WHERE ARE THE LIMITS FOR CORPORATE WHERE ARE THE LIMITS FOR CORPORATE CRISIS MANAGEMENT ATTEMPTS?CRISIS MANAGEMENT ATTEMPTS?

Dejan KružićDejan Kružić

Faculty of Economics, University of SplitFaculty of Economics, University of Split

Matice hrvatske 31, 21000 Split, CroatiaMatice hrvatske 31, 21000 Split, Croatia

E-mail: E-mail: dkruzic@efst.hrdkruzic@efst.hr

THE PHOENIX EFFECTTHE PHOENIX EFFECT (In ancient Egyptian mythology the Phoenix is a (In ancient Egyptian mythology the Phoenix is a

mythical sacred firebird. At the end of its life-cycle the mythical sacred firebird. At the end of its life-cycle the Phoenix is burnt and is reduced to ashes, from which Phoenix is burnt and is reduced to ashes, from which

a new, young Phoenix arises)a new, young Phoenix arises)

Mic '07Mic '07PortorožPortorož22.11.2007.22.11.2007.

Corporate collapse and managing the crisisCorporate collapse and managing the crisisLike in human life where there exists border between life and deathLike in human life where there exists border between life and death, , so, in the so, in the business lives of companies there is a line between success and failure. business lives of companies there is a line between success and failure. Corporate business failure is remarkably similar to human death. In some cases, Corporate business failure is remarkably similar to human death. In some cases, extremely rarely, a human being is reanimated and comes back from clinical extremely rarely, a human being is reanimated and comes back from clinical death to a world of life. Likewise, a failed company that has collapsed and is near death to a world of life. Likewise, a failed company that has collapsed and is near extinction may be revived and overcome theextinction may be revived and overcome the multimulti--annual business crisis. annual business crisis.

A A crisis is the moment of truth for companiescrisis is the moment of truth for companies, so management, so management is facedis faced with with some explorative questions:some explorative questions:

What is to be done when the crisis strikes and when years-long classic therapy What is to be done when the crisis strikes and when years-long classic therapy provides no positive results?provides no positive results?

What behaviour is acceptable?What behaviour is acceptable? Where are the limits for regeneration attempt?Where are the limits for regeneration attempt?

The crucial role in this issue is that The crucial role in this issue is that crisis leadership is acting under crisis leadership is acting under emotionalemotional pressurepressure of critical situationof critical situation within a multidimensional framework of the crisis within a multidimensional framework of the crisis managementmanagement process.process.

Conceptual Conceptual frameworkframework

Crucial concept in corporate renewal is breakeven analysis - it providesCrucial concept in corporate renewal is breakeven analysis - it provides

information on whether a distressed enterprise is salvageable. information on whether a distressed enterprise is salvageable. Crisis-Crisis-

basedbased corporate renewalcorporate renewal does not focus on achieving profit breakeven.does not focus on achieving profit breakeven.

In a crisis, non-cash charges (such as depreciation and amortization) In a crisis, non-cash charges (such as depreciation and amortization)

are ignored. This leads to a lower breakeven outputare ignored. This leads to a lower breakeven output level. level.

A firm that achieves EBIT or EBITDA breakeven can be A firm that achieves EBIT or EBITDA breakeven can be

reorganized insteadreorganized instead of liquidated by creating a new capitalof liquidated by creating a new capital

structure that includes nostructure that includes no debt, if necessary.debt, if necessary.

Profit, cash and EBITDA breakeven provide threeProfit, cash and EBITDA breakeven provide three output goals to output goals to

direct thedirect the corporate renewal process - if none of themcorporate renewal process - if none of them areare

achievable, theachievable, the firm cannot survivefirm cannot survive (Platt).(Platt).

