ANNEX IX : MORE ABOUT PHASE II
–
TURNING YOUR COMPANY AROUND
When the key causes of the company's problems are internal (in 80% of
the cases, you will recall) rarely then is poor performance limited to
one or two functional areas of the company. As a rule, it is a
complacent or sleepy management attitude, and obsolete and inadequate
management practices that prevail throughout a troubled company. If the
problems are less widely spread, so much the better. In business units
operated autonomously, there is a tendency to have a different corporate
culture, and these units may not share management problems of the rest
of the corporation. In any event, once the diagnosis is made I have my
work cut out for me.
As discussed in Section 3 above under turnaround
priorities, in situations calling for a drastic turnaround,
usually my first and foremost concern is to stop the hemorrhaging. What
I do in this regard follows standard turnaround principles, which are
detailed on this site. The essence of this part of my turnaround effort
is to quickly bring the costs in line with revenues and to quickly bring
the cash outflow in line with the inflow – by reducing expenses,
postponing payments, increasing sales, divestment of assets, and
accelerating collections. See more details under Corporate
Surgery. At the same time, I act to stop the hemorrhaging of
good will and morale by these and related actions, including through
turnaround communications.
As mentioned in Section 9 above, under Background
of Alex Wolf, in many instances my experience allows me to see
almost immediately that certain practices / activities in an enterprise
are substandard compared to what's done in other companies. In other
cases, I do research to find the guidance and the relevant benchmark.
Better Chances for Turnarounds Today. Fortunately, because of
the Internet, nowadays, business research typically takes only a
fraction of time it used to take only 10 years ago. Because of that,
today many troubled companies can put together their recovery plan much
faster than in the past. This may mean weeks or even months of
additional breathing room for a troubled company that needs to be
reorganized, compared to a company in a similar situation years ago.
This and the greater awareness of the advantages of Chapter
11 reorganization techniques, constitute some of the general improvements
in the business environment in favor of turnarounds.
The factor that continues to limit the number of turnarounds is the
availability of qualified management. There are only a few thousand
professional turnaround managers in the US. That, of course, is by far
not enough for the number of companies that are in trouble. In addition,
because of the high demand for turnaround services, most turnaround
professionals perform primarily the initial phases of crisis management
and repositioning. Thereafter they move on to other assignments,
typically leaving the company to complete most of the restructuring, and
all or most of the re-engineering by itself. That is to say, typically
they move on before the client attains
sustained viability.
However, turnarounds depend on the quality of management probably
more than any other business endeavor. My own disciplined and
comprehensive approach follows all the requirements outlined above,
particularly in Section
7 and Annex VI.
Below, I comment further on these requirements and give further examples
from my experience.
More About Turnaround Priorities
and Methods. Needless to say, not all parts of a company can be
re-structured or re-engineered at the same time, or at the same speed.
As your turnaround leader I will set detailed function-by-function
priorities for restructuring and re-engineering your corporation. I will
set these priorities following the general turnaround priorities
listed in Section 3 above, which are
normative. These detailed functional priorities form part of
the Turnaround Concept
for the client corporation.
The client's and his industry's financial and operating data often
point me directly to these functional priorities. The sequencing of
these priorities can also make a big difference to the survival of the
company and the speed with which it recovers its financial health, as
the following case illustrates.
Case #4 – Optimal Sequence of Turnaround Actions.This
case concerns a corporate
client who succeeded in a turnaround with my assistance but escaped all
publicity of its troubles and to this day wishes those past troubles to
remain confidential. Therefore, I have to disguise his identity, and can
only say the corporation is in the service industry in Canada. The client's
income statement combined with data from the other players in his
industry told me that the expenses of my client's Activity A amounted to
8% of his total expenses and could be reduced by a half within roughly 3
months, while the expenses of his Activity B amounted to 50% of his
total expenses and could likely be reduced by 20% within roughly 4
months. Because of limited management resources, we could improve only
one of these activities at a time. I chose to reorganize Activity B
first, even though it was already far more efficient. I simply
calculated that this strategy promised to improve the profit picture 2.5
times more than the alternative strategy (savings of 0.2 x 50% = 10% of
total expense, compared with 0.5 x 8% = 4%). The extra saving generated
by this strategy was 6% of total monthly expenses during the time period
until Activity A could also be improved (3 months). In that particular
case this benefit amounted to over $300,000, and this money was used to
finance other improvement projects.
