Managing in a Turnaround Environment

Turnaround is the process of reviving and growing under-performing companies. Turnaround efforts are usually led by experienced turnaround managers, who are consultants brought into a company during its decline phase. The turnaround process has three phases, namely, the crises stage, stabilization stage, and recovery stage. Turnaround managers, already working under difficult conditions, face many challenges from factors both internal and external to their company.

A turnaround is a process whereby a company that has been experiencing an extended period of poor performance, is led to experience substantial and sustained positive performance. As a topic in the field of business management, turnaround is attracting increasing attention from researchers, educators, investors, managers and consultants. Developments in this area have led to the establishment of the discipline of turnaround management, the profession of turnaround managers, and the practice of turnaround investing.

Turnaround managers are consultants who are hired during financial crises, to save distressed companies from bankruptcy and turn around their fortunes. Turnaround managers join a company either as CEO or consultant, so that they can direct the turnaround process. This is largely preferable to the situation where a company's owners or senior mangers attempt to turn around their company themselves, since their lack of objectivity and emotional involvement often lead them to create new problems without resolving any of the old ones. Much depends on the turnaround manager: If he or she is not able to save a company from bankruptcy, or if the company's core business is not profitable, the company will be liquidated.

Even though turnarounds can be one of the best means by which a company can attain long-term sustainability, many of those in top positions in ailing companies find it difficult to even accept that they need a turnaround. This is one of the biggest obstacles to turnaround, and it is based on several factors:

• Firstly, many corporate executives believe that to initiate a turnaround is tantamount to admitting failure.
• Secondly, some corporate executives believe that turnarounds lead to mass redundancies, and this leads them to resist the idea of a turnaround. However, this is not the case: It is only those employees who do not add value in the workplace that will typically be laid off during the turnover process.
• Thirdly, there is a misconception that other companies will cease to do business with a company undergoing a turnaround. On the contrary, however, firms tend to be drawn to a company in turnaround, because the very fact that it has initiated a turnaround implies that it is a responsible and serious company.

Even when CEOs accept that their company needs a turnaround, they often take a long time to arrive at such a decision. Due to such hesitation, turnarounds are often initiated by third parties such as lenders (such as banks), bankruptcy attorneys, or investors who have a stake in the company.

Companies that need a turnaround most often experience under-performance in the areas of management, finances, competition, operations, and strategy. Management underperformance can usually be seen in areas such as leadership issues; skills issues; micromanagement instead of delegation; organizational structure issues; ineffective communication; misplaced compensation and incentives; and high employee turnover.

Financial underperformance is usually evident in excessively low sales volume; excessively low prices; excessively high expenses; poor balance sheet management; debt; and insufficient working capital. Competitive under-performance tends to be characterized by factors such as uncompetitive products; service and support issues; obsolescence; and quality issues. These can lead to a loss of established business and/or a failure to get new businesses.

Operational underperformance is characterized by lean manufacturing opportunities; poor capacity planning; poor scheduling; and process inefficiencies. The last area of underperformance, strategic underperformance, is characterized by market channel issues; supply chain tier issues; and scale issues.

Further Insights

A turnaround environment can be defined as the social, technological, economic and political environment in which a turnaround company functions. The internal turnaround environment consists of stakeholders such as customers, suppliers, employees, board of directors, and creditors; the external turnaround environment consists of factors and forces beyond the control of the company, including the economic environment, technical environment, legal environment, political environment and cultural environment. The nature of a company's internal and external turnaround environment has an effect on that company's decisions, turnaround strategies, processes and performance.

Needless to say, managing a turnaround is a challenging experience. For instance, those managing in a turnaround environment must do so under intense time pressure. Today's turnaround managers are being given less time to carry out their tasks, with some being expected to complete a turnaround in six months. Turnaround managers need special skills and competencies to effectively manage the unique planning and control processes that are required in managing and turning around a distressed and loss-making company. As if these challenges were not enough, turnaround managers also have to deal with opposition from within their assigned company, for instance from senior managers who resist replacement, or from employees who fear losing their jobs.

