Corporate strategy begins with an understanding of the current state of the firm. The state of a company can be defined in multiple ways and my corporate framework uses leader, obsolete, stressed, and distressed. Corporate leadership is generally well understood – the company  and the economy are doing well and the executive team’s goal is to remain ahead of the competition and in tune with its clients’ needs by innovating. However, the phrases corporate turnaround, corporate transition and corporate transformation are often used, especially in challenging economic times, but there is no clear agreement amongst business executives and board directors as to what these terms mean. This confusion in terms of defining the state of the company usually leads to catastrophic strategic failure since any strategy that does not understand the current state of the company cannot address the issues faced by the company.

Disagreement about these issues is partly due to a lack of a general consensus on definitions but also partly due to the negative connotations they can evoke. In the minds of business executives the phrase “turnaround” immediately signals a distressed company which is considered an unacceptable message. At this point minds close. Executives avoid discussing what distressed might mean in this context and why it should be considered unacceptable. At one end of the scale are companies with large negative cash flows, no cash, no current assets, high short term debt, and facing legal action. Such a company is easily understood to be distressed. But at the other end of the scale is a company with multiple product/service lines that have high barriers to entry, each generating strong free cash flow. This is a successful company. The question is where on this scale does a company switch from distressed to a leader?

This question can be decomposed into three questions: 1. What is the corporate health scale that we are using? 2. What are the possible corporate states a company can be in? and 3. Where on the scale is each corporate state positioned?

Measuring Corporation State

There are many measures used in evaluating a company’s state: cash flow, leverage, barriers to entry, brand, etc. Just looking at the financials of a firm there are easily dozens of measures that executives can use to understand the state of the company. Investment analysts have many such measures, both direct, such as cash flow from operations, and derived, such as the cost to income ratio. Investment analyst measures, useful in certain circumstances to company executives, are not completely useful in formulating strategy. First, they predominantly focus on financials. Second, they are backward looking. Third, they usually only compare the company’s financial information with competitors when looking at external information, ignoring the wider economy let alone other issues affecting the external business environment.

The problem of looking at the position of a company is not new and there are many models available. One widely used model is the SWOT analysis. SWOT splits the corporate measurement scale into two dimensions: 1. The internal characteristics of the company, and 2. The external business environment. SWOT simply has two values for each dimension: positive or negative. These four values, two for each dimension, are listed in the table below.

SWOT Definition

• Strengths: Positive internal characteristics of the company.
• Weaknesses: Negative internal characteristics of the company.
• Opportunities: Positive external business environment.
• Threats: Negative external business environment.

The name SWOT is simply an acronym of the first letters of these four values. The values are intentionally not specifically defined further as the use of SWOT analysis, predominantly to drive strategy, is high level. Nevertheless, some examples are useful:

• Internal characteristics: Product adoption rates, cost efficiencies, scale, human capital, efficient processes.
• External business environment: Consumer tastes, technological disruption, legislation/regulation, interest rates.

This leads to the simple but extremely powerful matrix

SWOT Matrix

Classifying Corporate State

SWOT analysis is too often used in a purely reactive manner, e.g. if a company is strong but in a threatening environment, then it should use its strength to defend against threats. The four main SWOT pairings, based on the internal positioning of the company and the external business environment, and their conventional strategic responses are:

• Strengths – Opportunities: How can the company exploit opportunities to its advantage? This is the only proactive strategy of the four pairings.
• Strengths – Threats: How can a company use its strengths to defend itself against external threats?
• Weaknesses – Opportunities: How can a company use the external opportunities to compensate for its internal weakness?
• Weaknesses – Threat: How can the company minimise its weaknesses to avoid the external threats?

Other than the clearly superior strengths – opportunities strategy the other three are too reactive. As an example, a company that finds itself in the strengths – threats state should try and use its strengths to minimise threats, but that is not enough to become successful. When the external environment is negative a strong company can achieve far more than protect itself – it can use its strengths to take market share from weaker companies unable to manage the new weaker external environment. This leads to the idea of an externally based classification of competitive versus uncompetitive. The other internally based classification is a little more nuanced.