Crisis management in chronic crisisCrisis management in chronic crisis

This paper This paper will try to dispel the paradigm about managing the corporate crisis, will try to dispel the paradigm about managing the corporate crisis, according to whichaccording to which the bankruptcy is the only possible solutionthe bankruptcy is the only possible solution if the following facts if the following facts are presented:are presented:

The company has a blocked account for a longer period, The company has a blocked account for a longer period, Corporation has a total chronic insolvency and illiquidity problems,Corporation has a total chronic insolvency and illiquidity problems, The value of liabilities exceeds the value of corporation assets,The value of liabilities exceeds the value of corporation assets,

The article illustrates how an effective crisis reanimation management canThe article illustrates how an effective crisis reanimation management can::

after 8after 8 years of blocked-frozen company accountyears of blocked-frozen company account, , with the cumulative losses exceeding the value of corporate assetswith the cumulative losses exceeding the value of corporate assets

lead to the survival and recovery of the company. Moreover, the lead to the survival and recovery of the company. Moreover, the successful successful corporate turnaround implies the Phoenix effectcorporate turnaround implies the Phoenix effect - corporate renewal with an - corporate renewal with an increase in the number of employees and enhancement of the company's market increase in the number of employees and enhancement of the company's market share prices.share prices.

Corporate historyCorporate historyIn order to illustrate the possibility of how to save a firm that is undergoing a multi-In order to illustrate the possibility of how to save a firm that is undergoing a multi-

annual business crisis - a Croatian stock company with a rich business history annual business crisis - a Croatian stock company with a rich business history

(established in 1947), which employed about (established in 1947), which employed about 1150 people in 19901150 people in 1990 will be taken as will be taken as

an example. an example. Corporate core businessCorporate core business in 1990 includes: in 1990 includes:

ImportImport & & export of oil, aluminum and consumer goods, export of oil, aluminum and consumer goods, Purchasing raw materials (leather and wool) on the domestic market and their Purchasing raw materials (leather and wool) on the domestic market and their

selling on the international market,selling on the international market, Wholesaling and retailing of the whole range of consumer goods (food, drink, Wholesaling and retailing of the whole range of consumer goods (food, drink,

clothes and footwear, furniture, household appliances etc.),clothes and footwear, furniture, household appliances etc.), Providing hotel accommodation in its own small hotel. Providing hotel accommodation in its own small hotel.

The analysed corporation owned 5 international companies, which helped it to The analysed corporation owned 5 international companies, which helped it to

perform international business. The shareholder's book perform international business. The shareholder's book equity was approximately equity was approximately €€

17 million.17 million.

Corporate anamnesisCorporate anamnesis

TThe period 1990 he period 1990 -- 2000 were characterized by a 2000 were characterized by a continuous decaycontinuous decay: : unsuccessfully unsuccessfully carried out processes of company transformation from socially-owned to public and carried out processes of company transformation from socially-owned to public and finally private ownership, intensified by incapability of management to respond to finally private ownership, intensified by incapability of management to respond to radically changed market circumstances, have led to a significant loss of market radically changed market circumstances, have led to a significant loss of market segment, serious cumulated losses and the absence of core businesses. segment, serious cumulated losses and the absence of core businesses. It was all It was all further intensified by a constant insolvency and the blocked - frozen company further intensified by a constant insolvency and the blocked - frozen company account, which was a company's situation that has been going on since 1994.account, which was a company's situation that has been going on since 1994.

In 2000, before the new In 2000, before the new CMTCMT assumed the office, the company employed assumed the office, the company employed only 90 only 90 peoplepeople. Analysed corporation . Analysed corporation didn't have a core businessdidn't have a core business, but only hiring a part of its , but only hiring a part of its commercial real estates generating minimal and insufficient revenue. commercial real estates generating minimal and insufficient revenue.

Diagnosis Diagnosis of the company's health indicates an of the company's health indicates an extremely difficult situationextremely difficult situation - lack - lack of core business and the blocked account for six years had resulted in the factof core business and the blocked account for six years had resulted in the fact that that thethe cumulative losses and corporate liabilities had been significantly higher cumulative losses and corporate liabilities had been significantly higher than the company assets. than the company assets.

Fundamental questionsFundamental questionsAccording to the previously indicated diagnosis, the crisis management isAccording to the previously indicated diagnosis, the crisis management is faced faced

with the following fundamental questions:with the following fundamental questions:

What is to be done when years-long classic therapy provides no positive What is to be done when years-long classic therapy provides no positive results?results?

