A Tale Of Three Breakdowns

A horse breeder, a pharmaceutical giant, and a automaker each offer lessons on damaged brand reputation.

By Bob Vanourek and Gregg Vanourek

Today we see too many leadership failures, too many leadership breakdowns and scandals. We need leadership that can build excellent, ethical, and enduring organizations. We need triple crown leadership.

Personal leadership is necessary but not sufficient in avoiding organizational breakdowns. In today’s volatile global environment, such organizational breakdowns are fairly common. Sometimes a breakdown is a quiet affair with an orderly dissolution of assets. Other times it is a seismic crash with embarrassing headlines, prison sentences, and painful ripple effects. Sometimes an organization rises to the top of its industry and then slowly falls back in the field.
In any list of great organizations, some are likely to descend from great to grim. Witness the success studies cited over the years, with Atari and Wang on the In Search of Excellence list and with Fannie Mae and Circuit City on the Good to Great list—all since humbled or bankrupted. Witness the demise of financial stars such as MF Global (where did that billion dollars of customer funds go?), Galleon Group (the hedge fund whose CEO, Raj Rajaratnam, was convicted of insider trading), AIG, and Lehman Brothers. Even the vaunted Goldman Sachs has attracted recent criticism, as has its former director Raj Gupta, who was linked to the Galleon scandal.

General Electric, founded in 1892, has long been an exemplar company, admired for its financial performance, its leadership development, and its large and influential “Ecomagination” sustainability initiatives. Yet during the past 10 years, GE’s stock performance has been lagging, trading at half its 2002 level in 2011; and its return on assets has lagged far behind that of its peer group. A large, diverse company operating in competitive fields in many challenging countries, GE has focused on excellence and ethics, as Ben Heineman, Jr., relates in High Performance with High Integrity. But in recent years, GE has not achieved excellent financial results.

Of course, breakdowns are not limited to the commercial sector. According to Princeton University president Shirley Tilghman, “In the early 1980s, Princeton had arguably the best biochemistry department in the world, just stunningly good. But within five years, 90 percent of the faculty in the department had left the university. Excellence is fragile. We should never take it for granted. We should be constantly vigilant in making sure that something that is really good doesn’t lose its edge . . . It required a $35 million investment to re-create that department. Luckily, it succeeded, but it is an example of how quickly something can get lost.”

Even as we aim high, we cannot achieve perfection. Over the course of their racing careers, the Triple Crown–winning thoroughbreds won less than two-thirds of the time. Many were scratched from races when they were not 100 percent healthy or the track conditions were not favorable to their style.

Like Ruffian, the filly Zenyatta had long limbs and sculpted muscles. She won a record-breaking 19 consecutive starts. Between 2008 and 2010, her purses exceeded $7 million, making her the all-time North American female money earner. In 2009, she was runner-up to Serena Williams for the Associated Press Female Athlete of the Year. In 2010, she was American Horse of the Year. Yet in her final race, she had an off day and fell almost eight lengths behind. She surged in the final stretch but lost by a nose. Peak performance is impossible to sustain permanently. All organizations stumble. The question is how they respond.

By examining the breakdowns at three heralded organizations, Calumet Farm, Johnson & Johnson, and Toyota, we can extract lessons about how to avoid breakdowns and how to respond if they occur.

Calumet Farm
Calumet Farm was at the pinnacle of thoroughbred horseracing for six decades. With more than 700 pastoral, bluegrass acres in Lexington, Kentucky, the stable had a track record that was astonishing: nine Calumet steeds ranked among the top hundred racehorses of the twentieth century. Calumet owned eight Kentucky Derby winners and seven Preakness winners, and it won six Eclipse (horse of the year) Awards, the most of any stable. Two Calumet thorough- breds, Whirlaway and Citation, won the Triple Crown. Citation was the third-ranked horse of the century.

