Five Myths About Business Failure in a Downturn

I recently discovered a blog on the Financial Times' web site written by Don Sull, a former management consultant who is now a professor at the London Business School. In a recent blog post he discusses five myths about business failure in a downturn:

(From the Financial Times): "Many companies are suffering in the current recession, and their leaders blame their struggles on the financial crisis. Many of these explanations are too simplistic. Below are five myths about business failure in a downturn to watch out for.

Myth 1: The downturn caused our problems. For most industries facing serious problems right now, including big losers like automobiles and print media, the recession is not the ultimate cause of their suffering. Instead the downturn reveals (and aggravates) fundamental flaws in their business model. When the tide goes out, as Warren Buffett famously observed, you find out who has been swimming naked….

Myth 2: Companies fail quickly. Companies make the news when they abruptly file for bankruptcy. While firms file quickly, they fail slowly. As a junior consultant at McKinsey twenty years ago, I remember a presentation to a Detroit automaker highlighting many of the problems that plague the industry today, including poor product quality, high cost structure, and slow response to shifting consumer trends. The executives did not respond with indignation or denial, but indifference. One manager dismissed the report by saying “there is nothing new here.” That was in 1988….

Myth 3: No one saw it coming. If by “it” people mean the current recession, this is true. But the downturn is the proximate rather than the ultimate cause of most business failures...

Myth 4: Things will return to normal after the downturn. Successive cohorts of executives in the automobile and airline industries, among others, have consoled themselves and appeased their investors with this myth. In many realities, the situation is likely to be worse, and stay worse after the downturn. Consumers and corporations do not stop spending altogether in a recession, but they do seek out value for money. As a result, they are more likely to move away from companies that offer poor value for money and experiment with alternatives….

Myth 5: It couldn’t happen to us. Some executives resort to Schadenfreude to lift their spirits in a downturn. To feel better about the woes in their industry, book publishers snicker at newspapers, and even print executives can look down on their unfortunate counterparts in the music industry. In reality, leading companies in many industries, including law firms, pharmaceuticals, fast moving consumer goods, and executive education among others, are persisting in very flawed business models, even if the severity of their problems are not yet apparent to everyone…"

You can read more here.

The other day I was speaking to a former direct report of mine who is still working at a company I left back in '07, a company that is slowing dying due to not addressing a multitude of issues I first brought to the CEO and COO's attention over three years ago. The response I got was similar to what Don's colleagues received along with: "But that's how we do business", "well that's never going to change", etc. Even when facing the negative consequences predicted by a presentation I put together, the company's approach was to try and find a way to maintain the current business model, as opposed to scrapping it, implementing the changes I suggested and creating a business model that would enable success.

Even now as the company is facing its potential demise, the company is only begrudgingly starting to do "some" of the things that myself and many other talented managers suggested during our tenure at the firm.

I've encountered these situations many times over the course of my career and often chalked them up to stupidity, being short-sighted, laziness, etc. But after reading Don's blog post I'm beginning to wonder if it's really a case of "defending the religion of the current business model." In other words, senior management is more interested in defending the current business model, company practices, etc., than they are in making the wholesale changes that would save the business.

It's as simple as not having the intestinal fortitude to say: "everything we're doing is wrong, the way I know how to run this business is wrong and I now must learn a new way in order for the company to survive." Many struggling companies know what their true problems are, have been presented with all the advice it needs to survive, etc., they're just unable to act on it due to the inability of management to admit that they're wrong. It's a case of a company not being able (or being unwilling) to turn the microscope inwards, recognize its faults and engage in a process of continuous internal improvement. In other words: the problem is mostly psychological as opposed to being a function of their ability to innovate, recognize problems with their business, etc.

How else can you explain the fact that many troubled companies put the blame on everyone but themselves, are slow to change the way they do business even in the face of bankruptcy, and seem primarily more interested in finding a way to prolong the old ways as opposed to forging a new one? It seems like once a struggling company gets to a certain point in its failure arc, its ability to turn things around are more a function of psychology than anything else.

Finally: I think the other issue (in my experience at least) is that in some cases managers who are actively trying to implement changes are punished, while those who celebrate the broken business model are rewarded. This creates an environment where change can't happen because people are being incentivized to prevent it.

As the saying goes: "you can't get better until you admit you have a problem."

Sources:

The Financial Times: "Five myths about business failure in a downturn" -- Don Sull, April 15, 2009

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Comments

[Friar Hilarius:]

Well observed

So what is the solution at the Corporate level

How do you reward innovation and punish stagnation?

