Three Steps for Surviving Chapter 11: A Guide for CIOs

Janis Emplit started as CIO of Flagstar, the parent of Denny’s and a handful of other restaurant chains. On Emplit’s second day, the Spartanburg, S.C.-based company filed for Chapter 11 bankruptcy protection.

The restauranteur’s financial woes (an $85.5 million loss for 1996) were no secret when Emplit signed on. Flagstar’s bankruptcy, which had been in the works for four months before the new CIO took her job, was a last-ditch effort to restore to order what Emplit describes as a company in chaos, where the problems permeated IT. Flagstar’s CIO left the company in 1996, and a lack of coordination reflected it. Each of Flagstar’s six restaurant brands had its own homegrown systems for purchasing, inventory,

point of sale, accounts payable and other functions. Even the corporate parent had three different general ledgers. And nothing was Y2K compliant. “We were playing catch-up,” Emplit says in what now sounds like an understatement.

Starting when she did gave Emplit a mandate: Use IT to help turn the company around; do it fast and without spending a nickel more than you need. By the time the company reemerged from bankruptcy six months later, complete with the new name Advantica Restaurant Group, Emplit had reassessed everything her company did?and took part in deciding what it should do next.

The experience has stayed with her. The bottom-line impact of every decision “is always in the back of your mind,” says Emplit. “You aren’t constrained to go with the low-cost solution all the time, and I never felt like I couldn’t do something. I just always felt like I had to make the right decision, and there had to be a return.”

Something extraordinary happens to CIOs who go through a Chapter 11 reorganization. Clarity overtakes chaos. Circumstances force executives to confront questions that aren’t as urgent when times are good. Aligning business and IT goals is not a to-do?it’s now or never.

Last year, 257 publicly traded companies?with more than $256 billion dollars in assets?and close to 10,000 privately held companies filed for Chapter 11, according to Carter Pate, author of The Phoenix Effect, a study of corporate failures. Pate predicts that only 100 of the public companies will successfully emerge from Chapter 11 in the next 18 months. So far, 2002 has seen its share of bankruptcies. High-profile filings include Global Crossing, Kmart and Williams Communications, and Pate says he expects another 200 public companies to join them before the end of the year.

While U.S. bankruptcy law is two centuries old (see “A Critical Chapter in Business History,” Page 58), IT’s strategic importance in companies’ reorganizations is a relatively recent development. Tom Smith, CIO of Waste Management, was CIO at America West when the Tempe, Ariz.-based airline filed for bankruptcy in 1991. Smith says that his former company basically “ran out of cash” and the IT department went into maintenance mode, ceasing all project development and laying off staff. Smith passed the time planning for the future?a future that took almost four years to come.

That’s not how it’s done today. Chapter 11 gives companies in crisis a chance to regroup, and IT plays a vital role. CIOs from currently or formerly bankrupt companies express a clear three-step strategy for emerging leaner and stronger: One, figure out where every dollar goes; two, plan out IT’s strategic role in fixing the business; and three, subject that strategic plan to regular scrutiny.

CIOs who have gone through bankruptcy say that the experience teaches them how to do their job better. And they stress that there is little about managing a company through bankruptcy that they couldn’t transfer to other businesses. With few exceptions, what they have learned applies to everyone.

Find Every Dollar. And Shrink It.

When times are good, you and your vendors break bread. When you’re in Chapter 11, you break contracts.

Through the late 1990s and into 2000, Federal Mogul was a thriving auto parts maker in Southfield, Mich., whose growth accelerated through a series of acquisitions. But the 1998 acquisition of auto parts maker T&N, formerly a British asbestos, insulation and piping company, proved to be Federal Mogul’s undoing. T&N and several of its subsidiaries also bought by Federal Mogul were named in asbestos lawsuits. As word got out, the claims mounted. When the company filed for bankruptcy last October, 365,000 claims were pending.

Federal Mogul is using Chapter 11 to protect itself from the claims; the company plans to set up a trust for asbestos victims as part of its reorganization. One clause of the bankruptcy rules that Federal Mogul senior vice president and CIO Michael Gaynor says is helping the most is the court-appointed right to reject any current contract. “Take the example of a wide area network,” says Gaynor. “If you went into a contract 14 months ago, those costs have gone down anywhere from 10 to 15 percent. We can reject that contract and renegotiate because of Chapter 11.” And that’s exactly what the auto parts maker is doing. Federal Mogul is in the request-for-proposals stage for a new WAN contract, and is consolidating its PC leases with one vendor (down from five) to save a couple million dollars, Gaynor says.

