Stage V: Diversification

After an organization has completed the consolidation stage, the next developmental challenge it faces is to diversify. This can occur either because the organization's product life cycle has reached the mature part of the S-curve, or because the core product has simply created new opportunities.

Diversification Attributable to Product Maturation and Competition. If the company's original product or product line has become relatively mature and will not facilitate sufficient future growth to sustain the organization at its current rate of growth, its historical rate of growth, or its immediate future growth expectations, the solution is diversification. This problem is simply a result of the phenomenon of market saturation.

When a business initially introduces a product as a new venture, the market is typically unsaturated, and there is relatively little competition. As the organization becomes successful, it inevitably attracts competitors. A classic example was Apple Computer and the development of the personal computer. Apple Computer found and developed the market for the personal computer (they were the first to offer a product that required little assembly) but attracted a host of competitors, including IBM. The presence of competition decreases the firm's profit margins and erodes its market share over time. Similarly, Google developed Google Glass, and then Microsoft developed the HoloLens.

Sometimes a company can have the market or playing field to itself, with limited competition, for a very long time. For example, Mattel dominated the market for dolls for young girls for many years with its iconic doll, Barbie. Since 2001, MGA Entertainment has taken away a significant portion of Mattel's market share with its edgier, multiethnic Bratz dolls. Another example of how a company can have the market to itself is in the biotechnology business. Companies such as Amgen or those specializing in orphan drugs can patent their drugs (or molecules) and create a virtual monopoly for the products, at least for a limited period of time. Amgen owns patents for its products such as Epogen and Neupogen, and has an army of lawyers to protect its intellectual property. While the patent remains valid, Amgen has a market protected from competition and can earn high profit margins. The same is true for so-called orphan drugs, which are drugs that treat relatively rare but serious diseases. Such diseases would not be profitable for investment and development by pharmaceutical companies if competition were permitted. Once a drug has been patented, it has special status and is relatively protected.

As the market for the new product becomes increasingly saturated, the new venture's rate of growth cannot be sustained for its given product vehicle. A classic historical example of this phenomenon was the highly successful dBASE II—one of the first software products for database management, marketed by Ashton-Tate, a company that no longer exists. As the potential users of dBASE II were reached, and as new competitors entered the marketplace, it was necessary for Ashton-Tate to identify new products to continue its growth. Ultimately, the company was unsuccessful in accomplishing this task and was, as a result, sold to Borland, which in turn was ultimately purchased by another company. In contrast, Oracle Corporation, which is itself built on a platform of database management software, has been able to deal successfully with the challenge of product diversification through software applications to become a dominant multibillion-dollar company.

One way of thinking about the difference between the issues faced by a company during Stages I through IV and the issues faced in Stage V is to consider the analogy of a product as an oil field. The central problem in petroleum exploration is finding new oil fields. Once an organization has found an oil field, it builds up an infrastructure to tap the oil well and convert it into marketable products. As the size of the business increases, the firm has to build its business around that oil well. The central issues here are developing the capability to tap the oil well and marketing its products. From this standpoint, the oil well is essentially a resource that the firm is drawing on. However, this resource has a finite life, which means it will not last forever—only until all of the oil has been pumped out.

Most consumer and industrial markets are very much like oil wells, in that they will not last forever. They may produce a gusher that leads to very rapid growth for an organization, but over time the oil wells inevitably play themselves out. When a company builds up its organizational and management infrastructure to tap an oil well, it usually does so with the intention of remaining a going concern. This means that if the organization is to continue to exist, it must find other oil fields that it can begin to extract resources from. Accordingly, if the company is to become more than a one-time venture, it must use some of the resources earned from tapping the oil well to invest in exploration of other oil fields. It should be hiring geologists to search for additional oil fields, spending additional resources in drilling test wells, and so forth.

Companies in totally different businesses from petroleum exploration and refining will find it useful to think of their business in terms of the oil well analogy just described. A company's entrepreneur identifies a new market, which is analogous to a petroleum corporation finding an oil field. The company develops a product that is accepted by consumers, which is, again, analogous to a firm beginning to tap the oil in the field. The organization then builds up the operational management infrastructure necessary to operate the day-to-day business, while simultaneously preparing an infrastructure that is necessary to continue the operation after its first product has been used up. Thus the challenge of Stage V is essentially long-run organizational sustainability. This is analogous to finding another oil well. If the organization is prudent, it will not wait until its markets are sufficiently dried up to begin locating new markets and building new products. Accordingly, it will be engaged in a process of research and development designed to identify new oil fields and begin their production while its current oil fields are still producing.

Typically, an organization can only expect that a given product vehicle will carry it to the range of $100 to $500 million in annual revenue. As discussed previously, this is simply the normal curve for this phenomenon, and certain companies may not experience the need for a new product vehicle until significantly after $500 million in revenue is reached. A number of companies have reached $1 billion in annual revenue before they experienced the need for a new product vehicle; however, these are the exception rather than the general rule. The upper limit for growth through a single product or line of business may be reached well before a company generates $500 million in annual revenues. For example, Bell-Carter Foods—a family-owned business that is the largest producer of table olives in the United States and the second-largest in the world—faced this problem at about $100 million, because at that size they had captured about 80% of the market for their core product (ripe black olives).

A variation on this problem was experienced by Amazon.com. The cost of developing the infrastructure to operate the business of selling books over the Internet was sufficiently great that the company needed to diversify its product line. Today, Amazon sells a variety of products over the Internet, including magazines, music, DVDs, videos, electronics, computers, software, apparel and accessories, and shoes—as well as books.

