THE PHOENIX EFFECT ON CROATIAN CORPORATE CASE: WHERE ARE THE LIMITS FOR CORPORATE CRISIS MANAGEMENT ATTEMPTS?
Dr. Dejan Kružić, University of Split, Croatia
ABSTRACT
This paper is dedicated to the question about the possibilities for a distressed company to reanimate its business in a short period, to unfreeze the company's resources, to de-blockade the corporate account and to regain liquidity status: in other words to achieve corporate turnaround with a radical and an almost unexpected change. In order to reach these possibilities - all at a highly advanced chronic crisis stage - it is necessary to achieve the Phoenix effect in extremely uncertain conditions. The paper presents the results obtained by the author participating in a crisis management team in regeneration of the business process of a Croatian corporation. In the analysed case the corporate turnaround was achieved by using the crisis as an entrepreneurial challenge - by establishing new activities, starting from scratch and implementing a new core business within the organisational and financial structures of a dying corporation. The results reveal that some characteristics seem to be important ones; they illustrate ideas and provide arguments, for both academics and practitioners, on how to effectively manage and overcome a chronic business crisis, and even how to save a distressed corporation that is near extinction.
Keywords: Corporate crisis management, battle for survival, sustainable turnaround, distress symptoms, corporate revival
INTRODUCTION
Like in human life where there exists border between life and death, so, in the business lives of companies there is a line between success and failure. Corporate business failure is remarkably similar to human death. In some cases, 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 extinction may be revived and overcome the business crisis.
The cases of companies which do not suffer a critical situation over a longer period of time are rather rare. If the crisis situation is not solved, it implies a long-lasting critical condition followed by the collapse of the company. We are, daily, witnesses of the huge world of bankruptcies and, also, the collapse of a great number of corporations in transition economies, particular in those which have not promptly adjusted their strategies to the considerably changed economic and political conditions.
Increased uncertainty and risk implies a considerably higher vulnerability of companies, especially in those economies that are still undergoing the transition process and are not yet strong enough to adapt quickly to changes in new market conditions. Regardless of the different types of crises, they always present unfortunate, but inevitable, situations in the life of any business subject - frequently with dramatic and sometimes even catastrophic effects. Managing under the conditions of crisis and uncertainty in distressed corporations isn't impossible. It is a frequent phenomenon which requires a specific art and special skills - crisis management.
BUSINESS CRISES ANATOMY AND CRISIS MANAGEMENT ACTIVITIES
Business crises represent unfortunate situations in the life of every business subject, which can be generated either externally or internally - they are problems caused by nature or by human factors with dramatic and, sometimes, even catastrophic impact. Major crises occur, not only because of what a corporation knows, anticipates and plans for, but, just as much, because of what it does not know and does not anticipate (Mitroff, Anagos, 2001). Fink (2002) offered an anatomy of the business crisis cycle with the following stages: prodromal crisis stage, acute crisis stage, chronic crisis stage and crisis resolution stage. Hancock (2002) and Ulmer (2006) provide four stages of action: recognising a crisis, determining the damage and extent of a crisis, actual management of a crisis, and terminating crisis management mode.
Crisis management is a relatively new field of management, which includes identification of the nature of a crisis, intervention to minimize damage and activities for crisis recovery, often with a strong focus on public relations to recover any damage to the company's public image and to assure stakeholders that recovery is underway. Critical fields of crisis management are: identifying the crisis, isolating the crisis, crisis communications, damage control, assembling a crisis management team, creating a crisis management plan and crisis intervention with crisis forecasting. Following the above mentioned critical fields it is possible to describe crisis management as a set of activities that contain an urgent response to crisis situations, efforts to reduce the impact of the crisis and readiness for future crisis occurrences.
