Description
Taken to the extreme a resource based and dynamic capabilities model for business attempting turnaround.
10
th
Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
Taken to the extreme: a resource based and dynamic capabilities
model for business attempting turnaround
Fernando De Cesare Kolya
Master Student at the University of São Paulo
[email protected]
Maria Sylvia Macchione Saes
Professor at University of São Paulo
[email protected]
Abstract
The ability of a firm to recover from a declining financial performance is called
turnaround. The understanding of the actions taken by such firms and the differences in
between them and those that went bankrupt is one of the main goals addressed by the
turnaround literature. However, a definition of a general model that can be applied to any
business situation seems to be something still distant for research on the subject. Ultimately,
understanding the transition from the period of decline to the recovery period is to set how to
restore firms competitive advantage. Thus, the evolution of turnaround research may have had
contributions from strategy literature, such as Industrial Organization (IO), Resource Based
View (RBV) and Transaction Cost Economics (TCE), that tries to explain how firm created
sub-normal rents. This paper proposes an investigation into turnaround literature in order to
understand the evolution of the topic as well as the contributions of strategy literature to the
turnaround field. Propositions about a model of firm turnaround process and recovery strategy
will be made. The results achieved indicate paths for general model of development on the
turnaround of firms as well as aspects that should be studied in greater depth.
Keywords: strategy; firm recovery; rent creation
10
th
Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
1 INTRODUCTION
The research topic that embraces turnaround studies is quite recent. Earlier works are
dated from the end of the 70´s and research evolved from a very propositional approach from
field observation and lacked empirical evidence. During the 90´s and 2000´s the research
topic gained a more robust body with some consolidation and empirical large sample studies
looking to a wide variety of aspects of the turnaround process (KOLYA, 2015).
Turnaround is “the combination of activities by which once-successful firms that
experience severely declining performance for a protracted period of time overcome their
troubles and return to match or exceed their most prosperous periods of pre-downturn […]
turnaround response is conceived as encompassing two stages of activities: retrenchment
1
and
recovery (PEARCE II; ROBBINS, 1993, p. 22)”. Thus, turnaround is being represented by
the literature as a process that has its retrenchment and recovery responses tailored principally
by the causes of decline.
From a financial point of view, recovering business performance might encompass the
rearrangement of activities, cut offs, layoffs, divestments and so on, with one crystal clear
goal: turning performance at a good level again. Apart of the good intentions of financial
recovery plan, one may argument that such actions could damage firm strategy. Indeed,
layoffs, cutoffs and disinvestments could put the firm strategy in danger since it can dismantle
firms rent creation mechanism and must be taken carefully (LIM et al., 2013).
Considering that firm strategy is being challenged by the state of performance decline,
we expected to have, by the one hand, the researchers from strategy field preoccupied with the
situation of firms claiming for turnaround, and by the other hand, the turnaround research
flirting with strategy literature to explain strategic failure and recovery strategies. However
the first case is not observed and strategy literature barely contributed to the study of firms
facing decline. Fortunately, some turnaround researchers have taken arguments from the
strategy field and added contributions to the turnaround literature. Adopting the concept of
firm rent creation mechanism, the authors brought the turnaround research closer to the
strategy literature (LIM et al., 2013).
Taking the importance of strategy to design recovery strategy of firms facing decline
and the lack of attention by strategy research to the turnaround situation, this paper seeks to
address what are the possible contributions of strategy research to turnaround studies and how
can the strategy literature foster turnaround models to recover business from failure.
The methodological approach will encompass a theoretical discussion about the recent
contribution of strategy research to turnaround research and the proposition of a model for
turnaround strategies based on the elements of strategy research.
1
The retrenchment phase encompass the cost cutting and asset liquidation actions taken in an
initial stage of turnaround process aiming to generate cash and promote financial slack.
10
th
Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
2 TUNRAROUND RESEARCH
This section aims to discuss the main issues addressed by front of knowledge about
turnaround found by Kolya (2015) in a bibliometric research. The topics are: organizational
decline: causes, patterns and prediction of bankruptcy; recovery: turnaround strategies and
retrenchment; and causal attribution: the role of top management. During the discussion on
the evolution of themes, will be derived recommendations for a turnaround model companies,
which reflect how far advanced the literature and what their recommendations on how to
recover firms declining.
2.1 Organizational Decline: Causes, consequences, patterns and predicting bankruptcy
The term "organizational decline" is the more central, in turnaround research. Among
its most classic works are the Altman (1968; 1983) studies related to the prediction of
bankruptcy of firms. The author develops an indicator called Z-score, constructed from a UK
company database and providing the risk of bankruptcy of a company due to aspects of
financial health. The model shows quite accepted among work on turnaround companies as
indicative of the closeness of bankruptcy (BARKER III; DUHAIME, 1997; BARKER III et
al., 2001; SUDARSANAM; LAI, 2001) or in a similar way as an indication the severity of the
"turnaround situation" (ROBBINS; PEARCE II, 1992; PEARCE II; ROBBINS, 1993). The
indicator is appropriate and limited to the evaluation of companies listed on the stock
exchange, since it uses the value of the shares in the capital market as one of its metrics.
As proposed by Altman (1968; 1983) the probability of bankruptcy, was used in the
literature as an indicator of severity of turnaround situation, but requires information that only
companies with capital listed on the stock market have. One way to assess the severity of the
decline and the performance during and after the turnaround is to use the return on
investments (ROI) indicator (HAMBRICK; SCHECTER, 1983; ROBBINS; PEARCE II,
1992; BARKER III; DUHAIME, 1997; MORROW et al., 2004)
The early work on turnaround were basically exploratory, assessing cases and attempts
to generalize, as a first step to building a theory about the decline and recovery companies.
Schendel et al. (1976) developed a model that sought the relationship between the situation of
declining performance and causes of decline. The authors, from cases evaluation, proposed a
list of strategic actions for cases in which the decline was the result of bad strategies and a list
of operational actions to achieve the turnaround for the case in which the decline was caused
by inefficiency operating (Robbins; Pearce II, 1992).Hofer (1980) adopts the same
terminology and define strategic reasons as increased competition, profitability falling, rise of
wages, supply of raw materials and management difficulties. Operating causes include
reduced prices, recession, strike and work force problems and excess capacity.
The strategic-operational distinction has not been fully accepted by the literature that
sought to improve the understanding, since what seemed operating for a firm could be
strategic for another. Slatter (1984) purposed eleven general factors to which the decline of
10
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
organizations are assigned. They are: mismanagement; inadequate financial controls;
competition; costly organizational structure; change in the demand pattern; price instability;
little effort in marketing; major projects; acquisitions; financial policy; and operating above
the cash generation capacity. In this approach the author puts aspects of various kinds as
causes of decline, i.e. causes that can be recognized as internal, such as poor management and
financial policy, and external causes such as change in the pattern of demand and price
instability. Subsequent studies supported this understanding of the causes of decline
(PEARCE II; ROBBINS, 1994; ROBBINS; PEARCE II, 1992).
The concern of the understanding of the causes of decline stems from the fact that
research on the turnaround seek to understand which strategies should be adopted by the
company in declining performance and it becomes crucial to establish the relationship of
cause-recovery strategy. However, Barker III and Duhaime (1997) criticize the previous work
that did not take care in the selection of the sample of companies evaluated in order to
identify the turnaround strategies and that somehow mixed firms with different levels of need
for strategic change . A research branch emerged suggesting that the decline of organizations
can be either based on internal aspects of the company or on market aspects (firm-based
decline versus industry contraction-based decline) (BARKER III; Duhaime, 1997 cited
WHETTEN, 1987 and CAMERON et al., 1988). This is because the need for strategic change
to a declining firm in a stable or growing industry, is far superior to a firm with superior
performance to its competitors, but it is in an industry contraction. Thus, the internal-based
decline of the firm is associated with poor adaptation to environmental changes while the
contraction-based decline attentive to markets ability to support the initial number of firms
causing a part of them to performance deterioration. So understanding the causes of the
decline as resulting from internal aspects of the firm or market contraction, appears more
appropriate. Thus, two important aspects can be gathered from the progress of work on
organizational decline: the severity of the decline that defines the probability of recovery; and
the causes of decline which are essential for establishing recovery actions.
Literature Recommendation 1: A model on firm turnaround should consider the
causes of the decline as internals or based on market contraction and severity of decline
as moderating factors.
In addition to research on severity of decline and causes of the decline a third group of
researchers has developed research and models to understand the pattern of decline of
organizations and their consequences for firms. Hambrick and Daveni (1988) define the
decline of organizations as a downward spiral that can last more than ten years until the
bankruptcy occurs. Given this feature of the process of decline, causes and consequences mix
since the consequence of onset of the decline can lead to further decline. The origin of the
decline is a financial resources deficiency and deterioration of the return on assets employed
(net income / assets), which will lead to a situation of extreme and uncertain decision making.
If the environment does not express many changes and the firm find a momentary equilibrium
with the availability of transitory cash flow, this will give false encouragement that can later
10
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
further undermine the situation, if there is a shrinking market and this could lead to
bankruptcy.
Daveni (1989) evaluates the pattern of decline of organizations measured by the
change in the "magnitude of internal resources", which considers the financial and managerial
resources of the firms. The author aims to understand three fundamental questions about the
decline: a) the consequences of decline in the management and firms strategy; b) the link
between declining patterns and their impact on the time required for the consequences arise;
c) factors affecting the time at which the failure occurs. To this end, the author evaluating the
decline of various organizations, and notes the existence of three distinct patterns: sudden -
rapid collapse followed by bankruptcy; gradual - slow and incremental decline with
bankruptcy immediately after the decline reached its worst level; lingerers - decline can be
sudden or gradual and after that the company keeps for a long time before they fail. The
author concluded that the lowest rate of mergers and acquisitions by post-decline firms
indicates a strategic paralysis condition in relation to survivors. In addition, there is a size
reduction process with settlements and divestments, but not necessarily in business where it
has worse performance, reinforcing the idea of “strategic paralysis”. There was also lower
number of employees in R & D, marketing and production area and larger number of
employees in finance and greater concentration by the president. The paper also concludes
that the decline patterns are related to the time the consequences take to appear, such as
imbalance in the management, actions related to efficiency, power centralization, and
strategic paralysis. All this reflected in rigid response against the threat. Although the study
suggests that management actions are the source of the turnaround, the author argues that we
must recognize that the managerial variables are not alone responsible for strategic actions,
barriers to exit the industry, for example, can hold firms in difficult situations to escape. And
yet, the results showed that some firms may postpone or even avoid bankruptcy in situations
where the market is sufficiently abundant to accommodate a firm with lack of resources.
