May 2, 2018 / 3:04 PM / 5 months ago

Breakingviews - Hadas: Shrinking to greatness is next CEO trick

LONDON (Reuters Breakingviews) - Deutsche Bank and Ford have taken the plunge. General Electric is testing the waters. These big companies are trying out their own versions of a corporate strategy that has almost never worked: shrinking to greatness.

Painted Matryoshka dolls, or Russian nesting dolls, are pictured in the Centre of Russian Culture in Daugavpils March 21, 2014. REUTERS/Ints Kalnins

Each story is different. Deutsche never really got its global financial markets operations to gel with its traditional German banking culture. Ford is getting out of the drooping U.S. passenger car business, which is now dominated by foreign companies. GE seems to have lost its way to high profitability and strong growth in almost every division.

What they have in common is the recognition that a longstanding strategy has failed. Chief executives are often among the last to admit this unpleasant reality. That is not surprising, since everything in their world makes the decision to shrink feel like a dereliction of duty.

In business schools, the future leaders learned that growth is necessary for survival in a competitive world. Shareholders insist on positive revenue comparisons. Pay packages usually increase with corporate size. And despite much venture capital buzz about daring to fail, the psychology of business success sits uncomfortably with cool calculations that amputation or dismemberment are better than limping on.

The unpalatability of big retreats is one reason they are so rare. Another is that the chances of success are low. Backwards moves rarely take companies forward. On the contrary, the most common consequence of sharp corporate pullbacks is more trouble later.

A gigantic example is Westinghouse. A century ago the electricity pioneer was a serious rival to GE in almost every business line. Westinghouse initially fell behind its traditional nemesis and then into increasingly serious trouble. After much strategic flailing, including numerous large asset sales, the company disappeared in 1999. Only the brand name lives on.

Though Westinghouse is extreme, few big companies have managed to prune their way to renewed corporate vigour. International Business Machines is a notable exception. In 1993, disaster loomed for the former near-monopolist. New boss Lou Gerstner got out of almost all its traditional businesses and helped change the corporate culture. IBM returned to solid profitability and growth.

Another former technology leader, Nokia, has a more typical story. Since divesting its largest business in 2014, the Finnish company’s shares have sharply underperformed European indices.

However, it still exists, which might not have been the case if it had not decided to let the much richer Microsoft try – and fail – to improve its weak position in mobile phone handsets.

There are big obstacles to successfully becoming both smaller and stronger. As many retailers have found, closing unprofitable branches leaves excessive overheads and wary suppliers. Shrinking companies generally struggle to recruit good workers. Besides, even after a business has been closed or sold, it is difficult to repair the broken corporate culture which helped create the mess.

Bad cultures frequently spawn weak CEOs who put off making hard decisions until financial weakness compels them to make even harder ones. Even fresh leaders recruited from outside can find their efforts at renewal stymied by disheartened and often mediocre middle managers.

If globalisation continues, so will the need for corporate shrinkage. As Ford and Deutsche Bank can testify, national leaders can become subscale and outclassed regional players on the global stage. The losing companies lack economies of scale and network effects that benefit the winners. They also often lag behind in technical and marketing skills.

U.S. companies’ experience of competing with newly emerging Japanese exporters in the 1980s provides a frightening precedent for weak incumbents. No amount of patriotic rhetoric or retrenching to core strengths could save America’s machine tool and electronic goods makers.

The next generation’s disrupters are likely to be from China. That country’s national champions, which benefit from a much larger home market and a more extensive diaspora than Japanese companies ever did, could cause even greater damage.

The best way to approach corporate shrinkage is to avoid it, by planning ahead. It is better to merge and slim first, even on apparently poor terms, than to slide and fall later. General Motors, for example, has unloaded its European car operations on Peugeot. The combined business will shrink significantly, but GM has probably been spared a big future headache.

Walmart is trying to set another good example. Rather than waiting to see which supermarket chain ends up surplus to requirements in the oversupplied UK grocery market, it is trying to fold its Asda stores into rival J. Sainsbury. Together, the two have a better chance at surviving.

The Arkansas retailer has learned that even national leaders are not immune to domestic challengers. Amazon has shaken its traditional stronghold, but Walmart is learning to choose its battles. Many top managers and company directors could learn from its experience. An increasing need for negative corporate thinking provides an opportunity for business schools and management gurus. Managing decline could be the next growth sector.

Breakingviews

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