Corporate decline
| by David Elliott 03 Feb 2001 Diploma in Financial Management Relevant to Paper D4 |
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Corporate decline and recovery has appeared on three of the past six Business Analysis papers. As such, it must be viewed by students as a core topic, and rightly so. Case studies rarely present the student with a rosy picture of a trouble-free organisation. Internal weaknesses are often apparent. Strengths may be under-utilised. Externally, threats that the organisation has failed to respond to or opportunities that it has failed to exploit may have led to present difficulties. The four italicised words used in this paragraph identify the possible reasons for or causes of corporate decline.
SWOT analysis is a tool used to evaluate the current position of an organisation within its environment prior to the design of suitable strategies. It could be argued that the preparation of a SWOT, whether required explicitly by the question or not, is the best way to summarise the information presented in the case study. The result is a brief but focused synopsis of the key points contained in the text.
Students often complain that there are ‘too many points to learn and remember for the exam’. The secret is to learn a few key models very well, and then look at how they can be applied to different topics. Basing a discussion of the reasons for corporate decline on the SWOT is, of course, a case in point.
The preparation of a full SWOT will involve the examination of a number of aspects of both the internal organisation and the wider environment in which it operates. You ought to be familiar with these, and with the models available to assist in its execution.
External environmental causes of decline
It may be a little simplistic to assume that blame can be apportioned
exclusively to the organisation’s environment when, in fact,
weaknesses in say the management team or the organisational structure
may have led to a compounding of the problems arising externally.
Indeed, throughout our analysis we must bear in mind the linkages
between issues and the possibility that it may have been a combination
of various issues that led to the problems being experienced.
Political and legal causes
Changes in the law can affect organisations in many ways. A tightening
of health and safety legislation may increase costs. Premises
failing to meet the higher standards could be closed down. Particularly
damaging might be the imposition of a complete ban on the organisation’s
product, clearly made worse should they have failed to develop
a product portfolio sufficiently broad to absorb such a loss.
Tobacco companies are at present faced with the prospect of a
ban on advertising, if not on their products.
Economic causes
A downturn in the economy can lead to corporate failures across
a number of industry sectors. Those worst affected will be suppliers
of goods with a high income-elasticity of demand. House-builders
and related industries (such as home furnishings) are good examples.
Suppliers of basic necessities will be less badly hit. The recent
economic crisis in East Asia led to many cases of corporate decline
in the Asia-Pacific region. A World Bank Group report (1999) surveyed
almost 4000 firms across the five countries most affected and
emphasised the role of governments in stimulating corporate recovery
through an appropriate package of macroeconomic measures such
as low interest rates. Deflationary government fiscal policy (low
government spending, high taxation and a planned budget surplus)
and central bank monetary policy (high interest rates, restriction
of money supply expansion and revaluation of the currency) can
have a highly damaging impact on business. They can adversely
affect levels of demand both domestically and overseas, and impact
on financial strategy through increasing the cost of capital and
reducing after-tax profits available for distribution or retention.
Socio-cultural causes
Demographic changes can have an adverse impact on demand. Falling
birth rates could indicate problems ahead for producers and sellers
of baby products and, later, toys. Emigrating populations can
reduce demand on a local basis. Culturally, changes in tastes
and fashions can have a damaging effect on organisations that
fail to anticipate the changes. Clothing is an excellent case
in point, and Marks & Spencer is currently experiencing decline
for this very reason. Even cars and furniture are susceptible
to changes in trends and tastes. Health-scares such as the BSE
crisis can affect sales (in this case of beef). A change in attitudes
is taking place in the United Kingdom at present in relation to
willingness to seek compensation from organisations for alleged
wrongs. The potential costs of this ‘compensation culture’
could be huge and may lead to some corporate casualties. The culture
has, to a certain extent, been imported from the United States.
An increasing concern about greenhouse gases and the ozone layer,
testing of products on animals and generally greater social awareness
could spell disaster in the future for those firms unwilling to
embrace this cultural shift. Indirectly, cultural changes often
lead to changes in legislation, such as the banning of CFCs.
