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Corporate Decline and Turnaround Strategies

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Corporate decline and Turnaround Strategies
Abdalrahman Faleh Al-abadleh
Research submitted for publication
E-mail:abdaly8@gmail.com
Telephone number:0790969488
9 – 4 - 2017
Corporate Decline and Turnaround Strategies
1
Abstract
This research is a literature review for corporate decline and turnaround strategies. It
aims to identify what are business decline symptoms and causes and which strategies
have been identified by scholars and associated with turnaround situation. The
literature review has offered further insights into the understanding of symptoms and
causes of business decline. It has raised the issues of confusion between symptoms
and causes of decline and the subject of how to determine the causes decline. Two
lines of thought that considered the company’s failure and decline have been
discussed: external/internal category of causes of decline and the loss of competitive
advantage as the main cause of decline. Furthermore, this research revealed that the
most common strategies which associated with turnaround situation were cost
reduction, divestment, investment, CEO replacement, refocusing/repositioning. These
strategies have been classified in different categories such as “Efficiency”,
“operation”, “Strategic” and “entrepreneurial” by different authors
Introduction
The fall of a company from a superior position in terms of performance to poor
position reflects a fundamental problem with its management or a drastic change in its
environment. How should managers respond in such circumstances? The ailing
company can be rescued by adopting a set of strategies called turnaround strategies.
However, survival is not taken for granted even if companies adopt such strategies.
While turning around ailing companies has become a prevalent phenomenon in the
past two decades, researchers (e.g. Pettigrew, 1990; Winn, 1993; Pandit, 2000; Bruton
et al., 2000; Sudarsanam et al., 2001) have stressed that our understanding of this
phenomenon is still incomplete and require more research to fill the gap in order to
provide a better understanding of turnaround. For example, Winn (1993, p. 48) cited
in Pandit (2000) states that:
While companies facing near-bankruptcy, market losses, or substandard performance
are increasing in frequency, strategy researchers have provided little help for the
managers with turning around deteriorating performance.
Turnaround is considered to be an extreme situation in a company’s life cycle, and
turning around ailing companies is a complex process. It is a big challenge for
managers and researcher to uncover the reasons behind performance decline and the
action required to put companies back on track. Based on the challenge involved in
such research and the recommendations by other researchers, turnaround has been
chosen to be researched.
The purpose of this research is to interpret business decline and understand the
reasons behind this decline as well as analyse and evaluate turnaround strategies in
the extant literature in response to corporate decline.
1. Corporate decline
In practice, companies’ performance tends to fluctuate from time to time due to rapid
change in their internal and external environment. However, the real problem for
management is the declining performance of their companies. Why high profile
companies which dominated their market and had been markedly successful lose
destiny with their profit being transformed to loss? This dilemma had pushed
managers and encouraged researchers to interpret business decline and understand the
reasons behind this decline. Companies’ performance decline is distinguished by early
signals and indicators of decline, regardless of whether these signals and indicators
have been observed or not. These signals do not give an explanation for business
failure and decline, instead, the root of those signals is the most important thing which
managers should consider.
1.1 Symptoms of decline
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Many researchers have described and examined symptoms for companies’ decline.
For instance, Slatter & Lovett (1999) described symptoms of decline as danger signals
which can be discerned by people outside the ailing company. Thompson (2001)
described symptoms of decline as indicators for a deteriorating situation while
Scherrer (2003) has described them as warning signals which start flashing a long
time before a company’s performance starts its decline. From the a above description,
symptoms of decline can be derived from companies’ performance measurement and
considered as a sign of the existence of an undesirable situation when compared with
the past performance, future target, competitors’ performance or the industry average
performance.
Symptoms of decline are not the same as causes of decline which will be discussed in
the next part; they give clues that something is going wrong inside or outside
companies’ environment which, ultimately affects the companies’ performance
negatively but they do not answer the questions of why is something going wrong?
And which factors drive things to go wrong? The most common symptoms of decline
are financial in their nature; however, there are some non financial symptoms of
decline. Slatter (1984) conducted research on 40 UK declining companies and
revealed a combination of ten financial and non financial symptoms of decline
summarised in Table 1 (Cited in Thompsom, 2001).
Profitability decline
Sales decline
Decreasing liquidity
Market share erosion
Lack of strategic planning
Dividends reduction
Debt increase
Delays in publishing financial reports
High turnover of managers
Top management fear of ignoring important tasks and
pressing problem
Table 1 Symptoms of decline Source: Slatter (1984) cited in Thompson (2001. P. 623)
Recent research, however, conducted by Scherrer (2003) has described symptoms of
decline from different perspective; he developed three stages of decline: early, mid-
term and late. Scherrer (2003) also argued that each stage has its own symptoms or
signals. Table 2 summarise some of Scherrer symptoms of decline.
Early decline Mid-term decline
Lack of cash
Liquidity strain
Decrease in working capital
Return of investment declining by 20%-
30%
Late financial information
Increase in customer complaints
Flat sales
Increase in inventory
Decrease in margin
Increase in bank advances
Unreliable financial information
Erosion of customer confidence
Overdraft made at banks
Bank is sued to cover payroll
Violation of loan covenants
Late decline All stages of decline
Increase in inventory
No liquidity
Hasty lay-off
Decrease in working capital
Cut-off of supplies
Market share erosion in key product line
Increase in management turnover
Poor internal accounting
Management conflict with company goals
Table 2 symptoms of decline Source: Scherrer (2003)
Researchers (e.g. Slatter, 1984; Slatter and Lovett, 1999; Scherrer, 2003) have
introduced lists of symptoms of decline, some of them financial and some of them
non financial and the number of symptoms vary from one researcher to another, for
example, Slatter (1984) concluded that there are 10 major symptoms. Slatter and
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Lovett (1999) introduced 47 symptoms from different observer’s perspective while
Scherrer (2003) mentioned 32 symptoms which related to different stages of decline.
