by Jim Collins
Lazier would stop his pacing, walk over to the blank chalkboard, and write in giant letters (and I mean giant, at least two feet high) one word: CASH.
“Never forget,” Lazier would say. “You pay your bills with cash. You can be profitable and bankrupt.”
You can be profitable and bankrupt. The idea had never occurred to most students who’d worked in big companies. In the entrepreneurial phase, leaders struggle just to get enough cash to become self-sustaining, but as an organization becomes big and successful, cash consciousness atrophies. Leaders in successful companies worry more about earnings. But organizations do not die from lack of earnings. They die from lack of cash.
While editing this piece in late 2008, I’m looking at a stunning news story: General Motors, the monumental symbol of American Corporate Power, is seeking salvation from the government, standing on the verge of late Stage 4 as it runs short on cash. Even for a company that had once been the largest corporation in the world, Lazier’s lesson can hit full force: you pay your bills with cash.
As institutions hurtle toward Stage 5, they spiral downward, increasingly out of control. Each cycle—grasping followed by disappointment followed by more grasping—erodes resources. Cash tightens. Hope fades. Options narrow.
We found two basic versions of Stage 5. In the first version, those in power come to believe that capitulation offers a better overall outcome than continuing to fight. In the second version, those in power continue the struggle, but they run out of options, and the enterprise either dies outright or shrinks into utter irrelevance compared to its previous grandeur. Let’s look at two companies, one that chose to give up the fight and sell out, and the other that fought on, only to go bankrupt.
GIVING UP THE FIGHT
By the late 1980s, Scott Paper had fallen so far behind P&G and Kimberly-Clark that it had little choice but to take on huge debt to reinvest in a series of last-gasp efforts to catch up. Its debt-to-equity ratio jumped to average 175 percent from 1985 to 1994. Capital constraints led to chronic restructuring and cost cutting: $167 million in 1990, $249 million in 1991, and another $490 million in early 1994. Scott’s debt rating fell to just one step above junk bonds.139 And that’s when the board brought in Rambo Al.
When analyst Kathryn McAuley heard the news that Al Dunlap had been named CEO of Scott Paper in 1994, she did some quick research on his track record. “I said to myself: ‘Well, the board sold the company.’ ”140 Dunlap became infamous for his nickname, “Rambo in Pinstripes,” an image reinforced when he posed for a photograph sporting black paint under his eyes, bandoliers, and two very real-looking mock automatic weapons, while also garbed in a white dress shirt and a lion-emblazoned necktie.141 Dunlap slashed more than 11,000 jobs, including 71 percent of upper management. Profits rebounded as cost cutting flowed directly to the bottom line, and Dunlap capitalized on the moment to sell the once-proud Scott Paper to archrival Kimberly-Clark.
It would be easy to focus on how corporate Rambo Al Dunlap made eight figures for less than two years’ effort and how he justified his pay by writing, “I’m a superstar in my field, much like Michael Jordan in basketball and Bruce Springsteen in rock 'n’ roll. My pay should be compared to superstars in other fields, not to the average CEO.”142 But Dunlap, for all his pugnacious bravado, was simply the mechanism of Scott Paper’s capitulation, not its cause. Had Scott Paper not fallen through Stages 1, 2, 3, and 4—and had Scott Paper not lost control of its financial freedom—Dunlap would have never been brought in to burn the village in order to save it.
No company we studied was destined to fall all the way to Stage 5, and each company could have made different decisions earlier in the journey to reverse its downward slide. But by the time a company has moved through Stages 1, 2, 3, and 4, those in power can become exhausted and dispirited, and eventually abandon hope. And when you abandon hope, you should begin preparing for the end.
But hope alone is not enough; you need enough resources to continue the fight. If you lose the ability to make strategic choices, forced into short-term survival decisions that cripple the enterprise, then the odds of full recovery become increasingly remote. That’s exactly what we see in the long, tragic demise of one of America’s great success stories, Zenith Corporation.