This approach demonstrates the process of decline is in some way dependent on the
signals of the external environment and reactions that express companies. This view is
complemented by Arogyaswamy et al. (1995) citing Cameron et al. (1988) which says that the
decline in firms' performance occurs when they become ill adapted to the environment, when
the environment becomes hostile, or both factors (firm-based decline and market contraction-
based decline). These causes will lead to the erosion of support of stakeholders, internal
inefficiencies growth and deterioration of the organizational climate and the decision-making
process. The authors propose a recovery model for companies that before the implementation
of recovery strategies, undergoes a decline interruption process, through the rehabilitation of
the confidence of stakeholders, eliminating inefficiencies and stabilizing the organizational
climate and decision making. Thus, considering that the decline is a process that usually leads
to a stage of strategic paralysis, regardless of their initial causes, the turnaround process
should propose actions that break inertia and interrupt decline.
10
th
Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
Literature Recommendation 2: A model on firm turnaround should propose
inertia breaking actions, with the rehabilitation of stakeholders confidence, eliminating
inefficiencies, stabilizing internal climate and decision-making, to interrupt decline.
As seen, the decline of organizations is a topic that receives different approaches. It is
observed that the decline can be considered a process (Hambrick; DAVENI, 1988) with
different patterns and consequences (DAVENI, 1989). Its causes are not unanimous, but it is
possible to separate them in: decline due to misguided strategies and poor adaptation of the
firm to the environment and on the other hand, the decline due to market changes. In a
simplified approximation of the literature is the understanding that the decline may occur for
external forces or internal problems of firms. Moreover, the severity of the decline is an
important factor to be considered in the design of recovery strategies.
2.2 Causal attribution: the role of top management
As an integrant part of the inertial process, several authors investigated the importance
or need of replacement of top management, president and board members to achieve the
success of the turnaround. The empirical-exploratory work justify the change of top
management being necessary given the belief that the leaders of a company a understanding
of how the business should be conducted, but must be wrong vis à vis the situation in which
the company find itself. Thus the way to improve firm performance is to bring a new team of
top management (Hofer, 1980). The exchange is also reasonable since the manager's
credibility is lost once he put the firm in a decadent situation (ONEILL, 1986). In addition,
the current managers are less motivated to undertake turnaround actions due to their
commitment to previous strategies and to exchange them can have a positive effect on new
strategies building and signals changes to external stakeholders (CATER; SCHWAB, 2008).
As previously mentioned, Arogyaswamy et al. (1995) proposed a theoretical model of
turnaround that passes through disruption strategies of decline and recovery. The authors
argue that firms that achieve the turnaround must present the decline interruption strategies
that: a) renew the support of key stakeholders; b) raise the efficiency; c) stabilize the internal
climate and decision-making process. Therefore, replacing the president and top management
will increase the effectiveness of strategies when in the case of decline based on internal
factors of the firm, as the declining performance situation resulted from the decision-making
of current managers. Where the decline had its origin attributed to the market, the stability of
the president and top management will lead to greater success because switching costs are
higher than the benefits generated, except in the event of prolonged decline and/or weak firm
competitive position that require strategic changes. The model, however, lacks empirical
evidence.
Empirically investigating the relationship between the decline and the succession of
the chief executive officer (CEO) and board members, Daily and Dalton (1995) found no
significant difference in turnover ratio (percentage of members exchanged relative to total) for
CEO positions and the board, among firms failed and that did not fail, suggesting that as
10
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
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USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
advocated by other studies, the decline is a downward spiral in which companies find it
difficult to change and come out even with the exchange of managers, it does not explain the
success or failure of the turnaround. However, the authors did not differentiate firms that
declined by internal factors or market issues, as suggested by Arogyaswamy et al. (1995).
In order to understand other issues related to decision-making structure and
differences between companies that have recovered and not, Mueller and Barker (1997)
empirically assess 33 pairs of companies (companies that failed versus companies that have
recovered) to identify differences regarding the composition and board size, duality for the
president (when the chief executive is also chairman of the board), size and change of the top
management team (TMT). The results indicated that firms that managed the turnaround is
more likely to have their president also as a board member, the board has average size, and
greater external control, as the presence of shareholders. The theory of agency touts the
president of the company should not be both chairman of the board by agency conflicts, on
the other hand there is a view that holds that this situation is interesting for companies in
turnaround situation, as it provides a stronger leadership united leadership, and the existence
of a president on the board and one in the company can generate some kind of conflict about
who in fact is the decision maker. The presence of the external advice can be explained by the
agency theory and the theory of resources. In the first case, the external act as monitors
(principal) of the CEO and other executive officers (agents). For the resource based
perspective, the presence of external might be interesting, since these have capacity to
influence other organizations to which the firm may have some dependence on resources.
Specifically external can confer legitimacy, ability to access capital and other key features
that affect the survival of the firm. Another result found was that the end of the recovery
process, firms TMT had a lower incidence in relation to the time prior to decline. This
suggests that recovery is more likely to swap at least a portion of the TMT. The presence of
the CEO on the board and the performance of the external advice suggests that recovering
firms develop decision-making structures that are more agile and influenced by external
perspectives.
The purpose behind the change of TMT is to promote the breakdown of inertia caused
by the permanence of a cognitively biased team and therefore unable to properly relate the
decline to internal causes, reducing the probability of a firm to take strategic change actions.
Thus, the work of Barker III and Patterson (1996) aims, from field data and case studies,
identify the differences between causal attribution of decline for TMT older and younger in
the company. Rescuing arguments of the social psychology field and work on organizational
decline and turnaround, the authors find empirical support (though not statistical) to the
hypothesis that younger TMT tend to attribute the causes of the decline to internal factors,
controllable and stable, therefore there is less likely to attribute the decline to market factors.
Furthermore, the study showed that the arrival of new agents has been associated with
changes in the understanding of the problems Company, strengthening the hypothesis that the
causal assignment between young and old management tends to be different. In addition, the
result puts arguments against a part of the literature that argues that the replacement of TMT
10
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
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USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
works as a necessary sacrifice ritual whereby TMT becomes a scapegoat only to meet part of
the stakeholders need and maintain employment of managers with more power.
Barker III and Duhaime (1997) conducted a work to assess the effects of TMT
exchange in strategic change of firms and found statistical support to justify the replacement
of the President, since the level of strategic changes in companies that began the turnaround
was higher in those which the chairman was replaced. A similar result was found by Barker
III et al. (2001). The authors investigated inertial factors and forces of change that influence
the replacement of TMT, which in turn is related to the level of strategic changes. The results
of empirical work with a sample of 154 US companies have shown that in larger firms, that
have had a longer period of pre-implantation decline strategies, exchange of TMT tends to be
less likely (inertial force), while the increase of external participants on the council was
positively related with changes in the TMT (forces of change). The authors had predicted that
firms that have applied for recovery would have greater rate of change of TMT (force of
change), but the results did not corroborate this hypothesis. Finally, higher levels of TMT
replacement were more associated with changes in business strategy and structure and internal
controls. Therefore, one must consider that the initial strategy of breaking inertia announced
before, should consider the option of TMT replacement (even partially) and approach of
externals to the council (not board members).
Literature Recommendation 3: A turnaround model should consider changing
the top management and participation of external advice on a strategy for switching the
decline and take action for recovery.
2.3 Recovery companies: turnaround strategies and retrenchment
The recovery actions taken from a decadent firm are certainly the object of greatest
interest of this study. The literature on the subject sought the understanding of the turnaround
process and further establish the relationship between the causes of the decline and recovery
strategies and adds moderating factors such as the severity of the decline, the role of TMT,
stakeholder (HOFER, 1980; ROBBINS; PEARCE II, 1992; TRAHMS et al., 2013).
Moreover, another concern was to deepening the understanding of the turnaround strategy
itself and the retrenchment action known as cost cutting or assets liquidation (HAMBRICK;
SCHECTER, 1983; MORROW et al., 2004; LIM et al., 2013).
In one of the early work on turnaround strategies, Hofer (1980) adds to the strategic-
operational recovery approach proposed by Schendel et al. (1976), the notion of severity of
"turnaround situation." This term is well understood in the literature as being the time when
the performance depreciated firm to the point where recovery efforts are necessary (Robbins;
Pearce II, 1992). Companies in turnaround situations sustain a loss of resources that will lead
to bankruptcy if not tackled (AROGYASWAMY et al., 1995). In his work, Hofer (1980) and
develop the types of turnaround strategies, it proposes that the nature of the turnaround
situation go through the evaluation of the operational health and strategic health of the
10
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Research Workshop on Institutions and Organizations – RWIO
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, 2015
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USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
organization. The firm chooses to operational activities or strategic actions or a combination
of both. The operating strategy focuses on cost reduction and cash generation actions in order
to achieve breakeven, while the strategic action focus on recovering competitive position,
market segmentation or focus on specific niches. This change can be difficult according to the
authors, if the competitors have superior strategic resources. Another important contribution
of this study was the conceptualization of the notion that the cost reduction and liquidation of
assets (retrenchment) is an action within the turnaround process, contingent on the severity of
the turnaround situation.
Hambrick and Schecter (1983) challenge this "strategic-operational" dichotomy for
recovery actions. The authors explain that differentiate what is strategic that which is
operating can be confusing. An example is the case of a company that buys automated
machines and improves its cost controls. This action can easily be understood as operating,
however, it can also be seen as a strategy leading costs as proposed by Porter (1980).
Furthermore, these strategies held by Hofer (1980) flees from the reality of mature industries.
So the authors propose that the actions can be understood as entrepreneurs, aiming income
generation or focus on products or markets, or efficiency actions represented by asset and cost
cutting. Hambrick and Schecter (1983) were the first to empirically test the propositions of
Schendel et al. (1976) and Hofer (1980) and found that in mature industries, effective
turnaround strategies had been those that reduce costs and assets, products line cutting,
market exits and incremental strategy. Cost cutting and assets liquidation were used by firms
with low levels installed capacity utilization. Cutting products and markets was mainly used
by companies with high rate of capacity utilization. The incremental strategy has been
adopted by firm with high market share which have undertaken actions to generate revenue
from increase on installed capacity utilization rate and labor productivity.