Calumet had 11 hall of fame horses and was the number one money-earning stable for 12 years, boasting renowned trainers and jockeys. In 1978, Calumet’s star thoroughbred, Alydar, capped a stellar career with 24 finishes in the money (first, second, or third) out of 26 starts. In 1982, the stable had $93 million in assets and earned $1.8 million in profits with no debt. Calumet Farm was the epitome of racing excellence. No other stable came close.

Then everything collapsed. Ann Hagedorn Auerbach documents Calumet’s problems in her riveting book, Wild Ride. Under new leadership, the stable made dramatic changes. After deaths in the family that owned Calumet Farm, a bank held a majority of the voting stock in a trust, but the new leaders arranged to control the board’s executive committee. The bank requested a “hold harmless agreement” to avoid liability for future losses. It was among many documents that family members say they signed without full understanding.

The new CEO terminated most of the longtime staff, including exceptional managers and trainers, and the CEO-controlled executive committee authorized him to borrow $10 million on Calumet’s behalf. Not long after, the farm had a corporate jet and swimming pools for injured horses on site. Calumet paid $25 million for half the ownership rights in a racehorse named Secreto. When the value of these investments tanked in the “bluegrass bubble” (a rush by investors to own a piece of a thoroughbred horse), the CEO borrowed even more aggressively through a cozy relationship with another bank, whose officer was later convicted of criminal charges.

Soon Calumet’s debt had soared to $44 million, and the farm was under tremendous financial strain. Mysteriously, its star horse, Alydar, suffered a leg fracture in his stall and was euthanized. Suspicions swirled around the horse’s injury, with allegations that Calumet officials killed the horse to cash in on his $36.5 million insurance policy.
Finally, with debt exceeding $162 million, the legendary stable filed for bankruptcy in 1991, auctioning off the remaining thoroughbreds and real estate. In 2000, the former CEO and CFO were convicted of fraud and bribery. The dynasty that reigned supreme with incredible accomplishments and an impeccable reputation for integrity was in tatters. Ironically, Calumet’s leading horse at its demise was named Criminal Type.

The fall of Calumet Farm is a modern-day Greek tragedy with numerous culprits, from the CEO and CFO to the board and bank, all seemingly derelict in or oblivious to their fiduciary responsibilities.

The rise to the top can take decades, but without a commitment to build an excellent, ethical, and enduring organization, the fall can be precipitous.

Calumet’s new owners were clueless about the triple crown quest. The family owners failed to set up the plans and safeguards to protect and sustain what they had built. Consequently, a greedy executive and his associates wrested control of Calumet and bamboozled the owners into abdicating their fiduciary obligations. Calumet’s owners were snoozing at the board table and did not act in the face of increasingly egregious abuses. Most puzzling is the behavior of officials at the bank that held the family trust. How could they let a cabal of insiders wrest control of the enterprise and run it into the ground?

Calumet’s demise contains an important lesson: triple crown status can be fleeting. The quest requires courage and vigilance. Leaders must not outsource or farm out the triple crown quest to unqualified people, and they cannot always trust third parties like banks or law firms to do what is right. The board that delegates the triple crown quest abdicates it. Triple crown leadership requires stewardship at all levels.

Johnson & Johnson
In 1982, Johnson & Johnson set the gold standard for crisis management. Someone had laced Tylenol bottles in the Chicago area with poison, causing the death of seven people. The company, under the leadership of then-CEO Jim Burke, quickly instituted a recall, not just in the greater Chicago area or even the Midwest, but nationwide, encompassing all 31 million Tylenol bottles in the marketplace. The recall cost $100 million but established J&J as a trustworthy and ethical business.

J&J’s actions were based on its 1943 credo—written by Chairman Robert Wood Johnson, a member of the company’s founding family. The credo outlines J&J’s responsibilities in order of importance: first to customers (doctors, nurses, patients, mothers, and fathers), next to employees, then to the communities in which they live and work (including the world community), and finally to their stockholders.

