Last month I started a discussion on Jim Collins’ book “How the Might Fall” and focused on his first stage of decline; Hubris Born of Success.

This stage could be quickly summarized as losing one’s focus on what made the company successful in the first place; that is, its core competency. To put it in even simpler terms; drinking your own Kool-Aid and thinking everything you touch will naturally turn to gold.

Many companies think they can do anything and while they chase countless “shiny objects,” their core business begins to suffer and they lose the momentum needed to keep the business afloat and slip into a decline.

This month I’m going to touch on the second stage which is the Undisciplined Pursuit of More.

In the 1980s, Ames Department Stores acquired Zayre department stores in order to more than double the size of the company within one year.

It wasn’t an acquisition based on an underlying strategy like tapping into a better distribution system or a most cost effective supply network. It was done to simply grow the company for the sake of growth.

Ames began to use many of Zayre’s strategies which were a clear departure from what made Ames great in the first place. With the help of loss leader promotions (one of Zayre’s strategies), Ames more than doubled its revenues from 1986 to 1989, which was in-line with their initial goals. However, from 1986 to 1992, Ames’ cumulative stock returns fell 98% as the company sunk into bankruptcy and was eventually liquidated in 2002.

Contrary to conventional wisdom, most companies fail, not because of laziness, but rather, because of overreaching. They try to grow too fast and either fail to control costs or take unsubstantiated risks.

Think about the collapse on Wall Street in 2008; Lehman Brothers, AIG and Bear Stearns didn’t fail due to lack of drive or ambition – they went too far and took too many risks in order to grow profits at record setting levels. Where are they now?

In the early 1990s Rubbermaid tried to introduce a new product every day, seven days a week, 365 days per year while entering into a new product category every 12 to 18 months.

Does this sound like an ambitious goal, and one that would be incredibly difficult to manage while trying to produce, market and distribute an already expansive offering? Well, it was and as expected Rubbermaid began to fray at the edges, failing to control costs and fill orders in a timely manner.

In a statement to investors, Rubbermaid’s CEO originally stated, “Our vision is to grow.” That was it; there was no strategy beyond doing lots of new stuff, all at the same time.

Rubbermaid tried to innovate too fast, across too many industries, and in 1995 posted its first loss in decades. The losses forced Rubbermaid to scuttle 6,000 product variations, close 9 production plants and lay off more than 1,100 workers. The company eventually sold out to Newell Corporation in 1998 and never had a chance to recover on its own.

Innovation can drive growth, however, chaotic growth can easily bring down a company if not properly managed with a clear strategic goal.

In the 2000 annual report shareholders, Merck’s CEO stated, “As a company, Merck is totally focused on growth.” Not to be confused with profitability, research driven R&D or productivity, but rather, plain and simple growth.

Unfortunately for Merck, it was about to lose patent protection on five of its drugs that represented close to $5 billion in annual revenue. Generic drugs would eventually undercut Merck’s pricing and deteriorate most of its profitability and Merck wasn’t prepared.

Merck had to continually develop new drugs to fuel the same levels of growth it had experienced in prior years, but that wasn’t a simple task. Harvard case studies calculated the probability of a new molecule creating profitable returns at a mere 1 in 15,000. Merck was successful at beating these odds in the past, so when Vioxx was approved by the FDA, Merck seized the opportunity and marketed the product as their best launch ever.

By 2002, Vioxx sales rose to $2.5 billion and by 2004 over one hundred million prescriptions were written in the US alone. All efforts were poured into Vioxx not because it was successful but because it had to be a blockbuster. Merck’s only goal was growth and Vioxx was providing the majority of the growth needed to sustain the company.

As you might already know, Vioxx was pulled from the shelves in late 2004 amid concerns of heart attacks and strokes with patients using the drug over a prolonged period of time. Merck’s stock dropped nearly $25 billion in one day once the news broke and shareholders lost another $15 billion over the next six weeks.

Merck placed all bets on the success of Vioxx. It would have been lauded as a great company had the drug succeeded but hubris can lead a company to make unwarranted commitments for more and more. As soon as you’ve set the expectations too high, if you fall, you fall hard.

Merck wasn’t always focused on growth. George Merck II stated his goals back in 1950: “We try never to forget that medicine is for the people. It is not for the profits. The profits follow, and if we have remembered that, they have never failed to appear.”