RUNNING OUT OF OPTIONS
Zenith’s rise to greatness dates back to the first half of the twentieth century, when eccentric mastermind Eugene McDonald led Zenith to dominant positions in radio and television. In June 1945, Fortune ran a big spread titled “Commander McDonald of Zenith” and featured a full-page photo of McDonald posing with artifacts from his world-traveling adventures: a marine clock, guns, Eskimo relics, and even a stuffed penguin that used to be his pet. The article showcased McDonald fishing in the Caribbean, navigating his yacht in a dashing sea cap given to him by a European count, paddling a kayak with Eskimos, hunting pirate treasure in the Pacific, examining ancient bones from a dig, preparing to pilot a glider, working his Mexican gold mine, and reading National Geographic aloud to his children.143 Visionary and frenetic, McDonald applied his genius to business, pioneering portable home radios and moving Zenith into television during the industry’s early days.
Zenith entered Stage 1, Hubris Born of Success, late in the McDonald era. Zenith became the #1 manufacturer of black-and-white televisions, and every dollar invested in Zenith at the start of 1950 and held through 1965 increased in value more than one hundred times, generating cumulative returns more than ten times the market. When Japanese televisions began to gain market traction, Zenith arrogantly ignored the Japanese threat. In Zenith’s view, the Japanese (the Japanese, for goodness’ sake, with their cheap products) could not possibly pose a serious threat to the Great American Quality Brand, captured in the tagline “Zenith—The Quality Goes In Before The Name Goes On.”144
Zenith moved through Stage 2, Undisciplined Pursuit of More, in the late 1960s and early 1970s. After achieving its goal to surpass RCA as the #1 maker of color television sets, Zenith invested in a massive increase in manufacturing capacity that doubled its debt-to-equity ratio to 100 percent. Zenith also experienced a problematic succession of power. Commander McDonald left the company in the hands of a septuagenarian CEO, with Zenith’s counsel Joseph Wright as president. Wright eventually moved into the CEO role, but when his chosen successor died, Wright faced limited succession options. Zenith brought in an outsider from Ford, who eventually became chairman.145
Zenith moved into Stage 3, Denial of Risk and Peril, externalizing blame (pointing out the window to Japanese trade practices, the struggling U.S. economy, labor unrest, oil shocks, and so forth) rather than confronting its own lack of competitiveness. Saddled with excess capacity, Zenith lowered prices in a battle for market share and took on more debt, both of which drove its profitability ratios down to levels not seen in thirty years.146
Zenith fell into Stage 4, Grasping for Salvation, in the late 1970s, when it leapt at a slew of opportunities all at the same time. “If we have any plan at all, it’s that we’ll take a shot at everything,” explained a Zenith senior leader to BusinessWeek. Zenith jumped into VCRs, videodiscs, telephones that linked through televisions, home-security video cameras, cable TV decoders, and personal computers. To fund all these moves, Zenith drove its debt-to-equity ratio to 140 percent.147
But this unhappy saga does not end there. Amazingly, given its scattershot grasping for salvation, Zenith stumbled by luck upon a new opportunity that nearly made the company great again, the newly formed Data Systems unit headed by the energetic Jerry Pearlman. Brilliant and articulate, a cum laude graduate from Princeton who’d finished in the top 2 percent of his class at Harvard Business School, Pearlman had been called a “corporate visionary” by BusinessWeek.148 Pearlman became CEO and led Zenith to become the #2 maker of IBM-compatible personal computers, and in a stroke of prescient genius, staked out a leading position for Zenith in the emerging laptop market. From 1980 to 1989, the Data Systems Division increased its reve
nues thirtyfold, generating more than 50 percent of Zenith’s total revenues and nearly all of Zenith’s profits. Zenith could have become Dell or Compaq.149
But Zenith still had the television business, and after all those years of denial and grasping for salvation, Zenith’s financial condition had deteriorated; cash on hand had dropped to less than 5 percent of current liabilities. Pearlman tried to sell the television business but didn’t get the price he wanted. A few years earlier, before it ran out of cash, Zenith might have had the opportunity to close down the television business, channel all its remaining resources into the Data Systems Division, and turn itself into one of the great computer companies. Instead, exhausted, harried by angry shareholders, and burdened by Zenith’s half a billion dollars of debt and shrinking cash reserves, Pearlman found himself running out of options. On September 29, 1989, Pearlman met Bull Corporation CEO Francis Lorentz at a Paris restaurant to consummate the sale of Zenith’s computer business to Bull. Lorentz later commented that Pearlman simply looked “relieved.” To his credit, Pearlman tried to rebuild Zenith after selling the computer flywheel, but the television business just kept dragging Zenith down, generating year upon year of losses, and in 1995, Pearlman stepped down.150