Fast forward to today: J&J appeared on the cover of Bloomberg Businessweek in 2011, with two Band-Aids over the J&J logo in a story titled “Ouch!”—asking if J&J can still be trusted after more than 50 recalls in 15 months.
Ouch, indeed. Here is a partial list of recent challenges facing the company:

• Recalls of Tylenol, Motrin, Rolaids, Benadryl, children’s
medications, artificial hips, heart medications, and more;

• Takeovers of three J&J manufacturing plants by U.S.
regulators and closure of another;

• Thousands of lawsuits filed against the company;

• Criticism about a deceptive “phantom recall” of Motrin;

• A suit for wrongful termination by a former vice president,
alleging he was dismissed for raising safety concerns;

• $70 million to settle cases involving the Foreign Corrupt
Practices Act, with allegations of paying kickbacks to secure business; and
• Allegations of marketing drugs for unapproved uses
and overstating benefits.

“This is a real American tragedy,” said University of Michigan professor Erik Gordon. “They really have blown one of the great brands.” According to Bloomberg Businessweek, the firm’s shares have been the third-worst performers in the Dow Jones Industrial Average since March 2009 and fell nearly 9 percent between 2010 and 2011 while the S&P 500 Health Care Index was rising.10

What happened? Observers have speculated widely on possible reasons:

• Sacrificing quality and safety in pursuit of short-term stock gains driven by growth, following an aggressive series of acquisitions;

• Overly aggressive cost cutting, with operating margins rising from 17.7 percent in 1990 to 26.8 percent in 2010, an astonishing increase;

• Too much decentralization in a company with 120 manufacturing facilities;

• Deterioration of manufacturing procedures, including mislabeling and inadequate inspections and cleaning and maintenance practices; and
• Subpar training.William Weldon (who stepped down as CEO in 2012 but remains chairman) said that the criticism is overblown and that the main problems concern one company, J&J’s McNeil Consumer Healthcare unit. Nonetheless, the company had more than twice as many major product recalls as Pfizer, the world’s largest healthcare products company. Veteran industry analyst Ira Loss said, “I’m not familiar with another company that has had this many debacles in a very short period of time.”

Using our triple crown leadership practices, where might J&J have gone off track?
• Where was the steel leadership to demand adherence to the credo? Has the credo been gathering dust?
• Does J&J recruit and promote for integrity and fit with the credo culture, as well as competence?
• Are the board, CEO, and officers serving as stewards
and making defensible decisions about short- versus long-term tradeoffs?
• Is the company, with its sprawling network of manufacturing facilities, aligned?
• Are management goals and metrics too financially oriented, without sufficient attention to ethical practices?
• Are the firm’s processes, such as quality control, compliance, and ethics, sufficiently rigorous?
• Are the communication loops robust enough for leaders to know about and take action on issues?

The healthcare industry is fraught with peril.

Mistakes happen; people die; lawsuits and adverse publicity result. But the company’s recent track record is unacceptable. J&J, an enduring institution founded in 1886, once an iconic example of triple crown leadership, has lost its stature.

Dr. Dan Sweeney, director of the Institute for Enterprise Excellence at the University of Denver, told us: “My suspicion is the credo culture didn’t get moved across new generations of executives.” It appears that J&J leaders put revenue growth and earnings ahead of doing the right thing, and they failed to find a sustainable balance between short-term performance pressures and long-term ethics, reputation, and investment considerations. Based on their public statements, some company leaders seem to be in denial about that imbalance.

The lesson of J&J’s breakdown is that when one of the three Es (in this case, “excellent”) dominates, the odds of a fall increase dramatically, regardless of prior reputation or performance.

Toyota
In 2010, Toyota Motor Corporation became the world’s largest automaker (by production), an extraordinary accomplishment for a company that was fourth largest in 1970. The company had built a stellar reputation for quality and long-running financial success in the brutally competitive auto industry. Its share price surged from around $50 in 2002 to more than $130 in early 2007.

Ultimately, something happened on the way to the top. As early as 2002, there were concerns about Toyota’s quality. In 2005, the company had more vehicles recalled than sold, according to a high-ranking official. Toyota’s legendary quality was slipping.

