Corporate Planning and

Corporate Collapse
John Argenti’

PetteStree Lodge, Woodbridge, Suffolk

Barmash, for example, boils it all down to just

ln this article John Argenti describes whet one fundamental cause-greed. It must be confessed
he found during a year’s investigation into that the 16 cases he describes in Great Business
company failure that he undertook for a re- Disasters’ do provide impressive backing for his
cently published book ‘Corporate Collapse’. claim. On the other hand, in a book confusingly
At first it was difficult to see any pattern but
certain conclusions gradually emerged as he
called Great Company Crashes by Deeson, we find
discussed the causes and symptoms of failure 10 cases which do not at all support this view and
with more and more people. indeed could be adduced to support almost any
Many of the lessons are of particular view.
significance for bankers, shareholders, ac- This multiplicity of causes of failure is also noted
countants and others but John Argenti by Professor Altman who is probably the only
believes there are a number of extremely serious academic writer in this field. In Corporate
important lessons for corporate planners as Bankruptcy in America4 Altman says that there
well-especially as ‘defective response to probably are many different causes of failure but in
change’ turns out to be one of the prime any case the prevention or prediction of failure can
causes of failure in mature companies.
probably not be improved by any attempt to estab-
lish causal links. Much more sensible, he suggests,
is to try to detect impending failure far enough
ahead to be able to do something about it. To this

T HJ2 STUDY OF THE CAUSES AND SYMPTOMS OF

company failure has been a most neglected
area of management. There is hardly any literature
end he derives two equations. In one he links the
general failure rate (i.e. failures per 10,000 existing
firms which, in America, normally runs at around
at all and there is certainly nothing approaching ‘a 40) to the business cycle. In the other, and perhaps
body of knowledge’ such as one can easily find on more interesting equation, he shows how to calcu-
many other management subjects-mergers, for late ‘Z’, or the propensity to fail, for any individual
example, or incentive schemes. A study of failure company. Certain London stockbrokers are using
does nevertheless contain some very important equations similar to Altman’s and a good deal of
lessons for corporate planners-as indeed it does work is now in progress in this field.
for everyone. One other book deserves mention, that by Smith’
Consider first the literature. There is Ross and called Corporations in Crisis. Among the causes he
Kami’ who say there are Ten Commandments of lists, after reviewing the history of a number of
management and that companies will fail if they failures, are diversification, decentralization and
break a number of these. They include strategic centralization. In addition to these five books there
planning, control systems, recognition that the are half a dozen articles which consist, for the most
customer is king-and so on. It is a strange fact but part, of lists of causes and symptoms. They are all
very few of these ten appear in the lists of any of different.
the other authors. While it may not come as a An extremely confused picture emerges from this
surprise that no other author lists ‘do not misuse literature although one or two threads can be seen
computers’ which is one of Ross and Kami’s ten, running through it. A much clearer picture emerges
it is surprising that none of them also list ‘strategic in discussion with receivers, accountants, bankers
planning’. and analysts. Moreover the threads that run quite
clearly through their experience of failed companies
are seen to be the same dimly perceived ones in the
*The author is well known to readers of LRP particularly literature. The picture becomes sharper still, and is
for his book ‘Corporate Planning a Practical Guide’. given a new dimension of reality, if a detailed and