If the diversification is attributable to a decline in growth, the transition to Stage V will require a redeployment of entrepreneurial skills. The entrepreneurship that was the basis of founding the business in Stage I must reemerge and become a dominant force in Stage V. Because the original product vehicle was sufficient to carry the company along in its chosen market, the managerial problems of Stages II through IV involved building the operational and management infrastructure to support the growing organization. However, the need to diversify translates into the need to be entrepreneurial again.

Unfortunately, it may not be possible for the company to simply go back to its original entrepreneur and have that person repeat the entire process that began some time ago in Stage I. In some cases, the entrepreneur is no longer with the organization and may be deceased. For example, when The Walt Disney Company required revitalization and diversification, its founder and namesake Walt Disney was deceased and so a new team of executives needed to lead this effort.

There are many examples in business where the original entrepreneur has not been available to grow with the firm as it developed from one stage to the next. For example, Steve Jobs and Steve Wozniak both left Apple Computer. Jobs returned in the late 1990s and, in fact, served as the champion of that company's diversification through the development of its “i” line (iPod, iPad, etc.) of products. Even if the entrepreneur is still with the company, a significant amount of time has usually elapsed, as it has passed from Stage I through Stage IV, and at this point the entrepreneur is now burdened by a significant number of organizational activities. This means that the entrepreneur may not have the time or mindset available for thinking entrepreneurially about new products and markets.

It is often, then, extremely difficult for entrepreneurs to repeat their earlier success. There are many examples of companies where there was a brilliant entrepreneurial success but a failure to repeat that success at any significant level. Accordingly, what is needed is to reestablish entrepreneurship in the organization, but it must be done in a different way. Rather than looking to a single entrepreneur, organizations at Stage V must develop a cadre of so-called entrepreneurial managers.

An entrepreneurial manager is different from a pure entrepreneur. Howard Schultz, the late Steve Jobs, Jack Ma, and Michael Dell are relatively pure entrepreneurial types—very different from professional managers. As described in Chapter 1, an entrepreneur is typically someone who is above average in intelligence and has a very strong sense of the way he or she wants things to be done in the organization—that is, has a high need for control. Some people might even consider the entrepreneur to be a workaholic or to have an obsessive personality. Nevertheless, these are the very personality traits that are both necessary and useful to a company during its early stages of growth. Although a Stage V organization needs to develop a cadre of entrepreneurial managers, it is not necessary for these managers to have the same personality as an entrepreneur; rather, what is necessary is to train the entrepreneurial manager to mimic or simulate some of the behavioral patterns of the entrepreneur.

A number of organizations have experimented with the reintroduction of entrepreneurship and the training of entrepreneurial managers. The term corporate entrepreneurship has been used to distinguish this process of reintroducing entrepreneurship through entrepreneurial managers from the entrepreneurs required to start a new company. The entrepreneur is someone who can create a new business where none existed previously. In contrast to the entrepreneur, the corporate entrepreneurial manager is someone who can create a new business venture within an established organization. The challenge, then, is to create development programs that will help people make the transition to being entrepreneurial managers. Further, the company must develop systems and a way of thinking (a culture) that supports corporate entrepreneurship. 3M is the classic company that has demonstrated this as a core competency. This company's focus on corporate entrepreneurship has resulted in many innovative products—including Post-it, which has become a multimillion-dollar business.

Diversification Attributable to New Opportunities. Diversification can also occur simply because the core business creates opportunities for expansion in quasi-related areas. For example, Tommy Bahama, a men's clothing line, developed Tommy Bahama as a lifestyle brand. The iconic advertising figure of Tommy Bahama and its South Seas image led other companies to seek license relationships with Tommy Bahama and has led to Tommy Bahama stores that sell not just clothing but watches, cologne, and related accessories. It also led to the development of a Tommy Bahama restaurant chain and Tommy Bahama furniture.

Another example of diversification attributable to extension of an organization's core capabilities is Techmer PM (Techmer). Founded in 1981 by John Manuck, a chemical engineer who had worked for Monsanto, Techmer PM provides design and technical support for colorants and various additives that modify and enhance the physical and visual properties of plastic products that are used by automotive, home furnishing, hospital supply, food packaging, construction, and many other industries. By 2014, the company had grown to over 600 employees and had manufacturing sites in California, Tennessee, Ohio, Illinois, Kansas, Georgia, and Pennsylvania, as well as a presence in many international markets.

In 1982, Techmer PM began selling colorants to industrial trash bag producers. Manuck noticed that while the trash bag makers normally purchased the cheapest colorants they could find, they occasionally purchased red colorant at a much higher price. He learned that the red was for a new market segment to indicate biohazard—the variation of shade was unimportant, as long as it was red. The other important property was the high opacity of the bag so that you could not see the physical contents. With a flash of brilliant insight, Manuck had the idea of developing a specially formulated red colorant by adding a low-cost iron oxide pigment to the usual red formula that dramatically increased the opacity while lowering the cost. The only negative was that the bright red color became a dull red color. When the customer pointed out the change in color, he was asked if he would be interested in trying a test run using 20% less of the colorant to achieve his desired opacity while paying the same price per pound that he had been paying for his previous red. It became an instant success and quickly became known as Techmer hospital red.

