Discussion
What are the advantages and disadvantages of being a first mover in an industry? Give some real life examples of first mover and late mover firms. Were they successful?
120 words
ONLY Source: Pg. 243 of Textbook (attached)
Due: 9/26
Strategic Management Model
Gathering
Information
Societal
Environment:
General forces
Natural
Environment:
Resources and
climate
Task
Environment:
Industry analysis
Internal:
Strengths and
Weaknesses
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
External:
Opportunities
and Threats
Developing
Long-range Plans
Mission
Reason for
existence Objectives
What
results to
accomplish
by when
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Environmental
Scanning:
Strategy
Formulation:
Feedback/Learning: Make corrections as needed
Putting Strategy
into Action
Monitoring
Performance
Programs
Activities
needed to
accomplish
a plan
Budgets
Cost of the
programs Procedures
Sequence
of steps
needed to
do the job
Performance
Actual results
Strategy
Implementation:
Evaluation
and Control:
THIRTEENTH EDITION
Strategic
Management
and Business
Policy
TOWARD GLOBAL SUSTAINABILITY
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THIRTEENTH EDITION
Thomas L. Wheelen
Formerly with University of Virginia
Trinity College, Dublin, Ireland
J. David Hunger
Iowa State University
St. John’s University
Strategic
Management
and Business
Policy
TOWARD GLOBAL SUSTAINABILITY
with major contributions by
Kathryn E. Wheelen
Alan N. Hoffman
Bentley University
Boston Columbus Indianapolis New York San Francisco Upper Saddle River
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Library of Congress Cataloging-in-Publication Data
Wheelen, Thomas L.
Strategic management and business policy : toward global
sustainability / Thomas L. Wheelen, J. David Hunger. — 13th ed.
p. cm.
Includes bibliographical references and index.
ISBN-13: 978-0-13-215322-5
ISBN-10: 0-13-215322-X
1. Strategic planning. 2. Strategic planning—Case studies.
3. Sustainability. I. Hunger, J. David, II. Title.
HD30.28.W43 2012
658.4’012—dc22
2011013549
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Dedicated to
KATHY, RICHARD, AND TOM BETTY, KARI AND JEFF, MADDIE AND
MEGAN, SUZI AND NICK, SUMMER AND
KACEY, LORI, MERRY AND DYLAN,
AND WOOFIE (ARF!).
SPECIAL DEDICATION TO KATHRYN WHEELEN:
Kathryn has worked on every phase of the case section of this book. Until this edition, she also managed
the construction of the Case Instructor’s Manual. She has done every job with a high level of dedication
and concern for both the case authors and the readers of this book.
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vi
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BROOK MATTHEWS
GEORGIA MAY
ALICIA MCAULIFFE
MASON McCARTNEY
KAREN McFADYEN
BRIAN McGARRY
MICHELLE McGOVERN
IRENE McGUINNESS
RYAN McHENRY
CRISTIN McMICHAEL
KEVIN MEASELLE
RAY MEDINA
KELLY MEIERHOFER
MOLLY MEINERS
MATT MESAROS
SHALON MILLER
JAMI MINARD
WILLIAM MINERICH
EMILY MITCHELL
JILINE MIX
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OLIVIA MOUG
DOLLY MUNIZ
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BOB NISBET
BETSY NIXON
TOM NIXON
LAURA NOAH
COLLEEN O’DELL
DEBBIE OGILIVE
SARI ORLANSKY
DAVE OSTROW
DARCEY PALMER
KRISTINA PARKER
TONI PAYNE
JULIANNE PETERSON
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BELEN POLTORAK
ELIZABETH POPIELARZ
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LYNDA SAX
BOB SCANLON
MARCUS SCHERER
KIMBERLY SCHEYVING
HEIDI SCHICK (Miller)
BRAD SCHICK
CHRIS SCHMIDT
DEBORAH SCHMIDT
MOLLY SCHMIDT
CORRINA SCHULTZ
WHITNEY SEAGO
CHRISTIANA SERLE
MARTHA SERNAS
MARY SHAPIRO
BARBARA SHERRY
KEN SHIPBAUGH
DAVE SHULER
JESSICA SIEMINSKI
LEA SILVERMAN
AUTUMN SLAUGHTER
KRISTA SLAVICEK
SCOTT SMITH
ADRIENNE SNOW
LEE SOLOMONIDES
BEN STEPHEN
DAN SULLIVAN
JOHN SULLIVAN
LORI SULLIVAN
STEPHANIE SURFUS
AMANDA SVEC
CHRISTINA TATE
SARAH THOMAS
ABBY THORNBLADH
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ELIZABETH TREPKOWSKI
TARA TRIPP
CAROLYN TWIST
JOE VIRZI
AMANDA VOLZ
BRITNEY WALKER
MADELEINE WATSON
BEN WEBER
DANIEL WELLS
MARK WHEELER
LIZ WILDES
MICHELLE WILES
BRIAN WILLIAMS
ERIN WILLIAMS
CINDY WILLIAMSON
RACHEL WILLIS
SIMON WONG
KIMBERLY WOODS
JACKIE WRIGHT
HEATHER WRUBLESKY
GEORGE YOUNG
MARY ZIMMERMANN
KACIE ZIN
DEDICATION vii
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Brief Contents
PART ONE Introduction to Strategic Management and Business Policy 1
C H A P T E R 1 Basic Concepts of Strategic Management 2
C H A P T E R 2 Corporate Governance 42
C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 70
PART TWO Scanning the Environment 93
C H A P T E R 4 Environmental Scanning and Industry Analysis 94
C H A P T E R 5 Internal Scanning: Organizational Analysis 136
PART THREE Strategy Formulation 173
C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 174
C H A P T E R 7 Strategy Formulation: Corporate Strategy 204
C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 236
PART FOUR Strategy Implementation and Control 269
C H A P T E R 9 Strategy Implementation: Organizing for Action 270
C H A P T E R 1 0 Strategy Implementation: Staffing and Directing 300
C H A P T E R 1 1 Evaluation and Control 328
PART FIVE Introduction to Case Analysis 363
C H A P T E R 1 2 Suggestions for Case Analysis 364
PART SIX WEB CHAPTERS Other Strategic Issues
W E B C H A P T E R A Strategic Issues in Managing Technology & Innovation
W E B C H A P T E R B Strategic Issues in Entrepreneurial Ventures & Small Businesses
W E B C H A P T E R C Strategic Issues in Not-For-Profit Organizations
PART SEVEN Cases in Strategic Management 1-1
GLOSSARY G-1
NAME INDEX I-1
SUBJECT INDEX I-7
ix
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Contents
Preface xxix
PART ONE Introduction to Strategic Management and Business Policy 1
C H A P T E R 1 Basic Concepts of Strategic Management 2
1.1 The Study of Strategic Management 5
Phases of Strategic Management 5
Benefits of Strategic Management 6
1.2 Globalization and Environmental Sustainability: Challenges to Strategic Management 7
Impact of Globalization 8
Impact of Environmental Sustainability 8
Global Issue: REGIONAL TRADE ASSOCIATIONS REPLACE NATIONAL TRADE BARRIERS 9
Environmental Sustainability Issue: PROJECTED EFFECTS OF CLIMATE CHANGE 12
1.3 Theories of Organizational Adaptation 12
1.4 Creating a Learning Organization 13
1.5 Basic Model of Strategic Management 14
Environmental Scanning 16
Strategy Formulation 17
Strategy Highlight 1.1: DO YOU HAVE A GOOD MISSION STATEMENT? 18
Strategy Implementation 21
Evaluation and Control 22
Feedback/Learning Process 23
1.6 Initiation of Strategy: Triggering Events 23
Strategy Highlight 1.2: TRIGGERING EVENT AT UNILEVER 24
1.7 Strategic Decision Making 25
What Makes a Decision Strategic 25
Mintzberg’s Modes of Strategic Decision Making 25
Strategic Decision-Making Process: Aid to Better Decisions 27
1.8 The Strategic Audit: Aid to Strategic Decision-Making 28
1.9 End of Chapter Summary 29
APPENDIX 1.A Strategic Audit of a Corporation 34
xi
C H A P T E R 2 Corporate Governance 42
2.1 Role of the Board of Directors 45
Responsibilities of the Board 45
Members of a Board of Directors 48
Strategy Highlight 2.1: AGENCY THEORY VERSUS STEWARDSHIP THEORY
IN CORPORATE GOVERNANCE 50
Nomination and Election of Board Members 53
Organization of the Board 54
Impact of the Sarbanes-Oxley Act on U.S. Corporate Governance 55
Global Issue: CORPORATE GOVERNANCE IMPROVEMENTS THROUGHOUT THE WORLD 56
Trends in Corporate Governance 57
2.2 The Role of Top Management 58
Responsibilities of Top Management 58
Environmental Sustainability Issue: CONFLICT AT THE BODY SHOP 59
2.3 End of Chapter Summary 62
C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 70
3.1 Social Responsibilities of Strategic Decision Makers 72
Responsibilities of a Business Firm 72
Sustainability: More than Environmental? 75
Corporate Stakeholders 75
Environmental Sustainability Issue: THE DOW JONES SUSTAINABILITY INDEX 76
Strategy Highlight 3.1: JOHNSON & JOHNSON CREDO 78
3.2 Ethical Decision Making 79
Some Reasons for Unethical Behavior 79
Strategy Highlight 3.2: UNETHICAL PRACTICES AT ENRON AND WORLDCOM EXPOSED
BY “WHISTLE-BLOWERS” 80
Global Issue: HOW RULE-BASED AND RELATIONSHIP-BASED GOVERNANCE SYSTEMS
AFFECT ETHICAL BEHAVIOR 81
Encouraging Ethical Behavior 83
3.3 End of Chapter Summary 86
Ending Case for Part One: BLOOD BANANAS 90
PART TWO Scanning the Environment 93
C H A P T E R 4 Environmental Scanning and Industry Analysis 94
4.1 Environmental Scanning 98
Identifying External Environmental Variables 98
Environmental Sustainability Issue: MEASURING AND SHRINKING YOUR PERSONAL
CARBON FOOTPRINT 100
xii CONTENTS
Global Issue: IDENTIFYING POTENTIAL MARKETS IN DEVELOPING NATIONS 107
Identifying External Strategic Factors 108
4.2 Industry Analysis: Analyzing the Task Environment 109
Porter’s Approach to Industry Analysis 110
Industry Evolution 114
Categorizing International Industries 114
International Risk Assessment 115
Strategic Groups 115
Strategic Types 117
Hypercompetition 117
Using Key Success Factors to Create an Industry Matrix 118
Strategy Highlight 4.1: MICROSOFT IN A HYPERCOMPETITIVE INDUSTRY 118
4.3 Competitive Intelligence 120
Sources of Competitive Intelligence 121
Strategy Highlight 4.2: EVALUATING COMPETITIVE INTELLIGENCE 122
Monitoring Competitors for Strategic Planning 122
4.4 Forecasting 123
Danger of Assumptions 123
Useful Forecasting Techniques 124
4.5 The Strategic Audit: A Checklist for Environmental Scanning 125
4.6 Synthesis of External Factors—EFAS 126
4.7 End of Chapter Summary 127
APPENDIX 4.A Competitive Analysis Techniques 133
C H A P T E R 5 Internal Scanning: Organizational Analysis 136
5.1 A Resource-Based Approach to Organizational Analysis 138
Core and Distinctive Competencies 138
Using Resources to Gain Competitive Advantage 139
Determining the Sustainability of an Advantage 140
5.2 Business Models 142
5.3 Value-Chain Analysis 143
Strategy Highlight 5.1: A NEW BUSINESS MODEL AT SMARTYPIG 144
Industry Value-Chain Analysis 145
Corporate Value-Chain Analysis 146
5.4 Scanning Functional Resources and Capabilities 147
Basic Organizational Structures 147
Corporate Culture: The Company Way 149
CONTENTS xiii
Global Issue: MANAGING CORPORATE CULTURE FOR GLOBAL COMPETITIVE
ADVANTAGE: ABB VERSUS MATSUSHITA 150
Strategic Marketing Issues 151
Strategic Financial Issues 153
Strategic Research and Development (R&D) Issues 154
Strategic Operations Issues 156
Strategic Human Resource (HRM) Issues 158
Environmental Sustainability Issue: USING ENERGY EFFICIENCY FOR COMPETITIVE
ADVANTAGE AND QUALITY OF WORK LIFE 161
Strategic Information Systems/Technology Issues 162
5.5 The Strategic Audit: A Checklist for Organizational
Analysis 163
5.6 Synthesis of Internal Factors 164
5.7 End of Chapter Summary 165
Ending Case for Part Two: BOEING BETS THE COMPANY 170
PART THREE Strategy Formulation 173
C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 174
6.1 Situation Analysis: SWOT Analysis 176
Generating a Strategic Factors Analysis Summary (SFAS)
Matrix 176
Finding a Propitious Niche 177
Global Issue: SAB DEFENDS ITS PROPITIOUS NICHE 181
6.2 Review of Mission and Objectives 181
6.3 Generating Alternative Strategies by Using a TOWS Matrix 182
6.4 Business Strategies 183
Porter’s Competitive Strategies 183
Environmental Sustainability Issue: PATAGONIA USES SUSTAINABILITY
AS DIFFERENTIATION COMPETITIVE STRATEGY 187
Cooperative Strategies 195
6.5 End of Chapter Summary 199
C H A P T E R 7 Strategy Formulation: Corporate Strategy 204
7.1 Corporate Strategy 206
7.2 Directional Strategy 206
Growth Strategies 207
Strategy Highlight 7.1: TRANSACTION COST ECONOMICS ANALYZES VERTICAL
GROWTH STRATEGY 210
xiv CONTENTS
Global Issue: COMPANIES LOOK TO INTERNATIONAL MARKETS
FOR HORIZONTAL GROWTH 212
Strategy Highlight 7.2: SCREENING CRITERIA FOR CONCENTRIC
DIVERSIFICATION 215
Controversies in Directional Growth Strategies 216
Stability Strategies 217
Retrenchment Strategies 218
7.3 Portfolio Analysis 220
BCG Growth-Share Matrix 221
Environmental Sustainability Issue: GENERAL MOTORS
AND THE ELECTRIC CAR 222
GE Business Screen 223
Advantages and Limitations of Portfolio Analysis 225
Managing a Strategic Alliance Portfolio 225
7.4 Corporate Parenting 226
Developing a Corporate Parenting Strategy 227
Horizontal Strategy and Multipoint Competition 228
7.5 End of Chapter Summary 229
C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 236
8.1 Functional Strategy 238
Marketing Strategy 238
Financial Strategy 239
Research and Development (R&D) Strategy 241
Operations Strategy 242
Global Issue: INTERNATIONAL DIFFERENCES ALTER WHIRLPOOL’S
OPERATIONS STRATEGY 243
Purchasing Strategy 244
Environmental Sustainability Issue: OPERATIONS NEED FRESH WATER
AND LOTS OF IT! 245
Logistics Strategy 246
Human Resource Management (HRM) Strategy 246
Information Technology Strategy 247
8.2 The Sourcing Decision: Location of Functions 247
8.3 Strategies to Avoid 250
8.4 Strategic Choice: Selecting the Best Strategy 251
Constructing Corporate Scenarios 251
Process of Strategic Choice 257
CONTENTS xv
8.5 Developing Policies 258
8.6 End of Chapter Summary 259
Ending Case for Part Three: KMART AND SEARS: STILL STUCK IN THE MIDDLE? 266
PART FOUR Strategy Implementation and Control 269
C H A P T E R 9 Strategy Implementation: Organizing for Action 270
9.1 Strategy Implementation 272
9.2 Who Implements Strategy? 273
9.3 What Must Be Done? 273
Developing Programs, Budgets, and Procedures 274
Environmental Sustainability Issue: FORD’S SOYBEAN SEAT FOAM PROGRAM 274
Strategy Highlight 9.1: THE TOP TEN EXCUSES FOR BAD SERVICE 277
Achieving Synergy 278
9.4 How Is Strategy to Be Implemented? Organizing for Action 278
Structure Follows Strategy 279
Stages of Corporate Development 280
Organizational Life Cycle 283
Advanced Types of Organizational Structures 285
Reengineering and Strategy Implementation 288
Six Sigma 289
Designing Jobs to Implement Strategy 290
Strategy Highlight 9.2: DESIGNING JOBS WITH THE JOB CHARACTERISTICS MODEL 291
9.5 International Issues in Strategy Implementation 291
International Strategic Alliances 292
Stages of International Development 293
Global Issue: MULTIPLE HEADQUARTERS: A SIXTH STAGE
OF INTERNATIONAL DEVELOPMENT? 294
Centralization Versus Decentralization 294
9.6 End of Chapter Summary 296
C H A P T E R 1 0 Strategy Implementation: Staffing and Directing 300
10.1 Staffing 302
Staffing Follows Strategy 303
Selection and Management Development 305
Strategy Highlight 10.1: HOW HEWLETT-PACKARD IDENTIFIES POTENTIAL EXECUTIVES 306
Problems in Retrenchment 308
International Issues in Staffing 309
xvi CONTENTS
10.2 Leading 311
Managing Corporate Culture 311
Environmental Sustainability Issue: ABBOTT LABORATORIES’ NEW PROCEDURES
FOR GREENER COMPANY CARS 312
Action Planning 316
Management by Objectives 318
Total Quality Management 318
International Considerations in Leading 319
Global Issue: CULTURAL DIFFERENCES CREATE IMPLEMENTATION
PROBLEMS IN MERGER 321
10.3 End of Chapter Summary 322
C H A P T E R 1 1 Evaluation and Control 328
11.1 Evaluation and Control in Strategic Management 330
11.2 Measuring Performance 332
Appropriate Measures 332
Types of Controls 332
Activity-Based Costing 334
Enterprise Risk Management 335
Primary Measures of Corporate Performance 335
Environmental Sustainability Issue: HOW GLOBAL WARMING COULD
AFFECT CORPORATE VALUATION 340
Primary Measures of Divisional and Functional Performance 342
International Measurement Issues 344
Global Issue: COUNTERFEIT GOODS AND PIRATED SOFTWARE:
A GLOBAL PROBLEM 346
11.3 Strategic Information Systems 347
Enterprise Resource Planning (ERP) 347
Radio Frequency Identification (RFID) 348
Divisional and Functional IS Support 348
11.4 Problems in Measuring Performance 348
Short-Term Orientation 349
Goal Displacement 350
11.5 Guidelines for Proper Control 351
Strategy Highlight 11.1: SOME RULES OF THUMB IN STRATEGY 351
11.6 Strategic Incentive Management 352
11.7 End of Chapter Summary 354
Ending Case for Part Four: HEWLETT-PACKARD BUYS EDS 360
CONTENTS xvii
PART FIVE Introduction to Case Analysis 363
C H A P T E R 1 2 Suggestions for Case Analysis 364
12.1 The Case Method 365
12.2 Researching the Case Situation 366
12.3 Financial Analysis: A Place to Begin 366
Analyzing Financial Statements 369
Environmental Sustainability Issue: IMPACT OF CARBON TRADING 370
Global Issue: FINANCIAL STATEMENTS OF MULTINATIONAL CORPORATIONS:
NOT ALWAYS WHAT THEY SEEM 371
Common-Size Statements 371
Z-value and Index of Sustainable Growth 371
Useful Economic Measures 372
12.4 Format for Case Analysis: The Strategic Audit 373
12.5 End of Chapter Summary 375
APPENDIX 12.A Resources for Case Research 377
APPENDIX 12.B Suggested Case Analysis Methodology Using the Strategic Audit 380
APPENDIX 12.C Example of a Student-Written Strategic Audit 383
Ending Case for Part Five: IN THE GARDEN 391
GLOSSARY G-1
NAME INDEX I-1
SUBJECT INDEX I-1
PART SIX WEB CHAPTERS Other Strategic Issues
W E B C H A P T E R A Strategic Issues in Managing Technology and Innovation
1 The Role of Management
Strategy Highlight 1: EXAMPLES OF INNOVATION EMPHASIS IN MISSION
STATEMENTS
2 Environmental Scanning
External Scanning
Internal Scanning
3 Strategy Formulation
Product vs. Process R&D
Technology Sourcing
Global Issue: USE OF INTELLECTUAL PROPERTY AT HUAWEI TECHNOLOGIES
Importance of Technological Competence
Categories of Innovation
Product Portfolio
xviii CONTENTS
4 Strategy Implementation
Developing an Innovative Entrepreneurial Culture
Organizing for Innovation: Corporate Entrepreneurship
Strategy Highlight 2: HOW NOT TO DEVELOP AN INNOVATIVE ORGANIZATION
5 Evaluation and Control
Evaluation and Control Techniques
Evaluation and Control Measures
6 End of Chapter Summary
W E B C H A P T E R B Strategic Issues in Entrepreneurial Ventures and Small Businesses
1 Importance of Small Business and Entrepreneurial Ventures
Global Issue: ENTREPRENEURSHIP: SOME COUNTRIES ARE MORE
SUPPORTIVE THAN OTHERS
Definition of Small-Business Firms and Entrepreneurial
Ventures
The Entrepreneur as Strategist
2 Use of Strategic Planning and Strategic Management
Degree of Formality
Usefulness of the Strategic Management Model
Usefulness of the Strategic Decision-Making Process
3 Issues in Corporate Governance
Boards of Directors and Advisory Boards
Impact of the Sarbanes-Oxley Act
4 Issues in Environmental Scanning and Strategy Formulation
Sources of Innovation
Factors Affecting a New Venture’s Success
Strategy Highlight 1: SUGGESTIONS FOR LOCATING AN OPPORTUNITY
AND FORMULATING A BUSINESS STRATEGY
5 Issues in Strategy Implementation
Substages of Small Business Development
Transfer of Power and Wealth in Family Businesses
6 Issues in Evaluation and Control
7 End of Chapter Summary
W E B C H A P T E R C Strategic Issues in Not-for-Profit Organizations
1 Why Not-for-Profit?
Global Issue: WHICH IS BEST FOR SOCIETY: BUSINESS
OR NOT-FOR-PROFIT?
CONTENTS xix
2 Importance of Revenue Source
Sources of Not-for-Profit Revenue
Patterns of Influence on Strategic Decision Making
Usefulness of Strategic Management Concepts and Techniques
3 Impact of Constraints on Strategic Management
Impact on Strategy Formulation
Impact on Strategy Implementation
Impact on Evaluation and Control
4 Not-for-Profit Strategies
Strategic Piggybacking
Strategy Highlight 1: RESOURCES NEEDED FOR SUCCESSFUL STRATEGIC
PIGGYBACKING
Mergers
Strategic Alliances
5 End of Chapter Summary
PART SEVEN Cases in Strategic Management 1-1
S E C T I O N A Corporate Governance and Social Responsibility: Executive Leadership
CASE 1 The Recalcitrant Director at Byte Products Inc.: Corporate Legality versus
Corporate Responsibility 1-7
(Contributors: Dan R. Dalton, Richard A. Cosier, and Cathy A. Enz)
A plant location decision forces a confrontation between the board of directors and the CEO regarding
an issue in social responsibility and ethics.
CASE 2 The Wallace Group 2-1
(Contributor: Laurence J. Stybel)
Managers question the company’s strategic direction and how it is being managed by its founder
and CEO. Company growth has resulted not only in disorganization and confusion among
employees, but in poor overall performance. How should the board deal with the company’s
founder?
S E C T I O N B Business Ethics
CASE 3 Everyone Does It 3-1
(Contributors: Steven M. Cox and Shawana P. Johnson)
When Jim Willis, Marketing VP, learns that the launch date for the company’s new satellite will
be late by at least a year, he is told by the company’s president to continue using the earlier
published date for the launch. When Jim protests that the use of an incorrect date to market
contracts is unethical, he is told that spacecraft are never launched on time and that it is common
industry practice to list unrealistic launch dates. If a realistic date was used, no one would contract
with the company.
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CASE 4 The Audit 4-1
(Contributors: John A. Kilpatrick, Gamewell D. Gantt, and George A. Johnson)
A questionable accounting practice by the company being audited puts a new CPA in a difficult
position. Although the practice is clearly wrong, she is being pressured by her manager to ignore it
because it is common in the industry.
S E C T I O N C International Issues in Strategic Management
CASE 5 Starbucks’ Coffee Company: The Indian Dilemma 5-1
(Contributors: Ruchi Mankad and Joel Sarosh Thadamalla)
Starbucks is the world’s largest coffee retailer with over 11,000 stores in 36 countries and over
10,000 employees. The case focuses on India as a potential market for the coffee retailer, presenting
information on India’s societal environment and beverage industry. Profiles are provided for various
existing coffee shop chains in India. The key issue in the case revolves around the question: Are
circumstances right for Starbucks to enter India?
CASE 6 Guajilote Cooperativo Forestal: Honduras 6-1
(Contributors: Nathan Nebbe and J. David Hunger)
This forestry cooperative has the right to harvest, transport, and sell fallen mahogany trees in
La Muralla National Park of Honduras. Although the cooperative has been successful thus far, it is
facing some serious issues: low prices for its product, illegal logging, deforestation by poor farmers,
and possible world trade restrictions on the sale of mahogany.
S E C T I O N D General Issues in Strategic Management
I N D U S T RY O N E : Information Technology
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-1
(Contributors: Kathryn E. Wheelen, Thomas L. Wheelen II, Richard D. Wheelen, Moustafa H.
Abdelsamad, Bernard A. Morin, Lawrence C. Pettit, David B. Croll, and Thomas L. Wheelen)
Apple, the first company to mass-market a personal computer, had become a minor player in an
industry dominated by Microsoft. After being expelled from the company in 1985, founder Steve Jobs
returned as CEO in 1997 to reenergize the firm. The introduction of the iPod in 2001, followed by the
iPad, catapulted Apple back into the spotlight. However, in 2011 Jobs was forced to take his third
medical leave, leading to questions regarding his ability to lead Apple. How can Apple continue its
success? How dependent is the company on Steve Jobs?
CASE 8 iRobot: Finding the Right Market Mix? 8-1
(Contributor: Alan N. Hoffman)
Founded in 1990, iRobot was among the first companies to introduce robotic technology into the
consumer market. Employing over 500 robotic professionals, the firm planned to lead the robotics
industry. Unfortunately, its largest revenue source, home care robots, are a luxury good and vulnerable
to recessions. Many of iRobot’s patents are due to expire by 2019. The firm is highly dependent upon
suppliers to make its consumer products and the U.S. government for military sales. What is the best
strategy for its future success?
CASE 9 Dell Inc.: Changing the Business Model (Mini Case) 9-1
(Contributor: J. David Hunger)
Dell, once the largest PC vendor in the world, is now battling with Acer for second place in the global PC
market. Its chief advantages—direct marketing and power over suppliers—no longer provided a
competitive advantage. The industry’s focus has shifted from desktop PCs to mobile computing, software,
and technology services, areas of relative weakness for Dell. Is it time for Dell to change its strategy?
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CASE 10 Rosetta Stone Inc.: Changing the Way People Learn Languages 10-1
(Contributors: Christine B. Buenafe and Joyce P. Vincelette)
Rosetta Stone’s mission was to change the way people learn languages. The company blended
language learning with technology at a time when globalization connected more and more individuals
and institutions to each other. How should the company move forward? Would it be appropriate for
Rosetta Stone to offer products like audio books or services in order to increase market share? Which
international markets could provide the company with a successful future?
CASE 11 Logitech (Mini Case) 11-1
(Contributor: Alan N. Hoffman)
Logitech, the world’s leading provider of computer peripherals, was on the forefront of mouse,
keyboard, and video conferencing technology. By 2010, however, Logitech’s products were threatened
by new technologies, such as touch pads, that could replace both the mouse and keyboard. As the
peripherals market begins to disintegrate, Logitech is considering a change in strategy.
I N D U S T RY T W O : INTERNET COMPANIES
CASE 12 Google Inc. (2010): The Future of the Internet Search Engine 12-1
(Contributor: Patricia A. Ryan)
Google, an online company that provides a reliable Internet search engine, was founded in 1998 and soon
replaced Yahoo as the market leader in Internet search engines. By 2010, Google was one of the strongest
brands in the world. Nevertheless, its growth by acquisition strategy was showing signs of weakness. Its
2006 acquisition of YouTube had thus far not generated significant revenue growth. Groupon, a shopping
Web site, rebuffed Google’s acquisition attempt in 2010. Is it time for a strategic change?
CASE 13 Reorganizing Yahoo! 13-1
(Contributors: P. Indu and Vivek Gupta)
Yahoo! created the first successful Internet search engine, but by 2004 it was losing its identity. Was it
a search engine, a portal, or a media company? On December 5, 2006, Yahoo’s CEO announced a
reorganization of the company into three groups. It was hoped that a new mission statement and a new
structure would make Yahoo leaner and more responsive to customers. Would this be enough to turn
around the company?
I N D U S T RY T H R E E : ENTERTAINMENT AND LEISURE
CASE 14 TiVo Inc.: TiVo vs. Cable and Satellite DVR: Can TiVo survive? 14-1
(Contributors: Alan N. Hoffman, Randy Halim, Rangki Son, and Suzanne Wong)
TiVo was founded to create a device capable of recording digitized video on a computer hard drive for
television viewing. Even though revenues had jumped from $96 million in 2003 to $259 million in
2007, the company had never earned a profit. Despite many alliances, TiVo faced increasing
competition from generic DVRs offered by satellite and cable companies. How long can the company
continue to sell TiVo DVRs when the competition sells generic DVRs at a lower price or gives them
away for free?
CASE 15 Marvel Entertainment Inc. 15-1
(Contributors: Ellie A. Fogarty and Joyce P. Vincelette)
Marvel Entertainment was known for its comic book characters Captain America, Spider Man,
the Fantastic Four, the Incredible Hulk, the Avengers, and the X-Men. With its 2008 self-produced
films, Iron Man and The Incredible Hulk, Marvel had expanded out of comic books to become a
leader in the entertainment industry. The company was no longer competing against other comic
book publishers like DC Comics, but was now competing against entertainment giants like Walt
Disney and NBC Universal. What should Marvel’s management do to ensure the company’s future
success?
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CASE 16 Carnival Corporation and plc (2010) 16-1
(Contributors: Michael J. Keeffe, John K. Ross III, Sherry K. Ross, Bill J. Middlebrook,
and Thomas L. Wheelen)
With its “fun ship,” Carnival Cruises changed the way people think of ocean cruises. The cruise
became more important than the destination. Through acquisition, Carnival expanded its product line
to encompass an entire range of industry offerings. How can Carnival continue to grow in the industry
it now dominates?
I N D U S T RY F O U R : TRANSPORTATION
CASE 17 Chrysler in Trouble 17-1
(Contributors: Barnali Chakraborty and Vivek Gupta)
On April 30, 2009, Chrysler Motors, the third-largest auto manufacturer in the United States, filed
for bankruptcy protection along with its 24 wholly owned U.S. subsidiaries. As a condition of the
U.S. federal government’s loan of more than $8 billion, Fiat was given 20% of the new Chrysler
Corporation with the option of increasing its stake to 51% by 2016 after the new company had
repaid the federal government’s loan. What does Chrysler need to do to ensure the success of its
partnership with Fiat?
CASE 18 Tesla Motors Inc. (Mini Case) 18-1
(Contributor: J. David Hunger)
Tesla Motors was founded in 2004 to produce electric automobiles. Its first car, the Tesla Roadster,
sold for $101,000. It could accelerate from zero to 60 mph in 3.9 seconds and cruise for 236 miles on a
single charge. In contrast to existing automakers, Tesla sold and serviced its cars through the Internet
and its own Tesla stores. With the goal of building a full line of electric vehicles, Tesla Motors faced
increasing competition from established automakers. How could Tesla Motors succeed in an industry
dominated by giant global competitors?
CASE 19 Harley-Davidson Inc. 2008: Thriving through a Recession 19-1
(Contributors: Patricia A. Ryan and Thomas Wheelen)
Harley-Davidson 2008: Thriving Through Recession is a modern success story of a motorcycle
company that turned itself around by emphasizing quality manufacturing and image marketing. After
consistently growing through the 1990s, sales were showing signs of slowing as the baby boomers
continued to age. Safety was also becoming an issue. For the first time in recent history, sales and
profits declined in 2007 from 2006. Analysts wondered how the company would be affected in a
recession. How does Harley-Davidson continue to grow at its past rate?
CASE 20 JetBlue Airways: Growing Pains? 20-1
(Contributors: Shirisha Regani and S. S. George)
JetBlue Airways had been founded as a “value player” in the niche between full service airlines and
low-cost carriers. Competition had recently intensified and several airlines were taking advantage of
bankruptcy protection to recapture market share through price cuts. JetBlue’s operating costs were
rising as a result of increasing fuel costs, aircraft maintenance expenses, and service costs. Has
JetBlue been growing too fast and was growth no longer sustainable?
CASE 21 TomTom: New Competition Everywhere! 21-1
(Contributor: Alan N. Hoffman)
TomTom, an Amsterdam-based company that provided navigation services and devices, led the
navigation systems market in Europe and was second in popularity in the United States. However, the
company was facing increasing competition from other platforms using GPS technology like cell
phones and Smartphones with a built-in navigation function. As its primary markets in the United
States and Europe mature, how can the company ensure its future growth and success?
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I N D U S T RY F I V E : CLOTHING
CASE 22 Volcom Inc.: Riding the Wave 22-1
(Contributors: Christine B. Buenafe and Joyce P. Vincelette)
Volcom was formed south of Los Angeles in 1991 as a clothing company rooted in the action sports of
skateboarding, surfing, and snowboarding. By 2008, Volcom-branded products were sold throughout
the United States and in over 40 countries. It did not own any manufacturing facilities, but instead
worked with foreign contract manufacturers. As a primary competitor in the boardsports community,
Volcom was committed to maintaining its brand, position, and lifestyle and needed to reassess its
strategy.
CASE 23 TOMS Shoes (Mini Case) 23-1
(Contributor: J. David Hunger)
Founded in 2006 by Blake Mycoskie, TOMS Shoes is an American footwear company based in Santa
Monica, California. Although TOMS Shoes is a for-profit business, its mission is more like that of a
not-for-profit organization. The firm’s reason for existence is to donate to children in need one new
pair of shoes for every pair of shoes sold. By 2010, the company had sold over one million pairs of
shoes. How should the company plan its future growth?
I N D U S T RY S I X : SPECIALTY RETAILING
CASE 24 Best Buy Co. Inc.: Sustainable Customer Centricity Model? 24-1
(Contributor: Alan N. Hoffman)
Best Buy, the largest consumer electronics retailer in the United States, operates 4,000 stores in North
America, China, and Turkey. Best Buy distinguishes itself from competitors by deploying a
differentiation strategy based on superior service rather than low price. The recent recession has
stressed its finances and the quality of its customer service. How can Best Buy continue to have
innovative products, top-notch employees, and superior customer service while facing increased
competition, operational costs, and financial stress?
CASE 25 The Future of Gap Inc. 25-1
(Contributor: Mridu Verma)
Gap Inc. offered clothing, accessories, and personal care products under the Gap, Banana Republic,
and Old Navy brands. After a new CEO introduced a turnaround strategy, sales increased briefly, then
fell. Tired of declining sales, the board of directors hired Goldman Sachs to explore strategies to
improve, ranging from the sale of its stores to spinning off a single division.
CASE 26 Rocky Mountain Chocolate Factory Inc. (2008) 26-1
(Contributors: Annie Phan and Joyce P. Vincelette)
Rocky Mountain Chocolate Factory had five company-owned and 329 franchised stores in 38 states,
Canada, and the United Arab Emirates. Even though revenues and net income had increased from
2005 through 2008, they had been increasing at a decreasing rate. Candy purchased from the factory
by the stores had actually dropped 9% in 2008 from 2007. Was the bloom off the rose at Rocky
Mountain Chocolate?
CASE 27 Dollar General Corporation (Mini Case) 27-1
(Contributor: Kathryn E. Wheelen)
With annual revenues of $12.7 billion and 9,200 stores in 35 states, Dollar General is the largest of the
discount “dollar stores” in the United States. Although far smaller than its “big brothers” Wal-Mart
and Target, Dollar General has done very well during the recent economic recession. In 2011, it plans
to open 625 new stores in three new states. Given that the company has substantial long-term debt, is
this the right time to expand the company’s operations?
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I N D U S T RY S E V E N : MANUFACTURING
CASE 28 Inner-City Paint Corporation (Revised) 28-1
(Contributors: Donald F. Kuratko and Norman J. Gierlasinski)
Inner-City Paint makes paint for sale to contractors in the Chicago area. However, the founder’s lack
of management knowledge is creating difficulties for the firm, and the company is in financial
difficulty. Unless something is done soon, it may go out of business.
CASE 29 The Carey Plant 29-1
(Contributors: Thomas L. Wheelen and J. David Hunger)
The Carey Plant was a profitable manufacturer of quality machine parts until it was acquired by the
Gardner Company. Since its acquisition, the plant has been plagued by labor problems, increasing
costs, leveling sales, and decreasing profits. Gardner Company’s top management is attempting to
improve the plant’s performance and better integrate its activities with those of the corporation by
selecting a new person to manage the plant.
I N D U S T RY E I G H T: FOOD AND BEVERAGE
CASE 30 The Boston Beer Company: Brewers of Samuel Adams Boston Lager
(Mini Case) 30-1
(Contributor: Alan N. Hoffman)
The Boston Beer Company was founded in 1984 by Jim Koch, viewed as the pioneer of the American
craft beer revolution. Brewing over 1 million barrels of 25 different styles of beer, Boston Beer is the
sixth-largest brewer in the United States. Even though overall domestic beer sales declined 1.2% in
2010, sales of craft beer have increased 20% since 2002, with Boston Beer’s increasing 22% from
2007 to 2009. How can the company continue its rapid growth in a mature industry?
CASE 31 Wal-Mart and Vlasic Pickles 31-1
(Contributor: Karen A. Berger)
A manager of Vlasic Foods International closed a deal with Wal-Mart that resulted in selling more
pickles than Vlasic had ever sold to any one account. The expected profit of one to two cents per jar
was not sustainable, however, due to unplanned expenses. Vlasic’s net income plummeted and the
company faced bankruptcy. Given that Wal-Mart was Vlasic’s largest customer, what action should
management take?
CASE 32 Panera Bread Company (2010): Still Rising Fortunes? 32-1
(Contributors: Joyce Vincelette and Ellie A. Fogarty)
Panera Bread is a successful bakery-café known for its quality soups and sandwiches. Even though
Panera’s revenues and net earnings have been rising rapidly, new unit expansion throughout North
America has fueled this growth. Will revenue growth stop once expansion slows? The retirement of
CEO Ronald Shaich, the master baker who created the “starter” for the company’s phenomenal
growth, is an opportunity to rethink Panera’s growth strategy.
CASE 33 Whole Foods Market (2010): How to Grow in an Increasingly Competitive Market?
(Mini Case) 33-1
(Contributors: Patricia Harasta and Alan N. Hoffman)
Whole Foods Market is the world’s leading retailer of natural and organic foods. The company
differentiates itself from competitors by focusing on innovation, quality, and service excellence,
allowing it to charge premium prices. Although the company dominates the natural/organic foods
category in North America, it is facing increasing competition from larger food retailers, such as Wal-
Mart, who are adding natural/organic foods to their offerings.
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CASE 34 Burger King (Mini Case) 34-1
(Contributor: J. David Hunger)
Founded in Florida in 1953, Burger King has always trailed behind McDonald’s as the second-largest
fast-food hamburger chain in the world. Although its total revenues dropped only slightly from 2009,
its 2010 profits dropped significantly, due to high expenses. Burger King’s purchase by an investment
group in 2010 was an opportunity to rethink the firm’s strategy.
CASE 35 Church & Dwight: Time to Rethink the Portfolio? 35-1
(Contributor: Roy A. Cook)
Church & Dwight, the maker of ARM & HAMMER Baking Soda, has used brand extension to
successfully market multiple consumer products based on sodium bicarbonate. Searching for a new
growth strategy, the firm turned to acquisitions. Can management successfully achieve a balancing act
based on finding growth through expanded uses of sodium bicarbonate while assimilating a divergent
group of consumer products into an expanding international footprint?
S E C T I O N E Web Mini Cases
Additional Mini Cases Available on the Companion Web Site at
www.pearsonhighered.com/wheelen.
W E B C A S E 1 Eli Lily & Company
(Contributor: Maryanne M. Rouse)
A leading pharmaceutical company, Eli Lilly produces a wide variety of ethical drugs and animal
health products. Despite an array of new products, the company’s profits declined after the firm lost
patent protection for Prozac. In addition, the FDA found quality problems at several of the company’s
manufacturing sites, resulting in a delay of new product approvals. How should Lily position itself in
a very complex industry?
W E B C A S E 2 Tech Data Corporation
(Contributor: Maryanne M. Rouse)
Tech Data, a distributor of information technology and logistics management, has rapidly
grown through acquisition to become the second-largest global IT distributor. Sales and profits
have been declining, however, since 2001. As computers become more like a commodity, the
increasing emphasis on direct distribution by manufacturers threaten wholesale distributors like
Tech Data.
W E B C A S E 3 Stryker Corporation
(Contributor: Maryanne M. Rouse)
Stryker is a leading maker of specialty medical and surgical products, a market expected to show
strong sales growth. Stryker markets its products directly to hospitals and physicians in the United
States and 100 other countries. Given the decline in the number of hospitals due to consolidation
and cost containment efforts by government programs and health care insurers, the industry
expects continued downward pressure on prices. How can Stryker effectively deal with these
developments?
W E B C A S E 4 Sykes Enterprises
(Contributor: Maryanne M. Rouse)
Sykes provides outsourced customer relationship management services worldwide in a highly
competitive, fragmented industry. Like its customers, Sykes has recently been closing its call
centers in America and moving to Asia in order to reduce costs. Small towns felt betrayed by the
firm’s decision to leave—especially after providing financial incentives to attract the firm.
Nevertheless, declining revenue and net income has caused the company’s stock to drop to an
all-time low.
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W E B C A S E 5 Pfizer Inc.
(Contributor: Maryanne M. Rouse)
With its acquisition in 2000 of rival pharmaceutical firm Warner-Lambert for its Lipitor prescription
drug, Pfizer has become the world’s largest ethical pharmaceutical company in terms of sales. Already
the leading company in the United States, Pfizer’s purchase of Pharmacia in 2002 moved Pfizer from
fourth to first place in Europe. Will large size hurt or help the company’s future growth and
profitability in an industry facing increasing scrutiny?
W E B C A S E 6 Williams-Sonoma
(Contributor: Maryanne M. Rouse)
Williams-Sonoma is a specialty retailer of home products. Following a related diversification
growth strategy, the company operates 415 Williams-Sonoma, Pottery Barn, and Hold Everything
retail stores throughout North America. Its direct sales segment includes six retail catalogues and
three e-commerce sites. The company must deal with increasing competition in this fragmented
industry characterized by low entry barriers.
W E B C A S E 7 Tyson Foods Inc.
(Contributor: Maryanne M. Rouse)
Tyson produces and distributes beef, chicken, and pork products in the United States. It acquired IBP, a
major competitor, but has been the subject of lawsuits by its employees and the EPA. How should
management deal with its poor public relations and position the company to gain and sustain competitive
advantage in an industry characterized by increasing consolidation and intense competition?
W E B C A S E 8 Southwest Airlines Company
(Contributor: Maryanne M. Rouse)
The fourth-largest U.S. airline in terms of passengers carried and second-largest in scheduled domestic
departures, Southwest was the only domestic airline to remain profitable in 2001. Emphasizing high-
frequency, short-haul, point-to-point, and low-fare service, the airline has the lowest cost per available
seat mile flown of any U.S. major passenger carrier. Can Southwest continue to be successful as
competitors increasingly imitate its competitive strategy?
W E B C A S E 9 Outback Steakhouse Inc.
(Contributor: Maryanne M. Rouse)
With 1,185 restaurants in 50 states and 21 foreign countries, Outback (OSI) is one of the largest casual
dining restaurant companies in the world. In addition to Outback Steakhouse, the company is
composed of Carrabba’s Italian Grill, Fleming’s Prime Steakhouse & Wine Bar, Bonefish Grill, Roy’s,
Lee Roy Selmon’s, Cheeseburger in Paradise, and Paul Lee’s Kitchen. Analysts wonder how long OSI
can continue to grow by adding new types of restaurants to its portfolio.
W E B C A S E 10 Intel Corporation
(Contributor: J. David Hunger)
Although more than 80% of the world’s personal computers and servers use its microprocessors, Intel
is facing strong competition from AMD in a maturing market. Sales growth is slowing. Profits are
expected to rise only 5% in 2006 compared to 40% annual growth previously. The new CEO decides to
reinvent Intel to avoid a fate of eventual decline.
W E B C A S E 11 AirTran Holdings Inc.
(Contributor: Maryanne M. Rouse)
AirTran (known as ValuJet before a disastrous crash in the Everglades) is the second-largest low-
fare scheduled airline (after Southwest) in the United States in terms of departures and, along with
Southwest, the only U.S. airline to post a profit in 2004. The company’s labor costs as a percentage
of sales are the lowest in the industry. Will AirTran continue to be successful in this highly
competitive industry?
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W E B C A S E 12 Boise Cascade/Office Max
(Contributor: Maryanne M. Rouse)
Boise Cascade, an integrated manufacturer and distributor of paper, packaging, and wood products,
purchased OfficeMax, the third-largest office supplies catalogue retailer (after Staples and Office
Depot), in 2003. Soon thereafter, Boise announced that it was selling its land, plants, headquarters
location, and even its name to an equity investment firm. Upon completion of the sale in 2004, the
company assumed the name of OfficeMax. Can this manufacturer become a successful retailer?
W E B C A S E 13 H. J. Heinz Company
(Contributor: Maryanne M. Rouse)
Heinz, a manufacturer and marketer of processed food products, pursued global growth via market
penetration and acquisitions. Unfortunately, its modest sales growth was primarily from its
acquisitions. Now that the firm has divested a number of lines of businesses and brands to Del Monte
Foods, analysts wonder how a 20% smaller Heinz will grow its sales and profits in this very
competitive industry.
W E B C A S E 14 Nike Inc.
(Contributor: Maryanne M. Rouse)
Nike is the largest maker of athletic footwear and apparel in the world with a U.S. market share
exceeding 40%. Since almost all its products are manufactured by 700 independent contractors
(99% of which are in Southeast Asia), Nike is a target of activists opposing manufacturing practices
in developing nations. Although industry sales growth in athletic footwear is slowing, Nike refused
to change its product mix in 2002 to suit Foot Locker, the dominant global footwear retailer. Is it
time for Nike to change its strategy and practices?
W E B C A S E 15 Six Flags Inc.: The 2006 Business Turnaround
(Contributor: Patricia A. Ryan)
Known for its fast roller coasters and adventure rides, Six Flags has successfully built a group of
regional theme and water parks in the United States. Nevertheless, the company has not turned a
profit since 1998. Long-term debt had increased to 61% of total assets by 2005. New management is
implementing a retrenchment strategy, but industry analysts are unsure if this will be enough to save
the company.
W E B C A S E 16 Lowe’s Companies Inc.
(Contributor: Maryanne M. Rouse)
As the second-largest U.S. “big box” home improvement retailer (behind Home Depot), Lowe’s
competes in a highly fragmented industry. The company has grown with the increase in home
ownership and has no plans to expand internationally. With more than 1,000 stores in 2004, Lowe’s
intended to increase its U.S. presence with 150 store openings per year in 2005 and 2006. Are there
limits to Lowe’s current growth strategy?
W E B C A S E 17 Movie Gallery Inc.
(Contributor: J. David Hunger)
Movie Gallery is the second-largest North American video retail rental company, specializing in the
rental and sale of movies and video games through its Movie Gallery and Hollywood Entertainment
stores. Growing through acquisitions, the company is heavily in debt. The recent rise of online video
rental services, such as Netflix, is cutting into retail store revenues and reducing the company’s cash
flow. With just $135 million in cash at the end of 2005, Movie Gallery’s management finds itself facing
possible bankruptcy.
xxviii CONTENTS
Preface
Welcome to the 13th edition of Strategic Management and Business Policy! Although the chapters
are the same as those in the 12th edition, many of the cases are new and different. We completely
revised seven of your favorite cases (Apple, Dell, Google, Carnival, Panera Bread, Whole
Foods, and Church & Dwight) and added 12 brand-new ones (iRobot, Rosetta Stone, Logitech,
Chrysler, Tesla Motors, TomTom, Volcom, TOMS Shoes, Best Buy, Dollar General, Boston
Beer, and Burger King) for a total of 19 new cases! More than half of the cases in this book are
new to this edition! Although we still make a distinction between full-length and mini cases, we
have interwoven them throughout the book to better identify them with their industries.
This edition continues the theme that runs throughout all 12 chapters: global environmental
sustainability. This strategic issue will become even more important in the years ahead, as all
of us struggle to deal with the consequences of climate change, global warming, and energy
availability. We continue to be the most comprehensive strategy book on the market, with
chapters ranging from corporate governance and social responsibility to competitive strategy,
functional strategy, and strategic alliances. To keep the size of the book manageable, we offer
special issue chapters dealing with technology, entrepreneurship, and not-for-profit organiza-
tions on the Web site (www.pearsonhighered.com/wheelen).
FEATURES NEW TO THIS 13th EDITION
Nineteen New Cases: Both Full Length and Mini Length
Eleven full-length new or updated comprehensive cases and eight mini-length cases have been
added to support the 16 popular full-length cases carried forward from past editions. Twelve
of the cases are brand new. Seven are updated favorites from past editions. Of the 35 cases
appearing in this book, 22 are exclusive and do not appear in other books.
� Five of the new cases deal with technology issues (Apple, iRobot, Dell, Rosetta Stone,
and Logitech).
� One of the new cases deals with the Internet (Google).
� One new case involves entertainment (Carnival).
� Three new cases are of old and new transportation firms (Chrysler, TomTom, and Tesla
Motors).
� Two new cases are of entrepreneurial clothing companies (Volcom and TOMS Shoes).
� Two new specialty retailing cases spotlight electronics (Best Buy) and variety (Dollar
General).
� Five new cases come from the food, beverage, and restaurant industries (Boston Beer,
Panera Bread, Whole Foods Market, Burger King, and Church & Dwight).
HOW THIS BOOK IS DIFFERENT FROM OTHER
STRATEGY TEXTBOOKS
This book contains a Strategic Management Model that runs through the first 11 chapters
and is made operational through the Strategic Audit, a complete case analysis methodology.
The Strategic Audit provides a professional framework for case analysis in terms of external
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and internal factors and takes the student through the generation of strategic alternatives and
implementation programs.
To help the student synthesize the many factors in a complex strategy case, we developed
three useful techniques:
� External Factor Analysis (EFAS) Table in Chapter 4
This reduces the external Opportunities and Threats to the 8 to 10 most important exter-
nal factors facing management.
� Internal Factor Analysis (IFAS) Table in Chapter 5
This reduces the internal Strengths and Weaknesses to the 8 to 10 most important internal
factors facing management.
� Strategic Factor Analysis Summary (SFAS) Matrix in Chapter 6
This condenses the 16 to 20 factors generated in the EFAS and IFAS Tables into the 8 to 10
most important (strategic) factors facing the company. These strategic factors become the
basis for generating alternatives and a recommendation for the company’s future direction.
Suggestions for Case Analysis are provided in Appendix 12.B (end of Chapter 12) and
contain step-by-step procedures for how to use the Strategic Audit in analyzing a case. This
appendix includes an example of a student-written Strategic Audit. Thousands of students
around the world have applied this methodology to case analysis with great success. The
Case Instructor’s Manual contains examples of student-written Strategic Audits for each of
the full-length comprehensive strategy cases.
FEATURES FOCUSED ON ENVIRONMENTAL SUSTAINABILITY
� Each chapter contains a boxed insert dealing with an issue in environmental sustainability.
� Each chapter ends with Eco Bits, interesting tidbits of ecological information, such as the
number of plastic bags added to landfills each year.
� Special sections on sustainability are found in Chapters 1 and 3.
� A section on the natural environment is included in the societal and task environments in
Chapter 4.
TIME-TESTED FEATURES
This edition contains many of the same features and
content that helped make previous editions success-
ful. Some of the features are the following:
xxx PREFACE
� A Strategic Management Model runs through-
out the first 11 chapters as a unifying concept.
(Explained in Chapter 1)
� The Strategic Audit, a way to operationalize the strategic decision-
making process, serves as a checklist in case analysis. (Chapter 1)
� Corporate governance is examined in terms of the roles, re-
sponsibilities, and interactions of top management and the board
of directors and includes the impact of the Sarbanes-Oxley Act.
(Chapter 2)
� Social responsibility and managerial ethics are
examined in detail in terms of how they affect
strategic decision making. They include the
process of stakeholder analysis and the concept of
social capital. (Chapter 3)
� Equal emphasis is placed on environmental scan-
ning of the societal environment as well as on the
task environment. Topics include forecasting and
Miles and Snow’s typology in addition to compet-
itive intelligence techniques and Porter’s industry
analysis. (Chapter 4)
Discretionary
Ethical
LegalEconomic
Social
Responsibilities
FIGURE 3–1
Responsibilities
of Business
SOURCE: Based on A. B. Carroll, “A Three Dimensional Conceptual Model of Corporate Performance,” Academy
of Management Review (October 1979), pp. 497–505; A. B. Carroll, “Managing Ethically with Global Stakeholders:
A Present and Future Challenge,” Academy of Management Executive (May 2004), pp. 114–120; and A. B. Carroll,
“The Pyramid of Corporate Social Responsibility: Toward the Moral Management of Organizational Stakeholders,”
Business Horizons (July–August 1991), pp. 39–48.
� Core and distinctive competencies are examined within the framework of the resource-
based view of the firm. (Chapter 5)
� Organizational analysis includes material on business models, supply chain management,
and corporate reputation. (Chapter 5)
� Internal and external strategic factors are emphasized through the use of specially
designed EFAS, IFAS, and SFAS tables. (Chapters 4, 5, and 6)
� Functional strategies are examined in light of outsourcing. (Chapter 8)
PREFACE xxxi
� Two chapters deal with issues in strategy implementation,
such as organizational and job design plus strategy-manager fit,
action planning, corporate culture, and international strate-
gic alliances. (Chapters 9 and 10)
� A separate chapter on evaluation and control explains the importance of measurement
and incentives to organizational performance. (Chapter 11)
� Suggestions for in-depth case analysis pro-
vide a complete listing of financial ratios, rec-
ommendations for oral and written analysis,
and ideas for further research. (Chapter 12)
xxxii PREFACE
� The Strategic Audit Worksheet is based on the time-tested
Strategic Audit and is designed to help students organize and
structure daily case preparation in a brief period of time. The
worksheet works exceedingly well for checking the level of
daily student case preparation—especially for open class dis-
cussions of cases. (Chapter 12)
� Special chapters deal with strategic issues in managing
technology and innovation, entrepreneurial ventures and
small businesses, and not-for-profit organizations. (Web
Chapters A, B, and C, respectively) These issues are often
ignored by other strategy textbooks, but are available on this
book’s Web site at www.pearsonhighered.com/wheelen.
� An experiential exercise focusing on the
material covered in each chapter helps the
reader to apply strategic concepts to an actual
situation.
� A list of key terms and the pages in which they are discussed enable the reader to keep
track of important concepts as they are introduced in each chapter.
� Learning objectives begin each chapter.
� Each Part ends with a short case that acts to integrate the material discussed within
the previous chapters.
� Timely, well-researched, and class-tested cases deal with interesting companies and
industries. Many of the cases are about well-known, publicly held corporations—ideal
subjects for further research by students wishing to “update” the cases.
Both the text and the cases have been class-tested in strategy courses and revised based on
feedback from students and instructors. The first 11 chapters are organized around a Strategic
Management Model that begins each chapter and provides a structure for both content and
case analysis. We emphasize those concepts that have proven to be most useful in under-
standing strategic decision making and in conducting case analysis. Our goal was to make the
text as comprehensive as possible without getting bogged down in any one area. Endnote
references are provided for those who wish to learn more about any particular topic. All cases
are about actual organizations. The firms range in size from large, established multinationals
to small, entrepreneurial ventures, and cover a broad variety of issues. As an aid to case
analysis, we propose the Strategic Audit as an analytical technique.
PREFACE xxxiii
www.pearsonhighered.com/wheelen
SUPPLEMENTS
Instructor Resource Center
At www.pearsonhighered.com/irc, instructors can access teaching resources available with
this text in downloadable, digital format. Registration is simple and gives you immediate ac-
cess to new titles and new editions. As a registered faculty member, you can download re-
source files and receive immediate access and instructions for installing course management
content on your campus server. In case you ever need assistance, our dedicated technical sup-
port team is ready to assist instructors with questions about the media supplements that ac-
company this text. Visit http://247.pearsoned.com/ for answers to frequently asked questions
and toll-free user support phone numbers. The Instructor Resource Center provides the fol-
lowing electronic resources.
Instructor’s Manuals
Two comprehensive Instructor’s Manuals have been carefully constructed to accompany this
book. The first one accompanies the concepts chapters; the second one accompanies the cases.
Concepts Instructor’s Manual
To aid in discussing the 12 strategy chapters as well as the three web special issue chapters,
the Concepts Instructor’s Manual includes:
� Suggestions for Teaching Strategic Management: These include various teaching
methods and suggested course syllabi.
� Chapter Notes: These include summaries of each chapter, suggested answers to discus-
sion questions, and suggestions for using end-of-chapter cases/exercises and part-ending
cases, plus additional discussion questions (with answers) and lecture modules.
Case Instructor’s Manual
To aid in case method teaching, the Case Instructor’s Manual includes detailed suggestions
for use, teaching objectives, and examples of student analyses for each of the full-length com-
prehensive cases. This is the most comprehensive Instructor’s Manual available in strategic
management. A standardized format is provided for each case:
1. Case Abstract
2. Case Issues and Subjects
3. Steps Covered in the Strategic Decision-Making Process
4. Case Objectives
5. Suggested Classroom Approaches
6. Discussion Questions
7. Case Author’s Teaching Note
8. Student-Written Strategic Audit, if appropriate
9. EFAS, IFAS, and SFAS Exhibits
10. Financial Analysis—ratios and common-size income statements, if appropriate
PowerPoint Slides
PowerPoint slides, provided in a comprehensive package of text outlines and figures corre-
sponding to the text, are designed to aid the educator and supplement in-class lectures.
xxxiv PREFACE
www.pearsonhighered.com/irc
http://247.pearsoned.com/
Test Item File
This Test Item File contains over 1,200 questions, including multiple-choice, true/false, and
essay questions. Each question is followed by the correct answer, page reference, AACSB
category, and difficulty rating.
TestGen
TestGen software is preloaded with all of the Test Item File questions. It allows instructors to
manually or randomly view test questions, and to add, delete, or modify test-bank questions
as needed to create multiple tests.
Videos on DVD
Exciting and high-quality video clips help deliver engaging topics to the classroom to help
students better understand the concepts explained in the textbook. Please contact your local
representative to receive a copy of the DVD.
CourseSmart
CourseSmart eTextbooks were developed for students looking to save on required or recom-
mended textbooks. Students simply select their eText by title or author and purchase immedi-
ate access to the content for the duration of the course using any major credit card. With a
CourseSmart eText, students can search for specific keywords or page numbers, take notes
online, print out reading assignments that incorporate lecture notes, and bookmark important
passages for later review. For more information or to purchase a CourseSmart eTextbook, visit
www.coursesmart.com.
Acknowledgments
We thank the many people at Prentice Hall/Pearson who helped to make this edition possi-
ble. We thank our editor, Kim Norbuta. We are especially grateful to Kim’s project manager,
Claudia Fernandes, who managed to keep everything on an even keel. We also thank
Becca Groves and Emily Bush, who took the book through the production process.
We are very thankful to Jeanne McNett, Assumption College; Bob McNeal, Alabama
State University; Don Wicker, Brazosport College; Dan Kipley, Azusa Pacific University;
Roxanna Wright, Plymouth State University; Kristl Davison, University of Mississippi;
Francis Fabian, University of Memphis; Susan Fox-Wolfgramm, Hawaii Pacific University;
Conrad Francis, Nova Southeastern University; and Gene Simko, Monmouth University for
their constructive criticism of the 12th edition cases. They helped us to decide which of our
favorite cases to keep and which to delete or update.
We are very grateful to Kathy Wheelen for her first-rate administrative support of the
cases and to Alan N. Hoffman for helping us with the Case Instructor’s Manual. We are
especially thankful to the many students who tried out the cases we chose to include in this
book. Their comments helped us find any flaws in the cases before the book went to the
printer.
In addition, we express our appreciation to Wendy Klepetar, Management Department
Chair of Saint John’s University and the College of Saint Benedict, for her support and
provision of the resources so helpful to revise a textbook. Both of us acknowledge our debt to
PREFACE xxxv
www.coursesmart.com
Dr. William Shenkir and Dr. Frank S. Kaulback, former Deans of the McIntire School of
Commerce of the University of Virginia, for the provision of a work climate most supportive
to the original development of this book.
We offer a special thanks to the hundreds of case authors who have provided us with
excellent cases for the 13 editions of this book. We consider many of these case authors to be
our friends. A special thanks to you!! The adage is true: The path to greatness is through others.
Lastly, to the many strategy instructors and students who have moaned to us about their
problems with the strategy course: We have tried to respond to your problems and concerns as
best we could by providing a comprehensive yet usable text coupled with recent and complex
cases. To you, the people who work hard in the strategy trenches, we acknowledge our debt.
This book is yours.
T. L. W.
Saint Petersburg, Florida
J. D. H.
St. Joseph, Minnesota
xxxvi PREFACE
About the Contributors
MOUSTAFA H. ABDELSAMAD, DBA (George Washington University), is Dean of the College
of Business at Texas A&M University–Corpus Christi. He previously served as Dean of the
College of Business and Industry at University of Massachusetts–Dartmouth and as Professor
of Finance and Associate Dean of Graduate Studies in Business at Virginia Commonwealth
University. He is Editor–in-Chief of SAM Advanced Management Journal and International
President of the Society of Advancement of Management. He is author of A Guide to Capital
Expenditure Analysis and two chapters in the Dow Jones–Irwin Capital Budgeting Handbook.
He is the author and coauthor of numerous articles in various publications.
Hitesh (John) P. Adhia, CPA, MS and BA (University of South Florida), is the President and
Chief Investment Officer of Adhia Investment Advisors, Inc. (the “Firm”). Mr. Adhia is a CPA
and has been in the finace industry since 1982. Mr Adhia is the founder and Investment Man-
ager for the Adhia Twenty Fund, and the Adhia Health Care Fund, the Adhia Short Term Ad-
vantage Fund, the Adhia Arbitrage Fund, and the Adhia Derivative Fund. Prior to forming
Adhia Investment Advisors, Mr. Adhia owned a Tampa-based public accounting practice and
also served as Acting CFO and Independent Advisor to the Well Care Group of Companies. Mr.
Adhia has over twenty years experience in managing fixed income strategies.
KAREN A. BERGER, PhD (M. Phil and New York University), MBA (University of Connecticut),
MA (Columbia University), and BA (S.U.N.Y. at Buffalo), is Chairperson of the Marketing
Department and Associate Professor of Marketing at Pace University. She previously held aca-
demic positions with New York University, Stern School of Business, and Mercy College. Berger
has published literature in the field of Marketing and has won several teaching awards.
CHRISTINE B. BUENAFE, student of The College of New Jersey, co-author with Joyce
Vincelette of the Rosetta Stone and Volcom cases in this edition.
BARNALI CHAKRABORTY, is a faculty member at the ICFAI Center for Management Research
(ICMR).
RICHARD A. COISER, PhD (University of Iowa), is Dean and Leeds Professor of Management
at Purdue University. He formerly was Dean and Fred B. Brown Chair at the University of
Oklahoma and was Associate Dean for Academics and Professor of Business Administration
at Indiana University. He served as Chairperson of the Department of Management at Indiana
University. For seven years prior to assuming his current position, he was a Planning Engineer
with Western Electric Company and Instructor of Management and Quantitative Methods at
the University of Notre Dame. Dr. Coiser is interested in researching the managerial decision-
making process, organization responses to external forces, and participative management. He
has published in Behavior Science, Academy of Management Journal, Academy of Manage-
ment Review, Organizational Behavior and Human Performance, Management Science,
Strategic Management Journal, Business Horizons, Decision Sciences, Personnel Psychology,
Journal of Creative Behavior, International Journal of Management, The Business Quarterly,
Public Administration Quarterly, Human Relations, and other journals. In addition, Dr. Coiser
has presented numerous papers at professional meetings and has coauthored a management
xxxvii
text. He has been active in many executive development programs and has acted as management-
education consultant for several organizations. Dr. Coiser is the recipient of Teaching
Excellence Awards in the MBA Program at Indiana and a Richard D. Irwin Fellowship. He be-
longs to the Institute of Management, Sigma Iota Epsilon, and the Decision Sciences Institute.
ROY A. COOK, DBA (Mississippi State University), is past Associate Dean of the School
of Business Administration and previously a Professor at Fort Lewis College, Durango, Col-
orado. He has written a best-selling textbook, Tourism: The Business of Travel, now in its
2nd edition, and has two forthcoming textbooks: Cases and Experiential Exercises in Hu-
man Resource Management and Guide to Business Etiquette. He has authored numerous ar-
ticles, cases, and papers based on his extensive experience in the hospitality industry and
research interests in the areas of strategy, small business management, human resource man-
agement, and communication. Dr. Cook has served as the Director of Colorado’s Center for
Tourism Research® and Editor of The Annual Advances in Business Cases, and also on the
editorial boards of the Business Case Journal, the Journal of Business Strategies, and the
Journal of Teaching and Tourism. He is a member of the Academy of Management, Society
for Case Research (past President), and the International Society of Travel and Tourism Ed-
ucators. Dr. Cook teaches courses in Strategic Management, Small Business Management,
Tourism and Resort Management, and Human Resource Management.
STEVEN M. COX, PhD (University of Nebraska), is an Associate Professor of Marketing,
McColl School of Business, Queens University of Charlotte. He has a 25-year career in execu-
tive level marketing and sales positions with AT&T, GE, and several satellite imaging compa-
nies. He owns and manages LSI, a geographic information system company. He currently serves
as a case reviewer for the Business Case Journal and the Southeast Case Research Journal.
DAVID B. CROLL, PhD (Pennsylvania State University), is Professor Emeritus of Accounting
at the McIntire School of Commerce, the University of Virginia. He was Visiting Associate Pro-
fessor at the Graduate Business School, the University of Michigan. He is on the editorial board
of SAM Advanced Management Journal. He has published in the Accounting Review and the
Case Research Journal. His cases appear in 12 accounting and management textbooks.
DAN R. DALTON, PhD (University of California, Irvine), is the Dean of the Graduate School of
Business, Indiana University, and Harold A. Polipl Chair of Strategic Management. He was for-
merly with General Telephone & Electronics for 13 years. Widely published in business and
psychology periodicals, his articles have appeared in the Academy of Management Journal,
Journal of Applied Psychology, Personnel Psychology, Academy of Management Review, and
Strategic Management Journal.
CATHY A. ENZ, PhD (Ohio State University), is the Lewis G. Schaeneman Jr. Professor of
Innovation and Dynamic Management at Cornell University’s School of Hotel Administra-
tion. She is also the Executive Director of the Center for Hospitality Research at that insti-
tution. Her doctoral degree is in Organization Theory and Behavior. Professor Enz has
written numerous articles, cases, and books on corporate culture, value sharing, change
management, and strategic human resource management effects on performance. Professor
Enz consults extensively in the service sector and serves on the Board of Directors for two
hospitality-related organizations.
ELLIE A. FOGARTY, EdD (University of Pennsylvania), MBA (Temple University), MLS
(University of Pittsburgh), and BA (Immaculata University), is the Director of Compliance and
Ethics at The College of New Jersey (TCNJ). Previously, she served as the Associate Provost
for Planning and Resource Allocation, Executive Assistant to the Provost, and Business and
xxxviii ABOUT THE CONTRIBUTORS
Economics Librarian, all at TCNJ. She has written five cases used in earlier editions of
Strategic Management and Business Policy. She has taught management courses at both TCNJ
and Rutgers University.
GAMEWELL D. GANTT, JD, CPA, is Professor of Accounting and Management in the College
of Business at Idaho State University in Pocatello. Idaho, where he teaches a variety of legal
studies courses. He is past President of the Rocky Mountain Academy of Legal Studies in Busi-
ness and a past Chair of the Idaho Endowment Investment Fund Board. His published articles
and papers have appeared in journals including Midwest Law Review, Business Law Review,
Copyright World, and Intellectual Property World. His published cases have appeared in sev-
eral textbooks and in Annual Advances in Business Cases.
S. S. GEORGE is a faculty associate at the ICFAI Center for Management Research (ICMR).
NORMAN J. GIERLASINSKI, DBA, CPA, CFE, CIA, is Professor of Accounting at Central
Washington University. He served as Chairman of the Small Business Division of the Midwest
Business Administration Association. He has authored or coauthored cases for professional
associations and the Harvard Case Study Series. He has authored various articles in profes-
sional journals as well as serving as a contributing author for textbooks and as a consultant to
many organizations. He also served as a reviewer for various publications.
VIVEK GUPTA is a faculty member at the ICFAI Center for Management Research (ICMR).
RENDY HALIN, MBA and BS (Bentley University), is currently focusing on equity and com-
modity trading, as well as venturing on a new startup company. Actively involved in his church
ministry, he is also contributing his time and thought on how to properly manage the church’s
management and financial report effectively.
PATRICIA HARASTA, MBA (Bentley McCallum Graduate School of Business), is Director of
Quality Assurance at CA (formerly Computer Associates). She manages a distributed team
responsible for new development and maintenance QA activities for products that provide
management of applications such as SAP, Microsoft Exchange, Lotus Domino, WebSphere,
WebLogic, MQ, and Web Servers.
ALAN N. HOFFMAN, MBA, DBA (Indiana University), is Professor of Strategic Management
and Director of the MBA program at the McCallum Graduate School, Bentley University. His
major areas of interest include strategic management, global competition, investment strategy,
and technology. Professor Hoffman is coauthor of The Strategic Management Casebook and
Skill Builder textbook. His recent publications have appeared in the Academy of Management
Journal, Human Relations, the Journal of Business Ethics, the Journal of Business Research,
and Business Horizons. He has authored more than 20 strategic management cases including
The Boston YWCA, Ryka Inc., Liz Claiborne, Ben & Jerry’s, Cisco Systems, Sun Microsys-
tems, Palm Inc., Handspring, Ebay, AOL/Time Warner, McAfee, Apple Computer, Tivo Inc.,
and Wynn Resorts. He is the recipient of the 2004 Bentley University Teaching Innovation
Award for his course: “The Organizational Life Cycle—The Boston Beer Company Brewers of
Samuel Adams Lager Beer.”
J. DAVID HUNGER, PhD (Ohio State University), is currently Strategic Management Scholar in
Residence at Saint John’s University in Minnesota. He is also Professor Emeritus at Iowa State
University where he taught for 23 years. He previously taught at George Mason University, the
University of Virginia, and Baldwin-Wallace College. He worked in brand management at Proc-
ter & Gamble Company, worked as a selling supervisor at Lazarus Department Store, and
ABOUT THE CONTRIBUTORS xxxix
served as a Captain in U.S. Army Military Intelligence. He has been active as a consultant and
trainer to business corporations, as well as to state and federal government agencies. He has
written numerous articles and cases that have appeared in the Academy of Management Jour-
nal, International Journal of Management, Human Resource Management, Journal of Business
Strategies, Case Research Journal, Business Case Journal, Handbook of Business Strategy,
Journal of Management Case Studies, Annual Advances in Business Cases, Journal of Retail
Banking, SAM Advanced Management Journal, and Journal of Management, among others.
Dr. Hunger is a member of the Academy of Management, North American Case Research
Association, Society for Case Research, North American Management Society, Textbook and
Academic Authors Association, and the Strategic Management Society. He is past President of
the North American Case Research Association, the Society for Case Research, and the Iowa
State University Press Board of Directors. He also served as a Vice President of the U.S. Asso-
ciation for Small Business and Entrepreneurship. He was Academic Director of the Pappajohn
Center for Entrepreneurship at Iowa State University. He has served on the editorial review
boards of SAM Advanced Management Journal, Journal of Business Strategies, and Journal of
Business Research. He has served on the Board of Directors of the North American Case
Research Association, the Society for Case Research, the Iowa State University Press, and the
North American Management Society. He is coauthor with Thomas L. Wheelen of Strategic
Management and Business Policy and Essentials of Strategic Management plus Concepts in
Strategic Management and Business Policy and Cases in Strategic Management and Business
Policy, as well as Strategic Management Cases (PIC: Preferred Individualized Cases), and a
monograph assessing undergraduate business education in the United States. The 8th edition of
Strategic Management and Business Policy received the McGuffey Award for Excellence and
Longevity in 1999 from the Text and Academic Authors Association. Dr. Hunger received the
Best Case Award given by the McGraw-Hill Publishing Company and the Society for Case
Research in 1991 for outstanding case development. He is listed in various versions of Who’s
Who, including Who’s Who in the United States and Who’s Who in the World. He was also
recognized in 1999 by the Iowa State University College of Business with its Innovation in
Teaching Award and was elected a Fellow of the Teaching and Academic Authors Association
and of the North American Case Research Association.
P. INDU is a student of Vivek Gupta at the ICFAI Center of Management Research (ICMR).
GEORGE A. JOHNSON, PhD, is Professor of Management and Director of the Idaho State
University MBA program. He has published in the fields of Management Education, Ethics,
Project Management, and Simulation. He is also active in developing and publishing case
material for educational purposes. His industry experience includes several years as a Pro-
ject Manager in the development and procurement of aircraft systems.
SHAWANA P. JOHNSON, PhD (Case Western Reserve University), is president of Global Mar-
keting Insights, Inc. She has 27 years of management and marketing experience in the Hi-Tech
Information and Geospatial Technology Industry with companies such as Lockheed Martin and
General Electric Aerospace.
MICHAEL KEEFFE, PhD (University of Arkansas), is Associate Professor of Management and
Chair of Undergraduate Assurance of Learning in the McCoy College of Business Administra-
tion, Texas State University. He was the developer and draft writer of the College of Business
policy and procedure system, co-director of initial AACSB-International accreditation efforts,
sponsor of the Alpha Chi University Honor Society for over a decade, and developed and im-
plemented the Assurance of Learning system for the McCoy College. Additionally, he has been
Chair or Acting Chair of three departments in the college. With over a dozen journal articles and
xl ABOUT THE CONTRIBUTORS
numerous refereed proceedings, Dr. Keeffe is an avid case writer with over 21 cases appearing
in 32 textbooks over the last 20 years.
JOHN A. KILPATRICK, PhD (University of Iowa), is Professor of Management and Interna-
tional Business, Idaho State University. He has taught in the areas of business and business
ethics for over 25 years. He served as Co-Chair of the management track of the Institute for
Behavioral and Applied Management from its inception and continues as a board member
for that organization. He is author of The Labor Content of American Foreign Trade, and is
coauthor of Issues in International Business. His cases have appeared in a number of orga-
nizational behavior and strategy texts and casebooks, and in Annual Advances in Business
Cases.
DONALD F. KURATKO is the Jack M. Gill Chair of Entrepreneurship, Professor of Entrepreneur-
ship, and Executive Director of the Johnson Center for Entrepreneurship & Innovation at The
Kelley School of Business, Indiana University–Bloomington. He has published over 150 ar-
ticles on aspects of entrepreneurship, new venture development, and corporate entrepreneurship.
His work has been published in journals such as Strategic Management Journal, Academy of
Management Executive, Journal of Business Venturing, Entrepreneurship Theory & Practice,
Journal of Small Business Management, Journal of Small Business Strategy, Family Business Re-
view, and Advanced Management Journal. Dr. Kuratko has authored 20 books,
Entrepreneurship: Theory, Process, Practice, 7th edition (South-Western/Thomson Publishers,
2007), as well as Strategic Entrepreneurial Growth, 2nd edition (South-Western/Thomson Pub-
lishers, 2004), Corporate Entrepreneurship (South-Western/Thomson Publishers, 2007), and
Effective Small Business Management, 7th edition (Wiley & Sons Publishers, 2001). In addition,
Dr. Kuratko has been consultant on Corporate Entrepreneurship and Entrepreneurial Strategies
to a number of major corporations such as Anthem Blue Cross/Blue Shield, AT&T, United Tech-
nologies, Ameritech, The Associated Group (Acordia), Union Carbide Corporation, Service-
Master, and TruServ. Before coming to Indiana University, he was the Stoops Distinguished
Professor of Entrepreneurship and Founding Director of the Entrepreneurship Program at Ball
State University. In addition, he was the Executive Director of The Midwest Entrepreneurial Ed-
ucation Center.
Dr. Kuratko’s honors include earning the Ball State University College of Business Teach-
ing Award 15 consecutive years as well as being the only professor in the history of Ball State
University to achieve all four of the university’s major lifetime awards: Outstanding Young
Faculty (1987); Outstanding Teaching Award (1990); Outstanding Faculty Award (1996); and
Outstanding Researcher Award (1999). He was also honored as the Entrepreneur of the Year
for the state of Indiana and was inducted into the Institute of American Entrepreneurs Hall of
Fame (1990). He has been honored with The George Washington Medal of Honor; the Leavey
Foundation Award for Excellence in Private Enterprise; the NFIB Entrepreneurship Excel-
lence Award; and the National Model Innovative Pedagogy Award for Entrepreneurship. In
addition, Dr. Kuratko was named the National Outstanding Entrepreneurship Educator (by the
U.S. Association for Small Business and Entrepreneurship) and selected as one of the Top 3
Entrepreneurship Professors in the United States by the Kauffman Foundation, Ernst & Young,
Inc. magazine, and Merrill Lynch. He received the Thomas W. Binford Memorial Award for
Outstanding Contribution to Entrepreneurial Development from the Indiana Health Industry
Forum. Dr. Kuratko has been named a 21st Century Entrepreneurship Research Fellow by the
National Consortium of Entrepreneurship Centers as well as the U.S. Association for Small
Business & Entrepreneurship Scholar for Corporate Entrepreneurship in 2003. Finally, he has
been honored by his peers in Entrepreneur magazine as one of the Top 2 Entrepreneurship
ABOUT THE CONTRIBUTORS xli
Program Directors in the nation for three consecutive years including the #1 Entrepreneurship
Program Director in 2003.
RUCHI MANKAD is a former faculty member at the ICFAI Center for Management Research
(ICMR).
BILL J. MIDDLEBROOK, PhD (University of North Texas), is Professor of Management at
Southwest Texas State University. He served as Acting Chair of the Department of Man-
agement and Marketing, published in numerous journals, served as a consultant in industry,
and is currently teaching and researching in the fields of Strategic Management and Human
Resources.
BERNARD A. MORIN, B.S., M.B.A., Ph.D., Professor Emeritus of Commerce at the University
of Virginia.
NATHAN NEBBE, MBA and MA (Iowa State University), has significant interests in the in-
digenous peoples of the Americas. With an undergraduate degree in Animal Ecology, he
served as a Peace Corps Volunteer in Honduras, where he worked at the Honduran national
forestry school ESNAACIFORE (Escuela National de Ciencias Forestales). After some
time in the Peace Corps, Nathan worked for a year on a recycling project for the Town of
Ignacio and the Southern Ute Indian Tribe in southwestern Colorado. Following his expe-
rience in Colorado, Nathan returned to Iowa State University where he obtained his MBA,
followed by an MA in Anthropology. He is currently studying how globalization of the
Chilian forestry industry is affecting the culture of the indigenous Mapuche people of south
central Chile.
LAWRENCE C. PETTIT, Jr., B.S., M.S., D.B.A., Professor Emeritus of Commerce at the
McIntire School of Commerce University of Virginia.
ANNIE PHAN, BS (The College of New Jersey), is currently an associate at Goldman Sachs
Asset Management, and is an MBA candidate at New York University Leonard N. Stern School
of Business. In addition, she has assisted with research for The Global Corporate Brand Book.
SHIRISHA REGANI is a faculty associate at the ICFAI Center for Management Research
(ICMR).
JOHN K. ROSS III, PhD (University of North Texas), is Associate Professor of Management
at Southwest Texas State University. He has served as SBI Director, Associate Dean, Chair
of the Department of Management and Marketing, published in numerous journals, and is
currently teaching and researching in the fields of Strategic Management and Human
Resource.
SHERRY K. ROSS, CPA (Texas), MBA (Southwest Texas State University), is a Senior Lecturer
at Texas State University–San Marcos, Texas. She is the core course coordinator for financial
accounting and teaches introductory financial accounting courses. Her recent work experience
is Executive Director of a not-for-profit corporation.
MARYANNE M. ROUSE, CPA, MBA (University of South Florida) was a faculty member, As-
sistant Dean, and Director of Management Education and Development at the College of
Business Administration of the University of South Florida until her retirement.
PATRICIA A. RYAN, PhD (University of South Florida), is an Associate Professor of Finance,
Colorado State University. She currently serves on the Board of Directors of the Midwest
Finance Association and was the Associate Editor of the Business Case Journal. Her research
xlii ABOUT THE CONTRIBUTORS
interests lie in corporate finance, specifically initial public offerings, capital budgeting, and
case writing. She has published in the Journal of Business and Management, the Business Case
Journal, Educational and Psychological Measurement, the Journal of Research in Finance,
the Journal of Financial and Strategic Decisions, and the Journal of Accounting and Finance
Research. Her research has been cited in the Wall Street Journal, CFO Magazine, and
Investment Dealers Digest.
RANGKI SON, MBA, earned his degree in Finance at the McCallum Graduate School of Busi-
ness, Bentley University, in May 2007. He is currently working for KPMG Korea as a Business
Performance Service Consultant.
LAURENCE J. STYBEL, EdD (Harvard University), is cofounder of Stybel Peabody Lincolnshire,
a Boston-based management consulting firm devoted to enhancing career effectiveness of
executives who report to boards of directors. Its services include search, outplacement,
outplacement avoidance, and valued executive career consulting. Stybel Peabody Lincolnshire
was voted “Best Outplacement Firm” by the readers of Massachusetts Lawyers Weekly. Its
programs are the only ones officially endorsed by the Massachusetts Hospital Association and
the Financial Executives Institute. He serves on the Board of Directors of the New England Chap-
ter of the National Association of Corporate Directors and the Boston Human Resources Asso-
ciation. His home page can be found at www.stybelpeabody.com. The “Your Career” department
of the home page contains downloadable back issues of his monthly Boston Business Journal
column, “Your Career.”
JOEL SAROSH THADAMALLA is a faculty member at the ICFAI center for Management Research
(ICMR).
MRIDU VERMA serves as a Consulting Editor at ICFAI Business School (ICMR).
JOYCE P. VINCELETTE, DBA (Indiana University), is a Professor of Management and the
Coordinator of Management and Interdisciplinary Business Programs at The College of New
Jersey. She was previously a faculty member at the University of South Florida. She has au-
thored and coauthored various articles, chapters, and cases that have appeared in management
journals and strategic management texts and casebooks. She is also active as a consultant and
trainer for a number of local and national business organizations as well as for a variety of not-
for-profit and government agencies. She currently teaches and conducts research in the fields of
Strategic Management and Leadership.
KATHRYN E. WHEELEN, MEd (Nova Southern University), BA, LMT, (University of
Tampa), has worked as an Administrative Assistant for case and textbook development with
the Thomas L. Wheelen Company (circa 1879). She works as a Special Education Teacher
in the Hillsborough County School District at Citrus Park Elementary School, Tampa,
Florida.
RICHARD D. WHEELEN, BS (University of South Florida), has worked as a case research
assistant. He is currently practicing in the field of Health Care. He currently lives in Everett,
Washington.
THOMAS L. WHEELEN, DBA (George Washington University), MBA (Babson College) and
BS cum laude (Boston College), has taught as Visiting Professor at Trinity College of the
University of Dublin, University of South Florida as Professor of Strategic Management, the
McIntire School of Commerce of the University of Virginia as the Ralph A. Beeton Professor
of Free Enterprise, and Visiting Professor at both the University of Arizona and Northeastern
ABOUT THE CONTRIBUTORS xliii
www.stybelpeabody.com
University. He was also affiliated with the University of Virginia College of Continuing
Education, where he served in the following capacities: (1) Coordinator for Business Educa-
tion (1978–1983, 1971–1976)—approve all undergraduate courses offered at seven regional
centers and approved faculty; (2) Liaison Faculty and Consultant to the National Academy of
the FBI Academy (1972–1983) and; (3) developed, sold, and conducted over 200 seminars for
local, state, and national governments, and companies for McIntire School of Commerce and
Continuing Education. He worked at General Electric Company, holding various management
positions (1961–1965); U.S. Navy Supply Corps (SC)–Lt. (SC) USNR–Assistant Supply
Officer aboard nuclear support tender (1957–1960). He has been published in the monograph,
An Assessment of Undergraduate Business Education in the United States (with J. D. Hunger),
1980. He’s also authored 60 published books, with 14 books translated into eight languages
(Arabic, Bahasa, Indonesia, Chinese, Chinese Simplified, Greek, Italian, Japanese, Portuguese
and Thai); he is coauthor with J. D. Hunger of four active books: Strategic Management and
Business Policy, 13th edition (2012); Concepts in Strategic Management and Business Policy,
13th edition (2012); Strategic Management and Business Policy, 13th edition International
edition (2012); and Essentials of Strategic Management, 5th edition (2011). He is co-editor of
Developments in Information Systems (1974) and Collective Bargaining in the Public Sector
(1977), and co-developer of the software program STrategic Financial ANalyzer (ST. FAN)
(1989, 1990, 1993—different versions). He has authored over 40 articles that have appeared
in such journals as the Journal of Management, Business Quarterly, Personnel Journal, SAM
Advanced Management Journal, Journal of Retailing, International Journal of Management,
and the Handbook of Business Strategy. He has created roughly 280 cases appearing in over
83 text and case books, as well as the Business Case Journal, Journal of Management Case
Studies, International Journal of Case Studies, and Research and Case Research Journal. He
has won numerous awards, including the following: (1) Fellow elected by the Society for Ad-
vancement of Management in 2002; (2) Fellow elected by the North American Case Research
Association in 2000; (3) Fellow elected by the Text and Academic Authors Association in
2000; (4) 1999 Phil Carroll Advancement of Management Award in Strategic Management
from the Society for Advancement of Management; (5) 1999 McGuffey Award for Excellence
and Longevity for Strategic Management and Business Policy, 6th edition from the Text and
Academic Authors Association; (6) 1996/97 Teaching Incentive Program Award for teaching
undergraduate strategic management; (7) Fulbright, 1996–1997, to Ireland, which he had to
decline; (8) Endowed Chair, Ralph A. Beeton Professor, at University of Virginia
(1981–1985); (9) Sesquicentennial Associateship research grant from the Center for Advanced
Studies at the University of Virginia, 1979–1980; (10) Small Business Administration (Small
Business Institute) supervised undergraduate team that won District, Regional III, and Honor-
able Mention Awards; and (11) awards for two articles. Dr. Wheelen currently serves on the
Board of Directors of Adhia Mutual Fund, Society for Advancement of Management, and on
the Editorial Board and is the Associate Editor of SAM Advanced Management Journal. He
served on the Board of Directors of Lazer Surgical Software Inc, and Southern Management
Association and on the Editorial Boards of the Journal of Management and Journal of
Management Case Studies, Journal of Retail Banking, Case Research Journal, and Business
Case Journal. He was Vice President of Strategic Management for the Society for the
Advancement of Management, and President of the North American Case Research Associa-
tion. Dr. Wheelen is a member of the Academy of Management, Beta Gamma Sigma, Southern
Management Association, North American Case Research Association, Society for Advance-
ment of Management, Society for Case Research, Strategic Management Association, and
World Association for Case Method Research and Application. He has been listed in Who’s
Who in Finance and Industry, Who’s Who in the South and Southwest, and Who’s Who in
American Education.
xliv ABOUT THE CONTRIBUTORS
THOMAS L. WHEELEN II, BA (Boston College), has worked as a Case Research Assistant.
SUZANNE WONG was born and raised in Jakarta, Indonesia. She graduated with a dual BSBA degree in Finance and
Marketing from Northeastern University in 2004, followed by an MBA in Finance from Bentley University in 2006.
Upon graduation, Suzanne joined Fidelity Investments’ parent company FMRCo in Boston as an Analyst in Technol-
ogy Risk Management–Information Security. She plans to continue the future operational success of her parents’
pharmaceutical company in Indonesia.
ABOUT THE CONTRIBUTORS xlv
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THIRTEENTH EDITION
Strategic
Management
and Business
Policy
TOWARD GLOBAL SUSTAINABILITY
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PA R T1
Introduction to
Strategic
Management
and Business
Policy
How does a company become successful and stay successful? Certainly not
by playing it safe and following the traditional ways of doing business! Taking a
strategic risk is what General Electric (GE) did when it launched its Ecomagination
strategic initiative in 2005. According to Jeffrey Immelt, Chairman and CEO:
Ecomagination is GE’s commitment to address challenges, such as the need for cleaner,
more efficient sources of energy, reduced emissions, and abundant sources of clean water.
And we plan to make money doing it. Increasingly for business, “green” is green.1
Immelt announced in a May 9, 2005, conference call that the company planned to more
than double its spending on research and development from $700 million in 2004 to $1.5 bil-
lion by 2010 for cleaner products ranging from power generation to locomotives to water pro-
cessing. The company intended to introduce 30 to 40 new products, including more efficient
lighting and appliances, over the next two years. It also expected to double revenues from busi-
nesses that made wind turbines, treat water, and reduce greenhouse-emitting gases to at least
$20 billion by 2010. In addition to working with customers to develop more efficient power gen-
erators, the company planned to reduce its own emission of greenhouse gases by 1% by 2012
and reduce the intensity of those gases 30% by 2008.2 In 2006, GE’s top management informed
the many managers of its global business units that in the future they would be judged not only
by the usual measures, such as return on capital, but that they would also be accountable for
achieving corporate environmental objectives.
Ecomagination was a strategic change for GE, a company that had previously been con-
demned by environmentalists for its emphasis on coal and nuclear power and for polluting the
Hudson and Housatonic rivers with polychlorinated biphenyls (PCBs) in the 1980s. Over the
years, GE had been criticized for its lack of social responsibility and for its emphasis on prof-
itability and financial performance over social and environmental objectives. What caused GE’s
management to make this strategic change?
In the 18 months before launching its new environmental strategy, GE invited managers
from companies in various industries to participate in two-day “dreaming sessions” during
which they were asked to imagine life in 2015—and the products they, as customers, would
need from GE. The consensus was a future of rising fuel costs, restrictive environmental regula-
tions, and growing consumer expectations for cleaner technologies, especially in the energy in-
dustry. Based on this conclusion, GE’s management made the strategic decision to move in a new
basic concepts of
Strategic Management
C H A P T E R 1
3
� Understand the benefits of strategic
management
� Explain how globalization and
environmental sustainability influence
strategic management
� Understand the basic model of strategic
management and its components
� Identify some common triggering events
that act as stimuli for strategic change
� Understand strategic decision-making
modes
� Use the strategic audit as a method of
analyzing corporate functions and
activities
Learning Objectives
Gathering
Information
Putting Strategy
into Action
Monitoring
Performance
Societal
Environment:
General forces
Natural
Environment:
Resources and
climate
Task
Environment:
Industry analysis
Internal:
Strengths and
Weaknesses
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
Programs
Activities
needed to
accomplish
a plan
Budgets
Cost of the
programs Procedures
Sequence
of steps
needed to
do the job
Performance
Actual results
External:
Opportunities
and Threats
Developing
Long-range Plans
Mission
Reason for
existence Objectives
What
results to
accomplish
by when
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Environmental
Scanning:
Strategy
Formulation:
Strategy
Implementation:
Evaluation
and Control:
Feedback/Learning: Make corrections as needed
After reading this chapter, you should be able to:
direction. According to Vice Chairman David Calhoun, “We decided that if this is what our
customers want, let’s stop putting our heads in the sand, dodging environmental inter-
ests, and go from defense to offense.”3
Following GE’s announcement of its new strategic initiative, analysts raised questions
regarding the company’s ability to make Ecomagination successful. They not only ques-
tioned CEO Immelt’s claim that green could be profitable as well as socially responsible,
but they also wondered if Immelt could transform GE’s incremental approach to innova-
tion to one of pursuing riskier technologies, such as fuel cells, solar energy, hydrogen stor-
age, and nanotechnology.4 Other companies had made announcements of green
initiatives, only to leave them withering on the vine when they interfered with profits. For
example, FedEx had announced in 2003 that it would soon be deploying clean-burning hy-
brid trucks at a rate of 3,000 per year, eventually cutting emissions by 250,000 tons of
greenhouse gases. Four years later, FedEx had purchased fewer than 100 hybrid vehicles,
less than 1% of its fleet! With hybrid trucks costing 75% more than conventional trucks,
it would take 10 years for the fuel savings to pay for the costly vehicles. FedEx manage-
ment concluded that breaking even over a 10-year period was not the best use of com-
pany capital. As a result of this and other experiences, skeptics felt that most large
companies were only indulging in greenwash when they talked loudly about their sus-
tainability efforts, but followed through with very little actual results.5
CEO Immelt had put his reputation at risk by personally leading GE’s Ecomagination
initiative. Skeptics wondered if the environmental markets would materialize and if they
would be as profitable as demanded by GE’s shareholders. Would a corporate culture
known for its pursuit of the Six Sigma statistics-based approach to quality control be able
to create technological breakthroughs and new green businesses? If Immelt was correct,
not only would GE benefit, but other companies would soon follow GE’s lead. If, however,
he was wrong, Immelt would have led his company down a dead end where it would be
difficult to recover from the damage to its reputation and financial standing. According to
a 25-year veteran of GE, “Jeff is asking us to take a really big swing . . . . This is hard for us.”6
4 PART 1 Introduction to Strategic Management and Business Policy
CHAPTER 1 Basic Concepts of Strategic Management 5
1.1 The Study of Strategic Management
Strategic management is a set of managerial decisions and actions that determines the long-
run performance of a corporation. It includes environmental scanning (both external and in-
ternal), strategy formulation (strategic or long-range planning), strategy implementation, and
evaluation and control. The study of strategic management, therefore, emphasizes the moni-
toring and evaluating of external opportunities and threats in light of a corporation’s strengths
and weaknesses. Originally called business policy, strategic management incorporates such
topics as strategic planning, environmental scanning, and industry analysis.
PHASES OF STRATEGIC MANAGEMENT
Many of the concepts and techniques that deal with strategic management have been developed
and used successfully by business corporations such as General Electric and the Boston Con-
sulting Group. Over time, business practitioners and academic researchers have expanded and
refined these concepts. Initially, strategic management was of most use to large corporations op-
erating in multiple industries. Increasing risks of error, costly mistakes, and even economic ruin
are causing today’s professional managers in all organizations to take strategic management se-
riously in order to keep their companies competitive in an increasingly volatile environment.
As managers attempt to better deal with their changing world, a firm generally evolves
through the following four phases of strategic management:7
Phase 1—Basic financial planning: Managers initiate serious planning when they are re-
quested to propose the following year’s budget. Projects are proposed on the basis of very
little analysis, with most information coming from within the firm. The sales force usu-
ally provides the small amount of environmental information. Such simplistic operational
planning only pretends to be strategic management, yet it is quite time consuming. Nor-
mal company activities are often suspended for weeks while managers try to cram ideas
into the proposed budget. The time horizon is usually one year.
Phase 2—Forecast-based planning: As annual budgets become less useful at stimulating long-
term planning, managers attempt to propose five-year plans. At this point they consider proj-
ects that may take more than one year. In addition to internal information, managers gather
any available environmental data—usually on an ad hoc basis—and extrapolate current trends
five years into the future. This phase is also time consuming, often involving a full month of
managerial activity to make sure all the proposed budgets fit together. The process gets very
political as managers compete for larger shares of funds. Endless meetings take place to eval-
uate proposals and justify assumptions. The time horizon is usually three to five years.
Phase 3—Externally oriented (strategic) planning: Frustrated with highly political yet inef-
fectual five-year plans, top management takes control of the planning process by initiating
strategic planning. The company seeks to increase its responsiveness to changing markets
and competition by thinking strategically. Planning is taken out of the hands of lower-level
managers and concentrated in a planning staff whose task is to develop strategic plans for
the corporation. Consultants often provide the sophisticated and innovative techniques that
the planning staff uses to gather information and forecast future trends. Ex-military experts
develop competitive intelligence units. Upper-level managers meet once a year at a resort
“retreat” led by key members of the planning staff to evaluate and update the current strate-
gic plan. Such top-down planning emphasizes formal strategy formulation and leaves the
implementation issues to lower management levels. Top management typically develops
five-year plans with help from consultants but minimal input from lower levels.
6 PART 1 Introduction to Strategic Management and Business Policy
Phase 4—Strategic management: Realizing that even the best strategic plans are worthless
without the input and commitment of lower-level managers, top management forms plan-
ning groups of managers and key employees at many levels, from various departments
and workgroups. They develop and integrate a series of strategic plans aimed at achiev-
ing the company’s primary objectives. Strategic plans at this point detail the implementa-
tion, evaluation, and control issues. Rather than attempting to perfectly forecast the future,
the plans emphasize probable scenarios and contingency strategies. The sophisticated an-
nual five-year strategic plan is replaced with strategic thinking at all levels of the organi-
zation throughout the year. Strategic information, previously available only centrally to
top management, is available via local area networks and intranets to people throughout
the organization. Instead of a large centralized planning staff, internal and external plan-
ning consultants are available to help guide group strategy discussions. Although top man-
agement may still initiate the strategic planning process, the resulting strategies may come
from anywhere in the organization. Planning is typically interactive across levels and is
no longer top down. People at all levels are now involved.
General Electric, one of the pioneers of strategic planning, led the transition from strategic
planning to strategic management during the 1980s.8 By the 1990s, most other corporations
around the world had also begun the conversion to strategic management.
BENEFITS OF STRATEGIC MANAGEMENT
Strategic management emphasizes long-term performance. Many companies can manage
short-term bursts of high performance, but only a few can sustain it over a longer period of
time. For example, of the original Forbes 100 companies listed in 1917, only 13 have survived
to the present day. To be successful in the long-run, companies must not only be able to execute
current activities to satisfy an existing market, but they must also adapt those activities to sat-
isfy new and changing markets.9
Research reveals that organizations that engage in strategic management generally out-
perform those that do not.10 The attainment of an appropriate match, or “fit,” between an or-
ganization’s environment and its strategy, structure, and processes has positive effects on the
organization’s performance.11 Strategic planning becomes increasingly important as the envi-
ronment becomes more unstable.12 For example, studies of the impact of deregulation on the
U.S. railroad and trucking industries found that companies that changed their strategies and
structures as their environment changed outperformed companies that did not change.13
A survey of nearly 50 corporations in a variety of countries and industries found the three
most highly rated benefits of strategic management to be:
� Clearer sense of strategic vision for the firm.
� Sharper focus on what is strategically important.
� Improved understanding of a rapidly changing environment.14
A recent survey by McKinsey & Company of 800 executives found that formal strategic
planning processes improve overall satisfaction with strategy development.15 To be effective,
however, strategic management need not always be a formal process. It can begin with a few
simple questions:
1. Where is the organization now? (Not where do we hope it is!)
2. If no changes are made, where will the organization be in one year? two years? five years?
10 years? Are the answers acceptable?
3. If the answers are not acceptable, what specific actions should management undertake?
What are the risks and payoffs involved?
CHAPTER 1 Basic Concepts of Strategic Management 7
Bain & Company’s 2007 Management Tools and Trends survey of 1,221 global executives
revealed strategic planning to be the most used management tool—used by 88% of respon-
dents. Strategic planning is particularly effective at identifying new opportunities for growth
and in ensuring that all managers have the same goals.16 Other highly-ranked strategic man-
agement tools were mission and vision statements (used by 79% of respondents), core compe-
tencies (79%), scenario and contingency planning (69%), knowledge management (69%),
strategic alliances (68%), and growth strategy tools (65%).17 A study by Joyce, Nohria, and
Roberson of 200 firms in 50 subindustries found that devising and maintaining an engaged, fo-
cused strategy was the first of four essential management practices that best differentiated be-
tween successful and unsuccessful companies.18 Based on these and other studies, it can be
concluded that strategic management is crucial for long-term organizational success.
Research into the planning practices of companies in the oil industry concludes that the
real value of modern strategic planning is more in the strategic thinking and organizational
learning that is part of a future-oriented planning process than in any resulting written strate-
gic plan.19 Small companies, in particular, may plan informally and irregularly. Nevertheless,
studies of small- and medium-sized businesses reveal that the greater the level of planning in-
tensity, as measured by the presence of a formal strategic plan, the greater the level of finan-
cial performance, especially when measured in terms of sales increases.20
Planning the strategy of large, multidivisional corporations can be complex and time con-
suming. It often takes slightly more than a year for a large company to move from situation as-
sessment to a final decision agreement. For example, strategic plans in the global oil industry tend
to cover four to five years. The planning horizon for oil exploration is even longer—up to 15
years.21 Because of the relatively large number of people affected by a strategic decision in a large
firm, a formalized, more sophisticated system is needed to ensure that strategic planning leads to
successful performance. Otherwise, top management becomes isolated from developments in the
business units, and lower-level managers lose sight of the corporate mission and objectives.
1.2 Globalization and Environmental Sustainability:
Challenges to Strategic Management
Not too long ago, a business corporation could be successful by focusing only on making and
selling goods and services within its national boundaries. International considerations were min-
imal. Profits earned from exporting products to foreign lands were considered frosting on the
cake, but not really essential to corporate success. During the 1960s, for example, most U.S. com-
panies organized themselves around a number of product divisions that made and sold goods
only in the United States. All manufacturing and sales outside the United States were typically
managed through one international division. An international assignment was usually considered
a message that the person was no longer promotable and should be looking for another job.
Similarly, until the later part of the 20th century, a business firm could be very successful
without being environmentally sensitive. Companies dumped their waste products in nearby
streams or lakes and freely polluted the air with smoke containing noxious gases. Responding
to complaints, governments eventually passed laws restricting the freedom to pollute the en-
vironment. Lawsuits forced companies to stop old practices. Nevertheless, until the dawn of
the 21st century, most executives considered pollution abatement measures to be a cost of busi-
ness that should be either minimized or avoided. Rather than clean up a polluting manufac-
turing site, they often closed the plant and moved manufacturing offshore to a developing
nation with fewer environmental restrictions. Sustainability, as a term, was used to describe
competitive advantage, not the environment.
8 PART 1 Introduction to Strategic Management and Business Policy
IMPACT OF GLOBALIZATION
Today, everything has changed. Globalization, the integrated internationalization of markets
and corporations, has changed the way modern corporations do business. As Thomas Fried-
man points out in The World Is Flat, jobs, knowledge, and capital are now able to move across
borders with far greater speed and far less friction than was possible only a few years ago.22
For example, the inter-connected nature of the global financial community meant that the
mortgage lending problems of U.S. banks led to a global financial crisis in 2008. The world-
wide availability of the Internet and supply-chain logistical improvements, such as con-
tainerized shipping, mean that companies can now locate anywhere and work with multiple
partners to serve any market. To reach the economies of scale necessary to achieve the low
costs, and thus the low prices, needed to be competitive, companies are now thinking of a
global market instead of national markets. Nike and Reebok, for example, manufacture their
athletic shoes in various countries throughout Asia for sale on every continent. Many other
companies in North America and Western Europe are outsourcing their manufacturing, soft-
ware development, or customer service to companies in China, Eastern Europe, or India.
Large pools of talented software programmers, English language proficiency, and lower
wages in India enables IBM to employ 75,000 people in its global delivery centers in Banga-
lore, Delhi, or Kolkata to serve the needs of clients in Atlanta, Munich, or Melbourne.23 In-
stead of using one international division to manage everything outside the home country, large
corporations are now using matrix structures in which product units are interwoven with
country or regional units. International assignments are now considered key for anyone in-
terested in reaching top management.
As more industries become global, strategic management is becoming an increasingly im-
portant way to keep track of international developments and position a company for long-term
competitive advantage. For example, General Electric moved a major research and develop-
ment lab for its medical systems division from Japan to China in order to learn more about de-
veloping new products for developing economies. Microsoft’s largest research center outside
Redmond, Washington, is in Beijing. According to Wilbur Chung, a Wharton professor,
“Whatever China develops is rolled out to the rest of the world. China may have a lower GDP
per-capita than developed countries, but the Chinese have a strong sense of how products
should be designed for their market.”24
The formation of regional trade associations and agreements, such as the European Union,
NAFTA, Mercosur, Andean Community, CAFTA, and ASEAN, is changing how international
business is being conducted. See the Global Issue feature to learn how regional trade associ-
ations are forcing corporations to establish a manufacturing presence wherever they wish to
market goods or else face significant tariffs. These associations have led to the increasing har-
monization of standards so that products can more easily be sold and moved across national
boundaries. International considerations have led to the strategic alliance between British Air-
ways and American Airlines and to the acquisition of the Miller Brewing Company by South
African Breweries (SAB), among others.
IMPACT OF ENVIRONMENTAL SUSTAINABILITY
Environmental sustainability refers to the use of business practices to reduce a company’s im-
pact upon the natural, physical environment. Climate change is playing a growing role in busi-
ness decisions. More than half of the global executives surveyed by McKinsey & Company in
2007 selected “environmental issues, including climate change,” as the most important issue fac-
ing them over the next five years.25 A 2005 survey of 27 large, publicly-held, multinational cor-
porations based in North America revealed that 90% believed that government regulation was
CHAPTER 1 Basic Concepts of Strategic Management 9
imminent and 67% believed that such regulation would come between 2010 and 2015.26 Ac-
cording to Eileen Claussen, President of the Pew Center on Global Climate Change:
There is a growing consensus among corporate leaders that taking action on climate change is a
responsible business decision. From market shifts to regulatory constraints, climate change poses
real risks and opportunities that companies must begin planning for today, or risk losing ground
Formed as the European Eco-
nomic Community in 1957,
the European Union (EU) is the
most significant trade association in
the world. The goal of the EU is the com-
plete economic integration of its 27 member countries so
that goods made in one part of Europe can move freely
without ever stopping for a customs inspection. The EU in-
cludes Austria, Belgium, Bulgaria, Cyprus, Czech Republic,
Denmark, Estonia, Finland, France, Germany, Greece, Hun-
gary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta,
Netherlands, Poland, Portugal, Romania, Slovakia, Slove-
nia, Spain, Sweden, and the United Kingdom. Others, in-
cluding Croatia, Macedonia, and Turkey, have either
recently applied or are in the process of applying. The EU is
less than half the size of the United States of America, but
has 50% more population. One currency, the euro, is be-
ing used throughout the region as members integrate their
monetary systems. The steady elimination of barriers to
free trade is providing the impetus for a series of mergers,
acquisitions, and joint ventures among business corpora-
tions. The requirement of at least 60% local content to
avoid tariffs has forced many U.S. and Asian companies to
abandon exporting in favor of having a strong local pres-
ence in Europe.
Canada, the United States, and Mexico are affiliated eco-
nomically under the North American Free Trade Agree-
ment (NAFTA). The goal of NAFTA is improved trade
among the three member countries rather than complete
economic integration. Launched in 1994, the agreement re-
quired all three members to remove all tariffs among them-
selves over 15 years, but they were allowed to have their
own tariff arrangements with nonmember countries. Cars
and trucks must have 62.5% North American content to
qualify for duty-free status. Transportation restrictions and
other regulations have been being significantly reduced. A
number of Asian and European corporations, such as Swe-
den’s Electrolux, have built manufacturing facilities in Mex-
ico to take advantage of the country’s lower wages and easy
access to the entire North American region.
GLOBAL issue
REGIONAL TRADE ASSOCIATIONS REPLACE
NATIONAL TRADE BARRIERS
South American countries are also working to harmonize
their trading relationships with each other and to form trade
associations. The establishment of the Mercosur (Mercosul
in Portuguese) free-trade area among Argentina, Brazil,
Uruguay, and Paraguay means that a manufacturing pres-
ence within these countries is becoming essential to avoid
tariffs for nonmember countries. Venezuela has applied for
admission to Mercosur. The Andean Community (Comu-
nidad Andina de Naciones) is a free-trade alliance composed
of Columbia, Ecuador, Peru, Bolivia, and Chile. On May 23,
2008, the Union of South American Nations was formed
to unite the two existing free-trade areas with a secretariat
in Ecuador and a parliament in Bolivia.
In 2004, the five Central American countries of El Sal-
vador, Guatemala, Honduras, Nicaragua, and Costa Rica
plus the United States signed the Central American Free
Trade Agreement (CAFTA). The Dominican Republic
joined soon thereafter. Previously, Central American textile
manufacturers had to pay import duties of 18%–28% to
sell their clothes in the United States unless they bought
their raw material from U.S. companies. Under CAFTA,
members can buy raw material from anywhere and their
exports are duty free. In addition, CAFTA eliminated import
duties on 80% of U.S. goods exported to the region, with
the remaining tariffs being phased out over 10 years.
The Association of Southeast Asian Nations
(ASEAN)—composed of Brunei Darussalam, Cambodia,
Indonesia, Laos, Malaysia, Myanmar, Philippines, Singa-
pore, Thailand, and Vietnam—is in the process of linking
its members into a borderless economic zone by 2020. Tar-
iffs had been significantly reduced among member coun-
tries by 2008. Increasingly referred to as ASEAN+3, ASEAN
now includes China, Japan, and South Korea in its annual
summit meetings. The ASEAN nations negotiated linkage
of the ASEAN Free Trade Area (AFTA) with the existing free-
trade area of Australia and New Zealand. With the EU ex-
tending eastward and NAFTA extending southward to
someday connect with CAFTA and the Union of South
American Nations, pressure is building on the independent
Asian nations to join ASEAN.
10 PART 1 Introduction to Strategic Management and Business Policy
to their more forward-thinking competitors. Prudent steps taken now to address climate change
can improve a company’s competitive position relative to its peers and earn it a seat at the table
to influence climate policy. With more and more action at the state level and increasing scientific
clarity, it is time for businesses to craft corporate strategies that address climate change.27
Porter and Reinhardt warn that “in addition to understanding its emissions costs, every
firm needs to evaluate its vulnerability to climate-related effects such as regional shifts in the
availability of energy and water, the reliability of infrastructures and supply chains, and the
prevalence of infectious diseases.”28 Swiss Re, the world’s second-largest reinsurer, estimated
that the overall economic costs of climate catastrophes related to climate change threatens to
double to $150 billion per year by 2014. The insurance industry’s share of this loss would be
$30–$40 billion annually.29
The effects of climate change on industries and companies throughout the world can be
grouped into six categories of risks: regulatory, supply chain, product and technology, litiga-
tion, reputational, and physical.30
1. Regulatory Risk: Companies in much of the world are already subject to the Kyoto Pro-
tocol, which requires the developed countries (and thus the companies operating within
them) to reduce carbon dioxide and other greenhouse gases by an average of 6% from
1990 levels by 2012. The European Union has an emissions trading program that allows
companies that emit greenhouse gases beyond a certain point to buy additional allowances
from other companies whose emissions are lower than that allowed. Companies can also
earn credits toward their emissions by investing in emissions abatement projects outside
their own firms. Although the United States withdrew from the Kyoto Protocol, various
regional, state, and local government policies affect company activities in the U.S. For ex-
ample, seven Northeastern states, six Western states, and four Canadian provinces have
adopted proposals to cap carbon emissions and establish carbon-trading programs.
2. Supply Chain Risk: Suppliers will be increasingly vulnerable to government regulations—
leading to higher component and energy costs as they pass along increasing carbon-related
costs to their customers. Global supply chains will be at risk from an increasing intensity of
major storms and flooding. Higher sea levels resulting from the melting of polar ice will
create problems for seaports. China, where much of the world’s manufacturing is cur-
rently being outsourced, is becoming concerned with environmental degradation. In 2006,
12 Chinese ministries produced a report on global warming foreseeing a 5%–10% reduc-
tion in agricultural output by 2030; more droughts, floods, typhoons, and sandstorms; and
a 40% increase in population threatened by plague.31
The increasing scarcity of fossil-based fuel is already boosting transportation costs sig-
nificantly. For example, Tesla Motors, the maker of an electric-powered sports car, trans-
ferred assembly of battery packs from Thailand to California because Thailand’s low wages
were more than offset by the costs of shipping thousand-pound battery packs across the Pa-
cific Ocean.32 Although the world production of oil had leveled off at 85 million barrels a
day by 2008, the International Energy Agency predicted global demand to increase to
116 million barrels by 2030. Given that output from existing fields was falling 8% annu-
ally, oil companies must develop up to seven million barrels a day in additional capacity to
meet projected demand. Nevertheless, James Mulva, CEO of ConocoPhilips, estimated in
late 2007 that the output of oil will realistically stall at around 100 million barrels a day.33
3. Product and Technology Risk: Environmental sustainability can be a prerequisite to prof-
itable growth. For example, worldwide investments in sustainable energy (including wind,
solar, and water power) more than doubled to $70.9 billion from 2004 to 2006.34 Sixty per-
cent of U.S. respondents to an Environics study stated that knowing a company is mindful
of its impact on the environment and society makes them more likely to buy their products
CHAPTER 1 Basic Concepts of Strategic Management 11
and services.35 Carbon-friendly products using new technologies are becoming increas-
ingly popular with consumers. Those automobile companies, for example, that were quick
to introduce hybrid or alternative energy cars gained a competitive advantage.
4. Litigation Risk: Companies that generate significant carbon emissions face the threat of
lawsuits similar to those in the tobacco, pharmaceutical, and building supplies (e.g., as-
bestos) industries. For example, oil and gas companies were sued for greenhouse gas
emissions in the federal district court of Mississippi, based on the assertion that these
companies contributed to the severity of Hurricane Katrina. As of October 2006, at least
16 cases were pending in federal or state courts in the U.S. “This boomlet in global warm-
ing litigation represents frustration with the White House’s and Congress’ failure to come
to grips with the issue,” explained John Echeverria, executive director of Georgetown
University’s Environmental Law & Policy Institute.36
5. Reputational Risk: A company’s impact on the environment can heavily affect its over-
all reputation. The Carbon Trust, a consulting group, found that in some sectors the value
of a company’s brand could be at risk because of negative perceptions related to climate
change. In contrast, a company with a good record of environmental sustainability may
create a competitive advantage in terms of attracting and keeping loyal consumers, em-
ployees, and investors. For example, Wal-Mart’s pursuit of environmental sustainability
as a core business strategy has helped soften its negative reputation as a low-wage, low-
benefit employer. By setting objectives for its retail stores of reducing greenhouse gases
by 20%, reducing solid waste by 25%, increasing truck fleet efficiency by 25%, and us-
ing 100% renewable energy, it is also forcing its suppliers to become more environmen-
tally sustainable.37 Tools have recently been developed to measure sustainability on a
variety of factors. For example, the SAM (Sustainable Asset Management) Group of
Zurich, Switzerland, has been assessing and documenting the sustainability performance
of over 1,000 corporations annually since 1999. SAM lists the top 15% of firms in its Sus-
tainability Yearbook and classifies them into gold, silver, and bronze categories.38
Business Week published its first list of the world’s 100 most sustainable corporations Jan-
uary 29, 2007. The Dow Jones Sustainability Indexes and the KLD Broad Market Social
Index, which evaluate companies on a range of environmental, social, and governance cri-
teria are used for investment decisions.39 Financial services firms, such as Goldman
Sachs, Bank of America, JPMorgan Chase, and Citigroup have adopted guidelines for
lending and asset management aimed at promoting clean-energy alternatives.40
6. Physical Risk: The direct risk posed by climate change includes the physical effects of
droughts, floods, storms, and rising sea levels. Average Arctic temperatures have risen four
to five degrees Fahrenheit (two to three degrees Celsius) in the past 50 years, leading to
melting glaciers and sea levels rising one inch per decade.41 Industries most likely to be af-
fected are insurance, agriculture, fishing, forestry, real estate, and tourism. Physical risk
can also affect other industries, such as oil and gas, through higher insurance premiums
paid on facilities in vulnerable areas. Coca-Cola, for example, studies the linkages between
climate change and water availability in terms of how this will affect the location of its new
bottling plants. The warming of the Tibetan plateau has led to a thawing of the per-
mafrost—thereby threatening the newly-completed railway line between China and Ti-
bet.42 (See the Environmental Sustainability Issue feature for a more complete list of
projected effects of climate change.)
Although global warming remains a controversial topic, the best argument in favor of working
toward environmental sustainability is a variation of Pascal’s Wager on the existence of God:
The same goes for global warming. If you accept it as reality, adapting your strategy and prac-
tices, your plants will use less energy and emit fewer effluents. Your packaging will be more
12 PART 1 Introduction to Strategic Management and Business Policy
SOURCE: F. G. Sussman and J. R. Freed, “Adapting to Climate
Change: A Business Approach,” Paper prepared for the Pew Cen-
ter on Global Climate Change (April 2008), pp. 5–6.
� Annual precipitation increases in most of northern Eu-
rope, Canada, northeastern U.S., and the Arctic.
� Winter precipitation increases in northern Asia and the
Tibetan Plateau.
� Dry spells increase in length and frequency in the Mediter-
ranean, Australia, and New Zealand; seasonal droughts
increase in many mid-latitude continent interiors.
EXTREME WEATHER-RELATED EVENTS
� Increasing intense tropical cyclone activity.
� Increasing frequency of flash floods and large-area
floods in many regions.
� Increasing risk of drought in Australia, eastern New
Zealand, and the Mediterranean, with seasonal
droughts in central Europe and Central America.
� Increasing wildfires in arid and semi-arid areas such as
Australia and the western U.S.
OTHER RELATED EFFECTS
� Decreasing snow season length and depth in Europe
and North America.
� Fewer cold days and nights leading to decreasing frosts.
� Accelerated glacier loss.
� Reduction in and warming of permafrost.
According to the Intergov-
ernmental Panel on Climate
Change (IPCC), the global cli-
mate system is projected to in-
clude a number of changes during
the 21st century:
TEMPERATURE INCREASE
� Global average warming of approximately 0.2 degrees
Celsius each decade.
� Long-term warming associated with doubled carbon
dioxide concentrations in the range of 2 to 4.5 degrees
Celsius.
� Fewer cold days and nights; warmer and more frequent
hot days and nights.
� Increased frequency, intensity, and duration of heat waves
in central Europe, western U.S., East Asia, and Korea.
SEA LEVEL RISE
� Sea level will continue to rise due to thermal expansion
of seawater and loss of land ice at greater rates.
� Sea level rise of 18 to 59 centimeters by the end of the
21st century.
� Warming will continue contributing to sea level rise for
many centuries even if greenhouse gas concentrations
are stabilized.
PRECIPITATION AND HUMIDITY
� Increasing numbers of wet days in high latitudes; in-
creasing numbers of dry spells in subtropical areas.
PROJECTED EFFECTS OF CLIMATE CHANGE
ENVIRONMENTAL sustainability issue
biodegradable, and your new products will be able to capture any markets created by severe
weather effects. Yes, global warming might not be as damaging as some predict, and you might
have invested more than you needed, but it’s just as Pascal said: Given all the possible outcomes,
the upside of being ready and prepared for a “fearsome event” surely beats the alternative.43
1.3 Theories of Organizational Adaptation
Globalization and environmental sustainability present real challenges to the strategic manage-
ment of business corporations. How can any one company keep track of all the changing tech-
nological, economic, political–legal, and sociocultural trends around the world and make the
necessary adjustments? This is not an easy task. Various theories have been proposed to account
for how organizations obtain fit with their environment. The theory of population ecology, for
CHAPTER 1 Basic Concepts of Strategic Management 13
1.4 Creating a Learning Organization
Strategic management has now evolved to the point that its primary value is in helping an or-
ganization operate successfully in a dynamic, complex environment. To be competitive in dy-
namic environments, corporations are becoming less bureaucratic and more flexible. In stable
environments such as those that existed in years past, a competitive strategy simply involved
defining a competitive position and then defending it. As it takes less and less time for one
product or technology to replace another, companies are finding that there is no such thing as
a permanent competitive advantage. Many agree with Richard D’Aveni, who says in his book
Hypercompetition that any sustainable competitive advantage lies not in doggedly following
a centrally managed five-year plan but in stringing together a series of strategic short-term
thrusts (as Intel does by cutting into the sales of its own offerings with periodic introductions
of new products).48 This means that corporations must develop strategic flexibility—the abil-
ity to shift from one dominant strategy to another.49
Strategic flexibility demands a long-term commitment to the development and nurturing
of critical resources. It also demands that the company become a learning organization—an
organization skilled at creating, acquiring, and transferring knowledge and at modifying its be-
havior to reflect new knowledge and insights. Organizational learning is a critical component
of competitiveness in a dynamic environment. It is particularly important to innovation and new
product development.50 For example, both Hewlett-Packard and British Petroleum (BP) use an
extensive network of informal committees to transfer knowledge among their cross-functional
teams and to help spread new sources of knowledge quickly.51 Siemens, a major electronics
company, created a global knowledge-sharing network, called ShareNet, in order to quickly
spread information technology throughout the firm. Based on its experience with ShareNet,
Siemens established PeopleShareNet, a system that serves as a virtual expert marketplace for
example, proposes that once an organization is successfully established in a particular envi-
ronmental niche, it is unable to adapt to changing conditions. Inertia prevents the organization
from changing. The company is thus replaced (is bought out or goes bankrupt) by other
organizations more suited to the new environment. Although it is a popular theory in sociol-
ogy, research fails to support the arguments of population ecology.44 Institution theory, in
contrast, proposes that organizations can and do adapt to changing conditions by imitating
other successful organizations. To its credit, many examples can be found of companies that
have adapted to changing circumstances by imitating an admired firm’s strategies and man-
agement techniques.45 The theory does not, however, explain how or by whom successful new
strategies are developed in the first place. The strategic choice perspective goes one step
further by proposing that not only do organizations adapt to a changing environment, but they
also have the opportunity and power to reshape their environment. This perspective is
supported by research indicating that the decisions of a firm’s management have at least as
great an impact on firm performance as overall industry factors.46 Because of its emphasis on
managers making rational strategic decisions, the strategic choice perspective is the dominant
one taken in strategic management. Its argument that adaptation is a dynamic process fits with
the view of organizational learning theory, which says that an organization adjusts defen-
sively to a changing environment and uses knowledge offensively to improve the fit between
itself and its environment. This perspective expands the strategic choice perspective to include
people at all levels becoming involved in providing input into strategic decisions.47
In agreement with the concepts of organizational learning theory, an increasing number
of companies are realizing that they must shift from a vertically organized, top-down type of
organization to a more horizontally managed, interactive organization. They are attempting to
adapt more quickly to changing conditions by becoming “learning organizations.”
14 PART 1 Introduction to Strategic Management and Business Policy
facilitating the creation of cross-cultural teams composed of members with specific knowledge
and competencies.52
Learning organizations are skilled at four main activities:
� Solving problems systematically
� Experimenting with new approaches
� Learning from their own experiences and past history as well as from the experiences
of others
� Transferring knowledge quickly and efficiently throughout the organization53
Business historian Alfred Chandler proposes that high-technology industries are defined by
“paths of learning” in which organizational strengths derive from learned capabilities.54 Ac-
cording to Chandler, companies spring from an individual entrepreneur’s knowledge, which
then evolves into organizational knowledge. This organizational knowledge is composed of
three basic strengths: technical skills, mainly in research; functional knowledge, such as pro-
duction and marketing; and managerial expertise. This knowledge leads to new businesses
where the company can succeed and creates an entry barrier to new competitors. Chandler
points out that once a corporation has built its learning base to the point where it has become
a core company in its industry, entrepreneurial startups are rarely able to successfully enter.
Thus, organizational knowledge becomes a competitive advantage.
Strategic management is essential for learning organizations to avoid stagnation through con-
tinuous self-examination and experimentation. People at all levels, not just top management, par-
ticipate in strategic management—helping to scan the environment for critical information,
suggesting changes to strategies and programs to take advantage of environmental shifts, and
working with others to continuously improve work methods, procedures, and evaluation tech-
niques. For example, Motorola developed an action learning format in which people from mar-
keting, product development, and manufacturing meet to argue and reach agreement about the
needs of the market, the best new product, and the schedules of each group producing it. This ac-
tion learning approach overcame the problems that arose previously when the three departments
met and formally agreed on plans but continued with their work as if nothing had happened.55 Re-
search indicates that involving more people in the strategy process results in people not only view-
ing the process more positively, but also acting in ways that make the process more effective.56
Organizations that are willing to experiment and are able to learn from their experiences
are more successful than those that are not.57 For example, in a study of U.S. manufacturers
of diagnostic imaging equipment, the most successful firms were those that improved prod-
ucts sold in the United States by incorporating some of what they had learned from their man-
ufacturing and sales experiences in other nations. The less successful firms used the foreign
operations primarily as sales outlets, not as important sources of technical knowledge.58 Re-
search also reveals that multidivisional corporations that establish ways to transfer knowledge
across divisions are more innovative than other diversified corporations that do not.59
1.5 Basic Model of Strategic Management
Strategic management consists of four basic elements:
� Environmental scanning
� Strategy formulation
� Strategy implementation
� Evaluation and control
CHAPTER 1 Basic Concepts of Strategic Management 15
Environmental
Scanning
Strategy
Formulation
Strategy
Implementation
Evaluation
and
Control
FIGURE 1–1
Basic Elements of
the Strategic
Management
Process
Figure 1–1 illustrates how these four elements interact; Figure 1–2 expands each of these
elements and serves as the model for this book. This model is both rational and prescriptive.
It is a planning model that presents what a corporation should do in terms of the strategic man-
agement process, not what any particular firm may actually do. The rational planning model
predicts that as environmental uncertainty increases, corporations that work more diligently to
analyze and predict more accurately the changing situation in which they operate will outper-
form those that do not. Empirical research studies support this model.60 The terms used in
Figure 1–2 are explained in the following pages.
Gathering
Information
Putting Strategy
into Action
Monitoring
Performance
Societal
Environment:
General forces
Natural
Environment:
Resources and
climate
Task
Environment:
Industry analysis
Internal:
Strengths and
Weaknesses
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
Programs
Activities
needed to
accomplish
a plan
Budgets
Cost of the
programs Procedures
Sequence
of steps
needed to
do the job
Performance
Actual results
External:
Opportunities
and Threats
Developing
Long-range Plans
Mission
Reason for
existence Objectives
What
results to
accomplish
by when
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Environmental
Scanning:
Strategy
Formulation:
Strategy
Implementation:
Evaluation
and Control:
Feedback/Learning: Make corrections as needed
FIGURE 1–2 Strategic Management Model
SOURCE: T. L. Wheelen, “Strategic Management Model,” adapted from “Concepts of Management,” presented to Society for Advancement of
Management (SAM), International Meeting, Richmond, VA, 1981. T.L. Wheelen and SAM. Copyright © 1982, 1985, 1988, and 2005 by
T.L. Wheelen and J.D. Hunger. Revised 1989, 1995, 1998, 2000 and 2005. Reprinted with permission.
16 PART 1 Introduction to Strategic Management and Business Policy
Environmental scanning is the monitoring, evaluating, and disseminating of information
from the external and internal environments to key people within the corporation. Its purpose
is to identify strategic factors—those external and internal elements that will determine the
future of the corporation. The simplest way to conduct environmental scanning is through
SWOT analysis. SWOT is an acronym used to describe the particular Strengths, Weaknesses,
Opportunities, and Threats that are strategic factors for a specific company. The external en-
vironment consists of variables (Opportunities and Threats) that are outside the organization
and not typically within the short-run control of top management. These variables form the
context within which the corporation exists. Figure 1–3 depicts key environmental variables.
They may be general forces and trends within the natural or societal environments or specific
factors that operate within an organization’s specific task environment—often called its
industry. (These external variables are defined and discussed in more detail in Chapter 4.)
The internal environment of a corporation consists of variables (Strengths and
Weaknesses) that are within the organization itself and are not usually within the short-run
ENVIRONMENTAL SCANNING
Sociocultural
Forces
Economic
Forces
Political–Legal
Forces
Societal
Environment
Technological
Forces
Structure
Culture
Resources
Governments
Natural
Physical
Environment
Wildlife
Physical
Resources
Climate
Shareholders
Suppliers
Competitors
Trade Associations
Communities
Creditors
Customers
Employees/
Labor Unions
Special
Interest Groups
Task
Environment
(Industry)
Internal
Environment
FIGURE 1–3 Environmental Variables
CHAPTER 1 Basic Concepts of Strategic Management 17
control of top management. These variables form the context in which work is done. They in-
clude the corporation’s structure, culture, and resources. Key strengths form a set of core com-
petencies that the corporation can use to gain competitive advantage. (These internal variables
and core competencies are defined and discussed in more detail in Chapter 5.)
STRATEGY FORMULATION
Strategy formulation is the development of long-range plans for the effective management
of environmental opportunities and threats, in light of corporate strengths and weaknesses
(SWOT). It includes defining the corporate mission, specifying achievable objectives, devel-
oping strategies, and setting policy guidelines.
Mission
An organization’s mission is the purpose or reason for the organization’s existence. It tells
what the company is providing to society—either a service such as housecleaning or a prod-
uct such as automobiles. A well-conceived mission statement defines the fundamental, unique
purpose that sets a company apart from other firms of its type and identifies the scope or do-
main of the company’s operations in terms of products (including services) offered and mar-
kets served. Research reveals that firms with mission statements containing explicit
descriptions of customers served and technologies used have significantly higher growth than
firms without such statements.61 A mission statement may also include the firm’s values and
philosophy about how it does business and treats its employees. It puts into words not only
what the company is now but what it wants to become—management’s strategic vision of the
firm’s future. The mission statement promotes a sense of shared expectations in employees and
communicates a public image to important stakeholder groups in the company’s task environ-
ment. Some people like to consider vision and mission as two different concepts: Mission de-
scribes what the organization is now; vision describes what the organization would like to
become. We prefer to combine these ideas into a single mission statement.62 Some companies
prefer to list their values and philosophy of doing business in a separate publication called a
values statement. For a listing of the many things that could go into a mission statement, see
Strategy Highlight 1.1.
One example of a mission statement is that of Google:
To organize the world’s information and make it universally accessible and useful.63
Another classic example is that etched in bronze at Newport News Shipbuilding, unchanged
since its founding in 1886:
We shall build good ships here—at a profit if we can—at a loss if we must—but always good ships.64
A mission may be defined narrowly or broadly in scope. An example of a broad mission
statement is that used by many corporations: “Serve the best interests of shareowners, cus-
tomers, and employees.” A broadly defined mission statement such as this keeps the company
from restricting itself to one field or product line, but it fails to clearly identify either what it
makes or which products/markets it plans to emphasize. Because this broad statement is so
general, a narrow mission statement, such as the preceding examples by Google and Newport
News Shipbuilding, is generally more useful. A narrow mission very clearly states the organi-
zation’s primary business, but it may limit the scope of the firm’s activities in terms of the
product or service offered, the technology used, and the market served. Research indicates that
a narrow mission statement may be best in a turbulent industry because it keeps the firm fo-
cused on what it does best; whereas, a broad mission statement may be best in a stable envi-
ronment that lacks growth opportunities.65
18 PART 1 Introduction to Strategic Management and Business Policy
4. Does the statement describe the strategic
positioning that the company prefers in a way that
helps to identify the sort of competitive advantage it
will look for?
5. Does the statement identify values that link with the
organization’s purpose and act as beliefs with which
employees can feel proud?
6. Do the values resonate with and reinforce the
organization’s strategy?
7. Does the statement describe important behavior
standards that serve as beacons of the strategy and
the values?
8. Are the behavior standards described in a way that
enables individual employees to judge whether they
are behaving correctly?
9. Does the statement give a portrait of the company,
capturing the culture of the organization?
10. Is the statement easy to read?
Andrew Campbell, a direc-
tor of Ashridge Strategic
Management Centre and a
long-time contributor to Long
Range Planning, proposes a
means for evaluating a mission state-
ment. Arguing that mission statements can be more than
just an expression of a company’s purpose and ambition,
he suggests that they can also be a company flag to rally
around, a signpost for all stakeholders, a guide to behav-
ior, and a celebration of a company’s culture. For a com-
pany trying to achieve all of the above, evaluate its mission
statement using the following 10-question test. Score each
question 0 for no, 1 for somewhat, or 2 for yes. According
to Campbell, a score of over 15 is exceptional, and a score
of less than 10 suggests that more work needs to be done.
1. Does the statement describe an inspiring purpose
that avoids playing to the selfish interests of the
stakeholders?
2. Does the statement describe the company’s
responsibility to its stakeholders?
3. Does the statement define a business domain and
explain why it is attractive?
DO YOU HAVE A GOOD MISSION STATEMENT?
SOURCE: Reprinted from Long Range Planning, Vol. 30, No. 6,
1997, Campbell “Mission Statements”, pp. 931–932, Copyright
© 1997 with permission of Elsevier.
STRATEGY highlight 1.1
Objectives
Objectives are the end results of planned activity. They should be stated as action verbs and
tell what is to be accomplished by when and quantified if possible. The achievement of cor-
porate objectives should result in the fulfillment of a corporation’s mission. In effect, this
is what society gives back to the corporation when the corporation does a good job of ful-
filling its mission. For example, by providing society with gums, candy, iced tea, and car-
bonated drinks, Cadbury Schweppes, has become the world’s largest confectioner by sales.
One of its prime objectives is to increase sales 4%–6% each year. Even though its profit
margins were lower than those of Nestlé, Kraft, and Wrigley, its rivals in confectionary, or
those of Coca-Cola or Pepsi, its rivals in soft drinks, Cadbury Schweppes’ management es-
tablished the objective of increasing profit margins from around 10% in 2007 to the mid-
teens by 2011.66
The term goal is often used interchangeably with the term objective. In this book, we pre-
fer to differentiate the two terms. In contrast to an objective, we consider a goal as an open-
ended statement of what one wants to accomplish, with no quantification of what is to be
achieved and no time criteria for completion. For example, a simple statement of “increased
profitability” is thus a goal, not an objective, because it does not state how much profit the firm
wants to make the next year. A good objective should be action-oriented and begin with the word
to. An example of an objective is “to increase the firm’s profitability in 2010 by 10% over 2009.”
CHAPTER 1 Basic Concepts of Strategic Management 19
Some of the areas in which a corporation might establish its goals and objectives are:
� Profitability (net profits)
� Efficiency (low costs, etc.)
� Growth (increase in total assets, sales, etc.)
� Shareholder wealth (dividends plus stock price appreciation)
� Utilization of resources (ROE or ROI)
� Reputation (being considered a “top” firm)
� Contributions to employees (employment security, wages, diversity)
� Contributions to society (taxes paid, participation in charities, providing a needed product
or service)
� Market leadership (market share)
� Technological leadership (innovations, creativity)
� Survival (avoiding bankruptcy)
� Personal needs of top management (using the firm for personal purposes, such as provid-
ing jobs for relatives)
Strategies
A strategy of a corporation forms a comprehensive master plan that states how the corpo-
ration will achieve its mission and objectives. It maximizes competitive advantage and min-
imizes competitive disadvantage. For example, even though Cadbury Schweppes was a
major competitor in confectionary and soft drinks, it was not likely to achieve its challeng-
ing objective of significantly increasing its profit margin within four years without making
a major change in strategy. Management therefore decided to cut costs by closing 33 facto-
ries and reducing staff by 10%. It also made the strategic decision to concentrate on the con-
fectionary business by divesting its less-profitable Dr. Pepper/Snapple soft drinks unit.
Management was also considering acquisitions as a means of building on its existing
strengths in confectionary by purchasing either Kraft’s confectionary unit or the Hershey
Company.
The typical business firm usually considers three types of strategy: corporate, business,
and functional.
1. Corporate strategy describes a company’s overall direction in terms of its general atti-
tude toward growth and the management of its various businesses and product lines. Cor-
porate strategies typically fit within the three main categories of stability, growth, and
retrenchment. Cadbury Schweppes, for example, was following a corporate strategy of re-
trenchment by selling its marginally profitable soft drink business and concentrating on
its very successful confectionary business.
2. Business strategy usually occurs at the business unit or product level, and it emphasizes
improvement of the competitive position of a corporation’s products or services in the
specific industry or market segment served by that business unit. Business strategies may
fit within the two overall categories, competitive and cooperative strategies. For example,
Staples, the U.S. office supply store chain, has used a competitive strategy to differenti-
ate its retail stores from its competitors by adding services to its stores, such as copying,
UPS shipping, and hiring mobile technicians who can fix computers and install networks.
British Airways has followed a cooperative strategy by forming an alliance with Ameri-
can Airlines in order to provide global service. Cooperative strategy may thus be used to
20 PART 1 Introduction to Strategic Management and Business Policy
provide a competitive advantage. Intel, a manufacturer of computer microprocessors, uses
its alliance (cooperative strategy) with Microsoft to differentiate itself (competitive
strategy) from AMD, its primary competitor.
3. Functional strategy is the approach taken by a functional area to achieve corporate and
business unit objectives and strategies by maximizing resource productivity. It is con-
cerned with developing and nurturing a distinctive competence to provide a company or
business unit with a competitive advantage. Examples of research and development
(R&D) functional strategies are technological followership (imitation of the products of
other companies) and technological leadership (pioneering an innovation). For years,
Magic Chef had been a successful appliance maker by spending little on R&D but by
quickly imitating the innovations of other competitors. This helped the company to keep
its costs lower than those of its competitors and consequently to compete with lower
prices. In terms of marketing functional strategies, Procter & Gamble (P&G) is a master
of marketing “pull”—the process of spending huge amounts on advertising in order to cre-
ate customer demand. This supports P&G’s competitive strategy of differentiating its
products from those of its competitors.
Business firms use all three types of strategy simultaneously. A hierarchy of strategy
is a grouping of strategy types by level in the organization. Hierarchy of strategy is a nest-
ing of one strategy within another so that they complement and support one another. (See
Figure 1–4.) Functional strategies support business strategies, which, in turn, support the
corporate strategy(ies).
Just as many firms often have no formally stated objectives, many firms have unstated,
incremental, or intuitive strategies that have never been articulated or analyzed. Often the only
way to spot a corporation’s implicit strategies is to look not at what management says but at
what it does. Implicit strategies can be derived from corporate policies, programs approved
(and disapproved), and authorized budgets. Programs and divisions favored by budget in-
creases and staffed by managers who are considered to be on the fast promotion track reveal
where the corporation is putting its money and its energy.
Corporate Strategy:
Overall Direction of
Company and Management
of Its Businesses
Business
Strategy:
Competitive and
Cooperative Strategies
Functional
Strategy:
Maximize Resource
Productivity
FIGURE 1–4
Hierarchy
of Strategy
CHAPTER 1 Basic Concepts of Strategic Management 21
Policies
A policy is a broad guideline for decision making that links the formulation of a strategy with
its implementation. Companies use policies to make sure that employees throughout the firm
make decisions and take actions that support the corporation’s mission, objectives, and strate-
gies. For example, when Cisco decided on a strategy of growth through acquisitions, it estab-
lished a policy to consider only companies with no more than 75 employees, 75% of whom
were engineers.67 Consider the following company policies:
� 3M: 3M says researchers should spend 15% of their time working on something other
than their primary project. (This supports 3M’s strong product development strategy.)
� Intel: Intel cannibalizes its own product line (undercuts the sales of its current products)
with better products before a competitor does so. (This supports Intel’s objective of mar-
ket leadership.)
� General Electric: GE must be number one or two wherever it competes. (This supports
GE’s objective to be number one in market capitalization.)
� Southwest Airlines: Southwest offers no meals or reserved seating on airplanes. (This
supports Southwest’s competitive strategy of having the lowest costs in the industry.)
� Exxon: Exxon pursues only projects that will be profitable even when the price of oil
drops to a low level. (This supports Exxon’s profitability objective.)
Policies such as these provide clear guidance to managers throughout the organization.
(Strategy formulation is discussed in greater detail in Chapters 6, 7, and 8.)
STRATEGY IMPLEMENTATION
Strategy implementation is a process by which strategies and policies are put into action
through the development of programs, budgets, and procedures. This process might involve
changes within the overall culture, structure, and/or management system of the entire organi-
zation. Except when such drastic corporatewide changes are needed, however, the implemen-
tation of strategy is typically conducted by middle- and lower-level managers, with review by
top management. Sometimes referred to as operational planning, strategy implementation of-
ten involves day-to-day decisions in resource allocation.
Programs
A program is a statement of the activities or steps needed to accomplish a single-use plan. It
makes a strategy action oriented. It may involve restructuring the corporation, changing the
company’s internal culture, or beginning a new research effort. For example, Boeing’s strat-
egy to regain industry leadership with its proposed 787 Dreamliner meant that the company
had to increase its manufacturing efficiency in order to keep the price low. To significantly cut
costs, management decided to implement a series of programs:
� Outsource approximately 70% of manufacturing.
� Reduce final assembly time to three days (compared to 20 for its 737 plane) by having
suppliers build completed plane sections.
� Use new, lightweight composite materials in place of aluminum to reduce inspection time.
� Resolve poor relations with labor unions caused by downsizing and outsourcing.
Another example is a set of programs used by automaker BMW to achieve its objective
of increasing production efficiency by 5% each year: (a) shorten new model development time
from 60 to 30 months, (b) reduce preproduction time from a year to no more than five months,
22 PART 1 Introduction to Strategic Management and Business Policy
and (c) build at least two vehicles in each plant so that production can shift among models de-
pending upon demand.
Budgets
A budget is a statement of a corporation’s programs in terms of dollars. Used in planning and
control, a budget lists the detailed cost of each program. Many corporations demand a certain
percentage return on investment, often called a “hurdle rate,” before management will approve
a new program. This ensures that the new program will significantly add to the corporation’s
profit performance and thus build shareholder value. The budget thus not only serves as a de-
tailed plan of the new strategy in action, it also specifies through pro forma financial state-
ments the expected impact on the firm’s financial future.
For example, General Motors budgeted $4.3 billion to update and expand its Cadillac
line of automobiles. With this money, the company was able to increase the number of mod-
els from five to nine and to offer more powerful engines, sportier handling, and edgier
styling. The company reversed its declining market share by appealing to a younger market.
(The average Cadillac buyer in 2000 was 67 years old.)68 Another example is the $8 billion
budget that General Electric established to invest in new jet engine technology for regional-
jet airplanes. Management decided that an anticipated growth in regional jets should be the
company’s target market. The program paid off when GE won a $3 billion contract to pro-
vide jet engines for China’s new fleet of 500 regional jets in time for the 2008 Beijing
Olympics.69
Procedures
Procedures, sometimes termed Standard Operating Procedures (SOP), are a system of se-
quential steps or techniques that describe in detail how a particular task or job is to be done.
They typically detail the various activities that must be carried out in order to complete the cor-
poration’s program. For example, when the home improvement retailer Home Depot noted
that sales were lagging because its stores were full of clogged aisles, long checkout times, and
too few salespeople, management changed its procedures for restocking shelves and pricing
the products. Instead of requiring its employees to do these activities at the same time they
were working with customers, management moved these activities to when the stores were
closed at night. Employees were then able to focus on increasing customer sales during the
day. Both UPS and FedEx put such an emphasis on consistent, quality service that both com-
panies have strict rules for employee behavior, ranging from how a driver dresses to how keys
are held when approaching a customer’s door. (Strategy implementation is discussed in more
detail in Chapters 9 and 10.)
EVALUATION AND CONTROL
Evaluation and control is a process in which corporate activities and performance results are
monitored so that actual performance can be compared with desired performance. Managers
at all levels use the resulting information to take corrective action and resolve problems. Al-
though evaluation and control is the final major element of strategic management, it can also
pinpoint weaknesses in previously implemented strategic plans and thus stimulate the entire
process to begin again.
Performance is the end result of activities.70 It includes the actual outcomes of the strate-
gic management process. The practice of strategic management is justified in terms of its abil-
ity to improve an organization’s performance, typically measured in terms of profits and return
on investment. For evaluation and control to be effective, managers must obtain clear, prompt,
and unbiased information from the people below them in the corporation’s hierarchy. Using
CHAPTER 1 Basic Concepts of Strategic Management 23
this information, managers compare what is actually happening with what was originally
planned in the formulation stage.
For example, when market share (followed by profits) declined at Dell in 2007, Michael
Dell, founder, returned to the CEO position and reevaluated his company’s strategy and oper-
ations. Planning for continued growth, the company’s expansion of its computer product line
into new types of hardware, such as storage, printers, and televisions, had not worked as
planned. In some areas, like televisions and printers, Dell’s customization ability did not add
much value. In other areas, like services, lower-cost competitors were already established.
Michael Dell concluded, “I think you’re going to see a more streamlined organization, with a
much clearer strategy.”71
The evaluation and control of performance completes the strategic management model.
Based on performance results, management may need to make adjustments in its strategy for-
mulation, in implementation, or in both. (Evaluation and control is discussed in more detail in
Chapter 11.)
FEEDBACK/LEARNING PROCESS
Note that the strategic management model depicted in Figure 1–2 includes a feedback/learning
process. Arrows are drawn coming out of each part of the model and taking information to
each of the previous parts of the model. As a firm or business unit develops strategies, pro-
grams, and the like, it often must go back to revise or correct decisions made earlier in the
process. For example, poor performance (as measured in evaluation and control) usually in-
dicates that something has gone wrong with either strategy formulation or implementation. It
could also mean that a key variable, such as a new competitor, was ignored during environ-
mental scanning and assessment. In the case of Dell, the personal computer market had ma-
tured and by 2007 there were fewer growth opportunities available within the industry. Even
Jim Cramer, host of the popular television program, Mad Money, was referring to computers
in 2008 as “old technology” having few growth prospects. Dell’s management needed to re-
assess the company’s environment and find better opportunities to profitably apply its core
competencies.
1.6 Initiation of Strategy: Triggering Events
After much research, Henry Mintzberg discovered that strategy formulation is typically not a
regular, continuous process: “It is most often an irregular, discontinuous process, proceeding
in fits and starts. There are periods of stability in strategy development, but also there are pe-
riods of flux, of groping, of piecemeal change, and of global change.”72 This view of strategy
formulation as an irregular process can be explained by the very human tendency to continue
on a particular course of action until something goes wrong or a person is forced to question
his or her actions. This period of strategic drift may result from inertia on the part of the orga-
nization, or it may reflect management’s belief that the current strategy is still appropriate and
needs only some fine-tuning.
Most large organizations tend to follow a particular strategic orientation for about 15 to
20 years before making a significant change in direction.73 This phenomenon, called
punctuated equilibrium, describes corporations as evolving through relatively long periods of
stability (equilibrium periods) punctuated by relatively short bursts of fundamental change
(revolutionary periods).74 After this rather long period of fine-tuning an existing strategy, some
sort of shock to the system is needed to motivate management to seriously reassess the corpo-
ration’s situation.
24 PART 1 Introduction to Strategic Management and Business Policy
A triggering event is something that acts as a stimulus for a change in strategy. Some pos-
sible triggering events are:75
� New CEO: By asking a series of embarrassing questions, a new CEO cuts through the veil
of complacency and forces people to question the very reason for the corporation’s existence.
� External intervention: A firm’s bank suddenly refuses to approve a new loan or suddenly
demands payment in full on an old one. A key customer complains about a serious prod-
uct defect.
� Threat of a change in ownership: Another firm may initiate a takeover by buying a com-
pany’s common stock.
� Performance gap: A performance gap exists when performance does not meet expecta-
tions. Sales and profits either are no longer increasing or may even be falling.
� Strategic inflection point: Coined by Andy Grove, past-CEO of Intel Corporation, a
strategic inflection point is what happens to a business when a major change takes place
due to the introduction of new technologies, a different regulatory environment, a change
in customers’ values, or a change in what customers prefer.76
Unilever is an example of one company in which a triggering event forced management
to radically rethink what it was doing. See Strategy Highlight 1.2 to learn how a slumping
stock price stimulated a change in strategy at Unilever.
decades of operating in almost every country in the world,
the company had become fat with unnecessary bureau-
cracy and complexity. Unilever’s traditional emphasis on
the autonomy of its country managers had led to a lack of
synergy and a duplication of corporate structures. Country
managers had been making strategic decisions without re-
gard for their effect on other regions or on the corporation
as a whole. Starting at the top, two joint chairmen were re-
placed by one sole chief executive. In China, three compa-
nies with three chief executives were replaced by one
company with one person in charge. Overall staff was cut
from 223,000 in 2004 to 179,000 in 2008. By 2010, man-
agement planned close to 50 of its 300 factories and to
eliminate 75 of 100 regional centers. Twenty thousand
more jobs were selected to be eliminated over a four-year
period. Ralph Kugler, manager of Unilever’s home and per-
sonal care division, exhibited confidence that after these
changes, the company was better prepared to face com-
petition. “We are much better organized now to defend
ourselves,” he stated.
Unilever, the world’s second-
largest consumer goods
company, received a jolt in
2004 when its stock price fell
sharply after management had
warned investors that profits would be
lower than anticipated. Even though the company had
been the first consumer goods company to enter the
world’s emerging economies in Africa, China, India, and
Latin America with a formidable range of products and lo-
cal knowledge, its sales faltered when rivals began to at-
tack its entrenched position in these markets. Procter &
Gamble’s (P&G) acquisition of Gillette had greatly bolstered
P&G’s growing portfolio of global brands and allowed it to
undermine Unilever’s global market share. For example,
when P&G targeted India for a sales initiative in 2003–04,
profit margins fell at Unilever’s Indian subsidiary from 20%
to 13%.
An in-depth review of Unilever’s brands revealed that its
brands were doing as well as were those of its rivals. Some-
thing else was wrong. According to Richard Rivers,
Unilever’s head of corporate strategy, “We were just not
executing as well as we should have.”
Unilever’s management realized that it had no choice
but to make-over the company from top to bottom. Over
TRIGGERING EVENT AT UNILEVER
SOURCE: Summarized from “The Legacy that Got Left on the
Shelf,” The Economist (February 2, 2008), pp. 77–79.
STRATEGY highlight 1.2
CHAPTER 1 Basic Concepts of Strategic Management 25
MINTZBERG’S MODES OF STRATEGIC DECISION MAKING
Some strategic decisions are made in a flash by one person (often an entrepreneur or a pow-
erful chief executive officer) who has a brilliant insight and is quickly able to convince oth-
ers to adopt his or her idea. Other strategic decisions seem to develop out of a series of small
incremental choices that over time push an organization more in one direction than another.
1.7 Strategic Decision Making
The distinguishing characteristic of strategic management is its emphasis on strategic decision
making. As organizations grow larger and more complex, with more uncertain environments,
decisions become increasingly complicated and difficult to make. In agreement with the strate-
gic choice perspective mentioned earlier, this book proposes a strategic decision-making
framework that can help people make these decisions regardless of their level and function in
the corporation.
WHAT MAKES A DECISION STRATEGIC
Unlike many other decisions, strategic decisions deal with the long-run future of an entire or-
ganization and have three characteristics:
1. Rare: Strategic decisions are unusual and typically have no precedent to follow.
2. Consequential: Strategic decisions commit substantial resources and demand a great deal
of commitment from people at all levels.
3. Directive: Strategic decisions set precedents for lesser decisions and future actions
throughout an organization.77
One example of a strategic decision with all of these characteristics was that made by Genen-
tech, a biotechnology company that had been founded in 1976 to produce protein-based drugs
from cloned genes. After building sales to $9 billion and profits to $2 billion in 2006, the com-
pany’s sales growth slowed and its stock price dropped in 2007. The company’s products were
reaching maturity with few new ones in the pipeline. To regain revenue growth, management de-
cided to target autoimmune diseases, such as multiple sclerosis, rheumatoid arthritis, lupus, and
80 other ailments for which there was no known lasting treatment. This was an enormous oppor-
tunity, but also a very large risk for the company. Existing drugs in this area either weren’t effec-
tive for many patients or caused side effects that were worse than the disease. Competition from
companies like Amgen and Novartis were already vying for leadership in this area. A number of
Genentech’s first attempts in the area had failed to do well against the competition.
The strategic decision to commit resources to this new area was based on a report from a
British physician that the Genentech’s cancer drug Rituxan eased the agony of rheumatoid arthri-
tis in five of his patients. CEO Arthur Levinson was so impressed with this report that he imme-
diately informed Genentech’s board of directors. He urged them to support a full research
program for Rituxan in autoimmune disease. With the board’s blessing, Levinson launched a pro-
gram to study the drug as a treatment for rheumatoid arthritis, MS, and lupus. The company de-
ployed a third of its 1,000 researchers to pursue new drugs to fight autoimmune diseases. In 2006,
Rituxan was approved to treat rheumatoid arthritis and captured 10% of the market. The com-
pany was working on some completely new approaches to autoimmune disease. The research
mandate was to consider ideas others might overlook. “There’s this tremendous herd instinct out
there,” said Levinson. “That’s a great opportunity, because often the crowd is wrong.”78
26 PART 1 Introduction to Strategic Management and Business Policy
According to Henry Mintzberg, the three most typical approaches, or modes, of strategic de-
cision making are entrepreneurial, adaptive, and planning (a fourth mode, logical incremen-
talism, was added later by Quinn):79
� Entrepreneurial mode: Strategy is made by one powerful individual. The focus is on op-
portunities; problems are secondary. Strategy is guided by the founder’s own vision of di-
rection and is exemplified by large, bold decisions. The dominant goal is growth of the
corporation. Amazon.com, founded by Jeff Bezos, is an example of this mode of strategic
decision making. The company reflected Bezos’ vision of using the Internet to market
books and more. Although Amazon’s clear growth strategy was certainly an advantage of
the entrepreneurial mode, Bezos’ eccentric management style made it difficult to retain
senior executives.80
� Adaptive mode: Sometimes referred to as “muddling through,” this decision-making
mode is characterized by reactive solutions to existing problems, rather than a proactive
search for new opportunities. Much bargaining goes on concerning priorities of objec-
tives. Strategy is fragmented and is developed to move a corporation forward incremen-
tally. This mode is typical of most universities, many large hospitals, a large number of
governmental agencies, and a surprising number of large corporations. Encyclopaedia
Britannica Inc., operated successfully for many years in this mode, but it continued to rely
on the door-to-door selling of its prestigious books long after dual-career couples made that
marketing approach obsolete. Only after it was acquired in 1996 did the company change
its door-to-door sales to television advertising and Internet marketing. The company now
charges libraries and individual subscribers for complete access to Brittanica.com and of-
fers CD-ROMs in addition to a small number of its 32-volume print set.81
� Planning mode: This decision-making mode involves the systematic gathering of appro-
priate information for situation analysis, the generation of feasible alternative strategies,
and the rational selection of the most appropriate strategy. It includes both the proactive
search for new opportunities and the reactive solution of existing problems. IBM under
CEO Louis Gerstner is an example of the planning mode. When Gerstner accepted the po-
sition of CEO in 1993, he realized that IBM was in serious difficulty. Mainframe comput-
ers, the company’s primary product line, were suffering a rapid decline both in sales and
market share. One of Gerstner’s first actions was to convene a two-day meeting on corpo-
rate strategy with senior executives. An in-depth analysis of IBM’s product lines revealed
that the only part of the company that was growing was services, but it was a relatively small
segment and not very profitable. Rather than focusing on making and selling its own com-
puter hardware, IBM made the strategic decision to invest in services that integrated infor-
mation technology. IBM thus decided to provide a complete set of services from building
systems to defining architecture to actually running and managing the computers for the
customer—regardless of who made the products. Because it was no longer important that
the company be completely vertically integrated, it sold off its DRAM, disk-drive, and lap-
top computer businesses and exited software application development. Since making this
strategic decision in 1993, 80% of IBM’s revenue growth has come from services.82
� Logical incrementalism: A fourth decision-making mode can be viewed as a synthesis
of the planning, adaptive, and, to a lesser extent, the entrepreneurial modes. In this mode,
CHAPTER 1 Basic Concepts of Strategic Management 27
STRATEGIC DECISION-MAKING PROCESS: AID TO BETTER DECISIONS
Good arguments can be made for using either the entrepreneurial or adaptive modes (or logi-
cal incrementalism) in certain situations.85 This book proposes, however, that in most situa-
tions the planning mode, which includes the basic elements of the strategic management
process, is a more rational and thus better way of making strategic decisions. Research indi-
cates that the planning mode is not only more analytical and less political than are the other
modes, but it is also more appropriate for dealing with complex, changing environments.86 We
therefore propose the following eight-step strategic decision-making process to improve the
making of strategic decisions (see Figure 1–5):
1. Evaluate current performance results in terms of (a) return on investment, profitabil-
ity, and so forth, and (b) the current mission, objectives, strategies, and policies.
2. Review corporate governance—that is, the performance of the firm’s board of directors
and top management.
3. Scan and assess the external environment to determine the strategic factors that pose
Opportunities and Threats.
4. Scan and assess the internal corporate environment to determine the strategic factors
that are Strengths (especially core competencies) and Weaknesses.
5. Analyze strategic (SWOT) factors to (a) pinpoint problem areas and (b) review and re-
vise the corporate mission and objectives, as necessary.
6. Generate, evaluate, and select the best alternative strategy in light of the analysis con-
ducted in step 5.
7. Implement selected strategies via programs, budgets, and procedures.
8. Evaluate implemented strategies via feedback systems, and the control of activities to
ensure their minimum deviation from plans.
This rational approach to strategic decision making has been used successfully by corpo-
rations such as Warner-Lambert, Target, General Electric, IBM, Avon Products, Bechtel Group
Inc., and Taisei Corporation.
top management has a reasonably clear idea of the corporation’s mission and objectives,
but, in its development of strategies, it chooses to use “an interactive process in which the
organization probes the future, experiments and learns from a series of partial (incremen-
tal) commitments rather than through global formulations of total strategies.”83 Thus,
although the mission and objectives are set, the strategy is allowed to emerge out of debate,
discussion, and experimentation. This approach appears to be useful when the environ-
ment is changing rapidly and when it is important to build consensus and develop needed
resources before committing an entire corporation to a specific strategy. In his analysis of
the petroleum industry, Grant described strategic planning in this industry as “planned
emergence.” Corporate headquarters established the mission and objectives but allowed
the business units to propose strategies to achieve them.84
28 PART 1 Introduction to Strategic Management and Business Policy
1.8 The Strategic Audit:Aid to Strategic Decision-Making
The strategic decision-making process is put into action through a technique known as the
strategic audit. A strategic audit provides a checklist of questions, by area or issue, that en-
ables a systematic analysis to be made of various corporate functions and activities. (See
Appendix 1.A at the end of this chapter.) Note that the numbered primary headings in the au-
dit are the same as the numbered blocks in the strategic decision-making process in Figure 1–5.
Beginning with an evaluation of current performance, the audit continues with environmental
scanning, strategy formulation, and strategy implementation, and it concludes with evaluation
and control. A strategic audit is a type of management audit and is extremely useful as a diag-
nostic tool to pinpoint corporatewide problem areas and to highlight organizational strengths
and weaknesses.87 A strategic audit can help determine why a certain area is creating problems
for a corporation and help generate solutions to the problem.
A strategic audit is not an all-inclusive list, but it presents many of the critical questions
needed for a detailed strategic analysis of any business corporation. Some questions or even
some areas might be inappropriate for a particular company; in other cases, the questions may
1(a)
3(a) 3(b)
Strategy
Formulation:
Steps 1–6
1(b) 2
Evaluate
Current
Performance
Results
Review
Corporate
Governance:
Board of
Directors
Top Man-
agement
Examine and
Evaluate the
Current:
Mission
Objectives
Strategies
Policies
5(a)
4(b)
Select
Strategic
Factors
(SWOT)
in Light of
Current
Situation
Analyze
Internal
Factors:
Strengths
Weak-
nesses
Analyze
External
Factors:
Opportun-
ities
Threats
Scan and
Assess
External
Environment:
Natural
Societal
Task
4(a)
Scan and
Assess
Internal
Environment:
Structure
Culture
Resources
FIGURE 1–5
Strategic Decision-
Making Process
SOURCE: T. L. Wheelen and J. D. Hunger, Strategic Decision-Making Process. Copyright © 1994 and 1997 by
Wheelen & Hunger Associates. Reprinted by permission.
CHAPTER 1 Basic Concepts of Strategic Management 29
End of Chapter SUMMARY
Strategy scholars Donald Hambrick and James Fredrickson propose that a good strategy has
five elements, providing answers to five questions:
1. Arenas: Where will we be active?
2. Vehicles: How will we get there?
3. Differentiators: How will we win in the marketplace?
4. Staging: What will be our speed and sequence of moves?
5. Economic logic: How will we obtain our returns?88
This chapter introduces you to a well-accepted model of strategic management
(Figure 1–2) in which environmental scanning leads to strategy formulation, strategy imple-
mentation, and evaluation and control. It further shows how that model can be put into action
Strategy
Implementation:
Step 7
Evaluation
and Control:
Step 8
5(b) 6(a) 6(b)
Select
and
Recommend
Best
Alternative
Generate
and
Evaluate
Strategic
Alternatives
7 8
Evaluate
and
Control
Implement
Strategies:
Programs
Budgets
Procedures
Review and
Revise as
Necessary:
Mission
Objectives
be insufficient for a complete analysis. However, each question in a particular area of a strate-
gic audit can be broken down into an additional series of sub-questions. An analyst can develop
these sub-questions when they are needed for a complete strategic analysis of a company.
30 PART 1 Introduction to Strategic Management and Business Policy
E C O – B I T S
� The world’s primary energy consumption by fuel in
2004 was 35% oil, 25% coal, 21% natural gas, 10% bio-
mass and waste, 6% nuclear, 2% hydroelectric, and 1%
other renewable.90
� The price per watt of photovoltaic modules used in so-
lar power dropped from $18 in 1980 to $4 in 2007.91
� Since 1869 world crude oil prices, adjusted for infla-
tion, have averaged $21.66 per barrel in 2006 dollars.
By 2008, the price per barrel reached $140 for the first
time in history.92
D I S C U S S I O N Q U E S T I O N S
1. Why has strategic management become so important to
today’s corporations?
2. How does strategic management typically evolve in a
corporation?
3. What is a learning organization? Is this approach to
strategic management better than the more traditional
top-down approach in which strategic planning is prima-
rily done by top management?
4. Why are strategic decisions different from other kinds of
decisions?
5. When is the planning mode of strategic decision making
superior to the entrepreneurial and adaptive modes?
S T R A T E G I C P R A C T I C E E X E R C I S E S
Mission statements vary widely from one company to another.
Why is one mission statement better than another? Using
Campbell’s questions in Strategy Highlight 1.2 as a start-
ing point, develop criteria for evaluating any mission state-
ment. Then do one or both of the following exercises:
1. Evaluate the following mission statement of Celestial
Seasonings. How many points would Campbell give it?
Our mission is to grow and dominate the U.S. specialty
tea market by exceeding consumer expectations with the
best tasting, 100% natural hot and iced teas, packaged
with Celestial art and philosophy, creating the most val-
ued tea experience. Through leadership, innovation, fo-
cus, and teamwork, we are dedicated to continuously
improving value to our consumers, customers, employ-
ees, and stakeholders with a quality-first organization.93
2. Using the Internet, find the mission statements of three
different organizations, which can be business or not-for-
profit. (Hint: Check annual reports and 10K forms. They
can often be found via a link on a company’s Web page
or through Hoovers.com.) Which mission statement is
best? Why?
K E Y T E R M S
budget (p. 22)
business strategy (p. 19)
corporate strategy (p. 19)
environmental scanning (p. 16)
environmental sustainability (p. 8)
evaluation and control (p. 22)
external environment (p. 16)
functional strategy (p. 20)
globalization (p. 8)
through the strategic decision-making process (Figure 1–5) and a strategic audit
(Appendix 1.A). As pointed out by Hambrick and Fredrickson, “strategy consists of an inte-
grated set of choices.”89 The questions “Where will we be active?” and “How will we get
there?” are dealt with by a company’s mission, objectives, and corporate strategy. The question
“How will we win in the marketplace?” is the concern of business strategy. The question “What
will be our speed and sequence of moves?” is answered not only by business strategy and tac-
tics but also by functional strategy and by implemented programs, budgets, and procedures. The
question “How will we obtain our returns?” is the primary emphasis of the evaluation and con-
trol element of the strategic management model. Each of these questions and topics will be dealt
with in greater detail in the chapters to come. Welcome to the study of strategic management!
CHAPTER 1 Basic Concepts of Strategic Management 31
N O T E S
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hierarchy of strategy (p. 20)
institution theory (p. 13)
internal environment (p. 16)
learning organization (p. 13)
mission (p. 17)
objective (p. 18)
organizational learning theory (p. 13)
performance (p. 22)
phases of strategic management (p. 5)
policy (p. 21)
population ecology (p. 12)
procedure (p. 22)
program (p. 21)
strategic audit (p. 28)
strategic choice perspective (p. 13)
strategic decision (p. 25)
strategic decision-making process (p. 27)
strategic factor (p. 16)
strategic management (p. 5)
strategy (p. 19)
strategy formulation (p. 17)
strategy implementation (p. 21)
SWOT analysis (p. 16)
triggering event (p. 24)
vision (p. 17)
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ment Effects and Business Performance: A Non-Parametric Ap-
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pp. 861–879; Y. E. Spanos, G. Zaralis, and S. Lioukas, “Strategy
and Industry Effects on Profitability: Evidence from Greece,”
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E. H. Bowman and C. E. Helfat, “Does Corporate Strategy Mat-
ter?” Strategic Management Journal (January 2001), pp. 1–23;
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B. Yeung, “The Effect of Own-Firm and Other Firm Experience
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CHAPTER 1 Basic Concepts of Strategic Management 33
http://www.wtrg.com/prices.htm
I. Current Situation
A. Current Performance
How did the corporation perform the past year overall in terms of return on investment,
market share, and profitability?
B. Strategic Posture
What are the corporation’s current mission, objectives, strategies, and policies?
1. Are they clearly stated, or are they merely implied from performance?
2. Mission: What business(es) is the corporation in? Why?
3. Objectives: What are the corporate, business, and functional objectives? Are they con-
sistent with each other, with the mission, and with the internal and external environments?
4. Strategies: What strategy or mix of strategies is the corporation following? Are they
consistent with each other, with the mission and objectives, and with the internal and
external environments?
5. Policies: What are the corporation’s policies? Are they consistent with each other, with
the mission, objectives, and strategies, and with the internal and external environments?
6. Do the current mission, objectives, strategies, and policies reflect the corporation’s in-
ternational operations, whether global or multidomestic?
II. Corporate Governance
A. Board of Directors
1. Who is on the board? Are they internal (employees) or external members?
2. Do they own significant shares of stock?
3. Is the stock privately held or publicly traded? Are there different classes of stock with
different voting rights?
4. What do the board members contribute to the corporation in terms of knowledge, skills,
background, and connections? If the corporation has international operations, do board
members have international experience? Are board members concerned with environ-
mental sustainability?
Strategic Audit
of a Corporation
A P P E N D I X 1.A
SOURCE: T.L. Wheelen, J.D. Hunger, Strategic Audit of a Corporation, Copyright © 1982 by Wheelen & Hunger
Associates. Reprinted by permission. Revised 1988, 1991, 1994, 1997, 2000, 2002, 2005, and 2008.
34
CHAPTER 1 Basic Concepts of Strategic Management 35
5. How long have the board members served on the board?
6. What is their level of involvement in strategic management? Do they merely rubber-stamp
top management’s proposals or do they actively participate and suggest future directions?
Do they evaluate management’s proposals in terms of environmental sustainability?
B. Top Management
1. What person or group constitutes top management?
2. What are top management’s chief characteristics in terms of knowledge, skills, back-
ground, and style? If the corporation has international operations, does top management
have international experience? Are executives from acquired companies considered
part of the top management team?
3. Has top management been responsible for the corporation’s performance over the past
few years? How many managers have been in their current position for less than three
years? Were they promoted internally or externally hired?
4. Has top management established a systematic approach to strategic management?
5. What is top management’s level of involvement in the strategic management process?
6. How well does top management interact with lower-level managers and with the board
of directors?
7. Are strategic decisions made ethically in a socially responsible manner?
8. Are strategic decisions made in an environmentally sustainable manner?
9. Do top executives own significant amounts of stock in the corporation?
10. Is top management sufficiently skilled to cope with likely future challenges?
III. External Environment:
Opportunities and Threats (SWOT)
A. Natural Physical Environment: Sustainability Issues
1. What forces from the natural physical environmental are currently affecting the corpo-
ration and the industries in which it competes? Which present current or future threats?
Opportunities?
a. Climate, including global temperature, sea level, and fresh water availability
b. Weather-related events, such as severe storms, floods, and droughts
c. Solar phenomena, such as sun spots and solar wind
2. Do these forces have different effects in other regions of the world?
B. Societal Environment
1. What general environmental forces are currently affecting both the corporation and the
industries in which it competes? Which present current or future threats? Opportunities?
a. Economic
b. Technological
c. Political–legal
d. Sociocultural
2. Are these forces different in other regions of the world?
36 PART 1 Introduction to Strategic Management and Business Policy
C. Task Environment
1. What forces drive industry competition? Are these forces the same globally or do they
vary from country to country? Rate each force as high, medium, or low.
a. Threat of new entrants
b. Bargaining power of buyers
c. Threat of substitute products or services
d. Bargaining power of suppliers
e. Rivalry among competing firms
f. Relative power of unions, governments, special interest groups, etc.
2. What key factors in the immediate environment (that is, customers, competitors, sup-
pliers, creditors, labor unions, governments, trade associations, interest groups, local
communities, and shareholders) are currently affecting the corporation? Which are cur-
rent or future Threats? Opportunities?
D. Summary of External Factors
(List in the EFAS Table 4–5, p. 126)
Which of these forces and factors are the most important to the corporation and to the in-
dustries in which it competes at the present time? Which will be important in the future?
IV. Internal Environment:
Strengths and Weaknesses (SWOT)
A. Corporate Structure
1. How is the corporation structured at present?
a. Is the decision-making authority centralized around one group or decentralized to
many units?
b. Is the corporation organized on the basis of functions, projects, geography, or some
combination of these?
2. Is the structure clearly understood by everyone in the corporation?
3. Is the present structure consistent with current corporate objectives, strategies, policies,
and programs, as well as with the firm’s international operations?
4. In what ways does this structure compare with those of similar corporations?
B. Corporate Culture
1. Is there a well-defined or emerging culture composed of shared beliefs, expectations,
and values?
2. Is the culture consistent with the current objectives, strategies, policies, and programs?
3. What is the culture’s position on environmental sustainability?
4. What is the culture’s position on other important issues facing the corporation (that
is, on productivity, quality of performance, adaptability to changing conditions, and
internationalization)?
5. Is the culture compatible with the employees’ diversity of backgrounds?
6. Does the company take into consideration the values of the culture of each nation in
which the firm operates?
CHAPTER 1 Basic Concepts of Strategic Management 37
C. Corporate Resources
1. Marketing
a. What are the corporation’s current marketing objectives, strategies, policies, and
programs?
i. Are they clearly stated or merely implied from performance and/or budgets?
ii. Are they consistent with the corporation’s mission, objectives, strategies, and
policies and with internal and external environments?
b. How well is the corporation performing in terms of analysis of market position and
marketing mix (that is, product, price, place, and promotion) in both domestic and in-
ternational markets? How dependent is the corporation on a few customers? How big
is its market? Where is it gaining or losing market share? What percentage of sales
comes from developed versus developing regions? Where are current products in the
product life cycle?
i. What trends emerge from this analysis?
ii. What impact have these trends had on past performance and how might these
trends affect future performance?
iii. Does this analysis support the corporation’s past and pending strategic decisions?
iv. Does marketing provide the company with a competitive advantage?
c. How well does the corporation’s marketing performance compare with that of sim-
ilar corporations?
d. Are marketing managers using accepted marketing concepts and techniques to eval-
uate and improve product performance? (Consider product life cycle, market seg-
mentation, market research, and product portfolios.)
e. Does marketing adjust to the conditions in each country in which it operates?
f. Does marketing consider environmental sustainability when making decisions?
g. What is the role of the marketing manager in the strategic management process?
2. Finance
a. What are the corporation’s current financial objectives, strategies, and policies and
programs?
i. Are they clearly stated or merely implied from performance and/or budgets?
ii. Are they consistent with the corporation’s mission, objectives, strategies, and
policies and with internal and external environments?
b. How well is the corporation performing in terms of financial analysis? (Consider ra-
tio analysis, common size statements, and capitalization structure.) How balanced,
in terms of cash flow, is the company’s portfolio of products and businesses? What
are investor expectations in terms of share price?
i. What trends emerge from this analysis?
ii. Are there any significant differences when statements are calculated in con-
stant versus reported dollars?
iii. What impact have these trends had on past performance and how might these
trends affect future performance?
iv. Does this analysis support the corporation’s past and pending strategic decisions?
v. Does finance provide the company with a competitive advantage?
c. How well does the corporation’s financial performance compare with that of simi-
lar corporations?
d. Are financial managers using accepted financial concepts and techniques to evalu-
ate and improve current corporate and divisional performance? (Consider financial
leverage, capital budgeting, ratio analysis, and managing foreign currencies.)
e. Does finance adjust to the conditions in each country in which the company operates?
f. Does finance cope with global financial issues?
g. What is the role of the financial manager in the strategic management process?
38 PART 1 Introduction to Strategic Management and Business Policy
3. Research and Development (R&D)
a. What are the corporation’s current R&D objectives, strategies, policies, and programs?
i. Are they clearly stated or merely implied from performance or budgets?
ii. Are they consistent with the corporation’s mission, objectives, strategies and poli-
cies and with internal and external environments?
iii. What is the role of technology in corporate performance?
iv. Is the mix of basic, applied, and engineering research appropriate given the cor-
porate mission and strategies?
v. Does R&D provide the company with a competitive advantage?
b. What return is the corporation receiving from its investment in R&D?
c. Is the corporation competent in technology transfer? Does it use concurrent engi-
neering and cross-functional work teams in product and process design?
d. What role does technological discontinuity play in the company’s products?
e. How well does the corporation’s investment in R&D compare with the investments
of similar corporations? How much R&D is being outsourced? Is the corporation us-
ing value-chain alliances appropriately for innovation and competitive advantage?
f. Does R&D adjust to the conditions in each country in which the company operates?
g. Does R&D consider environmental sustainability in product development and
packaging?
h. What is the role of the R&D manager in the strategic management process?
4. Operations and Logistics
a. What are the corporation’s current manufacturing/service objectives, strategies,
policies, and programs?
i. Are they clearly stated or merely implied from performance or budgets?
ii. Are they consistent with the corporation’s mission, objectives, strategies, and
policies and with internal and external environments?
b. What are the type and extent of operations capabilities of the corporation? How
much is done domestically versus internationally? Is the amount of outsourcing ap-
propriate to be competitive? Is purchasing being handled appropriately? Are sup-
pliers and distributors operating in an environmentally sustainable manner? Which
products have the highest and lowest profit margins?
i. If the corporation is product oriented, consider plant facilities, type of manu-
facturing system (continuous mass production, intermittent job shop, or flexi-
ble manufacturing), age and type of equipment, degree and role of automation
and/or robots, plant capacities and utilization, productivity ratings, and avail-
ability and type of transportation.
ii. If the corporation is service oriented, consider service facilities (hospital, theater,
or school buildings), type of operations systems (continuous service over time to
same clientele or intermittent service over time to varied clientele), age and type
of supporting equipment, degree and role of automation and use of mass commu-
nication devices (diagnostic machinery, video machines), facility capacities and
utilization rates, efficiency ratings of professional and service personnel, and
availability and type of transportation to bring service staff and clientele together.
c. Are manufacturing or service facilities vulnerable to natural disasters, local or national
strikes, reduction or limitation of resources from suppliers, substantial cost increases
of materials, or nationalization by governments?
d. Is there an appropriate mix of people and machines (in manufacturing firms) or of
support staff to professionals (in service firms)?
e. How well does the corporation perform relative to the competition? Is it balancing in-
ventory costs (warehousing) with logistical costs (just-in-time)? Consider costs per
unit of labor, material, and overhead; downtime; inventory control management and
scheduling of service staff; production ratings; facility utilization percentages; and
number of clients successfully treated by category (if service firm) or percentage of
orders shipped on time (if product firm).
CHAPTER 1 Basic Concepts of Strategic Management 39
i. What trends emerge from this analysis?
ii. What impact have these trends had on past performance and how might these
trends affect future performance?
iii. Does this analysis support the corporation’s past and pending strategic decisions?
iv. Does operations provide the company with a competitive advantage?
f. Are operations managers using appropriate concepts and techniques to evaluate and
improve current performance? Consider cost systems, quality control and reliabil-
ity systems, inventory control management, personnel scheduling, TQM, learning
curves, safety programs, and engineering programs that can improve efficiency of
manufacturing or of service.
g. Do operations adjust to the conditions in each country in which it has facilities?
h. Do operations consider environmental sustainability when making decisions?
i. What is the role of the operations manager in the strategic management process?
5. Human Resources Management (HRM)
a. What are the corporation’s current HRM objectives, strategies, policies, and pro-
grams?
i. Are they clearly stated or merely implied from performance and/or budgets?
ii. Are they consistent with the corporation’s mission, objectives, strategies, and
policies and with internal and external environments?
b. How well is the corporation’s HRM performing in terms of improving the fit be-
tween the individual employee and the job? Consider turnover, grievances, strikes,
layoffs, employee training, and quality of work life.
i. What trends emerge from this analysis?
ii. What impact have these trends had on past performance and how might these
trends affect future performance?
iii. Does this analysis support the corporation’s past and pending strategic decisions?
iv. Does HRM provide the company with a competitive advantage?
c. How does this corporation’s HRM performance compare with that of similar cor-
porations?
d. Are HRM managers using appropriate concepts and techniques to evaluate and im-
prove corporate performance? Consider the job analysis program, performance ap-
praisal system, up-to-date job descriptions, training and development programs,
attitude surveys, job design programs, quality of relationships with unions, and use of
autonomous work teams.
e. How well is the company managing the diversity of its workforce? What is the
company’s record on human rights? Does the company monitor the human rights
record of key suppliers and distributors?
f. Does HRM adjust to the conditions in each country in which the company oper-
ates? Does the company have a code of conduct for HRM for itself and key sup-
pliers in developing nations? Are employees receiving international assignments to
prepare them for managerial positions?
g. What is the role of outsourcing in HRM planning?
h. What is the role of the HRM manager in the strategic management process?
6. Information Technology (IT)
a. What are the corporation’s current IT objectives, strategies, policies, and programs?
i. Are they clearly stated or merely implied from performance and/or budgets?
ii. Are they consistent with the corporation’s mission, objectives, strategies, and
policies and with internal and external environments?
b. How well is the corporation’s IT performing in terms of providing a useful database,
automating routine clerical operations, assisting managers in making routine deci-
sions, and providing information necessary for strategic decisions?
i. What trends emerge from this analysis?
ii. What impact have these trends had on past performance and how might these
trends affect future performance?
40 PART 1 Introduction to Strategic Management and Business Policy
iii. Does this analysis support the corporation’s past and pending strategic decisions?
iv. Does IT provide the company with a competitive advantage?
c. How does this corporation’s IT performance and stage of development compare
with that of similar corporations? Is it appropriately using the Internet, intranet, and
extranets?
d. Are IT managers using appropriate concepts and techniques to evaluate and improve
corporate performance? Do they know how to build and manage a complex data-
base, establish Web sites with firewalls and virus protection, conduct system analy-
ses, and implement interactive decision-support systems?
e. Does the company have a global IT and Internet presence? Does it have difficulty
with getting data across national boundaries?
f. What is the role of the IT manager in the strategic management process?
D. Summary of Internal Factors
(List in the IFAS Table 5–2, p.164)
Which of these factors are core competencies? Which, if any, are distinctive competen-
cies? Which of these factors are the most important to the corporation and to the indus-
tries in which it competes at the present time? Which might be important in the future?
Which functions or activities are candidates for outsourcing?
V. Analysis of Strategic Factors (SWOT)
A. Situational Analysis (List in SFAS Matrix, Figure 6–1, p. 179)
Of the external (EFAS) and internal (IFAS) factors listed in III.D and IV.D, which are the
strategic (most important) factors that strongly affect the corporation’s present and future
performance?
B. Review of Mission and Objectives
1. Are the current mission and objectives appropriate in light of the key strategic factors
and problems?
2. Should the mission and objectives be changed? If so, how?
3. If they are changed, what will be the effects on the firm?
VI. Strategic Alternatives
and Recommended Strategy
A. Strategic Alternatives
(See the TOWS Matrix, Figure 6–3, p. 182)
1. Can the current or revised objectives be met through more careful implementation of
those strategies presently in use (for example, fine-tuning the strategies)?
2. What are the major feasible alternative strategies available to the corporation? What are
the pros and cons of each? Can corporate scenarios be developed and agreed on? (Al-
ternatives must fit the natural physical environment, societal environment, industry, and
corporation for the next three to five years.)
a. Consider stability, growth, and retrenchment as corporate strategies.
b. Consider cost leadership and differentiation as business strategies.
CHAPTER 1 Basic Concepts of Strategic Management 41
c. Consider any functional strategic alternatives that might be needed for reinforcement
of an important corporate or business strategic alternative.
B. Recommended Strategy
1. Specify which of the strategic alternatives you are recommending for the corporate,
business, and functional levels of the corporation. Do you recommend different busi-
ness or functional strategies for different units of the corporation?
2. Justify your recommendation in terms of its ability to resolve both long- and short-term
problems and effectively deal with the strategic factors.
3. What policies should be developed or revised to guide effective implementation?
4. What is the impact of your recommended strategy on the company’s core and distinc-
tive competencies?
VII. Implementation
A. What Kinds of Programs (for Example, Restructuring the
Corporation or Instituting TQM) Should Be Developed to
Implement the Recommended Strategy?
1. Who should develop these programs?
2. Who should be in charge of these programs?
B. Are the Programs Financially Feasible? Can Pro Forma
Budgets Be Developed and Agreed On? Are Priorities
and Timetables Appropriate to Individual Programs?
C. Will New Standard Operating Procedures Need to Be
Developed?
VIII. Evaluation and Control
A. Is the Current Information System Capable of Providing
Sufficient Feedback on Implementation Activities and
Performance? Can It Measure Strategic Factors?
1. Can performance results be pinpointed by area, unit, project, or function?
2. Is the information timely?
3. Is the corporation using benchmarking to evaluate its functions and activities?
B. Are Adequate Control Measures in Place to Ensure
Conformance with the Recommended Strategic Plan?
1. Are appropriate standards and measures being used?
2. Are reward systems capable of recognizing and rewarding good performance?
On paper, Robert Nardelli, seemed to be doing everything right. Selected
personally by the founders, Arthur Blank, Kenneth Langone, and Bernard Marcus,
the board of directors felt that the company was lucky to have hired Nardelli from
General Electric to be CEO of Home Depot in December 2000. Between 2000 and
2005, the company opened more than 900 stores, doubled sales to $81.5 billion, and
achieved earnings per share growth of at least 20% every year. According to Nardelli, the com-
pany had the strongest balance sheet in the industry and tremendous potential for future
growth. The board loved Nardelli and had been happy to support his decisions.
The stockholders, however, were not as satisfied with Nardelli’s performance. They won-
dered why Home Depot’s common stock had fallen 30% since Nardelli had taken charge of the
company. In addition, Nardelli was increasingly being attacked for having “excessive compen-
sation,” given the firm’s poor stock performance. People questioned why he was receiving $38.1
million annually in salary, cash bonuses, and stock options. Nardelli was one of the six executives
highlighted in a July 24, 2006 Fortune article entitled “The Real CEO Pay Problem.”1
Stockholders were unhappy with Nardelli’s tendency to manipulate negative performance
data. For example, when same-store sales failed to increase in 2005, he announced that man-
agement would no longer report that figure. When a Business Week reporter questioned his
persuading the board not to use stock price to decide his compensation, Nardelli responded that
he and the board had felt that the leadership team should be measured on things over which
the team had direct control, such as earnings per share instead of stock price compared to the
retail index.2
Since Nardelli saw little growth opportunity in the company’s retail stores, he pushed to
make the stores run more efficiently. Importing ideas, people, and management concepts from
the military was one way to reshape an increasingly unwieldy Home Depot into a more central-
ized and efficient organization. Under Nardelli, the emphasis was on building a disciplined man-
ager corps, one predisposed to following orders, operating in high-pressure environments, and
executing with high standards.3 He hired ex-military to be store managers. The previous con-
stant flow of ideas and suggestions flowing up the organization from Home Depot’s many em-
ployees was replaced by major decisions and goals flowing down from top management.
Former Home Depot executives reported that a “culture of fear” had caused customer ser-
vice to decline. The once-heavy ranks of full-time store employees had been replaced with part-
timers to reduce labor costs. Since 2001, 98% of Home Depot’s 170 top executives had left the
corporate
Governance
C H A P T E R 2
43
� Describe the role and responsibilities of
the board of directors in corporate
governance
� Understand how the composition of a
board can affect its operation
� Describe the impact of the Sarbanes-Oxley
Act on corporate governance in the
United States
� Discuss trends in corporate governance
� Explain how executive leadership is an
important part of strategic management
Learning Objectives
Gathering
Information
Putting Strategy
into Action
Monitoring
Performance
Societal
Environment:
General forces
Natural
Environment:
Resources and
climate
Task
Environment:
Industry analysis
Internal:
Strengths and
Weaknesses
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
Programs
Activities
needed to
accomplish
a plan
Budgets
Cost of the
programs Procedures
Sequence
of steps
needed to
do the job
Performance
Actual results
External:
Opportunities
and Threats
Developing
Long-range Plans
Mission
Reason for
existence Objectives
What
results to
accomplish
by when
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Environmental
Scanning:
Strategy
Formulation:
Strategy
Implementation:
Evaluation
and Control:
Feedback/Learning: Make corrections as needed
After reading this chapter, you should be able to:
company. The University of Michigan’s American Customer Satisfaction Index, compiled in
2005, revealed that Home Depot, with a score of 67, had slipped to last place among
major U.S. retailers.
Nardelli did not react well to criticism. For example, the agenda for the May 2006
shareholders meeting contained a number of shareholder proposals dealing with “exces-
sive” senior management compensation, separating the position of Chairman of the
Board from another management position, requiring a majority (instead of plurality) vote
for board member elections, shareholder approval for future “extraordinary” retirement
benefits for senior executives, and disclosure of the monetary value of executive benefits.
The votes on these proposals indicated an unusually high level of shareholder dissent,
with at least one-third of shareholders voting for every proposal—votes cast before the
meeting. Upon arriving at the annual shareholders meeting, people were surprised to
note a number of changes from previous annual meetings. For one thing, except for CEO
Nardelli, none of the members of the board of directors were present. For another, share-
holders were allowed to speak about their shareholder proposals, but each had a time
limit that was carefully tracked by a giant clock. Nardelli did not present a performance
review, refused to acknowledge comments or answer questions, and adjourned the meet-
ing after 30 minutes. Many of the shareholders were enraged by Nardelli’s arrogance.
Pushed by the shareholders to reduce the CEO’s large compensation package, the
board of directors finally asked Nardelli to accept future stock awards being tied to in-
creases in the company’s stock price. Nardelli flatly refused and instead quit the company
in January 2007—taking with him a $210 million retirement package. Observers could not
understand why the board had been so generous with a CEO who during his tenure had
been more concerned with building his own compensation than in building shareholder
wealth.4
Home Depot’s shareholders are not the only ones who are concerned with question-
able top managers and weak boards of directors. A record 1,169 shareholder resolutions
were proposed in the U.S. during 2007. Proposals on CEO pay and other governance issues
received record high support votes of 30% to 60% from investors.5 Successful shareholder
activist campaigns increased in Europe from less than 10 in 2001 to over 50 in 2007.6
Research revealing that managers at 29% of all U.S. public corporations had back-dated
stock options in order to boost executive pay led to civil charges and shareholder lawsuits
in addition to criminal indictments.7 Board members are increasingly being held account-
able for poor corporate governance. For example, 10 former directors from WorldCom
and Enron agreed to pay $18 million and $13 million, respectively, of their own money to
settle lawsuits launched by enraged stockholders over the unethical and even criminal ac-
tions of top management overseen by a passive board of directors.8
44 PART 1 Introduction to Strategic Management and Business Policy
CHAPTER 2 Corporate Governance 45
2.1 Role of the Board of Directors
A corporation is a mechanism established to allow different parties to contribute capital, ex-
pertise, and labor for their mutual benefit. The investor/shareholder participates in the profits
of the enterprise without taking responsibility for the operations. Management runs the com-
pany without being responsible for personally providing the funds. To make this possible, laws
have been passed that give shareholders limited liability and, correspondingly, limited in-
volvement in a corporation’s activities. That involvement does include, however, the right to
elect directors who have a legal duty to represent the shareholders and protect their interests.
As representatives of the shareholders, directors have both the authority and the responsibil-
ity to establish basic corporate policies and to ensure that they are followed.9
The board of directors, therefore, has an obligation to approve all decisions that might af-
fect the long-run performance of the corporation. This means that the corporation is fundamen-
tally governed by the board of directors overseeing top management, with the concurrence of
the shareholder. The term corporate governance refers to the relationship among these three
groups in determining the direction and performance of the corporation.10
Over the past decade, shareholders and various interest groups have seriously questioned
the role of the board of directors in corporations. They are concerned that inside board mem-
bers may use their position to feather their own nests and that outside board members often
lack sufficient knowledge, involvement, and enthusiasm to do an adequate job of monitoring
and providing guidance to top management. Instances of widespread corruption and question-
able accounting practices at Enron, Global Crossing, WorldCom, Tyco, and Qwest, among oth-
ers, seem to justify their concerns. Home Depot’s board, for example, seemed more interested
in keeping CEO Nardelli happy than in promoting shareholder interests.
The general public has not only become more aware and more critical of many boards’
apparent lack of responsibility for corporate activities, it has begun to push government to de-
mand accountability. As a result, the board as a rubber stamp of the CEO or as a bastion of the
“old-boy” selection system is being replaced by more active, more professional boards.
RESPONSIBILITIES OF THE BOARD
Laws and standards defining the responsibilities of boards of directors vary from country to
country. For example, board members in Ontario, Canada, face more than 100 provincial and
federal laws governing director liability. The United States, however, has no clear national
standards or federal laws. Specific requirements of directors vary, depending on the state in
which the corporate charter is issued. There is, nevertheless, a developing worldwide consen-
sus concerning the major responsibilities of a board. Interviews with 200 directors from eight
countries (Canada, France, Germany, Finland, Switzerland, the Netherlands, the United King-
dom, and Venezuela) revealed strong agreement on the following five board of director re-
sponsibilities, listed in order of importance:
1. Setting corporate strategy, overall direction, mission, or vision
2. Hiring and firing the CEO and top management
3. Controlling, monitoring, or supervising top management
4. Reviewing and approving the use of resources
5. Caring for shareholder interests11
These results are in agreement with a survey by the National Association of Corporate
Directors, in which U.S. CEOs reported that the four most important issues boards should
46 PART 1 Introduction to Strategic Management and Business Policy
address are corporate performance, CEO succession, strategic planning, and corporate gov-
ernance.12 Directors in the United States must make certain, in addition to the duties just
listed, that the corporation is managed in accordance with the laws of the state in which it is
incorporated. Because more than half of all publicly traded companies in the United States
are incorporated in the state of Delaware, this state’s laws and rulings have more impact than
do those of any other state.13 Directors must also ensure management’s adherence to laws
and regulations, such as those dealing with the issuance of securities, insider trading, and
other conflict-of-interest situations. They must also be aware of the needs and demands of
constituent groups so that they can achieve a judicious balance among the interests of these
diverse groups while ensuring the continued functioning of the corporation.
In a legal sense, the board is required to direct the affairs of the corporation but not to man-
age them. It is charged by law to act with due care. If a director or the board as a whole fails
to act with due care and, as a result, the corporation is in some way harmed, the careless direc-
tor or directors can be held personally liable for the harm done. This is no small concern given
that one survey of outside directors revealed that more than 40% had been named as part of
lawsuits against corporations.14 For example, board members of Equitable Life in Britain were
sued for up to $5.4 billion for failure to question the CEO’s reckless policies.15 For this rea-
son, corporations have found that they need directors and officers’ liability insurance in order
to attract people to become members of boards of directors.
A 2008 global survey of directors by McKinsey & Company revealed the average amount
of time boards spend on a given issue during their meetings:16
� Strategy (development and analysis of strategies)—24%
� Execution (prioritizing programs and approving mergers and acquisitions)—24%
� Performance management (development of incentives and measuring performance)—20%
� Governance and compliance (nominations, compensation, audits)—17%
� Talent management—11%
Role of the Board in Strategic Management
How does a board of directors fulfill these many responsibilities? The role of the board of di-
rectors in strategic management is to carry out three basic tasks:
� Monitor: By acting through its committees, a board can keep abreast of developments in-
side and outside the corporation, bringing to management’s attention developments it
might have overlooked. A board should at the minimum carry out this task.
� Evaluate and influence: A board can examine management’s proposals, decisions, and
actions; agree or disagree with them; give advice and offer suggestions; and outline alter-
natives. More active boards perform this task in addition to monitoring.
� Initiate and determine: A board can delineate a corporation’s mission and specify strate-
gic options to its management. Only the most active boards take on this task in addition
to the two previous ones.
Board of Directors’ Continuum
A board of directors is involved in strategic management to the extent that it carries out the
three tasks of monitoring, evaluating and influencing, and initiating and determining. The
board of directors’ continuum shown in Figure 2–1 shows the possible degree of involve-
ment (from low to high) in the strategic management process. Boards can range from phantom
boards with no real involvement to catalyst boards with a very high degree of involvement.17
Research suggests that active board involvement in strategic management is positively related
to a corporation’s financial performance and its credit rating.18
CHAPTER 2 Corporate Governance 47
DEGREE OF INVOLVEMENT IN STRATEGIC MANAGEMENT
Low
(Passive)
Rubber
StampPhantom
Never knows
what to do, if
anything; no
degree of
involvement.
Formally reviews
selected issues
that officers
bring to its
attention.
Involved to a
limited degree
in the perfor-
mance or review
of selected key
decisions,
indicators, or
programs of
managment.
Approves,
questions, and
makes final de-
cisions on mis-
sion, strategy,
policies, and
objectives. Has
active board
committees.
Performs fiscal
and manage-
ment audits.
Takes the
leading role in
establishing
and modifying
the mission,
objectives,
strategy, and
policies. It has
a very active
strategy
committee.
Permits officers
to make all
decisions. It
votes as the
officers recom-
mend on action
issues.
Minimal
Review
Nominal
Participation
Active
Participation Catalyst
High
(Active)
FIGURE 2–1 Board of Directors’ Continuum
SOURCE: T. L. Wheelen and J. D. Hunger, “Board of Directors’ Continuum,” Copyright © 1994 by Wheelen and Hunger Associates. Reprinted
by permission.
Highly involved boards tend to be very active. They take their tasks of monitoring, eval-
uating and influencing, and initiating and determining very seriously; they provide advice
when necessary and keep management alert. As depicted in Figure 2–1, their heavy involve-
ment in the strategic management process places them in the active participation or even cat-
alyst positions. Although 74% of public corporations have periodic board meetings devoted
primarily to the review of overall company strategy, the boards may not have had much influ-
ence in generating the plan itself.19 A 2008 global survey of directors by McKinsey & Company
found that 43% of respondents had high to very high influence in creating corporate value.
Thirty-eight percent stated that they had moderate influence and 18% reported that they had
little to very little influence. Those boards reporting high influence typically shared a common
plan for creating value and had healthy debate about what actions the company should take to
create value. Together with top management, these high-influence boards considered global
trends and future scenarios and developed plans. In contrast, those boards with low influence
tended not to do any of these things.20 These results are supported by a 2006 survey by
Korn/Ferry International revealing that 30% of directors felt that their CEO was not utilizing
them to their full capacity. In the same study, 73% of the directors indicated that were not con-
tent with an oversight role mandated by regulation and wanted to be more involved in setting
strategic plans.21 Nevertheless, studies indicate that boards are becoming increasingly active.
For example, in a global survey of directors conducted by McKinsey & Company in 2005, 64%
of the respondents indicated that they were more actively involved in the core areas of com-
pany performance and value creation than they had been five years earlier. This percentage was
higher in large companies (77%) and in publicly held companies (75%).22
These and other studies suggest that most large publicly owned corporations have boards
that operate at some point between nominal and active participation. Some corporations with
actively participating boards are Target, Medtronic, Best Western, Service Corporation Inter-
national, Bank of Montreal, Mead Corporation, Rolm and Haas, Whirlpool, 3M, Apria
Healthcare, General Electric, Pfizer, and Texas Instruments.23 Target, a corporate governance
leader, has a board that each year sets three top priorities, such as strategic direction, capital
allocation, and succession planning. Each of these priority topics is placed at the top of the agenda
48 PART 1 Introduction to Strategic Management and Business Policy
for at least one meeting. Target’s board also devotes one meeting a year to setting the strategic
direction for each major operating division.24
As a board becomes less involved in the affairs of the corporation, it moves farther to the
left on the continuum (see Figure 2–1). On the far left are passive phantom or rubber-stamp
boards that typically never initiate or determine strategy unless a crisis occurs. In these situations,
the CEO also serves as Chairman of the Board, personally nominates all directors, and works to
keep board members under his or her control by giving them the “mushroom treatment”—throw
manure on them and keep them in the dark!
Generally, the smaller the corporation, the less active is its board of directors in strategic
management.25 In an entrepreneurial venture, for example, the privately held corporation may
be 100% owned by the founders—who also manage the company. In this case, there is no need
for an active board to protect the interests of the owner-manager shareholders—the interests of
the owners and the managers are identical. In this instance, a board is really unnecessary and only
meets to satisfy legal requirements. If stock is sold to outsiders to finance growth, however, the
board becomes more active. Key investors want seats on the board so they can oversee their in-
vestment. To the extent that they still control most of the stock, however, the founders dominate
the board. Friends, family members, and key shareholders usually become members, but the
board acts primarily as a rubber stamp for any proposals put forward by the owner-managers. In
this type of company, the founder tends to be both CEO and Chairman of the Board and the board
includes few people who are not affiliated with the firm or family.26 This cozy relationship be-
tween the board and management should change, however, when the corporation goes public
and stock is more widely dispersed. The founders, who are still acting as management, may
sometimes make decisions that conflict with the needs of the other shareholders (especially if
the founders own less than 50% of the common stock). In this instance, problems could occur
if the board fails to become more active in terms of its roles and responsibilities.
MEMBERS OF A BOARD OF DIRECTORS
The boards of most publicly owned corporations are composed of both inside and outside direc-
tors. Inside directors (sometimes called management directors) are typically officers or execu-
tives employed by the corporation. Outside directors (sometimes called non-management
directors) may be executives of other firms but are not employees of the board’s corporation. Al-
though there is yet no clear evidence indicating that a high proportion of outsiders on a board re-
sults in improved financial performance,27 there is a trend in the United States to increase the
number of outsiders on boards and to reduce the total size of the board.28 The board of direc-
tors of a typical large U.S. corporation has an average of 10 directors, 2 of whom are insiders.29
Outsiders thus account for 80% of the board members in large U.S. corporations (approxi-
mately the same as in Canada). Boards in the UK typically have 5 inside and 5 outside
directors, whereas in France boards usually consist of 3 insiders and 8 outsiders. Japanese
boards, in contrast, contain 2 outsiders and 12 insiders.30 The board of directors in a typical
small U.S. corporation has four to five members, of whom only one or two are outsiders.31
Research from large and small corporations reveals a negative relationship between board
size and firm profitability.32
People who favor a high proportion of outsiders state that outside directors are less biased
and more likely to evaluate management’s performance objectively than are inside directors.
This is the main reason why the U.S. Securities and Exchange Commission (SEC) in 2003 re-
quired that a majority of directors on the board be independent outsiders. The SEC also re-
quired that all listed companies staff their audit, compensation, and nominating/corporate
governance committees entirely with independent, outside members. This view is in agree-
ment with agency theory, which states that problems arise in corporations because the agents
CHAPTER 2 Corporate Governance 49
(top management) are not willing to bear responsibility for their decisions unless they own a
substantial amount of stock in the corporation. The theory suggests that a majority of a board
needs to be from outside the firm so that top management is prevented from acting selfishly to
the detriment of the shareholders. For example, proponents of agency theory argue that man-
agers in management-controlled firms (contrasted with owner-controlled firms in which the
founder or family still own a significant amount of stock) select less risky strategies with quick
payoffs in order to keep their jobs.33 This view is supported by research revealing that manager-
controlled firms (with weak boards) are more likely to go into debt to diversify into unrelated
markets (thus quickly boosting sales and assets to justify higher salaries for themselves), thus
resulting in poorer long-term performance than owner-controlled firms.34 Boards with a larger
proportion of outside directors tend to favor growth through international expansion and inno-
vative venturing activities than do boards with a smaller proportion of outsiders.35 Outsiders
tend to be more objective and critical of corporate activities. For example, research reveals that
the likelihood of a firm engaging in illegal behavior or being sued declines with the addition
of outsiders on the board.36 Research on family businesses has found that boards with a larger
number of outsiders on the board tended to have better corporate governance and better per-
formance than did boards with fewer outsiders.37
In contrast, those who prefer inside over outside directors contend that outside directors
are less effective than are insiders because the outsiders are less likely to have the necessary
interest, availability, or competency. Stewardship theory proposes that, because of their long
tenure with the corporation, insiders (senior executives) tend to identify with the corporation
and its success. Rather than use the firm for their own ends, these executives are thus most in-
terested in guaranteeing the continued life and success of the corporation. (See Strategy High-
light 2.1 for a discussion of Agency Theory contrasted with Stewardship Theory.) Excluding
all insiders but the CEO reduces the opportunity for outside directors to see potential succes-
sors in action or to obtain alternate points of view of management decisions. Outside directors
may sometimes serve on so many boards that they spread their time and interest too thin to ac-
tively fulfill their responsibilities. The average board member of a U.S. Fortune 500 firm
serves on three boards. Research indicates that firm performance decreases as the number of
directorships held by the average board member increases.38 Although only 40% of surveyed
U.S. boards currently limit the number of directorships a board member may hold in other cor-
porations, 60% limit the number of boards on which their CEO may be a member.39
Those who question the value of having more outside board members point out that the
term outsider is too simplistic because some outsiders are not truly objective and should be
considered more as insiders than as outsiders. For example, there can be:
1. Affiliated directors, who, though not really employed by the corporation, handle the le-
gal or insurance work for the company or are important suppliers (thus dependent on the
current management for a key part of their business). These outsiders face a conflict of in-
terest and are not likely to be objective. As a result of recent actions by the U.S. Congress,
Securities and Exchange Commission, New York Stock Exchange, and NASDAQ, affili-
ated directors are being banned from U.S. corporate boardrooms. U.S. boards can no longer
include representatives of major suppliers or customers or even professional organizations
that might do business with the firm, even though these people could provide valuable
knowledge and expertise.40 The New York Stock Exchange decided in 2004 that anyone
paid by the company during the previous three years could not be classified as an inde-
pendent outside director.41
2. Retired executive directors, who used to work for the company, such as the past CEO who
is partly responsible for much of the corporation’s current strategy and who probably
groomed the current CEO as his or her replacement. In the recent past, many boards of large
firms kept the firm’s recently retired CEO on the board for a year or two after retirement as
50 PART 1 Introduction to Strategic Management and Business Policy
AGENCY THEORY VERSUS STEWARDSHIP THEORY
IN CORPORATE GOVERNANCE
Managers of large, modern
publicly held corporations are
typically not the owners. In fact,
most of today’s top managers own
only nominal amounts of stock in the corporation they
manage. The real owners (shareholders) elect boards of di-
rectors who hire managers as their agents to run the firm’s
day-to-day activities. Once hired, how trustworthy are
these executives? Do they put themselves or the firm first?
Agency Theory. As suggested in the classic study by Berle
and Means, top managers are, in effect, “hired hands”
who may very likely be more interested in their personal
welfare than that of the shareholders. For example, man-
agement might emphasize strategies, such as acquisitions,
that increase the size of the firm (to become more power-
ful and to demand increased pay and benefits) or that di-
versify the firm into unrelated businesses (to reduce
short-term risk and to allow them to put less effort into a
core product line that may be facing difficulty) but that re-
sult in a reduction of dividends and/or stock price.
Agency theory is concerned with analyzing and resolv-
ing two problems that occur in relationships between
principals (owners/shareholders) and their agents (top
management):
1. The agency problem that arises when (a) the desires
or objectives of the owners and the agents conflict
or (b) it is difficult or expensive for the owners to
verify what the agent is actually doing. One example
is when top management is more interested in
raising its own salary than in increasing stock
dividends.
2. The risk-sharing problem that arises when the owners
and agents have different attitudes toward risk.
Executives may not select risky strategies because
they fear losing their jobs if the strategy fails.
According to agency theory, the likelihood that these
problems will occur increases when stock is widely held
(that is, when no one shareholder owns more than a small
percentage of the total common stock), when the board of
directors is composed of people who know little of the
company or who are personal friends of top management,
and when a high percentage of board members are inside
(management) directors.
To better align the interests of the agents with those of
the owners and to increase the corporation’s overall perfor-
mance, agency theory suggests that top management
have a significant degree of ownership in the firm and/or
have a strong financial stake in its long-term performance.
In support of this argument, research indicates a positive
relationship between corporate performance and the
amount of stock owned by directors.
Stewardship Theory. In contrast, stewardship theory
suggests that executives tend to be more motivated to act
in the best interests of the corporation than in their own
self-interests. Whereas agency theory focuses on extrinsic
rewards that serve the lower-level needs, such as pay and
security, stewardship theory focuses on the higher-order
needs, such as achievement and self-actualization. Stew-
ardship theory argues that senior executives over time tend
to view the corporation as an extension of themselves.
Rather than use the firm for their own ends, these execu-
tives are most interested in guaranteeing the continued life
and success of the corporation. The relationship between
the board and top management is thus one of principal
and steward, not principal and agent (“hired hand”).
Stewardship theory notes that in a widely held corporation,
the shareholder is free to sell his or her stock at any time.
In fact, the average share of stock is held less than 10
months. A diversified investor or speculator may care little
about risk at the company level—preferring management
to assume extraordinary risk so long as the return is ade-
quate. Because executives in a firm cannot easily leave their
jobs when in difficulty, they are more interested in a merely
satisfactory return and put heavy emphasis on the firm’s
continued survival. Thus, stewardship theory argues that in
many instances top management may care more about a
company’s long-term success than do more short-term ori-
ented shareholders.
For more information about agency and stewardship theory, see A.
A. Berle and G. C. Means, The Modern Corporation and Private
Property (NY: Macmillan, 1936). Also see J. H. Davis, F. D.
Schoorman, and L. Donaldson, “Toward a Stewardship Theory of
Management,” Academy of Management Review (January 1997),
pp. 20–47; P. J. Lane, A. A. Cannella, Jr. & M. H. Lubatkin, “Agency
Problems as Antecedents to Unrelated Mergers and Diversification:
Amihud and Lev Reconsidered,” Strategic Management Journal
(June 1998), pp. 555–578; M. L. Hayward and D. C. Hambrick,
“Explaining the Premiums Paid for Large Acquisitions: Evidence
of CEO Hubris,” Administrative Science Quarterly (March
1997), pp. 103–127; and C. M. Christensen and S. D. Anthony, “Put
Investors in their Place,” Business Week (May 28, 2007), p. 108.
STRATEGY highlight 2.1
CHAPTER 2 Corporate Governance 51
a courtesy, especially if he/she had performed well as the CEO. It is almost certain, how-
ever, that this person will not be able to objectively evaluate the corporation’s performance.
Because of the likelihood of a conflict of interest, only 31% of boards in the Americas, 25%
in Europe, and 20% in Australasia now include the former CEO on their boards.42
3. Family directors, who are descendants of the founder and own significant blocks of stock
(with personal agendas based on a family relationship with the current CEO). The Schlitz
Brewing Company, for example, was unable to complete its turnaround strategy with a
non-family CEO because family members serving on the board wanted their money out
of the company, forcing it to be sold.43
The majority of outside directors are active or retired CEOs and COOs of other corpora-
tions. Others are major investors/shareholders, academicians, attorneys, consultants, former
government officials, and bankers. Given that 66% of the outstanding stock in the largest U.S.
and UK corporations is now owned by institutional investors, such as mutual funds and pen-
sion plans, these investors are taking an increasingly active role in board membership and ac-
tivities.44 For example, TIAA-CREF’s Corporate Governance team monitors governance
practices of the 4,000 companies in which it invests its pension funds through its Corporate
Assessment Program. If its analysis of a company reveals problems, TIAA-CREF first sends
letters stating its concerns, followed up by visits, and it finally sponsors a shareholder resolu-
tion in opposition to management’s actions.45 Institutional investors are also powerful in many
other countries. In Germany, bankers are represented on almost every board—primarily be-
cause they own large blocks of stock in German corporations. In Denmark, Sweden, Belgium,
and Italy, however, investment companies assume this role. For example, the investment com-
pany Investor casts 42.5% of the Electrolux shareholder votes, thus guaranteeing itself posi-
tions on the Electrolux board.
Boards of directors have been working to increase the number of women and minorities
serving on boards. Korn/Ferry International reports that of the Fortune 1000 largest U.S. firms,
85% had at least one woman director in 2006 (compared to 69% in 1995), comprising 15% of
total directors. Approximately one-half of the boards in Europe included a female director,
comprising 9% of total directors. (The percentage of female directors in Europe in 2006 ranged
from less than 1% in Portugal to almost 40% in Norway.)46 Korn/Ferry’s survey also revealed
that 76% of the U.S. boards had at least one ethnic minority in 2006 (African-American, 47%;
Latino, 19%; Asian, 10%) as director compared to only 47% in 1995, comprising around 14%
of total directors.47 Among the top 200 S&P companies in the U.S., however, 84% have at least
one African-American director.48 The globalization of business is having an impact on board
membership. According to the Spencer Stuart executive recruiting firm, 33% of U.S. boards
had an international director.49 Europe was the most “globalized” region of the world, with
most companies reporting one or more non-national directors.50 Although Asian and Latin
American boards are still predominantly staffed by nationals, they are working to add more in-
ternational directors.51
Outside directors serving on the boards of large Fortune 1000 U.S. corporations annually
earned on average $58,217 in cash plus an average of $75,499 in stock options. Most of the
companies (63%) paid their outside directors an annual retainer plus a fee for every meeting
attended.52 Directors serving on the boards of small companies usually received much less
compensation (around $10,000). One study found directors of a sample of large U.S. firms to
hold on average 3% of their corporations’ outstanding stock.53
The vast majority of inside directors are the chief executive officer and either the chief op-
erating officer (if not also the CEO) or the chief financial officer. Presidents or vice presidents
of key operating divisions or functional units sometimes serve on the board. Few, if any, in-
side directors receive any extra compensation for assuming this extra duty. Very rarely does a
U.S. board include any lower-level operating employees.
52 PART 1 Introduction to Strategic Management and Business Policy
Codetermination: Should Employees Serve on Boards?
Codetermination, the inclusion of a corporation’s workers on its board, began only recently in
the United States. Corporations such as Chrysler, Northwest Airlines, United Airlines (UAL),
and Wheeling-Pittsburgh Steel added representatives from employee associations to their
boards as part of union agreements or Employee Stock Ownership Plans (ESOPs). For exam-
ple, United Airlines workers traded 15% in pay cuts for 55% of the company (through an ESOP)
and 3 of the firm’s 12 board seats. In this instance, workers represent themselves on the board
not so much as employees but primarily as owners. At Chrysler, however, the United Auto
Workers union obtained a temporary seat on the board as part of a union contract agreement in
exchange for changes in work rules and reductions in benefits. This was at a time when Chrysler
was facing bankruptcy in the late 1970s. In situations like this when a director represents an in-
ternal stakeholder, critics raise the issue of conflict of interest. Can a member of the board, who
is privy to confidential managerial information, function, for example, as a union leader whose
primary duty is to fight for the best benefits for his or her members? Although the movement to
place employees on the boards of directors of U.S. companies shows little likelihood of increas-
ing (except through employee stock ownership), the European experience reveals an increasing
acceptance of worker participation (without ownership) on corporate boards.
Germany pioneered codetermination during the 1950s with a two-tiered system: (1) a su-
pervisory board elected by shareholders and employees to approve or decide corporate strat-
egy and policy and (2) a management board (composed primarily of top management)
appointed by the supervisory board to manage the company’s activities. Most other Western
European countries have either passed similar codetermination legislation (as in Sweden,
Denmark, Norway, and Austria) or use worker councils to work closely with management (as
in Belgium, Luxembourg, France, Italy, Ireland, and the Netherlands).
Interlocking Directorates
CEOs often nominate chief executives (as well as board members) from other firms to mem-
bership on their own boards in order to create an interlocking directorate. A direct interlocking
directorate occurs when two firms share a director or when an executive of one firm sits on
the board of a second firm. An indirect interlock occurs when two corporations have directors
who also serve on the board of a third firm, such as a bank.
Although the Clayton Act and the Banking Act of 1933 prohibit interlocking directorates
by U.S. companies competing in the same industry, interlocking continues to occur in almost
all corporations, especially large ones. Interlocking occurs because large firms have a large
impact on other corporations and these other corporations, in turn, have some control over the
firm’s inputs and marketplace. For example, most large corporations in the United States,
Japan, and Germany are interlocked either directly or indirectly with financial institutions.54
Eleven of the 15 largest U.S. corporations have at least two board members who sit together
on another board. Twenty percent of the 1,000 largest U.S. firms share at least one board
member.55
Interlocking directorates are useful for gaining both inside information about an uncertain
environment and objective expertise about potential strategies and tactics.56 For example,
Kleiner Perkins, a high-tech venture capital firm, not only has seats on the boards of the com-
panies in which it invests, but it also has executives (which Kleiner Perkins hired) from one
entrepreneurial venture who serve as directors on others. Kleiner Perkins refers to its network
of interlocked firms as its keiretsu, a Japanese term for a set of companies with interlocking
business relationships and share-holdings.57 Family-owned corporations, however, are less
likely to have interlocking directorates than are corporations with highly dispersed stock own-
ership, probably because family-owned corporations do not like to dilute their corporate con-
trol by adding outsiders to boardroom discussions.
CHAPTER 2 Corporate Governance 53
There is some concern, however, when the chairs of separate corporations serve on each
other’s boards. Twenty-two such pairs of corporate chairs (who typically also served as their
firm’s CEO) existed in 2003. In one instance, the three chairmen of Anheuser-Busch, SBC
Communications, and Emerson Electric served on all three of the boards. Typically a CEO sits
on only one board in addition to his or her own—down from two additional boards in previ-
ous years. Although such interlocks may provide valuable information, they are increasingly
frowned upon because of the possibility of collusion.58 Nevertheless, evidence indicates that
well-interlocked corporations are better able to survive in a highly competitive environment.59
NOMINATION AND ELECTION OF BOARD MEMBERS
Traditionally the CEO of a corporation decided whom to invite to board membership and
merely asked the shareholders for approval in the annual proxy statement. All nominees
were usually elected. There are some dangers, however, in allowing the CEO free rein in
nominating directors. The CEO might select only board members who, in the CEO’s opin-
ion, will not disturb the company’s policies and functioning. Given that the average length
of service of a U.S. board member is for three three-year terms (but can range up to 20 years
for some boards), CEO-friendly, passive boards are likely to result. This is especially likely
given that only 7% of surveyed directors indicated that their company had term limits for
board members. Nevertheless, 60% of U.S. boards and 58% of European boards have a
mandatory retirement age—typically around 70.60 Research reveals that boards rated as least
effective by the Corporate Library, a corporate governance research firm, tend to have
members serving longer (an average of 9.7 years) than boards rated as most effective
(7.5 years).61 Directors selected by the CEO often feel that they should go along with any
proposal the CEO makes. Thus board members find themselves accountable to the very
management they are charged to oversee. Because this is likely to happen, more boards are
using a nominating committee to nominate new outside board members for the shareholders
to elect. Ninety-seven percent of large U.S. corporations now use nominating committees to
identify potential directors. This practice is less common in Europe where 60% of boards
use nominating committees.62
Many corporations whose directors serve terms of more than one year divides the board
into classes and staggers elections so that only a portion of the board stands for election each
year. This is called a staggered board. Sixty-three percent of U.S. boards currently have stag-
gered boards.63 Arguments in favor of this practice are that it provides continuity by reducing
the chance of an abrupt turnover in its membership and that it reduces the likelihood of elect-
ing people unfriendly to management (who might be interested in a hostile takeover) through
cumulative voting. An argument against staggered boards is that they make it more difficult
for concerned shareholders to curb a CEO’s power—especially when that CEO is also Chair-
man of the Board. An increasing number of shareholder resolutions to replace staggered boards
with annual elections of all board members are currently being passed at annual meetings.
When nominating people for election to a board of directors, it is important that nominees
have previous experience dealing with corporate issues. For example, research reveals that a
firm makes better acquisition decisions when the firm’s outside directors have had experience
with such decisions.64
A survey of directors of U.S. corporations revealed the following criteria in a good director:
� Willing to challenge management when necessary—95%
� Special expertise important to the company—67%
� Available outside meetings to advise management—57%
� Expertise on global business issues—41%
54 PART 1 Introduction to Strategic Management and Business Policy
� Understands the firm’s key technologies and processes—39%
� Brings external contacts that are potentially valuable to the firm—33%
� Has detailed knowledge of the firm’s industry—31%
� Has high visibility in his or her field—31%
� Is accomplished at representing the firm to stakeholders—18%65
ORGANIZATION OF THE BOARD
The size of a board in the United States is determined by the corporation’s charter and its by-
laws, in compliance with state laws. Although some states require a minimum number of board
members, most corporations have quite a bit of discretion in determining board size. The av-
erage large, publicly held U.S. firm has 10 directors on its board. The average small, privately-
held company has four to five members. The average size of boards elsewhere is Japan, 14;
Non-Japan Asia, 9; Germany, 16; UK, 10; and France, 11.66
Approximately 70% of the top executives of U.S. publicly held corporations hold the dual
designation of Chairman and CEO. (Only 5% of the firms in the UK have a combined
Chair/CEO.)67 The combined Chair/CEO position is being increasingly criticized because of
the potential for conflict of interest. The CEO is supposed to concentrate on strategy, planning,
external relations, and responsibility to the board. The Chairman’s responsibility is to ensure that
the board and its committees perform their functions as stated in the board’s charter. Further, the
Chairman schedules board meetings and presides over the annual shareholders’ meeting.
Critics of having one person in the two offices ask how the board can properly oversee top
management if the Chairman is also a part of top management. For this reason, the Chairman
and CEO roles are separated by law in Germany, the Netherlands, South Africa, and Finland.
A similar law has been considered in the United Kingdom and Australia. Although research is
mixed regarding the impact of the combined Chair/CEO position on overall corporate finan-
cial performance, firm stock price and credit ratings both respond negatively to announcements
of CEOs also assuming the Chairman position.68 Research also shows that corporations with a
combined Chair/CEO have a greater likelihood of fraudulent financial reporting when CEO
stock options are not present.69
Many of those who prefer that the Chairman and CEO positions be combined agree that
the outside directors should elect a lead director. This person is consulted by the Chair/CEO
regarding board affairs and coordinates the annual evaluation of the CEO.70 The lead director
position is very popular in the United Kingdom, where it originated. Of those U.S. companies
combining the Chairman and CEO positions, 96% had a lead director.71 This is one way to give
the board more power without undermining the power of the Chair/CEO. The lead director be-
comes increasingly important because 94% of U.S. boards in 2006 (compared to only 41% in
2002) held regular executive sessions without the CEO being present.72 Nevertheless, there are
many ways in which an unscrupulous Chair/CEO can guarantee a director’s loyalty. Research
indicates that an increase in board independence often results in higher levels of CEO ingrati-
ation behavior aimed at persuading directors to support CEO proposals. Long-tenured direc-
tors who support the CEO may use social pressure to persuade a new board member to
conform to the group. Directors are more likely to be recommended for membership on other
boards if they “don’t rock the boat” and engage in low levels of monitoring and control behav-
ior.73 Even in those situations when the board has a nominating committee composed only of
outsiders, the committee often obtains the CEO’s approval for each new board candidate.74
The most effective boards accomplish much of their work through committees. Although
they do not usually have legal duties, most committees are granted full power to act with the
authority of the board between board meetings. Typical standing committees (in order of
CHAPTER 2 Corporate Governance 55
prevalence) are the audit (100%), compensation (99%), nominating (97%), corporate gover-
nance (94%), stock options (84%), director compensation (52%), and executive (43%) com-
mittees.75 The executive committee is usually composed of two inside and two outside
directors located nearby who can meet between board meetings to attend to matters that must
be settled quickly. This committee acts as an extension of the board and, consequently, may
have almost unrestricted authority in certain areas.76 Except for the executive, finance, and in-
vestment committees, board committees are now typically staffed only by outside directors.
Although each board committee typically meets four to five times annually, the average audit
committee met nine times during 2006.77
IMPACT OF THE SARBANES-OXLEY ACT
ON U.S. CORPORATE GOVERNANCE
In response to the many corporate scandals uncovered since 2000, the U.S. Congress passed the
Sarbanes-Oxley Act in June 2002. This act was designed to protect shareholders from the ex-
cesses and failed oversight that characterized failures at Enron, Tyco, WorldCom, Adelphia
Communications, Qwest, and Global Crossing, among other prominent firms. Several key el-
ements of Sarbanes-Oxley were designed to formalize greater board independence and over-
sight. For example, the act requires that all directors serving on the audit committee be
independent of the firm and receive no fees other than for services of the director. In addition,
boards may no longer grant loans to corporate officers. The act has also established formal pro-
cedures for individuals (known as “whistleblowers”) to report incidents of questionable ac-
counting or auditing. Firms are prohibited from retaliating against anyone reporting
wrongdoing. Both the CEO and CFO must certify the corporation’s financial information. The
act bans auditors from providing both external and internal audit services to the same company.
It also requires that a firm identify whether it has a “financial expert” serving on the audit com-
mittee who is independent from management.
Although the cost to a large corporation of implementing the provisions of the law was
$8.5 million in 2004, the first year of compliance, the costs to a large firm fell to $1–$5
million annually during the following years as accounting and information processes were
refined and made more efficient.78 Pitney Bowes, for example, saved more than $500,000 in
2005 simply by consolidating four accounts receivable offices into one. Similar savings were
realized at Cisco and Genentech.79 An additional benefit of the increased disclosure require-
ments is more reliable corporate financial statements. Companies are now reporting numbers
with fewer adjustments for unusual charges and write-offs, which in the past have been used to
boost reported earnings.80 The new rules have also made it more difficult for firms to post-date
executive stock options. “This is an unintended consequence of disclosure,” remarked Gregory
Taxin, CEO of Glass, Lewis & Company, a stock research firm.81 See the Global Issue feature
to learn how corporate governance is being improved in other parts of the world.
Improving Governance
In implementing the Sarbanes-Oxley Act, the U.S. Securities and Exchange Commission
(SEC) required in 2003 that a company disclose whether it has adopted a code of ethics that
applies to the CEO and to the company’s principal financial officer. Among other things, the
SEC requires that the audit, nominating, and compensation committees be staffed entirely by
outside directors. The New York Stock Exchange reinforced the mandates of Sarbanes-Oxley
by requiring that companies have a nominating/governance committee composed entirely of
independent outside directors. Similarly, NASDAQ rules require that nominations for new di-
rectors be made by either a nominating committee of independent outsiders or by a majority
of independent outside directors.82
56 PART 1 Introduction to Strategic Management and Business Policy
CORPORATE GOVERNANCE IMPROVEMENTS
THROUGHOUT THE WORLD
Countries throughout the
world are working to im-
prove corporate governance.
Provisions that are roughly equiv-
alent to Sarbanes-Oxley are in place
in France and Japan, while both China and Canada are im-
plementing similar rules. In the UK, the Cadbury Report has
led to revisions to the Combined Code of Conduct that have
placed additional responsibilities on non-management di-
rectors, altered board and committee composition, and
modified the roles of the CEO and Chairman. The adoption
of recommendations from the government-sponsored
Cromme Commission has reduced the power of manage-
ment directors and increased the transparency of Germany’s
two-tier system of governance. Italy has implemented the
Draghi Law of 1998 and the Preda Code of Conduct. Since
many corporations in non-Japan Asia are family-controlled
or have stock that is at least partially owned by the state, the
Anglo-American system of corporate governance does not
quite fit. Nevertheless, many of the changes in other parts of
the world, such as CEO performance reviews and executive
succession planning, are taking place in Asian corporations.
In an attempt to make Korean businesses more attrac-
tive to foreign investors, for example, the South Korean
government recommended that companies listed on the
stock exchange introduce a two-tiered structure. One
structure was to consist entirely of non-executive (outside)
directors. One of the few companies to immediately adopt
this new system of governance was Pohang Iron & Steel
Company Ltd. (POSCO), the world’s largest steelmaker.
POSCO was listed on the New York Stock Exchange and
had significant operations in the United States, plus a joint
venture with U.S. Steel. According to Youn-Gil Ro, Corpo-
rate Information Team Manager, “We needed professional
advice on international business practices as well as Amer-
ican practices.”
SOURCES: A. L. Nazareth, “Keeping SarbOx Is Crucial,” Business
Week (November 13, 2006), p. 134; 33rd Annual Board of
Directors Study (New York: Korn/Ferry International, 2007); C. A.
Mallin, editor, Handbook on International Corporate Governance
(Northampton, Massachusetts: Edward Elgar Publishing, 2006).
Globalizing the Board of Directors: Trends and Strategies (New
York: Conference Board, 1999), p. 16.
Partially in response to Sarbanes-Oxley, a survey of directors of Fortune 1000 U.S. compa-
nies by Mercer Delta Consulting and the University of Southern California revealed that 60% of
directors were spending more time on board matters than before Sarbanes-Oxley, with 85%
spending more time on their company’s accounts, 83% more on governance practices, and 52%
on monitoring financial performance.83 Newly elected outside directors with financial manage-
ment experience increased to 10% of all outside directors in 2003 from only 1% of outsiders in
1998.84 Seventy-eight percent of Fortune 1000 U.S. boards in 2006 required that directors own
stock in the corporation, compared to just 36% in Europe, and 26% in Asia.85
Evaluating Governance
To help investors evaluate a firm’s corporate governance, a number of independent rating
services, such as Standard & Poor’s (S&P), Moody’s, Morningstar, The Corporate Library,
Institutional Shareholder Services (ISS), and Governance Metrics International (GMI), have
established criteria for good governance. Business Week annually publishes a list of the best
and worst boards of U.S. corporations. Whereas rating service firms like S&P, Moody’s, and
The Corporate Library use a wide mix of research data and criteria to evaluate companies, ISS
and GMI have been criticized because they primarily use public records to score firms, using
simple checklists.86 In contrast, the S&P Corporate Governance Scoring System researches
four major issues:
� Ownership Structure and Influence
� Financial Stakeholder Rights and Relations
GLOBAL issue
CHAPTER 2 Corporate Governance 57
� Financial Transparency and Information Disclosure
� Board Structure and Processes
Although the S&P scoring system is proprietary and confidential, independent re-
search using generally accepted measures of S&P’s four issues revealed that moving from
the poorest- to the best-governed categories nearly doubled a firm’s likelihood of receiv-
ing an investment-grade credit rating.87
Avoiding Governance Improvements
A number of corporations are concerned that various requirements to improve corporate gov-
ernance will constrain top management’s ability to effectively manage the company. For ex-
ample, more U.S. public corporations have gone private in the years since the passage of
Sarbanes-Oxley than before its passage. Other companies use multiple classes of stock to keep
outsiders from having sufficient voting power to change the company. Insiders, usually the
company’s founders, get stock with extra votes, while others get second-class stock with fewer
votes. For example, Brian Roberts, CEO of Comcast, owns “superstock” that represents only
0.4% of outstanding common stock but guarantees him one-third of the voting stock. The In-
vestor Responsibility Research Center reports that 11.3% of the companies it monitored in
2004 had multiple classes, up from 7.5% in 1990.88
Another approach to sidestepping new governance requirements is being used by corpora-
tions such as Google, Infrasource Services, Orbitz, and W&T Offshore. If a corporation in
which an individual group or another company controls more than 50% of the voting shares de-
cides to become a “controlled company,” the firm is then exempt from requirements by the New
York Stock Exchange and NASDAQ that a majority of the board and all members of key board
committees be independent outsiders. According to governance authority Jay Lorsch, this will
result in a situation in which “the majority shareholders can walk all over the minority.”89
TRENDS IN CORPORATE GOVERNANCE
The role of the board of directors in the strategic management of a corporation is likely to be
more active in the future. Although neither the composition of boards nor the board leadership
structure has been consistently linked to firm financial performance, better governance does
lead to higher credit ratings and stock prices. A McKinsey survey reveals that investors are
willing to pay 16% more for a corporation’s stock if it is known to have good corporate gov-
ernance. The investors explained that they would pay more because, in their opinion (1) good
governance leads to better performance over time, (2) good governance reduces the risk of the
company getting into trouble, and (3) governance is a major strategic issue.90
Some of today’s trends in governance (particularly prevalent in the United States and the
United Kingdom) that are likely to continue include the following:
� Boards are getting more involved not only in reviewing and evaluating company strategy
but also in shaping it.
� Institutional investors, such as pension funds, mutual funds, and insurance companies,
are becoming active on boards and are putting increasing pressure on top management to
improve corporate performance. This trend is supported by a U.S. SEC requirement that
a mutual fund must publicly disclose the proxy votes cast at company board meetings in
its portfolio. This reduces the tendency for mutual funds to rubber-stamp management
proposals.91
� Shareholders are demanding that directors and top managers own more than token
amounts of stock in the corporation. Research indicates that boards with equity ownership
use quantifiable, verifiable criteria (instead of vague, qualitative criteria) to evaluate the
CEO.92 When compensation committee members are significant shareholders, they tend
58 PART 1 Introduction to Strategic Management and Business Policy
to offer the CEO less salary but with a higher incentive component than do compensation
committee members who own little to no stock.93
� Non-affiliated outside (non-management) directors are increasing their numbers and
power in publicly held corporations as CEOs loosen their grip on boards. Outside mem-
bers are taking charge of annual CEO evaluations.
� Women and minorities are being increasingly represented on boards.
� Boards are establishing mandatory retirement ages for board members—typically around
age 70.
� Boards are evaluating not only their own overall performance, but also that of individual
directors.
� Boards are getting smaller—partially because of the reduction in the number of insiders
but also because boards desire new directors to have specialized knowledge and expertise
instead of general experience.
� Boards continue to take more control of board functions by either splitting the combined
Chair/CEO into two separate positions or establishing a lead outside director position.
� Boards are eliminating 1970s anti-takeover defenses that served to entrench current man-
agement. In just one year, for example, 66 boards repealed their staggered boards and
25 eliminated poison pills.94
� As corporations become more global, they are increasingly looking for board members
with international experience.
� Instead of merely being able to vote for or against directors nominated by the board’s
nominating committee, shareholders may eventually be allowed to nominate board mem-
bers. This was originally proposed by the U.S. Securities and Exchange Commission in
2004, but was not implemented. Supported by the AFL-CIO, a more open nominating
process would enable shareholders to vote out directors who ignore shareholder
interests.95
� Society, in the form of special interest groups, increasingly expects boards of directors to
balance the economic goal of profitability with the social needs of society. Issues dealing
with workforce diversity and environmental sustainability are now reaching the board
level. (See the Environmental Sustainability Issue feature for an example of a conflict
between a CEO and the board of directors over environmental issues.)
2.2 The Role of Top Management
The top management function is usually conducted by the CEO of the corporation in coordi-
nation with the COO (Chief Operating Officer) or president, executive vice president, and vice
presidents of divisions and functional areas.96 Even though strategic management involves
everyone in the organization, the board of directors holds top management primarily respon-
sible for the strategic management of a firm.97
RESPONSIBILITIES OF TOP MANAGEMENT
Top management responsibilities, especially those of the CEO, involve getting things ac-
complished through and with others in order to meet the corporate objectives. Top manage-
ment’s job is thus multidimensional and is oriented toward the welfare of the total
CHAPTER 2 Corporate Governance 59
CONFLICT AT THE BODY SHOP
of Roddick’s social and environmental “radicalism,” the
board forced her to resign as CEO. Roddick and her husband
(with just 18% of the stock) remained on the board as co-
chairmen until 2002, when they were replaced. Roddick
continued to carry out public relations functions for the
company and traveled the world in search of new product
ideas, but no longer had any control over the strategic direc-
tion of the firm she had founded.
On March 17, 2006, the Body Shop’s board agreed to
the company’s sale to L’Oreal for a premium of 34.2% over
the company’s stock price. The sale was perceived by ob-
servers as quite ironic, given that for years Anita Roddick
had criticized L’Oreal for its animal testing practices and for
its exploitation of women in the workplace. On its Web
site, Naturewatch said: “We feel that the Body Shop has
‘sold out’ and is not standing on its principles.” Animal
rights activists and some consumers vowed to boycott
Body Shop stores. Within three weeks of the announce-
ment, the Body Shop’s “satisfaction” rating compiled by
BrandIndex fell 11 points, to 14, its “buzz” rating fell by 10
points, to �4, and its “general impression” fell by 3 points,
to 19. One Body Shop customer reflected the widespread
dissatisfaction: “The Body Shop used to be my high street
“safe house,” a place where I could walk into and know
that what I bought was okay, that people were actually
benefiting from my purchase. . . . By buying from the Body
Shop, you are now no longer supporting ethical con-
sumerism. If I want legitimate fair-trade, non-animal tested
products, I can find them easily, at the same price, else-
where.”
When Anita Roddick
opened the first Body Shop
in 1976, she probably had no
idea that she would become
one of the first “green” business
executives. She simply liked the idea of
selling cosmetics in small sizes that were made from natu-
ral ingredients. By 1998, her entrepreneurial venture grew
through franchising into a global business with 1,594
shops in 47 countries. Roddick’s personal philosophy in fa-
vor of human rights, endangered wildlife, and the environ-
ment, while being strongly against the use of animals in
testing cosmetics, became an inherent part of the com-
pany’s philosophy of business. Reflecting an environmental
awareness far in advance of other firms, the company’s pub-
lication, This Is the Body Shop, stated: “We aim to avoid ex-
cessive packaging, to refill our bottles, and to recycle our
packaging and use raw materials from renewable sources
when technologically and economically feasible.” The com-
pany drafted the European Union’s Eco-Management and
Audit Regulation in 1991 and the company’s first environ-
mental statement, The Green Book, in 1992.
The Body Shop became a publicly traded corporation in
1984 when it was listed on London’s Unlisted Securities
Market for just 95 pence per stock. By 1986, the stock price
had increased ten-fold in value and was listed on the Lon-
don Stock Exchange. The company grew quickly to be
worth 700 million British pounds in 1991. Although the in-
flux of money from the sale of stock enabled the company
to expand throughout the world, there were disadvantages
to having shareholders and a board of directors. Some
shareholders began to complain that the company was di-
verting money into social projects instead of maximizing
profits. Roddick had used her position as CEO to join the
Body Shop with Greenpeace’s “Save the Whales” cam-
paign and to form alliances with Amnesty International and
Friends of the Earth. Although the company continued to
grow in size, its market value was declining by 1998. Tiring
SOURCES: E. A. Fogarty, J. P. Vincelette, and T. L. Wheelen, “The
Body Shop International PLC: Anita Roddick, OBE,” in T. L. Wheelen
and J. D. Hunger, Strategic Management and Business Policy,
8th ed. (Upper Saddle River, NJ: Prentice Hall, 2002), pp. 7.1–7.26;
D. Purkayastha and R. Fernando, The Body Shop: Social Responsi-
bility or Sustained Greenwashing? (Hyderabad, India: ICFAI Center
for Management Research, 2006).
ENVIRONMENTAL sustainability issue
organization. Specific top management tasks vary from firm to firm and are developed from
an analysis of the mission, objectives, strategies, and key activities of the corporation. Tasks
are typically divided among the members of the top management team. A diversity of skills
can thus be very important. Research indicates that top management teams with a diversity of
functional backgrounds, experiences, and length of time with the company tend to be signifi-
cantly related to improvements in corporate market share and profitability.98 In addition,
highly diverse teams with some international experience tend to emphasize international
60 PART 1 Introduction to Strategic Management and Business Policy
growth strategies and strategic innovation, especially in uncertain environments, to boost fi-
nancial performance.99 The CEO, with the support of the rest of the top management team,
must successfully handle two primary responsibilities that are crucial to the effective strategic
management of the corporation: (1) provide executive leadership and a strategic vision and
(2) manage the strategic planning process.
Executive Leadership and Strategic Vision
Executive leadership is the directing of activities toward the accomplishment of corporate
objectives. Executive leadership is important because it sets the tone for the entire corpora-
tion. A strategic vision is a description of what the company is capable of becoming. It is of-
ten communicated in the company’s mission and vision statements (as described in Chapter 1).
People in an organization want to have a sense of mission, but only top management is in the
position to specify and communicate this strategic vision to the general workforce. Top man-
agement’s enthusiasm (or lack of it) about the corporation tends to be contagious. The impor-
tance of executive leadership is illustrated by Steve Reinemund, past-CEO of PepsiCo:
“A leader’s job is to define overall direction and motivate others to get there.”100
Successful CEOs are noted for having a clear strategic vision, a strong passion for their com-
pany, and an ability to communicate with others. They are often perceived to be dynamic and
charismatic leaders—which is especially important for high firm performance and investor con-
fidence in uncertain environments.101 They have many of the characteristics of transformational
leaders—that is, leaders who provide change and movement in an organization by providing
a vision for that change.102 For instance, the positive attitude characterizing many well-
known industrial leaders—such as Bill Gates at Microsoft, Anita Roddick at the Body Shop,
Richard Branson at Virgin, Steve Jobs at Apple Computer, Phil Knight at Nike, Bob Lutz at
General Motors, and Louis Gerstner at IBM—has energized their respective corporations.
These transformational leaders have been able to command respect and to influence strategy for-
mulation and implementation because they tend to have three key characteristics:103
1. The CEO articulates a strategic vision for the corporation: The CEO envisions the
company not as it currently is but as it can become. The new perspective that the CEO’s
vision brings to activities and conflicts gives renewed meaning to everyone’s work and
enables employees to see beyond the details of their own jobs to the functioning of the to-
tal corporation.104 Louis Gerstner proposed a new vision for IBM when he proposed that
the company change its business model from computer hardware to services: “If cus-
tomers were going to look to an integrator to help them envision, design, and build end-
to-end solutions, then the companies playing that role would exert tremendous influence
over the full range of technology decisions—from architecture and applications to hard-
ware and software choices.”105 In a survey of 1,500 senior executives from 20 different
countries, when asked the most important behavioral trait a CEO must have, 98% re-
sponded that the CEO must convey “a strong sense of vision.”106
2. The CEO presents a role for others to identify with and to follow: The leader em-
pathizes with followers and sets an example in terms of behavior, dress, and actions. The
CEO’s attitudes and values concerning the corporation’s purpose and activities are clear-
cut and constantly communicated in words and deeds. For example, when design engi-
neers at General Motors had problems with monitor resolution using the Windows
operating system, Steve Ballmer, CEO of Microsoft, personally crawled under conference
room tables to plug in PC monitors and diagnose the problem.107 People know what to ex-
pect and have trust in their CEO. Research indicates that businesses in which the general
manager has the trust of the employees have higher sales and profits with lower turnover
than do businesses in which there is a lesser amount of trust.108
CHAPTER 2 Corporate Governance 61
3. The CEO communicates high performance standards and also shows confidence in
the followers’ abilities to meet these standards: The leader empowers followers by rais-
ing their beliefs in their own capabilities. No leader ever improved performance by set-
ting easily attainable goals that provided no challenge. Communicating high expectations
to others can often lead to high performance.109 The CEO must be willing to follow
through by coaching people. As a result, employees view their work as very important and
thus motivating.110 Ivan Seidenberg, chief executive of Verizon Communications, was
closely involved in deciding Verizon’s strategic direction, and he showed his faith in his
people by letting his key managers handle important projects and represent the company
in public forums. “All of these people could be CEOs in their own right. They are war-
riors and they are on a mission,” explained Seidenberg. Grateful for his faith in them, his
managers were fiercely loyal both to him and the company.111
The negative side of confident executive leaders is that their very confidence may lead to
hubris, in which their confidence blinds them to information that is contrary to a decided
course of action. For example, overconfident CEOs tend to charge ahead with mergers and
acquisitions even though they are aware that most acquisitions destroy shareholder value. Re-
search by Tate and Malmendier found that “overconfident CEOs are more likely to conduct
mergers than rational CEOs at any point in time. Overconfident CEOs view their company as
undervalued by outside investors who are less optimistic about the prospects of the firm.”
Overconfident CEOs were most likely to make acquisitions when they could avoid selling
new stock to finance them, and they were more likely to do deals that diversified their firm’s
lines of businesses.112
Managing the Strategic Planning Process
As business corporations adopt more of the characteristics of the learning organization, strate-
gic planning initiatives can come from any part of an organization. A survey of 156 large cor-
porations throughout the world revealed that, in two-thirds of the firms, strategies were first
proposed in the business units and sent to headquarters for approval.113 However, unless top
management encourages and supports the planning process, strategic management is not likely
to result. In most corporations, top management must initiate and manage the strategic plan-
ning process. It may do so by first asking business units and functional areas to propose strate-
gic plans for themselves, or it may begin by drafting an overall corporate plan within which
the units can then build their own plans. Research suggests that bottom-up strategic planing
may be most appropriate in multidivisional corporations operating in relatively stable environ-
ments but that top-down strategic planning may be most appropriate for firms operating in tur-
bulent environments.114 Other organizations engage in concurrent strategic planning in which
all the organization’s units draft plans for themselves after they have been provided with the
organization’s overall mission and objectives.
Regardless of the approach taken, the typical board of directors expects top management
to manage the overall strategic planning process so that the plans of all the units and functional
areas fit together into an overall corporate plan. Top management’s job therefore includes the
tasks of evaluating unit plans and providing feedback. To do this, it may require each unit to
justify its proposed objectives, strategies, and programs in terms of how well they satisfy the
organization’s overall objectives in light of available resources. If a company is not organized
into business units, top managers may work together as a team to do strategic planning. CEO
Jeff Bezos tells how this is done at Amazon.com:
We have a group called the S Team—S meaning “senior” [management]—that stays abreast of
what the company is working on and delves into strategy issues. It meets for about four hours
every Tuesday. Once or twice a year the S Team also gets together in a two-day meeting where
62 PART 1 Introduction to Strategic Management and Business Policy
End of Chapter SUMMARY
Who determines a corporation’s performance? According to the popular press, it is the chief
executive officer who seems to be personally responsible for a company’s success or failure.
When a company is in trouble, one of the first alternatives usually presented is to fire the CEO.
That was certainly the case at the Walt Disney Company under Michael Eisner and Hewlett-
Packard under Carly Fiorina. Both CEOs were first viewed as transformational leaders who
made needed strategic changes to their companies. After a few years, both were perceived to
be the primary reason for their company’s poor performance and were fired by their boards.
The truth is rarely this simple.
According to research by Margarethe Wiersema, firing the CEO rarely solves a corpora-
tion’s problems. In a study of CEO turnover caused by dismissals and retirements in the
500 largest public U.S. companies, 71% of the departures were involuntary. In those firms in which
the CEO was fired or asked to resign and replaced by another, Wiersema found no significant
improvement in the company’s operating earnings or stock price. She couldn’t find a single
measure suggesting that CEO dismissal had a positive effect on corporate performance!
Wiersema placed the blame for the poor results squarely on the shoulders of the boards of di-
rectors. Boards typically lack an in-depth understanding of the business and consequently rely
too heavily on executive search firms that know even less about the business. According to
Wiersema, boards that successfully managed the executive succession process had three things
in common:
� The board set the criteria for candidate selection based on the strategic needs of the
company.
� The board set realistic performance expectations rather than demanding a quick fix to
please the investment community.
� The board developed a deep understanding of the business and provided strong strategic
oversight of top management, including thoughtful annual reviews of CEO
performance.118
As noted at the beginning of this chapter, corporate governance involves not just the CEO
or the board of directors. It involves the combined active participation of the board, top man-
agement, and shareholders. One positive result of the many corporate scandals occurring over
different ideas are explored. Homework is assigned ahead of time. . . . Eventually we have to
choose just a couple of things, if they’re big, and make bets.115
In contrast to the seemingly continuous strategic planning being done at Amazon.com,
most large corporations conduct the strategic planning process just once a year—often at off-
site strategy workshops attended by senior executives.116
Many large organizations have a strategic planning staff charged with supporting both top
management and the business units in the strategic planning process. This staff may prepare
the background materials used in senior management’s off-site strategy workshop. This plan-
ning staff typically consists of fewer than ten people, headed by a senior executive with the ti-
tle of Director of Corporate Development or Chief Strategy Officer. The staff’s major
responsibilities are to:
1. Identify and analyze companywide strategic issues, and suggest corporate strategic alter-
natives to top management.
2. Work as facilitators with business units to guide them through the strategic planning
process.117
CHAPTER 2 Corporate Governance 63
the past decade is the increased interest in governance. Institutional investors are no longer
content to be passive shareholders. Thanks to new regulations, boards of directors are taking
their responsibilities more seriously and including more independent outsiders on key over-
sight committees. Top managers are beginning to understand the value of working with boards
as partners, not just as adversaries or as people to be manipulated. Although there will always
be passive shareholders, rubber-stamp boards, and dominating CEOs, the simple truth is that
good corporate governance means better strategic management.
E C O – B I T S
� DuPont, originally founded in 1802 to make gunpowder
and explosives, was a major producer in 1990 of nitrous
oxides and fluorocarbons—gases with a global warm-
ing potential 310 and 11,700 times that of carbon diox-
ide, respectively.
� DuPont was the first company to phase-out CFCs and
the first to develop and commercialize CFC alternatives
for refrigeration and air conditioning.
� DuPont’s reputation changed from “Top U.S. Polluter
of 1995” to Business Week’s list of “Top Green Compa-
nies” in 2005; meanwhile, its earnings per share in-
creased from $1 in 2003 to $3.25 in 2007.119
D I S C U S S I O N Q U E S T I O N S
1. When does a corporation need a board of directors?
2. Who should and should not serve on a board of directors?
What about environmentalists or union leaders?
3. Should a CEO be allowed to serve on another company’s
board of directors?
4. What would be the result if the only insider on a corpora-
tion’s board were the CEO?
5. Should all CEOs be transformational leaders? Would you
like to work for a transformational leader?
S T R A T E G I C P R A C T I C E E X E R C I S E
A. Think of the best manager for whom you have ever
worked. What was it about this person that made him or
her such a good manager? Consider the following state-
ments as they pertain to that person. Fill in the blank in
front of each statement with one of the following values:
STRONGLY AGREE � 5; AGREE � 4; NEUTRAL � 3;
DISAGREE � 2; STRONGLY DISAGREE � 1.
1. ___ I respect him/her personally, and want to act in a
way that merits his/her respect and admiration. ___
2. ___ I respect her/his competence about things
she/he is more experienced about than I. ___
3. ___ He/she can give special help to those who coop-
erate with him/her. ___
4. ___ He/she can apply pressure on those who coop-
erate with him/her. ___
5. ___ He/she has a legitimate right, considering
his/her position, to expect that his/her sugges-
tions will be carried out. ___
6. ___ I defer to his/her judgment in areas with which
he/she is more familiar than I. ___
7. ___ He/she can make things difficult for me if I fail
to follow his/her advice. ___
8. ___ Because of his/her job title and rank, I am obli-
gated to follow his/her suggestions. ___
9. ___ I can personally benefit by cooperating with
him/her. ___
10. ___ Following his/her advice results in better deci-
sions. ___
11. ___ I cooperate with him/her because I have high re-
gard for him/her as an individual. ___
12. ___ He/she can penalize those who do not follow
his/her suggestions. ___
64 PART 1 Introduction to Strategic Management and Business Policy
BEST MANAGER
Reward Coercive Legitimate Referent Expert
3. 4. 5. 1. 2.
9. 7. 8. 11. 6.
15. 12. 13. 14. 10.
Total Total Total Total Total
WORST MANAGER
Reward Coercive Legitimate Referent Expert
3. 4. 5. 1. 2.
9. 7. 8. 11. 6.
15. 12. 13. 14. 10.
Total Total Total Total Total
K E Y T E R M S
affiliated director (p. 49)
agency theory (p. 48)
board of directors’ continuum (p. 46)
board of director responsibilities (p. 45)
codetermination (p. 52)
corporate governance (p. 45)
due care (p. 46)
executive leadership (p. 60)
inside director (p. 48)
interlocking directorate (p. 52)
lead director (p. 54)
outside director (p. 48)
Sarbanes-Oxley Act (p. 55)
stewardship theory (p. 49)
strategic vision (p. 60)
top management responsibilities (p. 58)
transformational leader (p. 60)
13. ___ I feel I have to cooperate with him/her. ___
14. ___ I cooperate with him/her because I wish to be
identified with him/her. ___
15. ___ Cooperating with him/her can positively affect
my performance. ___
B. Now think of the worst manager for whom you have
ever worked. What was it about this person that made him
or her such a poor manager? Please consider the state-
ments above as they pertain to that person. Please place a
number after each statement with one of the values from
5 � strongly agree to 1 � strongly disagree.
C. Add the values you marked for the best manager within
each of the five categories of power below. Then do the
same for the values you marked for the worst manager.
SOURCE: Questionnaire developed by J. D. Hunger from the article “Influence and Information: An Exploratory Investigation of the Boundary
Role Person’s Bases of Power” by Robert Spekman, Academy of Management Journal, March 1979. Copyright © 2004 by J. David Hunger.
D. Consider the differences between how you rated your
best and your worst manager. How different are the two
profiles? In many cases, the best manager’s profile tends
to be similar to that of transformational leaders in that the
best manager tends to score highest on referent, followed
by expert and reward, power—especially when com-
pared to the worst manager’s profile. The worst manager
often scores highest on coercive and legitimate power,
followed by reward power. The results of this survey may
help you to answer the fifth discussion question for this
chapter.
CHAPTER 2 Corporate Governance 65
N O T E S
1. R. Kirkland, “The Real CEO Pay Problem,” Fortune (July 10,
2006), pp. 78–81.
2. M. Bartiromo, “Bob Nardelli Explains Himself,” Business Week
(July 24, 2006), pp. 98–100.
3. B. Grow, “Renovating Home Depot,” Business Week (March 6,
2006), pp. 50–58.
4. B. Grow, “Out at Home Depot,” Business Week (January 15,
2007), pp. 56–62.
5. M. Fetterman, “Boardrooms Open Up to Investors’ Input,” USA
Today (September 7, 2007), pp. 1B–2B.
6. “Raising Their Voices,” The Economist (March 22, 2008), p. 72.
7. P. Burrows, “He’s Making Hay as CEOs Squirm,” Business
Week (January 15, 2007), pp. 64–65.
8. “The Price of Prominence,” The Economist (January 15, 2005),
p. 69.
9. A. G. Monks and N. Minow, Corporate Governance (Cam-
bridge, MA: Blackwell Business, 1995), pp. 8–32.
10. Ibid., p. 1.
11. A. Demb, and F. F. Neubauer, “The Corporate Board: Con-
fronting the Paradoxes,” Long Range Planning (June 1992),
p. 13. These results are supported by a 1995 Korn/Ferry Inter-
national survey in which chairs and directors agreed that strat-
egy and management succession, in that order, are the most
important issues the board expects to face.
12. Reported by E. L. Biggs in “CEO Succession Planning: An
Emerging Challenge for Boards of Directors,” Academy of
Management Executive (February 2004), pp. 105–107.
13. A. Borrus, “Less Laissez-Faire in Delaware?” Business Week
(March 22, 2004), pp. 80–82.
14. L. Light, “Why Outside Directors Have Nightmares,” Business
Week (October 23, 1996), p. 6.
15. “Where’s All the Fun Gone?” Economist (March 20, 2004),
p. 76.
16. A. Chen, J. Osofsky, and E. Stephenson, “Making the Board
More Strategic: A McKinsey Global Survey,” McKinsey Quar-
terly (March 2008), pp. 1–10.
17. Nadler proposes a similar five-step continuum for board in-
volvement ranging from the least involved “passive board” to
the most involved “operating board,” plus a form for measuring
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66 PART 1 Introduction to Strategic Management and Business Policy
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CHAPTER 2 Corporate Governance 67
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68 PART 1 Introduction to Strategic Management and Business Policy
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CHAPTER 2 Corporate Governance 69
Only a few miles from the gleaming skyscrapers of prosperous Minneapolis
was a neighborhood littered with shattered glass from stolen cars and derelict
houses used by drug lords. During the 1990s, the Hawthorne neighborhood
became a no-man’s-land where gun battles terrified local residents and raised
the per capita murder rate 70% higher than that of New York.
Executives at General Mills became concerned when the murder rate reached a
record high in 1996. The company’s headquarters was located just five miles away from
Hawthorne, then the city’s most violent neighborhood. Working with law enforcement, politi-
cians, community leaders, and residents, General Mills spent $2.5 million and donated thou-
sands of employee hours to help clean up Hawthorne. Crack houses were demolished to make
way for a new elementary school. Dilapidated houses in the neighborhood’s core were rebuilt.
General Mills provided grants to help people buy Hawthorne’s houses. By 2003, homicides were
down 32% and robberies had declined 56% in Hawthorne.
