When Strategies Go Bad
How many times have you read an article in the newspaper or seen a report on television news about a company which appeared to be doing very well, but which recently had come on hard times? Lately, this has happened more often than we remember it occurring in the past. But, this is not just a current phenomenon; it has happened many times in the past, and is happening now only with a little more frequency, or so it would seem.
In former IBM Chairman Louis V. Gerstner's book, Who Says Elephants Can't Dance? Inside IBM's Historic Turnaround, you will read about the tremendous rebirth of IBM. Under Gerstner's leadership, IBM virtually reinvented itself, pulling up from near ruin.
What happened to Big Blue? In the 50s, 60s and 70s, IBM was the 800 pound gorilla in the computing marketplace. IBM set the standard for performance, sales capabilities, service, innovation and market leadership. Things were done the IBM way: Blue suit, white shirt, red tie, black wingtip shoes, black briefcase. There were prescribed ways to sell IBM systems, and conformity was demanded of everyone. Why, after all these years of success, did IBM require turning around? Much of the responsibility for this goes back to the type of market intelligence IBM listened to during the late 70s and early 80s.
When IBM sought market intelligence, they went to their best resources – or so they thought. They contacted the people who used and managed their systems in the many installations around the country. In essence, they talked with people who had a vested interest in preserving the IBM way of life: Large systems which require lots of highly trained, highly paid systems people. Self-reinforcing market intelligence told IBM what it wanted to hear.
The thought that personal computers and distributed processing could replace main frames was totally alien to the IBM way, and talk of this type of future could cost a person a job if the wrong people heard it. A friend who worked on a special project for IBM during the roll-out of the IBM Personal Computer said the resistance within the company was palpable and obvious. The consequence was that while IBM developed and sold desktops and later, laptop computers, the heart and soul of the company remained committed to main frames. This resulted in a lack of real commitment on the part of IBM to the PC, which allowed other companies to clone their machines and to push IBM from the initial position of dominance to near irrelevance in a short time.
All this happened while IBM was still primarily focused on their large systems, and resulted in the near-meltdown of IBM. While this statement is extreme, it reflects what happened to IBM because they did market research in too restricted a manner, resulting in bad information on which they based their future course and direction. Lesson: Be sure that your information sources reflect fully and accurately the true characteristics of your market place, and not one which tells you what you want to hear. Failing to listen to the true intent of the market can lead to poor investments in developments, direction and strategies.
An example of not paying enough attention to the realities of the market place was also exemplified by Global Crossing. Global Crossing decided they would build up their inventory of fibre cable to the point where they would dominate domestic, trans-Atlantic, and trans-Pacific data and voice traffic. The company spent billions to install/lay fibre. The problem was that they were not the only ones doing this. The result was that there was a tremendous overcapacity of fibre to the point where the market price for fibre cable usage collapsed, leaving Global Crossing with very high debt and low revenue, a fatal combination.
Global Crossing failed to look at the competitive capacity being built by others, and at the actual levels of usage, which were miles below the forecasts which were the basis on which they built their capacity. They took no notice of the drivers which shaped and limited the real needs they thought they were filling. As a result, they filed Chapter 11, when their stock was down to $0.30 per share from a high around $60. While they currently have a large cash reserve, they will need a large infusion of capital as they are competing in a market which is suffering from both low utilization and low prices.
The result is that revenues do not appear to be enough to sustain this business model in the future. Lesson: Be sure your assumptions about the future direction of your markets are realistic. Overly optimistic assumptions can easily allow you to charge off in a direction that the market place will not support - a recipe for disaster.
Another area of serious concern is the recent rash of ethical lapses which have dominated the headlines for the last year plus. What leads companies and their leaders to stray from what is acceptable morally and ethically? Why do companies violate the laws for short term gain, when it is highly likely that the efficiency of the market place, in the long term, will force them public? Let's look at a few of them.
Worldcom, formerly and lately known as MCI, had a fabulous idea. Become the primary carrier of telecommunications, from telephone to wireless and data, world-wide. The company made acquisitions and investments which took them to the top of their industry, but at what cost? They were overextended and overleveraged with more than $32 billion in debt, and when world wide capacity exceeded world wide demand by a large amount, they began to cover their tracks.
Part of their problem stemmed from the method by which the top people were compensated. Much of their compensation was based on their stock options and the price of their stock. In order to keep the stock price up, they started manipulating their books to reflect sales that were not real, by swapping contracts and counting the swaps as revenue. The further they got into the scheme, the harder it became to go back, principally because the market did not recover as they had expected. Nearly $3.1 billion of false profits had been reported by the company in 2001 and early 2002 prior to the schemes becoming public knowledge.
Worldcom was not the only company which fell prey to this general problem of not playing fair with its books. Enron, an energy company, started off as a leading reseller of electric power, natural gas and other energy. They developed a series of highly innovative schemes to resell energy and to make good returns while doing so.
When the state of California "deregulated" its electrical power market, Enron led the way in buying and reselling electric power. Everything they did at the beginning was acceptable, as far as we know. Not too long after this "deregulation" was implemented, the rules for trading of energy were seen to allow a very unusual situation.
As it turned out, the trading of electrical power during each day's trading was priced at whatever the HIGHEST PRICE was for that day's trading. This meant that there was considerable incentive for traders to bid up the contracts during the day, because at the end of the day, all contracts would be repriced at whatever the highest price paid during the day turned out to be. It is folly to think that a corporation is not going to maximize its return/earnings when the market will allow it to do so.