There is also a more recent example of diversification at Techmer PM. In 2014, Techmer became involved with the new technology of 3D printing because this manufacturing process utilizes specific polymer properties. Also, it is an example of innovation via collaboration. Techmer's largest facility is located in Tennessee and is about 20 miles from the Oak Ridge National Laboratory (ORNL). In early 2014, Techmer and ORNL began working together to produce parts using Big Area Additive Manufacturing (BAMM), large parts that are 3D printed. In December 2014, they produced a 3D-printed electric motor version of the 50th anniversary Shelby Cobra. The thermoplastic/carbon fiber composite used for the chassis was designed and produced by Techmer. This innovation was viewed as sufficiently important that it led to a visit by President Obama to the Techmer plant in Clinton, Tennessee, one month later.

Another example of diversification concerns the authors' own firm, Management Systems Consulting Corporation (Management Systems). Founded in 1978 by Eric Flamholtz to assist organizations in applying the methods and tools presented in this book, Management Systems engages in research to develop methods and tools to help build sustainably successful organizations^®. Our clients have ranged from start-ups to members of the Fortune 500—including Amgen, American Century Investments, Baskin-Robbins, City National Bank, Guggenheim Partners, The Disney Store, IBM, Kusto Group (Kazakhstan and Singapore), Li-Ning (China), Navistar, Neutrogena, 99 Cents Only Stores, Mövenpick Gastronomy International (Switzerland), PIMCO, PowerBar, Princess Cruises, Simon Property Group, Starbucks, Techcombank (Vietnam), The Riverside Group (China), Westfield, Wolfgang Puck Food Company, and many others.

For many years, Management Systems received inquiries from consultants around the world who were interested in becoming affiliated with the firm and in licensing its methodology and tools to apply them in their own countries. Finally, in 2011, at the request of Vladimir Kuryakov, associate professor at the Russian Presidential Academy of National Economy and Public Administration, our firm initiated a program to license, train, and certify affiliates to deliver our methodology and tools in their countries.

By 2015, Management Systems had licensed and certified affiliates in Argentina, Bulgaria, Italy, Israel, Kazakhstan, Poland, Russia, and the Ukraine as well as in the United States, and Canada. In addition, the firm had associates who represented it in Australia, China, Hong Kong, and Vietnam.

Management Systems' global affiliates business was a diversification from its core business of researching and developing methodologies and tools to deliver directly to companies to enhance their effectiveness. By 2014, approximately 50% of Management Systems' revenues were derived directly from royalties paid by affiliates for its intellectual property and/or indirectly from client referrals created by its affiliates business.

Failure to Achieve Diversification. When an organization fails to diversify successfully, the result can be stagnation, sale of the company, or even bankruptcy. Even companies with well-established iconic brands can ultimately suffer or meet their demise. A classic example is Cuisinart. Cuisinart was an upscale brand well-known for its food processors that were highly popular in the 1970s. Yet, the company filed for bankruptcy under Chapter 11 of the federal Bankruptcy Code in 1989. The food-processing business had become saturated, and though the company still controlled about 45% of the food-processing market, it experienced difficulties.

Cuisinart had not done effective strategic planning and failed to capitalize on its famous name. By the time it filed for Chapter 11, the company had only recently begun branching out to items such as cooking utensils, hand blenders, and other cooking products. Cuisinart had defined its business as the “food-processing business,” rather than more broadly, and unfortunately its traditional market dried up before it found a new one. It should be noted that Cuisinart was purchased by Conair Corporation in 1989, rebuilt its brand and business, and became a company offering what it refers to as “culinary tools,” including bakeware, coffee makers, microwaves, and, of course, food processors.

Two other companies that had iconic brands but suffered due to lack of diversification were Smith Corona and Schwinn. A leading maker of typewriters, Smith Corona filed for bankruptcy, in part, because the market for typewriters disappeared. Typewriters had been replaced by personal computers, and the company had not effectively responded with new products to meet changing customer needs. This company no longer exists. Schwinn, once a leading brand of bicycles, failed to recognize the changing needs and preferences of potential customers. The type of cycle that had become popular was quite different from those offered by Schwinn, and the company filed for bankruptcy in the early 1990s and was purchased by another company.

Starbucks Illustrates Successful Diversification. One spectacular example of a company that has taken both internal and external routes to achieve successful diversification is Starbucks. The company has diversified from its original core product (coffee) with the addition of other beverages and products sold within its cafés/stores. It has also leveraged the Starbucks brand with other products such as ice cream (a joint venture with Dreyer's) and has made acquisitions in the United States and Europe. Starbucks had the infrastructure to do this. Even though Starbucks seems to have saturated the U.S. market for cafés, growth in stores continues with its expansion into teas, juices, and food.

Apple Illustrates Successful Diversification. Apple illustrates that successful diversification can occur in technology as well as in more basic products like coffee and restaurants. With one of its founders, Steve Jobs, serving as CEO and champion of new products, Apple diversified from its early dependence on computers with the development of the iPod and then the iPhone. The “i” products have been spectacularly successful and have led Apple to become an iconic company with a loyal following. Its products have achieved what some manufacturers dream of—becoming “cool.” Among its constituency, the use of an Apple product conveys prestige on its user and marks the user as a member of what can be termed Apple Nation©.

Apple has continued its diversification development with the Apple Watch and Apple Pay. Apple was not the first to try to enter the mobile payments industry with their Apple Pay services; however, they were the first to successfully reach mass adoption. Within the first three days of its launch, Apple Pay had already become the largest mobile payment system with more than 1 million credit cards registered.¹ The success of Apple Pay is largely due to Apple's leveraging its mobile hardware, dominant position, and clout in the mobile phone market, and (rather than trying to challenge them) partnering with the major credit card companies (American Express, MasterCard, Visa) and several of the large banks.²

The Apple Watch was introduced at the same time as the Apple Pay system. The Apple Watch was designed to integrate with many of Apple's other products and services. It provides functionality beyond telling time, including fitness tracking, mobile alerts, handling messages and calls, providing directions, and running third-party apps. The majority of the watch's functionality is dependent on the iPhone, and each is intended to be integrated with the other.