This story was nothing new for General Mills, a company often listed in Fortune magazine’s
“Most Admired Companies,” ranked third most socially responsible company in a survey con-
ducted by The Wall Street Journal and Harris Interactive, and fourth in Business Week’s 2007 sur-
vey of “most generous corporate donors.” Since 2000, the company has annually contributed
5% of pretax profits to a wide variety of social causes. In 2007, for example, the company do-
nated $82 million to causes ranging from education and the arts to social services. Every day, the
company ships three truckloads of Cheerios, Wheaties, and other packaged goods to food banks
throughout the nation. Community performance is even reflected in the performance reviews
of top management. According to Christina Shea, president of General Mills Foundation, “We
take as innovative approach to giving back to our communities as we do in our business.” For
joining with a nonprofit organization and a minority-owned food company to create 150 inner-
city jobs, General Mills received Business Ethics’ annual corporate citizenship award.1
Was this the best use of General Mills’ time and money? At a time when companies were
being pressured to cut costs and outsource jobs to countries with cheaper labor, what do busi-
ness corporations owe their local communities? Should business firms give away shareholders’
money, support social causes, and ask employees to donate their time to the community? Crit-
ics argue that this sort of thing is done best by government and not-for-profit charities. Isn’t the
primary goal of business to maximize profits, not to be a social worker?
social responsibility
and ethics in
Strategic Management
C H A P T E R 3
71
� Compare and contrast Friedman’s
traditional view with Carroll’s
contemporary view of social responsibility
� Understand the relationship between
social responsibility and corporate
performance
� Explain the concept of sustainability
� Conduct a stakeholder analysis
� Explain why people may act unethically
� Describe different views of ethics
according to the utilitarian, individual
rights, and justice approaches
Learning Objectives
Gathering
Information
Putting Strategy
into Action
Monitoring
Performance
Societal
Environment:
General forces
Natural
Environment:
Resources and
climate
Task
Environment:
Industry analysis
Internal:
Strengths and
Weaknesses
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
Programs
Activities
needed to
accomplish
a plan
Budgets
Cost of the
programs Procedures
Sequence
of steps
needed to
do the job
Performance
Actual results
External:
Opportunities
and Threats
Developing
Long-range Plans
Mission
Reason for
existence Objectives
What
results to
accomplish
by when
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Environmental
Scanning:
Strategy
Formulation:
Strategy
Implementation:
Evaluation
and Control:
Feedback/Learning: Make corrections as needed
After reading this chapter, you should be able to:
3.1 Social Responsibilities of Strategic Decision Makers
Should strategic decision makers be responsible only to shareholders, or do they have broader
responsibilities? The concept of social responsibility proposes that a private corporation has
responsibilities to society that extend beyond making a profit. Strategic decisions often affect
more than just the corporation. A decision to retrench by closing some plants and discontinu-
ing product lines, for example, affects not only the firm’s workforce but also the communities
where the plants are located and the customers with no other source for the discontinued prod-
uct. Such situations raise questions of the appropriateness of certain missions, objectives, and
strategies of business corporations. Managers must be able to deal with these conflicting in-
terests in an ethical manner to formulate a viable strategic plan.
RESPONSIBILITIES OF A BUSINESS FIRM
What are the responsibilities of a business firm and how many of them must be fulfilled?
Milton Friedman and Archie Carroll offer two contrasting views of the responsibilities of busi-
ness firms to society.
Friedman’s Traditional View of Business Responsibility
Urging a return to a laissez-faire worldwide economy with a minimum of government regula-
tion, Milton Friedman argues against the concept of social responsibility. A business person
who acts “responsibly” by cutting the price of the firm’s product to prevent inflation, or by
making expenditures to reduce pollution, or by hiring the hard-core unemployed, according to
Friedman, is spending the shareholder’s money for a general social interest. Even if the busi-
nessperson has shareholder permission or encouragement to do so, he or she is still acting from
motives other than economic and may, in the long run, harm the very society the firm is try-
ing to help. By taking on the burden of these social costs, the business becomes less efficient—
either prices go up to pay for the increased costs or investment in new activities and research
is postponed. These results negatively affect—perhaps fatally—the long-term efficiency of a
business. Friedman thus referred to the social responsibility of business as a “fundamentally
subversive doctrine” and stated that:
There is one and only one social responsibility of business—to use its resources and engage in
activities designed to increase its profits so long as it stays within the rules of the game, which
is to say, engages in open and free competition without deception or fraud.2
Following Friedman’s reasoning, the management of General Mills was clearly guilty of
misusing corporate assets and negatively affecting shareholder wealth. The millions spent in
social services could have been invested in new product development or given back as divi-
dends to the shareholders. Instead of General Mills’ management acting on its own, sharehold-
ers could have decided which charities to support.
Carroll’s Four Responsibilities of Business
Friedman’s contention that the primary goal of business is profit maximization is only one side
of an ongoing debate regarding corporate social responsibility (CSR). According to William J.
Byron, Distinguished Professor of Ethics at Georgetown University and past-President of
Catholic University of America, profits are merely a means to an end, not an end in itself. Just
as a person needs food to survive and grow, so does a business corporation need profits to sur-
vive and grow. “Maximizing profits is like maximizing food.” Thus, contends Byron, maxi-
mization of profits cannot be the primary obligation of business.3
72 PART 1 Introduction to Strategic Management and Business Policy
CHAPTER 3 Social Responsibility and Ethics in Strategic Management 73
Discretionary
Ethical
LegalEconomic
Social
Responsibilities
FIGURE 3–1
Responsibilities
of Business
As shown in Figure 3–1, Archie Carroll proposes that the managers of business organi-
zations have four responsibilities: economic, legal, ethical, and discretionary.4
1. Economic responsibilities of a business organization’s management are to produce goods
and services of value to society so that the firm may repay its creditors and shareholders.
2. Legal responsibilities are defined by governments in laws that management is expected
to obey. For example, U.S. business firms are required to hire and promote people based
on their credentials rather than to discriminate on non-job-related characteristics such as
race, gender, or religion.
3. Ethical responsibilities of an organization’s management are to follow the generally held
beliefs about behavior in a society. For example, society generally expects firms to work
with the employees and the community in planning for layoffs, even though no law may
require this. The affected people can get very upset if an organization’s management fails
to act according to generally prevailing ethical values.
4. Discretionary responsibilities are the purely voluntary obligations a corporation as-
sumes. Examples are philanthropic contributions, training the hard-core unemployed, and
providing day-care centers. The difference between ethical and discretionary responsibil-
ities is that few people expect an organization to fulfill discretionary responsibilities,
whereas many expect an organization to fulfill ethical ones.5
Carroll lists these four responsibilities in order of priority. A business firm must first make
a profit to satisfy its economic responsibilities. To continue in existence, the firm must follow
the laws, thus fulfilling its legal responsibilities. There is evidence that companies found guilty
of violating laws have lower profits and sales growth after conviction.6 To this point Carroll
and Friedman are in agreement. Carroll, however, goes further by arguing that business man-
agers have responsibilities beyond economic and legal ones.
Having satisfied the two basic responsibilities, according to Carroll, a firm should look to
fulfilling its social responsibilities. Social responsibility, therefore, includes both ethical and
discretionary, but not economic and legal, responsibilities. A firm can fulfill its ethical respon-
sibilities by taking actions that society tends to value but has not yet put into law. When ethi-
cal responsibilities are satisfied, a firm can focus on discretionary responsibilities—purely
voluntary actions that society has not yet decided are important. For example, when Cisco Sys-
tems decided to dismiss 6,000 full-time employees, it provided a novel severance package.
Those employees who agreed to work for a local nonprofit organization for a year would re-
ceive one-third of their salaries plus benefits and stock options and be the first to be rehired.
Nonprofits were delighted to hire such highly qualified people and Cisco was able to maintain
its talent pool for when it could hire once again.7
SOURCE: Based on A. B. Carroll, “A Three Dimensional Conceptual Model of Corporate Performance,” Academy
of Management Review (October 1979), pp. 497–505; A. B. Carroll, “Managing Ethically with Global Stakeholders:
A Present and Future Challenge,” Academy of Management Executive (May 2004), pp. 114–120; and A. B. Carroll,
“The Pyramid of Corporate Social Responsibility: Toward the Moral Management of Organizational Stakeholders,”
Business Horizons (July–August 1991), pp. 39–48.
As societal values evolve, the discretionary responsibilities of today may become the eth-
ical responsibilities of tomorrow. For example, in 1990, 86% of people in the U.S. believed
that obesity was caused by the individuals themselves, with only 14% blaming either corpo-
rate marketing or government guidelines. By 2003, however, only 54% blamed obesity on in-
dividuals and 46% put responsibility on corporate marketing and government guidelines.
Thus, the offering of healthy, low-calorie food by food processors and restaurants is moving
rapidly from being a discretionary to an ethical responsibility.8 One example of this change in
values is the film documentary Super Size Me, which criticizes the health benefits of eating
McDonald’s deep-fried fast food. (McDonald’s responded by offering more healthy food
items.)
Carroll suggests that to the extent that business corporations fail to acknowledge discre-
tionary or ethical responsibilities, society, through government, will act, making them legal re-
sponsibilities. Government may do this, moreover, without regard to an organization’s economic
responsibilities. As a result, the organization may have greater difficulty in earning a profit than
it would have if it had voluntarily assumed some ethical and discretionary responsibilities.
Both Friedman and Carroll argue their positions based on the impact of socially respon-
sible actions on a firm’s profits. Friedman says that socially responsible actions hurt a firm’s
efficiency. Carroll proposes that a lack of social responsibility results in increased government
regulations, which reduce a firm’s efficiency.
Friedman’s position on social responsibility appears to be losing traction with business ex-
ecutives. For example, a 2006 survey of business executives across the world by McKinsey &
Company revealed that only 16% felt that business should focus solely on providing the highest
possible returns to investors while obeying all laws and regulations, contrasted with 84% who
stated that business should generate high returns to investors but balance it with contributions
to the broader public good.9 A 2007 survey of global executives by the Economist Intelligence
Unit found that the percentage of companies giving either high or very high priority to corpo-
rate social responsibility had risen from less than 40% in 2004 to over 50% in 2007 and was
expected to increase to almost 70% by 2010.10
Empirical research now indicates that socially responsible actions may have a positive ef-
fect on a firm’s financial performance. Although a number of studies in the past have found no
significant relationship,11 an increasing number are finding a small, but positive relationship.12
A recent in-depth analysis by Margolis and Walsh of 127 studies found that “there is a posi-
tive association and very little evidence of a negative association between a company’s social
performance and its financial performance.”13 Another meta-analysis of 52 studies on social
responsibility and performance reached this same conclusion.14
According to Porter and Kramer, “social and economic goals are not inherently conflict-
ing, but integrally connected.”15 Being known as a socially responsible firm may provide a
company with social capital, the goodwill of key stakeholders, that can be used for competi-
tive advantage.16 Target, for example, tries to attract socially concerned younger consumers by
offering brands from companies that can boost ethical track records and community involve-
ment.17 In a 2004 study conducted by the strategic marketing firm Cone, Inc., eight in ten
Americans said that corporate support of social causes helps earn their loyalty. This was a 21%
increase since 1997.18
Being socially responsible does provide a firm a more positive overall reputation.19 A sur-
vey of more than 700 global companies by the Conference Board reported that 60% of the
managers state that citizenship activities had led to (1) goodwill that opened doors in local
communities and (2) an enhanced reputation with consumers.20 Another survey of 140 U.S.
firms revealed that being more socially responsible regarding environmental sustainability
resulted not only in competitive advantages but also in cost savings.21 For example, compa-
nies that take the lead in being environmentally friendly, such as by using recycled materials,
preempt attacks from environmental groups and enhance their corporate image. Programs to
74 PART 1 Introduction to Strategic Management and Business Policy
CHAPTER 3 Social Responsibility and Ethics in Strategic Management 75
reduce pollution, for example, can actually reduce waste and maximize resource productivity.
One study that examined 70 ecological initiatives taken by 43 companies found the average
payback period to be 18 months.22 Other examples of benefits received from being socially
responsible are:23
� Their environmental concerns may enable them to charge premium prices and gain brand
loyalty (for example, Ben & Jerry’s Ice Cream).
� Their trustworthiness may help them generate enduring relationships with suppliers and
distributors without requiring them to spend a lot of time and money policing contracts.
� They can attract outstanding employees who prefer working for a responsible firm (for
example, Procter & Gamble and Starbucks).
� They are more likely to be welcomed into a foreign country (for example, Levi Strauss).
� They can utilize the goodwill of public officials for support in difficult times.
� They are more likely to attract capital infusions from investors who view reputable com-
panies as desirable long-term investments. For example, mutual funds investing only in
socially responsible companies more than doubled in size from 1995 to 2007 and outper-
formed the S&P 500 list of stocks.24
SUSTAINABILITY: MORE THAN ENVIRONMENTAL?
As a term, sustainability may include more than just ecological concerns and the natural envi-
ronment. Crane and Matten point out that the concept of sustainability can be broadened to in-
clude economic and social as well as environmental concerns. They argue that it is sometimes
impossible to address the sustainability of the natural environment without considering the so-
cial and economic aspects of relevant communities and their activities. For example, even
though environmentalists may oppose road-building programs because of their effect on
wildlife and conservation efforts, others point to the benefits to local communities of less traf-
fic congestion and more jobs.25 Dow Jones & Company, a leading provider of global business
news and information, developed a sustainability index that considers not only environmen-
tal, but also economic and social factors. See the Environmental Sustainability Issue feature
to learn the criteria Dow Jones uses in its index.
The broader concept of sustainability has much in common with Carroll’s list of business
responsibilities presented earlier. In order for a business corporation to be sustainable, that is,
to be successful over a long period of time, it must satisfy all of its economic, legal, ethical,
and discretionary responsibilities. Sustainability thus involves many issues, concerns, and
tradeoffs—leading us to an examination of corporate stakeholders.
CORPORATE STAKEHOLDERS
The concept that business must be socially responsible sounds appealing until we ask, “Re-
sponsible to whom?” A corporation’s task environment includes a large number of groups with
interest in a business organization’s activities. These groups are referred to as stakeholders
because they affect or are affected by the achievement of the firm’s objectives.26 Should a cor-
poration be responsible only to some of these groups, or does business have an equal respon-
sibility to all of them?
A survey of the U.S. general public by Harris Poll revealed that 95% of the respondents felt
that U.S. corporations owe something to their workers and the communities in which they op-
erate and that they should sometimes sacrifice some profit for the sake of making things better
for their workers and communities. People were concerned that business executives seemed to
76 PART 1 Introduction to Strategic Management and Business Policy
NOTE: For more information on SAM Sustainable Asset Manage-
ment, see Sustainability Yearbook 2008, available from PriceWa-
terHouseCoopers (www.pwc.com).
SOURCES: Dow Jones Indexes Web site (www.djindexes.com/) as
of July 15, 2008 and A. Crane and D. Matten, Business Ethics: A
European Perspective (Oxford: Oxford University Press, 2004),
pp. 214–215.
� Environmental sustainability. This includes environ-
mental reporting, eco-design and efficiency, environmen-
tal management systems, and executive commitment to
environmental issues.
� Economic sustainability. This includes codes of con-
duct and compliance, anti-corruption policies, corpo-
rate governance, risk and crisis management, strategic
planning, quality and knowledge management, and
supply chain management.
� Social sustainability. This includes corporate citizen-
ship, philanthropy, labor practices, human capital devel-
opment, social reporting, talent attraction and retention,
and stakeholder dialogue.
Dow Jones & Company, a
leading provider of global
business news and informa-
tion, pioneered in 1999 the first
index of common stocks that rates
corporations according to their perfor-
mance on sustainability. This index has grown to include
multiple sustainability indexes, such as a World Index,
North America Index, and United States Index, among oth-
ers. The Dow Jones Sustainability Index (DJSI) follows a
“best in class” approach that identifies sustainability lead-
ers in each industry. Companies are evaluated against gen-
eral and industry-specific criteria and ranked with their
peers. Data come from questionnaires, submitted docu-
mentation, corporate policies, reports, and available public
information. Since its inception, the Dow Jones Sustain-
ability Index has slightly outperformed its well-known Dow
Jones Industrial Index. Based on SAM (Sustainable Asset
Management AG) Research’s corporate sustainability as-
sessment, Dow Jones includes not only environmental, but
also economic and social criteria in its sustainability index.
THE DOW JONES SUSTAINABILITY INDEX
ENVIRONMENTAL sustainability issue
be more interested in making profits and boosting their own pay than they were in the safety and
quality of the products made by their companies.27 The percentage of the U.S. general public
that agreed that business leaders could be trusted to do what is right “most of the time or almost
always” fell from 36% in 2002 to 28% in 2006.28 These negative feelings receive some support
from a study that revealed that the CEOs at the 50 U.S. companies that outsourced the greatest
number of jobs received a greater increase in pay than did the CEOs of 365 U.S. firms overall.29
In any one strategic decision, the interests of one stakeholder group can conflict with those
of another. For example, a business firm’s decision to use only recycled materials in its man-
ufacturing process may have a positive effect on environmental groups but a negative effect
on shareholder dividends. In another example, Maytag Corporation’s top management decided
to move refrigerator production from Galesburg, Illinois, to a lower-wage location in Mexico.
On the one hand, shareholders were generally pleased with the decision because it would lower
costs. On the other hand, officials and local union people were very unhappy at the loss of jobs
when the Galesburg plant closed. Which group’s interests should have priority?
In order to answer this question, the corporation may need to craft an enterprise
strategy—an overarching strategy that explicitly articulates the firm’s ethical relationship with
its stakeholders. This requires not only that management clearly state the firm’s key ethical
values, but also that it understands the firm’s societal context, and undertakes stakeholder
analysis to identify the concerns and abilities of each stakeholder.30
Stakeholder Analysis
Stakeholder analysis is the identification and evaluation of corporate stakeholders. This can
be done in a three-step process.
www.pwc.com
www.djindexes.com/
CHAPTER 3 Social Responsibility and Ethics in Strategic Management 77
The first step in stakeholder analysis is to identify primary stakeholders, those who have
a direct connection with the corporation and who have sufficient bargaining power to directly
affect corporate activities. Primary stakeholders are directly affected by the corporation and
usually include customers, employees, suppliers, shareholders, and creditors.
But who exactly are a firm’s customers or employees and what do they want? This is not
always a simple exercise. For example, Intel’s customers were clearly computer manufactur-
ers because that’s to whom Intel sold its electronic chips. When a math professor found a small
flaw in Intel’s Pentium microprocessor in 1994, computer users demanded that Intel replace
the defective chips. At first Intel refused to do so because it hadn’t sold to these individuals.
According to then-CEO Andy Grove, “I got irritated and angry because of user demands that
we take back a device we didn’t sell.” Intel wanted the PC users to follow the supply chain and
complain to the firms from whom they had bought the computers. Gradually Grove was per-
suaded that Intel had a direct duty to these consumers. “Although we didn’t sell to these indi-
viduals directly, we marketed to them. . . . It took me a while to understand this,” explained
Grove. In the end, Intel paid $450 million to replace the defective parts.31
Aside from the Intel example, business corporations usually know their primary stake-
holders and what they want. The corporation systematically monitors these stakeholders be-
cause they are important to a firm’s meeting its economic and legal responsibilities.
Employees want a fair day’s pay and fringe benefits. Customers want safe products and value
for price paid. Shareholders want dividends and stock price appreciation. Suppliers want pre-
dictable orders and bills paid. Creditors want commitments to be met on time. In the normal
course of affairs, the relationship between a firm and each of its primary stakeholders is regu-
lated by written or verbal agreements and laws. Once a problem is identified, negotiation takes
place based on costs and benefits to each party. (Government is not usually considered a pri-
mary stakeholder because laws apply to all in a category and usually cannot be negotiated.)
The second step in stakeholder analysis is to identify the secondary stakeholders—those
who have only an indirect stake in the corporation but who are also affected by corporate activ-
ities. These usually include nongovernmental organizations (NGOs, such as Greenpeace), ac-
tivists, local communities, trade associations, competitors, and governments. Because the
corporation’s relationship with each of these stakeholders is usually not covered by any written
or verbal agreement, there is room for misunderstanding. As in the case of NGOs and activists,
there actually may be no relationship until a problem develops—usually brought up by the
stakeholder. In the normal course of events, these stakeholders do not affect the corporation’s
ability to meet its economic or legal responsibilities. Aside from competitors, these secondary
stakeholders are not usually monitored by the corporation in any systematic fashion. As a result,
relationships are usually based on a set of questionable assumptions about each other’s needs
and wants. Although these stakeholders may not directly affect a firm’s short-term profitability,
their actions could determine a corporation’s reputation and thus its long-term performance.
The third step in stakeholder analysis is to estimate the effect on each stakeholder group
from any particular strategic decision. Because the primary decision criteria are typically eco-
nomic, this is the point where secondary stakeholders may be ignored or discounted as unim-
portant. For a firm to fulfill its ethical or discretionary responsibilities, it must seriously
consider the needs and wants of its secondary stakeholders in any strategic decision. For ex-
ample, how much will specific stakeholder groups lose or gain? What other alternatives do
they have to replace what may be lost?
Stakeholder Input
Once stakeholder impacts have been identified, managers should decide whether stake-
holder input should be invited into the discussion of the strategic alternatives. A group is
more likely to accept or even help implement a decision if it has some input into which
78 PART 1 Introduction to Strategic Management and Business Policy
ment for those qualified. We must provide competent
management, and their actions must be just and ethical.
We are responsible to the communities where we live
and work and to the world community as well. We must be
good citizens—support good works and charities and bear
our fair share of taxes. We must encourage civic improve-
ments and better health and education. We must maintain
in good order the property we are privileged to use, and
protecting the environment and natural resources.
Our final responsibility is to our stockholders. Business
must make a sound profit. We must experiment with new
ideas. Research must be carried on, innovative programs
developed, and mistakes paid for. New equipment must be
purchased, new facilities provided, and new products
launched. Reserves must be created for adverse times.
When we operate according to these principles, the stock-
holders should realize a fair return.
We believe our first respon-
sibility is to the doctors,
nurses, and patients, to
mothers and fathers and all
others who use our products and
services. In meeting their needs every-
thing we do must be of high quality. We must constantly
strive to reduce our costs in order to maintain reasonable
prices. Customers’ orders must be serviced promptly and
accurately. Our suppliers and distributors must have an op-
portunity to make a fair profit.
We are responsible to our employees, the men and
women who work with us throughout the world. Everyone
must be considered as an individual. We must respect their
dignity and recognize their merit. They must have a sense
of security in their jobs. Compensation must be fair and ad-
equate, and working conditions clean, orderly, and safe.
We must be mindful of ways to help our employees fulfill
their family responsibilities. Employees must feel free to
make suggestions and complaints. There must be equal
opportunity for employment, development, and advance-
JOHNSON & JOHNSON CREDO
SOURCE: Johnson & Johnson Company Web site, September 28,
2004. (http://www.jnj.com) Copyright by Johnson & Johnson. All
rights reserved. Reprinted by permission.
STRATEGY highlight 3.1
alternative is chosen and how it is to be implemented. In the case of Maytag’s decision to
close its Galesburg, Illinois, refrigeration plant, the community was not a part of the deci-
sion. Nevertheless, management decided to inform the local community of its decision three
years in advance of the closing instead of the 60 days required by law. Although the an-
nouncement created negative attention, it gave the Galesburg employees and townspeople
more time to adjust to the eventual closing.
Given the wide range of interests and concerns present in any organization’s task environ-
ment, one or more groups, at any one time, probably will be dissatisfied with an organization’s
activities—even if management is trying to be socially responsible. A company may have
some stakeholders of which it is only marginally aware. For example, when Ford Motor Com-
pany extended its advertising to magazines read by gay and lesbian readers in 2005, manage-
ment had no idea that the American Family Association (AFA) would argue that this was
tantamount to promoting a homosexual agenda and call for a boycott of all Ford products. In
response, Ford pulled its ads. Gay and lesbian groups then protested Ford’s backpedaling. Ford
then placed corporate ads in many of the same publications, which gays saw as clumsy and the
AFA saw as backsliding.32
Therefore, before making a strategic decision, strategic managers should consider how
each alternative will affect various stakeholder groups. What seems at first to be the best de-
cision because it appears to be the most profitable may actually result in the worst set of con-
sequences to the corporation. One example of a company that does its best to consider its
responsibilities to its primary and secondary stakeholders when making strategic decisions is
Johnson & Johnson. See Strategy Highlight 3.1 for the J & J Credo.
http://www.jnj.com
CHAPTER 3 Social Responsibility and Ethics in Strategic Management 79
3.2 Ethical Decision Making
Some people joke that there is no such thing as “business ethics.” They call it an oxymoron—
a concept that combines opposite or contradictory ideas. Unfortunately, there is some truth to
this sarcastic comment. For example, a survey by the Ethics Resource Center of 1,324 employ-
ees of 747 U.S. companies found that 48% of employees surveyed said that they had engaged
in one or more unethical and/or illegal actions during the past year. The most common ques-
tionable behaviors involved cutting corners on quality (16%), covering up incidents (14%),
abusing or lying about sick days (11%), and lying to or deceiving customers (9%).33 Some 52%
of workers reported observing at least one type of misconduct in the workplace, but only 55%
reported it.34 From 1996 to 2005, top managers at 2,270 firms (29.2% of the firms analyzed)
had backdated or otherwise manipulated stock option grants to take advantage of favorable
share-price movements.35 In a survey, 53% of employees in corporations of all sizes admitted
that they would be willing to misrepresent corporate financial statements if asked to do so by
a superior.36 A survey of 141 chief financial executives (CFOs) revealed that 17% had been
pressured by their CEOs over a five-year period to misrepresent the company’s financial re-
sults. Five percent admitted that they had succumbed to the request.37
Around 53,000 cases of suspected mortgage fraud were reported by banks in 2007. The
most common type of mortgage fraud was misstatement of income or assets, followed by
forged documents, inflated appraisals, and misrepresentation of a buyer’s intent to occupy a
property as a primary residence.38 In one instance, Allison Bice, office manager at Leonard
Fazio’s RE/MAX A-1 Best Realtors in Urbandale, Iowa, admitted that she submitted fake in-
voices and copies of checks drawn on a closed account as part of a scheme to obtain more
money from Homecoming Financial, a mortgage company that had hired Fazio’s agency to re-
sell foreclosed homes. “I was directed by Mr. Fazio to have the bills be larger to Homecom-
ings because we didn’t make much money on commissions,” Bice told a federal jury in Des
Moines. “He told me that everybody in the business does it.”39
A study of more than 5,000 graduate students at 32 colleges and universities in the United
States and Canada revealed that 56% of business students and 47% of non-business students
admitted to cheating at least once during the past year. Cheating was more likely when a stu-
dent’s peers also cheated.40 In another example, 6,000 people paid $30 to enter a VIP section
on ScoreTop.com’s Web site to obtain access to actual test questions posted by those who had
recently taken the Graduate Management Admission Test (GMAT). In response, the Graduate
Management Admission Council promised to cancel the scores of anyone who posted “live”
questions to the site or knowingly read them.41 Given this lack of ethical behavior among stu-
dents, it is easy to understand why some could run into trouble if they obtained a job at a cor-
poration having an unethical culture, such as Enron, WorldCom, or Tyco. (See Strategy
Highlight 3.2 for examples of unethical practices at Enron and Worldcom.)
SOME REASONS FOR UNETHICAL BEHAVIOR
Why are many business people perceived to be acting unethically? It may be that the involved
people are not even aware that they are doing something questionable. There is no worldwide
standard of conduct for business people. This is especially important given the global nature
of business activities. Cultural norms and values vary between countries and even between dif-
ferent geographic regions and ethnic groups within a country. For example, what is considered
in one country to be a bribe to expedite service is sometimes considered in another country to
be normal business practice. Some of these differences may derive from whether a country’s
80 PART 1 Introduction to Strategic Management and Business Policy
ment. None of that will protect Enron if these transac-
tions are ever disclosed in the bright light of day.
At WorldCom, Cynthia Cooper, an internal auditor,
noted that some of the company’s capital expenditures
should have been listed on the second-quarter financial
statements as expenses. When she mentioned this to both
WorldCom’s controller and its chief financial officer, she
was told to stop what she was doing and to delay the au-
dit until the third quarter (when expensing the transactions
would not be noticed). Instead, Cooper informed the
board of directors’ audit committee. Two weeks later,
WorldCom announced that it was reducing earnings by
$3.9 billion, the largest restatement in history.
Corporate scandals at Enron,
WorldCom, and Tyco, among
other international companies,
have caused people around the
world to seriously question the ethics of business executives.
Enron, in particular, has become infamous for the question-
able actions of its top executives in the form of (1) off-
balance sheet partnerships used to hide the company’s dete-
riorating finances, (2) revenue from long-term contracts
being recorded in the first year instead of being spread over
multiple years, (3) financial reports being falsified to inflate
executive bonuses, and (4) manipulation of the electricity
market—leading to a California energy crisis. Only Sherron
Watkins, an Enron accountant, was willing to speak out re-
garding the questionable nature of these practices. In a now-
famous memo to then-CEO Kenneth Lay, Watkins warned:
I realize that we have had a lot of smart people looking
at this and a lot of accountants including AA & Co.
[Arthur Andersen] have blessed the accounting treat-
UNETHICAL PRACTICES AT ENRON AND WORLDCOM
EXPOSED BY “WHISTLE-BLOWERS”
SOURCES: G. Colvin, “Wonder Women of Whistleblowers,” Fortune
(August 12, 2002), p. 56; W. Zellner, “The Deadly Sins of Enron,”
Business Week (October 14, 2002), pp. 26–28; M. J. Mandel, “And
the Enron Award Goes to . . . Enron,” Business Week (May 20, 2002),
p. 46.
STRATEGY highlight 3.2
governance system is rule-based or relationship-based. Relationship-based countries tend to
be less transparent and have a higher degree of corruption than do rule-based countries.42 See
the Global Issue feature for an explanation of country governance systems and how they may
affect business practices.
Another possible reason for what is often perceived to be unethical behavior lies in differ-
ences in values between business people and key stakeholders. Some businesspeople may be-
lieve profit maximization is the key goal of their firm, whereas concerned interest groups may
have other priorities, such as the hiring of minorities and women or the safety of their neigh-
borhoods. Of the six values measured by the Allport-Vernon-Lindzey Study of Values test (aes-
thetic, economic, political, religious, social, and theoretical), both U.S. and UK executives
consistently score highest on economic and political values and lowest on social and religious
ones. This is similar to the value profile of managers from Japan, Korea, India, and Australia,
as well as those of U.S. business school students. U.S. Protestant ministers, in contrast, score
highest on religious and social values and very low on economic values.43
This difference in values can make it difficult for one group of people to understand an-
other’s actions. For example, even though some people feel that the advertising of cigarettes
and alcoholic drinks (especially to youth) is unethical, the people managing these companies
can respond that they are simply offering a product; “Let the buyer beware” is a traditional
saying in free-market capitalism. They argue that customers in a free market democracy have
the right to choose how they spend their money and live their lives. Social progressives may
contend that business people working in tobacco, alcoholic beverages, and gambling indus-
tries are acting unethically by making and advertising products with potentially dangerous and
expensive side effects, such as cancer, alcoholism, and addiction. People working in these in-
dustries could respond by asking whether it is ethical for people who don’t smoke, drink, or
CHAPTER 3 Social Responsibility and Ethics in Strategic Management 81
HOW RULE-BASED AND RELATIONSHIP-BASED
GOVERNANCE SYSTEMS AFFECT ETHICAL BEHAVIOR
based system in a developing nation is inherently nontrans-
parent due to the local and non-verifiable nature of its in-
formation. A business person needs to develop and
nurture a wide network of personal relationships. What
you know is less important than who you know.
The investment in time and money needed to build the
necessary relationships to conduct business in a developing
nation creates a high entry barrier for any newcomers to an
industry. Thus, key industries in developing nations tend to
be controlled by a small number of companies, usually pri-
vately owned, family-controlled conglomerates. Because
public information is unreliable and insufficient for deci-
sions, strategic decisions may depend more on a CEO play-
ing golf with the prime minister than with questionable
market share data. In a relationship-based system, the cul-
ture of the country (and the founder’s family) strongly af-
fects corporate culture and business ethics. What is “fair”
depends on whether one is a family member, a close
friend, a neighbor, or a stranger. Because behavior tends to
be less controlled by laws and agreed-upon standards than
by tradition, businesspeople from a rule-based developed
nation perceive the relationship-based system in a develop-
ing nation to be less ethical and more corrupt. According
to Larry Smeltzer, ethics professor at Arizona State Univer-
sity: “The lack of openness and predictable business stan-
dards drives companies away. Why would you want to do
business in, say Libya, where you don’t know the rules?”
SOURCES: S. Li, S. H. Park, and S. Li, “The Great Leap Forward:
The Transition from Relation-Based Governance to Rule-Based
Governance,” Organizational Dynamics, Vol. 33, No. 1 (2003),
pp. 63–78; M. Davids, “Global Standards, Local Problems,”
Journal of Business Strategy (January/February 1999), pp. 38–43;
“The Opacity Index,” Economist (September 18, 2004), p. 106.
gamble to reject another person’s right to do so. One example is the recent controversy over
the marketing of “alcopops,” caffeinated malt beverages containing twice as much alcohol as
many beers in the U.S. Critics of Sparks and Tilt call them alcoholic beverages disguised as
energy drinks aimed at luring underage drinkers.44
Seventy percent of executives representing 111 diverse national and multinational corpo-
rations reported that they bend the rules to attain their objectives.45 The three most common
reasons given were:
� Organizational performance required it—74%
� Rules were ambiguous or out of date—70%
� Pressure from others and everyone does it—47%
The developed nations of the
world operate under gover-
nance systems quite different
from those used by developing
nations. The developed nations and the
business firms within them follow well-recognized rules in
their dealings and financial reporting. To the extent that a
country’s rules force business corporations to publicly dis-
close in-depth information about the company to potential
shareholders and others, that country’s financial and legal
system is said to be transparent. Transparency is said to
simplify transactions and reduce the temptation to behave
illegally or unethically. Finland, the United Kingdom, Hong
Kong, the United States, and Australia have very transpar-
ent business climates. The Kurtzman Group, a consulting
firm, developed an opacity index that measures the risks
associated with unclear legal systems, regulations, eco-
nomic policies, corporate governance standards, and cor-
ruption in 48 countries. The countries with the most
opaque/least transparent ratings are Indonesia, Venezuela,
China, Nigeria, India, Egypt, and Russia.
Developing nations tend to have relationship-based
governance. Transactions are based on personal and im-
plicit agreements, not on formal contracts enforceable by
a court. Information about a business is largely local and
private—thus cannot be easily verified by a third party. In
contrast, rule-based governance relies on publicly verifiable
information—the type of information that is typically not
available in a developing country. The rule-based system
has an infrastructure, based on accounting, auditing, rat-
ings systems, legal cases, and codes, to provide and moni-
tor this information. If present in a developing nation, the
infrastructure is not very sophisticated. This is why invest-
ing in a developing country is very risky. The relationship-
GLOBAL issue
82 PART 1 Introduction to Strategic Management and Business Policy
The financial community’s emphasis on short-term earnings performance is a significant
pressure for executives to “manage” quarterly earnings. For example, a company achieving its
forecasted quarterly earnings figure signals the investment community that its strategy and op-
erations are proceeding as planned. Failing to meet its targeted objective signals that the com-
pany is in trouble—thus causing the stock price to fall and shareholders to become worried.
Research by Degeorge and Patel involving more than 100,000 quarterly earnings reports re-
vealed that a preponderance (82%) of reported earnings exactly matched analysts’expectations
or exceeded them by 1%. The disparity between the number of earnings reports that missed
estimates by a penny and the number that exceeded them by a penny suggests that executives
who risked falling short of forecasts “borrowed” earnings from future quarters.46
In explaining why executives and accountants at Enron engaged in unethical and illegal ac-
tions, former Enron vice president Sherron Watkins used the “frogs in boiling water” analogy.
If, for example, one were to toss a frog into a pan of boiling water, according to the folk tale, the
frog would quickly jump out. It might be burned, but the frog would survive. However, if one
put a frog in a pan of cold water and turned up the heat very slowly, the frog would not sense the
increasing heat until it was too lethargic to jump out and would be boiled.According to Watkins:
Enron’s accounting moved from creative to aggressive, to fraudulent, like the pot of water mov-
ing from cool to lukewarm to boiling; those involved with the creative transactions soon found
themselves working on the aggressive transactions and were finally in the uncomfortable situa-
tion of working on fraudulent deals.47
Moral Relativism
Some people justify their seemingly unethical positions by arguing that there is no one ab-
solute code of ethics and that morality is relative. Simply put, moral relativism claims that
morality is relative to some personal, social, or cultural standard and that there is no method
for deciding whether one decision is better than another.
At one time or another, most managers have probably used one of the four types of moral
relativism—naïve, role, social group, or cultural—to justify questionable behavior.48
Naïve relativism: Based on the belief that all moral decisions are deeply personal and that in-
dividuals have the right to run their own lives, adherents of moral relativism argue that
each person should be allowed to interpret situations and act on his or her own moral val-
ues. This is not so much a belief as it is an excuse for not having a belief or is a common
excuse for not taking action when observing others lying or cheating.
Role relativism: Based on the belief that social roles carry with them certain obligations to
that role, adherents of role relativism argue that a manager in charge of a work unit must
put aside his or her personal beliefs and do instead what the role requires, that is, act in
the best interests of the unit. Blindly following orders was a common excuse provided by
Nazi war criminals after World War II.
Social group relativism: Based on a belief that morality is simply a matter of following the
norms of an individual’s peer group, social group relativism argues that a decision is
considered legitimate if it is common practice, regardless of other considerations
(“everyone’s doing it”). A real danger in embracing this view is that the person may in-
correctly believe that a certain action is commonly accepted practice in an industry when
it is not.
Cultural relativism: Based on the belief that morality is relative to a particular culture, soci-
ety, or community, adherents of cultural relativism argue that people should understand
the practices of other societies, but not judge them. This view not only suggests that one
should not criticize another culture’s norms and customs, but also that it is acceptable to
personally follow these norms and customs (“When in Rome, do as the Romans do.”).
CHAPTER 3 Social Responsibility and Ethics in Strategic Management 83
Although these arguments make some sense, moral relativism could enable a person to
justify almost any sort of decision or action, so long as it is not declared illegal.
Kohlberg’s Levels of Moral Development
Another reason why some business people might be seen as unethical is that they may have no
well-developed personal sense of ethics. A person’s ethical behavior is affected by his or her
level of moral development, certain personality variables, and such situational factors as the
job itself, the supervisor, and the organizational culture.49 Kohlberg proposes that a person pro-
gresses through three levels of moral development.50 Similar in some ways to Maslow’s hi-
erarchy of needs, in Kohlberg’s system, the individual moves from total self-centeredness to a
concern for universal values. Kohlberg’s three levels are as follows:
1. The preconventional level: This level is characterized by a concern for self. Small chil-
dren and others who have not progressed beyond this stage evaluate behaviors on the ba-
sis of personal interest—avoiding punishment or quid pro quo.
2. The conventional level: This level is characterized by considerations of society’s laws
and norms. Actions are justified by an external code of conduct.
3. The principled level: This level is characterized by a person’s adherence to an internal
moral code. An individual at this level looks beyond norms or laws to find universal val-
ues or principles.
Kohlberg places most people in the conventional level, with fewer than 20% of U.S. adults
in the principled level of development.51 Research appears to support Kohlberg’s concept. For
example, one study found that individuals higher in cognitive moral development, lower in
Machiavellianism, with a more internal locus of control, a less-relativistic moral philosophy,
and higher job satisfaction are less likely to plan and enact unethical choices.52
ENCOURAGING ETHICAL BEHAVIOR
Following Carroll’s work, if business people do not act ethically, government will be forced
to pass laws regulating their actions—and usually increasing their costs. For self-interest, if
for no other reason, managers should be more ethical in their decision making. One way to do
that is by developing codes of ethics. Another is by providing guidelines for ethical behavior.
Codes of Ethics
A code of ethics specifies how an organization expects its employees to behave while on the job.
Developing codes of ethics can be a useful way to promote ethical behavior, especially for peo-
ple who are operating at Kohlberg’s conventional level of moral development. Such codes are
currently being used by more than half of U.S. business corporations. A code of ethics (1) clar-
ifies company expectations of employee conduct in various situations and (2) makes clear that
the company expects its people to recognize the ethical dimensions in decisions and actions.53
Various studies indicate that an increasing number of companies are developing codes of
ethics and implementing ethics training workshops and seminars. However, research also indi-
cates that when faced with a question of ethics, managers tend to ignore codes of ethics and try
to solve dilemmas on their own.54 To combat this tendency, the management of a company that
wants to improve its employees’ ethical behavior should not only develop a comprehensive
code of ethics but also communicate the code in its training programs, in its performance ap-
praisal system, policies and procedures, and through its own actions.55 It may even include key
values in its values and mission statements. According to a 2004 survey of CEOs by the Busi-
ness Roundtable Institute for Corporate Ethics, 74% of CEOs confirmed that their companies
84 PART 1 Introduction to Strategic Management and Business Policy
had made changes within the previous two years in how they handled or reported ethics issues.
Specific changes reported were:
� Enhanced internal reporting and communications—33%
� Ethics hotlines—17%
� Improved compliance procedures—12%
� Greater oversight by the board of directors—10%56
In addition, U.S. corporations have attempted to support whistle-blowers, those employ-
ees who report illegal or unethical behavior on the part of others. The U.S. False Claims Act
gives whistle-blowers 15% to 30% of any damages recovered in cases where the government
is defrauded. Even though the Sarbanes-Oxley Act forbids firms from retaliating against any-
one reporting wrongdoing, 82% of those who uncovered fraud from 1996 to 2004 reported be-
ing ostracized, demoted, or pressured to quit.57
Corporations appear to benefit from well-conceived and implemented ethics programs.
For example, companies with strong ethical cultures and enforced codes of conduct have fewer
unethical choices available to employees—thus fewer temptations.58 A study by the Open
Compliance and Ethics Group found that no company with an ethics program in place for
10 years or more experienced “reputational damage” in the last five years.59 Some of the com-
panies identified in surveys as having strong moral cultures are Canon, Hewlett-Packard,
Johnson & Johnson, Levi Strauss, Medtronic, Motorola, Newman’s Own, Patagonia, S. C.
Johnson, Shorebank, Smucker, and Sony.60
A corporation’s management should consider establishing and enforcing a code of ethical
behavior for those companies with which it does business—especially if it outsources its man-
ufacturing to a company in another country. For example, Gap International, one of Ameri-
can’s largest fashion retailers, developed one of the most rigorous codes of conduct for its
suppliers. Its suppliers must comply with all child-labor laws on hiring, working hours, over-
time, and working conditions. Workers must be at least 14 years of age. Rather than simply
canceling business with suppliers using child labor, Gap requires suppliers to stop using child
workers and to provide them with schooling instead, while continuing to pay them regularly
and guaranteeing them a job once they reach legal age. In one year, Gap canceled contracts
with 23 factories that did not meet its standards.61
Gap’s experience, however, may be unusual. Recent surveys of over one hundred compa-
nies in the Global 2000 uncovered that 64% have some code of conduct that regulates supplier
conduct, but only 40% require suppliers to actually take any action with respect to the code,
such as disseminating it to employees, offering training, certifying compliance, or even read-
ing or acknowledging receipt of the code.62
It is important to note that having a code of ethics for suppliers does not prevent harm to
a corporation’s reputation if one of its offshore suppliers is able to conceal abuses. Numerous
Chinese factories, for example, keep double sets of books to fool auditors and distribute scripts
for employees to recite if they are questioned. Consultants have found new business helping
Chinese companies evade audits.63
Guidelines for Ethical Behavior
Ethics is defined as the consensually accepted standards of behavior for an occupation, a trade,
or a profession. Morality, in contrast, is the precepts of personal behavior based on religious
or philosophical grounds. Law refers to formal codes that permit or forbid certain behaviors
and may or may not enforce ethics or morality.64 Given these definitions, how do we arrive at
a comprehensive statement of ethics to use in making decisions in a specific occupation, trade,
or profession? A starting point for such a code of ethics is to consider the three basic ap-
proaches to ethical behavior:65
CHAPTER 3 Social Responsibility and Ethics in Strategic Management 85
1. Utilitarian approach: The utilitarian approach proposes that actions and plans should
be judged by their consequences. People should therefore behave in a way that will pro-
duce the greatest benefit to society and produce the least harm or the lowest cost. A prob-
lem with this approach is the difficulty in recognizing all the benefits and the costs of any
particular decision. Research reveals that only the stakeholders who have the most power
(ability to affect the company), legitimacy (legal or moral claim on company resources),
and urgency (demand for immediate attention) are given priority by CEOs.66 It is therefore
likely that only the most obvious stakeholders will be considered, while others are ignored.
2. Individual rights approach: The individual rights approach proposes that human be-
ings have certain fundamental rights that should be respected in all decisions. A particular
decision or behavior should be avoided if it interferes with the rights of others. A problem
with this approach is in defining “fundamental rights.” The U.S. Constitution includes a
Bill of Rights that may or may not be accepted throughout the world. The approach can
also encourage selfish behavior when a person defines a personal need or want as a “right.”
3. Justice approach: The justice approach proposes that decision makers be equitable, fair,
and impartial in the distribution of costs and benefits to individuals and groups. It follows
the principles of distributive justice (people who are similar on relevant dimensions such
as job seniority should be treated in the same way) and fairness (liberty should be equal for
all persons). The justice approach can also include the concepts of retributive justice (pun-
ishment should be proportional to the offense) and compensatory justice (wrongs should
be compensated in proportion to the offense). Affirmative action issues such as reverse dis-
crimination are examples of conflicts between distributive and compensatory justice.
Cavanagh proposes that we solve ethical problems by asking the following three ques-
tions regarding an act or a decision:
1. Utility: Does it optimize the satisfactions of all stakeholders?
2. Rights: Does it respect the rights of the individuals involved?
3. Justice: Is it consistent with the canons of justice?
For example, is padding an expense account ethical? Using the utility criterion, this ac-
tion increases the company’s costs and thus does not optimize benefits for shareholders or cus-
tomers. Using the rights approach, a person has no right to the money (otherwise, we wouldn’t
call it “padding”). Using the justice criterion, salary and commissions constitute ordinary com-
pensation, but expense accounts compensate a person only for expenses incurred in doing his
or her job—expenses that the person would not normally incur except in doing the job.67
Another approach to resolving ethical dilemmas is by applying the logic of the philoso-
pher Immanuel Kant. Kant presents two principles (called categorical imperatives) to guide
our actions:
1. A person’s action is ethical only if that person is willing for that same action to be taken
by everyone who is in a similar situation. This is the same as the Golden Rule: Treat oth-
ers as you would like them to treat you. For example, padding an expense account would
be considered ethical if the person were also willing for everyone else to do the same if
they were the boss. Because it is very doubtful that any manager would be pleased with
expense account padding, the action must be considered unethical.
2. A person should never treat another human being simply as a means but always as an end.
This means that an action is morally wrong for a person if that person uses others merely
as means for advancing his or her own interests. To be moral, the act should not restrict
other people’s actions so that they are disadvantaged in some way.68
86 PART 1 Introduction to Strategic Management and Business Policy
D I S C U S S I O N Q U E S T I O N S
1. What is the relationship between corporate governance
and social responsibility?
2. What is your opinion of Gap International’s having a code
of conduct for its suppliers? What would Milton Fried-
man say? Contrast his view with Archie Carroll’s view.
3. Does a company have to act selflessly to be considered
socially responsible? For example, when building a new
plant, a corporation voluntarily invested in additional
equipment that enabled it to reduce its pollution emis-
sions beyond any current laws. Knowing that it would be
very expensive for its competitors to do the same, the
firm lobbied the government to make pollution regula-
tions more restrictive on the entire industry. Is this com-
pany socially responsible? Were its managers acting
ethically?
4. Are people living in a relationship-based governance sys-
tem likely to be unethical in business dealings?
5. Given that people rarely use a company’s code of ethics
to guide their decision making, what good are the
codes?
In his book Defining Moments, Joseph Badaracco states that most ethics problems deal with
“right versus right” problems in which neither choice is wrong. These are what he calls “dirty
hands problems” in which a person has to deal with very specific situations that are covered
only vaguely in corporate credos or mission statements. For example, many mission state-
ments endorse fairness but fail to define the term. At the personal level, fairness could mean
playing by the rules of the game, following basic morality, treating everyone alike and not
playing favorites, treating others as you would want to be treated, being sensitive to individ-
ual needs, providing equal opportunity for everyone, or creating a level playing field for the
disadvantaged. According to Badaracco, codes of ethics are not always helpful because they
tend to emphasize problems of misconduct and wrongdoing, not a choice between two accept-
able alternatives, such as keeping an inefficient plant operating for the good of the community
or closing the plant and relocating to a more efficient location to lower costs.69
This chapter provides a framework for understanding the social responsibilities of a busi-
ness corporation. Following Carroll, it proposes that a manager should consider not only the
economic and legal responsibilities of a firm but also its ethical and discretionary responsibil-
ities. It also provides a method for making ethical choices, whether they are right versus right
or some combination of right and wrong. It is important to consider Cavanaugh’s questions us-
ing the three approaches of utilitarian, rights, and justice plus Kant’s categorical imperatives
when making a strategic decision. A corporation should try to move from Kohlberg’s conven-
tional to a principled level of ethical development. If nothing else, the frameworks should con-
tribute to well-reasoned strategic decisions that a person can defend when interviewed by
hostile media or questioned in a court room.
E C O – B I T S
� An Australian nut orchard converts the shells of old
Macintosh computers into houses for pest-eating birds.
� Nike gathers old athletic shoes and turns them into raw
material for “sports surfaces” like tennis courts and run-
ning tracks.
� The British company Ecopods sells stylish coffins made
from hardened recycled paper.
� It takes three months for a recycled aluminum can to re-
turn to the supermarket shelf in reincarnated form.70
End of Chapter SUMMARY
CHAPTER 3 Social Responsibility and Ethics in Strategic Management 87
S T R A T E G I C P R A C T I C E E X E R C I S E
It is 1982. Zombie Savings and Loan is in trouble. This is a
time when many savings and loans (S&Ls) are in financial dif-
ficulty. Zombie holds many 30-year mortgages at low fixed-
interest rates in its loan portfolio. Interest rates have risen
significantly, and the Deregulation Act of 1980 has given
Zombie and other S&Ls the right to make business loans and
hold up to 20% of its assets as such. Because interest rates in
general have risen, but the rate that Zombie receives on its old
mortgages has not, Zombie must now pay out higher interest
rates to its deposit customers or see them leave, and it has neg-
ative cash flow until rates fall below the rates in its mortgage
portfolio or Zombie itself fails.
In present value terms, Zombie is insolvent, but the ac-
counting rules of the time do not require marking assets to mar-
ket, so Zombie is allowed to continue to operate and is faced
with two choices: It can wait and hope interest rates fall before
it is declared insolvent and is closed down, or it can raise fresh
(insured) deposits and make risky loans that have high interest
rates. Risky loans promise high payoffs (if they are repaid), but
the probability of loss to Zombie and being closed later with
greater loss to the Federal Savings & Loan Insurance Corpora-
tion (FSLIC) is high. Zombie stays in business if its gamble
pays off, and it loses no more than it has already lost if the gam-
ble does not pay off. Indeed, if not closed, Zombie will raise
increasingly greater new deposits and make more risky loans
until it either wins or is shut down by the regulators.
Waiting for lower interest rates and accepting early closure
if lower rates do not arrive is certainly in the best interest of the
FSLIC and of the taxpayers, but the manager of Zombie has
more immediate responsibilities, such as employees’ jobs,
mortgage customers, depositors, the local neighborhood, and
his or her job. As a typical S&L, Zombie’s depositors are its
shareholders and vote according to how much money they have
in savings accounts with Zombie. If Zombie closes, depositors
may lose some, but not all of their money, because their deposits
are insured by the FSLIC. There is no other provider of home
mortgages in the immediate area. What should the manager do?
SOURCE: Adapted from D. W. Swanton, “Teaching Students the
Nature of Moral Hazard: An Ethical Component for Finance Classes,”
paper presented to the annual meeting of the Academy of Finance,
Chicago (March 13, 2003). Reprinted with permission.
categorical imperatives (p. 85)
code of ethics (p. 83)
ethics (p. 84)
individual rights approach (p. 85)
justice approach (p. 85)
law (p. 84)
levels of moral development (p. 83)
morality (p. 84)
moral relativism (p. 82)
social responsibility (p. 72)
stakeholder analysis (p. 76)
stakeholders (p. 75)
utilitarian approach (p. 85)
whistle-blowers (p. 84)
K E Y T E R M S
N O T E S
1. 2008 Corporate Social Responsibility Report, General Mills
Inc., Minneapolis, MN; M. Conlin, J. Hempel, J. Tanzer, and
D. Poole, “The Corporate Donors,” Business Week (December
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3. W. J. Byron, Old Ethical Principles for the New Corporate Cul-
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4. A. B. Carroll, “A Three-Dimensional Conceptual Model of
Corporate Performance,” Academy of Management Review
(October 1979), pp. 497–505. This model of business responsi-
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with Global Stakeholders: A Present and Future Challenge,”
Academy of Management Executive (May 2004), pp. 114–120.
5. Carroll refers to discretionary responsibilities as philanthropic
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16. P. S. Adler and S. W. Kwon, “Social Capital: Prospects for a
New Concept,” Academy of Management Journal (January
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CHAPTER 3 Social Responsibility and Ethics in Strategic Management 89
http://ethisphere.com
90 PART 1 Introduction to Strategic Management and Business Policy
Ending Case for Part One
BLOOD BANANAS
Every company hates to be blackmailed, but that was
exactly what was happening to one of America’s largest
fruit growing and processing companies, Chiquita
Brands. Carlos Castaño, leader of the United Self De-
fense Forces of Columbia (AUC), a Colombian paramil-
itary organization, had just proposed that it would be in
the best interests of Chiquita Brands and its subsidiary
in Colombia, Banadex, to pay the AUC a few thousand
dollars per month for “security” services. The security
services were little more than protection from the AUC
itself. Unfortunately, the local law enforcement agencies
as well as the U.S. government were in no position to of-
fer legitimate protection from paramilitary groups like
the AUC. Chiquita was forced to decide whether to pay
the AUC for protection or risk the lives of Chiquita em-
ployees in Colombia.
Chiquita Brands International Inc., headquartered
in Cincinnati, Ohio, was a leading international mar-
keter and distributor of high-quality fresh produce that
was sold under the Chiquita® premium brand and related
trademarks. The company was one of the largest banana
producers in the world and a major supplier of bananas
in Europe and North America. The company had rev-
enues of approximately $4.5 billion and employed about
25,000 people in 70 countries in 2006.
Chiquita Brands, formerly United Brands and
United Fruit, had been operating fruit plantations in
Colombia for nearly 100 years. Chiquita’s Banadex was
responsible for 4,400 direct and an additional 8,000 in-
direct jobs in Colombia, jobs that were almost entirely
performed by local (Colombian) workers. The company
“contributed almost $70 million annually to the Colom-
bian economy in the form of capital expenditures, pay-
roll, taxes, social security, pensions, and local purchases
of goods and services.” Banadex was responsible for
managing Chiquita’s extensive plantation holding and
was Chiquita’s most profitable international operation.
By the 1990s, Colombia had become a very vio-
lent country. Kidnappings and murders of wealthy
Colombians and foreigners had become common-
place. The U.S. State Department had issued several
advisories warning U.S. citizens about the dangers of
travel to the country. In 1997, Carlos Castaño, leader
of the AUC, met with senior officials of Banadex and
offered to provide security services to the Banadex
workers and property in Colombia. The AUC, often
described as a “death squad,” was one of the most vi-
olent, paramilitary organizations that existed in
Colombia. Estimated by the U.S. State Department to
number between 8,000 and 11,000 members, their ac-
tivities included assassinations, guerrilla warfare, and
drug trafficking. So far the AUC had not been desig-
nated a Foreign Terrorist Organization by the U.S.
State Department, so it was not illegal to do business
with the AUC. The implication of the offer for Banadex
employees was obvious. Extortion or not, the implica-
tion of non-participation by Banadex would put
employees at serious risk.
The options for Chiquita were straightforward: agree
to pay, refuse to pay, or exit the country. The ramifica-
tions of any of the actions, however, were not pleasant.
Agree to Pay: If Chiquita agreed to pay for “protection”
they might forestall killings and kidnappings; how-
ever, they would be financing a group of terrorists.
The money it paid would be used to further the ac-
tivities of AUC.
Refuse to Pay: If Chiquita chose to reject the offer of
“protection” from Castaño, then there was the real
likelihood that Banadex employees would be kid-
napped and/or executed. There was ample evidence
of the brutality of the AUC and similar organiza-
tions currently operating in Colombia. While a le-
gitimate security company might be found to protect
the plantations and employees, the cost to hire suf-
ficient men to withstand a force of 8,000–11,000
paramilitary fighters would be inordinately expen-
sive. Only governments had the strength to mount
such a protective service and neither the U.S. nor
Colombian governments were willing to support
such an effort. Furthermore, it was unlikely that the
Colombian government would welcome a merce-
nary force hired by Chiquita into the country.
Exit the Country: If the decision was made to abandon
the plantations in Colombia what would happen to
This case was written by Steven M. Cox, Bradley W. Brooks, and
S. Catherine Anderson of the Queens University of Charlotte and ap-
peared in the Journal of Critical Incidents, Volume 1 (2008). Copy-
right © 2008 by Steven M. Cox, Bradley W. Brooks, and S. Catherine
Anderson. Edited for publication in Strategic Management and Busi-
ness Policy, 12th edition and Concepts in Strategic Management and
Business Policy, 12th edition. Reprinted by permission of the authors
and the Society for Case Research.
CHAPTER 3 Social Responsibility and Ethics in Strategic Management 91
the 12,000 individuals whose livelihoods depended
upon the work or workers on the plantation? Contribut-
ing $70 million annually to the economy, a rapid exit
would represent a significant loss to the Colombian
people. Further, Banadex exports represented a
significant portion of the bananas sold by Chiquita
brands. The loss of this supply would not only
affect Chiquita Brands’ profitability and share-
holder value but also the profitability of numerous
Chiquita distributors around the world.
Study Question
1. What should Chiquita do?
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PA R T2
Scanning the
Environment
The Arctic is undergoing an extraordinary transformation—a transformation
that will have global impact not only on wildlife, but upon many countries
and a number of industries. Some of the most significant environmental changes
are retreating sea ice, melting glaciers, thawing permafrost, increasing coastal
erosion, and shifting vegetation zones. The average temperature of the Arctic has risen
at twice the rate of the rest of the planet. According to Impacts of a Warming Arctic: Arctic
Climate Impact Assessment, a 2004 report by the eight-nation Arctic Council, the melting of the
area’s highly reflective snow and sea ice is uncovering darker land and ocean surfaces, further in-
creasing the absorption of the sun’s heat. Reductions in Arctic sea ice will drastically shrink marine
habitats for polar bears, ice seals, and some seabirds. The warming of the tundra will likely boost
greenhouse gases by releasing long-stored quantities of methane and carbon dioxide.
In addition to containing a large percentage of the world’s water as ice, the Arctic is a large
storehouse of natural resources. Given that the Arctic Ocean could be ice-free in the summer by
2040, countries bordering the Arctic are already positioning themselves for exploitation of these
resources. Lawson Brigham, Alaska Office Director of the U.S. Arctic Research Commission and
a former chief of strategic planning for the U.S. Coast Guard, examined how regional warming
will affect transportation systems, resource development, indigenous Arctic peoples, regional
environmental degradation and protection schemes, and overall geopolitical issues. From this,
he proposes four possible scenarios for the Arctic in 2040:
1. Globalized frontier: In this scenario, the Arctic by 2040 has become an integral component
of the global economic system, but is itself a semi-lawless frontier with participants jockey-
ing for control. The summer sea ice has completely disappeared for a two-week period, al-
lowing greater marine access and commercial shipping throughout the area. The famous
“Northwest Passage” dreamed by 16th century navigators is now a reality. Rising prices for
oil, natural gas, nickel, copper, zinc, and freshwater in conjunction with an easily accessible
and less-harsh climate have made Arctic natural resource exploitation economically viable.
Even though overfishing has reduced fish stocks, Arctic tourism is flourishing. By now, well-
worn oil and gas pipelines in western Siberia and Alaska are experiencing recurring serious
environmental
scanning and
Industry Analysis
C H A P T E R 4
95
� Recognize aspects of an organization’s
environment that can influence its long-
term decisions
� Identify the aspects of an organization’s
environment that are most strategically
important
� Conduct an industry analysis to
understand the competitive forces that
influence the intensity of rivalry within an
industry
� Understand how industry maturity affects
industry competitive forces
� Categorize international industries based
on their pressures for coordination and
local responsiveness
� Construct strategic group maps to assess the
competitive positions of firms in an industry
� Identify key success factors and develop an
industry matrix
� Use publicly available information to
conduct competitive intelligence
� Know how to develop an industry scenario
� Be able to construct an EFAS table that
summarizes external environmental factors
Learning Objectives
Gathering
Information
Putting Strategy
into Action
Monitoring
Performance
Societal
Environment:
General forces
Natural
Environment:
Resources and
climate
Task
Environment:
Industry analysis
Internal:
Strengths and
Weaknesses
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
Programs
Activities
needed to
accomplish
a plan
Budgets
Cost of the
programs Procedures
Sequence
of steps
needed to
do the job
Performance
Actual results
External:
Opportunities
and Threats
Developing
Long-range Plans
Mission
Reason for
existence Objectives
What
results to
accomplish
by when
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Environmental
Scanning:
Strategy
Formulation:
Strategy
Implementation:
Evaluation
and Control:
Feedback/Learning: Make corrections as needed
After reading this chapter, you should be able to:
spills. By 2020, Canada, Denmark (Greenland), Norway, Russia, and the United States
had asserted their sovereignty over sea bed resources beyond 200 nautical miles—leav-
ing only two small regions in the central Arctic Ocean under international jurisdiction.
Environmental concerns that once fostered polar cooperation have been replaced by
economic and political interests. The protection, development, and governance of the
Svalbard Islands became a problem when Russia refused to recognize Norway’s 200-
nautical mile exclusive economic zone around the islands. Issues regarding freedom of
navigation and commercial access rights are highly contentious. The eight permanent
members of the Arctic Council have increasingly excluded outside participation in the
Council’s deliberations.
2. Adaptive frontier: In this scenario, the Arctic in 2040 is being drawn much more slowly
into the global economy. The area is viewed as an international resource. Competition
among the Arctic countries for control of the region’s resources never grew beyond a
low level and the region is the scene of international cooperation among many inter-
national stakeholders. The indigenous peoples throughout the area have organized
and now have significant influence over decisions relating to regional environmental
protection and economic development. The exploitation of Arctic oil and gas is re-
stricted to the few key areas that are most cost-competitive. Air and water transporta-
tion systems flourish throughout the area. Commercially viable fishing has continued,
thanks to stringent harvesting quotas and other bilateral agreements. The Arctic Coun-
cil is a proactive forum resolving several disputes and engaging the indigenous peoples
in all deliberations. Nevertheless, the impact of global warming on the Arctic is wide-
spread and serious. Contingency planning for manmade and natural emergencies is ad-
vanced and well coordinated. Sustainable development is widely supported by most
stakeholders. The Arctic region has become a model for habitat protection. Arctic na-
tional parks have expanded modestly and adapted to deal with increased tourism.
3. Fortress frontier: In this scenario, widespread resource exploitation and increased in-
ternational tension exist throughout the Arctic. The region is viewed by much of the
global community as a storehouse of natural resources that is being jealously guarded
by a handful of wealthy circumpolar nations. Although the Arctic is part of the global
economic system, any linkage is controlled by the most powerful Arctic countries for
their own benefit. By 2040, the Arctic is undergoing extreme environmental stress, as
global warming continues unabated. Many indigenous peoples have been displaced
from their traditional homelands due to extreme environmental events. Illegal immi-
gration becomes an issue in many subarctic regions. Although air and marine trans-
portation routes are open, foreign access has been periodically suspended for
political or security reasons. Russia and Canada, in particular, continue to tightly con-
trol marine access through the Northern Sea Route and Northwest Passage. Fishing
rights have been suspended to all but the Arctic countries. Oil and gas exploration
and production has intensified throughout the Arctic. The Svalbard Islands, claimed
96 PART 2 Scanning the Environment
by Norway, have been a source of potential conflict over access to living and nonliv-
ing resources. Norway, Russia, and the United States have increased military forces in
the region. Rather than dealing with sustainable development, the Arctic Council fo-
cuses on economic and security concerns, such as illegal immigrants and controlling
the flow of exports from the Arctic consortium. Early in the 21st century, the five
countries bordering the Arctic declared their sovereignty over resources beyond
200 nautical miles to the edge of the continental shelf extensions. By 2030, the Arctic
Council unilaterally took jurisdiction over the two small regions that remained within
international jurisdiction. Arctic tourism thrives, since many other traditional destina-
tions are experiencing turmoil and a shortage of necessities.
4. Equitable frontier: In this scenario, the Arctic is integrated with the global economic
system by 2040, but international concern for sustainable development has slowed the
region’s economic development. Mutual respect and cooperation among the circum-
polar nations allows for the development of a respected Arctic governance system.
Even though the world is working hard to reduce greenhouse gas emissions, the Arc-
tic continues to warm. Transport user fees and other eco-taxes are used to support en-
dangered wildlife and impacted indigenous communities. The growth of the Northern
Sea Route and Northwest Passage has enabled significant efficiencies in commercial
shipping. Canada and Russia have maintained stringent marine regulations that em-
phasize environmental protection. Despite differences over freedom of navigation,
the United States, Canada, and Russia have negotiated an agreement that allows a
seamless voyage around Alaska and through the routes under a uniform set of opera-
tional procedures. The Arctic Council has created regional disaster teams to respond to
maritime and other emergencies. Boundary disputes have been resolved and fishing
rights have been allocated to various nations. The University of the Arctic has brought
quality online education to easy reach of all northern citizens. The Arctic Council has
brokered an agreement to allow 30,000 environmental refugees to settle in subarctic
territories. Oil exploration and production in the Arctic has slowed considerably. Arc-
tic tourism continues its steady growth, prompting national and regional parliaments
to establish additional wilderness lands funded by tourist fees. There is low military
presence in the region, thanks to the diplomatic efforts of the Arctic Council.
The Arctic is a complex, but relatively small region. These four scenarios suggest how
climate change combined with a growing need for natural resources might impact this re-
gion and the world.1
� Which of the four preceding scenarios is most likely?
� Which industries are likely to be affected (either positively or negatively) by the
warming of the Arctic?
� If in an affected industry, how could a business corporation prepare for each of these
scenarios?
CHAPTER 4 Environmental Scanning and Industry Analysis 97
4.1 Environmental Scanning
A changing environment can help as well as hurt a company. Many pioneering com-
panies have gone out of business because of their failure to adapt to environmental
change or, even worse, because of their failure to create change. For example, Baldwin
Locomotive, the major manufacturer of steam locomotives, was very slow in making the
switch to diesel locomotives. General Electric and General Motors soon dominated the
diesel locomotive business and Baldwin went out of business. The dominant manufactur-
ers of vacuum tubes failed to make the change to transistors and consequently lost this
market. Eastman Kodak, the pioneer and market leader of chemical-based film photogra-
phy, continues to struggle with its transition to the newer digital technology. Failure to
adapt is, however, only one side of the coin. The aforementioned Arctic warming exam-
ple shows how a changing environment can create new opportunities at the same time it
destroys old ones. The lesson is simple: To be successful over time, an organization needs
to be in tune with its external environment. There must be a strategic fit between what
the environment wants and what the corporation has to offer, as well as between what
the corporation needs and what the environment can provide.
Current predictions are that the environment for all organizations will become even
more uncertain with every passing year. What is environmental uncertainty? It is the
degree of complexity plus the degree of change that exists in an organization’s external
environment. As more and more markets become global, the number of factors a company
must consider in any decision becomes huge and much more complex. With new technolo-
gies being discovered every year, markets change and products must change with them.
On the one hand, environmental uncertainty is a threat to strategic managers be-
cause it hampers their ability to develop long-range plans and to make strategic decisions
to keep the corporation in equilibrium with its external environment. On the other hand,
environmental uncertainty is an opportunity because it creates a new playing field in
which creativity and innovation can play a major part in strategic decisions.
98 PART 2 Scanning the Environment
Before an organization can begin strategy formulation, it must scan the external environment to
identify possible opportunities and threats and its internal environment for strengths and weak-
nesses. Environmental scanning is the monitoring, evaluation, and dissemination of information
from the external and internal environments to key people within the corporation. A corporation
uses this tool to avoid strategic surprise and to ensure its long-term health. Research has found a
positive relationship between environmental scanning and profits.2 Approximately 70% of exec-
utives around the world state that global social, environmental, and business trends are increas-
ingly important to corporate strategy, according to a 2008 survey by McKinsey & Company.3
IDENTIFYING EXTERNAL ENVIRONMENTAL VARIABLES
In undertaking environmental scanning, strategic managers must first be aware of the many
variables within a corporation’s natural, societal, and task environments (see Figure 1–3). The
CHAPTER 4 Environmental Scanning and Industry Analysis 99
natural environment includes physical resources, wildlife, and climate that are an inherent
part of existence on Earth. These factors form an ecological system of interrelated life. The
societal environment is mankind’s social system that includes general forces that do not di-
rectly touch on the short-run activities of the organization that can, and often do, influence its
long-run decisions. These factors affect multiple industries and are as follows:
� Economic forces that regulate the exchange of materials, money, energy, and information.
� Technological forces that generate problem-solving inventions.
� Political–legal forces that allocate power and provide constraining and protecting laws
and regulations.
� Sociocultural forces that regulate the values, mores, and customs of society.
The task environment includes those elements or groups that directly affect a corporation and,
in turn, are affected by it. These are governments, local communities, suppliers, competitors,
customers, creditors, employees/labor unions, special-interest groups, and trade associations.
A corporation’s task environment is typically the industry within which the firm operates.
Industry analysis (popularized by Michael Porter) refers to an in-depth examination of key
factors within a corporation’s task environment. The natural, societal, and task environments
must be monitored to detect the strategic factors that are likely in the future to have a strong
impact on corporate success or failure. Changes in the natural environment usually affect a
business corporation first through its impact on the societal environment in terms of resource
availability and costs and then upon the task environment in terms of the growth or decline of
particular industries.
Scanning the Natural Environment
The natural environment includes physical resources, wildlife, and climate that are an in-
herent part of existence on Earth. Until the 20th century, the natural environment was gen-
erally perceived by business people to be a given—something to exploit, not conserve. It
was viewed as a free resource, something to be taken or fought over, like arable land, dia-
mond mines, deep water harbors, or fresh water. Once they were controlled by a person or
entity, these resources were considered assets and thus valued as part of the general eco-
nomic system—a resource to be bought, sold, or sometimes shared. Side effects, such as
pollution, were considered to be externalities, costs not included in a business firm’s ac-
counting system, but felt by others. Eventually these externalities were identified by gov-
ernments, which passed regulations to force business corporations to deal with the side
effects of their activities.
The concept of sustainability argues that a firm’s ability to continuously renew itself for
long-term success and survival is dependent not only upon the greater economic and social sys-
tem of which it is a part, but also upon the natural ecosystem in which the firm is embedded.4
A business corporation must thus scan the natural environment for factors that might previously
have been taken for granted, such as the availability of fresh water and clean air. Global warm-
ing means that aspects of the natural environment, such as sea level, weather, and climate, are
becoming increasingly uncertain and difficult to predict. Management must therefore scan not
only the natural environment for possible strategic factors, but also include in its strategic
decision-making processes the impact of its activities upon the natural environment. In a world
concerned with global warming, a company should measure and reduce its carbon footprint—
the amount of greenhouse gases it is emitting into the air. Research reveals that scanning the
market for environmental issues is positively related to firm performance because it helps man-
agement identify opportunities to fulfill future market demand based upon environmentally
friendly products or processes.5 See the Environmental Sustainability Issue feature to learn
how individuals can also measure and shrink their personal carbon footprints.
Scanning the Societal Environment: STEEP Analysis
The number of possible strategic factors in the societal environment is very high. The number
becomes enormous when we realize that, generally speaking, each country in the world can be
represented by its own unique set of societal forces—some of which are very similar to those
of neighboring countries and some of which are very different.
For example, even though Korea and China share Asia’s Pacific Rim area with Thai-
land, Taiwan, and Hong Kong (sharing many similar cultural values), they have very differ-
ent views about the role of business in society. It is generally believed in Korea and China
(and to a lesser extent in Japan) that the role of business is primarily to contribute to na-
tional development; however in Hong Kong, Taiwan, and Thailand (and to a lesser extent
in the Philippines, Indonesia, Singapore, and Malaysia), the role of business is primarily to
make profits for the shareholders.6 Such differences may translate into different trade regu-
lations and varying difficulty in the repatriation of profits (the transfer of profits from a for-
eign subsidiary to a corporation’s headquarters) from one group of Pacific Rim countries to
another.
100 PART 2 Scanning the Environment
SOURCES: B. Walsh and T. Sharples, “Sizing Up Carbon Footprints,”
Time (May 26, 2008), pp. 53–55 and www.carbonrally.com.
mated 18% of global carbon emissions, eating a ham-
burger results in carbon emissions by the consumer. Some-
thing as small as an iPod adds to a person’s carbon
footprint due not only to the energy used to produce and
transport the product, but also to the energy used to
charge it over its lifetime—approximately 68 pounds of
CO2. Both the Nature Conservancy and the U.S. Environ-
mental Protection Agency provide ways to measure an in-
dividual carbon footprint. The EPA even offers a carbon
calculator on its Web site, epa.gov.
Carbonrally offers concrete ways to start cutting carbon
emissions. One 2008 contest challenged people to avoid
bottled soda, tea, and sports drinks for a month for an av-
erage individual savings of 25.7 pounds of CO2.
Other challenges were using a clothesline to dry one
laundry load a week, unplugging computers every night
for one month, and using a personal cup for coffee instead
of using a disposable cup. By the end of 2008, nearly 15,000
individuals had completed a challenge, effectively reducing
over 1,622.57 tons of CO2.
Given that global carbon dioxide emissions total more
than 28 billion tons annually, one person’s reductions can
seem very small. Why bother? Carbonrally might respond
that the best way to change the world is one person at a
time.
As people become more
“green,” that is more con-
scious of environmental sus-
tainability, they wonder what they
can do as individuals to reduce the emission of green-
house gases. This is an important issue given that a typical
American produces more than 20 tons of carbon dioxide
annually—a very large carbon footprint. Even a homeless
American has a carbon footprint of 8.5 tons, more than
twice the global average! The first problem for concerned
individuals is finding a way to measure the size of their
own carbon footprint. The second problem is developing
feasible programs to reduce that footprint in some mean-
ingful way.
The Web site carbonrally.com solves these problems by
presenting competitive environmental challenges and
keeping score by translating green actions into pounds of
carbon dioxide averted. For instance, cutting the time of a
daily shower by two minutes for a month reduces CO2
emissions by 15.3 pounds. According to Kelsey Schroeder,
who has logged savings of more than 1,000 pounds of
emissions, “This has been a great motivational technique.
We just want to keep going and see if we can do better.”
How does Carbonrally calculate someone’s carbon shoe
size? Since everything a person does that is powered by
fossil fuels has a carbon dioxide cost, many activities have
the potential of being counted. Commuting in a gasoline
powered car has obvious carbon costs, but so does eating
a hamburger. Since livestock are responsible for an esti-
MEASURING AND SHRINKING
YOUR PERSONAL CARBON FOOTPRINT
ENVIRONMENTAL sustainability issue
www.carbonrally.com
CHAPTER 4 Environmental Scanning and Industry Analysis 101
STEEP Analysis: Monitoring Trends in the Societal and Natural Environments. As
shown in Table 4–1, large corporations categorize the societal environment in any one
geographic region into four areas and focus their scanning in each area on trends that have
corporatewide relevance. By including trends from the natural environment, this scanning can
be called STEEP Analysis, the scanning of Sociocultural, Technological, Economic,
Ecological, and Political-legal environmental forces.7 (It may also be called PESTEL Analysis
for Political, Economic, Sociocultural, Technological, Ecological, and Legal forces.)
Obviously, trends in any one area may be very important to firms in one industry but of lesser
importance to firms in other industries.
Trends in the economic part of the societal environment can have an obvious impact on
business activity. For example, an increase in interest rates means fewer sales of major home
appliances. Why? A rising interest rate tends to be reflected in higher mortgage rates. Because
higher mortgage rates increase the cost of buying a house, the demand for new and used houses
tends to fall. Because most major home appliances are sold when people change houses, a re-
duction in house sales soon translates into a decline in sales of refrigerators, stoves, and dish-
washers and reduced profits for everyone in the appliance industry. Changes in the price of oil
have a similar impact upon multiple industries, from packaging and automobiles to hospital-
ity and shipping.
The rapid economic development of Brazil, Russia, India, and China (often called the
BRIC countries) is having a major impact on the rest of the world. By 2007, China had become
the world’s second-largest economy according to the World Bank. With India graduating more
English-speaking scientists, engineers, and technicians than all other nations combined, it has
become the primary location for the outsourcing of services, computer software, and telecom-
munications.8 Eastern Europe has become a major manufacturing supplier to the European
Union countries. According to the International Monetary Fund, emerging markets make up
less than one-third of total world gross domestic product (GDP), but account for more than
half of GDP growth.9
TABLE 4–1 Some Important Variables in the Societal Environment
Economic Technological Political–Legal Sociocultural
GDP trends
Interest rates
Money supply
Inflation rates
Unemployment levels
Wage/price controls
Devaluation/revaluation
Energy alternatives
Energy availability
and cost
Disposable and
discretionary income
Currency markets
Global financial system
Total government spending
for R&D
Total industry spending
for R&D
Focus of technological efforts
Patent protection
New products
New developments in
technology transfer from lab
to marketplace
Productivity improvements
through automation
Internet availability
Telecommunication
infrastructure
Computer hacking activity
Antitrust regulations
Environmental protection
laws
Global warming legislation
Immigration laws
Tax laws
Special incentives
Foreign trade regulations
Attitudes toward foreign
companies
Laws on hiring and
promotion
Stability of government
Outsourcing regulation
Foreign “sweat shops”
Lifestyle changes
Career expectations
Consumer activism
Rate of family formation
Growth rate of population
Age distribution
of population
Regional shifts
in population
Life expectancies
Birthrates
Pension plans
Health care
Level of education
Living wage
Unionization
Changes in the technological part of the societal environment can also have a great impact
on multiple industries. Improvements in computer microprocessors have not only led to the
widespread use of personal computers but also to better automobile engine performance in terms
of power and fuel economy through the use of microprocessors to monitor fuel injection. Digi-
tal technology allows movies and music to be available instantly over the Internet or through ca-
ble service, but it also means falling fortunes for video rental shops such as the Movie Gallery
and CD stores such as Tower Records. Advances in nanotechnology are enabling companies to
manufacture extremely small devices that are very energy efficient. Developing biotechnology,
including gene manipulation techniques, is already providing new approaches to dealing with
disease and agriculture. Researchers at George Washington University have identified a number
of technological breakthroughs that are already having a significant impact on many industries:
� Portable information devices and electronic networking: Combining the computing
power of the personal computer, the networking of the Internet, the images of the televi-
sion, and the convenience of the telephone, these appliances will soon be used by a major-
ity of the population of industrialized nations to make phone calls, send e-mail, and
transmit documents and other data. Even now, homes, autos, and offices are being con-
nected (via wires and wirelessly) into intelligent networks that interact with one another.
This trend is being supported by the development of cloud computing, in which a person
can tap into computing power elsewhere through a Web connection.10 The traditional stand-
alone desktop computer may soon join the manual typewriter as a historical curiosity.
� Alternative energy sources: The use of wind, geothermal, hydroelectric, solar, biomass,
and other alternative energy sources should increase considerably. Over the past two
decades, the cost of manufacturing and installing a photovoltaic solar-power system has
decreased by 20% with every doubling of installed capacity. The cost of generating elec-
tricity from conventional sources, in contrast, has been rising along with the price of pe-
troleum and natural gas.11
� Precision farming: The computerized management of crops to suit variations in land
characteristics will make farming more efficient and sustainable. Farm equipment dealers
such as Case and John Deere add this equipment to tractors for an additional $6,000 or so.
It enables farmers to reduce costs, increase yields, and decrease environmental impact.
The old system of small, low-tech farming is becoming less viable as large corporate
farms increase crop yields on limited farmland for a growing population.
� Virtual personal assistants: Very smart computer programs that monitor e-mail, faxes,
and phone calls will be able to take over routine tasks, such as writing a letter, retrieving
a file, making a phone call, or screening requests. Acting like a secretary, a person’s vir-
tual assistant could substitute for a person at meetings or in dealing with routine actions.
� Genetically altered organisms: A convergence of biotechnology and agriculture is cre-
ating a new field of life sciences. Plant seeds can be genetically modified to produce more
needed vitamins or to be less attractive to pests and more able to survive. Animals (includ-
ing people) could be similarly modified for desirable characteristics and to eliminate ge-
netic disabilities and diseases.
� Smart, mobile robots: Robot development has been limited by a lack of sensory devices
and sophisticated artificial intelligence systems. Improvements in these areas mean that
robots will be created to perform more sophisticated factory work, run errands, do house-
hold chores, and assist the disabled.12
Trends in the political–legal part of the societal environment have a significant impact not only
on the level of competition within an industry but also on which strategies might be successful.13
For example, periods of strict enforcement of U.S. antitrust laws directly affect corporate growth
102 PART 2 Scanning the Environment
CHAPTER 4 Environmental Scanning and Industry Analysis 103
strategy. As large companies find it more difficult to acquire another firm in the same or a related
industry, they are typically driven to diversify into unrelated industries.14 High levels of taxation
and constraining labor laws in Western European countries stimulate companies to alter their
competitive strategies or find better locations elsewhere. It is because Germany has some of the
highest labor and tax costs in Europe that German companies have been forced to compete at the
top end of the market with high-quality products or else move their manufacturing to lower-cost
countries.15 Government bureaucracy can create multiple regulations and make it almost impos-
sible for a business firm to operate profitably in some countries. For example, the number of days
needed to obtain the government approvals necessary to start a new business vary from only one
day in Singapore to 14 in Mexico, 59 in Saudi Arabia, 87 in Indonesia, to 481 in the Congo.16
The $66 trillion global economy operates through a set of rules established by the World
Trade Organization (WTO). Composed of 153 member nations and 30 observer nations, the
WTO is a forum for governments to negotiate trade agreements and settle trade disputes. Orig-
inally founded in 1947 as the General Agreement on Tariffs and Trade (GATT), the WTO was
created in 1995 to extend the ground rules for international commerce. The system’s purpose
is to encourage free trade among nations with the least undesirable side effects. Among its prin-
ciples is trade without discrimination. This is exemplified by its most-favored nation clause,
which states that a country cannot grant a trading partner lower customs duties without grant-
ing them to all other WTO member nations. Another principle is that of lowering trade barri-
ers gradually though negotiation. It implements this principle through a series of rounds of
trade negotiations. As a result of these negotiations, industrial countries’ tariff rates on indus-
trial goods had fallen steadily to less than 4% by the mid-1990s. The WTO is currently nego-
tiating its ninth round of negotiations, called the Doha Round. The WTO is also in favor of fair
competition, predictability of member markets, and the encouragement of economic develop-
ment and reform. As a result of many negotiations, developed nations have started to allow
duty-free and quota-free imports from almost all products from the least-developed countries.17
Demographic trends are part of the sociocultural aspect of the societal environment. Even
though the world’s population is growing from 3.71 billion people in 1970 to 6.82 billion in
2010 to 8.72 billion by 2040, not all regions will grow equally. Most of the growth will be in
the developing nations. The population of the developed nations will fall from 14% of the to-
tal world population in 2000 to only 10% in 2050.18 Around 75% of the world will live in a city
by 2050 compared to little more than half in 2008.19 Developing nations will continue to have
more young than old people, but it will be the reverse in the industrialized nations. For exam-
ple, the demographic bulge in the U.S. population caused by the baby boom in the 1950s con-
tinues to affect market demand in many industries. This group of 77 million people now in their
50s and 60s is the largest age group in all developed countries, especially in Europe. (See
Table 4–2.) Although the median age in the United States will rise from 35 in 2000 to 40 by
2050, it will increase from 40 to 47 during the same time period in Germany, and it will in-
crease up to 50 in Italy as soon as 2025.20 By 2050, one in three Italians will be over 65, nearly
TABLE 4–2 Generation Born Age in 2005 Number
WWII/Silent Generation 1932–1945 60–73 32 million
Baby Boomers 1946–1964 41–59 77 million
Generation X 1965–1977 28–40 45 million
Generation Y 1978–1994 11–27 70 million
SOURCE: Developed from data listed in D. Parkinson, Voices of Experience: Mature Workers in the Future Work-
force (New York: The Conference Board, 2002), p. 19.
Current U.S.
Generations
double the number in 2005.21 With its low birthrate, Japan’s population is expected to fall from
127.6 million in 2004 to around 100 million by 2050.22 China’s stringent birth control policy
is causing the ratio of workers to retirees to fall from 20 to 1 during the early 1980s to 2.5 to
one by 2020.23 Companies with an eye on the future can find many opportunities to offer prod-
ucts and services to the growing number of “woofies” (well-off old folks—defined as people
over 50 with money to spend).24 These people are very likely to purchase recreational vehicles
(RVs), take ocean cruises, and enjoy leisure sports, such as boating, fishing, and bowling, in
addition to needing financial services and health care. Anticipating the needs of seniors for pre-
scription drugs is one reason the Walgreen Company has been opening a new corner pharmacy
every 19 hours!25
To attract older customers, retailers will need to place seats in their larger stores so aging
shoppers can rest. Washrooms need to be more accessible. Signs need to be larger. Restaurants
need to raise the level of lighting so people can read their menus. Home appliances need sim-
pler and larger controls. Automobiles need larger door openings and more comfortable seats.
Zimmer Holdings, an innovative manufacturer of artificial joints, is looking forward to its mar-
ket growing rapidly over the next 20 years. According to J. Raymond Elliot, chair and CEO of
Zimmer, “It’s simple math. Our best years are still in front of us.”26
Eight current sociocultural trends are transforming North America and the rest of the world:
1. Increasing environmental awareness: Recycling and conservation are becoming more
than slogans. Busch Gardens, for example, has eliminated the use of disposable styrofoam
trays in favor of washing and reusing plastic trays.
2. Growing health consciousness: Concerns about personal health fuel the trend toward
physical fitness and healthier living. As a result, sales growth is slowing at fast-food
“burgers and fries” retailers such as McDonald’s. Changing public tastes away from
sugar-laden processed foods forced Interstate Bakeries, the maker of Twinkies and Won-
der Bread, to declare bankruptcy in 2004. In 2008, the French government was consider-
ing increasing sales taxes on extra-fatty, salty, or sugary products.27 The European Union
forbade the importation of genetically altered grain (“Frankenfood”) because of possible
side effects. The spread of AIDS to more than 40 million people worldwide adds even fur-
ther impetus to the health movement.
3. Expanding seniors market: As their numbers increase, people over age 55 will become
an even more important market. Already some companies are segmenting the senior pop-
ulation into Young Matures, Older Matures, and the Elderly—each having a different set
of attitudes and interests. Both mature segments, for example, are good markets for the
health care and tourism industries; whereas, the elderly are the key market for long-term
care facilities. The desire for companionship by people whose children are grown is caus-
ing the pet care industry to grow 4.5% annually in the United States. In 2007, for exam-
ple, 71.1 million households in the U.S. spent $41 billion on their pets—more than the
gross domestic product of all but 16 countries in the world.28
4. Impact of Generation Y Boomlet: Born between 1978 and 1994 to the baby boom and
X generations, this cohort is almost as large as the baby boom generation. In 1957, the peak
year of the postwar boom, 4.3 million babies were born. In 1990, there were 4.2 million
births in Generation Y’s peak year. By 2000, they were overcrowding elementary and high
schools and entering college in numbers not seen since the baby boomers. Now in its teens
and 20s, this cohort is expected to have a strong impact on future products and services.
5. Declining mass market: Niche markets are defining the marketers’ environment. People
want products and services that are adapted more to their personal needs. For example,
Estée Lauder’s “All Skin” and Maybelline’s “Shades of You” lines of cosmetic products
are specifically made for African-American women. “Mass customization”—the making
104 PART 2 Scanning the Environment
CHAPTER 4 Environmental Scanning and Industry Analysis 105
and marketing of products tailored to a person’s requirements (Dell for example, and
Gateway computers)—is replacing the mass production and marketing of the same prod-
uct in some markets. Only 10% of the 6,200 magazines sold in the United States in 2004
were aimed at the mass market, down from 30% in the 1970s.29
6. Changing pace and location of life: Instant communication via e-mail, cell phones, and
overnight mail enhances efficiency, but it also puts more pressure on people. Merging the
personal computer with the communication and entertainment industries through tele-
phone lines, satellite dishes, and cable television increases consumers’ choices and allows
workers to leave overcrowded urban areas for small towns and telecommute via personal
computers and modems.
7. Changing household composition: Single-person households, especially those of single
women with children, could soon become the most common household type in the United
States. Married-couple households slipped from nearly 80% in the 1950s to 50.7% of all
households in 2002.30 By 2007, for the first time in U.S. history, more than half of women
were single.31 Thirty-eight percent of U.S. children are currently being born out of wed-
lock.32 A typical family household is no longer the same as it was once portrayed in The
Brady Bunch in the 1970s or The Cosby Show in the 1980s.
8. Increasing diversity of workforce and markets: Between now and 2050, minorities
will account for nearly 90% of population growth in the United States. Over time, group
percentages of the total United States population are expected to change as follows: Non-
Hispanic Whites—from 90% in 1950 to 74% in 1995 to 53% by 2050; Hispanic
Whites—from 9% in 1995 to 22% in 2050; Blacks—from 13% in 1995 to 15% in 2050;
Asians—from 4% in 1995 to 9% in 2050; American Indians—1%, with slight increase.33
Heavy immigration from the developing to the developed nations is increasing the
number of minorities in all developed countries and forcing an acceptance of the value of
diversity in races, religions, and life style. For example, 24% of the Swiss population was
born elsewhere.34 Traditional minority groups are increasing their numbers in the work-
force and are being identified as desirable target markets. For example, Sears, Roebuck
transformed 97 of its stores in October 2004 into “multicultural stores” containing fash-
ions for Hispanic, African-American, and Asian shoppers.35
International Societal Considerations. Each country or group of countries in which a
company operates presents a unique societal environment with a different set of economic,
technological, political–legal, and sociocultural variables for the company to face.
International societal environments vary so widely that a corporation’s internal environment
and strategic management process must be very flexible. Cultural trends in Germany, for
example, have resulted in the inclusion of worker representatives in corporate strategic
planning. Because Islamic law (sharia) forbids interest (riba), loans of capital in Islamic
countries must be arranged on the basis of profit-sharing instead of interest rates.36
Differences in societal environments strongly affect the ways in which a multinational
corporation (MNC), a company with significant assets and activities in multiple countries,
conducts its marketing, financial, manufacturing, and other functional activities. For example,
Europe’s lower labor productivity, due to a shorter work week and restrictions on the ability to
lay off unproductive workers, forces European-based MNCs to expand operations in countries
where labor is cheaper and productivity is higher.37 Moving manufacturing to a lower-cost lo-
cation, such as China, was a successful strategy during the 1990s, but a country’s labor costs rise
as it develops economically. For example, China required all firms in January 2008 to consult
employees on material work-related issues, enabling the country to achieve its stated objective
of having trade unions in all of China’s non-state-owned enterprises. By September 2008, the
All-China Federation of Trade Unions had signed with 80% of the largest foreign companies.38
106 PART 2 Scanning the Environment
To account for the many differences among societal environments from one country to an-
other, consider Table 4–3. It includes a list of economic, technological, political–legal, and so-
ciocultural variables for any particular country or region. For example, an important economic
variable for any firm investing in a foreign country is currency convertibility. Without convert-
ibility, a company operating in Russia cannot convert its profits from rubles to dollars or euros.
In terms of sociocultural variables, many Asian cultures (especially China) are less concerned
with the values of human rights than are European and North American cultures. Some Asians
actually contend that U.S. companies are trying to impose Western human rights requirements
on them in an attempt to make Asian products less competitive by raising their costs.39
Before planning its strategy for a particular international location, a company must scan
the particular country environment(s) in question for opportunities and threats, and it must
compare those with its own organizational strengths and weaknesses. Focusing only on the de-
veloped nations may cause a corporation to miss important market opportunities in the devel-
oping nations of the world. Although those nations may not have developed to the point that
they have significant demand for a broad spectrum of products, they may very likely be on the
threshold of rapid growth in the demand for specific products like cell phones. This would be
the ideal time for a company to enter this market—before competition is established. The key
is to be able to identify the trigger point when demand for a particular product or service is
ready to boom. See the Global Issue boxed highlight for an in-depth explanation of a tech-
nique to identify the optimum time to enter a particular market in a developing nation.
Creating a Scanning System. How can anyone monitor and keep track of all the trends and
factors in the worldwide societal environment? With the existence of the Internet, it is now
possible to scan the entire world. Nevertheless, the vast amount of raw data makes scanning
TABLE 4–3 Some Important Variables in International Societal Environments
Economic Technological Political–Legal Sociocultural
Economic development
Per capita income
Climate
GDP trends
Monetary and fiscal
policies
Unemployment levels
Currency convertibility
Wage levels
Nature of competition
Membership in regional
economic associations,
e.g., EU, NAFTA,
ASEAN
Membership in World
Trade Organization
(WTO)
Outsourcing capability
Global financial system
Regulations on technology
transfer
Energy availability/cost
Natural resource availability
Transportation network
Skill level of workforce
Patent-trademark protection
Internet availability
Telecommunication
infrastructure
Computer hacking technology
New energy sources
Form of government
Political ideology
Tax laws
Stability of government
Government attitude toward
foreign companies
Regulations on foreign
ownership of assets
Strength of opposition groups
Trade regulations
Protectionist sentiment
Foreign policies
Terrorist activity
Legal system
Global warming laws
Immigration laws
Customs, norms, values
Language
Demographics
Life expectancies
Social institutions
Status symbols
Lifestyle
Religious beliefs
Attitudes toward
foreigners
Literacy level
Human rights
Environmentalism
“Sweat shops”
Pension plans
Health care
Slavery
CHAPTER 4 Environmental Scanning and Industry Analysis 107
SOURCE: D. Fraser and M. Raynor, “The Power of Parity,” Forecast
(May/June, 1996), pp. 8–12; “A Survey of the World Economy:
The Dragon and the Eagle,” Special Insert, Economist (October 2,
2004), p. 8; “The Big Mac Index: Food for Thought,” Economist
(May 29, 2004), pp. 71–72.
were purchased in Mexico last year, using the PPP model
would effectively increase the Mexican GDP by $5 million
to $10 million. Using PPP, China becomes the world’s
second-largest economy after the United States, fol-
lowed by Japan, India, and Germany.
A trigger point identifies when demand for a particular
product is about to rapidly increase in a country. Identify-
ing a trigger point can be a very useful technique for de-
termining when to enter a new market in a developing
nation. Trigger points vary for different products. For exam-
ple, an apparent trigger point for long-distance telephone
services is at $7,500 in GDP per capita—a point when de-
mand for telecommunications services increases rapidly.
Once national wealth surpasses $15,000 per capita, de-
mand increases at a much slower rate with further in-
creases in wealth. The trigger point for life insurance is
around $8,000 in GDP per capita. At this point, the de-
mand for life insurance increases between 200% and
300% above those countries with GDP per capita below
the trigger point.
Research by the Deloitte &
Touche Consulting Group
reveals that the demand for a
specific product increases ex-
ponentially at certain points in a
country’s development. Identifying this
trigger point of demand is thus critical to entering emerg-
ing markets at the best time. A trigger point is the time
when enough people have enough money to buy what a
company has to sell but before competition is established.
This can be determined by using the concept of purchasing
power parity (PPP), which measures the cost in dollars of
the U.S.–produced equivalent volume of goods that an
economy produces.
PPP offers an estimate of the material wealth a nation
can purchase, rather than the financial wealth it creates as
typically measured by Gross Domestic Product (GDP). As a
result, restating a nation’s GDP in PPP terms reveals much
greater spending power than market exchange rates
would suggest. For example, a shoe shine costing $5 to
$10 in New York City can be purchased for 50¢ in Mexico
City. Consequently the people of Mexico City can enjoy the
same standard of living (with respect to shoe shines) as
people in New York City with only 5% to 10% of the
money. Correcting for PPP restates all Mexican shoe shines
at their U.S. purchase value of $5. If one million shoe shines
IDENTIFYING POTENTIAL MARKETS IN DEVELOPING NATIONS
GLOBAL issue
for information similar to drinking from a fire hose. It is a daunting task for even a large
corporation with many resources. To deal with this problem, in 2002 IBM created a tool called
WebFountain to help the company analyze the vast amounts of environmental data available
on the Internet. WebFountain is an advanced information discovery system designed to help
extract trends, detect patterns, and find relationships within vast amounts of raw data. For
example, IBM sought to learn whether there was a trend toward more positive discussions
about e-business. Within a week, the company had data that experts within the company used
to replace their hunches with valid conclusions. The company uses WebFountain to:
� Locate negative publicity or investor discontent
� Track general trends
� Learn competitive information
� Identify emerging competitive threats
� Unravel consumer attitudes40
Scanning the Task Environment
As shown in Figure 4–1, a corporation’s scanning of the environment includes analyses of all
the relevant elements in the task environment. These analyses take the form of individual re-
ports written by various people in different parts of the firm. At Procter & Gamble (P&G), for
108 PART 2 Scanning the Environment
Interest Group
Analysis
Community
Analysis
Market
Analysis
Competitor
Analysis
Supplier
Analysis
Government
Analysis
Analysis of Societal Environment
Economic, Sociocultural, Technological, Political–Legal Factors
Selection of
Strategic Factors
Opportunities
Threats
FIGURE 4–1
Scanning External
Environment
example, people from each of the brand management teams work with key people from the
sales and market research departments to research and write a “competitive activity report”
each quarter on each of the product categories in which P&G competes. People in purchasing
also write similar reports concerning new developments in the industries that supply P&G.
These and other reports are then summarized and transmitted up the corporate hierarchy for
top management to use in strategic decision making. If a new development is reported regard-
ing a particular product category, top management may then send memos asking people
throughout the organization to watch for and report on developments in related product areas.
The many reports resulting from these scanning efforts, when boiled down to their essentials,
act as a detailed list of external strategic factors.
IDENTIFYING EXTERNAL STRATEGIC FACTORS
The origin of competitive advantage lies in the ability to identify and respond to environmen-
tal change well in advance of competition.41 Although this seems obvious, why are some com-
panies better able to adapt than others? One reason is because of differences in the ability of
managers to recognize and understand external strategic issues and factors. For example, in a
global survey conducted by the Fuld-Gilad-Herring Academy of Competitive Intelligence,
two-thirds of 140 corporate strategists admitted that their firms had been surprised by as many
as three high-impact events in the past five years. Moreover, as recently as 2003, 97% stated
that their companies had no early warning system in place.42
No firm can successfully monitor all external factors. Choices must be made regarding
which factors are important and which are not. Even though managers agree that strategic im-
portance determines what variables are consistently tracked, they sometimes miss or choose
to ignore crucial new developments.43 Personal values and functional experiences of a corpo-
ration’s managers as well as the success of current strategies are likely to bias both their per-
ception of what is important to monitor in the external environment and their interpretations
of what they perceive.44
This willingness to reject unfamiliar as well as negative information is called strategic my-
opia.45 If a firm needs to change its strategy, it might not be gathering the appropriate external
CHAPTER 4 Environmental Scanning and Industry Analysis 109
4.2 Industry Analysis: Analyzing the Task Environment
An industry is a group of firms that produces a similar product or service, such as soft drinks
or financial services. An examination of the important stakeholder groups, such as suppliers
and customers, in a particular corporation’s task environment is a part of industry analysis.
information to change strategies successfully. For example, when Daniel Hesse became CEO
of Sprint Nextel in December 2007, he assumed that improving customer service would be one
of his biggest challenges. He quickly discovered that none of the current Sprint Nextel execu-
tives were even thinking about the topic. “We weren’t talking about the customer when I first
joined,” said Hesse. “Now this is the No. 1 priority of the company.”46
One way to identify and analyze developments in the external environment is to use the
issues priority matrix (see Figure 4–2) as follows:
1. Identify a number of likely trends emerging in the natural, societal, and task environ-
ments. These are strategic environmental issues—those important trends that, if they occur,
determine what the industry or the world will look like in the near future.
2. Assess the probability of these trends actually occurring, from low to medium to high.
3. Attempt to ascertain the likely impact (from low to high) of each of these trends on the
corporation being examined.
A corporation’s external strategic factors are the key environmental trends that are judged to
have both a medium to high probability of occurrence and a medium to high probability of im-
pact on the corporation. The issues priority matrix can then be used to help managers decide
which environmental trends should be merely scanned (low priority) and which should be
monitored as strategic factors (high priority). Those environmental trends judged to be a cor-
poration’s strategic factors are then categorized as opportunities and threats and are included
in strategy formulation.
Probable Impact on Corporation
High
Priority
High
Priority
P
ro
b
ab
ili
ty
o
f
O
cc
u
rr
en
ce
Low
Priority
Low
Priority
Low
Priority
High
Priority
Medium
Priority
Medium
Priority
Medium
Priority
High
H
ig
h
M
ed
iu
m
Lo
w
Medium Low
FIGURE 4–2
Issues Priority
Matrix
SOURCE: Reprinted from Long-Range Planning, Vol. 17, No. 3, 1984, Campbell, “Foresight Activities in the U.S.A.:
Time for a Re-Assessment?” p. 46. Copyright © 1984 with permission from Elsevier.
110 PART 2 Scanning the Environment
Other
Stakeholders
Relative
Power
of Unions,
Governments,
Special
Interest
Groups, etc.
Bargaining
Power
of Buyers
Threat
of New
Entrants
Industry
Competitors
Bargaining
Power
of Suppliers
Rivalry Among
Existing Firms
Threat of
Substitute
Products
or Services
Potential
Entrants
Buyers
Substitutes
Suppliers
FIGURE 4–3
Forces Driving
Industry
Competition
PORTER’S APPROACH TO INDUSTRY ANALYSIS
Michael Porter, an authority on competitive strategy, contends that a corporation is most con-
cerned with the intensity of competition within its industry. The level of this intensity is deter-
mined by basic competitive forces, as depicted in Figure 4–3. “The collective strength of these
forces,” he contends, “determines the ultimate profit potential in the industry, where profit po-
tential is measured in terms of long-run return on invested capital.”47 In carefully scanning its
industry, a corporation must assess the importance to its success of each of six forces: threat
of new entrants, rivalry among existing firms, threat of substitute products or services, bar-
gaining power of buyers, bargaining power of suppliers, and relative power of other stakehold-
ers.48 The stronger each of these forces, the more limited companies are in their ability to raise
prices and earn greater profits. Although Porter mentions only five forces, a sixth—other
stakeholders—is added here to reflect the power that governments, local communities, and
other groups from the task environment wield over industry activities.
Using the model in Figure 4–3, a high force can be regarded as a threat because it is likely
to reduce profits. A low force, in contrast, can be viewed as an opportunity because it may al-
low the company to earn greater profits. In the short run, these forces act as constraints on a
company’s activities. In the long run, however, it may be possible for a company, through its
choice of strategy, to change the strength of one or more of the forces to the company’s advan-
tage. For example, Dell’s early use of the Internet to market its computers was an effective way
to negate the bargaining power of distributors in the PC industry.
A strategist can analyze any industry by rating each competitive force as high, medium,
or low in strength. For example, the global athletic shoe industry could be rated as follows:
SOURCE: Reprinted with the permission of The Free Press, A Division of Simon & Schuster, from COMPETITIVE
ADVANTAGE: Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980, 1988
by The Free Press. All rights reserved.
CHAPTER 4 Environmental Scanning and Industry Analysis 111
rivalry is high (Nike, Reebok, New Balance, Converse, and Adidas are strong competitors
worldwide), threat of potential entrants is low (the industry has reached maturity/sales growth
rate has slowed), threat of substitutes is low (other shoes don’t provide support for sports ac-
tivities), bargaining power of suppliers is medium but rising (suppliers in Asian countries are
increasing in size and ability), bargaining power of buyers is medium but increasing (prices
are falling as the low-priced shoe market has grown to be half of the U.S. branded athletic shoe
market), and threat of other stakeholders is medium to high (government regulations and hu-
man rights concerns are growing). Based on current trends in each of these competitive forces,
the industry’s level of competitive intensity will continue to be high—meaning that sales in-
creases and profit margins should continue to be modest for the industry as a whole.49
Threat of New Entrants
New entrants to an industry typically bring to it new capacity, a desire to gain market share,
and substantial resources. They are, therefore, threats to an established corporation. The threat
of entry depends on the presence of entry barriers and the reaction that can be expected from
existing competitors. An entry barrier is an obstruction that makes it difficult for a company
to enter an industry. For example, no new domestic automobile companies have been success-
fully established in the United States since the 1930s because of the high capital requirements
to build production facilities and to develop a dealer distribution network. Some of the possi-
ble barriers to entry are:
� Economies of scale: Scale economies in the production and sale of microprocessors, for
example, gave Intel a significant cost advantage over any new rival.
� Product differentiation: Corporations such as Procter & Gamble and General Mills,
which manufacture products such as Tide and Cheerios, create high entry barriers through
their high levels of advertising and promotion.
� Capital requirements: The need to invest huge financial resources in manufacturing fa-
cilities in order to produce large commercial airplanes creates a significant barrier to en-
try to any competitor for Boeing and Airbus.
� Switching costs: Once a software program such as Excel or Word becomes established in
an office, office managers are very reluctant to switch to a new program because of the
high training costs.
� Access to distribution channels: Small entrepreneurs often have difficulty obtaining su-
permarket shelf space for their goods because large retailers charge for space on their
shelves and give priority to the established firms who can pay for the advertising needed
to generate high customer demand.
� Cost disadvantages independent of size: Once a new product earns sufficient market
share to be accepted as the standard for that type of product, the maker has a key ad-
vantage. Microsoft’s development of the first widely adopted operating system (MS-
DOS) for the IBM-type personal computer gave it a significant competitive advantage
over potential competitors. Its introduction of Windows helped to cement that advan-
tage so that the Microsoft operating system is now on more than 90% of personal com-
puters worldwide.
� Government policy: Governments can limit entry into an industry through licensing re-
quirements by restricting access to raw materials, such as oil-drilling sites in protected areas.
Rivalry among Existing Firms
In most industries, corporations are mutually dependent. A competitive move by one firm can
be expected to have a noticeable effect on its competitors and thus may cause retaliation. For
112 PART 2 Scanning the Environment
example, the entry by mail order companies such as Dell and Gateway into a PC industry previ-
ously dominated by IBM, Apple, and Compaq increased the level of competitive activity to such
an extent that any price reduction or new product introduction was quickly followed by similar
moves from other PC makers. The same is true of prices in the United States airline industry. Ac-
cording to Porter, intense rivalry is related to the presence of several factors, including:
� Number of competitors: When competitors are few and roughly equal in size, such as in
the auto and major home appliance industries, they watch each other carefully to make
sure that they match any move by another firm with an equal countermove.
� Rate of industry growth: Any slowing in passenger traffic tends to set off price wars in
the airline industry because the only path to growth is to take sales away from a competitor.
� Product or service characteristics: A product can be very unique, with many qualities
differentiating it from others of its kind or it may be a commodity, a product whose char-
acteristics are the same, regardless of who sells it. For example, most people choose a gas
station based on location and pricing because they view gasoline as a commodity.
� Amount of fixed costs: Because airlines must fly their planes on a schedule, regardless
of the number of paying passengers for any one flight, they offer cheap standby fares
whenever a plane has empty seats.
� Capacity: If the only way a manufacturer can increase capacity is in a large increment by
building a new plant (as in the paper industry), it will run that new plant at full capacity
to keep its unit costs as low as possible—thus producing so much that the selling price
falls throughout the industry.
� Height of exit barriers: Exit barriers keep a company from leaving an industry. The brew-
ing industry, for example, has a low percentage of companies that voluntarily leave the in-
dustry because breweries are specialized assets with few uses except for making beer.
� Diversity of rivals: Rivals that have very different ideas of how to compete are likely
to cross paths often and unknowingly challenge each other’s position. This happens of-
ten in the retail clothing industry when a number of retailers open outlets in the same
location—thus taking sales away from each other. This is also likely to happen in some
countries or regions when multinational corporations compete in an increasingly global
economy.
Threat of Substitute Products or Services
A substitute product is a product that appears to be different but can satisfy the same need as
another product. For example, e-mail is a substitute for the fax, Nutrasweet is a substitute for
sugar, the Internet is a substitute for video stores, and bottled water is a substitute for a cola.
According to Porter, “Substitutes limit the potential returns of an industry by placing a ceiling
on the prices firms in the industry can profitably charge.”50 To the extent that switching costs
are low, substitutes may have a strong effect on an industry. Tea can be considered a substitute
for coffee. If the price of coffee goes up high enough, coffee drinkers will slowly begin switch-
ing to tea. The price of tea thus puts a price ceiling on the price of coffee. Sometimes a diffi-
cult task, the identification of possible substitute products or services means searching for
products or services that can perform the same function, even though they have a different ap-
pearance and may not appear to be easily substitutable.
Bargaining Power of Buyers
Buyers affect an industry through their ability to force down prices, bargain for higher quality
or more services, and play competitors against each other. A buyer or a group of buyers is pow-
erful if some of the following factors hold true:
CHAPTER 4 Environmental Scanning and Industry Analysis 113
� A buyer purchases a large proportion of the seller’s product or service (for example, oil
filters purchased by a major auto maker).
� A buyer has the potential to integrate backward by producing the product itself (for exam-
ple, a newspaper chain could make its own paper).
� Alternative suppliers are plentiful because the product is standard or undifferentiated (for
example, motorists can choose among many gas stations).
� Changing suppliers costs very little (for example, office supplies are easy to find).
� The purchased product represents a high percentage of a buyer’s costs, thus providing an
incentive to shop around for a lower price (for example, gasoline purchased for resale by
convenience stores makes up half their total costs).
� A buyer earns low profits and is thus very sensitive to costs and service differences (for
example, grocery stores have very small margins).
� The purchased product is unimportant to the final quality or price of a buyer’s products or
services and thus can be easily substituted without affecting the final product adversely
(for example, electric wire bought for use in lamps).
Bargaining Power of Suppliers
Suppliers can affect an industry through their ability to raise prices or reduce the quality of pur-
chased goods and services. A supplier or supplier group is powerful if some of the following
factors apply:
� The supplier industry is dominated by a few companies, but it sells to many (for example,
the petroleum industry).
� Its product or service is unique and/or it has built up switching costs (for example, word
processing software).
� Substitutes are not readily available (for example, electricity).
� Suppliers are able to integrate forward and compete directly with their present customers
(for example, a microprocessor producer such as Intel can make PCs).
� A purchasing industry buys only a small portion of the supplier group’s goods and ser-
vices and is thus unimportant to the supplier (for example, sales of lawn mower tires are
less important to the tire industry than are sales of auto tires).
Relative Power of Other Stakeholders
A sixth force should be added to Porter’s list to include a variety of stakeholder groups from
the task environment. Some of these groups are governments (if not explicitly included else-
where), local communities, creditors (if not included with suppliers), trade associations,
special-interest groups, unions (if not included with suppliers), shareholders, and complemen-
tors. According to Andy Grove, Chairman and past CEO of Intel, a complementor is a com-
pany (e.g., Microsoft) or an industry whose product works well with a firm’s (e.g., Intel’s)
product and without which the product would lose much of its value.51 An example of com-
plementary industries is the tire and automobile industries. Key international stakeholders who
determine many of the international trade regulations and standards are the World Trade Or-
ganization, the European Union, NAFTA, ASEAN, and Mercosur.
The importance of these stakeholders varies by industry. For example, environmental
groups in Maine, Michigan, Oregon, and Iowa successfully fought to pass bills outlawing dis-
posable bottles and cans, and thus deposits for most drink containers are now required. This
effectively raised costs across the board, with the most impact on the marginal producers who
114 PART 2 Scanning the Environment
Multidomestic Global
Industry in which companies tailor
their products to the specific needs
of consumers in a particular country.
Retailing
Insurance
Banking
Industry in which companies manufacture
and sell the same products, with only minor
adjustments made for individual countries
around the world.
Automobiles
Tires
Television sets
FIGURE 4–4
Continuum
of International
Industries
could not internally absorb all these costs. The traditionally strong power of national unions in
the United States’ auto and railroad industries has effectively raised costs throughout these in-
dustries but is of little importance in computer software.
INDUSTRY EVOLUTION
Over time, most industries evolve through a series of stages from growth through maturity to
eventual decline. The strength of each of the six forces mentioned earlier varies according to
the stage of industry evolution. The industry life cycle is useful for explaining and predicting
trends among the six forces that drive industry competition. For example, when an industry is
new, people often buy the product, regardless of price, because it fulfills a unique need. This
usually occurs in a fragmented industry—where no firm has large market share, and each
firm serves only a small piece of the total market in competition with others (for example,
cleaning services).52 As new competitors enter the industry, prices drop as a result of competi-
tion. Companies use the experience curve (discussed in Chapter 5) and economies of scale to
reduce costs faster than the competition. Companies integrate to reduce costs even further by
acquiring their suppliers and distributors. Competitors try to differentiate their products from
one another’s in order to avoid the fierce price competition common to a maturing industry.
By the time an industry enters maturity, products tend to become more like commodities.
This is now a consolidated industry—dominated by a few large firms, each of which strug-
gles to differentiate its products from those of the competition. As buyers become more so-
phisticated over time, purchasing decisions are based on better information. Price becomes a
dominant concern, given a minimum level of quality and features, and profit margins decline.
The automobile, petroleum, and major home appliance industries are examples of mature, con-
solidated industries each controlled by a few large competitors. In the case of the United States
major home appliance industry, the industry changed from being a fragmented industry (pure
competition) composed of hundreds of appliance manufacturers in the industry’s early years
to a consolidated industry (mature oligopoly) composed of three companies controlling over
90% of United States appliance sales. A similar consolidation is occurring now in European
major home appliances.
As an industry moves through maturity toward possible decline, its products’ growth rate
of sales slows and may even begin to decrease. To the extent that exit barriers are low, firms
begin converting their facilities to alternate uses or sell them to other firms. The industry tends
to consolidate around fewer but larger competitors. The tobacco industry is an example of an
industry currently in decline.
CATEGORIZING INTERNATIONAL INDUSTRIES
According to Porter, world industries vary on a continuum from multidomestic to global (see
Figure 4–4).53 Multidomestic industries are specific to each country or group of countries.
This type of international industry is a collection of essentially domestic industries, such as
CHAPTER 4 Environmental Scanning and Industry Analysis 115
retailing and insurance. The activities in a subsidiary of a multinational corporation (MNC)
in this type of industry are essentially independent of the activities of the MNC’s subsidiaries
in other countries. Within each country, it has a manufacturing facility to produce goods for
sale within that country. The MNC is thus able to tailor its products or services to the very
specific needs of consumers in a particular country or group of countries having similar soci-
etal environments.
Global industries, in contrast, operate worldwide, with MNCs making only small adjust-
ments for country-specific circumstances. In a global industry an MNC’s activities in one
country are significantly affected by its activities in other countries. MNCs in global industries
produce products or services in various locations throughout the world and sell them, making
only minor adjustments for specific country requirements. Examples of global industries are
commercial aircraft, television sets, semiconductors, copiers, automobiles, watches, and tires.
The largest industrial corporations in the world in terms of sales revenue are, for the most part,
MNCs operating in global industries.
The factors that tend to determine whether an industry will be primarily multidomestic or
primarily global are:
1. Pressure for coordination within the MNCs operating in that industry
2. Pressure for local responsiveness on the part of individual country markets
To the extent that the pressure for coordination is strong and the pressure for local responsive-
ness is weak for MNCs within a particular industry, that industry will tend to become global. In
contrast, when the pressure for local responsiveness is strong and the pressure for coordination
is weak for multinational corporations in an industry, that industry will tend to be multidomes-
tic. Between these two extremes lie a number of industries with varying characteristics of both
multidomestic and global industries. These are regional industries, in which MNCs primarily
coordinate their activities within regions, such as the Americas or Asia.54 The major home ap-
pliance industry is a current example of a regional industry becoming a global industry. Japa-
nese appliance makers, for example, are major competitors in Asia, but only minor players in
Europe or America. The dynamic tension between the pressure for coordination and the pres-
sure for local responsiveness is contained in the phrase, “Think globally but act locally.”
INTERNATIONAL RISK ASSESSMENT
Some firms develop elaborate information networks and computerized systems to evaluate
and rank investment risks. Small companies may hire outside consultants, such as Boston’s
Arthur D. Little Inc., to provide political-risk assessments. Among the many systems that ex-
ist to assess political and economic risks are the Business Environment Risk Index, the Econ-
omist Intelligence Unit, and Frost and Sullivan’s World Political Risk Forecasts. The
Economist Intelligence Unit, for example, provides a constant flow of analysis and forecasts
on more than 200 countries and eight key industries. Regardless of the source of data, a firm
must develop its own method of assessing risk. It must decide on its most important risk fac-
tors and then assign weights to each.
STRATEGIC GROUPS
A strategic group is a set of business units or firms that “pursue similar strategies with simi-
lar resources.”55 Categorizing firms in any one industry into a set of strategic groups is very
useful as a way of better understanding the competitive environment.56 Research shows that
some strategic groups in the same industry are more profitable than others.57 Because a corpo-
ration’s structure and culture tend to reflect the kinds of strategies it follows, companies or
116 PART 2 Scanning the Environment
Red Lobster
Olive Garden
ChiChi’s
High
Shoney’s
Denny’s
Country Kitchen
Perkins
International House
of Pancakes
Ponderosa
Bonanza
KFC
Pizza Hut
Long John Silver’s
Arby’s
Domino’s
Hardee’s
Burger King
Wendy’s
Dairy Queen
Taco Bell
McDonald’s
P
ri
ce
Low
Limited Menu
Product-Line Breadth
Full Menu
FIGURE 4–5
Mapping Strategic
Groups in the
U.S. Restaurant
Chain Industry
business units belonging to a particular strategic group within the same industry tend to be
strong rivals and tend to be more similar to each other than to competitors in other strategic
groups within the same industry.58
For example, although McDonald’s and Olive Garden are a part of the same industry, the
restaurant industry, they have different missions, objectives, and strategies, and thus they be-
long to different strategic groups. They generally have very little in common and pay little at-
tention to each other when planning competitive actions. Burger King and Hardee’s, however,
have a great deal in common with McDonald’s in terms of their similar strategy of producing
a high volume of low-priced meals targeted for sale to the average family. Consequently, they
are strong rivals and are organized to operate similarly.
Strategic groups in a particular industry can be mapped by plotting the market positions
of industry competitors on a two-dimensional graph, using two strategic variables as the ver-
tical and horizontal axes (See Figure 4–5):
1. Select two broad characteristics, such as price and menu, that differentiate the companies
in an industry from one another.
2. Plot the firms, using these two characteristics as the dimensions.
3. Draw a circle around those companies that are closest to one another as one strategic
group, varying the size of the circle in proportion to the group’s share of total industry
sales. (You could also name each strategic group in the restaurant industry with an iden-
tifying title, such as quick fast food or buffet-style service.)
CHAPTER 4 Environmental Scanning and Industry Analysis 117
STRATEGIC TYPES
In analyzing the level of competitive intensity within a particular industry or strategic group,
it is useful to characterize the various competitors for predictive purposes. A strategic type is
a category of firms based on a common strategic orientation and a combination of structure,
culture, and processes consistent with that strategy. According to Miles and Snow, competing
firms within a single industry can be categorized into one of four basic types on the basis of
their general strategic orientation.59 This distinction helps explain why companies facing sim-
ilar situations behave differently and why they continue to do so over long periods of time.60
These general types have the following characteristics:
� Defenders are companies with a limited product line that focus on improving the effi-
ciency of their existing operations. This cost orientation makes them unlikely to inno-
vate in new areas. With its emphasis on efficiency, Lincoln Electric is an example of a
defender.
� Prospectors are companies with fairly broad product lines that focus on product innova-
tion and market opportunities. This sales orientation makes them somewhat inefficient.
They tend to emphasize creativity over efficiency. Rubbermaid’s emphasis on new prod-
uct development makes it an example of a prospector.
� Analyzers are corporations that operate in at least two different product-market areas,
one stable and one variable. In the stable areas, efficiency is emphasized. In the variable
areas, innovation is emphasized. Multidivisional firms, such as IBM and Procter &
Gamble, which operate in multiple industries, tend to be analyzers.
� Reactors are corporations that lack a consistent strategy-structure-culture relationship.
Their (often ineffective) responses to environmental pressures tend to be piecemeal strate-
gic changes. Most major U.S. airlines have recently tended to be reactors—given the way
they have been forced to respond to new entrants such as Southwest and JetBlue.
Dividing the competition into these four categories enables the strategic manager not only to
monitor the effectiveness of certain strategic orientations, but also to develop scenarios of fu-
ture industry developments (discussed later in this chapter).
Other dimensions, such as quality, service, location, or degree of vertical integration,
could also be used in additional graphs of the restaurant industry to gain a better understand-
ing of how the various firms in the industry compete. Keep in mind, however, that the two di-
mensions should not be highly correlated; otherwise, the circles on the map will simply lie
along the diagonal, providing very little new information other than the obvious.
HYPERCOMPETITION
Most industries today are facing an ever-increasing level of environmental uncertainty. They
are becoming more complex and more dynamic. Industries that used to be multidomestic are
becoming global. New flexible, aggressive, innovative competitors are moving into estab-
lished markets to rapidly erode the advantages of large previously dominant firms. Distribu-
tion channels vary from country to country and are being altered daily through the use of
sophisticated information systems. Closer relationships with suppliers are being forged to re-
duce costs, increase quality, and gain access to new technology. Companies learn to quickly
imitate the successful strategies of market leaders, and it becomes harder to sustain any com-
petitive advantage for very long. Consequently, the level of competitive intensity is increasing
in most industries.
118 PART 2 Scanning the Environment
from current products. Microsoft was one of the first com-
panies to disprove this argument against cannibalization.
Bill Gates, Microsoft’s co-founder, chair, and CEO, real-
ized that if his company didn’t replace its own DOS prod-
uct line with a better product, someone else would (such
as Linux or IBM’s OS/2 Warp). He knew that success in the
software industry depends not so much on company size
as on moving aggressively to the next competitive advan-
tage before a competitor does. “This is a hypercompetitive
market,” explained Gates. “Scale is not all positive in this
business. Cleverness is the position in this business.” By
2008, Microsoft still controlled over 90% of operating sys-
tems software and had achieved a dominant position in
applications software as well.
Microsoft is a hypercompet-
itive firm operating in a hy-
percompetitive industry. It has
used its dominance in operating
systems (DOS and Windows) to
move into a very strong position in appli-
cation programs such as word processing and spread-
sheets (Word and Excel). Even though Microsoft held 90%
of the market for personal computer operating systems in
1992, it still invested millions in developing the next gen-
eration—Windows 95 and Windows NT. These were soon
followed by Windows Me, XP, and Vista. Instead of trying
to protect its advantage in the profitable DOS operating
system, Microsoft actively sought to replace DOS with var-
ious versions of Windows. Before hypercompetition, most
experts argued against cannibalization of a company’s own
product line because it destroys a very profitable product
instead of harvesting it like a “cash cow.” According to this
line of thought, a company would be better off defending
its older products. New products would be introduced only
if it could be proven that they would not take sales away
MICROSOFT IN A HYPERCOMPETITIVE INDUSTRY
SOURCE: Richard A. D’Aveni, “Hypercompetition: Managing the
Dynamics of Strategic Maneuvering.” Copyright © 1994 by
Richard A. D’Aveni. All rights reserved.
STRATEGY highlight 4.1
USING KEY SUCCESS FACTORS TO CREATE AN INDUSTRY MATRIX
Within any industry there are usually certain variables—key success factors—that a com-
pany’s management must understand in order to be successful. Key success factors are vari-
ables that can significantly affect the overall competitive positions of companies within any
particular industry. They typically vary from industry to industry and are crucial to determin-
ing a company’s ability to succeed within that industry. They are usually determined by the
Richard D’Aveni contends that as this type of environmental turbulence reaches more in-
dustries, competition becomes hypercompetition. According to D’Aveni:
In hypercompetition the frequency, boldness, and aggressiveness of dynamic movement by the
players accelerates to create a condition of constant disequilibrium and change. Market stabil-
ity is threatened by short product life cycles, short product design cycles, new technologies, fre-
quent entry by unexpected outsiders, repositioning by incumbents, and tactical redefinitions of
market boundaries as diverse industries merge. In other words, environments escalate toward
higher and higher levels of uncertainty, dynamism, heterogeneity of the players and hostility.61
In hypercompetitive industries such as computers, competitive advantage comes from an up-
to-date knowledge of environmental trends and competitive activity coupled with a willing-
ness to risk a current advantage for a possible new advantage. Companies must be willing to
cannibalize their own products (that is, replace popular products before competitors do so) in or-
der to sustain their competitive advantage. See Strategy Highlight 4.1 to learn how Microsoft is
operating in the hypercompetitive industry of computer software. (Hypercompetition is dis-
cussed in more detail in Chapter 6.)
CHAPTER 4 Environmental Scanning and Industry Analysis 119
economic and technological characteristics of the industry and by the competitive weapons on
which the firms in the industry have built their strategies.62 For example, in the major home
appliance industry, a firm must achieve low costs, typically by building large manufacturing
facilities dedicated to making multiple versions of one type of appliance, such as washing ma-
chines. Because 60% of major home appliances in the United States are sold through “power
retailers” such as Sears and Best Buy, a firm must have a strong presence in the mass merchan-
diser distribution channel. It must offer a full line of appliances and provide a just-in-time de-
livery system to keep store inventory and ordering costs to a minimum. Because the consumer
expects reliability and durability in an appliance, a firm must have excellent process R&D.
Any appliance manufacturer that is unable to deal successfully with these key success factors
will not survive long in the U.S. market.
An industry matrix summarizes the key success factors within a particular industry. As
shown in Table 4–4, the matrix gives a weight for each factor based on how important that fac-
tor is for success within the industry. The matrix also specifies how well various competitors
in the industry are responding to each factor. To generate an industry matrix using two indus-
try competitors (called A and B), complete the following steps for the industry being analyzed:
1. In Column 1 (Key Success Factors), list the 8 to 10 factors that appear to determine suc-
cess in the industry.
2. In Column 2 (Weight), assign a weight to each factor, from 1.0 (Most Important) to 0.0 (Not
Important) based on that factor’s probable impact on the overall industry’s current and fu-
ture success. (All weights must sum to 1.0 regardless of the number of strategic factors.)
3. In Column 3 (Company A Rating), examine a particular company within the industry—for
example, Company A. Assign a rating to each factor from 5 (Outstanding) to 1 (Poor) based
on Company A’s current response to that particular factor. Each rating is a judgment regard-
ing how well that company is specifically dealing with each key success factor.
TABLE 4–4 Industry Matrix
Key Success Factors Weight
Company A
Rating
Company A
Weighted Score
Company B
Rating
Company B
Weighted Score
1 2 3 4 5 6
Total 1.00
SOURCE: T. L. Wheelen and J. D. Hunger, Industry Matrix. Copyright © 1997, 2001, and 2005 by Wheelen & Hunger Associates. Reprinted
with permission.
5.0
Outstanding Above Average Average Below Average Poor
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
4. In Column 4 (Company A Weighted Score), multiply the weight in Column 2 for each
factor by its rating in Column 3 to obtain that factor’s weighted score for Company A.
120 PART 2 Scanning the Environment
5. In Column 5 (Company B Rating), examine a second company within the industry – in
this case, Company B. Assign a rating to each key success factor from 5.0 (Outstanding)
to 1.0 (Poor), based on Company B’s current response to each particular factor.
6. In Column 6 (Company B Weighted Score), multiply the weight in Column 2 for
each factor times its rating in Column 5 to obtain that factor’s weighted score for
Company B.
7. Finally, add the weighted scores for all the factors in Columns 4 and 6 to determine the
total weighted scores for companies A and B. The total weighted score indicates how
well each company is responding to current and expected key success factors in the
industry’s environment. Check to ensure that the total weighted score truly reflects the
company’s current performance in terms of profitability and market share. (An average
company should have a total weighted score of 3.)
The industry matrix can be expanded to include all the major competitors within an industry
through the addition of two additional columns for each additional competitor.
4.3 Competitive Intelligence
Much external environmental scanning is done on an informal and individual basis. Informa-
tion is obtained from a variety of sources—suppliers, customers, industry publications, em-
ployees, industry experts, industry conferences, and the Internet.63 For example, scientists and
engineers working in a firm’s R&D lab can learn about new products and competitors’ ideas
at professional meetings; someone from the purchasing department, speaking with supplier-
representatives’ personnel, may also uncover valuable bits of information about a competitor.
A study of product innovation found that 77% of all product innovations in scientific instru-
ments and 67% in semiconductors and printed circuit boards were initiated by the customer in
the form of inquiries and complaints.64 In these industries, the sales force and service depart-
ments must be especially vigilant.
A recent survey of global executives by McKinsey & Company found that the single fac-
tor contributing most to the increasing competitive intensity in their industries was the im-
proved capabilities of competitors.65 Yet, without competitive intelligence, companies run the
risk of flying blind in the marketplace. In a 2008 survey of global executives, the majority re-
vealed that their companies typically learned about a competitor’s price change or significant
innovation too late to respond before it was introduced into the market.66 According to work
by Ryall, firms can have competitive advantages simply because their rivals have erroneous
beliefs about them.67 This is why competitive intelligence has become an important part of en-
vironmental scanning in most companies.
Competitive intelligence is a formal program of gathering information on a company’s
competitors. Often called business intelligence, it is one of the fastest growing fields within
strategic management. Research indicates that there is a strong association between corporate
performance and competitive intelligence activities.68 According to a survey of competitive in-
telligence professionals, the primary reasons for practicing competitive intelligence are to
build industry awareness (90.6%), support the strategic planning process (79.2%), develop
new products (73.6%), and create new marketing strategies and tactics.69 As early as the 1990s,
78% of large U.S. corporations conducted competitive intelligence activities.70 In about a third
of the firms, the competitive/business intelligence function is housed in its own unit, with the
remainder being housed within marketing, strategic planning, information services, business
development (merger & acquisitions), product development, or other units.71 According to a
CHAPTER 4 Environmental Scanning and Industry Analysis 121
2007 survey of 141 large American corporations, spending on competitive intelligence activ-
ities was rising from $1 billion in 2007 to $10 billion by 2012.72 At General Mills, for exam-
ple, all employees have been trained to recognize and tap sources of competitive information.
Janitors no longer simply place orders with suppliers of cleaning materials; they also ask about
relevant practices at competing firms!
SOURCES OF COMPETITIVE INTELLIGENCE
Most corporations use outside organizations to provide them with environmental data. Firms
such as A. C. Nielsen Co. provide subscribers with bimonthly data on brand share, retail prices,
percentages of stores stocking an item, and percentages of stock-out stores. Strategists can use
this data to spot regional and national trends as well as to assess market share. Information on
market conditions, government regulations, industry competitors, and new products can be
bought from “information brokers” such as Market Research.com (Findex), LexisNexis (com-
pany and country analyses), and Finsbury Data Services. Company and industry profiles are
generally available from the Hoover’s Web site, at www.hoovers.com. Many business corpo-
rations have established their own in-house libraries and computerized information systems to
deal with the growing mass of available information.
The Internet has changed the way strategists engage in environmental scanning. It provides
the quickest means to obtain data on almost any subject. Although the scope and quality of In-
ternet information is increasing geometrically, it is also littered with “noise,” misinformation,
and utter nonsense. For example, a number of corporate Web sites are sending unwanted guests
to specially constructed bogus Web sites.73 Unlike the library, the Internet lacks the tight bibli-
ographic control standards that exist in the print world. There is no ISBN or Dewey Decimal
System to identify, search, and retrieve a document. Many Web documents lack the name of the
author and the date of publication. A Web page providing useful information may be accessible
on the Web one day and gone the next. Unhappy ex-employees, far-out environmentalists, and
prank-prone hackers create “blog” Web sites to attack and discredit an otherwise reputable cor-
poration. Rumors with no basis in fact are spread via chat rooms and personal Web sites. This
creates a serious problem for researchers. How can one evaluate the information found on the
Internet? For a way to evaluate intelligence information, see Strategy Highlight 4.2.
Some companies choose to use industrial espionage or other intelligence-gathering tech-
niques to get their information straight from their competitors. According to a survey by the
American Society for Industrial Security, PricewaterhouseCoopers, and the United States
Chamber of Commerce, Fortune 1000 companies lost an estimated $59 billion in one year
alone due to the theft of trade secrets.74 By using current or former competitors’ employees and
private contractors, some firms attempt to steal trade secrets, technology, business plans, and
pricing strategies. For example, Avon Products hired private investigators to retrieve from a
public dumpster documents (some of them shredded) that Mary Kay Corporation had thrown
away. Oracle Corporation also hired detectives to obtain the trash of a think tank that had de-
fended the pricing practices of its rival Microsoft. Studies reveal that 32% of the trash typi-
cally found next to copy machines contains confidential company data, in addition to personal
data (29%) and gossip (39%).75 Even P&G, which defends itself like a fortress from informa-
tion leaks, is vulnerable. A competitor was able to learn the precise launch date of a concen-
trated laundry detergent in Europe when one of its people visited the factory where machinery
was being made. Simply asking a few questions about what a certain machine did, whom it
was for, and when it would be delivered was all that was necessary.
Some of the firms providing investigatory services are Kroll Inc. with 4,000 employees
in 25 countries, Fairfax, Security Outsourcing Solutions, Trident Group, and Diligence Inc.76
Trident, for example, specializes in helping American companies enter the Russian market and
www.hoovers.com
122 PART 2 Scanning the Environment
is a U.S.-based corporate intelligence firm founded and managed by former veterans of Rus-
sian intelligence services, like the KGB.77
To combat the increasing theft of company secrets, the United States government passed
the Economic Espionage Act in 1996. The law makes it illegal (with fines up to $5 million and
10 years in jail) to steal any material that a business has taken “reasonable efforts” to keep se-
cret and that derives its value from not being known.78 The Society of Competitive Intelligence
Professionals (www.scip.org) urges strategists to stay within the law and to act ethically when
searching for information. The society states that illegal activities are foolish because the vast
majority of worthwhile competitive intelligence is available publicly via annual reports, Web
sites, and libraries. Unfortunately, a number of firms hire “kites,” consultants with question-
able reputations, who do what is necessary to get information when the selected methods do
not meet SPIC ethical standards or are illegal. This allows the company that initiated the ac-
tion to deny that it did anything wrong.79
MONITORING COMPETITORS FOR STRATEGIC PLANNING
The primary activity of a competitive intelligence unit is to monitor competitors—organiza-
tions that offer same, similar, or substitutable products or services in the business area in which
a particular company operates. To understand a competitor, it is important to answer the fol-
lowing 10 questions:
found through library research in sources such as Moody’s
Industrials, Standard & Poor’s, or Value Line can generally
be evaluated as having a reliability of A. The correctness of
the data can still range anywhere from 1 to 5, but in most
instances is likely to be either 1 or 2, but probably no worse
than 3 or 4. Web sites are quite different.
Web sites, such as those sponsored by the U.S. Securi-
ties and Exchange Commission (www.sec.gov), the Econo-
mist (www.economist.com), or Hoovers Online (www
.hoovers.com) are extremely reliable. Company-sponsored
Web sites are generally reliable, but are not the place to go
for trade secrets, strategic plans, or proprietary informa-
tion. For one thing, many firms think of their Web sites pri-
marily in terms of marketing and provide little data aside
from product descriptions and distributors. Other compa-
nies provide their latest financial statements and links to
other useful Web sites. Nevertheless, some companies in
very competitive industries may install software on their
Web site to ascertain a visitor’s web address. Visitors from
a competitor’s domain name are thus screened before they
are allowed to access certain Web sites. They may not be
allowed beyond the product information page or they may
be sent to a bogus Web site containing misinformation.
Cisco Systems, for example, uses its Web site to send visi-
tors from other high-tech firms to a special Web page ask-
ing if they would like to apply for a job at Cisco!
A basic rule in intelligence
gathering is that before a
piece of information can be
used in any report or briefing, it
must first be evaluated in two
ways. First, the source of the information
should be judged in terms of its truthfulness and reliability.
How trustworthy is the source? How well can a researcher
rely upon it for truthful and correct information? One ap-
proach is to rank the reliability of the source on a scale from
A (extremely reliable), B (reliable), C (unknown reliability),
D (probably unreliable), to E (very questionable reliability).
The reliability of a source can be judged on the basis of the
author’s credentials, the organization sponsoring the infor-
mation, and past performance, among other factors.
Second, the information or data should be judged in terms
of its likelihood of being correct. The correctness of the
data may be ranked on a scale from 1 (correct), 2 (proba-
bly correct), 3 (unknown), 4 (doubtful), to 5 (extremely
doubtful). The correctness of a piece of data or information
can be judged on the basis of its agreement with other bits
of separately-obtained information or with a general trend
supported by previous data. For every piece of information
found on the Internet, for example, list not only the URL of
the Web page, but also the evaluation of the information
from A1 (good stuff) to E5 (bad doodoo). Information
EVALUATING COMPETITIVE INTELLIGENCE
STRATEGY highlight 4.2
www.scip.org
www.sec.gov
www.economist.com
www.hoovers.com
www.hoovers.com
CHAPTER 4 Environmental Scanning and Industry Analysis 123
1. Why do your competitors exist? Do they exist to make profits or just to support another unit?
2. Where do they add customer value—higher quality, lower price, excellent credit terms, or
better service?
3. Which of your customers are the competitors most interested in? Are they cherry-picking
your best customers, picking the ones you don’t want, or going after all of them?
4. What is their cost base and liquidity? How much cash do they have? How do they get their
supplies?
5. Are they less exposed with their suppliers than your firm? Are their suppliers better
than yours?
6. What do they intend to do in the future? Do they have a strategic plan to target your mar-
ket segments? How committed are they to growth? Are there any succession issues?
7. How will their activity affect your strategies? Should you adjust your plans and operations?
8. How much better than your competitor do you need to be in order to win customers? Do
either of you have a competitive advantage in the marketplace?
9. Will new competitors or new ways of doing things appear over the next few years? Who
is a potential new entrant?
10. If you were a customer, would you choose your product over those offered by your com-
petitors? What irritates your current customers? What competitors solve these particular
customer complaints?80
To answer these and other questions, competitive intelligence professionals utilize a number of
analytical techniques. In addition to the previously discussed SWOT analysis, Michael Porter’s
industry forces analysis, and strategic group analysis, some of these techniques are Porter’s four-
corner exercise, Treacy and Wiersema’s value disciplines, Gilad’s blind spot analysis, and war
gaming.81 See Appendix 4.A for more information about these competitive analysis techniques.
Done right, competitive intelligence is a key input to strategic planning. Avnet Inc., one
of the world’s largest distributors of electronic components, uses competitive intelligence in
its growth by acquisition strategy. According to John Hovis, Avnet’s senior vice president of
corporate planning and investor relations:
Our competitive intelligence team has a significant responsibility in tracking all of the varied
competitors, not just our direct competitors, but all the peripheral competitors that have a po-
tential to impact our ability to create value. . . . One of the things we are about is finding new
acquisition candidates, and our competitive intelligence unit is very much involved with our ac-
quisition team, in helping to profile potential acquisition candidates.82
4.4 Forecasting
Environmental scanning provides reasonably hard data on the present situation and current
trends, but intuition and luck are needed to accurately predict whether these trends will con-
tinue. The resulting forecasts are, however, usually based on a set of assumptions that may or
may not be valid.
DANGER OF ASSUMPTIONS
Faulty underlying assumptions are the most frequent cause of forecasting errors. Neverthe-
less, many managers who formulate and implement strategic plans rarely consider that their
success is based on a series of basic assumptions. Many strategic plans are simply based on
124 PART 2 Scanning the Environment
USEFUL FORECASTING TECHNIQUES
Various techniques are used to forecast future situations. They do not tell the future; they merely
state what can be, not what will be. As such, they can be used to form a set of reasonable assump-
tions about the future. Each technique has its proponents and its critics. A study of nearly 500 of
the world’s largest corporations revealed trend extrapolation to be the most widely practiced
form of forecasting—over 70% use this technique either occasionally or frequently.83 Simply
stated, extrapolation is the extension of present trends into the future. It rests on the assumption
that the world is reasonably consistent and changes slowly in the short run. Time-series meth-
ods are approaches of this type; they attempt to carry a series of historical events forward into
the future. The basic problem with extrapolation is that a historical trend is based on a series of
patterns or relationships among so many different variables that a change in any one can drasti-
cally alter the future direction of the trend. As a rule of thumb, the further back into the past you
can find relevant data supporting the trend, the more confidence you can have in the prediction.
Brainstorming, expert opinion, and statistical modeling are also very popular forecasting
techniques. Brainstorming is a non-quantitative approach that requires simply the presence of
people with some knowledge of the situation to be predicted. The basic ground rule is to pro-
pose ideas without first mentally screening them. No criticism is allowed. “Wild” ideas are en-
couraged. Ideas should build on previous ideas until a consensus is reached.84 This is a good
technique to use with operating managers who have more faith in “gut feel” than in more quan-
titative number-crunching techniques. Expert opinion is a nonquantitative technique in which
experts in a particular area attempt to forecast likely developments. This type of forecast is
based on the ability of a knowledgeable person(s) to construct probable future developments
based on the interaction of key variables. One application, developed by the RAND Corpora-
tion, is the Delphi technique, in which separated experts independently assess the likelihoods
of specified events. These assessments are combined and sent back to each expert for fine-
tuning until agreement is reached. These assessments are most useful if they are shaped into
several possible scenarios that allow decision makers to more fully understand their implica-
tion.85 Statistical modeling is a quantitative technique that attempts to discover causal or at
least explanatory factors that link two or more time series together. Examples of statistical
modeling are regression analysis and other econometric methods. Although very useful in the
grasping of historic trends, statistical modeling, such as trend extrapolation, is based on his-
torical data. As the patterns of relationships change, the accuracy of the forecast deteriorates.
Prediction markets is a recent forecasting technique enabled by easy access to the Inter-
net. As emphasized by James Surowiecki in The Wisdom of Crowds, the conclusions of large
groups can often be better than those of experts because such groups can aggregate a large
amount of dispersed wisdom.86 Prediction markets are small-scale electronic markets, fre-
quently open to any employee, that tie payoffs to measurable future events, such as sales data
projections of the current situation. For example, few people in 2007 expected the price of oil
(light, sweet crude, also called West Texas intermediate) to rise above $80 per barrel and were
extremely surprised to see the price approach $150 by July 2008, especially since the price
had been around $20 per barrel in 2002. U.S. auto companies, in particular, had continued to
design and manufacture large cars, pick-up trucks, and SUVs under the assumption of gaso-
line being available for around $2.00 a gallon. Market demand for these types of cars col-
lapsed when the price of gasoline passed $3.00 to reach $4.00 a gallon in July 2008. In
another example, many banks made a number of questionable mortgages based on the as-
sumption that housing prices would continue to rise as they had in the past. When housing
prices fell in 2007, these “sub-prime” mortgages were almost worthless—causing a number
of banks to sell out or fail in 2008. Assumptions like these can be dangerous to your health!
for a computer workstation, the number of bugs in an application, or a product usage patterns.
These markets yield prices on prediction contracts—prices that can be interpreted as market-
aggregated forecasts.87 Companies including Microsoft, Google, and Eli Lilly have asked their
employees to participate in prediction markets by betting on whether products will sell, when
new offices will open, and whether profits will be high in the next quarter. Early predictions
have been exceedingly accurate.88 Intrade.com offers a free Web site in which people can buy
or sell various predictions in a manner similar to buying or selling common stock. On May 26,
2008, for example, Intrade.com listed the buying price for democratic presidential candidate
Barack Obama as $91.50 compared to $8.00 for Hillary Clinton, and $37.70 for John McCain.
Thus far, prediction markets have not been documented for long-term forecasting, so its value
in strategic planning has not yet been established. Other forecasting techniques, such as cross-
impact analysis (CIA) and trend-impact analysis (TIA), have not established themselves suc-
cessfully as regularly employed tools.89
Scenario writing is the most widely used forecasting technique after trend extrapolation.
Originated by Royal Dutch Shell, scenarios are focused descriptions of different likely futures
presented in a narrative fashion. A scenario thus may be merely a written description of some
future state, in terms of key variables and issues, or it may be generated in combination with
other forecasting techniques. Often called scenario planning, this technique has been success-
fully used by 3M, Levi-Strauss, General Electric, United Distillers, Electrolux, British Air-
ways, and Pacific Gas and Electricity, among others.90 According to Mike Eskew, Chairman
and CEO of United Parcel Service, UPS uses scenario writing to envision what its customers
might need five to ten years in the future.91 The four Arctic scenarios that began this chapter
are an example of scenario writing that should be an input to a transportation company’s strate-
gic planning.
An industry scenario is a forecasted description of a particular industry’s likely future.
Such a scenario is developed by analyzing the probable impact of future societal forces on key
groups in a particular industry. The process may operate as follows:92
1. Examine possible shifts in the natural environment and in societal variables globally.
2. Identify uncertainties in each of the six forces of the task environment (that is, potential
entrants, competitors, likely substitutes, buyers, suppliers, and other key stakeholders).
3. Make a range of plausible assumptions about future trends.
4. Combine assumptions about individual trends into internally consistent scenarios.
5. Analyze the industry situation that would prevail under each scenario.
6. Determine the sources of competitive advantage under each scenario.
7. Predict competitors’ behavior under each scenario.
8. Select the scenarios that are either most likely to occur or most likely to have a strong impact
on the future of the company. Use these scenarios as assumptions in strategy formulation.
CHAPTER 4 Environmental Scanning and Industry Analysis 125
4.5 The Strategic Audit:
A Checklist for Environmental Scanning
One way of scanning the environment to identify opportunities and threats is by using the
Strategic Audit found in Appendix 1.A at the end of Chapter 1. The audit provides a check-
list of questions by area of concern. For example, Part III of the audit examines the natural,
societal, and task environments. It looks at the societal environment in terms of economic,
technological, political-legal, and sociocultural forces. It also considers the task environment
126 PART 2 Scanning the Environment
4.6 Synthesis of External Factors—EFAS
After strategic managers have scanned the societal and task environments and identified a
number of likely external factors for their particular corporation, they may want to refine their
analysis of these factors by using a form such as that given in Table 4–5. Using an EFAS (Ex-
ternal Factors Analysis Summary) Table is one way to organize the external factors into the
generally accepted categories of opportunities and threats as well as to analyze how well a par-
ticular company’s management (rating) is responding to these specific factors in light of the
perceived importance (weight) of these factors to the company. To generate an EFAS Table for
the company being analyzed, complete the following steps:
1. In Column 1 (External Factors), list the eight to ten most important opportunities and
threats facing the company.
(industry) in terms of threat of new entrants, bargaining power of buyers and suppliers, threat
of substitute products, rivalry among existing firms, and the relative power of other stake-
holders.
TABLE 4–5 External Factor Analysis Summary (EFAS Table): Maytag as Example
External Factors Weight Rating
Weighted
Score Comments
1 2 3 4 5
Opportunities
� Economic integration of European Community .20 4.1 .82 Acquisition of Hoover
� Demographics favor quality appliances .10 5.0 .50 Maytag quality
� Economic development of Asia .05 1.0 .05 Low Maytag presence
� Opening of Eastern Europe .05 2.0 .10 Will take time
� Trend to “Super Stores” .10 1.8 .18 Maytag weak in this channel
Threats
� Increasing government regulations .10 4.3 .43 Well positioned
� Strong U.S. competition .10 4.0 .40 Well positioned
� Whirlpool and Electrolux strong globally .15 3.0 .45 Hoover weak globally
� New product advances .05 1.2 .06 Questionable
� Japanese appliance companies .10 1.6 .16 Only Asian presence in
Australia
Total Scores 1.00 3.15
NOTES:
1. List opportunities and threats (8–10) in Column 1.
2. Weight each factor from 1.0 (Most Important) to 0.0 (Not Important) in Column 2 based on that factor’s probable impact on the com-
pany’s strategic position. The total weights must sum to 1.00.
3. Rate each factor from 5.0 (Outstanding) to 1.0 (Poor) in Column 3 based on the company’s response to that factor.
4. Multiply each factor’s weight times its rating to obtain each factor’s weighted score in Column 4.
5. Use Column 5 (comments) for rationale used for each factor.
6. Add the individual weighted scores to obtain the total weighted score for the company in Column 4. This tells how well the company is
responding to the factors in its external environment.
SOURCE: T.L. Wheelen, J.D. Hunger, “External Factors Analysis Summary (EFAS)”. Copyright © 1987, 1988, 1989, 1990, and 2005 by
T. L Wheelen. Copyright © 1991, 2003, and 2005 by Wheelen & Hunger Associates. Reprinted by permission.
CHAPTER 4 Environmental Scanning and Industry Analysis 127
5.0
Outstanding Above Average Average Below Average Poor
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
4. In Column 4 (Weighted Score), multiply the weight in Column 2 for each factor times
its rating in Column 3 to obtain that factor’s weighted score.
5. In Column 5 (Comments), note why a particular factor was selected and how its weight
and rating were estimated.
6. Finally, add the weighted scores for all the external factors in Column 4 to determine the
total weighted score for that particular company. The total weighted score indicates how
well a particular company is responding to current and expected factors in its external en-
vironment. The score can be used to compare that firm to other firms in the industry.
Check to ensure that the total weighted score truly reflects the company’s current perfor-
mance in terms of profitability and market share. The total weighted score for an average
firm in an industry is always 3.0.
As an example of this procedure, Table 4–5 includes a number of external factors for Maytag
Corporation with corresponding weights, ratings, and weighted scores provided. This table is
appropriate for 1995, long before Maytag was acquired by Whirlpool. Note that Maytag’s
total weight was 3.15, meaning that the corporation was slightly above average in the major
home appliance industry at that time.
2. In Column 2 (Weight), assign a weight to each factor from 1.0 (Most Important) to 0.0 (Not
Important) based on that factor’s probable impact on a particular company’s current strate-
gic position. The higher the weight, the more important is this factor to the current and fu-
ture success of the company. (All weights must sum to 1.0 regardless of the number of
factors.)
3. In Column 3 (Rating), assign a rating to each factor from 5.0 (Outstanding) to 1.0 (Poor)
based on that particular company’s specific response to that particular factor. Each rating
is a judgment regarding how well the company is currently dealing with each specific ex-
ternal factor.
End of Chapter SUMMARY
Wayne Gretzky was one of the most famous people ever to play professional ice hockey. He
wasn’t very fast. His shot was fairly weak. He was usually last in his team in strength training.
He tended to operate in the back of his opponent’s goal, anticipating where his team members
would be long before they got there and fed them passes so unsuspected that he would often
surprise his own team members. In an interview with Time magazine, Gretzky stated that the
key to winning is skating not to where the puck is but to where it is going to be. “People talk
about skating, puck handling and shooting, but the whole sport is angles and caroms, forget-
ting the straight direction the puck is going, calculating where it will be diverted, factoring in
all the interruptions,” explained Gretzky.93
Environmental scanning involves monitoring, collecting, and evaluating information in
order to understand the current trends in the natural, societal, and task environments. The
128 PART 2 Scanning the Environment
E C O – B I T S
� The International Panel on Climate Change reports that
carbon dioxide emissions are rising faster than its
worst-case scenario and that without new government
action greenhouse gases will rise 25% to 90% over
2000 levels by 2030.
� China surpassed the United States in carbon emissions
in 2006 by producing 6.6 billion tons of carbon dioxide,
24% of the world’s annual production of CO2.
� The total number of people affected by natural disasters
has tripled over the past decade to two billion people.
� By 2025, 1.8 billion people could be living in water-
scarce areas with the likely result being mass migra-
tions out of these areas.94
D I S C U S S I O N Q U E S T I O N S
1. Discuss how a development in a corporation’s natural and
societal environments can affect the corporation through
its task environment.
2. According to Porter, what determines the level of com-
petitive intensity in an industry?
3. According to Porter’s discussion of industry analysis, is
Pepsi Cola a substitute for Coca-Cola?
4. How can a decision maker identify strategic factors in a
corporation’s external international environment?
5. Compare and contrast trend extrapolation with the writ-
ing of scenarios as forecasting techniques.
S T R A T E G I C P R A C T I C E E X E R C I S E
How far should people in a business firm go in gathering com-
petitive intelligence? Where do you draw the line?
Evaluate each of the following approaches that a person
could use to gather information about competitors. For each
approach, mark your feeling about its appropriateness:
1 (DEFINITELY NOT APPROPRIATE), 2 (PROBABLY NOT APPROPRIATE),
3 (UNDECIDED), 4 (PROBABLY APPROPRIATE), OR 5 (DEFINITELY APPROPRIATE).
The business firm should try to get useful information about
competitors by:
_____ Carefully studying trade journals
_____ Wiretapping the telephones of competitors
_____ Posing as a potential customer to competitors
_____ Getting loyal customers to put out a phony “request
for proposal” soliciting competitors’ bids
_____ Buying competitors’ products and taking them apart
_____ Hiring management consultants who have worked for
competitors
_____ Rewarding competitors’ employees for useful “tips”
_____ Questioning competitors’ customers and/or suppliers
_____ Buying and analyzing competitors’ garbage
_____ Advertising and interviewing for nonexistent jobs
information is then used to forecast whether these trends will continue or whether others will
take their place. How will developments in the natural environment affect the world? What
kind of developments can we expect in the societal environment to affect our industry? What
will an industry look like in 10 to 20 years? Who will be the key competitors? Who is likely
to fall by the wayside? We use this information to make certain assumptions about the future—
assumptions that are then used in strategic planning. In many ways, success in the business
world is like ice hockey: The key to winning is not to assume that your industry will continue
as it is now but to assume that the industry will change and to make sure that your company
will be in position to take advantage of those changes.
CHAPTER 4 Environmental Scanning and Industry Analysis 129
_____ Taking public tours of competitors’ facilities
_____ Releasing false information about the company in
order to confuse competitors
_____ Questioning competitors’ technical people at trade
shows and conferences
_____ Hiring key people away from competitors
_____ Analyzing competitors’ labor union contracts
_____ Having employees date persons who work for
competitors
_____ Studying aerial photographs of competitors’ facilities
After marking each of the preceding approaches, compare
your responses to those of other people in your class. For each
approach, the people marking 4 or 5 should say why they
thought this particular act would be appropriate. Those who
marked 1 or 2 should then state why they thought this act
would be inappropriate.
Go to the Web site of the Society for Competitive
Intelligence Professionals (www.scip.org). What does SCIP
say about these approaches?
K E Y T E R M S
competitive intelligence (p. 120)
competitors (p. 122)
complementor (p. 113)
consolidated industry (p. 114)
EFAS Table (p. 126)
entry barrier (p. 111)
environmental scanning (p. 98)
environmental uncertainty (p. 98)
exit barrier (p. 112)
fragmented industry (p. 114)
global industry (p. 115)
hypercompetition (p. 118)
industry (p. 109)
industry analysis (p. 99)
industry matrix (p. 119)
industry scenario (p. 125)
issues priority matrix (p. 109)
key success factor (p. 118)
multidomestic industry (p. 114)
multinational corporation (MNC)
(p. 105)
natural environment (p. 99)
new entrant (p. 111)
regional industries (p. 115)
societal environment (p. 99)
STEEP analysis (p. 101)
strategic group (p. 115)
strategic type (p. 117)
substitute product (p. 112)
task environment (p. 99)
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130 PART 2 Scanning the Environment
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CHAPTER 4 Environmental Scanning and Industry Analysis 131
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74. E. Iwata, “More U.S. Trade Secrets Walk Out Door with For-
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78. B. Flora, “Ethical Business Intelligence in NOT Mission Im-
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Know About Competitors,” Competitive Intelligence Magazine
(September–October 2001), pp. 12–15.
81. For the percentage of CI professionals using each analytical
technique, see A. Badr, E. Madden, and S. Wright, “The Contri-
butions of CI to the Strategic Decision Making Process: Empir-
ical Study of the European Pharmaceutical Industry,” Journal of
Competitive Intelligence and Management (Vol. 3, No. 4,
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“State of the Art: Competitive Intelligence,” Research Report of
the Competitive Intelligence Foundation (2006).
82. “CI at Avnet: A Bottom-Line Impact,” Competitive Intelligence
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competitive intelligence, see C. S. Fleisher and D. L. Blenkhorn,
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(Westport, CT: Praeger Publishers, 2003); C. Vibert, Competitive
Intelligence: A Framework for Web-Based Analysis and Decision
Making (Mason, OH: Thomson/Southwestern, 2004); and C. S.
Fleisher and B. E. Bensoussan, Strategic and Competitive Analysis
(Upper Saddle River, NJ: Prentice Hall, 2003).
83. H. E. Klein and R. E. Linneman, “Environmental Assessment:
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pp. 17–21.
85. R. S. Duboff, “The Wisdom of Expert Crowds,” Harvard Busi-
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86. J. Surowiecki, The Wisdom of Crowds (NY: Doubleday, 2004).
87. R. Dye, “The Promise of Prediction Markets: A Roundtable,”
McKinsey Quarterly (April 2008), pp. 83–93.
88. C. R. Sunstein, “When Crowds Aren’t Wise,” Harvard Business
Review (September 2006), pp. 20–21.
89. See L. E. Schlange and U. Juttner, “Helping Managers to Iden-
tify the Key Strategic Issues,” Long Range Planning (October
1997), pp. 777–786, for an explanation and application of the
cross-impact matrix.
90. G. Ringland, Scenario Planning: Managing for the Future
(Chichester, England: Wiley, 1998); N. C. Georgantzas and
W. Acar, Scenario-Driven Planning: Learning to Manage Strate-
gic Uncertainty (Westport, CN: Quorum Books, 1995); L. Fahey
and R. M. Randall (eds), Learning from the Future: Competitive
Foresight Scenarios (New York: John Wiley & Sons, 1998).
132 PART 2 Scanning the Environment
91. M. Eskew, “Stick with Your Vision,” Harvard Business Review
(July–August 2007), pp. 56–57.
92. This process of scenario development is adapted from M. E.
Porter, Competitive Advantage (New York: The Free Press,
1985), pp. 448–470.
93. H. C. Sashittal and A. R. Jassawalla, “Learning from Wayne
Gretzky,” Organizational Dynamics (Spring 2002),
pp. 341–355.
94. J. C. Glenn, “Scanning the Global Situation and Prospects for
the Future,” The Futurist (January–February 2008), pp. 41–46.
95. M. E. Porter, Competitive Strategy: Techniques for Analyzing
Industries and Competitors (New York: The Free Press, 1980),
pp. 47–75.
96. M. Treacy and F. Wiersema, The Discipline of Market Leaders
(Reading, MA: Addison-Wesley, 1995).
97. Presentation by W. A. Rosenkrans, Jr., to the Iowa Chapter of
the Society of Competitive Intelligence Professionals, Des
Moines, IA (August 5, 2004).
98. B. Gilad, Early Warning (New York: AMACOM, 2004),
pp. 97–103. Also see C. S. Fleisher and B. E. Bensoussan,
Strategic and Competitive Analysis (Upper Saddle River, NJ:
Prentice Hall, 2003), pp. 122–143.
99. Presentation by W. A. Rosenkrans, Jr., to the Iowa Chapter of
the Society of Competitive Intelligence Professionals, Des
Moines, IA (August 5, 2004). See also S. M. Shaker and M. P.
Gembicki, War Room Guide to Competitive Intelligence (New
York: McGraw-Hill, 1999).
100. L. Fahey, “Invented Competitors: A New Competitor Analysis
Methodology,” Strategy & Leadership, Vol. 30, No. 6 (2002),
pp. 5–12.
101. A. Beurschgens, “Using Business War Gaming to Generate
Actionable Intelligence,” Competitive Intelligence Magazine
(January–February 2008), pp. 43–45.
Analytical techniques commonly used in competitive intelligence are SWOT analysis, Porter’s industry
forces, ratio analysis, and strategic group analysis (also called competitive cluster analysis). In addition
to these are Porter’s four-corner exercise, Treacy and Wiersema’s value disciplines, and Gilad’s blind
spot analysis. These can be used in a war game simulation in which people role-play different competitors
and their possible future strategies.
Porter’s four-corner exercise involves analyzing a specific competitor’s future goals, assumptions,
current strategies, and capabilities in order to compile a competitor’s response profile. See Figure 4–6.
Having knowledge of a competitor’s goals allows predictions about how likely the competitor is to change
strategy and respond to changing conditions. Identifying a competitor’s assumptions about itself and the
industry can reveal blind spots about how management perceives its environment. Considering a com-
petitor’s current strategy and how long it has been in place may indicate whether the company is likely to
continue in its current direction. If a strategy is not stated explicitly, one should consider its actions and
policies in order to note its implicit strategy. The last step is to objectively evaluate a competitor’s capa-
bilities in terms of strengths and weaknesses. The competitor’s goals, assumptions, and current strategy
influence the likelihood, timing, nature, and intensity of a competitor’s reactions. Its strengths and weak-
nesses determine its ability to initiate or react to strategic moves and to deal with environmental changes.95
Treacy and Wiersema’s value disciplines involves the evaluation of a competitor in terms of three di-
mensions: product leadership, operational excellence, and customer intimacy. (See Figure 4–7.) After an-
alyzing 80 market-leading companies, Treacy and Wiersema noted that each of these firms developed a
compelling and unmatched value proposition on one dimension but was able to maintain acceptable stan-
dards on the other two dimensions. Operationally excellent companies deliver a combination of quality,
price, and ease of purchase that no other can match in their market. An example is Dell Computer, a mas-
ter of operational excellence. A product leader consistently strives to provide its market with leading-edge
products or new applications of existing products or services. Johnson & Johnson is an example of a prod-
uct leader that finds new ideas, develops them quickly, and then looks for ways to improve them. A com-
pany that delivers value through customer intimacy bonds with its customers and develops high customer
loyalty. IBM is an example of a company that pursues excellence in customer intimacy. IBM’s current
strategy is to provide a total information technology service to its customers so that customers can totally
rely on IBM to take care of any Information Technology (IT) problems.96 According to Wayne
Rosenkrans, past president of SCIP, it is possible to mark a spot on each of the three value dimensions
shown in Figure 4–7 for each competitor being analyzed. Then one can draw lines connecting each of the
marks, resulting in a triangle that reveals that competitor’s overall value proposition.97
Gilad’s blind spot analysis is based on the premise that the assumptions held by decision makers re-
garding their own company and their industry may act as perceptual biases or blind spots. As a result,
(1) the firm may not be aware of strategically important developments, (2) the firm may inaccurately per-
ceive strategically important developments, or (3) even if the firm is aware of important developments,
it may learn too slowly to allow for a timely response. It is important to gather sufficient information
about a competitor and its executives to be able to list top management’s assumptions about buyers’ pref-
erences, the nature of the supply chain, the industry’s key success factors, barriers to entry, and the threat
appeal of substitutes to customers. One should analyze the industry objectively without regard to these
assumptions. Any gap between an objective industry analysis and a competitor’s top management as-
sumptions is a potential blind spot. One should include these blind spots when considering how this com-
petitor might respond to environmental change.98
Competitive
Analysis Techniques
A P P E N D I X 4.A
133
134 PART 2 Scanning the Environment
What Drives
the Competitor
What the Competitor
Is Doing and Can Do
FUTURE GOALS
COMPETITOR’S RESPONSE PROFILE
At all levels of management
and in multiple dimensions
Is the competitor satisfied with current position?
What likely moves or strategy shifts will the competitor make?
Where is the competitor vulnerable?
What will provoke the greatest and most effective retaliation by the competitor?
How the business is
currently competing
Held about itself
and the industry
Both strengths
and weaknesses
CURRENT STRATEGY
ASSUMPTIONS CAPABILITIES
FIGURE 4–6
Four-Corner
Exercise: Porter’s
Components
of Competitor
Analysis
SOURCE: Reprinted with the permission of The Free Press, A Division of Simon & Schuster, from COMPETITIVE
ADVANTAGE: Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980, 1998
by The Free Press. All rights reserved.
Rosenkrans suggests that an analyst should first use Porter’s industry forces technique to develop the
four-corner analysis. Then the analyst should use the four-corner analysis to generate a strategic group
(cluster) analysis. Finally, the analyst should include the three value dimensions to develop a blind spot
analysis.
These techniques can be used to conduct a war game simulating the various competitors in the in-
dustry. Gather people from various functional areas in your own corporation and put them into teams
identified as industry competitors. Each company team should perform a complete analysis of the com-
petitor it is role-playing. Each company team first creates starting strategies for its company and presents
it to the entire group. Each company team then creates counter-strategies and presents them to the entire
group. After all the presentations are complete, the full group creates new strategic considerations to be
included as items to monitor in future environmental scanning.99 Some of the companies that have used
war gaming successfully are Kimberly Clark, Baxter Healthcare, Lockheed Martin, Hewlett-Packard,
and Dow Corning. If a corporation does not have the expertise needed to run a war game, it can utilize
management consultants, like KappaWest, who prepare and facilitate a complete war game simulation.
Some competitive intelligence analysts take the war game approach one step further by creating
an “invented” company that could appear in the future but does not exist today. A team brainstorms what
type of strategy the invented competitor might employ. The strategy is often based on a new break-
through product that is radically different from current offerings. Its goals, strategies, and competitive
CHAPTER 4 Environmental Scanning and Industry Analysis 135
“Best product”
Product
differentiation
Product Leadership
Operational
Competence
Customer
Responsive
Operational Excellence
“Best total cost”
Customer Intimacy
“Best total solution”
FIGURE 4–7 Value
Discipline Triad
SOURCE: From DISCIPLINE OF MARKET LEADERS by Michael Treacy. Copyright © 1997 Michael Treacy.
Reprinted by permission of Perseus Books Group.
posture should be different from any currently being used in the industry. According to Liam Fahey, an
authority on competitive intelligence, “the invented competitor is proving to be a spur to bold and in-
novative thinking.”100 War games are especially useful when (externally) the market is shifting, com-
petitive rules are changing, new competitors are entering the industry, a significant competitor is
changing its strategy, a firm’s competitive position is weakening, the “uncontrollables” are getting
stronger, and/or when (internally) the company is “flying blind,” its current strategy is stale or confused,
managers are over-confident or arrogant, and/or the firm suffers from a “silo” mentality.101
On January 10, 2008, a new automobile from Tata Motors was introduced to
the world at the Indian Auto Show in New Delhi. Called the People’s Car, the
new auto was planned to sell for $2,500 in India. Even though many manufactur-
ers were hoping to introduce cheap small cars into India and other developing na-
tions, Tata Motors seemed to have significant advantages that other companies
lacked. India’s low labor costs meant that Tata could engineer a new model for 20%
of the $350 million it would cost in developed nations. A factory worker in Mumbai
earned just $1.20 per hour, less than auto workers earned in China. The car was kept very sim-
ple. The company would save about $900 per car by skipping equipment that the U.S., Europe,
and Japan required for emissions control. The People’s Car did not have features like antilock
brakes, air bags, or support beams to protect passengers in case of a crash. The dashboard con-
tained just a speedometer, fuel gauge, and oil light. It lacked a radio, reclining seats, or power
steering. It came with a small 650 cc engine that generated only 70 horsepower, but obtained
50 to 60 miles per gallon. The car’s suspension system used old technology that was cheap, but
resulted in a rougher ride than in more expensive cars. More importantly, Tata Motors would
save money by using an innovative distribution strategy. Instead of selling completed cars to
dealers, Tata planned to supply kits that would then be assembled by the dealers. By eliminat-
ing large, centralized assembly plants, Tata could cut the car’s retail price by 20%.
Although Tata Motors intended to initially sell the people’s car in India and then offer it in
other developing markets, management felt that they could build a car that would meet U.S. or
European specifications for around $6,000—still a low price for an automobile. Given that Tata
Motors was able to acquire Jaguar and Land Rover from Ford later in the year, other auto com-
panies had to admit that Tata was on its way to becoming a major competitor in the industry.1
internal scanning:
Organizational
Analysis
C H A P T E R 5
137
� Apply the resource view of the firm to
determine core and distinctive
competencies
� Use the VRIO framework and the value
chain to assess an organization’s
competitive advantage and how it can be
sustained
� Understand a company’s business model
and how it could be imitated
Learning Objectives
Gathering
Information
Putting Strategy
into Action
Monitoring
Performance
Societal
Environment:
General forces
Natural
Environment:
Resources and
climate
Task
Environment:
Industry analysis
Internal:
Strengths and
Weaknesses
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
Programs
Activities
needed to
accomplish
a plan
Budgets
Cost of the
programs Procedures
Sequence
of steps
needed to
do the job
Performance
Actual results
External:
Opportunities
and Threats
Developing
Long-range Plans
Mission
Reason for
existence Objectives
What
results to
accomplish
by when
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Environmental
Scanning:
Strategy
Formulation:
Strategy
Implementation:
Evaluation
and Control:
Feedback/Learning: Make corrections as needed
After reading this chapter, you should be able to:
� Assess a company’s corporate culture and
how it might affect a proposed strategy
� Scan functional resources to determine
their fit with a firm’s strategy
� Construct an IFAS Table that summarizes
internal factors
5.1 A Resource-Based Approach
to Organizational Analysis
Scanning and analyzing the external environment for opportunities and threats is not enough
to provide an organization a competitive advantage. Analysts must also look within the corpo-
ration itself to identify internal strategic factors—critical strengths and weaknesses that are
likely to determine whether a firm will be able to take advantage of opportunities while avoid-
ing threats. This internal scanning, often referred to as organizational analysis, is concerned
with identifying and developing an organization’s resources and competencies.
CORE AND DISTINCTIVE COMPETENCIES
Resources are an organization’s assets and are thus the basic building blocks of the organiza-
tion. They include tangible assets, such as its plant, equipment, finances, and location, human
assets, in terms of the number of employees, their skills, and motivation, and intangible assets,
such as its technology (patents and copyrights), culture, and reputation.2 Capabilities refer to
a corporation’s ability to exploit its resources. They consist of business processes and routines
that manage the interaction among resources to turn inputs into outputs. For example, a com-
pany’s marketing capability can be based on the interaction among its marketing specialists,
distribution channels, and sales people. A capability is functionally based and is resident in a
particular function. Thus, there are marketing capabilities, manufacturing capabilities, and hu-
man resource management capabilities. When these capabilities are constantly being changed
and reconfigured to make them more adaptive to an uncertain environment, they are called
dynamic capabilities.3 A competency is a cross-functional integration and coordination of ca-
pabilities. For example, a competency in new product development in one division of a cor-
poration may be the consequence of integrating management of information systems (MIS)
capabilities, marketing capabilities, R&D capabilities, and production capabilities within the
division. A core competency is a collection of competencies that crosses divisional bound-
aries, is widespread within the corporation, and is something that the corporation can do ex-
ceedingly well. Thus, new product development is a core competency if it goes beyond one
division.4 For example, a core competency of Avon Products is its expertise in door-to-door
selling. FedEx has a core competency in its application of information technology to all its op-
erations. A company must continually reinvest in a core competency or risk its becoming a
core rigidity or deficiency, that is, a strength that over time matures and may become a weak-
ness.5 Although it is typically not an asset in the accounting sense, a core competency is a very
valuable resource—it does not “wear out” with use. In general, the more core competencies
are used, the more refined they get, and the more valuable they become. When core compe-
tencies are superior to those of the competition, they are called distinctive competencies. For
example, General Electric is well known for its distinctive competency in management devel-
opment. Its executives are sought out by other companies hiring top managers.6
Barney, in his VRIO framework of analysis, proposes four questions to evaluate a firm’s
competencies:
1. Value: Does it provide customer value and competitive advantage?
2. Rareness: Do no other competitors possess it?
3. Imitability: Is it costly for others to imitate?
4. Organization: Is the firm organized to exploit the resource?
138 PART 2 Scanning the Environment
CHAPTER 5 Internal Scanning: Organizational Analysis 139
If the answer to each of these questions is yes for a particular competency, it is considered
to be a strength and thus a distinctive competence.7 This should give the company a competi-
tive advantage and lead to higher performance.8
It is important to evaluate the importance of a company’s resources, capabilities, and com-
petencies to ascertain whether they are internal strategic factors—that is, particular strengths
and weaknesses that will help determine the future of the company. This can be done by com-
paring measures of these factors with measures of (1) the company’s past performance, (2) the
company’s key competitors, and (3) the industry as a whole. To the extent that a resource (such
as a firm’s cash situation), capability, or competency is significantly different from the firm’s
own past, its key competitors, or the industry average, that resource is likely to be a strategic
factor and should be considered in strategic decisions.
Even though a distinctive competency is certainly considered to be a corporation’s key
strength, a key strength may not always be a distinctive competency. As competitors attempt
to imitate another company’s competency (especially during hypercompetition), what was
once a distinctive competency becomes a minimum requirement to compete in the industry.9
Even though the competency may still be a core competency and thus a strength, it is no longer
unique. For example, when Maytag Company alone made high-quality home appliances, this
ability was a distinctive competency. As other appliance makers imitated Maytag’s quality
control and design processes, this continued to be a key strength (that is, a core competency)
of Maytag, but it was less and less a distinctive competency.
USING RESOURCES TO GAIN COMPETITIVE ADVANTAGE
Proposing that a company’s sustained competitive advantage is primarily determined by its re-
source endowments, Grant proposes a five-step, resource-based approach to strategy analysis.
1. Identify and classify the firm’s resources in terms of strengths and weaknesses.
2. Combine the firm’s strengths into specific capabilities and core competencies.
3. Appraise the profit potential of these capabilities and competencies in terms of their po-
tential for sustainable competitive advantage and the ability to harvest the profits result-
ing from their use. Are there any distinctive competencies?
4. Select the strategy that best exploits the firm’s capabilities and competencies relative to
external opportunities.
5. Identify resource gaps and invest in upgrading weaknesses.10
Where do these competencies come from? A corporation can gain access to a distinctive com-
petency in four ways:
� It may be an asset endowment, such as a key patent, coming from the founding of the com-
pany. For example, Xerox grew on the basis of its original copying patent.
� It may be acquired from someone else. For example, Whirlpool bought a worldwide dis-
tribution system when it purchased Philips’s appliance division.
� It may be shared with another business unit or alliance partner. For example, Apple Computer
worked with a design firm to create the special appeal of its personal computers and iPods.
� It may be carefully built and accumulated over time within the company. For example,
Honda carefully extended its expertise in small motor manufacturing from motorcycles to
autos and lawnmowers.11
There is some evidence that the best corporations prefer organic internal growth over acquisi-
tions. One study of large global companies identified firms that outperformed their peers on
140 PART 2 Scanning the Environment
both revenue growth and profitability over a decade. These excellent performers generated
value from knowledge-intensive intangibles, such as copyrights, trade secrets, or strong
brands, not from acquisitions.12
The desire to build or upgrade a core competency is one reason entrepreneurial and other
fast-growing firms often tend to locate close to their competitors. They form clusters—
geographic concentrations of interconnected companies and industries. Examples in the
United States are computer technology in Silicon Valley in northern California; light aircraft
in Wichita, Kansas; financial services in New York City; agricultural equipment in Iowa and
Illinois; and home furniture in North Carolina. According to Michael Porter, clusters provide
access to employees, suppliers, specialized information, and complementary products.13 Be-
ing close to one’s competitors makes it easier to measure and compare performance against
rivals. Capabilities may thus be formed externally through a firm’s network resources. An
example is the presence of many venture capitalists located in Silicon Valley who provide fi-
nancial support and assistance to high-tech startup firms in the region. Employees from com-
petitive firms in these clusters often socialize. As a result, companies learn from each other
while competing with each other. Interestingly, research reveals that companies with core
competencies have little to gain from locating in a cluster with other firms and therefore do not
do so. In contrast, firms with the weakest technologies, human resources, training programs,
suppliers, and distributors are strongly motivated to cluster. They have little to lose and a lot
to gain from locating close to their competitors.14
DETERMINING THE SUSTAINABILITY OF AN ADVANTAGE
Just because a firm is able to use its resources, capabilities, and competencies to develop a
competitive advantage does not mean it will be able to sustain it. Two characteristics deter-
mine the sustainability of a firm’s distinctive competency(ies): durability and imitability.
Durability is the rate at which a firm’s underlying resources, capabilities, or core com-
petencies depreciate or become obsolete. New technology can make a company’s core com-
petency obsolete or irrelevant. For example, Intel’s skills in using basic technology
developed by others to manufacture and market quality microprocessors was a crucial capa-
bility until management realized that the firm had taken current technology as far as possible
with the Pentium chip. Without basic R&D of its own, it would slowly lose its competitive
advantage to others. It thus formed a strategic alliance with HP to gain access to a needed
technology.
Imitability is the rate at which a firm’s underlying resources, capabilities, or core com-
petencies can be duplicated by others. To the extent that a firm’s distinctive competency gives
it competitive advantage in the marketplace, competitors will do what they can to learn and
imitate that set of skills and capabilities. Competitors’ efforts may range from reverse engi-
neering (which involves taking apart a competitor’s product in order to find out how it works),
to hiring employees from the competitor, to outright patent infringement. A core competency
can be easily imitated to the extent that it is transparent, transferable, and replicable.
� Transparency is the speed with which other firms can understand the relationship of re-
sources and capabilities supporting a successful firm’s strategy. For example, Gillette has
always supported its dominance in the marketing of razors with excellent R&D. A com-
petitor could never understand how the Sensor or Mach 3 razor was produced simply by
taking one apart. Gillette’s razor design was very difficult to copy, partially because the
manufacturing equipment needed to produce it was so expensive and complicated.
� Transferability is the ability of competitors to gather the resources and capabilities nec-
essary to support a competitive challenge. For example, it may be very difficult for a wine
CHAPTER 5 Internal Scanning: Organizational Analysis 141
maker to duplicate a French winery’s key resources of land and climate, especially if the
imitator is located in Iowa.
� Replicability is the ability of competitors to use duplicated resources and capabilities
to imitate the other firm’s success. For example, even though many companies have
tried to imitate Procter & Gamble’s success with brand management by hiring brand
managers away from P&G, they have often failed to duplicate P&G’s success. The
competitors failed to identify less visible P&G coordination mechanisms or to realize
that P&G’s brand management style conflicted with the competitor’s own corporate
culture.
It is relatively easy to learn and imitate another company’s core competency or capability if it
comes from explicit knowledge, that is, knowledge that can be easily articulated and commu-
nicated. This is the type of knowledge that competitive intelligence activities can quickly iden-
tify and communicate. Tacit knowledge, in contrast, is knowledge that is not easily
communicated because it is deeply rooted in employee experience or in a corporation’s cul-
ture.15 Tacit knowledge is more valuable and more likely to lead to a sustainable competitive
advantage than is explicit knowledge because it is much harder for competitors to imitate.16
As explained by Michael Dell, founder of the Dell computer company, “others can understand
what they do, but they can’t do it.”17 The knowledge may be complex and combined with other
types of knowledge in an unclear fashion in such a way that even management cannot clearly
explain the competency.18 Tacit knowledge is thus subject to a paradox. For a corporation to
be successful and grow, its tacit knowledge must be clearly identified and codified if the
knowledge is to be spread throughout the firm. Once tacit knowledge is identified and written
down, however, it is easily imitable by competitors.19 This forces companies to establish com-
plex security systems to safeguard their key knowledge.
An organization’s resources and capabilities can be placed on a continuum to the extent
they are durable and can’t be imitated (that is, aren’t transparent, transferable, or replicable)
by another firm. This continuum of sustainability is depicted in Figure 5–1. At one extreme
are slow-cycle resources, which are sustainable because they are shielded by patents, geogra-
phy, strong brand names, or tacit knowledge. These resources and capabilities are distinctive
competencies because they provide a sustainable competitive advantage. Gillette’s razor tech-
nology is a good example of a product built around slow-cycle resources. The other extreme
includes fast-cycle resources, which face the highest imitation pressures because they are
High
(Hard to lmitate)
Level of Resource Sustainability
Slow-Cycle Resource
• Strongly shielded • Standardized mass
production
• Easily duplicated
• Idea driven
• Sony: Walkman• Economies of scale
• Complicated processes
• Chrysler: Minivan
• Patents, brand name
• Gilette: Sensor razor
Standard-Cycle Resources Fast-Cycle Resources
Low
(Easy to lmitate)
FIGURE 5–1
Continuum of
Resource
Sustainability
SOURCE: Copyright © 1992 by the Regents of the University of California. Reprinted from the California
Management Review, Vol. 34, No. 3. By permission of The Regents.
142 PART 2 Scanning the Environment
based on a concept or technology that can be easily duplicated, such as Sony’s walkman. To
the extent that a company has fast-cycle resources, the primary way it can compete success-
fully is through increased speed from lab to marketplace. Otherwise, it has no real sustainable
competitive advantage.
With its low-cost position and innovative marketing strategy, Tata Motors appeared to
have a competitive advantage in making and selling its new People’s Car at the lowest price
in the industry. Would this low-cost competitive advantage be sustainable? In terms of dura-
bility, the car’s lack of safety or emissions equipment could be a disadvantage when India and
other developing nations begin to require such technology. Given that most developing na-
tions also have low labor costs, Tata’s low wages could be easily imitated—probably fairly
quickly. For example, the Renault—Nissan auto firm had already formed an alliance in 2008
with Indian motorcycle maker Bajal Auto to launch a $3,000 car in India in 2009.20 Tata
Motor’s strategy of selling its new car in kit form was highly imitable, assuming that a com-
petitor’s car could be kept simple enough for dealers to assemble easily. Overall, the sustain-
ability of Tata Motors’ competitive advantage seemed fairly low, given the fast-cycle nature
of its resources.
5.2 Business Models
When analyzing a company, it is helpful to learn what sort of business model it is following.
This is especially important when analyzing Internet-based companies. A business model is a
company’s method for making money in the current business environment. It includes the key
structural and operational characteristics of a firm—how it earns revenue and makes a profit.
A business model is usually composed of five elements:
� Who it serves
� What it provides
� How it makes money
� How it differentiates and sustains competitive advantage
� How it provides its product/service21
The simplest business model is to provide a good or service that can be sold so that revenues
exceed costs and expenses. Other models can be much more complicated. Some of the many
possible business models are:
� Customer solutions model: IBM uses this model to make money not by selling IBM
products, but by selling its expertise to improve its customers’ operations. This is a con-
sulting model.
� Profit pyramid model: General Motors offers a full line of automobiles in order to close
out any niches where a competitor might find a position. The key is to get customers to
buy in at the low-priced, low-margin entry point (Saturn’s basic sedans) and move them
up to high-priced, high-margin products (SUVs and pickup trucks) where the company
makes its money.
� Multi-component system/installed base model: Gillette invented this classic model to
sell razors at break-even pricing in order to make money on higher-margin razor blades.
HP does the same with printers and printer cartridges. The product is thus a system, not
just one product, with one component providing most of the profits.
� Advertising model: Similar to the multi-component system/installed base model, this
model offers its basic product free in order to make money on advertising. Originating in
CHAPTER 5 Internal Scanning: Organizational Analysis 143
the newspaper industry, this model is used heavily in commercial radio and television.
Internet-based firms, such as Google, offer free services to users in order to expose them
to the advertising that pays the bills. This model is analogous to Mary Poppins’ “spoon-
ful of sugar (content) helps the medicine (advertising) go down.”
� Switchboard model: In this model a firm acts as an intermediary to connect multiple sell-
ers to multiple buyers. Financial planners juggle a wide range of products for sale to mul-
tiple customers with different needs. This model has been successfully used by eBay and
Amazon.com.
� Time model: Product R&D and speed are the keys to success in the time model. Being
the first to market with a new innovation allows a pioneer like Sony to earn high margins.
Once others enter the market with process R&D and lower margins, it’s time to move on.
� Efficiency model: In this model a company waits until a product becomes standardized
and then enters the market with a low-priced, low-margin product that appeals to the mass
market. This model is used by Wal-Mart, Dell, and Southwest Airlines.
� Blockbuster model: In some industries, such as pharmaceuticals and motion picture stu-
dios, profitability is driven by a few key products. The focus is on high investment in a
few products with high potential payoffs—especially if they can be protected by patents.
� Profit multiplier model: The idea of this model is to develop a concept that may or may
not make money on its own but, through synergy, can spin off many profitable products.
Walt Disney invented this concept by using cartoon characters to develop high-margin
theme parks, merchandise, and licensing opportunities.
� Entrepreneurial model: In this model, a company offers specialized products/services
to market niches that are too small to be worthwhile to large competitors but have the po-
tential to grow quickly. Small, local brew pubs have been very successful in a mature in-
dustry dominated by Anheuser-Busch. This model has often been used by small high-tech
firms that develop innovative prototypes in order to sell off the companies (without ever
selling a product) to Microsoft or DuPont.
� De Facto industry standard model: In this model, a company offers products free or at
a very low price in order to saturate the market and become the industry standard. Once
users are locked in, the company offers higher-margin products using this standard. For
example, Microsoft packaged Internet Explorer free with its Windows software in order
to take market share from Netscape’s Web browser.22
In order to understand how some of these business models work, it is important to learn where
on the value chain the company makes its money. Although a company might offer a large
number of products and services, one product line might contribute most of the profits. For ex-
ample, ink and toner supplies for Hewlett-Packard’s printers make up more than half of the
company’s profits while accounting for less than 25% of its sales.23 For an example of a new
business model at SmartyPig, see Strategy Highlight 5.1.
5.3 Value-Chain Analysis
A value chain is a linked set of value-creating activities that begin with basic raw materials com-
ing from suppliers, moving on to a series of value-added activities involved in producing and
marketing a product or service, and ending with distributors getting the final goods into the hands
of the ultimate consumer. See Figure 5–2 for an example of a typical value chain for a manufac-
tured product. The focus of value-chain analysis is to examine the corporation in the context of
the overall chain of value-creating activities, of which the firm may be only a small part.
144 PART 2 Scanning the Environment
a saver’s goal, such as a birthday or Christmas present.
They can even view how close the saver is to reaching a
goal.
� It creates rewards for reaching a savings goal by offer-
ing 5% discounts from merchants, like Best Buy or Cir-
cuit City, who offer the product being saved for.
� It offers the option for a saver to collect the money
saved on an ATM debit card.
SmartyPig also offers gift cards for a friend or family
member to purchase using e-mail or regular mail; cards
that are not redeemable until an account has been opened
and a goal has been selected.
The company’s co-founders spent over a year dealing
with regulatory and security issues. “The hurdles to make
it work were huge, but it’s the neatest savings device I’ve
ever seen,” reported Tom Stanberry, Chairman and CEO of
SmartyPig’s bank partner, West Bank.
Are you having difficulty
saving up for an important
purchase like a trip or a car or
a big-screen television? Would
savings go faster if your friends
and family could contribute to your sav-
ings account? What if they lived far away from your cur-
rent bank?
Mike Ferari and Jon Gaskell of Des Moines, Iowa, are
co-founders of SmartyPig, an online company that pro-
motes savings through social networking. According to
Gaskell, it’s the 21st century version of a piggy bank—a
new business model for motivating people to save money
(instead of going into debt) for specific purchases. It’s not
a bank, but it works in partnership with West Bank of Des
Moines, Iowa to provide an innovative service at its www
.smartypig.com Web site.
� It creates an online way for a person to save money (and
earn interest) for a specific goal, like a vacation, a big-
screen TV, or even a house.
� It merges a savings account with digital social network-
ing so that friends and family can contribute money to
A NEW BUSINESS MODEL AT SMARTYPIG
SOURCE:“Online Company Promotes Savings,” Saint Cloud Times
(April 27, 2008), p. 11A; A. Kamenetz, “Making Banking Fun,”
Fast Company (September 2008); Corporate Web sites at www
.smartpig.com and www.westbankiowa.com.
STRATEGY highlight 5.1
Raw
Materials
Primary
Manufacturing Fabrication Distributor Retailer
FIGURE 5–2
Typical Value
Chain for a
Manufactured
Product
Very few corporations include a product’s entire value chain. Ford Motor Company did
when it was managed by its founder, Henry Ford I. During the 1920s and 1930s, the company
owned its own iron mines, ore-carrying ships, and a small rail line to bring ore to its mile-long
River Rouge plant in Detroit. Visitors to the plant would walk along an elevated walkway,
where they could watch iron ore being dumped from the rail cars into huge furnaces. The re-
sulting steel was poured and rolled out onto a moving belt to be fabricated into auto frames
and parts while the visitors watched in awe. As visitors walked along the walkway, they ob-
served an automobile being built piece by piece. Reaching the end of the moving line, the fin-
ished automobile was driven out of the plant into a vast adjoining parking lot. Ford trucks
would then load the cars for delivery to dealers. Although the Ford dealers were not employ-
ees of the company, they had almost no power in the arrangement. Dealerships were awarded
by the company and taken away if a dealer was at all disloyal. Ford Motor Company at that
time was completely vertically integrated, that is, it controlled (usually by ownership) every
stage of the value chain, from the iron mines to the retailers.
www.smartypig.com
www.smartypig.com
www.smartpig.com
www.smartpig.com
www.westbankiowa.com
CHAPTER 5 Internal Scanning: Organizational Analysis 145
INDUSTRY VALUE-CHAIN ANALYSIS
The value chains of most industries can be split into two segments, upstream and downstream
segments. In the petroleum industry, for example, upstream refers to oil exploration, drilling,
and moving of the crude oil to the refinery, and downstream refers to refining the oil plus
transporting and marketing gasoline and refined oil to distributors and gas station retailers.
Even though most large oil companies are completely integrated, they often vary in the
amount of expertise they have at each part of the value chain. Amoco, for example, had strong
expertise downstream in marketing and retailing. British Petroleum, in contrast, was more
dominant in upstream activities like exploration. That’s one reason the two companies merged
to form BP Amoco.
An industry can be analyzed in terms of the profit margin available at any point along the
value chain. For example, the U.S. auto industry’s revenues and profits are divided among many
value-chain activities, including manufacturing, new and used car sales, gasoline retailing, in-
surance, after-sales service and parts, and lease financing. From a revenue standpoint, auto
manufacturers dominate the industry, accounting for almost 60% of total industry revenues.
Profits, however, are a different matter. Auto leasing has been the most profitable activity in the
value chain, followed by insurance and auto loans. The core activities of manufacturing and dis-
tribution, however, earn significantly smaller shares of the total industry profits than they do of
total revenues. For example, because auto sales have become marginally profitable, dealerships
are now emphasizing service and repair. As a result of various differences along the industry
value chain, manufacturers have moved aggressively into auto financing.24 Ford, for example,
generated $1.2 billion in profits from financial services in 2007 compared to a loss of $5 billion
from automobiles, even though financing accounted for only 10.5% of the company’s revenues!
In analyzing the complete value chain of a product, note that even if a firm operates up
and down the entire industry chain, it usually has an area of expertise where its primary activ-
ities lie. A company’s center of gravity is the part of the chain that is most important to the
company and the point where its greatest expertise and capabilities lie—its core competencies.
According to Galbraith, a company’s center of gravity is usually the point at which the com-
pany started. After a firm successfully establishes itself at this point by obtaining a competi-
tive advantage, one of its first strategic moves is to move forward or backward along the value
chain in order to reduce costs, guarantee access to key raw materials, or to guarantee distribu-
tion.25 This process, called vertical integration, is discussed in more detail in Chapter 7.
In the paper industry, for example, Weyerhauser’s center of gravity is in the raw materi-
als and primary manufacturing parts of the value chain as shown in Figure 5–2. Weyerhauser’s
expertise is in lumbering and pulp mills, which is where the company started. It integrated for-
ward by using its wood pulp to make paper and boxes, but its greatest capability still lay in
getting the greatest return from its lumbering activities. In contrast, P&G is primarily a con-
sumer products company that also owned timberland and operated pulp mills. Its expertise is
in the fabrication and distribution parts of the Figure 5–2 value chain. P&G purchased these
assets to guarantee access to the large quantities of wood pulp it needed to expand its dispos-
able diaper, toilet tissue, and napkin products. P&G’s strongest capabilities have always been
in the downstream activities of product development, marketing, and brand management. It
has never been as efficient in upstream paper activities as Weyerhauser. It had no real distinc-
tive competency on that part of the value chain. When paper supplies became more plentiful
(and competition got rougher), P&G gladly sold its land and mills to focus more on the part of
the value chain where it could provide the greatest value at the lowest cost—creating and mar-
keting innovative consumer products. As was the case with P&G’s experience in the paper in-
dustry, it makes sense for a company to outsource any weak areas it may control internally on
the industry value chain.
146 PART 2 Scanning the Environment
CORPORATE VALUE-CHAIN ANALYSIS
Each corporation has its own internal value chain of activities. See Figure 5–3 for an exam-
ple of a corporate value chain. Porter proposes that a manufacturing firm’s primary activities
usually begin with inbound logistics (raw materials handling and warehousing), go through an
operations process in which a product is manufactured, and continue on to outbound logistics
(warehousing and distribution), to marketing and sales, and finally to service (installation, re-
pair, and sale of parts). Several support activities, such as procurement (purchasing), technol-
ogy development (R&D), human resource management, and firm infrastructure (accounting,
finance, strategic planning), ensure that the primary value chain activities operate effectively
and efficiently. Each of a company’s product lines has its own distinctive value chain. Because
most corporations make several different products or services, an internal analysis of the firm
involves analyzing a series of different value chains.
The systematic examination of individual value activities can lead to a better understand-
ing of a corporation’s strengths and weaknesses. According to Porter, “Differences among
competitor value chains are a key source of competitive advantage.”26 Corporate value chain
analysis involves the following three steps:
1. Examine each product line’s value chain in terms of the various activities involved in
producing that product or service: Which activities can be considered strengths (core
competencies) or weaknesses (core deficiencies)? Do any of the strengths provide com-
petitive advantage and can they thus be labeled distinctive competencies?
2. Examine the “linkages” within each product line’s value chain: Linkages are the con-
nections between the way one value activity (for example, marketing) is performed and
the cost of performance of another activity (for example, quality control). In seeking ways
for a corporation to gain competitive advantage in the marketplace, the same function can
be performed in different ways with different results. For example, quality inspection of
100% of output by the workers themselves instead of the usual 10% by quality control
Support
Activities
Firm Infrastructure
(general management, accounting, finance, strategic planning)
Human Resource Management
(recruiting, training, development)
Technology Development
(R&D, product and process improvement)
Inbound
Logistics
(raw
materials
handling and
warehousing)
Outbound
Logistics
(warehousing
and
distribution
of finished
product)
Marketing
and Sales
(advertising,
promotion,
pricing,
channel
relations)
Service
(installation,
repair, parts)
Primary Activities
Profit
Margin
Operations
(machining,
assembling,
testing)
Procurement
(purchasing of raw materials, machines, supplies)
FIGURE 5–3
A Corporation’s
Value Chain
SOURCE: Reprinted with the permission of The Free Press, a Division of Simon & Schuster, from COMPETITIVE
ADVANTAGE: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1998 by The
Free Press. All rights reserved.
CHAPTER 5 Internal Scanning: Organizational Analysis 147
inspectors might increase production costs, but that increase could be more than offset by
the savings obtained from reducing the number of repair people needed to fix defective
products and increasing the amount of salespeople’s time devoted to selling instead of ex-
changing already-sold but defective products.
3. Examine the potential synergies among the value chains of different product lines or
business units: Each value element, such as advertising or manufacturing, has an inher-
ent economy of scale in which activities are conducted at their lowest possible cost per
unit of output. If a particular product is not being produced at a high enough level to reach
economies of scale in distribution, another product could be used to share the same dis-
tribution channel. This is an example of economies of scope, which result when the value
chains of two separate products or services share activities, such as the same marketing
channels or manufacturing facilities. The cost of joint production of multiple products can
be lower than the cost of separate production.
5.4 Scanning Functional Resources and Capabilities
The simplest way to begin an analysis of a corporation’s value chain is by carefully examin-
ing its traditional functional areas for potential strengths and weaknesses. Functional resources
and capabilities include not only the financial, physical, and human assets in each area but also
the ability of the people in each area to formulate and implement the necessary functional ob-
jectives, strategies, and policies. These resources and capabilities include the knowledge of an-
alytical concepts and procedural techniques common to each area as well as the ability of the
people in each area to use them effectively. If used properly, these resources and capabilities
serve as strengths to carry out value-added activities and support strategic decisions. In addi-
tion to the usual business functions of marketing, finance, R&D, operations, human resources,
and information systems/technology, we also discuss structure and culture as key parts of a
business corporation’s value chain.
BASIC ORGANIZATIONAL STRUCTURES
Although there is an almost infinite variety of structural forms, certain basic types predomi-
nate in modern complex organizations. Figure 5–4 illustrates three basic organizational
structures. The conglomerate structure is a variant of divisional structure and is thus not de-
picted as a fourth structure. Generally speaking, each structure tends to support some corpo-
rate strategies over others:
� Simple structure has no functional or product categories and is appropriate for a small,
entrepreneur-dominated company with one or two product lines that operates in a reason-
ably small, easily identifiable market niche. Employees tend to be generalists and jacks-
of-all-trades. In terms of stages of development (to be discussed in Chapter 9), this is a
Stage I company.
� Functional structure is appropriate for a medium-sized firm with several product lines
in one industry. Employees tend to be specialists in the business functions that are impor-
tant to that industry, such as manufacturing, marketing, finance, and human resources. In
terms of stages of development (discussed in Chapter 9), this is a Stage II company.
� Divisional structure is appropriate for a large corporation with many product lines in sev-
eral related industries. Employees tend to be functional specialists organized according to
product/market distinctions. General Motors, for example, groups its various auto lines
into the separate divisions of Saturn, Chevrolet, Pontiac, Buick, and Cadillac. Management
148 PART 2 Scanning the Environment
I. Simple Structure
II. Functional Structure
III. Divisional Structure*
Owner-Manager
Workers
Top Management
Manufacturing
Top Management
Product Division A
Manufacturing
Sales
*Strategic Business Units and the conglomerate structure are variants of the divisional structure.
Personnel
Finance Manufacturing
Sales Personnel
Finance
Product Division B
Sales Finance Personnel
FIGURE 5–4
Basic
Organizational
Structures
attempts to find some synergy among divisional activities through the use of committees
and horizontal linkages. In terms of stages of development (to be discussed in Chapter 9),
this is a Stage III company.
� Strategic business units (SBUs) are a modification of the divisional structure. Strategic
business units are divisions or groups of divisions composed of independent product-
market segments that are given primary responsibility and authority for the management
of their own functional areas. An SBU may be of any size or level, but it must have (1) a
unique mission, (2) identifiable competitors, (3) an external market focus, and (4) control
of its business functions.27 The idea is to decentralize on the basis of strategic elements
rather than on the basis of size, product characteristics, or span of control and to create
horizontal linkages among units previously kept separate. For example, rather than orga-
nize products on the basis of packaging technology like frozen foods, canned foods, and
bagged foods, General Foods organized its products into SBUs on the basis of consumer-
oriented menu segments: breakfast food, beverage, main meal, dessert, and pet foods. In
terms of stages of development (to be discussed in Chapter 9), this is also a Stage III
company.
� Conglomerate structure is appropriate for a large corporation with many product lines
in several unrelated industries. A variant of the divisional structure, the conglomerate
structure (sometimes called a holding company) is typically an assemblage of legally in-
dependent firms (subsidiaries) operating under one corporate umbrella but controlled
through the subsidiaries’ boards of directors. The unrelated nature of the subsidiaries
CHAPTER 5 Internal Scanning: Organizational Analysis 149
prevents any attempt at gaining synergy among them. In terms of stages of development
(discussed in Chapter 9), this is also a Stage III company.
If the current basic structure of a corporation does not easily support a strategy under con-
sideration, top management must decide whether the proposed strategy is feasible or whether
the structure should be changed to a more advanced structure such as a matrix or network. (Ad-
vanced structural designs such as the matrix and network are discussed in Chapter 9.)
CORPORATE CULTURE: THE COMPANY WAY
There is an oft-told story of a person new to a company asking an experienced co-worker what
an employee should do when a customer calls. The old-timer responded: “There are three ways
to do any job—the right way, the wrong way, and the company way. Around here, we always do
things the company way.” In most organizations, the “company way” is derived from the corpo-
ration’s culture. Corporate culture is the collection of beliefs, expectations, and values learned
and shared by a corporation’s members and transmitted from one generation of employees to an-
other. The corporate culture generally reflects the values of the founder(s) and the mission of the
firm.28 It gives a company a sense of identity: “This is who we are. This is what we do. This is
what we stand for.” The culture includes the dominant orientation of the company, such as R&D
at HP, high productivity at Nucor, customer service at Nordstrom, innovation at Google, or prod-
uct quality at BMW. It often includes a number of informal work rules (forming the “company
way”) that employees follow without question. These work practices over time become part of
a company’s unquestioned tradition. The culture, therefore, reflects the company’s values.
Corporate culture has two distinct attributes, intensity and integration.29 Cultural inten-
sity is the degree to which members of a unit accept the norms, values, or other culture con-
tent associated with the unit. This shows the culture’s depth. Organizations with strong norms
promoting a particular value, such as quality at BMW, have intensive cultures, whereas new
firms (or those in transition) have weaker, less intensive cultures. Employees in an intensive
culture tend to exhibit consistent behavior, that is, they tend to act similarly over time.
Cultural integration is the extent to which units throughout an organization share a common
culture. This is the culture’s breadth. Organizations with a pervasive dominant culture may be
hierarchically controlled and power-oriented, such as a military unit, and have highly inte-
grated cultures. All employees tend to hold the same cultural values and norms. In contrast, a
company that is structured into diverse units by functions or divisions usually exhibits some
strong subcultures (for example, R&D versus manufacturing) and a less integrated corporate
culture.
Corporate culture fulfills several important functions in an organization:
1. Conveys a sense of identity for employees.
2. Helps generate employee commitment to something greater than themselves.
3. Adds to the stability of the organization as a social system.
4. Serves as a frame of reference for employees to use to make sense of organizational ac-
tivities and to use as a guide for appropriate behavior.30
Corporate culture shapes the behavior of people in a corporation, thus affecting corporate
performance. For example, corporate cultures that emphasize the socialization of new employ-
ees have less employee turnover, leading to lower costs.31 Because corporate cultures have a
powerful influence on the behavior of people at all levels, they can strongly affect a corpora-
tion’s ability to shift its strategic direction. A strong culture should not only promote survival,
but it should also create the basis for a superior competitive position by increasing motivation
150 PART 2 Scanning the Environment
and facilitating coordination and control.32 For example, a culture emphasizing constant re-
newal may help a company adapt to a changing, hypercompetitive environment.33 To the ex-
tent that a corporation’s distinctive competence is embedded in an organization’s culture, it
will be a form of tacit knowledge and very difficult for a competitor to imitate. The Global
Issue feature shows the differences between ABB Asea Brown Boveri AG and Matsushita
Electric in terms of how they manage their corporate cultures in a global industry.
A change in mission, objectives, strategies, or policies is not likely to be successful if it is
in opposition to the accepted culture of a firm. Foot-dragging and even sabotage may result,
as employees fight to resist a radical change in corporate philosophy. As with structure, if an
organization’s culture is compatible with a new strategy, it is an internal strength. But if the
corporate culture is not compatible with the proposed strategy, it is a serious weakness. For ex-
ample, when General Motors created a collaborative effort in 1996 among the three internal
units of Saturn, International Operations, and Small Car Group for its proposed Delta Small
Car Program, it caused a conflict with the company’s long-standing cultural tradition of unit
autonomy. GM employees found that they were expected to cooperate with other GM employ-
ees who did not share their views regarding vehicle requirements and architecture or of work
SOURCES: Summarized from J. Guyon, “ABB Fuses Units with One
Set of Values,” Wall Street Journal (October 2, 1996), p. A15 and
N. Holden, “Why Globalizing with a Conservative Corporate
Culture Inhibits Localization of Management: The Telling Case of
Matsushita Electric,” International Journal of Cross Cultural
Management, Vol. 1, No. 1 (2001), pp. 53–72.
MEI is the third-largest electrical company in the world.
Konosuke Matsushita founded the company in 1918. His
management philosophy led to the company’s success but
became institutionalized in the corporate culture—a cul-
ture that was more focused on Japanese values than on
cross-cultural globalization. As a result, MEI’s corporate
culture does not adapt well to local conditions. Not only is
MEI’s top management exclusively Japanese, its subsidiary
managers are overwhelmingly Japanese. The company’s
distrust of non-Japanese managers in the United States
and some European countries results in a “rice-paper ceil-
ing” that prevents non-Japanese people from being pro-
moted into MEI subsidiaries’ top management. Foreign
employees are often confused by the corporate philosophy
that has not been adapted to suit local realities. MEI’s cor-
porate culture perpetuates a cross-cultural divide that sep-
arates the Japanese from the non-Japanese managers,
leaving the non-Japanese managers feeling frustrated and
undervalued. This divide prevents the flow of knowledge
and experience from regional operations to the headquar-
ters and may hinder MEI’s ability to compete globally.
Zurich-based ABB Asea
Brown Boveri AG is a world-
wide builder of power plants,
electrical equipment, and industrial
factories in 140 countries. By establishing
one set of multicultural values throughout its global opera-
tions, ABB’s management believes that the company will
gain an advantage over its rivals Siemens AG of Germany,
France’s Alcatel-Alsthom NV, and the U.S.’s General Electric
Company. ABB is a company with no geographic base. In-
stead, it has many “home” markets that can draw on exper-
tise from around the globe. ABB created a set of 500 global
managers who could adapt to local cultures while executing
ABB’s global strategies. These people are multilingual and
move around each of ABB’s 5,000 profit centers in 140 coun-
tries. Their assignment is to cut costs, improve efficiency, and
integrate local businesses with the ABB worldview.
Few multinational corporations are as successful as ABB
in getting global strategies to work with local operations.
In agreement with the resource-based view of the firm, the
past Chairman of ABB, Percy Barnevik stated, “Our
strength comes from pulling together. . . . If you can make
this work real well, then you get a competitive edge out of
the organization which is very, very difficult to copy.”
Contrast ABB’s globally-oriented corporate culture with
the more Japanese-oriented parochial culture of Mat-
sushita Electric Industrial Corporation (MEI) of Japan. Oper-
ating under the brand names of Panasonic and Technic,
MANAGING CORPORATE CULTURE FOR GLOBAL
COMPETITIVE ADVANTAGE: ABB VERSUS MATSUSHITA
GLOBAL issue
CHAPTER 5 Internal Scanning: Organizational Analysis 151
STRATEGIC MARKETING ISSUES
The marketing manager is a company’s primary link to the customer and the competition. The
manager, therefore, must be especially concerned with the market position and marketing mix
of the firm as well as with the overall reputation of the company and its brands.
Market Position and Segmentation
Market position deals with the question, “Who are our customers?” It refers to the selection of
specific areas for marketing concentration and can be expressed in terms of market, product,
and geographic locations. Through market research, corporations are able to practice market
segmentation with various products or services so that managers can discover what niches to
seek, which new types of products to develop, and how to ensure that a company’s many prod-
ucts do not directly compete with one another.
Marketing Mix
Marketing mix refers to the particular combination of key variables under a corporation’s
control that can be used to affect demand and to gain competitive advantage. These variables
are product, place, promotion, and price. Within each of these four variables are several sub-
variables, listed in Table 5–1, that should be analyzed in terms of their effects on divisional
and corporate performance.
practices and processes. Significant cultural differences among the three units led to the pro-
gram being abandoned in 2000.34
Corporate culture is also important when considering an acquisition. The merging of two
dissimilar cultures, if not handled wisely, can create some serious internal conflicts. Procter &
Gamble’s management knew, for example, that their 2005 acquisition of Gillette might create
some cultural problems. Even though both companies were strong consumer goods marketers,
they each had a fundamental difference that led to many, subtle differences between the cul-
tures: Gillette sold its razors, toothbrushes, and batteries to men; whereas, P&G sold its health
and beauty aids to women. Art Lafley, P&G’s CEO, admitted a year after the merger that it
would take an additional year to 15 months to align the two companies.35
TABLE 5–1 Product Place Promotion Price
Marketing Mix
Variables
Quality Channels Advertising List price
Features Coverage Personal selling Discounts
Options Locations Sales promotion Allowances
Style Inventory Publicity Payment periods
Brand name Transport Credit items
Packaging
Sizes
Services
Warranties
Returns
SOURCE: KOTLER, PHILIP, MARKETING MANAGEMENT, 11th edition © 2003, p. 16. Reprinted by Pearson
Education, Inc., Upper Saddle River, NJ.
152 PART 2 Scanning the Environment
Introduction
* The right end of the Growth stage is often called Competitive Turbulence because
of price and distribution competition that shakes out the weaker competitors. For
further information, see C. R. Wasson, Dynamic Competitive Strategy and
Product Life Cycles. 3rd ed. (Austin, TX: Austin Press, 1978).
Growth* Maturity
Time
S
al
es
Decline
FIGURE 5–5
Product Life Cycle
Product Life Cycle
One of the most useful concepts in marketing, insofar as strategic management is concerned,
is the product life cycle. As depicted in Figure 5–5, the product life cycle is a graph showing
time plotted against the monetary sales of a product as it moves from introduction through
growth and maturity to decline. This concept enables a marketing manager to examine the mar-
keting mix of a particular product or group of products in terms of its position in its life cycle.
Brand and Corporate Reputation
A brand is a name given to a company’s product which identifies that item in the mind of the
consumer. Over time and with proper advertising, a brand connotes various characteristics in
the consumers’ minds. For example, Disney stands for family entertainment. Ivory suggests
“pure” soap. BMW means high-performance autos. A brand can thus be an important corpo-
rate resource. If done well, a brand name is connected to the product to such an extent that a
brand may stand for an entire product category, such as Kleenex for facial tissue. The objec-
tive is for the customer to ask for the brand name (Coke or Pepsi) instead of the product cate-
gory (cola). The world’s 10 most valuable brands in 2007 were Coca-Cola, Microsoft, IBM,
GE, Nokia, Toyota, Intel, McDonald’s, Disney, and Mercedes-Benz, in that order. According
to Business Week, the value of the Coca-Cola brand is worth $65.3 billion.36
A corporate brand is a type of brand in which the company’s name serves as the brand.
Of the world’s top 10 world brands listed previously, all are company names. The value of a
corporate brand is that it typically stands for consumers’ impressions of a company and can
thus be extended onto products not currently offered—regardless of the company’s actual ex-
pertise. For example, Caterpillar, a manufacturer of heavy earth-moving equipment, used con-
sumer associations with the Caterpillar brand (rugged, masculine, construction-related) to
market work boots. Thus, consumer impressions of a brand can suggest new product cate-
gories to enter even though a company may have no competencies in making or marketing that
type of product or service.37
A corporate reputation is a widely held perception of a company by the general pub-
lic. It consists of two attributes: (1) stakeholders’ perceptions of a corporation’s ability to
produce quality goods and (2) a corporation’s prominence in the minds of stakeholders.38 A
CHAPTER 5 Internal Scanning: Organizational Analysis 153
good corporate reputation can be a strategic resource. It can serve in marketing as both a sig-
nal and an entry barrier. It contributes to its goods having a price premium.39 Reputation is es-
pecially important when the quality of a company’s product or service is not directly
observable and can be learned only through experience. For example, retail stores are willing
to stock a new product from P&G or Anheuser-Busch because they know that both companies
market only good-quality products that are highly advertised. Like tacit knowledge, reputation
tends to be long-lasting and hard for others to duplicate—thus providing sustainable compet-
itive advantage.40 It can have a significant impact on a firm’s stock price.41 Research reveals a
positive relationship between corporate reputation and financial performance.42
STRATEGIC FINANCIAL ISSUES
A financial manager must ascertain the best sources of funds, uses of funds, and control of
funds. All strategic issues have financial implications. Cash must be raised from internal or ex-
ternal (local and global) sources and allocated for different uses. The flow of funds in the op-
erations of an organization must be monitored. To the extent that a corporation is involved in
international activities, currency fluctuations must be dealt with to ensure that profits aren’t
wiped out by the rise or fall of the dollar versus the yen, euro, or other currencies. Benefits in
the form of returns, repayments, or products and services must be given to the sources of out-
side financing. All these tasks must be handled in a way that complements and supports over-
all corporate strategy. A firm’s capital structure (amounts of debt and equity) can influence its
strategic choices. For example, increased debt tends to increase risk aversion and decrease the
willingness of management to invest in R&D.43
Financial Leverage
The mix of externally generated short-term and long-term funds in relation to the amount and
timing of internally generated funds should be appropriate to the corporate objectives, strate-
gies, and policies. The concept of financial leverage (the ratio of total debt to total assets) is
helpful in describing how debt is used to increase the earnings available to common sharehold-
ers. When the company finances its activities by sales of bonds or notes instead of through
stock, the earnings per share are boosted: the interest paid on the debt reduces taxable income,
but fewer shareholders share the profits than if the company had sold more stock to finance its
activities. The debt, however, does raise the firm’s break-even point above what it would have
been if the firm had financed from internally generated funds only. High leverage may there-
fore be perceived as a corporate strength in times of prosperity and ever-increasing sales, or as
a weakness in times of a recession and falling sales. This is because leverage acts to magnify
the effect on earnings per share of an increase or decrease in dollar sales. Research indicates
that greater leverage has a positive impact on performance for firms in stable environments,
but a negative impact for firms in dynamic environments.44
Capital Budgeting
Capital budgeting is the analyzing and ranking of possible investments in fixed assets such
as land, buildings, and equipment in terms of the additional outlays and additional receipts that
will result from each investment. A good finance department will be able to prepare such cap-
ital budgets and to rank them on the basis of some accepted criteria or hurdle rate (for exam-
ple, years to pay back investment, rate of return, or time to break-even point) for the purpose
of strategic decision making. Most firms have more than one hurdle rate and vary it as a func-
tion of the type of project being considered. Projects with high strategic significance, such as
entering new markets or defending market share, will often have low hurdle rates.45
154 PART 2 Scanning the Environment
STRATEGIC RESEARCH AND DEVELOPMENT (R&D) ISSUES
The R&D manager is responsible for suggesting and implementing a company’s technologi-
cal strategy in light of its corporate objectives and policies. The manager’s job, therefore, in-
volves (1) choosing among alternative new technologies to use within the corporation,
(2) developing methods of embodying the new technology in new products and processes, and
(3) deploying resources so that the new technology can be successfully implemented.
R&D Intensity, Technological Competence, and Technology Transfer
The company must make available the resources necessary for effective research and devel-
opment. A company’s R&D intensity (its spending on R&D as a percentage of sales revenue)
is a principal means of gaining market share in global competition. The amount spent on
R&D often varies by industry. For example, the U.S. computer software industry tradition-
ally spends 13.5% of its sales dollar for R&D, whereas the paper and forest products indus-
try spends only 1.0%.46 A good rule of thumb for R&D spending is that a corporation should
spend at a “normal” rate for that particular industry unless its strategic plan calls for unusual
expenditures.
Simply spending money on R&D or new projects does not mean, however, that the money
will produce useful results. For example, Pharmacia Upjohn spent more of its revenues on re-
search than any other company in any industry (18%), but it was ranked low in innovation.47
A company’s R&D unit should be evaluated for technological competence in both the devel-
opment and the use of innovative technology. Not only should the corporation make a consis-
tent research effort (as measured by reasonably constant corporate expenditures that result in
usable innovations), it should also be proficient in managing research personnel and integrat-
ing their innovations into its day-to-day operations. A company should also be proficient in
technology transfer, the process of taking a new technology from the laboratory to the mar-
ketplace. Aerospace parts maker Rockwell Collins, for example, is a master of developing new
technology, such as the “heads-up display” (transparent screens in an airplane cockpit that tell
pilots speed, altitude, and direction), for the military and then using it in products built for the
civilian market.48
R&D Mix
Basic R&D is conducted by scientists in well-equipped laboratories where the focus is on the-
oretical problem areas. The best indicators of a company’s capability in this area are its patents
and research publications. Product R&D concentrates on marketing and is concerned with
product or product-packaging improvements. The best measurements of ability in this area are
the number of successful new products introduced and the percentage of total sales and prof-
its coming from products introduced within the past five years. Engineering (or process) R&D
is concerned with engineering, concentrating on quality control, and the development of de-
sign specifications and improved production equipment. A company’s capability in this area
can be measured by consistent reductions in unit manufacturing costs and by the number of
product defects.
Most corporations will have a mix of basic, product, and process R&D, which varies
by industry, company, and product line. The balance of these types of research is known as
the R&D mix and should be appropriate to the strategy being considered and to each prod-
uct’s life cycle. For example, it is generally accepted that product R&D normally dominates
the early stages of a product’s life cycle (when the product’s optimal form and features are
still being debated), whereas process R&D becomes especially important in the later stages
(when the product’s design is solidified and the emphasis is on reducing costs and improv-
ing quality).
CHAPTER 5 Internal Scanning: Organizational Analysis 155
Impact of Technological Discontinuity on Strategy
The R&D manager must determine when to abandon present technology and when to develop
or adopt new technology. Richard Foster of McKinsey and Company states that the displace-
ment of one technology by another (technological discontinuity) is a frequent and strategi-
cally important phenomenon. Such a discontinuity occurs when a new technology cannot
simply be used to enhance the current technology, but actually substitutes for that technology
to yield better performance. For each technology within a given field or industry, according to
Foster, the plotting of product performance against research effort/expenditures on a graph re-
sults in an S-shaped curve. He describes the process depicted in Figure 5–6:
Early in the development of the technology a knowledge base is being built and progress requires
a relatively large amount of effort. Later, progress comes more easily. And then, as the limits of
that technology are approached, progress becomes slow and expensive. That is when R&D dol-
lars should be allocated to technology with more potential. That is also—not so incidentally—
when a competitor who has bet on a new technology can sweep away your business or topple an
entire industry.49
Computerized information technology is currently on the steep upward slope of its
S-curve in which relatively small increments in R&D effort result in significant improve-
ment in performance. This is an example of Moore’s Law, which states that silicon chips
(microprocessors) double in complexity every 18 months.50 The presence of a technological
discontinuity in the world’s steel industry during the 1960s explains why the large capital
expenditures by U.S. steel companies failed to keep them competitive with the Japanese
firms that adopted the new technologies. As Foster points out, “History has shown that as
one technology nears the end of its S-curve, competitive leadership in a market generally
changes hands.”51
What the S-Curves Reveal
Research Effort/Expenditure
In the corporate planning process, it is generally assumed
that incremental progress in technology will occur. But past
developments in a given technology cannot be extrapolated
into the future because every technology has its limits. The
key to competitiveness is to determine when to shift re-
sources to a technology that has more potential.
Mature
Technology New
Technology
P
ro
d
u
ct
P
er
fo
rm
an
ce
FIGURE 5–6
Technological
Discontinuity
SOURCE: From “Are You Investing in the Wrong Technology?” P. Pascarella, Industry Week, July 25, 1983.
Reprinted by permission of Penton Media, Inc.
156 PART 2 Scanning the Environment
Christensen explains in The Innovator’s Dilemma why this transition occurs when a “dis-
ruptive technology” enters an industry. In a study of computer disk drive manufacturers, he ex-
plains that established market leaders are typically reluctant to move in a timely manner to a
new technology. This reluctance to switch technologies (even when the firm is aware of the
new technology and may have even invented it!) is because the resource allocation process in
most companies gives priority to those projects (typically based on the old technology) with
the greatest likelihood of generating a good return on investment—those projects appealing to
the firm’s current customers (whose products are also based on the characteristics of the old
technology). For example, in the 1980s a disk drive manufacturer’s customers (PC manufac-
turers) wanted a better (faster) 5 1/4� drive with greater capacity. These PC makers were not
interested in the new 3 1/2� drives based on the new technology because (at that time) the
smaller drives were slower and had less capacity. Smaller size was irrelevant since these com-
panies primarily made desk top personal computers which were designed to hold large drives.
The new technology is generally riskier and of little appeal to the current customers of es-
tablished firms. Products derived from the new technology are more expensive and do not
meet the customers’ requirements—requirements based on the old technology. New entrepre-
neurial firms are typically more interested in the new technology because it is one way to ap-
peal to a developing market niche in a market currently dominated by established companies.
Even though the new technology may be more expensive to develop, it offers performance im-
provements in areas that are attractive to this small niche, but of no consequence to the cus-
tomers of the established competitors.
This was the case with the entrepreneurial manufacturers of 3 1/2� disk drives. These
smaller drives appealed to the PC makers who were trying to increase their small PC market
share by offering laptop computers. Size and weight were more important to these customers
than were capacity and speed. By the time the new technology was developed to the point that
the 31/2� drive matched and even surpassed the 51/4� drive in terms of speed and capacity (in
addition to size and weight), it was too late for the established 5 1/4� disk drive firms to switch
to the new technology. Once their customers begin demanding smaller products using the new
technology, the established firms were unable to respond quickly and lost their leadership po-
sition in the industry. They were able to remain in the industry (with a much reduced market
share) only if they were able to utilize the new technology to be competitive in the new prod-
uct line.52
The same phenomenon can be seen in many product categories ranging from flat-panel
display screens to railroad locomotives to digital photography to musical recordings. For ex-
ample, George Heilmeier created the first practical liquid-crystal display (LCD) in 1964 at
RCA Labs. RCA unveiled the new display in 1968 with much fanfare about LCDs being the
future of TV sets, but then refused to fund further development of the new technology. In con-
trast, Japanese television and computer manufacturers invested in long-term development of
LCDs. Today, Japanese, Korean, and Taiwanese companies dominate the $39 billion LCD
business and RCA no longer makes televisions. Interestingly, Heilmeier received the Kyoto
Prize in 2005 for his LCD invention.53
STRATEGIC OPERATIONS ISSUES
The primary task of the operations (manufacturing or service) manager is to develop and op-
erate a system that will produce the required number of products or services, with a certain
quality, at a given cost, within an allotted time. Many of the key concepts and techniques pop-
ularly used in manufacturing can be applied to service businesses.
In very general terms, manufacturing can be intermittent or continuous. In intermittent
systems (job shops), the item is normally processed sequentially, but the work and sequence
CHAPTER 5 Internal Scanning: Organizational Analysis 157
of the process vary. An example is an auto body repair shop. At each location, the tasks deter-
mine the details of processing and the time required for them. These job shops can be very la-
bor intensive. For example, a job shop usually has little automated machinery and thus a small
amount of fixed costs. It has a fairly low break-even point, but its variable cost line (composed
of wages and costs of special parts) has a relatively steep slope. Because most of the costs as-
sociated with the product are variable (many employees earn piece-rate wages), a job shop’s
variable costs are higher than those of automated firms. Its advantage over other firms is that
it can operate at low levels and still be profitable. After a job shop’s sales reach break-even,
however, the huge variable costs as a percentage of total costs keep the profit per unit at a rel-
atively low level. In terms of strategy, this firm should look for a niche in the marketplace for
which it can produce and sell a reasonably small quantity of custom-made goods.
In contrast, continuous systems are those laid out as lines on which products can be con-
tinuously assembled or processed. An example is an automobile assembly line. A firm using
continuous systems invests heavily in fixed investments such as automated processes and
highly sophisticated machinery. Its labor force, relatively small but highly skilled, earns
salaries rather than piece-rate wages. Consequently, this firm has a high amount of fixed costs.
It also has a relatively high break-even point, but its variable cost line rises slowly. This is an
example of operating leverage, the impact of a specific change in sales volume on net operat-
ing income. The advantage of high operating leverage is that once the firm reaches break-even,
its profits rise faster than do those of less automated firms having lower operating leverage.
Continuous systems reap benefits from economies of scale. In terms of strategy, this firm needs
to find a high-demand niche in the marketplace for which it can produce and sell a large quan-
tity of goods. However, a firm with high operating leverage is likely to suffer huge losses dur-
ing a recession. During an economic downturn, the firm with less automation and thus less
leverage is more likely to survive comfortably because a drop in sales primarily affects vari-
able costs. It is often easier to lay off labor than to sell off specialized plants and machines.
Experience Curve
A conceptual framework that many large corporations have used successfully is the experience
curve (originally called the learning curve). The experience curve suggests that unit produc-
tion costs decline by some fixed percentage (commonly 20%–30%) each time the total accu-
mulated volume of production in units doubles. The actual percentage varies by industry and is
based on many variables: the amount of time it takes a person to learn a new task, scale
economies, product and process improvements, and lower raw materials cost, among others.
For example, in an industry with an 85% experience curve, a corporation might expect a 15%
reduction in unit costs for every doubling of volume. The total costs per unit can be expected to
drop from $100 when the total production is 10 units, to $85 ($100 x 85%) when production in-
creases to 20 units, and to $72.25 ($85 x 85%) when it reaches 40 units. Achieving these results
often means investing in R&D and fixed assets; higher fixed costs and less flexibility thus re-
sult. Nevertheless the manufacturing strategy is one of building capacity ahead of demand in
order to achieve the lower unit costs that develop from the experience curve. On the basis of
some future point on the experience curve, the corporation should price the product or service
very low to preempt competition and increase market demand. The resulting high number of
units sold and high market share should result in high profits, based on the low unit costs.
Management commonly uses the experience curve in estimating the production costs
of (1) a product never before made with the present techniques and processes or (2) current
products produced by newly introduced techniques or processes. The concept was first ap-
plied in the airframe industry and can be applied in the service industry as well. For exam-
ple, a cleaning company can reduce its costs per employee by having its workers use the
same equipment and techniques to clean many adjacent offices in one office building rather
158 PART 2 Scanning the Environment
STRATEGIC HUMAN RESOURCE (HRM) ISSUES
The primary task of the manager of human resources is to improve the match between indi-
viduals and jobs. Research indicates that companies with good HRM practices have higher
profits and a better survival rate than do firms without these practices.57 A good HRM depart-
ment should know how to use attitude surveys and other feedback devices to assess employ-
ees’ satisfaction with their jobs and with the corporation as a whole. HRM managers should
also use job analysis to obtain job description information about what each job needs to ac-
complish in terms of quality and quantity. Up-to-date job descriptions are essential not only
for proper employee selection, appraisal, training, and development for wage and salary ad-
ministration, and for labor negotiations, but also for summarizing the corporate-wide human
resources in terms of employee-skill categories. Just as a company must know the number,
type, and quality of its manufacturing facilities, it must also know the kinds of people it em-
ploys and the skills they possess. The best strategies are meaningless if employees do not have
the skills to carry them out or if jobs cannot be designed to accommodate the available work-
ers. IBM, Procter & Gamble, and Hewlett-Packard, for example, use employee profiles to en-
sure that they have the best mix of talents to implement their planned strategies. Because
project managers at IBM are now able to scan the company’s databases to identify employee
capabilities and availability, the average time needed to assemble a team has declined 20% for
a savings of $500 million overall.58
Increasing Use of Teams
Management is beginning to realize that it must be more flexible in its utilization of employees
in order for human resources to be classified as a strength. Human resource managers, therefore,
need to be knowledgeable about work options such as part-time work, job sharing, flex-time,
than just cleaning a few offices in multiple buildings. Although many firms have used ex-
perience curves extensively, an unquestioning acceptance of the industry norm (such as
80% for the airframe industry or 70% for integrated circuits) is very risky. The experience
curve of the industry as a whole might not hold true for a particular company for a variety
of reasons.54
Flexible Manufacturing for Mass Customization
The use of large, continuous, mass-production facilities to take advantage of experience-curve
economies has recently been criticized. The use of Computer-Assisted Design and Computer-
Assisted Manufacturing (CAD/CAM) and robot technology means that learning times are
shorter and products can be economically manufactured in small, customized batches in a
process called mass customization—the low-cost production of individually customized goods
and services.55 Economies of scope (in which common parts of the manufacturing activities
of various products are combined to gain economies even though small numbers of each prod-
uct are made) replace Economies of scale (in which unit costs are reduced by making large
numbers of the same product) in flexible manufacturing. Flexible manufacturing permits the
low-volume output of custom-tailored products at relatively low unit costs through
economies of scope. It is thus possible to have the cost advantages of continuous systems with
the customer-oriented advantages of intermittent systems. The auto maker, BMW, for exam-
ple, uses flexible manufacturing to customize cars to suit each buyer’s preference. It replaced
its two assembly lines in its Spartanburg, South Carolina, plant with one flexible assembly line
in 2006. According to spokesperson Bunny Richardson, “Until now, if we wanted to introduce
an additional model, we’d have to construct a new line.”56
CHAPTER 5 Internal Scanning: Organizational Analysis 159
extended leaves, and contract work, and especially about the proper use of teams. Over two-
thirds of large U.S. companies are successfully using autonomous (self-managing) work teams
in which a group of people work together without a supervisor to plan, coordinate, and evaluate
their own work.59 Northern Telecom found productivity and quality to increase with work teams
to such an extent that it was able to reduce the number of quality inspectors by 40%.60
As a way to move a product more quickly through its development stage, companies like
Motorola, Chrysler, NCR, Boeing, and General Electric are using cross-functional work teams.
Instead of developing products in a series of steps—beginning with a request from sales, which
leads to design, then to engineering and on to purchasing, and finally to manufacturing (and of-
ten resulting in a costly product rejected by the customer)—companies are tearing down the tra-
ditional walls separating the departments so that people from each discipline can get involved
in projects early on. In a process called concurrent engineering, the once-isolated specialists
now work side by side and compare notes constantly in an effort to design cost-effective prod-
ucts with features customers want. Taking this approach enabled Chrysler Corporation to reduce
its product development cycle from 60 to 36 months.61 For such cross-functional work teams to
be successful, the groups must receive training and coaching. Otherwise, poorly implemented
teams may worsen morale, create divisiveness, and raise the level of cynicism among workers.62
Virtual teams are groups of geographically and/or organizationally dispersed coworkers
that are assembled using a combination of telecommunications and information technologies
to accomplish an organizational task.63 In the U.S. alone, more than half of companies having
over 5,000 employees use virtual teams involving around 8.4 million people.64 According to
the Gartner Group, more than 60% of professional employees now work in virtual teams.65 In-
ternet, intranet, and extranet systems are combining with other new technologies, such as desk-
top video conferencing and collaborative software, to create a new workplace in which teams
of workers are no longer restrained by geography, time, or organizational boundaries. This
technology allows about 12% of the U.S. workforce, who have no permanent office at their
companies, to do team projects over the Internet and report to a manager thousands of miles
away. More than 20 million people in the U.S. are engaged in telecommuting.66 Charles
Grantham of Work Design Collaborative predicts that 40% of the workforce will be working
remotely by 2012.67
As more companies outsource some of the activities previously conducted internally, the
traditional organizational structure is being replaced by a series of virtual teams, which rarely,
if ever, meet face-to-face. Such teams may be established as temporary groups to accomplish a
specific task or may be more permanent to address continuing issues such as strategic planning.
Membership on these teams is often fluid, depending upon the task to be accomplished. They
may include not only employees from different functions within a company, but also members
of various stakeholder groups, such as suppliers, customers, and law or consulting firms. The
use of virtual teams to replace traditional face-to-face work groups is being driven by five trends:
1. Flatter organizational structures with increasing cross-functional coordination need
2. Turbulent environments requiring more inter-organizational cooperation
3. Increasing employee autonomy and participation in decision making
4. Higher knowledge requirements derived from a greater emphasis on service
5. Increasing globalization of trade and corporate activity68
Union Relations and Temporary/Part-Time Workers
If the corporation is unionized, a good human resource manager should be able to work closely
with the union. Even though union membership had dropped to only 12.1% of the U.S. work-
force by 2007 compared to 20.1% in 1983, it still included 15.7 million people. Nevertheless,
160 PART 2 Scanning the Environment
only 7.5% of the 108,714 million private sector employees belonged to a union (compared to
35.9% of public sector employees).69 To save jobs, U.S. unions are increasingly willing to sup-
port new strategic initiatives and employee involvement programs. For example, United Steel
Workers hired Ron Bloom, an investment banker, to propose a strategic plan to make
Goodyear Tire & Rubber globally competitive in a way that would preserve as many jobs as
possible. In a recent contract, the union gave up $1.15 billion in wage and benefit concessions
over three years in return for a promise by Goodyear’s top management to invest in 12 of its
14 U.S. factories, to limit imports from its factories in Brazil and Asia, and to maintain 85%
of its 19,000-person workforce. The company also agreed to aggressively restructure the
firm’s $5 billion debt. According to Bloom, “We told Goodyear, ‘We’ll make you profitable,
but you’re going to adopt this strategy.’. . . We think the company should be a patient, long-
term builder of value for the employees and shareholders.”70
Outside the United States, the average proportion of unionized workers among major in-
dustrialized nations is around 50%. European unions tend to be militant, politically oriented,
and much less interested in working with management to increase efficiency. Nationwide
strikes can occur quickly. In contrast, Japanese unions are typically tied to individual compa-
nies and are usually supportive of management. These differences among countries have sig-
nificant implications for the management of multinational corporations.
To increase flexibility, avoid layoffs, and reduce labor costs, corporations are using more
temporary (also known as contingent) workers. Over 90% of U.S. and European firms use tem-
porary workers in some capacity; 43% use them in professional and technical functions.71 Ap-
proximately 13% of the U.S. workforce are part-time workers. The percentage is even higher
in Japan, where 26% of workers are part-time, and in the Netherlands, where 36% of all em-
ployees work part-time.72 Labor unions are concerned that companies use temps to avoid hir-
ing costlier unionized workers. At United Parcel Service, for example, 80% of the jobs created
from 1993 to 1997 were staffed by part-timers, whose pay rates hadn’t changed since 1982.
Fully 10% of the company’s 128,000 part-timers worked 30 hours or more per week, but were
still paid at a lower rate than were full-time employees.73
Quality of Work Life and Human Diversity
Human resource departments have found that to reduce employee dissatisfaction and union-
ization efforts (or, conversely, to improve employee satisfaction and existing union relations),
they must consider the quality of work life in the design of jobs. Partially a reaction to the tra-
ditionally heavy emphasis on technical and economic factors in job design, quality of work life
emphasizes improving the human dimension of work. The knowledgeable human resource
manager, therefore, should be able to improve the corporation’s quality of work life by (1) in-
troducing participative problem solving, (2) restructuring work, (3) introducing innovative re-
ward systems, and (4) improving the work environment. It is hoped that these improvements
will lead to a more participative corporate culture and thus higher productivity and quality
products. Ford Motor Company, for example, rebuilt and modernized its famous River Rouge
plant using flexible equipment and new processes. Employees work in teams and use Internet-
connected PCs on the shop floor to share their concerns instantly with suppliers or product en-
gineers. Workstations were redesigned to make them more ergonomic and reduce
repetitive-strain injuries. “If you feel good while you’re working, I think quality and produc-
tivity will increase, and Ford thinks that too, otherwise, they wouldn’t do this,” observed Jerry
Sullivan, president of United Auto Workers Local 600.74
Companies are also discovering that by redesigning their plants and offices for improved
energy efficiency, they can receive a side effect of improving their employees’ quality of work
life—thus raising labor productivity. See the Environmental Sustainability Issue feature to
learn how improved energy efficiency can not only cut costs, but also boost employee morale.
CHAPTER 5 Internal Scanning: Organizational Analysis 161
SOURCE: Material based on M. Hirschland, J. M. Oppenheim, and
A. P. Webb, “Using Energy More Efficiently: An Interview with the
Rocky Mountain Institute’s Amory Lovins,” McKinsey Quarterly
(July 2008), pp. 1–7.
lar power, geothermal, small hydro, and waste- or biomass-
fueled plants. Lovins points out that a sixth of the world’s
electricity and a third of new electricity now comes from mi-
cropower because it’s cheaper with lower financial risk.
Lovins points out that energy redesigns often have side
effects that may be far more valuable than the direct sav-
ings. For example, a typical office pays around 160 times
more in payroll than for energy. According to Lovins, his
programs routinely get a 6% to 16% increase gain in la-
bor productivity in more efficient buildings having im-
proved thermal, visual, and acoustic comfort. “When
people can see what they are doing, hear themselves
think, breathe cleaner air, and feel more comfortable, they
do more and better work,” says Lovins.
Amory Lovins, Co-founder
and Chairman of the Rocky
Mountain Institute, works to ed-
ucate business executives on how
the efficient use of energy can lead not only to lower costs,
but also to competitive advantage and increased labor pro-
ductivity. His Rocky Mountain Institute is a nonprofit orga-
nization that develops and implements programs for
energy and resource efficiency. According to Lovins:
In my team’s latest redesigns for $30 billion worth of fa-
cilities in 29 sectors, we consistently found about 30 to
60 percent energy savings that could be captured through
retrofits, which paid for themselves in two to three years.
In new facilities, 40 to 90 percent savings could be
gleaned—and with nearly always lower capital cost.
Lovins’ Rocky Mountain Institute promotes the use of
micropower, on-site or decentralized energy production,
such as waste-heat, or gas-fired cogeneration, wind and so-
USING ENERGY EFFICIENCY FOR COMPETITIVE
ADVANTAGE AND QUALITY OF WORK LIFE
ENVIRONMENTAL sustainability issue
Human diversity refers to the mix in the workplace of people from different races, cul-
tures, and backgrounds. Realizing that the demographics are changing toward an increasing
percentage of minorities and women in the U.S. workforce, companies are now concerned
with hiring and promoting people without regard to ethnic background. Research does indi-
cate that an increase in racial diversity leads to an increase in firm performance.75 In a survey
of 131 leading European companies, 67.2% stated that a diverse work force can provide com-
petitive advantage.76 A manager from Nestlé stated: “To deliver products that meet the needs
of individual consumers, we need people who respect other cultures, embrace diversity, and
never discriminate on any basis.”77 Good human resource managers should be working to en-
sure that people are treated fairly on the job and not harassed by prejudiced co-workers or man-
agers. Otherwise, they may find themselves subject to lawsuits. Coca-Cola Company, for
example, agreed to pay $192.5 million because of discrimination against African-American
salaried employees in pay, promotions, and evaluations from 1995 and 2000. According to
Chairman and CEO Douglas Daft, “Sometimes things happen in an unintentional manner. And
I’ve made it clear that can’t happen anymore.”78
An organization’s human resources may be a key to achieving a sustainable competitive
advantage. Advances in technology are copied almost immediately by competitors around the
world. People, however, are not as willing to move to other companies in other countries. This
means that the only long-term resource advantage remaining to corporations operating in the
industrialized nations may lie in the area of skilled human resources.79 Research does reveal
that competitive strategies are more successfully executed in those companies with a high level
of commitment to their employees than in those firms with less commitment.80
162 PART 2 Scanning the Environment
STRATEGIC INFORMATION SYSTEMS/TECHNOLOGY ISSUES
The primary task of the manager of information systems/technology is to design and manage
the flow of information in an organization in ways that improve productivity and decision
making. Information must be collected, stored, and synthesized in such a manner that it will
answer important operating and strategic questions. A corporation’s information system can be
a strength or a weakness in multiple areas of strategic management. It can not only aid in en-
vironmental scanning and in controlling a company’s many activities, it can also be used as a
strategic weapon in gaining competitive advantage.
Impact on Performance
Information systems/technology offers four main contributions to corporate performance. First,
(beginning in the 1970s with mainframe computers) it is used to automate existing back-office
processes, such as payroll, human resource records, accounts payable and receivable, and to estab-
lish huge databases. Second, (beginning in the 1980s) it is used to automate individual tasks, such
as keeping track of clients and expenses, through the use of personal computers with word process-
ing and spreadsheet software. Corporate databases are accessed to provide sufficient data to ana-
lyze the data and create what-if scenarios. These first two contributions tend to focus on reducing
costs. Third, (beginning in the 1990s) it is used to enhance key business functions, such as market-
ing and operations. This third contribution focuses on productivity improvements. The system pro-
vides customer support and help in distribution and logistics. For example, Federal Express found
that by allowing customers to directly access its package-tracking database via its Internet Web site
instead of their having to ask a human operator, the company saved up to $2 million annually.81
Business processes are analyzed to increase efficiency and productivity via reengineering. Enter-
prise resource planning (ERP) application software, such as SAP, PeopleSoft, Oracle, Baan, and
J.D. Edwards, (discussed further in Chapter 10) is used to integrate worldwide business activities
so that employees need to enter information only once and that information is available to all cor-
porate systems (including accounting) around the world. Fourth, (beginning in 2000) it is used to
develop competitive advantage. For example, American Hospital Supply (AHS), a leading manu-
facturer and distributor of a broad line of products for doctors, laboratories, and hospitals, devel-
oped an order entry distribution system that directly linked the majority of its customers to AHS
computers. The system was successful because it simplified ordering processes for customers, re-
duced costs for both AHS and the customer, and allowed AHS to provide pricing incentives to the
customer. As a result, customer loyalty was high and AHS’s share of the market became large.
A current trend in corporate information systems/technology is the increasing use of the
Internet for marketing, intranets for internal communication, and extranets for logistics and
distribution. An intranet is an information network within an organization that also has access
to the external worldwide Internet. Intranets typically begin as ways to provide employees
with company information such as lists of product prices, fringe benefits, and company poli-
cies. They are then converted into extranets for supply chain management. An extranet is an
information network within an organization that is available to key suppliers and customers.
The key issue in building an extranet is the creation of “fire walls” to block extranet users from
accessing the firm’s or other users’ confidential data. Once this is accomplished, companies
can allow employees, customers, and suppliers to access information and conduct business on
the Internet in a completely automated manner. By connecting these groups, companies hope
to obtain a competitive advantage by reducing the time needed to design and bring new prod-
ucts to market, slashing inventories, customizing manufacturing, and entering new markets.82
A recent development in information systems/technology is Web 2.0. Web 2.0 refers to the
use of wikis, blogs, RSS (Really Simple Syndication), social networks (e.g., MySpace and
Facebook), podcasts, and mash-ups through company Web sites to forge tighter links with cus-
tomers and suppliers and to engage employees more successfully. A 2008 survey by McKinsey
CHAPTER 5 Internal Scanning: Organizational Analysis 163
revealed the percentage of companies using individual Web 2.0 technologies to be Web ser-
vices (58%), blogs (34%), RSS (33%), wikis (32%), podcasts (29%), social networking (28%),
peer-to-peer (18%), and mash-ups (10%). The most heavily used tool is Web services, soft-
ware that makes it easier to exchange information and conduct transactions. Wikis and blogs
are being increasingly used in companies throughout the world. Satisfied users of these infor-
mation technologies report that they are using these tools to interact with their customers, sup-
pliers, and outside experts in product development efforts known as co-creation. For example,
LEGO invited customers to suggest new models interactively and then financially rewarded
the people whose ideas proved marketable.83
Supply Chain Management
The expansion of the marketing-oriented Internet into intranets and extranets is making sig-
nificant contributions to organizational performance through supply chain management.
Supply chain management is the forming of networks for sourcing raw materials, manufac-
turing products or creating services, storing and distributing the goods, and delivering them to
customers and consumers.84 Research indicates that supplier network resources have a signif-
icant impact on firm performance.85 A survey of global executives revealed that their interest
in supply chains was first to reduce costs, and then to improve customer service and get new
products to market faster.86 More than 85% of senior executives stated that improving their
firm’s supply-chain performance was a top priority. Companies, like Wal-Mart, Dell, and Toy-
ota, who are known to be exemplars in supply-chain management, spend only 4% of their rev-
enues on supply chain costs compared to 10% by the average firm.87
Industry leaders are integrating modern information systems into their corporate value
chains to harmonize companywide efforts and to achieve competitive advantage. For example,
Heineken beer distributors input actual depletion figures and replenishment orders to the Nether-
lands brewer through their linked Web pages. This interactive planning system generates time-
phased orders based on actual usage rather than on projected demand. Distributors are then able
to modify plans based on local conditions or changes in marketing. Heineken uses these modifi-
cations to adjust brewing and supply schedules. As a result of this system, lead times have been
reduced from the traditional 10–12 weeks to 4–6 weeks. This time savings is especially useful in
an industry competing on product freshness. In another example, Procter & Gamble participates
in an information network to move the company’s line of consumer products through Wal-Mart’s
many stores. Radio-frequency identification (RFID) tags containing product information is used
to track goods through inventory and distribution channels. As part of the network with Wal-
Mart, P&G knows by cash register and by store what products have passed through the system
every hour of each day. The network is linked by satellite communications on a real-time basis.
With actual point-of-sale information, products are replenished to meet current demand and min-
imize stockouts while maintaining exceptionally low inventories.88
5.5 The Strategic Audit:
A Checklist for Organizational Analysis
One way of conducting an organizational analysis to ascertain a company’s strengths and
weakness is by using the Strategic Audit found in Appendix 1.A at the end of Chapter 1. The
audit provides a checklist of questions by area of concern. For example, Part IV of the audit
examines corporate structure, culture, and resources. It looks at organizational resources and
capabilities in terms of the functional areas of marketing, finance, R&D, operations, human
resources, and information systems, among others.
164 PART 2 Scanning the Environment
TABLE 5–2 Internal Factor Analysis Summary (IFAS Table): Maytag as Example
Internal Factors Weight Rating
Weighted
Score Comments
1 2 3 4 5
Strengths
� Quality Maytag culture
� Experienced top management
� Vertical integration
� Employer relations
� Hoover’s international orientation
.15
.05
.10
.05
.15
5.0
4.2
3.9
3.0
2.8
.75
.21
.39
.15
.42
Quality key to success
Know appliances
Dedicated factories
Good, but deteriorating
Hoover name in cleaners
Weaknesses
� Process-oriented R&D
� Distribution channels
� Financial position
� Global positioning
� Manufacturing facilities
.05
.05
.15
.20
.05
2.2
2.0
2.0
2.1
4.0
.11
.10
.30
.42
.20
Slow on new products
Superstores replacing small dealers
High debt load
Hoover weak outside the United
Kingdom and Australia
Investing now
Total Scores 1.00 3.05
NOTES:
1. List strengths and weaknesses (8–10) in Column 1.
2. Weight each factor from 1.0 (Most Important) to 0.0 (Not Important) in Column 2 based on that factor’s probable impact on the company’s
strategic position. The total weights must sum to 1.00.
3. Rate each factor from 5.0 (Outstanding) to 1.0 (Poor) in Column 3 based on the company’s response to that factor.
4. Multiply each factor’s weight times its rating to obtain each factor’s weighted score in Column 4.
5. Use Column 5 (comments) for rationale used for each factor.
6. Add the individual weighted scores to obtain the total weighted score for the company in Column 4. This tells how well the company is
responding to the factors in its internal environment.
SOURCE: T.L. Wheelen & J.D. Hunger, “Internal Factor Analysis Summary (IFAS)” Copyright © 1987, 1988, 1989, 1990 and 2005 by
T.L. Wheelen. Copyright © 1991, 2003, and 2005 by Wheelen and Hunger Associates. Reprinted by permission.
5.6 Synthesis of Internal Factors
After strategists have scanned the internal organizational environment and identified factors
for their particular corporation, they may want to summarize their analysis of these factors us-
ing a form such as that given in Table 5–2. This IFAS (Internal Factor Analysis Summary)
Table is one way to organize the internal factors into the generally accepted categories of
strengths and weaknesses as well as to analyze how well a particular company’s management
is responding to these specific factors in light of the perceived importance of these factors to
the company. Use the VRIO framework (Value, Rareness, Imitability, & Organization) to as-
sess the importance of each of the factors that might be considered strengths. Except for its in-
ternal orientation, this IFAS Table is built the same way as the EFAS Table described in
Chapter 4 (in Table 4–5). To use the IFAS Table, complete the following steps:
1. In Column 1 (Internal Factors), list the eight to ten most important strengths and weak-
nesses facing the company.
CHAPTER 5 Internal Scanning: Organizational Analysis 165
2. In Column 2 (Weight), assign a weight to each factor from 1.0 (Most Important) to
0.0 (Not Important) based on that factor’s probable impact on a particular company’s
current strategic position. The higher the weight, the more important is this factor to the
current and future success of the company. All weights must sum to 1.0 regardless of
the number of factors.
3. In Column 3 (Rating), assign a rating to each factor from 5.0 (Outstanding) to 1.0 (Poor)
based on management’s specific response to that particular factor. Each rating is a judg-
ment regarding how well the company’s management is currently dealing with each spe-
cific internal factor.
4. In Column 4 (Weighted Score), multiply the weight in Column 2 for each factor times
its rating in Column 3 to obtain that factor’s weighted score.
5. In Column 5 (Comments), note why a particular factor was selected and/or how its
weight and rating were estimated.
6. Finally, add the weighted scores for all the internal factors in Column 4 to determine the
total weighted score for that particular company. The total weighted score indicates how
well a particular company is responding to current and expected factors in its internal en-
vironment. The score can be used to compare that firm to other firms in its industry. Check
to ensure that the total weighted score truly reflects the company’s current performance
in terms of profitability and market share. The total weighted score for an average firm
in an industry is always 3.0.
As an example of this procedure, Table 5–2 includes a number of internal factors for May-
tag Corporation in 1995 (before Maytag was acquired by Whirlpool) with corresponding
weights, ratings, and weighted scores provided. Note that Maytag’s total weighted score is
3.05, meaning that the corporation is about average compared to the strengths and weaknesses
of others in the major home appliance industry.
End of Chapter SUMMARY
Every day, about 17 truckloads of used diesel engines and other parts are dumped at a
receiving facility at Caterpillar’s remanufacturing plant in Corinth, Mississippi. The filthy
iron engines are then broken down by two workers, who manually hammer and drill for
half a day until they have taken every bolt off the engine and put each component into its
own bin. The engines are then cleaned and re-made at a half the cost of a new engine and
sold for a tidy profit. This system works at Caterpillar because as a general rule, 70% of
the cost to build something new is in the materials and 30% is in the labor. Remanufactur-
ing simply starts the manufacturing process over again with materials that are essentially
free and which already contain most of the energy costs needed to make them. The would-
be discards become fodder for the next product, eliminating waste, and cutting costs.
Caterpillar’s management was so impressed by the remanufacturing operation that they
made the business a separate division in 2005. The unit earned more than $1 billion in sales
in 2005 and expects 15% growth for many more years—given the steadily increasing cost
of oil and raw materials.
Caterpillar’s remanufacturing unit was successful not only because of its capability of
wringing productivity out of materials and labor, but also because it designed its products for
re-use. Before they are built new, remanufactured products must be designed for disassembly.
In order to achieve this, Caterpillar asks its designers to check a “Reman” box on Caterpillar’s
166 PART 2 Scanning the Environment
E C O – B I T S
� The average number of plastic bottles used each year in
the U.S. per person: 200
� The average number of plastic bottles recycled each
year in the U.S. per person: 40
� Revenue produced in 2007 by recycling and ancillary
industries: $236 billion
� Share of electronic waste that is hauled overseas,
stripped unsafely, and dumped: 80%90
D I S C U S S I O N Q U E S T I O N S
1. What is the relevance of the resource-based view of the
firm to strategic management in a global environment?
2. How can value-chain analysis help identify a company’s
strengths and weaknesses?
3. In what ways can a corporation’s structure and culture be
internal strengths or weaknesses?
4. What are the pros and cons of management’s using the
experience curve to determine strategy?
5. How might a firm’s management decide whether it
should continue to invest in current known technology or
in new, but untested technology? What factors might en-
courage or discourage such a shift?
S T R A T E G I C P R A C T I C E E X E R C I S E S
Can you analyze a corporation using the Internet? Try the fol-
lowing exercise.
1. Form into teams of around three to five people. Select a
well-known publicly owned company to research. Inform
the instructor of your choice.
2. Assign each person a separate task. One task might be to
find the latest financial statements. Another would be to
learn as much as possible about its top management and
board of directors.Another might be to identify its business
model. Another might be to identify its key competitors.
3. Conduct research on the company using the Internet only.
4. Meet with your team members to discuss what you have
found. What are the company’s opportunities, threats,
strengths, and weaknesses? Go back to the Internet for
more information, if needed.
5. Prepare a 3- to-5 page typed report of the company. The
report should include the following:
a. Does the firm have any core competencies? Are any
of these distinctive (better than the competition)
competencies? Does the firm have any competitive
product development checklist. The company also needs to know where its products are being
used in order to take them back—known as the art of reverse logistics. This is achieved by
Caterpillar’s excellent relationship with its dealers throughout the world as well as through fi-
nancial incentives. For example, when a customer orders a crankshaft, that customer is offered
a remanufactured one for half the cost of a new one—assuming the customer turns in the old
crankshaft to Caterpillar. The products also should be built for performance with little regard
for changing fashion. Since diesel engines change little from year to year, a remanufactured
engine is very similar to a new engine and might perform even better.
Monitoring the external environment is only one part of environmental scanning. Strate-
gists also need to scan a corporation’s internal environment to identify its resources, capabili-
ties, and competencies. What are its strengths and weaknesses? At Caterpillar, management
clearly noted that the environment was changing in a way to make its remanufactured product
more desirable. It took advantage of its strengths in manufacturing and distribution to offer a
recycling service for its current customers and a low-cost alternative product for those who
could not afford a new Caterpillar engine. It also happened to be an environmentally friendly,
sustainable business model. Caterpillar’s management felt that remanufacturing thus provided
them with a strategic advantage over competitors who don’t remanufacture. This is an exam-
ple of a company using its capabilities in key functional areas to expand its business by mov-
ing into a new profitable position on its value chain.89
CHAPTER 5 Internal Scanning: Organizational Analysis 167
K E Y T E R M S
brand (p. 152)
business model (p. 142)
capabilities (p. 138)
capital budgeting (p. 153)
competency (p. 138)
conglomerate structure (p. 148)
continuum of sustainability (p. 141)
core competencies (p. 138)
corporate culture (p. 149)
corporate reputation (p. 152)
distinctive competencies (p. 138)
divisional structure (p. 147)
durability (p. 140)
economies of scale (p. 158)
economies of scope (p. 147)
experience curve (p. 157)
explicit knowledge (p. 141)
financial leverage (p. 153)
functional structure (p. 147)
IFAS Table (p. 164)
imitability (p. 140)
marketing mix (p. 151)
operating leverage (p. 157)
organizational analysis (p. 138)
organizational structures (p. 147)
product life cycle (p. 152)
R&D intensity (p. 154)
R&D mix (p. 154)
replicability (p. 141)
resource (p. 138)
simple structure (p. 147)
strategic business units (SBUs) (p. 148)
supply chain management (p. 163)
tacit knowledge (p. 141)
technological competence (p. 154)
technological discontinuity (p. 155)
technology transfer (p. 154)
transferability (p. 140)
transparency (p. 140)
value chain (p. 143)
virtual teams (p. 159)
VRIO framework (p. 138)
advantage? Provide a SWOT analysis using EFAS
and IFAS Tables.
b. What is the likely future of this firm if it continues on
its current path?
c. Would you buy stock in this company? Assume that
your team has $25,000 to invest. Allocate the money
among the four to five primary competitors in this in-
dustry. List the companies, the number of shares pur-
chased of each, the cost of each share as of a given
date, and the total cost for each purchase assuming a
typical commission used by an Internet broker, such
as E-Trade or Scottrade.
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168 PART 2 Scanning the Environment
CHAPTER 5 Internal Scanning: Organizational Analysis 169
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gust 2006), pp. 701–719.
86. D. Paulonis and S. Norton, “Managing Global Supply Chains,”
McKinsey Quarterly Online (August 2008).
87. M. Cook and R. Hagey, “Why Companies Flunk Supply-Chain
101: Only 33 Percent Correctly Measure Supply-Chain Perfor-
mance; Few Use the Right Incentives,” Journal of Business
Strategy, Vol. 24, No. 4 (2003), pp. 35–42.
88. C. C. Poirer, pp. 3–5. For further information on RFID technol-
ogy, see F. Taghaboni-Dutta and B. Velthouse, “RFID Technol-
ogy is Revolutionary: Who Should Be Involved in This Game
of Tag?” Academy of Management Perspectives (November
2006), pp. 65–78.
