Chapter 4
Undisciplined Pursuit of More: The Dangerous Second Stage
Stage 2 begins when companies overreach beyond their core competencies. In 1988, Ames Department Stores purchased Zayre, attempting to double its size overnight. This binary acquisition proved catastrophic. While Wal-Mart continued methodically expanding from rural to urban areas with consistent everyday low pricing, Ames radically shifted to urban markets and special promotions that contradicted its original success formula. Despite doubling revenues from 1986 to 1989, Ames's stock plummeted 98 percent by 1992 as it entered bankruptcy.
Contrary to conventional wisdom, companies rarely fall from greatness due to complacency. The research reveals that overreaching-not laziness-better explains how once-invincible companies self-destruct. Only A&P showed strong evidence of complacency, while every other case demonstrated tremendous energy during Stage 2. Companies like Motorola, Merck, and HP actually increased innovation during their decline. Rubbermaid's collapse was particularly terrifying-introducing one new product per day while pursuing "leap growth" in multiple directions simultaneously. Their frenetic innovation eroded tactical excellence, sending them cascading through decline in just four years.
Merck exemplified growth obsession under CEO Ray Gilmartin, who made being a "top-tier growth company" their #1 business objective. Despite facing patent expirations on drugs worth $5 billion annually and the challenge of maintaining growth on a $25 billion revenue base (where new molecule success rates were 1 in 15,000), Merck remained fixated on growth. Their confidence stemmed largely from Vioxx, which they launched in 1999 as their "biggest, fastest and best launch ever." Though early studies raised cardiovascular risk questions, Merck attributed these to naproxen's protective effects. By 2004, after generating over 100 million prescriptions, alarming safety data forced Gilmartin to withdraw Vioxx from the market, erasing $40 billion in market value within six weeks.
Stage 2 problems stem not from growth itself but from undisciplined pursuit of more-whether through discontinuous leaps into areas without passion, actions inconsistent with core values, or investing where you can't attain distinctive capability. Packard's Law states no company can grow revenues faster than its ability to get enough right people to implement that growth. Breaking this law creates a vicious spiral: wrong people fill key seats, bureaucratic procedures compensate for their inadequacies, right people leave, more bureaucracy follows, and mediocrity replaces excellence.
Problematic succession of power also marks Stage 2 decline. In our analysis, all but one company showed signs of problematic succession by the end of Stage 2, including domineering leaders failing to develop strong successors, unexpected departures, divided boards, monarchy-style family dynamics, and chronically poor CEO selection.
Chapter 5
Denial of Risk and Peril: When Warning Signs Are Ignored
As companies move into Stage 3, the cumulative effects of previous stages become evident. Stage 1 hubris leads to Stage 2 overreaching, setting up the company for Stage 3, Denial of Risk and Peril.
Motorola's Iridium project exemplifies Stage 3 denial. The company invested $5 billion in a satellite phone system despite mounting evidence that the concept faced fundamental flaws-phones were bulky, expensive, and couldn't work indoors. Contrast this with Texas Instruments' approach to DSP technology. TI patiently evolved their DSP strategy over fifteen years, starting with the Speak & Spell toy and a modest $150,000 investment in 1979. They gradually built empirical evidence, reaching $6 million in DSP revenues by 1986, then securing a Nokia contract in 1993. Only after two decades of proven success did CEO Tom Engibous boldly declare TI would become "the Intel of DSP," selling off defense and memory-chip businesses to focus on DSP. By 2004, TI commanded half the $8 billion DSP market.
The Challenger disaster illustrates the dangers of misinterpreting ambiguous data when facing catastrophic consequences. On January 27, 1986, engineers worried about launching in unprecedented cold temperatures that might affect O-ring seals. During a three-hour teleconference, the decision frame shifted from "prove it's safe" to "prove it's unsafe." With conflicting data and unclear trends, Morton Thiokol reversed its initial recommendation against launch. The next day, an O-ring failed and Challenger exploded, killing all seven crew members.
