by Jim Collins
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* The contrast-selection year for Circuit City, HP, Merck, and Motorola is 1995; for Rubbermaid it is 1992.
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BUSINESS FIT: The success-contrast candidate and the fallen company were in similar businesses at the contrast-selection year. In each case, we developed an objective framework for the degree of business overlap, allowing us to score each candidate on a 1-to-4 scale.
SIZE FIT: The success-contrast candidate and the fallen company were of a comparable size at the contrast-selection year.
Score 4: if the revenue ratio is between 0.80 and 1.25
Score 3: if the revenue ratio is between 0.60 and 0.80, or between 1.25 and 1.67
Score 2: if the revenue ratio is between 0.40 and 0.60, or between 1.67 and 2.50
Score 1: if the revenue ratio is under 0.40 or above 2.50
AGE FIT: The success-contrast candidate and the fallen company were of a comparable age at the contrast-selection year.
Score 4: if both the fallen company and the success-contrast candidate were founded before 1950 or if the age ratio is between 0.90 and 1.11
Score 3: if the age ratio is between 0.75 and 0.90, or between 1.11 and 1.33
Score 2: if the age ratio is between 0.50 and 0.75, or between 1.33 and 2.00
Score 1: if the age ratio is below 0.50 or above 2.00
PERFORMANCE FIT: The success-contrast candidate and the fallen company had comparable stock returns in the ten years preceding the contrast-selection year.
Score 4: if there’s a 0 to 10 percent difference in cumulative stock returns
Score 3: if there’s a 10 to 25 percent difference in cumulative stock returns
Score 2: if there’s a 25 to 50 percent difference in cumulative stock returns
Score 1: if there’s a 50 percent or greater difference in cumulative stock returns
PERFORMANCE DIVERGENCE: The success-contrast candidate substantially outperformed the fallen company from the contrast-selection year to ten years out.
Score 4: if the ratio of cumulative stock returns of the success-contrast candidate to the fallen company is above 3.0
Score 3: if the ratio of cumulative stock returns of the success-contrast candidate to the fallen company is between 2.0 and 3.0
Score 2: if the ratio of cumulative stock returns of the success-contrast candidate to the fallen company is between 1.5 and 2.0
Score 1: if the ratio of cumulative stock returns of the success-contrast candidate to the fallen company is between 1.0 and 1.5
Automatically exclude the company: if the ratio of cumulative stock returns of the success-contrast candidate to the fallen company is below 1.0
GREATNESS TEST: The success-contrast candidate performed strongly from the contrast-selection year to ten years out and had a strong corporate reputation. Scoring starts with 4 points.
No deduction: if the ratio of its cumulative stock returns to the general market is above 2.5
Deduct 0.5: if the ratio of its cumulative stock returns to the general market is between 2.0 and 2.5
Deduct 1.0: if the ratio of its cumulative stock returns to the general market is between 1.5 and 2.0
Deduct 1.5: if the ratio of its cumulative stock returns to the general market is between 1.0 and 1.5
Deduct 2.0: if the ratio of its cumulative stock returns to the general market is between 0.80 and 1.0
Automatically exclude the company: if the ratio of its cumulative stock returns to the general market is below 0.80
If the company’s industry rank on Fortune’s “Most Admired Companies” list at the contrast-selection year plus ten years out is:
#1, no deduction
#2 or #3, deduct 0.5
#4 or below, deduct 1.0
Circuit City Success-Contrast Candidate Scoring
Best Buy 18.5
Wal-Mart 14.0
Radio Shack 11.0
HP Success-Contrast Candidate Scoring
IBM 15.5*
Texas Instruments 15.5*
Dell 13.5
Apple 11.0
Intel 10.5
Sun Microsystems 9.5
* IBM wins in the business-fit tiebreaker.
Merck Success-Contrast Candidate Scoring
Johnson & Johnson 19.0
Pfizer 17.0
Abbott Labs 16.0
Eli Lilly 16.0
Wyeth 15.5
Schering-Plough 14.0
Motorola Success-Contrast Candidate Scoring
Texas Instruments 17.5
IBM 15.0
GE 14.5
Intel 14.5
Harris 14.0
Applied Materials 11.0
Cisco 11.0
Emerson 10.5
We were able to identify a strong success-contrast company for each fallen company except for Rubbermaid. In the case of Rubbermaid, we began with twenty-six possibilities. After eliminating companies for lack of business overlap, loss of independence during the time of study, lack of publicly available performance information due to being privately held, or poor performance, we found no company that qualified as a viable success-contrast. The final study set of success-contrast cases appears below. It is interesting to note that the success contrast for one company (Motorola in contrast to Zenith during the 1970s) became a fallen company in the 1990s. There are no guarantees of lasting success!
