
receives.Initial impressions, estimates, or data anchor subsequent
thoughts and judgments. Review a problem from different
perspectives, alternative starting points and approaches; b) Think
about the problem on your own before consulting others lest you
should be anchored by their biases; c) Be open-minded, transparent,
seeking information and opinions from a variety of people to widen
your frame of reference and fresh directions.Stereotypes we draw
from a customers color, looks, accent, nationality, age or even
dress. Past sales and forecasts become our anchor when predicting
the future.
Status Quo TrapDecision makers display a strong bias toward
alternatives that perpetuate the status quo. Status quo implies
less psychological risk. Our unconscious desire to protect our egos
from damage; the more choices we have, the more the influence of
the status quo. a) Change status quo especially if it fails to
achieve your current goals and objectives; b) identify other
alternatives as counterbalances with all their positives and
negatives; c) avoid exaggerating the effort or cost of switching
from the status quo, and d) dare to rock the boat if need be.
The first automobiles called horseless carriages looked very
much like the buggies they replaced. The first electronic
newspapers on the World Wide Web looked very much like their print
precursors. Most mergers founder because both firms seek individual
status quo.
Sunk-Cost TrapWe are inordinately attached to sunk-costs that
represent old investments of time and money and which are currently
irrecoverable. Admitting past mistakes is painful.While we
rationally believe that sunk costs are irrelevant to the present
decision, they, nevertheless, prey on our minds, leading us to make
inappropriate decisions. a) Listen carefully to the views of the
people who were uninvolved with the earlier bad decisions; b)
examine why admitting past mistakes distresses you and encounter
the distress (e.g., sunk-self-esteem, loosing face); c) remember
Warren Buffets advice: when you find yourself in a hole, the best
thing you can do is to stop digging; and d) reassess past decisions
not only by the quality of the outcomes but also by the
decision-making process.Firms use the sunk-cost bias to defend
previous decisions even though they currently reveal to be errors
or mistakes. Often, we continue to invest into wrong choices hoping
to be lucky to recover; thereby we throw good money into bad, and
drag failing projects endlessly.
Confirming Evidence TrapThis bias leads us to seek out
information that supports our existing instinct or point of view
while avoiding data that contradicts it. This bias affects our
information collection and its interpretation. We accept supporting
information and dismiss conflicting information.a) Examine all the
evidence with equal vigor and avoid confirming evidence without
question; b) build counter-arguments yourself or by a devils
advocate; that is, identify the strongest reasons for doing
something else; c) be honest with yourself about your motives; look
for smarter choices and stop collecting evidence to perpetuate old
choices.
Surrounding yourself with yes-people as consultants; if there
are too many that support your point of view, change your
consultants. Two fundamental psychological forces entrap us: a) we
subconsciously decide what we want to do before we figure out why
we want to do it; b) we are inclined to be more engaged by things
we like than by things we dislike
Framing TrapWe often frame a problem or question. However,
framing can also be very dangerous. The way we frame a problem can
profoundly influence the choices we make. Our frames are affected
by possible gains or losses. a) Reframe the problem in various ways
(i.e., do not automatically accept your initial frame or those of
others); b) re-position the problem with different trade-offs of
gains and losses or different reference points; c) check your
framing strategy; ask yourself how your thinking might change if
the framing changed.
People are risk-averse when a problem is framed in terms of
gains and risk-prone when a problem is posed in terms of losses.
Losing triggers a conservative response in many peoples minds.
with a Volkswagen Touareg modified by a team from Stanford
University (the team was rewarded $2 million). DARPA had set the
stage for rapid success by deliberately encouraging a high failure
rate.
7. When the advertising pioneer David Ogilvy tested his ideas,
he deliberately included ads that he thought would not work in
order to test and improve his decision rules for evaluating
advertising; (most of these ads were dismal failures, but those
that worked pointed to innovative approaches in the fickle world of
advertising).
8. Googles recent IPO prospectus states: We would fund projects
that have a 10% chance of earning a billion dollars, thereby,
alerting investors to expect company actions that may look like
mistakes.