You might think that companies fall all the way to the bottom because their leaders make just-plain-stupid decisions. But through Zenith’s story, we see how even some of the smartest and most capable leaders can find themselves unable to control their company’s destiny if the accumulated impact of Stages 1 through 4 destroys their cash position. After Pearlman, Zenith churned through five CEOs in ten years, fell into bankruptcy, and reemerged with less than 400 employees, 98 percent fewer than the 36,000 employed in 1988. It had fallen from one of the greatest success stories of American business history at midcentury into just a shadow of its former self.151
DENIAL OR HOPE
Not all companies deserve to last. Perhaps society is better off getting rid of organizations that have fallen from great to terrible rather than continuing to let them inflict their massive inadequacies on their stakeholders. Institutional self-perpetuation holds no legitimate place in a world of scarce resources; institutional mediocrity should be terminated, or transformed into excellence.
When should a company continue to fight, and when does refusal to capitulate become just another form of denial? Perhaps the Scott Paper board made a wise decision to surrender the company’s independence rather than watch it die a slow, painful death or atrophy into irrelevance. And perhaps Zenith would have been better off had it capitulated earlier to a willing buyer, before mounting debt forced its hand. If you cannot marshal a compelling answer to the question, “What would be lost, and how would the world be worse off, if we ceased to exist?” then perhaps capitulation is the wise path. But if you have a clear and inspired purpose built upon solid core values, then the noble course may be to fight on, to reverse decline, and to try to rekindle greatness.
The point of the struggle is not just to survive, but to build an enterprise that makes such a distinctive impact on the world it touches, and does so with such superior performance, that it would leave a gaping hole—a hole that could not be easily filled by any other institution—if it ceased to exist. To accomplish this requires leaders who retain faith that they can find a way to prevail in pursuit of a cause larger than mere survival (and larger than themselves), while also maintaining the stoic will needed to take whatever actions must be taken, however excruciating, for the sake of that cause. This is the very type of leader who finds a path out of the darkness and gives us well-founded hope. And it is to that type of leadership that we now turn.
Well-Founded Hope
When Anne Mulcahy became chief executive of Xerox in 2001, she inherited a company mired in Stage 4. Digesting a $273 million loss, Xerox stock had dropped 92 percent in less than two years, wiping out more than $38 billion in shareholder value. With Xerox’s debt-to-equity ratio exceeding 900 percent, Moody’s rated its bonds as junk. The Securities and Exchange Commission had launched an investigation into Xerox’s books, which precluded Xerox from registering any securities and limited its fundraising options. With $19 billion in debt and only $100 million in cash, Mulcahy described the situation as “terrifying.” Prior to Mulcahy’s appointment, Xerox had strived to reinvent itself for the Digital Age, hiring superstar Richard Thoman from IBM (where he’d been a valued member of Gerstner’s team) to succeed CEO Paul Allaire, who remained chairman. “We were looking for a change agent,” Allaire said of the decision to go outside. But Thoman lasted only thirteen months as CEO.152
In May 2000, Mulcahy had finished packing for a business trip to Tokyo when Allaire asked her to come to his office right away. “Here’s the deal,” said Allaire. “Rick’s [Thoman] out. I’m coming back in as CEO, and I want you to be president and COO of Xerox, and a year later, if things are right, you’ll be CEO.”153
Mulcahy had never planned or expected to become CEO, describing her ascension as a total surprise.154 “The board probably sat back and said, ‘What choice do we have?’ So I can’t say it was a roaring endorsement,” Mulcahy later told writer Kevin Maney. “It probably was a little bit of a last resort.”155 The consummate insider, she’d worked nearly a quarter of a century at Xerox in sales and human resources, never drawing outside attention; Mulcahy didn’t even appear in Fortune magazine’s “50 Most Powerful Women in Business” ranking the year before becoming president.156
