How the Mighty Fall_And Why Some Companies Never Give In Page 4
APPROACH 1: Suppose you discount your own success (“We might have been just really lucky or were in the right place at the right time or have been living off momentum or have been operating without serious competition”) and thereby worry incessantly about how to make yourself stronger and better positioned for the day your good luck runs out. What’s the downside if you’re wrong? Minimal; if you’re wrong, you’ll just be that much stronger by virtue of your disciplined approach.
APPROACH 2: Suppose you attribute success to your own superior qualities (“We deserve success because we’re so good, so smart, so innovative, so amazing”). What’s the downside if you’re wrong? Significant; if you’re wrong, you just might find yourself surprised and unprepared when you wake up to discover your vulnerabilities too late.
Like inquisitive scientists, the best corporate leaders we’ve researched remain students of their work, relentlessly asking questions—why, why, why?—and have an incurable compulsion to vacuum the brains of people they meet. To be a knowing person (“I already know everything about why this works, and let me tell you”) differs fundamentally from being a learning person. The “knowing people” can set companies on the path to decline in two ways. First, they can become dogmatic about their specific practices (“We know we’re successful because we do these specific things, and we see no reason to question them”) as we saw with A&P. Second, they can overreach, moving into sectors or growing to a scale at which the original success factors no longer apply (“We’ve been so successful that we can really go for the big bet, the huge growth, the gigantic leap to exciting new adventures”), as we’ll see in the following contrast between two companies, one that became the largest company in America and the other, its competitor, that died.
In the late 1950s, a small, unknown company had a Very Big Idea: “to bring discount retailing to rural and small town areas.”35 It became one of the first companies to bet its future on this concept, and it built a substantial early lead by adopting everyday low prices for everything, not just specific lure-the-customer items.36 Its visionary leader created an ethos of partnership with his people, engineered sophisticated information systems, and cultivated a performance-driven culture, with store managers reviewing weekly scorecards at 5 A.M. every Monday morning. Not only did the company decimate Main Street stores in small towns, but it also learned how to beat its primary competitor, Kmart, in head-to-head competition.37 Every dollar invested in its stock at the start of 1970 and held through 1985 grew more than six thousand percent.38
So, now, what is the company?
If you answered Wal-Mart, good guess. But wrong.
The answer is Ames Department Stores.
Ames began in 1958 with the same idea that eventually made Wal-Mart famous and did so four years before Sam Walton opened his first Wal-Mart store.39 Over the next two decades, both companies built seemingly unstoppable momentum, Wal-Mart growing in the mid-South and Ames in the Northeast. From 1973 to 1986, Ames’s and Wal-Mart’s stock performances roughly tracked each other, with both companies generating returns over nine times the market.40
So where is Ames at the time of this writing, in 2008?
Dead. Gone. Never to be heard from again. Wal-Mart is alive and well, #1 on the Fortune 500 with $379 billion in annual revenues.
What happened? What distinguished Wal-Mart from Ames?
A big part of the answer lies in Walton’s deep humility and learning orientation. In the late 1980s, a group of Brazilian investors bought a discount retail chain in South America. After purchasing the company, they figured they’d better learn more about discount retailing, so they sent off letters to about ten CEOs of American retailing companies, asking for a meeting to learn about how to run the new company better. All the CEOs either declined or neglected to respond, except one: Sam Walton.41
When the Brazilians deplaned at Bentonville, Arkansas, a kindly, white-haired gentleman approached them, inquiring, “Can I help you?”
“Yes, we’re looking for Sam Walton.”
“That’s me,” said the man. He led them to his pickup truck, and the Brazilians piled in alongside Sam’s dog, Ol’ Roy.
Over the next few days, Walton barraged the Brazilians with question after question about their country, retailing in Latin America, and so on, often while standing at the kitchen sink washing and drying dishes after dinner. Finally, the Brazilians realized, Walton—the founder of what may well become the world’s first trillion-dollar-per-year corporation—sought first and foremost to learn from them, not the other way around.
