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Why a CEO Needs to Have a Plan B

October 4, 2011

For nearly three decades, in good times and bad, Jack Stack has run his company, SRC, as though disaster could strike at any moment. Now, with the economy cratering, he’s glad he did.

If you think times are tough now, consider that in the early ’80s, the prime interest rate topped 21 percent, and unemployment was just shy of 11 percent. That was the economic environment confronting Jack Stack and 12 other managers of a small engine-remanufacturing plant in Springfield, Missouri, as they prepared to buy the factory from International Harvester in a desperate attempt to save their own jobs and those of the people they worked with. Their new company, Springfield ReManufacturing Corporation, survived that recession and went on to prosper for the next 26 years.

Today, Stack, the company’s CEO, and his colleagues are weathering a recession of similar magnitude. But they find themselves in a far different situation. The enterprise, now called SRC Holdings, is a mini conglomerate of seven holding companies with 26 businesses whose 1,200 employees make automobile engines, irrigation pumps, home furnishings, and more. Its current health is no accident. Having launched the company to save jobs, Stack was determined never to be forced to lay people off. He spoke with editor-at-large Bo Burlingham (with whom he has co-authored two books) about how he has worked to keep that promise to his employees — and build a company that is bucking nearly every current economic trend.

Most American manufacturers are in terrible shape right now. And yet you seem to be doing well. What do you attribute that to?

Paranoia. We’ve always been terrified of being forced to lay people off, and so we’ve spent the past 26 years trying to make sure we would never have to do that.

Where does that paranoia come from?

It goes back to our beginnings. When we started out in February 1983, we were at rock bottom. Everybody was at the bottom in 1983. It was ugly and painful, just like today. We’d bought our factory to save our jobs, but to do it we had to take on a huge amount of debt, $8.9 million, because we had very little money ourselves. Our debt-to-equity ratio was 89:1. Let me tell you, you’re brain-dead in that situation. You’re on life support. We had bank auditors literally camped outside our doors. If we’d had one little slip-up — if we’d been an hour late with a payment — they would have rushed in and closed us down, and 120 people would have been out on the street.

When you go through a period like that, you don’t ever want to do it again. I am sure people who lived through the Great Depression developed some form of trapdoor thinking and contingency planning — whether it was having two or three jobs or investments or just not living outside their means. Anyway, that experience made us realize that a job is never secure. If you let yourself get lulled to sleep, you’re going to get screwed — even if you have what you think is a fail-safe deal.

How do you keep from getting lulled to sleep?

We constantly look for our vulnerabilities. We do forecasting to determine where they are, and then we ask ourselves a lot of what-ifs. What if we’re getting wrong information? What if a market goes down? What if we have a collection problem with a major customer? What if interest rates go through the roof? What if there’s a 9/11? The whole idea is to provide our people with job security and job opportunities. I think it’s led us to go one step further than most companies do. A lot of businesses put up a plan to satisfy their bankers or because they think it’s what you’re supposed to do. But our culture is, “Let’s find out where our weaknesses and vulnerabilities are and then build something to offset them.”

How does that work in practice?

We measure each piece of business by the amount of labor that goes into it. Then we see how concentrated our labor is. When we were starting out in the 1980s, more than 75 percent of our labor hours were in the truck market. We did some investigating and found out that the truck market has a recession every six years. So we had to ask ourselves what we’d do if we had a recession.

And the answer?

We thought about what goes up in a down market, and we discovered that automobile parts go up, because people keep their cars longer and fix them. That’s how we got into the automotive aftermarket business. That kind of thinking became part of our culture and our way of doing business.

So is this all about saving jobs?

No, it’s about creating jobs. That’s our goal. And once you create them, you don’t want to lose them. What we’re doing here is helping people to get through life. I never want to have to take someone else’s livelihood away because of mistakes I’ve made in not anticipating a problem — even if it’s a problem I couldn’t have seen coming. It’s management’s job to anticipate those problems and prepare for them. A layoff is a failure of management. But the people who usually pay for that failure are not the ones responsible for it.

It’s interesting to me that your paranoia actually led you to expand the company in some very ambitious ways.

Absolutely. The contingencies and trapdoors we developed eventually became new businesses. Our values drove our paranoia. Our paranoia drove our contingency planning. And our contingency planning drove our diversification. We knew the more we diversified, the safer we would be. So we spread out of our core competencies. We’ve spun off 55, 56 businesses as a result of this process.

A lot of people would say you took a big risk by getting outside your core competencies. The common wisdom is that you’re supposed to stick to your knitting.

I think that’s really bad advice in most cases. Sure, if we’d stayed in our core competency, we might have been very successful in the truck market. We could have reduced our expenses and increased our margins, but we would have been tremendously vulnerable. We would have had 100 percent of our eggs in one basket.

Certainly, some people have been successful by sticking to their core competencies.

