How the Mighty Fall_And Why Some Companies Never Give In

by Jim Collins

  Great companies can stumble, badly, and recover. While you can’t come back from Stage 5, you can tumble into the grim depths of Stage 4 and climb out. Most companies eventually fall, and we cannot deny this fact. Yet our research indicates that organizational decline is largely self-inflicted, and recovery largely within our own control.

  All companies go through ups and downs, and many show signs of Stage 1 or 2, or even Stage 3 or 4, at some point in their histories. Yet Stage 1 does not inevitably lead to Stage 5. The evidence simply does not support the notion that all companies must inevitably succumb to demise and disintegration, at least not within a 100-year time frame. Otherwise, how could you explain companies with ten to fifteen decades of achievement, companies like Procter & Gamble (P&G), 3M, and Johnson & Johnson? Just because you may have made mistakes and fallen into the stages of decline does not seal your fate. So long as you never fall all the way to Stage 5, you can rebuild a great enterprise worthy of lasting.

  As you read the following pages, you might wonder, but what should we do if we find ourselves falling? It turns out that much of the answer lies in adhering to highly disciplined management practices, and we’ll return to the question of recovery at the end of this piece. But for now, we need to descend into the darkness to better understand why the mighty fall, so that we might avoid their fate.

  Stage 1: Hubris Born of Success

  In December 1983, the last U.S.-made Motorola car radio rolled off the manufacturing line and into Chairman Robert Galvin’s hands as a reminder. Not as a sentimental memento, but as a tangible admonition to continue to develop newer technologies in an ongoing process of creative self-renewal. Motorola’s history taught Galvin that it’s far better to create your own future, repeatedly, than to wait for external forces to dictate your choices.16 When the fledgling Galvin Manufacturing Corporation’s first business, battery eliminators for radios, became obsolete, Paul Galvin (Robert’s father) faced severe financial distress in 1929. In response, he experimented with car radios, changed the name of the company to Motorola, and started making a profit. But this near-death experience shaped Motorola’s founding culture, instilling a belief that past accomplishment guarantees nothing about future success and an almost obsessive need for self-initiated progress and improvement. When Jerry Porras and I surveyed a representative sample of 165 CEOs in 1989, they selected Motorola as one of the most visionary companies in the world, and we included Motorola in our Built to Last research study. Amongst the eighteen visionary companies we studied at that time, Motorola received some of the highest scores on dimensions such as adherence to core values, willingness to experiment, management continuity, and mechanisms of self-improvement. We noted how Motorola pioneered Six Sigma quality programs and embraced “technology road maps” to anticipate opportunities ten years into the future.

  By the mid-1990s, however, Motorola’s magnificent run of success, which culminated in having grown from $5 billion to $27 billion in annual revenues in just a decade, contributed to a cultural shift from humility to arrogance. In 1995, Motorola executives felt great pride in their soon-to-be-released StarTAC cell phone; the then-smallest cell phone in the world, with its sleek clamshell design, was the first of its kind. There was just one problem: the StarTAC used analog technology just as wireless carriers began to demand digital. And how did Motorola respond? According to Roger O. Crockett, who closely covered the company for BusinessWeek, one of Motorola’s senior leaders dismissed the digital threat: “Forty-three million analog customers can’t be wrong.”17 Then Motorola tried to strong-arm carrier companies like Bell Atlantic. If you want the hot StarTAC, explained the Motorola people, you’ll need to agree to our rules: a high percentage (along the lines of 75 percent) of all your phones must be Motorola, and you must promote our phones with stand-alone displays. Bell Atlantic, irritated by this “you must” attitude, blasted back that no manufacturer would dictate how much of their product to distribute. “Do you mean to tell me that [if we don’t agree to the program] you don’t want to sell the StarTAC in Manhattan?” a Bell Atlantic leader reportedly challenged the Motorola executives. Motorola’s arrogance gave competitors an opening, and Motorola fell from being the #1 cell phone maker in the world, at one point garnering nearly 50 percent market share, to having only 17 percent share by 1999.18 Motorola’s fall from greatness began with Stage 1, Hubris Born of Success.

