Chapter One

Business Turnaround Situations:

Concepts, Definitions and Illustrations
Ozzie 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
o Organizational downturn
o Organizational crisis
Organizational sickness
Organizational distress
Organizational failure
Organizational insolvency
o 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.
11

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.
2.

How to resolve the day-to-day operational problems of cash flow management and
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
12

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 Turnarounds

In 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 increasing1. 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.

For example, Arogyaswamy 1992; Barker and Duhaime 1997; Hambrick and Schecter 1983; Hambrick and
DAveni 1988; Ramanujam 1984; Robbins and Pearce 1992; Schendel and Patton 1976; Sutton 1987, and Thietart
1988.
13

Figure 1.1: Product and Business Cycles of Prosperity and Insolvency

New Product
Development
Stages

Introduction

Maturity

Penetration

Market
Saturation

Decline

Phase out

Producer Cycle or
Market Structure
Customer Cycle

Monopoly

Duopoly

Oligopoly

Oligopoly

Duopoly or monopoly

Innovators

Early
adopters
Penetration

Late
Adopters
Skimming

Polypoly or
competition
Laggards

Trailers

Fire-fighting

Discounts

Status Quo Inactive

customers
Clearance pricing

Selective
Mass
advertising advertising
High
Upscale
Upscale
Brand new
Product
personalized bundling
product
Very High
High
Low
Moderate
None: Pay
Limited:
Cash full
Pay more;
Credit less
Very low
Minimum
Very High
High

Massive
advertising
Midscale

Reduced
advertising
Discount stores

Clearance-house
advertising
Clearance Houses

Price
bundling

Product-price
bundling

Lean
advertising
Deep
discount
Standardizing
Losing
Moderate
Moderate:
Pay less;
credit more
High
Lowest

Heavy losses
Clearance House
Limited:
Clearance credit

Pricing Cycle
Promotion Cycle
Placing Cycle
Product Cycle
Profit Cycle
Inventory Cycle
Consumer Credit
Cycle
Receivables Cycle
Payables Cycle

Premium

Medium
Negligible
High
Highest
Moderate:
Generous:
Pay half;
Carry now; pay
Credit half
later
Medium
Very high
Medium
Low
14

Commoditizing

High
Very low

Business Cycle
Stages
Start-up phase
Early take-offs: first
inflection point: B
Competition
Turning point

Turnaround
Management

A Successful Business

A Failing Business

AA': Start-up costs

AB : Early lucky but planned beginnings
A'B': Pre-breakeven period: no profits yet
BC: Early progress when forging into new
and high-risk markets
B'C': Early harvest of increasing profits
BCD: Strategizing against increasing
competition: Planning attack
C'D': Profits are flat but certain.
D: Transformation: market and/or
technological breakthrough or radical
innovation
DE*: Sales start increasing.
DE*F*:
Transformation management sales
D'E**F**: Transformation management
profits

AA': Start-up costs

AB: Early lucky serendipity-based beginnings
A'B': Longer pre-breakeven period
BC: Early progress and forging into new and risky
markets
B'C': Early harvest of profits if any
BCD: Firefighting tough and increasing competition:
Stagnancy
C'D': Profits are slim and uncertain.
D: Underperformance: no market or technological
breakthroughs
DE: Sales continue to decrease.

Product life cycle

E*F*: Prosperity, expansion, growth.

E**F**: Transformation prosperity profits
ABCDE*F*

DEF : Unsuccessful turnaround management sales

D'E'F' : Unsuccessful turnaround profits/losses
FH : Delayed turnaround management
F'H': Delayed turnaround management profits
G: Insolvency, bankruptcy
G': Insolvency losses
ABCDEFG

Business life cycle

A'B'C'D'E**F**

A'B'C'D'E'F'G'

Destiny

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 salerevenues 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. 2
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
2

Mathematically speaking, during the phase AB, the first derivative of sales with respect to time (ds/dt) is positive and the
second derivative (d2s/dt2) is positive. At point B, (ds/dt) is positive while (d 2s/dt2) is zero. During the phase BC, (ds/dt) is
positive while (d2s/dt2) is negative. During CD, both ds/dt and (d 2s/dt2) are zero. During DE, ds/dt is negative and (d 2s/dt2) is
negative. Finally, during FG, ds/dt is negative but (d 2s/dt2) is positive. One can similarly interpret other phases such as DE*,
E*F*, D'E**, E**F**, C'D', D'E', FG, and so on.

15

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
16

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 productcustomer 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 valuedestruction 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?

17

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.
18

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 WalMart. 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
19

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 identity

These 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].

20

Table 1.1: Contrasting Organizational High Performance with Underperformance Measures

[See also Kirby (2005)]
Authors

Study Samples

Peters and
Waterman
(1982)

3M, Atari, Boeing, Data

General, DEC, Delta
Airlines, HP, IBM,
Lanier, McDonalds,
NCR, United
Technologies, and Wang

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
Disney
Avon Products, BMC
Software, Hambrecht and
Quist, Hills Pet
Nutrition, Home Depot,
KFC, Marriott
International, NASA,
Southwest Airlines, U.S.
Marine Corps
Corning, Enron, General
Electric, Johnson &
Johnson, Kleiner Perkins,
Caufield & Byers,
Kohlberg Kravis Roberts,
and LOral

Katzenbach
(2000)

Foster and
Kaplan
(2001)

Zook and
Allen
(2001)

Anheuser-Busch, Biogen,
Coca-Cola, Dell, EMC,
Hilti International, Intel,
Microsoft, and Nokia
among others

Joyce,
Nohria and
Roberson
(2003)

160 companies across 40

different industries,
including Dollar General,
Flowers Industries, Home
Depot, Nucor, ScheringPlough, Target, and WalMart.

Choice Criteria

Proven High Performance

Measures

Predicted
Underperformance
Measures

Consistent 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.
Iconic stature and
stellar performance
for five to 15
decades

Bias for action, staying close to

the customer, fostering
autonomy and entrepreneurship,
gaining productivity through
people, hands-on and valuedriven 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

Clock 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

Proven 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

Sustained marketbeating
performance for
more than 15 years

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
Built unique strength in a core
business and mined that core
for its full growth potential by
expanding into logical
directions.

No 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

The 4+2 formula, involving

simultaneous superior performance in 4 primary areas
(strategy, execution, culture, &
structure) and in any 2 of 4
areas (talent, leadership, innovation, mergers/ partnerships).

Poor strategy; poor execution;

Low corporate culture;
Lack of effective structure;
Low talent and leadership;
Low innovativeness;
Ineffective mergers and
acquisitions.

Sustained longterm growth in

revenues and
profits while
generating total
shareholder returns
Total shareholder
returns over a tenyear period.

21

No seeking strength in the core

business; poor mining of the core
business to achieve full growth
potential; expanding into noncore businesses

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.
22

Table 1.2: What Characterizes Winner from Loser Corporations

Dimension

Loser Corporations

Winner Corporations

(Sustained marginal or decreasing

performance= industrial mediocrities)

(Sustained super-performance = industrial

icons)

Examples

K-Mart, Westinghouse, Burroughs, BristolMyers, Motorola, Gateway, .

Wal-Mart, GE, IBM, Johnson & Johnson, Sony,

Dell, .

Economic
Situation

Same era, same market opportunities, same

demographic shifts, technological shifts,
socioeconomic trends

Same era, same market opportunities, same

demographic shifts, technological shifts,
socioeconomic trends

Primary
quests

How 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
Values

Make 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
means

Routine 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.

Strategies

Reactive, inactive, temporary, random,

haphazard, exploitative and opportunistic

Success
Criteria

Increasing sales, market share, profits, ROS,

ROA, ROE, ROI, ROM, EPS and P/E.

Outcomes

Local market success, and leadership,

profitability at the expense of others winloss status, often ending in organizational
decline, distress, insolvency and failure

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 selfrenewing 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.
Vision-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.
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.
Lasting global market success, visionary
leadership, humanizing products and services,
creation of global wealth and opportunity

23

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-selfesteem, 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;

24

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.
2.
3.
4.

5.

6.

The FedEx distribution system - the bankers rejected the idea as impractical and risky.
The Enterprise - the experts considered it foolish to offer rental cars off airports and city centers.
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.
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.
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
25

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,

26

Table 1.3: Organizational Underperformance as a Function of Psychological

and Economic Traps in Decision Making
[See Hammond, Keeney and Raiffa (2006)]

Trap Type

Trap Type
Definition

Trap Type
Symptoms

Combating Trap Type

Symptoms

Organization
Examples

Anchoring
Trap

When considering a
decision, the mind
gives disproportionate weight to the
first information it
receives.

Initial impressions,
estimates, or data
anchor subsequent
thoughts and
judgments.

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
Trap

Decision 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.

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 openminded, transparent, seeking
information and opinions from a
variety of people to widen your frame
of reference and fresh directions.
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.

Sunk-Cost
Trap

We are inordinately
attached to sunkcosts 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.

Confirming
Evidence
Trap

This 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.

Framing
Trap

We 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.

27

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., sunkself-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 decisionmaking process.
a) Examine all the evidence with equal
vigor and avoid confirming evidence
without question; b) build counterarguments 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.
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.

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.
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.

Surrounding yourself with yespeople 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
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.

28

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
29

e)

controllable and controllable variables of the problem, and hence, possibly, seek more alternative
solutions.
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.
2.
3.
4.
5.
6.
7.

Cold calling Fortune 100 prospects does not work.

Our clients are primarily based on trust and reputation, with limited price sensitivity.
Young MBAs do not work well for us; we need experienced consultants on the team.
Bundled pricing is better than separate pricing for each of a projects components.
Senior partners must get more pay from their billing bonuses than from their base salaries.
Formal interviews with clients must always be done by two consultants, with one taking notes.
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].
30

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)
31

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 resourcebase 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].
32

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 costcutting, 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
33

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].
34

Figure 1.2: Organizational Decline: Antecedents, Concomitants and

Consequences

Pathological Decision-Making:
(Firm-specific problems)

Inertia and stagnation in strategy,

structure and ideology;
misalignment between resources
and external market challenges
(Organization Theory School)

Macro External
Factors:
Industry contraction
Stakeholders support
Global competition
Shrinking markets
Demographic shifts
Technology shifts
Government regulation.
Deregulation
Tougher EPA standards
Disruptive events such as
crime, fraud, sabotage

Organizational
Decline as Reduced
Resource Base
Progressive erosion
of sales, market
share and profits

Weak Strategic Position:

Poor planning; reduced R&D,
plant and equipment purchasing,
and marketing expenses.
(Strategic Management School)

Organizational
Decline as
Underperformance
even in a stable &
growing industry

Operational Inefficiencies:

Organizational
Decline as reduced
inducementcontribution ratios

(Firm-specific problems)

Poor cost-cutting tactics;

Inadequate revenue-generating
moves; Ineffective asset
reductions (e.g., plant closings,
layoffs, selling unproductive fixed
assets).
(Operational Management
School)

Support/
Withdrawal
from
Stakeholders

Decrease in cash
flows; Increased
receivables/sales,
inventory/sales,
and CGS/sales

Decrease in profit
ratios: ROS, ROM,
ROQ, ROA, ROI,
ROE, EPS, P/E,

Organizational
distress,
insolvency,
bankruptcy and
death

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).

35

Types of Organizational Downturns

Organizational 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 Downturn

Weitzel 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?
36

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.
37

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. 3 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). 4 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 members and e)
present an organizational dilemma that needs to be resolved. In general, most organizational crises imply
or result in losses of capital, market valuation, human resources, revenues and reputation.
Management efforts for surviving an organizational crisis are not enough. Pulling an organization
unscathed through a crisis may not always be possible. Between these two extremes, effective crisis
management implies: a) that operations are sustained or resumed; i.e., the organization is able to maintain
or regain the momentum of core activities necessary for satisfying its customers; b) organizational and
external stakeholder losses are minimized, and c) organizational learning occurs so that future similar
incidents are avoided or better handled. For instance, Johnson & Johnsons management of the Tylenol
crisis was very effective and successful, reinforcing the reputation of the company for integrity and
trustworthiness. Nevertheless, it was not very successful, given that the perpetrator was never identified,
and some plans or procedures during the management of the crisis failed.
On the other hand, Exxon Valdez Oil Spill crisis in Prince William Sound was not very successful
judged by: a) warning signals were ignored; b) plans and preparations for such events were substandard;
c) public statement made by Rawl, CEO of Exxon, outraged the public and immediate stakeholders, d)
and media coverage indicated that Exxon management was generally unwilling to learn from the crisis.
Some financial analysts, however, claimed that the crisis management was effective since the financial
costs incurred were manageable for Exxon and that the costs of fixing the crisis were less compared to
suggested preventive alternatives (e.g., invest in double-hulled vessels throughout the fleet; conduct
ongoing fitness evaluations for those in command; have a comprehensive crisis containment plan for all
of Prince William Sound).

Table 1.4: A Typology of Organizational Downturns (ODs)

Main Type

Subtypes

Characteristics

Examples of symptoms of OD Subtypes

For example, Barker and Patterson 1996; Barr, Stimpert and Huff 1992; DAunno and Sutton 1992; Edwards, McKinley and
Moon 2002; Ford 1985; Ford and Baucus 1987.
4
We are living in a world of crises. Typical global crises that affect us today are - infinite war, permanent political
destabilization in many regions of the world, the praxis of falsehood and cynicism, the insolent violation of the rule of law,
homicidal and suicidal terrorism, the impudent practice of torture, indifference and even contempt vis--vis the poor, the
destruction of the natural environment, and the deployment of dehumanizing bio-technologies (words of Antonio Papisca,
UNESCO Chair of Human Rights at the First International Cross-Cultural Conference of Theological Ethicists in Padua, Italy, in
2006); cited in Keenan 2008: 126).

