Maintaining a long-term view
during turnarounds
Changing
course demands an intense focus on short-term performance, but success needn’t
come at the expense of long-term value.
Peter switched on his desk lamp. It
was getting dark, and the past 11 hours had been full of meetings and
decisions. His trucking company had been struggling with the high diesel prices
and soft economy of the early 2000s, but he had been fighting back by cutting
costs across the board. He wasn’t failing yet, but he wasn’t sure how long he
could fend it off.
He opened an approval request on his
desk for the second time that week and read it again. It was a
multimillion-dollar purchase order for retrofitting his entire fleet to natural
gas. Several months earlier, the decision had seemed to be a no-brainer: his
trucks could run on natural gas for a fraction of the cost of diesel. In a weak
economy, the reduction in operating costs would be welcome—and he’d be
positioned well to compete when the economy picked up. But as he stared at the
numbers, he now wondered if it would still be the right move. The switch to
natural gas would require a host of difficult organizational and operational
changes—even if some of them would free up much-needed cash. He put down his
pen and closed the file. What he really needed, he realized, was a way to more
fundamentally turn things around.
Any leader who’s been through a
turnaround knows that driving one requires an intense focus on delivering
near-term results. Some moves make obvious sense. Building value-creation
metrics into a long-term vision and implementing aggressive cash-management
practices, for example, can help fund restructuring while avoiding existential
crises down the road.
Other moves are riskier. The
short-term pressure is so intense that many managers succumb to myopic decision
making that can hurt a company’s long-term health or even sow the seeds of
irreversible failure. Examples abound of companies that survived a financial
crisis by shutting off all discretionary spending, only to fail later when
their operations became unreliable or required considerable new investment. The
damage in these cases can exceed the impact of the initial financial hit.
Depriving an organization of continuous investment in sustaining
capital—whether in maintenance, growth and innovation, or people—can result in
dozens of other incidents, each individually small and correctable but together
adding up to create an unreliable operation that hurts the customer, the
business, and its reputation.
The most successful turnarounds are
those in which managers balance the short and long term in business decisions,
both financially and organizationally. Financially, many investments that do
not pay back their costs quickly (in less than two years) still create value
and are important for the viability and health of the company. There are rarely
clear answers to such investment decisions, but in our experience, a few
techniques can help ensure that you make the best decisions with the
information you have.
Avoid sweeping decrees
When faced with financial troubles,
many companies respond by ordering a freeze on all spending, from capital
spending to hiring, travel, and other discretionary expenses. Such moves can
certainly be necessary in times of distress. In most cases, however, it’s
better to take a more nuanced approach.
Managers should always discuss a
company’s largest investments individually, giving time and attention to both
the short-term and long-term implications of delaying investment. Letting such
decisions fall under a broad spending directive can have a devastating impact.
One global manufacturing company whose operations relied on substantial
electrical power decided to delay a scheduled transformer rebuild by a year to
save cash. Five months into the year, the transformer failed catastrophically,
taking 20 percent of production off line while the company built and installed
a replacement. Elsewhere, a transportation company that delayed the scheduled
replacement of key logistical equipment suffered a setback when the equipment
failed, resulting in collateral damage to the physical plant and equipment.
For smaller investments, it’s better
to organize spending into categories in which the implications for long-term
health can better be discussed and understood. There is an important distinction,
for example, between repainting the hallways and refurbishing an electrical
transformer that a broad proscription of spending on maintenance would not
recognize. Similarly, a hiring freeze on executive assistants results in
different risks from a freeze on vehicle operators or sales managers.
During one turnaround, executives at
a consumer-products company found that plant managers historically had little
discipline in spending—they invested in projects without considering hurdle
rates or returns on the investment—and more than 350 projects would be affected
by a spending freeze. During the turnaround process, executives worked
alongside plant managers to weigh the trade-offs between what was necessary to
serve customers and deliver products and what could be delayed to reduce costs.
Together, they determined that nearly half of the planned projects could be
postponed. They then implemented an aggressive program for working-capital
management to simplify inventory management, approving spending that would help
the business grow in the short and medium term while instituting strict
internal controls on areas that were less critical, such as overtime, excessive
travel, and some maintenance.
Prioritize investments
Managers under pressure in
turnaround situations have little time to evaluate thoughtfully which
activities and investments to support and which to cut. Often, decisions rest
on which department head has the most organizational clout, has the strongest
personality, or argues the loudest to protect his own programs and people—an
understandable but not particularly effective way of making cuts.