  ARROGANT NEGLECT

  Dating back to ancient Greece, the concept of hubris is defined as excessive pride that brings down a hero, or alternatively (to paraphrase classics professor J. Rufus Fears), outrageous arrogance that inflicts suffering upon the innocent.19 Motorola began 2001 with 147,000 employees; by the end of 2003, the number dropped to 88,000—nearly 60,000 jobs gone.20 As Motorola descended through the stages of decline, shareholders also suffered as stock returns fell more than 50 percent behind the market from 1995 to 2005.21

  We will encounter multiple forms of hubris in our journey through the stages of decline. We will see hubris in undisciplined leaps into areas where a company cannot become the best. We will see hubris in a company’s pursuit of growth beyond what it can deliver with excellence. We will see hubris in bold, risky decisions that fly in the face of conflicting or negative evidence. We will see hubris in denying even the possibility that the enterprise could be at risk, imperiled by external threats or internal erosion. And we will encounter one of the most insidious forms of hubris: arrogant neglect.

  In October 1995, Forbes magazine ran a laudatory story about Circuit City’s CEO. Under his leadership, Circuit City had grown more than 20 percent per year, multiplying the size of the company nearly ten times in a decade. How to keep the growth going? After all, as Forbes commented, in the end every market becomes mature, and this energetic CEO had “no intention of sitting around and waiting for his business to be overwhelmed by the competition.”22 And so Circuit City sought The Next Big Thing. The company had already piloted CarMax, a visionary application of the company’s superstore expertise to the used car business. Circuit City also became enamored with an adventure called Divx. Using a special DVD player, customers would be able to “rent” a DVD for as long as they liked before playing it, using an encryption system to unlock the DVD for viewing. The advantage: not having to return a DVD to the video store before having had a chance to watch it.23

  In late 1998, the Wall Street Transcript interviewed Circuit City’s CEO. There came a telling moment when the interviewer asked what investors should worry about at Circuit City. “[Investors] can be fairly relaxed about our ability to run the business well,” he replied. Then he felt compelled to add, “I think there has been some investor sentiment . . . that our CarMax endeavor and our Divx endeavor is taking attention away from our Circuit City business. I’d refer . . . [to] our 44 percent earnings growth in the Circuit City business in the first half of the year.” He concluded, “This is a company that’s in great shape.”24

  Yet Circuit City plummeted through all five stages of decline. Profit margins eroded and return on equity atrophied from nearly 20 percent in the mid-1990s to single digits, leading to the company’s first loss in more than a quarter of a century. And on November 10, 2008, Circuit City announced that it had filed for bankruptcy.

  Circuit City originally made the leap from good to great, a process that began to gain momentum in the early 1970s, under the inspired leadership of Alan Wurtzel. As with most climbs to greatness, it involved sustained, cumulative effort, like turning a giant, heavy flywheel: each push builds upon previous work, compounding the investment of effort—days, weeks, months, and years of work—generating momentum, from one turn to ten, from ten to a hundred, from a hundred to a thousand, from a thousand to a million. Once an organization gets one flywheel going, it might create a second or third flywheel. But to remain successful in any given area of activity, you have to keep pushing with as much intensity as when you first began building that flywheel, exactly what Circuit City did not do. Circuit City in declin
e exemplifies a cycle of arrogant neglect that goes like this:

  1. You build a successful flywheel.

  2. You succumb to the notion that new opportunities will sustain your success better than your primary flywheel, either because you face an impending threat or because you find other opportunities more exciting (or perhaps you’re just bored).

  3. You divert your creative attention to new adventures and fail to improve your primary flywheel as if your life depended on it.

