Why big companies fail

Large players can run into trouble for any number of reasons — including inertia, strategic myopia and just plain old human folly.

At a venture capital event in San Francisco in February 2000, a month before the dot-com crash, investors and analysts were hit with a startling piece of news. Barely an hour before they were to attend a presentation by a networking company called xROS, they learned that the startup had been scooped up by Nortel for US$3.2 billion.

"That was an astounding amount, considering that xROS had only 10 employees, that it had not yet made a single sale and that its product was still in early development stages," recalls a Montreal technology consultant who was at the San Francisco event. However, the venture capitalists who had to reorganize their afternoon’s agenda remained unperturbed. "Paying stratospheric prices for technologies barely off the drawing board had become common practice," says the consultant. "Just a few months earlier, Nortel had put up US$3.5 billion for another early startup, Qtera, in a savage competition with archrival Cisco Systems."

In the end, Nortel’s lavish spending was to take a heavy toll. At the time of the San Francisco event, with sales surpassing US$27 billion, the company’s stock price hovered near its alltime high of US$126 and represented more than a third of the total capitalization of the TSX index. A month later, when the dot-com bubble burst, the stock imploded. Two years later it had fallen below US$1 and then began a slow and painful descent into nothingness. By 2009, 94,500 workers worldwide, including 25,900 in Canada, had lost their jobs and the venerable company, founded in 1895, had disappeared.

The irresistible force of inertia

Although it was Canada’s largest-ever corporate failure, Nortel was just one of many companies that lost their way or went under in the early 2000s. Others included former heavy hitters such as Celestica, American Airlines Inc., Enron, Lehman Brothers Holdings Inc., Polaroid, General Motors, Kmart and, more recently, Research in Motion (now BlackBerry Ltd.). The public is often surprised to hear when big players run into trouble. Yet their failure is often to be expected, according to author and digital analyst Brian Solis. According to statistics on his website, briansolis.com, only 71 companies from the original Fortune 500 list, compiled in 1955, are still in operation. The other 429 have either been bought out or gone under.

Why do once-successful organizations fail? The list of reasons is long, but some factors stand out more than others. Foremost is inertia, a fundamental flaw that runs through many company processes. The company becomes mired in ways of working that keep it "from simply seeing and responding to changes that are looming," says Will Mitchell, professor of strategic management at the University of Toronto’s Rotman School of Management.

Mitchell cites the example of Kmart, which suffered from what might be called intellectual inertia: "This company saw the challenge posed by Walmart and did make a few marginal changes, such as developing a Martha Stewart line of products," he says. But under these cosmetic changes lay deep- seated convictions that ultimately led to the company’s downfall. For example, Kmart held prime real estate in cities, which gave it a location advantage. "People will come to us because we are close to them" was the prevailing thinking among top managers at the company, says Mitchell. Instead, potential customers "just drove by to go to Walmart in the suburbs."

Inertia can also permeate organizational structures. This seems to have been the problem with Zellers, which also buckled under the Walmart juggernaut. "They had dismal stores and few product lines," says Mitchell. "When you finally found salespeople to serve you, they were nice, but couldn’t find what you wanted."

Often the problem lies within the multiple layers of management, according to Claude Bismuth, a Montreal strategy consultant. Companies that Bismuth prefers not to name have worked hard to improve client service. At the top, those responsible for defining strategy have a good vision. "But people down the hierarchy are not willing to adjust," he says. "Because of the size of the organization, the message gets lost as it moves downward."

Organizational opacity also works in the other direction, leading to what Julian Birkenshaw, professor of strategic and international management at London Business School, calls a disenfranchised front line. "The first insights into changes in your business environment come from the people on the front line — salespeople, developers working with third parties, purchasing managers," he writes in a Fortune article (May 8, 2013). "But their voice — if it is raised at all — typically gets drowned out among all the others clamoring for executive attention."

Losing the edge

Arguably the most pernicious form of inertia is innovation avoidance — or even worse, the avoidance of any form of change. "Large companies become complacent with their procedures and products," says Bruce Good, executive director of the Centre for Business Innovation at the Conference Board of Canada. "The more rigid the processes, the more difficult it is to manage any innovation." Good has a memorable rule of thumb: "You need to make yourself obsolete before someone else does."

That’s what RIM seems to have failed to accomplish, says Mitchell. Management thought it had an unassailable position with a device offering a good level of security — a prime asset for business clients. "But Apple and Google said, ‘Let’s see if people want this in the consumer market,’ " he says.

