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Why Good Companies Go Bad

Article in Harvard Business Review · January 2005

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Why good companies go bad
Donald N. Sull
Financial Times (3 October 2005)

Donald N. Sull is an associate professor of management practice at the

London Business School. He recently published Why good companies go
bad and how great managers remake them (Harvard Business School
Press, 2005).

Management gurus exhort companies to go from good to great. Regrettably most

move in the opposite direction. Recent examples of companies that have gone from
good to bad include Sainsbury’s, Parmalat, and Lego to name just a few prominent
examples. Microsoft, for years the gold standard of corporate excellence, stands accused
of slipping into mediocrity. A few of these fallen stars—IBM or Ericsson--regain their
stride, but most—such as Xerox, KMart or Laura Ashley—hobble on as pale shadows of
their former glory, or like NatWest and Andersen—disappear altogether.

Why do good companies go bad? Managers usually draw the blame. Common
explanations include executives who are too thick to notice big changes in their market,
freeze like deer in the headlights of an oncoming car when the market shifts, or simply
plunder the corporate coffers. All plausible explanations. Unfortunately none fit the
facts. Over the past decade, I have studied dozens of successful companies that have
gone bad (as well as comparable firms that responded effectively to the vicissitudes of the
market). In the majority of failures, senior executives saw market changes coming and
responded aggressively. They were capable managers—indeed many led the companies
to the top—trying to do the right thing.

If these familiar explanations don’t account for corporate failure, what does? My
research suggests that companies fall prey to active inertia—responding to even the most
disruptive market shifts by accelerating activities that succeeded in the past. When the
world changes, organizations trapped in active inertia do more of the same. A little faster
perhaps or tweaked at the margin, but basically the same old same old. Managers often
equate inertia with inaction, like the tendency of a billiard ball at rest to remain immobile.
But executives in failing companies unleash a flurry of initiatives—indeed they typically
work more frenetically than their counterparts at competitors which adapt more
effectively. Organizations trapped in active inertia resemble a car with its back wheels
stuck in a rut. Managers step on the gas. Rather than escape the rut, they only dig
themselves in deeper.

The failure of success

What locks firms in a rut? The surprising answer is the very commitments that
that enabled a firm’s initial success. Everyone knows that success breeds complacency
and arrogance. But a more fundamental dynamic links early success to subsequent
failure. Clear commitments are required for initial success, but these commitments

© Copyright 2005 Donald N. Sull

harden with time and ultimately constrain a firm’s ability to adapt when its competitive
environment shifts. This dynamic can lead good firms to go bad, even when executives
avoid arrogance and complacency.

To win in the market, executives must make a set of commitments that together
constitute the organization’s success formula. A distinctive success formula focuses
employees, confers efficiency, attracts resources, and differentiates the company from
rivals. Five categories of commitments comprise the success formula:
• Strategic frames: What we see when we look at the world, including definition of
industry, relevant competitors and how to create value.
• Processes: How we do things around here entailing both informal and formal
routines.
• Resources: Tangible and intangible assets that we control which help us compete,
such as brand, technology, real estate, expertise, etc.
• Relationships: Established links with external stakeholders including investors,
technology partners or distributors
• Values: Beliefs that inspire, unify and identify us.

Although commitments are essential for initial success, they tend to harden over
time. Initial success reinforces management’s belief that they should fortify their success
formula. With time and repetition, people stop considering alternatives to their
commitments, and take them for granted. The individual components of the success
formula grow less flexible: Strategic frames become blinders, resources harden into
millstones hanging around a company’s neck, processes settle into routines, relationships
become shackles, and values ossify into dogmas.

An ossified success formula is just fine, as long as the context remains stable.
When the environment shifts, however, a gap can grow between what the market
demands and what the firm does. Managers see the gap, often at an early stage, and
respond aggressively to close it. But their hardened commitments channel their responses
into well-worn ruts. The harder they work, the wider the gap becomes. The result is
active inertia (see figure “active inertia”).

© Copyright 2005 Donald N. Sull

 Figure 2:2
The Dynamics of Standing Still

ENVIRONMENT

FRAMES BLINDERS

PROCESSES RESOURCES RELATIONSHIPS ROUTINES MILLSTONES SHACKLES

VALUES DOGMAS

Frames Become Blinders

Strategic frames provide focus and fit new information into a broader pattern. By
continually focusing on the same aspects, frames can constrict managers’ peripheral
vision, blinding them to novel opportunities and threats. As their strategic frames grow
more rigid, managers often shoe-horn surprising information into existing frames or
ignore it altogether.

Consider NatWest Bank (National Westminster until 1995). At its foundation,

National Westminster’s executives committed to a clear set of strategic frames--retail
banking is stagnant and UK suffering irreversible decline. The bank diversified into the
US, Europe, Far East and Soviet Union and expanded into new financial services. When
the Big Bang deregulation heightened competition, rivals such as Lloyds TSB refocused
on their domestic retail business. NatWest, in contrast, responded by accelerating
geographic and product diversification. Critics blasted NatWest throughout the 1990s for
waiting too long to divest money-losing distractions until RBS acquired NatWest in
2000.

