Wednesday, February 16, 2011

Why Didn't Borders See It Coming?

When a company such as Borders files for bankruptcy, we hear many people exclaiming: "They had their heads buried in the sand." The comment suggests that companies such as Borders failed to identify a threat soon enough, that they didn't recognize how the world was changing quickly around them. Certainly, some companies fail to see emerging threats for quite some time. Many firms, however, falter because of a lack of action, not a lack of attention. They see the problem, but they cannot adapt quickly enough.

What are the barriers to taking effective action in the face of a daunting new threat? One could build a very lengthy list. Let's focus on just a few key obstacles. First, firms make commitments as part of their strategy. They commit to certain physical assets, types of human capital, contracts and relationships, and organizational cultures. These commitments often prove very rigid. One cannot easily undo major commitments to a physical infrastructure, such as Borders' brick and mortar stores. One also cannot easily undo major "soft" commitments such as the culture, mentality, and skills of the executive team.

Second, companies have a hard time determining the appropriate pace of the transition from the old business model to a new one. How quickly can and should we abandon our brick and mortar strategy and move toward a digital one? The pace question proves difficult because one cannot decimate an old revenue stream before a new one fully emerges.

Third, firms face certain exit barriers and exit costs associated with an old business model. Do we have expenses that will be substantial if we shut down old operations very quickly? Those expenditures might include lease termination fees, asset writedowns, severance costs, and the like. While firms perhaps should just bite the bullet on these types of costs, we know that executives sometimes have a hard time doing so. They feel pressure to make short term earnings targets.

Finally, firms simply don't like to shrink in size. Sometimes, making a transition to a new business model means having to shrink in the near term so as to grow profitably in the future. However, managers have a hard time with the size and scope of a firm. We know that executive compensation in larger firms often exceeds that in smaller firms. Morever, a certain level of prestige sometimes comes with running a larger firm.

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