Death Spiral
Categories: Company Management
The term conjures a few connotations: As you'd guess, all of them are bad news. Except maybe in figure skating. In pairs figure skating, it's the move where the guy spins in a circle while holding onto the girl, who kind of lies on the ice and carves out a circle around him. Very beautiful and graceful.
Less beautiful in insurance, where a death spiral indicates an actual corkscrew-shaped dive towards destruction. Imagine a insurance company has a pool of customers. Now, a bunch of the low-risk customers decide to drop their insurance. All that's left is high-risk people filing claims all the time and there's not enough money to cover the losses.
Example time: Your company offers vampire bite insurance. But a documentary comes out on Netflix claiming (ludicrously) that vampires aren't real. So, a bunch of clients decide they don't need vampire insurance anymore.
After the exodus, the entire risk pool for the company is now women aged 15-22 living in Transylvania within 25 miles of Dracula's castle. Uh-oh. Now the company is paying off vampire bite claims every day and there's not enough people paying premiums from low-risk groups (elderly garlic farmers; holy water hot tub manufacturers) to cover the losses. Death spiral.
Another kind of financial death spiral: high volumes of convertible debt. A company desperate for cash issues a large volume of convertible bonds. Investors can transform these bonds into shares of stock. However, as they do, it puts large number of shares on the market, driving share prices lower. The lower share price makes it more difficult to raise money with equity, so the company turns to the issuance of more convertible debt. Death spiral.
Yet another situation: Accounting. It comes up when a product's cost accounting gets misallocated. A company has a lot of products. Some are complicated, high cost to produce and done at relatively low volume. Another is fairly simple, low cost on a unit basis, but is produced at high volume.
However, the company hired the CEO's idiot cousin as its accountant, and when he figured out the cost of the simple product, he just divided the costs of manufacturing by the total number of products produced. The high volume product now looks expensive to make. So the company overreacts.
It jacks up the price, which hurts demand. Sales slump. Now it panics and offshores production of the product, which adds to transportation costs (and doesn't really lower the manufacturing cost, because in reality it wasn't costing that much to make in the first place). Still unable to figure out what's going on, the company simply drops the product entirely. Death spiral.