December 2, 2016
By: Neil J. Smith
As a bankruptcy practitioner, I have seen a fair share of business failures. Unless a company’s management is particularly nearsighted (or the failure is sudden and due to external forces), towards the end management teams do usually recognize that there are problems and try to correct them.
Unfortunately, in many cases companies put a great deal of effort into strategies that have little chance of succeeding. If your company is struggling and trying to pull off a turnaround, please reconsider if you are pinning your hopes on these strategies. As a concrete example, let’s consider FailCo, a company that manufactures widgets at a cost of $1.05 per unit, but faces national market demand that will only support a price of $1.00 per unit.
1. Pointless and expensive marketing campaigns. Smart marketing, of course, is essential. Sometimes, however, companies see declines in revenues and respond by throwing a bunch of money at expensive marketing consultants without first asking the question of whether marketing is really the problem. If the problem is an underlying issue with cost structure, compensation, or a host of other things, then all of the best marketing in the world won’t fix anything. It is very tempting to throw money at marketing and hope the company will magically grow its way out of problems (and perhaps distract company owners and lenders from poor management), but that will only work if marketing was the real problem in the first place. Selling a million more widgets at $1.00 a piece won’t help FailCo if the problem is that the widgets cost $1.05 each to produce.
2. Calls to intensify current efforts without any substantial changes in strategy. Instead of making a difficult examination the company’s strategy, management often will simply admonish employees to simply do more of the same, only harder/better/faster. This can be a result of thinking along the lines of “we’ve successfully done things this way for 50 years; we just need to stay the course.” That is a recipe for failure. Every strategy/asset/employee should be justified as if it were being adopted/purchased/hired today. FailCo management could try to placate FailCo’s owners by reporting impressive statistics about increasing numbers of widgets produced. Even if FailCo builds ever more widgets at a cost of $1.05 per unit, it still will not help the situation if they are still selling in the market for $1.00 each.
3. Playing accounting games. Simply papering over problems by massaging the numbers is an old tactic and is a very tempting way to avoid hard decisions. Avoiding reporting important metrics that may be worsening, such as accounts receivable days or inventories, will make things look better in QuickBooks but won’t actually make one any richer. FailCo’s management could satisfy its owners with a budget for next year that says its price will be $1.10 for each widget, but if after rebates FailCo still really sells the widgets for $1.00 each, then it better start saving up for a bankruptcy attorney.
4. Getting loans just to cover operational deficits and not as true working capital. This is particularly tempting in the current environment of low interest rates. While new money can cover over a multitude of fiscal sins, simply filling a hole with borrowed money won’t fix a long term problem. Money should be borrowed to create inventory or buy productive assets to make more money, not to plug holes in a budget. FailCo’s management could draw on a line of credit to plug the hole in its budget and/or pay a dividend to owners to distract them from poor performance. FailCo could even pay down some of the line of credit at some high point in the next cash flow cycle, but the hole in budget will reappear if the fundamental problems are not addressed.
These strategies are tempting traps because they can feel like they are working, at least in the short term. However, they mostly just mask more fundamental problems. The real solution for FailCo is none of the above strategies; it is cutting costs to get the cost of widget production down to less than $1.00 a unit. Cutting that cost, however, will likely require extensive consultations with lawyers and accountants, and considering strategies such as selling the company, layoffs, merger, or reorganization in bankruptcy court.