38

of ODs

of ODs

Absolute

of OD subtypes
Absolute crosssectional changes
in performance

Absolute downward drifts in sales, market share, or profits;

Absolute upward trends in costs, production delays, cost
overruns, product defects, crimes, and worker defections

Absolute
longitudinal
changes in
performance

Absolute downward trend in growth rates of sales, market

share, market demand, and profits over a significant period.
Absolute upward trends in growth rates of costs, production
delays, cost overruns, product defects, crimes, and worker
defections
Lower returns (e.g., ROS, ROA, ROI, ROE, ROM, and ROQ)
compared to industry returns despite positive inducements in
investments (e.g., price decreases, wage increases, promotions,
R&D, new patents purchase, and new acquisitions).
Higher costs, production delays, cost overruns, product defects,
crimes, and worker defections compared to competition despite
positive inducements in investments (e.g., rewards, promotions,
commissions, new technologies, new acquisitions or new joint
ventures).
Downward drifts in returns (e.g., ROS, ROA, ROI, ROE, ROM,
and ROQ) compared to competition, despite positive
inducements in investments (e.g., price decreases, wage
increases, promotions, R&D, new patents purchase, and new
acquisitions).
Upward trends in costs, production delays, cost overruns,
product defects, crimes, and worker defections compared to
competition, despite positive inducements in investments (e.g.,
rewards, promotions, commissions, new technologies, new
acquisitions or new joint ventures)

Detrimental crosssectional changes

in inducementscontribution ratio

Manifest
Relative

Detrimental
longitudinal
changes in
inducementscontribution ratio

Internal

Decision makers in an organization ascertain or anticipate the corporations inabilities

to satisfy their inducement aspirations relative to other benchmarking organizations
(e.g., subsidiaries, competition)

External

Organizations demographics, psychographics and environmental demands change

causing actual or potential downward shifts in demand for companys products and
services.
Induced
Sudden and unexpected external revolutionary human
interventions (e.g., crime, sabotage, strike, boycott) that can
paralyze organizational operations and performance
Natural
Sudden and unexpected external natural catastrophic events
(e.g., earthquakes, tidal waves, tornados, fires, epidemics) that
can paralyze organizational operations and performance
Induced
Periodic and persistent negative external but human
revolutionary interventions (e.g., industrial theft, hacking,
corporate fraud, aggression, war, terrorism, nuclear threats)
that can paralyze organizational operations and performance

Latent

Sporadic

Discontinuous
Periodic

Natural

Periodic and persistent external natural catastrophic events

(e.g., earthquakes, tidal waves, tornados and fires in areas prone
to them such as the gulf coast) that can paralyze organizational
operations and performance

39

Table 1.5: Categorizing Organizational Crises by Source and Impact

Probability of
Occurrence and
Magnitude of
Organizational
Impact

Low Probability
but High
Organizational
Impact

High Probability
but Low
Organizational
Impact

Normal Crises:
System-Breakdown

Abnormal Crises:
Human Intervention

Natural Disasters:
Acts of God

Plant explosion
Escape of hazardous materials
(e.g., oil spills)
Product recall
Vehicular fatality
Major environmental spill
Dramatic demographic shifts
Major supply breakdown
Massive global competition

Workplace bombing
Terrorist attack
Hostile takeover
Product tampering
Computer hacking
Personnel assault
Executive kidnapping
Work-related homicide
Product-service boycott
Industrial labor strike
Corporate fraud
Money laundering

Natural disasters (e.g.,

earthquakes, tidal waves,
tornados, fires, epidemics,
droughts, famines) that
destroy corporate physical
assets

Product defects
Wastage
Industrial pollution
Minor environmental spills
Energy failure
Minor industrial accidents
Minor demographic shifts
Minor technology shifts
Minor supply breakdown

Absenteeism
Worker apathy
Go slow at work
Bribery
Counterfeiting
Information sabotage
Malicious rumor
Security breach
Sexual harassment
Assault of customers
Extortion
Copyright infringement
Trademark infringement
Stealing Intellectual
property
Computer tampering

Natural disasters (e.g.,

earthquakes, tidal waves,
tornados, fires, epidemics,
droughts, famines) that
destroy non-physical assets
(e.g., human resources;
organizational information
and databases; plans and
strategies)
Natural disaster (e.g.,
storm, blizzards) that
disrupt a major product or
service
Natural disaster (e.g., death,
major disability or accident)
that eliminates key
stakeholders

Table 1.5 categorizes organizational crisis by: a) its source (system breakdown, human intervention,
or natural disaster) and b) its low versus high probability of occurrence and low versus high
organizational impact. The first categorizing factor (system breakdown, human intervention and natural
disaster) is from Mitroff and Alpaslan (2003). The second factor follows from the definition of
organizational crisis by Pearson and Clair (1998). Some crises can be recurrent and non-preventable,
whether they are system breakdowns, human interventions or natural disasters. However, their
organizational impact is low. Other crises are rare but their organizational impact is high. Effective
management of such a crisis is difficult and often partial. [See Turnaround Executive Exercise 1.15].

What is Corporate Sickness?

Corporate sickness occurs when an organization plans, operates, produces, markets and financially
performs under par, under industry average, under benchmarking companies, and under self-targeted
40

goals and objectives. Corporate sickness can be of many kinds, degrees, origins, symptoms and
outcomes. For instance, typical input, process and output symptoms of corporate sickness can be early
and easily identified, such as:

Input-Symptoms or typical antecedents and causes of corporate sickness are many. They include:
outdated labor skills, outdated while collar skills, low hiring, low job enlargement, enrichment
and rotation, low employee retraining, development and retention, no new technologies, no
technological breakthrough, no cross-selling of patents and licenses, outdated equipment and
labor-intensive technologies, no new joint ventures, no corporate strategic alliances, and no
effective mergers, acquisitions or divestitures.

Process-Symptoms are early operational concomitants of corporate sickness. They include

symptoms such as lack of innovativeness, no radical innovations, mostly incremental innovations,
no market breakthrough, low R&D, poor and unimaginative organizational planning, lack of
rigorous and continuous market scanning, and lack of new products and services. One could
also include other operational negative symptoms such as lack of quality control (e.g., SQC, Six
Sigma quality procedures), lack of total quality management (TQM), poor supply-chain
management (SCM) and employee relations management (ERM), poor distributor-retailer
partner relationship management (PRM), ineffective customer relations management (CRM),
and extended absence of properly timed fresh management inputs.

Outcome-symptoms of corporate sickness relate to low customer satisfaction scores, low total
customer experience (TCE) scores, low customer loyalty scores, eroding customer bases, and low
lifetime loyalty customer bases. Hence, follow decreasing sales revenues, decreasing domestic
market shares (DMS) and decreasing global market shares (GMS), low brand equity, decreasing
brand community, and low company reputation. With falling sales arise other sequential
process-symptoms such as low cash flow, increasing accounts payable, inability to collect accounts
receivable, accumulating bad debts, inability to service long-term debt, inability to pay shortterm debts, increasing per unit costs of goods sold, low economies of scale, low gross margins,
high marketing and selling expenses, and high administrative overhead.

Financial Outcome Symptoms: The year end consequences of all input, process and outcome
symptoms are negative profitability outcomes such as low or negative pretax profits (EBIT), low
return on sales (ROS), low returns on promotions (ROP) such as discounts and rebates, low
returns on marketing (ROM) such as ads, free samples, and PR. Long term negative outcomes
are: low returns on assets (ROA), low returns on investments (ROI), usually lower than the cost
of capital, low return on equity (ROE), low earnings per share (EPS), low price/earning ratio
(P/E), low corporate net worth, low market evaluation, low Tobins Q, and low returns on total
shareholder returns (TSR).

As in any sickness, some symptoms are manageable, some are critical, and some are chronic (the
latter subsist for years and there is little you can do about them).
A typical reaction to combat sickness is deferring payables, deferring debt service, seeking more cash
(e.g., by selling personal assets, selling fixed assets), seeking another loan, or looking for another partner
who will bring in additional equity. However, if the enterprise is already riddled with debt and
delinquency and if it gets more money, it may lose it faster than it gets. Hence, stopping the cash bleeding
is most critical. Sometimes, banks may lend you more money, because they do not want the creditors to
push the company into Chapter 11 (in this sense, banks can be their own worst enemies). Nevertheless,
these stopgap arrangements are ineffective until you stop the bleeding. The common thread in virtually
every financially troubled company is lack of discipline in management; that is, no fixed goals and targets
to increase revenues, cut costs and increase net cash flows. Hence, your first task is to get the bank to
41

stop lending, and get the company to stop bleeding relying on its own resources and breathing by its own
vital organs and opportunities. [For stop-the-bleeding tactics and exercises, see Chapters 3 & 4].
Caplan (2003: 9-15) lists seven signs of organizational sickness or troubles that can threaten a
business:
a)

Little or no revenue growth: the growth should at least beat the national inflation rate and the
companys cost-inflation rate of rent, taxes, wages and benefits, utilities, stationery and office
equipment.

b)

Deteriorating Capital Base: Periods of flat growth in revenue can cause negative cash flows and
negative profits that you need to stop. You need some growth in profits to pay the principal debt
service, and to reinvest in new technology, equipment and new product development.

c)

Equipment Failures that Threaten Productivity: The above two factors can reduce your
expenditures on equipment, maintenance, and renovation, all of which can trigger breakdowns
and negatively affect productivity.

d)

Poor Employee Morale: The above three factors can affect your worker morale, work ethic,
organizational climate, and you may quickly end with employees who are angry, frustrated,
disillusioned or confused.

e)

Unpaid Taxes: When you owe taxes to the IRS, you are in dangerous territory. Heavy penalties
are attached to defaulted taxes (5% per month!) Moreover, the IRS can jump ahead of everybody
else with lien-wielding IRS agents in the liquidation line and make a demand for payment, file a
lien, and execute a levy on your bank or even your customers in record time.

f)

Failure or Closing of Major Customers: If one of your major customers cuts back operations, files
for reorganization, or just closes, your entire business may be jeopardized. Look for new
business, accounts, clients and customers.

g)

New Technology Creating Price Pressure: Years bring new technology, new automation avenues,
new robotic machines, new scanners for assessing inventory and shipping and new out-sourcing
opportunities. Failure to keep up with these will erode you sustainable competitive advantage,
and cost advantage, especially, if your competitors are abreast with the cutting-edge technologies.

We should also clearly distinguish between symptoms and causes of corporate sickness or decline.

Symptoms are merely telltale signs or danger signals that perceptive investors, customers and
analysts quickly perceive.
Symptoms provide clues as to what might be wrong with the firm, but they do not provide a
guideline for management action (Slatter and Lovett 1999: 13).
Causes are the sources of symptoms, and are difficult to detect.

Turnaround managers should look for both symptoms and their causes. Serious forms of
organizational sickness are usually defined in terms of profitability: The firms profitability is less than
acceptable (Sloma 1985/2000: 12). The firm may be profitable, but not profitable enough because the
flow of cash is unacceptable. That is, there is credible evidence that the cash or profit flow is soon going
to be inadequate to meet immediate disbursements. [See Turnaround Executive Exercises 1.16 and
1.17].

42

Who Recognizes Corporate Sickness?

Most turnarounds occur because of managements incompetence, inexperience, lack of expertise,
neglect and ego problems. Because of which, the incumbent management is the least likely candidate to
recognize corporate sickness (Sloma 1985/2000: 13). The incumbent managers will normally find
difficult to be objective in evaluating the past or the present performance. This is because they would
tend to be very defensive of their achievements, be inclined to explain away apparent failures by
unpredictable and unavoidable cruel circumstances of market and political forces, and meanwhile, would
allow the financial health of the firm to deteriorate to dangerous levels.
However, those who work closest to the company, other than corporate executives, such as financial
and accounting managers, marketing managers, procurement managers and employees are usually able to
see the onset of problems before outsiders. We may distinguish two major types of detectors of corporate
sickness: outsiders versus insiders. Both have three sources of information: the company, the capital
market, and financial information. Symptoms within the company are seen first as they are obvious both
to the insiders and outsiders. Observers that are more sophisticated would access capital markets such as
banks, institutional lenders, stock and bond brokers, and mutual funds operators to discern signs of
corporate decline. Others would look for financial information from SEC, SCC, S&P and other financial
analysts. There is, however, usually a lengthy time lag with financial information and by the time it
comes, corporate decline would have taken serious stages, and it may be too late to save the company.

External Detectors of Corporate Sickness

The outsiders detect corporate sickness first and most of the times. Table 1.6 lists most likely
outsider detectors and investigates their earliest sources of symptoms detection by three categories:
business, capital markets, and financial information. [See Turnaround Executive Exercises 1.18].
1.
2.
3.
4.

5.
6.
7.

Wall Street Journal analysts (in the case of publicly traded companies) are the first to track, detect
and warn symptoms of corporate sickness. They may even force you to do something about these
symptoms before they threaten to lower your bond and stock ratings.
Suppliers and vendors: They will detect sickness by invoices that are not paid on time, accumulated
debts, and decreasing orders or lack of new orders.
Banks who loaned the capital and who are engaged in a workout with you: dissatisfied with debt
service or debt amortization and bank overdrafts, they will warn you of corporate sickness when
they are unwilling to extend credit.
Distributors who retail products diagnose sickness when lack of demand for the companys products
or services forces them to offer deep discounts to clear inventories of the companys products. They
also detect trouble when the company is forcing higher sales quota or larger purchases, or when the
company is unable to pay slotting allowances or refuses to sell on consignment.
Customers detect sickness when product/service warranties or guarantees are not being honored or
their complaints are not redressed promptly; customers lose confidence in the company and its
products.
Federal and state governments: who catch up with taxes deferred, unpaid or evaded.
If the company has gone public, then the Shareholders and Security Analysts detect sickness of falling
stock prices, reduced market valuation, lack of dividends, decreasing return on sales (ROS),
diminishing return on assets (ROA), eroding return on equity (ROE), and reduced earning per share
(EPS).

