Corporate recovery

In my first article, I explored the reasons for corporate decline. This article goes on to consider what can and should be done about it.

A contingency approach to recovery

A contingency approach to the design of recovery strategies is vital; a ‘horses for courses’ approach. As with any other aspect of strategy, a ‘one size fits all’ philosophy is both dangerous and wrong. The particular circumstances of the organisation must be analysed to determine the action needed. It is important to note that the options I shall discuss below are not mutually exclusive; in other words, it may be possible (and, indeed, desirable) to select and implement several of these strategies either simultaneously or sequentially.

DIY versus external consultants

A decision may have to be made whether to engage consultants to act as the agents of change. External consultants will be able to draw on their experience of managing decline and recovery in similar situations. They will be skilled not only in identifying the causes (something that internal management may be oblivious to) but also in analysing and evaluating the options for recovery. The organisation may only get one chance to save itself.

Despite their commercial experience, the uniqueness of each organisation means that consultants will inevitably have to pass along a learning curve. The time needed for them to familiarise themselves with the company’s staff, its culture and its systems must be minimised. The consultants will bring with them a tool-kit of change management techniques, and may well be more influential in their attempt to persuade stakeholders of the need for change than an internal change agent would be. The consultants, if successful, might even justify their considerable fees!

Retrenchment and turnaround strategies

We invariably criticise organisations for their short-termist cultures; cancellation of training programmes, under-investment in capital projects and other decisions engineered to increase a return on capital employed are an all-too-familiar mistake in the quest for a long-term competitive edge. A crisis scenario is one instance in which short-termism can be tolerated, or even encouraged. After all, without the placing of a firm emphasis on survival, there may well be no long-term to plan for.

Retrenchment strategies focus on ‘stopping the rot’ and have an unashamedly short-term slant. The aim is to generate quick results and to ‘buy time’. Examples include the disposal of assets to generate cash.

Turnaround strategies follow on naturally from retrenchment. They aim to build on the results of the retrenchment options. They focus on the long-term. Several of the strategies I shall discuss below will incorporate elements of both retrenchment and turnaround. Indeed, the neat compartmentalisation of strategies into these two categories is both unimportant and, at worst, dangerous. The most important task is that of compiling a package of feasible, acceptable and suitable options. Defensive retrenchment must pave the way for a belligerent turnaround.

I shall now consider some of the strategies commonly used to bring about corporate recovery.

Management changes

A strengthening of the current team is quite common in recovery situations – in particular, the appointment of a new chief executive officer. In effecting a transformation at Continental Airlines, a consultant working on the project became President, then ‘cleaned out’ the existing management at every level. He sought forgiveness from wronged customers, and created a ‘new look’ image by refurbishing aircraft and terminal furnishings.

A new culture

In order to successfully transform an organisation, the incredibly difficult task of effecting cultural change may be necessary. Culture can be thought of as the set of values, attitudes and beliefs held by the organisation’s members. The well-publicised mis-selling of pensions in the UK in the 1990s led to large pension companies, whose images had been tarnished by the scandal, trying to adopt a more ethical culture. An inability to respond quickly to change might require the conversion of a mechanistic role culture to a more organic and flexible task culture. A number of key points are worth stating in terms of managing cultural change:

1. Senior management must be committed to the change and must lead by example
2. A policy statement should be issued setting out the new values, and any new mission statement should reflect the same
3. The sources of resistance to any proposed changes should be identified and mapped, together with the driving forces propelling change (Force Field Analysis can be used)
4. Appropriate strategies for change must be identified and selected:
   • Education of staff and other stakeholders in the importance of adopting the change agent’s proposals, and the implications of not doing so (this can be easier in a crisis situation, as the negatives may be tangible).
   • Facilitation of the process, by enabling staff and others to cope with the change (through, for example, the provision of counselling and financial support for those who might be adversely affected).
   • Participation of staff and other involved stakeholders, by inviting them to contribute their own ideas, and making them feel as if they ‘own the change’.
   • Negotiation with key stakeholders, with a view to minimising destructive conflict and reaching a solution that is acceptable to the parties.