89. M. Arndt, “Everything Old Is New Again,” Business Week (Sep-
tember 25, 2006), pp. 64–70.
90. R. Farzad, “Cash for Trash,” Business Week (August 4, 2008),
pp. 36–46.
170 PART 2 Scanning the Environment
Ending Case for Part Two
BOEING BETS THE COMPANY
The Boeing Company, a well-known U.S.-based manu-
facturer of commercial and military aircraft, faced a
dilemma in 2004. Long the leader of the global airframe
manufacturing industry, Boeing had been slowly losing
market share since the 1990s to the European-based Air-
bus Industrie—now incorporated as the European Aero-
nautic & Space Company (EADS). In December 2001,
the EADS board of directors had committed the corpo-
ration to an objective it had never before achieved—tak-
ing from Boeing the leadership of the commercial
aviation industry by building the largest commercial jet
plane in the world, the Airbus 380. The A380 would
carry 481 passengers in a normal multiple-class seating
configuration compared to the 416 passengers carried
by Boeing’s 747—400 in a similar seating configura-
tion. The A380 would not only fly 621 miles farther than
the 747, but it would cost airlines 15%–20% less per
passenger to operate. With orders for 50 A380 aircraft in
hand, the EADS board announced that the new plane
would be ready for delivery during 2006. The proposed
A380 program decimated the sales of Boeing’s jumbo
jet. Since 2000, airlines had ordered only 10 Boeing
747s configured for passengers.
Boeing was clearly a company in difficulty in 2004.
Distracted by the 1996 acquisitions of McDonnell
Douglas and Rockwell Aerospace, Boeing’s top man-
agement had spent the next few years strengthening the
corporation’s historically weak position in aerospace
and defense and had allowed its traditional competency
in commercial aviation to deteriorate. Boeing, once the
manufacturing marvel of the world, was now spending
10%–20% more than EADS (Airbus) to build a plane.
The prices it asked for its planes were thus also higher.
As a result, Boeing’s estimated market share of the com-
mercial market slid from nearly 70% in 1996 to less than
half that by the end of 2003. EADS claimed to have de-
livered 300 aircraft to Boeing’s 285 and to have won
56% of the 396 orders placed by airlines in 2003—quite
an improvement from 1994, when EADS controlled
only one-fifth of the market! This was quite an
accomplishment, given that the A380 was so large that
the modifications needed to accommodate it at airports
would cost $80 to $100 million.
Even though defense sales now accounted for more
than half of the company’s revenues, Boeing’s CEO re-
alized that he needed to quickly act to regain Boeing’s
leadership of the commercial part of the industry. In
December 2003, the board approved the strategic deci-
sion to promote a new commercial airplane, the Boeing
787, for sale to airlines. The 787 was a midrange air-
craft, not a jumbo jet such as the A380. The 787 would
carry between 220 and 250 passengers but consume
20% less fuel and be 10% cheaper to operate than its
competitor, EADS’ current midrange plane, the smaller
wide-body A330-200. It was to be made from a graphite/
epoxy resin instead of aluminum. It was designed to fly
faster, higher, farther, cleaner, more quietly, and more
efficiently than any other medium-sized jet. This was
the first time since approving the 777 jet in 1990 that the
company had launched an all-new plane program. De-
velopment costs were estimated at $8 billion over five
years. Depending on the results of these sales efforts, the
board would decide sometime during 2004 to either be-
gin or cancel the 787 construction program. If approved,
the planes could be delivered in 2008—two years after
the delivery of the A380.
The Boeing 787 decision was based on a completely
different set of assumptions from those used by the EADS
board to approve the A380. EADS top management be-
lieved that the commercial market wanted even larger
jumbo jets to travel long international routes. Airports in
Asia, the Middle East, and Europe were becoming heavily
congested. In these locations, the “hub-and-spoke”
method of creating major airline hubs was flourishing.
Using larger planes was a way of dealing with that con-
gestion by flying more passengers per plane out of these
hubs. EADS management believed that over the next
20 years, airlines and freight carriers would need a mini-
mum of 1,500 more aircraft at least as big as the B747.
EADS management had concluded that the key to con-
trolling the future commercial market was by using larger,
more expensive planes. The A380 was a very large bet on
that future scenario. TheA380 program would cost EADS
almost $13 million before the first plane was delivered.
In contrast, Boeing’s management believed in a very
different future scenario. Noting the success of Southwest
and JetBlue, among other airlines in NorthAmerica, it con-
cluded that no more than 320 extra-large planes would be
This case was written by J. David Hunger for Strategic Management and
Business Policy, 12th edition and for Concepts in Strategic Management
and Business Policy, 12th edition. Copyright © 2008 by J. David
Hunger. Reprinted by permission. References available upon request.
CHAPTER 5 Internal Scanning: Organizational Analysis 171
sold in the future as the airline industry moved away from
hub-and-spoke networks toward more direct flights be-
tween smaller airports. The fragmentation of the airline in-
dustry, with its emphasis on competing through lower
costs was the primary rationale for Boeing’s fuel-efficient
787. A secondary reason was to deal with increasing
passenger complaints about shrinking legroom and seat
room on current planes flown by cost-conscious airlines.
The 787 was designed with larger windows, seats, lava-
tories, and overhead bins. The plane was being designed
in both short- and long-range versions. Boeing’s manage-
ment predicted a market for 2,000 to 3,000 such planes.
Additional support for the midrange plane came from
some industry analysts who predicted that the huge A380
would give new meaning to the term “cattle class.” To
reach necessary economies of scale, the A380 would
likely devote a large portion of both of its decks to econ-
omy class, with passengers sitting three or four across,
the same configuration as most of Boeing’s 747s.
Boeing’s strategy to regain industry leadership with
its proposed 787 airplane meant that the company would
have to increase its manufacturing efficiency in order to
keep the price low. To significantly cut costs, management
would be forced to implement a series of new programs:
� Outsource approximately 70% of manufacturing.
Could it find suppliers who could consistently make
the high-quality parts needed by Boeing?
� Reduce final assembly time to three days (compared
to 20 for its 737 plane) by having suppliers build
completed plane sections. Could this many
suppliers meet Boeing’s exacting deadlines?
� Use new, lightweight composite materials in place
of aluminum to reduce inspection time. Would the
plane be as dependable and as easy to maintain as
Boeing’s aluminum airplanes?
� Resolve poor relations with labor unions caused by
downsizing and outsourcing. The machinists’ union
would have to be given a greater voice in specifying
manufacturing procedures. Would Boeing’s middle
managers be willing to share power with an antago-
nistic union?
Which vision of the future was correct? The long-
term fortunes of both Boeing and EADS depended on
two contrasting strategic decisions, based on two very
different assessments of the market. If EADS was cor-
rect, the market would continue to demand ever-larger
airplanes. If Boeing was correct, the current wave of
jumbo jets had crested, and a new wave of fuel-saving
midrange jets would soon replace them. Which com-
pany’s strategy had the best chance of succeeding?
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PA R T3
Strategy
Formulation
Midamar Corporation is a family-owned company in Cedar Rapids, Iowa, that
has carved out a growing niche for itself in the world food industry: supply-
ing food prepared according to strict religious standards. The company specializes
in halal foods, which are produced and processed according to Islamic law for sale
to Muslims. Why did it focus on this one type of food? According to owner-founder
Bill Aossey, “It’s a big world, and you can only specialize in so many places.”
Although halal foods are not as widely known as kosher foods (processed according to
Judaic law), their market is growing along with Islam, the world’s fastest-growing religion.
Midamar purchases halal-certified meat from Midwestern companies certified to conduct halal
processing. Certification requires practicing Muslims schooled in halal processing to slaughter
the livestock and to oversee meat and poultry processing.
Aossey is a practicing Muslim who did not imagine such a vast market when he founded his
business in 1974. “People thought it would be a passing fad,” remarked Aossey. The company has
grown to the point where it now exports halal-certified beef, lamb, and poultry to hotels, restau-
rants, and distributors in 30 countries throughout Asia, Africa, Europe, and North America. Its cus-
tomers include McDonald’s, Pizza Hut, and KFC. McDonald’s, for example, uses Midamar’s turkey
strips as a bacon-alternative in a breakfast product in Singapore.1
Midamar is successful because its chief executive formulated a strategy designed to give it
an advantage in a very competitive industry. It is an example of a differentiation focus compet-
itive strategy in which a company focuses on a particular target market to provide a differenti-
ated product or service. This strategy is one of the business competitive strategies discussed in
this chapter.
strategy formulation:
situation analysis and
Business Strategy
C H A P T E R 6
175
Gathering
Information
Putting Strategy
into Action
Monitoring
Performance
Societal
Environment:
General forces
Natural
Environment:
Resources and
climate
Task
Environment:
Industry analysis
Internal:
Strengths and
Weaknesses
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
Programs
Activities
needed to
accomplish
a plan
Budgets
Cost of the
programs Procedures
Sequence
of steps
needed to
do the job
Performance
Actual results
External:
Opportunities
and Threats
Developing
Long-range Plans
Mission
Reason for
existence Objectives
What
results to
accomplish
by when
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Environmental
Scanning:
Strategy
Formulation:
Strategy
Implementation:
Evaluation
and Control:
Feedback/Learning: Make corrections as needed
� Organize environmental and
organizational information using SWOT
analysis and a SFAS matrix
� Generate strategic options by using the
TOWS matrix
� Understand the competitive and
cooperative strategies available to
corporations
� List the competitive tactics that would
accompany competitive strategies
� Identify the basic types of strategic
alliances
Learning Objectives
After reading this chapter, you should be able to:
176 PART 3 Strategy Formulation
Strategy formulation, often referred to as strategic planning or long-range planning, is con-
cerned with developing a corporation’s mission, objectives, strategies, and policies. It begins
with situation analysis: the process of finding a strategic fit between external opportunities and
internal strengths while working around external threats and internal weaknesses. As shown in
the Strategic Decision-Making Process in Figure 1–5, step 5(a) is analyzing strategic factors in
light of the current situation using SWOT analysis. SWOT is an acronym used to describe the
particular Strengths, Weaknesses, Opportunities, and Threats that are strategic factors for a spe-
cific company. SWOT analysis should not only result in the identification of a corporation’s dis-
tinctive competencies—the particular capabilities and resources that a firm possesses and the
superior way in which they are used—but also in the identification of opportunities that the firm
is not currently able to take advantage of due to a lack of appropriate resources. Over the years,
SWOT analysis has proven to be the most enduring analytical technique used in strategic man-
agement. For example, in a 2007 McKinsey & Company global survey of 2,700 executives,
82% of the executives stated that the most relevant activities for strategy formulation were eval-
uating the strengths and weaknesses of the organization and identifying top environmental
trends affecting business unit performance over the next three to five years.2 A 2005 survey of
competitive intelligence professionals found that SWOT analysis was used by 82.7% of the re-
spondents, the second most frequently used technique, trailing only competitor analysis.3
It can be said that the essence of strategy is opportunity divided by capacity.4 An oppor-
tunity by itself has no real value unless a company has the capacity (i.e., resources) to take ad-
vantage of that opportunity. This approach, however, considers only opportunities and
strengths when considering alternative strategies. By itself, a distinctive competency in a key
resource or capability is no guarantee of competitive advantage. Weaknesses in other resource
areas can prevent a strategy from being successful. SWOT can thus be used to take a broader
view of strategy through the formula SA � O/(S – W) that is, (Strategic Alternative equals Op-
portunity divided by Strengths minus Weaknesses). This reflects an important issue strategic
managers face: Should we invest more in our strengths to make them even stronger (a distinc-
tive competence) or should we invest in our weaknesses to at least make them competitive?
SWOT analysis, by itself, is not a panacea. Some of the primary criticisms of SWOT
analysis are:
� It generates lengthy lists.
� It uses no weights to reflect priorities.
� It uses ambiguous words and phrases.
� The same factor can be placed in two categories (e.g., a strength may also be a weakness).
� There is no obligation to verify opinions with data or analysis.
� It requires only a single level of analysis.
� There is no logical link to strategy implementation.5
GENERATING A STRATEGIC FACTORS ANALYSIS SUMMARY (SFAS) MATRIX
The EFAS and IFAS Tables plus the SFAS Matrix have been developed to deal with the criti-
cisms of SWOT analysis. When used together, they are a powerful analytical set of tools for
strategic analysis. The SFAS (Strategic Factors Analysis Summary) Matrix summarizes an
organization’s strategic factors by combining the external factors from the EFAS Table with
6.1 Situational Analysis: SWOT Analysis
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 177
the internal factors from the IFAS Table. The EFAS and IFAS examples given of Maytag Cor-
poration (as it was in 1995) in Tables 4–5 and 5–2 list a total of 20 internal and external fac-
tors. These are too many factors for most people to use in strategy formulation. The SFAS
Matrix requires a strategic decision maker to condense these strengths, weaknesses, opportu-
nities, and threats into fewer than 10 strategic factors. This is done by reviewing and revising
the weight given each factor. The revised weights reflect the priority of each factor as a deter-
minant of the company’s future success. The highest-weighted EFAS and IFAS factors should
appear in the SFAS Matrix.
As shown in Figure 6–1, you can create an SFAS Matrix by following these steps:
1. In Column 1 (Strategic Factors), list the most important EFAS and IFAS items. After
each factor, indicate whether it is a Strength (S), Weakness (W), an Opportunity (O), or a
Threat (T).
2. In Column 2 (Weight), assign weights for all of the internal and external strategic factors.
As with the EFAS and IFAS Tables presented earlier, the weight column must total 1.00.
This means that the weights calculated earlier for EFAS and IFAS will probably have to
be adjusted.
3. In Column 3 (Rating), assign a rating of how the company’s management is responding
to each of the strategic factors. These ratings will probably (but not always) be the same
as those listed in the EFAS and IFAS Tables.
4. In Column 4 (Weighted Score), multiply the weight in Column 2 for each factor by its
rating in Column 3 to obtain the factor’s rated score.
5. In Column 5 (Duration), depicted in Figure 6–1, indicate short-term (less than
one year), intermediate-term (one to three years), or long-term (three years and
beyond).
6. In Column 6 (Comments), repeat or revise your comments for each strategic factor from
the previous EFAS and IFAS Tables. The total weighted score for the average firm in
an industry is always 3.0.
The resulting SFAS Matrix is a listing of the firm’s external and internal strategic factors
in one table. The example given in Figure 6–1 is for Maytag Corporation in 1995, before the
firm sold its European and Australian operations and it was acquired by Whirlpool. The SFAS
Matrix includes only the most important factors gathered from environmental scanning and
thus provides information that is essential for strategy formulation. The use of EFAS and IFAS
Tables together with the SFAS Matrix deals with some of the criticisms of SWOT analysis.
For example, the use of the SFAS Matrix reduces the list of factors to a manageable number,
puts weights on each factor, and allows one factor to be listed as both a strength and a weak-
ness (or as an opportunity and a threat).
FINDING A PROPITIOUS NICHE
One desired outcome of analyzing strategic factors is identifying a niche where an organiza-
tion can use its core competencies to take advantage of a particular market opportunity. A niche
is a need in the marketplace that is currently unsatisfied. The goal is to find a propitious
niche—an extremely favorable niche—that is so well suited to the firm’s internal and exter-
nal environment that other corporations are not likely to challenge or dislodge it.6 A niche is
propitious to the extent that it currently is just large enough for one firm to satisfy its demand.
After a firm has found and filled that niche, it is not worth a potential competitor’s time or
money to also go after the same niche. Such a niche may also be called a strategic sweet spot
178 PART 3 Strategy Formulation
FIGURE 6–1 Strategic Factor Analysis Summary (SFAS) Matrix
*The most important external and internal factors are identified in the EFAS and IFAS tables as shown here by shading these factors.
Weighted
External Strategic Factors Weight Rating Score Comments
1 2 3 4 5
Opportunities
O1 Economic integration of
European Community .20 4.1 .82 Acquisition of Hoover
O2 Demographics favor quality
appliances .10 5.0 .50 Maytag quality
O3 Economic development of Asia .05 1.0 .05 Low Maytag presence
O4 Opening of Eastern Europe .05 2.0 .10 Will take time
O5 Trend to “Super Stores” .10 1.8 .18 Maytag weak in this channel
Threats
T1 Increasing government regulations .10 4.3 .43 Well positioned
T2 Strong U.S. competition .10 4.0 .40 Well positioned
T3 Whirlpool and Electrolux strong
globally .15 3.0 .45 Hoover weak globally
T4 New product advances .05 1.2 .06 Questionable
T5 Japanese appliance companies .10 1.6 .16 Only Asian presence is Australia
Total Scores 1.00 3.15
Weighted
Internal Strategic Factors Weight Rating Score Comments
1 2 3 4 5
Strengths
S1 Quality Maytag culture .15 5.0 .75 Quality key to success
S2 Experienced top management .05 4.2 .21 Know appliances
S3 Vertical integration .10 3.9 .39 Dedicated factories
S4 Employee relations .05 3.0 .15 Good, but deteriorating
S5 Hoover’s international orientation .15 2.8 .42 Hoover name in cleaners
Weaknesses
W1 Process-oriented R&D .05 2.2 .11 Slow on new products
W2 Distribution channels .05 2.0 .10 Superstores replacing small
dealers
W3 Financial position .15 2.0 .30 High debt load
W4 Global positioning .20 2.1 .42 Hoover weak outside the
United Kingdom and
Australia
W5 Manufacturing facilities .05 4.0 .20 Investing now
Total Scores 1.00 3.05
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 179
1 2 3 4 Duration 5 6
I
N
T
E
R
M
E
Strategic Factors (Select the most S D
important opportunities/threats H I L
from EFAS, Table 4–5 and the most O A O
important strengths and weaknesses Weighted R T N
from IFAS, Table 5–2) Weight Rating Score T E G Comments
S1 Quality Maytag culture (S) .10 5.0 .50 X Quality key to success
S5 Hoover’s international
orientation (S) .10 2.8 .28 X X Name recognition
W3 Financial position (W) .10 2.0 .20 X X High debt
W4 Global positioning (W) .15 2.2 .33 X X Only in N.A., U.K., and
Australia
O1 Economic integration of
European Community (O) .10 4.1 .41 X Acquisition of Hoover
O2 Demographics favor quality (O) .10 5.0 .50 X Maytag quality
O5 Trend to super stores (O + T) .10 1.8 .18 X Weak in this channel
T3 Whirlpool and Electrolux (T) .15 3.0 .45 X Dominate industry
T5 Japanese appliance
companies (T) .10 1.6 .16 X Asian presence
Total Scores 1.00 3.01
Notes:
1. List each of the most important factors developed in your IFAS and EFAS Tables in Column 1.
2. Weight each factor from 1.0 (Most Important) to 0.0 (Not Important) in Column 2 based on that factor’s probable impact on the compa-
ny’s strategic position. The total weights must sum to 1.00.
3. Rate each factor from 5.0 (Outstanding) to 1.0 (Poor) in Column 3 based on the company’s response to that factor.
4. Multiply each factor’s weight times its rating to obtain each factor’s weighted score in Column 4.
5. For duration in Column 5, check appropriate column (short term—less than 1 year; intermediate—1 to 3 years; long term—over 3 years).
6. Use Column 6 (comments) for rationale used for each factor.
SOURCE: T.L. Wheelen, J.D. Hunger, “Strategic Factor Analysis Summary (SFAS).” Copyright © 1987, 1988, 1989, 1990, 1991, 1992, 1993,
1994, 1995, 1996 and 2005 by T.L. Wheelen Copyright © 1997 and 2005 by Wheelen and Associates. Reprinted by permission.
(see Figure 6–2)—where a company is able to satisfy customers’ needs in a way that rivals
cannot, given the context in which it operates.7
Finding such a niche or sweet spot is not always easy. A firm’s management must be al-
ways looking for a strategic window—that is, a unique market opportunity that is available
only for a particular time. The first firm through a strategic window can occupy a propitious
niche and discourage competition (if the firm has the required internal strengths). One com-
pany that successfully found a propitious niche was Frank J. Zamboni & Company, the man-
ufacturer of the machines that smooth the ice at ice skating rinks. Frank Zamboni invented the
180 PART 3 Strategy Formulation
The Strategic Sweet Spot
The strategic sweet spot of a company
is where it meets customers’ needs in
a way that rivals can’t, given the context
in which it competes.
COMPANY’S
capabilities
CONTEXT
(technology, industry,
demographics, regulation, and so on)
COMPETITORS’
offerings
CUSTOMERS’
needs
SWEET
SPOT
FIGURE 6–2
The Strategic
Sweet Spot
unique tractor-like machine in 1949 and no one has found a substitute for what it does. Before
the machine was invented, people had to clean and scrape the ice by hand to prepare the sur-
face for skating. Now hockey fans look forward to intermissions just to watch “the Zamboni”
slowly drive up and down the ice rink, turning rough, scraped ice into a smooth mirror
surface—almost like magic. So long as Zamboni’s company was able to produce the ma-
chines in the quantity and quality desired, at a reasonable price, it was not worth another com-
pany’s while to go after Frank Zamboni & Company’s propitious niche.
As a niche grows, so can a company within that niche—by increasing its operations’ ca-
pacity or through alliances with larger firms. The key is to identify a market opportunity in
which the first firm to reach that market segment can obtain and keep dominant market share.
For example, Church & Dwight was the first company in the United States to successfully mar-
ket sodium bicarbonate for use in cooking. Its Arm & Hammer brand baking soda is still found
in 95% of all U.S. households. The propitious niche concept is crucial to the software indus-
try. Small initial demand in emerging markets allows new entrepreneurial ventures to go after
niches too small to be noticed by established companies. When Microsoft developed its first
disk operating system (DOS) in 1980 for IBM’s personal computers, for example, the demand
for such open systems software was very small—a small niche for a then very small Microsoft.
The company was able to fill that niche and to successfully grow with it.
Niches can also change—sometimes faster than a firm can adapt to that change. A com-
pany’s management may discover in their situation analysis that they need to invest heavily
in the firm’s capabilities to keep them competitively strong in a changing niche. South African
SOURCE: D. J. Collis and M. G. Rukstad, “Can You Say What Your Strategy Is?” Reprinted by permission of Harvard
Business Review. ‘The Strategic Sweet Spot’ from “Can You Say What Strategy is?” by D. J. Collis & M. G. Rukstad
April 2008. Copyright © 2008 by the Harvard Business School Publishing Corporation. All rights reserved.
Out of 50 beers drunk by
South Africans, 49 are
brewed by South African
Breweries (SAB). Founded
more than a century ago, SAB
controlled most of the local beer mar-
ket by 1950 with brands such as Castle and Lion. When the
government repealed the ban on the sale of alcohol to
blacks in the 1960s, SAB and other brewers competed for
the rapidly growing market. SAB fought successfully to re-
tain its dominance of the market. With the end of
apartheid, foreign brewers have been tempted to break
SAB’s near-monopoly but have been deterred by the entry
barriers SAB has erected:
Entry Barrier #1: Every year for the past two decades SAB
has reduced its prices. The “real” (adjusted for inflation)
price of its beer is now half what it was during the
1970s. SAB has been able to achieve this through a
continuous emphasis on productivity improvements—
boosting production while cutting the workforce al-
most in half. Keeping prices low has been key to SAB’s
avoiding charges of abusing its monopoly.
Entry Barrier #2: In South Africa’s poor and rural areas,
roads are rough, and electricity is undependable. SAB
has long experience in transporting crates to remote vil-
lages along bad roads and making sure that distributors
have refrigerators (and electricity generators if needed).
Many of its distributors are former employees who have
Breweries (SAB), for example, took this approach when management realized that the only
way to keep competitors out of its market was to continuously invest in increased productiv-
ity and infrastructure in order to keep its prices very low. See the Global Issue feature to see
how SAB was able to successfully defend its market niche during significant changes in its
environment.
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 181
GLOBAL issue
SAB DEFENDS ITS PROPITIOUS NICHE
been helped by the company to start their own truck-
ing businesses.
Entry Barrier #3: Most of the beer sold in South Africa is
sold through unlicensed pubs called shebeens—most of
which date back to apartheid, when blacks were not al-
lowed licenses. Although the current government of
South Africa would be pleased to grant pub licenses to
blacks, the shebeen owners don’t want them. They en-
joy not paying any taxes. SAB cannot sell directly to the
shebeens, but it does so indirectly through wholesalers.
The government, in turn, ignores the situation, prefer-
ring that people drink SAB beer than potentially deadly
moonshine.
To break into South Africa, a new entrant would have
to build large breweries and a substantial distribution net-
work. SAB would, in turn, probably reduce its prices still
further to defend its market. The difficulties of operating in
South Africa are too great, the market is growing too
slowly, and (given SAB’s low cost position) the likely profit
margin is too low to justify entering the market. Some for-
eign brewers, such as Heineken, would rather use SAB to
distribute their products throughout South Africa. With its
home market secure, SAB purchased Miller Brewing to se-
cure a strong presence in North America.
SOURCE: Summarized from “Big Lion, Small Cage,” The Economist
(August 12, 2000), p. 56, and other sources.
6.2 Review of Mission and Objectives
A reexamination of an organization’s current mission and objectives must be made before al-
ternative strategies can be generated and evaluated. Even when formulating strategy, decision
makers tend to concentrate on the alternatives—the action possibilities—rather than on a mis-
sion to be fulfilled and objectives to be achieved. This tendency is so attractive because it is
much easier to deal with alternative courses of action that exist right here and now than to re-
ally think about what you want to accomplish in the future. The end result is that we often
choose strategies that set our objectives for us rather than having our choices incorporate clear
objectives and a mission statement.
182 PART 3 Strategy Formulation
6.3 Generating Alternative Strategies
by Using a TOWS Matrix
Thus far we have discussed how a firm uses SWOT analysis to assess its situation. SWOT can
also be used to generate a number of possible alternative strategies. The TOWS Matrix
(TOWS is just another way of saying SWOT) illustrates how the external opportunities and
threats facing a particular corporation can be matched with that company’s internal strengths
and weaknesses to result in four sets of possible strategic alternatives. (See Figure 6–3.) This
is a good way to use brainstorming to create alternative strategies that might not otherwise be
considered. It forces strategic managers to create various kinds of growth as well as retrench-
ment strategies. It can be used to generate corporate as well as business strategies.
INTERNAL
FACTORS
(IFAS)
EXTERNAL
FACTORS
(EFAS)
Strengths (S) Weaknesses (W)
Opportunities (O)
Threats (T)
SO Strategies WO Strategies
ST Strategies
List 5 – 10 internal
strengths here
List 5 – 10 internal
weaknesses here
List 5 – 10 external
opportunities here
List 5 – 10 external
threats here
Generate strategies here
that use strengths to take
advantage of opportunities
Generate strategies here
that use strengths to
avoid threats
Generate strategies here
that minimize weaknesses
and avoid threats
Generate strategies here
that take advantage of
opportunities by
overcoming weaknesses
WT Strategies
FIGURE 6–3
TOWS Matrix
Problems in performance can derive from an inappropriate statement of mission, which
may be too narrow or too broad. If the mission does not provide a common thread (a unify-
ing theme) for a corporation’s businesses, managers may be unclear about where the company
is heading. Objectives and strategies might be in conflict with each other. Divisions might be
competing against one another rather than against outside competition—to the detriment of the
corporation as a whole.
A company’s objectives can also be inappropriately stated. They can either focus too much
on short-term operational goals or be so general that they provide little real guidance. There may
be a gap between planned and achieved objectives. When such a gap occurs, either the strategies
have to be changed to improve performance or the objectives need to be adjusted downward to
be more realistic. Consequently, objectives should be constantly reviewed to ensure their useful-
ness. This is what happened at Boeing when management decided to change its primary objec-
tive from being the largest in the industry to being the most profitable. This had a significant
effect on its strategies and policies. Following its new objective, the company cancelled its pol-
icy of competing with Airbus on price and abandoned its commitment to maintaining a manu-
facturing capacity that could produce more than half a peak year’s demand for airplanes.8
SOURCE: Reprinted from Long-Range Planning, Vol. 15, No. 2, 1982, Weihrich “The TOWS Matrix—A Tool For
Situational Analysis,” p. 60. Copyright © 1982 with permission of Elsevier.
To generate a TOWS Matrix for Maytag Corporation in 1995, for example, use the Exter-
nal Factor Analysis Summary (EFAS) Table listed in Table 4–5 from Chapter 4 and the In-
ternal Factor Analysis Summary (IFAS) Table listed in Table 5–2 from Chapter 5. To build
Figure 6–4, take the following steps:
1. In the Opportunities (O) block, list the external opportunities available in the company’s
or business unit’s current and future environment from the EFAS Table (Table 4–5).
2. In the Threats (T) block, list the external threats facing the company or unit now and in
the future from the EFAS Table (Table 4–5).
3. In the Strengths (S) block, list the specific areas of current and future strength for the
company or unit from the IFAS Table (Table 5–2).
4. In the Weaknesses (W) block, list the specific areas of current and future weakness for
the company or unit from the IFAS Table (Table 5–2).
5. Generate a series of possible strategies for the company or business unit under consider-
ation based on particular combinations of the four sets of factors:
� SO Strategies are generated by thinking of ways in which a company or business unit
could use its strengths to take advantage of opportunities.
� ST Strategies consider a company’s or unit’s strengths as a way to avoid threats.
� WO Strategies attempt to take advantage of opportunities by overcoming weaknesses.
� WT Strategies are basically defensive and primarily act to minimize weaknesses and
avoid threats.
The TOWS Matrix is very useful for generating a series of alternatives that the decision
makers of a company or business unit might not otherwise have considered. It can be used for
the corporation as a whole (as is done in Figure 6–4 with Maytag Corporation before it sold
Hoover Europe), or it can be used for a specific business unit within a corporation (such as
Hoover’s floor care products). Nevertheless using a TOWS Matrix is only one of many ways
to generate alternative strategies. Another approach is to evaluate each business unit within a
corporation in terms of possible competitive and cooperative strategies.
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 183
6.4 Business Strategies
Business strategy focuses on improving the competitive position of a company’s or business
unit’s products or services within the specific industry or market segment that the company or
business unit serves. Business strategy is extremely important because research shows that
business unit effects have double the impact on overall company performance than do either
corporate or industry effects.9 Business strategy can be competitive (battling against all com-
petitors for advantage) and/or cooperative (working with one or more companies to gain ad-
vantage against other competitors). Just as corporate strategy asks what industry(ies) the
company should be in, business strategy asks how the company or its units should compete or
cooperate in each industry.
PORTER’S COMPETITIVE STRATEGIES
Competitive strategy raises the following questions:
� Should we compete on the basis of lower cost (and thus price), or should we differentiate
our products or services on some basis other than cost, such as quality or service?
184 PART 3 Strategy Formulation
FIGURE 6–4 Generating a TOWS Matrix for Maytag Corporation
*The most important external and internal factors are identified in the EFAS and IFAS Tables as shown here by shading these factors.
Weighted
Internal Strategic Factors Weight Rating Score Comments
1 2 3 4 5
Strengths
S1 Quality Maytag culture .15 5.0 .75 Quality key to success
S2 Experienced top management .05 4.2 .21 Know appliances
S3 Vertical integration .10 3.9 .39 Dedicated factories
S4 Employee relations .05 3.0 .15 Good, but deteriorating
S5 Hoover’s international orientation .15 2.8 .42 Hoover name in cleaners
Weaknesses
W1 Process-oriented R&D .05 2.2 .11 Slow on new products
W2 Distribution channels .05 2.0 .10 Superstores replacing small
dealers
W3 Financial position .15 2.0 .30 High debt load
W4 Global positioning .20 2.1 .42 Hoover weak outside the
United Kingdom and
Australia
W5 Manufacturing facilities .05 4.0 .20 Investing now
Total Scores 1.00 3.05
Weighted
External Strategic Factors Weight Rating Score Comments
1 2 3 4 5
Opportunities
O1 Economic integration of
European Community .20 4.1 .82 Acquisition of Hoover
O2 Demographics favor quality
appliances .10 5.0 .50 Maytag quality
O3 Economic development of Asia .05 1.0 .05 Low Maytag presence
O4 Opening of Eastern Europe .05 2.0 .10 Will take time
O5 Trend to “Super Stores” .10 1.8 .18 Maytag weak in this channel
Threats
T1 Increasing government regulations .10 4.3 .43 Well positioned
T2 Strong U.S. competition .10 4.0 .40 Well positioned
T3 Whirlpool and Electrolux strong
globally .15 3.0 .45 Hoover weak globally
T4 New product advances .05 1.2 .06 Questionable
T5 Japanese appliance companies .10 1.6 .16 Only Asian presence is Australia
Total Scores 1.00 3.15
Internal Factors
(IFAS Table 5–2)
Strengths (S) Weaknesses (W)
S1 Quality Maytag culture W1 Process-oriented R&D
External Factors
S2 Experienced top management W2 Distribution channels
(EFAS Table 4–5)
S3 Vertical integration W3 Financial position
S4 Employee relations W4 Global positioning
S5 Hoover’s international orientation W5 Manufacturing facilities
Opportunities (O) SO Strategies WO Strategies
O1 Economic integration of • Use worldwide Hoover distribution • Expand Hoover’s presence in
European Community channels to sell both Hoover and continental Europe by improving
O2 Demographics favor quality Maytag major appliances. Hoover quality and reducing
O3 Economic development of Asia • Find joint venture partners in manufacturing and distribution costs.
O4 Opening of Eastern Europe Eastern Europe and Asia. • Emphasize superstore channel for all
O5 Trend toward super stores non-Maytag brands.
Threats (T) ST Strategies WT Strategies
T1 Increasing government regulation • Acquire Raytheon’s appliance • Sell off Dixie-Narco Division to
T2 Strong U.S. competition business to increase U.S. market reduce debt.
T3 Whirlpool and Electrolux share. • Emphasize cost reduction to reduce
positioned for global economy • Merge with a Japanese major home break-even point.
T4 New product advances appliance company. • Sell out to Raytheon or a Japanese
T5 Japanese appliance companies • Sell off all non-Maytag brands and firm.
strongly defend Maytag’s U.S. niche.
Strengths
Weaknesses
Oppor
tu
niti
es
Threa
ts
� Should we compete head to head with our major competitors for the biggest but most
sought-after share of the market, or should we focus on a niche in which we can satisfy a
less sought-after but also profitable segment of the market?
Michael Porter proposes two “generic” competitive strategies for outperforming other
corporations in a particular industry: lower cost and differentiation.10 These strategies are
called generic because they can be pursued by any type or size of business firm, even by not-
for-profit organizations:
� Lower cost strategy is the ability of a company or a business unit to design, produce, and
market a comparable product more efficiently than its competitors.
� Differentiation strategy is the ability of a company to provide unique and superior value
to the buyer in terms of product quality, special features, or after-sale service.
Porter further proposes that a firm’s competitive advantage in an industry is determined
by its competitive scope, that is, the breadth of the company’s or business unit’s target mar-
ket. Before using one of the two generic competitive strategies (lower cost or differentiation),
the firm or unit must choose the range of product varieties it will produce, the distribution
channels it will employ, the types of buyers it will serve, the geographic areas in which it will
sell, and the array of related industries in which it will also compete. This should reflect an
understanding of the firm’s unique resources. Simply put, a company or business unit can
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 185
choose a broad target (that is, aim at the middle of the mass market) or a narrow target (that
is, aim at a market niche). Combining these two types of target markets with the two compet-
itive strategies results in the four variations of generic strategies depicted in Figure 6–5.
When the lower-cost and differentiation strategies have a broad mass-market target, they are
simply called cost leadership and differentiation. When they are focused on a market niche
(narrow target), however, they are called cost focus and differentiation focus. Although re-
search does indicate that established firms pursuing broad-scope strategies outperform firms
following narrow-scope strategies in terms of ROA (Return on Assets), new entrepreneurial
firms have a better chance of surviving if they follow a narrow-scope rather than a broad-
scope strategy.11
Cost leadership is a lower-cost competitive strategy that aims at the broad mass market
and requires “aggressive construction of efficient-scale facilities, vigorous pursuit of cost re-
ductions from experience, tight cost and overhead control, avoidance of marginal customer ac-
counts, and cost minimization in areas like R&D, service, sales force, advertising, and so
on.”12 Because of its lower costs, the cost leader is able to charge a lower price for its products
than its competitors and still make a satisfactory profit. Although it may not necessarily have
the lowest costs in the industry, it has lower costs than its competitors. Some companies suc-
cessfully following this strategy are Wal-Mart (discount retailing), McDonald’s (fast-food
restaurants), Dell (computers), Alamo (rental cars), Aldi (grocery stores), Southwest Airlines,
and Timex (watches). Having a lower-cost position also gives a company or business unit a
defense against rivals. Its lower costs allow it to continue to earn profits during times of heavy
competition. Its high market share means that it will have high bargaining power relative to its
suppliers (because it buys in large quantities). Its low price will also serve as a barrier to entry
because few new entrants will be able to match the leader’s cost advantage. As a result, cost
leaders are likely to earn above-average returns on investment.
Differentiation is aimed at the broad mass market and involves the creation of a product or
service that is perceived throughout its industry as unique. The company or business unit may
then charge a premium for its product. This specialty can be associated with design or brand im-
age, technology, features, a dealer network, or customer service. Differentiation is a viable strat-
186 PART 3 Strategy Formulation
Competitive Advantage
Lower Cost Differentiation
N
ar
ro
w
T
ar
ge
t
B
ro
ad
T
ar
ge
t
Cost Leadership Differentiation
Cost Focus Differentiation Focus
C
o
m
p
et
it
iv
e
S
co
p
e
FIGURE 6–5
Porter’s Generic
Competitive
Strategies
SOURCE: Reprinted with permission of The Free Press, A Division of Simon & Schuster, from THE COMPETITIVE
ADVANTAGE OF NATIONS by Michael E. Porter. Copyright © 1990, 1998 by The Free Press. All rights reserved.
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 187
egy for earning above-average returns in a specific business because the resulting brand loyalty
lowers customers’ sensitivity to price. Increased costs can usually be passed on to the buyers.
Buyer loyalty also serves as an entry barrier; new firms must develop their own distinctive com-
petence to differentiate their products in some way in order to compete successfully. Examples
of companies that successfully use a differentiation strategy are Walt Disney Productions (en-
tertainment), BMW (automobiles), Nike (athletic shoes), Apple Computer (computers and cell
phones), and Pacar (trucks). Pacar Inc., for example, charges 10% more for its Kenworth and
Peterbilt 10-wheel diesel trucks than does market-leader Chrysler’s Freightliner because of its
focus on product quality and a superior dealer experience.13 Research does suggest that a differ-
entiation strategy is more likely to generate higher profits than does a low-cost strategy because
differentiation creates a better entry barrier. A low-cost strategy is more likely, however, to gen-
erate increases in market share.14 For an example of a differentiation strategy based upon envi-
ronmental sustainability, see the Environmental Sustainability Issue feature on Patagonia.
Cost focus is a low-cost competitive strategy that focuses on a particular buyer group or
geographic market and attempts to serve only this niche, to the exclusion of others. In using
cost focus, the company or business unit seeks a cost advantage in its target segment. A good
example of this strategy is Potlach Corporation, a manufacturer of toilet tissue. Rather than
Patagonia is a highly re-
spected designer and manu-
facturer of outdoor clothing,
outdoor gear, footwear, and lug-
gage. Founded by Yvon Chouinard, an avid surfer and out-
doorsman, the company reflects his commitment to both
quality clothing and sustainable business practices. Since
its founding in 1973, Patagonia has grown at a healthy
rate and retained an excellent reputation in a highly com-
petitive industry. It uses a differentiation competitive strat-
egy emphasizing quality, but defines quality in a way
differently from most other companies.
Our definition of quality includes a mandate for build-
ing products and working with processes that cause the
least harm to the environment. We evaluate raw mate-
rials, invest in innovative technologies, rigorously police
our waste and use a portion (1%) of our sales to sup-
port groups working to make a real difference. We ac-
knowledge that the wild world we love best is
disappearing. That is why those of us who work here
share a strong commitment to protecting undomesti-
cated lands and waters. We believe in using business to
inspire solutions to the environmental crisis.
Patagonia’s Web site includes not only the usual infor-
mation about its products lines, but also an environmental
section that examines the company’s business practices. Its
PATAGONIA USES SUSTAINABILITY
AS DIFFERENTIATION COMPETITIVE STRATEGY
ENVIRONMENTAL sustainability issue
Footprint Chronicles is an interactive mini-site that allows
the viewer to track the impact of 10 specific Patagonia prod-
ucts from design through delivery. For example, the down
sweater page tells how the company uses high-quality
goose down from humanely raised geese. The down is min-
imally processed and the shell is made of recycled polyester.
One problem is that the company had to increase the
weight of the shell fabric when it switched to recycled
polyester. Another problem is that the zipper is treated
with a water repellent that contains perfluorooctanoic acid
(PFOA), which has been found to persist in the environ-
ment and is not recyclable. The Web page tells that the
company is investigating alternatives to the use of PFOA in
water repellents and looking for ways to recycle down gar-
ments. The page then asks for feedback and gives the
viewer the opportunity to see what others are saying.
Chairman Chouinard is proud of his company’s reputa-
tion as a “green” company, but also wants the firm to be
economically sustainable as well. According to Chouinard,
“I look at this company as an experiment to see if we can
run it so it’s here 100 years from now and always makes
the best-quality stuff.”
SOURCE: S. Hamm, “A Passion for the Plan,” Business Week (Au-
gust 21/28, 2006), pp. 92–93 and corporate Web site accessed
September 17, 2008, www.patagonia.com.
www.patagonia.com
188 PART 3 Strategy Formulation
compete directly against Procter & Gamble’s Charmin, Potlach makes the house brands for Al-
bertson’s, Safeway, Jewel, and many other grocery store chains. It matches the quality of the
well-known brands, but keeps costs low by eliminating advertising and promotion expenses.
As a result, Spokane-based Potlach makes 92% of the private-label bathroom tissue and one-
third of all bathroom tissue sold in Western U.S. grocery stores.15
Differentiation focus, like cost focus, concentrates on a particular buyer group, product
line segment, or geographic market. This is the strategy successfully followed by Midamar
Corporation (distributor of halal foods), Morgan Motor Car Company (a manufacturer of clas-
sic British sports cars), Nickelodeon (a cable channel for children), Orphagenix (pharmaceu-
ticals), and local ethnic grocery stores. In using differentiation focus, a company or business
unit seeks differentiation in a targeted market segment. This strategy is valued by those who
believe that a company or a unit that focuses its efforts is better able to serve the special needs
of a narrow strategic target more effectively than can its competition. For example, Orpha-
genix is a small biotech pharmaceutical company that avoids head-to-head competition with
big companies like AstraZenica and Merck by developing “orphan” drugs to target diseases
that affect fewer than 200,000 people—diseases such as sickle cell anemia and spinal muscu-
lar atrophy that big drug makers are overlooking.16
Risks in Competitive Strategies
No one competitive strategy is guaranteed to achieve success, and some companies that have
successfully implemented one of Porter’s competitive strategies have found that they could not
sustain the strategy. As shown in Table 6–1, each of the generic strategies has risks. For ex-
ample, a company following a differentiation strategy must ensure that the higher price it
charges for its higher quality is not too far above the price of the competition; otherwise cus-
tomers will not see the extra quality as worth the extra cost. This is what is meant in Table 6.1
by the term cost proximity. For years, Deere & Company was the leader in farm machinery
until low-cost competitors from India and other developing countries began making low-
priced products. Deere responded by building high-tech flexible manufacturing plants using
mass-customization to cut its manufacturing costs and using innovation to create differenti-
ated products which, although higher-priced, reduced customers’ labor and fuel expenses.17
TABLE 6–1 Risks of Generic Competitive Strategies
Risks of Cost Leadership Risks of Differentiation Risks of Focus
Cost leadership is not sustained:
� Competitors imitate.
� Technology changes.
� Other bases for cost leadership
erode.
Differentiation is not sustained:
� Competitors imitate.
� Bases for differentiation become
less important to buyers.
The focus strategy is imitated.
The target segment becomes structurally
unattractive:
� Structure erodes.
� Demand disappears.
Proximity in differentiation is lost. Cost proximity is lost. Broadly targeted competitors overwhelm
the segment:
� The segment’s differences from other
segments narrow.
� The advantages of a broad line increase.
Cost focusers achieve even lower
cost in segments.
Differentiation focusers achieve even
greater differentiation in segments.
New focusers subsegment the industry.
SOURCE: Reprinted with permission of The Free Press, a Division of Simon & Schuster, Inc. from COMPETITIVE ADVANTAGE: Creating and
Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1998 by The Free Press. All rights reserved.
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 189
Issues in Competitive Strategies
Porter argues that to be successful, a company or business unit must achieve one of the previ-
ously mentioned generic competitive strategies. Otherwise, the company or business unit is
stuck in the middle of the competitive marketplace with no competitive advantage and is
doomed to below-average performance. A classic example of a company that found itself stuck
in the middle was K-Mart. The company spent a lot of money trying to imitate both Wal-Mart’s
low-cost strategy and Target’s quality differentiation strategy—only to end up in bankruptcy
with no clear competitive advantage. Although some studies do support Porter’s argument that
companies tend to sort themselves into either lower cost or differentiation strategies and that
successful companies emphasize only one strategy,18 other research suggests that some com-
bination of the two competitive strategies may also be successful.19
The Toyota and Honda auto companies are often presented as examples of successful
firms able to achieve both of these generic competitive strategies. Thanks to advances in tech-
nology, a company may be able to design quality into a product or service in such a way that
it can achieve both high quality and high market share—thus lowering costs.20 Although Porter
agrees that it is possible for a company or a business unit to achieve low cost and differentia-
tion simultaneously, he continues to argue that this state is often temporary.21 Porter does ad-
mit, however, that many different kinds of potentially profitable competitive strategies exist.
Although there is generally room for only one company to successfully pursue the mass-
market cost leadership strategy (because it is so dependent on achieving dominant market
share), there is room for an almost unlimited number of differentiation and focus strategies
(depending on the range of possible desirable features and the number of identifiable market
niches). Quality, alone, has eight different dimensions—each with the potential of providing a
product with a competitive advantage (see Table 6–2).
Most entrepreneurial ventures follow focus strategies. The successful ones differentiate
their product from those of other competitors in the areas of quality and service, and they fo-
cus the product on customer needs in a segment of the market, thereby achieving a dominant
TABLE 6–2 1. Performance
2. Features
3. Reliability
4. Conformance
5. Durability
6. Serviceability
7. Aesthetics
8. Perceived Quality
Primary operating characteristics, such as a washing machine’s cleaning
ability.
“Bells and whistles,” such as cruise control in a car, that supplement the
basic functions.
Probability that the product will continue functioning without any
significant maintenance.
Degree to which a product meets standards. When a customer buys a
product out of the warehouse, it should perform identically to that viewed
on the showroom floor.
Number of years of service a consumer can expect from a product before
it significantly deteriorates. Differs from reliability in that a product can
be durable but still need a lot of maintenance.
Product’s ease of repair.
How a product looks, feels, sounds, tastes, or smells.
Product’s overall reputation. Especially important if there are no
objective, easily used measures of quality.
SOURCE: Reprinted with the permission of The Free Press, A Division of Simon & Schuster, Inc. from
MANAGING QUALITY: The Strategic and Competitive Edge by David A. Garvin. Copyright © 1988 by
David A. Garvin. All rights reserved.
The Eight
Dimensions
of Quality
190 PART 3 Strategy Formulation
share of that part of the market. Adopting guerrilla warfare tactics, these companies go after
opportunities in market niches too small to justify retaliation from the market leaders.
Industry Structure and Competitive Strategy
Although each of Porter’s generic competitive strategies may be used in any industry, certain
strategies are more likely to succeed than others in some instances. In a fragmented industry,
for example, where many small- and medium-sized local companies compete for relatively
small shares of the total market, focus strategies will likely predominate. Fragmented indus-
tries are typical for products in the early stages of their life cycles. If few economies are to be
gained through size, no large firms will emerge and entry barriers will be low—allowing a
stream of new entrants into the industry. Chinese restaurants, veterinary care, used-car sales,
ethnic grocery stores, and funeral homes are examples. Even though P.F. Chang’s and the
Panda Restaurant Group have firmly established themselves as chains in the United States, lo-
cal, family-owned restaurants still comprise 87% of Asian casual dining restaurants.22
If a company is able to overcome the limitations of a fragmented market, however, it can
reap the benefits of a broadly targeted cost-leadership or differentiation strategy. Until Pizza
Hut was able to use advertising to differentiate itself from local competitors, the pizza fast-
food business was a fragmented industry composed primarily of locally owned pizza parlors,
each with its own distinctive product and service offering. Subsequently Domino’s used the
cost-leader strategy to achieve U.S. national market share.
As an industry matures, fragmentation is overcome, and the industry tends to become a
consolidated industry dominated by a few large companies. Although many industries start
out being fragmented, battles for market share and creative attempts to overcome local or niche
market boundaries often increase the market share of a few companies. After product standards
become established for minimum quality and features, competition shifts to a greater empha-
sis on cost and service. Slower growth, overcapacity, and knowledgeable buyers combine to
put a premium on a firm’s ability to achieve cost leadership or differentiation along the dimen-
sions most desired by the market. R&D shifts from product to process improvements. Overall
product quality improves, and costs are reduced significantly.
The strategic rollup was developed in the mid-1990s as an efficient way to quickly consoli-
date a fragmented industry. With the aid of money from venture capitalists, an entrepreneur ac-
quires hundreds of owner-operated small businesses. The resulting large firm creates economies
of scale by building regional or national brands, applies best practices across all aspects of mar-
keting and operations, and hires more sophisticated managers than the small businesses could pre-
viously afford. Rollups differ from conventional mergers and acquisitions in three ways: (1) they
involve large numbers of firms, (2) the acquired firms are typically owner operated, and (3) the
objective is not to gain incremental advantage, but to reinvent an entire industry.23 Rollups are cur-
rently under way in the funeral industry led by Service Corporation International, Stewart Enter-
prises, and the Loewen Group; and in the veterinary care industries by VCA (Veterinary Centers
of America ) Antech Inc. Of the 22,000 pet hospitals in the U.S., VCA Antech had acquired 465
by July 2008 with plans to continue acquisitions for the foreseeable future.24
Once consolidated, an industry has become one in which cost leadership and differentia-
tion tend to be combined to various degrees, even though one competitive strategy may be pri-
marily emphasized. A firm can no longer gain and keep high market share simply through low
price. The buyers are more sophisticated and demand a certain minimum level of quality for
price paid. For example, low-cost office supplies retailer Staples introduced in 2007 a line of
premium office supplies called “My Style, My Way” in order to halt sliding sales.25 Even Mc-
Donald’s, long the leader in low-cost fast-food restaurants, has been forced to add healthier
and more upscale food items, such as Asian chicken salad, comfortable chairs, and Wi-Fi In-
ternet access in order to keep its increasingly sophisticated customer base.26 The same is true
for firms emphasizing high quality. Either the quality must be high enough and valued by the
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 191
customer enough to justify the higher price or the price must be dropped (through lowering
costs) to compete effectively with the lower priced products. Hewlett-Packard, for example,
spent years restructuring its computer business in order to cut Dell’s cost advantage from 20%
to just 10%.27 Consolidation is taking place worldwide in the automobile, airline, computer,
and home appliance industries.
Hypercompetition and Competitive Advantage Sustainability
Some firms are able to sustain their competitive advantage for many years,28 but most find that
competitive advantage erodes over time. In his book Hypercompetition, D’Aveni proposes that
it is becoming increasingly difficult to sustain a competitive advantage for very long. “Market
stability is threatened by short product life cycles, short product design cycles, new technolo-
gies, frequent entry by unexpected outsiders, repositioning by incumbents, and tactical redef-
initions of market boundaries as diverse industries merge.”29 Consequently, a company or
business unit must constantly work to improve its competitive advantage. It is not enough to
be just the lowest-cost competitor. Through continuous improvement programs, competitors
are usually working to lower their costs as well. Firms must find new ways not only to reduce
costs further but also to add value to the product or service being provided.
The same is true of a firm or unit that is following a differentiation strategy. Maytag Cor-
poration, for example, was successful for many years by offering the most reliable brand in
North American major home appliances. It was able to charge the highest prices for Maytag
brand washing machines. When other competitors improved the quality of their products, how-
ever, it became increasingly difficult for customers to justify Maytag’s significantly higher price.
Consequently Maytag Corporation was forced not only to add new features to its products but
also to reduce costs through improved manufacturing processes so that its prices were no longer
out of line with those of the competition. D’Aveni’s theory of hypercompetition is supported by
developing research on the importance of building dynamic capabilities to better cope with un-
certain environments (discussed previously in Chapter 5 in the resource-based view of the firm).
D’Aveni contends that when industries become hypercompetitive, they tend to go through
escalating stages of competition. Firms initially compete on cost and quality, until an abun-
dance of high-quality, low-priced goods result. This occurred in the U.S. major home appli-
ance industry by 1980. In a second stage of competition, the competitors move into untapped
markets. Others usually imitate these moves until the moves become too risky or expensive.
This epitomized the major home appliance industry during the 1980s and 1990s, as strong U.S.
and European firms like Whirlpool, Electrolux, and Bosch-Siemens established presences in
both Europe and the Americas and then moved into Asia. Strong Asian firms like LG and Haier
likewise entered Europe and the Americas in the late 1990s.
According to D’Aveni, firms then raise entry barriers to limit competitors. Economies of
scale, distribution agreements, and strategic alliances made it all but impossible for a new firm
to enter the major home appliance industry by the end of the 20th century. After the established
players have entered and consolidated all new markets, the next stage is for the remaining
firms to attack and destroy the strongholds of other firms. Maytag’s inability to hold onto its
North American stronghold led to its acquisition by Whirlpool in 2006. Eventually, according
to D’Aveni, the remaining large global competitors work their way to a situation of perfect
competition in which no one has any advantage and profits are minimal.
Before hypercompetition, strategic initiatives provided competitive advantage for many
years, perhaps for decades. Except for a few stable industries, this is no longer the case. Ac-
cording to D’Aveni, as industries become hypercompetitive, there is no such thing as a sus-
tainable competitive advantage. Successful strategic initiatives in this type of industry
typically last only months to a few years. According to D’Aveni, the only way a firm in this
kind of dynamic industry can sustain any competitive advantage is through a continuous se-
ries of multiple short-term initiatives aimed at replacing a firm’s current successful products
192 PART 3 Strategy Formulation
with the next generation of products before the competitors can do so. Intel and Microsoft are
taking this approach in the hypercompetitive computer industry.
Hypercompetition views competition, in effect, as a distinct series of ocean waves on what
used to be a fairly calm stretch of water. As industry competition becomes more intense, the
waves grow higher and require more dexterity to handle. Although a strategy is still needed to
sail from point A to point B, more turbulent water means that a craft must continually adjust
course to suit each new large wave. One danger of D’Aveni’s concept of hypercompetition,
however, is that it may lead to an overemphasis on short-term tactics (discussed in the next sec-
tion) over long-term strategy. Too much of an orientation on the individual waves of hyper-
competition could cause a company to focus too much on short-term temporary advantage and
not enough on achieving its long-term objectives through building sustainable competitive ad-
vantage. Nevertheless, research supports D’Aveni’s argument that sustained competitive ad-
vantage is increasingly a matter not of a single advantage maintained over time, but more a
matter of sequencing advantages over time.30
Which Competitive Strategy Is Best?
Before selecting one of Porter’s generic competitive strategies for a company or business unit,
management should assess its feasibility in terms of company or business unit resources and
capabilities. Porter lists some of the commonly required skills and resources, as well as orga-
nizational requirements, in Table 6–3.
Competitive Tactics
Studies of decision making report that half the decisions made in organizations fail because of
poor tactics.31 A tactic is a specific operating plan that details how a strategy is to be imple-
mented in terms of when and where it is to be put into action. By their nature, tactics are nar-
rower in scope and shorter in time horizon than are strategies. Tactics, therefore, may be viewed
TABLE 6–3 Requirements for Generic Competitive Strategies
Generic
Strategy Commonly Required Skills and Resources Common Organizational Requirements
Overall Cost
Leadership
� Sustained capital investment and access to capital
� Process engineering skills
� Intense supervision of labor
� Products designed for ease of manufacture
� Low-cost distribution system
� Tight cost control
� Frequent, detailed control reports
� Structured organization and responsibilities
� Incentives based on meeting strict
quantitative targets
Differentiation � Strong marketing abilities
� Product engineering
� Creative flair
� Strong capability in basic research
� Corporate reputation for quality or technological
leadership
� Long tradition in the industry or unique
combination of skills drawn from other businesses
� Strong cooperation from channels
� Strong coordination among functions in
R&D, product development, and marketing
� Subjective measurement and incentives
instead of quantitative measures
� Amenities to attract highly skilled labor,
scientists, or creative people
Focus � Combination of the above policies directed at the
particular strategic target
� Combination of the above policies directed
at the particular strategic target
SOURCE: Reprinted with the permission of The Free Press, a Division of Simon & Schuster, from COMPETITIVE ADVANTAGE: Techniques for
Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980, 1998 by The Free Press. All rights reserved.
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 193
(like policies) as a link between the formulation and implementation of strategy. Some of the tac-
tics available to implement competitive strategies are timing tactics and market location tactics.
Timing Tactics: When to Compete
A timing tactic deals with when a company implements a strategy. The first company to man-
ufacture and sell a new product or service is called the first mover (or pioneer). Some of the
advantages of being a first mover are that the company is able to establish a reputation as an
industry leader, move down the learning curve to assume the cost-leader position, and earn
temporarily high profits from buyers who value the product or service very highly. A success-
ful first mover can also set the standard for all subsequent products in the industry. A company
that sets the standard “locks in” customers and is then able to offer further products based on
that standard.32 Microsoft was able to do this in software with its Windows operating system,
and Netscape garnered over an 80% share of the Internet browser market by being first to com-
mercialize the product successfully. Research does indicate that moving first or second into a
new industry or foreign country results in greater market share and shareholder wealth than
does moving later.33 Being first provides a company profit advantages for about 10 years in
consumer goods and about 12 years in industrial goods.34 This is true, however, only if the first
mover has sufficient resources to both exploit the new market and to defend its position against
later arrivals with greater resources.35 Gillette, for example, has been able to keep its leader-
ship of the razor category (70% market share) by continuously introducing new products.36
Being a first mover does, however, have its disadvantages. These disadvantages can be, con-
versely, advantages enjoyed by late-mover firms. Late movers may be able to imitate the tech-
nological advances of others (and thus keep R&D costs low), keep risks down by waiting until
a new technological standard or market is established, and take advantage of the first mover’s
natural inclination to ignore market segments.37 Research indicates that successful late movers
tend to be large firms with considerable resources and related experience.38 Microsoft is one ex-
ample. Once Netscape had established itself as the standard for Internet browsers in the 1990s,
Microsoft used its huge resources to directly attack Netscape’s position with its Internet Explorer.
It did not want Netscape to also set the standard in the developing and highly lucrative intranet
market inside corporations. By 2004, Microsoft’s Internet Explorer dominated Web browsers,
and Netscape was only a minor presence. Nevertheless, research suggests that the advantages
and disadvantages of first and late movers may not always generalize across industries because
of differences in entry barriers and the resources of the specific competitors.39
Market Location Tactics: Where to Compete
A market location tactic deals with where a company implements a strategy. A company or
business unit can implement a competitive strategy either offensively or defensively. An
offensive tactic usually takes place in an established competitor’s market location. A defensive
tactic usually takes place in the firm’s own current market position as a defense against possi-
ble attack by a rival.40
Offensive Tactics. Some of the methods used to attack a competitor’s position are:
� Frontal assault: The attacking firm goes head to head with its competitor. It matches the
competitor in every category from price to promotion to distribution channel. To be success-
ful, the attacker must have not only superior resources, but also the willingness to persevere.
This is generally a very expensive tactic and may serve to awaken a sleeping giant, depress-
ing profits for the whole industry. This is what Kimberly-Clark did when it introduced Hug-
gies disposable diapers against P&G’s market-leading Pampers. The resulting competitive
battle between the two firms depressed Kimberly-Clark’s profits.41
194 PART 3 Strategy Formulation
� Flanking maneuver: Rather than going straight for a competitor’s position of strength
with a frontal assault, a firm may attack a part of the market where the competitor is weak.
Texas Instruments, for example, avoided competing directly with Intel by developing mi-
croprocessors for consumer electronics, cell phones, and medical devices instead of com-
puters. Taken together, these other applications are worth more in terms of dollars and
influence than are computers, where Intel dominates.42
� Bypass attack: Rather than directly attacking the established competitor frontally or on
its flanks, a company or business unit may choose to change the rules of the game. This
tactic attempts to cut the market out from under the established defender by offering a new
type of product that makes the competitor’s product unnecessary. For example, instead of
competing directly against Microsoft’s Pocket PC and Palm Pilot for the handheld com-
puter market, Apple introduced the iPod as a personal digital music player. It was the most
radical change to the way people listen to music since the Sony Walkman. By redefining
the market, Apple successfully sidestepped both Intel and Microsoft, leaving them to play
“catch-up.”43
� Encirclement: Usually evolving out of a frontal assault or flanking maneuver, encir-
clement occurs as an attacking company or unit encircles the competitor’s position in
terms of products or markets or both. The encircler has greater product variety (e.g., a
complete product line, ranging from low to high price) and/or serves more markets (e.g.,
it dominates every secondary market). For example, Steinway was a major manufacturer
of pianos in the United States until Yamaha entered the market with a broader range of pi-
anos, keyboards, and other musical instruments. Although Steinway still dominates con-
cert halls, it has only a 2% share of the U.S. market.44 Oracle is using this strategy in its
battle against market leader SAP for enterprise resource planning (ERP) software by “sur-
rounding” SAP with acquisitions.45
� Guerrilla warfare: Instead of a continual and extensive resource-expensive attack on a
competitor, a firm or business unit may choose to “hit and run.” Guerrilla warfare is char-
acterized by the use of small, intermittent assaults on different market segments held by
the competitor. In this way, a new entrant or small firm can make some gains without se-
riously threatening a large, established competitor and evoking some form of retaliation.
To be successful, the firm or unit conducting guerrilla warfare must be patient enough to
accept small gains and to avoid pushing the established competitor to the point that it must
respond or else lose face. Microbreweries, which make beer for sale to local customers,
use this tactic against major brewers such as Anheuser-Busch.
Defensive Tactics. According to Porter, defensive tactics aim to lower the probability of
attack, divert attacks to less threatening avenues, or lessen the intensity of an attack. Instead
of increasing competitive advantage per se, they make a company’s or business unit’s
competitive advantage more sustainable by causing a challenger to conclude that an attack is
unattractive. These tactics deliberately reduce short-term profitability to ensure long-term
profitability:46
� Raise structural barriers. Entry barriers act to block a challenger’s logical avenues of
attack. Some of the most important, according to Porter, are to:
1. Offer a full line of products in every profitable market segment to close off any entry
points (for example, Coca Cola offers unprofitable noncarbonated beverages to keep
competitors off store shelves);
2. Block channel access by signing exclusive agreements with distributors;
3. Raise buyer switching costs by offering low-cost training to users;
4. Raise the cost of gaining trial users by keeping prices low on items new users are most
likely to purchase;
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 195
5. Increase scale economies to reduce unit costs;
6. Foreclose alternative technologies through patenting or licensing;
7. Limit outside access to facilities and personnel;
8. Tie up suppliers by obtaining exclusive contracts or purchasing key locations;
9. Avoid suppliers that also serve competitors; and
10. Encourage the government to raise barriers, such as safety and pollution standards or
favorable trade policies.
� Increase expected retaliation: This tactic is any action that increases the perceived threat
of retaliation for an attack. For example, management may strongly defend any erosion of
market share by drastically cutting prices or matching a challenger’s promotion through
a policy of accepting any price-reduction coupons for a competitor’s product. This coun-
terattack is especially important in markets that are very important to the defending com-
pany or business unit. For example, when Clorox Company challenged P&G in the
detergent market with Clorox Super Detergent, P&G retaliated by test marketing its liq-
uid bleach, Lemon Fresh Comet, in an attempt to scare Clorox into retreating from the de-
tergent market. Research suggests that retaliating quickly is not as successful in slowing
market share loss as a slower, but more concentrated and aggressive response.47
� Lower the inducement for attack: A third type of defensive tactic is to reduce a chal-
lenger’s expectations of future profits in the industry. Like Southwest Airlines, a company
can deliberately keep prices low and constantly invest in cost-reducing measures. With
prices kept very low, there is little profit incentive for a new entrant.48
COOPERATIVE STRATEGIES
A company uses competitive strategies and tactics to gain competitive advantage within an
industry by battling against other firms. These are not, however, the only business strategy
options available to a company or business unit for competing successfully within an industry.
A company can also use cooperative strategies to gain competitive advantage within an
industry by working with other firms. The two general types of cooperative strategies are
collusion and strategic alliances.
Collusion
Collusion is the active cooperation of firms within an industry to reduce output and raise
prices in order to get around the normal economic law of supply and demand. Collusion may
be explicit, in which case firms cooperate through direct communication and negotiation, or
tacit, in which case firms cooperate indirectly through an informal system of signals. Explicit
collusion is illegal in most countries and in a number of regional trade associations, such as
the European Union. For example, Archer Daniels Midland (ADM), the large U.S. agricultural
products firm, conspired with its competitors to limit the sales volume and raise the price of
the food additive lysine. Executives from three Japanese and South Korean lysine manufac-
turers admitted meeting in hotels in major cities throughout the world to form a “lysine trade
association.” The three companies were fined more than $20 million by the U.S. federal gov-
ernment.49 In another example, Denver-based Qwest signed agreements favoring competitors
that agreed not to oppose Qwest’s merger with U.S. West or its entry into the long-distance
business in its 14-state region. In one agreement, Qwest agreed to pay McLeodUSA almost
$30 million to settle a billing dispute in return for McLeod’s withdrawing its objections to
Qwest’s purchase of U.S. West.50
Collusion can also be tacit, in which case there is no direct communication among com-
peting firms. According to Barney, tacit collusion in an industry is most likely to be success-
ful if (1) there are a small number of identifiable competitors, (2) costs are similar among
196 PART 3 Strategy Formulation
firms, (3) one firm tends to act as the price leader, (4) there is a common industry culture that
accepts cooperation, (5) sales are characterized by a high frequency of small orders, (6) large
inventories and order backlogs are normal ways of dealing with fluctuations in demand, and
(7) there are high entry barriers to keep out new competitors.51
Even tacit collusion can, however, be illegal. For example, when General Electric
wanted to ease price competition in the steam turbine industry, it widely advertised its prices
and publicly committed not to sell below those prices. Customers were even told that if GE
reduced turbine prices in the future, it would give customers a refund equal to the price re-
duction. GE’s message was not lost on Westinghouse, the major competitor in steam tur-
bines. Both prices and profit margins remained stable for the next 10 years in this industry.
The U.S. Department of Justice then sued both firms for engaging in “conscious paral-
lelism” (following each other’s lead to reduce the level of competition) in order to reduce
competition.
Strategic Alliances
A strategic alliance is a long-term cooperative arrangement between two or more independent
firms or business units that engage in business activities for mutual economic gain.52 Alliances
between companies or business units have become a fact of life in modern business. In the
U.S. software industry, for example, the percentage of publicly traded firms that engaged in al-
liances increased from 32% in 1990 to 95% in 2001. During the same time period, the average
number of alliances grew from four to more than 30 per firm.53 Each of the top 500 global busi-
ness firms now averages 60 major alliances.54 Some alliances are very short term, only lasting
long enough for one partner to establish a beachhead in a new market. Over time, conflicts over
objectives and control often develop among the partners. For these and other reasons, around
half of all alliances (including international alliances) perform unsatisfactorily.55 Others are
more long lasting and may even be preludes to full mergers between companies.
Many alliances do increase profitability of the members and have a positive effect on firm
value.56 A study by Cooper & Lybrand found that firms involved in strategic alliances had 11%
higher revenue and 20% higher growth rate than did companies not involved in alliances.57
Forming and managing strategic alliances is a capability that is learned over time. Research
reveals that the more experience a firm has with strategic alliances, the more likely that its al-
liances will be successful.58 (There is some evidence, however, that too much partnering ex-
perience with the same partners generates diminishing returns over time and leads to reduced
performance.)59 Consequently, leading firms are making investments in building and develop-
ing their partnering capabilities.60
Companies or business units may form a strategic alliance for a number of reasons, in-
cluding:
1. To obtain or learn new capabilities: For example, General Motors and Chrysler formed
an alliance in 2004 to develop new fuel-saving hybrid engines for their automobiles.61 Al-
liances are especially useful if the desired knowledge or capability is based on tacit
knowledge or on new poorly-understood technology.62 A study found that firms with
strategic alliances had more modern manufacturing technologies than did firms without
alliances.63
2. To obtain access to specific markets: Rather than buy a foreign company or build brew-
eries of its own in other countries, Anheuser-Busch chose to license the right to brew and
market Budweiser to other brewers, such as Labatt in Canada, Modelo in Mexico, and Kirin
in Japan. As another example, U.S. defense contractors and aircraft manufacturers selling to
foreign governments are typically required by these governments to spend a percentage of
the contract/purchase value, either by purchasing parts or obtaining sub-contractors, in that
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 197
country. This is often achieved by forming value-chain alliances with foreign companies ei-
ther as parts suppliers or as sub-contractors.64 In a survey by the Economist Intelligence Unit,
59% of executives stated that their primary reason for engaging in alliances was the need for
fast and low-cost expansion into new markets.65
3. To reduce financial risk: Alliances take less financial resources than do acquisitions or
going it alone and are easier to exit if necessary.66 For example, because the costs of de-
veloping new large jet airplanes were becoming too high for any one manufacturer,
Aerospatiale of France, British Aerospace, Construcciones Aeronáuticas of Spain, and
Daimler-Benz Aerospace of Germany formed a joint consortium called Airbus Industrie
to design and build such planes. Using alliances with suppliers is a popular means of out-
sourcing an expensive activity.
4. To reduce political risk: Forming alliances with local partners is a good way to overcome
deficiencies in resources and capabilities when expanding into international markets.67 To
gain access to China while ensuring a positive relationship with the often restrictive Chi-
nese government, Maytag Corporation formed a joint venture with the Chinese appliance
maker, RSD.
Cooperative arrangements between companies and business units fall along a continuum
from weak and distant to strong and close. (See Figure 6–6.) The types of alliances range
from mutual service consortia to joint ventures and licensing arrangements to value-chain
partnerships.68
Mutual Service Consortia. A mutual service consortium is a partnership of similar
companies in similar industries that pool their resources to gain a benefit that is too expensive
to develop alone, such as access to advanced technology. For example, IBM established a
research alliance with Sony Electronics and Toshiba to build its next generation of computer
chips. The result was the “cell” chip, a microprocessor running at 256 gigaflops—around ten
times the performance of the fastest chips currently used in desktop computers. Referred to as
a “supercomputer on a chip,” cell chips were to be used by Sony in its PlayStation 3, by
Toshiba in its high-definition televisions, and by IBM in its super computers.69 The mutual
service consortia is a fairly weak and distant alliance—appropriate for partners that wish to
work together but not share their core competencies. There is very little interaction or
communication among the partners.
Joint Venture. A joint venture is a “cooperative business activity, formed by two or more
separate organizations for strategic purposes, that creates an independent business entity and
allocates ownership, operational responsibilities, and financial risks and rewards to each
member, while preserving their separate identity/autonomy.”70 Along with licensing
arrangements, joint ventures lie at the midpoint of the continuum and are formed to pursue an
Weak and Distant
Mutual Service
Consortia
Joint Venture,
Licensing Arrangement
Value-Chain
Partnership
Strong and Close
FIGURE 6–6
Continuum
of Strategic
Alliances
SOURCE: R.M. Kanter, ‘Continuum of Strategic Alliances’ from “Collaborative Advantage: The Art of Alliances,”
July-August 1994. Copyright © 1994 by the Harvard Business School Publishing Corporation. All rights reserved.
198 PART 3 Strategy Formulation
opportunity that needs a capability from two or more companies or business units, such as the
technology of one and the distribution channels of another.
Joint ventures are the most popular form of strategic alliance. They often occur because
the companies involved do not want to or cannot legally merge permanently. Joint ventures
provide a way to temporarily combine the different strengths of partners to achieve an outcome
of value to all. For example, Proctor & Gamble formed a joint venture with Clorox to produce
food-storage wraps. P&G brought its cling-film technology and 20 full-time employees to the
venture, while Clorox contributed its bags, containers, and wraps business.71
Extremely popular in international undertakings because of financial and political–legal
constraints, forming joint ventures is a convenient way for corporations to work together with-
out losing their independence. Around 30% to 55% of international joint ventures include three
or more partners.72 Disadvantages of joint ventures include loss of control, lower profits, prob-
ability of conflicts with partners, and the likely transfer of technological advantage to the part-
ner. Joint ventures are often meant to be temporary, especially by some companies that may
view them as a way to rectify a competitive weakness until they can achieve long-term dom-
inance in the partnership. Partially for this reason, joint ventures have a high failure rate. Re-
search indicates, however, that joint ventures tend to be more successful when both partners
have equal ownership in the venture and are mutually dependent on each other for results.73
Licensing Arrangements. A licensing arrangement is an agreement in which the licensing
firm grants rights to another firm in another country or market to produce and/or sell a product.
The licensee pays compensation to the licensing firm in return for technical expertise.
Licensing is an especially useful strategy if the trademark or brand name is well known but the
MNC does not have sufficient funds to finance its entering the country directly. For example,
Yum! Brands successfully used franchising and licensing to establish its KFC, Pizza Hut, Taco
Bell, Long John Silvers, and A&W restaurants throughout the world. In 2007 alone, it opened
471 restaurants in China alone plus 852 more across six continents.74 This strategy also
becomes important if the country makes entry via investment either difficult or impossible.
The danger always exists, however, that the licensee might develop its competence to the point
that it becomes a competitor to the licensing firm. Therefore, a company should never license
its distinctive competence, even for some short-run advantage.
Value-Chain Partnerships. A value-chain partnership is a strong and close alliance in
which one company or unit forms a long-term arrangement with a key supplier or distributor
for mutual advantage. For example, P&G, the maker of Folgers and Millstone coffee, worked
with coffee appliance makers Mr. Coffee, Krups, and Hamilton Beach to use technology
licensed from Black & Decker to market a pressurized, single-serve coffee-making system
called Home Cafe. This was an attempt to reverse declining at-home coffee consumption at a
time when coffeehouse sales were rising.75
To improve the quality of parts it purchases, companies in the U.S. auto industry, for ex-
ample, have decided to work more closely with fewer suppliers and to involve them more in
product design decisions. Activities that had previously been done internally by an automaker
are being outsourced to suppliers specializing in those activities. The benefits of such relation-
ships do not just accrue to the purchasing firm. Research suggests that suppliers that engage in
long-term relationships are more profitable than suppliers with multiple short-term contracts.76
All forms of strategic alliances involve uncertainty. Many issues need to be dealt with
when an alliance is initially formed, and others, which emerge later. Many problems revolve
around the fact that a firm’s alliance partners may also be its competitors, either immediately
or in the future. According to Peter Lorange, an authority in strategy, one thorny issue in any
strategic alliance is how to cooperate without giving away the company or business unit’s core
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 199
TABLE 6–4
Strategic
Alliance Success
Factors
� Have a clear strategic purpose. Integrate the alliance with each partner’s strategy. Ensure that
mutual value is created for all partners.
� Find a fitting partner with compatible goals and complementary capabilities.
� Identify likely partnering risks and deal with them when the alliance is formed.
� Allocate tasks and responsibilities so that each partner can specialize in what it does best.
� Create incentives for cooperation to minimize differences in corporate culture or organization fit.
� Minimize conflicts among the partners by clarifying objectives and avoiding direct competition
in the marketplace.
� In an international alliance, ensure that those managing it have comprehensive cross-cultural
knowledge.
� Exchange human resources to maintain communication and trust. Don’t allow individual egos to
dominate.
� Operate with long-term time horizons. The expectation of future gains can minimize short-term
conflicts.
� Develop multiple joint projects so that any failures are counterbalanced by successes.
� Agree on a monitoring process. Share information to build trust and keep projects on target.
Monitor customer responses and service complaints.
� Be flexible in terms of willingness to renegotiate the relationship in terms of environmental
changes and new opportunities.
� Agree on an exit strategy for when the partners’ objectives are achieved or the alliance is judged
a failure.
SOURCE: Compiled from B. Gomes-Casseres, “Do You Really Have an Alliance Strategy?” Strategy & Leadership
(September/October 1998), pp. 6–11; L. Segil, “Strategic Alliances for the 21st Century,” Strategy & Leadership
(September/October 1998), pp. 12–16; and A. C. Inkpen and K-Q Li, “Joint Venture Formation: Planning and
Knowledge Gathering for Success,” Organizational Dynamics (Spring 1999), pp. 33–47. Inkpen and Li provide a
checklist of 17 questions on p. 46.
competence: “Particularly when advanced technology is involved, it can be difficult for part-
ners in an alliance to cooperate and openly share strategic know-how, but it is mandatory if the
joint venture is to succeed.”77 It is therefore important that a company or business unit that is
interested in joining or forming a strategic alliance consider the strategic alliance success fac-
tors listed in Table 6–4.
End of Chapter SUMMARY
Once environmental scanning is completed, situational analysis calls for the integration of
this information. SWOT analysis is the most popular method for examining external and in-
ternal information. We recommend using the SFAS Matrix as one way to identify a corpo-
ration’s strategic factors. Using the TOWS Matrix to identify a propitious niche is one way
to develop a sustainable competitive advantage using those strategic factors.
Business strategy is composed of both competitive and cooperative strategy. As the ex-
ternal environment becomes more uncertain, an increasing number of corporations are
choosing to simultaneously compete and cooperate with their competitors. These firms
may cooperate to obtain efficiency in some areas, while each firm simultaneously tries to
differentiate itself for competitive purposes. Raymond Noorda, Novell’s founder and
200 PART 3 Strategy Formulation
E C O – B I T S
� Target became a certified organic produce retailer in
2006 and now offers more than 500 choices of organic
certified food. The company reduces waste by giving
away 7 million pounds of food annually.
� Home Depot offers more than 2,500 environmentally
friendly products, ranging from all-natural insect repel-
lants to front-loading washing machines, specially
tagged as Eco Options.
� Vowing to become “carbon neutral” by 2010, Timber-
land introduced Green Index tags, which rate its prod-
ucts on the use of greenhouse gas emissions, solvents,
and organic materials.81
D I S C U S S I O N Q U E S T I O N S
1. What industry forces might cause a propitious niche to
disappear?
2. Is it possible for a company or business unit to follow a
cost leadership strategy and a differentiation strategy si-
multaneously? Why or why not?
3. Is it possible for a company to have a sustainable com-
petitive advantage when its industry becomes hyper-
competitive?
4. What are the advantages and disadvantages of being a
first mover in an industry? Give some examples of first
mover and late mover firms. Were they successful?
5. Why are many strategic alliances temporary?
S T R A T E G I C P R A C T I C E E X E R C I S E
Select an industry to analyze. Identify companies for each of Porter’s four competitive strategies. How many different kinds of
differentiation strategies can you find?
INDUSTRY: ___________________________________________________________________________________________
Cost Leadership: ________________________________________________________________________________________
Differentiation: _________________________________________________________________________________________
Cost Focus: ____________________________________________________________________________________________
Differentiation Focus: ____________________________________________________________________________________
former CEO, coined the term co-opetition to describe such simultaneous competition and
cooperation among firms.78 One example is the collaboration between competitors DHL
and UPS in the express delivery market. DHL’s American delivery business was losing
money and UPS’ costly airfreight network had excess capacity. Under the terms of a 10-
year agreement signed in 2008, UPS carried DHL packages in its American airfreight net-
work for a fee. The agreement covered only air freight, leaving both firms free to compete
in the rest of the express-parcel business.79 A careful balancing act, co-opetition involves
the careful management of alliance partners so that each partner obtains sufficient benefits
to keep the alliance together. A long-term view is crucial. An unintended transfer of knowl-
edge could be enough to provide one partner a significant competitive advantage over the
others.80 Unless that company forebears from using that knowledge against its partners, the
alliance will be doomed.
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 201
K E Y T E R M S
business strategy (p. 183)
collusion (p. 195)
common thread (p. 182)
competitive scope (p. 185)
competitive strategy (p. 183)
consolidated industry (p. 190)
cooperative strategy (p. 195)
cost focus (p. 187)
cost leadership (p. 186)
differentiation (p. 186)
differentiation focus (p. 188)
differentiation strategy (p. 185)
first mover (p. 193)
fragmented industry (p. 190)
joint venture (p. 197)
late mover (p. 193)
licensing arrangement (p. 198)
lower cost strategy (p. 185)
market location tactics (p. 193)
mutual service consortium (p. 197)
propitious niche (p. 177)
SFAS (Strategic Factors Analysis
Summary) Matrix (p. 176)
strategic alliance (p. 196)
strategy formulation (p. 176)
SWOT (p. 176)
tactic (p. 192)
timing tactic (p. 193)
TOWS Matrix (p. 182)
value-chain partnership (p. 198)
N O T E S
1. A. Fitzgerald, “Cedar Rapids Export Company Serves Muslims
Worldwide,” Des Moines Register (October 26, 2003),
pp. 1M–2M. See also corporate Web site at www.midamar.com.
2. J. Choi, D. Lovallo, and A. Tarasova, “Better Strategy for Busi-
ness Units: A McKinsey Global Survey,” McKinsey Quarterly
Online (July 2007).
3. D. Fehringer, “Six Steps to Better SWOTs,” Competitive Intel-
ligence Magazine (January–February, 2007), p. 54.
4. T. Brown, “The Essence of Strategy,” Management Review
(April 1997), pp. 8–13.
5. T. Hill and R. Westbrook, “SWOT Analysis: It’s Time for a
Product Recall,” Long Range Planning (February 1997),
pp. 46–52.
6. W. H. Newman, “Shaping the Master Strategy of Your Firm,”
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7. D. J. Collis and M. G. Rukstad, “Can You Say What Your Strat-
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8. D. J. Collis and M. G. Rukstad, “Can You Say What Your Strat-
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9. V. F. Misangyi, H. Elms, T. Greckhamer, and J. A Lepine, “A
New Perspective on a Fundamental Debate: A Multilevel Ap-
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10. M. E. Porter, Competitive Strategy (New York: The Free Press,
1980), pp. 34–41 as revised in M. E. Porter, The Competitive
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pp. 37–40.
11. J. O. DeCastro and J. J. Chrisman, “Narrow-Scope Strategies
and Firm Performance: An Empirical Investigation,” Journal of
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Survival: Industry, Strategy, and Location,” Journal of Business
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12. Porter, Competitive Strategy (New York: The Free Press, 1980),
p. 35.
13. M. Arndt, “Built for the Long Haul,” Business Week (January
30, 2006), p. 66.
14. R. E. Caves, and P. Ghemawat, “Identifying Mobility Barriers,”
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15. N. K. Geranios, “Potlach Aims to Squeeze Toilet Tissue Lead-
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16. “Company Targets ‘Orphan Drugs,’” St. Cloud (MN) Times
(May 9, 2007), p. 2A.
17. M. Arndt, “Deere’s Revolution on Wheels,” Business Week
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18. S. Thornhill and R. E. White, “Strategic Purity: A Multi-
Industry Evaluation of Pure Vs. Hybrid Business Strategies,”
Strategic Management Journal (May 2007), pp. 553–561;
M. Delmas, M. V. Russo, and M. J. Montes-Sancho, “Deregu-
lation and Environmental Differentiation in the Electric Utility
Industry,” Strategic Management Journal (February 2007),
pp. 189–209.
19. C. Campbell-Hunt, “What Have We Learned About Generic
Competitive Strategy? A Meta Analysis,” Strategic Manage-
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20. M. Kroll, P. Wright, and R. A. Heiens, “The Contribution of
Product Quality to Competitive Advantage: Impacts on System-
atic Variance and Unexplained Variance in Returns,” Strategic
Management Journal (April 1999), pp. 375–384.
21. R. M. Hodgetts, “A Conversation with Michael E. Porter: A
‘Significant Extension’ Toward Operational Improvement and
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22. M. Rushlo, “P. F. Chang’s Plans Succeed Where Others Have
Failed,” Des Moines Register (May 18, 2004), pp. 1D, 6D.
23. P. F. Kocourek, S. Y. Chung, and M. G. McKenna, “Strategic
Rollups: Overhauling the Multi-Merger Machine,” Strategy �
Business (2nd Quarter 2000), pp. 45–53.
24. J. A. Tannenbaum, “Acquisitive Companies Set Out to ‘Roll
Up’ Fragmented Industries,” Wall Street Journal (March 3,
1997), pp. A1, A6; 2007 Form 10-K and Quarterly Report (July
2008), VCA Antech, Inc.
25. A. Pressman, “Upwardly Mobile Stationary,” Business Week
(March 17, 2008), pp. 60–61.
26. P. Gogoi, “Mickey D’s McMakeover,” Business Week (May 15,
2006), pp. 42–43.
27. N. Kumar, “Strategies to Fight Low-Cost Rivals,” Harvard
Business Review (December 2006), pp. 104–112.
28. J. C. Bou and A. Satorra, “The Presistence of Abnormal Returns
at Industry and Firm Levels: Evidence from Spain,” Strategic
Management Journal (July 2007), pp. 707–722.
29. R. A. D’Aveni, Hypercompetition (New York: The Free Press,
1994), pp. xiii–xiv.
www.midamar.com
30. R. R. Wiggins and T. W. Ruefli, “Schumpeter’s Ghost: Is Hy-
percompetition Making the Best of Times Shorter?” Strategic
Management Journal (October 2005), pp. 887–911.
31. P. C. Nutt, “Surprising But True: Half the Decisions in Organi-
zations Fail,” Academy of Management Executive (November
1999), pp. 75–90.
32. Some refer to this as the economic concept of “increasing re-
turns.” Instead of the curve leveling off when the company
reaches a point of diminishing returns when a product saturates
a market, the curve continues to go up as the company takes ad-
vantage of setting the standard to spin off new products that use
the new standard to achieve higher performance than competi-
tors. See J. Alley, “The Theory That Made Microsoft,” Fortune
(April 29, 1996), pp. 65–66.
33. H. Lee, K. G. Smith, C. M. Grimm and A. Schomburg, “Tim-
ing, Order and Durability of New Product Advantages with Im-
itation,” Strategic Management Journal (January 2000),
pp. 23–30; Y. Pan and P. C. K. Chi, “Financial Performance and
Survival of Multinational Corporations in China,” Strategic
Management Journal (April 1999), pp. 359–374; R. Makadok,
“Can First-Mover and Early-Mover Advantages Be Sustained
in an Industry with Low Barriers to Entry/Imitation?” Strategic
Management Journal (July 1998), pp. 683–696); B. Mascaren-
has, “The Order and Size of Entry into International Markets,”
Journal of Business Venturing (July 1997), pp. 287–299.
34. At these respective points, cost disadvantages vis-à-vis later en-
trants fully eroded the earlier returns to first movers. See
W. Boulding and M. Christen, “Idea—First Mover Disadvan-
tage,” Harvard Business Review, Vol. 79, No. 9 (2001),
pp. 20–21 as reported by D. J. Ketchen, Jr., C. C. Snow, and
V. L. Hoover, “Research on Competitive Dynamics: Recent Ac-
complishments and Future Challenges,” Journal of Manage-
ment, Vol. 30, No. 6 (2004), pp. 779–804.
35. M. B. Lieberman and D. B. Montgomery, “First-Mover (Dis)
Advantages: Retrospective and Link with the Resource-Based
View,” Strategic Management Journal (December, 1998),
pp. 1111–1125; G. J. Tellis and P. N. Golder, “First to Market,
First to Fail? Real Causes of Enduring Market Leadership,”
Sloan Management Review (Winter 1996), pp. 65–75.
36. J. Pope, “Schick Entry May Work Industry into a Lather,” Des
Moines Register (May 15, 2003), p. 6D.
37. S. K. Ethiraj and D. H. Zhu, “Performance Effects of Imitative
Entry,” Strategic Management Journal (August 2008),
pp. 797–817; G. Dowell and A. Swaminathan, “Entry Timing,
Exploration, and Firm Survival in the Early U.S. Bicycle Indus-
try,” Strategic Management Journal (December 2006),
pp. 1159–1182. For an in-depth discussion of first and late
mover advantages and disadvantages, see D. S. Cho, D. J. Kim,
and D. K. Rhee, “Latecomer Strategies: Evidence from the
Semiconductor Industry in Japan and Korea,” Organization
Science (July–August 1998), pp. 489–505.
38. J. Shamsie, C. Phelps, and J. Kuperman, “Better Late Than Never:
A Study of Late Entrants in Household Electrical Equipment,”
Strategic Management Journal (January 2004), pp. 69–84.
39. T. S. Schoenecker and A. C. Cooper, “The Role of Firm Re-
sources and Organizational Attributes in Determining Entry
Timing: A Cross-Industry Study,” Strategic Management Jour-
nal (December 1998), pp. 1127–1143.
40. Summarized from various articles by L. Fahey in The Strategic
Management Reader, edited by L. Fahey (Englewood Cliffs,
NJ: Prentice Hall, 1989), pp. 178–205.
41. M. Boyle, “Dueling Diapers,” Fortune (February 17, 2003),
pp. 115–116.
42. C. Edwards, “To See Where Tech Is Headed, Watch TI,”
Business Week (November 6, 2006), p. 74.
43. P. Burrows, “Show Time,” Business Week (February 2, 2004),
pp. 56–64.
44. A. Serwer, “Happy Birthday, Steinway,” Fortune (March 17,
2003), pp. 94–97.
45. “Programmed for a Fight,” The Economist (October 20, 2007),
p. 85.
46. This information on defensive tactics is summarized from M. E.
Porter, Competitive Advantage (New York: The Free Press,
1985), pp. 482–512.
47. H. D. Hopkins, “The Response Strategies of Dominant U.S.
Firms to Japanese Challengers,” Journal of Management,
Vol. 29, No. 1 (2003), pp. 5–25.
48. For additional information on defensive competitive tactics, see
G. Stalk, “Curveball Strategies to Fool the Competition,”
Harvard Business Review (September 2006), pp. 115–122.
49. T. M. Burton, “Archer-Daniels Faces a Potential Blow As Three
Firms Admit Price-Fixing Plot,” Wall Street Journal (August
28, 1996), pp. A3, A6; R. Henkoff, “The ADM Tale Gets Even
Stranger,” Fortune (May 13, 1996), pp. 113–120.
50. B. Gordon, “Qwest Defends Pacts with Competitors,” Des
Moines Register (April 30, 2002), p. 1D.
51. Much of the content on cooperative strategies was summarized
from J. B. Barney, Gaining and Sustaining Competitive Advan-
tage (Reading, MA: Addison-Wesley, 1997), pp. 255–278.
52. A. C. Inkpen and E. W. K. Tsang, “Learning and Strategic Al-
liances,” Academy of Management Annals, Vol. 1, edited by J. F.
Walsh and A. F. Brief (December 2007), pp. 479–511.
53. D. Lavie, “Alliance Portfolios and Firm Performance: A Study
of Value Creation and Appropriation in the U.S. Software In-
dustry.” Strategic Management Journal (December 2007),
pp. 1187–1212.
54. R. D. Ireland, M. A. Hitt, and D. Vaidyanath, “Alliance Man-
agement as a Source of Competitive Advantage,” Journal of
Management, Vol. 28, No. 3 (2002), pp. 413–446.
55. S. H. Park and G. R. Ungson, “Interfirm Rivalry and Manage-
rial Complexity: A Conceptual Framework of Alliance Failure,”
Organization Science (January–February 2001), pp. 37–53.;
D. C. Hambrick, J. Li, K. Xin, and A. S. Tsui, “Compositional
Gaps and Downward Spirals in International Joint Venture
Management Groups,” Strategic Management Journal
(November 2001), pp. 1033–1053; T. K. Das and B. S. Teng,
“Instabilities of Strategic Alliances: An Internal Tensions Per-
spective,” Organization Science (January–February 2000),
pp. 77–101; J. F. Hennart, D. J. Kim, and M. Zeng, “The Impact
of Joint Venture Status on the Longevity of Japanese Stakes in
U.S. Manufacturing Affiliates,” Organization Science
(May–June 1998), pp. 382–395.
56. N. K. Park, J. M. Mezias, and J. Song, “A Resource-based View
of Strategic Alliances and Firm Value in the Electronic Market-
place,” Journal of Management, Vol. 30, No. 1 (2004),
pp. 7–27; T. Khanna and J. W. Rivkin, “Estimating the Perfor-
mance Effects of Business Groups in Emerging Markets,”
Strategic Management Journal (January 2001), pp. 45–74;
G. Garai, “Leveraging the Rewards of Strategic Alliances,”
Journal of Business Strategy (March–April 1999), pp. 40–43.
57. L. Segil, “Strategic Alliances for the 21st Century,” Strategy &
Leadership (September/October 1998), pp. 12–16.
202 PART 3 Strategy Formulation
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy 203
58. R. C. Sampson, “Experience Effects and Collaborative Returns
in R&D Alliances,” Strategic Management Journal (November
2005), pp. 1009–1031; J. Draulans, A-P deMan, and H. W. Vol-
berda, “Building Alliance Capability: Management Techniques
for Superior Alliance Performance,” Long Range Planning
(April 2003), pp. 151–166; P. Kale, J. H. Dyer, and H. Singh,
“Alliance Capability, Stock Market Response, and Long-Term
Alliance Success: The Role of the Alliance Function,” Strategic
Management Journal (August 2002), pp. 747–767.
59. H. Hoang and F. T. Rothaermel, “The Effect of General and
Partner-Specific Alliance Experience on Joint R&D Project
Performance,” Academy of Management Journal (April 2005),
pp. 332–345; A. Goerzen, “Alliance Networks and Firm Perfor-
mance: The Impact of Repeated Partnerships,” Strategic Man-
agement Journal (May 2007), pp. 487–509.
60. A. MacCormack and T. Forbath, “Learning the Fine Art of
Global Collaboration,” Harvard Business Review (January
2008), pp. 24–26.
61. J. Porretto, “Rival Automakers Team Up to Catch Up,” Des
Moines Register (December 14, 2004), pp. 1D–2D.
62. H. Bapuji and M. Crossan, “Knowledge Types and Knowledge
Management Strategies,” in Strategic Networks: Learning to
Compete, M. Gibbert and T. Durand, eds. (Malden, MA: Black-
well Publishing, 2007), pp. 8–25; F. T. Rothaermel and
W. Boeker, “Old Technology Meets New Technology: Comple-
mentarities, Similarities, and Alliance Formation,” Strategic
Management Journal (January 2008), pp. 47–77.
63. M. M. Bear, “How Japanese Partners Help U.S. Manufacturers
to Raise Productivity,” Long Range Planning (December
1998), pp. 919–926.
64. According to M. J. Thome of Rockwell Collins in a June 26,
2008, e-mail, these are called “international offsets.”
65. P. Anslinger and J. Jenk, “Creating Successful Alliances,”
Journal of Business Strategy, Vol. 25, No. 2 (2004), p. 18.
66. X. Yin and M. Shanley, “Industry Determinants of the ‘Merger
Versus Alliance’ Decision,” Academy of Management Review
(April 2008), pp. 473–491.
67. J. W. Lu and P. W. Beamish, “The Internationalization and Per-
formance of SMEs,” Strategic Management Journal (June–July
2001), pp. 565–586.
68. R. M. Kanter, “Collaborative Advantage: The Art of Alliances,”
Harvard Business Review (July–August 1994), pp. 96–108.
69. “The Cell of the New Machine,” The Economist (February 12,
2005), pp. 77–78.
70. R. P. Lynch, The Practical Guide to Joint Ventures and Corpo-
rate Alliances (New York: John Wiley and Sons, 1989), p. 7.
71. “Will She, Won’t She? The Economist (August 11, 2007),
pp. 61–63.
72. Y Gong, O Shenkar, Y. Luo, and M-K Nyaw, “Do Multiple Par-
ents Help or Hinder International Joint Venture Performance?
The Mediating Roles of Contract Completeness and Partner Co-
operation,” Strategic Management Journal (October 2007),
pp. 1021–1034.
73. L. L. Blodgett, “Factors in the Instability of International Joint
Ventures: An Event History Analysis,” Strategic Management
Journal (September 1992), pp. 475–481; J. Bleeke and
D. Ernst, “The Way to Win in Cross-Border Alliances,”
Harvard Business Review (November–December 1991),
pp. 127–135; J. M. Geringer, “Partner Selection Criteria for De-
veloped Country Joint Ventures,” in International Management
Behavior, 2nd ed., edited by H. W. Lane and J. J. DiStephano
(Boston: PWS-Kent, 1992), pp. 206–216.
74. 2007 Annual Report, Yum! Brands.
75. B. Horovitz, “New Coffee Maker May Jolt Industry,” USA To-
day (February 18, 2004), pp. 1E–2E.
76. K. Z. Andrews, “Manufacturer/Supplier Relationships: The
Supplier Payoff,” Harvard Business Review (September–
October 1995), pp. 14–15.
77. P. Lorange, “Black-Box Protection of Your Core Competencies
in Strategic Alliances,” in Cooperative Strategies: European
Perspectives, edited by P. W. Beamish and J. P. Killing (San
Francisco: The New Lexington Press, 1997), pp. 59–99.
78. E. P. Gee, “Co-opetition: The New Market Milieu,” Journal of
Healthcare Management, Vol. 45 (2000), pp. 359–363.
79. “Make Love—and War,” The Economist (August 9, 2008),
pp. 57–58.
80. D. J. Ketchen, Jr., C. C. Snow, and V. L. Hoover, “Research on
Competitive Dynamics: Recent Accomplishments and Future
Challenges,” Journal of Management, Vol. 30, No. 6 (2004),
pp. 779–804.
81. J. O’Donnell and C. Dugas, “More Retailers Go for Green—the
Eco Kind,” USA Today (April 18, 2007), p. 3B.
What is the best way for a company to grow if its primary business is ma-
turing? A study of 1,850 companies by Zook and Allen revealed two conclusions:
First, the most sustained profitable growth occurs when a corporation pushes out
of the boundary around its core business into adjacent businesses. Second, corpo-
rations that consistently outgrow their rivals do so by developing a formula for ex-
panding those boundaries in a predicable, repeatable manner.1
Nike is a classic example of this process. Despite its success in athletic shoes, no one expected
Nike to be successful when it diversified in 1995 from shoes into golf apparel, balls, and equip-
ment. Only a few years later, it was acknowledged to be a major player in the new business. Ac-
cording to researchers Zook and Allen, the key to Nike’s success was a formula for growth that
the company had applied and adapted successfully in a series of entries into sports markets,
from jogging to volleyball to tennis to basketball to soccer and, most recently, to golf. First, Nike
established a leading position in athletic shoes in the target market, in this case, golf shoes. Sec-
ond, Nike launched a clothing line endorsed by the sports’ top athletes—in this case, Tiger
Woods. Third, the company formed new distribution channels and contracts with key suppliers
in the new business. Nike’s reputation as a strong marketer of new products gave it credibility.
Fourth, the company introduced higher-margin equipment into the new market. In the case of
golf clubs, it started with irons and then moved to drivers. Once it had captured a significant
share in the U.S. market, Nike’s next step was global distribution.
Zook and Allen propose that this formula was the reason Nike moved past Reebok in the
sporting goods industry. In 1987, Nike’s operating profits were only $164 million compared to
Reebok’s much larger $309 million. Fifteen years later, Nike’s operating profits had grown to
$1.1 billion while Reebok’s had declined to $247 million.2 Reebok was subsequently acquired by
Adidas in 2005 while Nike went on to generate operating profits of $2.4 billion in 2008.
C H A P T E R 7
strategy formulation:
corporate Strategy
205
� Understand the three aspects of corporate
strategy
� Apply the directional strategies of growth,
stability, and retrenchment
� Understand the differences between
vertical and horizontal growth as well as
concentric and conglomerate
diversification
Learning Objectives
Gathering
Information
Putting Strategy
into Action
Monitoring
Performance
Societal
Environment:
General forces
Natural
Environment:
Resources and
climate
Task
Environment:
Industry analysis
Internal:
Strengths and
Weaknesses
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
Programs
Activities
needed to
accomplish
a plan
Budgets
Cost of the
programs Procedures
Sequence
of steps
needed to
do the job
Performance
Actual results
External:
Opportunities
and Threats
Developing
Long-range Plans
Mission
Reason for
existence Objectives
What
results to
accomplish
by when
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Environmental
Scanning:
Strategy
Formulation:
Strategy
Implementation:
Evaluation
and Control:
Feedback/Learning: Make corrections as needed
After reading this chapter, you should be able to:
� Identify strategic options to enter a
foreign country
� Apply portfolio analysis to guide decisions
in companies with multiple products and
businesses
� Develop a parenting strategy for a
multiple-business corporation
206 PART 3 Strategy Formulation
7.1 Corporate Strategy
The vignette about Nike illustrates the importance of corporate strategy to a firm’s survival
and success. Corporate strategy deals with three key issues facing the corporation as a whole:
1. The firm’s overall orientation toward growth, stability, or retrenchment (directional strategy)
2. The industries or markets in which the firm competes through its products and business
units (portfolio analysis)
3. The manner in which management coordinates activities and transfers resources and cul-
tivates capabilities among product lines and business units (parenting strategy)
Corporate strategy is primarily about the choice of direction for a firm as a whole and the man-
agement of its business or product portfolio.3 This is true whether the firm is a small company
or a large multinational corporation (MNC). In a large multiple-business company, in particu-
lar, corporate strategy is concerned with managing various product lines and business units for
maximum value. In this instance, corporate headquarters must play the role of the organizational
“parent,” in that it must deal with various product and business unit “children.” Even though
each product line or business unit has its own competitive or cooperative strategy that it uses to
obtain its own competitive advantage in the marketplace, the corporation must coordinate these
different business strategies so that the corporation as a whole succeeds as a “family.”4
Corporate strategy, therefore, includes decisions regarding the flow of financial and other
resources to and from a company’s product lines and business units. Through a series of coor-
dinating devices, a company transfers skills and capabilities developed in one unit to other
units that need such resources. In this way, it attempts to obtain synergy among numerous
product lines and business units so that the corporate whole is greater than the sum of its indi-
vidual business unit parts.5 All corporations, from the smallest company offering one product
in only one industry to the largest conglomerate operating in many industries with many prod-
ucts, must at one time or another consider one or more of these issues.
To deal with each of the key issues, this chapter is organized into three parts that examine
corporate strategy in terms of directional strategy (orientation toward growth), portfolio
analysis (coordination of cash flow among units), and corporate parenting (the building of
corporate synergies through resource sharing and development).6
7.2 Directional Strategy
Just as every product or business unit must follow a business strategy to improve its compet-
itive position, every corporation must decide its orientation toward growth by asking the fol-
lowing three questions:
1. Should we expand, cut back, or continue our operations unchanged?
2. Should we concentrate our activities within our current industry, or should we diversify
into other industries?
3. If we want to grow and expand nationally and/or globally, should we do so through inter-
nal development or through external acquisitions, mergers, or strategic alliances?
GROWTH STRATEGIES
CHAPTER 7 Strategy Formulation: Corporate Strategy 207
By far the most widely pursued corporate directional strategies are those designed to achieve
growth in sales, assets, profits, or some combination. Companies that do business in expand-
ing industries must grow to survive. Continuing growth means increasing sales and a chance
to take advantage of the experience curve to reduce the per-unit cost of products sold, thereby
increasing profits. This cost reduction becomes extremely important if a corporation’s indus-
try is growing quickly or consolidating and if competitors are engaging in price wars in at-
tempts to increase their shares of the market. Firms that have not reached “critical mass” (that
is, gained the necessary economy of large-scale production) face large losses unless they can
find and fill a small, but profitable, niche where higher prices can be offset by special product
or service features. That is why Oracle acquired PeopleSoft, a rival software firm, in 2005. Al-
though still growing, the software industry was maturing around a handful of large firms. Ac-
cording to CEO Larry Ellison, Oracle needed to double or even triple in size by buying smaller
and weaker rivals if it was to compete with SAP and Microsoft.7 Growth is a popular strategy
because larger businesses tend to survive longer than smaller companies due to the greater
availability of financial resources, organizational routines, and external ties.8
A corporation can grow internally by expanding its operations both globally and domes-
tically, or it can grow externally through mergers, acquisitions, and strategic alliances. A
merger is a transaction involving two or more corporations in which stock is exchanged but
in which only one corporation survives. Mergers usually occur between firms of somewhat
similar size and are usually “friendly.” The resulting firm is likely to have a name derived from
its composite firms. One example is the merging of Allied Corporation and Signal Companies
Concentration
Vertical Growth
Horizontal Growth
Diversification
Concentric
Conglomerate
Pause/Proceed with Caution
No Change
Profit
Turnaround
Captive Company
Sell-Out/Divestment
Bankruptcy/Liquidation
GROWTH STABILITY RETRENCHMENT
FIGURE 7–1
Corporate
Directional
Strategies
A corporation’s directional strategy is composed of three general orientations (some-
times called grand strategies):
� Growth strategies expand the company’s activities.
� Stability strategies make no change to the company’s current activities.
� Retrenchment strategies reduce the company’s level of activities.
Having chosen the general orientation (such as growth), a company’s managers can select
from several more specific corporate strategies such as concentration within one product
line/industry or diversification into other products/industries. (See Figure 7–1.) These strate-
gies are useful both to corporations operating in only one industry with one product line and
to those operating in many industries with many product lines.
to form Allied Signal. An acquisition is the purchase of a company that is completely absorbed
as an operating subsidiary or division of the acquiring corporation. Procter & Gamble’s
(P&G’s) purchase of Gillette is an example of a recent acquisition. Acquisitions usually occur
between firms of different sizes and can be either friendly or hostile. Hostile acquisitions are
often called takeovers.
Growth is a very attractive strategy for two key reasons:
� Growth based on increasing market demand may mask flaws in a company—flaws that
would be immediately evident in a stable or declining market. A growing flow of revenue
into a highly leveraged corporation can create a large amount of organization slack (un-
used resources) that can be used to quickly resolve problems and conflicts between de-
partments and divisions. Growth also provides a big cushion for turnaround in case a
strategic error is made. Larger firms also have more bargaining power than do small firms
and are more likely to obtain support from key stakeholders in case of difficulty.
� A growing firm offers more opportunities for advancement, promotion, and interesting
jobs. Growth itself is exciting and ego-enhancing for CEOs. The marketplace and poten-
tial investors tend to view a growing corporation as a “winner” or “on the move.” Exec-
utive compensation tends to get bigger as an organization increases in size. Large firms
are also more difficult to acquire than are smaller ones; thus an executive’s job in a large
firm is more secure.
The two basic growth strategies are concentration on the current product line(s) in one
industry and diversification into other product lines in other industries.
Concentration
If a company’s current product lines have real growth potential, concentration of resources on
those product lines makes sense as a strategy for growth. The two basic concentration strate-
gies are vertical growth and horizontal growth. Growing firms in a growing industry tend to
choose these strategies before they try diversification.
Vertical Growth. Vertical growth can be achieved by taking over a function previously
provided by a supplier or by a distributor. The company, in effect, grows by making its own
supplies and/or by distributing its own products. This may be done in order to reduce costs,
gain control over a scarce resource, guarantee quality of a key input, or obtain access to
potential customers. This growth can be achieved either internally by expanding current
operations or externally through acquisitions. Henry Ford, for example, used internal company
resources to build his River Rouge plant outside Detroit. The manufacturing process was
integrated to the point that iron ore entered one end of the long plant, and finished automobiles
rolled out the other end, into a huge parking lot. In contrast, Cisco Systems, a maker of Internet
hardware, chose the external route to vertical growth by purchasing Scientific-Atlanta Inc., a
maker of set-top boxes for television programs and movies-on-demand. This acquisition gave
Cisco access to technology for distributing television to living rooms through the Internet.9
Vertical growth results in vertical integration—the degree to which a firm operates ver-
tically in multiple locations on an industry’s value chain from extracting raw materials to man-
ufacturing to retailing. More specifically, assuming a function previously provided by a
supplier is called backward integration (going backward on an industry’s value chain). The
purchase of Carroll’s Foods for its hog-growing facilities by Smithfield Foods, the world’s
largest pork processor, is an example of backward integration.10 Assuming a function previ-
ously provided by a distributor is labeled forward integration (going forward on an industry’s
value chain). FedEx, for example, used forward integration when it purchased Kinko’s in order
to provide store-front package drop-off and delivery services for the small-business market.11
208 PART 3 Strategy Formulation
CHAPTER 7 Strategy Formulation: Corporate Strategy 209
Vertical growth is a logical strategy for a corporation or business unit with a strong com-
petitive position in a highly attractive industry—especially when technology is predictable and
markets are growing.12 To keep and even improve its competitive position, a company may use
backward integration to minimize resource acquisition costs and inefficient operations as well
as forward integration to gain more control over product distribution. The firm, in effect, builds
on its distinctive competence by expanding along the industry’s value chain to gain greater
competitive advantage.
Although backward integration is often more profitable than forward integration (because
of typical low margins in retailing), it can reduce a corporation’s strategic flexibility. The re-
sulting encumbrance of expensive assets that might be hard to sell could create an exit barrier,
preventing the corporation from leaving that particular industry. Examples of single-use assets
are blast furnaces and breweries. When demand drops in either of these industries (steel or
beer), these assets have no alternative use, but continue to cost money in terms of debt pay-
ments, property taxes, and security expenses.
Transaction cost economics proposes that vertical integration is more efficient than con-
tracting for goods and services in the marketplace when the transaction costs of buying goods
on the open market become too great. When highly vertically integrated firms become exces-
sively large and bureaucratic, however, the costs of managing the internal transactions may be-
come greater than simply purchasing the needed goods externally—thus justifying
outsourcing over vertical integration. This is why vertical integration and outsourcing are sit-
uation specific. Neither approach is best for all companies in all situations.13 See the Strategy
Highlight 7.1 feature on how transaction cost economics helps explain why firms vertically
integrate or outsource important activities. Research thus far provides mixed support for the
predictions of transaction cost economics.14
Harrigan proposes that a company’s degree of vertical integration can range from total
ownership of the value chain needed to make and sell a product to no ownership at all.15 (See
Figure 7–2.) Under full integration, a firm internally makes 100% of its key supplies and com-
pletely controls its distributors. Large oil companies, such as British Petroleum and Royal Dutch
Shell, are fully integrated. They own the oil rigs that pump the oil out of the ground, the ships
and pipelines that transport the oil, the refineries that convert the oil to gasoline, and the trucks
that deliver the gasoline to company-owned and franchised gas stations. Sherwin-Williams
Company, which not only manufacturers paint, but also sells it in its own chain of 3,000 retail
stores, is another example of a fully-integrated firm.16 If a corporation does not want the disad-
vantages of full vertical integration, it may choose either taper or quasi-integration strategies.
With taper integration (also called concurrent sourcing), a firm internally produces less
than half of its own requirements and buys the rest from outside suppliers (backward taper in-
tegration).17 In the case of Smithfield Foods, its purchase of Carroll’s allowed it to produce 27%
of the hogs it needed to process into pork. In terms of forward taper integration, a firm sells part
of its goods through company-owned stores and the rest through general wholesalers. Although
Apple had 216 of its own retain stores in 2008, much of the company’s sales continued to be
through national chains such as Best Buy and through independent local and regional dealers.
With quasi-integration, a company does not make any of its key supplies but purchases
most of its requirements from outside suppliers that are under its partial control (backward
Full
Integration
Taper
Integration
Quasi-
Integration
Long-Term
Contract
FIGURE 7–2
Vertical
Integration
Continuum
SOURCE: Suggested by K. R. Harrigan, Strategies for Vertical Integration (Lexington, Mass.: Lexington Books, D.C.
Health, 1983), pp. 16–21.
Why do corporations use ver-
tical growth to permanently
own suppliers or distributors
when they could simply purchase in-
dividual items when needed on the open market? Transac-
tion cost economics is a branch of institutional economics
that attempts to answer this question. Transaction cost eco-
nomics proposes that owning resources through vertical
growth is more efficient than contracting for goods and
services in the marketplace when the transaction costs of
buying goods on the open market become too great. Trans-
action costs include the basic costs of drafting, negotiating,
and safeguarding a market agreement (a contract) as well
as the later managerial costs when the agreement is creat-
ing problems (goods aren’t being delivered on time or qual-
ity is lower than needed), renegotiation costs (e.g., costs of
meetings and phone calls), and the costs of settling dis-
putes (e.g., lawyers’ fees and court costs).
According to Williamson, three conditions must be met
before a corporation will prefer internalizing a vertical
transaction through ownership over contracting for the
transaction in the marketplace: (1) a high level of uncer-
tainty must surround the transaction, (2) assets involved in
the transaction must be highly specialized to the transac-
tion, and (3) the transaction must occur frequently. If there
is a high level of uncertainty, it will be impossible to write
a contract covering all contingencies, and it is likely that
the contractor will act opportunistically to exploit any gaps
in the written agreement—thus creating problems and in-
creasing costs. If the assets being contracted for are highly
210 PART 3 Strategy Formulation
STRATEGY highlight 7.1
TRANSACTION COST ECONOMICS
ANALYZES VERTICAL GROWTH STRATEGY
specialized (e.g., goods or services with few alternate
uses), there are likely to be few alternative suppliers—thus
allowing the contractor to take advantage of the situation
and increase costs. The more frequent the transactions, the
more opportunity for the contractor to demand special
treatment and thus increase costs further.
Vertical integration is not always more efficient than the
marketplace, however. When highly vertically integrated
firms become excessively large and bureaucratic, the costs
of managing the internal transactions may become greater
than simply purchasing the needed goods externally—thus
justifying outsourcing over ownership. The usually hidden
management costs (e.g., excessive layers of management,
endless committee meetings needed for interdepartmental
coordination, and delayed decision making due to exces-
sively detailed rules and policies) add to the internal trans-
action costs—thus reducing the effectiveness and
efficiency of vertical integration. The decision to own or to
outsource is, therefore, based on the particular situation
surrounding the transaction and the ability of the corpora-
tion to manage the transaction internally both effectively
and efficiently.
SOURCES: O. E. Williamson and S. G. Winter, eds., The Nature of
the Firm: Origins, Evolution, and Development (New York: Oxford
University Press, 1991); E. Mosakowski, “Organizational Bound-
aries and Economic Performance: An Empirical Study of Entrepre-
neurial Computer Firms,” Strategic Management Journal
(February 1991), pp. 115–133; P. S. Ring and A. H. Van de Ven,
“Structuring Cooperative Relationships Between Organizations,”
Strategic Management Journal (October 1992), pp. 483–498.
quasi-integration). A company may not want to purchase outright a supplier or distributor, but
it still may want to guarantee access to needed supplies, new products, technologies, or distri-
bution channels. For example, the pharmaceutical company Bristol-Myers Squibb purchased
17% of the common stock of ImClone in order to gain access to new drug products being de-
veloped through biotechnology. An example of forward quasi-integration would be a paper
company acquiring part interest in an office products chain in order to guarantee that its prod-
ucts had access to the distribution channel. Purchasing part interest in another company usu-
ally provides a company with a seat on the other firm’s board of directors, thus guaranteeing
the acquiring firm both information and control. As in the case of Bristol-Myers Squibb and
ImClone, a quasi-integrated firm may later decide to buy the rest of a key supplier that it did
not already own.18
Long-term contracts are agreements between two firms to provide agreed-upon goods
and services to each other for a specified period of time. This cannot really be considered to
be vertical integration unless it is an exclusive contract that specifies that the supplier or dis-
tributor cannot have a similar relationship with a competitive firm. In that case, the supplier
CHAPTER 7 Strategy Formulation: Corporate Strategy 211
or distributor is really a captive company that, although officially independent, does most of
its business with the contracted firm and is formally tied to the other company through a long-
term contract.
Recently there has been a movement away from vertical growth strategies (and thus ver-
tical integration) toward cooperative contractual relationships with suppliers and even with
competitors.19 These relationships range from outsourcing, in which resources are purchased
from outsiders through long-term contracts instead of being made in-house (for example,
Hewlett-Packard bought its laser engines from Canon for HP’s laser jet printers), to strategic
alliances, in which partnerships, technology licensing agreements, and joint ventures supple-
ment a firm’s capabilities (for example, Toshiba has used strategic alliances with GE, Siemens,
Motorola, and Ericsson to become one of the world’s leading electronic companies).20
Horizontal Growth. A firm can achieve horizontal growth by expanding its operations into
other geographic locations and/or by increasing the range of products and services offered to
current markets. Research indicates that firms that grow horizontally by broadening their
product lines have high survival rates.21 Horizontal growth results in horizontal
integration—the degree to which a firm operates in multiple geographic locations at the same
point on an industry’s value chain. For example, Procter & Gamble (P&G) continually adds
additional sizes and multiple variations to its existing product lines to reduce possible niches
competitors may enter. In addition, it introduces successful products from one part of the world
to other regions. P&G has been introducing into China a steady stream of popular American
brands, such as Head & Shoulders, Crest, Olay, Tide, Pampers, and Whisper. By 2007, it had
6,300 employees in China and the extensive distribution network it needed to prosper in the
world’s fastest growing market.22
Horizontal growth can be achieved through internal development or externally through
acquisitions and strategic alliances with other firms in the same industry. For example, Delta
Airlines acquired Northwest Airlines in 2008 to obtain access to Northwest’s Asian markets
and those American markets that Delta was not then serving. In contrast, many small com-
muter airlines engage in long-term contracts with major airlines in order to offer a complete
arrangement for travelers. For example, the regional carrier Mesa Airlines arranged contrac-
tual agreements with United Airlines, U.S. Airways, and America West to be listed on their
computer reservations, respectively, as United Express, U.S. Airways Express, and America
West Express.
Horizontal growth is increasingly being achieved in today’s world through international
expansion. American’s Wal-Mart, France’s Carrefour, and Britain’s Tesco are examples of na-
tional supermarket discount chains expanding horizontally throughout the world. This type of
growth can be achieved internationally through many different strategies.
International Entry Options for Horizontal Growth
Research indicates that growing internationally is positively associated with firm profitability.23
A corporation can select from several strategic options the most appropriate method for entering
a foreign market or establishing manufacturing facilities in another country. The options vary
from simple exporting to acquisitions to management contracts. See the Global Issue feature to
see how U.S.-based firms are using international entry options in a horizontal growth strategy to
expand throughout the world.
Some of the most popular options for international entry are as follows:
� Exporting: A good way to minimize risk and experiment with a specific product is
exporting, shipping goods produced in the company’s home country to other countries for
marketing. The company could choose to handle all critical functions itself, or it could con-
tract these functions to an export management company. Exporting is becoming increasingly
What do Wal-Mart, Star-
bucks, and International Pa-
per have in common? For one
thing, they are successful U.S.
companies that grew to the point that
eventually their products saturated the domestic market—
resulting in slower growth in domestic sales and profits. For
another, all are companies that have chosen the corporate
growth strategy of concentrating in one industry. A third
thing in common is that all of them are using international
markets as a key growth opportunity.
From its humble beginnings in Bentonville, Arkansas,
Wal-Mart has successfully grown such that its discount
stores can now be found in most every corner of the nation.
Knowing that Wal-Mart had fewer locations left in the
United States on which to build stores, the company’s man-
agement knew that the company’s domestic growth could
not be sustained past 2007. Consequently, the company be-
gan acquiring retail chains in other countries to eventually
become the largest company in the world in terms of sales.
Growing from its base in Seattle, Washington, Star-
bucks expanded its coffee shops to every city in the coun-
212 PART 3 Strategy Formulation
GLOBAL issue
COMPANIES LOOK TO INTERNATIONAL
MARKETS FOR HORIZONTAL GROWTH
try in only a few years. Soon imitators began opening their
own versions until the U.S. market was completely satu-
rated with coffee shops. Facing slow growth in its domes-
tic market, Starbucks’ management made the strategic
decision to add fewer U.S. stores and to make international
expansion its top priority.
Until recently, International Paper (IP) was international
in name only. Founded in 1898, the company had once
supplied 60% of the newsprint for American newspapers.
After years of slow growth and weak financial perfor-
mance, IP’s management decided to divest unrelated busi-
nesses and to branch out from its North American roots to
developing international markets. Acquisitions in Russia
and green-field development in Brazil now positioned the
company within low-cost, high-growth markets. IP’s man-
agement hoped to soon control about half the office pa-
per market in Latin America.
SOURCES: B. Helm and J. McGregor, “Howard Schultz’s Grande
Challenge,” Business Week (January 21, 2008), p. 28; J. Bush,
“Now It’s Really International Paper,” Business Week (December
17, 2007).
popular for small businesses because of the Internet, fax machines, toll-free numbers, and
overnight express services, which reduce the once-formidable costs of going international.
� Licensing: Under a licensing agreement, the licensing firm grants rights to another firm
in the host country to produce and/or sell a product. The licensee pays compensation to
the licensing firm in return for technical expertise. This is an especially useful strategy if
the trademark or brand name is well known, but the company does not have sufficient
funds to finance its entering the country directly. Anheuser-Busch used this strategy to
produce and market Budweiser beer in the United Kingdom, Japan, Israel, Australia,
Korea, and the Philippines. This strategy is also important if the country makes entry
via investment either difficult or impossible.
� Franchising: Under a franchising agreement, the franchiser grants rights to another
company to open a retail store using the franchiser’s name and operating system. In ex-
change, the franchisee pays the franchiser a percentage of its sales as a royalty. Franchis-
ing provides an opportunity for a firm to establish a presence in countries where the
population or per capita spending is not sufficient for a major expansion effort.24 Fran-
chising accounts for 40% of total U.S. retail sales. Close to half of U.S. franchisers, such
as Yum! Brands, franchise internationally.25
� Joint Ventures: Forming a joint venture between a foreign corporation and a domestic
company is the most popular strategy used to enter a new country.26 Companies often form
joint ventures to combine the resources and expertise needed to develop new products or
technologies. A joint venture may be an association between a company and a firm in the
host country or a government agency in that country. A quick method of obtaining local
CHAPTER 7 Strategy Formulation: Corporate Strategy 213
management, it also reduces the risks of expropriation and harassment by host country of-
ficials. A joint venture may also enable a firm to enter a country that restricts foreign own-
ership. The corporation can enter another country with fewer assets at stake and thus lower
risk. Under Indian law, for example, foreign retailers are permitted to own no more than
51% of shops selling single-brand products, or to sell to others on a wholesale basis. These
and other restrictions deterred supermarket giants Tesco and Carrefour from entering In-
dia. As a result, 97% of Indian retailing is composed of small, family-run stores. Eager to
enter India, Wal-Mart’s management formed an equal partnership joint venture in 2007
with Bharti Enterprises to start wholesale operations. Under the name Bharti-Mart, the
new company planned to open a dozen small retail stores by 2015.27
� Acquisitions: A relatively quick way to move into an international area is through acquisi-
tions—purchasing another company already operating in that area. Synergistic benefits can
result if the company acquires a firm with strong complementary product lines and a good
distribution network. For example, Belgium’s InBev purchased Anheuser-Busch in 2008
for $52 billion to obtain a solid position in the profitable North American beer market. Be-
fore the acquisition, InBev had only a small presence in the U.S., but a strong one in Europe
and Latin American, where Anheuser-Busch was weak.28 Research suggests that wholly
owned subsidiaries are more successful in international undertakings than are strategic al-
liances, such as joint ventures.29 This is one reason why firms more experienced in interna-
tional markets take a higher ownership position when making a foreign investment.30
Cross-border acquisitions now account for 19% of all acquisitions in the United States—up
from only 6% in 1985.31 In some countries, however, acquisitions can be difficult to arrange
because of a lack of available information about potential candidates. Government restric-
tions on ownership, such as the U.S. requirement that limits foreign ownership of U.S. air-
lines to 49% of nonvoting and 25% of voting stock, can also discourage acquisitions.
� Green-Field Development: If a company doesn’t want to purchase another company’s
problems along with its assets, it may choose green-field development and build its own
manufacturing plant and distribution system. Research indicates that firms possessing
high levels of technology, multinational experience, and diverse product lines prefer
green-field development to acquisitions.32 This is usually a far more complicated and ex-
pensive operation than acquisition, but it allows a company more freedom in designing
the plant, choosing suppliers, and hiring a workforce. For example, Nissan, Honda, and
Toyota built auto factories in rural areas of Great Britain and then hired a young work-
force with no experience in the industry. BMW did the same thing when it built its auto
plant in Spartanburg, South Carolina, to make its Z3 and Z4 sports cars.
� Production Sharing: Coined by Peter Drucker, the term production sharing means the
process of combining the higher labor skills and technology available in developed coun-
tries with the lower-cost labor available in developing countries. Often called outsourcing,
one example is Maytag’s moving some of its refrigeration production to a new plant in
Reynosa, Mexico, in order to reduce labor costs. Many companies have moved data pro-
cessing, programming, and customer service activities “offshore” to Ireland, India, Barba-
dos, Jamaica, the Philippines, and Singapore, where wages are lower, English is spoken,
and telecommunications are in place. As the number of technology services employees in
India grew to be 15% of IBM’s total tech services employees by 2007, the company has
been able to eliminate 20,000 jobs in high-cost locations in the U.S., Europe, and Japan.33
� Turnkey Operations: Turnkey operations are typically contracts for the construction of
operating facilities in exchange for a fee. The facilities are transferred to the host country
or firm when they are complete. The customer is usually a government agency of, for ex-
ample, a Middle Eastern country that has decreed that a particular product must be pro-
duced locally and under its control. For example, Fiat built an auto plant in Tagliatti,
214 PART 3 Strategy Formulation
Russia, for the Soviet Union in the late 1960s to produce an older model of Fiat under the
brand name of Lada. MNCs that perform turnkey operations are frequently industrial
equipment manufacturers that supply some of their own equipment for the project and that
commonly sell replacement parts and maintenance services to the host country. They
thereby create customers as well as future competitors. Interestingly, Renault purchased in
2008 a 25% stake in the same Tagliatti factory built by Fiat to help the Russian carmaker
modernize, using Renault’s low cost Logan as the base for the plant’s new Lada model.34
� BOT Concept: The BOT (Build, Operate, Transfer) concept is a variation of the
turnkey operation. Instead of turning the facility (usually a power plant or toll road) over
to the host country when completed, the company operates the facility for a fixed period
of time during which it earns back its investment plus a profit. It then turns the facility
over to the government at little or no cost to the host country.35
� Management Contracts: A large corporation operating throughout the world is likely to
have a large amount of management talent at its disposal. Management contracts offer
a means through which a corporation can use some of its personnel to assist a firm in a
host country for a specified fee and period of time. Management contracts are common
when a host government expropriates part or all of a foreign-owned company’s holdings
in its country. The contracts allow the firm to continue to earn some income from its in-
vestment and keep the operations going until local management is trained.36
Diversification Strategies
According to strategist Richard Rumelt, companies begin thinking about diversification when
their growth has plateaued and opportunities for growth in the original business have been de-
pleted.37 This often occurs when an industry consolidates, becomes mature, and most of the
surviving firms have reached the limits of growth using vertical and horizontal growth strate-
gies. Unless the competitors are able to expand internationally into less mature markets, they
may have no choice but to diversify into different industries if they want to continue growing.
The two basic diversification strategies are concentric and conglomerate.
Concentric (Related) Diversification. Growth through concentric diversification into a
related industry may be a very appropriate corporate strategy when a firm has a strong
competitive position but industry attractiveness is low.
Research indicates that the probability of succeeding by moving into a related business is a
function of a company’s position in its core business. For companies in leadership positions, the
chances for success are nearly three times higher than those for followers.38 By focusing on the
characteristics that have given the company its distinctive competence, the company uses those
very strengths as its means of diversification. The firm attempts to secure strategic fit in a new
industry where the firm’s product knowledge, its manufacturing capabilities, and the marketing
skills it used so effectively in the original industry can be put to good use.39 The corporation’s
products or processes are related in some way: they possess some common thread.
The search is for synergy, the concept that two businesses will generate more profits to-
gether than they could separately. The point of commonality may be similar technology, cus-
tomer usage, distribution, managerial skills, or product similarity. This is the rationale taken
by Quebec-based Bombardier, the world’s third-largest aircraft manufacturer. In the 1980s, the
company expanded beyond snowmobiles into making light rail equipment. Defining itself as
a transportation company, it entered the aircraft business in 1986, with its purchase of
Canadair, then best known for its fire-fighting airplanes. It later bought Learjet, a well-known
maker of business jets. Over a 14-year period, Bombardier launched 14 new aircraft. In July
2008, the company announced its C Series Aircraft Program to manufacture a 110–130-seat
“green” single-aisle family of airplanes to directly compete with Airbus and Boeing.40
Market Attractiveness
1. Is the market large
enough to be attractive?
2. Is the market growing
faster than the economy?
3. Does it offer the potential to increase revenue from
current customers?
4. Does it provide the ability to sell existing services to
new customers?
5. Does it create a recurring revenue stream?
6. Are average earnings in the industry/market higher
than in current businesses?
7. Is the market already taken by strong competitors?
8. Does it strengthen relationships with existing value-
chain players?
CHAPTER 7 Strategy Formulation: Corporate Strategy 215
A firm may choose to diversify concentrically through either internal or external means.
Bombardier, for example, diversified externally through acquisitions. Toro, in contrast, grew
internally in North America by using its current manufacturing processes and distributors to
make and market snow blowers in addition to lawn mowers. When considering concentric di-
versification alternatives, see the criteria presented in Strategy Highlight 7.2.
Conglomerate (Unrelated) Diversification. When management realizes that the current
industry is unattractive and that the firm lacks outstanding abilities or skills that it could easily
transfer to related products or services in other industries, the most likely strategy is
conglomerate diversification—diversifying into an industry unrelated to its current one.
Rather than maintaining a common thread throughout their organization, strategic managers
who adopt this strategy are primarily concerned with financial considerations of cash flow or
risk reduction. This is also a good strategy for a firm that is able to transfer its own excellent
management system into less-well-managed acquired firms. General Electric and Berkshire
Hathaway are examples of companies that have used conglomerate diversification to grow
successfully. Managed by Warren Buffet, Berkshire Hathaway has interests in furniture
retailing, razor blades, airlines, paper, broadcasting, soft drinks, and publishing.41
The emphasis in conglomerate diversification is on sound investment and value-oriented
management rather than on the product-market synergy common to concentric diversifica-
tion. A cash-rich company with few opportunities for growth in its industry might, for exam-
ple, move into another industry where opportunities are great but cash is hard to find. Another
instance of conglomerate diversification might be when a company with a seasonal and,
STRATEGY highlight 7.2
SCREENING CRITERIA FOR CONCENTRIC DIVERSIFICATION
Market Feasibility
1. Can the company enter the market within a year?
2. Are there any synergies in the geographic region
where the market is located?
3. Can existing capabilities be leveraged for market
entry?
4. Can existing assets be leveraged for market entry?
5. Can existing employees be used to support this
opportunity?
6. Will current and future laws and regulations affect
entry?
7. Is there a need for a strong brand in the new
market?
8. If there is a need for partners, can the company
secure and manage partner relationships?
SOURCE: Summarized from N. J. Kaplan, “Surviving and Thriving
When Your Customers Contract,” Journal of Business Strategy
(January/February, 2003), p. 20.
216 PART 3 Strategy Formulation
therefore, uneven cash flow purchases a firm in an unrelated industry with complementing
seasonal sales that will level out the cash flow. CSX management considered the purchase of
a natural gas transmission business (Texas Gas Resources) by CSX Corporation (a railroad-
dominated transportation company) to be a good fit because most of the gas transmission rev-
enue was realized in the winter months—the lean period in the railroad business.
CONTROVERSIES IN DIRECTIONAL GROWTH STRATEGIES
Is vertical growth better than horizontal growth? Is concentration better than diversifica-
tion? Is concentric diversification better than conglomerate diversification? Research re-
veals that companies following a related diversification strategy appear to be higher
performers and survive longer than do companies with narrower scope following a pure con-
centration strategy.42 Although the research is not in complete agreement, growth into areas
related to a company’s current product lines is generally more successful than is growth into
completely unrelated areas.43 For example, one study of various growth projects examined
how many were considered successful, that is, still in existence after 22 years. The results
were vertical growth, 80%; horizontal growth, 50%; concentric diversification, 35%; and
conglomerate diversification, 28%.44 This supports the conclusion from a study of 40 suc-
cessful European companies that companies should first exploit their existing assets and ca-
pabilities before exploring for new ones, but that they should also diversify their portfolio
of products.45
In terms of diversification strategies, research suggests that the relationship between re-
latedness and performance is curvilinear in the shape of an inverted U-shaped curve. If a new
business is very similar to that of the acquiring firm, it adds little new to the corporation and
only marginally improves performance. If the new business is completely different from the
acquiring company’s businesses, there may be very little potential for any synergy. If, how-
ever, the new business provides new resources and capabilities in a different, but similar, busi-
ness, the likelihood of a significant performance improvement is high.46
Is internal growth better than external growth? Corporations can follow the growth strate-
gies of either concentration or diversification through the internal development of new products
and services, or through external acquisitions, mergers, and strategic alliances. The value
of global acquisitions and mergers has steadily increased from less than $1 trillion in 1990 to
$3.5 trillion in 2000.47 According to a McKinsey & Company survey, managers are primarily
motivated to purchase other companies in order to add capabilities, expand geographically, and
buy growth.48 Research generally concludes, however, that firms growing through acquisitions
do not perform financially as well as firms that grow through internal means.49 For example, on
September 3, 2001, the day before HP announced that it was purchasing Compaq, HP’s stock
was selling at $23.11. After the announcement, the stock price fell to $18.87. Three years later,
on September 21, 2004, the shares sold at $18.70.50 One reason for this poor performance may
be that acquiring firms tend to spend less on R&D than do other firms.51 Another reason may
be the typically high price of the acquisition itself. Studies reveal that over half to two-thirds of
acquisitions are failures primarily because the premiums paid were too high for them to earn
their cost of capital.52 Another reason for the poor stock performance is that 50% of the cus-
tomers of a merged firm are less satisfied with the combined company’s service two years af-
ter the merger.53 It is likely that neither strategy is best by itself and that some combination of
internal and external growth strategies is better than using one or the other.54
What can improve acquisition performance? For one thing, the acquisition should be
linked to strategic objectives and support corporate strategy. In addition, a corporation must
be prepared to identify roughly 100 candidates and conduct due diligence investigation on
around 40 companies in order to ultimately purchase 10 companies. This kind of effort requires
CHAPTER 7 Strategy Formulation: Corporate Strategy 217
the capacity to sift through many candidates while simultaneously integrating previous acqui-
sitions.55 A study by Bain & Company of more than 11,000 acquisitions by companies
throughout the world concluded that successful acquirers make small, low-risk acquisitions
before moving on to larger ones.56 Previous experience between an acquirer and a target firm
in terms of R&D, manufacturing, or marketing alliances improves the likelihood of a success-
ful acquisition.57 Realizing that an acquired company must be carefully assimilated into the
acquiring firm’s operations, Cisco uses three criteria to judge whether a company is a suitable
candidate for takeover:
� It must be relatively small.
� It must be comparable in organizational culture.
� It must be physically close to one of the existing affiliates.58
STABILITY STRATEGIES
A corporation may choose stability over growth by continuing its current activities without any
significant change in direction. Although sometimes viewed as a lack of strategy, the stability
family of corporate strategies can be appropriate for a successful corporation operating in a
reasonably predictable environment.59 They are very popular with small business owners who
have found a niche and are happy with their success and the manageable size of their firms.
Stability strategies can be very useful in the short run, but they can be dangerous if followed
for too long. Some of the more popular of these strategies are the pause/proceed-with-caution,
no-change, and profit strategies.
Pause/Proceed with Caution Strategy
A pause/proceed-with-caution strategy is, in effect, a timeout—an opportunity to rest be-
fore continuing a growth or retrenchment strategy. It is a very deliberate attempt to make
only incremental improvements until a particular environmental situation changes. It is typ-
ically conceived as a temporary strategy to be used until the environment becomes more hos-
pitable or to enable a company to consolidate its resources after prolonged rapid growth. This
was the strategy Dell followed after its growth strategy had resulted in more growth than it
could handle. Explained CEO Michael Dell, “We grew 285% in two years, and we’re hav-
ing some growing pains.” Selling personal computers by mail enabled Dell to underprice
competitors, but it could not keep up with the needs of a $2 billion, 5,600-employee com-
pany selling PCs in 95 countries. Dell did not give up on its growth strategy; it merely put it
temporarily in limbo until the company was able to hire new managers, improve the struc-
ture, and build new facilities.60 This was a popular strategy in late-2008 during a U.S. finan-
cial crisis when banks were freezing their lending and awaiting a rescue package from the
federal government.
No-Change Strategy
A no-change strategy is a decision to do nothing new—a choice to continue current opera-
tions and policies for the foreseeable future. Rarely articulated as a definite strategy, a no-
change strategy’s success depends on a lack of significant change in a corporation’s situation.
The relative stability created by the firm’s modest competitive position in an industry facing
little or no growth encourages the company to continue on its current course, making only
small adjustments for inflation in its sales and profit objectives. There are no obvious oppor-
tunities or threats, nor is there much in the way of significant strengths or weaknesses. Few ag-
gressive new competitors are likely to enter such an industry. The corporation has probably
218 PART 3 Strategy Formulation
found a reasonably profitable and stable niche for its products. Unless the industry is under-
going consolidation, the relative comfort a company in this situation experiences is likely to
encourage the company to follow a no-change strategy in which the future is expected to con-
tinue as an extension of the present. Many small-town businesses followed this strategy before
Wal-Mart moved into their areas and forced them to rethink their strategy.
Profit Strategy
A profit strategy is a decision to do nothing new in a worsening situation but instead to act as
though the company’s problems are only temporary. The profit strategy is an attempt to artifi-
cially support profits when a company’s sales are declining by reducing investment and short-
term discretionary expenditures. Rather than announce the company’s poor position to
shareholders and the investment community at large, top management may be tempted to fol-
low this very seductive strategy. Blaming the company’s problems on a hostile environment
(such as anti-business government policies, unethical competitors, finicky customers, and/or
greedy lenders), management defers investments and/or cuts expenses (such as R&D, mainte-
nance, and advertising) to stabilize profits during this period. It may even sell one of its prod-
uct lines for the cash-flow benefits.
The profit strategy is useful only to help a company get through a temporary difficulty. It
may also be a way to boost the value of a company in preparation for going public via an ini-
tial public offering (IPO). Unfortunately, the strategy is seductive and if continued long
enough it will lead to a serious deterioration in a corporation’s competitive position. The profit
strategy is typically top management’s passive, short-term, and often self-serving response to
a difficult situation. In such situations, it is often better to face the problem directly by choos-
ing a retrenchment strategy.
RETRENCHMENT STRATEGIES
A company may pursue retrenchment strategies when it has a weak competitive position in
some or all of its product lines resulting in poor performance—sales are down and profits are
becoming losses. These strategies impose a great deal of pressure to improve performance. In
an attempt to eliminate the weaknesses that are dragging the company down, management may
follow one of several retrenchment strategies, ranging from turnaround or becoming a captive
company to selling out, bankruptcy, or liquidation.
Turnaround Strategy
Turnaround strategy emphasizes the improvement of operational efficiency and is probably
most appropriate when a corporation’s problems are pervasive but not yet critical. Research
shows that poorly performing firms in mature industries have been able to improve their per-
formance by cutting costs and expenses and by selling off assets.61 Analogous to a weight-
reduction diet, the two basic phases of a turnaround strategy are contraction and consolidation.62
Contraction is the initial effort to quickly “stop the bleeding” with a general, across-the-
board cutback in size and costs. For example, when Howard Stringer was selected to be CEO
of Sony Corporation in 2005, he immediately implemented the first stage of a turnaround plan
by eliminating 10,000 jobs, closing 11 of 65 plants, and divesting many unprofitable electron-
ics businesses. 63 The second phase, consolidation, implements a program to stabilize the now-
leaner corporation. To streamline the company, plans are developed to reduce unnecessary
overhead and to make functional activities cost-justified. This is a crucial time for the organiza-
tion. If the consolidation phase is not conducted in a positive manner, many of the best people
leave the organization. An overemphasis on downsizing and cutting costs coupled with a heavy
CHAPTER 7 Strategy Formulation: Corporate Strategy 219
hand by top management is usually counterproductive and can actually hurt performance.64 If,
however, all employees are encouraged to get involved in productivity improvements, the firm
is likely to emerge from this retrenchment period a much stronger and better-organized com-
pany. It has improved its competitive position and is able once again to expand the business.65
Captive Company Strategy
A captive company strategy involves giving up independence in exchange for security. A com-
pany with a weak competitive position may not be able to engage in a full-blown turnaround strat-
egy. The industry may not be sufficiently attractive to justify such an effort from either the current
management or investors. Nevertheless, a company in this situation faces poor sales and increas-
ing losses unless it takes some action. Management desperately searches for an “angel” by offer-
ing to be a captive company to one of its larger customers in order to guarantee the company’s
continued existence with a long-term contract. In this way, the corporation may be able to reduce
the scope of some of its functional activities, such as marketing, thus significantly reducing costs.
The weaker company gains certainty of sales and production in return for becoming heavily de-
pendent on another firm for at least 75% of its sales. For example, to become the sole supplier of
an auto part to General Motors, Simpson Industries of Birmingham, Michigan, agreed to let a
special team from GM inspect its engine parts facilities and books and interview its employees.
In return, nearly 80% of the company’s production was sold to GM through long-term contracts.66
Sell-Out/Divestment Strategy
If a corporation with a weak competitive position in an industry is unable either to pull itself up
by its bootstraps or to find a customer to which it can become a captive company, it may have
no choice but to sell out. The sell-out strategy makes sense if management can still obtain a
good price for its shareholders and the employees can keep their jobs by selling the entire com-
pany to another firm. The hope is that another company will have the necessary resources and
determination to return the company to profitability. Marginal performance in a troubled indus-
try was one reason Northwest Airlines was willing to be acquired by Delta Airlines in 2008.
If the corporation has multiple business lines and it chooses to sell off a division with low
growth potential, this is called divestment. This was the strategy Ford used when it sold its
struggling Jaguar and Land Rover units to Tata Motors in 2008 for $2 billion. Ford had spent
$10 billion trying to turn around Jaguar after spending $2.5 billion to buy it in 1990. In addi-
tion, Ford had paid $2.8 billion for Land Rover in 2000. Ford’s management hoped to use the
proceeds of the sale to help the company reach profitability in 2009.67 General Electric’s man-
agement used the same reasoning when it decided to sell or spin off its slow-growth appliance
business in 2008.
Divestment is often used after a corporation acquires a multi-unit corporation in order to
shed the units that do not fit with the corporation’s new strategy. This is why Whirlpool sold
Maytag’s Hoover vacuum cleaner unit after Whirlpool purchased Maytag. Divestment was
also a key part of Lego’s turnaround strategy when management decided to divest its theme
parks to concentrate more on its core business of making toys.68
Bankruptcy/Liquidation Strategy
When a company finds itself in the worst possible situation with a poor competitive position
in an industry with few prospects, management has only a few alternatives—all of them dis-
tasteful. Because no one is interested in buying a weak company in an unattractive industry,
the firm must pursue a bankruptcy or liquidation strategy. Bankruptcy involves giving up
management of the firm to the courts in return for some settlement of the corporation’s obli-
gations. Top management hopes that once the court decides the claims on the company, the
220 PART 3 Strategy Formulation
company will be stronger and better able to compete in a more attractive industry. Faced with
a recessionary economy and falling market demand for casual dining, restaurants like Benni-
gan’s Grill & Tavern and Steak & Ale, that once thrived by offering mid-priced menus with po-
tato skins and thick hamburgers, filed for bankruptcy in July 2008. Within the troubled airline
industry, at least 30 airlines went bankrupt during just the first half of 2008 with 30 more bank-
ruptcies expected by the end of the year.69 A controversial approach was used by Delphi Cor-
poration when it filed for Chapter 11 bankruptcy only for its U.S. operations, which employed
32,000 high-wage union workers, but not for its foreign factories in low-wage countries.70
In contrast to bankruptcy, which seeks to perpetuate a corporation, liquidation is the ter-
mination of the firm. When the industry is unattractive and the company too weak to be sold
as a going concern, management may choose to convert as many saleable assets as possible to
cash, which is then distributed to the shareholders after all obligations are paid. Liquidation is
a prudent strategy for distressed firms with a small number of choices, all of which are prob-
lematic.71 This was Circuit City’s situation in 2008, when it liquidated its retail stores. The ben-
efit of liquidation over bankruptcy is that the board of directors, as representatives of the
shareholders, together with top management make the decisions instead of turning them over
to the bankruptcy court, which may choose to ignore shareholders completely.
At times, top management must be willing to select one of these less desirable retrench-
ment strategies. Unfortunately, many top managers are unwilling to admit that their company
has serious weaknesses for fear that they may be personally blamed. Even worse, top manage-
ment may not even perceive that crises are developing. When these top managers eventually
notice trouble, they are prone to attribute the problems to temporary environmental distur-
bances and tend to follow profit strategies. Even when things are going terribly wrong, top
management is greatly tempted to avoid liquidation in the hope of a miracle. Top management
enters a cycle of decline, in which it goes through a process of secrecy and denial, followed by
blame and scorn, avoidance and turf protection, ending with passivity and helplessness.72
Thus, a corporation needs a strong board of directors who, to safeguard shareholders’ inter-
ests, can tell top management when to quit.
7.3 Portfolio Analysis
Chapter 6 dealt with how individual product lines and business units can gain competitive ad-
vantage in the marketplace by using competitive and cooperative strategies. Companies with
multiple product lines or business units must also ask themselves how these various products
and business units should be managed to boost overall corporate performance:
� How much of our time and money should we spend on our best products and business
units to ensure that they continue to be successful?
� How much of our time and money should we spend developing new costly products, most
of which will never be successful?
One of the most popular aids to developing corporate strategy in a multiple-business cor-
poration is portfolio analysis. Although its popularity has dropped since the 1970s and 1980s,
when more than half of the largest business corporations used portfolio analysis, it is still used
by around 27% of Fortune 500 firms in corporate strategy formulation.73 Portfolio analysis
puts corporate headquarters into the role of an internal banker. In portfolio analysis, top man-
agement views its product lines and business units as a series of investments from which it ex-
pects a profitable return. The product lines/business units form a portfolio of investments that
top management must constantly juggle to ensure the best return on the corporation’s invested
money. A McKinsey & Company study of the performance of the 200 largest U.S. corporations
CHAPTER 7 Strategy Formulation: Corporate Strategy 221
BCG GROWTH-SHARE MATRIX
Using the BCG (Boston Consulting Group) Growth-Share Matrix depicted in Figure 7–3
is the simplest way to portray a corporation’s portfolio of investments. Each of the corpora-
tion’s product lines or business units is plotted on the matrix according to both the growth rate
of the industry in which it competes and its relative market share. A unit’s relative competitive
position is defined as its market share in the industry divided by that of the largest other com-
petitor. By this calculation, a relative market share above 1.0 belongs to the market leader. The
business growth rate is the percentage of market growth, that is, the percentage by which sales
of a particular business unit classification of products have increased. The matrix assumes that,
other things being equal, a growing market is attractive.
The line separating areas of high and low relative competitive position is set at 1.5 times.
A product line or business unit must have relative strengths of this magnitude to ensure that it
will have the dominant position needed to be a “star” or “cash cow.” On the other hand, a prod-
uct line or unit having a relative competitive position less than 1.0 has “dog” status.75 Each
product or unit is represented in Figure 7–3 by a circle. The area of the circle represents the
relative significance of each business unit or product line to the corporation in terms of assets
used or sales generated.
found that companies that actively managed their business portfolios through acquisitions and
divestitures created substantially more shareholder value than those companies that passively
held their businesses.74 Given the increasing number of strategic alliances in today’s corpora-
tions, portfolio analysis is also being used to evaluate the contribution of alliances to corpo-
rate and business unit objectives.
Two of the most popular portfolio techniques are the BCG Growth-Share Matrix and GE
Business Screen.
Stars
Cash Cows Dogs
22
20
18
16
14
12
10
8
6
4
2
0
10
x
4x
Relative Competitive Position
(Market Share)
B
u
si
n
es
s
G
ro
w
th
R
at
e
(P
er
ce
nt
ag
e)
2x 1x
0.
5x
0.
4x
0.
3x
0.
2x
0.
1x
1.
5x
Question Marks
FIGURE 7–3
BCG Growth-
Share Matrix
SOURCE: Reprinted from Long Range Planning, Vol. 10, No. 2, 1977, Hedley, “Strategy and the Business Portfolio,”
p. 12. Copyright © 1977 with permission from Elsevier.
In 2003, top management
at General Motors (GM) de-
cided to discontinue further
work on its EV1 electric auto-
mobile. Working versions of the
car had been leased to a limited number
of people, but never sold. Environmentalists protested that
GM stopped making the car just to send a message to gov-
ernment policy makers that an electric car was bad busi-
ness. Management responded by stating that the car
would never have made a profit.
In an April 2005 meeting of GM’s top management
team, Vice Chairman Robert Lutz suggested that it might
be time to build another electric car. He noted that Toyota’s
Prius hybrid had made Toyota look environmentally sensi-
tive; whereas, GM was viewed as making gas “hogs.” The
response was negative. Lutz recalled one executive saying,
“We lost $1 billion on the last one. Do you want to lose
$1 billion on the next one?”
Even though worldwide car ownership was growing
5% annually, rising fuel prices in 2005 reduced sales of
GM’s profitable SUVs—resulting in a loss of $11 billion.
Board members began signaling that it was time for man-
agement to take some riskier bets to get the company out
of financial trouble. In February 2006, management reluc-
tantly approved developmental work on another electric
car. At the time, no one in GM knew if batteries could be
made small enough to power a car, but they knew that
222 PART 3 Strategy Formulation
The BCG Growth-Share Matrix has a lot in common with the product life cycle. As a
product moves through its life cycle, it is categorized into one of four types for the purpose of
funding decisions:
� Question marks (sometimes called “problem children” or “wildcats”) are new products
with the potential for success, but they need a lot of cash for development. If such a prod-
uct is to gain enough market share to become a market leader and thus a star, money must
be taken from more mature products and spent on the question mark. This is a “fish or cut
bait” decision in which management must decide if the business is worth the investment
needed. For example, after years of fruitlessly experimenting with an electric car, General
Motors finally decided in 2006 to take a chance on developing the Chevrolet Volt.76 To
learn more of GM’s decision to build the electric car, see the Environmental Sustainabil-
ity Issue feature.
� Stars are market leaders that are typically at the peak of their product life cycle and are
able to generate enough cash to maintain their high share of the market and usually con-
tribute to the company’s profits. HP’s printer business has been called HP’s “crown jewel”
because of its 41% market share in printers and its control of the replacement cartridge
GENERAL MOTORS AND THE ELECTRIC CAR
ENVIRONMENTAL sustainability issue
choices were limited. According to Larry Burns, Vice Presi-
dent of R&D and Strategic Planning, “This industry is 98%
dependent on petroleum. GM has concluded that that’s
not sustainable.”
Chairman and CEO Richard Wagoner, Jr. surprised the
world at the January 2007 Detroit Auto Show with a vow
to start developing an electric car called the Chevrolet Volt.
It would plug into a regular electric outlet, leapfrog the
competition, and be on sale in 2010. The company not
only needed to build a radical new car, but had to convert
as much as 75% of its current fleet to hybrid engines to
meet fuel economy rules taking effect in 2017.
Management created a new team dedicated to getting
hybrid and electric cars to market. The R&D budget was in-
creased from $6.6 billion in 2006 to $8.1 billion in 2007.
Several new models were canceled to free resources. The
battery lab was under pressure to design batteries that
could propel the Volt 40 miles before a small gasoline en-
gine would re-charge the battery and extend the range to
600 miles. Douglas Drauch, battery lab manager, promised
that the batteries would be ready on schedule. “We’re
making history,” he said. “Fifty years from now, people will
remember the Volt—like they remember a ‘53 Corvette.”
SOURCES: D. Welch, “GM: Live Green or Die,” Business Week
(May 26, 2008), pp. 36–41; “The Drive for Low Emissions,” The
Economist’s Special Report on Business and Climate Change
(June 2, 2007), pp. 26–28.
CHAPTER 7 Strategy Formulation: Corporate Strategy 223
market. On its own, it accounted for more than half of HP’s operating profit.77 When a
star’s market growth rate slows, it becomes a cash cow.
� Cash cows typically bring in far more money than is needed to maintain their market
share. In this declining stage of their life cycle, these products are “milked” for cash that
will be invested in new question marks. Expenses such as advertising and R&D are re-
duced. Panasonic’s video cassette recorders (VCRs) moved to this category when sales
declined and DVD player/recorders replaced them. Question marks unable to obtain dom-
inant market share (and thus become stars) by the time the industry growth rate inevitably
slows become dogs.
� Dogs have low market share and do not have the potential (because they are in an unat-
tractive industry) to bring in much cash. According to the BCG Growth-Share Matrix,
dogs should be either sold off or managed carefully for the small amount of cash they can
generate. For example, DuPont, the inventor of nylon, sold its textiles unit in 2003 be-
cause the company wanted to eliminate its low-margin products and focus more on its
growing biotech business.78 The same was true of IBM when it sold its PC business to
China’s Lenovo Group in order to emphasize its growing services business.
Underlying the BCG Growth-Share Matrix is the concept of the experience curve (dis-
cussed in Chapter 5). The key to success is assumed to be market share. Firms with the high-
est market share tend to have a cost leadership position based on economies of scale, among
other things. If a company is able to use the experience curve to its advantage, it should be able
to manufacture and sell new products at a price low enough to garner early market share lead-
ership (assuming no successful imitation by competitors). Once the product becomes a star, it
is destined to be very profitable, considering its inevitable future as a cash cow.
Having plotted the current positions of its product lines or business units on a matrix, a
company can project its future positions, assuming no change in strategy. Present and pro-
jected matrixes can thus be used to help identify major strategic issues facing the organization.
The goal of any company is to maintain a balanced portfolio so it can be self-sufficient in cash
and always working to harvest mature products in declining industries to support new ones in
growing industries.
The BCG Growth-Share Matrix is a very well-known portfolio concept with some clear
advantages. It is quantifiable and easy to use. Cash cow, dog, question mark, and star are easy-
to-remember terms for referring to a corporation’s business units or products. Unfortunately,
the BCG Growth-Share Matrix also has some serious limitations:
� The use of highs and lows to form four categories is too simplistic.
� The link between market share and profitability is questionable.79 Low-share businesses
can also be profitable.80 For example, Olivetti is still profitably selling manual typewrit-
ers through mail-order catalogs.
� Growth rate is only one aspect of industry attractiveness.
� Product lines or business units are considered only in relation to one competitor: the mar-
ket leader. Small competitors with fast-growing market shares are ignored.
� Market share is only one aspect of overall competitive position.
GE BUSINESS SCREEN
General Electric, with the assistance of the McKinsey & Company consulting firm, developed
a more complicated matrix. As depicted in Figure 7–4, the GE Business Screen includes nine
cells based on long-term industry attractiveness and business strength competitive position.
The GE Business Screen, in contrast to the BCG Growth-Share Matrix, includes much more
224 PART 3 Strategy Formulation
Winners
A
Winners
B
C
Average
Businesses
F
Winners
E
Profit
Producers
Low
Losers
G
AverageStrong
Medium
High
In
d
u
st
ry
A
tt
ra
ct
iv
en
es
s
H
Losers
Losers
Weak
Question
Marks
D
Business Strength/Competitive Position
FIGURE 7–4
General Electric’s
Business Screen
data in its two key factors than just business growth rate and comparable market share. For ex-
ample, at GE, industry attractiveness includes market growth rate, industry profitability, size,
and pricing practices, among other possible opportunities and threats. Business strength or
competitive position includes market share as well as technological position, profitability, and
size, among other possible strengths and weaknesses.81
The individual product lines or business units are identified by a letter and plotted as cir-
cles on the GE Business Screen. The area of each circle is in proportion to the size of the in-
dustry in terms of sales. The pie slices within the circles depict the market shares of the product
lines or business units.
To plot product lines or business units on the GE Business Screen, follow these four steps:
1. Select criteria to rate the industry for each product line or business unit. Assess overall in-
dustry attractiveness for each product line or business unit on a scale from 1 (very unat-
tractive) to 5 (very attractive).
2. Select the key factors needed for success in each product line or business unit. Assess
business strength/competitive position for each product line or business unit on a scale of
1 (very weak) to 5 (very strong).
3. Plot each product line’s or business unit’s current position on a matrix as that depicted in
Figure 7–4.
4. Plot the firm’s future portfolio, assuming that present corporate and business strategies re-
main unchanged. Is there a performance gap between projected and desired portfolios? If
so, this gap should serve as a stimulus to seriously review the corporation’s current mis-
sion, objectives, strategies, and policies.
Overall, the nine-cell GE Business Screen is an improvement over the BCG Growth-
Share Matrix. The GE Business Screen considers many more variables and does not lead to
SOURCE: Adapted from Strategic Management in GE, Corporate Planning and Development, General Electric
Corporation, Reprinted by permission of General Electric Company.
CHAPTER 7 Strategy Formulation: Corporate Strategy 225
such simplistic conclusions. It recognizes, for example, that the attractiveness of an industry
can be assessed in many different ways (other than simply using growth rate), and it thus al-
lows users to select whatever criteria they feel are most appropriate to their situation. This port-
folio matrix, however, does have some shortcomings:
� It can get quite complicated and cumbersome.
� The numerical estimates of industry attractiveness and business strength/competitive po-
sition give the appearance of objectivity, but they are in reality subjective judgments that
may vary from one person to another.
� It cannot effectively depict the positions of new products or business units in developing
industries.
ADVANTAGES AND LIMITATIONS OF PORTFOLIO ANALYSIS
Portfolio analysis is commonly used in strategy formulation because it offers certain
advantages:
� It encourages top management to evaluate each of the corporation’s businesses individu-
ally and to set objectives and allocate resources for each.
� It stimulates the use of externally oriented data to supplement management’s judgment.
� It raises the issue of cash-flow availability for use in expansion and growth.
� Its graphic depiction facilitates communication.
Portfolio analysis does, however, have some very real limitations that have caused some
companies to reduce their use of this approach:
� Defining product/market segments is difficult.
� It suggests the use of standard strategies that can miss opportunities or be impractical.
� It provides an illusion of scientific rigor when in reality positions are based on subjective
judgments.
� Its value-laden terms such as cash cow and dog can lead to self-fulfilling prophecies.
� It is not always clear what makes an industry attractive or where a product is in its life cycle.
� Naively following the prescriptions of a portfolio model may actually reduce corporate
profits if they are used inappropriately. For example, General Mills’ Chief Executive H.
Brewster Atwater cited his company’s Bisquick brand of baking mix as a product that
would have been written off years ago based on portfolio analysis. “This product is
57 years old. By all rights it should have been overtaken by newer products. But with the
proper research to improve the product and promotion to keep customers excited, it’s do-
ing very well.”82
MANAGING A STRATEGIC ALLIANCE PORTFOLIO
Just as product lines/business units form a portfolio of investments that top management must
constantly juggle to ensure the best return on the corporation’s invested money, strategic al-
liances can also be viewed as a portfolio of investments—investments of money, time, and en-
ergy. The way a company manages these intertwined relationships can significantly influence
corporate competitiveness. Alliances are thus recognized as an important source of competi-
tive advantage and superior performance.83
Managing groups of strategic alliances is primarily the job of the business unit. Its deci-
sions may escalate, however, to the corporate level. Toman Corporation, for example, has
226 PART 3 Strategy Formulation
7.4 Corporate Parenting
Campbell, Goold, and Alexander, authors of Corporate-Level Strategy: Creating Value in the
Multibusiness Company, contend that corporate strategists must address two crucial questions:
� What businesses should this company own and why?
� What organizational structure, management processes, and philosophy will foster supe-
rior performance from the company’s business units?86
195 international joint ventures containing 422 alliance partners. According to a Toman exec-
utive, “If headquarters is trying to bring us and some other company closer together, they
should understand not only our business unit, but also other business units. Sometimes the
whole of our company may benefit (from an alliance) but it may not be good for one of our
business units. And if it proceeds, headquarters must give some credit to our business unit so
that we can agree. But it is not acceptable if they say to us that we are to lose something as a
result of the alliance and now we have to make up the difference in one of our other busi-
nesses.” In this instance the stage is set for negotiations across business units at the corporate
level to achieve a broadly supported alliance network management system.84
A study of 25 leading European corporations found four tasks of multi-alliance manage-
ment that are necessary for successful alliance portfolio management:
1. Developing and implementing a portfolio strategy for each business unit and a cor-
porate policy for managing all the alliances of the entire company: Alliances are pri-
marily determined by business units. The corporate level develops general rules
concerning when, how, and with whom to cooperate. The task of alliance policy is to
strategically align all of the corporation’s alliance activities with corporate strategy and
corporate values. Every new alliance is thus checked against corporate policy before it is
approved.
2. Monitoring the alliance portfolio in terms of implementing business unit strategies
and corporate strategy and policies: Each alliance is measured in terms of achievement
of objectives (e.g., market share), financial measures (e.g., profits and cash flow), con-
tributed resource quality and quantity, and the overall relationship. The more a firm is di-
versified, the less the need for monitoring at the corporate level.
3. Coordinating the portfolio to obtain synergies and avoid conflicts among alliances:
Because the interdependencies among alliances within a business unit are usually greater
than among different businesses, the need for coordination is greater at the business level
than at the corporate level. The need for coordination increases as the number of alliances
in one business unit and the company as a whole increases, the average number of part-
ners per alliance increases, and/or the overlap of the alliances increases.
4. Establishing an alliance management system to support other tasks of multi-alliance
management: This infrastructure consists of formalized processes, standardized tools
and specialized organizational units. All but two of the 25 companies established centers
of competence for alliance management. The centers were often part of a department for
corporate development or a department of alliance management at the corporate level.
In other corporations, specialized positions for alliance management were created at both
the corporate and business unit levels or only at the business unit level. Most corporations
prefer a system in which the corporate level provides the methods and tools to support
alliances centrally, but decentralizes day-to-day alliance management to the business
units.85
CHAPTER 7 Strategy Formulation: Corporate Strategy 227
Portfolio analysis typically attempts to answer these questions by examining the at-
tractiveness of various industries and by managing business units for cash flow, that is, by
using cash generated from mature units to build new product lines. Unfortunately, portfo-
lio analysis fails to deal with the question of what industries a corporation should enter or
with how a corporation can attain synergy among its product lines and business units. As
suggested by its name, portfolio analysis tends to primarily view matters financially, re-
garding business units and product lines as separate and independent investments.
Corporate parenting, in contrast, views a corporation in terms of resources and ca-
pabilities that can be used to build business unit value as well as generate synergies across
business units. According to Campbell, Goold, and Alexander:
Multibusiness companies create value by influencing—or parenting—the businesses they
own. The best parent companies create more value than any of their rivals would if they
owned the same businesses. Those companies have what we call parenting advantage.87
Corporate parenting generates corporate strategy by focusing on the core competen-
cies of the parent corporation and on the value created from the relationship between the
parent and its businesses. In the form of corporate headquarters, the parent has a great
deal of power in this relationship. According to Campbell, Goold, and Alexander, if there
is a good fit between the parent’s skills and resources and the needs and opportunities of
the business units, the corporation is likely to create value. If, however, there is not a good
fit, the corporation is likely to destroy value.88 Research indicates that companies that
have a good fit between their strategy and their parenting roles are better performers than
those companies that do not have a good fit.89 This approach to corporate strategy is use-
ful not only in deciding what new businesses to acquire but also in choosing how each
existing business unit should be best managed. This appears to have been the secret to the
success of General Electric under CEO Jack Welch. According to one analyst in 2000,
“He and his managers really add value by imposing tough standards of profitability and
by disseminating knowledge and best practice quickly around the GE empire. If some
manufacturing trick cuts costs in GE’s aero-engine repair shops in Wales, he insists it be
applied across the group.”90
The primary job of corporate headquarters is, therefore, to obtain synergy among the
business units by providing needed resources to units, transferring skills and capabilities
among the units, and coordinating the activities of shared unit functions to attain
economies of scope (as in centralized purchasing).91 This is in agreement with the con-
cept of the learning organization discussed in Chapter 1 in which the role of a large firm
is to facilitate and transfer the knowledge assets and services throughout the
corporation.92 This is especially important given that 75% or more of a modern com-
pany’s market value stems from its intangible assets—the organization’s knowledge and
capabilities.93 At Proctor & Gamble, for example, the various business units are expected
to work together to develop innovative products. Crest Whitestrips, which controls 68%
of the at-home tooth-whitening market, was based on the P&G laundry division’s knowl-
edge of whitening agents.94
DEVELOPING A CORPORATE PARENTING STRATEGY
Campbell, Goold, and Alexander recommend that the search for appropriate corporate strat-
egy involves three analytical steps:
1. Examine each business unit (or target firm in the case of acquisition) in terms of its
strategic factors: People in the business units probably identified the strategic factors
when they were generating business strategies for their units. One popular approach is to
228 PART 3 Strategy Formulation
HORIZONTAL STRATEGY AND MULTIPOINT COMPETITION
A horizontal strategy is a corporate strategy that cuts across business unit boundaries to build
synergy across business units and to improve the competitive position of one or more business
units.96 When used to build synergy, it acts like a parenting strategy. When used to improve the
competitive position of one or more business units, it can be thought of as a corporate compet-
itive strategy. In multipoint competition, large multi-business corporations compete against
other large multi-business firms in a number of markets. These multipoint competitors are firms
that compete with each other not only in one business unit, but also in a number of business
units. At one time or another, a cash-rich competitor may choose to build its own market share
in a particular market to the disadvantage of another corporation’s business unit. Although each
business unit has primary responsibility for its own business strategy, it may sometimes need
some help from its corporate parent, especially if the competitor business unit is getting heavy
financial support from its corporate parent. In this instance, corporate headquarters develops a
horizontal strategy to coordinate the various goals and strategies of related business units.
For example, P&G, Kimberly-Clark, Scott Paper, and Johnson & Johnson (J&J) compete
with one another in varying combinations of consumer paper products, from disposable dia-
pers to facial tissue. If (purely hypothetically) J&J had just developed a toilet tissue with which
it chose to challenge Procter & Gamble’s high-share Charmin brand in a particular district, it
might charge a low price for its new brand to build sales quickly. P&G might not choose to re-
spond to this attack on its share by cutting prices on Charmin. Because of Charmin’s high mar-
ket share, P&G would lose significantly more sales dollars in a price war than J&J would with
its initially low-share brand. To retaliate, P&G might thus challenge J&J’s high-share baby
establish centers of excellence throughout the corporation. According to Frost, Birkin-
shaw, and Ensign, a center of excellence is “an organizational unit that embodies a set of
capabilities that has been explicitly recognized by the firm as an important source of value
creation, with the intention that these capabilities be leveraged by and/or disseminated to
other parts of the firm.”95
2. Examine each business unit (or target firm) in terms of areas in which performance
can be improved: These are considered to be parenting opportunities. For example, two
business units might be able to gain economies of scope by combining their sales forces.
In another instance, a unit may have good, but not great, manufacturing and logistics
skills. A parent company having world-class expertise in these areas could improve that
unit’s performance. The corporate parent could also transfer some people from one busi-
ness unit who have the desired skills to another unit that is in need of those skills. People
at corporate headquarters may, because of their experience in many industries, spot areas
where improvements are possible that even people in the business unit may not have no-
ticed. Unless specific areas are significantly weaker than the competition, people in the
business units may not even be aware that these areas could be improved, especially if
each business unit monitors only its own particular industry.
3. Analyze how well the parent corporation fits with the business unit (or target firm):
Corporate headquarters must be aware of its own strengths and weaknesses in terms of re-
sources, skills, and capabilities. To do this, the corporate parent must ask whether it has
the characteristics that fit the parenting opportunities in each business unit. It must also
ask whether there is a misfit between the parent’s characteristics and the critical success
factors of each business unit.
CHAPTER 7 Strategy Formulation: Corporate Strategy 229
shampoo with P&G’s own low-share brand of baby shampoo in a different district. Once J&J
had perceived P&G’s response, it might choose to stop challenging Charmin so that P&G
would stop challenging J&J’s baby shampoo.
Multipoint competition and the resulting use of horizontal strategy may actually slow the
development of hypercompetition in an industry. The realization that an attack on a market
leader’s position could result in a response in another market leads to mutual forbearance in
which managers behave more conservatively toward multimarket rivals and competitive ri-
valry is reduced.97 In one industry, for example, multipoint competition resulted in firms be-
ing less likely to exit a market. “Live and let live” replaced strong competitive rivalry.98
Multipoint competition is likely to become even more prevalent in the future, as corporations
become global competitors and expand into more markets through strategic alliances.99
End of Chapter SUMMARY
Corporate strategy is primarily about the choice of direction for the firm as a whole. It deals
with three key issues that a corporation faces: (1) the firm’s overall orientation toward
growth, stability, or retrenchment; (2) the industries or markets in which the firm competes
through its products and business units; and (3) the manner in which management coordi-
nates activities and transfers resources and cultivates capabilities among product lines and
business units. These issues are dealt with through directional strategy, portfolio analysis,
and corporate parenting.
Managers must constantly examine their corporation’s entire portfolio of products, busi-
nesses, and opportunities as if they were planning to reinvest all of its capital.100 One example
is Cummins, Inc. in 2003 when management decided to invest heavily in the firm’s power gen-
eration business. Management realized at the time that the global appetite for power was grow-
ing far faster than local power grids could provide, especially in the fast-growing developing
countries. Unfortunately, power generation was the only one of Cummins’ four business units
to lose money. Tom Linebarger, Cummins’ CFO, took over the power generation unit, cut
costs, and reorganized the division around product lines rather than territories. Over the next
four years, sales of the company’s power generators, ranging from portables for RVs to house-
sized machines for factories, more than tripled to $3 billion—20% of the company’s total
sales. Cummins achieved second place, behind Caterpillar, in the global power generator mar-
ket. Management decided to grow horizontally by building plants in China and India and mak-
ing small home generators to sell through mass merchandisers.101
E C O – B I T S
� Bosch Appliances, the German multinational corpora-
tion, was the only U.S. appliance manufacturer whose
entire line of major appliances in 2008 was Energy Star
qualified in the categories that the program rates. Ac-
cording to Bosch, if the more than 8 million U.S. con-
sumers who purchased a new dishwasher in 2007 had
bought a Bosch 800 model instead of a conventional
unit, the lifetime energy savings would be equal to pre-
venting 21 billion pounds of CO2 emissions.102
� The green building industry is projected to grow from
$2.2 billion in 2006 to $4.7 billion by 2011.103
230 PART 3 Strategy Formulation
S T R A T E G I C P R A C T I C E E X E R C I S E
On March 14, 2000, Stephen King, the horror writer, published
his new book, Riding the Bullet, on the Internet before it ap-
peared in print. Within 24 hours, around 400,000 people had
downloaded the book—even though most of them needed to
download software in order to read the book. The unexpected
demand crashed servers. According to Jack Romanos, presi-
dent of Simon & Schuster, “I don’t think anybody could have
anticipated how many people were out there who are willing
to accept the written word in a paperless format.” To many, this
announced the coming of the electronic novel. Environmental-
ists applauded that e-books would soon replace paper books
and newspapers, thus reducing pollution coming from paper
mills and landfills. The King book was easy to download and
took less time than a trip to the bookstore. Critics argued that
the King book used the Internet because at 66 pages, it was too
short to be a standard printed novel. It was also free, so there
was nothing to discourage natural curiosity. Some people in
the industry estimated that 75% of those who downloaded the
book did not read it.104
By 2008, HarperCollins and Random House were offer-
ing free online book content. Amazon was selling a $399 Kin-
dle e-book reader for downloadable books costing $10 each,
but Apple CEO Steve Jobs described the Kindle as something
that filled no void and would “go nowhere.” Sales in electronic
trade books increased from $5.8 million in 2002 to $20 million
in 2006 compared to total 2006 book sales of $25–$30 billion.
Borders was market testing the downloading of digital pur-
chases. Tim O’Reilly, coiner of the term Web 2.0, had been
urging publishers to go digital since the early 1980s, but pub-
lishers and authors were still concerned with how they would
be paid for the intellectual property they created. Om Malik,
senior writer for Business 2.0 magazine reported that the
money earned from advertising clicks related to their blog con-
tent was barely enough to cover the costs of blogging. Flat
World Knowledge, a new entrepreneurial digital textbook pub-
lisher, announced that in 2009 it planned to offer free online
textbooks with the hope that the firm would make money sell-
ing supplementary materials like study guides. Publishers
wondered how an industry built on a 15th century paper tech-
nology could make a profitable transition to a 21st century pa-
perless electronic technology.105
1. Form into small groups in the class to discuss the future
of Internet publishing.
2. Consider the following questions as discussion guides:
� What are the pros and cons of electronic publishing?
� What is the impact of electronic publishing on the
environment?
� Should newspaper and book publishers completely
convert to electronic publishing over paper? (The
Wall Street Journal and others publish in both paper
and electronic formats. Is this a success?)
� Would you prefer this textbook and others in an elec-
tronic format? How would you prefer to read the
book?
� What business model should publishers use to make
money publishing on the Internet?
3. Present your group’s conclusions to the class.
D I S C U S S I O N Q U E S T I O N S
1. How does horizontal growth differ from vertical growth
as a corporate strategy? From concentric diversification?
2. What are the tradeoffs between an internal and an exter-
nal growth strategy? Which approach is best as an inter-
national entry strategy?
3. Is stability really a strategy or just a term for no strategy?
4. Compare and contrast SWOT analysis with portfolio
analysis.
5. How is corporate parenting different from portfolio
analysis? How is it alike? Is it a useful concept in a global
industry?
CHAPTER 7 Strategy Formulation: Corporate Strategy 231
K E Y T E R M S
acquisition (p. 208)
backward integration (p. 208)
bankruptcy (p. 219)
BCG (Boston Consulting Group)
Growth-Share Matrix (p. 221)
BOT (Build, Operate, Transfer)
concept (p. 214)
captive company strategy (p. 219)
cash cows (p. 223)
concentration (p. 208)
concentric diversification (p. 214)
conglomerate diversification (p. 215)
corporate parenting (p. 227)
corporate strategy (p. 206)
directional strategy (p. 207)
diversification (p. 208)
divestment (p. 219)
dogs (p. 223)
exporting (p. 211)
forward integration (p. 208)
franchising (p. 212)
full integration (p. 209)
GE business screen (p. 223)
green-field development (p. 213)
growth strategy (p. 207)
horizontal growth (p. 211)
horizontal integration (p. 211)
horizontal strategy (p. 228)
joint venture (p. 212)
licensing (p. 212)
liquidation (p. 220)
long-term contracts (p. 210)
management contracts (p. 214)
merger (p. 207)
multipoint competition (p. 228)
no-change strategy (p. 217)
parenting strategy (p. 206)
pause/proceed with caution strategy
(p. 217)
portfolio analysis (p. 220)
production sharing (p. 213)
profit strategy (p. 218)
quasi-integration (p. 209)
question marks (p. 222)
retrenchment strategies (p. 207)
sell-out strategy (p. 219)
stability strategy (p. 207)
stars (p. 222)
synergy (p. 214)
taper integration (p. 209)
transaction cost economics (p. 209)
turnaround strategy (p. 218)
turnkey operations (p. 213)
vertical growth (p. 208)
vertical integration (p. 208)
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59. A. Inkpen and N. Choudhury, “The Seeking of Strategy Where
It Is Not: Towards a Theory of Strategy Absence,” Strategic
Management Journal (May 1995), pp. 313–323.
60. P. Burrows and S. Anderson, “Dell Computer Goes Into the
Shop,” Business Week (July 12, 1993), pp. 138–140.
61. M. Brauer, “What Have We Acquired and What Should We Ac-
quire in Divestiture Research? AReview and Research Agenda,”
Journal of Management (December 2006), pp. 751–785; J. L.
Morrow, Jr., R. A. Johnson, and L. W. Busenitz, “The Effects of
Cost and Asset Retrenchment on Firm Performance: The Over-
looked Role of a Firm’s Competitive Environment,” Journal of
Management, Vol. 30, No. 2 (2004), pp. 189–208.
62. J. A. Pearce II and D. K. Robbins, “Retrenchment Remains the
Foundation of Business Turnaround,” Strategic Management
Journal (June 1994), pp. 407–417.
63. Y. Kageyama, “Sony Turnaround Plan Draws Yawns,” Des
Moines Register (September 23, 2005), p. 3D.
64. F. Gandolfi, “Reflecting on Downsizing: What Have We
Learned?” SAM Advanced Management Journal (Spring
2008), pp. 46–55; C. Chadwick, L. W. Hunter, and S. L. Wal-
ston, “Effects of Downsizing Practices on the Performance of
Hospitals,” Strategic Management Journal (May 2004), pp.
405–427; J. R. Morris, W. F. Cascio, and C. E. Young, “Down-
sizing After All These Years,” Organizational Dynamics
(Winter 1999), pp. 78–87; P. H. Mirvis, “Human Resource
Management: Leaders, Laggards, and Followers,” Academy of
Management Executive (May 1997), pp. 43–56; J. K. DeDee
and D. W. Vorhies, “Retrenchment Activities of Small Firms
During Economic Downturn: An Empirical Investigation,”
Journal of Small Business Management (July 1998),
pp. 46–61.
65. C. Chadwick, L. W. Hunter, and S. L Walston, “Effects of
Downsizing Practices on the Performance of Hospitals,”
Strategic Management Journal (May 2004), pp. 405–427.
CHAPTER 7 Strategy Formulation: Corporate Strategy 233
234 PART 3 Strategy Formulation
66. J. B. Treece, “U.S. Parts Makers Just Won’t Say ‘Uncle,’”
Business Week (August 10, 1987), pp. 76–77.
67. S. S. Carty, “Ford Plans to Park Jaguar, Land Rover with Tata
Motors,” USA Today (March 26, 2008), p. 1B–2B.
68. For more on divestment, see C. Dexter and T. Mellewight,
“Thirty Years After Michael E. Porter: What Do We Know
about Business Exit?” Academy of Management Perspectives
(May 2007), pp. 41–55.
69. “Shredding Money,” The Economist (September 20, 2008),
pp. 77–78.
70. D. Welch, “Go Bankrupt, Then Go Overseas,” Business Week
(April 24, 2006), pp. 52–55.
71. D. D. Dawley, J. J. Hoffman, and B. T. Lamont, “Choice Situa-
tion, Refocusing, and Post-Bankruptcy Performance,” Journal
of Management, Vol. 28, No. 5 (2002), pp. 695–717.
72. R. M. Kanter, “Leadership and the Psychology of Turn-
arounds,” Harvard Business Review (June 2003), pp. 58–67.
73. B. C. Reimann and A. Reichert, “Portfolio Planning Methods
for Strategic Capital Allocation: A Survey of Fortune 500
Firms,” International Journal of Management (March 1996),
pp. 84–93; D. K. Sinha, “Strategic Planning in the Fortune
500,” Handbook of Business Strategy, 1991/92 Yearbook, edited
by H. E. Glass and M. A. Hovde (Boston: Warren, Gorham &
Lamont, 1991), p. 9.6.
74. L. Dranikoff, T. Koller, and A. Schneider, “Divestiture: Strat-
egy’s Missing Link,” Harvard Business Review (May 2002),
pp. 74–83.
75. B. Hedley, “Strategy and the Business Portfolio,” Long Range
Planning (February 1977), p. 9.
76. D. Welch, “GM: Live Green or Die,” Business Week (May 26,
2008), pp. 36–41.
77. P. Burrows and S. Hamm, “Tech Has a New Top Dog,” Business
Week (June 19, 2006), p. 60.
78. A. Fitzgerald, “Going Global,” Des Moines Register (March 14,
2004), pp. 1M, 3M.
79. C. Anterasian, J. L. Graham, and R. B. Money, “Are U.S. Man-
agers Superstitious About Market Share?” Sloan Management
Review (Summer 1996), pp. 67–77.
80. D. Rosenblum, D. Tomlinson, and L. Scott, “Bottom-Feeding
for Blockbuster Businesses,” Harvard Business Review (March
2003), pp. 52–59.
81. R. G. Hamermesh, Making Strategy Work (New York: John
Wiley & Sons, 1986), p. 14.
82. J. J. Curran, “Companies That Rob the Future,” Fortune (July 4,
1988), p. 84.
83. W. H. Hoffmann, “Strategies for Managing a Portfolio of
Alliances,” Strategic Management Journal (August 2007),
pp. 827–856; D. Lavie, “Alliance Portfolios and Firm Perfor-
mance: A Study of Value Creation and Appropriation in the U.S.
Software Industry,” Strategic Management Journal (December
2007), pp. 1187–1212.
84. A. Goerzen, “Managing Alliance Networks: Emerging Prac-
tices of Multinational Corporations,” Academy of Management
Executive (May 2005), pp. 94–107; S. Lazzarini, “The Impact
of Membership in Competing Alliance Constellations: Evi-
dence on the Operational Performance of Global Airlines,”
Strategic Management Journal (April 2007), pp. 345–367.
85. W. H. Hoffmann, “How to Manage a Portfolio of Alliances,”
Long Range Planning (April 2005), pp. 121–143.
86. A. Campbell, M. Goold, and M. Alexander, Corporate-Level
Strategy: Creating Value in the Multibusiness Company (New
York: John Wiley & Sons, 1994). See also M. Goold, A.
Campbell, and M. Alexander, “Corporate Strategy and Parent-
ing Theory,” Long Range Planning (April 1998), pp. 308–318,
and M. Goold and A. Campbell, “Parenting in Complex Struc-
tures,” Long Range Planning (June 2002), pp. 219–243.
87. A. Campbell, M. Goold, and M. Alexander, “Corporate Strat-
egy: The Quest for Parenting Advantage,” Harvard Business
Review (March–April 1995), p. 121.
88. Ibid., p. 122.
89. A. van Oijen and S. Douma, “Diversification Strategy and the
Roles of the Centre,” Long Range Planning (August 2000),
pp. 560–578.
90. “Jack’s Gamble,” The Economist (October 28, 2000), pp. 13–14.
91. D. J. Collis, “Corporate Strategy in Multibusiness Firms,” Long
Range Planning (June 1996), pp. 416–418; D. Lei, M. A. Hitt,
and R. Bettis, “Dynamic Core Competencies Through Meta-
Learning and Strategic Context,” Journal of Management, Vol.
22, No. 4 (1996), pp. 549–569.
92. D. J. Teece, “Strategies for Managing Knowledge Assets: The
Role of Firm Structure and Industrial Context,” Long Range
Planning (February 2000), pp. 35–54.
93. R. S. Kaplan and D. P. Norton, “The Strategy Map: Guide to
Aligning Intangible Assets,” Strategy & Leadership, Vol. 32,
No. 5 (2004), pp. 10–17; L. Edvinsson, “The New Knowledge
Economics,” Business Strategy Review (September 2002),
pp. 72–76; C. Havens and E. Knapp, “Easing into Knowledge
Management,” Strategy & Leadership (March/April 1999),
pp. 4–9.
94. J. Scanlon, “Cross-Pollinators,” Business Week’s Inside Innova-
tion (September 2007), pp. 8–11.
95. T. S. Frost, J. M. Birkinshaw, and P. C. Ensign, “Centers of Ex-
cellence in Multinational Corporations,” Strategic Management
Journal (November 2002), pp. 997–1018.
96. M. E. Porter, Competitive Advantage (New York: The Free
Press, 1985), pp. 317–382.
97. H. R. Greve, “Multimarket Contact and Sales Growth: Evi-
dence from Insurance,” Strategic Management Journal
(March 2008), pp. 229–249; L. Fuentelsaz and J. Gomez,
“Multipoint Competition, Strategic Similarity and Entry Into
Geographic Markets,” Strategic Management Journal (May
2006), pp. 477–499; J. Gimeno, “Reciprocal Threats in Multi-
market Rivalry: Staking Out ‘Spheres of Influence’ in the U.S.
Airline Industry,” Strategic Management Journal (February
1999), pp. 101–128; J. Baum and H. J. Korn, “Dynamics of
Dyadic Competitive Interaction,” Strategic Management
Journal (March 1999), pp. 251–278; J. Gimeno and C. Y.
Woo, “Hypercompetition in a Multimarket Environment: The
Role of Strategic Similarity and Multimarket Contact in Com-
petitive De-escalation,” Organization Science (May/June
1996), pp. 322–341.
98. W. Boeker, J. Goodstein, J. Stephan, and J. P. Murmann, “Com-
petition in a Multimarket Environment: The Case of Market
Exit,” Organization Science (March/April 1997), pp. 126–142.
CHAPTER 7 Strategy Formulation: Corporate Strategy 235
99. J. Gimeno and C. Y. Woo, “Multimarket Contact, Economies of
Scope, and Firm Performance,” Academy of Management Jour-
nal (June 1999), pp. 239–259.
100. L. Carlesi, B. Verster, and F. Wenger, “The New Dynamics of
Managing the Corporate Portfolio,” McKinsey Quarterly On-
line (April 2007).
101. B. Hindo, “Generating Power for Cummins,” Business Week
(September 24, 2007), p. 90.
102. “Energy Efficiency Update,” Appliance Magazine Online
(April 2008).
103. “Sustainability Living Grows Up,” St. Cloud (MN) Times
(July 11, 2008), p. 5C.
104. “Learning to E-Read,” The Economist Survey E-Entertainment
(October 7, 2000), p. 22.
105. P. Tucker, “The 21st-Century Writer,” The Futurist (July–
August 2008), pp. 25–31; M. J. Perenson, “Amazon Kindles
Interest in E-Books,” PC World (February 2008), p. 64; M. R.
Nelson, “E-Books in Higher Education: Nearing the End of
the Era of Hype?” EDUCAUSE Review (March/April 2008),
pp. 40–56.
For almost 150 years, the Church & Dwight Company has been building
market share on a brand name whose products are in 95% of all U.S.
households. Yet if you asked the average person what products this company
makes, few would know. Although Church & Dwight may not be a household
name, the company’s ubiquitous orange box of Arm & Hammer1 brand baking
soda is common throughout North America. Church & Dwight provides a classic
example of a marketing functional strategy called market development—finding new uses/
markets for an existing product. Shortly after its introduction in 1878, Arm & Hammer Baking
Soda became a fundamental item on the pantry shelf as people found many uses for sodium
bicarbonate other than baking, such as cleaning, deodorizing, and tooth brushing. Hearing of
the many uses people were finding for its product, the company advertised that its baking soda
was good not only for baking but also for deodorizing refrigerators—simply by leaving an open
box in the refrigerator. In a brilliant marketing move, the firm then suggested that consumers
buy the product and throw it away—deodorize a kitchen sink by dumping Arm & Hammer
baking soda down the drain!
The company did not stop there. It initiated a product development strategy by looking for
other uses of its sodium bicarbonate in new products. Church & Dwight has achieved consistent
growth in sales and earnings through the use of brand extensions, putting the Arm & Hammer
brand first on baking soda and then on laundry detergents, toothpaste, and deodorants. By the
beginning of the 21st century, Church & Dwight had become a significant competitor in mar-
kets previously dominated only by giants such as Procter & Gamble, Unilever, and Colgate-
Palmolive—using only one brand name. Was there a limit to this growth? Was there a point at
which these continuous line extensions would begin to eat away at the integrity of the Arm &
Hammer name?
strategy formulation:
functional strategy and
Strategic Choice
C H A P T E R 8
237
� Identify a variety of functional strategies
that can be used to achieve organizational
goals and objectives
� Understand what activities and functions
are appropriate to outsource in order to
gain or strengthen competitive advantage
� Recognize strategies to avoid and
understand why they are dangerous
� Construct corporate scenarios to evaluate
strategic options
� Use a stakeholder priority matrix to aid in
strategic decision making
� Develop policies to implement corporate,
business, and functional strategies
Learning Objectives
Gathering
Information
Putting Strategy
into Action
Monitoring
Performance
Societal
Environment:
General forces
Natural
Environment:
Resources and
climate
Task
Environment:
Industry analysis
Internal:
Strengths and
Weaknesses
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
Programs
Activities
needed to
accomplish
a plan
Budgets
Cost of the
programs Procedures
Sequence
of steps
needed to
do the job
Performance
Actual results
External:
Opportunities
and Threats
Developing
Long-range Plans
Mission
Reason for
existence Objectives
What
results to
accomplish
by when
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Environmental
Scanning:
Strategy
Formulation:
Strategy
Implementation:
Evaluation
and Control:
Feedback/Learning: Make corrections as needed
After reading this chapter, you should be able to:
238 PART 3 Strategy Formulation
8.1 Functional Strategy
Functional strategy is the approach a functional area takes to achieve corporate and business
unit objectives and strategies by maximizing resource productivity. It is concerned with devel-
oping and nurturing a distinctive competence to provide a company or business unit with a
competitive advantage. Just as a multidivisional corporation has several business units, each
with its own business strategy, each business unit has its own set of departments, each with its
own functional strategy.
The orientation of a functional strategy is dictated by its parent business unit’s strategy.2
For example, a business unit following a competitive strategy of differentiation through high
quality needs a manufacturing functional strategy that emphasizes expensive quality assurance
processes over cheaper, high-volume production; a human resource functional strategy that
emphasizes the hiring and training of a highly skilled, but costly, workforce; and a marketing
functional strategy that emphasizes distribution channel “pull,” using advertising to increase
consumer demand, over “push,” using promotional allowances to retailers. If a business unit
were to follow a low-cost competitive strategy, however, a different set of functional strategies
would be needed to support the business strategy.
Just as competitive strategies may need to vary from one region of the world to another,
functional strategies may need to vary from region to region. When Mr. Donut expanded into
Japan, for example, it had to market donuts not as breakfast, but as snack food. Because the
Japanese had no breakfast coffee-and-donut custom, they preferred to eat the donuts in the af-
ternoon or evening. Mr. Donut restaurants were thus located near railroad stations and super-
markets. All signs were in English to appeal to the Western interests of the Japanese.
MARKETING STRATEGY
Marketing strategy deals with pricing, selling, and distributing a product. Using a market
development strategy, a company or business unit can (1) capture a larger share of an existing
market for current products through market saturation and market penetration or (2) develop
new uses and/or markets for current products. Consumer product giants such as P&G, Colgate-
Palmolive, and Unilever are experts at using advertising and promotion to implement a mar-
ket saturation/penetration strategy to gain the dominant market share in a product category. As
seeming masters of the product life cycle, these companies are able to extend product life al-
most indefinitely through “new and improved” variations of product and packaging that ap-
peal to most market niches. A company, such as Arm & Hammer, follows the second market
development strategy by finding new uses for its successful current product, baking soda.
Using the product development strategy, a company or unit can (1) develop new prod-
ucts for existing markets or (2) develop new products for new markets. Church & Dwight has
had great success by following the first product development strategy developing new prod-
ucts to sell to its current customers in its existing markets. Acknowledging the widespread ap-
peal of its Arm & Hammer brand baking soda, the company has generated new uses for its
sodium bicarbonate by reformulating it as toothpaste, deodorant, and detergent. In another ex-
ample, Ocean Spray developed craisans, mock berries, light cranberry juices, and juice boxes
in order to market its cranberries to current customers.3 Using a successful brand name to mar-
ket other products is called brand extension, and it is a good way to appeal to a company’s cur-
rent customers. Smith & Wesson, famous for its handguns, has taken this approach by using
licensing to put its name on men’s cologne and other products like the Smith & Wesson
357 Magnum Wood Pellet Smoker (for smoking meats).4 Arm & Hammer has successfully
followed the second product development strategy (new products for new markets) by
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 239
developing new pollution-reduction products (using sodium bicarbonate compounds) for sale
to coal-fired electric utility plants—a very different market from grocery stores.
There are numerous other marketing strategies. For advertising and promotion, for exam-
ple, a company or business unit can choose between “push” and “pull” marketing strategies.
Many large food and consumer products companies in the United States and Canada follow a
push strategy by spending a large amount of money on trade promotion in order to gain or hold
shelf space in retail outlets. Trade promotion includes discounts, in-store special offers, and ad-
vertising allowances designed to “push” products through the distribution system. The Kellogg
Company decided a few years ago to change its emphasis from a push to a pull strategy, in which
advertising “pulls” the products through the distribution channels. The company now spends
more money on consumer advertising designed to build brand awareness so that shoppers will
ask for the products. Research has found that a high level of advertising (a key part of a pull strat-
egy) is beneficial to leading brands in a market.5 Strong brands provide a competitive advantage
to a firm because they act as entry barriers and usually generate high market share.6
Other marketing strategies deal with distribution and pricing. Should a company use distrib-
utors and dealers to sell its products, or should it sell directly to mass merchandisers or use the
direct marketing model by selling straight to the consumers via the Internet? Using multiple chan-
nels simultaneously can lead to problems. In order to increase the sales of its lawn tractors and
mowers, for example, John Deere decided to sell the products not only through its current dealer
network but also through mass merchandisers such as Home Depot. Deere’s dealers, however,
were furious. They considered Home Depot to be a key competitor. The dealers were concerned
that Home Depot’s ability to underprice them would eventually lead to their becoming little more
than repair facilities for their competition and left with insufficient sales to stay in business.7
When pricing a new product, a company or business unit can follow one of two strategies.
For new-product pioneers, skim pricing offers the opportunity to “skim the cream” from the
top of the demand curve with a high price while the product is novel and competitors are few.
Penetration pricing, in contrast, attempts to hasten market development and offers the pioneer
the opportunity to use the experience curve to gain market share with a low price and then
dominate the industry. Depending on corporate and business unit objectives and strategies, ei-
ther of these choices may be desirable to a particular company or unit. Penetration pricing is,
however, more likely than skim pricing to raise a unit’s operating profit in the long term.8 The
use of the Internet to market goods directly to consumers allows a company to use dynamic
pricing, a practice in which prices vary frequently based upon demand, market segment, and
product availability.9
FINANCIAL STRATEGY
Financial strategy examines the financial implications of corporate and business-level strate-
gic options and identifies the best financial course of action. It can also provide competitive
advantage through a lower cost of funds and a flexible ability to raise capital to support a busi-
ness strategy. Financial strategy usually attempts to maximize the financial value of a firm.
The trade-off between achieving the desired debt-to-equity ratio and relying on internal
long-term financing via cash flow is a key issue in financial strategy. Many small- and medium-
sized family-owned companies such as Urschel Laboratories try to avoid all external sources of
funds in order to avoid outside entanglements and to keep control of the company within the
family. Few large publicly-held firms have no long-term debt and instead keep a large amount
of money in cash and short-term investments. One of these is Apple, Inc. According to Apple’s
Chief Financial Officer, Peter Oppenheimer, “Our preference is to maintain a strong balance
sheet in order to preserve our flexibility.”10 Many financial analysts believe, however, that only
by financing through long-term debt can a corporation use financial leverage to boost earnings
240 PART 3 Strategy Formulation
per share—thus raising stock price and the overall value of the company. Research indicates
that higher debt levels not only deter takeover by other firms (by making the company less at-
tractive) but also lead to improved productivity and improved cash flows by forcing manage-
ment to focus on core businesses.11 High debt can be a problem, however, when the economy
falters and a company’s cash flow drops.
Research reveals that a firm’s financial strategy is influenced by its corporate diversifica-
tion strategy. Equity financing, for example, is preferred for related diversification, whereas
debt financing is preferred for unrelated diversification.12 The trend away from unrelated to re-
lated acquisitions explains why the number of acquisitions being paid for entirely with stock
increased from only 2% in 1988 to 50% in 1998.13
A very popular financial strategy is the leveraged buyout (LBO). During 2006 and 2007, for
example, the total value of LBOs was $1.4 trillion, about one-third of all the buyouts ever done.14
In a leveraged buyout, a company is acquired in a transaction financed largely by debt, usually
obtained from a third party, such as an insurance company or an investment banker. Ultimately
the debt is paid with money generated from the acquired company’s operations or by sales of its
assets. The acquired company, in effect, pays for its own acquisition. Management of the LBO is
then under tremendous pressure to keep the highly leveraged company profitable. Unfortunately,
the huge amount of debt on the acquired company’s books may actually cause its eventual de-
cline by focusing management’s attention on short-term matters. For example, one year after the
buyout, the cash flow of eight of the largest LBOs made during 2006–2007 was barely enough
to cover interest payments.15 One study of LBOs (also called MBOs—Management BuyOuts)
revealed that the financial performance of the typical LBO usually falls below the industry aver-
age in the fourth year after the buyout. The firm declines because of inflated expectations, uti-
lization of all slack, management burnout, and a lack of strategic management.16 Often the only
solutions are to sell the company or to again go public by selling stock to finance growth.17
The management of dividends and stock price is an important part of a corporation’s fi-
nancial strategy. Corporations in fast-growing industries such as computers and computer soft-
ware often do not declare dividends. They use the money they might have spent on dividends
to finance rapid growth. If the company is successful, its growth in sales and profits is reflected
in a higher stock price, eventually resulting in a hefty capital gain when shareholders sell their
common stock. Other corporations, such as Whirlpool Corporation, that do not face rapid
growth, must support the value of their stock by offering consistent dividends. Instead of rais-
ing dividends when profits are high, a popular financial strategy is to use excess cash (or even
use debt) to buy back a company’s own shares of stock. During 2005, for example, 1,012 U.S.-
based publicly traded companies declared $446 billion worth of stock repurchase plans. Be-
cause stock buybacks increase earnings per share, they typically increase a firm’s stock price
and make unwanted takeover attempts more difficult. Such buybacks do signal, however, that
either management may not have been able to find any profitable investment opportunities for
the company or that it is anticipating reduced future earnings.18
A number of firms have been supporting the price of their stock by using reverse stock
splits. Contrasted with a typical forward 2-for-1 stock split in which an investor receives an
additional share for every share owned (with each share being worth only half as much), in a
reverse 1-for-2 stock split, an investor’s shares are split in half for the same total amount of
money (with each share now being worth twice as much). Thus, 100 shares of stock worth $10
each are exchanged for 50 shares worth $20 each. A reverse stock split may successfully raise
a company’s stock price, but it does not solve underlying problems. A study by Credit Suisse
First Boston revealed that almost all 800 companies that had reverse stock splits in a five-year
period underperformed their peers over the long term.19
A rather novel financial strategy is the selling of a company’s patents. Companies such as
AT&T, Bellsouth, American Express, Kimberly Clark, and 3Com have been selling patents for
products that they no longer wish to commercialize or are not a part of their core business.
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 241
TABLE 8–1 Technological Leadership Technological Followership
Research and
Development
Strategy and
Competitive
Advantage
Cost Advantage Pioneer the lowest-cost production
design.
Be the first down the learning curve.
Create low cost ways of performing
value activities.
Lower the cost of the product or
value activities by learning from the
leader’s experience.
Avoid R & D costs through
imitation.
Differentiation Pioneer a unique product that increases
buyer value.
Innovate in other activities to increase
buyer value.
Adapt the product or delivery
system more closely to buyer needs
by learning from the leader’s
experience.
SOURCE: Reprinted with the permission of The Free Press, a Division of Simon & Schuster, from COMPETITIVE
ADVANTAGE. Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1988 by
The Free Press. All rights reserved.
They use an intermediary, like Chicago-based Ocean Tomo, to group the patents into lots re-
lated to a common area and sell them to the highest bidder.20
RESEARCH AND DEVELOPMENT (R&D) STRATEGY
R&D strategy deals with product and process innovation and improvement. It also deals with
the appropriate mix of different types of R&D (basic, product, or process) and with the ques-
tion of how new technology should be accessed—through internal development, external ac-
quisition, or strategic alliances.
One of the R&D choices is to be either a technological leader, pioneering an innovation,
or a technological follower, imitating the products of competitors. Porter suggests that decid-
ing to become a technological leader or follower can be a way of achieving either overall low
cost or differentiation. (See Table 8–1.)
One example of an effective use of the leader R&D functional strategy to achieve a dif-
ferentiation competitive advantage is Nike, Inc. Nike spends more than most in the industry
on R&D to differentiate the performance of its athletic shoes from that of its competitors. As
a result, its products have become the favorite of serious athletes. An example of the use of the
follower R&D functional strategy to achieve a low-cost competitive advantage is Dean Foods
Company. “We’re able to have the customer come to us and say, ‘If you can produce X, Y, and
Z product for the same quality and service, but at a lower price and without that expensive la-
bel on it, you can have the business,’” says Howard Dean, president of the company.21
An increasing number of companies are working with their suppliers to help them keep up
with changing technology. They are beginning to realize that a firm cannot be competitive tech-
nologically only through internal development. For example, Chrysler Corporation’s skillful
use of parts suppliers to design everything from car seats to drive shafts has enabled it to spend
consistently less money than its competitors to develop new car models. Using strategic tech-
nology alliances is one way to combine the R&D capabilities of two companies. Maytag Com-
pany worked with one of its suppliers to apply fuzzy logic technology to its IntelliSense™
dishwasher. The partnership enabled Maytag to complete the project in a shorter amount of time
than if it had tried to do it alone.22 One UK study found that 93% of UK auto assemblers and
component manufacturers use their suppliers as technology suppliers.23
A new approach to R&D is open innovation, in which a firm uses alliances and connec-
tions with corporate, government, academic labs, and even consumers to develop new prod-
ucts and processes. For example, Intel opened four small-scale research facilities adjacent to
universities to promote the cross-pollination of ideas. Thirteen U.S. university labs engaging
242 PART 3 Strategy Formulation
in nanotechnology research have formed the National Nanotechnology Infrastructure Network
in order to offer their resources to businesses for a fee.24 Mattel, Wal-Mart, and other toy man-
ufacturers and retailers use idea brokers such as Big Idea Group to scout for new toy ideas. Big
Idea Group invites inventors to submit ideas to its Web site (www.bigideagroup.net). It then
refines and promotes to its clients the most promising ideas.25 IBM adopted the open operat-
ing system Linux for some of its computer products and systems, drawing on a core code base
that is continually improved and enhanced by a massive global community of software devel-
opers, of whom only a fraction work for IBM.26 To open its own labs to ideas being generated
elsewhere, P&G’s CEO Art Lafley decreed that half of the company’s ideas must come from
outside, up from 10% in 2000. P&G instituted the use of technology scouts to search beyond
the company for promising innovations. By 2007, the objective was achieved: 50% of the
company’s innovations originated outside P&G.27
A slightly different approach to technology development is for a large firm such as IBM
or Microsoft to purchase minority stakes in relatively new high-tech entrepreneurial ventures
that need capital to continue operation. Investing corporate venture capital is one way to gain
access to promising innovations at a lower cost than by developing them internally.28
OPERATIONS STRATEGY
Operations strategy determines how and where a product or service is to be manufactured,
the level of vertical integration in the production process, the deployment of physical re-
sources, and relationships with suppliers. It should also deal with the optimum level of tech-
nology the firm should use in its operations processes. See the Global Issue feature to see how
differences in national conditions can lead to differences in product design and manufacturing
facilities from one country to another.
Advanced Manufacturing Technology (AMT) is revolutionizing operations worldwide
and should continue to have a major impact as corporations strive to integrate diverse busi-
ness activities by using computer assisted design and manufacturing (CAD/CAM) principles.
The use of CAD/CAM, flexible manufacturing systems, computer numerically controlled sys-
tems, automatically guided vehicles, robotics, manufacturing resource planning (MRP II), op-
timized production technology, and just-in-time techniques contribute to increased flexibility,
quick response time, and higher productivity. Such investments also act to increase the com-
pany’s fixed costs and could cause significant problems if the company is unable to achieve
economies of scale or scope. Baldor Electric Company, the largest maker of industrial electric
motors in the United States, built a new factory by using the new technology to eliminate
undesirable jobs with high employee turnover. With one-tenth the employees of its foreign
plants, the plant was cost-competitive with motors produced in Mexico or China.29
A firm’s manufacturing strategy is often affected by a product’s life cycle. As the sales of
a product increase, there will be an increase in production volume ranging from lot sizes as
low as one in a job shop (one-of-a-kind production using skilled labor) through connected line
batch flow (components are standardized; each machine functions such as a job shop but is po-
sitioned in the same order as the parts are processed) to lot sizes as high as 100,000 or more
per year for flexible manufacturing systems (parts are grouped into manufacturing families to
produce a wide variety of mass-produced items) and dedicated transfer lines (highly auto-
mated assembly lines making one mass-produced product using little human labor). Accord-
ing to this concept, the product becomes standardized into a commodity over time in
conjunction with increasing demand. Flexibility thus gives way to efficiency.30
Increasing competitive intensity in many industries has forced companies to switch from
traditional mass production using dedicated transfer lines to a continuous improvement pro-
duction strategy. A mass-production system was an excellent method to produce a large num-
ber of low-cost, standard goods and services. Employees worked on narrowly defined,
www.bigideagroup.net
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 243
SOURCE: WHEELEN, TOM; HUNGER, J. DAVID, STRATEGIC MAN-
AGEMENT AND BUSINESS POLICY, 9th Edition, © 2004, p. 172.
Reprinted by permission of Pearson Education, Inc. Upper Saddle
River, NJ.
ple, material costs may run as much as 200% to 800%
higher than elsewhere, while labor and overhead costs are
comparatively minimal,” added Kremer. Another consider-
ation was the garments to be washed in each country. For
example, saris—the 18-foot lengths of cotton or silk with
which Indian women drape themselves—needed special
treatment in an Indian washing machine, forcing addi-
tional modifications.
Manufacturing facilities also varied from country to
country. Brastemp, Whirlpool’s Brazilian partner, built its
plant of precast concrete to address the problems of high
humidity. In India, however, the construction crew cast the
concrete, allowed it to cure, and then using chain, block,
and tackle, five or six men raised each three-ton slab into
place. Instead of using one building, Mexican operations
used two, one housing the flexible assembly lines and
stamping operations, and an adjacent facility housing the
injection molding and extrusion processes.
INTERNATIONAL DIFFERENCES ALTER WHIRLPOOL’S
OPERATIONS STRATEGY
To better penetrate the
growing markets in develop-
ing nations, Whirlpool decided
to build a “world washer.” This
new type of washing machine was to be
produced in Brazil, Mexico, and India. Lightweight, with
substantially fewer parts than its U.S. counterpart, its per-
formance was to be equal to or better than anything on
the world market while being competitive in price with the
most popular models in these markets. The goal was to de-
velop a complete product, process, and facility design
package that could be used in different countries with low
initial investment. Originally the plan had been to make the
same low-cost washer in identical plants in each of the
three countries.
Significant differences in each of the three countries
forced Whirlpool to change its product design to adapt to
each nation’s situation. According to Lawrence Kremer, Se-
nior Vice President of Global Technology and Operations,
“Our Mexican affiliate, Vitromatic, has porcelain and glass-
making capabilities. Porcelain baskets made sense for
them. Stainless steel became the preferred material for the
others.” Costs also affected decisions. “In India, for exam-
GLOBAL issue
repetitious tasks under close supervision in a bureaucratic and hierarchical structure. Quality,
however, often tended to be fairly low. Learning how to do something better was the preroga-
tive of management; workers were expected only to learn what was assigned to them. This sys-
tem tended to dominate manufacturing until the 1970s. Under the continuous improvement
system developed by Japanese firms, empowered cross-functional teams strive constantly to
improve production processes. Managers are more like coaches than like bosses. The result is
a large quantity of low-cost, standard goods and services, but with high quality. The key to
continuous improvement is the acknowledgment that workers’ experience and knowledge can
help managers solve production problems and contribute to tightening variances and reducing
errors. Because continuous improvement enables firms to use the same low-cost competitive
strategy as do mass-production firms but at a significantly higher level of quality, it is rapidly
replacing mass production as an operations strategy.
The automobile industry is currently experimenting with the strategy of modular manu-
facturing in which preassembled subassemblies are delivered as they are needed (i.e., Just-
in-Time) to a company’s assembly-line workers, who quickly piece the modules together into
a finished product. For example, General Motors built a new automotive complex in Brazil
to make its new subcompact, the Celta. Sixteen of the 17 buildings were occupied by suppli-
ers, including Delphi, Lear, and Goodyear. These suppliers delivered preassembled modules
(which comprised 85% of the final value of each car) to GM’s building for assembly. In a
process new to the industry, the suppliers acted as a team to build a single module compris-
ing the motor, transmission, fuel lines, rear axle, brake-fluid lines, and exhaust system, which
was then installed as one piece. GM hoped that this manufacturing strategy would enable it
244 PART 3 Strategy Formulation
to produce 100 vehicles annually per worker compared to the standard rate of 30 to 50 autos
per worker.31 Ford and Chrysler have also opened similar modular facilities in Brazil.
The concept of a product’s life cycle eventually leading to one-size-fits-all mass produc-
tion is being increasingly challenged by the new concept of mass customization. Appropriate
for an ever-changing environment, mass customization requires that people, processes, units,
and technology reconfigure themselves to give customers exactly what they want, when they
want it. In the case of Dell Computer, customers use the Internet to design their own comput-
ers. In contrast to continuous improvement, mass customization requires flexibility and quick
responsiveness. Managers coordinate independent, capable individuals. An efficient linkage
system is crucial. The result is low-cost, high-quality, customized goods and services appro-
priate for a large number of market niches.
A contentious issue for manufacturing companies throughout the world is the availability
of resources needed to operate a modern factory. The increasing cost of oil during 2007 and
2008 drastically boosted costs, only some of which could be passed on to the customers in a
competitive environment. The likelihood that fresh water could become an equally scarce re-
source is causing many companies to rethink water-intensive manufacturing processes. To
learn how companies are beginning to deal with increasing fresh water scarcity, see the
Environmental Sustainability Issue feature.
PURCHASING STRATEGY
Purchasing strategy deals with obtaining the raw materials, parts, and supplies needed to per-
form the operations function. Purchasing strategy is important because materials and compo-
nents purchased from suppliers comprise 50% of total manufacturing costs of manufacturing
companies in the United Kingdom, United States, Australia, Belgium, and Finland.32 The ba-
sic purchasing choices are multiple, sole, and parallel sourcing. Under multiple sourcing, the
purchasing company orders a particular part from several vendors. Multiple sourcing has tra-
ditionally been considered superior to other purchasing approaches because (1) it forces sup-
pliers to compete for the business of an important buyer, thus reducing purchasing costs, and
(2) if one supplier cannot deliver, another usually can, thus guaranteeing that parts and sup-
plies are always on hand when needed. Multiple sourcing has been one way for a purchasing
firm to control the relationship with its suppliers. So long as suppliers can provide evidence
that they can meet the product specifications, they are kept on the purchaser’s list of accept-
able vendors for specific parts and supplies. Unfortunately, the common practice of accepting
the lowest bid often compromises quality.
W. Edward Deming, a well-known management consultant, strongly recommended sole
sourcing as the only manageable way to obtain high supplier quality. Sole sourcing relies on only
one supplier for a particular part. Given his concern with designing quality into a product in its
early stages of development, Deming argued that the buyer should work closely with the sup-
plier at all stages. This reduces both cost and time spent on product design and it also improves
quality. It can also simplify the purchasing company’s production process by using the Just-In-
Time (JIT) concept of having the purchased parts arrive at the plant just when they are needed
rather than keeping inventories. The concept of sole sourcing is taken one step further in JIT II,
in which vendor sales representatives actually have desks next to the purchasing company’s fac-
tory floor, attend production status meetings, visit the R&D lab, and analyze the purchasing com-
pany’s sales forecasts. These in-house suppliers then write sales orders for which the purchasing
company is billed. Developed by Lance Dixon at Bose Corporation, JIT II is also being used at
IBM, Honeywell, and Ingersoll-Rand. Karen Dale, purchasing manager for Honeywell’s office
supplies, said she was very concerned about confidentiality when JIT II was first suggested to
her. Soon she had five suppliers working with her 20 buyers and reported few problems.33
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 245
Sole sourcing reduces transaction costs and builds quality by having the purchaser and
supplier work together as partners rather than as adversaries. With sole sourcing, more com-
panies will have longer relationships with fewer suppliers. Research has found that buyer-
supplier collaboration and joint problem solving with both parties dependent upon the other
results in the development of competitive capabilities, higher quality, lower costs, and better
scheduling.34 Sole sourcing does, however, have limitations. If a supplier is unable to deliver
a part, the purchaser has no alternative but to delay production. Multiple suppliers can provide
the purchaser with better information about new technology and performance capabilities. The
limitations of sole sourcing have led to the development of parallel sourcing. In parallel sourc-
ing, two suppliers are the sole suppliers of two different parts, but they are also backup sup-
pliers for each other’s parts. If one vendor cannot supply all of its parts on time, the other
vendor is asked to make up the difference.35
SOURCE: K. Kube, “Into the Wild Brown Yonder,” Trains (Novem-
ber 2008), pp. 68–73; “Running Dry,” The Economist (August 23,
2008), pp. 53–54.
“Water is the oil of the 21st century,” contends Andrew
Liveris, CEO of the chemical company Dow. Like oil, sup-
plies of clean, easily accessible fresh water are under a
growing strain because of the growing population and
widespread improvements in living standards. Industrial-
ization in developing nations is contaminating rivers and
aquifers. Climate change is altering the patterns of fresh
water availability so that droughts are more likely in many
parts of the world. According to a survey by the Marsh
Center for Risk Insights, 40% of Fortune 1000 companies
stated that the impact of a water shortage on their busi-
ness would be “severe” or “catastrophic,” but only 17%
said that they were prepared for such a crisis. Of Nestlé’s
481 factories worldwide, 49 are located in water-scarce re-
gions. Environmental activists have attacked PepsiCo and
Coca-Cola for allegedly depleting groundwater in India to
make bottled drinks.
There are a number of companies that are taking action
to protect their future supply of freshwater. Dow has re-
duced the amount of water it uses by over a third since
1995. During 1997–2006, when Nestle almost doubled
the volume of food it produced, it reduced the amount of
water used by 29%. By 2008, Coca-Cola had achieved
85% of its objective to clean all of the wastewater gener-
ated at its bottling plants by 2010. China’s Elion Chemical
is working with General Electric to recycle 90% of its
wastewater to comply with the government’s new “zero-
liquid” discharge rules.
The U.S. Department of En-
ergy (DOE) plans to build a rail
line more than 300 miles long
through the Nevada wilderness
to move spent nuclear fuel from
121 sites in 39 states to a geologic repos-
itory at Yucca Mountain. One of the biggest issues to over-
come will be water supply. The DOE estimates that the
construction phase would require 5,500 acre feet of water
for earthwork compaction, 370 acre-feet for construction
personnel, 200 acre-feet for dust control along access roads,
and 30 acre-feet for quarry operations, totaling 6,100 acre-
feet, or two billion gallons, of water to support a four-year
construction period. To meet this need, DOE wants to drill
150 to 176 new wells. The state of Nevada, however, has re-
jected a permit request to use water for drilling on the Yucca
Mountain site, stating that water has to be used for the ben-
efit of the public. Negotiations continue.
This is just one of the ways that organizations need
fresh water for their operations. Nestlé, Unilever, Coca-
Cola, Anheuser-Busch, and Danone consume almost
575 billion liters of water a year, enough to satisfy the daily
water needs of every person on the planet. It takes about
13 cubic meters of freshwater to produce a single 200 mm
semiconductor wafer. As a result, chip making is believed to
account for 25% of the water consumption in Silicon Valley.
According to Jose Lopez, Nestlé’s COO, it takes four liters of
water to make one liter of product in Nestlé’s factories, but
3,000 liters of water are needed to grow the agricultural
produce that supplies them. Each year, around 40% of the
freshwater withdrawn from lakes and aquifers in America is
used to cool power plants. Separating one liter of oil from
Canada’s tar sands requires up to five liters of water!
OPERATIONS NEED FRESH WATER AND LOTS OF IT!
ENVIRONMENTAL sustainability issue
246 PART 3 Strategy Formulation
The Internet is being increasingly used both to find new sources of supply and to keep in-
ventories replenished. For example, Hewlett-Packard introduced a Web-based procurement
system to enable its 84,000 employees to buy office supplies from a standard set of suppliers.
The new system enabled the company to save $60 to $100 million annually in purchasing
costs.36 Research indicates that companies using Internet-based technologies are able to lower
administrative costs and purchase prices.37
LOGISTICS STRATEGY
Logistics strategy deals with the flow of products into and out of the manufacturing process.
Three trends related to this strategy are evident: centralization, outsourcing, and the use of the
Internet. To gain logistical synergies across business units, corporations began centralizing lo-
gistics in the headquarters group. This centralized logistics group usually contains specialists
with expertise in different transportation modes such as rail or trucking. They work to aggregate
shipping volumes across the entire corporation to gain better contracts with shippers. Compa-
nies such as Georgia-Pacific, Marriott, and Union Carbide view the logistics function as an im-
portant way to differentiate themselves from the competition, to add value, and to reduce costs.
Many companies have found that outsourcing logistics reduces costs and improves deliv-
ery time. For example, HP contracted with Roadway Logistics to manage its inbound raw ma-
terials warehousing in Vancouver, Canada. Nearly 140 Roadway employees replaced 250 HP
workers, who were transferred to other HP activities.38
Many companies are using the Internet to simplify their logistical system. For example,
Ace Hardware created an online system for its retailers and suppliers. An individual hardware
store can now see on the Web site that ordering 210 cases of wrenches is cheaper than order-
ing 200 cases. Because a full pallet is composed of 210 cases of wrenches, an order for a full
pallet means that the supplier doesn’t have to pull 10 cases off a pallet and repackage them
for storage. There is less chance that loose cases will be lost in delivery, and the paperwork
doesn’t have to be redone. As a result, Ace’s transportation costs are down 18%, and ware-
house costs have been cut 28%.39
HUMAN RESOURCE MANAGEMENT (HRM) STRATEGY
HRM strategy, among other things, addresses the issue of whether a company or business unit
should hire a large number of low-skilled employees who receive low pay, perform repetitive
jobs, and are most likely quit after a short time (the McDonald’s restaurant strategy) or hire
skilled employees who receive relatively high pay and are cross-trained to participate in self-
managing work teams. As work increases in complexity, the more suited it is for teams, espe-
cially in the case of innovative product development efforts. Multinational corporations are
increasingly using self-managing work teams in their foreign affiliates as well as in home-
country operations.40 Research indicates that the use of work teams leads to increased quality
and productivity as well as to higher employee satisfaction and commitment.41
Companies following a competitive strategy of differentiation through high quality use in-
put from subordinates and peers in performance appraisals to a greater extent than do firms
following other business strategies.42 A complete 360-degree appraisal, in which input is gath-
ered from multiple sources, is now being used by more than 10% of U.S. corporations and has
become one of the most popular and effective tools in developing employees and new man-
agers.43 One Indian company, HCL Technologies, publishes the appraisal ratings for the top
20 managers on the company’s intranet for all to see.44
Companies are finding that having a diverse workforce can be a competitive advantage.
Research reveals that firms with a high degree of racial diversity following a growth strategy
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 247
have higher productivity than do firms with less racial diversity.45 Avon Company, for exam-
ple, was able to turn around its unprofitable inner-city markets by putting African-American
and Hispanic managers in charge of marketing to these markets.46 Diversity in terms of age
and national origin also offers benefits. DuPont’s use of multinational teams has helped the
company develop and market products internationally. McDonald’s has discovered that older
workers perform as well as, if not better than, younger employees. According to Edward Rensi,
CEO of McDonald’s USA, “We find these people to be particularly well motivated, with a sort
of discipline and work habits hard to find in younger employees.”47
INFORMATION TECHNOLOGY STRATEGY
Corporations are increasingly using information technology strategy to provide business units
with competitive advantage. When FedEx first provided its customers with PowerShip computer
software to store addresses, print shipping labels, and track package location, its sales jumped
significantly. UPS soon followed with its own MaxiShips software. Viewing its information sys-
tem as a distinctive competency, FedEx continued to push for further advantage over UPS by us-
ing its Web site to enable customers to track their packages. FedEx uses this competency in its
advertisements by showing how customers can track the progress of their shipments. Soon there-
after, UPS provided the same service.Although it can be argued that information technology has
now become so pervasive that it no longer offers companies a competitive advantage, corpora-
tions worldwide continue to spend over $2 trillion annually on information technology.48
Multinational corporations are finding that having a sophisticated intranet allows employ-
ees to practice follow-the-sun management, in which project team members living in one coun-
try can pass their work to team members in another country in which the work day is just
beginning. Thus, night shifts are no longer needed.49 The development of instant translation
software is also enabling workers to have online communication with co-workers in other
countries who use a different language.50 For example, Mattel has cut the time it takes to de-
velop new products by 10% by enabling designers and licensees in other countries to collabo-
rate on toy design. IBM uses its intranet to allow its employees to collaborate and improve
their skills, thus reducing its training and travel expenses.51
Many companies, such as Lockheed Martin, General Electric, and Whirlpool, use informa-
tion technology to form closer relationships with both their customers and suppliers through so-
phisticated extranets. For example, General Electric’s Trading Process Network allows suppliers
to electronically download GE’s requests for proposals, view diagrams of parts specifications,
and communicate with GE purchasing managers. According to Robert Livingston, GE’s head of
worldwide sourcing for the Lighting Division, going on the Web reduces processing time by
one-third.52 Thus, the use of information technology through extranets makes it easier for a com-
pany to buy from others (outsource) rather than make it themselves (vertically integrate).53
8.2 The Sourcing Decision: Location of Functions
For a functional strategy to have the best chance of success, it should be built on a distinc-
tive competency residing within that functional area. If a corporation does not have a distinc-
tive competency in a particular functional area, that functional area could be a candidate for
outsourcing.
Outsourcing is purchasing from someone else a product or service that had been previously
provided internally. Thus, it is the reverse of vertical integration. Outsourcing is becoming an in-
creasingly important part of strategic decision making and an important way to increase effi-
ciency and often quality. In a study of 30 firms, outsourcing resulted on average in a 9% reduction
248 PART 3 Strategy Formulation
in costs and a 15% increase in capacity and quality.54 For example, Boeing used outsourcing as
a way to reduce the cost of designing and manufacturing its new 787 Dreamliner. Up to 70% of
the plane was outsourced. In a break from past practice, suppliers make large parts of the fuse-
lage, including plumbing, electrical, and computer systems, and ship them to Seattle for assem-
bly by Boeing. Outsourcing enabled Boeing to build a 787 in 4 months instead of the usual 12.55
According to an American Management Association survey of member companies, 94%
of the responding firms outsource at least one activity. The outsourced activities are general
and administrative (78%), human resources (77%), transportation and distribution (66%), in-
formation systems (63%), manufacturing (56%), marketing (51%), and finance and account-
ing (18%). The survey also reveals that 25% of the respondents have been disappointed in their
outsourcing results. Fifty-one percent of the firms reported bringing an outsourced activity
back in-house. Nevertheless, authorities not only expect the number of companies engaging in
outsourcing to increase, they also expect companies to outsource an increasing number of
functions, especially those in customer service, bookkeeping, financial/clerical, sales/telemar-
keting, and the mailroom.56 It is estimated that 50% of U.S. manufacturing will be outsourced
to firms in 28 developing countries by 2015.57
Offshoring is the outsourcing of an activity or a function to a wholly owned company or
an independent provider in another country. Offshoring is a global phenomenon that has been
supported by advances in information and communication technologies, the development of
stable, secure, and high-speed data transmission systems, and logistical advances like con-
tainerized shipping. According to Bain & Company, 51% of large firms in North America,
Europe, and Asia outsource offshore.58 Although India currently has 70% of the offshoring
market, countries such as Brazil, China, Russia, the Phillipines, Malaysia, Hungary, the Czech
Republic, and Israel are growing in importance. These countries have low-cost qualified la-
bor and an educated workforce. These are important considerations because more than 93%
of offshoring companies do so to reduce costs.59 For example, Mexican assembly line work-
ers average $3.50 an hour plus benefits compared to $27 an hour plus benefits at a GM or Ford
plant in the U.S. Less skilled Mexican workers at auto parts makers earn as little as $1.50 per
hour with fewer benefits.60
Software programming and customer service, in particular, are being outsourced to
India. For example, General Electric’s back-office services unit, GE Capital International
Services, is one of the oldest and biggest of India’s outsourcing companies. From only
$26 million in 1999, its annual revenues grew to over $420 million by 2004.61 As part of this
trend, IBM acquired Daksh eServices Ltd., one of India’s biggest suppliers of remote busi-
ness services.62
Outsourcing, including offshoring, has significant disadvantages. For example, mount-
ing complaints forced Dell Computer to stop routing corporate customers to a technical sup-
port call center in Bangalore, India.63 GE’s introduction of a new washing machine was
delayed three weeks because of production problems at a supplier’s company to which it had
contracted out key work. Some companies have found themselves locked into long-term con-
tracts with outside suppliers that were no longer competitive.64 Some authorities propose that
the cumulative effects of continued outsourcing steadily reduces a firm’s ability to learn new
skills and to develop new core competencies.65 One survey of 129 outsourcing firms revealed
that half the outsourcing projects undertaken in one year failed to deliver anticipated savings.
This is in agreement with a survey by Bain & Company in which 51% of large North Amer-
ican, European, and Asian firms stated that outsourcing (including offshoring) did not meet
their expectations.66 Another survey of software projects, by MIT, found that the median In-
dian project had 10% more software bugs than did comparable U.S. projects.67 During
2007–2008, tainted goods made by Chinese manufacturers, ranging from lead paint on toys,
contaminated heparin, and melamine-laced milk caused their customers to reevaluate the
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 249
manner in which they engaged in offshore outsourcing.68 The increasing cost of oil was mak-
ing offshoring less economical. Since 2003, crude oil increased in price from $28 to over
$100 a barrel in 2008, causing the cost to ship a standard 40-foot container to triple. By 2008
it cost about $100 to ship a ton of iron from Brazil to China, more than the cost of the min-
eral itself.69
A study of 91 outsourcing efforts conducted by European and North American firms found
seven major errors that should be avoided:
1. Outsourcing activities that should not be outsourced: Companies failed to keep core
activities in-house.
2. Selecting the wrong vendor: Vendors were not trustworthy or lacked state-of-the-art
processes.
3. Writing a poor contract: Companies failed to establish a balance of power in the
relationship.
4. Overlooking personnel issues: Employees lost commitment to the firm.
5. Losing control over the outsourced activity: Qualified managers failed to manage the
outsourced activity.70
6. Overlooking the hidden costs of outsourcing: Transaction costs overwhelmed other
savings.
7. Failing to plan an exit strategy: Companies failed to build reversibility clauses into the
contract.71
The key to outsourcing is to purchase from outside only those activities that are not key
to the company’s distinctive competencies. Otherwise, the company may give up the very ca-
pabilities that made it successful in the first place—thus putting itself on the road to eventual
decline. This is supported by research reporting that companies that have more experience with
a particular manufacturing technology tend to keep manufacturing in-house.72 J. P. Morgan
Chase & Company terminated a seven-year technology outsourcing agreement with IBM be-
cause the bank’s management realized that information technology (IT) was too important
strategically to be outsourced.73
In determining functional strategy, the strategist must:
� Identify the company’s or business unit’s core competencies
� Ensure that the competencies are continually being strengthened
� Manage the competencies in such a way that best preserves the competitive advantage
they create
An outsourcing decision depends on the fraction of total value added that the activity un-
der consideration represents and on the amount of potential competitive advantage in that ac-
tivity for the company or business unit. See the outsourcing matrix in Figure 8–1. A firm
should consider outsourcing any activity or function that has low potential for competitive ad-
vantage. If that activity constitutes only a small part of the total value of the firm’s products or
services, it should be purchased on the open market (assuming that quality providers of the ac-
tivity are plentiful). If, however, the activity contributes highly to the company’s products or
services, the firm should purchase it through long-term contracts with trusted suppliers or dis-
tributors. A firm should always produce at least some of the activity or function (i.e., taper ver-
tical integration) if that activity has the potential for providing the company some competitive
advantage. However, full vertical integration should be considered only when that activity or
function adds significant value to the company’s products or services in addition to providing
competitive advantage.74
250 PART 3 Strategy Formulation
Activity’s Total Value-Added to Firm’s
Products and Services
A
ct
iv
it
y’
s
P
o
te
n
ti
al
fo
r
C
o
m
p
et
it
iv
e
A
d
va
n
ta
g
e
Low
Taper Vertical
Integration:
Produce Some
Internally
Full Vertical
Integration:
Produce All
Internally
Outsource
Completely:
Buy on Open
Market
Outsource
Completely:
Purchase with
Long-Term
Contracts
Lo
w
High
H
ig
h
FIGURE 8–1
Proposed
Outsourcing
Matrix
8.3 Strategies to Avoid
Several strategies, that could be considered corporate, business, or functional are very danger-
ous. Managers who have made poor analyses or lack creativity may be trapped into consider-
ing some of the following strategies to avoid:
� Follow the leader: Imitating a leading competitor’s strategy might seem to be a good
idea, but it ignores a firm’s particular strengths and weaknesses and the possibility that the
leader may be wrong. Fujitsu Ltd., the world’s second-largest computer maker, had been
driven since the 1960s by the sole ambition of catching up to IBM. Like IBM, Fujitsu
competed primarily as a mainframe computer maker. So devoted was it to catching IBM,
however, that it failed to notice that the mainframe business had reached maturity by 1990
and was no longer growing.
� Hit another home run: If a company is successful because it pioneered an extremely suc-
cessful product, it tends to search for another super product that will ensure growth and
prosperity. As in betting on long shots in horse races, the probability of finding a second
winner is slight. Polaroid spent a lot of money developing an “instant” movie camera, but
the public ignored it in favor of the camcorder.
� Arms race: Entering into a spirited battle with another firm for increased market share
might increase sales revenue, but that increase will probably be more than offset by in-
creases in advertising, promotion, R&D, and manufacturing costs. Since the deregula-
tion of airlines, price wars and rate specials have contributed to the low profit margins
and bankruptcies of many major airlines, such as Eastern, Pan American, TWA, and
United.
� Do everything: When faced with several interesting opportunities, management might
tend to leap at all of them. At first, a corporation might have enough resources to develop
SOURCE: J. D. Hunger and T. L. Wheelen, “Proposed Outsourcing Matrix.” Copyright © 1996 and 2005 by Wheelen
and Hunger Associates. Reprinted by permission.
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 251
each idea into a project, but money, time, and energy are soon exhausted as the many proj-
ects demand large infusions of resources. The Walt Disney Company’s expertise in the en-
tertainment industry led it to acquire the ABC network. As the company churned out new
motion pictures and television programs such as Who Wants to Be a Millionaire? it spent
$750 million to build new theme parks and buy a cruise line and a hockey team. By 2000,
even though corporate sales had continued to increase, net income was falling.75
� Losing hand: A corporation might have invested so much in a particular strategy that top
management is unwilling to accept its failure. Believing that it has too much invested to
quit, management may continue to throw “good money after bad.” Pan American Airlines,
for example, chose to sell its Pan Am Building and Intercontinental Hotels, the most prof-
itable parts of the corporation, to keep its money-losing airline flying. Continuing to suf-
fer losses, the company followed this profit strategy of shedding assets for cash until it
had sold off everything and went bankrupt.
8.4 Strategic Choice: Selecting the Best Strategy
After the pros and cons of the potential strategic alternatives have been identified and evalu-
ated, one must be selected for implementation. By now, it is likely that many feasible alterna-
tives will have emerged. How is the best strategy determined?
Perhaps the most important criterion is the capability of the proposed strategy to deal with
the specific strategic factors developed earlier, in the SWOT analysis. If the alternative doesn’t
take advantage of environmental opportunities and corporate strengths/competencies, and lead
away from environmental threats and corporate weaknesses, it will probably fail.
Another important consideration in the selection of a strategy is the ability of each alter-
native to satisfy agreed-on objectives with the least resources and the fewest negative side ef-
fects. It is, therefore, important to develop a tentative implementation plan in order to address
the difficulties that management is likely to face. This should be done in light of societal
trends, the industry, and the company’s situation based on the construction of scenarios.
CONSTRUCTING CORPORATE SCENARIOS
Corporate scenarios are pro forma (estimated future) balance sheets and income statements
that forecast the effect each alternative strategy and its various programs will likely have on
division and corporate return on investment. (Pro forma financial statements are discussed in
Chapter 12.) In a survey of Fortune 500 firms, 84% reported using computer simulation mod-
els in strategic planning. Most of these were simply spreadsheet-based simulation models
dealing with what-if questions.76
The recommended scenarios are simply extensions of the industry scenarios discussed in
Chapter 4. If, for example, industry scenarios suggest the probable emergence of a strong
market demand in a specific country for certain products, a series of alternative strategy sce-
narios can be developed. The alternative of acquiring another firm having these products in
that country can be compared with the alternative of a green-field development (e.g., building
new operations in that country). Using three sets of estimated sales figures (Optimistic, Pes-
simistic, and Most Likely) for the new products over the next five years, the two alternatives
can be evaluated in terms of their effect on future company performance as reflected in the
company’s probable future financial statements. Pro forma balance sheets and income state-
ments can be generated with spreadsheet software, such as Excel, on a personal computer. Pro
forma statements are based on financial and economic scenarios.
252 PART 3 Strategy Formulation
TABLE 8–2 Scenario Box for Use in Generating Financial Pro Forma Statements
Projections1
200– 200– 200–
Factor
Last
Year
Historical
Average
Trend
Analysis O P ML O P ML O P ML Comments
GDP
CPI
Other
Sales units
Dollars
COGS
Advertising and
marketing
Interest expense
Plant expansion
Dividends
Net profits
EPS
ROI
ROE
Other
NOTE 1: O � Optimistic; P � Pessimistic; ML � Most Likely.
SOURCE: T. L. Wheelen and J. D. Hunger. Copyright © 1987, 1988, 1989, 1990, 1992, 2005, and 2009 by T. L. Wheelen. Copyright © 1993 and
2005 by Wheelen and Hunger Associates. Reprinted with permission.
To construct a corporate scenario, follow these steps:
1. Use industry scenarios (as discussed in Chapter 4) to develop a set of assumptions about
the task environment (in the specific country under consideration). For example, 3M re-
quires the general manager of each business unit to describe annually what his or her in-
dustry will look like in 15 years. List optimistic, pessimistic, and most likely assumptions
for key economic factors such as the GDP (Gross Domestic Product), CPI (Consumer
Price Index), and prime interest rate and for other key external strategic factors such as
governmental regulation and industry trends. This should be done for every country/
region in which the corporation has significant operations that will be affected by each
strategic alternative. These same underlying assumptions should be listed for each of the
alternative scenarios to be developed.
2. Develop common-size financial statements (as discussed in Chapter 12) for the com-
pany’s or business unit’s previous years, to serve as the basis for the trend analysis projec-
tions of pro forma financial statements. Use the Scenario Box form shown in Table 8–2:
a. Use the historical common-size percentages to estimate the level of revenues, ex-
penses, and other categories in estimated pro forma statements for future years.
b. Develop for each strategic alternative a set of Optimistic(O), Pessimistic(P), and Most
Likely(ML) assumptions about the impact of key variables on the company’s future fi-
nancial statements.
c. Forecast three sets of sales and cost of goods sold figures for at least five years into
the future.
d. Analyze historical data and make adjustments based on the environmental assump-
tions listed earlier. Do the same for other figures that can vary significantly.
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 253
e. Assume for other figures that they will continue in their historical relationship to sales
or some other key determining factor. Plug in expected inventory levels, accounts re-
ceivable, accounts payable, R&D expenses, advertising and promotion expenses, cap-
ital expenditures, and debt payments (assuming that debt is used to finance the
strategy), among others.
f. Consider not only historical trends but also programs that might be needed to imple-
ment each alternative strategy (such as building a new manufacturing facility or ex-
panding the sales force).
3. Construct detailed pro forma financial statements for each strategic alternative:
a. List the actual figures from this year’s financial statements in the left column of the
spreadsheet.
b. List to the right of this column the optimistic figures for years 1 through 5.
c. Go through this same process with the same strategic alternative, but now list the pes-
simistic figures for the next five years.
d. Do the same with the most likely figures.
e. Develop a similar set of optimistic (O), pessimistic (P), and most likely (ML) pro
forma statements for the second strategic alternative. This process generates six dif-
ferent pro forma scenarios reflecting three different situations (O, P, and ML) for two
strategic alternatives.
f. Calculate financial ratios and common-size income statements, and create balance
sheets to accompany the pro forma statements.
g. Compare the assumptions underlying the scenarios with the financial statements and
ratios to determine the feasibility of the scenarios. For example, if cost of goods sold
drops from 70% to 50% of total sales revenue in the pro forma income statements,
this drop should result from a change in the production process or a shift to cheaper
raw materials or labor costs rather than from a failure to keep the cost of goods sold
in its usual percentage relationship to sales revenue when the predicted statement was
developed.
The result of this detailed scenario construction should be anticipated net profits, cash
flow, and net working capital for each of three versions of the two alternatives for five years
into the future. A strategist might want to go further into the future if the strategy is expected
to have a major impact on the company’s financial statements beyond five years. The result of
this work should provide sufficient information on which forecasts of the likely feasibility and
probable profitability of each of the strategic alternatives could be based.
Obviously, these scenarios can quickly become very complicated, especially if three sets
of acquisition prices and development costs are calculated. Nevertheless, this sort of detailed
what-if analysis is needed to realistically compare the projected outcome of each reasonable
alternative strategy and its attendant programs, budgets, and procedures. Regardless of the
quantifiable pros and cons of each alternative, the actual decision will probably be influenced
by several subjective factors such as those described in the following sections.
Management’s Attitude Toward Risk
The attractiveness of a particular strategic alternative is partially a function of the amount of
risk it entails. Risk is composed not only of the probability that the strategy will be effective
but also of the amount of assets the corporation must allocate to that strategy and the length of
time the assets will be unavailable for other uses. Because of variation among countries in terms
of customs, regulations, and resources, companies operating in global industries must deal with
a greater amount of risk than firms operating only in one country.77 The greater the assets in-
volved and the longer they are committed, the more likely top management is to demand a high
probability of success. Managers with no ownership position in a company are unlikely to have
254 PART 3 Strategy Formulation
much interest in putting their jobs in danger with risky decisions. Research indicates that man-
agers who own a significant amount of stock in their firms are more likely to engage in risk-
taking actions than are managers with no stock.78
A high level of risk was why Intel’s board of directors found it difficult to vote for a pro-
posal in the early 1990s to commit $5 billion to making the Pentium microprocessor chip—
five times the amount of money needed for its previous chip. In looking back on that board
meeting, then-CEO Andy Grove remarked, “I remember people’s eyes looking at that chart
and getting big. I wasn’t even sure I believed those numbers at the time.” The proposal com-
mitted the company to building new factories—something Intel had been reluctant to do. A
wrong decision would mean that the company would end up with a killing amount of overca-
pacity. Based on Grove’s presentation, the board decided to take the gamble. Intel’s resulting
manufacturing expansion eventually cost $10 billion but resulted in Intel’s obtaining 75% of
the microprocessor business and huge cash profits.79
Risk might be one reason that significant innovations occur more often in small firms than
in large, established corporations. A small firm managed by an entrepreneur is often willing to
accept greater risk than is a large firm of diversified ownership run by professional managers.80
It is one thing to take a chance if you are the primary shareholder and are not concerned with
periodic changes in the value of the company’s common stock. It is something else if the cor-
poration’s stock is widely held and acquisition-hungry competitors or takeover artists surround
the company like sharks every time the company’s stock price falls below some external as-
sessment of the firm’s value.
Anew approach to evaluating alternatives under conditions of high environmental uncertainty
is to use real-options theory. According to the real-options approach, when the future is highly
uncertain, it pays to have a broad range of options open. This is in contrast to using net present value
(NPV) to calculate the value of a project by predicting its payouts, adjusting them for risk, and
subtracting the amount invested. By boiling everything down to one scenario, NPV doesn’t provide
any flexibility in case circumstances change. NPV is also difficult to apply to projects in which the
potential payoffs are currently unknown. The real-options approach, however, deals with these
issues by breaking the investment into stages. Management allocates a small amount of funding to
initiate multiple projects, monitors their development, and then cancels the projects that aren’t suc-
cessful and funds those that are doing well.81 This approach is very similar to the way venture cap-
italists fund an entrepreneurial venture in stages of funding based on the venture’s performance.
A survey of 4,000 CFOs found that 27% of them always or almost always used some sort
of options approach to evaluating and deciding upon growth opportunities.82 Research indi-
cates that the use of the real-options approach does improve organizational performance.83
Some of the corporations using the real-options approach are Chevron for bidding on petro-
leum reserves, Airbus for calculating the costs of airlines changing their orders at the last
minute, and the Tennessee Valley Authority for outsourcing electricity generation instead of
building its own plant. Because of its complexity, the real-options approach is not worthwhile
for minor decisions or for projects requiring a full commitment at the beginning.84
Pressures from Stakeholders
The attractiveness of a strategic alternative is affected by its perceived compatibility with the
key stakeholders in a corporation’s task environment. Creditors want to be paid on time.
Unions exert pressure for comparable wage and employment security. Governments and inter-
est groups demand social responsibility. Shareholders want dividends. All these pressures
must be given some consideration in the selection of the best alternative.
Stakeholders can be categorized in terms of their (1) interest in the corporation’s activities and
(2) relative power to influence the corporation’s activities. As shown in Figure 8–2, each stake-
holder group can be shown graphically based on its level of interest (from low to high) in a corpo-
ration’s activities and on its relative power (from low to high) to influence a corporation’s activities.
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 255
High
Local
Communities
Creditors
Shareholders
St
ak
eh
ol
de
r
In
te
re
st
in
C
or
po
ra
te
A
ct
iv
it
ie
s
Customers
Greenpeace
Federal
Government
Low
Low High
Relative Power of Stakeholder
FIGURE 8–2
Stakeholder
Priority Matrix
Strategic managers should ask four questions to assess the importance of stakeholder con-
cerns in a particular decision:
1. How will this decision affect each stakeholder, especially those given high and medium
priority?
2. How much of what each stakeholder wants is he or she likely to get under this alternative?
3. What are the stakeholders likely to do if they don’t get what they want?
4. What is the probability that they will do it?
Strategy makers should choose strategic alternatives that minimize external pressures and
maximize the probability of gaining stakeholder support. Managers may, however, ignore or
take some stakeholders for granted—leading to serious problems later. The Tata Group, for ex-
ample, failed to consider the unwillingness of farmers in Singur, India, to accept the West Ben-
gal government’s compensation for expropriating their land so that Tata could build its Nano
auto plant. Farmers formed rallies against the plant, blocked roads, and even assaulted an em-
ployee of a Tata supplier.86
Top management can also propose a political strategy to influence its key stakeholders. A
political strategy is a plan to bring stakeholders into agreement with a corporation’s actions.
Some of the most commonly used political strategies are constituency building, political ac-
tion committee contributions, advocacy advertising, lobbying, and coalition building. Re-
search reveals that large firms, those operating in concentrated industries, and firms that are
highly dependent upon government regulation are more politically active.87 Political support
can be critical in entering a new international market, especially in transition economies where
free market competition did not previously exist.88
Pressures from the Corporate Culture
If a strategy is incompatible with a company’s corporate culture, the likelihood of its success
is very low. Foot-dragging and even sabotage will result as employees fight to resist a radical
SOURCE: Based on C. Anderson, “Values-Based Management,” Academy of Management Executive (November
1997), pp. 25–46.
256 PART 3 Strategy Formulation
change in corporate philosophy. Precedents from the past tend to restrict the kinds of objectives
and strategies that are seriously considered.89 The “aura” of the founders of a corporation can
linger long past their lifetimes because their values are imprinted on a corporation’s members.
In evaluating a strategic alternative, strategy makers must consider pressures from the cor-
porate culture and assess a strategy’s compatibility with that culture. If there is little fit, man-
agement must decide if it should:
� Take a chance on ignoring the culture
� Manage around the culture and change the implementation plan
� Try to change the culture to fit the strategy
� Change the strategy to fit the culture
Further, a decision to proceed with a particular strategy without a commitment to change
the culture or manage around the culture (both very tricky and time consuming) is dangerous.
Nevertheless, restricting a corporation to only those strategies that are completely compatible
with its culture might eliminate from consideration the most profitable alternatives. (See
Chapter 10 for more information on managing corporate culture.)
Needs and Desires of Key Managers
Even the most attractive alternative might not be selected if it is contrary to the needs and desires
of important top managers. Personal characteristics and experience affect a person’s assessment
of an alternative’s attractiveness.90 For example, one study found that narcissistic (self-absorbed
and arrogant) CEOs favor bold actions that attract attention, like many large acquisitions—re-
sulting in either big wins or big losses.91 A person’s ego may be tied to a particular proposal to
the extent that all other alternatives are strongly lobbied against.As a result, the person may have
unfavorable forecasts altered so that they are more in agreement with the desired alternative.92
In a study by McKinsey & Company of 2,507 executives from around the world, 36% responded
that managers hide, restrict, or misrepresent information at least “somewhat” frequently when
submitting capital-investment proposals. In addition, an executive might influence other people
in top management to favor a particular alternative so that objections to it are overruled. In the
same McKinsey study of global executives, more than 60% of the managers reported that busi-
ness unit and divisional heads form alliances with peers or lobby someone more senior in the or-
ganization at least “somewhat” frequently when resource allocation decisions are being made.93
Industry and cultural backgrounds affect strategic choice. For example, executives with
strong ties within an industry tend to choose strategies commonly used in that industry. Other
executives who have come to the firm from another industry and have strong ties outside the
industry tend to choose different strategies from what is being currently used in their
industry.94 Country of origin often affects preferences. For example, Japanese managers pre-
fer a cost-leadership strategy more than do United States managers.95 Research reveals that ex-
ecutives from Korea, the U.S., Japan, and Germany tend to make different strategic choices in
similar situations because they use different decision criteria and weights. For example, Ko-
rean executives emphasize industry attractiveness, sales, and market share in their decisions;
whereas, U.S. executives emphasize projected demand, discounted cash flow, and ROI.96
There is a tendency to maintain the status quo, which means that decision makers con-
tinue with existing goals and plans beyond the point when an objective observer would rec-
ommend a change in course.97 Some executives show a self-serving tendency to attribute the
firm’s problems not to their own poor decisions but to environmental events out of their con-
trol, such as government policies or a poor economic climate.98 For example, a CEO is more
likely to divest a poorly performing unit when its poor performance does not incriminate that
same CEO who had acquired it.99 Negative information about a particular course of action
to which a person is committed may be ignored because of a desire to appear competent or
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 257
PROCESS OF STRATEGIC CHOICE
There is an old story told at General Motors:
At a meeting with his key executives, CEO Alfred Sloan proposed a controversial strategic deci-
sion. When asked for comments, each executive responded with supportive comments and praise.
After announcing that they were all in apparent agreement, Sloan stated that they were not going
to proceed with the decision. Either his executives didn’t know enough to point out potential down-
sides of the decision, or they were agreeing to avoid upsetting the boss and disrupting the cohe-
sion of the group. The decision was delayed until a debate could occur over the pros and cons.101
Strategic choice is the evaluation of alternative strategies and selection of the best alterna-
tive.According to Paul Nutt, an authority in decision making, half of the decisions made by man-
agers are failures.102 After analyzing 400 decisions, Nutt found that failure almost always stems
from the actions of the decision maker, not from bad luck or situational limitations. In these in-
stances, managers commit one or more key blunders: (1) their desire for speedy actions leads to
a rush to judgment, (2) they apply failure-prone decision-making practices such as adopting the
claim of an influential stakeholder, and (3) they make poor use of resources by investigating
only one or two options. These three blunders cause executives to limit their search for feasible
alternatives and look for quick consensus. Only 4% of the 400 managers set an objective and
considered several alternatives. The search for innovative options was attempted in only 24%
of the decisions studied.103 Another study of 68 divestiture decisions found a strong tendency
for managers to rely heavily on past experience when developing strategic alternatives.104
There is mounting evidence that when an organization is facing a dynamic environment,
the best strategic decisions are not arrived at through consensus when everyone agrees on one
alternative. They actually involve a certain amount of heated disagreement, and even
conflict.105 Many diverse opinions are presented, participants trust in one another’s abilities and
competences, and conflict is task-oriented, not personal.106 This is certainly the case for firms
operating in global industries. Because unmanaged conflict often carries a high emotional cost,
authorities in decision making propose that strategic managers use “programmed conflict” to
raise different opinions, regardless of the personal feelings of the people involved.107 Two tech-
niques help strategic managers avoid the consensus trap that Alfred Sloan found:
1. Devil’s advocate: The idea of the devil’s advocate originated in the medieval Roman
Catholic Church as a way of ensuring that impostors were not canonized as saints. One
trusted person was selected to find and present all the reasons why a person should not be
canonized. When this process is applied to strategic decision making, a devil’s advocate
(who may be an individual or a group) is assigned to identify potential pitfalls and prob-
lems with a proposed alternative strategy in a formal presentation.
2. Dialectical inquiry: The dialectical philosophy, which can be traced back to Plato and
Aristotle and more recently to Hegel, involves combining two conflicting views—the
thesis and the antithesis—into a synthesis. When applied to strategic decision making,
dialectical inquiry requires that two proposals using different assumptions be generated
for each alternative strategy under consideration. After advocates of each position present
and debate the merits of their arguments before key decision makers, either one of the al-
ternatives or a new compromise alternative is selected as the strategy to be implemented.
because of strongly held values regarding consistency. It may take a crisis or an unlikely event
to cause strategic decision makers to seriously consider an alternative they had previously ig-
nored or discounted.100 For example, it wasn’t until the CEO of ConAgra, a multinational food
products company, had a heart attack that ConAgra started producing the Healthy Choice line
of low-fat, low-cholesterol, low-sodium frozen-food entrees.
258 PART 3 Strategy Formulation
Research generally supports the conclusion that the devil’s advocate and dialectical in-
quiry methods are equally superior to consensus in decision making, especially when the
firm’s environment is dynamic. The debate itself, rather than its particular format, appears to
improve the quality of decisions by formalizing and legitimizing constructive conflict and by
encouraging critical evaluation. Both lead to better assumptions and recommendations and to
a higher level of critical thinking among the people involved.108
Regardless of the process used to generate strategic alternatives, each resulting alternative
must be rigorously evaluated in terms of its ability to meet four criteria:
1. Mutual Exclusivity: Doing any one alternative would preclude doing any other.
2. Success: It must be feasible and have a good probability of success.
3. Completeness: It must take into account all the key strategic issues.
4. Internal Consistency: It must make sense on its own as a strategic decision for the entire
firm and not contradict key goals, policies, and strategies currently being pursued by the
firm or its units.109
8.5 Developing Policies
The selection of the best strategic alternative is not the end of strategy formulation. The orga-
nization must then engage in developing policies. Policies define the broad guidelines for im-
plementation. Flowing from the selected strategy, policies provide guidance for decision
making and actions throughout the organization. They are the principles under which the cor-
poration operates on a day-to-day basis. At General Electric, for example, Chairman Jack
Welch initiated the policy that any GE business unit must be Number One or Number Two in
whatever market it competes. This policy gave clear guidance to managers throughout the or-
ganization. Another example of such a policy is Casey’s General Stores’ policy that a new ser-
vice or product line may be added to its stores only when the product or service can be justified
in terms of increasing store traffic.
When crafted correctly, an effective policy accomplishes three things:
� It forces trade-offs between competing resource demands.
� It tests the strategic soundness of a particular action.
� It sets clear boundaries within which employees must operate while granting them free-
dom to experiment within those constraints.110
Policies tend to be rather long lived and can even outlast the particular strategy that cre-
ated them. These general policies—such as “The customer is always right” (Nordstrom) or
“Low prices, every day” (Wal-Mart)—can become, in time, part of a corporation’s culture.
Such policies can make the implementation of specific strategies easier. They can also restrict
top management’s strategic options in the future. Thus a change in strategy should be fol-
lowed quickly by a change in policies. Managing policy is one way to manage the corporate
culture.
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 259
This chapter completes the part of this book on strategy formulation and sets the stage for strat-
egy implementation. Functional strategies must be formulated to support business and corpo-
rate strategies; otherwise, the company will move in multiple directions and eventually pull
itself apart. For a functional strategy to have the best chance of success, it should be built on
a distinctive competency residing within that functional area. If a corporation does not have a
distinctive competency in a particular functional area, that functional area could be a candi-
date for outsourcing.
When evaluating a strategic alternative, the most important criterion is the ability of the
proposed strategy to deal with the specific strategic factors developed earlier, in the SWOT
analysis. If the alternative doesn’t take advantage of environmental opportunities and corpo-
rate strengths/competencies, and lead away from environmental threats and corporate weak-
nesses, it will probably fail. Developing corporate scenarios and pro forma projections for each
alternative are rational aids for strategic decision making. This logical approach fits
Mintzberg’s planning mode of strategic decision making, as discussed earlier in Chapter 1.
Nevertheless, some strategic decisions are inherently risky and may be resolved on the basis
of one person’s “gut feel.” This is an aspect of the entrepreneurial mode and may be used in
large established corporations as well as in new venture startups. Various management studies
have found that executives routinely rely on their intuition to solve complex problems. The ef-
fective use of intuition has been found to differentiate successful top executives and board
members from lower-level managers and dysfunctional boards.111 According to Ralph Larsen,
Chair and CEO of Johnson & Johnson, “Often there is absolutely no way that you could have
the time to thoroughly analyze every one of the options or alternatives available to you. So you
have to rely on your business judgment.”112 For managerial intuition to be effective, however,
it requires years of experience in problem solving and is founded upon a complete understand-
ing of the details of the business.113
For example, when Bob Lutz, President of Chrysler Corporation, was enjoying a fast drive
in his Cobra roadster one weekend in 1988, he wondered why Chrysler’s cars were so dull. “I
felt guilty: there I was, the president of Chrysler, driving this great car that had such a strong
Ford association,” said Lutz, referring to the original Cobra’s Ford V-8 engine. That Monday,
Lutz enlisted allies at Chrysler to develop a muscular, outrageous sports car that would turn
heads and stop traffic. Others in management argued that the $80 million investment would be
better spent elsewhere. The sales force warned that no U.S. auto maker had ever succeeded in
selling a $50,000 car. With only his gut instincts to support him, he pushed the project forward
with unwavering commitment. The result was the Dodge Viper—a car that single-handedly
changed the public’s perception of Chrysler. Years later, Lutz had trouble describing exactly
how he had made this critical decision. “It was this subconscious, visceral feeling. And it just
felt right,” explained Lutz.114
End of Chapter SUMMARY
260 PART 3 Strategy Formulation
D I S C U S S I O N Q U E S T I O N S
1. Are functional strategies interdependent, or can they be
formulated independently of other functions?
2. Why is penetration pricing more likely than skim pricing
to raise a company’s or a business unit’s operating profit
in the long run?
3. How does mass customization support a business unit’s
competitive strategy?
4. When should a corporation or business unit outsource a
function or an activity?