Arogyaswamy et al. (1995) reviewing previous works argue that the turnaround
strategies can be defined in terms of two attributes: the need for strategic change and the
impact of the contraction or expansion of industry, often involved in the implementation of
the strategies. Thus, the competitive position of the firm and the cause of the decline is
moderating factors for the turnaround strategies. The choice of incremental strategies should
be the most appropriate in turnaround situations caused by industry contraction when the
competitive position is strong. Whereas in times of crisis, the competitors with strong
competitive position are fighting for survival with incremental strategies, companies with
weak competitive position should reduce their scope of activities for which their resources
and capabilities are better valued.
Literature Recommendation 4: A model for firm turnaround should consider the
moderating factors such as causes of the decline and competitive position, for designing
recovery strategies.
The conditioning factors proposed by Oneill (1986) are understood as possible causes
of the decline (ie the inadequacy their part) by Robbins and Pearce II (1992), which are
divided between internal and external factors for which a set of maintenance strategies
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Research Workshop on Institutions and Organizations – RWIO
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, 2015
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of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
efficiency or entrepreneurial expansion will be required for the first and second cases,
respectively. For the authors the severity of the turnaround situation measured by Z-score
indicator, proposed by Altman (1968; 1983) is moderating factor for the need and intensity of
the cutting action costs or liquidation of assets, known as retrenchment. By analyzing
recovery cases in the textile industry, the authors observed that the retrenchmnet is less
common in companies that have the decline associated with external factors and firms
running retrenchment has higher performance turnaround, so those whose decline was linked
to internal causes presented better recovery performance in relation to others. It was observed
that the retrenchent cost was associated with the success and recovery companies with
different levels of severity while the retrenchment of assets only proved feasible for high
levels of severity. The authors concluded that firms must perform independent retrenchment
of turnaround situation and that firms close to bankruptcy should complement the cost cutting
with liquidation of assets.
Recommendation 5: A model on firm turnaround should consider asset and cost
retrenchment in an intermediary stage of the recovery process.
Morrow et al. (2004) found statistical support for the results of previous studies
presenting the retrenchment as a recovery strategy (SCHENDEL et al., 1976; HOFER, 1980;
ONEILL, 1986; ROBBINS; PEARCE II, 1992; PEARCE II; ROBBINS, 1993). However,
arguing that in such previous studies the possibility of generalization is restricted because
they were conducted in a single industry and few companies so that disregarded the influence
of the competitive dynamics of the industry as a moderating factor of the success of
retrenchment actions. Thus, the authors propose that retrenchment strategies in a declining
industry are different from that on a mature or in expansion industry. Whereas in new or
expanding industries, competitive dynamics imposes the need for innovation, marketing, new
product development as a way to impose barriers to entry and reduce the strength of
competitors, the authors argue that opting for cost cutting should have a negative impact on
the competitive advantage of the firm. However, the choice of cutting assets may be
interesting, because in a booming industry, readily available assets are overvalued by the
market. In declining industries, in which there is a large number of competitors and the level
of innovation is low, the option of cutting costs will be a successful strategy, while the
liquidation of assets not because these industries the value of the asset on the market may be
less than the value of their potential use by the declining firm.
The authors test the hypothesis with a sample of 412 firms in industries at different
stages of development in the USA. The results achieved in addition to corroborate previous
studies that pointed to the cost reduction actions and assets as turnaround strategies in mature
industries, observed that in declining industries cutting costs is a strategy that works, but
reduction of assets not, as had been predicted. In the case of expanding industries, the result
partly corroborated hypotheses: the performance was higher when there was liquidation of
assets, probably due to strong market sale of assets in these industries, but cost cutting had no
negative relationship with performance turnaround as had been predicted (in this case the
result was inconclusive).
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
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USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
Arguing that studies on the impact of the turnaround in the performance of recovery
were inconclusive because disregarded the cause of the decline, Ndofor et al. (2013) adds the
cause of decline as moderating factor as to test the impact of operational actions
(retrenchment of costs and assets) and strategic (acquisitions, strategic alliances and launching
new products) in the turnaround performance. Thus, from a group of companies performing
below average on a high profitability and expanding industry, the authors tested the
hypothesis that retrenchment actions will lead to worse performance turnaround while
strategic actions will lead to a performance turnaround higher. The authors consider that
retrenchment actions are part of the turnaround strategy, not just a stage as proposed by
Robbins and Pearce II (1992). The hypothesis that the retrenchment will have a negative
effect on the turnaround of performance is supported by the argument that companies in decay
in a booming industry, are in such a situation because of its weak strategic positioning
(because of the decline) and the struggle for efficiency will not solve the problem of poorly
adapted strategies. The results from the evaluation of a sample of companies in the computer
industry in the United States corroborated the hypothesis raised and strengthened the
importance of considering moderating factors as the cause of the decline in turnaround
strategies design and also that in industries high technology, efficiency measures should not
lead to superior performance in an attempt to turnaround.
In the same direction - to understand the role of moderating factors in the success of
retrenchment strategies-, Lim et. al. (2013) proposes a model in which the rent creation
mechanism (resources and capabilities) is the main moderating factor in the success of the
turnaround. The authors support their model in the existence of two sources of rent
generation: the Ricardian associated with the firm's ability to exploit superior resources that
lead the company to a situation of lower average cost; and on the other hand the
Schumpeterian rent achieved by the action of taking entrepreneurial risk, supported by unique
capabilities that allow the firm to reach values higher for their products and services. This
kind of income is generally associated with a dynamic environment and gives the firm the
ability to adapt and innovate. The authors tested their models with a group of 2406 Japanese
companies listed in the Nikkei stock market and obtained partial support for their hypotheses.
Firms that have Schumpeterian nature of income but that have adopted cost cutting strategy
had their post retrenchment performance less than their peers. This effect was accentuated
when the industry to which the firm belongs have a competition pattern typically based in the
generation of Schumpeterian rent. The hypothesis about the negative impact of cutting assets
when the nature of rent generation is Ricardian was not supported by the results. The authors
argues that the Ricardian rent is based on the selective picking of assets in the strategic factor
market, but also the option of not acquiring a non-productive resource. This second
alternative may explain some of the inconclusive results.
Retrenchment actions have two approaches in the literature. A view points to
retrenchment as a turnaround strategy (LIM et al, 2013;. NDOFOR; VANEVENHOVEN;
BARKER III, 2013) but the other one argues that retrenchment is not the turnaround strategy
in itself, but a condition that may be needed for further implementing strategic actions and
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focus (retrenchment of assets or costs) will depend on the severity of the turnaround situation
(ROBBINS; PEARCE II, 1992). So part of the literature keeps cost cutting and assets
liquidation actions as a recovery strategy while another believes that it is a stage prior to the
recovery phase. In general, the studies point to moderating factors such as industry life cycle
of products and nature of the firm's rent creation mechanism, which define circumstances
under which a retrenchment strategy should or should not be adopted. But as suggested by
Morrow et al. (2004), Lim et al. (2013) and Ndofor et al. (2013), the mechanism of rent
generation is the most important aspect since the industry life cycle, product and type of
industry are factors that do not capture the strategy of rent creation from the firm.
Literature Recommendation 6: The retrenchment as integral action in a model of
turnaround companies should consider the impact of cost cutting and assets liquidation
on the firms´ rent creation mechanism.
This section discussed the state of the art of the knowledge on business turnaround and
depicted from the literature six well discussed recommendations from literature to the process
of turning a business around. Next, discussion concerning the last stage of this process will be
brought and we will shed light on the role of rent creation mechanism to the recovery
strategy.
3 A COMPETITIVE STRATEGY MODEL FOR THE TURNAROUND
COMPANIES
As previously discussed, the literature on turnaround strategy arguments that the last
stage of the turnaround process pass through the delineation of recovery strategies, which are
moderated by the competitive position and the cause of the decline. Besides of that, Morrow
et al. (2004) argues that industry stage of development defines the most appropriate strategy.
For example, in a booming industry, firms compete for innovation while in an industry under
contraction competition is for efficiency. The arguments of Morrow et al. (2004), clearly
influenced by Industrial Organization (IO) approach may be restated with the RBV lenses.
For example, competition for innovation typically involves investments in R&D and
marketing, and is associated to firms with Schumpeterian rent, the low church branch of
RBV. On the other hand, the notion of competition for efficiency is typically of firms that
compete for Ricardian rent, for which the possession of valuable, difficult to imitate and rare
resources allows the firms to achieve lower costs. Lim et al. (2013) uses this approach
(Ricardian rent versus Schumpeterian rents) in his proposal for retrenchment actions. Taking
this approach, we propose to extend the application of the concept used by Lim et al. (2013)
to the model of turnaround process, developed by Arogyaswamy et al. (1995). The model
presented on Figure 1 bellow adds the moderating role of the rent creation mechanism to the
recovery strategy discussed previously.
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Figure 1 – A turnaround process model
Source: authors
Few firms in declining condition maintain strong competitive position, but this can
occur when the decline is caused by market contraction or when the firm declines for internal
reasons but remains strong competitive position because it has latent resources and
underutilized capabilities (AROGYASWAMY et al., 1995). Thus strategies for firms in a
strong competitive position and decline from internal conditions aims to maintain this position
with incremental actions to better exploit resources and capabilities. When the decline occurs
by cyclical contraction of the industry or even prolonged contraction, the strategy aims to
maintain the position with incremental strategy of using existing resources and capabilities
and to expand into other segments where these resources and capabilities has more value
(AROGYASWAMY et al., 1995).
Firms with mechanism for generating Schumpeterian or Ricardian rent, which holds
strong competitive position, that is, valued resources or capabilities, and come into decline for
internal reasons should adopt incremental strategies that better exploits their resources and
capabilities to maintain or even expand its competitive position. Inaction against the decline
will lead to deterioration of resources and capabilities and loss of competitive position,
exacerbating the decline. When the competitive position is weak, it means that the resources
and capabilities has no value in that market. Thus, it is required a strategic reorientation with a
focus on particular segment in which the firm can develop resources and capabilities with
greater value.
