Closely held companies that get into trouble often fall victim to some type of value rigidity. Just like our little monkey friend who cannot let go of the rice even as he can see the villagers closing in around him, companies that become distressed are unable to respond in a positive way to changing circumstances, even in the face of very strong evidence that such action is necessary if they are to survive.

Due to prolonged periods of deteriorating performance, denial, wishful thinking and perhaps even some incompetence, the businesses – and sometimes the families themselves – must eventually confront the consequences of their failure to act.

1. Reasons for a Company’s Inertia
The reasons for a company’s inertia can take many forms:

• Perhaps the business refuses to rethink certain cherished beliefs, such as a “requirement” to internally manufacture everything it sells, that superior quality “costs too much” or that the one and only route to prosperity is to get bigger.
• Perhaps it cannot recognize that its customers’ perception of value has changed dramatically from what it has always been before.
• Perhaps it has underestimated an upstart competitor, especially a renegade that is not playing by the “established rules”.
• Perhaps management is unwilling to rethink the size, location or compensation system for its sales force or distribution network.
• Perhaps there is a stubborn unwillingness to restructure or discontinue some major activities of the business – a division, product line or function – despite overwhelming evidence that to continue the status quo is seriously hurting the company.
• Perhaps an aging patriarch will not let go, retire and facilitate the inevitable transition to the next generation.
• Conversely, perhaps the chief executive really is ready to retire, but is suddenly faced with the stark realization that over all these years he or she has failed to develop a successor.
• Or perhaps interfamily relations are so dysfunctional that the ownership and management are literally paralyzed – even in the face of obvious danger.
• Finally, perhaps too much consideration has been given to saving tax dollars, thereby thwarting possible solutions to a broader business and family crisis.
• Typical symptoms of a business heading for trouble can be categorized into two types: the “quantitative signals” and the more difficult-to-spot “intangible signs”.

2. Quantitative Danger Signals.
The quantitative symptoms of serious trouble are recognizable, relatively easy to pinpoint and usually unmistakable. Sadly, managers sometimes lack the gumption to acknowledge the problem.

1. Loss of Market Position. A healthy company does not give up its market share – certainly not without a fight or at least a very good, well thought-out reason. It is not unusual for profitability to look “good” while share is still eroding, a fact which can create a dangerously false sense of security leading to further inaction.
2. Sales Growth Without Profit Growth. If growth in sales over a period of time has not achieved a corresponding profit increase, the company is headed for distress. Whether because of price cutting, rising manufacturing costs or excessive spending on marketing and sales expenses, sales growth can actually make things worse if the additional business does not earn the cost of the additional capital needed to support it.
3. Declining Gross Profit Margin. This is perhaps the most critical measure of a company’s “competitiveness” within its industry – how its products, quality, service, costs, and marketing effectiveness stack-up versus the competition as perceived by its customers. Changes in the gross margin always mean something, and a business that sloughs-off the importance of these changes does so at its peril.
4. Declining Asset Productivity and Unsatisfactory Return on Investment. Along with gross margin decline, deteriorating asset productivity is one of the plainest warnings of all and it often goes completely unnoticed. The failure to address effectively the fundamental causes of the decline can, in effect, result in liquidating the business. Continued decline of ROI leaves the business with no means to make the investment needed to stay competitive.
5. Undisciplined Sales Mania. Businesses that have difficulty distinguishing between a good sale and a bad sale often find themselves knocking at the door of a crisis. Aggressively pursuing strategies to get more business, expand the product lines and customer segments, and extend geographic coverage at any cost, results all too often in unprofitable products, unprofitable customers, and runaway marketing expenses.
6. Deteriorating Operating Cash Flow. For a business to be a net user of cash during a period of rapid, profitable growth is not bad. In fact, it is to be expected. Deteriorating operating cash flow without a good reason is a warning signal.
7. Continuously Rising Debt. Economics literature teaches us that additional debt can increase the company’s financial leverage. Yet, debt levels spinning out of control will erode the financial base.

3. Intangible Warning Signals.
Review of financial, operating and marketing performance can very clearly pinpoint eras of impending trouble in closely held businesses. There is another group of warning signals usually not so easy to see but at least equally crucial.