I apply this type of reasoning to the ordering of all major
priorities within the Turnaround
Concept, including priorities of actions and projects listed in
the Catalogue.
More about Attitudes and When to Eat Crow. The turnaround
leader must be assertive, of course, but must also be able to put the
interest of the company ahead of his/her ego. Actually, often at the
beginning he/she has to eat crow because of real and perceived sins of
his predecessors, particularly in dealings with bankers and other
creditors.
It is surprising how often the management of troubled companies tell
lenders that the sources of all company problems no longer exist and /
or are mainly external. But this is not the way to regain lenders'
confidence, when lenders previously cautioned management not to do
certain things, or when lenders are aware that financial ratios of the
company are well below the company's peers. Notably professional lenders receive periodic reports on
financial performance of various industries, and may know better than
management of a troubled company how that company stacks against its
peers.
Case #5 –
Crisis Management : Refinancing and Cost Reduction.
Some years ago, after a pause of several years I was
re-called by a former client, an industrial, 300-employee company for
whom I consulted in 1980s. Actually, it was their new president (a man
who inherited the shares and decided to run the company himself) who
called me, having learned that I solved some problems for that company
in the past. He said that since I already knew the company and its
industry, perhaps I could have a quick look around and suggest
improvements in production and other internal operations. We made an
arrangement and I decided to start my assignment the next day. Before
that, I asked for the financial statements to assist me in my work, and
he told me I will get them later. I was not concerned, because I knew
that the company was almost always profitable since its creation in the
fifties, and there was no sign this would be a turnaround situation.
The next morning I began to observe the work on the shop floor. A few
hours later, I was called to the president's office. He showed me a
letter from the Bank, which he received that morning, requesting
repayment of the loans, totaling over $6,500,000 within 30 days, and
saying nothing more than that. The president asked for my suggestions. I
said that the company will have to negotiate with the existing Bank and
other lenders to refinance the loan. I added that we needed to prepare
for this, and asked again for the financial statements. He was reluctant
to provide them, but told me secretly that the company was in trouble.
I already knew this. That morning on the shop floor I noticed that
the fluid (oil) used to cool the cutting tools on several lathes was
dirty, and I asked the lead hand if my observation was right. He
confirmed it and added that the foreman told them there was no money for
new oil. The foreman confirmed this and he and I discussed ways to
improve the filtration and recycling of this oil, compared to the cost
of new oil. However, I realized that this was a bad sign – well beyond
immediate shop floor problems. I informed the president of this, and
suggested that my priority be changed to dealing with the banks. He
gladly accepted, but was still reluctant to provide me with the
financial statements, which I now urgently requested. He said these
statements made the company look worse than it is in the reality. I did
not want to debate the quality of the financial statements in a vacuum
when I was receiving all the signals that this was an insolvency or
pre-insolvency situation. My answer was that I will either receive the
financial statements that afternoon or will terminate the assignment. I
was given the statements and was provided with all other information
that I requested and which was available.
Within a few days I had an outline of the whole situation, which was
as follows. The company was profitable less than 3 years prior. Then
rather suddenly, it experienced very large losses for those 3 years.
This coincided with the periods of absence and illnesses of some former
managers, including the late president. In those 3 years revenues
dropped significantly while expenses stayed almost the same as before.
In the present year, during some months the losses continued, in others
not – I did not yet know why.
All or most of the equity was wiped out. The company appeared to have
retained a certain net worth in production machinery and the building,
but this was uncertain, because the recession in the industry at the time made
the market values of these assets also very uncertain. Furthermore, a
rapid divestment of these assets at reasonable prices was impossible.
Most of the former senior managers who had good track record were gone.
There was no replacement to speak of, including the new president, who
did not know this technical industry, did not have a technical
background and had limited management experience, except in sales. The
company still had a good, though increasingly dissatisfied, clientele
with whom the new president had some contact. The key big clients
provided the company with long-term contracts, but practices on the shop
floor had badly deteriorated, and efficiency was so low that on the average,
prices did not cover variable costs.