In real life, some of these symptoms exist in declining and healthy companies at the
same time (Slatter and Lovett, 1999). For instance, reducing dividends does not have
to mean that the company performance is declining. Rather, the company may tend to
invest a substantial amount of profit for future growth. Inventory increase is not sign
of decline in the stage of company expansion in growing industry. This leads us to the
point that many symptoms of decline mentioned by researchers such as Slatter (1984);
Slatter and lovett (1999); and Scherrer (2003) are description of the declining
performance rather than an early signal of decline. Therefore, it is quite difficult to
judge whether a company in real trouble or not because one or more symptoms of
decline exist.
Managers are desperate to recognise signals of decline as early as possible, therefore
there is no need to mention symptoms of decline for example in the late decline stage
because in this stage the company’s managers know the fact that they are in big
trouble already. In this context, companies need to establish their own measurement
system to trace those signals of decline; Jack Welch the CEO of General Electric US
states that:
The three most important things you need to measure in business are customer
satisfaction, employee satisfaction and cash flow (Cited in Thompson, 2001).
This confirms the facts that the less number of signals the more attention will be
drawn to them. Kaplan and Norton emphasised that companies should focus on
limited and critical performance measures and they summarised them in their
framework which is known as ‘balanced scorecard’ (Thompson, 2001).
1.3 Predicting company’s failure
Many investors, authors and external observers are concerned more with companies’
financial performance as a measurement of decline. Some of them such as Altman
(1968) and Taffler (1977) went far toward predicting company failure using the
company’s financial ratios; the work of Altman (1968) led to the development of ‘Z-
scores’ which is redeveloped by Taffler (1977. Z-scores were considered to be a good
indicator to assess a company’s potential bankruptcy; where Altman Z-scores were
below 1.81, the company was considered bankrupt; where Z-scores were above 2.99,
the company was considered healthy. If we use Taffler Z-scores; a score above 0.2
indicates that the company is healthy while a score below 0.2 indicates to the
company potential bankruptcy (Slatter and Lovett, 1999; Thompson, 2001).
1.4 Causes of decline
Causes of decline are those factors that stand behind the existence of symptoms of
decline. Sales decline is a symptom not a cause of decline; the factors that pushed
down sales are the root of problem which causes the decline. In this context, many
authors failed to explicitly distinguish between symptoms and causes of decline; for
example Thompson (2001, p. 624) states that:
An investigation of 1000 insolvencies in 1994 determined that the greatest single
cause of business failure was loss of market, which was responsible for 29% of the
insolvencies. Inadequate cash flow accounted for a further 25% and leadership failing
16%.
Loss of market and inadequate cash flow are symptoms of decline while leadership
failure is cause of decline. Sherrer (2003) introduced list of 32 symptoms of decline
and 21 causes of decline which reflects how subjective this issue. Many authors
sought to categorise the factors causing decline; the popular internal/external
categorisation used by Casseells, 1992; Slatter and Lovett, 1999; Pandit, 2000 and
Scherrer, 2003, while, other authors such as Pearce II & Robbins, 1992; Chan, 1993;
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Thompson, 2001 categorised the cause of decline in terms of issues such as
leadership, finance, competitiveness, poor management, technological change,
economic problems and over expansion.
The different emphasis on the importance of any single cause of decline between the
authors reflects their subjectivity in this topic. For example, Chan (1993) stressed on
poor management and external factors as a common reason in most businesses that
start to get in trouble. While, Thompson (2001) emphasis on poor strategic leadership,
inadequate financial management, and lack of competitiveness categories as causes of
decline. It is not easy task to identify the causes of decline in general because the
significance of each cause varies from company to another and from industry to
another. If manufacturing problems regarded as a particular cause of decline among
computer companies we can not generalise this on services companies. Using the
external/internal framework of the causes of decline, Table 3 summarises the
argument and findings of sixteen authors whom discussed this issue.
Schenel
et al.
(1976
Bibealt
(1982)
Slatter
(1984)
Thain &
Goldthorpe
(1989)
Grinyer
et al.
(1990)
Gopal
(1991)
Pearce &
Robbins
(1992)
Cassells
(1992)
Chan
(1993)
External
causes
Intense
competition
X X 40% X X X X X X
Falling demand X X 33% X X X X X X
Input price
increase
X X 30% X X X X X
Internal causes
Poor
management
X X 73% X X X X X X
Poor financial
control
X 75% X X X X X
High cost
structure
X 35% X X X X X
Overtrading X 17% X X X
(Continued)
Richardson et
al. (1994)
Hill & Jones
(1995)
Hacker (1996) Gething (1997) Scherrer (2003)
External causes
Intense
competition
X X 44% X
Falling demand X X 68% X
Input price
increase
X 20% X
Internal causes
Poor management X X X 84% X
Poor financial
control
X X X 60% X
High cost structure X X 56%
Overtrading X X X 20%
Table 3 Causes of decline*.Adapted from Slatter and Lovett (1999), and Pandit (2001)
* X authors stresses on these factors as causes of decline
The same causes of decline could be categorised in different ways as discussed above,
however using external/internal category is much easier especially for the purpose of
this research.
1.4.1 External Causes
External causes can be defined as those factors that exist in the companies’ business
environment but beyond their control, therefore, these factors pose a real threat to the
companies’ survival. In this context, Robert Marks states that:
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Catastrophes build up slowly while the existing management is busy looking after
day-to-day business: competitors steals its market share, demand for the product
diminishes, lack of investment in new technology makes the company uncompetitive
(cited in Richardson et al., 1994).
1.4.1.1 Intensity of competition
Companies’ performance decline when they fail to remain competitive, simply
because their products are obsolete or their price is too high. Product’s obsoleteness
comes from a shift in customer demand due to new products developed by other
competitors. Therefore, a company runs into trouble when it fails to respond quickly
to their competitors’ move in terms of developing new products. Slatter and Lovett
(1999) pointed out that companies fail to replace their existing obsolete products
because:
Company’s management believes that the existing products are unbeatable
because it is the best in the market.
