6 ‘interrelated factors’ that can lead to corporate failure

Lessons from the record-breaking bankruptcies of WorldCom and Nortel.

Comments

'In both cases the three initial factors - ineffective leadership and governance, followed by unduly risky strategic decisions and then by lax implementation - set the stage for failure'

WorldCom was the largest bankruptcy in US history when it filed in July 2002 with US$35 billion of debt, while Nortel Networks was once the powerhouse of the Canadian tech industry before it went bust in 2009 following an accounting scandal.

A new study outlines the six factors that led to the collapse of the two telecom giants.

“Being aware of these risk factors and avoiding them is essential for leaders and boards of directors,” says Professor Loizos Heracleous of Warwick Business School and one of the authors of the study.

“We identified six interrelated factors of strategic misalignment, the processes that can lead to corporate failure if left unchecked,” says Heracleous, who co-authored the study On The Road To Disaster: Strategic Misalignments And Corporate Failure, with Katrin Werres, senior industry analyst at Google.

Corporate failure is a process arrived at over time

Professor Loizos Heracleous, Warwick Business School

“Once strategic misalignments are established these then spread to other areas inside the organisation.”

“In the latter stages significant gaps are created between the strategy and competencies of the firm, and between strategy and the demands of the competitive environment, which leads to corporate failure,” says Heracleous, in a statement.

The paper lists the following ‘six steps to failure’.

The road to disaster

WorldCom, built through rapid acquisitions, accumulated $41 billion in debts, according to the report. Founded in 1983 as LDDS Communications, it became the nation's second-largest long-distance company and the largest handler of internet data.

But by 2000 the telecommunications industry was in decline and it was discovered WorldCom was covering up its losses, inflating its total assets by about $11 billion, making it the largest accounting fraud in US history when it went bust in 2002.

“A case analysis of WorldCom indicates three main interconnected areas of misalignment,” says Heracleous.

“Firstly, between strategy and organisation, due to aggressive expansion and insufficient integration of acquired firms. Secondly, internal misalignment due to problematic corporate culture and human resource practices. Thirdly, compounding both of those, ineffective leadership and corporate governance.”

At its height from 1999 to 2000, Nortel was worth nearly US$300 billion and employed more than 90,000 people worldwide, but an accounting scandal left it needing a credit support facility of up to $750 million from the Canadian Government in 2003. The financial crash in 2007 to 2008 saw it file for bankruptcy in 2009.

“With Nortel three main areas of misalignment can be identified as being most significant, ultimately leading to its downfall,” notes Heracleous.

First was a misalignment between strategy and environment; second was a misalignment between strategy and competencies; and third was a misalignment affecting all levels of the organisation, rooted in ineffective leadership and corporate governance. External, industry factors contributed to Nortel’s ultimate failure, by exacerbating the effects of these misalignments, he states.

“In both cases the three initial factors - ineffective leadership and governance, followed by unduly risky strategic decisions and then by lax implementation - set the stage for failure."

Back to basics

Corporate failure should not be understood simply as the result of a single wrong action such as accounting fraud, or a single strategic decision such as an ill-fated acquisition.

“Rather, the six factors show corporate failure is a process arrived at over time,” says Heracleous.

“The findings point to a back-to-basics approach for senior executives.

“They remind us of the crucial role of leadership and governance, the limits and dangers of risky and aggressive growth strategies and how a dominant CEO combined with a passive board can enable aggressive growth strategies to go unchecked.

“Such strategies can become a stone around the neck of organisations if the environment turns sour and if, in the meantime, they have built up substantial debt, which they cannot service once their performance and share prices decline.

“A risky strategy, badly executed, is a recipe for failure," he states. "It leads to organisational misalignments that gradually spread to put the organisation in a highly compromising position, from which it is almost impossible to recover."