Gaynor stresses that as a matter of principle he wouldn’t renegotiate a contract outside of bankruptcy, where judges require companies to break above-market leases.

Even so, the benefits of taking a fresh look at a vendor contract can go two ways, says George Muller, CIO of Imperial Sugar, a Sugarland, Texas, food company that came out of bankruptcy in August 2001. Muller says he has found that as long as there are mutual benefits?a reduced rate in exchange for a longer deal, for example?vendors are willing to play ball.

Regardless of their intention to break contracts, CIOs who have been through bankruptcy agree that compiling a comprehensive database that tracks all of a company’s spending is the first thing they would do if they started a new job tomorrow?whether or not Chapter 11 was a factor.

“With Chapter 11 there is a lot more information required than you would typically track inside a company,” says Gaynor. “You have to present stuff to the bankruptcy court, the creditors committee and in our case to the asbestos bar [a special court for asbestos suits]. So all of these people are asking for information that is not information we commonly worry about.”

To meet the information requests, Gaynor built a data warehouse that tracks contracts, leases and other spending figures. It was an eye-opener: multiple vendors for the same products, redundant software licenses and bills from consultants who weren’t under contract. “We are going to use this for our own purposes to make better decisions about how we manage the business,” he adds.

Chart a Strategy. And Expect to Concede Some Points.

When times are hard, every dollar spent must promote company goals.

Emplit says that when she arrived at Advantica, she entered an alignment vacuum, with no IT strategy in place. Despite some pressing needs, such as fixing non-Y2K compliant systems, Emplit spent her first three months ranking IT projects in order of their overall importance to the company and mapping out the cost and timetable for each. For example, the first move Emplit made once the plan was completed was consolidating the restaurants’ financial systems, which solved the Y2K problem and had a clear bottom-line ROI. One project she delayed was installing a new benefits management system. The old one worked fine, so Emplit’s plan simply called for it to be Y2K remediated.

Even though creating the plan took precious time early in her tenure, Emplit says that the finished product gave her troops a clear understanding of the challenges ahead and how to attack them. In retrospect, she says, it was the best move she made.

Federal Mogul’s Gaynor says the auto parts maker should get out of bankruptcy in the next two to three years. But it won’t happen without the efficiencies generated by a detailed strategic plan that helps executives get control of IT projects across the company. The plan helps to focus matters on companywide benefits and allows you to set new priorities, Gaynor says. “We have X amount of money we are going to spend on IT, so let’s make sure that we are going to spend it on the top priorities for the company globally, not just for this plant or for this region. You might know that a project was costing you X, but it was also supposed to create Y cost savings,” he adds. So if a project isn’t living up to expectations, a CIO can take decisive action.

Decisive action, what USG CIO Jean Holley calls her accelerator pedal, is critical when the company’s future is at stake. The Chicago-based sheetrock maker is another casualty of asbestos lawsuits (one of about 30 such companies that have filed for bankruptcy). “People say they are doing a project because they have it mapped out for this year,” she says, “but you have to look at it and constantly ask, Is the timing right? It’s like a stereo, it doesn’t just have on and off; there is the volume [knob].”

For example, after the company’s Chapter 11 filing, increased sales traffic forced Holley to accelerate a million-dollar mainframe upgrade by about six months. Waiting would have created problems for the product sales group, so Holley moved early even though it means “I will run in the red for a month or two,” she says. Holley decided that she could chisel away at her software licensing contracts during the next few months. “My financials don’t look great right now. But I can level it out,” she says. The lesson, she adds, is to “stick with your strategy. Don’t throw it out the window. We looked and said, What pieces need to happen regardless? And how do you speed up some pieces and slow down other pieces?”

Review Your Strategy Early and Often. And Spend More Now If You Can Save Later.

Cutting spending and coming up with an IT strategy are the relatively easy parts to managing a company out of bankruptcy. You also have to make sure that every decision drives the business forward.

