Zombie Companies– Barely Alive, Living Corpse, Walking Dead: Clinging-Financially Undead, Waiting For Creative Destruction…

Zombie companies… it’s inevitable and necessary to allow the failure of some non-competitive companies, so as to release the capital and labor for more promising companies ~Winnie Wu

Zombie companies are neither dead or alive… they have so much debt that any cash generated is used to pay off the interest on the debt… there is no spare cash or capacity for the company to invest or grow…  Zombie company is a media term for a company that needs constant bailouts in order to operate, or indebted company that is able to repay the interest on its debts but not reduce its debts…

The term can be traced to Edward Kane and his analysis of the insolvency of U.S. ‘savings and loans’ in 1980s, and Japanese banks in early 1990s. Zombie firms are loss-making and have little hope of improvement in near future. Therefore, they depend on banks-other investors to grant them continuous loans to survive, effectively putting them on never-ending life support…

According to R3; there are 146,000 zombie businesses teetering on the edge of solvency… they are only able to pay the interest on their debts but not tackle payments around the debt itself… R3 identifies three defining features of a zombie company; having to negotiate payment terms with suppliers; struggling to pay debts; facing the probability that if interest rates rise, they will be unable to service debts at all…

According to Richael O’Brien; while allowing businesses to fail may not be a popular choice, it is becoming increasingly evident that it’s vital for overall economic growth. It can be easy to think in short-term when faced with the economic problems, but allowing progressively weaker business models to stack up will ultimately stall economic growth in the longer term. There is a lot to be learned from the Japanese and other similar experiences over zombie companies… As long as economic capital is tied up in struggling companies, the playing field is not level for emerging businesses…

According to Hugh Pym; the rise of so-called zombie companies is, to some extent, a consequence of the current record low-interest rates… And, according to some experts around a third of UK companies– approaching 50,000– could be doomed to failure if interest rates go up. According to Christine Elliott; urgent attention is needed to avoid multiple failures and tens of thousands of job losses.

According to Jon Moulton; more companies should be allowed to fail to overcome the economic downturn… Zombie companies is not a phrase that bankers and regulators like to use. Most shy away from the idea-prefer to talk in the usual jargon, like ‘forbearance’ and ‘provisions’. But there is no doubt that the dead hand of the zombie is casting a shadow over the economy…

In the article The Rise of the Zombie Companies by financialtimes writes: Europe is in midst of a zombie company revolution, where thousands of firms that should have folded due to colossal debts, are clinging on to solvency… Zombie companies are being blamed for Europe’s weak recovery, triggering fear that it may echo Japan in 1990s, where low-interest rates, loose government policy, big banks reluctance to foreclose unprofitable companies, caused decades of weak growth. According to Alan Bloom; the basic tenet of capitalism is that some bad companies need to fail to make way for new and better ones, is being rewritten. Many European companies are just declining slowly and have an urgent need for new management, revised capital structure, or at worst allowed to fail.

According to Bank of England; some companies were able to remain in operation during recession [as result of government and central bank action], and might have hindered reallocation of capital towards more productive sectors. In U.S., ‘creative destruction’ is more in play; there are increases in insolvency rates since the crisis. But far less in Europe, where policy makers are focused on protecting jobs than on boosting efficiency. Europe is like a forest floor that is being clogged with weeds, choking off nutrients-light to saplings with a chance of becoming trees. What Europe needs is fire to clear undergrowth.

In the article Zombie Companies by Ian Stewart writes: Some commentators suggest that the UK economy is being held back by so-called zombie companies. These are weak companies that only survive thanks to low-interest rates and more tolerant attitude to corporate borrowers on part of banks-investors. The argument runs– that if zombie companies are allowed to fail, then more productive businesses would fill the gap, leading to more efficient allocation of resources. To advocates this sort of ‘creative destruction’ makes way for stronger businesses of the future…

However, it’s impossible to prove weaker companies are holding back recovery. But some data are consistent with this theory. For example, despite a deep downturn– corporate insolvency have remained remarkably low in recent years. Roughly a third of UK companies is now making loss, and at higher rate than economy experienced in the 1990s recession. UK productivity growth has also been weak, something which might in part, be explained by the poor performance of zombie companies.

The idea of zombie companies is not new: Economists of ‘Austrian School’ champion the notion that recessions clear out unproductive capacity and create space for more efficient companies. Joseph Schumpeter’s coined the phrase ‘creative destruction’ to describe this process… The failure of Japanese banks to foreclose on highly indebted and  unprofitable firms in late 1980s recession is seen by some as contributing to two decades of weak growth.