43

Internal Detectors of Corporate Sickness

Table 1.7 is analogous to Table 1.6, but covers the most likely inside detectors of organizational
sickness. Internally, several players may diagnose organizational trouble, and possibly in this sequence:
Marketing executives may forecast sickness when product line and brand sales (by units, dollars,
preferred customers or target markets) are consistently falling, when repeat sales are low, when the
number of loyal customers is decreasing, when market shares are declining, when sales and marketing
expenses are unduly increasing, when product quality is failing, when product/service warranties and
guarantees are not being honored, and when sales and profitability per salesperson, per customer, per
product line, per flagship brand, per store, or per retail outlet are declining fast.
Corporate financial analysts may predict financial trouble when debt/equity ratio becomes too
excessive, when gross margins are thinning because of increasing unit labor costs and unit material costs,
when physical-plant and machine related variable and fixed costs are surging upwards, when
administrative overhead variable and fixed expenses keep increasing, and when sales and profits per
employee, per product line and per major brand are falling.
Company employees may discern financial trouble when the management is unable to pay wages,
salaries and commissions on time, when the company defaults on paying their fringes, pensions and other
bonuses, when employees get laid-off increasingly and unjustly, when hiring is frozen for a long time,
when employee promotions are unduly deferred, and when off-days cannot be cashed. Obviously, all
these symptoms can easily undermine the companys employee morale.
Company engineers may sound an alarm when capacity utilization is fast decreasing, when in-house
engineering expenses increase by skilled engineers, and/or by process technologies, product technologies
and by production lines, and when off-sourced engineering expenses of contractual jobs, employees,
production and products are increasing. Slow production, backlogged orders, deferred maintenance,
technological obsolescence, and outdated process and product technologies are other symptoms of
operations sickness.
Company accountants of the firm will perceive trouble when accounts payable keep on increasing,
when accounts receivable are not timely collected, when inventories get large, when aging stocks are
forced to sell on deep discounts, when short term debts are not cleared, when accrued interest on longterm debts gets unpaid or deferred, when contractual obligations such as payment into pension plans,
social security and other 401K accounts are not fulfilled, and when cash flow is progressively declining.
Lastly, corporate executives may recognize financial disaster when rescue strategies such as
downsizing, divestitures, plant relocation, off-sourcing, mergers, acquisitions, and joint ventures are not
working as expected, when banks and creditors refuse to extend credit, when corporate investor sharks are
forcing takeovers, and when shareholders are putting increasing pressure on the top management to
resign.

44

Table 1.6: Symptoms of Corporate Decline as Detectable by Outsider

Stakeholders
Outsider
Detector
Stakeholders
Customers
and small
investors

Outsider Detectors Sources

Business

Capital Market

Financial
Information

Fewer salespeople per square feet

of retail space; product/service
warranties and guarantees not
honored; complaints are not
redressed promptly and declining
customer service.

Public refinancing deals;

Loss of equity;
Stock prices plummeting
downward

Subject of takeover
bid; CEO fired;
Low bond ratings;
Low stock ratings;
Product safety- violations and litigations

Shareholders
and Security
Analysts

Rapid senior management

turnover;
Repeated failure of new product
launches.

Serious profit loss; falling

stock prices and hence,
reduced market valuation;
low or no dividends;
decreasing ROS, ROA, ROE,
EPS and P/E.

Rumors of mergers,
acquisitions or
leveraged buyouts;
Hostile takeover moves

Suppliers
and Vendors

Invoices not paid on time;

accumulated debts;
decreasing new orders, and
worsening terms of trade

Supplier disputes.

Banks

Dissatisfaction with timely

payment of debt service (e.g.
interest); company chronically
seeks bank overdrafts.

Increasing accounts payable

and accumulated trade debts.
Negotiations of suppliers with
bankers to support a
restructuring plan
Banks unwilling to extend
credit; company failure to
meet scheduled debt
amortization; banks
requiring higher collateral for
bank loans

Distributors

Lack of demand for companys

products or services; they are
forced to offer deep discounts to
clear aging inventories; company
is refusing to sell on consignment;
company is forcing higher sales
quota or larger purchases;
inability to pay slotting
allowances.

Poor terms of trade credit;

Banks not offering capital to
stock companys products

Other distributor
concerns;
Poor bond and stock
ratings of the company

Federal and
state
governments

Taxes unpaid; taxes deferred; tax

evasions; product liabilities;
OSHA violations; EPA violations;
antitrust violations; dumping;
trademark infringements; price
wars; predator pricing.

Breach of banking covenants,

Discussion of financial
restructuring plans

Destruction of
shareholder value;
EPS, P/E ratio and
market value
significantly lower than
industry averages.

45

SECs concerns over

the declining company;
Major bank ratings of
the company

Table 1.7: Symptoms of Corporate Decline as Detectable by Insider

Stakeholders
Insider
Detector
Stakeholders
Marketing
Executives

Insider Detectors Sources

Business

Capital Market

Financial
Information

Product line and brand sales (by units and

dollars) are consistently falling; the
number of preferred and loyal customers is
decreasing; repeat sales are low; heavy
brand switching; market shares are
declining; sales and marketing expenses are
unduly increasing; product quality is
failing and warranties and guarantees are
not being honored; sales and profitability
per salesperson, per customer, product line,
brand, store or per any other outlet are
falling fast.

Creditors, suppliers and

banks are distrusting
CEOs capacity to
turnaround the company.

Companys image,
covenants and existence
are questioned.
Wall Street analysts
lower companys bond
and stock ratings.

Corporate
Financial
Analysts

Debt/equity ratio is excessive; gross

margins are thinning; increasing unit labor
costs and unit material costs; physicalplant and machine related variable and
fixed costs are soaring; administrative
overhead variable and fixed costs are
increasing; sales and profits per employee,
per product line and per major brand are
decreasing.

Banks collude to refuse

credit, overdraft, and offer
other secured or unsecured
loans.
Capacity to raise equity is
low.

Wall Street analysts

lower companys bond
and stock ratings.
SEC does not grant IPOs
(initial public offers) or
reissue of stock.

Companys
Employees

Deferred payroll, commissions and

bonuses; employees get laid-off
increasingly and consistently; freeze on
hiring for a long time; employee
promotions unduly deferred; off-days
cannot be cashed; forced early retirement;
fear, anxiety and low worker morale.

Defaulting obligations on
401K and other pension
plans;
Employees forced stock
options show declining
returns.

Managerial finger
pointing and bickering;
Poor bond and stock
ratings of the company;
Emergency board
meetings;
Litigations pending

Companys
Engineers

Capacity utilization is fast decreasing;

slack labor; in-house engineering expenses
significantly increase; high skills turnover;
obsolesced process and product
technologies; delayed maintenance
engineering.

Downsizing: domestic and

overseas off sourcing.
Plant relocations;
Delayed plant redesign
owing to lack of capital.

ISO 9000 de-certification; poor bond and

stock ratings of the
company

Companys
Accountants

Increasing accounts payable; accounts

receivable not timely collected; inventories
are enlarging; pressure to sell aging stocks
via deep discounts; cash flow is
progressively declining.

Creative or deceptive
accounting practices;
Doctoring or inflating
annual sales reports;
Large negative variances
of actual performance to
budget

Corporate
Executives

Rescue strategies such as downsizing,

relocation, off sourcing, mergers,
acquisitions, and joint ventures are not
working as expected.

Short-term debts are not

cleared; accrued interest
on long-term debts gets
unpaid or deferred;
contractual obligations
such as payment into
pension plans, social
security, and other 401K
accounts are not fulfilled.
Banks and creditors are
refusing to extend credit.
Signs of cash flow crisis,
insolvency and
bankruptcy.

46

Corporate investor
sharks are forcing
takeovers; shareholders
are pressuring top
management to resign.

What is Organizational Distress?

Organizational distress is a state of exhaustion or weakness with strain of any sort. Prolonged
organizational underperformance, organizational decline and downturn, coupled with organizational
sickness and crises can generate organizational distress and strain and can render day-to-day production,
distribution, promotion, and retailing operations inefficient and ineffective. The organization in distress
suffers pain, anxiety, survival-anguish, and death-threatening agony. 5

Characterizing Companies in Distress

Appendix 1.2 lists 15 companies in worst distress compiled from the Fortune 500 list of 2003. They
were under organizational distress measured by various performance metrics: significant loss in sales,
loss in Fortune rank, loss in profits, loss in market value, loss in ROS, ROA, ROI and EPS, and loss in
sales and profits per employee. In fact, as far as 2002-2003 profits are concerned, they are among the
worst 25 U. S. performers. These 15 companies totaled $166.121 billion (Mean = $11.865 billion; SD =
25.267) loss in profits to shareholders. All companies listed in Appendix 1.2 reported negative ROS,
ROA, ROE and EPS.
The worst loser in profits was AOL Time Warner that reported a gigantic loss of over $98 billion in
2002. This, however, may reflect a charge from the cumulative effect of change in accounting of at least
10% (Fortune, April 14, 2003, p. F22). The company experienced poor performance also in 2001 and lost
$4.921 billion in profits (ranked 491). Its market value on March 14, 2002 was $113.942 billion that
quickly plunged to $49.973 billion by March 14, 2003, a loss of $63.969 billion (56%) to its shareholders
in exactly one year! Its regular vital signs such as ROA, ROS, ROE and EPS have been negative both in
2001 and 2002.
Another interesting example is AT&T from New York. Whereas it reported a profit of $7.715 billion
in 2002 (ranked 7th among winners), in 2003 it reported a loss of $13.082 billion (ranked third worst
loser), that is, a loss of {[-13.082 7.715]/7.715 = - 20.797/7.715 = -2.696}, a drop of 269.6% from the
previous year! Another striking example of a loser was Owens Corning of Toledo, Ohio. It had a profit
of $39 million in 2002 but reported a steep loss of $2.809 billion in 2003, an enormous loss of {[-2.809
-0.039]/0.039 = 2.848/0.039 = - 73.026} or a drop of 7,302.6% from the previous year! Dynegy, an
energy company from Houston, TX, slipped from Fortune 500 rank of 30 in 2002 to rank 336 in 2003; it
showed a profit of $648 million in 2002 but ended losing $2.802 billion in 2003, a loss of 788.6%.
Apart from AT&T, Corning, and Dynegy, all the other companies also reported loss in profits in the
previous year, and hence, their performance cannot be meaningfully compared to that year [indicated by a
(---) sign) in Tables A1.2.1 to A1.2.6 in Appendix 1.2].
Companies in distress are highly pervasive. In a study of 810,000 businesses by the New Jersey
Institute of Technology, only 56 percent of the companies managed to survive their first eight years, while
44 percent did not. While fewer than half of the 1970 Fortune 500 companies are still around, only 300
of the 1994 Fortune 500 will be around in the year 2000 (Shuchman and White 1995: 13).
5

The Websters Dictionary distinguishes the following: distress implies mental or physical strain imposed by pain, trouble,
worry, or the like and usually suggests a state or situation that can be relieved (e.g., distress caused from famine can be relieved).
Suffering stresses the actual enduring of pain, distress or tribulation (e.g., suffering of the wounded troops in war). Agony
suggests mental or physical torment so excruciating that the body is convulsing with its force (e.g., mortal agony). Anguish is
mental agony or acute mental suffering (e.g., the agony of despair).

47

Table 1.8 lists 21 companies listed in 2005 Fortune 500 that have totally disappeared even from the
2006 Fortune 1000 list. Possibly, some might have been acquired, merged, divested, or leveraged bought
out.

Table 1.8: Corporations that have Disappeared from 2006 Fortune 1000 Listing
(Source: Fortune, April 30, 2007, F-27; April 17, 2006, F-1 F-19, F-44 F-67)

2005 Fortune 500

Company

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.

Albertons
Bellsouth
Enterprise Products
Navistar International
AES
Kinder Morgan Energy
Fidelity National Financial
Transmontaigne
Burlington Resources
Jabil Circuit
Cox Communications
Kerr-McGee
Golden West Financial
Energy Transfer Partners
Freescale Semiconductor

16.
17.
18.
19.
20.
21.

Fisher Scientific Intl

Cinergy
Hughes Supply
Maytag
Engelhard
Jefferson Pilot

Sum
Mean
Standard Deviation
Median
Maximum
Minimum
Range

2005
Revenues in
$Billions

2005
Fortune
500
Rank

2004
Fortune
500 Rank

Industry

40.397
20.613
12.257
11.696
10.692
9.781
9.669
8.549
7.587
7.524
7.054
6.921
6.662
6.274
5.843
5.590

47
106
183
201
221
243
248
269
298
303
316
320
326
347
368
389

35
87
260
233
226
271
261
193
353
324
322
379
435
----414

Food & Drug Stores

Telecommunications
Pipelines
Motor Vehicles and Parts
Utilities: Gas & Electric
Pipelines
Insurance: Property & Casualty
Pipelines
Mining, Crude-Oil Production
Semiconductors & Other Electronics
Telecommunications
Mining, Crude-Oil Production
Savings Institutions
Energy
Semiconductors & Other Electronics
Wholesalers: Diversified

5.464
5.438
4.901
4.618
4.220

398
400
435
454
478

412
437
410
456
461

Utilities: Gas & Electric

Wholesalers: Diversified
Electronics, Electrical Equipment
Chemicals
Insurance: Life, Health

201.750
9.607
7.763
7.054
40.397
4.220
36.177

6350
302.381
108.562
316
47
478
431

5969
314.16
119.68
324
35
461
426

Pipelines 3
Telecommunications 2
Mining, Crude-Oil Production 2
Utilities: Gas & Electric 2
Wholesalers: Diversified 2
Semiconductors & Other Electronics 2
Insurance 2

The 21 companies listed in Table 1.8 lost over $200 billion in sales revenues in 2005 and an average
of $9.6 billion per company. Together, they lost 6,350 Fortune 500 ranks in 2006 with an average loss of
302 ranks per company. Since these companies did not make it even to the Fortune 1000 list of 2006,
they actually lost a total [21x1000 6350] = 14650 Fortune 1000 ranks in 2006, or an average loss of 698

48

ranks per company. Barring other reasons such as mergers, acquisitions etc., and the companies
presumably were in serious organizational distress by 2006.

