Less than two years ago, thousands of corporate failures took place in the span of just a couple months amidst the subprime mortgage crisis. These included the legendary Lehman Brothers going bankrupt and Fannie Mae being taken over by the federal government. Stock market drops were severe as the Dow plunged 500 points in one day - the biggest point loss since the terrorist attack on September 11, 2001. In the aftermath of this deadly financial crisis, academics and professionals have analyzed the market and theorized the exact causes of this panic both on Wall Street and around the world. Subprime loans, housing bubble, and market instability are few of the key terms that have been constantly popping up on business publications such as the Wall Street Journal in 2008. These terms, along with other market-related explanations, are deemed to be the trigger for this catastrophe. However, this understanding of failures creates the unreasonable perception that the financial market functions on its own, and is the most important cause behind corporate failures. This undoubtedly leads us, consumers and participants in this economy, to question: what is the innate cause of these failures beyond the apparent economical explanation?
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Just as William Cronon re-examines the concept of wilderness from a fresh perspective in his article "The Trouble with Wildnerness", "the time has come to rethink" corporate failures in this current state of immense financial changes (Cronon, 83). It is crucial to realize that any business entity, in fact, is independently run by people, despite being influenced by the market. Therefore, it follows that in order to truly understand the causes of any corporate failure, one must examine the business entity at an individual level through a biological and psychological perspective, instead of at a market level through a economical perspective. From analyzing few exemplary cases of corporate failure, it is evident that the most important triggers of failure stem from the ignorance, arrogance, and denial of company executives, which are factors often overlooked by economists and academia.
In order to pursue with the topic of corporate failures, we must first define the term. Breaking it down into separate words, corporate represents any business entity participating in the global economy, and failure means poor performance in the economical sense. Together, corporate failure refers to the bankruptcy or long-term decline of a company. The gradual decline of Motorola and the federal takeover of Fannie Mae as it was going bankrupt are examples of the two extremes of corporate failures. Yet, both institutions share similar underlying causes for their decline, which are not market based, but instead, are behavior and psychological based.
Motorola and Fannie Mae, both with almost a century of establishment, are not without vulnerability to failure. Jim Collins, author of the national bestseller and writer for many journals including Fortune, BusinessWeek, and The Economist, is also interested in understanding the reason behind this vulnerability. He was pulled aside by the chief executive officer of one of America's most successful companies at a conference. The CEO asked, "When you are at the top of the world, the most powerful nation on Earth, the most successful company in your industry, the best player in your game, your very power and success might cover up the fact that you're already on the path to decline. So, how would you know?" (Collins, 2). This immediately captured Collins attention and imagination, and became the ultimate inspiration behind his book How the Mighty Fall. Looking at corporate decline as analogous to a disease that can grow on the inside while leaving the person healthy looking on the outside, is it possible to detect this decline in its early stages and reverse its course, just as in the case of using preventive medicine? This is the ultimate stake of understanding corporate failures. If it is possible to fully understand its cause, such deadly outcomes can be avoided.
Economist Paul Ormerod, in his book Why Most Things Fail, which was named Business Week Book of the year in 2006, offers a fresh perspective on failure, specifically relating it to both society and biology. "Failure is all around us. Failure is pervasive. Failure is everywhere, across time, across place and across different aspects of life", and Ormerod coins this phenomenon the "Iron Law of Failure", a law extremely difficult to break (ix). As much as economists and journalists eulogize business success, there is a great need to look for why firms fail. And it is often ignored that many of these great firms, after receiving their acclaim, soon fall on harder times. Analogous to biology, Charles Darwin's theory of evolution explains why organisms succeed, but not why they go extinct. In this process of natural selection, species gradually become better adapted to their immediate environment and fitter for survival. However, in spite of this, species still eventually become extinct, and "the survival of the fittest comes up against the Iron Law of Failure" (x). Viewing corporations more like living organisms, we can understand corporate failures by identifying the "subtle patterns amongst the apparent disorder of failure, and analyzing why failure arises" (vii).
