Maintaining a long-term view during turnarounds

By Kevin Carmody, Ryan Davies, and Doug Yakola

Changing course demands an intense focus on short-term performance, but success needn’t come at the expense of long-term value.

Peter switched on his desk lamp. It was getting dark, and the past 11 hours had been full of meetings and decisions. His trucking company had been struggling with the high diesel prices and soft economy of the early 2000s, but he had been fighting back by cutting costs across the board. He wasn’t failing yet, but he wasn’t sure how long he could fend it off.

Maintaining a long-term view during turnarounds
Article narration

He opened an approval request on his desk for the second time that week and read it again. It was a multimillion-dollar purchase order for retrofitting his entire fleet to natural gas. Several months earlier, the decision had seemed to be a no-brainer: his trucks could run on natural gas for a fraction of the cost of diesel. In a weak economy, the reduction in operating costs would be welcome—and he’d be positioned well to compete when the economy picked up. But as he stared at the numbers, he now wondered if it would still be the right move. The switch to natural gas would require a host of difficult organizational and operational changes—even if some of them would free up much-needed cash. He put down his pen and closed the file. What he really needed, he realized, was a way to more fundamentally turn things around.

Any leader who’s been through a turnaround knows that driving one requires an intense focus on delivering near-term results. Some moves make obvious sense. Building value-creation metrics into a long-term vision and implementing aggressive cash-management practices, for example, can help fund restructuring while avoiding existential crises down the road.1

Other moves are riskier. The short-term pressure is so intense that many managers succumb to myopic decision making that can hurt a company’s long-term health or even sow the seeds of irreversible failure. Examples abound of companies that survived a financial crisis by shutting off all discretionary spending, only to fail later when their operations became unreliable or required considerable new investment. The damage in these cases can exceed the impact of the initial financial hit. Depriving an organization of continuous investment in sustaining capital—whether in maintenance, growth and innovation, or people—can result in dozens of other incidents, each individually small and correctable but together adding up to create an unreliable operation that hurts the customer, the business, and its reputation.

The most successful turnarounds are those in which managers balance the short and long term in business decisions, both financially and organizationally. Financially, many investments that do not pay back their costs quickly (in less than two years) still create value and are important for the viability and health of the company. There are rarely clear answers to such investment decisions, but in our experience, a few techniques can help ensure that you make the best decisions with the information you have.

Avoid sweeping decrees

When faced with financial troubles, many companies respond by ordering a freeze on all spending, from capital spending to hiring, travel, and other discretionary expenses. Such moves can certainly be necessary in times of distress. In most cases, however, it’s better to take a more nuanced approach.

Managers should always discuss a company’s largest investments individually, giving time and attention to both the short-term and long-term implications of delaying investment. Letting such decisions fall under a broad spending directive can have a devastating impact. One global manufacturing company whose operations relied on substantial electrical power decided to delay a scheduled transformer rebuild by a year to save cash. Five months into the year, the transformer failed catastrophically, taking 20 percent of production off line while the company built and installed a replacement. Elsewhere, a transportation company that delayed the scheduled replacement of key logistical equipment suffered a setback when the equipment failed, resulting in collateral damage to the physical plant and equipment.

For smaller investments, it’s better to organize spending into categories in which the implications for long-term health can better be discussed and understood. There is an important distinction, for example, between repainting the hallways and refurbishing an electrical transformer that a broad proscription of spending on maintenance would not recognize. Similarly, a hiring freeze on executive assistants results in different risks from a freeze on vehicle operators or sales managers.

During one turnaround, executives at a consumer-products company found that plant managers historically had little discipline in spending—they invested in projects without considering hurdle rates or returns on the investment—and more than 350 projects would be affected by a spending freeze. During the turnaround process, executives worked alongside plant managers to weigh the trade-offs between what was necessary to serve customers and deliver products and what could be delayed to reduce costs. Together, they determined that nearly half of the planned projects could be postponed. They then implemented an aggressive program for working-capital management to simplify inventory management, approving spending that would help the business grow in the short and medium term while instituting strict internal controls on areas that were less critical, such as overtime, excessive travel, and some maintenance.2

Prioritize investments

Managers under pressure in turnaround situations have little time to evaluate thoughtfully which activities and investments to support and which to cut. Often, decisions rest on which department head has the most organizational clout, has the strongest personality, or argues the loudest to protect his own programs and people—an understandable but not particularly effective way of making cuts.

A better approach we’ve seen companies take is to make a list of all actions that would create near-term cash, force ranked by the amount of damage each would do to the long-term health of the company—typically prioritizing actions with the highest net present value (NPV) at one end and those with the most negative NPV at the other. Such a list should be created and discussed very early in a turnaround, and it must assess the effect of divesting or discontinuing every activity and selling every asset, with no exceptions. It will only be complete when the last thing left to do after taking every action on the list would be to shut the doors. It’s a tough exercise to go through, but it gets all the ideas on the table for discussion.