Given time and a little cash I was certain that the efficiency could
be improved. Actually, being familiar with the industry, I was able to
quickly estimate financial benefits of some operating improvements that
I thought could be made. Unfortunately, they did not add up to a picture
of a break-even operation. In
other words, the recovery was very uncertain. There was no Turnarounds Concept, as yet.
My overall short term objectives were to reduce the hemorrhaging and
to gain enough time to prepare the Turnaround Concept.
However, in these circumstances, I just did not see how another lender would
want to replace the present Bank. I could also see why the
existing bankers would want their loans to be repaid at that particular
time. Lastly, I learned that the personal relationship between the Bank
manager and the new president was very bad, and that the bad
relationship started still while the late president was in office.
I saw my first task as obtaining an extension of the delay to repay
the loans, and here I thought I could turn the bad relationship between
the management and the Bank to the company's advantage. With a letter
authorizing me to negotiate with the Bank, I phoned the Bank manager for
an appointment. He immediately asked if I would bring the check for the
$6,500,000 to the meeting. When I said no, he said that in that case he
saw little point in meeting with me.
But by saying this he gave me an opening, because I then asked him
directly, if he believed the company could make the payment now.
Fortunately, his reply was honest, he said no. So I asked him if it
wasn't a fact that he knew why I wanted to see him. He said yes, and
added that he had very bad experience with that account (my client). He
told me that his agreeing to meet with me was purely a courtesy. I told
him that I knew he had a bad experience with the company lately, and
that this was exactly what I wanted to talk to him about.
When I arrived at the Bank, the Bank manager had the bank's lawyer
with him and made a point of that. This did not impress or concern me,
because the lawyer could not squeeze blood out of a stone either. In
fact, I saw the lawyer's presence as an opportunity to convince another
representative of the Bank to give us a reprieve.
Although I called for the meeting, in actual fact the Bank manager
quickly took over. He told me that he saw six other representatives of
the company during the past 3 years, and that I was just wasting his
time. I asked him to inform me in detail how he felt about the company,
its management and the way the latter dealt with the Bank. Surely, I
said, he was not afraid to tell me that. He opened up and the picture he
painted was very ugly. However, I only opposed, and at that very
briefly, a few obvious errors he made, namely when he jumped to totally
unjustified conclusions. Most of the time, I simply listened. I also asked for
certain explanations. When he seemed to end, I asked if he was finished.
I had to ask this a few times, because he was only pausing, and he
continued enumerating his grievances and worse. He talked about lack of
control over expenses, false accounting, dishonesty, navel gazing, lack
of competent management, broken promises, and so on – unfortunately,
with plenty of examples backed by documents from the Bank's files. When he
finally finished, I asked the banks' lawyer if he had anything to add.
He did, and the picture they painted now got even worse. Their message,
their words and their tone were very hostile, even ugly. However, it did
not seem to me that they knew anything about the company's potential for
recovery. On the other hand, our weakness (mentioned above), was that I
was not sure either if it was realistic to expect a return to
profitability. But the Bank did not know that, and I still had some time
to figure it out.
The message I gave them at the time had surprised both the Bank
manager and the bank's lawyer. For I told them, that I thought they
probably were right about everything except dishonesty on the part of
the company. I said that in fact, I knew they were right about many
things and I named some of them. However in the process of
eating this crow, I was also partly (though very slowly) disarming them,
and of course, I mentioned some improvements that I thought could be
made. I added that my work was just starting.
At the time of that meeting the company had 22 days left of
the 30-day notice given by the Bank. I told my interlocutors
that I did not think the company could refinance the loan within 22
days, and that an extension was needed in the mutual interest of the
parties. The Bank manager icily said the Bank would have to see a real
improvement before they would consider an extension and that we had 3
weeks to accomplish that, but that also meant that the door was not
closed.
Eventually, working long hours on several fronts, we lowered
productions costs, amongst others, by quality assurance, improving shop
floor practices, reorganizing the purchasing and subletting a part of
the premises. Step-by-step, we reduced costs and simultaneously, we
obtained from the Bank several extensions of its notice to repay loans.
