If Merck had underpromised and overdelivered as a consistent practice, we might not be writing about Merck’s spectacular tumble. But that’s the problem; hubris can lead to making brash commitments for more and more and more. And then one day, just when you’ve elevated expectations too far, you fall. Hard.
In 1988, Ames bought Zayre department stores, with self-proclaimed expectations to more than double the size of the company in a single year.43 You cannot do a 0.2 or a 0.5 or a 0.7 acquisition. The decision is binary. You either do the acquisition or you don’t, one or zero, no in between. And if that acquisition turns out to be a mistake, you cannot undo the decision. Big mergers or acquisitions that do not fit with your core values or that undermine your culture or that run counter to that at which you’ve proven to be best in the world or that defy economic logic—big acquisitions taken out of bravado rather than penetrating insight and understanding—can bring you down.
In Ames’s case, the Zayre acquisition destroyed the momentum built over three decades. While Wal-Mart continued to focus first on rural and small town areas before making an evolutionary migration into more urban settings, the Zayre acquisition revolutionized Ames, making it a significant urban player overnight. And while Wal-Mart remained obsessed with offering everyday low prices on all brands all the time, Ames dramatically changed its strategy with Zayre, which relied on special loss-leader promotions. Ames more than doubled its revenues from 1986 to 1989, but much of its growth simply did not fit with the strategic insight that produced Ames’s greatness in the first place. From 1986 through 1992, Ames’s cumulative stock returns fell 98 percent as the company plunged into bankruptcy.44 Ames emerged from bankruptcy, but never regained momentum and liquidated in 2002.45 Meanwhile, Wal-Mart continued its relentless march across the United States—step by step, store by store, region by region—until it reached the Northeast and killed Ames with the very same business model that Ames pioneered in the first place.46
OVERREACHING, NOT COMPLACENCY
We anticipated that most companies fall from greatness because they become complacent—they fail to stimulate innovation, they fail to initiate bold action, they fail to ignite change, they just become lazy—and watch the world pass them by. It’s a plausible theory, with a problem: it doesn’t square with our data. Certainly, any enterprise that becomes complacent and refuses to change or innovate will eventually fall. But, and this is the surprising point, the companies in our analysis showed little evidence of complacency when they fell. Overreaching much better explains how the once-invincible self-destruct.
Only one case showed strong evidence of complacency: A&P. (A&P followed a pattern of Hubris → Complacency → Denial → Grasping for Salvation.) In every other case, we found tremendous energy—stimulated by ambition, creativity, aggression, and/or fear—in Stage 2. (See Appendix 4.A for an evidence table.) We even found substantial innovation during this stage, which eliminated the hypothesis that the fall of a great company is necessarily preceded by a decline in innovation. In only three of eleven cases did we find significant evidence that the company failed to innovate during the early stages of decline (A&P, Scott Paper, and Zenith). Motorola increased its number of patents from 613 to 1,016 from 1991 to 1995, and stated about its patent productivity, “We rank No. 3 in the United States.”47 Merck patented 1,933 new compounds from 1996 to 2002 (the best performance in the industry, 400 ahead of second place) yet was already in the stages of decline.48 In 1999, HP launched its “Invent” campaign and nearly doubled patent applications in two years, just as it spiraled into Stage 4 decline.49
And then there’s the terrifying demise of Rubbermaid. In the early 1990s, two Rubbermaid executives visited the antiquities section of the British Museum. The ancient Egyptians “used a lot of kitchen utensils, some of which were very nice,” said one of the executives in a Fortune magazine feature, designs so nice that he came away from the museum with eleven ideas for new products. “The Egyptians had some really neat ideas for food storage,” echoed the other. “They had clever little levers that made it easy to take the lids off wooden vessels.”50
