Journal of Business Strategy

Emerald Article: Traps in diagnosing organization failure Vincent L. Barker III

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To cite this document: Vincent L. Barker III, (2005),"Traps in diagnosing organization failure", Journal of Business Strategy, Vol. 26 Iss: 2 pp. 44 - 50 Permanent link to this document: http://dx.doi.org/10.1108/02756660510586337 Downloaded on: 29-05-2012 Citations: This document has been cited by 1 other documents To copy this document: permissions@emeraldinsight.com This document has been downloaded 1572 times.

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Traps in diagnosing organization failure

Vincent L. Barker III

Grasping reasons for decline may be elusive

Vincent L. Barker is an Associate Professor of Strategic Management and Charles W. Oswald Research Fellow at the University of Kansas School of Business, where he teaches classes on general management and corporate strategy. His research on corporate turnaround attempts has been published in a number of academic journals (vbarker@ku.edu).

When your company is in trouble, nding and understanding the sources of problems is not as simple as looking in the mirror. If diagnosing decline were easy, we never would have seen corporate icons staffed by very smart managers like GM, Sears, K-Mart, Montgomery-Ward or IBM go through long periods of poor performance in recent decades. In reality, however, understanding the causes of corporate failure can elude even the smartest managers. In this article, I describe why nding the sources of decline in an organization can be so elusive and I outline some actions that managers can take to help themselves in troubled times. What makes diagnosing decline so difcult is that it is a complex human informationprocessing task. For the sources of decline to be discovered, an organizations top managers must both perceive the sources of decline and develop an understanding of how these sources negatively affect the achievement of the organizations goals. While this process seems simple enough, the nature of how people (i.e. top managers) make sense of complex information in organizations is riddled with pitfalls that throw the process awry. These pitfalls happen in both the perception and understanding of the sources of decline. I focus most on the pitfalls that I have discovered most frequently in my interviews, surveys and studies of top executives at rms trying to turn around that have been the basis of a number of academic studies of turnarounds that I have published in the last decade[1].

Pitfalls in perceiving the sources of decline

For top managers to understand the sources of organizational decline, they must rst perceive or see the factors or forces driving problems. This seeing is made difcult by two facts. First, decline often stems from multiple sources both outside and inside the organization that coalesce at the same time. Outside the organization, decline can be caused by changes in technology, a recession, the moves of competitors or numerous other causes that hurt the organizations ability to achieve its mission. Inside, decline can stem from sources such as a weak strategy, a dysfunctional organizational culture, nancial mismanagement or other factors. Thus, the fact that decline can and usually does result from multiple sources makes perceiving its causes difcult. Second, top executives in todays organizations are overwhelmed with potential data or signals about the sources of rm decline. They read accounting reports, internal memos, consultants reports and media accounts about their organizations problems. They are bombarded with verbal information about potential problems from subordinates, suppliers, friends and other people. Some of this data may provide clues to the sources of decline but much of it will be useless. Sorting through this vast tidal wave of information is difcult because top managers, as human beings, have limited abilities to handle and process information[2]. Hence, top managers, often unknowingly, take mental shortcuts in looking for the sources of their organizations decline. While these shortcuts help them deal with the overwhelming amount

The author would like to thank Paul Nystrom, Mark Mone and George Mueller for his discussions with them over the years on this topic. Also, the author would like to thank Chris Lamke and Martina Musteen for their help on this version of the manuscript. However, any errors are the authors alone.

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JOURNAL OF BUSINESS STRATEGY

VOL. 26 NO. 2 2005, pp. 44-50, Q Emerald Group Publishing Limited, ISSN 0275-6668