Processes Lapse into Routines

Established processes confer efficiency and facilitate coordination across

functional and geographic units. Over time, these routines resist change. With repetition,
processes become second nature; people stop thinking of them as a means to an end, if
they think of them at all. When the environment shifts, managers’ commitments to
existing processes trigger an actively inert response.

© Copyright 2005 Donald N. Sull

 Consider Compaq, which grew to sales of $3.6 billion in its first eight years based
on processes that consistently produced high quality products. Manufacturing routines
made quality the first priority (and cost a distant fifth) while the product development
process sacrificed speed and thrift to get the product specs 100% right every time.
Compaq’s quality-at-any-price processes served the company well in the early days of the
PC industry when customers worried about the product’s usability and low-cost
alternatives were rare. As PCs became commodities and nimble rivals like Dell rose to
the fore, competition shifted to value for money. Compaq relied on its well-honed
processes to churn out gold-plated products priced to gather dust on dealers’ shelves.

Resources Harden into Millstones

Specialized resources build competitive advantage that rivals cannot easily

replicate. Shifts in the competitive environment, however, can devalue established
resources. Major airlines historically competed on the strength of their hub-and-spoke
systems in which the carriers controlled valuable real estate at hub airports and a fleet
optimized for this business model. The rise of low-cost upstarts such as Southwest and
Ryan Air depressed industry pricing and poached customers. Traditional carriers could
not easily redeploy their hubs and planes to compete cost-effectively against new
entrants.

Relationships Become Shackles

Managers commit to external relationships by investing in specialized facilities to

serve a key customer, for example, or writing long-term service contracts. These
relationships can make or break a company—think of Microsoft and Intel or Wal-Mart
and Procter & Gamble. Over time, however, established relationships can turn into
shackles that limit flexibility.

Recall the Daewoo Group, which at its peak approached $20 billion in revenues
and employed two hundred thousand worldwide before falling into bankruptcy. Daewoo
owed much of its growth to cosy relationships with South Korea’s General Park, who
ruled the country with an iron fist for nearly two decades. Park supported Daewoo and
other favored conglomerates with financing and tariffs. In exchange, Daewoo invested in
industries targeted for expansion. When subsequent governments ended policies that
favored the conglomerates, Daewoo’s Chairman Kim tightened links with remaining
friendly Korean politicians, and forged bonds with politicians in emerging markets such
as Vietnam, the Sudan and Uzbekistan to replicate cozy relationships at home.

Values Ossify into Dogmas

Strong values can elicit fierce loyalty from employees, strengthen the bonds
between a company and its customers, attract like-minded partners, and hold together a
company’s far-flung operations. As companies mature, however, their values often
harden into outdated dogmas, that oppress rather than inspire.

© Copyright 2005 Donald N. Sull

 Consider Laura Ashley who founded her company to defend traditional values
under siege from miniskirts. Frilly frocks embodying Laura Ashley’s commitment to
traditional values of modesty initially appealed to many women but lost their attraction as
more women entered the workforce. The company, however , continued to pursue the
outdated designs that embodied an ossified view of its core values.

xxxxxx

Managers who understand why good companies go bad are better equipped to monitor
existing commitments and keep them supple as markets shift.

© Copyright 2005 Donald N. Sull

Box: Warning signals of active inertia

Add one point for each risk factor that applies to your company. One is fine, two or three
get nervous, three or more and your firm is at risk for active inertia.

Your CEO appears on the cover of a major business magazine. Praise from the
business press reinforces attachment to the success formula. By the time a firm has
attracted critical acclaim, managers should be rethinking their success formula.

Management gurus praise your company. Few companies survive guru praise for
long. Consider the fall of most In Search of Excellence firms. The problem is not sloppy
research. Rather guru praise reinforces confidence in the success formula.

Your CEO writes a book on the secret of your firm’s success. A book publicly links a
CEO to a success formula’s, making it harder for him to later change those commitments.

You build a grand new headquarters. Managers often build grand monuments to
commemorate their triumph. They are rarely in the state of mind to question the
commitments that led to victory. (Bonus point for indoor waterfalls, heliports or
architectural awards).

You name a stadium. CEOs sometimes name rather than build monuments, as did
Enron, United, cmgi, American Airlines, PSINet, Compaq and Conseco did. Not every
company falls prey—consider Pepsi or Staples—but it is another red flag.

Your competitors share your postal code. Detroit’s automakers, Sheffield’s

steelmakers and Route 128 microcomputer firms all went bad. Clustered firms often
make similar commitments and reinforce one anothers’ success formula.

Your top executives are clones. Homogenous top executives generally rose through the
ranks by reinforcing a success formula and know little else.

© Copyright 2005 Donald N. Sull

 © Copyright 2005 Donald N. Sull

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