The central problem with the zombie company’s argument is the difficult to distinguish between unviable businesses and those that, if nursed through a downturn, would have a bright future. The main weapon to counter the financial crisis and recession has been low-interest rates… it may be that one result of current ultra low levels of interest rates, in fact, is that some unviable companies are able to survive for a longer period. Yet this does not prove that low-interest rates or forbearance on the part of banks is an inappropriate response to the crisis.

According to Spencer Dale; the whole point of monetary loosing is to keep companies that have a viable long-term future in business while demand is temporarily weak… The willingness of banks to nurse companies through tough times is predicated on a view that business has a long-term future. More generally, all economic policies that aim to bolster demand have unavoidable-unwanted side effects: For example; low-interest, ‘quantitative easing’ rates hit savers… Increasing government spending adds to the debt burden faced by future generations…

Killing off zombie companies by raising interest rates could have huge, unwanted side effects, e.g., raising debt servicing costs for consumers-business, hitting confidence-depressing demand. Some experts predict that one percentage rise in interest rates could depress GDP up to 0.35%. This as a potential medicinal cure can risk killing the patient. The aim of the current macro-economic policy is to sustain business through this difficult period. The hope is, in time, many of zombie companies will be able to ‘rise from the dead’…

In the article How to Spot Zombie Company by Sydney Finkelstein writes: Nearly every company studied in our ‘failure’ research was glorified as ‘number one’ in some category and made this status part of their self-image. Almost all of them trumpeted their front-runner status in company slogans, displays, PR… For example; Enron had a sign inside its corporate entrance that read: The world’s best energy company. Later, this sign was changed to read: The world’s best company. Nice.

The problem is that when a company makes being ‘number one’ part of its self-image, the behavior that made the company ‘number one’ starts to change. The consequences of this inward maintenance of status can be seen almost immediately in the way employees of the company begin to treat others from outside the company. They are polite but condescending; since they believe they don’t have to listen to others, because they already know better.

Many executives of failed companies were not only arrogant, but they were proud of it… Another sign of a zombie company is when it has unwavering vision of what it’s doing and this vision takes on a momentum of its own… then, after a while, the company will tend to do things not because they make any business sense, but because they carry out the vision.

The extreme form of this irrational sense of mission is the strategy that could be called; ‘if-we-build-it-they-will-come’. The single worst aspect of this excessive loyalty is that it prevents companies from hearing what their customers are trying to tell them; they don’t just claim; we know what our customers want. They go further, claiming in effect; we know what our customers want better than they do, because we know what’s best for them, and eventually they’ll see it too…

Now, astute readers may ask, doesn’t Apple do this too? Well, if you want to create a successful strategy, following Apple’s strategy, in the Steve Jobs era, is like professional basketball teams selecting Ivy League players, at the top of the draft, because of Jeremy Lin. Wild exceptions do not make the rule folks…

The term zombie company is metaphor to describe companies that are merely treading water until a trigger, such as an increase in interest rates, pushes them into insolvency. It can be argued that this stagnation ties up capital that could be used for other healthier businesses and indeed these zombie businesses risk dragging healthy companies into decline…

According to Ernst & Young; financial crisis had created an environment where it’s ‘too difficult to fail’, with businesses being kept afloat to detriment of the broader economy… According to Alan Bloom; everything is becoming complicated and making insolvency difficult option…. It means that businesses which probably should fail, don’t fail. In a capitalist economy you get winners and losers…

According to Sarah O’Connor and Brian Groom; companies with broken business models should be allowed to fail, so that their resources and workers can then ‘flow’ into new-expanding companies that are better able to drive economic growth. However, according to Richard Barwell; real world is messier than the world of macro-economic models. Workers do not always ‘flow’ effortlessly into new and more productive jobs, especially when the economy is weak. However, in the long run we do probably need capital, and more importantly human capital, to be released from inefficient firms to more efficient ones…

According to Lauren Lyster; in the life cycle of capitalistic boom-and-bust there is failure, as well as success… One must acknowledge– failure, then re-price, liquidate, and move on… According to Joseph Schumpeter; capitalism is like– forest floor– life, death, regeneration… Here you’re looking at stagnation without death-regeneration… zombie imagesCA2DYW2M