DOI 10.1108/02756660510586337

of signals they face, the shortcuts often lead managers to misperceive the sources of decline. Problem shortcut #1: relying on ltered data To sort out potentially good from bad information, top managers often heavily rely on written and verbal reports from their subordinates. While this sharply reduces information overload, the danger in this shortcut is that they receive poor quality or ltered information about the factors driving rm problems. For example, most accounting and information systems are very good at reporting operational data about costs, revenues, and manufacturing defects even at the lowest product/market level. However, this information tells managers, at best, if a problem already exists and sometimes where that problem may be located. This is relatively poor data for perceiving the actual sources of problems. For example, a CEO with an accounting report saying that revenues are falling for a particular product line cannot readily perceive why revenues are falling (is it predatory pricing by competitors, poor product design, end of the products life cycle, etc?)[3]. Because accounting systems provide rough data that often is not timely, top managers rely on verbal (and sometimes written) reports from subordinates about possible problems, but verbal information often gets distorted in organizations as it is passed between people or rises through the hierarchy. Supervisors near the sources of problems may be reluctant to pass along information that makes them look bad and, therefore, they may sugar coat problems or even hide them completely. As a result, senior managers often receive heavily distorted information or even wrong information about the causes of decline. This situation makes accurately perceiving the sources of decline difcult. Problem shortcut #2: paying too much attention to salient information Another way that decision makers deal with the tidal wave of information facing them is to allocate most attention to pieces of information that are salient or most visible in their environments[4]. While this makes some sense, as the causes of problems are sometimes obvious, information salience is easily skewed by the sources that provide information to top managers. For example, the business media, business gurus and consulting rms tend to promote fads that can have a bandwagon effect that sweeps through the corporate and organizational world. As scholars have noted, these fads tend to come and go and many do not prove to have much long-term effect on organizational performance[5]. However, these salient ideas can absorb a managers attention at a critical juncture when he or she is trying to perceive what is causing performance to decline. If one follows trends in the popular press, a manager of a declining rm in the mid-to-late 1990s might have looked at not having an Internet presence as a reason for decline (at the time, many press outlets were talking about how bricks and mortar organizations were doomed by the Internet and how a business model without a web presence was obsolete). Yet now, in the early twenty-rst century, the same media are talking about how organizations doomed themselves by rushing into Internet commerce without a clear strategy and turned their businesses into enterprises forced to compete on low margins. In either case, the Internet becomes a salient source of possible organizational decline, even though the press spin differs. Thus, salience has the possibility to focus managers on fads or whatever

For example, a CEO with an accounting report saying that revenues are falling for a particular product line cannot readily perceive why revenues are falling (is it predatory pricing by competitors, poor product design, end of the products life cycle, etc?)

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industry competitors are doing rather than more thoughtfully sorting through the signals of what might be causing poor performance. Problem shortcut #3: selective perception To further handle the tidal wave of signals competing for their attention, executives practice selective perception. In particular, they tend to look for information originating in areas of the organization or competitive environment where they have found useful information in the past about organizational problems or issues. Signals originating from other sources tend to be ignored and are off the radar of top executives. This practice of selective perception can be very useful for screening out noise information, if the organizations decline is caused by issues that top management has faced previously. However, it can also blind managers to perceiving threats stemming from novel problems. For example, selective perception by top executives seems to have played a role in IBMs decline in the early 1990s. The genesis of IBMs problems actually began in the mid-1970s with the birth of personal computer (PC) technology. While some scientists at IBM were well aware of the potential of PC technology, IBM top managers largely ignored it for almost a decade, investing most of IBMs massive R&D budget in traditional mainframes, minicomputers, software and services that could be sold to its traditional customers, which were large corporations. Because PCs were not being demanded by these traditional, familiar customers, IBMs top managers were not paying much attention to the revolution in PC technology. It was not until the early 1980s (more than half a decade after the birth of the PC), when Apple computers started suddenly showing up in some big corporations, that IBMs top managers started to notice the threat that PCs could play to IBMs business. The years of not perceiving the importance of this technology put IBM far behind in PC product development, and they were forced to quickly rush a product to market to meet exploding PC demand. It was during this rush to market that IBMs managers decided to outsource their PC operating systems to Microsoft and their microprocessor to Intel. These decisions led to the open standard that dominates the PC market today, turning it into a low-margin, commodity business for PC manufacturers. IBM was never able to compete very well in this low-margin market and was bleeding red ink by the early 1990s as PCs increasingly replaced mainframes and minicomputers in corporations. Had IBMs top managers perceived the threat of PC technology earlier, the computer industry might look quite different today. IBM historically made products with strong proprietary content, and the company would have likely developed a PC that was not an open system if product development had been launched years earlier. This would have given IBM a much stronger competitive position in the PC market today and avoided the nancial losses that plagued IBM in the early 1990s[6].

