Don Sull's blog

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

Myth 1: The downturn caused our problems. For most industries facing serious problems right now, including big losers like automobiles and print media, the recession is not the ultimate cause of their suffering. Instead the downturn reveals (and aggravates) fundamental flaws in their business model. When the tide goes out, as Warren Buffett famously observed, you find out who has been swimming naked.  These business models were broken long before Lehman filed for bankruptcy, and will remain broken unless executives use the downturn to begin fixing them. Take General Motors. The automaker’s problems certainly did not originate with the current drop in consumer demand or higher retiree and medical costs. GM’s problems arise from the company’s inability, over decades, to make cars people wanted to buy. US car and light truck registrations more than doubled between 1970 (104 million) and 2006 (235 million). At the same time, GM’s market share collapsed from nearly 45% in 1970 to under 20% in 2009.

Myth 2: Companies fail quickly. Companies make the news when they abruptly file for bankruptcy. While firms file quickly, they fail slowly. As a junior consultant at McKinsey twenty years ago, I remember a presentation to a Detroit automaker highlighting many of the problems that plague the industry today, including poor product quality, high cost structure, and slow response to shifting consumer trends. The executives did not respond with indignation or denial, but indifference. One manager dismissed the report by saying “there is nothing new here.” That was in 1988.  Some companies do fail quickly, particurlarly trading firms such as Lehman Brothers or Long Term Capital Management, that rely on their ability to raise short term funds. When counterparties lose confidence and withhold cash, they fuel a vicious downward circle. Most companies fail like GM, however, not Lehman. Slow decline is both good news and bad news for leaders. It provides them with the time to experiment with new business models and implement change, but can also sap the urgency needed for change.

Myth 3: No one saw it coming. If by “it” people mean the current recession, this is true. But the downturn is the proximate rather than the ultimate cause of most business failures. The newspaper industry, for example, responded with dismay when the Tribune company, owner of the Chicago Tribune and the Los Angeles Times, filed for bankruptcy late last year. When might they have seen the fallout of digital technology coming? Maybe in 1995, when the Nieman foundation hosted a conference on the “on-line era” that included Arthur Sulzberger, Jr., the publisher of the New York Times? Or in 1981, when the Thomson Corporation, which then published over one hundred newspapers in North America. In this year Thomson bought a medical information business and sold the London Times newspaper, beginning its transformation into a digital media powerhouse that culminated in its 2007 acquisition of Reuters. Or might print executives have noticed the signs in 1978, when Knight Ridder recognized the imminent emergence of digital media and launched videotex, which loaded news over a dedicated telephone connection? The reality is that the newspaper industry has had at least three decades of clues that their business model was at risk. The problem wasn’t that they couldn’t see the writing on the wall, but that executives at most newspapers failed to experiment creatively or drive transformation aggressively.

Myth 4: Things will return to normal after the downturn. Successive cohorts of executives in the automobile and airline industries, among others, have consoled themselves and appeased their investors with this myth. In many realities, the situation is likely to be worse, and stay worse after the downturn. Consumers and corporations do not stop spending altogether in a recession, but they do seek out value for money. As a result, they are more likely to move away from companies that offer poor value for money and experiment with alternatives. Shoppers at Asda, for example, are increasingly turning to the company’s George budget clothing line, and if they are satisfied with the quality may not return to higher priced brands.  Homeowners who cut out real estate agents to save costs, may find the process of buying or selling a house without a middleman is not only cheaper, but more straightforward and quicker. Consumers who try alternatives are unlikely to flock back to business models that do not add value after the recession.

Myth 5: It couldn’t happen to us. Some executives resort to Schadenfreude to lift their spirits in a downturn. To feel better about the woes in their industry, book publishers snicker at newspapers, and even print executives can look down on their unfortunate counterparts in the music industry. In reality, leading companies in many industries, including law firms, pharmaceuticals, fast moving consumer goods, and executive education among others, are persisting in very flawed business models, even if the severity of their problems are not yet apparent to everyone. (My next post will discuss industries following broken business models). The best way to ensure corporate failure is to assume it could never happen to you.