Executives perceive that flawless execution is what makes them
valuable to the organization, and in the process, carefully and
deliberately avoid mistakes. Resistance to making mistakes runs
deep in organizations, as most companies are designed for optimum
performance rather than learning, and mistakes are seen as defects
that need to be minimized. After all, top executives are rewarded
for their successes and not for their depth of learning from
failures. Organizations, however, need to make mistakes in order to
improve, contend Schoemaker and Gunther (2006). They cite four
reasons why humans avoid mistakes: a) We are overconfident: we are
often blind to the limits of our expertise or specialization.
Inexperienced managers make many mistakes but learn fast from them.
b) We are risk-averse: our professional and personal pride is
reinforced in being right. We are very reluctant to submit our
fragile egos to tests that might show we have been wrong all along.
Employees are rewarded for good decisions and penalized for
failures, so they spend enormous time and energy trying to avoid
mistakes. c) We seek confirming evidence: we tend to favor and look
for data that support our beliefs and assumptions, and hence refuse
to look at other alternatives. [See previous section for decision
traps].d) We assume feedback is reliable: we listen to feedback
that confirms our beliefs.
But in general, experimentation, venturing and risk-taking,
navigating unchartered seas, exploring blue oceans (Kim and
Mauborgne 2005) where no competitor has entered, even though all
these alternatives may be fraught with risks, errors and mistakes,
can be high roads to organizational performance. This is especially
true, if our fundamental assumptions whereby we avoid mistakes are
wrong. If a mistake does succeed, then it has undermined at least
one current assumption, and this is what creates opportunities for
profitable learning. Philosophers of science have long advocated
falsification (i.e., disproving a hypothesis and testing new ones)
as a legitimate search and fastest way for truth. That is, making
mistakes can be the quickest way to discover solutions to a
problem. Sometimes, committing error is not the just the fastest
way to the correct answer, its the only way (Schoemaker and Gunther
2006: 113).Companies need carefully to analyze the trade-off
between the costs (e.g., expenses incurred) of a mistake and
potential benefits of learning from that mistake. Schoemaker and
Gunther (2006) encourage executives to make potential smart
mistakes when the following conditions are prevalent:
a) The potential gain from learning greatly outweighs the cost
of the mistake.
b) Decisions are made repeatedly (e.g., routine decisions of
hiring, running ads, assessing credit risks). The idea is that the
benefits will be multiplied over a large number of future
decisions. c) The environment has dramatically changed and cannot
justify the prevailing assumptions. The environment can change the
problem, the context, the assumptions, and the presuppositions. d)
The problem is complex and solutions are numerous. The more complex
the problem and the environment, the more difficult it is to
define, formulate and specify the relations between the
controllable and controllable variables of the problem, and hence,
possibly, seek more alternative solutions. e) Your organizations
experience with the problem is limited. Your unfamiliarity (e.g.,
because of technological obsolescence, new products, new markets,
new regulations, new competition) with the problem should make you
open-minded about it. Making deliberate mistakes at the outset can
expedite learning.From their vast consulting experience, Schoemaker
and Gunther (2006) list ten deeply held (faulty) assumptions that
executives make in best running a business and avoiding
mistakes:
1. Cold calling Fortune 100 prospects does not work.
2. Our clients are primarily based on trust and reputation, with
limited price sensitivity.
3. Young MBAs do not work well for us; we need experienced
consultants on the team.
4. Bundled pricing is better than separate pricing for each of a
projects components.
5. Senior partners must get more pay from their billing bonuses
than from their base salaries.
6. Formal interviews with clients must always be done by two
consultants, with one taking notes.
7. The firm can be successfully run by a president who is not a
senior consultant with significant billings.
8. Executive education and consulting are natural cross-selling
activities.
9. Books and articles are vital to the firms image as
cutting-edge and rigorous.
10. Responding to proposals is not worthwhile, because
organizations that send them out are usually price shopping or just
going through the motions to justify a choice already
made.Organizations should focus on assumptions that lie at the core
of the business in areas such as planning, strategy, organizational
creativity, new product development, R&D funding, operations,
marketing, finance, legal matters, IT, and human resources. [See
Turnaround Executive Exercise 1.8].
Is a mistake that is deliberately undertaken an experiment and
not a mistake? A decision or an act can be viewed as a mistake from
one viewpoint and as an experiment from another. Daniel Kahneman,
the Nobel Laureate in economics, identified two levels of thinking,
known as System 1 and System 2, to which Schoemaker and Gunther
(2006) add system 3 as follows: System 1: Instinctive and
intuitive: thoughts and actions come to mind spontaneously; these
are mostly reflex, internalized or routine actions that we just do
(e.g., driving a car, speaking ones native language, cooking an
ethnic meal, running a mom and pop business). This stage could be
emotional and loaded with feelings.