5. What is the relationship of policies to strategies?
S T R A T E G I C P R A C T I C E E X E R C I S E
Pierre Omidyar founded a sole proprietorship in September
1995 called Auction Web to allow people to buy and sell goods
over the Internet. The new venture was based on the idea of de-
veloping a community-driven process, where an organic,
evolving, self-organizing web of individual relationships,
formed around shared interests, would handle tasks that other
companies handle with customer service operations. By May
1996, Omidyar had added Jeff Skoll as a partner and the ven-
ture was incorporated as eBay. Two years later, Omidyar asked
Meg Whitman to direct corporate strategy to continue the ac-
celerated growth rate of the company. Whitman brought to the
company global management and marketing experience and
soon became President and CEO. In almost no time, the com-
pany became one of the Web’s most successful sites, with
233 million registered users. By 2007, the average eBay user
spent nearly two hours a month on the site—more than five
times the time spent on Amazon.com.117
Whitman expanded the company’s operations and spent
more than $6 billion to acquire companies, such as Internet-
phone operation Skype, online payments service PayPal,
ticket reseller StubHub, property rental and roommate search
firm Rent.com, comparison shopping site Shopping.com,
Web site recommender Stumbleupon, and 25% interest in
Craigslist. Expansion and diversification provided revenue
and profit growth plus stock price appreciation. Although fi-
nancial analysts wondered how all these businesses would fit
together, Whitman argued that she wanted eBay to be every-
where users wanted to be. At developer conferences, com-
pany representatives unveiled new services that let buyers
shop for and purchase eBay items outside of the core
eBay.com site.
By 2008, eBay was in trouble. Its stock price had lost half
its value over the past three years. The core auction and retail
businesses, which accounted for the majority of revenue, were
showing signs of weakness. The number of active users had
been flat for three quarters, at 83 million. The number of new
products listed on the site had increased only 4% from the pre-
vious year. The number of stores selling goods at fixed prices
on eBay declined from a year earlier to 532,000. The company
had not done a good job of integrating Skype with its main
business. Since its acquisition, Skype’s service had actually
deteriorated.118 Competition had increased as rival Web sites,
particularly Amazon, now provided similar Web services and
eroded eBay’s competitive advantage.
On January 23, 2008, CEO Whitman announced that
John Donahoe would take over as the company’s CEO. Dona-
hoe stated that his first priority would be to revitalize eBay’s
core business, even at the expense of investors. “We need to
aggressively change our product, our customer approach, and
our business model,” announced the new CEO.119
1. What is eBay’s problem?
2. Which marketing strategy was eBay following: market de-
velopment or product development? Do you agree with it?
3. What decision-making process should CEO Donahoe uti-
lize to make the decisions necessary to change the com-
pany’s product, customer approach, and business model?
E C O – B I T S
� In the two-day period after joining the U.S. Environ-
mental Protection Agency’s voluntary Climate Leader’s
initiative, which requires members to reduce or offset
emissions over the next 5 to 10 years, the average com-
pany’s stock price dropped 0.9% more than it would
have from normal market factors.115
� General Motors states that its facilities recycle 89% of
the waste they generate and that GM is one of the
world’s largest industrial users of solar power.116
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 261
K E Y T E R M S
consensus (p. 257)
corporate scenarios (p. 251)
devil’s advocate (p. 257)
dialectical inquiry (p. 257)
financial strategy (p. 239)
functional strategy (p. 238)
HRM strategy (p. 246)
information technology strategy (p. 247)
leveraged buyout (p. 240)
logistics strategy (p. 246)
market development (p. 238)
marketing strategy (p. 238)
offshoring (p. 248)
operations strategy (p. 242)
outsourcing (p. 247)
political strategy (p. 255)
product development (p. 238)
purchasing strategy (p. 244)
R&D strategy (p. 241)
real-options (p. 254)
risk (p. 253)
Stakeholder Priority Matrix (p. 255)
strategic choice (p. 257)
technological follower (p. 241)
technological leader (p. 241)
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262 PART 3 Strategy Formulation
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264 PART 3 Strategy Formulation
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CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 265
266 PART 3 Strategy Formulation
KMART AND SEARS:
STILL STUCK IN THE MIDDLE?
On January 22, 2002, Kmart Corporation became the
largest retailer in U.S. history to seek bankruptcy protec-
tion. In Kmart’s petition for reorganization under
Chapter 11 of the U.S. Bankruptcy Code, Kmart man-
agement announced that they would outline a plan for
repaying Kmart’s creditors, reducing its size, and re-
structuring its business so that it could leave court pro-
tection as a viable competitor in discount mass-market
retailing. Emerging from bankruptcy in May 2003,
Kmart still lacked a business strategy to succeed in an
extremely competitive marketplace.
The U.S. discount department store industry had
reached maturity by 2004 and Kmart no longer pos-
sessed a clearly-defined position within that industry. Its
primary competitors were Wal-Mart, Sears, Target,
Kohl’s, and J.C. Penney, with secondary competitors in
certain categories. Wal-Mart, an extremely efficient re-
tailer, was known for consistently having the lowest
costs (reflected in low prices) and the highest sales in the
industry. Having started in rural America, Wal-Mart was
now actively growing internationally. Sears, with the
second-highest annual sales, had a strong position in
hard goods, such as home appliances and tools. Around
40% of all major home appliance sales continued to be
controlled by Sears. Nevertheless, Sears was struggling
with slumping sales as customers turned from Sears
mall stores to stand-alone, big-box retailers, such as
Lowe’s and Home Depot, to buy their hard goods. Tar-
get, third in sales but second in profits, behind Wal-
Mart, had distinguished itself as a merchandiser of
stylish upscale products. Along with Wal-Mart, Target
had flourished to such an extent that Dayton-Hudson, its
parent company, had changed its corporate name to Tar-
get. Kohl’s, a relatively new entrant to the industry, op-
erated 420 family-oriented stores in 32 states. J.C.
Penney operated more than 1,000 stores in all 50 states.
Both Kohl’s and J.C. Penney emphasized soft goods,
such as clothing and related items.
Ending Case for Part Three
Kmart was also challenged by “category killers”
that competed in only one or a few industry categories,
but in greater depth within any category than could any
department store. Some of these were Toys “R” Us,
Home Depot, Lowe’s, and drug stores such as Rite Aid,
CVS, Eckerd, and Walgreens.
Kmart had been established in 1962 by its parent
company S.S. Kresge as a discount department store of-
fering the most variety of goods at the lowest prices. Un-
like Sears, the company chose not to locate in large
shopping malls but to establish its discount stores in
highly visible corner locations. During the 1960s, ’70s,
and ’80s, Kmart prospered. By 1990, however, when
Wal-Mart first surpassed Kmart in annual sales, Kmart’s
stores had become dated and lost their appeal. Other
well-known discount stores, such as Korvette’s, Grant’s,
Woolco, Ames, Bradlees, and Montgomery Ward, had
gone out of business as the industry had consolidated and
reached maturity. Attempting to avoid this fate, Kmart
management updated and enlarged the stores, added
name brands, and hired Martha Stewart as its lifestyle
consultant. None of these changes improved Kmart’s fi-
nancial situation. By the time it declared bankruptcy, it
had lost money in five of the past 10 years.
Out of bankruptcy, Kmart became profitable—pri-
marily by closing or selling (to Sears and Home Depot)
around 600 of its retail stores. Management had been un-
able to invigorate sales in its stores. Declared guilty of in-
sider trading, Martha Stewart went to prison just before
the 2004 Christmas season. In a surprise move, Edward
Lampert, Kmart’s Chairman of the Board and a control-
ling shareholder of Kmart, initiated the acquisition of
Sears by Kmart for $11 billion in November 2004. The
new company was to be called Sears Holdings Corpora-
tion. Even though management predicted that the com-
bined company’s costs could be reduced by $500 million
annually within three years through supplier and admin-
istrative economies, analysts wondered how these two
struggling firms could ever be successful.
By the end of 2007, the stock of Sears Holdings had
fallen to 111 from its peak of 195 earlier in the year. Like
many retailers, both Sears and Kmart struggled to attract
shoppers in an overcrowded industry and a slumping
economy. Sears Holdings did, however, have $1.5 bil-
lion in cash, a significant advantage during lean times,
and more than its rivals J.C. Penney, Kohl’s, and Macy’s
combined. The company’s debt load was only 25% of
This case was written by J. David Hunger for Strategic Management and
Business Policy, 12th edition and for Concepts in Strategic Management
and Business Policy, 12th edition. Copyright © 2008 by J. David
Hunger. Reprinted by permission. References available upon request.
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice 267
the total capital on its balance sheet, compared to 46%
for Penney’s and 53% for Macy’s. It also had significant
real estate assets on its balance sheet. For example,
Sears owned outright 518 of its 816 locations and many
of the Kmart stores were located in strip malls close to
large cities. Since fewer shopping malls were now being
built, it was becoming harder to find space for “big-box”
retailers in metropolitan areas.
The most recent quarterly results for 2007 of Sears
Holdings reported the third straight quarter of deteriorating
profit margins and same-store sales. After months of
cutting the number of employees and reducing other
expenses, industry analysts felt that there was little left to
cut. They were also concerned that management had failed
to invest in store improvements. Sears Holdings had just
launched a bid in November 2007 to purchase Restoration
Hardware, a home-goods retailer. Even though Restora-
tion Hardware was also facing sluggish sales, it was
thought that Sears’ management could use the acquisition
to create an upscale boutique within its stores.
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PA R T4
Strategy
Implementation
and
Control
For nearly five decades, Wal-Mart’s “everyday low prices” and low cost position
had enabled it to rapidly grow to dominate North America’s retailing landscape. By
2006, however, its U.S. division generated only 1.9% growth in its same-store sales.
By 2007, Target, Costco, Kroger, Safeway, Walgreens, CVS, and Best Buy were all
growing faster than Wal-Mart. At about the same time, Microsoft, whose software
had grown to dominate personal computers worldwide, saw its revenue growth slow to
just 8% in 2005. The company’s stock price had been flat since 2002, an indication that investors
no longer perceived Microsoft as a growth company. What had happened to these two success-
ful companies? Was this an isolated phenomenon? What could be done, if anything, to reinvig-
orate these giants?1
A research study by Matthew Olson, Derek van Bever, and Seth Verry attempts to provide
an answer. After analyzing the experiences of 500 successful companies over a 50-year period,
they found that 87% of the firms had suffered one or more serious declines in sales and prof-
its. This included a diverse set of corporations, such as Levi Strauss, 3M, Apple, Bank One, Cater-
pillar, Daimler-Benz, Toys“R”Us, and Volvo. After years of prolonged growth in sales and
profits, revenue growth at each of these firms suddenly stopped and even turned negative!
Olson, van Bever, and Verry called these long-term reversals in company growth stall points. On
average, corporations lost 74% of their market capitalization in the decade surrounding a
growth stall. Even though the CEO and other members of top management were typically re-
placed, only 46% of the firms were able to return to moderate or high growth within the
decade. When slow growth was allowed to persist for more than 10 years, the delay was usu-
ally fatal. Only 7% of this group was able to return to moderate or high growth.2
At Levi Strauss & Company, for example, sales topped $7 billion in 1996—extending growth
that had more than doubled over the previous decade. From that high-water mark, sales plum-
meted until they reached $4.6 in 2000—a 35% decline. Market share in its U.S. jeans market
dropped from 31% in 1990 to 14% by 2000. Its market value fell from $14 billion to $8 billion
during these four years. After replacing management, the company underwent a companywide
transformation, but by 2008 it had yet to return to growth.
strategy
implementation:
organizing for Action
C H A P T E R 9
271
� Develop programs, budgets, and
procedures to implement strategic change
� Understand the importance of achieving
synergy during strategy implementation
� List the stages of corporate development
and the structure that characterizes each
stage
� Identify the blocks to changing from one
stage to another
� Construct matrix and network structures
to support flexible and nimble
organizational strategies
� Decide when and if programs such as
reengineering, Six Sigma, and job redesign
are appropriate methods of strategy
implementation
� Understand the centralization versus
decentralization issue in multinational
corporations
Learning Objectives
After reading this chapter, you should be able to:
Gathering
Information
Putting Strategy
into Action
Monitoring
Performance
Societal
Environment:
General forces
Natural
Environment:
Resources and
climate
Task
Environment:
Industry analysis
Internal:
Strengths and
Weaknesses
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
Programs
Activities
needed to
accomplish
a plan
Budgets
Cost of the
programs Procedures
Sequence
of steps
needed to
do the job
Performance
Actual results
External:
Opportunities
and Threats
Developing
Long-range Plans
Mission
Reason for
existence Objectives
What
results to
accomplish
by when
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Environmental
Scanning:
Strategy
Formulation:
Strategy
Implementation:
Evaluation
and Control:
Feedback/Learning: Make corrections as needed
272 PART 4 Strategy Implementation and Control
According to Olson, van Bever, and Verry, these stall points occurred primarily be-
cause of a poor choice in strategy or organizational design. The root causes fell into four
categories:
1. Premium position backfires: This happens to a firm that has developed a premium po-
sition in the market, but is unable to respond effectively to new, low-cost competitors
or a shift in customer valuation of product features. Management teams go through
a process of disdain, denial, and rationalization that precedes the fall.
2. Innovation management breaks down: Management processes for updating existing
products and creating new ones falter and become systemic inefficiencies.
3. Core business abandoned: Management fails to exploit growth opportunities in ex-
isting core businesses and instead engages in growth initiatives in areas remote from
existing customers, products, and distribution channels.
4. Talent and capabilities run short: Strategies are not executed properly because of a
lack of managers and staff with the skills and capabilities needed for strategy imple-
mentation. Often supported by promote-from-within policies, top management has a
narrow experience base, which too often replicates the skill set of past top managers.3
9.1 Strategy Implementation
Strategy implementation is the sum total of the activities and choices required for the execu-
tion of a strategic plan. It is the process by which objectives, strategies, and policies are put
into action through the development of programs, budgets, and procedures. Although imple-
mentation is usually considered after strategy has been formulated, implementation is a key
part of strategic management. Strategy formulation and strategy implementation should thus
be considered as two sides of the same coin.
Poor implementation has been blamed for a number of strategic failures. For example,
studies show that half of all acquisitions fail to achieve what was expected of them, and one
out of four international ventures does not succeed.4 The most-mentioned problems reported
in post-merger integration were poor communication, unrealistic synergy expectations, struc-
tural problems, missing master plan, lost momentum, lack of top management commitment,
and unclear strategic fit. A study by A. T. Kearney found that a company has just two years in
which to make an acquisition perform. After the second year, the window of opportunity for
forging synergies has mostly closed. Kearney’s study was supported by further independent
research by Bert, MacDonald, and Herd. Among the most successful acquirers studied, 70%
to 85% of all merger synergies were realized within the first 12 months, with the remainder
being realized in year two.5
To begin the implementation process, strategy makers must consider these questions:
� Who are the people who will carry out the strategic plan?
� What must be done to align the company’s operations in the new intended direction?
� How is everyone going to work together to do what is needed?
CHAPTER 9 Strategy Implementation: Organizing for Action 273
These questions and similar ones should have been addressed initially when the pros and
cons of strategic alternatives were analyzed. They must also be addressed again before appro-
priate implementation plans can be made. Unless top management can answer these basic ques-
tions satisfactorily, even the best planned strategy is unlikely to provide the desired outcome.
A survey of 93 Fortune 500 firms revealed that more than half of the corporations expe-
rienced the following 10 problems when they attempted to implement a strategic change.
These problems are listed in order of frequency:
1. Implementation took more time than originally planned.
2. Unanticipated major problems arose.
3. Activities were ineffectively coordinated.
4. Competing activities and crises took attention away from implementation.
5. The involved employees had insufficient capabilities to perform their jobs.
6. Lower-level employees were inadequately trained.
7. Uncontrollable external environmental factors created problems.
8. Departmental managers provided inadequate leadership and direction.
9. Key implementation tasks and activities were poorly defined.
10. The information system inadequately monitored activities.6
9.2 Who Implements Strategy?
Depending on how a corporation is organized, those who implement strategy will probably be
a much more diverse set of people than those who formulate it. In most large, multi-industry
corporations, the implementers are everyone in the organization. Vice presidents of functional
areas and directors of divisions or strategic business units (SBUs) work with their subordinates
to put together large-scale implementation plans. Plant managers, project managers, and unit
heads put together plans for their specific plants, departments, and units. Therefore, every op-
erational manager down to the first-line supervisor and every employee is involved in some
way in the implementation of corporate, business, and functional strategies.
Many of the people in the organization who are crucial to successful strategy implemen-
tation probably had little to do with the development of the corporate and even business strat-
egy. Therefore, they might be entirely ignorant of the vast amount of data and work that went
into the formulation process. Unless changes in mission, objectives, strategies, and policies
and their importance to the company are communicated clearly to all operational managers,
there can be a lot of resistance and foot-dragging. Managers might hope to influence top man-
agement into abandoning its new plans and returning to its old ways. This is one reason why
involving people from all organizational levels in the formulation and implementation of strat-
egy tends to result in better organizational performance.7
9.3 What Must Be Done?
The managers of divisions and functional areas work with their fellow managers to develop
programs, budgets, and procedures for the implementation of strategy. They also work to
achieve synergy among the divisions and functional areas in order to establish and maintain a
company’s distinctive competence.
274 PART 4 Strategy Implementation and Control
DEVELOPING PROGRAMS, BUDGETS, AND PROCEDURES
Strategy implementation involves establishing programs to create a series of new organiza-
tional activities, budgets to allocate funds to the new activities, and procedures to handle the
day-to-day details.
Programs
The purpose of a program is to make a strategy action oriented. For example, when Xerox
Corporation undertook a turnaround strategy, it needed to significantly reduce its costs and ex-
penses. Management introduced a program called Lean Six Sigma. This program was devel-
oped to identify and improve a poorly performing process. Xerox first trained its top
executives in the program and then launched around 250 individual Six Sigma projects
throughout the corporation. The result was $6 million in savings in one year, with even more
expected the next.8 (Six Sigma is explained later in this chapter.)
Most corporate headquarters have around 10 to 30 programs in effect at any one time.9
One of the programs initiated by Ford Motor Company was to find an organic substitute for
petroleum-based foam being used in vehicle seats. For more information on Ford’s innovative
soybean seat program, see the Environment Sustainability Issue feature.
One way to examine the likely impact new programs will have on an existing organiza-
tion is to compare proposed programs and activities with current programs and activities.
Brynjolfsson, Renshaw, and Van Alstyne proposed a matrix of change to help managers de-
cide how quickly change should proceed, in what order changes should take place, whether to
start at a new site, and whether the proposed systems are stable and coherent. As shown in
Figure 9–1, target practices (new programs) for a manufacturing plant are drawn on the
SOURCE: “Manufacturers Turn to Soy for Cushy Seats,” St. Cloud
(MN) Times (January 26, 2008), p. 3A, and Ford Motor Company
Web site (www.Ford.com).
Mustang and other Ford vehicles delivered to auto show-
rooms beginning August 2007.
Sears Manufacturing Company, a seat supplier to Deere
and other companies, licensed the Ford technology to
work with Deere in developing soy-based foam for seats
on Deere’s farm and construction equipment. Deere was
already using soy-based materials for parts such as hoods,
side panels, and doors on some models of tractors, com-
bines, cotton pickers, and backhoes. According to John
Koutsky, Vice President of Product Development, Sears
started commercial production of the new seats in 2009
and planned to use soy foam throughout its product line
being sold to heavy truck manufacturers like Freightliner
and International. “It’s good to be green,” commented
Koutsky.
The Model T Ford once con-
tained 60 pounds of soy-
beans in its paint and molded
plastic parts. Since that time,
petroleum has become the primary
ingredient in most plastic parts, including
the foam currently used in car and truck seats. Neverthe-
less, today’s manufacturers are looking for ways to replace
petroleum-based products with ones made from agricul-
tural crops, as the political, environmental, and economic
costs of oil increase. According to Larry Johnson, Director of
the Center for Crops Utilization Research at Iowa State Uni-
versity, soy is usually cheaper and more environmentally
friendly than petroleum and comes from a renewable agri-
cultural source. With this in mind, Ford’s management initi-
ated a program in 2001 with seat supplier Lear Corporation
to research soy-based foam as a possible substitute for
petroleum-based foam. The program was a huge success.
A complete seating system, including suspension systems,
contains about 20% soy oil. The new seats were used in the
FORD’S SOYBEAN SEAT FOAM PROGRAM
ENVIRONMENTAL sustainability issue
www.Ford.com
CHAPTER 9 Strategy Implementation: Organizing for Action 275
vertical axis and existing practices (current activities) are drawn on the horizontal axis. As
shown, any new strategy will likely involve a sequence of new programs and activities. Any
one of these may conflict with existing practices/activities—and that creates implementation
problems. Use the following steps to create the matrix:
1. Compare the new programs/target practices with each other to see if they are complemen-
tary (�), interfering (�), or have no effect on each other (leave blank).
2. Examine existing practices/activities for their interactions with each other using the same
symbols as in step 1.
3. Compare each new program/target practice with each existing practice/activity for any in-
teraction effects. Place the appropriate symbols in the cells in the lower-right part of the
matrix.
4. Evaluate each program/activity in terms of its relative importance to achieving the strat-
egy or getting the job accomplished.
5. Examine the overall matrix to identify problem areas where proposed programs are likely
to either interfere with each other or with existing practices/activities. Note in Figure 9–1
that the proposed program of installing flexible equipment interferes with the proposed
Existing Practices
Ta
rg
et
P
ra
ct
ic
es
Efficient Low-Cost
Operation
Meet Product
Requirements
Vertical Structure
Designated Equipment
Narrow Job Functions
Piece-Rate (Output) Pay
Several Management Layers (6)
Importance
Im
po
rt
an
ce
F
le
xi
bl
e
E
qu
ip
m
en
t
G
re
at
er
R
es
po
ns
ib
ili
ty
W
or
ke
rs
P
ai
d
F
la
t R
at
e
Lo
w
J
IT
In
ve
nt
or
y
F
ew
M
an
ag
em
en
t L
ay
er
s
(3
–4
)
Li
ne
R
at
io
na
liz
at
io
n
Large WIP and FG Inventories
Matrix Interaction
+ Complementary Practices
Weak/No Interaction
– Interfering Practices
+
+
+
+
++
++
+
–
–2
+2 +2 +2 +1 +1
+
+
–
–
–
–
–
–
–
––
–
––1
+1
Importance to Job
+2 Very Important
+1 Somewhat Important
0 Irrelevant
–1 Somewhat Interfering
–2 Significantly Interfering
En
er
gi
ze
d
O
rg
an
iz
at
io
n
Ze
ro
N
on
-C
on
fo
rm
an
ce
El
im
in
at
io
n
of
N
on
–
Va
lu
e-
Ad
di
ng
C
os
ts
FIGURE 9–1
The Matrix
of Change
SOURCE: Reprinted from The Matrix of Change by E. Brynjolfsson, A.A. Renshaw, and M. Van Alstyne. Sloan
Management Review, Winter 1997, pp. 168-181. From MIT Sloan Management Review © 1997 by Massachusetts
Institute of Technology. All rights reserved. Distributed by Tribune Media Services.
276 PART 4 Strategy Implementation and Control
program of assembly line rationalization. The two new programs need to be changed so
that they no longer conflict with each other. Note also that the amount of change neces-
sary to carry out the proposed implementation programs (target practices) is a function of
the number of times each program interferes with existing practices/activities. That is, the
more minus signs and the fewer plus signs in the matrix, the more implementation prob-
lems can be expected.
The matrix of change can be used to address the following types of questions:
� Feasibility: Do the proposed programs and activities constitute a coherent, stable system?
Are the current activities coherent and stable? Is the transition likely to be difficult?
� Sequence of execution: Where should the change begin? How does the sequence affect
success? Are there reasonable stopping points?
� Location: Are we better off instituting the new programs at a new site, or can we reorga-
nize the existing facilities at a reasonable cost?
� Pace and nature of change: Should the change be slow or fast, incremental or radical?
Which blocks of current activities must be changed at the same time?
� Stakeholder evaluations: Have we overlooked any important activities or interactions?
Should we get further input from interested stakeholders? Which new programs and cur-
rent activities offer the greatest sources of value?
The matrix offers useful guidelines on where, when, and how fast to implement change.10
Budgets
After programs have been developed, the budget process begins. Planning a budget is the last
real check a corporation has on the feasibility of its selected strategy. An ideal strategy might
be found to be completely impractical only after specific implementation programs are costed
in detail. As an example, once Cadbury Schweppes’ management realized how dependent the
company was on cocoa from Ghana to continue the company’s growth strategy, it developed
a program to show cocoa farmers how to increase yields using fertilizers and by working with
each other. Ghana produced 70% of Cadbury’s worldwide supply of the high-quality cocoa
necessary to provide the distinctive taste of Dairy Milk, Crème Egg, and other treats. Manage-
ment introduced the “Cadbury Cocoa Partnership” on January 28, 2008, and budgeted $87 mil-
lion for this program over a 10-year period.11
Procedures
After the program, divisional, and corporate budgets are approved, procedures must be devel-
oped. Often called Standard Operating Procedures (SOPs), they typically detail the various
activities that must be carried out to complete a corporation’s programs. Also known as
organizational routines, procedures are the primary means by which organizations accomplish
much of what they do.12 Once in place, procedures must be updated to reflect any changes in
technology as well as in strategy. For example, a company following a differentiation compet-
itive strategy manages its sales force more closely than does a firm following a low-cost strat-
egy. Differentiation requires long-term customer relationships created out of close interaction
with the sales force. An in-depth understanding of the customer’s needs provides the founda-
tion for product development and improvement.13
In a retail store, procedures ensure that the day-to-day store operations will be consistent
over time (that is, next week’s work activities will be the same as this week’s) and consistent
among stores (that is, each store will operate in the same manner as the others). Properly
planned procedures can help eliminate poor service by making sure that employees do use not
CHAPTER 9 Strategy Implementation: Organizing for Action 277
excuses to justify poor behavior toward customers. Even though McDonald’s, the fast-food
restaurant, has developed very detailed procedures to ensure that customers have high quality
service, not every business is so well managed. See Strategy Highlight 9.1 for the top 10 ex-
cuses for bad service.
Before a new strategy can be successfully implemented, current procedures may need to
be changed. For example, in order to implement Home Depot’s strategic move into services,
such as kitchen and bathroom installation, the company had to first improve its productivity.
Store managers were drowning in paperwork designed for a smaller and simpler company.
“We’d get a fax, an e-mail, a call, and a memo, all on the same project,” reported store man-
ager Michael Jones. One executive used just three weeks of memos to wallpaper an entire con-
ference room, floor to ceiling, windows included. CEO Robert Nardelli told his top managers
and up to date, but we can’t afford to follow every
customer around to make sure we pick up
everything, nor can we refurbish our place all the
time.
#5. Customer complaint: I placed my order a while
ago, why is it taking so long? Excuse: Sorry, but
we are very busy right now. You came at our
“busy” time and you must be patient.
#4. Customer complaint: Your server did not seem to
know what he/she was doing and made a mess of
my experience. Excuse: Unfortunately, with all the
turnover we are having right now, we just didn’t
have the time to train everyone up to our standards.
#3. Customer complaint: Your employee was rude to
me and has a bad attitude. Excuse: We do
apologize for the unfortunate attitude of a few
employees.
#2. Customer complaint: The server didn’t seem to
be interested in doing what he/she was supposed
to do. Why can’t she/he do it the right way?
Excuse: We are sorry. While we trained them to do
it the right way, sometimes they just seem to
ignore what we taught them.
#1. Customer complaint: We expected something
different from your company and we are really
disappointed. Excuse: You must be misinformed,
as we have been successful for a long time and
obviously know exactly what our customers want
and need.
Corporations may have offi-
cial policies stating that the
“customer is always right” or
“customer is number one,” but
these quickly become meaningless
platitudes unless procedures are devel-
oped and communicated to all employees for them to fol-
low when confronted with a problem or a question from a
customer. Beware of the top ten excuses for bad service.
They can sabotage a company’s strategy and send valued
customers to the competition. How many times have you
heard the following excuses when you received poor ser-
vice? Or even worse, how many times have you personally
given one or all of these excuses?
#10. Customer complaint: Why do I have to wait so
long for service? Excuse: To get service as good as
ours, sometimes you have to wait; our guests
expect that.
#9. Customer complaint: Why didn’t your service
meet what I expected? Excuse: Nobody’s perfect;
we simply can’t make every customer happy.
#8. Customer complaint: Why didn’t you let us have
it “our way”? Excuse: We’re sorry, but if we did it
“your way” for all our customers, we would crash
our systems and overextend our already
overworked employees.
#7. Customer complaint: Service wasn’t as good this
time as it was the last time we were here. Excuse:
Everybody has good days and bad days; we’re
doing our best to please you, but we can’t always
be perfect.
#6. Customer complaint: Your place is dirty, dated,
and worn. Excuse: We do our best to keep it clean
THE TOP TEN EXCUSES FOR BAD SERVICE
SOURCE: D. Dickson, R. C. Ford, and B. Laval, “The Top Ten Ex-
cuses for Bad Service (and How to Avoid Needing Them)”
Organizational Dynamics, Vol. 34, Issue 2 (2005), pp. 168–181.
STRATEGY highlight 9.1
278 PART 4 Strategy Implementation and Control
ACHIEVING SYNERGY
One of the goals to be achieved in strategy implementation is synergy between and among
functions and business units. This is the reason corporations commonly reorganize after an ac-
quisition. Synergy is said to exist for a divisional corporation if the return on investment (ROI)
of each division is greater than what the return would be if each division were an independent
business. According to Goold and Campbell, synergy can take place in one of six forms:
� Shared know-how: Combined units often benefit from sharing knowledge or skills. This
is a leveraging of core competencies. One reason that Procter & Gamble purchased
Gillette was to combine P&G’s knowledge of the female consumer with Gillette’s knowl-
edge of the male consumer.
� Coordinated strategies: Aligning the business strategies of two or more business units
may provide a corporation significant advantage by reducing inter-unit competition and
developing a coordinated response to common competitors (horizontal strategy). The
merger between Arcelor and Mittal Steel, for example, gave the combined company en-
hanced R&D capabilities and wider global coverage while presenting a common face to
the market.
� Shared tangible resources: Combined units can sometimes save money by sharing re-
sources, such as a common manufacturing facility or R&D lab. The alliance between
Renault and Nissan allowed it to build new factories that would build both Nissan and
Renault vehicles.
� Economies of scale or scope: Coordinating the flow of products or services of one unit
with that of another unit can reduce inventory, increase capacity utilization, and improve
market access. This was a reason Delta Airlines bought Northwest Airlines.
� Pooled negotiating power: Combined units can combine their purchasing to gain bar-
gaining power over common suppliers to reduce costs and improve quality. The same can
be done with common distributors. The acquisitions of Macy’s and the May Company en-
abled Federated Department Stores (which changed its name to Macy’s in 2007) to gain
purchasing economies for all of its stores.
� New business creation: Exchanging knowledge and skills can facilitate new products or
services by extracting discrete activities from various units and combining them in a new
unit or by establishing joint ventures among internal business units. Oracle, for example,
purchased a number of software companies in order to create a suite of software code-
named “Project Fusion” to help corporations run everything from accounting and sales to
customer relations and supply-chain management.15
9.4 How Is Strategy to Be Implemented?
Organizing for Action
Before plans can lead to actual performance, a corporation should be appropriately organized,
programs should be adequately staffed, and activities should be directed toward achieving de-
sired objectives. (Organizing activities are reviewed briefly in this chapter; staffing, directing,
and control activities are discussed in Chapters 10 and 11.)
to eliminate duplicate communications and streamline work projects. Directives not related to
work orders had to be sent separately and only once a month. The company also spent $2 mil-
lion on workload-management software.14
CHAPTER 9 Strategy Implementation: Organizing for Action 279
STRUCTURE FOLLOWS STRATEGY
In a classic study of large U.S. corporations such as DuPont, General Motors, Sears, and Stan-
dard Oil, Alfred Chandler concluded that structure follows strategy—that is, changes in cor-
porate strategy lead to changes in organizational structure.16 He also concluded that
organizations follow a pattern of development from one kind of structural arrangement to an-
other as they expand. According to Chandler, these structural changes occur because the old
structure, having been pushed too far, has caused inefficiencies that have become too obvi-
ously detrimental to bear. Chandler, therefore, proposed the following as the sequence of what
occurs:
1. New strategy is created.
2. New administrative problems emerge.
3. Economic performance declines.
4. New appropriate structure is invented.
5. Profit returns to its previous level.
Chandler found that in their early years, corporations such as DuPont tend to have a cen-
tralized functional organizational structure that is well suited to producing and selling a lim-
ited range of products. As they add new product lines, purchase their own sources of supply,
and create their own distribution networks, they become too complex for highly centralized
structures. To remain successful, this type of organization needs to shift to a decentralized
structure with several semiautonomous divisions (referred to in Chapter 5 as divisional
structure).
Alfred P. Sloan, past CEO of General Motors, detailed how GM conducted such structural
changes in the 1920s.17 He saw decentralization of structure as “centralized policy determina-
tion coupled with decentralized operating management.” After top management had devel-
oped a strategy for the total corporation, the individual divisions (Chevrolet, Buick, and so on)
were free to choose how to implement that strategy. Patterned after DuPont, GM found the de-
centralized multidivisional structure to be extremely effective in allowing the maximum
amount of freedom for product development. Return on investment was used as a financial
control. (ROI is discussed in more detail in Chapter 11.)
Research generally supports Chandler’s proposition that structure follows strategy (as well
as the reverse proposition that structure influences strategy).18 As mentioned earlier, changes in
the environment tend to be reflected in changes in a corporation’s strategy, thus leading to
changes in a corporation’s structure. In 2008, Arctic Cat, the recreational vehicles firm, reorga-
nized its ATV (all terrain vehicles), snowmobile and parts, and garments and accessories product
Any change in corporate strategy is very likely to require some sort of change in the way
an organization is structured and in the kind of skills needed in particular positions. Managers
must, therefore, closely examine the way their company is structured in order to decide what,
if any, changes should be made in the way work is accomplished. Should activities be grouped
differently? Should the authority to make key decisions be centralized at headquarters or de-
centralized to managers in distant locations? Should the company be managed like a “tight
ship” with many rules and controls, or “loosely” with few rules and controls? Should the cor-
poration be organized into a “tall” structure with many layers of managers, each having a nar-
row span of control (that is, few employees per supervisor) to better control his or her
subordinates; or should it be organized into a “flat” structure with fewer layers of managers,
each having a wide span of control (that is, more employees per supervisor) to give more free-
dom to his or her subordinates?
280 PART 4 Strategy Implementation and Control
lines into three separate business units, each led by a general manager focused on expanding the
business. True to Chandler’s findings, the restructuring of Arctic Cat came after seven consecu-
tive years of record growth followed by its first loss in 25 years.
Strategy, structure, and the environment need to be closely aligned; otherwise, organiza-
tional performance will likely suffer.19 For example, a business unit following a differentiation
strategy needs more freedom from headquarters to be successful than does another unit fol-
lowing a low-cost strategy.20
Although it is agreed that organizational structure must vary with different environmen-
tal conditions, which, in turn, affect an organization’s strategy, there is no agreement about an
optimal organizational design. What was appropriate for DuPont and General Motors in the
1920s might not be appropriate today. Firms in the same industry do, however, tend to orga-
nize themselves similarly to one another. For example, automobile manufacturers tend to em-
ulate General Motors’ divisional concept, whereas consumer-goods producers tend to emulate
the brand-management concept (a type of matrix structure) pioneered by Procter & Gamble
Company. The general conclusion seems to be that firms following similar strategies in simi-
lar industries tend to adopt similar structures.
STAGES OF CORPORATE DEVELOPMENT
Successful corporations tend to follow a pattern of structural development as they grow and
expand. Beginning with the simple structure of the entrepreneurial firm (in which everybody
does everything), successful corporations usually get larger and organize along functional
lines, with marketing, production, and finance departments. With continuing success, the com-
pany adds new product lines in different industries and organizes itself into interconnected di-
visions. The differences among these three structural stages of corporate development in
terms of typical problems, objectives, strategies, reward systems, and other characteristics are
specified in detail in Table 9–1.
Stage I: Simple Structure
Stage I is typified by the entrepreneur, who founds a company to promote an idea (a product
or a service). The entrepreneur tends to make all the important decisions personally and is in-
volved in every detail and phase of the organization. The Stage I company has little formal
structure, which allows the entrepreneur to directly supervise the activities of every employee
(see Figure 5–4 for an illustration of the simple, functional, and divisional structures). Plan-
ning is usually short range or reactive. The typical managerial functions of planning, orga-
nizing, directing, staffing, and controlling are usually performed to a very limited degree, if at
all. The greatest strengths of a Stage I corporation are its flexibility and dynamism. The drive
of the entrepreneur energizes the organization in its struggle for growth. Its greatest weakness
is its extreme reliance on the entrepreneur to decide general strategies as well as detailed pro-
cedures. If the entrepreneur falters, the company usually flounders. This is labeled by Greiner
as a crisis of leadership.21
Stage I describes Oracle Corporation, the computer software firm, under the management
of its co-founder and CEO Lawrence Ellison. The company adopted a pioneering approach to
retrieving data, called Structured Query Language (SQL). When IBM made SQL its standard,
Oracle’s success was assured. Unfortunately, Ellison’s technical wizardry was not sufficient to
manage the company. Often working at home, he lost sight of details outside his technical in-
terests. Although the company’s sales were rapidly increasing, its financial controls were so
weak that management had to restate an entire year’s results to rectify irregularities. After the
company recorded its first loss, Ellison hired a set of functional managers to run the company
while he retreated to focus on new product development.
CHAPTER 9 Strategy Implementation: Organizing for Action 281
Stage II: Functional Structure
Stage II is the point when the entrepreneur is replaced by a team of managers who have func-
tional specializations. The transition to this stage requires a substantial managerial style
change for the chief officer of the company, especially if he or she was the Stage I entrepre-
neur. He or she must learn to delegate; otherwise, having additional staff members yields no
benefits to the organization. The previous example of Ellison’s retreat from top management
TABLE 9–1 Factors Differentiating Stage I, II, and III Companies
Function Stage I Stage II Stage III
1. Sizing up:
Major problems
Survival and growth
dealing with short-term
operating problems.
Growth, rationalization, and
expansion of resources,
providing for adequate
attention to product problems.
Trusteeship in management and
investment and control of large,
increasing, and diversified
resources. Also, important to
diagnose and take action on
problems at division level.
2. Objectives Personal and subjective. Profits and meeting
functionally oriented budgets
and performance targets.
ROI, profits, earnings per share.
3. Strategy Implicit and personal;
exploitation of immediate
opportunities seen by
owner-manager.
Functionally oriented moves
restricted to “one product”
scope; exploitation of one
basic product or service field.
Growth and product
diversification; exploitation of
general business opportunities.
4. Organization:
Major characteristic
of structure
One unit, “one-man
show.”
One unit, functionally
specialized group.
Multiunit general staff office
and decentralized operating
divisions.
5. (a) Measurement and
control
Personal, subjective
control based on simple
accounting system and
daily communication and
observation.
Control grows beyond one
person; assessment of
functional operations
necessary; structured control
systems evolve.
Complex formal system geared
to comparative assessment of
performance measures,
indicating problems and
opportunities and assessing
management ability of division
managers.
5. (b) Key performance
indicators
Personal criteria,
relationships with owner,
operating efficiency,
ability to solve operating
problems.
Functional and internal
criteria such as sales,
performance compared to
budget, size of empire, status
in group, personal,
relationships, etc.
More impersonal application of
comparisons such as profits,
ROI, P/E ratio, sales, market
share, productivity, product
leadership, personnel
development, employee
attitudes, public responsibility.
6. Reward-punishment
system
Informal, personal,
subjective; used to
maintain control and
divide small pool of
resources for key
performers to provide
personal incentives.
More structured; usually
based to a greater extent on
agreed policies as opposed to
personal opinion and
relationships.
Allotment by “due process” of a
wide variety of different rewards
and punishments on a formal
and systematic basis.
Companywide policies usually
apply to many different classes
of managers and workers with
few major exceptions for
individual cases.
SOURCE: D.H. Thain, “Stages of Corporate Development,” Ivey Business Quarterly, Winter 1969, p. 37. © 1969 Ivey Management Services.
One time Permission to reproduce granted by Ivey Management Services.
282 PART 4 Strategy Implementation and Control
at Oracle Corporation to new product development manager is one way that technically bril-
liant founders are able to get out of the way of the newly empowered functional managers. In
Stage II, the corporate strategy favors protectionism through dominance of the industry, often
through vertical and horizontal growth. The great strength of a Stage II corporation lies in its
concentration and specialization in one industry. Its great weakness is that all its eggs are in
one basket.
By concentrating on one industry while that industry remains attractive, a Stage II com-
pany, such as Oracle Corporation in computer software, can be very successful. Once a func-
tionally structured firm diversifies into other products in different industries, however, the
advantages of the functional structure break down. A crisis of autonomy can now develop, in
which people managing diversified product lines need more decision-making freedom than
top management is willing to delegate to them. The company needs to move to a different
structure.
Stage III: Divisional Structure
Stage III is typified by the corporation’s managing diverse product lines in numerous indus-
tries; it decentralizes the decision-making authority. Stage III organizations grow by diversi-
fying their product lines and expanding to cover wider geographical areas. They move to a
divisional structure with a central headquarters and decentralized operating divisions—with
each division or business unit a functionally organized Stage II company. They may also use
a conglomerate structure if top management chooses to keep its collection of Stage II sub-
sidiaries operating autonomously. A crisis of control can now develop, in which the various
units act to optimize their own sales and profits without regard to the overall corporation,
whose headquarters seems far away and almost irrelevant.
Recently, divisions have been evolving into SBUs to better reflect product-market consid-
erations. Headquarters attempts to coordinate the activities of its operating divisions or SBUs
through performance- and results-oriented control and reporting systems and by stressing cor-
porate planning techniques. The units are not tightly controlled but are held responsible for
their own performance results. Therefore, to be effective, the company has to have a decen-
tralized decision process. The greatest strength of a Stage III corporation is its almost unlim-
ited resources. Its most significant weakness is that it is usually so large and complex that it
tends to become relatively inflexible. General Electric, DuPont, and General Motors are ex-
amples of Stage III corporations.
Stage IV: Beyond SBUs
Even with its evolution into SBUs during the 1970s and 1980s, the divisional structure is not
the last word in organization structure. The use of SBUs may result in a red tape crisis in which
the corporation has grown too large and complex to be managed through formal programs and
rigid systems, and procedures take precedence over problem solving.22 For example, Pfizer’s
acquisitions of Warner-Lambert and Pharmacia resulted in 14 layers of management between
scientists and top executives and forced researchers to spend most of their time in meetings.23
Under conditions of (1) increasing environmental uncertainty, (2) greater use of sophisticated
technological production methods and information systems, (3) the increasing size and scope
of worldwide business corporations, (4) a greater emphasis on multi-industry competitive strat-
egy, and (5) a more educated cadre of managers and employees, new advanced forms of orga-
nizational structure are emerging. These structures emphasize collaboration over competition
in the managing of an organization’s multiple overlapping projects and developing businesses.
The matrix and the network are two possible candidates for a fourth stage in corporate de-
velopment—a stage that not only emphasizes horizontal over vertical connections between
people and groups but also organizes work around temporary projects in which sophisticated
CHAPTER 9 Strategy Implementation: Organizing for Action 283
information systems support collaborative activities. According to Greiner, it is likely that this
stage of development will have its own crisis as well—a sort of pressure-cooker crisis. He pre-
dicts that employees in these collaborative organizations will eventually grow emotionally
and physically exhausted from the intensity of teamwork and the heavy pressure for innova-
tive solutions.24
Blocks to Changing Stages
Corporations often find themselves in difficulty because they are blocked from moving into
the next logical stage of development. Blocks to development may be internal (such as lack of
resources, lack of ability, or refusal of top management to delegate decision making to others)
or external (such as economic conditions, labor shortages, and lack of market growth). For ex-
ample, Chandler noted in his study that the successful founder/CEO in one stage was rarely
the person who created the new structure to fit the new strategy, and as a result, the transition
from one stage to another was often painful. This was true of General Motors Corporation un-
der the management of William Durant, Ford Motor Company under Henry Ford I, Polaroid
Corporation under Edwin Land, Apple Computer under Steven Jobs, and Sun Microsystems
under Scott McNealy.
Entrepreneurs who start businesses generally have four tendencies that work very well for
small new ventures but become Achilles’ heels for these same individuals when they try to
manage a larger firm with diverse needs, departments, priorities, and constituencies:
� Loyalty to comrades: This is good at the beginning but soon becomes a liability as
“favoritism.”
� Task oriented: Focusing on the job is critical at first but then becomes excessive atten-
tion to detail.
� Single-mindedness: A grand vision is needed to introduce a new product but can become
tunnel vision as the company grows into more markets and products.
� Working in isolation: This is good for a brilliant scientist but disastrous for a CEO with
multiple constituencies.25
This difficulty in moving to a new stage is compounded by the founder’s tendency to ma-
neuver around the need to delegate by carefully hiring, training, and grooming his or her own
team of managers. The team tends to maintain the founder’s influence throughout the organi-
zation long after the founder is gone. This is what happened at Walt Disney Productions when
the family continued to emphasize Walt’s policies and plans long after he was dead. Although
this may often be an organization’s strength, it may also be a weakness—to the extent that the
culture supports the status quo and blocks needed change.
ORGANIZATIONAL LIFE CYCLE
Instead of considering stages of development in terms of structure, the organizational life cy-
cle approach places the primary emphasis on the dominant issue facing the corporation. Orga-
nizational structure is only a secondary concern. The organizational life cycle describes how
organizations grow, develop, and eventually decline. It is the organizational equivalent of the
product life cycle in marketing. These stages are Birth (Stage I), Growth (Stage II), Maturity
(Stage III), Decline (Stage IV), and Death (Stage V). The impact of these stages on corporate
strategy and structure is summarized in Table 9–2. Note that the first three stages of the orga-
nizational life cycle are similar to the three commonly accepted stages of corporate develop-
ment mentioned previously. The only significant difference is the addition of the Decline and
Death stages to complete the cycle. Even though a company’s strategy may still be sound, its
284 PART 4 Strategy Implementation and Control
aging structure, culture, and processes may be such that they prevent the strategy from being
executed properly. Its core competencies become core rigidities that are no longer able to adapt
to changing conditions—thus the company moves into Decline.26
Movement from Growth to Maturity to Decline and finally to Death is not, however, in-
evitable. A Revival phase may occur sometime during the Maturity or Decline stages. The cor-
poration’s life cycle can be extended by managerial and product innovations.27 Developing
new combinations of existing resources to introduce new products or acquiring new resources
through acquisitions can enable firms with declining performance to regain growth—so long
as the action is valuable and difficult to imitate.28 This can occur during the implementation of
a turnaround strategy.29 Nevertheless, the fact that firms in decline are less likely to search for
new technologies suggests that it is difficult to revive a company in decline.30
Eastman Kodak is an example of a firm in decline that has been attempting to develop new
combinations of its existing resources to introduce new products, and thus, revive the corpo-
ration. When Antonio Perez left Hewlett-Packard to become Kodak’s President in 2003,
Kodak was in the midst of its struggle to make the transition from chemical film technology
to digital technology and digital cameras. Instead of focusing the company’s efforts on acqui-
sitions to find growth, Perez looked at technologies that Kodak already owned, but was not
utilizing. He noticed that Kodak scientists had developed new ink to yield photo prints with vivid
colors that would last a lifetime. He suddenly realized that Kodak’s distinctive competence was
not in digital photography, where other competitors led the market, but in color printing. Perez
initiated project Goza to go head to head with HP in the consumer inkjet printer business. In
2007, Kodak unveiled its new line of multipurpose machines that not only handled photographs
and documents, but also made copies and sent faxes. The printers were designed to print high-
quality photos with ink that would stay vibrant for 100 rather than the usual 15 years. Most im-
portantly, replacement ink cartridges would cost half the price of competitors’ cartridges.
According to Perez, “We think it will give us the opportunity to disrupt the industry’s business
model and address consumers’ key dissatisfaction: the high cost of ink.” Perez then predicted
that Kodak’s inkjet printers would become a multibillion-dollar product line.31
Unless a company is able to resolve the critical issues facing it in the Decline stage, it is
likely to move into Stage V, Death—also known as bankruptcy. This is what happened to
Montgomery Ward, Pan American Airlines, Macy’s Department Stores, Baldwin-United, East-
ern Airlines, Colt’s Manufacturing, Orion Pictures, and Wheeling-Pittsburgh Steel, as well as
many other firms. As in the cases of Johns-Manville, International Harvester, Macy’s, and
Kmart—all of which went bankrupt—a corporation can rise like a phoenix from its own
ashes and live again under the same or a different name. The company may be reorganized or
liquidated, depending on individual circumstances. For example, Kmart emerged from
Chapter 11 bankruptcy in 2003 with a new CEO and a plan to sell a number of its stores to
TABLE 9–2 Organizational Life Cycle
Stage I Stage II Stage III* Stage IV Stage V
Dominant Issue Birth Growth Maturity Decline Death
Popular Strategies Concentration
in a niche
Horizontal and
vertical growth
Concentric and
conglomerate
diversification
Profit strategy
followed by
retrenchment
Liquidation or
bankruptcy
Likely Structure Entrepreneur
dominated
Functional
management
emphasized
Decentralization
into profit or
investment centers
Structural surgery Dismemberment
of structure
NOTE: *An organization may enter a Revival phase either during the Maturity or Decline stages and thus extend the organization’s life.
CHAPTER 9 Strategy Implementation: Organizing for Action 285
Home Depot and Sears. These sales earned the company close to $1 billion. Although store
sales continued to erode, Kmart had sufficient cash reserves to continue with its turnaround.32
It used that money to acquire Sears in 2005. Unfortunately, however, fewer than 20% of firms
entering Chapter 11 bankruptcy in the United States emerge as going concerns; the rest are
forced into liquidation.33
Few corporations will move through these five stages in order. Some corporations, for ex-
ample, might never move past Stage II. Others, such as General Motors, might go directly from
Stage I to Stage III. A large number of entrepreneurial ventures jump from Stage I or II directly
into Stage IV or V. Hayes Microcomputer Products, for example, went from the Growth to De-
cline stage under its founder Dennis Hayes. The key is to be able to identify indications that a
firm is in the process of changing stages and to make the appropriate strategic and structural
adjustments to ensure that corporate performance is maintained or even improved.
ADVANCED TYPES OF ORGANIZATIONAL STRUCTURES
The basic structures (simple, functional, divisional, and conglomerate) are discussed in
Chapter 5 and summarized under the first three stages of corporate development in this chap-
ter. A new strategy may require more flexible characteristics than the traditional functional or
divisional structure can offer. Today’s business organizations are becoming less centralized with
a greater use of cross-functional work teams. Table 9–3 depicts some of the changing structural
characteristics of modern corporations. Although many variations and hybrid structures contain
these characteristics, two forms stand out: the matrix structure and the network structure.
Matrix Structure
Most organizations find that organizing around either functions (in the functional structure)
or products and geography (in the divisional structure) provides an appropriate organiza-
tional structure. The matrix structure, in contrast, may be very appropriate when organiza-
tions conclude that neither functional nor divisional forms, even when combined with
horizontal linking mechanisms such as SBUs, are right for their situations. In matrix
structures, functional and product forms are combined simultaneously at the same level of
the organization. (See Figure 9–2.) Employees have two superiors, a product or project man-
ager, and a functional manager. The “home” department—that is, engineering, manufactur-
ing, or sales—is usually functional and is reasonably permanent. People from these
functional units are often assigned temporarily to one or more product units or projects. The
product units or projects are usually temporary and act like divisions in that they are differ-
entiated on a product-market basis.
TABLE 9–3 Old Organization Design New Organization Design
Changing
Structural
Characteristics
of Modern
Corporations
One large corporation Minibusiness units and cooperative relationships
Vertical communication Horizontal communication
Centralized, top-down decision making Decentralized participative decision making
Vertical integration Outsourcing and virtual organizations
Work/quality teams Autonomous work teams
Functional work teams Cross-functional work teams
Minimal training Extensive training
Specialized job design focused on individuals Value-chain team-focused job design
SOURCE: Reprinted from RESEARCH IN ORGANIZATIONAL CHANGE AND DEVELOPMENT, Vol. 7, No. 1,
1993, Macy and Izumi, “Organizational Change, Design, and Work Innovation: A Meta-Analysis of 131 North
American Field Studies—1961–1991,” p. 298. Copyright © 1993 with permission.
286 PART 4 Strategy Implementation and Control
Top Management
Manufacturing
Manufacturing
Unit
Manager:
Project A
Manager:
Project B
Manager:
Project C
Manager:
Project D
Manufacturing
Unit
Manufacturing
Unit
Manufacturing
Unit
Sales
Sales
Unit
Sales
Unit
Sales
Unit
Sales
Unit
Finance
Finance
Unit
Finance
Unit
Finance
Unit
Finance
Unit
Human
Resources
Matrix Structure
Network Structure
Designers Suppliers
Manufacturers Distributors
Packagers
Promotion/
Advertising
Agencies
Corporate
Headquarters
(Broker)
Human
Resources Unit
Human
Resources Unit
Human
Resources Unit
Human
Resources Unit
FIGURE 9–2
Matrix
and Network
Structures
Pioneered in the aerospace industry, the matrix structure was developed to combine the
stability of the functional structure with the flexibility of the product form. The matrix struc-
ture is very useful when the external environment (especially its technological and market as-
pects) is very complex and changeable. It does, however, produce conflicts revolving around
duties, authority, and resource allocation. To the extent that the goals to be achieved are vague
and the technology used is poorly understood, a continuous battle for power between product
and functional managers is likely. The matrix structure is often found in an organization or
SBU when the following three conditions exist:
� Ideas need to be cross-fertilized across projects or products.
� Resources are scarce.
� Abilities to process information and to make decisions need to be improved.34
Davis and Lawrence, authorities on the matrix form of organization, propose that three
distinct phases exist in the development of the matrix structure:35
1. Temporary cross-functional task forces: These are initially used when a new product
line is being introduced. A project manager is in charge as the key horizontal link. J&J’s
experience with cross-functional teams in its drug group led it to emphasize teams cross-
ing multiple units.
2. Product/brand management: If the cross-functional task forces become more perma-
nent, the project manager becomes a product or brand manager and a second phase be-
gins. In this arrangement, function is still the primary organizational structure, but product
or brand managers act as the integrators of semi-permanent products or brands. Consid-
ered by many a key to the success of P&G, brand management has been widely imitated
by other consumer products firms around the world.
3. Mature matrix: The third and final phase of matrix development involves a true dual-
authority structure. Both the functional and product structures are permanent. All employ-
ees are connected to both a vertical functional superior and a horizontal product manager.
Functional and product managers have equal authority and must work well together to re-
solve disagreements over resources and priorities. Boeing, Philips, and TRW Systems are
example of companies that use a mature matrix.
Network Structure–The Virtual Organization
A newer and somewhat more radical organizational design, the network structure (see
Figure 9–2) is an example of what could be termed a “non-structure” because of its virtual
elimination of in-house business functions. Many activities are outsourced. A corporation or-
ganized in this manner is often called a virtual organization because it is composed of a se-
ries of project groups or collaborations linked by constantly changing nonhierarchical,
cobweb-like electronic networks.36
The network structure becomes most useful when the environment of a firm is unstable and
is expected to remain so.37 Under such conditions, there is usually a strong need for innovation
and quick response. Instead of having salaried employees, the company may contract with people
for a specific project or length of time. Long-term contracts with suppliers and distributors replace
services that the company could provide for itself through vertical integration. Electronic markets
and sophisticated information systems reduce the transaction costs of the marketplace, thus justi-
fying a “buy” over a “make” decision. Rather than being located in a single building or area, the
organization’s business functions are scattered worldwide. The organization is, in effect, only a
shell, with a small headquarters acting as a “broker,” electronically connected to some completely
owned divisions, partially owned subsidiaries, and other independent companies. In its ultimate
form, a network organization is a series of independent firms or business units linked together by
computers in an information system that designs, produces, and markets a product or service.38
Entrepreneurial ventures often start out as network organizations. For example, Randy
and Nicole Wilburn of Dorchester, Massachusetts, run real estate, consulting, design, and baby
food companies out of their home. Nicole, a stay-at-home mom and graphic designer, farms
out design work to freelancers and cooks her own line of organic baby food. For $300, an In-
dian artist designed the logo for Nicole’s “Baby Fresh Organic Baby Foods.” A London free-
lancer wrote promotional materials. Instead of hiring a secretary, Randy hired “virtual
assistants” in Jerusalem to transcribe voice mail, update his Web site, and design PowerPoint
graphics. Retired brokers in Virginia and Michigan deal with his real estate paperwork.39
Large companies such as Nike, Reebok, and Benetton use the network structure in their op-
erations function by subcontracting (outsourcing) manufacturing to other companies in low-cost
locations around the world. For control purposes, the Italian-based Benetton maintains what it
calls an “umbilical cord” by assuring production planning for all its subcontractors, planning ma-
terials requirements for them, and providing them with bills of labor and standard prices and
costs, as well as technical assistance to make sure their quality is up to Benetton’s standards.
CHAPTER 9 Strategy Implementation: Organizing for Action 287
288 PART 4 Strategy Implementation and Control
The network organizational structure provides an organization with increased flexibility
and adaptability to cope with rapid technological change and shifting patterns of international
trade and competition. It allows a company to concentrate on its distinctive competencies,
while gathering efficiencies from other firms that are concentrating their efforts in their ar-
eas of expertise. The network does, however, have disadvantages. Some believe that the net-
work is really only a transitional structure because it is inherently unstable and subject to
tensions.40 The availability of numerous potential partners can be a source of trouble. Con-
tracting out individual activities to separate suppliers/distributors may keep the firm from dis-
covering any internal synergies by combining these activities. If a particular firm
overspecializes on only a few functions, it runs the risk of choosing the wrong functions and
thus becoming noncompetitive.
Cellular/Modular Organization: A New Type of Structure?
Some authorities in the field propose that the evolution of organizational forms is leading from
the matrix and the network to the cellular (also called modular) organizational form. Accord-
ing to Miles and Snow et al., “a cellular organization is composed of cells (self-managing
teams, autonomous business units, etc.) which can operate alone but which can interact with
other cells to produce a more potent and competent business mechanism.” This combination
of independence and interdependence allows the cellular/modular organizational form to gen-
erate and share the knowledge and expertise needed to produce continuous innovation. The
cellular/modular form includes the dispersed entrepreneurship of the divisional structure, cus-
tomer responsiveness of the matrix, and self-organizing knowledge and asset sharing of the
network.41 Bombardier, for example, broke up the design of its Continental business jet into
12 parts provided by internal divisions and external contractors. The cockpit, center, and for-
ward fuselage were produced in-house, but other major parts were supplied by manufacturers
spread around the globe. The cellular/modular structure is used when it is possible to break up
a company’s products into self-contained modules or cells and where interfaces can be speci-
fied such that the cells/modules work when they are joined together.42 The cellular/modular
structure is similar to a current trend in industry of using internal joint ventures to temporar-
ily combine specialized expertise and skills within a corporation to accomplish a task which
individual units alone could not accomplish.43
The impetus for such a new structure is the pressure for a continuous process of innova-
tion in all industries. Each cell/module has an entrepreneurial responsibility to the larger orga-
nization. Beyond knowledge creation and sharing, the cellular/modular form adds value by
keeping the firm’s total knowledge assets more fully in use than any other type of structure.44
It is beginning to appear in firms that are focused on rapid product and service innovation—
providing unique or state-of-the-art offerings in industries such as automobile manufacture, bi-
cycle production, consumer electronics, household appliances, power tools, computing
products, and software.45
REENGINEERING AND STRATEGY IMPLEMENTATION
Reengineering is the radical redesign of business processes to achieve major gains in cost,
service, or time. It is not in itself a type of structure, but it is an effective program to imple-
ment a turnaround strategy.
Business process reengineering strives to break away from the old rules and procedures
that develop and become ingrained in every organization over the years. They may be a com-
bination of policies, rules, and procedures that have never been seriously questioned because
they were established years earlier. These may range from “Credit decisions are made by the
credit department” to “Local inventory is needed for good customer service.” These rules of
CHAPTER 9 Strategy Implementation: Organizing for Action 289
organization and work design may have been based on assumptions about technology, people,
and organizational goals that may no longer be relevant. Rather than attempting to fix existing
problems through minor adjustments and fine-tuning of existing processes, the key to reengi-
neering is asking “If this were a new company, how would we run this place?”
Michael Hammer, who popularized the concept of reengineering, suggests the following
principles for reengineering:
� Organize around outcomes, not tasks: Design a person’s or a department’s job around
an objective or outcome instead of a single task or series of tasks.
� Have those who use the output of the process perform the process: With computer-
based information systems, processes can now be reengineered so that the people who
need the result of the process can do it themselves.
� Subsume information-processing work into the real work that produces the informa-
tion: People or departments that produce information can also process it for use instead
of just sending raw data to others in the organization to interpret.
� Treat geographically dispersed resources as though they were centralized: With mod-
ern information systems, companies can provide flexible service locally while keeping the
actual resources in a centralized location for coordination purposes.
� Link parallel activities instead of integrating their results: Instead of having separate
units perform different activities that must eventually come together, have them commu-
nicate while they work so that they can do the integrating.
� Put the decision point where the work is performed and build control into the
process: The people who do the work should make the decisions and be self-controlling.
� Capture information once and at the source: Instead of having each unit develop its
own database and information processing activities, the information can be put on a net-
work so that all can access it.46
Studies of the performance of reengineering programs show mixed results. Several com-
panies have had success with business process reengineering. For example, the Mossville En-
gine Center, a business unit of Caterpillar Inc., used reengineering to decrease process cycle
times by 50%, reduce the number of process steps by 45%, reduce human effort by 8%, and
improve cross-divisional interactions and overall employee decision making.47
One study of North American financial firms found that “the average reengineering proj-
ect took 15 months, consumed 66 person-months of effort, and delivered cost savings of
24%.”48 In a survey of 782 corporations using reengineering, 75% of the executives said their
companies had succeeded in reducing operating expenses and increasing productivity.49 A
study of 134 large and small Canadian companies found that reengineering programs resulted
in (1) an increase in productivity and product quality, (2) cost reductions, and (3) an increase
in overall organization quality, for both large and small firms.50 Other studies report, however,
that anywhere from 50% to 70% of reengineering programs fail to achieve their objectives.51
Reengineering thus appears to be more useful for redesigning specific processes like order en-
try, than for changing an entire organization.52
SIX SIGMA
Originally conceived by Motorola as a quality improvement program in the mid-1980s, Six
Sigma has become a cost-saving program for all types of manufacturers. Briefly, Six Sigma is
an analytical method for achieving near-perfect results on a production line. Although the em-
phasis is on reducing product variance in order to boost quality and efficiency, it is increas-
ingly being applied to accounts receivable, sales, and R&D. In statistics, the Greek letter sigma
290 PART 4 Strategy Implementation and Control
DESIGNING JOBS TO IMPLEMENT STRATEGY
Organizing a company’s activities and people to implement strategy involves more than
simply redesigning a corporation’s overall structure; it also involves redesigning the way
jobs are done. With the increasing emphasis on reengineering, many companies are begin-
ning to rethink their work processes with an eye toward phasing unnecessary people and ac-
tivities out of the process. Process steps that have traditionally been performed sequentially
can be improved by performing them concurrently using cross-functional work teams.
Harley-Davidson, for example, has managed to reduce total plant employment by 25%
while reducing by 50% the time needed to build a motorcycle. Restructuring through need-
ing fewer people requires broadening the scope of jobs and encouraging teamwork. The de-
sign of jobs and subsequent job performance are, therefore, increasingly being considered
as sources of competitive advantage.
Job design refers to the study of individual tasks in an attempt to make them more rele-
vant to the company and to the employee(s). To minimize some of the adverse consequences
of task specialization, corporations have turned to new job design techniques: job enlargement
(combining tasks to give a worker more of the same type of duties to perform), job rotation
(moving workers through several jobs to increase variety), and job enrichment (altering the
jobs by giving the worker more autonomy and control over activities). The job characteristics
denotes variation in the standard bell-shaped curve. One sigma equals 690,000 defects per
1 million. Most companies are able to achieve only three sigma, or 66,000 errors per million.
Six Sigma reduces the defects to only 3.4 per million—thus saving money by preventing
waste. The process of Six Sigma encompasses five steps.
1. Define a process where results are poorer than average.
2. Measure the process to determine exact current performance.
3. Analyze the information to pinpoint where things are going wrong.
4. Improve the process and eliminate the error.
5. Establish controls to prevent future defects from occurring.53
Savings attributed to Six Sigma programs have ranged from 1.2% to 4.5% of annual revenue
for a number of Fortune 500 firms. Firms that have successfully employed Six Sigma are Gen-
eral Electric, Allied Signal, ABB, and Ford Motor Company.54 About 35% of U.S. companies
now have a Six Sigma program in place.55 At Dow Chemical, each Six Sigma project has resulted
in cost savings of $500,000 in the first year.According to Jack Welch, GE’s past CEO, Six Sigma
is an appropriate change program for the entire organization.56 Six Sigma experts at 3M have
been able to speed up R&D and analyze why its top sales people sold more than others. A disad-
vantage of the program is that training costs in the beginning may outweigh any savings. The ex-
pense of compiling and analyzing data, especially in areas where a process cannot be easily
standardized, may exceed what is saved.57 Another disadvantage is that Six Sigma can lead to
less-risky incremental innovation based on previous work than on riskier “blue-sky” projects.58
A new program called Lean Six Sigma is becoming increasingly popular in companies.
This program incorporates the statistical approach of Six Sigma with the lean manufacturing
program originally developed by Toyota. Like reengineering, it includes the removal of un-
necessary steps in any process and fixing those that remain. This is the “lean” addition to Six
Sigma. Xerox used Lean Six Sigma to resolve a problem with a $500,000 printing press it had
just introduced. Teams from supply, manufacturing, and R&D used Lean Six Sigma to find the
cause of the problem and to resolve it by working with a supplier to change the chemistry of
the oil on a roller.59
CHAPTER 9 Strategy Implementation: Organizing for Action 291
model is a good example of job enrichment. (See Strategy Highlight 9.2.) Although each of
these methods has its adherents, no one method seems to work in all situations.
A good example of modern job design is the introduction of team-based production by the
glass manufacturer Corning Inc., in its Blacksburg, Virginia, plant. With union approval, Corn-
ing reduced job classifications from 47 to 4 to enable production workers to rotate jobs after
learning new skills. The workers were divided into 14-member teams that, in effect, managed
themselves. The plant had only two levels of management: Plant Manager Robert Hoover and
two line leaders who only advised the teams. Employees worked demanding 12 1⁄2-hour shifts, al-
ternating three-day and four-day weeks. The teams made managerial decisions, imposed disci-
pline on fellow workers, and were required to learn three “skill modules” within two years or else
lose their jobs. As a result of this new job design, a Blacksburg team, made up of workers with
interchangeable skills, can retool a line to produce a different type of filter in only 10 minutes—
six times faster than workers in a traditionally designed filter plant. The Blacksburg plant earned
a $2 million profit in its first eight months of production instead of losing the $2.3 million pro-
jected for the startup period. The plant performed so well that Corning’s top management acted
to convert the company’s 27 other factories to team-based production.60
4. Vertically load the job by giving workers increased
authority and responsibility over their activities.
5. Open feedback channels by providing workers with
information on how they are performing.
Research supports the job characteristics model as a
way to improve job performance through job enrichment.
Although there are several other approaches to job design,
practicing managers seem increasingly to follow the pre-
scriptions of this model as a way of improving productivity
and product quality.
The job characteristics model
is an advanced approach to
job design based on the belief
that tasks can be described in
terms of certain objective character-
istics and that these characteristics affect
employee motivation. In order for a job to be motivating,
(1) the worker needs to feel a sense of responsibility, feel the
task to be meaningful, and receive useful feedback on his or
her performance, and (2) the job has to satisfy needs that are
important to the worker. The model proposes that managers
follow five principles for redesigning work:
1. Combine tasks to increase task variety and to enable
workers to identify with what they are doing.
2. Form natural work units to make a worker more
responsible and accountable for the performance of
the job.
3. Establish client relationships so the worker will know
what performance is required and why.
DESIGNING JOBS WITH THE JOB CHARACTERISTICS MODEL
SOURCE: J. R. Hackman and G. R. Oldham, Work Redesign (Read-
ing, MA: Addison-Wesley, 1980), pp. 135–141; G. Johns, J. L. Xie,
and Y. Fang, “Mediating and Moderating Effects in Job Design,”
Journal of Management (December 1992), pp. 657–676; R. W.
Griffin, “Effects of Work Redesign on Employee Perceptions, Atti-
tudes, and Behaviors: A Long-Term Investigation,” Academy of
Management Journal (June 1991), pp. 425–435.
STRATEGY highlight 9.2
9.5 International Issues in Strategy Implementation
An international company is one that engages in any combination of activities, from export-
ing/importing to full-scale manufacturing, in foreign countries. A multinational corporation
(MNC), in contrast, is a highly developed international company with a deep involvement
throughout the world, plus a worldwide perspective in its management and decision making.
292 PART 4 Strategy Implementation and Control
INTERNATIONAL STRATEGIC ALLIANCES
Strategic alliances, such as joint ventures and licensing agreements, between an MNC and a
local partner in a host country are becoming increasingly popular as a means by which a cor-
poration can gain entry into other countries, especially less developed countries. The key to
the successful implementation of these strategies is the selection of the local partner. Each
party needs to assess not only the strategic fit of each company’s project strategy but also the
fit of each company’s respective resources. A successful joint venture may require as much as
two years of prior contacts between the parties. A prior relationship helps to develop a level of
trust, which facilitates openness in sharing knowledge and a reduced fear of opportunistic be-
havior by the alliance partners. This is especially important when the environmental uncer-
tainty is high.62 Research reveals that firms favor past partners when forming new alliances.63
Key drivers for strategic fit between alliance partners are the following:
� Partners must agree on fundamental values and have a shared vision about the potential
for joint value creation.
� Alliance strategy must be derived from business, corporate, and functional strategy.
� The alliance must be important to both partners, especially to top management.
� Partners must be mutually dependent for achieving clear and realistic objectives.
For an MNC to be considered global, it must manage its worldwide operations as if they were
totally interconnected. This approach works best when the industry has moved from being
multidomestic (each country’s industry is essentially separate from the same industry in other
countries) to global (each country is a part of one worldwide industry).
The global MNC faces the dual challenge of achieving scale economies through standard-
ization while at the same time responding to local customer differences. According to Spulber
in his book, Global Competitive Strategy, the forces pushing for standardization are:
� Convergence in customer preferences and income across target countries.
� Competition from successful global products.
� Growing customer awareness of international brands.
� Economies of scale.
� Falling trading costs across countries.
� Cultural exchange and business interactions among countries.
The forces pushing for customization to local markets are:
� Persistent differences in customer preferences.
� Persistent differences in customer incomes.
� The need to build local brand reputation.
� Competition from successful, innovative domestic companies.
� Variations in trading costs across countries.
� Local regulatory requirements.61
The design of an organization’s structure is strongly affected by the company’s stage of
development in international activities and the types of industries in which the company is in-
volved. Strategic alliances may complement or even substitute for an internal functional ac-
tivity. The issue of centralization versus decentralization becomes especially important for an
MNC operating in both multidomestic and global industries.
CHAPTER 9 Strategy Implementation: Organizing for Action 293
� Joint activities must have added value for customers and the partners.
� The alliance must be accepted by key stakeholders.
� Partners contribute key strengths but protect core competencies.64
STAGES OF INTERNATIONAL DEVELOPMENT
Corporations operating internationally tend to evolve through five common stages, both in
their relationships with widely dispersed geographic markets and in the manner in which they
structure their operations and programs. These stages of international development are:
� Stage 1 (Domestic company): The primarily domestic company exports some of its prod-
ucts through local dealers and distributors in the foreign countries. The impact on the or-
ganization’s structure is minimal because an export department at corporate headquarters
handles everything.
� Stage 2 (Domestic company with export division): Success in Stage 1 leads the com-
pany to establish its own sales company with offices in other countries to eliminate the
middlemen and to better control marketing. Because exports have now become more im-
portant, the company establishes an export division to oversee foreign sales offices.
� Stage 3 (Primarily domestic company with international division): Success in earlier
stages leads the company to establish manufacturing facilities in addition to sales and ser-
vice offices in key countries. The company now adds an international division with re-
sponsibilities for most of the business functions conducted in other countries.
� Stage 4 (Multinational corporation with multidomestic emphasis): Now a full-fledged
MNC, the company increases its investments in other countries. The company establishes a
local operating division or company in the host country, such as Ford of Britain, to better serve
the market. The product line is expanded, and local manufacturing capacity is established.
Managerial functions (product development, finance, marketing, and so on) are organized
locally. Over time, the parent company acquires other related businesses, broadening the base
of the local operating division. As the subsidiary in the host country successfully develops a
strong regional presence, it achieves greater autonomy and self-sufficiency. The operations in
each country are, nevertheless, managed separately as if each is a domestic company.
� Stage 5 (MNC with global emphasis): The most successful MNCs move into a fifth stage
in which they have worldwide human resources, R&D, and financing strategies. Typically
operating in a global industry, the MNC denationalizes its operations and plans product
design, manufacturing, and marketing around worldwide considerations. Global consid-
erations now dominate organizational design. The global MNC structures itself in a ma-
trix form around some combination of geographic areas, product lines, and functions. All
managers are responsible for dealing with international as well as domestic issues.
Research provides some support for stages of international development, but it does not
necessarily support the preceding sequence of stages. For example, a company may initiate
production and sales in multiple countries without having gone through the steps of exporting
or having local sales subsidiaries. In addition, any one corporation can be at different stages
simultaneously, with different products in different markets at different levels. Firms may also
leapfrog across stages to a global emphasis. In addition, most firms that are considered to be
stage 5 global MNCs are actually regional. Around 88% of the world’s biggest MNCs derive
at least half of their sales from their home regions. Just 2% (a total of nine firms) derive 20%
or more of their sales from each of the North American, European, and Asian regions.65
Developments in information technology are changing the way business is being done inter-
nationally. See the Global Issue feature for a possible sixth stage of international development, in
294 PART 4 Strategy Implementation and Control
which an MNC locates its headquarters and key functions at multiple locations around the world.66
Nevertheless, the stages concept provides a useful way to illustrate some of the structural changes
corporations undergo when they increase their involvement in international activities.
SOURCES: S. Hamm, “Borders Are So 20th Century,” Business
Week (January 22, 2003), pp. 68–70; “Globalization from the Top
Down,” Futurist (November–December 2003), p. 13.
what is a multinational company. Does it have a home
country? What does headquarters mean? Can you frag-
ment your corporate functions globally?” Corporate head-
quarters are now becoming virtual with executives and
core corporate functions dispersed throughout various
world regions. These primarily technology companies are
using geography to obtain competitive advantage through
the availability of talent or capital, low costs, or proximity
to most important customers. Logitech, for example, has
its manufacturing headquarters in Taiwan to capitalize on
low-cost Asian manufacturing, its business-development
headquarters in Switzerland where it has a series of strate-
gic technology partnerships, and a third headquarters in
Fremont, California.
In what could be a sixth
stage of international devel-
opment, an increasing number
of MNCs are relocating their head-
quarters and headquarters functions at
multiple locations around the world. Of the 800 corporate
headquarters established in 2002, 200 of them were in de-
veloping nations. The antivirus software company Trend
Micro, for example, spreads its top executives, engineers,
and support staff throughout the world to improve its abil-
ity to respond to new virus threats. “With the Internet,
viruses became global. To fight them, we had to become a
global company,” explained Chairman Steve Chang. Trend
Micro’s financial headquarters is in Tokyo, where it went
public. Its product development is in Taiwan, and its sales
headquarters is in America’s Silicon Valley.
C. K. Prahalad, strategy professor at the University of
Michigan, proposes that this is a new stage of international
development. “There is a fundamental rethinking about
MULTIPLE HEADQUARTERS:
A SIXTH STAGE OF INTERNATIONAL DEVELOPMENT?
GLOBAL issue
CENTRALIZATION VERSUS DECENTRALIZATION
A basic dilemma an MNC faces is how to organize authority centrally so that it operates as a
vast interlocking system that achieves synergy and at the same time decentralize authority so
that local managers can make the decisions necessary to meet the demands of the local mar-
ket or host government.67 To deal with this problem, MNCs tend to structure themselves either
along product groups or geographic areas. They may even combine both in a matrix struc-
ture—the design chosen by 3M Corporation, Philips, and Asea Brown Boveri (ABB), among
others.68 One side of 3M’s matrix represents the company’s product divisions; the other side
includes the company’s international country and regional subsidiaries.
Two examples of the usual international structure are Nestlé and American Cyanamid.
Nestlé’s structure is one in which significant power and authority have been decentralized to
geographic entities. This structure is similar to that depicted in Figure 9–3, in which each ge-
ographic set of operating companies has a different group of products. In contrast, American
Cyanamid has a series of centralized product groups with worldwide responsibilities. To de-
pict Cyanamid’s structure, the geographical entities in Figure 9–3 would have to be replaced
by product groups or SBUs.
CHAPTER 9 Strategy Implementation: Organizing for Action 295
The product-group structure of American Cyanamid enables the company to intro-
duce and manage a similar line of products around the world. This enables the corporation
to centralize decision making along product lines and to reduce costs. The geographic-area
structure of Nestlé, in contrast, allows the company to tailor products to regional differences
and to achieve regional coordination. For instance, Nestlé markets 200 different varieties of
its instant coffee, Nescafé. The geographic-area structure decentralizes decision making to
the local subsidiaries.
As industries move from being multidomestic to more globally integrated, MNCs are in-
creasingly switching from the geographic-area to the product-group structure. Nestlé, for ex-
ample, has found that its decentralized area structure had become increasingly inefficient. As
a result, operating margins at Nestlé have trailed those at rivals Unilever, Group Danone, and
Kraft Foods by as much as 50%. CEO Peter Brabeck-Letmathe acted to eliminate country-by-
country responsibilities for many functions. In one instance, he established five centers
worldwide to handle most coffee and cocoa purchasing. Nevertheless, Nestlé is still using
three different versions of accounting, planning, and inventory software for each of its main
regions—Europe, the Americas, and Asia, Oceania, and Africa.69
Simultaneous pressures for decentralization to be locally responsive and centralization
to be maximally efficient are causing interesting structural adjustments in most large corpo-
rations. This is what is meant by the phrase “think globally, act locally.” Companies are at-
tempting to decentralize those operations that are culturally oriented and closest to the
customers—manufacturing, marketing, and human resources. At the same time, the compa-
nies are consolidating less visible internal functions, such as research and development, fi-
nance, and information systems, where there can be significant economies of scale.
Board of Directors
President
Operating
Companies
U.S.
Operating
Companies
Europe*
Operating
Companies
Latin
America
Operating
Companies
Africa
Operating
Companies
Asia*
Product
Group
B
Product
Group
D
Corporate
Staff
Product
Group
A
Product
Group
B
Product
Group
C
R&D
FIGURE 9–3
Geographic Area
Structure
for an MNC
*NOTE: Because of space limitations, product groups for only Europe and Asia are shown here.
296 PART 4 Strategy Implementation and Control
End of Chapter SUMMARY
Strategy implementation is where “the rubber hits the road.” Environmental scanning and
strategy formulation are crucial to strategic management but are only the beginning of the
process. The failure to carry a strategic plan into the day-to-day operations of the workplace
is a major reason why strategic planning often fails to achieve its objectives. It is discour-
aging to note that in one study nearly 70% of the strategic plans were never successfully
implemented.70
For a strategy to be successfully implemented, it must be made action oriented. This is done
through a series of programs that are funded through specific budgets and contain new detailed
procedures. This is what Sergio Marchionne did when he implemented a turnaround strategy as
the new Fiat Group CEO in 2004. He attacked the lethargic, bureaucratic system by flattening
Fiat’s structure and giving younger managers a larger amount of authority and responsibility. He
and other managers worked to reduce the number of auto platforms from 19 to six by 2012. The
time from the completion of the design process to new car production was cut from 26 to
18 months. By 2008, the Fiat auto unit was again profitable. Marchionne’s next step was to
revive the other two underperforming units of Lancia and Alfa Romeo.71
This chapter explains how jobs and organizational units can be designed to support a
change in strategy. We will continue with staffing and directing issues in strategy implemen-
tation in the next chapter.
E C O – B I T S
� Only 5% of the 30 million tons of annual plastic waste
in the U.S. is currently being recycled.72
� Cargill is building the first large-scale manufacturing
plant to make soybean-based “polyols,” the building
blocks of polyurethane. The company says that the use
of polyols is a more sustainable option for manufactur-
ers of plastic and ultimately for consumers interested in
reducing their environmental footprint.73
D I S C U S S I O N Q U E S T I O N S
1. How should a corporation attempt to achieve synergy
among functions and business units?
2. How should an owner-manager prepare a company for its
movement from Stage I to Stage II?
3. How can a corporation keep from sliding into the Decline
stage of the organizational life cycle?
4. Is reengineering just another management fad, or does it
offer something of lasting value?
5. How is the cellular/modular structure different from the
network structure?
S T R A T E G I C P R A C T I C E E X E R C I S E
The Synergy Game
Yolanda Sarason and Catherine Banbury
Setup
Put three to five chairs on either side of a room, facing each
other, in the front of the class. Put a table in the middle, with a
bell in the middle of the table.
Procedure
The instructor/moderator divides the class into teams of three to
five people. Each team selects a name for itself. The instructor/
moderator lists the team names on the board. The first two
teams come to the front and sit in the chairs facing each other.
The instructor/moderator reads a list of products or services
being provided by an actual company. The winning team must
CHAPTER 9 Strategy Implementation: Organizing for Action 297
identify (1) possible sources of synergy and (2) the actual com-
pany being described. For example, if the products/services
listed are family restaurants, airline catering, hotels, and retire-
ment centers, the synergy is standardized food service and
hospitality settings and the company is The Marriott Corpo-
ration. The first team to successfully name the company and
the synergy wins the round.
After one practice session, the game begins. Each of the
teams is free to discuss the question with other team mem-
bers. When one of the two teams thinks that it has the answer
to both parts of the question, it must be the first to ring the bell
in order to announce its answer. If it gives the correct answer,
it is deemed the winner of round one. Both parts of the answer
must be given for a team to have the correct answer. If a team
correctly provides only one part, that answer is still wrong—
no partial credit. The instructor/moderator does not say which
part of the answer, if either, was correct. The second team
then has the opportunity to state the answer. If the second
team is wrong, both teams may try once more. If neither
chooses to try again, the instructor/moderator may (1) declare
no round winner and both teams sit down, (2) allow the next
two teams to provide the answer to round one, or (3) go on to
the next round with the same two teams. Two new teams then
come to the front for the next round. Once all groups have
played once, the winning teams play each other. Rounds con-
tinue until there is a grand champion. The instructor should
provide a suitable prize, such as candy bars, for the winning
team.
Note from Wheelen and Hunger
The Instructors’ Manual for this book contains a list of prod-
ucts and services with their synergy and the name of the com-
pany. In case your instructor does not use this exercise, try the
following examples:
Example 1: Motorcycles, autos, lawn mowers, generators
Example 2: Athletic footwear, Rockport shoes, Greg
Norman clothing, sportswear
For each example, did you guess the company providing
these products/services and the synergy obtained? The answers
are printed here, upside-down:
K E Y T E R M S
budget (p. 276)
cellular organization (p. 288)
geographic-area structure (p. 295)
job design (p. 290)
matrix of change (p. 274)
matrix structure (p. 285)
multinational corporation (MNC) (p. 291)
network structure (p. 287)
organizational life cycle (p. 283)
procedure (p. 276)
product-group structure (p. 295)
program (p. 274)
reengineering (p. 288)
Six Sigma (p. 289)
stages of corporate development (p. 280)
stages of international development
(p. 293)
strategy implementation (p. 272)
structure follows strategy (p. 279)
synergy (p. 278)
virtual organization (p. 287)
N O T E S
1. A. Bianco, M. Der Hovanesian, L. Young, and P. Gogoi, “Wal-
Mart’s Midlife Crisis,” Business Week (April 30, 2007),
pp. 46–56; “The Bulldozer of Bentonville Slows,” The Econo-
mist (February 17, 2007), p. 64; D. Kirkpatrick, “Microsoft’s
New Brain,” Fortune (May 1, 2006), pp. 56–68; “Spot the Di-
nosaur,” The Economist (April 1, 2006), pp. 53–54; J. Greene,
“Microsoft’s Midlife Crisis,” Business Week (April 19, 2004),
pp. 88–98.
2. M. S. Olson, D. van Bever, and S. Verry, “When Growth Stalls,”
Harvard Business Review (March 2008), pp. 50–61. This phe-
nomenon was called the “burnout syndrome” by G. Probst and
S. Raisch in “Organizational Crisis: The Logic of Failure,”
Academy of Management Executive (February 2005),
pp. 90–105.
3. Ibid.
4. J. W. Gadella, “Avoiding Expensive Mistakes in Capital Invest-
ment,” Long Range Planning (April 1994), pp. 103–110; B. Voss,
“World Market Is Not for Everyone,” Journal of Business Strat-
egy (July/August 1993), p. 4.
5. A. Bert, T. MacDonald, and T. Herd, “Two Merger Integration
Imperatives: Urgency and Execution,” Strategy & Leadership,
Vol. 31, No. 3 (2003), pp. 42–49.
6. L. D. Alexander, “Strategy Implementation: Nature of the Prob-
lem,” International Review of Strategic Management, Vol. 2, No. 1,
edited by D. E. Hussey (New York: John Wiley & Sons, 1991),
pp. 73–113. See also L. G. Hrebiniak, “Obstacles to Effective Strat-
egy Implementation,” Organizational Dynamics, Vol. 35, Issue 1
(2006), pp. 12–31 for six obstacles to implementation.
SOURCE: This exercise was developed by Professors Yolanda
Sarason of Colorado State University and Catherine Banbury of St.
Mary’s College and Purdue University and presented at the
Organizational Behavior Teaching Conference, June 1999. Copyright
© 1999 by Yolanda Sarason and Catherine Banbury. Adapted with
permission.
Example 1: Engine technology by Honda
Example 2: Marketing and distribution for the athletically-
oriented by Reebok
7. L. G. Hrebiniak (2006).
8. F. Arner and A. Aston, “How Xerox Got Up to Speed,” Business
Week (May 3, 2004), pp. 103–104.
9. J. Darragh and A. Campbell, “Why Corporate Initiatives Get
Stuck?” Long Range Planning (February 2001), pp. 33–52.
10. E. Brynjolfsson, A. A. Renshaw, and M. Van Alstyne, “The Ma-
trix of Change,” Sloan Management Review (Winter 1997),
pp. 37–54.
11. “Cocoa Farming: Fair Enough?” The Economist (February 2,
2008), p. 74.
12. M. S. Feldman and B. T. Pentland, “Reconceptualizing Organi-
zational Routines as a Source of Flexibility and Change,”
Administrative Science Quarterly (March 2003), pp. 94–118.
13. S. F. Slater and E. M. Olson, “Strategy Type and Performance:
The Influence of Sales Force Management,” Strategic Manage-
ment Journal (August 2000), pp. 813–829.
14. B. Grow, “Thinking Outside the Box,” Business Week (October
25, 2004), pp. 70–72.
15. M. Goold and A. Campbell, “Desperately Seeking Synergy,”
Harvard Business Review (September–October 1998),
pp. 131–143.
16. A. D. Chandler, Strategy and Structure (Cambridge, MA: MIT
Press, 1962).
17. A. P. Sloan, Jr., My Years with General Motors (Garden City,
NY: Doubleday, 1964).
18. T. L. Amburgey and T. Dacin, “As the Left Foot Follows the Right?
The Dynamics of Strategic and Structural Change,” Academy of
Management Journal (December 1994), pp. 1427–1452; M.
Ollinger, “The Limits of Growth of the Multidivisional Firm: A
Case Study of the U.S. Oil Industry from 1930–90,” Strategic Man-
agement Journal (September 1994), pp. 503–520.
19. D. F. Jennings and S. L. Seaman, “High and Low Levels of Or-
ganizational Adaptation: An Empirical Analysis of Strategy,
Structure, and Performance,” Strategic Management Journal
(July 1994), pp. 459–475; L. Donaldson, “The Normal Science
of Structured Contingency Theory,” in Handbook of Organiza-
tion Studies, edited by S. R. Clegg, C. Hardy, and W. R. Nord
(London: Sage Publications, 1996), pp. 57–76.
20. A. K. Gupta, “SBU Strategies, Corporate-SBU Relations, and
SBU Effectiveness in Strategy Implementation,” Academy of
Management Journal (September 1987), pp. 477–500.
21. L. E. Greiner, “Evolution and Revolution As Organizations
Grow,” Harvard Business Review (May–June 1998), pp. 55–67.
This is an updated version of Greiner’s classic 1972 article.
22. K. Shimizu and M. A. Hitt, “What Constrains or Facilitates Di-
vestitures of Formerly Acquired Firms? The Effects of Organiza-
tional Inertia,” Journal of Management (February 2005),
pp. 50–72.
23. A. Weintraub, “Can Pfizer Prime the Pipeline?” Business Week
(December 31, 2007), pp. 90–91.
24. Ibid, p. 64. Although Greiner simply labeled this as the “?” cri-
sis, the term pressure-cooker seems apt.
25. J. Hamm, “Why Entrepreneurs Don’t Scale,” Harvard Business
Review (December 2002), pp. 110–115. See also C. B. Gibson
and R. M. Rottner, “The Social Foundations for Building a
Company Around an Inventor,” Organizational Dynamics,
Vol. 37, Issue 1 ( January–March 2008), pp. 21–34.
26. W. P. Barnett, “The Dynamics of Competitive Intensity,”
Administrative Science Quarterly (March 1997), pp. 128–160; D.
Miller, The Icarus Paradox: How Exceptional Companies Bring
About Their Own Downfall (New York: Harper Business, 1990).
27. D. Miller and P. H. Friesen, “A Longitudinal Study of the Cor-
porate Life Cycle,” Management Science (October 1984),
pp. 1161–1183.
28. J. L. Morrow, Jr., D. G. Sirmon, M. A. Hitt, and T. R. Holcomb,
“Creating Value in the Face of Declining Performance: Firm
Strategies and Organizational Recovery,” Strategic Manage-
ment Journal (March 2007), pp. 271–283; C. Zook, “Finding
Your Next Core Business,” Harvard Business Review
(April 2007), pp. 66–75.
29. J. P. Sheppard and S. D. Chowdhury, “Riding the Wrong Wave:
Organizational Failure as a Failed Turnaround,” Long Range
Planning (June 2005), pp. 239–260.
30. W-R. Chen and K. D. Miller, “Situational and Institutional De-
terminants of Firms’R&D Search Intensity,” Strategic Manage-
ment Journal (April 2007), pp. 369–381.
31. S. Hamm, “Kodak’s Moment of Truth,” Business Week
(February 19, 2007), pp. 42–49.
32. R. Berner, “Turning Kmart into a Cash Cow,” Business Week
(July 12, 2004), p. 81.
33. H. Tavakolian, “Bankruptcy: An Emerging Corporate Strat-
egy,” SAM Advanced Management Journal (Spring 1995),
p. 19.
34. L. G. Hrebiniak and W. F. Joyce, Implementing Strategy (New
York: Macmillan, 1984), pp. 85–86.
35. S. M. Davis and P. R. Lawrence, Matrix (Reading, MA:
Addison-Wesley, 1977), pp. 11–24.
36. J. G. March, “The Future Disposable Organizations and the
Rigidities of Imagination,” Organization (August/November
1995), p. 434.
37. M. A. Schilling and H. K. Steensma, “The Use of Modular Or-
ganizational Forms: An Industry-Level Analysis,” Academy of
Management Journal (December 2001), pp. 1149–1168.
38. M. P. Koza and A. Y. Lewin, “The Coevolution of Network Al-
liances: A Longitudinal Analysis of an International Profes-
sional Service Network,” Organization Science (September/
October 1999), pp. 638–653.
39. P. Engardio, “Mom-and-Pop Multinationals,” Business Week
(July 14 & 21, 2008), pp. 77–78.
40. For more information on managing a network organization, see
G. Lorenzoni and C Baden-Fuller, “Creating a Strategic Center
to Manage a Web of Partners,” California Management Review
(Spring 1995), pp. 146–163.
41. R. E. Miles, C. C. Snow, J. A. Mathews, G. Miles, and H. J.
Coleman, Jr., “Organizing in the Knowledge Age: Anticipating
the Cellular Form,” Academy of Management Executive
(November 1997), pp. 7–24.
42. N. Anand and R. L. Daft, “What Is the Right Organization De-
sign?” Organizational Dynamics, Vol. 36, No. 4 (2007),
pp. 329–344.
43. J. Naylor and M. Lewis, “Internal Alliances: Using Joint Ven-
tures in a Diversified Company,” Long Range Planning
(October 1997), pp. 678–688.
44. G. Hoetker, “Do Modular Products Lead to Modular Organiza-
tions?” Strategic Management Journal (June 2006),
pp. 501–518.
45. Anand and Daft, pp. 336–338.
46. Summarized from M. Hammer, “Reengineering Work: Don’t
Automate, Obliterate,” Harvard Business Review (July–August
1990), pp. 104–112.
47. D. Paper, “BPR: Creating the Conditions for Success,” Long
Range Planning (June 1998), pp. 426–435.
298 PART 4 Strategy Implementation and Control
CHAPTER 9 Strategy Implementation: Organizing for Action 299
48. S. Drew, “BPR in Financial Services: Factors for Success,”
Long Range Planning (October 1994), pp. 25–41.
49. “Do As I Say, Not As I Do,” Journal of Business Strategy
(May/June 1997), pp. 3–4.
50. L. Raymond and S. Rivard, “Determinants of Business Process
Reengineering Success in Small and Large Enterprises: An Em-
pirical Study in the Canadian Context,” Journal of Small Busi-
ness Management (January 1998), pp. 72–85.
51. K. Grint, “Reengineering History: Social Resonances and Busi-
ness Process Reengineering,” Organization (July 1994),
pp. 179–201; A. Kleiner, “Revisiting Reengineering,”
Strategy � Business (3rd Quarter 2000), pp. 27–31.
52. E. A. Hall, J. Rosenthal, and J. Wade, “How to Make Reengi-
neering Really Work,” McKinsey Quarterly (1994, No.2),
pp. 107–128.
53. M. Arndt, “Quality Isn’t Just for Widgets,” Business Week
(July 22, 2002), pp. 72–73.
54. T. M. Box, “Six Sigma Quality: Experiential Learning,” SAM
Advanced Management Journal (Winter 2006), pp. 20–23.
55. R. O. Crockett, “Six Sigma Still Pays Off at Motorola,”
Business Week (December 4, 2006), p. 50.
56. J. Welch and S. Welch, “The Six Sigma Shotgun,” Business
Week (May 21, 2007), p. 110.
57. Arndt, p. 73.
58. B. Hindo, “At 3M, A Struggle Between Efficiency and Creativ-
ity,” Business Week IN (June 11, 2007), pp. 8–16.
59. F. Arner and A. Aston, “How Xerox Got Up to Speed,” Business
Week (May 3, 2004), pp. 103–104.
60. J. Hoerr, “Sharpening Minds for a Competitive Edge,” Business
Week (December 17, 1990), pp. 72–78.
61. D. Spulberg, Global Competitive Strategy (Cambridge, UK:
Cambridge University Press, 2007), p. 257; See also A. K.
Gupta, V. Govindarajan, and H. Wang, The Quest for Global
Dominance, 2nd ed. (San Francisco: Jossey-Bass, 2007) for a
similar set of forces.
62. R. Krishnan, X. Martin, and N. G. Noorderhaven, “When Does
Trust Matter to Alliance Performance,” Academy of Manage-
ment Journal (October 2006), pp. 894–917.
63. S. X. Li and T. J. Rowley, “Inertia and Evaluation Mechanisms
in Interorganizational Partner Selection: Syndicate Formation
Among U.S. Investment Banks,” Academy of Management
Journal (December 2002), pp. 1104–1119.
64. M. U. Douma, J. Bilderbeek, P. J. Idenburg, and J. K. Loise,
“Strategic Alliances: Managing the Dynamics of Fit,” Long
Range Planning (August 2000), pp. 579–598; W. Hoffmann and
R. Schlosser, “Success Factors of Strategic Alliances in Small
and Medium-Sized Enterprises—An Empirical Survey,” Long
Range Planning (June 2001), pp. 357–381; Y. Luo, “How Im-
portant Are Shared Perceptions of Procedural Justice in Coop-
erative Alliances?” Academy of Management Journal (August
2005), pp. 695–709.
65. Alan M. Rugman, The Regional Multinationals (Cambridge,
UK: Cambridge University Press, 2005); P. Ghemawat, “Re-
gional Strategies for Global Leadership,” Harvard Business Re-
view (December 2005), pp. 98–108.
66. J. Birkinshaw, P. Braunerhjelm, U. Holm, and S. Terjesen,
“Why Do Some Multinational Corporations Relocate Their
Headquarters Overseas?” Strategic Management Journal (July
2006), pp. 681–700.
67. J. H. Taggart, “Strategy Shifts in MNC Subsidiaries,” Strategic
Management Journal (July 1998), pp. 663–681.
68. C. A. Bartlett and S. Ghoshal, “Beyond the M-Form: Toward a
Managerial Theory of the Firm,” Strategic Management Jour-
nal (Winter 1993), pp. 23–46.
69. C. Matlack, “Nestle Is Starting to Slim Down at Last,” Business
Week (October 27, 2003), pp. 56–57; “Daring, Defying to
Grow,” Economist (August 7, 2004), pp. 55–58.
70. J. Sterling, “Translating Strategy into Effective Implementa-
tion: Dispelling the Myths and Highlighting What Works,”
Strategy & Leadership, Vol. 31, No. 3 (2003), pp. 27–34.
71. “Rebirth of a Carmaker,” The Economist (April 26, 2008),
pp. 87–89.
72. M. Der Hovanesian, “I Have One Word for You: Bioplastics,”
Business Week (June 30, 2008), pp. 44–47.
73. “Cargill Begins to Build Chicago Plant,” St. Cloud (MN) Times
(July 9, 2008), p. 3A.
Have you heard of Enterprise Rent-A-Car? Hertz, Avis, and National Car Rental
operations are much more visible at airports. Yet Enterprise owns more cars and op-
erates in more locations than Hertz or Avis. Enterprise began operations in St. Louis
in 1957, but didn’t locate at an airport until 1995. It is the largest rental car com-
pany in North America, but only 230 out of its 7,000 worldwide offices are at airports.
In virtually ignoring the highly competitive airport market, Enterprise has chosen a cost-
leadership competitive strategy by marketing to people in need of a spare car at neighborhood
locations. Its offices are within 15 miles of 90% of the U.S. population. Instead of locating many
cars at a few high-priced locations at airports, Enterprise sets up inexpensive offices throughout
metropolitan areas. As a result, cars are rented for 30% less than they cost at airports. As soon
as one branch office grows to about 150 cars, the company opens another rental office a few
miles away. People are increasingly renting from Enterprise even when their current car works
fine. According to CEO Andy Taylor, “We call it a ‘virtual car.’ Small-business people who have
to pick up clients call us when they want something better than their own car.” Why is this com-
petitive strategy so successful for Enterprise even though its locations are now being imitated
by Hertz and Avis?
The secret to Enterprise’s success is its well-executed strategy implementation. Clearly laid
out programs, budgets, and procedures support the company’s competitive strategy by making
Enterprise stand out in the mind of the consumer. It was ranked on Business Week’s list of “Cus-
tomer Service Champs” in both 2007 and 2008. When a new rental office opens, employees
spend time developing relationships with the service managers of every auto dealership and
body shop in the area. Enterprise employees bring pizza and doughnuts to workers at the auto
garages across the country. Enterprise forms agreements with dealers to provide replacements
for cars brought in for service. At major accounts, the company actually staffs an office at the
dealership and has cars parked outside so customers don’t have to go to an Enterprise office to
complete paperwork.
One key to implementation at Enterprise is staffing—hiring and promoting a certain kind
of person. Virtually every Enterprise employee is a college graduate, usually from the bottom
strategy
implementation:
staffing and Directing
C H A P T E R 10
301
� Understand the link between strategy and
staffing decisions
� Match the appropriate manager to the
strategy
� Understand how to implement an
effective downsizing program
� Discuss important issues in effectively
staffing and directing international
expansion
� Assess and manage the corporate culture’s
fit with a new strategy
� Decide when and if programs such as MBO
and TQM are appropriate methods of
strategy implementation
� Formulate action plans
Learning Objectives
Gathering
Information
Putting Strategy
into Action
Monitoring
Performance
Societal
Environment:
General forces
Natural
Environment:
Resources and
climate
Task
Environment:
Industry analysis
Internal:
Strengths and
Weaknesses
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
Programs
Activities
needed to
accomplish
a plan
Budgets
Cost of the
programs Procedures
Sequence
of steps
needed to
do the job
Performance
Actual results
External:
Opportunities
and Threats
Developing
Long-range Plans
Mission
Reason for
existence Objectives
What
results to
accomplish
by when
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Environmental
Scanning:
Strategy
Formulation:
Strategy
Implementation:
Evaluation
and Control:
Feedback/Learning: Make corrections as needed
After reading this chapter, you should be able to:
10.1 Staffing
The implementation of new strategies and policies often calls for new human resource man-
agement priorities and a different use of personnel. Such staffing issues can involve hiring new
people with new skills, firing people with inappropriate or substandard skills, and/or training
existing employees to learn new skills. Research demonstrates that companies with enlight-
ened talent-management policies and programs have higher returns on sales, investments,
assets, and equity.2 This is especially important given that it takes an average of 48 days for an
American company to fill a job vacancy at an average cost per hire of $3,270.3
If growth strategies are to be implemented, new people may need to be hired and trained.
Experienced people with the necessary skills need to be found for promotion to newly created
managerial positions. When a corporation follows a growth through acquisition strategy, it
may find that it needs to replace several managers in the acquired company. The percentage
of an acquired company’s top management team that either quit or was asked to leave is
around 25% after the first year, 35% after the second year, 48% after the third year, 55% after
the fourth year, and 61% after five years.4 In addition, executives who join an acquired com-
pany after the acquisition quit at significantly higher-than-normal rates beginning in their sec-
ond year. Executives continue to depart at higher-than-normal rates for nine years after the
half of the class. According to COO Donald Ross, “We hire from the half of the college class
that makes the upper half possible. We want athletes, fraternity types—especially frater-
nity presidents and social directors. People people.” These new employees begin as man-
agement trainees. Instead of regular raises, their pay is tied to branch office profits.
Another key to implementation at Enterprise is leading—specifying clear perfor-
mance objectives and promoting a team-oriented corporate culture. The company stresses
promotion from within and advancement based on performance. Every Enterprise em-
ployee, including top executives, starts at the bottom. As a result, a bond of shared expe-
rience connects all employees and managers. Enterprise was included in Business Week’s
“50 Best Places to Launch a Career” three years in a row. To reinforce a cohesive culture
of camaraderie, senior executives routinely do “grunt work” at branch offices. Even Andy
Taylor, the CEO, joins the work. “We were visiting an office in Berkeley and it was mobbed,
so I started cleaning cars,” says Taylor. “As it was happening, I wondered if it was a good
use of my time, but the effect on morale was tremendous.” Because the financial results
of every branch office and every region are available to all, the collegial culture stimulates
good-natured competition. “We’re this close to beating out Middlesex,” grins Woody
Erhardt, an area manager in New Jersey. “I want to pound them into the ground. If they
lose, they have to throw a party for us, and we get to decide what they wear.”1
This example from Enterprise Rent-A-Car illustrates how a strategy must be imple-
mented with carefully considered programs in order to succeed. This chapter discusses
strategy implementation in terms of staffing and leading. Staffing focuses on the selec-
tion and use of employees. Leading emphasizes the use of programs to better align em-
ployee interests and attitudes with a new strategy.
302 PART 4 Strategy Implementation and Control
CHAPTER 10 Strategy Implementation: Staffing and Directing 303
acquisition.5 Turnover rates of executives in firms acquired by foreign firms are significantly
higher than for firms acquired by domestic firms, primarily in the fourth and fifth years after
the acquisition.6
It is one thing to lose excess employees after a merger, but it is something else to lose
highly skilled people who are difficult to replace. In a study of 40 mergers, 90% of the acquir-
ing companies in the 15 successful mergers identified key employees and targeted them for
retention within 30 days after the announcement. In contrast, this task was carried out only in
one-third of the unsuccessful acquisitions.7 To deal with integration issues such as these, some
companies are appointing special integration managers to shepherd companies through the im-
plementation process. The job of the integrator is to prepare a competitive profile of the com-
bined company in terms of its strengths and weaknesses, draft an ideal profile of what the
combined company should look like, develop action plans to close the gap between the actu-
ality and the ideal, and establish training programs to unite the combined company and to make
it more competitive.8 To be a successful integration manager, a person should have (1) a deep
knowledge of the acquiring company, (2) a flexible management style, (3) an ability to work
in cross-functional project teams, (4) a willingness to work independently, and (5) sufficient
emotional and cultural intelligence to work well with people from all backgrounds.9
If a corporation adopts a retrenchment strategy, however, a large number of people may
need to be laid off or fired (in many instances, being laid off is the same as being fired); and
top management, as well as the divisional managers, needs to specify the criteria to be used in
making these personnel decisions. Should employees be fired on the basis of low seniority or
on the basis of poor performance? Sometimes corporations find it easier to close or sell off an
entire division than to choose which individuals to fire.
As in the case of structure, staffing requirements are likely to follow a change in strategy. For
example, promotions should be based not only on current job performance but also on whether
a person has the skills and abilities to do what is needed to implement the new strategy.
Changing Hiring and Training Requirements
Having formulated a new strategy, a corporation may find that it needs to either hire different
people or retrain current employees to implement the new strategy. Consider the introduction
of team-based production at Corning’s filter plant mentioned in Chapter 9. Employee selec-
tion and training were crucial to the success of the new manufacturing strategy. Plant Manager
Robert Hoover sorted through 8,000 job applications before hiring 150 people with the best
problem-solving ability and a willingness to work in a team setting. Those selected received
extensive training in technical and interpersonal skills. During the first year of production,
25% of all hours worked were devoted to training, at a cost of $750,000.10
One way to implement a company’s business strategy, such as overall low cost, is through
training and development. According to the American Society of Training and Development,
the average annual expenditure per employee on corporate training and development is $1,000
per employee.11 A study of 51 corporations in the UK found that 71% of “leading” companies
rated staff learning and training as important or very important compared to 62% of the other
companies.12 Another study of 155 U. S. manufacturing firms revealed that those with train-
ing programs had 19% higher productivity than did those without such programs. Another
study found that a doubling of formal training per employee resulted in a 7% reduction in
scrap.13 Training is especially important for a differentiation strategy emphasizing quality or
customer service. For example, Motorola, with annual sales of $17 billion, spends 4% of its
payroll on training by providing at least 40 hours of training a year to each employee. There
STAFFING FOLLOWS STRATEGY
304 PART 4 Strategy Implementation and Control
is a very strong connection between strategy and training at Motorola. For example, after set-
ting a goal to reduce product development cycle time, Motorola created a two-week course to
teach its employees how to accomplish that goal. It brought together marketing, product de-
velopment, and manufacturing managers to create an action learning format in which the man-
agers worked together instead of separately. The company is especially concerned with
attaining the highest quality possible in all its operations. Realizing that it couldn’t hit quality
targets with poor parts, Motorola developed a class for its suppliers on statistical process con-
trol. The company estimates that every $1 it spends on training delivers $30 in productivity
gains within three years.14
Training is also important when implementing a retrenchment strategy. As suggested ear-
lier, successful downsizing means that a company has to invest in its remaining employees.
General Electric’s Aircraft Engine Group used training to maintain its share of the market even
though it had cut its workforce from 42,000 to 33,000 in the 1990s.15
Matching the Manager to the Strategy
Executive characteristics influence strategic outcomes for a corporation.16 It is possible that a
current CEO may not be appropriate to implement a new strategy. Research indicates that there
may be a career life cycle for top executives. During the early years of executives’ tenure, for
example, they tend to experiment intensively with product lines to learn about their business.
This is their learning stage. Later, their accumulated knowledge allows them to reduce exper-
imentation and increase performance. This is their harvest stage. They enter a decline stage in
their later years, when they reduce experimentation still further, and performance declines.
Thus, there is an inverted U-shaped relationship between top executive tenure and the firm’s
financial performance. Some executives retire before any decline occurs. Others stave off de-
cline longer than their counterparts. Because the length of time spent in each stage varies
among CEOs, it is up to the board to decide when a top executive should be replaced.17
The most appropriate type of general manager needed to effectively implement a new cor-
porate or business strategy depends on the desired strategic direction of that firm or business
unit. Executives with a particular mix of skills and experiences may be classified as an
executive type and paired with a specific corporate strategy. For example, a corporation fol-
lowing a concentration strategy emphasizing vertical or horizontal growth would probably
want an aggressive new chief executive with a great deal of experience in that particular in-
dustry—a dynamic industry expert. A diversification strategy, in contrast, might call for some-
one with an analytical mind who is highly knowledgeable in other industries and can manage
diverse product lines—an analytical portfolio manager. A corporation choosing to follow a
stability strategy would probably want as its CEO a cautious profit planner, a person with a
conservative style, a production or engineering background, and experience with controlling
budgets, capital expenditures, inventories, and standardization procedures.
Weak companies in a relatively attractive industry tend to turn to a type of challenge-
oriented executive known as a turnaround specialist to save the company. For example, when
former IHOP (International House of Pancakes) waitress Julia Stewart left Applebee’s restau-
rant chain to become CEO of IHOP, she worked to rebuild the company with better food,
better ads, and better atmosphere. Six years later, a much improved IHOP acquired the strug-
gling Applebee’s restaurant chain. CEO Stewart vowed to turnaround Applebee’s within a year
by improving service, food quality and focusing the menu on what the restaurant does best:
riblets, burgers, and salads. She wanted Applebee’s to again be the friendly, neighborhood bar
and grill that it once was.18
If a company cannot be saved, a professional liquidator might be called on by a bankruptcy
court to close the firm and liquidate its assets. This is what happened to Montgomery Ward, Inc.,
the nation’s first catalog retailer, which closed its stores for good in 2001, after declaring
CHAPTER 10 Strategy Implementation: Staffing and Directing 305
bankruptcy for the second time.19 Research tends to support the conclusion that as a firm’s en-
vironment changes, it tends to change the type of top executive to implement a new strategy.20
For example, during the 1990s when the emphasis was on growth in a company’s core
products/services, the most desired background for a U.S. CEO was either in marketing or in-
ternational experience. With the current decade’s emphasis on mergers, acquisitions, and di-
vestitures, the most desired background is finance. Currently, one out of five American and UK
CEOs are former Chief Financial Officers, twice the percentage during the previous decade.21
This approach is in agreement with Chandler, who proposes (see Chapter 9) that the most
appropriate CEO of a company changes as a firm moves from one stage of development to an-
other. Because priorities certainly change over an organization’s life, successful corporations
need to select managers who have skills and characteristics appropriate to the organization’s
particular stage of development and position in its life cycle. For example, founders of firms
tend to have functional backgrounds in technological specialties, whereas successors tend to
have backgrounds in marketing and administration.22 A change in the environment leading to
a change in a company’s strategy also leads to a change in the top management team. For ex-
ample, a change in the U.S. utility industry’s environment in 1992 supporting internally fo-
cused, efficiency-oriented strategies, led to top management teams being dominated by older
managers with longer company and industry tenure, with efficiency-oriented backgrounds in
operations, engineering, and accounting.23 Research reveals that executives having a specific
personality characteristic (external locus of control) are more effective in regulated industries
than are executives with a different characteristic (internal locus of control).24
Other studies have found a link between the type of CEO and a firm’s overall strategic
type. (Strategic types were presented in Chapter 4). For example, successful prospector firms
tended to be headed by CEOs from research/engineering and general management back-
grounds. High performance defenders tended to have CEOs with accounting/finance, manu-
facturing/production, and general management experience. Analyzers tended to have CEOs
with a marketing/sales background.25
A study of 173 firms over a 25-year period revealed that CEOs in these companies tended
to have the same functional specialization as the former CEO, especially when the past CEO’s
strategy continued to be successful. This may be a pattern for successful corporations.26 In par-
ticular, it explains why so many prosperous companies tend to recruit their top executives from
one particular area. At Procter & Gamble (P&G)—a good example of an analyzer firm—for
example, the route to the CEO’s position has traditionally been through brand management,
with a strong emphasis on marketing—and more recently international experience. In other
firms, the route may be through manufacturing, marketing, accounting, or finance—depend-
ing on what the corporation has always considered its core capability (and its overall strategic
orientation).
SELECTION AND MANAGEMENT DEVELOPMENT
Selection and development are important not only to ensure that people with the right mix of
skills and experiences are initially hired but also to help them grow on the job so that they
might be prepared for future promotions.
Executive Succession: Insiders versus Outsiders
Executive succession is the process of replacing a key top manager. The average tenure of a
chief executive of a large U.S. company declined from nearly nine years in 1980 to six years in
2006.27 Given that two-thirds of all major corporations worldwide replace their CEO at least
once in a five-year period, it is important that the firm plan for this eventuality.28 It is especially
important for a company that usually promotes from within to prepare its current managers for
Hewlett-Packard identifies
those with high potential for
executive leadership by look-
ing for six broad competencies
that the company believes are
necessary:
1. Practice the HP Way by building trust and respect,
focusing on achievement, demonstrating integrity,
being innovative with customers, contributing to the
community, and developing organizational decision
making.
2. Lead change and learning by recognizing and acting
on signals for change, leading organizational
change, learning from organizational experience,
removing barriers to change, developing self, and
challenging and developing others.
3. Know the internal and external environments by
anticipating global trends, acting on trends, and
learning from others.
STRATEGY highlight 10.1
HOW HEWLETT-PACKARD IDENTIFIES POTENTIAL EXECUTIVES
4. Lead strategy setting by inspiring breakthrough
business strategy, leading the strategy-making
process, committing to business vision, creating
long-range strategies, building financial strategies,
and defining a business-planning system.
5. Align the organization by working across
boundaries, implementing competitive cost
structures, developing alliances and partnerships,
planning and managing core business, and designing
the organization.
6. Achieve results by building a track record,
establishing accountability, supporting calculated
risks, making tough individual decisions, and
resolving performance problems.
SOURCE: Summarized from R. M. Fulmer, P. A. Gibbs, and
M. Goldsmith, “The New HP Way: Leveraging Strategy with Diver-
sity, Leadership Development and Decentralization,” Strategy &
Leadership (October/November/December, 1999), pp. 21–29.
promotion. For example, companies using relay executive succession, in which a candidate is
groomed to take over the CEO position, have significantly higher performance than those that
hire someone from the outside or hold a competition between internal candidates.29 These “heirs
apparent” are provided special assignments including membership on other firms’ boards of di-
rectors.30 Nevertheless, only half of large U.S. companies have CEO succession plans in place.31
Companies known for being excellent training grounds for executive talent are AlliedSig-
nal, Bain & Company, Bankers Trust, Bristol Myers Squibb, Cititcorp, General Electric,
Hewlett-Packard, McDonald’s, McKinsey & Company, Microsoft, Nike, PepsiCo, Pfizer, and
P&G. For example, one study showed that hiring 19 GE executives into CEO positions added
$24.5 billion to the share prices of the companies that hired them. One year after people from
GE started their new jobs, 11 of the 19 companies they joined were outperforming their com-
petitors and the overall market.32
Some of the best practices for top management succession are encouraging boards to help
the CEO create a succession plan, identifying succession candidates below the top layer, mea-
suring internal candidates against outside candidates to ensure the development of a comprehen-
sive set of skills, and providing appropriate financial incentives.33 Succession planning has
become the most important topic discussed by boards of directors.34 See Strategy Highlight 10.1
to see how Hewlett-Packard identifies those with potential for executive leadership positions.
Prosperous firms tend to look outside for CEO candidates only if they have no obvious
internal candidates.35 For example, 85% of the CEOs selected to run S&P 500 companies in
2006 were insiders, according to executive search firm Spencer Stuart.36 Hiring an outsider to
be a CEO is a risky gamble. CEOs from the outside tend to introduce significant change and
high turnover among the current top management.37 For example, in one study, the percentage
of senior executives that left a firm after a new CEO took office was 20% when the new CEO
306 PART 4 Strategy Implementation and Control
CHAPTER 10 Strategy Implementation: Staffing and Directing 307
was an insider, but increased to 34% when the new CEO was an outsider.38 CEOs hired from
outside the firm tend to have a low survival rate. According to RHR International, 40% to
60% of high-level executives brought in from outside a company failed within two years.39 A
study of 392 large U.S. firms revealed that only 16.6% of them had hired outsiders to be their
CEOs. The outsiders tended to perform slightly worse than insiders but had a very high vari-
ance in performance. Compared to that of insiders, the performance of outsiders tended to be
either very good or very poor. Although outsiders performed much better (in terms of share-
holder returns) than insiders in the first half of their tenures, they did much worse in their sec-
ond half. As a result, the average tenure of an outsider was significantly less than for insiders.40
Firms in trouble, however, overwhelmingly choose outsiders to lead them.41 For example,
one study of 22 firms undertaking turnaround strategies over a 13-year period found that the
CEO was replaced in all but two companies. Of 27 changes of CEO (several firms had more
than one CEO during this period), only seven were insiders—20 were outsiders.42 The proba-
bility of an outsider being chosen to lead a firm in difficulty increases if there is no internal heir
apparent, if the last CEO was fired, and if the board of directors is composed of a large percent-
age of outsiders.43 Boards realize that the best way to force a change in strategy is to hire a new
CEO who has no connections to the current strategy.44 For example, outsiders have been found
to be very effective in leading strategic change for firms in Chapter 11 bankruptcy.45
Identifying Abilities and Potential
A company can identify and prepare its people for important positions in several ways. One
approach is to establish a sound performance appraisal system to identify good performers
with promotion potential. A survey of 34 corporate planners and human resource executives
from 24 large U.S. corporations revealed that approximately 80% made some attempt to iden-
tify managers’ talents and behavioral tendencies so that they could place a manager with a
likely fit to a given competitive strategy.46 Companies select those people with promotion po-
tential to be in their executive development training program. Approximately 10,000 of GE’s
276,000 employees take at least one class at the company’s famous Leadership Development
Center in Crotonville, New York.47 Doug Pelino, chief talent officer at Xerox, keeps a list of
about 100 managers in middle management and at the vice presidential levels who have been
selected to receive special training, leadership experience, and mentorship to become the next
generation of top management.48
A company should examine its human resource system to ensure not only that people are
being hired without regard to their racial, ethnic, or religious background, but also that they
are being identified for training and promotion in the same manner. Management diversity
could be a competitive advantage in a multi-ethnic world. With more women in the workplace,
an increasing number are moving into top management, but are demanding more flexible ca-
reer ladders to allow for family responsibilities.
Many large organizations are using assessment centers to evaluate a person’s suitability
for an advanced position. Corporations such as AT&T, Standard Oil, IBM, Sears, and GE have
successfully used assessment centers. Because each is specifically tailored to its corporation,
these assessment centers are unique. They use special interviews, management games, in-basket
exercises, leaderless group discussions, case analyses, decision-making exercises, and oral
presentations to assess the potential of employees for specific positions. Promotions into these
positions are based on performance levels in the assessment center. Assessment centers have
generally been able to accurately predict subsequent job performance and career success.49
Job rotation—moving people from one job to another—is also used in many large corpo-
rations to ensure that employees are gaining the appropriate mix of experiences to prepare
them for future responsibilities. Rotating people among divisions is one way that a corpora-
tion can improve the level of organizational learning. General Electric, for example, routinely
308 PART 4 Strategy Implementation and Control
rotates its executives from one sector to a completely different one to learn the skills of man-
aging in different industries. Jeffrey Immelt, who took over as CEO from Jack Welch, had
managed businesses in plastics, appliances, and medical systems.50 Companies that pursue re-
lated diversification strategies through internal development make greater use of interdivi-
sional transfers of people than do companies that grow through unrelated acquisitions.
Apparently, the companies that grow internally attempt to transfer important knowledge and
skills throughout the corporation in order to achieve some sort of synergy.51
PROBLEMS IN RETRENCHMENT
On January 28, 2009, Starbucks announced that it was closing 300 stores in addition to the 600
closures it had announced earlier and thus reduce its workforce by 7,000 people. Meanwhile,
Hershey Foods closed six plants in the U.S. and Canada and eliminated 3,000 U.S. jobs. Like
other companies at the time, both firms were experiencing declining sales and profits and at-
tempting to cut costs. Due to a poor economy, more than 2.1 million U.S. workers were laid
off in 2008. Downsizing (sometimes called “rightsizing” or “resizing”) refers to the planned
elimination of positions or jobs. This program is often used to implement retrenchment strate-
gies. Because the financial community is likely to react favorably to announcements of down-
sizing from a company in difficulty, such a program may provide some short-term benefits
such as raising the company’s stock price. If not done properly, however, downsizing may re-
sult in less, rather than more, productivity. One study found that a 10% reduction in people re-
sulted in only a 1.5% reduction in costs, profits increased in only half the firms downsizing,
and the stock prices of downsized firms increased over three years, but not as much as did
those of firms that did not downsize.52 Why were the results so marginal?
A study of downsizing at automobile-related U.S. industrial companies revealed that at 20
out of 30 companies, either the wrong jobs were eliminated or blanket offers of early retirement
prompted managers, even those considered invaluable, to leave. After the layoffs, the remain-
ing employees had to do not only their work but also the work of the people who had gone. Be-
cause the survivors often didn’t know how to do the departeds’ work, morale and productivity
plummeted.53 Downsizing can seriously damage the learning capacity of organizations.54 Cre-
ativity drops significantly (affecting new product development), and it becomes very difficult
to keep high performers from leaving the company.55 In addition, cost-conscious executives tend
to defer maintenance, skimp on training, delay new product introductions, and avoid risky new
businesses—all of which leads to lower sales and eventually to lower profits.56 These are some
of the reasons why layoffs worry customers and have a negative effect on a firm’s reputation.57
A good retrenchment strategy can thus be implemented well in terms of organizing but
poorly in terms of staffing. A situation can develop in which retrenchment feeds on itself and
acts to further weaken instead of strengthen the company. Research indicates that companies
undertaking cost-cutting programs are four times more likely than others to cut costs again,
typically by reducing staff.58 This happened at Eastman Kodak, Xerox, Ford, and General Mo-
tors during the 1990s, but 10 years later the companies were still downsizing and working to
regain their profitable past performance. In contrast, successful downsizing firms undertake a
strategic reorientation, not just a bloodletting of employees. Research shows that when com-
panies use downsizing as part of a larger restructuring program to narrow company focus, they
enjoy better performance.59
Consider the following guidelines that have been proposed for successful downsizing:
� Eliminate unnecessary work instead of making across-the-board cuts: Spend the time
to research where money is going and eliminate the task, not the workers, if it doesn’t add
value to what the firm is producing. Reduce the number of administrative levels rather
CHAPTER 10 Strategy Implementation: Staffing and Directing 309
than the number of individual positions. Look for interdependent relationships before
eliminating activities. Identify and protect core competencies.
� Contract out work that others can do cheaper: For example, Bankers Trust of New
York contracted out its mailroom and printing services and some of its payroll and ac-
counts payable activities to a division of Xerox. Outsourcing may be cheaper than verti-
cal integration.
� Plan for long-run efficiencies: Don’t simply eliminate all postponable expenses, such
as maintenance, R&D, and advertising, in the unjustifiable hope that the environment
will become more supportive. Continue to hire, grow, and develop—particularly in crit-
ical areas.
� Communicate the reasons for actions: Tell employees not only why the company is
downsizing but also what the company is trying to achieve. Promote educational programs.
� Invest in the remaining employees: Because most “survivors” in a corporate downsizing
will probably be doing different tasks from what they were doing before the change, firms
need to draft new job specifications, performance standards, appraisal techniques, and
compensation packages. Additional training is needed to ensure that everyone has the
proper skills to deal with expanded jobs and responsibilities. Empower key individuals/
groups and emphasize team building. Identify, protect, and mentor people who have lead-
ership talent.
� Develop value-added jobs to balance out job elimination: When no other jobs are cur-
rently available within the organization to transfer employees to, management must con-
sider other staffing alternatives. For example, Harley-Davidson worked with the
company’s unions to find other work for surplus employees by moving into Harley plants
work that had previously been done by suppliers.60
INTERNATIONAL ISSUES IN STAFFING
Implementing a strategy of international expansion takes a lot of planning and can be very ex-
pensive. Nearly 80% of midsize and larger companies send their employees abroad, and 45%
plan to increase the number they have on foreign assignment. A complete package for one ex-
ecutive working in another country costs from $300,000 to $1 million annually. Nevertheless,
between 10% and 20% of all U.S. managers sent abroad returned early because of job dissat-
isfaction or difficulties in adjusting to a foreign country. Of those who stayed for the duration
of their assignment, nearly one-third did not perform as well as expected. One-fourth of those
completing an assignment left their company within one year of returning home—often leav-
ing to join a competitor.61 One common mistake is failing to educate the person about the cus-
toms and values in other countries.
Because of cultural differences, managerial style and human resource practices must be
tailored to fit the particular situations in other countries. Because only 11% of human resource
managers have ever worked abroad, most have little understanding of a global assignment’s
unique personal and professional challenges and thus fail to develop the training necessary for
such an assignment.62 Ninety percent of companies select employees for an international as-
signment based on their technical expertise while ignoring other areas.63 A lack of knowledge
of national and ethnic differences can make managing an international operation extremely
difficult. For example, the three ethnic groups living in Malaysia (Malay, Chinese, and Indian)
share different religions, attend different schools, and do not like to work in the same factories
with each other. Because of the importance of cultural distinctions such as these, multinational
corporations (MNCs) are now putting more emphasis on intercultural training for managers
310 PART 4 Strategy Implementation and Control
being sent on an assignment to a foreign country. This type of training is one of the commonly
cited reasons for the lower expatriate failure rates—6% or less—for European and Japanese
MNCs, which have emphasized cross-cultural experiences, compared with a 35% failure rate
for U.S.-based MNCs.64
To improve organizational learning, many MNCs are providing their managers with in-
ternational assignments lasting as long as five years. Upon their return to headquarters, these
expatriates have an in-depth understanding of the company’s operations in another part of the
world. This has value to the extent that these employees communicate this understanding to
others in decision-making positions. Research indicates that an MNC performs at a higher
level when its CEO has international experience.65 Global MNCs, in particular, emphasize in-
ternational experience, have a greater number of senior managers who have been expatriates,
and have a strong focus on leadership development through the expatriate experience.66
Unfortunately, not all corporations appropriately manage international assignments. While out
of the country, a person may be overlooked for an important promotion (out of sight, out of
mind). Upon his or her return to the home country, co-workers may deprecate the out-of
country experience as a waste of time. The perceived lack of organizational support for interna-
tional assignments increases the likelihood that an expatriate will return home early.67
From their study of 750 U.S., Japanese, and European companies, Black and Gregersen
found that the companies that do a good job of managing foreign assignments follow three
general practices:
� When making international assignments, they focus on transferring knowledge and devel-
oping global leadership.
� They make foreign assignments to people whose technical skills are matched or exceeded
by their cross-cultural abilities.
� They end foreign assignments with a deliberate repatriation process, with career guidance
and jobs where the employees can apply what they learned in their assignments.68
Once a corporation has established itself in another country, it hires and promotes people
from the host country into higher-level positions. For example, most large MNCs attempt to
fill managerial positions in their subsidiaries with well-qualified citizens of the host countries.
Unilever and IBM have traditionally taken this approach to international staffing. This policy
serves to placate nationalistic governments and to better attune management practices to the
host country’s culture. The danger in using primarily foreign nationals to staff managerial po-
sitions in subsidiaries is the increased likelihood of suboptimization (the local subsidiary ig-
nores the needs of the larger parent corporation). This makes it difficult for an MNC to meet
its long-term, worldwide objectives. To a local national in an MNC subsidiary, the corporation
as a whole is an abstraction. Communication and coordination across subsidiaries become
more difficult. As it becomes harder to coordinate the activities of several international sub-
sidiaries, an MNC will have serious problems operating in a global industry.
Another approach to staffing the managerial positions of MNCs is to use people with an
“international” orientation, regardless of their country of origin or host country assignment.
This is a widespread practice among European firms. For example, Electrolux, a Swedish firm,
had a French director in its Singapore factory. Using third-country “nationals” can allow for
more opportunities for promotion than does Unilever’s policy of hiring local people, but it can
also result in more misunderstandings and conflicts with the local employees and with the host
country’s government.
Some corporations take advantage of immigrants and their children to staff key positions
when negotiating entry into another country and when selecting an executive to manage the
company’s new foreign operations. For example, when General Motors wanted to learn more
about business opportunities in China, it turned to Shirley Young, a Vice President of Marketing
CHAPTER 10 Strategy Implementation: Staffing and Directing 311
at GM. Born in Shanghai and fluent in Chinese language and customs, Young was instrumen-
tal in helping GM negotiate a $1 billion joint venture with Shanghai Automotive to build a
Buick plant in China. With other Chinese-Americans, Young formed a committee to advise
GM on relations with China. Although just a part of a larger team of GM employees working
on the joint venture, Young coached GM employees on Chinese customs and traditions.69
MNCs with a high level of international interdependence among activities need to pro-
vide their managers with significant international assignments and experiences as part of their
training and development. Such assignments provide future corporate leaders with a series of
valuable international contacts in additional to a better personal understanding of international
issues and global linkages among corporate activities.70 Research reveals that corporations us-
ing cross-national teams, whose members have international experience and communicate fre-
quently with overseas managers, have greater product development capabilities than others.71
Executive recruiters report that more major corporations are now requiring candidates to have
international experience.72 To increase its own top management’s global expertise, Cisco Sys-
tems introduced a staffing program in 2007 with the objective of locating 20% of its senior
managers at its new Bangalore, India, Globalization Center by 2010.73
Since an increasing number of multinational corporations are primarily organized around
business units and product lines instead of geographic areas, product and SBU managers who
are based at corporate headquarters are often traveling around the world to work personally
with country managers. These managers and other mobile workers are being called stealth ex-
patriates because they are either cross-border commuters (especially in the EU) or the acci-
dental expatriate who goes on many business trips or temporary assignments due to offshoring
and/or international joint ventures.74
10.2 Leading
Implementation also involves leading through coaching people to use their abilities and skills
most effectively and efficiently to achieve organizational objectives. Without direction, peo-
ple tend to do their work according to their personal view of what tasks should be done, how,
and in what order. They may approach their work as they have in the past or emphasize those
tasks that they most enjoy—regardless of the corporation’s priorities. This can create real prob-
lems, particularly if the company is operating internationally and must adjust to customs and
traditions in other countries. This direction may take the form of management leadership, com-
municated norms of behavior from the corporate culture, or agreements among workers in au-
tonomous work groups. It may be accomplished more formally through action planning or
through programs, such as Management By Objectives and Total Quality Management. Pro-
cedures can be changed to provide incentives to motivate employees to align their behavior
with corporate objectives. For an example of Abbott Laboratories’ new procedures to motivate
employees to drive carbon neutral autos, see the Environmental Sustainability Issue feature.
MANAGING CORPORATE CULTURE
Because an organization’s culture can exert a powerful influence on the behavior of all em-
ployees, it can strongly affect a company’s ability to shift its strategic direction. A problem for
a strong culture is that a change in mission, objectives, strategies, or policies is not likely to be
successful if it is in opposition to the accepted culture of the company. Corporate culture has
a strong tendency to resist change because its very reason for existence often rests on preserv-
ing stable relationships and patterns of behavior. For example, when Robert Nardelli became
Abbott Laboratories, which
provides its sales staff with
6,000 vehicles, has changed its
procedures for mileage reimburse-
ment in order to make its car fleet more carbon neutral.
Under previous rules, Abbott’s employees reimbursed the
company for personal use of company cars at 17.3¢ per
mile. Starting January 2009, those choosing SUVs were re-
312 PART 4 Strategy Implementation and Control
ABBOTT LABORATORIES’ NEW PROCEDURES
FOR GREENER COMPANY CARS
ENVIRONMENTAL sustainability issue
quired to pay 72.3¢ per mile. As a result, 48% of the sales
reps selected sedans compared to only 25% in 2008. Re-
quests for SUVs dropped from 44% of the sales reps the
previous year to 29% in 2009. Requests for hybrid autos
increased from 6% in 2008 to 18% in 2009.
SOURCE: Summarized from D. Kiley, “Steering Workers into the
Green Lane,” Business Week (October 27, 2008), p. 18.
CEO at Home Depot in 2000, he changed the corporate strategy to growing the company’s
small professional supply business (sales to building contractors) through acquisitions and
making the mature retail business cost-effective. He attempted to replace the old informal en-
trepreneurial collaborative culture with one of military efficiency. Before Nardelli’s arrival,
most store managers had based their decisions upon their personal knowledge of their cus-
tomers’ preferences. Under Nardelli, they were instead given weekly sales and profit targets.
Underperforming managers were asked to leave the company. The once-heavy ranks of full-
time employees were replaced with cheaper part-timers. In this “culture of fear,” morale fell
and Home Depot’s customer satisfaction score dropped to last place among major U.S. retail-
ers. By 2007, Nardelli was asked to leave the company.
There is no one best corporate culture. An optimal culture is one that best supports the
mission and strategy of the company of which it is a part. This means that corporate culture
should support the strategy. Unless strategy is in complete agreement with the culture, any sig-
nificant change in strategy should be followed by a modification of the organization’s culture.
Although corporate culture can be changed, it may often take a long time, and it requires much
effort. At Home Depot, for example, CEO Nardelli attempted to change the corporate culture
by hiring GE veterans like himself into top management positions, hiring ex-military officers
as store managers, and instituting a top-down command structure.
A key job of management involves managing corporate culture. In doing so, management
must evaluate what a particular change in strategy means to the corporate culture, assess
whether a change in culture is needed, and decide whether an attempt to change the culture is
worth the likely costs.
Assessing Strategy-Culture Compatibility
When implementing a new strategy, a company should take the time to assess strategy-culture
compatibility. (See Figure 10–1.) Consider the following questions regarding a corporation’s
culture:
1. Is the proposed strategy compatible with the company’s current culture? If yes, full
steam ahead. Tie organizational changes into the company’s culture by identifying how
the new strategy will achieve the mission better than the current strategy does. If not . . .
2. Can the culture be easily modified to make it more compatible with the new strat-
egy? If yes, move forward carefully by introducing a set of culture-changing activities
such as minor structural modifications, training and development activities, and/or hiring
new managers who are more compatible with the new strategy. When Procter & Gamble’s
CHAPTER 10 Strategy Implementation: Staffing and Directing 313
No
No
No
Is the proposed strategy compatible
with the current culture?
Tie changes into the culture.
Introduce minor
culture-changing activities
Yes
Yes
No
Find a joint-venture partner or
contract with another company
to carry out the strategy.
Manage around the culture by
establishing a new structural unit
to implement the new strategy.
Is management willing and able to
make major organizational changes
and accept probable delays and a
likely increase in costs?
Yes
Yes
Is management still committed
to implementing the strategy?
Formulate a different strategy.
Can the culture be easily modified to
make it more compatible with the
new strategy?
FIGURE 10–1 Assessing Strategy–Culture Compatibility
top management decided to implement a strategy aimed at reducing costs, for example, it
made some changes in how things were done, but it did not eliminate its brand-management
system. The culture adapted to these modifications over a couple years and productivity
increased. If not . . .
3. Is management willing and able to make major organizational changes and accept
probable delays and a likely increase in costs? If yes, manage around the culture by es-
tablishing a new structural unit to implement the new strategy. At General Motors, for ex-
ample, top management realized the company had to make some radical changes to be
more competitive. Because the current structure, culture, and procedures were very in-
flexible, management decided to establish a completely new Saturn division (GM’s first
new division since 1918) to build its new auto. In cooperation with the United Auto Work-
ers, an entirely new labor agreement was developed, based on decisions reached by con-
sensus. Carefully selected employees received from 100 to 750 hours of training, and a
whole new culture was built, piece by piece. If not . . .
4. Is management still committed to implementing the strategy? If yes, find a joint-
venture partner or contract with another company to carry out the strategy. If not, formu-
late a different strategy.
314 PART 4 Strategy Implementation and Control
Based on Robert Nardelli’s decisions when he initially started as Home Depot’s CEO, he
probably answered “no” to the first question and “yes” to the second question—thus justifying
his many changes in staffing and leading. Unfortunately, these changes didn’t work very well.
Instead, he should have replied “no” to the first and second questions and stopped at the third
question. As suggested by this question, he should have considered a different corporate strat-
egy, such as growing the professional side of the business without changing the collegial culture
of the retail stores. Not surprisingly, once Nardelli was replaced by a new CEO, the company
divested the professional supply companies that Nardelli had spent so much time and money ac-
quiring and returned to its previous strategy of concentrating on Home Depot retail stores.
Managing Cultural Change Through Communication
Communication is key to the effective management of change.Asurvey of 3,199 world-wide ex-
ecutives by McKinsey & Company revealed that ongoing communication and involvement was
the approach most used by companies that successfully transformed themselves.75 Rationale for
strategic changes should be communicated to workers not only in newsletters and speeches, but
also in training and development programs. This is especially important in decentralized firms
where a large number of employees work in far-flung business units.76 Companies in which ma-
jor cultural changes have successfully taken place had the following characteristics in common:
� The CEO and other top managers had a strategic vision of what the company could be-
come and communicated that vision to employees at all levels. The current performance
of the company was compared to that of its competition and constantly updated.
� The vision was translated into the key elements necessary to accomplish that vision. For ex-
ample, if the vision called for the company to become a leader in quality or service, aspects
of quality and service were pinpointed for improvement, and appropriate measurement sys-
tems were developed to monitor them. These measures were communicated widely through
contests, formal and informal recognition, and monetary rewards, among other devices.77
For example, when Pizza Hut, Taco Bell, and KFC were purchased by Tricon Global
Restaurants (now Yum! Brands) from PepsiCo, the new management knew that it had to cre-
ate a radically different culture than the one at PepsiCo if the company was to succeed. To be-
gin, management formulated a statement of shared values—“How We Work Together”
principles. They declared their differences with the “mother country” (PepsiCo) and wrote a
“Declaration of Independence” stating what the new company would stand for. Restaurant
managers participated in team-building activities at the corporate headquarters and finished by
signing the company’s “Declaration of Independence” as “founders” of the company. Since
then, “Founder’s Day” has become an annual event celebrating the culture of the company.
Headquarters was renamed the “Restaurant Support Center,” signifying the cultural value that
the restaurants were the central focus of the company. People measures were added to finan-
cial measures and customer measures, reinforcing the “putting people first” value. In an un-
precedented move in the industry, restaurant managers were given stock options and added to
the list of performance incentives. The company created values-focused 360-degree perfor-
mance reviews, which were eventually pushed to the restaurant manager level.78
Managing Diverse Cultures Following an Acquisition
When merging with or acquiring another company, top management must give some consid-
eration to a potential clash of corporate cultures. According to a Hewitt Associates survey of
218 major U.S. corporations, integrating culture was a top challenge for 69% of the reporting
companies.79 Cultural differences are even more problematic when a company acquires a
firm in another country. DaimlerChrysler’s purchase of a controlling interest in Mitsubishi
Motors in 2001 was insufficient to overcome Mitsubishi’s resistance to change. After investing
CHAPTER 10 Strategy Implementation: Staffing and Directing 315
Integration
Equal merger of both cultures into a new corporate culture
Assimilation
Acquiring firm’s culture kept intact, but subservient to that of acquiring firm’s corporate culture
Separation
Conflicting cultures kept intact, but kept separate in different units
Deculturation
Forced replacement of conflicting acquired firm’s culture with that of the acquiring firm’s culture
FIGURE 10–2
Methods
of Managing
the Culture
of an
Acquired Firm
SOURCE: Based on A. R. Malezadeh and A. Nahavandi, “Making Mergers Work in Managing Cultures,” Journal of
Business Strategy (May/June 1990), pp. 53–57 and “Acculturation in Mergers and Acquisitions,” Academy
of Management Review (January 1988), pp. 79–90.
$2 billion to cut Mitsubishi’s costs and improve its product development, DaimlerChrysler
gave up.80 It’s dangerous to assume that the firms can simply be integrated into the same re-
porting structure. The greater the gap between the cultures of the acquired firm and the acquir-
ing firm, the faster executives in the acquired firm quit their jobs and valuable talent is lost.
Conversely, when corporate cultures are similar, performance problems are minimized.81
There are four general methods of managing two different cultures. (See Figure 10–2.)
The choice of which method to use should be based on (1) how much members of the acquired
firm value preserving their own culture and (2) how attractive they perceive the culture of the
acquirer to be.82
1. Integration involves a relatively balanced give-and-take of cultural and managerial prac-
tices between the merger partners, and no strong imposition of cultural change on either
company. It merges the two cultures in such a way that the separate cultures of both firms
are preserved in the resulting culture. This is what occurred when France’s Renault pur-
chased a controlling interest in Japan’s Nissan Motor Company and installed Carlos
Ghosn as Nissan’s new CEO to turn around the company. Ghosn was very sensitive to
Nissan’s culture and allowed the company room to develop a new corporate culture based
on the best elements of Japan’s national culture. His goal was to form one successful auto
group from two very distinct companies.83
2. Assimilation involves the domination of one organization over the other. The domination
is not forced, but it is welcomed by members of the acquired firm, who may feel for many
reasons that their culture and managerial practices have not produced success. The ac-
quired firm surrenders its culture and adopts the culture of the acquiring company. This
was the case when Maytag Company (now part of Whirlpool) acquired Admiral. Because
Admiral’s previous owners had not kept the manufacturing facilities up to date, quality had
drastically fallen over the years. Admiral’s employees were willing to accept the domi-
nance of Maytag’s strong quality-oriented culture because they respected it and knew that
without significant changes at Admiral, they would soon be out of work. In turn, they ex-
pected to be treated with some respect for their skills in refrigeration technology.
316 PART 4 Strategy Implementation and Control
3. Separation is characterized by a separation of the two companies’cultures. They are struc-
turally separated, without cultural exchange. When Boeing acquired McDonnell-Douglas,
known for its expertise in military aircraft and missiles, Boeing created a separate unit to
house both McDonnell’s operations and Boeing’s own military business. McDonnell ex-
ecutives were given top posts in the new unit and other measures were taken to protect the
strong McDonnell culture. On the commercial side, where Boeing had the most expertise,
McDonnell’s commercial operations were combined with Boeing’s in a separate unit
managed by Boeing executives.84
4. Deculturation involves the disintegration of one company’s culture resulting from unwanted
and extreme pressure from the other to impose its culture and practices. This is the most
common and most destructive method of dealing with two different cultures. It is often ac-
companied by much confusion, conflict, resentment, and stress. This is a primary reason
why so many executives tend to leave after their firm is acquired. Such a merger typically
results in poor performance by the acquired company and its eventual divestment. This is
what happened when AT&T acquired NCR Corporation in 1990 for its computer business.
It replaced NCR managers with an AT&T management team, reorganized sales, forced em-
ployees to adhere to the AT&T code of values (called the “Common Bond”), and even
dropped the proud NCR name (successor to National Cash Register) in favor of a sterile GIS
(Global Information Solutions) nonidentity. By 1995, AT&T was forced to take a $1.2 bil-
lion loss and lay off 10,000 people.85 The NCR unit was consequently sold.
ACTION PLANNING
Activities can be directed toward accomplishing strategic goals through action planning. At a
minimum, an action plan states what actions are going to be taken, by whom, during what
time frame, and with what expected results. After a program has been selected to implement a
particular strategy, an action plan should be developed to put the program in place. Table 10–1
shows an example of an action plan for a new advertising and promotion program.
Take the example of a company choosing forward vertical integration through the acqui-
sition of a retailing chain as its growth strategy. Once it owns its own retail outlets, it must in-
tegrate the stores into the company. One of the many programs it would have to develop is a
new advertising program for the stores. The resulting action plan to develop a new advertising
program should include much of the following information:
1. Specific actions to be taken to make the program operational: One action might be to
contact three reputable advertising agencies and ask them to prepare a proposal for a new
radio and newspaper ad campaign based on the theme “Jones Surplus is now a part of Ajax
Continental. Prices are lower. Selection is better.”
2. Dates to begin and end each action: Time would have to be allotted not only to select
and contact three agencies, but to allow them sufficient time to prepare a detailed pro-
posal. For example, allow one week to select and contact the agencies plus three months
for them to prepare detailed proposals to present to the company’s marketing director.
Also allow some time to decide which proposal to accept.
3. Person (identified by name and title) responsible for carrying out each action: List some-
one—such as Jan Lewis, advertising manager—who can be put in charge of the program.
4. Person responsible for monitoring the timeliness and effectiveness of each action:
Indicate that Jan Lewis is responsible for ensuring that the proposals are of good quality
and are priced within the planned program budget. She will be the primary company con-
tact for the ad agencies and will report on the progress of the program once a week to the
company’s marketing director.
CHAPTER 10 Strategy Implementation: Staffing and Directing 317
TABLE 10–1 Example of an Action Plan
Action Plan for Jan Lewis, Advertising Manager, and Rick Carter, Advertising Assistant, Ajax Continental
Program Objective: To Run a New Advertising and Promotion Campaign for the Combined Jones Surplus/Ajax
Continental Retail Stores for the Coming Christmas Season within a Budget of $XX.
Program Activities:
1. Identify Three Best Ad Agencies for New Campaign.
2. Ask Three Ad Agencies to Submit a Proposal for a New Advertising and Promotion Campaign for Combined Stores.
3. Agencies Present Proposals to Marketing Manager.
4. Select Best Proposal and Inform Agencies of Decision.
5. Agency Presents Winning Proposal to Top Management.
6. Ads Air on TV and Promotions Appear in Stores.
7. Measure Results of Campaign in Terms of Viewer Recall and Increase in Store Sales.
Action Steps Responsibility Start–End
1. A. Review previous programs
B. Discuss with boss
C. Decide on three agencies
Lewis & Carter
Lewis & Smith
Lewis
1/1–2/1
2/1–2/3
2/4
2. A. Write specifications for ad
B. Assistant writes ad request
C. Contact ad agencies
D. Send request to three agencies
E. Meet with agency acct. execs
Lewis
Carter
Lewis
Carter
Lewis & Carter
1/15–1/20
1/20–1/30
2/5–2/8
2/10
2/16–2/20
3. A. Agencies work on proposals
B. Agencies present proposals
Acct. Execs
Carter
2/23–5/1
5/1–5/15
4. A. Select best proposal
B. Meet with winning agency
C. Inform losers
Lewis
Lewis
Carter
5/15–5/20
5/22–5/30
6/1
5. A. Fine-tune proposal
B. Presentation to management
Acct. Exec
Lewis
6/1–7/1
7/1–7/3
6. A. Ads air on TV
B. Floor displays in stores
Lewis
Carter
9/1–12/24
8/20–8/30
7. A. Gather recall measures of ads
B. Evaluate sales data
C. Prepare analysis of campaign
Carter
Carter
Carter
9/1–12/24
1/1–1/10
1/10–2/15
5. Expected financial and physical consequences of each action: Estimate when a com-
pleted ad campaign will be ready to show top management and how long it will take af-
ter approval to begin to air the ads. Estimate also the expected increase in store sales over
the six-month period after the ads are first aired. Indicate whether “recall” measures will
be used to help assess the ad campaign’s effectiveness plus how, when, and by whom the
recall data will be collected and analyzed.
6. Contingency plans: Indicate how long it will take to get an acceptable ad campaign to
show top management if none of the initial proposals is acceptable.
Action plans are important for several reasons. First, action plans serve as a link between
strategy formulation and evaluation and control. Second, the action plan specifies what needs
to be done differently from the way operations are currently carried out. Third, during the eval-
uation and control process that comes later, an action plan helps in both the appraisal of per-
formance and in the identification of any remedial actions, as needed. In addition, the explicit
318 PART 4 Strategy Implementation and Control
assignment of responsibilities for implementing and monitoring the programs may contribute
to better motivation.
MANAGEMENT BY OBJECTIVES
Management By Objectives (MBO) is a technique that encourages participative decision
making through shared goal setting at all organizational levels and performance assessment
based on the achievement of stated objectives.86 MBO links organizational objectives and the
behavior of individuals. Because it is a system that links plans with performance, it is a pow-
erful implementation technique.
The MBO process involves:
1. Establishing and communicating organizational objectives.
2. Setting individual objectives (through superior-subordinate interaction) that help imple-
ment organizational ones.
3. Developing an action plan of activities needed to achieve the objectives.
4. Periodically (at least quarterly) reviewing performance as it relates to the objectives and
including the results in the annual performance appraisal.87
MBO provides an opportunity for the corporation to connect the objectives of people at
each level to those at the next higher level. MBO, therefore, acts to tie together corporate, busi-
ness, and functional objectives, as well as the strategies developed to achieve them. Although
MBO originated the 1950s, 90% of surveyed practicing managers feel that MBO is applicable
today.88 The principles of MBO are a part of self-managing work teams and quality circles.89
One of the real benefits of MBO is that it can reduce the amount of internal politics oper-
ating within a large corporation. Political actions within a firm can cause conflict and create
divisions between the very people and groups who should be working together to implement
strategy. People are less likely to jockey for position if the company’s mission and objectives
are clear and they know that the reward system is based not on game playing, but on achiev-
ing clearly communicated, measurable objectives.
TOTAL QUALITY MANAGEMENT
Total Quality Management (TQM) is an operational philosophy committed to customer sat-
isfaction and continuous improvement. TQM is committed to quality/excellence and to being
the best in all functions. Because TQM aims to reduce costs and improve quality, it can be used
as a program to implement an overall low-cost or a differentiation business strategy. About
92% of manufacturing companies and 69% of service firms have implemented some form of
quality management practices.90 Not all TQM programs have been successes. Nevertheless, a
recent survey of 325 manufacturing firms in Canada, Hungary, Italy, Lebanon, Taiwan, and the
United States revealed that total quality management and just-in-time were the two highest-
ranked improvement programs to improve company performance. This study agreed with a
2004 Census of Manufacturing survey that identified total quality management and lean man-
ufacturing as the top improvement methodologies in both the U.S. and China.91 An analysis of
the successes and failures of TQM concluded that the key ingredient is top management. Suc-
cessful TQM programs occur in those companies in which “top managers move beyond de-
fensive and tactical orientations to embrace a developmental orientation.”92
TQM has four objectives:
1. Better, less variable quality of the product and service
2. Quicker, less variable response in processes to customer needs
CHAPTER 10 Strategy Implementation: Staffing and Directing 319
3. Greater flexibility in adjusting to customers’ shifting requirements
4. Lower cost through quality improvement and elimination of non-value-adding work93
According to TQM, faulty processes, not poorly motivated employees, are the cause of
defects in quality. The program involves a significant change in corporate culture, requiring
strong leadership from top management, employee training, empowerment of lower-level em-
ployees (giving people more control over their work), and teamwork in order to succeed in a
company. TQM emphasizes prevention, not correction. Inspection for quality still takes place,
but the emphasis is on improving the process to prevent errors and deficiencies. Thus, quality
circles or quality improvement teams are formed to identify problems and to suggest how to
improve the processes that may be causing the problems.
TQM’s essential ingredients are:
� An intense focus on customer satisfaction: Everyone (not just people in the sales and
marketing departments) understands that their jobs exist only because of customer needs.
Thus all jobs must be approached in terms of how they will affect customer satisfaction.
� Internal as well as external customers: An employee in the shipping department may be
the internal customer of another employee who completes the assembly of a product, just as
a person who buys the product is a customer of the entire company. An employee must be
just as concerned with pleasing the internal customer as in satisfying the external customer.
� Accurate measurement of every critical variable in a company’s operations: This
means that employees have to be trained in what to measure, how to measure, and how to
interpret the data. A rule of TQM is that you only improve what you measure.
� Continuous improvement of products and services: Everyone realizes that operations
need to be continuously monitored to find ways to improve products and services.
� New work relationships based on trust and teamwork: Important is the idea of
empowerment—giving employees wide latitude in how they go about achieving the
company’s goals. Research indicates that the keys to TQM success lie in executive com-
mitment, an open organizational culture, and employee empowerment.94
INTERNATIONAL CONSIDERATIONS IN LEADING
In a study of 53 different national cultures, Hofstede found that each nation’s unique culture could
be identified using five dimensions. He found that national culture is so influential that it tends to
overwhelm even a strong corporate culture. (See the numerous sociocultural societal variables
that compose another country’s culture that are listed in Table 4–3.) In measuring the differences
among these dimensions of national culture from country to country, he was able to explain why
a certain management practice might be successful in one nation but fail in another:95
1. Power distance (PD) is the extent to which a society accepts an unequal distribution of
power in organizations. Malaysia and Mexico scored highest, whereas Germany and
Austria scored lowest. People in those countries scoring high on this dimension tend to
prefer autocratic to more participative managers.
2. Uncertainty avoidance (UA) is the extent to which a society feels threatened by uncertain
and ambiguous situations. Greece and Japan scored highest on disliking ambiguity, whereas
the United States and Singapore scored lowest. People in those nations scoring high on this
dimension tend to want career stability, formal rules, and clear-cut measures of performance.
3. Individualism-collectivism (I-C) is the extent to which a society values individual free-
dom and independence of action compared with a tight social framework and loyalty to the
group. The United States and Canada scored highest on individualism, whereas Mexico
320 PART 4 Strategy Implementation and Control
and Guatemala scored lowest. People in nations scoring high on individualism tend to
value individual success through competition, whereas people scoring low on individual-
ism (thus high on collectivism) tend to value group success through collective cooperation.
4. Masculinity-femininity (M-F) is the extent to which society is oriented toward money
and things (which Hofstede labels masculine) or toward people (which Hofstede labels
feminine). Japan and Mexico scored highest on masculinity, whereas France and Sweden
scored lowest (thus highest on femininity). People in nations scoring high on masculinity
tend to value clearly defined sex roles where men dominate, and to emphasize perfor-
mance and independence, whereas people scoring low on masculinity (and thus high on
femininity) tend to value equality of the sexes where power is shared, and to emphasize
the quality of life and interdependence.
5. Long-term orientation (LT) is the extent to which society is oriented toward the long-
versus the short-term. Hong Kong and Japan scored highest on long-term orientation,
whereas Pakistan scored the lowest. A long-term time orientation emphasizes the impor-
tance of hard work, education, and persistence as well as the importance of thrift. Nations
with a long-term time orientation tend to value strategic planning and other management
techniques with a long-term payback.
Hofstede’s work was extended by Project GLOBE, a team of 150 researchers who collected
data on cultural values and practices and leadership attributes from 18,000 managers in 62 coun-
tries. The project studied the nine cultural dimensions of assertiveness, future orientation, gen-
der differentiation, uncertainty avoidance, power distance, institutional emphasis on collectivism
versus individualism, in-group collectivism, performance orientation, and humane orientation.96
The dimensions of national culture help explain why some management practices work
well in some countries but not in others. For example, MBO, which originated in the United
States, succeeded in Germany, according to Hofstede, because the idea of replacing the arbi-
trary authority of the boss with the impersonal authority of mutually agreed-upon objectives
fits the low power distance that is a dimension of the German culture. It failed in France, how-
ever, because the French are used to high power distances; they are used to accepting orders
from a highly personalized authority. In countries with high levels of uncertainty avoidance,
such as Switzerland and Austria, communication should be clear and explicit, based on
facts. Meetings should be planned in advance and have clear agendas. In contrast, in low-
uncertainty-avoidance countries such as Greece or Russia, people are not used to structured
communication and prefer more open-ended meetings. Because Thailand has a high level of
power distance, Thai managers feel that communication should go from the top to the bottom
of a corporation. As a result, 360-degree performance appraisals are seen as dysfunctional.97
Some of the difficulties experienced by U.S. companies in using Japanese-style quality circles
in TQM may stem from the extremely high value U.S. culture places on individualism. The
differences between the United States and Mexico in terms of the power distance (Mexico 104
vs. U.S. 46) and individualism-collectivism (U.S. 91 vs. Mexico 30) dimensions may help ex-
plain why some companies operating in both countries have difficulty adapting to the differ-
ences in customs.98 In addition, research has found that technology alliance formation is
strongest in countries that value cooperation and avoid uncertainty.99
When one successful company in one country merges with another successful company
in another country, the clash of corporate cultures is compounded by the clash of national cul-
tures. For example, when two companies, one from a high-uncertainty-avoidance society and
one from a low-uncertainty-avoidance country, are considering a merger, they should investi-
gate each other’s management practices to determine potential areas of conflict. Given the
growing number of cross-border mergers and acquisitions, the management of cultures is be-
coming a key issue in strategy implementation. See the Global Issue feature to learn how
CHAPTER 10 Strategy Implementation: Staffing and Directing 321
When Upjohn Pharmaceuti-
cals of Kalamazoo, Michigan,
and Pharmacia AB of Stock-
holm, Sweden, merged in 1995,
employees of both sides were optimistic for
the newly formed Pharmacia & Upjohn, Inc. Both companies
were second-tier competitors fighting for survival in a global
industry. Together, the firms would create a global company
that could compete scientifically with its bigger rivals.
Because Pharmacia had acquired an Italian firm in 1993,
it also had a large operation in Milan. U.S. executives sched-
uled meetings throughout the summer of 1996—only to
cancel them when their European counterparts could not at-
tend. Although it was common knowledge in Europe that
most Swedes take the entire month of July for vacation and
that Italians take off all of August, this was not common
knowledge in Michigan. Differences in management styles
became a special irritant. Swedes were used to an open sys-
tem, with autonomous work teams. Executives sought the
whole group’s approval before making an important deci-
sion. Upjohn executives followed the more traditional Amer-
ican top-down approach. Upon taking command of the
newly merged firm, Dr. Zabriskie (who had been Upjohn’s
CEO), divided the company into departments reporting to
the new London headquarters. He required frequent reports,
budgets, and staffing updates. The Swedes reacted nega-
tively to this top-down management hierarchical style. “It
was degrading,” said Stener Kvinnsland, head of Pharmacia’s
cancer research in Italy before he quit the new company.
differences in national and corporate cultures created conflict when Upjohn Company of the
United States and Pharmacia AB of Sweden merged.
MNCs must pay attention to the many differences in cultural dimensions around the world
and adjust their management practices accordingly. Cultural differences can easily go unrecog-
nized by a headquarters staff that may interpret these differences as personality defects, whether
the people in the subsidiaries are locals or expatriates. When conducting strategic planning in an
MNC, top management must be aware that the process will vary based upon the national culture
where a subsidiary is located. For example, in one MNC, the French expect concepts and key
questions and answers. North American managers provide heavy financial analysis. Germans
give precise dates and financial analysis. Information is usually late from Spanish and Moroccan
operations and quotas are typically inflated. It is up to management to adapt to the differences.100
The values embedded in his or her national culture have a profound and enduring effect on an
executive’s orientation, regardless of the impact of industry experience or corporate culture.101
Hofstede and Bond conclude: “Whether they like it or not, the headquarters of multinationals are
in the business of multicultural management.”102
GLOBAL issue
CULTURAL DIFFERENCES CREATE
IMPLEMENTATION PROBLEMS IN MERGER
The Italian operations baffled the Americans, even
though the Italians felt comfortable with a hierarchical
management style. Italy’s laws and unions made layoffs dif-
ficult. Italian data and accounting were often inaccurate.
Because the Americans didn’t trust the data, they were
constantly asking for verification. In turn, the Italians were
concerned that the Americans were trying to take over Ital-
ian operations. At Upjohn, all workers were subject to test-
ing for drug and alcohol abuse. Upjohn also banned
smoking. At Pharmacia’s Italian business center, however,
waiters poured wine freely every afternoon in the company
dining room. Pharmacia’s boardrooms were stocked with
humidors for executives who smoked cigars during long
meetings. After a brief attempt to enforce Upjohn’s poli-
cies, the company dropped both the no-drinking and no-
smoking policies for European workers.
Although the combined company had cut annual costs
by $200 million, overall costs of the merger reached $800
million, some $200 million more than projected. Never-
theless, Jan Eckberg, CEO of Pharmacia before the
merger, remained confident of the new company’s ability
to succeed. He admitted, however, that “we have to make
some smaller changes to release the full power of the two
companies.”
SOURCE: Summarized from R. Frank and T. M. Burton, “Cross-
Border Merger Results in Headaches for a Drug Company,” Wall
Street Journal (February 4, 1997), pp. A1, A12.
322 PART 4 Strategy Implementation and Control
End of Chapter SUMMARY
Strategy is implemented by modifying structure (organizing), selecting the appropriate people
to carry out the strategy (staffing), and communicating clearly how the strategy can be put into
action (leading). A number of programs, such as organizational and job design, reengineering,
Six Sigma, MBO, TQM, and action planning, can be used to implement a new strategy. Exec-
utives must manage the corporate culture and find the right mix of qualified people to put a
strategy in place.
Research on executive succession reveals that it is very risky to hire new top managers
from outside the corporation. Although this is often done when a company is in trouble, it can
be dangerous for a successful firm. This is also true when hiring people for non-executive
positions. An in-depth study of 1,052 stock analysts at 78 investment banks revealed that hir-
ing a star (an outstanding performer) from another company did not improve the hiring com-
pany’s performance. When a company hires a star, the star’s performance plunges, there is a
sharp decline in the functioning of the team the person works with, and the company’s market
value declines. Their performance dropped about 20% and did not return to the level before
the job change—even after five years. Interestingly, around 36% of the stars left the invest-
ment banks that hired them within 36 months. Another 29% quit in the next 24 months.
This phenomenon occurs not because a star doesn’t suddenly become less intelligent
when switching firms, but because the star cannot take to the new firm the firm-specific re-
sources that contributed to her or his achievements at the previous company. As a result, the
star is unable to repeat the high performance in another company until he/she learns the new
system. This may take years, but only if the new company has a good support system in place.
Otherwise, the performance may never improve. For these reasons, companies cannot obtain
competitive advantage by hiring stars from the outside. Instead, they should emphasize grow-
ing their own talent and developing the infrastructure necessary for high performance.103
It is important to not ignore the 75% of the workforce who, while not being stars, are the
solid performers that keep a company going over the years. An undue emphasis on attracting
stars wastes money and destroys morale. The CEO of McKesson, a pharmaceutical wholesaler,
calls these B players “performers in place. . . .They are happy living in Dubuque. I have more
time and admiration for them than the A player who is at my desk every six months asking for
the next promotion.” Coaches who try to forge a sports team composed of stars court disaster.
According to Karen Freeman, former head coach of women’s basketball at Wake Forest Uni-
versity, “During my coaching days, the most dysfunctional teams were the ones who had no
respect for the B players.” In basketball or business, when the team goes into a slump, the stars
are the first to whine, Freeman reports.104
E C O – B I T S
� The U.S. Climate Action Partnership (USCAP), com-
posed of General Electric, Caterpillar, Alcoa, General
Motors, Chrysler, and Duke Energy plus 21 other major
corporations, endorses reducing greenhouse gas emis-
sions by 10% to 30% within 15 years and 60% to 80%
by 2050 to avert the severest consequences of global
warming.
� General Electric, Caterpillar, and Alcoa also sit on the
board of the Center for Energy & Economic Develop-
ment (CEED), an organization that opposes a federal cli-
mate bill requiring a 65% reduction in emissions by
2050.
� USCAP members General Motors and Chrysler are also
members of the Heartland Institute, an organization that
disputes humanity’s role in global warming.
� Duke Energy, a USCAP member, is currently building
two coal-burning power plants and also belongs to
Americans for Balanced Energy Choices, a group that
advocates expanded coal use.105
CHAPTER 10 Strategy Implementation: Staffing and Directing 323
D I S C U S S I O N Q U E S T I O N S
1. What skills should a person have for managing a business
unit following a differentiation strategy? Why? What
should a company do if no one is available internally and
the company has a policy of promotion from within?
2. When should someone from outside a company be hired
to manage the company or one of its business units?
3. What are some ways to implement a retrenchment strat-
egy without creating a lot of resentment and conflict with
labor unions?
4. How can corporate culture be changed?
5. Why is an understanding of national cultures important in
strategic management?
S T R A T E G I C P R A C T I C E E X E R C I S E
Staffing involves finding the person with the right blend of
characteristics, such as personality, training, and experience,
to implement a particular strategy. The Keirsey Temperament
Sorter is designed to identify different kinds of personality
temperament. It is similar to other instruments derived from
Carl Jung’s theory of psychological types, such as the Myers-
Briggs, the Singer-Loomis, and the Grey-Wheelright. The
questionnaire identifies four temperament types: Guardian
(SJ), Artisan (SP), Idealist (NF), and Rational (NT).
Guardians have natural talent in managing goods and ser-
vices. They are dependable and trustworthy. Artisans have keen
senses and are at home with tools, instruments, and vehicles.
They are risk-takers and like action. Idealists are concerned
with growth and development and like to work with people.
They prefer friendly cooperation over confrontation and con-
flict. Rationalists are problem solvers who like to know how
things work. They work tirelessly to accomplish their goals.
Each of these four types has four variants.106
Keirsey challenges the assumption that people are basi-
cally the same in the ways that they think, feel, and approach
problems. Keirsey argues that it is far less desirable to attempt
to change others (because it has little likelihood of success)
than to attempt to understand, work with, and take advantage of
normal differences. Companies can use this type of question-
naire to help team members understand how each person can
contribute to team performance. For example, Lucent Technol-
ogy used the Myers-Briggs Type Indicator to help build trust
and understanding among 500 engineers in 13 time zones and
three continents in a distributed development project.
1. Access the Keirsey Temperament Sorter using your
Internet browser. Type in the following URL:
www.advisorteam.com
2. Complete and score the questionnaire. Print the descrip-
tion of your personality type.
3. Read the information on the Web site about each person-
ality type. Become familiar with each.
4. Bring to class a sheet of paper containing your name and
your personality type: Guardian, Artisan, Idealist, or
Rational. Your instructor will either put you into a group
containing people with the same predominant style or into
a group with representatives from each type. He or she
may then give each group a number. The instructor will
then give the teams a task to accomplish. Each group will
have approximately 30 minutes to do the task. It may be to
solve a problem, analyze a short case, or propose a new en-
trepreneurial venture. The instructor will provide you with
very little guidance other than to form and number the
groups, give them a task, and keep track of time. He or she
may move from group to group to sit in on each team’s
progress. When the time is up, the instructor will ask a
spokesperson from each group to (1) describe the process
the group went through and (2) present orally each group’s
ideas. After each group makes its presentation, the instruc-
tor may choose one or more of the following:
� On a sheet of paper, each person in the class identifies
his/her personality type and votes which team did the
best on the assignment.
� The class as a whole tries to identify each group’s
dominant decision-making style in terms of how they
did their assignment. See how many people vote for
one of the four types for each team.
� Each member of a group guesses if she/he was put into
a team composed of the same personality types or in
one composed of all four personality types.
K E Y T E R M S
action plan (p. 316)
dimensions of national culture (p. 319)
downsizing (p. 308)
executive succession (p. 305)
executive type (p. 304)
individualism-collectivism (I-C) (p. 319)
integration manager (p. 303)
leading (p. 302)
long-term orientation (LT) (p. 320)
Management By Objectives (MBO)
(p. 318)
masculinity-femininity (M-F) (p. 320)
power distance (PD) (p. 319)
staffing (p. 302)
Total Quality Management (TQM)
(p. 318)
uncertainty avoidance (UA) (p. 319)
www.advisorteam.com
324 PART 4 Strategy Implementation and Control
N O T E S
1. B. O’Reilly, “The Rent-A-Car Jocks Who Made Enterprise #1,”
Fortune (October 28, 1996), pp. 125–128; J. Schlereth, “Putting
People First,” an interview with Andrew Taylor, BizEd
(July/August 2003), pp. 16–20; P. Lehman, “A Clear Road to
the Top,” Business Week (September 18, 2006), p. 72; Company
Web site at www.enterprise.com.
2. S. Caudron, “How HR Drives Profits,” Workforce Management
(December 2001), pp. 26–31 as reported by L. L. Bryan, C. I.
Joyce, and L. M. Weiss in “Making a Market in Talent,”
McKinsey Quarterly (2006, No. 2), pp. 1–7.
3. “The Stat,” Business Week (October 24, 2005), p. 16.
4. The numbers are approximate averages from three separate stud-
ies of top management turnover after mergers. See M. Lubatkin,
D. Schweiger, and Y. Weber, “Top Management Turnover in
Related M&Ss: An Additional Test of the Theory of Relative
Standing,” Journal of Management, Vol. 25, No. 1 (1999),
pp. 55–73.
5. J. A. Krug, “Executive Turnover in Acquired Firms: A Longitu-
dinal Analysis of Long-Term Interaction Effects,” paper pre-
sented to annual meeting of Academy of Management, Seattle,
WA (2003).
6. J. A. Krug and W. H. Hegarty, “Post-Acquisition Turnover Among
U.S. Top Management Teams: An Analysis of the Effects of For-
eign vs. Domestic Acquisitions of U.S. Targets,” Strategic Man-
agement Journal (September 1997), pp. 667–675; J. A. Jrug and
W. H. Hegarty, “Predicting Who Stays and Leaves After an Acqui-
sition: A Study of Top Managers in Multinational Firms,”
Strategic Management Journal (February 2001), pp. 185–196.
7. D. Harding and T. Rouse, “Human Due Diligence,” Harvard
Business Review (April 2007), pp. 124–131.
8. A. Hinterhuber, “Making M&A Work,” Business Strategy Re-
view (September 2002), pp. 7–9.
9. R. N. Ashkenas and S. C. Francis, “Integration Managers: Spe-
cial Leaders for Special Times,” Harvard Business Review
(November–December 2000), pp. 108–116.
10. J. Hoerr, “Sharpening Minds for a Competitive Edge,” Business
Week (December 17, 1990), pp. 72–78.
11. K. Hess and N. J. Nentl, “Strategic Training for Managers,”
SAM Management in Practice (2006, No. 4).
12. “Training and Human Resources,” Business Strategy News Re-
view (July 2000), p. 6.
13. High Performance Work Practices and Firm Performance
(Washington, DC: U.S. Department of Labor, Office of the
American Workplace, 1993), pp. i, 4.
14. T. T. Baldwin, C. Danielson, and W. Wiggenhorn, “The Evolu-
tion of Learning Strategies in Organizations: From Employee
Development to Business Redefinition,” Academy of Manage-
ment Executive (November 1997), pp. 47–58; K. Kelly, “Mo-
torola: Training for the Millennium,” Business Week (March 28,
1996), pp. 158–161.
15. R. Henkoff, “Companies That Train Best,” Fortune (March 22,
1993), pp. 62–75.
16. D. C. Hambrick, “Upper Echelons Theory: An Update,”
Academy of Management Review (April 2007), pp. 334–343.
17. D. Miller and J. Shamsie, “Learning Across the Life Cycle: Ex-
perimentation and Performance Among the Hollywood Studio
Heads,” Strategic Management Journal (August 2001),
pp. 725–745). An exception to these findings may be the com-
puter software industry in which CEOs are at their best when
they start their jobs and steadily decline during their tenures.
See A. D. Henderson, D. Miller, and D. C. Hambrick, “How
Quickly Do CEOs Become Obsolete? Industry Dynamism,
CEO Tenure, and Company Performance,” Strategic Manage-
ment Journal (May 2006), pp. 447–460.
18. B. Hrowvitz, “New CEO Puts Comeback on the Menu at
Applebee’s,” USA Today (April 28, 2008), pp. 1B, 2B.
19. A study of former General Electric executives who became
CEOs categorized them as cost controllers, growers, or cycle
managers on the basis of their line experience at GE. See
B. Groysberg, A. N. McLean, and N. Nohria, “Are Leaders
Portable?” Harvard Business Review (May 2006), pp. 92–100.
20. D. K. Datta and N. Rajagopalan, “Industry Structure and CEO
Characteristics: An Empirical Study of Succession Events,”
Strategic Management Journal (September 1998),
pp. 833–852; A. S. Thomas and K. Ramaswamy, “Environmen-
tal Change and Management Staffing: A Comment,” Journal of
Management (Winter 1993), pp. 877–887; J. P. Guthrie, C. M.
Grimm, and K. G. Smith, “Environmental Change and Manage-
ment Staffing: An Empirical Study,” Journal of Management
(December 1991), pp. 735–748.
21. J. Greco, “The Search Goes On,” Journal of Business Strategy
(September/October 1997), pp. 22–25; W. Ocasio and H. Kim,
“The Circulation of Corporate Control: Selection of Func-
tional Backgrounds on New CEOs in Large U.S. Manufactur-
ing Firms, 1981–1992,” Administrative Science Quarterly
(September 1999), pp. 532–562; R. Dobbs, D. Harris, and
A. Rasmussen, “When Should CFOs Take the Helm?”
McKinsey Quarterly Online (November 2006); “How to Get
to the Top,” The Economist (May 31, 2008), p. 70.
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the Analysis of Cross-Classification Data: A Test of CEO Suc-
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Management Journal (December 1993), pp. 1374–1399; W. E.
Rothschild, “A Portfolio of Strategic Leaders,” Planning Re-
view (January/February 1996), pp. 16–19.
23. R. Subramanian and C. M. Sanchez, “Environmental Change
and Management Staffing: An Empirical Examination of the
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The Impact of Executive-Strategy Fit on Performance,” Journal
of Business Strategies (Spring 1994), pp. 49–62.
26. M. Smith and M. C. White, “Strategy, CEO Specialization,
and Succession,” Administrative Science Quarterly (June
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27. “Making Companies Work,” Economist (October 25, 2003),
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ing Role of Inside Directors,” Organizational Dynamics,
Vol. 36, No. 4 (2007), pp. 418–428. Note, however, that the
tenures of CEOs of family firms typically exceed 15 years. See
I. Le Breton-Miller and D. Miller, “Why Do Some Family Busi-
nesses Out-Compete? Governance, Long-Term Orientations,
and Sustainable Capability,” Entrepreneurship Theory and
Practice (November 2006), pp. 731–746.
www.enterprise.com
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Intervention,” Long Range Planning (December 1991),
pp. 96–101.
43. K. B. Schwartz and K. Menon, “Executive Succession in Fail-
ing Firms,” Academy of Management Journal (September
1985), pp. 680–686; A. A. Cannella Jr., and M. Lubatkin, “Suc-
cession as a Sociopolitical Process: Internal Impediments to
Outsider Selection,” Academy of Management Journal (August
1993), pp. 763–793; W. Boeker and J. Goodstein, “Performance
and Succession Choice: The Moderating Effects of Governance
and Ownership,” Academy of Management Journal (February
1993), pp. 172–186.
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Effect of Top Manager Movement on Product-Market Entry,”
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Theory of CEO Successor Choice and Post-Bankruptcy Strate-
gic Change,” Paper presented to annual meeting of Academy of
Management, Seattle, WA (2003).
46. P. Lorange, and D. Murphy, “Bringing Human Resources Into
Strategic Planning: System Design Characteristics,” in
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48. S. Armour, “Playing the Succession Game,” USA Today
(November 24, 2003), p. 3B.
49. D. A. Waldman and T. Korbar, “Student Assessment Center Per-
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50. “Coming and Going,” Survey of Corporate Leadership, Econo-
mist (October 25, 2003), pp. 12–14.
51. R. A. Pitts, “Strategies and Structures for Diversification,”
Academy of Management Journal (June 1997), pp. 197–208.
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Employee Morale During Downsizing,” Sloan Management
Review (Winter 1998), pp. 83–95.
53. B. O’Reilly, “Is Your Company Asking Too Much?” Fortune
(March 12, 1990), p. 41. For more information on the emotional
reactions of survivors of downsizing, see C. R. Stoner and
R. I. Hartman, “Organizational Therapy: Building Survivor
Health & Competitiveness,” SAM Advanced Management Jour-
nal (Summer 1997), pp. 15–31, 41.
54. S. R. Fisher and M. A. White, “Downsizing in a Learning Orga-
nization: Are There Hidden Costs?” Academy of Management
Review (January 2000), pp. 244–251.
55. T. M. Amabile and R. Conti, “Changes in the Work Environ-
ment for Creativity During Downsizing,” Academy of Manage-
ment Journal (December 1999), pp. 630–640; A. G. Bedeian
and A. A. Armenakis, “The Cesspool Syndrome: How Dreck
Floats to the Top of Declining Organizations,” Academy of
Management Executive (February 1998), pp. 58–67.
56. For a more complete listing of the psychological and behavioral
reactions to downsizing, see M. L. Marks and K. P. De Meuse,
“Resizing the Organization: Maximizing the Gain While Mini-
mizing the Pain of Layoffs, Divestitures, and Closings,”
Organizational Dynamics, Vol. 34, No. 1 (2005), pp. 19–35.
57. D. J. Flanagan and K. C. O’Shaughnessy, “The Effect of Lay-
offs on Firm Reputation,” Journal of Management (June 2005),
pp. 445–463.
28. A. Bianco, L. Lavelle, J. Merrit, and A. Barrett, “The CEO
Trap,” Business Week (December 11, 2000), pp. 86–92.
29. Y. Zhang and N. Rajagopalan, “When the Known Devil Is Better
Than an Unknown God: An Empirical Study of the Antecedents
and Consequences of Relay CEO Succession,” Academy of
Management Journal (August 2004), pp. 483–500; W. Shen and
A. A. Cannella, Jr., “Will Succession Planning Increase Share-
holder Wealth? Evidence from Investor Reactions to Relay CEO
Successions,” Strategic Management Journal (February 2003),
pp. 191–198.
30. G. A. Bigley and M. F. Wiersema, “New CEOs and Corporate
Strategic Refocusing: How Experience as Heir Apparent Influ-
ences the Use of Power,” Administrative Science Quarterly
(December 2002), pp. 707–727.
31. J. L. Bower, “Solve the Succession Crisis by Growing Inside-
Outside Leaders,” Harvard Business Review (November 2007),
pp. 91–96; Y. Zhang and N. Rajagopalan, “Grooming for the
Top Post and Ending the CEO Succession Crisis,”
Organizational Dynamics, Vol. 35, Issue 1 (2006), pp. 96–105.
32. “Coming and Going,” Survey of Corporate Leadership, Econo-
mist (October 25, 2003), pp. 12–14.
33. D. C. Carey and D. Ogden, CEO Succession: A Window on How
Boards Do It Right When Choosing a New Chief Executive
(New York: Oxford University Press, 2000).
34. “The King Lear Syndrome,” Economist (December 13, 2003),
p. 65.
35. Y. Zang and N. Rajagopalan, “Grooming for the Top Post and
Ending the CEO Succession Crisis,” Organizational Dynamics,
Vol. 35, Issue 1 (2006), pp. 96–105.
36. J. Weber, “The Accidental CEO,” Business Week (April 23,
2007), pp. 64–72.
37. M. S. Kraatz and J. H. Moore, “Executive Migration and Insti-
tutional Change,” Academy of Management Journal (February
2002), pp. 120–143; Y. Zhang and N. Rajagopalan, “When the
Known Devil Is Better Than an Unknown God: An Empirical
Study of the Antecedents and Consequences of Relay CEO Suc-
cession,” Academy of Management Journal (August 2004),
pp. 483–500; W. Shen and A. A. Cannella, Jr., “Revisiting the
Performance Consequences of CEO Succession: The Impacts
of Successor Type, Post-Succession Senior Executive
Turnover, and Departing CEO Tenure,” Academy of Manage-
ment Journal (August 2002), pp. 717–733.
38. K. P. Coyne and E. J. Coyne, Sr., “Surviving Your New CEO,”
Harvard Business Review (May 2007), pp. 62–69.
39. N. Byrnes and D. Kiley, “Hello, You Must Be Going,” Business
Week (February 12, 2007), pp. 30–32.
40. C. Lucier and J. Dyer, “Hiring an Outside CEO: A Board’s Best
Moves,” Directors & Boards (Winter 2004), pp. 36–38. These
findings are supported by a later study by Booz Allen Hamilton
in which 1,595 worldwide companies during 1995 to 2005
showed the same results. See J. Webber, “The Accidental
CEO,” Business Week (April 23, 2007), pp. 64–72.
41. Q. Yue, “Antecedents of Top Management Successor Origin in
China,” paper presented to the annual meeting of the Academy of
Management, Seattle, WA (2003); A. A. Buchko and D. DiVerde,
“Antecedents, Moderators, and Consequences of CEO Turnover:
A Review and Reconceptualization,” Paper presented to Midwest
Academy of Management (Lincoln, NE: 1997), p. 10; W. Ocasio,
“Institutionalized Action and Corporate Governance: The Re-
liance on Rules of CEO Succession,” Administrative Science
Quarterly (June 1999), pp. 384–416.
CHAPTER 10 Strategy Implementation: Staffing and Directing 325
326 PART 4 Strategy Implementation and Control
58. Wall Street Journal (December 22, 1992), p. B1.
59. R. D. Nixon, M. A. Hitt, H. Lee, and E. Jeong, “Market Reac-
tions to Announcements of Corporate Downsizing Actions and
Implementation Strategies,” Strategic Management Journal
(November 2004), pp. 1121–1129; G. D. Bruton, J. K. Keels,
and C. L. Shook, “Downsizing the Firm: Answering the Strate-
gic Questions,” Academy of Management Executive (May
1996), pp. 38–45; E. G. Love and N. Nohria, “Reducing Slack:
The Performance Consequences of Downsizing by Large In-
dustrial Firms, 1977–93,” Strategic Management Journal
(December 2005), pp. 1087–1108; C. D. Zatzick and R. D. Iver-
son, “High-Involvement Management and Workforce Reduc-
tion: Competitive Advantage or Disadvantage?” Academy of
Management Journal (October 2006), pp. 999–1015.
60. M. A. Hitt, B. W. Keats, H. F. Harback, and R. D. Nixon,
“Rightsizing: Building and Maintaining Strategic Leadership
and Long-Term Competitiveness,” Organizational Dynamics
(Autumn 1994), pp. 18–32. For additional suggestions, see
W. F. Cascio, “Strategies for Responsible Restructuring,”
Academy of Management Executive (August 2002), pp. 80–91,
and T. Mroczkowski and M. Hanaoka, “Effective Rightsizing
Strategies in Japan and America: Is There a Convergence of
Employment Practices?” Academy of Management Executive
(May 1997), pp. 57–67. For an excellent list of cost-reduction
programs for use in short, medium, and long-term time hori-
zons, see F. Gandolfi, “Cost Reductions, Downsizing-related
Layoffs, and HR Practices,” SAM Advanced Management Jour-
nal (Spring 2008), pp. 52–58.
61. J. S. Black and H. B. Gregersen, “The Right Way to Manage Ex-
pats,” Harvard Business Review (March–April 1999),
pp. 52–61.
62. Ibid, p. 54.
63. J. I. Sanchez, P. E. Spector, and C. L. Cooper, “Adapting to a
Boundaryless World: A Developmental Expatriate Model,”
Academy of Management Executive (May 2000), pp. 96–106.
64. R. L. Tung, The New Expatriates (Cambridge, MA.: Ballinger,
1988); J. S. Black, M. Mendenhall, and G. Oddou, “Toward a
Comprehensive Model of International Adjustment: An Inte-
gration of Multiple Theoretical Perspectives,” Academy of
Management Review (April 1991), pp. 291–317.
65. M. A. Carpenter, W. G. Sanders, and H. B. Gregersen,
“Bundling Human Capital with Organizational Context: The
Impact of International Assignment Experience on Multina-
tional Firm Performance and CEO Pay,” Academy of Manage-
ment Journal (June 2001), pp. 493–511.
66. P. M. Caligiuri and S. Colakoglu, “A Strategic Contingency Ap-
proach to Expatriate Assignment Management,” Human Re-
source Management Journal, Vol. 17, No. 4 (2007), pp. 393–410.
67. M. A. Shaffer, D. A. Harrison, K. M. Gilley, and D. M. Luk,
“Struggling for Balance Amid Turbulence on International As-
signments: Work-Family Conflict, Support, and Commitment,”
Journal of Management, Vol. 27, No. 1 (2001), pp. 99–121.
68. J. S. Black and H. B. Gregersen, “The Right Way to Manage Ex-
pats,” Harvard Business Review (March–April 1999), p. 54.
69. G. Stern, “GM Executive’s Ties to Native Country Help Auto
Maker Clinch Deal in China,” Wall Street Journal (November 2,
1995), p. B7.
70. K. Roth, “Managing International Interdependence: CEO Char-
acteristics in a Resource-Based Framework,” Academy of Man-
agement Journal (February 1995), pp. 200–231.
71. M. Subramaniam and N. Venkatraman, “Determinants of
Transnational New Product Development Capability: Testing
the Influence of Transferring and Deploying Tacit Overseas
Knowledge,” Strategic Management Journal (April 2001),
pp. 359–378.
72. J. S. Lublin, “An Overseas Stint Can Be a Ticket to the Top,”
Wall Street Journal (January 29, 1996), pp. B1, B2.
73. “Cisco Shifts Senior Executives to India,” St. Cloud (MN)
Times (January 13, 2007), p. 6A.
74. “Expatriate Employees: In Search of Stealth,” The Economist
(April 23, 2005), pp. 62–64.
75. M. Meaney, C. Pung, and S. Kamath, “Creating Organizational
Transformations,” McKinsey Quarterly Online (September 10,
2008).
76. L. G. Love, R. L. Priem, and G. T. Lumpkin, “Explicitly Artic-
ulated Strategy and Firm Performance Under Alternative Lev-
els of Centralization,” Journal of Management, Vol. 28, No. 5
(2002), pp. 611–627.
77. G. G. Gordon, “The Relationship of Corporate Culture to Indus-
try Sector and Corporate Performance,” in Gaining Control of
the Corporate Culture, edited by R. H. Kilmann, M. J. Saxton,
R. Serpa, and Associates (San Francisco: Jossey-Bass, 1985),
p. 123; T. Kono, “Corporate Culture and Long-Range Plan-
ning,” Long Range Planning (August 1990), pp. 9–19.
78. B. Mike and J. W. Slocum, Jr., “Changing Culture at Pizza Hut
and Yum! Brands,” Organizational Dynamics, Vol. 32, No. 4
(2003), pp. 319–330.
79. T. J. Tetenbaum, “Seven Key Practices That Improve the
Chance for Expected Integration and Synergies,”
Organizational Dynamics (Autumn 1999), pp. 22–35.
80. B. Bremner and G. Edmondson, “Japan: A Tale of Two Merg-
ers,” Business Week (May 10, 2004), p. 42.
81. P. Very, M. Lubatkin, R. Calori, and J. Veiga, “Relative Standing
and the Performance of Recently Acquired European Firms,”
Strategic Management Journal (September 1997), pp. 593–614.
82. A. R. Malekzadeh and A. Nahavandi, “Making Mergers Work
by Managing Cultures,” Journal of Business Strategy
(May/June 1990), pp. 53–57; A. Nahavandi, and A. R.
Malekzadeh, “Acculturation in Mergers and Acquisitions,”
Academy of Management Review (January 1988), pp. 79–90.
83. C. Ghosn, “Saving the Business Without Losing the Company,”
Harvard Business Review (January 2002), pp. 37–45; B. Bremner,
G. Edmondson, C. Dawson, D. Welch, and K. Kerwin, “Nissan’s
Boss,” Business Week (October 4, 2004), pp. 50–60.
84. D. Harding and T. Rouse, “Human Due Diligence,” Harvard
Business Review (April 2007), pp. 124–131.
85. J. J. Keller, “Why AT&T Takeover of NCR Hasn’t Been a
Real Bell Ringer,” Wall Street Journal (September 19, 1995),
pp. A1, A5.
86. J. W. Gibson and D. V. Tesone, “Management Fads: Emergence,
Evolution, and Implications for Managers,” Academy of Man-
agement Executive (November 2001), pp. 122–133.
87. For additional information, see S. J. Carroll, Jr., and M. L.
Tosi, Jr., Management by Objectives: Applications and Re-
search (New York: Macmillan, 1973), and A. P. Raia, Managing
by Objectives (Glenview, IL: Scott, Foresman, and Company,
1974).
88. J. W. Gibson, D. V. Tesone, and C. W. Blackwell, “Management
Fads: Here Yesterday, Gone Today?” SAM Advanced Manage-
ment Journal (Autumn 2003), pp. 12–17.
CHAPTER 10 Strategy Implementation: Staffing and Directing 327
89. J. W. Gibson and D. V. Tesone, “Management Fads: Emergence,
Evolution, and Implications fdor Managers,” Academy of Man-
agement Executive (November 2001), p. 125.
90. S. S. Masterson, and M. S. Taylor, “Total Quality Management
and Performance Appraisal: An Integrative Perspective,” Journal
of Quality Management, Vol. 1, No. 1 (1996), pp. 67–89.
91. R. J. Vokurka, R. R. Lummus, and D. Krumwiede, “Improving
Manufacturing Flexibility: The Enduring Value of JIT and TQM,”
SAM Advanced Management Journal (Winter 2007), pp. 14–21.
92. T. Y. Choi and O. C. Behling, “Top Managers and TQM Suc-
cess: One More Look After All These Years,” Academy of Man-
agement Executive (February 1997), pp. 37–47.
93. R. J. Schonberger, “Total Quality Management Cuts a Broad
Swath—Through Manufacturing and Beyond,” Organizational
Dynamics (Spring 1992), pp. 16–28.
94. T. C. Powell, “Total Quality Management as Competitive Ad-
vantage: A Review and Empirical Study,” Strategic Manage-
ment Journal (January 1995), pp. 15–37.
95. G. Hofstede, “Culture’s Recent Consequences: Using Dimen-
sional Scores in Theory and Research,” International Journal of
Cross Cultural Management, Vol. 1, No. 1 (2001), pp. 11–17;
G. Hofstede, Cultures and Organizations: Software of the Mind
(London: McGraw-Hill, 1991); G. Hofstede and M. H. Bond,
“The Confucius Connection: From Cultural Roots to Economic
Growth,” Organizational Dynamics (Spring 1988), pp. 5–21;
R. Hodgetts, “A Conversation with Geert Hofstede,”
Organizational Dynamics (Spring 1993), pp. 53–61.
96. M. Javidan and R. J. House, “Cultural Acumen for the Global
Manager: Lessons from Project GLOBE,” Organizational Dy-
namics, Vol. 29, No. 4 (2001), pp. 289–305; R. J. House, P. J.
Hanges, M. Javidan, P. W. Dorfman, and V. Gupta, eds.,
Culture, Leadership and Organizations: The GLOBE Study of
62 Societies (Thousand Oaks, CA: Sage, 2004).
97. M. Javidan and R. J. House, “Cultural Acumen for the Global
Manager: Lessons from Project GLOBE,” Organizational Dy-
namics, Vol. 29, No. 4 (2001), p. 303.
98. See G. Hofstede and M. H. Bond, “The Confucius Connection,
From Cultural Roots to Economic Growth,” Organizational
Dynamics, (Spring 1988), pp. 12–13.
99. H. K. Steensma, L. Marino, K. M. Weaver, and P. H. Dickson,
“The Influence of National Culture on the Formation of Tech-
nology Alliances by Entrepreneurial Firms,” Academy of Man-
agement Journal (October 2000), pp. 951–973.
100. T. T. Herbert, “Multinational Strategic Planning: Matching
Central Expectations to Local Realities,” Long Range Planning
(February 1999), pp. 81–87.
101. M. A. Geletkancz, “The Salience of ‘Culture’s Consequences’:
The Effects of Cultural Values on Top Executive Commitment
to the Status Quo,” Strategic Management Journal (September
1997), pp. 615–634.
102. G. Hofstede and M. H. Bond, “The Confucius Connection,
From Cultural Roots to Economic Growth,” Organizational
Dynamics, (Spring 1988), p. 20.
103. B. Groysberg, A. Nanda, and N. Nohria, “The Risky Business
of Hiring Stars,” Harvard Business Review (May 2004),
pp. 92–100.
104. D. Jones, “Employers Learning That ‘B Players’ Hold the
Cards,” USA Today (September 9, 2003), pp. 1B–2B.
105. B. Elgin, “Green—Up to a Point,” Business Week (March 3,
2008), pp. 25–26.
106. D. Keirsey, Please Understand Me II (Del Mar, CA:
Prometheus Nemesis Book Co., 1998).
Nucor Corporation, one of the most successful steel firms operating in the
United States, keeps its evaluation and control process simple and easy to
manage. According to Kenneth Iverson, Chairman of the Board:
We try to keep our focus on what really matters—bottom-line performance and
long-term survival. That’s what we want our people to be thinking about. Manage-
ment takes care not to distract the company with a lot of talk about other issues. We don’t
clutter the picture with lofty vision statements or ask employees to pursue vague, interme-
diate objectives such as “excellence” or burden them with complex business strategies. Our
competitive strategy is to build manufacturing facilities economically and to operate them
efficiently. Period. Basically, we ask our employees to produce more product for less money.
Then we reward them for doing that well.1
The evaluation and control process ensures that a company is achieving what it set out to
accomplish. It compares performance with desired results and provides the feedback necessary
for management to evaluate results and take corrective action, as needed. This process can be
viewed as a five-step feedback model, as depicted in Figure 11–1.
1. Determine what to measure: Top managers and operational managers need to specify
what implementation processes and results will be monitored and evaluated. The processes
and results must be capable of being measured in a reasonably objective and consistent
manner. The focus should be on the most significant elements in a process—the ones that
account for the highest proportion of expense or the greatest number of problems. Mea-
surements must be found for all important areas, regardless of difficulty.
2. Establish standards of performance: Standards used to measure performance are detailed
expressions of strategic objectives. They are measures of acceptable performance results.
Each standard usually includes a tolerance range, which defines acceptable deviations.
Standards can be set not only for final output but also for intermediate stages of produc-
tion output.
3. Measure actual performance: Measurements must be made at predetermined times.
4. Compare actual performance with the standard: If actual performance results are within
the desired tolerance range, the measurement process stops here.
evaluation
and Control
C H A P T E R 11
329
� Understand the basic control process
� Choose among traditional measures, such
as ROI, and shareholder value measures,
such as economic value added, to properly
assess performance
� Use the balanced scorecard approach to
develop key performance measures
� Apply the benchmarking process to a
function or an activity
� Understand the impact of problems with
measuring performance
� Develop appropriate control systems to
support specific strategies
Learning Objectives
Gathering
Information
Putting Strategy
into Action
Monitoring
Performance
Societal
Environment:
General forces
Natural
Environment:
Resources and
climate
Task
Environment:
Industry analysis
Internal:
Strengths and
Weaknesses
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
Programs
Activities
needed to
accomplish
a plan
Budgets
Cost of the
programs Procedures
Sequence
of steps
needed to
do the job
Performance
Actual results
External:
Opportunities
and Threats
Developing
Long-range Plans
Mission
Reason for
existence Objectives
What
results to
accomplish
by when
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Environmental
Scanning:
Strategy
Formulation:
Strategy
Implementation:
Evaluation
and Control:
Feedback/Learning: Make corrections as needed
After reading this chapter, you should be able to:
330 PART 4 Strategy Implementation and Control
1
Determine
what to
measure.
Establish
predetermined
standards.
Measure
performance.
No
5432
Yes
STOP
Does
perfor-
mance match
stan-
dards?
Take
corrective
action.
FIGURE 11–1
Evaluation and
Control Process
5. Take corrective action: If actual results fall outside the desired tolerance range, action
must be taken to correct the deviation. The following questions must be answered:
a. Is the deviation only a chance fluctuation?
b. Are the processes being carried out incorrectly?
c. Are the processes appropriate to the achievement of the desired standard? Action
must be taken that will not only correct the deviation but also prevent its happen-
ing again.
d. Who is the best person to take corrective action?
Top management is often better at the first two steps of the control model than it is at
the last two follow-through steps. It tends to establish a control system and then delegate
the implementation to others. This can have unfortunate results. Nucor is unusual in its
ability to deal with the entire evaluation and control process.
11.1 Evaluation and Control in Strategic Management
Evaluation and control information consists of performance data and activity reports (gathered
in Step 3 in Figure 11–1). If undesired performance results because the strategic management
processes were inappropriately used, operational managers must know about it so that they can
correct the employee activity. Top management need not be involved. If, however, undesired
performance results from the processes themselves, top managers, as well as operational man-
agers, must know about it so that they can develop new implementation programs or proce-
dures. Evaluation and control information must be relevant to what is being monitored. One
of the obstacles to effective control is the difficulty in developing appropriate measures of im-
portant activities and outputs.
An application of the control process to strategic management is depicted in Figure 11–2.
It provides strategic managers with a series of questions to use in evaluating an implemented
strategy. Such a strategy review is usually initiated when a gap appears between a company’s
financial objectives and the expected results of current activities. After answering the proposed
set of questions, a manager should have a good idea of where the problem originated and what
must be done to correct the situation.
CHAPTER 11 Evaluation and Control 331
Issue
No
No
No
No
No
No
No
No
No
No
NoYes
Yes
YesYesYes
Yes
Yes
Yes
Yes
No
Conclusions
Yes
Did the existing
strategies
produce the
desired results?
Were the under-
lying assumptions
and premises
valid?
Were alternative
scenarios defined
and assessed?
Were the current
situation and
important trends
properly
diagnosed?
Was strategy
formulation
adversely
affected?
Were supporting
functional stra-
tegies consistent
with the business
unit strategies?
Inconsistent
functional plans.
Were resource
allocations suffi-
cient and
consistent with
the selected
strategies?
Incorrect
assessment of
resource
requirements.
Successful
strategy
and results.
Were results
monitored and
strategies revised
as needed?
Did management
commit to and
follow through
with the
strategies?
Weak
commitment of
operating
management.
Failure to
establish
proper feedback
mechanism.
Invalid planning
bases: incorrect
strategy
formulation.
Were strategies
poorly executed?
Were strategies
and their
requirements
communicated
effectively?
Poor
communication.
FIGURE 11–2
Evaluating an
Implemented
Strategy
SOURCE: From “The Strategic Review,” Planning Review, Jeffrey A. Schmidt, 1998 © MCB University Press Limited.
Republished with permission of Emerald Group Publishing Ltd.
332 PART 4 Strategy Implementation and Control
TYPES OF CONTROLS
Controls can be established to focus on actual performance results (output), the activities that
generate the performance (behavior), or on resources that are used in performance (input).
Output controls specify what is to be accomplished by focusing on the end result of the be-
haviors through the use of objectives and performance targets or milestones. Behavior
controls specify how something is to be done through policies, rules, standard operating
11.2 Measuring Performance
Performance is the end result of activity. Select measures to assess performance based on the
organizational unit to be appraised and the objectives to be achieved. The objectives that were
established earlier in the strategy formulation part of the strategic management process (deal-
ing with profitability, market share, and cost reduction, among others) should certainly be used
to measure corporate performance once the strategies have been implemented.
APPROPRIATE MEASURES
Some measures, such as return on investment (ROI) and earnings per share (EPS), are appro-
priate for evaluating a corporation’s or a division’s ability to achieve a profitability objective.
This type of measure, however, is inadequate for evaluating additional corporate objectives
such as social responsibility or employee development. Even though profitability is a corpo-
ration’s major objective, ROI and EPS can be computed only after profits are totaled for a pe-
riod. It tells what happened after the fact—not what is happening or what will happen. A firm,
therefore, needs to develop measures that predict likely profitability. These are referred to as
steering controls because they measure variables that influence future profitability. Every in-
dustry has its own set of key metrics which tend to predict profits. Airlines, for example,
closely monitor cost per passenger mile. In the 1990s, Southwest’s cost per passenger mile was
6.43¢, the lowest in the industry, contrasted with American’s 12.95¢, the highest in the indus-
try.2 Its low costs gave Southwest a significant competitive advantage.
An example of a steering control used by retail stores is the inventory turnover ratio, in
which a retailer’s cost of goods sold is divided by the average value of its inventories. This
measure shows how hard an investment in inventory is working; the higher the ratio, the bet-
ter. Not only does quicker moving inventory tie up less cash in inventories, it also reduces the
risk that the goods will grow obsolete before they’re sold—a crucial measure for computers
and other technology items. For example, Office Depot increased its inventory turnover ratio
from 6.9 in one year to 7.5 the next year, leading to improved annual profits.3
Another steering control is customer satisfaction. Research reveals that companies that
score high on the American Customer Satisfaction Index (ACSI), a measure developed by the
University of Michigan’s National Research Center, have higher stock returns and better cash
flows than do those companies that score low on the ACSI. A change in a firm’s customer sat-
isfaction typically works its way through a firm’s value chain and is eventually reflected in
quarterly profits.4 Other approaches to measuring customer satisfaction include Oracle’s use
of the ratio of quarterly sales divided by customer service requests and the total number of
hours that technicians spend on the phone solving customer problems. To help executives keep
track of important steering controls, Netsuite developed dashboard software that displays crit-
ical information in easy-to-read computer graphics assembled from data pulled from other cor-
porate software programs.5
CHAPTER 11 Evaluation and Control 333
procedures, and orders from a superior. Input controls emphasize resources, such as knowl-
edge, skills, abilities, values, and motives of employees.6
Output, behavior, and input controls are not interchangeable. Output controls (such as
sales quotas, specific cost-reduction or profit objectives, and surveys of customer satisfac-
tion) are most appropriate when specific output measures have been agreed on but the
cause–effect connection between activities and results is not clear. Behavior controls (such as
following company procedures, making sales calls to potential customers, and getting to work
on time) are most appropriate when performance results are hard to measure, but the
cause–effect connection between activities and results is clear. Input controls (such as num-
ber of years of education and experience) are most appropriate when output is difficult to
measure and there is no clear cause–effect relationship between behavior and performance
(such as in college teaching). Corporations following the strategy of conglomerate diversifi-
cation tend to emphasize output controls with their divisions and subsidiaries (presumably be-
cause they are managed independently of each other), whereas, corporations following
concentric diversification use all three types of controls (presumably because synergy is de-
sired).7 Even if all three types of control are used, one or two of them may be emphasized
more than another depending on the circumstances. For example, Muralidharan and Hamilton
propose that as a multinational corporation moves through its stages of development, its em-
phasis on control should shift from being primarily output at first, to behavioral, and finally
to input control.8
Examples of increasingly popular behavior controls are the ISO 9000 and 14000 Stan-
dards Series on quality and environmental assurance, developed by the International Standards
Association of Geneva, Switzerland. Using the ISO 9000 Standards Series (composed of five
sections from 9000 to 9004) is a way of objectively documenting a company’s high level of
quality operations. Using the ISO 14000 Standards Series is a way to document the com-
pany’s impact on the environment. A company wanting ISO 9000 certification would docu-
ment its process for product introductions, among other things. ISO 9001 would require this
firm to separately document design input, design process, design output, and design verification—
a large amount of work. ISO 14001 would specify how companies should establish, maintain
and continually improve an environmental management system. Although the average total
cost for a company to be ISO 9000 certified is close to $250,000, the annual savings are around
$175,000 per company.9 Overall, ISO 14001-related savings are about equal to the costs,
reports Tim Delawder, Vice President of SWD, Inc., a metal finishing company in Addison,
Illinois.10
Many corporations view ISO 9000 certification as assurance that a supplier sells quality
products. Firms such as DuPont, Hewlett-Packard, and 3M have facilities registered to ISO
standards. Companies in more than 60 countries, including Canada, Mexico, Japan, the United
States (including the entire U.S. auto industry), and the European Union, require ISO 9000 cer-
tification of their suppliers.11 The same is happening for ISO 14000. Both Ford and General
Motors require their suppliers to follow ISO 14001. In a survey of manufacturing executives,
51% of the executives found that ISO 9000 certification increased their international compet-
itiveness. Other executives noted that it signaled their commitment to quality and gave them
a strategic advantage over noncertified competitors.12
Since its ISO 14000 certification, SWD Inc. has become a showplace for environmental
awareness. According to SWD’s Delawder, ISO 14000 certification improves environmental
awareness among employees, reduces risks of violating regulations, and improves the firm’s
image among customers and the local community.13
Another example of a behavior control is a company’s monitoring of employee phone
calls and PCs to ensure that employees are behaving according to company guidelines. In a
study by the American Management Association, nearly 75% of U.S. companies actively mon-
itored their workers’ communications and on-the-job activities. Around 54% tracked individual
334 PART 4 Strategy Implementation and Control
employees’ Internet connections and 38% admitted storing and reviewing their employees’
e-mail. About 45% of the companies surveyed had disciplined workers (16% had fired them).
For example, Xerox fired 40 employees for visiting pornographic Web sites.14
ACTIVITY-BASED COSTING
Activity-based costing (ABC) is a recently developed accounting method for allocating indi-
rect and fixed costs to individual products or product lines based on the value-added activities
going into that product.15 This accounting method is thus very useful in doing a value-chain
analysis of a firm’s activities for making outsourcing decisions. Traditional cost accounting,
in contrast, focuses on valuing a company’s inventory for financial reporting purposes. To ob-
tain a unit’s cost, cost accountants typically add direct labor to the cost of materials. Then they
compute overhead from rent to R&D expenses, based on the number of direct labor hours it
takes to make a product. To obtain unit cost, they divide the total by the number of items made
during the period under consideration.
Traditional cost accounting is useful when direct labor accounts for most of total costs and
a company produces just a few products requiring the same processes. This may have been true
of companies during the early part of the twentieth century, but it is no longer relevant today,
when overhead may account for as much as 70% of manufacturing costs. According to Bob
Van Der Linde, CEO of a contract manufacturing services firm in San Diego, California:
“Overhead is 80% to 90% in our industry, so allocation errors lead to pricing errors, which
could easily bankrupt the company.”16 The appropriate allocation of indirect costs and over-
head has thus become crucial for decision making. The traditional volume-based cost-driven
system systematically understates the cost per unit of products with low sales volumes and
products with a high degree of complexity. Similarly, it overstates the cost per unit of products
with high sales volumes and a low degree of complexity.17 When Chrysler used ABC, it dis-
covered that the true cost of some of the parts used in making cars was 30 times what the com-
pany had previously estimated.18
ABC accounting allows accountants to charge costs more accurately than the traditional
method because it allocates overhead far more precisely. For example, imagine a production
line in a pen factory where black pens are made in high volume and blue pens in low volume.
Assume that it takes eight hours to retool (reprogram the machinery) to shift production from
one kind of pen to the other. The total costs include supplies (the same for both pens), the di-
rect labor of the line workers, and factory overhead. In this instance, a very significant part of
the overhead cost is the cost of reprogramming the machinery to switch from one pen to an-
other. If the company produces 10 times as many black pens as blue pens, 10 times the cost of
the reprogramming expenses will be allocated to the black pens as to the blue pens under tra-
ditional cost accounting methods. This approach underestimates, however, the true cost of
making the blue pens.
ABC accounting, in contrast, first breaks down pen manufacturing into its activities. It is
then very easy to see that it is the activity of changing pens that triggers the cost of retooling.
The ABC accountant calculates an average cost of setting up the machinery and charges it
against each batch of pens that requires retooling, regardless of the size of the run. Thus a prod-
uct carries only those costs for the overhead it actually consumes. Management is now able to
discover that its blue pens cost almost twice as much as do the black pens. Unless the com-
pany is able to charge a higher price for its blue pens, it cannot make a profit on these pens.
Unless there is a strategic reason why it must offer blue pens (such as a key customer who must
have a small number of blue pens with every large order of black pens or a marketing trend
away from black to blue pens), the company will earn significantly greater profits if it com-
pletely stops making blue pens.19
CHAPTER 11 Evaluation and Control 335
ENTERPRISE RISK MANAGEMENT
Enterprise Risk Management (ERM) is a corporatewide, integrated process for managing
the uncertainties that could negatively or positively influence the achievement of the corpora-
tion’s objectives. In the past, managing risk was done in a fragmented manner within func-
tions or business units. Individuals would manage process risk, safety risk, and insurance,
financial, and other assorted risks. As a result of this fragmented approach, companies would
take huge risks in some areas of the business while over-managing substantially smaller risks
in other areas. ERM is being adopted because of the increasing amount of environmental un-
certainty that can affect an entire corporation. As a result, the position Chief Risk Officer is
one of the fastest growing executive positions in U.S. corporations.20 Microsoft uses scenario
analysis to identify key business risks. According to Microsoft’s treasurer, Brent Callinicos,
“The scenarios are really what we’re trying to protect against.”21 The scenarios were the pos-
sibility of an earthquake in the Seattle region and a major downturn in the stock market.
The process of rating risks involves three steps:
1. Identify the risks using scenario analysis or brainstorming or by performing risk self-
assessments.
2. Rank the risks, using some scale of impact and likelihood.
3. Measure the risks, using some agreed-upon standard.
Some companies are using value at risk, or VAR (effect of unlikely events in normal mar-
kets), and stress testing (effect of plausible events in abnormal markets) methodologies to
measure the potential impact of the financial risks they face. DuPont uses earnings at risk
(EAR) measuring tools to measure the effect of risk on reported earnings. It can then manage
risk to a specified earnings level based on the company’s “risk appetite.” With this integrated
view, DuPont can view how risks affect the likelihood of achieving certain earnings targets.22
Research has shown that companies with integrative risk management capabilities achieve su-
perior economic performance.23
PRIMARY MEASURES OF CORPORATE PERFORMANCE
The days when simple financial measures such as ROI or EPS were used alone to assess over-
all corporate performance are coming to an end. Analysts now recommend a broad range of
methods to evaluate the success or failure of a strategy. Some of these methods are stakeholder
measures, shareholder value, and the balanced scorecard approach. Even though each of these
methods has supporters as well as detractors, the current trend is clearly toward more compli-
cated financial measures and an increasing use of non-financial measures of corporate perfor-
mance. For example, research indicates that companies pursuing strategies founded on
innovation and new product development now tend to favor non-financial over financial
measures.24
Traditional Financial Measures
The most commonly used measure of corporate performance (in terms of profits) is Return
On Investment (ROI). It is simply the result of dividing net income before taxes by the total
amount invested in the company (typically measured by total assets). Although using ROI has
several advantages, it also has several distinct limitations. (See Table 11–1.) Although ROI
gives the impression of objectivity and precision, it can be easily manipulated.
Earnings Per Share (EPS), which involves dividing net earnings by the amount of com-
mon stock, also has several deficiencies as an evaluation of past and future performance. First,
because alternative accounting principles are available, EPS can have several different but
336 PART 4 Strategy Implementation and Control
TABLE 11–1 Before using Return on Investment (ROI) as a measure of corporate performance, consider its
advantages and limitations.
Advantages
� ROI is a single, comprehensive number that includes all revenues, costs, and expenses.
� It can be used to evaluate the performance of a general manager of a division or SBU.
� It can be compared across companies to see which firms are performing better.
� It provides an incentive to use current assets efficiently and to acquire new assets only when
they would increase profits significantly.
Limitations
� ROI is very sensitive to depreciation policy. ROI can be increased by writing down the value of
assets through accelerated depreciation.
� It can discourage investment in new facilities or the upgrading of old ones. Older plants with
depreciated assets have an advantage over newer plants in earning a higher ROI.
� It provides an incentive for division managers to set transfer prices for goods sold to other
divisions as high as possible and to lobby for corporate policy favoring in-house transfers over
purchases from other firms.
� Managers tend to focus more on ROI in the short-run over its use in the long-run. This provides
an incentive for goal displacement and other dysfunctional consequences.
� ROI is not comparable across industries which operate under different conditions of
favorability.
� It is influenced by the overall economy and will tend to be higher in prosperity and lower in a
recession.
SOURCE: From Higgins. Organizational Policy and Strategic Management, 2nd edition, © 1983 South-Western,
a part of Cengage Learning, Inc. Reproduced by permission. www.cengage.com/permissions
equally acceptable values, depending on the principle selected for its computation. Second, be-
cause EPS is based on accrual income, the conversion of income to cash can be near term or
delayed. Therefore, EPS does not consider the time value of money. Return On Equity
(ROE), which involves dividing net income by total equity, also has limitations because it is
also derived from accounting-based data. In addition, EPS and ROE are often unrelated to a
company’s stock price.
Operating cash flow, the amount of money generated by a company before the cost of
financing and taxes, is a broad measure of a company’s funds. This is the company’s net in-
come plus depreciation, depletion, amortization, interest expense, and income tax expense.25
Some takeover specialists look at a much narrower free cash flow: the amount of money a
new owner can take out of the firm without harming the business. This is net income plus de-
preciation, depletion, and amortization less capital expenditures and dividends. The free cash
flow ratio is very useful in evaluating the stability of an entrepreneurial venture.26 Although
cash flow may be harder to manipulate than earnings, the number can be increased by selling
accounts receivable, classifying outstanding checks as accounts payable, trading securities,
and capitalizing certain expenses, such as direct-response advertising.27
Because of these and other limitations, ROI, EPS, ROE, and operating cash flow are not
by themselves adequate measures of corporate performance. At the same time, these tradi-
tional financial measures are very appropriate when used with complementary financial and
non-financial measures. For example, some non–financial performance measures often used
by Internet business ventures are stickiness (length of Web site visit), eyeballs (number of peo-
ple who visit a Web site), and mindshare (brand awareness). Mergers and acquisitions may be
priced on multiples of MUUs (monthly unique users) or even on registered users.
Advantages and
Limitations
of Using ROI as a
Measure of
Corporate
Performance
www.cengage.com/permissions
CHAPTER 11 Evaluation and Control 337
TABLE 11–2 A Sample Scorecard for “Keeping Score” with Stakeholders
Stakeholder Category Possible Near-Term Measures Possible Long-Term Measures
Customers Sales ($ and volume)
New customers
Number of new customer needs met
(“tries”)
Growth in sales
Turnover of customer base
Ability to control price
Suppliers Cost of raw material
Delivery time
Inventory
Availability of raw material
Growth rates of:
Raw material costs
Delivery time
Inventory
New ideas from suppliers
Financial community EPS
Stock price
Number of “buy” lists
ROE
Ability to convince Wall Street of strategy
Growth in ROE
Employees Number of suggestions
Productivity
Number of grievances
Number of internal promotions
Turnover
Congress Number of new pieces of legislation
that affect the firm
Access to key members and staff
Number of new regulations that affect industry
Ratio of “cooperative” vs. “competitive” encounters
Consumer advocate (CA) Number of meetings
Number of “hostile” encounters
Number of times coalitions formed
Number of legal actions
Number of changes in policy due to CA
Number of CA-initiated “calls for help”
Environmentalists Number of meetings
Number of hostile encounters
Number of times coalitions formed
Number of EPA complaints
Number of legal actions
Number of changes in policy due to
environmentalists
Number of environmentalist “calls for help”
SOURCE: R. E. Freeman, Strategic Management: A Stakeholder Approach (Boston: Ballinger Publishing Company, 1984), p. 179. Copyright
© 1984 by R. E. Freeman. Reprinted by permission of R. Edward Freeman.
Stakeholder Measures
Each stakeholder has its own set of criteria to determine how well the corporation is perform-
ing. These criteria typically deal with the direct and indirect impacts of corporate activities on
stakeholder interests. Top management should establish one or more stakeholder measures for
each stakeholder category so that it can keep track of stakeholder concerns. (See Table 11–2.)
Shareholder Value
Because of the belief that accounting-based numbers such as ROI, ROE, and EPS are not re-
liable indicators of a corporation’s economic value, many corporations are using shareholder
value as a better measure of corporate performance and strategic management effectiveness.
Shareholder value can be defined as the present value of the anticipated future stream of
cash flows from the business plus the value of the company if liquidated. Arguing that the pur-
pose of a company is to increase shareholder wealth, shareholder value analysis concentrates
on cash flow as the key measure of performance. The value of a corporation is thus the value
of its cash flows discounted back to their present value, using the business’s cost of capital as
338 PART 4 Strategy Implementation and Control
the discount rate. As long as the returns from a business exceed its cost of capital, the business
will create value and be worth more than the capital invested in it. For example, Deere and
Company charges each business unit a cost of capital of 1% of assets a month. Each business
unit is required to earn a shareholder value-added profit margin of 20% on average over the
business cycle. Financial rewards are linked to this measure.28
The New York consulting firm Stern Stewart & Company devised and popularized two
shareholder value measures: economic value added (EVA) and market value added (MVA). A
basic tenet of EVA and MVA is that businesses should not invest in projects unless they can
generate a profit above the cost of capital. Stern Stewart argues that a deficiency of traditional
accounting-based measures is that they assume the cost of capital to be zero.29 Well-known
companies, such as Coca-Cola, General Electric, AT&T, Whirlpool, Quaker Oats, Eli Lilly,
Georgia-Pacific, Polaroid, Sprint, Teledyne, and Tenneco have adopted MVA and/or EVA as
the best yardstick for corporate performance.
Economic Value Added (EVA) has become an extremely popular shareholder value
method of measuring corporate and divisional performance and may be on its way to replac-
ing ROI as the standard performance measure. EVA measures the difference between the pre-
strategy and post-strategy values for the business. Simply put, EVA is after-tax operating
income minus the total annual cost of capital. The formula to measure EVA is:
EVA � after tax operating income � (investment in assets �
weighted average cost of capital)30
The cost of capital combines the cost of debt and equity. The annual cost of borrowed capital
is the interest charged by the firm’s banks and bondholders. To calculate the cost of equity, as-
sume that shareholders generally earn about 6% more on stocks than on government bonds. If
long-term treasury bills are selling at 7.5%, the firm’s cost of equity should be 13.5%—more
if the firm is in a risky industry. A corporation’s overall cost of capital is the weighted-average
cost of the firm’s debt and equity capital. The investment in assets is the total amount of cap-
ital invested in the business, including buildings, machines, computers, and investments in
R&D and training (allocating costs annually over their useful life). Because the typical bal-
ance sheet understates the investment made in a company, Stern Stewart has identified 150
possible adjustments, before EVA is calculated.31 Multiply the firm’s total investment in assets
by the weighted-average cost of capital. Subtract that figure from after-tax operating income.
If the difference is positive, the strategy (and the management employing it) is generating
value for the shareholders. If it is negative, the strategy is destroying shareholder value.32
Roberto Goizueta, past-CEO of Coca-Cola, explained, “We raise capital to make concentrate,
and sell it at an operating profit. Then we pay the cost of that capital. Shareholders pocket the dif-
ference.”33 Managers can improve their company’s or business unit’s EVA by: (1) earning more
profit without using more capital, (2) using less capital, and (3) investing capital in high-return proj-
ects. Studies have found that companies using EVA outperform their median competitor by an av-
erage of 8.43% of total return annually.34 EVA does, however, have some limitations. For one thing,
it does not control for size differences across plants or divisions. As with ROI, managers can ma-
nipulate the numbers. As with ROI, EVA is an after-the-fact measure and cannot be used like a steer-
ing control.35 Although proponents of EVA argue that EVA (unlike Return on Investment, Equity,
or Sales) has a strong relationship to stock price, other studies do not support this contention.36
Market Value Added (MVA) is the difference between the market value of a corporation
and the capital contributed by shareholders and lenders. Like net present value, it measures the
stock market’s estimate of the net present value of a firm’s past and expected capital invest-
ment projects. As such, MVA is the present value of future EVA.37 To calculate MVA,
1. Add all the capital that has been put into a company—from shareholders, bondholders,
and retained earnings.
CHAPTER 11 Evaluation and Control 339
2. Reclassify certain accounting expenses, such as R&D, to reflect that they are actually in-
vestments in future earnings. This provides the firm’s total capital. So far, this is the same
approach taken in calculating EVA.
3. Using the current stock price, total the value of all outstanding stock, adding it to the com-
pany’s debt. This is the company’s market value. If the company’s market value is greater
than all the capital invested in it, the firm has a positive MVA—meaning that management
(and the strategy it is following) has created wealth. In some cases, however, the market
value of the company is actually less than the capital put into it, which means shareholder
wealth is being destroyed.
Microsoft, General Electric, Intel, and Coca-Cola have tended to have high MVAs in the
United States, whereas, General Motors and RJR Nabisco have had low ones.38 Studies have
shown that EVA is a predictor of MVA. Consecutive years of positive EVA generally lead to a
soaring MVA.39 Research also reveals that CEO turnover is significantly correlated with MVA
and EVA, whereas ROA and ROE are not. This suggests that EVA and MVA may be more ap-
propriate measures of the market’s evaluation of a firm’s strategy and its management than are
the traditional measures of corporate performance.40 Nevertheless, these measures consider
only the financial interests of the shareholder and ignore other stakeholders, such as environ-
mentalists and employees.
Climate change is likely to lead to new regulations, technological remedies, and shifts in
consumer behavior. It will thus have a significant impact on the financial performance of many
corporations. To learn how global warming is likely to affect different industrial sectors and
corporations, see the Environmental Sustainability Issue feature.
Balanced Scorecard Approach: Using Key Performance Measures
Rather than evaluate a corporation using a few financial measures, Kaplan and Norton ar-
gue for a “balanced scorecard,” that includes non-financial as well as financial measures.41
This approach is especially useful given that research indicates that non-financial assets ex-
plain 50% to 80% of a firm’s value.42 The balanced scorecard combines financial measures
that tell the results of actions already taken with operational measures on customer satisfac-
tion, internal processes, and the corporation’s innovation and improvement activities—the
drivers of future financial performance. Thus steering controls are combined with output
controls. In the balanced scorecard, management develops goals or objectives in each of
four areas:
1. Financial: How do we appear to shareholders?
2. Customer: How do customers view us?
3. Internal business perspective: What must we excel at?
4. Innovation and learning: Can we continue to improve and create value?43
Each goal in each area (for example, avoiding bankruptcy in the financial area) is then as-
signed one or more measures, as well as a target and an initiative. These measures can be
thought of as key performance measures—measures that are essential for achieving a desired
strategic option.44 For example, a company could include cash flow, quarterly sales growth,
and ROE as measures for success in the financial area. It could include market share (compet-
itive position goal), customer satisfaction, and percentage of new sales coming from new prod-
ucts (customer acceptance goal) as measures under the customer perspective. It could include
cycle time and unit cost (manufacturing excellence goal) as measures under the internal busi-
ness perspective. It could include time to develop next generation products (technology lead-
ership objective) under the innovation and learning perspective.
How will global warming af-
fect the value of a corpora-
tion’s stock? To answer this
question, the U.S.-based consulting
firm McKinsey & Company undertook a joint project with
the Carbon Trust, a UK research organization. The result-
ing research found that the large reductions in greenhouse
gas emissions needed to stop climate change will create
significant opportunities and risks for most companies.
Well-positioned, forward-thinking corporations could, for
example, increase company value (stock price � number of
shares outstanding) by up to 80%. The research found that
as much as 65% of company value was at risk in some in-
dustrial sectors.
340 PART 4 Strategy Implementation and Control
HOW GLOBAL WARMING
COULD AFFECT CORPORATE VALUATION
ENVIRONMENTAL sustainability issue
The joint study investigated the industrial sectors of alu-
minum, automotive, oil and gas, consumer electronics,
building materials, and beer. It quantified the impacts on
each industrial sector and found that the impact of climate
change will vary by sector. The resulting report lists both
the maximum value creation opportunity for a prepared
company and the maximum company value at risk for a
company that fails to adapt.
Note that the oil and gas sectors will have very few op-
portunities (especially in exploration and production), but
many risks. This overall negative impact will mean falling
cash flows and stock prices for the companies in those sec-
tors. In contrast, the building materials sector will benefit
from rising demand for improved energy efficiency and in-
sulation products, leading to increasing cash flows and
stock prices. The consumer electronics sector is also in a
good position. Using current technology, consumer elec-
tronics companies can make their products significantly
more energy efficient (by reducing active and standby
power consumption) at low and diminishing costs. Auto-
mobile companies, in contrast, face both a high level of op-
portunities and threats. The better prepared companies
should do well, but the laggards will likely face serious cash
flow problems and falling stock prices.
Tom Delay, Carbon Trust’s CEO warns: “We have a short
window of opportunity to act but at present business and
investor actions are way out of step with the need to tackle
climate change. They must be urgently re-aligned by devel-
oping new business and investment strategies and by
working with governments to develop policy frameworks
that reward early and effective action to rapidly reduce car-
bon emissions.”
SOURCES: M. W. Brinkman, N. Hoffman, J. M. Oppenheim, “How
Climate Change Could Affect Corporate Valuations,” McKinsey
Quarterly (Autumn 2008), pp. 1–7; “Climate Change: The Trillion
Dollar Wake-Up Call,” Carbon Trust Web site (September 22,
2008), www.carbontrust.com.
Industrial
Sector
Maximum
Company
Value Creation
Opportunity
for Prepared
Company
Maximum
Company
Value at Risk
for a Company
Failing to
Adapt
Aluminum 30% 65%
Automotive 60% 65%
Oil & Gas
(Exploration &
Production)
0% 35%
Oil & Gas (Refining) 7% 30%
Consumer Electronics 35% 7%
Building Materials 80% 20%
Beer 0% 15%
A survey by Bain & Company reported that 50% of Fortune 1,000 companies in North
America and about 40% in Europe use a version of the balanced scorecard.45 Another survey re-
ported that the balanced scorecard is used by over half of Fortune’s Global 1000 companies.46
A study of the Fortune 500 firms in the U.S. and the Post 300 firms in Canada revealed the most
popular non-financial measures to be customer satisfaction, customer service, product quality,
market share, productivity, service quality, and core competencies. New product development,
corporate culture, and market growth were not far behind.47 DuPont’s Engineering Polymers Di-
vision uses the balanced scorecard to align employees, business units, and shared services
www.carbontrust.com
CHAPTER 11 Evaluation and Control 341
around a common strategy involving productivity improvements and revenue growth.48 Corpo-
rate experience with the balanced scorecard reveals that a firm should tailor the system to suit
its situation, not just adopt it as a cookbook approach. When the balanced scorecard comple-
ments corporate strategy, it improves performance. Using the method in a mechanistic fashion
without any link to strategy hinders performance and may even decrease it.49
Evaluating Top Management and the Board of Directors
Through its strategy, audit, and compensation committees, a board of directors closely evalu-
ates the job performance of the CEO and the top management team. The vast majority of
American (91%), European (75%), and Asian (75%) boards review the CEO’s performance
using a formalized process.50 Objective evaluations of the CEO by the board are very impor-
tant given that CEOs tend to evaluate senior management’s performance significantly more
positively than do other executives.51 The board is concerned primarily with overall corporate
profitability as measured quantitatively by ROI, ROE, EPS, and shareholder value. The ab-
sence of short-run profitability certainly contributes to the firing of any CEO. The board, how-
ever, is also concerned with other factors.
Members of the compensation committees of today’s boards of directors generally agree
that a CEO’s ability to establish strategic direction, build a management team, and provide lead-
ership are more critical in the long run than are a few quantitative measures. The board should
evaluate top management not only on the typical output-oriented quantitative measures, but
also on behavioral measures—factors relating to its strategic management practices. Accord-
ing to a survey by Korn/Ferry International, the criteria used by American boards are financial
(81%), ethical behavior (63%), thought leadership (58%), corporate reputation (32%), stock
price performance (22%), and meeting participation (10%).52 The specific items that a board
uses to evaluate its top management should be derived from the objectives that both the board
and top management agreed on earlier. If better relations with the local community and im-
proved safety practices in work areas were selected as objectives for the year (or for five years),
these items should be included in the evaluation. In addition, other factors that tend to lead to
profitability might be included, such as market share, product quality, or investment intensity.
Performance evaluations of the overall board’s performance are standard practice for 87%
of directors in the Americas, 72% in Europe, and 62% in Asia.53 Evaluations of individual di-
rectors are less common. According to a PriceWaterhouseCoopers survey of 1,100 directors,
77% of the directors agreed that individual directors should be appraised regularly on their per-
formance, but only 37% responded that they actually do so.54 Corporations that have success-
fully used board performance appraisal systems are Target, Radio Shack, Eastman Chemical
Company, Bell South, Raytheon, and Gillette.55
Chairman-CEO Feedback Instrument. An increasing number of companies are evaluating
their CEO by using a 17-item questionnaire developed by Ram Charan, an authority on
corporate governance. The questionnaire focuses on four key areas: (1) company per-
formance, (2) leadership of the organization, (3) team-building and management succession,
and (4) leadership of external constituencies.56 After taking an hour to complete the
questionnaire, the board of KeraVision, Inc., used it as a basis for a lengthy discussion with
the CEO, Thomas Loarie. The board criticized Loarie for “not tempering enthusiasm with
reality” and urged Loarie to develop a clear management succession plan. The evaluation
caused Loarie to more closely involve the board in setting the company’s primary objectives
and discussing “where we are, where we want to go, and the operating environment.”57
Management Audit. Management audits are very useful to boards of directors in evaluating
management’s handling of various corporate activities. Management audits have been
developed to evaluate activities such as corporate social responsibility, functional areas such
342 PART 4 Strategy Implementation and Control
as the marketing department, and divisions such as the international division. These can be
helpful if the board has selected particular functional areas or activities for improvement.
Strategic Audit. The strategic audit, presented in the Chapter 1 Appendix 1.A, is a type of
management audit. The strategic audit provides a checklist of questions, by area or issue, that
enables a systematic analysis of various corporate functions and activities to be made. It is a
type of management audit and is extremely useful as a diagnostic tool to pinpoint corporate-
wide problem areas and to highlight organizational strengths and weaknesses.58 A strategic
audit can help determine why a certain area is creating problems for a corporation and help
generate solutions to the problem. As such, it can be very useful in evaluating the performance
of top management.
PRIMARY MEASURES OF DIVISIONAL
AND FUNCTIONAL PERFORMANCE
Companies use a variety of techniques to evaluate and control performance in divisions, strate-
gic business units (SBUs), and functional areas. If a corporation is composed of SBUs or di-
visions, it will use many of the same performance measures (ROI or EVA, for instance) that it
uses to assess overall corporate performance. To the extent that it can isolate specific func-
tional units such as R&D, the corporation may develop responsibility centers. It will also use
typical functional measures, such as market share and sales per employee (marketing), unit
costs and percentage of defects (operations), percentage of sales from new products and num-
ber of patents (R&D), and turnover and job satisfaction (HRM). For example, FedEx uses En-
hanced Tracker software with its COSMOS database to track the progress of its 2.5 to 3.5
million shipments daily. As a courier is completing her or his day’s activities, the Enhanced
Tracker asks whether the person’s package count equals the Enhanced Tracker’s count. If the
count is off, the software helps reconcile the differences.59
During strategy formulation and implementation, top management approves a series of
programs and supporting operating budgets from its business units. During evaluation and
control, actual expenses are contrasted with planned expenditures, and the degree of variance
is assessed. This is typically done on a monthly basis. In addition, top management will prob-
ably require periodic statistical reports summarizing data on such key factors as the number
of new customer contracts, the volume of received orders, and productivity figures.
Responsibility Centers
Control systems can be established to monitor specific functions, projects, or divisions. Bud-
gets are one type of control system that is typically used to control the financial indicators of
performance. Responsibility centers are used to isolate a unit so that it can be evaluated sep-
arately from the rest of the corporation. Each responsibility center, therefore, has its own
budget and is evaluated on its use of budgeted resources. It is headed by the manager respon-
sible for the center’s performance. The center uses resources (measured in terms of costs or
expenses) to produce a service or a product (measured in terms of volume or revenues). There
are five major types of responsibility centers. The type is determined by the way the corpora-
tion’s control system measures these resources and services or products.
1. Standard cost centers: Standard cost centers are primarily used in manufacturing fa-
cilities. Standard (or expected) costs are computed for each operation on the basis of his-
torical data. In evaluating the center’s performance, its total standard costs are multiplied
by the units produced. The result is the expected cost of production, which is then com-
pared to the actual cost of production.
CHAPTER 11 Evaluation and Control 343
2. Revenue centers: With revenue centers, production, usually in terms of unit or dollar
sales, is measured without consideration of resource costs (for example, salaries). The
center is thus judged in terms of effectiveness rather than efficiency. The effectiveness of
a sales region, for example, is determined by comparing its actual sales to its projected or
previous year’s sales. Profits are not considered because sales departments have very lim-
ited influence over the cost of the products they sell.
3. Expense centers: Resources are measured in dollars, without consideration for service or
product costs. Thus budgets will have been prepared for engineered expenses (costs that
can be calculated) and for discretionary expenses (costs that can be only estimated). Typ-
ical expense centers are administrative, service, and research departments. They cost a
company money, but they only indirectly contribute to revenues.
4. Profit centers: Performance is measured in terms of the difference between revenues
(which measure production) and expenditures (which measure resources). A profit center
is typically established whenever an organizational unit has control over both its resources
and its products or services. By having such centers, a company can be organized into di-
visions of separate product lines. The manager of each division is given autonomy to the
extent that he or she is able to keep profits at a satisfactory (or better) level.
Some organizational units that are not usually considered potentially autonomous
can, for the purpose of profit center evaluations, be made so. A manufacturing department,
for example, can be converted from a standard cost center (or expense center) into a profit
center; it is allowed to charge a transfer price for each product it “sells” to the sales de-
partment. The difference between the manufacturing cost per unit and the agreed-upon
transfer price is the unit’s “profit.”
Transfer pricing is commonly used in vertically integrated corporations and can work
well when a price can be easily determined for a designated amount of product. Even though
most experts agree that market-based transfer prices are the best choice, only 30%–40% of
companies use market price to set the transfer price. (Of the rest, 50% use cost; 10%–20%
use negotiation.)60 When a price cannot be set easily, however, the relative bargaining power
of the centers, rather than strategic considerations, tends to influence the agreed-upon price.
Top management has an obligation to make sure that these political considerations do not
overwhelm the strategic ones. Otherwise, profit figures for each center will be biased and
provide poor information for strategic decisions at both the corporate and divisional levels.
5. Investment centers: Because many divisions in large manufacturing corporations use
significant assets to make their products, their asset base should be factored into their per-
formance evaluation. Thus it is insufficient to focus only on profits, as in the case of profit
centers. An investment center’s performance is measured in terms of the difference be-
tween its resources and its services or products. For example, two divisions in a corpora-
tion made identical profits, but one division owns a $3 million plant, whereas the other
owns a $1 million plant. Both make the same profits, but one is obviously more efficient;
the smaller plant provides the shareholders with a better return on their investment. The
most widely used measure of investment center performance is ROI.
Most single-business corporations, such as Apple, tend to use a combination of cost,
expense, and revenue centers. In these corporations, most managers are functional specialists
and manage against a budget. Total profitability is integrated at the corporate level. Multidivisional
corporations with one dominating product line (such as Anheuser-Busch), that have diversified
into a few businesses but that still depend on a single product line (such as beer) for most of
their revenue and income, generally use a combination of cost, expense, revenue, and profit
centers. Multidivisional corporations, such as General Electric, tend to emphasize investment
centers—although in various units throughout the corporation other types of responsibility
344 PART 4 Strategy Implementation and Control
centers are also used. One problem with using responsibility centers, however, is that the sep-
aration needed to measure and evaluate a division’s performance can diminish the level of co-
operation among divisions that is needed to attain synergy for the corporation as a whole. (This
problem is discussed later in this chapter, under “Suboptimization.”)
Using Benchmarking to Evaluate Performance
According to Xerox Corporation, the company that pioneered this concept in the United States,
benchmarking is “the continual process of measuring products, services, and practices
against the toughest competitors or those companies recognized as industry leaders.”61 Bench-
marking, an increasingly popular program, is based on the concept that it makes no sense to
reinvent something that someone else is already using. It involves openly learning how others
do something better than one’s own company so that the company not only can imitate, but
perhaps even improve on its techniques. The benchmarking process usually involves the fol-
lowing steps:
1. Identify the area or process to be examined. It should be an activity that has the potential
to determine a business unit’s competitive advantage.
2. Find behavioral and output measures of the area or process and obtain measurements.
3. Select an accessible set of competitors and best-in-class companies against which to
benchmark. These may very often be companies that are in completely different indus-
tries, but perform similar activities. For example, when Xerox wanted to improve its or-
der fulfillment, it went to L. L. Bean, the successful mail order firm, to learn how it
achieved excellence in this area.
4. Calculate the differences among the company’s performance measurements and those of
the best-in-class and determine why the differences exist.
5. Develop tactical programs for closing performance gaps.
6. Implement the programs and then compare the resulting new measurements with those of
the best-in-class companies.
Benchmarking has been found to produce best results in companies that are already well
managed. Apparently poorer performing firms tend to be overwhelmed by the discrepancy be-
tween their performance and the benchmark—and tend to view the benchmark as too difficult
to reach.62 Nevertheless, a survey by Bain & Company of 460 companies of various sizes
across all U.S. industries indicated that more than 70% were using benchmarking in either a
major or limited manner.63 Cost reductions range from 15% to 45%.64 Benchmarking can also
increase sales, improve goal setting, and boost employee motivation.65 The average cost of a
benchmarking study is around $100,000 and involves 30 weeks of effort.66 Manco, Inc., a
small Cleveland-area producer of duct tape regularly benchmarks itself against Wal-Mart,
Rubbermaid, and Pepsico to enable it to better compete with giant 3M. APQC (American Pro-
ductivity & Quality Center), a Houston research group, established the Open Standards Bench-
marking Collaborative database, composed of more than 1,200 commonly used measures and
individual benchmarks, to track the performance of core operational functions. Firms can sub-
mit their performance data to this online database to learn how they compare to top perform-
ers and industry peers (see www.apqc.org).
INTERNATIONAL MEASUREMENT ISSUES
The three most widely used techniques for international performance evaluation are ROI,
budget analysis, and historical comparisons. In one study, 95% of the corporate officers inter-
viewed stated that they use the same evaluation techniques for foreign and domestic operations.
www.apqc.org
CHAPTER 11 Evaluation and Control 345
Rate of return was mentioned as the single most important measure.67 However, ROI can cause
problems when it is applied to international operations: Because of foreign currencies, differ-
ent accounting systems, different rates of inflation, different tax laws, and the use of transfer
pricing, both the net income figure and the investment base may be seriously distorted.68 To
deal with different accounting systems throughout the world, the London-based International
Accounting Standards Board developed International Financial Reporting Standards (IFRS) to
harmonize accounting practices. Over 100 countries have thus far adopted the rules. Foreign-
based companies operating in the U.S. have a choice starting 2009 of using IFRS accounting
standards or continuing the costly process translating their accounts using America’s Gener-
ally Accepted Accounting Principles (GAAP). Nevertheless, enforcement and cultural inter-
pretations of the international rules can still vary by country and may undercut what is hoped
to be a uniform accounting system.69
A study of 79 MNCs revealed that international transfer pricing from one country unit to
another is primarily used not to evaluate performance but to minimize taxes.70 Taxes are an im-
portant issue for MNCs, given that corporate tax rates vary from 55% in Kuwait, 41% in Japan,
40% in the United States, and 34% in Canada and India, to 28% in the UK, South Korea, and
Mexico, 25% in China, 18% in Singapore, 10% in Albania, and 0% in Bahrain and the Cayman
Islands.71 For example, the U.S. Internal Revenue Service contended in the early 1990s that
many Japanese firms doing business in the United States artificially inflated the value of U.S.
deliveries in order to reduce the profits and thus the taxes of their American subsidiaries.72
Parts made in a subsidiary of a Japanese MNC in a low-tax country such as Singapore could
be shipped to its subsidiary in a high-tax country such as the United States at such a high price
that the U.S. subsidiary reports very little profit (and thus pays few taxes), while the Singapore
subsidiary reports a very high profit (but also pays few taxes because of the lower tax rate).
A Japanese MNC could, therefore, earn more profit worldwide by reporting less profit in high-
tax countries and more profit in low-tax countries. Transfer pricing can thus be one way the
parent company can reduce taxes and “capture profits” from a subsidiary. Other common ways
of transferring profits to the parent company (often referred to as the repatriation of profits)
are through dividends, royalties, and management fees.73
Among the most important barriers to international trade are the different standards for
products and services. There are at least three categories of standards: safety/environmental, en-
ergy efficiency, and testing procedures. Existing standards have been drafted by such bodies as
the British Standards Institute (BSI-UK) in the United Kingdom, Japanese Industrial Standards
Committee (JISC), AFNOR in France, DIN in Germany, CSA in Canada, and American Stan-
dards Institute in the United States. These standards traditionally created entry barriers that
served to fragment various industries, such as major home appliances, by country. The Interna-
tional Electrotechnical Commission (IEC) standards were created to harmonize standards in the
European Union and eventually to serve as worldwide standards, with some national deviations
to satisfy specific needs. Because the European Union (EU) was the first to harmonize the many
different standards of its member countries, the EU is shaping standards for the rest of the world.
In addition, the International Organization for Standardization (ISO) is preparing and publish-
ing international standards. These standards provide a foundation for regional associations to
build upon. CANENA, the Council for Harmonization of Electrotechnical Standards of the Na-
tions of the Americas, was created in 1992 to further coordinate the harmonization of standards
in North and South America. Efforts are also under way in Asia to harmonize standards.74
An important issue in international trade is counterfeiting/piracy. Firms in developing na-
tions around the world make money by making counterfeit/pirated copies of well-known
name-brand products and selling them globally as well as locally. See the Global Issue fea-
ture to learn how this is being done.
Authorities in international business recommend that the control and reward systems used
by a global MNC be different from those used by a multidomestic MNC.75 A multidomestic
“We know that 15 to 20
percent of all goods in China
are counterfeit,” states Dan
Chow, a law professor at Ohio
State University. This includes products
from Tide detergent and Budweiser beer to Marlboro cig-
arettes. There is a saying in Shanghai, China: “We can copy
everything except your mother.” Yamaha estimates that
five out of every six bikes bearing its brand name are fake.
Fake Cisco network routers (known as “Chiscos”) and
counterfeit Nokia mobile phones can be easily found
throughout China. Procter & Gamble estimates that 15%
of the soaps and detergents under its Head & Shoulders,
Vidal Sassoon, Safeguard, and Tide brands in China are
counterfeit, costing the company $150 million in lost sales.
In Yiwu, a few hours from Shanghai, one person admit-
ted to a 60 Minutes reporter that she could make 1,000
pairs of counterfeit Nike shoes in 10 days for $4.00 a pair.
According to the market research firm Automotive Re-
sources, the profit margins on counterfeit shock absorbers
can reach 80% versus only 15% for the real ones. The
World Custom Organization estimates that 7% of the
world’s merchandise is bogus.
Tens of thousands of counterfeiters are active in China.
They range from factories mixing shampoo and soap in
back rooms to large state-owned enterprises making copies
of soft drinks and beer. Other factories make everything
346 PART 4 Strategy Implementation and Control
GLOBAL issue
COUNTERFEIT GOODS & PIRATED SOFTWARE:
A GLOBAL PROBLEM
from car batteries to automobiles. Mobile CD factories with
optical disc-mastering machines counterfeit music and soft-
ware. 60 Minutes found a small factory in Donguan mak-
ing fake Callaway golf clubs and bags at a rate of 500 bags
per week. Factories in southern Guangdong or Fujian
provinces truck their products to a central distribution cen-
ter, such as the one in Yiwu. They may also be shipped
across the border into Russia, Pakistan, Vietnam, or Burma.
Chinese counterfeiters have developed a global reach
through their connections with organized crime.
As much as 35% of software on personal computers
worldwide is pirated, according to the Business Software
Alliance and ISDC, a market research firm. The worldwide
cost of software piracy was around $34 billion in 2005. For
example, 21% of the software sold in the United States is
pirated. That figure increases to 26%–30% in the Euro-
pean Union, 83% in Russia, Algeria, and Bolivia, to 86% in
China, 87% in Indonesia, and 90% in Vietnam.
SOURCES:“The Sincerest Form of Flattery,” The Economist (April 7,
2007), pp. 64–65; F. Balfour, “Fakes!” Business Week (February 7,
2005), pp. 54–64; “PC Software Piracy,” The Economist (June 10,
2006), p. 102; “The World’s Greatest Fakes,” 60 Minutes, CBS
News (August 8, 2004); “Business Software Piracy,” Pocket World
in Figures 2004 (London: Economist & Profile Book, 2003), p. 60;
D. Roberts, F. Balfour, P. Magnusson, P. Engardio, and J. Lee,
“China’s Piracy Plague,” Business Week (June 5, 2000), pp. 44–48.
MNC should use loose controls on its foreign units. The management of each geographic unit
should be given considerable operational latitude, but it should be expected to meet some per-
formance targets. Because profit and ROI measures are often unreliable in international oper-
ations, it is recommended that the MNC’s top management, in this instance, emphasize
budgets and non-financial measures of performance such as market share, productivity, pub-
lic image, employee morale, and relations with the host country government.76 Multiple mea-
sures should be used to differentiate between the worth of the subsidiary and the performance
of its management.
A global MNC, however, needs tight controls over its many units. To reduce costs and gain
competitive advantage, it is trying to spread the manufacturing and marketing operations of a
few fairly uniform products around the world. Therefore, its key operational decisions must
be centralized. Its environmental scanning must include research not only into each of the na-
tional markets in which the MNC competes but also into the “global arena” of the interaction
between markets. Foreign units are thus evaluated more as cost centers, revenue centers, or ex-
pense centers than as investment or profit centers because MNCs operating in a global indus-
try do not often make the entire product in the country in which it is sold.
CHAPTER 11 Evaluation and Control 347
11.3 Strategic Information Systems
Before performance measures can have any impact on strategic management, they must first
be communicated to the people responsible for formulating and implementing strategic plans.
Strategic information systems can perform this function. They can be computer based or man-
ual, formal or informal. One of the key reasons given for the bankruptcy of International Har-
vester was the inability of the corporation’s top management to precisely determine income by
major class of similar products. Because of this inability, management kept trying to fix ailing
businesses and was unable to respond flexibly to major changes and unexpected events. In
contrast, one of the key reasons for the success of Wal-Mart has been management’s use of the
company’s sophisticated information system to control purchasing decisions. Cash registers in
Wal-Mart retail stores transmit information hourly to computers at company headquarters.
Consequently, managers know every morning exactly how many of each item were sold the
day before, how many have been sold so far in the year, and how this year’s sales compare to
last year’s. The information system allows all reordering to be done automatically by comput-
ers, without any managerial input. It also allows the company to experiment with new prod-
ucts without committing to big orders in advance. In effect, the system allows the customers
to decide through their purchases what gets reordered.
ENTERPRISE RESOURCE PLANNING (ERP)
Many corporations around the world have adopted enterprise resource planning (ERP) soft-
ware. ERP unites all of a company’s major business activities, from order processing to pro-
duction, within a single family of software modules. The system provides instant access to
critical information to everyone in the organization, from the CEO to the factory floor worker.
Because of the ability of ERP software to use a common information system throughout a com-
pany’s many operations around the world, it is becoming the business information systems’
global standard. The major providers of this software are SAP AG, Oracle (including People-
Soft), J. D. Edwards, Baan, and SSA.
The German company SAP AG originated the concept with its R/3 software system. Mi-
crosoft, for example, used R/3 to replace a tangle of 33 financial tracking systems in 26 sub-
sidiaries. Even though it cost the company $25 million and took 10 months to install, R/3
annually saves Microsoft $18 million. Coca-Cola uses the R/3 system to enable a manager in
Atlanta to use her personal computer to check the latest sales of 20-ounce bottles of Coke
Classic in India. Owens-Corning envisioned that its R/3 system allowed salespeople to learn
what was available at any plant or warehouse and to quickly assemble orders for customers.
ERP may not fit every company, however. The system is extremely complicated and de-
mands a high level of standardization throughout a corporation. Its demanding nature often
forces companies to change the way they do business. There are three reasons ERP could fail:
(1) insufficient tailoring of the software to fit the company, (2) inadequate training, and (3) in-
sufficient implementation support.77 Over the two-year period of installing R/3, Owens-
Corning had to completely overhaul its operations. Because R/3 was incompatible with Apple’s
very organic corporate culture, the company was able to apply it only to its order manage-
ment and financial operations, but not to manufacturing. Other companies that had diffi-
culty installing and using ERP are Whirlpool, Hershey Foods, Volkswagen, and Stanley
Works. At Whirlpool, SAP’s software led to missed and delayed shipments, causing Home
Depot to cancel its agreement for selling Whirlpool products.78 One survey found that 65% of
executives believed that ERP had a moderate chance of hurting their business because of
348 PART 4 Strategy Implementation and Control
RADIO FREQUENCY IDENTIFICATION (RFID)
Radio frequency identification (RFID) is an electronic tagging technology used in a number
of companies to improve supply-chain efficiency. By tagging containers and items with tiny
chips, companies use the tags as wireless bar-codes to track inventory more efficiently. Both
Wal-Mart and the U.S. Department of Defense began requiring their largest suppliers to incor-
porate RFID tags in their goods in 2003. Although Tesco has experimented with RFID in Eu-
rope, full-scale use of the technology proved unfeasible because of incompatible standards.
Nevertheless, some suppliers and retailers of expensive consumer products view the cost of
the tag as worthwhile because it reduces losses from counterfeiting and theft. RFID technol-
ogy is currently in wide use as wireless commuter passes for toll roads, tunnels, and bridges.
Even though RFID standards may vary among companies, individual firms like Audi, Sony,
and Dole Food use the tags to track goods within their own factories and warehouses.80 Ac-
cording to Dan Mullen of AIM Global, “RFID will go through a process similar to what hap-
pened in bar code technology 20 years ago. . . . As companies implement the technology deeper
within their operations, the return on investment will grow and applications will expand.”81
DIVISIONAL AND FUNCTIONAL IS SUPPORT
At the divisional or SBU level of a corporation, the information system should be used to sup-
port, reinforce, or enlarge its business-level strategy through its decision support system. An
SBU pursuing a strategy of overall cost leadership could use its information system to reduce
costs either by improving labor productivity or improving the use of other resources such as
inventory or machinery. Merrill Lynch took this approach when it developed PRISM software
to provide its 500 U.S. retail offices with quick access to financial information in order to boost
brokers’ efficiency. Another SBU, in contrast, might want to pursue a differentiation strategy.
It could use its information system to add uniqueness to the product or service and contribute
to quality, service, or image through the functional areas. FedEx wanted to use superior ser-
vice to gain a competitive advantage. It invested significantly in several types of information
systems to measure and track the performance of its delivery service. Together, these informa-
tion systems gave FedEx the fastest error-response time in the overnight delivery business.
11.4 Problems in Measuring Performance
The measurement of performance is a crucial part of evaluation and control. The lack of quantifi-
able objectives or performance standards and the inability of the information system to provide
timely and valid information are two obvious control problems. According to Meg Whitman, past-
CEO of eBay, “If you can’t measure it, you can’t control it.” That’s why eBay has a multitude of
measures, from total revenues and profits to take rate, the ratio of revenues to the value of goods
traded on the site.82 Without objective and timely measurements, it would be extremely difficult
to make operational, let alone strategic, decisions. Nevertheless, the use of timely, quantifiable
standards does not guarantee good performance. The very act of monitoring and measuring per-
formance can cause side effects that interfere with overall corporate performance. Among the most
frequent negative side effects are a short-term orientation and goal displacement.
implementation problems. Nevertheless, the payoff from ERP software is likely to be worth
the effort. ERP is a key ingredient for gaining competitive advantage, streamlining operations,
and managing a lean manufacturing system.79
CHAPTER 11 Evaluation and Control 349
SHORT-TERM ORIENTATION
Top executives report that in many situations, they analyze neither the long-term implications
of present operations on the strategy they have adopted nor the operational impact of a strategy
on the corporate mission. Long-run evaluations may not be conducted because executives
(1) don’t realize their importance, (2) believe that short-run considerations are more impor-
tant than long-run considerations, (3) aren’t personally evaluated on a long-term basis, or
(4) don’t have the time to make a long-run analysis.83 There is no real justification for the first
and last reasons. If executives realize the importance of long-run evaluations, they make the
time needed to conduct them. Even though many chief executives point to immediate pressures
from the investment community and to short-term incentive and promotion plans to support the
second and third reasons, evidence does not always support their claims.84
At one international heavy-equipment manufacturer, managers were so strongly moti-
vated to achieve their quarterly revenue target that they shipped unfinished products from their
plant in England to a warehouse in the Netherlands for final assembly. By shipping the incom-
plete products, they were able to realize the sales before the end of the quarter—thus fulfilling
their budgeted objective and making their bonuses. Unfortunately, the high cost of assembling
the goods at a distant location (requiring not only the renting the warehouse but also paying
additional labor) ended up reducing the company’s overall profit.85
Many accounting-based measures, such as EPS and ROI, encourage a short-term
orientation in which managers consider only current tactical or operational issues and ignore
long-term strategic ones. Because growth in EPS (earnings per share) is an important driver of
near-term stock price, top managers are biased against investments that might reduce short-
term EPS.86 This is compounded by pressure from financial analysts and investors for quar-
terly earnings guidance, that is, estimates of future corporate earnings.87 For example, in a
$303 million law suit settled in 2008, General Motors admitted that its top managers and au-
ditor had misstated its revenue, earnings, and cash flow in order to artificially inflate the com-
pany’s stock price and debt securities.88
Table 11.1 indicates that one of the limitations of ROI as a performance measure is its
short-term nature. In theory, ROI is not limited to the short run, but in practice it is often diffi-
cult to use this measure to realize long-term benefits for a company. Because managers can of-
ten manipulate both the numerator (earnings) and the denominator (investment), the resulting
ROI figure can be meaningless. Advertising, maintenance, and research efforts can be reduced.
Estimates of pension-fund profits, unpaid receivables, and old inventory, are easy to adjust. Op-
timistic estimates of returned products, bad debts, and obsolete inventory inflate the present
year’s sales and earnings.89 Expensive retooling and plant modernization can be delayed as long
as a manager can manipulate figures on production defects and absenteeism. In a recent survey
of financial executives, 80% of the managers stated that they would decrease spending on re-
search and development, advertising, maintenance, and hiring in order to meet earnings targets.
More than half said that they would delay a new project even if it meant sacrificing value.90
Mergers can be undertaken that will do more for the present year’s earnings (and the next
year’s paycheck) than for the division’s or corporation’s future profits. For example, research on
55 firms that engaged in major acquisitions revealed that even though the firms performed poorly
after the acquisition, the acquiring firms’ top management still received significant increases in com-
pensation.91 Determining CEO compensation on the basis of firm size rather than performance is
typical and is particularly likely for firms that are not monitored closely by independent analysts.92
Research supports the conclusion that many CEOs and their friends on the board of direc-
tors’ compensation committee manipulate information to provide themselves a pay raise.93 For
example, CEOs tend to announce bad news—thus reducing the company’s stock price—just
before the issuance of stock options. Once the options are issued, the CEOs tend to announce
good news—thus raising the stock price and making their options more valuable.94 Board
350 PART 4 Strategy Implementation and Control
GOAL DISPLACEMENT
If not carefully done, monitoring and measuring of performance can actually result in a de-
cline in overall corporate performance. Goal displacement is the confusion of means with
ends and occurs when activities originally intended to help managers attain corporate objec-
tives become ends in themselves—or are adapted to meet ends other than those for which they
were intended. Two types of goal displacement are behavior substitution and suboptimization.