Keys to Success at Stage V. The central problem of Stage V is to diversify the business so that it is no longer dependent on its initial product vehicle or the initial market. The key to success in Stage V is to identify and produce one or more new products (or services) and/or to identify and effectively enter one or more new markets. This might involve diversifying outside of the organization's initial business segment. The company may be developing multiple businesses (typically, but not always through the creation of new divisions). Thus Stage V is a time when the business should be making two transitions: (1) from one product, service, and/or market to multiple products, services, and/or markets; and (2) from a single business to a set of businesses. This can be accomplished through internal development of new products, identification of new markets, or acquisition of other organizations. This is not a trivial challenge, and many companies fail to achieve it. However, once Stage V has been successfully completed, the next challenge is to effectively integrate these new businesses, which is the focus of stage VI.

Stage VI: Integration

In the process of making the transition to Stage V, an organization sets in motion the forces that require it to move to Stage VI—the stage of integration. During Stage V, the entity will have made the transition from a single product line (or service line) company to a multiproduct (or multiservice) company, and/or it will be operating in very different markets. This means that by the time the organization completes the diversification process begun in Stage V, it will consist of a number of individual business entities. As a result, it will need to develop an infrastructure that will support managing each of these individual units as part of an integrated whole.

Developing an infrastructure to support this new business becomes the key challenge of Stage VI. The organization now needs to focus on ensuring that it has the appropriate resources, operational systems, management systems, and corporate culture to support the now very different company that it has become. A new kind of operational and management infrastructure must be created and implemented. These new systems at the corporate level must be designed to manage a set of businesses, rather than just one business.

Issues to be Resolved in the Integration Stage. Several different but related issues must be addressed during this stage of organizational growth. One issue involves the process of strategic planning, both at the corporate level and within each division, and the problems involved with integrating both. There are also issues involving the proper organizational structure of each division and of the company as a whole. By the time an organization completes Stage V, for example, it will most likely be (or need to be) organized into divisions (that is, it will be “divisionalized”) and this brings the need to clearly define the role of “corporate” versus the roles of each division. There are also issues related to how performance management systems should be designed and implemented within the now larger, diversified business. The organization needs to focus on ensuring that the operational systems at both the corporate and divisional levels of the company promote effective and efficient operations.

Another issue involves questions of managing the corporate culture. Specifically, each of the separate divisions within a company may have somewhat varying cultures. The systems and culture of each division may need to be, in some cases, blended so as to promote the cooperation needed to achieve goals; in other cases, the company needs to promote the belief that differences in systems and culture between divisions will be maintained in the service of meeting the organization's long-term goals. A key challenge at this stage, then, involves deciding how best to integrate the systems and corporate culture of the various units created in Stage V.

A critical issue underlying the design of the management system for a Stage VI organization involves the degree of centralization or decentralization of authority accorded to each division. Companies vary widely in the amount of decentralization that they grant to their operating divisions. This issue can be viewed as points on a continuum. At one end of the continuum are firms that attempt to control virtually everything their operating divisions do. At the other end of the continuum, a corporation essentially operates as a passive investor with a “portfolio” containing various companies. The strategy here is to defer strategic decisions and daily operations to the divisional general managers, while requiring a specified performance in terms of return on investment or amount of profit. In between are companies that strike a balance between controlling everything and being a passive investor. This type of managerial philosophy has been used for many years at Johnson & Johnson.

For example, at Johnson & Johnson, divisions may be required to achieve a 15% pretax return on investment. The methods of achieving this target return are left to divisional managers. The corporation also requires that various management systems be in place, such as a planning process. In addition, Johnson & Johnson has used its Signature of Quality Award process to motivate the development of operational and management systems at its individual companies. Companies must apply for the Signature of Quality Award, and they are evaluated on, for example, business competitiveness, organizational alignment, and information competitiveness. The specific details of these categories are less significant than the process that Johnson & Johnson is using to motivate operating divisions to develop their infrastructure.

The phenomenon of having a number of businesses within a larger entity is not only found in large, established companies such as Starbucks, Johnson & Johnson, Procter & Gamble (which now owns Gillette), GE, Citicorp, IBM, Apple, and Microsoft; it also exists in many smaller organizations. For example, Infotek—a rapidly growing Stage III company, with $40 million in revenues—had three independent divisions. Similarly, Starbucks had four divisions when it had approximately $350 million in sales.

Special Issues in Integration of Acquisitions. Another version of the need for integration of different businesses arises from the acquisition of other companies. In fact, some organizations use acquisitions as their main vehicle of growth. For example, Emergent BioSolutions—a publicly traded biopharmaceutical company focused on developing, manufacturing, and commercializing vaccines and therapeutics that assist the body's immune system in preventing or treating disease—regularly acquires smaller biotech companies as part of its overall growth strategy.

When an organization grows by acquiring other companies, it faces the need to integrate. There are many examples of failed or disappointing acquisitions attributable to the failure of effective integration. The typical cause of this integration failure is incompatible cultures.

There are, however, some companies (such as Johnson & Johnson) that have developed a core competency in the successful integration of acquisitions. Johnson & Johnson (J&J) has had a long history of successful acquisitions that includes companies such as Alza (drug delivery products), Centocor (biotechnology), LifeScan (diabetic monitoring equipment), Neutrogena (personal care and cosmetics), and Scios (biotechnology). For example, when Johnson & Johnson acquired Neutrogena, it put a J&J person in place to manage the acquisition. The person who became CEO of Neutrogena was told (in effect), “We put a lot of chips on the table. Don't screw it up.”

