Why Enron Run Out of Gas
Abstract
Five years had already passed since Enron Corporation filed for bankruptcy protection on December 2, 2001, but the business world is still reeling from the unlikely event that shook the very foundations where great organizations are made. Enron’s application for bankruptcy protection was one of the most highly publicized business fiascos in history. The legal battle of settlements, criminal and civil charges and workouts will continue for years. But outside of the courts and the overly sensational press, what really happened? What caused the collapse of what at one time was the sixth largest company in the United States? The case explores the many stories of Enron in an attempt to find not only the answer to what happened, but what maybe learned from this failure.
The Enron Corporation and the Man behind
Enron was created in 1985 when InterNorth of Omaha acquired Houston Natural Gas. The merger/combination created the single largest operator of gas pipeline in the whole of the United States. Kenneth J. Lay was named the CEO of the merger/combination in February 1986. The combined company was then christened Enron. Kenneth Lay instantly became the fifth highest paid CEO in the United States. Working closely with his Chief Operating Officer (COO), Rich Kinder, Lay took in charge a rapid growth strategy for his newly created and named company. The Houston, Texas-based company, formed in 1985, grew into the nation’s seventh-biggest company in revenue by buying electricity from generators and selling it to consumers. It was admired on Wall Street as a technological innovator.
In 1996, energy markets were changed so that the price of energy could now be decided by competition among energy companies instead of being regulated or fixed by the Government. With this change, Enron began to function more as a middleman than a traditional energy supplier, trading in energy contracts instead of buying and selling natural gas. Enron’s rapid growth created excitement among investors and drove the stock price up.
Although a cast of characters were involved in the Enron’s rise and fall, one person stands out as the thread which binds all others together throughout the brief yet intriguing history of Enron’s, Kenneth L. Lay. Lay earned his BA and Ma in economics at the University of Missouri. He found job with the Humble Oil in Houston after earning his degree. Oil industry, was the equivalent of the gold rush of the later century. It was a brief stint with the said company for he joined the US Navy and found his way to the pentagon corners and earned considerable connections. Lay returned to Houston where he earned his PhD in economics at the University of Houston. he then returned to government service, first at the Federal Energy Regulatory Commission (FERC), then the Department of Interior. Throughout his time in Washington, Lay focused on what he believed to be the inevitable movement towards deregulation of the U.S. energy sector. He believed boldly in its correctness. The U.S. energy sector was deregulated on 1996, Lay was already the CEO of Enron Corporation.
After only eighteen months in Washington, Lay joined Florida Gas in 1973 as Vice President for Corporate Planning, rising to President of the pipeline division in 1976, and finally to the Presidency itself in 1979. His career path was already clearly established with the energy sector. He moved along this career path from Florida Gas to Transco Energy in Houston, and from there to Houston Natural Gas. On June 1984, at the age of 42 he became the Chief Executive Officer of Houston Natural Gas and he started executing which he would pursue above all others for the next 17 years, get big fast.
Enron Corporation, before meeting its final end in 2002 was a conglomerate of big business ventures ranging from coal energy to internet broadband. By the end of 2000, Enron break the 100 billion dollar revenue mark after only 15 years in operation. The highest revenue growth was reported from 1996 to 2000, from .3 billion of 1996 to 0.8 billion in 2000, a 57% increase in revenue unparalleled in any business ventures in history. Also by the end of 2000, Enron have more than 19, 000 employees which generates .9 million revenue per employee, peerless even with the monopolists people from Microsoft (2002).