Technological causes
New technology can lead to the emergence of substitutes. The cinema
industry went into decline in the early 1980s as a result of video.
Traditional methods of delivering services have been turned upside
down by rapid developments in information technology. This erosion
of entry barriers to industries such as banking and insurance
through easier access to distribution channels (the Internet rather
than a high street presence) and much lower start-up costs has
created threats to the established players which, if they do not
respond to them, could lead to decline. Within any industry, failure
to exploit information technology and new production technology
can lead to an organisation falling behind its rivals and losing
its competitive edge
Internal causes of decline
The ACCA Open Learning Workbook suggests that students use the
following framework to help focus on the key elements of the internal
analysis. The potential for each of these issues to lead to corporate
decline will be considered
- Objectives
- Organisation structure
- Financial resources
- Marketing
- Production activities
- Research and development
- Personnel resources
- Systems and procedures
Objectives
A starting point might be to develop a mission statement. Such
a document would formally set out the organisation’s reasons
for existence and provide a general sense of purpose to management
and staff. It may also contain core corporate values that can
act as a filtering mechanism in the setting of objectives and
the design, evaluation and selection of strategy. Failure to establish
a coherent framework of objectives for all parts of the organisation,
and at all management levels, can lead to a lack of goal congruence
and the taking of damaging, sub-optimal decisions.
Organisation structure
Structural weaknesses can have a far-reaching impact on organisational
performance. Excessive centralisation may lead, amongst other
things, to slow decision-making by out-of-touch managers, far
removed from the local conditions of the decision situation. But
an organisation that decentralises too much could find itself
with other difficulties - such as a high cost structure brought
about by duplication of activities, or image casualty effected
by un-co-ordinated local decisions.
Within the context of organisational structure, excessive bureaucracy can slow down decision-making and create a role culture of inflexibility. But bureaucracy can work well in some situations. Whether it is likely to be a factor in bringing about organisational decline depends very much on the circumstances. Hierarchies that are too tall will lead to high management costs - but by taking de-layering too far and chopping out management levels, spans of control will widen and this too can cause huge problems. An organisation growing in terms of products or markets that fails to recognise the need to change its functional structure to a divisional structure could also be a casualty.
Financial resources
Students will recall carrying out ratio analysis and interpretation
of financial statements from their Paper D1 studies. High gearing
leads to high committed costs in terms of exposure to interest
payments and low interest cover. During an economic downturn,
if operating profits fall, a high proportion of debt to equity
is bound to be a drain on cash flow. Over-trading, whereby the
organisation grows too quickly and cannot finance the growth from
working capital can lead to cash flow problems, as can an insistence
on paying ever-increasing dividends to keep shareholders happy,
thereby starving the company of internal funds for investment.
The Boston Consulting Group (BCG) suggested that organisations should maintain a balanced portfolio of businesses. Large investments will be needed for a Problem Child, in order to build market share. Further investment will be needed to support and hold a Rising Star. In part, these funds should be generated by Cash Cows. Too many cash-absorbing businesses (and not enough cash-generating Cows) could lead to problems.
Many organisations run into difficulties after failing to appraise investment projects. In Paper D3 you learned about appraisal techniques such as Net Present Value, Internal Rate of Return and payback. The long-term nature of many projects means that outcomes are difficult to forecast, and probabilities are usually subjective. ‘Big projects gone wrong’ is a common cause of decline - a specific example being the acquisition of a ‘loser’. Inappropriate evaluation of the acquired company (its strengths and weaknesses) or an over-estimation of the potential synergy from the deal can lead to the organisation paying too much and suffering the consequences. Acquisition of unrelated businesses (conglomerate diversification) can be particularly risky.
Marketing
Despite Michael Porter’s inclusion of a ‘focus’
option in his model of generic strategies for competitive advantage,
excessive reliance on niche markets can lead to problems if that
market becomes saturated. Indeed, many organisations focus on
markets that just aren’t big enough. Peters and Waterman
pointed out the need to be ‘close to the customer’ -
psychologically, that is, not physically. A lack of understanding
of customer needs and expectations will lead to inappropriate
product design.
