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Observing companies and identifying the stages of their individual corporate lifecycles can help investors spot some excellent opportunities. Peter Webb goes business-watching

We recently examined how pressures building inside a company can force management’s hand and make a profit warning more likely. A lot of these pressures are generated by the competitive landscape a company faces but other pressures also force a company to react. Contrary to competitive pressures, these are generic and are tied to the way a corporation develops and is managed.

In his book Corporate Life Cycles, Ichak Adizes documents the stages all businesses must pass through and the issues that must be solved.

Spotting where a company is going wrong or right is important, as it can initially confirm your suspicions as to why the current valuation is low. But as well as spotting potential problems it may also present an opportunity to participate if the business turns around.

At the core of any business is management’s ability to solve problems and create new opportunities. This differentiates successful from unsuccessful businesses. A company can suffer declines relative to its own previous standards or those of the competition. Economic reality always seems to dawn later rather than sooner and the initial slide is often gentle and hidden. The general decline can have several causes.

Decline and fall

Denial – Because of its elevated opinion of itself, management cannot accept criticism.

Systemic failure – The organisation is geared to continuity rather than development, which will involve change.

Bureaucracy – The layers of command and control slow down effective reactions.

Complacency – A rich cashflow quashes any sense of urgency.

Conservatism – Dissenting voices are ignored or suppressed by senior managers whose motivation is continuity rather than development and risk-taking.

A good recent example was Marks & Spencer. It hit quite a large bumpy patch before recovering. The post mortem blamed failure on its inability to keep up with fashion on the clothing side of the business. There was a perception among customers that the chain had shifted to providing only moderate quality at high prices. The business model that M&S had used for a long time is one you see in a number of retailers. It designed the product positioning, prescribed the quality, the manufacturing methods and dictated the price and the delivery schedule. Most goods sold were own-brand but produced by third parties.

Seeds of failure in success

The incumbent chairman had begun his reign by forcing through powerful reforms that had produced marked gains in growth and profits. But success in a chief executive can easily reinforce errors. Not only does he become impervious to criticism, he gets less of it anyway. Keeping up with industry changes requires real long-term reform, feedback and risk-taking. This is often difficult to achieve if nobody wants to listen or take risks. Often the short-sightedness of the City can hinder this mode of thinking as well.

Over time, the M&S system had become slow, cumbersome and inefficient. When quality suffered in consequence, that struck to the heart of the business. The well-publicised troubles reported by press and customers were actually symptoms of that decline and not the cause of it as most people had thought.

New broom

The escape for M&S was to replace the chairman and get some new energy and thinking into the business. While this may seem an extreme but common occurrence in the corporate world, a new broom can often sweep away inherited inertia and put things back on the right track. When inertia is removed or evidence of its removal is apparent this often presents an excellent buying opportunity.

Large and small

The corporate lifecycle isn’t only applicable to large companies, small companies also experience it. For small companies, though, the issues can be more critical. Several break points occur on the climb to maturity, and the business needs to move from a situation where it is sales-led and typically in a survival mode to one where it can stand on its own feet and take on a life of its own. Each point on this climb will make or break the company. One advantage large companies have is that they usually have a large cushion of brand equity and cash. When issues occur, larger companies often have the ability to respond where smaller companies, less well funded and more unstable, are unable to bridge that gap to the next level.

By understanding the corporate lifecycle you can spot potential problems but also opportunities. Taking advantage of this cycle in either direction can present excellent opportunities and allow you to choose a better time to buy or sell.