As illustrated in this brief example, a key to Johnson & Johnson's success is that they acquire companies that generally fit their culture and gently bring them into the “J&J way” of doing things. This has contributed not only to successful growth and integration of companies but has led to the consistent recognition of Johnson & Johnson as one of the most admired companies.³

When acquisitions are used as all or part of the process of diversifying the business, it might also be the case that certain corporate-wide systems will need to be adjusted to meet the needs of a new division while at the same time maintaining control. In one $100 million division of a Fortune 500 company, for example, problems were created because the corporate parent mandated that certain operating systems would be used that did not adequately meet the needs of the smaller firm. Further, the parent company's culture promoted cautiousness, while the subsidiary needed to respond quickly to take advantage of market opportunities. Finally, the compensation system of the parent could not reward behavior that contributed to business development; it was structured to maintain the status quo. Without careful management and negotiation with the parent organization, such practices can adversely affect a division or subsidiary's ability to succeed.

Overall Aspects of Integration. Problems faced by organizations in Stage VI are, to a great extent, a function of organizational size, complexity, and geographical dispersion. The greater the revenues (and, in turn, personnel and transactions), the greater the degree of geographical dispersion, and the greater the degree of business variety, the greater the problems of organizational integration are likely to be.

There is a considerable payoff for successfully meeting the challenges associated with this stage. Once an organization has completed this stage of development, it will typically have achieved more than $1 billion in revenue. Our research data (discussed in Chapter 5) suggest that the probability of continuing to operate successfully after an organization has reached $1 billion or more in revenues is enhanced. Although some organizations experience difficulty and even fail, organizations are more likely to continue to grow successfully after completing Stage VI. At that point, they have become “institutions,” with a variety of self-perpetuating capabilities.

Companies that have been successful as institutions of this kind are Starbucks, GE, Nestlé, Procter & Gamble, and Johnson & Johnson. All are companies with self-perpetuating capabilities.

Keys to Success at Stage VI. The central problem facing corporations in Stage VI is how to integrate a set of diverse divisions into one unified business entity. Successfully meeting the challenges of this stage involves integrating the operations of the new businesses created or acquired during Stage V, while maintaining the organization's entrepreneurial spirit.

During the integration stage, the company has a simultaneous need to have some degree of centralized control over the diverse operating units and to allow divisional managers sufficient freedom to be entrepreneurial in managing their operations. Many companies do not do a good job of striking this delicate balance and lean too heavily toward organizational control. The price is a loss of entrepreneurial instinct and culture, and the creation of institutional bureaucracy that is more concerned with form than with substance.

Stage VII: Decline and Revitalization

The final stage in the organizational life cycle is Stage VII—Decline and Revitalization. The key issue facing management at Stage VII involves revitalization of the entire organization.

In contrast to most of the other stages, which constitute a sequential hierarchy as an organization grows in size, an organization can jump to Stage VII from almost any other stage. Although it is typically the larger organizations that are most in need of revitalization, there are examples of organizations at $30 million, $50 million, and $100 million that have reached Stage VII and are in need of revitalization. By the time a company has reached the multibillion-dollar level, however, it is sure to have the seeds of future potential decline within, even though it appears to outsiders to be at the apex of its success and power.

The stage of organizational decline and revitalization seems to be inevitable. All organizations, regardless of their greatness or past success, inevitably experience a period of decline. In the late nineteenth century, the railroads were the dominant enterprises, but they failed to use their resources to move into other aspects of transportation. In the early part of the last century, United States Steel Corporation was the hallmark of the U.S. economy, but it did not retain that position. In the 1950s, General Motors was at its apex, yet it, too, experienced decline. Other once-great corporations that have experienced organizational decline include IBM, AT&T, Sears, Kodak, National Lead, International Harvester, Xerox, Levi Strauss, and Ford.

This phenomenon occurs not only in the United States but in other parts of the world as well. Examples of once-great companies in other parts of the world experiencing decline include Reuters, Allied Domecq, Toyota, and Mövenpick. For some, decline led the company to the brink of bankruptcy; for others, it merely led to stunted growth; for still others, it led to their demise.

Causes of Organizational Decline. The problems that lead to decline and the need for organizational revitalization are frequently caused by an organization's own success. With organizational success comes an increase in the organization's size. Increases in an organization's size seem to create a certain degree of resistance to change. This can result from the vested interests of people who control the organization, or it can be that the organization's size has made it very ponderous, creating lengthy delays between the time the organization identifies a trend or problem and the time it takes action. For example, Kodak, which has a distinguished history as a successful company, missed major new markets (such as instant photography, videotape recorders, and digital photography) because its size, structure, and culture all made it move too slowly. It eventually went into bankruptcy and sold off its patents to a group of companies that included Apple, Facebook, Microsoft, and Amazon.

Organizational size does not seem to protect against decline; indeed, size itself may be one of the major factors creating the need for revitalization. A wide variety of organizations, including American Express, Hewlett-Packard, General Motors, and Sears have all faced the need for organizational revitalization, despite their many billions of dollars in assets and revenues. Even such an outstanding organization as IBM has faced the need for a revitalization effort.