Pitfalls in understanding the sources of decline

Not only must top managers perceive the sources of decline, developing effective response strategies necessitates understanding the drivers of decline and how they affect the organization. Once again, the nature of how people make decisions can lead them astray in this process of trying to assign causes to decline. Indeed, top managers often suffer what can be called cognitive biases that color their view of the world. These biases can cause different decision makers to come to opposite conclusions when faced with the same situation. The following is a short overview of several important biases, drawing examples from my own research. Cognitive bias #1: self-serving causal interpretations For decades, researchers in psychology have been showing that people tend to develop self-serving interpretations of how the world around them operates. In particular, one fundamental bias is that people tend to take credit for their own successes and but blame failure on circumstances beyond their control. Top managers are no exception to this rule, which can strongly inuence how they make sense of their rms problems.

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A classic example of this bias comes from my own research. Some years ago, I interviewed 20 chief executive ofcers of publicly traded companies in growing industries that were trying to turn around from decline (as part of a larger research project). As part of this interview process, each CEO lled out a survey with a list of questions asking him or her to rate how some possible causes of decline were affecting the rms situation. As illustrated in Figure 1 below, the CEOs answers revealed a self-serving tendency when asked about the contribution of top managements abilities to the decline and if the causes of decline were controllable by rm management. In particular, if the CEO was part of the top management team that was in place when the rm initially began to decline, there was a marked tendency of the CEO to blame decline on causes uncontrollable by management and to suggest that top managements abilities were not sources of decline but rather strengths in the face of failing performance. This belief pattern is self-serving because it absolves top management of causing the rms troubles. In contrast, CEOs who were not part of the top management team when the rm began to decline (i.e. were either brought in from the outside or were promoted to lead the turnaround attempt) were much less sanguine about top managements role in causing the decline and believed more in its controllability by top managers. Of course, these CEOs had no personal connection to strategic decisions that were made before the decline and therefore had no reputation or ego to protect in believing that top managers were at least partly responsible for rm problems. This is not to say that either group of CEOs in the above cited study were right or wrong in their beliefs about the causes of decline at their rms. Rather, Figure 1 illustrates that top executives tend to develop causal understandings of decline that are somewhat self-serving, indicating that diagnoses of decline are not necessarily objective but rather get intertwined with individual motivations. Cognitive bias #2: experiential and personality inuences Our varied experiences as individuals can cause us to see complex problems and their solutions very differently. While everyone can agree on solutions to simple problems (i.e. we Figure 1 CEOs answers

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all know that 2 2 4), messy problems where causes may be multiple and not obvious, such as trying to x a declining organization, bring out different perspectives and solutions from people based on their experiences and personalities. For example, I tried an experiment several years ago with night MBA and executive MBA students to illustrate experiential biases in diagnosing decline. In this experiment, students were given a fairly complex case to read about a declining leather goods manufacturer as part of a class on general management and strategy. The case contained numerous possible causes of the rms decline, such as poor control systems, weak product development, high labor costs, strong competition and retail channel problems, to name just a few. Indeed, the company in the case had numerous inter-related problems (i.e. a messy situation). I then asked the students to imagine themselves as the new CEO of the company and gave them a questionnaire with a long list of possible actions that the new CEO could take in trying to turn around the rm. The students were then asked to rate on a ve-point scale how likely they were to take each action as CEO. The students also lled out an anonymous questionnaire about their demographics, background and career experiences. While I expected to nd evidence of biases in students preferred turnaround actions based on their experiences in various functional areas (i.e. accounting vs marketing), I found only very limited evidence of such biases. What I did nd, however, were stronger biases based on both gender and nationality. In particular, women were more likely to lean away from downsizing than men, as were international students compared to their American counterparts[7]. These ndings illustrate how individual characteristics may color an understanding of the sources of rm problems and what is perceived to be an efcacious response. A number of studies have documented how women may practice a more people-oriented form of management, which may explain their leaning away from downsizing in this experiment. Also, in these particular graduate programs, the international masters students tended to come from Southeast Asia, where a more community-oriented form of capitalism is practiced. As such, these students grew up in cultures where top executives are more likely to take community needs (i.e. avoid lay-offs) into account when making business decisions[8].