Behavior Substitution
Behavior substitution refers to a phenomenon when people substitute activities that do not
lead to goal accomplishment for activities that do lead to goal accomplishment because the
wrong activities are being rewarded. Managers, like most other people, tend to focus more of
their attention on behaviors that are clearly measurable than on those that are not. Employees
often receive little or no reward for engaging in hard-to-measure activities such as cooperation
and initiative. However, easy-to-measure activities might have little or no relationship to the
desired good performance. Rational people, nevertheless, tend to work for the rewards that the
system has to offer. Therefore, people tend to substitute behaviors that are recognized and re-
warded for behaviors that are ignored, without regard to their contribution to goal accomplish-
ment. A research study of 157 corporations revealed that most of the companies made little
attempt to identify areas of non-financial performance that might advance their chosen strat-
egy. Only 23% consistently built and verified cause-and-effect relationships between interme-
diate controls (such as number of patents filed or product flaws) and company performance.96
A U.S. Navy quip sums up this situation: “What you inspect (or reward) is what you get.”
If the reward system emphasizes quantity while merely asking for quality and cooperation, the
system is likely to produce a large number of low-quality products and unsatisfied customers.97
A proposed law governing the effect of measurement on behavior is that quantifiable measures
drive out non-quantifiable measures.
A classic example of behavior substitution happened a few years ago at Sears. Sears’ man-
agement thought that it could improve employee productivity by tying performance to re-
wards. It, therefore, paid commissions to its auto shop employees as a percentage of each
repair bill. Behavior substitution resulted as employees altered their behavior to fit the reward
system. The results were over-billed customers, charges for work never done, and a scandal
that tarnished Sears’ reputation for many years.98
Suboptimization
Suboptimization refers to the phenomenon of a unit optimizing its goal accomplishment to the
detriment of the organization as a whole. The emphasis in large corporations on developing
separate responsibility centers can create some problems for the corporation as a whole. To the
extent that a division or functional unit views itself as a separate entity, it might refuse to coop-
erate with other units or divisions in the same corporation if cooperation could in some way
negatively affect its performance evaluation. The competition between divisions to achieve a
high ROI can result in one division’s refusal to share its new technology or work process im-
provements. One division’s attempt to optimize the accomplishment of its goals can cause other
divisions to fall behind and thus negatively affect overall corporate performance. One common
example of suboptimization occurs when a marketing department approves an early shipment
date to a customer as a means of getting an order and forces the manufacturing department into
compensation committees tend to expand the peer group comparison outside their industry to
include lower-performing firms to justify a high raise to the CEO. They tend to do this when
the company performs poorly, the industry performs well, the CEO is already highly paid, and
shareholders are powerful and active.95
CHAPTER 11 Evaluation and Control 351
11.5 Guidelines for Proper Control
In designing a control system, top management should remember that controls should follow
strategy. Unless controls ensure the use of the proper strategy to achieve objectives, there is a
strong likelihood that dysfunctional side effects will completely undermine the implementa-
tion of the objectives. The following guidelines are recommended:
1. Control should involve only the minimum amount of information needed to give a re-
liable picture of events: Too many controls create confusion. Focus on the strategic factors
by following the 80/20 rule: Monitor those 20% of the factors that determine 80% of the re-
sults. See Strategy Highlight 11.1 for some additional rules of thumb used by strategists.
2. Controls should monitor only meaningful activities and results, regardless of mea-
surement difficulty: If cooperation between divisions is important to corporate perfor-
mance, some form of qualitative or quantitative measure should be established to monitor
cooperation.
3. Controls should be timely so that corrective action can be taken before it is too late:
Steering controls, controls that monitor or measure the factors influencing performance,
should be stressed so that advance notice of problems is given.
Managers use many rules of
thumb, such as the 80/20
rule, in making strategic deci-
sions. These “rules” are prima-
rily approximations based on years
of practical experience by many managers.
Although most of these rules have no objective data to
support them, they are often accepted by practicing man-
agers as a way of estimating the cost or time necessary to
conduct certain activities. They may be useful because they
can help narrow the number of alternatives into a shorter
list for more detailed analysis. Some of the rules of thumb
used by experienced strategists are described here.
INDIRECT COSTS OF STRATEGIC INITIATIVES
� The R&D Rule of Sevens is that for every $1 spent in de-
veloping a new prototype, $7 will be needed to get a
product ready for market, and $7 additional dollars will
be required to get to the first sale. These estimates
don’t cover working capital requirements for stocking
distributor inventories.
STRATEGY highlight 11.1
SOME RULES OF THUMB IN STRATEGY
� First-year costs for promoting a new consumer goods
product are 33% of anticipated first-year sales. Second-
year costs should be 20%, and third-year costs 15%.
� A reasonably successful patent-based innovation will
require $2 million in legal defense costs.
SAFETY MARGINS FOR NEW BUSINESS INITIATIVES
� A new manufacturing business should have sufficient
startup capital to cover one year of costs.
� A new consumer goods business should have sufficient
capital to cover two years of business.
� A new professional services business should have suffi-
cient capital to cover three years of costs.
SOURCE: R. West and F. Wolek, “Rules of Thumb in Strategic Think-
ing,” Strategy & Leadership (March/April 1999), p. 34. Copyright ©
1999 by Emerald Group Publishing Ltd. Reprinted by permission.
overtime production for that one order. Production costs are raised, which reduces the manu-
facturing department’s overall efficiency. The end result might be that, although marketing
achieves its sales goal, the corporation as a whole fails to achieve its expected profitability.99
352 PART 4 Strategy Implementation and Control
11.6 Strategic Incentive Management
To ensure congruence between the needs of a corporation as a whole and the needs of the em-
ployees as individuals, management and the board of directors should develop an incentive
program that rewards desired performance. This reduces the likelihood of the agency problems
(when employees act to feather their own nests instead of building shareholder value) men-
tioned earlier in Chapter 2. Incentive plans should be linked in some way to corporate and di-
visional strategy. Research reveals that firm performance is affected by its compensation
policies.102 Companies using different strategies tend to adopt different pay policies. For ex-
ample, a survey of 600 business units indicates that the pay mix associated with a growth strat-
egy emphasizes bonuses and other incentives over salary and benefits, whereas the pay mix
associated with a stability strategy has the reverse emphasis.103 Research indicates that SBU
managers having long-term performance elements in their compensation program favor a
long-term perspective and thus greater investments in R&D, capital equipment, and employee
training.104 Although the typical CEO pay package is composed of 21% salary, 27% short-term
annual incentives, 16% long-term incentives, and 36% stock options,105 there is some evidence
that stock options are being replaced by greater emphasis on performance-related pay.106
The following three approaches are tailored to help match measurements and rewards
with explicit strategic objectives and time frames:107
1. Weighted-factor method: The weighted-factor method is particularly appropriate for
measuring and rewarding the performance of top SBU managers and group-level executives
when performance factors and their importance vary from one SBU to another. Using port-
folio analysis, one corporation’s measurements might contain the following variations: the
performance of high-performing (star) SBUs is measured equally in terms of ROI, cash
flow, market share, and progress on several future-oriented strategic projects; the perfor-
mance of low-growth, but strong (cash cow) SBUs, in contrast, is measured in terms of ROI,
market share, and cash generation; and the performance of developing (question marks)
SBUs is measured in terms of development and market share growth with no weight on ROI
or cash flow. (Refer to Figure 11.3.)
2. Long-term evaluation method: The long-term evaluation method compensates man-
agers for achieving objectives set over a multiyear period. An executive is promised some
company stock or “performance units” (convertible into money or stock) in amounts to be
4. Long-term and short-term controls should be used: If only short-term measures are
emphasized, a short-term managerial orientation is likely.
5. Controls should aim at pinpointing exceptions: Only activities or results that fall out-
side a predetermined tolerance range should call for action.
6. Emphasize the reward of meeting or exceeding standards rather than punishment
for failing to meet standards: Heavy punishment of failure typically results in goal dis-
placement. Managers will “fudge” reports and lobby for lower standards.
If corporate culture complements and reinforces the strategic orientation of a firm, there
is less need for an extensive formal control system. In their book In Search of Excellence,
Peters and Waterman state that “the stronger the culture and the more it was directed toward
the marketplace, the less need was there for policy manuals, organization charts, or detailed
procedures and rules. In these companies, people way down the line know what they are sup-
posed to do in most situations because the handful of guiding values is crystal clear.”100 For
example, at Eaton Corporation, the employees are expected to enforce the rules themselves. If
someone misses too much work or picks fights with co-workers, other members of the produc-
tion team point out the problem. According to Randy Savage, a long-time Eaton employee,
“They say there are no bosses here, but if you screw up, you find one pretty fast.”101
CHAPTER 11 Evaluation and Control 353
based on long-term performance. A board of directors, for example, might set a particular
objective in terms of growth in earnings per share during a five-year period. The giving of
awards would be contingent on the corporation’s meeting that objective within the desig-
nated time. Any executive who leaves the corporation before the objective is met receives
nothing. The typical emphasis on stock prices makes this approach more applicable to top
management than to business unit managers. Because rising stock markets tend to raise
the stock price of mediocre companies, there is a developing trend to index stock options
to competitors or to the Standard & Poor’s 500.108 General Electric, for example, offered
its CEO 250,000 performance share units (PSUs) tied to performance targets achieved
over five years. Half of the PSUs convert into GE stock only if GE achieves 10% average
annual growth in operations. The other half converts to stock only if total shareholder re-
turn meets or beats the S&P 500.109
3. Strategic-funds method: The strategic-funds method encourages executives to look at
developmental expenses as being different from expenses required for current operations.
The accounting statement for a corporate unit enters strategic funds as a separate entry
below the current ROI. It is, therefore, possible to distinguish between expense dollars
consumed in the generation of current revenues and those invested in the future of a busi-
ness. Therefore, a manager can be evaluated on both a short- and a long-term basis and
has an incentive to invest strategic funds in the future. For example, begin with the total
sales of a unit ($12,300,000). Subtract cost of goods sold ($6,900,000) leaving a gross
margin of $5,400,000. Subtract general and administrative expenses ($3,700,000) leav-
ing an operating profit/ROI of $1,700,000. So far, this is standard accounting procedure.
The strategic-funds approach goes one step further by subtracting an additional
$1,000,000 for “strategic funds/development expenses.” This results in a pretax profit of
$700,000. This strategic-funds approach is a good way to ensure that the manager of a
high-performing unit (e.g., star) not only generates $700,000 in ROI, but also invests
$1 million in the unit for its continued growth. It also ensures that a manager of a
In
d
u
st
ry
A
tt
ra
ct
iv
en
es
s
High
H
ig
h
Lo
w
Low
ROI (25%)
Cash Flow (25%)
Strategic Funds (25%)
Market Share (25%)
ROI (20%)
Cash Flow (60%)
Strategic Funds (0%)
Market Share (20%)
ROI (50%)
Cash Flow (50%)
Market Share (0%)
Strategic Funds (0%)
ROI (0%)
Cash Flow (0%)
Strategic Funds (50%)
Market Share Growth
(50%)
Star Question Mark
Cash Cow DOG
Business Strength/Competitive Position
SOURCE: Based on Paul J. Stonich, “The Performance Measurement and Reward System: Critical to Strategic
Management,” Organizational Dynamics, (Winter 1984), pp. 45–57.
FIGURE 11–3
Weighted-Factor
Approach to
Strategic Incentive
Management
354 PART 4 Strategy Implementation and Control
developing unit is appropriately evaluated on the basis of market share growth and prod-
uct development and not on ROI or cash flow.
An effective way to achieve the desired strategic results through a reward system is to
combine the three approaches:
1. Segregate strategic funds from short-term funds, as is done in the strategic-funds method.
2. Develop a weighted-factor chart for each SBU.
3. Measure performance on three bases: The pretax profit indicated by the strategic-funds
approach, the weighted factors, and the long-term evaluation of the SBUs’ and the corpo-
ration’s performance.
Genentech, General Electric, Adobe, IBM, and Textron are some firms in which top man-
agement compensation is contingent upon the company’s achieving strategic objectives.110
The board of directors and top management must be careful to develop a compensation plan
that achieves the appropriate objectives. One reason why top executives are often criticized for
being overpaid (the ratio of CEO to average worker pay is currently 400 to 1)111 is that in a large
number of corporations the incentives for sales growth exceed those for shareholder wealth,
resulting in too many executives pursuing growth to the detriment of shareholder value.112
End of Chapter SUMMARY
Having strategic management without evaluation and control is like playing football with-
out any goalposts. Unless strategic management improves performance, it is only an exer-
cise. In business, the bottom-line measure of performance is making a profit. If people aren’t
willing to pay more than what it costs to make a product or provide a service, that business
will not continue to exist. Chapter 1 explains that organizations engaging in strategic man-
agement outperform those that do not. The sticky issue is: How should we measure perfor-
mance? Is measuring profits sufficient? Does an income statement tell us what we need to
know? The accrual method of accounting enables us to count a sale even when the cash has
not yet been received. Therefore, a firm might be profitable, but still go bankrupt because it
can’t pay its bills. Is profit the amount of cash on hand at the end of the year after paying
costs and expenses? But what if you made a big sale in December and must wait until
January to get paid? Like retail stores, perhaps we need to use a fiscal year ending January 31
(to include returned Christmas items that were bought in December) instead of a calendar
year ending December 31. Should two managers receive the same bonus when their divi-
sions earn the same profit, even though one division is much smaller than the other? What
of the manager who is managing a new product introduction that won’t make a profit for
another two years?
Evaluation and control is one of the most difficult parts of strategic management. No one
measure can tell us what we need to know. That’s why we need to use not only the traditional
measures of financial performance, such as net earnings, ROI, and EPS, but we need to con-
sider using EVA or MVA and a balanced scorecard, among other possibilities. On top of that,
science informs us that just attempting to measure something changes what is being measured.
The measurement of performance can and does result in short-term oriented actions and goal
displacement. That’s why experts suggest that we use multiple measures of only those things
that provide a meaningful and reliable picture of events: Measure those 20% of the factors that
CHAPTER 11 Evaluation and Control 355
determine 80% of the results. Once the appropriate performance measurements are taken, it is
possible to learn whether the strategy was successful. As shown in the model of strategic man-
agement depicted at the beginning this chapter, the measured results of corporate performance
allow us to decide whether we need to reformulate the strategy, improve its implementation,
or gather more information about our competition.
E C O – B I T S
� In 2007, 64% of the Fortune Global 100 published a
Corporate Social Responsibility report explaining their
economic, environmental, and social performance.
� More than 4,000 organizations from over 100 countries
are members of the United Nations Global Compact.
Three of the 10 principles are:
� Support a precautionary approach to environmental
challenges.
� Undertake initiatives to promote greater environ-
mental responsibility.
� Encourage the development and diffusion of envi-
ronmentally friendly technologies.113
D I S C U S S I O N Q U E S T I O N S
1. Is Figure 11–1 a realistic model of the evaluation and
control process?
2. What are some examples of behavior controls? Output
controls? Input controls?
3. Is EVA an improvement over ROI, ROE, or EPS?
4. How much faith can a manager place in a transfer price
as a substitute for a market price in measuring a profit
center’s performance?
5. Is the evaluation and control process appropriate for a
corporation that emphasizes creativity? Are control and
creativity compatible?
S T R A T E G I C P R A C T I C E E X E R C I S E
Each year, Fortune magazine publishes an article entitled,
“America’s Most Admired Companies.” It lists the 10 most ad-
mired companies in the United States and in the world.
Fortune’s rankings are based on scoring publicly held compa-
nies on what it calls “eight key attributes of reputation”: innova-
tion, people management, use of corporate assets, social
responsibility, quality of management, financial soundness,
long-term investment value, and quality of products/services. In
2008, Fortune asked Hay Group to survey more than 3,700 peo-
ple from multiple industries. Respondents were asked to choose
the companies they admired most, regardless of industry.
Fortune has been publishing this list since 1982. The 2008 For-
tune list of the top 10 most admired U.S. companies were (start-
ing with #1): Apple, Berkshire Hathaway, General Electric,
Google, Toyota Motor, Starbucks, FedEx, Procter & Gamble,
Johnson & Johnson, and Goldman Sachs Group. The next 10
most admired were (from 11 to 20): Target, Southwest Airlines,
American Express, BMW, Costco Wholesale, Microsoft,
United Parcel Service, Cisco Systems, 3M, and Nordstrom.114
Four years earlier in 2004, the list of 10 most admired
U.S. companies was: Wal-Mart, Berkshire Hathaway, South-
west Airlines, General Electric, Dell Computer, Microsoft,
Johnson & Johnson, Starbucks, FedEx, and IBM.115
� Why did the most admired U.S. firm in 2004 (Wal-Mart)
drop off the 10 listing in 2008?
� Why did Apple go from not even being on the 10 U.S.
listing in 2004 to No. 1 in 2008?
� Which firms appeared on both top 10 lists? Why?
� Why did some firms drop off the list from 2004 to 2008
and why did others get included?
� What companies should be on the most admired list this
year? Why?
Try One of These Exercises
1. Go to the library and find a “Most Admired Companies”
Fortune article from the 1980s or early 1990s and com-
pare that list to the latest one. (See www.fortune.com for
the latest list.) Which companies have fallen out of the top
10? Pick one of the companies and investigate why it is
no longer on the list.
www.fortune.com
356 PART 4 Strategy Implementation and Control
K E Y T E R M S
80/20 rule (p. 351)
activity-based costing (ABC) (p. 334)
balanced scorecard (p. 339)
behavior control (p. 332)
behavior substitution (p. 350)
benchmarking (p. 344)
earnings per share (EPS) (p. 335)
economic value added (EVA) (p. 338)
enterprise resource planning (ERP)
(p. 347)
enterprise risk management (ERM)
(p. 335)
evaluation and control process (p. 328)
expense center (p. 343)
free cash flow (p. 336)
goal displacement (p. 350)
input control (p. 333)
investment center (p. 343)
ISO 9000 Standards Service (p. 333)
ISO 14000 Standards Service (p. 333)
key performance measures (p. 339)
long-term evaluation method (p. 352)
management audit (p. 341)
market value added (MVA) (p. 338)
operating cash flow (p. 336)
output control (p. 332)
performance (p. 332)
profit center (p. 343)
responsibility center (p. 342)
return on equity (ROE) (p. 336)
return on investment (ROI) (p. 335)
revenue center (p. 343)
shareholder value (p. 337)
short-term orientation (p. 349)
standard cost center (p. 342)
steering control (p. 332)
strategic-funds method (p. 353)
suboptimization (p. 350)
transfer pricing (p. 343)
weighted-factor method (p. 352)
N O T E S
1. K. F. Iverson with T. Varian, “Plain Talk,” Inc. (October 1997),
p. 81. Excerpted from Iverson’s book, Plain Talk: Lessons from
a Business Maverick, (New York: John Wiley & Sons, 1997).
2. R. Roach & Associates, cited in Air Transport World (June
1996), p. 1.
3. R. Barker, “A Surprise in Office Depot’s In-Box,” Business
Week (October 25, 2004), p. 122.
4. C. W. Hart, “Customer Service: Beating the Market with Cus-
tomer Satisfaction,” Harvard Business Review (March 2007),
pp. 30–32.
5. S. E. Ante, “Giving the Boss the Big Picture,” Business Week
(February 13, 2006), pp. 48–51.
6. R. Muralidharan and R. D. Hamilton III, “Aligning Multina-
tional Control Systems,” Long Range Planning (June 1999),
pp. 352–361. These types are based on W. G. Ouchi, “The Re-
lationship Between Organizational Structure and Organiza-
tional Control,” Administrative Science Quarterly, Vol. 20
(1977), pp. 95–113 and W. G. Ouchi, “A Conceptual Frame-
work for the Design of Organizational Control Mechanisms,”
Management Science, Vol. 25 (1979), pp. 833–848. Muralid-
hara and Hamilton refer to Ouchi’s clan control as input control.
7. W. G. Rowe and P. M. Wright, “Related and Unrelated Diversi-
fication and Their Effect on Human Resource Management
Controls,” Strategic Management Journal (April 1997),
pp. 329–338.
8. R. Muralidharan and R. D. Hamilton III, “Aligning Multina-
tional Control Systems,” Long Range Planning (June 1999)
pp. 356–359.
9. F. C. Barnes, “ISO 9000 Myth and Reality: A Reasonable Ap-
proach to ISO 9000,” SAM Advanced Management Journal
(Spring 1998), pp. 23–30.
10. M. Henricks, “A New Standard,” Entrepreneur (October 2002),
pp. 83–84.
11. M. V. Uzumeri, “ISO 9000 and Other Metastandards: Principles
for Management Practice?” Academy of Management Execu-
tive (February 1997), pp. 21–36.
12. A. M. Hormozi, “Understanding and Implementing ISO 9000:
A Manager’s Guide,” SAM Advanced Management Journal
(Autumn 1995), pp. 4–11.
13. M. Henricks, “A New Standard,” Entrepreneur (October 2002)
p. 84.
14. L. Armstrong, “Someone to Watch Over You,” Business Week
(July 10, 2000), pp. 189–190.
15. J. K. Shank and V. Govindarajan, Strategic Cost Management
(New York: The Free Press, 1993).
16. S. S. Rao, “ABCs of Cost Control,” Inc. Technology, No. 2
(1997), pp. 79–81.
17. R. Gruber, “Why You Should Consider Activity-Based Cost-
ing,” Small Business Forum (Spring 1994), pp. 20–36.
18. “Easier Than ABC,” Economist (October 25, 2003), p. 56.
19. T. P. Pare, “A New Tool for Managing Costs,” Fortune (June 14,
1993), pp. 124–129. For further information on the use of ABC with
EVA, see T. L. Pohlen and B. J. Coleman, “Evaluating Internal Op-
erations and Supply Chain Performance Using EVA and ABC,”
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2. Given the likely impact of global warming on various in-
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3. Compare Fortune’s list to that compiled by the Reputa-
tion Institute (www.reputationinstitute.com). Why is
there a difference between the ratings?
www.reputationinstitute.com
CHAPTER 11 Evaluation and Control 357
(March/April 2001), pp. 48–51; P. L. Walker, W. G. Shenkir,
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and the Politics of the Comparable Firm in CEO Compensation,”
Administrative Science Quarterly (March 1999), pp. 112–144.
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Reilly, and M. E. Yoder, “Executive Compensation: A Multidis-
ciplinary Review of Recent Developments,” Journal of Manage-
ment (December 2007), pp. 1016–1072; M. Chan, “Executive
Compensation,” Business and Society Review (March 2008),
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of Management Perspective (May 2008), pp. 5–20.
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Business Review (November 2003), pp. 88–95.
97. See the classic article by S. Kerr, “On the Folly of Rewarding
A, While Hoping for B,” Academy of Management Journal,
Vol. 18 (December 1975), 769–783.
358 PART 4 Strategy Implementation and Control
CHAPTER 11 Evaluation and Control 359
98. W. Zellner, E. Schine, and G. Smith, “Trickle-Down Is Trick-
ling Down at Work,” Business Week (March 18, 1996), p. 34.
99. For more information on how goals can have dysfunctional side
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Neat as It Sounds,” Wall Street Journal (September 8, 1997),
pp. A1, A13.
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Relationship Between Strategy, Rewards, and Organizational
Performance,” Journal of Business Strategies (Fall 2002),
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of CEO Compensation in Strategic Variation and Deviation
from Industry Strategy Norms,” Journal of Management,
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http://money.cnn.com/magazines/fortune/mostadmired/2008/top20/index.html
http://money.cnn.com/magazines/fortune/mostadmired/2008/top20/index.html
360 PART 4 Strategy Implementation and Control
Ending Case for Part Four
HEWLETT-PACKARD BUYS EDS
On May 13, 2008, Hewlett-Packard (HP) announced its
$13.9 billion acquisition of Electronic Data Systems
(EDS), a technology services company. Together, HP
and EDS formed a formidable tech services provider
with $38 billion in revenues. It enabled HP to better
compete with IBM, which controlled more than 7% mar-
ket share of the $748 billion market for services. Tech
services included managing the data centers of large
companies and governments, or handling entire func-
tions such as personnel or claims processing. At the time
of the acquisition, IBM was the leading firm in the area,
with EDS in second place with much lower profit mar-
gins, and HP following in fifth place.
Founded by Ross Perot in 1962, EDS pioneered the
business of outsourced data management. Perot sold
EDS to General Motors (GM) in 1984, but GM was un-
able to obtain any synergy with the purchase and spun
off the company in 1996. EDS profits turned to losses
during the technology downturn in 2000. The company
eventually became profitable once again, but with
smaller margins. EDS had been slow to respond to the
threat of Indian rivals offering services at sharply lower
prices. The company did increase its overseas hiring and
bought control of MphasiS, an Indian services company.
Since MphasiS was allowed to operate independently,
with its own sales force and customer base, EDS did not
gain much synergy from the acquisition. By 2008, EDS
had 45,000 people working offshore and planned to hire
more. Nevertheless, the best services companies had a
large, low-cost workforce with tightly integrated opera-
tions so that employees with diverse skills could collab-
orate smoothly. This was the case with IBM, Accenture,
and Indian companies like Tata Consultancy Services,
but not with EDS or HP. Commenting on HP’s purchase
of EDS, N. Venkat Venktraman, chair of the Information
Systems Department at Boston University’s School of
Management said, “The services sector is going through
a shift, and this merger doesn’t address the global service-
delivery challenges that HP faces.”
Founded in 1940 by Dave Packard and Bill Hewlett
in a garage in Palo Alto, California, Hewlett-Packard
soon developed a reputation for making high-quality
testing and measurement devices. Emphasizing their en-
gineering roots, the two founders worked hard to de-
velop the company’s strong corporate culture. Their
philosophy of managing became known as the “HP
Way,” composed of five basic values:
� We have trust and respect for individuals.
� We focus on a high level of achievement and
contribution.
� We focus on a high level of business with
uncompromising integrity.
� We achieve our common objectives through
teamwork.
� We encourage flexibility and innovation.
These values continued to be emphasized by the
CEOs following in the founder’s footsteps. Until
Carleton (Carly) Fiorina was hired as CEO in 1999, HP
had been primarily known for its engineering excel-
lence, but not for its marketing. For example, it devel-
oped the first handheld calculator, a quality product long
cherished by engineers, but never developed or priced
for the mass market. Fiorina lamented that Dell offered
information technology products that were “low-tech
and low cost; and IBM offered “high-tech and high
cost,” but HP was stuck somewhere in between them.
She wanted to offer customers “high-tech and low cost”
by improving the marketing of the company’s outstand-
ing products. During her tenure, HP acquired Compaq,
the personal computer company. She also tried to buy
the computer services unit of PriceWaterhouseCoopers
in 2000, but lost out to IBM. Problems with integrating
Compaq’s middle-market orientation with HP’s top-end
orientation led to her firing by the board in 2005.
Fiorina was replaced by Mark Hurd, known to be a
disciplined operations manager, who vowed to focus on
implementation. Hurd had come to the company from
Dayton, Ohio’s NCR, where he had been President and
CEO. Hurd dumped the matrix management structure
initiated by Fiorina and gave responsibility back to the
business unit managers. According to Hurd, “the more
accountable I can make you, the easier it is for you to
show you’re a great performer. The more I use a matrix,
the easier I make it to blame someone else.” He also
This case was written by J. David Hunger for Strategic Management
and Business Policy, 12th edition and for Concepts in Strategic
Management and Business Policy, 12th edition. Copyright © 2008
by J. David Hunger. Reprinted by permission.
CHAPTER 11 Evaluation and Control 361
broke up the centralized sales force and assigned sales
people to each business unit. The SBUs now controlled
over 70% of their own budget expenses, up from just
30% under Fiorina. Among other changes, Hurd hired
executives from outside the company and cut costs by
laying off 14,500 workers from a workforce of 150,000.
Prith Banerjee, HP’s new director of R&D, worked to
make HP’s famed research lab more efficient by cutting
the number of projects from 150 to 20 or 30. Re-
searchers would now be competing for money and man-
power by proposing projects, complete with business
plans to a central review board. Hurd knew that he had
to make further changes to improve HP’s competitive
position. HP’s corporate computing business seemed in-
capable of competing against IBM and Dell. Margins
were slipping in the printer business, the source of 85%
of HP’s profits.
Hewlett-Packard was organized into three main
groups: Imaging & Printing (27% of revenues), Personal
Systems (35%), and Technology Solutions, which was
composed of the Enterprise Storage & Servers segment
(18%), HP Services segment (16%), and HP Software
segment (2%). An additional business segment was Fi-
nancial Services & Other (2% of revenues).
Even though Hurd was working hard to change the
company by tightening up HP’s operations, many of
HP’s middle managers still subscribed to the gentle, col-
legiate “HP Way.” This culture fit the relaxed and casual
style common to California’s Silicon Valley and was
part of the company’s soul. People ate ahi tuna in the
cafeteria. In contrast, EDS was founded in Plano, Texas,
by the hard-charging entrepreneur, Ross Perot, who ran
for U.S. president as an independent in 1992 and 1996.
Reflecting Perot’s no-nonsense style, the EDS corporate
culture was military, buttoned-down, and staid. People
wore ties and ate steak and fries in the EDS cafeteria.
One advantage of EDS was that it was the largest
services firm that was independent of any hardware or
software vendor. According to CEO Hurd, even though
EDS would continue to advise clients to buy systems
from all vendors, those clients would now be more
likely to pay more attention when the boxes came from
HP. Nevertheless, one disadvantage of the acquisition
was the likely culture clash that would result from inte-
grating EDS into HP’s operations. Even though one an-
alyst commented that Hurd’s operations style made him
“an EDS guy sitting on top of the HP Way,” others won-
dered if the EDS acquisition would be as problematic as
was the Compaq merger.
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Introduction to
Case Analysis
PA R T5
Howard Schilit, founder of the Center for Financial Research & Analysis
(CFRA), works with a staff of 15 analysts to screen financial databases and analyze
public financial filings of 3,600 companies, looking for inconsistencies and aggres-
sive accounting methods. Schilit calls this search for hidden weaknesses in a com-
pany’s performance forensic accounting. “I’m like an investigative reporter,” explains
Schilit. “I’m interested in finding companies where the conventional wisdom is that they’re
very healthy, but if you dig a bit deeper, you find the emperor is not wearing the clothes you
thought.”1 He advises anyone interested in analyzing a company to look deeply into its financial
statements. For example, when the CFRA noticed that Kraft Foods made $122 million in acquisi-
tions in 2002, but claimed $539 million as “goodwill” assets related to the purchases, it concluded
that Kraft was padding its earnings with one-time gains. According to Schilit, unusually high
goodwill gains related to recent acquisitions is a red flag that suggests an underlying problem.
Schilit proposes a short checklist of items to examine for red flags:
� Cash flow from operations should exceed net income: If cash flow from operations drops
below net income, it could mean that the company is propping up its earnings by selling as-
sets, borrowing cash, or shuffling numbers. Says Schilit, “You could have spotted the prob-
lems at Enron by just doing this.”2
� Accounts receivable should not grow faster than sales: A firm facing slowing sales can
make itself look better by inflating accounts receivable with expected future sales and by
making sales to customers who are not credit worthy. “It’s like mailing a contract to a dead
person and then counting it as a sale,” says Schilit.3
� Gross margins should not fluctuate over time: A change of more than 2% in either direc-
tion from year to year is worth a closer look. It could mean that the company is using other
revenue, such as sales of assets or write-offs to boost profits. Sunbeam reported an increase
of 10% in gross margins just before it was investigated by the SEC.
� Examine carefully information about top management and the board: When Schilit learned
that the chairman of Checkers Restaurants had put his two young sons on the board, he
warned investors of nepotism. Two years later, Checkers’ huge debt caused its stock to fall
85% and all three family members were forced out of the company.
suggestions for
Case Analysis
C H A P T E R 12
365
� Research the case situation as needed
� Analyze financial statements by using
ratios and common-size statements
� Use the strategic audit as a method of
organizing and analyzing case information
Learning Objectives
After reading this chapter, you should be able to:
12.1 The Case Method
The analysis and discussion of case problems has been the most popular method of teaching
strategy and policy for many years. The case method provides the opportunity to move from
a narrow, specialized view that emphasizes functional techniques to a broader, less precise
analysis of the overall corporation. Cases present actual business situations and enable you to
examine both successful and unsuccessful corporations. In case analysis, you might be asked
to critically analyze a situation in which a manager had to make a decision of long-term cor-
porate importance. This approach gives you a feel for what it is like to face making and imple-
menting strategic decisions.
� Footnotes are important: When companies change their accounting assumptions to
make the statements more attractive, they often bury their rationale in the footnotes.
Schilit dislikes companies that extend the depreciable life of their assets. “There’s only
one reason to do that—to add a penny or two to earnings—and it makes me very mis-
trustful of management.”4
Schilit makes his living analyzing companies and selling his reports to investors. Annual re-
ports and financial statements provide a lot of information about a company’s health, but
it’s hard to find problem areas when management is massaging the numbers to make the
company appear more attractive than it is. That’s why Michelle Leder created her Web site,
www.footnoted.org. She likes to highlight “the things that companies bury in their rou-
tine SEC filings.”5 This type of in-depth, investigative analysis is a key part of analyzing
strategy cases. This chapter provides various analytical techniques and suggestions for
conducting this kind of case analysis.
www.footnoted.org
12.2 Researching the Case Situation
366 PART 5 Introduction to Case Analysis
You should not restrict yourself only to the information written in the case unless your instruc-
tor states otherwise. You should, if possible, undertake outside research about the environmen-
tal setting. Check the decision date of each case (typically the latest date mentioned in the case)
to find out when the situation occurred and then screen the business periodicals for that time
period. An understanding of the economy during that period will help you avoid making a se-
rious error in your analysis, for example, suggesting a sale of stock when the stock market is
at an all-time low or taking on more debt when the prime interest rate is over 15%. Informa-
tion about the industry will provide insights into its competitive activities. Important Note:
Don’t go beyond the decision date of the case in your research unless directed to do so by your
instructor.
Use computerized company and industry information services such as Compustat, Com-
pact Disclosure, and CD/International, available on CD-ROM or online at the library. On the
Internet, Hoover’s OnLine Corporate Directory (www.hoovers.com) and the Security Ex-
change Commission’s Edgar database (www.sec.gov) provide access to corporate annual re-
ports and 10-K forms. This background will give you an appreciation for the situation as it was
experienced by the participants in the case. Use a search engine such as Google to find addi-
tional information about the industry and the company.
A company’s annual report and SEC 10-K form from the year of the case can be very
helpful. According to the Yankelovich Partners survey firm, 8 out of 10 portfolio managers and
75% of security analysts use annual reports when making decisions.6 They contain not only
the usual income statements and balance sheets, but also cash flow statements and notes to the
financial statements indicating why certain actions were taken. 10-K forms include detailed
information not usually available in an annual report. SEC 10-Q forms include quarterly fi-
nancial reports. SEC 14-A forms include detailed information on members of a company’s
board of directors and proxy statements for annual meetings. Some resources available for re-
search into the economy and a corporation’s industry are suggested in Appendix 12.A.
A caveat: Before obtaining additional information about the company profiled in a par-
ticular case, ask your instructor if doing so is appropriate for your class assignment. Your strat-
egy instructor may want you to stay within the confines of the case information provided in
the book. In this case, it is usually acceptable to at least learn more about the societal environ-
ment at the time of the case.
12.3 Financial Analysis: A Place to Begin
Once you have read a case, a good place to begin your analysis is with the financial statements.
Ratio analysis is the calculation of ratios from data in these statements. It is done to identify
possible financial strengths or weaknesses. Thus it is a valuable part of SWOT analysis. A re-
view of key financial ratios can help you assess a company’s overall situation and pinpoint
some problem areas. Ratios are useful regardless of firm size and enable you to compare a
company’s ratios with industry averages. Table 12–1 lists some of the most important finan-
cial ratios, which are (1) liquidity ratios, (2) profitability ratios, (3) activity ratios, and
(4) leverage ratios.
www.hoovers.com
www.sec.gov
CHAPTER 12 Suggestions for Case Analysis 367
TABLE 12–1 Financial Ratio Analysis
Formula
How
Expressed Meaning
1. Liquidity Ratios
Current ratio Current assets
Current liabilities
Decimal A short-term indicator of the company’s
ability to pay its short-term liabilities from
short-term assets; how much of current
assets are available to cover each dollar of
current liabilities.
Quick (acid test) ratio Current assets � Inventory
Current liabilities
Decimal Measures the company’s ability to pay off
its short-term obligations from current
assets, excluding inventories.
Inventory to net
working capital
Inventory
Current assets � Current liabilities
Decimal A measure of inventory balance; measures
the extent to which the cushion of excess
current assets over current liabilities may
be threatened by unfavorable changes in
inventory.
Cash ratio Cash � Cash equivalents
Current liabilities
Decimal Measures the extent to which the
company’s capital is in cash or cash
equivalents; shows how much of the
current obligations can be paid from cash
or near-cash assets.
2. Profitability Ratios
Net profit margin
Net profit after taxes
Net sales
Percentage Shows how much after-tax profits are
generated by each dollar of sales.
Gross profit margin Sales � Cost of goods sold
Net sales
Percentage Indicates the total margin available to
cover other expenses beyond cost of goods
sold and still yield a profit.
Return on investment
(ROI)
Net profit after taxes
Total assets
Percentage Measures the rate of return on the total
assets utilized in the company; a measure
of management’s efficiency, it shows the
return on all the assets under its control,
regardless of source of financing.
Return on equity
(ROE)
Net profit after taxes
Shareholders’ equity
Percentage Measures the rate of return on the book
value of shareholders’ total investment in
the company.
Earnings per share
(EPS)
Net profit after taxes –
Preferred stock dividends
Average number of
common shares
Dollars
per share
Shows the after-tax earnings generated for
each share of common stock.
3. Activity Ratios
Inventory turnover
Net sales
Inventory Decimal Measures the number of times that average
inventory of finished goods was turned
over or sold during a period of time,
usually a year.
Days of inventory Inventory
Cost of goods sold � 365
Days Measures the number of one day’s worth
of inventory that a company has on hand at
any given time.
continued
368 PART 5 Introduction to Case Analysis
TABLE 12–1 Financial Ratio Analysis
Formula
How
Expressed Meaning
Net working capital
turnover
Net sales
Net working capital
Decimal Measures how effectively the net working
capital is used to generate sales.
Asset turnover Sales
Total assets
Decimal Measures the utilization of all the
company’s assets; measures how many
sales are generated by each dollar of assets.
Fixed asset turnover Sales
Fixed assets
Decimal Measures the utilization of the company’s
fixed assets (i.e., plant and equipment);
measures how many sales are generated by
each dollar of fixed assets.
Average collection
period
Accounts receivable
Sales for year � 365
Days Indicates the average length of time in
days that a company must wait to collect a
sale after making it; may be compared to
the credit terms offered by the company to
its customers.
Accounts receivable
turnover
Annual credit sales
Accounts receivable
Decimal Indicates the number of times that accounts
receivable are cycled during the period
(usually a year).
Accounts payable
period
Accounts payable
Purchases for year � 365
Days Indicates the average length of time in
days that the company takes to pay its
credit purchases.
Days of cash Cash
Net sales for year � 365
Days Indicates the number of days of cash on
hand, at present sales levels.
4. Leverage Ratios
Debt to asset ratio
Total debt
Total assets Percentage Measures the extent to which borrowed
funds have been used to finance the
company’s assets.
Debt to equity ratio Total debt
Shareholders’ equity
Percentage Measures the funds provided by creditors
versus the funds provided by owners.
Long-term debt to
capital structure
Percentage Measures the long-term component of
capital structure.
Times interest earned Profit before taxes �
Interest charges
Interest charges
Decimal Indicates the ability of the company to
meet its annual interest costs.
Coverage of fixed
charges
Profit before taxes �
Interest charges �
Lease charges
Interest charges �
Lease obligations
Decimal A measure of the company’s ability to
meet all of its fixed-charge obligations.
Current liabilities
to equity
Current liabilities
Shareholders’ equity
Percentage Measures the short-term financing portion
versus that provided by owners.
, (continued)
Long-term debt
Shareholders’ equity
CHAPTER 12 Suggestions for Case Analysis 369
TABLE 12–1 Financial Ratio Analysis
Formula
How
Expressed Meaning
5. Other Ratios
Price/earnings ratio
Market price per share
Earnings per share
Decimal Shows the current market’s evaluation of a
stock, based on its earnings; shows how
much the investor is willing to pay for each
dollar of earnings.
Divided payout ratio Annual dividends per share
Annual earnings per share
Percentage Indicates the percentage of profit that is
paid out as dividends.
Dividend yield on
common stock
Annual dividends per share
Current market price per share
Percentage Indicates the dividend rate of return to
common shareholders at the current market
price.
NOTE: In using ratios for analysis, calculate ratios for the corporation and compare them to the average and quartile ratios for the particular in-
dustry. Refer to Standard & Poor’s and Robert Morris Associates for average industry data. Special thanks to Dr. Moustafa H. Abdelsamad,
Dean, Business School, Texas A&M University—Corpus Christi, Corpus Christi, Texas, for his definitions of these ratios.
ANALYZING FINANCIAL STATEMENTS
In your analysis, do not simply make an exhibit that includes all the ratios (unless your instruc-
tor requires you to do so), but select and discuss only those ratios that have an impact on the
company’s problems. For instance, accounts receivable and inventory may provide a source of
funds. If receivables and inventories are double the industry average, reducing them may pro-
vide needed cash. In this situation, the case report should include not only sources of funds but
also the number of dollars freed for use. Compare these ratios with industry averages to dis-
cover whether the company is out of line with others in the industry. Annual and quarterly in-
dustry ratios can be found in the library or on the Internet. (See the resources for case research
in Appendix 12.A.) In the years to come, expect to see financial entries for the trading of CERs
(Certified Emissions Reductions). This is the amount of money a company earns from reduc-
ing carbon emissions and selling them on the open market. To learn how carbon trading is
likely to affect corporations, see the Environmental Sustainability Issue.
A typical financial analysis of a firm would include a study of the operating statements for
five or so years, including a trend analysis of sales, profits, earnings per share, debt-to-equity ra-
tio, return on investment, and so on, plus a ratio study comparing the firm under study with in-
dustry standards. As a minimum, undertake the following five steps in basic financial analysis.
1. Scrutinize historical income statements and balance sheets: These two basic state-
ments provide most of the data needed for analysis. Statements of cash flow may also be
useful.
2. Compare historical statements over time if a series of statements is available.
3. Calculate changes that occur in individual categories from year to year, as well as the
cumulative total change.
4. Determine the change as a percentage as well as an absolute amount.
5. Adjust for inflation if that was a significant factor.
Examination of this information may reveal developing trends. Compare trends in one
category with trends in related categories. For example, an increase in sales of 15% over three
years may appear to be satisfactory until you note an increase of 20% in the cost of goods sold
, (continued)
370 PART 5 Introduction to Case Analysis
Do you know about carbon
trading, emissions al-
lowances, cap-and-trade, or
CERs? These are terms you can
expect to hear a lot more in the
years to come. The concept of carbon
trading is something that will soon be affecting the bal-
ance sheets and income statements of all corporations, es-
pecially those with international operations. It is one way
to account for environmental sustainability initiatives.
The Kyoto Protocol established an emissions trading
program that assigned annual limits on greenhouse gases
emitted by facilities within each country’s boundaries. The
countries signing the pact, including Canada, Japan, and
the European Union, were then able to trade emission sur-
pluses and deficits with each other. In addition, individual
countries or companies could invest in projects in develop-
ing nations that would reduce emissions and use those re-
ductions to meet their own targets.
In 2005 the European Union initiated a trading system
allowing individual facilities to sell credit allowances they
had earned for reducing greenhouse gas emissions. It cre-
ated a tradable commodity, the Certified Emissions Reduc-
tion (CER), which gave a facility the right to emit one
metric ton of carbon dioxide annually. The CER was created
by another facility that reduced its carbon dioxide emis-
sions. (Reducing or trapping one metric ton of methane
from entering the atmosphere was worth 21 CERs due to
IMPACT OF CARBON TRADING
ENVIRONMENTAL sustainability issue
methane’s greater impact on global warming.) By 2006, a
CER traded on the European market for around 25 euros
with trading volume totaling one million CERs per day. Bar-
clays, Citibank, Credit Suisse, HSBC, Lehman Brothers, and
Morgan Stanley soon opened trading desks for CERs at
London’s Canary Wharf, the global center for carbon trad-
ing. By 2007, European and Asian traders bought and sold
approximately $60 billion worth of emission CERs.
Carbon trading has created an opportunity for new and
established companies. For example, Mission Point Capital
Partners is one of more than 50 private equity and hedge
funds specializing in carbon finance and clean energy. Mis-
sion Point created a joint venture in 2008 with GE and AES
to develop large volumes of emissions credits. These would
be sold to U.S. companies like Yahoo! and News Corp that
wanted to become carbon neutral by offsetting their car-
bon emissions. Assuming that the U.S. federal government
would soon establish a cap-and-trade market for emissions,
the joint venture partners expected to produce 10 million
tons of emission credits by 2010. According to Kevin Walsh,
managing director of GE Energy Financial Services, “We
think this is going to be an enormous market.”
SOURCE: A. White, “Environment: The Greening of the Balance
Sheet,” Harvard Business Review (March 2006), pp. 27–28;
M. Gunther, “Carbon Finance Comes of Age,” Fortune (April 28,
2008), pp. 124–132.
during the same period. The outcome of this comparison might suggest that further investiga-
tion into the manufacturing process is necessary. If a company is reporting strong net income
growth but negative cash flow, this would suggest that the company is relying on something
other than operations for earnings growth. Is it selling off assets or cutting R&D? If accounts
receivable are growing faster than sales revenues, the company is not getting paid for the prod-
ucts or services it is counting as sold. Is the company dumping product on its distributors at the
end of the year to boost its reported annual sales? If so, expect the distributors to return the un-
ordered product the next month, thus drastically cutting the next year’s reported sales.
Other “tricks of the trade” need to be examined. Until June 2000, firms growing through
acquisition were allowed to account for the cost of the purchased company, through the pool-
ing of both companies’ stock. This approach was used in 40% of the value of mergers between
1997 and 1999. The pooling method enabled the acquiring company to disregard the premium
it paid for the other firm (the amount above the fair market value of the purchased company
often called “good will”). Thus, when PepsiCo agreed to purchase Quaker Oats for $13.4 bil-
lion in PepsiCo stock, the $13.4 billion was not found on PepsiCo’s balance sheet. As of June
2000, merging firms must use the “purchase” accounting rules in which the true purchase price
is reflected in the financial statements.7
CHAPTER 12 Suggestions for Case Analysis 371
The analysis of a multinational corporation’s financial statements can get very compli-
cated, especially if its headquarters is in another country that uses different accounting stan-
dards. See the Global Issue for why financial analysis can get tricky at times.
A multinational corporation
follows the accounting rules
for its home country. As a re-
sult, its financial statements may
be somewhat difficult to understand or
to use for comparisons with competitors from other
countries. For example, British firms such as British Petro-
leum use the term turnover rather than sales revenue. In
the case of AB Electrolux of Sweden, a footnote to an an-
GLOBAL issue
FINANCIAL STATEMENTS OF MULTINATIONAL
CORPORATIONS: NOT ALWAYS WHAT THEY SEEM
nual report indicates that the consolidated accounts have
been prepared in accordance with Swedish accounting
standards, which differ in certain significant respects from
U.S. generally accepted accounting principles (U.S.
GAAP). For one year, net income of 4,830m SEK (Swedish
kronor) approximated 5,655m SEK according to U.S.
GAAP. Total assets for the same period were 84,183m
SEK according to Swedish principle, but 86,658m accord-
ing to U.S. GAAP.
COMMON-SIZE STATEMENTS
Common-size statements are income statements and balance sheets in which the dollar fig-
ures have been converted into percentages. These statements are used to identify trends in each
of the categories, such as cost of goods sold as a percentage of sales (sales is the denomina-
tor). For the income statement, net sales represent 100%: calculate the percentage for each cat-
egory so that the categories sum to the net sales percentage (100%). For the balance sheet, give
the total assets a value of 100% and calculate other asset and liability categories as percent-
ages of the total assets with total assets as the denominator. (Individual asset and liability
items, such as accounts receivable and accounts payable, can also be calculated as a percent-
age of net sales.)
When you convert statements to this form, it is relatively easy to note the percentage that
each category represents of the total. Look for trends in specific items, such as cost of goods
sold, when compared to the company’s historical figures. To get a proper picture, however, you
need to make comparisons with industry data, if available, to see whether fluctuations are
merely reflecting industry-wide trends. If a firm’s trends are generally in line with those of the
rest of the industry, problems are less likely than if the firm’s trends are worse than industry
averages. If ratios are not available for the industry, calculate the ratios for the industry’s best
and worst firms and compare them to the firm you are analyzing. Common-size statements are
especially helpful in developing scenarios and pro forma statements because they provide a
series of historical relationships (for example, cost of goods sold to sales, interest to sales, and
inventories as a percentage of assets) from which you can estimate the future with your sce-
nario assumptions for each year.
Z-VALUE AND INDEX OF SUSTAINABLE GROWTH
If the corporation being studied appears to be in poor financial condition, use Altman’s
Z-Value Bankruptcy Formula to calculate its likelihood of going bankrupt. The Z-value formula
372 PART 5 Introduction to Case Analysis
USEFUL ECONOMIC MEASURES
If you are analyzing a company over many years, you may want to adjust sales and net income
for inflation to arrive at “true” financial performance in constant dollars. Constant dollars are
dollars adjusted for inflation to make them comparable over various years. One way to adjust
for inflation in the United States is to use the Consumer Price Index (CPI), as given in
Table 12–2. Dividing sales and net income by the CPI factor for that year will change the fig-
ures to 1982–1984 U.S. constant dollars (when the CPI was 1.0). Adjusting for inflation is es-
pecially important for companies operating in the emerging economies, like China and Russia,
where inflation in 2008 rose to 6.6%, the highest in 10 years. In that same year, Zimbabwe’s
inflation rate was the highest in the world at 2.2 million%!11
Another helpful analytical aid provided in Table 12–2 is the prime interest rate, the rate
of interest banks charge on their lowest-risk loans. For better assessments of strategic deci-
sions, it can be useful to note the level of the prime interest rate at the time of the case. A de-
cision to borrow money to build a new plant would have been a good one in 2003 at 4.1% but
less practical in 2007 when the average rate was 8.1%.
combines five ratios by weighting them according to their importance to a corporation’s finan-
cial strength. The formula is:
Z � 1.2×1 � 1.4×2 � 3.3×3 � 0.6×4 � 1.0×5
where:
x1 � Working capital/Total assets (%)
x2 � Retained earnings/Total assets (%)
x3 � Earnings before interest and taxes/Total assets (%)
x4 � Market value of equity/Total liabilities (%)
x5 � Sales/Total assets (number of times)
A score below 1.81 indicates significant credit problems, whereas a score above 3.0 indi-
cates a healthy firm. Scores between 1.81 and 3.0 indicate question marks.8 The Altman Z
model has achieved a remarkable 94% accuracy in predicting corporate bankruptcies. Its ac-
curacy is excellent in the two years before financial distress, but diminishes as the lead time
increases.9
The index of sustainable growth is useful to learn whether a company embarking on a
growth strategy will need to take on debt to fund this growth. The index indicates how much
of the growth rate of sales can be sustained by internally generated funds. The formula is:
where:
P � (Net profit before tax/Net sales)�100
D � Target dividends/Profit after tax
L � Total liabilities/Net worth
T � (Total assets/Net sales)�100
If the planned growth rate calls for a growth rate higher than its g*, external capital will be
needed to fund the growth unless management is able to find efficiencies, decrease dividends,
increase the debt-equity ratio, or reduce assets through renting or leasing arrangements.10
g* =
3P11 – D211 + L24
3T – P11 – D211 + L24
CHAPTER 12 Suggestions for Case Analysis 373
TABLE 12–2
Year
GDP (in $ billions)
Gross Domestic
Product
CPI (for all items)
Consumer Price
Index
PIR (in %)
Prime Interest
Rate
1980 2,789.5 .824 Ï15.27
1985 4,220.3 1.076 9.93
1990 5,803.1 1.307 10.01
1995 7,397.7 1.524 8.83
1996 7,816.9 1.569 8.27
1997 8,304.3 1.605 8.44
1998 8,747.0 1.630 8.35
1999 9,268.4 1.666 7.99
2000 9,817.0 1.722 9.23
2001 10,128.0 1.771 6.92
2002 10,469.6 1.799 4.68
2003 10,960.8 1.840 4.12
2004 11,685.9 1.889 4.29
2005 12,421.9 1.953 6.10
2006 13,178.4 2.016 7.94
2007 13,807.5 2.073 8.08
2008 14,280.7 2.153 5.21
NOTES: Gross Domestic Product (GDP) in Billions of Dollars; Consumer Price Index for All Items (CPI) (1982–84
� 1.0); Prime Interest Rate (PIR) in Percentages.
SOURCES: Gross Domestic Product (GDP) from U.S. Bureau of Economic Analysis, National Economic Accounts
(www.bea.gov). Consumer Price Index (CPI) from U.S. Bureau of Labor Statistics (www.bls.gov). Prime Interest
Rate (PIR) from www.moneycafe.com.
U.S. Economic
Indicators
In preparing a scenario for your pro forma financial statements, you may want to use the
gross domestic product (GDP) from Table 12–2. GDP is used worldwide and measures the
total output of goods and services within a country’s borders. The amount of change from one
year to the next indicates how much that country’s economy is growing. Remember that sce-
narios have to be adjusted for a country’s specific conditions. For other economic information,
see the resources for case research in Appendix 12.A.
12.4 Format for Case Analysis: The Strategic Audit
There is no one best way to analyze or present a case report. Each instructor has personal pref-
erences for format and approach. Nevertheless, in Appendix 12.B we suggest an approach for
both written and oral reports that provides a systematic method for successfully attacking a
case. This approach is based on the strategic audit, which is presented at the end of Chapter 1
in Appendix 1.A). We find that this approach provides structure and is very helpful for the typ-
ical student who may be a relative novice in case analysis. Regardless of the format chosen,
be careful to include a complete analysis of key environmental variables—especially of trends
in the industry and of the competition. Look at international developments as well.
If you choose to use the strategic audit as a guide to the analysis of complex strategy cases,
you may want to use the strategic audit worksheet in Figure 12–1. Print a copy of the work-
sheet to use to take notes as you analyze a case. See Appendix 12.C for an example of a com-
pleted student-written analysis of a 1993 Maytag Corporation case done in an outline form
www.bea.gov
www.bls.gov
www.moneycafe.com
Analysis
Strategic Audit Heading (+) Factors (−) Factors Comments
I. Current Situation
A. Past Corporate Performance Indexes
B. Strategic Posture:
Current Mission
Current Objectives
Current Strategies
Current Policies
SWOT Analysis Begins:
II. Corporate Governance
A. Board of Directors
B. Top Management
III. External Environment (EFAS):
Opportunities and Threats (SWOT)
A. Natural Environment
B. Societal Environment
C. Task Environment (Industry Analysis)
IV. Internal Environment (IFAS):
Strengths and Weaknesses (SWOT)
A. Corporate Structure
B. Corporate Culture
C. Corporate Resources
1. Marketing
2. Finance
3. Research and Development
4. Operations and Logistics
5. Human Resources
6. Information Technology
V. Analysis of Strategic Factors (SFAS)
A. Key Internal and External
Strategic Factors (SWOT)
B. Review of Mission and Objectives
SWOT Analysis Ends. Recommendation Begins:
VI. Alternatives and Recommendations
A. Strategic Alternatives—pros and cons
B. Recommended Strategy
VII. Implementation
VIII. Evaluation and Control
FIGURE 12–1
Strategic Audit
Worksheet
NOTE: See the complete Strategic Audit on pages 34–41. It lists the pages in the book that discuss each of the eight
headings.
SOURCE: T. L. Wheelen and J. D. Hunger, “Strategic Audit Worksheet.” Copyright © 1985, 1986, 1987, 1988, 1989,
2005, and 2009 by T. L. Wheelen. Copyright © 1989, 2005, and 2009 by Wheelen and Hunger Associates. Revised
1991, 1994, and 1997. Reprinted by permission. Additional copies available for classroom use in Part D of Case
Instructors Manual and on the Prentice Hall Web site (www.prenhall.com/wheelen).
374
www.prenhall.com/wheelen
CHAPTER 12 Suggestions for Case Analysis 375
End of Chapter SUMMARY
Using case analysis is one of the best ways to understand and remember the strategic manage-
ment process. By applying to cases the concepts and techniques you have learned, you will be
able to remember them long past the time when you have forgotten other memorized bits of
information. The use of cases to examine actual situations brings alive the field of strategic
management and helps build your analytic and decision-making skills. These are just some of
the reasons why the use of cases in disciplines from agribusiness to health care is increasing
throughout the world.
E C O – B I T S
� A 2007 McKinsey & Company survey of 7,751 people
in eight countries found that 87% of consumers worry
about the environment and the social impact of the
products they buy.
� The same 2007 survey found that only 33% of the con-
sumers said that they were ready to buy green products
or had already done so.
� In a 2007 Chain Store Age survey of U.S. consumers,
only 25% of them had bought any green products other
than organic food or energy-efficient lighting.12
D I S C U S S I O N Q U E S T I O N S
1. Why should you begin a case analysis with a financial
analysis? When are other approaches appropriate?
2. What are common-size financial statements? What is
their value to case analysis? How are they calculated?
3. When should you gather information outside a case by
going to the library or using the Internet? What should
you look for?
4. When is inflation an important issue in conducting case
analysis? Why bother?
5. How can you learn what date a case took place?
using the strategic audit format. This is one example of what a case analysis in outline form
may look like.
Case discussion focuses on critical analysis and logical development of thought. A solu-
tion is satisfactory if it resolves important problems and is likely to be implemented success-
fully. How the corporation actually dealt with the case problems has no real bearing on the
analysis because management might have analyzed its problems incorrectly or implemented a
series of flawed solutions.
376 PART 5 Introduction to Case Analysis
S T R A T E G I C P R A C T I C E E X E R C I S E
Convert the following two years of income statements from
the Maytag Corporation into common-size statements. The
dollar figures are in thousands. What does converting to a
common size reveal?
K E Y T E R M S
activity ratio (p. 366)
Altman’s Z-Value Bankruptcy
Formula (p. 371)
annual report (p. 366)
common-size statement (p. 371)
constant dollars (p. 372)
gross domestic product (GDP) (p. 373)
index of sustainable growth (p. 372)
leverage ratio (p. 366)
liquidity ratio (p. 366)
prime interest rate (p. 372)
profitability ratio (p. 366)
ratio analysis (p. 366)
SEC 10-K form (p. 366)
SEC 10-Q form (p. 366)
SEC 14-A form (p. 366)
strategic audit worksheet (p. 373)
Consolidated Statements of Income: Maytag Corporation
1992 % 1991 %
Net sales $3,041,223 100 $2,970,626 100
Cost of sales 2,339,406 — 2,254,221 —
Gross profits 701,817 — 716,405 —
Selling, general, & admin. expenses 528,250 — 524,898 —
Reorganization expenses 95,000 — 0 —
Operating income 78,567 — 191,507 —
Interest expense (75,004) — (75,159) —
Other—net 3,983 — 7,069 —
Income before taxes and
accounting changes
7,546 — 123,417 —
Income taxes (15,900) — (44,400) —
Income before accounting changes (8,354) — 79,017 —
Effects of accounting changes
for postretirement benefits
(307,000) — 0 —
Net income (loss) $(315,354) — $79,017 —
N O T E S
1. M. Heimer, “Wall Street Sherlock,” Smart Money (July 2003),
pp. 103–107.
2. Ibid., p. 105.
3. Ibid., p. 105.
4. Ibid., p. 105.
5. D. Stead, “The Secrets in SEC Filings,” Business Week
(September 1, 2008), p. 12.
6. M. Vanac, “What’s a Novice Investor to Do?” Des Moines Reg-
ister (November 30, 1997), p. 3G.
7. A. R. Sorking, “New Path on Mergers Could Contain Loop-
holes,” The (Ames, IA) Daily Tribune (January 9, 2001), p. B7;
“Firms Resist Effort to Unveil True Costs of Doing Business,”
USA Today (July 3, 2000), p. 10A.
8. M. S. Fridson, Financial Statement Analysis (New York: John
Wiley & Sons, 1991), pp. 192–194.
9. E. I. Altman, “Predicting Financial Distress of Companies: Re-
visiting the Z-Score and Zeta Models,” Working paper at http://
pages.stern.nyu.edu/~ealtman/Zscores (July 2000).
10. D. H. Bangs, Managing by the Numbers (Dover, N.H.: Upstart
Publications, 1992), pp. 106–107.
11. “Economic Focus: A Tale of Two Worlds,” The Economist
(May 10, 2008), p. 88; “Zimbabwe: A Worthless Currency,”
The Economist (July 19, 2008), pp. 56–57.
12. S. M. J. Bonini and J. M. Oppenheim, “Helping ‘Green’ Prod-
ucts Grow,” McKinsey Quarterly (October 2008), pp. 1–8.
http://pages.stern.nyu.edu/~ealtman/Zscores
http://pages.stern.nyu.edu/~ealtman/Zscores
Company Information
1. Annual reports
2. Moody’s Manuals on Investment (a listing of companies within certain industries that contains a
brief history and a five-year financial statement of each company)
3. Securities and Exchange Commission Annual Report Form 10-K (annually) and 10-Q (quarterly)
4. Standard & Poor’s Register of Corporations, Directors, and Executives
5. Value Line’s Investment Survey
6. Findex’s Directory of Market Research Reports, Studies and Surveys (a listing by Find/SVP of more
than 11,000 studies conducted by leading research firms)
7. Compustat, Compact Disclosure, CD/International, and Hoover’s Online Corporate Directory
(computerized operating and financial information on thousands of publicly held corporations)
8. Shareholders meeting notices in SEC Form 14-A (proxy notices)
Economic Information
1. Regional statistics and local forecasts from large banks
2. Business Cycle Development (Department of Commerce)
3. Chase Econometric Associates’ publications
4. U.S. Census Bureau publications on population, transportation, and housing
5. Current Business Reports (U.S. Department of Commerce)
6. Economic Indicators (U.S. Joint Economic Committee)
7. Economic Report of the President to Congress
8. Long-Term Economic Growth (U.S. Department of Commerce)
9. Monthly Labor Review (U.S. Department of Labor)
10. Monthly Bulletin of Statistics (United Nations)
11. Statistical Abstract of the United States (U.S. Department of Commerce)
12. Statistical Yearbook (United Nations)
13. Survey of Current Business (U.S. Department of Commerce)
14. U.S. Industrial Outlook (U.S. Department of Defense)
15. World Trade Annual (United Nations)
16. Overseas Business Reports (by country, published by the U.S. Department of Commerce)
Industry Information
1. Analyses of companies and industries by investment brokerage firms
2. Business Week (provides weekly economic and business information, as well as quarterly profit and
sales rankings of corporations)
377
Resources
for Case Research
A P P E N D I X 12.A
3. Fortune (each April publishes listings of financial information on corporations within certain
industries)
4. Industry Survey (published quarterly by Standard & Poor’s)
5. Industry Week (late March/early April issue provides information on 14 industry groups)
6. Forbes (mid-January issue provides performance data on firms in various industries)
7. Inc. (May and December issues give information on fast-growing entrepreneurial companies)
Directory and Index Information on Companies and Industries
1. Business Periodical Index (on computers in many libraries)
2. Directory of National Trade Associations
3. Encyclopedia of Associations
4. Funk and Scott’s Index of Corporations and Industries
5. Thomas’ Register of American Manufacturers
6. Wall Street Journal Index
Ratio Analysis Information
1. Almanac of Business and Industrial Financial Ratios (Prentice Hall)
2. Annual Statement Studies (Risk Management Associates; also Robert Morris Associates)
3. Dun’s Review (Dun & Bradstreet; published annually in September–December issues)
4. Industry Norms and Key Business Ratios (Dun & Bradstreet)
Online Information
1. Hoover’s Online—financial statements and profiles of public companies (www.hoovers.com)
2. U.S. Securities and Exchange Commission—official filings of public companies in Edgar database
(www.sec.gov)
3. Fortune 500—statistics for largest U.S. corporations (www.fortune.com)
4. Dun & Bradstreet’s Online—short reports on 10 million public and private U.S. companies
(smallbusiness.dnb.com)
5. Ecola’s 24-Hour Newsstand—links to Web sites of 2,000 newspapers, journals, and magazines
(www.ecola.com)
6. Competitive Intelligence Guide—information on company resources (www.fuld.com)
7. Society of Competitive Intelligence Professionals (www.scip.org)
8. The Economist—provides international information and surveys (www.economist.com)
9. CIA World Fact Book—international information by country (http://www.cia.gov)
10. Bloomberg—information on interest rates, stock prices, currency conversion rates, and other gen-
eral financial information (www.bloomberg.com)
11. The Scannery—information on international companies (www.thescannery.com)
12. CEOExpress—links to many valuable sources of business information (www.ceoexpress.com)
13. Wall Street Journal—business news (www.wsj.com)
14. Forbes—America’s largest private companies (http://www.forbes.com/lists/)
15. CorporateInformation.com—subscription service for company profiles
(www.corporateinformation.com)
16. Kompass International—industry information (www.kompass.com)
17. CorpTech—database of technology companies (www.corptech.com)
18. ADNet—information technology industry (www.companyfinder.com)
19. CNN company research—provides company information (http://money.cnn.com/news/crc/)
378 PART 5 Introduction to Case Analysis
www.hoovers.com
www.sec.gov
www.fortune.com
www.ecola.com
www.fuld.com
www.scip.org
www.economist.com
http://www.cia.gov
www.bloomberg.com
www.thescannery.com
www.ceoexpress.com
www.wsj.com
http://www.forbes.com/lists/
www.corporateinformation.com
www.kompass.com
www.corptech.com
www.companyfinder.com
http://money.cnn.com/news/crc/
CHAPTER 12 Suggestions for Case Analysis 379
20. Paywatch—database of executive compensation (http://www.aflcio.org/corporatewatch/paywatch/)
21. Global Edge Global Resources—international resources (http://globaledge.msu.edu/resourceDesk/)
22. Google Finance—data on North American stocks (http://finance.google.com/finance)
23. World Federation of Exchanges—international stock exchanges (www.world-exchanges.org/)
24. SEC International Registry—data on international corporations (http://www.sec.gov/divisions/
corpfin/internatl/companies.shtml)
25. Yahoo Finance—data on North American companies (http://finance.yahoo.com)
http://www.aflcio.org/corporatewatch/paywatch/
http://globaledge.msu.edu/resourceDesk/
http://finance.google.com/finance
www.world-exchanges.org/
http://www.sec.gov/divisions/corpfin/internatl/companies.shtml
http://www.sec.gov/divisions/corpfin/internatl/companies.shtml
http://finance.yahoo.com
First Reading of the Case
� Develop a general overview of the company and its external environment.
� Begin a list of the possible strategic factors facing the company at this time.
� List the research information you may need on the economy, industry, and competitors.
Suggested Case
Analysis
Methodology Using
the Strategic Audit
A P P E N D I X 12.B
1. READ CASE
2. READ
THE CASE
WITH THE
STRATEGIC
AUDIT
3. DO OUTSIDE
RESEARCH
Second Reading of the Case
� Read the case a second time, using the strategic audit as a framework for in-depth analysis. (See
Appendix 1.A on pages 34–41.) You may want to make a copy of the strategic audit worksheet
(Figure 12–1) to use to keep track of your comments as you read the case.
� The questions in the strategic audit parallel the strategic decision-making process shown in
Figure 1–5 (pages 28–29).
� The audit provides you with a conceptual framework to examine the company’s mission, objectives,
strategies, and policies as well as problems, symptoms, facts, opinions, and issues.
� Perform a financial analysis of the company, using ratio analysis (see Table 12–1), and do the cal-
culations necessary to convert key parts of the financial statements to a common-size basis.
Library and Online Computer Services
� Each case has a decision date indicating when the case actually took place. Your research should be
based on the time period for the case.
� See Appendix 12.A for resources for case research. Your research should include information about
the environment at the time of the case. Find average industry ratios. You may also want to obtain
further information regarding competitors and the company itself (10-K forms and annual reports).
This information should help you conduct an industry analysis. Check with your instructor to see
what kind of outside research is appropriate for your assignment.
� Don’t try to learn what actually happened to the company discussed in the case. What management
actually decided may not be the best solution. It will certainly bias your analysis and will probably
cause your recommendation to lack proper justification.
BYTE PRODUCTS, INC., IS PRIMARILY INVOLVED IN THE PRODUCTION OF ELECTRONIC components
that are used in personal computers. Although such components might be found in a few com-
puters in home use, Byte products are found most frequently in computers used for sophisti-
cated business and engineering applications. Annual sales of these products have been
steadily increasing over the past several years; Byte Products, Inc., currently has total sales
of approximately $265 million.
Over the past six years, increases in yearly revenues have consistently reached 12%.
Byte Products, Inc., headquartered in the midwestern United States, is regarded as one
of the largest-volume suppliers of specialized components and is easily the industry leader,
with some 32% market share. Unfortunately for Byte, many new firms—domestic and for-
eign—have entered the industry. A dramatic surge in demand, high profitability, and the rela-
tive ease of a new firm’s entry into the industry explain in part the increased number of
competing firms.
Although Byte management—and presumably shareholders as well—is very pleased
about the growth of its markets, it faces a major problem: Byte simply cannot meet the demand
for these components. The company currently operates three manufacturing facilities in vari-
ous locations throughout the United States. Each of these plants operates three production
shifts (24 hours per day), 7 days a week. This activity constitutes virtually all of the company’s
production capacity. Without an additional manufacturing plant, Byte simply cannot increase
its output of components.
This case was prepared by Professors Dan R. Dalton and Richard A. Cosier of the Graduate School of Business at
Indiana University and Cathy A. Enz of Cornell University. The names of the organization, individual, location,
and/or financial information have been disguised to preserve the organization’s desire for anonymity. This case was
edited for SMBP–9th, 10th, 11th, and 12th Editions. Reprint permission is solely granted to the publisher, Prentice
Hall, for the book, Strategic Management and Business Policy – 12th Edition and cases in Strategic Management
and Business Policy, 12th Edition by copyright holders Dan R. Dalton, Richard A. Cosier, and Cathy A. Enz. Any
other publication of this case (translation, any form of electronic or other media), or sold (any form of partnership)
to another publisher will be in violation of copyright laws, unless the copyright holders have granted an additional
written reprint permission.
401
C A S E 1
The Recalcitrant Director
at Byte Products, Inc.:
CORPORATE LEGALITY VERSUS CORPORATE RESPONSIBILITY
Dan R. Dalton, Richard A. Cosier, and Cathy A. Enz
S E C T I O N A
Corporate Governance and Social Responsibility
Analysis
Strategic Audit Heading (+) Factors (−) Factors Comments
I. Current Situation
A. Past Corporate Performance Indexes
B. Strategic Posture:
Current Mission
Current Objectives
Current Strategies
Current Policies
SWOT Analysis Begins:
II. Corporate Governance
A. Board of Directors
B. Top Management
III. External Environment (EFAS):
Opportunities and Threats (SWOT)
A. Societal Environment
B. Task Environment (Industry Analysis)
IV. Internal Environment (IFAS):
Strengths and Weaknesses (SWOT)
A. Corporate Structure
B. Corporate Culture
C. Corporate Resources
1. Marketing
2. Finance
3. Research and Development
4. Operations and Logistics
5. Human Resources
6. Information Systems
V. Analysis of Strategic Factors (SFAS)
A. Key Internal and External
Strategic Factors (SWOT)
B. Review of Mission and Objectives
SWOT Analysis Ends. Recommendation Begins:
VI. Alternatives and Recommendations
A. Strategic Alternatives—pros and cons
B. Recommended Strategy
VII. Implementation
VIII. Evaluation and Control
FIGURE 12–1
Strategic Audit
Worksheet
NOTE: See the complete Strategic Audit on pages 26–33. It lists the pages in the book that discuss each of the eight
headings.
SOURCE: T. L. Wheelen and J. D. Hunger, “Strategic Audit Worksheet.” Copyright © 1985, 1986, 1987, 1988, 1989,
2005, and 2009 by T. L. Wheelen. Copyright © 1989, 2005, and 2009 by Wheelen and Hunger Associates. Revised
1991, 1994, and 1997. Reprinted by permission. Additional copies available for classroom use in Part D of Case
Instructors Manual and on the Prentice Hall Web site (www.prenhall.com/wheelen).
380
www.prenhall.com/wheelen
CHAPTER 12 Suggestions for Case Analysis 381
External Environmental Analysis: EFAS
� Analyze the natural and societal environments to see what general trends are likely to affect the
industry(s) in which the company is operating.
� Conduct an industry analysis using Porter’s competitive forces from Chapter 4. Develop an Indus-
try Matrix (Table 4–4 on page 119).
� Generate 8 to 10 external factors. These should be the most important opportunities and threats fac-
ing the company at the time of the case.
� Develop an EFAS Table, as shown in Table 4–5 (page 126), for your list of external strategic factors.
� Suggestion: Rank the 8 to 10 factors from most to least important. Start by grouping the 3 top fac-
tors and then the 3 bottom factors.
Internal Organizational Analysis: IFAS
� Generate 8 to 10 internal factors. These should be the most important strengths and weaknesses of
the company at the time of the case.
� Develop an IFAS Table, as shown in Table 5–2 (page 164), for your list of internal strategic factors.
� Suggestion: Rank the 8 to 10 factors from most to least important. Start by grouping the 3 top fac-
tors and then the 3 bottom factors.
TABLE 4–5 External Factor Analysis Summary (EFAS Table): Maytag as Example
External Factors Weight Rating
Weighted
Score Comments
1 2 3 4 5
Opportunities
� Economic integration of European Community .20 4.1 .82 Acquisition of Hoover
� Demographics favor quality appliances .10 5.0 .50 Maytag quality
� Economic development of Asia .05 1.0 .05 Low Maytag presence
� Opening of Eastern Europe .05 2.0 .10 Will take time
� Trend to “Super Stores” .10 1.8 .18 Maytag weak in this channel
Threats
� Increasing government regulations .10 4.3 .43 Well positioned
� Strong U.S. competition .10 4.0 .40 Well positioned
� Whirlpool and Electrolux strong globally .15 3.0 .45 Hoover weak globally
� New product advances .05 1.2 .06 Questionable
� Japanese appliance companies .10 1.6 .16 Only Asian presence in
Australia
Total Scores 1.00 3.15
OTES:
1. List opportunities and threats (8–10) in Column 1.
2. Weight each factor from 1.0 (Most Important) to 0.0 (Not Important) in Column 2 based on that factor’s probable impact on the com-
pany’s strategic position. The total weights must sum to 1.00.
3. Rate each factor from 5.0 (Outstanding) to 1.0 (Poor) in Column 3 based on the company’s response to that factor.
4. Multiply each factor’s weight times its rating to obtain each factor’s weighted score in Column 4.
5. Use Column 5 (comments) for rationale used for each factor.
6. Add the individual weighted scores to obtain the total weighted score for the company in Column 4. This tells how well the company is
responding to the factors in its external environment.
OURCE: T. L. Wheelen and J. D. Hunger, “External Factors Analysis Summary (EFAS).” Copyright © 1987, 1988, 1989, 1990, 2005 and
07 by T. L. Wheelen. Copyright © 1991, 2003, 2005 and 2009 by Wheelen and Hunger Associates. Reprinted by permission.
4. BEGIN SWOT
ANALYSIS
5. WRITE YOUR
STRATEGIC
AUDIT:
PARTS I TO IV
First Draft of Your Strategic Audit
� Review the student-written audit of an old Maytag case in Appendix 12.C for an example.
� Write Parts I to IV of the strategic audit. Remember to include the factors from your EFAS and IFAS
Tables in your audit.
6. WRITE YOUR
STRATEGIC
AUDIT: PART V
FIGURE 6–1 Strategic Factor Analysis Summary (SFAS) Matrix
*The most important external and internal factors are identified in the EFAS and IFAS tables as shown here by shading these factors.
Weighted
External Strategic Factors Weight Rating Score Comments
1 2 3 4 5
Opportunities
O1 Economic integration of
European Community .20 4.1 .82 Acquisition of Hoover
O2 Demographics favor quality
appliances .10 5.0 .50 Maytag quality
O3 Economic development of Asia .05 1.0 .05 Low Maytag presence
O4 Opening of Eastern Europe .05 2.0 .10 Will take time
O5 Trend to “Super Stores” .10 1.8 .18 Maytag weak in this channel
Threats
T1 Increasing government regulations .10 4.3 .43 Well positioned
T2 Strong U.S. competition .10 4.0 .40 Well positioned
T3 Whirlpool and Electrolux strong
globally .15 3.0 .45 Hoover weak globally
T4 New product advances .05 1.2 .06 Questionable
T5 Japanese appliance companies .10 1.6 .16 Only Asian presence is Australia
Total Scores 1.00 3.15
Weighted
Internal Strategic Factors Weight Rating Score Comments
1 2 3 4 5
Strengths
S1 Quality Maytag culture .15 5.0 .75 Quality key to success
S2 Experienced top management .05 4.2 .21 Know appliances
S3 Vertical integration .10 3.9 .39 Dedicated factories
S4 Employee relations .05 3.0 .15 Good, but deteriorating
S5 Hoover’s international orientation .15 2.8 .42 Hoover name in cleaners
Weaknesses
W1 Process-oriented R&D .05 2.2 .11 Slow on new products
W2 Distribution channels .05 2.0 .10 Superstores replacing small
dealers
W3 Financial position .15 2.0 .30 High debt load
W4 Global positioning .20 2.1 .42 Hoover weak outside the
United Kingdom and
Australia
W5 Manufacturing facilities .05 4.0 .20 Investing now
Total Scores 1.00 3.05
1 2 3 4 Duration 5 6
I
N
T
E
R
M
E
Strategic Factors (Select the most S D
important opportunities/threats H I L
from EFAS, Table 4–5 and the most O A O
important strengths and weaknesses Weighted R T N
from IFAS, Table 5–2) Weight Rating Score T E G Comments
S1 Quality Maytag culture (S) .10 5.0 .50 X Quality key to success
S5 Hoover’s international
orientation (S) .10 2.8 .28 X X Name recognition
W3 Financial position (W) .10 2.0 .20 X X High debt
W4 Global positioning (W) .15 2.2 .33 X X Only in N.A., U.K., and
Australia
O1 Economic integration of
European Community (O) .10 4.1 .41 X Acquisition of Hoover
O2 Demographics favor quality (O) .10 5.0 .50 X Maytag quality
O5 Trend to super stores (O + T) .10 1.8 .18 X Weak in this channel
T3 Whirlpool and Electrolux (T) .15 3.0 .45 X Dominate industry
T5 Japanese appliance
companies (T) .10 1.6 .16 X Asian presence
Total Scores 1.00 3.01
Notes:
1. List each of the most important factors developed in your IFAS and EFAS Tables in Column 1.
2. Weight each factor from 1.0 (Most Important) to 0.0 (Not Important) in Column 2 based on that factor’s probable impact on the compa-
ny’s strategic position. The total weights must sum to 1.00.
3. Rate each factor from 5.0 (Outstanding) to 1.0 (Poor) in Column 3 based on the company’s response to that factor.
4. Multiply each factor’s weight times its rating to obtain each factor’s weighted score in Column 4.
5. For duration in Column 5, check appropriate column (short term—less than 1 year; intermediate—1 to 3 years; long term—over 3 years).
6. Use Column 6 (comments) for rationale used for each factor.
SOURCE: T. L. Wheelen and J. D. Hunger, “Strategic Factors Analysis Summary (SFAS).” Copyright © 1987, 1988, 1989, 1990, 1991, 1992,
1993, 1994, 1995, 1996, 2005, and 2009, by T. L. Wheelen. Copyright © 1997, 2005, and 2009 by Wheelen and Hunger Associates. Reprinted by
permission.
(see Figure 6–2)—where a company is able to satisfy customers’ needs in a way that rivals
cannot, given the context in which it operates.7
Finding such a niche or sweet spot is not always easy. A firm’s management must be al-
ways looking for a strategic window—that is, a unique market opportunity that is available
only for a particular time. The first firm through a strategic window can occupy a propitious
niche and discourage competition (if the firm has the required internal strengths). One com-
pany that successfully found a propitious niche was Frank J. Zamboni & Company, the man-
ufacturer of the machines that smooth the ice at ice skating rinks. Frank Zamboni invented the
Strategic Factor Analysis Summary: SFAS
� Condense the list of factors from the 16 to 20 identified in your EFAS and IFAS Tables to only
the 8 to 10 most important factors.
� Select the most important EFAS and IFAS factors. Recalculate the weights of each. The weights still
need to add to 1.0.
� Develop a SFAS Matrix, as shown in Figure 6–1 (page 178), for your final list of strategic factors.
Although the weights (indicating the importance of each factor) will probably change from the
EFAS and IFAS Tables, the numeric rating (1 to 5) of each factor should remain the same. These
ratings are your assessment of management’s performance on each factor.
� This is a good time to reexamine what you wrote earlier in Parts I to IV. You may want to add to or
delete some of what you wrote. Ensure that each one of the strategic factors you have included in
your SFAS Matrix is discussed in the appropriate place in Parts I to IV. Part V of the audit is not the
place to mention a strategic factor for the first time.
� Write Part V of your strategic audit. This completes your SWOT analysis.
� This is the place to suggest a revised mission statement and a better set of objectives for the com-
pany. The SWOT analysis coupled with revised mission and objectives for the company set the stage
for the generation of strategic alternatives.
TABLE 5–2 Internal Factor Analysis Summary (IFAS Table): Maytag as Example
Internal Factors Weight Rating
Weighted
Score Comments
1 2 3 4 5
Strengths
� Quality Maytag culture
� Experienced top management
� Vertical integration
� Employer relations
� Hoover’s international orientation
.15
.05
.10
.05
.15
5.0
4.2
3.9
3.0
2.8
.75
.21
.39
.15
.42
Quality key to success
Know appliances
Dedicated factories
Good, but deteriorating
Hoover name in cleaners
Weaknesses
� Process-oriented R&D
� Distribution channels
� Financial position
� Global positioning
� Manufacturing facilities
.05
.05
.15
.20
.05
2.2
2.0
2.0
2.1
4.0
.11
.10
.30
.42
.20
Slow on new products
Superstores replacing small dealers
High debt load
Hoover weak outside the United
Kingdom and Australia
Investing now
Total Scores 1.00 3.05
NOTES:
1. List strengths and weaknesses (8–10) in Column 1.
2. Weight each factor from 1.0 (Most Important) to 0.0 (Not Important) in Column 2 based on that factor’s probable impact on the company’s
strategic position. The total weights must sum to 1.00.
3. Rate each factor from 5.0 (Outstanding) to 1.0 (Poor) in Column 3 based on the company’s response to that factor.
4. Multiply each factor’s weight times its rating to obtain each factor’s weighted score in Column 4.
5. Use Column 5 (comments) for rationale used for each factor.
6. Add the individual weighted scores to obtain the total weighted score for the company in Column 4. This tells how well the company is
responding to the factors in its internal environment.
SOURCE: T. L. Wheelen and J. D. Hunger, “Internal Factor Analysis Summary (IFAS).” Copyright © 1987, 1988, 1989, 1990, 2005, and 2009
by T. L. Wheelen. Copyright © 1991, 2003, 2005, and 2009 by Wheelen and Hunger Associates. Reprinted by permission.
382 PART 5 Introduction to Case Analysis
8. WRITE YOUR
STRATEGIC
AUDIT: PART VII
Implementation
� Develop programs to implement your recommended strategy.
� Specify who is to be responsible for implementing each program and how long each program will
take to complete.
� Refer to the pro forma financial statements you developed earlier for your recommended strategy.
Use common-size historical income statements as the basis for the pro forma statement. Do the
numbers still make sense? If not, this may be a good time to rethink the budget numbers to reflect
your recommended programs.
9. WRITE YOUR
STRATEGIC
AUDIT: PART VIII
Evaluation and Control
� Specify the type of evaluation and controls that you need to ensure that your recommendation is car-
ried out successfully. Specify who is responsible for monitoring these controls.
� Indicate whether sufficient information is available to monitor how the strategy is being imple-
mented. If not, suggest a change to the information system.
TABLE 10–1 Example of an Action Plan
Action Plan for Jan Lewis, Advertising Manager, and Rick Carter, Advertising Assistant, Ajax Continental
Program Objective: To Run a New Advertising and Promotion Campaign for the Combined Jones Surplus/Ajax
Continental Retail Stores for the Coming Christmas Season Within a Budget of $XX.
Program Activities:
1. Identify Three Best Ad Agencies for New Campaign.
2. Ask Three Ad Agencies to Submit a Proposal for a New Advertising and Promotion Campaign for Combined Stores.
3. Agencies Present Proposals to Marketing Manager.
4. Select Best Proposal and Inform Agencies of Decision.
5. Agency Presents Winning Proposal to Top Management.
6. Ads Air on TV and Promotions Appear in Stores.
7. Measure Results of Campaign in Terms of Viewer Recall and Increase in Store Sales.
Action Steps Responsibility Start–End
1. A. Review previous programs
B. Discuss with boss
C. Decide on three agencies
Lewis & Carter
Lewis & Smith
Lewis
1/1–2/1
2/1–2/3
2/4
2. A. Write specifications for ad
B. Assistant writes ad request
C. Contact ad agencies
D. Send request to three agencies
E. Meet with agency acct. execs
Lewis
Carter
Lewis
Carter
Lewis & Carter
1/15–1/20
1/20–1/30
2/5–2/8
2/10
2/16–2/20
3. A. Agencies work on proposals
B. Agencies present proposals
Acct. Execs
Carter
2/23–5/1
5/1–5/15
4. A. Select best proposal
B. Meet with winning agency
C. Inform losers
Lewis
Lewis
Carter
5/15–5/20
5/22–5/30
6/1
5. A. Fine-tune proposal
B. Presentation to management
Acct. Exec
Lewis
6/1–7/1
7/1–7/3
6. A. Ads air on TV
B. Floor displays in stores
Lewis
Carter
9/1–12/24
8/20–8/30
7. A. Gather recall measures of ads
B. Evaluate sales data
C. Prepare analysis of campaign
Carter
Carter
Carter
9/1–12/24
1/1–1/10
1/10–2/15
10. PROOF AND
FINE-TUNE
YOUR AUDIT
Final Draft of Your Strategic Audit
� Check to ensure that your audit is within the page limits of your professor. You may need to cut some
parts and expand others.
� Make sure that your recommendation clearly deals with the strategic factors.
� Attach your EFAS and IFAS Tables, and SFAS Matrix, plus your ratio analysis and pro forma
statements. Label them as numbered exhibits and refer to each of them within the body of the audit.
� Proof your work for errors. If on a computer, use a spell checker.
SPECIAL NOTE: Depending on your assignment, it is relatively easy to use the strategic audit you have
just developed to write a written case analysis in essay form or to make an oral presentation. The strate-
gic audit is just a detailed case analysis in an outline form and can be used as the basic framework for
any sort of case analysis and presentation.
1
Determine
what to
measure.
Establish
predetermined
standards.
Measure
performance.
No
5432
Yes
STOP
Does
perfor-
mance match
stan-
dards?
Take
corrective
action.
FIGURE 11–1
Evaluation and
Control Process
5. Take corrective action: If actual results fall outside the desired tolerance range, action
must be taken to correct the deviation. The following questions must be answered:
a. Is the deviation only a chance fluctuation?
b. Are the processes being carried out incorrectly?
c. Are the processes appropriate to the achievement of the desired standard? Action
must be taken that will not only correct the deviation but also prevent its happen-
ing again.
d. Who is the best person to take corrective action?
Top management is often better at the first two steps of the control model than it is at
the last two follow-through steps. It tends to establish a control system and then delegate
the implementation to others. This can have unfortunate results. Nucor is unusual in its
ability to deal with the entire evaluation and control process.
11.1 Evaluation and Control in Strategic Management
Evaluation and control information consists of performance data and activity reports (gathered
in Step 3 in Figure 11–1). If undesired performance results because the strategic management
processes were inappropriately used, operational managers must know about it so that they can
correct the employee activity. Top management need not be involved. If, however, undesired
performance results from the processes themselves, top managers, as well as operational man-
agers, must know about it so that they can develop new implementation programs or proce-
dures. Evaluation and control information must be relevant to what is being monitored. One
of the obstacles to effective control is the difficulty in developing appropriate measures of im-
portant activities and outputs.
An application of the control process to strategic management is depicted in Figure 11–2.
It provides strategic managers with a series of questions to use in evaluating an implemented
strategy. Such a strategy review is usually initiated when a gap appears between a company’s
financial objectives and the expected results of current activities. After answering the proposed
set of questions, a manager should have a good idea of where the problem originated and what
must be done to correct the situation.
Strategic Alternatives and Recommendation
A. Alternatives
� Develop around three mutually exclusive strategic alternatives. If appropriate to the case you are an-
alyzing, you might propose one alternative for growth, one for stability, and one for retrenchment.
Within each corporate strategy, you should probably propose an appropriate business/competitive
strategy. You may also want to include some functional strategies where appropriate.
� Construct a corporate scenario for each alternative. Use the data from your outside research to pro-
ject general societal trends (GDP, inflation, and etc.) and industry trends. Use these as the basis of
your assumptions to write pro forma financial statements (particularly income statements) for each
strategic alternative for the next five years.
� List pros and cons for each alternative based on your scenarios.
B. Recommendation
� Specify which one of your alternative strategies you recommend. Justify your choice in terms of
dealing with the strategic factors you listed in Part V of the strategic audit.
� Develop policies to help implement your strategies.
7. WRITE YOUR
STRATEGIC
AUDIT: PART VI
GROWTH STRATEGIES
CHAPTER 7 Strategy Formulation: Corporate Strategy 207
By far the most widely pursued corporate directional strategies are those designed to achieve
growth in sales, assets, profits, or some combination. Companies that do business in expand-
ing industries must grow to survive. Continuing growth means increasing sales and a chance
to take advantage of the experience curve to reduce the per-unit cost of products sold, thereby
increasing profits. This cost reduction becomes extremely important if a corporation’s indus-
try is growing quickly or consolidating and if competitors are engaging in price wars in at-
tempts to increase their shares of the market. Firms that have not reached “critical mass” (that
is, gained the necessary economy of large-scale production) face large losses unless they can
find and fill a small, but profitable, niche where higher prices can be offset by special product
or service features. That is why Oracle acquired PeopleSoft, a rival software firm, in 2005. Al-
though still growing, the software industry was maturing around a handful of large firms. Ac-
cording to CEO Larry Ellison, Oracle needed to double or even triple in size by buying smaller
and weaker rivals if it was to compete with SAP and Microsoft.7 Growth is a popular strategy
because larger businesses tend to survive longer than smaller companies due to the greater
availability of financial resources, organizational routines, and external ties.8
A corporation can grow internally by expanding its operations both globally and domes-
tically, or it can grow externally through mergers, acquisitions, and strategic alliances. A
merger is a transaction involving two or more corporations in which stock is exchanged but
in which only one corporation survives. Mergers usually occur between firms of somewhat
similar size and are usually “friendly.” The resulting firm is likely to have a name derived from
its composite firms. One example is the merging of Allied Corporation and Signal Companies
Concentration
Vertical Growth
Horizontal Growth
Diversification
Concentric
Conglomerate
Pause/Proceed with Caution
No Change
Profit
Turnaround
Captive Company
Sell-Out/Divestment
Bankruptcy/Liquidation
GROWTH STABILITY RETRENCHMENT
FIGURE 7–1
Corporate
Directional
Strategies
A corporation’s directional strategy is composed of three general orientations (some-
times called grand strategies):
� Growth strategies expand the company’s activities.
� Stability strategies make no change to the company’s current activities.
� Retrenchment strategies reduce the company’s level of activities.
Having chosen the general orientation (such as growth), a company’s managers can select
from several more specific corporate strategies such as concentration within one product
line/industry or diversification into other products/industries. (See Figure 7–1.) These strate-
gies are useful both to corporations operating in only one industry with one product line and
to those operating in many industries with many product lines.
I. Current Situation
A. Current Performance
Poor financials, high debt load, first losses since 1920s, price/earnings ratio negative.
� First loss since 1920s.
� Laid off 4,500 employees at Magic Chef.
� Hoover Europe still showing losses.
B. Strategic Posture
1. Mission
� Developed in 1989 for the Maytag Company: “To provide our customers with prod-
ucts of unsurpassed performance that last longer, need fewer repairs, and are pro-
duced at the lowest possible cost.”
� Updated in 1991: “Our collective mission is world class quality.” Expands Maytag’s
belief in product quality to all aspects of operations.
2. Objectives
� “To be profitability leader in industry for every product line Maytag manufactures.”
Selected profitability rather than market share.
� “To be number one in total customer satisfaction.” Doesn’t say how to measure
satisfaction.
� “To grow the North American appliance business and become the third largest ap-
pliance manufacturer (in unit sales) in North America.”
� To increase profitable market share growth in North American appliance and floor
care business, 6.5% return on sales, 10% return on assets, 20% return on equity, beat
competition in satisfying customers, dealer, builder and endorser, move into third
place in total units shipped per year. Nicely quantified objectives.
3. Strategies
� Global growth through acquisition, and alliance with Bosch-Siemens.
� Differentiate brand names for competitive advantage.
� Create synergy between companies, product improvement, investment in plant and
equipment.
383
A P P E N D I X 12.C
Example of
Student-Written
Strategic Audit
(For the 1993 Maytag Corporation Case)
4. Policies
� Cost reduction is secondary to high quality.
� Promotion from within.
� Slow but sure R&D: Maytag slow to respond to changes in market.
II. Strategic Managers
A. Board of Directors
1. Fourteen members—eleven are outsiders.
2. Well-respected Americans, most on board since 1986 or earlier.
3. No international or marketing backgrounds.
4. Time for a change?
B. Top Management
1. Top management promoted from within Maytag Company. Too inbred?
2. Very experienced in the industry.
3. Responsible for current situation.
4. May be too parochial for global industry. May need new blood.
III. External Environment
(EFAS Table; see Exhibit 1)
A. Natural Environment
1. Growing water scarcity
2. Energy availability a growing problem
B. Societal Environment
1. Economic
a. Unstable economy but recession ending, consumer confidence growing—could in-
crease spending for big ticket items like houses, cars, and appliances. (O)
b. Individual economies becoming interconnected into a world economy. (O)
2. Technological
a. Fuzzy logic technology being applied to sense and measure activities. (O)
b. Computers and information technology increasingly important. (O)
3. Political–Legal
a. NAFTA, European Union, other regional trade pacts opening doors to markets in
Europe, Asia, and Latin America that offer enormous potential. (O)
b. Breakdown of communism means less chance of world war. (O)
c. Environmentalism being reflected in laws on pollution and energy usage. (T)
4. Sociocultural
a. Developing nations desire goods seen on TV. (O)
b. Middle-aged baby boomers want attractive, high-quality products, like BMWs and
Maytag. (O)
c. Dual-career couples increases need for labor-saving appliances, second cars, and
day care. (O)
d. Divorce and career mobility means need for more houses and goods to fill them. (O)
384 PART 5 Introduction to Case Analysis
C. Task Environment
1. North American market mature and extremely competitive—vigilant consumers de-
mand high quality with low price in safe, environmentally sound products. (T)
2. Industry going global as North American and European firms expand internationally. (T)
3. European design popular and consumer desire for technologically advanced
appliances. (O)
4. Rivalry High. Whirlpool, Electrolux, GE have enormous resources & developing
global presence. (T)
5. Buyers’ Power Low. Technology and materials can be sourced worldwide. (O)
6. Power of Other Stakeholders Medium. Quality, safety, environmental regulations
increasing. (T)
7. Distributors’Power High. Super retailers more important: mom and pop dealers less. (T)
8. Threat of Substitutes Low. (O)
9. Entry Barriers High. New entrants unlikely except for large international firms. (T)
IV. Internal Environment
(IFAS Table; see Exhibit 2)
A. Corporate Structure
1. Divisional structure: appliance manufacturing and vending machines. Floor care man-
aged separately. (S)
2. Centralized major decisions by Newton corporate staff, with a time line of about three
years. (S)
B. Corporate Culture
1. Quality key ingredient—commitment to quality shared by executives and workers. (S)
2. Much of corporate culture is based on founder F. L. Maytag’s personal philosophy, includ-
ing concern for quality, employees, local community, innovation, and performance. (S)
3. Acquired companies, except for European, seem to accept dominance of Maytag
culture. (S)
C. Corporate Resources
1. Marketing
a. Maytag brand lonely repairman advertising successful but dated. (W)
b. Efforts focus on distribution—combining three sales forces into two, concentrating
on major retailers. (Cost $95 million for this restructuring.) (S)
c. Hoover’s well-publicized marketing fiasco involving airline tickets. (W)
2. Finance (see Exhibits 4 and 5)
a. Revenues are up slightly, operating income is down significantly. (W)
b. Some key ratios are troubling, such as a 57% debt/asset ratio, 132% long-term
debt/equity ratio. No room for more debt to grow company. (W)
c. Net income is 400% less than 1988, based on common-size income statements. (W)
3. R&D
a. Process-oriented with focus on manufacturing process and durability. (S)
b. Maytag becoming a technology follower, taking too long to get product innovations to
market (competitors put out more in last 6 months than prior 2 years combined), lag-
ging in fuzzy logic and other technological areas. (W)
CHAPTER 12 Suggestions for Case Analysis 385
4. Operations
a. Maytag’s core competence. Continual improvement process kept it dominant in the
U.S. market for many years. (S)
b. Plants aging and may be losing competitiveness as rivals upgrade facilities. Quality
no longer distinctive competence? (W)
5. Human Resources
a. Traditionally very good relations with unions and employees. (S)
b. Labor relations increasingly strained, with two salary raise delays, and layoffs of
4,500 employees at Magic Chef. (W)
c. Unions express concern at new, more distant tone from Maytag Corporation. (W)
6. Information Systems
a. Not mentioned in case. Hoover fiasco in Europe suggests information systems need
significant upgrading. (W)
b. Critical area where Maytag may be unwilling or unable to commit resources needed
to stay competitive. (W)
V. Analysis of Strategic Factors
A. Situational Analysis (SWOT) (SFAS Matrix; see Exhibit 3)
1. Strengths
a. Quality Maytag culture.
b. Maytag well-known and respected brand.
c. Hoover’s international orientation.
d. Core competencies in process R&D and manufacturing.
2. Weaknesses
a. Lacks financial resources of competitors.
b. Poor global positioning. Hoover weak on European continent.
c. Product R&D and customer service innovation areas of serious weakness.
d. Dependent on small dealers.
e. Marketing needs improvement.
3. Opportunities
a. Economic integration of European Community.
b. Demographics favor quality.
c. Trend to superstores.
4. Threats
a. Trend to superstores.
b. Aggressive rivals—Whirlpool and Electrolux.
c. Japanese appliance companies—new entrants?
B. Review of Current Mission and Objectives
1. Current mission appears appropriate.
2. Some of the objectives are really goals and need to be quantified and given time horizons.
VI. Strategic Alternatives
and Recommended Strategy
A. Strategic Alternatives
1. Growth through Concentric Diversification: Acquire a company in a related industry
such as commercial appliances.
a. [Pros]: Product/market synergy created by acquisition of related company.
b. [Cons]: Maytag does not have the financial resources to play this game.
386 PART 5 Introduction to Case Analysis
2. Pause Strategy: Consolidate various acquisitions to find economies and to encourage
innovation among the business units.
a. [Pros]: Maytag needs to get its financial house in order and get administrative con-
trol over its recent acquisitions.
b. [Cons]: Unless it can grow through a stronger alliance with Bosch-Siemens or some
other backer, Maytag is a prime candidate for takeover because of its poor financial
performance in recent years, and it is suffering from the initial reduction in effi-
ciency inherent in acquisition strategy.
3. Retrenchment: Sell Hoover’s foreign major home appliance businesses (Australia and
UK) to emphasize increasing market share in North America.
a. [Pros]: Divesting Hoover improves bottom line and enables Maytag Corp. to focus
on North America while Whirlpool, Electrolux, and GE are battling elsewhere.
b. [Cons]: Maytag may be giving up its only opportunity to become a player in the
coming global appliance industry.
B. Recommended Strategy
1. Recommend pause strategy, at least for a year, so Maytag can get a grip on its European
operation and consolidate its companies in a more synergistic way.
2. Maytag quality must be maintained, and continued shortage of operating capital will
take its toll, so investment must be made in R&D.
3. Maytag may be able to make the Hoover UK investment work better since the reces-
sion is ending and the EU countries are closer to integrating than ever before.
4. Because it is only an average competitor, Maytag needs the Hoover link to Europe to
provide a jumping off place for negotiations with Bosch-Siemens that could strengthen
their alliance.
VII. Implementation
A. The only way to increase profitability in North America is to further involve Maytag
with the superstore retailers; sure to anger the independent dealers, but necessary for
Maytag to compete.
B. Board members with more global business experience should be recruited, with an eye
toward the future, especially with expertise in Asia and Latin America.
C. R&D needs to be improved, as does marketing, to get new products online quickly.
VIII. Evaluation and Control
A. MIS needs to be developed for speedier evaluation and control. While the question of
control vs. autonomy is “under review,” another Hoover fiasco may be brewing.
B. The acquired companies do not all share the Midwestern work ethic or the Maytag Cor-
poration culture, and Maytag’s managers must inculcate these values into the employ-
ees of all acquired companies.
C. Systems should be developed to decide if the size and location of Maytag manufactur-
ing plants is still correct and to plan for the future. Industry analysis indicates that
smaller automated plants may be more efficient now than in the past.
CHAPTER 12 Suggestions for Case Analysis 387
388 PART 5 Introduction to Case Analysis
EXHIBIT 1 EFAS Table for Maytag Corporation 1993
External Factors Weight Rating
Weighted
Score Comments
1 2 3 4 5
Opportunities
� Economic integration of European Community .20 4.1 .82 Acquisition of Hoover
� Demographics favor quality appliances .10 5.0 .50 Maytag quality
� Economic development of Asia .05 1.0 .05 Low Maytag presence
� Opening of Eastern Europe .05 2.0 .10 Will take time
� Trend to “Super Stores” .10 1.8 .18 Maytag weak in this channel
Threats
� Increasing government regulations .10 4.3 .43 Well positioned
� Strong U.S. competition .10 4.0 .40 Well positioned
� Whirlpool and Electrolux strong globally .15 3.0 .45 Hoover weak globally
� New product advances .05 1.2 .06 Questionable
� Japanese appliance companies .10 1.6 .16 Only Asian presence in
Australia
Total Scores 1.00 3.15
EXHIBIT 2 IFAS Table for Maytag Corporation 1993
Internal Factors Weight Rating
Weighted
Score Comments
1 2 3 4 5
Strengths
� Quality Maytag culture .15 5.0 .75 Quality key to success
� Experienced top management .05 4.2 .21 Know appliances
� Vertical integration .10 3.9 .39 Dedicated factories
� Employer relations .05 3.0 .15 Good, but deteriorating
� Hoover’s international orientation .15 2.8 .42 Hoover name in cleaners
Weaknesses
� Process-oriented R&D .05 2.2 .11 Slow on new products
� Distribution channels .05 2.0 .10 Superstores replacing small dealers
� Financial position .15 2.0 .30 High debt load
� Global positioning .20 2.1 .42 Hoover weak outside the United
Kingdom and Australia
� Manufacturing facilities .05 4.0 .20 Investing now
Total Scores 1.00 3.05
Common Size
Income
Statements for
Maytag
Corporation
1993
390 PART 5 Introduction to Case Analysis
EXHIBIT 5 1992 1991 1990
Net Sales 100.0% 100.0% 100.0%
Cost of Sales 76.92 75.88 75.50
Gross Profit 23.08 24.12 24.46
Selling, general/admin. expenses 17.37 17.67 16.90
Reorganization Expenses .031 ———————— ————————
Operating Income .026 .064 .075
Interest Expense (.025) (.025) (0.26)
Other-net .001 .002 .009
Income before accounting changes .002 .042 .052
Income taxes .005 .015 .020
Income before accounting changes (.002) .026 .032
Effect of accounting changes for
post-retirement benefits other than
pensions and income taxes
(.101) — — — — — — — — — — — —
Total Operating Costs and Expenses 74.9 76.0 76.3
Net Income (.104) .026 .032
EXHIBIT 6 Implementation, Evaluation, & Control Plan for Maytag Corporation 1993
Strategic
Factor Action Plan
Priority
System
(1–5)
Who Will
Implement
Who Will
Review
How
Often
Review
Criteria
Used
Quality
Maytag
culture
Build quality in
acquired units
1 Heads of
acquired units
Manufacturing
VP
Quarterly Number defects
& customer
satisfaction
Hoover’s
international
orientation
Identify ways to
expand sales
2 Head of
Hoover
Marketing VP Quarterly Feasible
alternatives
generated
Financial position Pay down debt 1 CFO CEO Monthly Leverage ratios
Global
positioning
Find strategic
alliance partners
2 VP of Business
Development
COO Quarterly Feasible
alternatives
generated
EU economic
integration
Grow sales
throughout EU
3 Hoover UK
Head
Marketing VP Annually Sales growth
Demographics
favor quality
Simplify
controls
3 Manufacturing
VP
COO Annually Market research
user satisfaction
Trend to super
stores
Market through
Sears
1 Marketing VP CEO Monthly Sales growth
Whirlpool &
Electrolux
Monitor
competitor
performance
1 Competition
committee
COO Quarterly Competitor sales
& new products
Japanese
appliance
companies
Monitor
expansion
4 Head of
Hoover
Australia
Competition
committee
Semi-
annually
Sales growth
outside Japan
CHAPTER 12 Suggestions for Case Analysis 391
Ending Case for Part Five
IN THE GARDEN
Walking with my watering can underneath the cherry
tree, the apricot tree, the plum tree, and the nectarine
tree, strawberry vines and raspberry canes at my feet,
I gazed at my hedge and thought what would it take to
avoid disease in the garden this year? I was amazed
how this garden, so similar and different from previ-
ous seasons, had evolved from two saplings, pur-
chased by chance, placed by happenstance, but
planted with care. Now I wondered at the wild order.
Was this the fruit I should be growing? How could I
end up with the sweetest fruit, and what about the
most fruit and the largest fruit? How would I set my-
self up for more success next year, and what of the
years after that? And, I sadly thought, what shall I do
with the wonderful apple tree I climbed as a child that
now yielded so little fruit?
All these thoughts I had walking with my watering
can under the cherry tree, the apricot tree, the plum tree,
and the nectarine tree, strawberry vines and raspberry
canes at my feet.
This case was written by Mark Meckler, University of Portland and
presented to the North American Case Research Association at its
2006 annual meeting. Copyright © 2006 by Mark Meckler. Edited for
publication in Strategic Management and Business Policy, 12th
edition and Concepts in Strategic Management and Business Policy,
12th edition. Reprinted by permission of Mark Meckler and the North
American Case Research Association.
Ratio Analysis
for Maytag
Corporation
1993
CHAPTER 12 Suggestions for Case Analysis 389
EXHIBIT 3 SFAS Matrix for Maytag Corporation 1993
1 2 3 4 Duration 5 6
Strategic Factors (Select the most
important opportunities/threats
from EFAS, Table 4–5 and the
most important strengths and
weaknesses from IFAS, Table 5–2) Weight Rating
Weighted
Score
S
H
O
R
T
I
N
T
E
R
M
E
D
I
A
T
E
L
O
N
G Comments
�S1 Quality Maytag culture (S) .10 5.0 .50 X Quality key to success
�S5 Hoover’s international
orientation (S) .10 2.8 .28 X X Name recognition
�W3 Financial position (W) .10 2.0 .20 X X High debt
�W4 Global positioning (W) .15 2.2 .33 X X Only in N.A., U.K., and
Australia
�O1 Economic integration of
European Community (O) .10 4.1 .41 X Acquisition of Hoover
�O2 Demographics favor quality (O) .10 5.0 .50 X Maytag quality
�O5 Trend to super stores (O � T) .10 1.8 .18 X Weak in this channel
�T3 Whirlpool and Electrolux (T) .15 3.0 .45 X Dominate industry
�T5 Japanese appliance
companies (T) .10 1.6 .16 X Asian presence
Total Scores 1.00 3.01
EXHIBIT 4 1990 1991 1992 1993
1. LIQUIDITY RATIOS
Current 2.1 1.9 1.8 1.6
Quick 1.1 1.0 1.1 1.0
2. LEVERAGE RATIOS
Debt to Total Assets 61% 60% 76% 57%
Debt to Equity 155% 151% 317% 254%
3. ACTIVITY RATIOS
Inventory turnover—sales 5.7 6.1 7.6 6.9
Inventory Turnover—cost of sales 4.3 4.6 5.8 6.5
Avg. Collection Period—days 57 55 56 0
Fixed Asset Turnover 3.9 3.6 3.6 3.6
Total Assets Turnover 1.2 1.2 1.2 1.1
4. PROFITABILITY RATIOS
Gross Profit Margin 24% 24% 23% 5%
Net Operating Margin 8% 6% 3% 5%
Profit Margin on Sales 3% 3% �0% 2%
Return on Total Assets 4% 3% �0% 2%
Return on Equity 10% 8% �1% 8%
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Strategic
Management
Cases in
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CONTENTS
S E C T I O N A
Corporate Governance and Social Responsibility: Executive Leadership
S E C T I O N B
Business Ethics
S E C T I O N C
International Issues in Strategic Management
S E C T I O N D
General Issues in Strategic Management
Industry One—Information Technology
Industry Two—Internet Companies
Industry Three—Entertainment and Leisure
Industry Four—Transportation
Industry Five—Clothing
Industry Six—Specialty Retailing
Industry Seven—Manufacturing
Industry Eight—Food and Beverage
cases in
strategic management
This page intentionally left blank
Apple, Inc., Case 7
Audit, Case 4
Best Buy Co., Inc., Case 24
Boston Beer Company, Case 30
Burger King, Case 34
Carey Plant, Case 29
Carnival Corporation, Case 16
Chrysler, Case 17
Church & Dwight, Case 35
Dell, Inc., Case 9
Dollar General Stores, Case 27
Everyone Does It, Case 3
Future of Gap Inc., Case 25
Google, Case 12
Guajilote Cooperativo Forestal, Honduras, Case 6
Harley-Davidson, Inc., Case 19
Inner-City Paint Corporation, Case 28
iRobot, Case 8
JetBlue Airways, Case 20
Logitech, Case 11
Marvel Entertainment, Inc., Case 15
Panera Bread Company, Case 32
alphabetical
listing of cases
Recalcitrant Director at Byte Products, Inc., Case 1
Reorganizing Yahoo!, Case 13
Rosetta Stone Inc., Case 10
Rocky Mountain Chocolate Factory, Inc., Case 26
Starbucks’ Coffee Company, Case 5
Tesla Motors, Inc., Case 18
TiVo, Inc., Case 14
TOMS Shoes, Case 23
Tom-Tom, Case 21
Volcom Inc., Case 22
Wallace Group, Case 2
Wal-Mart and Vlasic Pickles, Case 31
Whole Foods Market, Case 33
L I S T I N G O F C A S E S
BYTE PRODUCTS, INC., IS PRIMARILY INVOLVED IN THE PRODUCTION OF ELECTRONIC components
that are used in personal computers. Although such components might be found in a few com-
puters in home use, Byte products are found most frequently in computers used for sophis-
ticated business and engineering applications. Annual sales of these products have been
steadily increasing over the past several years; Byte Products, Inc., currently has total sales
of approximately $265 million.
Over the past six years, increases in yearly revenues have consistently reached
12%. Byte Products, Inc., headquartered in the midwestern United States, is regarded as
one of the largest-volume suppliers of specialized components and is easily the industry
leader, with some 32% market share. Unfortunately for Byte, many new firms—domestic
and foreign—have entered the industry. A dramatic surge in demand, high profitability, and
the relative ease of a new firm’s entry into the industry explain in part the increased num-
ber of competing firms.
Although Byte management—and presumably shareholders as well—is very pleased
about the growth of its markets, it faces a major problem: Byte simply cannot meet the demand
for these components. The company currently operates three manufacturing facilities in vari-
ous locations throughout the United States. Each of these plants operates three production
shifts (24 hours per day), 7 days a week. This activity constitutes virtually all of the company’s
production capacity. Without an additional manufacturing plant, Byte simply cannot increase
its output of components.
This case was prepared by Professors Dan R. Dalton and Richard A. Cosier of the Graduate School of Business at
Indiana University and Cathy A. Enz of Cornell University. The names of the organization, individual, location,
and/or financial information have been disguised to preserve the organization’s desire for anonymity. This case was
edited for SMBP–9th, 10th, 11th, 12th, and 13th Editions. Reprint permission is solely granted to the publisher,
Prentice Hall, for the book, Strategic Management and Business Policy – 13th Edition by copyright holders Dan R.
Dalton, Richard A. Cosier, and Cathy A. Enz. Any other publication of this case (translation, any form of electronic
or other media), or sold (any form of partnership) to another publisher will be in violation of copyright laws, unless
the copyright holders have granted an additional written reprint permission.
1-7
C A S E 1
The Recalcitrant Director
at Byte Products, Inc.:
CORPORATE LEGALITY VERSUS CORPORATE RESPONSIBILITY
Dan R. Dalton, Richard A. Cosier, and Cathy A. Enz
S E C T I O N A
Corporate Governance and Social Responsibility: Executive Leadership
1-8 SECTION A Corporate Governance and Social Responsibility: Executive Leadership
James M. Elliott, Chief Executive Officer and Chairman of the Board, recognizes the
gravity of the problem. If Byte Products cannot continue to manufacture components in suffi-
cient numbers to meet the demand, buyers will go elsewhere. Worse yet is the possibility that
any continued lack of supply will encourage others to enter the market. As a long-term solu-
tion to this problem, the Board of Directors unanimously authorized the construction of a new,
state-of-the-art manufacturing facility in the southwestern United States. When the planned
capacity of this plant is added to that of the three current plants, Byte should be able to meet
demand for many years to come. Unfortunately, an estimated three years will be required to
complete the plant and bring it online.
Jim Elliott believes very strongly that this three-year period is far too long and has insisted
that there also be a shorter-range, stopgap solution while the plant is under construction. The
instability of the market and the pressure to maintain leader status are two factors contributing
to Elliott’s insistence on a more immediate solution. Without such a move, Byte management
believes that it will lose market share and, again, attract competitors into the market.
Several Solutions
A number of suggestions for such a temporary measure were offered by various staff specialists
but rejected by Elliott. For example, licensing Byte’s product and process technology to other
manufacturers in the short run to meet immediate demand was possible. This licensing authori-
zation would be short term, or just until the new plant could come online. Top management, as
well as the board, was uncomfortable with this solution for several reasons. They thought it un-
likely that any manufacturer would shoulder the fixed costs of producing appropriate components
for such a short term. Any manufacturer that would do so would charge a premium to recover its
costs. This suggestion, obviously, would make Byte’s own products available to its customers at
an unacceptable price. Nor did passing any price increase to its customers seem sensible, for this
too would almost certainly reduce Byte’s market share as well as encourage further competition.
Overseas facilities and licensing also were considered but rejected. Before it became a
publicly traded company, Byte’s founders had decided that its manufacturing facilities would
be domestic. Top management strongly felt that this strategy had served Byte well; moreover,
Byte’s majority stockholders (initial owners of the then privately held Byte) were not likely to
endorse such a move. Beyond that, however, top management was reluctant to foreign li-
cense—or make available by any means the technologies for others to produce Byte products—
as they could not then properly control patents. Top management feared that foreign licensing
would essentially give away costly proprietary information regarding the company’s highly ef-
ficient means of product development. There also was the potential for initial low product qual-
ity—whether produced domestically or otherwise—especially for such a short-run operation.
Any reduction in quality, however brief, would threaten Byte’s share of this sensitive market.
The Solution!
One recommendation that has come to the attention of the Chief Executive Officer could help
solve Byte’s problem in the short run. Certain members of his staff have notified him that an
abandoned plant currently is available in Plainville, a small town in the northeastern United
States. Before its closing eight years before, this plant was used primarily for the manufac-
ture of electronic components. As is, it could not possibly be used to produce Byte products,
but it could be inexpensively refitted to do so in as few as three months. Moreover, this plant
is available at a very attractive price. In fact, discreet inquiries by Elliott’s staff indicate that
this plant could probably be leased immediately from its present owners because the build-
ing has been vacant for some eight years.
CASE 1 The Recalcitrant Director at Byte Products, Inc. 1-9
All the news about this temporary plant proposal, however, is not nearly so positive.
Elliott’s staff concedes that this plant will never be efficient and its profitability will be low. In
addition, the Plainville location is a poor one in terms of high labor costs (the area is highly
unionized), warehousing expenses, and inadequate transportation links to Byte’s major markets
and suppliers. Plainville is simply not a candidate for a long-term solution. Still, in the short
run, a temporary plant could help meet the demand and might forestall additional competition.
The staff is persuasive and notes that this option has several advantages: (1) there is no
need for any licensing, foreign or domestic, (2) quality control remains firmly in the com-
pany’s hands, and (3) an increase in the product price will be unnecessary. The temporary
plant, then, would be used for three years or so until the new plant could be built. Then the
temporary plant would be immediately closed.
CEO Elliott is convinced.
Taking the Plan to the Board
The quarterly meeting of the Board of Directors is set to commence at 2:00 P.M. Jim Elliott
has been reviewing his notes and agenda for the meeting most of the morning. The issue of
the temporary plant is clearly the most important agenda item. Reviewing his detailed pre-
sentation of this matter, including the associated financial analyses, has occupied much of his
time for several days. All the available information underscores his contention that the tem-
porary plant in Plainville is the only responsible solution to the demand problems. No other
option offers the same low level of risk and ensures Byte’s status as industry leader.
At the meeting, after the board has dispensed with a number of routine matters, Jim
Elliott turns his attention to the temporary plant. In short order, he advises the 11-member
board (himself, 3 additional inside members, and 7 outside members) of his proposal to obtain
and refit the existing plant to ameliorate demand problems in the short run, authorizes the con-
struction of the new plant (the completion of which is estimated to take some three years), and
plans to switch capacity from the temporary plant to the new one when it is operational. He
also briefly reviews additional details concerning the costs involved, advantages of this pro-
posal versus domestic or foreign licensing, and so on.
All the board members except one are in favor of the proposal. In fact, they are most en-
thusiastic; the overwhelming majority agree that the temporary plant is an excellent—even in-
spired—stopgap measure. Ten of the eleven board members seem relieved because the board
was most reluctant to endorse any of the other alternatives that had been mentioned.
The single dissenter—T. Kevin Williams, an outside director—is, however, steadfast in
his objections. He will not, under any circumstances, endorse the notion of the temporary plant
and states rather strongly that “I will not be party to this nonsense, not now, not ever.”
T. Kevin Williams, the senior executive of a major nonprofit organization, is normally a
reserved and really quite agreeable person. This sudden, uncharacteristic burst of emotion
clearly startles the remaining board members into silence. The following excerpt captures the
ensuing, essentially one-on-one conversation between Williams and Elliott:
Williams: How many workers do your people estimate will be employed in the temporary plant?
Elliott: Roughly 1,200, possibly a few more.
Williams: I presume it would be fair, then, to say that, including spouses and children, some-
thing on the order of 4,000 people will be attracted to the community.
Elliott: I certainly would not be surprised.
Williams: If I understand the situation correctly, this plant closed just over eight years ago,
and that closing had a catastrophic effect on Plainville. Isn’t it true that a large portion of
the community was employed by this plant?
Elliott: Yes, it was far and away the majority employer.
Williams: And most of these people have left the community, presumably to find employment
elsewhere.
Elliott: Definitely, there was a drastic decrease in the area’s population.
Williams: Are you concerned, then, that our company can attract the 1,200 employees to
Plainville from other parts of New England?
Elliott: Not in the least. We are absolutely confident that we will attract 1,200—even more,
for that matter virtually any number we need. That, in fact, is one of the chief advantages
of this proposal. I would think that the community would be very pleased to have us there.
Williams: On the contrary, I would suspect that the community will rue the day we arrived.
Beyond that, though, this plan is totally unworkable if we are candid. On the other hand, if
we are less than candid, the proposal will work for us, but only at great cost to Plainville.
In fact, quite frankly, the implications are appalling. Once again, I must enter my serious
objections.
Elliott: I don’t follow you.
Williams: The temporary plant would employ some 1,200 people. Again, this means the in-
fusion of over 4,000 to the community and surrounding areas. Byte Products, however,
intends to close this plant in three years or less. If Byte informs the community or the em-
ployees that the jobs are temporary, the proposal simply won’t work. When the new peo-
ple arrive in the community, there will be a need for more schools, instructors, utilities,
housing, restaurants, and so forth. Obviously, if the banks and local government know that
the plant is temporary, no funding will be made available for these projects and certainly
no credit for the new employees to buy homes, appliances, automobiles, and so forth.
If, on the other hand, Byte Products does not tell the community of its “temporary”
plans, the project can go on. But, in several years when the plant closes (and we here have
agreed today that it will close), we will have created a ghost town. The tax base of the com-
munity will have been destroyed; property values will decrease precipitously; practically
the whole town will be unemployed. This proposal will place Byte Products in an unten-
able position and in extreme jeopardy.
Elliott: Are you suggesting that this proposal jeopardizes us legally? If so, it should be noted
that the legal department has reviewed this proposal in its entirety and has indicated no
problem.
Williams: No! I don’t think we are dealing with an issue of legality here. In fact, I don’t doubt
for a minute that this proposal is altogether legal. I do, however, resolutely believe that this
proposal constitutes gross irresponsibility.
I think this decision has captured most of my major concerns. These along with a host
of collateral problems associated with this project lead me to strongly suggest that you and
the balance of the board reconsider and not endorse this proposal. Byte Products must find
another way.
The Dilemma
After a short recess, the board meeting reconvened. Presumably because of some discussion
during the recess, several other board members indicated that they were no longer inclined to
support the proposal. After a short period of rather heated discussion, the following exchange
took place:
1-10 SECTION A Corporate Governance and Social Responsibility: Executive Leadership
Elliott: It appears to me that any vote on this matter is likely to be very close. Given the grav-
ity of our demand capacity problem, I must insist that the stockholders’ equity be protected.
We cannot wait three years; that is clearly out of the question. I still feel that licensing—
domestic or foreign—is not in our long-term interests for any number of reasons, some of
which have been discussed here. On the other hand, I do not want to take this project for-
ward on the strength of a mixed vote. A vote of 6–5 or 7–4, for example, does not indicate
that the board is remotely close to being of one mind. Mr. Williams, is there a compromise
to be reached?
Williams: Respectfully, I have to say no. If we tell the truth—namely, the temporary nature
of our operations—the proposal is simply not viable. If we are less than candid in this re-
spect, we do grave damage to the community as well as to our image. It seems to me that
we can only go one way or the other. I don’t see a middle ground.
CASE 1 The Recalcitrant Director at Byte Products, Inc. 1-11
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FRANCES RAMPAR, PRESIDENT OF RAMPAR ASSOCIATES, DRUMMED HER FINGERS ON THE desk. Scat-
tered before her were her notes. She had to put the pieces together in order to make an effec-
tive sales presentation to Harold Wallace.
Hal Wallace was the President of The Wallace Group. He had asked Rampar to con-
duct a series of interviews with some key Wallace Group employees, in preparation for a
possible consulting assignment for Rampar Associates.
During the past three days, Rampar had been talking with some of these key people
and had received background material about the company. The problem was not in finding
the problem. The problem was that there were too many problems!
2-1
C A S E 2
The Wallace Group
Laurence J. Stybel
Background on The Wallace Group
The Wallace Group, Inc., is a diversified company dealing in the manufacture and development
of technical products and systems (see Exhibit 1). The company currently consists of three op-
erational groups and a corporate staff. The three groups include Electronics, Plastics, and Chem-
icals, each operating under the direction of a Group Vice President (see Exhibits 2, 3, and 4).
The company generates $70 million in sales as a manufacturer of plastics, chemical products,
and electronic components and systems. Principal sales are to large contractors in governmental
and automotive markets. With respect to sales volume, Plastics and Chemicals are approximately
equal in size, and both of them together equal the size of the Electronics Group.
Electronics offers competence in the areas of microelectronics, electromagnetic sensors, an-
tennas, microwaves, and minicomputers. Presently, these skills are devoted primarily to the engi-
neering and manufacture of countermeasure equipment for aircraft. This includes radar detection
systems that allow an aircraft crew to know that they are being tracked by radar units on the
ground, on ships, or on other aircraft. Further, the company manufactures displays that provide
the crew with a visual “fix” on where they are relative to the radar units that are tracking them.
This case was prepared by Dr. Laurence J. Stybel. It was prepared for class discussion rather than to illustrate either
effective or ineffective handling of an administrative situation. Unauthorized duplication of copyright materials is a
violation of federal law. This case was edited for SMBP-9th, 10th, 11th, 12th, and 13th Editions. The copyright holders
are solely responsible for case content. Reprint permission is solely granted to the publisher, Prentice Hall, for the book,
Strategic Management and Business Policy – 13th Edition by copyright holder, Dr. Laurence J. Stybel. Any other pub-
lication of this case (translation, any form of electronic or other media), or sold (any form of partnership) to another
publisher will be in violation of copyright laws, unless the copyright holder has granted an additional written reprint
permission.
EXHIBIT 1
An Excerpt from the
Annual Report
To the Shareholders:
This past year was one of definite accomplishment for The Wallace Group, although with
some admitted soft spots. This is a period of consolidation, of strengthening our internal capacity
for future growth and development. Presently, we are in the process of creating a strong manage-
ment team to meet the challenges we will set for the future.
Despite our failure to achieve some objectives, we turned a profit of $3,521,000 before taxes,
which was a growth over the previous year’s earnings. And we have declared a dividend for the
fifth consecutive year, albeit one that is less than the year before. However, the retention of earn-
ings is imperative if we are to lay a firm foundation for future accomplishment.
Currently, The Wallace Group has achieved a level of stability. We have a firm foothold in
our current markets, and we could elect to simply enact strong internal controls and maximize our
profits. However, this would not be a growth strategy. Instead, we have chosen to adopt a more
aggressive posture for the future, to reach out into new markets wherever possible and to institute
the controls necessary to move forward in a planned and orderly fashion.
The Electronics Group performed well this past year and is engaged in two major programs
under Defense Department contracts. These are developmental programs that provide us with the
opportunity for ongoing sales upon testing of the final product. Both involve the creation of tacti-
cal display systems for aircraft being built by Lombard Aircraft for the Navy and the Air Force.
Future potential sales from these efforts could amount to approximately $56 million over the next
five years. Additionally, we are developing technical refinements to older, already installed sys-
tems under Army Department contracts.
In the future, we will continue to offer our technological competence in such tactical display
systems and anticipate additional breakthroughs and success in meeting the demands of this mar-
ket. However, we also believe that we have unique contributions to make to other markets, and to
that end we are making the investments necessary to expand our opportunities.
Plastics also turned in a solid performance this past year and has continued to be a major sup-
plier to Chrysler, Martin Tool, Foster Electric, and, of course, to our Electronics Group. The mar-
ket for this group continues to expand, and we believe that additional investments in this group
will allow us to seize a larger share of the future.
Chemicals’ performance, admittedly, has not been as satisfactory as anticipated during the
past year. However, we have been able to realize a small amount of profit from this operation and
to halt what was a potentially dangerous decline in profits. We believe that this situation is only
temporary and that infusions of capital for developing new technology, plus the streamlining of
operations, has stabilized the situation. The next step will be to begin more aggressive marketing
to capitalize on the group’s basic strengths.
Overall, the outlook seems to be one of modest but profitable growth. The near term will be
one of creating the technology and controls necessary for developing our market offerings and
growing in a planned and purposeful manner. Our improvement efforts in the various company
groups can be expected to take hold over the years with positive effect on results.
We wish to express our appreciation to all those who participated in our efforts this past year.
Harold Wallace
Chairman and President
In addition to manufacturing tested and proven systems developed in the past, The
Wallace Group is currently involved in two major and two minor programs, all involving
display systems. The Navy-A Program calls for the development of a display system for a
tactical fighter plane; Air Force-B is another such system for an observation plane. Ongoing
production orders are anticipated following flight testing. The other two minor programs,
Army-LG and OBT-37, involve the incorporation of new technology into existing aircraft
systems.
2-2 SECTION A Corporate Governance and Social Responsibility: Executive Leadership
CASE 2 The Wallace Group 2-3
President
VP
Electronics Group
VP Industrial Relations
VP Marketing
VP
Plastics Group
Director
Industrial
Relations
Personnel
Services
Manpower
Planning and
Development
Director
Administration
and Planning
Director
Operations
Production
Manager
Director
Engineering
Maintenance
Engineer
Chief Engineer
VP
Chemicals Group
Director
Advanced
Engineering
Program
Manager
Navy-A
Program
Manager
Air Force-B
Program
Manager
OBT-37
Program
Manager
Army-LG
Product Engineer
Chief Engineer
Microwave
Engineering
Department
Digital
Engineering
Department
Mechanical
Engineering
Department
Electronic
Engineering
Department
Drafting
Test Equipment
Engineering
Department
Engineering
Services
Material
Manager
Plant Engineering
Manager
Customer Service
Manager
Quality Assurance
Manager
Manager
Contracts
Manager
Cost and
Schedule
Administration
Controller
VP Secretarial/Legal
VP Finance
Operations Control
Manager
EXHIBIT 2
Organizational Chart: The Wallace Group (Electronics)
President
H.Wallace
VP
Chemicals Group
J. Luskics
Director
Industrial
Relations
A. Lowe
Director
R&D
V. Thomas
Director
Operations
T. Piksolu
Director
Administration
B. Brady
EXHIBIT 3
The Wallace Group
(Chemicals)
The Plastics Group manufactures plastic components utilized by the electronics, automo-
tive, and other industries requiring plastic products. These include switches, knobs, keys, in-
sulation materials, and so on, used in the manufacture of electronic equipment and other small
made-to-order components installed in automobiles, planes, and other products.
The Chemicals Group produces chemicals used in the development of plastics. It supplies
bulk chemicals to the Plastics Group and other companies. These chemicals are then injected
into molds or extruded to form a variety of finished products.
History of The Wallace Group
Each of the three groups began as a sole proprietorship under the direct operating control of an
owner/manager. Several years ago, Harold Wallace, owner of the original electronics company,
determined to undertake a program of diversification. Initially, he attempted to expand his mar-
ket through product development and line extensions entirely within the electronics industry.
However, because of initial problems, he drew back and sought other opportunities. Wallace’s
primary concern was his almost total dependence on defense-related contracts. He had felt for
some time that he should take some strong action to gain a foothold in the private markets. The
first major opportunity that seemed to satisfy his various requirements was the acquisition of a
former supplier, a plastics company whose primary market was not defense-related. The com-
pany’s owner desired to sell his operation and retire. At the time, Wallace’s debt structure was
such that he could not manage the acquisition and so he had to attract equity capital. He was able
to gather a relatively small group of investors and form a closed corporation. The group estab-
lished a Board of Directors with Wallace as Chairman and President of the new corporate entity.
With respect to operations, little changed. Wallace continued direct operational control
over the Electronics Group. As holder of 60% of the stock, he maintained effective control
over policy and operations. However, because of his personal interests, the Plastics Group,
now under the direction of a newly hired Vice President, Martin Hempton, was left mainly to
its own devices except for yearly progress reviews by the President. All Wallace asked at the
time was that the Plastics Group continue its profitable operation, which it did.
Several years ago, Wallace and the board decided to diversify further because two-thirds
of their business was still defense dependent. They learned that one of the major suppliers of
the Plastics Group, a chemical company, was on the verge of bankruptcy. The company’s
President
H. Wallace
VP
Plastics Group
M. Hempton
Director
Industrial
Relations
R. Otis
Director
Administration
and Planning
B. Blumenthal
Director
Operations
V. Nipol
EXHIBIT 4
The Wallace Group
(Plastics)
2-4 SECTION A Corporate Governance and Social Responsibility: Executive Leadership
CASE 2 The Wallace Group 2-5
owner, Jerome Luskics, agreed to sell. However, this acquisition required a public stock offer-
ing, with most of the funds going to pay off debts incurred by the three groups, especially the
Chemicals Group. The net result was that Wallace now holds 45% of The Wallace Group and
Jerome Luskics 5%, with the remainder distributed among the public.
Organization and Personnel
Presently, Harold Wallace serves as Chairman and President of The Wallace Group. The Electron-
ics Group had been run by LeRoy Tuscher, who just resigned as Vice President. Hempton contin-
ued as Vice President of Plastics, and Luskics served as Vice President of the Chemicals Group.
Reflecting the requirements of a corporate perspective and approach, a corporate staff has
grown up, consisting of Vice Presidents for Finance, Secretarial/Legal, Marketing, and Industrial
Relations. This staff has assumed many functions formerly associated with the group offices.
Because these positions are recent additions, many of the job accountabilities are still be-
ing defined. Problems have arisen over the responsibilities and relationships between corpo-
rate and group positions. President Wallace has settled most of the disputes himself because of
the inability of the various parties to resolve differences among themselves.
Current Trends
Presently, there is a mood of lethargy and drift within The Wallace Group. Most managers feel
that each of the three groups functions as an independent company. And, with respect to group
performance, not much change or progress has been made in recent years. Electronics and Plas-
tics are still stable and profitable, but both lack growth in markets and profits. The infusion of
capital breathed new life and hope into the Chemicals operation but did not solve most of the
old problems and failings that had caused its initial decline. For all these reasons, Wallace de-
cided that strong action was necessary. His greatest disappointment was with the Electronics
Group, in which he had placed high hopes for future development. Thus he acted by requesting
and getting the Electronics Group Vice President’s resignation. Hired from a computer com-
pany to replace LeRoy Tuscher, Jason Matthews joined The Wallace Group a week ago.
As of last week, Wallace’s annual net sales were $70 million. By group they were:
Electronics $35,000,000
Plastics $20,000,000
Chemicals $15,000,000
On a consolidated basis, the financial highlights of the past two years are as follows:
Last Year Two Years Ago
Net sales $70,434,000 $69,950,000
Income (pre-tax) 3,521,000 3,497,500
Income (after-tax) 2,760,500 1,748,750
Working capital 16,200,000 16,088,500
Shareholders’ equity 39,000,000 38,647,000
Total assets 59,869,000 59,457,000
Long-term debt 4,350,000 3,500,000
Per Share of Common Stock
Net income $.37 $.36
Cash dividends paid .15 .25
The Problem Confronting Frances Rampar
As Rampar finished reviewing her notes (see Exhibits 5–11), she kept reflecting on what Hal
Wallace had told her:
Don’t give me a laundry list of problems, Fran. Anyone can do that. I want a set of priorities I
should focus on during the next year. I want a clear action plan from you. And I want to know
how much this plan is going to cost me!
Fran Rampar again drummed her fingers on the desk.
EXHIBIT 5
Selected Portions of
a Transcribed
Interview with
H. Wallace
Rampar: What is your greatest problem right now?
Wallace: That’s why I called you in! Engineers are a high-strung, temperamental lot. Always
complaining. It’s hard to take them seriously.
Last month we had an annual stockholder’s meeting. We have an Employee Stock Option
Plan, and many of our long-term employees attended the meeting. One of my managers—and
I won’t mention any names—introduced a resolution calling for the resignation of the
President—me!
The vote was defeated. But, of course, I own 45% of the stock!
Now I realize that there could be no serious attempt to get rid of me. Those who voted for
the resolution were making a dramatic effort to show me how upset they are with the way
things are going.
I could fire those employees who voted against me. I was surprised by how many did.
Some of my key people were in that group. Perhaps I ought to stop and listen to what they are
saying.
Businesswise, I think we’re O.K. Not great, but O.K. Last year we turned in a profit of
$3.5 million before taxes, which was a growth over previous years’ earnings. We declared a
dividend for the fifth consecutive year.
We’re currently working on the creation of a tactical display system for aircraft being built
by Lombard Aircraft for the Navy and the Air Force. If Lombard gets the contract to produce
the prototype, future sales could amount to $56 million over the next five years.
Why are they complaining?
Rampar: You must have thoughts on the matter.
Wallace: I think the issue revolves around how we manage people. It’s a personnel problem. You
were highly recommended as someone with expertise in high-technology human resource
management.
I have some ideas on what is the problem. But I’d like you to do an independent investi-
gation and give me your findings. Give me a plan of action.
Don’t give me a laundry list of problems, Fran. Anyone can do that. I want a set of prior-
ities I should focus on during the next year. I want a clear action plan from you. And I want to
know how much this plan is going to cost me!
Other than that, I’ll leave you alone and let you talk to anyone in the company you want.
Of the net income, approximately 70% came from Electronics, 25% from Plastics, and 5%
from Chemicals.
2-6 SECTION A Corporate Governance and Social Responsibility: Executive Leadership
CASE 2 The Wallace Group 2-7
EXHIBIT 6
Selected Portions of
a Transcribed
Interview with
Frank Campbell,
Vice President of
Industrial Relations
Rampar: What is your greatest problem right now?
Campbell: Trying to contain my enthusiasm over the fact that Wallace brought you in!
Morale is really poor here. Hal runs this place like a one man operation, when it’s grown
too big for that. It took a palace revolt to finally get him to see the depths of the resentment.
Whether he’ll do anything about it, that’s another matter.
Rampar: What would you like to see changed?
Campbell: Other than a new President?
Rampar: Uh-huh.
Campbell: We badly need a management development program for our group. Because of our
growth, we have been forced to promote technical people to management positions who have
had no prior managerial experience. Mr. Tuscher agreed on the need for a program, but Hal
Wallace vetoed the idea because developing such a program would be too expensive. I think it
is too expensive not to move ahead on this.
Rampar: Anything else?
Campbell: The IEWU negotiations have been extremely tough this time around, due to excessive
demands they have been making. Union pay scales are already pushing up against our foreman
salary levels, and foremen are being paid high in their salary ranges. This problem, coupled
with union insistence on a no-layoff clause, is causing us fits. How can we keep all our work-
ers when we have production equipment on order that will eliminate 20% of our assembly
positions?
Rampar: Wow.
Campbell: We have been sued by a rejected candidate for a position on the basis of discrimina-
tion. She claimed our entrance qualifications are excessive because we require shorthand.
There is some basis for this statement since most reports are given to secretaries in handwrit-
ten form or on audio cassettes. In fact, we have always required it and our executives want their
secretaries to have skill in taking dictation. Not only is this case taking time, but I need to re-
consider if any of our position entrance requirements, in fact, are excessive. I am sure we do
not want another case like this one.
Rampar: That puts The Wallace Group in a vulnerable position, considering the amount of gov-
ernment work you do.
Campbell: We have a tremendous recruiting backlog, especially for engineering positions. Either
our pay scales are too low, our job specs are too high, or we are using the wrong recruiting
channels. Kane and Smith [Director of Engineering and Director of Advanced Systems] keep
rejecting everyone we send down there as being unqualified.
Rampar: Gee.
Campbell: Being head of human resources around here is a tough job. We don’t act. We react.
EXHIBIT 7
Selected Portions of
a Transcribed
Interview with
Matthew Smith,
Director of
Advanced Systems
Rampar: What is your greatest problem right now?
Smith: Corporate brass keeps making demands on me and others that don’t relate to the job we
are trying to get done. They say that the information they need is to satisfy corporate planning
and operations review requirements, but they don’t seem to recognize how much time and ef-
fort is required to provide this information. Sometimes it seems like they are generating analy-
ses, reports, and requests for data just to keep themselves busy. Someone should be evaluating
how critical these corporate staff activities really are. To me and the Electronics Group, these
activities are unnecessary.
An example is the Vice President, Marketing (L. Holt), who keeps asking us for support-
ing data so he can prepare a corporate marketing strategy. As you know, we prepare our own
group marketing strategic plans annually, but using data and formats that are oriented to our
needs, rather than Corporate’s. This planning activity, which occurs at the same time as
Corporate’s, coupled with heavy work loads on current projects, makes us appear to Holt as
though we are being unresponsive.
Somehow we need to integrate our marketing planning efforts between our group and
Corporate. This is especially true if our group is to successfully grow in nondefense-oriented
markets and products. We do need corporate help, but not arbitrary demands for information
that divert us from putting together effective marketing strategies for our group.
I am getting too old to keep fighting these battles.
Rampar: This is a long-standing problem?
Smith: You bet! Our problems are fairly classic in the high-tech field. I’ve been at other compa-
nies and they’re not much better. We spend so much time firefighting, we never really get or-
ganized. Everything is done on an ad hoc basis.
I’m still waiting for tomorrow.
EXHIBIT 8
Selected Portions of
a Transcribed
Interview with
Ralph Kane,
Director of
Engineering
Rampar: What is your greatest problem right now?
Kane: Knowing you were coming, I wrote them down. They fall into four areas:
1. Our salary schedules are too low to attract good, experienced EEs. We have been told by
our Vice President (Frank Campbell) that corporate policy is to hire new people below the
salary grade midpoint. All qualified candidates are making more than that now and in
some case are making more than our grade maximums. I think our Project Engineer job
is rated too low.
2. Chemicals Group asked for and the former Electronics Vice President (Tuscher) agreed
to “lend” six of our best EEs to help solve problems it is having developing a new battery.
That is great for the Chemicals Group, but meanwhile how do we solve the engineering
problems that have cropped up in our Navy-A and OBT-37 programs?
3. As you know, Matt Smith (Director of Advanced Systems) is retiring in six months. I de-
pend heavily on his group for technical expertise, and in some areas he depends heavily
on some of my key engineers. I have lost some people to the Chemicals Group, and Matt
has been trying to lend me some of his people to fill in. But he and his staff have been
heavily involved in marketing planning and trying to identify or recruit a qualified suc-
cessor long enough before his retirement to be able to train him or her. The result is that
his people are up to their eyeballs in doing their own stuff and cannot continue to help me
meet my needs.
4. IR has been preoccupied with union negotiations in the plant and has not had time to help
me deal with this issue of management planning. Campbell is working on some kind of
system that will help deal with this kind of problem and prevent them in the future. That
is great, but I need help now—not when his “system” is ready.
2-8 SECTION A Corporate Governance and Social Responsibility: Executive Leadership
CASE 2 The Wallace Group 2-9
EXHIBIT 10
Selected Portions of
a Transcribed
Interview with
Phil Jones,
Director of
Administration and
Planning
Rampar: What is your greatest problem right now?
Jones: Wheel spinning—that’s our problem! We talk about expansion, but we don’t do anything
about it. Are we serious or not?
For example, a bid request came in from a prime contractor seeking help in developing a
countermeasure system for a medium-range aircraft. They needed an immediate response and
concept proposal in one week. Tuscher just sat on my urgent memo to him asking for a go/no
go decision on bidding. I could not give the contractor an answer (because no decision came
from Tuscher), so they gave up on us.
I am frustrated because (1) we lost an opportunity we were “naturals” to win, and (2) my
personal reputation was damaged because I was unable to answer the bid request. Okay,
Tuscher’s gone now, but we need to develop some mechanism so an answer to such a request
can be made quickly.
Another thing, our MIS is being developed by the Corporate Finance Group. More wheel
spinning! They are telling us what information we need rather than asking us what we want!
E. Kay (our Group Controller) is going crazy trying to sort out the input requirements they need
for the system and understanding the complicated reports that came out. Maybe this new sys-
tem is great as a technical achievement, but what good is it to us if we can’t use it?
EXHIBIT 9
Selected Portions of
a Transcribed
Interview with
Brad Lowell,
Program Manager,
Navy-A
Rampar: What is your . . . ?
Lowell: . . . great problem? I’ll tell you what it is. I still cannot get the support I need from Kane
in Engineering. He commits and then doesn’t deliver, and it has me quite concerned. The ex-
cuse now is that in “his judgment,” Sid Wright needs the help for the Air Force program more
than I do. Wright’s program is one week ahead of schedule, so I disagree with “his judgment.”
Kane keeps complaining about not having enough people.
Rampar: Why do you think Kane says he doesn’t have enough people?
Lowell: Because Hal Wallace is a tight-fisted S.O.B. who won’t let us hire the people we need!
EXHIBIT 11
Selected Portions of
a Transcribed
Interview with
Burt Williams,
Director of
Operations
Rampar: What is your biggest problem right now?
Williams: One of the biggest problems we face right now stems from corporate policy regarding
transfer pricing. I realize we are “encouraged” to purchase our plastics and chemicals from our
sister Wallace groups, but we are also committed to making a profit! Because manufacturing
problems in those groups have forced them to raise their prices, should we suffer the conse-
quences? We can get some materials cheaper from other suppliers. How can we meet our vol-
ume and profit targets when we are saddled with noncompetitive material costs?
Rampar: And if that issue was settled to your satisfaction, then would things be O.K.?
Williams: Although out of my direct function, it occurs to me that we are not planning effectively
our efforts to expand into nondefense areas. With minimal alteration to existing production
methods, we can develop both end-use products (e.g., small motors, traffic control devices, and
microwave transceivers for highway emergency communications) and components (e.g., LED
and LCD displays, police radar tracking devices, and word processing system memory and
control devices) with large potential markets.
The problems in this regard are:
1. Matt Smith (Director, Advanced Systems) is retiring and has had only defense-related ex-
perience. Therefore, he is not leading any product development efforts along these lines.
2. We have no marketing function at the group level to develop a strategy, define markets,
and research and develop product opportunities.
3. Even if we had a marketing plan and products for industrial/commercial application, we
have no sales force or rep network to sell the stuff.
Maybe I am way off base, but it seems to me we need a Groups/Marketing/Sales function
to lead us in this business expansion effort. It should be headed by an experienced tech-
nical marketing manager with a proven track record in developing such products and
markets.
Rampar: Have you discussed your concerns with others?
Williams: I have brought these ideas up with Mr. Matthews and others at the Group Manage-
ment Committee. No one else seems interested in pursuing this concept, but they won’t
say this outright and don’t say why it should not be addressed. I guess that in raising the
idea with you I am trying to relieve some of my frustrations.
2-10 SECTION A Corporate Governance and Social Responsibility: Executive Leadership
JIM WILLIS WAS THE VICE PRESIDENT OF MARKETING AND SALES FOR INTERNATIONAL Satellite Im-
ages (ISI). ISI had been building a satellite to image the world at a resolution of one meter.
At that resolution, a trained photo interpreter could identify virtually any military and civil-
ian vehicle as well as numerous other military and non-military objects. The ISI team had
been preparing a proposal for a Japanese government contractor. The contract called for a
commitment of a minimum imagery purchase of $10 million per year for five years. In a
recent executive staff meeting it became clear that the ISI satellite camera subcontractor
was having trouble with the development of a thermal stabilizer for the instrument. It ap-
peared that the development delay would be at least one year and possibly 18 months.
When Jim approached Fred Ballard, the President of ISI, for advice on what launch date
to put into the proposal, Fred told Jim to use the published date because that was still the offi-
cial launch date. When Jim protested that the use of an incorrect date was clearly unethical,
Fred said, “Look Jim, no satellite has ever been launched on time. Everyone, including our
competitors, publishes very aggressive launch dates. Customers understand the tentative na-
ture of launch schedules. In fact, it is so common that customers factor into their plans the like-
lihood that spacecraft will not be launched on time. If we provided realistic dates, our launch
dates would be so much later than those published by our competitors that we would never be
able to sell any advanced contracts. So do not worry about it, just use the published date and
we will revise it in a few months.” Fred’s words were not very comforting to Jim. It was true
that satellite launch dates were seldom met, but putting a launch date into a proposal that ISI
knew was no longer possible seemed underhanded. He wondered about the ethics of such a
practice and the effect on his own reputation.
3-1
C A S E 3
Everyone Does It
Steven M. Cox and Shawana P. Johnson
This case was prepared by Professor Steven Cox at Meredith College and Shawana P. Johnson of Global Marketing
Insight. This case was edited for 11th 12th, and 13th Editions. Copyright © 2005 by Steven M. Cox and Shawana
P. Johnson. The copyright holders are solely responsible for case content. Reprint permission is solely granted to the
publisher, Prentice Hall, for the book, Strategic Management and Business Policy – 13th Edition by copyright holder,
Steven M. Cox. Any other publication of this case (translation, any form of electronic or other media), or sold (any
form of partnership) to another publisher will be in violation of copyright laws, unless the copyright holders have
granted an additional written reprint permission.
S E C T I O N B
Business Ethics
3-2 SECTION B Business Ethics
The Industry
Companies from four nations, the United States, France, Russia, and Israel, controlled the
satellite imaging industry. The U.S. companies had a clear advantage in technology and im-
agery clarity. In the United States, three companies dominated: Lockart, Global Sciences, and
ISI. Each of these companies had received a license from the U.S. government to build and
launch a satellite able to identify objects as small as one square meter. However, none had yet
been able to successfully launch a commercial satellite with such a fine resolution. Currently,
all of the companies had announced a launch date within six months of the ISI published
launch date. Further, each company had to revise its launch date at least once, and in the case
of Global Sciences, twice. Each time a company had revised its launch date, ongoing inter-
national contract negotiations with that company had been either stalled or terminated.
Financing a Satellite Program
The construction and ongoing operations of each of the programs was financed by venture
capitalists. The venture capitalists relied heavily on advance contract acquisition to ensure the
success of their investment. As a result, if any company was unable to acquire sufficient ad-
vance contracts, or if one company appeared to be gaining a lead on the others, there was a
real possibility that the financiers would pull the plug on the other projects and the losing
companies would be forced to stop production and possibly declare bankruptcy. The typical
advance contract target was 150% of the cost of building and launching a satellite. Since the
cost to build and launch was $200 million, each company was striving to acquire $300 mil-
lion in advance contracts.
Advance contracts were typically written like franchise licensing agreements. Each fran-
chisee guaranteed to purchase a minimum amount of imagery per year for five years, the en-
gineered life of the satellite. In addition, each franchisee agreed to acquire the capability to
receive, process, and archive the images sent to them from the satellite. Typically, the hard-
ware and software cost was between $10 million and $15 million per installation. Because the
data from each satellite was different, much of the software could not be used for multiple pro-
grams. In exchange, the franchisee was granted an exclusive reception and selling territory.
The amount of each contract was dependent on the anticipated size of the market, the number
of possible competitors in the market, and the readiness of the local military and civilian agen-
cies to use the imagery. Thus, a contract in Africa would sell for as little as $1 million per year,
whereas in several European countries $5–$10 million was not unreasonable. The problem
was complicated by the fact that in each market there were usually only one or two companies
with the financial strength and market penetration to become a successful franchisee. There-
fore, each of the U.S. companies had targeted these companies as their prime prospects.
The Current Problem
Japan was expected to be the third largest market for satellite imagery after the United States
and Europe. Imagery sales in Japan were estimated to be from $20 million to $30 million per
year. Although the principal user would be the Japanese government, for political reasons the
government had made it clear that they would be purchasing data through a local Japanese
company. One Japanese company, Higashi Trading Company (HTC), had provided most of
the imagery for civilian and military use to the Japanese government.
ISI had been negotiating with HTC for the past six months. It was no secret that HTC had
also been meeting with representatives from Lockart and Global Sciences. HTC had sent
CASE 3 Everyone Does It 3-3
several engineers to ISI to evaluate the satellite and its construction progress. Jim Willis be-
lieved that ISI was currently the front-runner in the quest to sign HTC to a $10 million annual
contract. Over five years, that one contract would represent one sixth of the contracts neces-
sary to ensure sufficient venture capital to complete the satellite.
Jim was concerned that if a new launch date was announced, HTC would delay signing a
contract. Jim was equally concerned that if HTC learned that Jim and his team knew of the
camera design problems and knowingly withheld announcement of a new launch date until af-
ter completing negotiations, not only his personal reputation but that of ISI would be damaged.
Furthermore, as with any franchise arrangement, mutual trust was critical to the success of
each party. Jim was worried that even if only a 12-month delay in launch occurred, trust would
be broken between ISI and the Japanese.
Jim’s boss, Fred Ballard, had specifically told Jim that launch date information was com-
pany proprietary and that Jim was to use the existing published date when talking with clients.
Fred feared that if HTC became aware of the delay, they would begin negotiating with one of
ISI’s competitors, who in Fred’s opinion were not likely to meet their launch dates either. This
change in negotiation focus by the Japanese would then have ramifications with the venture
capitalists whom Fred had assured that a contract with the Japanese would soon be signed.
Jim knew that with the presentation date rapidly approaching, it was time to make a decision.
This page intentionally left blank
SUE WAS PUZZLED AS TO WHAT COURSE OF ACTION TO TAKE. SHE HAD RECENTLY STARTED her job
with a national CPA firm, and she was already confronted with a problem that could affect
her future with the firm. On an audit, she encountered a client who had been treating pay-
ments to a large number, but by no means a majority, of its workers as payments to inde-
pendent contractors. This practice saves the client the payroll taxes that would otherwise
be due on the payments if the workers were classified as employees. In Sue’s judgment
this was improper as well as illegal and should have been noted in the audit. She raised the
issue with John, the senior accountant to whom she reported. He thought it was a possible
problem but did not seem willing to do anything about it. He encouraged her to talk to the part-
ner in charge if she didn’t feel satisfied.
She thought about the problem for a considerable time before approaching the partner in
charge. The ongoing professional education classes she had received from her employer em-
phasized the ethical responsibilities that she had as a CPA and the fact that her firm endorsed
adherence to high ethical standards. This finally swayed her to pursue the issue with the part-
ner in charge of the audit. The visit was most unsatisfactory. Paul, the partner, virtually con-
firmed her initial reaction that the practice was wrong, but he said that many other companies
in the industry follow such a practice. He went on to say that if an issue was made of it, Sue
would lose the account, and he was not about to take such action. She came away from the
meeting with the distinct feeling that had she chosen to pursue the issue, she would have cre-
ated an enemy.
Sue still felt disturbed and decided to discuss the problem with some of her co-workers.
She approached Bill and Mike, both of whom had been working for the firm for a couple of
years. They were familiar with the problem because they had encountered the same issue when
doing the audit the previous year. They expressed considerable concern that if she went over
the head of the partner in charge of the audit, they could be in big trouble since they had failed
to question the practice during the previous audit. They said that they realized it was probably
wrong, but they went ahead because it had been ignored in previous years, and they knew their
supervisor wanted them to ignore it again this year. They didn’t want to cause problems. They
encouraged Sue to be a “team player” and drop the issue.
This case was prepared by Professors John A. Kilpatrick, Gamewell D. Gantt, and George A. Johnson of the College
of Business, Idaho State University. The names of the organization, individual, location, and/or financial information
have been disguised to preserve the organization’s desire for anonymity. This case was edited for SMBP-9th, 10th,
11th, 12th, and 13th Editions. Presented to and accepted by the refereed Society for Case Research. All rights reserved
to the authors and the SCR. Copyright © 1995 by John A. Kilpatrick, Gamewell D. Gantt, and George A. Johnson.
This case may not be reproduced without written permission of the copyright holders. Reprinted by permission.
4-1
C A S E 4
The Audit
Gamewell D. Gantt, George A. Johnson, and John A. Kilpatrick
This page intentionally left blank
IN 2006, STARBUCKS COFFEE COMPANY (STARBUCKS), the world’s No.1 specialty coffee re-
tailer had over 11,000 stores in 36 countries of the world and employed over 10,000 peo-
ple (see Exhibit 1). Every week over 40 million customers visited Starbucks
coffeehouses. The company had over 7,600 retail locations in the United States, which
was its home country and its biggest market. After phenomenal success in the United
States, Starbucks entered one country after another and popularized its specialty coffee
worldwide.
During the 1990s, Starbucks concentrated its expansion efforts mainly in Asia. In 1995 it
entered Japan and by late 1990s Japan had became the second-most-profitable market for
Starbucks. In 1999, Starbucks entered China and by 2006 Starbucks had become the leader in
specialty coffee in China and had moved China up to the No. 1 priority.3
After Japan and China, Starbucks expressed its intentions to enter India. In 2002, Star-
bucks announced for the first time that it was planning to enter India.4 Later it postponed
its entry as it had entered China recently and was facing problems in Japan. In 2003, there was
news again that Starbucks was reviving its plans to enter India. In 2004, Starbucks
5-1
C A S E 5
Starbucks Coffee Company:
THE INDIAN DILEMMA
Ruchi Mankad and Joel Sarosh Thadamalla
As the world’s second most populous country, with more than 1 billion people and growing at 6% per year,
we see unique and great opportunity for bringing the Starbucks experience to this market (India).1
HOWARD SCHULTZ, CHAIRMAN, STARBUCKS CORPORATION
India is an important long-term growth opportunity in the Asia Pacific region. We’re looking at our own strategy . . .
We believe there is a growing affinity for global brands.2
MARTIN COLES, PRESIDENT, STARBUCKS COFFEE INTERNATIONAL
Copyright © 2008, ICFAI. Reprinted by permission of ICFAI Center for Management Research (ICMR), Hyderbad,
India. Website: www.icmrindia.org. The authors are Ruchi Mankad and Joel Sarosh Thadamalla. This case cannot be
reproduced in any form without the written permission of the copyright holder, ICFAI Center for Management
Research (ICMR). Reprint permission is solely granted by the publisher, Prentice Hall, for the books, Strategic
Management and Business Policy–13th Edition (and the International version of this book) by copyright holder,
ICFAI Center for Management Research (ICMR). This case was edited for SM&BP-13th edition. The copyright
holder is solely responsible for case content. Any other publication of the case (translation, any form of electronics or
other media) or sold (any form of partnership) to another publisher will be in violation of copyright law, unless ICFAI
Center for Management Research (ICMR) has granted an additional written reprint permission.
S E C T I O N C
International Issues in Strategic Management
www.icmrindia.org
5-2 SECTION C International Issues in Strategic Management
EXHIBIT 1
Starbucks Timeline 1971: The first Starbucks, under partners Gordon Bowker, Jerry Baldwin, and Zez Siegel, is
opened across from Pike Place Market in Seattle, Washington.
1972: A second Starbucks store is opened in Seattle.
Early 1980s: Zev Siegel leaves the company. Jerry Baldwin takes over management of the
company and functions as CEO. Gordon Bowker remains involved as a co-owner but other
projects take up most of his time.
1982: Howard Schultz joins the company, taking charge of marketing and overseeing the re-
tail stores.
1984: Starbucks acquires the five stores in San Francisco’s Peet’s Coffee and Tea chain.
April 1984: Starbucks opens its fifth store, the first one in downtown Seattle. Schultz convinces
the owners to test an espresso bar, making this Starbucks the first to sell coffee beverages.
It becomes a huge success.
Late 1984: The Starbucks founders are still resistant to installing espresso bars into other
Starbucks locations and Schultz becomes increasingly frustrated. He has visited the
espresso bars of Milan, Italy, and has a vision of bringing Italian-style espresso bars to
America.
Late 1985: Schultz leaves Starbucks and starts the Il Giornale Coffee Company.
April 1986: The first Il Giornale store opens.
March 1987: Baldwin and Bowker decide to sell the Starbucks Coffee Company.
Aug. 1987: Schultz acquires Starbucks and rebrands all of his Il Giornale coffee houses with
Starbucks name.
1992: Starbucks goes public with its initial public stock offering. At this time it has 165 outlets.
1996: The first Starbucks opens outside of North America in Tokyo, Japan.
Sept. 1997: Starbucks Chairman Howard Schultz publishes a book called Pour Your Heart Into
It: How Starbucks Built a Company One Cup at a Time.
1999: Starbucks enters Hong Kong and China.
April 2003: Starbucks purchases Seattle’s Best Coffee and Torrefazione Italia from AFC
Enterprises and turns them all into Starbucks outlets. By this time, Starbucks has more than
6,400 outlets worldwide.
Oct. 4, 2004: XM Satellite Radio and Starbucks Coffee Company announce the debut of the
Starbucks “Hear Music” channel on XM Radio. The station will feature 24-hour music pro-
gramming featuring an “ever-changing mix of the best new music and essential recordings
from all kinds of genres.”
Sept. 8, 2005: Starbucks announces plans to donate funds and supplies to the Hurricane Katrina
relief effort, worth monetary donations over $5 million as well as donations of coffee, wa-
ter, and tea products.
Late 2005: Starbucks and Jim Beam Brands Co., a unit of Fortune Brands Inc., introduce a cof-
fee liqueur product in the United States and announces plans to launch the product in 2006
in restaurants, bars, and retail outlets where premium distilled spirits are sold. The product
will not be sold in company-operated or licensed stores.
SOURCE: Compiled from www.starbucks.com.
officials visited India but according to sources they returned unconvinced as they could not
crystallize on an appropriate partner for its entry. In mid 2006, a Starbucks spokesperson
said, “We are excited about the great opportunities that India presents to the company. We
are looking forward to offering the finest coffee in the world, handcrafted beverages, the
unique Starbucks experience (see Exhibit 2) to customers in this country within the next
18 months.”5
www.starbucks.com
CASE 5 Starbucks Coffee Company 5-3
EXHIBIT 2
The Starbucks
Experience
Howard Schultz believed that Starbucks did not sell just a cup of coffee but provided a Starbucks
experience, which he defined as, “You get more than the finest coffee when you visit a Starbucks—
you get great people, first-rate music, a comfortable and upbeat meeting place, and sound advice
on brewing excellent coffee at home. We establish the value of buying a product at Starbucks by
our uncompromising quality and by building a personal relationship with each of our customers.
Starbucks is rekindling America’s love affair with coffee, bring romance and fresh flavor back to
the brew.6
Starbucks’ outlets provided a captivating atmosphere. Its stores were distinctive, sleek, and
comfortable. Though the sizes of the stores and their formats varied, most were modeled after the
Italian coffee bars where regulars sat and drank espresso with their friends. Starbucks stores tend
to be located in high-traffic locations such as malls, busy street corners, and even grocery stores.
They were well lighted and featured plenty of light cherry wood and artwork. The people who pre-
pared the coffee are referred to as “baristas.” Jazz or opera music played softly in the background.
The stores ranged from 200 to 4,000 square feet, with new units tending to range from 1,500 to
1,700 square feet.
SOURCE: Compiled by IBS Ahmedabad Research Center.
About Starbucks
The Initial Years
In 1971, three partners, Gordon Bowker, Jerry Baldwin, and Zev Siegel opened a store in
Seattle to roast and sell quality whole coffee beans. The trio had a passion for dark-roasted cof-
fee, which was popular in Europe but yet to catch on in the United States. They chose Starbucks
Coffee, Tea and Spice as the name of their store. The name Starbucks was taken from the name
of a character from the novel Moby Dick. They chose the logo of a mermaid encircled by the
store’s name. The store offered a selection of 30 different varieties of whole-bean coffee, bulk
tea, spices and other supplies but did not sell coffee by the cup. The popularity of the store grew
and within 10 years, it employed 85 people, had five retail stores which sold freshly roasted
coffee beans, a small roasting facility, and a wholesale business that supplied coffee to local
restaurants. Its logo had become one of the most visible and respected logos.
Howard Schultz and Starbucks
Howard Schultz, who was later to lead Starbucks, was born in 1953. He started his career as
a sales trainee at Xerox.7 After three years at Xerox, the 26-year-old Schultz joined a Swedish
housewares company, Hammerplast, which sold coffee makers to various retailers and Star-
bucks was one of its major customers. In 1981, Schultz visited Starbucks while on a business
trip to Seattle. After visiting the company and its owners, he was completely fascinated. He
realized that the specialty coffee business was close to his heart and he decided to be a part
of Starbucks. In 1982 Schultz joined Starbucks as director, Retail Operations & Marketing.
In 1983, while on a company trip to Milan, Italy, Schultz observed the immense popular-
ity of coffee, which was central to the national culture. In 1983, there were around 200,000
coffee bars in Italy and 1,500 coffee bars in Milan alone. The espresso8 bars in the cities had
trained baristas9 who used high-quality Arabica beans to prepare espresso, cappuccino, and
other drinks. Schultz witnessed that though each coffee bar had its own individual character,
all provided a sense of comfort and the ambience of an extended family. During his week-long
stay in Milan, he made frequent visits to espresso bars. These visits were a revelation to
Schultz, which he described in his book10 thus:
As I watched, I had a revelation: Starbucks had missed the point, completely missed it… The con-
nection to the people who loved coffee did not have to take place only in their homes, where they
ground and brewed whole-bean coffee. What we had to do was unlock the romance and mystery
of coffee, firsthand, in coffee bars. The Italians understood the personal relationship that people
could have to coffee, its social aspect. Starbucks sold great coffee beans, but we didn’t serve cof-
fee by the cup. We treated coffee as produce, something to be bagged and sent home with the gro-
ceries. We stayed one big step away from the heart and soul of what coffee has meant throughout
the centuries.11
Schultz was convinced that he could recreate the Italian coffee culture in the United
States through Starbucks and differentiate it from other specialty coffee suppliers. After re-
turning, he tried to convince the owners to build Starbucks into a chain of Italian style
espresso bars, but they refused. In 1985, Schultz left Starbucks and launched his own coffee
bar; Il Giornale12 coffee bar chain. The first Il Giornale store was opened in mid-1986 in a
well-known office building in Seattle. The décor of the store resembled an Italian style cof-
fee bar. The baristas wore white shirts and bow ties. All service was stand-up and no seating
was provided. National and international newspapers were hung on stands. Only Italian opera
was played. The store offered high-quality coffee in whole beans and in espresso drinks, such
as cappuccino and caffe lattes.13 It also offered salads and sandwiches. The menu was cov-
ered with Italian words. With the passage of time, many changes were done in the store décor
based on feedback from customers. Chairs were added for those customers who wanted to
stay longer in the store. Carryout business constituted a large part of the revenues, so paper
cups for serving carryout customers were introduced. The store gained popularity and within
six months the store was serving more than 1,000 customers a day. A second store opened in
Seattle, six months after the first store. For the third store, Giornale went international and
opened a store in Vancouver, British Columbia, in mid-1987. By this time, the sales in each
store had reached around $500,000 a year.14
5-4 SECTION C International Issues in Strategic Management
The New Starbucks
In early 1987 the founders of Starbucks decided to sell the assets of Starbucks, including its
name. As soon as Schultz came to know about the decision, he decided to buy Starbucks. In
August 1987, Schultz with the help of investors bought Starbucks, including its name, for
$3.8 million.15 All the stores were consolidated under the name Starbucks. Schultz promised
the investors that Starbucks would open 125 stores in the next five years.
Starbucks first always gained a foothold in the market it entered and then moved on to the
next market. Starbucks entered Chicago in 1987. Chicago proved a difficult market and pre-
sented several challenges to the company, initially. It took around three years for Starbucks to
become successful in Chicago and by 1990 it was able to build a critical mass of loyal cus-
tomers. Starbucks entered Los Angles in 1991 and achieved success without much struggle.
As in other markets, Starbucks did not advertise its locations heavily but relied on the word-
of-mouth promotions by the consumers.
Between 1990 and 1992 sales at Starbucks increased almost 300% and reached $103 million.
Earnings reached to $4.4 million in 1992. Starbucks came out with an IPO16 in 1992, which
was very successful and raised $29 million for the company.
In 1993, Starbucks opened its first store in Washington, D.C. After succeeding in Wash-
ington, Starbucks opened stores in New York and Boston in 1994. Starbucks opened stores at
places that were home to many opinion makers. Within a short duration, Starbucks was rated
as the best coffee in New York. In Boston after opening a few company-owned stores, Star-
bucks acquired the leading competitor, The Coffee Connection. The Coffee Connection was
founded in 1975 and had around 24 stores in Boston in 1994. It specialized in light-roasted
gourmet coffee and had a loyal customer base in Boston. After the acquisition, Starbucks be-
came the leading player in Boston overnight.
Hot drinks at Starbucks were available in four cup sizes: Venti containing 20 oz.,17 Grande
containing 16 oz., Tall containing 12 oz., and Short containing 8 oz. Cold drinks were avail-
able in three cup sizes; Iced Venti–24 oz., Iced Grande–16 oz., and Iced Tall–12 oz.18 In 1994,
Starbucks launched Frappuccino, a cold drink made from coffee, sugar, low-fat milk, and ice.
It became an instant hit and drew many non–coffee drinkers also to the store. In 1995, more
than three million people visited Starbucks stores each week.19
Over time and with experience, Starbucks developed a sophisticated store-development
process based on a six-month opening schedule. The process enabled it to open a store every
day. In 1996 alone, Starbucks opened 330 outlets. It also refined its expansion strategy. Schultz
said, “For each region we targeted a large city to serve as a hub where we located teams of pro-
fessionals to support new stores. We entered large markets quickly, with the goal of opening
20 or more stores in the first two years. Then from that core we branched out, entering nearby
spoke markets, including smaller cities and suburban locations with demographics similar to
our typical customer mix.”20
Starbucks was opposed to the concept of franchising. Schultz believed that, “If we had
franchised, Starbucks would have lost the common culture that made us strong. We teach
baristas not only how to handle the coffee properly but also how to impart to customers our
passions for our products. They understand the vision and value system of the company, which
is seldom the case when someone else’s employees are serving Starbucks coffee.”21
Starbucks initially believed in selling coffee only through its own outlets. But with the pas-
sage of time, to broaden its distribution channels and product line, it started to enter into strate-
gic alliances. Schultz said, “When we enter into any partnership, we first assess the quality of
the candidate. We look for a company that has brand name recognition and a good reputation in
its field, be it hotels or airlines or cruise ships. It must be committed to quality and customer ser-
vice. We look for people who understand the value of Starbucks and promise to protect our brand
and the quality of our coffee. All these factors are weighted before financial considerations.”22
The first strategic alliance Starbucks entered was with the real estate company Host
Marriott wherein Starbucks licensed Marriott to open Starbucks outlets at select airport loca-
tions. Starbucks licensed Aramark23 to open Starbucks stores at a few college campuses. Other
partnerships were with the department store Nordstrom, the specialty retailer Barnes & Noble,
the Holland America cruise lines, Starwood hotels, Dreyer’s Grand Ice Cream, and United Air-
lines. Under a joint venture with PepsiCo Inc.,24 a new version of Frappuccino was bottled and
sold through grocery stores.
Starbucks maintained a non-smoking policy at all its outlets worldwide. It believed that
the smoke could adversely affect the aroma of its coffee. For similar reasons, its employees
were required to refrain from using strong perfumes.
CASE 5 Starbucks Coffee Company 5-5
Focusing on Asia
In 1994, Starbucks International was formed and Howard Behar became its president. Starbucks
pursued international expansion with three objectives in mind: to prevent competitors from get-
ting a head start, to build upon the growing desire for Western brands, and to take advantage of
higher coffee consumption rates in different countries.25 Starbucks entered new markets outside
the United States either through joint ventures, licenses, or by company-owned operations. In
5-6 SECTION C International Issues in Strategic Management
Starbucks in Japan
As its first international destination, Starbucks chose Japan because it was the third-largest
coffee importer in the world after the United States and Germany and the largest economy
in the Pacific Rim. Japan originally was a tea-drinking country and the per capita consump-
tion of coffee in Japan in 1965 was only 300 grams per year.27 Owing to the decade-long
promotional activities of coffee companies and coffee associations, coffee became im-
mensely popular in Japan and by 1990s the per capita consumption of coffee had reached
3.17 kilograms.28
In the Japanese coffee industry, specialty blends were the fastest growing segment.
Gourmet coffee accounted for 2.5% of the 1.2 billion pounds of coffee imported by Japan an-
nually. The average per capita consumption among gourmet coffee drinkers had doubled from
1990 to 1.5 cups a day in 1997.29 An industry analyst said, “The Japanese have taken to cof-
fee like a baby to milk.”30
In 1995, Starbucks entered Japan with a joint venture—Starbucks Coffee Japan, Ltd. with
a leading Japanese retailer and restaurant operator, Sazaby Inc. In 1996, Starbucks opened its
first shop in the upscale Ginza shopping district, Tokyo, Japan. The décor and logo of the stores
were similar to its U.S. stores. The menu remained the same but with slight variations. The
store also offered Starbucks coffee beans and coffee-making equipment as well as fresh pas-
tries and sandwiches. The store gathered a huge crowd on the opening day and Japanese lined
around the block to get a taste of the Starbucks coffee.
The initial sales volume in Japan was twice as that in the United States. Starbucks rapidly
expanded and by 1997 it had 10 stores at prime locations. Despite the slump in economic
growth in Japan in the late 1990s, Starbucks remained profitable. Japan had become the most
profitable market for Starbucks outside North America. The success of Starbucks and the
growing popularity of coffee propelled other players to enter Japan.
By 2002, Starbucks had opened over 360 stores in Japan. But in the same year, Star-
bucks incurred huge losses in its Japanese operations. According to analysts, Starbucks
was opening stores too close to each other, which affected its brand image. Food menu
was another reason, for Japanese consumers, food was a major part of the coffee experi-
ence. The no-smoking policy of Starbucks also displeased many. As a result many com-
petitors took advantage and included an elaborate food menu with coffee and had separate
smoking areas. Other challenges that Japan presented to Starbucks were high rent and cost
of labor. The land rent rate in Tokyo was more than double that of Seattle. Moreover, Star-
bucks did not have a roasting facility in Japan; it had to ship coffee from its roasting
facility in Kent.
After cost-cutting exercises and introduction of new products based on consumer
research, Starbucks Japan returned to profitability in 2004. By 2006, Starbucks had over 600
retail locations in Japan.31
1996, Starbucks entered Japan, Hawaii, and Singapore. In 1998, it entered Taiwan, Thailand,
New Zealand, and Malaysia, and in 1999, it opened stores in Kuwait, Korea, Lebanon, and
China. During the 1990s Starbucks concentrated its expansion efforts mainly in Asia. Schultz
said, “The maturity of the coffee market in Europe was very strong and was not going to change
much over the years. The Asian market share was in its developmental stage and we had an
opportunity to position Starbucks as a leader in a new industry, and in a sense, educate a market
about the quality of coffee, the experience, and the idea of Starbucks becoming the third place
between home and work in those countries.”26
CASE 5 Starbucks Coffee Company 5-7
Starbucks in China32
A key component of our development in the China market was finding the right business partner who un-
derstands the marketplace, and, more importantly, share similar values, vision, and business philosophy.33
Howard Schultz
Starbucks had begun its groundwork for entering China since 1994 and entered China in
1999. Starbucks decided to first enter Hong Kong. In Hong Kong, Starbucks created a joint
venture, Coffee Concepts (Hong Kong) Ltd., with Maxim’s Caterer, a food and beverage
company that had 46 years of experience in Hong Kong. Maxim had a thorough know-how
of establishing and running businesses in China. Maxim was also the business partner of
Hong Kong Land Company, which had cornered a lot of real estate market in Hong Kong.
Maxim provided Starbucks with valuable insights about Chinese preferences.
After Hong Kong, Starbucks opened a store at Beijing through a joint venture with Beijing
Mei Da Coffee Co. Ltd.34 The first Starbucks store opened in 1999 at the China World
Trade Center, Beijing. The store opening was celebrated according to Chinese traditions. The
store offered a complete menu of Starbucks internationally acclaimed coffee beverages, a se-
lection of more than 15 varieties and blends of the finest Arabica coffee beans, freshly baked
local pastries and desserts, and a wide selection of coffee brewing equipment, accessories, and
service-ware. The ambience and décor of the store were kept similar to its stores in the United
States. After Beijing, Starbucks opened stores in Shanghai. As in other markets, Starbucks did
not market, advertise, or promote its stores in China and relied mainly on word-of-mouth pro-
motion. Starbucks selected high visibility, high traffic locations to open its stores.
By 2002 Starbucks had expanded to 50 outlets in China. Pedro Man, the then-president
of Starbucks Asia Pacific said, “These are still early days of our expansion in the China mar-
ket. Our approach is very focused. We plan to open one store at a time, serve one customer
at a time.”35
In 2003, Starbucks raised its stake in its joint venture operations in Shanghai to 50%. In
mid-2005, Starbucks became the majority owner of its operations in Southern China. The first
wholly owned and operated Starbucks store opened in Qingdao36 in 2005 and by mid-2006,
there were nine wholly owned stores in Qingdao, Dalian, and Shenyang.37
Starbucks had to face many challenges in China. In its initial years, many were op-
posed to the opening of a Western coffee chain in China, which was traditionally a tea
drinking country. Another challenge it faced was the dominance of instant coffee among
coffee drinkers. Specialty coffee was limited to mainly urban consumers. Competition had
also grown intense and many domestic and foreign players were setting up specialty cof-
fee shops. Despite the challenges, Starbucks achieved significant success in China and be-
came the leader in specialty coffee. By 2005, China contributed to little less than 10% of
the global sales of Starbucks and by 2008, Starbucks expected to derive 20% of its revenue
from Chinese locations.38
The Next Destination
In 2006, Schultz said,39 “We are equally excited about two other major markets we intend to
enter during 2007—India and Russia (see Exhibit 3). We are in discussions with potential joint
venture partners. Meanwhile, we are scouting locations, meeting with government officials—
all toward gaining additional market knowledge and building critical relationships to make
our market entries a success.”40
5-8 SECTION C International Issues in Strategic Management
About India
India had embarked on a series of economic reforms since 1991. The reforms included liber-
alization of foreign investment, significant reduction in tariffs and other trade barriers and
significant adjustments in government policies.41 The reforms over the years had resulted in
higher growth rates, lower inflation, and significant increase in foreign investment (see
Exhibit 4). In 2006, India was ranked as the fourth-largest economy in the world in terms of
purchasing power parity42 and the tenth-most-industrialized country in the world.43 In 2006,
the middle class44 in India was estimated at around 250 million and was growing in double
digits in urban and second tier 45 cities.46 The spending power had increased considerably in
the recent years (see Exhibit 5). According to a report47 by KPMG,48 disposable incomes re-
mained concentrated in urban areas, well-off and affluent classes, and double-income house-
holds. Consumers in the age group of 20–45 years were emerging as the fastest growing
consumer group.
India’s population was one of the youngest in the world and was to remain the youngest in
the coming years (see Exhibit 6). In 2000, one-third of India’s population was below 15 years
Very favorable
Parameter
Availability of workforce-
quantity
Availability of skilled
workforce
Cost of labor
English-language skills
Cost and quality of telecom
infrastructure
(1) Labor productivity for India highest in IT services vis-à-vis competing nations
Note: Russia and China included as they will compete in specific areas despite aggregate shortages: Israel and Ireland
not included because they are not expected to be significant competitors due to lack of manpower
Labor productivity
(PPP)(1)
Perceived stability of
government policies
Perceived operational risk
• Risk of personal harm
• Risk of business disruption
India Indonesia China Mexico RussiaPhilip-
pines
Unfavorable
EXHIBIT 3
India’s Performance
against Competing
Nations
SOURCE: Reserve Bank of India.
Key economic
indicators
GDP
growth (%)
CPI (%)
6.0
3.4
4.4
3.7
5.6
4.3
4.3
4.0
8.1
4.6
1999-00 2000-01 2001-02 2002-03 2003-04
EXHIBIT 4
Pricewaterhouse
Coopers 2004/2005
Global Retail &
Consumer Study
from Beijing to
Budapest–India
SOURCE: “India’s new opportunity – 2020,” Report of the High level strategic group in consultation with The Boston
Consulting Group.
CASE 5 Starbucks Coffee Company 5-9
Consumer spending rises
INR tr
25
20
15
10
5
2001 2002 2003 2004 2005
0
Growing middle class
m households by income group
120
100
80
60
40
20
<=35 0 36–70 71–105 Annual income ‘000 INR 105–140 >140
1992-1993
1998-1999
2005-2006 (estimate)
Food
Furniture
Recreation
Clothing
Health
Misc.
Housing
Transport
EXHIBIT 5
Growing Middle
Class and Increase
in Spending
SOURCE: NCAER, DB Research.
Aging population
0–14 years (%)
15–59 years (%)
60 and above (%)
35.6
58.2
6.3
32.5
60.4
7
29.7
62.5
7.9
27.1
64.0
8.9
2001 2006
(projected)
2011
(projected)
2016
(projected)
EXHIBIT 6
Population
Distribution
SOURCE: Statistical Outline of India (2003–2004).
SOURCE: MSPI, DB Research.
of age and close to 20% of its people were in the age group of 15–24 years. The population of
Indians in the age group of 15–24 years in 2000 was around 190 million, which increased to around
210 million by 2005. The average age of an Indian in 2020 would be 29 years, compared to
37 years in China and the United States, 45 years in Western Europe, and 48 years in Japan.49
India had emerged as a prime destination for business process outsourcing (BPO) companies, which
employed mainly the young people. The real estate market in India was also undergoing a boom.
Mumbai was considered the economic and financial center of India. It housed headquar-
ters of numerous Indian companies and many foreign financial service providers.50 Many IT
companies, financial service providers, and business process outsourcing companies had
sprung up in Mumbai. Delhi was the third biggest city in India, had the seat of the government
and the most important city in the northern India. Delhi and the neighboring towns of Gurgaon
and Noida were established as the call-center hubs. Another prominent city was Bangalore,
which was also known as India’s Silicon Valley. Many famous Indian and global IT compa-
nies were present in Bangalore. In 2005, there were a total of 35 cities with population more
than 1 million in India (see Exhibit 7).
However, there were certain factors that constrained economic growth. The factors in-
cluded inadequate infrastructure, bureaucracy, regulatory and foreign investment controls, the
reservation of key products for small-scale industries, and high fiscal deficits.51
5-10 SECTION C International Issues in Strategic Management
The Retail Environment
EXHIBIT 7
India’s Largest Cities/
Urban Areas
Rank City / Urban Area Population
1 Mumbai (Bombay) 16,368,000
2 Kolkata (Calcutta) 13,217,000
3 Delhi 12,791,000
4 Chennai 6,425,000
5 Bangalore 5,687,000
6 Hyderabad 5,534,000
7 Ahmadabad 4,519,000
8 Pune 3,756,000
9 Surat 2,811,000
10 Kanpur 2,690,000
11 Jaipur 2,324,000
12 Lucknow 2,267,000
13 Nagpur 2,123,000
14 Patna 1,707,000
15 Indore 1,639,044
16 Vadodara 1,492,000
17 Bhopal 1,455,000
18 Coimbatore 1,446,000
19 Ludhiana 1,395,000
20 Kochi 1,355,000
21 Visakhapatnam 1,329,000
22 Agra 1,321,000
23 Varanasi 1,212,000
24 Madurai 1,195,000
25 Meerut 1,167,000
26 Nashik 1,152,000
27 Jabalpur 1,117,000
28 Jamshedpur 1,102,000
29 Asansol 1,090,000
30 Dhanbad 1,064,000
31 Faridabad 1,055,000
32 Allahabad 1,050,000
33 Amritsar 1,011,000
34 Vijayawada 1,011,000
35 Rajkot 1,002,000
In 2006, the Indian retail market was estimated at US$350 billion. The market was largely
unorganized and dominated by small and individually owned businesses. Organized retailing
accounted for only 3% of the market, but by 2010, the share was expected to reach over
10%.52 Modern and organized retail channels such as hypermarkets, supermarkets, depart-
ment stores, discount stores, etc. were sprouting in a big way. Retailing in grocery accounted
for more than three-quarters of overall retailing sales.53 In 2005, non-grocery retailing grew
by 14% in sales value compared to 2004.54 Department stores were the frontrunners in growth
in non-grocery retailing and the number of department stores had grown by 24% per year
since 1999–2000.55 Department stores were largely frequented by the high-income and the
upper-middle segment. Specialty retailing was also increasing (see Exhibit 8).
In early 2006, the Indian government permitted Foreign Direct Investment (FDI) up to
51% in retail trade of single-brand products with prior government approval. FDI was subjected
SOURCE: India’s national census of 2001.
CASE 5 Starbucks Coffee Company 5-11
to three conditions; products could be sold under a single brand, the products should be sold
under the same brand internationally and the products needed to be branded during manufac-
turing.56 Any addition to the product or product categories under the single brand would re-
quire fresh government approval.
Many single-brand global retail giants such as Gap and Zara announced their plans to en-
ter India and many were in the exploration stage. Many domestic conglomerates also had big
plans. One of the leading Indian conglomerates, Reliance Industries, announced its plans to in-
vest US$3.4 billion in retail in India and establish a chain of 1,575 stores by mid-2007. An-
other group, K Raheja Group, had plans to open 55 hypermarkets by 2015.57 In 2006, India
was ranked as the top destination for retailers according to A.T. Kearney’s58 Global Retail De-
velopment Index (GRDI) (see Exhibit 9).
EXHIBIT 8
Key Players of the Indian Organized Retail Sector
Food Retail Channels
Category Company Group Name
No. of
Outlets
Net Sales
(2003–04) Future Plans
Hypermarkets Big Bazaar Pantaloon Retail 9 2300 Over 22 stores by 2006
Giant RPG Group 2 900 21 stores by 2007
Supermarkets Food World RPG (51%) & Dairy Farm
(49%)
93 3519 Not Available
Nilgiris Nilgiris 30 2550 20 new outlets in 3 years
Food Bazaar Pantaloon Retail 12 1650 Over 30 stores by 2006
Discount stores Subhiksha Viswapriya group 143 2350 Over 55 new stores by 2006
Margin free markets Independent retailer 300 540 Not Available
Cash & Carry Metro Cash & Carry Metro Group of Germany 2 650 Wait and watch
Non Food Retail Channels
Category Company Group Name
No. of
Outlets
Net Sales
(2003–04) Future Plans
Department
stores
Shoppers Stop K Raheja Group 14 4040 11 new stores by 2006,
venture in food retailing
Westside Trent Ltd. 15 1555 6 new stores by 2006,
venture in food retailing
Lifestyle Landmark Group 7 2400 13 new stores by 2006
Globus R Raheja Group 7 1100 8 new stores by 2006
Pantaloon Pantaloon Retail 16 2500 Over 21 stores by 2006
Ebony DS Group 8 820 2 new stores by 2006
Specialty
retailing
Music World (Music) RPG Group 125 600 14 new stores by 2006
Tanishq (Jewelry) TATA 65 3900 Over 75 stores by 2006
Health & Glow
(Pharma)
RPG Group 24 282 3 new stores by 2006
Crossword (Book) Shoppers’ Stop (51%),
ICICI Ventures (49%)
18 370 Over 28 stores and turnover
of 680 million by 2006
SOURCE: Compiled by IBS, Ahmedabad Research Center from 2004/2005 Global Retail & Consumer Study from Beijing to Budapest – India,
www.pwc.com.
www.pwc.com
5-12 SECTION C International Issues in Strategic Management
Food Habits
Region
Country
Risk
Market
Attractiveness
Market
Saturation
Time
Pressure
2006
Rank Country Weight 25% 25% 30% 20%
GRDI
Score
1 India Asia 55 34 89 76 100
2 Russia Eastern Europe 43 59 53 90 85
3 Vietnam Asia 43 24 87 81 84
4 Ukraine Eastern Europe 42 37 76 81 83
5 China Asia 58 40 57 86 82
6 Chile Americas 67 57 47 48 71
7 Latvia Eastern Europe 58 50 31 88 69
8 Slovenia Eastern Europe 78 52 25 70 68
9 Croatia Eastern Europe 57 51 28 91 67
10 Turkey Mediterranean 46 59 64 40 66
11 Tunisia Mediterranean 58 40 79 25 65
12 Thailand Asia 57 39 49 72 64
13 Korea, South Asia 68 73 35 36 63
14 Malaysia Asia 66 49 54 38 62
15 Macedonia Eastern Europe 32 32 75 64 61
16 United Arab Emirates Asia 78 67 33 25 60
17 Saudi Arabia Asia 53 46 67 30 59
18 Slovakia Eastern Europe 61 51 23 78 58
19 Mexico Americas 54 67 47 28 57
20 Egypt Mediterranean 45 35 81 35 60
21 Bulgaria Eastern Europe 48 37 52 65 55
22 Romania Eastern Europe 45 40 53 60 54
23 Hungary Eastern Europe 65 50 17 76 53
24 Taiwan Asia 83 69 32 6 52
25 Bosnia and Herzegovina Eastern Europe 31 18 71 75 51
26 Lithuania Eastern Europe 59 52 32 55 50
27 Brazil Americas 46 56 64 16 49
28 Morocco Mediterranean 45 31 76 30 48
29 Colombia Americas 39 42 65 37 47
30 Kazakhstan Asia 48 15 99 8 46
Key On the radar screen
Lower priority
To consider
Legend 0 = high
risk
100 = low
risk
0 = low
attractiveness
100 = high
attractiveness
0 = saturated
100 = not
saturated
0 = no time
pressure
100 =
urgency to
enter
EXHIBIT 9
A. T. Kearney’s Global Retail Development Index (GRDI)
SOURCE: www.atkearney.com.
India had a diverse cuisine that varied from region to region. Both vegetarian and nonvege-
tarian cuisines were eaten. Spicy food and sweets remained popular in India (see Exhibit 10).
In 2006, a nationwide survey59 was conducted that threw fresh light on the eating habits of
Indians (see Exhibit 11).
www.atkearney.com
CASE 5 Starbucks Coffee Company 5-13
EXHIBIT 10
Indian Cuisine In India, the food habits differed across diverse religions and regions. There was no single style
of Indian cooking and no single national dish. Styles of cooking and commonly used ingredients
differed from region to region and from one household to another. The Hindu and Muslim cultures
played a pivotal role in the development of the Indian cuisine. The Portuguese, the Persians, and
the British also made important contributions to the Indian cuisine scene.
Overall, wheat and rice were the staple foods. Gravy-based dishes were prominent through-
out India. The essence of Indian cooking revolved around the use of spices, which served both as
appetizers and digestives. The other main ingredients of Indian cooking were the milk products—
ghee and curd. Dals or pulses were also used across the country. Vegetables differed across regions
and with seasons. The style of cooking vegetables was dependent upon the main dish or cereal
with which they were served. Several customs were associated with the way in which food was
consumed. Traditionally, meals were eaten while sitting on the floor or on very low stools, eating
with the fingers of the right hand.
The Indian cuisine included a host of beverages, desserts, and paan for a grand finale. But-
termilk, an accompaniment to Indian meals, was made by vigorously churning yogurt and water.
It was called lassi in the north and mor or majige in the South. Tender coconut was available in
plenty in the coastal areas and was consumed to beat the summer heat.
Coffee was more popular in South India, and tea in North India. Indian tea grown on the
mountain slopes of Darjeeling, Munnar, and Coonoor was exported the world over. Coffee was
primarily grown in Karnataka.
Bottled drinks included various brands of lime, orange, and cola. Other fruit-based drinks—
apple, guava, mango, and tomato—were available in tetra packs and tins. Alcoholic beverages in-
cluded gin and rum. Fenny, a cashew or palm extract, was popular in Goa.
SOURCE: Compiled from http://www.geocities.com/Tokyo/Shrine/4287/cuisine.htm.
EXHIBIT 11
Key Findings of
The Hindu-CNN-IBN
State of the Nation
Survey
SOURCE: Yogendra Yadav, Sanjay Sharma “The food habits of a nation,”
www.hinduonnet.com, August 14, 2006.
Category Persons Families*
Vegetarians 31% 21%
Vegetarians who take eggs 9% 3%
Non-Vegetarians 60% 44%
Mixed eating habits – 32%
*Family includes parents and spouses. Figures are for families where everyone
falls in the same category. 32% of families have mixed eating habits.
Those who consume* Rural Urban
Tea/Coffee 83 96
Cold drinks 22 44
Eat out in restaurants – 23
*Figures in percentage for those who consume either daily or once or twice a
week or once or twice a month.
Indian Beverage Market
The Indian beverage market is chiefly composed of milk, tea, coffee, bottled water, carbon-
ated soft drinks, fruit beverages, distilled spirits, beer, wine, and others (see Exhibit 12). Con-
sumers in different parts of the country had different tastes and preferences. The middle class was
the biggest consumer of beverages. Consumption in rural areas had stagnated as a majority of the
http://www.geocities.com/Tokyo/Shrine/4287/cuisine.htm
www.hinduonnet.com
5-14 SECTION C International Issues in Strategic Management
EXHIBIT 12
Indian Beverage
Market
A. Change in volume by category—2001–2005
Segment 2000/01 2001/02 2002/03 2003/04 2004/05
Milk 3.0% 4.7% 2.1% 2.2% 2.0%
Tea 3.2% 3.1% 3.0% 3.0% 2.9%
Bottled Water 51.9% 63.7% 45.6% 32.7% 23.8%
Coffee 6.7% 6.2% 2.9% 2.0% 2.0%
Carbonated Soft Drinks 20.0% 25.0% -5.0% -15.0% -5.0%
Distilled Spirits 4.3% 14.9% 11.6% 11.3% 10.4%
Beer 7.6% 8.2% 6.6% 5.3% 6.3%
Fruit Beverages 15.6% 20.6% 48.8% 23.9% 23.2%
Wine — — — 18.0% 19.3%
Subtotal 3.4% 4.7% 2.9% 2.8% 2.8%
All Others1 0.8% 0.5% 0.8% 0.9% 0.9%
TOTAL 1.2% 1.2% 1.2% 1.2% 1.2%
Note: 1Includes tap water, vegetable juices, powdered drinks, and miscellaneous others.
SOURCE: Beverage Marketing Corporation.
B. Per Capita Consumption by Category
Liters Per Person
Categories 1995 1996 1997 1998 1999 2000
Beer 0.5 0.5 0.6 0.6 0.7 0.7
Bottled Water 0.1 0.1 0.1 0.2 0.3 0.5
CSDs 1.0 1.2 1.2 1.5 1.6 1.8
Coffee 2.0 1.2 1.3 1.3 1.3 1.2
Distilled Spirits 0.3 0.3 0.4 0.5 0.6 0.6
Fruit Beverages 0.1 0.1 0.1 0.2 0.2 0.2
Milk 41.2 41.7 40.2 40.7 40.1 40.5
Tea 49.7 50.9 49.2 52.5 48.2 44.2
Wine 0.0 0.0 0.0 0.0 0.0 0.0
Subtotal 94.9 96.0 93.1 97.5 93.0 89.7
All Others* 631.9 630.6 633.6 629.3 633.7 637.0
TOTAL2 726.7 726.7 726.7 726.7 726.7 726.7
Gallons Per Capita
Categories 1995 1996 1997 1998 1999 2000
Beer 0.1 0.1 0.2 0.2 0.2 0.2
Bottled Water 0.0 0.0 0.0 0.1 0.1 0.1
CSDs 0.3 0.3 0.3 0.4 0.4 0.5
Coffee 0.5 0.3 0.3 0.3 0.3 0.3
Distilled Spirits 0.1 0.1 0.1 0.1 0.1 0.2
Fruit Beverages 0.0 0.0 0.0 0.0 0.0 0.1
Milk 10.9 11.0 10.6 10.8 10.6 10.7
Tea 13.1 13.4 13.0 13.9 12.7 11.7
Wine 0.0 0.0 0.0 0.0 0.0 0.0
Subtotal 25.0 25.2 24.5 25.8 24.4 23.8
All Others1 166.9 166.6 167.4 166.3 167.4 168.3
TOTAL2 192.0 192.0 192.0 192.0 192.0 192.0
Note: 1Includes tap water, vegetable juices powders, and miscellaneous others.
2Rounding errors
SOURCE: Beverage Marketing Corporation.
CASE 5 Starbucks Coffee Company 5-15
Indian Coffee Market
Between 1947 and 1996, coffee consumption in India had remained stagnant at 50,000 tons
per year. Since 1996, coffee consumption witnessed a steady rise reaching 85,000 tons in
2005.62 The late 1990s saw the emergence of trendy coffee bars, specialty coffee serving
chains that started replacing the conventional and old-fashioned coffee houses.
According to market research studies, coffee was mainly consumed in the urban areas
(71%) and to a much lesser extent in the rural areas (29%).63 The people in southern states of
India largely consumed coffee (see Exhibit 13). The people in the northern states were gener-
ally not coffee drinkers, but drank coffee and experimented with various flavors as a fashion
statement. The consumption of instant coffee and filter coffee64 was almost equal on the na-
tional level. But region-wise, filter coffee was more popular in the south and the proportion of
instant coffee was very high in the non-south regions.65 The Coffee Board of India66 undertook
research studies in 2001 and 2003 regarding the consumption of coffee and attitude of coffee
drinkers in India (see Appendix 1).
The size of the total packaged coffee market was 19,600 tones or US$87 million.67 Ac-
cording to industry reports, the gourmet coffee market in India in 2004, which was still in its
nascent stage, held potential for 5,000 cafes over the next five years.68 As mentioned by
Schultz, “Much like China, India has traditionally been a tea culture, yet there is a growing
coffee culture emerging, especially among the country’s young adults. Also like China, there
is a growing interest in Western consumer brands and luxury products.”69
EXHIBIT 13
Per Capita
Consumption of
Coffee in India –
State-wise
States 1981 1991 2001
Tamil Nadu 0.633 0.425 0.493
Karnataka 0.498 0.370 0.350
Kerala 0.179 0.070 0.143
AP 0.109 0.062 0.077
Total South 0.362 0.237 0.267
Total for Non-South 0.009 0.004 0.005
Total for all States 0.094 0.076 0.062
SOURCE: http://indiacoffee.org/newsletter/2004/april/cover_story.html.
Competitive Scenario
Homegrown brands dominated the retail coffee market. Coffee Café Day (CCD) pioneered
the concept of specialty coffee in India followed by Qwiky’s and Barista Coffee.
rural population depended on agricultural products. Also, most of the advertisements were tar-
geted at the urban population living in cities, and very few advertisements targeted the rural mar-
ket. The Indian hot-beverage market was dominated by tea. India was the largest producer and
consumer of tea in the world and accounted for 29% of the total production and over 20% of the
total consumption globally.60 Most of the Indians consumed tea at least twice a day, in the morn-
ing and in the afternoon. Tea, perceived as having health benefits, was extensively and easily
available, but more than half was available in unpacked or loose form. Milk followed tea as the
second-most-popular drink. Coffee was third in the hot beverage market. The total soft drink mar-
ket (carbonated soft drinks and juices) was estimated at US$1 billion per year. Mineral water mar-
ket in India was a US$50 million industry.61
http://indiacoffee.org/newsletter/2004/april/cover_story.html.Competitive
http://indiacoffee.org/newsletter/2004/april/cover_story.html.Competitive
5-16 SECTION C International Issues in Strategic Management
Qwiky’s
Two software engineers, Shashi Chimala and Shyam, opened the first Qwiky’s outlet in
Chennai in 1999. They were inspired by the specialty coffee bars in the United States. The
menu at Qwiky’s included varieties in hot Italian coffee, Indian coffee, specialty hot coffee,
cold coffee, frappes, milk shakes, tea, other beverages, desserts, and snacks. It targeted
youths in the age group of 18 to 30 years. By 2002, the annual revenues of Qwiky’s were
43 million INR.
Qwiky’s had three types of formats; Qwiky’s Coffee Pubs were stand-alone coffee bars,
Qwiky’s Coffee Islands were outlets within big stores, multiplexes, and movie theatres, and
Qwiky’s Coffee Xpress were coffee kiosks. By 2006 it had over 20 outlets in nine cities in India
and one franchise in Sri Lanka. Qwiky’s had plans to open more outlets in metropolitan and
To be the best café chain in the country by offering a world class coffee experience at affordable prices.70
CCD Mission statement
CCD, India’s first coffee bar was established in 1996 in Bangalore by the largest exporter of
coffee in India, the Amalgamated Bean Coffee Trading Company (ABCTCL). By 2002, CCD
had 50 outlets in 9 cities, which increased to 326 outlets in 65 cities by 2006.71 CCD offered
a wide variety of Indian and international flavors of hot and cold coffee, hot chocolate, cold
drinks, ice creams, pastries, sundaes, quick snacks, and powder coffee.
Customer Profile at CCD
The best-selling item at CCD in summer was Frappe72 and Cappuccino in winters. In north-
ern states, hot coffee was the most popular. Country-wise, on an average, the sales of cold
coffee exceeded the sales of hot coffee.73
CCD also sold merchandise such as caps, T-shirts, bags, mugs, mints, and coffee filters at
its outlets. Other brands were also promoted in a CCD outlet through innovative and interac-
tive use of posters, cards, danglers, leaflets, contest forms, etc. CCD had tied up with popular
television serials and also ran promotion contests for many brands. It had also tied up with
some popular Indian movies where CCD was featured in some of the scenes.
By 2006, CCD had six café formats; Music Cafés, Book Cafés, Highway Cafés, Lounge
Cafés, Garden Cafés & Cyber Cafés. Music Cafés provided customers with the choice of playing
their favorite music tracks on the digital audio jukeboxes installed in the café. CCD had 85 Music
Cafés out of which 32 cafés also allowed the customers to watch their favorite music videos through
video jukeboxes. Book Cafés offered the customers bestsellers and classic books to read while en-
joying coffee. CCD had allied with a leading Indian book distributor for supplying books that
would appeal to the customers. There were 15 Book Cafés in 12 cities. There were highway cafés
on two important highways in the country that provided coffee and clean restrooms to relax. CCD
had three Lounge Cafés at Delhi, Kolkata, and Hyderabad, which provided exquisite interiors, an
exotic menu, and theme music. It had hostesses to assist who were looked upon as fashion icons.
There were two Garden Cafés at Bangalore and Delhi amidst famous gardens. Cyber Cafés at
Bangalore and Delhi allowed the customer to surf while enjoying coffee. CCD had plans to come
out with more formats like sports Café, singles café, and fashion café.
In 2006, ABCTCL earned revenues of 3.5 billion INR.74 It had plans to increase its outlets
to 500 by June 2007 by opening 3–4 shops per week and increase its revenue to 10 billion INR.75
Speaking on competition with other players, Sudipta SenGupta, marketing head, CCD
said: We don’t have any competition because we are not competing with the others. In fact we
are aiding each other in creating and growing the coffee culture. All of us have a distinct iden-
tity. We sure do!76
Café Coffee Day
CASE 5 Starbucks Coffee Company 5-17
Barista
The first outlet of Barista Coffee Company Limited (Barista) was established in 2000 in Delhi
by an investment company,77 promoted by Amit Judge. Barista offered a range of hot coffee,
international coffee, cold coffee, ice cream, cold non-coffee, ice cream sundaes, add-ons,
other beverages, and fast food in their outlets. Coffee and other products at Barista were
priced high and its target audiences were youth from the upper-middle-class segment. The
coffee at Barista was made with high-quality Arabica coffee beans and baristas (brew mas-
ters) were invited from Italy to make new blends. Brotin Banerjee, vice president of market-
ing, Barista, said, “Our inspiration was the traditional Italian Espresso bars where the idea is
to create a ‘home away from home.’”78 In 2001, Barista entered into a strategic alliance with
Tata Coffee Ltd. (Tata), the largest coffee producer in India. Tata later acquired a 35% stake
in Barista. The alliance allowed Barista to enlarge its distribution network and set up outlets
in the Taj Group of hotels owned by Tata and its other allied businesses.
The outlets also offered many merchandise such as mugs, flasks, coffee-made candles,
coffee filters, coffee cup miniatures, soft toys, and chocolates.79 The outlets also gave away
gift certificates that could be redeemed at any Barista outlet. By 2003, Barista became a chain
of over 100 cafés (mainly in the northern cities), had sales of 650 million INR, and served
35,000 customers daily.80 It had surpassed CCD in sales, which had over 50 outlets by 2003.
In 2004, Amit sold 65.4% stake of the company to an NRI81 businessman, Sivasankaran (Siva),
who later in 2004 bought the remaining stakes from Tata as well. After the acquisition, Siva
revamped the chain, opened more Barista outlets in Southern cities, and began franchising its
outlets. It started opening up a new outlet every 10 days. A new look was given to its outlets
by making changes in its seating arrangements, in-store merchandise, and providing a better
youthful ambience of the store.82 The brew masters maintained friendly relations with the cus-
tomers and called them by their first names.
Barista joined with specialty retailers such as the music retailer Planet M, the book retailer
Crossword, and the Taj Group of hotels for setting up espresso corners in their premises. It also
launched a concept called Bancafe, a coffee shop within the bank premises and joined with the
bank ABN AMRO.83 By 2006, Barista had over 130 café chains.
Others
Costa Coffee, owned by the UK-based Whitbread plc, opened its first coffee retail chain in
Delhi in late 2005.84 It entered India through a joint venture agreement with RK Jaipuria
Group of India. It had plans to open 300 outlets in India by 2010. Costa coffee, which had
100 outlets in nine countries, was the first international coffee, chain to enter India. In India
it priced its coffee, which was locally competitive.
After Costa Coffee, Orlando-based coffee chain Barnie’s entered India through a franchis-
ing agreement with an Indian company and set up its first outlet at Delhi.85 The company had
plans to invest around 750 million INR and open 300 stores across the country in the next five
years. The world’s second-largest specialty coffee company, Australia-based Gloria Jean’s also
disclosed its plans to enter India and set up 20 outlets in seven large cities in India by 2006.86
Illy, an Italian-based coffee chain, was also in exploration stages to enter India.87
The Road Ahead
In 2004, Starbucks had signed an agreement with Tata to source premium coffee beans. Tata
had won a gold medal for the best Robusta88 coffee in the world at the international cupping
large cities in India and abroad through franchising its business. It had joined with retailers
such as Lifestyle, Music World, and Ebony to open store-in-store outlets.
5-18 SECTION C International Issues in Strategic Management
competition, Grands Crus de Café held at Paris.89 The agreement was the first instance when
Starbucks decided to source coffee from anyplace other than South America and Indonesia.
Tata had met all the stringent standards and conditions followed by Starbucks such as quality,
soil, water, pest, waste and energy management, forest and biodiversity conservation to work-
ers’ welfare, wages and benefits, living conditions, health, safety, etc. Hamid Ashraff, manag-
ing director, Tata Coffee, said, “Starbucks deal with Tata Coffee is yet another significant
milestone to show how Indian coffee is gaining acceptance in the international market.”90
In mid-2006, a Starbucks spokesperson said, “We are excited about the great opportuni-
ties that India presents to the company. We are looking forward to offering the finest coffee in
the world, handcrafted beverages, the unique Starbucks experience to customers in this coun-
try within the next 18 months.”91 Starbucks was said to have been in talks with several prob-
able partners (see Exhibit 14) for their much-talked-about entry in India. The marketplace was
full of many such speculations that Starbucks had finalized their Indian partner but there was
no confirmation from Starbucks. In an interview with a leading Indian newspaper,92 Coles said,
“When we open a new market, we take time to make sure we have the right joint venture part-
ner or licensee to help develop the brand. As it is very important for us to find a partner with
the right business and retail experience as well as cultural fit for Starbucks, the process can be
a long one. We will open each market when the time is right, one store at a time.”93
Starbucks sounded firm on its Indian ambitions and seemed prepared to meet the chal-
lenges that the Indian market could pose for Starbucks. Starbucks products were priced at a
premium and the per capita income in India was lower compared to other markets where it was
already present. Coles said, “We price our products competitively in each market, so product
prices in India would be locally competitive.”94
Speaking on competition with the traditional Indian beverage tea, Christine Day, president
of Starbucks Asia Pacific Group said, “India is a tea-based culture. We’re not saying coffee is
a substitute. We’re saying Starbucks is a place to hang out, to eat and drink, to see and be
seen.”95
Another significant challenge that Starbucks could face was the increasing rate of obesity
and obesity related diseases such as diabetes, high blood pressure, and heart diseases in India.
In 2005, 25 million Indians suffered from diabetes, which according to estimates by WHO96
would increase to 57 million by 2025.97 Starbucks was said to have been on the target of many
consumer health groups worldwide who planned to campaign against the high-calorie and high-
fat products that Starbucks sold and which could lead to increased obesity risk, heart diseases,
EXHIBIT 14
Some of the Probable Partners, Starbucks Reported to be in Discussion
SOURCE: Compiled by IBS Ahmedabad, Research Center.
Group Assets Financials
Anil Dhirubhai
Ambani Group
(ADAG)
Runs Java Green coffee chain in its Reliance
Webworld stores, businesses in energy, finance,
telecom. Plans to venture in pharma retail
Operating Profit ADAG Group—
INR 50 billion (As on May 2005)
K Raheja Group Owner of Shopper’s Stop, 19 department stores
in 10 cities in India (2006)
Shoppers’ Stop Revenues—
INR 6.75 billion (year ending
March 2006)
Pantaloon Retail Owner of Pantaloons, Big Bazaar, Food Bazaar.
100 stores in 25 cities in India (2005)
Group Revenues—INR 10.73 billion
(year ending June 2005)
Planet Sports Licensee of Starbucks in Indonesia, Licensee of
Marks & Spencer in India, 25 stores in India
Turnover in India—INR 0.3–
0.4 billion (2005)
CASE 5 Starbucks Coffee Company 5-19
Appendix 1: Salient Results of the Studies Undertaken
by The Coffee Board of India
Consumption of Coffee in India
� Consumption of coffee was 19% when compared to tea at
85%. Consumption was the highest in the South at 31%
while it ranged between 35% in the weak coffee zones:
North, East, and South.
� Per capita consumption of coffee (among all respondents—
both drinkers and non-drinkers) was 0.33 cups against
1.77 cups for tea. However, coffee consumption among
drinkers was at 1.76 cups compared with that of tea at
2.1 cups.
� About 41% of the respondents were non-drinkers of cof-
fee and 40% were occasional drinkers.
� Consumption was the highest among the age groups of
15–24 and 35–44 years. The proportion of non-drinkers
was the highest in the age group of 55+ years.
� Coffee consumption dipped from 11% at home to
6% outside.
� Coffee was consumed as the first cup only by 23% of cof-
fee drinkers, including in the South.
� Penetration level was found to decrease from higher
socioeconomic class (SEC) to the lower socioeconomic
class. Penetration of filter coffee was highest in South
India. In the rural areas of South India, instant coffee had
a higher level of penetration than filter coffee.
� Visiting cafes was not a frequent habit. Of all respondents
surveyed, about 12% visited cafes and there was a greater
tendency among the upper SECs to visit cafes. About 10%
have ever visited cafes; the highest proportion was higher
among men and the younger age groups (15–34 years).
� The average number of cups of coffee consumed in-
creased marginally from summer to winter.
� The North had an increased consumption of cold coffee
in summer, showing 60% consuming cold coffee at least
once a week in summer.
� Around 65% of households bought instant coffee and 18%
bought filter coffee. Among filter coffee drinking house-
holds, 49% were branded coffee drinkers and 51% were
unbranded coffee drinkers. In the South, filter coffee was
bought mostly from R&G (Roast & Ground) outlets.
� Amongst coffee consumers in the rural areas, a majority
were light drinkers, consuming 1–2 cups every day. About
a fifth of rural consumers consumed coffee occasionally.
� A majority of the rural households (71%) bought pack-
aged and branded coffee powder. Of those, 47% bought
instant coffee, and 53% filter coffee.
Attitude Toward Coffee Consumption
� Coffee at home was significantly different to coffee out-
side. Rating for coffee outside home was better than tea
outside home, specifically in the North and the East.
� Coffee from vending machines rated significantly more
satisfactory in the North as compared to the East or the
West. Consumers in the North believed that making filter
coffee was time-consuming.
� In the weak coffee markets, the key barriers to coffee ap-
peared to be its bitter taste (East) and its inconsistent taste
outside. High price of coffee was also felt as a barrier in
the South and the North.
and cancer.98 For instance, Banana Mocha Frappuccino with whipped cream, offered by Star-
bucks, contained 720 calories and 11 grams of saturated fat.99 According to the consumer
groups, Starbucks should use healthier shortenings100 and publicize its smallest cup size, short,
which was available but did not appear on the menu card. Starbucks provided information
about the nutritional value of each of its offerings on its Web site and in-store brochures. The
health groups insisted that the information should also be provided on its menu card.101 A Star-
bucks official said they were actively researching alternatives to high-fat products.
Starbucks had expressed its interest in entering India several times in recent history. In
2002, Starbucks announced for the first time that it was planning to enter India.102 Later it post-
poned its entry as it had entered China recently and was facing problems in Japan. In 2003,
there was news again that Starbucks was reviving its plans to enter India. In 2004, Starbucks
officials visited India but according to sources they returned unconvinced as they could not
agree on an appropriate partner for its entry. Banerjee of Barista said, “We’ve been hearing
about them [Starbucks] coming for the last 3 to 4 years. We don’t know why they are not here
yet. If they do come, we still believe we have a number of factors to our advantage.” Cole com-
mented: Without sounding arrogant, we are looking at our own strategy. There is nothing that
keeps us doing business in India.”103
5-20 SECTION C International Issues in Strategic Management
R E F E R E N C E S
Source: www.starbucks.com
Chaitali Chakravarty, Sabarinath, Starbucks brews success
recipe for Indian palate, www.indiacoffee.org, July 15,
2005.
Starbucks seeks partner for India tour, www.economictimes.
com, April 8, 2005.
Starbucks sees big opportunity in China, www.msnbc.com,
February 14, 2006.
Sudha Menon, Starbucks coffee firms up India plans, www
.blonnet.com, May 26, 2006.
Howard Schultz, Dori Jones Yang, Pour your heart into it:
How Starbucks built a company one cup at a time.
A V Vedpuriswar, Starbucks, www.vedpuriswar.org.
Jen-Lin Hwang, Coffee goes to China: An examination of
Starbucks Market Entry Strategy, www.clas.ufl.edu,
July/August 2005.
Starbucks Coffee: Expansion in Asia, www.interscience
.wiley.com.
www.starbucks.com.
Ruchi Mankad, Anand Rao, Aspiration of Starbucks in China:
Popularizing coffee among tea-drinkers, www.ecch.com.
Allen Liao, Starbucks brings in coffee culture to China, www
.teacoffeeasia.com.
Starbucks brews a business in tea-drinking China, www
.siamfuture.com, March 25, 2002.
Starbucks soars in China, www.atimes.com, June 15, 2005.
Joseph Pratt, Starbucks-China blend: A Slam Dunk Grande,
www.dailyindia.com, March 12, 2006.
Investing in India, www.ibef.org, June 18, 2005.
Rules laid out for FDI in branded retail, www.economictimes.
com, February 15, 2006.
Jayati Ghosh, India’s potential demographic dividend, www
.blonnet.com, January 17, 2006.
Parija Bhatnagar, After caffeinating China, the coffee chain
has its sights set on yet another tea-drinking nation, www
.cnn.com, November 1, 2004.
Starbucks Q3 2006 Earnings Conference Call Transcript,
http://retail.seekingalpha.com/article/14895, August 2,
2006.
www.economictimes.com.
Starbucks seeks partner for India tour, www.economictimes
.com, April 8, 2005.
India’s new opportunity 2020, Report of the High level strate-
gic group in consultation with The Boston Consulting
Group.
www.ibef.org
Starbucks to source premium coffee beans from Tata coffee,
www.tata.com, October 18, 2004.
www.google.com
www.pantaloon.com
www.shoppersstop.com
www.starbucks.com
www.cia.gov
www.ficci.com
www.finmin.nic.in
www.indiastat.com
www.wikipedia.org
N O T E S
1. ‘Starbucks Q3 2006 Earnings Conference Call Transcript,’
http://retail.seekingalpha.com/article/14895, 2 August 2006.
2. Chaitali Chakravarty, Sabarinath ‘Starbucks brews success
recipe for Indian palate,’ www.indiacoffee.org, 15 July 2005.
3. ‘Starbucks sees big opportunity in China,’ www.msnbc.com,
February 14th 2006.
4. ‘Starbucks looks for Indian entry early next year,’ www
.helplinelaw.com.
� The knowledge levels on coffee appeared to be relatively
weak in the North and East.
� While consumers in the North believed that instant coffee
was convenient and tasted good, the seasoned coffee con-
sumer in the South believed that all instant coffee con-
tains chicory and that filter coffee is the gold standard in
coffee.
� Respondents in the North, followed by East, appeared to
be most positively inclined to consume more coffee at
home if the price was less, they were reassured on health,
and they could try different recipes.
� Respondents in the North, followed by West and East, ap-
peared to be most positively inclined to consume more
coffee outside if the price was less, consistently good cof-
fee was more easily available outside, and they were re-
assured on health.
� In South, consumers believed that they would consume
more coffee at home if their family & friends consumed
coffee.
� In the East, there appeared to be a certain level of eagerness
to learn about making “just right” coffee and they
would make filter coffee if they knew how to make it well.
SOURCE: S. Radhakrishnan “Coffee consumption in India—
Perspectives and Prospects,” www.indiacoffee.org, April 2004.
www.starbucks.com
www.indiacoffee.org
www.economictimes.com
www.economictimes.com
www.msnbc.com
www.blonnet.com
www.blonnet.com
www.vedpuriswar.org
www.clas.ufl.eduJuly/August
www.interscience.wiley.com
www.interscience.wiley.com
www.starbucks.com
www.ecch.com
www.teacoffeeasia.com
www.teacoffeeasia.com
www.siamfuture.com
www.siamfuture.com
www.atimes.com
www.dailyindia.com
www.ibef.org
www.economictimes.com
www.economictimes.com
www.blonnet.com
www.blonnet.com
www.cnn.com
www.cnn.com
http://retail.seekingalpha.com/article/14895
www.economictimes.com
www.economictimes.com
www.economictimes.com
www.ibef.org
www.tata.com
www.google.com
www.pantaloon.com
www.shoppersstop.com
www.starbucks.com
www.cia.gov
www.ficci.com
www.finmin.nic.in
www.indiastat.com
www.wikipedia.org
http://retail.seekingalpha.com/article/14895
www.indiacoffee.org
www.msnbc.com
www.helplinelaw.com
www.helplinelaw.com
www.indiacoffee.org
www.clas.ufl.eduJuly/August
CASE 5 Starbucks Coffee Company 5-21
5. Sudha Menon ‘Starbucks coffee firms up India plans,’ www
.bIonnet.com, May 26th 2006.
6. Allen Liao, ‘Starbucks brings in coffee culture to China,’ www
.teacoffeeasia.com.
7. A global company providing office solutions such as copiers,
fax machines, etc.
8. Espresso is a strong, flavorful coffee beverage brewed by forc-
ing hot water through finely ground roasted coffee beans. In
Italian, espresso means “to press,” and refers to the pressure ap-
plied to the water as it is forced through the grinds.
9. A person who made coffee drinks as a profession.
10. Howard Schultz, Dori Jones Yang ‘Pour your heart into it: How
Starbucks built a company one cup at a time,’ Hyperion, 1997.
11. Ibid., Pg. 52.
12. Giornale was the name of the largest newspaper company in
Italy and also meant ‘daily’ in general.
13. A shot of coffee mixed with hot steamed milk and up to a half
inch of foamed milk on top.
14. Op cit ‘Pour your heart into it: How Starbucks built a company
one cup at a time,’ Pg. 90.
15. ‘Planet Starbucks (A),’ www.thunderbird.edu, 2003.
16. Initial Public Offering is the first sale of stock by a private com-
pany to the public. IPOs are often done when smaller, younger
companies seek capital to expand their business.
17. Oz is abbreviation for Ounce. 1 Ounce = 28.349 grams.
18. www.wikipedia.org.
19. ‘Starbucks Corporation,’ http://www.referenceforbusiness.com/
businesses/M-Z/Starbucks-Corporation.html.
20. Op cit ‘Pour your heart into it: How Starbucks built a company
one cup at a time,’ Pg. 195–196.
21. Ibid., Pg. 173.
22. Ibid., Pg. 273.
23. Aramark is an international company based in US, specializing
in food services for stadiums, campuses, businesses, and
schools.
24. The global food and beverage company.
25. A V Vedpuriswar ‘Starbucks,’ www.vedpuriswar.org.
26. Jen-Lin Hwang ‘Coffee goes to China: An examination of Star-
bucks’ Market Entry Strategy,’ www.clas.ufl.edu, July/August
2005.
27. ‘Analysis: The Chinese Coffee Market,’ www.friedlnet.com,
16 September 2003.
28. Ibid.
29. ‘Starbucks Coffee: Expansion in Asia,’ www3.interscience
.wiley.com.
30. Ibid.
31. www.starbucks.com.
32. Information adapted from the case “Aspiration of Starbucks in
China: Popularizing coffee among tea-drinkers,’ authored by
Ruchi Mankad under the supervision of Prof. Anand Rao,
ICFAI Business School, Ahmedabad.
33. Allen Liao ‘Starbucks brings in coffee culture to China,’ www
.teacoffeeasia.com.
34. Beijing Mei Da Coffee Co. was the distribution agent for Star-
bucks wholesale operations in Beijing since 1994. It was set up
by the Beijing General Corp, of Agriculture, Industry, and
Commerce and the Borderless Investment Group. Borderless
Investment Group was headed by a former Starbucks executive.
35. ‘Starbucks brews a business in tea-drinking China,’ www
.siamfuture.com, March 25th 2002.
36. Qingdao is situated in Eastern China’s Shandong province.
37. Dalian and Shenyang are located northeastern China’s Liaoning
province.
38. Joseph Pratt ‘Starbucks-China blend: A Slam Dunk Grande,’
www.dailyindia.com, March 12th 2006.
39. Starbucks Q3 2006 Earnings Conference.
40. ‘Starbucks Q3 2006 Earnings Conference Call Transcript,’ http://
retail.seekingalpha.com/article/14895, August 2nd 2006.
41. ‘Economy of India,’ http://dictionary.laborlawtalk.com/
Economy_of_India.
42. Purchasing Power Parity (PPP) is a method of measuring the
relative purchasing power of different countries’ currencies
over the same types of goods and services. As goods and ser-
vices may cost more in one country than in another, PPP provides
more accurate comparisons of standards of living across coun-
tries. PPP estimates use price comparisons of comparable items.
43. ‘Investing in India,’ www.ibef.org, June 18th 2005.
44. In India middle income was defined as income between 5,000
and 20,000 INR or approximately US$110 to US$450 per
month.
45. Tier 1 cities included Delhi, Mumbai, & Bangalore. Tier 2 cities
included Hyderabad, Pune, & Chennai. Tier 3 cities included
Kolkata, Nagpur, Ahmedabad, Chandigarh, Indore, Kochi,
Trivandrum, Mangalore, and 30 other cities.
46. ‘The multiple beverage marketplace in India-2006 edition,’
Data taken from the sample text of the report, accessible to all.
47. Consumer Markets in India: the next big thing?
48. KPMG is a global network of professional firms providing Au-
dit, Tax and Advisory services.
49. Jayati Ghosh ‘India’s potential demographic dividend,’ www
.blonnet.com, January 17th 2006.
50. ‘Building up India-Outlook for India’s real estate markets,’
www.dbresearch.com, May 8th 2006.
51. ‘Background note: India,’ http://www.state.gov/r/pa/ei/bgn/
3454.htm, December 2005.
52. Op Cit ‘Building up India-Outlook for India’s real estate
markets.’
53. ‘Retailing in India,’ www.euromonitor.com, July 2006, Data
taken from the sample text of the report, accessible to all.
54. Op Cit ‘Retailing in India.’
55. ‘2004/2005 Global Retail & Consumer Study from Beijing to
Budapest – India,’ www.pwc.com.
56. ‘Rules laid out for FDI in branded retail,’ www.economictimes
.com, February 15th 2006.
57. ‘Emerging market priorities for global retailers—The 2006
Global Retail Development Index,’ www.atkearney.com.
58. A.T Kearney headquartered in Chicago is a management con-
sulting firm.
59. ‘State of the Nation’ survey was conducted by The Hindu-
CNN-IBN between August 1st and 6th 2006 whereby
14,680 respondents spread across 883 villages and urban areas
in 19 states were interviewed.
60. ‘Agricultural commodities: Profiles and relevant WTO negoti-
ating issues -Sugar and beverages,’ http://www.fao.org/
DOCREP/006/Y4343E/y4343e05.htm#bm05.
61. www.beveragemarketing.com.
62. ‘Foreign brands to flavour Indian coffee cuppa!,’ www.hindu
.com, August 22nd 2006.
63. S. Radhakrishnan ‘Coffee consumption in India-Perspectives
and Prospects,’ www.indiacoffee.org, April 2004.
64. Filter Coffee is a sweet milky coffee made from dark roasted
coffee beans (70%–80%) and chicory (20%–30%), especially
www.bIonnet.com
www.bIonnet.com
www.teacoffeeasia.com
www.teacoffeeasia.com
www.thunderbird.edu
www.wikipedia.org
http://www.referenceforbusiness.com/businesses/M-Z/Starbucks-Corporation.html
http://www.referenceforbusiness.com/businesses/M-Z/Starbucks-Corporation.html
www.vedpuriswar.org
www.clas.ufl.edu
www.friedlnet.com
www3.interscience.wiley.com
www3.interscience.wiley.com
www.starbucks.com
www.teacoffeeasia.com
www.teacoffeeasia.com
www.siamfuture.com
www.siamfuture.com
www.dailyindia.com
http://retail.seekingalpha.com/article/14895
http://retail.seekingalpha.com/article/14895
http://dictionary.laborlawtalk.com/Economy_of_India
http://dictionary.laborlawtalk.com/Economy_of_India
www.ibef.org
www.blonnet.com
www.blonnet.com
www.dbresearch.com
http://www.state.gov/r/pa/ei/bgn/3454.htm
http://www.state.gov/r/pa/ei/bgn/3454.htm
www.euromonitor.com
www.pwc.com
www.economictimes.com
www.economictimes.com
www.atkearney.com
http://www.fao.org/DOCREP/006/Y4343E/y4343e05.htm#bm05
http://www.fao.org/DOCREP/006/Y4343E/y4343e05.htm#bm05
www.beveragemarketing.com
www.hindu.com
www.hindu.com
www.indiacoffee.org
5-22 SECTION C International Issues in Strategic Management
popular in the southern states of India. Outside India, a cof-
fee drink prepared using a filter is known as Filter Coffee or
as Drip Coffee as the water passes through the grounds solely
by gravity and not under pressure or in longer-term contact.
65. S. Radhakrishnan ‘Coffee consumption in India—Perspectives
and Prospects,’ www.indiacoffee.org, April 2004.
66. The Coffee Board of India is an autonomous body functioning
under the Ministry of Commerce and Industry, Government of
India. The Board set up in the year 1942 focuses on research,
development, extension, quality up-gradation, market infor-
mation, and the domestic and external promotion of Indian
coffee.
67. ‘The great Indian bazaar,’ www.ibef.org.
68. Parija Bhatnagar ‘After caffeinating China, the coffee chain has
its sights set on yet another tea-drinking nation,’ www.cnn.com,
1 November 2004.
69. ‘Starbucks Q3 2006 Earnings Conference Call Transcript,’
http://retail.seekingalpha.com/article/14895, 2 August 2006.
70. www.cafecoffeeday.com.
71. Ibid.
72. Frappe is coffee and ice-cream blended together.
73. ‘Interview with Café Coffee Day marketing head Sudipta Sen
Gupta,’ www.indiantelevision.com, May 27th 2004.
74. As on September 6th 2006, 1 US $ was equal to 46.19 INR.
75. Arthur Cundy ‘Coffee Day parent brews plans to double pres-
ence,’ www.cafelist.blogpost.com, May 17th 2006.
76. ‘Interview with Café Coffee Day marketing head Sudipta Sen
Gupta,’ www.indiantelevision.com, May 27th 2004.
77. Turner Morrison.
78. Parija Bhatnagar ‘Starbucks: A passage to India,’ www.money
.cnn.com, 1 November 2004.
79. www.barista.co.in.
80. ‘Acoffee-man’s ‘circle of influence,’www.rediff.com, 4 February
2003.
81. Non Resident Indian.
82. ‘More Barista cafes,’ www.chennaionline.com, 27 August 2004.
83. Ratna Bhushan ‘Keeping the coffee hot,’ www.thehindubusi-
nessline.com, 22 May 2003.
84. ‘Costa Coffee launch in India,’ www.news.yahoo.com,
8 September, 2005.
85. ‘Barnie’s gourmet coffee enters India,’www.thehindubusinessline
.com, 17 August 2006.
86. ‘Gloria Jeans plans first outlet in Delhi by July,’ http://franchise
.business-opportunities.biz, 24 April 2006.
87. Sravanthi Challapalli ‘There’s deep interest in coffee here,’
www.thehindubusinessline.com, 1 June 2006.
88. The two main types of coffee traded internationally are Arabics and
Robusta. Robusta coffee is a milder variety compared to Arabica.
89. ‘Starbucks to source premium coffee beans from Tata coffee,’
www.tata.com, October 18th 2004.
90. Ibid.
91. Sudha Menon ‘Starbucks coffee firms up India plans,’ www
.blonnet.com. May 26th 2006.
92. The Economic Times.
93. ‘Starbucks seeks partner for India tour,’ www.economictimes
.com, 8 April 2005.
94. Ibid.
95. Op Cit ‘After caffeinating China, the coffee chain has its sights
set on yet another tea-drinking nation.’
96. World Health Association.
97. Amelia Gentleman ‘India’s newly rich battle with obesity,’
www.indiaresource.org, 4 December 2005.
98. ‘Starbucks may be next target of fatty-fighting group,’ www
.foxnews.com, 19 June 2006.
99. www.starbucks.com.
100. Shortening is a fat used in food preparation specially baked
goods. It has 100% fat content.
101. Op Cit ‘Starbucks may be next target of fatty-fighting group.’
102. ‘Starbucks looks for Indian entry early next year,’ www
.helplinelaw.com.
103. Op Cit ‘After caffeinating China, the coffee chain has its sights
set on yet another tea-drinking nation.’
www.indiacoffee.org
www.ibef.org
www.cnn.com
http://retail.seekingalpha.com/article/14895
www.cafecoffeeday.com
www.indiantelevision.com
www.cafelist.blogpost.com
www.indiantelevision.com
www.money.cnn.com
www.money.cnn.com
www.barista.co.in
www.rediff.com
www.chennaionline.com
www.thehindubusinessline.com
www.thehindubusinessline.com
www.news.yahoo.com
www.thehindubusinessline.com
www.thehindubusinessline.com
http://franchise.business-opportunities.biz
http://franchise.business-opportunities.biz
www.thehindubusinessline.com
www.tata.com
www.blonnet.com
www.blonnet.com
www.economictimes.com
www.economictimes.com
www.indiaresource.org
www.foxnews.com
www.foxnews.com
www.starbucks.com
www.helplinelaw.com
www.helplinelaw.com
GUAJILOTE (PRONOUNCED WA-HEE-LOW-TAY) COOPERATIVO FORESTAL WAS A FORESTRY coopera-
tive that operated out of Chaparral, a small village located in the buffer zone of La Muralla
National Park in Honduras’ Olancho province. Olancho was one of 18 Honduran provinces
and was located inland, bordering Nicaragua. The cooperative was one result of a rela-
tively new movement among international donor agencies promoting sustainable eco-
nomic development of developing countries’ natural resources.1 A cooperative in
Honduras was similar to a cooperative in the United States: It was an enterprise jointly
owned and operated by members who used its facilities and services.
Guajilote was founded in 1991 as a component of a USAID (United States Agency for In-
ternational Development) project. The project attempted to develop La Muralla National Park
as an administrative and socioeconomic model that COHDEFOR (the Honduran forestry de-
velopment service) could transfer to Honduras’ other national parks. The Guajilote Coopera-
tivo Forestal was given the right to exploit naturally fallen (not chopped down) mahogany
trees in La Muralla’s buffer zone. Thus far, it was the only venture in Honduras with this right.
A buffer zone was the designated area within a park’s boundaries but outside its core protected
zone. People were allowed to live and engage in economically sustainable activities within this
buffer zone.
In 1998, Guajilote was facing some important issues and concerns that could affect not
only its future growth but its very survival. For one thing, the amount of mahogany wood was
limited and was increasingly being threatened by forest fires, illegal logging, and slash-and-
burn agriculture. If the total number of mahogany trees continued to decline, trade in its wood
could be restricted internationally. For another, the cooperative had no way to transport its
wood to market and was thus forced to accept low prices for its wood from the only distribu-
tor in the area. What could be done to guarantee the survival of the cooperative?
6-1
C A S E 6
Guajilote Cooperativo
Forestal, Honduras
Nathan Nebbe and J. David Hunger
This case was prepared by Nathan Nebbe and Professor J. David Hunger of Iowa State University. Copyright © 1999
and 2005 by Nathan Nebbe and J. David Hunger. This case was edited for SMBP 9th, 10th, 11th, 12th, and 13th editions.
Presented to the Society for Case Research and published in Annual Advances in Business Case 1999. The copyright
holders are solely responsible for its content. Further use or reproduction of this material is strictly subject to the
express permission of copyright holders. Reprinted by permission of the copyright holders, Nathan Nebbe and
J. David Hunger, for the 13th Edition of SMBP.
6-2 SECTION C International Issues in Strategic Management
Operations
Guajilote’s work activities included three operations using very simple technologies. First,
members searched the area to locate appropriate fallen trees. This, in itself, could be very dif-
ficult since mahogany trees were naturally rare. These trees were found at elevations up to
1,800 meters (5,400 feet) and normally were found singly or in small clusters of no more than
four to eight trees per hectare (2.2 acres).2
Finding fallen mahogany in La Muralla’s buffer zone was hampered due to the area’s
steep and sometimes treacherous terrain. (La Muralla means “steep wall of rock” in Spanish.)
The work was affected by the weather. For example, more downed trees were available dur-
ing the wet season due to storms and higher soil moisture—leading to the uprooting of trees.
Second, the cooperative set up a temporary hand-sawmill as close as possible to a fallen
tree. Due to the steep terrain, it was often difficult to find a suitable location nearby to operate
the hand-sawmill. Once a suitable work location was found, men used a large cross-cut saw to
disassemble the tree into various components. The disassembling process was a long and ar-
duous process that could take weeks for an especially large tree. The length of time it took to
process a tree depended on the tree’s size—mature mahogany trees could be gigantic. Tree size
thus affected how many trees Guajilote was able to process in a year.
Third, after a tree was disassembled, the wood was either carried out of the forest using a
combination of mule and human power or floated down a stream or river. Even if a stream hap-
pened to be near a fallen tree, it was typically usable only during the wet season. The wood
was then sold to a distributor who, in turn, transported it via trucks to the cities to sell to fur-
niture makers for a profit.
Guajilote’s permit to use fallen mahogany was originally granted in 1991 for a 10-year
period by COHDEFOR. The permit was simply written, and stated that if Guajilote restricted
itself to downed mahogany, its permit renewal should be granted automatically. The adminis-
trator of the area’s COHDEFOR office indicated that if things remained as they were,
Guajilote should not have any problem obtaining renewal in 2001. Given the nature of Hon-
duran politics, however, nothing could be completely assured.
In 1998, Guajilote’s mahogany was still sold as a commodity. The cooperative did very
little to add value to its product. Nevertheless, the continuing depletion of mahogany trees
around the world meant that the remaining wood should increase in value over time.
Management and Human Resources
Santos Munguia, 29 years old, had been Guajilote’s leader since 1995. Although Munguia
had only a primary school education, he was energetic and intelligent and had proven to be a
very skillful politician. In addition to directing Guajilote, Munguia farmed a small parcel of
land and raised a few head of cattle. He was also involved in local politics.
Munguia had joined the cooperative in 1994. Although he had not been one of Guajilote’s
original members, he quickly became its de facto leader in 1995, when he renegotiated a bet-
ter price for the sale of the cooperative’s wood.
Before Munguia joined the cooperative, Guajilote had been receiving between 3 and
4 lempiras ($0.37, or 11 lempiras to the dollar) per foot of cut mahogany from its sole distrib-
utor, Juan Suazo. No other distributors were available in this remote location. The distributor
transported the wood to Tegucigalpa or San Pedro Sula and sold it for 16 to 18 lempiras per
foot. Believing that Suazo was taking advantage of the cooperative, Munguia negotiated a
price increase to 7 to 8 lempiras per foot ($0.60 to $0.62 per foot at the July 15, 1998, exchange
rate) by putting political pressure on Suazo. The distributor agreed to the price increase only
after a police investigation had been launched to investigate his business dealings. (Rumors
CASE 9 Guajilote Cooperativo Forestal, Honduras 6-3
Munguia: El Caudillo
After renegotiating successfully with the cooperative’s distributor, Munguia quickly became
the group’s caudillo (strong man). The caudillo was a Latin American political and social in-
stitution. A caudillo was a (typically male) purveyor of patronage. All decisions went through,
and were usually made by, him. A caudillo was often revered, feared, and hated at the same
time because of the power he wielded. Munguia was viewed by many in the area as an as-
cending caudillo because of his leadership of Guajilote.
Guajilote did not operate in a democratic fashion. Munguia made all the decisions—
sometimes with input from his second in command and nephew, Miguel Flores Munguia—and
handled all of Guajilote’s financial matters. Guajilote’s members did not seem to have a prob-
lem with this management style. The prevailing opinion seemed to be that Guajilote was a lot
better off with Munguia running the show by himself than with more involvement by the mem-
bers. One man put the members’ view very succinctly: “Santos, he saved us (from Suazo, from
COHDEFOR, from ourselves).”
Guajilote’s organizational structure emphasized Munguia’s importance. He was alone at
the top in his role as decision maker. If, in the future, Munguia became more involved in pol-
itics and other ventures that could take him out of Chaparral (possibly for long periods of
time), he would very likely be forced to spend less time with Guajilote’s operations. Munguia’s
leadership has been of key importance to Guajilote’s maturing as both a work group and as a
business. In 1998, there did not seem to be another person in the cooperative that could take
Munguia’s place.
Guajilote’s Members
When founded, the cooperative had been composed of 15 members. Members were initially
selected for the cooperative by employees of USAID and COHDEFOR. The number of em-
ployees has held steady over time. Since the cooperative’s founding, 3 original members have
quit; 4 others were allowed to join. Although no specific reasons were given for members
leaving, they appeared to be because of personality differences, family problems, or differ-
ences of opinion. No money had been paid to them when they left the cooperative. In 1998
there were 16 members in the cooperative.
None of Guajilote’s members had any education beyond primary school. Many of the
members had no schooling at all and were illiterate. As a whole, the group knew little of mar-
kets or business practices.
Guajilote’s existence has had an important impact on its members. One member stated that
before he had joined Guajilote, he was lucky to have made 2,000 lempiras in a year, whereas
he made around 1,000 to 1,500 in one month as a member of the cooperative. He stated that
all five of his children were in school, something that he could not have afforded previously.
Before joining the cooperative, he had been involved in subsistence farming and other activi-
ties that brought in a small amount of money and food. He said that his children had been re-
quired previously to work as soon as they were able. As a simple farmer, he often had to leave his
family to find work, mostly migrant farm work, to help his family survive. Because of Guajilote,
his family now had enough to eat, and he was able to be home with his family.
This was a common story among Guajilote’s members. The general improvement in its
members’ quality of life also appeared to have strengthened the cooperative members’ per-
sonal bonds with each other.
circulated that Suazo was transporting and selling illegally logged mahogany by mixing it with
that purchased from Guajilote.)
6-4 SECTION C International Issues in Strategic Management
Financial Situation
No formal public financial records were available. As head of the cooperative, Munguia kept
informal records. Guajilote’s 1997 revenues were approximately 288,000 lempiras
(US$22,153). (Revenues for 1996 were not available.) Guajilote processed around 36,000
feet of wood during 1997. Very little of the money was held back for capital improvement
purchases due to the operation’s simple material needs. Capital expenditures for 1997 in-
cluded a mule plus materials needed to maintain Guajilote’s large cross-cut saws.
Each of Guajilote’s 16 members was paid an average of about 1,500 lempiras (US$113)
per month in 1997 and 1,300 lempiras (US$100) per month in 1996. 1998 payments per month
had been similar to 1997’s payments, according to Guajilote’s members. Money was paid to
members based on their participation in Guajilote’s operations.
There was conjecture, among some workers, that Munguia and his second in charge were
paying themselves more than the other members were receiving. When Munguia was asked if
he received a higher wage than the others because of his administrative position in the group,
he responded that everything was distributed evenly. An employee of COHDEFOR indicated,
however, that Munguia had purchased a house in La Union—the largest town in the area. That
person conjectured, based on this evidence, that Munguia was likely receiving more from the
cooperative than were the other members.
Issues Facing the Cooperative
Guajilote’s size and growth potential were limited by the amount of mahogany it could pro-
duce in a year. Mahogany was fairly rare in the forest, and Guajilote was legally restricted to
downed trees. Moreover, with the difficulties of finding, processing by hand, and then mov-
ing the wood out of the forest, Guajilote was further restricted in the quantity of wood it could
handle.
Lack of transportation was a major problem for Guajilote. The cooperative had been un-
able to secure the capital needed to buy its own truck; lending through legitimate sources was
very tight in Honduras and enterprises like Guajilote did not typically have access to lines of
credit. Although the prices the cooperative was receiving for its wood had improved, the men
still thought that the distributor, Juan Suazo, was not paying them what the wood was worth.
It was argued that when demand was high for mahogany, the cooperative gave up as much as
10 lempiras per foot in sales to Suazo. Guajilote could conceivably double its revenues if it
could somehow haul its wood to Honduras’ major market centers and sell it without use of a
distributor. The closest market center was Tegucigalpa—three to four hours from Chaparral on
dangerous, often rain soaked, mountain roads.
A Possibility
Some of the members of Guajilote wondered if the cooperative could do better financially by
skipping the distributor completely. It was possible that some specialty shops (chains and in-
dependents) and catalogs throughout the world might be interested in selling high-quality ma-
hogany furniture, i.e., chests or chairs, that were produced in an environmentally friendly
manner. Guajilote, unfortunately, had no highly skilled carpenters or furniture makers in its
membership. There were, however, a couple towns in Honduras with highly skilled furniture
makers who worked on a contract basis.
A U.S. citizen with a furniture export business in Honduras worked with a number of in-
dependent furniture makers on contract to make miniature ornamental chairs. This exporter re-
CASE 9 Guajilote Cooperativo Forestal, Honduras 6-5
Concerns
In spite of Guajilote’s improved outlook, there were many concerns that could affect the co-
operative’s future. A serious concern was the threat of deforestation through fires, illegal log-
ging (i.e., poaching of mahogany as well as clear cutting), and slash-and-burn agriculture.
Small fires were typically set to prepare soils for planting and to help clear new areas for
cultivation. Often these fires were either not well supervised or burned out of the control of the
people starting them. Due to the 1998 drought, the number of out-of-control forest fires had
been far greater than normal. There seemed to be a consensus among Hondurans that 1998
would be one of the worst years for forest fires. Mahogany and tropical deciduous forests are
not fire resistant. Fires not only kill adult and young mahogany trees, but they also destroy their
seeds.3 Mahogany could therefore be quickly eliminated from a site. Each year, Guajilote lost
more area from which it could take mahogany.
To make matters worse, many Hondurans considered the area around La Muralla National
Park to be a frontier open to settlement by landless campesinos (peasant farmers). In fleeing
poverty and desertification, people were migrating to the Olancho province in large numbers.4
Not only did they clear the forests for cultivation, but they also cut wood for fuel and for use
in building their homes. Most of the new settlements were being established in the area’s best
mahogany growing habitats.
Another concern was that of potential restrictions by CITIES (the international conven-
tion on trade in endangered species). Although trade in mahogany was still permitted, it was
supposed to be monitored very closely. If the populations of the 12 mahogany species contin-
ued to decrease, it was possible that mahogany would be given even greater protection under
the CITIES framework. This could include even tighter restrictions on the trade in mahogany
or could even result in an outright ban similar to the worldwide ban on ivory trading.
N O T E S
viewed Guajilote’s situation and concluded that the cooperative might be able to make and
market furniture very profitably—even if it had to go through an exporter to find suitable mar-
kets. Upon studying Guajilote’s operations, he estimated that Guajilote might be able to more
than treble its revenues. In order to do this, however, the exporter felt that Guajilote would
have to overcome problems with transportation and upgrade its administrative competence.
Guajilote would need to utilize the talents of its members more if it were to widen its opera-
tional scope. It would have to purchase trucks and hire drivers to transport the wood over
treacherous mountain roads. The role of administrator would become much more demanding,
thus forcing Munguia to delegate some authority to others in the cooperative.
1. K. Norsworthy, Inside Honduras (Albuquerque, NM: Inter-
Hemispheric Education Resource, 1993), pp. 133–138.
2. H. Lamprecht, Silviculture in the Tropics (Hamburg, Germany:
Verlag, 1989), pp. 245–246.
3. Ibid.
4. K. Norsworthy, Inside Honduras (Albuquerque, NM: Inter-
Hemispheric Education Resource, 1993), pp. 133–138.
This page intentionally left blank
7-1
C A S E 7
Apple Inc.: Performance
in a Zero-Sum World Economy
Moustafa H. Abdelsamad, Hitesh (John) Adhia, David B. Croll, Bernard A. Morin,
Lawrence C. Pettit Jr., Kathryn E. Wheelen, Richard D. Wheelen,
Thomas L. Wheelen II, and Thomas L. Wheelen
S E C T I O N D
General Issues in Strategic Management
Industry One – Information Technology
ON NOVEMBER 1, 2010, JOHN TARPEY, SENIOR FINANCIAL ANALYST at a securities firm, was
sitting at his conference table to begin the task of fully analyzing the 2010 financial per-
formance and strategic strategies of Apple Inc. On his table were hundreds of articles,
reports, SEC documents, and company documents. The basic question he sought an-
swers to with this in-depth analysis was how Apple’s performance continued to be out-
standing, while the world and U.S. economy was flat to negative.
A second, and more important question, was if Apple could sustain this high level
of performance and major innovation. Exhibit 1 shows unit sales by key products, net
sales by the same products, net sales by the company’s operating segments, and Mac unit
sales by operating segments. John noted that there were nine positive increases versus
three negative ones. He saw that the positive increases outnumbered the negative changes
by three to one. In 2010, there were only three negative changes compared with nine
changes for 2009. Net sales of desktop computers were up 43% in 2010, compared with a
23% drop in sales in 2009.
John considered Apple’s Consolidated Statement of Operations (see Exhibit 2) and
Balance Sheet (see Exhibit 3).
This case was prepared by Professors Thomas L. Wheelen, Moustafa H. Abdelsamad, Hitesh (John) Adhia, Pro-
fessor David B. Croll, Professor Bernard A. Morin, Professor Lawrence C. Pettit Jr., Kathryn E. Wheelen, Richard
D. Wheelen, and Thomas L. Wheelen II. Copyright ©2010 by Richard D. Wheelen. The copyright holder is solely
responsible for the case content. This case was edited for Strategic Management and Business Policy, 13th edition.
Reprinted by permission only for the 13th edition of Strategic Management and Business Policy (including inter-
national and electronic versions of the book). Any other publication of this case (translation, any form of elec-
tronic or media) or sale (any form of partnership) to another publisher will be in violation of copyright law unless
Richard D. Wheelen has granted additional written reprint permission.
7-2 SECTION D Industry One—Information Technology
2010 Change 2009 Change 2008
NET SALES BY OPERATING SEGMENT
Americas net sales $24,498 29% $18,981 15% $16,552
Europe net sales 18,692 58% 11,810 28% 9,233
Japan net sales 3,981 75% 2,279 32% 1,728
Asia-Pacific net sales 8,256 160% 3,179 18% 2,686
Retail net sales 9,798 47% 6,656 -9% 7,292
Total net sales $65,225 52% $42,905 14% $37,491
MAC UNIT SALES BY OPERATING SEGMENT
Americas Mac unit sales 4,976 21% 4,120 4% 3,980
Europe Mac unit sales 3,859 36% 2,840 13% 2,519
Japan Mac unit sales 481 22% 395 2% 389
Asia-Pacific Mac unit sales 1,500 62% 926 17% 793
Retail Mac unit sales 2,846 35% 2,115 4% 2,034
Total Mac unit sales 13,662 31% 10,396 7% 9,715
NET SALES BY PRODUCT
Desktops $6,201 43% $4,324 –23% $5,622
Portables 11,278 18% 9,535 9% 8,732
Total Mac net sales 17,479 26% 13,859 9% 14,354
iPod 8,274 2% 8,091 –12% 9,153
Other music-related
products/services
4,948 23% 4,036 21% 3,340
iPhone and related
products/services
25,179 93% 13,033 93% 6,742
iPad and related
products/services
4,958 – 0 – 0
Peripherals and other hardware 1,814 23% 1,475 –13% 1,694
Software, service, and other
sales
2,573 7% 2,411 9% 2,208
Total net sales $65,225 52% $42,905 14% $37,491
UNIT SALES BY PRODUCT
Desktops 4,627 45% 3,182 –14% 3,712
Portables 9,035 23% 7,214 20% 6,003
Total Mac unit sales 13,662 31% 10,396 7% 9,715
Net sales per Mac unit sold $1,279 –4% $1,333 –10% $1,478
iPod unit sales 50,312 –7% 54,132 –1% 54,828
Net sales per iPod unit sold $164 10% $149 –11% $167
iPhone units sold 39,989 93% 20,731 78% 11,627
iPad units sold 7,458 – 0 – 0
Note: The notes were deleted.
EXHIBIT 1 Selected Sales Information: Apple Inc. (Sales in millions, except unit sales in thousands)
SOURCE: Apple Inc., SEC 10-K Report, (September 25, 2010), p. 33.
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-3
Year Ending September 25 2010 2009 2008
NET SALES $65,225 $42,905 $37,491
Cost of sales 39,541 25,683 24,294
Gross margin 25,684 17,222 13,197
Operating expenses:
Research and development 1,782 1,333 1,109
Selling, general and administrative 5,517 4,149 3,761
Total operating expenses 7,299 5,482 4,870
Operating income 18,385 11,740 8,327
Other income and expenses 155 326 620
Income before provision for income taxes 18,540 12,066 8,947
Provision for income taxes 4,527 3,831 2,828
NET INCOME $14,013 $8,235 $6,119
Earnings per common share:
Basic $15.41 $9.22 $6.94
Diluted $15.15 $9.08 $6.78
Shares used in computing earnings per share:
Basic 909,461 893,016 881,592
Diluted 924,712 907,005 902,139
EXHIBIT 2
Consolidated
Statements of
Operations: Apple
Inc. (Amounts in
millions, except
share amounts
which are reflected
in thousands and
per share amounts)
SOURCE: Apple Inc., SEC 10-K Form (September 25, 2010), p.46.
Management’s View of the Company1
John searched and found in the 10-K report management’s views on the company’s perform-
ance in 2010 as stated below.
First, the company designed, manufactured, and marketed a range of personal comput-
ers, mobile communication and media devices, and portable digital music players, and sold
a variety of related software, services, peripherals, networking solutions, and third-party
digital content and applications. The company’s products and services included Mac
computers, iPhone, iPad, iPod, Apple TV, Xserve, a portfolio of consumer and professional
software applications, the Mac OS X and iOS operating systems, third-party digital content
and applications through the iTunes Store, and a variety of accessory, service, and support
offerings. The company sold its products worldwide through its retail stores, online stores,
and direct sales force, as well as third-party cellular network carriers, wholesalers, retailers,
and value-added resellers. In addition, the company sold a variety of third-party Mac,
iPhone, iPad, and iPod compatible products, including application software, printers, stor-
age devices, speakers, headphones, and various other accessories and peripherals through its
online and retail stores. The company sold to SMB, education, enterprise, government, and
creative markets.
Second, the company was committed to bringing the best user experience to its cus-
tomers through its innovative hardware, software, peripherals, services, and Internet offer-
ings. The company’s business strategy leverages its unique ability to design and develop its
own operating systems, hardware, application software, and services to provide its cus-
tomers new products and solutions with superior ease-of-use, seamless integration, and
7-4 SECTION D Industry One—Information Technology
Years Ending September 30 2010 2009
ASSETS
Current assets
Cash and cash equivalents $ 11,261 $ 5, 263
Short-term marketable securities 14,359 18,201
Accounts receivable, less allowances of $55 and
$52, respectively
5,510 3,361
Inventories 1,051 455
Deferred tax assets 1,636 1,135
Vendor non-trade receivables 4,414 1,696
Other current assets 3,447 1,444
Total current assets 41,678 31,555
Long-term marketable securities $ 25,391 $ 10,528
Property, plant, and equipment, net 4,768 2,954
Goodwill 741 206
Acquired intangible assets, net 342 247
Other assets 2,263 2,011
Total assets $ 75,183 $ 47,501
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities
Accounts payable $ 12,015 $ 5,601
Accrued expenses 5,723 3,852
Deferred revenue 2,984 2,053
Total current liabilities 20,722 11,506
Deferred revenue—non-current 1,139 853
Other non-current liabilities 5,531 3,502
Total liabilities 27,392 15,861
Commitments and contingencies
Shareholders’ equity
Common stock, no par value; 1,800,000,000
shares authorized; 915,970,050, and 899,805,500
shares issued and outstanding, respectively 10,668 8,210
Retained earnings 37,169 23,353
Accumulated other comprehensive (loss)/income –46 77
Total shareholders’ equity 47,791 31,640
Total Liabilities and Stockholders’ Equity $ 75,183 $ 47,501
EXHIBIT 3
Consolidated
Balance Sheets:
Apple Inc. (Dollar
amounts in millions,
except share
amounts)
SOURCE: Apple Inc., SEC 10-K Form (September 25, 2010).
innovative industrial design. The company believed continual investment in research and de-
velopment was critical to the development and enhancement of innovative products and
technologies. In conjunction with its strategy, the company continued to build and host a ro-
bust platform for the discovery and delivery of third-party digital content and applications
through the iTunes Store. Within the iTunes Store, the company expanded its offerings
through the App Store and iBookstore, which allowed customers to browse, search for, and
purchase third-party applications and books through either a Mac or Windows-based com-
puter or by wirelessly downloading directly to an iPhone, iPad, or iPod touch. The company
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-5
also worked to support a community for the development of third-party software and hard-
ware products and digital content that complement the company’s offerings. Additionally,
the company’s strategy included expanding its distribution network to effectively reach more
customers and provide them with a high-quality sales and post-sales support experience. The
company was therefore uniquely positioned to offer superior and well-integrated digital
lifestyle and productivity solutions.
Third, the company participated in several highly competitive markets, including personal
computers with its Mac computers; mobile communications and media devices with its iPhone,
iPad, and iPod product families; and distribution of third-party digital content and applications
with its online iTunes Store. While the company was widely recognized as a leading innovator
in the markets where it competes, these markets were highly competitive and subject to aggres-
sive pricing. To remain competitive, the company believed that increased investment in research
and development, marketing, and advertising was necessary to maintain or expand its position
in these markets. The company’s research and development spending was focused on further de-
veloping its existing Mac line of personal computers; the Mac OS X and iOS operating systems;
application software for the Mac; iPhone, iPad, and iPod and related software; development of
new digital lifestyle consumer and professional software applications; and investments in new
product areas and technologies. The company also believed increased investment in marketing
and advertising programs was critical to increasing product and brand awareness.
