Is the Sears bankruptcy the fault of financiers, looking at the world through spreadsheets?
Don’t blame the spreadsheets.
Logic is in the eye of the logician.
There is a core belief that is shared among financiers and MBAs: companies have natural cycles of Startup, growth, maturity, and death.
I was always sort of sad when we covered this in B-School. I guess it’s why I like the innovation side of the equation, but lately I’ve been questioning the dominant logic of decline.
How it works:
In the birth stage, there is more upside and little opportunity for downside. The job is to move from nothingness to taking the first breath of air. You don’t even ask about profits, or revenues - you look at non-financial metrics like user growth or adoption or sales cycles.
The growth stage is about searching for the upside, accelerating the growth. You have less to lose at this stage and all math formulas are optimized to spend into growth to get the company enough heft and advantage to shape the market.
KPIs shift to the balance between lifetime value and cost of customer acquisition. Value is best seen through the lens of comparisons to other companies, rather than detailed cash flow analysis.
Then the maturity phase kicks in - growth smoothes out. Time to move the efficiency experts in. The BCG framework tells us what to do - start managing the business to become a cash cow: repeatable steady growth, steady cash. Siphon the cash off to higher potential growth opportunities, and avoid overspending on the cows because no amount of spend can jump start that growth curve again.
Here’s where those classical financial models work best: discounted cash flows, using net present value to evaluate investments. Seen through this lens, big time marketing spend makes no sense. It’s time to reduce that brand and marketing spend to the most crucial promotion efforts that have provable ROI.
Then there is the decline phase. You know you’re in the decline phase when the financiers start to circle. They may attempt an investor activist move and take company private, while they leverage up on debt. There are one of two goals:
1/ Manage the last remaining years to siphon off as much cash as possible, and split up the company into salable assets. You can still make good financing fees and a return for your investors if you manage to not go bankrupt.
2/ Attempt a rebirth. A rebirth is nothing like a startup - it’s more of a controlled effort to restart and recharge. GM, Marvel Entertainment, and yes even Apple are examples of successful rebirths, emerging from bankruptcy, recharging, and now even thriving.
What can we learn from the Sears story?
Lesson one: financiers’ short term benefits are not calibrated to the survival of the firms they manage
Eddie Lampert and his Greenwich CT-based hedge fund purchased Kmart out of bankruptcy, became its chairman, and merged it into Sears. The year of the merger, 2005, his hedge fund earned a 69% return. Lampert was the first hedge fund manager to earn more than $1 billion in a single year.
Lesson two: There is no rebirth if customers cannot see it
Sears has not invested in revamping the stores, rebranding, investing in anything beyond bare bones customer service. Sears needed a more thorough revamping, beginning with things that customers could see.
Lesson three: It’s not the spreadsheet, it’s the mental model
Our mental model for decline is wrong, because our assumptions are wrong. Customers are not as captive and habit-based as in times before. Sears did not have a steady loyal customer base, so likely the revenue expectations were too "bullish" as they say.
The model was also missing critical context: flat customer income for a segment overlooked by recovery, the shift to online and mobile shopping, and the ever increasing expectations of customers (the Amazon effect).
All of the above needed to be factored into the decline phase for Sears - and to make a determination of whether to go big, or go home.
Decline, perhaps, is inevitable. Nothing lasts forever.
But our models for such thinking were created in the last century, when we had factories and plants and machinery.
We overlook employees who have ideas for innovation, but cannot act when the engines of creation are shut down by financiers looking to squeeze out the last bits of cash.
We kill marketing and brand efforts that accelerate the signal to customers that the end is near.
For those willing to take on a company that is past its prime, we need to take a systems view, building adaptive models to understand our complex times.
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