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When extended from the world of biology to human activities, especially to economic organizations, there is a parallel between the two. All companies, in essence, are run by a network of human interactions and decisions, just as living organisms are brought to life by a network of nerve signals and cell communication. For corporations, the nerves that bring the operations to life are the company executives and employees. Although in human societies, individuals and firms strive consciously to devise strategies for success to combat circumstances of change and hardship, yet still, failure strikes, just as they do in the world of biology. Therefore, it is important to examine the mentality of the company, through its workers, at times of decision making, in order to understand their reasoning for such decisions that have led to failure. These often shed light on the flaws that determine the company's ultimate downfall.
A single bad decision is enough to cause the collapse of a long-founded and reputable corporation. This is the story of Motorola. Looking deeper at the process of decision making, we can discover the psychological flaws that led to this error. Motorola is a representative company for corporate failure because "if companies like Motorola â€¦that had once served as paragons of excellence can succumb to the downward forces of gravity, then no one is immune" (Collins, 8). When Jerry Porras and Jim Collins surveyed a representative sample of 165 CEOs in 1989, they selected Motorola as one of the most visionary companies in the world, and included Motorola in their research study and book, Built to Last. Amongst the eighteen visionary companies studied at that time, Motorola received some of the highest scores on dimensions such as adherence to core values, willingness to experiment, management continuity, and mechanisms of self-improvement (Collins and Porras, 127). By the mid-1990s, however, Motorola's magnificent run of success, which culminated in having grown from $5 billion to $27 billion in annual revenues in just a decade, has drastically stopped.
Sydney Finkelstein, professor at Tuck School of Business, provides a comprehensive background on Motorola's history, focusing specifically on the time of its decline in his book "Why Smart Executives Fail." By the 1970s Motorola had solidified its reputation as a world leader in technology by developing its own brand of microprocessor and inventing world's first pager. Then came the age of cell phones in the 1990s. In 1995, Motorola executives felt great pride in their soon-to-be-released StarTAC cell phone - the then-smallest cell phone in the world. However, there was one big problem: the StarTAC used analog technology just as wireless carriers and customers began to demand digital. It was a time of new opportunity for digital technology. But "even with such incontrovertible data on market trends and customer needs, Motorola chose to rely on internal forecasting models" and believed that what consumers really wanted were better, sleeker analogue phones, instead of the new digital technology phone (Finkelstein, 156). Though this is the root of Motorola's decline, it does not explain why Motorola chose to pursue a heavy reliance on its own models. However, when examining at Motorola through a biological model and taking into account the psychology behind such decision, the reason of failure is much more clear and profound.
Just like species need to adapt to the new environment in order to secure survival, so do corporations. This ignorance to the outside world due to a developing hubris based on past success was detrimental to the future of Motorola. According to Roger O. Crockett, who closely covered the company for Business Week, one of Motorola's senior leaders completely dismissed the digital threat: "Forty-three million analog customers can't be wrong." (Crockett, 2). His assumption that the loyalty of the customers will stay the same regardless of Motorola's decision leads him to ignore the conditions of the outside world. It is this "fortress mentality, cut off from reality, in-bred, with tremendous self-confidence, and a lack of concern with the outside world" that has led to Motorola's demise, resulting in long series of layoffs, restructuring, and re-strategizing that plagued the company for years (Finkelstein, 157). In the fast-moving cell phone business, by the time Motorola finally launched its own digital phone in 1997, the competition was far ahead and Motorola's market share was hit dramatically. Motorola's US share peaked at "60 per cent in 1994 only to dip to 34 per cent in early 1998, while Nokia's share went from 11 per cent to 34 per cent during the same time period" (Finkelstein, 157). A culture as strong and successful as Motorola's found its way resistant to new ways of thinking and new ideas. Motorola's ignorance gave competitors an opening, as Motorola fell from being the number one cell phone maker in the world, "at one point garnering nearly 50 percent market share, to having only 17 percent share by 1999" (Collins, 29). Motorola's corporate failure was without the influence of a poor market or low economy, as other companies in the same industry, such as Nokia and Ericsson, who were responsive to consumer needs, rose to immense success. This failure was in fact caused by the company's ignorance as its cultural shifted from humility to arrogance.