The company utilized a variety of direct and indirect distribution channels, including its re-
tail stores, online stores, and direct sales force, as well as third-party cellular network carriers,
wholesalers, retailers, and value-added resellers. The company believed that sales of its inno-
vative and differentiated products were enhanced by knowledgeable salespersons who could
convey the value of the hardware, software, and peripheral integration; demonstrate the unique
digital lifestyle solutions that were available on its products; and demonstrate the compatibility
of the Mac with the Windows platform and networks. The company further believed providing
direct contact with its targeted customers was an effective way to demonstrate the advantages
of its products over those of its competitors, and that providing a high-quality sales and after-
sales support experience is critical to attracting new—and retaining existing—customers. To
ensure a high-quality buying experience for its products in which service and education were
emphasized, the company continued to expand and improve its distribution capabilities by ex-
panding the number of its own retail stores worldwide. Additionally, the company invested in
programs to enhance reseller sales by placing high-quality Apple fixtures, merchandising ma-
terials, and other resources within selected third-party reseller locations. Through the Apple
Premium Reseller Program, certain third-party resellers focused on the Apple platform by pro-
viding a high level of integration and support services, as well as product expertise.
History of Apple Inc.2
The history of Apple can be broken into five separate time periods, each with its own strate-
gic issues and concerns.
1976–1984: The Founders Build a Company
Founded in a California garage on April 1, 1976, Apple created the personal computer revo-
lution with powerful yet easy-to-use machines for the desktop. Steve Jobs sold his
Volkswagen bus and Steve Wozniak hocked his HP programmable calculator to raise $1,300
in seed money to start their new company. Not long afterward, a mutual friend helped recruit
A. C. “Mike” Markkula to help market the company and give it a million-dollar image. Even
7-6 SECTION D Industry One—Information Technology
1985–1997: Professional Managers Fail to Extend the Company
In 1985, amid a slumping market, Apple saw the departure of its founders, Jobs and
Wozniak. As Chairman of the Board, Jobs had recruited John Sculley, an experienced exec-
utive from PepsiCo, to replace him as Apple’s CEO in 1983. Jobs had challenged Sculley
when recruiting him by saying, “Do you want to spend the rest of your life selling sugared
water, or do you want to change the world?” Jobs willingly gave up his title as CEO so that
he could have Sculley as his mentor. In 1985, a power struggle took place between Sculley
and Jobs. With his entrepreneurial orientation, Jobs wanted to continue taking the company
in risky new directions. Sculley, in contrast, felt that Apple had grown to the point where it
needed not only to be more careful in its strategic moves, but also better organized and
rationally managed. The board of directors supported Sculley’s request to strip Jobs of his
duties, since it felt that the company needed an experienced executive to lead Apple into
its next stage of development.
Jobs then resigned from the company he had founded and sold all but one share of his
Apple stock. Under the leadership of John Sculley, CEO and Chairman, the company engi-
neered a remarkable turnaround. He instituted a massive reorganization to streamline opera-
tions and expenses. During this time Wozniak left the company. Macintosh sales gained
momentum throughout 1986 and 1987. Sales increased 40% from $1.9 billion to $2.7 billion
in fiscal 1987, and earnings jumped 41% to $217 million.
In the early 1990s, Apple sold more personal computers than any other computer company.
Net sales grew to over $7 billion, net income to over $540 million, and earnings per share to
$4.33. The period from 1993 to 1995 was, however, a time of considerable change in the man-
agement of Apple. The industry was rapidly changing. Personal computers using Microsoft’s
Windows operating system and Office software plus Intel microprocessors began to dominate
the personal computer marketplace. (The alliance between Microsoft and Intel was known in the
trade as Wintel.) Dell, Hewlett-Packard, Compaq, and Gateway replaced both IBM and Apple as
though all three founders had left the company’s management team during the 1980s,
Markkula continued serving on Apple’s Board of Directors until August 1997.
The early success of Apple was attributed largely to marketing and technological inno-
vation. In the high-growth industry of personal computers in the early 1980s, Apple grew
quickly, staying ahead of competitors by contributing key products that stimulated the de-
velopment of software for the computer. Landmark programs such as Visicalc (forerunner
to Lotus 1-2-3 and other spreadsheet programs) were developed first for the Apple II. Apple
also secured early dominance in the education and consumer markets by awarding hundreds
of thousands of dollars in grants to schools and individuals for the development of educa-
tion software.
Even with enormous competition, Apple revenues continued to grow at an unprece-
dented rate, reaching $583.3 million by fiscal 1982. The introduction of the Macintosh
graphical user interface in 1984, which included icons, pull-down menus, and windows, be-
came the catalyst for desktop publishing and instigated the second technological revolution
attributable to Apple. Apple kept the architecture of the Macintosh proprietary; that is, it
could not be cloned like the “open system” IBM PC. This allowed the company to charge a
premium for its distinctive “user-friendly” features.
A shakeout in the personal computer industry began in 1983 when IBM entered the PC
market, initially affecting companies selling low-priced machines to consumers. Companies
that made strategic blunders or that lacked sufficient distribution or brand awareness of their
products disappeared.
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-7
the primary makers of PCs. The new Windows system had successfully imitated the user-friendly
“look and feel” of Apple’s Macintosh operating system. As a result, Apple lost its competitive
edge. In June 1993, Sculley was forced to resign and Michael H. Spindler was appointed CEO
of the company. At this time, Apple was receiving a number of offers to acquire the company.
Many of the company’s executives advocated Apple’s merging with another company. However,
when no merger took place, many executives chose to resign.
Unable to reverse the company’s falling sales, Spindler was soon forced out and Gilbert
Amelio was hired from outside Apple to serve as CEO. Amelio’s regime presided over an
accelerated loss of market share, deteriorating earnings, and stock that had lost half of its
value. Apple’s refusal to license the Mac operating system to other manufacturers had given
Microsoft the opening it needed to take the market with its Windows operating system. Wintel
PCs now dominated the market—pushing Apple into a steadily declining market niche
composed primarily of artisans and teachers. By 1996, Apple’s management seemed to be in
utter disarray.
Looking for a new product with which Apple could retake the initiative in personal
computers, the company bought NeXT for $402 million on December 20, 1996. Steve Jobs, who
formed the NeXT computer company when he left Apple, had envisioned his new company as
the developer of the “next generation” in personal computers. Part of the purchase agreement
was that Jobs would return to Apple as a consultant. In July of 1997, Amelio resigned and was
replaced by Steve Jobs as Apple’s interim CEO (iCEO). This ended Steve Jobs’ 14-year exile
from the company that he and Wozniak had founded. In addition to being iCEO of Apple, Jobs
also served as CEO of Pixar, a company he had personally purchased from Lucasfilm for
$5 million. Receiving only $1.00 a year as CEO of both Pixar and Apple, Jobs held the Guinness
World Record as the “Lowest Paid Chief Executive Officer.”
1998–2001: Jobs Leads Apple “Back to the Future”
Once in position as Apple’s CEO, Steve Jobs terminated many of the company’s existing
projects. Dropped were the iBook and the AirPort products series, which had helped popu-
larize the use of wireless LAN technology to connect a computer to a network.
In May 2001, the company announced the reopening of Apple Retail Stores. Like
IBM and Xerox, Apple had opened its own retail stores to market its computers during
the 1980s. All such stores had been closed however, when Wintel-type computers began
being sold by mass merchandisers, such as Sears and Circuit City, as well as through cor-
porate websites.
Apple introduced the iPod portable digital audio player, and the company opened its own
iTunes music store to provide downloaded music to iPod users. Given the thorny copyright issues
inherent in the music business, analysts doubted if the new product would be successful.
2002–2006: A Corporate Renaissance?
In 2002, Apple introduced a redesigned iMac using a 64-bit processor. The iMac had a hemi-
spherical base and a flat-panel all-digital display. Although it received a lot of press, the iMac
failed to live up to the company’s sales expectations.
In 2004 and 2005, Apple opened its first retail stores in Europe and Canada. By November
2006, the company had 149 stores in the United States, 4 stores in Canada, 7 stores in the United
Kingdom, and 7 stores in Japan.
In 2006, Jobs announced that Apple would sell an Intel-based Macintosh. Previously,
Microsoft had purchased all of its microprocessors from Motorola. By this time, Microsoft’s
7-8 SECTION D Industry One—Information Technology
2007–Present: Mobile Consumer Electronics Era
While delivering his keynote speech at the Macworld Expo on January 9, 2007, Jobs
announced that Apple Computer, Inc. would from that point on be known as Apple Inc., due
to the fact that computers were no longer the singular focus for the company. This change
reflected the company’s shift of emphasis to mobile electronic devices from personal com-
puters. The event also saw the announcement of the iPhone and the Apple TV. The follow-
ing day, Apple shares hit $97.80, an all-time high at that point. In May, Apple’s share price
passed the $100 mark. In an article posted on Apple’s website on February 6, 2007, Steve
Jobs wrote that Apple would be willing to sell music on the iTunes Store with DRM (which
would allow tracks to be played on third-party players) if record labels would agree to drop
the technology. On April 2, 2007, Apple and EMI jointly announced the removal of DMR
technology from EMI’s catalog in the iTunes Store, effective in May. Other record labels
followed later that year.
In July of the following year, Apple launched the App Store to sell third-party applica-
tions for the iPhone and iPod Touch. Within a month, the store sold 60 million applications
and brought in $1 million daily on average, with Jobs speculating that the App Store could
become a billion-dollar business for Apple. Three months later, it was announced that
Apple had become the third-largest mobile handset supplier in the world due to the popular-
ity of the iPhone.
On December 16, 2008, Apple announced that, after over 20 years, 2009 would be the
last year Steve Jobs would be attending the Macworld Expo, and that Phil Schiller would
deliver the 2009 keynote speech in lieu of the expected Jobs. Almost exactly one month
later, on January 14, 2009, an internal Apple memo from Jobs announced that he would be
taking a six-month leave of absence, until the end of June 2009, to allow him to better focus
on his health and to allow the company to better focus on its products without having the
rampant media speculating about his health. Despite Jobs’ absence, Apple recorded its best
non-holiday quarter (q1 FY 2009) during the recession with revenue of $8.16 billion and a
profit of $1.21 billion.
After years of speculation and multiple rumored “leaks,” Apple announced a large screen,
tablet-like media device known as the iPad on January 27, 2010. The iPad ran the same touch-
based operating system that the iPhone used and many of the same iPhone apps were compat-
ible with the iPad. This gave the iPad a large app catalog on launch even with very little
development time before the release. Later that year on April 3, 2010, the iPad was launched
in the United States and sold more than 300,000 units on that day, reaching 500,000 by the end
of the first week. In May 2010, Apple’s market cap exceeded that of competitor Microsoft for
the first time since 1989.
operating system with Intel microprocessors was running on 97.5% of the personal computers
sold, with Apple having only a 2.5% share of the market. The company also introduced its first
Intel-based machines, the iMac and MacBook Pro.
By this time, Apple’s iPod had emerged as the market leader of a completely new industry
category, which it had created. In 2006, Apple controlled 75.6% of the market, followed by
SunDisk with 9.7%, and Creative Technology in third place with 4.3%. Although one analyst pre-
dicted that more than 30 million iPods would be sold in fiscal 2006, Apple actually sold
41,385,000. Taking advantage of its lead in music downloading, the company’s next strategic
move was to extend its iTunes music stores by offering movies for $9.99 each. An analyst review-
ing this strategic move said that Apple was able to create a $1 billion-a-year market for the legal
sale of music. Apple may be able to provide the movie industry with a similar formula.
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-9
In June 2010, Apple released the fourth generation iPhone, which introduced video
calling, multitasking, and a new insulated stainless steel design which served as the phone’s
antenna. Because of this antenna implementation, some iPhone 4 users reported a reduction in
signal strength when the phone was held in specific ways. Apple offered buyers a free rubber
“bumper” case until September 30, 2010, as cases had been developed to solve/improve the
signal strength issue.
In September 2010, Apple refreshed its iPod line of MP3 players, introducing a multi-
touch iPod Nano, iPod Touch with FaceTime, and iPod Shuffle with buttons. In October 2010,
Apple shares hit an all-time high, eclipsing $300. Additionally, on October 20, Apple updated
its MacBook Air laptop, iLife suite of applications, and unveiled Mac OS X Lion, the latest
installment in its Mac OS X operating system. On November 16, 2010, Apple Inc., after years
of negotiations, finalized a deal to allow iTunes to sell The Beatles’ music at $1.29 per song.
The five major Web-TV boxes were (1) Apple TV, (2) Boxee, (3) Google TV, (4) WD TV Hub,
and (5) Roku.
Steven P. Jobs: Entrepreneur and Corporate Executive3
In 2010, Steve Jobs was chosen as “Executive of the Decade” by Fortune magazine. He has also
been referred to as the “Henry Ford” of the current world business market. Steven P. Jobs was
born on February 24, 1955, in San Francisco. He was adopted by Paul and Clara Jobs in
February 1955. In 1972, Jobs graduated from Homestead High School in Los Altos, California.
His high school electronics teacher said, “He was somewhat of a loner and always had a differ-
ent way of looking at things.” After graduation, Jobs was hired by Hewlett-Packard as a sum-
mer employee. This is where he met Steve Wozniak, a recent dropout from The University of
California at Berkeley. Wozniak had a genius IQ and was an engineering whiz with a passion
for inventing electronic gadgets. At this time, Wozniak was perfecting his “blue box,” an
illegal pocket-size telephone attachment that allowed the user to make free long-distance calls.
Jobs helped Wozniak sell this device to customers.4
In 1972, Jobs enrolled at Reed College in Portland, Oregon, but dropped out after one
semester. He remained around Reed for a year and became involved in the counterculture.
During that year, he enrolled in various classes in philosophy and other topics. In a later
speech at Stanford University, Jobs explained, “If I had never dropped in on that single
course (calligraphy), that Mac would have never had multiple typefaces or proportionally
spaced fonts.”5
In early 1974, Jobs took a job as a video-game designer for Atari, a pioneer in electronic
arcade games. After earning enough money, Jobs went to India in search of personal spiritual
enlightenment. Later that year, Jobs returned to California and began attending meetings of
Steve Wozniak’s “Homebrew Computer Club.” Wozniak converted his TV monitor into what
would become a computer. Wozniak was a very good engineer and extremely interested in
creating new electronic devices. Although Jobs was not interested in developing new devices,
he realized the marketability of Wozniak’s converted TV. Together they designed the Apple I
computer in Jobs’ bedroom and built the first prototype in Jobs’ garage. Jobs showed the
Apple I to a local electronics retailer, the Byte Shop, and received a $25,000 order for
50 computers. Jobs took this purchase order to Cramer Electronics to order the components
needed to assemble the 50 computers.
The local credit manager asked Jobs how he was going to pay for the parts and he replied,
“I have this purchase order from the Byte Shop chain of computer stores for 50 of my comput-
ers and the payment terms are COD. If you give me the parts on net 30 day terms, I can build
and deliver the computers in that time frame, collect my money from Turrell at the Byte Shop
7-10 SECTION D Industry One—Information Technology
and pay you.” With that, the credit manager called Paul Turrell, who was attending an IEEE
computer conference, and verified the validity of the purchase order. Amazed at the tenacity of
Jobs, Turrell assured the credit manager that if the computers showed up in his stores Jobs
would be paid and would have more than enough money to pay for the parts order. The two
Steves and their small crew spent day and night building and testing the computers and
delivered them to Turrell on time to pay his suppliers and have a tidy profit left over for their
celebration and next order. Steve Jobs had found a way to finance his soon-to-be multimillion
dollar company without giving away one share of stock or ownership.6
Jobs and Wozniak decided to start a computer company to manufacture and sell personal
computers. They contributed $1,300 of their own money to start the business. Jobs selected the
name Apple for the company based on his memories of a summer job as an orchard worker.
On April 1, 1976, Apple Computer company was formed as a partnership.
During Jobs’ early tenure at Apple, he was a persuasive and charismatic evangelist for the
company. Some of his employees have described him at that time as an erratic and tempestu-
ous manager.An analyst said that many persons who look at Jobs’management style forget that
he was 30 years old in 1985 and he received his management and leadership education on the
job. Jobs guided the company’s revenues to $1,515,616,000 and profits of $64,055,000 in
1984. Jobs was cited in several articles as having a demanding and aggressive personality. One
analyst said that these two attributes described most of the successful entrepreneurs. Jobs strate-
gically managed the company through a period of new product introduction, rapidly changing
technology, and intense competition—a time during which many companies have failed.
In 1985, after leaving Apple, Jobs formed a new computer company, NeXT Computer Inc.
Jobs served as Chairman and CEO.7 NeXT was a computer company that built machines with
futuristic designs and ran the UNIX-derived NeXT step operating system. It was marketed to
academic and scientific organizations. NeXT was not a commercial success, however, in part
because of its high price.
In 1986, Jobs purchased Pixar Animation from Lucasfilm for $5 million. He provided
another $5 million in capital, owned 50.6% of the stock, and served as Chairman and CEO.
Pixar created three of the six highest grossing domestic (gross revenues) animated films of
all time—Toy Story (1995), A Bug’s Life (1998), and Toy Story 2 (1999). Each of these films,
released under a partnership with the Walt Disney Company, was the highest grossing animated
film for the year in which it was released. During this period, Jobs delegated more to his
executives. Many analysts felt that the excellent executive staff and animators were prime
reasons that Disney management subsequently wanted to acquire Pixar. Jobs served as CEO
of NeXT and Pixar from 1985 to 1997. Jobs ultimately sold NeXT in 1996 to Apple for
$402 million and became iCEO of Apple in July 1997.8
At Pixar, Jobs focused on business duties, which was different than his earlier management
style at Apple. The creative staff was given a great deal of autonomy. Sources say he spent less
than one day a week at the Pixar campus in Emeryville, just across the San Francisco Bay from
Apple’s headquarters. A Pixar employee said, “Steve did not tell us what to do.” He further
stated, “Steve’s our benevolent benefactor.”9
Michael D. Eisner, CEO of the Walt Disney Company, did not have a smooth relation-
ship with Jobs during the years of the Pixar/Disney partnership. Critics explained that Eisner
was unable to work with Jobs because both men were supremely confident (some said
arrogant) that their own judgment was correct—regardless of what others said. In 2005, in
response to Eisner’s unwillingness to modify Disney’s movie distribution agreement with
Pixar, Jobs refused to renew the contract. At the time, Disney’s own animation unit was
faltering and unable to match Pixar’s new computer technology and creativity. Concerned
with Eisner’s leadership style and his inability to support the company’s distinctive compe-
tence in animation, Roy Disney led a shareholders’ revolt. On October 1, 2005, Eisner was
replaced by Robert A. Iger as CEO of Disney.10
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-11
On January 24, 2006, CEO Iger announced that Disney had agreed to pay $7.4 billion in
stock to acquire Pixar Animation Studios. Since this deal made Jobs the largest stockholder
(6.67%) in Disney, he was appointed to Disney’s board of directors.11
Edward S. Woodward Jr., former chairman of Apple Computer, told Apple’s board of
directors, “He (Jobs) has a good relationship with you; there is nobody better with you; there
is nobody better in the world to work with. Iger made a very wise move, and two years from
now everyone will be saying that.”12
Peter Burrows and Ronald Grover stated in an article: “The alliance between Jobs and
Disney is full of promise. If he can bring to Disney the same kind of industry-sharing, boundary-
busting energy that has lifted Apple and Pixar sky-high, he could help the staid company become
the leading laboratory for media convergences. It’s not hard to imagine a day when you could
fire up your Apple TV and watch net-only spin-offs of popular TV shows from Disney’s ABC
Inc. (DIS). Or use your Apple iPhone to watch Los Angeles Lakers superstar Kobe Bryant’s
video blog delivered via Disney’s ESPN Inc. ‘We’ve been talking about a lot of things,’said Jobs.
‘It’s going to be a pretty exciting world looking ahead over the next five years’.”13
An expert on Jobs asked, “So what is Jobs’ secret?” His answer: “There are many, but it
starts with focus and a non-religious faith in his strategy.” In his return to Apple, he took a
proprietary approach as he cut dozens of projects and products. Many on Wall Street were not
initially happy with Jobs’new directions for the company, but soon were impressed by Apple’s
successful turnaround.14
Jim Cramer, host of Mad Money, has said several times on his television program that Steve
Jobs is the “Henry Ford” of this period of America’s industry. Others claim Steve is the present
Thomas Edison. Steve Jobs over the years has received many honors, such as the National
Medal of Technology (with Steve Wozniak) from President Reagan in 1985. Jobs was among
the first people to ever receive the honor, and a Jefferson Award for Public Service in the
category “Greatest Public Service by an Individual 35 Years or Under” (a.k.a. the Samuel S.
Beard Award) in 1987. On November 27, 2007, California Governor Arnold Schwarzenegger
and First Lady Maria Shriver inducted Jobs into the California Hall of Fame, located at the Cal-
ifornia Museum for History, Women and the Arts. In August 2009, Jobs was selected the most
admired entrepreneur among teenagers on a survey by Junior Achievement. On November 5,
2009, Jobs was named the CEO of the decade by Fortune Magazine. On November 22, 2010,
Forbes Magazine named Steve Jobs the “17th Most Powerful Person on Earth.” The list had
only 68 individuals out of the world population of 6.8 billion people.15
Health Concerns
In mid-2004, Jobs announced to his employees that he had been diagnosed with a cancerous
tumor in his pancreas. The prognosis for pancreatic cancer was usually very grim; Jobs,
however, stated that he had a rare, far less aggressive type known as islet cell neuro-endocrine
tumor. After initially resisting the idea of conventional medical intervention and embarking on
a special diet to thwart the disease, Jobs underwent a pancreaticoduodenectomy (or “Whipple
procedure”) in July 2004 that appeared to successfully remove the tumor. Jobs apparently did
not require nor receive chemotherapy or radiation therapy. During Jobs’ absence, Timothy D.
Cook, head of worldwide sales and operations at Apple, ran the company.
In early August 2006, Jobs delivered the keynote speech for Apple’s annual Worldwide
Developers Conference. His “thin, almost gaunt” appearance and unusually “listless” delivery,
together with his choice to delegate significant portions of his keynote speech to other presenters,
inspired a flurry of media and Internet speculation about his health. In contrast, according to
an Ars Technica journal report, WWDC attendees who saw Jobs in person said he “looked
fine”; following the keynote, an Apple spokesperson said that “Steve’s health is robust.”
7-12 SECTION D Industry One—Information Technology
Two years later, similar concerns followed Jobs’ 2008 WWDC keynote address; Apple
officials stated Jobs was victim to a “common bug” and that he was taking antibiotics, while
others surmised his cachectic appearance was due to the Whipple procedure. During a July con-
ference call discussing Apple earnings, participants responded to repeated questions about
Steve Jobs’health by insisting that it was a “private matter.” Others, however, opined that share-
holders had a right to know more, given Jobs’ hands-on approach to running his company. The
New York Times published an article based on an off-the-record phone conversation with Jobs,
noting that “while his health issues have amounted to a good deal more than ‘a common bug,’
they weren’t life-threatening and he doesn’t have a recurrence of cancer.”
On August 28, 2008, Bloomberg mistakenly published a 2,500-word obituary of Jobs in its
corporate news service, containing blank spaces for his age and cause of death. (News carriers cus-
tomarily stockpile up-to-date obituaries to facilitate news delivery in the event of a well-known
figure’s untimely death.) Although the error was promptly rectified, many news carriers and blogs
reported on it, intensifying rumors concerning Jobs’ health. Jobs responded at Apple’s September
2008 Let’s Rock keynote by quoting Mark Twain: “Reports of my death are greatly exaggerated”;
at a subsequent media event, Jobs concluded his presentation with a slide reading “110 / 70,” re-
ferring to his blood pressure, stating he would not address further questions about his health.
On December 16, 2008, Apple announced that Marketing Vice-President Phil Schiller
would deliver the company’s final keynote address at the Macworld Conference and Expo
2009, again reviving questions about Jobs’ health. In a statement given on January 5, 2009,
on Apple.com, Jobs said that he had been suffering from a “hormone imbalance” for several
months. On January 14, 2009, in an internal Apple memo, Jobs wrote that in the previous
week he had “learned that my health-related issues are more complex than I originally
thought” and announced a six-month leave of absence until the end of June 2009 to allow him
to better focus on his health. Tim Cook, who had previously acted as CEO in Jobs’ 2004 ab-
sence, became acting CEO of Apple, with Jobs still involved with “major strategic decisions.”
In April 2009, Jobs underwent a liver transplant at Methodist University Hospital Trans-
plant Institute in Memphis, Tennessee. Jobs’ prognosis was “excellent.”16
On June 29, 2010, Steve Jobs returned to his position as leader at Apple. Jobs had about
10 serious discussions with associates about the possibility of him not returning to active man-
agement at Apple, and what impact his decision would have on Apple’s future success. Most
felt that if Steve departed Apple, “Apple’s future success was in question.”17
Surprised Leave of Absence Announced—2011
Team,
At my request, the board of directors has granted me a medical leave of absence so
I can focus on my health. I will continue as CEO and be involved in major strategic de-
cisions for the company.
I have asked Tim Cook to be responsible for all of Apple’s day to day operations. I
have great confidence that Tim and the rest of the executive management team will do
a terrific job executing plans we have in place for 2011.
I love Apple so much and hope to be back as soon as I can. In the meantime, my
family and I would deeply appreciate respect for our privacy.
Steve
On January 17, 2011, Steve Jobs sent the following e-mail to all Apple employees:
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-13
This was Job’s second leave of absence. The first one was from January 2009 until
June 2009.
Tim Cook, chief operating officer, again took over the day-to day activities of the CEO
position, but Jobs kept the title as he did on his first leave of absence. After Jobs’ first
medical leave of absence was granted in January 2009, a 10% drop occurred in the stock.
On January 19, 2011, the stock’s close price was $348.48; as of the last trade January 20, it
was $340.65 (a change down $7.83 or 2.25%).18 This was not in line with the trading in the
past month.
The following is Timothy (Tim) Cook’s biography sketch as it appeared in the Apple Inc.
2011 Proxy Statement:
Timothy D. Cook, (50) Chief Operating Officer, joined the company in March 1998. Mr. Cook
also served as Executive Vice President, Worldwide Sales Operations from 2002 to 2005.
In 2004, his responsibilities were expanded to include the company’s Macintosh hardware en-
gineering. From 2000 to 2002, Mr. Cook served as Senior Vice President, Worldwide Opera-
tions. Prior to joining the company, Mr. Cook was Vice President, corporate materials for
Compaq Computer Corporation (“Compaq”). Prior to his work at Compaq, Mr. Cook was
Chief Operating Officer of the Reseller Division at Intelligent Electronics. Mr. Cook also
spent 12 years with International Business Machines Corporation (“IBM”), most recently as
Director of North American Fulfillment. Mr. Cook also served as a director for NIKE, Inc.
since November 2005.19
The Apple Board of Directors rewarded Cook’s performance in covering for Jobs in his
day-to-day operations as CEO with a $5 million bonus and $52.5 million in stock options. The
company’s financial performance excelled during these six months.
A side effect of Jobs’ latest announcement was the indefinite delay in the announcement
of the launch of Rupert Murdock’s iPad-only newspaper The Daily—which had been sched-
uled to take place later in January 2011 in San Francisco.”20
A shareholder proposal for the 2011 Apple’s Annual Meeting focused on asking the board
for an executive succession plan and publishing the plan. The board opposed this proposal.21
The meeting was scheduled for February 23, 2011.
On January 18, 2011, Apple announced its first quarter results, which surpassed the ana-
lysts’ expected results. Key financial results are shown in the following table.22
(Dollars in Thousands except per Share)
First Quarter December 31 2011 2010
Revenue $26,741 $15,683
Gross profit 10,298 6,471
Total operating expenses 2,471 1,686
Net income 6,004 3,378
EPS–Basic $6.53 $3.74
EPS–Diluted $6.43 $3.67
“We had a phenomenal holiday quarter with record Mac, iPhone, and iPad sales” said
Steve Jobs, Apple CEO. “We are firing on all cylinders and we’ve got some exciting things in
the pipeline for this year including iPhone on Verizon and consumers can’t wait to get their
hands on it.”23
7-14 SECTION D Industry One—Information Technology
Corporate Governance24
Exhibit 4 lists the eight members of the board of directors and the executive officers as of
January 26, 2010. Steve Jobs, as CEO, was the only internal board member and the only
member who had served on the original board. On September 30, 2006, Fred Anderson, who
had joined the board in 2004, resigned from the board over a stock options investigation. On
August 28, 2006, Dr. Eric Schmidt, CEO of Google, was appointed to the board. Shaw
Nu, analyst, said, “He (Schmidt) gives Jobs and Apple more perspective on dealing with
Microsoft. . . . And like Jobs, Schmidt has lost at times against (Microsoft).” As soon as
Schmidt’s board appointment was announced, speculation began about the potential for future
partnerships between Google and Apple.
On August 3, 2009, Dr. Eric Schmidt resigned from the board because Google was devel-
oping new products which would directly compete with Apple’s products. In 2008, Andrea
Jung became the newest member of the eight member board (see Exhibit 4).
Directors were eligible to receive up to two free computer systems, as well as discounts
on the purchase of additional products. On the fourth anniversary of joining the board, each
member was entitled to receive an option to acquire 30,000 shares of stock.
A. Directors
Name Position Age Since
Fred A. Anderson Director 61 2004
William V. Campbell Co-lead Director 65 1997
Millard S. Drexler Director 61 1999
Albert A. Gore Jr. Director 57 2000
Steven P. Jobs Director and CEO 50 1997
Andrea Jung Co-lead Director 51 2008
Arthur D. Levinson, PhD Co-lead Director 55 2000
Jerome B. York Director 67 1997
B. Executives
Steven P. Jobs
CEO, Apple
CEO, Pixar
Director, Apple
Director, Walt Disney
Timothy D. Cook
Chief Operating Officer
Nancy R. Heinen
Senior Vice President
and General Counsel
Ron Johnson
Senior Vice President Retail
Peter Oppenheimer
Senior Vice President
Chief Financial Officer
Dr. Avdias “Avie” Tevanian Jr.
Chief Software Technology Officer
Jon Rubinstein
Senior Vice President
iPod Divison
Philip W. Schiller
Senior Vice President
Worldwide Product Marketing
Bertrand Seriet
Senior Vice President
Software Engineering
Sina Tamaddon
Senior Vice President, Applications
EXHIBIT 4 Apple’s
Board of Directors
and Top
Management
SOURCE: Apple Inc. SEC DEFR 14a (January 26, 2010), pp. 8 & 13.
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-15
Business Strategy25
The company was committed to bringing the best user experience to its customers through its
innovative hardware, software, peripherals, services, and Internet offerings. The company’s
business strategy leveraged its unique ability to design and develop its own operating systems,
hardware, application software, and services to provide its customers new products and solu-
tions with superior ease-of-use, seamless integration, and innovative industrial design. The
company believed continual investment in research and development was critical to the de-
velopment and enhancement of innovative products and technologies. In conjunction with its
strategy, the company continued to build and host a robust platform for the discovery and de-
livery of third-party digital content and applications through the iTunes Store. The iTunes
Store included theApp Store and iBookstore, which allowed customers to discover and down-
load third-party applications and books through either a Mac or Windows-based computer or
wirelessly through an iPhone, iPad, or iPod touch. The company also worked to support a
community for the development of third-party software and hardware products and digital
content that complemented the company’s offerings.Additionally, the company’s strategy in-
cluded expanding its distribution to effectively reach more customers and provided them with
a high-quality sales and post-sales support experience. The company was therefore uniquely
positioned to offer superior and well-integrated digital lifestyle and productivity solutions.
Although Steve Jobs’ annual salary was only $1.00 as CEO of Apple, the board gave Jobs
a bonus of $84 million in 2001, consisting of $43.5 million for a private jet, a Gulfstream V; as
well as $40.5 million to pay Jobs’ income taxes on this bonus. Jobs owned 10,200,004 shares
(1.25%) of Apple’s stock. The closing price on November 8, 2010, was $318.62 per share.
Consumer and Small and Mid-Sized Business
The company believed a high-quality buying experience with knowledgeable salespersons
who could convey the value of the company’s products and services greatly enhanced its abil-
ity to attract and retain customers. The company sold many of its products and resells certain
third-party products in most of its major markets directly to consumers and businesses
through its retail and online stores. The company has also invested in programs to enhance
reseller sales by placing high-quality Apple fixtures, merchandising materials, and other
resources within selected third-party reseller locations. Through the Apple Premium Reseller
Program, certain third-party resellers focused on the Apple platform by providing a high level
of integration and support services, as well as product expertise.
As of September 25, 2010, the company had opened a total of 317 retail stores—233
stores in the United States and 84 stores internationally. The company typically located
its stores at high-traffic locations in quality shopping malls and urban shopping districts. By
operating its own stores and locating them in desirable high traffic locations, the company
was better positioned to control the customer buying experience and attract new customers.
The stores were designed to simplify and enhance the presentation and marketing of the com-
pany’s products and related solutions. To that end, retail store configurations had evolved into
various sizes to accommodate market-specific demands. The company believed providing
direct contact with its targeted customers was an effective way to demonstrate the advantages
of its products over those of its competitors. The stores employed experienced and knowl-
edgeable personnel who provided product advice, service, and training. The stores offered a
wide selection of third-party hardware, software, and various other accessories and peripher-
als that complemented the company’s products.
7-16 SECTION D Industry One—Information Technology
Education
Throughout its history, the company focused on the use of technology in education and was
committed to delivering tools to help educators teach and students learn. The company
believed effective integration of technology into classroom instruction can result in higher
levels of student achievement, especially when used to support collaboration, information
access, and the expression and representation of student thoughts and ideas. The company
designed a range of products, services, and programs to address the needs of education
customers, including individual laptop programs and education road shows. In addition, the
company supported mobile learning and real-time distribution and accessibility of education-
related materials through iTunes U, which allowed students and teachers to share and distrib-
ute educational media directly through their computers and mobile communication and
media devices. The company sold its products to the education market through its direct sales
force, select third-party resellers, and its online and retail stores.
Enterprise, Government, and Creative
The company also sold its hardware and software products to customers in enterprise,
government, and creative markets in each of its geographic segments. These markets were
also important to many third-party developers who provided Mac-compatible hardware and
software solutions. Customers in these markets utilized the company’s products because of
their high-powered computing performance and expansion capabilities, networking function-
ality, and seamless integration with complementary products. The company designed its
high-end hardware solutions to incorporate the power, expandability, compatibility, and other
features desired by these markets.
Other
In addition to consumer, SMB, education, enterprise, government, and creative markets, the
company provided hardware and software products and solutions for customers in the infor-
mation technology and scientific markets.
Business Organization26
The company managed its business primarily on a geographic basis. The company’s
reportable operating segments consisted of the Americas, Europe, Japan, Asia-Pacific, and
Retail. The Americas, Europe, Japan, and Asia-Pacific reportable segments did not include
activities related to the Retail segment. The Americas segment included both North and South
America. The Europe segment included European countries, as well as the Middle East and
Africa. The Asia-Pacific segment included Australia and Asia, but did not include Japan. The
Retail segment operated Apple-owned retail stores in the United States and in international
markets. Each reportable operating segment provided similar hardware and software prod-
ucts and similar services.
Each of the five operating centers is discussed below.
1. Americas
During 2010, net sales in the Americas segment increased $5.5 billion or 29% compared to
2009. This increase in net sales was driven by increased iPhone revenue, strong demand for
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-17
2. Europe
During 2010, net sales in Europe increased $6.9 billion or 58% compared to 2009. The
growth in net sales was due mainly to a significant increase in iPhone revenue attributable
to continued growth from existing carriers and country and carrier expansion, increased
sales of Mac desktop and portable systems, and strong demand for the iPad, partially offset
by a stronger U.S. dollar. Europe Mac net sales and unit sales increased 32% and 36%,
respectively, during the year due to strong demand for MacBook Pro and iMac. The Europe
segment represented 29% and 28% of the company’s total net sales in 2010 and 2009,
respectively.
During 2009, net sales in Europe increased $2.6 billion or 28% compared to 2008. The
increase in net sales was due mainly to increased iPhone revenue and strong sales of Mac
portable systems, offset partially by lower net sales of Mac desktop systems, iPods, and a
stronger U.S. dollar. Mac unit sales increased 13% in 2009 compared to 2008, which was
driven primarily by increased sales of Mac portable systems, particularly MacBook Pro, while
total Mac net sales declined as a result of lower average selling prices across all Mac products.
iPod net sales decreased year-over-year as a result of lower average selling prices, partially
offset by increased unit sales of the higher priced iPod touch. The Europe segment represented
28% and 25% of total net sales in 2009 and 2008, respectively.
the iPad, continued demand for Mac desktop and portable systems, and higher sales of third-
party digital content and applications from the iTunes Store. Americas Mac net sales and unit
sales increased 18% and 21%, respectively, during 2010 compared to 2009, largely due to
strong demand for MacBook Pro. The Americas segment represented 37% and 44% of the
company’s total net sales in 2010 and 2009, respectively.
During 2009, net sales in the Americas segment increased $2.4 billion or 15% compared to
2008. The increase in net sales during 2009 was attributable to the significant year-over-year in-
crease in iPhone revenue, higher sales of third-party digital content and applications from the
iTunes Store, and increased sales of Mac portable systems, partially offset by a decrease in sales
of Mac desktop systems and iPods. Americas Mac net sales decreased 6% due primarily to lower
average selling prices, while Mac unit sales increased by 4% on a year-over-year basis. The in-
crease in Mac unit sales was due primarily to strong demand for the MacBook Pro. The Americas
segment represented approximately 44% of the company’s total net sales in both 2009 and 2008.
3. Japan
During 2010, Japan’s net sales increased $1.7 billion or 75% compared to 2009. The primary con-
tributors to this growth were significant year-over-year increases in iPhone revenue, strong demand
for iPad, and to a lesser extent strength in the Japanese Yen. Mac net sales increased by 8% driven
by a 22% increase in unit sales due primarily to strong demand for MacBook Pro and iMac, partially
offset by lower average selling prices in Japan on a year-over-year basis. The Japan segment repre-
sented 6% and 5% of the company’s total net sales for 2010 and 2009, respectively.
Japan’s net sales increased $551 million or 32% in 2009 compared to 2008. The primary
contributors to this growth were increased iPhone revenue, stronger demand for certain Mac
portable systems and iPods, and strength in the Japanese Yen, partially offset by decreased
sales of Mac desktop systems. Net sales and unit sales of Mac portable systems increased
during 2009 compared to 2008, driven primarily by stronger demand for MacBook Pro. Net
sales and unit sales of iPods increased during 2009 compared to 2008, driven by strong
demand for iPod touch and iPod nano. The Japan segment represented approximately 5% of
the company’s total net sales in both 2009 and 2008.
7-18 SECTION D Industry One—Information Technology
4. Asia-Pacific
Net sales in Asia-Pacific increased $5.1 billion or 160% during 2010 compared to 2009. The
significant growth in Asia-Pacific net sales was due mainly to increased iPhone revenue, which
was primarily attributable to country and carrier expansion and continued growth from exist-
ing carriers. Asia-Pacific net sales were also favorably affected by strong demand for Mac
portable and desktop systems and for the iPad. Particularly strong year-over-year growth was
experienced in China, Korea, and Australia. The Asia-Pacific segment represented 13% and
7% of the company’s total net sales for 2010 and 2009, respectively. Net sales in Asia-Pacific
increased $493 million or 18% during 2009 compared to 2008, reflecting strong growth in sales
of iPhone and Mac portable systems, offset partially by a decline in sales of iPods and Mac
desktop systems, as well as a strengthening of the U.S. dollar against the Australian dollar and
other Asian currencies. Mac net sales and unit sales grew in the Asia-Pacific region by 4% and
17%, respectively, due to increased sales of the MacBook Pro. The Asia-Pacific segment
represented approximately 7% of the company’s total net sales in both 2009 and 2008.
5. Retail
Retail net sales increased $3.1 billion or 47% during 2010 compared to 2009. The increase in net
sales was driven primarily by strong demand for iPad, increased sales of Mac desktop and
portable systems, and a significant year-over-year increase in iPhone revenue. Mac net sales and
unit sales grew in the retail segment by 25% and 35%, respectively, during 2010. The company
opened 44 new retail stores during the year, 28 of which were international stores, ending the year
with 317 stores open compared to 273 stores at the end of 2009. With an average of 288 stores
and 254 stores opened during 2010 and 2009, respectively, average revenue per store increased
to $34.1 million in 2010, compared to $26.2 million in 2009. The Retail segment represented 15%
and 16% of the company’s total net sales in 2010 and 2009, respectively.
Retail net sales decreased $636 million or 9% during 2009 compared to 2008. The decline
in net sales was driven largely by a decrease in net sales of iPhones, iPods, and Mac desktop sys-
tems, offset partially by strong demand for Mac portable systems. The year-over-year decline in
Retail net sales was attributable to continued third-party channel expansion, particularly in the
United States where most of the company’s stores were located, and also reflects the challeng-
ing consumer-spending environment in 2009. The company opened 26 new retail stores during
2009, including 14 international stores, ending the year with 273 stores open. This compared to
247 stores open as of September 27, 2008. With an average of 254 stores and 211 stores opened
during 2009 and 2008, respectively, average revenue per store decreased to $26.2 million for
2009 from $34.6 million in 2008.
The Retail segment reported operating income of $2.4 billion during 2010 and $1.7 billion
during both 2009 and 2008. The increase in Retail operating income during 2010 compared to
2009 was attributable to higher overall net sales. Despite the decline in Retail net sales during
2009 compared to 2008, the Retail segment’s operating income was flat at $1.7 billion in 2009
compared to 2008, due primarily to a higher gross margin percentage in 2009 consistent with
that experienced by the overall company.
Expansion of the Retail segment has required, and will continue to require, a substantial
investment in fixed assets and related infrastructure, operating lease commitments, personnel,
and other operating expenses. Capital asset purchases associated with the Retail segment since
its inception totaled $2.2 billion through the end of 2010. As of September 25, 2010, the Retail
segment had approximately 26,500 full-time equivalent employees and had outstanding lease
commitments associated with retail space and related facilities of $1.7 billion. The company
would incur substantial costs if it were to close multiple retail stores, and such costs could
adversely affect the company’s financial condition and operating results.
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-19
Product Support and Services27
AppleCare® offered a range of support options for the company’s customers. These options
included assistance that was built into software products, printed and electronic product
manuals, online support including comprehensive product information as well as technical
assistance, and the AppleCare Protection Plan (“APP”). APP was a fee-based service that
typically included two to three years of phone support and hardware repairs, dedicated web-
based support resources, and user diagnostic tools.
Markets and Distribution28
The company’s customers were primarily in the consumer, SMB, education, enterprise, gov-
ernment, and creative markets. The company utilized a variety of direct and indirect distribu-
tion channels, such as its retail stores, online stores, and direct sales force, as well as
third-party cellular network carriers, wholesalers, retailers, and value-added resellers. The
company believed that sales of its innovative and differentiated products were enhanced
by knowledgeable salespersons who could convey the value of the hardware, software, and
peripheral integration; demonstrate the unique digital lifestyle solutions that were available
on its products; and demonstrate the compatibility of the Mac with the Windows platform and
networks. The company further believed providing direct contact with its targeted customers was
an effective way to demonstrate the advantages of its products over those of its competitors
and providing a high-quality sales and after-sales support experience was critical to attract-
ing new—and retaining existing—customers. To ensure a high-quality buying experience for
its products in which service and education were emphasized, the company continued to
expand and improve its distribution capabilities by expanding the number of its own retail
stores worldwide. Additionally, the company invested in programs to enhance reseller sales
by placing high-quality Apple fixtures, merchandising materials, and other resources within
selected third-party reseller locations. Through the Apple Premium Reseller Program, certain
third-party resellers focused on the Apple platform by providing a high level of integration
and support services, as well as product expertise. One of the company’s customers accounted
for 11% of net sales in 2009; there was no single customer that accounted for more than 10%
of net sales in 2010 or 2008.
Competition29
The company was confronted by aggressive competition in all areas of its business. The mar-
kets for the company’s products and services were highly competitive. These markets were
characterized by frequent product introductions and rapid technological advances that had
substantially increased the capabilities and use of personal computers, mobile communica-
tion and media devices, and other digital electronic devices. The company’s competitors who
sold personal computers based on other operating systems had aggressively cut prices and
lowered their product margins to gain or maintain market share. The company’s financial
condition and operating results could be adversely affected by these and other industry-wide
downward pressures on gross margins. The principal competitive factors included price,
product features, relative price/performance, product quality and reliability, design innova-
tion, availability of software and peripherals, marketing and distribution capability, service
and support, and corporate reputation.
The company was focused on expanding its market opportunities related to mobile com-
munication and media devices, including iPhone and iPad. The mobile communications and
7-20 SECTION D Industry One—Information Technology
Supply of Components30
Although most components essential to the company’s business were generally available from
multiple sources, certain key components including but not limited to microprocessors, enclo-
sures,certainliquidcrystaldisplays(“LCDs”),certainopticaldrives,andapplication-specific in-
tegrated circuits (“ASICs”) were currently obtained by the company from single or limited
sources, which subjected the company to significant supply and pricing risks. Many of these and
other key components that were available from multiple sources, including but not limited to
NANDflashmemory,dynamicrandomaccessmemory(“DRAM”),andcertainLCDs,weresub-
ject at times to industry-wide shortages and significant commodity pricing fluctuations. In addi-
tion, thecompanyenteredintocertainagreementsfor thesupplyofkeycomponents includingbut
not limited to microprocessors, NAND flash memory, DRAM, and LCDs at favorable pricing.
However, therewasnoguaranteethecompanywouldbeable toextendorrenewtheseagreements
on similar favorable terms, or at all, upon expiration or otherwise obtain favorable pricing in the
future. Therefore, the company remained subject to significant risks of supply shortages and/or
price increases thatcouldmateriallyadverselyaffect its financialconditionandoperatingresults.
The company and other participants in the personal computer and mobile communication
and media device industries also competed for various components with other industries that
experienced increased demand for their products. In addition, the company used some custom
components that were not common to the rest of these industries, and introduced new prod-
ucts that often utilized custom components available from only one source. When a compo-
nent or product used new technologies, initial capacity constraints existed until the suppliers’
yields had matured or manufacturing capacity had increased. If the company’s supply of a key
single-sourced component for a new or existing product was delayed or constrained, if such
components were available only at significantly higher prices, or if a key manufacturing
media device industries were highly competitive and included several large, well-funded, and
experienced participants. The company expected competition in these industries to intensify
significantly as competitors attempted to imitate some of the iPhone and iPad features and
applications within their own products or, alternatively, collaborate with each other to offer
solutions that were more competitive than those they currently offered. These industries were
characterized by aggressive pricing practices, frequent product introductions, evolving design
approaches and technologies, rapid adoption of technological and product advancements by
competitors, and price sensitivity on the part of consumers and businesses.
The company’s iPod and digital content services faced significant competition from other
companies promoting their own digital music and content products and services, including
those offering free peer-to-peer music and video services. The company believed it offered
superior innovation and integration of the entire solution including the hardware (personal
computer, iPhone, iPad, and iPod), software (iTunes), and distribution of digital content and
applications (iTunes Store, App Store, and iBookstore). Some of the company’s current and
potential competitors had substantial resources and may have been able to provide such prod-
ucts and services at little or no profit or even at a loss to compete with the company’s offer-
ings. Alternatively, these competitors may have collaborated with each other to offer solutions
that were more integrated than those they currently offered.
The company’s future financial condition and operating results were substantially depen-
dent on the company’s ability to continue to develop and offer new innovative products and
services in each of the markets it competed in. In 2010, only AT&T was the carrier for the
iPhone. Verizon began selling a version of the iPhone in early 2011. AT&T activated 11 million
iPhone accounts in the first nine months of 2010. Before Verizon, the iPhone had been exclu-
sive to AT&T since its launch in 2007.
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-21
vendor delayed shipments of completed products to the company, the company’s financial
condition and operating results could be materially adversely affected. The company’s busi-
ness and financial performance could also be adversely affected depending on the time re-
quired to obtain sufficient quantities from the original source, or to identify and obtain
sufficient quantities from an alternative source. Continued availability of these components at
acceptable prices, or at all, may be affected if those suppliers decided to concentrate on the
production of common components instead of components customized to meet the company’s
requirements.
Substantially all of the company’s Macs, iPhones, iPads, iPods, logic boards, and other
assembled products were manufactured by outsourcing partners, primarily in various parts of
Asia. A significant concentration of this outsourced manufacturing was performed by only a
few outsourcing partners of the company, including Hon Hai Precision Industry Co. Ltd. and
Quanta Computer Inc. The company’s outsourced manufacturing was often performed in sin-
gle locations. Among these outsourcing partners were the sole-sourced supplier of components
and manufacturing outsourcing for many of the company’s key products, including but not
limited to final assembly of substantially all of the company’s Macs, iPhones, iPads, and iPods.
Although the company worked closely with its outsourcing partners on manufacturing sched-
ules, the company’s operating results would be adversely affected if its outsourcing partners
were unable to meet their production commitments. The company’s purchase commitments
typically covered the company’s requirements for periods ranging from 30 to 150 days.
The company sources components from a number of suppliers and manufacturing vendors.
The loss of supply from any of these suppliers or vendors, whether temporary or permanent,
would materially adversely affect the company’s business and financial condition.
Research and Development31
Because the industries in which the company competed were characterized by rapid techno-
logical advances, the company’s ability to compete successfully was heavily dependent upon
its ability to ensure a continual and timely flow of competitive products, services, and tech-
nologies to the marketplace. The company continued to develop new products and technolo-
gies and to enhance existing products that expanded the range of its product offerings and
intellectual property through licensing and acquisition of third-party business and technology.
Total research and development expense were $1.8 billion, $1.3 billion, and $1.1 billion in
2010, 2009, and 2008, respectively.
Patents, Trademarks, Copyrights, and Licenses32
The company currently held rights to patents and copyrights relating to certain aspects of its
Macs; iPhone, iPad, and iPod devices; peripherals; software; and services. In addition, the
company registered and/or applied to register trademarks and service marks in the United
States and a number of foreign countries for “Apple,” the Apple logo, “Macintosh,” “Mac,”
“iPhone,” “iPad,” “iPod,” “iTunes,” “iTunes Store,” “Apple TV,” “MobileMe,” and numerous
other trademarks, and service marks. Although the company believed the ownership of such
patents, copyrights, trademarks, and service marks was an important factor in its business and
that its success depended in part on the ownership thereof, the company relied primarily on the
innovative skills, technical competence, and marketing abilities of its personnel.
The company regularly filed patent applications to protect inventions arising from its
research and development, and was currently pursuing thousands of patent applications
around the world. Over time, the company had accumulated a portfolio of several thousand
7-22 SECTION D Industry One—Information Technology
Foreign and Domestic Operations and Geographic Data33
The United States represented the company’s largest geographic marketplace. Approximately
44% of the company’s net sales in 2010 came from sales to customers inside the United States.
Final assembly of the company’s products was performed in the company’s manufacturing fa-
cility in Ireland, and by external vendors in California, Texas, the People’s Republic, of China
(“China”), the Czech Republic, and the Republic of Korea (“Korea”). The supply and manu-
facture of many critical components was performed by sole-sourced third-party vendors in the
United States, China, Germany, Ireland, Israel, Japan, Korea, Malaysia, the Netherlands, the
Philippines, Taiwan, Thailand, and Singapore. Sole-sourced third-party vendors in China per-
formed final assembly of substantially all of the company’s Macs, iPhones, iPads, and iPods.
Margins on sales of the company’s products in foreign countries, and on sales of products that
include components obtained from foreign suppliers, can be adversely affected by foreign cur-
rency exchange rate fluctuations and by international trade regulations, including tariffs and
antidumping penalties.
Seasonal Business34
The company historically experienced increased net sales in its first and fourth fiscal quar-
ters compared to other quarters in its fiscal year due to the seasonal demand of consumer
markets related to the holiday season and the beginning of the school year; however,
this pattern was less pronounced following the introductions of the iPhone and iPad. This
historical pattern should not be considered a reliable indicator of the company’s future net sales
or financial performance.
Warranty35
The company offered a basic limited parts and labor warranty on most of its hardware products,
including Macs, iPhones, iPads, and iPods. The basic warranty period was typically one year
issued patents in the United States and worldwide. In addition, the company held copyrights
relating to certain aspects of its products and services. No single patent or copyright was
solely responsible for protecting the company’s products. The company believed the duration
of the applicable patents it had been granted was adequate relative to the expected lives of its
products. Due to the fast pace of innovation and product development, the company’s prod-
ucts were often obsolete before the patents related to them expired—and sometimes were
obsolete before the patents related to them were even granted.
Many of the company’s products were designed to include intellectual property obtained
from third parties. While it may be necessary in the future to seek or renew licenses relating
to various aspects of its products and business methods, the company believed, based upon
past experience and industry practice, that such licenses generally could be obtained on com-
mercially reasonable terms; however, there was no guarantee such licenses could be obtained
at all. Because of technological changes in the industries in which the company competed,
current extensive patent coverage, and the rapid rate of issuance of new patents, it was pos-
sible certain components of the company’s products and business methods may unknowingly
infringe upon existing patents or the intellectual property rights of others. From time to time,
the company had been notified that it may be infringing upon certain patents or other intel-
lectual property rights of third parties.
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-23
Backlog36
In the company’s experience, the actual amount of product backlog at any particular time
was not a meaningful indication of its future business prospects. In particular, backlog
often increased in anticipation of or immediately following new product introductions as
dealers anticipated shortages. Backlog was often reduced once dealers and customers be-
lieved they were able to obtain sufficient supply. Because of the foregoing, backlog should
not be considered a reliable indicator of the company’s ability to achieve any particular level
of revenue or financial performance.
Environmental Laws
Compliance with federal, state, local, and foreign laws enacted for the protection of the
environment has to date had no significant effect on the company’s capital expenditures, earn-
ings, or competitive position. In the future, however, compliance with environmental laws
could materially adversely affect the company.
Production and marketing of products in certain states and countries may subject the com-
pany to environmental and other regulations including, in some instances, the requirement to
provide customers with the ability to return a product at the end of its useful life, as well as
place responsibility for environmentally safe disposal or recycling with the company. Such
laws and regulations had been passed in several jurisdictions in which the company operates
including various countries within Europe and Asia and certain states and provinces within
North America. Although the company did not anticipate any material adverse effects in the
future based on the nature of its operations and the thrust of such laws, there was no assurance
that such existing laws or future laws will not materially adversely affect the company’s finan-
cial condition or operating results.
Employees
As of September 25, 2010, the company had approximately 46,600 full-time equivalent
employees and an additional 2,800 full-time equivalent temporary employees and contractors.
Legal Proceedings
As of September 25, 2010, the company was subject to the various legal proceedings and
claims as well as certain other legal proceedings and claims that had not been fully resolved
and that had arisen in the ordinary course of business. In the opinion of management, the com-
pany did not have a potential liability related to any current legal proceeding or claim that
would individually or in the aggregate materially adversely affect its financial condition or op-
erating results. However, the results of legal proceedings could not be predicted with certainty.
Should the company fail to prevail in any of these legal matters or should several of these le-
gal matters be resolved against the company in the same reporting period, the operating results
from the date of purchase by the original end-user. The company also offered a 90-day basic
warranty for its service parts used to repair the company’s hardware products. In addition, con-
sumers may purchase the APP, which extended service coverage on many of the company’s
hardware products in most of its major markets.
7-24 SECTION D Industry One—Information Technology
Properties
The company’s headquarters were located in Cupertino, California. As of September 25,
2010, the company owned or leased approximately 10.6 million square feet of building space,
primarily in the United States and, to a lesser extent, in Europe, Japan, Canada, and the
Asia-Pacific regions. Of that amount, approximately 5.6 million square feet was leased, of
which approximately 2.5 million square feet was retail building space. Additionally, the com-
pany owned a total of 480 acres of land in various locations.
As of September 25, 2010, the company owned a manufacturing facility in Cork, Ireland, that
also housed a customer support call center and facilities in Elk Grove, California, that included
warehousing and distribution operations and a customer support call center. In addition, the
company owned facilities for research and development and corporate functions in Cupertino,
California, including land for the future development of the company’s second corporate campus.
The company also owned a data center in Newark, California, and land in North Carolina for a
new data center facility currently under construction. Outside the United States, the company
owned additional facilities for various purposes.
John Tarpey’s Decision
After analyzing Apple’s most recent balance sheets and income statements and integrating
that information with his knowledge of the company, John Tarpey was unsure of his next
move. As a senior financial analyst of a securities firm, he was obligated to make a recom-
mendation. Should he tell his clients to buy, hold, or sell Apple’s common stock?
He had a number of concerns about the company’s future. For example, how dependent
was Apple on Steve Jobs? The shareholder proposal at the most recent shareholder meeting
asking the board to develop an executive succession plan indicated that current shareholders
were certainly worried about Jobs’ health and ability to lead the company. In addition, how
long would it take for Apple’s competitors to catch up with the company’s lead in product
development and perhaps even surpass Apple? There was no doubt in John’s mind that Apple’s
stock price had done very well over the past few years. Even Mad Money’s Jim Cramer was
still touting Apple as the industry’s leader and “best of breed.” Was this a good time to be
of a particular reporting period could be materially adversely affected. The company settled
certain matters during the fourth quarter of 2010 that did not individually or in the aggregate
have a material impact on the company’s financial condition and results of operations.
Software Development Costs
Research and development costs were expensed as incurred. Development costs of computer
software to be sold, leased, or otherwise marketed were subject to capitalization beginning
when a product’s technological feasibility has been established and ending when a product
was available for general release to customers. In most instances, the company’s products
were released soon after technological feasibility had been established. Therefore, costs in-
curred subsequent to achievement of technological feasibility were usually not significant,
and generally most software development costs have been expensed as incurred.
The company did not capitalize any software development costs during 2010. In 2009 and
2008, the company capitalized $71 million and $11 million, respectively, of costs associated
with the development of Mac OS X.
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-25
buying more Apple stock or was the smarter move to sell the stock and take some profit while
it was still a solid performer?
Given Apple’s history of boom-and-bust performance over its lifetime, what should the
company be doing to cement its market leadership in this constantly evolving industry?
N O T E S
1. This section was directly quoted from Apple Inc., “SEC 10-K,”
p. 22, September 25, 2010, p. 32.
2. This section, History of Apple, is a combination of information
from previous revisions of the Apple Case in this book,
Strategic Management and Business Policy, over the past 20
years, Wikipedia, the free encyclopedia, “History of Apple,
Inc., pp. 1–20.
3. This section was directly quoted from “Steve Jobs,” Wikipedia,
the free encyclopedia, pp. 1–8.
4. Ibid., pp. 1–2.
5. Ibid.
6. “History of Apple, Inc.,” pp. 2–3.
7. Previous Apple Case.
8. Pixar, “Corporate Overview,” p. 1.
9. “Steve Jobs Magic Kingdom,” Business Week, p. 3.
10. Ibid., pp. 1–5, and Vandana Sinna, “Disney, Pixar Give Mar-
riage Second Chance,” pp. 1–3.
11. ”Steve Jobs Magic Kingdom,” p. 1.
12. Ibid., p. 2.
13. Ibid.
14. Ibid.
15. “The Most Powerful People on Earth,” Forbes, November 22,
2010, p. 88, and Peter Newcomb, “Business-Person of the
Year,” pp. 136–137.
16. This section was directly quoted from “Steve Jobs—Health
Concerns,” Wikipedia, the free encyclopedia, p. 11.
17. This section was directly quoted from Apple Inc., “SEC 10-K,”
September 23, 2010.
18. These five sections below were directly quoted from Apple Inc.,
“SEC 10-K,” September 25, 2010, p. 1.
19. This section and its five subsections below are directly quoted
from Apple Inc., “SEC 10-K,” September 25, 2010, pp. 36–37.
20. Ibid., p. 5.
21. Ibid., p. 6.
22. Ibid., pp. 6–7.
23. Ibid., p. 7.
24. Ibid., pp. 7–8.
25. Ibid., p. 8.
26. Ibid., pp. 8–9.
27. Ibid., p. 9.
28. Ibid.
29. Ibid.
30. Ibid.
31. Ibid., p. 10.
32. Ibid., p. 10.
33. Ibid., p. 22.
34. Ibid., p. 8.
35. Ibid., p. 21.
Note: Footnotes 20–35 were directly quoted from Apple, Inc.,
“SEC 10-K,” September 25, 2010.
36. Peter Oppenheimer (Chief Financial Officer of Apple Inc.),
“Live Update: Apple 4Q Financial Report.” Presented at Mac-
world live conference. www.macworld.com
www.macworld.com
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IROBOT CORPORATION, FOUNDED IN 1990 IN DELAWARE, designed and built a vast array of
behavior-based robots for home, military, and industrial uses. iRobot was among the first
companies to introduce robotic technology into the consumer market. Home care robots
were iRobot’s most successful products, with over 5 million units sold worldwide and
accounting for over half of its total annual revenue. iRobot had a long-standing contrac-
tual relationship with the U.S. government to produce robots for military defense.
iRobot was fully gauged toward first mover radical innovation with an extensive R&D
budget. Made up of over 500 of the most distinguished robotics professionals in the
world, it aimed at leading the robotics industry. By forming alliances with companies
like Boeing and Advanced Scientific Concepts, it is able to develop and improve upon
products that it otherwise is incapable of obtaining using only its own technology.
The company also has a healthy financial position with an excellent cash and long-term
debt rate.
Despite these competencies, iRobot still had serious concerns. Although the robotics
industry was not highly competitive, iRobot needed more competition to help build up the total
scale and visibility of the fledgling industry it had pioneered. Home care robots, its biggest
revenue source, was a luxury supplemental good. Times of economic recession could prove to
8-1
C A S E 8
iRobot: Finding the Right
Market Mix?
Alan N. Hoffman
This case was prepared by Professor Alan N. Hoffman, Bentley University and Erasmus University. Copyright ©2010 by
Alan N. Hoffman. The copyright holder is solely responsible for case content. Reprint permission is solely granted to the
publisher, Prentice Hall, for Strategic Management and Business Policy, 13th Edition (and the international and electronic
versions of this book) by the copyright holder, Alan N. Hoffman. Any other publication of the case (translation, any form
of electronics or other media) or sale (any form of partnership) to another publisher will be in violation of copyright law,
unless Alan N. Hoffman has granted an additional written permission. Reprinted by permission. The author would like to
thank MBA students Jeremy Elias, Ryan Herrick, Steven Iem, Jaspreet Khambay, and Marina Smirnova at Bentley
University for their research. RSM Case Development Centre prepared this case to provide material for class discussion
rather than to illustrate either effective or ineffective handling of a management situation. Copyright © 2010, RSM Case
Development Centre, Erasmus University. No part of this publication may be copied, stored, transmitted, reproduced or
distributed in any form or medium whatsoever without the permission of the copyright owner, Alan N. Hoffman.
be a problem for the sales of iRobot’s consumer goods given that discretionary budgets are
likely decreased. In addition, iRobot had over 70 patents, many of which will begin to expire
in 2019. In a rapidly advancing industry, technology can also become obsolete quickly and
render patents useless. Additionally, iRobot was highly dependent on several third-party sup-
pliers to manufacture its consumer products. It also depends on the U.S. government for the
sales of its military products. Any volatility in its supply chain or government fiscal policy has
grave consequences for the company’s future.
8-2 SECTION D Industry One—Information Technology
Company History
In the late 1980s, the coolest robots in the world were being developed at the MIT Artificial
Intelligence Lab. These robots, modeled on insects, captured the imagination of researchers,
explorers, military, and dreamers alike. iRobot cofounders, MIT professor Rodney Brooks
and graduates Colin Angle and Helen Greiner, saw this technology as the basis for a whole
new class of robots that could make people’s lives easier and more fun. So, in 1990, the three
decided to work full time on fulfilling this promise and incorporated iRobot in Delaware.1
After leaving the MIT extraterrestrial labs, the three entrepreneurs focused their business
on extraterrestrial exploration, introducing the Genghis for robotic researchers in 1990. In 1998,
the founders shifted their focus onto military tactile robots and consumer robots after landing a
pivotal contract with the U.S. Defense Advanced Research Project Agency (DARPA). This con-
tract provided the funding for necessary R&D to develop new technologies. As a direct result,
iRobot delivered the PacBot to the government in 2001 to assist in the search at the NYC World
Trade Center. In 2010, thousands of PacBots were serving the country on the war front.
In 2002, iRobot began selling its first practical and affordable home robot, the Roomba
vacuuming robot. With millions of Roomba vacuums sold, iRobot has continued to develop
and unveil new consumer robots such as a robotic gutter cleaner and pool vacuum. In 2005,
iRobot raised US$120 million in its IPO and began trading on the NASDAQ stock exchange.
iRobot’s Products and Distribution
iRobot designed and built robots for consumer, government, and industrial use, as shown in
Exhibit 1. On the consumer robots front, the company offered floor cleaning robots, pool
cleaning robots, gutter cleaning robots, and programmable robots. iRobot sold its home
robots through a network of over 30 national retailers. Internationally, iRobot relies on a
network of in-country distributors to sell these products to retail stores in their respective
countries. iRobot also sold its products through its own online store and other online stores
like Amazon and Wal-Mart.
Home robots have been the company’s most successful products with over 5 million units
sold worldwide. Sales of home robots accounted for 55.5% and 56.4% of iRobot’s total
revenue in 2009 and 2008, respectively.2 Currently, iRobot is exploring new technological
opportunities, including those that can automatically clean windows, showers, and toilets. The
potential to fully clean one’s house using automated robots is appealing to customers.
On the government and industrial robotics front, iRobot offered both ground and
maritime unmanned vehicles, selling the vehicles directly to end-users or through prime
contractors and distributors.3 Its government customers included the U.S. Army, U.S. Marine
Corp, U.S. Army and Marine Corps Robotic Systems Joint Program office, U.S. Navy
EOD Technical Division, U.S. Air Force, and Domestic Police and First Responders. For
2009 and 2008, 36.9% and 40.3% (respectively) of iRobot total revenue came from the
U.S. government.
CASE 8 iRobot: Finding the Right Market Mix? 8-3
Consumer Products:
� Roomba floor vacuuming robot: vacuum floors and rugs at the press of a button
(US$129–US$549).
� Scooba floor washing robot: preps, washes, scrubs, and dries hard floor surfaces
(US$299–US$499).
� Verro pool cleaning robot: cleans a standard size pool in about an hour while removing debris
as small as two microns from the pool floor, walls, and stairs (US$399–US$999).
� Looj gutter cleaning robot: simplifies the difficult and dangerous job of gutter cleaning
(US$69–US$129).
� Create programmable robot: a fully assembled programmable robot based on the Roomba
technology that is compatible with Roomba’s rechargeable batteries, remote control, and
other accessories (US$129–US$299).
Government and Industrial Products:
� iRobot 510 PackBot (advanced EOD configuration)
� iRobot 510 PackBot (FasTac configuration)
� iRobot 510 PackBot (First responder configuration)
� iRobot 510 PackBot (Engineer configuration)
� iRobot 210 Negotiator
� 310 SUGV
� iRobot 1Ka Seaglider
� iRobot 710 Warrior
� Daredevil Project
� LANdroids Project
EXHIBIT 1
iRobot Complete
Product Listing
iRobot’s distribution networks were carefully monitored. “We closely manage hand-picked
distributors, so that our involvement on the ground is critical as far as how to sell the product, how
to help them understand the product. But their local knowledge has proven to be equally critical in
finding the right sorts of distribution and handling the customers,” iRobot CEO, Colin Angle, said.4
Competition
The robot-based products market was an emerging market with high entry barriers as it re-
quired new entrants to have access to advanced technology and large amounts of capital to in-
vest in R&D. As a result, the market had relatively few companies competing with each other.
iRobot competed with large and small companies, government contractors, and government-
sponsored laboratories and universities. It also competed with companies producing traditional
push vacuum cleaners such as Dyson and Oreck.
Many of iRobot’s competitors had significantly more financial resources. They include
Sweden-based AB Electrolux, German-based Kärcher, South Korea-based Samsung, UK-based
QinetiQ, and U.S.-based Lockheed competing against iRobot mainly in the robot vacuum
cleaning market and the unmanned ground vehicle market. The iRobot product (for example,
its Roomba vacuum robot) was not the most expensive but was rated the highest across the
majority of the comparison points.
AB Electrolux
Founded in 1910, Electrolux was headquartered in Stockholm, Sweden. It did business in
150 countries with sales of 109 billion SEK (US$15 billion), and was engaged in the
8-4 SECTION D Industry One—Information Technology
manufacture and sales of household and professional appliances. Its Electrolux Trilobite
vacuum cleaner competed with the iRobot’s Roomba vacuum cleaner in the international
markets. Although Electrolux Trilobite is currently unavailable in the United States it was
anticipated to be sold on the company’s website. An Electrolux Trilobite was priced at about
US$1,800, much more than a Roomba, which retailed between US$200 and US$500.
Alfred Kärcher GmbH & Co.
Founded in 1935, Kärcher was a German manufacturer of cleaning systems and equipment,
and was known for its high-pressure cleaners. Kärcher did business worldwide, with sales of
€1.3 billion (US$1.7 billion). In 2003, it launched Kärcher RC 3000, the world’s first au-
tonomous cleaning system that competed with the iRobot Roomba vacuum cleaner in the in-
ternational markets. Kärcher RC 3000 is not currently sold in the United States but can be
purchased and shipped directly from Germany for approximately US$1,500.
Samsung Electronics Co., Ltd
Founded in 1969, Samsung was headquartered in South Korea. Samsung was the world’s
largest electronics company with revenue of US$117.4 billion in 2009. It was a prominent
player in the world market for more than 60 products including home appliances such as
washing machines, refrigerators, ovens, and vacuum cleaners. In November 2009, Samsung
launched Tango, its autonomous vacuum cleaner robot, which was available in South Korea.
In March 2010, the company launched the Samsung NaviBot, an autonomous vacuum
cleaner, in Europe. It was priced at €400 to €600 (US$516 to US$774).
QinetiQ
Founded in 2001, QinetiQ was a defense technology company headquartered in the UK with
revenues of £1.6 billion (US$2.4 billion). It produced aircraft, unmanned aerial vehicles, and
energy products. iRobot’s stiffest competitor in the unmanned aerial vehicles market was
QinetiQ, which had 2,500 Talon robots deployed in Iraq and Afghanistan. iRobot had
delivered more than 3,000 PackBot robots worldwide.
Lockheed Martin Corporation
Based in Maryland, the U.S.-based Lockheed was the world’s second largest defense
contractor by revenue and employed 140,000 people worldwide. It was formed by the merger
of Lockheed and Martin Marietta in 1995, and competed with iRobot in the unmanned ground
vehicle market.
Research and Development at iRobot
Research and development (R&D) was a critical part of iRobot’s success. The company spent
nearly 6% of its revenue on R&D. In 2009, its total R&D costs were US$45.5 million, of
which US$14.7 million was internally funded while the remaining amount was funded by
government-sponsored research and development contracts. iRobot believed that by utilizing
R&D capital it would be able to respond and stay ahead of customer needs by bringing new,
innovative products to the market. iRobot had 538 full-time employees, 254 of which were
in R&D.5
The company’s core technology areas were collaborative systems, semi-autonomous
operations, advanced platforms, and human-robot interaction. Each area provided a unique
benefit to the development and advancement of robot technology. Research in these fields was
CASE 8 iRobot: Finding the Right Market Mix? 8-5
Financial Results
Sales, Net Income, and Gross Margins
From 2005 through 2009, iRobot total revenue more than doubled from US$142 million to
US$299 million. Revenues received from products accounted for nearly 88% of total rev-
enue, far greater than the remaining 12% received from contract revenue, though contract
revenue showed a record high of US$36 million by the end of 2009. (See Exhibit 2).
Revenues from 2009 showed a decline of US$9 million from 2008 that was mainly attrib-
utable to a 6.3% decrease in home robots shipped. This decrease resulted from softening
demand in the domestic market. On a more positive note, the total US$30.9 million decrease
in domestic sales was partially offset by an increase in international sales (US$23.2 million).
Even though revenues declined in 2009, iRobot was able to control its costs and operating
expenses, resulting in an increase in net income of over four-fold from US$756,000 in 2008
to US$3.3 million in 2009.
Cash and Long-Term Debt
iRobot was in a strong financial position as it related to cash and long-term debt. In 2009,
iRobot increased its cash position by over US$31 million while decreasing the amount of long-
term debt by about US$400,000. Its cash position by the end of 2009 was US$72 million
versus US$41 million in 2010, an increase of over 77%. This put iRobot in a good position to
continue investing in research and development even if sales began to slow. At the end of 2009,
iRobot’s long-term debt was just over US$4 million (see Exhibit 3). iRobot’s financial status
gives it a competitive edge as it should be able to withstand both current and future unforeseen
swings in sales, supplier issues, and cancellation of government contracts.
done in three different methods: team organization, spiral development, and the leveraged
model.
Team organization revolved around small teams that focused on certain specific projects
or robots. They worked together with all different lines of the business to ensure that a prod-
uct was well integrated. Primary locations for these teams were Bedford, Massachusetts;
Durham, North Carolina; and San Luis Obispo, California.
Spiral development was used for military products. Newly creatd products were sent into
the field and tested by soldiers with an in-field engineer nearby to receive feedback from the
soldiers on the product’s performance. Updates and improvements were made in a timely man-
ner, and the product was sent back to the field for retesting. This method of in-field testing has
allowed iRobot to quickly improve its technology and design so it can truly fulfill the needs of
the end-users.
The leveraged model used other organizations for funding, research, and product devel-
opment. iRobot’s next generation of military products were supported by various U.S. govern-
ment organizations. Although the government had certain rights to these products, iRobot did
“retain ownership of patents and know-how and are generally free to develop other commer-
cial products, including consumer and industrial products, utilizing the technologies developed
during these projects.”6 The same methodology holds true when designing consumer products.
If expertise was developed that would assist in governmental projects, then it is transferred to
the appropriate team.
iRobot’s continued success depended on its proprietary technology, intellectual skills of
the employees, and the ability to innovate. The company held 71 U.S. patents, 150 pending
U.S. patents, 34 international patents, and more than 108 pending foreign applications. The
patents held, however, will start to expire in 2019.
8-6 SECTION D Industry One—Information Technology
Year Ending
January 2,
2010
December 27,
2008
December 29,
2007
December 30,
2006
December 31,
2005
REVENUE
Product revenue $262,199 $281,187 $227,457 $167,687 $124,616
Contract revenue 36,418 26,434 21,624 21,268 17,352
Total revenue 298,617 307,621 249,081 188,955 141,968
Cost of revenue
Cost of product revenue 176,631 190,250 147,689 103,651 81,855
Cost of contract revenue 30,790 23,900 18,805 15,569 12,534
Total cost of revenue 207,421 214,150 166,494 119,220 94,389
Gross margin 91,196 93,471 82,587 69,735 47,579
Operating expenses
Research and development 14,747 17,566 17,082 17,025 11,601
Selling and marketing 40,902 46,866 44,894 33,969 21,796
General and administrative 30,110 28,840 20,919 18,703 12,072
Litigation and related
expenses — — 2,341 — —
Total operating expenses 85,759 93,272 85,236 69,697 45,469
Operating (loss) income 5,437 199 (2,649) 38 2,110
NET INCOME $3,330 $756 $9,060 $3,565 $2,610
Net income attributable to
common stockholders $3,330 $756 $9,060 $3,565 $1,553
Net income per common share
Basic $0.13 $0.03 $0.37 $0.15 $0.13
Diluted $0.13 $0.03 $0.36 $0.14 $0.11
Shares used in per common
share calculations
Basic 24,998 24,654 24,229 23,516 12,007
Diluted 25,640 25,533 25,501 25,601 14,331
EXHIBIT 2
Consolidated Statement of Operations: iRobot Corporation (Dollar amounts in thousands per share of data)
Marketing
iRobot’s promotion strategies varied by product group; however, neither its defense product
group nor its home care product group utilized television or radio advertising. Since defense
products were produced solely for the U.S. government, promotion was unnecessary. Home
care products, on the other hand, needed to be marketed to generate public demand. iRobot
aggressively utilized social media tools such as Facebook and Twitter primarily for promot-
ing support services and brand recognition. For example, Facebook had at least 10 fan pages
for either iRobot Corporation or selected iRobot home cleaning products like Roomba.
Another branding strategy used by iRobot education. iRobot recognized that fewer and
fewer American children went into STEM (science, technology, engineering, math) areas.
Therefore, it launched the SPARK (Starter Programs for the Advancement of Robotics Knowl-
edge) program to stimulate an interest in science and technology. The program catered to
students from elementary school to university. iRobot also initiated an annual National Robot-
ics Week program to educate the public on how robotics technology impacts society. The first
national robotics week was held in April 2010 in the Museum of Science in Boston.
iRobot developed an education and research robot, the Create(R) programmable mobile
robot, to provide educators, students, and developers with an affordable, pre-assembled plat-
form for hands-on programming and development. Students can learn the fundamentals of
CASE 8 iRobot: Finding the Right Market Mix? 8-7
Year Ending January 2, 2010 December 27, 2008
ASSETS
Current assets
Cash and cash equivalents $71,856 $40,852
Short-term investments 4,959 —
Accounts receivable, net of allowance of $90 and $65 at January 2,
2010, and December 27, 2008, respectively
35,171 35,930
Unbilled revenue 1,831 2,014
Inventory 32,406 34,560
Deferred tax assets 8,669 7,299
Other current assets 4,119 3,340
Total current assets 159,011 123,995
Property and equipment, net 20,230 22,929
Deferred tax assets 6,089 4,508
Other assets 14,254 12,246
Total assets $199,584 $163,678
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK, AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable $30,559 $19,544
Accrued expenses 14,384 10,989
Accrued compensation 13,525 6,393
Deferred revenue and customer advances 3,908 2,632
Total current liabilities 62,376 39,558
Long-term liabilities 4,014 4,444
Commitments and contingencies:
Redeemable convertible preferred stock, 5,000,000 shares authorized
zero outstanding
— —
Common stock, $0.01 par value, 100,000,000 and 100,000,000
shares authorized and 25,091,619 and 24,810,736 shares issued
and outstanding at January 2, 2010, and December 27, 2008,
respectively
251 248
Additional paid-in capital 140,613 130,637
Deferred compensation (64) (314)
Accumulated deficit (7,565) (10,895)
Accumulated other comprehensive loss (41) —
Total stockholders’ equity 133,194 119,676
Total liabilities, redeemable convertible preferred stock,
and stockholders’ equity
$199,584 $163,678
EXHIBIT 3
Consolidated Balance Sheet: iRobot Corporation (Dollar amount in thousands)
robotics, computer science, and engineering; program behaviors, sounds, and movements; and
attach accessories like sensors, cameras, and grippers. It also ran a unique and multifaceted
Educational Outreach Program that included classroom visits and tours of its company head-
quarters. It was designed to inspire students to choose careers in the robotics industry and
become future roboticists.
Despite multiple methods of reaching out to current and potential consumers, some indus-
try analysts claimed iRobot lacked aggressiveness toward customer acquisition. According to
Mark Raskino, analyst for Gartner Research, “iRobot needs more competition, not less, to help
build up the total scale and visibility of the fledgling industry it has been pioneering.”7
8-8 SECTION D Industry One—Information Technology
The Robotic Industry
Robots serve a wide variety of industries such as consumer, automotive, military, construc-
tion, agricultural, space, renewable energy, medical, law enforcement, utilities, manufactur-
ing, entertainment, mining, transportation, space, and warehouse industries.
In 2008, before the economic downturn, the global market for industry robot systems was
estimated to be about US$19 billion.9 Industrial robots sold worldwide in 2009 slumped by
about 50% compared to 2008. The sales started to improve from the third quarter of 2009
onward with the slow recovery coming from emerging markets in Asia and especially from
China. In North America and Europe, sales were also seen slowly improving from late 2009.10
The sales of professional services robots, including military and defense robots, were
about US$11 billon at the end of 2008 and were expected to grow by US$10 billion for the
period of 2009 to 2012.11
Twelve million units of household and entertainment robots were expected to be sold from
2009 to 2012 in the mass market, with an estimated value of US$3 billion.12
New Markets
The 2009 economic recession had negative impacts on consumer spending. iRobot domestic
sales of robot vacuum cleaners, predominantly the Roomba, were down comparable to other
US$400 discretionary purchases, and its international sales also experienced a slowdown.13 In
addition to lower consumer demand, the national and international credit crunches led to a
scarcity of credit, tighter lending standards, and higher interest rates on consumer and business
loans. Continued disruptions in credit markets may limit consumer credit availability and impact
home robot sales.
If the robot market does not experience significant growth, the entire industry may not
survive. “Fallout has forced the robotics industry to look outside of its comfort zone and move
into emerging energy technologies like batteries, wind, and solar power,” said Roger Christian,
Vice President of Marketing and International Groups at Motoman Inc. He also predicted
growing demand for robotics in healthcare and the food and beverage industry.14 Under the
Obama administration, there were economic incentives devoted to R&D in alternative energy
industries. For example, “the Stimulus Act passed by Congress in early 2009, a US$787 billion
package of tax cuts, state aid, and government contracts, has made some impact on the alter-
native energy market in favor of robotics.”15
In addition to its home care and military markets, iRobot hoped to expand into the civil
law enforcement market and the maritime market. It also explored possibilities in the
Operations
iRobot was not a manufacturing company, nor did it claim to be. Its core competency was
to design, develop, and market robots, not manufacture them. All non-core activities were
outsourced to third parties skilled in manufacturing. While third-party manufacturers pro-
vided raw materials and labor, iRobot concentrated on developing and optimizing prototypes.
Until April 2010, iRobot used only two third-party manufacturers for its consumer prod-
ucts: Jetta Co. Ltd. and Kin Yat Industrial Co. Ltd., both located in China. iRobot did not have
a long-term contract with either company, and the manufacturing was done on a purchase
order basis. This changed in April 2010, when iRobot entered a multi-year manufacturing
agreement with electronic parts maker Jabil Circuit Inc., which would make, test, and supply
iRobot’s consumer products, including the Roomba.8
CASE 8 iRobot: Finding the Right Market Mix? 8-9
Challenges Ahead
Consumer Marketplace
iRobot was competing in a new and emerging market. Although the industry had relatively
low competition, analysts believed iRobot needed “more competition, not less, to help build
up the total scale and visibility of the fledgling industry it had been pioneering.”18 If the
demand for the home robots became stagnant or declined, this would greatly impact the
vitality of iRobot and put it under pressure to remain innovative and adaptive to consumer
needs in the event that it did gain widespread popularity.
iRobot’s consumer products were primarily a luxury supplemental good gauged toward
the middle and upper class. iRobot’s home cleaning robots were reasonably priced from
US$129 to US$1,000, depending on the model and accessories. Such a price range was com-
parable with luxury brands of vacuum machines. However, times of economic recession could
prove to be a problem for iRobot’s consumer goods sales given that discretionary budgets have
contracted. To save money, iRobot’s base customers may revert to manual labor.
Supply Chain
For many years, iRobot had only two China-based manufacturers to produce its home clean-
ing robots and had no long-term contract with either of those companies. Its best-selling
Roomba 400 series and Scooba series, for example, were both produced by Jetta at a single
plant in China. This put iRobot in a high-risk situation if Jetta was unable to deliver products
for any unforeseen reason, or if quality started to dip below standards.
Fortunately, iRobot was aware of the problem and signed a new manufacturing agree-
ment with U.S.-based Jabil Circuit. This relationship would provide iRobot with numerous
benefits, including diversifying key elements of its supply chain, providing geographic
flexibility to address new markets, and expanding overall capacity to meet growing demands,
explained Jeffrey Beck, president of iRobot’s Home Robots Division. Whether this attempt
to diversify its supply chain with a new partnership will work out is of crucial importance for
iRobot.
Intellectual Property
Although iRobot had over 70 patents and over 150 patents pending, finding ways to continue
to protect this intellectual property in the long run will be a challenge. The patents iRobot
holds will begin to expire in 2019. In a rapidly advancing industry, technology can also
become obsolete quickly and render patents useless.
Continued development of products that were difficult to duplicate through reverse engi-
neering will be the key to success in this area. By maintaining strong relationships and giving
superior service to customers such as government agencies, iRobot can create an advantage
even if they are unable to ultimately protect their technology from being duplicated. At the
same time, iRobot also needs to ensure that its employees will continue to be innovative and
create new technologies to keep iRobot competitive for years to come.
healthcare market.16 It partnered with the toy company Hasbro to enter the toy market with
My Real Baby—an evolutionary doll that has animatronics and emotional response software.
iRobot continued to grow its international presence by entering new markets. The percent-
age of its international sales rose from 38% in 2008 to 53.8% in 2009.17 Its growing focus on
international sales resulted in an increase of US$23.2 million in international home robots
revenue for 2009 compared to 2008. iRobot also sold its military products overseas in compli-
ance with the International Traffic in Arms Regulations.
8-10 SECTION D Industry One—Information Technology
Government Contracts
Nearly 40% of iRobot’s revenues were from government-contracted military robots. As a
contractor or a subcontractor to the U.S. government, iRobot was subject to federal regula-
tions. Fiscal policy and expenditure can be volatile, not only through a single presidency, but
certainly during the transition from one presidency to the next. The volatility and unknown
demand of the U.S. government presented a problem. The economic fallout from the reces-
sion also impacted U.S. federal budgetary considerations. Emphasis and focus had been
placed on larger, more troubled industries, with large bailout packages made available to
financial and automotive companies. It remains to be seen how these large outlays will affect
the federal government’s ability to continue to fund contracts for robotics.
Strategic Alliances
iRobot relied on strategic alliances to provide technology, complementary product offerings, and
better and quicker access to markets. It entered an agreement with The Boeing Company to de-
velop and market a commercial version of the SUGV that was being developed under the Army’s
BCTM (formerly FCS) program. It also formed an alliance with Advanced Scientific Concepts
Inc. for exclusive rights to use the latter’s LADAR technology of unmanned ground vehicles. In
exchange, iRobot commited itself to purchase units from Advanced Scientific Concepts.
iRobot’s Challenge
iRobot’s focus on home cleaning products differentiates iRobot from all the other manufac-
turers in the robotics industry, which are mainly focused on manufacturing robots for the
automotive sector. iRobot’s focus on two entirely different markets—consumer and military—
allowed it (1) the ability to leverage its core capabilities and diversification, and (2) provided
it with a hedge against slower demand in one sector. By introducing robotics to the consumer
market, iRobot created a “blue ocean of new opportunities.” However, iRobot had numerous
competitors with more experience in the consumer marketplace.
An analyst wondered if the long-term success in the consumer market would require iRobot
to develop more “blue oceans.” Also, did it make sense for iRobot to continue to develop new con-
sumer products or would it be better off focusing on the military and aerospace marketplace?
1. http://www.irobot.com/uk/about_irobot_story.cfm.
2. iRobot 2009 Annual Report, Form 10K, filed February 19, 2010.
3. Ibid.
4. M. Raskino, (a), 2010, “Insights on a Future Growth Industry.”
An interview with Colin Angle, CEO, iRobot. http://my.gartner
.com/portal/server.pt?open=512&objID=260&mode=2&PageID
=3460702&resId=1275816&ref=QuickSearch&sthkw=irobot.
5. iRobot 2009 Annual Report, 2010.
6. Ibid.
7. M. Raskino, (b), 2010, “Cool Vendors in Emerging Technologies,”
2010. http://my.gartner.com/portal/server.pt?open=512&objID
=260&mode=2&PageID=3460702&resId=133843&ref=Quick
Search&sthkw=irobot.
8. “iRobot Enters Manufacturing Deal with Jabil,” The Lowell
Sun, (April 28, 2010). http://www.lowellsun.com/latestnews/
ci_ 14830219.
9. Press information, World Robotics 2009—Industrial Robots.
http://worldrobotics.org/downloads/PR_Industrial_Robots_
30.09.2009_EN(1) .
N O T E S
10. Gudrun Litzenberger, IFR Statistical Department, “The Robot-
ics Industry Is Looking Ahead with Confidence to 2010,”
�http:// www.worldrobotics.org/downloads/IFR_Press_release_
18_ Feb_2010 .
11. Ibid.
12. Ibid.
13. M. Raskino, (a), 2010.
14. B. Brumson, 2010, “Robotics Market Cautiously Optimistic for
2010.” Robotic Industries Association. http://www.robotics.org/
content-detail.cfm/Industrial-Robotics-Feature-Article/Robotics-
Market-Cautiously-Optimistic-for-2010/content_id/1936.
15. Ibid.
16. Robotreviews, 2010, “iRobot Celebrates Two Decades of Inno-
vation in Robotics,” http://www.robotreviews.com/news/
its-national-robotics-week.
17. iRobot 2009 Annual Report, 2010.
18. M. Raskino, (b), 2010.
http://www.irobot.com/uk/about_irobot_story.cfm
http://my.gartner.com/portal/server.pt?open=512&objID=260&mode=2&PageID=3460702&resId=1275816&ref=QuickSearch&sthkw=irobot
http://my.gartner.com/portal/server.pt?open=512&objID=260&mode=2&PageID=3460702&resId=1275816&ref=QuickSearch&sthkw=irobot
http://my.gartner.com/portal/server.pt?open=512&objID=260&mode=2&PageID=3460702&resId=133843&ref=QuickSearch&sthkw=irobot
http://www.lowellsun.com/latestnews/ci_14830219
http://www.lowellsun.com/latestnews/ci_14830219
http://worldrobotics.org/downloads/PR_Industrial_Robots_30.09.2009_EN(1)
http://worldrobotics.org/downloads/PR_Industrial_Robots_30.09.2009_EN(1)
http://www.worldrobotics.org/downloads/IFR_Press_release_18_Feb_2010
http://www.worldrobotics.org/downloads/IFR_Press_release_18_Feb_2010
http://www.robotics.org/content-detail.cfm/Industrial-Robotics-Feature-Article/Robotics-Market-Cautiously-Optimistic-for-2010/content_id/1936
http://www.robotics.org/content-detail.cfm/Industrial-Robotics-Feature-Article/Robotics-Market-Cautiously-Optimistic-for-2010/content_id/1936
http://www.robotics.org/content-detail.cfm/Industrial-Robotics-Feature-Article/Robotics-Market-Cautiously-Optimistic-for-2010/content_id/1936
http://www.robotreviews.com/news/its-national-robotics-week
http://www.robotreviews.com/news/its-national-robotics-week
http://my.gartner.com/portal/server.pt?open=512&objID=260&mode=2&PageID=3460702&resId=1275816&ref=QuickSearch&sthkw=irobot
http://my.gartner.com/portal/server.pt?open=512&objID=260&mode=2&PageID=3460702&resId=133843&ref=QuickSearch&sthkw=irobot
http://my.gartner.com/portal/server.pt?open=512&objID=260&mode=2&PageID=3460702&resId=133843&ref=QuickSearch&sthkw=irobot
DELL INC. was founded in 1984 by Michael Dell at age 19 while he was a student living in a
dormitory at the University of Texas. As a college freshman, he bought personal computers
(PCs) from the excess inventory of local retailers, added features such as more memory
and disk drives, and sold them out of the trunk of his car. He withdrew $1,000 in personal
savings, used his car as collateral for a bank loan, hired a few friends, and placed ads in
the local newspaper offering computers at 10%–15% below retail price. Soon he was sell-
ing $50,000 worth of PCs a month to local businesses. Sales during the first year reached
$600,000 and doubled almost every year thereafter. After his freshman year, Dell left school
to run the business full time.
Michael Dell began assembling his own computers in 1985 and marketed them through
ads in computer trade publications. Two years later, his company witnessed tremendous
change: It launched its first catalog, initiated a field sales force to reach large corporate ac-
counts, went public, changed its name from PCs Limited to Dell Computer Corporation, and
established its first international subsidiary in Britain. Michael Dell was selected “Entrepre-
neur of the Year” by Inc. in 1989, “Man of the Year” by PC Magazine in 1992, and “CEO of
the Year” by Financial World in 1993. In 1992, the company was included for the first time
among the Fortune 500 roster of the world’s largest companies.
By 1995, with sales of nearly $3.5 billion, the company was the world’s leading direct
marketer of personal computers and one of the top five PC vendors in the world. In 1996, Dell
supplemented its direct mail and telephone sales by offering its PCs via the Internet at dell.com.
By 2001, Dell ranked first in global market share and number one in the United States for
shipments of standard Intel architecture servers. The company changed its name to Dell Inc.
9-1
C A S E 9
Dell Inc.: Changing the Business
Model (Mini Case)
J. David Hunger
This case was prepared by Professor J. David Hunger, Iowa State University and St. John’s University. Copyright ©2010
by J. David Hunger. The copyright holder is solely responsible for case content. Reprint permission is solely granted to
the publisher, Prentice Hall, for Strategic Management and Business Policy, 13th Edition (and the international and
electronic versions of this book) by the copyright holder, J. David Hunger. Any other publication of the case (translation,
any form of electronics or other media) or sale (any form of partnership) to another publisher will be in violation of
copyright law, unless J. David Hunger has granted an additional written permission. Reprinted by permission.
in 2003 as a way of reflecting the evolution of the company into a diverse supplier of technol-
ogy products and services. In 2005, Dell topped Fortune’s list of “Most Admired Companies.”
Fiscal year 2005 (Dell’s fiscal year ended in early February or late January of the same calen-
dar year) was an outstanding year in which the company earned $3.6 billion in net income on
$55.8 billion in net revenue.
Soon, however, increasing competition and cost pressures began to erode Dell’s margins.
Even though the company’s net revenue continued to increase to $57.4 billion in fiscal year
2007 and $61.1 billion during fiscal year 2008, its net income dropped to $2.6 billion in 2007
with a slight increase to $2.9 billion in 2008. The “great recession” of 2008–2009 took its toll
on both Dell and the computer industry. Dell’s fiscal 2010 (ending January 29, 2010) net
income fell further to $1.4 billion on $52.9 billion in net revenue. Sales improved during
calendar year 2010 as the global economy showed signs of recovery. Net revenue for February
through July 2010 increased to $30.4 billion compared to only $25.1 billion during the first
half of 2009, while first half net income rose to $886 million in 2010 compared to $762 million
during the same period in 2009. Nevertheless, Dell’s net income was only 2.91% of net revenue
during the first half of 2010 contrasted with a much rosier 6.45% during 2006. (Note: Dell’s
financial reports are available via the company’s website at www.dell.com.)
9-2 SECTION D Industry One—Information Technology
Problems of Early Growth
The company’s early rapid growth resulted in disorganization. Sales jumped from $546 million
in fiscal 1991 to $3.4 billion in 1995. Growth had been pursued to the exclusion of all else,
but no one seemed to know how the numbers really added up. When Michael Dell saw that
the wheels were beginning to fly off his nine-year-old entrepreneurial venture, he sought
older, outside management help. He temporarily slowed the corporation’s growth strategy
while he worked to assemble and integrate a team of experienced executives from companies
like Motorola, Hewlett-Packard, and Apple.
The new executive team worked to get Dell’s house in order so that the company could
continue its phenomenal sales growth. Management decided in 1995 to abandon distribution
of Dell’s products through U.S. retail stores and return solely to direct distribution. This
enabled the company to refocus Dell’s efforts in areas that matched its philosophy of high
emphasis on customer support and service. In July 2004, Kevin Rollins replaced Michael Dell
as Chief Executive Officer, allowing the founder to focus on being Chairman of the Board. This
situation did not last long, however. Rising sales coupled with rapidly falling net income
caused Michael Dell to rethink his retirement and resume his role as CEO in January 2007.
Although Michael Dell in 2010 owned only 11.7% of the corporation’s stock, at age 45, he owned
the largest block of stock and continued to be the “heart and soul” of the firm. The rest of the
directors and executive officers owned less than 1% of the stock.
Business Model
Dell’s original business model was very simple: Dell machines were made to order and
delivered directly to the customer. The company had no distributors or retail stores. Dell PCs
had consistently been listed among the best PCs on the market by PC World and PC
Magazine. Cash flow was never a problem because Dell was paid by customers long before
Dell paid its suppliers. The company held virtually no parts inventory. As a result, Dell made
computers more quickly and cheaply than any other company.
Dell became the master of process engineering and supply chain management. It spent
less on R&D than did Apple or Hewlett-Packard, but focused its spending on improving
www.dell.com
CASE 9 Dell Inc.: Changing the Business Model (Mini Case) 9-3
its manufacturing process. (Dell spent 1% of sales on R&D versus the 5% typically invested
by other large computer firms.) Instead of spending its money on new computer technology,
Dell waited until a new technology became a standard. Michael Dell explained that soon
after a technology product arrived on the market, it was a high-priced, high-margin item
made differently by each company. Over time, the technology standardized—the way PCs
standardized around Intel microprocessors and Microsoft operating systems. At a certain point
between the development of the standard and its becoming a commodity, that technology
became ripe for Dell. When the leaders were earning 40% or 50% profit margins, they were
vulnerable to Dell making a profit on far smaller margins. Dell drove down costs further
by perfecting its manufacturing processes and using its buying power to obtain cheaper parts.
Its reduction of overhead expenses to only 9.6% of revenue meant that Dell earned nearly
$1 million in revenue per employee—three times the revenue per employee at IBM and almost
twice HP’s rate.
Although the company outsourced some operations, such as component production and
express shipping, it had its own assembly lines in the United States, Malaysia, China, Brazil,
India, and Poland. A North Carolina plant had been opened in 2005 as Dell’s third American
desktop plant. Cost pressures had, however, caused management to rethink its manufacturing
strategy. They closed the company’s desktop plants in Texas and Tennessee in 2008 and 2009
respectively, and were planning to close the firm’s last desktop assembly plant in North Carolina
in January 2011. From then on, desktop assembly for the North American market would take
place in Dell’s factories in other countries and by contract manufacturers in Asia and Mexico.
In Europe, the company closed its Ireland plant and sold its plant in Poland to Foxconn
Technology, a unit of Hon Hai, the world’s largest contract manufacturer. They then contracted
with Foxconn for manufacturing services. In contrast to its global desktop manufacturing
strategy, 95% of Dell’s notebook computers were assembled in Dell’s plants in Malaysia
and China.
After its failed experiment with distribution through U.S. retail stores in the 1990s,
management again changed its mind regarding its reliance on direct marketing. Over time,
Dell’s competitors had imitated Dell’s direct marketing model, but were also successfully selling
through retail outlets. A presence in retail was becoming especially important in countries outside
North America. Sales in these countries were often based on the advice of sales staff, putting
Dell’s “direct only” business model at a disadvantage. In response, Dell began shipping
its products in 2007 to major U.S. and Canadian retailers, such as Wal-Mart, Sam’s Club, Staples,
and Best Buy. This was soon followed by sales elsewhere in the world through DSGI, GOME,
and Carrefour, among others, to number over 56,000 outlets worldwide.
Product Line and Structure
Over the years, Dell Inc. has broadened its product line to include not only desktop and lap-
top (listed under mobility) computers, but also servers, storage systems, printers, software,
peripherals, and services, such as infrastructure services. By 2010, net revenue by product
line was composed of desktop PCs (25%), mobility (31%), software and peripherals (18%),
servers and networking (11%), services (11%), and storage (4%). Desktop PCs’ net revenue
dropped from 38% in 2006, with each of the other product lines (especially mobility) increas-
ing as a percentage of total revenue. Although the 2010 gross margin for all Dell products was
only 14.1% of sales, due to a lower average selling price, the gross margin for services, in-
cluding software, was a much fatter 33.7%.
Dell’s corporate headquarters was located in Round Rock, Texas, near Austin. In 2009, the
company was reorganized from a geographic structure into four global business units based on
9-4 SECTION D Industry One—Information Technology
The Industry Matures
By 2006, the once torrid growth in PC sales had slowed to about 5% a year. Sales fell signif-
icantly during the “great recession” of 2008–2009 as companies and consumers deferred
computer purchases. With the economy improving, the output of U.S. computer manufacturers
was forecast to grow at an annual compounded rate of 7% between 2010 and 2015.
Nevertheless, margins were getting progressively smaller for the desktop PC, Dell’s flagship
product. Competitors were becoming increasingly competitive in both desktop and mobile
computers.
Gateway, for example, found ways to reduce its costs and fight its way back to prof-
itability. The same was true for Hewlett-Packard (HP) once it had digested its acquisition of
Compaq. Asian manufacturers, such as Acer, Toshiba, and Lenovo, with strengths in laptops
were becoming major global competitors. Ironically, by driving down supplier costs, Dell
also reduced its rivals’ costs. In addition, the sales growth in the computer industry was in
the consumer market and in emerging countries rather than in the corporate market and
developed countries in which Dell sold most of its products. Between 2006 and 2010,
HP replaced Dell as the company with the largest global market share in personal computers.
Using price reductions, Dell was now battling with Acer for second place in global PC
market share.
As the personal computer became more like a commodity, consumers were no longer
interested in paying top dollar for a computer unless it was “unique.” Wal-Mart and Best Buy
were selling basic laptop computers for less than $300 in 2010 and intended to maintain this
pricing so long as manufacturers continued to supply low-cost products. PC notebook sales
had been falling during 2010, primarily due to the introduction of Apple’s highly featured iPad
and the consequent rise in “tablet” PC sales. According to Morgan Stanley, Apple’s iPad
cannibalized about 25% of PC notebook sales since its introduction in April through August, 2010.
Dell countered the iPad with a tablet computer called Streak in May 2010, but failed to generate
much enthusiasm or sales for this product.
As corporate buyers increasingly purchased their computer equipment as part of a pack-
age of services to address specific problems, service-oriented rivals like IBM, HP, and Oracle
had an advantage over Dell. All of these competitors had made large commitments to servers,
software, and consulting—all having higher margins than personal computers. IBM had sold
its laptop, hard drive, and printer businesses to focus on building its services business.
Hewlett-Packard acquired Electronic Data Systems in 2008 to boost its expertise in services.
By offering customers a package of servers, software, and storage, HP dominated the server
business with 32% market share, with IBM closely following with 28% share of the market.
Oracle’s acquisition of Sun Microsystems gave it 8% of the server market. IBM and Oracle
offered proprietary server platforms in enterprise accounts. In contrast, Dell (along with HP)
offered x86 open-system servers. In order to better compete in the large enterprise market
segment, Dell purchased Perot Systems, an IT services company, in 2009. Even after this
acquisition, however, services accounted for only 13% of Dell’s sales. In 2010, Dell attempted
to acquire 2PAR, a data storage firm, but was outbid by HP.
customers: Large Enterprise, Public, Small & Medium Business, and Consumer. Its 2010 revenue
by segment was 27% from Large Enterprise, 27% from Public, 23% from Small & Medium
Business, and 23% from the Consumer unit. Interestingly, operating income as a percentage of
total revenue totaled 9% for both Public and Small & Medium Business units, 6% from Large
Enterprise, and only 1% from the Consumer unit. Commercial customers accounted for 77% of
total revenue. Dell was dependent upon the U.S. market for 53% of its total 2010 revenues.
CASE 9 Dell Inc.: Changing the Business Model (Mini Case) 9-5
Issues and Strategy
Since 2007, when Michael Dell resumed being the company’s CEO, Dell has made more than
10 acquisitions, cut about 10,000 jobs, and hired executives from Motorola and Nike to add more
excitement to its product line. Its $3.6 billion purchase of Perot Systems allowed it to expand
into higher-margin computing services. Nevertheless, Dell’s stock fell 42% since January 2007,
during a period in which Hewlett-Packard’s stock gained 11% and IBM gained 31%.
The industry’s focus shifted from desktop PCs to mobile computing, software, and
technology services—areas of relative weakness at Dell. Due to a changing industry, the com-
pany’s original business model based on direct sales and value chain efficiencies had been
abandoned. It was now using the same distribution channels, component providers, and assem-
bly contractors as its competitors. Unfortunately, Dell’s emphasis on cost reduction and com-
petitive pricing meant that it was no longer perceived as providing high-quality personal
computers or the quality service to go with them. Previously a strength of the company, its
customer service rating in 2005 fell to a score of 74 (average for the industry) in a survey by
the University of Michigan. Complaints about Dell’s service more than doubled in 2005 to
1,533. Although the company successfully worked to improve customer satisfaction by adding
more service people, more people meant increased costs and smaller margins.
In order to improve the company’s competitive position, Dell’s management initiated a
three-pronged strategy:
� Improve the core business by profitably growing the desktop and mobile computer business
and enhancing the online experience for customers. This involved cost-savings initiatives
and simplifying product offerings.
� Shift the portfolio to higher-margin and recurring revenue offerings by expanding the
customer solutions business in servers, storage, services, and software. This involved
growing organically as well as through acquisitions.
� Balance liquidity, profitability, and growth by maintaining a strong balance sheet with
sufficient liquidity to respond to the changing industry. This provided the capability to
develop and acquire more capabilities in enterprise products and solutions.
Future Prospects
A number of industry analysts felt that Dell was not well positioned either for a future of
low-priced, commodity-like personal computers or one of highly featured innovative digital
products like the iPad and iPod. To continue as a major player in the industry, they argued that
Dell needed an acquisition similar to HP’s $13.2 billion purchase of EDS in order to compete
in business information services. Overall, analysts were ambivalent about the firm’s prospects
in a changing industry. Should Dell continue with its current strategy of following the consumer
market down in price and adjusting its costs accordingly or, like IBM, should it change its
focus to more profitable business services, or, like HP, should it try to do both?
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ROSETTA STONE’S MISSION WAS TO CHANGE the way people learn languages. The company
blended language learning with technology at a time when globalization connected more and
more individuals and institutions to each other.
The potential for profit in the language-learning industry encouraged management to
become more proactive and aggressive about Rosetta Stone’s growth. In 2007, an industry
analysis commissioned from The Nielsen Company, a market research firm, found that the
language-learning industry produced over $83 billion in consumer spending.1 Of this
amount, $32 billion, or 39% of the total, was spent on self-study options. In the United States,
the industry generated $5 billion in consumer spending in 2007, of which $2 billion was for self-
study.2 Over 90% of the $83 billion was spent outside the United States.
The company’s debut on the New York Stock Exchange brought capital and resources that
placed Rosetta Stone in an exciting and promising position. Tom Adams, President and Chief
Executive Officer, said, “We are excited about hardware trends and the potential of educational
technology in general. We are working in new ways with online socialization. We see our pri-
mary opportunity as growing through our own innovation. . . (W)ith added financial resources
we can entertain mergers and acquisitions down the line.”3
How should the company move forward in order to sustain its momentum? Would it be ap-
propriate for Rosetta Stone to offer products like audio books or services such as language class-
rooms in order to increase market share? Which international markets would provide the company
a strategic and guaranteed return? Could changes in the company’s advertising and financial
strategies improve Rosetta Stone’s position? Should the company maintain anti-piracy initiatives
10-1
C A S E 10
Rosetta Stone Inc.:
CHANGING THE WAY PEOPLE LEARN LANGUAGES
Christine B. Buenafe and Joyce P. Vincelette
Introduction
This case was prepared by Christine B. Buenafe, a student, and Professor Joyce P. Vincelette of the College of New
Jersey. Copyright © 2010 by Christine B. Buenafe and Professor Joyce P. Vincelette. This case cannot be reproduced
in any form without the written permission of the copyright holders, Christine B. Buenafe and Professor
Joyce P. Vincelette. Reprint permission is solely granted by the publisher, Prentice Hall, for the books, Strategic
Management and Business Policy, 13th Edition (and the international and electronic versions of this book) by the
copyright holders, Christine B. Buenafe and Professor Joyce P. Vincelette. This case was edited for SMBP, 13th Edition.
The copyright holders are solely responsible for case content. Any other publication of the case (translation, any form
of electronic or other media) or sale (any form of partnership) to another publisher will be in violation of copyright
law, unless Christine B. Buenafe and Professor Joyce P. Vincelette have granted additional written reprint permission.
Reprinted by permission.
10-2 SECTION D Industry One—Information Technology
Business Summary
Rosetta Stone Inc. provided technology-based, self-study language-learning solutions prima-
rily under the Rosetta Stone brand. It developed, marketed, and sold software, online services,
and audio practice tools to individuals, educational institutions, the armed forces, government
agencies, and corporations. The company presented the language-learning market with a
trusted name-brand solution that was more convenient and affordable than classroom
courses, and more effective, interactive, and engaging than other self-study options.5
Although other programs and services claimed to teach through immersion, the company
asserted that it provided the only solution that did not utilize classic teaching tools like trans-
lations, explicit grammar explanations, or extensive vocabulary lists.6 The company believed
these elements delayed and impeded achieving language proficiency. Rosetta Stone’s ap-
proach sought to replicate the innate, natural language-learning ability that children use to
learn their first language.7 It referred to its teaching method as Dynamic Immersion.
The business model developed for Rosetta Stone distinguished the firm from other language-
learning companies. The company was able to offer many languages on personal computers, on lo-
cal networks, and online using its proprietary content as a result of its scalable technology platform.8
Marketing, sales, and distribution efforts were highly integrated and focused on customer interaction
with Rosetta Stone products.9 Each marketing and distribution channel was meant to complement
and support the others. This ensured greater awareness across channels, cost-effective consumer ac-
quisition and education, premium brand building, and improved convenience for customers.10
The company’s executive offices were in Washington, DC. It also had offices in London, Mu-
nich, Tokyo, Seoul, and Boulder, Colorado. As of December 31, 2009, the company employed 1,738
individuals: 922 full-time and 816 part-time employees.11 Its personnel consisted of 266 employees
in sales and marketing, 333 employees in research and development, 190 in general and administra-
tive, and 894 kiosk sales employees. The company’s website is www.RosettaStone.com.
History12
The idea for Rosetta Stone originated in the 1980s, when Allen Stoltzfus set out to learn
Russian. Stoltzfus was having a difficult time with the language and he attributed his slow progress
to his study methods. Years earlier, he lived and studied in Germany. His control of German
was facilitated by the language immersion he experienced while abroad. To learn Russian,
Stoltzfus realized that he needed to create an environment conducive to learning a language
naturally, rather than sit in a classroom reviewing grammar rules and translating texts.
Stoltzfus turned to computer technology, along with contextualized inputs like pictures
and conversations, to simulate the way people acquired their first language. He discussed his
idea with his brother-in-law, John Fairfield, who had a PhD in Computer Science. They believed
that technology was not yet ready for their ambitions.
By 1992 technology had improved. Allen Stoltzfus founded Fairfield Language Technologies
in Harrisonburg, Virginia, and became the company’s Chairman and President. He recruited
his brother, Eugene Stoltzfus, to be Fairfield’s Executive Vice President. Eugene had a back-
ground in architecture and he contributed his expertise in designing the program’s appearance
and organization. Allen and Eugene Stoltzfus, along with John Fairfield, named their product
as a priority or could its efforts be better allocated elsewhere? Companies that depend on technol-
ogy face environmental risks which include economic conditions; federal, state, and local regula-
tions; and taxes and supplier or vendor concerns.4 To effectively compete, Rosetta Stone will have
to push product and service development as well as attract and retain talented personnel.
www.RosettaStone.com
CASE 10 Rosetta Stone Inc. 10-3
Rosetta Stone, after the artifact that served as the key to understanding Egyptian hieroglyphics.
Like the artifact, their product was meant to unlock language-learning success.
Allen Stoltzfus passed away in 2002 and Eugene filled the role of President and Chairman
until the end of 2005. In 2003, Tom Adams was named CEO and began guiding the company’s
expansionary strategies. In 2005, the company opened an office in the United Kingdom.13 In
2006, investment firms ABS Capital Partners and Northwest Equity Partners bought Fairfield
Language Technologies, renaming the company Rosetta Stone.
At the end of that year, the company paid an up-front fee for a perpetual, irrevocable, and
worldwide license allowing Rosetta Stone Inc. to use speech recognition technology devel-
oped at the University of Colorado.14 The University of Colorado, Boulder, was ranked 24th
and 25th on U.S. News & World Report’s lists of Top Speech–Language Pathology Programs
and Top Audiology Programs, respectively.15 The company also hired some of the technol-
ogy’s original developers to build on its speech recognition expertise. Rosetta Stone opened
an office in Japan in 2007 and in Korea in 2009.16
The company sold its products in more than 30 different languages and in more than
150 countries when it had its initial public offering. Rosetta Stone Inc. (RST) began public
trading on the New York Stock Exchange in April 2009. Its shares were priced at $18, above
the estimated $15 to $17 range. The price for RST jumped 42% from $18 to $25.55 in late-
morning trading.17 Rosetta Stone sold 6.25 million shares for a total of $112.5 million. Ana-
lysts tied the company’s success to a lack of publicly held competitors.18
In November 2009, Rosetta Stone acquired assets from SGLC International Co. Ltd., a
software reseller in Seoul, South Korea. The purchase price consisted of an initial cash
payment of $100,000 followed by three annual cash installment payments, based on revenue
performance in South Korea.19 Rosetta Stone’s total revenue for the year ended December 31,
2009, was $252.3 million.
Corporate Governance20
Management Team
Tom Adams was the Chief Executive Officer of Rosetta Stone; he joined the company in 2003.
In 2009, he was named the Ernst & Young Entrepreneur of the Year® overall national win-
ner, the Executive of the Year by the American Business Awards (Stevies), and SmartCEO
CEO of the Year. He was fluent in French, Swedish, English, and Spanish. He had a work-
ing knowledge of German and Chinese and was learning Russian.
Brian Helman acted as Chief Financial Officer. Prior to joining Rosetta Stone, he was CFO
for NEON Systems, a publicly held provider of mainframe integration software.
Greg Keim was the head of the company’s technology labs and was responsible for innovation
across all products. He joined Rosetta Stone in 1992, leading technical design and devel-
opment. In 1999, Keim returned to Rosetta Stone as the company’s Chief Technical Officer.
Gregory Long was responsible for product development functions. He also oversaw the con-
tent team, the software development group, and the product management organization.
Prior to joining Rosetta Stone, Long was Vice President of Product Development for
LeapFrog SchoolHouse.
Michael Wu was responsible for all legal, corporate governance, government affairs, and
compliance matters at Rosetta Stone. He joined the company in 2006 and established
the firm’s corporate compliance and corporate governance functions as well as its anti-
piracy and anti-fraud enforcement program. He was fluent in English and Mandarin
Chinese.
10-4 SECTION D Industry One—Information Technology
Mike Fulkerson led the advanced research and development group, which drove innovation
for all language-learning technologies related to future products. Before joining Rosetta
Stone, he was a technical director for Serco, a provider of managerial and technological
consulting services.
Pamela Mulder led the international development team in charge of new market expansion
and sharing best practices across markets outside the United States. Mulder joined the
company in 2004 as the head of Consumer Sales and Marketing and later built up the
global brand team. She was fluent in English and Spanish and was learning Italian.
Jay Topper was responsible for the Customer Success organization within Rosetta Stone,
which included the support departments, language-learning coaches and the customer
success team. Topper joined the Company in 2007 as Chief Information Officer.
Pete Rumpel led the company’s institutional sales and marketing efforts. Before Rosetta
Stone, Rumpel was Vice President and leader of SAPAmericas business development. He
was learning French.
Eric Duehring led global brand marketing and all United States consumer efforts including online
and offline marketing, creative services, public relations, retail sales, and kiosk sales and oper-
ations. Prior to Rosetta Stone, Duehring was with AOL as senior Vice President of Marketing.
Michaela Oliver was the senior Vice President of Human Resources for Rosetta Stone. She
had served as the senior Vice President of Human Resources at AOL. Oliver was conver-
sational in Russian and French.
International Leadership
Tak Shiohama acted as President of Rosetta Stone Japan Inc., a subsidiary of Rosetta
Stone Inc. Shiohama previously worked as a strategic consultant of Accenture and
A.T. Kearney. He was fluent in Japanese and English and was learning Spanish, French,
and Chinese.
Steven Cho was responsible for the company’s business and operations in South Korea. Prior
to joining Rosetta Stone, Cho was a managing partner at SGLC International. He was fluent
in English and Korean and was learning French.
Sylke Riester was Managing Director of Rosetta Stone, Europe. Riester had a strong back-
ground in telecommunications and expertise in business growth. A native Dutch speaker,
Riester was also fluent in German and English. She was also learning Swedish.
Oskar Handrick was the Country Manager for Germany. Handrick had worked in research
and development for the BMW Group in Germany. He spoke English, French, and German
fluently and was learning Spanish.
Board of Directors
Phil Clough was a managing general partner at ABS Capital Partners; his investment interests
and experience included business services companies.
John Coleman was President and Chief Operating Officer of Massachusetts-based Bose
Corporation until he retired in July 2005.
Laurence Franklin was the CEO of Tumi, the leading international brand of luxury travel,
business, and lifestyle accessories.
Patrick Gross was Chairman of The Lovell Group, a private advisory and investment firm.
John Lindahl was a managing general partner at Norwest Equity Partners, a private equity firm.
CASE 10 Rosetta Stone Inc. 10-5
Products and Services
As of December 31, 2009, Rosetta Stone offered the language-learning market 31 languages
from which to choose. Six languages were available in up to five levels of proficiency. Nine-
teen languages were available in up to three levels. Six languages were available in only one
level of proficiency. The company’s language offerings are listed in Exhibit 1, which also
Level 1 Level 2 Level 3 Level 4 Level 5
Audio
Companion TOTALe Version 2 Version 3
Arabic • • • • • •
Chinese (Mandarin) • • • • • •
Danish • •
Dutch • • • • • •
English (U.K.) • • • • • •
English (U.S.) • • • • • • • •
Farsi (Persian) • • • • • •
French • • • • • • • •
German • • • • • • • •
Greek • • • • • •
Hebrew • • • • • •
Hindi • • • • • •
Indonesian • •
Irish • • • • • •
Italian • • • • • • • •
Japanese • • • • • •
Korean • • • • • •
Latin • • • • •
Pashto • •
Polish • • • • • •
Portuguese (Brazil) • • • • • •
Russian • • • • • •
Spanish (Latin
American)
• • • • • • • •
Spanish (Spain) • • • • • • • •
Swahili • •
Swedish • • • • • •
Tagalog • • • • • •
Thai • •
Turkish • • • • • •
Vietnamese • • • • • •
Welsh • •
EXHIBIT 1
Language Offerings: Rosetta Stone Inc.
SOURCE: Rosetta Stone Inc., 2009 Form 10-K, p. 10.
Ted Leonsis held numerous leadership positions at AOL in his 15-year tenure, including Vice
Chairman and President.
Laura Witt was a General Partner at ABS Capital Partners; her investment interests and
experience included software and technology services companies.
10-6 SECTION D Industry One—Information Technology
Edition Target Market Description
Personal Individual consumers Contains the core software product used for all editions. Accompanied by a
compact disc audio practice tool, the Audio Companion. This disc contains
digital audio files that can be transferred to MP3 players. The audio lessons
are meant to supplement the software.
Enterprise Businesses, armed forces,
government organizations,
and not-for-profit entities
Includes management tools that provide easy-to-use administrative and
reporting functionality. These tools deliver easy-to-read reports and graphs
that track learner activity, progress, and scores.
Classroom Language programs in
primary, secondary, and
higher education settings
Designed to be incorporated into a teacher’s language curriculum,
complementing in-class teaching and enabling individualized self-paced
learning outside the classroom. Includes a learner management tool, the
Rosetta Stone Manager, which provides administrative and reporting
functionality. This tool enables teachers to plan lessons and generate reports
and graphs that track student and classroom activity, progress, and scores.
Home School Families with home school
students
Designed to provide parents the tools and resources they need to manage
student progress without extensive planning or supervision. Includes
administrative tools that permit parents to follow student progress and
access specific information about student performance, such as completed
exercises, test scores, and time spent learning, and to generate printable
progress reports. Parents also have the ability to enroll their students in
predefined curriculum paths designed to assist in lesson planning and in
achieving learning objectives.
EXHIBIT 2
Product Editions: Rosetta Stone Inc.
SOURCE: Rosetta Stone Inc., 2009 Form 10-K, p. 9–10.
shows the available levels and software versions. Each level provided approximately 40 hours
of the target language broken down into units, lessons, and activities.21 Rosetta Stone offered
four different editions of its language offerings: personal, enterprise, classroom, and home
school. Exhibit 2 lists the intended market for each edition and provides descriptions of any
special features.
The company had Version 2 and Version 3 of its programs available at the end of fiscal
year 2009. Version 2 of its software was available in 31 languages and Version 3 was available
in 25 languages. The newer version of the program featured improvements in the images and
audio samples used, as well as in the organization and presentation of content. Other benefits
of Version 3 included: speaking activities, grammar and spelling components, simulated con-
versations, advanced speech recognition technology, and Adaptive Recall.22 Adaptive Recall
referred to algorithms developed by the company that had students review problem areas at
longer and longer intervals, thereby improving language learners’ long-term retention.23 In
July 2009, the company introduced Rosetta Stone TOTALe. These online offerings of integrated
courses with coach-led practice sessions included language games, encouraged interaction
with native speakers, and provided live support from customer service.24
The company also developed Rosetta Stone products for the exclusive use of Native
American communities to help preserve their languages. Examples included: Mohawk, Chit-
macha, Innutitut, and Iñupiaq.25 In addition, the company offered a customized version of its
learning solutions which focused on military-specific content for the United States Army.26
Customers could choose to enjoy Rosetta Stone’s services on a CD-ROM or online. For
the year ended December 31, 2009, the company made 87% of its revenue from CD-ROM
sales and 13% from online subscriptions.27 Customers could choose to purchase each language
CASE 10 Rosetta Stone Inc. 10-7
Content and Curriculum30
Rosetta Stone’s curriculum encouraged students to progress from seeing and recognizing
pictures and vocabulary and hearing native speakers to actually speaking the target language.
Language learners reviewed the alphabet, vocabulary, and intuitive grammar as well as the
skills of reading, listening, pronunciation, and conversation without the use of translation
exercises or detailed explanations. Lessons combined the introduction of new concepts, a review
of recent material, and the production of key phrases. The curriculum was designed to be flexible
so that learners could focus on meeting particular goals or developing certain abilities.
The company’s products relied on a library of more than 25,000 photographic images and
400,000 professionally recorded sound files. The images, along with their combinations,
aimed to convey a universal meaning. This enabled the company to apply the same curriculum
across multiple languages and conveniently sped up the rate at which the company could add
new languages to its product line. Rosetta Stone implemented a specific sequencing method
devised to teach the user the most important and relevant language skills. It also incorporated
languages’ specific nuances, such as dual forms for parts of speech in Arabic. Any localization
tailored by the company was minimal because Rosetta Stone did not rely on translations from
the target language to the learner’s native language.
Technology31
Rosetta Stone developed most of its own technology. It created content development tools that
allowed curriculum specialists to write, edit, manage, and publish course materials. These
tools allowed authors, translators, voicers, photographers, and editors to work efficiently and
cooperatively across multiple locations. The company developed the software’s intuitive user
interface which assisted in the learner’s transition from listening comprehension to speaking.
Rosetta Stone established a student management system designed to allow teachers and ad-
ministrators to configure lesson plans and to review student progress reports. The company,
with the help of software firm Parature Inc., offered customer service via Facebook.32
The technology supporting Rosetta Stone’s programs was specially designed to handle
the complexities of languages. For example, the company’s software was able to support
languages written from right-to-left such as Arabic and Hebrew, along with languages with
characters such as Chinese and Japanese. Rosetta Stone’s speech recognition technology was
level separately or pay a discounted price by purchasing all available levels of a language
together. Prices ranged from $219 for Level 1 of Indonesian to $1,199 for TOTALe Korean.
The company also supported an online peer-to-peer practice environment called
SharedTalk at www.SharedTalk.com.28 Anyone was able to register on the website for free in
order to find language partners across the world and acquire pen pals for e-mail exchange.
SharedTalk had more than 125,000 active users in 2009.
The company’s growth strategies centered on expanding its offerings and target market.
Rosetta Stone planned to develop advanced course levels and add new languages. The com-
pany also recognized that adding skill development and remediation courses to its product line
could attract advanced language learners to the brand. In addition, the company could develop
customized versions of its programs for industries like healthcare, business, real estate, and re-
tail. Rosetta Stone Version 4 TOTALe was planned for release in September 2010.29 It would
integrate the Version 3 language-learning software solution with the online features of Rosetta
Stone TOTALe.
www.SharedTalk.com
10-8 SECTION D Industry One—Information Technology
included in Version 3. This technology targeted the different challenges language learners
encountered when speaking. For example, this technology recognized non-native speech un-
derstanding and highlighted pronunciation feedback, reinforcing correct pronunciation. The
speech recognition models used by the program also included languages and dialects that had
not been supported by speech recognition software in the past, such as Irish.
For the year ended December 31, 2009, the company’s research and development
expenses were $26.2 million, or 10.4% of total revenue. Rosetta Stone intended to advance its
software platform and its speech recognition technology. The company also sought to build on
its success with www.SharedTalk.com. The company was evaluating opportunities to extend
its offerings to mobile technology. For example, it was developing a mobile application called
Rosetta Stone Mini for release during the second half of 2010.
Manufacturing and Fulfillment33
Rosetta Stone focused on minimizing costs and achieving efficiency as it met its production
goals. It obtained most of its products and packaging components from third-party contract
manufacturers. It also had alternative sources to turn to in the event that its main manufacturers
and suppliers were unavailable.
The company’s fulfillment facility in Harrisonburg, Virginia, was its primary facility for
packaging and distributing products. Rosetta Stone also contracted with third-party vendors in
Munich for fulfillment services such as order processing, inventory control, and e-commerce;
the Netherlands for consumer orders in Europe; and Tokyo, Japan, for orders in Japan.
Language-Learning Success34
In 2009, Rosetta Stone Inc. commissioned Roumen Vesselinov, PhD, a visiting professor at
Queens College, City University of New York, as well as Rockman et al., an independent
evaluation research and consulting firm, to study the effectiveness of Rosetta Stone’s offerings.
Their results, along with the numerous awards and recognition the company received,
supported the company’s initiatives and accomplishments.
Vesselinov discovered that after 55 hours of study using the company’s Spanish
program, a student would be able to achieve a WebCAPE score at a level sufficient to fulfill
the requirements for one semester of Spanish in a college that offered six semesters of the
language, with 95% confidence. WebCAPE, or the Web-based Computer Adaptive Placement
Exam, was a standardized test which was used by over 500 colleges and universities for language-
level placement. Sixty-four percent of the students from this study improved their oral profi-
ciency by at least one level on a seven-level scale based on the American Council on the
Teaching of Foreign Languages (ACTFL) OPIc test. This test was used worldwide by academic
institutions, government agencies, and private corporations for evaluating oral language
proficiency.
Rockman’s study showed that after 64 hours of study with Rosetta Stone Spanish (Latin
American) and six hours of Rosetta Stone Studio sessions, 78% of the students participating
in its study increased their oral proficiency by at least one level on the seven-level scale
developed by ACTFL. Rosetta Stone Studio provided an interactive online environment in
real-time where learners communicated with students and native-speaking coaches.
In 2009, the company placed #14 on the Inc. 5000 list for the education industry. It also
received the National Parenting Publications Awards (NAPPA) Honors Award for Rosetta
Stone Version 3 Personal Edition, four classroom-specific awards for Classroom Version 3,
www.SharedTalk.com
CASE 10 Rosetta Stone Inc. 10-9
Marketing, Sales, and Distribution35
The company’s growth and profitability were dependent upon the effectiveness and effi-
ciency of Rosetta Stone’s direct marketing expenditures. In 2009, 82% of Rosetta Stone’s
revenue was generated through the company’s direct sales channels, which included its call
centers, websites, institutional sales force, and kiosks.
Rosetta Stone’s advertising campaigns encompassed radio, television, and print. The
company had advertisements in national publications such as Time, The Economist, The
New Yorker, and National Geographic. The company’s strategy was to purchase “remnant”
advertising segments.36 These segments were random time slots and publication dates that
had remained unsold and were offered at discounts. There was a limited supply of this type
of advertising, and it was not guaranteed that the company would be able to stay within its
marketing budget if these discounted slots were unavailable. Past Rosetta Stone advertise-
ments featured U.S. Olympic gold medal swimmer Michael Phelps. Another marketing
campaign depicted a farmer hoping to impress a supermodel with his Italian-speaking
abilities.37
The company’s online media advertising strategy included banner and paid search adver-
tising, as well as affiliate relationships. Rosetta Stone worked with online agencies to buy
impression-based and performance-based traffic. The company tracked the effectiveness of its
advertising by asking customers to indicate the marketing campaigns that caught their attention.
The company’s website provided a space for users to leave testimonials and reviews. Positive
stories and comments served as free word-of-mouth advertising favoring Rosetta Stone’s
products and services.
Marketing research supported the success of the company’s advertising programs.
According to an August 2008 survey commissioned from Global Market Insite Inc., a market
research services firm, Rosetta Stone was the most recognized language-learning brand in the
United States. Of those surveyed who had an opinion of the brand, over 80% had associated it
with high quality and effective products and services for teaching foreign languages. In addition,
internal studies from January and February 2009 showed that aided brand awareness for
Rosetta Stone in the United States was approximately 74%–79%, based on general population
surveys. Aided brand awareness refers to customers’ recollection of a particular brand name
after seeing or hearing about the product.
Sales and marketing expenses were 46% of total revenue for the year ended December 31,
2009.38 That year, Rosetta Stone expanded its direct marketing activities, and sales and mar-
keting expenses increased by $21.5 million, or by 23%, to $114.9 million. During 2009, the
company increased direct advertising expenses by 25% to $42.4 million. Advertising expenses
related to television and radio media and Internet marketing grew by $8.6 million. Rosetta
Stone Inc. also increased its number of kiosks from 150 to 242 in 2009, which resulted in
$6.2 million of additional kiosk operating expenses, which included rent and sales compensation-
related expenses. Personnel costs related to growth in the institutional sales channel and
marketing and sales support activities increased by $6.4 million since 2008.
as well as two enterprise-specific awards for its products. In 2008, it received the CODiE
awards for best corporate learning solution and best instructional solution in other curricu-
lum areas from the Software & Information Industry Association. In 2007, the company
won the EDDIE multilevel foreign language award for Chinese levels 1 and 2 and a multi-
level English-as-a-second-language, or ESL, award for English levels 1, 2, and 3 from
ComputED Gazette.
Channel Customer Type Representative Customers
Consumer Individual According to internal studies, 60% annually earn more than $75,000
and 44% earn more than $100,000
Retailers Amazon.com, Apple, Barnes & Noble, Borders, Office Depot,
Books-A-Million, London Drugs
Institutional Educational institutions Primary and Secondary Schools: New York City Department of Education
(NY), DeKalb County Schools (GA), Cherokee County Board of
Education (GA), Yonkers Public Schools (NY), Oakland Unified School
District (CA), Manatee County Schools (FL)
Universities: James Madison University, University of Wisconsin, West
Chester University, Virginia Commonwealth University, Clark Atlanta
University, Jackson State University
Government, armed forces,
and not-for profit
organizations
U.S. Department of Homeland Security, U.S. Immigration and Customs
Enforcement, Foreign Service Institute, Defense Intelligence Agency,
U.S. Department of the Air Force, U.S. Army, U.S. Marines, The Church
of Jesus Christ of Latter-Day Saints, Council for Adult and Experimental
Learning, Pacific Training Institute Clinic, AARP, Neighborhood House
of St. Paul, Seattle Goodwill
Corporations Reuters Group Plc, General Motors Corp., Pride International Inc.,
Res-Care, Inc., Cerner Corp., Tyco Electronics Corp., Molex Inc.,
Experian Information Solutions, Inc., Marriot International, Inc., Whole
Foods Market Inc.
EXHIBIT 3
Sales Channels: Rosetta Stone Inc.
SOURCE: Rosetta Stone Inc., 2009 Form 10-K, p. 13.
The Consumer Channel39
Exhibit 3 provides examples of customers that represent Rosetta Stone’s sales channels. For
the year ended December 31, 2009, consumer sales accounted for 79% of total revenue. The
consumer distribution model encompassed call centers, websites, kiosks, and select retail
resellers. Language products were also offered in a limited number of ZoomShop unmanned
automated kiosks. The company’s growth strategy for its consumer channel involved the purchase
of additional advertising services and exploration of new media channels. Rosetta Stone also
intended to add retail relationships and kiosks.
The direct-to-consumer channel produced 57% of consumer revenue for the year ended
December 31, 2009. This channel included sales from websites and call centers. Sales to
retailers such as Amazon.com, Apple, Barnes & Noble, Books-A-Million, Borders, London
Drugs retail outlets, and Office Depot accounted for 23% of consumer revenue. Sales from
kiosks made up 20%.
Rosetta Stone operated 242 retail kiosks, including three full service retail outlets,
in airports, malls, and other strategic high-traffic locations in 39 states and the District of
Columbia. Sales associates at these kiosks promoted interest with personal demonstrations.
These kiosks were considered an efficient use of retail space. Most kiosk site licenses ranged
between three to six months with renewal options; the company closed underperforming
kiosks.
Rosetta Stone also offered products in unmanned ZoomShop automated kiosks.
ZoomShop kiosks were owned by ZoomSystems and worked like vending machines. These
10-10 SECTION D Industry One—Information Technology
kiosks provided interactive demonstrations on their touch screens with audio that helped illus-
trate teaching techniques. These devices required low capital commitment and allowed
Rosetta Stone to quickly establish a presence in retail locations. Other retailers that relied on
ZoomSystems to sell their products from kiosks included Apple, Best Buy, Proactive Solution,
Sephora, and the Body Shop.
The Institutional Channel40
For the year ended December 31, 2009, institutional sales accounted for 21% of total revenue.
Rosetta Stone’s institutional distribution model served four markets: primary and secondary
schools, colleges, and universities; the U.S. armed forces and federal government agencies;
corporations; and not-for-profit organizations.
Sales to educational institutions represented 44% of institutional sales for the year ended
December 31, 2009. Sales to governmental agencies, the armed forces, and not-for-profit or-
ganizations accounted for 25% of institutional sales. Examples of not-for-profit groups pur-
chasing Rosetta Stone products included those that trained volunteers to teach ESL students,
sent members overseas for work, and established literacy programs. Home school sales repre-
sented 19% and corporations 12% of institutional revenue.
Regional sales managers were assigned to sales territories and supervised account man-
agers who maintained the customer base. The company expanded its sales force to keep up
with its institutional marketing activities. Rosetta Stone promoted interest within this channel
with onsite visits, speaking engagements, trade show and conference demonstrations, seminar
attendance, direct mailings, advertising in institutional publications, and responses to request-
for-proposals and to calls based on recommendations from existing customers. Request-for-
proposals were statements seeking certain services through a bidding process that were made
to vendors.
International
International sales accounted for 8% of revenue for the year ended December 31, 2009. In ad-
dition to its international subsidiaries in the United Kingdom, Germany, South Korea, and
Japan, the company operated nine kiosks in the United Kingdom, 12 in Japan, and 20 in South
Korea.41 To facilitate growth, the company planned to develop its international business
through its subsidiaries and to explore opportunities in additional markets in Europe, Asia, and
Latin America.
Protecting Rosetta Stone
The company relied on patents, trade secrets, trademarks, copyrights, and nondisclosure and
other contractual arrangements to protect its intellectual property.42 Exhibit 4 lists the com-
pany’s intangible assets. Rosetta Stone also protected its trade dress, or the visual appearance
of its products and its packaging. The company believed that its yellow box and blue logos
were important in building Rosetta Stone’s brand image and distinguishing its solutions from
those of its competitors.43 In addition, individuals who worked for Rosetta Stone were re-
quired to sign agreements that prohibited the unauthorized disclosure of the company’s pro-
prietary rights, information, and technology.44
Each CD-ROM came with a product key that verified that the disc was not illegally
copied. The key activated the program after installation and prevented multiple accesses to the
CASE 10 Rosetta Stone Inc. 10-11
10-12 SECTION D Industry One—Information Technology
product. Rosetta Stone customers had to agree to terms listed in a license agreement in order
to use the programs. Software could be installed on more than one personal computer, but not
more than one person was allowed to use the program at the same time.45 Those who purchased
the CD-ROM were not allowed to make backup copies. Online users were forbidden to trans-
fer their user name, password, or activation ID to any other person.
Rosetta Stone Inc. was sensitive to software piracy and how unauthorized access to its lan-
guage programs affected the company’s reputation and profitability. Peer-to-peer file sharing
network sites like eDonkey, BitTorrent, and Direct Connect provided individuals with a means
of distributing and downloading illegal copies of Rosetta Stone.46 Unauthorized users took ad-
vantage of paid subscribers’ information, using corporate or educational logins in order to ac-
cess the company’s online offerings. Those who disregarded Rosetta Stone’s protection
measures were subject to civil and criminal laws. Violators could be fined up to $250,000, face
up to five years in prison, or both.47 The company provided links on its website where individ-
uals could report instances of piracy.
The company also attempted to educate users about the various risks they were exposed
to as a result of Internet fraud.48 On its website, Rosetta Stone explained that buying from
unauthorized dealers leaves users subject to identity theft and exposed to defective or cor-
rupted software and software viruses. In addition, using unauthorized products excluded users
from access to warranties, proper manuals, support services, and software upgrades.
The Language-Learning Industry
Rosetta Stone’s target customers had a number of reasons for learning a second, third, or
fourth language. The language-learning industry served a replenishing global customer base.
For some people, learning a language provided a means of personal enjoyment and enrichment.49
It allowed learners to participate in new cultures and travel abroad. Many individuals also
took advantage of language instruction to improve their earning power and career flexibility.
In addition, people learned languages to communicate with friends and family and allow for
opportunities to extend relationships past language borders. Institutions like businesses
and schools especially took note of this interest in language learning in developing products,
services, or advertisements in order to reach more people.
Among the most studied languages were Chinese (Mandarin), Spanish, English, and
Arabic.50 According to Simple-Chinese.com, there were 40 million people learning Chinese as
a second language in 2009. This number had increased by 60% since 2004, reflecting a 10%
December 31, 2009 December 31, 2008
Gross
Carrying
Amount
Accumulated
Amortization
Net
Carrying
Amount
Gross
Carrying
Amount
Accumulated
Amortization
Net
Carrying
Amount
Trade name/trademark $10,607 $ — $10,607 $10,607 $ — $10,607
Core technology 2,453 (2,453) — 2,453 (2,453) —
Customer relationships 10,842 (10,747) 95 10,739 (10,706) 33
Website 12 (10) 2 12 (7) 5
Total $23,914 $(13,210) $10,704 $23,811 $(13,166) $10,645
EXHIBIT 4
Intangible Assets: Rosetta Stone Inc. (Dollar amount in millions)
SOURCE: Rosetta Stone Inc., 2009 Form 10-K, p. F-20.
CASE 10 Rosetta Stone Inc. 10-13
increase in Chinese learners every year.51 The growth in the Spanish-speaking population in
the United States influenced the popularity of the language. In 2009, the Pew Hispanic
Research Center estimated that there were 44 million Hispanics living in the United States. It
projected that this number would grow exponentially to over 100 million people by 2050,
when Hispanics would be 25% of the total population.52
There were 328 million native English speakers in 2009.53 English was the predomi-
nant language for careers in business, science, and technology. According to Asiaone.com,
33% of the world’s population would be learning English by 2016.54 British Prime Minister
Gordon Brown estimated that 300 million people from China and 350 million people from
India spoke English. The demand for Arabic speakers in the United States increased after
the September 11, 2001, attacks and the movement of American troops into Afghanistan
and Iraq.55 Companies like Sakhr Software took advantage of this demand and their
technology to market services to the U.S. government. Sakhr Software was an Egyptian
company that developed a mobile application that could transmit audio translations of
spoken phrases.56
The demand for language-learning products and services created a fragmented industry
influenced by trends and consumer preferences. The industry provided language students
with many alternative educational materials and environments in which to practice. Students
could seek language lessons from textbook publishers, audio CD and MP3 download
providers, schools and universities, language centers like Berlitz and Inlingua, and online
tutoring services.57 Students also relied on online dictionaries, translation services, and online
social environments for language aid. Some services required students to pay, and others
provided their offerings for free. Students could pay anywhere from $1.99 for a mobile
application to $54,410 for one year of undergraduate education at Sarah Lawrence College
in Bronxville, New York.58
Students differentiated language references and instruction by their teaching methods,
effectiveness, convenience, fun and likelihood of continued practice, advertising, reputation,
and price.59 The industry took advantage of trends such as increased online accessibility and
dependence, interactive games, social networking, and the use of mobile applications. According
to a 2008 report by Euromonitor International Inc., a market research firm, there were more
than one billion personal computers in use and 1.7 billion people using the Internet by 2009.60
According to a 2007 report by Global Industry Analysts Inc., a market research firm, the global
demand for the delivery of instructional content through the use of electronic technology, or
eLearning, would grow an average of 21% annually between 2007 and 2010, reaching a total
estimated value of $53 billion by 2010.61
Competitors
Rosetta Stone’s primary competitors, most of which were privately held and divisions of
larger corporations, included Berlitz International Inc., Simon & Schuster, Inc. (Pimsleur),
Random House Ventures LLC (Living Language), Disney Publishing Worldwide, McGraw-Hill
Education, and Pearson. These companies differentiated their products and services by means
of the following features: teaching methods, effectiveness, convenience, fun and likelihood
of continued practice, advertising, reputation, and price.62
Berlitz International Inc. presented the Berlitz Method® as a teaching style that contextu-
alized vocabulary and grammar in real-life situations and simulated natural conversations.63
The Berlitz School of Language was founded in 1878 and marketed to individuals, businesses,
and institutions. The company had over 500 locations in 70 countries and provided access to
more than 50 languages. Examples of Berlitz’s offerings included online courses, study abroad
programs, and cultural consulting. Language students could participate in Berlitz’s virtual
semi-private instruction which started at $1,445.
Simon & Schuster, Inc. (Pimsleur) was founded in 1924.64 It was the publishing arm
of CBS Corporation, a media company. The Audio Division’s Pimsleur Language Program
was a series of audio books available in more than 50 languages. It was even accessible
on the iPhone™ as an application. The Pimsleur Method relied on graduated interval recall,
anticipation of correct responses, and utilization of core vocabulary. The program encouraged
students to understand and speak from the start. Prices for Pimsleur products ranged from
$11.95 to $345.
Random House Ventures LLC (Living Language) was originally developed by U.S.
government experts in 1946 for overseas-bound service personnel and diplomats.65 It offered
books, CDs, digital downloads, and online courses in 28 different languages. Among its
offerings were applications for the iPod or iPhone and niche references on language learning
for babies and bilingual children. Prices for Living Language products ranged from $9.95
to $99.95.
Disney Publishing Worldwide was the publishing arm of Walt Disney’s Consumer
Products Division.66 The company licensed its characters to English-training ventures in China
until it decided to develop its own schools there for children ages 1 to 11. Disney planned to
increase the number of its schools from 11 to 148 and earn over $100 million from 2010
to 2015. The company sought to reach 150,000 children whose parents were willing to pay
$2,200 a year for tuition that would cover two hours of instruction per week. In China, Disney
also considered initiatives such as establishing an English distance-learning program, which
could involve lessons via web conferencing, e-mail, or recorded video, and developing En-
glish learning products to sell in retail outlets.
McGraw-Hill Education was a division of The McGraw-Hill Companies, founded in
1888.67 It provided educational materials and references for the following markets: Pre-K to 12,
Assessment, Higher Education, and Professional. The company had offices in 33 countries
and works published in more than 65 languages. Within the language-learning industry, the
company offered materials for students of all ages. Abroad, McGraw-Hill Education partnered
with the Tata Group to offer English training courses tailored for the Banking/Financial
Services sector.68 In 2009, the company partnered with the Chinese vocational-training firm
Ambow to launch an English-language program specifically for IT engineers.69 The McGraw-Hill
Companies had sales of $5.95 billion in 2009.
Pearson had businesses in education, business information, and consumer publishing.70 It
employed 37,000 individuals in 60 countries and provided products and services ranging from
textbooks and software to assessment and teacher development materials. Pearson’s English
language division, Pearson Longman, provided English programs for more than 20 million
students. The company also owned the Learning Education Center chain of language schools
in China and developed digitally deliverable products, such as English language materials on
mobile phones, for institutional and individual customers. The company made $9.1 billion in
revenue fiscal year 2009.
Rosetta Stone’s online competitors provided students with a myriad of language aids and
opportunities to practice their skills. Some websites offered all of their services for free, while
some programs charged users as their skills progressed. GermanPod101.com and ChinesePod
.com offered audio and video language lessons in addition to tutoring. RhinoSpike.com,
launched in March 2010, supported a library of almost 2,500 recordings spoken by native
speakers.71 Language learners frequented the site to improve their pronunciation.
WordReference.com hosted forums where individuals could post and answer questions about
correct phrasing and grammar.
10-14 SECTION D Industry One—Information Technology
Financial Analysis
From 2004 to 2009, Rosetta Stone’s revenue increased from $25.4 million to $252.3 million,
representing a 58% compound annual growth rate.76 The company’s consolidated statement
of operations from 2006 to 2009 is available in Exhibit 5. Select data from the consolidated
statement of operations featuring figures from 2006 to 2009 is shown as a percent of revenue
in Exhibit 6. Revenue from 2009 reflected an increase of $42.9 million or 21% from the
amount produced in 2008. Exhibit 7 compares revenue from 2009 to revenue from 2008.
Rosetta Stone’s 2008 revenue included a $2.6 million initial stocking order from Barnes &
Noble to support the bookstore’s expansion of Rosetta Stone products to over 650 of its na-
tional stores.77 In 2009, Rosetta Stone did not have any comparable stocking orders. Rosetta
Stone’s consolidated balance sheet is available in Exhibit 8.
For fiscal year 2009, consumer revenue was $199.3 million, up 19% from the previous
year. The company attributed this growth to a 14% increase in unit sales and a 4% increase in
the average selling price of each unit.78 The increase in sales resulted in a $23.8 million
increase in revenue, and the price increase accounted for a $7.8 million increase in revenue.
The increase in units sold was traced to Rosetta Stone’s planned expansion of its direct
marketing strategies as well as growth in its retail distribution network.79 Product revenue
represented 96% of total consumer revenue, and subscription and service revenue represented
the remaining 4%.
Institutional revenue amounted to $53.0 million in 2009, increasing by $11.3 million, or
27%, since 2008. The increase in institutional revenue was primarily due to the expansion of
Rosetta Stone’s direct sales force.80 This expansion increased education revenue by $4.8 million,
government revenue by $3.9 million, and corporate revenue by $2.0 million. Product revenue
represented 52% of total institutional revenue for the year ended December 31, 2009, and sub-
scription and service revenue represented 48% of total institutional revenue.
According to Tom Adams, “Strong demand from both consumers and institutions for (its)
industry-leading language-learning solution drove record revenues and earnings in Rosetta
Stone’s fourth quarter (of 2009). Rosetta Stone’s consumer business delivered solid results on
the back of record demand. . . .”81 The company’s international revenue accounted for 11% of
fourth quarter 2009 revenue, up from 5% for the same period in 2008. It grew to $8.5 million,
or 76% over the third quarter of 2009, and more than 160% over the fourth quarter of 2008.
A number of competitors took advantage of the Internet and social networking trends to
help individuals feel more engaged during the learning process. Livemocha.com, a company
with $14 million in venture capital financing, offered language lessons on a social network en-
vironment for more than 38 languages.72 Users corrected each other’s writing assignments and
their profiles displayed points and medals won from language games. In August 2009, LiveMocha
partnered with Pearson to co-develop and launch an English conversational program available
on LiveMocha’s online platform.73
MyLanguageExchange.com, founded in 2000, listed profiles of people who want to share
their language expertise with others trying to learn the language.74 MyLanguageExchange
users could pay $24 per year to e-mail other users for one-on-one practice. In 2009, this website
boasted 1.5 million members studying 115 languages. UsingEnglish.com, Englishcage.com,
and Englishbaby.com allowed users to share photos and interests.75 Skype, a software applica-
tion that allowed users to make voice calls over the Internet, set up forums where people from
around the world could practice with native speakers.
CASE 10 Rosetta Stone Inc. 10-15
Exchange Rate Used Is That of the Year End Reported Date Jan. 4
Year Ending December 31 2009 % Change 2008 % Change 2007 % Change 2006 % Change 2006
Revenue
Product 218,549 18.7 184,182 53.6 119,897 48.7 80,604 45,183.1 178
Subscription & service 33,722 33.8 25,198 44.6 17,424 62.9 10,694 11,276.6 94
Total revenue 252,271 20.5 209,380 52.5 137,321 50.4 91,298 33,465.4 272
Cost of product revenue 30,264 14.0 26,539 39.3 19,055 65.0 11,549 5,703.5 199
Cost of subscription & service revenue 3,163 48.0 2,137 30.9 1,632 64.5 992 24,700.0 4
Total cost of revenue 33,427 16.6 28,676 38.6 20,687 65.0 12,541 6,077.8 203
Gross profit 218,844 21.1 180,704 54.9 116,634 48.1 78,757 114,040.6 69
Operating expenses
Sales & marketing expenses 114,899 23.0 93,384 42.7 65,437 42.7 45,854 6,497.7 695
Research & development* 26,239 42.7 18,387 42.6 12,893 58.8 20,714 19,697.6 41
General & administrative expenses 57,174 44.5 39,577 32.9 29,786 79.5 16,590 11,583.1 142
Lease abandonment – – 1,831 – – – – – –
Total operating expenses 198,312 29.5 153,179 41.7 108,116 30.0 83,158 –
Other income and expense
Interest income 159 (65.0) 454 (32.5) 673 9.8 613 – –
Interest expense 356 (60.0) 891 (33.1) 1,331 (14.7) 1,560 – –
Other income 112 (53.1) 239 55.2 154 156.7 60 1,900.0 3
Total other income (expense) (85) (57.1) (198) (60.7) (504) (43.2) (887) (29,666.7) 3
Income (loss) before income taxes 20,447 (25.2) 27,327 241.0 8,014 (251.6) (5,288) (52.5) (11,121)
Income tax provision (benefit) 7,084 (47.3) 13,435 147.2 5,435 (538.3) (1,240) – –
Net income (loss) 13,363 (3.8) 13,892 438.7 2,579 (163.7) (4,048) (63.6) (11,121)
Preferred stock accretion – – – – 80 (49.7) 159 – –
Net income (loss) attributable to common
stockholders
13,363 (3.8) 13,892 455.9 2,499 (159.4) (4,207) (62.2) (11,121)
Year end shares outstanding 20,440 955.8 1,936 5.4 1,837 14.0 1,612 – –
Net earnings (loss) per share—basic 1 (87.8) 7 395.9 1 (155.9) (3) (979.6) 0
Net earnings (loss) per share—diluted 1 (18.3) 1 446.7 0 (105.7) (3) (979.6) 0
Weighted average shares outstanding—basic 14,990 686.9 1,905 11.9 1,702 6.5 1,598 (104.3) (37,194)
Weighted average shares outstanding—diluted 19,930 17.8 16,924 2.4 16,533 934.6 1,598 (104.3) (37,194)
*In 2006, Research and Development expenses included $12,597 of acquired in-process R&D.
EXHIBIT 5
Consolidated Statement of Operations: Rosetta Stone Inc. (Dollar amounts in thousands except per share amount)
SOURCE: Rosetta Stone Inc., 2009 Form 10-K, p. F-4.
10-16
As a Percent of Total Revenue
Exchange Rate Used Is That of the Year End Reported Date
Year Ended December 31, January 4,
Year Ending December 31 2009
% of
Revenue 2008
% of
Revenue 2007
% of
Revenue 2006
% of
Revenue 2006
% of
Revenue
Revenue
Product 218,549 86.6 184,182 88.0 119,897 87.3 80,604 88.3 178 65.4
Subscription & service 33,722 13.4 25,198 12.0 17,424 12.7 10,694 11.7 94 34.6
Total revenue 252,271 209,380 137,321 91,298 272
Cost of product revenue 30,264 26,539 19,055 11,549 199
Cost of subscription
& service revenue 3,163 2,137 1,632 992 4
Total cost of revenue 33,427 28,676 20,687 12,541 203
Gross profit 218,844 180,704 116,634 78,757 69
Operating expenses
Sales & marketing
expenses
114,899 45.5 93,384 44.6 65,437 47.7 45,854 50.2 695 255.5
Research & development* 26,239 10.4 18,387 8.8 12,893 9.4 20,714 8.9 41 15.1
General & administrative
expenses
57,174 22.7 39,577 18.9 29,786 21.7 16,590 18.2 142 52.2
Lease abandonment – – 1,831.0 0.9 – – – – – –
Total operating
expenses
198,312 78.6 153,179 73.2 108,116 78.7 83,158 91.1 878 322.8
*In 2006, Research and Development expenses included $12,597 of acquired in-process R&D.
EXHIBIT 6
Consolidated Statement of Operations: Rosetta Stone Inc. (Dollar amount in thousands except per share amounts)
SOURCE: Rosetta Stone Inc., 2009 Form 10-K, p. F-4.
Year Ended December 31
2009 2008
(dollars in thousands)
Change % Change
Product revenue $218,549 86.6% $184,182 88.0% $34,367 18.7%
Subscription and service
revenue
33,722 13.4% 25,198 12.0% $8,524 33.8%
Total revenue $252,271 100.0% $209,380 100.0% $42,891 20.5%
Revenue by sales channel
Direct-to-consumer $114,002 45.2% $96,702 46.2% $17,300 17.9%
Kiosk 40,418 16.0% 36,314 17.3% $4,104 11.3%
Retail 44,850 17.8% 34,638 16.5% $10,212 29.5%
Total consumer 199,270 79.0% 167,654 80.1% 31,616 18.9%
Institutional 53,001 21.0% 41,726 19.9% $11,275 27.0%
Total revenue $252,271 100.0% $209,380 100.0% $42,891 20.5%
EXHIBIT 7
Revenue Comparison for 2009 and 2008: Rosetta Stone Inc.
SOURCE: Rosetta Stone Inc., 2009 Form 10-K, p. 53.
CASE 10 Rosetta Stone Inc. 10-17
Exchange Rate Used Is That of the Year End Reported Date
Year Ending December 31 2009 % Change 2008 % Change 2007
ASSETS
Current assets
Cash & cash equivalents 95,188 210.8 30,626 41.2 21,691
Restricted cash 50 47.1 34 (91.3) 393
Accounts receivable, net 37,400 41.1 26,497 123.6 11,852
Inventory, net 8,984 82.9 4,912 27.2 3,861
Prepaid expenses & other current assets 7,447 12.9 6,598 70.4 3,872
Deferred income taxes 6,020 163.8 2,282 169.1 848
Total current assets 155,089 118.6 70,949 66.9 42,517
Property & equipment, net 18,374 16.8 15,727 17.0 13,445
Goodwill 34,838 1.9 34,199 0.0 34,199
Intangible assets, net 10,704 0.6 10,645 (22.1) 13,661
Deferred income taxes 5,565 (18.5) 6,828 12.2 6,085
Other assets 872 85.5 470 0.2 469
Total assets 225,442 62.4 138,818 25.8 110,376
LIABILITIES
Current liabilities
Accounts payable 1,605 (50.0) 3,207 (30.8) 4,636
Accrued compensation 10,463 22.1 8,570 73.5 4,940
Other current liabilities 25,638 20.1 21,353 87.0 11,421
Deferred revenues 24,291 68.9 14,382 19.4 12,045
Income taxes payable 4,184 – – – –
Current maturities of long-term debt—related party – – 4,250 25.0 3,400
Total current liabilities 66,181 27.9 51,762 42.0 36,442
Long-term debt, related party – – 5,660 (42.9) 9,909
Deferred revenue 1,815 33.3 1,362 52.3 894
Other long-term liabilities 1,011 5.0 963 15,950.0 6
Total liabilities 69,007 15.5 59,747 26.4 47,251
STOCKHOLDERS’ EQUITY
Class B redeemable convertible preferred stock – – – – 5,000
Class A, series A-1 convertible preferred stock – – 26,876 0.0 26,876
Class A, series A-2 convertible preferred stock – – 17,820 0.0 17,820
Class B convertible preferred stock – – 11,341 78.9 6,341
Common stock, net 2 100.0 1 0.0 1
Additional paid-in capital 130,872 1,110.2 10,814 25.6 8,613
Accumulated income (loss) 25,785 107.6 12,422 (945.0) (1,470)
Accumulated other comprehensive income (loss) (224) 10.3 (203) 262.5 (56)
Total stockholders’ equity (deficit) 156,435 97.8 79,071 36.0 63,125
Total liabilities and stockholders’ equity 225,442 62.4 138,818 31.7 110,376
EXHIBIT 8
Consolidated Balance Sheet: Rosetta Stone Inc. (in thousands, except per share amounts)
SOURCE: Rosetta Stone Inc., 2009 Form 10-K, p. F-3.
10-18 SECTION D Industry One—Information Technology
N O T E S
1. Rosetta Stone, Inc., 2009 Form 10-K, p. 3.
2. Ibid.
3. Lora Kolodny, “Going Public in the Throes of a Recession,” The
New York Times (January 30, 2009), http://www.nytimes.com/
2009/07/01/business/smallbusiness/01public.html (September 7,
2010).
4. “Top 20 Risks Facing U.S. Tech Companies—IT Management
from EWeek,” EWeek, http://www.eweek.com/c/a/IT-Management/
Top-20-Risks-Facing-US-Tech-Companies-879264/ (September 7,
2010).
5. Rosetta Stone, Inc., 2009 Form 10-K, p. 5.
6. Ibid., p. 1.
7. Bill Simpson, “Customer Satisfaction Drives Rosetta Stone’s
Strong Growth—Seeking Alpha,” Stock Market News, Opinion
& Analysis, Investing Ideas—Seeking Alpha (April 17, 2009),
http://seekingalpha.com/article/131398-customer-satisfaction-
drives-rosetta-stone-s-strong-growth (September 7, 2010).
8. Rosetta Stone, Inc., 2009 Form 10-K, p. 5.
9. Ibid., p. 7.
10. Ibid., 13.
11. Ibid., p. 17. This section was directly quoted, except for minor
editing.
12. History | Rosetta Stone, http://www.rosettastone.com/ (August 21,
2010).
13. Rosetta Stone, Inc., 2009 Form 10-K, p. 15.
14. Ibid.
15. “Best Graduate Schools 2008,” US News, http://grad-schools
.usnews.rankingsandreviews.com/best-graduate-schools/ (Sep-
tember 6, 2010).
16. Rosetta Stone, Inc., 2009 Form 10-K, p. 15.
17. Phil Wahba, “Rosetta Stone IPO Prices Above Estimate Range |
Reuters,” Reuters.co.uk (April 16, 2009), http://uk.reuters.com/
article/idUKTRE53E7GP20090416 (September 7, 2010).
18. Ibid.
19. Rosetta Stone, Inc., 2009 Form 10-K, p. 18.
20. Corporate Governance | Rosetta Stone, http://www.rosettastone
.com/ (August 21, 2010). This section was directly quoted, except
for minor editing.
21. Rosetta Stone, Inc., 2009 Form 10-K, p. 6.
22. Language Learning | Rosetta Stone, http://www.rosettastone
.com/ (August 21, 2010).
23. Rosetta Stone, Inc., 2009 Form 10-K, p. 5.
24. Language Learning | Rosetta Stone, http://www.rosettastone
.com/ (August 21, 2010).
25. Rosetta Stone, Inc., 2009 Form 10-K, p. 11.
26. Ibid., p. 12.
27. Ibid., p. 10.
28. Ibid., p. 11.
29. Ibid., p. 8.
30. Ibid., p. 12.
31. Ibid., p. 11. This section was directly quoted, except for minor
editing.
32. Susan J. Campbell, “Rosetta Stone Now Offering Dedicated
Customer Support on Facebook via ‘Parature for Facebook,’”
TMCnet.com (August 13, 2010), http://www.tmcnet.com/
channels/customer-support-software/articles/95152-rosetta-
stone-now-offering-dedicated-customer-support-facebook.htm
(August 21, 2010).
33. Rosetta Stone, Inc., 2009 Form 10-K, p. 16.
34. Ibid., pp. 7–8. This section was directly quoted, except for minor
editing.
35. Ibid., pp. 3, 13–15. This section was directly quoted, except for
minor editing.
36. Ibid., p. 21.
37. Phil Wahba, “Rosetta Stone IPO Prices Above Estimate Range |
Reuters,” Reuters.co.uk (April 16, 2009), http://uk.reuters.com/
article/idUKTRE53E7GP20090416 (September 7, 2010).
38. Rosetta Stone, Inc., 2009 Form 10-K, p. 45. This section was di-
rectly quoted, except for minor editing.
39. Rosetta Stone, Inc., 2009 Form 10-K., pp. 3, 13–14. This section
was directly quoted, except for minor editing.
40. Ibid., pp. 14–15.
41. Ibid., p. 14.
42. Rosetta Stone, Inc., 2009 Form 10-K., p. 17.
43. Ibid.
44. Ibid.
45. “Global End User Agreement,” Rosetta Stone. (Septem-
ber 6, 2010). http://www.rosettastone.com/us_assets/eulas/
eula-global-eng .
46. “Rosetta Stone Continues Strong Stand on Piracy and Distribu-
tion of Counterfeit Products | Rosetta Stone | Rosetta Stone,”
Rosetta Stone (February 13, 2009), http://www.rosettastone.co
.uk/global/press/releases/20090213-rosetta-stone-continues-
strong-stand-on-piracy-and-distribution-of-counterfeit-products
(September 7, 2010).
47. “Anti Piracy,” Rosetta Stone, http://www.rosettastone.com/
global/anti-piracy (September 7, 2010).
48. Ibid.
49. Rosetta Stone, Inc., 2009 Form 10-K, p. 3.
50. “Most Popular Languages in the World by Number of Speakers—
Infoplease.com,” Infoplease: Encyclopedia, Almanac, Atlas,
Biographies, Dictionary, Thesaurus. Free Online Reference,
Research & Homework Help—Infoplease.com, http://www
.infoplease.com/ipa/A0775272.html (September 7, 2010).
51. “Chinese Language Becomes More Popular Worldwide,”
Simple-Chinese.com, http://www.simple-chinese.com/china-
blog/chinese-language-becomes-more-popular-worldwide/
(September 7, 2010).
52. “Why Is It Important to Learn Spanish?” Learn Spanish Abroad:
IMAC Spanish Language Schools | Spanish Language Courses,
http://www.spanish-school.com.mx/learnspanish.php (September 7,
2010).
53. “State of Global Translation Industry (2009),” MyGengo.com,
http://www.slideshare.net/dmc500hats/mygengocom-state-of-
global-translation-industry-2009 (September 7, 2010).
54. “India Falling behind China in English,” Asiaone, http://www
.asiaone.com/News/Education/Story/A1Story20091120-181251
.html (September 6, 2010).
55. “US Scrambles to Find Linguists for Afghan Surge,” The Jour-
nal of Turkish Weekly, http://www.turkishweekly.net/news/
78751/-us-scrambles-to-find-linguists-for-afghan-surge.html
(September 5, 2010).
56. “Now, Smartphones That Translate Languages—The Economic
Times,” The Economic Times: Business News, Personal Finance,
Financial News, India Stock Market Investing, Economy News,
SENSEX, NIFTY, NSE, BSE Live, IPO News, http://
economictimes.indiatimes.com/Now-smartphones-that-translate-
languages/articleshow/4724646.cms (September 7, 2010).
CASE 10 Rosetta Stone Inc. 10-19
http://www.nytimes.com/2009/07/01/business/smallbusiness/01public.html
http://www.nytimes.com/2009/07/01/business/smallbusiness/01public.html
http://www.eweek.com/c/a/IT-Management/Top-20-Risks-Facing-US-Tech-Companies-879264/
http://www.eweek.com/c/a/IT-Management/Top-20-Risks-Facing-US-Tech-Companies-879264/
http://seekingalpha.com/article/131398-customer-satisfaction-drives-rosetta-stone-s-strong-growth
http://seekingalpha.com/article/131398-customer-satisfaction-drives-rosetta-stone-s-strong-growth
http://www.rosettastone.com/
http://grad-schools.usnews.rankingsandreviews.com/best-graduate-schools/
http://grad-schools.usnews.rankingsandreviews.com/best-graduate-schools/
http://uk.reuters.com/article/idUKTRE53E7GP20090416
http://www.rosettastone.com/
http://www.rosettastone.com/
http://www.rosettastone.com/
http://www.rosettastone.com/
http://www.rosettastone.com/
http://www.rosettastone.com/
http://www.tmcnet.com/channels/customer-support-software/articles/95152-rosetta-stone-now-offering-dedicated-customer-support-facebook.htm
http://www.tmcnet.com/channels/customer-support-software/articles/95152-rosetta-stone-now-offering-dedicated-customer-support-facebook.htm
http://www.tmcnet.com/channels/customer-support-software/articles/95152-rosetta-stone-now-offering-dedicated-customer-support-facebook.htm
http://uk.reuters.com/article/idUKTRE53E7GP20090416
http://uk.reuters.com/article/idUKTRE53E7GP20090416
http://www.rosettastone.com/us_assets/eulas/eula-global-eng
http://www.rosettastone.com/us_assets/eulas/eula-global-eng
http://www.rosettastone.co.uk/global/press/releases/20090213-rosetta-stone-continues-strong-stand-on-piracy-and-distribution-of-counterfeit-products
http://www.rosettastone.co.uk/global/press/releases/20090213-rosetta-stone-continues-strong-stand-on-piracy-and-distribution-of-counterfeit-products
http://www.rosettastone.co.uk/global/press/releases/20090213-rosetta-stone-continues-strong-stand-on-piracy-and-distribution-of-counterfeit-products
http://www.rosettastone.com/global/anti-piracy
http://www.rosettastone.com/global/anti-piracy
http://www.infoplease.com/ipa/A0775272.html
http://www.infoplease.com/ipa/A0775272.html
http://www.simple-chinese.com/chinablog/chinese-language-becomes-more-popular-worldwide/
http://www.simple-chinese.com/chinablog/chinese-language-becomes-more-popular-worldwide/
http://www.spanish-school.com.mx/learnspanish.php
http://www.slideshare.net/dmc500hats/mygengocom-state-of-global-translation-industry-2009
http://www.slideshare.net/dmc500hats/mygengocom-state-of-global-translation-industry-2009
http://www.asiaone.com/News/Education/Story/A1Story20091120-181251.html
http://www.asiaone.com/News/Education/Story/A1Story20091120-181251.html
http://www.asiaone.com/News/Education/Story/A1Story20091120-181251.html
http://www.turkishweekly.net/news/78751/-us-scrambles-to-find-linguists-for-afghan-surge.html
http://www.turkishweekly.net/news/78751/-us-scrambles-to-find-linguists-for-afghan-surge.html
http://economictimes.indiatimes.com/Now-smartphones-that-translate-languages/articleshow/4724646.cms
http://economictimes.indiatimes.com/Now-smartphones-that-translate-languages/articleshow/4724646.cms
http://economictimes.indiatimes.com/Now-smartphones-that-translate-languages/articleshow/4724646.cms
http://uk.reuters.com/article/idUKTRE53E7GP20090416
57. Jane L. Levere, “As Many Software Choices as Languages to
Learn,” The New York Times (November 26, 2006).
http://www.nytimes.com/2006/11/26/business/yourmoney/
26language.html?_r�1&scp�3&sq�rosetta stone, languages&st�
nyt (August 21, 2010).
58. Lindsay Dittman, “The Most EXPENSIVE Colleges and Univer-
sities (PHOTOS),” The Huffington Post (March 29, 2010), http://
www.huffingtonpost.com/2010/03/29/the-most-expensive-colleg_
n_517861.html (September 7, 2007).
59. Rosetta Stone, Inc., 2009 Form 10-K, pp. 16–17.
60. Ibid., p. 5. This section was directly quoted, except for minor
editing.
61. Ibid. This section was directly quoted, except for minor editing.
62. Rosetta Stone, Inc., 2009 Form 10-K, p. 16.
63. Berlitz Home, http://www.berlitz.com/ (September 7, 2010).
64. Foreign Language Learning Programs from Pimsleur, http://
www.pimsleur.com/ (September 7, 2010).
65. Living Language, http://www.randomhouse.com/livinglanguage/
(September 6, 2010).
66. Matthew Garrahan and Annie Saperstein, “Disney to Expand
Language Schools in China,” Financial Times [Los Angeles]
(July 6, 2010).
67. “About Us,” The McGraw-Hill Companies, http://www
.mcgraw-hill.com/site/about-us (September 7, 2010).
68. “McGraw-Hill Education and Tata Expand Partnership in Edu-
cation and Professional Training,” Investor Relations—The
McGraw-Hill Companies (March 17, 2010), http://investor. mcgraw-
hill.com/phoenix.zhtml?c=96562&p=irol-newsArticle&
ID=1403377&highlight= (August 21, 2010).
69. “McGraw-Hill Deepens Commitment to China’s $4 Billion
Professional Development Education Market through New
Relationship with Ambow Education,” Investor Relations—The
McGraw-Hill Companies (November 11, 2009), http:// investor
.mcgraw-hill.com/phoenix.zhtml?c�96562&p�irol-newsArticle
&ID�1354199&highlight� (September 7, 2010).
70. Pearson, http://www.pearson.com/ (September 7, 2010).
71. Peter Wayner, “Learning a Language From an Expert, on the
Web,” The New York Times (July 28, 2010).
72. Ibid.
73. Ibid.
74. Ibid.
75. Ibid.
76. Rosetta Stone, Inc., 2009 Form 10-K, p. 3.
77. Ibid., p. 53.
78. Ibid.
79. Ibid.
80. Ibid.
81. “Rosetta Stone Inc. Reports Fourth Quarter 2009 Results,”
Rosetta Stone (February 25, 2010), http://pr.rosettastone
.com/phoenix.zhtml?c�228009&p�irol-newsArticle&ID�
1395780&highlight� (September 7, 2010).
10-20 SECTION D Industry One—Information Technology
http://www.nytimes.com/2006/11/26/business/yourmoney/26language.html?_r=1&scp=3&sq=rosettastone,languages&st=nyt
http://www.nytimes.com/2006/11/26/business/yourmoney/26language.html?_r=1&scp=3&sq=rosettastone,languages&st=nyt
http://www.huffingtonpost.com/2010/03/29/the-most-expensive-colleg_n_517861.html
http://www.huffingtonpost.com/2010/03/29/the-most-expensive-colleg_n_517861.html
http://www.huffingtonpost.com/2010/03/29/the-most-expensive-colleg_n_517861.html
http://www.berlitz.com/
http://www.pimsleur.com/
http://www.pimsleur.com/
http://www.randomhouse.com/livinglanguage/
http://www.mcgraw-hill.com/site/about-us
http://www.mcgraw-hill.com/site/about-us
http://investor.mcgraw-hill.com/phoenix.zhtml?c=96562&p=irol-newsArticle&ID=1403377&highlight=
http://investor.mcgraw-hill.com/phoenix.zhtml?c=96562&p=irol-newsArticle&ID=1403377&highlight=
http://investor.mcgraw-hill.com/phoenix.zhtml?c=96562&p=irol-newsArticle&ID=1354199&highlight=
http://investor.mcgraw-hill.com/phoenix.zhtml?c=96562&p=irol-newsArticle&ID=1354199&highlight=
http://www.pearson.com/
http://pr.rosettastone.com/phoenix.zhtml?c=228009&p=irol-newsArticle&ID=1395780&highlight=
http://pr.rosettastone.com/phoenix.zhtml?c=228009&p=irol-newsArticle&ID=1395780&highlight=
http://www.nytimes.com/2006/11/26/business/yourmoney/26language.html?_r=1&scp=3&sq=rosettastone,languages&st=nyt
http://investor.mcgraw-hill.com/phoenix.zhtml?c=96562&p=irol-newsArticle&ID=1354199&highlight=
http://pr.rosettastone.com/phoenix.zhtml?c=228009&p=irol-newsArticle&ID=1395780&highlight=
http://investor.mcgraw-hill.com/phoenix.zhtml?c=96562&p=irol-newsArticle&ID=1403377&highlight=
11-1
C A S E 11
Logitech (Mini Case)
Alan N. Hoffman
Company Background
LOGITECH, HEADQUARTERED IN ROMANEL-SUR-MORGES, SWITZERLAND, was the world’s leading
provider of computer peripherals in 2010. Personal computer peripherals were input and
interface devices that were used for navigation, Internet communications, digital music,
home-entertainment control, gaming, and wireless devices. Derived from the French word
logiciel, meaning software, Logitech was originally established as a software development
and hardware architecture company by two Stanford graduate students in Apples, Switzer-
land. Shortly after establishing itself as a quality software development company, Logitech
saw a new hardware product opportunity that was emerging in the mid 1980s, the computer
mouse. The mouse was standard equipment on the original Macintosh computer launched in
January 1984. Logitech viewed the mouse as a growth opportunity and it became a turning
point for the company’s future. Logitech introduced its first hardware device, the P4 mouse,
for users of graphics software. An OEM sales contract with HP followed, and in 1985 it en-
tered the retail market, selling 800 units in the first month.
In July of 1988, Logitech’s executives decided to take the company public to help finance its
rapid growth. Then, in the early 1990s, while facing increasingly strong competition in the mouse
business, Logitech identified a larger market opportunity for computer peripherals and began
growing its business beyond the mouse. In the next few years, Logitech introduced products such
as (1) computer keyboards, (2) a digital still camera, (3) a headphone/microphone, (4) a joystick
gaming peripheral, and (5) a web camera on a flexible arm. While these new products were being
introduced under the Logitech name, the company also continued innovation in its core mouse
This case was prepared by Professor Alan N. Hoffman, Rotterdam School of Management, Erasmus University and
Bentley University. Copyright © 2010 by Alan N. Hoffman. The copyright holder is solely responsible for case content.
Reprint permission is solely granted to the publisher, Prentice Hall, for Strategic Management and Business Policy, 13th
Edition (and the international and electronic versions of this book) by the copyright holder, Alan N. Hoffman. Any other
publication of the case (translation, any form of electronics or other media) or sale (any form of partnership) to another
publisher will be in violation of copyright law, unless Alan N. Hoffman has granted an additional written permission.
Reprinted by permission. RSM Case Development Centre prepared this case to provide material for class discussion
rather than to illustrate either effective or ineffective handling of a management situation. Copyright © 2010, RSM Case
Development Centre, Erasmus University. No part of this publication may be copied, stored, transmitted, reproduced,
or distributed in any form or medium whatsoever without the permission of the copyright owner, Alan N. Hoffman.
11-2 SECTION D Industry One—Information Technology
Competitors
Within the specialized personal peripherals industry, Logitech had three major competitors:
Creative Technology Ltd., Microsoft Corporation, and Royal Philips Electronics N.V.
Creative Technology Ltd. was one of the worldwide leaders in digital entertainment prod-
ucts for the personal computer (PC) and the Internet. Creative Technology was founded in
Singapore in 1981, with the vision that multimedia would revolutionize the way people inter-
act with their PCs. The product line offered by Creative Technology included MP3 players,
portable media centers, multimedia speakers and headphones, digital and web cameras, graphics
solutions, revolutionary music keyboards, and PC peripherals. Creative had a net profit
margin of (�29.58%) in FY 2009 and (�32.82%) in the first quarter of 2010.
Microsoft Corporation provided software and hardware products and solutions world-
wide. Founded in 1975 by Bill Gates and Paul Allen, Microsoft’s core business was to create
operating systems and computer software applications. Microsoft expanded into markets such
as mice, keyboards, video game consoles, customer relationship management applications,
server and storage software, and digital music players. In FY 2009, Microsoft Corporation had
annual sales of $58.4 billion and a net income of $14.5 billion.
Royal Philips Electronics was a Netherlands-based company that focused on improving
people’s lives through innovation. Philips was a well-diversified company with products in
many different businesses: consumer electronics, televisions, VCRs, DVD players, and fax
machines, as well as light bulbs, electric shavers and other personal care appliances, medical
systems, and silicon systems solutions. With this diversified portfolio of products, Royal
Philips had FY 2009 revenues of $30.76 billion and a gross profit of $11.59 billion.
Logitech was the only company exclusively focused on personal computer peripheral
products, whereas all of its competitors had products and resources invested in a variety of
other industries as well.
business. New and revolutionary technologies that were being developed by Logitech allowed it
to continue to be an industry leader in the mouse and keyboard business.
In the mid-1990s, the PC market exploded due to the popularity of the Internet and new
home/office software applications. This growth of the PC industry created demand for the
peripheral products that Logitech produced. The Internet allowed computer users to access
new areas such as music, video, communications, and gaming. From this point forward, Logitech
continued to grow both organically and through acquisition as new opportunities arose to expand
its portfolio of products.
Between 1998 and 2006, Logitech made a number of significant acquisitions to expand
its product portfolio. It acquired companies such as Connectix for its line of webcams, Labtec
for its audio business presence, Intrigue Technologies for its “Harmony” remote controls, and
Slim Devices for its music systems. All of these acquisitions were done strategically to help
Logitech position itself in all aspects of the personal computer peripherals world.
In addition to growing significantly through strategic acquisitions, Logitech also continued
to innovate and grow its core business. Logitech made significant innovations in the area of
cordless mice and keyboards. It also introduced the industry’s first retail pointing device with
Bluetooth wireless technology. Logitech then expanded its Bluetooth technology to many other
products in the digital world such as cordless gaming controllers and a personal digital pen.
Logitech provided consumers with cutting-edge innovation while maintaining its product
quality. Logitech maintained its product leadership by combining continued innovation,
award-winning industrial design, and excellent price performance with core technologies such
as wireless, media-rich communications and digital entertainment.
CASE 11 Logitech (Mini Case) 11-3
Trends
Logitech implemented a strategy of innovation, mixed with strategic acquisitions, to enhance
its products with the technologies and software of other companies in order to create the most
advanced, safest, and most innovative and collaborative experience for its customers. As
Logitech had always been on the forefront of mouse and keyboard technology, it had also
been a leader in video conferencing technology since the early stages of the Logitech mount-
able computer camera.
From 1998–2004, Logitech made many important strategic acquisitions in order to
enhance future portfolios and expand the depth of the peripheral product lines. Its first acqui-
sition was the video camera division, QuickCam PC, of Connectix Corporation. This led to an
influx of peripherals such as cameras and wireless cameras, and served as a very early intro-
duction to the current video conferencing division of Logitech. The second successful acqui-
sition for Logitech was Labtec Inc., an audio peripheral maker, in 2001. Following this
acquisition, with a hunger to expand product focus, Logitech acquired Intrigue Technologies
Inc. in 2004. This acquisition positioned Logitech as a leader in advanced remote control-making,
allowing peripherals to accommodate more than just computer and video game uses. This po-
sitioned it for its next acquisition—Slim Devices, a manufacturer of music systems—in 2006.
Logitech used these acquisitions to expand its multibusiness unit corporation into a diverse and
specialized company appealing to a large group of technology users. Finally, with its acquisi-
tion of Paradial AS, Logitech was able to combine its peripheral products with the software,
video effects, and security features of Paradial. This allowed Logitech to deliver a complete
and intuitive HD video conferencing experience for companies of any size.
Future industry trends revolved around content strategy and consumer expectations of the
mobile web and smartphone applications. Content strategy involved the decisions about what
information/features to include in a product, including those that provided the most benefit or
fulfill the most needs; anything else was just noise and diluted the product. In terms of the
mobile web and smartphone application trends, Logitech had three options: (1) develop closed
partnerships with specific platforms (iPhone or Blackberry); (2) produce apps (applications)
for each platform; or (3) produce “platform-neutral” apps by using the mobile web.
Global Presence
As the global economy has expanded and become more reliant on technology, Logitech has seen
an increase in the desire for ease of use when it comes to portable computers, games, and video
conferencing technology. Logitech has consistently expanded its product offerings to satisfy this
growing demand for computer peripherals. In FY 2009, 85% of its revenue came from retail
sales of peripheral products such as mice, keyboards, speakers, webcams, headsets, headphones,
and notebook stands. Logitech has also seen global demand sharpen for devices designed for
specific purposes such as gaming, digital music, multimedia, audio and visual communication
over the Internet, and PC-based video security. The company’s products combined essential
core technologies, continued innovation, award-winning industrial design, and excellent value
that were necessary to come out on top of a rapidly changing and evolving technological industry.
Since its inception in 1981 in Apples, Switzerland, Logitech has been a growing player in the
technological product market and distributed products to over 100 different countries.
For Logitech, opportunities arose as the desire for global communication has risen. The
trend of wireless and portable communication, such as Skype and Apple’s Facetime,
has opened up a window of opportunity for new and more advanced products to enable video
communication and conferencing.
11-4 SECTION D Industry One—Information Technology
Finance
The recession in 2008–2009 hit hard on Logitech’s business: for the full fiscal year 2010,
sales were $2.0 billion, down from $2.2 billion in fiscal 2009. Operating income was $78 million,
down from $110 million the previous year. Net income was $65 million ($0.36 per share),
compared to $107 million ($0.59 per share) in the prior year. Gross margin for fiscal 2010
was 31.9% compared to 31.3% in fiscal 2009. As a result of the economic downturn, Logitech
found it necessary to restructure its workforce. In early 2009 Logitech reduced its salaried
workforce globally by 15%.
Logitech’s stock price spiked to $40 in late 2007, as a result of record sales and profits
from its successful launch of iPod-capable peripherals. Its iPod peripherals—speakers, docks,
and headphones—made the increasingly popular iPod easier to use.
In 2009, Logitech’s operating margin was 5.15%, far below its 2007 high of 12% due to
increasing price competition.
Logitech did not issue dividends to shareholders so that it could reinvest its net income
back into research and development and product advertising, as well as have it available for
strategic acquisitions, causing a continuous cycle.
Logitech outlined specific financial objectives that it sought to achieve. It wanted to
achieve sales growth between 13%–19% and a gross margin between 32%–34%. Logitech
also intended to invest 5% of its sales revenue in R&D and 12%–14% in marketing. By con-
tinuously investing resources in research and development, Logitech took a strategic approach
to maintaining long-term growth and profitability.
Operations
One of the initial weaknesses that Logitech faced regarding operations was that it had numerous
manufacturing locations dispersed throughout the world. The problem with having so many
locations was that these facilities were not cost effective. Many of its plants were located in
countries where it was expensive to operate and the labor costs for qualified employees was
high. Logitech saw that, in the early 1990s, the personal computer industry was becoming
increasingly competitive. Having recognized this, Logitech made two primary operations
decisions that allowed it to increase its competitiveness. First, Logitech consolidated
manufacturing, which was once widely dispersed in China. This allowed the company to
As computers age, Logitech has been able to sell add-on peripherals to users that want to
add newer applications to their older computers. Logitech has been able to sell products at the
end of the product life cycle such as mice and keyboards and generate profits to fund new prod-
uct development such as the new Logitech Revue with Google TV. As its consumers became
more globally conscious and connected, Logitech was able to tailor its products toward the
many uses of video communication and high speed Internet capabilities.
Logitech created a global presence and reputation for its brand and products. In 2009,
Logitech’s sales were distributed globally with 45.3% in the Eastern Europe, Middle East, and
North Africa regions; 35.6% in the Americas; and 19.1% in Asia Pacific. By expanding its
presence globally, Logitech became the leading provider of personal peripherals in the world.
In addition to being an innovator in its industry, Logitech has also maintained reasonably
priced products as well. In 2009, 67% of its sales stemmed from products that were priced less
than $60. This innovative mindset, in addition to reasonable prices, has also contributed to
large sales and, in the end, Logitech’s good financial health as a company.
CASE 11 Logitech (Mini Case) 11-5
The Changing Landscape Ahead
Logitech became a leader in computer peripherals by developing innovative products and
focusing on the consumer’s experience. Between 2007 and 2010 alone, Logitech received
11 different awards for 19 products in 14 categories. In a market that was saturated with deep-
pocketed competitors such as Microsoft and Philips, Logitech used innovation as its means
of survival.
In 2010, Logitech faced a significant challenge in that the way that people interacted with
its devices was changing. The iPhone and iPad used touch-screen technology with built-in
accelerometers, eliminating the need for mice and trackpads. Secondly, cameras and higher
quality speakers became standard equipment built into the iPhone, iPad, and Windows laptop
computers. Apple introduced the “magic pad” to replace the mouse altogether. The need for
consumers to buy add-on peripherals was slowly evaporating as more of the peripherals
became standard equipment designed into new mobile technologies.
Logitech could see its peripherals market someday disintegrate before its own eyes.
Logitech needed to decide if it should invest more in video conferencing and television all-
in-one remote controls and/or focus on developing partnerships with computer and telecom
manufacturers and mobile carriers such as AT&T, Verizon, T-Mobile, and Sprint. Once again,
the computer industry was changing and Logitech needed to formulate diversification strategies
to ensure its long-term survival.
maintain lower prices on its products and increase its competitiveness. In addition to its China
manufacturing facilities, Logitech established a second center for R&D, located in Cork,
Ireland, a prime location for innovation in the technology and IT sectors. This resolved the
issue of Logitech having several expensive locations by moving into fewer, more cost effective
facilities. In addition to moving manufacturing, Logitech also knew its category was changing
and that it would no longer be able to compete by only manufacturing computer mice. Therefore,
Logitech expanded its product line beyond the mouse and introduced a variety of products
including a handheld scanner, Fotoman (a digital camera), Audioman (a speaker/microphone),
and Wingman (the first gaming peripheral).
These operational decisions not only helped Logitech remain innovative and competitive
within the industry, but also positioned it for success during the personal computing industry
boom in the mid- to late 1990s, when the Internet and online industries took off. Logitech,
known as a leading personal peripheral provider, was both innovative, with more than 130 personal
computer peripheral products, and reasonably priced. When the PC industry took off, Logitech
was already established as an industry leader and its sales soared.
Logitech was also a leader in the wireless peripherals sector. By following consumer
trends, Logitech saw the personal peripherals sector was moving into a new digital era, where
wireless peripherals was a new trend. Logitech created an entirely new product category with
the Logitech Cordless Desktop, a wireless mouse and keyboard bundle. By staying on top of
consumer trends, Logitech sold over 100 million cordless mice and keyboards.
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12-1
C A S E 12
Google Inc. (2010): The Future
of the Internet Search Engine
Patricia A. Ryan
This case was prepared by Professor Patricia A. Ryan of Colorado State University with the research assistance of
RyanA. Neff. Copyright ©2010 by Patricia A. Ryan. The copyright holder is solely responsible for the case content. This
case was edited for Strategic Management and Business Policy, 13th Edition. Reprinted by permission only for the 13th edi-
tion of Strategic Management and Business Policy (including international and electronic versions of the book).Any other
publication of this case (translation, any form of electronic or media) or sale (any form of partnership) to another
publisher will be in violation of copyright law unless Patricia A. Ryan has granted additional written reprint permission.
Background2
Google was founded in a garage in 1998 by Larry Page and Sergey Brin, two Stanford com-
puter science graduate students, based on ideas generated in 1995. The name Google was cho-
sen as a play on googol, a mathematical term for the number one followed by one hundred zeros.
It is thought the term was appealing to the founders as it related to their mission to organize an
exponentially growing web. Founded on $100,000 from Sun Microsystems, Brin and Page were
on their way to creating an Internet engine giant. Google immediately gained the attention of
the Internet sector for being a better search engine than its competitors, including Yahoo!
Industry Two—Internet Companies
Google began with a mission: to create the ultimate search engine to help users tame
the unruly and exponentially growing repository of information that is the Internet.
And most would agree that when the word “Google” became a verb, that mission was
largely accomplished.1
IT HAD BEEN NEARLY SIX YEARS SINCE GOOGLE’S ATTENTION-grabbing initial public offering
and, despite overall stock market weakness, Google remained strong. Although the stock
moved with the market in general, the company returned significantly higher returns to its
shareholders than did the S&P 500 (Exhibit 1). Founders Sergey Brin and Larry Page had cre-
ated a huge empire in which they now faced challenges of continued growth and innovation.
These challenges would carry them through the second decade of the new millennium.
12-2 SECTION D Industry Two—Internet Companies
By 2000, Google was in 15 languages and gaining international acclaim for its web search
services. The Google toolbar was first released in late 2000. Current Chairman of the Board
Eric Schmidt joined Google in that capacity in March 2001. In 2002, Google released
Adwords, which was a new cost per click pricing system for advertising.
In August 2004, Google went public with 19,605,042 shares at an opening price of
$83 per share. Exhibit 1 traces the growth of Google stock to over $600 per share at the end of
2009. Gmail, an instant messaging and free e-mail service, was released in 2006, just a few months
before the announced acquisition of YouTube. In that announcement, CEO Eric Schmidt stated:
The YouTube team has built an exciting and powerful media platform that compliments Google’s
mission to organize the world’s information and make it universally accessible and useful. Our
companies share similar values; we both always put our users first and are committed to
innovating to improve their experience. Together, we are natural partners to offer a compelling
media entertainment service to users, content owners, and advertisers.3
DoubleClick was acquired in 2008. In 2009, Google Docs was introduced. It allowed a user
to upload all file types, including ZIP files, in order to work with those files online. The company
moved into public education, starting in Oregon with Google Apps for Education. Regarding the
transformation of technology in education, Jeff Keltner, a senior manager at Google who worked
with educational institutions to increase the use of Google’s technology in higher education, com-
mented, “We don’t know what the future classrooms will look like. We want to work with schools
in a continual evolution to discover what it could look like.”4 The use of Google Docs and Google
Spreadsheets in team projects provided the opportunity for increased technological application in
the classroom in a manner that business professors had not had the opportunity to apply in the past.
Keltner stated that he did not see the biggest challenges as technology-based, but rather culture-
based, in that business school professors must be willing and able to accept failure as a part of the
process. He believed that the most successful adopters of Google technology will be those that
have embraced the willingness to fail in order to drive to a higher level of success.
In 2010, Google was seen as a global leader in technology that was focused on the ways
people obtained information. Simply by its growth and product and application development,
200%
150%
100%
50%
0%
−50%
−100%
10
/1
1/
20
04
Date
12
/1
3/
20
04
2/
14
/2
00
5
4/
18
/2
00
5
6/
20
/2
00
5
8/
22
/2
00
5
10
/2
4/
20
05
12
/2
7/
20
05
2/
27
/2
00
6
5/
1/
20
06
7/
3/
20
06
9/
5/
20
06
11
/6
/2
00
6
1/
8/
20
07
3/
12
/2
00
7
5/
14
/2
00
7
7/
16
/2
00
7
9/
17
/2
00
7
11
/1
9/
20
07
11
/2
2/
20
08
3/
24
/2
00
8
5/
27
/2
00
8
7/
28
/2
00
8
9/
29
/2
00
8
12
/1
/2
00
8
2/
2/
20
09
4/
6/
20
09
6/
8/
20
09
8/
10
/2
00
9
10
/1
2/
20
09
12
/1
4/
20
09
2/
16
/2
01
0
4/
19
/2
01
0
6/
21
/2
01
0
8/
23
/2
01
0
EXHIBIT 1
Cumulative Returns
on Google (red line) vs.
S&P 500 (blue line)
(2004–2010)
CASE 12 Google Inc. (2010): The Future of the Internet Search Engine 12-3
GOOGLE.COM—SEARCH ENGINE
AND PERSONALIZATIONS
Google Images
Google Books
Google Scholar
Google News
Google Finance
Google Videos
Google Blog Search
iGoogle and Personalized Search
Google Product Search
Google Merchant Search
Google Custom Search
Google Trends
Google Music Search
Google Webmaster Tools
APPLICATIONS
Google Docs
Google Calendar
Gmail
Google Groups
Google Reader
Orkut
Blogger
Google Sites
YouTube
CLIENTS
Google Toolbar
Google Chrome
Google Chrome OS
Google Pack
Picasa
Google Desktop
GOOGLE GEO—MAPS, EARTH,
AND LOCAL
Google Local Search
Google Maps
Panoramio
Google Earth
Google SketchUp
ANDROID AND GOOGLE MOBILE
Google Mobile
Mobile Search
Mobile Applications
Mobile Ads
GOOGLE CHECKOUT
GOOGLE LABS
EXHIBIT 2
Products and Services
2010: Google Inc.
the company had one of the strongest brand recognitions in the world. There were three pri-
mary groups served by Google: (1) Users, (2) Advertisers, and (3) Google Network Members
and Other Content Providers. Users gained the ability to find information quickly and easily on
the Internet. Advertisers provided 97% of the revenue for Google and gained cost-effective on-
line and offline ads to reach their target market as determined partially by Internet click
history. Finally, Google Network Members gained access to AdSense, which allowed for mul-
tiple consumer contacts and revenue-sharing among the companies. A full list of products and
applications is presented in Exhibit 2.
Management and Board of Directors
In 2002, Google hired former Sun Microsystems executive Eric Schmidt to assume the role
as Chairman and, later in the same year, CEO. Cofounders Sergey Brin and Larry Page were
active members of the Board of Directors. Members of the Executive Team and the Board of
Directors are listed in Exhibit 3.
12-4 SECTION D Industry Two—Internet Companies
A. EXECUTIVE TEAM
Eric Schmidt, 54, Chairman of the Board and CEO, joined Google in 2001 and helped grow the company from a Silicon
Valley startup to a global enterprise. Prior to joining Google, Schmidt was the Chief Technology Officer at Sun
Microsystems and the President of Sun Technology Enterprises.
Sergey Brin, 36, cofounder, served as a member of the board of directors since Google’s inception in September 1998
and as the President of Technology since July 2001. From September 1998 to July 2001, Sergey served as President.
Sergey holds a Masters degree in computer science from Stanford University and a Bachelor of Science degree with
high honors in mathematics and computer science from the University of Maryland at College Park.
Larry Page, 37, cofounder, has served as a member of the board of directors since Google’s inception in September 1998
and as the President of Products since July 2001. Larry served as Chief Executive Officer from September 1998 to
July 2001 and as Chief Financial Officer from September 1998 to July 2002. Larry holds a Masters degree in
computer science from Stanford University and a Bachelor of Science degree in engineering, with a concentration
in computer engineering, from the University of Michigan.
Nikesh Arora, 41, has served as President, Global Sales Operations and Business Development, since April 2009. Prior
to that, Nikesh worked for Deutsche Telekom, Putnam Investments, and Fidelity Investments.
David C. Drummond, 46, served as Senior Vice President of Corporate Development since January 2006 and as Chief
Legal Officer since December 2006. Prior to joining Google, David served as Chief Financial Officer of SmartForce,
an educational software applications company.
Patrick Pichette, 47, served as Chief Financial Officer and Senior Vice President since August 2008. Prior to joining
Google, Patrick served as President–Operations for Bell Canada, a telecommunications company.
Jonathan J. Rosenberg, 48, served as Senior Vice President of Product Management since January 2006. Prior to
joining Google, Jonathan served as Vice President of Software for palmOne, a provider of handheld computer and
communications solutions, and held various executive positions at Excite@Home, an Internet media company.
Shona L. Brown, 43, served as Senior Vice President of Business Operations since January 2006. Prior to joining
Google, Shona was at McKinsey & Company, a management consulting firm, where she had been a partner in the
Los Angeles office since December 2000.
Alan Eustace, 53, served as Senior Vice President of Engineering and Research since January 2006. Previously, he
served as a Vice President of Engineering since July 2002. Prior to joining Google, Alan was at Hewlett-Packard, a
provider of technology products, software, and services.
B. BOARD OF DIRECTORS
Eric Schmidt, 54, served as Chairman of the Board from 2001 to 2004 and from 2007 to the present, as well as Chief
Executive Officer and board member since 2001.
Sergey Brin, 36, was cofounder and President of Technology. He served on the board since its inception in 1998.
Larry Page, 37, was cofounder and President of Products. He served on the board since its inception in 1998.
L. John Doerr, 58, served as board member since 1999. He has been General Partner of the venture capital firm Kleiner
Perkins Caufield since August 1980.
John L. Hennessy, 57, served as Lead Independent Director since 2007. He served on the board since 2004. He has been
President of Stanford University since 2000 and previously served as Dean of the Stanford School of Engineering
and Chair of the Stanford Department of Computer Science.
Ann Mather, 49, served as board member since 2005. She also served as Executive Vice President and Chief Financial
Officer of Pixar from 1999 to 2004 and held various executive positions at Village Roadshow Pictures and Walt
Disney Company.
Paul S. Otellini, 59, served as board member since 2004. He has been CEO and President of Intel Corporation since
2005 and served previously in various Intel executive positions.
K. Ram Shriram, 52, served as board member since 1998. He has been Managing Partner of Sherpalo Ventures, an
angel venture investment company, since 2000. He previously served as VP of Business Development at Amazon.com.
Shirley M. Tilghman, 63, served as board member since 2005. She has been President of Princeton University since
2001. Previously she served as Professor of Biochemistry and Founding Director of Princeton’s multidisciplinary
Lewis-Sigler Institute for Integrative Genomics.
EXHIBIT 3
Executive Team and Board of Directors: Google Inc.
SOURCE: Google Forms 10-K and 14-A (2009).
CASE 12 Google Inc. (2010): The Future of the Internet Search Engine 12-5
Mission
Google’s mission was to organize the world’s information and make it universally accessible
and useful. Management believed that the most effective, and ultimately the most profitable,
way to accomplish the company’s mission was to put the needs of the users first. They found
that offering a high-quality user experience led to increased traffic and strong word-of-mouth
promotion. “The perfect search engine would understand exactly what you mean and give
back exactly what you want,” explained cofounder Larry Page.5
The complete mission statement is provided in Exhibit 4. Management extended the com-
pany’s mission statement by providing guiding principles for the company, as shown in
Exhibits 5 and 6.
Google’s mission was to organize the world’s information and make it universally accessible and
useful. Management believed that the most effective, and ultimately the most profitable, way to
accomplish their mission was to put the needs of the users first. They found that offering a high-
quality user experience led to increased traffic and strong word-of-mouth promotion. Dedication
to putting users first was reflected in three key commitments:
� Google will do its best to provide the most relevant and useful search results possible, in-
dependent of financial incentives. Its search results would be objective, and the company
did not accept payment for search result ranking or inclusion.
� Google will do its best to provide the most relevant and useful advertising. Advertisements
should not be an annoying interruption. If any element on a search result page is influenced
by payment to the management, it will make it clear to our users.
� Google will never stop working to improve the user experience, its search technology, and
other important areas of information organization.
Management believed that their user focus was the foundation of their success to date. They also
believed that this focus was critical for the creation of long-term value. Management stated they
did not intend to compromise their user focus for short-term economic gain.
EXHIBIT 4
Mission Statement:
Google Inc.
SOURCE: Google Form 2009 10-K, modified by case author.
EXHIBIT 5
The Philosophy:
Google Inc.
Ten Things We
Know to Be True
SOURCE: http://www.google.com/corporate/tenthings.html, accessed October 15, 2010.
1. Focus on the user and all else will follow.
2. It’s best to do one thing really, really well.
3. Fast is better than slow.
4. Democracy on the web works.
5. You don’t have to be at your desk to need an answer.
6. You can make money without doing evil.
7. There’s always more information out there.
8. The need for information crosses all borders.
9. You can be serious without a suit.
10. Great just isn’t good enough.
http://www.google.com/corporate/tenthings.html
12-6 SECTION D Industry Two—Internet Companies
1. Focus on people, their lives, their work, their dreams.
2. Every millisecond counts.
3. Simplicity is powerful.
4. Engage beginners and attract experts.
5. Dare to innovate.
6. Design for the world.
7. Plan for today’s and tomorrow’s business.
8. Delight the eye without distracting the mind.
9. Be worthy of people’s trust.
10. Add a human touch.
EXHIBIT 6
Principles that
Contribute to
a Google User’s
Experience
Issues and Risk Factors Facing Google in 20106
Competition
According to top management, Google’s industry was characterized by rapid change and con-
verging, as well as new and disruptive, technologies. Google faced formidable competition
in every aspect of its business, particularly from companies that sought to connect people
with information on the web and provide them with relevant advertising. Google faced sig-
nificant direct and indirect competition from:
� Traditional search engines, such as Yahoo! Inc. and Microsoft Corporation’s Bing.
Although Yahoo! was the first search engine to gain widespread acceptance, it lost its
dominant position to Google when Google introduced its superior search engine technol-
ogy. Microsoft’s failed attempt to buy Yahoo! in 2008 led to the introduction of Bing, its
own search engine, in 2010. Microsoft’s marketing power could make Bing a serious
competitor to Google. Some industry statistics are listed in Exhibit 7.
� Vertical search engines and e-commerce sites, such as WebMD (for health queries),
Kayak (travel queries), Monster.com (job queries), and Amazon.com and eBay
(commerce). Google competed with these sites because they, like Google, were trying to
attract users to their websites to search for product or service information, and some users
may navigate directly to those sites rather than go through Google.
� Social networks, such as Facebook, Yelp, or Twitter. Some users were beginning to rely
more on social networks for product or service referrals, rather than seeking information
through traditional search engines.
� Other forms of advertising. Google competed against traditional forms of advertising, such
as television, radio, newspapers, magazines, billboards, and yellow pages, for ad dollars.
� Mobile applications. As the mobile application ecosystem developed further, users were
increasingly accessing e-commerce and other sites through those companies’ stand-alone
mobile applications, instead of through search engines.
� Providers of online products and services. Google provided a number of online prod-
ucts and services, including Gmail, YouTube, and Google Docs, that competed directly
with new and established companies that offered communication, information, and enter-
tainment services integrated into their products or media properties.
SOURCE: http://www.google.com/corporate/ux.html, accessed October 15, 2010.
http://www.google.com/corporate/ux.html
CASE 12 Google Inc. (2010): The Future of the Internet Search Engine 12-7
Google AOL Yahoo Industry
Market cap ($) 186.01B 2.65B 21.05B 87.07M
Employees 23,331 6,700 13,900 289
Quarterly revenue growth 22.60% –26.20% 1.60% 28.50%
Revenue ($) 27.55B 2.65B 6.53B 82.12M
Gross margin 64.15% 42.78% 56.83% 61.03%
EBITDA ($) 11.26B 788.00M 1.40B 7.09M
Operating margin 35.86% 17.27% 11.21% 3.63%
Net income ($) 7.94B –924.60M 1.07B N/A
Earnings per share ($) 24.62 –7.96 0.77 0.02
Price/earnings 23.63 N/A 20.97 22.16
Price/earnings to growth 1.21 –1.12 1.45 1.39
Price/sales 6.86 1.02 3.3 2.21
EXHIBIT 7
Direct Competitor
Comparison 2010
SOURCE: http://finance.yahoo.com/q/co?s�GOOG, accessed on November 23, 2010.
Google competed to attract and retain users of its search and communication products and
services. Most of the products and services offered to users were free, so Google did not compete
on price. Instead, the company competed in this area on the basis of the relevance and usefulness
of search results and the features, availability, and ease of use of Google’s products and services.
Neither Google’s users nor its advertisers were locked into Google. For users, other search
engines were literally one click away, and there were no costs to switching search engines.
Google’s advertisers typically advertised in multiple places, both online and offline. The com-
pany competed to attract and retain content providers (Google Network members, as well as
other content providers for whom the company distributed or licensed content) primarily based
on the size and quality of Google’s advertiser base. Google’s ability to help these partners gen-
erated revenues from advertising and the terms of the agreements. Since 97% of Google’s rev-
enues were generated from advertising, this placed the company in a tight position if any
advertising contracts were to dissolve or diminish in growth. However, Google was reliant on
strong brand recognition and its brand identity.7
Legal and Regulatory Issues
Google was subject to increased regulatory scrutiny that may have negatively impacted the
business. This was an increased risk with continued growth and corporate expansion. There
may be regulatory issues related to potential monopolistic power as the industry faced both
growth with expansion and consolidation.
Legal issues were a developing concern for Google. Many laws currently in place had been
enacted prior to the Internet age and thus could not have taken into consideration the business
practices and implications of the Internet and computer technology. Liability issues, such as
laws related to the liability of online services, remained uncertain and were thus a legal risk for
Google.
The Digital Millennium Copyright Act contained provisions that limited, but did not elim-
inate, Google’s liability for listing or linking to third-party websites that included materials
that infringed copyrights or other rights, so long as the company complied with the statutory
requirements of the act. Various U.S. and international laws restricted the distribution of
materials considered harmful to children and imposed additional restrictions on the ability of
http://finance.yahoo.com/q/co?s GOOG
12-8 SECTION D Industry Two—Internet Companies
International Risk
Google’s international revenues were increasing annually, and amounted to 51% of corporate
revenues in 2008. (See Exhibit 8.) Over half of user traffic in 2009 was international. There were
increased challenges with international operations which included, but were not limited to, geo-
graphic, language, and cultural differences among countries. Countries had different accounting
practices, and the credit risk was generally greater for international transactions. Furthermore,
exchange rate risk, potential negative tax consequences, foreign exchange controls, and cultural
barriers related to customers, employees, and other stakeholders were more prevalent with inter-
national dealings. Privacy laws and government censorship often varied among countries.
Government pressure led Google to censor its web content in numerous locations. For exam-
ple, it was illegal to publish material in Germany, France, and Poland that denied the Holocaust.
Google thus used filters to screen for such material. In Turkey, videos that mocked “Turkishness”
were filtered by Google for its Google.com.tr website. Since China restricted Internet content and
political speech, Google had to agree to censor some of its Internet search results to establish its
Google.com.cn website in 2006. Google’s management made the controversial decision in early
2010 to move its China website from China.cn where it had been under heavy censorship pres-
sure to its site in Hong Kong (Google.hk) that wasn’t filtered. According to management, there
was clearly a benefit from international transactions that in general outweighed the costs.9
2004
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2005 2006 2007 2008 2009
Rest of the World United Kingdom United States
online services to collect information from minors. Furthermore, in the area of data protection,
many states had passed laws requiring notification to users when there was a security breach
of personal data. One example was California’s Information Practices Act.8
EXHIBIT 8
Revenues by
Geographic Area
SOURCE: Google Form 10-K (2009).
CASE 12 Google Inc. (2010): The Future of the Internet Search Engine 12-9
Internet Security Issues
Internet security was an issue that plagued the industry, as a security breach would be poten-
tially harmful to Google. Sophisticated software could already track users’ Internet activity
while they shopped for goods and services on the web. Skilled hackers from around the world
were now able to enter supposedly “secure” websites to obtain user records and credit card
information. Identity theft was becoming a major problem for the general population.
Security/privacy issues were likely to become even more important as the amount of data and
applications available on the Internet increased.
Revenue Growth and Sustainability
Google had experienced remarkable revenue growth in the past six years as evidenced by its
financial statements. See Exhibits 9 and 10 for balance sheets, and income statements for
2004–2009. Google’s management recognized that the firm’s revenue growth rate may soon
decrease due to stronger direct and indirect competition, the developing maturity of the on-
line advertising market, and the growing size of the firm. This could put pressure on operat-
ing margins and profits in the future, thus lowering the free cash flow available to investors.
Google’s management recognized that future profit margins may be tightened further by
lower profit margins on revenues received from Google Network members. Furthermore,
since 97% of revenue came from advertising, any blockage of online advertising would have
a negative effect on operating profits.
Intellectual Property
Google, YouTube, DoubleClick, DART, AdSense, AdWords, Gmail, I’m Feeling Lucky,
PageRank, Blogger, orkut, Picassa, SketchUp, and Postini were registered trademarks in the
United States. Google also had unregistered trademarks, such as Blog*Spot, Jaiku, Android,
Open Handset Alliance, OpenSocial, Panoramio, and Knol. The first version of the PageRank
technology was created while Google’s cofounders attended Stanford University—thus, Stan-
ford owned a patent to PageRank which was due to expire in 2017. Although Google owned a
perpetual license to this patent, the license was due to become non-exclusive at the end of 2011.
Google must fend off threats to their trademarks and secrets. Mainly, the company runs the
risk of the name Google becoming commonly used by the public to describe “searching”
the Internet. Google could actually lose its trademark on the name, as it would become part of
the public domain. Trade secrets are also something Google defended, as an internal leak would
diminish the value of these secrets.
Furthermore, intellectual property rights claims were costly to defend in the legal system.
Litigations challenging the IP rights of companies within the technology industry were fre-
quent, and as Google expanded its business, it had experienced more claims against it. Com-
panies had filed trademark infringements against Google, usually over advertisements.
Companies have also filed claims against Google for copyright infringement on the features
of its website and its products. Examples include the class action settlement with the Authors
Guild and the Association of the American Publishers, which will end up costing the company.
In addition, some of Google’s products have been attacked for patent infringements, for which
Google could be required to pay damages or licensing fees. Patent infringement settlements
would lead to higher costs and prevent the ability of Google to produce certain services or
products, leading to lost profits.
12-10 SECTION D Industry Two—Internet Companies
EXHIBIT 9
Balance Sheet: Google Inc. (Dollar amount in millions)
Year Ending December 31 2004 2005 2006 2007 2008 2009
Assets
Current assets
Cash and cash
equivalents $426,873 $3,877,174 $3,544,671 $6,081,593 $8,656,672 $10,197,588
Marketable securities 1,705,424 4,157,073 7,699,243 8,137,020 7,189,099 14,287,187
Accounts receivable 311,836 687,976 1,322,340 2,162,521 2,642,192 3,178,471
Deferred income taxes, net 19,463 49,341 29,713 68,538 286,105 644,406
Income taxes receivable 70,509 0 0 145,253 0 23,244
Prepaid revenue share,
expenses, and other assets 159,360 229,507 443,880 694,213 1,404,114 836,062
Total current assets 2,693,465 9,001,071 13,039,847 17,289,138 20,178,182 29,166,958
Prepaid revenue share,
expenses, and other
assets, noncurrent 35,493 31,310 114,455 168,530 433,846 416,119
Deferred income taxes,
net, noncurrent 11,590 0 0 33,219 0 262,611
Nonmarketable
equity securities 0 0 1,031,850 1,059,694 85,160 128,977
Property and
equipment, net 378,916 961,749 2,395,239 4,039,261 5,233,843 4,844,610
Intangible assets, net 71,069 82,783 346,841 446,596 996,690 774,938
Goodwill 122,818 194,900 1,545,119 2,299,368 4,839,854 4,902,565
Total assets $3,313,351 $10,271,813 $18,473,351 $25,335,806 $31,767,575 $40,496,778
Liabilities and stockholders’ equity
Current liabilities
Accounts payable $32,672 $115,575 $211,169 $282,106 $178,004 $215,867
Accrued compensation
and benefits 82,631 198,788 351,671 588,390 811,643 982,482
Accrued expenses and
other current liabilities
64,111 114,377 266,247 465,032 480,263 570,080
Accrued revenue share 122,544 215,771 370,364 522,001 532,547 693,958
Deferred revenue 36,508 73,099 105,136 178,073 218,084 285,080
Income taxes payable, net 0 27,774 0 0 81,549 0
Current portion of
equipment leases 1,902 0 0 0 0 0
Total current liabilities 340,368 745,384 1,304,587 2,035,602 2,302,090 2,747,467
Deferred revenue, long-term 7,443 10,468 20,006 30,249 29,818 41,618
Liability for stock options
exercised early, long-term 5,982 2,083 40,421 0 890,115 1,392,468
Deferred income taxes, net 1 35,419 0 478,372 12,515 0
Other long term liabilities 30,502 59,502 68,497 101,904 294,175 311,001
Commitments and
contingencies
Stockholder’s equity
CASE 12 Google Inc. (2010): The Future of the Internet Search Engine 12-11
EXHIBIT 9
(Continued)
SOURCE: Google Form10-K (2009).
SOURCE: Google Form10-K (2009).
Year Ending December 31 2004 2005 2006 2007 2008 2009
Revenues $3,189,223 $6,138,560 $10,604,917 $16,593,986 $21,795,550 $23,650,563
Costs and expenses
Cost of revenues 1,468,967 2,577,088 4,225,027 6,649,085 8,621,506 8,844,115
Research and development 395,164 599,510 1,228,589 2,119,985 2,793,192 2,843,027
Sales and marketing 295,749 468,152 849,518 1,461,266 1,946,244 1,983,941
General and administrative 188,151 386,532 751,787 1,279,250 1,802,639 1,667,294
Contribution to Google Foundation 0 90,000 0 0 0 0
Nonrecurring portion of settlement
of disputes with Yahoo 201,000 0 0 0 0 0
Total costs and expenses 2,549,031 4,121,282 7,054,921 11,509,586 15,163,581 15,338,377
Income from operations 640,192 2,017,278 3,549,996 5,084,400 6,631,969 8,312,186
Interest income and other, net 10,042 124,399 461,044 589,580 316,384 69,003
Impairment of equity investments 0 0 0 0 (1,094,757) 0
Income before income taxes 650,234 2,141,677 4,011,040 5,673,980 5,853,596 8,381,189
Provision for income taxes 251,115 676,280 933,594 1,470,260 1,626,738 1,860,741
Net income $399,119 $1,465,397 $3,077,446 $4,203,720 $4,226,858 $6,520,448
Net income per share of Class A
and Class B common stock
Basic $2.07 $5.31 $10.21 $13.53 $13.46 $20.62
Diluted 1.46 5.02 9.94 13.29 13.31 20.41
Shares outstanding (mil) 267 293 309 313 315 318
Year-end stock price $192.79 $414.86 $460.48 $691.48 $307.65 $619.98
EXHIBIT 10
Income Statement: Google Inc. (Dollar amount in millions)
SOURCE: Google Form 10-K (2009).
Convertible preferred stock,
$0.001 par value, 100,000
shares authorized; no shares
issued and outstanding 0 0 0 0 0 0
Class A and Class B
common stock, $0.001 par
value: 9,00,000 shares 267 293 309 313 315 318
Additional paid-in capital 2,582,352 7,477,792 11,882,906 13,241,221 14,450,338 15,816,738
Deferred stock-based
compensation
(249,470) (119,015) 0 0 0 0
Accumulated other
comprehensive income 5,436 4,019 23,311 113,373 226,579 105,090
Retained earnings 590,471 2,055,868 5,133,314 9,334,772 13,561,630 20,082,078
Total stockholders’ equity 2,929,056 9,418,957 17,039,840 22,689,679 28,238,862 36,004,224
Total liabilities and
stockholders’ equity $3,313,351 $10,271,813 $18,473,351 $25,335,806 $31,767,575 $40,496,778
12-12 SECTION D Industry Two—Internet Companies
Culture and Employees
Like many successful technology firms, Google provided its employees with an open and col-
laborative culture in which ideas were exchanged and new products and application ideas
were developed. Google’s management strived to be transparent in their workings, making
sure that employees knew about company announcements and new product or application
development before the public. The company used both technology and standard processes
to convey information. For example, “Tech Talks” blogs and weekly “TGIF” meetings were
used to convey information and to communicate with employees.
On December 31, 2009, Google had 19,835 employees, consisting of 7,443 in research and
development, 7,338 in sales and marketing, 2,941 in general and administrative, and 2,113 in
operations. Given that Google relied on highly skilled workers, its continued success was
strongly related to its ability to maintain and grow its strong talent pool. Once the current reces-
sion ends, it may become more difficult to attract and maintain skilled, talented employees.10
Google experienced rapid and strong growth with strong employee satisfaction. The
company worked to gain a globally diverse workforce with different perspectives in which
Information Technology Issues
Google was susceptible to threats from false or invalid visits to the ads it displayed, and has
had to refund fees charged for advertising due to fraudulent clicks. If Google failed to detect
click fraud or other invalid clicks, it could lose the confidence of its advertisers, which would
harm the company’s image and viability.
Additionally, interruption or failure of the information technology and communications
systems the company used could hurt its ability to effectively provide products and services,
damaging the reputation Google worked to maintain, as well as harming its operating income.
Its IT system was exposed to impairment from numerous sources, such as natural disasters,
infrastructure failures, and computer hackers. Although management had contingency plans
for many of these situations, such plans could not cover every possibility.
Index spammers could harm the integrity of Google’s web service by falsifying
users’ search attempts. This could damage the company’s reputation and lead to users becoming
unhappy with Google’s products and services, leading to a decline in website visits. This could
result in lower advertising revenues from its Google Network partners. Google relied greatly on
these members for a significant portion of its revenues, and both parties benefited from their as-
sociation with each other. The loss of these associates could adversely affect the business.
The future of the business depended upon continued and unimpeded access to the Inter-
net for both the company and its users. Internet access providers may be able to block, degrade,
or charge for access to certain Google products and services, which could lead to additional
expenses and the loss of users and advertisers.
As Google spread its operations across the globe, more and more of its receivables were
being denominated in foreign currencies. If currency exchange rates become unfavorable, the
company could lose some revenues in U.S. dollar terms. Although many multinational corpo-
rations used hedging strategies to lower or negate the risk of doing business overseas, Google
had limited experience with many of these financial strategies. Hedging strategies also had
high costs, reducing the company’s overall profitability.
Alternative Technology
Each day, more individuals were using devices other than personal computers to access the Internet.
If users of these devices did not widely adopt versions of Google’s web search technology, products,
or operating systems developed for these devices, the business could be adversely affected. These al-
ternative devices may make it problematic to use the services provided by Google, and make it chal-
lenging for the company to produce products which capture customers’ imaginations and loyalties.
CASE 12 Google Inc. (2010): The Future of the Internet Search Engine 12-13
Seasonality
While there were some seasonal effects on Google’s business, it was generally not as significant
as in retail stores, which earned much of their revenue in the last quarter of the calendar year.
In Google’s case, there had generally been an increase in business in the last quarter of the
calendar year, as represented by commercial queries. Likewise, the summer months tended
to be the slowest time of the year. While seasonality might be an issue for Google’s business
and revenue, it was generally not perceived by management to be a major issue.
employees were rewarded for performance. Google had historically worked hard to maintain
a corporate culture of innovation and performance that aligned the interests of the corporation
with those of employees. The company’s $1,000 cash bonus and 10% raise paid to all of its
employees in 2010 were examples of the lengths to which the company acted to retain top
talent. This was important since Google’s stock price had dropped 4.7% in 2010. According to
Paul Kedrosky, a venture capitalist, “It used to be people were fine taking Google’s money and
stock, because they believed it would appreciate rapidly. Not it’s not as attractive.”11
The company considered cofounders Brin and Page to be a key corporate resource, even
though their spending $15 million for a former Qantas Boeing 767 jet airplane in 2006 to use as
a company plane was listed by Bloomberg Business Week as an example of “executive excess.”12
As the company continues to grow, management will be challenged to find new and inno-
vative ways to maintain a strong corporate culture.
Google’s Future
Google had thus far thrived in the Internet search engine industry, garnishing a name that, for
many, was synonymous with “Internet search.” Up to now, growth had been strong, suggest-
ing a bright future. Google appeared to be poised to take advantage of what the future had to
offer in new technology by creating new products. In order to continue doing this, it will need
to retain the best and brightest minds. For example, one of Google’s new concepts was arti-
ficial intelligence software for use in automobiles that could drive themselves.13 The com-
pany’s stock price had climbed tremendously in the past, but some analysts now felt that
Google was maturing as a corporation and that its stock value was leveling off.14
As Google continued to grow, it continued purchasing other companies, such as its
acquisitions of YouTube, DoubleClick, and Postini.15 Nevertheless, growth by acquisition may
not necessarily lead to increasing growth in revenues or profits. For example, YouTube was an
$1.6 billion 2006 acquisition that as of 2010 had not generated significant additional revenue
for Google, despite its growth potential.
There were some indications that acquisitions might become an increasingly difficult
strategy in the future. In 2010, Google failed in an attempt to purchase Groupon, a website spe-
cializing in local shopping promotions. Google’s offer of $6 billion for Groupon was almost
double what it had paid for DoubleClick in 2008. Groupon’s rejection of the offer reflected a
fear common to web entrepreneurs that their small ventures might get lost inside Google’s
vastness. For example, several other startups, such as Yelp, that had also been pursued by
Google had opted to stay privately owned.16
Google’s top management needed to consider these and other factors in order to plan
strategically. Legal issues will likely continue, such as allegations that Google used Wi-Fi net-
works to take personal information. Google’s management had moved on this quickly with
corrective action and similar future responses to legal challenges will be important.17 The
future of mobile computing was an open, uncharted area.18
All of these considerations and more were relevant as CEO Schmidt and his executive team
pondered the second decade of the new millennium and discussed Google’s future strategies.
12-14 SECTION D Industry Two—Internet Companies
N O T E S
1. Trish, Bisoux, “First Adopters” BizEd (November/December
2010), p. 20.
2. Much of this section was developed from http://www.google
.com/corporate/milestones.html (November 30, 2010).
3. Eric Schmidt, chief executive officer of Google.
4. Trish, Bisoux, “First Adopters,” BizEd (November/December
2010), p. 22.
5. http://www.google.com/corporate.tenthings.html (October 15,
2010).
6. Much of this information is from Google 10-K, 2009, filed with
the SEC.
7. Google Form 10-K, 2009, filed with the SEC.
8. This paragraph was paraphrased from Google’s Form 19-K,
2009, filed with the SEC.
9. Peter Burrows, “Apple vs. Google: How the Battle Between
Silicon Valley’s Superstars will Shape the Future of Mobile
Computing,” Bloomberg Business Week (January 25, 2010),
pp. 28–34; and Lawrence Carrel, “Apple, Google, and Microsoft:
Buy or Avoid?” Kiplinger Personal Finance http://www
.kiplinger.com/printstory.php?pid�20382 (September 24, 2010).
10. Google Form 10-K, 2009, filed with the SEC.
11. Brad Stone and Douglas MacMillan, “Groupon’s $6 Billion
Snub,” Bloomberg Business Week (December 13–19, 2010), p. 7.
12. “A Century of Executive Excess,” Bloomberg Business Week
(December 13–19, 2010), p. 99.
13. “Cars Drive Themselves: Google Is Testing Artificial-
Intelligence Software in Cars in California,” St. Petersburg
Times (October 10, 2010), p.1a.
14. “Google: Time to Take Profits? S&P Downgrades on Valuation,”
http://blogs.barrons.com/techtraderdaily/2010/11/08 (Novem-
ber 8, 2010); and Lawrence Carrel, “Apple, Google, and Microsoft:
Buy or Avoid?” Kiplinger Personal Finance, http://www.kiplinger
.com/printstory.php?pid�20382 (September 24, 2010).
15. “Google to Acquire YouTube for $1.65 Billion in Stock,” http://
www.google.com/intl/en/press/pressrel/google_youtube.html
(November 8, 2010).
16. Brad Stone and Douglas MacMillan, “Groupon’s $6 Billion Snub,”
Bloomberg Business Week (December 13–19, 2010), pp. 6–7.
17. “Google Grabs Personal Info Off of Wi-Fi Networks,” http://
finance.yahoo.com/news/Google-grabs-personal-info-apf-
2162289993.html (November 8, 2010).
18. Peter Burrows, “Apple vs. Google: How the Battle Between
Silicon Valley’s Superstars will Shape the Future of Mobile Com-
puting, Bloomberg BusinessWeek (January 25, 2010), pp. 28–34.
R E F E R E N C E S
Byron Acohido, Kathy Chu, and Calum MacLeod, “Google
Clash Highlights How China Does Business: Foreign
Companies Have Jumped Through China’s Hoops for
Years,” USA Today (January 25, 2010), pp. 1b–2b.
Associated Press. “China Says Dispute Is with Google, not
U.S.,” St. Petersburg Times (2010, January 22), pp. 4b–5b.
Tricia Bisoux, “First Adopters,” BizEd (November/December,
2010), pp. 20–26.
Peter Burrows, “Apple vs. Google: How the Battle Between
Silicon Valley’s Superstars will Shape the Future of Mo-
bile Computing,” Bloomberg BusinessWeek (January 25,
2010), pp. 28–34.
Lawrence Carrel, “Apple, Google, and Microsoft: Buy or
Avoid?” Kiplinger Personal Finance, http://www.kiplinger
.com/printstory.php?pid�20382 (September 24, 2010).
Simon Dumenco, “Can We Trust Google to Avoid Chronic
AOL-ism?” Advertising Age, http://adage.com/print?
article_id�48584 (February 26, 2006).
Bruce Einhorn, “Google and China: A Win for Liberty—and
Strategy,” Bloomberg BusinessWeek (January 25, 2010),
p. 35.
“Exclusive: How Google’s Algorithm Rules the Web,” http://
www.wired.com/magazine/2010/02/ff_google_algorithm/
(November 8, 2010).
“Frequently Asked Questions—Investor Relations—Google,”
http://investor.google.com/corporate/faq.html (Novem-
ber 18, 2010).
Steven Goldberg, “Tech Titans Are Cheap,” Kiplinger
Personal Finance (September 28, 2010).
Google 10-K form for the year ended December 31, 2009,
filed with the SEC.
Google 10-Q form for the third quarter ended on September 30,
2010, filed with the SEC.
“Google: Time to Take Profits? S&P Downgrades on Valuation,”
http://blogs.barrons.com/techtraderdaily/2010/11/08
(November 8, 2010).
“Google Grabs Personal Info Off of Wi-Fi Networks,” http://
finance.yahoo.com/news/Google-grabs-personal-info-apf-
2162289993.html (November 8, 2010).
“Google to Acquire YouTube for $1.65 Billion in Stock,” http://
www.google.com/intl/en/press/pressrel/google_youtube
.html (November 8, 2010).
“Google User Experience—Google Corporate Information,”
http://www.google.com/corporate/ex.html (November 18,
2010).
“In Search of the Real Google,” Time Magazine, http://
www/time.com/time/printout/0,8816,1158961,00.html
(February 12, 2006).
“Management Team—Google Corporate Information,” http://
www.google.com/corporate/execs.html (November 18,
2010).
“Cars Drive Themselves: Google Is Testing Artificial-
Intelligence Software in Cars in California. St. Petersburg
Times (October 10, 2010), p. 1a.
“Our Philosophy—Google Corporate Information,” http://
www.google.com/corporate/tenthings.html (November 18,
2010).
http://www.google.com/corporate/milestones.html
http://www.google.com/corporate/milestones.html
http://www.google.com/corporate.tenthings.html
http://www.kiplinger.com/printstory.php?pid=20382
http://www.kiplinger.com/printstory.php?pi=20382
http://blogs.barrons.com/techtraderdaily/2010/11/08
http://www.kiplinger.com/printstory.php?pid 20382
http://www.kiplinger.com/printstory.php?pid=20382
http://www.google.com/intl/en/press/pressrel/google_youtube.html
http://www.google.com/intl/en/press/pressrel/google_youtube.html
http://finance.yahoo.com/news/Google-grabs-personal-info-apf-2162289993.html
http://finance.yahoo.com/news/Google-grabs-personal-info-apf-2162289993.html
http://finance.yahoo.com/news/Google-grabs-personal-info-apf-2162289993.html
http://www.kiplinger.com/printstory.php?pid=20382
http://www.kiplinger.com/printstory.php?pid=20382
http://adage.com/print?article_id=48584
http://www.wired.com/magazine/2010/02/ff_google_algorithm/
http://www.wired.com/magazine/2010/02/ff_google_algorithm/
http://investor.google.com/corporate/faq.html
http://blogs.barrons.com/techtraderdaily/2010/11/08
http://finance.yahoo.com/news/Google-grabs-personal-info-apf-2162289993.html
http://finance.yahoo.com/news/Google-grabs-personal-info-apf-2162289993.html
http://finance.yahoo.com/news/Google-grabs-personal-info-apf-2162289993.html
http://www.google.com/intl/en/press/pressrel/google_youtube.html
http://www.google.com/intl/en/press/pressrel/google_youtube.html
http://www.google.com/intl/en/press/pressrel/google_youtube.html
http://www.google.com/corporate/ex.html
http://www/time.com/time/printout/0,8816,1158961,00.html
http://www/time.com/time/printout/0,8816,1158961,00.html
http://www.google.com/corporate/execs.html
http://www.google.com/corporate/execs.html
http://www.google.com/corporate/tenthings.html
http://www.google.com/corporate/tenthings.html
http://adage.com/print?article_id=48584
Introduction
ON FEBRUARY 05, 2006, U.S.-BASED INTERNET SERVICES COMPANY YAHOO! INC. (Yahoo!)
moved all its advertisers to a new ranking model called ‘Panama’ in order to regain cus-
tomers who had shifted to the Google’s4 more popular AdWords.5 Yahoo!’s new algorithm
and ranking model would rank the advertisements based on the highest bid on search key-
words by the advertiser and the number of clicks. Industry analysts opined that with the new
model, Yahoo! would be in a better position to challenge Google. Panama received encourag-
ing reviews from the customers and the advertisers. According to Marianne Wolk, analyst at
Susquehanna Financial Group,6 “The early feedback on Panama is strong. Click-through rates
are better than expected.”7
In December 2006, prior to the launch of Panama, Yahoo! had announced that it was re-
organizing the company. The reorganization became necessary as Yahoo! found itself unable
to generate enough revenues from search-related advertising despite being the most visited
Web site on the Internet. Between July 2005 and July 2006, Yahoo!’s share in total online
searches in the United States went down from 30.5% to 28.8% (see Exhibit 1 for share of
online searches by engine in July 2005 and July 2006).
13-1
C A S E 13
Reorganizing Yahoo!
P. Indu and Vivek Gupta
“We’re putting the right people in the right places to execute our focused growth strategy. Yahoo! has an extraordinarily skilled
and experienced group of senior executives and we’re adding outside senior talent to this already strong team. Our new
structure gives us the opportunity to draw more fully on Yahoo!’s deep bench of talent, both at the new group level and down
through the organization, while also increasing accountability, reducing bottlenecks and speeding decision-making.
We’ll also continue to drive sustained innovation by recruiting, developing and retaining the best talent in our industry.”1
TERRY SEMEL, CHAIRMAN & CEO, YAHOO!, ON THE COMPANY’S REORGANIZATION PROGRAM ANNOUNCED IN 2006.
“This is just the beginning of what Yahoo! needs to do. It may take all of 2007. Change like this is evolutionary,
not revolutionary. The new division heads will need time to grasp the enormity of the task at hand.”2
JORDAN ROHAN, ANALYST RBC CAPITAL MARKETS3 ON YAHOO!’S REORGANIZATION, IN 2006.
Copyright © 2007, ICFAI. Reprinted by permission of ICFAI Center for Management Research (ICMR), Hyderbad,
India. Website: www.icmrindia.org. This case cannot be reproduced in any form without the written permission of the
copyright holder, ICFAI Center for Management Research (ICMR). Reprint permission is solely granted by the pub-
lisher, Prentice Hall, for the book, Strategic Management and Business Policy–13th Edition (and the International and
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www.icmrindia.org
13-2 SECTION D Industry Two—Internet Companies
EXHIBIT 2
Income Statement: Yahoo!, Inc.
(Dollar amounts in millions)
Year Ending December 31 2006 2005 2004 2003 2002 2001
Total Revenue $6,425.68 $5,257.67 $ 3,574.52 $1,625.10 $953.07 $ 717.42
Cost Revenue 2,669.10 2,096.20 1,342.34 370.09 162.88 157.00
Gross Profit 3,756.58 3,161.47 2,232.18 1,255.01 790.19 560.42
Selling, General, Adm Expenses 2,002.48 1,397.41 1,072.92 709.67 539.05 470.91
Research & Development 688.34 547.14 368.76 207.28 141.77 121.47
Depreciation/Amortization 124.79 109.19 101.92 42.38 21.19 64.08
Unusual Income (Expense) 63.23
Total Operating Expense 2,815.61 2,053.74 1,543.60 959.33 702.01 719.69
Operating Income 940.97 1,107.73 688.58 295.68 88.18 –159.27
Interest Income, Net Non-Operating 139.78 1,092.45 475.95 45.98 87.69 4.36
Gain (Loss) on Sales of Assets 15.16 337.96
Other, Net 2.09 5.44 20.49 1.53 2.35 72.09
Income Before Tax 1,098.00 2,543.58 1,185.02 343.19 178.22 –82.82
Income After Tax 458.01 767.82 437.97 147.04 71.28 –9.97
Minority Interest –0.71 –7.78 –2.50 –5.92
Equity in Affiliates 112.11 128.24 94.99 47.65
Net Income $ 751.39 $1,896.22 $ 839.54 $ 237.88 $106.94 $ –92.79
Consolidated Balance Sheets Data:
December 31,
2002 2003 2004 2005 2006
(In thousands)
Cash and cash equivalents . . . . . . . . . . . . $ 234,073 $ 415,892 $ 823,723 $ 1,429,693 $ 1,569,871
Marketable debt securities . . . . . . . . . . . . $1,299,965 $2,150,323 $2,918,539 $ 2,570,155 $ 1,967,414
Working capital . . . . . . . . . . . . . . . . . . . . $ 558,190 $1,013,913 $2,909,768 $ 2,245,481 $ 2,276,148
Total assets . . . . . . . . . . . . . . . . . . . . . . . . $2,790,181 $5,931,654 $9,178,201 $10,831,834 $11,513,608
Long-term liabilities . . . . . . . . . . . . . . . . . $ 84,540 $ 822,890 $ 851,782 $ 1,061,367 $ 870,948
Total stockholders’ equity . . . . . . . . . . . . $2,262,270 $4,363,490 $7,101,446 $ 8,566,415 $ 9,160,610
EXHIBIT 1
Share of Online
Searches by Engine1
July 05 June 06 July 06 % Change
Google Sites 36.5 44.7 43.7 4.2
Yahoo! Sites 30.5 28.5 28.8 –1.7
MSN Microsoft sites 15.5 12.8 12.8 –2.7
Times Warner Network 9.9 5.6 5.9 –4.0
Ask Network 6.1 5.1 5.4 –0.7
Note:1 Total work, home and university Internet users in the United States, Internet population is 100%.
SOURCE: www.comscore.com.
SOURCES: finance.google.com and 2006 Annual Report, Yahoo!, Inc., 1.33.
In spite of total revenues going up from US$5,257.67 million in 2005 to US$6,425.68 million
in 2006, Yahoo!’s net income fell from US$1,896.22 million to US$751 million (see Exhibit 2 for
Yahoo!’s Income Statement between 2001 and 2006). According to analysts, the problem was that
Yahoo! was not focusing on any particular product, but was trying instead to cater to different cus-
tomers through a single portal. Though Yahoo! acquired several companies, it failed to integrate
www.comscore.com
CASE 13 Reorganizing Yahoo! 13-3
Background Note
Yahoo! was founded by Jerry Yang and David Filo, who began exploring the Internet as a
hobby after finishing their doctoral theses in electrical engineering at Stanford University. In
April 1994, they created a directory to keep track of their personal interests on the Internet.
Gradually, they began to spend more and more time on their directory. Later, Yang and Filo
started categorizing Web sites as a way to keep track of all the sites they had visited. They
posted this list on the Web as “Jerry and David’s Guide to the Worldwide Web.”
The guide became very popular and became the first choice of people browsing the Web
to find sites intelligently. It helped people to discover useful, interesting, and entertaining con-
tent on the Internet. In late 1994, the duo changed the name of the guide to Yahoo!,11 position-
ing it as a customized database designed to serve different users. They developed customized
software to help locate, identify, and edit material stored on the Internet. Yahoo! rapidly be-
came popular and attracted a lot of media attention.
Yahoo! was formally incorporated in March 1995, and by mid-1995 it had implemented
a business plan modeled on traditional broadcast media companies. Through its IPO in April
1996, Yahoo! sold 2.6 million shares, raising US$38.8 million.
Yahoo! generated its revenues mainly from online advertisements, primarily banner ads12 and
ad placement fees, promotions,13 sponsorships, direct marketing,14 and merchandising. It also gen-
erated revenues from monthly hosting fees and commissions on online sales from its merchant
partners. These included transaction fees generated from the sale of merchandise on its site.
Within the four years from 1997 to 2000, Yahoo! reported substantial growth in its revenues.
More than 85% of its revenues came from the sale of banners and sponsorship advertising while
the remaining came from business services and e-commerce transactions. By mid-2000, Yahoo!
was drawing more than 180 million unique visitors,15 which made Yahoo! a leading Internet brand.
In late 2000, Yahoo! faced several problems owing to the internal rivalry between President
Jeffrey Mallett and CEO Timothy A Koogle (Koogle). Its troubles were compounded by the fact
that the company had grown complacent and did not adapt to the rapidly changing business envi-
ronment. Yahoo! was heavily dependent on the advertising revenues generated through dotcoms.
Once the dotcoms began going out of business, Yahoo!’s ad revenues declined sharply. The
them. Even in search-related advertising, which had emerged as a major revenue generator in the
Internet business, Yahoo! fell behind its competitor Google, which was generating twice as much
revenue on each search ad. The challenges that Yahoo! was facing externally were further com-
pounded by the internal turmoil in the company brought about by the complex organization struc-
ture and slow decision-making process.
Yahoo! delayed several product launches as it wanted to focus on Panama, which had been
delayed by more than two quarters. Panama was to be launched in the second quarter of
2006 but was not launched even at the end of 2006. Yahoo!’s problems were reported widely
in the media. At the same time, the Wall Street Journal8 published an internal memo that was
circulated by a senior vice president at Yahoo!, about the lack of focus in the company due to
which its resources were thinly spread across several business segments.
Within a month, Yahoo! introduced a new organization structure, under which the com-
pany was reorganized into three operating units, namely the Audience Group, the Advertiser &
Publisher Group, and the Technology Group with the focus on the customers, advertisers, and
technology, respectively. The heads of the three units reported directly to Terry Semel (Semel),
chairman & CEO of Yahoo!.
Analysts opined that with the reorganization and Panama in place, Yahoo! could well be
on its way to regaining its lost glory. According to Martin Pyykkonen, analyst, Global Crown
Capital,9 “I’m not forecasting any kind of wholesale shift here, that all of a sudden Google is
going to fall by the wayside … but I do think they (Yahoo!) will narrow the gap.”10
13-4 SECTION D Industry Two—Internet Companies
online advertising market was going through major changes, and the advertisers were looking
beyond the banner ads, toward ads that integrated the Internet, television, and radio. Yahoo!,
however, did not understand what kind of advertising would work for the customers. It failed to
make any improvements in its business models, which would have allowed it to cater to a wide
range of customers. Several key personnel also left the company during the time.
In the first quarter of 2001, with a sharp decline in online advertisement sales, Yahoo! re-
duced its revenue forecast from US$230 million to US$175 million. At a board meeting con-
vened in February 2001, it was decided that Koogle should step down, making way for Semel.
Semel brought in several changes in the company and the number of business units was re-
duced from 44 to just five. He also announced the layoff of 400 people from Yahoo!’s 3,500
workforce. Several new services, including subscription-based services were introduced.
In order to consolidate its position, Yahoo! entered into several partnership deals. One
such deal was with Overture, a paid search services16 provider. The acquisitions made by
Yahoo! included Hotjobs.com, an online careers site, in February 2002 for US$435 million,
and Inktomi Corporation17 in March 2003 for US$257 million. Yahoo! also entered into a
licensing agreement with Google to use its search engine technology.
At the end of 2003, Yahoo! acquired Overture for around US$1.6 billion. At the time, Over-
ture dominated search-related advertising, and its revenues were almost double that of Google.
Through Overture’s advertising platform, advertisers could select words and search phrases and
bid for them. This enabled their advertisements to be shown along with the regular search results.
As Overture was highly successful, analysts opined that Yahoo! was making the right moves and
could consolidate its position in the rapidly growing online advertising market by acquiring
Overture. With Inktomi and Overture,18 Yahoo! was expected to become a domination force in
the search advertising market (see Exhibit 3 for online advertising market in the United States).
The Problems
Though Yahoo! possessed search engine and search advertising technology, integrating both
proved to be a difficult task. The engineers in the company had to be convinced that, rather
than build the new technology from scratch, it was better to use the acquired technology from
Inktomi and Overture. In order to convince the engineers, Semel announced the integration
of Yahoo!, Inktomi, and Overture to create the best search technology consumers and an ef-
fective advertising platform for the advertisers.
However, even until early 2004, Yahoo! continued using Google’s search engine. In
February 2004, Yahoo! launched a Web crawler–based19 search engine, based on Yahoo!
Slurp.20 With the prevailing optimism about Yahoo!, its stock hit US$36.42 by mid-2004.
Through Overture, advertisements were placed depending on the amount the advertiser
had agreed to pay per click. So the advertisements of the highest bidder were placed on the
top, irrespective of their relevance. The technology used in Overture could not handle the high
traffic expected out of a Yahoo! search. Overture required each advertisement to be reviewed
and placed with human intervention, and this required a lot of time. To display advertise-
ments based on relevance, Yahoo! needed to create new ranking software and a database to
measure the clicks the advertisements were receiving. The company planned to spruce up
technology and call the project Panama. However, the project ran into trouble with execu-
tives from Yahoo! and Overture not being able to work together. Meanwhile, by 2004,
Google had surpassed Overture in terms of revenues. There were several other areas in
which Yahoo! faced problems. According to analysts, Yahoo! had become a victim of it own
success. The company had adopted the model of being a one-stop portal, offering all the serv-
ices on its website. Over the years, Yahoo!’s home page grew highly cluttered. The difference
was quite stark when compared to Google’s home page. Google’s home page was simple and
user-friendly while Yahoo!’s homepage had links to a host of products and services, such as
CASE 13 Reorganizing Yahoo! 13-5
EXHIBIT 3
A Note on Online
Advertising Market
in the U.S.
With the increase in the number of broadband connections, especially after 2000, an Internet ad-
vertising market began growing rapidly in the United States. The faster broadband connections of-
fered advertisers an opportunity to dabble with rich media advertising. Moreover, limitations
began to surface in the til-then most popular advertising channel, the television, making advertis-
ers look for a better alternative in their efforts to reach the right kind of audience. This led to the
emergence of online advertising, especially search-based advertising, where the advertisers chose
to advertise only to their target audience. One of the first Internet advertising companies was
GoTo.com, later named Overture, which pioneered the concept of paid search. The next player on
the horizon was Google, which came out with the idea of payment for advertising according to the
clicks the advertisement received. These advertisements were also contextual and were related to
the content on the page. On similar lines, companies like Microsoft launched AdCenter and eBay
launched AdContext.
Online advertising techniques include banners, pop-ups, pop-unders, search and display ads,
and interactive advertising, etc. In display advertising, advertisers pay the online company for
space to display the ad, which could be a hyperlinked banner, logo, etc. In the case of sponsorship,
the advertisers sponsor a Web site or some of the pages on the website for a particular period. Ad-
vertisers opting to advertise through e-mail place their banner ads, links, or newsletters on the
e-mails. Other forms of Internet advertising are lead generation, referrals, classifieds, auctions,
rich media, and slotting fees.
It is search advertising that remains highly popular. In search advertising, a fee is paid by the
advertisers to the online companies to list or link their site domain name to a specific search word
or a search phrase. There are different types of search advertising. In paid listings, text links ap-
pear at the top of the search results. The advertiser pays only when users click the link. In contex-
tual search, the text links of the advertisers appear depending on the context of the content,
irrespective of the search word. Even in this, the advertisers pay the online company only when
users click the links. Through paid inclusion, advertisers are guaranteed that their URL is indexed
on a search engine.
In the year 2003, Internet advertising was the fastest-growing advertising medium, and by
2005 Internet advertising in the United States was valued at over US$12.5 billion, showing a
growth of 30% over 2004. Internet advertising accounted for around 5% of the total advertising
revenues in the United States in 2005.
In 2005, keyword search accounted for 34% of the total Internet ad revenue at US$5142
million. Display advertising’s share was at 20% with US$2508 million, rich media was US$1003
million, sponsorship at US$627 million, slotting fee US$125 million, classifieds US$2132 million,
e-mail US$251 million, and referrals/lead generation about US$753 million.
Internet Advertising – Annual Revenues
Year Revenue (In US$ Million)
1996 267
1997 907
1998 1,920
1999 4,621
2000 8,087
2001 7,134
2002 6,010
2003 7,267
2004 9,626
2005 12,452
SOURCE: Adapted from IAB Internet Advertising
Revenue Report and PricewaterhouseCoopers.
Advertising Market in the U.S. (2005)
Media In US$ Million
Direct mail 56.6
Newspapers 47.9
Broadcast & Syndicated TV 35.0
Radio 21.7
Cable TV 18.9
Consumer Magazines 12.9
Internet 12.4
Business Magazines 7.8
Outdoor 6.2
13-6 SECTION D Industry Two—Internet Companies
EXHIBIT 4
Home Page in 1996:
Yahoo!, Inc.
e-mail, music, mobile, small business services, health, finance, games, movies, personals, etc.
Tucked away among all these was a search engine. Some of the Yahoo! employees were of the
opinion that the home page suffered “from too many cooks in the kitchen.”21 (See Exhibit 4
for Yahoo!’s homepage in 1996 and see Exhibit 5 for Yahoo!’s homepage in 2004.)
Yahoo! seemed unclear about its identity, about whether it was a portal, search engine, or a
media company.At the same time, several sites such as Google, eBay,22 and MySpace23 were suc-
cessful in their specialized area, and consumers shifted their preferences to those sites. In the
process of diversifying into several areas, Yahoo! appeared to have lost its identity. According to
Stewart Butterfield, director of project management, Yahoo!, and cofounder of Flickr,24 “There’s
always been some ambiguity about whether it’s a tech company or a media company.”25
There were other problems too. For instance, Yahoo! was the most visited Web site on the
Internet, with an average of 500 million monthly visitors as of mid-2006. The company’s rev-
enues for the first three quarters of 2006 stood at US$4.5 billion. On the other hand, Google,
with 380 million visitors, recorded revenue of US$7.2 billion in the same period. This meant
that Yahoo! was failing to generate enough revenues from the users visiting its site.
Yahoo! had been actively acquiring companies since 2002. Some of the companies acquired
by Yahoo! were Flickr, Konfabulator, Upcoming.org,26 Del.icio.us,27 and Webjay.28 Konfabulator
was a widget29 engine, Upcoming.org was a social event calendar, Del.icio.us was a bookmark-
ing site, and Webjay, a music playlist service. Yahoo! launched Yahoo! 360°, a social networking
service. However, many of these acquisitions could not be integrated with the company’s oper-
ations. Though all these were part of Yahoo!, a user had to log in separately for accessing each
of the services (see Exhibit 6 for some of Yahoo!’s acquisitions over the years).
Yahoo!’s problems were compounded by the company’s complex matrix organization struc-
ture with overlapping responsibilities, which slowed down the decision-making process. Many
SOURCE: www.cnet.com. Reproduced with permission of Yahoo! Inc. © 2011 Yahoo! Inc. YAHOO! and the YAHOO!
logo are registered trademarks of Yahoo! Inc.
www.cnet.com
CASE 13 Reorganizing Yahoo! 13-7
EXHIBIT 5
Home Page in 2004:
Yahoo!, Inc.
new employees in the company were of the view that the company’s top-down approach did not
encourage creativity. There was little cooperation between the different teams in the company.
According to one of the media buyers, even the search and display teams in Yahoo! did not com-
municate with each other. He complained, “Their organization is set up in such a way that we
could spend 50 million dollars in search, and not be recognized at all by the display people.”30
Yahoo! had planned to acquire several companies with the objective of boosting its presence
in the emerging social networking market. But it failed in these attempts. The company’s existing
sites were overrun by the competition. Yahoo!’s plans to acquire Facebook31 did not meet with
success as Facebook backed out of the deal, and YouTube,32 which Yahoo! was planning to ac-
quire, was acquired by Google. Nor did the company’s plan to create original content meet with
success. Yahoo! brought in several high-profile executives like Lloyd Brown from ABC Televi-
sion Entertainment, as the head of Media group, Neil Budde from the Wall Street Journal Online,
and David Katz from CBS Television. Yahoo! planned to produce television-style programs,
SOURCE: www.cnet.com. Reproduced with permission of Yahoo! Inc. © 2011 Yahoo! Inc. YAHOO! and the YAHOO!
logo are registered trademarks of Yahoo! Inc.
www.cnet.com
13-8 SECTION D Industry Two—Internet Companies
EXHIBIT 6
Acquisitions:
Yahoo!, Inc.
Year Acquired Company
2002 Hotjobs
Inktomi
2003 Overture
2004 3721 Internet Assistant
Kelkoo
Oddpost
The All-Seeing Eye
MusicMatch
Stata Lab Inc
WUF Networks
2005 Verdisoft
Ludicorp Research (Flickr)
Stadeon
TeRespondo
Dialpad
blo.gs
Konfabulator
Alibaba
Upcoming.org
Whereonearth
del.icio.us
2006 Searchfox
Meedio
Gmarket
Jumpcut.com
Adlnterax
Right Media
Kenet Works
bix.com
Wretch
Compiled from various sources.
including sitcoms and talk shows for the Internet audience. Within a year, in March 2006, Yahoo!
announced that it was scaling back these efforts. The content development was not going as
planned, and the entertainment unit suffered from the same problems. The employment listings of
Yahoo!, Hotjobs, could not withstand the competition from other employment sites like Monster
and Careerbuilder. David A. Utter, staff writer covering technology and business for
webpronews.com said, “Declining ad sales in the finance and automotive markets, a delayed
launch of new contextual ad service, and splashy acquisitions by Google have left Yahoo! feeling
like the last grape in a wine press.”33
According to Nick Blunden, client services director, Profero,34 “Yahoo! has lost some of
the magic that propelled it into the digital stratosphere in its heyday. While there is no single
explanation for this, its quest for growth appears to have undermined the sense of purpose and
identity that drove its success. Just a few years ago, Yahoo!’s services seemed to be clustered
around themes of communication, content, and commerce and it was renowned for its innova-
tion in these areas. Today, it appears to be a much looser collection of services that are united
by the Yahoo! name.”35
In July 2006, when Semel announced that the launch of Panama would be delayed by
three months, the stock took a beating and fell by 22% on a single day. The price dropped from
CASE 13 Reorganizing Yahoo! 13-9
US$32.24 to US$25.24. When Yahoo!’s third quarter results were announced on October 12,
2006, profits were down by 38% as compared to third quarter of 2005 (see Exhibit 7 for quarter-
wise revenue and net income details of Yahoo!). At that time, Semel realized that Yahoo!
needed to improve its search advertising capability in order to take advantage of growing rev-
enues from that category. One of the founding executives of Yahoo!, Ellen Siminoff, said, “A
lot of people (at Yahoo!) feel abused by the outside world and its perception of the company.
They have missed a few quarters this year, they have lowered expectations, they were late in
delivering Panama, and so they’re in the penalty box with Wall Street.”36
In October 2006, the New York Times published an article titled, “Yahoo!’s growth being
eroded by new rivals” in which it was written that the company was slow in negotiating with
other companies. The article particularly referred to Google’s acquisition of YouTube. It was
said that in spite of being the most popular website, Yahoo! had suffered setbacks in advertis-
ing, both search related and display advertising. The article quoted David Cohen, senior vice
president, Universal McCann,37 saying that many clients were opting for new sites. He said,
“Yahoo! has lost the favor it enjoyed a year or two ago. There are more players in town, and
the others are closing the gap relative to the things Yahoo! is good at.”38 The article said
Yahoo! was late in launching new products, many of its products did not perform up to expec-
tations, and the company was said to be demanding and inconsistent in carrying out negotia-
tions. The new advertising upgrade was blamed for the delay in developing other products.
Yahoo! was said to be competing with established players like CNN in news, ESPN in
Sports, Microsoft in e-mail, AOL in instant messaging, Google in Search, and MySpace in so-
cial networking. Tim Hanlon, senior vice president, Denuo,39 said, “It’s hard to figure out what
they want to be when they grow up, even though they are grown up now. Are they a content
company? Are they a service company? Or are they a portal to other things? You ask three peo-
ple and you may get three different answers.”40
After the article was published, Brad Garlinghouse, senior vice president, Communica-
tions and Communities Products at Yahoo!, sent an internal memo to some of the employees.
The memo compared Yahoo!’s activities and investments to a thinly spread layer of peanut but-
ter, as Yahoo! was involved in several activities without focus on any particular activity. The
memo was leaked to the press and was published in the Wall Street Journal. The analogy with
peanut butter led to journalists and industry insiders dubbing the memo “The Peanut Butter
Manifesto.”
In “The Peanut Butter Manifesto,” Garlinghouse wrote that Yahoo! needed to reduce its
workforce by 15–20% by eliminating the unit structure through which the company had
spread its attention over several products and services and by decentralizing the matrix struc-
ture of the organization. Restructuring Yahoo! was necessary to eliminate the existing bureau-
cracies. Pointing out that different units in the company lacked coordination and were
EXHIBIT 7
Quarterly Income
Statement
(September
2005–September
2006): Yahoo!, Inc.
(Dollar amounts
in millions)
Quarter Ending Sep 30, 06 Jun 30, 06 Mar 31, 06 Sep 30, 05
Total Revenue $1,580.32 $1,575.84 $1,567.05 $1,329.93
Cost of Revenue 681.12 645.77 657.94 520.24
Gross Profit 899.20 930.07 909.11 809.69
Selling, General, Admin. Expenses 462.00 457.75 459.46 343.44
Research & Development 202.09 208.74 217.58 141.62
Others 32.77 34.00 30.86 54.57
Total Operating Expense $1,377.98 $1,346.26 $1,365.84 $1,059.87
Operating Income $202.34 $229.58 $201.21 $270.06
Net Income $158.52 $164.33 $159.86 $253.77
13-10 SECTION D Industry Two—Internet Companies
EXHIBIT 8
Services Offered
by Yahoo!
YME or Yahoo! Music Jukebox is a free music player released in 2005. The features include CD
burning, CD ripping, transfer of music to portable devices, playlist creation, music subscription,
etc. Several plug-ins are also provided with Yahoo! Music Jukebox.
Musicmatch is an audio player used to manage a digital audio library. The features include
CD ripping, CD playback, Internet audio, and an online music store. Musicmatch was acquired by
Yahoo! in October 2004.
Yahoo! Photos is the photo sharing service provided by Yahoo!. Through this service,
Yahoo! users can store photos with a jpeg or jpg extension. The users can create their individual
albums, categorize the photos, and can publish the albums for others to see. An uploader tool is
provided through which photos can be dragged from the computer and dropped to Yahoo! Photos.
Using the other services, users can order prints, create calendars or personal stamps. Pictures
stored in Yahoo! Photos can be shared through Yahoo! 360°, displayed on Yahoo! Pages, and
used through Yahoo! Messenger.
Flickr is an online community platform that is popular for its photo sharing service and is
widely used as a photo repository. Flickr was launched by Canada-based Ludicorp in February
2004. In March 2005, Yahoo! acquired Ludicorp.
My Web was launched in June 2005 and is a social bookmarking site, which allows users to
save the cached copy of their favorite Web pages. These pages are saved to the users’personal “My
Web.” Users can access these Web pages any time and can conduct searches through these pages.
Users can save their Yahoo! search results to My Web through Yahoo! toolbar.
Del.icio.us is social bookmarking Web site that allows the users to store, share, and discover
Web bookmarks. This Web site was launched in 2003 and Yahoo! acquired it in December 2005.
Del.icio.us uses non-hierarchical keyword categorization, with which users can tag bookmarks
with any keyword. Most of the content on the Web site is viewable, and users can mark some book-
marks as private.
Yahoo! Widgets bring the updated view of the favorite services of the users to the desktop.
Widget refers to an interface element through which the computer and the user interact. Yahoo!
has more than 4,000 desktop widgets, with which several tasks can be performed; these include
tracking information of the browsing history, weather widget, which downloads the weather fore-
casts from the selected place, digital clock widget, which shows the time and has an alarm facil-
ity, stock ticker widget, which shows updated stock prices, etc.