Mulcahy could have perpetuated a Stage 4 doom loop by setting forth to utterly smash the culture and revolutionize the company overnight. But instead, she retorted to those who said she would need to kill the culture to save the company, “I am the culture. If I can’t figure out how to bring the culture with me, I’m the wrong person for the job.”157 For Mulcahy, it was all about Xerox, not about her. When Newsweek called her, Mulcahy declined to be interviewed about her management style.158 In fact, we found only four feature articles about Mulcahy during her first three years as CEO, a surprisingly small number, given how few women become CEO of storied Fortune 500 companies.159
Some observers questioned whether this insider, this unknown team player who had Xerox DNA baked into her chromosomes, would have the ferocious will needed to save the company.160 They needn’t have worried. Their first clue might have come in reading her favorite book, Caroline Alexander’s The Endurance, which chronicles how, against all odds, adventurer Ernest Shackleton rescued his men after their ship splintered into thousands of pieces as Antarctic ice crushed in around it in 1916. Accompanied by five crew members, Shackleton navigated 800 miles of violent seas in a 22-foot lifeboat to find help for the remaining survivors.161 Drawing inspiration from Shackleton, Mulcahy didn’t take a weekend off for two years.162 She shut down a number of businesses, including the inkjet-printer unit that she’d championed earlier in her career, and cut $2.5 billion out of Xerox’s cost structure. Not that she found these decisions easy—“I don’t think I want them to get easy,” she later reflected—but they were necessary to stave off utter catastrophe.163 During its darkest days, Xerox faced the very real threat of bankruptcy, yet Mulcahy rebuffed with steely silence her advisors’ repeated suggestions that she consider Chapter 11. She also held fast against a torrent of advice from outsiders to cut R&D to save the company, noting that a return to greatness depended on both tough cost cutting and long-term investment, and actually increased R&D as a percentage of sales during the darkest days. “For me, this was all about having a company that people could retire from, having a company that their kids could come and work at, having a company that actually would have pride some day in terms of its accomplishments.”164
For 2000 and 2001, Xerox posted a total of nearly $367 million in losses. By 2006, Xerox posted profits in excess of $1 billion and sported a much stronger balance sheet. And in 2008, Chief Executive magazine selected Mulcahy as chief executive of the year. At the time of this writing in 2008, Xerox’s transition had been going strong for seven years—no
guarantee, of course, that Xerox will continue to climb, but an impressive recovery from the early 2000s.165
Xerox. Nucor. IBM. Texas Instruments. Pitney Bowes. Nordstrom. Disney. Boeing. HP. Merck. What do these companies have in common? Every one took at least one tremendous fall at some point in its history and recovered. Sometimes the tumble came early, when they were small and vulnerable, and sometimes the tumble came when they were large, established enterprises. But in every case, leaders emerged who broke the trajectory of decline and simply refused to give up on the idea of not only survival, but of ultimate triumph despite the most extreme odds. And like Mulcahy, these leaders used decline as a catalyst. As Dick Clark, the quiet, longtime head of Merck manufacturing who became CEO after Gilmartin, put it, “A crisis is a terrible thing to waste.”166
If we discovered that organizational decline is a function first and foremost of forces out of our control—and if we discovered that those who fall will inevitably keep falling to their doom—we could rightly indulge in despair. But that is not our conclusion from this analysis, not if you catch decline in Stages 1, 2, or 3. And in some cases, you might even be able to reverse course once in Stage 4, as long as you still have enough resources to get out of the cycle of grasping and rebuild one step at a time.
If you have not yet fallen, beware the temptation to proclaim a crisis when none exists. Recall the Gerstner philosophy: the right leaders feel a sense of urgency in good times and bad, whether facing threat or opportunity, no matter what. They’re obsessed, afflicted with a creative compulsion and inner drive for progress—burning hot coals in the stomach—that remain constant whether facing threat or not. To manufacture a crisis when none exists, to shriek that we’re all standing on a “burning platform” soon to collapse in a spectacular conflagration, creates cynicism. The right people will drive improvement, whether standing on a burning platform or not, and they never take well to manipulation.
