Xerox: The Downfall

The inside story of a management fiasco

One morning last May, G. Richard Thoman arrived for work to find an urgent summons from Paul A. Allaire, the man he had replaced as chief executive of Xerox Corp. just 13 months earlier. Allaire, who had remained as chairman, was waiting next door in his office at Xerox headquarters. A man of few words even on happy occasions, Allaire delivered the bad news without preamble. He said that Thoman's colleagues had lost confidence in him and that the next afternoon the board would announce his resignation. In other words, Thoman, who had left IBM in 1997 to join Xerox as heir apparent to Allaire, would be out of a job in about 30 hours.

Thoman was livid, but obligingly fell on the sword Allaire handed him. Late the next day, after the board had announced Allaire's reinstatement as CEO, Thoman sat alone in a Xerox conference room and fielded calls from the press. "The board and I agreed that it made more sense to implement our strategy with an internal team," he told one caller. Actually, he could only guess at what his fellow directors wanted. Thoman had not been invited to the board meeting or even asked to defend himself by speakerphone. He had been fired in absentia, the bizarre but perhaps inevitable outcome of a CEO succession that had begun so promisingly yet ended in utter disaster for Allaire and Xerox no less than for Rick Thoman.

Xerox' failures to commercialize the breakthroughs made in its famous Palo Alto Research Center (PARC) in the 1970s and 1980s--including the personal computer--have been thoroughly documented. It is also common knowledge that over the past few years the company fumbled the digital future yet again by badly underestimating the inkjet printer, a deceptively humble device around which Hewlett-Packard Co. has built a profitable division larger now than all of Xerox. What is not well understood--what has been hidden until now behind the silence of its participants--is that Xerox' downfall was also rooted in executive-suite discord so intractable as to amount to corporate civil war. This is the story of the management fiasco at Xerox, based on exclusive interviews with Allaire, Thoman, and many other company executives, past and present.

On one side of the struggle were Thoman, the perpetual outsider, and a small coterie of like-minded executives, mostly newcomers to the company. Pitted against them were Allaire, the consummate Xerox insider, and most of the senior management team he had assembled since he was first named CEO in 1990. This is a saga in which neither of the two principal antagonists fits comfortably into the role of villain. Each man's reach exceeded his grasp by an ultimately ruinous margin, but neither seems to have acted from venal motives or indifference to the greater good of the company and its shareholders. Allaire, now 62, and Thoman, 56, shared a basic belief that Xerox needed to reinvent itself to succeed in the Digital Age. In the end, though, each would blame the other for screwing up the implementation of the strategic plan they developed together.

Thoman contends that he never had the authority he needed to be an effective leader because Xerox' board, dominated by Allaire, denied him the crucial prerogative of assembling a full management team of his own. "The analogy to my experience would have been if Lou Gerstner had tried to turn around IBM with John Akers still there--and without his own team," he says. However, Allaire insists that he did nothing to impair Thoman's authority. "There can only be one CEO, and I respected that," he says, adding that Thoman erred in forcing a pace of change on Xerox that it simply could not withstand. "The problem Rick had was he did not connect well enough with people to get a good feel of what was going on in the organization and what was and wasn't possible."

ONCE-HOT STOCK. Less than two years ago, Xerox looked to be a company on a roll. Earnings were rising smartly, and investors were bidding up its shares in a market enthralled with all things tech. Xerox hit a record high of nearly $64 a share in May, 1999, just three weeks after Thoman replaced Allaire as CEO. Today, the stock trades around $7, a few dollars above the price at which it listed on the New York Stock Exchange in 1961. The evisceration of $38 billion in shareholder wealth already qualifies Xerox as a corporate catastrophe of the first order. And the company's woes are not over yet--not by a long shot.

Xerox posted a loss of $198 million over the last three months of 2000, the largest quarterly loss in a decade. By even the most optimistic forecast (its own), the company will not edge back into the black until the second half of this year, at the earliest. With $2.6 billion in debt coming due this year and a $7 billion bank loan looming in 2002, Xerox is cutting spending, firing workers, and trying to raise as much as $4 billion by selling off assets. Its take to date: $550 million.

Anne M. Mulcahy, a popular 24-year Xerox veteran promoted to president and chief operating officer when Thoman was fired, astonished analysts in October by conceding that Xerox has "an unsustainable business model." Mulcahy later backed away from this statement, saying that she meant only that the company needed to cut operating costs and redirect investment from money-losing to high-margin businesses. Shrinking Xerox down to the scale of its diminished prospects may be prudent but does not a new, sustainable business model make. "I hear about asset sales, about refinancing, but I don't hear anyone saying convincingly, `Here is our future,"' says a senior Xerox sales executive. "What I see is a retreat back into the comfort zone of the way things used to be before Rick Thoman."