By August 28, 2009, it had slipped too far. At 6:35 p.m., a California 911 operator received an emergency call from a man in a Lexus (a Toyota brand) on Highway 125 near San Diego: “Our accelerator is stuck . . . we’re in trouble . . . there’s no brakes . . . we’re approaching the intersection…hold on…hold on and pray…pray…”
The driver was an off-duty officer in the California Highway Patrol. He died in the crash, along with his wife, daughter, and brother-in-law. The incident brought widespread attention to thousands of complaints about unintended speed control issues.

Ultimately, a National Highway Traffic Safety Administration report, written in conjunction with NASA engineers, pointed to driver error, “sticking” accelerators, and a design flaw that allowed accelerators to become trapped in floor mats, but no electronic flaws. Meanwhile, millions of recalls for quality and safety concerns badly damaged the company’s reputation and financial performance.

The company’s market capitalization fell more than 40 percent from its 2006 value. In 2011, the company dropped out of Interbrand’s annual list of the top 10 global brands. What happened?

To understand the breakdown, we need to start with what got Toyota to the top. For decades, Toyota had been synonymous with quality. The “Toyota Way” of operating, developed and refined over 75 years, draws upon two pillars: respect for people and continuous improvement. It also emphasizes continuously solving the root causes of problems and focuses on organizational learning, people development, and long-term thinking.

The Toyota system of just-in-time production and lean manufacturing has been widely hailed and emulated. Toyota’s guiding principles emphasize clean and safe products. Its corporate culture embraces creativity, teamwork, harmony, integrity, mutual trust, and responsibility.

Corporate training programs seek to educate people in the Toyota culture and traditions. Company leaders emphasize employee health and safety, and they offer fitness and work-life balance programs to employees.
Toyota uses an extensive consensus-building process to refine new ideas and debug products. The company has for a long time used the famous “andon cord,” which employees can pull to stop the production line if they suspect a problem.

Toyota has embraced sustainability, earning Interbrand’s top global green brand ranking in 2011. The company subscribes to the Global Earth Charter and spent large sums to develop some of the first hybrid vehicles before there was a proven market for them.

There is much to admire in these practices. However, as Jim Lentz, president of Toyota Motor Sales USA, told us, “Sometimes your greatest strength can become your greatest challenge. In our case, we knew we had great quality, so perhaps we didn’t spend enough time and attention continuing to improve it.”

We also spoke to Toyota critics. Many feel the company was not responsive to their concerns or sufficiently focused on safety. Something had changed. Observers have speculated widely on the causes of the problems, including:
• Overemphasis on becoming the world’s number one automaker;

• Too much cost cutting to boost profitability;

• Engineers insulated from marketplace feedback;

• Overly centralized decision-making with functional silos that create barriers;

• Reluctance to report bad news up the chain of command; and
• Legal and financial concerns about taking responsibility and admitting liability.
• A board composed entirely of Japanese men, none of them independent, all company insiders.

Ultimately, the company recalled about nine million vehicles. Toyota halted production for a week to divert parts to repair the cars of customers already on the road. In one case, federal safety regulators rebuked the firm for issuing an “inaccurate and misleading” statement.

Akio Toyoda, who took over as president and CEO in late 2009, publicly assumed responsibility for the company’s actions. Testifying before the U.S. Congress, he said:

Toyota has, for the past few years, been expanding its business rapidly. Quite frankly, I fear the pace at which we have grown may have been too quick. I would like to point out here that Toyota’s priority has traditionally been the following: First: Safety, Second: Quality, and Third: Volume. These priorities became confused, and we were not able to stop, think, and make improvements as much as we were able to before . . . We pursued growth over the speed at which we were able to develop our people and our organization… I regret that this has resulted in the safety issues described in the recalls we face today, and I am deeply sorry for any accidents that Toyota drivers have experienced.”

This public testimony, acknowledging responsibility and apologizing, is an important part of Toyota’s quest to get
back on track.