12 LONG RANGE PLANNING

careful study is also made of the Rolls Royce creative accounting; if a company is using creative
failure6 and that of Penn Central.‘,s accounting it is failing.
This then, is why no one, not even the board, saw
the Rolls Royce failure coming. Because the com-
pany capitalized the annual R & D costs of the
THE FAILURE TIME SPAN
RB211 the company could demonstrate a fairly
One thing seems quite certain; companies do not healthy profit and hence justify the continued
dividend payments. In fact it was making a loss.
fail suddenly as they are widely believed to do, not
But no one wanted to know.
only by the man in the street, but by bankers and
accountants and managers. Even quite small com-
panies take years to fail and large ones may take a THE MANAGEMENT DEFECTS
decade. Some workers in America believe they can
predict failure 5 years ahead but that is a figure But surely, it will be objected, no properly run com-
that most experts would halve. Even so, this brings pany would behave like that? Surely the other
the failure time span into the same order of magni- members of the board or the finance director would
tude as the horizons that are used in corporate protest-in public, if necessary? The answer brings
planning-a point of some significance as will be us to the second major thread that emerges. Every-
noted later. one agrees that failure is caused by ‘bad manage-
ment’ and, while not by any means unanimous,
This confusion over the failure time span is one
there does seem to be strong agreement as to the
of the most extraordinary phenomenon in the meaning of this term. Companies that fail display
whole of management and it is undoubtedly some-
up to six defects in the top management team.
thing that has to be explained by any theory of
failure that asks to be taken seriously. How does (1) The chief executive is an autocrat. He is not a
one explain the remarkable fact that most of the leader or primus inter pares; instead he domi-
directors of Rolls Royce were unaware that their nates his colleagues.
company had failed until a Board Meeting 9 days (2) Most of the members of the board do not parti-
before the Receiver was called in? Or that a well- cipate in top management decisions. Some are
known British merchant bank bought Elm. equity non-executive and do not know enough about
in a well-known Japanese company last year only the company’s affairs to contribute. Others are
to see the company fail 2 weeks later? Or the real- departmental or specialist directors who leave
ization of ‘a new dimension of risk’ by Court Line’s overall company policy to the generals.
bankers only 13 days before it failed? (3) The chief executive is also the company chair-
How, in other words, does one explain away the man.
fact that most people think that failure takes days The skills and knowledge of the board members
(4)
or weeks when it really takes years or decades? are unbalanced-there are too many engineers,
The answer apparently lies in what is known as for example, or too few men with marketing
‘creative accounting’ performed by companies that experience perhaps.
are failing. The chain of events seems to be this;
the proprietor or chief executive is very often the (5) In particular the finance function is not repre-
only member of the company to see the firm as a sented at all or weakly.
whole and so, if it is facing a period of distress, he (6) There is insufficient depth of management skill
will usually be the first to recognize this. In certain below the board.
circumstances (see below) he will wish to hide this It is now clear why no one protests when the chief
knowledge not only from his colleagues and the executive puts an optimistic slant on the annual
company’s auditors and bankers, but also from accounts! Of course not all failing companies dis-
himself. Accordingly he subconsciously, or deliber- play all six defects; Rolls Royce had plenty of
ately, or even fraudulently-depending much upon second level management, for example, and Penn
his personality no doubt-ensures that an opti- Central only had three of these defects. One’s
mistic slant is placed on all statements and reports anxiety concerning the future of a company is
and figures. proportional to the number and extent of these six
It is seldom necessary for a chief executive to defects taken together with three more.
resort to intricate or illegal or even immoral devices These are the defects in the accounting systems
to put everyone off the scent for most people con- of a company. Failed companies are usually defi-
nected with a company wish to see it prosper and cient in three areas. They have nonexistent or
are very ready to believe good news. Nor are inadequate budgetary control systems so the com-
accountancy definitions so precise that auditors pany neither knows where it is going nor how far it
can easily identify optimism unless it be wholly has gone. They have defective cash flow plans so
excessive. Time and again this thread emerges; that they may not know when the next peak demand for
no one, least of all the chief executive, wants to cash will come nor how it will be met. They have
believe that their company is facing failure and a deficient costing system and do not know, for
they will go to considerable lengths to avoid facing example, what each product costs, nor the contri-
that fact. If a company is failing it will be using bution to profits from any given activity.