The prevailing view is that the company will avoid the humiliation of Chapter 11 bankruptcy. On the other hand, financial management has not exactly been Xerox' strong suit of late. The company just fired 13 employees of its Mexican subsidiary, accusing them of doctoring the unit's books to make its performance look better than it really was. Xerox took write-offs of $119 million--a hefty sum for a subsidiary with revenues of $400 million. The company maintains that no one at headquarters was complicit in the abuses and that its internal audit controls are adequate. However, Xerox will not have the last word on these issues. The Securities & Exchange Commission is investigating, and Xerox and its management have been hit with at least 11 shareholder suits.

BRAZIL BROUHAHA. Doubts about Chief Financial Officer Barry D. Romeril's stewardship go beyond the issue of Xerox' accounting integrity. In 1999, the company lost 13%, or $1 billion, of its net worth because of foreign-currency losses, mostly in Brazil. Analysts were stunned that Xerox would have left such a big chunk of its equity exposed to the vagaries of the notoriously volatile Brazilian economy. Xerox suffers from "a clear deficiency in financial oversight," contends Richard J. Lane, a vice-president of Moody's Investors Service, which downgraded Xerox bonds to junk status last year. Adds one stock analyst: "I can't believe that Romeril is still there." Romeril declined to be interviewed.

If Thoman had had his way, Romeril would not still be at Xerox. He says that he wanted to replace Romeril but was told by Allaire that the board would not countenance his dismissal. Allaire disputes this but does acknowledge that all was not well between Thoman and Romeril. "Clearly, there was a personality conflict," he says. "Rick had lost some degree of confidence in Barry and was not as accepting of Barry's advice as Barry thought he should be." By late 1999, Allaire says, Romeril had agreed to remain as CFO only as long as it took to find a replacement. Thoman drove to work on May 10 intending to offer the CFO job to a man he had interviewed several times. He never got the chance, because May 10 was the day Allaire canned him.

Thoman says now that he erred in not insisting that Allaire also step down as chairman when he transferred the CEO title. It wasn't that Allaire bossed Thoman around. The two worked out an arrangement by which Allaire would be permitted to attend top management meetings, but only if he promised not to speak. Although Allaire was as good as his word, he undermined his successor by his mere presence. Says one former top executive: "I knew it was doomed to fail when Rick and Paul would be in the same meeting and the line of eyes around the table would keep focusing on Paul even though Rick was doing all the talking."

The irony, no doubt a bitter one for all concerned, is that Allaire yearned to leave Xerox behind and take full retirement. But duty--and his board--would not let him. "Even before the transition, Paul thought he should step aside and be on his way," says Nicholas J. Nicholas Jr., a former CEO of Time-Warner Inc. and a longtime Xerox director. "But a number of people on the board wanted him to stay [as chairman] because Rick was an outsider. The thinking was, `We like what we see so far with Rick, but we'd like you to be here, just in case."'

Xerox' bungled CEO succession is an object lesson in the difficulty of reinventing an old-line company. For a good 20 years now, Xerox executives have been restructuring, revamping, and repositioning virtually nonstop. But in the last analysis, Allaire's Xerox has been far better at proclaiming the need for change than actually making change. "There was always a huge gap between the visionary aspirations the company nominally was pursuing and what it actually drove employees to do," says a former senior Xerox executive.

There was a time when Xerox embodied visionary aspirations realized. Throughout the 1960s, the company was as potent a symbol of the transformational power of technology innovation as Apple Computer Inc. and Microsoft Corp. would be later. Xerox is descended from the Haloid Co., a photographic supply company founded in Rochester, N.Y., in 1906. Under Joseph C. Wilson, its longtime leader, Haloid spent 14 years and virtually all of its income to develop the 914, the first xerographic copier. Introduced in 1959, the new copier was a money machine nonpareil. By the time the 914 was retired in 1973, it was the biggest-selling industrial product of all time, and Xerox was in the dictionary as a synonym for photocopy.

