Turnaround managers must identify a company's core competency,^[31] which will necessarily determine the strategy for the future that best allows the company to exploit that core competency. Conversely, if a company lacks a core competency—that is, if it doesn't do any one thing sufficiently better than its competitors that it can win business from them or charge a higher price—then it is likely that the company is not worth turning around. Without a core competency, a company becomes the dismal black box described by classical economists, competing solely on price in a world with zero economic profit.

An example I use in classes with executives is to hold up a plastic bottle of a popular cola, then ask: "I make this. What might be my core competency?" Eventually, the following are the correct answers they offer:

The answer could be just one or a combination of the list above. The key is to break down what a company does into finite steps and ask which step(s) make(s) up the core competency. Executives should be asking this question as part of setting strategy every year, even if not in trouble.

The identification of a company's core competency is frequently an interactive and iterative process, requiring senior management engagement. Managers must remain intellectually honest with themselves; the claims made in a company's marketing materials regarding quality or service rarely correspond to the company's actual core competency. In fact, a company's core competency may lie in an unusual or unexpected area, such as a manufacturing company who realizes that it holds no competitive advantage in the production of its products but realizes that its reputation for on-time delivery is considered the best in the business. Such a company might go through a transformational turnaround whereby management strips out the manufacturing assets and refocuses the business on executing the fulfillment strategy for its former competitors to leverage its core strength in logistics.

Known by generations of video gamers as a creator of popular games, Atari, Inc. discovered its core competency under a great deal of pressure and at great cost. The company still had some popular titles in its portfolio, such as Dragon Ball Z, Test Drive, and Alone in the Dark, but most of these top sellers had resulted from outsourcing or licensing. In continuing to believe it could return to the days of producing such hit games in-house, management ignored Atari's true core competency: its game distribution system to almost all of the mass merchants in the United States, Mexico, and Canada. Even various competitors paid Atari to use its supply chain management systems as a way to sell their games efficiently to the big box stores and to large Internet sales organizations. It was that core competency that led to the buyout of struggling Atari by Infogrames, a French producer of games late in 2008 who realized the potential of the distribution channel. In effect, the company's management failed to identify its core competency and instead had it brought to its attention by the strategic buyers who lined up to purchase its highly valuable distribution channel into thousands of retailers worldwide.

When Northbrook Corporation found itself in bankruptcy, it had to determine its own core competency in order to survive. As a full-service lessor of railroad freight cars and truck trailers, Northbrook acquired and financed the equipment, maintained it, paid multistate taxes as the equipment moved around, and found lessees for thousands of pieces of equipment, while competing with dozens of companies from very small mom-and-pop operators up to and including General Electric. The bankruptcy of its then-public company parent caused Northbrook to declare its own Chapter 11, which uncovered a seemingly unsolvable mess. Northbrook owed $400 million but had less than $50,000 in unencumbered assets, not enough to cover their lawyers' requested retainer. After suppliers learned that they might get one to two cents on the dollar they were owed, they weren't too keen on working with the company any longer.

Northbrook executives didn't give up. They realized their core competency was in the management of the equipment and in the relationships they had with customers such as Cargill for grain-hauling cars, Peabody for coal-handling cars, and other corporate users of rail and truck equipment. Those customers valued Northbrook's rapid-response maintenance teams and payment-settlement process with the railroads and taxing authorities. Management convinced the lenders, who now owned the equipment, to leave it with Northbrook, with the owners responsible for all costs. Northbrook would take 20 percent of gross income on the cars as a management fee. They even convinced competitors, such as GE, to give them part of their underutilized fleet to manage. As described later in Chapter Nine, Northbrook went on to acquire and turn around other underperforming companies, eventually paying off all of its creditors in full.