Cognitive bias #3: problem framing Diagnosing decline occurs within a very difcult context. Declining organizations must deal with shaky stakeholder support, and top managers are often under extreme pressures from stockholders, institutions, lenders, employees and suppliers that have a nancial stake in the organization. In addition, nding solutions to decline is a multi-stage process where problem areas must rst be identied, and then causes of problems must be determined within these areas. If the problem area is identied or perceived incorrectly, solutions may also be off course. For example, in the experiment where I had MBA students read the messy case about a declining organization, they were also asked to individually assume the CEO role to perform an analysis of the rms environment and internal slack resources. Finally, they were asked to rate the likelihood that they would use a number of either aggressive growth-oriented or retrenchment actions as the turnaround manager. While I believed that a students perceptions of the environment would inuence the aggressiveness of his preferred turnaround strategy (moderated by the amount of slack), a different relationship, reported in Figure 2, emerged from the analyses[9]. As shown in Figure 2, a students analysis of the environment framed subsequent evaluation of slack, which then inuenced the aggressiveness of response to decline. In other words, if a decision maker originally perceived the environment as hostile, this framed the subsequent decision by predisposing the decision maker to perceive less rm slack, which then led to a less aggressive response to decline. Interestingly, this nding matches other scholars suggestions and ndings that perceptions of environmental hostility frame subsequent decisions to be less aggressive and more conservative[10].

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Figure 2 Framing the decline problem

There were no right or wrong answers in the list of actions given to the student decision makers in the experiment. Both aggressive growth actions and retrenchment actions could be justied by some evidence in the case. The point of the experiment was to illustrate how the initial framings of the decline problem can lead top managers down different decision paths when analyzing the same facts.

Help for managers

Following are some guidelines for managers when searching for the sources of an organizations decline: Tip #1: top managers should directly engage the environment Top managers can decrease their chances of misperceiving the causes of decline by not relying on ltered or distorted data. In particular, by talking directly and frankly with entry-level employees, customers and suppliers, they can learn quite a bit about how the organization is failing. So, for example, when a key customer defects to a competitor, the CEO needs to visit that customer and nd out exactly why the customer left. Such frank discussions can often reveal where real organization problems lie. Also, entry level employees often know about problems that their supervisors are either unaware of or are unwilling to pass up the hierarchy. Better information will make for better perception of problems. Tip #2: top managers need to be self-condent but avoid hubris Top managers need to be self-condent in order to make tough decisions. However, excessive self-condence can become hubris, which increases the chances of making self-serving interpretations of the causes of decline. Overcondence also accentuates personality idiosyncrasies in diagnosing decline, thus automatically discounting certain possible explanations for organizational problems. As such, when top managers suffer from hubris, many possible sources of decline may not be considered. In contrast, when top managers are willing to listen to others, change their views and admit that they have made mistakes, many more avenues for the sources of decline can be explored, increasing the chances of a correct diagnosis of organizational problems. Tip #3: have a diversied management team that shares individual viewpoints If every member of the top management team has a similar background and tenure in the organization, they will probably share the same personality idiosyncrasies in diagnosing decline. Greater diversity of experiences will generate more ideas to explore as possible sources of decline and possible turnaround actions. However, the top management team must not be so diverse that they cannot communicate seamlessly and work together. Sharing and honestly debating divergent viewpoints is what unlocks more ideas from the top management group. Tip #4: get outside advice on major problems and issues Because top managers often have a difcult time seeing their organizations objectively, outside perspectives can help provide input into diagnosing and treating decline. Most consulting rms, however, do not have the industry expertise or knowledge of organizational history to effectively diagnose and treat decline. Instead, top managers need key outsiders that they can turn to for advice or guidance when needed. These outsiders can come from