Oh, sure. It’s not too bad a strategy if you plan to sell the business. You build up your earnings and your sales, and then you cash out. But to create something sustainable, you have to be totally paranoid. You have to be realistic that you’re going to get hit with a lot of unknown events. If you diversify, you can handle those unknowns. But it takes a lot of courage to fix a weakness when it’s not immediately painful.

Describe the process that leads to the creation of the new businesses.

It’s centered around our sales meetings, which we hold twice a year — one in June and one in October. We tell people, “Give us your honest-to-God forecast. We’d love to see 15 percent growth. If we get 6 percent or more, that’s OK, but tell us what it would take to get to 15.” Generally, we prefer to grow organically, increasing sales of products we already make and selling to customers and markets we already have. Organic growth is the most profitable kind. Your margins are always better when you grow with something you’re already strong at.

But we want people to have new products and new markets lined up in case they can’t reach their goals organically. Those are the contingencies and trapdoors. Let’s say one company needs 100 people this year and projects it will need 106 people to handle its growth next year. At the sales meeting, its representatives tell us how they plan to do it in terms of product lines, customers, and the marketplace. But they also have to consider that they might be wrong. So we ask them to come to the meeting with an additional 15 percent of sales in what-ifs. What if they can’t cover the 106 people? Because if they’re wrong on the forecast, they’re also wrong on somebody’s life.

And 15 percent is the magic number?

We want at least 15 percent of our projected sales in research and development at all times. The whole idea of the trapdoor is that if something happens, we can rush that new product to market, or we can rush that product we already have to a new customer. We look at a variety of factors. For example, one of our companies makes agricultural machinery, and agriculture tends to be good in the spring and the fall, but there’s a gap in the middle. We asked ourselves, “What sells in the summertime?” The answer: refrigeration units. So we put refrigeration units in there. It was a contingency. We began to develop a lot of contingencies like that, and some of the contingencies ultimately became businesses.

Is that why you’ve done so well despite the current downturn?

Yes. Look at SRC Automotive. It remanufactures automotive and marine engines. Its biggest customers are Mercury Marine and General Motors. Our GM orders fell off a cliff in November. Up to then, we’d been doing 800 to 1,000 engines a month for them. In December, we sold 212 engines. Marine got hit hard, too. It was a tsunami. If we hadn’t had these contingencies and trapdoors, we would have had no option but to lay off 35 percent of the work force and wait until the business came back. We figured that would be at least five or six months.

I take it that’s not what you did.

Fortunately, we didn’t have to. We were able to move some of the people into our other companies that needed the extra manpower and had jobs they could do. We also found a Missouri program that helped us out. Instead of laying people off, we put them on a four-day workweek, and they collect unemployment for the days they aren’t working. On their days off, they wind up with about $10 less than what they’d been making, but that’s a loss they can handle. Meanwhile, we bought time to execute our contingencies.

What did you do?

One of automotive’s contingencies was to build natural-gas pumping units. They’d been looking at that opportunity for a year or more. When the cuts came, they went after the business. They also had their eye on remanufacturing engines for the postal service. So by February, automotive was back to a five-day workweek. March was a full month as well. In three months, they repositioned the company. And now, if their two main customers come back to normal levels, they’ll be stronger than ever. In fact, they’ll have to start hiring people.

That’s impressive.

But understand, there’s no way to develop new markets and new customers if you lay people off. How are they going to do natural-gas pumps or the post-office business if they’ve gotten rid of the people who do the work?

Is this the process you use in all the companies?

More or less. Our program is the four Ps: people, profits, positive cash flow, and positioning. We’re saying to ourselves, “Look, we got this far by creating jobs. We’ve done all this to build the type of culture we want — a culture that puts people at the center. What are we going to do to keep it? How much are we willing to invest in keeping it?” I’m willing to give up profits if the losses go to repositioning the company, so that when we come out of this thing, we’re stronger than when we went in.

We had two months when we lost $200,000 while we were executing the contingencies and moving people around to keep them employed. But that’s money we were going to lose anyway, and we were able to keep our cash flow positive by dropping our inventories. When you sell finished goods that were in inventory or when you don’t buy as many parts to put in inventory, you have more cash. Of course, it doesn’t hurt that we have so much cash in the bank — enough to carry us for three or four years.

Where did that come from?

That was the result of another contingency. A little more than 10 years ago, we started a joint venture with John Deere to remanufacture diesel engines for its agricultural and construction equipment divisions. We’d been looking at Deere for a while as a potential way to diversify SRC Heavy Duty. That particular contingency turned into a business fairly quickly. We became 50-50 partners with Deere in the joint venture, which we called ReGen Technologies, and we each had an option to buy the other out according to a formula we agreed upon in advance. Last year, we mutually decided that the time had come for us to exercise the option and sell our interest in ReGen to Deere. This was several months before the financial crisis. The deal closed at the beginning of November and put all that cash on our balance sheet. Suddenly, we looked like the smartest guys in the world.

