by Jim Collins
Armacost ripped apart outmoded traditions, closed branches, and ended lifetime employment. He instituted more incentive compensation. “We’re trying to drive a wedge between our top performers and our nonperformers,” noted one executive about the new culture.11 He allowed Schwab’s leaders to continue their practice of leasing BMWs, Porsches, and even a Jaguar, irritating traditional bankers limited to more traditional Fords, Buicks, and Chevrolets.12 He hired a high-profile change consultant and shepherded people through a transformation process that BusinessWeek likened to a religious conversion (describing the bank as “born again”) and that the Wall Street Journal depicted as “its own version of Mao’s Cultural Revolution.”13 Proclaimed Armacost, “No other financial institution has had this much change.”14 And yet, despite all this leadership, all this change, all this bold action, Bank of America fell from its net income peak of more than $600 million into a decline that culminated from 1985 to 1987 with some of the largest losses up to that point in banking history.
To be fair to Mr. Armacost, Bank of America was already poised for a downward turn before he became CEO.* My point is not to malign Armacost, but to show how Bank of America took a spectacular fall despite his revolutionary fervor. Clearly, the solution to decline lies not in the simple bromide “Change or Die”; Bank of America changed a lot, and nearly killed itself in the process. We need a more nuanced understanding of how decline happens, which brings us to the five stages of decline that we uncovered in our research project.
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* For an excellent account, see Gary Hector’s well-written and authoritative book, Breaking the Bank: The Decline of BankAmerica.
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Five Stages of Decline
In one sense, my research colleagues and I have been studying failure and mediocrity for years, as our research methodology relies upon contrast, studying those that became great in contrast to those that did not and asking, “What’s different?” But the primary focus of our quest had been on building greatness, an inherently bright and cheery topic. After my West Point experience, I wanted to turn the question around, curious to understand the decline and fall of once-great companies. I joked with my colleagues, “We’re turning to the dark side.”
THE RESEARCH PROCESS
We had a substantial amount of data collected from prior research studies, consisting of more than six thousand years of combined corporate history—boxes and binders of historical documents, and spreadsheets of financial information going back more than seventy years, along with substantial research chronologies and financial analyses. We expected that a rigorous screening of this data would yield a set of robust cases of companies that rose to greatness and then subsequently fell. We began with sixty major corporations from the good-to-great and built-to-last research archives, and systematically identified eleven cases that met rigorous rise-and-fall criteria at some point in their history: A&P, Addressograph, Ames Department Stores, Bank of America (before it was acquired by NationsBank), Circuit City, Hewlett-Packard (HP), Merck, Motorola, Rubbermaid, Scott Paper, and Zenith. (In Appendix 1, I’ve outlined the selection process.) We updated our research data archives and then examined the history of each fallen company across a range of dimensions, such as financial ratios and patterns, vision and strategy, organization, culture, leadership, technology, markets, environment, and competitive landscape. Our principal effort focused on the two-part question, What happened leading up to the point at which decline became visible and what did the company do once it began to fall?
Before we delve into the five-stage framework we derived from this analysis, allow me to make a few important research notes.
Companies in Recovery: Some of the companies in our analysis may have regained their footing by the time you read this. Merck and HP, for instance, appeared to have reversed their steep declines as we were working on this piece; whether they sustain their recovery remains to be seen, but both show improved results at the time of this writing. This brings me to an important subtheme of this work to which we will return: just as great companies can topple, some rise again. It’s important to understand that the point of our research is not to proclaim which companies are great today, or which companies will become great, remain great, or fall from greatness in the future. We study historical eras of performance to understand the underlying dynamics that correlate with building greatness (or losing it).
Fannie Mae and Other Financial Meltdowns of 2008: When we selected the study set of fallen companies in 2005, Fannie Mae and other financial institutions in our original database had not yet fallen far enough to qualify for this analysis. It would lack rigor to tack any of these companies onto our study as an afterthought, but at the same time, it would lack common sense to ignore the fact that some well-known financial companies (and in particular, Fannie Mae, which had been a good-to-great company) have succumbed to one of the most spectacular financial meltdowns in history. Instead of throwing these companies into the research study at the last minute because they happened to be in the news, I’ve included a brief commentary about Fannie Mae in Appendix 3.
Success Comparison Set: All our research studies involve a control comparison set. The critical question is not “What do successes share in common?” or “What do failures share in common?” The critical question is “What do we learn by studying the contrast between success and failure?” For this analysis, we constructed a set of “success contrasts” that had risen in the same industries during the era when our primary study companies declined. (See Appendix 2 for comparison-company selection methodology.) For an illustration, consider the chart “A Study of Contrasts” below. In the early 1970s, the two companies in this chart, Ames Department Stores and Wal-Mart (a contrast we’ll discuss in a few pages), stood as almost identical twins. They had the same business model. They had similar revenues and profits. They both achieved tremendous growth. Both had strong entrepreneurial leaders at the helm. And as you can see in the chart, both achieved exceptional investor returns far in excess of the general stock market for more than a decade, the two curves tracking each other very closely. But then the curves diverge completely, one company plummeting while the other continues to rise. Why did one fall, while the other did not? This single contrast illustrates our comparison method.