Eleven ideas from one visit to the British Museum might sound like a lot, but not when you consider that Rubbermaid aimed to introduce at least one new product per day, seven days per week, 365 days per year, while entering a new product category every twelve to eighteen months.51 “Our vision is to grow,” proclaimed Rubbermaid’s CEO in a 1994 statement that outlined goals for “leap growth.” Growth would come from doing lots of new stuff, all at the same time—new markets, new acquisitions, new geographies, new technologies, new joint ventures, and above all, hundreds of new product innovations per year. “Exhibit A in the case for innovation,” wrote Fortune about Rubbermaid’s climb to become the #1 “Most Admired Company” in America, more innovative than 3M, more innovative than Apple, more innovative than Intel.52
Choking on nearly one thousand new products introduced in three years, hammered on one side by raw materials costs that nearly doubled in eighteen months, and pressed on the other side by its ambitious growth targets, Rubbermaid began to fray at the edges, failing at basic mechanics like controlling costs and filling orders on time.53 From 1994 to 1998, Rubbermaid raced through the stages of decline so rapidly that it should terrify anyone who has enjoyed a burst of success. In the fourth quarter of 1995, Rubbermaid reported its first loss in decades. The company eliminated nearly six thousand product variations, closed nine plants, and wiped out 1,170 jobs. It also made one of the largest acquisitions in its history, recast incentive compensation, and initiated a radical marketing bet on the Internet as “a renaissance tool.”54 Yet Rubbermaid continued to sputter, embarked on a second major restructuring in a little over two years, and on October 21, 1998, sold out to Newell Corporation, forfeiting forever the chance to come back as a great company.55 As Rubbermaid realized too late, innovation can fuel growth, but frenetic innovation—growth that erodes consistent tactical excellence—can just as easily send a company cascading through the stages of decline.
This provokes a question: Why do we instinctively point to complacency and lack of innovation as a dominant pattern of decline, despite evidence to the contrary? I can offer two answers. First, those who build great companies have drive and passion and intensity and an incurable itch for progress somewhere in their DNA to begin with; if we studied companies that never excelled, those that fell from so-so to bad, we might see a different pattern. Second, perhaps people want to attribute the fall of others to a character flaw they don’t see in themselves rather than face the frightening possibility that they might be just as vulnerable. “They fell because they became lazy and self-satisfied, but since I work incredibly hard and I’m willing to change and innovate and lead with passion, well, then I don’t have that character flaw. I’m immune. It can’t happen to me!” But of course, catastrophic decline can be brought about by driven, intense, hard-working, and creative people. It’s hard to argue that the primary cause of the Wall Street meltdowns of 2008 lay in a lack of drive or ambition; if anything, people went too far—too much risk, too much leverage, too much financial innovation, too much aggressive opportunism, too much growth.
OBSESSED WITH GROWTH
In his 1995 annual letter to shareholders, Merck’s chairman and CEO Ray Gilmartin delineated the company’s #1 business objective: being a top-tier growth company. Not profitability, not breakthrough drugs, not scientific excellence, not research-driven R&D, not productivity (although Gilmartin did highlight these as essential elements of Merck’s strategy), but one overriding business objective: growth. Merck’s drive for growth remained remarkably consistent for the next seven years. The opening line of the chairman’s letter in the 2000 annual report stated simply, “As a company, Merck is totally focused on growth.”
