Why Companies Fail

GM sold 478 million common shares at $33 each, as well as a sizable chunk of preferred stock, raising $20.1 billion. While the IPO itself didn’t fully recover the federal government’s post-crash investment in GM (some $50 billion), a complete payoff seemed possible if the stock price rose enough, allowing the government to sell off its remaining stake at a better price. More important, said sober analysts, the stripped-down cost structure, looser union contracts, and management shake-up that preceded the IPO would allow GM to finally shed its decades-old legacy of divisive labor battles and mediocre, gas-­guzzling cars. (As I reported in these pages in 2010, I, too, saw inklings of hope.)

In November 2011, roughly a year later, Treasury revised its estimate of the government’s likely loss upward from $14.3 billion to $23.6 billion. As of this writing, GM’s stock was hovering around $20 a share. The company was beset by reports that the batteries in its splashy new hybrid-electric car had an unfortunate tendency to catch fire. Meanwhile, sales of the Chevy Cruze, which was supposed to be the Corolla-killer, were slipping after a strong initial showing.

This despite the fact that the company’s major Japanese competitors had been crippled by a tsunami and a nuclear meltdown. Business journalists often joke that some struggling firm could be saved only by “an act of God,” but in the case of GM’s stock price, even that hasn’t been enough.

Which has to raise the question: Was the company really saved? Did it finally have its “Come to Jesus” moment? Or was this just one more temporary detour in the company’s erratic amble toward perdition?

Historical precedent offers strong reasons to worry that GM might continue to backslide. Though casual glosses usually present the company’s history as a steady decline from the mighty 1960s to the debacle of 2008, in fact, there were quite a few moments when GM—and Detroit more generally—­appeared to have mended its ways. In 1994, during one of those moments, the reporter Paul Ingrassia published a book called Comeback: The Fall and Rise of the American Automobile Industry. In his 2010 book, Crash Course, he sounds older and wiser:

Over the past few decades, GM’s ability to resist change has proved almost uncanny. Why did the company wait so long and do so little—not once, but time and again—before finally falling into bankruptcy? And what, if anything, does that portend for its future? The questions go beyond GM, a company that’s hardly unique. Why did Blockbuster idly watch Netflix destroy its business? Why did Kodak let digital cameras drive a once-mighty industrial giant into penny-stock territory?

Ask Jeff Stibel, and he’ll tell you: because that’s what troubled companies do. Stibel, once an aspiring cognitive scientist in Brown’s graduate program, is now a serial entrepreneur who has led turnarounds at Web.com and Dun & Bradstreet Credibility Corp. “Once the human mind has set out to do something, or has gotten in the habit of doing something,” he told me, changing it is “very hard.” When you add group dynamics, it’s even harder. You don’t need to be a brain scientist, of course, to know that people resist change … and yet, even knowing that, you’d be surprised at how many firms keep driving toward inevitable disaster at top speed. GM’s record is very much the norm, not the exception.

Years ago, I listened to an earnings call with the head of a biotech firm that had sold off the income streams from all its patents, had nothing in its pipeline, and was rapidly burning through its cash. Nonetheless, the CEO kept talking about “our future” as if the company had one, other than liquidation. The equity analysts on the call didn’t seem fazed; apparently, that’s how companies in these situations usually behave. Management and workers seem oblivious to their failures. They wait too long before they act, and even when they do take action, it’s often inadequate.

This dynamic has given rise to a booming industry of turnaround specialists. They range from serial CEOs, like Stibel, who may walk in with an entire senior management team, to more-traditional management consultants. The industry is big enough to support considerable specialization—by company size, by industry, even by technique (cost cutter, brand builder). All seem to agree on one thing: most companies wait far too long to even recognize that they have a problem.

“Typically, a company doesn’t pull someone in until they’re on the brink of disaster,” says Thomas Kim, a Denver-­based turnaround specialist and an officer of the Turnaround Management Association. “They can’t make payroll, can’t make a loan payment, or can’t pay off their loan that’s coming due.” Obviously, if everyone waits until the checks get rubbery, the chances of avoiding the onrushing debacle are slim. But the flip side of the problem, says Michael Buenzow, a senior managing director in the corporate finance and restructuring practice at FTI Consulting, is that unless the crisis is acute, it’s hard to make anything happen. “If you’re brought in too early,” he says, “the employees in the organization won’t have that same sense of urgency.”

And yet, the argument that people continue down dead ends merely because they hate change seems inadequate. After all, people also hate losing their jobs and their money. As economists like to say, most people are risk-averse—it’s why unions accept wage cuts to keep pensions and health-care benefits, and why extended warranties are big business for Best Buy. Firms are full of these mostly risk-averse people. So why do they so commonly refuse to swerve?

One possibility is that firms don’t change because inertia is in their DNA—indeed, it’s a gene that once made many of them successful. In their 1989 book, Organizational Ecology, Michael Hannan and John Freeman argue that organizations are actually selected for inertia by their environment, and “rarely change their fundamental structural features.” Change is risky, after all, since it definitionally involves doing something that isn’t already working—and even product lines that have grown lackluster still have some customers. Firms that are prone to frequent large changes will probably have more opportunities to kill themselves off with bad choices than firms that resist big changes.