Next, propositions 1 to 8 (p1 to p8), relate the recovery strategies that should be
adopted moderated by competitive position, cause of decline and rent generation mechanism.
p1: Firms with Ricardian rent mechanism, with a strong competitive position and
internal cause of decline, which adopt incremental strategies for better use of their resources
in order to maintain or even expand its competitive position, have higher post turnaround
performance than those that do not adopt such actions.
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p2: Firms with Schumpeterian rent creation mechanism, with a strong competitive
position and internal cause of decline, which adopt incremental strategies to recombine its
internal routines and strengthen its dynamic capabilities in order to maintain or even expand
its competitive position, will present higher post turnaround performance than those that do
not adopt such actions.
Firms with weak competitive position, in a stable or growing industry declining due to
internal aspects should take actions to bring them into a strong competitive position.
Considering the high cost of accessing the market of strategic factors and the cost of
developing new skills and competencies, the firm should focus on sectors where their
resources have greater value and lead to a situation of high efficiency and where their
capabilities can produce products and services of higher value.
p3: Firms with Ricardian rent creation mechanism, with weak competitive position
and internal cause of decline, which adopt strategic reorientation focusing on segments where
resources can lead to greater efficiency, will have greater post turnaround performance than
those that do not adopt such actions.
p4: Firms with Schumpeterian rent creation mechanism, with weak competitive
position and internal cause of decline, which adopt strategic reorientation focusing on
segments where capabilities can lead to the generation of greater value, will have greater post
turnaround performance than those that do not adopt such actions.
The most critical situation is found for firms with weak competitive position in
contracting industries. In these cases the strategy should be to reduce the business for those
consumers and segments in which resources and capabilities provide greater competitive
advantage. The adoption of strategic reorientation in these cases is dangerous because a weak
firm in a hostile environment find it difficult to absorb the cost of a strategic shift
(AROGYASWAMY et al., 1995). However, contrary to this argument, it is known that in
crisis industries, the value of assets in the strategic factor market is generally undervalued. In
markets contraction, a firm with weak competitive position has no valuable resources and
capabilities and the low cost of resources in these markets can be attractive in some way so
the firm can recover, even partially, its competitive strength by acquiring and recombining
resources. This action will depend on the financial capacity of the firm, which is often
delicate at this point, then as proposed by Arogyaswamy et al. (1995) a viable alternative may
be to reduce firm size and focus on segments in which resources and capabilities are most
valuable.
p5: Firms with Ricardian rent creation mechanism, with weak competitive position in
industries in crisis, that access new resources in strategic factor markets or reduce their
operations to segments where resources have greater value, will have higher post turnaround
performance compared to those that do not adopt such actions.
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p6: Firms with Schumpeterian rent creation mechanism, with weak competitive
position in industries in contraction that develop new capabilities or reduce their operations to
sectors where their capabilities have the potential to generate greater value, will have higher
post turnaround performance compared to those that do not adopt such actions.
Access to the strategic factors market may be a strategy also for declining firms with a
strong competitive position in an industry in contraction. For these firms the strategy should
be to maintain the competitive position with available resources, but the expansion of
competitive position may be feasible via strategic factor market. In the case of capabilities, it
may be the opportune moment to invest in the reorganization of routines and construction of
new capabilities in order to strengthen the competitive position.
p7: Firms with Ricardian rent creation mechanism, with a strong competitive position
in industries in contraction that keep their resources and/or access new resources in strategic
factor markets, have superior post turnaround performance than those that do not adopt such
actions.
p8: Firms with Schumpeterian rent creation mechanism, with a strong competitive
position in industries in contraction that maintain their capabilities and/or invest in
strengthening and creating new capabilities, have superior post turnaround performance than
those that do not adopt such actions.
Figure 2 bellow is following these eight propositions in the form of recommendation
for each of the eight possible situations that firms under performance decline may come
acrros.
Figure 2 – Recovey strategies model
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In order to partially check the adherence of the model we are proposing, the recovery
strategies adopted in a turnaround case discussed by Balgobin and Pandit (2001) will be
assessed and discussed. The case at stake is the performance recovery of a UK subsidiary of
the International Business Machine (IBM) at the 1990´s. This business unit had its
performance dramatically affected by a change in demand pattern that has not been followed
by the firm. The computer industry has moved from a model where companies were vertically
integrated, controlling everything from the manufacture of chips to the development of
software and services to a horizontal model where each company is specialized in a particular
aspect of the chain. The main industries that compete with IBM at the time focused on
software development and services (Microsoft) or production of chips (Intel) and there was a
change in the pattern of computers demand, from large mainframes to personal computers
(PC). Access to PC went from a luxury item to almost commodities. IBM - UK failed to keep
up with changes and went from a cash generation capacity of close to £ 500 million in 1988 to
an almost £ 1.0 billion loss in 1991/92.
Balgobin and Pandit (2001) attributed the decline to external factors, like changing the
industry standard, however from what has been discussed in this work, not following market
changes is an internal problem to the firm. As suggested by Lim et al. (2013), high-tech
industries such as which shall include IBM-UK, has a competition pattern based on
investment in R&D, marketing and personnel. Indeed, Balgobin and Pandit (2001) proposed
some internal factors that led to the decline as the delay of IBM-UK in exploring new
technologies and their products did not meet customers need anymore. This inability of the
firm was said linked to the distance between the leaders and the real market (the decision was
concentrated in the hands of a few and far from the customer and market). The pattern of
competition in these industries is based on the generation of Schumpeterian rents as suggested
by Lim et al. (2013), associated to dynamic capabilities building that lead to income
generation from disruptive innovation.
As there was no crisis in the technology industry at that time it is possible to affirm
that the decline of IBM-UK was due to internal issues and its competitive position has
changed from strong to a weak position. Thus, as proposed in the model, the recovery strategy
should focus on a particular market segment and build new capabilities (decline caused by
internal issues, Schumpeterian income and weak competitive position).
As described by Balgobin and Pandit (2001) the main objective of the CEO at the time
was to transform the IBM-UK, a general computer firm into a leader in solutions. Thus, the
firm divested in segments that were not part of this new concept and promoted a series of
changes in the organizational structure. Each business division became accountable for its
results thus giving more autonomy to its action and responsible for its results. The focus
shifted to consulting and services with strong expertise in the market. The guideline was to
become a customer-oriented company and highly responsive to the market. The elimination of
four management levels turned the firm more agile in decision making and responsive to the
market. Various programs to measure the satisfaction of service to consumers have been
implemented, and a new framework of required skills has been applied to managers who
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should be more general and less functional, in order to strengthen the ability to see trends and
propose solutions.
As it was seen, the actions taken by IBM-UK sought to focus on a specific segment,
followed by actions to build internal capabilities that allow a leading position in consulting
services and IT segment. The capabilities briefly presented above may be understood as the
dynamic capabilities needed to generate Schumpeterian rents.
The evaluation of the case of IBM-UK, although superficial, in light of the discussed
model in Figure xx, shown that actions taken by the UK subsidiary in its turnaround process
were quite close to the recommended actions in the model: focus on particular segment with
the development of capabilities that can generate greater value.
4 DISCUSSION AND FINAL REMARKS
The present study had as main objective to investigate what are the possible
contributions of strategy research to turnaround studies and how can the strategy literature
foster turnaround models to recover business from failure. To meet the objectives a review of
the existent literature was conducted and recommendations for a model of turnaround process
were raised from literature. Arguments from previous research and from strategy field, more
specifically from resource based view, were taken and integrated in a model for turnaround
strategies, understood as the last step of a turnaround process. The proposed model was used
to discuss the case of IMB-UK presented by Balgobin and Pandit (2001).
This study demonstrate how turnaround research provide fertile ground for application
and testing strategy concepts and theory and suggests that there may still be more to be done
regarding the integration of strategy approaches to turnaround research.
The contribution of strategy literature for the theme is clear when we evaluate,
especially the works that deal with the process of retrenchment and recovery strategies. As
discussed, the Resource Based View appeared to explain retrenchment actions. Besides
Industrial Organization theory with its structure-conduct-performance determinism was used
to design recovery strategies depending on the industry structure.
Nevertheless, this work was limited to the examination of the various issues
surrounding the turnaround and didn´t went deeper in other aspects besides recovery strategy.
The aspect of decision making and the role of managers, for example, received less attention
in this study. However, it does not mean that the human aspect in the turnaround process is
less important. We saw that, as an initial stage of the turnaround process the renew of TMT
and approximation of externals to the board may break inertia and promote strategic shifts.
The importance of human factor in strategy building is being a vivid topic in strategy
research. Recently, studies in the field of strategy have turned its attention to the micro
foundations related to decision-making within the framework of competitive strategy (FOSS,
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2011). We observe that turnaround studies tested approaches related to decision-making and
this should be an avenue of development for future research in turnaround.
Finally, it is proposed that the next studies of turnaround seek greater integration with
strategy literature, as these have proven useful for building more robust turnaround models
and contribute to a more complete theory for firm recovery.
5 BIBLIOGRAPHY
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ALTMAN, E. I. Corporate financial distress and bankrupcty: a complete guide to
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AROGYASWAMY, K.; BARKER III, V. L.; YASAI-ARDEKANT, M. Firm turnarounds: an
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BALGOBIN, R.; PANDIT, N. Stages in the turnaround process: the case of IBM UK.
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BARKER III, V. L.; PATTERSON, P. W. Top management team tenure and top manager
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BARKER III, V. L.; PATTERSON, P. W. J.; MUELLER, G. C. Organizational causes and
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CAMERON, K. S.; SUTTON, R. I.; WHETTEN, D. A. Issues in organizational decline. In:
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CATER, J.; SCHWAB, A. Turnaround strategies in established small family firms. Family
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change? Strategic Management Journal, v. 16, p. 393–400, 1995.
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of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
DAVENI, R. A. The aftermath of organizational decline: a longitudinal study of the strategic
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HAMBRICK, D. C.; SCHECTER, S. M. Turnaround strategies for mature industrial-product
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empresas. 2015.
LIM, D. S. K.; CELLY, N.; MORSE, E. A.; ROWE, W. G. Rethinking the effectivness of
assest and cost retrenchmen: the contigency effects of a firm´s rent creation mechanism.
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MORROW, J.; JOHNSON, R. A.; BUSENITZ, L. W. The effects of cost and asset
retrenchment on firm performance: the overlooked role of a firm’s competitive environment.