Merck’s public commitments to achieve audacious growth seemed odd, given the facts. Five Merck drugs with annual revenues of nearly $5 billion would lose their U.S. patent protection in the early 2000s.56 Generic copycat drugs, an increasing force in the pharmaceutical industry, would curtail Merck’s pricing power, wiping out billions in profitable sales. Moreover, Gilmartin faced a significantly larger revenue base upon which to achieve growth than his predecessor, Roy Vagelos. It’s one thing to develop enough new drugs to deliver growth on a base of approximately $5 billion, as Vagelos did in the late 1980s, but entirely another to develop enough new drugs to fuel the same or faster growth on a base of more than $25 billion, as Gilmartin faced in the late 1990s. And for a company like Merck that relied primarily upon scientific discovery, growth would be increasingly difficult to attain; according to a Harvard Business School case study, the probabilities of any new molecule creating a profitable return were about 1 in 15,000.57
“But if Gilmartin is worried,” wrote BusinessWeek in 1998, “he doesn’t show it.”58 And why would Merck feel so confident about its prospects? The second paragraph of the chairman’s message in the 1998 annual report reveals part of the answer: Vioxx.59 In 1999, Merck received FDA approval and launched Vioxx, touting it as a potentially huge blockbuster, emblazoning the front cover of its annual report with “Vioxx: Our biggest, fastest and best launch ever.”60
In March 2000, preliminary results of a study of more than eight thousand rheumatoid arthritis patients demonstrated Vioxx’s powerful advantage: a painkiller with fewer gastrointestinal side effects than the painkiller naproxen. But the study also raised troubling, albeit inconclusive, questions about Vioxx’s safety, indicating that those taking naproxen had lower rates of “cardiovascular thrombotic events” (in lay terms, heart attacks and strokes) than the Vioxx group.61 Since the study was designed without a placebo-taking control group, the results could be interpreted a number of ways: naproxen lowers cardiovascular risk, Vioxx increases cardiovascular risk, or some combination of the two. Naproxen, like aspirin, has what scientists call “cardioprotective” effects, and Merck concluded that the difference in the frequency of cardiovascular events was “most likely due to the effects of naproxen.”62
By 2002, Vioxx sales had climbed to $2.5 billion, and by 2004 it had generated more than one hundred million prescriptions in the United States, including one for Gilmartin’s wife.63 Meanwhile, outside critics continued to raise questions about Vioxx.64 Merck countered with interim findings from studies involving twenty-eight thousand patients that did not show higher rates of cardiovascular risk for those taking Vioxx.65
Then, in mid-September 2004, the safety monitors for the Vioxx study of colon-polyp prevention received Federal Express deliveries containing alarming data. According to Brooke Masters and Marc Kaufman, who covered the story for the Washington Post, the safety-monitor team pored over the data for several days and couldn’t escape a frightening conclusion, later summarized in Merck’s annual report: “there was an increased relative risk for confirmed cardiovascular events, such as heart attack and stroke, beginning after 18 months of treatment in the patients taking Vioxx compared to those taking placebo.”66 The study’s steering committee halted the trials, sending shock waves throughout Merck.67 “It was totally out of the blue,” Gilmartin told the Boston Globe when he learned of the steering committee’s conclusion. “I was stunned.”68 To his credit, Gilmartin made a decision, clear and unequivocal; on September 30, within a week of when he learned of the new data, Merck voluntarily removed Vioxx from the market. Merck’s stock dropped from $45 to $33, chopping off more than $25 billion in market capitalization in one day, and shareholders lost another $15 billion as its stock dropped below $26 in early November—$40 billion in market valuation gone in six weeks.69
The final perspective on Vioxx—of the courts, of the marketplace, of investors, of the medical and scientific community, of the general public—continues to evolve as I write these words. My point here is not to argue that Merck leaders were villains seeking profits at the expense of patient lives or, conversely, that they were heroes who courageously removed a hugely profitable product without anyone requiring that they do so. Nor is my point that Merck made a mistake by pursuing a blockbuster; Merck has pursued blockbusters for decades, often with great success and benefit to patients. My point, rather, is that Merck committed itself to attaining such huge growth that Vioxx had to be a blockbuster, which, in turn, positioned the company for a gigantic fall if Vioxx failed to live up to its promise.
Merck’s quest for growth subtly diluted the power of Merck’s purpose-driven philosophy that made the company great in the first place. In 1950, George Merck II articulated a visionary business purpose: “We try never to forget that medicine is for the people. It is not for the profits. The profits follow, and if we have remembered that, they have never failed to appear.”70 It’s not that Merck abandoned this core purpose (indeed, Gilmartin drew inspiration from it when he removed Vioxx from the market), so much as it appears to have been relegated to more of a background role, a constraint on growth rather than the company’s fundamental driving force.