Moreover, the need for accountability and reliability in the modern economy selects against constant radical experimentation—people like knowing that their bank has cumbersome and invariable procedures for keeping track of deposits, for instance. Think of McDonald’s, where a core premise is that no matter where you go, the food and decor will be reliably, exactly the same. Or consider what happened to Coke after it tried to change the recipe of its iconic product, even though taste tests showed that most people actually liked the new version better. The larger and older the firm is, the heavier the selection for stability.

This is a powerfully attractive model for explaining why innovation so often seems to be driven by newcomers, rather than by profitable incumbents with huge R&D budgets. It also helps explain why so many companies in turnaround situations are gripped by inertia.

Blockbuster, for instance, promised—­and for a long time delivered—­reliability and ubiquity. Most customers were never more than a few minutes from a bright, clean, spacious store with an ample selection of the latest videos. But eventually that commitment to ubiquity and sameness killed the company. Blockbuster did see the possibilities of streaming, and explored some partnerships to exploit them, but was slow to roll out changes to its core business (as late as August 1999, only 1,000 Blockbuster stores even carried DVDs). Meanwhile, the commitment to ubiquity had caused the firm to take on a mountain of debt to lease all that pricey real estate. At some point, the company needed to leap into the unknown. But by the time its managers all held hands and took the plunge, the clock had run out. Blockbuster’s online DVD-rental service, launched in 2004, was far too little, and far, far too late.*

Thomas Kim sums up the problem of corporate inflexibility pungently. “There are companies that perform reasonably well, and are completely dysfunctional.” But then the market changes. “In the companies that we see that hit the wall, that dysfunctional corporate culture really becomes a problem.”

Detroit labor relations have been a disaster ever since the early unionization drives, which were acrimonious and at times violent (at the infamous “Battle of the Overpass,” in 1937, a claque of Ford security guards attacked union agitators in front of an assembled press delegation). The result was a poison­ous relationship; in many ways, GM workers were more a part of the United Auto Workers than of GM. Eventually, the union became a sort of shadow management that had to sign off on every production decision the company made, if it had any effect at all on workers.

This system actually worked during the boom years. Because GM’s competitors were unionized too, the UAW’s power kept wages more or less equal across the Big Three, and helped contain cost competition that might have led to price wars, undercutting margins. The UAW, meanwhile, never had to worry that an excessively rich compensation package would put the Big Three in jeopardy.

Conditions changed, but the thinking didn’t. The union frequently behaved like a parasite that didn’t care whether it killed its host—calling strikes just as the company was trying to launch a pathbreaking small car; demanding that GM keep paying surplus workers nearly full salary indefinitely, even as market share declined. Rather than trying to change this dynamic, management caved, again and again—possibly, Ingrassia suggests, because any increase in wages would “trickle up,” as GM strove to maintain a pay differential between management and the hourly workers.

GM’s strategy, which focused first and foremost on sheer scale, also became ineffective over time, yet the company never moved substantially beyond it. Competitors built well-understood brands based on super-reliability, or style and performance, picking off customers year after year. But GM never settled on what it wanted to be, beyond gigantic.

Even a dysfunctional culture, once well established, is astonishingly efficient at reproducing itself. The UCLA sociologist Gabriel Rossman told me, “If new entrants assimilate to whatever is the majority at the time they enter, and if new entrants trickle in slowly, then the founding culture can persist over time, even if over the long run they make up a tiny minority.” This is why Americans speak English even though more of us are ethnically German or Yoruba. In linguistics and sociology, it’s known as the “founder effect.” In corporations, it’s known as “how we’ve always done things.”

Corporate culture, like any other culture, can change, of course. Edward Nieder­meyer, of TheTruthAboutCars.com, who has been a pretty tough critic of GM, thinks that this time may really be different. Finally, he says, “folks over there seem well aware of the ‘old bad habits’ and are trying extremely hard to avoid them.” (Although he is quick to point out that new bad habits could easily emerge.)

David Cole, of the Center for Auto­motive Research, agrees. For one thing, it’s clear that the UAW has come to under­stand that it needs to actively work to keep the auto industry healthy. With membership a quarter of what it used to be, the union is now in worse shape than the Big Three. So it is focused on providing a more flexible, better-skilled workforce. It has also allowed workers’ pay to be tied to the fate of GM.

“One of the things that the UAW never wanted,” says Cole, “was to have an equity position in the company, because they didn’t want the membership to think like investors. Now with the bonus scheme, they’ve essentially got an equity position.”

But then, some questions linger … the scattered complaints that the company is “channel stuffing” (upping its reported sales by getting dealers to take cars they don’t want), the continued reliance on incentives like zero percent financing, and of course, those exploding batteries. Unfortunately, corporate culture is a sort of black box; from the outside, you can’t see what’s going on. You have to wait to see what emerges.

What we can say is that this time, we’re actually going to find out. GM has fixed basically every other problem that anyone could name: Instead of a $2,000-a-car cost disadvantage due in large part to legacy costs such as wages and retiree benefits, it now has a cost advantage. The eight marques that multi­plied the overhead and muddied the value propositions of its brands have been streamlined to four. The excess dealerships have been closed.

What’s left is culture. After everything, if GM begins losing market share again, we’ll know that it’s beyond saving. To paraphrase the old joke: “How many experts does it take to turn around a big company? Only one—but the company has to really want to change.”

*This article originally stated that Blockbuster’s streaming service was launched in 2004. It has been corrected to state that Blockbuster launched its online DVD-rental service in 2004.