A better approach we’ve seen
companies take is to make a list of all actions that would create near-term
cash, force ranked by the amount of damage each would do to the long-term
health of the company—typically prioritizing actions with the highest net
present value (NPV) at one end and those with the most negative NPV at the
other. Such a list should be created and discussed very early in a turnaround,
and it must assess the effect of divesting or discontinuing every activity and
selling every asset, with no exceptions. It will only be complete when the last
thing left to do after taking every action on the list would be to shut the
doors. It’s a tough exercise to go through, but it gets all the ideas on the
table for discussion.
Highest on this list will be a number
of immediate actions that create little risk. Lower down will be actions that
begin to affect long-term growth prospects or operational reliability. The
trick is to separate sources of real long-term damage potential from threats of
damage that are merely perceived. This can be accomplished by taking the time
and effort to understand each investment in depth and by making sure someone is
assigned to ask the tough questions.
It’s also a good idea to assign
quantifiable metrics to trigger the next cut on the list when a company comes
within a certain number of months of no longer having sufficient cash to pay
its bills. This creates a clear contingency plan in case things turn worse.
Just as important, it creates a clear understanding of the future health risk
required to stabilize the business in the short term.
If Peter, the manager discussed at
the beginning of this article, were to conduct this exercise, he might find
many actions he could take that are higher on the list, with less long-term
damage than eliminating the natural-gas conversion project. That could help him
feel better about approving it. The exercise would also give him an opportunity
to tighten the spending-approval interval so that he would only approve the
minimal spending possible each time. This would ensure that he could retain
control of future financial investments in case things were to change and he
needed to take this more drastic action.
Discourage short-term actions with negative long-term consequences
In any turnaround, increased
accountability and pressure on business-unit managers to hit their numbers can
exacerbate short-termism—which often leads to decisions that create less value
for the company. They can be tempted, for example, by any number of little ways
to cheat. Some tactics may incur purely financial risk, such as conceding sales
discounts to meet near-term volume and margin goals or structuring back-loaded
or risky contracts. Others can be more dangerous, such as allowing
lower-quality products to go to market, delaying a maintenance outage until the
next accounting period, or continuing production despite safety or reliability
concerns. A manager at a global commodities company, for example, hoped to
catch up on production by delaying the routine maintenance of a piece of heavy
equipment despite concerns identified by engineers. The equipment failed not
long after, leading to a lengthy production outage. The tension between
execution and innovation is worth special note. Innovation requires
experimentation and failure, which can be hard to defend in an environment
where every dollar counts.
The challenge is to create urgency
and accountability for near-term performance targets without encouraging
shortcuts that destroy value and may have insurmountable negative consequences.
Some companies deal with this by protecting people and budgets for
strategically important innovation, even while aggressively reducing costs in
other areas of the company. Others set targets for near-term results and then
outline everything managers can do to meet those targets. The most important
approach is to explicitly identify and understand the impact of every step
that’s part of the company’s ability to create value.
Invest in people
In our experience, the single
largest attribute of a successful turnaround and a healthy company is the
people who manage and run it. Yet, in many cases, investment in people is one
of the first areas to go when companies struggle. Whether that means pay
freezes or cuts or the elimination of benefits, training, or team-building
activities, such steps are often the easiest and fastest way to save cash fast.
More than one company we know of dramatically reduced hiring of entry-level
leadership talent during the 2009 recession and now struggles with a gap in future
leaders at the middle levels of the organization.
Our view is that almost all of these
moves will affect a company’s long-term health. When a business is struggling,
companies count on their employees even more than they do when it’s healthy,
whether to increase productivity, come up with creative ideas, improve
teamwork, or simply provide moral support. Avoiding cuts in this area for as
long as possible sends a message that people are valuable and will energize
staff to take part in the turnaround. To be clear, it is important to continue
to make case-by-case decisions on talent, but avoiding across-the-board cuts
for people and benefits should be a strong consideration.
It is also crucial to support and
encourage leaders to make hard decisions for the long term, even at some risk
to near-term results. This starts with an aggressive education-and-awareness
campaign that provides the entire organization with the tools to understand
what value creation means and how it is measured. This can include training on how to interpret financial
statements and how to calculate NPV, return on invested capital, and economic
profit. Incentives are obviously important—ideally, performance evaluation is
tied to short-term results, with compensation linked in some ways to equity in
order to reflect long-term value (particularly for senior leaders).
Consistently communicating the narrative is also critical, as is role modeling
by senior leaders.
Rapid performance transformation is
hard to pull off. And even if a company succeeds in delivering near-term
results, creating value in the longer term is an even higher bar. Turnaround
leaders should create a vision and a road map with markers that keep both in
mind—and lead their teams in managing against these
By Kevin Carmody,
Ryan Davies, and Doug Yakola
http://www.mckinsey.com/insights/corporate_finance/Maintaining_a_long-term_view_during_turnarounds?cid=other-eml-alt-mip-mck-oth-1504
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