This tragedy demonstrates Bill Gore's "waterline principle": decisions above the waterline (where failure won't sink the ship) allow for learning, but holes below the waterline can be fatal. When making risky decisions with ambiguous data, ask: What's the upside if things go well? What's the downside if things go badly? Can you truly live with that downside?
Companies in Stage 3 often blame external factors rather than confronting harsh realities. IBM executives dismissed reports of distributed computing threats with "there must be something wrong with your data." Zenith blamed "unfair" Japanese competition rather than addressing how Japanese companies lowered costs while increasing quality. Scott Paper responded to market share erosion by obsessively reorganizing-restructuring three times in four years while failing to mount effective responses to competitors.
Stage 3 markers include: amplifying positives while discounting negatives, making bold bets without empirical validation, taking huge risks based on ambiguous data, deteriorating team dynamics, externalizing blame, obsessive reorganizations, and imperious detachment of leadership.
Chapter 6
Grasping for Salvation: The Desperate Fourth Stage
When companies hit the wall after periods of unsustainable growth, they often grasp for dramatic salvation. HP's Lew Platt grew the company from $15 billion to $45 billion in just seven years, but when growth stalled in 1998, the board sought a new type of leader. They selected Carly Fiorina, a celebrity CEO and business rock star who created immediate media frenzy. Unlike IBM's Louis Gerstner who went "dark" during his first 100 days to assess problems, Fiorina starred in television commercials, proclaimed HP's reinvention, and created marketing sizzle with the "Invent" slogan. Forbes called it "The Cult of Carly," with Fiorina herself declaring "Leadership is a performance."
Collins' research shows a distinct negative correlation between building great companies and hiring outside CEOs. Eight of the eleven fallen companies in this study went for outside CEOs during decline, whereas only one success contrast did so. When companies in trouble hire outsiders, performance generally worsened under these supposed saviors. In previous research, over 90 percent of CEOs who led companies from good to great came from inside, while two-thirds of comparison companies hired outside CEOs yet failed to make comparable leaps.
IBM's turnaround under outsider Lou Gerstner appears to contradict this pattern. However, Gerstner succeeded because he rejected the "radical change agent" frame typically given to outside saviors. Instead, he returned to the methodical, consistent approach that produces greatness. When troubled organizations hire outsiders, they often demand "Help! We need a revolutionary to change everything-fast!" If leaders accept this frame, they perpetuate Stage 4 rather than reverse it.
Every company in this study that fell into late-stage decline grasped for at least one silver bullet. Circuit City replaced its CEO with a Best Buy executive, fired 3,000 experienced employees, and sought a buyout before filing for bankruptcy. Scott Paper hired expensive consultants and launched a cultural transformation where employees had to "get religion or get shown the door." Ames churned through three management teams in 33 months. A&P's desperate "WEO" price-cutting strategy proved catastrophic to profitability.
The signature of mediocrity isn't an unwillingness to change but chronic inconsistency. Companies in Stage 4 try endless new programs, fads, strategies, visions, cultures, and breakthroughs. When one silver bullet fails, they search for another. Importantly, companies don't generally find themselves on the verge of death at the start of Stage 4-but by succumbing to Stage 4 behavior, they worsen their position.
When organizations face crisis, their survival instinct can trigger reactive behavior that accelerates their demise. Leaders in late Stage 4 companies need to return to a calm, clear-headed approach rather than frantic action. As a former Marine turned entrepreneur advised: "When you have just a few people, and there is enemy all around you... do not fire on automatic. Take one shot at a time."
Chapter 7
Capitulation to Irrelevance or Death: The Final Stage
In Stage 5, companies spiral downward increasingly out of control. Each cycle of grasping and disappointment erodes resources. Cash tightens, hope fades, and options narrow. Professor Bill Lazier's lesson becomes painfully relevant: "You pay your bills with cash. You can be profitable and bankrupt." Organizations don't die from lack of earnings-they die from lack of cash.