What is Organizational Death?

Organizational death is insolvency, Chapter 7 or 11 bankruptcy filing, liquidation and closure. Much
has been written why organizations die or get bankrupt 6 but little is written on the process of
organizational death (Whetten 1987). Sutton (1987) was one of the first to analyze how dying
organizations make the transition to death. If we view an organization as a social construction of reality,
then we can define it as dead if its participants perceive that it does not exist.
Organizations are cycles of events. Hence, mergers or name changes are not to be construed as
deaths since the full set of the organizations activities continues intact, even though under a different
name or label. Thus, one definition of an unambiguous organizational death is that the set of activities
that defined the organization did not exist anymore, and the organization would not be revived in the near
future.
Sutton (1987) studied eight dying firms from southeastern Michigan during 1982-83 when the
automotive region was suffering its worst economic downturn since the Great Depression, with
unemployment raging at 17 percent in the state and as high as 25 percent in industrial cities. All eight
organizations had given an advance notice of shutting down within the range of two weeks to one year
before the actual closing. Based on over 70 informed executive (CEOs, CFOs, CAOs) and gatekeeper
(e.g., secretaries, spouses, receptionists) interviews averaging over 90 minutes, and other sources
(records, questionnaires, annual reports), Sutton (1987) observed the following process in the unfolding
of organizational dying and death in almost all the eight companies:
a) Efforts to avert the demise: Prior to any death-announcement there was a general wishful feeling that the
organization was there to stay indefinitely even though its leaders had warned that organizational death
might occur. Some warnings spurred collective renewal efforts (e.g., improve quality, cut costs, revenue
increasing tactics, layoffs, plant closings, changing brand name, heavy advertising, mergers, divestitures)
to save the company from premature death. Members of all eight organizations wanted unambiguous
information about whether or not their organization would survive or die, but leaders could not provide
such information. Failing which, members indulged in rumors to structure their uncertainty and anxiety.
b) Death Announcements: As soon as the leaders announced that organizational death is likely or imminent,
such announcements carried an overcharging message that had five components: 1) Efforts to avert
demise failed and nothing could be done to avert eventual death. 2) The decision was made by a
legitimate and rational process that weighed all alternatives, analyzed accounting and financial data, and
even consulted external agencies. 3) Members were told how to operate in the temporary organization
without further trying to save the company. 4) Disbanding (e.g., firing, closing plants, downsizing) and
reconnecting (e.g., transferring to other plants or departments of subsidiaries) will commence. 5) The
organization will close on a given date. All these announcements conveyed that members should adjust to
organizational death and its consequences. Such announcements caused stakeholders cognitive shifts
from hope to despair, calmness to sadness and anger, and from denial to resistance.
c)

The process of disbanding starts: disbanding is severing links between the organization and its members
(employees), external participants (e.g., banks, suppliers, creditors, and clients), and physical objects and
settings (e.g., auctioning inventory or furniture, plant closings, leaving ghost towns behind). Disbanding
would exacerbate tensions as to who would be kept and who fired, which department would be closed and

Altman 1971; Cameron and Whetten 1983; Carroll and Delacroix 1982; Goodman et al. 1977; Hannan and
Freeman 1984.
49

which retained, and which plant closed and which saved. Most of these procedures would be new and
untested, thus resulting in errors and further aggravating endemic tensions.
d) The process of reconnecting starts: Reconnecting consists of creating and strengthening links between
members of the dying organization and other social systems, customers and clients and other
organizations, and physical objects. Often disbanding and reconnecting would go simultaneously: e.g.,
members fired from one department would be assigned elsewhere to the parent company or its other
subsidiaries, displaced people would be helped to find new jobs, and customers and clients would be
assigned to other business partners.
e)

Final Transition to death: Working in a dead organization becomes traumatic. The process of
disbanding, dismantling, dumping, closing, reconnecting, shredding documents and junking furniture
and aged stocks becomes itself a slow painful dying experience. Some could not face it and left. Others
indulged in long parting or waking ceremonies. While others tried to renew their efforts to salvage what
could be saved, hoping thereby to create better impressions that would generate strong recommendations
and references for new jobs they applied.

These five interpretation shifts in the process of organizational death are interesting and naturally
sequenced. They explain organization behaviors before, during and after executive announcements of
closure.

Reasons for Organizational Failure (Qualitative Criteria)

Reasons or failure typologies of organizational failure have been many:

A headless firm of inconsistency and vacillation in strategy with different parts of the firm
working at cross-purposes (Miles and Snow 1978; Miller 1977);

Executive inertia, the sluggish organization, or very limited domain initiative (the latter construct
is the extent to which the firm changes its products and markets) stemming from environmental
restraints or from the firms own capacity to act (Hannan and Freeman 1977; 1984);

Excessive risk taking (financial, technological, scale and organizational risks) adding to those
already present; this typology is the opposite of executive inertia;

Impulsive firm with extremely bold and rapid expansion in the years preceding failure (Miller
1977);

Lacking domain initiative (Argenti 1976): that is, lacking leadership, pioneering, market venture,
risk-taking, creativity, inventions, innovations and entrepreneurship within the industry domain
or product-lines) and stagnant bureaucracy (Miller 1977; Miller and Friesen 1980);

Rapidly contracting environmental carrying capacity (i.e., the ability of the environment to support
the firm owing to industry contraction) was suddenly shrinking or eroding (Harrigan 1980;
Staw, Sandelands and Dutton 1981; Zammuto and Cameron 1985) or the contrary;

Slow environmental decline: This is the boiled frog phenomenon. [In a physiological response
experiment, the frog that was dropped into an already boiling pan of water reacts
instantaneously by jumping out, whereas the frog placed in a pan of cold water that is gradually
heated to boiling sits in the pan and idly cooks to death]. The failing firm does not register the
slow but noticeable differences in the declining environment, is slow or rigid or too late to
respond, and does not escape to more favorable environments.
50

Organizational slack: Originally conceived as a surplus of resources beyond those required to

maintain the organizational coalition (Cyert and March 1963), organizational slack has been
more broadly defined as a cushion of actual or potential resources (Bourgeois 1981:30). Singh
(1986) distinguishes unabsorbed slack (excess unlimited liquid resources) from absorbed
slack (excess costs in organizations). Slack can be stored in different forms (e.g., financial,
human resources, technology) that do not provide equal buffers from environmental jolts (Meyer
1982). In general, slack stimulates innovation (Cyert and March 1963) and allows risk taking
(Singh 1986), while reduced or sharply depleted slack can cause managerial paralysis causing
rigidity and tightening of control that precipitates failure (Staw, Sandelands and Dutton 1981).
There is research, however, that links complacency, minimal adaptive initiatives and failure
associated with high slack (Starbuck, Greve and Hedberg 1978; Tushman and Romanelli 1985;
Whetten 1980).

Downward Spiral: Organizational decline reflects a downward spiral as weakness (especially, in

sales, profits,) leads to even greater weakness in linked variables (e.g., debt-equity, net
income/assets) and lack of financial and cash slack (Hambrick and DAveni 1988; Staw,
Sandelands and Dutton 1981). Analyzing data from 57 large private-sector bankrupt companies
versus matched industry survivors during 1972-1982, Hambrick and DAveni (1988: 14)
characterize this downward spiral in four distinct stages: 1) Origins of disadvantage occur about
ten years before failure manifested by deficient performance and deficient resources slack; 2)
Early impairment occurs 6 to 10 years before failure evidenced by further deterioration of
performance and slack, strategic extremism and vacillation under neutral or buoyant
environments; 3) Marginal existence: 3 to 6 years before failure indicated by marginal
performance and slack despite satisfactory working capital; 4) Death struggle: one to two years
before actual death indicated by sudden environmental decline, sharp deterioration of slack and
performance. [See Turnaround Executive Exercises 1.19].

Reasons for Organizational or Corporate Failure (Quantitative Criteria)

Table 1.9 lists standard accounting ratios that reflect competitive advantage (CA) and sustainable
competitive advantage (SCA). Significant departures of a companys standard accounting ratios from
corresponding industry averages may indicate corporate sickness. Other things being equal:

Profitability ratios measure profits relative to firm size.

Liquidity ratios measure a firms ability to meet short-term financial obligations.
Leverage ratios measure a firms indebtedness, and
Activity ratios measure cost effectives of a firms activities.

In general, all accounting ratios (see Table 1.9) have limitations. Chief among these are:
a) They are post-mortem analysis of the past; they indicate nothing of the future.
b) They are short term annual figures; hence, for e.g., returns on R&D or assets invested over
several years may not be seen in the balance sheets in the early years of investment.

51

Table 1.9: Standard Accounting Measures of Competitive Corporate

Performance
Ratio

Calculation

Interpretation

Profitability Ratios:
Return on Sales (ROS)

(Profits after taxes)/Total sales

Return on Total Assets (ROA)

(Profits after taxes)/Total assets

Return on Equity (ROE)

(Profits after taxes)/(Total

stockholders equity)
(Sales CGS)/ Sales

Gross Profit Margin

Earnings Per Share (EPS)
Price Earnings Ratio (P/E)

Cash Flow per Share

(Profits after taxes Preferred

Stock Dividends)/No of Common
Stock Shares Outstanding
(Current Market Price per Share)/
After Tax Earnings per Share
(Profits after taxes + Depreciation)/
No of Common Stock Shares
Outstanding

Measures efficiency of sales

management
Measures return on total
investments in the firm
Measures return on total equity
investments in the firm
Measures sales available to cover
operating expenses other than CGS
Measures or common stock
profitability.
Measures anticipated firm
performance; a high P/E ratio
indicates that investors anticipate
strong future firm performance.
Measures funds available to fund
activities above current level costs

Liquidity Ratios:
Current Ratio
Quick Ratio

(Current assets)/(Current
liabilities)
(Current assets - Inventory)/
(Current liabilities)

Measures firms ability to cover its

current liabilities
Measures firms ability to cover its
short term liabilities without selling
its inventories

Leverage Ratios:
Debt to Assets

(Total debts)/(Total assets)

Debt to Equity

(Total debts)/(Total equity)

Times Interest Earned

(Profits before Interest & Taxes)/

Total Interest Charges

Measures debt-financing of a firms

activities.
Measures debt versus equityfinancing of a firms activities.
Measures profitability (EBIT) over
capital rent

Activity Ratios:
Inventory Turnover

(CGS)/ Average Inventory

Accounts Receivable Turnover

(Annual credit sales)/(accounts

receivable)
(Accounts receivable)/Average
daily sales

Average Collection Period

52

Measures inventory depletion or

non-inventory costs of production
Measures average time to collect on
credit sales
Measures average time to receive
payment after a credit sale

c)

Balanced Sheets and Profit & Loss statements are often an accountants opinions. Most
accounting ratios can be manipulated by accounting methods such as FIFO (first in, first out)
and LIFO (last in, first out) of valuing inventories, straight-line versus accelerated depreciation
methods, amortization, depletion, and so forth.

d) They do not reflect intangible resources such as corporate history and renown, brand image,
brand equity, accumulated organizational experiences, human resources development (HRD),
customer and supplier loyalties, employee skills and routines, corporate core competences,
corporate relational assets such as customer relationships management (CRM), supply chain
management (SCM), employee relationships management (ERM) and channel partner
relationships management (PRM).

Other useful and more insightful financial performance measures include: (See Barney 2001:38-66).
NOPLAT (Net Operating Profit less Adjusted Taxes)
= EBIT [taxes on EBIT + charges on deferred income taxes].
IC (Invested Capital) = (Operating current assets + book value of fixed current assets)
(net other operating assets + non-interest bearing current liabilities).
WAATCD

= weighted average after tax cost of debt

= (market value of debt) (after tax cost of debt)/firms market value.

WACE (weighted average cost of equity) = (market value of equity)(cost of equity)/firms market value.
WACC (Weighted Average Cost of Capital) = WAATCD + WACE
ROIC (return on invested capital): = NOPLAT/IC
EP (economic profit) = IC (ROIC WACC)
= actual economic value created by the firm.

The Significance of Tobins Q

Two important ratios in assessing the value (that is, health or sickness) of the firm are market value
added (MVA) and Tobins Q defined as follows:
MVA = (market value of equity + market value of debt) economic book value.
TOBINS Q = market value (MV) of the firm/replacement value of the firms total assets.

Tobins Q is market value (MV) of the firm divided by the replacement value of the firms total assets.
MV is the product of the number of outstanding shares (common + preferred) and the average value of the
share price on given day. Tobins Q is approximately equivalent to:
= MV/total assets = market value performance of the firms assets.
= Market value/book value or market-to-book ratio of the firm.
= Value shareholders and other investors attach to the firm over and above its asset or book value.