By the time RIM understood what was happening and started throwing money at new products, "it had become second fiddle," says Mitchell. And now, after seeing its revenue dwindle to US$6.8 billion in March 2014 from US$19.9 billion in February 2011, the company is scrambling to fill the gaping holes in its product offering.

To a certain extent, innovation avoidance hinges on a lack of metrics. Few companies fail because of inadequacies in the financial or manufacturing areas — and that is probably because standard metrics are easy to find. There are accounting procedures to follow and manufacturing companies keep track of production schedules, inventory and so on. "Things that get measured get managed," says Good. But the same does not hold for concepts such as innovation. In a survey of 628 large and small firms, Good found that only a few have metrics in place to gauge innovation throughout the organization, not just in the R&D department. Yet there are more than 82 metrics for measuring innovation, Good says. (For more on how companies can foster and measure innovation, see Genius at work.)

Of course, many companies overcome inertia and stand up to face whatever competitive threat is before them. But that action can be misguided, and the wrong changes can be made.

Celestica is a case in point. After experiencing stratospheric growth in the late 1990s, culminating in sales of $10 billion, the Canadian company hit a wall. Following the 2000 crash, many clients just stopped buying. "The company still had a lot of cash, so management decided, ‘Let’s buy businesses,’ " says Mitchell. So Celestica bought IBM facilities in Italy, Lucent facilities in Texas and other companies in Poland, the Czech Republic and Vietnam. After five years, it ended up with a completely unmanageable logistics nightmare."

Fortunately, in 2008, Celestica came up with a solution, says Good. "It took its core skills and applied them to a whole new field — solar energy," he says. "Within 18 months, it built a fully automated solar array assembly unit. Had it not taken that route, it probably would have been in serious trouble."

Going too fast

Nortel fell victim to the opposite of inertia: hypervelocity. From 1998 to 2000, it made 10 acquisitions, using an inflated stock price as its main form of payment. Meanwhile, it systematically sold its manufacturing units in order to morph into a sales and marketing company. It massively financed its clients’ purchases of equipment.

All these tactics failed when Nortel’s overvalued stock price was punctured by the stock market downturn. Mitchell thinks that at the core of Nortel’s downfall lies a classic syndrome: "It got trapped on the supply side and missed the demand side. It based its vision on the products and services it wanted to sell rather than on those that clients wanted. When it became clear that the supply side was failing, management tried to find exits to a sinking ship."

Inertia, misguided change and unsuccessful tactics can all lead to company failure. But as causes, they are relatively objective and impersonal. The Nortel debacle, like that of many other companies over the past 15 years, was precipitated by other, more subjective factors — such as good old-fashioned greed.

"Nortel is a perfect case study on the perverse ideology of ‘shareholder value,’ " said one former Nortel executive in a 2005 Revue Commerce article. "The company even set up a compulsory course for all employees on ‘value to investors.’ All management decisions were taken with the objective of pumping up the stock price. They weren’t managing the company with a view to its long-term prosperity and growth, but to inflate the price in the stock market. Of course, when everyone has stock options, everyone benefits from a stock price that increases."

It’s interesting to note that only months before the market crash, Nortel CEO John Roth cashed in stock options worth $135 million.

Tales of the heart

It’s precisely this kind of over-the-top behaviour (which, in this case, seems to have been related to a basic thirst for gold) that has caused an increasing number of commentators to blame corporate failure on the character of the executives themselves.

"Scrutinizing every aspect of executive failure represents a good portion of every search consultant’s job," writes Angel Mehta, managing director at headhunting firm Sterling-Hoffman Management Consultants, in a blog for the company. "My own perspective, after having listened to thousands of stories of failure, is that most companies fail precisely due to a lack of emotional maturity in at least one — usually several — of its key executives."

Such immaturity can take many forms. For example, you might have a purchasing director who plays games with suppliers to enhance his own self-image. "These are the types who force you to jump through endless hoops, ask stupid questions, remind you constantly that they are the authority figure in this process, etc., and in doing so hurt not only the vendors but also the organizations they are paid to support," says Mehta.

In the end, the unravelling of corporate behemoths — their implosion under the weight of their massive inertia, their ill-inspired tactics and attempts at change, their inability to avert massive layoffs — are, to a large extent, tales of the human heart. "What undoes companies," writes communications specialist Ken Makovsky on Forbes.com (May 31, 2012), "is the familiar stuff of human folly: denial, hubris, ego, wishful thinking, poor communication, lax oversight, greed and deceit."