System 2: Linear, logical and objective reasoning: This stage
requires conscious effort and attention, analysis and evaluation.
An action might be considered a mistake in System 1 but sensible in
System 2, and vice versa. System 3: Thinking about thinking:
challenging conclusions of Systems 1 and 2. Systems 1 & 2 do
not guarantee right answers or solutions if they are based on
erroneous assumptions. System 3 allows for a deliberate mistake or
a unique alternative consideration that may yield better solution
to the problem in hand.When fundamental assumptions are wrong,
companies can achieve success more quickly by deliberately making
errors than by considering only data that support the assumptions.
That is, research has proved that those who test their assumptions
by deliberately making mistakes or undertaking experimentation are
faster in finding the better solution to the problem. In bringing
Craig Mundie, who had founded a supercomputer company that
ultimately failed, to Microsoft, Bill Gates noted that every
company needs people who have made mistakes and then made most of
them [cited in Schoemaker and Gunther (2006: 115)] [See Turnaround
Executive Exercise 1.9].
Indecisions or Overachievement can contribute to
Underperformance
Organizational underperformance is also plagued with a culture
of indecision (Charan 2006). Instances and patterns of indecision
abound in underperforming firms. The people charged with reaching a
decision and acting on it fail to connect and engage with one
another. Intimidated by the group dynamics of hierarchy and
constrained by formality and lack of trust, they speak their lines
woodenly and without conviction. Lacking emotional commitment, the
people who must carry out the plan dont act decisively (Charan
2006:110). Often enough, top management may create a culture of
indecisiveness or break it. The primary instrument for breaking
this culture is dialogue - human interactions through which
assumptions are challenged, information shared, disagreements
surfaced, and efforts are coordinated. Dialogue is the basic unit
of work in an organization; its quality determines how people
gather and process information, make decisions, and how they feel
about one another and about the outcomes of these decisions.
Dialogue can lead to new ideas, and speed and sustain competitive
advantage. It is the single most important factor underlying the
productivity and growth of the knowledge worker (Charan 2006: 110).
According to Spreier, Fontaine and Malloy (2006), even
overachieving executives that relentlessly focus on tasks and goals
(e.g., revenue or sales targets) can over time damage
organizational performance. This happens, especially, if
overachievers:
Command and coerce, rather than coach and collaborate, thus,
stifling subordinates.
They direct rather than influence subordinates.
They are arrogant, aloof and demanding, and rarely listening to
others.
They, accordingly, focus more on numbers and results and not on
people.
They take frequent shortcuts and forget to communicate crucial
information to their key charges.
They are oblivious to the concerns of others and roughshod over
the rest of the management team.
Under such conditions, team performance begins to suffer, and
they risk missing the very goals that triggered the
achievement-oriented behavior. In the process, talented leaders
crash and burn as they exert ever more pressure on their employees
and themselves to produce.
Lastly, given all these studies and investigations on
organizational underperformance, we could use quantitative criteria
for benchmarking underperformance within a given industry. See
Appendix 1.1 for such a discussion and procedure.What is an
Organizational Decline?Prolonged organizational underperformance
leads to organizational decline. Symptoms of organizational
underperformance and decline include protracted erosion of sales,
market share, reduced customer base, or substantially depleted
product demand, and hence, financial losses. The short-term
consequences of organizational underperformance and decline are
negative cash flow and inability to honor payables while the
long-term implications are financial adversity, budget cuts,
distress, insolvency, bankruptcy and organizational death. Earlier
investigations in the phenomenon of organizational decline focused
on the definition of the construct. Whetten (1980b) defines
organizational decline as stagnation or cutback. Ford (1980a,
1980b) describes it as a decrease in the number of organizational
employees. McKinley (1987) calls it a downturn in organizational
size or performance. Greenhalgh (1988) and Weitzel and Johnson
(1989) characterize organizational decline as mal-adaptation to the
environment. Organization decline occurs when an organization
becomes less adapted to its environment, and resources are
subsequently reduced within the organization (Cameron, Sutton and
Whetten 1988). Cameron, Kim and Whetten (1987) delineate
organizational decline as a decrease in the resource base of an
organization. This definition seems to have prevailed in the
management literature judged by its consistent use by subsequent
researchers. For instance, Mone, McKinley and Barker (1998) define
organizational decline as a decrease in organizational resources.