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Keywords: Management strategy, Turnarounds, Business failures, Senior management

several sources; independent board members who have been through turnarounds or crises before with other organizations are a great source of advice. Also, rms can contract with outsiders to get perspectives on particular problems. In a study that I conducted ten years ago, a declining telecommunications equipment rm was having trouble bringing out products with state of the art technology. The CEO was convinced that his R&D people were competent, but that they had just made some wrong assumptions about how technology was changing in their industry. As a result, the CEO contracted with a handful of top university professors in the telecommunications eld to be a technology review board for the rm that met on a regular basis to review R&D plans. This review board was instrumental in moving the rm into an emerging niche in the industry where the rm quickly became a dominant player, and the rms nancial fortunes turned around.

Notes
1. My published academic studies of turnarounds include, but are not limited to: Barker, V.L. III and Barr, P.S., Linking top manager attributions to strategic reorientation in declining rms attempting turnarounds, Journal of Business Research, Vol. 55, 2002, pp. 963-79; Barker, V.L. III and Mone, M.A., The mechanistic structure shift and strategic reorientation in declining rms attempting turnarounds, Human Relations, Vol. 51, 1998, pp. 1227-58; Barker, V.L. III and Duhaime, I.M., Strategic change in the turnaround process: theory and empirical evidence, Strategic Management Journal, Vol. 18, 1997, pp. 13-38; Barker, V.L. III and Mone, M.A., Retrenchment: cause of turnaround or consequence of decline?, Strategic Management Journal, Vol. 15, 1994, pp. 395-405. 2. A top managers limited ability to process a tidal wave of information was originally noted by the late Herbert Simon in his classic book Administrative Behavior (John Wiley & Sons, New York, NY, 1947). This observation and numerous others about the human element of economic decision making won Simon the Nobel Prize for Economics in 1978. 3. The failure of information systems to provide good information for diagnosing decline was noted 25 years ago in Hedberg, B.L.T., Nystrom, P.C., Starbuck, W.H., Camping on seesaws: prescriptions for a self-designing organization, Administrative Science Quarterly, Vol. 21, 1976, p. 41-65. Even recent advances in accounting information systems such as the balanced scorecard, which quantify organizational performance on strategically important variables (such as customer service), cannot provide answers about what causes those variables to decline. However, such accounting systems may provide management with quicker recognition that problems exist than accounting systems focused solely on revenues and costs. 4. Nisbett, R. and Ross, L., Human Inference: Strategies and Shortcomings of Social Judgement, Prentice-Hall, Englewood Cliffs, NJ, 1980. 5. For example, see Abrahamson, E., Management fashion, Academy of Management Review, Vol. 21, 1996, pp. 254-85; Abrahamson, E. and Eisenman, M., Why management scholars must intervene strategically in the management knowledge market, Human Relations, Vol. 54, 2001, pp. 67-75. 6. A very readable history of IBMs decline can be found in Carroll, P., Big Blues: The Unmaking of IBM, Crown Publishers, New York, NY, 1994. 7. The gender (p , 0:01) and nationality (p , 0:03) differences were tested using t-tests of a scale of possible downsizing actions in response to decline that had good reliability. These differences also hold in more sophisticated analyses that control for other demographics such as age and work experience. 8. For more information on how gender may affect management style, please see reviews in Powell, G., Women and Men in Management, 2nd ed., Sage, Newbury Park, CA, 1993. For more on how nationality affects management style, see Hofstede, G., Cultures Consequences: International Differences in Work-related Values, Sage, Beverly Hills, CA, 1984. 9. The analysis was performed using LISREL structural equation modeling software and the relationships in Figure 2 are signicant at p , 0:05. The full version of this analysis is available in Musteen, M. and Barker, V.L. III, How managerial interpretations of rm decline determine the level of innovation in turnaround strategies, working paper, School of Business, University of Kansas, Lawrence, KS, 2004. 10. See Dutton, J.E. and Jackson, S.E., Categorizing strategic issues: links to organizational action, Academy of Management Review, Vol. 12, 1987, pp. 76-90.

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