Having identified a company's core competency, the manager should then analyze industry or industries in which the company competes to identify its structure and how it drives market forces. In his seminal work on the subject, Competitive Strategy: Techniques for Analyzing Industries and Competitors, Michael Porter described the five forces that shape industries:

Generally speaking, the higher each of these five metrics, the less attractive the industry will be. Consider, for example, the airline industry. Since deregulation of the industry, the threat of entry of new competitors is high because it is relatively easy to acquire the planes and permits necessary to launch a new airline. There are many substitutes owing to the industry's excess capacity (not to mention the frequent consumer option to drive or take a train). Many suppliers have bargaining power because airlines cannot operate without critical inputs such as petroleum. Customers have bargaining power because aggregators such as Kayak.com, Expedia, or Priceline have made pricing transparent and allowed them to choose the absolute lowest possible fare for any flight. And the industry has a high degree of competitive rivalry because there is excess capacity in a situation in which an unsold seat represents an asset that depreciates to zero once the plane takes off. The pressure to sell that seat gives airlines more incentive to cut costs to win a sale at any cost, thus resulting in an aggressively competitive rivalry. Although certain providers in the industry have carved out defensible niches, these five factors collectively make the airline industry a very difficult industry in which to operate profitably. Not surprisingly, airlines are repeat customers of turnaround shops and bankruptcy attorneys, and they will likely remain so until one of frequent bankruptcy filings by airlines results in a liquidation instead of a reorganization, thereby eliminating some of the industry's excess capacity and restoring some pricing power (i.e., reducing customer bargaining power) to the operators that remain in business.

By contrast, the pharmaceutical companies have historically enjoyed significantly higher profitability margins than airlines. Intellectual property laws eliminate the threat of new entrants during the life of a drug's patent, thus allowing drug companies to enjoy almost monopolistic pricing power. Suppliers have little bargaining power because the inputs to most drugs are commodity chemicals, readily available from any number of manufacturers. Customers similarly have very little bargaining power, because a patient requiring an expensive chemotherapy treatment has little option but to purchase it, or more accurately, require her health care insurance provider to purchase it on her behalf in accordance with the terms of her health care coverage policy. The enormous cost of bringing new drugs to market generally means that there are few substitutes for a given product, and even when substitutes exist, a small number of very large competitors will split the market in a sort of oligarchic pricing structure. Finally, a never-ending supply of new customers with new ailments and new therapies with which to treat them—as well as the aforementioned bar to competition frequently provided by patent protection and laws preventing the government from negotiating volume discounts—reduces the competitive rivalry within the industry to moderate levels. Clearly, the pharmaceutical industry offers a significantly more attractive industry structure than does the airline industry . . . at least in 2010. Industries change rapidly, and the liquidation of one or more airlines could reduce the competitive pressures in that industry significantly, while major changes to health care regulations around the world could put downward pressure on the margins of pharmaceutical companies. An analysis of Porter's Five Forces is therefore a snapshot in time, and should come with the acknowledgment that industries naturally evolve over time, both for the better and for the worse.

Porter's Five Forces suggest that companies in crisis typically face scenarios very different from those of their healthy competitors. In the pharmaceutical industry, which we have established as having an attractive structure, a struggling company will find its suppliers holding greater bargaining power, as management can ill-afford the distraction of seeking new suppliers even when such alternate providers are plentiful. Knowing that their business has taken on a disproportionate level of importance to the company's survival, customers will attempt to exercise similar bargaining power by pushing for price reductions, citing the increased risk of doing business with a company that might shut its doors. Rivalry in the industry may increase as well, for competitors may attempt more aggressive short-term price reductions in the hopes of forcing the company into liquidation, thus leaving them with one fewer competitive threat going forward. A company in crisis will therefore face at best the same Five Forces of its healthy competitors, and at worst may find itself at a significant competitive disadvantage even in industries with attractive structural factors. A company must, whether or not using the Five Forces model, audit the environment in which it operates.

A popular tool to audit the business environment for an organization is SWOT analysis. It is also useful to help guide the choice of strategy. The acronym stands for strengths, weaknesses, opportunities, and threats. Strengths and weaknesses are used to evaluate internal factors. Opportunities and threats are viewed as external issues.

Examples of strengths are

Management must be realistic when using SWOT analysis, being as specific as possible, especially in making comparisons to competition. Where possible, focus this analysis on a specific market segment, which may look different from that of the entire company. Any SWOT entry that cannot generate a change in strategy is not important.

The key is whether an executive group can think like entrepreneurs. As outlined in the Introduction, the environment is similar. Matching strengths with opportunities can yield a new strategy. Another approach could be to find ways to convert weaknesses or threats into strengths or opportunities.