An erosion of organizational resource-base poses as a threat to an
organizations continued viability. A decrease in the resource base
of an organization can be mostly considered as the root cause of
all other aspects of organizational decline such as stagnation or
cutback, employee layoffs, downturn in organizational size,
underperformance, and maladaptation to the environment. A decrease
in the resource base, however, reflects company-specific problems,
while an organization decline can also result from exogenous
contexts of industry contraction, industry stagnancy, tough
competition, new government regulation, technological obsolescence,
and globalization of resources and opportunities. Thus, while a
decrease in the resource base of an organization seems to be
unintentional, all other consequences such as organizational
restructuring, layoffs, plant closing, downsizing and cutbacks are
intentional aspects of an organizational decline. Organizational
decline, thus defined, differs from organizational downsizing: the
latter is defined as intended reductions in personnel (e.g.,
Freeman and Cameron 1993; Mone 1998). Earlier definitions of
organizational decline (e.g., Ford 1980a,1980b; McKinley 1987;
Whetten 1980b) relate more to downsizing than to decline. The
reductions via downsizing are planned and intended, while those in
organizational decline are unintended, but are often determined by
market forces. In general, therefore, scholars studying decline and
turnarounds trace organization decline to two sets of causes: a)
firm specific problems, and b) industry contraction that reduces
demand and increases competition (Arogyaswamy, Barker and
Yasai-Ardekani 1995; Cameron, Sutton and Whetten 1988; Whetten
1987). In either case, declines if not abated, will lead to the
dissolution of the firm as stakeholders (e.g., customers,
creditors, suppliers, distributors, stockholders, employees) who
find no appropriate rewards for their participation will withdraw
their support. A survey of the literature on organizational decline
raises some problems regarding its definition (Weitzel and Jonsson
1991):
a) Decline is frequently defined as a decrease in some
measurement such as sales, work force, profits, or profitability
ratios (ROS, ROI, ROA, and ROE). A decrease in one or more of these
measurements, however, does not necessarily indicate imminent
failure but may reflect other signs such as temporary cutback or a
change in direction.
b) Conversely, increases in such measures do not predict
organizational success.
c) Organizational decline is defined as a downward trend in such
measures over a long period of time.
d) However, are these decreases occurring early or later? e) Are
these decreases in efficiency or effectiveness?
Some decreases over a given period of time may be symptoms of
normal business fluctuations in one industry while signifying
serious difficulties in another industry. [See Turnaround Executive
Exercise 1.11].
Causes of Organizational Decline
How does a decrease in the resource base of an organization
occur? Is it an independent or a dependent variable? Most research
has treated organizational decline as an independent variable and
has devoted little attention to the causes of organizational
decline (Edwards, McKinley and Moon 2002). The few investigations
into the causes of organizational decline have dealt primarily with
macro-level factors that are external to the organization (Zammuto
and Cameron 1985) such as global competition, shrinking customer
bases in a product market, deregulation and other environmental
phenomena (Cameron, Sutton and Whetten 1988; Harrigan 1980).
Various schools of management offer their own reasons and
theories for organizational decline, and accordingly, prescribe
corresponding strategies for reversing firm-threatening performance
declines.
Strategic Management School: A firms decline is a core problem
which could be either operational (not efficient) or strategic
(weak strategic position relative to competitors). Ineffective
turnaround attempts often occur when managers fail to diagnose
successfully causes of their organizational decline and respond
inappropriately; e.g., trying to increase efficiency when the firms
weak strategic position is the cause of the decline (Hofer 1980;
Hofer and Schendel 1978; Schendel and Patton 1976; Schendel, Patton
and Riggs 1976). A weak strategic position may be strengthened by
tactical changes such as cost-cutting, asset reductions (e.g.,
selling fixed assets) and sales-pushing campaigns.
