Woolworths

The cost of failure

Even in a strong economy, companies can find themselves staring down the barrel of a gun. Today it's a battlefield. E&T asks leading law and accountancy firms why companies fail and what to do about it.

Business disaster may strike from anywhere. Sometimes even blue-chips misread a market. Many say IBM took far too long to see the value of the Internet. But then, during the dot-com bubble, the market over-valued businesses with websites and little else. 

Companies develop products no one wants. When lauded UK inventing genius Clive Sinclair refused to take to the London streets in his own C5 runabout, the public wasn't inclined to argue with him about its safety. 

You can be a victim of your own success. Coke had become such a lifestyle accessory that when Coca-Cola launched New Coke, soft-drink guzzlers looked puzzled, then asked for the old one. 

A new marketing wheeze may mean pneumonia. Few in this category match Hoover UK's 1992 offer of two free transatlantic flights with every appliance over £100 (€108). Hoover couldn't meet demand for the gift tickets, and unwanted £101 vacuum cleaners piled up in landfill.

Companies are caught out by hubris: Hewlett-Packard didn't see Dell streaking up behind it until 1971, when ruin beckoned. Rolls-Royce thought the RB211's development costs didn't matter. The list under the 'greed' heading grows by the hour: Enron, Worldcom, Broadcom, Tyco, Parmalat, Madoff…

More often, however, business blunders defy categorisation. How would you label the cocktail of folly, incompetence and worse that finished MG Rover, or wiped 98 per cent from shares in Marconi, once manufacturing colossus GEC? 

Free-on-board

What price unnecessary leaps in the dark? Wedgwood''s China adventure is instructive now that currency fluctuations have made offshoring to the Far East a debatable strategy. Michael Wilcock, the chinaware company's manufacturing and supply director, once revealed to an industrial seminar how Wedgwood had decided to make the Johnson Brothers tableware line in China. From the beginning, he said: "We didn't know what we were talking about."

The 2003 decision was made on "gut feel, guesswork and no hard facts." All Wedgwood knew was that the free-on-board (FOB) cost of a China-made plate was 70 cents compared with £2 in Stoke-on-Trent. But the FOB price excluded the time taken and charges made for goods inwards inspections, storage and handling, extra inventory incurred on a 43-day voyage from Europe, handling at ports, working capital, administrative costs, duties, quotas, bureaucracy and the 'introductory envelopes' required to lubricate every process. 

China's yield was two-thirds Stoke-on-Trent's 96 per cent. The UK could put wrong quantities or incomplete orders right in hours; fixing problems in China cost Wedgwood $100,000 a year. Currency forecasts, said Watkin, "never work out".

The Chinese, with no spreadsheets, could not calculate production and handling costs. In six months, cost of production was double its former figure, "but since we had shut two factories we had no choice".

Some say companies can just have a run of bad luck. How would you categorise Perrier's benzene scare or Mattel's Far East toy story? In 2007, Mattel was one of a score of companies hauled before a US congressional committee to explain why it was allegedly poisoning American children with lead-laden paint and loose magnets. 

Mattel's experience as a customer of the Kadar toy factory in Bangkok, where the worst industrial factory fire in history killed 188 workers and injured 500 in 1993, shocked it into setting itself up as a model of toy-safety best practice. It established codes the International Council of Toys Industries followed to police safety standards. 

You make your own luck. In 2007 UK journalist Eric Clark found working conditions in China's Pearl River delta remained bestial. The production price for toys, watches and other goods varied between 0.4 and 6 per cent of sale price. Producers received 35 cents for Mattel's $10 Barbie doll, he added, noting that the Mattel CEO's salary and stock options alone amounted to more in one year than the combined incomes of the Chinese workers making his company's products. 

Go West

Sometimes competitors seem to come from nowhere. In the 1970s, UK consumer-audio companies banned Japanese makers and importers from their trade association just as, in the 1950s, the German camera industry had dismissed Japanese competition. A generation later, Western carmakers didn't see Toyota, Honda and co coming.

The big three US carmakers, says Tom Lawton, head of manufacturing at BDO Stoy Hayward, had a monopoly of the US market until the Japanese arrived. When Japanese car warranties extended to one, two, three and more years, the writing was on the wall. Even so, the Detroit-based companies did little or nothing. Hubris again, says Lawton: "I think there was a degree of insularity - 'we are the biggest in the world therefore nobody can threaten us'." 