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This arrogant mentality of successful companies often mars the ability of good decision making. As Collins puts it, when "the rhetoric of success replaces penetrating understanding and insight, decline will very likely follow" (Collins, 21). This is applicable to any business operation, including that of Motorola. They assumed their internal forecast model to be true since it has always been successful, but they ignore to understand the why it has worked in the past and under what conditions it will no longer work. The refusal to shift to a digital market is one tragic error that derived from both the existing ignorance and the arrogance of the Motorola culture. This hypothesis of corporate failure is applicable to not just Motorola, but many more companies, even to Fannie Mae. Fannie Mae, featured in Good to Great as one of the few exemplary companies, was forced to succumb to government conservatorship at the end of 2008. Its missionary zeal for expanding the American Dream of home ownership to as many Americans as possible contributed, in part, to its arrogance, its pursuit of growth, and even its ignorance to the increased risk profile, which partly spurred the start of the subprime mortgage crisis.
Another cause of Fannie Mae's fall that follows this mentality of arrogance and ignorance, which is also common to other corporations, is its denial of risk and failure. Immediately following a bad decision, companies might still have strong results to suggest that the difficulties are "temporary" or "cyclic" or "not that bad," and "nothing is fundamentally wrong" (Collins, 22). Executives often "discount negative data, amplify positive data, and put a positive spin on ambiguous data as a way to blame external factors for setbacks rather than accept responsibility" (Collins, 22). In 2008, as the housing market bubble grew, so did the probability for a bubble bust and a real estate crash increase. With this drastic additions in leveraged and mortgage-backed securities, banks and mortgage institutions, like Fannie Mae, were either able to make more profit or be subjected to total collapse, depending on the risks they take. For Fannie Mae, it almost completely overlooked the risks associated with its business operations. In examining the materials assembled on the demise of Fannie Mae, Collins found little evidence that the company's executives seriously considered the possibility of failure. CEO of Fannie Mae, Daniel H. Mudd, even defended the company by pointing out that "almost no one expected what was coming. It's not fair to blame us for not predicting the unthinkable" (Duhigg, 1). This denial of risk and failure, developed through its success, is ironically the cause of its ultimate failure.
Species, people, and firms are all complex entities that must survive in dynamic environments that evolve over time. What separates biological or human social and economic organization is the ability to make decisions. Animals, living in the natural world, face inherent uncertainty about their environment, which impacts the effect of their actions. Humans, however, both acting as individuals or in a collective fashion in a firm, are given the opportunity to make decisions and take charge of their actions. Despite this, many firms are unable to pass Darwin's test of survival because they make the mistake of becoming ignorant and arrogant in decision making, as well as oblivious to risks after rising to the top. This mentality of thinking whatever they do will be successful because they are already successful is absolutely detrimental. Corporate decline is analogous to a disease, one as deadly as cancer, growing on the inside while letting the company look strong on the outside even after its onset, but fortunately, unlike cancer, it is largely self-inflicted. Knowing the importance of humility and remaining humble even after success is the cure to many corporate failures.
Many economists and academia, however, still view corporate failure based on understanding the company with relation to the whole market. Some argue that corporate failures, along with the financial crisis, are just another part of the economic cycle that is independent of human decisions. If the 2008 financial crisis is just another part of the economic cycle, a fluctuation in economic growth expansion and contraction, does that mean companies also fluctuated in success at the time? This is clearly not the case. There are companies that have done extremely well over many years, both in economic boom and recession. Even in the recent market crash, some banks, such as J.P. Morgan, outperformed others, and shined in comparison to the bankruptcy of Lehman Brothers and Bear Sterns. Forbes published an article earlier this year, titled "Fewer Corporate Failures Ahead: An improving economy and buoyant bond markets spur S&P to change its forecast" (Craft, 1). It argues that with more financing and issuance of bonds, companies are expected higher performance. However, as with the case of Motorola, companies still face vulnerability to failure even in good market conditions.
When analyzing how companies function and operate, it is not enough to understand them as a part of the market function from solely an economical perspective. Companies operate much on its own with its set of culture, apart from the activities of the market. It is more important to understand the human aspect of corporations, where they should be regarded as entities of their own, run by human motives and interactions. Corporations, on the rise to success, are prone to becoming ignorant to the outside world, arrogant in decision making, and oblivious to the apparent risks and failure. With this understanding, leaders can re-examine themselves, especially their method of thinking and decision, for poor performance, rather than exert the blame to external forces. This will help companies to make better decisions that will reduce their chances of vulnerability to failure in the market and learn to recover from any decline. Without understanding the importance of psychology in corporate operations, more losses, some of which are unnecessary and can be avoided, will occur and even the greatest company is subjected to collapse.