Success spoiled Xerox, in a sense. To sustain its rapid growth, it needed to move beyond copiers, but what could ever measure up to the 70% gross profit margins of the 914? Xerox was defined as "the copier company" in its very DNA, blinding it to the enormous commercial potential of PARC's many innovations. Attempts to buy its way into new businesses were equally unsuccessful. Whether it was mainframe computers or financial services, Xerox tended to buy the wrong company at the wrong price and then run it into the ground. Novelty in any form simply was no match for the well-heeled copier bureaucracy--or "Burox"--spawned by the phenomenal success of the 914.

CUT-PRICE COMPETITION. Burox almost was the death of Xerox. The company's xerography patents began expiring in the early 1970s, and its 95% share of the market dwindled. By 1982, its portion of the U.S. copier business had declined to 13% under an onslaught of cut-price copiers imported from Japan. Through sheer force of personality, CEO David Kearns, a former IBM marketing executive, inspired the Xeroid masses to commit to elaborate Japanese-style programs to improve product quality and pare manufacturing cost. Rejuvenated, Xerox reclaimed lost market share at home and by 1990 was even taking business away from Canon and Ricoh in Japan.

In keeping with Xerox tradition, Kearns stepped down as CEO in 1990, when he turned 60, and yielded to Allaire. The son of a Massachusetts vegetable farmer turned quarry operator, Allaire had joined Xerox in 1966 and worked his way up through the finance and administration ranks. Kearns remained as chairman, but not for long. Just nine months after Allaire became CEO, Kearns resigned from the board to accept the No. 2 spot at the Education Dept. in the Bush Administration. "I had zero involvement in Xerox during the two years I was in Washington," Kearns says now. "And I never went back on the board."

Free to act on his belief that Xerox needed new blood, Allaire remade senior management with executives imported from the outside. The two Allaire recruits who would rise to the highest rank were Romeril, formerly finance director of British Telecommunications, and William F. Buehler, an affable sales executive from AT&T. Allaire developed close relationships with both men, especially Buehler, who spent so much time with the boss socially that they were presumed inside the company to be best friends. Buehler, who recently retired, declined to be interviewed.

Kearns brought Xerox back from the abyss in the copier business only to jeopardize its future anew by putting the company into property and casualty insurance on a grand scale. By the time Allaire took over, Xerox' balance sheet had been crippled by billions of dollars in insurance liabilities. This time, Allaire saved Xerox, methodically disentangling the company from insurance and other financial-services businesses. He also got Xerox' stock moving again with a Street-pleasing mix of cost-cutting and new product introductions, including the first digital copier--Document Center. With great fanfare, Xerox rebranded itself as "The Document Company" in 1994, signaling its ambition to move far beyond copiers as the growth of desktop computing stimulated huge increases in the number of documents being created.

In keeping with accepted management practice, Allaire had discussed succession prospects with his board a couple times a year since the early 1990s. There were several internal candidates for a time, but none panned out. In late 1996, the board decided to create the new position of president and chief operating officer and to go outside to fill it with someone who could move up to CEO in a year or two. Through the executive-recruiting firm Ramsey Beirne Associates, Xerox found Thoman, the 52-year-old chief financial officer of IBM. Says Allaire: "We were looking for a change agent, and he seemed to be a perfect match."

BEST SHOT. Thoman had spent his entire business career working for Louis V. Gerstner, first at McKinsey & Co., then American Express and RJR Nabisco. At IBM, Thoman ranked just below Gerstner in the hierarchy but was only a few years younger than his mentor, whose retirement was not imminent in any event. After much soul-searching, Thoman concluded that joining Xerox might be his best shot at becoming CEO of a major company. He met not only with Allaire but with several other executives and directors, impressing one and all with his knowledge and intensity. "We had such an engaging discussion," recalls Nicholas. "Three hours went by like that," he adds, snapping his fingers.

Thoman boasted a gilt-edged resume. He had collected four advanced degrees from four different institutions of higher learning, including a PhD in international economics from Tufts University. In 1992, the French government had awarded Thoman, a devoted Francophile, the Legion of Honor for helping build American tourism in France as an executive of American Express. His breadth of business experience also set him apart at Xerox, which was filled with managers who had joined straight from college and never left. Thoman had been chief of corporate strategy at AmEx, president of Nabisco International, and the leader of IBM's restructuring of its personal-computer operation. Xerox shares rose $2 on Thoman's hiring in June, 1997. Dispensing with the false modesty usually spooned out on such occasions, Thoman emphasized that he was no mere Mr. Fixit. "I see myself as more of a leader, someone who can size up a situation and act on it quickly," Xerox' new president declared. "I came to Xerox to be chief executive."