Organization Theory School: Organizational decline is pathology
in corporate decision-making and adaptation processes (Hedberg,
Nystrom and Starbuck 1976; Starbuck and Hedberg 1977; Starbuck,
Greve and Hedberg 1978)). Firm-threatening performance declines
(e.g., organizational crises) are an inevitable consequence of
organizational stagnation over time as managers fail to maintain
the alignment of the firms strategy, structure and ideology with
the demands of a changing and evolving environment. Combating
stagnation-caused declines needs organizational metamorphosis that
drastically alters the firms strategy, structure and ideology to
align them totally with the threatening environment. An
organizational metamorphosis and overcoming inertia need drastic
strategic reorientation or corporate restructuring. Mere
cost-cutting, asset-reducing or sales-pushing tactics will not work
under such contingencies. Instead, one would require radical
strategies such as a declaration of financial crisis, hauling top
management, or restructuring the organization with Chapter 7 or 11
provisions.
Both schools of thought make two inter-related assumptions: a) a
firms weak strategic positioning causes organizational decline and
deterioration; b) inertial firms suffer from weak strategic
positioning; that is, organizational inertia constrains strategic
change. Both schools also agree on two points: a) firms suffering
from performance declines need strategic change; b) failure to
execute strategic change often explains why some firms fail to
turnaround a declining company.
Empirical School of Research: Large sample studies of turnaround
versus non-declining firms link organizational decline to
operational and financial ratios. Hambrick and Schecter (1983)
found that turnaround or performance (ROI) increase of declining
strategic business units (SBUs) was highly correlated with reduced:
a) R&D expenditures/SBU sales, marketing expenditures/SBU
sales, receivables/SBU sales and inventory/SBU sales. ROI gains,
however, were also associated with market share gains and
purchasing new plant and equipment. Conversely, the reversal of
these ratios would cause further organizational decline and
insolvency. Ramanujam (1984) studied the financial ratios of turned
around undiversified manufacturing firms and found that increased
sales, decreased CGS/sales, reduced inventory/sales and
receivables/sales were significantly instrumental in turning around
these companies. Conversely, those that did not control the
reversal of these ratios failed to turnaround. Arogyaswamy (1992)
studied the financial ratios and financial statement changes of
manufacturing firms that were turning around and found decrease in
any three of the following ratios improved financial performance:
employees/sales, receivables/sales, inventory/sales, CGS/sales, and
SGA expenses/sales. Conversely, reversal of these ratios would
exacerbate organizational decline.
These studies, however, do not necessarily militate against the
theories of the strategic management and organization theory
schools. The turnaround strategies that the declining firms adopted
directly or indirectly relate to strategic (or pathological)
manipulation of financial or performance ratios. These ratios,
moreover, do not reveal the qualitative changes or tactics that
underlie them: e.g., cutbacks, retrenchment, new product
development or switching to new distribution channels (Schendel and
Patton 1976), new R&D expenses as further investments in
existing strategies, and the like (Hedberg, Nystrom and Starbuck
1976; Starbuck and Hedberg 1977). Further, changes in financial
ratios (especially efficiency ratios) may not reflect managerial
actions that the researchers attach to them (Barker and Duhaime
1997). Most of the large-sample turnaround studies also report that
most turnarounds were accompanied by dramatically increased sales
that tell us more about the denominators in the financial ratios
but nothing about the numerators (e.g., inventory, receivables, and
R&D expenses, CGA or SGA). In general, these studies worked on
declining firms without necessarily studying the causes of the
decline.
Figure 1.2 captures the determinants, process and consequences
of an organizational decline. [See Turnaround Executive Exercise
1.10]. Figure 1.2 incorporates all three schools of organizational
decline that we discussed (above) organization theory schools,
strategic management schools, and operational management school
supported by empirical research. All three theories help to
understand, trace, and turnaround organizational underperformance,
decline, downturns, and failure.What is an Organizational
Downturn?While organizational decline is a micro firm-specific
phenomenon primarily caused by internal problems, organizational
downturns are macro industry-nation-global specific events that
impact sets of firms in a given industry and are linked to external
problems such as national and global stagnation, wage and price
inflation, shrinking markets and global recession. The two events
are intimately connected - organizational downturn may precede and
cause organizational decline, or vice versa.