Fallen Company Success Contrast
A&P Kroger
Addressograph Pitney Bowes
Ames Wal-Mart
Bank of America Wells Fargo
Circuit City Best Buy
HP IBM
Merck Johnson & Johnson
Motorola Texas Instruments
Rubbermaid None qualified
Scott Paper Kimberly-Clark
Zenith Motorola
Appendix 3:
Fannie Mae and the Financial Crisis of 2008
We featured Fannie Mae in Good to Great due to its extraordinary performance leap in the early 1980s under David Maxwell. Under Maxwell’s leadership, Fannie Mae transformed itself from a bureaucratic, government-chartered entity into a high-powered capital markets enterprise, generating cumulative stock returns substantially above the general stock market. The thirty-year cumulative stock-return pattern used as the basis for selecting Fannie Mae for Good to Great ran from 1969 to 1999, and our research regarding Fannie Mae focused on those years.
Unfortunately, Fannie Mae of the 2000s exemplified just the opposite: great to good to nearly gone. As I mentioned earlier in the text, we didn’t include Fannie Mae in the full analysis for How the Mighty Fall for the simple reason that when we selected our study set of fallen companies in 2005, Fannie Mae (and other financial institutions in our database) hadn’t yet fallen, so they didn’t qualify for this study. Instead of throwing Fannie Mae into the research project at the last minute because it happened to be in the news, I’ve decided to include a brief commentary about it in this appendix.
In reviewing the demise of Fannie Mae and other financial institutions in 2008, I kept thinking about a scene from the movie Titanic. In that scene, J. Bruce Ismay of the White Star Line, which owned the Titanic, turns incredulous when confronted with the impending doom of the giant ship: “But this ship can’t sink.”
“She’s made of iron, sir,” replies ship designer Thomas Andrews. “I assure you, she can.”
As the housing bubble burst, financial executives at major institutions turned incredulous, seemingly unable to believe the terrifying reality of their situation. In examining the materials we assembled on the demise of Fannie Mae, we found little evidence that the company’s executives seriously considered the possibility of failure. Yet in September 2008, Fannie Mae found itself under government conservatorship, a legal status similar to bankruptcy.172 On October 31, Fannie Mae’s stock price, which had stood at $57 a year earlier, had essentially evaporated, falling 98 percent to 93 cents.173
According to an article in the New York Times, Fannie Mae’s CEO later de
fended the company, pointing out that “almost no one expected what was coming. It’s not fair to blame us for not predicting the unthinkable.”174 And indeed, nearly every major financial institution got mauled in the housing-bubble, subprime-mortgage mess of 2008, including Fannie Mae’s fraternal twin, Freddie Mac, along with institutions like Citigroup. When Vikram Pandit, CEO of Citigroup, appeared on the Charlie Rose show in late November 2008, he made the same argument. “How many times have you seen AAA bonds go to zero?” he asked rhetorically, adding that risk-management models simply didn’t account for the scenarios that had actually unfolded. He later added, “I’m not so sure anybody . . . anybody . . . ran a stress test of the kind of environment that we’re living through today.”175
So, perhaps Fannie Mae just got hammered down by an industry catastrophe; maybe its failure had nothing to do with its self-management. That said, we did find evidence of the first three stages of decline (Stage 1: Hubris Born of Success; Stage 2: Undisciplined Pursuit of More; and Stage 3: Denial of Risk and Peril) at Fannie Mae in the 2000s, leading up to the 2008 crisis.
Maxwell had cultivated an ethic of willful humility while leading Fannie Mae during the 1980s. However, by the early 2000s, Fannie Mae had acquired a reputation for arrogance, enabled by both its extraordinary success and its sense of missionary righteousness vis-à-vis its special role in advancing the American Dream of home ownership.176 Fannie Mae had long prided itself on being a disciplined organization, especially in managing risk, but it also experienced substantial pressures for growth—from within and from Wall Street—compounded by political pressures to help more low-income families become homeowners.177 Its 2001 annual report stated that Fannie Mae was on track to double operating earnings per share in the five years ending in 2003, which implied a 15 percent annual growth rate (compared to the 7 to 10 percent growth rate of the overall residential mortgage market at the time).178 Fannie Mae achieved its goal, appearing headed toward further growth and success, and then became ensnared in an accounting storm.179
In September 2004, the Office of Federal Housing Enterprise Oversight (OFHEO) issued a report accusing Fannie Mae of misapplying Generally Accepted Accounting Principles in an effort to minimize earnings volatility.180 Fannie Mae eventually resolved the crisis, but at a cost. In the words of its 2006 annual report:
“We entered into comprehensive settlements that resolved open matters with the OFHEO special examination, as well as with the SEC’s [Security and Exchange Commission’s] related investigation. As part of the OFHEO settlement, we agreed to OFHEO’s issuance of a consent order. In entering into this settlement, we neither admitted nor denied any wrongdoing or any asserted or implied finding or other basis for the consent order. We also agreed to pay a $400 million civil penalty, with $50 million payable to the U.S. Treasury and $350 million payable to the SEC for distribution to certain shareholders pursuant to the Fair Funds for Investors provision of the Sarbanes-Oxley Act of 2002.”181
More costly than the financial penalties, Fannie Mae had lost much of its momentum while embroiled in the investigation.
