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 / Winter 2003 / Issue 33(originally published by Booz & Company)


Learning Success from Distress

Lesson #4: There’s no such thing as “too fast.” The earlier you start and the faster you move, the more degrees of freedom you have to fix a business. Wait, and your options fade and control slips away.

This follows on the principles enumerated above. If you wait until a crisis manifests itself, your room to maneuver will be very limited. Putting a division or location or process into turnaround at the first sign of trouble can give management many months to avert a crisis. Leadership will have time to rethink strategy, to make major changes to the business model, to implement new information technology, and the like. If you are running out of cash in 18 weeks, the only levers you have available are quick-and-dirty cost cutting and asset fire sales.

The need for speed is evidenced in the bankruptcy boom. Public company bankruptcy filings have been at historic highs, with 179 in 2000, 257 during 2001, 189 during 2002, and an estimated 160 for 2003. There has been an acceleration of the crisis cycle, as well, for many companies. In other words, firms are going from peak to trough much faster than before.

Exhibit 1 illustrates this principle. Using 12 of the most significant companies that fell into trouble between June 1999 and April 2002, it depicts the increasingly rapid “crisis momentum” in public companies by plotting the number of days between a triggering event — a public announcement of an earnings decline, an accounting investigation, a fraud allegation, or the like — and a stock-price trough. As the least-squares line shows, the time plummeted from more than 200 days in 2000 to 100 days or fewer in 2002. Shareholder tolerance is very low for companies that allow themselves to fall into a visible crisis, and that tolerance is not likely to improve.

True, the “move fast” mentality means that action will be commenced before all the analysis can be done. But our experience is that the “80/20 rule of management” really does work. Decisive leaders making good intuitive decisions informed by 80 percent of the data and analysis will always outperform those who insist on more and more analysis until the moment for action passes.

Lesson #5: Fix the business, not the financials. If you are a senior manager or director and you’re not spending most of your time on the business itself, you must ask yourself why. We have seen a disturbing pattern in some recent crises we’ve been called in to remedy:

  1. A company with terrific performance generates tremendous share price gains.
  2. Operating performance starts to slip for a combination of external and internal reasons.
  3. Desperate to keep the stock price up, the management team, with board acquiescence, turns to financial engineering rather than business issue repair.
  4. The mask of financial manipulation is eventually removed to reveal the operating problems underneath.

In one example, a company we know reported a healthy 13 percent gain in EBITDA from 2000 to 2001. However, management got it there by capitalizing operating expenses and engaging in swap transactions to enhance revenue. In so doing, they disguised the troubles at the heart of the business, and when their actions caught up with them, the business fell hard.

We suggest a better solution and a more enlightened approach to governance for the board and management: Maintain a laser focus on the operations of the business, rather than the stock price and consolidated GAAP-based financials. Cash is king even in healthy companies, because there is nothing more fundamental than cash.

The distance between healthy and underperforming companies can be as thin as a dime. Every business has operating weaknesses. Companies are not machines with fixed inputs and outputs. Companies are adaptive organizations closer to biological cells thriving in more or less hostile environments.

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