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