  4. The new ventures fail outright, siphon off your best creative energy, or take longer to succeed than expected.

  5. You turn your creative attention back to your primary flywheel only to find it wobbling and losing momentum.

  A core business that meets a fundamental human need—and one at which you’ve become best in the world—rarely becomes obsolete. In this analysis of decline, only one company, Zenith, fell largely because it stayed focused on its core business too long and failed to confront its impending demise. Furthermore, in 60 percent of our matched pairs, the success-contrast company paid greater attention to improving and evolving its core business than the fallen company during the relevant era of comparison.

  My point here is not that you should never evolve into new arenas or that Circuit City made a mistake by investing in CarMax or Divx. Creating CarMax required an impressive leap of imagination; Circuit City invented an entirely new business concept, doing for used cars what it had done for consumer electronics (bringing a professional chain-store approach to an industry that had previously been unprofessional and fragmented).25 Indeed, Circuit City would have done well to keep CarMax rather than sell it. And with Divx, while the idea ultimately failed in the marketplace, it can be viewed as a relatively small experiment that just didn’t work in the end, a positive example of the Built to Last principle “Try a Lot of Stuff and Keep What Works.” The real lesson is that Circuit City left itself exposed by not revitalizing its electronics superstores with as much passion and intensity as when it first began building that business two decades earlier. The great irony is that one of its biggest opportunities for continued growth and success lay in its core business, and the proof rests in two words: Best Buy.

  In 1981, a tornado touched down in Roseville, Minnesota, blasting to pieces the showroom of the local Sound of Music store. Customers hurled themselves away from the windows as shards of glass and splintered wood flew about in the gale. Luckily, the storeroom remained largely undamaged, leaving founder Richard Schulze with boxes of stereos and TVs, but no storefront. A resourceful entrepreneur, he decided to throw a “Tornado Sale” in the parking lot. He spent his entire marketing budget on a local ad blitz that created a two-mile traffic jam as droves of customers converged on the lot. Schulze realized that he’d stumbled upon a great concept: advertise like crazy, have lots of name-brand stuff to sell in a no-frills setting (albeit a step up from a parking lot), and offer low prices. Based on his discovery, he invested all his money into creating a consumer electronics superstore that he dubbed Best Buy.26

  From 1982 to 1988, Best Buy opened forty superstores (what it called its Concept I stores) in the Midwest. In 1989, after systematically asking customers what would make for a better experience, Best Buy created its Concept II store model, which replaced a commission-driven sales culture with a consultative help-the-customer-find-the-best-answer culture.27 In 1995, Best Buy created Concept III superstores chock-full of snazzy ways to learn about products—touchscreen information kiosks, simulated car interiors for checking out sound systems, CD listening posts to sample music, “fun & games” areas for testing video games—and then in 1999 moved on to Concept IV stores, designed to help customers navigate the confusing myriad of new electronics products flooding the market. Then it evolved yet again in 2002, and in 2003 added Geek Squads to help customers baffled by technology.28

  We found little evidence that Circuit City senior leaders took seriously the threat from Best Buy until the late 1990s. Yet if Circuit City had invested as much creative energy into making its superstore business a superior alternative to Best Buy and had captured half of Best Buy’s growth from 1997 (when the companies had the same revenues) to 2006, Circuit City would have grown to nearly twice the revenues it actually achieved during that period.29 But instead, Best Buy eclipsed Circuit City by more than 2.5 times, in both revenues and profit per employee. Every dollar invested in Best Buy in 1995 and held to 2006 outperformed a dollar invested in Circuit City by four times.30

  To disrespect the potential remaining in your primary flywheel—or worse, to neglect that flywheel out of boredom while you turn your attention to The Next Big Thing in the arrogant belief that its success will continue almost automatically—is hubris. And even if you face the impending demise of a core business, that’s still no excuse to let it just run on autopilot. Exit definitively or renew obsessively, but do not ever neglect a primary flywheel.

  If you’re struggling with the tension between continuing your commitment to what made you successful and living in fear about what comes next, ask yourself two questions:

  1. Does your primary flywheel face inevitable demise within the next five to ten years due to forces outside your control—will it become impossible for it to remain best in the world with a robust economic engine?