Conceptual background
All companies need a way to manage a crisis and assure the continuity of their operations. For a corporation to sustain itself, there are certain preconditions. It must be economically viable. At least at its core, it must have a sound economic raison d'être. It must have the human, financial and physical resources that can be deployed to meet a challenge or take advantage of an opportunity. Most importantly, it must have a management that is sensitive to internal as well as external challenges (Bibeault, 1999). Strained financial resources, demoralized executives, fearful employees, unhappy customers, tense bankers, angry investors, and competitors waiting to pounce - these are the classic challenges of turnarounds in troubled companies (Whitney, 1999). A crucial concept in corporate renewal is breakeven analysis that provides information on whether a distressed company is salvageable. Profit, cash and EBITDA breakeven provide three output goals to direct the corporate renewal process - if none of them are achievable, the firm cannot survive (Platt, 1998).
This paper will try to illustrate the relativity of paradigm about managing the corporate crisis, according to which, if the company has a blocked account for a longer period or the corporation has a total chronic insolvency problem, and/or the total liabilities exceed the value of corporation assets, bankruptcy is the only possible solution. A crisis is a turning point which sometimes also offers opportunities. The paper illustrates how an effective crisis management can, after eight years of blocked-frozen company accounts and with cumulative losses exceeding the value of corporate assets, lead to the survival and recovery of a distressed corporation. Moreover, the successful corporate turnaround implies the Phoenix effect - corporate renewal with an increase in the number of employees and enhancement of the company's market share prices. (In ancient Egyptian mythology the Phoenix is a mythical sacred firebird. At the end of its life-cycle the Phoenix is burnt and is reduced to ashes, from which a new, young Phoenix arises).
Before the crisis begins
In order to illustrate the possibility of how to save a corporation that has been undergoing a business crisis for several years, by regenerating the business process, a Croatian joint stock company will be taken as an example (to preserve confidentiality and privacy, the name of company will not be appointed). The analysed corporation had a rich business history (established in 1947), employed about 1150 people in 1990 and was one of the leading Croatian export-import companies. The core business of the corporation involved the export and re-export of oil, aluminium and consumer goods on the international market, and wholesale and retail of the whole range of consumer goods on domestic and international markets. The analysed corporation owned five international companies that were registered abroad, which helped it to carry out its international business. The shareholders book equity value was approximately €17 million.
Crisis framework - diagnostic review
In the period between 1990 and 2000 the development of the analysed corporation was characterised by continuous decay as a consequence of a lack of adjustment to the market demands and to the system of the free market economy. The process of company transformation from socially-owned to public and private ownership was carried out non-transparently and unsuccessfully; this was intensified by incapability of management to respond to radically changed market circumstances and it led to a significant loss of market segment, serious cumulated losses in regular business, and the absence of core businesses. It was all further intensified by a constant insolvency and the blocked - frozen company account, which was a situation that has been going on since 1994.
In 2000, before the new management team - which took over the authority of the crisis management team (CMT) - assumed office, the company employed only 90 people. The analysed corporation didn't have a core business, only hiring a part of its commercial real estate generating minimal and insufficient revenue. The main shareholder - Croatian Privatisation Fund owns about 53% of equity. The total number of issued shares is 635,000. The book share price was €26,9 per share. The market share price was non-existent, because of the near extinction of the company during the crisis over several years. Table 1 presents the facts and data on which CMT had to rely in making its decisions; it provides an intensive inside look at the corporate health of the company.
Table1: The basic facts about the corporation in chronic crisis - declared balance sheet
Balance Sheet as at December 31st 1999 (Millions of EUROS)-prepared by the "old" management - short review
1. Tangible assets
2. Inventories
3. Trade receivables
4. Financial assets
5. Cash and cash equivalents
6. Other assets
TOTAL ASSETS /
9,97
-
2,79
1,96
-
0,02
14,74 / 1. Shareholders' equity
2. Capital reserve
3. Accumulated losses (1993 - 1999)
4. Current liabilities towards creditors
5. Current trade payables
6. Current tax liabilities
7. Long-term debt
8. Other long-term liabilities
TOTAL LIABILITIES & EQUITY / 17,08
0,62
(8,70)
4,58
0,47
0,68
-
0,01
14,74
The company's account has been blocked constantly since 1994.
Source: Company annual report.