Messenger Plug-ins provide easy access to the user’s favorite content. Some of the popular
plug-ins include eBay plug-in, which displays the listings and bids on eBay, and Calendar plug-
in, which allows users to view calendars. Other plug-ins allow users to listen to music, send in-
vites, plan events, and view the blogs and photos of friends.
competing with each other, Garlinghouse recommended a major revamp in the corporate
structure. According to the Wall Street Journal, Garlinghouse’s memo was circulated among
the top brass of Yahoo!.
According to Garlinghouse, Yahoo! did not have a particular focus or strategy and was
trying to cater to all the customer segments. He felt that the company should focus on a few
key areas like video, mobile, and social networking. The memo mentioned that there were
several competing silos existing in the company, such as Yahoo! Music Engine (YME)41 and
Musicmatch, Yahoo! Photos and Flickr, Del.icio.us and Myweb, Messenger Plug-ins and
Sidebar widgets, (see Exhibit 8 for a note on services offered by Yahoo!), which were tar-
geted at the same customers (see Exhibit 9 for excerpts from “The Peanut Butter Mani-
festo”). According to Allen Weiner, an analyst from Gartner, “Yahoo! is by no means out of
the game, but [it’s time] to execute on a more tightly focused vision. That’s what’s missing.
Garlinghouse is right in saying there are way too many people doing way too many
things.”42
CASE 13 Reorganizing Yahoo! 13-11
EXHIBIT 9
Excerpts from
‘Peanut Butter
Manifesto’
We lack a focused, cohesive vision for our company. We want to do everything and be every-
thing – to everyone. We’ve known this for years, talk about it incessantly, but do nothing to fun-
damentally address it. We are scared to be left out. We are reactive instead of charting an
unwavering course. We are separated into silos that far too frequently don’t talk to each other. And
when we do talk, it isn’t to collaborate on a clearly focused strategy, but rather to argue and fight
about ownership, strategies, and tactics.
Our inclination and proclivity to repeatedly hire leaders from outside the company results in
disparate visions of what winning looks like—rather than a leadership team rallying around a sin-
gle cohesive strategy.
I’ve heard our strategy described as spreading peanut butter across the myriad opportunities
that continue to evolve in the online world. The result: a thin layer of investment spread across
everything we do and thus we focus on nothing in particular.
We lack clarity of ownership and accountability. The most painful manifestation of this is
the massive redundancy that exists throughout the organization. We now operate in an organiza-
tional structure—admittedly created with the best of intentions—that has become overly bureau-
cratic. For far too many employees, there is another person with dramatically similar and
overlapping responsibilities. This slows us down and burdens the company with unnecessary costs.
Equally problematic, at what point in the organization does someone really OWN the suc-
cess of their product or service or feature? Product, marketing, engineering, corporate strategy, fi-
nancial operations . . . there are so many people in charge (or believe that they are in charge) that
it’s not clear if anyone is in charge. This forces decisions to be pushed up—rather than down. It
forces decisions by committee or consensus and discourages the innovators from breaking the
mold . . . thinking outside the box.
We lack decisiveness. Combine a lack of focus with unclear ownership, and the result is that
decisions are either made or are made when it is already too late. Without a clear and focused vi-
sion, and without complete clarity of ownership, we lack a macro perspective to guide our deci-
sions and visibility into who should make those decisions. We are repeatedly stymied by
challenging and hairy decisions. We are held hostage by our analysis paralysis.
We have awesome assets. Nearly every media and communications company is painfully
jealous of our position. We have the largest audience, they are highly engaged and our brand is
synonymous with the Internet.
Independent of specific proposals of what this reorganization should look like, two key prin-
ciples must be represented:
Blow up the matrix. Empower a new generation and model of General Managers to be true
general managers, Product, marketing, user experience & design, engineering, business develop-
ment & operations all report into a small number of focused General Managers. Leave no doubt
as to where accountability lies.
Kill the redundancies. Align a set of new BUs so that they are not competing against each
other. Search focuses on search. Social media aligns with community and communications. No
competing owners for Video, Photos, etc. And Front Page becomes Switzerland. This will be a
delicate exercise – decentralization can create inefficiencies, but I believe we can find the right
balance.
My motivation for this memo is the adamant belief that, as before, we have a tremendous op-
portunity ahead. I don’t pretend that I have the only available answers, but we need to get the dis-
cussion going; change is needed and it is needed soon. We can be a stronger and faster company—a
company with a clearer vision and clearer ownership and clearer accountability.
We may have fallen down, but the race is a marathon and not a sprint. I don’t pretend that this
will be easy. It will take courage, conviction, insight, and tremendous commitment. I very much—
look forward to the challenge.
SOURCE: Yahoo! Memo: The ‘Peanut Butter Manifesto,’The Wall Street Journal, November 18, 2006.
13-12 SECTION D Industry Two—Internet Companies
EXHIBIT 10
Key Objectives
of Reorganization
Expand customer-centric culture and capabilities. Yahoo! will develop rich experiences for
each audience segment and deliver solutions to meet the needs of all advertisers and publishers
worldwide. Yahoo! will organize its services around audience segments and advertising cus-
tomers, rather than around products.
Create leading social media environments. Yahoo! will leverage its strong positions in
community, communications, search, as well as media content across its global network to create
leading social media environments, which will encourage every user on the Yahoo! network to
participate in the consumption and publishing of information, and knowledge through tagging, re-
viewing, sharing of images and audio, and other social media activities.
Lead in next-generation advertising platforms. Yahoo! will extend its industry-leading
breadth of offerings to give the most diverse array of advertisers, from large brand marketers to
local merchants, every opportunity to connect with audiences on and off Yahoo!
Drive organizational effectiveness and scale. Yahoo! will recruit and retain the best indus-
try talent and focus its resources on high-impact, network-wide platforms to help capture the most
significant long-term growth opportunities.
The Reorganization Program
On December 5, 2006, Semel announced the reorganization of Yahoo! and major changes in
its executive team. Semel announced, “Yahoo! is now entering what I call its third phase—
focused on customers. We’re seeing the competitive and advertising landscapes evolve yet
again and today we announced the realignment that we believe will let Yahoo! capture the
major growth opportunities ahead.”43
Though it was widely speculated that Yahoo!’s announcement of reorganization was
prompted by the leaked memo, the company denied this and said that reorganization was al-
ready in the process. According to Semel, “Now, I know what you’re thinking—this is all
about peanut butter. Actually, we’ve been orchestrating this plan for a number of months as we
envisioned the next phase of growth for the Internet. Following our third quarter results, I very
openly discussed that we were going to become more focused and bring about change.”44 (see
Exhibit 10 for key objectives of Yahoo!’s reorganization).
The reorganization aimed at making Yahoo! leaner, more nimble, and responsive to cus-
tomers. Through the reorganization, the company planned to align its operations with the key
customer segments of audiences, advertisers, and publishers and capture the emerging growth
opportunities especially on the Internet, and become more customer-focused with the support
of technology. Yahoo! was reorganized around three groups, with two groups, the Audience
Group, and the Advertising & Publishing Group, focusing on the customer. The third group,
Technology Group, aimed at strengthening the technology function in the company. The heads
of the three groups reported directly to Semel.
The Audience Group’s main focus was on creating user experiences and at the same
time, generating value for the advertisers. The group was a result of the merger of seven ex-
isting product groups in the company, and was created to maintain a better focus on the cus-
tomer. According to Yahoo!, the focus of the Audience Group was to “enhance its existing
products in search, media, communities and communications; build social media environment
across Yahoo!; open more opportunities for users to take advantage of Yahoo! tools and ser-
vices off network and through mobile and digital devices; and pursue growth opportunities in
emerging international markets.”45 The Audience Group focused on different services offered
by Yahoo!, which included search, e-mail, messenger, e-commerce, music, and video.
Through reorganization, Yahoo! aimed to bring coherence to the wide array of services it pro-
vided. The creation of the Audience Group was expected to transform the company into a so-
cial media provider and help it bring in the content that was relevant to the audience.
The Advertising & Publisher Group’s main task was to manage Yahoo!’s advertising con-
tent, build a large audience in association with Yahoo! partner publishers, and create a global ad-
vertising network on and off Yahoo! sites. The group’s aim was to transform the way in which
the advertisers connected with their target audience and provide them with more value. Susan L.
Decker, who was heading Yahoo! Marketplaces business unit, took over the revamped advertis-
ing unit, while continuing to function as the CFO until a new CFO was recruited. The group, with
the aim of building a global advertising network, was created combining several existing units,
including a search marketing unit, publishing unit, and media sales and graphical advertising unit.
The group was created to serve the customer in major customer segments such as large advertis-
ers, large adverting agencies, businesses of small and medium size, resellers, and publishers.
The Advertising & Publisher Group was organized around three functions, which were
demand channels, supply channels, and marketing products (see Exhibit 11 for more about di-
visions in Advertising & Publishing Group).
The Technology Group was headed by Farzad Nazem, chief technology officer (CTO) of
Yahoo!. This group was responsible for integrated product development, and the Platform &
Infrastructure sub-groups were a part of the Technology Group. The group aimed at achieving
integration within product development teams. Through this group, Yahoo! wanted to channel
its investment toward global platforms with high impact and scalability. Leveraging on the
investments in communities to create technology and advertising platforms, Yahoo! aimed at
expanding the advertising network and remaining focused on product development. With the
EXHIBIT 11
Divisions in
Advertising &
Publishing Group
DEMAND CHANNELS (MARKETING SOLUTIONS)
Yahoo!’s demand channels were organized into the Direct Sales Channel and the Online Channel,
based on the advertisers. The direct sales channel catered to the advertisers who interacted directly
with the company while the online channel was targeted at self-service advertisers, who used on-
line services.
SUPPLY CHANNELS (YAHOO! PUBLISHER NETWORK)
This channel catered to publishing customers, and was responsible for display and display based
ad networks, by securing ad inventory from different Yahoo! and non-Yahoo! sites. Yahoo!
planned to offer its advertising customers a wide range of marketing products and also high qual-
ity customers through this channel.
MARKETING PRODUCTS DIVISION
The marketing products division connected the demand and supply channels, by connecting the
marketing offers from demand channels with ad inventory generated by different Yahoo! chan-
nels. This division was responsible for developing products and marketplaces that would offer ef-
fectiveness for advertising customers and monetization for publishing customers. The division
comprised search and listing marketplaces, and display marketplaces. These marketplaces were
supported by project management, and engineering teams.
LOCAL MARKETS & COMMERCE DIVISION
This division, formerly known as Marketplaces, was brought under the Advertising & Publishing
Group. This included shopping, travel, autos, hotjobs, personals, and real estate.
STRATEGIC MARKETING & MAJOR INITIATIVES
The main task of this division was to work closely with other divisions in the Advertising &
Publishing group, and bring in a unified marketing strategy and customer and market segments.
SOURCE: Adapted from E-Mail Titled ‘Update on APG Organization’Sent by Susan Decker to all Yahoo! Employees
on February 14, 2007. Retrieved from www.techcrunch.com.
CASE 13 Reorganizing Yahoo! 13-13
www.techcrunch.com
13-14 SECTION D Industry Two—Internet Companies
EXHIBIT 12
Stock Price Chart (April 2002–March 2007): Yahoo!, Inc.
SOURCE: www.bigchart.com
45
3/02/07
40
35
30
25
20
15
10
5
M
ill
io
ns
0
400
300
200
100
0
YHOO Weekly
Volume @BigCharts.com
03 04 05 06 07
The Road Ahead
Yahoo!’s reorganization was expected to eliminate the bureaucracy that had crept into the
company over a period of time. After the reorganization was announced, the company’s stock
price fell by 2% to US$26.86. Industry experts were of the view that it was high time Yahoo!
was reorganized, as the previous reorganization48 was done about five years back (see
Exhibit 12 for Yahoo!’s stock price chart).
centralized technology group, it was expected that users could access all the services provided
by Yahoo! products with a single Yahoo! e-mail account. According to Justin Port, analyst with
Merrill Lynch,46 “The elevated status of the Technology Group underscores management’s
commitment to improving product innovation.”47
As part of the reorganization program, which was expected to be completed by the end of
March 2007, three executives—Dan Rosensweig, COO, Lloyd Braun, head Media Group, and
John Marcom, senior vice president, International Operations, resigned from the organization
during the first quarter 2007. The reorganization program also led to a new mission statement
for Yahoo!: “to connect people to their passions, their communities, and the world’s knowl-
edge.” Analyst opined that the new mission statement signified the fact that Yahoo! had put
people at the center of their strategy. They said that by restructuring, Yahoo! was changing its
focus to eliminate redundancies and increase accountability and decision making and emerge
as a customer-focused organization.
www.bigchart.com
Another strategy that Yahoo! adopted was “Brand Universe” through which it planned to
develop sites dedicated to high-profile entertainment brands, including television shows like
Lost 49 and The Office,50 video games like Halo51 and The Sims,52 and movies like Harry
Potter.53 Through Brand Universe, Yahoo! planned to link entertainment content across differ-
ent Yahoo! services and Web sites. All the entertainment partners would also be informed
about the traffic their content was attracting, the reach of the brands, and other such details.
The fact the YouTube was planning to include short advertisements before each video clip was
expected to boost Yahoo!’s ability to attract visitors, as visitors who wished to skip the adver-
tisements would opt for other alternatives, such as Yahoo!.
To spruce up Yahoo! News, which was accessed by 34 million unique users every month
as of 2006, Yahoo! launched video content in association with CBS owned stations. Yahoo!
News served over 60 million video streams per month as of February 2007.
In November 2006, Yahoo! entered into an agreement with a consortium of nine companies,
representing more than 170 newspapers in the United States. The consortium included Hearst
Newspapers, MediaNews Group, Cox Newspapers, Lee Enterprises, Journal Register, and EW
Scripps.As per the agreement, the newspapers started usingYahoo! HotJobs from December 2006
onward. Both the parties were expected to benefit from the deal, as Yahoo! would get regional ex-
posure while advertisements from local newspapers would acquire a wider reach. Over a period
of time, other content such as local news and advertisements were also planned to be included.
In the first week of December 2006, Yahoo! released a mobile social networking service
called Mixd with which customers could coordinate outings and meetings with friends using
text messages and photo messages. The activities were simultaneously posted on the Web
page. The service was targeted at young users of 18–25 years of age and Yahoo! started mar-
keting the service in some university campuses in the United States.
According to industry experts, Yahoo! was on the right path in proposing a restructuring
plan; however, what mattered most was how the plan was executed. They said Yahoo! should
be careful in executing the reorganization program. Analysts also opined that the reorganiza-
tion might take some time to show results. Meanwhile, Yahoo! had to face competition not
only from existing players but also from new ones, which were making their presence felt in
the market. Yahoo! needed to generate more revenues from social media and user-generated
content. There were suggestions that Yahoo! could consider a merger with AOL or Microsoft,
as neither of these companies was strong in search engine technology. Any such deal, accord-
ing to analysts, would help Yahoo! compete with Google effectively.
Analysts were of the opinion that as Yahoo! was one of the most popular sites attracting
millions of unique visitors, through Panama, it could increase the number of clicks on the ads,
and thus generate more revenues. Commenting on Panama, Paul Kedrosky, partner, Ventures
West,54 said, “It doesn’t have to be as good as Google, Yahoo! has this bazooka. It stomps
Google in page views. And Yahoo! is still the king of audience. There is a huge upside for
them.”55 Yahoo! also had another advantage of having specialized sites like Yahoo! Finance,
Yahoo! Real Estate, Yahoo! Tech, etc. through which it could charge a premium from adver-
tisers who were targeting a particular set of audience.
Yahoo! itself considered 2007 to be a year of transition with many challenges to face. Ana-
lysts too were of the same view, as Imran Khan, analyst at JP Morgan Chase,56 said, “The coming
year will be challenging, in terms of numbers. The management change doesn’t fix the problem.
There are lots of new competitors and Yahoo! is not as well-positioned in search as Google.”57
Within one month of the launch of Panama, Yahoo! experienced better click-through rates
for sponsored search ads. comScore58 analyzed the click-through rates before and after the
launch of Panama, by dividing the total clicks on sponsored search ads by the total search ads.
It was found that after the launch of Panama, in the first week the click-through ads grew by 5%
compared to a week before the launch. By the second week, the click-through rates rose to 9%.
CASE 13 Reorganizing Yahoo! 13-15
13-16 SECTION D Industry Two—Internet Companies
Some analysts were of the view that Yahoo!’s wide array of service had attracted millions
of users to the portal. These users did not need to go to different Web sites to access different
services. They said that Yahoo! should continue to provide all these services, and should only
look at revamping its advertising services and better search engine.
Industry experts also opined that the problem lay not with Yahoo! but with advertisers,
who were highly optimistic about search-based advertising and its prospects. They felt that
Yahoo!, even if it came up with the best in terms of search engine, would not be able to com-
pete with Google. Yahoo! remained strong in financial forums and community sites like Flickr
and del.icio.us. Instead of trying to attract customers from Google, Yahoo! could target com-
petitors like MSN and ask.com, opined an analyst from Standard & Poor’s.
However, industry experts remained optimistic about Yahoo!’s future prospects after its
reorganization and the launch of Panama. According to comScore Media Networks, Google’s
share in the Internet search market in the United States stood at 47.5% in January 2007, while
Yahoo!’s share was at 28.1%. According to Nick Blunden, client services director, Profero,
“Despite recent challenges, the Yahoo! business has a lot going for it. The brand is a fantastic
asset with extraordinary levels of awareness. Yahoo! also retains one of the single biggest on-
line audiences worldwide. Finally, while it may not have outright market leadership in all of
its services, many of them are extremely competitive.”59
N O T E S
1. “Yahoo! Re-Aligns Organization to More Effectively Focus on
Key Customer Segments and Capture Future Growth Opportu-
nities,” Yahoo! press release, December 05, 2006.
2. “Yahoo! Shake-up to Take on Rivals,” http://news.bbc.co.uk,
December 6, 2006.
3. RBC Capital Markets, a part of Royal Bank of Canada, is a cor-
porate and investment bank providing a wide range of services
and products catering to institutions, corporations, and govern-
ments across the world.
4. U.S.-based Google has specialized in Internet search and online
advertising. As of December 2006, the company’s revenue was
at US$10.604 billion and net income stood at US$3.077 billion.
5. Adwords allows advertisers to place their advertisements on
Google’s search results. It provides pay-per-click advertising
and site-targeted advertising for text and banner ads.
6. The Susquehanna Financial Group is a part of Susquehanna In-
ternational Group of companies of SIG, which comprises several
trading and investment related companies. The company’s pri-
mary focus is on investment banking, trading, and institutional
sales and research.
7. Paul R. La Monica, “Yahoo! Thumps Google on Wall Street,”
CNNMoney.com, March 05, 2007.
8. Dow Jones & Company-owned Wall Street Journal is a daily
newspaper published from New York, with a circulation of
around 2 million per day.
9. Global Crown Capital is a San Francisco–based boutique invest-
ment firm, specializing in objective and actionable research, in-
stitutional sales and trading, hedge funds, wealth management,
and asset management.
10. Michele Gershberg, “Yahoo!’s New Ad System Could Boost
Growth: Analysts,” Reuters, January 24, 2007.
11. Yahoo! is the abbreviation for Yet Another Hierarchical Offi-
cious Oracle.
12. Banner advertisements appear on Web pages within various
Yahoo! channels. Hypertext links were embedded in each banner
advertisement to give users instant access to the advertiser’s
Web site, to obtain additional information, or to purchase prod-
ucts and services.
13. Promotional sponsorships were typically focused on a particular
event, such as sweepstakes. The merchant sponsorship icon ad-
vertised products. Users had to click on the icon to complete a
transaction.
14. Direct marketing revenues came through e-mail campaigns tar-
geted at Yahoo!’s registered users who had indicated their will-
ingness to receive such promotions.
15. While tracking the number of visitors on a Web site, unique visi-
tor refers to a person who visits a Web site more than once within
a specified period of time. Through the use of software, a com-
pany can track and count Web site visitors and can also distin-
guish between visitors who visit the site only once and unique
visitors who return to the site.
16. Pioneered by Overture, the “paid search” advertising model is
also know as “pay-per-click” model. In this model, Overture pro-
vided an auction room for online advertisers, whose bidding de-
termined how prominently their link will be displayed. Overture
then provided a list of these advertisers to customers, including
Yahoo! and shared with them the advertising revenues once the
visitors on Yahoo!’s site clicked on those ads.
17. Based in California, Inktomi is a pioneer in Web search technol-
ogy. The company was a leading provider of Web search and
paid inclusion services.
18. Yahoo! renamed Overture as Yahoo! Search Marketing.
19. Web Crawler, also known as Spider, is a program that visits
Web sites and reads their pages and other information in order to
create entries for search engine index.
20. Yahoo! Slurp, a Web crawler, is used to put content into the
search engine. Yahoo! Slurp was based on the Web search tech-
nology of Inktomi.
21. Robert Hof, “Five Steps to Get Yahoo! Back on Track,” Busi-
nessWeek, December 7, 2006.
http://news.bbc.co.uk
22. eBay.com is an online auction and shopping Web site managed
by the U.S.-based Internet company eBay Inc. In 2005, eBay Inc.
recorded revenues of US$4.55 billion.
23. MySpace is a social networking Web site and its content includes
personal profiles, blogs, groups, photos, music, and videos. The
parent company of MySpace is News Corporation.
24. Flickr is a photo sharing Web site and an online community plat-
form. It was launched by Ludicorp in 2004. In March 2005, Yahoo!
acquired Ludicorp and Flickr.
25. Jeremy Caplan, Jeffrey Ressner, “How Yahoo! Aims to Reboot,”
Time South Pacific, February 12, 2007.
26. Upcoming.org is a social events calendar that used user-generated
content and social media to capture event information. Yahoo! ac-
quired the company in October 2005.
27. Del.icio.us is a social bookmarking Web service used for stor-
ing and sharing bookmarks. Yahoo! acquired the company in
December 2005.
28. Webjay is a Web-based playlist service, containing links to au-
dio files on the Web. Yahoo! acquired Webjay in January 2006.
29. Widget is a small application with a graphical interface compo-
nent that can be used to perform a variety of functions like
search, photo, and mapping services. Widgets run on the desk-
tops without use of browsers. Through the widgets the portals
can draw visitors directly from the desktop.
30. Gavin O’Malley, “Madison Ave: Yahoo! Overhaul Might Fall
Short,” Online Media Daily, December 8, 2006.
31. Facebook is a social networking Web site, focused on college
and university students. It is the seventh most visited Web site in
the United States and boasts of several photo uploads. The Web site
was founded by Mark Zuckerberg, a sophomore at Harvard
University, in February 2004.
32. YouTube is a video sharing Web site that allows the users to up-
load, share, and view video clips, and was founded in February
2005. YouTube was named Time Magazine’s Invention of the
Year for 2006. In October 2006, Google acquired YouTube for
US$1.65 billion.
33. David A. Utter, “Yahoo! Pressed from All Sides,” www
.webpronews.com, October 13, 2006.
34. London-based Profero, is a digital marketing agency that pro-
vides services like Web development, search and affiliate mar-
keting, advertising, media planning and buying, and relationship
marketing. The clients of Profero include CNN, Sky TV, BBC
World, Black & Decker, Singapore Airlines, Johnson & Johnson,
and Merrill Lynch.
35. Gemma Charles, “Yahoo!” Marketing, January 3, 2007.
36. Jeremy Caplan, Jeffrey Ressner, “How Yahoo! Aims to Reboot,”
Time South Pacific, February 12, 2007.
37. Universal McCann was created in 1999 through the consolidation
of the media operations of McCann Erickson. The company’s
worldwide billings stood at US$13 billion in 2006.
38. Saul Hansell, “Yahoo!’s Growth Being Eroded by New Rivals,”
New York Times, October 11, 2006.
39. Denuo is the media futures consulting arm of the Publicis
Groupe, the fourth largest communications company. The com-
pany has a presence in 104 countries across the world. Denuo is
actively involved in strategic consulting, ventures and partner-
ships, and catalyst and activation.
40. Saul Hansell, “Yahoo!’s Growth Being Eroded by New Rivals,”
New York Times, October 11, 2006.
41. In August 2006, the Yahoo! Music Engine was renamed Yahoo!
Music Jukebox.
42. “Peanut Butter Sticks to Yahoo!,” www.infoworld.com,
November 27, 2006.
43. Terry Semel, “Taking Yahoo! Forward,” http://yodel.yahoo.com,
December 5, 2006.
44. Terry Semel, “Taking Yahoo! Forward,” http://yodel.yahoo.com,
December 5, 2006.
45. “Yahoo! Re-Aligns Organization to More Effectively Focus on
Key Customer Segments and Capture Future Growth Opportu-
nities,” Yahoo! press release, December 5, 2006.
46. Merrill Lynch is one of the world’s leading financial manage-
ment and advisory companies, with offices in 36 countries and
territories and total client assets of approximately $1.8 trillion.
The services provided by Merrill Lynch, its subsidiaries, and af-
filiates are capital market services, investment banking and ad-
visory, wealth management, asset management, and insurance
and banking. In 2005, the company recorded revenue of
US$47.78 billion and net income of US$5.046 billion.
47. Robert Hof, “Five Steps to Get Yahoo! Back on Track,”
BusinessWeek, December 7, 2006.
48. A detailed description of Yahoo!’s previous reorganization is
covered in the ICMR case study, “reviving Yahoo!—Strategies
that Turned the Leading Internet Portal Around,” Reference No.
BSTR064 (www.icmr.icfai.org).
49. Lost is a highly popular television drama series aired on ABC
network in the United States. Lost has won several awards, in-
cluding Golden Globes and Emmys. The series depicts the lives
of plane crash survivors.
50. After the success of the BBC series The Office in the UK, NBC
created a U.S. version of the popular show, which premiered in
March 2005. This situation comedy series is set in the office of
a paper supply company.
51. Halo is a video game from Bungie Studios, which featured Mas-
ter Chief, a soldier with superhuman strength and technologi-
cally advanced armor.
52. Sims is a computer game published by Maxis. It is a strategic life
simulation computer game, about the day-to-day activities of
people in a household in fictional SimCity. The game was re-
leased in February 2000 and went on to become one of the best
selling PC games.
53. Harry Potter is a series of novels written by JK Rowling, featur-
ing Harry Potter and his fight against an evil wizard. The movies
based on the Harry Potter series were distributed by Warner
Brothers.
54. Ventures West is a Canada-based Venture Capital partner, which
has invested in more than 150 companies.
55. Catherine Holahan, “Why Yahoo!’s Panama Won’t be Enough,”
BusinessWeek, December 26, 2006.
56. Incorporated in 1800s by Janius S. Morgan, a merchant banker, JP
Morgan is one of the leading banks in the United States. In 2001,
JP Morgan merged with Chase Manhattan to create the second
largest bank in the United States. In July 2004, JP Morgan bought
Bank One Corporation, which created an entity with combined as-
sets of US$1.1 trillion. In 2006, the revenues of the merged entity
stood at US$61.437 billion and net income at US$14.44 billion.
57. Jefferson Graham, “Yahoo!’s Shake-up: Too Little, Too Late?”
USA Today, December 7, 2006.
58. comScore provided marketing and data services to several large
businesses and is one of the leading Internet market research com-
panies. comScore provides insight into the online behavior of con-
sumers by tracking the Internet data on the surveyed computers.
59. Gemma Charles, “Yahoo!” Marketing, January 3, 2007.
CASE 13 Reorganizing Yahoo! 13-17
www.webpronews.com
www.webpronews.com
www.infoworld.com
http://yodel.yahoo.com
http://yodel.yahoo.com
www.icmr.icfai.org
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Background
“With TiVo, TV fits into your busy life, NOT the other way around.”
THE HISTORY OF TELEVISION BEGAN IN 1939 with the purpose of providing people with
entertainment in their homes. It was followed in 1950 by the invention of the remote
control—an extraordinarily successful invention. Forty years later, two creative Silicon Val-
ley veterans, Mike Ramsey and Jim Barton, invented an innovative and advanced technolog-
ical development, a digital video recorder (DVR) called the TiVo. They created TiVo to be “TV
Your Way.” According to its founders, “With TiVo, TV fits into your busy life, NOT the other
way around.”
By now, many people may have heard of TiVo from its being mentioned in popular TV
shows and motion pictures. Even Oprah Winfrey wondered in the September 2005 issue of her
“O” magazine: “Why can’t life be like TiVo?” Unfortunately, even by 2007, not very many
people knew what TiVo did or how it did it.
14-1
C A S E 14
TiVo Inc.:
TIVO VS. CABLE AND SATELLITE DVR; CAN TIVO SURVIVE?
Alan N. Hoffman, Rendy Halim, Rangki Son, and Suzanne Wong
Industry Three—Entertainment and Leisure
This case was prepared by Rendy Halim, Rangki Son, and Suzanne Wong, MBA graduate, and Professor and MBA
Director Alan N. Hoffman of Bentley College. This case cannot be reproduced in any form without the written
permission of the copyright holder, Rendy Halim, Rangki Son, Suzanne Wong, and Alan N. Hoffman. Reprint
permission is solely granted to the publisher, Prentice Hall, for the book Strategic Management and Business Policy—
13th (and the International and electronic version of these books) by copyright holders, Rendy Halim, Rangki Son,
Suzanne Wong, and Alan N. Hoffman. This case was edited for SMBP-13th Edition. Copyright © 2008 by Alan N.
Hoffman. The copyright holders are solely responsible for the case content. Any other publication of the case (transla-
tion, any form of electronics or other media), or sold (any form of partnership) to another publisher will be in viola-
tion of copyrights. Rendy Halim, Rangki Son, Suzanne Wong and Alan N. Hoffman have granted an additional written
reprint permission.
Once Upon a TiVo …
Pioneered by Mike Ramsay and Jim Barton, TiVo redefined television entertainment by de-
livering the promise of technologies that up until then had only been promised. Incorporated
in Delaware and originally named Teleworld, TiVo was founded as a company on August 4,
1997. As proposed, the original concept was to create a home network–based multimedia
14-2 SECTION D Industry Three—Entertainment and Leisure
From the Server Room to the Living Room
Departing slightly from their original idea to create a home network device, the founders de-
veloped the idea of recording digitized video on a computer hard drive. Inside TiVo’s Silicon
Valley headquarters in Alviso, California, the founders created what they called a “fantasy
living room” that they hoped would serve as a prototype for 100 million living rooms across
North America. The fantasy living room was composed of an oval coffee table and a com-
fortable chair. The only objects on the table surface were a telephone and TiVo’s distinctive
peanut-shaped remote control. The sofa and chairs all faced an entertainment center contain-
ing a big-screen television that was linked to several TiVo boxes.
At the time, Ramsey and Barton both knew it would be fun to exploit and develop their
concept into an actual product with a promising future—the dream of most start-ups compa-
nies. In the early days of the company, Mike Ramsay commented that they used to think:
“Wow, you know, you can pause live television—isn’t that a cool thing?” Jim Barton worked
to store a live TV signal on a computer and play it back. That was the start of TiVo—an inven-
tion to create the world’s first interactive entertainment network, in which the luxury of enter-
tainment and control was firmly in the viewers’own hands. TiVo shipped its first unit on March 31,
1999. Since that date was considered to be a blue moon (second full moon in a month), the
engineering staff code-named TiVo’s first version as the “Blue Moon.” Both Jim Barton and
Mike Ramsay were excited by the market introduction of their innovative product. Teleworld
was renamed TiVo in July 1999.
TiVo Acclamation
With the success of on-demand programs and online streaming catering to people’s viewing
habits, many people have found the DVR to be an essential part of their digital home enter-
tainment center. Salespeople at big box retailers, such as Best Buy, Circuit City, Target, and
Wal-Mart, often referred to any DVR as a TiVo even though TiVo was not the only DVR on
the market. Both ReplayTV and TiVo launched DVRs at the 1999 Consumer Electronics
Show in Las Vegas. ReplayTV won the “Best of Show” award in the video category and was
later acquired by SonicBlue and D&M Holdings. Surprisingly, ReplayTV’s version of the
DVR failed to attract customers. TiVo, in contrast, became widely known and succeeded at
becoming the only stand-alone DVR company in the industry. According to the research firm,
Forrester, TiVo’s brand trust among regular users scored 4.2 (out of 5 possible), while its
brand potential among aspiring users scored an “A” with 11.1 million potential users.
Spending approximately 13 months to develop the first TiVo unit, the company found the
wait to be worthwhile. TiVo received an Emmy award in August 19, 2006, in recognition of
server in which content to “thin” clients would be streamed throughout the home. In order to
market such a product, a solid software foundation was first needed. The device had to oper-
ate flawlessly, be reliable, and handle power failure gracefully for the users. At the time, both
founders were working at Silicon Graphics (SGI) and were very much involved in the enter-
tainment industry. Jim Barton was then involved with an on-demand video system and was
the executive sponsor of an effort to port an open source system called Linux to the SGI Indy
workstation. Mike Ramsay was responsible at that time for products that created movies’ spe-
cial effects for such companies as ILM and Pixar. These two SGI veterans thought Linux soft-
ware would serve TiVo well as its operating system foundation. The hardware was designed
solely by TiVo Inc., but manufactured by other companies, including Philips, Sony, Hughes,
Pioneer, Toshiba, and Humax. They created a product that was interactive, delivering a ser-
vice that allowed people to assume greater control of their television viewing.
CASE 14 TiVo Inc. 14-3
The Brain Inside the Box
The Surf and Turf
As people’s daily life became busier and they demanded more convenience in watching TV,
digital video recorders became the tool to satisfy that need. DVRs were far easier to use than
VCRs (video cassette recorders) and provided more capabilities, such as replaying a program
in slow motion or temporarily putting a TV program on hold while answering the door or
making a phone call. The DVR platform created a massive opportunity for TiVo to continue
developing creative and sophisticated applications, features, and services. As a digital video
recorder, TiVo used Linux-based software to allow users to capture any TV program and
record it onto internal hard disk storage for later viewing.
The TiVo device also allowed users to watch their programs without having to watch the
commercials. This feature was very attractive to consumers, but not to television networks and
advertising agencies. However, unlike ReplayTV, which allowed users to automatically skip
advertisements (causing it to be the target of several lawsuits from ad agencies and TV net-
works), TiVo took a different approach. As with a VCR, viewers using TiVo could either watch
the commercials or fast-forward through them.
With an inventive advertising feature, TiVo created a business opportunity. Knowing
that advertising could be a source of revenue, TiVo’s management tested a “pop-up” feature.
While recording or watching a program, advertisements popped up at the bottom of the TV
screen. If a customer was interested in any of these advertisements, he/she had the ability to
TiVo’s providing innovative and interactive services that greatly enhanced television viewing.
Other finalists for that Emmy award included AOL Music on Demand, CNN Enhanced, and Di-
recTV Interactive Sports. TiVo established a well-known brand that became extremely popular
among fiercely loyal customers and even non-users. Becoming a cult-like product, TiVo was
transformed into a verb. Celebrities like Regis Philbin would say “TiVo it,” meaning to record a
program.Aworking wife, who had an important business dinner meeting that night and was rush-
ing through the door, would ask her husband: “Could you TiVo Desperate Housewives for me
tonight, dear?” On the other hand, TiVo felt that this verb transformation might jeopardize the
TiVo brand and associate its products with the generic DVR. People might say, “I want two
TiVos,” when they meant DVRs. Nevertheless, thanks to TiVo’s product acceptance, TiVo be-
came publicly listed September 30, 1999, on the NASDAQ at an opening price of $16 per share
with 5.5 million shares being offered. On its way to the IPO (initial product offering), TiVo es-
tablished one of the most rapid adoption rates in the history of consumer electronics. According
to the April 2007 issue of PC World, TiVo was third on its list of 50 best technology products of
all time.
As of 2007, TiVo was available in four countries: the United States, United Kingdom,
Canada, and Taiwan. Although TiVo was not yet being sold in Australia, New Zealand, Nether-
lands, or South Africa, its technology was informally being modified by end users so it could
fit their systems. Nevertheless, TiVo had not generated a profit since its launching in 1997.
Considered to be the best DVR system in use by a variety of top-notch publications, such as
Business Week, New York Times, and Popular Science, TiVo achieved a 3 million subscriber
milestone on February 18, 2005. TiVo’s subscribers included well-known loyal subscribers,
such as Oprah Winfrey, Brad Pitt, Regis Philbin, and entrepreneur Craig Newmark (the owner
of Craigslist). TiVo’s mission was simple: Connect consumers to the digital entertainment they
want, where and when they want it.
“It’s not TiVo unless it’s a TiVo”
click to get more information about the product being advertised. People thus had the choice
to get advertisers’ information or not, depending on their interests. “Product Watch” let users
choose the products, services, or even brands that interested them and would automatically
find and deliver the requested products straight to a viewer’s list. Surprisingly, during the
2002 Super Bowl, TiVo tracked the viewing patterns of 10,000 of its subscribers and found
that TiVo’s instant replay feature was used more on certain commercials, notably the Pepsi
ad with Britney Spears, than on the game itself. TiVo included 70 “showcase” advertising
campaigns in its TiVo platforms for companies such as Acura, Best Buy, BMW, Buick, Cadil-
lac, Charles Schwab, Coca-Cola, Dell, General Motors, GMC, New Line Cinema, Nissan,
Pioneer, Porsche, and Target.
In addition to the features previously mentioned, there was much more for users to expe-
rience. A “Season Pass Manager” avoided conflicts, such as one recording canceling another.
A “Wish List” platform allowed viewers to store their search accordingly to their interests,
such as actor, keyword, director, etc. No other company had yet been able to match these two
TiVo recording features. In addition, the easy-to-use remote control with its distinctive
“Thumbs Up and Down” feature allowed users to rate the shows they had watched so that TiVo
could assist and provide users with programs similar to what they had rated positively. This
feature also provided TiVo with some useful market research data. The remote control had won
design awards from the Consumer Electronics Association. Jakob Nielsen, a technology con-
sultant of the Nielsen Norman Group, called the oversize yellow pause button in the middle of
the remote “the most beautiful pause button I’ve ever seen.” Steve Wozniak, the co-founder of
Apple Computer, stated that “TiVo adjusts to my tastes. Its remote has been the most er-
gonomic and easy to use one that I have had encountered in many years.”
“TiVoToGo,” a feature launched in January 2005, allowed users to connect their TiVo to
a computer with an Internet or a home network, transferring recorded shows from TiVo boxes
to users’ PCs. Through a software program developed with Sonic, customers were able to edit
and save their TiVo files. In August 2005, TiVo released a software program that allowed cus-
tomers to transfer MPEG2 video files from their PC to their TiVo boxes in order to play the
video on the TiVo DVR.
The TiVoToGo feature included TiVo’s “Central Online,” which allowed users to schedule
recordings on its Web site, “MultiRoom Viewing,” and allowed them to transfer recordings be-
tween TiVo units in multiple rooms, download any programs in any format into the TiVo box and
transfer them into other devices, such as an IPOD, laptop, or other mobile device, such as cellu-
lar phones. This provided users with the opportunity to view recordings anytime and anywhere
the users desired. With various partnerships that TiVo had established regarding third-party net-
work content, viewers could access weather, traffic condition, and even purchase a last-minute
movie ticket at Fandango.com. Viewers could also use “Amazon Unbox” to buy or rent the lat-
est movies and TV shows that would be downloaded into the TiVo box. By early 2007, Amazon
had 1,500 TiVo-compatible movies listed for rent and 2,300 available for purchase.
“Behind The Box”—The Hardware Anatomy of TiVo 101
TiVo units can be installed fairly easily because they had been designed for anyone to install
and operate. Parts that went into the device and its internal architecture had been made less
complex. An online self-installation guide with step-by-step pictured instruction was used to
complete the installation request. It was possible, however, to have professional installation
service through a retailer, such as Best Buy or a customer’s cable provider.
In reality, TiVo was simply a cable box with a hard drive that provided the ability to record
using a fancy user interface. The main idea at the beginning was to free people from a TV net-
work’s schedule. With TiVo, the viewer could watch programs at any time using features such
as pause, rewind, fast forward, and slow motion.
14-4 SECTION D Industry Three—Entertainment and Leisure
CASE 14 TiVo Inc. 14-5
What the Hack!
Where technology was involved, there were always incentives for hackers to challenge the
system. Some people hacked into the TiVo boxes to improve the service and expand its
recording and/or storage capacity. Others tried to make TiVo available in countries where
TiVo was not currently available. In the latest version of TiVo, improved encryption of the
hardware and software made it more difficult for people to hack the systems.
The Tivo Operation – Behind the Scenes …
TiVo’s model Series 2 was supported with USB ports that had been integrated into the
TiVo system to support network adapters that included wired Ethernet and WiFi capabilities.
It received its signal from the cable or satellite box. It also provided the ability to record a pro-
gram over-the-air. The next generation, TiVo Series 3, had been built with two internal cable-
ready tuners and supported a single external cable or satellite box. As a result, the Series 3 TiVo
provided the ability to record two shows at once, unlike other DVRs available at that time.
Moreover, the latest version of the TiVo box had a 10/1000 Ethernet connection port and a
SATA port which could support external storage hardware. It also had an HDMI plug, which
provided an interface between any compatible digital audio/video source, such as a DVD
player, a PC, or a video game system. With the new Series 3 TiVo box, customers no longer
needed their cable box. Some recent models contained DVD-R/RW drives that transferred
recordings from the TiVo box to a DVD disc.
TiVo hardware could also work alone as a normal DVR. It was thus possible for TiVo users
to keep the TiVo hardware but cancel their TiVo subscription. This, of course, could seriously
damage TiVo’s revenue stream.
“. . . .and I never miss an episode. TiVo takes care of the details”
Manufacturing and Supply Chain
TiVo outsourced the manufacturing of its products to third-party manufacturers. This out-
sourcing extended from prototyping to volume manufacturing and included activities such as
material procurement, final assembly, test, quality control, and shipment to distribution cen-
ters. The majority of the company’s products were assembled in Mexico. TiVo’s primary dis-
tribution center was operated on an outsourced basis in Texas.
Several consumer electronics manufacturers, including Toshiba, Humax, and Pioneer,
manufactured and distributed TiVo-enabled stand-alone DVRs during the last three years. The
company also engaged contract manufacturers to build TiVo-enabled stand-alone DVRs.
The components that made up TiVo’s products were purchased from various vendors, in-
cluding key suppliers such as Broadcom, which supplied microprocessors. Some of TiVo’s
components, including microprocessors, chassis, remote controls, and certain discrete compo-
nents were currently supplied by sole source suppliers.
Marketing
Feel the Buzzzzzz—Hail Thy TiVo
When it came to new technology, penetrating existing consumer markets was usually diffi-
cult. Customers were often slower to embrace new product than forecasters predicted and
opted to choose an older and more familiar technology, like that used by VCRs. TiVo founder
Mike Ramsay would often get upset in TiVo’s early days when someone said, “Oh, that’s just
like a VCR.” He would then retort, “No, no, no, no, no. It’s much more than a VCR. It does
this. . . . It does that. . . . Let’s personalize it and all that stuff.” At that point, Ramsey found
that it became difficult to describe what TiVo actually was, leading to a five- to 10-minute con-
versation instead of a 30-second TiVo advertisement.
In its early years, TiVo tried the standard approach of explaining the product via ads—
resulting in a series of stumbles in marketing. Millions of dollars spent on advertising did not
help consumers understand what TiVo actually did. A customer claimed, “I personally remem-
ber seeing TiVo ads on TV before I even knew what a TiVo was, and it took seven years for
me to finally see one ‘in the flesh.’”
What made TiVo DVRs different from generic DVRs could not be grasped by most peo-
ple by simply seeing the differences listed in Exhibit 1. As a true “experience good,” it could
only be felt and experienced by using the product itself. TiVo’s interface was vastly superior
to that used by most competitive DVRs. According to Gartner analyst Van Baker, “For cable
and satellite DVRs, the interface stinks. They do a really bad job of it.” Once people used a
TiVo, many told others about the product and how it had improved their enjoyment of televi-
sion. According to a survey reported on the TiVo Web site, 98% of users said that they could
not live without their TiVo.
Between 1999 and 2000, TiVo’s subscriptions increased by 86%. In addition to capitaliz-
ing on its thousands of customer evangelists to move the product into the mainstream, TiVo’s
word-of-mouth strategy focused on celebrity endorsements and television show product place-
ment. The firm began giving its product away to such celebrities as Oprah Winfrey, Jay Leno,
Sarah Michelle Gellar, Rosie O’Donnell, and Drew Bledsoe, turning them into high-profile
members of the cult of satisfied TiVo users. Total subscriptions increased from 3.3 million
(1.2 million TiVo-owned plus 2.1 million DirecTV-controlled) in early 2005 to 4.4 million
(1.7 million TiVo-owned plus 2.7 million DirecTV-controlled) at end-2006.
Sales and marketing expenses consisted primarily of employee salaries and related ex-
penses, media advertising (including print, online, radio, and television), public relations ac-
tivities, special promotions, trade shows, and the production of product-related items,
including collateral and videos. Advertising expenses were $15.9 million, $10.4 million, and
$16.1 million for the fiscal years ended January 31, 2007, 2006, and 2005, respectively.
The TiVo-owned churn rate per month was 1.0% for the fiscal year ended January 31,
2007, compared to .9% and .7% for the fiscal years ended January 31, 2006, and 2005, re-
spectively. The churn rate measure was composed of total TiVo-owned subscription cancel-
lations during a period divided by the average TiVo-owned subscriptions for that period
divided by the number of months in the period. Management anticipated that the TiVo-
owned churn rate per month would increase in future periods as a result of increased com-
petition in the marketplace, competitive pricing issues, the growing importance of offering
competitive service features such as high definition television recording capabilities, and in-
creased churn from product lifetime subscriptions. TiVo had previously offered lifetime ser-
vice subscriptions to initially attract people to purchase TiVo DVRs, but was no longer
making this offer. It had been replaced by one- to three-year service contracts containing
monthly fees.
Subscription acquisition costs (SAC) totaled $267 million in 2006, $196 in 2005, and
$182 in 2004. Management defined SAC as the company’s total acquisition costs for a given
period divided by TiVo-owned subscription gross additions for the same period. Total acqui-
sition costs were the sum of sales and marketing expenses, rebates, revenue share, and other
payments to channel, minus hardware gross margin (defined as hardware revenues less cost of
hardware revenues). This included all fixed costs, including headcount-related expense, such
as stock-based compensation, marketing not directly associated with subscription acquisition,
operating expenses for the advertising sales business, and allocations.
14-6 SECTION D Industry Three—Entertainment and Leisure
CASE 14 TiVo Inc. 14-7
EXHIBIT 1
TiVo’s Product Specifications+
SOURCE: http://www.TiVo.com/1.0.chart.asp.
TiVo Series2™ Boxes
Leading
Cable Service
DVR*
Satellite
DVR**
DIRECTV
DVR with
TiVo©
Record from multiple sources
Yes
combine satellite,
cable, or antenna,
depending on product
No
Digital cable
only
No
Satellite only
No
DIRECTV
only
Easy search:
Find shows by title, actor, genre, or
keyword
Yes Titles only
browsing only
title, subject,
and actor only
Yes
Online scheduling:
Schedule recordings from the Internet Yes No No No
Dual Tuner:
Record 2 shows at once1 Yes Yes Yes Yes
Movie and TV Downloads:
Purchase or rent 1000s of movies and
television shows from Amazon Unbox
and have them delivered directly to
your television.2
Yes No No No
Home Movie Sharing:
Edit, enhance, and send movies and photo
slideshows from your One True Media
account to any broadband connected
TiVo box.3
Yes No No No
Online services:
Yahoo! weather, traffic & digital photos,
Internet Radio from Live365, Podcasts,
& movie tickets from Fandango
Yes Limited Limited No
Built-In Ethernet:
Broadband-ready right out of the box—
connecting to your home network is a snap4
Yes No No No
TiVoToGo transfers to mobile devices:
Transfer shows to your favorite portable
devices, laptop, or burn them to DVD.3
Yes No No No
Home media features:
Digital photos, digital music, and more Yes No No No
Transfer shows between boxes:
Record shows on one TV and watch them on
another.3, 5
Yes No No No
Notes:
*Leading cable services compared to Time Warner/Cox Communications Explorer® 8000™ DVR and Comcast DVR
**Leading satellite services compared to DISH Network 625 DVR
1On theTiVo® Series2™ DT DVR, you can record 2 basic cable channels, or one basic cable and one digital cable channel, at once.
2Requires broadband cable modem or DSL connection
3Requires your TiVo box to be connected to a home network wirelessly or via Ethernet
4Available on the new TiVo® Series2™ DT DVR and the TiVo® Series3™ DMR
5In order to burn TiVoToGo transfers to DVD you will need to purchase software from Roxio/Sonic Solutions.
(Continued)
http://www.TiVo.com/1.0.chart.asp
The Market Research Team
The need to create an emotional connection between people and its products was significant
to TiVo’s success. The company’s market research team was considered key to management’s
understanding of TiVo’s target market. The market research team was supported in its work
by Lieberman Research Worldwide and Nielsen Media Research. With Lieberman, the first
DVR-based panel was established in August 2002. Internally, TiVo had built a mechanism in
its system that sent detailed information back to TiVo on the viewing habits of its customers.
TiVo also fully embraced the viewing community with community and hackers programs so
that the TiVo research team better understood users’ viewing needs and wants.
Financial
Fast Forward or Rewind TiVo’s Stock?
Upon going public with an IPO in 1999, TiVo’s stock was listed with an initial price of $16
per share. TiVo’s stock soon reached $78.75, the highest price in the stock’s history. After the
initial enthusiasm, TiVo’s stock price eventually dropped by 2002 to a low of $2.25, the low-
est in its history. TiVo’s stock price began to rise in 2003 when the FCC Chairman Michael
Powell announced that he used TiVo—claiming TiVo was a “God’s Machine”—and when the
White House Press Secretary Ari Fleischer admitted to being a loyal user of TiVo. In mid-2003,
14-8 SECTION D Industry Three—Entertainment and Leisure
EXHIBIT 1
(Continued)
Multiroom Solutions
Diego/Maxi Motorola
Scientific-
Atlanta EchoStar TiVo Microsoft
Main DVR Cable DVR1 Cable DVR2 Cable DVR3 Satellite DVR4 Tivo box Media
Set-top box on additional TV(s) IP terminal Cable box5 Cable box None Analog TiVo box
Center PC
Xbox 360
How boxes share content IP IP Digital broadcast IP5 IP
Physical connection Coax Coax
broadcast
Coax Coax
Home
network
Home
network
Features available on additional TVs:
Play back recorded programs ✓ ✓ ✓ ✓ ✓ ✓
Record programs ✓ ✓ ✓ ✓ ✓
Pause programs ✓ ✓ ✓ ✓ ✓
View Internet content 3✓ x ✓ ✓
View personal digital content x x ✓ ✓
Notes:
1New product specifically designed for multiroom use
2Standard cable DVR plus modifications for multiroom use
3Requires additional IP dongle on standard digital set-top box
4Available, but operators have not yet deployed
5Requires transferring files from one TiVo box to the other
SOURCE: Forrester Research Inc., 2006.
when TiVo achieved one million subscribers, its stock price jumped to $14.00 per share. It
then fell to a low of $3.50 per share resulting from the resignation of its founder-CEO, Mike
Ramsay. With a new CEO in place, TiVo reached the 3 million subscriber milestone by mid-
2005. The stock fluctuated around $6–$8 per share in 2006 and closed at $5.35 on January
31, 2007, the end of the company’s 2006 fiscal year. The company followed a policy of de-
claring no cash dividends.
Since its founding, the company had incurred significant losses and has had substantial
negative cash flow. During the 2006 fiscal year ended January 31, 2007, the firm had a net loss
of $47.8 million. TiVo had a positive cash flow of $3.8 million for the year of 2006 thanks to
$64.5 million raised from the sale of 8.2 million shares of its common stock in September,
2006. (See Exhibits 2 and 3 for financial statements.)
EXHIBIT 2
Consolidated Statements of Operations: TiVo, Inc. (Dollar amounts in thousands, except per share and share amounts)
Year Ending January 31 2007 2006 2005
Revenues
Service and technology revenues (includes $6,805 from
related parties for the fiscal year ended January 31, 2005)
$ 217,985 $ 170,859 $ 115,476
Hardware revenues 88,740 72,093 111,275
Rebates, revenue share, and other payments to channel (48,136) (47,027) (54,696)
Net revenues 258,589 195,925 172,055
Cost of revenues
Cost of service and technology revenues (1) 60,177 34,961 35,935
Cost of hardware revenues 112,212 86,817 120,323
Total cost of revenues 172,389 121,778 156,258
Gross margin 86,200 74,147 15,797
Research and development (1) 50,728 41,087 37,634
Sales and marketing (1) (includes $1,100 from related
parties for the fiscal year ended January 31, 2005) 42,955 35,047 37,367
General and administrative (1) 44,813 38,018 16,593
Total operating expenses 138,496 114,152 91,594
Loss from operations (52,296) (40,005) (75,797)
Interest income 4,767 3,084 1,548
Interest expense and other (173) (14) (5,459)
Loss before income taxes (47,702) (36,935) (79,708)
Provision for income taxes (52) (64) (134)
Net loss $ (47,754) $ (36,999) $ (79,842)
Net loss per common share – basic and diluted $ (0.53) $ (0.44) $ (0.99)
Weighted average common shares used to calculate
basic and diluted net loss per share
89,864,237 83,682,575 80,263,980
(1) Includes stock-based compensation expense
(benefit) as follows:
Cost of service and technology revenues $ 1,490 $ — $ —
Research and development 5,596 (85) 754
Sales and marketing 1,649 55 302
General and administrative 5,977 415 —
CASE 14 TiVo Inc. 14-9
EXHIBIT 3
Consolidated Balance Sheets: TiVo, Inc. (Dollar amounts in thousands, except share amounts)
Year Ending January 31, 2007 January 31, 2006
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 89,079 $ 85,298
Short-term investments 39,686 18,915
Accounts receivable, net of allowance for doubtful accounts of $271 and $56 20,641 20,111
Inventories 29,980 10,939
Prepaid expenses and other, current 3,071 8,744
Total current assets 182,457 144,007
LONG-TERM ASSETS
Property and equipment, net 11,706 9,448
Purchased technology, capitalized software, and intangible assets, net 16,769 5,206
Prepaid expenses and other, long-term 1,018 347
Total long-term assets 29,493 15,001
Total assets $ 211,950 $ 159,008
Liabilities’ and Stockholders’ Equity (Deficit) Liabilities
Current Liabilities
Accounts payable $ 37,127 $ 24,050
Accrued liabilities 36,542 37,449
Deferred revenue, current 64,872 57,902
Total current liabilities 138,541 119,401
Long-Term Liabilities
Deferred revenue, long-term 54,851 67,575
Deferred rent and other 1,562 1,404
Total long-term liabilities 56,413 68,979
Total liabilities 194,954 188,380
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY (DEFICIT)
Preferred stock, par value $0.001:
Authorized shares are 10,000,000;
Issued and outstanding shares – none — —
Common stock, par value $0.001:
Authorized shares are 150,000,000;
Issued shares are 97,311,986 and 85,376,191, respectively and
outstanding shares are 97,231,483 and 85,376,191, respectively
97 85
Additional paid-in capital 759,314 667,055
Deferred compensation — (2,421)
Accumulated deficit (741,845) (694,091)
Less: Treasury stock, at cost – 80,503 shares (570) —
Total stockholders’ equity (deficit) 16,996 (29,372)
Total liabilities and stockholders’ equity (deficit) $ 211,950 $ 159,008
14-10 SECTION D Industry Three—Entertainment and Leisure
CASE 14 TiVo Inc. 14-11
Decontructing TiVo
Since its founding in 1997, TiVo had accumulated $741.8 million in losses. Looking at TiVo’s
revenue and cost structures in Exhibit 2, the company recorded its revenues under service
and technology and hardware. In order to become profitable, the company’s management
needed to find ways to increase revenues faster than costs increased. In terms of service and
technology revenues, for example, TiVo needed to know the actual value of TiVo-owned sub-
scribers and not just TiVo’s partnership subscribers of DirectTV and Comcast. Deconstruct-
ing the value of just this one particular matter led to larger questions, which included, how
long did a TiVo subscriber remain a subscriber, how much did each of them they pay, how
much were they willing to pay, and how much advertising revenue did users produce for
every tag they clicked? Moreover, how long and how could TiVo maintain its subscribers as
TiVo-owned subscribers?
TiVo’s hardware revenue was subject to a chicken and egg problem. If management
dropped the price of TiVo hardware, more people would buy TiVo DVRs and subscribe to the
TiVo service. It would then, however, be selling hardware at a significant loss. Even though
rebates were offered, TiVo’s management in 2007 had not yet found a price point that would
attract a significantly larger number of buyers. In early 2007, TiVo offered three types of boxes
depending on the hours of programming storage capacity. These ranged from an 80-hour TiVo
Series 2 to a 300-hour TiVo Series 3. The basic TiVo Series 2 box of 80 hours and 180 hours
had a one-time price of $99.99 and $199.99, respectively, while the TiVo Series 3 box with
300-hour storage capacity was priced at $799.99. TiVo customers then needed to pay a
monthly subscription fee to obtain TiVo service.
The company had been a heavy user of mail-in rebates, which were reflected on the in-
come statement as negative revenue. According to Business Week, $5 million in additional pos-
itive revenue was recognized because nearly half of TiVo’s 100,000 new subscribers failed to
apply for a $100 rebate. This slippage, known to marketers as the “shoebox effect,” was very
helpful to TiVo’s revenues.
Research and Development
The word “interactive” was the slogan of R&D. TiVo’s R&D team made sure that they built
TiVo from the user’s perspective and his/her viewing habits. There was a TiVo Forum com-
posed of communication through TiVo Community.com and TiVo hackers. In this forum, crit-
icism was allowed and even encouraged, so long as it was constructive and helped TiVo to
grow. Ideas generated through this forum helped TiVo’s R&D team and developers to be in-
novative by continuous adjusting to people’s ever-changing lifestyles. TiVo’s management
was also concerned with how TiVo’s platform could be used inappropriately by children. As
a result, TiVo had collaborated with parents to build a new feature called the TiVo Parental
Zone that allowed parents to control what their kids watched. TiVo protected its users’ pri-
vacy by storing personal information on a computer behind its “firewall” in a secure location
and by restricting the number of employees internally who could access this data.
In its early years, TiVo’s R&D staff consisted only of contract-based engineers. As the
company grew, management expanded its R&D team to consist of a diverse and creative group
of on-staff engineers. It had an R&D policy stating that new benefits must extend people’s ex-
isting behaviors. The design team had a very detailed list of steps to follow to ensure the fit of
TiVo products to user needs. As an example of TiVo’s meticulous product design process, TiVo
created a remote control that combined personalization and interconnectivity. TiVo’s remote
had a feature of thumbs up and down to be clicked by users to rate shows so that the TiVo box
would know what to record. In addition, TiVo enabled Braille on its remote for vision-impaired
14-12 SECTION D Industry Three—Entertainment and Leisure
Corporate Governance
Top Management
In its early years, TiVo’s top management had been personally involved in operations and
marketing. Founder Mike Ramsay often made overseas trips to conduct meetings and semi-
nars with consumer electronics manufacturers. This was as an attempt to convince the man-
ufacturers to embed TiVo’s software into their products. In order to make sure everything
went well and accordingly to plan, Ramsey focused on maintaining partnerships. He would
rarely be in his office. He would instead be on the road talking to companies that could help
TiVo build software and subscribers. During his tenure as TiVo’s CEO, Ramsey did commit
a number of managerial errors. For example, instead of re-doubling marketing efforts when
two distribution contracts were lost during 2001, he laid-off 80 employees (approx 25% of
its workforce at the time) in April, 2001, plus 40 more employees (approx 20% of its remain-
ing workforce) in the following October. Ramsay was an engineer and knew how to be cre-
ative and build great machines, but didn’t truly understand the industry or how to manage the
company’s growth. By 2005, the company was drowning in red ink and its future was in
doubt. As a result, Mike Ramsay was forced to resign in July 2005 and a change of CEO was
implemented by the board of directors. The board hired as TiVo’s new CEO the former pres-
ident of NBC Cable, Tom Rogers.
Mike Ramsey continued to serve on TiVo’s board of directors after his resignation. The
board agreed to a transition agreement with Ramsey in which Ramsay agreed to provide ser-
vices to TiVo that included assistance with executive transition matters, service as chairman of
the Technology Advisory Committee of TiVo’s Board and TiVo’s beta test program, coopera-
tion with existing or future litigation, and the provision of other advice and assistance that fell
within Mr. Ramsay’s knowledge and expertise in exchange for a salary of $100,000 annually
plus stock options. Ramsay’s transition employment agreement had been renewed and was in
effect through September 8, 2007.
In early 2007, TiVo’s current top managers were:
Thomas S. Rogers, 52, was appointed by TiVo’s board to serve as a director in September
2003 and was named president and chief executive officer of TiVo, effective July 1, 2005.
From 2004 until July 2005, he served as the senior operating executive for media and
users. Other R&D processes included product testing and development of software and plat-
forms, integration of software to satellite systems, and product integration, such as with the
DVD burner and TiVo recorder. Besides developing its main products, the TiVo R&D team
also designed platforms and technology that could be used with other products to enhance the
performance of TiVo’s main products, such as the ability to connect with computers, other
home theater technologies, and especially with cable and satellites.
Since competition was increasing in the DVR industry, TiVo’s management decided to
patent the company’s advanced software and technology platforms. TiVo licensed its TiVo-
ToGo software to chip maker AMD and digital media software, such as Sonic Solutions, to
Microsoft in order to enable video playback on pocket PCs and smart phones. As of end-2006,
TiVo had 85 patents granted and 117 patents pending, including both domestic and foreign
patents. TiVo licensed its patents through several of its trusted partners, including Sony,
Toshiba, Pioneer, and Direct TV. TiVo’s management believed that licensing its technology to
third parties was an excellent revenue generator.
Although total company employee headcount had increased by approximately 7% in fiscal
year 2007, the company increased the number of its regular, temporary, and part-time employ-
ees engaged in research and development by 9% from a total of 264 to 288 as of January 31, 2007,
compared to January 31, 2006.
CASE 14 TiVo Inc. 14-13
entertainment for Cerberus Capital Management, a large private equity firm. From Octo-
ber 1999 until April 2003, Rogers had been chairman and CEO of Primedia Inc., a print,
video, and online media company. From January 1987 until October 1999, Rogers held
positions with National Broadcast Company Inc., including president of NBC Cable and
executive vice president. Rogers held a B.A. degree in Government from Wesleyan
University and a J.D. degree from Columbia Law School. In 2006, he earned $504,583
in salary and $294,521 in bonuses plus $4,282,000 in stock options tied to long-term
performance.
Steve Sordello, 37, was named senior vice president and chief financial officer in August
2006. He replaced David H. Courtney, who had resigned from TiVo in April 2006. Prior to
joining TiVo, Sordello had served as executive vice president and chief financial officer at
Ask Jeeves from April 2001 until October 2005, when the company was acquired by
IAC/InterActiveCorp. Prior to Ask Jeeves, Sordello held senior positions at Adobe Systems
Inc. and Syntex Corporation. Sordello held a B.S. degree in Management/Accounting and
an M.B.A. degree from Santa Clara University.
James Barton, 48, was a co-founder of TiVo and served as TiVo’s vice president of Research
and Development, chief technical officer and director since the company’s inception to
January 2004, and was currently chief technical officer and senior vice president. From
June 1996 to August 1997, Barton had been president and chief executive officer of Net-
work Age Software Inc., a company that he founded to develop software products targeted
at managed electronic distribution. From November 1994 to May 1996, Barton had served
as chief technical officer of Interactive Digital Solutions Company, a joint venture of Sil-
icon Graphics Incorporated (SGI) and AT&T Network Systems created to develop inter-
active television systems. From June 1993 to November 1994, Barton had served as vice
president and general manager of the Media Systems Division of SGI. From January 1990
to May 1991, Barton had served as vice president and general manager for the Systems
Software Division of Silicon Graphics. Prior to joining SGI, Barton held technical and
management positions with Hewlett-Packard and Bell Laboratories. Mr. Barton held a
B.S. degree in Electrical Engineering and an M.S. degree in Computer Science from the
University of Colorado at Boulder. In 2006, Barton earned $275,000 in salary and
$133,100 in bonuses plus $151,694 in stock options tied to long-term performance.
Jeffrey Klugman, 46, was named senior vice president and general manager, Service Provider
and Media and Advertising Services Division, in April 2005. Klugman had served as vice
president of Technology Licensing from December 2001 until February 2004 and vice
president, TiVo Platform Business, from February 2004 until April 2005. Prior to joining
TiVo, Klugman had been CEO of PointsBeyond.com, an Internet-portal start-up focused
on outdoor activities and adventures. In 1999, Klugman served as vice president of Mar-
keting and Business Development for Quantum Corporation’s Consumer Electronics
Business Unit. Klugman held a B.S. degree in engineering from Carnegie Mellon University
and an M.B.A. degree from the Stanford Business School. In 2006, he earned $225,000
in salary and $108,419 in bonuses plus $238,315 in stock options tied to long-term
performance.
Mark A. Roberts, 46, was named senior vice president of Consumer Products and Operations
in October 2005 responsible for Consumer Products Engineering and Product Strategy,
Manufacturing, Distribution, Call Center, Service Operations, Information Technology,
Facilities and Broadcast Center Operations. He had served as senior vice president of
Engineering since December 2002 until October 2005 and chief information officer of
TiVo from March 1999 until December 2002. Prior to joining TiVo, he had served as vice
president of Information Technology atAcuson Corporation, a medical ultrasound company,
14-14 SECTION D Industry Three—Entertainment and Leisure
from March 1996 to March 1999. From July 1990 to March 1996, Roberts was director of
Information Systems at SGI. Roberts held a B.S. degree in Economics from Santa Clara
University. In 2006, he earned $255,000 in salary and $148,717 in bonuses plus $222,395
in stock options based on long-term performance.
Matthew Zinn, 42, was named senior vice president, general counsel, secretary, and chief pri-
vacy officer in April 2006. Zinn had served as vice president, general counsel, and chief
privacy officer since July 2000 and as corporate secretary since November 2003. From
May 1998 to July 2000, Zinn was the senior attorney, Broadband Law and Policy, for the
MediaOne Group, a global communications company. From August 1995 to May 1998,
Zinn served as corporate counsel for Continental Cablevision, the third largest cable tel-
evision operator in the United States. From November 1993 to August 1995, he was an
associate with the Washington, D.C., law firm of Cole, Raywid & Braverman, where he
represented cable operators in federal, state, and local matters. Zinn held a B.A. degree in
Political Science from the University of Vermont and a J.D. degree from the George
Washington University National Law Center.
Nancy Kato, 52, was named senior vice president of Human Resources in April 2006. Kato
had served as vice president, Human Resources, since January 2005. From January 2003
to January 2005 Kato was vice president of Global Compensation at Hewlett-Packard.
From December 2000 to October 2002 Kato was senior vice president of Human Re-
sources for Ariba. She has also held senior roles at Compaq and Tandem. Kato held a B.S.
in Health Sciences and M.A. in Education and Counseling from San Jose State University.
Joe Miller, 40, was named senior vice president, Consumer Sales and Distribution, in
September 2006 and was responsible for all aspects of the company’s TiVo-Owned sales
and distribution efforts. Miller had served as TiVo’s vice president, Consumer Sales and
Distribution, from May 1999 to August 2006. Prior to joining TiVo. Miller was with U.S.
Satellite Broadcasting from February 1994 to May 1999 as general manager of Retail
Sales and prior to that Miller was a national sales manager for Cox Satellite Program-
ming. Miller held a B.A. degree in Public Relations from Southwest Texas State.
Individual senior executives who owned shares of the company’s stock in 2006 were:
CEO Thomas Rogers, 960,816 shares (1.1% of total shares outstanding), Sr. VP & Chief Tech-
nical Officer James Barton, 1,135,928 shares (1.3% of total shares outstanding), Sr. VP & Gen-
eral Manager of Service Provider & Media Advertising Services Jeffrey Klugman, 115,887
shares (less than 1% of total shares outstanding), and Sr. VP of Consumer Products & Opera-
tions Mark Roberts, 151,173 shares (less than 1%).
Board of Directors
TiVo’s board of directors consisted of three executives from the venture capital firms of
Kleiner Perkins Caufield & Byers, Redpoint Ventures, and New Enterprise Associates, three
senior executives from NBC, Coca-Cola, and Univision Communications, an independent
consultant who had been CFO at Univision Communications, plus TiVo’s current and past
CEO, for a total of nine members of the board. The board selected Jeffrey Hinson as its ninth
member on January 26, 2007, for his financial experience as an ex-CFO to join the board and
serve as chairman of its audit committee. See Exhibit 4 for a list of the members of the board
of directors, their backgrounds, and committee assignments.
Individual non-management directors owned the following amounts of stock in 2006 (%
of total in parentheses): Michael Ramsey, 3,020,102 shares (3.5%), David Zaslav, 3,777,151
shares (4.4%), Geoffrey Y. Yang, 2,663,295 shares (3.1%), Mark Perry, 849,063 shares (less
than 1%), Randy Komisar, 333,963 shares (less than 1%), Joseph Uva, 75,000 shares (less than
CASE 14 TiVo Inc. 14-15
1%), and Charles Fruit, 75,000 shares (less than 1%). All executive officers and directors
owned as a group 16.3% of shares outstanding. Other shareholders owning more than 5% of
shares outstanding were the investment firms of FMR Corporation (8.1%) and Wellington
Management (7.5%).
The TiVo board used five committees to conduct its business: audit, compensation, nom-
inating and governance, pricing, and technology committees. Non-employee (outside) directors
received an annual retainer of $15,000, plus $1,000 for each committee meeting attended.
(Committee chairs receive an additional $2,000 for each committee meeting attended.) In ad-
dition, each director received stock option grants to purchase 50,000 shares when elected to
the board and an additional grant to purchase 25,000 shares each year thereafter.
EXHIBIT 4
Board of Directors: TiVo
1. Board of Directors: TiVo Inc.
Name of Director Age Principal Occupation
Term
Expires
Director
Since
Michael Ramsey1 56 Former Chairman of the Board & CEO, TiVo Inc. 2009 1997
Geoffrey Y. Yang1 47 Managing Director, Redpoint Ventures & General Partner,
Institutional Ventures Partners
2009 1997
Randy Komisar1 51 Partner, Kleiner Perkins Caufield & Byers 2009 1998
David M. Zaslav 46 Executive Vice President, NBC & President, NBC Cable 2007 2000
Mark W. Perry 62 General Partner, New Enterprise Associates 2007 2003
Thomas S. Rogers 51 President & CEO, TiVo Inc. 2008 2003
Charles B. Fruit 59 Sr. Vice President, Chief Marketing Officer,
Coca-Cola Company
2007 2004
Joseph Uva 50 CEO, Univision Communications, Inc. 2008 2004
Jeffrey Hinson2 51 Consultant. Past-CFO, Univision Communications Inc. 2007 2007
Notes:
1Elected at 2006 annual meeting.
2Added in January, 2007.
2. Board Committees
(as of 1/31/2007)
Audit: Hinson (Chair), Fruit, Perry
Compensation: Yang (Chair), Uva
Nominating & Governance: Komisar (Chair), Yang
Pricing: Zaslav (Chair), Perry
Technology: Ramsey (Chair), Komisar, Yang
Human Resources
TiVo employed approximately 451 employees, including 48 in service operations, 246 in re-
search and development, 44 in sales and marketing, and 113 in general and administration.
The company also employed, from time to time, a number of temporary and part-time em-
ployees as well as consultants on a contract basis. The employees were not represented by a
collective bargaining organization. The company had never experienced a work stoppage or
strike and management considered employee relations to be good.
14-16 SECTION D Industry Three—Entertainment and Leisure
Sleeping with Enemies
The Industry
SOFTWARE
& PROGRAMMING
Open TV, Microsoft,
Liberate Technologies,
Canal Group, NDS
COMMUNICATION
& ELECTRONICS
NDS, Nagra Vision,
Scientific Atlanta
EQUIPMENT
& INSTRUMENTS
Sony, Panasonic
Phillips, Motorola
TV
& BROADCASTING
Echo Star, DirectTV, Replay
TV,
AOL, BSkyB, Cox, Liberty
For TiVo, the introduction of its digital video recorder was full of obstacles. The DVR was a
“disruptive technology,” a technology that created something new which usurped existing
products and services. According to TiVo’s founder Mike Ramsay, the DVR phenomenon es-
tablished that “people really want to take control of television, and if you give them control,
they don’t want you to take it back.” Although TiVo had added the software, platforms, and
services that a TiVo DVR had to offer, the viewing experience was incomplete without a con-
nection to a cable network or to satellite signals. Therefore, users who wanted a TiVo DVR
needed to subscribe to the TiVo service, pay a one-time fee for a TiVo box, and subscribe to
a cable or satellite provider, such as Comcast or DirecTV. Because of this requirement, the
TiVo DVR had been made with a built-in cable-ready tuner for use with any external cable
box or satellite receiver. TiVo had forged many alliances and sometimes even competed with
cable operators and satellite networks. With cable, satellite, and electronics companies push-
ing to market their own DVRs, the DVR industry was expected to grow rapidly.
In terms of market share, TiVo claimed to cover the entire U.S. market (See Exhibit 6).
EXHIBIT 5
The Digital Video Recorder or Personal Video Recorder
Market Was Located at the Convergence of Four
Established Industries: TV and Broadcasting, Software
and Programming, Equipment and Instruments, and
Communication and Electronics.
“. . . So Long, TiVo! Hello DVR! . . .”
Friends or Foe?
In 2000, AOL had invested $200 million in TiVo and became the largest shareholder of the
company and one of its main service partners. The AOL connection enabled TiVo to release
a box that provided both TiVo’s capabilities and AOL services. In addition to AOL, TiVo es-
tablished other service partnerships. TiVo and Discovery Communication and NBC agreed to
an $8.1 million deal in the form of advertising and promotional services. An additional
$5 million was paid to NBC for promotions. TiVo also collaborated on research and development
with Discover Communication, allowing TiVo to use a portion of its satellite network. AT&T
supported TiVo in the marketing and selling of its service in the Boston, Denver, and Silicon
Valley areas. BSkyB was the service partner for TiVo in the United Kingdom. Creative Artists
Agency marketed and gave promotional support to the personal video recorder and was given
in exchange 67,122 shares of TiVo’s preferred stock.
Despite TiVo’s many alliances, the company was faced with the difficult challenge of
working with cable and satellite operators who offered their own digital video recorder-equipped
CASE 14 TiVo Inc. 14-17
set-top boxes. Cable operators like Time Warner Cable and Cox Communications offered
built-in DVR capability in set-top boxes and provided the equipment free to subscribers. In
August 2003, Echostar announced a free DVR promotion, an unprecedented move in the
industry. TiVo’s relatively expensive hardware could jeopardize the company’s ability to
compete with cable or satellite service providers that offered their own DVRs at a lower price.
There were relatively few nationwide cable or satellite providers, leaving TiVo with little
bargaining power. These cable/satellite providers could affect pricing of the TiVo technology
because of their size and because of their ability to market their own version of a generic DVR
unit to their subscription base. Although TiVo had to give a piece of its potential profits to
partners, TiVo’s management decided to form strategic relationships with competitors and
cable companies for distribution.
DirecTV, the satellite service provider, had served as TiVo’s backbone in its early years.
This service partner had fueled most of TiVo’s early growth. TiVo’s current 4.4 million sub-
scribers had mostly come from its partnership with DirecTV. In early 2002, subscribers to
TiVo’s service through DirecTV increased from 230,000 to 2.1 million, representing more than
half of all DVR subscriptions. Subscription fees to Direct TV ranged from $29.99/month for
40 channels to $65.99/month for over 250 channels. Interestingly, when DirecTV first began
negotiations with TiVo, the satellite provider had already been equipped with a DVR service
through its partnership with Microsoft’s Ultimate TV.
DirecTV decided in 2005 to develop its own DVR device in cooperation with the NDS
Group. It soon informed TiVo that it would stop marketing and selling TiVo’s digital recorders
to its satellite TV subscribers starting in 2007. This was a serious blow to TiVo. DirecTV’s
DVR would cost users a $299 onetime fee, but it included unique features, such as the ability
to jump to a specific scene in the program as well as allowing users to pay for downloaded
pay-per-view movies only when they were being viewed. In 2006, TiVo and DirecTV reached
a commercial extension agreement for three years. The agreement allowed existing DirecTV
customers using the TiVo digital video recorder to continue to receive maintenance and sup-
port from DirecTV. As part of the agreement, TiVo and DirecTV agreed that they wouldn’t
sue each other over patent rights. Since the agreement with DirecTV was facing an expiration
date in 2009, TiVo has been rushing to differentiate its product and working to make other dis-
tribution agreements.
WE COVER the ENTIRE U.S. MARKET
20%
Over The Air
Households : 26 Million
Channel : Comcast, Retailers
Competition : Yes
Households : 26 Million
Channel : DirectTV, Retailers
Competition : Yes
Households : 22 Million
Channel : Retailers
Competition : Limited
23%
Digital Satellite
33%
Basic Cable
24%
Digital Cable
Households : 36 Million
Channel : Retailers, Cablevision,
Cebridge, NCTC, etc.
Competition : Limited
EXHIBIT 6
SOURCE: Natexis Bielchroeder, Inc., July 2005.
14-18 SECTION D Industry Three—Entertainment and Leisure
In July 2000, Comcast, the nation’s leading cable operator, agreed to a trial offering of
TiVo boxes to its subscribers. TiVo’s management hoped that the trial would lead to a big-
ger deal in which Comcast would integrate TiVo software into Comcast cable boxes. Unfor-
tunately, Comcast balked and was unwilling to agree to this extension of the agreement. In
April 2001, when another trial failed to lead to a larger deal, TiVo laid off approximately
25% of its staff. In November 2001, after AT&T Broadband had just agreed to offer TiVo
DVRs to its customers, Comcast acquired the cable provider and its 14 million customers,
and canceled the agreement. In 2002, cable operators such as Comcast ended up developing
their own DVR boxes with makers such as Motorola and Scientific-Atlanta. Even though
the DVR was similar to that offered by DirecTV, Comcast announced in March 2005 that it
would offer its customers a video recorder service from TiVo and even would allow TiVo to
develop its software for Comcast’s DVR platform. Comcast and TiVo agreed to make TiVo’s
DVR service and interactive advertising capability (ad management system) available
through Comcast’s cable network and its set-top DVR boxes. This agreement also included
that the first of their co-developed products would be available in mid- to late-2006 under
the TiVo brand name.
Subscriptions to Comcast’s basic or standard cable cost users $8.63 or $52.55, respec-
tively. Adding a DVR feature cost an additional $13.94 with Comcast in addition to the
TiVo subscription, which ranged from $12.95 to $16.95 per month depending on the length
of the plan (from one to three years). Following this agreement with Comcast, TiVo’s
shares closed up nearly 75%, or $2.87 per share, to $6.70. Investment analysts were posi-
tive about the news, some upgrading TiVo’s investment rating from a sell to a hold. Since
DirecTV had started using a second company, NDS, to provide DVR service, the deal with
Comcast put to rest some of these concerns by opening up a large new potential audience
for TiVo’s service. According to a TiVo filing with the SEC, TiVo received an upfront pay-
ment from Comcast for creating a new DVR that worked with Comcast’s current service.
TiVo also received a recurring monthly fee for each Comcast subscriber who used TiVo
through Comcast.
Offering new technology-driven products, such as a DVR, was easier for satellite broad-
casters because changes could be made in a central location. For cable operators, however, new
technologies and products needed to be deployed gradually as the operators had different
equipment in different areas.
TiVo and BellSouth FastAccess DSL recently agreed on a variety of co-marketing
arrangements. With its strong presence and high level of customer satisfaction in the South-
eastern United States, BellSouth could provide a DSL Internet pipeline for TiVo to send video
content directly to the television. To expand program recording to a cellular phone, its latest
TiVo Mobile feature, TiVo made an agreement with Verizon. The agreement brought the dig-
ital video recording pioneer’s capabilities beyond its set-top-boxes and the television directly
to cell phones for the first time. In terms of content, TiVo also had engaged in new partnerships
with CBS Corp, Reuters Group PLC, Forbes magazine, New York Times Co., and the National
Basketball Association, among others. This would make news and entertainment programs
available for downloading onto TiVos. International Creative Management recommended
films, television shows, and Internet videos that TiVo users could download onto their boxes.
In addition, TiVo’s management decided to offer amateur videos through an agreement with
One True Media Inc., an Internet start-up that operated a Web service designed to help users
easily edit their raw footage into quality home movies.
The TALKA TiVo
“. . . Bring ‘em on! We are talking the HD language now . . . Yeah!.”
CASE 14 TiVo Inc. 14-19
TiVo Series 2 DT
The company’s basic DVR was its TiVo Series 2 DT unit. It included dual tuners (DT) so that
a viewer could record two programs at the same time (but only one digital signal) or watch
one program while recording another. Customers could choose between two versions: the ba-
sic 80-hour unit or the 180-hour unit. The selling price for an 80-hour unit with a one-year
service commitment was $16.95 a month or $179 prepaid plus $99.99 for the box. The
monthly service fee was reduced by $2 for each additional year on the service commitment.
The Series 2 DT DVR could record from multiple sources, such as cable, satellite, or antenna.
See Exhibit 1 for product specifications.
High Definition Television
High definition (HD) was the most important new consumer electronic development in tele-
vision. HD products radically increased the quality of the viewing and listening experience.
High definition sets included HD TV, HD broadcasting, HD DVD, HD Radio, HD Photo, and
even HD Audio.
High definition TV (HD TV) was first introduced in the United States during the 1990s.
It was a digital television broadcasting system using a significantly higher resolution than the
traditional formats, such as NTSC, PAL, and SECAM. The technology during the 1990s was
very expensive. With increasing production levels, prices decreased and HD TV was being
offered in an increasing number of televisions. As of 2007, HD TVs were being used in 24 million
U.S. households. It was predicted that by 2009, high definition would replace standard defini-
tion television. With the price of computer hard drives becoming lower and the increasing
availability of HD TV broadcasting, demand for the HD products was increasing rapidly.
Compared to standard definition television, HD TV offered viewers greater screen clarity and
smoother motion with richer, more natural colors, and surround sound.
TiVo Series 3
TiVo recently introduced the TiVo Series 3 to allow customers to record high definition tele-
vision and digital cable. Since TiVo’s management realized that great quality video needed to
be supported by great quality audio, the company put a lot of effort in the audio development
and received the certification of being the first digital media recorder to meet the THX perfor-
mance standard in HD TV. THX was known to have developed the highest standard of audio—
mainly the surround-sound systems in the entertainment as well as the media industry.
The new high definition TiVo Series 3, which was being sold for $799.000, had two tuners,
giving it the ability to record two HD programs simultaneously while playing back a third pre-
viously recorded program. (This required two CableCARDS for dual-function capability
through cable or antenna, but did not support satellite service.) Its larger storage capacity allowed
it to record up to 300 hours of standard definition programming or 32 hours of high-definition
programming. It also had two signal inputs and it accepted cable TV and over-the-air signals. De-
spite TiVo’s ability to record and playback at high definition quality, a downside was its relatively
high price—especially when some cable companies were offering non-HD DVRs free to their
subscribers. The monthly service fee was, however, the same as that for the Series 2.
TiVo HD
The company was developing a new version of the TiVo box, which would be available for
sale in 2007. The TiVo HD had most of the features of the Series 3, but would be sold for
only $300. The new TiVo contained a 160 GB hard drive good for recording 180 hours of
14-20 SECTION D Industry Three—Entertainment and Leisure
HD TiVENemies
The cable operator, Comcast, did not sell DVRs, but allowed its subscribers to rent DVR
boxes for $13.94 per month (in addition to their cable subscription fee). Its HD DVR boxes
were manufactured by Motorola and Scientific Atlanta. Users of these DVRs were able to
navigate their own preferences as they would with TiVo, except that TiVo offered better and
more features built into its boxes.
The satellite operator, DirecTV, allowed subscribers to add an additional DVR subscrip-
tion service for $4.99 monthly on top of the chosen monthly subscription service package to
DirecTV cable channels (ranging in cost from $29.99 to $65.99 per month). DirecTV offered
its subscribers the opportunity to buy a standard definition DVR for $99.99 and an HD DVR
box for $299 with a $100 rebate.
Looking to the Future
As CEO Tom Rogers looked at TiVo’s financial statements for the 2006 fiscal year ending
January 31, 2007, he pondered TiVo’s future prospects. In some ways, the future looked very
promising. Approximately 16 million households had DVRs and this number was expected
to increase to 56 million by 2010 according to The Carmel Group. Given its user-friendly
software interface and celebrity endorsements, TiVo should be able to obtain a large piece of
that growth. Although there were many versions of the generic DVR, the TiVo DVR had per-
ceived sex appeal. TiVo had been successful in creating a unique set of technologies, prod-
ucts, and services that were meeting the needs of consumers, television distributors, and the
advertising community. TiVo’s advantages were clear:
� Compelling, easy-to-use consumer DVR offerings
� Differentiated features
� Integrated broadband and broadcast capabilities (download movies, etc.)
� Portable technology platform
� Advanced advertising and promotion solutions
The company’s current strategy included a number of key elements:
� Offer an increasingly differentiated service
� Diversify our sources of revenue to include more advertising
� Integrate TiVo technology with third-party DVR platforms to provide TiVo service
� Extend and protect TiVo’s intellectual property
� Promote and leverage the TiVo brand through multiple advertising and marketing channels
� Extend the TiVo product beyond the U.S. market into countries such as China and Mexico
There were also a number of challenges to consider. During the past fiscal year, the com-
pany experienced growth in its TiVo-owned subscription base and subscription revenues.
standard-definition programming or 20 hours of high-definition programming. Both Series 3
and HD models used the same architecture and had dual tuners, two slots for CableCARDS,
and the same ports. (Like the Series 3 DVR, the TiVo HD required two CableCARDS for
dual-function capability through antenna or cable, but did not support satellite service.) The
TiVo HD did come with a cheaper remote control and, contrasted with the Series 3 remote,
was not backlit or capable of controlling other components. The monthly service fee was the
same as that for the Series 2 or 3 DVRs.
CASE 14 TiVo Inc. 14-21
However, this subscription growth was largely offset by the loss of a portion of TiVo’s Di-
recTV installed subscription base. Even though management decided to invest in subscription
acquisition activities in an effort to expand TiVo’s subscription base and promote the TiVo
brand for future partnerships, TiVo-owned subscription gross additions for the fiscal year 2007
were 429,000—down 13% from fiscal year 2006. Although it was not unusual for entrepre-
neurial ventures to generate losses for their first few years of operation, TiVo had not earned a
profit in the 10 years since it had been founded or in the eight years since it went public. It hadn’t
had a profitable quarter in the past two years!
As with any publicly held U.S. company, TiVo had to list risk factors that might affect its
future performance. Compared to the list of risks found in the SEC Form 10-K Report of most
publicly held companies, TiVo’s list of risks was extremely long—over 17 pages! Some of
these risk factors were:
� We face intense competition from a number of sources, which may impair our revenues, in-
crease our subscription acquisition cost, and hinder our ability to generate new subscriptions.
� We depend upon a limited number of third parties to manufacture, distribute, and supply
critical components, assemblies, and services for the DVRs that enable the TiVo service. We
may not be able to operate our business if these parties do not perform their obligations.
� DVRs could be the subject of future regulations relating to copyright law or evolving in-
dustry standards and practices that could adversely impact our business.
� A significant part of our installed subscription base results from our relationship with
DirecTV which we expect to decrease in the future due to DirecTV’s support of a com-
peting DVR by NDS.
� We face a number of challenges in the sale and marketing of the TiVo service and products
that enable that service. Even when consumers are aware of the benefits of our products,
they may not be willing to pay for them, especially when competitors under price us.
� If we are unable to create or maintain multiple revenue streams, such as licensing, adver-
tising, audience research measurement, revenues from programmers, and electronic
commerce, we may not be able to recover our expenses and this could cause our revenues
to suffer.
� The product lifetime subscriptions we offered in the past obligate the company for an in-
definite period and may not be large enough to cover future increases in costs.
� If there is increased use of switched technologies to transmit television programs by ca-
ble operators (also known as switched digital) in the future, the desirability and competi-
tiveness of our current products could be reduced.
� We need to safeguard the security and privacy of our subscribers’ confidential data, and
any inability to do so may harm our reputation and brand and expose us to legal action.
� Product defects, system failures or interruptions to the TiVo service may have a negative
impact on our revenues, damage our reputation and decrease our ability to attract new
customers.
� We have limited experience in providing service and operations internationally that are
subject to different laws, regulations, and requirements than those in the U.S. and our in-
ability to comply with such could harm our reputation, brand, and have a negative impact
on revenues.
� If we are unable to raise additional capital through the issuance of equity, debt, or other
financing activities on acceptable terms, our ability to effectively manage growth and
build a strong brand could be harmed.
� We expect continued volatility in our stock price.
14-22 SECTION D Industry Three—Entertainment and Leisure
The full list of TiVo’s risks was daunting, but nothing terribly unusual for a fast-growing
entrepreneurial venture. The big issue facing top management was how to make the company
profitable without slowing its growth. Investors have a limited amount of patience. A no-
dividend policy made sense for a fast-growing entrepreneurial company, but a low, volatile
stock price was not going to be acceptable for long. How long can the company continue to
sell TiVo DVRs when the competition was selling DVRs at a lower price or even offering them
for free? What should Rogers do?
R E F E R E N C E S
http://www.TiVo.com/
http://en.wikipedia.org/wiki/TiVo
http://en.wikipedia.org/wiki/High-definition_television
http://egotron.com/ptv/ptvintro.htm
http://news.com.com/TiVo,�Comcast�reach�DVR�deal/
2100-1041_3-5616961.html
http://news.com.com/TiVo�and�DirecTV�extend�contract/
2100-1038_3-6060475.html
http://www.technologyreview.com
http://www.fastcompany.com/magazine/61/TiVo.html
http://iinnovate.blogspot.com/2006/09/mike-ramsay-co-
founder-of-TiVo.html
http://www.acmqueue.org/modules.php?name�Content&pa
�showpage&pid�53&page�7
http://www.internetnews.com/stats/article.php/3655331
http://thomashawk.com/2006/04/TiVo-history-101-how-
TiVo-built-pvr_24.html
http://www.tvpredictions.com/TiVohd030807.htm
http://www.TiVocommunity.com/TiVo-
vb/showthread.php?threadid�151443
2006 Form 10-K, TiVo, Inc. (filed 4/16/2007)
2006 Form 14A, TiVo, Inc. (filed 5/31/2006)
“Jeffrey Hinson Elected to TiVo Board of Directors,” press re-
lease, TiVo, Inc. (January 26, 2007).
Stafford, A., “Bargain TiVo Records HD Video Without a Ca-
ble Box,” PC World (October, 2007), p. 62.
http://www.TiVo.com/
http://en.wikipedia.org/wiki/TiVo
http://en.wikipedia.org/wiki/High-definition_television
http://egotron.com/ptv/ptvintro.htm
http://news.com.com/TiVo,+Comcast+reach+DVR+deal/2100-1041_3-5616961.html
http://news.com.com/TiVo,+Comcast+reach+DVR+deal/2100-1041_3-5616961.html
http://news.com.com/TiVo,+Comcast+reach+DVR+deal/2100-1041_3-5616961.html
http://news.com.com/TiVo,+Comcast+reach+DVR+deal/2100-1041_3-5616961.html
http://www.technologyreview.com
http://www.fastcompany.com/magazine/61/TiVo.html
http://iinnovate.blogspot.com/2006/09/mike-ramsay-co-founder-of-TiVo.html
http://iinnovate.blogspot.com/2006/09/mike-ramsay-co-founder-of-TiVo.html
http://www.acmqueue.org/modules.php?name=Content&pa=showpage&pid=53&page=7
http://www.internetnews.com/stats/article.php/3655331
http://www.tvpredictions.com/TiVohd030807.htm
http://www.TiVocommunity.com/TiVovb/showthread.php?threadid=151443
http://www.TiVocommunity.com/TiVovb/showthread.php?threadid=151443
http://www.acmqueue.org/modules.php?name=Content&pa=showpage&pid=53&page=7
Introduction
POW! BAM! ZAP! IN 2008, MARVEL MAN’S ENTIRE UNIVERSE SHIFTED. After 70 years of fe-
rocious struggle, Marvel Man’s domination of the printed page was strong, with occa-
sional swipes by his long-time nemesis DC Man and some puny domestic and foreign
rivals. With no longer the need to fight on every frontier to protect his formidable assets from
being exploited, Marvel Man was able to share his super strengths through lucrative licensing
agreements with other trusted big-name heroes who understood the ins and outs of their own
competitive worlds. Marvel Man was growing up and leaving toys behind. The new skirmishes
would be fought online and on the big screen. What surprises await Marvel Man in these new
media worlds? Which Hollywood villains might strike first—the writers or the actors? How
can Marvel Man stay fresh and relevant in these changing times? What superhuman strength
will be needed to triumph over sinister intellectual property thieves? What nefarious plot
would the unpredictable Wall Street Woman concoct and would it involve battling a bear or a
bull? Keep alert, loyal followers, and welcome to a brand new day!
15-1
C A S E 15
Marvel Entertainment Inc.:
IRON MAN TO THE RESCUE
Ellie A. Fogarty and Joyce P. Vincelette
This case was prepared by Ellie A. Fogarty, Ed.D., and Professor Joyce P. Vincelette of the College of New Jersey.
Copyright © 2008 by Ellie A. Fogarty and Joyce P. Vincelette. This case cannot be reproduced in any form without
the written permission of the copyright holders, Ellie A. Fogarty and Joyce P. Vincelette. Reprint permission is solely
granted to the publisher, Prentice Hall, for the book, Strategic Management and Business Policy—13th Edition (and
the International and electronic versions of this book) by the copyright holder, Ellie A. Fogarty and Joyce P. Vincelette.
This case was edited for SMBP 13th Edition. The copyright holders, are solely responsible for case content. Any other
publication of the case (translation, any form of electronic or other media) or sale (any form of partnership) to another
publisher will be in violation of copyright law, unless Ellie A. Fogarty and Joyce P. Vincelette have granted additional
written reprint permission. Reprinted by permission.
History
Today’s Marvel Entertainment Inc. traces its long, complicated history back to a small comic
book company, Timely Comics, which was owned by Martin Goodman in the 1930s. A New
York publisher of pulp magazines, Goodman’s selections featured stories about detectives,
15-2 SECTION D Industry Three—Entertainment and Leisure
science fiction, Westerns, crime, and horror. Following closely on the heels of rival DC
Comics, which had just introduced Superman and Batman, Timely Comics produced its first
Marvel Comics series in 1939, featuring the Human Torch and Namor the Sub-Mariner. The
issue sold well and solidified Goodman’s interest in the superhero genre. By late 1940, the
first Captain America issue was an instant success as he battled the emerging Nazi threat. At
$.10 an issue, comic books provided the action-packed distraction that the Depression-era
generation needed. Stanley Leiber, better known as Stan Lee, began working as an assistant
in 1940 at his cousin Goodman’s company. Lee would later become synonymous with Mar-
vel Comics as an editor, manager, and spokesman. Goodman’s company grew rapidly
throughout the 1930s and 40s during the Golden Age of comic books.
In the early 1950s, Goodman created Atlas News Company, which he set up as his na-
tional distribution system. Timely Comics was renamed Atlas Publishing in 1951. During the
1950s, the entire comic book industry slowed, not only from the popularity of television, but
also from a newly created censorship board, the Comics Code Authority, whose special seal of
approval guaranteed inoffensive, and bland, content between the pages. Distribution opera-
tions at Atlas News Company were suspended in 1956, forcing Atlas Publishing into a distri-
bution deal with competitor DC Comics to get a limited number of comics in the Marvel series
out per month.
In the 1960s, the re-emergence of superheroes appealed to the baby boomer generation,
now in high school and on college campuses. It was in 1962 that Stan Lee co-created Marvel’s
most recognizable character, Spider-Man. Over the next few years, with the releases of the Fan-
tastic Four, the Incredible Hulk, the Avengers, and the X-Men, the company, now publishing
under the name Marvel Comic Groups, began merchandising its products and debuted its first
superhero show on the ABC television network. Although the company was still reporting
strong sales, its profits had dropped due to consolidating distribution outlets. The increasing
popularity of chain supermarkets, which did not carry comic books, hurt many comic book
publishers that had relied on corner grocers as a primary distribution outlet. In 1968, Goodman
sold Atlas, including the Marvel Comics series, to Perfect Film and Chemical Corporation,
which was then re-named Cadence Industries. Marvel Comics existed within Cadence as part
of a business unit called Magazine Management. By the end of the 1970s, the market for comic
books was reduced to an all-time low. Readers had lost interest in comics.
In the 1980s, the growing number of comic book collectors ushered in a wave of stores
dedicated to the sales of comic books. Marvel began to target different demographics in the
market, and began to use new distribution outlets including shopping malls. Marvel’s revenues
continued to grow through character license agreements. As part of a liquidation, Marvel was
sold by Cadence to New World Entertainment for $46 million in 1986. Ron Perelman, through
his Andrews Group and MacAndrews & Forbes holding companies, acquired Marvel from
New World Entertainment in 1988 for $82.5 million and formed Marvel Entertainment Group.
In June of 1991, Perelman announced that Marvel would sell its stock to the public for the
first time. Perelman pushed Marvel to expand into other areas with the 1992 purchase of Fleer
Corporation, which made trading cards, and the 1993 exchange of a 46% interest in Toy Biz,
a toy company owned by Isaac Perlmutter, in return for the use of Marvel’s characters.
Throughout the early nineties, Marvel completed a number of acquisitions, including chil-
dren’s kites (Sepctra Star), stickers (Panini), toy rockets (Quest), smaller publishers (Welsh
Publishing and Malibu Comics), another trading card company (SkyBox), and a distribution
operation (Superhero Enterprises). Marvel Mania was opened as a theme restaurant with
servers in costume and menu selections with superhero descriptions. Confusion reigned as var-
ious firms claimed specific rights to produce and distribute films with Marvel characters. For
example, Columbia Tristar Home Video claimed video cassette rights and Viacom claimed tel-
evision rights for a possible motion picture based on Spider-Man. By December 1996, Marvel
filed for bankruptcy amid plunging sales and mounting debt.
CASE 15 Marvel Entertainment Inc. 15-3
In 1997, Perelman was accused of helping to divert over $553 million from Marvel to his
other companies before the bankruptcy. The suit was finally settled when Perelman agreed to
pay former shareholders $80 million in 2008.1 Perelman was ousted by the board, and Carl
Icahn, a major bondholder, won control of the company for about a year until the courts ap-
pointed a Chapter 11 trustee at the end of 1997. After Icahn’s failed attempts at a plan of reor-
ganization, the company merged and became a wholly-owned subsidiary of Toy Biz in 1998.
Toy Biz became known as Marvel Enterprises Inc. and changed the trading symbol for Toy
Biz stock on the New York Stock Exchange to MVL. Additional legal issues were resolved
with movie studios and Marvel entered into a joint venture with Sony Pictures to develop the
Spider-Man movie franchise. Also during the late nineties, the company streamlined publish-
ing efforts, diversified with licensing agreements that would help restore Marvel’s image, and
expanded into foreign markets hungry for Marvel superheroes. To signal its move into the en-
tertainment industry, Marvel Enterprises changed its name to Marvel Entertainment Inc. in
September 2005. After signing a master toy licensing agreement with Hasbro in 2006, Marvel
began its exit from its toy manufacturing and distributing businesses. Marvel made some of its
comic book archives available online through its Digital Comics division in 2007. By the end
of the decade, Marvel was well on its way to becoming a leader in the entertainment industry,
with two self-produced feature films in 2008 (Iron Man and the Incredible Hulk) and the fund-
ing and creative ideas for many more.
Marvel Entertainment Inc.’s history bears a striking resemblance to one of its down-
trodden superheroes that battles rivals and fights injustices. As it transitioned from a tradi-
tional publisher and toy maker into a new media and entertainment company, would Marvel
emerge triumphant over the forces of intense competition and flagrant disregard for the prin-
ciples of intellectual property?
Corporate Governance
Board of Directors
Exhibit 1 lists the company’s board of directors and the compensation received by each in
2007. The 8 directors were:2
Isaac Perlmutter, 65, had been Marvel’s Chief Executive Officer since January 1, 2005,
and was employed by Marvel as vice chairman of the board of directors since November 2001.
Mr. Perlmutter was a director since April 1993 and served as chairman of the board of direc-
tors until March 1995. Perlmutter held over 37% of the company’s common stock outstanding
EXHIBIT 1
Board of Directors: Marvel Entertainment Inc.
SOURCE: Marvel Entertainment, Inc. Proxy Statement (May 5, 2008), pp. 4–5, 7.
Name Age Title Compensation
Handel, Morton E. 72 Chairman of the Board $868,160
Perlmutter, Isaac 65 Vice Chairman of the Board, Chief Executive Officer $3,872,797
Breyer, James W. 46 Director $273,210
Charney, Laurence N. 60 Director $192,180
Cuneo, F. Peter 63 Vice Chairman of the Board (Non-Executive) $387,984
Ganis, Sid 68 Director $435,710
Halpin, James F. 57 Director $298,210
Solar, Richard L. 68 Director $312,984
15-4 SECTION D Industry Three—Entertainment and Leisure
as of March 2008.3 Under the terms of a share disposition agreement in February 2008,
Perlmutter agreed not to sell any of his Marvel stock until the company’s share repurchase pro-
gram ended in March 2010.4
F. Peter Cuneo, 63, was Marvel’s president and chief executive officer from July 1999
through December 2002 and served as the part-time special advisor to Marvel’s chief execu-
tive officer from January 2003 through December 2004. Mr. Cuneo had been a Marvel direc-
tor since July 1999, and since June 2003 he served as a non-executive vice chairman of the
board of directors. Mr. Cuneo was a senior advisor to Plainfield Asset Management LLC, a
hedge fund based in Greenwich, CT, that specialized in special and distressed situations. Mr.
Cuneo was a director of Iconix Brands Inc.
Sid Ganis, 68, had been a Marvel director since October 1999. Mr. Ganis was the presi-
dent of the Academy of Motion Picture Arts and Sciences, the organization that awards the Os-
cars. Mr. Ganis had been president of Out of the Blue . . . Entertainment, a company that he
founded, since September 1996. Out of the Blue . . . Entertainment was a provider of motion pic-
tures, television and musical entertainment for Sony Pictures Entertainment and others. From
January 1991 until September 1996, Mr. Ganis held various executive positions with Sony Pic-
tures Entertainment, including vice chairman of Columbia Pictures and president of World-
wide Marketing for Columbia/TriStar Motion Picture Companies.
James F. Halpin, 57, had been a Marvel director since March 1995. Mr. Halpin retired in
March 2000 as president and chief executive officer and a director of CompUSA Inc., a retailer
of computer hardware, software, accessories and related products, with which he had been em-
ployed since May 1993. Mr. Halpin was a director of Life Time Fitness Inc.
James W. Breyer, 46, had been a Marvel director since June 2006. Mr. Breyer had served
as a partner of the Silicon Valley-based venture capital firm, Accel Partners, since 1995. Mr.
Breyer was a director of Wal-Mart Stores Inc. and RealNetworks Inc. Mr. Breyer also served
on the boards of various privately held companies. Mr. Breyer was a member of the board of
dean’s advisors to Harvard Business School and was chairman of the Stanford Engineering
Venture Fund.
Laurence N. Charney, 60, had been a Marvel director since July 10, 2007. Mr. Charney
retired from his position as a partner of Ernst & Young LLP in 2007, having served that firm
for over thirty-five years. At Ernst & Young, Mr. Charney most recently served as the Ameri-
cas director of conflict management. In that role he had oversight and responsibility in ensur-
ing compliance with global and local conflict of interest policies for client and engagement
acceptance across all service lines. Mr. Charney previously served as an audit partner and was
Marvel’s audit partner for its 1999 through 2003 audits.
Morton E. Handel, 72, had been the chairman of the board of directors of Marvel since
October 1998 and was first appointed as a director in June 1997. Mr. Handel was a director of
Trump Entertainment Resorts Inc. and served from 2000 until February 2006 as a director of
Linens ’N Things Inc. Mr. Handel was also a regent of the University of Hartford and was
active on the boards of several not-for-profit organizations in the Hartford, CT, area.
Richard L. Solar, 68, had been a Marvel director since December 2002. Since Febru-
ary 2003, Mr. Solar had been a management consultant and investor. From June 2002 to
February 2003, Mr. Solar acted as a consultant for Gerber Childrenswear Inc., a marketer
of popular-priced licensed apparel sold under the Gerber name, as well as under licenses
from Baby Looney Tunes, Wilson, Converse and Coca-Cola. From 1996 to June 2002
(when Gerber Childrenswear was acquired by the Kellwood Company), Mr. Solar was sen-
ior vice president, director and chief financial officer of Gerber Childrenswear. Mr. Solar
was also vice president and treasurer of Barrington Stage Company Inc., which produced
plays, developed experimental musicals and provided a program for at-risk high school stu-
dents in the Berkshires.
CASE 15 Marvel Entertainment Inc. 15-5
Corporate Officers
Exhibit 2 lists Marvel’s corporate officers and the compensation received by each in 2007. In
addition to Mr. Isaac Perlmutter, listed earlier, there were four other key corporate officers:5
Alan Fine (57) had served as executive vice president and chief marketing officer of Mar-
vel Characters Inc. (a wholly owned subsidiary of Marvel Entertainment Inc. that owned and li-
censed Marvel’s intellectual property library) since May 2007. Mr. Fine also had served as Chief
Executive Officer of Marvel’s publishing division since September 2004, and as Chief Execu-
tive Officer of Marvel’s toy division since August 2001 and from October 1998 to April 2001.
David Maisel (45) had served as executive vice president, Office of the Chief Executive,
since September 2006 and became chairman of Marvel Studios in March 2007. From Septem-
ber 2005 until September 2006, Mr. Maisel served as executive vice president, Corporate De-
velopment, and from September 2005 until March 2007, Mr. Maisel served as vice chairman
of Marvel Studios. From January 2004 to September 2005, Mr. Maisel served as president and
chief operating officer of Marvel Studios. From October 2001 to November 2003, Mr. Maisel
headed Corporate Strategy and Business Development for Endeavor Agency, a Hollywood lit-
erary and talent agency.
John Turitzin (52) had served as executive vice president, Office of the Chief Executive,
since September 2006. From February 2006 until September 2006, Mr. Turitzin served as Mar-
vel’s chief administrative officer. Mr. Turitzin had also served as an executive vice president
and general counsel since February 2004. From June 2000 to February 2004, Mr. Turitzin was
a partner in the law firm of Paul, Hastings, Janofsky & Walker LLP.
Kenneth P. West (49) had served as executive vice president and chief financial officer
since June 2002.
EXHIBIT 2
Corporate Officers: Marvel Entertainment, Inc.
SOURCE: Marvel Entertainment, Inc. Proxy Statement (May 5, 2008), pp. 13, 23.
Name Age Title Compensation
Perlmutter, Isaac 65 Vice Chairman of the Board, Chief Executive Officer $3,872,797
West, Kenneth P. 49 Executive Vice President, Chief Financial Officer $766,526
Fine, Alan 57 Executive Vice President, Publishing/Toy/Characters $632,420
Maisel, David 45 Executive Vice President, Marvel Studios $4,118,999
Turitzin, John 52 Executive Vice President, Legal/General Counsel $1,390,212
Primary Operating Segments
In the first quarter of 2008, Marvel Entertainment eliminated its Toy division and reorganized
into three operating segments: Publishing, Licensing, and Film Production. Marvel operated
in these markets both domestically and internationally, although the U.S. market made up an
average of over 70% of the company’s annual revenues. Because each segment depended on
Marvel’s extensive library of characters, the company emphasized the integrated and
complementary nature of the three segments. Exhibit 3 shows Marvel’s primary business
segments and Exhibit 4 lists Marvel’s subsidiaries.
Corporate Structure
15-6 SECTION D Industry Three—Entertainment and Leisure
Motion Pictures Television
Marvel Entertainment, Inc.
Publishing
Comics Trade Paperbacks
Custom Projects
Digital Comics &
Online Activities
Destination-Based
Entertainment
Domestic &
International
Consumer Products
Spider-Man
Joint Venture
Direct-to-DVD Live Attractions
Studio Licensing
Licensing Film Production
EXHIBIT 3
Business Segments:
Marvel
Entertainment, Inc.
SOURCE: Derived from Marvel Entertainment, Inc., Form 10-Q (June 30, 2008), pp. 11–12 and Cuneo & Turitzin
presentation at JP Morgan US Mid Cap Growth Conference, London, (Sept. 30, 2008), pp. 6–7, 13.
For most of its history, Marvel’s primary direct competitors had been other comic book
publishers, such as the well-established DC Comics, a subsidiary of Warner Bros., and the pub-
lisher of Superman, Batman, and Wonder Woman comics, and the much younger Dark Horse
Comics. As Marvel repositioned itself as an entertainment firm, the company faced competi-
tion from industry giants such as the Walt Disney Company and NBC Universal.
The Publishing segment created and published comic books, trade paperbacks, custom
comics, and digital comics. Well-known characters included Spider-Man, X-Men, Fantastic
Four, Iron Man, the Incredible Hulk, Captain America, and Ghost Rider. The segment also re-
ceived revenues from related advertising and subscription operations. Publishing contributed
between 25% to 30% of the company’s annual net sales, with revenues coming overwhelm-
ingly (85%) from the U.S. market. Segment revenues were $125,657,000, $108,464,000, and
$92,455,000 in 2007, 2006, and 2005, respectively.
Over the course of 70 years, Marvel developed an extensive library of over 5,000 charac-
ters, most of which were developed and popularized through published comic books (see
Exhibit 5 for a listing of popular characters). The publishing segment had published comic
books since 1939 and was able to present characters in contemporary dramatic settings that
were suggestive of real people with real problems. The ability to stay relevant enabled Marvel
to retain the attention of old readers, while also attracting the attention of new readers over time.
In 2008, Marvel was focused on expanding its distribution channels as well as its product
lines. Comic books were distributed through three main channels: comic book specialty stores,
traditional retail outlets such as bookstores and newsstands, and on a subscription basis. Approx-
imately 70% of the Publishing segment’s revenues were attributed to sales from comic book spe-
cialty stores, also known as the “direct market.” Another 15% of the Publishing net sales were
derived from sales to the mass market retail outlets. The final 15% of the segment’s revenues
came from sales of advertising and subscriptions, including its online business. Because of the
growth of the Internet and the potential for online readership, online comic books were launched
in 2007 through Marvel Digital Comics Unlimited, in an attempt to reach existing readers in a
new medium while also further extending Marvel’s reach to new readers.
CASE 15 Marvel Entertainment Inc. 15-7
EXHIBIT 4
Subsidiaries: Marvel
Entertainment, Inc.
SOURCE: Marvel Entertainment, Inc., Form 10-K (Dec. 31, 2007), Exhibit 21.
Name Jurisdiction of Organization
1 Marvel Characters, Inc. Delaware
2 Marvel Characters B.V. The Netherlands
3 MVL International C.V. The Netherlands
4 Marvel International Character Holdings LLC Delaware
5 Marvel Entertainment International Limited United Kingdom
6 Marvel Property Inc. Delaware
7 Marvel Publishing Inc. Delaware
8 Marvel Internet Productions LLC Delaware
9 Marvel Toys Limited Hong Kong
10 Spider-Man Merchandising L.P.** Delaware
11 MRV, Inc. Delaware
12 Marvel Studios, Inc. Delaware
13 MVL Film Finance LLC* Delaware
14 MVL Productions LLC* Delaware
15 MVL Rights LLC* Delaware
16 MVL Development LLC Delaware
17 Marvel Film Productions LLC Delaware
18 Iron Works Productions LLC* Delaware
19 Incredible Productions LLC* Delaware
20 MVL Iron Works Productions Canada Inc.* Province of Ontario
21 MVL Incredible Productions Canada, Inc.* Province of Ontario
22 Asgard Productions LLC Delaware
23 Marvel Animation, Inc. Delaware
24 Green Guy Toons LLC Delaware
25 Squad Productions LLC Delaware
*Wholly owned subsidiaries formed as Film Slate Subsidiaries
**Joint venture with Sony Pictures for licensing Spider-Man
EXHIBIT 5
Popular Characters:
Marvel
Entertainment Inc.
Ant-Man
Avengers
Black Panther
Blade
Captain America
Cyclops
Daredevil
Dr. Doom
Dr. Strange
Elektra
Emma Frost
Fantastic Four
Gambit
Ghost Rider
Hawkeye
Human Torch
Incredible Hulk
Iron Man
Mr. Fantastic
Multiple Man
Nick Fury
Nightcrawler
Phoenix
Silver Surfer
Spider-Girl
Spider-Man
Sub-Mariner
The Punisher
The Thing
Thor
Wolverine
X-Men
15-8 SECTION D Industry Three—Entertainment and Leisure
In the publishing industry, Marvel was the number one publisher of comic books in the
United States with over 40% of the market. DC Comics followed with approximately 30% in
2007. Dark Horse Comics comprised about 5% of the comic book market.6 Throughout their his-
tories, Marvel and other comic book publishers struggled to expand readership beyond teenage
boys. Various attempts included romance comics, female superheroes, and adult-themed comics.
The most recent and successful expansion in this industry was the introduction of Japanese
comics called “manga” which often included stories with girl-friendly content and were distrib-
uted to both comic book shops and mainstream bookstores.7 Some comic book publishers also
entered the field of graphic novels, which was well-suited to serialized stories. In 2008, Marvel
had eight product lines that targeted different age groups and interests. These included stories
taken from classic literature (the Iliad), stories from best-selling authors, and an all-ages print
line for Wal-Mart and Target. Rival comic book company DC Comics had five print lines in-
cluding a manga-type line and one primarily for teenage girls. DC also used established novel-
ists to draw new readers to its publications.8
The Licensing segment typically delivered over half of the company’s net sales in a year.
An average of 70% of these sales were generated in the U.S. market. Licensing revenues were
$272,722,000, $127,261,000, and $230,063,000 in 2007, 2006, and 2005 respectively. The Li-
censing segment directed the licensing, promotion, and brand management for all Marvel
characters worldwide. Marvel pursued a strategy of concentrating licensee relationships with
fewer, larger licensees who demonstrated superior financial and merchandising capability.9
Revenues within this segment were broken into four categories as of 2007. This was be-
fore the restatement of Toys revenues within the segment. The Domestic Consumer Products
category represented $71.8 million or about 25% of total licensing sales in 2007. International
Consumer Products made up another $41.8 million. The Spider-Man Joint Venture with Sony
accounted for $122 million, or 45%, of total sales in this segment. Marvel Studios licensing
made up $37.1 million in 2007.10 Marvel was ranked within the top five licensing companies
by sales by License! magazine in 2008 (See Exhibit 6).
EXHIBIT 6
Top Licensing Companies, 2008
SOURCE: License! Global’s Top 100 Licensing Companies (April 2008).
(Dollar Amounts
in Billions)
Rank Company
Sales
2007
Sales
2006 Brands
1 Disney Consumer Brands $26.0 $24.0 Hannah Montana, High School Musical, Disney Princesses,
Disney Fairies, Pixar’s Cars, Chronicles of Narnia
2 Phillips-Van Heusen $6.7 $6.7 Van Heusen, Arrow, Izod, Bass
3 Warner Bros. Consumer
Products
$6.0 $6.0 Harry Potter and the Order of the Phonenix, The Dark
Knight, Speed Racer, Where the Wild Things Are
4 Iconix $6.0 NA Candie’s, Starter, Joe Boxer, OP, Cannon, Royal Velvet,
Mudd, Mossimo
5 Marvel Entertainment Inc. $5.5 $4.8 Spider-Man, X-Men, Hulk, Iron Man, Fantastic Four,
Avengers, Spider-Man & Friends
6 Nickelodeon & Viacom Cons.
Prod.
$5.5 $5.3 Dora, Diego, The Backyardigans, Ni-Hao, Kai Lan,
SpongeBob SquarePants, South Park, Neopets
7 Major League Baseball $5.1 $4.7 Major League Baseball
8 Sanrio $5.0 $5.2 Hello Kitty, Keroppi, Kuromi, Badtz-Maru
9 Cherokee Group $4.0 NA Cherokee, Sideout, Carole Little
10 National Football League $3.4 $3.2 National Football League
CASE 15 Marvel Entertainment Inc. 15-9
Marvel shifted its toy business to Hasbro during the first quarter of 2008. According to the
company:
We also completed a change in the focus of the support that we provide to Hasbro, which resulted
in changes to our internal organizational structure and staff reductions. These events altered our
internal reporting of segment performance, with the result that we are now including revenues
earned from Hasbro (associated with toys manufactured and sold by Hasbro) and related ex-
penses (associated with royalties that we owe on our Hasbro revenue) within our Licensing seg-
ment. Those revenues and expenses were formerly included in our Toy segment.11
Seeking a strategic partnership with a recognized industry giant, Marvel entered a 5-year
master toy license with Hasbro for the period January 1, 2007, to December 31, 2011. The
agreement gave Hasbro the exclusive right to make action figures, plush toys, and certain role-
play toys, and non-exclusive rights for several other types of toys, using Marvel’s characters.
The Hasbro agreement was reached after the early termination of a prior 5 1/2-year agreement
with Toy Biz Worldwide Limited (TBW) in December 2005, for which Marvel took a $12.5
million non-recurring expense. The agreement with TBW, a Hong Kong toy maker totally un-
related to the Toy Biz company previously owned by Perlmutter, began in 2001 and gave TBW
the right to use Marvel characters, except for Spider-Man, in producing and selling action fig-
ures and accessories. During the interim year (2006), Marvel produced and sold its own toys,
with TBW serving as a sourcing agent to help Marvel locate factories in China.
Marvel faced intense competition in the toy industry and relied on the expertise of Hasbro to
reach two main target markets: boys, primarily ages four through 13, and collectors aged 18–44.
For 2007, the last time that the company would report revenues in the Toy segment, U.S. toy sales
were responsible for about 60% of Marvel’s Toy segment sales. Beginning in 2008, domestic and
international licensing revenues from toy sales were reflected in the licensing segment.
With such an extensive catalog of characters, Marvel partnered with numerous companies
such as Activision and Sega for video games, Leapfrog for electronics, Hallmark for party sup-
plies, General Mills and 7-11 for food and beverages, and Johnson & Johnson for health &
beauty products. Footwear deals included an exclusive collection of children’s sneakers for
Reebok featuring Iron Man and the Incredible Hulk and sold only at Foot Locker and Kids
Foot Locker, as well as another deal with Crocs Inc. Fruit of the Loom held the licensing agree-
ment for children’s underwear printed with Marvel characters. As part of the licensing agree-
ments, Marvel received a flat fee for access to any proprietary character in addition to per unit
fees for every Marvel licensed item sold.
In 2007, Marvel began to enhance the product development and merchandising of its con-
sumer product categories. In addition to its mass market mainstays, Wal-Mart and Target, Mar-
vel was moving into new distribution channels such as Pottery Barn Kids with Spider-Man
room furnishings and accessories designed exclusively for the retailer and its more upscale
consumers. Additional deals were in place with Nordstrom, Fred Segal, and H&M.12
Although Marvel created its own film production business unit, there were a number of
outstanding licensing agreements with 20th Century Fox to produce major motion pictures
featuring X-Men and the Fantastic Four. Under this agreement Marvel retained more than 50%
of merchandising-based royalty revenue. Marvel also partnered with Lionsgate Entertainment
Corp. for animated DVDs for the home video market and with FX, a cable network from FOX,
to distribute Marvel’s self-produced movies on cable.13
Marvel licensed its characters for use at Universal Studios theme parks in Orlando,
Florida, and Osaka, Japan. In 2008, characters had been licensed for the development of a ma-
jor theme park in Dubai, two theme parks in South Korea, and a Broadway musical of Spider-
Man with director Julie Taymor (The Lion King) and music by U2’s Bono and The Edge.
Characters were licensed by other companies for short-term promotions of products and ser-
vices, and were used in foreign-language comic books, paperbacks, and coloring books.
15-10 SECTION D Industry Three—Entertainment and Leisure
Spider-Man Merchandising L.P. was a joint venture between Marvel and Sony Pictures
Entertainment Inc. for the purpose of pursuing licensing opportunities relating to characters
based upon movies or television shows featuring Spider-Man and produced by Sony. Marvel
maintained control of decision making and received the majority of the financial interest of the
joint venture.14
The Film Production segment included self-produced feature films. Marvel planned to self-
produce all future films based on characters that had not already been licensed to third parties. The
company felt it would have more control of films and have greater flexibility with respect to the
coordination of licensed products and film release timing. Marvel financed new films through a
$525 million credit facility funded by Merrill Lynch that enabled Marvel to independently finance
the development and production of up to 10 feature films over eight years. The theatrical film
rights of 12 second-tier characters and their supporting partners or rivals were pledged as collat-
eral to the film facility, including Ant-Man, Black Panther, Captain America, Doctor Strange, Nick
Fury, and The Avengers. Exhibit 7 shows the schedule of films and studios involved.
Marvel formed seven wholly owned subsidiaries, known as the Film Slate Subsidiaries,
in connection with the film facility, that are identified in Exhibit 4. The first two films pro-
duced by this $525 million investment were Iron Man and The Incredible Hulk, both of which
were released in mid-2008 with successful opening weekends of $98.6 million and $55.4 mil-
lion, respectively.15 Paramount Pictures distributed Iron Man, staring Robert Downey Jr.,
Gwyneth Paltrow, Terrence Howard, and Jeff Bridges, and Universal Pictures distributed The
Incredible Hulk, staring Edward Norton, Liv Tyler, William Hurt, and Tim Roth. Marvel be-
gan reporting revenues for the Film Production segment in the second quarter of 2008. In Sep-
tember 2008, Marvel leased sound stages, equipment, production spaces, and corporate offices
in California through its MVL Productions LLC subsidiary to make its next four self-produced
films.16
EXHIBIT 7
Film Schedule and
Studio: Marvel
Entertainment Inc.
SOURCE: Cuneo & Turitzin presentation at JP Morgan US Mid Cap Growth Con-
ference, London, (Sept. 30, 2008), pp. 14–15 and Marvel Entertainment, Inc.
Form 8-K, May 9, 2008, p. 3.
2000 X-Men Fox
2002 Spider-Man Sony
2003 Daredevil Fox
X2: X-Men United Fox
Hulk Universal
2004 Spider-Man 2 Sony
2005 Elecktra Fox
Fantastic Four Fox
2006 X-Men: The Last Stand Fox
2007 Ghost Rider Sony
Spider-Man 3 Sony
Fantastic Four-ROTSS Fox
2008 Iron Man Marvel
Incredible Hulk Marvel
Punisher: War Zone Lionsgate
2009 X-Men Origins: Wolverine Fox
2010 Iron Man 2 Marvel
Thor Marvel
2011 The First Avenger: Captain America Marvel
The Avengers Marvel
CASE 15 Marvel Entertainment Inc. 15-11
Cross-Segment Operations
Operating across segments was the company’s Global Digital Media Group, established in
2008 to coordinate Marvel’s expanding digital distribution strategy. This included Marvel
Digital Comics Unlimited, part of the Publishing segment, as well as digital video, animated
content, mobile games, and strategic partnerships.19 In late 2007, Marvel launched its Digi-
tal Comics online subscription service, providing high-resolution Internet access and search
capabilities to thousands of classic comic book titles from its archives as well as contempo-
rary issues. Special features on the Web site included the first 100 issues of the Amazing
Spider-Man, first-time appearances of specific super heroes, and series designed for young
readers. Rival publisher DC Comics pushed technology beyond static, digitized versions of
print materials by offering a hybrid of comic books and animation called “motion comics.”
DC’s first motion comic series featured the Dark Knight and coincided with the release of the
2008 Batman movie. The series could be downloaded for game consoles, mobile phones, and
video on demand.20 Following DC’s lead, Marvel partnered with thriller/horror author
Stephen King to develop a 25-episode animated video of King’s short-story “N,” from his
collection “Just After Sunset.” Marvel created the episodes specifically for small screens and
offered them via online and mobile channels prior to the book’s release.21
Serious legal considerations influenced all of Marvel’s operations, domestically and in-
ternationally. Marvel worked diligently to protect the most valuable assets of the company, its
globally-recognized characters and stories. In addition to the company’s registered trademarks
and copyrights within the United States, Marvel attempted to protect its intellectual property
abroad by registering trademarks in Africa, Asia, Latin America, the Middle East, and West-
ern Europe.22 According to the International Intellectual Property Alliance, over $18 billion in
revenue was lost in 2007 by U.S. firms due to copyright piracy of software, music, and books.23
Another $5 billion was lost by major U.S. motion picture studios.24 Marvel’s legal challenges
also extend to the virtual world, including its fights to protect its intellectual property by chal-
lenging the superhero avatars designed by players of massively multiplayer online role-playing
games (MMORPG). In a recent case against NCsoft, Marvel accused the videogame develop-
ers of infringement of copyright and trademarks. The case was dismissed and Marvel later set-
tled with the NCsoft, leaving many important questions about copyright and the boundaries of
fair use in game playing to be settled in the future.25
Marvel relied on hundreds of gifted individuals to conceive of, design, and deliver the
wide-ranging and ever-changing adventures of Marvel characters. Legal issues related to tal-
ent included claims of copyright ownership made by freelance writers, disputes with former
employees, and labor agreements with writers and actors. For example, Marvel faced a chal-
lenge during the 100-day strike in 2007–2008 of the Writers Guild of America (WGA), which
represents writers in the motion picture, broadcast, cable, and new media industries. Progress
on its ambitious film development slate stopped until Marvel negotiated an interim agreement
The move to self-produced films came as a result of hard learning experiences. Previous
failed attempts in Hollywood and unfavorable movie deals left Marvel with nothing to show
for its long history of investment in character and story development. In past arrangements,
the company did not bear the production risks and in exchange it reaped a small percentage of
the profits.17 Sometimes Marvel would receive only 2 to 10 percent of profits of a feature film.
For example, licensing mishandled during Ron Perelman’s era brought Marvel only one mil-
lion dollars from 1997’s Men in Black, a film that generated close to $600 million worldwide.
Another lesson was learned when Marvel made $25,000 from 1998’s Blade, which brought in
$133 million worldwide.18 However, popular films produced by other companies using Mar-
vel characters continued to generate increased licensing revenues for Marvel from toys and
consumer products, and often reignited interest in the comic books themselves.
EXHIBIT 8
Revenues by Segment and Geographic Area: Marvel Entertainment Inc.
SOURCE: Marvel Entertainment, Inc., Form 10-K (Dec. 31, 2007), p. F-40.
(Dollar Amounts in Thousands)
2007 2006 2005
U.S. Foreign U.S. Foreign U.S. Foreign
Licensing $ 178,534 $ 94,188 $ 83,955 $ 43,306 $ 181,959 $ 48,104
Publishing 106,858 18,799 90,924 17,540 77,312 15,143
Toys1 53,100 34,328 82,171 33,902 47,695 20,294
Total $ 338,492 $ 147,315 $ 257,050 $ 94,748 $ 306,966 $ 83,541
Note 1. $38.5 million and $4.4 million of U.S. toy revenue and $32.4 million and $0.8 million of foreign toy revenue for 2007 and 2006,
respectively, is attributable to royalties and service fees generated by Hasbro. $37.1 million of the U.S. toy revenue and $14.7 million of
the foreign toy revenues for 2005 are attributable to royalties and service fees from toy sales generated by TBW.
with the WGA to put the writers back to work. Marvel revised its two-films-per-year model
and amended its agreement concerning the $525 million film slate credit facility.26 As of No-
vember 2008, the Screen Actor’s Guild (SAG) had been without a contract for five months and
was seeking a strike authorization from its members.27
Financial Performance
Licensing segment net sales accounted for 56% of total net sales in 2007. The Publishing seg-
ment accounted for 26%, and Toys made up the remaining 18%. In 2007, revenue from for-
eign operations accounted for 30% of Marvel’s total revenues, up from just 21% in 2005.
Exhibit 8 provides revenues by segment and geographic area for Marvel in 2007. As noted
earlier, the company substantially exited the Toy business in early 2008 and began reporting
revenues for the Film Production segment in the second quarter of 2008. As of the third quar-
ter of 2008, Marvel’s Licensing business accounted for $237,479,000 in net sales, down from
a restated 2007 amount of $267,512,000. Publishing produced $92,322,000 in net sales, also
down from a restated 2007 amount of $95,356,000. Film production made up $119,105,000
of net sales in the third quarter of 2008.28
As of late 2008, the global economy had entered a recessionary period. On the strength of
its summer 2008 film releases, Marvel’s share price appeared to be weathering the storm in
late 2008. Because its characters were used across business segments, Marvel was able to
leverage exposure from films to create revenues from sales of licensed merchandise. However,
this ripple effect was expected to slow in the absence of new films or television shows. No
self-produced films were scheduled for release in 2009.
Since emerging from bankruptcy in 1998, Marvel’s net sales increased 110%, averaging
nearly 14% growth per year. However, a closer analysis of Marvel’s financials revealed wide
fluctuations over the period. For fiscal year 2007, consolidated net sales were up 38% over 2006
to $485.8 million. The increase came after a 24% drop from 2004, when net sales exceeded
$513.4 million, to 2005, and a further drop of 10% from 2005 to 2006. Marvel’s consolidated
statement of income is provided in Exhibit 9 and Exhibit 10, consolidated balance sheet.
15-12 SECTION D Industry Three—Entertainment and Leisure
EXHIBIT 9
Consolidated Statements of Income: Marvel Entertainment, Inc. (Dollar amounts in thousands of dollars)
Year Ending December 31 2007 2006 2005
Net Sales 485,807 351,798 390,507
Costs and expenses: — — —
Cost of revenues (excluding depreciation expense) 60,933 103,584 50,517
Selling, general and administrative 147,118 123,130 166,456
Depreciation and amortization 5,970 14,322 4,534
Total costs and expenses $214,021 $241,036 $221,507
Other income, net 2,643 1,798 2,167
Operating income $274,429 $112,560 $171,167
Interest expense 13,756 15,225 3,982
Interest income 2,559 1,465 3,863
Income before income tax expense and minority interest $263,232 $98,800 $171,048
Income tax expense (98,908) (39,071) (62,820)
Minority interest in consolidated joint venture (24,501) (1,025) (5,409)
Net Income $139,823 $58,704 $102,819
Basic and diluted net income per share: — — —
Weighted average shares outstanding: — — —
Weighted average shares for basic earnings per share 79,751 82,161 99,594
Effect of dilutive stock options, warrants and restricted stock 2,716 5,069 6,464
Weighted average shares for diluted earnings per share 82,467 87,230 106,058
Net income per share: — — —
Basic 1.75 0.71 1.03
Diluted 1.70 0.67 0.97
SOURCE: Marvel Entertainment, Inc., Form 10-K (Dec. 31, 2007), p. F-5.
EXHIBIT 10
Consolidated Balance Sheet: Marvel Entertainment, Inc. (Dollar amounts in thousands)
Year Ending December 31 2007 2006
Assets — —
Current assets: — —
Cash and cash equivalents 30,153 31,945
Restricted cash 20,836 8,527
Short-term investments 21,016 —
Accounts receivable, net 28,679 59,392
Inventories, net 10,647 10,224
Income tax receivable 10,882 45,569
Deferred income taxes, net 21,256 22,564
Advances to joint venture partner — 8,535
Prepaid expenses and other current assets 4,245 7,231
Total current assets $147,714 $193,987
Fixed assets, net 2,612 4,444
Product and package design costs, net — 1,497
Film inventory 264,817 15,055
Goodwill 346,152 341,708
Accounts receivable, non–current portion 1,300 12,879
Income tax receivable, non–current portion 4,998 —
Deferred income taxes, net 37,116 36,406
Deferred financing costs 11,400 15,771
Other assets 1,249 2,118
Total assets $817,358 $623,865
(Continued)
SOURCE: Marvel Entertainment, Inc., Form 10-K (Dec. 31, 2007), p. F-4.
N O T E S
1. “Perelman to settle Marvel suit.” New York Times, August 8,
2008.
2. Marvel Entertainment, Inc., Proxy Statement (May 5, 2008),
pp. 4–5. This section was directly quoted, except for minor ed-
iting.
3. Marvel Entertainment, Inc., Proxy Statement (May 5, 2008),
p. 35.
4. Marvel Entertainment, Inc., Form 8-K (February 19, 2008), p. 1.
5. Marvel Entertainment, Inc., Proxy Statement (May 5, 2008),
p. 13. This section was directly quoted, except for minor editing.
6. Market share 2007 from Diamond accessed September 6, 2008.
http://comicbooks.about.com/od/diamondreports2007/a/
2007publishers.htm
7. Phillips, Matt. “Pow! Romance! Comics court girls; Inspired by
Japanese manga, major American publishers aim for new fe-
male fans.” Wall Street Journal, June 8, 2007, p. B.1.
8. Lieberman, David. “Comic boom!” USA Today, July 25, 2008,
p. 1b.
9. Marvel Entertainment, Inc., 10-Q (September 30, 2008), p. 18.
10. Marvel Entertainment, Inc., 8-K (February 19, 2008), p. 2.
11. Marvel Entertainment, Inc., 10-Q (June 30, 2008), p. 16.
12. “News flash! Spidey merch spotted at Pottery Barn: Deal seeks
to break Marvel out of ‘commodity product’ mold.”
Brandweek, February 11, 2008, p. 8.
13. “Marvel Studios enters into free TV rights deal with FX for
Marvel’s self-produced movies,” accessed April 29, 2008.
http://www.marvel.com/company/index.htm?sub�viewstory_
current.php&id�1278
14. Marvel Entertainment, Inc., 10-Q (June 30, 2008), p. 5.
15. www.boxofficemojo.com, accessed September 6, 2008.
16. Marvel Entertainment, Inc., 10-Q (September 30, 2008),
p. 16, 37.
Year Ending December 31 2007 2006
Current liabilities: — —
Accounts payable 3,054 5,112
Accrued royalties 84,694 68,467
Accrued expenses and other current liabilities 37,012 38,895
Deferred revenue 88,617 140,072
Film facilities 42,264 —
Minority interest to be distributed 556 —
Total current liabilities $256,197 $252,546
Accrued royalties, non-current portion 10,273 12,860
Deferred revenue, non-current portion 58,166 35,667
Line of credit — 17,000
Film facilities, non-current portion 246,862 33,200
Income tax payable, non-current portion 54,066 10,999
Other liabilities 10,291 6,702
Total liabilities $635,855 $368,974
Commitments and contingencies — —
Stockholders—equity: — —
Preferred stock, $.01 par value, 100,000,000 shares
authorized, none issued
— —
Common stock, $.01 par value, 250,000,000 shares authorized,
133,179,310 issued and 77,624,842 outstanding in 2007 and
128,420,848 issued and 81,326,627 outstanding in 2006
1,333 1,284
Additional paid-in capital 728,815 710,460
Retained earnings 349,590 228,466
Accumulated other comprehensive loss (3,395) (2,433)
Total stockholders—equity before treasury stock $1,076,343 $937,777
Treasury stock, at cost, 55,554,468 shares in 2007 and 47,094,221
shares in 2006
(894,840) (682,886)
Total stockholders equity 181,503 254,891
Total liabilities and stockholders equity $817,358 $623,865
EXHIBIT 10
(Continued)
15-14 SECTION D Industry Three—Entertainment and Leisure
http://comicbooks.about.com/od/diamondreports2007/a/2007publishers.htm
http://comicbooks.about.com/od/diamondreports2007/a/2007publishers.htm
http://www.marvel.com/company/index.htm?sub=viewstory_current.php&id=1278
http://www.marvel.com/company/index.htm?sub=viewstory_current.php&id=1278
www.boxofficemojo.com
17. Marr, Merissa. “In new film venture, Marvel hopes to be its own
superhero.” Wall Street Journal, April 28, 2005, p. B1.
18. Hamner, Susanna. “Is Marvel ready for its close-up?” Business
2.0, May 2006, p. 112.
19. “Marvel appoints Ira Rubenstein Executive Vice President of its
newly launched Global Digital Media Group,” accessed April
29, 2008. http://www.marvel.com/company/index.htm?sub�
viewstory_current.php&id�1281
20. McBride, Sarah. “Web draws on comics: Online shorts boost
Batman.” Wall Street Journal, July 18, 2008, p. B.10.
21. Trachtenberg, Jeffrey A. “Author King enlists Marvel in video
plot.” Wall Street Journal, July 25, 2008, p. B.1.
22. Marvel Entertainment, Inc., 10-K (December 31, 2007), p. 8.
23. International Intellectual Property Alliance, “2008 ‘Special
301’ USTR decisions,” accessed September 6, 2008. http://
www.iipa.com/pdf/USTRdecisions2008Special301Tableof
EstimatedLossesandPiracyLevels2007Final061708
24. Motion Picture Association of American, “The cost of movie
piracy.” Dated 2005, accessed September 6, 2008. http://
www.mpaa.org/leksummaryMPA%20revised
25. Louie, Andrea W. M. “Designing avatars in virtual worlds: How
free are we to play Superman?” Journal of Internet Law, No-
vember 2007, pp. 3–12.
26. Marvel Entertainment, Inc., Form 8-K (January 18, 2008), p. 1.
27. Simmons, Leslie. “Actors will vote on strike.” Adweek, Novem-
ber 24, 2008, accessed November 24, 2008. http://www
.adweek.com/aw/content_display/news/media/
e3i550533f2636cdbd1ff5fc3bd8f91a1ad
28. Marvel Entertainment, Inc., 10-Q (September 30, 2008), p. 13.
CASE 15 Marvel Entertainment Inc. 15-15
http://www.marvel.com/company/index.htm?sub=viewstory_current.php&id=1281
http://www.iipa.com/pdf/USTRdecisions2008Special301Tableof
http://www.iipa.com/pdf/USTRdecisions2008Special301TableofEstimatedLossesandPiracyLevels2007Final061708
http://www.mpaa.org/leksummaryMPA%20revised
http://www.mpaa.org/leksummaryMPA%20revised
http://www.adweek.com/aw/content_display/news/media/e3i550533f2636cdbd1ff5fc3bd8f91a1ad
http://www.adweek.com/aw/content_display/news/media/e3i550533f2636cdbd1ff5fc3bd8f91a1ad
http://www.adweek.com/aw/content_display/news/media/e3i550533f2636cdbd1ff5fc3bd8f91a1ad
http://www.iipa.com/pdf/USTRdecisions2008Special301TableofEstimatedLossesandPiracyLevels2007Final061708
http://www.marvel.com/company/index.htm?sub=viewstory_current.php&id=1281
This page intentionally left blank
IT WAS EARLY MORNING IN NOVEMBER 2010 AS MICKEY ARISON, Chairman and CEO, drove up
the palm-lined entryway to the headquarters of Carnival Corporation. In front of the build-
ing, the large Carnival red, white, and blue logo (shaped like a ship’s funnel) reminded him
that his ships were not only still afloat, but doing well in this down economy.
As he reflected back on the year, he was delighted that the company had weathered the
global recession. Despite reduced leisure travel demand, the U.S. government’s advisory
against travel to Mexico as a result of the flu virus, terrorist fears, fuel price uncertainty, and
a host of other factors, Carnival managed to carry a record 8.5 million guests. Although 2009
sales were below the 2008 record, the company still posted a $1.8 billion net income. Quick re-
sponses by management offset the revenue declines through cost containment efforts, most no-
tably a 5% reduction in fuel consumption, and through expansion in its European market. This
expansion represented 39% of the company’s operations.
Third-quarter results (through August 31, 2010) showed improvement over the same
period in 2009, nearing the record levels of 2008. In the Western Hemisphere, the gulf oil spill
had not materially affected cruise operations and the hurricane season had not been as bad as
predicted. European expansion proceeded smoothly and expansion initiatives in Australia and
Asia produced positive results. Given a global economic recovery, the company should see a
return to the historical growth patterns it experienced in previous years.
The strategic outlook through 2012 and beyond was projected to be highly favorable.
Carnival Corporation’s management believed that only 20% of the U.S. population, 9%–10%
of the UK population, and 4%–5% of the continental European population had ever taken a
cruise. This left a large number of potential cruise guests. European growth potential was
consistent with the North American market 12 years ago. Anticipating this growth, Carnival
Corporation intended to continue average annual capacity growth in North America at a 3% rate
and European capacity growth at 9% through 2012.
16-1
C A S E 16
Carnival Corporation & plc (2010)
Michael J. Keeffe, John K. Ross III, Sherry K. Ross,
Bill J. Middlebrook, and Thomas L. Wheelen
This case was prepared by Michael J. Keefe, John K. Ross III, Sherry K. Ross, Bill J. Middlebrook, and Thomas L.
Wheelen. Copyright © 2010 by Kathryn E. Wheelen, Michael J. Keeffe, John K. Ross III, Sherry K. Ross, Bill J.
Middlebrook, and Thomas L. Wheelen. Reprinted by permission only for the 13th edition of Strategic Management
and Business Policy (including international and electronic versions of the book). Any other publication of this case
(translation, any form of electronic or media) or sale (any form of partnership) to another publisher will be in viola-
tion of copyright law unless Kathryn E. Wheelen, Michael J. Keeffe, John K. Ross III, Sherry K. Ross, Bill Middle-
brook, and Thomas L. Wheelen have granted additional written reprint permission.
16-2 SECTION D Industry Three—Entertainment and Leisure
Overview
In 1972, Ted Arison founded Carnival Cruise Lines with one ship, the Mardi Gras. Ted Arison’s
son, Mickey Arison, now served as Chairman and CEO. Exhibit 1 shows the brands, passenger
capacity, number of ships, and primary market from the 2010 Annual Report. By late 2010,
the number of operating ships had increased to 98 ships serving seven continents.
Ships added during 2010 included the Costa Deliziosa, Nieuw Amsterdam, Azura,
AIDAblu, Queen Elizabeth, and the Seabourn Sojourn. Carnival’s 98 ships had a capacity of
over 190,000 passenger berths. Given that fleet-wide occupancy rates usually hover at or
above 100% (ship berths are at double occupancy and additional berths can be made avail-
able), and with over 70,000 shipboard employees, more than 260,000 people were sailing
aboard the Carnival fleet at any given time (Exhibit 2). Additionally, Carnival Corporation
Cruise Brands
Passenger
Capacity (a)
Number of
Cruise Ships Primary Markets
North America
Carnival Cruise Lines 54,480 22 North America
Princess 37,608 17 North America
Holland America Line 23,492 15 North America
Seabourn 1,524 5 North America
North America Cruise Brands 117,104 59
Europe, Australia, & Asia
(“EAA”)
Costa 29,202 14 Italy, France, and Germany
P&O Cruises (UK) (b) 15,098 7 United Kingdom (“UK”)
AIDA 12,054 7 Germany
Cunard 6,676 3 UK and North America
P&O Cruises (Australia) 6,322 4 Australia
Ibero 5,008 4 Spain and South America
EAA Cruise Brands 74,360 39
191,464 98
(a) In accordance with cruise industry practice, passenger capacity is calculated based on two passengers per
cabin even though some cabins can accommodate three or more passengers.
(b) Includes the 1,200-passenger capacity Artemis, which was sold in October 2009 to an unrelated entity
and is being operated by P&O Cruises (UK) under a bareboat charter agreement until April 2011.
EXHIBIT 1
Cruise Brands,
Passenger Capacity,
Number of Cruise
Ships, and Primary
Markets
SOURCE: Carnival Corporation & plc 2010 Annual Report.
SOURCE: Carnival Corporation & plc 2010 Annual Report.
Fiscal Year Cruise Passengers Year-End Passenger Capacity Occupancy
2005 6,848,000 136,960 105.6%
2006 7,008,000 143,676 106.0%
2007 7,672,000 158,352 105.6%
2008 8,183,000 169,040 105.7%
2009 8,519,000 180,746 105.5%
2010 9,147,000 191,464 105.6%
EXHIBIT 2
Passengers, Capacity,
and Occupancy
CASE 16 Carnival Corporation & plc (2010) 16-3
expected delivery of nine ships by the end of 2014 (Carnival–2; Costa–2; AIDA–2;
Seabourn–1; Princess–2).
In a letter to stockholders, Arison stated that, “. . . While our targeted brands and strategic
growth initiatives remain important ingredients for success, and entrepreneurial spirit is what
our company thrives on. . . . Our culture empowers our brand managers to make daily deci-
sions to the best interest of building their respective operating companies. Each brand is
accountable for its individual performance.”
Carnival not only owned ships but also owned a chain of 16 hotels and lodges in Alaska
and the Canadian Yukon with 3,000 guest rooms to complement Alaska cruises. For
“Alaskan cruise tours,” Carnival operated two luxury day trips to the glaciers in Alaska
and the Yukon River and owned 30 domed rail cars operated by the Alaska Railroad as
sight-seeing trains.
The Evolution of Cruising
When aircraft replaced ocean liners as the primary means of transoceanic travel during the
1960s, the opportunity for developing the modern cruise industry was created. Ships that
were no longer required to ferry passengers from destination to destination became avail-
able to investors who envisioned new alternative vacations that complemented the increas-
ing affluence of Americans. Ted and Mickey Arison envisioned travelers experiencing
classical cruise elegance, along with the latest modern conveniences, at a price comparable
to land-based vacation packages sold by travel agents. Carnival’s all-inclusive package,
when compared to packages at resorts or theme parks such as Walt Disney World, often were
priced below those destinations, especially when the array of activities, entertainment, and
meals were considered. Once the purview of the rich and leisure class, cruising was now tar-
geted to the middle class, with service and amenities similar to the grand days of first-class
ocean travel.
According to Cruise Travel magazine, the increasing popularity of taking a cruise as a
vacation can be traced to two serendipitously timed events. First, television’s Love Boat se-
ries dispelled many myths associated with cruising and depicted people of all ages and back-
grounds enjoying the cruise experience. During the 1970s, this show was among the top 10
television programs and provided extensive publicity for cruise operators. Second, the in-
creasing affluence of Americans and the increased participation of women in the workforce
gave couples and families more disposable income for discretionary purposes, especially
vacations. As the myths were dispelled and disposable income grew, younger couples and
families realized the benefits of cruising as a vacation alternative, creating a large new target
market for the cruise product and accelerating growth in the number of Americans taking
cruises as a vacation.
Over the last 20 years the cruise industry and cruise vacation have matured with the de-
velopment of ships designed specifically for cruise vacations and varied itineraries world-
wide. Current cruise liners bear little resemblance to early industry cruise liners and are truly
a floating vacation resort. Modern cruise ships are much larger than previous ships, have lit-
tle motion due to computer-controlled stabilization systems, are environmentally friendly
with full recycling capabilities, and have a multitude of activities, entertainment, clubs, and
deck spaces for guests to explore. The common misconception of being perpetually seasick
or bored on a ship would be hard to fathom given the evolution and development of modern
cruise ships and the many and varied ports of call.
16-4 SECTION D Industry Three—Entertainment and Leisure
Carnival History
In 1972 Ted Arison, backed by the American Travel Services Inc. (AITS) purchased an ag-
ing ocean liner from Canadian Pacific Empress Lines for $6.5 million. The new AITS sub-
sidiary, Carnival Cruise Lines, refurbished the vessel from bow to stern and renamed it the
Mardi Gras to capture the party spirit. (Also included in the deal was another ship later re-
named the Carnivale.) The company’s beginning was less than promising when the Mardi
Gras ran aground in Miami Harbor with more than 300 invited travel agents aboard. The ship
was slow and guzzled expensive fuel, which limited the number of ports of call and length-
ened the minimum stay of passengers on the ship needed to reach break-even. Arison then
bought another older vessel from the Union Castle Lines to complement the Mardi Gras and
the Carnivale and named it the Festivale. To attract customers, Arison began adding onboard
diversions such as planned activities, a casino, discos, and other forms of entertainment de-
signed to enhance the shipboard experience.
Carnival lost money for the next three years, and in late 1974 Ted Arison bought out the
Carnival Cruise subsidiary from AITS Inc. for $1 cash and the assumption of $5 million in
debt. One month later, the Mardi Gras began showing a profit and, through the remainder of
1975, operated at more than 100% capacity. (Normal ship capacity was determined by the
number of fixed berths [referred to as lower berths available]. Ships, like hotels, operate
beyond this fixed capacity by using rollaway beds, pullmans, and upper bunks.)
Ted Arison, Chairman, along with his son Mickey Arison, President, and Bob Dickinson, Vice
President of Sales and Marketing, began to alter the current approach to cruise vacations.
Carnival targeted first-time cruisers and young people with a moderately priced vacation pack-
age that included airfare to the port of embarkation and airfare home after the cruise. Per-diem
rates were very competitive with other vacation packages. Carnival offered passage to multi-
ple exotic Caribbean ports, several meals served daily with premier restaurant service, and all
forms of entertainment and activities included in the base fare. The only items not included
in the fare were items of a personal nature, liquor purchases, gambling, and tips for the cabin
steward, table waiter, and busboy. Carnival continued to add to the shipboard experience with
a greater variety of activities, nightclubs, and other forms of entertainment. It also used mul-
timedia-advertising promotions and established the theme of “Fun Ship” cruises, primarily
promoting the ship as the destination and ports of call as secondary. Carnival told the public it
was throwing a shipboard party and everyone was invited. Today, the “Fun Ship” theme still
permeates all Carnival Cruise brand ships.
Throughout the 1980s, Carnival was able to maintain a growth rate of approximately 30%,
about three times that of the industry as a whole. Between 1982 and 1988, its ships sailed with
an average capacity of 104%. Targeting younger, first-time passengers by promoting the ship
as a destination proved to be extremely successful. Carnival’s customer profile showed that
approximately 30% of passengers at that time were between the ages of 25 and 39, with
household incomes of $25,000 to $50,000.
In 1987, Ted Arison sold 20% of his shares of Carnival Cruise Lines and immediately
generated over $400 million for further expansion. In 1988, Carnival acquired the Holland
America Line, which had four cruise ships with 4,500 berths. Holland America was positioned
to appeal to higher-income travelers with cruise prices averaging 25%–35% more than similar
Carnival cruises. The deal included two Holland America subsidiaries, Windstar Sail Cruises
and Holland America Westours. This purchase allowed Carnival to begin an aggressive
“superliner” building campaign for its core subsidiary. By 1989, the cruise segments of Carni-
val Corporation carried more than 75,000 passengers in one year, a “first” in the cruise industry.
Ted Arison relinquished the role of Chairman to his son Mickey in 1990, a time when the
explosive growth of the industry began to subside. Higher fuel prices and increased airline
costs began to affect the industry as a whole. The first Persian Gulf War caused many cruise
CASE 16 Carnival Corporation & plc (2010) 16-5
operators to divert ships to the Caribbean, increasing the number of ships competing directly
with Carnival. Carnival’s stock price fell from $25 in June of 1990 to $13 later in the year. The
company also incurred a $25.5 million loss during fiscal 1990 for the operation of the Crystal
Palace Resort and Casino in the Bahamas. In 1991, Carnival reached a settlement with the
Bahamian government (effective March 1, 1992) to surrender the 672-room Riviera Towers to
the Hotel Corporation of the Bahamas in exchange for debt cancellation incurred in construct-
ing and developing the resort. The corporation took a $135 million write-down on the Crystal
Palace that year.
In the early 1990s, Carnival attempted to acquire Premier Cruise Lines, which was then
the official cruise line for Walt Disney World in Orlando, Florida, for approximately $372
million. The deal was never consummated because the involved parties could not agree on
price. In 1992, Carnival acquired 50% of Seabourn, gaining the cruise operations of K/S
Seabourn Cruise Lines, and formed a partnership with Atle Brynestad. Seabourn served the
ultra-luxury market with destinations in South America, the Mediterranean, Southeast Asia,
and the Baltic.
The 1993 to 1995 period saw the addition of the superliner Imagination to Carnival Cruise
Lines and Ryndam for Holland America Lines. In 1994, the company discontinued the oper-
ations of Fiestamarina Lines, which had attempted to serve Spanish-speaking clientele. Fies-
tamarina had been beset with marketing and operational problems and had never reached
continuous operation. Many industry analysts and observers were surprised at the failure of
Carnival to successfully develop this market. In 1995 Carnival sold 49% interest in the
Epirotiki Line, a Greek cruise operation, for $25 million and purchased $101 million (face
amount) of senior secured notes of Kloster Cruise Limited, the parent of competitor Norwegian
Cruise Lines, for $81 million. Carnival Corporation continued to expand through internally
generated growth by adding new ships. Additionally, Carnival seemed to be willing to con-
tinue with its external expansion through acquisitions, if the right opportunity arose.
In June 1997, Royal Caribbean made a bid to buy Celebrity Cruise Lines for $500 million
and the assumption of its $800 million debt. Within a week, Carnival had responded by sub-
mitting a counteroffer to Celebrity for $510 million and the assumption of debt. Two days later,
Carnival raised the bid to $525 million. Nevertheless, Royal Caribbean announced on June 30,
1997, the final merger arrangements with Celebrity. The resulting company had 17 ships, with
more than 30,000 berths.
Not to be thwarted in its expansion, Carnival announced in June 1997 the purchase of
Costa, an Italian cruise company and the largest European cruise line, for $141 million. The
purchase was finalized in September 2000. External expansion continued when Carnival an-
nounced the acquisition of the Cunard Line for $500 million from Kvaerner ASA on May 28,
1998. Cunard was then operationally merged with Seabourn Cruise Line. Carnival announced
on December 2, 1999, a hostile bid for NCL Holding ASA, the parent company of Norwegian
Cruise Lines. Carnival was unsuccessful in this acquisition attempt.
The terrorist attacks on New York’s twin towers on September 11, 2001, caused tourists
to cancel cruise plans and affected the leisure travel industry worldwide. It forced several
smaller cruise line companies into bankruptcy while others reduced the size and scope of op-
erations. Other competitors discounted cruise prices to maintain historic occupancy levels.
Carnival was well positioned in the market and soon recovered once public fears subsided. It
also made a focused effort to expand into the German and Spanish markets in Europe.
Consolidation in the industry continued in 2003 when Carnival and P&O Princess Cruises
finalized an agreement to combine and created the first truly global cruise line. Carnival
remained the parent company and added P&O Cruises, Ocean Village, AIDA, P&O Cruises
Australia, and tour operator Princess Tours. The new Carnival now offered an ever expanding
selection of price points, alternative destinations, and varied accommodations which allowed
for even greater market penetration.
16-6 SECTION D Industry Three—Entertainment and Leisure
Carnival’s Corporate Governance
Board of Directors
Exhibit 3A shows the 14 members of Carnival’s Board of Directors, of whom three served
as internal officers and four others were retired company employees or had previous ties to
Carnival Corporation or one of its subsidiaries. Mickey Arison owned approximately one-third
of the company’s stock. (He also owned the Miami Heat, a basketball team which won the
2006 NBA Championship.) The Arison family and its trusts controlled roughly 36% of the
stock. All other directors and executive officers, as a group, owned or controlled approximately
30% of the total shares outstanding.
According to the Board’s by-laws, each outside director must own at least 5,000 shares of
stock. Additionally, external board members are yearly granted 10,000 stock options, and are
paid an annual retainer fee of $40,000 for serving on the Board. Fees are also paid for attending
board and committee meetings.
Exhibit 3B lists Carnival’s executive officers. Exhibit 4 shows compensation for the key
executives.
In 2007 Carnival sold Windstar Cruise Line to Ambassadors International Cruise Group
and Swan Hellenic to Lord Sterling.
Mickey Arison
Chairman of the Board
and Chief Executive Officer
Carnival Corporation & plc
Sir Jonathon Band
Former First Sea Lord and Chief of Naval
Staff British Navy
Robert H. Dickinson
Former President
and Chief Executive Officer
Carnival Cruise Lines
Arnold W. Donald
Former President
and Chief Executive Officer
Juvenile Diabetes Research Foundation
International
Pier Luigi Foschi
Chairman and Chief Executive Officer
Costa Crociere S.p.A.
Howard S. Frank
Vice Chairman of the Board
and Chief Operating Officer
Carnival Corporation & plc
Richard J. Glasier
Former President
and Chief Executive Officer
Argosy Gaming Company
Modesto A. Maidique
President Emeritus and Professor of
Management and Executive Director, FIU
Center for Leadership
Florida International University
Sir John Parker
Chairman, National Grid plc, Chairman,
Anglo American plc, and Vice Chairman,
DP World (Dubai)
Peter G. Ratcliffe
Former Chief Executive Officer
P&O Princess Cruises International
Stuart Subotnick
General Partner
and Executive Vice President
Metromedia Company
Laura Weil
Chief Executive Officer
Urban Brands, Inc.
Randall J. Weisenburger
Executive Vice President
and Chief Financial Officer
Omnicom Group Inc.
Uzi Zucker
Private Investor
EXHIBIT 3A
Board of Directors
CASE 16 Carnival Corporation & plc (2010) 16-7
Mickey Arison
Chairman of the Board
and Chief Executive Officer
Howard S. Frank
Vice Chairman of the Board
and Chief Operating Officer
David Bernstein
Senior Vice President
and Chief Financial Officer
Richard D. Ames
Senior Vice President—Shared Services
Arnaldo Perez
Senior Vice President, General Counsel
and Secretary
Larry Freedman
Chief Accounting Officer
and Vice President–Controller
OPERATIONS SEGMENTS
AIDA CRUISES
Michael Thamm
President
CARNIVAL CRUISE LINES
Gerald R. Cahill
President and Chief Executive Officer
CARNIVAL AUSTRALIA
Ann Sherry AO
Chief Executive Officer
Carnival Australia
CARNIVAL UK
David K. Dingle
Chief Executive Officer
COSTA CROCIERE S.p.A.
Pier Luigi Foschi
Chairman and Chief Executive Officer
Gianni Onorato
President
HOLLAND AMERICA LINE
Stein Kruse
President and Chief Executive Officer
PRINCESS CRUISES
Alan B. Buckelew
President and Chief Executive Officer
SEABOURN CRUISE LINE
Pamela C. Conover
President and Chief Executive Officer
EXHIBIT 3B
Principal Officers
Corporate Organization
Headquartered in Miami, Florida, U.S.A., and London, England, Carnival Corporation is in-
corporated in Panama, and Carnival plc is incorporated in England and Wales. Fleet opera-
tions are worldwide with the majority of operations in the North American market and
secondarily in Europe. The company’s total worldwide share of the cruise line vacation mar-
ket was at or above 50%, and distinctly higher in some geographically defined or segmented
markets.
According to Carnival’s investor relations site, Carnival Corporation & plc operated un-
der a dual listed company structure whereby Carnival Corporation and Carnival plc functioned
as a single economic entity through contractual agreements between separate legal entities.
Shareholders of both Carnival Corporation and Carnival plc had the same economic and vot-
ing interest, but their shares were listed on different stock exchanges and not fungible. Carni-
val Corporation common stock was traded on the New York Stock Exchange under the symbol
CCL. Carnival plc was traded on the London Stock Exchange under the symbol CCL and as
ADS on the New York Stock Exchange under the symbol CUK. Carnival was the only com-
pany in the world to be included in both the S&P 500 index in the United States and the FTSE
100 index in the United Kingdom.
Name and Principal
Position
Fiscal
Year Salary ($) Bonus ($)
Stock
Awards ($)
Option
Awards ($)
Non-Equity
Incentive Plan
Compensation
($)
Change in Pension
Value and Nonqualified
Deferred Compensation
Earnings ($)
All Other
Compensation
($) Total ($)
Micky Arison 2009 880,000 — 4,772,807 930,546 2,206,116 255,581 496,513 9,541,563
Chairman of the 2008 880,000 — 5,561,856 1,538,673 — 112,718 404,329 8,497,576
Board & CEO 2007 850,000 — 3,689,123 1,879,529 2,925,000 69,875 336,688 9,750,215
David Bernstein 2009 450,000 83,915 274,181 91,013 383,585 — 107,269 1,389,963
Senior Vice 2008 350,000 155,860 107,122 128,795 428,260 — 105,088 1,275,125
President & CFO 2007 269,596 — — 158,043 350,000 — 77,193 854,832
Gerald R. Cahill 2009 750,000 194,310 1,094,676 423,413 655,441 884,716 58,869 4,061,425
President and CEO 2008 750,000 — 708,717 569,727 1,162,288 675,536 48,775 3,915,043
of Carnival Cruise Lines 2007 625,000 — 168,248 654,499 1,000,000 343,435 42,841 2,834,023
Pier Luigi Foschi 2009 1,320,500 — 791,735 315,915 1,794,143 — 340,033 4,562,326
Chairman and CEO 2008 1,415,500 996,810 486,451 583,118 800,441 — 402,830 4,685,150
of Costa Crociere S.p.A. 2007 1,244,400 909,840 194,428 1,663,810 668,430 — 312,149 4,993,057
Howard S. Frank 2009 780,000 — 3,015,393 513,577 2,137,175 — 267,303 6,713,448
Vice Chairman of the 2008 780,000 — 2,893,800 827,976 2,709,400 3,899,136 355,255 11,465,567
Board & COO 2007 750,000 — 2,610,000 1,113,260 2,825,000 — 243,383 7,541,643
EXHIBIT 4
Annual Compensation: Carnival Corporation & plc
16-8
CASE 16 Carnival Corporation & plc (2010) 16-9
Mission
According to management, “Our mission is to deliver exceptional vacation experiences
through the world’s best-known cruise brands that cater to a variety of different lifestyle and
budgets, all at an outstanding value unrivaled on land or at sea.”
The 11 cruise lines competed in all of the three operational sectors of the cruise market
(contemporary, premium, and luxury).
Operating Segments and Corporate Brands
Carnival Cruise Lines (www.carnival.com)
Carnival Cruise Lines was the most popular and most profitable cruise line in the world. Op-
erating in the contemporary cruise sector, as of late 2010, Carnival operated 22 ships with a
total passenger capacity of 54,480. Occupancy rates typically exceeded 100% on average,
and the brand was the market leader in the contemporary segment of the industry. Carnival
still utilized the theme of the “Fun Ships,” and had embarked on a $250 million enhancement
program of its eight fantasy-class ships. Carnival ships cruised to destinations in the Bahamas,
Canada, the Caribbean, the Mexican Riviera, New England, the Panama Canal, Alaska,
and Hawaii, as well as limited operations in Europe, with most cruises ranging from three to
seven days.
Princess Cruises (www.princesscruises.com)
Princess Cruises offered a “complete escape” from daily routine. This segment operated
17 ships with a total passenger capacity of 37,588. Princess treated its passengers to world-class
cuisine, exceptional service, and a myriad of resort-like amenities onboard, including the Lotus
Spa, Movies Under the Stars, lavish casinos, nightclubs, and lounges. Princess was a pioneer
in offering a choice of dining experiences so guests could dine when and where it was conven-
ient. The Princess fleet cruised to all seven continents and boasted more than 280 destinations.
Princess was classified in the industry as contemporary to premium. The company offered
cruises ranging in length principally from 7 to 14 days.
Holland America Line (www.hollandamerica.com)
The Holland America Line was a leader in the premium cruise sector. Holland America oper-
ated a five-star fleet of 15 ships, with 23,484 passenger capacity. Holland America consistently
set a standard in the premium segment with feature programs and amenities such as culinary
arts demonstrations, greenhouse spas, and cabins with flat-panel TVs and Sealy plush-top
Mariner’s Dream beds. The company offered cruises from 7 to 21 days. Its ships sailed to more
than 300 ports of call on all seven continents with more than 500 cruises per year.
Seabourn Cruises (www.seabourn.com)
Seabourn Cruise Line epitomized luxury cruising aboard each of its five intimate all-suite
ships. The Yachts of Seabourn were lavishly appointed with virtually one staff member for
every guest, to ensure the highest quality service. Typical cruises were from 7 to 14 days.
Costa Cruises (www.costacruises.com)
Costa Cruises was the leading cruise company in Europe and South America. Headquartered
in Genoa, Italy, Costa offered guests on its 14 ships a multiethnic, multicultural, and multi-
lingual ambiance. A Costa cruise was distinguished by its “Cruising Italian Style” shipboard
ambiance. Costa’s fleet cruised the Caribbean, the Mediterranean, Northern Europe, South
America, Dubai, the Far East, and transoceanic crossings.
www.carnival.com
www.princesscruises.com
www.hollandamerica.com
www.seabourn.com
www.costacruises.com
16-10 SECTION D Industry Three—Entertainment and Leisure
P&O Cruises (www.pocruises.com)
P&O Cruises was the largest cruise operator and the best-known contemporary cruise brand
in the United Kingdom, and has cruised Australia for 78 years. The seven-ship main fleet and
the three-ship Australian fleet offered cruises to the Mediterranean, the Baltic, the Norwegian
Fjords, the Caribbean, and the Atlantic Islands, as well as Australia and the Far East. Total
passenger capacity was approaching 20,000 for both operational fleets, and its principal
market was the United Kingdom.
AIDA (www.aida.com)
AIDA was the best-known cruise brand in the fast-growing German cruise market. With its
seven club ships and a capacity of over 12,000, AIDA offered cruises to the Mediterranean,
the Baltic, the Norwegian Fjords, the Canary Islands, and the Caribbean. AIDA emphasized
elements of the upmarket clubs and resorts in the premium and four-star range, and its
facilities and activities attracted younger, more active vacationers.
Cunard Line (www.cunard.com)
The Cunard Line offered the only regular transatlantic crossing service aboard the world-
famous ocean liner Queen Mary 2 and the brand new Queen Elizabeth. Her equally famous
retired sister, Queen Elizabeth 2, sailed on unique itineraries worldwide serving both U.S.
and U.K. guests and still evoked memories of the grand days of ocean travel. The passenger
capacity of the three Cunard ships was 6,700 (double occupancy), and Cunard’s primary
market was the United Kingdom and North America. The line proudly carried the legacy of
the era of sophisticated floating palaces into the 21st century. These ships were classified in
the luxury sector of the cruise market.
Ocean Village (http://www.oceanvillageholidays.co.uk)
Ocean Village was founded in 2004 in the United Kingdom. Its one ship sailed throughout
the Mediterranean and the Caribbean, and targeted individuals in the 30 to 50 age range who
liked to explore and wanted a change from traditional cruising. Although performance had
been good, there have been indications that the ship may be transferred to the P&O brand at
some future date.
IberoCruceros (www.iberocruceros.com/)
IberoCruceros was one of the top operators in the fast-growing Spanish and Portuguese
language cruise markets. The company operated four ships with a berth capacity of 5,010.
Ibero vessels operated in Mediterranean, Brazilian, Northern Europe, and Caribbean waters.
Industry Projections
The leisure cruise vacation industry has fared very well over the last 25 years, originating from
transatlantic crossings and leisure cruises for the wealthy to being a staple vacation alternative for
the middle class. Cruise Market Watch, a cruise vacation research company, estimated that all
cruise lines will carry an annualized total passenger count worldwide of 18.4 million in 2010 and
projected an increase to 21.3 million in 2013, a 15.7% increase from 2010. Giving perspective to
the 2010 numbers, cruise travel accounted for less than half (50%) of all visitors to Las Vegas,
when including all cruise ships, from all lines, filled to capacity all year long. Cruise companies
can move ships to match demand patterns over the globe, while Las Vegas was a fixed destination.
www.pocruises.com
www.aida.com
www.cunard.com
http://www.oceanvillageholidays.co.uk
www.iberocruceros.com/
CASE 16 Carnival Corporation & plc (2010) 16-11
According to Cruise Lines International Association’s 2010 Cruise Market Overview,
growth in the number of North American passengers (95% U.S. and 5% Canadian) was cur-
rently flat. Mickey Arison estimated the number of people in the United States that have taken
a cruise at 20%. He based his estimate on the total U.S. population. Arison’s estimate did not
reflect the core market, the number of people who fit the cruiser potential profile: over 25, suffi-
cient income, leisure time, and other factors. Cruise Market Watch estimated the core market at
130 million, and approximately 60 million individuals in the core market had taken a cruise.
The North American market was a more mature market than other geographic markets inter-
nationally. Still, as of 2009, the North American market was the largest and was valued at
$15.95 billion with Carnival holding a commanding 55% market share.
Despite the 2008–2009 current economic slump, industry growth worldwide had been be-
tween 5% and 8% per year due to the growth in the number of international passengers. This
annual growth was expected to exceed that of the U.S. and Canadian market for the next sev-
eral years. Europe’s market was valued at $7.2 billion and the Asia/Australian markets com-
bined was valued at $2.9 billion. Faster market growth combined with a weakening U.S. dollar
would strengthen overseas earnings and create a greater focus to capture the fast growing
markets. In these two market areas, as of 2009, Carnival held a 52% market share.
Industry capacity continued to increase (up 6.9% over 2009 capacity) and should continue
through 2013. Industry occupancy (per ship) hovered between 102% and 104% in 2008–2009,
depending on the market. Ticket prices and onboard spending should improve slightly in 2010
when compared to 2009, but still remain below 2008 levels. Cruise Market Watch estimated
that average cruise revenue, per passenger, per diem for all cruise lines worldwide was pro-
jected to be approximately $208, of which $157 would be attributed to ticket price and $51 in
onboard spending.
Advertising
According to the Nielsen Company, hospitality and total travel advertising expenditures
showed a slight increase for the industry in 2009 over 2008 levels. Total industry advertising
in 2008 of $3.89 billion was roughly a 4% increase over 2007. While hospitality firms such
as Intercontinental Hotels, the Blackstone Group, and Southwest Airlines all increased ad-
vertising expenditures, Carnival Corporation decreased U.S. advertising expenditures as of
January 2009 to $89.3 million, a 21% decrease from the previous calendar year. The brand
with the greatest reduction in ad spending in the Carnival portfolio was Princess Cruises.
Hoover’s reported that, beginning in 2009, Carnival increased online and social media adver-
tising utilizing Facebook, YouTube, Twitter, Flickr, and Podcasts, to allow for two-way con-
versations with consumers and also create brand fans.
Human Resources Management
Carnival Corporation’s shore operations had approximately 10,000 full-time and 5,000 part-
time/seasonal employees. Carnival also employed approximately 70,000 officers, crew, and
staff onboard the 98 ships at any one time. Because of the highly seasonal nature of the
Alaskan and Canadian operations, Holland America Tours and Princess Tours increased their
workforce during the late spring and summer months in connection with the Alaskan cruise
season, employing additional seasonal personnel. Carnival had entered into agreements with
unions covering certain employee categories, and union relations were considered to be gen-
erally good. Nonetheless, the American Maritime union had cited Carnival (and other cruise
operators) several times for exploitation of its crews.
16-12 SECTION D Industry Three—Entertainment and Leisure
Suppliers
The company’s largest purchases were for travel agency services, fuel, advertising, food and
beverages, hotel and restaurant supplies and products, airfare, repairs and maintenance, dry-
docking, port facility utilization, and communication services. Most capital outlays were for
the construction of new ships as well as upgrades and refurbishment of current ships. Although
Carnival utilized a select number of suppliers for most of its food and beverages and hotel and
restaurant supplies, most of these items were available from numerous sources at competitive
prices. The use of a select number of suppliers enabled management to, among other things,
obtain volume discounts. The company purchased fuel and port facility services at some of its
ports of call from a limited number of suppliers. To better manage price fluctuations, the com-
pany hedged the price of fuel oil. In addition, the company performed major dry-dock and ship
improvement work at dry-dock facilities in the Bahamas, British Columbia, Canada, the
Caribbean, Europe, and the United States. Management believed there were sufficient dry-dock
and shipbuilding facilities to meet the company’s anticipated requirements.
Government Regulations
All of Carnival’s ships were registered in a country outside the United States and each ship flew
the flag of its country of registration. Carnival’s ships were regulated by various international,
national, state, and local port authorities’ laws, regulations, and treaties in force in the jurisdic-
tions in which the ships operated. Internationally, all ships and operations conformed to the
SOLAS (Safety of Life at Sea) regulations adopted by most seafaring nations. In U.S. waters and
ports, the ships had to comply with U.S. Coast Guard and U.S. Public Health regulations, the
Maritime Transportation Security Act, International Ship and Port Facility Security Code, U.S.
Oil Pollution Act of 1990, U.S. Maritime Commission, local port authorities, local and federal
law enforcement agencies, and all laws pertaining to the hiring of foreign workers. All cruise
ships were inspected for health issues and received a rating which was published on the Center
for Disease Control (CDC) website for potential cruisers to review. Terrorist threats had tight-
ened U.S. security of ports regarding docking facilities, cargo containers and storage areas, and
crews requiring compliance with various Homeland Security agencies.
Sustainability
Carnival Corporation had adopted the requirements of International Standard ISO 14001:2004
for the environmental management systems of all subsidiary lines. It had internal policies con-
cerning the reduction of the carbon and environmental footprint, energy reduction, shipboard
waste management, environmental training of crew members, health, safety and security, and
corporate social responsibility. The following excerpt from the Carnival Corporation investor
relations website illustrates the commitment of Carnival Management.
“. . . Carnival senior management maintains a continuing commitment to be responsible corporate
citizens, especially when it comes to protecting the environment. We have made great strides in this
Onboard service was labor intensive, employing help from almost 100 nations, many from
third-world countries, with reasonable returns to employees. For example, waiters on a Carni-
val Cruise Lines ship could earn approximately $18,000 to $27,000 per year (base salary and
tips), significantly greater than could be earned in their home countries for similar employ-
ment. Waiters typically worked 10 hours per day, 6–7 days per week, and had tenure of ap-
proximately eight years with the company. Even with these work parameters, applicants
exceeded demand for all cruise positions.
CASE 16 Carnival Corporation & plc (2010) 16-13
area and will continue to dedicate our efforts toward even more progress. In 2009, we published our
fourth annual Environmental Management Report. This action continues the expansion of our trans-
parency in publicly reporting the details of our ongoing commitment to the environment. We have
also begun to broaden the scope of our transparency to include sustainability reporting. Sustainabil-
ity reports have been published by two of our brands, Costa and AIDA. We are planning to use these
reports as models for similar sustainability reports by all of our brands, beginning in 2010.”
Legal Issues
Carnival Corporation, like all cruise companies and hospitality providers, usually had several
lawsuits pending at any point in time. Although consuming the time of corporate officers and
sometimes requiring substantial financial remuneration, the principal danger of lawsuits
results from the negative media publicity that may influence current and potential guests.
Some of the more publicized personal lawsuits came from passengers injured while on-
board a Carnival vessel, sexual assaults by crewmembers or other passengers, negligence of
the onboard medical staff, food contamination lawsuits, pay and working conditions lawsuits
brought by crewmembers, and a host of other related court filings.
Legal issues for the company also tarnished its corporate image and reputation. Carnival
had been sued by various entities for pollution, ship dumping of bilge and other waste contam-
inants in international and jurisdictional waters, and filing false statements with the U.S. Coast
Guard. Fuel surcharges for passengers that were not part of the stated cruise fare and various
other class-actions have also led to legal proceedings. The company had also been sued over
copyright infringement in its production of entertainment shows and materials onboard ship.
Carnival attempted to aggressively protect its corporate reputation and brand image by
attempting to minimize damage while ensuring that violations and actions were promptly cor-
rected. Management wanted the company to be perceived as a responsible corporate citizen for
guests, workers, and the world community.
Competitors
According to Cruise Lines International Association, there were several large cruise line
companies worldwide and a host of smaller companies totaling more than 100 ships compet-
ing with the Carnival fleet. Carnival’s primary competitors were Royal Caribbean, Disney,
and Norwegian Cruise Line, although several other companies competed with Carnival
brands in selected geographical markets and specific targeted cruise segments.
Royal Caribbean Cruises Ltd. operated five brands—Royal Caribbean International,
Celebrity Cruises, Pullmantur, Azamara Cruises, and CDF Croisieres de France—and had a
50% joint venture with TUI cruises. Royal Caribbean operated 38 cruise ships with a passen-
ger capacity of over 84,000. The company planned to add four new ships by 2012, bringing
the capacity to 100,000 berths. The fleet visited approximately 400 destinations worldwide.
The Royal Caribbean brand competed with the Carnival Cruise Lines brand and was perceived
as being slightly more upscale than Carnival ships. It competed secondarily with Costa and
other Carnival brands. Celebrity cruises competed in the premium segment against Carnival’s
Princess and Holland America brands. The Royal Caribbean company had a 27% market share
in North America and a 22% share in the remaining world markets.
Disney Cruise Line, had two cruise ships, each having 877 staterooms (3,508 berths).
Disney had its own private island, Castaway Bay, exclusive for Disney Cruise Line passengers,
and catered primarily to family vacations. One analyst said, “Carnival should thank Disney
for taking children off their ships.” Specific areas of the ships were designated for activities
preferred by adults, families, teens, and children. Disney Cruise Line used its ships primarily
as a complement to its theme park vacations, and had a 2% market share in North America.
16-14 SECTION D Industry Three—Entertainment and Leisure
Other Competitive Concerns
Carnival’s management described the firm’s competitors in the following manner:
First. Carnival competed with land-based vacation alternatives throughout the world includ-
ing resorts, hotels, theme parks, and vacation ownership properties located in Las Vegas,
Nevada, Orlando, Florida, various parts of the Caribbean and Mexico, Bahamian and
Hawaiian Island destination resorts, and numerous other vacation destinations throughout
Europe and the rest of the world.
Second. Carnival’s primary cruise competitors in the contemporary and/or premium cruise
segments for North American passengers were Royal Caribbean Cruise Ltd., Norwegian
Cruise Line, and Disney Cruise Line. The three primary cruise competitors for European
passengers were: (1) My Travel’s Sun Cruises, Fred Olsen, Saga and Thomson in the
United Kingdom; (2), Festival Cruises, Hapag-Lloyd, Peter Deilmann, Phoenix Reisen,
and Tranocean Cruises in Germany; and (3) Mediterranean Shipping Cruises, Louis
Cruise Line, Festival Cruises, and Spanish Cruise Line in Southern Europe. Carnival also
competed for passengers throughout Europe with Norwegian Cruise Line, Orient Lines,
Royal Caribbean International, and Celebrity Cruises.
Third. The company’s primary competitors in the luxury cruise segment for the Cunard
and Seabourn brands included Crystal Cruises, Radisson Seven Seas Cruise Line, and
Silversea Cruises.
Fourth. Carnival brands also competed with similar or overlapping product offerings across
all segments.
Financials
Stock
Like most corporations in the last five years, Carnival (CCL) stock had been a rollercoaster
ride ranging from approximately $55 per share common to $17 and back to $42 as of the third
quarter, 2010. With a beta of 1.51 the stock has moved parallel to both the DOW and S&P 500
but had underperformed both indexes. However, with a market cap of $33.51 billion and a
forward P/E of 14.59, market analysts were generally recommending Carnival as a “hold” in
October, 2010.
In 2006 the Board of Directors authorized the repurchase of $1 billion (maximum) of
Carnival Corporation common stock and Carnival plc. A repurchase authorization of approx-
imately $787 million was still in effect.
Because Carnival Corporation & plc operated under a dual listed company structure, an
unusual “Stock Swap” arrangement had been created. Each year the Boards of Directors au-
thorized the repurchase of a set dollar amount of Carnival plc ordinary shares and a set dollar
amount of Carnival Corporation common stock shares under the “Stock Swap” program. The
boards then used the “Stock Swap” program in situations where an economic benefit can be
obtained because either Carnival Corporation common stock or Carnival plc ordinary shares
were trading at a price that was at a premium or discount to the price of Carnival plc ordinary
Norwegian Cruise Line had 11 ships with a berth capacity of over 23,000, and marketed
“Freestyle Cruising,” which allowed guests freedom of choice with regard to a multiplicity of
dining venues and times. The atmosphere in the ships was “resort casual”; the fleet competed with
Royal Caribbean and Carnival ships, and, to a lesser extent, brands targeted to the premium segment.
The company was Hawaii’s cruise leader. NCL had a market share of 10% of the North American
Market and its affiliated companies had a small market share primarily in European markets.
CASE 16 Carnival Corporation & plc (2010) 16-15
shares or Carnival Corporation common stock, as the case may be. In effect, the company
would sell overpriced stock in one company to buy undervalued stock in the other company.
Income and Balance Sheet
Cash dropped from $1.1 billion to $0.5 billion over the last five years and remained steady
with a slight rise quarter over quarter during the third quarter of 2010. (See Exhibits 5 to 7.)
Reflecting the increase in the number of ships ordered and going online, property and equip-
ment steadily increased over the last five years from $21 billion to over $30 billion (3Q 2010).
For this same reason, by 2009 long-term debt also increased from $5.7 billion to over $9 billion,
but dropped to $7.6 billion by 3Q 2010.
Revenues had also seen a steady increase until the recession, but 3Q 2010 results indi-
cated the company was on the road to recovery and could reach the net profits of 2008.
Year Ending November 30 2009 2008 2007
Revenues
Cruise
Passenger tickets $ 9,985 $ 11,210 $ 9,792
Onboard and other 2,885 3,044 2,846
Other 287 392 395
13,157 14,646 13,033
Costs and expenses
Operating
Cruise
Commissions, transportation, and other 1,917 2,232 1,941
Onboard and other 461 501 495
Payroll and related 1,498 1,470 1,336
Fuel 1,156 1,774 1,096
Food 839 856 747
Other ship operating 1,997 1,913 1,717
Other 236 293 296
Total 8,104 9,039 7,628
Selling and administrative 1,590 1,629 1,579
Depreciation and amortization 1,309 1,249 1,101
11,003 11,917 10,308
Operating income 2,154 2,729 2,725
Nonoperating (expense) income
Interest income 14 35 67
Interest expense, net of capitalized interest (380) (414) (367)
Other income (expense), net 18 27 (1)
(348) (352) (301)
Income before income taxes 1,806 2,377 2,424
Income tax expense, net (16) (47) (16)
Net income $ 1,790 $ 2,330 $ 2,408
Earnings per share
Basic $ 2.27 $ 2.96 $ 3.04
Diluted $ 2.24 $ 2.90 $ 2.95
Dividends declared per share $ 1.60 $ 1.375
EXHIBIT 5
Consolidated
Statements of
Operations: Carnival
Corporation & plc
(Dollar amounts in
millions, except per
share data)
16-16 SECTION D Industry Three—Entertainment and Leisure
Year Ending November 30
Assets
Current assets
Cash and cash equivalents $ 538 $ 650
Trade and other receivables, net 362 418
Inventories 320 315
Prepaid expenses and other 298 267
Total current assets 1,518 1,650
Property and equipment, net 29,870 26,457
Goodwill 3,451 3,266
Trademarks 1,346 1,294
Other assets 650 733
Total assets $36,835 $33,400
Liabilities and shareholders’ equity
Current liabilities
Short-term borrowings $135 $256
Current portion of long-term debt 815 1,081
Convertible debt subject to current put option 271
Accounts payable 568 512
Accrued liabilities and other 874 1,142
Customer deposits 2,575 2,519
Total current liabilities 4,967 5,781
Long-term debt 9,097 7,735
Other long-term liabilities and deferred income 736 786
Commitments and contingencies
Shareholders’ equity
Common stock of Carnival Corporation; $0.01 par
value; 1,960 shares authorized; 644 shares at 2009
and 643 shares at 2008 issued 6 6
Ordinary shares of Carnival plc; $1.66 par value;
226 shares authorized; 213 shares at 2009 and 2008 issued 354 354
Additional paid-in capital 7,707 7,677
Retained earnings 15,770 13,980
Accumulated other comprehensive income (loss) 462 (623)
Treasury stock; 24 shares at 2009 and 19 shares at
2008 of Carnival Corporation and 46 shares at 2009
and 52 shares at 2008 of Carnival plc, at cost (2,264) (2,296)
Total shareholders’ equity 22,035 19,098
Total liabilities and shareholders’ equity $36,835 $33,400
EXHIBIT 6
Consolidated
Balance Sheets:
Carnival Corporation
& plc (Dollar
amounts in millions,
except par values)
Although both revenues and profits had begun to recover, trends in ROA, ROI, gross profit
margin, and net margin had steadily decreased over the last five years. Additionally, cost of
goods sold as a percentage of revenues had shown a slow, but steady increase over the last five
years. This increase had been partially offset by careful management of selling, general, and
administrative expenses.
Geographic, Segment, and Cost
Exhibit 8 shows the revenues by geographic region. Although revenues across the board
dropped in 2009, the percent of revenues from North America declined (�7.7%) with a
corresponding increase in Europe (up 5.5%) and Others (up 2.3%).
CASE 16 Carnival Corporation & plc (2010) 16-17
Carnival offered both cruises and tours. Exhibit 9 shows the breakdown of revenues and cost
for each segment. Cruises brought in the greatest revenue and had the least cost structure. Tours,
although profitable, were offered primarily to enhance the cruise experience and differentiate
one destination from another.
Selected Ratios 11/30/09 11/30/08 11/30/07 11/30/06 11/30/05
Return on assets 5.80 7.69 8.18 8.43 8.82
Return on invested capital 6.73 9.08 9.65 9.87 10.29
Cost of goods sold to sales 61.59 61.72 58.53 57.36 56.07
Net margin 13.60 15.91 18.48 19.25 20.36
From Common-Sized Income Statement
Cost of goods sold 61.59% 61.72% 58.53% 57.36% 56.07%
Selling, general, &
admin expenses
12.08% 10.94% 12.12% 12.22% 11.99%
EXHIBIT 7
Selected Ratios and
Common-Sized Data:
Carnival Corporation
& plc
SOURCE: Tompson One Banker, October 28, 2010.
Years Ended November 30
2009 2008 2007
North America $ 6,855 $ 8,090 $ 7,803
Europe 5,119 5,443 4,355
Others 1,183 1,113 875
$ 13,157 $ 14,646 $ 13,033
EXHIBIT 8
Revenues by
Geographic Area
(Dollar amount in
millions)
SOURCE: Carnival Corporation & plc 2010 Annual Report, p. F 24.
Nine Months Ended August 31
Revenues Operating
Expenses
Selling and
Administrative
Depreciation and
Amortization
Operating
Income
2010
Cruise $ 10,475 $ 6,306 $ 1,158 $ 1,019 $ 1,992
Tour and other 346 279 23 30 14
Intersegment elimination (105) (105) — — —
$ 10,716 $ 6,480 $ 1,181 $ 1,049 $ 2,006
2009
Cruise $ 9,698 $ 5,765 $ 1,142 $ 937 $ 1,854
Tour and other 373 316 24 27 6
Intersegment elimination (120) (120) — — —
Total revenue $ 9,951 $ 5,961 $ 1,166 $ 964 $ 1,860
EXHIBIT 9
Revenue by Segment: Carnival Corporation & plc (Dollar amount in millions)
SOURCE: Carnival 2010 10-Q, p. 7.
16-18 SECTION D Industry Three—Entertainment and Leisure
Exhibits 10 and 11 provide a further breakdown of costs associated with cruising and the
dramatic impact fuel costs have on the net profitability.
Year Ending Three Months
Ended August 31
Year Ending Nine Months
Ended August 31
2010 2009 2010 2009
Passengers carried (in thousands) 2,617 2,485 6,888 6,383
Occupancy percentage (a) 111.1% 111.4% 106.2% 106.4%
Fuel consumption (metric tons
in thousands)
838 807 2,473 2,359
Fuel cost per metric ton (b) $ 473 $ 405 $ 489 $ 330
Currencies
U.S. dollar to €1 $ 1.27 $ 1.41 $ 1.32 $ 1.37
U.S. dollar to £1 $ 1.52 $ 1.64 $ 1.54 $ 1.53
Notes:
(a) In accordance with cruise industry practice, occupancy is calculated using a denominator of two
passengers per cabin even though some cabins can accommodate three or more passengers. Percentages
in excess of 100% indicate that on average more than two passengers occupied some cabins.
(b) Fuel cost per metric ton is calculated by dividing the cost of fuel by the number of metric tons
consumed.
EXHIBIT 10
Selected Cruise and
Other Information:
Carnival
Corporation
& plc
SOURCE: Carnival 2010 10-Q, p. 16.
(Dollar amounts in millions except ALBDS*
and cost per ALBD) Three Months Ended August 31
2010
2010 Constant
Dollar 2009
(in millions, except ALBDs and costs per ALBD)
Cruise operating expenses $ 2,160 $ 2,224 $ 2,081
Cruise selling and administrative expenses 373 384 372
Gross cruise costs 2,533 2,608 2,453
Less cruise costs included in net
cruise revenues
Commissions, transportation, and other (517) (542) (515)
Onboard and other (131) (134) (131)
Net cruise costs 1,885 1,932 1,807
Less fuel (396) (396) (327)
Net cruise costs excluding fuel $ 1,489 $ 1,536 $ 1,480
ALBDs 17,255,120 17,255,120 16,241,798
Gross cruise costs per ALBD $ 146.84 $ 151.15 $ 151.07
Net cruise costs per ALBD $ 109.24 $ 111.96 $ 111.29
Net cruise costs excluding fuel per ALBD $ 86.28 $ 89.00 $ 91.16
Notes:
*ALBD stands for Available Lower Berth Day
EXHIBIT 11
Selected Overall and
ALBD* Expenses
SOURCE: Carnival 2010 10-Q, p. 18.
CASE 16 Carnival Corporation & plc (2010) 16-19
Carnival in the Future
Carnival currently held approximately 50% of the cruising market. The company’s strategy
of “do one thing and do it better than anyone else” had been very successful. This concentra-
tion strategy had been so successful, in fact, that continued expansion in the cruise market was
likely to become increasingly competitive and additional market share difficult to capture.
However, improving economic conditions may release pent-up demand for vacations with
corresponding increase in the entire cruising market. An improving economy may be offset by
increased terrorist activity in Europe and North America, a double dip recession, or rising fuel
prices.
Carnival seemed to be positioned to take advantage of changes in the cruising industry by
focusing more on Europe and differentiating with destinations, shipboard activities, and ship
size. As Mickey Arison pondered the future of Carnival, his vision must extend many years
into the future (ships must be ordered five or more years in advance) and attempt to forecast
the world of 2016 and beyond to be successful.
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17-1
C A S E 17
Chrysler in Trouble
Barnali Chakraborty, under the direction of Vivek Gupta
“For too long, Chrysler moved too slowly to adapt to the future, designing and building cars
that were less popular, less reliable and less fuel efficient than foreign competitors.”1
BARACK HUSSAIN OBAMA
PRESIDENT OF THE UNITED STATES, IN APRIL 2009
“More than anything the consumers are very hesitant to do business with a manufacturer in bankruptcy.”2
PETER GRADY
EXECUTIVE AT CHRYSLER, IN MAY 2009
“This partnership (with Fiat SpA) transforms Chrysler into a vibrant new company with a wealth of strategic advantages.
It enables us to better serve our customers and dealers with a broader and more competitive line-up
of environmentally friendly, fuel-efficient high-quality vehicles.”3
BOB NARDELLI
CHAIRMAN AND CEO OF CHRYSLER LLC, IN MAY 2009
Chrysler Files for Bankruptcy
ON APRIL 30, 2009, CHRYSLER MOTORS LLC (CHRYSLER), the third largest automobile
manufacturer in the United States, filed for bankruptcy protection under Section 3634 of
Chapter 115 of the U.S. bankruptcy code in the Manhattan Bankruptcy Court along with its
24 wholly-owned U.S. subsidiaries. As part of its bankruptcy filing, Chrysler announced that
it would establish a global strategic alliance with Fiat SpA (Fiat).6 It would create a new com-
pany in which Fiat would initially have a 20% stake, which would later be increased up to
35%. The Voluntary Employees’ Benefit Association (VEBA)7 would have a 55% stake in it
and the U.S. Treasury Department (U.S. Treasury) an 8% stake. The Canadian and Ontario
governments would have a combined 2% stake, with the Canadian government holding 1.33%
and the Ontario government holding the remaining 0.67% stake.
This case was written by Barnali Chackraborty, under the direction of Vivek Gupta, ICMR Management Research.
It was compiled from published sources, and is intended to be used as a basis for class discussion rather than to
illustrate either effective or ineffective handling of a management situation. © 2009, ICMR Center for Management
Research. This case cannot be reproduced in any form without the written permission of the copyright holders, Vivek
Gupta and ICMR Management Research. Reprint permission is solely granted by the publisher, Prentice Hall, for the
book Strategic Management and Business Policy, 13th Edition (and the international and electronic versions of this
book) by the copyright holders, Vivek Gupta and ICMR Management Research. This case was edited for SMBP, 13th
Edition. The copyright holders are solely responsible for case content. Any other publication of the case (translation,
any form of electronic or other media) or sale (any form of partnership) to another publisher will be in violation of
copyright law, unless Vivek Gupta and ICMR Management Research have granted additional written reprint permission.
Reprinted by permission.
Industry Four—Transportation
17-2 SECTION D Industry Four—Transportation
Chrysler was struggling to stay afloat even after receiving financial aid in the form of a fed-
eral loan of US$4 billion in January 2009, out of the requested amount of US$7 billion. However,
with declining sales, it had become increasingly difficult for Chrysler to continue with its opera-
tions. Therefore, in its Restructuring Plan for Long-Term Viability, submitted on February 17,
2009, the company asked for another US$2 billion federal loan over and above the US$7 billion
loan it had requested earlier. For Chrysler to get an additional federal loan, the U.S. government
had made it a condition that the company should establish an alliance with Fiat on or before
April 30, 2009. The company was also required to restructure its debt and negotiate with UAW
(United Auto Workers)8 and CAW (Canadian Auto Workers)9 to reduce costs. Although Chrysler
was able to reach an agreement with Fiat and had convinced UAW and CAW to reduce costs, it
failed to get all its creditors to agree to debt restructuring. The company finally had to file for
bankruptcy protection. Commenting on the company’s bankruptcy filing, Bob Nardelli (Nardelli),
Chairman and CEO of Chrysler, said, “Even though total agreement was not possible, I am truly
grateful for all that has been sacrificed, on the part of many of Chrysler’s stakeholders to reach an
agreement in principle with Fiat. My number one priority has been to preserve Chrysler and the
thousands of people who depend on its success. While I am excited about the creation of the
global alliance, I am personally disappointed that today Chrysler has filed for Chapter 11. This
was not my first choice.”10
While some analysts were apprehensive about Chrysler’s viability, others were of the
view that Chrysler would come out of the bankruptcy soon. According to Lee Iacocca
(Iacocca), former Chairman and Chief Executive Officer (CEO) of Chrysler, “It pains me to
see my old company, which has meant so much to America, on the ropes. But Chrysler has
been in trouble before, and we got through it, and I believe they can do it again.”11
About Chrysler
The history of Chrysler can be traced back to the 1920s. In 1921, Walter P. Chrysler (Walter)
joined as Chairman of Maxwell Motor Corporation (Maxwell).12 During that time, Maxwell
had high debts because of its declining sales after World War I.
In 1923, the production of automobiles under the brand name of Maxwell was stopped.
In 1924, a new vehicle named Chrysler Six, which had a light, powerful, high-compression
six-cylinder engine and the first ever four-wheel hydraulic brakes, was launched in the U.S.
automobile market. The vehicle was available for US$1,565.
In 1928, the company acquired the Dodge Brothers firm and became the third largest
automaker in the United States. The company also started the DeSoto and Plymouth divisions.
The company positioned the Plymouth brand as a low priced car, while DeSoto was introduced
in the medium price segment.
In 1934, the company introduced the Chrysler Airflow, one of the first cars to be aerody-
namically designed. However, it was not able to generate much interest among the public.
Nunetheless, the company was able to survive during the Great Depression13 because of the
strong sales generated by the entry-level Dodge and Plymouth brands.
In 1951, Chrysler developed the Firepower, the first hemispherical-head V8 engine,
which later became popular as the HEMI® engine.14 By the end of the 1950s, the company had
become famous for creating power steering, power windows, the alternator, electronic fuel
injection, and many other automotive innovations.
In the 1960s, Chrysler expanded into Europe and formed Chrysler Europe by acquiring
the UK-based Rootes Group,15 Simca,16 and Barreiros.17 In the 1970s, the company had to face
new challenges such as issues related to environmental pollution and rising gas prices. It also
started facing competition from foreign car manufacturers such as Honda Motor Company
(Honda) and Toyota Motor Corporation (Toyota).
CASE 17 Chrysler in Trouble 17-3
The oil crisis of the 1970s18 resulted in a high demand for fuel-efficient cars. American
customers started preferring small, fuel-efficient Japanese cars as compared to the U.S.-made
bigger cars. Moreover, as the performance of the Japanese cars was superior to the cars made
in the United States and their prices were competitive compared to the American cars, there
was an increase in their sales.
In the 1970s, Chrysler’s sales started declining. In 1978, the company hired Iacocca as the
Chief Operating Officer (COO) of Chrysler Corporation. In September 1979, Iacocca was pro-
moted to Chairman and CEO. Soon after, he carried out a revamping exercise in the company
and set up a new management team.
Iacocca initiated several cost-cutting measures including scaling down nonproductive opera-
tions, closing down plants, stopping some employee benefits, initiating temporary layoffs, and so
on. In the late 1970s, the company had a debt of approximately US$4.75 million and was in deep
financial trouble. It had to ask for financial help from the U.S. government. In 1979, U.S. President
Jimmy Carter signed a bill through which the U.S. government provided a US$1.5 billion federal
loan to Chrysler Corporation. The federal loan helped the company restructure itself.
During the restructuring, Chrysler’s product line was substantially expanded. Iacocca em-
phasized manufacturing passenger cars, like the Dodge Caravan and Plymouth Voyager, which
received a good response from consumers. Apart from that, the company also focused on design-
ing fuel-efficient K Cars.
By the early 1980s, Chrysler had started recovering from the crisis. In 1983, seven years
ahead of schedule, the company repaid the federal loan. In 1984, the company reported a profit
of US$2.4 billion.
Between 1984 and 1988, Chrysler acquired many companies including Gulfstream
Aerospace Corporation, a corporate jet manufacturer; Lamborghini, the Italian luxury car
manufacturer; Finance America; E. F. Hutton Credit Corporation; American Motors Corpora-
tion; and so on. Through the acquisition of American Motors Corporation, the world famous
Jeep® brand came into the company fold. In 1987, the company increased its shareholding in
Mitsubishi Motors Corporation and entered into a strategic alliance with Samsung, a South
Korean electronics company.
In the late 1980s, the financial condition of Chrysler Corporation started deteriorating.
The company began taking cost-cutting measures and introduced fuel-efficient vehicles like
the Dodge Shadow and the Plymouth Sundance. In 1989, it started a US$1 billion cost-cutting
and restructuring program. On December 31, 1992, Iacocca retired as the CEO of the com-
pany. In 1996, the company shifted to its new headquarters in Auburn Hills, Michigan, in the
United States.
The Failed Merger with Daimler-Benz
In May 1998, Chrysler Corporation and Daimler-Benz AG (Daimler), a German automobile
manufacturing company founded in 1926, agreed to combine their businesses in what they
called a “merger of equals.” On November 12, 1998, the merger process was completed.
Through a deal worth US$37 billion, the new company was named DaimlerChrysler AG
(DaimlerChrysler). Under DaimlerChrysler, Chrysler Corporation assumed its new name as
DaimlerChrysler Motors Company LLC and its U.S. operations started being referred to as
the Chrysler Group. The merger resulted in the world’s third19 largest automobile company
in terms of revenues, market capitalization, and earnings and the fifth20 largest in terms of
number of units produced.
To avoid a clash between the German and American management styles, the Chrysler
Group continued to manufacture mass market passenger cars and Daimler to build its luxury
marquee Mercedes. In the third quarter of 2000–2001, the Chrysler Group reported a loss of
US$512 million, which resulted in a decline of share value to US$40 in September 2000 from
US$108 in January 1999. After the merger, the market share of the Chrysler Group also fell
from 16.2% to 13.5%. After the bad performance reported by the company, its two successive
American presidents, James P. Holden and Thomas Stallkamp, were fired within a span of
19 months. Dieter Zetsche, a Daimler executive, was appointed as CEO of Chrysler and he
appointed another Daimler executive, Wolfgang Bernhard, as the Chief Operating Officer
(COO). According to the analysts, the sequence of events demoralized the employees of the
Chrysler Group, which became a division of DaimlerChrysler and did not have any representa-
tive on the DaimlerChrysler board of management.
The merged entity started facing problems mainly because of the significantly different
cultures of the two companies. While the Americans valued efficiency, empowerment, creativ-
ity, and informal relationships among the employees, the Germans followed more of a bureau-
cratic culture. Apart from cultural differences, other factors like differences in pay structures,
different working styles, and so on, also played a critical role in creating a rift between the two
companies.
For example, in Daimler, high disparities in pay package were discouraged and top man-
agement employees did not receive high incentives. In the American pay structure, however,
the top executives were paid higher salaries and incentives.
The working styles of both the companies also differed significantly. While the
Germans were used to having long meetings and submitting lengthy reports, the Americans
preferred to spend less time on discussions. While the Americans preferred experimenting by
following a trial and error method, the Germans had a comprehensive plan that they followed
exactly.
In early 2007, DaimlerChrysler AG engaged in talks with Cerberus Capital Management
L.P. (Cerberus)21 to sell the Chrysler Group. In May 2007, it announced that it would sell an
80.1% stake of Chrysler to Cerberus for US$7.4 billion.
On May 21, 2007, Daimler announced that, as part of the deal of selling Chrysler to Cer-
berus, it would provide US$1 billion for Chrysler’s pension plan, if the pension plan would be
terminated within five years. Daimler assumed the responsibility of the pension payment as per
the agreement between Chrysler and the U.S. Pension Benefit Guaranty Corporation (PBGC).22
Commenting on Daimler’s announcement, Vince Snowbarger, Interim Director of PBGC, said,
“I commend both Daimler and Cerberus on their willingness to work with the PBGC to protect
the retirement security of Chrysler workers and retirees. Both Daimler and Cerberus have made
significant financial commitments to strengthen Chrysler pensions. Daimler has agreed to
provide a guarantee of $1 billion to be paid into the Chrysler plans if the plans terminate within
five years.”23
In July 2007, the European Commission approved the pension deal. On August 6, 2007,
Daimler sold off the majority stake to Cerberus. Chrysler became Chrysler Motors LLC
(Chrysler) and DaimlerChrysler AG changed its name to Daimler AG. Nardelli was appointed
as Chrysler’s Chairman and CEO. Commenting on the deal, John Snow, the Chairman of Cer-
berus, said, “We are aware that Chrysler faces significant challenges, but we are confident that
they can and will be overcome. A private investment firm like Cerberus will provide manage-
ment with the opportunity to focus on their long-term plans rather than the pressures of short-
term earnings expectations.”24
In fiscal 2007, Chrysler reported an 8% growth in sales in markets outside the United
States as compared to that of 2006. However, the sales in the U.S. market in 2007 declined by
3% compared to the previous year. Commenting on the strong growth in international sales,
Jim Press (Press), Vice Chairman and President of Chrysler, said, “This is a revitalized orga-
nization, moving in the right directions, with a renewed emphasis on putting the global cus-
tomer first at every step in the process—anxious to serve, proud of the value and quality of our
products. I am pleased to say that our global results are beginning to show this.”25
17-4 SECTION D Industry Four—Transportation
CASE 17 Chrysler in Trouble 17-5
Chrysler Asks For Financial Aid
In 2007, Chrysler reported a net loss of US$1.6 billion. The company’s financial problems
continued in 2008, due to declining sales. (See Exhibit 1 for Chrysler’s annual U.S. sales be-
tween 2000 and 2008.)
In October 2008, Cerberus and General Motors Corporation (GM)26 engaged in discus-
sions regarding the merger of GM and Chrysler. Under the deal, it was proposed that
GM would acquire Chrysler’s automotive operations and Cerberus would get a 49%
stake in General Motors Acceptance Corporation (GMAC).27 However, the deal did not
materialize.
In November 2008, Nardelli announced in the media that Chrysler required US$4 billion
to run its operations until March 2009. Overall, Chrysler sought US$7 billion financial aid
from the U.S. government. On December 17, 2008, Chrysler announced that on December 19,
2008, it would close its 12 North American plants due to weak demand. In December 2008,
the sales figure of Chrysler declined by 54% as compared to the sales reported in the corre-
sponding month of 2007.
On January 2, 2009, Chrysler received a US$4 billion federal loan. According to the
terms of the loan, Chrysler had to submit a restructuring plan by February 17, 2009, for
achieving long-term viability of its operations. On February 17, 2009, Chrysler submitted
the restructuring plan to the U.S. Treasury and the U.S. Auto Task Force.28 (See Exhibit
2A and 2B for Chrysler’s restructuring plan.) In the plan, Chrysler made a request for an
additional federal loan. The company said that, due to the worsening demand for its cars
and trucks, it required a total of US$9 billion including the US$4 billion it had already re-
ceived. The company wanted the loan by March 31, 2009, to continue with its operations.
Commenting on Chrysler’s request for an additional federal loan, Nardelli said, “We be-
lieve the requested working capital loan is the least-costly alternative and will help pro-
vide an important stimulus to the U.S. economy and deliver positive results for American
taxpayers.”29
3.0
2.5
2.0
1.5
1.0
0.5
0.0
2000 01 02 03 04 05 06 07 08
Years
U
n
it
s
al
es
(
m
ill
io
n
s)
EXHIBIT 1
Chrysler’s Annual
U.S. Sales (2000–06)
SOURCE: Accessed from “Chrysler Bankruptcy Deal Revealed,” http://news.bbc.co.uk, April 30, 2009.
http://news.bbc.co.uk
STAND-ALONE PLAN
In its Stand-Alone Plan, Chrysler said,
� The company can be viable on a stand-alone basis in the short/midterm with the following assumptions:
i. The balance sheet is restructured to substantially reduce current debt and debt servicing requirements;
ii. Targeted concessions are obtained from all constituents;
iii. Additional U.S. government funding of $5 billion and DOE 136 funding of $6 billion is secured; and
iv. SAAR (Seasonally Adjusted Annual Rate) ≥ 10.1 million units.
� To be viable on a longer term basis, it is critical that Chrysler continues to pursue strategic partnerships/consolidation
to be both operationally viable (i.e., meet energy and environmental regulations) and financially viable (i.e., create an
acceptable ROI to shareholders and positive NPV).
� In a sustained U.S. industry below 9.1 M SAAR, we believe Chrysler LLC will struggle to remain viable and will
require an additional restructuring and funding.
STRATEGIC PARTNERSHIP/CONSOLIDATION
In its Strategic Partnership/Consolidation Plan, Chrysler said,
� In all industry scenarios (SAAR levels), Chrysler will be more viable, both operationally and financially, with a
strategic partner.
� Chrysler has signed a non-binding MOU with Fiat that will significantly enhance its viability by creating additional
free cash flow over the 2009–2016 period and leverage the advanced powertrain and small car technology that has
made Fiat number one in Europe in low CO2 emissions.
� Fiat’s proposal is contingent upon Chrysler LLC restructuring its debt, obtaining concessions, and receiving adequate
government funding.
� In a sustained U.S. industry below 9.1 M SAAR, we believe even with Fiat, Chrysler LLC will struggle to be viable
and will require additional restructuring and funding.
� Fiat alliance will create incremental jobs in the United States during the first five years compared with the
Stand-Alone Plan.
� There exist further benefits from U.S. consolidation but no clear action path with GM.
ORDERLY WIND DOWN
In its Orderly Wind Down Plan, Chrysler said,
� If Chrysler LLC is not able to successfully:
i. Restructure its balance sheet to substantially reduce its liabilities,
ii. Negotiate targeted concessions from constituents,
iii. Receive an additional $5 billion capital infusion from the U.S. government, as represented in the Stand-Alone
Plan, then the only other alternative is for Chrysler to file for Chapter 11 as a first step in an orderly wind down.
� Chrysler LLC would seek debtor-in-possession financing from both private sector lenders and the U.S. government.
We believe the estimated size of the financing need is US$24 billion over a two-year period.
� Without adequate DIP financing we estimate that the first lien lenders will only realize a 25% recovery, the U.S.
government 5%, while all other creditors will receive nothing.
� An Orderly Wind Down will result in a significant social impact, with 300,000 jobs lost at Chrysler and its suppliers
and over 3,300 dealers failing. Around 2–3 million jobs could be lost due to a follow-on collapse in the wider indus-
try, resulting in a US$150 billion reduction in U.S. government revenue over 3 years.
EXHIBIT 2A Highlights of the Three Alternatives Mentioned in Chrysler’s Restructuring Plan for Long-Term Viability
SOURCE: “Chrysler Restructuring Plan for Long-Term Viability,” http://www.media.chrysler.com, February 17, 2009.
17-6 SECTION D Industry Four—Transportation
http://www.media.chrysler.com
STRATEGIC ALLIANCE
Chrysler has signed a non-binding agreement to pursue a strategic alliance with Fiat that represents significant strategic and
financial benefits to the stakeholders. The written and oral testimony Chrysler submitted to the U.S. House and Senate in
2008 stated the company’s intent to seek the benefits of global partnerships and alliances. The proposed Fiat Alliance would
enhance Chrysler’s viability plan and would provide the company with access to competitive fuel-efficient vehicle plat-
forms, distribution capabilities in key growth markets, and substantial cost-saving opportunities.
PRODUCTS
Chrysler’s product line is a key component of its Viability Plan. In 2010, the company will launch four highly successful
platforms: a new Jeep Grand Cherokee, a new Dodge Charger, a new Dodge Durango, and a new Chrysler 300 (the most
awarded car in automotive history since its launch in 2005). The Chrysler 300 launch will be followed by a new, bolder
Dodge Charger and an all-new unibody Dodge Durango.
In 2008, Chrysler offered six vehicles with highway fuel economy of 28 miles per gallon or better. For 2009, 73% of
Chrysler LLC’s vehicles showed improved fuel economy compared with the previous year’s models. Fuel economy will
continue to improve in 2010 with the introduction of the all-new Phoenix V6 engine, which will provide fuel-efficiency im-
provements of between 6% to 8% over the engines it replaces. A two-mode hybrid version of the company’s best-selling
vehicle, the Dodge Ram, is scheduled for 2010. The first Chrysler electric-drive vehicle is also scheduled to reach the mar-
ket in 2010. It will be followed by other electric-drive vehicles, including Range-extended Electric Vehicles, in the follow-
ing years in order to further reduce fuel consumption.
The proposed Fiat alliance would further help the company achieve these standards as Chrysler gains access to Fiat’s
smaller, fuel-efficient platforms and powertrain technologies. The alliance would enable Chrysler to reduce its capital
expenditures while supporting the company’s commitment to develop a portfolio of vehicles that support the country’s
energy security and environmental objectives.
RESTRUCTURING ACTIONS
Chrysler LLC has aggressively restructured operations to significantly improve cost competitiveness while improving qual-
ity and productivity. Through year end 2008, Chrysler has
� Reduced fixed costs by US$3.1 billion
� Reduced its workforce by 32,000 (a 37% reduction since January 2007)
� Eliminated 12 production shifts
� Eliminated 1.2 million units (more than 30%) of production capacity
� Discontinued four vehicle models
� Disposed of US$700 million in non-earning assets
� Improved manufacturing productivity to equal Toyota as the best in the industry as measured by assembly hours per
vehicle according to the Harbour Report
� Achieved the lowest warranty claim rate in Chrysler’s history
� Recorded the fewest product recalls among leading automakers in 2008
The following additional restructuring actions are planned in 2009:
� Reduce fixed costs by US$700 million
� Reduce one shift of manufacturing
� Discontinue three vehicle models
� Sell US$300 million additional non-earning assets
MANAGEMENT CONCESSIONS
� Chrysler will fully comply with the restrictions established under section 111 of EESA relative to executive privi-
leges and compensation. In addition, the company has suspended the 401k match, incentive bonuses, and merit
increases, and has eliminated retiree life insurance benefits.
EXHIBIT 2B Highlights of Chrysler Restructuring for Long-Term Viability
(Continued )
CASE 17 Chrysler in Trouble 17-7
17-8 SECTION D Industry Four—Transportation
On March 30, 2009, the U.S. Treasury and the U.S. Auto Task Force rejected Chrysler’s
stand-alone Viability Plan. The U.S. Auto Task Force announced that it would provide another
US$6 billion federal loan to Chrysler. However, in order to get the additional loan, Chrysler
would have to form an alliance with Fiat by April 30, 2009. In addition, the company would
have to restructure its debt and would have to negotiate with the UAW and CAW unions to re-
duce employee benefits and increase productivity.
In order to form an alliance with Fiat, in April 2009, Chrysler started the process of getting
approval from its 45 lending institutions to surrender the first lien debt30 of US$6.9 billion. It also
entered into negotiations with UAW for it to accept a 55% equity stake in the new company in
lieu of Chrysler’s contribution to UAW’s retiree health care trust fund, VEBA. The negotiations
also included some adjustments to the UAW’s 2007 collective bargaining agreement.
On April 21, 2009, the U.S. Treasury announced that it would give Chrysler US$500 million
over and above the US$4 billion it had already given to continue its operations.
Meanwhile, on April 26, 2009, the CAW ratified an agreement it had reached with
Chrysler in early April 2009. The agreement helped Chrysler to save US$240 million in an-
nual costs. Giving details, Ken Lewenza, President of CAW, said, “Some of it comes from re-
duced compensation, some of it comes from lower legacy costs, some of it comes from
increased productivity and efficiencies in the workplace.”31
On April 28, 2009, the four largest creditor banks—JPMorgan Chase & Company,32 Gold-
man Sachs Group Inc.,33 Morgan Stanley,34 and the Citigroup Inc.,35 which collectively held
70% of Chrysler’s total debt—approved the U.S. Treasury’s offer of US$2 billion given to
Chrysler’s first lien debtors.
On April 29, 2009, the UAW also ratified the agreement it had reached with Chrysler. In
the agreement, UAW agreed to have a 55% equity stake in the company after an alliance with
DEALER CONCESSIONS
� Chrysler will achieve cost savings/improved cash flow through a number of initiatives including reduced dealer
margins, elimination of fuel fill, and reduction of service contract margins.
UNION CONCESSIONS
� The signed term sheets for the UAW Labor Modifications and VEBA modifications fundamentally comply with the
requirements set forth in the U.S. Treasury Loan and once realized would provide Chrysler with a workforce cost
structure that is competitive with the transplant automotive manufacturers. This agreement is subject to ratification.
SUPPLIER CONCESSIONS
� The company has initiated the dialogue with its suppliers and believes that it will be able to obtain substantial cost
reductions from suppliers that will result in achieving targeted savings. Chrysler supports the supplier associations’
proposals, which would provide a government guarantee of OEM accounts payables.
SECOND LIEN DEBT HOLDERS CONCESSIONS
� Chrysler anticipates that the holders of the Second Lien Debt will agree to convert 100% of their debt to equity.
Chrysler’s Viability Plan includes expectations to further reduce its outstanding debt by US$5 billion. In addition to
strengthening the company’s balance sheet for the long term, this reduction will provide immediate cash flow via
interest savings of between US$350 million and US$400 million annually.
EXHIBIT 2B Highlights of Chrysler Restructuring for Long-Term Viability (continued)
SOURCE: “Chrysler LLC Viability Plan Submitted Today to the U.S. Treasury Department,” http://www.chryslerllc.com, February 17, 2009.
http://www.chryslerllc.com
Fiat, instead of Chrysler’s contribution in VEBA. UAW would also have a representative on
the board of the new company.
However, the attempt to gain support from all the creditors was unsuccessful. About 20
financial firms including Oppenheimer Funds and Stairway Capital, who collectively held
US$1 billion, declined to agree to the terms of the proposed debt restructuring. Analysts
opined that the creditors might be better off after bankruptcy filing and liquidation of
Chrysler’s assets. They also opined that, in case of a bankruptcy filing by Chrysler, the credi-
tors would have no choice but to accept the US$2 billion offered by the U.S. Treasury.
The U.S. government later offered the creditors another US$250 million, which made the
total offering US$2.25 billion. However, the deal did not materialize. Criticizing the creditors,
President Barack Obama said, “A group of investment firms and hedge funds decided to hold
out for the prospect of an unjustified taxpayer-funded bailout. They were hoping that every-
body else would make sacrifices and they would have to make none. Some demanded twice
the return that other lenders were getting. I don’t stand with them.”36
CASE 17 Chrysler in Trouble 17-9
The Bankruptcy
On April 30, 2009, Chrysler and its 24 wholly-owned U.S. subsidiaries filed for bankruptcy.
However, Chrysler’s Mexican, Canadian, and other international operations were not part of
the bankruptcy filing. The company filed the bankruptcy under Section 363 so that it would
be able to emerge from bankruptcy within 30 to 60 days. According to Obama, “It would be
a very quick type of bankruptcy and they could continue operating and emerge on the other
side in a much stronger position.”37
As part of the bankruptcy filing, the U.S. Treasury was to give Chrysler a total of US$8
billion in additional aid including up to US$3.3 billion in debtor-in-possession (DIP)38 financ-
ing and up to US$4.7 billion in exit financing.39 Chrysler would have to repay the loan amount
within the next eight years.
The financial arm of Chrysler was to be merged with GMAC, the finance arm of GM. Dur-
ing the bankruptcy period, the U.S. government was to back the warranty on Chrysler vehi-
cles. Encouraging consumers to buy Chrysler products, Obama said, “No one should be
confused about what a bankruptcy process means. This is not a sign of weakness, but rather
one more step on a clearly charted path to Chrysler’s revival.”40
The new company would retain the Chrysler corporate name and would be run by a board
of nine members including six members appointed by the U.S. government and three by Fiat.
Nardelli was to resign as the CEO of Chrysler after the company emerged from bankruptcy
and a new chief executive would be appointed.
As part of the bankruptcy, Cerberus and Daimler were to give up their respective equity
stakes of 80.1% and 19.9% in Chrysler. In the new company, VEBA would have a 55% stake
and Fiat a 35% stake. Of the remaining 10% equity stake in the new company, the U.S. Trea-
sury would have 8% for the US$4.5 billion loan it had provided Chrysler. The Canadian and
Ontario governments would have a combined 2% stake for the US$3.8 million provided to
Chrysler—US$1.5 billion from the Ontario government and the remaining from the Canadian
government. The creditors would receive US$2 billion for the US$6.9 billion they had lent to
Chrysler.
On May 5, 2009, the company’s bankruptcy was approved by the Manhattan Bankruptcy
Court. Analysts welcomed Chrysler’s decision to file for Chapter 11 bankruptcy. According to
Aaron Bragman, Automotive Analyst at IHS Global Insight, “With all the major stakeholders
accounted for and in agreement, such a bankruptcy could be theoretically accomplished much
more easily than it otherwise would have been.”41
17-10 SECTION D Industry Four—Transportation
The Chrysler-Fiat Alliance
On May 5, 2009, Chrysler filed for bankruptcy. The company announced that it had reached an
agreement to establish a global strategic alliance with Fiat. (See Exhibit 3 for logos of Chrysler
and Fiat.) The company also made a reference to all its efforts to enter into partnerships with
different automobile companies, including GM, Volkswagen, Toyota, Honda, Nissan, and
Hyundai. However, except for Fiat, no other options had been viable for it, the company said.
Thomas LaSorda, Vice Chairman of Chrysler, said, “Despite continual efforts over the course
of approximately two and a half years, no party except Fiat has emerged as a viable and willing
alliance partner for us.”42
As part of the alliance, Chrysler decided to sell all its assets to Fiat except eight factories: a
sedan plant in Sterling Heights, Michigan; a St. Louis-area pickup-truck plant; a Dodge Viper
sports car plant in Detroit; factories in St. Louis and Newark, Delaware; a metal stamping plant
in Twinsburg, Ohio; an engine plant in Kenosha, Wisconsin; and an axle plant in Detroit. Com-
menting on the decision, Max Gates, spokesperson from Chrysler, said, “While some facilities
may eventually close, none other than Newark and St. Louis South are scheduled for closure in
the near term. Virtually all of the labor associated with these facilities will be offered employ-
ment with the new company.”43
After the alliance was formed, the new company would be the world’s sixth-largest car
manufacturer. Commenting on the alliance with Fiat, Nardelli said, “Our viability for the long
term would be enhanced even more by global strategic alliances and partnerships. The proposed
Fiat alliance provides significant benefits to Chrysler. Fiat would make available to us its entire
product portfolio and powertrain technology, worldwide distribution capabilities for vehicles
we produce today, and synergies in the areas of purchasing and engineering, among others. We
estimate the cash value of Fiat’s contribution to be between eight and ten billion dollars consid-
ering the cost to develop these vehicles, platforms, and power trains from scratch.”44
In the new company, Fiat was to initially have a 20% stake. Later, it could increase its
stake by 15% in three stages of 5% each. Fiat was to increase the first 5% stake in the new
company for providing a 40 mpg (miles per gallon) vehicle platform (i.e, assisting the new
company to manufacture a vehicle which would give a mileage of 40 mpg.) The new vehicle
would be produced in the United States. Fiat could increase its stake in the new company by
another 5% after providing Chrysler a “fuel-efficient engine family” which would be produced
in the United States and would be used in Chrysler vehicles. The third increase of a 5% stake
would be for giving Chrysler access to Fiat’s global distribution network. Fiat would not have
to pay anything for its stake in Chrysler. It thus could increase its stake to 51% by 2016, after
the new company had repaid the U.S. government’s loan. Commenting on Chrysler’s alliance
EXHIBIT 3
Logo of Chrysler
and Fiat
SOURCE: Tim O’Brien, “Bankrupt Chrysler U.S. Announces Alliance with Fiat,” http://www.motorreport.com.au,
May 01, 2009.
http://www.motorreport.com.au
with Fiat, Obama said, “It’s a partnership that will give Chrysler a chance not only to survive,
but to thrive in a global auto industry.”45
With this alliance, Chrysler and Fiat would have access to each other’s market. Accord-
ing to Pierluigi Bellini, an automotive analyst with IHS Global Insight, “Fiat has wanted to get
back into the U.S. market for years, so this is a very good opportunity for them because it pro-
duces a quick entry.”46
According to some analysts, the alliance between Chrysler and Fiat would not only help
both the companies to access each other’s market, but would also help to create jobs. Accord-
ing to a statement from Chrysler, the alliance would help the company to create or preserve
more than 5,000 manufacturing jobs.47 See Exhibit 4 for synergies of the Chrysler-Fiat alliance
mentioned in Chrysler’s Restructuring Plan for Long-Term Viability. According to Sergionot
Marchionne (Marchionne), Fiat, along with Chrysler, would be able to produce their first
vehicle in the United States in early 2011.
CASE 17 Chrysler in Trouble 17-11
Cash Flow Impact EBITDA Impact
Total 2009–2016 Total 2009–16
Area Approach (In US$ Billions) (In US$ Billions)
Products/ 2 million products localized 1.4 2.1
Platform or sold in NAFTA and exported
Sharing to global markets
Distribution New Chrysler markets adding 1.3 1.3
393,000 units, Alfa Romeo
distributed in NAFTA
Purchasing Integrate sourcing with 3.2 2.8
Fiat Group
Other Powertrain, technology, 1.0 1.2
Opportunities logistics, SG&A expense,
other funding for NSCs
provided by Fiat
Total Synergies* 6.9 7.4
Alliance with
Fiat Benefits**
(in US$ Billions) 2009 2010 2011 2012 2013 2014 2015 2016
EBITDA Synergy 0.0 0.0 0.3 1.2 1.3 1.5 1.6 1.5
Benefits
Cash Synergy (0.1) (0.1) (0.2) 1.0 2.4 3.9 5.5 6.9
Benefits
(cumulative)^
Notes:
* Synergies incremental to Chrysler only as calculated by Chrysler.
** A strategic alliance could reduce Chrysler’s overall capital requirements and could create additional jobs
in the United States. Additionally, the alliance would have the potential for better efficiency spending of
DOE funds.
^ The negative cash impact in the first three years is due to spending approx US$1 billion in new platforms
and powertrain technology offset by synergy savings.
EXHIBIT 4
Synergies of
Chrysler-Fiat
Alliance Mentioned
in Chrysler’s
Restructuring Plan
for Long-Term
Viability
SOURCE: “Chrysler Restructuring Plan for Long-Term Viability,”http://www.media.chrysler.com, February 17, 2009.
http://www.media.chrysler.com
17-12 SECTION D Industry Four—Transportation
What Went Wrong?
According to the analysts, the major reasons for Chrysler’s present financial problems were
its poor business strategy, lack of innovation, and the global financial crisis. According to
David Lewis, professor at the University of Michigan’s Ross School of Business, “In recent
decades, it’s had a more turbulent time, with more ups and downs than other automakers.
Each decade, it seemed that Chrysler had a crisis.”48
Chrysler failed to bring out new vehicles that met changing customer needs ahead of the
competition. The global financial crisis49 in 2008 only resulted in further deterioration of
the company’s financial health.
Poor Business Strategy
Analysts attributed Chrysler’s financial problems to its poor business management. In the early
1970s, when fuel prices were going up and consumers in the United States started preferring
fuel-efficient vehicles, Japanese companies like Toyota and Honda began coming out with
compact and fuel-efficient cars to cater to these needs. However, Chrysler’s focus remained
more on SUVs and trucks, leaving the Asian carmakers to capitalize on this change in con-
sumer preferences.
Other analysts criticized Chrysler’s decision to merge with Daimler. According to
Iacocca, “Eaton50 panicked. We were making $1 billion a quarter and had $12 billion in cash,
and while he said it was a merger of equals, he sold Chrysler to Daimler-Benz, when we should
have bought them.”51
Similar analysts also criticized Daimler’s decision to run Chrysler as a stand-alone
division. They opined that Daimler wanted to keep Chrysler separate from its luxury
Mercedes-Benz marquee. By doing this, it did not take advantage of the benefits of develop-
ing vehicles together.
Lack of Innovation
According to analysts, Chrysler’s sluggishness in launching innovative models when its
Japanese competitors kept coming out with new designs resulted in the company’s declining
sales. Japanese companies continued to offer fuel-efficient vehicles, while Chrysler contin-
ued to produce fuel-guzzling trucks.
Chrysler, which had been the innovator of automatic transmission, power steering, and
brakes, just did not live up to the consumer’s expectations. Although it came up with some in-
novative products in the early 1980s, quality-related issues dented the brand image of its cars.
After the merger with Daimler, Chrysler introduced some new models. However, those
models did not get much consumer attention. According to Jim Hall, Managing Director of
2953 Analytics of Birmingham, Michigan, “The truth is Daimler did them no favors. They ap-
proved products that previous Chrysler management wouldn’t have approved if they were
completely drunk and beaten crazy.”52
Even after Cerberus bought a majority stake in Chrysler, the company could not invest
enough money in research and development because of the declining sales of Chrysler’s
vehicles. The U.S. Auto Task Force also commented in March 2009 that “Chrysler’s products
have also historically underperformed in terms of quality, which remains a significant chal-
lenge. Unlike GM, which has had a number of successful recent product introductions and has
developed a new global product development process that has promise, there are few tangible
signs that Chrysler can reverse its share erosion.”53
CASE 17 Chrysler in Trouble 17-13
The Global Financial Crisis
In 2008, the tight credit situation, volatility in the stock markets, problems in the U.S. hous-
ing market, increases in unemployment, and declines in incomes started affecting consumer
spending. As a result, the U.S. car market was also badly affected. Those who wanted to pur-
chase vehicles found it difficult to get loans or found the available financing too expensive.
In 2008, the U.S. auto industry experienced its worst year since 1992. The total sales of
cars and light trucks were 13.2 million, a decline of 18% compared to 2007. The United States
was the largest market for Chrysler. As of November 2008, “73 percent of its sales were from
the U.S., 61 percent of its vehicles were produced in the country, 78 percent of its materials
were purchased in the U.S. and 62 percent of its dealers were based in the U.S.”54
As Chrysler’s market was restricted to the United States alone, the global financial crisis
which originated in the country affected its sales badly, leaving the company struggling to carry
on its business. Chrysler reported a 48% decline in vehicle sales in the United States for the
month of April 2009 as compared to the same month of 2008. In April 2009, Chrysler sold
76,682 units of vehicles in the United States. Its sales in April 2009 were also 24% less com-
pared to the sales reported in March 2009. See Exhibit 5 for Chrysler’s U.S. sales in April 2009.
Volume Four Months Four Months Volume
April April Change Ended Ended Change
Sales 2009 2008 (In %) April 2009 April 2008 (In %)
Car 15,563 39,564 �61 73,764 185,165 �60
Truck 61,119 108,187 �44 250,126 416,457 �40
Total 76,682 147,751 �48 323,890 601,622 �46
EXHIBIT 5
Chrysler U.S. Sales in
April 2009
The Challenges
Industry analysts were also apprehensive about whether the small cars that the new company
was to produce would be successful in the United States. According to Dennis DesRosiers, a
Canadian Automotive Analyst, “First, Americans have to embrace smaller cars, which they
never have. Second, they have to buy Italian small cars, which they never have. Third,
Fiat/Chrysler has to find a way to make small cars profitable in North America, which no one,
including the Japanese, has been able to do.”55
Analysts were also worried about the rising competition in the car market. According to
them, companies like Chevrolet, Ford, Toyota, and Honda had already launched their small car
models in the United States. They were of the opinion that Fiat’s entry into the United States,
especially at the time of an economic slowdown, may not be a success. According to Eric
Heymann, Auto Analyst at Deutsche Bank AG,56 “Entering the U.S. market is not easy for any-
one. Just look at how long it took the German or Japanese carmakers to be successful in the
U.S.”57 Some analysts also worried about Chrysler being jointly owned by different entities
such as the U.S. Government, Canadian Government, Ontario Government, UAW, and Fiat.
They opined that, given the failed merger of Daimler and Chrysler, it would be difficult for all
these entities to work together and repay the federal loan. According to Mirko Mikelic, port-
folio manager at Fifth Third Bank,58 “The biggest concern now is that the different stakehold-
ers will be able to make the tough decisions they need to make.”59
SOURCE: “Chrysler LLC Reports April 2009 U.S. Sales,” http://www.chryslerllc.com, May 1, 2009.
http://www.chryslerllc.com
17-14 SECTION D Industry Four—Transportation
Although analysts were apprehensive about Chrysler’s survival after the Fiat alliance, they
were of the view that the alliance was still a better option than Chrysler trying to survive alone
as this would just not be possible. According to Bob Corker, a Republican Senator from the U.S.
state of Tennessee, “I have not seen a way that Chrysler makes it as a standalone entity. It’s re-
ally a merger of two weaker entities, though I think it’s better than Chrysler being on its own.”60
On May 8, 2009, it was announced that Sergio Marchionne would be the chief of the new
company after its alliance with Fiat was completed. Analysts were concerned about whether
cultural issues would crop up after an Italian took charge of an American company. In April
2009, when asked about whether he would be the head of Chrysler after its alliance with
Fiat, Marchionne said, “It’s possible that I will have to divide my time between running Fiat
and running Chrysler. Fundamentally, that’s possible, but the title isn’t important. What’s
important is that they hear me at Chrysler.61 Analysts also wondered whether Marchionne
could successfully run the new company or not. According to Karl Brauer, Editor In Chief of
Edmunds.com,62 “No matter how capable a businessman you are, taking on another car com-
pany that’s been losing money for years and at the same time taking a bigger stake in an indus-
try that’s in freefall and has an uncertain future is a huge gamble.”63 Citing the poor performance
of Chrysler, analysts expressed concern about the company’s viability in the future. According
to Capstone Advisory Group (Capstone),64 Chrysler, which had lost US$16.8 billion in 2008,
was expected to lose US$4.7 billion in 2009. Jeremy Anwyl, the Chief Executive of Edmunds.
com, said, “The challenge is going to be for Chrysler to communicate some sort of a compelling
reason to buy their products. What’s the reason to consciously pick a Chrysler, Jeep, or Dodge
over a competitive vehicle with all of this stuff (bankruptcy) going on?”65
However, Chrysler was optimistic about its future. Press said, “The industry appears to
have stabilized, as it’s been fairly level for the past four months. We know where the bottom is
and, as the economy struggles to recover, vehicle sales should follow.66 On May 7, 2009,
Chrysler started a global corporate advertising campaign to restore confidence in the company
among consumers. The campaign created by BBDO Detroit had TV ads with the tagline, “We’re
building a better car company . . . come see what we’re building for you.” The print ad had
already started appearing in newspapers from May 3, 2009, under the headline, “We’re build-
ing a better car company.” From May 11, 2009, the ad was shown on network primetime tele-
vision. The first 30-second spot, called “Bright Future,” showed the strength of Chrysler and
how it was restructuring itself and had finalized its alliance with Fiat. The second 30-second
spot, called “Open Road,” showed its products and their features.
Commenting on the advertisement campaign, Steve Landry, Chief of Chrysler Sales and
Marketing, said, “We want to establish a level of trust and confidence that customers can still
buy cars and trucks from us and it is business as usual. We are working to exit bankruptcy as
fast as we can.”67 He added, “When we asked consumers what they wanted to know about
Chrysler, they told us to tell them about our products, tell them why they should buy our ve-
hicles, and give them a reason why they should be confident in the future of this company. We
believe this campaign delivers on all of those objectives.”68
R E F E R E N C E S A N D S U G G E S T E D R E A D I N G S
Zack Stoval, “Dealer Challenges Chrysler Closure Order in
Bankruptcy Court,” http://arkansas.com (May 22, 2009).
Justin Hyde, “Chrysler Dealers Prepare Legal Flight,”
http://www.freep.com (May 18, 2009).
“Chrysler LLC Files Papers to Retain Majority of U.S.
Dealer Network as Part of Company’s Sales Process,”
http://www.chryslerrestructuring.com (May 14, 2009).
“Chrysler LLC Launches New Global Corporate Advertis-
ing Campaign,” http://www.chryslerrestructuring.com
(May 7, 2009).
“U.S. Treasury Says Chrysler DIP Financing Reduced,”
http://in.reuters.com (May 07, 2009).
“–In Fiat, Chrysler Has a Simpatico Dance Partner,” http://
www.mydigitaltc.com (May 05, 2009).
http://arkansas.com
http://www.freep.com
http://www.chryslerrestructuring.com
http://www.chryslerrestructuring.com
http://in.reuters.com
http://www.mydigitaltc.com
http://www.mydigitaltc.com
CASE 17 Chrysler in Trouble 17-15
Emily Chasan and Chelsea Emery, “Chrysler Bankruptcy
Has Dealers on “Razor’s Edge,” http://in.reuters.com
(May 5, 2009).
“Chrysler to Launch Ad Campaign to Reassure Nervous
Buyers,” http://www.domain-b.com (May 4, 2009).
Nick Bunkley, “Sick Chrysler Optimistic Despite Crash,”
http://business.theage.com.au (May 3, 2009).
Linda Sandler and Christopher Scinta, “Chrysler Lawyers
May Get $200 Million from Bankruptcy Case Work,”
http://www.bloomberg.com (May 2, 2009).
“Chrysler Motors on: Bankruptcy Process Won’t Halt Op-
erations,” http://www.nydailynews.com (May 2, 2009).
John Ivison, “Chrysler’s Key Problem Remains,” http://
www.nationalpost.com (May 2,2009).
Christine Tierney, “Chrysler’s History Full of Crisis, Come-
backs,” http://www.detnews.com (May 1, 2009).
Ronald Jones, “Can Marchionne’s Magic Work at Chrysler?”
http://www.msnbc.msn.com (May 1, 2009).
“Chrysler LLC Reports April 2009 U.S. Sales,” http://www
.chryslerllc.com, (May 1, 2009).
Jorn Madslien, “Can Fiat Put Chrysler on Road to
Recovery?” http://news.bbc.co.uk ( May 1, 2009).
Rick Newman, “5 Reasons Chrysler May Still Die,” http://
www.msn.com (May 1, 2009).
Mike Ramsey, “Chrysler Plans to Leave 8 Factories in Bank-
ruptcy,” http://www.bloomberg.com (May 1, 2009).
Tim O’Brien, “Bankrupt Chrysler U.S. Announces Alliance
with Fiat,” http://www.motorreport.com.au(May 1, 2009).
“Chrysler LLC and Fiat Group Announce Global Strate-
gic Alliance to Form a Vibrant New Company,” http://
www.chryslerllc.com (April 30, 2009).
Tom Krisher and Stephen Manning, “Chrysler Succumbs to
Bankruptcy After Struggle,” http://news.yahoo.com
(April 30, 2009).
Clare Trapasso and Larry Mcshane, “Despite Bankruptcy,
Chrysler Still Has Fans Who Say Car Company Will
Survive,” http://www.nydailynews.com (April 30, 2009).
Larry Mcshane, “Obama Administration Official: Big 3 Au-
tomaker Chrysler LLC Will File for Chapter 11 Bank-
ruptcy,” http://www.nydailynews.com (April 30, 2009).
Jimmy Peterson, “U.S. Government Gives Chrysler April 30
Deadline to Strike Fiat Deal,” http://www.topnews.in
(April 30, 2009).
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“Chrysler Bankruptcy Deal Revealed,” http://news.bbc.co
.uk (April 30, 2009).
Kabir Chibber, “Chrysler’s Highway to Hell,” http://news
.bbc.co.uk (April 30, 2009).
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.uk (April 30, 2009).
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ibnlive.in.com (April 30, 2009).
“Chrysler, CAW Reach Deal to Save Company $240m a
Year,” http://www.cbc.ca (April 24, 2009).
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http://in.reuters.com (April 24, 2009).
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www.zeenews.com (April 2, 2009).
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(April 9, 2009).
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.mydigitalfc.com (March 17, 2009).
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(February 17, 2009).
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Repay $7.2 Billion News,” http://www.domain-b.com
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Chrysler in Trouble,” http://www.bnet.com (November 2,
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tional Markets’ Results Best in Company’s History;
Minivan Reign Continues,” http://www.chryslerllc.com
(January, 2007).http://www.chryslerllc.com.
N O T E S
1. Larry McShane. “Obama Administration Official: Big 3
Automaker Chrysler LLC Will File for Chapter 11 Bank-
ruptcy.” http://www.nydailynews.com, April 30, 2009.
2. Emily Chasan and Chelsea Emery, “Chrysler Bankruptcy
Has Dealers on “Razor’s Edge.” http://in.reuters.com, May 5,
2009.
3. Tim O’Brien, “Bankrupt Chrysler U.S. Announces Alliance with
Fiat,” http://www.motorreport.com.au, May 1, 2009.
4. Section 363 refers to the section of the U.S. Bankruptcy Code
that allows a company to enter a court supervised process to sell
assets quickly as the best means to protect value for the benefit
of its stakeholders. Unlike a typical bankruptcy proceeding,
http://in.reuters.com
http://www.domain-b.com
http://business.theage.com.au
http://www.bloomberg.com
http://www.nydailynews.com
http://www.nationalpost.com
http://www.nationalpost.com
http://www.detnews.com
http://www.msnbc.msn.com
http://www.chryslerllc.com
http://www.chryslerllc.com
http://news.bbc.co.uk
http://www.msn.com
http://www.msn.com
http://www.bloomberg.com
http://www.motorreport.com.au
http://www.chryslerllc.com
http://www.chryslerllc.com
http://news.yahoo.com
http://www.nydailynews.com
http://www.nydailynews.com
http://www.topnews.in
http://economictimes.indiatimes.com
http://news.bbc.co.uk
http://news.bbc.co.uk
http://news.bbc.co.uk
http://news.bbc.co.uk
http://news.bbc.co.uk
http://news.bbc.co.uk
http://ibnlive.in.com
http://ibnlive.in.com
http://www.cbc.ca
http://in.reuters.com
http://www.zeenews.com
http://en.ce.cn
http://www.livemint.com
http://www.livemint.com
http://www.mydigitalfc.com
http://www.mydigitalfc.com
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http://www.media.chrysler.com
http://www.chryslerllc.com
http://www.domain-b.com
http://www.bnet.com
http://www.chryslerllc.com
http://www.chryslerllc.com
http://www.domain-b.com
http://www.domain-b.com
http://in.reuters.com
http://www.pressbox.co.uk
http://www.pressbox.co.uk
http://money.cnn.com
http://money.cnn.com
http://www.chryslerllc.com
http://www.chryslerllc.com
http://www.nydailynews.com
http://in.reuters.com
http://www.motorreport.com.au
http://www.zeenews.com
17-16 SECTION D Industry Four—Transportation
which can often take a few years to resolve, the advantage of
363 bankruptcy is speed. Through the 363 process, a company
is able to emerge from bankruptcy in approximately 30 to
60 days (Source: http://www.chryslerrestructuring.com).
5. Chapter 11 of the United States Bankruptcy Code permits reor-
ganization under the bankruptcy laws of the U.S. It can be filed
by any business, whether a corporation or a sole proprietorship,
although it is mostly used by corporate entities. A Chapter 11
debtor usually proposes a plan of reorganization to keep its
business alive and pay creditors over time.
6. Founded in 1899, Fiat SpA is an Italian automobile manufac-
turer headquartered in Turin, Italy. For the fiscal 2008, the com-
pany earned revenues of €59.4 billion.
7. The Voluntary Employees’ Beneficiary Association (VEBA)
under Internal Revenue Code section 501(c)(9) of Internal
Revenue Service of the United States Department of the Trea-
sury is an organization organized to pay life, sick, accident, and
similar benefits to members or their dependents, or designated
beneficiaries. Members of this organization must be individu-
als who are employees who have an employment-related
common bond. This common bond may be a common em-
ployer (or affiliated employers), coverage under one or more
collective bargaining agreements, membership in a labor
union, or membership in one or more locals of a national or in-
ternational labor union. VEBA allowed a company to make tax
free contributions into the fund, which is later used to pay ben-
efits to its employees. The main aim of setting up this organi-
zation was to ensure the employees continued to get benefits
even if the company got into financial trouble. (Source: http://
www.irs.gov)
8. UAW was founded in 1935. As of 2008, it was one of the largest
labor unions in North America.
9. CAW, one of the largest labor unions in Canada, was founded
in 1985.
10. “Chrysler LLC and Fiat Group Announce Global Strategic
Alliance to Form a Vibrant New Company,” http://www
.chryslerllc.com, April 30, 2009.
11. Tom Krisher and Stephen Manning, “Chrysler Succumbs to Bank-
ruptcy After Struggle,” http://news.yahoo.com, April 30, 2009.
12. Maxwell Motor Corporation was founded in 1904.
13. The Great Depression that started in 1929 refers to the economic
slump in North America and Europe. The effects of the depres-
sion were felt across the world and it lasted till the late 1930s.
The Great Depression resulted in a major fall in stock prices,
which adversely affected individuals, financial institutions, and
banks, leading to the closure and insolvency of several banks.
This led to reduced demand, spending, and production, and to in-
creased unemployment.
14. A Chrysler Hemi engine, known by the trademark Hemi, is an
internal combustion engine built by Chrysler that utilizes a
hemispherical combustion chamber. A hemispherical (i.e.,
bowl-shaped) combustion chamber allows the valves of a two
valve-per-cylinder engine to be angled rather than side-by-side.
This creates more space in the combustion chamber roof for the
use of larger valves and also straightens the airflow passages
through the cylinder head (Source: http://en.wikipedia.org).
15. The Rootes Group is a British automobile manufacturer. It was
founded in 1913. Chrysler acquired the Rootes Group in 1967.
16. Simca was a French automaker and marquee, founded in 1934.
In 1958, Chrysler bought a 15 percent stake in it. Later, in 1970,
the company was acquired by Chrysler.
17. Barreiros was a Spanish manufacturer of engines, trucks, buses,
tractors, and automobiles. The company was founded in 1954. It
was acquired by Chrysler in 1969 (Source: http://en.wikipedia.org).
18. In 1973, the Yom-Kippur war also known as The October War,
broke out between Israel and some of its Arab neighbors, when
Israel attacked Egypt and Syria. Oil supply was disrupted be-
cause of the war and the oil prices jumped from US$ 3 to US$
12 per barrel. The rise in oil prices resulted in an increase in
gasoline prices in the U.S. from 38.5 cents per gallon in May
1973 to 53.1 cents per gallon in June 1974. In order to reduce
fuel consumption, the U.S. government imposed a 55 miles per
hour speed restriction on vehicles.
19. In 1998. the world’s first two largest automobile companies in
terms of revenues were General Motors and Ford Motor Company.
20. In 1998, the world’s four largest automobile company in terms
of number of units produced were General Motors, Ford Motor
Company, Toyota, and Volkswagen respectively.
21. Cerberus Capital Management is a private equity firm; head-
quartered in New York, the U.S. It was founded in 1992.
22. The Pension Benefit Guaranty Corporation (or PBGC) is an in-
dependent agency of the U.S. government that was created by
the Employee Retirement Income Security Act of 1974 (ERISA)
to encourage the continuation and maintenance of voluntary
private defined benefit pension plans, provide timely and unin-
terrupted payment of pension benefits, and keep pension insur-
ance premiums at the lowest level necessary to carry out its
operations (Source: http://en.wikipedia.org).
23. “Daimler Assumes $1 Billion Chrysler Pension Plan Risk.”
http://in.reuters.com, May 21, 2007.
24. Chris Isidore, “Daimler Pays to Dump Chrysler,” http://money
.cnn.com, May 14, 2007.
25. “Chrysler LLC Announces 2007 Global Sales; International
Markets Results Best in Company’s History: Minivan Reign
Continues,” http://www.chryslerllc.com, January 2009.
26. General Motors Corporation (GM), a multinational automobile
manufacturer, was founded in 1908. It is headquartered in
Detroit, Michigan, the U.S. In the fiscal 2008, it reported a rev-
enue of US$ 148.979 billion and a net loss of US$ 30.9 billion.
27. General Motors Acceptance Corporation (GMAC) was started
in 1919 to finance car buyers. It sold commercial and automo-
tive financing, real estate services, and insurance and mortgage
products. In 2006, GM sold 51 percent stake of GMAC to
Cerberus Capital Management in 2006.
28. On February 16, 2009, Barack Hussein Obama, the President of
the U.S., launched the U.S. Auto Task Force, to oversee the
restructuring of the U.S. auto industry.
29. Chris Isidore, “GM, Chrysler Ask For $ 21.6 Billion More,”
http://money.cnn.com, February 18, 2009.
30. First lien debt is the highest priority debt in the case of default.
If a property or other type of collateral is used to back a debt,
first lien debt holders are paid before all other debt holders.
(Source: http://www.investorwords.com)
31. “Chrysler, CAW Reach Deal To Save Company $240m AYear,”
http://www.cbc.ca, April 24, 2009.
32. JPMorgan Chase & Company is a U.S.-based, leading global
financial services firm. It was formed in 2000, after the merger
when Chase Manhattan Corporation acquired JP Morgan &
Company. As of December 31, 2008, it reported a net revenue
of US$ 67,252 million and a net profit of US$ 5,605 million.
33. Goldman Sachs Group, Inc is a bank holding company that
is engaged in investment banking, securities services, and
http://www.chryslerrestructuring.com
http://www.irs.gov
http://www.irs.gov
http://www.chryslerllc.com
http://www.chryslerllc.com
http://news.yahoo.com
http://en.wikipedia.org
http://en.wikipedia.org
http://en.wikipedia.org
http://in.reuters.com
http://money.cnn.com
http://money.cnn.com
http://www.chryslerllc.com
http://money.cnn.com
http://www.investorwords.com
http://www.cbc.ca
CASE 17 Chrysler in Trouble 17-17
investment management. For the fiscal year 2008, the com-
pany reported revenues of US$ 53.579 billion and net income
of US$ 2.322 billion (Source: http://en.wikipedia.org).
34. Morgan Stanley is a US-based global financial services provider.
It acts as a financial advisor to companies, governments, and
investors from across the world. For the fiscal year 2008, it
reported a net revenue of US$ 62.262 billion and a net income of
US$ 1.707 billion (Source: http://www.morganstanley.com).
35. Citigroup Inc. is an international financial conglomerate with
operations in consumer, corporate, investment banking and in-
surance. For the fiscal 2008, it reported total revenues of US$
52.793 billion and net loss of US$ 27,684. (Source: http://www
.citigroup.com).
36. “Chrysler Bankruptcy Deal Revealed.” http://news.bbc.co.uk,
April 30, 2009.
37. “Chrysler Approaches Key Deadline,” http://news.bbc.co.uk,
April 30, 2009.
38. Debtor-in-possession (DIP), under the United States bank-
ruptcy law, is a person or corporation who has field a bank-
ruptcy petition, but remains in possession of property upon
which a creditor has a lien or similar security interest. DIP fi-
nancing is a special form of financing provided for companies
in financial distress or under Chapter 11 bankruptcy process.
The specialty of DIP financing is that it gets priority over exist-
ing debt, equity, and other claims (http://en.wikipedia.org).
39. Exit financing in bankruptcy is the funding that is given to a
bankrupt company to come out of bankruptcy. In order to get
exit financing, the company requires to prepare a plan of reor-
ganization which has to be supported by all of its creditors. If
the bankruptcy court also agrees to the plan, then the company
can come out of bankruptcy with the exit financing.
40. Clare Trapasso and Larry Mcshane, “Despite Bankruptcy,
Chrysler Still Has Fans Who Say Car Company Will Survive.”
http://www.nydailynews.com, April 30, 2009.
41. IHS Global Insight is the global leader in economic and finan-
cial analysis forecasting and market intelligence. As of 2008, it
had more than 3,800 clients in industry, finance, and govern-
ment. (Source: http://www.globalinsight.com)
42. “In Fiat, Chrysler Has a Simpatico Dance Partner,” http://www
.mydigitaltc.com. May 5, 2009.
43. Mike Ramsey, “Chrysler Plans to Leave Eight Factories in
Bankruptcy,” http:www.bloomberg.com. May 1, 2009.
44. “Chrysler Has 30 Days to Reach Deal with Fiat: Report,” http://
economictimes.indiatimes.com, April 30, 2009.
45. “Chrysler Bankruptey Deal Revealed,” http://news.bbc.co.uk,
April 30, 2009.
46. Ronald Jones, “Can Marchionne’s Magic Work At Chrysler?”
http://www.msnbc.msn.com, May 1, 2009.
47. Mike Ramsey, “Chrysler Plans to Leave Eight Factories in
Bankruptcy,” http://www.bloomberg.com, May 1, 2009.
48. Christine Tierney, “Chrysler’s History Full of Crisis, Come-
backs,” http://www.detnews.com. May 1, 2009.
49. The global financial crisis of 2008–09 was an ongoing major
financial crisis that affected all countries across the world. The
crisis was triggered when sub-prime mortgages were offered
to borrowers without a proper check being done on whether
they would be able to repay the loan or not. When several
of these borrowers defaulted, there was a ripple effect in the
U.S. economy. The financial crisis became prominent from
mid-2008 with the failures of several large U.S.-based financial
firms. Soon, it started affecting financial markets of other coun-
tries also.
50. Robert Eaton was the Chairman and CEO of Chrysler Corpora-
tion between 1993 and 1999.
51. “How Daimler, Chrysler Merger Failed,” http://www.pressbox
.co.uk, May 18, 2007.
52. Tom Krisher, “Without a Big-Selling Design in Works. Chrysler
in Trouble,” http://www.bnet.com, November 2, 2008.
53. “Chrysler Faces Challenging Future: White House,” http://
www.livemint.com, March 30, 2009.
54. “Testimony of Robert Nardelli to the U.S. Senate,” http://www
.chryslerllo.com, November, 2008.
55. John Ivison, “Chrysler’s Key Problem Remains,” http://www
.nationalpost.com, May 2, 2009.
56. Deutsche Bank AG was founded in 1870. It is a Germany-based
financial services provider. As of 2008, it reported revenue of
US$ 13.490 billion and net loss of US$ 3.896 billion.
57. Jorn Madslien, “Can Fiat Put Chrysler on Road to Recovery?”
http://news.bbc.co.uk, May 1, 2009.
58. Fifth Third Bank was incorporated as Bank of the Ohio Valley
in 1858. It is a U.S.regional banking corporation, headquartered
in Cincinnati, Ohio (Source: http://en.wikipedia.org).
59. “Chrysler Files for Bankruptcy. CEO To Quit,” http://ibnlive.in
.com. (April 30, 2009.)
60. “Chrysler Chiefs Battle to Avoid Bankruptcy,” http://www
.mydigitalfc.com, March 17, 2009.
61. “Fiat Chief Marchionne Will Head Chrysler,” http://
timesofindia.indiatimes.com, May 8, 2009.
62. Edmunds.com, headquartered in Santa Monica, California,
was founded in 1966. It is a provider of automotive informa-
tion via websites, books, and other media (Source: http://en
.wikipedia.org).
63. Ronald Jones, “Can Marchionne’s Magic Work At Chrysler?”
http://www.msnbc.msn.com, May 1, 2009.
64. Capstone Advisory Group, LLC provides solutions for stake-
holders, lenders and investors dealing with distressed and fraud
situations, for parties in commercial disputes, and for lenders
and investors evaluating capital transactions. (Source: http://
www.capstonecr.com)
65. Nick Bunkley, “Sick Chrysler Optimistic Despite Crash,” http://
business.theage.com.au, May 3, 2009.
66. “Chrysler LLC Reports April 2009 U.S. Sales,” http://www
.chryslerllc.com, May 1, 2009.
67. “Chrysler to Launch Ad Campaign to Reassure Nervous Buy-
ers,” http://www.domain-b.com, May 4, 2009.
68. “Chrysler LLC Launches New Global Corporate Advertising
Campaign.” http://www.chryslerrestructuring.com, May 7, 2009.
http://en.wikipedia.org
http://www.morganstanley.com
http://www.citigroup.com
http://www.citigroup.com
http://news.bbc.co.uk
http://news.bbc.co.uk
http://en.wikipedia.org
http://www.nydailynews.com
http://www.globalinsight.com
http://www.mydigitaltc.com
http://www.mydigitaltc.com
http:www.bloomberg.com
http://economictimes.indiatimes.com
http://economictimes.indiatimes.com
http://news.bbc.co.uk
http://www.msnbc.msn.com
http://www.bloomberg.com
http://www.detnews.com
http://www.pressbox.co.uk
http://www.pressbox.co.uk
http://www.bnet.com
http://www.livemint.com
http://www.livemint.com
http://www.chryslerllo.com
http://www.chryslerllo.com
http://www.nationalpost.com
http://www.nationalpost.com
http://news.bbc.co.uk
http://en.wikipedia.org
http://ibnlive.in.com
http://ibnlive.in.com
http://www.mydigitalfc.com
http://www.mydigitalfc.com
http://timesofindia.indiatimes.com
http://timesofindia.indiatimes.com
http://en.wikipedia.org
http://en.wikipedia.org
http://www.msnbc.msn.com
http://www.capstonecr.com
http://www.capstonecr.com
http://business.theage.com.au
http://business.theage.com.au
http://www.chryslerllc.com
http://www.chryslerllc.com
http://www.domain-b.com
http://www.chryslerrestructuring.com
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THUS BEGAN THE INVESTORS OVERVIEW PAGE OF TESLA MOTORS’ website in September 2010.
(See www.teslamotors.com.) The company had just completed an initial public offering
(IPO) of 11,880,600 shares of its common stock plus a private sale of an additional
2,941,176 shares to Toyota Motor Corporation at the initial price of $17.00 per share.