You have been thinking this way for decades. What do you say to people in small companies who are scared that they are not going to be able to make it through this recession?

Well, it’s not so much what I would say as what I would ask. I’d ask, “How productive is your team? Are you leveraging the mental capacity of everybody in your organization?” Nine times out of 10, when I go into those small organizations you’re asking me about, I find CEOs who have taken all the responsibility upon themselves. They’re freaked out, because they believe they have to come up with all the answers. But that’s what leads to failure, especially in this type of economic environment. People just don’t understand that you do not have to take all the problems on yourself. Nobody is smart enough to take on a crisis like this one all alone. But people have been taught that it’s the job of a CEO to have the answers.

What should CEOs be thinking about if they want to emerge from the crisis stronger than when it began?

If your sales are down and you’re losing money, you’re crazy not to be investing in repositioning. You have underutilized capacity. People are standing around. Don’t lay them off. Have them come up with new products, new ideas, new services, new ways of doing things. Maybe you find something new to do with your underutilized capacity. Maybe you can change your products or go into different markets. That’s how we got into making engines for pumping natural gas. Our automotive people were building engines for cars. Someone noticed that they could be refitted for other uses. Natural-gas pumping equipment looked promising, given the stricter emissions standards in California. They did the research, made some adjustments, built a prototype, worked out the quality procedures, and found customers. Each step required an investment. In a down period, while you may not have cash to invest, you do have excess people capacity. Most companies reduce it by having a layoff. That’s what I call cutting to the bone. You wind up weaker as a result.

SRC is an employee-owned business. How important was employee ownership to doing all this?

That’s a great question, but it’s probably a question that has to be answered by the employee owners, not me. Personally, I don’t think we could ever have come this far if I owned 100 percent of the company. I know myself; I couldn’t have handled all that wealth. I would have felt guilty. That’s not the person I am and not the person I want to be. I just believed from the very beginning that the employees create the value.

You have often spoken about what you call the company’s contingent liability to its employee owners. Eventually, they will want to cash in their stock, and the company will have to come up with the cash to pay them. Your awareness of that contingent liability has driven a lot of the innovation, hasn’t it?

I think that is the best-kept secret of running a successful company. Knowing we have to cover the contingent liabilities pushed us to find answers. If your company is publicly owned, you don’t have that pressure, because there’s a market for the stock. When you’re privately owned, you definitely work in a different world.

Is that true only of employee-owned companies?

No, I think it applies to a lot of privately held companies, especially ones owned by families. It’s different in companies founded by people who’ve already decided they’re going to run it for five years and sell it. Granted, a lot of people tell themselves, “When push comes to shove, I can always sell the company.” They don’t think about how they’re going to feel when they find out their employees don’t want them to sell. You design a culture where people work 40 hours a week, make friends, raise kids, become members of a community. It’s very hard to let go of it. But if you want to keep it, you have to be willing to ask yourself, “What are our vulnerabilities, and how can we address them?” I will say this: We did not walk away from that question. Our people had the courage to come up with answers. That was the beginning of creating the subsidiaries, which became our vehicles for innovation. They brought out the entrepreneurship in us. And we still have some trapdoors left that we haven’t used.

What do you mean?

Well, 20 years ago, we bought a big piece of property here in Springfield for $250,000. Its value increased to about $4 million, but it’s still on our books at the purchase price. We could sell it if we needed cash. We also helped start a bank that eventually was sold. The stock is on our books at less than $500,000, but it’s worth $3.4 million.

Is there a downside to paranoia? Some people might say you miss opportunities if you are always worrying that something could come along and whack you.

I’d say you’re a fool if you know you’re going to get whacked and don’t do something about it.

You actually enjoy working in an environment like this one, don’t you? I can hear it in your voice.

I think that it’s really, really hard to win with a lead. I like coming from behind. And we’re all coming from behind right now. An economy like this one creates opportunities. You bring in something new, but you don’t let go of what you had before. When the economy comes back, you get a twofer. In the long run, it creates more jobs and more security.

Why do you prefer coming from behind? Is it the challenge?

I think there’s a sense of satisfaction when, regardless of how bleak the situation is, you find people succeeding. It gives you inspiration to see them going the extra mile. It gives you hope. In order to be courageous, you need to see things happening that generate hope. There’s a lot of bad things going on, and we’re totally influenced by the media, which tell us all about them. It’s great to see people fighting back.

Bo Burlingham

Burlingham joined Inc. in 1983. An editor at large, he is the author of Small Giants: Companies That Choose to Be Great Instead of Big. The book was a finalist for the Financial Times/Goldman Sachs Business Book of the Year Award in 2006. Burlingham is also the co-author with Norm Brodsky of The Knack; and the co-author with Jack Stack of The Great Game of Business and A Stake in the Outcome.

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