Stages of the Turnaround Process

The turnaround process comprises three stages: Crises, stabilization and recovery. Each stage has a different objective and requires a different type of action by the turnaround manager. The objectives and turnaround actions of each stage are depicted in the table below.

Turnaround Actions Crises Stage Objective Stabilization Stage Objective Recovery Stage Objective Financial Positive cash flow situation Operational Profit Strategic Growth

Pre-Turnaround Stage: Decline

Before the beginning of any turnaround, there is a significant phase that the company must have gone through, which is worth discussing here. This stage is called 'decline,' and it is characterized by sustained poor performance. Management perceptions and actions during this phase will determine whether or not a company requires a turnaround, since timely intervention can reverse the decline process. Even if a company does require a turnaround, management perceptions and actions during this phase will determine whether the company actually embarks on the turnaround; and how successful the turnaround is likely to be.

Decline can be caused by internal and external factors. For example, an internal factor such as the processing and analysis of company information, if ineffective, can lead to a decline. Likewise, companies that fail to keep up with changes in the external environment are also likely to decline.

Crisis Stage

The first of the three stages of a turnaround is the crises stage. At this stage, a company is close to bankruptcy or liquidation. By this stage, a company would have sustained heavy losses, and therefore, cash outflows would have exceeded cash inflows. As such, the crises stage calls for financial action to create a positive cash flow situation.

The dire situation may lead to changes in the top management team (this tends to happen often in Western countries, and in companies which have relatively high outsider control of the Board of Directors). A turnaround manager would typically be hired at this stage. The main reason why top managers are asked to leave companies that are embarking on a turnaround, is that the top managers find it difficult to recognize problems, since they are usually responsible -- at least in part -- for those same problems, and it would be difficult for them to put together the necessary creative solutions while having the same mindset that led to the problems in the first place.

Analysis

To be able to make proper evaluation and diagnoses of the situation at hand, a turnaround manager would need to conduct seven types of analyses with current -- not past or future -- company information. These seven analyses are: Financial analyses, working capital analyses, cost analyses, expense analyses, personnel analyses, asset analyses, and market analyses. Of the seven, financial and working capital analyses tend to be considered by turnaround managers to be the most important. Financial analyses are used to first of all improve cash flow, and secondly, they are used to reschedule debt, reduce expenses, reduce costs, and scale back operations. All seven analyses are prepared into reports and their contents are typically as follows (Fredenberger, Lipp & Watson, 1997):

• Financial Analyses: Balance statements & income statements.
• Working-Capital Analyses: Cash-flow statements (daily, weekly, monthly and quarterly); accounts receivable sales/collection/aging analyses; notes receivable aging analyses; inventory turnover, on-hand, sales per day, ABC analyses; accounts payable aging analyses; notes payable aging analyses; secured debt analyses; lender availability.
• Cost Analyses: Direct and indirect labor compensation (monetary value and percentage of sales); product material cost (percentage of sales); product material cost per supplier (percentage of sales).
• Expense Analyses: Sales/marketing other expense (percentage of sales); finance/administration other expense (percentage of sales); engineering in-house/contract product-related expense (percentage of sales); warranty expense (percentage of sales).
• Personnel Analyses: Burden people-related variable and fixed expense (percentage of sales); compensation expense per direct and indirect labor employee; overtime premium expense per direct and indirect labor employee; sales/marketing people-related expense (percentage of sales); finance/administration people-related expense (percentage of sales); engineering in-house/contract people-related expense (percentage of sales).
• Asset Analyses: Burden plant-related variable and fixed expense (percentage of sales); sales income per plant square foot; capacity utilization as a percentage of plant, equipment and machinery.
• Market Analyses: Product line gross margin as a percentage of profitability; product, model, catalog number gross margin percentage; cumulative margin funds by product, model, catalog number; customer gross margin funds profitability and as a percentage of profitability; cumulative gross margin funds by customer/region/channel/rep; product line margin/customer/region/channel/representative; sales dollars per employee.