Some companies have surely found the key to this, but I guess there is an inevitability about high start up growth fuelled by new ideas, followed by consolidation, then maturity and ultimate decline

The idea that companies can last forever implies that their energy will always exceed that of their competitors, and that their products will never be superseded

It may sound like a counsel of despair when I say these things, but actually I agree entirely with the observations made above

In looking for answers there need to be a philosophy of moral intelligence at the highest levels of leadership

The same issues seen in corporations in the article also plague nations at the highest level

Moral leadership at the highest level is all too rare and denial is all too common

Would people like to give some examples of inspired leadership in Corporations and Nations?

Perhaps the business schools should include religion in their courses ... since so far appear to have given morality little attention

For non-believers who assert that those without any faith in God can be moral ... the challenge is there to show that secular morality can match the best that the world religions have to offer

Certainly the article makes a good case about fear of change ... and for those who see change as vital a secure moral foundation (whether secular or non-secular) would appear to add strength to those who are not lost to denial and stagnation in their leadership styles

With Best Wishes

Friar Hilarius

Apr 21 09:16 AM

[Hot Richard:]

The Bezzle gets you in the correction...and the markets always (eventually) correct.

Full disclosure: I cheered when I saw Citi, BoA, AIG, and GM in crisis. FINALLY, these companies will be exposed as failures and replaced by the sometimes-fantastic companies in their respective industries.

D'OH!

The true cost of the bailouts spreads past the dollar amount and reaches into the very fabric (poetry here, folks!) of what it USED TO MEAN to be American. Something good died. I only hope in some future decade someone sees it.

Apr 21 10:26 AM

[Hot Richard:]

"So what is the solution at the Corporate level?"

Capitalism, good Friar. Capitalism.

Apr 21 10:28 AM

[kelm:]

My experience is similar to yours. What I have found is that maintaining the facade that this is how we do business and it works seems to be paramount. Very few managers or executives get where they are by bucking the system and forcing change. They may get promoted by leading some great effort but it is almost always done within the confines of the standard business. I have actually had multiple senior executives tell me "yes, ultimately you are right and the thing will fail but I just have to keep it going for another 8 years till I can retire".

The sad part is I have seen the same behavior on the part of the uniformed services in the DoD contracts I have been involved in. The rot is not limited to business.

Apr 21 10:33 AM

[Allan Frain:]

With respect to Myth #3--many saw this downturn coming. Every Austrian economist saw it. Every student of the business cycle not only saw it, but appreciated its magnitude, given the depth and breadth of the housing/credit expansion.

GM became "too big to adapt" which is an economic manifestation of the economies of scale allowed. It was allowed by poor managers supported by poor investors lured by the perceived social backstop. "Too big to fail" is a policy choice.

Apr 21 10:41 AM

[Leftfield:]

"Professional" management is a large part of the problem. They run something founded and built by others and rarely are they inspired. It's management by MBA: Cut costs, cut labor, get rewarded, leave no money "on the table" in a short-sighted way. They incentivize themselves nicely and this can go on a long time.

A rare exception was IBM which got into computers after calculators, but WWII gave that strategy an obvious boost. Nonetheless, management there anticipated wisely. Later, though, they famously spun off Microsoft.

Detroit would be an obvious example of reaching the absolute pinnacle for generations and ending where they are now due to resulting unlimited hubris. They fit the article to a T.

Now, though, success is punished to save failures by myopic, self-serving leaders who benefit hugely from those systems. If our system is mostly about cronyism and taxes and regulations plus huge new debt continue to cause the demise of the middle class, we lose everything that made us once great.

Apr 21 10:46 AM

[Markham Lee_:]

Kelm: at the company in question I was very successful in terms of improving profits, morale within my department, quality of service, etc, but to do so I had to buck the system and almost insulate my group from the larger company. SO it led to a lot of tension between myself and the executives I reported to, ditto for many of peers running other business groups.In other words "serving the religion" was more important than delivering results.

It was an odd situation because I had more incentives to be mediocre via "maintaining the facade" than I did to excel in ways that corrected and/or exposed our problems.

In the end it drove me (and all of my peers at the time) from the company. I.e. maintaining the facade removed the people who could drive change.

Friar - I think the way you reward innovation is to make it priority via sending the message that NOTHING is sacred, your employees have to understand that your mission is to innovate, drive change and constantly find ways to improve the business. Because when you make something sacred employees are afraid to speak-up, and/or feel as if there is no point in trying to fix certain things because management won't support it.

There is a book called "Execution" that puts forth the idea that managers should act like football coaches, in that they should always be looking for ways to improve the organization, raise the playing ability of their talent, etc. It's a good analogy because even though some players, offensive/defensive schemes, etc, stick around too long, in the end the team has to innovate, load up with better talent or die.

-M

Apr 21 01:10 PM

[TrezRek500:]

Leftfield, you hit it on the head. Professional management is rarely outstanding. Managers really manage their careers more than people or capital.

We missed out on a great opportunity. We missed out on letting Wall Street crumble. It would be rebuilt by entrepreneurs and we'd all be a lot better off in ten years because of it.

