Why Good Companies Go Bad

One of the most common business phenomena is also one of the most perplexing: when successful companies face big changes in their environment, they often fail to respond effectively. Unable to defend themselves against competitors armed with new products, technologies, or strategies, they watch their sales and profits erode, their best people leave, and their stock valuations tumble. Some ultimately manage to recover—usually after painful rounds of downsizing and restructuring—but many don’t.

One of the most common business phenomena is also one of the most perplexing: when successful companies face big changes, they often fail to respond effectively. Many assume that the problem is paralysis, but the real problem, according to Donald Sull, is active inertia--an organization's tendency to persist in established patterns of behavior. Most leading businesses owe their prosperity to a fresh competitive formula--a distinctive combination of strategies, relationships, processes, and values that sets them apart from the crowd. But when changes occur in a company's markets, the formula that brought success instead brings failure. Stuck in the modes of thinking and working that have been successful in the past, market leaders simply accelerate all their tried-and-true activities. In attempting to dig themselves out of a hole, they just deepen it. In particular, four things happen: strategic frames become blinders; processes harden into routines; relationships become shackles; and values turn into dogmas. To illustrate his point, the author draws on examples of pairs of industry leaders, like Goodyear and Firestone, whose fates diverged when they were forced to respond to dramatic changes in the tire industry. In addition to diagnosing the problem, Sull offers practical advice for avoiding active inertia. Rather than rushing to ask, "What should we do?" managers should pause to ask, "What hinders us?" That question focuses attention on the proper things: the strategic frames, processes, relationships, and values that can subvert action by channeling it in the wrong direction.

When long-established enterprises like Lehman Brothers or Chrysler collapse, it's enough to give any manager pause. In the current downturn, we're all feverishly cutting costs, shuffling strategies and greeting the world with an anxious bravado. Shouldn't that be enough to stay solvent? Or are lots of us trapped in the final rituals of doomed enterprises?

The frustrating truth is that we don't comprehend corporate breakdowns nearly as well as we understand other crises, such as human disease. Doctors keep getting smarter about how to spot early-stage cancer or heart disease, and act quickly even when patients think they are fine. If only there were a diagnostic kit for the business world that could help us size up trouble and ward off catastrophe when possible.

Business strategist Jim Collins takes on this challenge in his latest book, How the Mighty Fall. Collins is renowned for earlier best sellers such as Built to Last and Good to Great, which offered road maps to business success. These days, failure is on his mind. So he has produced a fascinating, idea-packed book that sets forth five stages of corporate decay, along with some thoughts about how to get back on track.

Collins's best insights come early in the cycle. Companies that look successful may already be on the path to decline, he argues, particularly if they exhibit what he calls "hubris born of success." Consider Motorola , which once had nearly 50% of the cell-phone handset market. It passed up chances in 1995 to enter the digital market early, sticking with more primitive analog designs, because it felt sure that analog's 43 million customers couldn't be wrong. Within four years, Motorola's market share had slumped to 17%.

Why do so many top-tier companies become blind to changing market dynamics? It's easy to contend that they grow complacent or lazy, but that's not the key issue, Collins contends. Many of these companies turn out to be furiously busy as their competitive edge erodes. However, they are focusing on all the wrong things. Instead of adapting carefully to new market dynamics, they chase fads or become fetishistic about protecting minor habits they associate with their rise to greatness.

The old A&P grocery chain provides an eerie case in point. After one pioneering executive died, his successor didn't just set out to protect a legacy, he wore the dead man's gray suits, telling people that the outfits shouldn't go to waste. It wasn't long before nimbler rivals such as Kroger devised new store formats that rapidly pushed A&P toward obscurity.

It gets worse. Constant learning stops being a priority, in favor of a louder, pushier approach that's all about claiming success and spinning away inconvenient facts. Employees no longer feel comfortable speaking the truth. They may appear to be in step with their bosses' decrees, but cynicism and careerism increase. Passion for the work at hand dwindles.

These diseases of attitude inevitably translate into bad decisions. Companies make bad acquisitions, and sloppy diversification moves in what Collins calls the second stage of trouble: "the undisciplined pursuit of more." They stop getting the right people in key seats. Instead of recognizing that things are going awry, companies slide into the third stage: "denial of risk and peril."

Consider the debates within Morton-Thiokol and NASA the night before the ill-fated Challenger shuttle launch in 1986. As Collins tells it, there was a conversation about the safety of cold-weather launches. The discussion touched on data which suggested that the O-rings might be more brittle at lower temperatures. Yet it was a hard batch of data to interpret, and the qualms didn't prevail. Unsure what to do, people picked the easier but catastrophic choice of staying with the launch. The O-rings ultimately failed in unusually chilly weather on the day of the launch.

Collins's analysis gets bumpier at the crucial fourth stage: "grasping for salvation." He salutes Lou Gerstner's remarkable turnaround at IBM in the mid-1990s and faults Circuit City , Scott Paper and A&P for reckless lunges that only made things worse. Before long, they were doomed to the fifth stage: "capitulation to irrelevance or death."

Clearly some companies can pull out of a dive; others can't. Good, sensible leadership and data-driven decisions appear to help; massive acquisitions and excessive faith in charismatic new chief executives can make things worse. But this time, Collins's examples feel tinged with too many one-of-a-kind anomalies to make his generalizations 100% useful.

Rather than scour thousands of corporate examples, as he did in his earlier books, Collins focuses on about 60 companies that he had featured in Built to Last and Good to Great. He acknowledges that some icons of those earlier books lost their magic pretty quickly. But he contends that those companies still deserved study at the top of their game, and that their subsequent stumbles are instructive, too.

Not all companies deserve to last, Collins says. But "if you've fallen into decline, get back to solid management disciplines--now! And if you're still strong, be vigilant for early markers of decline." It's simple, sensible advice, even if many of his readers won't really follow it.

Unfortunately, it's easy to fall into the bad habits of early-stage decline without paying any obvious penalty for a while. Companies keep doing it, in the same way that people in their 30s and 40s get sloppy about diet, exercise, seat belts and dozens of other healthy habits. For anyone who wants to avoid the corporate equivalent of an ambulance ride to the emergency room, Collins's new book packs a lot of wisdom into its slim 222 pages.