The founders of Merck, Motorola and HP all shared similar goals for their companies. They started their companies and built them with great success based on noble purposes instead of just making money. It was the later generations of CEOs who forgot these lessons and inverted the goals much to the demise of their companies.

Think about Apple – it was initially founded to create innovative, simple and user friendly systems. Apple grew because of Steve Jobs’ original vision and failed when they tried to “make money” under the direction of John Scully, an experienced executive (read: suit) from PepsiCo. Apple reclaimed its position as one of the world’s most successful companies once Jobs returned to refocus the company on design and simplicity rather than on profits. Apple just so happened to make a ton of money in the process. Note: Apple generated $8.8 billion dollars in profits in the last quarter and sits on over $19.7 billion in cash. Not too bad for a hippie, college drop out!

Running a public company is a tremendously difficult task. CEOs face the relentless task of pleasing their shareholders and most end up focusing on short term objectives like quarterly earnings growth. Successful companies focus on building shareholder value rather than maximizing shareflipper price. They do not succumb to growth that undermines long-term value, but that is becoming harder and harder to do nowadays. Wall Street demands continuous growth and punishes companies that don’t perform as expected. Few companies have the strength and energy to ignore these forces in order to focus on measured growth in concert with their underlying strategy.

Only time will tell if the pressures of Wall Street will influence such innovative companies as Facebook and demand relentless growth. Until only a few months ago Facebook was privately held and happily developing products for its users rather than profits for Wall Street. Will its users tolerate endless ads or other disruptions in the pursuit of revenue growth or will they look to other providers to keep them connected with friends and family?

There was a time when MySpace ruled Social Media and Facebook was virtually unknown; remember what happened to them?

~TJM

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For more information on Jim Collins and his other publications, please visit www.JimCollins.com
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2011 Caterpillar 320DL
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Contact: Travis Mottet
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Email: TJM@JPMmachinery.com

I am one of the few people that actually like attorneys – not because they are nice people or because they provide a valuable service, but because they are often well connected.

I was reacquainted with a former grad school classmate a couple years ago during a chance networking meeting at Starbucks. Chuck and I attended a few classes together and even teamed up on a project for a marketing class. He was working on his JD/MBA while I was working on my MBA.

We never really attempted to stay in contact once we both graduated but I knew he would stay in San Diego and pursue a career in law while I went on to work in finance.

When I ran into Chuck 11 years later I was actually in the market for a new corporate attorney. Chuck worked for a boutique law firm downtown and I hired him on the spot.

Most of our subsequent conversations surrounded business. We needed to reorganize the corporate ownership structure of several entities and firm up some of our consulting and employment agreements; very boring stuff indeed.

We rarely met in his office and held most of our meetings during lunch at a social club in his building.

During one of our meetings the topic of booze came up. Chuck was more of a vodka man while I was a scotch drinker. He complained about the taste of scotch and said he wasn’t much of a fan. I told him I was in the same boat until I forced myself to have one glass of scotch each night for 40 days so I could acquire the taste. It worked after 2 weeks. Chuck laughed at the idea but said he would try it. Three weeks later Chuck was hooked.

Chuck introduced me to a few of his drinking buddies over the next few months and our lunch meetings quickly evolved into happy hour meetings.

One of Chuck’s buddies was a guy named Kenny who works as an investment banker and knows just about everyone in town. His best connection is with the North American Ambassador for The Macallan. Ian held a Macallan tasting event a couple times a year and, thanks to Kenny, I suddenly found myself with a VIP pass to his next event.

The event was something every scotch drinker should attend at least once in their life. The night started out with a tasting of a 10 year old, then 12, then 15, then 17, then 18, then 21 and finally a 25 year old scotch. Along the way Ian was on stage describing each drink along with historical/hysterical facts on Scotland, The Macallan, the distillation process, and several jokes about the English.

Of all the varietals we sampled, the 17 year old was certainly my favorite and I try and treat myself to a bottle every once in awhile. I have Chuck to thank for the introduction to the 17, but I also curse his name each time I’m in the checkout line since a bottle typically sells for $130 and up. Needless to say, I don’t treat myself very often.

~ TJM