Wal-Mart’s success worried Walton. He fretted over how to instill his sense of purpose and humble inquisitiveness into the company beyond his own lifetime, as Wal-Mart grew to hundreds of billions of dollars of annual revenue. Part of his answer for how to stave off hubris came in handing the company to an equally inquisitive, self-deprecating CEO, the quiet and low-profile David Glass. Most people outside retailing do not recognize the name David Glass, which is exactly how Glass would want it. He learned from Walton that Wal-Mart does not exist for the aggrandizement of its leaders; it exists for its customers. Glass fervently believed in Wal-Mart’s core purpose (to enable people of average means to buy more of the same things previously available only to wealthier people) and in the need to stay true to that purpose. And like Walton, he relentlessly sought better ways for Wal-Mart to pursue its purpose. He kept hiring great people, building the culture, and expanding into new arenas (from groceries to electronics) while adhering to the principles that made Wal-Mart great in the first place.
Quite a contrast to Ames. Whereas Walton engineered a smooth transition of power to a homegrown insider who deeply understood the drivers of Wal-Mart’s success and exemplified the cultural DNA right down to his tippy toes, Ames’s CEO Herb Gilman brought in an outsider as his successor, a visionary leader who boldly redefined the company.42 While Wal-Mart maintained its near-religious fanaticism about its core values, purpose, and culture, Ames did the opposite in its quest for quick growth, catapulting itself right into Stage 2, Undisciplined Pursuit of More, to which we will turn next.
MARKERS FOR STAGE 1
At the end of each of the first four stages, I’ll summarize the stage with a series of markers. Not every marker shows up in every case of decline, and the presence of a marker does not necessarily mean that you have a disease, but it does indicate an increased possibility that you’re in that stage of decline. You can use these markers as a self-diagnostic checklist. Some of the markers listed have little or no text dedicated to them in the preceding pages, for the simple reason that they’re highly self-explanatory.
• SUCCESS ENTITLEMENT, ARROGANCE: Success is viewed as “deserved,” rather than fortuitous, fleeting, or even hard earned in the face of daunting odds; people begin to believe that success will continue almost no matter what the organization decides to do, or not to do.
• NEGLECT OF A PRIMARY FLYWHEEL: Distracted by extraneous threats, adventures, and opportunities, leaders neglect a primary flywheel, failing to renew it with the same creative intensity that made it great in the first place.
• “WHAT” REPLACES “WHY”: The rhetoric of success (“We’re successful because we do these specific things”) replaces understanding and insight (“We’re successful because we understand why we do these specific things and under what conditions they would no longer work”).
• DECLINE IN LEARNING ORIENTATION: Leaders lose the inquisitiveness and learning orientation that mark those truly great individuals who, no matter how successful they become, maintain a learning curve as steep as when they first began their careers.
• DISCOUNTING THE ROLE OF LUCK: Instead of acknowledging that luck and fortuitous events might have played a helpful role, people begin to presume that success is due entirely to the superior qualities of the enterprise and its leadership.
Stage 2: Undisciplined Pursuit of More
In 1988, Ames bought Zayre department stores, with self-proclaimed expec
tations to more than double the size of the company in a single year.43 You cannot do a 0.2 or a 0.5 or a 0.7 acquisition. The decision is binary. You either do the acquisition or you don’t, one or zero, no in between. And if that acquisition turns out to be a mistake, you cannot undo the decision. Big mergers or acquisitions that do not fit with your core values or that undermine your culture or that run counter to that at which you’ve proven to be best in the world or that defy economic logic—big acquisitions taken out of bravado rather than penetrating insight and understanding—can bring you down.