A lack of attention to the marketing mix, or ‘four P’s’ as it is often referred to, might include:
- Product limited new product development or research, leading to an ageing portfolio
- Promotion a lack of marketing spend, leading to deterioration in brand profiles
- Price this has already been discussed
- Place (distribution) use of inappropriate channels, meaning that the target audience does not have access to products at the right time in the right place
Production activities
Low productivity rates affected by low staff morale, a refusal
to train workers and an inability to attract or select good workers
are all likely to contribute to uncompetitive product costs. Quality
problems caused by failing to get things right first time will
lead to rework costs. And a failure to spot poor quality before
it reaches the customer can be catastrophic - leading to image
casualty and even lawsuits!
Research and development
Having already mentioned the BCG Matrix and the need for a balanced
portfolio, the importance of research and development will be
clear - but not in all industries to the same extent. Again, the
importance of looking at the context is emphasised. In pharmaceuticals,
both blue-sky (pure) and applied research may be important, with
huge expenditures each year. Failure to invest in this key factor
for success may well be a reason for decline.
Personnel resources
Weaknesses in the organisation’s human resources will pervade
many of the other issues already discussed. Problems could emanate
from:
- Too many staff
- Not enough staff
- Poor quality staff - lacking knowledge and skills
- Low morale
- An inappropriate culture - leading to dysfunctional behaviour
And at a strategic level, difficulties will be encountered if there is:
- A lack of strategic capability - to recognise strengths, weaknesses, opportunities and threats
- A failure to learn from past crises/ mistakes
- A failure to focus on core business (distractions) - recall how Peters and Waterman suggested that organisations should ‘stick to the knitting’
The last point ought to be emphasised and, perhaps, illustrated. Novell (a US based infotech company) was almost destroyed by management’s decision to diversify away from its core business. It had built a sizeable reputation for developing computer networking, but became fragmented and unfocused when it moved the battle onto Microsoft’s home turf of personal computer software and operating systems.
Systems and procedures
Papers D1 and D4 both include internal control systems within
their syllabi. A lack of controls, both financial and otherwise,
can lead to financial losses that may be difficult to recover.
The Barings Bank scandal, involving trader Nick Leeson, is an
excellent case in point.
Managers must be provided with information to aid decision-making. Poor management information systems will put the organisation at a strategic disadvantage and could lead to inappropriate decisions. Inadequate marketing research would prevent a thorough understanding of customer expectations. Overhead apportionment based on assumed cost-drivers such as floor area for telephone charges and staff numbers for canteen expenses, combined with wholly unrealistic bases of absorption like machine hours and labour hours, will lead to a failure to identify true product costs. Some products, which are really quite profitable, may even be discontinued based on such misleading accounting information. The solution, as all Paper D2 students are aware, would be to embrace activity-based techniques.
Conclusion
The list of possible reasons for decline is almost endless. I
started by using the SWOT model as a basic framework, and then
set out the key external and internal issues in the form of a
few major points or ‘headings’. In the context of an
examination question, the extent to which you should then ‘drill
down’ within each point depends very much on the number of
marks available.
In my second article, I will look at corporate recovery. Which businesses are worth saving? Can they be saved? What should be done in the short-term to ‘stop the rot’? And if the organisation gets through the short-term, what lies ahead?
| Michael Porter’s Five Forces
Model No external environmental analysis would be complete without a review of the impact of changes in the organisation’s microenvironment. The potential damage caused by a collapse in entry barriers has already been versed. But other changes within the industry can also contribute to the demise of some of its players. • Consolidation within the industry,
through acquisitions and mergers, can leave smaller organisations
failing to benefit from the economies of scale enjoyed by
the new, larger competitors. |
David Elliott BSc, ACA worked in Corporate Recovery at KPMG during the recession of the early 1990's. He is Senior Lecturer for paper D4 with Business Steps Training Company Ltd and is Managing Director of management consultancy firm Corporate Knowledge Ltd. He can be contacted at david@businessstepstraining.co.uk