53

By definition, the range of Tobins Q is 0 q . When Q is less than 1.0, it indicates poor investor
confidence; that is, investors are not prepared to value the company more than the replacement value of its
total assets. A value of 1.0 would mean market value matches book value. When Q exceeds 1.0, then
investors are appraising the company higher than its tangible assets. That is, they are prepared to pay
special premium for the stock because of companys growing intangible assets, such as new core businesses,
new core competencies, new core products, new core innovations, new core patents, new organizational
procedures and routines, new strategic alliances, new joint ventures, and new market entries. The value the
investors attach to these intangible assets can be very high. Hence, the upper bound of Tobins Q is infinity.
For instance, Tobins Q as market-to-book value of Fortune 500 companies has been approximately and
consistently 3.5 over the recent years. A value of 3.5 is 2.5/3.5 = 71.43% over book value. That is, over
70% of the Fortune 500 companies value lies in intangible (off-the-balance sheet) assets rather than in
tangible book assets (Srivastava, McInish, and Capraro 1997; Srivastava, Shervani, and Fahey 1997, 1998).
There is a growing recognition that a significant proportion of the market value of firms today lies in
intangible off-balance sheet assets, rather than in tangible book assets (Srivastava, Shervani, and Fahey
1998).
On the other hand, a value of less than 1.0 for Tobins Q would also imply that the assets of the firm:
a) Have little or no intangible value;
b) Market value of assets is depreciated, and
c) Investors and shareholders do not attach much value to the tangible and intangible assets of
the firm.

For instance, most of the domestic auto companies (e.g., GM, Ford) have Tobins Q less than 0.75,
but they are not necessarily failing. Organizational performance is increasingly tied to intangible assets
such as corporate culture, customer relationships and brand equity. Yet controllers who monitor and track
firm performance, traditionally concentrate on the tangible balance-sheets assets of a firm such as cash,
plants, equipment, and inventory. Little has been done in the last 20 years to project more accurately the
true asset base of the corporation in the global marketplace (Srivastava, Shervani, and Fahey 1997).

54

Financial and economic analysts employ Tobins Q to explain a number of diverse corporate phenomena
such as,

Cross-sectional differences in investment and diversification decisions (Jose, Nichols and Stevens
1986; Malkiel, von Furstenberg and Watson 1979);
The relationship between managerial equity ownership and firm value (McConnell and Servaes
1990; Morck, Schleifer and Vishny 1988),
The relationship between managerial performance and tender offer gains (Lang, Stultz and
Walking 1989),
Investment opportunities and tender offer responses (Lang, Stultz and Walking 1989), and
Financing, dividend and compensating policies.

Despite its influence over many aspect of corporate finance, however, Tobins Q is not much used by
corporate CEOs and financial CFOs, possibly because of their unfamiliarity with Q or because data for
estimating Q are not readily available (Chung and Pruitt 1994). Most often, it is difficult to assess the
replacement value of the total assets. Hence, researchers offer several alternatives to estimate the
denominator in Tobins Q. Existing formulae for Q (e.g., Lindenberg and Ross 1981) are extremely tough
on data requirements. Current easier formulations of Tobins Q (e.g., Chung and Pruitt 1994; Perfect and
Wiles 1994) require more readily available data and less computational effort. Both formulations assume
that the replacement value of the firms plant, equipment and inventories are equal to their book value. That
is, approximate Tobins Q is equivalent to market-to-book value of the firm.

What is Corporate Bankruptcy?

Bankruptcy in the legal sense occurs when the firm cannot pay its bills or when its liabilities exceed
the fair market value of its assets. In either of these situations, a firm may be declared legally bankrupt.
However, creditors generally attempt to avoid forcing a firm into bankruptcy if it appears to have
opportunities for future success. Edward Altman (1968) estimated the impact of five financial ratios on
the probability that a firm will declare bankruptcy. Most external observers of a firm rely on these
financial indicators to predict decline and bankruptcy. [Chapter 13 provides a more detailed presentation
on bankruptcy, bankruptcy law and strategic bankruptcy].

How to Predict Bankruptcy

In a model prepared by Altman (1968), five basic ratios were utilized in the prediction of corporate
bankruptcy. Analyzing empirical evidence from firms that failed, Altman (1968) estimated the impact of five
financial ratios on the probability that a firm will declare bankruptcy with the following Z scores equation:

Z = 1.2 x1 + 1.4 x2 + 3.3 x3 + 0.6 x4 + 1.0 x5

where
x1
x2
x3
x4
x5

=
=
=
=
=

Working capital/total assets

Retained earnings/total assets
Earnings before Interest and Taxes (EBIT)/book value of total debt
Market value of equity and preferred stock/book value of total debt (or total liabilities)
Sales/total assets.

55

Variable one is a liquidity ratio; variable two is a financial gearing ratio; variable three is a profitability
ratio or earnings ability; variable four is a size of a firms total equity to debt leverage ratio, a liability ratio
or indirectly, a shareholder wealth creation metric, and variable five is a revenue performance ratio. The
model attaches highest weights to profitability ratio (x3) and lowest weight to shareholder value variable(x4).
According to Altman, a Z score below 1.8 indicates sure failure; a score of 1.8 to 2.99 indicates probable
non-failure, and a score of greater than 3.0 indicates assured corporate health or non-failure. This model
predicts bankruptcy with 95 percent accuracy one year prior to bankruptcy and with 72 percent accuracy
two years prior to bankruptcy.
The Z scores, however, are not a good predictor for more than two years before bankruptcy. In this
sense, the model is not very useful, since banks and investors, using conventional methods, can predict
bankruptcy or that a firm is headed for insolvency two years before it actually happens. One could enhance
predictability by including the standard deviations of these ratios in the Z equation. [For further
improvements on predictability of Z scores, see Altman, Haldeman and Narayanan (1977); Dambolona and
Khoury (1980)].
Because it is difficult to determine the market value of private companies (see x 4), this model was
designed for public companies. Altman (1983: 108) believed that the market value of a firm is a more
effective indicator of bankruptcy than the commonly used ratio of net worth to total debt. Book value may
be used when calculating the X score for privately held companies. If book value is substituted for market
value, however, then the X coefficients would be changed.
Altman (1983:120-24) suggested the following revised model:
Z' = 0.717x1 + 0.847x2 + 3.107x3 + 0.420x4 + 0.998 x5
A larger area of uncertainty is associated with Z' scores, which indicates bankruptcy at a value of 1.23
(compared to 1.81 for Z scores) and non-bankruptcy at 2.90 (compared to 2.99 for Z scores).
Z or Z' scores, weights and cut-off points, however, may differ across countries, industries and
markets, will change over time as economic conditions change, and accordingly, Z scores will differ in
their predictive capacity. Hence, great care must be exercised in interpreting and drawing conclusions
from the Z scores (Slatter and Lovett 1999). For instance, Argenti and Taffler (1977) applied Altmans
(1968) model to UK financial data and concluded that financial gearing and profitability measures were
the most significant ratios in predicting failure, and that liquidity ratios are of less importance. Currently,
with the information of data and large computer processing capacity, Z scores for industries have been
developed (e.g., Syspass in the UK, S&P in the US).
Hambrick and DAveni (1988) studied 57 large bankrupt firms and 57 matched industry survivors to
determine what differentiated them over time (e.g., in the ten years preceding failure in the case of
bankruptcy). Their findings suggest: 1) failures showed signs of relative weakness very early, as far as
ten years before they failed. 2) The failures, on average, had significantly lower equity-to-debt ratios than
the matched industry survivors for each of the ten years examined before failure, with pronounced
deteriorations for the bankrupts in the last two years before bankruptcy. 3) Their operating performance,
measured by net-income/assets (or ROA = return on assets), was also significantly inferior to or lagged
the survivors in all the years observed.
These findings are linked and intertwined: poor profits limit any increases in equity (in the form of
retained earnings) and cause the firm to take on more debt to finance operations. The power of
equity/debt and net income/assets in predicting bankruptcy (measured by R-square values in a Logit
56

analysis using these as independent variables together with others) increased from 0.32 in the fifth year
before bankruptcy, to 0.39 in the fourth, 0.44 in the third, 0.79 in the second and 0.89 in the first year
before bankruptcy. Variables such as working-capital/sales did not feature as a marked difference
between bankrupts and survivors, presumably because the bankrupts maintained a satisfactory cushion for
current obligations. This cushion collapsed, however, in the two years immediately preceding
bankruptcy, thus indicating significant differences in working-capital/assets between bankrupts and
survivors. The fact that bankrupts showed signs of relative weakness as early as ten years before failing
suggests: 1) that organizational death was a protracted process that 2) could be early detected, predicted
and controlled.

How to Avoid Corporate Bankruptcy

Here are some suggestions from Edmond P. Friermuth, a banking consultant from Santa Monica, CA,
who was also a banker for 10 years, making loans to small and medium businesses: (See Jacobs 1984):
1.

Analyze companys financial difficulties, their extent and their causes.

2.

Estimate cash receipts and cash disbursements for the next three to six months.

3.

Analysis under (2) would indicate disbursements exceed receipts. Hence, be aggressive in
collecting receivables but do not let go accounts payables.

4.

The immediate remedy for paying payables is to cut expenses as quickly as possible. Take a
hard look at all expenditures, especially payroll. In general, small businesses have more
employees than they need; they feel reluctant to fire slack labor.

5.

Do not mislead your creditors. Your creditors, upon consistent defaults in payment, will look
at your disbursements, especially, your payroll. Follow them if they suggest serious labor
attrition. Cooperate with your creditors to keep your business out of bankruptcy proceedings.

6.

Even though Chapter 11 protects you from your aggressive creditors for a while until you
reorganize, it is an expensive process. Chapter 11 protection involves filing fees with the
Bankruptcy Court, referee and trustee fees, attorney fees, asset appraisal fees, accounting fees,
auctioneer and other liquidation fees, customary court costs for recording and transcribing the
proceedings, and the like. The ailing business can ill-afford these fees. Moreover, it consumes
time, energy, emotions, anxiety and fear all of which deter you from turning your business
around. Hence, avoid Chapter 11 at all costs.

Recent Bankruptcy Filings in the U. S.

It should be noted that not all the companies that fail, register their failure with the governments or
other institutions like the Dun and Bradstreet (D&B) that provide regular statistics on bankruptcy filings.
For instance, there is no public record of discontinued firms. Discontinued firms are those that
entrepreneurs voluntarily discontinue operations of for a variety of reasons, such as loss of capital,
inadequate profits, and ill health or retirement. As long as the creditors are paid in full, discontinued
firms are not tantamount to failure or bankruptcy, and hence, will not be tallied by D&B. Every year
several hundred firms are started, almost an equal number are discontinued, and even more, transfer
ownership and control (Bibeault 1999:9-10).
Financially distressed firms seek either bankruptcy or out-of-court restructuring settlements. In
general, large (e.g., Fortune 500) firms seek bankruptcy while smaller firms (who cannot afford heavy
57

bankruptcy court fees and prolonged litigations) seek out-of-court restructuring. Those who seek
bankruptcy may either choose to liquidate the firm or the institution under Chapter 7 provisions or seek to
reorganize it under Chapter 11 provisions. Those firms seeking out-of-court restructuring can also choose
to either reorganize or liquidate. Reorganizing under both cases has two fundamental options: a) reduce
or reschedule debt payments and b) sell assets or issue new equity (Gilson 2001: 24). Schematically:

Options of Financially
Distressed Firms
Usually larger firms in bankruptcy
courts:

Bankruptcy Protection
Provisions

Total liquidation
Foreign joint ventures excluded
Reduce or reschedule debt
Sell assets and/or issue new equity
Total liquidation
Foreign joint ventures excluded
Reduce or reschedule debt
Sell assets and/or issue new equity

Chapter 7 for Liquidation

Chapter 11 for Reorganization

Usually smaller firms out of

bankruptcy courts

Financial Strategies

Chapter 7 for Liquidation

Chapter 11 for Reorganization

During 1980-2000, all business bankruptcies in the United States that sought Chapter 7 protection
exceeded 11.5 million, averaging to over half million a year with a spread of about 0.23 million on either
side of the mean. Table 1.10 provides details. The least number of Chapter 7 filings were 234,594 in
1983 and the highest number was 1,035,696 in 1998. During the same period, namely 1980-2000, all
business bankruptcies that claimed Chapter 11 liquidation numbered over 344,000, averaging to over six
thousand per year with a standard deviation (SD) of 5,746. The highest Chapter 11 bankruptcy filings
were 24,740 in 1986 and the least were 6,348 in 1980. Thus, during 1980-2000, Chapter 7 bankruptcies
each year outnumbered about 33 times Chapter 11 bankruptcies. During the same period, 2,275 public
companies, totaling over $692 billion in assets, filed for Chapter 11 bankruptcy protection, and an equal
number of companies have restructured their debt out of court.