The success rate of new product is very low; therefore companies tend to avoid
such potential loss unless obliged to do so.
There is a lack of the required resources and ideas to develop new products.
In addition to new product development by competitors, price competition is another
factor which may drag down the companies’ profitability. Price competition is
considered by Slatter and Lovett (1999) to be the most common cause of decline in
manufacturing industry in Western countries and it is a common feature for mature
industry. High-cost companies will not be able to maintain their profit in price
competition situation because their profit margin will erode faster than their low-cost
competitors which ultimately will lead to a prominent declining performance for the
high-cost companies. The intensity of competition depends on the industry structure
as discussed in chapter two and the interaction between forces in Porter’s industry
framework determines the industry members’ profitability.
Thirteen authors out of fourteen mentioned or stressed competition as external cause
of decline. Slatter (1984), Grinyer et al. (1990) and Gething (1997) found that
competition accounted for 40%, 44% and 60% of externally caused decline
respectively.
1.4.1.2 Falling demand
Demand fall can be brought about by new substitute products/services (innovation
and technological change), economic recession and social and cultural change (Slatter
and Lovett, 1999). Some authors distinguished between many different kind of
demand; for example Schendel et al. (1976) identified secular decline (industry or
specific firm decline) and cyclical decline brought about by economic conditions
(Cited in Pandit, 2001). Slatter and Lovett (1999) distinguished between long-term
decline, cyclical decline and changing pattern of decline (shift in customer’s
preferences). Regardless of demand type, declining demand influences companies’
performance negatively and may drive some of them out of the market. Companies
aim to maintain or increase their level of sales, however, when demand falls
maintaining or increasing the level of sales will be inevitably at the expense of other
companies’ sales. Thirteen authors out of fourteen. emphasised falling demand as a
cause of decline. Declining market demand was the most frequent cause of
companies’ performance decline in Thain and Goldthorpe (1989) and Grinyer et al.
(1990) while, Gething (1997) found that change in market demand was the cause of
decline in 68% of his sample.
1.4.1.3 Input price increase
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Under the input category, Slatter and Lovett (1999) include the price of commodity
products such as raw material, interest rate, foreign currency prices and property
prices as cause of decline. Pandit (2001) emphasised wages and raw material cost as
cause of decline while other authors such as Thompson (2001) included it under cost
disadvantages. Input price increases push a company’s profit margin down;
financially, one of the most common indicators of a company’s profit rate is its gross
profit margin (II), which is the difference between total revenue (TR) and Total Cost
(TC), divided by Total Cost (TC):
II = (TR – TC)/TC
In another way:
II= {(Unit Price* Unit Sales) – (Unit Cost*Unit Sales)}/ (Unit Cost* Unit Sales).
In this context, Hill and Jones (1995) discussed that to maximise the gross profit
margin for any given company compared with its competitor’s one of the following
must occur:
The company’s unit price must be higher than its competitors and its unit cost
must be equivalent to its competitors.
The company’s unit cost must be lower than its competitors and its unit price must
be equivalent to its competitors.
The company must have both a lower unit cost and a higher unit price than its
competitors.
Higher cost found to be the most frequent category of decline in Schendel et al.
(1976) sample while it represented 30%, 20% in Slatter (1984) and Gething (1997)
respectively.
1.4.2 Internal causes
Internal causes can be described as those controllable factors inside companies such
as production, finance and marketing. If these factors are managed well, they will be a
source of the companies’ competitive advantage; the Japanese companies are well-
known for their production techniques which gave them the advantage to enter and
dominate different markets. However, these factors are a potential threat when they
are mismanaged.
1.4.2.1 Poor management
A common reason for companies to find themselves in a declining situation is poor
management (Chan, 1993; Pandit, 2001). Unqualified strategic leader or sometimes a
qualified autocratic strategic leader represents poor management where, negligence
and costly key decisions are features of their management. Furthermore, poor
management may take the form of unbalanced expertise at the top (for example, too
many accountants), lack of strong middle management, and a failure by the board of
directors to monitor management’s strategic decisions (Hill & Jones, 1995). Table 4
shows that all the authors identify poor management as a cause of decline. Slatter
(1984) found that an inadequate strategic leader was the major cause of decline in
73% of his sample; this result has been reinforced by Gething (1997) whereby poor
management accounted for 84% of his sample. Some authors such as Pandit (2001)
went so far as to argue that the root of companies’ performance decline must be poor
management.
1.4.2.2 Poor financial control
Poor financial control can be manifested in an inability to manage the company’s cash
flow, inability to allocate costs between products, inability to know which product/s
considered being profit centre and inability to monitor the company’s performance.
Poor financial control considered to be one of the most frequent causes of decline in
Slatter’s (1984) sample and accounted for 75% of his sample. This result has been
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reinforced by Gething (1997) who found that poor financial control was a cause of
decline in 60% of his sample .
1.4.2.3 High cost structure
Companies are considered to be at a cost disadvantage when their costs are higher
than their competitors. The source of high costs could be wages, manufacturing
process and raw materials. In this context, Slatter and Lovett (1999) distinguished
between different sources of cost disadvantage:
Inability to take advantage of economies of scale.
Absolute cost disadvantages.
Management style and companies’ structure can be source of cost disadvantages.
Operating inefficiencies due to lack of investment.
Slatter (1984) found that high cost structure is a cause of decline in 35% of his sample
while Gething (1997) reported 56% of his sample cite high cost structure as a cause of
decline.