DECEMBER, 1976 13
 Again one’s anxiety is proportional to the defects, project which, while not excessively large when
presumably. It has to be added that these account- launched, becomes a burden when something goes
ing defects receive scant mention in the literature wrong-a not infrequent occurrence with projects.
while, as one would expect, the accountants, No doubt the best of companies make all these
receivers and bankers whose views were sought for mistakes from time to time; the reason they are
this study, gave them much emphasis. Perhaps what not in the hands of the Receiver is that they did not
really matters is whether the people right at the suffer from the defects listed above and were able
top of the company know what is happening to the to manage themselves out of trouble. When one sees
business. They will know this only if two elements a company make one of these three classic mis-
are present and in good working order; one is the takes, therefore, one becomes anxious only if it also
accounting systems themselves and the other is a displays the significant defects. Well managed com-
strong financial-accounting voice on the board to panies do not fail. What is a well managed com-
explain the message that these systems have to tell. pany? One without those defects.
Take away either and the directors are in the dark.
One more defect is apparent in the company
that is going to fail; it does not adequately respond THE SYMPTOMS OF FAILURE
to change. There is wide agreement over this one.
To lose touch with the market-place, to fall behind This brings us to the third phase of the failure
in the technology, to operate an old fashioned plant, process-see Figure l-where the symptoms ap-
to treat one’s employees as if society had stood still pear. The most important of these are, or might be
since the war-all these are fatal. But to elaborate expected to be, the financial ones. One would
this theme here would be an insult to the readers of expect to see the various liquidity ratios beginning
this Journal ! to deteriorate, leverage to rise, sales versus f?xed
These, then, are the lethal defects. Up to six in assets to decline, cash flow versus debt, Altman’s Z,
the top team, up to three in the accounting systems price earnings ratio-and so on, all in disarray.
and the poor response to change. Their significance Indeed these may well be observed but due to the
is monumental for they appear long before- invariable operation of creative accounting their
probably years before-the company fails, even published deterioration will be so gentle that no one
before it makes the mistake that leads eventually to will doubt whether the company will recover from
failure. Indeed if it was not for these defects it this ‘setback’.
would never make such a mistake. Having made it It should be noted that well run companies do
the management may not recognize it as the major not indulge in creative accounting. They do cut
blunder that it is and, when they do recognize it, their dividend when they are in trouble. These are
they may not know how to put it right. the firms that recover.
There are three fatal mistakes. It appears that Also during this third phase a considerable
very few companies that fail do so as a result of any number of non financial symptoms of distress will
other mistake than these three. One is to allow the appear in increasing profusion and these are not so
financial leverage to rise too high-an error that easy to camouflage. Product quality may fall; for
lack of financial skill and defective cash flow plan- example in the last months of Penn Central their
ning can easily lead one into. Another is to over- regular passengers, who had come to believe that
trade-as when a company aims for a challenging the railroad’s service could never become worse
sales volume target without setting an equally than it already was, found to their dismay that it
challenging profit target. The third is to launch a could. Other signs are that the offices need painting,

l
I I , I I

I 1. Defects I 1 2. Mistakes I 3. Symptoms

I
I I I I I I
Management (6) Leverage Financial

Accounting (3) Overtrading Creative Accounting

Non Financial

Nose Dive

Figure 1. The Failure Sequence.