Table 1.10: Business Bankruptcy Filings in the United States: 1980-2000*

Year

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995

Public Companies
Chapter 7

Chapter 11

2433
1921
1150
1031
1404
1791
2255
2289
3020
3522
3006
3421
2741
2705
2688
4076

62
74
84
89
121
149
149
112
122
135
115
125
91
86
70
84

Non-Public
Companies

Total Assets Lost

in Chapter 11
Bankruptcies
($billions)
1.671
4.703
9.103
12.523
6.530
5.831
13.033
41.503
43.488
71.371
82.781
83.202
54.283
16.752
8.336
23.471

58

Chapter 7

246703
258743
256494
233563
233593
279195
372197
404472
434862
473471
540328
653039
678922
600275
564552
622074

Chapter 11

6286
9967
18737
20163
20131
23225
24591
19789
17568
18146
20668
23864
22543
19088
14703
12820

All Businesses
Chapter 7

249,136
260,664
257,644
234,594
234,997
280,986
374,452
406,761
437,882
476,993
543,334
656,460
681,663
602,980
567,240
626,150

Chapter 11

6,348
10,041
18,821
20,252
20,252
23,374
24,740
19,901
17,690
18,281
20,783
23,989
22,634
19,174
14,773
12,904

1996
1997
1998
1999
2000
Total
Mean
S.D.
Minimum
(year)
Maximum
(year)
Range
Annual
Compound
Growth rate g
during 19802000

5715
7536
14820
14431
15583

84
82
120
145
176

13.999
17.245
28.940
58.760
94.786

804685
981836
1020876
912643
855222

11827
10683
8266
9170
9659

810,400
989,372
1,035,696
927,074
870,805

11,911
10,765
8,386
9,315
9,835

97,539
4644.73
4558.43
1031
(1983)
15583
(2000)
14552

2,275
108.33
30.98
62
(1980)
176
(2000)
114

692.311
32.967
29.821
1.671
(1980)
94.786
(2000)
93.115

11,427,744
544,178
258,915.7
233,563
(1983)
1,020,876
(1998)
787,313

341,894
16,280
5738.24
6,286
(1980)
24,591
(1986)
18,305

11,525,283
548,823
262,627.3
234,594
(1983)
1,035,696
(1998)
801,102

344,169
16,389
5,745.96
6,348
(1980)
24,740
(1986)
18,392

9.73

5.36

16.15

6.41

2.17

6.46

2.21

* Columns data 3, 4, 7 and 8 are from New Generation Research, Inc. (2001); columns 2, 5 and 6 are deduced or estimated
from columns 3, 7 and 8. For instance, column 6 = columns 8-3; column 5 = columns 7(6/8) rounded, and column 2 =
columns 7-5].

59

Average assets of public company Chapter 11 bankruptcy filings lost during 1980-2000 surpassed 281 million
dollars (SD = 218.97). The highest mean loss in assets per company was $719.8 million in 1990 while the lowest
average was $26.95 million in 1980.

The annual compound growth rate during 1980-2001 differs across different types of bankruptcy
filings and has been as follows (See Table 1.10):
For Chapter 7 public companies:
9.73
For Chapter 11 public companies:
5.36
For Chapter 7 nonpublic companies: 6.41
For Chapter 11 nonpublic companies: 2.17
For all Chapter 7 bankruptcy filings: 6.46
For all Chapter 11 bankruptcy filings: 2.21

Thus, judged by 1980-2000 bankruptcy data in the USA, Chapter 7 Bankruptcy filings of public
companies have grown the fastest at 9.73 percent, while Chapter 11 bankruptcy filings for nonpublic
companies have grown the least at 2.17 percent during 1980-2001. Generally, larger publicly held firms
seek Chapter 11 protection (Bibeault 1999: 10). However, judged by assets lost for Chapter 11
bankruptcy filings of public companies, the liability per bankrupt company has been growing at 16.15
percent each year since 1980.
During 1980-2000, in the United States, more than 1,500 companies have split themselves through
equity spin-offs or by issuing tracking stocks, creating over $700 billion in new publicly traded equity.
Also during the same period, hundreds of corporate downsizing programs have laid off more than 10
million employees. Remarkably, all three types of corporate restructuring activities have grown almost
every year during this period, through both booms and busts in the economy (Gilson 2001).

A Statistical Analysis of Recent U. S. Bankruptcy Filings

Trend analysis is presented in Table 1.11. Based on 1980-2001 data, there is a significant positive
linear trend in the growth of Chapter 7 bankruptcies among all businesses: the correlation coefficient
between time (in years) and the number of Chapter 7 bankruptcies is 0.949 (p < 0.000; df = 21). The
regression trend equation is:
Number of Chapter 7 bankruptcies = -7.9E+07 + 40,165.35 (Year) (Adjusted R2 = 0.901; F = 171.96)

(1).

Specifically, the number of Chapter 7 bankruptcies among non-public companies shows a stronger
linear trend than the same number among public companies:
Chapter 7 non-public company bankruptcies = -7.825E+07 + 39,595.74 (Year) (Adj. R2 = 0.900; F = 171.79 (2).
Chapter 7 public company bankruptcies = -11,288.78 + 569,609 (Year) (Adj. R2 = 0.601; F = 28.63
(3).

That is, in general, Chapter bankruptcy filings among both public and non-public companies have
been increasing each year. Using this regression equation, we can project Chapter 7 bankruptcy filings
for future years, say 2001-2020 (for details see Table 1.12).
Based on 1980-2001 data, there are no significant linear trends in relation to Chapter 11 bankruptcies
among either public or non-public companies. The same 1980-2001 data also reveal a positive significant
relationship between the number of Chapter 11 public company bankruptcies and the total assets lost:
60

Number of Chapter 11 public company bankruptcies in a given year = 88.609 + 0.598 (Total assets lost by the
Chapter 11 public companies that year) (Adjusted R2 = 0.296; F = 9.427; p < 0.006).
(4).

Table 1.11: Regression Trend Analysis of Bankruptcy Filings:

Independent Variable: Year of Bankruptcy Filing
Dependent
Variable:
Bankruptcy
Filings

Constant

R2

Chapter 7
Non Public
Companies

-7.825E+07

39595.74

0.900

0.949

13.107

0.000

Chapter 7 Public
Companies

--1128878

569.609

0.601

0.775

5.351

0.000

Chapter 11
Non Public
Companies

666020.8

-326.503

0.079

-0.353

-1.645

0.116

Chapter 11 Public
Companies

-2489.004

1.305

0.019

0.261

1.180

0.352

All Chapter 7
Companies

-7.9E+07

40165.35

0.895

0.949

13.113

0.000

All Chapter 11
Companies

663,531.8

-325.197

0.077

-0.351

-1.635

0.119

Table 1.12: Forecasting Chapter 7 Bankruptcies among Public and NonPublic Companies for 2001-2020
Year

Extrapolated number of
Chapter 7 bankruptcies
among public companies

2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2020

10,910
11,480
12,050
12,619
13,189
13,758
14,328
14,898
15,467
16,037
21,733

Extrapolated number of
Chapter 7 bankruptcies
among non-public
companies
979,731
1,019,327
1,058,923
1,098,519
1,138,114
1,177,710
1,217,306
1,256,902
1,296,497
1,336,093
1,732,051

Extrapolated number
of Chapter 7
bankruptcies among
public and non-public
companies
990,641
1,030,807
1,070,973
1,111,138
1,151,303
1,191,468
1,231,634
1,271,800
1,311,964
1,352,130
1,753,784

Based on a correlation analysis of the 1980-2001 bankruptcy filings data, the following conclusions
are plausible:
61

1.

The higher the number of Chapter 7 bankruptcy filings among all businesses in a given year, the
lesser the Chapter 11 bankruptcy filings. [The correlation between the two variables is 0.439, p <
0.046].

2.

The higher the number of Chapter 11 bankruptcy filings among public companies, the higher are the
total assets lost by the Chapter 11 bankruptcy companies. [The correlation between the two variables
is 0.576, p < 0.006].

3.

There is a significant and positive correlation (r = 0.455, p < 0.038) between Chapter 7 and Chapter
11 bankruptcy filings for the public companies.

4.

There is a significant and negative correlation (r = -0.436, p < 0.048) between Chapter 7 and Chapter
11 bankruptcy filings for the nonpublic companies.

What are Business Turnarounds?

Given our discussions on organizational underperformance, decline, distress, crisis, sickness, and
death, and the complementary notion of bankruptcy, we should now be better situated to explore the
concept of business turnarounds.
A turnaround is a process of reversing organizational
underperformance or decline, thus averting consequent organizational distress, sickness, insolvency or
bankruptcy, crisis or death.
Business turnaround deals with reversing corporate organizational under-performance. Because
business turnarounds deal with organizational survivals, turnaround is viewed as a performance issue in
strategic management. A successful turnaround occurs when a firm undergoes a survival threatening
performance decline over a period of years but is able to reverse the performance decline, end the threat
to firm survival and achieve sustained profitability (Barker and Duhaime 1997: 18). Thus, business
turnarounds occur when a firm perseveres through an existing threatening performance decline; ends the
threat with a combination of strategies, systems, skills and capabilities and achieves sustainable recovery
(Chowdhury 2002: 250). The obverse of performance recovery is organizational failure and eventual
death.
It is difficult to define precisely what a business turnaround or corporate recovery is. It is described
as the art and strategy of restoring a sick firm to a healthy financial life and market progress (Shuchman
and White 1995). In most cases, a business turnaround follows several years of declining profitability.
Corporate sickness is not always fatal or necessarily unto death of insolvency or bankruptcy. The primary
role of turnaround management, therefore, is not always crisis management, cash flow generation, shortterm cost reduction, or other quick-fix solutions. In its most severe form, corporate sickness usually
culminates in substantial losses that threaten the financial viability of the firm. In its mildest form,
corporate sickness may not threaten the financial viability of the firm, but it can negatively affect
consumer confidence and loyalty, employee and corporate morale, and market competitive advantage.
The true object of corporate turnaround is a firm whose recent past or projected future financial
performance is unacceptable to the owners or creditors. In which case, a corporate turnaround is a
substantial and sustained positive change in the performance of a business (Bibeault 1999: 81).
Successful turnaround treatment to corporate sickness is a tailored, customized restorative program (Sloma
1985/2000, xiii). The treatment that is prescribed must relate directly to the symptoms of the corporate disease, and
must be administered with precision, dedication, commitment and perseverance. The goal is to restore the firm to
financial health: that is, the corporate capacity to generate a steady stream of cash flow and quality profits; or
enhance the enduring value of the stakeholders investment.
62

Somewhere along their history, most companies are likely to encounter situations that demand
turnaround strategies. Whether struggling firms can regain their vitality or continue to stagnate, or be
liquidated altogether depends on whether their management can successfully bring about a turnaround
(Bibeault 1991). In the past two decades, as global markets have grown increasingly competitive and as
global connectivity through the Internet has rapidly advanced, the world has seen record numbers of
corporations dramatically restructure their assets, operations, and capital resources. In Europe, with the
establishment of the monetary union and the adoption of the Euro, high-cost companies can no more hide
behind devaluations of their home currencies, or pass these costs along to consumers. Furthermore,
significant reduction of import tariffs and other export barriers have exposed inefficient high-cost firms to
the discipline of the global marketplace (Gilson 2001).

Classic Global Turnaround Cases

(See Khandwalla 1992:11-30)

During the last three decades, the world has known several thousands of turnarounds. Among
these, some turnarounds stand out as extremely successful, permanently robust and strategically
famous we call them the classic turnaround types. Some of these are:
1.

Chrysler Corporation: Operating in a fiercely competitive market dwarfed by industrial recession, the
company accumulated losses of $3.5 billion by 1981, with $1.7 billion in 1981 alone. By 1985, Lee
Iacocca turned it around. It broke even by 1982 and reported a hefty profit of $2.4 billion in 1984
[See Business Week (1983), Can Chrysler keep its comeback act rolling? (February 14), pp. 58-62;
Business Week (1986), The Next Act at Chrysler, (November 3), pp. 48-52; Gordon 1987].

2.

General Motors: From $80 billion sales in 1979, GM lost $760 million in sales in 1980, but broke even
in 1981. It earned a profit of $3.8 billion on $80 billion sales in 1983 (Burck 1983; Kharbanda and
Stallworthy 1987; Reilly 1984).

3.

Jaguar, a UK company that built luxury cars, enjoyed 500 million in sales in 1979 but lost 28% on
sales in 1980 and another 19% in 1981. Broke even in 1982; earned 10% on sales in 1983 when sales
tripled to that of 1980 to 1,080 million (Chambers 1988).

4.

Fiat of Italy produced 1.4 million cars in 1983 but with return on sales (ROS) of -1.9% in 1980 and
-3.4% in 1981. It broke even in 1983 and earned 2.2% ROS in 1984 (Galimberti 1986; Kharbanda
and Stallworthy 1987).

5.

Volkswagen of Germany sold over 2 million cars in 1978 worth DM 54 billion. Profits began to
decline in 1979 and losses peaked in 1982 and 1983. Broke even in 1984, and reported profits of DM
600 million on sales of DM 54 billion in 1985 (Kharbanda and Stallworthy 1987).

6.

Ilaltel, an Italian Telecommunications Equipment (government-owned) Company, dropped its sales

by 46% in 1980 from 1.2 trillion lira in 1979. However, it broke even by 1983 and earned 4% profits
(25 billion lira) on sales by 1984 (Bellisario 1985).

7.

Olivetti, an Italian office equipment company with 47,000 employees and $4 billion in sales in 1977.
Lost $72 million in sales in 1978. Turnaround to $201 million profits in 1984 (on sales $2.6 billion)
and $264 million in 1985 (on sales $3.9 billion) (Turner 1986).

8.

Black and Decker, a U. S. company that sold power tools and home appliances, reported $1.8 billion
sales in 1984 but lost $158 million in sales in 1985. It pulled back in 1986 with $6 million in profits on
sales of $1.8 billion [Business Week (1987), How Black and Decker Got Back in the Black, (July),
pp. 70-71].
63

9.

British Steel, one of the worlds then largest producer of steel (14 million tons production capacity in
1978), lost 530 million in 1979-80 and continued losing until 1985 when it broke even and earned
76 million profits in 1985-86 and 206 million in 1986-87 [MacGregor 1982; Chambers 1988;
Kharbanda and Stallworthy 1987, pp. 62-69].