Where are the limits for regeneration attempt? Where are the limits for regeneration attempt?

bearing in mind that encountered situation in the analysed company requiresbearing in mind that encountered situation in the analysed company requires

the crisis management to initiate the the crisis management to initiate the bankruptcybankruptcy process (*).process (*). In recent literature we In recent literature we

did not find decisive answers to stated questionsdid not find decisive answers to stated questions. . Since the best practice that Since the best practice that

could help in answering the previously statedcould help in answering the previously stated questions is non-existent, questions is non-existent, the CMT the CMT

decided not to initiate bankruptcy petitiondecided not to initiate bankruptcy petition but set off for an journeybut set off for an journey with with

highly uncertain outcome. highly uncertain outcome.

(*) (*) Croatian Bankruptcy Act recognizes Croatian Bankruptcy Act recognizes three reasons for bankruptcythree reasons for bankruptcy: insolvency, over-indebtedness : insolvency, over-indebtedness and threatening insolvency. and threatening insolvency. If the enterprise is insolvent or over-indebted the management should If the enterprise is insolvent or over-indebted the management should suggest initiating bankruptcy proceeding withoutsuggest initiating bankruptcy proceeding without delay and not later than 21 days upon occurrence of delay and not later than 21 days upon occurrence of bankruptcy reasons.bankruptcy reasons.

Managing the unthinkableManaging the unthinkable

In analysed company CMT try to do something what was, in that moment, impossible to In analysed company CMT try to do something what was, in that moment, impossible to

imagine: imagine:

Regenerate the business in a relatively short period, Regenerate the business in a relatively short period, Free a part of the frozen Free a part of the frozen company assetscompany assets, , Unblock the frozen corporate account, Unblock the frozen corporate account, Restore the liquidity of the company, Restore the liquidity of the company, Pay off the suppliers and creditors,Pay off the suppliers and creditors,

i.e. i.e. introduce a radical and almost impossible change with turnaroundintroduce a radical and almost impossible change with turnaround in in the encountered the encountered

conditions.conditions.

Strained financial resources, demoralized executives, fearful employees, unhappy Strained financial resources, demoralized executives, fearful employees, unhappy

customers, tense bankers, angry investors, and competitors waiting to pounce - these are customers, tense bankers, angry investors, and competitors waiting to pounce - these are

the classic challenges of turnarounds in troubled companiesthe classic challenges of turnarounds in troubled companies. . IfIf the the CMT CMT doesn't succeed doesn't succeed

in recovering the company its managers willin recovering the company its managers will gain thegain the "reputation" of losers"reputation" of losers, , and and

probably even assume legalprobably even assume legal responsibility for notresponsibility for not initiating bankruptcy proceeding.initiating bankruptcy proceeding.

TThe essence of turnaroundhe essence of turnaround: : entrepreneurshipentrepreneurship

After completing the diagnosisAfter completing the diagnosis,, CMT started with the stage of implementation its CMT started with the stage of implementation its new new measures formeasures for improvement of company performanceimprovement of company performance.. By using the By using the destroyeddestroyed and frozen and frozen resources of the company, with extremely little chance forresources of the company, with extremely little chance for survival, the activities of CMTsurvival, the activities of CMT is is focused on focused on seeking short-term performance enhancementsseeking short-term performance enhancements that could enable the business that could enable the business to generateto generate cash flowcash flow and avoid corporate tragedy:and avoid corporate tragedy:

Mobilise some of the resources which were not used,Mobilise some of the resources which were not used,Increase the engagement level of current employees by creating new businessIncrease the engagement level of current employees by creating new business

activities,activities,Sell non-core Sell non-core corporate assets,corporate assets,Decrease the level of corporate indebtedness by radical measures of debt collection,Decrease the level of corporate indebtedness by radical measures of debt collection,File a series of lawsuits and initiate a number of out-of-court agreements on a partial File a series of lawsuits and initiate a number of out-of-court agreements on a partial disbursement of creditors and disbursement of creditors and rescheduling of debt,rescheduling of debt,Establish a new organisational structure and change payroll computation,Establish a new organisational structure and change payroll computation,Successfully prevent requirements for initiating the bankruptcy process, Successfully prevent requirements for initiating the bankruptcy process,

what results in a reduction of the creditors' pressure on the corporationwhat results in a reduction of the creditors' pressure on the corporation. .