The wounded mortgage giant emerged from the accounting settlement to find a growing housing bubble and aggressive competition from companies like Countrywide, Lehman Brothers, Bear Stearns, and others.182 Fannie Mae increased its activity in subprime mortgages, although not to the extent of some other companies.183 As a Fannie Mae executive said to the New York Times, “Everybody understood that we were now buying loans that we would have previously rejected, and that the models were telling us that we were charging way too little. But our mandate was to stay relevant and to serve low-income borrowers. So that’s what we did.”184 As the housing bubble ruptured, Fannie Mae posted losses of $2.2 billion in the first quarter of 2008 and $2.3 billion in the second quarter. To help stave off a collapse of the entire U.S. financial system, the U.S. government put Fannie Mae and Freddie Mac into conservatorship, with the aim of restructuring them by 2010.185
Here are a few observations and lessons:
• Financial institutions have a peculiar relationship relative to Stages 3, 4, and 5. Because of the high levels of leverage that financial enterprises often use, a relatively small set of losses can create a potentially catastrophic loss. Financial institutions caught in a risk-gone-bad downward spiral can crash downward from Stage 3 right into Stage 5, sinking so fast that there remains little time to grasp for salvation.
• Companies already in the stages of decline are extremely vulnerable to turbulence. If the financial storm of 2008 had never happened, or if it hadn’t become so severe, perhaps Fannie Mae would have had an opportunity to reverse its own decline and return to greatness by its own efforts. It lost that opportunity in the calamity of September 2008.
• I’m struck by how the stages of decline—Hubris Born of Success, Undisciplined Pursuit of More, Denial of Risk and Peril, Grasping for Salvation (Government, save us!), and finally, Capitulation to Irrelevance or Death—map fairly well not just to individual companies, but perhaps even to an entire industry, such as financial services or the American auto industry. Even so, it is worth pointing out that companies need not be imprisoned by their industries. Not every financial company toppled during the 2008 crisis, and some seized the opportunity to take advantage of weaker competitors in the midst of the tumult.
• Finally, there’s a provocative lesson: beware the hubris that can arise in conjunction with missionary zeal. In the Built to Last study, Jerry Porras and I found that enduring great companies passionately adhere to a set of timeless core values and pursue a core purpose beyond just making money. But there is also a risk to manage: having an almost righteous sense of one’s values and purpose (“We’re the good guys”) can perhaps make a company more vulnerable to Stages 1 to 3. Fannie Mae’s missionary zeal for expanding the American Dream of home ownership to as many Americans as possible contributed, in part, to its arrogance, its pursuit of growth, and even its increased risk profile. Whenever people begin to confuse the nobility of their cause with the goodness and wisdom of their actions—“We’re good people in pursuit of a noble cause, and therefore our decisions are good and wise”—they can perhaps more easily lead themselves astray. Bad decisions made with good intentions are still bad decisions.
Appendix 4.A:
Evidence Table—Subverting the Complacency Hypothesis
Note: This table is designed to show that great companies can fall even if engaged in energetic and ambitious activity, thereby undermining the hypothesis that all great companies fall because they become complacent. In fact, as this table illustrates, ten of the eleven great companies in our analysis fell despite showing behaviors contrary to complacency.
Addressograph, Stage 2: 1956–1971
• Highly cognizant of the threat from Xerox, merged with Charles Bruning Co. to better compete. Launched the Bruning 3000, but the product failed.186
• Developed a duplicator + copier (AMCD-I), but the product never made it to market because it lacked two-sided capability, encountered production snags, and faced competition from other internal products.
• Launched a crash program to develop new products, releasing twenty-three new products in three years.187
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Ames, Stage 2: 1982–1988
• Grew by making a series of significant acquisitions.
• Moved aggressively from a rural focus to a more urban focus.188
• Embarked upon experimental ventures in stationery, variety, and craft and hobby stores.
• Acquired Zayre department stores, with anticipation to more than double the size of the company.
• Multiplied sales five times in five-year period ranging from 1983 to 1988.189
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Bank of America, Stage 2: 1970–1979
• Made a huge push internationally. In the 1960s, moved from having fewer than 20 to more than 90 international branches, then from 1971 to 1977, increased assets in overseas branches and subsidiaries by more tha
n three times. Decentralized authority for international lending so as to increase entrepreneurial growth in foreign markets.190
• Committed to action, CEO A. W. Clausen stated, “Our keyword must be ‘action.’ . . . Our mistakes must be the mistakes of decision, not the worse mistakes of indecision itself.”191
• Launched a venture capital partnership for high-risk, direct investments in small technology companies.192
• Doubled total assets from 1970 to 1974, then nearly doubled them again from 1974 to 1979.193
• Transformed BankAmericard (which it invented) into the ubiquitous Visa card.194
• In the late 1970s, significantly increased fixed-rate mortgages, agricultural lending, construction lending, and loans to high-risk countries in Latin America and Africa.195
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Circuit City, Stage 2: 1992–1997
• Made significant commitments for growth. Stated in 1996 that it aimed to more than double revenue to $15 billion by 2000. Anticipated growing to 800 Circuit City Superstores by 2000, an 80 percent increase over 1997.196