Restructuring

The most successful recoveries involve some variation in the organisational structure and business processes. In particular, a greater degree of decentralisation and better communication between staff feature highly. A flexible and organic form is the suggestion of current writers. A reliance on the formal, vertical channels of communication and lines of authority advocated by the classical writers of the early Twentieth Century (Fayol, Taylor, Weber, etc.) will, they point out, be unsuitable in the dynamic, complex, global environment facing today’s business. It is, however, worth pointing out that a contingency approach to organisational design would suggest that the specific circumstances of the organisation should be borne in mind when deciding on an ideal structure. The post-contingency school of writers (including Peters and Waterman, and Ouchi) argue that an excellent, strong culture will make unnecessary many of the structural controls traditionally employed.

Pricing

Getting the price ‘right’ is not always easy. This is particularly the case for businesses selling goods and services for which there is no direct comparison. Charging too much or too little could be equally damaging to revenues, gross margins and ultimately profits. A good knowledge of the price elasticity of demand for each product is essential.

If demand is price-elastic, then a reduction in the selling price will bring about a rise in revenue. For products with price-inelastic demand, an increase in the selling price will bring about a similar outcome. As the price of a good is increased, the demand becomes progressively more price-elastic. In theory, the price should be raised to the point at which demand switches over from being price-inelastic to price-elastic, in order to maximise revenues.

Since price-elasticity of demand often varies from one market segment to another, a policy of price discrimination might be practised in order to maximise revenue. One aspect of pricing that is particularly interesting is that involving so-called Giffen goods. Strangely, the demand for such goods increases as the selling price increases. Jewellery is often quoted as an example. If the organisation has been under-pricing such products, it may have suffered from a lack of demand due to perceived low quality.

Asset reductions

A large majority of successful recoveries involve cash generation strategies, with divestment being the most common. A manufacturer may select certain plants for closure with a view to rationalising production. Marks & Spencer recently announced it was to close all its stores outside the UK to enable it to focus on its core market. In announcing the closure of its 18 French outlets, it received heavy criticism for failing to consult with and inform local staff. C&A is another high street retailer that announced a closure of stores; it decided to withdraw from the UK market entirely and focus on what it felt to be its core market in mainland Europe.

The existence of significant equity in the plants or stores being closed could provide a much-needed cash injection to an ailing organisation. A sale and leaseback is another possible cash generation option that utilises equity in properties owned by companies.

In some instances, divestment involves the selling of complete business units or brands; large conglomerates often select non-core businesses for divestment. Unilever’s disposals included Caterpillar Trucks and British Airways, another ailing company, decided to sell its low-cost, no-frills ‘Go’ brand.

Cost reduction

Interestingly, cost-reduction strategies are used more frequently by firms that fail to recover than those that do. Despite being what some would consider one of the more obvious options for a declining organisation, it is clear that such a strategy is not enough on its own.

One way to reduce costs might be through the implementation of a redundancy programme. Care must be taken to ensure that this will not result in excessive deficiencies in knowledge and skills. There is an increasing trend towards reducing the number of traditional full-time staff in favour of creating a periphery of part-time, casual and freelance workers. A reduction in committed and fixed overheads will bring about a flexibility and leanness that may have eluded the declining firm. Outsourcing might be considered for non-core service functions.

Activity-based costing can highlight the true cost of carrying out functions in-house and enable a fairer comparison to be made with external agencies willing to provide these services. The restructuring process referred to earlier may lead to a flatter, leaner organisation with a corresponding reduction in managerial overheads. And just-in-time purchasing and production methods can eliminate the high costs of stockholding. Perhaps new production technology can be embraced to reduce unit costs.

Information technology may have a key role to play, not only in furnishing management with improved information, but also in such areas as product design. Companies like Boeing have achieved massive reductions in the huge costs of designing new products. Is the organisation maximising its potential to achieve economies of scale? Could centralised purchasing and the elimination of duplicated activities reduce corporate costs?