Harley-Davidson's major bout with financial distress came in the 1960s when foreign-made cycles penetrated the U.S. market. Honda, Kawasaki, and Yamaha invaded the country and drew buyers to the lighter-weight, higher-quality, and cheaper bikes that were made in Japan.^[32] Harley's quality problems made things even worse. A team of former executives came in and acquired the company to save it from bankruptcy with only $1 million in equity and $80 million in bank debt. The team now focused on converting two of its weaknesses (quality and cost) into a strength by improving quality, even going so far as touring a Honda plant to seek out improvement ideas. There the team learned about the Total Quality Management (TQM) process, which actually was invented in the United States by Dr. W. Edward Deming but previously rejected by American manufacturers. By putting TQM into use along with just-in-time inventory and employee involvement in the process, the break-even point for Harley's operations decreased by 40 percent, thus making them more cost competitive. The executives mitigated the threat of strong competitors by lobbying President Reagan to increase import tariffs on motorcycles with engines 700 cubic centimeters and over to 45 percent. The tariff took effect in 1983, and though it was only scheduled to last five years, it gave Harley time to recover. In the meantime, the company utilized one of its only strengths, a loyal customer base, and created the Harley Owners Group, known as HOGs, and they organized rallies to strengthen the relationship among its stakeholders, which of course included customers. Today there are over 750,000 members of the HOGs, which include accountants, lawyers, and doctors, both male and female, who spend on average 30 percent more than other Harley owners on apparel and special events.^[33]

This refocusing on its core competencies proved so successful that with great fanfare, Harley management requested that the tariffs be lifted in 1987, a year before they were due to expire. "We no longer need the special tariffs in order to compete with the Japanese," announced CEO Vaughn Beals.^[34] During a decade where many American manufacturers struggled to compete with lower-cost Japanese imports, the gesture proved to be a smashing public relations coup, prompting President Reagan to visit the company's plant in York, Pennsylvania, and call Harley "an American success story." In reality, the tariff actually had little effect after 1984, when Harley's Japanese competitors completed the retooling necessary to manufacture 699cc "tariff buster" motorcycles, thereby avoiding the tariff by one cubic centimeter.^[35] By then, Harley's problems were fixed.

By contrast, Montgomery Ward filed for bankruptcy in 1997 because it could not convert its weaknesses and threats. It was overleveraged and could not compete with Wal-Mart and other retailers that emphasized price. After a financial restructuring financed by a group led by GE Capital, it emerged from bankruptcy saying it would go for "the niche" between Sears and Wal-Mart. That strategy announcement drew a collective "Huh??" from retail professionals, who were right when they predicted Wards would end up back in bankruptcy court, liquidating soon thereafter. Just saying you have a strategy does not make it the right one. Montgomery Ward management did not realize that it had no real core competency, and instead suffered from a poor reputation without any real product differentiation.

The Chicago Tribune used the wrong strategy when they fired investigative and other experienced reporters as a cost-cutting move, the new owners failing to notice that their subscribers wanted information not mere "fluff pieces." Substantial numbers of subscribers voted with their (and the Tribune's) money by cancelling their subscriptions. The phrase most commonly heard was "they dumbed down my favorite paper." To their credit, management saw the results of their change in strategy and have tried to refocus on in-depth stories, a change that has slowed down the defections. Newspapers failed to react to the main threat, the Internet pipeline, until they were bleeding cash. The strength they fail to lever is that of a "trusted infomediary," a concept discussed in Chapter Ten.

Armed with these analyses, managers can then determine the strategic vision that best exploits the company's core competencies, based on the resources needed to implement that vision, the timing of the change, and how the company plans to measure the effectiveness of the change. A fresh set of eyes is often very helpful, as incumbent management can struggle to reexamine an industry with which they have become very familiar. "That won 't work" is a common refrain from such insiders, which can prove a destructive attitude in the kind of brainstorming necessary to identify an effective strategy that diverges from the status quo. As a result, outside resources can prove very helpful, such as a turnaround specialist or new management team, because they lack slavish devotion to "the way it's always been done."

