Every body continues in its state of rest, or of uniform motion in a straight line, unless it is compelled to change that state by forces impressed upon it
Successful business leaders clearly did not fail 7th grade science as they learned that this very important principal of physics has a 100% correlation to economic markets. Many economists have shown that efficient markets behave in cycles. History has shown that periods of economic upswings are followed by periods of economic downswings. While many factors may contribute to these swings, one thing is true – change is a constant when cycles move in either direction. Another constant for the vast majority of markets is competition. In most industries a characteristic of competition is that most firms feel the effects of each other’s moves and are prone to react to the outcomes of those moves. When faced with economic conditions that are turbulent, changes in markets can happen in many different ways. Customer demand can fluctuate, technology can shift product and services offerings, money supply can enhance or stall opportunities, competitors may appear where there were none in the past. This last concept, a term I refer to as “Boundary Blurring”, is a byproduct of competitive firms making changes so they may remain competitive. For instance, years ago life insurance was bought and sold primarily at the kitchen table. Today, life insurance is sold in so many ways by so many channels of distribution that for many, price can become the sole differentiator. Next time you are shopping at Sears, stop in and get a life insurance quote and see what I mean. Sears & Roebuck, the store where many of us as kids watched dad buy his tools – is now selling insurance.
So with all this change in markets, both internally and externally generated, how can anyone believe that the results of the past can so easily be replicated into the future? I ask every one of my MBA students if they can name the highest quality buggy whip maker in Maryland. To no surprise, I am met with a room of blank stares. It is not that the highest quality buggy whip makers of over 100 years ago ceased to make quality buggy whips, markets and products developed and their products were no longer required.
This simple but real example has been lost on so many entrepreneurs and employees that I encounter today. The world economic markets are going through a change that even highly educated and respected business leaders cannot explain. Changes are occurring rapidly and swiftly. Names like Lehman Brothers, Merrill Lynch, General Motors, Ford and Citibank are all corporate giants that so many thought would remain and prosper for many years to come. It is easy to look in the rear view mirror and see the causes for these Fortune 100 giants’ woes, but how did the leaders of these companies not see this coming? As another point of reference, of the top 10 companies on the Fortune 100 list in 1980, only 5 are still in the top 10 today. The top company in the 2008 Fortune 100, Wal-Mart, did not even make the top 500 until 1995.
Not a single one of these companies had a strategic initiative in their business plan that said they would fail, I am sure of this fact. But then why do so many companies not continue to achieve success when they achieved success in the past. Because “it worked before it will work again” mentalities are pervasive in today’s boardrooms and in the minds of many privately held company owners.
I highlight three real world examples of this rudimentary concept to you.
Public Company faced with Technological Change
This publicly traded firm specialized in consumer products and had achieved great success. They became the second largest firm in the United States in their industry and were achieving incredible profit margins of over 20% even though their products were seen as highly competitive and commoditized. The management team had been together for a long period of time and they worked very well together. And then a change occurred, the internet became a reality. As they had relied so heavily on print advertising for so many years, the change in consumer buying habits caused by the internet hit them dramatically. Their marketing staff and its leadership did not understand the internet or its capability of marketing and communicating to its current customers or potential customers. They continued to pour money into newspaper print advertising even though the response rates were declining and numerous outlets for this advertising were going out of business. “Our customers will continue to buy this way” was an often heard response from the long time senior executive running the marketing department.
Over time, this company saw its sales stagnate and its margins begin to erode. Price increases were allowing it to hold steady but at what cost? The CEO maintained that the senior executive of marketing was the right one for the job and did not make a change to replace him with a more knowledgeable executive with internet sales and marketing experience. Ultimately, the institutional investors said enough was enough and sold the company to a private equity firm. Not long after the deal closed, the new owners saw the need to make changes and the marketing department was quickly overhauled.
Niche Private Company believing nothing can change
A unique offering to a highly segmented market allowed this owner the opportunity to expand his revenue and earnings without much effort. He had come upon a model that worked and found that by adding more telephonic salespeople to his work force, customer expansion occurred. This owner grew to enjoy a very comfortable lifestyle accentuated by high priced cars and expensive vacations. His product and service offering did not change and he found that the business would run virtually on auto pilot.