1.5 Competitive advantage
A recent stream of research has related companies’ performance to their competitive
advantage, however, accumulating evidence of a strong relationship between
competitive advantage and business performance has been found (Karnani, 1984; Day
& Wensely, 1988 and Grant, 1991) cited in Anna Kaleka (2002). In this context,
businesses fail or their performance decline when they fail to remain competitive
(Richardson et al., 1994 and Pandit, 2001). For the purpose of this study, a company
achieves competitive advantage when it creates more value for customers, more than
its rivals. Because competitive advantage has been associated with business
performance, the question is where does competitive advantage come from?
The resource-based view (RBV) which is currently the dominant theoretical
perspective in strategy literature suggests that unique firm competencies provide
competitive advantage (Coates & McDermott, 2002 and Chuang, 2004). However,
competencies can be created by exploiting the company’s resources and capabilities
(Pandit, 2001; O’Regan & Ghobadian, 2004). Resources refer to tangible resources
(equipment, plant, geographic location…etc) and intangible resources (brand,
reputation, patents, organisational routine…etc) (Hill & Jones, 1995; Pandit, 2001).
While, Capabilities is the process of learning and accumulating new skills in order to
deploy and coordinate different resources (Teece et al., 1997) cited in Coates &
McDermott (2002). Their is arelation between resources and capabilities,
competencies, competitive advantage and performance. The basic idea is that
deploying and exploiting a company’s resources and capabilities will bring about
distinctive competencies from which competitive advantage arise. This competitive
advantage will yield superior performance, however, nothing lasts for ever,
competitors will catch up in somehow and the company’s competitive advantage may
diminish and its performance will definitely decline. Once this has happened, the
company’s management must realise that their resources and capabilities have become
obsolete, therefore, the existing resources and capabilities must be rejuvenated and
new one must be developed to regain the company competitive advantage. In RBV
perspective, Coates & McDermott (2002) contend that resources must meet the
following condition to yield distinctive competencies:
It must provide opportunities for the firm
It must differ from the company competitor’s resources
It must be difficult to imitate
1.6 Triggers for change
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Some authors focused on the level of performance deterioration required to trigger
change while others focused on the form of the trigger. Schendel and Patton (1976)
found that great performance decline is necessary to trigger change and their
argument has been reinforced by Taylor’s (1982/3, p. 13) when he stated that:
Necessity is the mother of invention. It often requires a crisis to stimulate new
initiatives, and to persuade boards of directors to take radical measures and to accept
new approaches which they would not normally be prepared to consider (Cited in
Pandit, 2001)
Grinyer et al. (1990) discussed the form of the triggers for change. Their findings are
summarised in Table 5. As shown in the table, the most frequent form of trigger for
change is new chief executive whereby 55% of Grinyer et al. (1990) sample cited this
form.
Form of the trigger % of firms citing this factors
Intervention from external bodies 30
Change of ownership or the threat of such change 25
New chief executive 55
Recognition by management of problems 35
Perception by management of new opportunities 10
Table 4 Triggers for change Adapted from Grinyer et al. (1990, p. 120) (Cited in Pandit, 2001)
2. Turnaround strategies
Corporate turnaround strategies have become crucial for the survival of ailing
companies. A turnaround strategy has been defined as the necessary set of actions that
when implemented will halt a declining performance situation (Gowen III et al.,
2002). Cater and Schwab, 2008, P. 32 define turnaround strategies as a set of
consequential, directive, long- term decision and action targeted at the reversal of
perceived crisis that threatens the firm’s survival”. However, turnaround is not taken
for granted because the feasibility of successful turnaround is a function of different
factors such as the severity of crisis, causes of decline. Different company’s decline
may refer to different factors; therefore, we expect to see different emphasis on the
strategies required to turnaround the ailing companies. Furthermore, other factors may
influence the chosen turnaround strategies such as the leadership vision, the company
national culture, and the degree of stakeholders support. When companies’
performance decline, recovery may or may not be viable. Slatter and Lovett (1999);
Thompson (2001) argue that the possible successful recovery depends on several
factors. These are presented in the following sub-sections.
1- Causes of decline
Usually, many different kind of causes contribute to the declining situation as
discussed in the previous chapter. The question is Can the causes of failure be tackled
successfully? Some causes are easier to tackle within a relatively short time, these are
internal causes which are under the management control such as production problems,
marketing problems and poor financial control. Other causes are more difficult to be
tackled and need a longer time, these are external causes which are not under the
direct management control such as falling demand and intense competition. In this
context, Slatter and Lovett (1999) stress that companies suffering from internal causes
are much easier to recover than those suffering a declining situation due to external
factors.
2- The industry attractiveness
The more attractive the industry the easier for ailing companies to recover. The
attractiveness of any given industry is determined by many factors such as the
industry growth rate, the degree of market segmentation, the rate of technological
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change, the strengths of competitors,…etc. In this context, Porter’s five forces model
is valuable in analysing industry attractiveness as shown in chapter two.
3- Attitude of stakeholders
Stakeholders are any individual or group capable of affecting and being affected by
the action and performance of an organisation such as banks, employees, government,
trade unions …etc (Thompson, 2001). In any turnaround situation the support of
various stakeholders has a crucial impact on the recovery viability. In this context,
Slatter and Lovett (1999) argue that if the shareholders act to change management
before the firms reach the crisis zone, recovery may be achieved simply. Other
stakeholders who have a crucial impact on companies’ recovery are creditors
especially banks. Today’s banks are hesitant to work with ailing companies because
they believe that certain industries are in decline and therefore, companies within
those industries cannot be recovered (Scherrer, 2002). Thus, the role of the turnaround
management is to negotiate the payment of the bank’s outstanding loans and to
convince them that the business is viable for a successful turnaround.
4- Severity of the crisis
Many authors such as Hofer (1980), and Slatter and Lovett (1999) considered the
severity of crisis as a significant factor shaping any appropriate recovery actions. For
instance, Hofer (1980) argues that small changes such as cost reduction can affect
recovery positively where the crisis facing the company is not severe. However, the
more sever the crisis the more dramatic changes such as asset reduction and market
reorientation are required (Cited in Pandit, 2001). Figure 2 represents Hofer (1980)
argument.
