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CMY K
cover apr-jun 03
S t r a t e g y + M a r k e t i n g + A n a l y s i s + R e s o u r c e s + T e c h n o l o g y
sir john
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profiled by
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at
APR-JUN 2003
VOL 2
ISSUE 2
arun maira
liz mellon
meher pudumjee
john philip jones
by
kumar
mangalam
birla
Z
Z
why good
companies
go bad
by donald n sull
lijjat papad
by jyoti naik
Z
Z
jacques horovitz
Q2
03
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cover apr-jun 03
CMY K
why good companies page 1
SMART THINKING
why good
companies
go bad
by Donald N Sull
Meera Chavan
Much has been written about how companies
can go from good to great, but the reality is
that most companies go from good to bad.
When the business environment changes,
highly successful companies tend to be the
slowest to adapt. Why? The problem is
active inertia, a powerful, subtle and silent
force which has claimed some of the world’s
greatest companies as its victims. Nothing
succeeds like success and nothing fails
as spectacularly as spectacular success.
why good companies page 1
why good companies page 3
W H Y G O O D C O M P A N I E S G O B A D by Donald N Sull
r
ecent history provides many examples of once-
n they
respond aggressively: the managers I studied
successful businesses that have fallen on hard times. Recall
were anything but lazy. Rather, they often worked longer
the recent fall of high-fliers such as Enron, Vivendi, and the
hours than their counterparts at companies that responded
Daewoo Group. Nor are Indian companies immune from
effectively to changes in the environment.
they are talented managers: in most cases, these are
the failure of success. Consider the recent decline of former
n
leaders such as TI Cycles, Indian Oxygen and the Essar Group.
the self-same executives responsible for the company’s
Why do good companies go bad? Sometimes they falter
previous success.
in the wake of a sudden, unforeseen jolt. Dozens of Brazilian
If good managers foresee changes and respond promptly
auto parts suppliers, for example, were wiped out in the span
and aggressively, why do their efforts fail? Why does so much
of a few years when the government unexpectedly eliminated
sound and fury, in the end, signify nothing?
the import tariffs that had protected the industry from foreign
competitors for decades. Such unforeseeable shocks are like
active inertia
meteorites in biological evolution; they come out of the blue
Managers can respond ineffectively to changes in their
and can cause sudden extinction. Despite our best prognostic
competitive environment for many reasons. They may lack
tools, we cannot forecast events like the terrorist attack on
the financial resources to fund necessary investments, for
New York’s World Trade Center in September 2001.
example, or fail to manage the risk associated with a new
Unexpected jolts are dramatic, but they are also
direction. Many times, however, managers fail to respond
comparatively rare. Most major shifts in technology,
for a different reason. They get trapped by the success
regulation, competitive dynamics, or consumer preferences
formula that led to their past success. I use the term ‘active
occur gradually. Managers generally see them coming. So
inertia’ to describe managers’ tendency to respond to even
why do managers fail to respond effectively to shifts that
the most disruptive changes by accelerating activities that
they see on the horizon? Are they paralyzed like deer trapped
worked in the past. When the world changes, in other words,
in the headlights of an oncoming car? I have spent a decade
they respond with more of the same.
studying corporate failure in companies around the world
This is exactly what happened to Indian Oxygen, an
and found this simple explanation doesn’t fit the facts.
Indian subsidiary of the British industrial gas maker, BOC.
Rather, my research shows that top managers of failed
Indian Oxygen had enjoyed decades of success as a market
companies shared the following characteristics:
leader and was one of the most visible and respected
n they
spot the changes early: top executives invariably
companies in India. In the mid-1980s, however, the Indian
anticipate the changes and often commission reports from
government began to liberalize the industrial gas sector,
management consulting firms that describe the shifts in
opening it up to new competitors. A rash of new rivals
great detail.
entered the market, many of which employed superior
technology. Indian Oxygen began to lose market share and
Donald N Sull
company doctor
“It’s ironical how the seeds of failure are sown
during a company’s most successful time,”
muses Sull, Professor at Harvard Business
School and earlier assistant professor of
strategic and international management at
London Business School.
watched as profits deteriorated.
In 1989, managing director Sashi Parsad began a dramatic
turnaround. He sold Indian Oxygen’s electrodes business,
closed a number of inefficient plants, and reduced the
number of employees from 5,392 in 1989 to 2,134 by 1993.
