When a big business goes belly-up, there’s always a reason for the failure. Sometimes, a good business has simply got left behind, as more innovative companies steal its markets; sometimes businesses go actively bad, chasing higher profits but at much higher risks. Whatever the reason for a corporate bankruptcy, there’s usually a lesson to be learned from it.
Enron went spectacularly bankrupt in 2001. A prime example of corporate greed, it had moved from its original energy markets into derivatives and futures markets of mind-boggling complexity – so complex that even the finance director possibly didn’t understand what risks the traders were really running. Energy companies regularly use the futures markets to fix their prices for future production, so it probably seemed a smart move to add a little margin by trading the markets on their own account. It wasn’t. The lesson? If you don’t understand it, don’t do it!
Once a gorilla, Blockbuster became a dinosaur, and like the dinosaurs ended up extinct, declaring bankruptcy in 2010. Blockbuster practically controlled the video rental market, and had grown huge while independent video stores closed down or sold out. But there was new competition coming from streaming video and online downloads, and Blockbuster hadn’t responded to it. So Netflix nibbled away its market and left it with a huge cost base and not enough customers. (Ironically, Blockbuster had once had a chance to buy Netflix, and turned it down.) When Blockbuster got around to trying to stream video itself, it was too late. The lesson? Make sure you keep up with what’s changing in your markets, and never overlook – or underestimate – new competition.
Northern Rock was a UK building society that saw a wide-open gap in the lending market, and concentrated on exploiting it in order to grow its market share rapidly. So far, so good. That’s the kind of strategy that can take a small company up the rankings very quickly indeed. Unfortunately the gap was lower credit score, higher risk mortgage lending, and Northern Rock expanded too quickly into that market. It also depended on customer deposits for its funding, and didn’t have enough long term, wholesale finance to withstand a ‘run on the bank’. Cue the 2007 credit crunch, and queues of customers wanting to take out their money, and Northern Rock had nowhere to run. The lesson? Stress test your business model, and make sure your funding matches your liabilities. (Maybe they should have got in touch with CMC Markets to see which way the market was headed!)
Webvan was one of the biggest busts of the first dot com rout. It raised $800m to revolutionise the grocery market by enabling customers to order online. It spent it on massive infrastructure, complex software, and quick rollout to 26 cities – getting big very quickly indeed. And it blew it. While successful dotcoms were picking their targets carefully, Webvan took on the entire supermarket business – which is very mature, has huge amounts of assets, and is very well funded – and believed it could win. The lesson? Be realistic about your markets and plan your infrastructure spending carefully to match. Go for a high margin segment that you can service at relatively low capital cost instead of spending millions on a high dice roll.
Sometimes it’s people rather than companies which go bad. Once upon a time Bernie Madoff was an honest broker. He pretty much built NASDAQ from scratch to compete with the New York Stock Exchange. His status as a well regarded and well liked man on Wall Street was a key factor in enabling him to put together a ponzi scheme and scam hundreds of customers. He may have started simply ‘borrowing’ money from successful clients to tide him over a few hard weeks, but eventually he was taking more and more from new client investments to pay off those who were leaving. His talk about options strategies and derivatives made customers think he had some kind of high-tech magic – in fact, the numbers didn’t add up, and a few keen number-crunchers saved their investment clients a lot of money when Madoff hit the skids. The lesson? If you don’t understand an investment that someone’s trying to sell you, do your own research.