A growing body of research on organizational decline (e.g.,
Cameron, Sutton and Whetten 1988; Whetten 1987) traces the causes
of organizational downturn to industry contraction (shrinking and
stagnation of the industry such that it can support less and less
firms). As a contrast, firm-specific problems that lead to decline
occur when an industry is stable or growing but the declining firm
failed to adapt to the changing industry environment (Cameron,
Sutton and Whetten 1988). Moreover, industry contractions could be
temporary or of long duration, cyclic or sporadic. Organizational
downturn caused by cyclical recessions may necessitate little
change in strategy for a turnaround. The need for strategic change
may be quite low for a declining firm that has relatively a strong
strategic position in a declining or contracting industry,
especially if the industry contraction is temporary due to an
economic cycle (Barker and Duhaime 1997: 18). On the contrary, in a
stable or growing industry, a declining firm that performs
considerably below industry average in absolute terms is
strategically sick with weak strategies and a turnaround may
necessitate major strategic reorientations. [See Turnaround
Executive Exercise 1.12].
Figure 1.2: Organizational Decline: Antecedents, Concomitants
and Consequences
A number of researchers have proposed that the reasons given by
top managers for their firms downturns and declines will influence
the subsequent strategies chosen to reverse the decline (Ford 1985;
Ford and Baucus 1987; Lant, Milliken and Batra 1992).
Types of Organizational DownturnsOrganizational downturn can be
either latent or manifest (Ford and Baucus 1987). The latter can be
absolute or relative. Manifest absolute organization downturn
occurs: a) when absolute downward changes in performance (e.g.,
sales, profits) or upward changes (e.g., in costs, theft, crime,
defects) are noticed, and b) when absolute downward growth rates
(e.g., in sales, market share, profits) or upward rates (e.g., in
costs, quality defects, crime) are observed over a long period.
Manifest relative organization downturn occurs when there is
detrimental change in the inducement-contribution ratio (March and
Cyert 1958) as viewed from the corporations decision makers. That
is, inducements of price reductions, wage increases, promotions,
advertising, R&D, acquisitions and the like do not generate
proportionately adequate returns (e.g., increase in demand, sales,
market share, profits, brand equity or reputation) to cover the
cost of inducements.Latent or potential organizational downturn
exists (Ford and Baucus 1987): a) when decision makers in an
organization ascertain or anticipate the corporations inabilities
to satisfy their inducement aspirations relative to other
organizations (e.g., subsidiaries, competition); and b) when the
organizations demographics change, producing potential shifts in
demand. Either case of latent downturn can cause a manifest
organizational decline.Not all manifest organizational downturns
result from latent downturns (Zammuto and Cameron 1985). Some
manifest downturns result from revolutionary or discontinuous
events that occur suddenly and without warning. For instance, when
someone laced Tylenol capsules with cyanide, killing seven people,
the subsequent impact on McNeils market share was drastic forcing
an instant organizational downturn. Similarly, the Bhopal (India)
toxic gas leak that killed over 4,000 workers and local residents
sent shockwaves all through Union Carbide. [See Turnaround
Executive Exercise 1.13].
The Process of Organizational DownturnWeitzel and Jonsson (2001:
8) argue, Organizations enter a state of decline when they fail to
anticipate, recognize, avoid, neutralize or adapt external or
internal pressures that threaten the organizations long-term
survival. In this definition, the organization is already in a
state of decline if decision makers are unaware of and insensitive
to detrimental changes in the environment. Weitzel and Jonsson
(2001: 8-10) identify five stages in an organizational downturn: 1.
The Blinded Stage: decline begins when the organization fails to
recognize negative pressures either internal (e.g.,
underperformance, inertia, entropy) or external (e.g.,
environmental threats of inflation, competition or stagnation). Key
question at this stage: are there sufficient internal and external
scanning systems capable of detecting such conditions? 2. The
Inaction Stage: decline becomes noticeable when the organization
may recognize the problem but fail to decide on corrective actions
and measures. The key question at this stage is - does the scanning
information system translate into trigger points or built-in
mechanisms that will precipitate corrective measures at appropriate
levels of the organization?3. The Faulty Action Stage: Decline
continues as the organization responds ineffectively or
inappropriately to internal or external contingencies. The key
question at this stage is - Do the firms decision makers use
appropriate information to resolve critical problems and set up
effective procedures to implement the solutions? 4. The Crisis
Stage: Decline worsens owing to faulty decisions of the previous
stage because of which resources are seriously diminished. This is
the last chance for reorganization and reversal. The key question
at this stage is - Does the organization have sufficient resources
and effective mechanisms for a major reorganization?5. The
Dissolution Stage: Decline precipitates until the organization
ceases to exist as a distinct viable entity. Slow demise sets in if
the environment is supportive; rapid demise takes place in an
unforgiving environment. The key question at this stage is - Is the
organizations leadership willing and able to manage an orderly
closing or liquidation?Managers tend to explain organizational
decline or downturn as a product of immutable external forces
beyond their control, and are generally unaware of the effects of
their own predictions and adaptations on organizational decline.