Organizational decline is typically a product of many complex factors. Historically, some of the most common factors include increasing competition in a business's markets, loss of competitive skills from an erosion of leadership, a sense of complacency that inhibits organizational change, and, as described throughout this book, the inability of management to build an organizational infrastructure sufficient to keep pace with the demands of organizational growth. In addition to these classic forces of decline, there is also the risk of a “disruptive” new technology, such as the Internet.

Sudden Decline from Disruptive Technology. The development of the Internet and the related businesses that utilize the platform has caused many companies to experience decline. This can be thought of as a “sudden decline syndrome.”

Amazon has taken market share away from traditional retailers in many spaces. For example, Amazon's sale of books has led to disruptive change and decline for traditional book sellers such as Barnes & Noble and Borders (a company that actually went into bankruptcy and closed its last store in 2011). Similarly, Netflix and others have leveraged the Internet to do video streaming for at-home movie viewing. This, in turn, led to the loss of visits to movie houses, and the closure of many. It has also led some movie chains to reconceptualize their business as more than movies. Some chains such as Landmark Theatres have created a broader “entertainment experience” by using sofas and providing alcoholic beverages and light meals at the seat.

The phenomenon of a disruptive new technology is not new. It is an essential feature of business. In the nineteenth century, the development of electricity disrupted the dominance of artificial lighting via kerosene. It led to a business war between J. P. Morgan, who sponsored the research and development of Edison, and John D. Rockefeller, who was the entrenched dominant player with kerosene.

Decline from Market Saturation. The most common causes of decline—competition and the related phenomenon of market saturation—tend to increase throughout an organization's life cycle. During the early stages of growth after a new market has been identified, an organization typically grows and prospers, simply as a “reward” for having found the market for that product or service. For example, Apple found the market for personal computers and grew to approximately $1 billion in annual revenues. During this period, IBM—potentially a major competitor for Apple—kept telling its customers that there was no need for personal computers. Once the market was developed to the point where it was large enough to attract IBM's interest, IBM brought out its own version of a personal computer and took 30 to 35% of the total market, squeezing Apple's sales and profitability. Further, the IBM operating system became the industry standard and put additional pressure on Apple. Eventually, a number of other companies entered the market with IBM-compatible PCs. When Apple had the market virtually to itself, it earned premium profitability. Once competition increased, Apple no longer had the profit cushion that would mask its underlying organizational problems. While IBM was highly successful with its PCs, competition from Dell Computer ultimately reduced their market share and led them to sell their PC business to Lenovo in 2005.

Decline from Leadership Erosion. Unfortunately, the longer organizations exist and the larger they grow in size, the greater the likelihood that they will outgrow their founder's capabilities. Sometimes, this occurs because there has been inadequate focus on leadership development. In other cases, it might be that the company has simply increased in size at such a rapid pace that there hasn't been time to develop the needed skills. Leadership erosion can also occur when strong and capable leaders retire and need to be replaced. Phil Knight has retired from Nike, Bill Gates has retired from Microsoft, and Sam Walton is deceased and long gone from Walmart. When strong leaders like these are present and have guided their companies for a number of years, the organization will face the challenge of replacing them.

Decline from Dysfunctional Culture. Still another contributing cause of organizational decline is a cultural problem—an increasing sense of complacency. When an organization is successful, people reasonably expect to be rewarded. Sometimes the rewards are too great for the organization to sustain. Moreover, the very fact that success has persisted over time may lead people to come to expect rewards as an entitlement. This form of managerial hubris can create a self-congratulatory atmosphere that produces a resistance to change and ultimately leads to decline. In many firms, this is reflected in a lack of concern about whether or not there are new products in the pipeline. It may also be reflected in an attitude of, “We know best what the customer wants,” without actually listening to customers. Further, and perhaps more dangerous, is the feeling that the company is somehow invincible. This attitude can be disastrous when a firm competes in markets where others have systems in place to both monitor and respond to customer needs. In one $150 million firm, for example, the belief was, “We found the market and we produce the best product. No one can catch us.” As the firm basked in the glory of its own success, it watched as competitors slowly took away a significant percentage of its market share.

Decline from Inadequate Infrastructure. A final, major contributing factor to organizational decline is the inability of management to develop an organizational infrastructure sufficient for the organization's stage of growth. This problem will be one of the key themes throughout this book. Indeed, the problem is the crucial issue of Stages II through IV, and when management is unsuccessful in meeting these developmental challenges, organizational decline is inevitable.

The Process of Revitalization

Although there are a number of issues involved in any case of organizational decline and revitalization, the basic problem that makes revitalization so difficult is that an organization at this stage must focus on all six of the key organizational development areas at the same time and may also need to focus on changing its business foundation. The organization must now simultaneously rethink “who it is,” what it should be working to achieve, how it should be competing, its markets, its products and services, its resources, its operational systems, its management systems, and its corporate culture. Although organizations at every stage must give some attention to all six levels in the Pyramid of Organizational Development, at Stage VII, it is critical that an organization simultaneously concentrate on all six areas plus the business foundation, and this makes revitalization complicated and challenging. Each aspect of the revitalization process (beginning with the business foundation) is examined next.

Revitalizing the Business Foundation. To exit decline and revitalize, some organizations may need to broaden, narrow, or completely change their business concepts. For example, Hewlett-Packard, which was originally in the test and measurement equipment business, is now in the business of providing personal computers, printers, enterprise server and storage technology, software, and a wide range of related products and services to individual and enterprise customers worldwide. If the business concept is changed, the strategic mission will also change because now the company will be focused on either a broader or more narrow segment of a market or will be operating in, perhaps, a completely new market. In most cases, however, the strategic mission will be focused upon “getting our house in order” and getting back to profitability. The core strategy—or overall way that the company competes—will also need to be examined and may need to be redefined to reflect the organization's current status, including the environment in which it is competing and its internal capabilities. We will explain these concepts further and describe how to develop them in Chapter 6. The bottom line is that for the organization to survive, it needs to be willing the change the very basics of how it operates and what it is in the business to do.