Apr 21 02:44 PM

[Dirk McCoy:]

The combination of globalization and outsourced labor with explosive information growth led to alot of businesses operating on thin margins. These margins and leverage used to make the associated thin returns on equity look respectable were insufficient to withstand this last business cycle- you could be the greatest manager in history and still lose lots of money as assets were being marked down. Many companies went from all time high stock prices in 2007 to near all time lows (just look at Citi and GM, for example).

The aggravation factor in my opinion is that the Fed's periodic inversion of the yield curve seems to slow our economy more than hurricanes or war. Once this recovery takes hold, I hope they spare us another decimation 5-6 years from now.

Apr 21 09:45 PM

[wavelength:]

More evidence of the inherent madness of the "too big to fail" mantra. "Professional" managers are not entrepreneurs. As TrezRek pointed out above, all they are really managing are their own careers. It is actually small business that creates the majority of jobs and wealth. However, while dysfunctional monoliths are subsidized, small business is punitively taxed and strangled with regulation, and their "thin" but REAL profit margins are regarded as objects of ridicucle, not evidence of quiet heroism and minor but daily victory. (Investors are not entrepeneurs either.) The fastest, most honorable route to SA is a small but successful business. However, it is also a very difficult route. And there will be no bailouts or stimulus windfalls - just a bill for the hubris of other, bigger players.

Apr 22 10:31 AM

[goldensunrise:]

Dirk misses the point here. "Globalization and outsourced labor" was largely explosive in growth because of "professional" managers making decisions to support this model because it maximized the short term bottom line that made shareholders happy for the moment and in turn provided big bonuses. This eroded the long-term stability and infrstructure needed to weather the cycle we are now in.

Apr 22 11:47 AM

[Dirk McCoy:]

Globalization and outsourced labor was explosive because in ten short years barriers were reduced by fiberoptic communications, WTO tariff reductions, and massive infrastructure investment- and competitive advantage was then exploited to the benefit of all. We got cheaper manufactured goods and foreigners got investment and higher living standards. And we all got a greater proportion of mankind living in peace than ever in history.

Golden, you remind me of someone who wrote a letter to the editor in 2000 decrying outsourcing, and that "goods should be made where they're used". As President of an electronics firm I shuddered, because, at the time, our country with 4% of world population was producing 40% of world electronics, much of it for export.

Free trade, private property rights, division of labor, competitive advantage- I thought the US already demonstrated the superiority of these principles. But if you want to cobble together your next television in your basement yourself (or do you plan to outsource that?), I guess that's your choice- at least some bogeyman manager won't be getting paid.

Apr 22 02:04 PM

[jsevenseven:]

In my experience, people who are in a position where they don't have to admit their mistakes never will. The managers that point out the emperors lack of clothes are crushed. And the managers that enforce the staus quo (even if they don't agree) are rewarded.

Apr 23 10:31 AM

[Chris B:]

I'm beginning to wonder if it's really a case of "defending the religion of the current business model."
----------------------...
In American culture, our ideal mythic leader is decisive, unwavering, and determined to force his leadership upon the group. You see this in our entertainment ("24", John Wayne), in our politics (protestors dressed as "flip flops" mocking politicans for changing their mind), and in our corporations (Ivy League degrees).

For executives who are paid millions of dollars in company resources, the job is to embody this cultural ideal so that their employers and employees will continue to see them as the proper and legitimate leader, deserving of the rewards. For them, continued rewards are tied to obtaining political support by conforming to expectations.

Yet, the modern business world is increasingly incompatible with our cultural ideal of a leader:

1) Decisions must be made - increasingly by teams, not individuals - based on a tentative interpretation of a vast amount of vauge data, which puts "decisive" leaders at a disadvantage because they jump to conclusions too soon. Perhaps many of Chrysler's recent mistakes in product development and quality control were based on decisions made by decisive leaders and then never questioned.

2) The business, economic, and technological environment is in constant flux, which means that "unwavering" leaders might be correct exactly once before reality changes a week or an hour later and makes them incorrect. Successful companies today are the ones that are (a) nimble, and (b) constantly studying changes in reality so that they know how to adapt. "Unwavering" companies are also known as sitting ducks.

Meanwhile, being an effective contributor - teamwork - is now much more important than individual fortitude, dominance, or ambition. There are too much data to analyze, too many systems to learn, too much specialized knowledge to remember, and too many languages to speak for one mythic leader to drive an organization's success alone just on the basis of hard work and determination. Increasingly, the task of managers is to find ways to unlock and collaborate the talents of their teammates and to then assign them credit for the positive results, rather than taking credit themselves like an arrogant jackass.

Unless the American cultural ideal for leadership changes, expect more of the same.

Apr 23 01:13 PM