14 LONG RANGE PLANNING

factory repairs are neglected, share of the market three tunes can be composed. The three categories
may fall, suppliers become suspicious and restrict are briefly described below.
delivery-and so on. Type I companies are those that are launched,
Finally the company’s affairs enter the last phase never get off the ground and fail within a few years.
which can only be described as the nosedive when They make up 60 per cent of all failures on both
all the symptoms become increasingly severe and sides of the Atlantic. They begin life with most of
increasingly difficult to hide. By now-and this is the management defects and all the accounting
probably only weeks away from the end-virtually system defects but, because they never survive more
everyone who is closely connected with the com- than a few years their response to change is never
pany, creditors, customers, employees and so on, tested. To add to their troubles they are granted a
know that something is wrong but even now may very large loan by a bank-so they start life with
refuse to accept that the worst may be about to one of the three lethal mistakes, namely excessive
happen. leverage. It is often possible to see that the com-
There are three other factors in the failure pro- pany is going to fail within weeks or even days of its
cess that have been left out of the above account launch when it is discovered that sales have fallen
but which appear with some regularity in the litera- fur. short of expectations (or costs are far higher,
ture. One of these is bad luck. Most experts agree or whatever). Very often they fail without ever
that this can cause failure but that it is exceedingly making a penny profit.
rare; some experts suggest that in only 1 per cent of Type II companies are launched by an entre-
all failures is bad luck a major element whereas, and preneur, they soar to fantastic levels of prosperity
in dramatic contrast, bad management is present and then collapse in a blaze of publicity. Contrary
in 99 per cent. Another element is fraud but, while to popular opinion they are extremely rare; there
this activity is in the increase, it is seldom found in might be as many as one a year in Britain. They are
association with failure except where the failure of also exceptional in that relatively few of the defects
the firm is part of a fraudulent plan. The other are present; their response to change is often excel-
element is Moral Constraints and here there is lent, for example, although not many are really
growing evidence that firms can be brought down tested in this area because they seldom last more
by the actions of trade unions, governments, protest than a decade. Nor are their accounting systems
groups and so on who act or claim to be acting on always defective; even if they are this may be
behalf of society or social justice. irrelevant because their key, dominating defect is
The sequence of events described above was the autocratic entrepreneur who founded the com-
derived from a wide survey of books, articles, pany and built it into a major organization in a few
expert opinion and case studies. It represents the hectic years. It becomes too large for him to control,
distillation of all these views. Many of them were in brilliant though he usually is.
stark disagreement with each other for while one These Type 11s fail partly because of this auto-
writer asserts that one element is a prime cause of crat and partly because they become absurd. Their
failure another will explicitly deny this and assert size and their rate of growth become such that in a
something quite different. The extent of this diver- few years they would overtake IBM! When London
gence of view is so marked that it demands to be and Counties Securities failed in 1973 its assets
explained. The explanation is probably this; they were worth f128m. and it was growing at 240 per
are all talking about different types of company. cent per annum. If it had not failed it would now
Thus the journalists are hardly likely to be inter- be larger than ICI and heading for assets of E4bn.
ested in the failure of small insignificant firms nor in 1977. Everyone connected with Type II com-
in dull muted declines; Barmash’s book therefore panies know that this is ridiculous but the person-
describes only the large dramatic disasters because ality of the autocrat is such that he can only go
Barmash is a journalist. On the other hand the onwards and upwards.
senior partner in a small firm of accountants may Type III companies are quite different. They are
never see the failure of a company employing more mature and have been trading profitably for many
than 50 people, and his description of how com- years or decades-or even centuries. Their corpor-
panies fail is really only a description of how small ate health is probably good or very good, see Figure
companies fail. 2, and there are no overt signs of impending diaster.
Within the company, however, employees will
know that the chief executive rules the board with
THE FAILURE PATHS
a rod or iron even though the company has long
It appears that there are three categories of com- since passed that point in most company stories
pany and they each fail in very different ways. It when an autocrat is needed. He may be chairman
would have been most surprising if it was found as well. There is no finance director. No one looks
that all companies failed in the same way but that at the chief accountant’s budgetary control report
there are only three standard failure-paths is also perhaps, as in the case of Rolls Royce, because it is
rather surprising. In all three types the defect- not among the board papers classified as important.
mistake-symptom sequence is present. All three dis- And so on through the defects listed above and
play a permutation of the defects-it is as though labelled MAC (management, accounting and
there were a set of basic musical notes from which change) in the exhibit.

DECEMBER, 1976 15
 clearly shown to have failed for their lack.
No other management techniques can claim
this distinction; companies do not fail for
lack of method study, linear programming,
discounted cash flow, critical path, or any
of the hundred other techniques. They do fail
for lack of corporate planning.