Thoman moved into Kearns's old office. The newcomer was struck by the hushed formality at headquarters. In 1969, Xerox had stripped off the top few layers of executives from its bustling base in Rochester and relocated them to a three-story building on a hill outside Stamford, Conn. "I can't emphasize enough how mandarin and isolated the headquarters culture became over time," says a former executive.

At once cerebral and passionate, Thoman is the corporate equivalent of the Washington policy wonk. Longtime colleagues say he is someone who continually walks around with a hypothesis in his head that he is only too happy to share with anyone he encounters, regardless of corporate station. Thoman likes nothing more than freewheeling, intellectually charged discussion. However, he can at times become overbearingly blunt in his criticism and, like Allaire, is all but incapable of small talk or water-cooler bonhomie. "Rick can seem haughty," says a former Xerox colleague generally sympathetic to Thoman. "He is not really a warm person."

BIG DISADVANTAGE. Inbred Xerox needed Thoman's intellectual energy and outsider's perspective, but in terms of personality this charm-challenged brainiac was a bad fit, as he himself realized. "To be successful at Xerox, you have to be liked," he says. "While everyone likes to be liked, for me it was more important to get things done." Executives at Intel Corp. were famous for having slanging matches and then going out afterward for a beer. But at Xerox you had to watch your tongue. "Xerox is totally political, but it's hidden behind a patina of fake collegiality," says one battle-scarred veteran.

It didn't take Thoman long to start violating decorum. One of the first things he did was order up a review of the economics of the existing Xerox product line. He was presented with charts showing that Xerox was "world class" in terms of manufacturing and development costs. "My response was `How do you know?"' he recalls. "They told me they'd get back to me." The third time he got this answer, he put his foot down. It turned out that staffers had relied on a sampling of 1994 market data so limited as to exclude most of Xerox' Japanese competitors. Thoman ordered them back to the drawing board. Weeks later, he finally was presented with evidence that Xerox had failed to maintain its hard-won parity with the Japanese. Says Thoman: "It was clear to me that we were at a large and material cost disadvantage against the Japanese across the copier market."

There was not much that could be done to alter the underlying economics, since research and development accounted for two-thirds of total product costs. But the new president did begin agitating for sharp reductions in Xerox' bloated payroll and overhead, which, in Thoman's view, left the company dangerously exposed to price-cutting by more efficient competitors. Allaire, who had engineered a major cost-cutting early in his tenure, recognized the need for further cutbacks, but swift, preemptive action had never been his style. Instead, 50 different Xerox management teams spent six months hashing out a complex restructuring plan finally unveiled in April, 1998. It set forth 150 different initiatives aimed at saving $1 billion a year in cost cuts and productivity gains. Some 9,000 jobs were to be eliminated, 10% of Xerox' workforce.

Internal tensions were rising but did not appear to be hurting Xerox' performance. Operating income was bounding upward in regular quarterly increments, while revenues now were rising at a double-digit rate. Allaire's early 1990s decision to reorient the company's office-product strategy around digital multifunction machines (copiers that also scanned, faxed, and printed) seemed about to pay big dividends. But Thoman was uneasy just the same. For the time being, Xerox had no competition in digital copying, but the Japanese would bring their own digital machines to market soon enough and if form held, would probably offer comparable quality at lower cost. Could Xerox sustain its revenue growth when it no longer had the market to itself? The burgeoning popularity of the inkjet printer posed an equally dire threat to Document Center's rosy unit sale and revenue projections. By now, inkjet sales were exploding in the so-called SOHO (small office, home office) market, which Xerox had studiously ignored for years in maintaining its focus on high-margin, high-end equipment.

By mid-1998, Thoman had concluded that Xerox had to make changes in its business strategy to deliver on its emphatic promises of double-digit revenue growth. He wanted to push hard into color and take on mighty HP in inkjet. At the same time, he believed that Xerox' direct-sales force had to shift emphasis from pushing hardware to selling "output management solutions." As Thoman envisioned it, Xerox' best long-term growth opportunity lay in helping big companies create new ways to use documents more creatively and efficiently. In practical terms, this meant signing companies to outsourcing contracts or selling them special Xerox-written software. This, in turn, required turning Xerox' box-sellers into systems consultants and reorganizing the sales force around industry groups rather than geographic areas.