All three companies from Built to Last that fell in this analysis—Merck, Motorola, and HP—pursued outsized growth to their detriment. Their founders had built their companies upon noble purposes far beyond just making money. George Merck II passionately sought to preserve and improve human life. Paul Galvin obsessed over the idea of continuous renewal through unleashing human creativity. Bill Hewlett and David Packard believed that HP existed to make technical contributions, with profit serving as only a means and measure of achieving that purpose. George Merck II, Paul Galvin, Bill Hewlett, and David Packard—they viewed expanding and increasing scale not as the end goal, but as a residual result, an inevitable outcome, of pursuing their core purpose. Later generations forgot this lesson. Indeed, they inverted it.
Public corporations face incessant pressure from the capital markets to grow as fast as possible, and we cannot deny this fact. But even so, we’ve found in all our research that those who resisted the pressures to succumb to unsustainable short-term growth delivered better long-term results by Wall Street’s own definition of success, namely cumulative returns to investors. Those who built the great companies in our research distinguished between share value and share price, between shareholders and shareflippers, and recognized that their responsibility lay in building shareholder value, not in maximizing shareflipper price. The greatest leaders do seek growth—growth in performance, growth in distinctive impact, growth in creativity, growth in people—but they do not succumb to growth that undermines long-term value. And they certainly do not confuse growth with excellence. Big does not equal great, and great does not equal big.
BREAKING PACKARD’S LAW
To be clear, the problems of Stage 2 stem not from growth per se, but from the undisciplined pursuit of more. While the Merck story highlights the perils of growth obsession, we can see Stage 2 behavior in any number of other forms. Discontinuous leaps into arenas for which you have no burning passion is undisciplined. Taking action inconsistent with your core values is undisciplined. Investing heavily in new arenas where you cannot attain distinctive capability, better than your competitors, is undisciplined. Launching headlong into activities that do not fit with your economic or resource engine is undisciplined. Addiction to scale is undisciplined. To neglect your core business while you leap after exciting new adventures is undisciplined. To use the organization primarily as a vehicle to increase your own personal success—more wealth, more fame, more power—at the expense of its long-term success is undisciplined. To compromise your values or lose sight of your core purpose in pursuit of growth and expansion is undisciplined.
One of the most damaging manifestations of Stage 2 comes in breaking “Packard’s Law.” (We named this law after David Packard, cofounder of HP, inspired by his insight that a great company is more likely to die of indigestion from too much opportunity than starvation from too little.71 Ironically, as we’ll see when we get to Stage 4, HP itself later broke Packard’s Law.) Packard’s Law states that no company can consistently grow revenues faster than its ability to get enough of the right people to implement that growth and still become a great company. Though we have discussed Packard’s Law in our previous work, as we looked through the lens of decline we gained a more profound understanding: if a great company consistently grows revenues faster than its ability to get enough of the right people to implement that growth, it will not simply stagnate; it will fall.
Any exceptional enterprise depends first and foremost upon having self-managed and self-motivated people—the #1 ingredient for a culture of discipline. While you might think that such a culture would be characterized by rules, rigidity, and bureaucracy, I’m suggesting quite the opposite. If you have the right people, who accept responsibility, you don’t need to have a lot of senseless rules and mindless bureaucracy in the first place! (For a brief discussion of the right people for key seats, see Appendix 5.)
But a Stage 2 company can fall into a vicious spiral. You break Packard’s Law and begin to fill key seats with the wrong people; to compensate for the wrong people’s inadequacies, you institute bureaucratic procedures; this, in turn, drives away the right people (because they chafe under the bureaucracy or cannot tolerate working with less competent people or both); this then invites more bureaucracy to compensate for having more of the wrong people, which then drives away more of the right people; and a culture of bureaucratic mediocrity gradually replaces a culture of disciplined excellence. When bureaucratic rules erode an ethic of freedom and responsibility within a framework of core values and demanding standards, you’ve become infected with the disease of mediocrity.
If I were to pick one marker above all others to use as a warning sign, it would be a declining proportion of key seats filled with the right people. Twenty-four hours a day, 365 days a year, you should be able to answer the following questions: What are the key seats in your organization? What percentage of those seats can you say with confidence are filled with the right people? What are your plans for increasing that percentage? What are your backup plans in the event that a right person leaves a key seat?