Companies are often near the brink because they put off difficult decisions, says David Dunckley, recovery and reorganisation specialist at UK accounting firm Grant Thornton. His client list is dominated by West Midlands car firms: "The car industry is great, because it goes in seven-year production cycles. If you're making [components for the Ford] Focus 2, right now you're thinking 'am I going to get the contract for Focus 3?'. Because if not you've got a whole level of cost which you need turnover to make use of."

"You should run the business for maximum profitability and cash flow always," says Lawton. Not every business is as rigorous about this as it should be until they realise they're carrying 100, 200, or even 10,000 employees more than they need in current market conditions. 

Longer term, the question is whether the business is viable, says Dunckley. In the car industry - as in every other - the questions are what products are you making, what price are you charging and what's the cost base? "The question we're seeing all the time, now there's too much capacity, is what alternative uses does that capacity have?" 

For Lawton, the current crisis is bringing to a head a problem that's been coming for the last ten years. Digby Jones, the former director general of the Confederation of British Industry and, until last year, a minister for trade and investment in the UK government, also speaks of two kinds of recession. In one, world class companies like Jaguar, Land Rover, JCB, Nissan, Honda, Toyota and Mini in Oxford are trapped by the lack of liquidity caused by the banking crisis. 

In the other, retailer Woolworth and van maker LDV, "have been found out. [They] were OK in a boom but the business model, the consumer base, has changed and they haven't changed with it. I wouldn't put a penny of government money into a manufacturer caught in that", says Lord Jones.

Business negligence

Businesses fail for myriad reasons, says Dunckley, usually because someone in the business has made a poor decision. He often sees planning so naïve or inadequate that it borders on business negligence. When times are tough, he says, it's best to stick to what you know. It's tempting to try to lower costs by moving production to China, but "you're fundamentally changing the dynamics of your business. To a customer you're doing the same thing; behind the scenes it's a radically different business model".

Professor Simon Deakin, assistant director at Cambridge University's Centre for Business Research (CBR) and a specialist in corporate governance, says his studies of corporate failure suggest that, "a lot of companies which have really bad governance get away with it when there's a bubble going on but can't really respond when the bubble is burst. I'm not sure there's any advice you can give to a company in that position apart from, 'don't get into it in the first place'."

Lawton counters that it's asking too much for any manager to have foreseen today's economic maelström.

It's a textbook example, he says, of outside events beyond management control. 

Changing consumer demand

In cars, audio, video games, computers and other industries, says Lawton, the far eastern offer is of continually improving quality and better features for prices low enough to encourage the buyer to replace the product a year later. And consumers have voted with their plastic: "That was very clever market positioning," says Lawton. "They spotted [and encouraged] a changing trend in consumer demand and consumer thinking. They recognised there was a whole wave of consumers out there that would quite like to change these products more often, and they could support it by offering a lower-cost product."

Lawton says most UK and Western managements haven't realised the way globalisation has changed the calculation of the strategic political, economic, social, and technological influences operating in any market. But it's harsh to blame managements since it's happened over such a short period, almost within a business cycle.

Lawton says no one business blunder is usually fatal by itself. What usually means real trouble is when a number of them coincide. Many businesses rely on one big customer - often a big supermarket chain like the UK's Tesco or Marks & Spencer. That only becomes a problem if something else intervenes - a delivery failure or some technical problem - to affect the relationship. But if you lose that customer, the banking support that would have been available to tide you over a year or 18 months ago is no longer there.

Servitisation

As for the future, over and again the same strategic messages shout for attention: servitisation and environmental performance. Photocopier maker Xerox is struggling in the recession just like many others. But it would not have survived a hammering by Canon, Konica Minolta and Ricoh without turning its products into the basis for a continuing revenue stream. Now it competes with Hewlett-Packard, Kodak and Canon for document-management and other consultancy services to energy companies, carmakers, public libraries, airlines and large retailers.

Rolls-Royce - in 1971 a business failure to end them all - is everyone's favourite 'servitisation' example. In 2006 it made 53 per cent of its £7.4bn revenue from services - 'Power By The Hour' programmes which give the airline or other operator a fixed engine maintenance cost over an extended period. 

UK pump maker Edwards Vacuum has turned refurbishment into an art form. Since 1990 Edwards has replaced failed units with remanufactured units built to the latest specifications. The recovered units are 'remediated' as stock for field replacements. Edwards now applies these principles to the remanufacture and field replacement of competitor products.

US floorings manufacturer InterfaceFLOR has long seen the 'waste' its products became as a valuable raw material. St Gobain glass buys back its customers' cullet. Both can bask in their suppliers' environmental rectitude.

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