Stage 5 manifests in two versions: either those in power decide capitulation offers a better outcome than continuing the fight, or they struggle on until they run out of options, leading to death or irrelevance. Even mighty corporations like General Motors can find themselves seeking government salvation when cash runs short.
By the late 1980s, Scott Paper had fallen so far behind competitors that it took on massive debt for last-gasp efforts to catch up. Its debt-to-equity ratio averaged 175 percent from 1985-1994, with chronic restructuring costing hundreds of millions. When the board brought in "Rambo Al" Dunlap as CEO in 1994, analyst Kathryn McAuley immediately recognized: "The board sold the company." Dunlap slashed 11,000 jobs, including 71% of upper management, and quickly sold Scott to rival Kimberly-Clark. Though Dunlap bragged about being a "superstar" deserving extraordinary compensation, he was merely the mechanism of Scott's capitulation, not its cause. The company's fall through the earlier stages of decline had eliminated its financial freedom, leaving few options but to "burn the village in order to save it."
Zenith Corporation's decline illustrates how even brilliant leadership can't overcome the accumulated damage of earlier stages. Once America's dominant television manufacturer, Zenith entered Stage 1 when it arrogantly dismissed Japanese competition. In Stage 2, it doubled manufacturing capacity and debt while experiencing leadership succession problems. During Stage 3, Zenith blamed external factors rather than confronting its lack of competitiveness. By Stage 4, the company was "taking a shot at everything"-jumping into VCRs, videodiscs, telephones, and computers while pushing debt-to-equity to 140%.
Ironically, Zenith stumbled upon potential salvation with its Data Systems unit under Jerry Pearlman, which became the #2 maker of IBM-compatible PCs and a leader in laptops. But years of denial and grasping had depleted Zenith's finances, leaving cash reserves at less than 5% of liabilities. Unable to sell the television business at his desired price and burdened with half a billion in debt, Pearlman reluctantly sold the promising computer business to Bull Corporation. Despite his efforts to rebuild, the television division continued generating losses, and Zenith eventually went bankrupt, emerging with just 2% of its former workforce.
Not all companies deserve to survive. Institutional mediocrity should be terminated or transformed into excellence. The key question is: "What would be lost, and how would the world be worse off, if we ceased to exist?" Without a compelling answer, capitulation may be wise, as perhaps it was for Scott Paper. But with clear purpose and solid values, fighting to reverse decline may be the noble path.
Chapter 8
The Path to Recovery: Well-Founded Hope
When Anne Mulcahy became Xerox's CEO in 2001, she inherited a company deep in Stage 4. Xerox had lost $273 million, with its stock down 92% in under two years, wiping out $38 billion in shareholder value. With a 900% debt-to-equity ratio, junk-rated bonds, an SEC investigation limiting fundraising options, and only $100 million cash against $19 billion in debt, Mulcahy described the situation as "terrifying."
Some questioned whether this insider with Xerox DNA could save the company, but they needn't have worried. Drawing inspiration from Ernest Shackleton's Antarctic rescue mission, Mulcahy didn't take a weekend off for two years. She shut down several businesses, including an inkjet-printer unit she'd previously championed, cut $2.5 billion in costs, and rebuffed repeated suggestions to file Chapter 11. Despite the crisis, she increased R&D spending as a percentage of sales, believing recovery required both cost-cutting and long-term investment. By 2006, Xerox posted profits exceeding $1 billion with a much stronger balance sheet.
Companies like Xerox, Nucor, IBM, Texas Instruments, Pitney Bowes, Nordstrom, Disney, Boeing, HP, and Merck have all experienced tremendous falls and recovered. In each case, leaders emerged who broke the trajectory of decline and refused to surrender to the idea of mere survival rather than ultimate triumph. As Dick Clark of Merck put it, "A crisis is a terrible thing to waste."
