5

Stopping
Free Fall

Using the Founder’s
Mentality to Save a
Business in Rapid Decline

Unlike stall-out, free fall is an existential problem that demands an immediate and dramatic response. It’s brought on by not just the internal winds of crisis but also by storm conditions on the outside that create sudden, violent, and unpredictable turbulence. It’s the combination of these internal and external forces that can threaten your very existence (see figure 5-1).

Free fall most often affects maturing incumbents whose business model comes under attack from new insurgents or is rendered obsolete by technological or market changes. In the case of Charles Schwab—whose story we used in chapter 2 to illustrate the problems of free fall—both factors played a role. In 2004 the company was facing enormous external market turbulence, new competitors, a 50 percent drop in trading volume, a 75 percent drop in market value, and a reversal of its customer Net Promoter Score from the highest in the industry to the lowest, with 34 percent more detractors than promoters. Internally, there were debates about how much of the trouble was the market and how much was self-induced. But the point is this: when Charles Schwab returned as CEO that year in an effort to save the company, there was not much time left. Things were getting worse fast, and Schwab had to engineer a swift and dramatic transformation.

Charles Goldman, the executive who was put in charge of the transformation, told us how it felt to him at the time. “Chuck wanted to refocus on the client experience,” he said. “He turned over half of the executive group right away. Chuck then turned to four areas of focus: renewed value to the customer, improved customer experience, a stronger balance sheet, and the choice of his successor.” The first order of business was stabilizing the company financially, lowering cost in order to lower price, and shedding noncore assets and businesses to focus all energy on fixing the original core business. “We did classic reengineering,” Goldman said. “We sold all the international businesses, sold the capital markets business we had just bought, simplified corporate service, and downsized the headquarters. We began to move power back to the leaders at the front line with full responsibility, except for shared services that were clearly made subsidiary in terms of decision rights. It used to be that if you sat in an executive committee meeting, the voices that were the loudest were the staff voices. Head of human resources. Head of strategy reporting to the CEO. All these people dominated the meetings, and the business unit heads—the line executives who had the responsibility to actually carry out the strategy and had the most current information from the market—sat there quietly just to get through the meetings. When Chuck returned, we moved it all back the other way.”

After Schwab took over, he immediately focused on how dramatically the customer experience had degraded. Originally, it had been one of the company’s primary assets. Funding for call centers had been cut in a squeeze for higher margins, and call-center operators were losing energy and confidence. Hidden nuisance and penalty fees to customers had risen to become a significant part of revenue and a significant annoyance to customers. Prices had risen, too, justified by an ever more complex set of products for the eight customer segments the company had set up. One executive told us that customers found the increase in prices particularly galling. “Our competitors were lowering price dramatically to get trades,” he said, “sometimes as low as $10. Our headline was $29.95, and the average was $35. Our best customers felt betrayed that we had lost our roots as a discount broker, the original idea of value in the customer experience. This affected the whole orientation of our business toward supporting these fees rather than becoming competitive again.”

To pull his company out of free fall, Schwab recognized that he would have to reinvest in the original source of its success and rebuild the company around the essence of what made it once great (its sense of itself as the ultimate insurgent). He understood, for example, that the company’s call centers were not a supplementary service that could be squeezed for margins. They were an invaluable tool for developing customer relationships. He and his team quantified the economics of customer loyalty (for instance, many new customers can be traced to positive referrals, which have low sales costs) and put in place a Net Promoter System^® so that they could monitor customer loyalty by call center, by employee, by branch, and by team on a daily basis. To reinforce this, they introduced mechanisms and norms for executives to listen to customer calls at the call centers, and to personally follow up with customers who had difficult problems. As for all of those nuisance and penalty fees, Schwab recognized that they represented what our colleague Fred Reichheld calls “bad profits,” and since returning, Schwab has eliminated most of them, along with minimum-balance fees. He knew, too, that no turnaround would be possible if he didn’t make prices competitive again, so he did, by dismantling the company’s complex segmentation and taking massive cost from the company.

His efforts yielded extraordinary success. In just a few years, the company’s loyalty scores rose by roughly 70 points, from negative 34 to positive 42. Soon it again had the highest Net Promoter Score in the brokerage industry. The company’s stock price soared as a result, quadrupling the company’s market value over the next ten years (see figure 5-2).

How Free Fall Differs from Stall-Out

We’ve identified two factors that define free fall and illustrate how it is distinct from stall-out. First, free fall is a time of rapid, almost shocking declines in profitable growth and market value. Think of Schwab’s 75 percent decline in value. Second, it’s generally triggered by outside market turbulence and the emergence of new competitive business models. This is different from stall-out, where the danger is not yet life threatening and the causes, like complexity, tend to be mostly internal.