In Ames’s case, the Zayre acquisition destroyed the momentum built over three decades. While Wal-Mart continued to focus first on rural and small town areas before making an evolutionary migration into more urban settings, the Zayre acquisition revolutionized Ames, making it a significant urban player overnight. And while Wal-Mart remained obsessed with offering everyday low prices on all brands all the time, Ames dramatically changed its strategy with Zayre, which relied on special loss-leader promotions. Ames more than doubled its revenues from 1986 to 1989, but much of its growth simply did not fit with the strategic insight that produced Ames’s greatness in the first place. From 1986 through 1992, Ames’s cumulative stock returns fell 98 percent as the company plunged into bankruptcy.44 Ames emerged from bankruptcy, but never regained momentum and liquidated in 2002.45 Meanwhile, Wal-Mart continued its relentless march across the United States—step by step, store by store, region by region—until it reached the Northeast and killed Ames with the very same business model that Ames pioneered in the first place.46
OVERREACHING, NOT COMPLACENCY
We anticipated that most companies fall from greatness because they become complacent—they fail to stimulate innovation, they fail to initiate bold action, they fail to ignite change, they just become lazy—and watch the world pass them by. It’s a plausible theory, with a problem: it doesn’t square with our data. Certainly, any enterprise that becomes complacent and refuses to change or innovate will eventually fall. But, and this is the surprising point, the companies in our analysis showed little evidence of complacency when they fell. Overreaching much better explains how the once-invincible self-destruct.
Only one case showed strong evidence of complacency: A&P. (A&P followed a pattern of Hubris → Complacency → Denial → Grasping for Salvation.) In every other case, we found tremendous energy—stimulated by ambition, creativity, aggression, and/or fear—in Stage 2. (See Appendix 4.A for an evidence table.) We even found substantial innovation during this stage, which eliminated the hypothesis that the fall of a great company is necessarily preceded by a decline in innovation. In only three of eleven cases did we find significant evidence that the company failed to innovate during the early stages of decline (A&P, Scott Paper, and Zenith). Motorola increased its number of patents from 613 to 1,016 from 1991 to 1995, and stated about its patent productivity, “We rank No. 3 in the United States.”47 Merck patented 1,933 new compounds from 1996 to 2002 (the best performance in the industry, 400 ahead of second place) yet was already in the stages of decline.48 In 1999, HP launched its “Invent” campaign and nearly doubled patent applications in two years, just as it spiraled into Stage 4 decline.49
And then there’s the terrifying demise of Rubbermaid. In the early 1990s, two Rubbermaid executives visited the antiquities section of the British Museum. The ancient Egyptians “used a lot of kitchen utensils, some of which were very nice,” said one of the executives in a Fortune magazine feature, designs so nice that he came away from the museum with eleven ideas for new products. “The Egyptians had some really neat ideas for food storage,” echoed the other. “They had clever little levers that made it easy to take the lids off wooden vessels.”50
Eleven ideas from one visit to the British Museum might sound like a lot, but not when you consider that Rubbermaid aimed to introduce at least one new product per day, seven days per week, 365 days per year, while entering a new product category every twelve to eighteen months.51 “Our vision is to grow,” proclaimed Rubbermaid’s CEO in a 1994 statement that outlined goals for “leap growth.” Growth would come from doing lots of new stuff, all at the same time—new markets, new acquisitions, new geographies, new technologies, new joint ventures, and above all, hundreds of new product innovations per year. “Exhibit A in the case for innovation,” wrote Fortune about Rubbermaid’s climb to become the #1 “Most Admired Company” in America, more innovative than 3M, more innovative than Apple, more innovative than Intel.52
Choking on nearly one thousand new products introduced in three years, hammered on one side by raw materials costs that nearly doubled in eighteen months, and pressed on the other side by its ambitious growth targets, Rubbermaid began to fray at the edges, failing at basic mechanics like controlling costs and filling orders on time.53 From 1994 to 1998, Rubbermaid raced through the stages of decline so rapidly that it should terrify anyone who has enjoyed a burst of success. In the fourth quarter of 1995, Rubbermaid reported its first loss in decades. The company eliminated nearly six thousand product variations, closed nine plants, and wiped out 1,170 jobs. It also made one of the largest acquisitions in its history, recast incentive compensation, and initiated a radical marketing bet on the Internet as “a renaissance tool.”54 Yet Rubbermaid continued to sputter, embarked on a second major restructuring in a little over two years, and on October 21, 1998, sold out to Newell Corporation, forfeiting forever the chance to come back as a great company.55 As Rubbermaid realized too late, innovation can fuel growth, but frenetic innovation—growth that erodes consistent tactical excellence—can just as easily send a company cascading through the stages of decline.