Break-even point
A B C D Output
Figure 1: The relationship between the severity of crisis and the appropriate turnaround actions
(adapted from Hofer, 1980, p. 27) cited in (Pandit, 2001, p. 39)
According to this figure, the most severe situation is when the firms operate in
corridors A. In this case, the firm needs to adopt the three identified strategies: Asset
reduction, revenue generating, and cost retrenchment in order to get to corridor D.
Corridor D represents the point where the company’s revenue is more than its total
costs. Likewise, the firm in corridor B is in a less severe situation compared to
corridor A, therefore, the strategies required to reach the break-even point are cost
reduction and revenue generating. In corridor C, the firm is close enough to reach the
break-even point, and this could be achieved by adopting cost reduction solely.
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Cost Retrenchment
+ Revenue Increasing
+ Asset
Reduction
Fixed
costs
Capacity
Total Revenue
Total Costs
Slatter and Lovett (1999) argue that the severity of crisis is a function of the causes of
decline and timing; however, they distinguished between different types of crisis such
as cash crisis and profit crisis. In their view, each type of crisis situation requires
different strategies to tackle it.
It is not an easy process to judge how severe the turnaround situation is; how can
we measure the severity of situation? Because severity of turnaround situation is a
function of causes of decline and time, any suggested measures should reflect
these two dimensions. Nevertheless, the bigger the company the more likelihood
of recovery success. How could somebody imagine that global big names such as
Coca Cola, GE, Sony, IBM, Toyota, Unilever, McDonald’s, Microsoft, …etc will
disappear from the market because of crisis situation. Statistically it could happen,
but practically, these companies live on crisis and are able to transform themselves
to any direction irrespective of how severe the crisis and the resources required to
overcome it.
2.1 Types of recovery
The likelihood of possible recovery varies from one company to another and is
determined by the factors discussed above. Slatter and Lovett (1999) described four
possible outcomes after adopting turnaround strategies, and these are illustrated in
Figure 2
Sustained recover
Sustained survival
Change of strategy
Short-term
Survival
Non-recoverable
Time (Years)
Figure 3 Types of recovery Adapted from Slatter and Lovett (1999).
1. Non-recoverable: Slatter and Lovett (1999) argue that these firms can not survive
even in the short term. The early strategies of turnaround which aims to stabilise
the business are more likely to fail. This situation is more likely to happen where
ailing businesses suffer from some or all of the following:
- The business is not competitive any more due to severe price competition from
lower-cost producers.
- Sharp decline in market demand.
- The business’s assets are indivisible which means that the business is single-
planet and often focus (single product). Firms in this situation can not divest
assets to generate cash flow and their access to further resources is limited.
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Non-crisis
Critical
Crisis and
insolvency
Profit
I would argue that the non-recoverable situation is more applicable to small and
midsize businesses rather than big businesses. Big companies have the resources
and capabilities to fund any potential opportunity, diversify, refocus and reposition
themselves and in some cases redefine the competitive rules and shift the market
demand toward new products and services.
2. Short-term survival: Slatter and Lovett (1999) suggest that firms in this category
may have succeeded in implementing the turnaround’s operation strategies which
usually aim to cut costs and generate revenue in the short-term. Nevertheless,
these companies will eventually fail and go into insolvency because they ignored
the other half of the turnaround which focuses on growth strategies and create
new competitive advantage.
3. Sustained survival: Firms in this category have achieved successful turnaround,
nevertheless, external factors such as industry decline and limited resources
restrict further growth. Financially, companies in this category have stopped
bleeding and become profitable, but their current performance is still below their
main competitors, industry average or their past performance before the declining
stage. To do a little more, these companies need to look for new resources, new
opportunities and new ideas to achieve sustained recovery.
4. Sustained recovery: This stage is the dream of any ailing company. Companies
in this category have achieved a genuine and successful turnaround (Thompson,
2001). It is the main objective of every declining business and it is the last stage
of a successful turnaround. Businesses which have reached this stage have fully
recovered, making reasonable profits and unlikely to face such crisis again in the
foreseeable future (Slatter and Lovett, 1999).
Where the causes of decline are internal, sustained recovery is more achievable
because those internal causes are controllable and can be changed in a relatively
short-time. Where the causes of decline are external, achieving sustained recovery
is far more difficult because those causes are not controllable; therefore,
tremendous effort and time are required.
2.2 Definitions of corporate turnaround
Corporate turnaround is operationalised in the literature as performance decline
followed by performance improvement (Schendel et al., 1976; Robbins and
Pearce, 1992) cited in Harker (1996). However, corporate turnaround has been
defined by many authors; For instance, O’Neill (1986) defined turnaround as a
situation where three years decline in net profit in comparison with the industry
average followed by at least two out of the following three years when net profit is
greater than the industry average (Cited in Pandit, 2001).
Brandes and Brege (1993, p. 92) proposed that turnaround is “a process that takes
a company from a situation of poor performance to a situation of good sustained
performance” cited in Harker (1996). Slatter and Lovett (1999) used the
turnaround term to refer to those companies whose financial performance
indicates that the company will fail sooner or later unless short-term corrective
action is taken.
2.3 Turnaround situation and performance measure
Firms experience turnaround situations when performance criteria are sufficiently
depressed to warrant turnaround efforts. These circumstances have been variously
defined by executive perceptions or by financial measures of firm performance
(Robbins and Pearce, 1992, p. 307). In any turnaround study the chosen participants
have to have encountered a turnaround situation. To have experienced a turnaround
12
situations Robbins and Pearce (1992) argue that the firm has to meet the following
conditions: Two successive years of increasing ROI and ROS followed by:
1. Absolute, simultaneous declines in ROI and ROS for a minimum of two years.
2. A rate of decline in ROI and ROS greater than the industry average over this two
years period.