Corporate Position Definitions (SWOT based)

• Successful: Things are going well internally and externally and all indications are that this will continue.
• Obsolete: There is nothing internally wrong with the company, but the external world has changed.
• Stressed: There is an internal issue with the company but the external world is positive.
• Distressed: Both the company and the external environment are stressed.

These definitions automatically lead to a natural classification system.

Classifying Corporate Strategy

Expanding on the terms defined so far there is a natural extension to the standard characterisation of the corporate state that is critical for the formulation of strategy:

• Strengths – Opportunities: How can the company exploit opportunities to its advantage and create barriers of entry to competitors, creating a sustainable leadership position?
• Strengths – Threats: How can a company use its strengths to defend itself against external threats and to further increase its competitive advantage, transitioning into a leadership position?
• Weaknesses – Opportunities: How can a company use the external opportunities to compensate for its internal weakness and redefine itself, transforming into a leadership position?
• Weaknesses – Threat: How can the company minimise its weaknesses to avoid the external threats and use external threats to strengthen its competitive position, turning itself around  into a leadership position?

In this context, there are four strategies that can be defined:

• Innovate: The current state of the company is known, it is in a relatively strong position, the market is positive, and the target state is unknown. The company needs to innovate to maintain its leadership position.
• Transition: The current state of the company is known, it is in a relatively strong position, the market is negative, and the target state is an extension of the current state to a known new corporate state. It needs to transition its product / service offerings to meet the challenges of the market.
• Transform: The current state of the company is known, it is in a relatively weak position, the market is positive, and the target state is not known.
• Turnaround: The current state of the company is weak and unclear, the market is negative, and the target state is unknown.

Strategy Classification Matrix

Classification Blind Spots

My experience is that there are a number of blind spots that shareholders, boards, and executives have that lead them to misclassify the state of the company and the requisite type of strategy. These include:

• Profits appear stable, or growing, which gives decision makers a false sense of security. They may miss the following warning signs:
  • Cashflow from operations is deteriorating or negative.
  • Cashflow from financing is increasing much faster than revenue growth.
  • Government or parent company pricing subsidies. Examples: customers buying at an inflated market price of suppliers selling at a discounted market price.
  • Long cash conversion cycles, with current profit realised on old sales, but new sales are deteriorating. Example: real estate off-plan sales.
  • Delayed (hidden) costs. Example: in an operating lease, or a sale and lease-back deal, the initial sale and lease payments are discounted to market prices, but the the repurchase of the assets in the future is at a much higher cost, compensating the investors but harming the company. A specific example would be an airline that has an aircraft valued on its books at USD 100 MM, which it sells for USD 100 MM, pays below market interest on it, but is obligated to buy back the aircraft after 10 years for USD 90 MM when the market price would be USD 50 MM.
• Not understanding that the company is not institutionalised. This would include the lack of, or ignored, authorities matrix, processes, and procedures. It is astounding how many companies insist that they have procedures, when none of the employees follow them or even know that they exist. Proper institutionalisation would also include:
  • Management committees to authority authority and responsibility across the executive team. Too many companies have a CEO, or even a chairman, who controls every aspect of the business.
  • Role definitions for each department. A frequent example is the interpretation of the HR function as an enforcement or policing function, rather than a strategic human capital identification, recruitment, retainment, and development function.
  • Inter-departmental service level agreements with concrete deliverables, transfer pricing and KPIs.

Endnote

This is the first article in a series on corporate turnaround, transition, transformation and innovation. In the rest of this series I will go into detail into the steps of crafting a strategy based on identifying the current status of the company and classifying the type of strategy required.

Series Navigation

Corporate Transformation: Organizational Diagnostic >>