Correlations, Not Causes: The variables we identify in our research are correlated with the performance patterns we study, but we cannot claim a definitive causal relationship. If we could conduct double-blind, prospective, randomized, placebo-controlled trials, we would be able to create a predictive model of corporate performance. But such experiments simply do not exist in the real world of management, and therefore it’s impossible to claim cause and effect with 100 percent certainty. That said, our contrast method does give us greater confidence in our findings than if we studied only success, or only failure.
Strength of Historical Analysis: We employ a historical method, studying each company from its founding up to the end point of our investigation, focusing on specific eras of performance. We gather a range of historical materials, such as financial and annual reports, major articles published on the company, books, academic case studies, analyst reports, and industry reference materials. This is important because drawing solely upon backward-looking commentary or retrospective interviews increases the chances of fallacious conclusions. Using a well-known success story to illustrate, if we relied on only retrospective commentary about Southwest Airlines after it had become successful, those materials would be colored by the authors’ knowledge of Southwest’s success and would therefore be biased by that knowledge. For example, some retrospective accounts attribute Southwest’s success to pioneering a unique and innovative airline model (in part, because the authors believe the winners must be the innovators), but in fact, a careful reading of historical documents shows that Southwest largely copied its model from Pacific Southwest Airlines in the late 1960s. If we were to rely on only retrospective accounts, we would be led astray about wh
y Southwest became a great company.
We therefore derive our frameworks primarily from evidence from the actual time of the events, before the outcome is known, and we read through the evidence in chronological order, moving forward through time. Documents published at each point in time are written without foreknowledge of the company’s eventual success or failure, and thereby avoid the bias of knowing the outcome. So, for instance, the materials we have on Zenith that were published in the early 1960s, when Zenith sat on top of its world, give us perspective on Zenith at that time, uncolored by the fact that Zenith would eventually fall. Interviews play a minimal part in our research method, and in this study (where people might have a strong need for self-justification), we conducted no interviews with current or recent members of management. Not that historical information is perfect—corporations can selectively exclude unhappy information from their annual reports, for example, and journalists may write with a preconceived point of view. Nor am I entirely immune from having some retrospective bias of my own, as I always know the success or failure of the company I’m studying, and I cannot erase that from my brain. But even with these limitations, our comparative historical method helps us see more clearly the factors correlated with the rise and fall of great companies.
This process of looking at historical evidence created at the time, before a company falls, yields one of the most important points to come from this work: it turns out that a company can indeed look like the picture of health on the outside yet already be in decline, dangerously on the cusp of a huge fall, just like Bank of America in 1980. And that’s what makes the process of decline so terrifying; it can sneak up on you, and then—seemingly all of a sudden—you’re in big trouble.
This raises a fascinating set of questions: Are there clearly distinguishable stages of decline? If so, can you spot decline early? Are there telltale markers? Can you reverse decline, and if so, how? Is there a point of no return?
THE RESULTS: A FIVE-STAGE FRAMEWORK
Surrounded by research papers at our dining room table one day, clicking away on my laptop while trying to make sense of the chronologies of decline, I commented to my wife, Joanne, “I find this much harder to get my head around than studying how companies become great.” No matter how I assembled and reassembled conceptual frameworks to capture the process of decline, I’d find counterexamples and different permutations of the pattern.
Joanne suggested I look at the first line of Tolstoy’s novel Anna Karenina. It reads, “All happy families are alike; each unhappy family is unhappy in its own way.” In finishing this piece, I kept coming back to the Anna Karenina quote. Having studied both sides of the coin, how companies become great and how companies fall, I’ve concluded that there are more ways to fall than to become great. Assembling a data-driven framework of decline proved harder than constructing a data-driven framework of ascent.
Even so, a staged framework of how the mighty fall did emerge from the data. It’s not the definitive framework of corporate decline—companies clearly can fall without following this framework exactly (from factors like fraud, catastrophic bad luck, scandal, and so forth)—but it is an accurate description of the cases we studied for this effort, with one slight exception (A&P had a different type of Stage 2). In the spirit of statistics professor George E. P. Box, who once wrote, “All models are wrong; some models are useful,” this framework is helpful for understanding, at least in part, how great companies can fall.15 Equally important, I believe it can be useful to leaders who seek to prevent, detect, or reverse decline.
The model consists of five stages that proceed in sequence. Let me summarize the five stages here and then provide a more detailed description of each stage in the following pages.