Harker (1996) also used financial criteria to choose his sample from the Australian
engineering industry but in slightly different way. His sample’s member had to
meet two conditions:
1. Two years decline in performance (contribution to profit/loss) in absolute terms
and relative to industry (sales) performance followed by;
2. At least two years increase in performance in absolute and relative terms.
Chowdhury and Lang (1996) used ROI as a primary measure of financial
performance in their sample which had to meet three selection criteria:
1. They had to have a two years ROI decline.
2. The average pre-tax ROI for these two consecutive years had to have gone below
10%.
3. The performance decline of these firms had to have been independent of the
performance of the industry in which they operated.
In recent studies, Mazumder and Ghoshal (2003) used different financial ratios as
indicators of performance decline and turnaround situations such as Debit-Equity
Ratio (D/E), Return on Networth (post tax) (RONW), Net sales/Total assets and
Net profit/ Net Sales. Francis and Pett (2004) used (ROI) as a financial measure of
turnaround situations and their sample’s members had to meet the following
performance criteria:
Two consecutive years of (ROI) above the risk-free rate of return.
At least three consecutive years of (ROI) below the risk-free rate.
At least one year within the three years of decline with a negative net income.
The dominant measures of performance in turnaround studies are financial in their
nature; for example, Robbins and Pearce II (1992) used Return On Investment
(ROI) and Return On Sales (ROS) in their study of American textile firms that had
encountered a turnaround situation. Chowdhury and Lang (1996) used (ROI) as
indicator for their sample selection; while, Harker (1996) used contribution to
profit/loss relative to industry sales in his study of Australian heavy engineering
industry. Other authors used Return on Total assets (ROA) as a financial measure
(Pandit, 2001). However, other financial measures have been used as indicators
for turnaround situation such as Return on Capital Employed (ROCE) and Pre-tax
profit. These two indicators have been used by Pandit (2001) in his study of IBM
UK.
In this context, Slatter and Lovett (1999) and Pandit (2001) argue that defining
turnaround situation on the basis of financial measures alone is not reliable.
Growth oriented companies may show profit while at the same time being in a
severe cash-crisis. Therefore, the profit picture of the turnaround situation should
be several years of successively lower profits leading to a loss situation and a
cash-flow crisis (Slatter and Lovett, 1999).
In order to tackle the problem of using financial indicators solely in defining the
turnaround situation, Zimmerman (1989) used a human judgment such as a
general agreement among stakeholders to judge whether the company has been
turned around or not, while, Robbins and Pearce (1992) require agreement from
one of the company’s executives that a turnaround had occurred (Cited in Pandit,
2000). A new set of researchers such as Castrogiovanni and Bruton (2000)
13
constructed a subjective measure of performance by using a panel of academic
evaluators such as industry experts, stock analysts, and business writers.
There is explicit disagreement among turnaround researchers concerning the issue
of performance; different authors used different financial performance indicators.
However, another set of researchers argued that financial indicators solely are
inadequate to judge whether a firm is in a turnaround situation or not. They
required a human judgment by stakeholders or academic evaluators to confirm
turnaround situations.
2.4 Turnaround strategies
Many authors such as Hill and Jones (1995); Thompson (2001); Wheelen and
Hunger (2002) considered turnaround strategies as a part of recovery strategies or
restructuring process. For instance, Hill and Jones (1995, p. 302) state that: An
integral part of restructuring, therefore, is the development of a strategy for turning around the
company’s core or remaining business areas”, While, Thompson (2001, p. 635) states
that: “Retrenchment and turnaround strategies are often collectively called recovery strategies”.
Are companies restructuring themselves only in declining situations? Is retrenchment
different from turnaround or part of it? The disagreement between authors on the
content of turnaround strategies led to misunderstanding turnaround strategies; for
example, we cannot consider a healthy and profitable company that adopted one kind
of retrenchment strategies such as cost reduction to be in a turnaround situation.
While, cost reduction strategy in declining situations is considered to be a part of
turnaround strategies.
(Schoenberg, Collier & Browman 2013)found that six turnaround strategies were
consistently identified in the literature as effective in helping firms make a sustained
recovery from a period of performance decline. Four of these relate to the content or
main objectives of the turnaround, namely cost efficiencies, asset retrenchment, a
focus on the firm’s core activities and building for the future. The remaining two
relate to accompanying change processes required for implementation: reinvigoration
of firm leadership and corporate culture change. While (Beeri, Itai & Navot,
Doron, 2014) research exposes a further interesting relationship
between TMS and recovery in poorperforming
local authorities. Some poor performers improve their rankings while
others persistently
stagnate. Yet, both groups appear to implement TMS to a large and,
more often than not, similar
extent
Turnaround strategies have been categorised by different researchers in different
ways. Schendel et al. (1976) first proposed that the selection of appropriate
turnaround strategies is a function of causes of decline. The authors distinguished
between two sets of turnaround situation: the first results from poor strategy and
the second results from poor operations. They proposed a list of strategies to
overcome each turnaround situation (Cited in Robbins and Pearce, 1992).
Hofer (1980) first suggested that the selection of appropriate turnaround strategies
is a function of the severity of a turnaround situation. His main idea is that
different degrees of crisis require different degree of cost and asset reductions.
Both Schendel (1976) and Hofer (1980) and other authors ( Bibeault, 1982;
Hambrick, 1985) tended to categorise turnaround strategies as either “operating”
or “strategic” (Cited in Robbins and Pearce, 1992; Chowdhury and Lang, 1996).
Operating turnaround strategies are geared toward generating immediate revenue
such as cost cutting or asset reduction. While, strategic turnaround strategies
14
considered the potential growth strategies such as diversification or vertical
integration (Chowdhury and Lang, 1996).
