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Think About It
Key Extracts from Billion Dollar Lessons
Wednesday, July 21, 2010
Andrew Guido

In their book, Billion Dollar Lessons, authors Paul B. Carroll and Chunka Mui essentially provide some invaluable lessons learned from some of the most significant if not spectacular business failures of the past quarter century. We are summarizing below their key findings that we feel provide valuable lessons for business leaders today.


About The Study
The authors examined 2,500 failures suffered by publicly traded companies in the United States and narrowed the list to the 750 most meaningful. The companies in the study period between 1981 and 2006 had the following financial results:


  • 423 major companies with combined assets totaling $1.5 trillion filed for bankruptcy.
  • 258 companies took $380 billion in write-offs.
  • 67 companies had combined losses from discontinued operations that totaled almost $30 billion.


The authors also draw on prominent studies conducted by others providing even greater learning and examples of companies that clearly failed to question their business decisions.

Key Findings
Carroll and Mui found that the number one cause of failure was misguided strategy—not sloppy execution, poor leadership, or bad luck. Once launched, the strategies were doomed to fail, and these failures probably could not have been prevented by even spotless execution.


Overall, what they found was that as many as 46 percent of the failures could have been avoided if companies had been more aware of the potential pitfalls. As well, a significant percentage of the other failures, the ones that they didn’t classify as avoidable, could have been mitigated if the companies had seen warning signs and had proceeded more cautiously.


The authors make a strong argument that many of the pitfalls shared below could have been avoided through healthy discourse and rigorous questioning and sober thought especially when companies bet the farm on their strategic decisions. They make the case for a “devil’s advocate” and suggest nine levels of acceptable disagreement to improve decision making at critical junctures in a company’s direction. The nine ways for increasing the level of disagreement to tease out and harness the knowledge and insights to the organization are:


  1. Grant license to the devil’s advocate concept – assign someone to the task.
  2. Smooth out management ruts – when critical issues arise familiar roles and positions need to be cast aside to ensure all perspectives can emerge.
  3. First, decide how to decide – agree ahead of time to lay out problems in detail before there is something to decide then agree on the decision criteria for new strategic moves before those strategies are needed.
  4. Find history that fits – use history to understand better the context for strategic decisions and learn from previous success and failures.
  5. Bet on it - make decisions like betting your own money.
  6. Stare into the abyss – take a hard look at the chance that something truly significant could go wrong.
  7. Construct alarm systems – once strategies are launched there should be mechanisms to gather feedback and continuously adapt.
  8. Always have escalation mechanisms – design incentives for reporting information that is relevant to impending strategic errors and other potential missteps to key decision makers.
  9. Hold second-chance meetings – hold second-chance meetings as a way for countering unexamined assumptions.


The Strategic Errors
The strategic errors fall into seven categories:


1. Synergy: Pursuing nonexistent synergies: Quaker Oats’ purchase of Snapple was suppose to capitalize on distribution synergies but instead led to a $1.4 billion loss. Synergies are seductive. What makes a synergy strategy so dangerous is that they promise something for nothing.


  1. A McKinsey study of 124 mergers found that only 30 percent, or about a one-in-three chance, of reaching their goals for revenue gains driven by synergy.
  2. A second McKinsey study, of more than 160 acquisitions, found that only 12 percent of the acquirers managed to significantly accelerate their growth over the next three years. Over all, the acquirers in the study produced organic growth rates that were 4 percentage points lower than peers in their industries.
  3. A BCG study found that more than 80 percent of companies don’t do detailed work in advance of an acquisition to make sure that the synergies that seem theoretically possible can, in fact, be produced.
  4. Customers don’t care about the synergies. One study found that customers thought they got better service or prices from only 29 percent of mergers. Another found that as many as 30 percent of a company’s customers may leave during the post merger phase because of what they perceive as bad service.