Corporate planning may be a vital tool for

mature companies but it is not vital for Type
II companies which, see above, are run by an
entrepreneur who, it appears, is perfectly
capable of achieving response to change. Not
only is he probably better at this than any
Years
formal planning system that could be devised
but any attempt to introduce a formal system
Figure 2. Type III Failure Path. would probably be vigorously resisted by the
entrepreneur. Corporate planning does not
seem appropriate in the case of Type I
Now something happens to cause a marked profit
companies either.
setback (an event E in the Figure). What this is is
not important; it may be an economic turn down, Although corporate planning is essential for
or a strike at a supplier’s premises or whatever. In mature companies (Type III) the introduc-
well managed companies profits would recover the tion of such a system would be ineffective
next year but because of the defects this company’s even if it could be introduced. Consider the
profits plateau out at an inadequate level. They barriers; an autocrat, a lack of finance skill,
have to borrow to meet their commitments and an excess of one skill such as engineering,
leverage (L) rises-Rolls Royce’s rose from 21 per defective accounting systems. Hardly a fertile
cent to 46 per cent in 1961 due to a number of soil for a top level, multidiscipline, finance-
mishaps and from then to 1971 their profits re- orientated approach such as corporate plan-
mained on a plateau such as shown in the exhibit. ning!
After some time the management decide they
must boost the company off the plateau and in their What is required in mature companies that
effort to gain sales they overtrade (0) or altema- are showing the defects that lead to failure is
tively they launch a big project (P). Both lead to not corporate planning but a change of top
cash shortages and the symptoms appear (S). The management. Only then can corporate plan-
receiver is called in at (R). The time scale is be- ning-and improved accounting systems-be
tween 2 and 10 years; perhaps 20 in the case of usefully introduced.
Penn Central.
Corporate planners should be aware of the
causes and symptoms of failure and of the
CONCLUSIONS three failure paths; they are often called upon
Some of the implications that emerge from this to advise their company on acquisition candi-
study are of especial significance for bankers, dates and one reason for offering a company
employees, and others concerned with the health of for acquisition is that it is failing. Planners
companies and these are examined in detail in should also be alert for signs of failure in a
Corporate Collapse.’ A number of conclusions may Group’s subsidiary companies, some of which
be of special interest to corporate planners and may be very small, very young or very entre-
these are listed below. preneurial.

l When corporate planning first appeared in Corporate planners are right to concentrate
Britain in the early 1960s it was sometimes on growth strategies. However, they should
‘sold’ to top managers as an offensive weapon not be entirely ignorant of risk-reducing
-one that would, if adopted and used correct- strategies and even rescue strategies. But,
ly, cause a rapid and remarkable improve- even more important, it is just as much the
ment in corporate growth rates. Whether it responsibility of a management to avoid
ever fulfilled this promise as a magic fertilizer failure as it is to achieve success. To set a
or not is academic for its role as a vitally challenging profit target for one’s firm is high-
important defensive weapon is shown by ly desirable but perhaps one should set a
what happens to mature companies that do minimum target as well and ensure that the
not adequately respond to change. The value firm’s chosen strategy will exceed it. This
of corporate planning is shown to be equal brings one back to something like the Perfor-
to the value of budgetary control, cash flow mance Risk concept in Systematic Corporate
planning and costing, for companies can be Planning.”

16 LONG RANGE PLANNING

 Many mature firms which do not use cor- REFERENCES
porate planning also do not have adequate J. E. Ross and M. J. Kami, Corporate Management
(1) in
accounting systems. To try to introduce cor- Crisis, Prentice Hall (I 973).
porate planning in these firms without allow-
ing at least a year or two for them to introduce (2) lsadore Barmash, Great Business Disasters, Ballan-
time Books (1973).
proper budgetary control, cash flow and
costing, may be unwise. A plan based on (3) A. F. L. Deeson, Great Company Crashes, W.
faulty data may not be very helpful. Foulsham (I 972).

Although all receivers know that three things (4) Edward I. Altman, Corporate Bankruptcy in America,
have to be done to rescue what is left of a Heath Lexington (1971).
failed company-retrench, reorganize the
(5) R. A. Smith, CorpofafionsinCrisis, Doubleday (1966).
management and correct the accounting
systems-none of them seem to be aware of (6) Department of Trade, Rolls Royce Limited. HMSO
the need to introduce corporate planning to (1973).
ensure that the company adequately responds
(7) Senate Committee on Commerce, Penn Central.
to change in the future. U.S. Government (I 973).
Corporate planners will no doubt take to J. R. Daughen and P. Binzen, The Wreck of the Penn
(8)
heart the three mistakes that so often prove Central, Little, Brown b Co. (I 971).
fatal; high leverage, overtrading and the
ambitious project. All of them come well (9) John Argenti, Corporate Co//apse-the causes and
symptoms. Published June 1976 by McGraw-Hill.
within the definition of corporate strategy
decisions and therefore within the profes- (IO) John Argenti, Systematic Corporate Planning.
sional competence of corporate planners. W Nelson (I 974).

DECEMBER, 1976 17