Two examples of successful revitalizations that involved a change in business concept were Disney and Nike. Under Michael Eisner's leadership, Disney revitalized from a distressed family-oriented motion picture and theme park company into a global entertainment powerhouse (a change in business concept). Similarly, Nike broadened its focus from athletic shoes to athletic wear and built a so-called power brand or “super” brand. Both companies did this as part of revitalization efforts.

There are also examples of companies who were unable to exit decline because they were unable to effectively create a solid business foundation. For example, the unsuccessful revitalizations of Radio Shack, Sears, and Kodak can all be traced to a problem in the business foundation, and in particular the business concept.⁵ None of these companies were able to redefine their business concepts in a workable way. This in turn had an impact on what they could be expected to achieve (the strategic mission)—particularly in the competitive markets that each faced. If the foundation of a building or a business is weak, then the structure built on top of it will also be weak or crumble. That is what happened in all three cases.

Revitalizing Markets. Once the business foundation has been reconceptualized, if it is necessary to do so, the next task is to revitalize markets. This involves finding ways to more effectively meet customer needs within the traditional market or identifying new markets to serve. During Stage I, a business is able to establish itself because it has been successful in identifying a single market. In Stage V, diversification efforts lead to the development of new markets. One of the fundamental reasons a Stage VII company experiences difficulty is that the organization's size has gotten out of sync with its ability to derive revenue from its traditional (or existing) market segments. The organization is now typically operating in one or more mature markets, meaning that the rate of growth in these markets is decreasing, with profit margins being squeezed. The business is trapped in a scissors effect, facing decreasing revenues from its markets on the one hand and rising operating costs caused by its increasing size and related inefficiencies on the other. With both blades of the scissors simultaneously closing in on the organization, management is busy doing its best to hold them apart.

The primary task now facing management is to identify markets that offer the most potential—in terms of growth rates and profit margins. IBM achieved this by changing its business concept from a manufacturing company providing computer equipment to an information solutions company, with a heavy emphasis upon information technology–related services.

Revitalizing Products/Services. Organizations in decline may need to significantly refine or update existing products and services or develop new ones. A company that is in decline and needs to be revitalized may have a product or set of products that have reached the mature stage. It might also be the case that the products and services being offered have become or are becoming obsolete due to new technology or new products being introduced by competitors. The critical problem in this situation is that the moment a company becomes aware that its products are no longer competitive in the marketplace, it has already lost a sufficient amount of lead time needed to react. Thus the organization is forced into a crisis. At a time when it needs additional revenues to invest in new directions, it finds that its revenues are declining for competitive reasons.

Revitalizing Resources. One of the relative advantages of established organizations is that they should have had the opportunity to accumulate resources over a period of time. At the same time, however, as an organization enters decline, these resources can dwindle very rapidly. The challenge for an organization in decline is to find the resources needed—including time—to invest in revitalization. At a minimum, senior leadership needs to find the time to devote to developing a revitalization plan. Resources might also need to be invested in product research and development, new technology, and, perhaps, new people.

A company facing revitalization may have a significant amount of resources at its disposal, but some of these resources will be redundant or obsolete. In brief, they may not be the type of resources that the company needs to support its exit from the decline stage. Some of its inventory, its plant and equipment, and even its people will not be appropriate for the new challenges it faces. The company may also find itself with the need to redeploy some of its assets from one market segment to another. At this stage, the company may need to make major investments to revitalize the organization, and unfortunately it may encounter internal resistance to investing in the resources needed to revitalize itself. While it is important to exercise care in making investments at a time when the company may be losing money or, at a minimum, experiencing significant challenges in continuing to successfully grow, these investments in people, technology, equipment, and so on, will be critical to the organization's very survival.

Revitalizing Operational Systems. Organizations in decline frequently have well-established operational systems—which can be both a blessing and a burden. It is a blessing because the company has systems in place. The problem is that they may not be effectively designed to meet the organization's current needs, and they may not be as efficient as they need to be. During revitalization, the leadership team may find that one or more of the company's operational systems simply “don't work” anymore, or have become obsolete. In these cases, the company may literally need to abandon some of its traditional systems and invest in implementing new ones. The time needed to replace old with new systems can also create problems as people learn how to use them and as they are debugged. In the shorter term, this might add to the company's already significant problems.

An effective strategy for identifying the steps that need to be taken to improve a company's operational systems in the context of a revitalization is to complete an assessment of the current systems' effectiveness. This assessment can be conducted by external consultants, by convening an internal task force, or a combination of both. If an internal task force is used, care must be taken to prevent members from protecting their vested interests in preserving certain systems, which may be beneficial to those members but hurt the overall organization.

A traditional area for operational system problems involves product development. Organizations needing revitalization frequently possess a functional organization structure in which the responsibility for product development is divided among production, sales, and engineering. This structure tends to create a very lengthy product development cycle. The revitalization period requires a unity of purpose within the organization. Accordingly, new products need to be developed with centralized coordination of engineering, manufacturing, and sales. The structure most appropriate for this is a divisional structure. In our judgment, it is not an accident that many of the revitalization efforts occur in organizations that have been using functional organizational structures.