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MUELLER, G. C.; BARKER, V. L. Upper echelons and board characteristics of turnaround
and nonturnaround declining firms. Journal of Business Research, v. 39, p. 119–134, 1997.
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the 1990s: an analysis of reversing decline in a growing, dynamic industry. Strategic
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PEARCE II, J. A.; ROBBINS, D. K. Retrenchment remains the foundation of business
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turnaround. Journal of Management, v. 19, n. 3, p. 613–636, 1993.
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of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
PORTER, M. E. Competitive strategy: techniques for analyzing industries and
competitors. First ed.New York: The Free Press, 1980.
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Implementation. London: Pinguin, 1984.
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TRAHMS, C. A.; NDOFOR, H. A.; SIRMON, D. G. Organizational decline and turnaround:
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v. 13, p. 335–358, 1987.
doc_747506265.pdf
Taken to the extreme a resource based and dynamic capabilities model for business attempting turnaround.
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of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
Taken to the extreme: a resource based and dynamic capabilities
model for business attempting turnaround
Fernando De Cesare Kolya
Master Student at the University of São Paulo
[email protected]
Maria Sylvia Macchione Saes
Professor at University of São Paulo
[email protected]
Abstract
The ability of a firm to recover from a declining financial performance is called
turnaround. The understanding of the actions taken by such firms and the differences in
between them and those that went bankrupt is one of the main goals addressed by the
turnaround literature. However, a definition of a general model that can be applied to any
business situation seems to be something still distant for research on the subject. Ultimately,
understanding the transition from the period of decline to the recovery period is to set how to
restore firms competitive advantage. Thus, the evolution of turnaround research may have had
contributions from strategy literature, such as Industrial Organization (IO), Resource Based
View (RBV) and Transaction Cost Economics (TCE), that tries to explain how firm created
sub-normal rents. This paper proposes an investigation into turnaround literature in order to
understand the evolution of the topic as well as the contributions of strategy literature to the
turnaround field. Propositions about a model of firm turnaround process and recovery strategy
will be made. The results achieved indicate paths for general model of development on the
turnaround of firms as well as aspects that should be studied in greater depth.
Keywords: strategy; firm recovery; rent creation
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1 INTRODUCTION
The research topic that embraces turnaround studies is quite recent. Earlier works are
dated from the end of the 70´s and research evolved from a very propositional approach from
field observation and lacked empirical evidence. During the 90´s and 2000´s the research
topic gained a more robust body with some consolidation and empirical large sample studies
looking to a wide variety of aspects of the turnaround process (KOLYA, 2015).
Turnaround is “the combination of activities by which once-successful firms that
experience severely declining performance for a protracted period of time overcome their
troubles and return to match or exceed their most prosperous periods of pre-downturn […]
turnaround response is conceived as encompassing two stages of activities: retrenchment
1
and
recovery (PEARCE II; ROBBINS, 1993, p. 22)”. Thus, turnaround is being represented by
the literature as a process that has its retrenchment and recovery responses tailored principally
by the causes of decline.
From a financial point of view, recovering business performance might encompass the
rearrangement of activities, cut offs, layoffs, divestments and so on, with one crystal clear
goal: turning performance at a good level again. Apart of the good intentions of financial
recovery plan, one may argument that such actions could damage firm strategy. Indeed,
layoffs, cutoffs and disinvestments could put the firm strategy in danger since it can dismantle
firms rent creation mechanism and must be taken carefully (LIM et al., 2013).
Considering that firm strategy is being challenged by the state of performance decline,
we expected to have, by the one hand, the researchers from strategy field preoccupied with the
situation of firms claiming for turnaround, and by the other hand, the turnaround research
flirting with strategy literature to explain strategic failure and recovery strategies. However
the first case is not observed and strategy literature barely contributed to the study of firms
facing decline. Fortunately, some turnaround researchers have taken arguments from the
strategy field and added contributions to the turnaround literature. Adopting the concept of
firm rent creation mechanism, the authors brought the turnaround research closer to the
strategy literature (LIM et al., 2013).
Taking the importance of strategy to design recovery strategy of firms facing decline
and the lack of attention by strategy research to the turnaround situation, this paper seeks to
address what are the possible contributions of strategy research to turnaround studies and how
can the strategy literature foster turnaround models to recover business from failure.
The methodological approach will encompass a theoretical discussion about the recent
contribution of strategy research to turnaround research and the proposition of a model for
turnaround strategies based on the elements of strategy research.
1
The retrenchment phase encompass the cost cutting and asset liquidation actions taken in an
initial stage of turnaround process aiming to generate cash and promote financial slack.
10
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
2 TUNRAROUND RESEARCH
This section aims to discuss the main issues addressed by front of knowledge about
turnaround found by Kolya (2015) in a bibliometric research. The topics are: organizational
decline: causes, patterns and prediction of bankruptcy; recovery: turnaround strategies and
retrenchment; and causal attribution: the role of top management. During the discussion on
the evolution of themes, will be derived recommendations for a turnaround model companies,
which reflect how far advanced the literature and what their recommendations on how to
recover firms declining.
2.1 Organizational Decline: Causes, consequences, patterns and predicting bankruptcy
The term "organizational decline" is the more central, in turnaround research. Among
its most classic works are the Altman (1968; 1983) studies related to the prediction of
bankruptcy of firms. The author develops an indicator called Z-score, constructed from a UK
company database and providing the risk of bankruptcy of a company due to aspects of
financial health. The model shows quite accepted among work on turnaround companies as
indicative of the closeness of bankruptcy (BARKER III; DUHAIME, 1997; BARKER III et
al., 2001; SUDARSANAM; LAI, 2001) or in a similar way as an indication the severity of the
"turnaround situation" (ROBBINS; PEARCE II, 1992; PEARCE II; ROBBINS, 1993). The
indicator is appropriate and limited to the evaluation of companies listed on the stock
exchange, since it uses the value of the shares in the capital market as one of its metrics.
As proposed by Altman (1968; 1983) the probability of bankruptcy, was used in the
literature as an indicator of severity of turnaround situation, but requires information that only
companies with capital listed on the stock market have. One way to assess the severity of the
decline and the performance during and after the turnaround is to use the return on
investments (ROI) indicator (HAMBRICK; SCHECTER, 1983; ROBBINS; PEARCE II,
1992; BARKER III; DUHAIME, 1997; MORROW et al., 2004)
The early work on turnaround were basically exploratory, assessing cases and attempts
to generalize, as a first step to building a theory about the decline and recovery companies.
Schendel et al. (1976) developed a model that sought the relationship between the situation of
declining performance and causes of decline. The authors, from cases evaluation, proposed a
list of strategic actions for cases in which the decline was the result of bad strategies and a list
of operational actions to achieve the turnaround for the case in which the decline was caused
by inefficiency operating (Robbins; Pearce II, 1992).Hofer (1980) adopts the same
terminology and define strategic reasons as increased competition, profitability falling, rise of
wages, supply of raw materials and management difficulties. Operating causes include
reduced prices, recession, strike and work force problems and excess capacity.
The strategic-operational distinction has not been fully accepted by the literature that
sought to improve the understanding, since what seemed operating for a firm could be
strategic for another. Slatter (1984) purposed eleven general factors to which the decline of
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Research Workshop on Institutions and Organizations – RWIO
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th,
, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
organizations are assigned. They are: mismanagement; inadequate financial controls;
competition; costly organizational structure; change in the demand pattern; price instability;
little effort in marketing; major projects; acquisitions; financial policy; and operating above
the cash generation capacity. In this approach the author puts aspects of various kinds as
causes of decline, i.e. causes that can be recognized as internal, such as poor management and
financial policy, and external causes such as change in the pattern of demand and price
instability. Subsequent studies supported this understanding of the causes of decline
(PEARCE II; ROBBINS, 1994; ROBBINS; PEARCE II, 1992).
The concern of the understanding of the causes of decline stems from the fact that
research on the turnaround seek to understand which strategies should be adopted by the
company in declining performance and it becomes crucial to establish the relationship of
cause-recovery strategy. However, Barker III and Duhaime (1997) criticize the previous work
that did not take care in the selection of the sample of companies evaluated in order to
identify the turnaround strategies and that somehow mixed firms with different levels of need
for strategic change . A research branch emerged suggesting that the decline of organizations
can be either based on internal aspects of the company or on market aspects (firm-based
decline versus industry contraction-based decline) (BARKER III; Duhaime, 1997 cited
WHETTEN, 1987 and CAMERON et al., 1988). This is because the need for strategic change
to a declining firm in a stable or growing industry, is far superior to a firm with superior
performance to its competitors, but it is in an industry contraction. Thus, the internal-based
decline of the firm is associated with poor adaptation to environmental changes while the
contraction-based decline attentive to markets ability to support the initial number of firms
causing a part of them to performance deterioration. So understanding the causes of the
decline as resulting from internal aspects of the firm or market contraction, appears more
appropriate. Thus, two important aspects can be gathered from the progress of work on
organizational decline: the severity of the decline that defines the probability of recovery; and
the causes of decline which are essential for establishing recovery actions.
Literature Recommendation 1: A model on firm turnaround should consider the
causes of the decline as internals or based on market contraction and severity of decline
as moderating factors.
In addition to research on severity of decline and causes of the decline a third group of
researchers has developed research and models to understand the pattern of decline of
organizations and their consequences for firms. Hambrick and Daveni (1988) define the
decline of organizations as a downward spiral that can last more than ten years until the
bankruptcy occurs. Given this feature of the process of decline, causes and consequences mix
since the consequence of onset of the decline can lead to further decline. The origin of the
decline is a financial resources deficiency and deterioration of the return on assets employed
(net income / assets), which will lead to a situation of extreme and uncertain decision making.
If the environment does not express many changes and the firm find a momentary equilibrium
with the availability of transitory cash flow, this will give false encouragement that can later
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
further undermine the situation, if there is a shrinking market and this could lead to
bankruptcy.
