Saturday, November 24, 2012

The real reason for almost all big business failures

The commonly voiced view of business, red in tooth and claw, a Darwinian landscape where only the fit survive may hold for small to mid-sized operations, but with big business, survival is surprisingly easy. As a rule it is only the remarkably unfit that die. When you see a big company go under you can generally find a history of incompetent management and stupid or shortsighted decisions.

Though as narrative-obsessed as their political brethren, business journalists tend to be notably averse to stories built around the question "what happens when you give the keys to an idiot?" That's a shame because some of the most entertaining accounts start with that premise. It's understandable though. Business journalists, once again like their political brethren, tend to have overly cozy relationships with their subjects and, (compared to reporters thirty or forty) tend to sympathize more with management than labor.

The decline of professional standards also plays a part. A surprising number of "news" stories are actually press releases in only slightly rewritten form and PR department go to great lengths to avoid statements that make their bosses look like morons.

Given these factors and the uncomfortable cognitive dissonance that journalists often feel when forced to report that a major corporation's management is incompetent, they will almost always pass over the obvious narrative and opt instead for one of these three standards:

1. the company was made obsolete by new technology;

2. it was doomed by changing markets;

3. it just couldn't get good help.

Of course, in theory, these things can doom a company, in practice though, when you hear one of these explanations given for a collapse, you will almost always find that managerial malpractice played at least as large a role. For example, ebooks had much less to do with Borders demise than did an ill-conceived expansion into the ridiculously over-served British market.*

Here the LA Times invaluable Michael Hiltzik takes apart the standard narratives (numbers 2 and 3) of the troubles at Hostess (via Thoma, as usual)
Let's get a few things clear. Hostess didn't fail for any of the reasons you've been fed. It didn't fail because Americans demanded more healthful food than its Twinkies and Ho-Hos snack cakes. It didn't fail because its unions wanted it to die.

It failed because the people that ran it had no idea what they were doing. Every other excuse is just an attempt by the guilty to blame someone else.


Hostess management's efforts to blame union intransigence for the company's collapse persisted right through to the Thanksgiving eve press release announcing Hostess' liquidation, when it cited a nationwide strike by bakery workers that "crippled its operations."

That overlooks the years of union givebacks and management bad faith. Example: Just before declaring bankruptcy for the second time in eight years Jan. 11, Hostess trebled the compensation of then-Chief Executive Brian Driscoll and raised other executives' pay up to twofold. At the same time, the company was demanding lower wages from workers and stiffing employee pension funds of $8 million a month in payment obligations.

Hostess management hasn't been able entirely to erase the paper trail pointing to its own derelictions. Consider a 163-page affidavit filed as part of the second bankruptcy petition.

There Driscoll outlined a "Turnaround Plan" to get the firm back on its feet. The steps included closing outmoded plants and improving the efficiency of those that remain; upgrading the company's "aging vehicle fleet" and merging its distribution warehouses for efficiency; installing software at the warehouses to allow it to track inventory; and closing unprofitable retail stores. It also proposed to restore its advertising budget and establish an R&D program to develop new products to "maintain existing customers and attract new ones."

None of these steps, Driscoll attested, required consultation with the unions. That raises the following question: You mean to tell me that as of January 2012, Hostess still hadn't gotten around to any of this?

The company had known for a decade or more that its market was changing, but had done nothing to modernize its product line or distribution system. Its trucks were breaking down. It was keeping unprofitable stores open and having trouble figuring out how to move inventory to customers and when. It had cut back advertising and marketing to the point where it was barely communicating with customers. It had gotten hundreds of millions of dollars in concessions from its unions, and spent none of it on these essential improvements.

The true recent history of Hostess can be excavated from piles of public filings from its two bankruptcy cases. To start with, the company has had six CEOs in the last 10 years, which is not exactly a precondition for consistent and effective corporate strategizing.

Hostess first entered bankruptcy in 2004, when it was known as Interstate Bakeries. During its five years in Chapter 11, the firm obtained concessions from its unions worth $110 million a year. The unions accepted layoffs that brought the workforce down to about 19,000 from more than 30,000. There were cuts in wages, pension and health benefits. The Teamsters committed to negotiations over changes in antiquated work rules. The givebacks helped reduce Hostess' labor costs to the point where they were roughly equal to or even lower than some of its major competitors'.

But the firm emerged from bankruptcy with more debt than when it went in — in with $575 million, out with $774 million, all secured by company assets. That's pretty much the opposite of what's supposed to happen in bankruptcy. By the end, there was barely a spare distributor cap in the motor pool that wasn't mortgaged to the private equity firms and hedge funds holding the notes (and also appointing management).

The post-bankruptcy leadership never executed a growth strategy. It failed to introduce a significant new product or acquire a single new brand. It lagged on bakery automation and product R&D, while rivals such as Bimbo Bakeries USA built research facilities and hired food scientists to keep their product lines fresh. At the time of the 2004 bankruptcy, Hostess was three times the size of Bimbo. Today it's less than half Bimbo's size. (Bimbo, which has been acquiring bakeries such as Sara Lee and Entenmann's right and left, might well end up with Hostess' brands.)

UPDATE * I meant to include a link to this growth fetish post that gives my take on what the people at Borders might have been thinking.


  1. Just like Cerberus and Chrysler.

  2. In fact all three reasons are huge failures of management:

    1. Management was unable to recognize and adapt the company to changing technology.
    2. Management was unable to recognize and adapt the company to changing markets.
    3. Management let the company deteriorate so much that it needed help, and then was unable to find good help.

    You see, these three things are the main tasks of management. At least, they should be.

    1. True but

      1. Press accounts often act as though these things are out of management's control

      2. We also see lots of other screw-ups in failed companies that get ignored as reporters converge on their three standard narratives.

  3. Great article...One caveat I can think of--if the environment radically changes, then even the best run large business won't survive if it can't adapt. In other words, a retail business--in which the management and staff are brilliant at brick and mortar retail--won't survive if everything goes digital/Internet and the management/workers do not know how to adjust.

  4. The thing that gets me is the common knee jerk reaction to blame unions. This makes no sense. Union members are employees. It's in their interest that the company survives. If they didn't need the 9-5 job they'd already be working for themselves. Who wouldn't?

    The only reason unions go for the nuclear option is that they can plainly see that management is running the company into the ground and trying to milk the employees for all they're worth before declaring bankruptcy. If the "shareholder revolution" had actually happened you'd expect to see boards/shareholders often siding with the unions and kicking out the management. The union members, unlike shareholders, are the people on the ground who can actually see what's going on.

  5. In my experience of being in the work force, I would say the only reason many big companies survive is that the competitors are equally incompetent.

  6. This comment has been removed by a blog administrator.