The headlines are heavy with iconic companies that have hit the skids recently, from Starbucks, to Boeing, to Intel. All have relatively new CEOs, each of whom has said that their respective company's path to salvation lies in returning to their roots, to once again be a coffee shop or an engineering firm. The assertion is that by going back to basics, they can regain the crown of leadership in their respective markets.
The problem is, there is no going back. The combination of circumstances that created the conditions for rapid growth and market dominance are long gone. The socio-economic factors have changed. The regulatory environment has changed. The key technologies have changed. The supply chain has changed. The competitive landscape has changed. Don't bother with the flux capacitor.
What those bosses are really saying, of course, is “we need a do-over.” But there is no do-over. Not only are years of financial engineering not easily un-done, they created a financial burden that operations have to carry by generating copious free cash flow. Sorry, but no matter how desperate the situation, the new CEO is not the William Cage figure in the Edge of Tomorrow.
While the Starbucks and Boeings grab the headlines at the moment, there are many once iconic companies that backed themselves into a corner by starving operations to feed the balance sheet. Time ran out, old management was shown the door, new management is ushered in.
This is the playbook that new management follows.
The first step is to alleviate immediate financial pressures, starting with the balance sheet. This means any or all of: maxing out credit facilities, selling assets, raising cash through equity sales, taking the company private, breaking up the company, and in the extreme filing for bankruptcy protection. Investors may win (a company breakup can work out well), investors may lose (dilution of equity), and investors may get wiped out (common equity is valueless in bankruptcy).
Fixing the balance sheet buys time, but not a lot of time, so the income statement needs to be shored up as well. Quality problems? Losing customers? Margins too thin? The playbook here is well established: simplify operations, promote quality above all other metrics, reduce contractors and staff, cut discretionary costs, slash prices, over-reward customer loyalty, etc. The good news is, customers mostly win. The bad news is, employees mostly lose, as they will face perpetual cost cutting efforts ranging from the structural (opportunistic terminations) to the petty (workplace surveillance).
Which brings us back to the CEO statement that “we need to become who we once were”.
Unless there are high-value trophy assets, or a large portion of the debt can be saddled onto divisions spun off, the financial stabilization effort will leave a balance sheet that is out of proportion with the income statement. That is, the balance sheet is structured for a company with higher sales growth and stronger cash earnings. Before it does anything else, the company must face the fact that financial stabilization isn’t going to return the capital structure to what it was before all of the financial engineering happened.
That has serious repercussions for operations. Recapturing lost competence only solves the growth problem if the core business can once again be a growth business. This is the fundamental hypocricy of CEOs trafficking in "back to the future" statements: the core business has to be a growth business or returning to core competencies solves nothing. Absolutely nothing. And they know it. Being good at what you used to do well will staunch decline, but it offers no guarantee of a return to growth if there’s not much growth to go round. It is also worth pointing out that the “we need to become what we once were” statement also masks the actual objective: it isn’t to be the pre-eminent firm in the market the company made its name at, as much as it is to resucitate the income statement to a point that the balance sheet makes sense again.
If the core market is slow- or ex-growth, the go-to strategy is to capture a greater share of total customer spend, a.k.a. “revenue grab”. The opportunities here include extending the brand by selling adjacnet products and services (e.g., as GE famously expanded from selling nuclear power plant technology to servicing nuclear power plants in the 1980s). Another is selling against type: where a company once differentiated from its competition by refusing to sell what it derided as low-value offerings, it will cheerfully sell anything and everything because every dollar of revenue is now the same. Yet another opportunity is predatory monetization: charging for things that were previously given away for free (e.g., whereas once upon a time, all economy seats were priced the same, those near bulkheads or the aisle cost more than seats in the middle).
None of these alternatives are revolutionary. All have the advantage of not being “bet the business” pursuits. Which is helpful, because the balance sheet limits the investment the company can make in pursuing any growth opportunities. All of these can be pursued through partnership and small acquisition, as opposed to organic development; this jumpstarts capability, minimizes cash outlay, and promises faster time to return.
Yet none of these are truly growth strategies in that they open new markets or compel buyers to spend where they had not spent before. They are only growth strategies because they assume that customer income statements are growing: growth in wallet share creates exposure to growth in customer income statements. Restated, as aggregate customer topline grows, aggregate customer expenses grow, and a greater capture of customer spend leads to growth. It’s growth by girth, not by invention, innovation or creativity.
The intermediate-term success of this strategy is a return to modest growth and sufficient cash flows to make its interest payments and modest - if only occasional - dividends. These are not steps that will help the company regain its lost edge. Just the opposite: they signal capitulation that it will never regain that edge. Its long-term success is either to be acquired (a possibility because inflation increases revenue and simultaneously reduces the debt burden), or to be in a position to grab more revenue should a competitor stumble or outright fail.
To become what the company once was - a company that made its own growth by obsoleting its own products and services (why keep that 286 PC when you can have a Pentium? Why fly a fleet of 707s when you could fly a fleet of 747s? Why keep using that old phone since it can’t keep a charge anyway?) - requires both a capacity for innovation and a growth market. Yes, I just wrote “the company makes its own growth” because it does so by proxy. Technological advances bring new consumers into the market: personal computer manufacturers expected to sell more PCs once they had more powerful CPUs that could solve more complex problems; airlines expected to fly more passengers once they had more planes and larger planes to drive down costs in the post-deregulation airline industry.
A cash strapped, debt laden business is an unlikely candidate to invent the market-creating technologies of the kind that brought it to prominence in the first place, if for no other reason than a company pursuing revenue grab is focused on yesterday’s growth markets and is therefore poorly attuned to tomorrow’s. That is not to say it is utterly hopeless, but that the path back to growth markets isn’t going to be self-directed. Finding the way back into a growth market requires that the company be quick to recognize, implement and operationalize something new. But that, too, requires balance sheet leeway that, depending how dire the straits it finds itself at the start of the retrenching cycle, will limit its ability to spend on the R&D necessary to innovate. This is the cundrum of retrenchment: while fortifying the balance sheet is unavoidable, the resulting fortress imprisons cash flows and, ultimately, the income statement. Add - well, subtract - labor severed during retrenchment and the disengaged labor that remains, and it is highly unlikly that a fallen icon will return to the vim and vigor of its go-go days.
The retrenching company needs balance sheet and operational restructuring. It will then look for easy money anywhere that it can extend its brand and monetize its offerings. It will hope to buy time for inflation to work its magic on the debt burden and the topline, and to be ready for a competitor to stumble. That is the definition of success.
While a nice sentiment, nothing in this playbook benefits from the business returning to what it used to be. Because success of the grafted-on rescue management isn't "to win", it is "not to lose."
