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Crisis-Avoiding Management
Recognizing ten caution signals of potential business problems
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Business New Haven
12/4/1995
By: Daniel M. Morris
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Many business crises or downturns can be avoided at an early stage by recognizing caution signals of potential problems. Ten of the most common are:
1. Management arrogance vs. confidence. While confidence involves a continuous and forthright exploration of how to satisfy needs of others, arrogance is exhibited by managers trying to substitute force of personality for substance. Too often, it amounts to bravado before the fall. Arrogant managers are slow to act, not open to constructive criticism and fail to provide necessary information or services to customers, employees, lenders and suppliers. The self-defeating attitude occurs most often in entrepreneurial and professional organizations in which managers in power are so certain of their ideas and decisions that they do not solicit or tolerate opinions of others.
2. Old equipment vs. state-of-the-art technology. Equipment that is antiquated or in poor repair usually is a cautionary indicator that the company can be out-produced by its competitors. Our firm's first visit to the plant of a plastics extruder, for instance, was an eye-opener. Production equipment literally was held together with rope and wire. At the same time, the company's principal competitor in the vinyl siding business used the latest technology and, for a comparable dollar expenditure on equipment, produced twice as much product in the same time period at a fraction of the cost.
3. New facilities vs. strong operating margins. Brand new facilities commonly destroy operating margins. Managers tend to follow a long learning curve to become experts in the new facility, spending less time running the basic business and attending to customer needs.
Three Midwestern grocery distributors of a larger organization merged and consolidated their businesses. Each had operated successfully out of old and cramped, but functional facilities. The owners build a new 200,000-square-foot semi-automated distribution center and suddenly found themselves becoming experts on debugging the computer system, temperatures of cold storage facilities, how much weight floors could bear, etc. In the first year after the merger, $4 million dollars was lost because the owners and managers took their eyes off the basic grocery distribution business. The lesson: improvements and innovations must be tested against customer satisfaction. New, bigger and better facilities only are worth the investment if they are meaningful to customers who provide the revenue to keep those businesses profitable.
4. Commodity orientation vs. proprietary products or services. Selling commodity products is a cautionary signal from the start. Companies that sell commodities or “me-too” products or services must be particularly vigilant about changes in market preferences and tastes. In addition, market prices for raw materials can spike without warning, as in the prices of coffee, rubber, petroleum, etc. Most significant, there are relatively few ways to distinguish the company's products from those of the supplier next door. Commodity companies constantly must be on the alert for ways to improve customer services and product quality, while keeping prices as low as possible.
5. Buyout leverage vs. operating leverage. Buyout leverage on the balance sheet always is a cautionary indicator. In a buyout, assets and cash flow are used solely to support an acquisition price, unlike operating leverage, which is debt generally reinvested in the business. In other words, buyout debt does not improve the company's operation one iota. The greater the leverage (particularly when there is no quid pro quo), the narrower the company's margin for operating errors and hence the more difficult it will be to maintain consistently profitable operations.
6. Traditional focus vs. current business environment. In general, management teams and employees who have a traditional focus are resistant to change. Such a position is tenuous in today's climate of evolving market tastes, advancing technologies and new ways of building and delivering products. If companies are not open to new ideas about products, services, manufacturing techniques or distribution methods, their markets will pass them by.
7. Staff tenure vs. industry change rate. There certainly is nothing wrong with having staff that has been in the business for decades. However, persons with long tenure at one firm do not bring the benefits of different methods and styles of doing business at other organizations. For instance, CAD/CAM applications eliminated a great deal of manual drafting work and were strongly opposed by some firms. However, companies that fought this inevitable trend were soon outpaced, outpriced and outperformed by competitors.
8. Inventory intensity vs. total assets. Companies whose assets consist mainly of inventory are constantly at risk of poor earnings performance. Their asset value can rise and fall based on events over which management has no control. For example, a $40 million scrap dealer depended heavily on the price of shredded metal. Unfortunately, after a sharp decline in steel prices, he attempted to compensate for stocking too much inventory when prices were high by speculating in his own commodity in the futures market. He made a number of wrong predictions on the direction of shredded-metal prices and, as a result, the business failed.
9. Bean counters vs. financial advisors. Be wary if a company has a large number of bean counters - employees who spend their days making debits equal credits without knowing or caring what the data means. Such firms usually generate reams of reports and few, if any, useful financial analyses. They also tend to have large MIS staffs, but few people out talking to customers. Reports are meaningful only if they are relevant and can be analyzed by those able to use them to develop new ideas, promote customer satisfaction and generate revenue.
10. Sense of urgency vs. laid-back culture. Are employees driven to get jobs done and find new ways to meet customer needs - or do they put off projects and make excuses? When opening at 9 a.m. and putting the key in the lock at 5 p.m. sharp is part of a company's culture, it raises the question of how effectively the staff can respond to changing markets, deadlines and any number of business problems. Without a company-wide sense of urgency, decisions made mañana may be a day too late. BNH
Daniel M. Morris is president of Morris•Anderson & Associates Ltd., a consulting firm to underperforming and financially troubled middle-market companies and their lenders, investors and creditors.
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