One notable distinction between wrong people and right people is that the former see themselves as having “jobs,” while the latter see themselves as having responsibilities. Every person in a key seat should be able to respond to the question “What do you do?” not with a job title, but with a statement of personal responsibility. “I’m the one person ultimately responsible for x and y. When I look to the left, to the right, in front, in back, there is no one ultimately responsible but me. And I accept that responsibility.” When executive teams visit our research laboratory, I sometimes begin by challenging them to introduce themselves not by using their titles, but by articulating their responsibilities. Some find this to be easy, but those who have lost (or not yet built) a culture of discipline find this question to be terribly difficult.
As Bank of America rose to greatness, the responsibility for sound loan decisions lay squarely on the shoulders of loan managers distributed across California; the loan manager in Modesto or Stockton or Anaheim had nowhere to look but in the mirror to assign responsibility for the quality of his or her loan portfolio. As Bank of America began to fall, however, a complex layering of about one hundred loan committees and as many as fifteen required signatures subverted the concept of responsibility. Who is the one person responsible for a loan decision? If I’ve put the loan request through a dozen committees and obtained fifteen signatures, then it can’t possibly be my fault if it turns out to be a bad loan. Someone else—the system!—is responsible. Mediocre loan officers could hide behind the bureaucracy, while self-disciplined officers found themselves increasingly frustrated by a system designed to compensate for incompetent colleagues. “One of the great tragedies of this company,” commented a Bank of America executive at the time, “is that it lost a lot of good young people because we weren’t a meritocracy.”72
Throughout our research studies, we found that dramatic leaps in performance came when an executive team of exceptional leaders coalesced and made a series of outstanding, supremely well-executed decisions. Whether a company sustains exceptional performance depends first and foremost on whether it continues to have the right people in power, which brings us to the last point in this stage.
PROBLEMATIC SUCCESSION OF POWER
On March 15, 44 BC, Gaius Julius Caesar bled to death in Pompeii’s Theatre of Rome, punctured by twenty-three stab wounds. In his will, Caesar had adopted and named as his heir his grandnephew, Octavian. Only eighteen years old at the time, Octavian first appeared to be a marginal player compared to Caesar’s longtime allies Mark Antony and Cleopatra (the mother of Caesar’s biological son), and of little threat to Caesar’s enemies. But Octavian proved a shrewd student of power, assembling legions of Julius Caesar’s loyal soldiers into a private army and demolishing Caesar’s enemies in 42 BC before facing off against Antony and Cleopatra. Meanwhile, Octavian legitimized his power in the eyes of the Senate, deftly refusing honors that might have appeared contrary to Roman tradition and accepting only powers—often with feigned protestations—granted by the Senate. Step by step over the course of two decades, Octavian transformed himself into the first emperor of Rome, known to history as Augustus. He ruled the Empire for more than four decades.
In his wonderful course, “Emperors of Rome,” Professor Garrett G. Fagan shows Augustus to be one of the most effective statesmen in history. He unified Rome, eliminating the civil wars that had ripped apart the Republic.73 He redesigned the system of government, brought peace, expanded the Empire, and increased prosperity. He avoided ostentation, living in a relatively modest house, and displayed a peculiar genius for political maneuvering, achieving objectives largely by making “suggestions” rather than invoking formal legal or military power.
But Augustus failed to solve a chronic problem that significantly hurt the Empire over the subsequent centuries: succession. After Augustus, Rome ping-ponged between competent leaders and despotic, even semideranged titans like Caligula and Nero. And while the fall of the Roman Empire cannot be explained entirely by problematic successions of power, Augustus failed to create effective mechanisms that would produce an effective transfer of power to generations of outstanding leadership.
Leaders who fail the process of succession set their enterprises on a path to decline. Sometimes they wait too long; sometimes they never address the question at all; sometimes they have bad luck and their chosen successor leaves or dies; sometimes they deliberately set their successor up for failure; and sometimes they just flat out pick badly. But however and whenever it happens, one of the most significant indicators of decline is the reallocation of power into the hands of leaders who fail to comprehend and/or lack the will to do what must be done—and equally, what must not be done—to sustain greatness.