He invested in modernizing the company’s manufacturing
infrastructure to cut production costs and reduce power
consumption and waste. Profits after tax jumped from
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W H Y G O O D C O M P A N I E S G O B A D by Donald N Sull
Rs2.5mn in 1990 to Rs70.5mn in 1993, leading to a ten-fold
company trapped in active inertia resembles a car stuck in
increase in Indian Oxygen’s market capitalization.
a rut. The more managers step on the gas, the deeper they
dig their company in. So, what are the ruts that trap
The share price had indeed increased dramatically, but
companies in active inertia?
Indian Oxygen’s market share continued to fall from 60%
in the mid-1980s to 40% in 1993. Top executives clearly saw
the changes in their competitive environment and responded
success formula hardens
aggressively. They responded, however, by incrementally
Active inertia results when a company’s success formula
refining the approach that had worked in the past. They
hardens. A ‘success formula’ refers to an organization’s
maintained the same strategy, processes, customers,
enduring set of strategic frames, resources (such as
technology, and culture. Middle managers expressed
technology, specialized facilities, and brands), processes,
dissatisfaction with top executives’ approach of responding
relationships, and values that collectively shape the behavior
to changed circumstances with minor modifications of
of managers and employees within the company. (See figure
what worked in the past. One manager observed that the
01 for a graphic depiction of the success formula).
constraint lay in the minds of top executives: “They can
A clear success formula provides many competitive
only think incrementally . . . everything is 10% . . . 10%
benefits. It confers a sharp focus that allows employees to
growth in compressed oxygen sales, 10% reduction in costs.”
concentrate on the organization’s core competencies. It
The incremental approach failed to halt Indian Oxygen’s
prevents employees and managers from dissipating energy
decline, and by 2002, the company had dropped off the radar
by chasing peripheral opportunities. A clearly articulated
screen of admired firms in India.
success formula enables efficient execution and coordination
Managers often equate inertia with inaction, for
across units. Executives can also scale their business more
example, like a deer frozen in front of a car’s headlights.
easily with a clear formula. In a competitive field, a distinctive
But executives at Indian Oxygen were anything but
formula can differentiate a company and allow it to rise
inactive. They unleashed a flurry of initiatives to respond
above the competitive fray.
to the shifts in the competitive context. The Indian Oxygen
If a formula facilitates initial success, it can attract
case illustrates the reality of active inertia. Executives
customers, employees, investors and imitators. This positive
respond to major changes by tweaking the formula that
feedback reinforces management’s belief that they should
led to historical success. Rather than freezing in place, a
maintain their success formula through additional
fig 01: success formula
what we see when we look at the world
frames
processes
how we do
things around here
resources
relationships
things we own that
help us compete
values
beliefs that inspire,
unify, and identify us
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why good companies page 4
enduring links
to external
stakeholders
and among
internal units
why good companies page 5
W H Y G O O D C O M P A N I E S G O B A D by Donald N Sull
investments that reinforce it. With time and repetition,
close it. Their ossified formula, however, channels their
people stop considering alternatives to their formula; it slips
efforts into well-worn ruts. The harder they work, the wider
into the taken-for-granted background. The individual
the gap becomes. The result is active inertia. (figure 02 depicts
components of the success formula grow less flexible: strategic
this cycle.)
frames become blinders, resources harden into millstones,
processes settle into routines, relationships become shackles,
strategic frames become blinders
and values ossify into dogmas. The linkages among the
Strategic frames are the mental models that shape how
components tend to tighten as well. The formula as a whole
managers and employees interpret their competitive
becomes invisible— “how we do things around here.”
landscape. These models answer key strategic questions such
Once a company has stabilized its formula, it generally
as: “What business are we in?” and “Who are our most
attracts and promotes managers who value stability rather
dangerous competitors?” Frames provide focus, allowing
than firebrands who might challenge the status quo. Long
managers to identify critical pieces of information and
periods of success provide the company with the capital to
recognize how new data fits into a broader pattern. While
pursue their success formula and reassure managers they have
frames enable managers to see, they can also blind them. By
hit on the one true way to compete. Geographic concentration
continually focusing on the same aspects of business, frames
of firms in the same industry—such as financial services in
can constrict managers’ vision, blinding them to novel
Mumbai or IT firms in Bangalore—increases the odds that
opportunities and threats beyond their normal periphery.
firms will follow similar formulas. As a result, clustering can
As their strategic frames grow more rigid, managers often
reinforce or even accelerate this entrenchment. All of these
force-fit surprising information into their existing mental
factors encourage managers to make commitments that
model or ignore it altogether.
Consider the case of Bajaj Auto, one of India’s leading
reinforce their tried-and-true formula.