I mentioned earlier that successful recoveries usually involve not only a restructuring, but also a critical review of current business processes. It is activities and processes that create value, not business functions. A radical examination of the reasons why certain activities are performed is necessary, with a view to focusing on value-adding processes.

Product-market repositioning

The ‘excellent’ companies studied by Tom Peters and Bob Waterman understood their customers better than their competitors did. The delivery of superior products and levels of service to customers must be preceded by a thorough analysis of their needs and expectations. I have already referred to the need to review pricing policies, and other aspects of the marketing mix should be subjected to a similar analysis. A decision may be taken to redefine the target market, or to create separately identifiable segments and approach each with a unique offering. Revitalising products and brands, or replacing ageing products within a brand portfolio might be a solution. Once again, Marks & Spencer is a useful case in point.

As a result of using modern management accounting techniques such as customer account profitability, it may even be decided to withdraw products from some market segments and to focus resources on more profitable groups of customers. Several UK banks have reached this conclusion. An in-depth analysis of product costs can lead to a better understanding of true product profitability. A rationalisation of product lines might be the result. The way that overheads are allocated and apportioned may need to be addressed using an activity-based approach. A good understanding of cost drivers is essential.

Marketing is common to both successful and unsuccessful recovery situations. The successful firms tend to combine it with a more fundamental product-market reorientation and with acquisitions.

Acquisitions

As a method of growth, an acquisition has many advantages over the organic option. Market share can be increased with immediate effect, rather than having to wait for aggressive pricing and promotion policies to have an impact. Payment for the acquired company can be made in shares rather than cash, or a mixture of the two. The purchasing of intangible assets such as goodwill and brand names could be of great benefit, especially if the turnaround involves developing new growth markets in which it is presently unknown. Asset-stripping and possible synergy are further attractive opportunities that an acquisition might present. The economies of scale that should be available from larger operations will increase competitiveness.

Capital restructuring

If the company is highly geared, it may be paying large amounts of interest to debt-holders. Whilst the payment of dividends is optional, interest payments are not. When interest cover is low, a large proportion of operating profits will be paid in interest, reducing the funds available for retention within the company. This is likely to lead to reduced investment, and the beginning of a vicious circle. One option open to a company is to try and convert its debt to equity. Debenture-holders could be offered shares in return for cancellation of the debt. Whilst this will dilute the existing shareholders’ interests, it will at least allow the company to reduce committed outgoings in the form of interest payments. If, following asset disposals, additional funding is still needed in order to implement the turnaround strategies it may be necessary to attempt a new issue of shares. If so, an upbeat message will have to be communicated in order to persuade investors to become more heavily involved.

Improved financial control

Common to many recovery scenarios is the implementation of enhanced financial control systems. Better management of working capital might involve:

• Reducing the credit terms allowed to customers.
• Tighter credit control.
• Negotiating improvements in the credit terms offered by suppliers.
• Increasing stock turnover and reducing the levels of stock held.

A review of the entire system of internal controls would be advised. These include non-financial controls such as segregation of duties and the need for authorisation. The aim of a good internal control system is to safeguard the assets of the company.

Investment in R&D

Having survived the short-term, establishing a long-term competitive advantage should be high on the organisation’s list of priorities. Investment in research and development may be an essential ingredient in such a recipe for long-term success. In sectors such as technology and pharmaceuticals, pure (blue-sky) research will absorb huge sums, but is of vital importance. R&D does not always lead to the development of breakthrough products, but may simply result in an improved version of an existing product. This too can give the firm a competitive edge over its rivals.

Conclusion

Although I have not covered every possible option for corporate recovery, I hope to have given the reader a flavour of some of the main strategies used. There is no definitive list, just as there is no standard organisation. The causes of decline discussed in my first article are as diverse as the potential solutions.

David Elliott BSc, ACA worked in Corporate Recovery at KPMG during the recession of the early 1990s