Think Big, Look Big (the rise of Enron)
Grow big, fast. With Ken Lay’s corporate philosophy, he was headstrong of making Enron one the largest company in the US, not only in the energy sector but in the whole business sector. He engaged McKinsey Consulting immediately following Enron’s formation to evaluate the company’s strategy. The head of the McKinsey team was , a graduate of the School of Engineering and Harvard Business School, where he finished his MBA on 1979. McKinsey consulting was widely considered the best and brightest of the time, and among many talents, Skilling stood out. Like Lay, Skilling also boldly voiced out what he considered the backwardness of the natural gas industry. One of his earliest proposals to Enron had been to apply the principles of market making, commonly applied in the financial sector to the natural gas industry. Although the Enron Board thought of the idea idiotic at that time, Skilling finally implemented this strategy in 1989 when he joined Enron. Skilling saw the company’s pipeline, which connected producers and buyers, as potential market maker. He created a gas bank, a natural gas trading business and envisioned Enron by being between the suppliers and demanders, the firm then was uniquely positioned to understand what gas was available from what sources at which points in time. Enron could then use that information for trading purposes in understanding the needs of buyers of natural gas. In a natural gas market suffering from a painful transition following deregulation as Ken Lay had foreseen, Enron quickly expanded sales and profits by offering both buyers and sellers longer-term fixed prices with little new investment in assets. This asset-light strategy became a centerpiece of Skilling’s approach to expanding the business. “To be a player in this business, you just need to understand the price of natural gas and the concept of risk. In the coming years, Wall Street firms piled into the business, but even Enron always had a huge advantage. Its immense network of physical assets, its ability to tie up all the moving pieces together and provide physical delivery of the gas itself, and its long history in the gas business gave it insights its Wall Street competitors could never match “( 2003). On Jeff Skilling’s insistence of to use an accounting system common to financial services, but unheard of in the energy industry, Enron applied the market-to-market accounting (MTM). MTM accounting allowed Enron to recognize its sales and earnings on deals today, although most of the actual sales and profits and cash flows would not actually occur until way into the future. Skilling successfully convinced both Ken Lay and Rich Kinder, then COO of Enron to use of MTM if they were to engage in trading business which Skilling envisioned by creating his gas bank.
Lay and Skilling began building a conglomerate little by little. Enron Finance was the brain child of Skilling, the unit was combined a year later with Enron Gas Marketing. It was a major development as it provided and established the much needed financing base to buoy Enron Finance, still a struggling unit. After another year, the business unit base was extended again, this time with the addition of the intrastate Houston pipeline business. The new combined unit was named Enron Capital and Trade Resources (ECT).
ECT occupied a whole floor of the Enron building and immediately became a subculture of its own. The majority of Enron’s traditional employees were from various engineering and science field related to natural gas and pipeline operation, ECT however recruited primarily MBA’s, who were selected on the basis of their intellect and ambition. Skilling encouraged out of the box thinking and behavior. With the culture of Enron before ECT as being rigid and strict to the rules as engineering and hard sciences fellows always seems to carry, the subculture of ECT was dubbed as “anti-Enron Enron”.
Skilling supported the development of a very loose culture in his own ECT. It was one which encouraged risk-taking and deal-making, but simultaneously did not expect loyalty, only performance. Ken Lay and Jeff Skillings, both become known as pushovers to prima donna traders or deal makers who demanded promotions, bonuses and perks.
From the very beginning, however, Enron only recruited the best and the brightest. Enron quickly gained a reputation of supporting and rewarding entrepreneurial thinking. In the words of a former employee, “If you could show that something new and different could make money, you could do it”. The company’s loose culture translated into a distaste for bureaucracy and a corporate belief in free markets.
Enron was growing rapidly, that it feels like the company needs a bigger space to market its business, and so in 1993 Enron International was created. Enron is now a multi-national company.
Although is typically associated with Enron International, it was John Wing who was largely responsible for its early growth. Enron international originated from the Teeside gas-fired cogeneration power plant in United Kingdom which Wing developed. The Teesside project was the source of considerable profit in its early years, but eventually became one of the big sources for significant looses. Enron had entered into along term take-or-pay contract for NorthSea Gas from a newly developed “J-Block” in order to provide adequate feedstock’s for its cogen plant. Enron entered into the long term contract unfortunately when the prices of feedstock’s were at historical high. In the end they were able to negotiate a 0 million settlement payment to end its long term commitment to take or pay at astronomical rates the gas originating from J-Block.
Both Mark and Skillings were pursuing booked earnings (accounting earnings) because that was the criteria for success at Enron. With their criteria for success, both were pursuing a short term recognition of financial results on business lines which often required years of delivery and execution to actually create value. However, Enron kept its fast paced sprint to being bigger by making deals and investments as far as India, most of them turned failures.
