Page 33 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 1. Executive Compensation Framework 19

Procedural manuals exist on almost every topic, specifying the preparation of forms to
get approval on everything from a dozen pencils to a multimillion-dollar capital investment.
Form has become more important than substance. Commitment to the process has replaced
commitment to results. Bureaucracy rules.
The organization is more formal in tone than in earlier phases, and first names are rarely
used, regardless of how well known the person. Individuals are oblique and obtuse in their
statements, and the manner of presentation has become more important than the substance.
Although the Titanic is listing badly, some crew members are methodically rearranging the
deck chairs, oblivious to the fact that the ship is sinking! Putter clutter rules!
Embedded costs are high but, paradoxically, cash is more likely to be available during this
phase than most others, due to cutbacks in research and marketing expenses or the sale of
part of the business. In capital-intensive companies the strong cash position could be the
result of depreciation allowances that have not been reinvested in newer equipment. Also, the
book value of the stock may very well exceed its market value. Or even more dramatically, net
working capital (assets less all liabilities including preferred stock) may exceed the aggregate
market value for the company’s common stock.
In this stage, many companies will be forced to diversify simply by nature of their
product line. Mining, oil, and gas companies facing a dwindling natural resource must
look to supplementary business lines. The projected exhaustion point can be set back by new
discoveries, but they delay, rather than alter, the inevitable results. For some, this will
mean other forms of geological exploration (such as minerals); for others, it will mean enter-
ing businesses where its products are an essential part of business (such as chemicals). Others
may reach outside of the related business worlds and enter a completely new field. The
decision to leave the energy business may not be related to demand, but rather to supply.
The problem with food companies is the reverse one of leveling demand in many coun-
tries (related to population). Here the desire to diversify within the field leads some to
different, higher-profit product lines or alternative preparations (such as fast-food outlets).
For others, vertical expansion to include growing, breeding, and shipping may be a more
logical approach.
To avoid taking the company into oblivion, the CEO and board of directors are looking
to “catch a wave,” as the surfers would say. They are looking for a market coming out of
the first stage and beginning to explode in growth. By moving to an industry in this early
stage, the company is able to reinvent itself by applying its expertise, shifting itself back to a
growth phase. Sometimes the industry will do it by itself. Some argued years back that the
pharmaceutical industry was in the maturity phase. There were no product breakthroughs
remaining. Talk about being wrong! An explosion of new products repositioned the industry
into the growth stage.
Ideally, the time to make this retro move is while in the late stage of growth or early
maturity. It is far riskier to wait until decline sets in, not only because revenues are declining
(although cash flow may be increasing) but also because the organization is becoming more
rigid and less able to respond to a dramatic shift. This is a time when CEOs and other sen-
ior executives are most at risk, because their board of directors may think them incapable of
making the daring but necessary move for survival. They have been part of the problem
rather than part of the solution. Failure to anticipate and act would be an indication of poor
strategic thinking.