1. Repeated Failure to Meet Sales and Profit Plans. The reasons can be several:
   1. Too many marginal product lines and a distribution system stretched beyond its capabilities.
   2. Excessive price cutting in a number of product lines where the company’s products are indistinguishable versus the competition.
   3. Weak sales and marketing management.
2. Low Expectations. Each shortfall in performance is followed by a ratcheting-down of expectations for the next year. Such willingness to reduce standards of acceptability and, then tolerate failure to meet the reduced standards threatens the onset of serious consequences.
3. Lack of Accountability. Excusitis can pervade a closely held business heading for trouble, and it is most dangerous when it radiates from the front office. An era of procrastination can only be stopped when top management accepts responsibility for the company’s performance and stops blaming the economy, the competition, the government, the customers, the minority shareholders, the children of the minority shareholders, the directors, the lawyers, or the accountants.
4. Top Management Isolation. Blindness, denial, and resistance to change at the top is a crucial danger sign, and is usually easy to spot. The physical environment inside the company can provide some clues, but the best sources of this information are the “little people” in the company. They usually see the true problems, know which family members are not pulling their weight, know which non-participating shareholders are either disruptive or key players to initiate positive change, and what the true strengths and weaknesses of the business are. They are usually eager to talk to someone. All one must do is win their trust and listen.
5. Failure of CEO/Founder/Owner to Address Succession Planning. By definition, any closely held business facing a transition to a new generation is in a crucial and difficult period of its life. If the CEO is already at or beyond normal retirement age and there is no one ready to take over, the company’s future as an independent family business is in jeopardy. The era of procrastination will continue until this issue is addressed.
6. Disruptive Spouses or Non-Working Shareholders. It does not take long to discover their existence. They can be perpetuators of an era of wrong-headed decisions and almost immovable obstacles to solutions. They must be identified and creatively confronted.
7. Hidden Agendas on the Part of Family Members, Shareholders or Non-Family Executives. To uncover this problem can take careful digging, but if it exists the consequences can be devastating to me business. A tendency towards organizational paralysis when it comes to major decision making is one clue. Another would be a company history alternating between periods of family-fighting and relative peace.
8. Turnover in the Financial Function. Lack of respect for the financial function is often a characteristic of any business headed for trouble, but there can be a. subtle added dimension in a closely held one. Family patriarchs often do not trust non-family chief financial officers; and they either do not confide in them the way that they should or simply shut them out. Beware of a constant succession of chief financial officers.
9. Technological Obsolescence. This problem can sneak-up on a company –but when it hits, the consequences can be devastating and often irreparable. The recognition of this problem can be particularly stubborn in a company that has been very successful in doing things its own way for a long time. This symptom can be difficult to spot, but one tell-tale sign is the emergence of small, upstart competitors starting on the fringes of a market, breaking the established rules and doing things in a way that evokes comments from established players such as “We tried that once. It won’t work.”

4. Summary of a Few Universal Truths

1. Numbers are Revealing. The onset of more serious trouble is almost always foretold in the numbers and it is usually years ahead of time.
2. nternal Problems. While the managements always blame external forces for their trouble, most often, the real causes are internal.
3. Entrenched Managers. Managements are unable to deal with the situation because they are unable to let go.
4. Great Hey Day. Sometimes, the more successful the business has been in its hey day, the more difficult it is to accomplish frame breaking change.
5. Top Managers. The blindness and rigidity is most severe at the top. The little people in an organization usually see the true problems – and often have a. pretty good idea of what to do about it.
6. Intentional and Rapid Implementation of Strategies. Major frame-breaking change must occur quickly before old hands re-think and re-trench. Moreover, the synergy of a totally new approach implemented at all levels is powerful.

5. Ideas on How to Stay Healthy

1. Advice to Clients - in Advance of Trouble.
   1. Understand and Appreciate the Difference between Marketing and Sales. Truly good marketing people are hard to find. An early sign that the company does not have one is when the person uses the terms sales and marketing interchangeably.
   2. Pay Attention to the Financial People. It is easy to slough off the CFO, but he or she has the information to identify the quantitative warning signals.
   3. Recruit the Best People. Find the best people for the organization, set demanding standards and really encourage independent thinking.
   4. Beware of Staff Department Build-up. People are an important, but expensive asset. Make sure each one contributes to the economic well-being of the company.
   5. Assure Accountability at the Top. It is important for managers to set the tone.
   6. Stop Using the Bank as a Crutch. Just because there is a banker willing to lend a company more money does not make it the right thing to do.
   7. Beware of Basking in the Glow of Past Successes.
   8. Don’t Let the Tax Tail Wag the Business Dog. Frequently, business issues should be of primary importance.
2. Advice to the Monkey who is in Trouble.
   What advice can we give the monkey who appears trapped and whose would-be captors are fast approaching? Perhaps the best thing we can say is to:
   • Stop yanking, sit still for a minute and stare at the coconut.
   • Rethink your fundamental values and decide if what you always thought was important really is. Is the rice really worth becoming (or remaining) a captive.

Make sure you are not your own worst enemy. Remember the monkey. All he has to do to save himself is do what he already knows: let go of the rice.

Closely Held Businesses and the World of Gumption Traps - Part II