The identification of a new strategy is an inherently innovative process, requiring an open mind and a willingness to defy convention that we often associate with entrepreneurs. My colleagues Robert Wolcott's and Mohanbir Sawhney's work on the twelve dimensions of innovation is relevant to this process; they argue that while we typically think of innovation as the creation and introduction of new products, there are actually many ways in which firms innovate new ways to provide value to their customers:^[36]

Turnaround managers should brainstorm along each of these dimensions in attempting to find the revised business strategy that best exploits the company's competitive advantage. An article by McKinsey & Company suggests that a "portfolio of initiatives" to refocus the company's strategy is best. Although any group of initiatives must be consistent and complementary to avoid the trap of attempting to be "all things to all people," the McKinsey study suggests that revising the company's strategy on multiple dimensions provides a quantity and diversity of tactics that collectively improve the likelihood of survival for any one of them.^[37]

Donut maker Krispy Kreme's strategy relied on a loyal customer base that stemmed from the product's unique taste, the novel customer experience of receiving piping hot fresh donuts, and scarcity. Krispy Kreme's cult following had customers lining up at locations where they saw the illuminated "hot donuts now" signs. That scarcity disappeared when management created easy accessibility to the product through factory production and ubiquitous locations and outlets, thus tarnishing the brand's mystique.^[38] Suddenly, Krispy Kreme could be found everywhere from retail outlets to grocery stores, gas stations, kiosks, campuses, and even prisons. In the midst of this overly aggressive expansion, Krispy Kreme sacrificed its core competencies of quality and traditions in exchange for growth. Customers soon felt like they were being cheated out of the fundamental Krispy Kreme experience: fresh, hot donuts.

In a misguided attempt to combat the growing popularity of low-carbohydrate diets such as the Atkins diet, the company further compromised its core strategy by tampering with this core competency by announcing the release of factory-made low-carb donuts. The resultant backlash of bad press delayed the product's release and antagonized loyal customers. Many of these blunders resulted in part from Krispy Kreme's decision to go public, which subjected an ill-equipped management team to the constant pressure from Wall Street analysts to hit forecasted quarterly earnings numbers.

Krispy Kreme's most disastrous move came when its large factory stores began selling to 20,000 grocery and convenience stores, a decision that severely damaged the products cachet and the company's differentiation from competitors. Further expansion into these distribution channels meant Krispy Kreme could not directly control the quality or presentation of its donuts, while cannibalizing existing store sales, commoditizing the product, and cheapening the brand. This represented a critical strategic error, for it annihilated the company's core competency and instead transformed it into a mass-produced donut supplier. Krispy Kreme also failed to diversify its product portfolio by promoting complementary high-margin products such as coffee, which accounted for roughly half of Dunkin' Donuts' revenues but just 10 percent of Krispy Kreme's. After input costs rose, wiping out Krispy Kreme's profit margin, several franchisees went bankrupt, and many analysts speculated that Krispy Kreme would do the same, until the board finally took action and brought in a known turnaround consulting firm, which crafted the refocused strategy that management had failed to produce. It eliminated underperforming franchisees in unprofitable markets while repositioning the company as a focused regional player to take advantage of its strong support in the South.

Even big, successful companies can stumble. In the mid-1980s, when Pepsi made slow but steady market share gains and claimed that it outscored Coca-Cola in blind taste tests, Coke executives were scared into marketing a "new formula" with a sweeter, more citrusy flavor. The company failed to anticipate the sheer outrage consumers expressed at the change of a flavor from their childhood, which they perceived (rightfully or wrongfully) as the repudiation of the memories they associate with the familiar red can or bottle. "New Coke" proved a disastrous miscalculation of a company's core competency by its own managers, who quickly backpedaled, withdrawing New Coke from the shelves just seventy-seven days after its launch and reintroducing the original formula as "Coca-Cola Classic."^[39] Cans of New Coke are still available from time to time on eBay or at antique fairs, an ironic knickknack that serves as testament to one of the greatest corporate strategy missteps in history.

Despite the time pressure imposed by impatient creditors, Korzenski and AlixPartners, the consultants, took a fresh look at Solo Cup's positioning in the industry to examine whether it was going to market with a clear, coherent strategy. Solo decided to shed noncore businesses and assets to allow the company to reduce debt and focus attention on a narrower set of operations. For example, they determined that most of Solo's private label brands—particularly Hoffmaster, a legacy of the Sweetheart acquisition that produced disposable tableware and other special occasion consumer products—contributed little to the company's profitability while presenting what Garfield called a "classic management distraction."

