Why good companies go bad

In turbulent markets, firms must disinvest from under-performing units to free resources necessary to exploit new opportunities. Most firms are better at getting into new things than getting out of established ones. In a recent survey, respondents cited their firm’s lack of a “well-defined processes to exit declining businesses and kill unsuccessful initiatives” as the second biggest obstacle to agility (out of a total of thirty possible factors). My last post summarized data suggesting that firms typically delay exit beyond the optimal point, and in the process deplete resources to invest in growth opportunities.

Why do firms struggle to kill failing initiatives? There are many sound reasons to delay exit, including uncertainty about the payoff to persistence, closing costs, and interdependencies among units that prevent a clean severing of ties. In many cases, however, executives fail to exit even as evidence mounts that the costs of persistence outweigh the benefits of staying the course.  Instead they double down, and increase their investment rather than pulling back to revisit their ingoing assumptions, and make mid-course corrections or pull the plug.

Management scholars refer to this tendency as “escalating commitment to a failed course of action,” and have

Execution begins with a mental map to guide action, but these maps represent the underlying competitive terrain imperfectly.  Turbulence, moreover, renders once useful maps outdated as market conditions shift. Leaders must update their mental map as circumstances change. They require the right type of data to do so,

Companies often respond to market shifts by accelerating activities that worked in the past, a tendency I call active inertia. Like a driver whose car has its back wheels stuck in a rut, managers press on the gas hoping to pull out, but instead dig themselves deeper.  Hardened commitments mark the well-worn grooves that channel behavior into historical patterns.

Companies fall prey to active inertia when their hardened commitments channel their response to market changes into existing grooves. Below are some warning signals that indicate executives at your organisation may be locked into their historical commitments and susceptible to active inertia, should the environment shift.

In today’s paper, I have written about why good companies decline.

Many people tell a simple story of corporate failure. Success breeds hubris which leads to overreach and triggers decline. After studying the causes of corporate failure and helping companies avoid it for two decades I have discovered a more profound dynamic that drives corporate decline. The commitments required to succeed harden over time and prevent companies from adapting effectively when circumstances shift. Organisastions often succumb to active inertia – they respond to disruptive changes in the environment by accelerating activities that worked in the past. This post describes the dynamic in finer detail.

Leaders avoid hard decisions for a variety of reasons. Brute uncertainty may obscure the right course of action, for example, or executives may lack incentives to make the tough calls. Often the right choice is obvious and managers have strong incentives to make the right call. Yet they still avoid tough calls. The story of Firestone’s response to the radial tire illustrates this dynamic.

Companies can hire stars in a downturn, but they can also develop existing employees. A recent survey of European HR executives found that the three least effective ways to cut costs in past recessions all entailed cutting back training and management development. Despite their negative impact on organizational effectiveness and employee commitment in the long-term, companies continue to rely on them to trim costs in the short-term. This is a mistake.  In a downturn, management development is not a luxury to cut, but an opportunity to seize. Talent development in a downturn can create a sustainable competitive advantage in three ways:

The newspaper industry is collapsing, after decades of gradual decline. Unfortunately at this point,  incumbents have few good options.  No one knows the future, but my hunch is most traditional newspapers and weekly magazines in the US and UK will disappear, while others will hang on eking out minimal profits. A handful of survivors will continue to create economic value, probably limited to publications with outstanding quality, a clear point of view, and a distinctive voice (think the Economist, New Yorker, Financial Times, Wall Street Journal).

The decline and fall of the newspaper industry holds important insights for executives in other industries–including pharmaceuticals, law firms, and fast-moving consumer goods–that may be suffering from the early stages of dry rot.  In particular, managers in these industries can avoid five mistakes that newspaper executives made as digital media began to erode customers’ willingness to pay for traditional print products.

The downturn has exposed flaws in business models, such as newspapers. Identifying basket cases after they have collapsed is easy, but by then it is too late to save them. The trick is to spot the weak spots in a damaged business model before it collapses, while management has the resources and time to fix it.

Long immersion in an industry can blind executives to flaws in their strategy and business processes. Managers can use a simple exercise to counteract the tendency to take an industry’s practices for granted.  Imagine ten years from now, your industry’s dominant business model has collapsed. You write a cynical blog post explaining why the business model collapsed. Don’t shoot for balance but instead emphasize the weak spots that killed the industry.  Below are a few examples of this analysis for some business models that look healthy right now, but collapse from dry rot in the future.

The gradual decline of a business model is often followed by an abrupt collapse. The decline and fall of an outmoded business model resembles the slow advance of dry rot. Dry rot is the deterioration of wood, in a building for example, which occurs when a fungus eats away at the cellulose that gives wood its hardness. The decay proceeds imperceptibly over time as the fungus erodes the timber’s solidity. In the advanced stages of dry rot, a wooden building can appear perfectly sound, but remains susceptible to collapse at any moment.

Leading in turbulent times

This blog is no longer active but it remains open as an archive.

Don Sull is professor of management practice in strategic and international management, and faculty director of executive education at London Business School. This blog is dedicated to helping entrepreneurs, managers, and outside directors to lead more effectively in a turbulent world.

Over the past decade, Prof Sull has studied volatile industries including telecommunications, airlines, fast fashion, and information technology, as well as turbulent countries including Brazil and China, and found specific behaviours that consistently differentiate more, and less, successful firms. His conclusion is that actions, not an individual’s traits, increase the odds of success in turbulent markets, and these actions can be learned.