The authors offer the following lessons to be learned from synergy strategies that fail:


  1. The synergy may exist only in the minds of the strategists and not in the minds of the customers.
  2. Excitement over the prospects for synergies can lead a company to vastly overpay for an acquisition.
  3. While the idea behind synergy strategies is that one plus one can equal three, clashes of culture, skills, or systems can mean that synergies that seem easy to achieve can be impossible to get.


2. Financial Engineering: Financial engineering strategies can produce inherently flawed strategies that cannot withstand sunshine or storms. The autopsies of many financial engineering failures conclude that designers did not foresee some external circumstance, some occurrence that fell well outside of recent experience and seemingly reasonable expectations. Yet any solid strategy must be able to withstand adversity, which means that strategists must look into the abyss, assess how their designs would perform under harsh conditions, and explicitly decide whether the risk is worth the return.


Another question is even more basic: Does the strategy make any sense? Too clever accounting is also a leading cause of strategic failure. As an example Green Tree Financial Corporation, a darling of Wall Street in the ‘90s, used financial engineering to book huge profits and, for a time, show stellar growth eventually leading to its multi-billion dollar demise.


The authors found through their research the following key lessons from financial engineering failures:


  1. Financial engineering strategies can produce inherently flawed financial products.
  2. The strategies can produce hopelessly optimistic levels of leverage.
  3. The strategies can depend on aggressive and unsustainable financial reporting.
  4. The strategies can result in positive feedback loops causing more financial engineering and eventually causing the system to implode.


3. Rollups: Research says more than two-thirds of rollups fail to create any value for investors. A Booz Allen study found that almost half had lost more than 50% of their market value between 1998 and 2000.


The authors identify four kinds of failures that their research found:


  1. Rollups that went for scale that wouldn’t produce economies.
  2. Rollups required an unsustainable fast rate of acquisitions.
  3. Companies were unrealistic about their assumptions and did not allow for tough times which almost every rollup experiences.
  4. Companies were overly optimistic and assumed they could get the benefit of both the decentralization and of integration. Most companies could only do one of these things well not both.

4. Staying the Course: This is like rearranging the proverbial deck chairs on the Titanic. For many of the failures in this regard, problems were apparent to outsiders but insiders were in denial and couldn’t fathom that their very existence could be threatened especially after a long history of success. Ignoring a threat is a very common problem that needs to be addressed. Because companies report what they do and not what they don’t do finding errors of omission is inherently harder to uncover than finding errors of commission.


A study published in 2004 found that just about every company is in danger of ignoring imminent threats. In the study, only 17% of managers felt that their company would react quickly enough and aggressively enough to a structural change in their industry that constituted a major threat. Some 20% said their companies were embodiment of “paralysis by analysis.” Roughly 16% said their companies would decide that the crisis would disappear; therefore, the companies wouldn’t even discuss the possibility of trouble. At most, 39% said their companies would take action, but said the action would be too slow and too late.


Another study, published in 2007, found that 60% of executives felt their primary source of competitive advantage was eroding. Some 65% said they needed to fundamentally restructure their business model. Roughly 72% felt that their main competitor five years down the road would likely be different from the main competitor at the time of the survey. The authors single out Kodak as a classic example of a company that missed many opportunities to rethink its analog print business and become a digital company. They simply thought they could ride out the storm and started to make the transformation when it was too late to be the leader and as a result experienced incredible write-offs and low profitability throughout most of the last decade. Up until 2005 Kodak lost more than 75% of its stock-market value over the past decade and employed less than a third of the number of employees from twenty years earlier.


The authors highlight three common mistakes that companies that fail to see changing market and or industry dynamics:


  1. They see the future as a variation of the present and can’t bring themselves to imagine truly radical threats, the kind that might wipe out their whole market.
  2. They tend to consider whether to adopt a new technology or business practice based on how the economics compare with those of the existing business—not accounting for the possibility that the new technology or approach to business will eventually kill the economics of the existing business and require an entirely new business model.
  3. They don’t consider all of their options, instead they focus on shoring up their existing business.