10. USX, formerly US Steel, the largest producer of steel in the U. S., lost $279 million in sales in 1979,
continued losing sales until 1983. It broke even in 1984, earned $223 million in profits in 1987, and
tripled profits to $670 million in 1988 [Business Week (1988), Big Steel is Humming Again, (August
8), pp. 50-51; Kharbanda and Stallworthy 1987; pp. 55-61].
11. Steel Authority of India Ltd. (SAIL): A government-owned public sector company in India with
250,000 employees, capacity of ten million tons of steel and 1980 sales of Rupees 60 billion (US$ 7.5
billion at Rs 8/- per US dollar in 1980. [Currently, (11/21/05), the dollar trades for Rs 45.7 in the open
currency market]. SAIL lost Rs 2 billion in sales during 1980-84, broke even in 1984-85, and earned
a profit of Rs 1.5 billion in 1985-86 and Rs 3.6 billion by 1988-89. SAIL experienced a total
turnaround by 1990 (Krishnamurthy 1987; Ninan 1986, 1987; Roy 1986, 1987, 1989).
12. Imperial Chemicals Industries (ICI): Worlds 5th largest chemical company, based in UK, boasted
$13 billion sales in 1979, but started losing thereafter. It lost 48 million in 1982, broke even by the
end of that year, experienced a dramatic complete turnaround that reaped profits of 474 million in
1983 and 734 million in 1984 (up by 55% from 1983) [Business Week (1985), Behind the Stunning
Comeback at Britains ICI, June 3, pp. 48-49; Nelson and Cutterback 1988].

All these 12 turnarounds experienced a complete turnaround during the times indicated. Some of
these companies, however, had setbacks in later years.

Concluding Remarks
Table 1.13 summarizes the stages, definitions, symptoms and remedies of corporate sickness under
corporate stagnancy, underperformance, decline, crisis and death. All businesses have problems: some
involve growth, and some involve underperformance, decline, distress, insolvency and liquidation.
No company is immortal. The best of companies have collapsed after decades of outstanding success.
Recent examples are Enron, Tyco, World.com, Qwest and Global Crossing. It is reported that these five
giant companies alone destroyed a combined capital of $460 billion in shareholder value while moving
inexorably toward bankruptcy (USA Today, October 21, 2002). Part of the failure in all the five firms was
corporate fraudulence.
However, even non-fraudulent companies may go down. GEICO (Government Employees Insurance
Company) grew within 40 years of its existence to be the fifth largest auto insurer in 1975 that offered
excellent values to its customers and shareholders. Suddenly, in 1976 GEICO announced that it lost $126
million on $603 million earned premium. Itel Corporation entertained record expectations in the
beginning of 1979 but reported a loss of $60 million in the second quarter of that year and a $170 million
loss in the third quarter.
However, no company loses just suddenly. Just as there is some pattern to every business success,
there is an analogous pattern to every business failure. Spectacular corporate failures that suddenly hit the
media headlines were years in the brewing. The warning signs and symptoms of gradual decline were
transparent to concerned and sensitive to the middle managers but not always to the top management
(Bibeault 1999: 8).
64

65

Table 1.13: Summarizing Stages, Symptoms and Remedies of Corporate

Sickness
Stage of
Definition of the Stage Major Symptoms
Major Remedies
Corporate
Sickness
Corporate
Stagnation

Status quo; no positive or

negative changes in
performance variables (sales,
market share, customer base,
profits, loyalty) and
profitability ratios (ROS,
ROM, ROQ, ROI, ROA, ROE,
EPS, P/E, NW)

Corporate
Underperformance

Lower performance than

industry averages in key
performance variables,
efficiency ratios, profitability
ratios, liquidity ratios, leverage
ratios and activity ratios.

Organizational
Decline

Zero growth in sales, market

share and profits compared to last
few periods (weeks, months,
quarters, or years). K-extinction:
the macroniche or industry
supporting a population of firms
is shrinking and getting
exhausted, and so does any firm
in the industry (Wilson 1980).
Intense inter-firm rivalry may
decide final survivors in the
industry.
Decreasing sales, market share
and profitability over several
contiguous periods (weeks,
months and quarters)

Reemphasize corporate mission, vision

and goals. Increase R&D for innovating
new products and services that induce
market or technological breakthroughs.
Explore new markets and trade regions.
Seek corporate strategic alliances.
Visionary leadership should energize
and empower all major stakeholders
(e.g., employees, customers, suppliers,
and channel partners).

Progressive decrease in the

resource base (e.g., capital,
skills, technology, patents,
suppliers, retail partners,
customers) of the organization

Cutbacks in R&D, innovations,

retraining, and revamping
products; downsizing of plants,
human power, R&D; no
innovations; mal-adaptation to
environmental changes;
protracted erosions of sales,
customer base, market share,
demand, and profitability

Revitalize resource base by HRD, CRM,

SCM, ERM and PRM. Identify and cut
cost overruns, slack, wastage, theft,
crime, worker apathy, and customer
dissatisfaction. Devise strategies for
generating revenues via exploring new
markets and product opportunities.

Organizational
Crisis

Low probability, high-impact

events (LPHI) or high
probability, low-impact (HPLI)
events that threaten the
viability of the organization;
they cannot be easily analyzed,
predicted or controlled.

LPHI events are normal crises

(e.g., systems breakdown),
abnormal crises (human
interventions) and natural
disasters. HPLI are normal crises
(e.g., product defects, wastage),
abnormal crises (absenteeism,
labor apathy) and common
natural disasters.

Foresee both LPHI and HPLI events,

preempt and prevent what can be
preempted and prevented, and buffer,
insure and insulate against what cannot
be avoided.

Organizational
Death

Imminent organizational death

is insolvency, Chapter 7
bankruptcy filing, and
subsequent liquidation and
closure. The organization
ceases to exist.

Protracted and unaddressed

industrial stagnancy, corporate
underperformance, decline and
distress; persistent loss in sales,
market share, customer base,
profits, efficiency ratios,
profitability ratios, liquidity
ratios, leverage ratios and activity
ratios; increasing loss of
confidence and support from
governments, suppliers, creditors,
employees and customers.

Seek turnaround expert help to bail out

the company from crisis or distress.
Make every internal effort to avert
demise. Double up collective renewal
efforts at cutting costs and generating
revenues. If you can reorganize, then
seek Chapter 11 Bankruptcy protection.
If death is inevitable, then announce
closure in time so that all stakeholders
are warned and prepared for a smooth
transition from moribund life to death.

66

Investigate external (e.g., economic

slump, industry stagnation, consumer
apathy) and internal (e.g., low employee
morale, ineffective promotional
strategies, poor product quality, not
honoring warranties and guarantees)
causes of and remedies for
underperformance.

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Turnaround Executive Exercises

1.1

In general, a failing business poses two main problems:

1.
2.

How to resolve the day-to-day operational problems of cash flow management and
How to restructure the debt and equity of the business until the corporation is back on its feet again.

Define the following concepts in resolving these problems:

a)
b)
c)
d)
e)
f)
g)
h)
i)
j)
k)

1.2

A turnaround
A turnaround process
A turnaround situation
Turnaround management
Restructuring management
Emergency strategies
Reorganization strategies
Rescue strategies
Restructuring strategies
Survival strategies
Transformation strategies.
Even though business turnarounds have had a history of over two and half centuries in the USA, yet a
consistent and systematic management theory of business turnarounds has not yet evolved. How do the
following arguments explain this phenomenon?

a)

The topic of business turnarounds remains largely idiosyncratic, descriptive, anecdotal, open-ended and
non-cumulative with hardly any conceptual and theoretical developments (Pearce and Robbins 1993).
b) Every turnaround deals with reversing a specific organizational underperformance and hence, has a
unique content and context that cannot be generalized into a concept, theory or model (Bibeault 1998).
c) Because a turnaround deals with the survival of organizations, it is viewed as a performance issue (and
not a conceptual and theoretical one) in strategic management (Chowdhurry 2002).
d) Analyzing corporate failure has been a major activity in management literature. But the first stream of
analyses was primarily restricted to large public-sector firms (Whetten 1980b, 1987; Zammuto 1983).
e) Analysis of large or small private-sector firms, however, has been steadily increasing (e.g.,
Arogyaswamy 1992; Barker and Duhaime 1997; Barker and Mone 1998; Bibeault 1998; Blayney 2002;
[See under References above].
1.3

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. In this context, define and illustrate the following
concepts:

a) A product life cycle

b)A business cycle
c) A corporate business life cycle
d)A first turning or an inflection point in sales
e) A first turning or an inflection point in profits
f) A turnaround situation
g)A second turning or an inflection point in sales because of market breakthroughs
h)A second turning or an inflection point in profits because of technological breakthroughs
i) A first mover
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j) A later mover
k)Initial competitive advantage
l) A duopoly
m) An oligopoly
n)Tough competition
o)Corporate decline
p)Transformation management
q)Delayed turnarounds
1.4

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, market share, return on sales
(ROS), 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), return on equity, earnings per share, price earnings (P/E) ratio, market
valuation (MVA), and Tobins Q).

Define and illustrate these three sets of variables for fiscal years 2005-2012 in relation to a failing company
(e.g., Ford, Visteon, Delphi, or King Fisher or Northwest Airlines) and a rising company (e.g., Tata & Sons,
Toyota, Dell, Microsoft, or Southwest Airlines).
1.5 Study Table 1.1: Contrasting Organizational High Performance with Underperformance Measures.
a)

Applying the organizational high performance measures verify them among your winners (e.g., Toyota,
Dell, Microsoft, AMD, or Southwest Airlines).
b) Applying the predicted organizational underperformance measures verify them among your losers (e.g.,
Ford, Chrysler, GMC, Visteon, Delphi, Intel, Fanny May, Delta Airlines, or Northwest Airlines).
c) Applying the organizational high performance measures verify them among the companies that recently
indulged in accounting irregularities (e.g., Qwest Communications, Broadcom, AOL Time Warner,
Gateway, Ariba, JDS Uniphase, I2 Technologies, Sun Microsystems, Enron, Global Crossing, Charles
Schwab, Yahoo, Cisco Systems, Peregrine Systems, Sycamore Networks, Nextel Communications,
Foundry Networks, Juniper Networks, Infospace, Commerce One, AT&T, Network Appliance,
Inktomi, and Priceline [See Chapter Two, Appendix 5.1; see also Fortune, September 2, 2002, pp. 6474].
d) Applying the organizational high performance measures verify them among the companies that recently
indulged in insider trading irregularities (e.g., Qwest Communications, Gateway, Ariba, I2
Technologies, Sun Microsystems, Enron, Global Crossing, Cisco Systems, Sycamore Networks, Nextel
Communications, Juniper Networks, Priceline, and Vignette). [See Chapter Two, Appendix 5.2; See
also Forbes (July 25, 2002)].
e) Applying the predicted organizational underperformance measures verify the same companies listed in
(c) above.
f) Applying the predicted organizational underperformance measures verify them among the same
companies listed in (d) above.

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1.6

Study Table 1.2: What Characterizes Winner from Loser Institutions?

a)

Explore what separates winners (e.g., Toyota, Dell, Microsoft, AMD, and Southwest Airlines) from
losers (e.g., Ford, Visteon, Delphi, Intel, Northwest Airlines).
b) Study the marketing performance variables of these companies during 2000-2005.
c) Study the marketing-finance performance variables of these companies during 2000-2005.
d) Study the financial performance variables of these companies during 2000-2005.
e) To what extent to these sets of performance variables separate the winners from the losers?
1.7

Hammond, Keeney and Raiffa (2006) identify several hidden traps of bad decision making that generally
lead to organizational underperformance. Study these traps in relation to the loser companies discussed
under Turnaround Executive Exercise 1.5. Specifically,
a)
b)
c)
d)
e)
f)
g)

1.8

Schoemaker and Gunther (2006) list ten deeply held (faulty) assumptions about how best to run a business
and avoid mistakes:
a) Cold calling Fortune 100 prospects does not work.
b) Our clients are primarily on trust and reputation, with limited price sensitivity.
c) Young MBAs dont work well for us; we need experienced consultants on the team.
d) Bundled pricing is better than separate pricing for each of a projects components.
e) Seniors partners must get more pay from their billing bonuses than from their base salaries.
f) Formal interviews with clients must always be done by two consultants, with one taking notes.
g) The firm can be successfully run by a president who is not a senior consultant with significant billings.
h) Executive education and consulting are natural cross-selling activities.
i) Books and articles are vital to the firms image as cutting-edge and rigorous.
j) 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.
a)
b)
c)
d)
e)
f)
g)
h)
i)
j)

1.9

Define, illustrate and explain how the Anchoring Trap plagued the losers.
Define, illustrate and explain how the Status Quo Trap constrained the losers.
Define, illustrate and explain how the Sunk Cost Trap vexed the losers.
Define, illustrate and explain how the Confirming-Evidence Trap stalled the losers.
Define, illustrate and explain how the Framing Trap restricted the losers.
Define, illustrate and explain how the Forecasting Trap miscued the losers.
Define, illustrate and explain how the Prudence Trap stymied the losers.

Do you agree with these ten assumptions, why or why not?

Identify fundamental sub-assumptions under each of the ten assumptions above.
Rank these assumptions according to the seriousness of their impact to a given company.
What would you do if you knew any one of the assumptions was false?
What would you be willing to bet (e.g., reputation, career) that this assumption is correct?
Would potential gain from a mistake in this area greatly outweigh the cost?
Do executives rely on this assumption repeatedly?
Have the original conditions that justified this assumption changed drastically since?
Does the complexity of the problem justify this assumption?
Is your experience with this assumption limited?

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 or internalized or routine actions that we just do (e.g., driving a car, speaking native
78

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.
a) Test the ten executive assumptions under Executive Exercise 1.8 by examining them under which
Systems 1-3 they fall best and why, either individually or in groups.
b) Among other things, factors that can justify certain assumptions are: 1) Would potential gain from a
mistake in this area greatly outweigh the cost? 2) Do executives rely on this assumption repeatedly?
3) Have the original conditions that justified this assumption changed drastically since? 4) Does the
complexity of the problem justify this assumption? And 5) Is your experience with this assumption
limited? Apply these five factors to each of the same ten assumptions and verify them.
c)

1.10

When fundamental assumptions are wrong, companies can achieve success more quickly by
deliberately making errors than by considering only data that support their 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. How will you go
about testing these ten assumptions (or their equivalents) in a failing company, especially in learning
faster from them via deliberate mistakes?