Daveni (1989) evaluates the pattern of decline of organizations measured by the
change in the "magnitude of internal resources", which considers the financial and managerial
resources of the firms. The author aims to understand three fundamental questions about the
decline: a) the consequences of decline in the management and firms strategy; b) the link
between declining patterns and their impact on the time required for the consequences arise;
c) factors affecting the time at which the failure occurs. To this end, the author evaluating the
decline of various organizations, and notes the existence of three distinct patterns: sudden -
rapid collapse followed by bankruptcy; gradual - slow and incremental decline with
bankruptcy immediately after the decline reached its worst level; lingerers - decline can be
sudden or gradual and after that the company keeps for a long time before they fail. The
author concluded that the lowest rate of mergers and acquisitions by post-decline firms
indicates a strategic paralysis condition in relation to survivors. In addition, there is a size
reduction process with settlements and divestments, but not necessarily in business where it
has worse performance, reinforcing the idea of “strategic paralysis”. There was also lower
number of employees in R & D, marketing and production area and larger number of
employees in finance and greater concentration by the president. The paper also concludes
that the decline patterns are related to the time the consequences take to appear, such as
imbalance in the management, actions related to efficiency, power centralization, and
strategic paralysis. All this reflected in rigid response against the threat. Although the study
suggests that management actions are the source of the turnaround, the author argues that we
must recognize that the managerial variables are not alone responsible for strategic actions,
barriers to exit the industry, for example, can hold firms in difficult situations to escape. And
yet, the results showed that some firms may postpone or even avoid bankruptcy in situations
where the market is sufficiently abundant to accommodate a firm with lack of resources.
This approach demonstrates the process of decline is in some way dependent on the
signals of the external environment and reactions that express companies. This view is
complemented by Arogyaswamy et al. (1995) citing Cameron et al. (1988) which says that the
decline in firms' performance occurs when they become ill adapted to the environment, when
the environment becomes hostile, or both factors (firm-based decline and market contraction-
based decline). These causes will lead to the erosion of support of stakeholders, internal
inefficiencies growth and deterioration of the organizational climate and the decision-making
process. The authors propose a recovery model for companies that before the implementation
of recovery strategies, undergoes a decline interruption process, through the rehabilitation of
the confidence of stakeholders, eliminating inefficiencies and stabilizing the organizational
climate and decision making. Thus, considering that the decline is a process that usually leads
to a stage of strategic paralysis, regardless of their initial causes, the turnaround process
should propose actions that break inertia and interrupt decline.
10
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
Literature Recommendation 2: A model on firm turnaround should propose
inertia breaking actions, with the rehabilitation of stakeholders confidence, eliminating
inefficiencies, stabilizing internal climate and decision-making, to interrupt decline.
As seen, the decline of organizations is a topic that receives different approaches. It is
observed that the decline can be considered a process (Hambrick; DAVENI, 1988) with
different patterns and consequences (DAVENI, 1989). Its causes are not unanimous, but it is
possible to separate them in: decline due to misguided strategies and poor adaptation of the
firm to the environment and on the other hand, the decline due to market changes. In a
simplified approximation of the literature is the understanding that the decline may occur for
external forces or internal problems of firms. Moreover, the severity of the decline is an
important factor to be considered in the design of recovery strategies.
2.2 Causal attribution: the role of top management
As an integrant part of the inertial process, several authors investigated the importance
or need of replacement of top management, president and board members to achieve the
success of the turnaround. The empirical-exploratory work justify the change of top
management being necessary given the belief that the leaders of a company a understanding
of how the business should be conducted, but must be wrong vis à vis the situation in which
the company find itself. Thus the way to improve firm performance is to bring a new team of
top management (Hofer, 1980). The exchange is also reasonable since the manager's
credibility is lost once he put the firm in a decadent situation (ONEILL, 1986). In addition,
the current managers are less motivated to undertake turnaround actions due to their
commitment to previous strategies and to exchange them can have a positive effect on new
strategies building and signals changes to external stakeholders (CATER; SCHWAB, 2008).
As previously mentioned, Arogyaswamy et al. (1995) proposed a theoretical model of
turnaround that passes through disruption strategies of decline and recovery. The authors
argue that firms that achieve the turnaround must present the decline interruption strategies
that: a) renew the support of key stakeholders; b) raise the efficiency; c) stabilize the internal
climate and decision-making process. Therefore, replacing the president and top management
will increase the effectiveness of strategies when in the case of decline based on internal
factors of the firm, as the declining performance situation resulted from the decision-making
of current managers. Where the decline had its origin attributed to the market, the stability of
the president and top management will lead to greater success because switching costs are
higher than the benefits generated, except in the event of prolonged decline and/or weak firm
competitive position that require strategic changes. The model, however, lacks empirical
evidence.
Empirically investigating the relationship between the decline and the succession of
the chief executive officer (CEO) and board members, Daily and Dalton (1995) found no
significant difference in turnover ratio (percentage of members exchanged relative to total) for
CEO positions and the board, among firms failed and that did not fail, suggesting that as
10
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
advocated by other studies, the decline is a downward spiral in which companies find it
difficult to change and come out even with the exchange of managers, it does not explain the
success or failure of the turnaround. However, the authors did not differentiate firms that
declined by internal factors or market issues, as suggested by Arogyaswamy et al. (1995).
In order to understand other issues related to decision-making structure and
differences between companies that have recovered and not, Mueller and Barker (1997)
empirically assess 33 pairs of companies (companies that failed versus companies that have
recovered) to identify differences regarding the composition and board size, duality for the
president (when the chief executive is also chairman of the board), size and change of the top
management team (TMT). The results indicated that firms that managed the turnaround is
more likely to have their president also as a board member, the board has average size, and
greater external control, as the presence of shareholders. The theory of agency touts the
president of the company should not be both chairman of the board by agency conflicts, on
the other hand there is a view that holds that this situation is interesting for companies in
turnaround situation, as it provides a stronger leadership united leadership, and the existence
of a president on the board and one in the company can generate some kind of conflict about
who in fact is the decision maker. The presence of the external advice can be explained by the
agency theory and the theory of resources. In the first case, the external act as monitors
(principal) of the CEO and other executive officers (agents). For the resource based
perspective, the presence of external might be interesting, since these have capacity to
influence other organizations to which the firm may have some dependence on resources.
Specifically external can confer legitimacy, ability to access capital and other key features
that affect the survival of the firm. Another result found was that the end of the recovery
process, firms TMT had a lower incidence in relation to the time prior to decline. This
suggests that recovery is more likely to swap at least a portion of the TMT. The presence of
the CEO on the board and the performance of the external advice suggests that recovering
firms develop decision-making structures that are more agile and influenced by external
perspectives.
The purpose behind the change of TMT is to promote the breakdown of inertia caused
by the permanence of a cognitively biased team and therefore unable to properly relate the
decline to internal causes, reducing the probability of a firm to take strategic change actions.
Thus, the work of Barker III and Patterson (1996) aims, from field data and case studies,
identify the differences between causal attribution of decline for TMT older and younger in
the company. Rescuing arguments of the social psychology field and work on organizational
decline and turnaround, the authors find empirical support (though not statistical) to the
hypothesis that younger TMT tend to attribute the causes of the decline to internal factors,
controllable and stable, therefore there is less likely to attribute the decline to market factors.
Furthermore, the study showed that the arrival of new agents has been associated with
changes in the understanding of the problems Company, strengthening the hypothesis that the
causal assignment between young and old management tends to be different. In addition, the
result puts arguments against a part of the literature that argues that the replacement of TMT
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Research Workshop on Institutions and Organizations – RWIO
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September 8-9
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, 2015
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USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
works as a necessary sacrifice ritual whereby TMT becomes a scapegoat only to meet part of
the stakeholders need and maintain employment of managers with more power.
Barker III and Duhaime (1997) conducted a work to assess the effects of TMT
exchange in strategic change of firms and found statistical support to justify the replacement
of the President, since the level of strategic changes in companies that began the turnaround
was higher in those which the chairman was replaced. A similar result was found by Barker
III et al. (2001). The authors investigated inertial factors and forces of change that influence
the replacement of TMT, which in turn is related to the level of strategic changes. The results
of empirical work with a sample of 154 US companies have shown that in larger firms, that
have had a longer period of pre-implantation decline strategies, exchange of TMT tends to be
less likely (inertial force), while the increase of external participants on the council was
positively related with changes in the TMT (forces of change). The authors had predicted that
firms that have applied for recovery would have greater rate of change of TMT (force of
change), but the results did not corroborate this hypothesis. Finally, higher levels of TMT
replacement were more associated with changes in business strategy and structure and internal
controls. Therefore, one must consider that the initial strategy of breaking inertia announced
before, should consider the option of TMT replacement (even partially) and approach of
externals to the council (not board members).
Literature Recommendation 3: A turnaround model should consider changing
the top management and participation of external advice on a strategy for switching the
decline and take action for recovery.
2.3 Recovery companies: turnaround strategies and retrenchment
The recovery actions taken from a decadent firm are certainly the object of greatest
interest of this study. The literature on the subject sought the understanding of the turnaround
process and further establish the relationship between the causes of the decline and recovery
strategies and adds moderating factors such as the severity of the decline, the role of TMT,
stakeholder (HOFER, 1980; ROBBINS; PEARCE II, 1992; TRAHMS et al., 2013).
Moreover, another concern was to deepening the understanding of the turnaround strategy
itself and the retrenchment action known as cost cutting or assets liquidation (HAMBRICK;
SCHECTER, 1983; MORROW et al., 2004; LIM et al., 2013).
In one of the early work on turnaround strategies, Hofer (1980) adds to the strategic-
operational recovery approach proposed by Schendel et al. (1976), the notion of severity of
"turnaround situation." This term is well understood in the literature as being the time when
the performance depreciated firm to the point where recovery efforts are necessary (Robbins;
Pearce II, 1992). Companies in turnaround situations sustain a loss of resources that will lead
to bankruptcy if not tackled (AROGYASWAMY et al., 1995). In his work, Hofer (1980) and
develop the types of turnaround strategies, it proposes that the nature of the turnaround
situation go through the evaluation of the operational health and strategic health of the
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Center for Organization Studies – CORS
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th,
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USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
organization. The firm chooses to operational activities or strategic actions or a combination
of both. The operating strategy focuses on cost reduction and cash generation actions in order
to achieve breakeven, while the strategic action focus on recovering competitive position,
market segmentation or focus on specific niches. This change can be difficult according to the
authors, if the competitors have superior strategic resources. Another important contribution
of this study was the conceptualization of the notion that the cost reduction and liquidation of
assets (retrenchment) is an action within the turnaround process, contingent on the severity of
the turnaround situation.
