What Makes Companies Fail?

How the Mighty Fall
Jim Collins is among the best researchers and writers on management effectiveness working today. He’s turned his attention from how companies succeed to how they fail. In his new book How the Mighty Fall and Why Some Companies Never Give In, Collins describes five stages of decline.

• Stage 1: Hubris born of success. Success seems automatic, practically an entitlement, and management blinds itself to threats in the market and weaknesses in the company.
• Stage 2: Undisciplined pursuit of more. Without the right resources, leaders chase after more scale, more growth, more acclaim, more of whatever they see as "success."
• Stage 3: Denial of risk and peril. Leaders dismiss the negative, exaggerate the positive, and put a positive spin on the uncertain. They blame external factors for setbacks instead of accepting responsibility.
• Stage 4: Grasping for salvation. When the company goes into a sharp decline, it looks for simplistic solutions -- like a visionary leader, a bold new strategy, a blockbuster product, or a big acquisition -- instead of getting back to basics.
• Stage 5: Capitulation to irrelevance or death. Successive setbacks sap competitive strength, the most capable people leave, and costly false starts sap financial strength.
  

Collins cites Anne Mulcahy’s turnaround at Xerox starting in 2001 as the counter-example to decline. She saw the company’s problems with unflinching clarity, shut down weak businesses to focus on strong ones, and cut costs in spite of the pain. She also restructured the company’s finances, narrowly avoiding bankruptcy.

Xerox's Brush with Death
Xerox may be a case in point for never giving in, but it is also a good example of how a company gets into trouble. In fact, it follows Collins’ stages of decline quite closely.

• Stage 1: Hubris born of success. Xerox created the copier industry, and thanks to its vaunted technological prowess and its famous sales force remained the leader through the mid-1990s. But the large-corporate market became saturated, Xerox was the high-cost producer, and more efficient rivals began eating into its market share.
• Stage 2: Undisciplined pursuit of more. Rather than overhaul its cost structure and cut prices, Xerox tried to grow its way out of trouble by introducing digital copiers and expanding into printers and small copiers for the small-office and home-office markets.
• Stage 3: Denial of risk and peril. Sales growth and profit margins began to shrink. Pricing for digital copiers proved to be much weaker than Xerox expected, and competition in printers and small copiers was ferocious. Xerox blamed economic problems in Russia, Brazil, and parts of Asia instead.
• Stage 4: Grasping for salvation. When growth and profitability fell even more, Xerox’s solution was to bring in Rick Thoman from IBM as CEO. His new strategy was to change from selling copiers to consulting on document processing, and he reorganized the entire sales force to that end. To meet earnings targets, senior managers began manipulating the revenue and expense accounts.
• Stage 5: Capitulation to irrelevance or death. Thoman also tried to cut costs, but at first the cuts created more inefficiencies than they corrected. Inventories shot out of control, and problems consolidating billing centers caused receivables to balloon. Because of the company’s bad accounting, the Securities and Exchange Commission refused to allow Xerox to issue any securities. As its funding dried up, Xerox ran out of liquidity and had to sell assets and renegotiate its bank lines in order to survive.
  

More to Come on Stages 4 and 5 and Risk
Collins looks at decline from a management perspective, but his framework is useful in risk analysis as well. The management mistakes that lead a company to Stage 5 can have dire financial consequences, as they did at Xerox. In our next blog entry, we’ll take a look at a framework for anticipating and evaluating the financial aspects of a company in decline.