In all but one case in our analysis of decline (the one exception being Circuit City), we observed signs of a problematic succession of power by the end of Stage 2. We observed each of the following modes of turmoil in at least one of the fallen companies:
• A domineering leader fails to develop strong successors (or drives strong successors away) and thereby creates a leadership vacuum when he or she steps away.
• An able executive dies or departs unexpectedly, with no strong replacement to step smoothly into the role.
• Strong successor candidates turn down the opportunity to become CEO.
• Strong successor candidates unexpectedly leave the company.
• The board of directors is acrimoniously divided on the designation of a leader, creating an adversarial “we” and “they” dynamic at the top.
• Leaders stay in power as long as they can and then pass the company to leaders who are late in their careers and assume a caretaker role.
• Monarchy-style family dynamics favor family members over nonfamily members, regardless of who would be the best leader.
• The board brings in a leader from the outside who doesn’t fit the core values, and the leader is ejected by the culture like a virus.
• The company chronically fails at getting CEO selection right.
From what we’ve seen in this study, Stage 2 overreaching tends to increase after a legendary leader steps away. Perhaps those who assume power next feel extra pressure to be bold, visionary, and aggressive, to live up to the implicit expectations of their predecessor or the irrational expectations of Wall Street, which accentuates Stage 2. Or perhaps legendary leaders pick successors less capable in a subconscious (or maybe even conscious) strategy to increase their own status by comparison. But whatever the underlying dynamic, when companies engage in Stage 2 overreaching and bungle the transfer of power, they tend to hurtle downward toward Stage 3 and beyond.
Over the years of conducting my research, I’ve been a leadership skeptic, influenced by the evidence that complex organizations achieve greatness through the efforts of more than one exceptional individual. The best leaders we’ve studied had a peculiar genius for seeing themselves as not all that important, recognizing the need to build an executive team and to craft a culture based on core values that do not depend upon a single heroic leader. But in cases of decline, we find a more pronounced role for the powerful individual, and not for the better. So, even though I remain a leadership skeptic, the evidence leads me to this sobering conclusion: while no leader can single-handedly build an enduring great company, the wrong leader vested with power can almost single-handedly bring a company down.
Choose well.
MARKERS FOR STAGE 2
• UNSUSTAINABLE QUEST FOR GROWTH, CONFUSING BIG WITH GREAT: Success creates pressure for more growth, setting up a vicious cycle of expectations; this strains people, the culture, and systems to the breaking point; unable to deliver consistent tactical excellence, the institution frays at the edges.
• UNDISCIPLINED DISCONTINUOUS LEAPS: The enterprise makes dramatic moves that fail at least one of the following three tests: 1. Do they ignite passion and fit with the company’s core values? 2. Can the organization be the best in the world at these activities or in these arenas? 3. Will these activities help drive the organization’s economic or resource engine?
• DECLINING PROPORTION OF RIGHT PEOPLE IN KEY SEATS: There is a declining proportion of right people in key seats, because of losing the right people and/or growing beyond the organization’s ability to get enough people to execute on that growth with excellence (e.g., breaking Packard’s Law).
• EASY CASH ERODES COST DISCIPLINE: The organization responds to increasing costs by increasing prices and revenues rather than increasing discipline.
• BUREAUCRACY SUBVERTS DISCIPLINE: A system of bureaucratic rules subverts the ethic of freedom and responsibility that marks a culture of discipline; people increasingly think in terms of jobs rather than responsibilities.
• PROBLEMATIC SUCCESSION OF POWER: The organization experiences leadership-transition difficulties, be they in the form of poor succession planning, failure to groom excellent leaders from within, political turmoil, bad luck, or an unwise selection of successors.
• PERSONAL INTERESTS PLACED ABOVE ORGANIZATIONAL INTERESTS: People in power allocate more for themselves or their constituents—more money, more privileges, more fame, more of the spoils of success—seeking to capitalize as much as possible in the short term, rather than investing primarily in building for greatness decades into the future.