Toyota suffered great damage from these events.
Where did it go off track?
• After decades of spectacular success, did it take its reputation for quality for granted?
• Did the company focus too much on short-term financial performance driven by growth?
• Was the board too insulated and deferential to company leaders?
• Where were the steel leadership and ethical fortitude to demand that employees raise and address suspected safety problems?
• Where were the stewards who would pull the andon cord on violations of Toyota’s culture of character?
• Were insufficient processes in place to ensure safety and quality?
• Were communication loops missing, thus preventing quality alerts from reaching the right people?

Today, Toyota is making progress in getting back on track. According to Lentz, the company has:
• Assigned a thousand engineers to work on component design and quality before parts go into vehicles;

• Appointed a chief quality officer and chief safety officer for North America;

• Developed “swift market analysis and response teams” to conduct onsite inspections of vehicles of concern;

• Established six product quality field offices to support resolution of complaints;

• Enhanced its computer system to mine more sources, including customer complaints, government data, and warranty claims
• Become the first full-line automaker to offer a package of six key accident avoidance technologies as standard equipment on every new vehicle.
Toyota made the same mistake as J&J: letting one of the three Es dominate the others. The quest to be number one in volume (excellent results in the short term) trumped safety and quality concerns (the ethical and enduring imperatives). Dr. Sweeney at the Institute for Enterprise Ethics told us, “The new generation was quite taken by the prospect of being the world’s largest automobile company. They were going to get bigger than General Motors, and they did.”

Fortunately, Toyota leaders do not appear to be in denial. They admitted their mistakes and appear to be correcting them. Only time will tell what happens with Toyota’s quest. In the wake of the devastating earthquake and tsunami in Japan in 2011, Toyota managed to rebuild one of the most complex supply chains in the world in about ninety days. Clearly, Toyota has tremendous capabilities.

Recovering From a Breakdown
Organizations do not break down before emitting warning signs. Normally, the financial signals, such as revenue declines, shrinking margins, slowing inventory turns, and deteriorating working capital ratios, are lagging indicators. Leading indicators are more important because leaders can address them before the financials go south.
All organizations suffer breakdowns at some level or at some time. The only question is how they respond when hit. The easy way out? Doing whatever it takes to make your numbers?

We have seen that people can perform extraordinary accomplishments. The late Steve Jobs of Apple was far from perfect as a leader, in our view, but he often refused to accept that something could not be done. “Leadership,” he once said, “is about inspiring people to do things they never thought they could.” The examples are legion, from insisting on “insanely great” products again and again to convincing the CEO of Corning Glass that Corning’s especially strong “gorilla glass” could be manufactured in the vast quantities needed for the iPhone.

Triple crown leadership sometimes entails constructively challenging people to do what they think is impossible. Often they produce astonishing results.

When the challenge is to make the numbers in the short and long term, and to do it ethically, while operating sustainably and honoring obligations to all stakeholders, that is when people really dig in and find the best way, a new way, and refuse to settle for the easy way out. We agree with Cory Booker, the dynamic mayor of Newark, New Jersey, who said, “You can’t surrender to the options before you. There’s always another way.”

As you encounter the initial signs of breakdown, you will need courage to face up to the obstacles and face down the critics. Whoever said, “don’t listen to your critics” was wrong. Your critics can give you important insights into what you may be missing. Listen to them. Engage with them. Then do what you think is right. While you cannot avoid breakdowns, the real issue is how you respond to them, becoming stronger in the broken places, as Hemingway said.

Practical Applications
Does your organization have a rock-solid commitment to being excellent, ethical, and enduring?
Does one of these considerations dominate the others?
a. What should you do to restore a proper balance
To what extent is your organization infused with triple crown leadership? a. How can you infuse it further?
Do you see signs of potential breakdown in your organization? What are they?
To what extent dows your organization have culture that welcomes raising concerns?
Are you prepared to raise alarms before things go awry? How and when?
If your organization is hopeless when it comes to excellent, ethical, and enduring performance and impact, should you find another place to work?

Excerpted with permission from Triple Crown Leadership, ©2012, McGraw-Hill Professional.

Posted May 10, 2013 in Corporate Governance