"Hoffmaster used a completely different set of equipment, and they had two plants in Wisconsin pretty much dedicated to that product line," Garfield said. "It was clearly non-core, it didn't have any overlap with the company's core competencies, and it was a separable business, so it was a logical divestiture."^[44]

Solo's well-intentioned move into the Asia-Pacific region had similarly backfired, as the division had failed to implement the broad range of products necessary to service its typical foodservice and retailer customers in the region, and instead sold mainly drinking straws and milk bottle caps. On the contrary, the flow of competition had gone in the opposite direction, with Asian competitors entering the U.S. market rather than the other way around. As Korzenski noted at the time, "Our production in Japan is narrow in scope and not well-aligned with our core disposable foodservice business."^[45]

Perhaps the greatest strategic repositioning effort came in the form of a product portfolio streamlining, as significant analytics were brought to bear on Solo's impossibly complex array of 35,000 different products or stock keeping units (SKUs). They sold directly to a foodservice operator in some cases, or through a distributor in others, so there were many different contract types, some of which were multiyear contracts on large portfolios of products. Some of these products were being phased out to customers that required different service levels. Meanwhile, some products had a competitive advantage in the marketplace—such as superior design—resulting in different pricing power.^[46]

The PIP team first focused on making a rationalized, consistent pricing scheme based on the product and geographic areas where Solo offered a competitive advantage. It required complex analytics to integrate data from divergent reporting systems.^[47] Working hand-in-hand with the operations-focused team members assigned to the sourcing, manufacturing, and inventory management challenges Solo faced, the pricing team identified a number of products that Solo simply could not offer at a positive margin, such as the uncoated white paper plates known as "penny plates." The company made a strategic decision to exit this commodity product line and focus its attention and investment on its decorated and coated white paper plate business.^[48]

Rationalizing the company's balance sheet became a top priority for the CEO, the board, and the consulting team, with several large debt payments looming. Solo's strategic repositioning had identified assets that did not support the long-term strategic vision of the company, and with the help of Goldman Sachs' M&A team, they set about monetizing them as quickly as possible. Solo Cup sold Hoffmaster to Kohlberg & Company for $170 million in September 2007, including its entire product line, two manufacturing facilities in Wisconsin, a distribution center in Indianapolis, and a sourcing subsidiary in Hong Kong. These sales and other closures resulted in a streamlined North American manufacturing footprint that reduced costs while "right-sizing" the company. At the time of the sale, Solo also announced the sale of the white paper plate business to AJM Packaging Corp for an undisclosed sum.^[49] Finally, Solo divested its Japanese subsidiaries, Yugen Kaisha Solo Cup Asia-Pacific and Solo Cup Japan to Yugen Kaisha PC Rose, an affiliate of Japanese investment fund Phoenix Capital, for approximately $48 million.^[50]

Divestitures were not the only balance sheet measures undertaken as part of the restructuring plan. In June, the company announced the sale and leaseback of six manufacturing facilities in Texas, Illinois, Georgia, and Maryland. The $130 million transaction allowed Solo to pay off its second lien term loan completely, as it entered into a twenty-year lease with four five-year extension options at each facility. Meanwhile, the company's distress had become clear to landlords at other leased facilities, who begrudgingly renegotiated unfavorable leases rather than risk losing Solo as a tenant entirely in the case of liquidation, or having to pursue a claim for breach of contract in a broken lease, or as an unsecured creditor in a potential Chapter 11 bankruptcy filing. Collectively, these efforts raised a combined $370 million in 2007, allowing the company to reduce its debt burden significantly.^[51]

Though these strategic and financial changes refocused the company and rationalized an upside-down balance sheet, the critical components of the Solo Cup turnaround came from the basic "blocking and tackling" of the PIP's operational improvements, which dictated the decisions behind the sale of divisions, the closure of plants, and the discontinuation of product lines. Critical to these efforts was a change in company culture, driven from the top by Korzenski.