Starting with the conditions stated above, at the beginning of 2000 a new CMT tried to fulfil the following assignments:
1. identify the conditions and circumstances of the crisis;
2. carry out actions and implement decisions on organising business activities in the period of crisis;
3. prepare an estimation on the possibility of recovery;
4. communicate continuously with employees, stakeholders, creditors and the media;
5. take over responsibility for introducing changes;
6. regularly carry out costs and cash control and operational efficiency;
7. seek the vision;
8. (possibly) produce the elements of crisis strategy.
The diagnosis, given by the new CMT, of the conditions of the company's health, indicated an extremely difficult situation; a lack of core business and the blocked account for six years had resulted in the fact that all the indicators relating to company solvency have constantly been negative, and corporate current liabilities (on and off balance sheet) had been significantly higher than the company assets. Further elements of the detailed basic diagnosis of corporate health indicated the existence of:
· transferred and stated losses (from the period between 1993 and 1999) amounting to 8,70 million €;
· unsettled liabilities towards the suppliers and creditors amounting to 5,73 million €;
· totally frozen current assets (customers' receivables and financial investments), which refer to the receivables from companies in bankruptcy processes, where the possibility of debt collection is minimised (only up to 20%);
· neglected book-keeping, unrecorded liabilities and off-balance sheet liabilities in the amount of at least an additional 6,71 million €;
· potential losses based on engaged warranties (for the other corporations in bankruptcy status) in the amount of 7,12 million €;
· a monthly burden, based on interests and amortisation, which is three times higher than the monthly expenses for employees' gross salary;
· estimated additional losses that exceed the capital of at least 6,85 million €.
The bankruptcy filing - new leadership challenge
According to the diagnosis indicated previously, the crisis management was faced with the following fundamental questions:
1. What is to be done when classic therapy, over several years, provides no positive results?
2. Where are the limits for the regeneration attempt?
Bear in mind that the situation encountered in the analysed company required the crisis management to initiate bankruptcy proceeding. The Croatian bankruptcy act recognises three reasons for bankruptcy: insolvency, over-indebtedness and threatening insolvency. If the company is insolvent or over-indebted, the management has an obligation to suggest that the bankruptcy court initiate a bankruptcy petition without delay and not later than 21 days after the occurrence of the reason for bankruptcy. CMT didn't want to impose this measure (initiating the bankruptcy proceeding) under any circumstances because CMT's response to the corporate crisis was based on the social approach of employees' protection. Potentially, initiation of the bankruptcy proceedings, which would lead to the liquidation of the corporation, would, most probably, and according to the experiences of other bankruptcy proceedings, result in all employees losing their jobs. The uncertain outcome, which at the moment of the CMT assuming its office was a very certain bankruptcy, didn't affect only employees, shareholders and stakeholders, but, also, and particularly, the members of the CMT. If the crisis team didn't succeed in recovering the company, its managers would gain the "reputation" of loser and, probably, even assume legal responsibility for not initiating bankruptcy proceedings.
In recent literature we do not find decisive answers to the two fundamental questions stated above. Since a best practice that could help answer the stated questions is non-existent, the CMT decided not to initiate a bankruptcy petition, but to set off in the battle for survival, albeit with a highly uncertain outcome. In other words, to try to do something that were, in that moment, impossible to imagine:
· regenerate the business in a relatively short period;
· release a part of the company's frozen assets;
· unblock the frozen corporate account;
· restore the liquidity status of the company;
· pay off the suppliers and creditors.
CMT introduced a radical and almost impossible change in order to try and bring about a corporate turnaround in the conditions they encountered.
TRAUMA TREATMENT AS A PART OF SURVIVAL STRATEGY
Introducing a radical change in the form of realising a business turnaround is very difficult, because it requires the company's performances to be changed from negative to positive in a relatively short period of time. Since the analysed crisis was formed by cumulated decline of the business activity over several years - this made the survival of the company extremely uncertain (a more certain situation is bankruptcy, with the liquidation of the company); the crisis management had to find a way to recover the corporation, bringing it within the framework which would ensure its desirable survival.