Hofer (1980) and Hambrick (1983) cited in Chowdhury and Lang (1996)
categorised turnaround strategies as “efficiency strategies” and “entrepreneurial
strategies”. Efficiency strategies are focused on better uses of organisational
resources, while entrepreneurial strategies are more market-oriented concerned
with growth and revenue generation or targeting new and different market-niches
(Woo and Cooper, 1981; Cameron, 1983; Hambrick and Schecter, 1983) cited in
(Chowdhury and Lang, 1996). However, Cost-cutting and assets reduction, as
strategies to improve efficiency, are recommended to precede entrepreneurial
strategies (Chowdhury and Lang, 1996). This indicates how important the
“efficiency strategies” are as an initial stage for successful turnaround.
In his study of textile companies in US, Robbins and Pearce (1992) found that
retrenchment is absolutely necessary to achieve turnaround and firms should
retrench regardless of the severity of situation. The major contribution of their
study is assuring that retrenchment is the initial stage of any successful
turnaround. In a recent study, Sudarsanam and Lai (2001) categorised turnaround
strategies into four categories:
Managerial restructuring: This means removal of Chairman or chief Executive
officer (CEO) or Managing Director (MD). Table 4 in Chapter 3 shows that all the
authors identify poor management as a major cause of decline, therefore many
turnaround situations required new leadership. Grinyer et al. (1988) found that
more management change was associated with firms who achieved turnaround in
their sample than a non-recovered one (Cited in Sudarsanam and Lai, 2001). This
supports Chan (1993) findings who found that replacement of CEO is crucial step
for successful turnarounds, and this confirms Cassells (1992) argument that a
change of management or CEO is one of the recovery strategies. The logic behind
the removal of leadership is that s/he was responsible of the failure; therefore it is
very unlikely that s/he can turnaround the company. Furthermore, leadership
change will send a strong message to stakeholders (especially banks and
creditors) that something is being done to turnaround the business, thus, their
support will continue (Slatter and Lovett, 1999; Sudarsanam and Lai, 2001).
Operational restructuring: This covers cost rationalisation, Lay-offs, closures
and integration of business units. The aim of these strategies is to improve
efficiency, and generate cash flow and profit improvement by reducing direct
costs and slimming overheads (Slatter, 1984) cited in Sudarsanam and Lai (2001).
Five strategies have been recommended by Slatter and Lovett (1999) to generate
cash, reduction of debtors, extension of creditors, reduction of stock, stopping
planned expenditures, and short-term financial support.
Asset restructuring: This includes divestment of subsidiaries, management buy-
outs (MBOs), spin-offs, sale and lease-back, and other asset sales. Asset
restructuring covers asset divestment and asset investment:
- Asset divestment : Where the short-term strategy is to generate cash asset
divestment is crucial. This strategy includes divestment of subsidiaries/divisions.
The aim is to get rid of non-profit generating assets, non-core assets or even
profitable assets for the purpose of generating further cash.
- Asset investment : It incorporates both internal capital expenditures and
acquisition. Capital expenditures are designed to achieve efficiency and improve
productivity such as building new plants and machinery.
15
Financial restructuring: “is the reworking of a firm’s capital structure to
relieve the strain of interest and debt repayments and is separated into two
strategies: equity-based and debt-based strategies” (Sudarsanam and Lai 2001, p.
187). Equity-based strategies include dividend cuts or omission and equity issues.
Firms in turnaround situation tend to adopt such strategies to overcome their
liquidity problems or to comply with debt agreement. Debt-based strategies refer
to the extensive restructuring of company debt. Debt restructuring can take the
form of interest or principal reduced, maturity extended, or debt-equity swap.
Castrogionanni and Bruton (2000), and Sudarsanam and Lai (2001) findings do
not seem to support the view presented by Robbins and Pearce (1992) that
retrenchment is the appropriate initial stage in every situation or context. In their
study of 46 acquired distressed firms, Castrogionanni and Bruton (2000) found
that retrenchment may not be a universal initial stage in the business turnaround
process. They also found that the majority of non-retrenching firms in their
sample experienced successful performance.
Sudarsanam and Lai (2001) found that recovery and non-recovery firms adopted
very similar turnaround strategies but their strategic choice differed over time.
Firms who had achieved successful turnaround focused on entrepreneurial
strategies such as investment and acquisition to lead them out of trouble, whereas,
failed turnaround firms were more internally focused on operational and financial
restructuring. They argued that retrenchment strategies may be a necessary but not
a sufficient condition for sustained recovery for many firms. Chowdhury and Lang
(1996) studied the content and the process of turnaround strategies in smaller
manufacturing firms. They found that turnaround for a smaller firm is a function
of three strategies. The first two (increased employee productivity and disposal of
older assets) are operating-related, while the third one is extending accounts
payable.
In recent study, Gowen III & Tallon (2002) have summarised turnaround strategy
actions in four categories action typology:
1. Revenue generation strategies: include raising product prices, increasing cash
discounts to customers, and loosening customer credit criteria (Sloma, 1985) cited
in Gowen III & Tallon (2002, p. 229).
2. Product/market refocusing strategies: include the elimination of unprofitable
products, and changes in marketing practices in terms of channels of distribution,
sales regions, and sales representatives.
3. Asset reduction strategies: include liquidation of inventory, equipment, physical
plant, and divestment of a subsidiary and/ or product line.
4. Productivity improvement strategies: include inventory control, improving
quality, investment in new machines or plant and workforce motivation.
The above discussion indicates that there is a set of strategies associated with
turnaround; however, different terminologies have been used to describe these
strategies by many authors. For instance, the term retrenchment when used by
Robbins and Pearce (1992) refers to cost and asset reductions used by other
authors such as Hofer (1980). Furthermore, these set of turnaround strategies have
been classified into different categories such as “Efficiency”, “operation”,
“Strategic” and “entrepreneurial” by other different authors. In this context, it is
quite difficult to classify specific sets of moves associated with the turnaround
process as efficiency or entrepreneurial moves, for example, under which category
can we classify managerial restructuring move? Is it efficiency or entrepreneurial
move?