Critical ingredient for corporate renewalCritical ingredient for corporate renewal

AA successful implementation of the successful implementation of the before statedbefore stated activities is only a activities is only a necessarynecessary but but not a sufficient prerequisitenot a sufficient prerequisite. Additional prerequisite is . Additional prerequisite is initiation ofinitiation of a new corea new core business,business, without which the chances for success are reducedwithout which the chances for success are reduced so much so much that there isthat there is no need to even start the regeneration- reanimation of businessno need to even start the regeneration- reanimation of business process.process.

CMT CMT found the response to the chronic crises problems in entrepreneurialfound the response to the chronic crises problems in entrepreneurial

challengechallenge: creative response to the encountered conditions - a different approach: creative response to the encountered conditions - a different approach to the market and establishing new activities - to the market and establishing new activities - starting from the beginning starting from the beginning andand implementing a new core business in the organisation structure implementing a new core business in the organisation structure of a dying companyof a dying company - which had a blocked account for more than six years and - which had a blocked account for more than six years and an estimatedan estimated debts exceeding its assets value. debts exceeding its assets value.

Business regenerationBusiness regeneration - - empirical findingsempirical findings

CMT managed to initiate a new activity onlyCMT managed to initiate a new activity only two monthstwo months after it assumed office. The results after it assumed office. The results achieved by the CMT in their first nine months of running the business (in 2000achieved by the CMT in their first nine months of running the business (in 2000 turnoverturnover was increased by 55% in relation to the year 1999, and expenses by 28% was increased by 55% in relation to the year 1999, and expenses by 28% )) were one were one of of the key-factorsthe key-factors directing the company towards the directing the company towards the main goal - survivalmain goal - survival andand for motivating for motivating andand achieving further business turnaround. The CMT create anachieving further business turnaround. The CMT create an atmosphere of faith in atmosphere of faith in successsuccess and and brought about a significant increase ofbrought about a significant increase of workers',workers', shareholders',shareholders', business business partners' and the public trust inpartners' and the public trust in the new management.the new management.

The The CMT's effortsCMT's efforts to introduce a visible changes in the business and financial to introduce a visible changes in the business and financial

conditions ofconditions of thethe company, contributedcompany, contributed to the improvements in the corporate culture to the improvements in the corporate culture

(the feelings of loser's(the feelings of loser's mentality,mentality, poverty and fear prevail in anpoverty and fear prevail in an enterprise which has enterprise which has

been making losses for years)been making losses for years) byby gradually turninggradually turning losers into potential winners. losers into potential winners. A A

good start of the CMT resulted in the initialgood start of the CMT resulted in the initial success of the companysuccess of the company and a reduced and a reduced

economic attack, enabled the CMT to move toeconomic attack, enabled the CMT to move to establishing of elements of the establishing of elements of the anti-anti-

crisiscrisis strategy based on implementation of the new corestrategy based on implementation of the new core businessbusiness by entering a new by entering a new

field of activitiesfield of activities..

From crisis to opportunity-turnaroundFrom crisis to opportunity-turnaround

Implementation of the new strategies and increase of business efficiency in 2001, Implementation of the new strategies and increase of business efficiency in 2001, enabled the analysed company to achieve (in relation to the previous year):enabled the analysed company to achieve (in relation to the previous year): an an revenue increasing by 16% and, at the same time, a decrease of business revenue increasing by 16% and, at the same time, a decrease of business expensesexpenses, , new job creation new job creation ((speed up of 20speed up of 20%)%),, unfreezing the frozen account level unfreezing the frozen account level by 40%,by 40%, a a positive financial results in current year, andpositive financial results in current year, and partially solving the problems partially solving the problems related to major creditors (not yet a final settlement).related to major creditors (not yet a final settlement).