The ascension of Skilling to the COO position, Skilling’s ECT subculture moved to the driver’s seat within Enron’s complex web of business units and corporate culture. There had always been a number of obvious differences in the subcultures across business units. And although both trading and international had increasingly shared accounting practices, there were still fundamental differences in how business was done and the personality characteristics of those doing it. In fact the battle with in the traders and the deal makers were so much aggravated by cultural differences. The deal makers cultivated personal relationships with customers and hammered out deals over many months. The traders on the other hand do business by phone and computer in a matter of seconds. The dealers viewed the traders in the company as bloodless mercenaries who would do everything to get the business done. The traders viewed the dealers in same not too flattering manner for they were associated with dinosaurs, destined for extinction. By Jeff Skilling’s words, he characterized Enron’s culture as loose-tight. The loose was the no holds barred approached to creativity in business development. The tight, as Skilling described it, was the organizational processes within Enron to manage the risk they often take. Skilling’s moved to put Enron into power trading in a bigger way resulted in a significant repositioning of much of the company’s core returns. The energy trading business, primarily in the North America boomed in 1996 to 2000 period. By Ken Lay’s vision, Enron had indeed gotten big fast. In 2000, it broke the 0 billion in revenues mark for the first time. Its market capitalization, the value of the total outstanding shares of the company, was now worth roughly billion. By this time Enron’s perception of its own core competence was changing. It was not any more confined to building and operating natural gas pipelines and power plants, or even to the trading of natural gas and electrical power. Trading is now its own self defined competence. The evolving strategy was to create markets where markets had never existed, exploit them for all they were worth, and when profits decline by competitor entry, move on to the next cutting edge market creation. Between 1996 and 2001, Enron tried, sometimes failed and sometimes succeeded, in trading water, weather derivatives, bandwidth and coal to name but a few…
Feeding the Giant
Enron grew so big and so fast, that feeding itself was becoming increasingly a problem. A particularly troublesome feature of Enron’s emerging business model was that revenues were growing much faster than earnings. The cost of undertaking all new trading ventures at panic face was catching up with the firm. The salaries, bonuses, start-up costs and general lack of control over all operating costs drowned whatever profits gained from the ventures. Even the more successful trading lines, its natural gas operation did not generate margins the business world had come to expect from Enron and all its older portfolio of business. Enron needed additional external capital, perhaps a new debt and new equity. Both Lay and Skillings however are reluctant to issue large amounts of new equity because it would dilute earnings and holdings of existing shareholders. The debt option was also limited given the already high debt levels Enron was carrying and left it in precarious position of being rated BBB, just barely investment grade by credit agency standards. After this, the downward dizzying spiral fall of one of the coolest and biggest company of the world began.
What happened at Enron? This question was been troubling many business analyst for some time now. The financial analyst thinks they have the answer, the organizational behavior theorists also thinks they have the answer. The business community needs the answer to these to avoid another company from going the same route of pitfall like Enron took. The fall of Enron could be viewed in many different perspectives, each leading to different complex questions. Was it the ethical and business judgment failures of select people at the top, or did it go deeper to the thousands of employees Enron have. Was Enron’s leadership responsible for the creation and growth of a corporate culture which was inherently flawed? Or was it a good business burdened with bad leadership, or a bad business with a bad leadership? Or was Enron a company, a victim itself of the market that has grown cynical as a result of the dotcom bubble collapse of the 1990s. Or did this culture just grow from specific instances of individual flaws and leadership malfeasance?
Organizational Analysis: ENRON
The explanations as to why the nation’s seventh largest corporation succumbed to dead end are as diverse as the baffling questions of how could such a thing happen. Enron as an organization was big and complex yet without a powerful HR department that would manage the company’s most important asset, the people. But before we talk about the flaws in the organization (Enron) we must remember that Enron did enjoyed success as a company. It was so successful that it was the seventh largest corporation in the United States with businesses in Asia, Europe and South America. It reached that status primarily because Enron’s primary concern, as to the words of Ken Lay, is to grow big and fast. Lay must have installed it in the heart of every employee through either his charisma, motivation factors (salary, incentives, bonuses…etc) or just finding the right people for Enron (brightest and smartest). Enron was lucky to have both intelligence and charisma that is in Ken Lay, that must have lead his people to rally behind his “grow big, fast slogan”. Leadership as defined by (1950) may be considered as the process of influencing the activities of an organized group in its efforts toward goal setting and goal achievement.
Enron’s employees could have been one of the most motivated workforce in the entire business industry. Enron selected only the brightest and smartest individuals, their only criteria, to work with in the company. As long as they deliver what the company expects them to be then they are rewarded with bonuses, perks and promotions. According to Maslow’s hierarchy of needs, we also need to fulfill our “need to boost our self esteem”. The esteem category lists some of the desires that should be fulfilled, the desire for the feeling of strength, adequacy, achievement, confidence, independence and freedom (1954).