For example, Baan, a Netherlands-based software maker, and other
enterprise-integration software makers such as SAP and Peoplesoft,
enjoyed increasing demand for their products through most of the
1990s and, accordingly, spent billions of dollars on more
sophisticated software for integrating business processes. The
market began to slump, however, in 1998, and Baan began incurring
quarterly losses. Many software makers including those of Baan
attributed the softening of market demand to client corporations
shifting a large portion of their data processing budgets to Y2K
fixes, a temporary cause that would normalize itself by the middle
of 2000. Meanwhile, Baan neglected innovation, new product
development, and got involved in high-cost production runs and poor
customer service. That is, consistent with this perception and
prediction of Y2K problems, Baan responded relatively
conservatively to their decline in financial performance, focusing
mostly on temporary layoffs and tighter controls on discretionary
expenditures. Baans prediction turned out to be wrong and its
difficulties went well beyond Y2K problems to high costs,
product-line problems and poor customer service. Baan bled cash
heavily through the year 2000; its shares dropped in price from $54
in 1998 to around $1 in mid-2000; it was on the verge of bankruptcy
when U.K.-based Invensys acquired it. Baans disastrous mistake was
waiting for the so-called temporary causes of decline to correct
themselves, meanwhile burning precious time and cash that
precipitated corporate decline (Mueller, McKinley, Mone and Barker
2001).
On the contrary, firms that proactively respond to the causes of
organizational downturn and perceive that the latter are
controllable have a higher sense of self-efficacy and set more
challenging goals for themselves. Consider Kodak in 1996. Then CEO
George Fisher knew that digital photography would eventually invade
or even replace Kodaks core business. Instead of declaring digital
photography as something of an ephemeral fad, Kodak rallied the
troops and aggressively invested more than $2 billion in R&D
for digital imaging. They spent too much money, however, before
they knew how the market would develop. They committed to price
points and product specifications that later proved difficult to
change. For instance, they hastily installed 10,000 digital kiosks
in Kodaks partner stores. The business Kodak built failed in the
traditional market and failed to find a new market. On the
contrary, industry outsiders like Hewlett-Packard, Canon and Sony
reacted differently: they launched complementary products based on
home storage and home printing capabilities, and in the process,
uncovered new demand for convenience, storage and selectivity,
applications that drove the development of digital photography.
Framing new disruptive technology such as digital photography,
e-marketing, e-books, and e-auctions as a threat may help one to
free up resources for the new technology, but such a
threat-perception may also bias the way those resources are
managed. [See Turnaround Executive Exercise 1.14].
Edwards, McKinley and Moon (2002) analyze organizational
downturn as an anticipated, but unintended and unwanted outcome of
managerial or industry predictions. That is, when managers or
external constituencies anticipate organizational downturn and try
to adjust to it, their actions, pro-actions or reactions can
sometimes exacerbate the very conditions of organizational decline
they predicted but would rather have avoided.Following this
discussion on the process, types and causes of organizational
decline and downturns, Figure 1.2 sketches the causal sequence of
an organizational decline and Table 1.4 outlines a typology of
organizational downturns. Corporations will adapt to organizational
downturns differently depending upon their identification,
anticipation, and shared interpretations of such downturns. We will
follow this discussion in the next chapter.What is an
Organizational Crisis?An organizational crisis is a low
probability, high-impact event that threatens the viability of the
organization and is characterized by ambiguity of cause, effect,
and means of resolution, as well as by a belief that decisions must
be made swiftly (Pearson and Clair 1998:60). This definition
implies that organizational crises: a) are highly ambiguous
situations where causes and effects are unknown; b) they have a low
probability of occurring but still pose a major threat to the
survival of an organization and its stakeholders; c) they offer
little time to respond; d) they often surprise organizational
me