Expensive mistakes

October 8, 2008

Free Market Foundation

Since 1981, 423 U.S. companies with assets of more than $500 million filed for bankruptcy, with total assets exceeding $1.5 trillion. What lessons can we learn from such colossal business failures? According to Paul Carroll and Chunka Mui, authors of “Billion-Dollar Lessons,” plenty.

The current emphasis in business literature suggests that everything boils down to execution, but the authors offer an alternative theory: failure stems from bad strategy. Based on their analysis, the cardinal sins of bad strategy include:

Synergy the mere mention of which should cause investors to flee lauds economies of scale and mutually beneficial business generations, but they almost never materialise; yet, investment-banking fees always do.

Financial engineering such as when clever and well-paid people create a host of complex debt instruments that are then sold to other clever and well-paid people who were similarly misemployed usually ends with catastrophic results.

Rollups, in which someone realises that a particular industry is still dominated by mom-and-pop operations and acquires dozens, if not hundreds, of them, will eventually discover that it is running an unwieldy behemoth.

Staying the course occurs too often, with businesses clinging to old strategies or technologies even when they are obviously doomed.

Many companies figure they can extend themselves into “adjacent” markets, often by making an acquisition; however, they usually do not understand the new market they have entered.

Executives sometimes bet on the wrong technology, resulting in their company going bust.

Consolidation is a natural process in a maturing industry, but that does not mean that just because a company can consolidate, it should.

Moreover, the authors urge executives to pose tough questions when they embark on dangerous courses of action, such as: “Can the strategy withstand sunshine;” Can the strategy withstand storms;” “When does it stop?”

Source: Daniel Akst, Expensive Mistakes, Wall Street Journal, September 24, 2008; based upon: Paul B. Carroll and Chunka Mui, Billion-Dollar Lessons, Portfolio, September 2008.

For text: http://online.wsj.com/article/SB122221497204869357.html

For more on Economic Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=17

FMF Policy Bulletin/ 30 September 2008