Hambrick and Schecter (1983) challenge this "strategic-operational" dichotomy for
recovery actions. The authors explain that differentiate what is strategic that which is
operating can be confusing. An example is the case of a company that buys automated
machines and improves its cost controls. This action can easily be understood as operating,
however, it can also be seen as a strategy leading costs as proposed by Porter (1980).
Furthermore, these strategies held by Hofer (1980) flees from the reality of mature industries.
So the authors propose that the actions can be understood as entrepreneurs, aiming income
generation or focus on products or markets, or efficiency actions represented by asset and cost
cutting. Hambrick and Schecter (1983) were the first to empirically test the propositions of
Schendel et al. (1976) and Hofer (1980) and found that in mature industries, effective
turnaround strategies had been those that reduce costs and assets, products line cutting,
market exits and incremental strategy. Cost cutting and assets liquidation were used by firms
with low levels installed capacity utilization. Cutting products and markets was mainly used
by companies with high rate of capacity utilization. The incremental strategy has been
adopted by firm with high market share which have undertaken actions to generate revenue
from increase on installed capacity utilization rate and labor productivity.
Arogyaswamy et al. (1995) reviewing previous works argue that the turnaround
strategies can be defined in terms of two attributes: the need for strategic change and the
impact of the contraction or expansion of industry, often involved in the implementation of
the strategies. Thus, the competitive position of the firm and the cause of the decline is
moderating factors for the turnaround strategies. The choice of incremental strategies should
be the most appropriate in turnaround situations caused by industry contraction when the
competitive position is strong. Whereas in times of crisis, the competitors with strong
competitive position are fighting for survival with incremental strategies, companies with
weak competitive position should reduce their scope of activities for which their resources
and capabilities are better valued.
Literature Recommendation 4: A model for firm turnaround should consider the
moderating factors such as causes of the decline and competitive position, for designing
recovery strategies.
The conditioning factors proposed by Oneill (1986) are understood as possible causes
of the decline (ie the inadequacy their part) by Robbins and Pearce II (1992), which are
divided between internal and external factors for which a set of maintenance strategies
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USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
efficiency or entrepreneurial expansion will be required for the first and second cases,
respectively. For the authors the severity of the turnaround situation measured by Z-score
indicator, proposed by Altman (1968; 1983) is moderating factor for the need and intensity of
the cutting action costs or liquidation of assets, known as retrenchment. By analyzing
recovery cases in the textile industry, the authors observed that the retrenchmnet is less
common in companies that have the decline associated with external factors and firms
running retrenchment has higher performance turnaround, so those whose decline was linked
to internal causes presented better recovery performance in relation to others. It was observed
that the retrenchent cost was associated with the success and recovery companies with
different levels of severity while the retrenchment of assets only proved feasible for high
levels of severity. The authors concluded that firms must perform independent retrenchment
of turnaround situation and that firms close to bankruptcy should complement the cost cutting
with liquidation of assets.
Recommendation 5: A model on firm turnaround should consider asset and cost
retrenchment in an intermediary stage of the recovery process.
Morrow et al. (2004) found statistical support for the results of previous studies
presenting the retrenchment as a recovery strategy (SCHENDEL et al., 1976; HOFER, 1980;
ONEILL, 1986; ROBBINS; PEARCE II, 1992; PEARCE II; ROBBINS, 1993). However,
arguing that in such previous studies the possibility of generalization is restricted because
they were conducted in a single industry and few companies so that disregarded the influence
of the competitive dynamics of the industry as a moderating factor of the success of
retrenchment actions. Thus, the authors propose that retrenchment strategies in a declining
industry are different from that on a mature or in expansion industry. Whereas in new or
expanding industries, competitive dynamics imposes the need for innovation, marketing, new
product development as a way to impose barriers to entry and reduce the strength of
competitors, the authors argue that opting for cost cutting should have a negative impact on
the competitive advantage of the firm. However, the choice of cutting assets may be
interesting, because in a booming industry, readily available assets are overvalued by the
market. In declining industries, in which there is a large number of competitors and the level
of innovation is low, the option of cutting costs will be a successful strategy, while the
liquidation of assets not because these industries the value of the asset on the market may be
less than the value of their potential use by the declining firm.
The authors test the hypothesis with a sample of 412 firms in industries at different
stages of development in the USA. The results achieved in addition to corroborate previous
studies that pointed to the cost reduction actions and assets as turnaround strategies in mature
industries, observed that in declining industries cutting costs is a strategy that works, but
reduction of assets not, as had been predicted. In the case of expanding industries, the result
partly corroborated hypotheses: the performance was higher when there was liquidation of
assets, probably due to strong market sale of assets in these industries, but cost cutting had no
negative relationship with performance turnaround as had been predicted (in this case the
result was inconclusive).
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
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USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
Arguing that studies on the impact of the turnaround in the performance of recovery
were inconclusive because disregarded the cause of the decline, Ndofor et al. (2013) adds the
cause of decline as moderating factor as to test the impact of operational actions
(retrenchment of costs and assets) and strategic (acquisitions, strategic alliances and launching
new products) in the turnaround performance. Thus, from a group of companies performing
below average on a high profitability and expanding industry, the authors tested the
hypothesis that retrenchment actions will lead to worse performance turnaround while
strategic actions will lead to a performance turnaround higher. The authors consider that
retrenchment actions are part of the turnaround strategy, not just a stage as proposed by
Robbins and Pearce II (1992). The hypothesis that the retrenchment will have a negative
effect on the turnaround of performance is supported by the argument that companies in decay
in a booming industry, are in such a situation because of its weak strategic positioning
(because of the decline) and the struggle for efficiency will not solve the problem of poorly
adapted strategies. The results from the evaluation of a sample of companies in the computer
industry in the United States corroborated the hypothesis raised and strengthened the
importance of considering moderating factors as the cause of the decline in turnaround
strategies design and also that in industries high technology, efficiency measures should not
lead to superior performance in an attempt to turnaround.
In the same direction - to understand the role of moderating factors in the success of
retrenchment strategies-, Lim et. al. (2013) proposes a model in which the rent creation
mechanism (resources and capabilities) is the main moderating factor in the success of the
turnaround. The authors support their model in the existence of two sources of rent
generation: the Ricardian associated with the firm's ability to exploit superior resources that
lead the company to a situation of lower average cost; and on the other hand the
Schumpeterian rent achieved by the action of taking entrepreneurial risk, supported by unique
capabilities that allow the firm to reach values higher for their products and services. This
kind of income is generally associated with a dynamic environment and gives the firm the
ability to adapt and innovate. The authors tested their models with a group of 2406 Japanese
companies listed in the Nikkei stock market and obtained partial support for their hypotheses.
Firms that have Schumpeterian nature of income but that have adopted cost cutting strategy
had their post retrenchment performance less than their peers. This effect was accentuated
when the industry to which the firm belongs have a competition pattern typically based in the
generation of Schumpeterian rent. The hypothesis about the negative impact of cutting assets
when the nature of rent generation is Ricardian was not supported by the results. The authors
argues that the Ricardian rent is based on the selective picking of assets in the strategic factor
market, but also the option of not acquiring a non-productive resource. This second
alternative may explain some of the inconclusive results.
Retrenchment actions have two approaches in the literature. A view points to
retrenchment as a turnaround strategy (LIM et al, 2013;. NDOFOR; VANEVENHOVEN;
BARKER III, 2013) but the other one argues that retrenchment is not the turnaround strategy
in itself, but a condition that may be needed for further implementing strategic actions and
10
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
focus (retrenchment of assets or costs) will depend on the severity of the turnaround situation
(ROBBINS; PEARCE II, 1992). So part of the literature keeps cost cutting and assets
liquidation actions as a recovery strategy while another believes that it is a stage prior to the
recovery phase. In general, the studies point to moderating factors such as industry life cycle
of products and nature of the firm's rent creation mechanism, which define circumstances
under which a retrenchment strategy should or should not be adopted. But as suggested by
Morrow et al. (2004), Lim et al. (2013) and Ndofor et al. (2013), the mechanism of rent
generation is the most important aspect since the industry life cycle, product and type of
industry are factors that do not capture the strategy of rent creation from the firm.
Literature Recommendation 6: The retrenchment as integral action in a model of
turnaround companies should consider the impact of cost cutting and assets liquidation
on the firms´ rent creation mechanism.
This section discussed the state of the art of the knowledge on business turnaround and
depicted from the literature six well discussed recommendations from literature to the process
of turning a business around. Next, discussion concerning the last stage of this process will be
brought and we will shed light on the role of rent creation mechanism to the recovery
strategy.
3 A COMPETITIVE STRATEGY MODEL FOR THE TURNAROUND
COMPANIES
As previously discussed, the literature on turnaround strategy arguments that the last
stage of the turnaround process pass through the delineation of recovery strategies, which are
moderated by the competitive position and the cause of the decline. Besides of that, Morrow
et al. (2004) argues that industry stage of development defines the most appropriate strategy.
For example, in a booming industry, firms compete for innovation while in an industry under
contraction competition is for efficiency. The arguments of Morrow et al. (2004), clearly
influenced by Industrial Organization (IO) approach may be restated with the RBV lenses.
For example, competition for innovation typically involves investments in R&D and
marketing, and is associated to firms with Schumpeterian rent, the low church branch of
RBV. On the other hand, the notion of competition for efficiency is typically of firms that
compete for Ricardian rent, for which the possession of valuable, difficult to imitate and rare
resources allows the firms to achieve lower costs. Lim et al. (2013) uses this approach
(Ricardian rent versus Schumpeterian rents) in his proposal for retrenchment actions. Taking
this approach, we propose to extend the application of the concept used by Lim et al. (2013)
to the model of turnaround process, developed by Arogyaswamy et al. (1995). The model
presented on Figure 1 bellow adds the moderating role of the rent creation mechanism to the
recovery strategy discussed previously.
10
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
September 8-9
th,
, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
Figure 1 – A turnaround process model
Source: authors
Few firms in declining condition maintain strong competitive position, but this can
occur when the decline is caused by market contraction or when the firm declines for internal
reasons but remains strong competitive position because it has latent resources and
underutilized capabilities (AROGYASWAMY et al., 1995). Thus strategies for firms in a
strong competitive position and decline from internal conditions aims to maintain this position
with incremental actions to better exploit resources and capabilities. When the decline occurs
by cyclical contraction of the industry or even prolonged contraction, the strategy aims to
maintain the position with incremental strategy of using existing resources and capabilities
and to expand into other segments where these resources and capabilities has more value
(AROGYASWAMY et al., 1995).