Turnaround managers face the challenge of gathering a lot of information as quickly as possible. As important as it is to have the necessary information at the right time, many turnaround managers find that the information available to them is often not in a usable condition, and even when it is usable, it usually gets to the turnaround manager too late. When it comes to information, turnaround managers specifically have to deal with problems such as neglected information systems, inadequate or missing financial information, 'creative' accounting, improper information formats, reports that are not matched to problems, and so on. Information is such a key part of any turnaround, that in order to resolve these kinds of information problems, some companies go to the extent of hiring experienced turnaround chief information officers (CIOs).

The lack of information faced by turnaround managers can partly be attributed to a deliberate ploy on the part of employees, to either hold back information, or to misinform the turnaround manager. This is often done out of fear, and it is therefore imperative that the turnaround manager quickly gains the trust of employees to prevent fear from arising, and to facilitate access to information. These can be achieved through effective collaboration with the human resources department to ensure that the entire company buys into the turnaround process; that the employees are kept informed about what is happening throughout the turnaround; that the employees are constantly reminded of the strengths of the company; and that the employees are ultimately allocated jobs that make the best use of their skills and talents.

Strategy Formulation

Next during the crises stage, a turnaround manager would need to formulate a strategy to recover from the crises. The turnaround strategy will be based on the factors which led to the corporate decline, and for this reason, it is imperative that the problem which caused the underperformance be accurately identified. For instance, if a company has had a single large financial setback such as a legal settlement, fraud or embezzlement, the solution will be mainly financial. If a company is facing efficiency problems, the solution will be mainly operational. If the problem is to do with the reconfiguration of the firm's portfolio of businesses or the positioning of units within that portfolio, the solution will be mainly strategic. In general, however, the primary cause of company non-performance is some form of managerial incompetence, especially related to improper control of the internal elements of a company.

Once a turnaround manager has discovered the core reason for the underperformance, he or she would need to develop a strategic and operating plan. This is quite a challenging task, because the revival of a declining company often calls for the improvement of operations, but under decline conditions, a company can hardly invest in the necessary plant and equipment. This weakness affords the company the opportunity to fully utilize its creative ability through initiatives like extended targets and suggestion forums. Creative negotiations with financial institutions will also support the financial management undertaken during the crises.

The strategic and operating plan may include details of the following actions:

• Retrenchment, which may involve all of some of the following:
• The reduction of expenses;
• The reduction of receivables;
• The reduction of inventory levels;
• The reduction of personnel.
• Raising the necessary capital, through means such as:
• Lenders (for example, banks and finance companies);
• Equity capital from turnaround investors and strategic acquirers;
• Asset sales;
• Bankruptcy reorganization.
• Management of the external stakeholders, including, for example:
• Joint cost reductions with suppliers;
• Improved trade credit;
• New strategic partnerships with suppliers;
• Change in distribution channels;
• Outsourcing of inefficient processes.
• Management of the internal climate through such means as:
• Management of the decision processes;
• Transformation of organizational structures;
• Formalization of control structures;
• Restructuring of lines of communication.
• Process improvement, which may result in quality improvement and improved productivity; as well as a reduction in expenses and inventory investment.
• Continuous improvement based on market needs.
• Strategic pricing for certain customers, where possible.

Stabilization Stage

Once the turnaround manger has decided on the best strategy to implement, he or she must take action to address the crises. At the point when cash inflows are at least equal to or greater than cash outflows, the crises would have passed, and it can be said that the company has reached the stabilization stage (also known as renewal). This second stage of the turnaround process calls for operational action to bring about profits. At this stage, the turnaround manager endeavors to motivate the company and allow it to become profitable and grow.

Depending on the circumstances and the turnaround manager's leadership qualities, a turnaround manager can stabilize and motivate a company by either exercising authoritarian leadership to get employees to follow a highly structured turnaround plan; or by empowering employees. Employee empowerment in a turnaround situation involves inverting the organization, practicing team-based problem-solving with cross-functional teams, putting in place a simple reporting structure, supporting senior management and corporate staff, setting measurable customer-driven goals for the entire organization, and measuring results.