The Enron organization seemed so perfect that every people within the organization deliver, and job satisfaction and efficiency was evident in the 2000 report that the 19,000 workers in Enron generates .9 million revenue per employee. Job satisfaction is viewed as an outgrowth of achievement, recognition (verbal), the work itself (challenging), responsibility, and advancement (promotion) (1994). All of these requirements were to be found in Enron, where employees are given the responsibility and challenged to think out of the box, to create new ideas where they can make money out of it.
Management will make full use of the potential capacities of its human resources only when each person in an organization is a member of one or more effectively functioning work groups that have a high degree of group loyalty, effective skills of interaction, and high performance goals. … An organization will function best when its personnel function not as individuals but as members of highly effective work groups with high performance goals. Consequently, management should deliberately endeavor to build these effective groups, linking them into an overall organization by means of people who hold overlapping group membership. The superior in one group is a subordinate- in the next group and so on through the organization. (1961)
X and Y theory also explains why the Enron’s employees was motivated to work best, because the only criteria in Enron to get promoted was to perform at best, central principle of theory Y states that individuals “achieve their own goals best by directing their efforts toward the success of the enterprise”.
Ultimately came to associate theory Y directly with participative management: “The principle of integration requires active and responsible participation of the individual in decisions affecting his own career” (1960).
Theorists such as (1978) advocated an open-system perspective. That perspective recognized that organizations are interdependent with other organizations and groups in their environment. It also recognized that these other systems influence both what goals organizations choose and the extent to which they can meet those goals (1978), for example, defined success in meeting internal goals as efficiency. They defined effectiveness as “. . . an external standard of how well an organization is meeting the demands of various groups and organizations that are concerned with its activities”
What has also been lacking with Enron was it compromised the importance of planning before taking a leap forward. An organization doesn’t just have to grow bigger, but better. The importance of planning and consultation must never be downplayed. Both strategy and planning are vital for innovation, but neither lessens uncertainty. Enron basically disdained planning. Its strategic intent pushed it into a number of different markets where it thought it could be successful, not by being better than other competitors, but by reinventing the market place. This was certainly innovative, but even if you can redefine the terms of competition, you still have to have a business plan, highly reliable core processes, and a sustainable ability to execute. The business media makes much of Enron’s strategic intent overreaching its capabilities of its efforts to innovate overwhelming its ability to deliver.
Innovation is about the people, not the organization (1996). While most of the people stories about Enron have been about employees losing their life savings, their jobs, and having their professional reputations tainted, what’s missing is the quality of ideas.
As growth was essential to the company’s business model and survival: to ensure new investments and global reach, the availability of the right personnel was crucial. Yet resource planning was somehow the most difficult part of the entire HR process (1995). Planning semantically refers to organization and structure. The traditional approach to resource planning: factoring in business and environmental needs, performing a gap analysis and job (re)design, and moving on to recruitment, proved impossible, as business plans could change, literally overnight. So recruitment had to be highly proactive and, paradoxically, well-planned. All the more so because qualified and experienced staff were almost unavailable: the Internet market’s rapid evolvement and yet immaturity had not created a large enough pool of competencies and experience. Those with even the most rudimentary know-how were being chased by a legion of job offers. Recruitment process of Enron was very loose and less standardized. The preceding factors combined called for the recruitment of potential, of versatility and flexibility. The main profile for recruitment was a young, bright graduate with international exposure, highly result-driven, a go-getter, willing to shift positions as soon as business models required adjustment in skills, and hence requiring minimum supervision (self-motivated) and the ability to be autodidactic. Ideally they would also be adventurous, risk takers, and “dreamers.”
Though Enron offered a very good environmental workplace and a fast career growth, it also did not require employee loyalty, which is a very important factor in organizational stability. It is in loyalty that trust is built with in the organization.
The last lesson of Enron is simply that the ideas people have, the changes they put into action, and the lessons learned in terms of success or failure are what innovation is all about. The tragedy of Enron is that the worth of those ideas and the workforce that produced them has been swallowed whole by management self-deception at best, or corporate corruption at worst. It should always have been about the individuals and the power of their ideas.
Credit:ivythesis.typepad.com
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