In researching this book, we examined a sample of 123 companies, each in a different market, and worked with experts to characterize how many of them were facing major threats of obsolescence in parts of their business model. We identified three forms of disruptive threat in particular. One is product substitution—the shift to smartphones, for example. Another is a major shift in the profit pools, of the sort that energy companies are encountering due to the effect of the smart grid and energy exchanges on pricing. The third involves the emergence of a new business model to deliver the product to consumers, as is happening with streaming video services that are competing with traditional television, or as Amazon did when it disrupted book retailing. We found that 54 percent of companies are currently facing one or more of these three types of disruption to a part of their business model, 16 percent are facing two disruptions, and a few are facing all three threats. We called these threats storms, and categorized them as level one, level two, and level three. Level-three storms, in which these three forms of disruption arrive at once, are truly the typhoons of business. Very few companies survive them.

Not surprisingly, most of the examples of each type of disruption today relate to the Internet and the explosion of digital technologies. Once, these threats of obsolescence were mostly confined to technology businesses, as was the case with Kodak when it faced the digitization of photography. Yet now these disruptions are spreading to even the most traditional sectors. Energy exchanges are collapsing the profit pool of utilities in Europe, Uber is disrupting traditional taxi services, and online degree courses are changing on-campus education.

Unlike stall-out, where one or two focused initiatives can often repel the danger, free fall requires strong, nonincremental action across multiple fronts. When a company is in free fall, the status quo is not an option for those in charge. This is when the number of theories about what to do proliferate. Some will inevitably say, “Just wait; this too will pass.” Others will propose jumping into hot new markets, which, our research shows, is almost never the answer. Still others will focus on ways the core business model needs to be redefined. This is a time of loss of consensus, lots of finger-pointing, job risk, and great internal stress.

Although only about 5 to 7 percent of companies experience free fall at any given moment, it is responsible for some of the largest swings in value—both up and down—in the stock market today. (Just think of what happened to Apple, which went down in flames and then rose from the ashes to reach $700 billion in value today.) In the sample of companies we followed that experienced free fall, this period accounted for more than 30 percent of the swings in value. And not only that, free fall is happening increasingly often, now that insurgents are scaling faster, acquiring new customers faster, and capturing market power faster.

We’ve worked with lots of companies in free fall: our clients at Bain, companies we’ve been involved with outside of Bain, and even Bain itself, which had a brief flirtation with free fall in the late 1980s. And what we’ve learned is that reversing free fall requires leveraging the full power of the founder’s mentality not just to rejuvenate a company but, in fact, to refound it. We’ve identified five steps (and one wild card) that have worked in successful turnarounds and transformations.

Essential Steps to Reverse Free Fall by Refounding the Company

1. Build a refounding team.
2. Focus on the “core of the core.”
3. Redefine the insurgency.
4. Rebuild the company at the front line.
5. Invest massively in a new capability.
6. Wild card: consider private ownership.

Let’s look at them one by one.

Build a New Refounding Team

When we looked at fifty well-documented cases of companies in free fall that turned around their operational performance and transformed their strategic direction at the same time, we found that forty-three of the fifty cases involved massive change in the leadership team, starting with the CEO. The case of Schwab, where over 70 percent of the top-two layers of management was replaced, was typical. In eight of these cases, the founder or the founding family returned to retake the helm, as was the case with Schwab and Apple.

When a company is in free fall, it makes sense to turn over the management team. First, there is the need to inject new energy into a tired organization under stress. The last thing you need is a leadership team that is worn out or not up for the hard work of the transformation. Second, you need to populate the leadership team with people who want to rebuild the future, not defend the past. One executive we interviewed, who was hired in the midst of a transformation, said that when he arrived, “the most common phrase was either ‘we used to do it that way,’ or ‘we don’t do it that way here.’” Knowledge of the past is good, but defense of what is no longer working is bad. Rebuilding is hard enough. Third, as the new strategy becomes clear, you may need to add new skills and capabilities, although you should do this with care. You need to hire insurgents with a rebellious spirit—people one executive described to us as “black sheep from blue chips”—rather than employees who are used to the trappings and stability of large companies. This time of transformation can also be a time to find the franchise players who know the detail at the front line and love the company but may not have been promoted to the most visible leadership positions under the past administration. Promoting them is a great sign to the organization, a source of knowledge and energy, and a further signal that the future will be about merit and open-mindedness. Fourth, obviously, it is unreasonable to expect the architects of a strategy and operating practices that led to free fall to see the error of their ways, as well as the right path forward. You want people with open minds to invent the future.

Finally, the change needs to happen relatively quickly. When the majority of a management team is replaced over a long time (tempting because it would seem to reduce disruption), two things happen. First, time is lost. You need to get the team on board before restructuring a business. Second, those who are brought in might begin to absorb the organizational biases of the past.

Focus on the “Core of the Core”

Reversing free fall takes enormous energy and resources. The leaders in most of the successful cases of transformation we’ve studied knew this and acted on it by combing through the company in search of noncore assets to shed, businesses to sell, activities to stop, functions to eliminate, and product lines to simplify. If the scarcest resource is the time and discretionary energy of the most effective employees, then this is a time to make sure that it is concentrated on the task at hand. One leader told us how the situation on his arrival was like Risk, the board game of international conquest. What he found, he told us, was “a few armies on all sorts of distant territories, and few armies massed on protecting and defending the homeland.” He knew what he had to do: “The first order of business was to concentrate forces.”

One company that very successfully engineered a transformation along these lines is LEGO. Let’s review its story.

LEGO was founded in the 1930s by Ole Kirk Kristiansen, who devoted himself to building a repeatable business model around a system of interlocking plastic bricks. After his death, his successors continued to grow the company, using the repeatable formula, and for many decades during this post-founder phase, the company stuck to its core. By 1993, revenues had risen to $1.3 billion, and in 2000, the LEGO system was voted the toy of the last century by Fortune and the British Association of Toy Retailers.

Starting in 1993, however, the company diverted cash from its profitable brick-system business into an astonishing array of adjacencies: theme parks, television programs, watches, retail stores, plastic toys without the brick system, video games, and even a Steven Spielberg co-branded “movie studio in a box.” All of these moves drew resources from the core; virtually all of them failed. “As a result,” the company’s current CEO, Jørgen Vig Knudstorp, told us, “the company entered a ten-year period of declining performance that saw the profit margin go from 15 percent in 1993, to negative 21 percent in 2003. Over this period, LEGO Group lost value at an average rate of 300,000 euros per day.” The company was in free fall.

When Knudstorp took over as CEO in 2004, he looked at every option and quickly settled on a course of action. To turn LEGO around and put it on a better path to long-term growth, he decided to return the company to its core and help it rediscover its insurgent mission. He installed a new management team and, with its help, began to strip the business to its basics, focusing the company’s energy on rebuilding around the one core product that had made it great: its toy-brick system. His employees embraced the change. “Even though LEGO was in a death spiral,” the company’s main historian, David Robertson, has written of this period, “many staffers greeted the leadership shake-up with unmitigated joy.”¹

So how did the leadership team at LEGO Group reverse the company’s free fall?

First, the team attacked the portfolio of assets. It sold part of the LEGOLAND theme park business to a private equity firm, retaining partial ownership, shut down all of the other adjacencies, and stopped planned expansions: books, plastic watches, LEGO dolls, magazines, the goal of three more theme parks and three hundred more retail stores, software, LEGO Movie Maker, computer games, and even television.

The team then went deeper to further simplify. For instance, it found that the number of unique elements in the LEGO sets had grown massively, from about six thousand in 1997 to more than fourteen thousand in 2004. Colors had proliferated from six to fifty. Moreover, it turned out that 90 percent of these elements were used only one time. So, in addition to cutting businesses, research projects, and toy lines, the team cut all the way down into the components and eliminated more than 50 percent of them. Commenting on this focus, Knudstorp told us, “We are now only investing in products that use repeatable parts and follow repeatable formulas.”

From here, the LEGO team began to create rules to determine when products and elements could be added. The cost of a single element is deceptively high, because each requires a separate mold and a machine changeover, and each creates scheduling and inventory complexity on the shop floor. Today, 70 percent of the parts in any LEGO product are from a subset of universal pieces.

The LEGO team then turned to rejuvenate the product line. It built technology into the bricks. It gave online customers the ability to design their own LEGO set or to order the bricks to make structures designed by others. It studied the thousands of the most intense LEGO fans, whose energy and detailed knowledge had never been tapped for conferences, networking events, input into new products, and even active involvement in product design. It began growing again by moving into adjacencies that were tightly linked to the core—LEGO for girls, licensing the brand for a LEGO movie, introducing a new set of mini-figure elements, and increasing the co-branded products, like the Star Wars line.

The five steps we listed earlier all played a role in reversing LEGO’s free fall. The company changed its management team. It simplified the business on many levels. It redefined the growth strategy around the play system and the user community. Internally, the company renewed its original principles and brought them into a contemporary setting. The designers and key front-line employees again became the heroes of the company. And the company added new capabilities, especially in the digital world. Among the internal moves were some that further symbolized this back-to-basics approach, such as selling off the LEGO Group’s headquarters to move into a modest building that also contained the packing plant. The company vigorously committed itself to each step, with amazing results. Since Knudstorp took over, LEGO’s revenues have increased by 400 percent, and its operating profit margin has increased from negative 21 percent to positive 34 percent.

This approach—shrinking to grow—has been adopted successfully by a number of companies in free fall. It was true in Lou Gerstner’s transformation of IBM: he shed a range of hardware businesses (like PCs) and shifted the company’s energy toward services and software. It was true in Steve Jobs’s turnaround of Apple: Jobs cut back to four main products and a handful of development projects early in his return as CEO. It was true in the example of Schwab, too, which shed several prominent acquisitions, including U.S. Trust, and reduced significantly the number of different customer segments its salesforce was treating separately. In each case, the approach was the same: first, strip away complexity and, second, return to the core of the core.

Redefine the Insurgency

To reverse free fall requires more than complexity reduction, a new team with the necessary energy and mindset, and liberated resources to fund the transformation. At some point, it is necessary to prove that “there is a there there” to justify the work. We have seen many business positions that are so far gone or behind such a large competitive eight ball that the effort is not worth it. To renew the insurgent energy on the inside, the new team will need to prove that it is all worth it on the outside.

Let’s look at one company in free fall where this was the central issue. Again, we have chosen an example from a number of years ago in order to see how it played out through the whole sweep of events. Remember, most reversals of free fall ultimately take four to six years because they are so comprehensive in their scope.

In 1994, when (believe it or not) mobile phones had penetrated only about 9 percent of the US market, Ted Miller, an entrepreneur in Texas, had a brilliant idea. Telecom operators, Miller knew, had launched a capital-intensive race to build out the network of cellular relay towers across the world, and he realized that each trying to do this unilaterally made no sense, just as it would have made no sense for car manufacturers to have built their own independent road systems in the early days of the automobile. Miller recognized an opportunity: a savvy businessman could found a very successful business based on the idea of owning and leasing out towers. He ran with the idea, and Crown Castle was born.

Miller started by buying a cluster of 133 towers in southwest Texas and, in 1995, forged an investor relationship with the private equity firms Berkshire Partners and Centennial Funds to help him execute as big a land grab as possible while the industry was still young. The company executed on its plan brilliantly, acquiring towers all over the world and quickly initiating acquisition efforts in more than fifteen different countries. It was an insurgent success story: Miller took the company public in 1998 at a stock price of $13 per share, and by 2000, the price reached $42 per share.

But then investors began scrutinizing the growth model and didn’t like what they found: the debt levels, the unending negative cash flow, the uncertain end point of the land-grab strategy. As public confidence in the company evaporated, the stock price fell to $1, driving the company’s equity market value below $300 million. Miller stepped down as CEO and left the company soon afterward, and employees marooned at the company found themselves worried about their jobs, their savings, and their direction.

In July 2001, John Kelly stepped in as the company’s new CEO and engineered a remarkable turnaround. In a frank discussion, he described to us how he helped the company adapt and restore its insurgent mission.

“The first thing we had to do,” he told us, “was to create a common view of our core, our purpose, and of the right way to scale the business. We concluded that it was not a global tower business but a regional-level business, and that we had to focus where we could build systems and services for customers to optimize the economics of each tower. We withdrew initially from ten countries with two more countries ceasing operations shortly thereafter, and focused on building three core markets where we could create regional density and generate market power by becoming the best provider to customers who made tower decisions at that level. The wrong expansion model had led us to taking excess risks outside and underinvesting inside in the systems that would allow us to expand profitably.”

Kelly and his team jumped to the forefront of the industry in creating these systems. “We created regional organizations to get more of our people into the field with the customers who made their network decisions on a local basis,” he said. “We developed sophisticated models of tower economics and detailed databases of tower attributes to manage the sites. We held meetings and training sessions with each of our employees so that they could understand that our success drivers came from regional density of the network, and deep technical expertise in the eyes of our customers, and how we wanted to grow from that platform. We completely rebuilt the company inside and out.”

Redefining the insurgent mission around customer service and leadership in dense regional networks (versus being an acquisition business buying towers everywhere worldwide) drove huge and immediate changes. The company divested towers and countries. It needed to develop new internal systems. It reset the acquisition agenda around local density. And it focused on hiring people who could understand and sell to telecom customers. Without the redefined mission spelled out and understood by the key employees within the first year, the free fall would probably not have been stopped in time. It affected everything, including the hope and energy of those who had to carry it out.

The results have been impressive. Crown Castle’s tower count has grown from seven thousand to over forty thousand in little more than a decade, making the company the largest US operator of shared wireless infrastructure. And it has grown in equity market value from about $250 million to over $25 billion.

Crown Castle’s redefined insurgency was based on the same market phenomenon that inspired the original insurgency: the knitting together of towers into regional and, ultimately, global networks. Yet its focus, the required skills, and the key profit drivers all changed dramatically. By adding new capabilities, the company changed the business model and, in effect, refounded itself on the fly.

We’ve found that this approach accounts for about a quarter of the successful cases of free-fall reversal that we studied. But there are other approaches, of course. Apple radically redefined its insurgency and its market advantage at a time when the boundaries of the industry were dissolving, and it needed to acquire or develop the skills to succeed across the range of newly connected markets. Central to Apple’s transformation has been its ability to add a series of powerful capabilities inside the company (such as managing online digital content and a new approach to retail stores) as well as outside (Apple’s more than three hundred thousand app developers, for instance). These capabilities allowed Apple to fix and redifferentiate its core, while enabling it to move into one new adjacency after another (iPod to iPad to iPhone to Apple Watch) in pursuit of new growth.

Another approach is much more fundamental: some companies focus ruthlessly on strengthening the insurgency and core mission of the past. DaVita, a chain of kidney dialysis centers that went into free fall but then pulled out of it and became the best-performing health-care company of the past decade, is such an example. We’ll tell its story in the next section.

Finally, there’s what might be called the big-bang approach, which involves transforming a company by having it leap to a new, hot market. Only rarely do companies pull this off. Marvel Entertainment did it, transforming itself from a bankrupt comic-book company to a highly profitable movie company that The Walt Disney Company acquired for $4 billion. Yet even here, Marvel built on its ability to pivot, not leap, into a new market.

Refound the Company on the Inside

A central premise of this book is that the majority of performance problems companies have on the outside actually have a more fundamental root cause on the inside. This premise is important in the case of free fall, because the dynamics on the outside are often so strong that it is easy to stop there. Nokia’s free fall, for example, can be attributed to many external forces, among them, Apple’s competitive strategy; the problems Nokia had with its mobile operating system, Symbion; and Nokia’s few app developers. But the deeper root cause of most of the company’s external problems proved to be internal.

One of the most remarkable examples of refounding a company on the inside is the story of how Kent Thiry and team pulled Total Renal Care out of free fall by reinventing it as DaVita.

When Thiry took over as CEO of Total Renal Care in 1999, the company was heading for disaster. Made up of 460 renal-dialysis care centers, it was losing more than $60 million per year, was under investigation by the federal government for fraud, was at risk for failing to meet payroll for its nine thousand employees, and was being sued by shareholders. Patient outcomes were poor relative to industry standards, and the overworked staff, feeling unappreciated and seeing no bright future ahead, was turning over at a rate of 40 percent per year. Reflecting the company’s state of crisis, the stock price had collapsed by 95 percent, from $23 per share to $1.71. It is hard to imagine a more disorienting free fall for people inside the company.

Thiry immediately attacked on many fronts at once. He replaced most of the management team, reduced costs to forestall bankruptcy, simplified by reducing the enormous variation in practices across the centers (he told us he found a company of 460 centers doing things in 460 ways), and returned to better customer practices, all of which were necessary simply to stabilize the business and give it some resources to make a turnaround possible. But, critically, he also dedicated himself to a multiyear program of essentially refounding the company from the inside.

To reinforce the idea that everybody at the company had a stake in its rescue and rebirth, Thiry began referring to Total Renal Care as a village. He abolished the use of formal titles internally (though they were still needed externally) and began to refer to himself as a mayor, not CEO. He convened town meetings with local staff and organized national voice-of-the-village phone calls every eight weeks that were often attended by four thousand people from the company’s offices or clinics around the country. He asked his employees (internally referred to as “teammates”) to come up with a new name for the company and to codify its values, a seven-month exercise that led to the name DaVita (which means “giver of life” in Italian) and seven core DaVita values, among them “one for all and all for one,” “continuous improvement,” and “service excellence.”

Those core values became a critical element of Thiry’s transformation plan. He and his team created measures in each of the centers for studying not only how well the center was handling patient care but also how steadfastly its employees were sticking to those values, and they made those measures public and linked pay to them. They began to capture, publicize, and financially reward “DaVita moments” of heroism among front-line employees. They began rating job candidates on how well they seemed to align with the core values. They even brought patients into the process by asking them to vote and comment on the caregivers who most helped them, so that the company could reward them appropriately.

Together, according to Thiry, these changes had two immediate and important effects. First, they helped create a powerful sense of shared mission throughout the company; and second, they had the effect of constantly flattening the organization, drawing the front line closer to the senior management. Increasingly, too, as they created a more repeatable model in the branches, Thiry and his team were able to push more decision authority downward in the organization, leading to a front line that felt more empowered and energized. Thiry realized that senior management needed to be a part of that process and so insisted that each manager spend a week each year working in the centers.

When we first wrote about the DaVita story in 2010, the company had just achieved a remarkable eleven-year run, during which it had become the best-performing stock in the Standard & Poor’s 500, earning investors a return of twenty-nine times. From the start of the turnaround to 2010, the company grew its revenues from $1.3 billion to $6.2 billion, and its operating earnings from a large loss to $1 billion. And the growth continues apace. By the end of 2014, DaVita had again doubled in size, to $12.8 billion, and its stock price had risen from $30 per share in 2010 to $84 in 2015 (see figure 5-3).

Thiry obviously employed a variety of strategies to engineer the rebirth of DaVita. But everybody involved will tell you that the internal transformation in values, principles, energy, and behaviors that he engineered was the primary reason for the company’s renewal. Today, if you walk through the new DaVita headquarters in Denver, Colorado, you’ll find cultural iconography everywhere: the seven values of DaVita, photos of the centers and their teams, quotes and sayings that were made meaningful during the turnaround, testimonials from patients praising the work, and hero stories of front-line employees. One big message comes across loud and clear: even when things look dire for a business, renewal might still be possible. But if you go for it, go all out. Refound the company. Don’t hold back.

Invest Massively in a Core Capability

Companies in free fall have a lot to fix but seldom have all of the tools they need. They usually find that they are missing at least one capability crucial for adapting their business model to new conditions.

Nearly all of the fifty cases of successful reversal of free fall that we studied required at least one major new capability. For instance, Steve Jobs would not have been able to renew Apple if the company had not built capabilities in digital rights management and retailing, both online and offline. Lou Gerstner would not have been able to renew IBM without building new capabilities in software, consulting, and IT services. John Kelly would not have been able to renew Crown Castle if the company had not built up technical-sales and service capabilities for telco operators to a high level. Reed Hastings would not have been able to renew Netflix had the company not developed the best digital-streaming capabilities in the industry, and the capability, through partnerships, to generate fresh content like the award-winning show House of Cards.

A lot has been written about the failure of Kodak, once the world leader in film and photography: how internal breakdowns prevented it from embracing the shift to digital, and how the large film profit pool, which Kodak dominated (accounting at one point for 90 percent of film and 85 percent of camera sales in the United States) encouraged the company to fight the future rather than reinventing it.

Yet some film and photography companies did make the shift and avoid or reverse free fall. For instance, Fujifilm, which was number two globally in film, added capabilities, shifted aggressively to digital photography, restructured to cut complexity and costs, and today is thriving. The company also invested $4 billion in adapting its technology to make optical films for LCD flat-panel screens.

In the photography industry, Leica provides an even sharper example of how adding new capabilities can help a company reverse free fall. The first Leica camera was invented by Oskar Barnack, an engineer who worked for the lens company Leitz. Barnack succeeded at creating the first lightweight camera whose most distinctive feature was the quality of its lens, allowing small film images to be blown up without losing much resolution. Leica’s image quality made it the preferred camera of the great photographers of the last century, among them Robert Capa, the war photographer who captured the D-Day landing; and Henri Cartier-Bresson, who became enraptured by the new camera and its remarkable images. (“The Leica,” he said, “feels like a big warm kiss, like a shot from a revolver, like the psychoanalyst’s couch.”)

Yet the company was slow to embrace digital photography. It invented autofocus but never exploited it in its cameras, and only began to put digital technology into its cameras in 2006. The company’s problems were compounded by the decline of traditional photo stores and the rise of the Internet and discount camera retailers. Because Leica made cameras at the top end of the price range and didn’t adapt to these changes, it lost money throughout the 1990s. Between 2005 and 2007, Leica saw its revenues decline from 144 million to 90 million euros, and it lost 10 to 20 million euros per year, which made it hard for the company to invest in the new capabilities it needed to compete. The company had entered free fall.

Enter Andreas Kaufmann, an Austrian investor who acquired a controlling stake in Leica in 2006 and believed that Leica possessed unique assets that it could build upon to renew itself—its brand, its unparalleled image quality, its heritage with the great photographers, the quality of its lenses. Kaufmann proceeded to engineer a turnaround of the company focusing on the top end of the market. Then, in 2011, the private equity firm Blackstone invested 160 million euros in the company. This capital, plus Kaufmann’s dream to renew Leica, has allowed the company to obtain the new capabilities that were central to revamping its product line (autofocus, digital version of the M line of cameras) and its channels of distribution (branded stores). Today, Leica’s revenues have tripled from its low point, and it is again solidly profitable. What the future holds is uncertain, with the wave of smartphone cameras eroding the market for traditional cameras. But for now one of the great brands in photography has reversed free fall and returned as the standard bearer of image quality, just in time for the company’s hundredth anniversary.

A leadership team confronting free fall usually feels stretched to the limit. It’s hard to think about new capabilities in this state. But if you don’t, all of the other work you do to pull your company out of free fall could go for naught. This is a special challenge for leaders. We will return to this topic—the leader’s role in building capabilities—in the next chapter.

Wild Card: Return to Private Ownership

Changing the mix of investors to avoid free fall is an option that a growing minority of companies pursue today, a process enabled by the massive growth in private equity firms during the past few decades. Shifting to private ownership can buy time, create currency to attract talent, and reduce external distractions to focus on the difficult internal task at hand.

It worked for the money-losing semiconductor division of Philips, which had roots that traced back to Fairchild Semiconductor, the earliest of all Silicon Valley tech companies. In 2006, the division was sold to a consortium of private equity investors that included KKR and Bain Capital, which promptly named the company NXP, shorthand for “next experience.”

It certainly was that. At the time of sale, the industry was in a slide, revenues were in decline, and profit margins were negative 12 percent, trending to bottom out at negative 40 percent. The company was in free fall.

Over the next five years, however, NXP underwent a complete transformation on pretty much every one of our six steps, including moving into private hands for the period of renewal. NXP replaced much of the management team, including the CEO. It simplified the portfolio of businesses and products and much more tightly circumscribed the core business. It divested several businesses, which helped the company shrink from about $6 billion in revenues in 2006 to $3.8 billion by 2009. The organization as a whole was simplified aggressively. It reduced layers of management and staff, taking out a quarter of the total cost base, and developed a more focused strategy to rebuild global market position in the company’s most iconic product area of high performance: mixed-signal electronics.

It’s been a great success. Since NXP returned to public ownership through an IPO in 2010, it has grown revenues by 30 percent, attained over $1 billion in operating income, and initiated a merger that will double the size of the company. In the five years since its IPO, NXP’s stock price has increased tenfold.

When we asked one of the senior executives at NXP about this remarkable story, he emphasized that it would not have happened if the company had remained a noncore business buried within an enormous, publicly traded conglomerate that itself was struggling with its own identity and performance. Furthermore, private ownership made it possible for the company to transform itself away from the scrutiny of stock market analysts, and to focus on four-year rather than quarterly results, the long-term perspective that is at the heart of the founder’s mentality.

We are hearing this more and more. Companies in free fall are turning increasingly to private investors for temporary shelter to restructure during free fall or to restore the founder’s mentality for the longer term. This is what Michael Dell recently did, in one of the largest public-to-private shifts in history. Though not in free fall, Dell faced stall-out and needed to make a lot of changes, internally and externally, given the rapid and disruptive changes in the computer industry.

Dell’s initial story is a remarkable and justly famous one. Few companies have scaled as fast and as profitably in the history of business. Since its founding in 1984 in Michael Dell’s dorm room, Dell set the world record for the most-rapid growth in its first twenty years of life—eight times as fast as Walmart and four times as fast as Microsoft. During the 1990s, a period of true hypergrowth (during which Dell made it through overload magnificently without missing a beat), it achieved annual returns to shareholders of an astonishing 95 percent, growing its earnings over this period by 63 percent per year. At its core was its “direct model” for selling computers, which bypassed retailers and had a negative cash-conversion cycle (meaning the company was paid for the computers before paying for all the components). The model at the time advantageously provided customer intimacy (customers ordered directly) and low cost (it had about a 15 percent cost advantage in personal computers over such rivals as Compaq and Hewlett-Packard).

Yet as Dell entered its third decade, a range of developments intervened to drive down its annual growth rate. From 1992 to 1999, growth increased at a remarkable 54 percent per year; from 1999 to 2006, growth declined to 17 percent per year; and by the period 2006–2013, stall-out was imminent. The annual growth rate during those seven years was a mere 2 percent. Many things occurred during this time to bring the highest flyer of all time down to earth. Priorities under new, professional management shifted the focus more and more to cost reduction instead of investing in customers. As a result, Dell’s Net Promoter Score went from best to near worst in the industry. New products were also not as “hot” as they were during the growth years when Michael Dell was at the helm as CEO. Also, the cost advantage of the direct model was declining. The result of all this was impending stall-out, signaled by a 74 percent loss in market value from $94 billion in 1999 to just $26 billion in 2013.

What went wrong? “We took our eye off of the customer,” Michael Dell told us recently. Increasingly, as a large public company, Dell had stopped investing in customers and, instead, was devoting its resources to cost reduction and hitting annual market-based benchmarks. By 2014, after failing to turn his company around with incremental measures, Dell decided to adopt a radical approach: he would take Dell private, with the equity partner Silver Lake.

It was an inspired move. “In going private,” he told us, “it’s amazing how we have been able to speed things up within the company. We simplified meeting structures, went to a board of directors with just three members, and increased our appetite for risk. When big committees talk about risk, they talk about risk committees, how risk is bad, the mitigation procedures of risk, and the reaction of the analysts. Yet now for us risk is about innovation and success. It has been very energizing to our one hundred thousand employees to feel the long-term focus coming back into the company.”

Dell has its owner’s mindset back, and it’s already performing better. Its customer-satisfaction scores have rebounded, and its employee-satisfaction scores are the highest in the company’s history. The company’s core businesses are outgrowing their industry again, and the company is investing heavily to redefine its model for the long term. “We changed our focus,” Dell told us, “to cash flow from quarterly earnings, to the long term from the shorter term, and to investing heavily in new capabilities. It has caused us all to think about the business totally differently.”

We recently asked Dell to reflect on this bold move. “We are in a ‘change or die’ kind of business that has to continually evolve,” he reminded us. “To do this, we realized that we needed to build a series of major capabilities for the long term, as well as to invest heavily in customer service. We tried to do this from 2007 to 2013, including a series of acquisitions, but the market was not patient enough. They said, ‘Just give us more dividends and repurchase shares.’ This is a depressing loop for anyone. We were spending nearly $2 billion per year as it was on dividends, interest costs, and share repurchases. We decided it was time to do something different and change our horizons by going private. Today our horizons are not quarterly, but are three, five, and ten years out in terms of our three priorities: sales capacity, new product, and capability.” In fact, as we write this, Dell has just announced the third-largest technology acquisition in history—the purchase of data storage leader EMC, for $65 billion.

Going private is not for everybody, of course, but there is an increasing body of evidence to suggest that returns are higher in private than public hands. We believe strongly that the main reason is the power of the three elements of the owner’s mindset—a bias to speed of decision and risk taking, a deeper sense of accountability, and a focus on cash flow. The early returns from Dell, which avoided free fall by going private, add to this weight of evidence.

Nothing about free fall is easy. But it can represent real opportunity. As we’ve noted, we’ve found that some of the largest positive swings in value can occur as companies recover from free fall, restore the founder’s mentality, and get themselves back on the path to scale insurgency. Sometimes the hardest materials are forged in the hottest crucibles.

In our next chapter, we’ll provide specific advice for leaders trying to grow their companies and make them “scale insurgents”—which is to say, companies that achieve sustained profitable growth at scale while also maintaining the strengths of the founder’s mentality.

USING THE FOUNDER’S MENTALITY IN YOUR ORGANIZATION

Take immediate actions to ensure your business can survive industry turbulence and respond to new insurgents. Specifically:

–Make the case for change with your people. Are parts of your business model becoming obsolete? If so, focus urgently on how they should be redesigned.

–Radically reduce complexity to liberate resources and sharpen focus, even if this means shrinking the business back to the “core of the core.” Demonstrate how actions to reduce complexity and costs create funds to invest in growth.

–Involve your strongest, next-generation franchise players in identifying how the core business needs to change to compete. Ask them for personal commitments to stay and execute their vision.

–Set up a program office of leaders assigned full-time to manage the turnaround and transformation of the business model.

–Ensure that 50 percent of management discussions are focused on investing in capabilities to grow over the long term.

Consider the role of private equity investors or private ownership.