When your company stalls, the results are devastating, and last several years
The Harvard Business Review had out a special issue this fall, the cover title of which was “Growing Your Business In A Downturn.” Since HBR is focused on Fortune 500 companies, and since I work with startups, I suppose I shouldn’t find these articles relevant, yet I do. I suppose it is good to know what comes after the startup phase. If a small company grows rapidly, what crisis next appears?
One article in particular interested me, “When Growth Stalls”, by Matthew Olson, Derek van Bever and Seth Verry. They analyze 400 big American companies and 100 international companies, looking back in time all the way to 1955, and they find that 87% of these companies suffered from a “growth stall” which they define as follows:
To qualify as having stalled in a given year, a company must have enjoyed compound annual growth (CARG) of at least 2% in real dollars for the 10 year period prior to the potential stall point; the difference in CARG for the 10 years preceding and the 10 years following the stall point must have been at least 4 percentage points; and the CARG of the subsequent 10 years must have fallen below 6% in real dollars.
They identify 4 main reasons for growth stalls:
1.) Premium position captivity
2.) Innovation management breakdown
3.) Premature core abandonment
4.) Talent bench shortfall
Of these, #1 and #3 don’t apply to startups, since they have no position to be captive to, and either their core focus is undergoing rapid growth, or the startup is as good as dead.
#2 has an echo in the world of startups. There is the problem of “the endless brainstorm“, a sort of mental illness where the entrepreneur hires a team and chases an idea, but then gives up on the idea because they worry it is not unique enough, so they then they chase another idea, and then another, always pursuing what they hope will be a unique idea, but then giving it up before it has had a chance to prove itself.
#4 is, of course, one of the central problems that startups face. When an organization can only afford to have 8 or 9 people on the team, it is impossible to get all the desired skills. One has to rely on the adaptivity and quick learning of the folks on the team to cover the deficits. Of the startups I’ve worked with, all the failures I’ve seen were of three causes:
1.) Initial idea was a bad one, no real market demand existed for this product or service.
2.) Under capitalized, and therefore unable to execute the vision.
3.) Talent bench shortfall crippled execution. Though the market demand was real and there was enough money to start the project, a lack of some critical skill eventually brings the organization down.
Though I don’t have to deal with #1 and #3 when dealing with startups, they were fascinating to read about.
#1 is simply the other side of the world of startups – when you are a big organization you have to worry about a feisty startup taking your market away from you. As the authors note in the article, this is a category of problem that was well covered by Clayton M. Christensen in his book “The Innovator’s Dilemma“.
The article offers a fascinating story to illustrate #3:
The two most common mistakes we saw in this category were believing that one’s core markets are saturated and viewing operational impediments in the core business model as a signal to move on to new, presumably easier competitive terrain. Either situation invariably ended badly, with some competitor moving in to displace the incumbent.
…In 1976 Kmart reached a peak in new store openings, adding 271 facilities to its countrywide network. That would prove to be its limit. Over the next decade the company reined in expansion in its core business, convinced that the US market was saturated. Its chairman, Robbert Dewar, created a special strategy group whose purpose was to study new growth avenues and, in the parlance of the time, far-out ideas. He also established a performance goal for the company: 25% of sales should come from new ventures by 1990.
What’s most disturbing about Kmart’s choices is not that management was tempted to diversify in search of growth – however misguided this appears in hindsight, given Wal-Mart’s concurrent gathering of strength. Rather, it is that the executive team failed to monitor and match the distribution and inventory management capabilities that its rival was pioneering in Bentonville, Arkansas. In the early 1980s, while Wal-Mart was installing its first point-of-service system with a satellite link for automatic recorders, Kmart was acquiring Furr’s Cafeterias of Texas, the Bishop’s Buffet chain, and pizza-video parlors as outlets for its retained earnings. Throughout the next decade Wal-Mart continued to invest in its cross-docking distribution system, while Kmart pursued a range of disparate businesses, including PayLess Drug Stores, the Sports Authority, and OfficeMax. By the end of the 1980s Kmart was at least 10 years behind Wal-Mart in its logistical capabilities, handing Wal-Mart a “gimme” advantage of more than 1% of sales in inbound logistics costs. As Kmart lagged ever further behind, its imagined need for outside-the-core growth platforms became real.
One other thing jumped out at me in this passage, an issue I’ve thought of a lot before, and that is the assumption that corporations should hang onto to profits and reinvest them, even when management feels its core market is saturated. The other option is to give the money to the owners of the corporation, the shareholders, and let them reinvest the money as they see fit. What is the ethical argument in favor of “acquiring Furr’s Cafeterias of Texas, the Bishop’s Buffet chain, and pizza-video parlors as outlets for its retained earnings”? I realize this is how things are done in all of the advanced industrial countries, and perhaps I should not argue with success. Still, it seems to me there is an alternative way to organize the economy, one which is not much discussed by either critics or supporters of the current system.
The alternative would involve companies not ever expanding outside of their core market, but instead giving all surplus capital (the profit) back to the shareholders, and allowing the shareholders, as private citizens, to make all the decisions about how capital is reallocated from one sector of the economy to another. What right (other than established precedent) do large corporations have to make these decisions? And why do so many people get angry about the government taking their money through taxes, yet so few get angry about corporations hanging onto money that really belongs to the shareholder (the question is rhetorical, I realize this is an example of the well studied psychology that people fear losses more than they value potential gains)?
I can imagine a hypothetical investor in Kmart, circa 1980, who realizes that Wal-Mart is moving ahead, while Kmart is stagnating. The investor would like to move their investment from Kmart to Wal-Mart, but they can not get the full value of their investment out of Kmart, because the management of Kmart is wasting its retained earnings on pizza parlors. The investor must sacrafice some small amount of potential value, when they sell their Kmart stock and reinvest in Wal-Mart.
I think on some level we all have a bias toward centralized decision making. This would explain why we think it is normal for large corporations to make decisions about reallocating capital from declining sectors to rising sectors. Otherwise, we would think it normal to push the money, and therefore the decision, back out to the millions of investors who make up the (nominally) real owners of capital in our society. (I say “nominally” since, in practice, it’s become common to treat investors as something other than real owners.)