Recovery Stage

The third and final stage of the turnaround process is recovery, also termed the expansion stage. This stage calls for strategic action to bring about a return to normal profits and growth. A turnaround manager can achieve growth through improved performance by selling more units of a company's product; by adding more products to its range; by raising prices; and/or by reducing fixed and variable expenses. The achievement of growth, however, should not be an end in itself -- the ultimate aim of a turnaround is to strengthen the company's position so that it will not fall back into a loss situation. At this stage, a turnaround manager will typically leave for the next assignment, possibly helping the owners of the company to hire a professional manager, before departing.

Issues

Turnaround management differs from country to country, and this is so because of variations in culture, institutional factors, commercial practices, and other environmental factors. The actions of individuals and organizations -- including managers and employees -- toward any given activity are largely determined by institutional factors such as culture. For instance, cultural differences can account for differences in the rate of recognition of company decline; differences in the speed of initiating or starting a turnaround effort; and so on. In some countries, due to the prevailing culture, it is extremely difficult to get a CEO to agree to step down for a turnaround consultant to take over.

In the West, top management typically has sufficient autonomy to make the necessary changes and cutbacks during a turnaround, but in some developing countries there may be significant constraints on managerial action, or there may be conflicting stakeholder priorities posing obstacles to a turnaround.

No matter the cultural setting, for a turnaround effort to have any chance of success, it must be adapted to suit the local setting.

Terms & Concepts

Crisis: This is the first of three stages of a turnaround, where a company is close to bankruptcy or liquidation, and where cash outflows exceed cash inflows. This stage calls for financial action, and preferably, changes in the top management team.

Decline: This is a period of sustained poor performance that a company goes through prior to a turnaround.

Recovery: Also known as 'expansion,' this is the third stage of the turnaround process. Recovery calls for strategic action to bring about a return to normal profits and growth.

Retrenchment: This refers to the reduction of expenditures by a company in order to achieve financial stability.

Stabilization: Also known as 'renewal,' this is the second stage of the turnaround process, beginning when cash flows equal or exceed cash outflows. This stage calls for operational action to bring about profits.

Turnaround: A turnaround is a process whereby a company that has been experiencing an extended period of poor performance, is led to experience substantial and sustained positive performance.

Turnaround Environment: This is the social, technological, economic and political environment in which an ailing company functions.

Turnaround Investing: A high-risk, potentially high-return form of investment, where investors are given the chance to acquire underperforming companies at low prices, and create value by bringing the companies to a position of substantial and sustained positive performance.

Turnaround Manager: This is a consultant who specializes in reviving failing businesses.

Turnaround Strategies: These are the key set of activities employed to halt decline and stimulate the upturn cycle of a company.

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Suggested Reading

Arogyaswamy, K., Barker, V. III, & Yasai-Ardekani, M. (1995). Firm turnarounds: An integrative two-stage model. Journal of Management Studies, 32(4), 493-525. Retrieved December 6, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9510114617&site=ehost-live

Bibeault, D. B. (1982). Corporate turnaround: How managers turn losers into winners. New York: McGraw-Hill.

Gadiesh, O., Pace, S., & Rogers, P. (2003). Successful turnarounds: Three key dimensions. Strategy & Leadership, 31(6), 41-43.

Hofer, C. W. (1980). Turnaround strategies. Journal of Business Strategy, 1, 19-31.

Hoffman, R. (1989). Strategies for corporate turnarounds: What do we know about them? Journal of General Management, 14(3), 46-66.

O’Callaghan. Shaun (2010). Turnaround Leadership: Making Decisions, Rebuilding Trust and Delivering Results After a Crisis. Philadelphia: Kogan Page.

Robbins, D. K., & Pearce, J. A. II (1992). Turnaround: Retrenchment and recovery. Strategic Management Journal, 13, 287-309.

Scherer, P.S. (1988). From warning to crises: A turnaround primer. Management Review, 77(9), 30-36.

Scherer, P.S. (1989). The turnaround consultant steers corporate renewal. Journal of Management Consulting, 5(1), 17-24.