STAGE 1: HUBRIS BORN OF SUCCESS. Great enterprises can become insulated by success; accumulated momentum can carry an enterprise forward, for a while, even if its leaders make poor decisions or lose discipline. Stage 1 kicks in when people become arrogant, regarding success virtually as an entitlement, and they lose sight of the true underlying factors that created success in the first place. When the rhetoric of success (“We’re successful because we do these specific things”) replaces penetrating understanding and insight (“We’re successful because we understand why we do these specific things and under what conditions they would no longer work”), decline will very likely follow. Luck and chance play a role in many successful outcomes, and those who fail to acknowledge the role luck may have played in their success—and thereby overestimate their own merit and capabilities—have succumbed to hubris.
STAGE 2: UNDISCIPLINED PURSUIT OF MORE. Hubris from Stage 1 (“We’re so great, we can do anything!”) leads right into Stage 2, the Undisciplined Pursuit of More—more scale, more growth, more acclaim, more of whatever those in power see as “success.” Companies in Stage 2 stray from the disciplined creativity that led them to greatness in the first place, making undisciplined leaps into areas where they cannot be great or growing faster than they can achieve with excellence, or both. When an organization grows beyond its ability to fill its key seats with the right people, it has set itself up for a fall. Although complacency and resistance to change remain dangers to any successful enterprise, overreaching better captures how the mighty fall.
STAGE 3: DENIAL OF RISK AND PERIL. As companies move into Stage 3, internal warning signs begin to mount, yet external results remain strong enough to “explain away” disturbing data or to suggest that the difficulties are “temporary” or “cyclic” or “not that bad,” and “nothing is fundamentally wrong.” In Stage 3, leaders discount negative data, amplify positive data, and put a positive spin on ambiguous data. Those in power start to blame external factors for setbacks rather than accept responsibility. The vigorous, fact-based dialogue that characterizes high-performance teams dwindles or disappears altogether. When those in power begin to imperil the enterprise by taking outsized risks and acting in a way that denies the consequences of those risks, they are headed straight for Stage 4.
STAGE 4: GRASPING FOR SALVATION. The cumulative peril and/or risks-gone-bad of Stage 3 assert themselves, throwing the enterprise into a sharp decline visible to all. The critical question is, How does its leadership respond? By lurching for a quick salvation or by getting back to the disciplines that brought about greatness in the first place? Those who grasp for salvation have fallen into Stage 4. Common “saviors” include a charismatic visionary leader, a bold but untested strategy, a radical transformation, a dramatic cultural revolution, a hoped-for blockbuster product, a “game changing” acquisition, or any number of other silver-bullet solutions. Initial results from taking dramatic action may appear positive, but they do not last.
STAGE 5: CAPITULATION TO IRRELEVANCE OR DEATH. The longer a company remains in Stage 4, repeatedly grasping for silver bullets, the more likely it will spiral downward. In Stage 5, accumulated setbacks and expensive false starts erode financial strength and individual spirit to such an extent that leaders abandon all hope of building a great future. In some cases, their leaders just sell out; in other cases, the institution atrophies into utter insignificance, and in the most extreme cases, the enterprise simply dies outright.
It is possible to skip a stage, although our research suggests that companies are likely to move through them in sequence. Some companies move quickly through the stages, while others languish for years, or even decades. Zenith, for example, took three decades to move through all five stages, whereas Rubbermaid fell from the end of Stage 2 all the way to Stage 5 in just five years. (The collapse of financial companies like Bear Stearns and Lehman Brothers that happened just as we were finishing up this work highlights the terrifying speed at which some companies fall.) An institution can stay in one stage for a long time, but then pass quickly through another stage; Ames, for instance, spent less than two years in Stage 3 but more than a decade in Stage 4 before capitulating to Stage 5. The stages can also overlap, the remnants of earlier stages playing an enabling role d
uring later stages. Hubris, for example, can easily coincide with Undisciplined Pursuit of More, or even with Denial of Risk and Peril (“There can’t be anything fundamentally wrong with us—we’re great!”). The following diagram shows how the stages can overlap.
IS THERE A WAY OUT?
When I sent a first draft of this piece to critical readers, many commented that they found our turn to the dark side grim, even a bit depressing. And you might have the same experience as you read through the five stages of decline, absorbing story upon story of once-great companies that precipitated their own demise. It’s a bit like studying train wrecks—interesting, in a morbid sort of way, but not inspiring. So, before you embark on this dark journey, allow me to provide two points of context.
First, we do ourselves a disservice by studying only success. We learn more by examining why a great company fell into mediocrity (or worse) and comparing it to a company that sustained its success than we do by merely studying a successful enterprise. Furthermore, one of the keys to sustained performance lies in understanding how greatness can be lost. Better to learn from how others fell than to repeat their mistakes out of ignorance.
Second, I ultimately see this as a work of well-founded hope. For one thing, with a roadmap of decline in hand, institutions heading downhill might be able to apply the brakes early and reverse course. For another, we’ve found companies that recovered—in some cases, coming back even stronger—after having crashed down into the depths of Stage 4. Companies like Nucor, Nordstrom, Disney, and IBM fell into the gloom at some point in their histories yet came back.