Study Figure 1.2: Organizational Decline: Antecedents, Concomitants and Consequences, and apply it to any
of the following declining firms: Ford, General Motors, Visteon, Delphi, Gateway, Intel, Motorola, and
Northwest Airlines). Specifically, examine:
a) Firm specific problems that brought about the decline.
b) Regulation-deregulation related challenges (e.g., EPA, CAF, and OSHA) that triggered the decline.
c) Industry related problems (e.g., contraction, stagnation, obsolescence, convergence) that precipitated
the decline.
d) Symptoms of decline (e.g., erosion of sales, market share, customer base, and profits).
e) Short term consequences of decline (e.g., negative cash flows, bleeding, cash crisis, inability to pay
payables, deferred taxes, and short-term debt defaults).
f) Long term operational consequences (e.g., cost overruns, revenues declines, budget cuts, and reduced
R&D).
g) Long term financial performance consequences (e.g., erosion of ROS, ROQ, ROM, ROA, ROE, ROI,
EPS, P/E, net worth, market cap, and Tobins Q).
h) Hence, assess support-withdrawal from stakeholders (e.g., customers, suppliers, creditors, investment
bankers, venture capitalists, distributors, retailers, stockholders, employees, and the top management).

1.11

In order to better understand the definition, dynamics and symptoms of an organization decline, do the
following:
a)
b)
c)
d)
e)

What is an organizational decline?

What are its typical determinants, concomitants and consequences?
What are its basic symptoms?
A prevalent definition of organizational decline (Cameron, Kim and Whetten (1987) states, that it is a
decrease in the resource base of an organization. What assumptions and questions does this definition
raise?
How does organizational decline differ from organizational downsizing?
79

f)
g)
h)
i)
j)
k)
l)
m)
n)
o)
1.12

How does organizational decline differ from organizational downturn?

How does organizational decline differ from industrial stagnation?
How does organizational decline differ from organizational mal-adaptation to its environment?
How does organizational decline differ from organizational cutback?
How does organizational decline differ from organizational distress?
How does organizational decline differ from organizational crisis?
How does organizational decline differ from organizational failure?
How does organizational decline differ from organizational insolvency?
How does organizational decline differ from organizational bankruptcy?
How does organizational decline differ from organizational death?

Study the causes of organizational decline in any of the currently failing companies (e.g., Ford, GMC, Delphi,
Visteon, Intel, or Northwest Airlines). Which of the following schools of thought best explain the causes
of this decline and why?
a)

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).
b) Organization Theory School: Organizational decline is pathology in corporate decision-making and
adaptation processes.
c) Empirical School of Research: Large sample studies of turnaround versus non-declining firms link
organizational decline to operational and financial ratios.
d) 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, R&D expenses, CGA or SGA). In general, these
studies worked on declining firms without necessarily studying the causes of the decline.
e) A growing body of research on organizational decline (e.g., Cameron, Sutton and Whetten 1988;
Whetten 1987) traces the causes of decline to industry contraction (shrinking and stagnation of the
industry such that it can support less and less firms).
f) A number of researchers have proposed that the reasons given by top managers for their firms declines
will influence the subsequent strategies chosen to reverse the decline (Ford 1985; Ford and Baucus
1987; Lant, Milliken and Batra 1992).
g) Weitzel 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.

1.13

Ford and Baucus (1987) identify several types of organizational decline such as latent or manifest, each of
which can be relative or absolute. Table 1.4 sketches these types.
a)

Manifest absolute organization downturn occurs: a) when absolute downward cross-sectional

changes in performance (e.g., sales, profits) or upward changes (e.g., in costs, crime, defects) are
noticed, and b) when absolute downward longitudinal 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.
Verify these stages of decline in the failing company you are studying.
b) 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 (e.g., promotions, wage increases, promotions,
advertising) do not generate proportionately adequate returns (e.g., increase in demand, sales,
market share, profits, brand name, reputation) to cover the cost of inducements. Verify these stages
of decline in the failing company you are studying.
c) Latent relative organizational downturn occurs when decision makers in an organization assess the
corporations inabilities to satisfy their inducement aspirations relative to other organizations (e.g.,
subsidiaries, competition). Verify these stages of decline in the failing company you are studying.
80

d) Latent absolute organizational downturn occurs when the organizations demographics change,
producing potential shifts in demand. Verify these stages of decline in the failing company you are
studying.
e) Some manifest downturns result from revolutionary or discontinuous events that occur suddenly
and without warning. Verify these stages of decline in the failing company you are studying.

1.14

Weitzel and Jonsson (2001: 8-10) identify five stages in an organizational decline:
1.

2.

3.
4.
5.

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?
The Inaction Stage: decline becomes noticeable when the organization may recognize the problem but fails 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?
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?
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?
The Dissolution Stage: Decline precipitates until the organization ceases to exist as a distinct viable entity. Slow
demise sets 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?

a) Which of these stages best explains the causes of organizational decline in any of the currently
failing companies (e.g., Ford, GMC, Delphi, Visteon, Intel, or Northwest Airlines) and why?
b) Which of these stages enables best to predict the causes of organizational decline in that failing
company and why?
c) Which of these stages enables best to control the causes of organizational decline in that failing
company and why?
d) Each of these stages raises key questions (as indicated above). How do they best explain, predict
and control the causes of organizational decline in the failing companies that you are studying?

1.15

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). Table 1.5 categorizes
organizational crisis by a) its source (system breakdown, human intervention, or natural disaster) and b)
its low versus high probability of occurrence and low versus high organizational impact.
a)
b)
c)
d)

Define an organizational crisis. Describe its symptoms, concomitants and consequences in

relation to the failing company you are studying.
Some crises can be recurrent and non-preventable, whether they are system breakdowns, human
interventions or natural disasters. However, their organizational impact is low. Describe its
symptoms, concomitants and consequences in relation to the failing company you are studying.
Other crises are rare but their organizational impact is high. Effective management of such a crisis
is difficult and often partial. Describe its symptoms, concomitants and consequences in relation to
the failing company you are studying.
This definition implies that organizations 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
81

e)
1.16

often surprise organizational members and e) they present an organizational dilemma that needs to
be resolved. Verify these circumstances in the failing company you are studying.
In general, most organizational crises imply and/or accompany losses of capital, human resources,
revenues and reputation. Verify these circumstances in the failing company you are studying.

Corporate sickness occurs when an organization plans, operates, produces, markets and financially
performs under par, under industry average, under benchmarking companies, and under self-targeted goals
and objectives. Corporate sickness can be of many kinds, degrees, origins, symptoms and outcomes.
a)
b)
c)
d)
e)
f)
g)

What is corporate sickness? What are its typical antecedents, concomitants and consequences?
How would you distinguish and treat corporate sickness from corporate underperformance?
How would you distinguish and treat corporate sickness from corporate decline?
How would you distinguish and treat corporate sickness from corporate distress?
How would you distinguish and treat corporate sickness from corporate crisis?
How would you distinguish and treat corporate sickness from corporate insolvency?
What are the input-symptoms of corporate sickness? Trace them in the failing companies that you are
investigating.
h) What are the primary process-symptoms of corporate sickness? Trace them in the failing companies
that you are investigating.
i) What are the secondary process-symptoms of corporate sickness? Trace them in the failing companies
that you are investigating.
j) What are the output-symptoms of corporate sickness? Trace them in the failing companies that you are
investigating.
1.17

Caplan (2003: 9-15) lists seven signs of sickness or trouble that can threaten a business: a) Little or no
revenue growth; b) Deteriorating capital base; c) Equipment failure that threaten productivity; d) Poor
employee morale; e) Unpaid taxes; f) Failure or closing of major customers, and g) New technology
creating price pressure. Trace them in the failing companies that you are investigating.
We should also clearly distinguish between symptoms from causes of corporate sickness or decline.
Symptoms are merely telltale signs or danger signals that perceptive investors, customers and analysts
quickly perceive. Symptoms provide clues as to what might be wrong with the firm, but they do not
provide a guideline for management action (Slatter and Lovett 1999:13). Identify these symptoms in the
failing companies that you are investigating.
Causes are the sources of symptoms, and are difficult to detect. Turnaround managers look for both
symptoms and causes of symptoms. Serious forms of organizational sickness are usually defined in terms
of profitability. Identify these symptoms in the failing companies that you are investigating.
The firm may be profitable, but not profitable enough because the flow of cash is unacceptable. There is
credible evidence that the cash or profit flow is soon going to be unacceptable. Identify these symptoms in
the failing companies that you are investigating.

1.18

Typically, outsiders detect corporate sickness most of the times. Table 1.7 lists most likely outsider
detectors and investigates their earliest sources of symptoms detection by three categories: business, capital
markets, and financial information. Using Table 1.7 investigate who among outsiders detected the sickness
symptoms in the failing companies you are investigating and how? Specifically, explore the following
outsider potential detectors:
a)

Where the Wall Street Journal analysts (in the case of publicly traded companies) the first to track,
detect and warn symptoms of corporate sickness? Did they force to do something about these
symptoms before they would threaten to lower the bond or stock ratings?
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b) What role did the Suppliers and vendors play in detecting sickness? Did invoices not getting paid on
time, accumulated debts, decreasing orders or lack of new orders trigger detection of sickness
symptoms?.
c) Did Banks who loaned the capital get dissatisfied with debt service or debt amortization, bank
overdrafts and thus unwilling to extend credit?
d) Did Distributors who retail products detect corporate sickness by the lack of demand for the
companys products or services? Were the distributors forced to offer deep discounts to clear
overstocked inventories of the companys products? Did the company force higher sales quota or
larger purchases? Was the company unable to pay slotting allowances? Did the company refuse to sell
on consignment?
e) Were the Customers angry and dissatisfied because their product/service warranties and guarantees
were not being honored or their complaints are not redressed promptly? Did customers lose
confidence in the company and its products?
f) Did the Federal and state governments use their lien-wielding weapons on the failing companies to
recover what was owed them in taxes and other payables? Did the failing companies catch up with
taxes unpaid or tried to evade them?
1.19

Management scholars identify several reasons for corporate sickness and failure. Investigate the following
qualitative criteria in the failing companies you are investigating.
a)
b)
c)
d)
e)
f)
g)
h)
i)

1.20

A headless firm of inconsistency and vacillation in strategy with different parts of the firm working at
cross-purposes (Miles and Snow 1978; Miller 1977)
Executive inertia, the sluggish organization, or very limited domain initiative (the latter construct is the
extent to which the firm changes its products and markets) stemming from environmental restraints or
from the firms own capacity to act (Hannan and Freeman 1977; 1984).
Excessive risk taking (financial, technological, scale and organizational risks) adding to those already
present (Richards 1973); this typology is the opposite of executive inertia.
Impulsive firm with extremely bold and rapid expansion in the years preceding failure (Miller 1977)
Lacking domain initiative (Argenti 1976), (that is, lacking leadership, pioneering, market venture, risktaking, creativity, inventions, innovations and entrepreneurship within the industry domain or productlines) and stagnant bureaucracy (Miller 1977; Miller and Friesen 1977).
Rapidly contracting environmental carrying capacity (i.e., the ability of the environment to support the
firm owing to industry contraction) was suddenly shrinking or eroding or the contrary.
Slow environmental decline (Tichy and Devanna 1986). The failing firm does not register the slow but
noticeable differences in the declining environment, is slow or rigid or too late to respond, and does not
escape to more favorable environments.
Organizational slack: Originally conceived as a surplus of resources beyond those required to maintain
the organizational coalition (Cyert and March 1963), organizational slack has been more broadly
defined as a cushion of actual or potential resources (Bourgeois 1981:30).
Downward Spiral: Organizational decline reflects a downward spiral as weakness (especially, in sales,
profits,) leads to even greater weakness in linked variables (e.g., debt-equity, net income/asserts) and
lack of financial and cash slack.

Managerial accountants and financial analysts have established several quantitative criteria for detecting
corporate sickness. More recent, effective and insightful financial performance measures include the
following (See Barney 2001:38-66). Investigate these ratios in the failing companies that you are
investigating:
a)

NOPLAT (Net Operating Profit less Adjusted Taxes) = EBIT [taxes on EBIT + charges on deferred
income taxes].
b) IC (Invested Capital) = (Operating current assets + book value of fixed current assets) (net other
operating assets + non-interest bearing current liabilities).
83

c)

WAATCD = weighted average after tax cost of debt = (market value of debt) x (after tax cost of
debt)/firms market value.
d) WACE (weighted average cost of equity) = (market value of equity)(cost of equity)/firms market value.
e) WACC (Weighted Average Cost of Capital) = WAATCD + WACE
f) ROIC (return on invested capital) = NOPLAT/IC
g) EP (economic profit) = IC (ROIC WACC) = actual economic value created by the firm.
h) MVA = (market value of equity + market value of debt) economic book value.
i) Tobins Q = market value (MV) of the firm/Replacement value of the firms assets.
j) Tobins Q may also be estimated as MV/Total assets = market value performance of the firms assets =
Market value/Book value or Market to book ratio of the firm = Value shareholders and other
investors attach to the firm over and above its asset or book value = market value of a companys
intangible assets.

84

Appendix A: Illustrating the Point of Inflection in Product Cycles

Year
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012

Annual Sales
($000)
200
250
320
420
540
670
810
970
1210
1500
2000
2300
2400
2400
2500
2540
2530
2500

D =ds/dt

D =ds2/dt2

50
70
100
120
130
140
160
240
290
500
300
100
0
100
40
-10
-30

20
30
20
10
10
20
80
50
210
-200
-200
-100
100
-60
-50
-20

85

Point of
Inflection

B*
C
D**
E
F