At this stage of an almost certain recovery (but still insufficient for solving the At this stage of an almost certain recovery (but still insufficient for solving the problem of unfreezing the corporate account) and directing the activities towards problem of unfreezing the corporate account) and directing the activities towards business stabilisation, a business stabilisation, a "blurred" vision and the fundamental goal of the company "blurred" vision and the fundamental goal of the company which were previously restricted to survival are now becoming clearerwhich were previously restricted to survival are now becoming clearer..

The The main goal of the CMTmain goal of the CMT is still: is still:

Unfreezing the company accountUnfreezing the company account, (and) , (and)

Getting out of the insolvencyGetting out of the insolvency..

The Phoenix aroseThe Phoenix aroseFurther development of the Further development of the battle for survivalbattle for survival stagestage is characterised by the already is characterised by the already described activities carried out in 2000-2001 directed towards unfreezing the described activities carried out in 2000-2001 directed towards unfreezing the corporate account, as well as by the corporate account, as well as by the daily fightingdaily fighting with the possibility of a new crisis with the possibility of a new crisis occurrence and the possibility of initiation of bankruptcy proceeding. occurrence and the possibility of initiation of bankruptcy proceeding.

In October 2002 the CMT managed to In October 2002 the CMT managed to unfreeze the corporate account - for the unfreeze the corporate account - for the first time after eight and a half years, or after 3100 daysfirst time after eight and a half years, or after 3100 days - and, in the same year, - and, in the same year, to earn a respectable net income to earn a respectable net income (app. 2,5 millions of Euros) enabling employment (app. 2,5 millions of Euros) enabling employment for an additional 19% of new workforce.for an additional 19% of new workforce.

Since there was no recurrence of freezing the company account after the account Since there was no recurrence of freezing the company account after the account had been successfully had been successfully unblockedunblocked, it is possible to place the whole stage of the battle , it is possible to place the whole stage of the battle for survival, as the part of chronic crisis stage, in the period between February 2000 for survival, as the part of chronic crisis stage, in the period between February 2000 and October 2002, in other words and October 2002, in other words it lasted about 32 months.it lasted about 32 months. The The battle for survivalbattle for survival stagestage can be divided into following can be divided into following 3 3 phases:phases:

I. I. Preparing and giving the diagnosisPreparing and giving the diagnosis (that took about a month) (that took about a month)

II. II. Realisation of the initialRealisation of the initial (but not sufficient) (but not sufficient) successessuccesses (lasting about 10 months) (lasting about 10 months)

III. III. Achieving a radical turnaroundAchieving a radical turnaround (lasting about 21 months). (lasting about 21 months).

The Phoenix aroseThe Phoenix arose

Some indicators of corporate health (December, 31st)

  1999. 2000. 2002. 2006.

Shareholders book equity (mill. €) 17.1 8.7 8.7 9.2

Total assets (mill. €) 14.7 9.5 7.4 6.3

Unrecorded & off-bal. sheet liabilities (mill. €) 13.8 7.6 0,0 0,0

Blocked company account (mill. €) 2.2 6.6 0,0 0,0

Book share price - €/ share 26.9 13.7 13.7 13.7

Market share price - €/ share 0.0 0.0 1.7-2.1 6.8-7.5

ConclusionConclusion

TThe paper he paper illustrates that the limits for decision about initiating bankruptcy illustrates that the limits for decision about initiating bankruptcy proceeding can be postponed and that is never too late to initiate it, proceeding can be postponed and that is never too late to initiate it, providing that the company has a management capable of tackling the providing that the company has a management capable of tackling the business crisis.business crisis.

Presented case suggests that:Presented case suggests that: Management should never give up from the anti-crisis battle,Management should never give up from the anti-crisis battle, There are no miraculous solutions,There are no miraculous solutions, The battle for survival should always be attempted,The battle for survival should always be attempted, regardless the fact that regardless the fact that

positive outcome may verge on miracle.positive outcome may verge on miracle.

Finally, Finally, paper documented that when company in years-long crisis successfully paper documented that when company in years-long crisis successfully regenerate business process and pay debts out of court procedure, the regenerate business process and pay debts out of court procedure, the market market share price increases emphaticallyshare price increases emphatically..

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