This provokes a question: Why do we instinctively point to complacency and lack of innovation as a dominant pattern of decline, despite evidence to the contrary? I can offer two answers. First, those who build great companies have drive and passion and intensity and an incurable itch for progress somewhere in their DNA to begin with; if we studied companies that never excelled, those that fell from so-so to bad, we might see a different pattern. Second, perhaps people want to attribute the fall of others to a character flaw they don’t see in themselves rather than face the frightening possibility that they might be just as vulnerable. “They fell because they became lazy and self-satisfied, but since I work incredibly hard and I’m willing to change and innovate and lead with passion, well, then I don’t have that character flaw. I’m immune. It can’t happen to me!” But of course, catastrophic decline can be brought about by driven, intense, hard-working, and creative people. It’s hard to argue that the primary cause of the Wall Street meltdowns of 2008 lay in a lack of drive or ambition; if anything, people went too far—too much risk, too much leverage, too much financial innovation, too much aggressive opportunism, too much growth.
OBSESSED WITH GROWTH
In his 1995 annual letter to shareholders, Merck’s chairman and CEO Ray Gilmartin delineated the company’s #1 business objective: being a top-tier growth company. Not profitability, not breakthrough drugs, not scientific excellence, not research-driven R&D, not productivity (although Gilmartin did highlight these as essential elements of Merck’s strategy), but one overriding business objective: growth. Merck’s drive for growth remained remarkably consistent for the next seven years. The opening line of the chairman’s letter in the 2000 annual report stated simply, “As a company, Merck is totally focused on growth.”
Merck’s public commitments to achieve audacious growth seemed odd, given the facts. Five Merck drugs with annual revenues of nearly $5 billion would lose their U.S. patent protection in the early 2000s.56 Generic copycat drugs, an increasing force in the pharmaceutical industry, would curtail Merck’s pricing power, wiping out billions in profitable sales. Moreover, Gilmartin faced a significantly larger revenue base upon which to achieve growth than his predecessor, Roy Vagelos. It’s one thing to develop enough new drugs to deliver growth on a base of approximately $5 billion, as Vagelos did in the late 1980s, but ent
irely another to develop enough new drugs to fuel the same or faster growth on a base of more than $25 billion, as Gilmartin faced in the late 1990s. And for a company like Merck that relied primarily upon scientific discovery, growth would be increasingly difficult to attain; according to a Harvard Business School case study, the probabilities of any new molecule creating a profitable return were about 1 in 15,000.57
“But if Gilmartin is worried,” wrote BusinessWeek in 1998, “he doesn’t show it.”58 And why would Merck feel so confident about its prospects? The second paragraph of the chairman’s message in the 1998 annual report reveals part of the answer: Vioxx.59 In 1999, Merck received FDA approval and launched Vioxx, touting it as a potentially huge blockbuster, emblazoning the front cover of its annual report with “Vioxx: Our biggest, fastest and best launch ever.”60
In March 2000, preliminary results of a study of more than eight thousand rheumatoid arthritis patients demonstrated Vioxx’s powerful advantage: a painkiller with fewer gastrointestinal side effects than the painkiller naproxen. But the study also raised troubling, albeit inconclusive, questions about Vioxx’s safety, indicating that those taking naproxen had lower rates of “cardiovascular thrombotic events” (in lay terms, heart attacks and strokes) than the Vioxx group.61 Since the study was designed without a placebo-taking control group, the results could be interpreted a number of ways: naproxen lowers cardiovascular risk, Vioxx increases cardiovascular risk, or some combination of the two. Naproxen, like aspirin, has what scientists call “cardioprotective” effects, and Merck concluded that the difference in the frequency of cardiovascular events was “most likely due to the effects of naproxen.”62