Highest on this list will be a number of immediate actions that create little risk. Lower down will be actions that begin to affect long-term growth prospects or operational reliability. The trick is to separate sources of real long-term damage potential from threats of damage that are merely perceived. This can be accomplished by taking the time and effort to understand each investment in depth and by making sure someone is assigned to ask the tough questions.

It’s also a good idea to assign quantifiable metrics to trigger the next cut on the list when a company comes within a certain number of months of no longer having sufficient cash to pay its bills. This creates a clear contingency plan in case things turn worse. Just as important, it creates a clear understanding of the future health risk required to stabilize the business in the short term.

If Peter, the manager discussed at the beginning of this article, were to conduct this exercise, he might find many actions he could take that are higher on the list, with less long-term damage than eliminating the natural-gas conversion project. That could help him feel better about approving it. The exercise would also give him an opportunity to tighten the spending-approval interval so that he would only approve the minimal spending possible each time. This would ensure that he could retain control of future financial investments in case things were to change and he needed to take this more drastic action.

Discourage short-term actions with negative long-term consequences

In any turnaround, increased accountability and pressure on business-unit managers to hit their numbers can exacerbate short-termism—which often leads to decisions that create less value for the company. They can be tempted, for example, by any number of little ways to cheat. Some tactics may incur purely financial risk, such as conceding sales discounts to meet near-term volume and margin goals or structuring back-loaded or risky contracts. Others can be more dangerous, such as allowing lower-quality products to go to market, delaying a maintenance outage until the next accounting period, or continuing production despite safety or reliability concerns. A manager at a global commodities company, for example, hoped to catch up on production by delaying the routine maintenance of a piece of heavy equipment despite concerns identified by engineers. The equipment failed not long after, leading to a lengthy production outage. The tension between execution and innovation is worth special note. Innovation requires experimentation and failure, which can be hard to defend in an environment where every dollar counts.

The challenge is to create urgency and accountability for near-term performance targets without encouraging shortcuts that destroy value and may have insurmountable negative consequences. Some companies deal with this by protecting people and budgets for strategically important innovation, even while aggressively reducing costs in other areas of the company. Others set targets for near-term results and then outline everything managers can do to meet those targets. The most important approach is to explicitly identify and understand the impact of every step that’s part of the company’s ability to create value.

Invest in people

In our experience, the single largest attribute of a successful turnaround and a healthy company is the people who manage and run it. Yet, in many cases, investment in people is one of the first areas to go when companies struggle. Whether that means pay freezes or cuts or the elimination of benefits, training, or team-building activities, such steps are often the easiest and fastest way to save cash fast. More than one company we know of dramatically reduced hiring of entry-level leadership talent during the 2009 recession and now struggles with a gap in future leaders at the middle levels of the organization.

Our view is that almost all of these moves will affect a company’s long-term health. When a business is struggling, companies count on their employees even more than they do when it’s healthy, whether to increase productivity, come up with creative ideas, improve teamwork, or simply provide moral support. Avoiding cuts in this area for as long as possible sends a message that people are valuable and will energize staff to take part in the turnaround. To be clear, it is important to continue to make case-by-case decisions on talent, but avoiding across-the-board cuts for people and benefits should be a strong consideration.

It is also crucial to support and encourage leaders to make hard decisions for the long term, even at some risk to near-term results. This starts with an aggressive education-and-awareness campaign that provides the entire organization with the tools to understand what value creation means and how it is measured. This can include training on how to interpret financial statements and how to calculate NPV, return on invested capital, and economic profit. Incentives are obviously important—ideally, performance evaluation is tied to short-term results, with compensation linked in some ways to equity in order to reflect long-term value (particularly for senior leaders). Consistently communicating the narrative is also critical, as is role modeling by senior leaders.

Rapid performance transformation is hard to pull off. And even if a company succeeds in delivering near-term results, creating value in the longer term is an even higher bar. Turnaround leaders should create a vision and a road map with markers that keep both in mind—and lead their teams in managing against these.

About the author(s)

Kevin Carmody is a partner of McKinsey Recovery & Transformation Services and is based in McKinsey’s Chicago office, Ryan Davies is a principal in the New York office, and Doug Yakola is a senior partner of McKinsey Recovery & Transformation Services and is based in the Boston office.

More on Strategy & Corporate Finance

The next-generation operating model for the digital world

Article - McKinsey Quarterly

What makes a CEO ‘exceptional’?

Article - McKinsey Quarterly

Three game changers for energy