An established formula serves a company well as long
makers of two-wheel vehicles. Throughout the 1980s and
as the competitive, technical and regulatory contexts remain
1990s, customers had to wait up to ten years to obtain one
stable. When the context shifts, however, a gap can grow
of the company’s highly coveted scooters. In 1995, the
between the demands of the competitive environment and
company produced 70,000 scooters per month. But today,
what the existing success formula does well. Managers see
Bajaj Auto makes less than one-third that amount despite
the gap, often at an early stage, and respond aggressively to
their widespread availability in stores. Prices, moreover,
fig 02: the dynamics of standing still
environment
frames
processes
resources
values
blinders
relationships
routines
millstones
dogmas
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shackles
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W H Y G O O D C O M P A N I E S G O B A D by Donald N Sull
a company that owns VALUABLE RESOURCES
can earn a STEADY STREAM of profits from them
are virtually the same as they were a decade ago. The
managers to view Xerox as a copier company and miss opp-
combination of sharply lower volume and flat prices has,
ortunities to exploit its early lead in personal computers.
of course, eroded Bajaj Auto’s profitability.
Consider the case of IPCL (Indian Petrochemicals Ltd).
So what happened? Part of the explanation lies in Bajaj
For almost two decades, IPCL dominated the Indian petro-
Auto’s strategic frames. Historically, executives had seen
chemicals industry. Its three plants fed half the country’s
the company as a ‘scooter maker’ and believed that India,
demand from plastics and textile industries. The remaining
like Italy and Taiwan, would remain a strong market for
50% was met through imports. In a supply-driven market,
scooters. Seeing the world through the lens of a ‘scooter
managers in its downtown Mumbai marketing office were
company’ blinded executives to the speed with which
constantly besieged by hundreds of small plastic processors
consumers were shifting to motorcycles. The same focus
hungry for raw materials for their factories. For years, IPCL
on scooters that provided efficiency in earlier decades
was one of the most successful public sector companies in
hindered Bajaj Auto from responding effectively when
the country, turning in sturdy profits.
circumstances changed.
resources harden into millstones
Resources consist of both tangible assets, such as factories
All this changed in the mid 1980s. The Indian
petrochemical industry continued to be supply driven but
two factors reversed IPCL’s fortunes. The first attack on the
government-run monopoly’s bottom line was a steady
or equipment, and intangible
softening in the international
assets, including brands and
prices of petrochemicals. Second
technology. To the extent that
attack was the commissioning
they are durable, specialized,
of Reliance Industries’ petro-
and illiquid, resources lock a
chemical plant at Hazira. IPCL
firm into a course of action. A
now had local competition.
company that owns valuable
IPCL executives, of course,
resources can earn a steady
saw the declining prices and the
stream of profits from them,
Hazira plant coming on stream.
much as a landlord earns rent for
The shifts would have been
the use of a building she owns.
impossible to miss. They also
When the environment shifts,
responded aggressively through
however, a company’s existing
such actions as building extra
resources can contribute to active
capacity through a new plant at
inertia. Managers hesitate to
Nagothane and expanding their
reconfigure their resources for fear
sales and marketing network.
of jeopardizing the associated
Their response, however, took
profits. Abandoning established resources also forces
for granted that they would maintain the firm’s aging
managers of incumbent companies to restart from scratch,
mother plant at Vadodara. The Ambani family that ran
often behind start-ups with a first-mover advantage.
Reliance Industries, in contrast, were determined to build a
Finally, resources often mold the company’s strategic frames,
plant with cutting-edge technology and world class scale.
processes, relationships, and values in ways that contribute
IPCL’s resource base of an outdated plant became a mill-
to active inertia. Xerox’s photo copier technology led
stone that limited their ability to compete with Reliance’s
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W H Y G O O D C O M P A N I E S G O B A D by Donald N Sull
a critical element of a company’s SUCCESS FORMULA, processes are
how an ORGANIZATION does BUSINESS, both formally and informally
‘Rolls-Royce’ factory. Within five years, Reliance overtook
through higher quality. In contrast to IBM, Compaq sold
IPCL as India’s leading petrochemical company. By 2000,
exclusively through retailers such as ComputerLand and
Reliance had built the world’s largest refinery and acquired
Sears Business Center.
the former leader IPCL.
processes lapse into routines
Compaq’s high-quality clone strategy resulted in
explosive growth. Compaq racked up revenues of $111
million in 1983, a record for first-year sales. Much of these
Processes, like strategic frames and resources, are a critical
new sales came out of the hide of IBM. IBM’s strategic
element of a company’s success formula. Processes are how
frames had hardened into blinders and led to focus on
an organization does business, both formally and informally.
