Read the latest campus information on coronavirus (COVID-19) here  

Why Giants Stumble

by Felix Barber, Jo Whitehead, and Julia Bistrova

Why Giants Stumble
Why do large successful public companies and their CEOs suddenly weaken?


It was a fall from grace of poetic proportions. Before 2012, Tesco had been popular with investors, including prolific investor Warren Buffett, and was widely seen as a safe bet. But from 2012 to 2014, Tesco’s stock price suddenly fell 43% relative to the FTSE100, and its CEO Philip Clarke left the firm soon after.

While dramatic, Tesco’s decline is not an anomaly. In the past decade, nearly one in five of the top 100 firms in the USA and Europe experienced a major stumble or a setback that can be largely attributed to management error. AIG, Citigroup, Intel, Rolls Royce, Target and Volkswagen are all firms that have encountered such a stumble. Unlike firms steadily declining over a long period, these are examples of large, well-established companies that weakened with little forewarning. So how do such successful companies suddenly fall?

Why do giants stumble?




Causes of Stumbles

New research from Barber, Whitehead, and Bistrova, detailed in their article “Why Giants Stumble,” found two broad causes of corporate stumbles: strategic failure and operational errors.

There are two broad causes of corporate stumbles: strategic failure and operational errors

In nearly every stumble belonging to the former category, the strategic challenge the firm faced was growth–low market growth, patent expiry, or disruptive competition. Specific reasons for the strategy-related stumble included:

  • Failing to meet pressures to innovate or reposition - the firm was unable to respond to industry developments when the market demanded it
  • Overinvesting in the core business - betting on more growth in the market than available
  • Risky portfolio diversification - allocating capital to new business investments that ultimately failed
  • Outsized “bet the farm” acquisitions - acquisitions too large for the relative size of the firm

Operational errors were also responsible for or substantially contributed to stumbles. More specifically, these errors were:

  • Failure to meet compliance requirements - improper supervision of the firm
  • Poor financial risk controls - failure to limit financial risk independent of acquisition or compliance issues
  • Failure to achieve efficiency targets - inefficiencies in controlling costs or meeting volume targets

In other words, these cases largely point to avoidable management errors.

Steps Leading to Stumbles

The study identified two prominent factors leading to the above stumbles. First, top decision-makers and their individual skills were poorly matched to the company’s strategic challenges and goals. Second, decision-makers had blind spots to major risks.

When finding an appropriate CEO to lead the firm through strategic challenges, the candidate must be qualified to address the specific challenges in addition to having general leadership capabilities. For example, despite having the business acumen that might have made him suitable for the firm in normal periods, Nokia’s CEO Olli-Pekka Kallasvuo did not have the necessary expertise in high-tech products to compete with the challenge posed by the rapidly innovating iPhone.

It is also important that the firm chooses a strategic challenge aligning with the company’s management capabilities. In many cases, decision-makers decided to adopt challenges that were too difficult for the management team, such as risky investments or expensive acquisitions. Firms should realistically assess the business, added-value, and capital markets logic of potential strategy prior to investing.

A firm can also fall prey to various biases that distort their decision-making. The study names two types of biases in stumblers: bias to growth and bias to trivializing compliance or financial risks. Executives can get over-excited about growth opportunities and fail to accurately analyze its risks. More often, however, operational errors were attributed to compliance or financial risk. Firms should monitor every level of operation for compliance, closely screen their outsourcing partners, and institutionalize strong control processes and a compliance culture.

The Emperor’s Clothes Test

To prevent these errors, the authors of “Why Giants Stumble” have devised an Emperor’s Clothes Test to review the capabilities and determine the appropriateness of a firm’s executive team. The test takes into account a CEO’s qualifications, the ability of their supporting team, and the appropriateness of the Board by asking a series of questions to evaluate a decision-maker’s ability including:

  • Are the CEO’s industry background, line management experience, and educational or professional background suited for the job?
  • Can the top executive team step in where the CEO has flaws?
  • Does the board comprise at least three non-executive directors and no more than twelve people total?

Screening the composition of a firm’s leadership for the most suitable decision-makers can help major companies avoid preventable setbacks. Giants can avoid stumbling by being realistic their strengths, recognizing the inadequacies and biases present in all levels of the firm. Diagnostic measures like the Emperor’s Clothes Test substantially reduce the likelihood of cautionary tales like Tesco’s stumble by holding up a mirror to firms and the actors operating within them.


Recommended




California Management Review

Berkeley-Haas's Premier Management Journal

Published at Berkeley Haas for more than sixty years, California Management Review seeks to share knowledge that challenges convention and shows a better way of doing business.

Learn more
Follow Us