Some of these notions had been circulating through Xerox for years but had been acted on only sporadically because of opposition from one Burox faction or another. Thoman articulated his vision with a clarity and an urgency new to Xerox. If, after countless management meetings, Thoman's ideas eventually prevailed, it was because Allaire agreed with him, not because he had won over anything close to a majority of his colleagues. Within the ranks, opposition was steadily building, though rarely was it expressed overtly. Burox had always excelled at passive resistance. "I kept putting groups of people in rooms to work on fixing a problem, but it wouldn't get fixed because someone would disagree and the issue would not be settled," Thoman says.

Thoman's frustrations were momentarily forgotten when he was named CEO at Xerox' annual meeting in April, 1999. "I'll always remember it as a summit moment, a wonderful feeling of arrival," says Thoman. The happy man hardly gave Allaire's decision to remain as chairman a second thought. This was not his only mistake. As a consolation prize for Buehler and Romeril, Allaire proposed giving each a seat on the board and the title of vice-chairman. Thoman didn't like the idea but went along. "I felt I couldn't say no. I really thought this was Paul's way of making sure everyone felt O.K. with my promotion. Of course, it straight-jacketed my ability to make changes."

Thoman was able to make some executive changes. He moved the company's European president aside to make way for Pierre Danon, a dashing Frenchman who was considered Xerox' most aggressive homegrown executive. He replaced Danon as head of retail distribution with James Firestone, a former IBM colleague. He brought in Michael Miron, a 39-year-old cellular-telephony executive as head of corporate strategy. When the head of Xerox' outsourcing subsidiary retired, Thoman recruited Michael A. Ruffolo, the 36-year-old chief information officer of NCR. These digital-savvy executives and a handful of other senior leaders believed in Thoman's change agenda but did not come close to changing the balance of power. Says one ally, who resigned even before Thoman's dismissal: "The challenge of changing Xerox was so profound that Rick needed eight or nine senior people pushing hard along with him as a group day after day."

INVESTOR FLIGHT. In the third quarter of 1999, Xerox posted an 11% drop in income instead of the healthy gain predicted. Investors deserted Xerox in droves, slicing nearly 25% off its value in a single day. It was as if everything had gone wrong at once. Document Center revenues were falling behind projections as lower-priced alternatives cut into its market share. The heavy expenses of entering the inkjet business were really starting to bite, and competitors were even beginning to eat away at Xerox' monopoly in high-end digital publishing. The Brazilian subsidiary, long the company's largest source of profit outside the U.S., was reeling from colossal currency translation losses and soaring interest rates. In North America, productivity was deteriorating as the sales force braced for the reorganization scheduled to begin in January.

Xerox' business woes brought the simmering tensions between Thoman and other executives to a boil. By all accounts, there wasn't a lot of yelling and screaming. But as Buehler and Romeril complained with increasing vehemence to Allaire, the fissures within top management became apparent to the board. Says one director: "Sure, we were alarmed--alarmed as an eight-alarm bell." Thoman soured his relations with Mulcahy, who had tried to bridge the growing divide between the CEO and his vice-chairmen, by clashing with her brother, Tom Dolan, who was the company's head of North American sales, reporting to Buehler. Dolan disagreed with so many aspects of the sales-force restructuring that Thoman pressed to have him transferred to a less vital job. "Rick's clash with Tom hurt Rick hugely with Anne," says a former executive close to her.

In mid-December, Allaire circulated a memo to senior management affirming his support of Thoman. The board is "unanimously supportive of Rick" despite the "clearly disappointing performance of the company," he wrote. Behind the scenes, though, Romeril, Buehler, and other executives were coming to Allaire and threatening to resign unless Thoman was removed. In the first quarter of 2000, Xerox actually exceeded the Street's expectations, modest though they were. But the die was cast. "There was no last straw, no flash of lightning, no thunder," Allaire says. "Rick had clearly lost the confidence of me, the board, and his extended management team. When that happens, you have to make a change."

There seems little doubt that Thoman did lack feel for the human and political realities of "the Xerox family" he had only recently joined. And he shares responsibility for the crippling strategic error of spending heavily to belatedly challenge HP at a time when Xerox would have been better off husbanding its cash. On the other hand, digital markets wait for no old-line company. It is likely that the pace of change that Thoman tried to dictate was in fact the pace Xerox needed to play in the Digital Age. "The lesson of Xerox is that halfway measures don't work," says a former executive. "If you bring in a change agent, then let him make change--or don't even start." Xerox probably will survive. It might even return to solid profitability. But its hopes of becoming an important player in the "office of the future" probably have been dashed for good.

By Anthony Bianco and Pamela L. Moore

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