  2. Have you lost passion for your primary flywheel?

  If you answer no to both these questions, then continue to push your primary flywheel with as much imagination and fanatical intensity as you did when you first began. (Of course, you also need to continually experiment with new ideas, both as a mechanism to stimulate progress and as a hedge against an uncertain future.)

  This does not mean static, unimaginative replication. Quite the opposite: it means never-ending creative renewal, just as Best Buy moved from Concept I to Concept II to Concept III and beyond. It’s like being an artist. Picasso didn’t renew himself by abandoning painting and sculpture to become a novelist or a banker; he painted his entire life yet progressed through distinct creative phases—from his Blue Period to cubism to surrealism—within his primary activity. Beethoven didn’t “reinvent” himself by abandoning music for poetry or painting; he remained first and foremost a composer. But neither did he just write the Third Symphony nine times.

  CONFUSING WHAT AND WHY

  Like an artist who pursues both enduring excellence and shocking creativity, great companies foster a productive tension between continuity and change. On the one hand, they adhere to the principles that produced success in the first place, yet on the other hand, they continually evolve, modifying their approach with creative improvements and intelligent adaptation. Best Buy understood this idea better than Circuit City, when it kept morphing its superstores yet did so in a manner consistent with the primary insight that produced success in the first place (customers really like having lots of name-brand stuff in an easy-to-navigate, low-price, and friendly environment). When institutions fail to distinguish between current practices and the enduring principles of their success, and mistakenly fossilize around their practices, they’ve set themselves up for decline.

  When George Hartford lay on his deathbed in 1957, he summoned his longtime loyal aide, Ralph Burger, and pleaded as his dying wish, “Take care of the organization.”31 The Hartford brothers (Mr. John and Mr. George) dedicated their lives to building the Great Atlantic & Pacific Tea Company (A&P) after taking it over from their father. Burger, himself nearly seventy years old, spent decades as a chief confidant and pursued his solemn oath to preserve and protect the Hartford legacy with fundamentalist zeal. He clothed himself in the authority of the Hartford brothers, and not just figuratively; according to William Walsh’s account The Rise and Decline of The Great Atlantic & Pacific Tea Company, Burger took to wearing Mr. John’s actual clothes, saying, “John would not have wanted those famous grey suits to go to waste.”32 Insulated by A&P’s comfortable position as the largest retailing organization in the world, Burger believed that “taking care of the organization”
meant preserving its specific practices and methods; as late as 1973, Mr. John’s office remained exactly as it had been two decades earlier, right down to the same coat hangers hanging in the same place in the closet.33

  During the Burger era, A&P’s arrogant stance that “we will continue to keep things just the way they are and we will continue to be successful because—well, we’re A&P!” left it vulnerable to new store formats developed by companies like Kroger. Burger failed to ask the fundamental question, Why was A&P successful in the first place? Not the specific practices and strategies that worked in the past, but the fundamental reasons for success. It retained its aging Depression-generation customers but became utterly irrelevant to a new generation. As one industry observer quipped, “Like the undertaker, A&P could have said every time a hearse went by, ‘There goes another customer.’ ”34

  The point here is not as simple as “they failed because they didn’t change.” As we’ll see in the later stages of decline, companies that change constantly but without any consistent rationale will collapse just as surely as those that change not at all. There’s nothing inherently wrong with adhering to specific practices and strategies (indeed, we see tremendous consistency over time in great companies), but only if you comprehend the underlying why behind those practices, and thereby see when to keep them and when to change them.

  Now you might be wondering, “How do you know if you’re right about the underlying causes of your success?” The best leaders we’ve studied never presume that they’ve reached ultimate understanding of all the factors that brought them success. For one thing, they retain a somewhat irrational fear that perhaps their success stems in large part from luck or fortuitous circumstance. Compare the downside of two approaches: