Anticipating Danger

Founded at the start of the 20th century by the Italian Irish inventor Guglielmo Marconi, the man credited with the invention of the radio, Marconi was acquired by English Electric in the 1940s, which was itself taken over by GEC in 1968. GEC was the creation of Arnold Weinstock, who, over 40 years, presided over the rationalisation of the British electrical industry.

Weinstock was notoriously meticulous and cautious, and by the time he retired in 1996 he had built up a conglomerate with profits of more than £1 billion on turnover of £11 billion. Weinstock divided opinion. To many he was simply 'Britain's best manager'; to others he was a narrow-minded bean counter who had sucked all the life out of a major chunk of Britain's industry, leaving the country ill-equipped to exploit the opportunities of the new digital era.

His nominated successor was Lord George Simpson, who addressed the challenge of reversing this trend with gusto. He recruited John Mayo, a high flying merchant banker, sold off GEC's unfashionable defence businesses and used the proceeds of this and an equally unfashionable £1.4 billion cash mountain to buy Marconi (as GEC was now called) a stake in the new economy. "Simpson continued to buy telecoms assets as if they were going out of fashion," former BBC business pundit Jeff Randall drily observed. "Unfortunately for him they were."

A bubble bursts

Founded by a husband and wife team in 1986 Cisco was the poster child for the new digital age and had, in a mere 14 years, become the world's most valuable company when in March 2000 its shares hit $80 (50 times earnings). The engine of this growth was Cisco's dominant position in the switching technology underpinning the internet. In 1990 there were 200,000 internet hosts. By the end of the decade there were more than 100 million.

Barely a year after this peak, however, Cisco's CEO John Chambers was having a miserable time. On 10 May 2001 he announced Cisco's first ever quarterly loss, a massive $2.89 billion on revenues for Q1, down 30% on the prior year quarter when sales had posted year-on-year growth of 70%. The decline was across all sectors and all territories. Over the next few months most of Cisco's competitors, customers and suppliers were to follow suit.

Chambers compared what had happened to a Biblical disaster: "This shows that a once in 100-year flood can happen in your lifetime. It is now clear to us that the peaks in this new economy will be much higher and the valleys much lower and the movement between these peaks and valleys will be much faster." He went on: "We are now in a valley very much deeper than any of us anticipated."

But the drop in the market was only half of the story. Based on overoptimistic sales forecasts Cisco had taken a gamble. To avoid losing sales because of a shortage of components it had bought stock ahead. The reason why Q1's results were so bad was that the company was forced to write off $2.25 billion of excess inventory, bringing the total inventory the company carried down to a mere $1.9 billion.

Chambers reported to analysts that visibility remained difficult. "The suspicion remains," reported the Financial Times, "that visibility is fine; it is merely that management does not like what it sees."

By the end of May Cisco had lost more than 75% of its March 2000 value and 25% of its employees had lost 100% of their jobs.

The calm and the storm

The day after Cisco's announcement, Liverpool, home to one of Marconi's 70 odd factories, was enjoying a spell of unseasonably hot weather and so management sent workers out to sunbathe on the lawns in front of the glass-fronted buildings of the Edge Hill plant. One of the topics of conversation was the shortage of orders that had led to this unofficial break. "There were simply no orders going through for hardware," reported one of the workers. This did not come as a surprise to the employees. In the period January to March when the plant's major customer, British Telecom, spends most of its money, workers "usually work around the clock, seven days a week because there is a flood of work". But this year "work dried up".

Management only seems to have noticed this much later. On 9 April senior management gave an upbeat presentation to union representatives at the company's Coventry plant. It employed 1200 people but was operating at below 50% capacity. Meanwhile, plants In Italy had been reporting a slowdown in orders at the beginning of the year.

The company, however, continued in an optimistic vein. At the annual shareholders' meeting on 15 May, Lord Simpson commented that while the first half of the year would be flat, "we anticipate that the market will recover around the end of this calendar year". On 19 June he told the Financial Times that "we have no reason to change our view of what we said a month ago".

But, when the 'flash results' came into Marconi's new Mayfair headquarters at the end of June it was clear that performance in the first quarter of the financial year was not merely weak; it was disastrous. Mayo flew back from a sales trip to Italy on the morning of Tuesday 3 July to go through the figures with Steve Hare, the finance director. At 6.26am on the following day, Marconi announced the completion of the sale of its medical unit to Philips, the Dutch electrical group. A quarter of an hour later the shares of the company were suspended. At 6.53pm, the Marconi board issued a trading statement. Sales would be 15% below the level of the previous year and profits halved. 4000 jobs would be lost.

"Normally, at the end of June we would see a sudden uptick in performance as orders are finalised at the end of the quarter. Instead what we saw in fact was a downturn…it did just happen that quickly," reported Lord Simpson.

The next day Marconi shares fell 54%. They closed at 101 pence, valuing the company at £2.6 billion compared to £35.5 billion nearly a year earlier. By September analysts had concluded that the shares were "virtually worthless".

By Friday evening of that same week Mayo had been forced to resign. Chairman Sir Roger Hurn and Lord Simpson resigned in September after a second profit warning. Hare lasted until November 2002 when he lost his job following a failure to renegotiate debt financing for the company. Weinstock, sadly, did not survive that long. He passed away on 24 July 2002. "I think he died of a broken heart because of what happened to his company," said Sir David Scholey, friend and one time banker to Weinstock.

In 2005, at the end of "one of the swiftest ever exercises in value destruction", according to the Financial Times, the bulk of what was left of Marconi was sold to Swedish company Ericsson for £1.2 billion.

The world's changed, but our thinking and tools have not kept pace

What do these stories teach us? Clearly, growth through acquisition can be risky; most acquisitions fail to deliver the anticipated benefits and many lead to calamity. And Marconi was certainly unlucky or unwise since they bought at the top of the market. Also, the simplistic, narrow-minded focus on a single financial metric, particularly when it is linked to generous financial incentives, can be a recipe for disaster.

All these, and many other criticisms may be valid, but there is something more profound, more relevant to the daily practice of management, that these stories illustrate.

Modern economies have evolved to the point that things can happen at a frightening speed. Start-ups can become huge, globally dominant corporations in a matter of a few years; conversely, institutions that have been around for a century can disappear almost overnight. Economies and institutions are now so interconnected that it can be dangerous to make assumptions about the business environment more than a few months ahead. It follows from this that businesses have to pay more attention to the opaque nature of the future than ever before. Opting out of the global economy is not an option, and there is a limit to our ability to manage risk – the product of our inability to forecast perfectly – using tools such as insurance, hedges or diversification. If we cannot avoid business risk altogether, and it is not possible to insulate ourselves against it, we have to get better at anticipating danger – or for that matter, opportunity – and responding to it, quickly and effectively. We have to become 'Future Ready'.

When making decisions, we cannot rely solely on information about what has happened, we need information about what we believe might happen as well; information that we create through the process of forecasting. Equally important, we then have to build the capability to act upon this information. If we have no such information, or it is deficient or misleading, then we risk loss of opportunity, resources or, in the case of Marconi, outright failure and collapse.

Without good forecasts, businesses are horribly exposed

What is particularly striking about the Marconi case is that it is clear that the information needed to anticipate the collapse of the telecommunications market did exist over six months before their bungled profit warning. What is more, it did not require superhuman powers of detection and insight to find it. Even shop floor workers knew about it. The information must have been in company systems, but for some reason the brains in the corporation were not in contact with the brain of the corporation.

"If it wasn't brutally clear to anyone at the start of the year that the industry was imploding it should have been clear by May," said James Heal, analyst at Commerzbank. "They must have been on another planet," concluded the Financial Times. Extraterrestrial vacations are not the only explanation for the catastrophic failure of Marconi, however. It is clear that it either did not have or did not use or trust its forecasts. When asked at the annual meeting held on 18 July whether the board knew about the poor sales figures in May, incredibly the chairman replied it had not: "We did not know it in May. It was the second month of the financial year."

Fortunately, when we are driving a car we do not wait until something has already happened before we change course, we look through the windshield. It is not recorded whether shareholders challenged the chairman on his reliance on the rear view mirror to manage his business or asked why the timing of the financial year-end was relevant to managing the business.

Another telling comment was made by Lord Simpson, who said orders were finalised at the end of the quarter. Why, you might ask, are orders finalised at quarter-end? We often hear this kind of thing from companies who run their business by simply trying to 'hit the numbers'. Set a target, pay people to hit it (or punish them for failing) and if you succeed then assume the business is performing well. It is dangerous to run a business on automatic pilot. Manage this way and nobody is looking at where you are heading and whether you need to change course, speed up or slow down.

Whatever the reason, the chronic inability of the business to anticipate the future was a major cause of Marconi's failure. With no early warning of the impending crash the painful truth revealed in the June quarter-end numbers was, from the perspective of company management, sudden and unexpected. It was not just that Marconi's business was weaker than everybody thought, or that the market had collapsed - the management systems relied upon were not up to the job. As a result, investors lost confidence in the ability of its managers to manage.

Swift and decisive action

Whatever you might think about the quality of Cisco's sales forecasts, it is manifestly clear that one of the reasons why it (and its management) survived relatively unscathed was because they spotted the problem sooner than Marconi and took swift and decisive action.

In the world of business today, any company that is not able to forecast (to anticipate and to respond) risks loss of money or opportunity, or in extreme case failure. And this is not just about what you say to the markets. Even Cisco, with its much-vaunted real-time reporting systems, paid a massive $2 billion price for failing to tie operational and financial forecasting together in a sound risk-management framework. Similarly, buried in the wreckage of Marconi accounts for 2001/2 are stock write-offs of £518m, attributed to overoptimistic forecasts made by two of Marconi's two big US acquisitions.

Steve Morlidge and Steve Player are the authors of Future Ready, published by Wiley. www.tinyurl.com/futureready-uk