Monday, November 02, 2009
Jim Collins’ How the Mighty Fall." The Five Stages of Decline.

The research for Good to Great and Built to Last provided author Jim Collins with a database of more than 6,000 years of financial data. These books evaluated the characteristics of companies that made the leap from good to great. In the intervening period, he and his staff noticed but never investigated why many of these companies lost their positions of prominence. Collins got his opportunity in 2004 when he was challenged to do just that: how exactly do great companies experience decline? In other words, how do the mighty fall?

After extensive discussion with senior executives, Collins came to the questions that were central to his research: How would a management team know that the firm was in decline? Shouldn’t it be possible to “detect decline early and reverse course” or better yet, shouldn’t it be possible to “practice preventative medicine?” Collins settled on these five stages of decline:

Stage 1. Hubris born of success. Insulation and momentum; arrogant and entitled to success. Decline often follows because executives underestimate the role of luck in their success, and overestimate their abilities. The smart managers know that any profits in excess of the industry average are anomalies that will soon disappear, and they better get strong today to fend off the inevitable competitors.

Stage 2. Undisciplined pursuit of more. Lack of discipline leads to attempts to grow beyond what is sustainable, given the company’s financial and organizational resources. Lack of discipline leads to deviating from the core values, entering lines of business not tied to the strategy, deciding on projects that benefit management, not the corporation.

Stage 3. Denial of risk and peril. Early warning signs are ignored. Subordinates who bring up the company’s financial or operational weaknesses are called “negative” and excluded from important decisions.

Stage 4. Grasping for salvation. Finally the company’s condition can no longer be hidden. How does management respond? Rationally? Or lunging from one extreme solution to the next, all of which depend on events with low probability of occurring.

Stage 5. Capitulation to irrelevance or death. Collins writes, “The longer a company remains in stage 4, the more likely it will spiral downward.” This often occurs when companies cannot pass the Viability Tests but still undertake the turnaround attempt. These firms waste their last remaining cash on an unrealistic business plan.
 

Here's the Practical Turnaround Thinking:  Don't wait until Stage 4 when the evidence is obvious.  Track all the early warning signs and keep a close eye on cash.