16
There is explicit agreement between authors on common turnaround strategies
such as cost reduction, divestment, and investment. However, some turnaround
strategies which have been considered by many authors have been ignored by the
others. For example, a new strategic leader is considered a crucial action by Chan
(1993); and Sundarsanam & Lai (2001) but has been ignored by Gowen III &
Tallon (2002). This may indicate that the degree of adopting some turnaround
strategies depends on other factors such as the culture of where the company
operates, size of the company and the severity of situation.
2.5 Stages in turnaround process
Bibeault (1982) distinguished between two stages for turnaround process: primary
stage and advanced stage. In the primary stage the aims of ailing companies are
survival and achievement of positive cash flow. The appropriate strategies to
achieve these objectives are retrenchment activities such as divestment, product
elimination and head count cuts. The advanced stage of turnaround is geared
towards growth and development. The appropriate strategies to achieve these
objectives are acquisition, new product, new market, and increase market
penetration (Cited in Robbins and Pearce, 1992).
Grinyer et al. (1988) found that the appropriate turnaround strategies to achieve a
sharply improved level of performance were operational, followed by
administrative and strategic (Cited in Robbins and Pearce, 1992). While, Robbins
and Pearce (1992) argue that companies’ turnaround can be achieved through a
two stage process: retrenchment and recovery. In this context, Robbins and Pearce
(1992) argue that firms may continue to pursue profitability through their
retrenchment strategies with an essentially unaltered strategy, or it follows the
retrenchment stage with growth strategies.
The significant point which emerged from the above discussion is that some
researchers such as Grinyer et al. (1988) and Chowdhury and Lang (1996) have
highlighted the issue of the first step or the starting point of turnaround process.
This means that turnaround is a multistage process, and these stages are
overlapped.
Theirs two stages of turnaround that dominate the extant literature:
1- Retrenchment stage: Retrenchment strategies-called sometimes “efficiency” or
“operating” strategies-are primarily cost and asset reductions which aim to
stop the ailing company’s bleeding, stabilize the company’s performance, and
enhance the stakeholders’ confidence in the business. It represents the initial
stage of turnaround process and considered to be a short-term strategy.
2- Growth stage: Growth strategies called sometimes “strategic” or “entrepreneurial”
strategies and aim to achieve sustained recovery. The strategies adopted in this
stage are product development, market penetration, diversification,
acquisition…etc. It represents the second stage of turnaround process and
considered to be a long-term strategy.
It is explicit that the turnaround process starts in a retrenchment stage and is
followed by the growth stage, however, the overlap between the two stages allows
ailing companies to pursue efficiency and growth strategies together. The
emphasis on each strategy depends largely on the causes of decline and the
severity of turnaround situation.
Robbins and Pearce (1992) proposed a valuable model of turnaround process that
represents the relationship between four variables that influence the turnaround
17
process a shown in Figure 5. This model shows that retrenchment strategies are
the initial stage of turnaround process regardless of the causes of decline,
however, the degree of retrenchment depends on the causes of decline. The more
severe the turnaround situation the more retrenchment is required.
This model links the causes of decline to the nature of turnaround strategies; when
the vast majority of causes of decline are internal we expect more emphasis on
efficiency strategies. Likewise, when the vast majority of causes of decline are
external we expect more emphasis on growth strategies.
Turnaround situation Turnaround strategies
Cause Retrenchment stage Growth
stage
Operating
Low
High
Turnaround situation
caused by internal and
external factors
The degree of retrenchment
depends on the severity of
turnaround situation; asset
reduction for severe situation,
while cost reduction for less
severe situation
The intended growth
strategies depend on the
external factors that caused
the decline. Different
causes required different
strategies.
Figure 3: A model of turnaround process (Adapted from Robbins and Pearce (1992, p. 291).
In the study of turnaround strategies undertaken by several US-based firms that
compete on a global basis and represent diverse industries, Chan (1993) concluded
that successful turnarounds share a common pattern of decisions, and he identified
four action steps towards turnarounds that were prevalent among his sample: Realise
need for turnaround, Replace CEO, Cut costs, Revfocus and reinvest.
2.6 Turnaround strategy results
Ailing companies may or may not recover, however, the outcome of successful
turnaround strategy actions should stop the company’s bleeding and achieve sound
profit. The turnaround results can be a mixture of improvements in gross profit
margin, sales growth, employee morale, ROI, new product development, return on
capital employed (ROCE),… etc.
Conclusion and further research
18
Internal
External
Cost
reduction
Asset
reduction
Situation
Stability
Efficiency
Maintenance
Growth
strategies
Recovery
The aim of this research was to identify what are business decline symptoms and
causes and which strategies have been identified by scholars and associated with
turnaround situation. The research highlighted the issue of confusion between
symptoms and causes of decline and the subject of how to determine the causes
decline. Two lines of thought that considered the company’s failure and decline have
been discussed: external/internal category of causes of decline and the loss of
competitive advantage as the main cause of decline. Furthermore, this research
revealed that the most common strategies which associated with turnaround situation
were cost reduction, divestment, investment, CEO replacement,
refocusing/repositioning. These strategies have been classified in different categories
such as “Efficiency”, “operation”, “Strategic” and “entrepreneurial” by different
authors.
In order to establish a comprehensive theoretical framework of business decline and
turnaround strategies more research is required in the form of qualitative and
quantitative studies to provide in depth understanding of these phenomena and to
identify commonalities among businesses. The concept of resource-based view (RBV)
and the current dominant theory of dynamic capabilities (DC) would provide new
lenses to explore and investigate corporate decline and turnaround strategies.
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