Revitalizing Management Systems. Companies in decline may need to revise or completely change their planning systems, their structure, their performance management systems, and the processes that they use to develop management capabilities. These companies may have well-developed planning systems, but these systems may not be designed to focus leadership on managing all six factors that drive long-term success. In fact, the reason that the organization entered decline may be because its planning system is flawed. This might have led to the company “missing” or ignoring key environmental trends that contributed to their own products' obsolescence, to a lack of focus on developing important operational systems, and to ineffective management of the company's culture. An ineffective planning process can also contribute to poor decision making and poor execution of key goals—which in turn can lead a company into decline. During revitalization, the existing planning process may need to be refined or completely replaced. Chapter 6 describes an approach to planning that can be used to both minimize the probability of decline and assist an organization in decline in identifying and effectively managing the key factors that will lead to revitalization.

The company's structure may also be contributing to its decline and may therefore need to be revised. The leadership team needs to assess the extent to which the structure—including functional and individual roles and responsibilities—is aligned with the current strategy (which may need to change to support the company's revitalization). When there is a lack of alignment, the leadership team should develop a plan for changing the structure to better support the organization's revitalization and continued success. The process for managing structure is described in Chapter 7.

Inadequate management and leadership development (including both how the company has recruited management talent from the outside and how it has been developed within) may have been a contributing factor to decline. Simply stated, there are not enough “good managers.” When this is the case, there needs to be a focus on acquiring or developing the appropriate management skills to take the business into the future. In other cases, it may be that there are not enough entrepreneurial managers who can help identify and implement new products or services and new ways of doing things—skills that are absolutely critical to an organization that is in need of revitalization. When either of these situations exists, there needs to be a focus on designing and delivering a leadership development program to “close the gaps” and position the company to exit the decline stage. Strategies for designing and implementing effective leadership development programs will be discussed in Chapter 9.

Underdeveloped or flawed performance management systems can significantly contribute to an organization's decline. Specific problems that can contribute to decline include having systems that measure the “wrong things,” inadequate or inaccurate reporting of results, underutilization of measurement results, and lack of action being taken when results suggest that adequate progress is not being made. Developing or refining performance management systems should be a priority because these systems will provide the information needed to help assess whether the plans being put in place are, in fact, helping move the company out of the decline stage. The design and implementation of effective performance management systems will be discussed in Chapter 8.

One of the critical factors in any revitalization effort is, of course, leadership. If existing management is unable to mount a successful turnaround, companies are likely to seek new leadership. For example, Louis Gerstner was recruited from outside to IBM to lead the revitalization process after an earlier effort led by an insider had failed.⁶ Similarly, first Carly Fiorina and later Mark Hurd were recruited by Hewlett-Packard to lead a revitalization process after an initial effort led by company insiders was unsuccessful. Fiorina was responsible for Hewlett-Packard's merger with Compaq, but she was replaced by Hurd when the company encountered difficulties in making the merger work effectively.

Revitalizing Corporate Culture. Culture can also contribute to organizational decline and, as a result, may need to be revitalized. One of the typical problems of established companies is that, unintentionally, the culture begins to emphasize politics and avoidance of conflict and risk more than performance, quality, customer service, innovation, and profitability. Many people will have well-entrenched positions, and some are likely to resist making required changes, even though they are needed by the organization.

When the culture promotes the status quo versus innovation, ideas that might have prevented decline are not shared, and so problems go unresolved until it is too late. Sometimes, a company's success creates the belief (although is it usually a false belief) that “no matter what we do, we will be successful.” This belief can result in leaders ignoring very real environmental threats (e.g., changing customer needs, competitive products that are reducing market share or making the organization's product obsolete) or not focusing enough attention on ensuring that the company's infrastructure is aligned with current needs. In brief, a culture that promotes the belief that “we will always be successful,” can actually be a major factor in eventually sending it into decline.

A major focus of revitalization, then, needs to be on creating and managing a culture that fits with the new goals of the organization—that is, that promotes revitalization. This will include a strong focus on embracing change, on being willing to make tough decisions in the interest of preventing further decline, and on holding people accountable for performance against revitalization goals.

Revitalization of Simon Property Group. During the early 1990s, Simon Property Group (formerly Melvin Simon & Associates)—one of the largest shopping center developers in the United States—was experiencing a variety of growing pains. The size of the company had outstripped the managerial capabilities of its founder, Melvin Simon, and his brother, Herbert Simon, who were both primarily real estate developers.

The company began a program of revitalization that lasted about five years. This included the introduction of strategic planning, changes in organizational structure, the implementation of a formal management development program, and the redesign of the company's performance management systems. It also led to the introduction into the company of its current CEO, David Simon (Melvin Simon's son), who had an MBA from Columbia University and was more oriented to being a professional manager than either of the two elder Simons, who were primarily deal-oriented. The company culminated its successful revitalization by going public as Simon Property Group .

In 2013, David Simon was selected as one of 30 people listed in Barron's “World's Best CEOs.”⁷ During his tenure as CEO, Simon Property Group has had annualized profit of 17.4%.⁸ In contrast, the return for the S&P (Standard and Poor's) 500 was 8.7% during the same period. The company's stock price increased from $24 per share in 1995 to $160 per share in 2013.

Keys to Success at Stage VII. The overall challenge for a Stage VII organization is revitalization. The key to success at Stage VII is the ability to entirely reconceptualize and redevelop an enterprise. This involves becoming entrepreneurial again and being willing to change, if needed, everything about the business and how it operates. It also involves having the ability to rebuild the entire enterprise from the business foundation to its culture. This is an enormous challenge, which many companies fail to meet.