To support our requests, we presented weekly financial statements,
showing improvements and reports of efficiency improvements on certain
jobs.
We used the time we gained to reorganize the company. Eventually, in
that serious recession of early 1990s, we managed to refinance only
about a half of that loan, because the Bank pressured us relentlessly
and forced us to refinance before the company was fully turned around.
However, what we did at the time was enough to get the Bank off our
back, and thereby to save the company.
My dealings with that Bank were part and parcel of the crisis
management phase that is common in turnarounds. Also characteristic of
effective crisis management in dealing with lenders was my factual
acknowledgment to these bankers that promises made to them
were broken, and that they had good reason to be upset. Beyond that
factual acknowledgment I ate a great deal of crow on behalf of the
company, using the opportunity to dissipate the bankers' frustrations
and their anger, and to describe some measures that were being taken to
prevent poor performance in the future.
In that particular case, as in some other such negotiations I
conducted, things went close to the brink a few times. That particular
Bank manager would never grant the extensions of the loans until the
last day of his previous 30 day notice. Moreover, he made a habit of
reminding us that 10 days were left until the deadline and that another
reprieve was not certain. I felt this was abusive, but I kept my counsel
on that. At the right time I used it to the company's advantage.
I acted as soon as the company's financial health had clearly
improved. Our monthly financial statements showed that we had
drastically reduced the losses and that we continued to reduce them. But
the attitude of the Bank manager did not change. So we sent copies of
those financial statements also to the Bank's vice-president. And I wrote them that
in these circumstances the Bank's relentless pressure compelled me to
point out that the Bank would collect less in case of bankruptcy than it
would, if it allowed further the improvements to realized. After my
letter the head office put a good word on our behalf. The next extension
was 90 days, and during that time we refinanced the loans. The new
lender we found was small, but knew our industry well, and was willing
to lend the company up to $3,000,000, provided we could refinance the
balance of the old loan package ($3,500,000). To induce our old Bank to
cooperate, I suggested to the new lender to make us an offer valid for
only 10 days, and to state explicitly that it was conditional on our old
Bank or another lender financing the balance of the loans. The lender
agreed. In these circumstances the old Bank extended a $3,500,000 loan.
Thereby, the whole $6,500,000 was refinanced.
Versatility and Innovation. In most cases, the manager taking
responsibility for a turnaround must be very versatile. One must combine
analytical skills, often associated with staff / advisory functions,
with a drive to innovate in a very practical way that characterizes good
operating executives. In most cases, to turn an ailing company into a
money-maker, one must innovate in the full business sense of the word
– innovate through equipment, through policies, procedures and
contracts, innovate through new organizational structure, through new
sales strategies, through new markets and new products, and innovate in
every other viable way. One also must be willing to reverse policies
that once made every sense.
Accordingly, when the company is in trouble, I question
every significant policy : What are the objectives of this policy? Does
this policy presently make sense? How can it be improved? Which part of
it can be improved quickly? How? In the above case, the innovation
consisted primarily in establishing proper machine shop practices, in
areas such as such as tool management, machine set-ups, quality
assurance, job scheduling, and in the related training of
workers.
If there are character traits that distinguish turnaround leaders from
other people, then surely these ever-questioning and innovating, i.e.
nonconformist and individualistic attitudes, rank high in
this regard.
The Centralize – Decentralize Model. In a company which needs
turnaround as a matter of its survival – typically a company that was
mismanaged or non-managed (the latter actually is more common) – it is
almost always necessary at first to centralize decision making in
purchasing, budgeting, and certain other policy areas. But as new
policies and new values behind these policies take hold in the company,
and as new leaders emerge, it makes a lot of sense to delegate more, to
empower the new leaders, in effect to decentralize.
Such flexibility of
means and key policies, depending on circumstances, is also a trait
necessary for effective turnaround work.
Combining the Old with the New. To locate "hidden productivity reserves",
to turn a troubled
business into a viable one, turnaround leaders often use a combination
of old and new techniques and methods – both to analyze the situation
and to re-engineer the business. We use such "old fashioned"
but proven techniques as industrial engineering (notably plant layout
analysis and material control), and cost-accounting on equal footing
with "more modern" techniques such as customer satisfaction
surveys, review of management process, promotional videos and
marketing through the Internet. In fact, very often these "hidden
productivity reserves" become apparent only through a combination
of various techniques.