Korzenski and the board pressed a theme of fostering a "culture of performance and accountability" in order to improve performance by making every employee individually accountable for his or her performance. The wide array of simultaneous initiatives—which included improving the company's competitive position, paying down significant debt, and rationalizing pricing to return to profitability—relied heavily on such accountability.^[52]

Instituting accountability in a company that for decades had not made it a priority proved challenging, but the team's objective analytical work made it possible. These analytics involved the construction of several proprietary forecasting and pricing tools, such as a Planner's Dashboard, that provided clear direction to all of Solo's supply chain managers to optimize inventory management.

The company also revised its incentive program, which problematically gave plant managers conflicting objectives. In an effort to provide high-quality customer service, plant managers were rewarded for on-time deliveries and high-quality products, which incentivized costly inventory buildup and overstaffing. Despite these incentives, Solo had just a 75 percent order fill rate, thus indicating that roughly one-quarter of ordered products arrived late or not at all, which infuriated customers.^[53] Recognizing that this more competitive marketplace demanded both high quality and efficiency, Solo revised its incentive plans to align with the company's needs.

Dovetailing with their strategic repositioning efforts, Solo Cup took a long hard look at its pricing scheme, finding in several instances that it had failed to take into account "hidden" costs like specialized packaging in determining its breakeven price on certain products. This flawed analysis made it look like only a very small percentage of certain divisions' sales were loss leaders, when in fact Solo had significantly underpriced a majority of its projects. Management had thought their product portfolio produced a weighted average contribution margin of 13 percent, but when the consulting team examined improperly allocated costs, the weighted average was much closer to 0 percent.^[54] In response, Solo raised prices to levels where it made sense to continue providing each product, and it clarified to customers exactly what drove the cost of their purchases by region, by customer, and by facility, which often resulted in the "firing" of unprofitable customers. The company shrank its sales by tens of millions of dollars to large customers who hadn't seen an increase in four years, a period during which Solo faced raw materials pricing increases, which cost it $50 million in 2005 alone. "We learned that you can't manage every customer the same way," Korzenski said. "We reviewed the strategic customers where we knew we were under-pricing the market, and we just matched the market, even though we lost a portion of our customer base. But we understood that they were a drain on the company, so we had to. The other thing about pricing is that there's a lot of 'bleed' that occurs, lots of deals had side actions where sales representatives would add a little service to close a deal to hit his number, but it would end up costing us. We focused on cleaning those up and getting our sales reps in line."^[55]

Individual Solo managers were also paired with consultants in each of the company's major functions to produce savings across the cost structure. In the manufacturing department, complex models optimized the process of worker utilization, adapting the level of labor to the level of production through better arrangement of full-time and part-time workers. Solo also redefined production processes to optimize labor and resources allocation, and shifted production to more efficient plants. Given the company's spike in cost of goods sold (COGS), the reduction of material scrap proved particularly helpful, as the team shaved 2 percent of resin materials out of the company's manufacturing processes, thereby saving millions of pounds of raw materials. Finally, the consultants and management completely revamped Solo's procurement operations by shifting toward lower-cost materials and sourcing more strategically by geography and by product.

Solo also attacked its working capital management, incentivizing customers to pay invoices early and stretching vendors to improve its cash conversion cycle. The company also integrated its separate IT systems, introducing an SAP order-to-cash system that for the first time allowed Solo to operate on a "one order, one truck, one invoice" basis. The system brought greater clarity and account information to sales representatives, and allowed for higher-level analysis to ensure that Solo approached its customers intelligently and with a coherent pricing scheme. These PIP measures proved incredibly successful, saving $7 million from more efficient sourcing efforts, $30 million from streamlined manufacturing processes, $35 million in superior inventory management, $13 million in reduced SG&A, and $10 million in improved sales and marketing in 2007. These measures helped Solo Cup reach $68 million in net income and $142 million in EBITDA, the highest figure in the history of the company.

The company and AlixPartners won recognition for the speed and success of the turnaround, winning both the Industrial Turnaround of the Year award from M&A Advisor in March of 2008 and the coveted Large Company Turnaround of the Year award from the Turnaround Management Association in August. As with most successful turnarounds, however, the efforts aimed at streamlining the company did not stop upon the return to profitability. Solo would go on to close additional plants in 2008 through 2010, demonstrating its ongoing focus on operational efficiency at other U.S. plants, while pursuing new growth opportunities such as a partnership with nonprofit educational organization Sesame Workshop to create a branded line of paper plates, bowls, and cups.