Firms with mechanism for generating Schumpeterian or Ricardian rent, which holds
strong competitive position, that is, valued resources or capabilities, and come into decline for
internal reasons should adopt incremental strategies that better exploits their resources and
capabilities to maintain or even expand its competitive position. Inaction against the decline
will lead to deterioration of resources and capabilities and loss of competitive position,
exacerbating the decline. When the competitive position is weak, it means that the resources
and capabilities has no value in that market. Thus, it is required a strategic reorientation with a
focus on particular segment in which the firm can develop resources and capabilities with
greater value.
Next, propositions 1 to 8 (p1 to p8), relate the recovery strategies that should be
adopted moderated by competitive position, cause of decline and rent generation mechanism.
p1: Firms with Ricardian rent mechanism, with a strong competitive position and
internal cause of decline, which adopt incremental strategies for better use of their resources
in order to maintain or even expand its competitive position, have higher post turnaround
performance than those that do not adopt such actions.
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Research Workshop on Institutions and Organizations – RWIO
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September 8-9
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, 2015
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USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
p2: Firms with Schumpeterian rent creation mechanism, with a strong competitive
position and internal cause of decline, which adopt incremental strategies to recombine its
internal routines and strengthen its dynamic capabilities in order to maintain or even expand
its competitive position, will present higher post turnaround performance than those that do
not adopt such actions.
Firms with weak competitive position, in a stable or growing industry declining due to
internal aspects should take actions to bring them into a strong competitive position.
Considering the high cost of accessing the market of strategic factors and the cost of
developing new skills and competencies, the firm should focus on sectors where their
resources have greater value and lead to a situation of high efficiency and where their
capabilities can produce products and services of higher value.
p3: Firms with Ricardian rent creation mechanism, with weak competitive position
and internal cause of decline, which adopt strategic reorientation focusing on segments where
resources can lead to greater efficiency, will have greater post turnaround performance than
those that do not adopt such actions.
p4: Firms with Schumpeterian rent creation mechanism, with weak competitive
position and internal cause of decline, which adopt strategic reorientation focusing on
segments where capabilities can lead to the generation of greater value, will have greater post
turnaround performance than those that do not adopt such actions.
The most critical situation is found for firms with weak competitive position in
contracting industries. In these cases the strategy should be to reduce the business for those
consumers and segments in which resources and capabilities provide greater competitive
advantage. The adoption of strategic reorientation in these cases is dangerous because a weak
firm in a hostile environment find it difficult to absorb the cost of a strategic shift
(AROGYASWAMY et al., 1995). However, contrary to this argument, it is known that in
crisis industries, the value of assets in the strategic factor market is generally undervalued. In
markets contraction, a firm with weak competitive position has no valuable resources and
capabilities and the low cost of resources in these markets can be attractive in some way so
the firm can recover, even partially, its competitive strength by acquiring and recombining
resources. This action will depend on the financial capacity of the firm, which is often
delicate at this point, then as proposed by Arogyaswamy et al. (1995) a viable alternative may
be to reduce firm size and focus on segments in which resources and capabilities are most
valuable.
p5: Firms with Ricardian rent creation mechanism, with weak competitive position in
industries in crisis, that access new resources in strategic factor markets or reduce their
operations to segments where resources have greater value, will have higher post turnaround
performance compared to those that do not adopt such actions.
10
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
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, 2015
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USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
p6: Firms with Schumpeterian rent creation mechanism, with weak competitive
position in industries in contraction that develop new capabilities or reduce their operations to
sectors where their capabilities have the potential to generate greater value, will have higher
post turnaround performance compared to those that do not adopt such actions.
Access to the strategic factors market may be a strategy also for declining firms with a
strong competitive position in an industry in contraction. For these firms the strategy should
be to maintain the competitive position with available resources, but the expansion of
competitive position may be feasible via strategic factor market. In the case of capabilities, it
may be the opportune moment to invest in the reorganization of routines and construction of
new capabilities in order to strengthen the competitive position.
p7: Firms with Ricardian rent creation mechanism, with a strong competitive position
in industries in contraction that keep their resources and/or access new resources in strategic
factor markets, have superior post turnaround performance than those that do not adopt such
actions.
p8: Firms with Schumpeterian rent creation mechanism, with a strong competitive
position in industries in contraction that maintain their capabilities and/or invest in
strengthening and creating new capabilities, have superior post turnaround performance than
those that do not adopt such actions.
Figure 2 bellow is following these eight propositions in the form of recommendation
for each of the eight possible situations that firms under performance decline may come
acrros.
Figure 2 – Recovey strategies model
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Center for Organization Studies – CORS
September 8-9
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, 2015
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USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
In order to partially check the adherence of the model we are proposing, the recovery
strategies adopted in a turnaround case discussed by Balgobin and Pandit (2001) will be
assessed and discussed. The case at stake is the performance recovery of a UK subsidiary of
the International Business Machine (IBM) at the 1990´s. This business unit had its
performance dramatically affected by a change in demand pattern that has not been followed
by the firm. The computer industry has moved from a model where companies were vertically
integrated, controlling everything from the manufacture of chips to the development of
software and services to a horizontal model where each company is specialized in a particular
aspect of the chain. The main industries that compete with IBM at the time focused on
software development and services (Microsoft) or production of chips (Intel) and there was a
change in the pattern of computers demand, from large mainframes to personal computers
(PC). Access to PC went from a luxury item to almost commodities. IBM - UK failed to keep
up with changes and went from a cash generation capacity of close to £ 500 million in 1988 to
an almost £ 1.0 billion loss in 1991/92.
Balgobin and Pandit (2001) attributed the decline to external factors, like changing the
industry standard, however from what has been discussed in this work, not following market
changes is an internal problem to the firm. As suggested by Lim et al. (2013), high-tech
industries such as which shall include IBM-UK, has a competition pattern based on
investment in R&D, marketing and personnel. Indeed, Balgobin and Pandit (2001) proposed
some internal factors that led to the decline as the delay of IBM-UK in exploring new
technologies and their products did not meet customers need anymore. This inability of the
firm was said linked to the distance between the leaders and the real market (the decision was
concentrated in the hands of a few and far from the customer and market). The pattern of
competition in these industries is based on the generation of Schumpeterian rents as suggested
by Lim et al. (2013), associated to dynamic capabilities building that lead to income
generation from disruptive innovation.
As there was no crisis in the technology industry at that time it is possible to affirm
that the decline of IBM-UK was due to internal issues and its competitive position has
changed from strong to a weak position. Thus, as proposed in the model, the recovery strategy
should focus on a particular market segment and build new capabilities (decline caused by
internal issues, Schumpeterian income and weak competitive position).
As described by Balgobin and Pandit (2001) the main objective of the CEO at the time
was to transform the IBM-UK, a general computer firm into a leader in solutions. Thus, the
firm divested in segments that were not part of this new concept and promoted a series of
changes in the organizational structure. Each business division became accountable for its
results thus giving more autonomy to its action and responsible for its results. The focus
shifted to consulting and services with strong expertise in the market. The guideline was to
become a customer-oriented company and highly responsive to the market. The elimination of
four management levels turned the firm more agile in decision making and responsive to the
market. Various programs to measure the satisfaction of service to consumers have been
implemented, and a new framework of required skills has been applied to managers who
10
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Research Workshop on Institutions and Organizations – RWIO
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USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
should be more general and less functional, in order to strengthen the ability to see trends and
propose solutions.
As it was seen, the actions taken by IBM-UK sought to focus on a specific segment,
followed by actions to build internal capabilities that allow a leading position in consulting
services and IT segment. The capabilities briefly presented above may be understood as the
dynamic capabilities needed to generate Schumpeterian rents.
The evaluation of the case of IBM-UK, although superficial, in light of the discussed
model in Figure xx, shown that actions taken by the UK subsidiary in its turnaround process
were quite close to the recommended actions in the model: focus on particular segment with
the development of capabilities that can generate greater value.
4 DISCUSSION AND FINAL REMARKS
The present study had as main objective to investigate what are the possible
contributions of strategy research to turnaround studies and how can the strategy literature
foster turnaround models to recover business from failure. To meet the objectives a review of
the existent literature was conducted and recommendations for a model of turnaround process
were raised from literature. Arguments from previous research and from strategy field, more
specifically from resource based view, were taken and integrated in a model for turnaround
strategies, understood as the last step of a turnaround process. The proposed model was used
to discuss the case of IMB-UK presented by Balgobin and Pandit (2001).
This study demonstrate how turnaround research provide fertile ground for application
and testing strategy concepts and theory and suggests that there may still be more to be done
regarding the integration of strategy approaches to turnaround research.
The contribution of strategy literature for the theme is clear when we evaluate,
especially the works that deal with the process of retrenchment and recovery strategies. As
discussed, the Resource Based View appeared to explain retrenchment actions. Besides
Industrial Organization theory with its structure-conduct-performance determinism was used
to design recovery strategies depending on the industry structure.
Nevertheless, this work was limited to the examination of the various issues
surrounding the turnaround and didn´t went deeper in other aspects besides recovery strategy.
The aspect of decision making and the role of managers, for example, received less attention
in this study. However, it does not mean that the human aspect in the turnaround process is
less important. We saw that, as an initial stage of the turnaround process the renew of TMT
and approximation of externals to the board may break inertia and promote strategic shifts.
The importance of human factor in strategy building is being a vivid topic in strategy
research. Recently, studies in the field of strategy have turned its attention to the micro
foundations related to decision-making within the framework of competitive strategy (FOSS,
10
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Research Workshop on Institutions and Organizations – RWIO
Center for Organization Studies – CORS
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, 2015
Center for Organization Studies (CORS)
USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
of Bahia); UFRJ (Federal University of Rio de Janeiro) and UFSCar (São Carlos Federal University)
2011). We observe that turnaround studies tested approaches related to decision-making and
this should be an avenue of development for future research in turnaround.
Finally, it is proposed that the next studies of turnaround seek greater integration with
strategy literature, as these have proven useful for building more robust turnaround models
and contribute to a more complete theory for firm recovery.
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USP (University of São Paulo); Insper (Institute of Education and Research); UFBA (Federal University
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