mainframes even as PC orders exploded. Stuck in active
When a company tries something new, employees usually
inertia, IBM lacked capacity to fill orders for PCs. Compaq
experiment with several ways of completing the activity.
quickly moved beyond cloning to take the technical lead
Once managers find a process that works well enough, they
and introduced computers running on Intel’s latest chips
usually stop experimenting and commit to what worked.
before IBM produced a comparable product. Compaq
Selecting a standardized process frees people’s time and
achieved $1 billion in revenues in record time, and achieved
energy to focus on other tasks. Standard operating procedures
Fortune 500 status. Eight years after its founding, the
also provide productivity gains as employees gain experience
company booked sales of $3.6 billion, employed more
with the process. Agreed-upon processes confer the
than ten thousand employees, and sold through more than
predictability required to coordinate activities within a
three thousand resellers.
complex organization and across the company’s boundaries.
Senior executives committed to a series of processes
Managers sometimes codify their processes into ‘handbooks’
that supported Compaq’s high-quality strategy. The manu-
that specify every step to follow in minute detail.
facturing process, for example was designed to ensure
As managers standardize operating procedures, these
quality, speed products to market, and adjust the mix of
routines resist change. Some obstacles are completely rational,
goods quickly. Product cost was a distant fifth priority. New
such as the costs of switching procedures after installing,
product development began with specifications that
learning, and integrating a process into a company’s
guaranteed the highest level of quality, which then drove
operations. With repetition, processes become second
the rest of the design. Claiming that managers aspired to be
nature; people stop thinking of them as a means to an end,
right 100 percent of the time, Canion and his colleagues
if they think of them at all, and stop considering alterna-
also established a decision-making method throughout the
tives to these comfortable, reassuring routines. When the
company that achieved this certainty by forcing employees
environment shifts, managers respond aggressively but
to discuss every detail until all participants agreed upon the
existing routines tend to channel their responses into well-
proper course of action.
worn grooves.
Compaq’s quality-at-any-price processes served the
Consider the fate of Compaq Computer founded in
company well in the early days of the PC industry when
1982 by Rod Canion and other executives from Texas
customers worried about the product’s usability and low-
Instruments. The founders designed a PC with a handle like
cost alternatives were rare. As hardware and software
a briefcase. They targeted their twenty-eight-pound luggable
improved considerably, and consumers began focusing on
machine at corporate ‘road warriors’ who needed a PC
price these routines no longer functioned effectively. As the
when traveling for business. Compaq priced its computers
industry moved toward commoditization, new competitors
just below IBM machines, and differentiated their product
entered the market. Dell Computer, for example, advertised
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unchanging RELATIONSHIPS can turn into SHACKLES that limit
an ORGANIZATION’S FLEXIBILITY and lock it into ACTIVE inertia
prices 20 percent to 40 percent lower than Compaq’s for a
make or break a company—think of Microsoft and Intel or
similar machine. Price wars depressed profits, and hurt
Wal-Mart and Procter & Gamble.
Compaq’s bottom line. In 1991, the company missed
However over time, unchanging relationships can
analysts’ earnings expectations for two quarters, suffered
turn into shackles that limit an organization’s flexibility
its first-ever quarterly loss, and announced layoffs. It also
and lock it into active inertia. Established relationships
announced plans to launch a single inexpensive product—
with customers can prevent firms from responding
more than a year later.
effectively to changes in technology, regulations, or
Compaq managers’ commitment to a set of standard
operating procedures channeled their response to declining
consumer preferences. Relationships among a company’s
units can also ossify.
profits into active inertia. Ignoring existing evidence, they
Few cases better illustrate how relationships can
gathered more and more data and analyzed and re-
become shackles than the rise and fall of the Daewoo
analyzed them to gain perfect consensus and certainty on
Group of South Korea. Woo-Choong Kim founded
the sources of profit shortfalls. Their well-honed new
Daewoo Industrial in 1967 with only five employees, but
product development routines continued to produce highly
he had great aspirations for his enterprise—the name
engineered products that were too expensive. The
Daewoo means ‘great universe’ in Korean. Thirty years later,
manufacturing process churned out machines of the
Daewoo had fulfilled its founder’s grand ambitions with
highest quality, still priced to gather dust on dealers’
consolidated revenues approaching $20bn, approximately
shelves. Processes that worked well in the early days of the
200,000 employees worldwide, and more than 450
industry had hardened into routines that prevented
overseas subsidiaries in businesses ranging from semi-
Compaq from responding effectively to the commoditi-
conductors to shipbuilding.
zation of the PC industry.
relationships become shackles
Daewoo’s astounding growth was due in large part to
its close relationships with the South Korean government.