He was approached by several large corporations that had noticed his success in the marketplace and they determined that he would be an attractive acquisition target. After many meetings, several of these firms placed highly lucrative cash offers on the table. After getting the bidding to a premium level, he said that the offers needed to be 10% higher or he could not continue to have the cash flow that he currently enjoyed. This analysis was completely flawed as he would have made over 10 years + in cash flow, after tax, in a guaranteed lump sum payment. In turning down these offers, he said that he could continue to run his business and only work a few hours a week and would maintain his lifestyle.
Within months of turning down these lucrative offers, his business began to crumble under the pressures of the current economic environment. His customers no longer wished to spend the money to buy his service even though it was a proven service which increased their profits. His profits have been reduced by over 50% and the prospect for recovery to the levels of revenue previously seen is many years away. Most importantly, he must now change his lifestyle which is loaded with fixed costs and expenses that he believed would always be able to be paid because his business was doing so well.
Internet Technology competing with the Big Boys
The members of the board of directors of this profitable small business were asking themselves if they should take the profits made over the past two years and re-invest them into a new idea and attempt to double their money, or should they take their chips off the table, cash in, and go home. The management team was not working well together because the President would not deal with confrontation or conflict, the sales force was littered with employees not producing or being managed to produce, the business did not demonstrate a technologically scalable foundation and the opportunity to expand into a new niche market was just beginning to look promising.
One of the largest individual shareholders was faced with a dilemma. Her personal goals were driving her decisions, not the broader reality of what situation she was facing. Could this company and her investment really be worth double?
Her cajoling of the other board members with a persistent promise of making this new opportunity work succeeded. She was given the green light to double down and make the opportunity a reality.
One problem – she did not change anything and tried to build this future opportunity on the back of a business that was not capable of growing under its current management structure and operating plan. She did not believe that the large public companies that competed against them in this space would be able to be nimble enough to capture first mover’s advantage in this highly promising niche of the market. She could not imagine that she could not will this opportunity across the finish line.
Within months of this decision, her business was in big trouble. Her opportunity was going nowhere – sales were not happening and momentum was slipping through their fingers. How could this happen, “we had grown considerably so far and there was no reason that this new opportunity should not work” – and she was right. The management team tried to build everything on an operation that had passed its useful life and under the changing market conditions; their collective hopes never had a fighting chance.
Today, the company is losing money and has spent most of the cash that it had saved – millions of dollars. Layoffs have occurred, and the basic business model has only recently been changed to reflect the changing market realities.
Lessons Learned
1. Did we prove Newton wrong in our examples? Each company would not change its actions even though the market and economic forces were creating forces which called for drastic change. No, Mr. Newton’s First Law of Motion remains intact. Because our companies did not change did not mean that the forces upon them were not compelling, it was their inability to understand these forces that caused the unfortunate results that occurred to each of them.
Size in this example really does not matter. Many pundits would state that larger companies are more likely to fight change and thus be more susceptible to being passed by their competitors. This may be true but it does not need to be that way.
Samuel J. Palmisano (a graduate of Johns Hopkins University) is the current chairman, chief executive officer, and president of IBM, one of the world's largest information technology companies. Sam joined IBM in 1973 and rose through the ranks of this Fortune 100 computer company. Several years ago, under his leadership, Sam and his management team made a market changing decision. IBM would no longer be a computer manufacturer and seller; it would become an information technology consulting firm. With over 350,000 employees worldwide, IBM is now the largest information technology employer in the world. IBM holds more patents than any other U.S. based technology company. It has engineers and consultants in over 170 countries and IBM Research has eight laboratories worldwide. IBM employees have earned three Nobel Prizes, four Turing Awards, five National Medals of Technology, and five National Medals of Science. Capitalizing on the "International" part of the company's name, IBM's focus on overseas business helped boost 2007 revenue numbers. IBM generated 63% of its revenue ($98 Billion) from overseas sales last year, helping it overcome U.S. economic woes. I guess you really can turn an aircraft carrier around on a dime.
2. The planning concept known as Scenario Planning is a practical development of scenario forecasting used to guide strategy. This tool was brought to the market forefront in 1971 as the Royal Dutch Shell group of companies began using this planning process which had primarily been used for more limited academic studies. At its foundation, this process calls for the understanding of what variables you can and cannot control. Once you understand this basic tenet, your planning revolves around these variables. IBM could control what it sold and how those products were sold, they could decide which markets to sell into, and they choose to make changes and capitalize on both of these variables over the past several years.
With these thoughts in mind, begin to challenge your strategic thinking and how you might deal with the current economic situation and conditions. Believing that the past will certainly predict the future is not a planning tool that I will use with my clients any time soon and I recommend that you do the same.