Case #3 – Combining Various Techniques. The following
case from my experience combined "walk around
management", material control and a bit of financial analysis. The
result was a startling finding of large and completely unnecessary loss
of profit. Re-occurrence was prevented through changes in job
descriptions of managers (re-engineering).
This is what happened. Many years ago, I was consulting in financial
and policy matters to a large machining house, which at the time had
around 250 employees and was profitable. I was not a turnaround
situation. In that company, every few days scrap dealers would pick up
bins with shavings, cuttings and other metal scrap from lathes, screw
machines and other metal working equipment. I learned this by "walk
around management", asking questions about contents of bins I saw
on the shop floor and in the shipping area. The materials included free
machining brass, aluminum and stainless steel, and were quite valuable,
even as scrap. I compared the amounts the company received from scrap
dealers with percentages of scrap-to-material revenue published by an
industry association, and I was surprised to learn that my client's
percentage was less than a third of industry average. I asked the chief
engineer for explanation. He told me the discrepancy was due to a
different nature of jobs run by this company as compared to typical jobs
in the industry, and also suggested that the figure from industry
association could be wrong. I realized that he was only guessing, and that
large amounts were at stake.
The overall issue was this : was the company receiving fair
compensation for its scrap? It was well worth my time to investigate,
because the potential was profit of several hundred thousands of dollars
per year. At the core was the average percentage of material removed
from feeding stock on big jobs. The chief engineer guessed that their
shop removed on the average probably 50% – 65% of the feedstock
material. I checked further. First, I confirmed with the industry
association that their figures were unlikely to be a misprint. Their
scrap-to-material percentages varied from year to year but within a
range that was always far removed from my client's figures. There was no
way to test the vice-president's hypothesis that the company's jobs were
different. Nor was there a need to test it. Instead, with a technician,
whom I borrowed from the chief engineer (who thought this was a waste of
time), we reviewed the records of some of the big jobs the company was
running, and which accounted for about a half of the company's revenue.
Our calculations from production drawings showed that on these jobs,
around 85% of material was removed on each good part. The total scrap on
these jobs would be higher, because scrap from end pieces, and bad parts
had to be added.
You probably had guessed it by now. My investigation revealed that
several scrap dealers, working with several employees of the
company, were systematically stealing the company's scrap worth hundreds of
thousands of dollars, year after year. In some years, a third of the
profits were lost this way.
The chief engineer was innocent, as was the controller, as was the
buyer, except that neither one set up any controls to prevent this large
theft. The head shipper did not set up the controls either. He did not
need them, he was part of the scam.
Upon some further analysis, I found that the implementation of
relevant controls was not a part of anyone's job description. The
controller had the title but not the responsibility for controlling. His
main duties were to supervise bookkeeping, to produce interim and annual
financial statements and some administrative work. If he had only put
in place a cost accountant with a mandate to review costs and
efficiencies... – but he did not. The chief engineer was not
responsible for material control, as was apparent from his rather
detailed job description. The VP manufacturing perhaps was responsible,
but certainly not explicitly. And on top of these things, the
owner-president often intervened in such matters, giving other managers
the sense he took over responsibility for certain things on shop floor,
whereas he did not feel that he did. He felt he was just helping out. He
also did cost accounting himself, when he had time for it, which was not
often.
As a result of my discovery, some controls were put in place,
including some changes to job descriptions. Upon reflection, I realized
that the root cause of the problem, which over the years cost the
company millions of dollars in lost profit through the theft of
valuable scrap, was an absence of proper management design, particularly,
the absence of a real controlling function. The long duration of the
scrap metal scam was further assisted by the absence of a
benchmarking
process in the company. Actually, until I did this, no one compared
the company's performance with statistics from the industry association.
However, at the time, my assignment for this client was limited, and
did not include the re-design of the whole management system. Several
years later, in a more difficult market, this company required a drastic
turnaround, but that is another story.
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