The path to recovery lies in returning to sound management practices and rigorous strategic thinking. While you must stop the bleeding first, that's merely emergency surgery, not full recovery. Passionate adherence to management discipline correlates with recovery and ascent.
Even in our turbulent world of "creative destruction," it's possible to build institutions that sustain exceptional performance for decades. In fact, if you've been practicing principles of greatness all along, you should welcome severe turbulence-that's when you can pull further ahead of those lacking your relentless intensity. But if you're caught in decline during turbulent times, your fall will be faster and more violent than in stable periods.
The signature of the truly great versus the merely successful isn't the absence of difficulty, but the ability to come back from setbacks stronger than before. Great nations, companies, institutions, and individuals can fall and recover. As long as you're not entirely knocked out of the game, hope remains.
Churchill's story exemplifies this resilience. In the early 1930s, his career had descended into "a quagmire from which there seemed no rescue." By 1940, he stood before Parliament as prime minister while Hitler's forces swept across Europe, declaring "We shall never surrender." His message to Harrow School in 1941 distills this spirit: "Never give in, never give in, never, never, never, never."
The path out of darkness begins with those exasperatingly persistent individuals constitutionally incapable of capitulation. Be willing to embrace loss, endure pain, and temporarily lose freedoms, but never give up on your core values. Failure is not so much a physical state as a state of mind; success is falling down and getting up one more time, without end.
Chapter 9
Principles for Preventing and Reversing Decline
The most powerful defense against institutional decline isn't just vigilance against the five stages, but building an organization that inherently generates excellence. The research reveals several critical principles that help prevent decline or reverse its course.
First, maintain a productive paranoia. Even at the height of success, the best leaders remain hypervigilant about potential threats. Andy Grove of Intel famously noted that "Only the paranoid survive," while Sam Walton continued visiting competitors' stores well into his seventies. This constructive worry creates an early warning system that detects decline before external results deteriorate.
Second, preserve a clear understanding of what drives your success. Companies that confuse the "what" (specific practices) with the "why" (underlying principles) become vulnerable when conditions change. Best Buy continuously evolved its store formats while maintaining its core insight about what customers wanted. A&P, meanwhile, fossilized around Hartford-era practices rather than principles, leaving it unable to adapt to changing retail environments.
Third, build your organization around responsibilities rather than jobs. When Bank of America thrived, loan officers had clear accountability for decisions. During decline, responsibility diffused across committees and bureaucratic processes. The proportion of key seats filled with the right people-those who see themselves as having responsibilities rather than jobs-serves as a critical indicator of institutional health.
Fourth, maintain rigorous succession planning. Augustus Caesar's political genius couldn't solve Rome's succession problems, leading to centuries of instability. Similarly, companies that fail to develop strong internal leadership pipelines set themselves up for decline. Nearly every fallen company in the study showed problematic succession by Stage 2, while successful companies like Texas Instruments maintained seamless leadership transitions.
Fifth, confront empirical realities without losing faith. Texas Instruments patiently built evidence for their DSP strategy over decades before making their big bet. Motorola, conversely, plunged into Iridium despite mounting evidence of fundamental flaws. Great companies maintain what Collins calls "the Stockdale Paradox"-confronting brutal facts while maintaining unwavering faith in ultimate success.
Sixth, avoid chronic inconsistency. The signature of mediocrity isn't an unwillingness to change but inconsistent, lurching change. When Xerox recovered under Anne Mulcahy, she didn't pursue dramatic reinvention but returned to disciplined execution of sound business principles. Recovery requires the discipline to resist the allure of silver bullets.
Finally, remember that decline is largely self-inflicted-and therefore, recovery is largely self-determined. Companies like IBM, Nucor, and Nordstrom all demonstrate that even deep decline can be reversed through returning to the fundamentals that create greatness: disciplined people, disciplined thought, and disciplined action.
As Churchill reminded the students at Harrow, the path forward isn't found in dramatic gestures but in persistent determination: "Never give in, never give in, never, never, never, never."