5. Adjacencies: Adjacent-market strategies attempt to build on core competencies to expand the business in a significant way while supposedly taking minimal risk. A move into adjacent markets generally seems quite sensible and is often regarded as the logical next step when organic growth in existing markets is too slow. However, empirical evidence says otherwise. In a Bain study looking at twenty-five of the most costly business failures from 1997 to 2002 (excluding the dot-com bubble) the study concluded that in 75% of those failures, the root cause or a major contributing factor was an attempt to enter an adjacent market. Those twenty-five companies lost $1.1 trillion in stock-market value, about 88% of their total value. In Avon’s case it decided its “culture of caring” qualified it to operate retirement homes. Subsequent write-offs totaled $545 million.


The authors found four patterns that show up in many strategies that fail:


  1. They move is being driven more by a change in a company’s core business rather than by some great opportunity in the adjacent market.
  2. The company lacks expertise in the adjacent market, leading the company to misjudge acquisitions and mismanage the competitive challenges of the new market.
  3. The company overestimates the strength or importance its core business capabilities will have in the new market.
  4. A company overestimates its hold on customers, leading to expectations of cross-selling that won’t materialize.


6. Riding Technology: Attempts at gaining an edge through technology often end in failure. A Wharton School study concluded that companies attempting to introduce new products or technology into new markets failed a staggering 70% to 95% of the time. Even efforts to introduce new products or technology into existing markets failed 45% to 65% of the time. When the rewards for success are so great it is not surprising that companies will take lots of stabs at achieving those rewards. What was surprising to the authors though was the number of ill conceived strategies from the get-go. No amount of luck or sophisticated execution could have saved them. They misjudged trends that were clearly working against them or even ignored fundamental physical limitations. The authors highlight Iridium’s spectacular failure. The phone system cost $5 billion to develop but went bankrupt less than a year after it began service and its assets were auctioned off for $25 million.


The author’s offer four important lessons from Iridium’s failure, which is often incorrectly thought to be because of failed execution or marketing:


  1. They evaluated their offering in isolation or at a single point in time, rather than in the context of how alternatives will evolve over time.
  2. They confuse market research with marketing, allowing their entrenched interests and hopes to colour the analysis of true market potential.
  3. They find false security in competition, incorrectly thinking that the presence of rivals equates to a validation of the potential market.
  4. They design the effort as a front-loaded gamble, foreclosing possibilities for adaptation and severely limiting the option to stop.


7. Consolidation: Depending on the conditions of the industry and of your company, buying a company as a consolidation move can amount to doubling down on a bad hand. The example the authors provide is despite pioneering the discount department store and being the fourth largest discount retailer behind Wal-Mart, K-Mart and Target, Ames flubbed consolidation efforts, landing in bankruptcy twice before eventually liquidating.


Lessons learned from Ames failure are four fold:


  1. You may not just be buying the assets you think you’re buying; you may also be buying problems.
  2. While the focus is generally on getting bigger to generate economies of scale, there may also be diseconomies of scale because of increased complexity.
  3. Although companies typically assume that they can hold on to customers of a company they buy, that’s often not the case.
  4. If you’re just thinking about being the industry’s consolidator, you may not be considering all of your options.


Even More Reason To Be Concerned
Carroll and Mui’s findings are all the scarier taking into consideration the following:


  • Many of the executives that failed were brilliant, went to the best schools, and had never had anything but success their whole careers.
  • Many failures occurred at companies that were long established.
  • Many companies were considered to be well managed, didn’t seem to be taking excessive risks, and weren’t undone by widespread fraud.


The authors aren’t saying these strategies are doomed to failure, as in the right circumstances, all of these strategies can succeed. What they are saying is that these strategies are danger zones. If you are pursuing one of these strategies you need to be extremely alert to what can go wrong, and ready to react before your business is flirting with disaster.

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