The problem is that Enron took this to extremes, while playing games with its liabilities at the same time. In order to maintain its share price, Enron developed a scheme to transport debt off its books and into affiliated partnerships. The need to keep share prices high was based on the reward scheme that the executives' pay was based on. Compounding this, the partnerships were mostly funded with Enron stock. When the value of the stock tanked, the partnerships came apart and many, many people suffered.
The real problem here is not the trading of energy futures contracts, although they were ethically questionable at best. The larger problem was the development of the off-book partnerships without disclosure and using company stock to fund the partnerships. This scheme was the real undoing of Enron.
While we are looking at Enron, let us also look at the State of California. Under the guise of deregulating the energy markets for the purpose of lowering the costs of energy to California consumers, both individual and corporate, the laws passed to accomplish this actually put the power companies within the state at real risk. The reason for this is that only a part of the energy market was deregulated: the supply side. The demand side was limited in how much it could charge consumers. This caused the eventual bankruptcy of the two major power companies in the state, because of the prohibition on long term energy supply contracts, resulting in the companies having to buy power on the spot market.
The impact of this was huge because of the requirement that each day's contracts had to be repriced at whatever was the highest intraday contract price. Added to this were limits on what the power companies could charge their customers. Eventually, after the two major power companies in the state filed for Chapter 11 Bankruptcy Protection, the state allowed them to increase their prices to cover their costs, only to discover that there were increases of up to 1200% which immediately drove consumers crazy and shut down businesses. In addition, at least two power generating plants were shut down for maintenance and upgrading, further aggravating the problems.
Lesson: Lack of attention to real world conditions combined with the idealistic (?) actions of the state resulted in the economic disaster which ended up costing a governor his job and the taxpayers of California many millions of dollars.
Tyco International Corporation's former CEO L. Dennis Kozlowski treated Tyco as if it were his personal plaything. He decorated a lavish town house in New York City with a budget of $6 million of company money. He purchased two classic paintings, a Monet for $3.95 million and another at nearly $2 million. He gave himself raises without permission of the Board of Directors Compensation Committee. He authorized high bonuses for himself and a few key henchmen, again without the permission of the Board of Directors Compensation Committee.
He hired people and gave them outrageous salaries, raises, and bonuses. For example, he hired one employee originally as a receptionist and switchboard operator. She was later promoted to bookkeeper and flight attendant on the company jet. Still later, she was promoted to his personal financial assistant. In this role, she approved millions of dollars of expenses for art, restaurant bills and the bills for a birthday party for his wife in Sardinia which cost the company over $2 million. Later on, it appears that she approved a $5 million loan to purchase a diamond ring for his wife from a fund which was created to pay taxes owed on restricted stock, again, apparently without permission of the corporation. As a result of her rising positions within Tyco, the company paid for her daughter's education at private high schools in Maine and Florida, and for college at the University of New Hampshire. The company also reportedly forgave a $239,000 mortgage on a home she bought in Florida after she was relocated there. She is now testifying against Kozlowski in his trial in New York City in which he and CFO Mark Swartz are charged with looting Tyco for approximately $600 million. Kozlowski apparently tried to buy the loyalty of his personal financial assistant with the largesse he doled out.
What happened here? Very simply, Kozlowski and Swartz apparently decided they were above the rules for ordinary people. They decided they were worth whatever they could take from the company. Their impression of their own importance was so large that they exceeded any possible boundaries. These were such egregious violations of ethics and securities laws that the State of New York had no choice but to prosecute. The complicity of Arthur Anderson here and with Enron prevented the public from learning the truth, and enabled the schemes of the top people to go on for much longer than they should have with proper audit and exposure to the public. Anderson was supposed to be the watchdog, but instead became a party to the problems. They let us all down.
What lessons may be learned from all of the examples we have listed above? The results of actions taken or not taken by companies and/or high level executives can have a huge impact on their companies. These impacts range from misdirection of the corporation to outright violations of laws.
When IBM forgot to listen to the market place, it not only fell behind the curve with its PC products, but it held on to its main frame products beyond their useful life in some cases. The saving of IBM is a powerful story, and a real tribute to Lou Gerstner and his drive and perseverance. But that it was necessary drives home the importance of listening to multiple sources of market intelligence. Global Crossing overcommitted to its ambitious fibre plan, badly misjudging the market growth and demand, then compounded errors by falsifying records. Worldcom and Enron took unfair advantage of their customers, their employees and their stockholders, with the responsible people at the top driven by unrealistic personal ambition. The State of California tried to take advantage of a temporary situation in the energy market, with no consideration for the long term implications for the citizens and businesses which ended up paying the bills. An attempt at social and economic engineering resulted in a tragic set of losses for all.
Tyco's CEO and CFO apparently looted the company for over $600 million. Their raw ambition and lust for money resulted in total disregard for the laws, ethics and morals that are required of businesses in the USA. They violated the trust of their stockholders, their employees, their customers, their bankers and the public.
A wide range of faults, from not listening to the market place to stealing from the company in huge amounts, resulted in some companies having to make a major turn-around, others going into bankruptcy. Many thousands of stockholders, creditors, customers, vendors and employees have been harmed, some grievously. A few were complicit, most were relatively innocent, with great losses thrust upon them, mostly for the benefit of the few.
At the corporate level, seeking broadly-based, multiple sources of market intelligence on which to base strategic planning is a good start. Having sufficient independent oversight on operations and finances is another good method. At the end, however, it comes down to the ethics of the company and its leaders. There is no substitute for good long-range strategic planning and good visibility inside the company, especially at the board level, of the activities and the direction of the company.
Dana Baldwin is a consultant with Center for Simplified Strategic Planning, Inc. He can be reached via e-mail at
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