Staging a military coup in 1960, General Chung-Hee Park
Managers commit to relationships of two kinds: external
seized control of the government and ruled with an
ones with customers, investors, governments, suppliers,
iron hand until his assassination in 1979. General Park had
and partners who provide access to critical resources that
studied under Kim’s father and wanted to help his teacher’s
the company does not own; and internal reporting
son. Under Park, the South Korean government supported
relationships among business units, such as those embodied
Daewoo and other favored chaebol with subsidized
in an organization chart. Managers commit to these
financing, tariff protection, export licenses, permits for
relationships through a variety of
capacity expansion, and tax
mechanisms. They invest in
breaks. In exchange, the
technology or facilities to,
government required Daewoo
example, serve a particular
and other family- controlled
customer, write long-term
conglomerates to invest in
service or licensing contracts,
industries
form joint ventures or industry
expansion. Daewoo dutifuly
consortia, or integrate operations
obliged, expanding first in
through acquisition, to name a
exports then in heavy industry,
few. These relationships can
shipbuilding, chemicals, semi-
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targeted
for
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W H Y G O O D C O M P A N I E S G O B A D by Donald N Sull
good managers get TRAPPED in the VERY FORMULAS
that ALLOWED them to SUCCEED in the first place
conductors, automotives, and consumer electronics as the
company and its customers, attract like-minded partners,
government targeted each for growth.
and hold together a company’s far-flung operations. As
When General Park was assassinated in 1979, major
companies mature, however, their values often harden into
shifts in the political and regulatory climate threatened
rigid rules and regulations codified in thick employee
Daewoo’s position. Subsequent governments opened
handbooks. Outdated dogmas slowly replace the once-living
South Korea’s product and capital markets to the outside
values until they oppress rather than inspire, and their
world and withdrew much of the support that favored
unifying power degenerates into mindless conformity. The
Daewoo and the other chaebol. Chinese competitors, in the
result, once more, is active inertia.
meantime, pressured them from the low end of the market
and Japanese firms from the high end.
Consider the example of Royal Dutch/Shell. During
the 1930s, Henri Deterding, a strong leader and Nazi
Chairman Kim saw the changes coming responded
sympathizer, dominated Royal Dutch/Shell and exerted his
aggressively. He expanded Daewoo assertively as if the
control though a highly centralized organization. Shell’s
government would intervene should these bets lose.
other executives ultimately forced Deterding out, but the
Instead of loosening ties with government, Daewoo
painful episode imprinted a strong value of decentralized
tightened them and invested heavily to build and acquire
control. To prevent another executive from again amassing
production and marketing capacity in developing countries
such centralized power, Shell’s executives translated their
such as China, Vietnam, India, the Sudan, and several nations
respect for independence into a decentralized organizational
in Eastern Europe. Chairman Kim forged tight bonds with
structure consisting of many highly autonomous country
local politicians to secure favorable trade and investment
operations. The resulting decentralized structure and
terms. In Uzbekistan, for example, Daewoo received a free
underlying values enabled Shell’s local operations to seize
factory site and tariff protection in exchange for a large
growth opportunities quickly. Over time, however, the
investment in automobile production; commentators joked
values hardened into an absolute dogma that all centralized
that the country should be renamed ‘Daewooistan.’
authority was bad. The organization came to resemble a
Kim borrowed as much as $47bn to fund his invest-
loose alliance of regional fiefdoms beyond the control of
ments, exceeding the foreign national debt of countries such
any corporate manager. When oil prices fell during the 1990s,
as Poland and Malaysia. Local governments could guarantee
the dogma of complete decentralization hindered Shell’s top
loans but not consumer demand for Daewoo’s products.
managers from consolidating operations to cut costs.
By the mid 1990s, several of Daewoo’s operations were
When conditions change, firms often fail to respond
running well below capacity. Rather than retrenching during
effectively. Their managers are sometimes accused of missing
South Korea’s recession in 1997, Kim kept expanding until
the changes, failing to respond, or worse. Yet the reality is
the Daewoo group collapsed under the weight of its own
much more complex than these simple explanations suggest.
debt. The Korean government intervened—not to save
Good managers get trapped in the very formulas that
Daewoo, but to dismantle it. Chairman Kim fled the country
allowed them to succeed in the first place. Recognizing the
to avoid criminal prosecution.
active inertia trap is the first step in breaking free. Managers
values ossify into dogmas
who understand the risks of a strong success formula are
better equipped to avoid active inertia in the first place.
Entrepreneurs and managers often commit to a strong set
of values for several reasons. Strong values can elicit fierce
loyalty from employees, strengthen the bonds between a
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