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Friday, April 11, 2014

Six Categories of Large Company Failure

Six Categories of Large Company Failure

Based on research undertaken by Hamilton and Micklethwait (2006, Greed and Corporate Failure), large company failures are caused by problems that can be grouped into six major categories:

  • Poor strategic decisions - most relevant when existing well established companies undertake expansion, either through the introduction of new products or technologies, expansion into new geographic markets or as a result of M&A (see more directly below); failure occurs as a result of a lack of understanding of critical business drivers, inadequate risk management (many aspects e.g. technological, competitive, financial) or insufficient due diligence.
  • Overexpansion through (bad) M&A - research clearly shows most M&A efforts fail; nevertheless companies continue to aggressively expand through tactics with odds worse than a coin toss. Typically for a large company integration costs will always exceed any foreseen benefits. Cultural differences and insufficient management capacity can derail M&A efforts as well. However top management typically stands to gain financially directly, disproportionately and without regard to the actual results of the merger which is why most of these efforts proceed in the first place.
    Additional drivers of failure through overexpansion include overpaying for acquisitions (partially driven by the probability for greater personal financial gain among management of both companies), and excessive focus on short term growth - sadly, again, with an eye towards personal gain.
    Hamilton and Micklethwait provide analysis of several examples of large scale M&A failure including:
    • AOL - Time Warner
    • Daimler - Chrysler
    • BMW - Rover
    • Enron - Wessex Water
    • Worldcom - Intermedia

  • Dominant CEO - empowered and often drunk on the heels of his or her success, a dominant CEO may surround himself with like-minded "aye sayers" and distance critics; when such a CEO manages to finagle his way into the Chairman's role as well the company is frequently doomed. Heterogeneity supports success, homogeneity and lack of criticism and oversight will eventually lead to failure.

  • Greed and the desire for power - most humans do not suffice with what they already have, and the over-achievers that tend to rise to positions of power within major corporations succumb more frequently to greed than the more complacent types who live below. This again leads to short-termism and the pursuit of personal gain even when clearly not in the best interests of the company and most stakeholders. Option awards may skew potential compensation to such a degree that extremely risky and questionable tactics be undertaken.
  • Failure of internal controls - as large, successful companies grow bureaucracy increases and additional managerial levels take hold the distance between top management and the real world - both inside of the corporation and external to it - widens. Where managerial control and firm leadership had ruled disorder and lack of focus takes reign. Some of the causes identified include:
    • Blurred reporting lines
    • Dispersed departments
    • Increase in remote operations
    • Under-resourced risk management departments
    • Weak, ineffective internal audit
    • Poor cash management
    • Inappropriate financial structures
  • Ineffective and complacent boards leading to ineffective governance - when directors are no longer genuinely independent the CEO loses an objective sounding board and failure looms. Similarly as highlighted above under greed - merging the roles of CEO and Chairman leaves the corporation susceptible to tunnel vision and worse. A company that wants to last must have in place a board that feels free to ask the tough questions, not a bunch of suits that feel compelled to rubber stamp any and all CEO decisions...