Kathy Markham, vice president of IS planning and architecture at Kindred Healthcare, says that the only time a struggling company should be spending is when there is a clear ROI. The Louisville, Ky.-based long-term care provider gets about 70 percent of its revenue from Medicare and Medicaid reimbursements. After a long period of lobbying and posturing, Congress cut the reimbursement rate as part of the Balanced Budget Act of 1997. Kindred was prepared for a 17 percent reduction. The cut was 30. The company was unable to meet its expenses, and in September of 1999 Kindred, then known as Vencor, filed for Chapter 11 (it came out of bankruptcy in April 2001).

Even during its bankruptcy, Kindred went ahead with an aggressive SAP implementation. Despite the project’s steep price tag, Markham says that the expected return was too high not to do it. “Sometimes it took us 45 days to close our books,” she says. When that happens “there is a lot that can go wrong. When we did SAP we were able to cut the time it took to close our books from 25-plus days to 10.” Other projects had benefits as well. A new patient-care reporting system had a built-in editor so that nurses could submit error-free claims to the government on time. “If you don’t file in time you get the default rate, which is very low, and that can cost a lot of money,” Markham says.

Even when projects have a clear return there are ways to curtail costs and still get them done. At Advantica, Emplit had to consolidate the company’s accounts payable systems and general ledgers?the projects were first and second on her plan?but she did it with an eye toward frugality. That meant choosing the cheaper Lawson ERP system over the more widely used SAP. “You have the Cadillac solution and the Chevrolet solution, and you don’t go for the Cadillac when you are in bankruptcy,” says Emplit. The same logic steered her other moves: She replaced the legacy inventory system for two of the restaurant chains but delayed replacing the other four and is only now installing a Lawson HR module.

At USG, Holley says executives used Chapter 11 to reevaluate an ERP project conceived prior to the filing. The goal was to migrate off legacy systems toward an Oracle ERP system that integrated accounts payable, general ledger and procurement applications. It turned out that the project’s benefits?such as shorter business cycle times?made it more important, and USG decided to expedite it. To do that, Holley had to pull in implementation dates. And she chose not to do the complex accounts receivable portion of the project, and decided that USG would do it right out of the box and not use consultants.

“Some of the customization that we wanted to do was in the area of procurement,” says Holley. “It would be nice if it followed our procedures, but if you do it once you will have to pay for it forever.” Looking through her cost-cutting glasses, she determined that preserving a traditional business process wasn’t worth the expense. Time was also important. A customized installation would drag on, whereas doing it out of the box allowed them to finish the project in August, only a year after it began. “When you look at the price tag it makes you realize that you don’t really need to do it,” Holley says.

That’s also the approach at Federal Mogul, where CIO Gaynor is depending on EAI technology to help alleviate ERP costs.

The company has “many, many” different types of ERP systems, and has a long-term strategy to standardize on two, SAP and MFG Pro from Carpinteria, Calif.-based QAD. Now, says Gaynor, “we wouldn’t do that. If we had a system that was running well right now, we wouldn’t take it out just to get common.” If an existing system was dying, Gaynor would replace it with one of the two standards, but otherwise he’ll leave it alone. “EAI technology is getting to where you can pull all the information from different sources together. Three years ago you couldn’t have done that. To replace an ERP system, you have a lot of expenses that we are not going to do right now. We would rather go with the EAI and pull that into a repository.”

CIOs who are part of the executive team and have input into a company’s overall strategy are already in a position to take the steps mentioned in this article. But even if there’s a chance to replicate only one step, consider that charting the numbers that show the costs and benefits of IT projects make a compelling argument in any business climate. Compiling a database that tracks spending across the IT department and eventually an entire company is not a giant investment. “If you spend a little bit of time looking at the numbers, you can easily reduce the spending 16 to 20 percent,” Emplit says. That’s the kind of argument that’s hard for a CEO to ignore.

Resisting the temptation to invest in Band-Aids also is critical. It simply doesn’t help move the company forward. Aside from the ability to break contracts, there is nothing about running an IT department in a bankrupt company that differs from running any other company. The stakes are just higher. In fact, Gaynor says that he is “running the department exactly the way we want to run it,” and that when he emerges from bankruptcy in two or three years, he won’t change a thing.

“There are so many dollars out there,” says USG’s Holley. “If you have good insight and control over them, your ship is going to run real tight. If you don’t, you are leaving money on the table, and you are sloppy.”