Management intended to use the proceeds to purchase an existing automobile factory in
Fremont, California, from NUMMI, the joint venture between Toyota and Tesla Motors
Liquidation Company, the owner of General Motors’ interest in this plant, and to fund the
expansion of retail stores. With Elon Musk, the founder of PayPal, as its CEO, the company
had developed and successfully sold over 1,200 electric-powered Roadsters as of July 1, 2010.
Advertising Age had named Tesla one of America’s Hottest Brands in 2009—even though the
company did no advertising and relied instead on the Internet, word-of-mouth, and presenta-
tions by CEO Musk.
Selling at $101,000 in the United States, the Tesla Roadster had become the darling of
celebrities like Jay Leno and David Letterman. Introduced in 2008, this electrically powered
auto could accelerate from 0 to 60 miles per hour (mph) in 3.9 seconds and cruise for 236 miles
on a single charge. Motor Trend found in its December 2009 road test that the Roadster
recorded 0 to 60 mph in 3.70 seconds and completed the quarter mile in 12.6 seconds, reach-
ing 102.6 mph. Engineering Editor Kim Reynolds called the acceleration “breathtaking.” The
18-1
C A S E 18
Tesla Motors Inc. (Mini Case)
J. David Hunger
We believe that more than 100 years after the invention of the internal combustion engine, incumbent automobile manufacturers
are at a crossroads and face significant industry-wide challenges. The reliance on the gasoline-powered internal combustion
engine as the principal automobile powertrain technology has raised environmental concerns, created dependence among
industrialized and developing nations on oil largely imported from foreign nations and exposed consumers to volatile fuel
prices. In addition, we believe the legacy investments made by incumbent automobile manufacturers in manufacturing and
technology related to the internal combustion engine have to date inhibited rapid innovation in alternative fuel powertrain
technologies. We believe these challenges offer an historic opportunity for companies with innovative electric powertrain
technologies and that are unencumbered with legacy investments in the internal combustion engine to lead the next
technological era of the automotive industry.
This case was prepared by Professor J. David Hunger, Iowa State University and St. John’s University. Copyright
©2010 by J. David Hunger. The copyright holder is solely responsible for case content. Reprint permission is solely
granted to the publisher, Prentice Hall, for Strategic Management and Business Policy, 13th Edition (and the interna-
tional version and electronic versions of this book) by the copyright holder, J. David Hunger. Any other publication
of the case (translation, any form of electronics or other media) or sale (any form of partnership) to another publisher
will be in violation of copyright law, unless J. David Hunger has granted an additional written permission. Reprinted
by permission.
www.teslamotors.com
December 14, 2008, episode of the British television program Top Gear found that the Roadster
was not only “biblically quick,” but also that it completed the test track with a score similar to
that recorded by the Porsche 911 GT3. According to Top Gear’s Jeremy Clarkson, the car was
an “astonishing technical achievement.”
The air-cooled electric motor weighed less than 70 pounds, but generated 248 horsepower
with no engine noise and no exhaust emissions. Instead of gasoline, it required electricity
stored in 6,831 lithium-ion batteries that were recharged by plugging them into an electric out-
let. It was a true green machine. The Roadster’s battery-to-wheel motor efficiency was 92%
on average and 85% at peak power, contrasted with the gas tank-to-wheel efficiency of inter-
nal combustion engines at about 15%. Tesla’s management reported an energy cost of approx-
imately one U.S. cent per mile when charging the car at night. A full-recharge of the battery
system required 3 1/2 hours using Tesla’s 70 amp, 240 volt electrical connection. The Tesla
Roadster set a new world distance record of 313 miles on a single charge for a production elec-
tric car in a rally across Australia as part of the 2009 Global Green Challenge. Based on
the attractive Lotus Elise sports car, the Tesla Roadster single-handedly destroyed the notion
held by many people at the time that electric cars had to be slow in acceleration and awkward
in appearance.
18-2 SECTION D Industry Four—Transportation
History
Originally conceived by Martin Eberhard and Marc Tarpenning, the Tesla Roadster began to
take shape when Elon Musk took an active role in the company starting in early 2004. He over-
saw the Roadster’s product design and expanded the company’s strategic goals to include mar-
keting mainstream vehicles. The company originally licensed AC Propulsion’s EV Power
System design and Reductive Charging patent. Tesla then re-designed and built its own
advanced battery pack, power electronics module, high efficiency motor, and extensive con-
trol software so that its powertrain was unique and no longer required a license from AC
Propulsion. The electric powertrain had fewer moving parts than an internal combustion en-
gine. In July 2005, Tesla signed an agreement with British sports car maker Lotus for help in
chassis development. Body panels were made from resin transfer molded carbon fiber com-
posite to minimize weight.
The company signed a production contract in 2007 with Group Lotus to produce a total
of 2,400 “gliders” (partially assembled vehicles) in its plant in Hethel, England. For Roadsters
bound for customers in North America, the gliders were sent to Tesla’s plant in Menlo Park,
California, for final assembly with the powertrain. For Roadsters being sold elsewhere in the
world, the gliders received their powertrain at a facility near the Lotus Hethel plant. As of
March 2010, Tesla had purchased 1,200 gliders. The contract with Lotus was scheduled to run
out in December 2011, but the Roadsters would continue being made in 2012 until the supply
of gliders from Lotus was exhausted. The next generation of the Tesla Roadster was to be man-
ufactured in Tesla’s new Fremont, California, facilities.
In August 2007, Martin Eberhard was replaced as CEO by interim CEO Michael Marks,
who was then replaced in December 2007 by Ze’ev Drori as CEO. In October 2008, Elon
Musk succeeded Drori as CEO and Chairman of the Board. Even though Musk was a key
part of Tesla’s progress, he was not a full-time CEO. Musk also served as CEO and Chief
Technology Officer of Space Exploration Technologies, a developer and manufacturer of
space launch vehicles, and as Chairman of SolarCity, a solar equipment installation com-
pany. Tesla’s top management team was quite new. Three of the five members of senior man-
agement, including the CFO and VP of Manufacturing, had joined the company between
2008 and 2010.
CASE 18 Tesla Motors Inc. (Mini Case) 18-3
Business Model
According to the company’s Prospectus, Tesla Motors designed, developed, manufactured,
and sold high-performance fully electric vehicles and advanced electric vehicle powertrain
components. The company intentionally departed from the traditional automotive industry
model by both exclusively focusing on electric powertrain technology and by owning its own
vehicle sales and service network. Tesla Motors was the first company to commercially pro-
duce a federally compliant highway-capable electric vehicle. Management believed that the
company’s core intellectual property contained within its electric powertrain would form
the foundation for its planned future electric vehicles. Since the management team combined the
innovation and speed-to-market characteristics of Silicon Valley firms with the engineering
experience of leading automotive companies, they believed that the company would be able
to rapidly and efficiently introduce additional vehicles, such as the planned Tesla Model S
sedan, and stay at the forefront of the automobile industry.
In contrast to existing auto manufacturers who sold their cars through franchised dealers,
Tesla intended to sell and service its cars through the Internet and through its own Tesla stores.
This was being done in order to reduce costs, to provide a better experience for Tesla cus-
tomers, and to incorporate customer feedback more quickly into the product development and
manufacturing processes. By June 2010, Tesla had opened 12 Tesla stores in major metropol-
itan areas throughout the United States and Europe. Management planned to open 50 stores
globally within the next several years in connection with the Model S introduction. Consequently,
the company hired former Apple and Gap executive George Blankenship to be Vice President
of Design and Store Development in July 2010. According to CEO Musk in a press release,
“George has a record of building customer-focused stores that revolutionize their industries,
and he does it on time and on budget. . . . With George’s leadership, I have no doubt Tesla will
have the best retail experience in the auto industry as we continue to grow and prepare to
launch the Model S.” Tesla stores were the service hub for Tesla Rangers, the mobil service
program that provided house calls for service.
In its Prospectus, management stated that it was designing a Model S four-door, five-
passenger premium sedan that “offered exceptional performance, functionality and attrac-
tive styling with zero tailpipe emissions” at an effective price of $49,900 in the United States
(assuming continuation of the $7,500 tax credit to alternative fuel vehicles). The company
intended to begin volume production at its new Fremont, California, plant in 2012 with a
target annual production of approximately 20,000 cars. The Model S would offer ranges
from 160 to 300 miles on a single charge. It was designed to be charged at home and at com-
mercial charging stations. The Model S would serve as an adaptable platform so that it could
be used to develop a full line of other vehicles, including a product line at lower prices than
the Model S.
In addition to making and selling its own autos, Tesla Motors sold its battery packs and
chargers to other auto companies. It developed a relationship with Daimler to sell 1,000 battery
packs and chargers in 2009 to Daimler’s Smart Fortwo electric drive. Daimler then extended
the order to 1,500 more packs and chargers. This was followed by a 2010 agreement for
Daimler to purchase battery packs and chargers for its A-Class of electric vehicles being
introduced during 2011. In May 2010, Tesla and Toyota Motor Corporation formally agreed
to cooperate in the development of electric vehicles, beginning with an electric version of
Toyota’s popular RAV4. In exchange, Tesla would receive Toyota’s support in sourcing parts
and production and engineering expertise for the Model S. As a result of these agreements,
Tesla management planned to expand its electric powertrain production facility in Palo Alto,
California, to develop and market powertrain components to Daimler, Toyota, and other auto
manufacturers.
18-4 SECTION D Industry Four—Transportation
Auto Industry
By late 2010, most automobile manufacturers were in the process of developing their own
versions of the electric car. General Motors was launching its electric Volt for about $41,000
less federal tax rebates. To combat “range anxiety,” the Volt contained a gasoline engine that
would run the electric motor when the batteries ran low after 40 miles. Nissan was also intro-
ducing its all-electric Leaf, a $33,600 compact that would average 100 miles on a charge.
Daimler was leasing an all-electric version of its SmartCar. In addition, BMW, Chrysler,
Ford, Toyota, and Mitsubishi were introducing electric models within a year or so. Industry
analysts were projecting that, following an expected increase in the world’s population from
6.8 billion to 9 billion people by 2050, the number of autos will rise from 800 million to
1.1 billion. According to Frost & Sullivan, the market for electric-based vehicles (including
electric, hybrid electric, and plug-in hybrid electric vehicles) was expected to grow approxi-
mately 10.6 million globally, or to approximately 14% of new vehicles sold by 2015, from
1.75 million units or 3% of new vehicles sold in 2008.
A number of factors would determine the success of the electric auto. One was the high
level of unemployment and economic anxiety due to the “great recession” of 2008–2009. In
the short run, potential consumers were likely to be very cost conscious and less willing or able
to use credit to purchase a new durable product, like a major appliance or an automobile. An
electric or hybrid electric auto generally cost more than a comparable gasoline-powered car.
Auto companies were aware that it will take some time for customers to become accustomed
to the vagaries of regenerative braking that slows the car as soon as the foot is lifted off the
accelerator. (In those situations when the car is fully charged, however, no regenerative brak-
ing is needed, and the car does not slow down until the brakes are applied.)
It was widely acknowledged in the industry that a key limiting factor was current battery
technology. Recharging batteries took much longer than did refilling a gas tank. Charging an
auto via a standard U.S. 110-volt outlet might take 8 to 12 hours. (The Nissan Leaf’s low price
included a 110-volt charging system, but could be upgraded to a 220-volt system by paying
$700 more.) Charging time could be reduced to 4–8 hours by installing a 240-volt outlet in the
garage. Another factor influencing electric car sales was “range anxiety,” a driver’s concern
with running out of power while far from a recharging station. The effective range of an elec-
tric car was a function of how hard the car was driven and the amount of electricity needed to
power the headlights, dash lights, radio, heater, and air conditioner, plus heated seats and other
power-consuming amenities. In addition, the batteries were likely over time to lose their capac-
ity to hold a charge. Tesla Motors estimated that its battery pack will retain about 60%–65% of
its ability to hold its initial charge after approximately 100,000 miles and 7 years.
A key influencing factor was the battery pack, which took up a significant amount of space
and added weight—thus affecting carrying capacity and handling. For example, the battery
pack took up the entire backseat of BMW’s Mini Cooper electric car. Top Gear’s 2008 road
test of the Tesla Roadster versus the Lotus Elise, upon which it was based, found the Tesla to
be less capable and much slower in turns than was the Lotus, even though the Tesla was the
faster car. Battery packs were also very expensive. The Nissan Leaf’s battery pack, for exam-
ple, cost about $15,000, half the car’s selling price. In addition, lithium-ion batteries had a his-
tory in laptop computers of heating up and sometimes failing. Even though auto makers were
designing their battery pack so that any single cell’s sudden release of energy would not spread
to adjacent cells, there was always the possibility of battery pack failure. Consumer Reports
reported that loud battery cooling fans in the Tesla Roadster emitted a constant roar of noise.
Nevertheless, as electric car technology advanced, the price, carrying capacity, and durability
of electric cars was expected to improve—thus increasing the size of the market.
CASE 18 Tesla Motors Inc. (Mini Case) 18-5
From the perspective of Tesla Motors, existing auto makers faced significant hurdles in
successfully competing in the electric car market. Even though GM and Toyota had each
invested over $1 billion in hybrid and plug-in electric vehicle programs, they continued to invest
in internal combustion technology because of their need to support their existing revenue base
and core competencies. The need of existing car makers to investigate multiple alternative
power technologies, such as hydrogen fuel cell, clean diesel, and natural gas powertrains, had
inhibited their ability to develop electric powertrain technology. Recent deteriorating margins
reduced flexibility and constrained auto companies’ liquid capital resources. Profitability pres-
sures were further exacerbated by the typically expensive and time-consuming new product
development process.
Tesla Motors’ Strategic Position
Tesla’s management argued that, due to their proprietary electric powertrain system, their
company had a competitive advantage over existing auto makers. For example, Tesla vehi-
cles were designed with greater range and recharging flexibility and were more efficient to
operate than were the electric cars of competitors. In addition, the Tesla Roadster offered high
performance without compromising design or functionality. Management pointed to the com-
pany’s many strengths:
� Leadership in electric power technology. The Tesla Roadster had a battery pack capable
of storing 53 kilowatt hours of usable energy, almost double the energy of any other com-
mercially available electric vehicle battery pack;
� Competencies in electrical engineering, software, and controls as well as vehicle engi-
neering and manufacturing;
� Ability to combine electric powertrain expertise with electric vehicle design and systems
integration;
� Rapid customer-focused product development;
� Ownership of its sales and service network;
� Brand leadership in high-performance, long-range electric vehicles;
� Long-term financial support from a $465 million loan facility agreement under the
U.S. Department of Energy’s Advanced Technology Vehicles Manufacturing Incentive
Program; and
� Efficient research & development process. Cumulative capital expenditures and R&D for
the Tesla Roadster totaled only $125 million.
Tesla’s management also admitted that the company had weaknesses and faced significant
risks. For one thing, even though its total revenues had increased from $73 million in 2007 to
$14.7 billion in 2008 to $111.9 billion in 2009, the company had never earned a profit. Its net
losses had varied from $78.2 billion in 2007 to $82.8 billion in 2008 to $55.7 billion in 2009.
For the first six months of 2010, revenues had increased to $49.2 billion from $47.8 billion
during the same period in 2009. If battery pack and charging equipment sales of $4.7 billion
to Daimler had not been included, however, 2010 six-month revenue from auto sales would
have only been $44.6 billion. For the same six-month period, net losses increased from
$26.9 billion in 2009 to $68.0 billion in 2010, primarily due to a tripling of both R&D and
selling, general, and administrative expenses. The company also incurred $45.4 billion in
long-term debt in 2010 compared to none in 2009.
18-6 SECTION D Industry Four—Transportation
Tesla’s management admitted that the rate at which the company incurred losses was
expected to increase significantly as it developed and manufactured the Model S, continued R&D
on its electric power train, equipped its manufacturing facilities, opened new Tesla stores, ex-
panded its service and repair facilities, and increased its marketing and its general and admin-
istrative functions to support growing operations. For example, one of the risks in selling autos
through the Internet or through company-owned retail stores was that many U.S. states prohib-
ited auto manufacturers from selling directly to consumers without the use of an independent
dealership or a physical presence in the state. As of 2010, the company was registered as both
a manufacturer and dealer in California, Colorado, Florida, Illinois, and Washington, and
licensed as a dealer in New York. Management also admitted that they had no experience to
date in high volume manufacturing and did not know if they would be able to develop efficient,
automated, low-cost manufacturing capabilities and processes, as well as reliable sources of
component supply. Even though Tesla Motors purchased 30% of its parts from North American
suppliers, 40% from European suppliers, and 30% from Asian suppliers, the company was
reliant upon a few single source suppliers. For example, Sotira Composites Group supplied all
carbon fiber body panels, BorgWarner supplied all gearboxes, and Lotus was the only supplier
of the Roadster glider. Other risks abounded. Even though none of the Tesla employees were
unionized in 2010, in-house manufacturing using the Fremont facility purchased from
NUMMI might result in a workforce inclined to form a union.
The Future
By September 2010, Tesla Motors had finalized the design of the Model S, built prototypes
of the Model S battery and powertrain, and released design specs to external parts suppliers.
Its new VP of Design and Store Development was expanding Tesla’s distribution and service
network. All powertrain manufacturing had been centralized in Tesla’s new corporate head-
quarters in Palo Alto, California. In order to manufacture both its Roadster and new Model S
in-house, the company had successfully purchased the old NUMMI manufacturing facility—
located just 20 miles from Tesla’s headquarters. Even though the company’s stock price had
first surged and then fallen from its initial IPO price of $17, a Tesla share of stock was worth
$19.56 at the September 23, 2010, stock market close. The firm appeared to be on track to
achieve its goal of staying at the forefront of the electric automobile industry by building a
full line of electric vehicles. Although it was unlikely that the company would become prof-
itable in the next few years, management continued to be optimistic about the future of Tesla
Motors.
Industry analysts cautioned, however, that no new company has been able to successfully
enter the U.S. auto manufacturing industry since the 1920s. Would Tesla Motors be an excep-
tion? Now that the large global auto corporations were developing their own versions of the
electric car, would it only be a matter of time before they caught up with Tesla’s technology
lead and surpassed it? Companies like GM, Toyota, and Ford had major advantages over Tesla
in resources, brand identity, economies of scale, and distribution. A technological advance in
battery power, size, and weight could completely alter the competitive landscape. How could
Tesla Motors defend itself against the entire industry and not only become profitable, but also
a major player in a very competitive global industry?
IT WAS A PRETTY AMAZING SIGHT, DOZENS AT A TIME, THOUSANDS IN A DAY DESCENDING ON THE
Sinclair gas station and Western café in Lusk, Wyoming, on their way to the 2008 Sturgis
rally in the blistering heat of early August. Lusk, a town of 1,348 people that lies 147 miles
southwest of Sturgis, saw bikers from all walks of life, needing fuel and small supplies,
some with tattoos, some with leather to protect themselves from the winds as they cruised
at 60 miles per hour along Highway 18 toward Sturgis. Some clearly were businessmen
on a weeklong reprieve, others were rougher in appearance. The one thing they all had in
common was the love of the ride . . . the ride of the Harley-Davidson motorcycle.
There were new issues facing Harley-Davidson in their 105th year of operation. Consider
the weak dollar, the probability that retail sales would continue a downward spiral, which in
turn would cause excess inventory of high priced motorcycles. Then there was the customer
base: the rockers who grew up in the sixties and seventies are graying and this threatens the
growth of Harley-Davidson. As riders approach sixty, it is important for Harley-Davidson to
recruit new riders of the younger generations. Their emphasis on recruiting women has been
instrumental in recent years. They were faced with an aging baby boomer population and
needed to focus on growing smaller segments of their business—women bikers and younger
bikers, the latter who could not traditionally afford a Harley-Davidson motorbike.
Many things were looking good for the 105-year-old motorcycle manufacturer; however,
President and CEO James Ziemer needed to continue the company’s strong growth as many
economists felt the economy was heading into a recession. Harley-Davidson had opened their
first dealership in mainland China, and named Beijing Feng Huo Lun as the first authorized
dealer. A Harley-Davidson museum was due to open in 2008 and sought to attract upwards of
19-1
C A S E 19
Harley-Davidson Inc. 2008:
THRIVING THROUGH A RECESSION
Patricia A. Ryan and Thomas L. Wheelen
We fulfill dreams through the experience of motorcycling by providing to motorcyclists and to the general public
an expanding line of motorcycles, branded products and services in selected market segments.1
HARLEY-DAVIDSON MISSION STATEMENT
Copyright ©2008 by Professor Patricia A. Ryan of Colorado State University and Thomas L. Wheelen, Wheelen
Strategic Audit. This case cannot be reproduced in any form without the written permission of the copyright holder,
Patricia A. Ryan. This case was edited for SMBP-13th Edition. The copyright holder is solely responsible for the case
content. Reprint permission is solely granted to the publisher, Prentice Hall, for the book Strategic Management and
Business Policy—13th Edition (and the International and electronic versions of this book) by the copyright holder,
Patricia A. Ryan. Any other publication of the case (translation, any form of electronics or other media) or sale (any
form of partnership) to another publisher will be in violation of copyright law, unless Patricia A. Ryan has granted
additional written reprint permission. Reprinted by permission.
History3
In 1901, William Harley (age 21), a draftsman, and his friend, Arthur R. Davidson, began ex-
perimenting with ideas to design and build their own motorcycles. They were joined by
Arthur’s brothers, William, a machinist, and Walter, a skilled mechanic. The Harley-Davidson
Motor Company started in a 10 � 15 foot shed in the Davidson family’s backyard in Milwaukee,
Wisconsin.
In 1903, three motorcycles were built and sold. The production increased to eight in 1904.
The company then moved to Juneau Avenue, which is the site of the company’s present of-
fices. In 1907, the company was incorporated.
Ownership by AMF
In 1969, AMF Inc., a leisure and industrial product conglomerate, acquired Harley-Davidson.
The management team expanded production from 15,000 in 1969 to 40,000 motorcycles in
1974. AMF favored short-term profits instead of investing in research and development and
retooling. During this time, Japanese competitors continued to improve the quality of their
motorcycles, while Harley-Davidson began to turn out noisy, oil-leaking, heavy vibrating,
poorly finished, and hard-to-handle machines. AMF ignored the Japanese competition. In
1975, Honda Motor Company introduced its “Gold Wing,” which became the standard for
large touring motorcycles. Harley-Davidson had controlled this segment of the market for
years. There was a $2,000 price difference between Harley’s top-of-the-line motorcycles and
Honda’s comparable Gold Wing. This caused American buyers of motorcycles to start
switching to Japanese motorcycles. The Japanese companies (Suzuki and Yamaha) from this
time until the middle 1980s continued to enter the heavyweight custom market with Harley
look-alikes.
During AMF’s ownership of the company, sales of motorcycles were strong, but profits
were weak. The company had serious problems with poor quality manufacturing and strong
Japanese competition. In 1981, Vaughn Beals, then head of the Harley Division, and 13 other
managers conducted a leveraged buyout of the company for $65 million.
Under New Management
New management installed a Materials As Needed (MAN) system to reduce inventories and
stabilize the production schedule. Also, this system forced production to work with market-
ing for more accurate forecasts. This led to precise production schedules for each month, al-
lowing only a 10% variance. The company forced its suppliers to increase their quality in
order to reduce customer complaints.
Citicorp, Harley’s main lender, refused to lend any more money in 1985. On New Year’s
Eve, four hours before a midnight that would have meant Harley’s demise, the company inked
350,000 tourists per year. CEO and President Ziemer worked his way up the ranks, starting
38 years ago as a freight elevator operator and most recently serving a 14-year stint at CFO,
but now at the driver’s seat, he faced a different set of responsibilities. As noted by one analyst,
There are indications that Harley-Davidson is at a turning point. “It’s a well managed
company with still one of the strongest brand names in consumer products, but I just ques-
tion whether the company can grow its production 7 to 9 percent in an environment where
demand doesn’t seem to be growing at that rate”
Ed Aaron, analyst with BRC Capital Markets2
19-2 SECTION D Industry Four—Transportation
CASE 19 Harley-Davidson Inc. 2008 19-3
Year Sales Units (thousands)
1994 $ 6 million 576
1995 $14 million 1,407
1996 $23 million 2,762
1997 $40 million 4,415
1998 $53.5 million 6,334
1999 $63.5 million 7,767
2000 $58.1 million 10,189
2001 $61.9 million 9,925
2002 $66.9 million 10,900
2003 $76.1 million 10,000
2004 $79.0 million 9,900
2005 $93.1 million 11,200
2006 $102.2 million 12,460
2007 $100.5 million 11,513
a deal with Heller Financial that kept its doors open. Seven months later, amid a hot market
for new stock, Harley-Davidson went public again. Ziemer, the CFO puts it more bluntly:
“You throw cash at it, try to grow too fast, you’d destroy this thing.”4
During the time Harley-Davidson was a privately held firm, management invested in re-
search and development. Management purchased a Computer-Aided Design (CAD) system
that allowed the company to make changes in the entire product line and still maintain its tra-
ditional styling. These investments by management had a quick payoff in that the break-even
point went from 53,000 motorcycles in 1982 to 35,000 in 1986.
During 1993, the company acquired a 49% interest in Buell Motorcycle Company, a man-
ufacturer of sport/performance motorcycles. This investment in Buell offered the company the
possibility of gradually gaining entry into select niches within the performance motorcycle
market. In 1998, Harley-Davidson owned most of the stock in Buell. Buell began distribution
of a limited number of Buell motorcycles during 1994 to select Harley-Davidson dealers.
Buell sales were:5
Buell’s mission “is to develop and employ innovative technology to enhance ‘the ride’and
give Buell owners a motorcycle experience that no other brand can provide.” The European
sport/performance market was four times larger than its U.S. counterpart. In 2007, there were
804 dealerships that sold Buell bikes dealerships worldwide. Most of these dealerships were
combined Harley-Davidson and Buell dealerships.
In 1995, the company acquired substantially all of the common stock and common stock
equivalents of Eaglemark Financial Services, Inc., a company in which it held a 49% interest
since 1993. Eaglemark provided credit to leisure product manufacturers, their dealers, and cus-
tomers in the United States and Canada. The transaction, valued at $45 million, was accounted
for as a step acquisition under the purchase method.
Concentration on Motorcycles
In 1996, the company announced its strategic decision to discontinue the operations of the
Transportation Vehicles segment in order to concentrate its financial and human resources on
its core motorcycle business. The Transportation Vehicles segment was composed of the
Recreation Vehicles division (Holiday Rambler trailers), the Commercial Vehicles division
(small delivery vehicles), and B & B Molders, a manufacturer of custom or standard tolling
and injection-molded plastic pieces. During 1996, the company completed the sale of the
Transportation Vehicles segment for an aggregate sales price of approximately $105 million;
approximately $100 million in cash and $5 million in notes and preferred stock.
19-4 SECTION D Industry Four—Transportation
Internal Makeover and New Products
In 1997, Harley-Davidson created an internal makeover. The unsung hero of Harley-Davidson’s
supply-chain makeover was an intense procurement expert named Garry Berryman, vice pres-
ident of Materials Management/Product Cost from 1995 to 2003 at Honda. When Berryman
joined Harley-Davidson, he found the supply-chain management neglected. There were nine
different purchasing departments operating from different plant locations, fourteen separate
sets of representative terms and conditions, and nearly 4,000 suppliers. Engineers with little
or no expertise in supply management were doing the bulk of the buying. To top it off, “the
voice of supply management was buried three layers deep in the corporate hierarchy,” said
Berryman.
While at Honda, Berryman studied Japanese keiretsu—huge, vertically integrated com-
panies that foster deep, trusting relationships with suppliers. He wanted to form similar strate-
gic alliances with Harley’s top suppliers, bringing them into the design and planning process.
Berryman felt that new technology and the Internet would make it easier than ever to form
these bonds and collaborate. He made it clear that relationship and strategy should drive ap-
plications, not vice versa. As Dave Cotteleer, the company’s manager of planning and control,
explained, “We’re using technology to cut back on communication times and administrative
trivia, like invoice tracking, so we can focus the relationships on more strategic issues. We’re
not saying, ‘Here’s a neat piece of technology. Let’s jam it into our model.”6
Also, in the 1990s, Harley-Davidson saw the need to build a motorcycle to appeal to the
younger and international markets who preferred sleeker, faster bikes. Harley-Davidson spent
an undisclosed amount of research and development dollars over several years to develop the
$17,000 V-Rod motorcycle. The V-Rod, introduced in 2001, had 110 horsepower, nearly dou-
ble that of the standard Harley Bike. The V-Rod was the quickest and fastest production model
the company had ever built, capable of reaching 60 miles an hour in 3.5 seconds and 100 mph
in a little over 8 seconds. Its top speed is about 140 mph. All in all, the V-Rod was faster and
handled better than the traditional bulky Harley bikes.
All other Harley models are powered by 45-degree V-twin air-cooled engines with
camshafts in the block; the new V-Rod has a 1,130-cc 60-degree engine with double overhead
cams and four values for each cylinder. The V-Rod has a very long 67.5-inch wheelbase, and
it handles better than other Harleys because it is so much lighter. Furthermore, the V-Rod is only
26 inches off the ground, so it will accommodate a wide range of rides.7 Harley-Davidson hoped
to gain some of the younger markets with this new bike.
In 2000, a new Softail model was introduced and all Softail models were outfitted with
the twin Cam 88B engine. Fuel injection was introduced for the Softails in 2001 and in 2000;
Buell introduced the Buell Blast, which was a single-cylinder bike. Along with the Buell Blast,
Harley-Davidson introduced a new beginner rider’s course aimed at the first time Harley
owner and rider. The course was offered in Harley-Davidson and Buell dealerships. The
VRSCA V-Rod in 2002 was the first Harley bike to combine fuel injection, overhead cams,
and liquid cooling along with new 115 horsepower.
In an attempt to gain further female support, Harley-Davidson announced the introduc-
tion of 17-year-old Jennifer Snyder, a champion dirt bike racer as the newest member of the
Harley-Davidson racing team. Female racers were starting to enter this predominantly male
sport and Harley-Davidson would not miss this opportunity to challenge market perceptions
of a Harley-Davidson rider.
In 2003, Harley-Davidson introduced the Lightning XBS9. In 2004, the Sportsters were
refitted with rubber engine mounting, a new frame and a wider rear tire. The FLHRSI Road
King was introduced with low rear suspension and wide handlebars for a beach appearance.
In 2005, the XL 883 Sportster 883 Low, featuring a lowered seating position aimed at aging
baby boomers, was added to the Sportster line. The FLSTNI Softail Deluxe was added to the
Softail line with a new sleek appearance reminiscent of the 1939 Harley-Davidson bike. In the
same year, the FLSTSC/I Softail Springer-Classic revived the late 1940s bike in appearance.
In 2006, the Dyna motorcycle line was developed with the first 6-speed transmission. The
new FLHX/I Street Glide was introduced as a lower profile touring bike. Scheduled for open-
ing in 2008 was the Harley-Davidson museum in Milwaukee, Wisconsin. In the area of inter-
national development, the first dealership was opened in mainland China. In 2008, the
company introduced four new bikes aimed at two markets—aging baby boomers and the
growing female market.
CASE 19 Harley-Davidson Inc. 2008 19-5
Corporate Governance
Board of Directors
The Board of Directors consisted of 11 members, of which only two were internal members—
James L. Ziemer, President and Chief Executive Officer (CEO), and Thomas E. Bergman, the
Chief Financial Officer. Exhibit 1 highlights board members in 2008.
The Board of Directors serve three-year staggered terms. Each of the nine non-employee
directors are compensated $100,000 per year. At least half of this amount is to be paid in com-
mon stock.
Since 2005, the board has authorized a stock repurchase. In 2007, 2006, and 2005, the
Company repurchased 20.4 million, 19.3 million, and 21.4 million shares of its common stock
at weighted-average prices of $56, $55, and $49, respectively. As of February 2008, all of the
20 million shares authorized in 2007 remained to be repurchased. Each of the prior two years
authorizations were fully repurchased by the end of the next year.
Top Management
James C. Ziemer started with Harley-Davidson 38 years ago as a freight elevator operator and
served as the CFO from 1991 to 2005. In 2005, upon the retirement of Harley veteran Jeffrey
Bluestein, Ziemer assumed the top role of President and CEO. He commented, “Harley-
Davidson is strong and well-positioned for the road ahead.”8 Ziemer further commented:
I believe there are three constants in our success as a company: 1. Our passion for this business,
for riding, and for relating to and being one with our customers; 2. Our sense of purpose—in
other words, our focus on growing demand by offering great products and unique experiences;
and 3. Operational Excellence—which is the continuous, relentless drive to eliminate waste in
all aspects of our operations and to run Harley-Davidson better and more efficiently with each
passing day. And I believe these three things—being close to our customers, growth and Opera-
tional Excellence—hold the keys to the future.9
Exhibit 2 shows the corporate officers for Harley-Davidson and its business segments—
motor company leadership, Buell leadership, and financial services leadership.
Through 2006, Harley-Davidson received positive attention from the popular press in
terms of rankings. In 2006, Business Week/Interbrand Annual Rankings Top 100 Global Brands
placed Harley-Davidson at #45, up 1 from 2005. Fortune also placed Harley-Davidson in its
2004 list of “Most Admired Companies.”10 Previously, Forbes named Harley Davidson its
“Company of the Year” for 2001. Harley-Davidson did not make Fortune’s list in 2008.
In 2007, Harley-Davidson experienced its first decline in 20 years. Motorcycle revenue
was down 1.27% over 2006, total revenue was down 0.69% and, perhaps most importantly, op-
erating income suffered a 10.74% decline. Harley-Davidson, which had fought back from near
demise in the 1980s was to face new rivals in the competitive market, an aging customer base,
and the recession. Given the recession in 2008, what did the future hold for Harley-Davidson?
These were issues management wrestled with as they planned for the future. One possible so-
lution was to gain new, younger customers as the future as their current customers aged.
19-6 SECTION D Industry Four—Transportation
EXHIBIT 1
Board of Directors: Harley-Davidson Inc.
Barry K. Allen, President, Allen Enterprises, LLC
Barry has been a member of the Board since 1992. His distinguished business career has taken him from the telecommu-
nications industry to leading a medical equipment and systems business and back again. Barry’s diverse experience has
been particularly valuable to the Board in the areas of marketing and organization transformation.
Richard I. Beattie, Chairman of the Executive Committee, Simpson Thacher & Bartlett
Dick has been a valued advisor to Harley-Davidson for nearly 20 years. His contributions evolved and grew with the com-
pany over time. In the early 1980s, he provided legal and strategic counsel to the 13 leaders who purchased Harley-
Davidson from AMF, taking it back to private ownership. He also advised the team when it was time to take the company
public again in 1986. Dick was elected to the Board in 1996.
Jeffrey L. Bleustein, Chairman of the Board, Harley-Davidson, Inc.
Jeff began his association with Harley-Davidson in 1975 when he was asked to oversee the engineering group. During his
tenure as Vice President-Engineering, Harley-Davidson developed the Evolution engine and established the foundations of
our current line of cruiser and touring motorcycles. Jeff has demonstrated creativity and vision across a wide range of sen-
ior leadership roles. In 1996, he was elected to the Board, and in June 1997, appointed CEO until his retirement in 2005.
He remains on as Chairman of the Board.
George H. Conrades, Executive Chairman of Akamai Technologies, Inc.
George has served as a director since 2002 and brings with him extensive experience in e-business. Akamai Technologies is
a provider of secure, outsourced e-business infrastructure services and software. He is also a partner with Polaris venture
Partners, an early-stage investment company.
Judson C. Green, President and CEO, NAVTEQ Corporation
NAVTEQ is a leading provider of comprehensive digital map information for automotive navigation systems, mobile nav-
igation devices and Internet-based mapping applications. Judson has served as a director since 2004.
Donald A. James, Vice Chairman and Chief Executive Officer, Fred Deeley Imports, Inc.
Don’s wisdom and knowledge of the motorcycle industry has guided the Board since 1991. As a 31-year veteran of Harley-
Davidson’s exclusive distributor in Canada, he has a strong sense for our core products. Don has a particularly keen under-
standing of the retrial issues involved with motorcycles and related products and the competitive advantage inherent in
strong, long-lasting dealer relationships.
Sara L. Levinson, ChairMom and Chief Executive Officer, ClubMom, Inc.
Sara joined the Board in 1996. She understands the value and power of strong brands, and her current senior leadership
role in marketing and licensing, together with her previous experience at MTV, give her solid insights into the entertain-
ment industries and younger customer segments.
George L. Miles, Jr., President and CEO, WQED Multimedia
George has been a director since 2002 and currently serves as president and CEO of WQED Multimedia, the public broad-
caster for southwestern Pennsylvania.
James A. Norling, Executive Vice President, Motorola, Inc.; President, Personal Communications Sector, retired
Jim has been a Board member since 1993. His career with Motorola has included extensive senior leadership assignments in
Europe, the Middle East, and Africa, and he has generously shared his international experience and understanding of techno-
logical change to benefit Harley-Davidson.
James L. Zeimer, President and CEO, Harley Davidson, Inc.
Jim has been with Harley-Davidson for over 38 years and served as CFO until 2005 when he assumed the role of CEO
upon Jeff Bluestein’s retirement. He has been a director since 2004.
Jochen Zeitz, Chief Executive Officer and Chairman of the Board, Puma AG.
Mr. Zeitz was elected to the Board in August 2007 when the size of the Board grew from 10 to 11 members. Mr. Zeitz will
serve as a Class II director with a term expiring at the Company’s 2008 annual meeting of shareholders.
SOURCE: Harley Davidson, Inc., 2007 Form 10-K, page 99.
CASE 19 Harley-Davidson Inc. 2008 19-7
EXHIBIT 2
SOURCE: Harley Davidson, Inc., 2006 Annual Report, p. 32.
Kathleen A. Lawler
Vice President, Communications
Lara L. Lee
Vice President, Enthusiast Services
Matthew S. Levatich
Vice President, Materials Management
Gail A. Lione
Vice President and General Counsel
James A. McCaslin
President and Chief Operating Officer
Jeffrey A. Merten
Managing Director, Asia Pacific and Latin America
Louis N. Netz
Vice President and Director, Styling
John A. Olin
Vice President, Controller
Steven R. Phillips
Vice President, Quality, Reliability and Technical Services
Harold A. Scott
Vice President, Human Resources
Patrick Smith
General Manager, General Merchandise
W. Kenneth Sutton, Jr.
Vice President, Engineering
Michael van der Sande
Managing Director, HD Europe
Jerry G. Wilke
Vice President, Customer Relationships and Product
Planning
3. Harley-Davidson Financial Services Leadership
Lawrence G. Hund
Vice President, Operations and Chief Financial Officer
Kathryn H. Marczak
Vice President, Chief Credit and Administrative Officer
Saiyid T. Naqvi
President
4. Buell Motorcycle Company Leadership
Erik F. Buell
Chairman and Chief Technical Officer
Jon R. Flickinger
President and Chief Operating Officer
1. Corporate Officers, Harley-Davidson, Inc.
James L. Ziemer
President and Chief Executive Officer
Thomas E. Bergmann
Executive Vice President, and Chief Financial Officer
Gail A. Lione
Vice President, General Counsel and Secretary
James M. Brostowitz
Vice President, Treasure, and Chief Accounting Officer
2. Motor Company Leadership
Joanne M. Bischmann
Vice President, Marketing
David P. Bozeman
General Manager, Powertrain Operations
James M. Brostowitz
Vice President and Treasurer
Leroy Coleman
Vice President, Advanced Operations
Rodney J. Copes
Vice President and General Manager, Powertrain
Operations
William B. Dannehl
Vice President, North American Sales and Dealers Services
William G. Davidson
Vice President and Chief Styling Officer
Karl M. Eberle
Vice President and General Manager, Kansas City
Operations
Robert S. Farchione
General Manager, Parts and Accessories
Fred C. Gates
General Manager, York Operations
James E. Haney
Vice President and Chief Information Officer
Michael P. Heerhold
General Manager, Tomahawk
Timothy K. Hoelter
Vice President, Government Affairs
Ronald M. Hutchinson
Vice President, New Business
Michael D. Keefe
Vice President and Director, Harley Owners Group®
19-8 SECTION D Industry Four—Transportation
EXHIBIT 3
2007 Profile of the
HOG and BRAG:
Harley-Davidson Inc.
SOURCE: Harley-Davidson, Inc, http://www.harley-davidson.com.
HOG Sponsored Events: In 2007, H.O.G.
continued to sponsor motorcycling events on
local, regional, national, and international
levels. The sixteenth annual international
H.O.G. Rally drew tens of thousands of
members.
HOG Membership: Any Harley-Davidson
motorcycle could become a member of
H.O.G. In fact, their first year of member-
ship was included with the purchase of a
new Harley-Davidson motorcycle. The
number of H.O.G. members had grown
rapidly since the motorcycle organization
began in 1983 with 33,000 members. Now,
the largest factory sponsored motorcycle
organization in the world, there were over
1 million H.O.G. members in 130 countries
worldwide. Sponsorship of H.O.G.
chapters by Harley-Davidson dealers grew
from 49 chapters in 1985 to over
1,400 chapters in 2007.
A Snapshot of H.O.G.
Created in 1983
Worldwide members 1,000,000
Worldwide dealer-sponsored chapters 1,400
Countries with members 115
A Snapshot of BRAG (Buell Riders Adventure Group)
Created in 1995
Worldwide members 11,000
Number of clubs 55
Harley Owners Group (H.O.G)
A special kind of camaraderie marked the Harley Owners Group rallies and other motorcy-
cle events. At events and rallies around the world, members of the H.O.G. came together for
fun, adventure, and a love of their machines and the open road. As the largest motorcycle
club in the world, H.O.G. offered customers organized opportunities to ride their famed
bikes. H.O.G. rallies visibly promote the Harley-Davidson experience to potential new cus-
tomers and strengthened the relationships among members, dealers, and Harley-Davidson
employees.
William G. Davidson, grandson of the co-founder, biker to the core, known to all as
Willie G., says, “There’s a lot of beaners, but they’re out on the motorcycles, which is a beau-
tiful thing.” He noted that he recently co-led a national rally of Canadian HOG groups with
Harley’s Chairman Jeff Bleustein.11
In 1995, the Buell Riders Adventure Group (BRAG) was created to bring Buell motorcy-
cle enthusiasts together and to share their on-road experiences. Harley-Davidson plans to grow
both organizations with new members and chapters in the years to come.
Exhibit 3 provides a profile of H.O.G and BRAG clubs. In 2007, H.O.G. membership
grew to over 1,000,000 strong, making it the largest factory-sponsored motorcycle club in the
world. The newer BRAG club for Buell riders numbered 11,000 members.
http://www.harley-davidson.com
CASE 19 Harley-Davidson Inc. 2008 19-9
The Harley-Davidson Museum
In June 2006, Harley-Davidson began construction of a 130,000 square foot museum. The
museum houses a collection of motorcycles and historical mementos from the company’s
105-year history. It was anticipated there will be over 350,000 visitors each year to the
Milwaukee museum with an anticipated opening in summer 2008.
“With over one hundred years and millions of motorcycles behind us, Harley-Davidson
has a rich history, and exciting present, and a vibrant future. In the years to come, the Harley-
Davidson Museum will be a centerpiece of the Harley-Davidson experience.” said CEO
Ziemer.12
Domestic and Foreign Distribution13
United States
Domestically, Harley-Davidson sold its motorcycles and related products at wholesale to a
network of approximately 684 independently-owned full-service Harley-Davidson dealer-
ships. Included in this figure were 307 combined Harley-Davidson and Buell dealerships. In
2007, in partial response to a dismissed lawsuit alleging improper allocation of motorcycles,
Harley-Davidson implemented a new U.S. motorcycle distribution system to better align de-
mand with supply of bikes.
With respect to sales of new motorcycles, approximately 80% of the U.S. dealerships
sold the Harley-Davidson motorcycles exclusively. Independent dealers also sold a smaller
portion of parts and accessories, general merchandise, and licensed products through “non-
traditional” retail outlets. The “non-traditional” outlets, which serve as extensions of the
main dealerships, consist of Secondary Retail Locations (SRLs), Alternate Retail Outlets
(AROs), and Seasonal Retail Outlets (SROs). Secondary retail locations are satellites of the
main dealership and were developed to meet the service needs of the company’s riding cus-
tomers. They also provided parts and accessories, general merchandise, and licensed prod-
ucts and were authorized to sell and service new motorcycles. Alternate retail outlets, located
primarily in high-traffic locations such as malls, airports, or popular vacation destinations,
focus on selling general merchandise and licensed products. Seasonal retail outlets, located
in similar high-traffic areas, operate on a seasonal basis. There were approximately
104 SRLs, 68 AROs, and 12 SROs in the United States.
Foreign Operations
Revenue from the sale of motorcycles and related products to independent dealers and dis-
tributors located outside of the United States was approximately $1.52 billion, $1.18 billion,
and $1.04 billion, or approximately 27%, 20%, and 19% of net revenue of the Motorcycles
segment during 2007, 2006, and 2005, respectively.
Europe/Middle East/Africa
At the end of 2007, there were 370 independent Harley-Davidson dealerships serving 32 Eu-
ropean country markets. This included 323 combined Harley-Davidson and Buell dealer-
ships. Buell was further represented by four dealerships that did not sell Harley-Davidson
motorcycles. Harley-Davidson planned to open a new sales office in South Africa in 2008.
19-10 SECTION D Industry Four—Transportation
Asia-Pacific
In the Asia/Pacific region, Harley-Davidson sold motorcycles and related products at whole-
sale to independent dealers and distributors. In Japan, sales, marketing, and distribution of
product are managed from its subsidiary in Tokyo, which sold motorcycles and related prod-
ucts through 130 independent Harley-Davidson dealers. Fifty-seven of these dealers sell both
Harleys and Buells. Three dealerships sold only Buell Bikes.
In Australia and New Zealand, the distribution of Harley-Davidson products was man-
aged by independent distributors that purchased directly from the Harley-Davidson’s U.S. op-
eration. In 2007, the Harley-Davidson’s subsidiary in Sydney, Australia managed the sales,
marketing, and distribution in that region. The Australia/New Zealand market was served at
retail by a network of 49 independent Harley-Davidson dealerships, including 32 that sold
both Harley-Davidson and Buell products.
Latin America
In Latin America, Harley-Davidson sold motorcycles and related products at wholesale to in-
dependent dealers. Harley-Davidson supplied all products sold in the Latin America region
directly to independent dealers from its U.S. operations, with the exception of certain motor-
cycles sold in Brazil which are assembled and distributed by the Company’s subsidiary in
Manaus, Brazil.
In Latin America, 12 countries were served by 31 independent dealers. Brazil was the
company’s largest market in Latin America and was served by 10 dealers. Mexico, the region’s
second largest market had 11 dealers. In the remaining Latin American countries, there were
10 dealers.
Canada
In Canada, Harley-Davidson sold its motorcycles and related products at wholesale to a sin-
gle independent distributor, Deeley Harley-Davidson Canada/Fred Deeley Imports Ltd.
In Canada, there were 75 independent Harley-Davidson dealerships. In Canada, 45 of the
74 dealerships sell both Harley-Davidson and Buell products.
Business Segments
Harley-Davidson operates in two principal business segments: Motorcycles and Related
Products (Motorcycles) and Financial Services. Exhibit 4 provides financial information on
the company’s two business segments.
Motorcycles and Related Products Segment
The primary business of the Motorcycles segment is to design, manufacture, and sell pre-
mium motorcycles for the heavyweight market. They are best known for Harley-Davidson
motorcycle products, but also offer a line of motorcycles and related products under the Buell
brand name. Sales from the company’s Motorcycle segment generated 93.2%, 93.8%, and
94.2% of the total sales during 2007, 2006, and 2005, respectively; with the remainder com-
ing from the Financial Services segment.
The majority of the Harley-Davidson branded motorcycle products emphasizes tradi-
tional styling, design simplicity, durability, ease of service, and evolutionary change. Harley’s
CASE 19 Harley-Davidson Inc. 2008 19-11
EXHIBIT 4
Information by Business Segments: Harley-Davidson Inc. (Dollar amounts in thousands)
A. Revenues and Income from Operations
Year ending December 31 2007 2006 2005
Net sales and Financial Services income:
Motorcycles and Related Products net sales $5,726,848 $5,800,686 $5,342,214
Financial Services income 416,196 384,891 331,618
$6,143,044 $6,185,577 $5,673,832
Income from operations:
Motorcycles and Related Products $1,230,643 $1,408,990 $1,299,865
Financial Services 212,169 210,724 191,620
General corporate expenses (17,251) (22,561) (21,474)
Operating Income $1,425,561 $1,597,153 $1,470,011
B. Assets, Depreciation, and Capital Expenditures
(Dollar amount in thousands)
Motorcycles
and Related
Products
Financial
Services Corporate Consolidated
2007
Identifiable Assets $1,804,202 $3,447,075 $405,329 $5,656,606
Depreciation and Amortization 197,655 6,517 – 204,172
Net Capital Expenditures 232,139 9,974 – 242,113
2006
Identifiable Assets $1,683,724 $2,951,896 $896,530 $5,532,150
Depreciation & Amortization 205,954 7,815 – 213,769
Net Capital Expenditures 209,055 10,547 – 219,602
2005
Identifiable Assets $1,845,802 $2,363,235 $1,046,172 $5,255,209
Depreciation and Amortization 198,833 6,872 – 205,705
Net Capital Expenditures 188,078 10,311 – 198,389
appeal straddles class boundaries, stirring the hearts of grease monkeys and corporate titans
alike. Malcolm Forbes, the late owner of Forbes magazine, was pivotal in introducing Harleys
to the business elite in the early 1980s.14
Based on data from the Motorcycle Industry Council owner survey, nearly 1 out of every
10 motorcycle owners is female15 The average U.S. Harley-Davidson motorcycle purchaser is
a married male in his late-forties, with a household income of approximately $81,300, who
purchases a motorcycle for recreational purposes rather than to provide transportation and is
an experienced motorcycle rider. Over two-thirds of the firm’s U.S. sales of Harley-Davidson
motorcycles are to buyers with at least one year of education beyond high school, and 31% of
the buyers have college degrees. (See Exhibit 5.)
In an effort to grow and recognize the importance of female riders to Harley-Davidson, the
company partnered with Jane magazine in 2005 in a contest called the Spirit of Freedom Con-
test to recognize women who overcome fears and other obstacles to become Harley riders. The
grand prize winner was to receive a new Sportster 883. “The adrenaline rush of riding a motor-
cycle out on the open is like no other experience. Through this contest, we are saluting women
SOURCE: Harley Davidson, Inc., 2007 Form 10-K, p. 95.
19-12 SECTION D Industry Four—Transportation
EXHIBIT 5
Purchaser
Demographic
Profile:
Harley-Davidson Inc.
SOURCE: Harley Davidson Fact Book, posted November 5, 2007, at http://investor.harley-davidson.com/downloads/
factsheet .
2006 2005 2004 2003 1983
Gender
Male 88% 89% 89% 89% 98%
Female 12% 12% 11% 11% 2%
Median Age
Years 47.1 46.5 46.1 45.2 34.1
Median Household Income ($000) 82.1 81.6 80.8 83.3 38.3
2006 Purchasers
49% Owned Harley-Davidson motorcycle previously
37% Coming off of competitive motorcycle
14% New to motorcycling or haven’t owned a motorcycle for at
least 5 years
who embody that spirit of adventure through small gestures, inner strength, and everyday self-
less acts” commented Kathleen Lawler, Vice President of Communications, Harley-Davidson.16
Buell motorcycle products emphasize innovative design, responsive handling, and over-
all performance. The Buell motorcycle product line has traditionally consisted of heavyweight
performance models, powered by the 1200cc V-Twin engine. However, in 2000, they intro-
duced the Buell Blast, a new vehicle designed specifically to attract new customers into the
sport of motorcycling. This vehicle was considerably smaller, lighter, and less expensive than
the traditional Buell heavyweight models and is powered by a 492-cc single-cylinder engine.
The Buell line has continued to grow since the introduction of the lower-priced Buell Blast.
The average U.S. purchaser of the Buell heavyweight motorcycle is a male at the median
age of 39 with a median household income of approximately $61,600. Internal documents in-
dicate that half of Buell Blast purchasers have never owned a motorcycle before, and in ex-
cess of 95% of them had never owned a Buell motorcycle before. The median age of Blast
purchasers is 38, with over one-half of them being female.
The heavyweight motorcycle market is comprised of four segments: standard, which em-
phasizes simplicity and cost; performance, which emphasizes handling and acceleration; tour-
ing, which emphasizes comfort and amenities for long-distance travel; and custom, which
emphasizes styling and individual owner customization.
In 2008, Harley-Davidson manufactured and sold 30 models of Harley-Davidson touring
and custom heavyweight motorcycles, with domestic manufacturer’s suggested retail prices
ranging from approximately $6,695 to $20,645. There were eight Buell bikes ranging from
$4,695 to $11,995. (See Exhibit 6.) The touring segment of the heavyweight market was pio-
neered by Harley-Davidson and includes motorcycles equipped for long-distance touring with
fairings, windshields, saddlebags, and Tour Pak luggage carriers. The custom segment of the
market includes motorcycles featuring the distinctive styling associated with classic Harley-
Davidson motorcycles. These motorcycles are highly customized through the use of trim and
accessories.
Harley-Davidson’s traditional heavyweight motorcycles are based on variations of five
basic chassis designs and are powered by one of four air-cooled, twin cylinder engines with
a 45-degree “V” configuration, which have displacements of 883cc, 1200cc, 1450cc, and
1550cc. The V-Rod has its own unique chassis design and is equipped with the new Revo-
lution powertrain, a new liquid-cooled, twin-cylinder, 1130cc engine, with a 60-degree “V”
configuration.
http://investor.harley-davidson.com/downloads/factsheet
http://investor.harley-davidson.com/downloads/factsheet
CASE 19 Harley-Davidson Inc. 2008 19-13
EXHIBIT 6
2008 Motorcycles
Product Line:
Harley-Davidson Inc.
SOURCE: http://www.harley-davidson.com/wcm/Content/Pages/2008_Motorcycles/2008_Motorcycles.jsp?locale�en_
US& cwpws/dwp/cont-without-flash�true&swfdwp�&dwp_dealerid�&dwp_pg�&cwpws/dwp/dwp-dealer-id�.
Motorcycle MSRP Base Price ($)
1. BUELL1
Buell® 1125R
XB12X Ulyssest®
XB12S/XB12Scg Lightning®
XB12STT Lightning® Long
XB12STT Lightning®
XB12R Firebolt®
XB9SX Lightning® CityX
XB9SX Blast
11,995
11,495
10,495
10,495
10,295
9,995
8,895
4,695
2. HARLEY-DAVIDSON SPORTSTER
XL1200C Sportster® Custom
XL 1200L Sportster® Low
XL1200N Sportster® Nightster™
XL1200R Sportster® Roadster
XL883C Sportster® Custom
XL883L Sportster®Low
XL883 Sportster®
9,895
9,695
9,695
8,895
7,945
7,145
6,695
3. DYNA
FXDWG Dyna® Wide Glide 105th Anniversary Edition
FXDF Dyna® Low Rider®
FXDF Dyna® Fat Bob™
FXDB Dyna® Street Bob®
FXDC Dyna® Super Glide® Custom
FXD Dyna® Super Glide®
17,620
14,995
14,795
13,795
12,995
11,995
4. SOFTAIL
FXCWC Softail Rocker™ C
FLSTC Heritage Softail® Classic
FLSTN Softail® Deluxe
FXCW Softail Rocker™
FLSTF Fat Boy®
FXSTC Softail® Custom
FXSTb Night Train®
19,840
17,945
17,445
17,295
17,195
16,895
15,895
5. VRSC™ Family (V-Rod)
VRSCAW V-Rod®
VRSCDX Night Rod® Special
VRSCD Night Rod®
16,995
16,695
14,995
6. TOURING
FLHTCU Ultra Classic® Electra Glide®
FLHTC Electra Glide® Classic
FLHX Street Glide
FLTR Road Glide®
FLHR Road King®
FLHT Electra Glide® Standard
20,695
18,695
18,675
18,145
17,945
16,545
1Buell Motorcycle Company partnered with Harley-Davidson in 1993 and was purchased by Harley-Davidson
in 1998.
http://www.harley-davidson.com/wcm/Content/Pages/2008_Motorcycles/2008_Motorcycles.jsp?locale=en_US&cwpws/dwp/cont-without-flash=true&swfdwp=&dwp_dealerid=&dwp_pg=&cwpws/dwp/dwp-dealer-id=
http://www.harley-davidson.com/wcm/Content/Pages/2008_Motorcycles/2008_Motorcycles.jsp?locale=en_US&cwpws/dwp/cont-without-flash=true&swfdwp=&dwp_dealerid=&dwp_pg=&cwpws/dwp/dwp-dealer-id=
19-14 SECTION D Industry Four—Transportation
President and CEO’s Comments1 7
James Ziemer has served as CEO since April 2005. Thomas E. Bergman, 41, succeeded him
as Chief Financial Officer. Ziemer “has the information of where we’re going, but he’s also
rooted in where we’ve been” commented Kirk Topel, co-owner of Hal’s Harley-Davidson
dealership in New Berlin, Wisconsin.
President Ziemer said in the press release announcing 2007 financial results,
Harley-Davidson managed through a weak U.S. economy during 2007. We reduced our whole-
sale motorcycle shipment plan for the fourth quarter, fulfilling our commitment to our dealers to
ship fewer Harley-Davidson motorcycles than we expected our dealers worldwide to sell at re-
tail during 2007. While these are challenging times in the U.S., our international dealer network
delivered double digit retail sales growth in 2007.
For 2008, the Company once again plans to ship fewer Harley-Davidson motorcycles than
it expects its worldwide dealer network to sell. The Company also expects moderate revenue
growth, lower operating margin, and diluted earnings per share growth rate of 4 to 7 percent
compared to 2007. For the first quarter, it expects to ship between 68,000 and 72,000 Harley-
Davidson motorcycles, which compares to 67,761 units in the first quarter of 2007.
Commenting on the long-term sustainability and the economy, Ziemer continued,
Looking ahead, we will continue to manage the Company to generate long-term sustainable
shareholder value while protecting the brand. We expect the U.S. economy to continue to be very
challenging in 2008, and we will closely monitor the retail environment and regularly assess our
wholesale shipments throughout the year.
Exhibits 7 and 8 present data on divisional revenues, worldwide motorcycle shipments, in-
come, and registrations, both worldwide and U.S, and Europe for 2007.
Although there are some accessory differences between the top-of-the line touring mo-
torcycles and those of its competitors, suggested retail prices are generally comparable. The
prices for the high-end of the Harley-Davidson custom product line range from being com-
petitive to 50% more than its competitors’ custom motorcycles. The custom portion of the
Harley-Davidson product line represents their highest unit volumes and continues to com-
mand a premium price because of the features, styling, and high resale value associated with
Harley-Davidson custom products. The smallest displacement custom motorcycle (the 883cc
Sportster) is directly price competitive with comparable motorcycles available in the market.
The surveys of retail purchasers indicate that, historically, over three-quarters of the pur-
chasers of its Sportster model either have previously owned competitive-brand motorcycles
or are completely new to the sport of motorcycling or have not participated in the sport for at
least five years. Since 1988, research has consistently shown purchasers of Harley-Davidson
motorcycles have a repurchase intent in excess of 90%, and management expects to see sales
of its 883cc Sportster model partially translated into sales of its higher-priced products in the
normal two-to-three-year ownership cycle.
Worldwide Parts and Accessories net sales comprised 15.2%, 14.9%, and 15.4% of net
sales in the motorcycles segment in 2007, 2006, and 2005, respectively. Worldwide net
sales of general merchandise, which includes MotorClothes apparel and collectibles, com-
prised 5.3%, 4.8%, and 4.6% of net sales in the Motorcycles segment in 2007, 2006, and
2005, respectively.
Management also provides a variety of services to its dealers and retail customers, includ-
ing service training schools, customized dealer software packages, delivery of its motorcycles,
an owners club membership, a motorcycle rental program, and a rider training program that is
available in the United States through a limited number of authorized dealers.
CASE 19 Harley-Davidson Inc. 2008 19-15
EXHIBIT 7
Selected
United States
and World Financial
and Sales
Information:
Harley-Davidson Inc.
B. Worldwide Motorcycle Shipments
(Units in thousands)
2003 2004 2005 2006 2007
Exports 47.7 50.8 52.5 75.8 89.1
Total Motorcycle Shipments 291.1 317.3 329.0 349.2 330.6
Export Percentage 16.4% 16.0% 16.0% 21.7% 26.9%
General
Merchandise
5%
Harley-Davidson Motorcycles
Parts and Accessories
General Merchandise
Buell Motorcycles
Other
Total
$4,446.8
868.3
305.4
100.5
6.0
$5,727.0
Parts and
Accessories
15%
Other
0%
Harley-
Davidson
Motorcycles
78%
Buell
Motorcycles
2%
A. Motor Company Revenue, 2007
(Dollar amounts in millions)
400
350
300
250
200
150
100
50
0
2003 2004 2005 2006 2007
Export
Total Shipments
(Continued)
EXHIBIT 7
(Continued)
19-16 SECTION D Industry Four—Transportation
D. Net Income from Continuing Operations
(Dollar amounts in millions)
2003 2004 2005 2006 2007
$761 $890 $960 $1,043 $933
C. Worldwide Parts & Accessories and General Merchandise Revenue
(Dollar amounts in millions)
2003 2004 2005 2006 2007
General Merchandise 211.4 223.7 247.9 277.5 305.4
Parts and Accessories 712.8 781.6 815.7 862.3 868.3
1000
900
800
700
600
500
400
300
200
100
0
2003 2004 2005 2006 2007
General Merchandise
Parts and Accessories
$1,200
$1,000
$800
$600
$400
$200
$0
2003 2004 2005 2006 2007
SOURCE: Harley-Davidson, Inc., 2007 and 2005 Annual Report and 10-K.
CASE 19 Harley-Davidson Inc. 2008 19-17
EXHIBIT 8
World Registrations: Harley-Davidson Inc.
SOURCE: Harley-Davidson, Inc., 2007 Annual Report, p. 40.
600
500
400
300
200
100
0
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
Harley-Davidson
Total Industry
450
400
350
300
250
200
150
100
50
0
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
Harley-Davidson
Total Industry
A. North American 651 cc Motorcycle Registrations
(Units in thousands)
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Total Industry 206.1 246.2 297.9 365.4 422.8 475.0 495.4 530.8 553.5 543.0 516.1
Harley-Davidson 99.3 116.1 142.0 163.1 185.6 220.1 238.2 255.8 264.7 267.9 251.4
Harley-Davidson
Market Share 48.2% 47.2% 47.7% 44.6% 43.9% 46.3% 48.1% 48.2% 47.8% 49.3% 48.2%
B. European 651 cc Motorcycle Registrations
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Total Industry 250.3 270.2 306.7 293.4 293.6 331.8 323.1 336.2 332.8 376.8 403.0
Harley-Davidson 15.1 15.7 17.8 19.9 19.6 23.5 26.3 25.9 29.7 34.3 38.7
Harley-Davidson
Market Share
6.0% 5.8% 5.8% 6.8% 6.7% 7.1% 8.2% 7.7% 8.9% 9.1% 9.6%
1997–2007 North American 651 cc Motorcycle Registrations
1997–2007 European 651 cc Motorcycle Registrations
�
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19-18 SECTION D Industry Four—Transportation
New Millennium Bikes: The Buell and the V-Rod
Harley’s new V-Rod was introduced in the Los Angeles Convention Center on July 12, 2001.
More than 4,000 packed into the center for the company’s long-awaited announcement. The
cavernous room went black. The engines roared in the darkness. Spotlights clicked on and
followed two glinting new hot-rods as they roared onto center stage.18
Harley-Davidson deviated from its traditional approach to styling, with the introduction
of the V-Rod motorcycle. The new, liquid cooled V-Rod, inspired by Harley-Davidson’s drag
racing heritage, combines the characteristics of a performance motorcycle with the styling of
a custom.19 Liquid cooling allows riders to rev a little higher and hotter in each gear, boosting
acceleration. It doesn’t sound like a big deal, but it was a giant step for a company so stub-
bornly conservative that it has made only air-cooled engines for 100 years; its designers just
couldn’t bear the idea of placing a radiator on the front of the bike.20
The V-Rod is Milwaukee-based Harley-Davison Inc.’s first truly new motorcycle in
more than 50 years. A sleek machine in the making for more than six years, the V-Rod is
designed more for speed and handling, unlike the company’s immensely popular touring
bikes.21
As it ramped up production, premiums on many models disappeared. Chief Executive Of-
ficer James L. Ziemer says Harley wants to “narrow the gap” between supply and demand in
order to curb the long-standing—but fast-diminishing—practice of selling bikes at a pre-
mium.22 The V-Rod’s $17,000 price tag has also failed to win younger buyers.23 To that end,
Harley has poured money into developing new, youth-oriented models. The V-Rod—a low-
slung, high-powered number known formally as a sport performance vehicle and colloquially
as a crotch rocket—was meant for hard-charging youths. Harley has also tried to go young
with the Buell Firebolt ($10,000), its answer to Japanese sport bikes, and the Buell Blast
($4,400), a starter motorcycle.
At the Detroit Harley-Davidson/Buell dealership in Center Line, owner Jim Loduca com-
mented: “This is the first time in 10 years that I’ve actually had product on the floor available,
but our sales are also up by 14 percent this year. The company has watched this demand curve
very carefully. They are simply riding the wave. They know full well that it would be cata-
strophic to saturate the market.” He is also encouraged by Harley’s biggest product departure
in recent decades—the V-Rod muscle bike.24
Clay Wilwert, whose family has owned a dealership in Dubuque since 1959, “But guess
what, as they rode it, they loved it.” They said, “Hey, this is really cool that it doesn’t shake
my hands asleep.”25
Some Harley traditionalists say the V-Rod, styled to compete with super-fast European
bikes, strays too far from the company’s all-American roots, which tend to favor heavier cruis-
ing machines.26
Licensing2 7
Harley-Davidson endeavored to create an awareness of the “Harley-Davidson” brand among
the non-riding public and provides a wide range of product for enthusiasts by licensing the
name “Harley-Davidson” and numerous related trademarks. Harley-Davidson had licensed
the production and sale of a broad range of consumer items, including T-shirts, jewelry, small
leather goods, toys, and numerous other products (licensed products). Although the majority
of licensing activity occurs in the United States, Harley-Davidson continues to expand these
activities in international markets. Royalty revenues from licensing, included in Motorcycles
segment net revenue, were approximately $46 million, $45.5 million, and $43 million in
2007, 2006, and 2005, respectively.
CASE 19 Harley-Davidson Inc. 2008 19-19
Marketing and Distribution2 8
Marketing efforts are divided among dealer promotions, customer events, magazine and direct
mail advertising, public relations, cooperative programs with Harley-Davidson/Buell dealers,
and national television advertising. Harley-Davidson also sponsors racing activities and special
promotional events and participates in all major motorcycle consumer shows and rallies.
E-Commerce2 9
Since 2001, Harley-Davidson utilized a highly interactive Web site at www.harley-davidson.
com. Their model is unique in the industry in that, while the online catalog is viewed from
the Harley-Davidson Web site, orders are actually distributed to the participating authorized
Harley-Davidson dealer that the customer selects. In turn, those dealers fill the order and han-
dle any after-sale services that the customer may require. In addition to purchasing, customers
actively browse the site, create and share product wish lists, and utilize the dealer locator.
Harley-Davidson Customer Base
Harley-Davidson’s customers are not what some people might expect. They see the rough and
tumble riders and do not expect that a good proportion of Harley-Davidson riders are white-
collar workers and executives taking the weekend relaxation on their bike. Selected quotes
from customers follow:
� “It’s about an image—freedom of the road, hop on your bike and go, independent living,
the loosing of the chains,” said Dave Sarnowski, a teacher and Harley rider from La Farge,
Wisconsin.30
� “The Harley people I know go to church, have jobs, shop at the mall, just like everyone
else,” says Angie Robison, 68, of Daytona Beach, who helps her husband, Joe, run a mo-
torcycle repair shop and Harley memorabilia/accessories store. “I can wear my silks over
here and my leathers over there, and I’m still the same person.”31
� “I worked at a computer all day for the city, and for me it’s pure relaxation. I wear the
leathers because they’re protective.”32
� “I love the feeling of being out on that bike on the roads—especially in the mountains.
You just can’t beat it, the feeling you get,” says Rob Barnett, Harley-Davidson owner.
� “In general, the motorcycle industry has increased for 12 years straight, and we’re expect-
ing another increase—especially in Harley-Davidson sales—this year,” says Don Brown,
motorcycle analyst with DJB Associates.33
� “A Harley is a rolling sculpture. A piece of artwork,” commented Matt Chase, sales man-
ager of N.F. Sheldon, Harley store. “You work all week, then on the weekends you put on
leathers and everyone’s equal . . . all the same, brothers and sisters.”34
Recession Resistance?
Ziemer recognized that 2008 would be a challenging year for Harley-Davidson given the
pending recession. How will this affect Harley-Davidson? Harley has seen tremendous sales
and stock price growth since 1986 until a slowdown in 2007. Some analysts question how
Harley-Davidson will be hit in a deep recession. “For years, Harley-Davidson and the ana-
lysts that covered the company have reported that the business is recession-resistant. Given
the recent changes in the economic and political landscape, this assertion is being put to the
www.harley-davidson.com
www.harley-davidson.com
19-20 SECTION D Industry Four—Transportation
EXHIBIT 9
Motorcycle Unit
Shipments
and Net Sales:
Harley-Davidson Inc.
SOURCE: Harley-Davidson 2007 10-K, page 34.
2007 2006
Increase
(Decrease)
Percentage
Change
Motorcycle Unit Shipments
Touring motorcycle units 114,076 123,444 (9,368) (11.6%)
Custom motorcycle units 144,507 161,195 (16,688) (10.4%)
Sportster motorcycle units 72,036 64,557 7,479 11.6%
Harley-Davidson® motorcycle units 330,619 349,196 (18,577) (5.3%)
Buell® motorcycle units 11,513 12,460 (947) (7.6%)
Total motorcycle units 342,132 361,656 $(19,524) (5.7%)
Net Sales ($ thousands)
Harley-Davidson motorcycles $4,446.6 $4,553.6 (107.0) (2.3%)
Buell motorcycles 100.5 102.2 (1.7) (1.7%)
Total motorcycles $4,547.1 $4,655.8 (108.7) (2.3%)
Parts and Accessories $868.3 $862.3 6.0 0.7%
General Merchandise 305.4 277.5 27.9 10.1%
Other 6.0 5.1 0.9 17.7%
Total Motorcycles and Related Parts $5,726.8 $5,800.7 $(73.9) (1.3%)
Competition3 6
The heavyweight (651�cc) motorcycle market is highly competitive. Major competitors are
based outside the United States and generally have more financial and marketing resources.
They also have larger worldwide sales volumes and are more diversified. In addition to these
larger, established competitors, a growing segment of competition has emerged in the United
States. The new U.S. competitors generally offer heavyweight motorcycles with traditional
styling that compete directly with many of the Harley-Davidson’s products. These competi-
tors currently have production and sales volumes that are lower than the Harley-Davidson’s
and did not hold a significant market share. (See Exhibits 10, 11, and 12.)
Competition in the heavyweight motorcycle market is based upon a number of factors, in-
cluding price, quality, reliability, styling, product features, customer preference, and war-
ranties. Harley-Davidson emphasizes quality, reliability, and styling in its products and offers
a one-year warranty for its motorcycles. Management regards its support of the motorcycling
lifestyle in the form of events, rides, rallies, H.O.G., and its financing through HDFS, as a com-
petitive advantage. In general, resale prices for used Harley-Davidson motorcycles, as a per-
centage of prices when new, are significantly higher than resale prices for used motorcycles of
competitors.
Domestically, Harley-Davidson competes most heavily in the touring and custom seg-
ments of the heavyweight motorcycle market, which together accounted for 80%, 79%, and
80% of total heavyweight retail unit sales in the United States during 2007, 2006, and 2005,
respectively. The custom and touring motorcycles are generally the most expensive vehicles
in the market and the most profitable. During 2007, the heavyweight segment including stan-
dard, performance, touring, and custom motorcycles, represented approximately 54% of the
total U.S. motorcycle market in terms of new units registered.
test, and from what we can tell, is ringing true. According the CEO Jim Ziemer, “motorcy-
cles, the critics say, are easily deferred purchases. We always said we feel we are recession-
resistant, not recession-proof.”35 (See Exhibit 9).
EXHIBIT 10
651�cc Motorcycle Market Regional Comparison by Segment: Harley Davidson Inc.
SOURCE: Harley Davidson Fact Book, posted November 5, 2007 at http://investor.harley-davidson.com/registrations/registrations_regional.cfm.
2006 2005 2004 2003 2002
United States
Custom 47.4 50.9 52.1 61.8 60.3
Touring 35.4 32.8 31.1 20.4 20.2
Performance 15.1 14.0 13.6 15.1 17.3
Standard 2.1 2.3 3.2 2.7 2.2
Total 100.1 100.0 100.0 100.0 100.0
2006 2005 2004 2003 2002
Europe
Custom 13.4 13.0 13.8 14.3 13.8
Touring 26.0 25.8 27.9 4.7 4.8
Performance 41.4 40.9 39.8 57.8 61.2
Standard 19.2 20.3 18.5 23.2 20.2
Total 100.1 100.0 100.0 100.0 100.0
2006 2005 2004 2003 2002
Asia/Pacific
Custom 30.0 30.3 29.6 32.7 26.2
Touring 9.3 9.2 9.1 9.8 8.7
Performance 47.7 47.8 54.0 53.3 60.0
Standard 13.3 12.8 7.3 4.2 5.1
Total 100.0 101.1 100.0 100.0 100.0
Notes:
Custom: Characterized by “American Styling.” These bikes are often personalized with accessories.
Touring: Designed for long trips with an emphasis on comfort, cargo capacity, and reliability. These bikes often have features such as
two-way radio for communication with a passenger, stereos, and cruise control.
Performance: Characterized by quick acceleration, top speed, and handling. These bikes are often referred to as sports bikes.
Standard: A basic, no frills motorcycle with an emphasis on low price. The standard percentage may also include the “adventure touring” niche.
EXHIBIT 11
Market Share of U.S. Heavyweight Motorcycles 1 (Engine Displacement of 651�cc)1
SOURCE: Harley-Davidson, Inc., Form 10-K, 2007, page 9 and Form 10-K, 2005, page 9.
2007 2006 2005 2004 2003 2002
New U.S. Registrations (thousands of units):
Total market new registrations 516.2 543.0 517.6 494.0 461.2 442.3
Harley-Davidson new registrations 251.4 267.9 252.9 244.5 228.4 209.3
Buell new registrations 3.7 3.8 3.6 3.6 3.5 2.9
Total Company new registrations 255.1 271.7 256.5 248.1 231.9 212.2
Percentage Market Share
Harley-Davidson motorcycles 48.7% 49.3% 48.9% 49.5% 49.5% 47.5%
Buell motorcycles 0.7% 0.7% 0.7% 0.7% 0.8% 0.7%
Total Company 49.4% 50.0% 49.6% 50.2% 50.3% 48.2%
Honda 14.2% 15.1% 16.6% 18.7% 18.4% 19.8%
Suzuki 12.5% 12.9% 12.4% 10.2% 9.8% 9.6%
Yamaha 9.2% 8.6% 8.9% 8.7% 8.5% 8.9%
Kawasaki 7.2% 6.8% 6.5% 6.4% 6.7% 6.9%
Other 7.5% 6.0% 6.0% 5.8% 6.3% 6.6%
Total 100.0% 99.4% 100.0% 100.0% 100.0% 100.0%
Note: 1Motorcycle registration and market share information has been derived from data published by the Motorcycle Industry
Council (MIC).
19-21
http://investor.harley-davidson.com/registrations/registrations_regional.cfm
19-22 SECTION D Industry Four—Transportation
EXHIBIT 12
Motorcycle Industry
Registration
Statistics (Units):
Harley-Davidson Inc.
SOURCE: Harley Davidson Fact Book, posted November 5, 2007, at http://investor.harley-davidson.com/downloads/
factsheet .
2003 2000 1997 1994 1991
U.S. and Canada
651+cc volume 495,436 366,247 205,407 150,419 100,705
H-D volume 238,243 163,984 99,298 69,529 48,260
Buell volume 3,719 4,306 1,912 194 n/a
HOG total volume 241,962 168,290 101,210 69,723 48,260
HOG market share 48.8% 45.9% 49.3% 46.4% 47.9%
Europe
651+cc volume 323,083 338,921 282,378 201,904 194,700
H-D volume 26,299 23,230 17,190 14,393 10,996
Buell volume 3,106 2,045 785 n/a n/a
HOG total volume 29,405 25,275 17,975 14,393 10,996
HOG market share 9.1% 7.5% 6.4% 7.1% 5.6%
Japan and Australia
651+cc volume 58,941 62,667 58,880 39,077 26,995
H-D volume 15,195 12,213 9,686 7,588 5,261
Buell volume 989 658 426 n/a n/a
HOG total volume 16,184 12,871 10,112 7,588 5,261
HOG market share 27.5% 20.5% 17.2% 19.4% 19.5%
Total for Markets Listed
651+cc volume 877,460 767,835 546,665 391,400 322,400
H-D volume 279,737 199,427 126,174 91,510 64,517
Buell volume 7,814 7,009 3,123 194 n/a
HOG total volume 287,551 206,436 129,297 91,704 64,517
HOG market share 32.8% 26.9% 23.7% 23.4% 20.0%
Notes:
1. HOG is the ticker for Harley-Davidson. These are actual registrations of motorcycles. The Harley-
Davidson, Inc. registrations are typically lower than actual sales due to timing differences.
2. Data provided by R. L. Polk (1994), Giral S. A., Australian Bureau of Statistics and H-D Japan. The most
recent date available is for 2003.
For the last 20 years, Harley-Davidson has led the industry in domestic (United States)
unit sales of heavyweight motorcycles. Its market share in the heavyweight market was 48.7%
in 2007 compared to 49.3% in 2006. The next largest competitor in the domestic market had
only a 14.2% market share.
Rider Training and Safety
“Increasingly, the motorcycle riders who are getting killed are in their 40s, 50s, and 60s,” says
Susan Ferguson, vice president for research at the Insurance Institute for Highway Safety,
which did the study.37 Riders over 40 accounted for 40% of all fatalities in 2000, up from
14% in 1990. Part of the reason for the dramatic increase in older biker’s deaths is the grow-
ing number of men and women over 40 buying motorcycles, IIHS says.
In 2000, Harley-Davidson launched an instruction program called Rider’s Edge, run
through dealers. Rookies pay $225 or so for a 25-hour class. This training program can be cred-
ited with bringing in more first-time riders as Harley customers. Forty-five percent are women,
http://investor.harley-davidson.com/downloads/factsheet
http://investor.harley-davidson.com/downloads/factsheet
CASE 19 Harley-Davidson Inc. 2008 19-23
86% buy something, and 25% buy a Harley-Davidson or a Buell within three months. “Going
into a Harley dealership can be intimidating,” says Lara Lee, who runs the program. “We give
them a home base and get them riding.”38
In March 2008, Harley-Davidson announced the company was moving the Rider’s Edge
program into California. There was hope the program would encourage more motorcycle
sales. Julie Chichlowski, the director of Rider Services stated, “One distinct advantage of the
Rider’s Edge New Rider Course is that feeling of being part of something bigger. Rider’s Edge
teaches the skills necessary to ride a motorcycle but in an environment that is pure Harley-
Davidson.39
Motorcycle Manufacturing4 0
Harley-Davidson designed its manufacturing process to increase capacity, improve product qual-
ity, reduce costs, and increase flexibility to respond to market changes. Harley-Davidson incor-
porated manufacturing techniques focused on the continuous improvement of its operations
designed to control costs and maintain quality. Included in these techniques were employee in-
volvement, just-in-time inventory principles, partnering agreements with the local unions, high
performance work organizations, and statistical process control, all designed to improve product
quality, productivity, and asset utilization in the production of Harley-Davidson motorcycles.
Harley-Davidson uses just-in-time inventory to minimize inventories of raw materials and
work in process, as well as scrap and rework costs. This system also allows quicker reaction
to engineering design changes, quality improvements, and market demands.
Raw Material and Purchase Components4 1
Harley-Davidson worked hard to establish and/or reinforce long-term, mutually beneficial re-
lationships with its suppliers. Through these collaborative relationships, it has gained access
to technical and commercial resources for application directly to product design and devel-
opment. Management anticipates the focus on collaboration and strong supplier manufactur-
ing initiatives to lead to increased commitment from suppliers. This strategy has resulted in
improved product quality, technical integrity, application of new features and innovations, re-
duced lead times for product development, and smoother/faster manufacturing ramp-up of
new vehicle introductions. Harley’s initiative to improve supplier productivity and compo-
nent cost has been instrumental in delivering improvements in cost and in offsetting raw ma-
terial price increases.
Harley-Davidson purchased all of its raw materials, principally steel and aluminum cast-
ings, forgings, sheets and bars, and certain motorcycle components, including carburetors, bat-
teries, tires, seats, electrical components, and instruments. Given current economic conditions
in certain raw material commodity markets, and pressure on certain suppliers due to difficul-
ties in the automotive industry, Harley-Davidson monitors supply, availability, and pricing for
both its suppliers and in-house operations.
Research and Development4 2
Harley-Davidson views research and development as a significant factor in its ability to lead the
custom and touring motorcycling market and to develop products for the performance segment.
The company’s Product Development Center (PDC) brings employees from styling, purchasing,
and manufacturing together with regulatory professionals and supplier representatives to create a
concurrent product and process development team. Research and development expenses were
$185.5 million, $177.7 million, and $178.5 million in 2007, 2006, and 2005, respectively.
Patents and Trademarks4 3
Harley-Davidson owns patents that relate to its motorcycles and related products and
processes for their production. Harley-Davidson has increased its efforts to patent its technol-
ogy and certain motorcycle-related designs and to enforce those patents. Management sees
such actions as important as it moves forward with new products, designs, and technologies.
Trademarks are important to the Harley-Davidson’s motorcycle business and licensing
activities. It has a vigorous global program of trademark registration and enforcement to
strengthen the value of the trademarks associated with its products and services, prevent the
unauthorized use of those trademarks, and enhance its image and customer goodwill. It be-
lieves the HARLEY-DAVIDSON trademark and its Bar and Shield trademark are each
highly recognizable by the public and are very valuable assets. The BUELL trademark is
well known in performance motorcycle circles, as is the associated Pegasus logo. The com-
pany is making efforts to ensure that each of these brands will become better known as the
Buell business expands.
Seasonality4 4
In general, Harley-Davidson has not experienced significant seasonal fluctuations in its sales.
This has been primarily the result of a strong demand for the Harley-Davidson motorcycles
and related products, as well as the availability of floor plan financing arrangements for its
North American and European independent dealers. Floor plan financing allows dealers to
build their inventory levels in anticipation of the spring and summer selling seasons. Harley-
Davidson expressed its belief that efforts to increase the availability of its motorcycles has
resulted in an increase in seasonality at its independent dealers. Over the last several years
they have been working to increase the availability of its motorcycles at dealers to improve
the customer experience.
Regulations4 5
Federal, state, and local authorities have various environmental control requirements relating
to air, water, and noise pollution that affect the business and operations. Harley-Davidson en-
deavors to ensure that its facilities and products comply with all applicable environmental
regulations and standards.
The motorcycles are subject to certification by the U.S. Environmental Protection
Agency (EPA) for compliance with applicable emissions and noise standards and by the
State of California Air Resources Board (CARB) with respect to CARB’s more stringent
emissions standards. Motorcycles sold in California are also subject to certain tailpipe and
evaporative emissions standards that are unique to California. The EPA finalized a new
tailpipe emissions standard for 2006 and 2010 respectively which are harmonized with the
California emission standards. Additionally, Harley-Davidson motorcycles must comply
with the emissions, noise, and safety standards of the European Union, Japan, and other in-
ternational markets.
Harley-Davidson, as a manufacturer of motorcycle products, is subject to the National
Traffic and Motor Vehicle Safety Act, which are administered by the National Highway
Traffic Safety Administration (NHTSA). They have certified to NHTSA that their motorcy-
cle products comply fully with all applicable federal motor vehicle safety standards and re-
lated regulations. Harley-Davidson has, from time to time, initiated certain voluntary
recalls. During the last three years, Harley-Davidson initiated 15 voluntary recalls at a total
cost of $10.8 million.
19-24 SECTION D Industry Four—Transportation
CASE 19 Harley-Davidson Inc. 2008 19-25
Employees4 6
As of December 31, 2007, the Motorcycles segment had approximately 9,000 employees.
Unionized employees at the motorcycle manufacturing and distribution facilities in
Wauwatosa, Menomonee Falls, Franklin, and Tomahawk, Wisconsin, and Kansas City,
Missouri, are represented principally by the Paper Allied-Industrial Chemical and Energy
Workers International Union (PACE) of the AFL-CIO, as well as the International Associa-
tion of Machinist and Aerospace Workers (IAM). Production workers at the motorcycle
manufacturing facility in York, Pennsylvania, are represented principally by the IAM. The
collective bargaining agreement with the Pennsylvania-IAM will expire on February 2,
2010, the collective bargaining agreement with the Kansas City-USW and IAM will expire
on July 30, 2012, and the collective bargaining agreement with the Wisconsin-USW and
IAM will expire on March 31, 2008.
Approximately 50% of Harley-Davidson’s 9,000 employees ride a Harley-Davidson. All
employees, including Ziemer and Bluestein, go through a dealer to purchase their bike. This
way, the employees see the customer experience firsthand.
Properties4 7
The following is a summary of the principal operating properties of Harley-Davidson as of
December 31, 2007. Seven facilities that perform manufacturing operations: Wauwatosa and
Menomonee Falls, Wisconsin, suburbs of Milwaukee (motorcycle powertrain production);
Tomahawk, Wisconsin (fiberglass parts production and painting); York, Pennsylvania (mo-
torcycle parts fabrication, painting and big-twin assembly); Kansas City, Missouri (Sportster
assembly); East Troy, Wisconsin (Buell motorcycles assembly); Manaus, Brazil (assembly of
select models for Brazilian market). (See Exhibit 13.)
Financial Services Segment48
The Financial Services segment has office facilities in Carson City, Nevada. Wholesale, in-
surance, and retail operations are in Plano, Texas, and European wholesale operations in
Oxford, England. Ownership and lease structures are outlined in Exhibit 13.
Harley-Davidson and Buell4 9
Harley-Davidson Financial Services HDFS, operating under the trade name Harley-Davidson
Credit, provides wholesale financial services to Harley-Davidson and Buell dealers and retail
financing to consumers. HDFS, operating under the trade name Harley-Davidson Insurance,
is an agent for the sale of motorcycle insurance policies and also sells extended service war-
ranty agreements, gap contracts, and debt protection products.
Wholesale financial services include floor plan and open account financing of motorcy-
cles and motorcycle parts and accessories, real estate loans, computer loans, and showroom
remodeling loans. HDFS offers wholesale financial services to Harley-Davidson dealers in the
United States, Canada, and Europe and during 2007; approximately 96% of such dealers uti-
lized those services. The wholesale finance operations of HDFS are located in Plano, Texas,
and Oxford, England.
Retail financial services include installment lending for new and used Harley-Davidson
and Buell motorcycles. HDFS’ retail financial services are available through most Harley-
Davidson and Buell dealers in the United States and Canada. HDFS’ retail finance operations
are located in Carson City, Nevada, and Plano, Texas.
19-26 SECTION D Industry Four—Transportation
EXHIBIT 13
Principal Operating Facilities: Harley Davidson Inc.
SOURCE: Harley-Davidson, Inc., 2007 Form 10-K, p. 20.
Type of Facility Location Square Feet Status
Corporate Office Milwaukee, WI 515,000 Owned
Warehouse Milwaukee, WI 24,000 Lease expiring 2009
Airplane Hanger Milwaukee, WI 14,600 Owned
Manufacturing Wauwatosa, WI 430,000 Owned
Product Development Center Wauwatosa, WI 409,000 Owned
Distribution Center Franklin, WI 250,000 Owned
Manufacturing Menomonee Falls, WI 868,000 Owned
Product Development and Office East Troy, WI 58,990 Lease expiring 2011
Manufacturing East Troy, WI 40,000 Lease expiring 2011
Manufacturing Tomahawk, WI 211,000 Owned
Office Ann Arbor, MI 3,400 Lease expiring 2009
Office Cleveland, OH 23,000 Lease expiring 2013
Manufacturing and Materials
Velocity Center
Kansas City, MO 450,000 Owned
Materials Velocity Center Manchester, PA 212,000 Owned
Manufacturing York, PA 1,321,000 Owned
Motorcycle Testing Talladega, AL 35,000 Lease expiring 2009
Motorcycle Testing Naples, FL 82,000 Owned
Motorcycle Testing Mesa, AZ 29,000 Lease expiring 2009
Office and Training Facility Monterrey, Mexico 1,100 Lease expiring 2008
Office Morfelden-Waldorf, Germany 22,000 Lease expiring 2008
Office and Warehouse Oxford, England 21,000 Lease expiring 2017
Office Liederdorp, The Netherlands 9,000 Lease expiring 2010
Office Creteil, France 8,450 Lease expiring 2016
Office and Warehouse Arese, Italy 17,000 Lease expiring 2009
Office Zurich, Switzerland 2,000 Lease expiring 2009
Office Sant Cugat, Spain 3,400 Lease expiring 2017
Warehouse Yokohama, Japan 15,000 Lease expiring 2008
Office Tokyo, Japan 14,000 Lease expiring 2008
Manufacturing Adelaide, Australia 485,000 Lease expiring 2011
Office Sidney, Australia 1,100 Lease expiring 2011
Office Shanghai, China 1,700 Lease expiring 2008
Manufacturing and Office Manaus, Brazil 30,000 Lease expiring 2009
Office Chicaog, IL 26,000 Lease expiring 2022
Office Plano, TX 61,500 Lease expiring 2014
Office Carson City, NV 100,000 Owned
Storage Carson City, NV 1,600 Lease expiring 2008
Office Oxford, England 6,000 Lease expiring 2017
Motorcycle insurance, extended service contracts, gap coverage, and debt protection
products are available through most Harley-Davidson and Buell dealers in the United States
and Canada. Motorcycle insurance is also marketed on a direct basis to motorcycle riders.
Funding5 0
HDFS is financed by operating cash flow, advances, and loans from Harley-Davidson, asset-
backed securitizations, commercial paper, revolving credit facilities, senior subordinated
CASE 19 Harley-Davidson Inc. 2008 19-27
debt, and redeemable preferred stock. HDFS also retains an interest in the excess cash flows
from receivables and recognizes income on this retained interest. After the sale, HDFS per-
forms billing and portfolio management services for these loans and receives a servicing fee
for providing these services.
Competition5 1
The ability to offer a package of wholesale and retail financial services is a significant com-
petitive advantage for HDFS. Competitors compete for business based largely on price and,
to a lesser extent, service. HDFS competes based on convenience, service, brand association,
strong dealer relations, industry experience, terms, and price.
During 2007, HDFS financed 55% of the new Harley-Davidson motorcycles retailed by
independent dealers in the United States, as compared to 48% in 2006. Competitors for retail
motorcycle finance business are primarily banks, credit unions, other financial institutions. In
the motorcycle insurance business, competition primarily comes from national insurance com-
panies and from insurance agencies serving local or regional markets. For insurance-related
products such as extended service warranty agreements, HDFS faces competition from certain
regional and national industry participants.
Seasonality5 2
In the northern United States and Canada, motorcycles are primarily used during warmer
months, generally March through August. Accordingly, HDFS experiences significant sea-
sonal variations. Retail customers typically do not buy motorcycles until they can ride them.
From mid-March through August, retail financing volume increases and wholesale financing
volume decreases as dealers deplete their inventories. From September through mid-March,
there is a decrease in retail financing volume while dealer inventories build and turn over
more slowly, substantially increasing wholesale financing volume.
Employees
At the end of 2007, the Financial Services segment had 755 employees, none of which were
unionized.
Corporate Financial and Stock Price Performance
It appeared as though the weakened U.S. economy would stifle growth for Harley-Davidson.
(Exhibits 14 and 15 provide the company’s income statement and balance sheet for the most re-
cent five years. Exhibit 16 provides a geographic breakdown of sales.) Since Harley went pub-
lic, its shares have risen over 23,000% (through the end of 2006) but declined in 2007. As of
February18, 2008, there were 90,748 shareholders of record of Harley-Davidson common stock
(Exhibit 17 provides a comparison of Harley-Davidson stock and the Standard and Poor’s 500
since the 1986 initial public offering.) What does the future hold for Harley-Davidson? While
trading near its five-year low, analysts considered two aspects of the Harley-Davidson product.
“It’s an upper-middle-class toy,” says Chad Hudson of the Prudent Bear fund, one of a
number of prominent short-sellers convinced that Harley will skid. “As people run out of dis-
posable income, that’s going to hurt.”53
“The risk is that retail trends may continue to weaken at Harley-Davidson, causing in-
ventories to build. Harley-Davidson may then lower its production numbers,” says analyst
Gregory Badishkanian.54
19-28 SECTION D Industry Four—Transportation
EXHIBIT 14
Balance Sheet 2003–2007: Harley-Davidson Inc. (Dollar amounts in thousands)
SOURCE: Harley-Davidson, Inc., 2007 Form 10-K, page 60 and 2005 Form 10-K, page 53.
Year Ending December 31 2007 2006 2005 2004 2003
Assets
Current Assets:
Cash and cash equivalents $402,854 $238,397 $140,975 $275,159 $329,329
Marketable securities 2,475 658,133 905,197 1,336,909 993,331
Account receivable, net 181,217 143,049 122,087 121,333 112,406
Current portion of finance receivables, net 2,356,563 2,101,366 0 1,207,124 1,001,990
Inventories 349,697 287,798 221,418 226,893 207,726
Deferred income taxes 103,278 73,389 61,285 60,517 51,156
Prepaid expenses and other current assets 71,230 48,501 52,509 38,337 33,189
Total Current Assets $3,467,314 $3,550,633 $1,503,471 $3,266,272 $2,729,127
Finance Receivables, net 845,044 725,957 600,831 488,262 735,859
Property, plant and equipment, net 1,060,590 1,024,469 1,011,612 1,024,665 1,046,310
Goodwill, net 61,401 58,800 56,563 59,456 53,678
Other Assets 222,257 172,291 72,801 94,402 358,114
Total Assets $5,656,606 $5,532,150 $4,887,044 $4,933,057 $4,923,088
Liabilities & Shareholder’s Equity
Current Liabilities:
Accounts Payable $300,188 $283,477 $270,614 $244,202 $223,902
Accrued expenses and other liabilities 484,936 479,709 397,525 433,053 407,566
Current portion of finance debt 1,119,955 832,491 204,973 495,441 324,305
Total Current Liabilities $1,905,079 $1,595,677 $873,112 $1,172,696 $955,773
Finance Debt 980,000 870,000 1,000,000 800,000 670,000
Other long-term liabilities 151,954 60,694 82,281 90,864 86,337
Postretirement healthcare benefits 192,531 201,126 0 149,848 127,444
Pension Liability 51,551 47,916 – – –
Deferred income taxes – – 155,236 51,432 125,842
Total Liabilities $3,281,115 $2,775,413 $2,110,629 $2,264,840 $1,965,396
Shareholder’s Equity:
Common Stock 3,352 3,343 $3,310 $3,300 $3,266
Additional PIC 812,224 766,382 596,239 533,068 419,455
Retained Earnings 6,117,567 5,460,629 4,630,390 3,844,571 3,074,037
Accumulated other comprehensive income (137,258) (206,662) 58,653 (12,096) 47,174
Less:
Treasury Stock (4,420,394) (3,266,955) (2,204,987) (1,150,372) (586,240)
Total Shareholder’s Equity $2,375,491 $2,756,737 $3,083,605 $3,218,471 $2,957,692
Total Liabilities and Shareholder’s Equity $5,656,606 $5,532,150 $5,255,209 $5,483,293 $4,923,088
How does Harley-Davidson move forward and continue to grow at the pace it has seen in
the past? Is this a reasonable long-term growth rate? How does it maintain interest in the 2008
model bikes? How does it grapple with the aging baby boomers, who are generally the indi-
viduals who can afford a Harley-Davidson motorcycle? These were but a few of the questions
in the minds of senior management as they did strategic planning.
CASE 19 Harley-Davidson Inc. 2008 19-29
EXHIBIT 15
Income Statement 2003–2007: Harley-Davidson Inc. (Dollar amounts in thousands)
SOURCE: Harley-Davidson, Inc., 2007 Form 10-K, page 31, 2005 Form 10-K, page 52.
Year Ending December 31, 2007 2006 2005 2004 2003
Net Sales $5,726,848 $5,800,686 $5,342,214 $5,015,190 $4,624,274
COGS 3,612,748 3,567,839 3,301,715 3,115,655 2,958,708
Gross Profit 2,114,100 2,232,847 $2,040,499 $1,899,535 $1,665,566
Financial Services Income 416,196 384,891 331,618 305,263 279,459
Financial Services Interest and Operating Expense 204,027 174,167 139,998 116,662 111,586
Operating Income from Financial Services 212,169 210,724 191,620 188,600 167,873
Selling, Admin, and Engineering Expense 900,708 846,418 (762,108) (726,644) (684,175)
Income from Operations 1,425,561 1,597,153 $1,470,011 $1,362,491 $1,149,264
Investment Income, net 22,258 27,087 22,797 23,101 23,088
Other, net – – (5,049) (5,106) (6,317)
Income before Provision for Income Taxes 1,447,819 1,624,240 $1,487,759 $1,380,486 $1,166,035
Provision for Income Taxes 513,976 581,087 528,155 489,720 405,107
Net Income $933,843 $1,043,153 $959,604 $890,766 $760,928
EXHIBIT 16
Geographic Information: Harley-Davidson Inc. (Dollar amount in thousands)
SOURCE: Harley-Davidson 2007 Form 10-K, page 96, and 2005 Form 10-K, page 70.
2007 2006 2005 2004 2003
Net Revenue (1):
United States $4,208,016 $4,618,997 $4,304,865 $4,097,882 $3,807,707
Europe 790,150 621,069 530,124 477,962 419,052
Japan 229,759 207,884 192,268 192,720 173,547
Canada 230,230 188,993 143,204 136,721 134,319
Australia 162,689 82,792 — — —
Other foreign countries 106,004 80,951 171,753 109,905 89,649
Total $5,726,848 $5,800,686 5,342,214 5,015,190 $4,624,274
Financial Services Income (1)
United States $381,001 $356,539 308,341 283,837 260,551
Europe 13,638 11,034 9,135 9,538 8,834
Canada 21,557 17,318 14,142 11,887 10,074
Total $416,196 $384,891 331,618 305,262 279,459
Long-lived assets (2):
United States $1,173,169 $1,139,846 1,450,278 1,246,808 $1,400,772
Other foreign countries 66,988 56,214 38,002 44,300 41,804
Total $1,240,157 $1,196,060 1,488,280 1,291,108 $1,442,576
Notes:
1. Net revenue and income is attributed to geographic regions based on location of customer.
2. Long-lived assets include all long-term assets except those specifically excluded under SFAS Number 131, such as deferred income
taxes and finance receivables.
19-30 SECTION D Industry Four—Transportation
V
al
u
e
Year
$25,000
$20,000
$15,000
$10,000
$5,000
$0
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
S&P 500
Harley-Davidson
EXHIBIT 17
Year-End Market Value of $100 invested on December 31, 1986 through December 31, 2006: Harley-Davidson vs. SP 500
SOURCE: http://investor.harley-davidson.com/HDvsSP500.cfm.
N O T E S
1. Harley Davidson Annual Report, 2002, back cover.
2. Nakashima, Ryan, “Potholes Ahead for Harley’s New Top Hog,”
Associated Press Financial Wire, April 13, 2005.
3. Thomas L. Wheelen, Kathryn E. Wheelen, Thomas L.
Wheelen II, and Richard D. Wheelen, “Harley-Davidson: The
95th Anniversary,” Case 16, Strategic Management and Business
Policy, 8th Ed., Prentice Hall/ Pearson Education, Inc., Upper
Saddle River, NJ, 2002.
4. Jonathan Fahey, “Love into Money,” Forbes, January 7, 2002,
p. 60–65.
5. Harley-Davidson Annual Reports, 2007, 2005, 2003, 2001,
1999, 1997, 1995.
6. Missy Sullivan. “High-Octane Hog,” Forbes, September 10,
2002, pp. 8–10. The preceding two paragraphs were directly
quoted with minor editing.
7. “A Harley Takes an Engine from Porsche” New York Times,
May 26, 2002. Accessed at http://www.nytimes.com. The pre-
ceding paragraph was directly quoted with minor editing.
8. James C. Ziemer, Letter to the Shareholders, Harley-Davidson
2005 Annual Report.
9. James C. Ziemer, Letter to the Shareholders, Harley-Davidson
2005 Annual Report.
10. Lustgarten, Abrahm, “The List of Industry Champs,” Fortune,
March 7, 2005. http://money.cnn.com/magazines/fortune/
fortune_archive/2005/03/07/8253449/index.htm
11. John Helyar, “Will Harley-Davidson Hit the Wall?” Fortune,
August 12, 2002, pp. 120–124.
12. Company press release, June 1, 2006, Harley-Davidson Kicks
Off Construction of Its Museum.
13. Harley-Davidson, 2007 10-K. The following section was di-
rectly quoted with minor editing, pages 6–8.
14. Jonathan Fahey, “Love into Money,” Forbes, January 7, 2002,
pp. 60–65.
15. Discover Today’s Motorcycling—Press Release “Rockefeller
Center Motorcycle Show Opens with “Today Show” segment
and Giant Preview Party, April 6, 2002.
http://investor.harley-davidson.com/HDvsSP500.cfm
http://www.nytimes.com
http://money.cnn.com/magazines/fortune/fortune_archive/2005/03/07/8253449/index.htm
http://money.cnn.com/magazines/fortune/fortune_archive/2005/03/07/8253449/index.htm
CASE 19 Harley-Davidson Inc. 2008 19-31
16. Harley-Davidson and Jane magazine roll out contest to honor
women with an unquenchable Spirit of Freedom, Market Wire,
June 7, 2005.
17. Harley-Davidson Reports Fourth Quarter and Full Year Results
for 2007. January 25, 2008. www.harley-davidson.com. Much
of this section was directly quoted from President Ziemer’s
comments with minor editing.
18. Missy Sullivan, “High-Octane Hog,” Forbes, September 10,
2002, pp. 8–10.
19. Harley-Davidson 10-K, 2005.
20. Jonathan Fahey, “Love into Money,” Forbes, January 7, 2002,
pp. 60–65.
21. Rich Rovito, “No Revving Needed for Sales of Harley’s V-Rod
Motorcycle,” The Business Journal Serving Greater Milwaukee,
January 14, 2002. Accessed at http://milwaukee.bizjournals
.com/milwaukee/stories/2002/01/14/story8.html
22. Joseph Weber, “Harley Investors May Get a Wobbly Ride,”
Business Week, February 11, 2002, p. 65.
23. The Business Week 50 Ranking, Business Week, Spring 2002,
p. 54.
24. James V. Higgins, “All Hail, Harley-Davidson” The Detroit
News, February 22, 2002. Accessed at http://detnews.com/2002.
25. Jonathan Fahey, “Love into Money,” Forbes, January 7, 2002,
pp. 60–65.
26. Jerry Shiver, “Richer, Older Harley Riders ‘Like Everyone
Else,’” USA Today, March 8, 2002, pp. 1A–2A.
27. Harley-Davidson, 2007 10-K. The following paragraph was di-
rectly quoted with minor editing.
28. Harley-Davidson, 2007 10-K. The following two paragraphs
were directly quoted with minor editing.
29. Harley-Davidson, 2007 10-K. The paragraph was directly
quoted with minor editing.
30. “Harley Roars into Its Second Century,” The Tribune, Ames
Iowa, July 26, 2002, p. A2.
31. Jerry Shiver, “Richer, Older Harley Riders ‘Like Everyone
Else,’” USA Today, March 8, 2002, pp. 1A–2A.
32. Jerry Shiver, “Richer, Older Harley Riders ‘Like Everyone
Else,’” USA Today, March 8, 2002, pp. 1A–2A.
33. Ridley, Amanda, Spartanburg, S.C., “Harley-Davidson dealer
moving to expanded showroom,” Herald-Journal, July 11,
2004.
34. Pisinski, Tonya M., “Me and my Harley: Hawg riders are down-
right passionate about their bike riding and hitting the trail,”
Worcester Telegram and Gazette, May 25, 2005.
35. David Wells, “Lehman’s Kantor Bets on Harley-Davidson: Call
of Day,” Bloomberg, November 14, 2001.
36. Harley-Davidson, Form 10-K, 2007. The following four para-
graphs were directly quoted with minor editing.
37. Earle Eldrige, “More Over-40 Motorcyclists Die in Crashes”
USA Today, January 10, 2002, p. 1B.
38. Jonathan Fahey, “Love into Money,” Forbes, January 7, 2002,
pp. 60–65.
39. “Rider’s Edge, the Harley-Davidson Academy of Motorcy-
cling, moves into California,” press release, March 11, 2008,
www.harley-davidson.com.
40. Harley-Davidson, Form 10-K, 2007. The following paragraph
was directly quoted with minor editing.
41. Harley-Davidson, Form 10-K, 2007. The following paragraph
was directly quoted with minor editing.
42. Harley-Davidson, Form 10-K, 2007. The following paragraph
was directly quoted with minor editing.
43. Harley-Davidson, Form 10-K, 2007. The first three paragraphs
were directly quoted with minor editing.
44. Harley-Davidson, Form 10-K, 2007. The first paragraph was
directly quoted with minor editing.
45. Harley-Davidson, Form 10-K, 2007. The first paragraph was
directly quoted with minor editing.
46. Harley-Davidson, Form 10-K, 2007. The first paragraph was
directly quoted with minor editing.
47. Harley-Davidson, Form 10-K, 2007, the following paragraph
was directly quoted with minor editing.
48. Harley-Davidson, Form 10-K, 2007, the following paragraph
was directly quoted with minor editing.
49. Harley-Davidson, Form 10-K, 2007, the following three para-
graphs were directly quoted with minor editing.
50. Harley-Davidson, Form 10-K, 2007, the following paragraph
was directly quoted with minor editing.
51. Harley-Davidson, Form 10-K, 2007, the following two para-
graphs were directly quoted with minor editing.
52. Harley-Davidson, Form 10-K, 2007, the following paragraph
was directly quoted with minor editing.
53. John Helyar, “Will Harley-Davidson hit the Wall?” Fortune,
August 12, 2002, pp. 120–124.
54. “Harley-Davidson Cut From Citi List,” Associated Press,
March 14, 2008.
www.harley-davidson.com
http://milwaukee.bizjournals.com/milwaukee/stories/2002/01/14/story8.html
http://milwaukee.bizjournals.com/milwaukee/stories/2002/01/14/story8.html
http://detnews.com/2002
www.harley-davidson.com
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A Change of Guard at JetBlue
IN MAY 2007, JETBLUE AIRWAYS INC. (JETBLUE), a low-cost carrier (LCC) based in New
York, announced a new leadership structure for the company. David Barger (Barger),
President and Chief Operating Officer (COO) of the airline, replaced David Neeleman
(Neeleman) as CEO. Neeleman, who founded JetBlue in 1999, had been its CEO ever
since. Under the new leadership structure, Neeleman was designated as the non-executive
Chairman of the Board. Russell Chew, a former Federal Aviation Administration (FAA)3 ex-
ecutive, took over as the COO; Barger retained his position as the President of the company.
Neeleman said at that time that the board’s suggestion that he step down had nothing to
do with the service breakdown that JetBlue had experienced in February 2007, when the north-
east region of the United States had been hit by a severe snowstorm. The airline’s slow reac-
tion to the adverse weather had left thousands of passengers stranded at airports. In addition
to having serious financial repercussions, this fiasco harmed JetBlue’s image as a customer-
friendly airline and tarnished its reliability record.
20-1
C A S E 20
JetBlue Airways:
GROWING PAINS
S. S. George and Shirisha Regani
“We don’t spend tens of millions of dollars telling people how cool we are. We put low fares out there and let them tell us.”
DAVID NEELEMAN, THE FOUNDER AND THEN CEO OF JETBLUE, IN 20011
“I do think they [JetBlue] had some growing pains. They were growing so fast
they didn’t have systems and redundancies in place.”
MICHAEL MAGIERA, MANAGING DIRECTOR AT MANNING & NAPIER, A MONEY MANAGEMENT FIRM THAT OWNED JETBLUE STOCK, IN 20072
Copyright © 2008, ICFAI. Reprinted by permission of ICFAI Center for Management Research (ICMR), Hyderbad,
India. Website: www.icmrindia.org. The authors are S.S. George and Shirisha Regani. This case cannot be reproduced
in any form without the written permission of the copyright holder, ICFAI Center for Management Research (ICMR).
Reprint permission is solely granted by the publisher, Prentice Hall, for the book, Strategic Management and Business
Policy—13th Edition (and the International and electronic versions of this book) by copyright holder, ICFAI Center for
Management Research (ICMR). This case was edited for SMBP—13th Edition. The copyright holder, is solely respon-
sible for case content. Any other publication of the case (translation, any form of electronics or other media) or sold
(any form of partnership) to another publisher will be in violation of copyright law, unless ICFAI Center for
Management Research (ICMR) has granted an additional written reprint permission.
www.icmrindia.org
Analysts greeted the leadership change positively. For several years after it was set up, Jet-
Blue had been one of the most successful airlines in the United States, rivaling Southwest Air-
lines (Southwest)4 in profitability and growth. However, it began facing various problems, both
internal and external, in 2005–2006. Several analysts were of the opinion that JetBlue’s growth
in its early years had been too fast and unsustainable in the longer term, and that it was because
of this that things started to come undone at the airline when the business environment changed.
20-2 SECTION D Industry Four—Transportation
Background
Business plans for setting up JetBlue were developed by Neeleman, along with lawyer Tom
Kelly, in 1998. Neeleman raised $160 million5 in capital from top investors such as Weston
Presidio Capital, J.P. Morgan Partners, and Soros Private Equity Partners, and founded the
airline in February 1999.
In September 1999, JetBlue was awarded 75 landing and takeoff slots at the John F.
Kennedy International Airport (JFK) in New York, which was to serve as its base. The airline
started commercial operations on February 11, 2000, with an inaugural flight from JFK to Fort
Lauderdale airport in Florida.
Business Model
JetBlue’s business was guided by five key values—safety, caring, integrity, fun, and passion.
From its inception, it was “anti-establishment” and went against many of the accepted norms
of the aviation industry. One example of this was its choice of New York, the biggest avia-
tion market in the United States, as its base. LCCs in the United States typically avoided op-
erating from New York because flying out of LaGuardia and Newark, the city’s two domestic
airports, was very expensive. Most domestic operators avoided JFK, as it mainly served
international flights, and was also farther from Manhattan than the other two airports.
Neeleman, however, reasoned that because JFK handled mostly international flights, JetBlue
would face very little competition from domestic flights at that airport.
Positioning
From the beginning, JetBlue was positioned as a colorful and fun airline. Although it was des-
ignated as an LCC; it was in fact a “value player.” The airline combined low fares with sev-
eral value-added services that improved customer service without adding to operating costs.
All the planes operated at JetBlue were fitted with leather seats instead of cloth ones.
Leather furnishings cost twice as much as cloth ones, but also lasted twice as long. Unlike typ-
ical LCCs, JetBlue provided assigned seating and allowed passengers to choose their seat on
the plane whenever possible.
JetBlue served light snacks such as chips, cookies, and crackers, and coffee and canned
drinks, which cost a fraction of a regular meal. The snacks were complimentary, unlike in
LCCs that sold food to passengers. JetBlue estimated that it saved about $3 per passenger by
choosing to serve sacks instead of regular food.
JetBlue provided free personal satellite television to all the passengers. The television sets
reportedly cost only about $1 per passenger per flight—one-fourth the cost of a meal.
Operations
JetBlue’s operations were the key to its low costs. JetBlue did not use old planes, but oper-
ated a fleet of new Airbus A-3206 aircraft. The Airbus A-320s were chosen over the more pop-
ular Boeing-737s7 (which Southwest used) because although they cost more initially, they
CASE 20 JetBlue Airways 20-3
would be easier to maintain and were more fuel-efficient. The planes also came with a five-
year warranty. Operating a uniform fleet of planes was also economical, as it reduced costs
significantly in the areas of pilot training, maintenance, and spare parts.
All the aircraft were configured in a single class, with a uniform level of service. This also
allowed JetBlue to put in the maximum number of seats possible in its planes.
Initially JetBlue did not try to fly too many routes, concentrating instead on the Northeast,
the West Coast, and Florida—routes for which demand was high, and it was easy to undercut
the fares of rivals. In addition, JetBlue also flew to secondary cities that were neglected by ma-
jor carriers.
JetBlue flew mainly to secondary airports that did not handle too much air traffic. In this
way, the airline was able to avoid congestion to a great extent and to establish a good on-time
record. (In 2001–2002, JetBlue had an on-time performance record of 80 percent, as against
the 72 percent for the top ten airlines in the United States.) Besides, secondary airports offered
better business terms than the main ones.
JetBlue tried to operate the maximum possible number of flights per day. Its average turn-
around time was 35 minutes, which was comparable to Southwest and much lower than that
of full service airlines (FSAs), which took an hour or more to turn around. JetBlue also oper-
ated several “red-eye” flights.8
JetBlue flew only point-to-point flights, avoiding the hub-and-spoke model used by ma-
jor carriers. This helped it avoid the complications that resulted from connecting flights and
passenger transfers, and the airline was also able to operate with far fewer airport staff.
JetBlue used electronic ticketing extensively. Typically, more than 70 percent of the tick-
ets were booked through the airline’s Web site. JetBlue also cut down on the costs of back-end
operations by allowing its call-center operators and customer service executives to work from
home, using voice-over-Internet protocol.
Automation and the effective harnessing of technology further helped cut costs. JetBlue
was the first airline to introduce paperless cockpits, where the pilots were equipped with lap-
tops to access flight manuals and make the requisite calculations before takeoff. This saved be-
tween 15 and 20 minutes in takeoff. JetBlue was also one of the first airlines in the United
States to allow automatic check-in and electronic baggage tagging. Automation helped JetBlue
maintain a lean workforce (labor costs were historically the highest component of an airline’s
operating costs). In 2002, JetBlue’s cost per available seat mile was 7 cents, which was 25 per-
cent less than the average of the major carriers. JetBlue was thus able to offer fares that were
typically 30 to 40 percent lower than other airlines.9
JetBlue was also one of the few airlines in the U.S. airline industry that had a non-unionized
workforce. All the employees from the CEO down to the lowest ranking ones were called
“crewmembers.” The top management tried to create a family-like atmosphere at the airline.
JetBlue looked for a positive attitude in its employees, as they were often called on to do
things that were outside their job descriptions. For instance, JetBlue did not employ cleaning
crews to clean the flights—the flight attendants and sometimes the pilots were expected to
pitch in to get the flight ready for the next takeoff. Airport ground staff also loaded or unloaded
baggage from the flight. However JetBlue rewarded employees frequently with bonuses and
profit sharing programs. Initiative was encouraged, and all employees were free to suggest
ideas to cut costs and improve operations.
Because of the positive work culture, when customers flew JetBlue, they were impressed
by the energy and attitude of the employees.
JetBlue also went out of its way to avoid inconveniencing customers. The airline had
a policy of never canceling flights, (all through the early 2000s, JetBlue had an average
Culture
20-4 SECTION D Industry Four—Transportation
Growth and Expansion
JetBlue was founded during one of the most turbulent times in the history of civil aviation in
the United States. September 11, 2001, terrorist attacks had hit the industry hard and any of
the major airlines had either gone into bankruptcy protection, or were on the verge of doing
so. In 2001, JetBlue planned to launch an IPO to fund its expansion plans.11 The IPO had to
be postponed in light of the terrorist attacks, but JetBlue continued with its expansion plans
using its share of the $15 billion bailout ($5 billion in direct compensation and another
$10 billion in loan guarantees)12 the U.S. government granted the aviation industry, and a
fresh infusion of funds from its original investors.
JetBlue was one of the first airlines to take a proactive approach to increase safety on air-
craft. It was the first national carrier to install bulletproof, deadbolted cockpit doors on its air-
craft, even before the FAA mandated their use. The airline also installed screens in the cockpit
so that pilots could see what was happening in the passenger cabins.
JetBlue’s message to customers after September 11 also set it apart from other airlines. It
ran a newspaper advertisement that said: “We know you need time to heal. JetBlue will be here
when you’re ready to fly again.”13 For a few weeks after flights resumed, JetBlue aircraft flew
almost empty from New York to the 17 destinations it served at that time, but the airline did
not scale back operations.
Soon after the September 11 attacks, JetBlue’s management identified the routes on which
other airlines had cut capacity. For instance, most of the major airlines had cut down their
flights from New York to Florida. JetBlue boosted its services to Florida, adding seven new
flights per week on this route within a few months. JetBlue also ordered three new A-320 air-
craft in 2001. JetBlue was one among only three airlines in the United States (the other two
being Southwest and AirTran Airways [AirTran]) to post a profit in 2001 (The company posted
a profit of $38.5 million, up from a loss of $21.3 million in 2000.)14 (See Exhibit 1 for Jet-
Blue’s annual income statements from 2002 to 2006.)
In April 2002, JetBlue launched an IPO of 5.87 million shares, raising $158 million.15 That
year, JetBlue started expanding operations on the West Coast, using LosAngeles as a second hub.
In late 2002, JetBlue acquired 100 percent ownership of LiveTV, the company that main-
tained its in-flight satellite TV channels, for $41 million in cash and the retirement of $39 mil-
lion in debt.16 It also started a customer loyalty program, TrueBlue, in mid-2002, collecting
nearly 40,000 members by the end of the year. In 2002, JetBlue’s cost per available seat mile
(CASM)17 was 6.43 cents, lower than all the other major U.S. airlines, which reported an av-
erage CASM of 9.58 cents.18 (See Exhibit 2 for JetBlue’s key operating statistics from 2002
to 2006.)
In 2003, JetBlue placed an order for 100 Embraer-19019 regional jets for a price of
$3 billion, with options for another 100 planes20 to serve more regional routes as a part of its
expansion plans. (This was in addition to the 16 A-320 aircraft added to the fleet that year,
with an order for 65 more, and options on another 50.21) The A-320 aircraft were configured
in a 162-seat arrangement, while the Embraer aircraft, which were configured with 100 seats,
were a more suitable size for regional routes. The first Embraer planes entered service in
October 2005.
completion factor10 of 99.5 percent). JetBlue also avoided overbooking flights. When there
was a delay, passengers were informed well in advance. During extreme delays, JetBlue
would hand out gift vouchers that could be redeemed for a future flight. All this was done
even when the delay was because of uncontrollable factors.
JetBlue’s passenger complaint numbers and baggage handling errors were among the low-
est in the industry.
CASE 20 JetBlue Airways 20-5
EXHIBIT 1
Annual Income
Statements:
JetBlue Airways
SOURCE: JetBlue Airways Annual Report 2006.
(Dollar amounts in millions except per share data)
Year Ending 2006 2005 2004 2003 2002
Operating Revenues $ 2,363 $ 1,701 $ 1,265 $ 998 $ 635
Operating Expenses
Salaries, wages, and benefits 553 428 337 267 162
Aircraft fuel 752 488 255 147 76
Landing fees and other rents 158 112 92 70 44
Depreciation and amortization 151 115 77 51 27
Aircraft rent 103 74 70 60 41
Sales and marketing 104 81 63 54 44
Maintenance materials and repairs 87 64 45 23 9
Other operating expenses1 328 291 215 159 127
Total operating expenses2 2,236 1,653 1,154 831 530
Operating income 127 48 111 167 105
Government compensation3 — — — 23 —
Other income (expense) (118) (72) (36) (16) (10)
Income (loss) before income taxes 9 (24) 75 174 95
Income tax expense (benefit) 10 (4) 29 71 40
Net income (loss) $ (1) $ (20) $ 46 $ 103 $ 55
Earnings (Loss) Per Common Share
Basic $ — $ (0.13) $ 0.30 $ 0.71 $ 0.49
Diluted $ — $ (0.13) $ 0.28 $ 0.64 $ 0.37
Other Financial Data
Operating margin 5.4% 2.8% 8.8% 16.8% 16.5%
Pre-tax margin 0.4% (1.4)% 5.9% 17.4% 15.0%
Ratio of earnings to fixed charges4 — — 1.6x 3.1x 2.7x
Net cash provided by operating activities $ 274 $ 170 $ 199 $ 287 $ 217
Net cash used in investing activities (1,307) (1,276) (720) (987) (880)
Net cash provided by financing activities 1,037 1,093 437 789 657
Notes:
1In 2006, we sold five Airbus A320 aircraft, which resulted in a gain of $12 million.
2In 2005, we recorded $7 million in non-cash stock-based compensation expense related to the acceleration
of certain employee stock options and wrote-off $6 million in development costs relating to a
maintenance and inventory tracking system that was not implemented.
3In 2003, we received $23 million in compensation under the Emergency War Time Supplemental
Appropriations Act.
4Earnings were inadequate to cover fixed charges by $17 million and $39 million for the years ended
December 31, 2006, and 2005, respectively.
In 2003, JetBlue received permission to build a new terminal at JFK, giving it 26 more
gates. (Construction of the terminal began in late 2005.) In 2004, JetBlue announced that it
planned to take delivery of one new Airbus A320 every three weeks and to hire five crew mem-
bers per day during the year.22
During 2004, JetBlue performed well on many operating metrics, with a 99.4 percent
completion factor, the highest on-time performance of 81.6 percent in the industry, and the
fewest baggage mishandlings of 2.99 per 1,000 customers boarded. Its CASM also remained
lower than the industry average at 6.10 cents.23 By the end of 2004, JetBlue flew to 30 desti-
nations, including one international destination—the Dominican Republic—launched that
year. (See Exhibit 3 for JetBlue’s growth between 2000 and 2006.)
EXHIBIT 2
Operating Statistics: JetBlue Airways1
SOURCE: JetBlue Airways Annual Report 2006.
20-6 SECTION D Industry Four—Transportation
2006 2005 2004 2003 2002
Revenue passengers2 (thousands) 18,565 14,729 11,783 9,012 5,752
Revenue passenger miles3 (millions) 23,320 20,200 15,730 11,527 6,836
Available seat miles4 (ASMs) (millions) 28,594 23,703 18,911 13,639 8,240
Load factor5 81.6% 85.2% 83.2% 84.5% 83.0%
Breakeven load factor6, 5 81.4% 86.1% 77.9% 72.6% 71.5%
Aircraft utilization7 (hours per day) 12.7 13.4 13.4 13.0 12.9
Average fare8 $ 119.73 $ 110.03 $ 103.49 $ 107.09 $ 106.95
Yield per passenger mile9 (cents) 9.53 8.02 7.75 8.37 9.00
Passenger revenue per10 ASM (cents) 7.77 6.84 6.45 7.08 7.47
Operating revenue per11 ASM (cents) 8.26 7.18 6.69 7.32 7.71
Operating expense per12 ASM (cents) 7.82 6.98 6.10 6.09 6.43
Operating expense per ASM, excluding fuel13 (cents) 5.19 4.92 4.75 5.01 5.51
Airline operating expense per ASM (cents)1 7.76 6.91 6.04 6.08 6.43
Departures 159,152 112,009 90,532 66,920 44,144
Average stage length14 (miles) 1,186 1,358 1,339 1,272 1,152
Average number of operating aircraft during period 106.5 77.5 60.6 44.0 27.0
Average fuel cost per gallon15 $ 1.99 $ 1.61 $ 1.06 $ 0.85 $ 0.72
Fuel gallons consumed (millions) 377 303 241 173 106
Percent of sales through jetblue.com during period 79.1% 77.5% 75.4% 73.0% 63.0%
Full-time equivalent employees at period end5 9,265 8,326 6,413 4,892 3,572
Notes:
1Excludes results of operations and employees of LiveTV, LLC, which are unrelated to our airline operations and are immaterial to our
consolidated operating results.
2“Revenue passengers” represents the total number of paying passengers flown on all flight segments.
3“Revenue passenger miles” represents the number of miles flown by revenue passengers.
4“Available seat miles” represents the number of seats available for passengers multiplied by the number of miles the seats are flown.
5“Load factor” represents the percentage of aircraft seating capacity that is actually utilized (revenue passenger miles divided by
available seat miles).
6“Breakeven load factor” is the passenger load factor that will result in operating revenues being equal to operating expenses, assuming
constant revenue per passenger mile and expenses.
7“Aircraft utilization” represents the average number of block hours operated per day per aircraft for the total fleet of aircraft.
8“Average fare” represents the average one-way fare paid per flight segment by a revenue passenger.
9“Yield per passenger mile” represents the average amount one passenger pays to fly one mile.
10“Passenger revenue per available seat mile” represents passenger revenue divided by available seat miles.
11“Operating revenue per available seat mile” represents operating revenues divided by available seat miles.
12“Operating expense per available seat mile” represents operating expenses divided by available seat miles.
13“Operating expense per available seat mile, excluding fuel” represents operating expenses, less aircraft fuel, divided by available seat
miles.
14“Average stage length” represents the average number of miles flown per flight.
15“Average fuel cost per gallon” represents total aircraft fuel costs, which excludes fuel taxes, divided by the total number of fuel gallons
consumed.
However, in the fourth quarter of 2004, JetBlue recorded a drastic drop in profits. It an-
nounced a net income of $2.3 million compared to $19.54 million in the corresponding quar-
ter of the previous year.24 The drop in earnings was attributed to increased operating expenses
as a result of a rise in fuel prices. The airline ended the year with a net income of $46 million,
on revenues of $1.2 billion.25 Following this, it was recognized as a “major airline” by the DOT.
CASE 20 JetBlue Airways 20-7
EXHIBIT 3
JetBlue’s Growth
SOURCE: JetBlue Airways Annual Report 2006.
Turbulent Times
Rising Fuel Costs
Fuel prices around the world experienced a sudden rise in 2004. Among the worst affected
sectors was aviation. Fuel was the second major expense in an airline’s operations after labor
in the United States, and typically constituted between 10 percent and 14 percent of an air-
line’s operating expenses. However, after the price increases, its share in operating expenses
became more than 20 percent. (See Exhibit 4 for the breakup of an airline’s operating ex-
penses in 2007.) Although the rise in fuel prices affected all airlines, its effect on LCCs such
as JetBlue was greater.
In 2005, fuel prices increased by nearly 50 percent over 2004. But even as fuel prices
pushed up operating expenses, JetBlue was unable to increase its fares significantly. The grow-
ing number of LCCs in the aviation industry, and the attempts of the FSAs to take away mar-
ket share from the LCCs had led to a fall in the average fares. The average price for a passenger
to fly a mile fell by more than 10 percent between 2000 and 2006 (see Exhibit 5). Added to
this, JetBlue had hedged only 20 percent of its fuel requirements for 2005 at $30 per barrel,
compared to the 42 percent hedged in 2004.27 By 2005, fuel constituted nearly 30 percent of
JetBlue’s operating expenses, compared to 14.4 percent in 2002. It exceeded 33 percent in
2006 (see Exhibit 6).
Operating Aircraft
Year Destinations Employees1 Owned Leased Total
2000 12 1174 4 6 10
2001 18 2361 9 12 21
2002 20 4011 21 16 37
2003 21 5433 29 24 53
2004 30 7211 44 25 69
2005 33 9021 61 31 92
2006 49 10,377 70 49 119
Note: 1Employees include full time and part time employees.
JetBlue’s performance in all the quarters of 2005 was considerably poorer than in the corre-
sponding quarters of 2004, and in the fourth quarter of 2005, it posted a quarterly loss for
the first time since its IPO. JetBlue ended the year with its first annual loss of $20 million
on revenues of $1.7 billion. The airline’s operating margins fell to 2.8 percent from 8.8 per-
cent in 2004.26
JetBlue’s performance statistics also showed a downward trend, and in 2005, the airline’s
on-time performance record fell to 71.4 percent, which was lower than almost all the major
airlines in the United States. The turbulence continued into 2006, and JetBlue announced a loss
in the first quarter of that year. JetBlue’s problems were attributed to a combination of several
internal and external factors.
20-8 SECTION D Industry Four—Transportation
EXHIBIT 4
Break-Up of an
Airline’s Operating
Costs (as of 1Q2007):
JetBlue Airways
SOURCE: http://www.airlines.org.
Passenger Airline Cost Index
First Quarter 2007
Index
(2000 � 100)
% of Operating
Expenses
Labor per FTE 111.1 24.5
Fuel per gallon 276.9 23.4
Aircraft ownership per operating seat 79.5 7.5
Non-aircraft ownership per enplanement 108.5 4.7
Professional services per ASM 114.9 8.6
Food & beverage per RPM 59.6 1.5
Landing fees per capacity ton landed 137.3 2.0
Maintenance material per revenue aircraft hour 53.7 1.3
Aircraft insurance as % of hull net book value 97.9 0.1
Non-aircraft insurance per rpm 221.0 0.5
Passenger commissions as % of passenger revenue 29.5 1.2
Communication per enplanement 71.0 0.9
Advertising & promotion per RPM 66.5 0.8
Utilities & office supplies per FTE 96.3 0.7
Transport-related per ASM 399.8 13.9
Other operating per RTM 111.6 8.3
Interest as % of outstanding debt 114.1 —
Composite1 182.9 100.0
Note: 1Although interest is a non-operating expense, it is factored into the composite cost index to capture
the role of debt in the provision of air service. It is not included in the composite cost per ASM or share of
operating expenses.
EXHIBIT 5
Increases in Fuel
Price—Jet Fuel
SOURCE: http://www.airlines.org/economics/energy/.
Year
Cost of Domestic Air Travel
(cents per mile)1
U.S. Jet Fuel
(cents per gallon)
U.S. CPI
(1982–84) � 100
2000 14.57 90.0 172.2
2001 13.25 75.0 177.1
2002 12.00 70.8 179.9
2003 12.29 88.2 184.0
2004 12.03 120.8 188.9
2005 12.29 172.2 195.3
2006 13.00 196.8 201.6
2006 vs. 2000 �10.8% �118.7% �17.1%
Note: 1Excludes government-imposed taxes and fees
EXHIBIT 6
Fuel Price History:
JetBlue Airways
SOURCE: Compiled from JetBlue’s Annual Reports.
Year Ending December 31 2006 2005 2004 2003 2002
Gallons consumed (millions) 377 303 241 173 105
Total cost ($ millions) 752 488 255 147 76
Average price per gallon 1.99 1.61 1.06 0.85 0.72
Percent of operating expenses % 33.6 29.5 22.1 17.8 14.4
http://www.airlines.org
http://www.airlines.org/economics/energy/
CASE 20 JetBlue Airways 20-9
Industry Factors
In the period between 2001 and 2003, when JetBlue’s growth was at a peak, most of the ma-
jor airlines in the United States were suffering from the adverse effects of the September 11
attacks. JetBlue had taken advantage of its competitors’ weakened state to boost its own
growth. However, by 2004–2005, many of the airlines that were operating under Chapter 1128
began to recapture market share. These airlines were able to undercut competition by offer-
ing very low fares, taking advantage of the protection of the bankruptcy laws. “It’s too much
competition from companies that are purposely allowing themselves to lose money. Compa-
nies in bankruptcy right now, such as United and US Air, have been significantly slashing
their own fares,” said Rick DiLisi, a spokesman for Independence Air, a low-cost airline
based in Virginia.29 JetBlue was also affected by the low fares offered by United Airlines
(United) and Delta Air Lines (Delta), both of which were operating under bankruptcy protec-
tion at the time, on transcontinental routes, American Airlines (American) and Continental
Airlines (Continental), which had escaped Chapter 11, also become aggressive about defend-
ing market share, and launched several new transcontinental flights at low prices.
In 2003, JetBlue launched flights from Atlanta to Los Angeles, one of the busiest routes
in the United States. Atlanta was Delta’s hub, and when JetBlue entered the market, Delta re-
sponded by instantly adding capacity and lowering prices on this route. It also added routes to
other destinations in California, quickly establishing its dominance in the region. AirTran, an-
other LCC that operated from Atlanta, also responded aggressively by leasing new planes to
increase capacity. Eventually, JetBlue was forced to withdraw from Atlanta in December 2003,
just seven months after it started its operations there.
Legacy carriers also launched low-cost subsidiaries of their own, in an effort to compete
with the growing number of LCCs. Delta launched an LCC called Song in April 2003, to com-
pete directly with JetBlue. Song was also based at JFK, and flew many of the same routes as
JetBlue. Like JetBlue, Song also offered amenities such as leather seats, and a free personal
entertainment system at every seat. It also served beverages, but charged for meals and liquor.
The airline was promoted heavily, and for a few months was successful in capturing a large
part of JetBlue’s business on the New York to Florida route. However, its financial perfor-
mance was not satisfactory and it was eventually integrated into Delta’s mainline service in
April 2006.
United also launched an LCC called “Ted” in February 2004. Although Ted was designed
more along the lines of the traditional LCC model and did not serve food, it provided in-flight
entertainment in the form of inflight music and videos. Ted operated mainly on central and
western routes in the United States. According to analysts, the success of Ted was one of the
main reasons why United was able to emerge from bankruptcy in February 2006.
Song and Ted had an advantage over the other LCCs, in that they allowed passengers to
connect to the flights of their parent airlines, which had far bigger route networks than any of
the LCCs. They also shared the frequent flier programs of their parents, and had access to the
gates and landing/takeoff slots of their parents in large airports.
JetBlue also faced competition from LCCs such as Southwest, AirTran, America West,
Spirit Airlines (Spirit), and Frontier Airlines (Frontier). Although none of these airlines offered
the same kind of service as JetBlue, all of them were well established in their home markets,
and had loyal customer bases. Southwest especially had the lowest cost even among the LCCs,
and was very popular among passengers who were willing to give up in-flight services for
cheap tickets. AirTran and Spirit operated two classes on their flights and targeted business
passengers successfully with their low-fare Business Classes. With the exception of Southwest
and Spirit, all the LCCs also offered some form of in-flight entertainment, although AirTran
was the only other airline that offered it free.
20-10 SECTION D Industry Four—Transportation
Internal Factors
When JetBlue had first started operations, it had used new planes and fittings, which did not
cost much in terms of maintenance. However, a few years later, as the fleet aged, maintenance
costs began to rise. Further, JetBlue had to employ more people to meet its requirements, and
also give pay increases to people who had been with the airlines for several years. In an ef-
fort to differentiate itself from its competitors, JetBlue had also kept adding new in-flight
services. In 2003, the airline changed the configuration of its A-320 aircraft, removing one
row of seats from the plane, in order to improve legroom for passengers (the number of seats
was brought down to 156, from 16230). While this made the aircraft more comfortable for pas-
sengers, it also lowered JetBlue’s revenue earning capacity. However, the move was expected
to cut fuel costs, due to the lower weight of the aircraft.
In 2005, JetBlue upgraded its seatback televisions.All the new aircraft were fitted with larger
TVs, and all the old aircraft were retrofitted. At the same time, the airline also equipped all its
planes with XM Satellite radio, and increased the size of the overhead bins on the aircraft.
Most LCCs gave complimentary beverages and sold food, or served complimentary re-
freshments in strictly measured quantities. But JetBlue offered a range of complimentary
snacks and beverages in unlimited quantities. Although the airline started out serving chips,
cookies, and coffee, over the years it added several items to its line of in-flight refreshments.
As of 2007, the airline offered a range of hot and cold beverages and several varieties of
snacks. It also sold a variety of cocktails at $5 each.
Passengers traveling on red-eye flights were given complimentary spa amenity kits con-
taining mint lip balm, body butter, an eyeshade, and ear plugs. JetBlue also set up a compli-
mentary snack bar in the plane for overnight flights, and passengers were given complimentary
hot towels, Dunkin Donuts coffee or tea, orange juice or bottled spring water, just before they
landed the next morning.
Another issue was the problems that JetBlue experienced with its new Embraer-190 air-
craft that entered service in late 2005. JetBlue faced a lot of glitches in integrating the new air-
craft into its operations. To begin with, Embraer delivered the planes two weeks behind
schedule, which caused several flight delays and cancellations. Second, JetBlue’s employees
lacked familiarity with the planes. Third, the Embraer-190 had some technical issues that
caused several delayed flights and significantly lowered JetBlue’s aircraft utilization rates. In
the opinion of some analysts, JetBlue had been too optimistic in placing such a large order for
the untried Embraer planes. After two consecutive losses in the last quarter of 2005 and the
first quarter of 2006, several analysts started comparing JetBlue to People Express Airlines,31
a low-cost airline operated in the United States between 1981 and 1987.
The Return to Profitability Plan
In April 2006, soon after announcing the first quarter loss, Neeleman and Barger announced
a recovery plan for JetBlue called the “Return to Profitability” plan (RTP). The main aims of
the RTP were revenue optimization, improved capacity management, cost reduction, and re-
taining the commitment to deliver high-quality service on every flight.
As a part of the revenue optimization goal, JetBlue announced that it would reduce the
number of long-haul flights and shift its focus back to short-to-medium routes. The company
said that it planned to reduce the ratio of long-haul to non–long-haul flights from 1.5:1 in 2005,
to 1.2:1 during 2006. JetBlue also said that it would offer fewer tickets at very low fares and
more tickets at mid-level fares on all its routes to improve the mix of fares in its revenues. The
average fare was expected to rise to at least partly reflect the increased fuel prices. During
2006, JetBlue increased its lowest transcontinental fare from $349 to $399.
CASE 20 JetBlue Airways 20-11
JetBlue also committed itself to conducting a careful scrutiny of its yield management
practices to ensure it did not sacrifice revenues to increase the load factor.32 Trying to increase
the load factor put stress on an airline’s operations and also led to delays as the airlines tried
to get as many passengers on board as possible, even minutes before a flight’s scheduled de-
parture. In 2005, JetBlue’s load factor was 85.2 percent and the yield per passenger mile was
8.02 cents. This changed to a load factor of 81.6 percent and yield per passenger mile33 of
9.53 cents in 2006, which was nearly a 19 percent increase in yield per passenger mile over
the previous year.34
The RTP also committed JetBlue to manage capacity better by cutting it on unprofitable
routes, and adding it on high-demand routes. During 2006, JetBlue added only 21 percent ca-
pacity, instead of the previously projected 28 percent. The capacity on the New York—Florida
route was cut by 15 percent, while the New York—Los Angeles route saw an 8 percent reduc-
tion in capacity.
On the other hand, JetBlue introduced short-haul routes from Boston to Washington, New
York to Richmond, and Boston to Richmond; and medium-haul routes from New York to
Austin, Boston to Austin, and Boston to Nassau. The airline introduced nonstop service on two
high-demand long-haul routes from Burbank (California) to Orlando (Florida) and Boston to
Phoenix (Arizona). On the whole, JetBlue added 16 new destinations during 2006, which
mainly involved “connecting the dots” between its existing destinations using the Embraer-190
aircraft.
JetBlue sold five of its oldest A-320 aircraft during 2006, and deferred the delivery of
12 A-320 aircraft that had originally been planned for 2007–2009, to 2011–2012. The options
the airline held on the A-320s were also adjusted. (See Exhibit 7.)
JetBlue also increased its focus on cost management. The airline managed to control its
distribution cost by achieving 80 percent of its bookings through its website in 2006—the
highest in the U.S. airline industry. It also implemented several initiatives to conserve fuel and
improve fuel efficiency, especially by using single-engine taxi techniques, utilizing ground
power units, and identifying ways to remove excess weight from the aircraft. In late 2006, Jet-
Blue announced it would remove one more row of seats from its A-320 aircraft, bringing the
total seat number down to 150.
In addition to this, JetBlue was also putting in efforts to improve the efficiency of its crew
members and was trying to accomplish more with fewer full-time employees per aircraft than
before. The elimination of one row of seats allowed JetBlue to operate each flight with three
attendants instead of four, as federal regulations require one flight attendant for every 50 pas-
sengers. JetBlue also began to go slow on hiring people for non-operational positions. Better
flight scheduling practices were also implemented to control costs. JetBlue started charging
for some premium services. For instance, the company changed some of its refund policies,
and increased the fees it charged for flying unaccompanied minors and the cancellation
charges on confirmed flights.
EXHIBIT 7
JetBlue’s A-320
Order Adjustments
SOURCE: http://investor.jetblue.com.
2007 2008 2009 2010 2011 2012 2013
Firm Orders Original 17 17 18 18 12 0 0
Adjusted to 12 12 16 18 18 6 0
Change (5) (5) (2) 0 6 6 0
Options Original 0 2 2 2 9 20 15
Adjusted to 0 2 4 4 6 16 18
Change (%) 0 0 2 2 (3) (4) 3
http://investor.jetblue.com
20-12 SECTION D Industry Four—Transportation
The RTP started showing results by the end of 2006. In the fourth quarter of 2006, JetBlue
posted a profit of $17 million on revenues on $633 million, compared to a loss of $42 million
in the corresponding quarter of the previous year. Analysts had expected the company to re-
turn to profitability only in the first quarter of 2007. (See Exhibit 8 for JetBlue’s quarterly re-
sults in 2006 and 2007.) JetBlue ended 2006 with a net loss of $1 million, compared to a loss
of $20 million in 2005. The operating margin also increased to 5.4 percent in 2006, compared
to 2.8 percent in 2005.35 The airline expected that the combination of higher revenues and
lower costs would help it achieve savings of around $70 million by the end of 2007.36
EXHIBIT 8
A Snapshot of Jetblue’s Quarterly Performance (dollar amount in millions)
Compiled from JetBlue’s Annual Report 2006 and 10K filings with the SEC.
Period Ending On
March 31,
2006
June 30,
2006
September 30,
2006
December 31,
2006
March 31,
2007
June 30,
2007
Operating Revenues 490 612 628 633 608 730
Operating Expenses 515 565 587 569 621 657
Operating Income (loss) (25) 47 41 64 (13) 73
Other Income (expense) (22) (22) (40) 34 (32) (30)
Income Tax Expense (benefit) (15) 11 1 13 (23) 22
Net Income (32) 14 – 17 (22) 21
The Customer Service Fiasco
Even as its financial performance started showing signs of improvement, JetBlue faced an-
other crisis in February 2007, when a snowstorm hit the Northeast and Midwest regions of
the United States, throwing the airline’s operations into chaos.
Because JetBlue followed the practice of never canceling flights, even when the ice storm
hit and the airline was forced to keep several flights on the ground, it desisted from calling
them off. Because of this, passengers were kept waiting at airports for their flight to take off.
In some cases, passengers who had already boarded their planes were kept waiting on the tar-
mac for several hours and not allowed to disembark. In one extreme instance, passengers were
stranded on board a plane on the tarmac at JFK for 11 hours. However, after all this, the air-
line was eventually forced to cancel most of its flights because of bad weather.
Even after the storm cleared, JetBlue struggled to get back on its feet as the canceled
flights had played havoc with its systems, which were not equipped to deal with cancellation.
The airline’s poor database management systems resulted in major problems in tracking and
lining up pilots and flight crew who were within federal regulation limits for the number of
flying hours to operate the resumed flights. In addition, the delays and cancellations had
caused a baggage crisis, with several passengers losing their luggage. The airline had to give
all its passengers full refunds if their flights were canceled, or rebook them on new flights,
which added to the complications.
The airline had canceled nearly 1,200 flights in the days following the storm and it took
several days of its operations to get back to even keel. In contrast, American, Continental, and
Delta, which had canceled flights immediately after the storm broke, were able to resume op-
erations more quickly. The fiasco reportedly cost JetBlue $30 million (which included $10 mil-
lion in refunding tickets for canceled flights, $16 million for issuing travel vouchers, and
$4 million for incremental costs, such as hiring overtime crews).37
CASE 20 JetBlue Airways 20-13
Notwithstanding the financial loss, the loss of goodwill was expected to be much more se-
rious for JetBlue. Traditionally, JetBlue had had one of the lowest rates of consumer com-
plaints filed with the DOT.38 It also usually ranked high on customer service.39 But following
the fiasco, BusinessWeek, a prominent business magazine, pulled JetBlue off its list of Cus-
tomer Service Champs, published early in 2007. JetBlue was to have held the #4 spot on the
list compiled from consumer responses from the first half of 2006.
Some analysts felt that JetBlue had taken its low-cost philosophy too far in having failed
to set up the necessary systems to support its rapid growth. Following the fiasco, JetBlue pub-
lished apology letters in the New York Times and USA Today, among other places. Neeleman
also apologized during his appearances on the Late Show with David Letterman on the CBS
Network, and on YouTube. “We should have acted quicker,” said Neeleman. “We should have
called the Port Authority quicker. These were all lessons learned from that experience.”40
In late February 2007, Neeleman unveiled a “Customer Bill of Rights,” which laid out the
airline’s policy on compensating passengers for delays and cancellations (see Exhibit 9). Ad-
ditionally, JetBlue launched a new database management system to help it track crew and bag-
gage better, and upgraded its Web site to allow online re-bookings. Employees at the airline’s
headquarters were being trained to help out with operations at the airport in emergency situa-
tions. JetBlue also became more proactive during bad weather conditions in the months fol-
lowing the storm. In March 2007, when bad weather hit the East Coast once again, JetBlue was
one of the first airlines to cancel flights to and from airports on the East Coast. The airline re-
portedly canceled nearly 230 flights during this time.
According to analysts, JetBlue’s handling of the events following the crisis was likely to
go a long way in redeeming it in the eyes of the public. “The single most important thing a
company needs to show in a crisis is that it cares. That’s not a feeling. It’s a behavior,” said
Bruce Blythe, the CEO of Crisis Management International41, 42. Several consumer polls con-
ducted after the February 2007 crisis also showed that JetBlue’s popularity with passengers
continued to remain high. The crisis and its repercussions were expected to put a burden on
JetBlue’s already strained finances. But JetBlue managed to return to profitability in the sec-
ond quarter of 2007, after a first quarter loss of $22 million.
More Turbulence Ahead?
Analysts felt that the appointment of Barger as the new CEO was likely to benefit JetBlue.
According to them, the fresh leadership was likely to help JetBlue through its growing pains
and provide it with a positive direction for the future. They also pointed out that Barger dif-
fered considerably from Neeleman in his leadership style. (Barger was thought to be more or-
ganized than Neeleman, and much more focused on operational issues than the latter, who
enjoyed strategizing.)
However, JetBlue was likely to face many more challenges in the future than it had faced
during the first few years of operations. The FSAs, most of which recovered by 2007, were
ready to defend their turf against LCCs. Delta had launched a big sale of discounted tickets
during the Thanksgiving weekend in 2006, triggering a price war in the industry.
In addition to this, JetBlue was likely to face competition from other LCCs such as Air-
Tran and Frontier, which had formed an alliance in late 2006, to combine their marketing and
mileage programs.43 Competition was also expected from new airlines like Virgin America,
which had been launched amidst a lot of buzz in August 2007, and was positioned as a “value”
carrier. Like JetBlue, Virgin America also tried to attract passengers with amenities such as
satellite TV, mood lighting, onboard self-service mini bar, and meals-on-demand. Virgin
America had announced that it expected to expand to 10 cities within a year of operation and
to up to 30 cities within five years.44
20-14 SECTION D Industry Four—Transportation
EXHIBIT 9
Jetblue’s Customer
Bill of Rights
INFORMATION
JetBlue will notify customers of the following:
� Delays prior to scheduled departure
� Cancellations and their cause
� Diversions and their cause
CANCELLATIONS
All customers whose flight is canceled by JetBlue will, at the customer’s option, receive a full re-
fund or reaccommodation on a future JetBlue flight at no additional charge or fare. If JetBlue can-
cels a flight within 12 hours of scheduled departure and the cancellation is due to a Controllable
Irregularity, JetBlue will also provide the customer with a Voucher valid for future travel on Jet-
Blue in the amount paid by the customer for the roundtrip (or the oneway trip, doubled).
DEPARTURE DELAYS
� Customers whose flight is delayed prior to scheduled departure for 1–1:59 hours due to a Con-
trollable Irregularity are entitled to a $25 Voucher good for future travel on JetBlue.
� Customers whose flight is delayed prior to scheduled departure for 2–3:59 hours due to a Con-
trollable Irregularity are entitled to a $50 Voucher good for future travel on JetBlue.
� Customers whose flight is delayed prior to scheduled departure for 4–5:59 hours due to a Con-
trollable Irregularity are entitled to a Voucher good for future travel on JetBlue in the amount
paid by the customer for the oneway trip.
� Customers whose flight is delayed prior to scheduled departure for 6 or more hours due to a
Controllable Irregularity are entitled to a Voucher good for future travel on JetBlue in the
amount paid by the customer for the roundtrip (or the oneway trip, doubled).
OVERBOOKINGS
(As defined in JetBlue’s Contract of Carriage)
Customers who are involuntarily denied boarding shall receive $1,000.
ONBOARD GROUND DELAYS
For customers who experience an onboard Ground Delay for more than 5 hours, JetBlue will take nec-
essary action so that customers may deplane. JetBlue will also provide customers experiencing an on-
board Ground Delay with food and drink, access to restrooms and, as necessary, medical treatment.
Arrivals:
� Customers who experience an onboard Ground Delay on Arrival for 30–59 minutes after
scheduled arrival time are entitled to a $25 Voucher good for future travel on JetBlue.
� Customers who experience an onboard Ground Delay on Arrival for 1–1:59 hours after sched-
uled arrival time are entitled to a $100 Voucher good for future travel on JetBlue.
� Customers who experience an onboard Ground Delay on Arrival for 2–2:59 hours after sched-
uled arrival time are entitled to a Voucher good for future travel on JetBlue in the amount paid
by the customer for the oneway trip, or $100, whichever is greater.
� Customers who experience an onboard Ground Delay on Arrival for 3 or more hours after
scheduled arrival time are entitled to a Voucher good for future travel on JetBlue in the amount
paid by the customer for the roundtrip (or the oneway trip, doubled).
Departures:
� Customers who experience an onboard Ground Delay on Departure for 3–3:59 hours are enti-
tled to a $100 Voucher good for future travel on JetBlue.
� Customers who experience an onboard Ground Delay on Departure for 4 or more hours are en-
titled to a Voucher good for future travel on JetBlue in the amount paid by the customer for the
roundtrip (or the oneway trip, doubled).
SOURCE: www.jetblue.com, accessed 2007.
www.jetblue.com
CASE 20 JetBlue Airways 20-15
N O T E S
1. Eryn Brown, “A Smokeless Herb JetBlue Founder David
Neeleman . . .,” Fortune, May 28, 2001.
2. Chris Zappone, “JetBlue Struggles with ‘Growing Pains,’”
money.cnn.com, April 20, 2007.
3. The Federal Aviation Administration is an agency of the United
States Department of Transportation with the authority to regu-
late and oversee all aspects of civil aviation in the United States.
4. Southwest Airlines, set up by Herb Kelleher in 1978, was the pi-
oneer of low-cost airlines in the United States. The airline was
headquartered in Dallas, Texas, and was known for its prof-
itability record (it had posted profits for the 34th consecutive
year in January 2007).
5. Eryn Brown, “A Smokeless Herb JetBlue Founder David
Neeleman . . .,” Fortune, May 28, 2001.
6. Airbus Industrie is a leading manufacturer of aircraft in the
world. It was established in 1970 and is headquartered in
France.
7. Boeing is a U.S.-based manufacturer of aircraft. Boeing and
Airbus are the two biggest aviation companies in the world.
8. Flights operating between 9:00 p.m. and 5:00 a.m. local time
are called red-eye flights. In North America, red-eye flights fly
from the west to the east coast, capitalizing on the time-zone
changes.
9. Amy Tsao, “Thinking of Taking Off with JetBlue?” Business
Week, April 5, 2002.
10. The percentage of accomplished flights in relation to scheduled
flight. In other words, it is the percentage of scheduled flights
that were not canceled.
11. Paul C. Judge, “How Will Your Company Adapt?” Fast Com-
pany, November 2001.
12. “Big Airlines Benefit from Bailout Bill,” www.taxpayer.net,
June 7, 2002.
13. Paul C. Judge, “How Will Your Company Adapt?” Fast Com-
pany, November 2001.
14. Amy Tsao, “Thinking of Taking Off with JetBlue?” Business
Week, April 5, 2002.
15. “JetBlue IPO Soars,” money.cnn.com, April 12, 2002.
16. “JetBlue Closes Live TVAcquisition,” Communications Today,
September 30, 2002.
17. An airline industry metric arrived at by dividing operating ex-
penses by available seat miles.
18. JetBlue Airways Annual Report 2002.
19. Embraer, a Brazil-based aircraft manufacturer, specialized in
manufacturing regional jets.
20. Michael Bobelian, “JetBlue Lands Expansion Plans,” Forbes,
June 10, 2003.
21. JetBlue Airways Annual Report 2003.
22. JetBlue Airways Annual Report 2003.
23. JetBlue Airways Annual Report 2004.
24. “JetBlue Stays in Black,” money.cnn.com, January 27, 2005.
25. JetBlue Airways Annual Report 2004.
26. JetBlue Airways Annual Report 2005.
27. JetBlue Airways Annual Report, 2005.
28. Chapter 11 is a chapter of the United States Bankruptcy Code,
which permits reorganization under the bankruptcy laws of the
United States. Chapter 11 bankruptcy is available to any busi-
ness, whether organized as a corporation or sole proprietorship,
or individual with unsecured debts of at least $336,900.00 or se-
cured debts of at least $1,010,650.00, although it is most promi-
nently used by corporate entities. (www.wikipedia.org)
29. Chris Isidore, “Low Fare Blues,” money.cnn.com, Novem-
ber 24, 2004.
30. Press release on www.jetblue.com, November 13, 2003.
31. People Express had revolutionized air travel with its low fares,
customer focus, and energetic staff. Within five years, the air-
line had reached one billion dollars in sales. However, People
Express’ troubles started in 1985 after it acquired several air-
lines in the United States, while facing aggressive competition
from the FSAs. It was eventually merged with Continental in
1987. The case of People Express was often cited by airline in-
dustry analysts as an example of an airline growing too fast and
not being able to sustain the growth.
32. The percentage of an aircraft seating capacity that is actually
utilized.
33. The average amount one passenger pays to fly one mile.
34. JetBlue Airways Annual Report 2006.
35. JetBlue Airways Annual Report 2006.
36. www.airlinepilotforums.com
37. Grace Wong, “JetBlue Fiasco: $30M price tag,” money.cnn.com,
February 20 2007.
38. In 2006, the complaint rate was only 0.4 complaints per 100,000
passengers, which was the third best in the industry, behind
Southwest, and a feeder airline for Continental Express called Ex-
pressJet (Source: “JetBlue Fliers Stranded on Plane for 8 hours,”
Fortune, February 15 2007.)
39. The airline featured consistently in the University of Nebraska’s
national Airline Quality Rating (AQR) study every year since
2003; it ranked first in 2004, 2005, and 2006. It won the Read-
ers’ Choice Award from Condé Nast Traveler for five years un-
til 2006, and ranked high in every measured category in the
airline satisfaction ratings study conducted by J.D. Power &
Associates.
Rising fuel costs were also a major concern for JetBlue in the future, as were potentially
increasing operational expenses as the airline’s fleet aged and operations expanded. Ana-
lysts also thought that JetBlue’s growth would dilute the close-knit culture that the company
enjoyed in its initial years. However, many industry experts still believed that the airline
would be able to overcome most of the hurdles it faced and enjoy significant growth in the
future.
www.taxpayer.net
www.wikipedia.org
www.jetblue.com
www.airlinepilotforums.com
20-16 SECTION D Industry Four—Transportation
40. “An Extraordinary Stumble at JetBlue,” Business Week,
March 5, 2007.
41. Crisis Management International was an Atlanta-based global
consulting firm that specialized in helping organizations pre-
pare for and manage the unexpected by offering strategic crisis
management planning and related consulting services.
42. Chuck Salter, “Lessons from the Tarmac,” Fast Company,
May 2007.
43. Under the alliance, passengers could use their frequent flier
miles on both the airlines.
44. Jessica Dickler, “Delays Thwart Virgin America’s First Flight,”
money.cnn.com, August 8, 2007.
TOMTOM WAS ONE OF THE LARGEST PRODUCERS OF SATELLITE NAVIGATION SYSTEMS IN THE WORLD.
Its products were comprised of both stand-alone devices and applications. TomTom led the
navigation systems market in Europe and was second in the United States. TomTom attrib-
uted its position as a market leader to the following factors: the size of its customer and
technology base, its distribution power, and its prominent brand image and recognition.1
With the acquisition of Tele Atlas, TomTom became vertically integrated and also con-
trolled the map creation process. This helped TomTom establish itself as an integrated content,
service, and technology business. The company was Dutch by origin and had its headquarters
based in Amsterdam, The Netherlands. In terms of geography, the company’s operations spanned
from Europe to Asia Pacific, covering North America, the Middle East, and Africa.2
TomTom was supported by a workforce of 3,300 employees from 40 countries. The diverse
workforce enabled the company to compete in international markets.3 The company’s revenues
had grown from €8 million in 2002 to €1.674 billion in 2008. (See Exhibits 1 and 2.)
21-1
C A S E 21
TomTom: New Competition
Everywhere!
Alan N. Hoffman
This case was prepared by Professor Alan N. Hoffman, Bentley University and Erasmus University. Copyright ©2010
by Alan N. Hoffman. The copyright holder is solely responsible for case content. Reprint permission is solely granted
to the publisher, Prentice Hall, for Strategic Management and Business Policy, 13th Edition (and the international and
electronic versions of this book) by the copyright holder, Alan N. Hoffman. Any other publication of the case (trans-
lation, any form of electronics or other media) or sale (any form of partnership) to another publisher will be in viola-
tion of copyright law, unless Alan N. Hoffman has granted an additional written permission. The authors would like
to thank Will Hoffman, Mansi Asthana, Aakashi Ganveer, Hing Lin, and Che Yii for their research. Please address all
correspondence to Professor Alan N. Hoffman, Bentley University, 175 Forest Street, Waltham, MA 02452;
ahoffman@bentley.edu. Printed by permission of Dr. Alan N. Hoffman.
RSM Case Development Centre prepared this case to provide material for class discussion rather than to illus-
trate either effective or ineffective handling of a management situation. Copyright © 2010, RSM Case Development
Centre, Erasmus University. No part of this publication may be copied, stored, transmitted, reproduced, or distributed
in any form or medium whatsoever without the permission of the copyright owner, Alan N. Hoffman.
21-2 SECTION D Industry Four—Transportation
Year Historical Event
1991 Palmtop founded by Harold Goddijn, Peter-Frans Pauwels and Pieter Geelen.
1994 Corinne Vigreux joined the Company to sell Palmtop applications in Europe.
1996 First navigation software for PDAs, EnRoute and RouteFinder launched.
2001 Palmtop renamed TomTom. Harold Goddijn joins TomTom as CEO. Number
of employees 30.
2002 First GPS-linked car navigation product for PDAs, TomTom NAVIGATOR shipped.
€8 million revenue.
2003 NavCore Software Architecture developed, on which all TomTom products are still
based. Number of employees 90.
2004 First portable navigation device shipped, the TomTom GO. 248,000 PND units sold.
2005 TomTom listed on Euronext Amsterdam. €720 million revenue.
2006 TomTom WORK and TomTom Mobility Solutions launched. Number of employees 818.
2007 TomTom makes offer for Tele Atlas. TomTom HD Traffic and TomTom Map
Share launched. 9.6 million PND units sold.
2008 TomTom acquired Tele Atlas.
1991
1996 2004 2006 2008
Tele AtlasTomTom
GO
Work &
Mobility
Solutions
2002
2001
Navigator1st PDA
Founded Renamed Navcore IPO
HDTraffic &
Mapshare
2003 2005 2007
EXHIBIT 1
Company History:
TomTom
2,000,000
1,500,000
1,000,000
500,000
–500,000
–1,000,000
–1,500,000
0
2005 2006 2007 2008
Sales
Net income
EXHIBIT 2
Sales Revenue and
Net Income (€):
TomTom (Dollar
amount in
millions of €)
SOURCE: http://investors.tomtom.com/overview.cfm
However, because of the Tele Atlas acquisition and the current economic downturn, the
company has recently become a cause of concern for investors. On July 22, 2009, TomTom re-
ported a fall of 61% in its net income at the end of the second quarter of 2009.4 TomTom was
in the business of navigation-based information services and devices. The company had been
investing structurally and strategically in research and development to bring new and better
http://investors.tomtom.com/overview.cfm
products and services to its customers. The company’s belief in radical innovation helped it
remain at the cutting edge of innovation within the navigation industry.
The vision of TomTom’s management was to improve people’s lives by transforming navi-
gation from a “don’t-get-lost solution” into a true travel companion that gets people from one place
to another safer, faster, cheaper, and better informed. This vision helped the company become a
market leader in every marketplace in the satellite navigation information services market.5
The company’s goals focused around radical advances in three key areas:
� Better maps: This goal was achieved by maintaining TomTom’s high-quality map data-
base, which was continuously kept up-to-date by a large community of active users who
provided corrections, verifications, and updates to TomTom. This was supplemented by
inputs from TomTom’s extensive fleet of surveying vehicles.6
� Better routing: TomTom had the world’s largest historical speed profile database IQ
Routes™ facilitated by TomTom HOME, the company’s user portal.7
� Better traffic information: TomTom possessed a unique, real-time traffic information
service called TomTom HD traffic™ which provided users with high-quality, real-time
traffic updates.8 These three goals formed the base of satellite navigation, working in con-
junction to help TomTom achieve its mission.
CASE 21 TomTom: New Competition Everywhere! 21-3
TomTom’s Products
TomTom offered a wide variety of products ranging from portable navigation devices to software
navigation applications and digital maps. The unique features in each of these products made them
truly “the smart choice in personal navigation.”9 Some of these products are described below.
TomTom Go and TomTom One
These devices came with a LCD screen that made it easy to use with fingertips while driving.
They provided 1,000 Points of Interest (POI) that helped in locating petrol stations, restau-
rants, and places of importance. A number of other POIs could also be downloaded. Precise,
up-to-the-minute traffic information, jam alerts, and road condition alerts were provided by
both these devices.10
TomTom Rider
These were portable models especially designed for bikers. The equipment consisted of an
integrated GPS receiver that can be mounted on any bike and a wireless headset inside the
helmet. Similar to the car Portable Navigation Devices (PNDs), the TomTom Rider models
had a number of POI applications. The interfaces used in TomTom Rider were user-friendly
and came in a variety of languages.11
TomTom Navigator and TomTom Mobile
These applications provided navigation software along with digital maps. Both of these ap-
plications were compatible with most mobiles and PDAs provided by companies like Sony,
Nokia, Acer, Dell, and HP. These applications came with TomTom HOME, which could be
used to upgrade to the most recent digital maps and application versions.12
21-4 SECTION D Industry Four—Transportation
TomTom for iPhone
On August 17, 2009, TomTom released TomTom for the iPhone. “With TomTom for iPhone,
millions of iPhone users can now benefit from the same easy-to-use and intuitive interface,
turn-by-turn spoken navigation and unique routing technology that our 30 million portable
navigation device users rely on every day,” said Corinne Vigreux, Managing Director of
TomTom. “As the world’s leading provider of navigation solutions and digital maps, TomTom
was the most natural fit for an advanced navigation application on the iPhone.”13
The TomTom app for iPhone 3G and 3GS users included a map of the United States and
Canada from Tele Atlas, and was available for $99.99 USD.
The TomTom app for iPhone included the exclusive IQ Routes™ technology. Instead of
using travel time assumptions, IQ Routes based its routes on the actual experience of millions
of TomTom drivers to calculate the fastest route and generate the most accurate arrival times
in the industry. TomTom IQ Routes empowered drivers to reach their destination faster up to
35% of the time.
Company History
TomTom was founded as “Palmtop” in 1991 by Peter-Frans Pauwels and Pieter Geelen, two
graduates from Amsterdam University, The Netherlands. Palmtop started out as a software
development company and was involved in producing software for handheld computers, one
of the most popular devices of the 1990s. In the following few years, the company diversified
into producing commercial applications including software for personal finance, games, a
dictionary, and maps. In the year 1996, Corinne Vigreux joined Palmtop as the third partner.
In the same year, the company announced the launch of Enroute and RouteFinder, the first
navigation software titles. As more and more people using PCs adopted Microsoft’s operat-
ing system, the company developed applications which were compatible with it. This helped
the company increase its market share. In 2001, the turning point in the history of TomTom,
Harold Goddijn, the former Chief Executive of Psion, joined the company as the fourth part-
ner. Not only did Palmtop get renamed to TomTom, but it also entered the satellite navigation
market. TomTom launched TomTom Navigator, the first mobile car satnav system. Since
then, as can be seen in Exhibit 3, the company has celebrated the successful launch of at least
a product each year.14
800
700
600
500
400
300
200
100
0
Q1 Q2 Q3 Q4
2009
2008
2007
EXHIBIT 3
Quarterly
Sales: TomTom
(Dollar amount
in millions €)
CASE 21 TomTom: New Competition Everywhere! 21-5
In 2002, the company generated revenue of €8 million by selling the first GPS-linked car
navigator, the TomTom Navigator, for PDAs. The upgraded version, Navigator 2, was released
in early 2003. Meanwhile, the company made efforts to gain technical and marketing person-
nel. TomTom took strategic steps to grow its sales. The former CTO of Psion, Mark Gretton,
led the hardware team while Alexander Ribbink, a former top marketing official, looked after
sales of new products introduced by the company.
TomTom Go, an all-in-one car navigation system, was the company’s next major launch.
With its useful and easy-to-use features, TomTom Go was included in the list of successful
products of 2004. In the same year, the company launched TomTom Mobile, a navigation sys-
tem which sat on top of Smartphones.15
TomTom completed its IPO on the Amsterdam Stock Exchange in May 2005, raising
€469 million ($587 million). The net worth of the company was nearly €2 billion after the IPO.
A majority of the shares were held by the four partners.16 From the years 2006 to 2008, TomTom
strengthened itself by making three key strategic acquisitions. Datafactory AG was acquired
to power TomTom WORK through WEBfleet technology, while Applied Generics gave its
technology for Mobility Solutions Services. However, the most prominent of these three was
the acquisition of Tele Atlas.17
In July of 2007, TomTom bid for Tele Atlas, a company specializing in digital maps. The
original bid price of €2 billion was countered by a €2.3 billion offer from Garmin, TomTom’s
biggest rival. When TomTom raised its bid price to €2.9 billion, the two companies initiated a
bidding war for Tele Atlas. Although there was speculation that Garmin would further increase
its bid price, in the end management decided not to pursue Tele Atlas any further. Rather,
Garmin struck a content agreement with Navteq. TomTom’s shareholders approved the
takeover in December 2007.18
TomTom’s Customers
TomTom was a company that had a wide array of customers, each with their own individual
needs and desires. TomTom had a variety of products to meet the requirements of a large and
varied customer base. As an example, its navigational products ranged from $100–$500 in
the United States, ranging from lower-end products with fewer capabilities to high-end prod-
ucts with advanced features.
The first group was the individual consumers who bought stand-alone portable navigation
devices and services. The second group was automobile manufacturers. TomTom teamed with
companies such as Renault to develop built-in navigational units to install as an option in cars.
A third group of customers was the aviation industry and pilots with personal planes. TomTom
produced navigational devices for air travel at affordable prices. A fourth group of customers
was business enterprises. Business enterprises referred to companies such as Wal-Mart, Tar-
get, or Home Depot; huge companies with large mobile workforces. To focus on these cus-
tomers, TomTom formed a strategic partnership with a technology company called Advanced
Integrated Solutions to “optimize business fleet organization and itinerary planning on the
TomTom pro series of navigation devices.” This new advanced feature on PNDs offered ways
for fleet managers and route dispatchers to organize, plan, and optimize routes and to provide
detailed mapping information about the final destination. “Every day, companies with mobile
workforces are challenged to direct all their people to all the places they need to go. Our cus-
tomers appreciate having a central web repository to hold and manage all their location and
address information,19 said Scott Wyatt, CEO of Advanced Integrated Solutions. TomTom’s
fifth group of customers, the Coast Guard, was able to use TomTom’s marine navigational de-
vices for its everyday responsibilities.
21-6 SECTION D Industry Four—Transportation
Mergers and Acquisitions
TomTom made various mergers and acquisitions as well as partnerships which positioned the
company well. In 2008, TomTom acquired a digital mapping company called Tele Atlas. The
acquisition significantly improved TomTom customers’ user experience and created other
benefits for the customers and partners of both companies, including more accurate navigation
information, improved coverage, and new enhanced features such as map updates and IQ
Routes, which will be discussed in the Resources and Capabilities section of the case. Com-
menting on the proposed offer, Alain De Taeye, Co-founder and CEO of Tele Atlas, said:
“. . . the TomTom-Tele Atlas partnership signals a new era in the digital mapping industry. The
combination of TomTom’s customer feedback tools and Tele Atlas’ pioneering map production
processes allows Tele Atlas to dramatically change the way digital maps are continuously updated
and enhanced. The result will be a completely new level of quality, content and innovation that
helps our partners deliver the best navigation products. This transaction is not only very attractive
to our shareholders but demonstrates our longstanding commitment towards all of our partners
and customers to deliver the best digital map products available.”20
In addition to its partnership with Advanced Integrated Solutions, TomTom partnered with
Avis in 2005, adding its user-friendly navigation system to all Avis rental cars. This partner-
ship began in Europe, and recently the devices had made their way into Avis rental cars in
North America as well as many other countries where Avis operated. Harold Goddijn, Chief
Executive Officer of TomTom, commented:
“Any traveler can relate to the stress of arriving in a new and unfamiliar city and getting horri-
bly lost. With the availability of the TomTom GO 700 we’re bringing unbeatable, full feature car
navigation straight into the hands of Avis customers.”21
TomTom acquired several patents for its many different technologies. By having these
patents for each of its ideas, the company protected itself against its competition and other
companies trying to enter into the market.
TomTom prided itself on being the industry innovator and always being a step ahead of the
competition in terms of its technology. On the company’s website it said, “TomTom leads
the navigation industry with the technological evolution of navigation products from static
‘find-your-destination’ devices into products and services that provide connected, dynamic
‘find-the-optimal-route-to-your-destination’, with time-accurate travel information. We are
well positioned to maintain that leading position over the long-term because of the size of our
customer and technology base, our distribution power, and our prominent brand image and
recognition. By being vertically integrated and also controlling the map creation process TomTom
is in a unique position to evolve into an integrated content, service and technology business.”22
TomTom had a strong brand name/image. TomTom positioned itself well throughout the
world as a leader in portable navigation devices. The company marketed its products through
its very user-friendly online website and also through large companies such as Best Buy and
Wal-Mart. TomTom also teamed up with Locutio Voice Technologies and Twentieth Century
Fox Licensing & Merchandising to bring the original voice of Homer Simpson to all TomTom
devices via download. “Let Homer Simpson be your TomTom co-pilot” was one of the many
interesting ways TomTom marketed its products and its name to its consumers.23
TomTom’s Resources and Capabilities
The company believed that there were three fundamental requirements to a navigation system—
digital mapping, routing technology, and dynamic information. Based on these requirements,
three key resources could be identified that really distinguished TomTom from its competition.
CASE 21 TomTom: New Competition Everywhere! 21-7
The first of these resources was the in-house routing algorithms. These algorithms en-
abled TomTom to introduce technologies like IQ Routes that provided a “community based in-
formation database.” IQ Routes calculated customer routes based on the real average speeds
measured on roads at that particular time. TomTom’s website said, “The smartest route hour-
by-hour, day-by-day, saving you time, money and fuel.”24
The second unique resource was Tele Atlas and the digital mapping technology that the
TomTom group specialized in. Having the technology and knowledge in mapping that the
company brought to TomTom allowed it to introduce many unique features to its customers.
First, TomTom came out with a map update feature. The company recognized that roads
around the world were constantly changing and, because of this, it used the technology to come
out with four new maps each year, one per business quarter. This allowed its customers to al-
ways have the latest routes to incorporate into their everyday travel. A second feature it intro-
duced is its Map Share program. The idea behind this is that customers of TomTom who notice
mistakes in a certain map are able to go in and request a change to be made. The change was
then verified and checked directly by TomTom and was shared with the rest of the global user
community. “One and a half million map corrections have been submitted since the launch of
TomTom Map Share™ in the summer of 2007.”25
The third unique resource was automotive partnerships with two companies in particu-
lar: Renault and Avis. At the end of 2008, TomTom reached a deal with Renault to install its
navigation devices in its cars as an option. An article in AutoWeek magazine said the following
about the deal: “Renault developed its new low-cost system in partnership with Amsterdam-
based technology company TomTom, the European leader in portable navigation systems. The
system will be an alternative to the existing satellite navigation devices in Renault’s upper-end
cars.”26 The catch was the new price of the built-in navigation units. The cost of a navigation
device installed in Renault’s cars before TomTom was €1,500. Now, with the TomTom system,
it cost only €500. As mentioned earlier, TomTom also partnered with Avis in 2005 to offer its
navigation devices, specifically the model GO 700, in all Avis rental cars, first starting in
Europe and then expanding into other countries where Avis operated.
Traditional Competition
TomTom faced competition from two main companies. The first of these was Garmin, which
held 45% of the market share, by far the largest and double TomTom’s market share (24%).
Garmin was founded in 1989 by Gary Burrell and Min H. Kao. The company was known for
its on-the-go directions since its introduction into GPS navigation in 1989. At the end of
2008, Garmin reported annual sales of $3.49 billion. Garmin had competed head-to-head in
2009 with TomTom in trying to acquire Tele Atlas for its mapmaking. Garmin withdrew its
bid when it became evident that it was becoming too expensive to own Tele Atlas. Garmin
executives made a decision that it was cheaper to work out a long-term deal with its current
supplier, Navteq, than to try to buy out a competitor.
The second direct competitor was Magellan, which held 15% of the market share.
Magellan was part of a privately held company under the name of MiTac Digital Corporation.
Similar to Garmin, Magellan products used Navteq-based maps. Magellan was the creator of
Magellan NAV 100, the world’s first commercial handheld GPS receiver, which was created
in 1989. The company was also well-known for its award-winning RoadMate and Maestro
series portable car navigation systems.
Together these three dominant players accounted for about 85% of the total market. Other
competitors in the personal navigation device market were Navigon, Nextar, and Nokia.
Navigon and Nextar competed in the personal navigation devices with TomTom, Magellan, and
21-8 SECTION D Industry Four—Transportation
New Competition Everywhere!
Cell Phones
Cell phones were widely used by people all around the world. With the 2005 FCC mandate
that required the location of any cell phone used to call 911 to be tracked, phone manufactur-
ers included a GPS receiver in almost every cell phone. Due to this mandate, cell phone man-
ufacturers and cellular services were able to offer GPS navigation services through the cell
phone for a fee.
AT&T Navigator
GPS Navigation with AT&T Navigator and AT&T Navigator Global Edition feature real-time
GPS-enabled turn-by-turn navigation on AT&T mobile Smartphones (iPhone and Black-
berry) or static navigation and Local Search on a non-GPS AT&T mobile Smartphone.
AT&T Navigator featured Global GPS turn-by-turn navigation—Mapping and Point of
AT&T Interest content for three continents, including North America (United States, Canada,
and Mexico), Western Europe, and China, where wireless coverage was available from AT&T
or its roaming providers. The AT&T Navigator was sold as a subscription service and
cost $9.99 per month.
Online Navigation Applications
Online navigation websites that were still popular among many users for driving directions
and maps were MapQuest, Google Maps, and Yahoo Maps. Users were able to use these free
sites to get detailed directions on how to get to their next destination. In the current economic
downturn, many people were looking for cheap, or if possible free, solutions to solve their
problems. These online websites offered the use of free mapping and navigation information
that will allow them to get what they needed at no additional cost. However, there were down-
sides to these programs: they were not portable and may have poor visualization designs
(such as vague image, or text-based).27
Built-In Car Navigation Devices
In-car navigation devices first came about in luxury, high-end vehicles. Currently, it had be-
come more mainstream and was now being offered in mid- to lower-tier vehicles. These
built-in car navigation devices offered similar features to the personal navigation device but
didn’t have the portability, so users wouldn’t have to carry multiple devices. However, it
Garmin, who were the top three in the industry. But Navigon competed in the high-end seg-
ment which retailed for more than any of the competitors but offered a few extra features in its
PNDs. Nextar competed in the low-end market and its strategy was low cost. Finally, Nokia
was mentioned as a competitor in this industry because the company acquired Navteq, a ma-
jor supplier of map services in this industry. Along with that, Nokia had a big market share in
the cell phone industry and planned on incorporating GPS technology in every phone, making
it a potential key player to look for in the GPS navigation industry.
CASE 21 TomTom: New Competition Everywhere! 21-9
came with a hefty price. Some examples of these are Kenwood, Pioneer, and Eclipse units,
which are all installed in cars. These units tended to be expensive and overpriced because
they were brand name products and required physical installation. For example, the top of
the line Pioneer unit was $1,000 for the monitor and another $500 for the navigation device
plus the physical labor. When buying such products, a customer spent a huge amount of
money on a product that was almost identical to a product TomTom offered at a significantly
lower price.
Physical Maps
Physical maps were the primary option for navigating for decades until technology improved
them. Physical maps provided detailed road information to help a person get from point A to
point B. Although more cumbersome to use than some of the modern technology alternatives,
it was an alternative for people who were not technically savvy or for whom a navigation de-
vice was an unnecessary luxury.
Potential Adverse Legislation and Restrictions
In the legal and political realm, TomTom had faced two issues that were not critical now, but
may have significant ramifications to not only TomTom in the future, but also the entire
portable navigation device industry. The reaction of TomTom’s management to each of these
issues will determine whether or not there was an opportunity for gain or a threat of a signifi-
cant loss to the company.
The most important issue TomTom dealt with was the possible legislative banning of all
navigational devices from automobiles. In Australia, there was growing concern over the dis-
traction caused by PNDs so the legislature took steps toward banning these devices entirely
from automobiles.28 There was a similar sentiment in Ontario, Canada, where a law that was
currently under review would ban all PNDs that were not mounted either to the dashboard or
to the windshield itself.29
With the increase in legislation adding to the restrictions placed on PND devices, the
threat that the PND market in the future will be severely limited could not be ignored. All
of the companies within the PND industry, not just TomTom, must create a coordinated and
united effort to stem this wave of restrictions as well as provide reassurance to the public
that they were also concerned with the safe use of their products. This effort can be seen in
the heavily regulated toy industry. Many companies within the toy industry had combined
to form the International Council of Toy Industries30 to be proactive in regards to safety
regulations, as well as lobby governments against laws that may unfairly threaten the toy
industry.31
The other issue within the legal and political spectrum that TomTom must focus on
was the growing use of GPS devices as tracking devices. Currently, law enforcement
agents were allowed to use their own GPS devices to track the movements and locations
of individuals they deemed suspicious. However, if budget cuts reduced the access to these
GPS devices, then the simple solution will be to use the PND devices already installed in
many automobiles.
This issue also required the industry as a whole to proactively work with the con-
sumers and the government to come to an amicable resolution. The threat of having every
21-10 SECTION D Industry Four—Transportation
consumer’s GPS information at the fingertips of either the government or surveillance
company will most certainly stunt or even completely halt any growth within the PND
industry.
Another alarming trend was the rise in PND thefts around the country.32 With the prices
for PNDs at a relatively high level, thieves were targeting vehicles that had visible docking sta-
tions for PNDs either on the dashboard or the windshield. The onus will be on TomTom to cre-
ate new designs that will not only hide PNDs from would-be thieves but also deter them from
trying to steal one. Consumers who were scared to purchase PNDs because of this rise in crime
will become an issue if this problem is not resolved.
There was also a current trend, labeled the GREEN movement,33 that aimed to reduce
any activities that will endanger the environment. This movement was a great opportunity for
TomTom to tout its technology as the smarter and more environmentally safe tool if driving
is an absolute necessity. Not only can individuals tout this improved efficiency, but more
importantly on a larger scale, businesses that require large amounts of materials to be trans-
ported across long stretches can show activists that they too are working to becoming a green
company.
It is ironic that the core technology used in TomTom’s navigation system, the GPS
system, has proliferated into other electronic devices at such a rapid pace that it has caused
serious competition to the PND industry. GPS functionality was a basic requirement for all
new Smartphones that entered the market and soon will become a basic functionality in reg-
ular cellular phones. TomTom will be hard pressed to compete with these multifunctional
devices unless it can improve upon its designs and transform itself into a single focused
device.
Another concern for not only TomTom, but also every company that relies heavily on
GPS technology, was the aging satellites that supported the GPS system. Analysts predicted
that these satellites will be either replaced or fixed before there are any issues, but this issue
was unsettling due to the fact that TomTom had no control over it.34 TomTom will have
to devise contingency plans in case of catastrophic failure of the GPS system, much like
what happened to Research in Motion when malfunctioning satellites caused disruption in
its service.
TomTom was one of the leading companies in the PND markets in both Europe and the
United States. Although they were the leader in Europe, that market was showing signs of
becoming saturated. Even though the U.S. market was currently growing, TomTom could
not wait for the inevitable signs of that market’s slowdown as well.
The two main opportunities for TomTom to expand—creating digital maps for develop-
ing countries and creating navigational services—can either be piggybacked or can be taken
in independent paths. The first-mover advantage for these opportunities will erect a high bar-
rier of entry for any companies that do not have large amounts of resources to invest in the de-
veloping country. TomTom was already playing catch-up to Garmin and its already established
service in India.
Globalization of any company’s products did not come without a certain set of issues. For
TomTom, the main threat brought on by foreign countries was twofold. The first threat, which
may be an isolated instance, but could also be repeated in many other countries, was the re-
striction of certain capabilities for all of TomTom’s products. Due to security and terrorism
concerns, GPS devices have not been allowed in Egypt since 2003.35 In times of global terror-
ism, TomTom must be vigilant of the growing trend for countries to become overly protective
of foreign companies and their technologies.
CASE 21 TomTom: New Competition Everywhere! 21-11
Internal Environment
Finance
TomTom’s financial goals were to diversify and become a broader revenue-based company.
The company not only sought to increase the revenue base in terms of geographical expan-
sion but also wanted to diversify its product and service portfolio. Additionally, another im-
portant goal the company strived to achieve was reducing its operating expenses.
Exhibit 2 shows that from 2005 to 2007 there was a consistent growth in sales revenue as well
as a corresponding increase in net income. However, year 2008 was an exception to this trend.
In this year sales revenue decreased by 3.7% and the net income decreased by 136%. In fact, in
the first quarter the net income was actually negative, totaling – €37 million. The decrease in sales
can be accounted for by the downturn in the economy. According to its 2008 annual report, the
sales are in line with market expectations. However, the net income plummeted much more
than the decrease in sales. This was actually triggered by its acquisition of the digital mapping
company—Tele Atlas—which was funded by both cash assets and debt.
Quarterly sales In the second quarter of 2009, TomTom received sales revenue of
€368 million compared to €213 million in the first quarter and €453 million in the same quar-
ter in 2008 (Exhibit 3). By evaluating quarterly sales for a three-year period from 2007 until
the present, it was apparent that the sales followed a seasonal trend in TomTom, with highest
sales in the last quarter and lowest in the first quarter. However, focusing on just the first and
second quarter for three years, one can infer that the sales revenue as a whole was also going
down year after year. To investigate further on the causes of this scenario, the company will
have to delve deeper into its revenue base. TomTom’s sources of revenue can be broadly
grouped into two categories—market segment and geographic location.
Sales Revenue and Net Income
(in € millions) Q 1’09 Q 1’08 y.o.y Q 4’08 q.o.q.
Revenue 172 264 –35% 473 –64%
PNDs 141 234 –40% 444 –68%
Others 31 29 5% 29 5%
# of PNDs sold (in thousands) 1,419 1,997 –29% 4,443 –68%
Average Selling Price (€) 99 117 –15% 100 –1%
EXHIBIT 4
Revenue per
Segment: TomTom
(Dollar amount in
million of €)
Revenue per Segment
TomTom’s per segment revenue stream can be divided into PNDs and others, where others
consisted of services and content. Evaluating the first quarter of 2008 against that of 2009 and
the last quarter of 2008, TomTom experienced steep declines of 40% and 68% (see Exhibit 4).
This could be a consequence of the compounded effect of the following: (1) The number of
devices (PNDs) decreased by a similar amount during both time periods. (2) The average selling
price of PNDs had also been decreasing consistently. In a technology company, a decrease in
21-12 SECTION D Industry Four—Transportation
2005 2006 2007 2008 2009
Long Term Debt 301 338 377 4,749 4,811
Cash Assets 178,377 437,801 463,339 321,039 422,530
Borrowings 0 0 0 1,241,900 1,195,715
EXHIBIT 6
Cash versus Long
Term Debt (Dollar
amount in thousands
of €)
30%
25%
20%
15%
10%
5%
0%
2005 2006 2007 2008
Operating margin
EXHIBIT 7
Operating Margin:
TomTom
Revenue per Region
TomTom’s per region revenue stream can be further divided into Europe, North America, and
the rest of the world. Comparing the first quarter of 2009 against 2008, it can be seen that rev-
enue from both Europe and North America were on the decline, with a decrease of 22% and
52%, respectively (see Exhibit 5). At the same time, revenue from the rest of the world had
seen a huge increase of 90%. Both of these analyses supported TomTom’s current goal to
increase its revenue base and is aligned with its long-term strategy of being a leader in the
navigation industry.
Long-term debt. In 2005, TomTom was a cash-rich company. However, the recent acqui-
sition of Tele Atlas, which amounted to €2.9 billion, was funded by cash, release of new shares,
and long-term debt (see Exhibit 6), in this case a €1.2 billion loan. These combined to use up
TomTom’s cash reserves. Currently, TomTom’s debt was €1,006 million.
Operating margin. TomTom saw a consistent increase in operating margin until 2006
(see Exhibit 7). However, since 2007 operating margin had been decreasing for the firm. In
fact, by the end of 2008 it came down to 13% compared to 26% in 2006.
Quarter 1 of 2009 Quarter 1 of 2009 Difference
Europe 178,114 146,549 –22%
North America 84,641 55,558 –52%
Rest of world 1,087 10,976 90%
Total 263,842 213,083 –24%
EXHIBIT 5
Revenue per
Region: TomTom
(Dollar amount
in millions of €)
average selling price is a part of doing business in a highly competitive and dynamic market-
place. Nevertheless, the revenue stream from business units other than PNDs had seen a
steady increase in both the scenarios.
CASE 21 TomTom: New Competition Everywhere! 21-13
Marketing
Traditionally, high quality and ease of use of solutions have been of utmost importance to
TomTom. In a 2006 interview, TomTom’s Marketing Head, Anne Louise Hanstad, emphasized
the importance of simplicity and ease of use with its devices. This underlined TomTom’s
belief that people prefer fit for purpose devices that are developed and designed to do one spe-
cific thing very well. At that time, both of these were core to TomTom’s strategy as its targeted
customers were early adopters. Now, however, as the navigation industry moved from embry-
onic to a growth industry, TomTom’s current customers were early majority. Hence, simplic-
ity and ease alone could no longer provide it with a competitive advantage.
Recently, to be in line with its immediate goal of diversifying into different market
segments, TomTom was more focused on strengthening its brand name. In December 2008,
TomTom’s CEO stated “. . . we are constantly striving to increase awareness of our brand and
strengthen our reputation for providing smart, easy-to-use, high-quality portable navigation
products and services.”36
Along with Tele Atlas, the TomTom group has gained depth and breadth of expertise over
the last 30 years, which made it a trusted brand. Three out of four people were aware of the
TomTom brand across the markets. The TomTom group has always been committed to the
three fundamentals of navigation: mapping, routing algorithm, and dynamic information. Tele
Atlas’ core competency was the digital mapping database and TomTom’s was routing algo-
rithms and guidance services using dynamic information. Together, the group created syner-
gies that enabled it to introduce products almost every year advancing on one or a combination
of these three elements. Acquiring its long time supplier of digital maps, Tele Atlas, in 2008
gave TomTom an edge with in-house digital mapping technology.
TomTom provided a range of PND devices like TomTom One, TomTom XL, and the Tom-
Tom Go Series. Periodically, it tried to enhance those devices with new features and services
that were built based on customer feedback. Examples of services were IQ Routes and LIVE
services. While IQ Routes provided drivers with the most efficient route planning, accounting
for situations as precise as speed bumps and traffic lights, LIVE services formed a range of in-
formation services delivered directly to the LIVE devices. The LIVE services bundle included
Map Share and HD Traffic, bringing the content collected from vast driving communities di-
rectly to the end user.
These products and services accentuated effective designs and unique features, and re-
quired TomTom to work with its customers to share precise updates and also get feedback for
future improvements. Hence, effective customer interaction became essential to its long-term
goal of innovation. In 2008, J. D. Power and Associates recognized TomTom for providing out-
standing customer service experience.37 Although it awarded TomTom for customer service
satisfaction, J. D. Power and Associates ranked Garmin highest in overall customer satisfac-
tion. TomTom followed Garmin in the ranking, performing well in the routing, speed of sys-
tem, and voice direction factors.38
As mentioned previously, when the navigation industry was still in its embryonic stages, fea-
tures, ease of use, and high quality of its solutions gave TomTom products a competitive edge.
Eventually, the competition increased in the navigation industry and even substitutes posed a sub-
stantial threat to market share. TomTom offered PNDs in different price ranges, broadly classi-
fied into high-range and mid-range PNDs, with an average selling price of €99. There were
entry-level options that allowed a savvy shopper to put navigation in his/her car for just over
$100. Higher-end models added advanced features and services that were previously described.
TomTom sold its PNDs to consumers through retailers and distributors. After acquiring
Tele Atlas, it was strategically placed to gain the first mover advantage created by its rapid
expansion of geographical coverage.39 This was of key importance when it came to increasing
its global market share.
21-14 SECTION D Industry Four—Transportation
TomTom directed its marketing expenditure toward B2B advertising that was directed
to retailers and distributors. TomTom also invested in an official blog website as well as
search optimization, which placed it in premium results in online searches. This enabled
TomTom to do effective word-of-mouth promotion while keeping flexible marketing spend-
ing, in accordance with changes in the macroeconomic environment or seasonal trends.40
Although this approach gave TomTom spending flexibility, it lacked a direct B2C approach.
In 2009, only 21% of U.S. adults owned PNDs, whereas 65% of U.S. adults neither owned
nor used navigation.41 By not spending on B2C marketing, TomTom discounted on the op-
portunity both to attract first-tier noncustomers and glean an insight of needs of second-tier
noncustomers.42
Operations
The focus of operations had always been on innovation. More recently, TomTom’s opera-
tional objective had been to channel all its resources and core capabilities to create
economies of scale so as to be aligned with its long-term strategy. TomTom aimed to focus
and centralize R&D resources to create scale economies to continue to lead the industry in
terms of innovation.43
Implementation of this strategy was well underway and the changes were visible. By the
second quarter of 2009, mid-range PNDs were introduced with the capabilities of high-range
devices. In addition, 50% of PNDs were sold with IQ Routes technology. The first in-dash
product was also launched in alliance with Renault, and the TomTom iPhone application was
also announced.44
After acquiring Tele Atlas to better support the broader navigation solutions and content
and services, the group underwent restructuring. The new organizational structure consisted of
four business units that had clear focus on a specific customer group and were supported by
two shared development centers.
The four business units were CONSUMER (B2C), composed of retail sales of PND, on-
board, and mobile; AUTOMOTIVE (B2B), composed of auto industry sales of integrated so-
lutions and content & services; LICENSING (B2B), composed of PND, automotive, mobile,
Internet, and GIS content and services; and WORK (B2B), composed of commercial fleet
sales of Webfleet & Connected Solutions.
TomTom’s supply chain and distribution model was outsourced. This increased
TomTom’s ability to scale up or down the supply chain, while limiting capital expenditure risks.
At the same time, however, it depended on a limited number of third parties—and in certain
instances sole suppliers—for component supply and manufacturing, which increased its de-
pendency on these suppliers.
TomTom’s dynamic content sharing model used high-quality digital maps along with the
connected services, like HD Traffic, Local Search with Google, and weather information. This
provided customers with relevant real-time information at the moment they needed it, which
helped them deliver the benefits of innovative technology directly to the end user at affordable
prices. Although the network externalities previously mentioned were among the advantages
of TomTom’s LIVE, it had also increased TomTom’s dependency on the network of the
connected driving community. The bigger the network, the more effective the information
gathered from the guidance services.
CASE 21 TomTom: New Competition Everywhere! 21-15
Furthermore, in order to reduce operating expenses and strengthen the balance sheet,
heavy emphasis had been placed on the cost-cutting program. In 2009, the cost reductions were
made up of reduction of staff, restructuring and integration of Tele Atlas, reduced discretionary
spending, and reduction in the number of contractors and marketing expenditures. However,
if not executed wisely, it could hamper TomTom’s long-term objective of being a market
leader. For example, one of the core capabilities of any technology company was its staff; re-
ducing it could hinder future innovative projects. This may also occur when reducing the mar-
keting expenditures in a market which still held rich prospects of high growth. Among U.S.
adults, 65% did not own any kind of navigation system.45
Human Resources
Like in any other technology company the success of individual employees was very important
to TomTom. Additionally, TomTom had a vision that company success should also mean suc-
cess for the individual employee. Therefore, at TomTom, employee competency was taken very
seriously and talent development programs were built around it. There was a personal naviga-
tion plan that provided employees with a selection of courses based on competencies in their
profile. In 2008, TomTom completed its Young Talent Development Program which was aimed
at broadening the participants’ knowledge, while improving their technical and personal skills.
TomTom’s motto was to do business efficiently and profitably, as well as responsibly. This
underlined its corporate social responsibility. TomTom’s headquarters was one of the most en-
ergy efficient buildings in Amsterdam. As previously mentioned, earlier navigation was ori-
ented toward making the drivers arrive at their destination without getting lost. TomTom was
the pioneer in introducing different technology that actually helped drivers to make their jour-
neys safer and more economical. This showed TomTom’s commitment to its customer base as
well as to the community as a whole.
Issues of Concern for TomTom
First, TomTom was facing increasing competition from other platforms using GPS technology,
such as cell phones and Smartphones. In the cell phone industry, Nokia was leading the
charge in combining cell phone technology with GPS technology. Around the same time
TomTom acquired Tele Atlas, Nokia purchased Navteq, a competitor to Tele Atlas. With the
acquisition of Navteq, Nokia hoped to shape the cell phone industry by merging cell phone,
Internet, and GPS technology.
The Smartphone industry was emerging with the iPhone and the Palm Pre. There was also
a shift in how people were able to utilize these technologies as a navigation tool. A big trend
in Smartphones were applications. Because of the ease of developing software on platforms for
Smartphones, more and more competitors were coming to the forefront and developing GPS
navigation applications. On October 28, 2009, Google announced the addition of Tom Tom and
Garmin Ltd. as competitors. Google was adding driving directions to its Smartphones.
For TomTom, both of these sectors might signal that major change was on the horizon and
that there was no longer a need for hardware for GPS navigation devices. The world seemed
to be heading toward a culture where consumers wanted an all-in-one device such as a cell
phone or Smartphone that would do everything needed, including offering GPS navigation
services. A recent study done by Charles Golvin for Forrester suggested that by 2013 phone-
based navigation will dominate the industry. The reason was due to Gen Y and Gen X cus-
tomers who were increasingly reliant on their mobile phone and who will demand that social
networking and other connected services be integrated into their navigation experience.46
21-16 SECTION D Industry Four—Transportation
N O T E S
1. TomTom AR-08, “TomTom Annual Report 2008,” TomTom An-
nual Report 2008, December 2008.
2. Ibid.
3. “TomTom Challenge,” http://www.tomtomchallenge.nl/resources/
AMGATE_400083_1_TICH_R76719135691/.
4. Compare GPS Sat Nav Systems. http://www.satellitenavigation
.org.uk/gps-manufacturers/tomtom/. Robert Daniel, “TomTom
Net Fell 61%, Revenue Off 19%,” http://www.foxbusiness.com/
story/markets/industries/telecom/tomtom-net-fell—revenue/.
5. TomTom, “TomTom, Portable GPS Car Navigation Systems,”
http://investors.tomtom.com/overview.cfm.
6. Ibid.
7. Ibid.
8. Ibid.
9. TomTom AR-08, “TomTom Annual Report 2008,” TomTom
Annual Report 2008, December 2008.
10. Compare GPS Sat Nav Systems. http://www.satellitenavigation
.org.uk/gps-manufacturers/tomtom/. Robert Daniel, “TomTom
Net Fell 61%, Revenue Off 19%,” http://www.foxbusiness.com/
story/markets/industries/telecom/tomtom-net-fell—revenue/.
11. Ibid.
12. Ibid.
13. TomTom, “TomTom, Portable GPS Car Navigation Systems,”
http://investors.tomtom.com/overview.cfm.
14. Compare Sat Nav Systems. http://www.satellitenavigation.org
.uk/gps-manufacturers/tomtom/. Robert Daniel, “TomTom Net
Fell 61%, Revenue Off 19%,” http://www.foxbusiness.com/
story/markets/industries/telecom/tomtom-net-fell—revenue/.
15. Ibid.
16. “TomTom NV,” http://www.answers.com/topic/tomtom-n-v.
17. Ibid.
18. Thomson Reuters, “TomTom Launches 2.9 bln Euro Bid for Tele
Atlas,” http://www.reuters.com/article/technology-media-telco-SP/
idUSL1839698320071119 (November 19, 2007).
19. Advanced Integrated Solutions, “TomTom and Advantage
Integrated Solutions Partner to Deliver an Intelligent Fleet Routing
Solution for Businesses,” http://www.highbeam.com/doc/
1G1-196311252.html (March 2009).
20. TeleAtlas Press Release, http://www.teleatlas.com/WhyTeleAtlas/
Pressroom/PressReleases/TA_CT015133.
21. TomTom Press Release, “TomTom and Avis Announce the First
Pan-European Deal to Provide TomTom GO.”
22. TomTom, “TomTom, Portable GPS Car Navigation Systems,”
http://investors.tomtom.com/overview.cfm.
23. Boston Business Article, http://www.boston.com/business/
ticker/2009/06/let_homer_simps.html).
24. “TomTom NV,” http://www.answers.com/topic/tomtom-n-v.
25. Ibid.
26. Auto-Week Article, “Renault, TomTom Promise Cheap Navi-
gation,” http://www.autoweek.com/article/20080929/free/
809299989#ixzz0MQ8bKdYo.
27. Magellan website, http://www.magellangps.com/about/.
28. David Richards, Smarthouse, June 17, 2009, http://www
.smarthouse.com.au/Automotive/Navigation/P4P3H9J8 (July 29,
2009).
29. Tanya Talaga and Rob Ferguson, TheStar.com, October 28, 2008,
http://www.thestar.com/News/Ontario/article/525697 (July 29,
2009).
30. ICTI, 2009, http://www.toy-icti.org/ (July 29, 2009).
31. Ibid.
32. GPS Magazine, September 23, 2007, http://gpsmagazine.com/
2007/09/gps_thefts_rise.php (July 29, 2009).
33. “Webist Media,” Web Ecoist, August 17, 2008, http://webecoist
.com/2008/08/17/a-brief-history-of-the-modern-green-movement/
(July 29, 2009).
34. Nick Jones, Garnter, January 5, 2009, http://www.gartner.com/
resources/168400/168438/findings_risks_of_gps_perfor_168438
(July 29, 2009).
35. US News, October 14, 2008, http://usnews.rankingsandreviews
.com/cars-trucks/daily-news/081014-GPS-Devices-Banned-in-
Egypt/ (July 29, 2009).
36. TomTom AR-08, “TomTom Annual Report 2008,” TomTom
Annual Report 2008, December 2008.
37. Reuters, “TomTom Inc. Recognized for Call Center Customer
Satisfaction Excellence by J.D. Power,” January 7, 2008,
http://www.reuters.com/article/pressRelease/idUS141391�07-
Jan-2008�PRN20080107.
38. J. D. Power and Associates, “Garmin Ranks Highest in Customer Sat-
isfaction with Portable Navigation Devices,” October 23, 2008,
http://www.jdpower.com/corporate/news/releases/pressrelease.aspx?
ID�2008221.
39. TomTom AR-08, “TomTom Annual Report 2008,” TomTom
Annual Report 2008, December 2008.
40. Ibid.
41. Forrestor Research, “Phone-Based Navigation Will Dominate by
2013,” March 27, 2009.
42. W. Chan Kim and Mauborgne, Blue Ocean Strategy (Boston:
Harvard Business School Press, 2005).
43. TomTom AR-08, “TomTom Annual Report 2008,” TomTom
Annual Report 2008, December 2008.
44. Ibid.
45. Forrestor Research, “Phone-Based Navigation Will Dominate by
2013,” March 27, 2009.
46. Ibid.
Secondly, TomTom faced a maturing U.S. and European personal navigation device market.
After three years of steady growth in the PND market, TomTom had seen decreasing growth rates
for PND sales. Initially entering the European market 12 months before entering the U.S. mar-
ket, TomTom witnessed a 21% dip in sales for the European market. Although TomTom experi-
enced some growth in the U.S. market for 2008, the growth rate was not as good as in prior years.
http://www.tomtomchallenge.nl/resources/AMGATE_400083_1_TICH_R76719135691/
http://www.tomtomchallenge.nl/resources/AMGATE_400083_1_TICH_R76719135691/
http://www.satellitenavigation.org.uk/gps-manufacturers/tomtom/
http://www.satellitenavigation.org.uk/gps-manufacturers/tomtom/
http://www.foxbusiness.com/story/markets/industries/telecom/tomtom-net-fell�revenue/
http://www.foxbusiness.com/story/markets/industries/telecom/tomtom-net-fell-revenue/
http://investors.tomtom.com/overview.cfm
http://www.satellitenavigation.org.uk/gps-manufacturers/tomtom/
http://www.satellitenavigation.org.uk/gps-manufacturers/tomtom/
http://www.foxbusiness.com/story/markets/industries/telecom/tomtom-net-fell%E2%80%94revenue/
http://www.foxbusiness.com/story/markets/industries/telecom/tomtom-net-fell%E2%80%94revenue/
http://investors.tomtom.com/overview.cfm
http://www.satellitenavigation.org.uk/gps-manufacturers/tomtom/
http://www.satellitenavigation.org.uk/gps-manufacturers/tomtom/
http://www.foxbusiness.com/story/markets/industries/telecom/tomtom-net-fell%E2%80%94revenue/
http://www.foxbusiness.com/story/markets/industries/telecom/tomtom-net-fell%E2%80%94revenue/
http://www.answers.com/topic/tomtom-n-v
http://www.reuters.com/article/technology-media-telco-SP/idUSL1839698320071119
http://www.reuters.com/article/technology-media-telco-SP/idUSL1839698320071119
http://www.highbeam.com/doc/1G1-196311252.html
http://www.highbeam.com/doc/1G1-196311252.html
http://www.teleatlas.com/WhyTeleAtlas/Pressroom/PressReleases/TA_CT015133
http://www.teleatlas.com/WhyTeleAtlas/Pressroom/PressReleases/TA_CT015133
http://investors.tomtom.com/overview.cfm
http://www.boston.com/business/ticker/2009/06/let_homer_simps.html
http://www.boston.com/business/ticker/2009/06/let_homer_simps.html
http://www.answers.com/topic/tomtom-n-v
http://www.autoweek.com/article/20080929/free/809299989#ixzz0MQ8bKdYo
http://www.autoweek.com/article/20080929/free/809299989#ixzz0MQ8bKdYo
http://www.magellangps.com/about/
http://www.smarthouse.com.au/Automotive/Navigation/P4P3H9J8
http://www.smarthouse.com.au/Automotive/Navigation/P4P3H9J8
http://www.thestar.com/News/Ontario/article/525697
http://www.toy-icti.org/
http://gpsmagazine.com/2007/09/gps_thefts_rise.php
http://gpsmagazine.com/2007/09/gps_thefts_rise.php
http://webecoist.com/2008/08/17/a-brief-history-of-the-modern-green-movement/
http://webecoist.com/2008/08/17/a-brief-history-of-the-modern-green-movement/
http://www.gartner.com/resources/168400/168438/findings_risks_of_gps_perfor_168438
http://www.gartner.com/resources/168400/168438/findings_risks_of_gps_perfor_168438
http://www.gartner.com/resources/168400/168438/findings_risks_of_gps_perfor_168438
http://usnews.rankingsandreviews.com/cars-trucks/daily-news/081014-GPS-Devices-Banned-in-Egypt/
http://usnews.rankingsandreviews.com/cars-trucks/daily-news/081014-GPS-Devices-Banned-in-Egypt/
http://usnews.rankingsandreviews.com/cars-trucks/daily-news/081014-GPS-Devices-Banned-in-Egypt/
http://www.reuters.com/article/pressRelease/idUS141391+07-Jan-2008+PRN20080107
http://www.reuters.com/article/pressRelease/idUS141391+07-Jan-2008+PRN20080107
http://www.jdpower.com/corporate/news/releases/pressrelease.aspx?ID=2008221
http://www.jdpower.com/corporate/news/releases/pressrelease.aspx?ID=2008221
Introduction
SOUTH OF LOS ANGELES, IN VELCRO VALLEY, LAND OF THE SUBURBAN UPPER-MIDDLE CLASS, the
top skaters, surfers, and snowboarders set the California fashion trends.1 Back in the
1990s, one of these individuals carved his path to becoming the CEO of Volcom Inc., a
clothing manufacturer, rooted in the action sports of skateboarding, surfing, and snow-
boarding. Armed with a business degree from Pepperdine University, time spent riding for
Quiksilver Inc. as a sponsored surfer, as well as experience in marketing and producing videos
for the clothing manufacturer, Richard Woolcott was well prepared to lead his company to its
destiny.2
By focusing on staying “core” and “respecting the stone,” the Volcom family has built a
reputation in the Orange County youth apparel industry for authenticity.3 In 1999, Woolcott
said, “Nobody’s getting rich. Nobody owns a house. But I know that low tide was in about
45 minutes, and I’m gonna go surfing . . . . I’m living the life that I always dreamed of living.”4
How much more “core” can a CEO get? Volcom has lived quite the life. From the end of fis-
cal year 2005 to the end of fiscal year 2008, the company’s revenues more than doubled from
$160 million to $334.3 million. Within the same period, net income ranged between $21.7 and
$33.3 million.
As a primary player in the boardsports community, Volcom was committed to maintain-
ing its brand, position, and lifestyle. Creative energy and a rebellious attitude had fueled
Volcom for years, but how much more market share can the company garner? How can the
company further differentiate itself from its competitors? When the economic downturn of
2008 hit the retail landscape, businesses reevaluated inventories and turned to discounting to
22-1
C A S E 22
Volcom Inc.: Riding the Wave
Christine B. Buenafe and Joyce P. Vincelette
This case was prepared by Christine B. Buenafe and Joyce P. Vincelette of New Jersey College. Copyright © 2010 by
Joyce P. Vincelette. The copyright holder was solely responsible for case content. Reprint permission was solely
granted to the publisher, Prentice Hall, for the books Strategic Management Business Policy, 13th Edition (and the
international and electronic versions of this book) by the copyright holder, Joyce P. Vincelette. Any other publication
of the case (translation, any form of electronics, or other media) or sale (any form of partnership) to another publisher
will be in violation of copyright law, unless Joyce P. Vincelette has granted an additional written permission. This case
was revised and edited for SMBP,13th Edition. Reprinted by permission.
Industry Five—Clothing
History
Volcom broke onto the retail scene in 1991 in Orange County, California, the epicenter of
boardsports culture.5 Richard “Wooly” Woolcott and Tucker “T-Dawg” Hall came up with the
idea to start a clothing company after one fateful snowboarding trip to Lake Tahoe. The two
were eager to build a business around their passion for skateboarding, snowboarding, and
surfing as well as their love for art, music, and film.
The founders borrowed $5,000 from Woolcott’s father to start their company while they
surfed and snowboarded on the side.6 Volcom was headquartered in Woolcott’s bedroom in
Newport Beach, California, and sales were handled out of Tucker’s home in Huntington
Beach.7 The two knew nothing about making clothes but left it all to spirit and creativity.
Volcom’s first year sales totaled $2,600. Richard Woolcott told Transworld Business mag-
azine that his father called one morning and said, “Son, looking at your numbers, if you don’t
get your act together, you’re going to be out of business in less than three months. I’m not go-
ing to help you or bail you out. So you better figure it out.”8 Without any inventory and hardly
any money, Woolcott and Tucker decided to take the business more seriously as a step into
Volcom’s future.
Marketing became a focus for the company as it sought to strengthen the brand and dif-
ferentiate Volcom within the action sports industry. In 1993, Veeco Production was formed to
market Volcom’s first video release. In 1995, the company added the Volcom Entertainment
division to produce music CDs, and introduced the Volcom Featured Artist Series to showcase
the brand’s artistic depth. At this time, the company began sponsoring skateboard, snowboard,
and surfing athletes and teams as team riders. Stars such as surfer Bruce Irons, skateboarder
Geoff Rowley, and Olympic Gold-winning snowboarder Shaun White were contracted to en-
dorse Volcom products.9 The company further expanded its marketing efforts via launching
boardsports competitions, global art tours such as its Hitten Switches book tours, and the Vol-
comics comic book tour. In early 2001, Volcom contracted with MCA Records to create a new
joint venture record label.10 Other music-related pursuits included sponsoring a stage on the
annual Vans Warped Tour, which was popular with the boarding crowd.11
Over the years, sales grew dramatically for Volcom, Woolcott’s father joined the com-
pany’s board of directors, and eventually Tucker Hall retired. In 2004, the company recorded
a net profit of $24.5 million on revenues of $110.6 million, up 42% from the year before.12
Menswear was outselling women’s by two to one and top customer Pacific Sunwear (PacSun)
accounted for 27% of total sales.13 Volcom products were available in nearly 3,000 stores, rep-
resenting 1,100 separate clients.14 Some 85% of sales took place in the United States, with
Canada and Japan accounting for most of the rest.15 The company reincorporated in Delaware
in April 2005 and went public in June of the same year. Until then, the company was officially
known as Stone Boardwear Inc. Volcom issued 4.19 million shares, which started at $19 and
closed at $26.77.16 In October 2005, the company acquired Welcom Distribution SARL, the
distributor of Volcom-branded products in Switzerland.17
Volcom Inc. made the No. 11 spot on BusinessWeek’s 2006 Hot Growth list of small com-
panies. In that year, the company introduced three new product extensions: Creedler sandals and
slip-ons, girl’s swimwear, and a boy’s clothing line for ages 4 to 7.18 In anticipating the
22-2 SECTION D Industry Five—Clothing
move products. What does this environment mean for a manufacturer like Volcom? Will the
company’s strategies effectively influence revenue growth for the long term? Woolcott’s team
has had plenty of experience in meeting waves, making jumps, and conquering slopes. The
company had established a loyal audience and supported talented individuals in living their
dreams. What other tricks can Volcom pull to maneuver through this point in the game?
CASE 22 Volcom Inc.: Riding the Wave 22-3
expiration of its licensing agreement with its European licensee at the end of fiscal year
2006, the company took direct control of the brand in Europe.19 The company had been
operating there under a licensee model for 10 years. Volcom began delivering product from
its newly formed, wholly owned subsidiary constructed in Anglet, France, in the second
half of 2007.
Volcom further expanded in 2008. The company entered into an agreement to take direct
control of the Volcom brand in the U.K. and acquired the Japanese distributor of Volcom-
branded products.20 Domestically, it acquired the assets of Laguna Surf & Sport, a California-
based retail chain operating two retail stores.21 Furthermore, the company acquired all of the
outstanding membership interests of Electric Visual Evolution LLC, or Electric, for $26.3 mil-
lion plus transaction costs of $1.2 million.22 Electric was a core action sports lifestyle brand
with a well-diversified product line encompassing surf, skate, snow, ski, motocross, and
NASCAR.23
As of December 31, 2008, Volcom employed 490 full-time European and domestic em-
ployees. The company had 13 full-price branded retail stores and licensed eight full-price
stores placed in strategic markets around the world. In addition, it owned two multi-brand
Laguna Surf & Sport stores. Volcom-branded products were sold throughout the United States
and in over 40 countries internationally by Volcom or international licenses supported by in-
house sales personnel, independent sales representatives, and distributors.24 At the end of fis-
cal year 2008, total revenues amounted to $334.3 million.
Corporate Governance
Board of Directors
The company’s seven directors as of December 31, 2008, were:25
Richard R. Woolcott, 43, founded Volcom in 1991 and has served as Chairman since June 2008 and
Chief Executive Officer since Volcom’s inception. Mr. Woolcott also served as the Chairman from incep-
tion until July 2000 and as President from inception until June 2008. From 1989 until 1991, he worked
in the marketing and promotions department of Quiksilver Inc. From 1981 to 1989, he was a sponsored
athlete for Quiksilver. Mr. Woolcott was inducted into the National Scholastic Surfing Association Hall
of Fame in 2004 and was named the Surf Industry Manufacturers Association Individual Achiever of the
Year in 2003. Mr. Woolcott was a member of the National Scholastic Surfing Association National Team
from 1982 through 1985 and was selected as a member of the United States Surfing Team in 1984. He
earned a BS in Business Administration from Pepperdine University.
Douglas S. Ingram, 46, has served on Volcom’s board of directors since June 2005. Mr. Ingram has served
as the Lead Independent Director since June 2008. Mr. Ingram has been the Executive Vice President,
Chief Administrative Officer, General Counsel, and Secretary of Allergan Inc., a NYSE-listed specialty
pharmaceutical company, since October 2006. Mr. Ingram received a BS from Arizona State University
and a law degree from the University of Arizona.
Anthony M. Palma, 47, has served on the board of directors since June 2005. Mr. Palma served as
President and Chief Executive Officer of Easton-Bell Sports, a privately held manufacturer, marketer,
and distributor of sports equipment, from April 2006 to March 2008. Mr. Palma earned a BS in Business
Administration and Accounting from California State University, Northridge.
Joseph B. Tyson, 47, has served on the board of directors since June 2005. From October 2006 until Au-
gust 2007, Mr. Tyson was the Chief Operating Officer of The Picerne Group, a privately funded interna-
tional investment firm.
Carl W. Womack, 57, has served on the board of directors since June 2005. Mr. Womack served as the Se-
nior Vice President and Chief Financial Officer of Pacific Sunwear of California Inc., a NASDAQ-listed
22-4 SECTION D Industry Five—Clothing
apparel retailer, from 1994 until his retirement in October 2004. He earned a BS in Business Administra-
tion and Accounting from California State University, Northridge.
René R. Woolcott, 77, has served on the board of directors since Volcom’s inception in 1991 and
served as the Chairman from July 2000 to June 2008. From 1985 to the present, Mr. Woolcott has
served as Chairman and President of Clarendon House Advisors, Ltd., a privately owned investment
company. He holds a BS summa cum laude from New York University and an MBA from Harvard
University.
Kevin G. Wulff, 57, has served on the board of directors since June 2005. Mr. Wulff has been the
President and Chief Executive Officer of Pony International, LLC since March 2007. Prior to that, he
was the President and Chief Executive Officer of American Sporting Goods from March 2005 through
February 2007. He worked for Adidas of America and for Nike Inc. from 1993 to 2001 in various senior
management positions. Mr. Wulff was Chairman and CEO of the Women’s Tennis Association. He holds
a BS in Social Science, Business, and Physical Education from the University of Northern Iowa.
Corporate Officers
In addition to Mr. Richard R. Woolcott, there were four other key corporate officers:26
Douglas P. Collier, 46, has served as the Chief Financial Officer and Secretary since 1994. He has also
served as the Treasurer since April 2005. He earned a BS in Business Administration and an MS in
Accounting from San Diego State University.
Jason W. Steris, 38, has served as President since June 2008 and Chief Operating Officer since 1998.
From 1995 to 1998, he served as the National Sales Manager and from 1993 to 1995 he served as the
company’s Southern California Sales Representative.
Tom D. Ruiz, 48, has served as the Vice President of Sales since 1998.
Troy C. Eckert, 36, was the third person to join Volcom and has served as the Vice President of Market-
ing since January 2001. Prior to January 2001, he held the position of Marketing Director since 1994.
Mr. Eckert joined the company in 1991 as the main team rider and as a marketing assistant. In addition
to his overall marketing duties, Mr. Eckert was charged with developing Volcom’s skateboarding, snow-
boarding, and surfing teams, the company’s special events programs, and co-developing Veeco Produc-
tions. He was a world-class surfer and a three-time champion of the H2O Winter Classic combined
surf/snow competition.
The Volcom Concept
The company stated the following as its mission on the Volcom website as well as on its
Facebook page:
Facets of an empire are vast. An empire was created somehow ingeniously, without paved roads
unique to their own trails. Pioneers to be forefathers. Clear thinking in a cloud of stagnant grey
confusion. Connections to vectors venting pressures of a pocket stuck in time. It was our oppor-
tunity to share our quest with yours in honor of an era unestablished to the present society. Fu-
turistic perhaps, but it does have people coming back for more. So let’s log now and reap later,
for the furthest forest was glowing a printless picture. . . . The genetic makeup . . . . Volcom Stone.27
The distinctive diamond-shaped “Volcom Stone” logo was developed for use on products
with the help of McElroy Designs.28 According to Woolcott, the stone “represents the buzz
from a good skate session or riding a 10-ft. wave at pipe. The stone represents the euphoric
state of riding.”29
The philosophy behind the brand, “youth against establishment,” captures an energy
based on youth culture to support young creative thinking. The people behind the company
“consider themselves to be a family of people not willing to accept the suppression of the
CASE 22 Volcom Inc.: Riding the Wave 22-5
established ways. The company was founded during a time when snowboarding and skate-
boarding were looked down on, when the U.S. was in a recession, there were riots in LA and
the Gulf War.”30 According to Volcom, “Nirvana and Pearl Jam expressed it the best.”31
Volcom may very well be the first major apparel company founded on the boardsports of
skateboarding, surfing, and snowboarding.32 The company’s headquarters in Orange County
was essential to Volcom’s strategy. According to Danny Kwok, Co-President of Quiksilver,
“Orange County was to the youth-apparel market what New York was to the fashion world.”33
The Volcom stone logo in Orange County commanded huge respect within the genre of
attitude-drenched brands that cool 15-year-olds craved.34
Products35
Volcom offered six primary product categories under the Volcom brand: mens, girls, boys,
footwear, girls’ swim, and snow. The company sold T-shirts, fleece, bottoms, tops, jackets,
boardshorts, denim, outerwear, and sandals that boasted the fusion of fashion, functionality,
and athletic performance. Through the Electric brand, Volcom generated revenues via the
company’s growing product line, which included sunglasses, goggles, T-shirts, bags, hats,
belts, and other accessories. Volcom also generated revenues from the sale of music produced
by Volcom Entertainment and films produced by Veeco Productions. Volcom’s products typ-
ically retailed at premium prices. Exhibit 1 shows company revenues by product category for
the years ended 2005 through 2008.
Clothing Design36
Volcom utilized the creativity, innovation, and athlete-driven youth energy behind the brand
to design products that evolve in style and functionality. A majority of its clothing products
displayed a distinctive art style via unique treatments, placements of screened images, de-
signs, or embroideries. In addition, the company incorporated technical features and fabrics
like Gore-Tex® to meet the demands of skateboarding, snowboarding, and surfing.
EXHIBIT 1 Revenues by Product Category: Volcom Inc. (Dollar amount in thousands)
2008 2007 2006 2005
Boys 21,867 20,023 11,860 7,133
Footwear 5,676 6,127 1,573 –
Girls’ swim 6,126 3,734 – –
Electric 24,190 – – –
Other* 3,233 2,667 2,361 1,411
Subtotal product categories 332,110 265,193 201,186 156,716
Licensing revenues 2,194 3,420 4,072 3,235
Total consolidated revenues $334,304 $268,613 $205,258 $159,951
SOURCE: Volcom, Inc., Form 10-K for 2005 (p. F-24) and 2008 (p. F-28).
*Other includes revenues primarily related to the company’s Volcom Entertainment division, films, and related accessories.
22-6 SECTION D Industry Five—Clothing
Music37
Volcom generated a mere 1% of revenue each year from 2005 until 2008 for the product cat-
egory it referred to as “Other,” which included revenues generated from Volcom Entertain-
ment, films, and related accessories. The company’s music label, Volcom Entertainment,
signed musical artists and produced and distributed recordings in the form of CDs, digital
downloads, vinyl LPs, and wireless media. Volcom did this worldwide through retail ac-
counts, music retailers, and online distribution channels. The label reinforced the company’s
brand image and enhanced marketing efforts. The Volcom band played at tradeshows, ac-
count demonstrations, and other company events. Music and bands were also integrated into
the Volcom brand seasonally via a line of music and musician-inspired clothing.
In 2007, the company launched “The Volcom Tour,” an international music tour featur-
ing its artists. Volcom also operated and sponsored an annual music competition, “Band
Joust,” for unsigned rock bands. In 2008, the company launched a subscription-based vinyl
record club, Volcom Ent Vinyl Club, which delivered to subscribers collectable vinyl sin-
gles on a bi-monthly basis. The company entered into a distribution arrangement with WEA
Rock LLC, pursuant to which ADA, a music distribution company owned by Warner Music
Group, distributed its music. The arrangement provided Volcom bands with worldwide dis-
tribution options.
Film38
The company produced skateboarding, snowboarding, and surfing films featuring sponsored
athletes through Veeco Productions, Volcom’s film production division. Volcom team riders
wore branded products to emphasize the company’s boardsports heritage and close associa-
tion with leading boardsports athletes. The division produced over 15 critically acclaimed
films that received awards such as Best Core Film at the X-Dance Film Festival, Best Cine-
matography for a Snow Movie at the Unvailed Band and Board Event, Surfer Magazine’s
Video of the Year, and Surfer Magazine’s Video Award for Best Performance by a Male
Surfer (Bruce Irons—twice).
Films were distributed to retail customers, as well as to music and video stores. In 2008,
Veeco Productions entered into distribution deals with iTunes and Fuel TV. As of 2008, the
company sold four movies on iTunes under Volcom Films and produced and released two
movies specifically for Fuel TV.
Volcom’s design and product development teams were based at headquarters in Orange
County and in France. Each team was organized into groups that separately focused on each
product category. The company designed for five major seasons: spring, summer, fall, snow,
and holiday. Volcom’s international licensees also hired designers and merchandisers to cre-
ate products that integrated the brand with local trends. Several times each year, the in-house
design team and the designers from the international licensees met to develop designs that re-
flected fashion trends from around the world. These groups participated in approximately three
trips per year to locations known for their influence on fashion and style, such as New York,
Paris, London, Sydney, and Tokyo.
Furthermore, the company utilized input from boardsports athletes and relevant artists in
product development and design, reinforcing the credibility and authenticity of the brand.
Through its V.Co-Operative product line, Volcom partnered with team riders, such as Bruce
Irons, Mark Appleyard, Ozzie Wright, Dean Morrwason, Bjorn Leines, Geoff Rowley, and
Dustin Dollin, to design signature product styles. Core retail accounts also offered input pro-
viding the company with additional insight into consumer preferences.
CASE 22 Volcom Inc.: Riding the Wave 22-7
Manufacturing39
In 2006, Volcom was awarded the Surf Industry Manufacturers Association (SIMA) “Manu-
facturer of the Year” title for the third time. Volcom did not own or operate any manufactur-
ing facilities; rather, the company worked with local sourcing agents aligned with
independently owned foreign contract manufacturers. Volcom’s apparel and accessories were
generally purchased or imported as finished goods; the company purchased only a limited
amount of raw materials. The manufacture of each product line was contracted separately
based on fabric and design requirements. Instead of pursuing long-term contracts with man-
ufacturers, Volcom chose to retain flexibility in re-evaluating sourcing and manufacturing de-
cisions. Volcom had traditionally received a significant portion of its customer orders prior to
placement of its initial manufacturing orders. It used these early season orders, and its expe-
rience, to project overall demand for its products to secure manufacturing capacity and to en-
able its manufacturers to order sufficient raw materials.
The company chose vendors based on the quality of their work, ability to deliver on time,
and cost. Commitment to quality control and monitoring procedures were an important and ef-
fective means of maintaining the quality of Volcom’s products and its reputation among con-
sumers. The company’s design and production staff, as well as third parties, formally assessed
manufacturers for quality and to ensure that they were in compliance with applicable labor
practices.
In 2008, Volcom contracted for manufacturing with approximately 49 foreign firms. An
estimated 66% and 14% of total product costs during 2008 and 72% and 13% of total product
costs during 2007 came from manufacturing operations in China and Mexico, respectively.
Two of Volcom’s Chinese manufacturers, Dragon Crowd and Ningbo Jehson Textiles, ac-
counted for 18% and 14% of product costs during 2008, respectively, and for 19% and 14% of
product costs during 2007, respectively. No other single manufacturer of finished goods
accounted for more than 10% of production expenditures during 2008 or 2007.
Volcom contracted with several screen printers in the United States. Relationships with
domestic printers resulted in short lead times and enabled the company to react quickly to
reorder demand from retailers and distributors.
Distribution and Sales40
The company sold merchandise in an environment that supported and reinforced its elite brand
image. Volcom’s retail customers were limited to independent surf and skateboard shops and
high-end retail chains. Volcom products were offered over the Internet through selected au-
thorized online retailers. In addition, the company sold to distributors in Latin America, Asia
Pacific, and other developing markets. Volcom sought to enhance brand image by controlling
the distribution of its products around the world. The company website provided a link where
customers could report counterfeit and unauthorized Volcom products, or fakes.
Some of Volcom’s retailers included 17th Street Surf, Becker Surfboards, Froghouse,
Hotline, Huntington Surf & Sport, IG Performance, K5 Board Shop, Macy’s, Nordstrom,
Pacific Sunwear, Snowboard Connection, Sun Diego, Surfside Sports, Tilly’s, Val Surf, West
Beach, and Zumiez. In 2008, 2007, and 2006, 28%, 33%, and 44%, respectively, of product
revenues were derived from Volcom’s five largest customers. The largest of the five, Pacific
Sunwear, accounted for 16%, 18%, and 26% of the company’s product revenues in 2008, 2007,
and 2006, respectively.
Retailers represented the foundation of the boardsports market and were therefore a crit-
ical element to Volcom’s success. Specialty retailers attracted skateboarders, snowboarders,
and surfers who influenced fashion trends and demand for boardsports products. Volcom
22-8 SECTION D Industry Five—Clothing
collaborated with specialty retailers by providing in-store marketing displays, which included
racks, wall units, and point-of-purchase materials that promote its brand image. Additionally,
Volcom sponsored events and programs at its retailers, such as autograph signings and board-
sport demonstrations with team riders.
The company maintained a national sales force of independent sales representatives. For
certain larger retail accounts and distributors, Volcom managed the sales relationship in-house.
The in-house sales team served major national accounts like Zumiez, Pacific Sunwear,
Nordstrom, and Macy’s. An in-house sales team also served international territories not repre-
sented by Volcom’s international licensees, such as Canada, Asia Pacific, and Latin America.
Volcom pre-booked orders in advance of delivery so as to maintain sufficient inventories
to meet the demands of its retailers. The company inspected, sorted, packed, and shipped sub-
stantially all of its products, other than those sold by its licensees or in Canada, from its distri-
bution warehouse in Orange County for its U.S. operations, and from its warehouse in France
for its European operations. Volcom distributed products sold in Canada through a third-party
distribution center located in Kamloops, British Columbia.
Volcom used an integrated software package designed for apparel distributors and pro-
ducers. It was used for stock keeping unit (SKU) management and classification inventory
tracking, purchase order management, merchandise distribution, and integrated financial
management, among other activities. The system provided summary data for all departments
and a daily executive summary report used by management to observe business and finan-
cial trends.
Licensing41
Volcom had license agreements with four independent licensees in Australia, Brazil, South
Africa, and Indonesia. The company had a 13.9% ownership interest in its Australian li-
censee, Volcom Australia. The expiration dates for its international license agreements are
listed in Exhibit 2.
EXHIBIT 2
International
License Agreements:
Volcom Inc.
Volcom’s international license agreements expire as follows:
Licensee Expiration Date Extension Termination Date
Australia June 30, 2012 N/A
Brazil December 31, 2013 N/A
South Africa December 31, 2011 N/A
Indonesia December 31, 2009 December 31, 2014
SOURCE: Volcom Inc., 2008 Form 10-K, p.7.
Research and Development: The Pipe House42
In February 2007, Volcom purchased the Pipe House (one of the most famous houses in surf-
ing history) on the North Shore of Oahu for $4.2 million. It was Volcom’s second residence in
front of the world-renowned Pipeline surf break. The Pipe House was the headquarters for top
Volcom team riders and also served as a research and development center for product design
CASE 22 Volcom Inc.: Riding the Wave 22-9
Marketing
Volcom management was aware of the possible brand degradation that would come with as-
sociation with “wannabe” skateboarders, snowboarders, or surfers. The company used its
own design team and managed advertising in-house to keep consistent with its heritage, pas-
sion for action sports, and the look of its clothing.43 The company’s advertising and promo-
tional strategy consisted of athlete sponsorship, print advertisements, branded events, online
marketing, branded retail stores, music, film, and the Featured Artist Series.
Athlete Sponsorship44
The company sponsored high-profile skateboarding, snowboarding, surfing, and motocross
athletes, in addition to supporting emerging talents to promote and build on the Volcom brand
image. Volcom made cash payments to the athletes in exchange for unlimited license for the
use of their names and likenesses for various public appearances, magazine exposure, and
competitive victories, as well as exclusive association with Volcom apparel. The company
also provided limited free products for the athletes’ use and paid some travel expenses in-
curred by sponsored athletes in conjunction with promoting Volcom products. Exhibit 3 lists
Volcom’s minimum obligations required to be paid under sponsorship contracts.
Volcom’s athletes had won prestigious domestic and international awards. They had par-
ticipated in a variety of competitions including the X-Games, the Olympics, the Association of
Surfing Professionals (ASP) World Championship Tour, and the Motocross des Nations. They
had appeared on magazine covers all over the world, and had been featured in video games like
EA Sports Skate 2 and Xbox games Amped and Amped 2. As of December 31, 2008, the com-
pany’s skateboarding athletes included Geoff Rowley, Mark Appleyard, and Rune Gliftberg.
Volcom snowboarders included Gigi Rüf, Terje Haakonsen, Bjorn Leines, Kevin Pearce, Janna
Meyen, and Elena Hight. Among Volcom’s surfers were Bruce Irons, Dean Morrwason, Ozzie
Wright, and Dusty Payne. Motocross athletes included Ryan Villopoto and Nico Izzi.
and testing, as well as retailer roundtables. The original Volcom house accommodated the ma-
jority of Volcom’s domestic and international up-and-coming team riders and served as a mar-
keting location throughout the year.
EXHIBIT 3
Schedule of Future
Estimated Minimum
Payments Required
Under Endorsement
Agreements: Volcom
Inc. (Dollar amount
in thousands)
SOURCE: Volcom Inc., 2008 Form 10-K, p. F-19.
Note: The amounts listed above are the approximate amounts of the minimum obligations required to be paid
under sponsorship contracts. The additional estimated maximum amount that could be paid under the com-
pany’s existing contracts, assuming that all bonuses, victories, and similar incentives are achieved during the
five-year period ending December 31, 2011, is approximately $4.1 million. The actual amounts paid under
these agreements may be higher or lower than the amounts discussed above as a result of the variable nature
of these obligations.
Year Ending December 31
2009 $ 6,581
2010 4,235
2011 1,730
2012 1,340
2013 800
Thereafter 1,972
$ 16,658
22-10 SECTION D Industry Five—Clothing
Print Advertisements45
Volcom placed print advertisements in boardsports magazines like Thrasher, Transworld
Skateboarding and Snowboarding, Snowboarder, Surfing, and Surfer. The company also ad-
vertised in fashion lifestyle magazines like Vice, Frank 151, and Elle. The internal art depart-
ment designed advertisements combining athletes, lifestyle, innovative visual designs, and
Volcom’s unique style.
Volcom Branded Events46
Hundreds of competitors and spectators attended the separate contest series that Volcom ran
for skateboarding, snowboarding, and surfing. Volcom had created a global championship
event for each series to which the company invited top qualifiers from each event to compete.
Volcom’s driving philosophy behind its grassroots-branded events was “Let the Kids Ride
Free.” This philosophy sought to embody the company’s anti-establishment brand image. The
contests were open on a first-come, first-served basis and entry was free, so amateurs and
first-time competitors could compete alongside professionals. Volcom’s contests included the
Wild in the Parks Skate Series, the Peanut Butter and Rail Jam Snow Series, and the Totally
Crustaceous Surf Series.
Volcom relied on its internal marketing department to choose venues and arrange spon-
sored athlete attendance, marketing, and staffing at each contest. Branded events provided an-
other source of consumer interaction and feedback to help keep the company connected to its
audience.
The Website47
The company also communicated with its target market via its website, www.volcom.com.
Volcom made its collection of apparel and accessories available for viewing online as well as
provided links to online retailers and iTunes for access to films and podcasts. The company
did not sell apparel on the website but did offer select Volcom Entertainment products.
The website provided news releases, information on team riders, Volcom skate parks, and
branded events. In addition, Volcom kept up with the Internet generation through pages on
Facebook, Myspace.com, Twitter, and YouTube. Facebook and Myspace friends could con-
nect with other Volcom fans, and consumer affiliation with the company allowed for increased
brand awareness. The company updated Twitter followers on events, contests, and its team rid-
ers. Videos on YouTube showcased the talent of the Volcom team riders and highlight com-
pany contest series.
The Operating Environment
From 2006 to 2007, the U.S. unemployment rate fluctuated between 4.5% and 4.9%.48 When
housing prices began declining in 2006, and defaults and foreclosures on sub-prime mort-
gages made their impact on the value of mortgage-backed securities in 2007, the resulting
credit crunch scared the public into caution and worry.49 Consumer confidence was low,
growth in consumer spending started to slow, and the unemployment rate went in the wrong
direction. In April 2008, the U.S. unemployment figure was 5.0%, but increased considerably
by 2009.50 News reports covered a frozen credit market, a global recession, and increased
government intervention in the financial markets.
www.volcom.com
CASE 22 Volcom Inc.: Riding the Wave 22-11
Competitors
Volcom competed with global companies of varying sizes and weights. The company’s direct
competitors include Quiksilver Inc., including the Roxy and DC brands; Billabong Interna-
tional Limited, including the Billabong and Element brands; as well as Burton and Hurley.60
The company also competed with smaller companies that focused on one or more boardsport
segments.
In examining the broader U.S. Athletic Apparel and Footwear Industry, Volcom faced
competitors like Nike Inc., the Adidas Group, Hanes/Champion, and Under Armour.61 In this
broad category, Volcom held market shares of 0.7%, 0.6%, and 0.8% for the years 2008, 2007,
and 2006, respectively.62 Nike Inc. held 8.3%, 8.0%, and 7.9% of the market, respectively.63
Quiksilver’s market share was 2.2%, 2.4%, and 2.6%.64 Billabong had 1.9%, 1.6%, and 1.7%.65
For retailers, this economic environment was like a tumultuous sea with threatening
waves. In 2007, companies like Circuit City, KB Toys, Mervyns, Boscov’s, Steve & Barry’s,
and Sharper Image filed for bankruptcy.51 When the holiday season arrived in 2008, retailers
held their breath. Consumers had to shop and spend money for others, and profitability was
sure to pick up. According to the International Council of Shopping Centers, however, indus-
try sales fell 2.2% for the holiday shopping season, the biggest decline since at least 1970.52 In
November 2008, chains posted a 2.7% decline in sales. In December, sales dropped 1.7%.53
Looking ahead, retail companies were keeping their eyes on pricing and costs in compet-
ing within the industry. The business environment looked weak and uncertain considering risks
like disruptions to supply chains, currency volatility, natural and man-made disasters, legal lia-
bility, and financial market disruption.54 High energy costs also influenced consumer behavior
and the supply chain. Companies had chosen to import products from emerging countries like
China due to lower transportation costs and wages. Nevertheless, rising transportation costs and
wages in those countries were making companies reconsider their sourcing and diversify their
options.55 In such an environment, retailers were willing to consolidate support functions, and
cut underperforming activities, as well as trim payroll. On the other hand, in this buyer’s mar-
ket, these companies had the advantage of negotiating better deals with their suppliers.
Besides maintaining extra cash on the company balance sheet, retailers were tailoring the
customer experience to fit their overall image and strategy. Understanding and relating to the
target market had to be second nature to the companies. In wooing an audience, retail compa-
nies were building their relationships with consumers by catering to niche markets and mov-
ing away from mass-marketing. Apparel retailers especially watched over consumers’
ever-changing tastes, preferences, and shopping behaviors. The execution of their strategies
determined success. As one means of getting to their customers, companies used the Internet
to build their brands and establish a following. Besides sharing information and offering en-
tertainment and opportunities to purchase products online, retail companies were competing
to flag consumer attention before they clicked someplace else.56
Teen shopping behavior and brand preferences were examined in a 2009 survey taken by
1,200 students as well as their parents from 12 cities across the United States. Apparel spend-
ing by parents for their teens in Spring 2009 was $915 compared to $1,085 in Fall 2008, but
was expected to increase in Fall 2009.57 West Coast Brands like Pacific Sunwear, Volcom,
Quiksilver, and Zumiez took the top spot in clothing brand preferences among teens, followed
by Forever 21, Hollwaster, Nike, and American Eagle.58 Jeff Klinefelter, a senior research an-
alyst, believed the fashion industry in 2009 was in the early stages of a new cycle with traffic
and conversion gradually improving as teenage consumers looked to replenish key items in
their wardrobes after underspending on the category.59
22-12 SECTION D Industry Five—Clothing
Burton Snowboards
Burton Snowboards, a private company, was founded in 1977 by Jake Burton Carpenter and
was headquartered in Vermont. Besides snowboards, the company’s product line encom-
passed bindings, boots, outerwear, and accessories under the brands Anon Optics, RED, and
Gravwas. Carpenter’s snowboards were inspired by surfers, the first marketed snowboards.
Carpenter campaigned resorts to open their slopes to snowboarders, creating a demand for his
product as well as a competitive sport.75 In 2006, the company extended its target market to
include surfers when it bought Channel Islands Surfboards.76 Burton sponsored athletic
events as well as snowboarders like Shaun White and Frederik Kalbermatten.
Billabong70
Billabong was an Australian company that was founded in 1973. It sold apparel, accessories,
eyewear, wetsuits, and hard goods in the boardsports sector under brands like Billabong, El-
ement, and Palmers Surf. The company’s products were licensed and distributed in more than
100 different countries. In 2008, the company had revenues of $1.35 billion.71 Billabong pro-
motion and advertising strategies included athlete sponsorships as well as pro surfing tourna-
ments in locations like Australia, South Africa, and Spain.
O’Neill
O’Neill offered surf and snow-related technical products, clothing, footwear, and accessories
in 84 countries.72 The company was founded in California in 1952 by Jack O’Neill, who was
credited with the design of neoprene wetsuits for surfers. Jack’s son, Pat, was credited with
the surfboard leash.73 In 2007, Logo International BV, a European fashion group, acquired
worldwide rights to the O’Neill brand and O’Neill Australia Pty Ltd. Under a separate agree-
ment, the O’Neill family continued to own and operate the O’Neill wetsuit business world-
wide, the U.S. outerwear business, and the O’Neill Surf Shops in Santa Cruz, California.74
O’Neill-sponsored events included the Swatch O’Neill Big Mountain Pro, and the O’Neill
Cold Water Classic held in locations like South Africa, Scotland, and Tasmania. The com-
pany sponsored team riders in snowboarding, surfing, and wakeboarding.
In reference to Volcom’s potential growth, Richard Woolcott was quoted in an article for
Time magazine saying that the core lifestyle was more important to him.66 He said, “Getting
bigger was totally secondary. I don’t want to put pressure on what we’re doing. I don’t even
think about getting Quiksilver big.”67
Quiksilver68
In 2008, Quiksilver was the largest apparel company targeting surfers, skaters, and snow-
boarders, with revenues of $2.26 billion. It sold apparel, footwear, accessories, and related
products in over 90 countries with the brands Quiksilver, Roxy, and DC, among others. This
California-based company was founded in 1970. Quiksilver’s roster of sponsored athletes
included Kelly Slater and Tony Hawk. Its sponsored events included Quiksilver’s Big Wave
Invitational and the Roxy Pro, a popular women’s surf event. In November 2008, the com-
pany sold Rossignol, a wintersports and golf equipment manufacturer, for $50.8 million,
eliminating Quiksilver’s risk in hard goods manufacturing and allowing the company to re-
duce its debt.69
CASE 22 Volcom Inc.: Riding the Wave 22-13
Hurley77
Hurley sold apparel, athletic footwear, equipment, and accessories related to skateboarding
and surfing. Besides sponsoring surfers and surf events, the company was also involved in the
music industry; it endorsed bands like Blink-182 and Avenged Sevenfold. In 1979, the com-
pany began as Hurley Surfboards in California. In 1982, management pursued Billabong and
established Billabong USA as a separate entity and licensee for its parent company. When the
license agreement was up for renewal in 1995, management returned Billabong USA to its
parent company and continued with Hurley. Nike purchased Hurley in 2002 as a strategic
move into the action sports industry.
Pacific Sunwear of California Inc.78
Pacific Sunwear of California Inc., also known as “Pacific Sunwear” or “PacSun,” was a spe-
cialty retailer inspired by the youth culture of Southern California. The company was incor-
porated in 1982 and, as of January 31, 2009, operated 932 stores across the United States and
Puerto Rico. PacSun’s objective was to be a “Branded House of Brands” that sold casual ap-
parel targeting teens and young adults.79
As a percentage of PacSun’s total net sales during fiscal 2008, Billabong brands accounted
for 11% and Quick brands accounted for 10%. The next largest brand, Fox Racing, accounted
for 9% of total net sales that year. The company also offered its own proprietary brands in
stores, including Bullhead, Kirra, Kirra Girl, Burt, and Nollie. Sales of these brands accounted
for approximately 38% and 30% in fiscal 2008 and 2007, respectively. The company consid-
ered its primary competitors to be Abercrombie and Fitch, Hollister, American Eagle Outfit-
ters, Aeropostale, and Urban Outfitters.
Like many other retail stores, PacSun found 2008 to be a difficult year.80 Net sales de-
creased 3.9% to $1.25 billion in fiscal 2008 from $1.31 billion in fiscal 2007. PacSun also saw
a 6.2% net decrease in gross margin as a percentage of sales. Of that decline, 4.7% was due to
increased markdowns and promotional activity associated with the decline in consumer spend-
ing and the economic environment, whereas 1.4% was attributed to an increase in occupancy
charges as a percentage of net sales in fiscal 2008.
The company expected continued negative same-store results in the short term. To better
position itself, PacSun reduced planned inventory levels by at least 20%; reduced planned cap-
ital expenditures to not more than $30 million for 2009, a reduction of over $50 million from
the fiscal 2008 level; and reduced planned selling, general, and administrative expenses by ap-
proximately $35 million versus the fiscal 2008 level.81 The company also announced a reduc-
tion of 11% of its headquarters and field management staff.
Financial Performance82
Volcom’s consolidated balance sheets and statements of operations for the fiscal years ended
2005 through 2008 are shown in Exhibits 4 and 5, respectively.
Even with the economic slowdown of 2008, Volcom’s consolidated revenues increased
24.5% to $334.4 million from $268.6 million in 2007. Revenues broken down by operating
segment are identified in Exhibit 6. Revenues from the European operations increased $32.0
million to $73.0 million primarily as a result of the transition from a licensee model to a direct
model during the third quarter of 2007. Consequently, licensing revenues in 2008 decreased
35.8% to $2.2 million. Electric contributed $24.2 million in revenues in 2008; it had been in-
cluded in Volcom’s operating results since January 17, 2008.
EXHIBIT 4
Condensed Consolidated Balance Sheets: Volcom Inc. (unaudited) (Dollar amount in thousands, except share and per share data)
Year Ending December 31 2008 2007 2006 2005
Assets
Current assets
Cash & cash equivalents $79,613 $92,962 $85,414 $71,712
Accounts receivable, gross 67,912 61,053 35,498 22,138
Less: allowances for doubtful accounts 6,998 2,783 1,323 730
Accounts receivable, net 60,914 58,270 34,175 21,408
Inventories
Finished goods 25,277 19,849 12,959 10,188
Work-in-process 269 214 41 312
Raw materials 1,540 377 185 333
Total inventories 27,086 20,440 13,185 10,833
Prepaid expenses & other current assets 2,596 1,720 1,383 1,366
Income taxes receivable 3,309 326 – 479
Deferred income taxes 4,947 2,956 2,353 1,110
Total current assets 178,465 176,674 136,510 106,908
Property and equipment
Furniture & fixtures 6,714 3,547 1,869 600
Office equipment 2,666 1,724 1,180 1,062
Computer equipment 6,405 4,959 2,173 1,141
Leasehold improvements 9,608 7,379 1,241 128
Land & building _ _ 2,004 2,004
Buildings 7,215 7,489 _ _
Land 4,723 4,723 _ _
Construction in progress 225 30 5,709 _
Property & equipment, gross 37,556 29,851 14,176 4,935
Less: accumulated depreciation 10,840 5,424 2,649 1,468
Net property & equipment 26,716 24,427 11,527 3,467
Investments in unconsolidated investees 330 298 298 298
Deferred income taxes 4,028 268 660 _
Intangible assets, net 10,578 363 386 451
Goodwill, net 665 _ 158 158
Other assets 841 464 209 99
Total assets $221,623 $202,494 $149,748 $111,381
Liabilities and stockholders’ equity
Current liabilities
Accounts payable $15,291 $18,694 $8,764 $5,779
Accrued expenses & other current liabilities
Payroll & related accruals 5,045 4,000 3,785 1,079
Deferred rent 649 _ _ _
Other accrued expenses & other current liabilities 6,333 6,561 2,390 1,508
Total accrued expenses & other current liabilities 12,027 10,561 6,175 2,587
Income taxes payable _ _ 424 _
Current portion of capital lease obligations 71 72 78 72
Total current liabilities 27,389 29,327 15,441 8,438
Long-term capital lease obligations 23 33 106 183
Other long-term liabilities 414 190 204 _
Income taxes payable, non-current 94 89 _ 80
Stockholders’ equity
Common stock 24 24 24 24
Additional paid-in capital 90,456 89,185 86,773 84,418
Retained earnings 101,935 80,226 47,019 18,266
Unrealized loss on foreign currency cash flow hedges, net of tax (223) _ _ _
Foreign currency translation adjustment 1,511 _ _ _
Accumulated other comprehensive income (loss) 1,288 3,420 181 (28)
Total stockholders’ equity 193,703 172,855 133,997 102,680
Total liabilities and stockholders’ equity $221,623 $202,494 $149,748 $111,381
SOURCE: Mergent Online: Volcom Company Financials.
CASE 22 Volcom Inc.: Riding the Wave 22-15
EXHIBIT 5
Statements of Operations: Volcom Inc. (Dollar amounts in thousands, except per share data)
Year Ending December 31 2008 2007 2006 2005
Revenues
Product revenues $332,110 $265,193 $201,186 $156,716
Licensing revenues 2,194 3,420 4,072 3,235
Total revenues 334,304 268,613 205,258 159,951
Cost of goods sold 171,208 138,570 103,237 78,632
Gross profit 163,096 130,043 102,021 81,319
Operating expenses
Selling, general, & administrative expenses 112,464 79,411 58,417 42,939
Asset impairments 16,230 _ _ _
Total operating expenses 128,694 _ _ _
Operating income 34,402 50,632 43,604 38,380
Other income
Interest income (expense), net 901 3,973 3,833 1,036
Dividend income from cost method investee _ _ 3 11
Foreign currency gain (loss) (1,807) 401 233 54
Total other income (expense) (906) 4,374 4,069 1,101
Income before provision for income taxes 33,496 55,006 47,673 39,481
Current income taxes
Current federal income taxes 12,903 _ _ _
Current state income taxes 3,189 _ _ _
Currnet foreign income taxes 2,004 _ _ _
Total current income taxes (benefit) 18,096 21,882 20,903 11,625
Deferred income taxes
Deferred federal income taxes (4,564)
Deferred state income taxes (1,181)
Deferred foreign income taxes (564)
Total deferred income taxes (benefit) (6,309) (211) (1,983) (1,150)
Provision for income taxes 11,787 21,671 18,920 10,475
Income before equity in earnings of investee _ 33,335 28,753 29,006
Equity in earnings of investee _ _ _ 331
Net income $21,709 $33,335 $28,753 $29,337
Weighted average shares outstanding—basic 24,338 24,303 24,228 21,628
Weghted average shares outstanding—diluted 24,358 24,420 24,305 21,840
Year end shares outstanding 24,374 24,350 24,295 24,214
Net income (loss) per share—basic $0.89 $1.37 $1.19 $1.36
Net income (loss) per share—diluted $0.89 $1.37 $1.18 $1.34
Number of full-time employees 490 337 259 181
Number of common stockholders 48 13 36 31
SOURCE: Mergent Online: Volcom Company Financials.
22-16 SECTION D Industry Five—Clothing
EXHIBIT 6
Information Related
to the Company’s
Operating
Segments: Volcom
Inc. (Dollar amounts
in thousands)
2008 2007 2006
Total revenues
United States $237,109 $228,494 $200,735
Europe 73,005 40,119 4,523
Electric 24,190 – –
Consolidated $334,304 $268,613 $205,258
Gross profit
United States $109,028 $110,412 $100,879
Europe 40,582 19,631 1,142
Electric 13,486 – –
Consolidated $163,096 $130,043 $102,021
Operating income (loss)
United States $ 33,019 $ 45,790 $ 45,918
Europe 17,470 4,842 (2,314)
Electric 16,087 – –
Consolidated $ 66,576 $ 50,632 $ 43,604
Identifiable assets
United States $143,776 $187,780 $137,581
Europe 55,997 14,714 12,167
Electric 21,850 – –
Consolidated $221,623 $202,494 $149,748
SOURCE: Volcom Inc., 2008 Form 10-K, p. F-28.
In 2008, 2007, and 2006, 28%, 33%, and 44%, respectively, of product revenues were de-
rived from Volcom’s five largest customers. Pacific Sunwear, a component of the five, ac-
counted for 16% of product revenues in 2008 and 18% in 2007. PacSun purchases were made
on a purchase order basis rather than with a long-term contract. Sales to Pacific Sunwear in-
creased 7%, or $3.4 million, for 2008 compared to 2007. Volcom’s management expected Pac-
Sun revenue to decrease in 2009 as Volcom diversified its account base. Management was
assessing strategies to lessen Volcom’s concentration with PacSun for it represented a mate-
rial amount of revenue and could have a significant adverse effect on future operating results.
In 2008, consolidated product revenues increased 25.2% to $332.1 million from
$265.2 million in 2007. Volcom experienced revenue growth in each of its product lines. The
lines with the strongest growth were girls’ swim, snow products, and mens, which increased
64.1%, 26.9%, and 22.0% to $6.1 million, $28.2 million, and $162.3 million, respectively. The
company’s other lines, boy’s products and girls, increased 9.2% and 4.1% to $21.9 million and
$80.5 million, respectively.
Exhibit 7 provides revenues by geographic regions for the years ended 2005 through
2008. Revenues in the United States made up the bulk of product revenues with 59.0% and
65.7% or $195.9 million and $174.3 million in 2008 and 2007, respectively. In Europe, prod-
uct revenues amounted to 23.5% and 15.1% of product revenues, or $77.9 million and
$40.1 million in 2008 and 2007, respectively. Product revenues from the rest of the world were
primarily the result of sales in Canada and Asia Pacific and did not include sales by Volcom’s
international licensees. These product revenues were 17.5% and 19.2%, $58.3 million and
$50.8 million, in 2008 and 2007, respectively.
For the fiscal year ended December 31, 2008, consolidated operating expenses increased
$49.3 million, or 62.1%, to $128.7 million. This increase included the $16.2 million non-cash
CASE 22 Volcom Inc.: Riding the Wave 22-17
EXHIBIT 7
Product Revenues by
Geographic Regions:
Volcom Inc.
(Dollar amount in
thousands of
dollars)
Includes revenues generated worldwide by the Electric operating segment; allocated based on
customer location.
Year Ending December 31
2008 2007 2006 2005
United States $195,846 $174,254 $157,581 $128,159
Canada 31,993 31,041 23,925 15,774
Asia Pacific 13,245 8,434 7,230 6,622
Europe 77,897 40,119 4,523 –
Other 13,129 11,345 7,927 6,161
$332,110 $265,193 $201,186 $156,716
SOURCE: Volcom, Inc., Form 10-K for 2005 (p. F-25) and 2008 (p. F-29).
asset impairment charge on goodwill and intangible assets related to the acquisitions of Elec-
tric and Laguna Surf & Sport. The estimated future cash flows expected from the reporting
units were significantly reduced, causing decreased estimated fair market values as a result of
the economic downturn. As a percentage of revenues, selling, general, and administrative ex-
penses increased to 33.6% from 29.6% in 2007. The $33.1 million increase was due primarily
to increased expenses of $8.0 million related to the transition of European operations to a di-
rect control model, the $14.7 million expense from the acquisition of Electric, and the
$1.0 million expense from the acquisition of Japanese operations. Volcom also increased pay-
roll and payroll-related expenses of $2.6 million due to expenditures on infrastructure and per-
sonnel, increased rent expense of $2.1 million from additional retail store leases and the Irvine
warehouse location, increased depreciation expense of $1.2 million, increased bad debt ex-
pense of $0.9 million, and a net increase of $2.6 million in other expense categories.
As a result of these factors, operating income as a percentage of revenues decreased
10.3% in 2008 from 18.8% in 2007. Consolidated operating income in 2008 decreased
$16.2 million to $34.4 million compared to $50.6 million in 2007.
The provision for income taxes was computed using an annual effective tax rate of 35.2%,
which decreased from 39.4% in 2007. The decrease was primarily due to the effect of the
foreign tax rate differential, which was partially offset by the income tax effect of the good-
will and intangible asset impairment recorded in 2008. The provision for income taxes de-
creased $9.9 million to $11.8 million in 2008.
In 2008, net income decreased $11.6 million or 34.9% to $21.7 million in 2008. As of the
first quarter ended March 31, 2009, Volcom was slightly ahead of expectations in each of its
business segments. According to Richard Woolcott, Volcom was “working diligently to main-
tain (its) competitive edge and position the company to remain financially strong and cre-
atively energized.”83
N O T E S
1. Karl Taro Greenfeld, “Killer Profits in Velcro Valley,” Time
(January 25, 1999), pp. 50–51.
2. “Volcom, Inc.—Company Profile, Information, Business
Description, History, Background Information on Volcom, Inc.,”
Reference for Business (June 25, 2009).
3. Karl Taro Greenfeld, “Killer Profits in Velcro Valley,” Time
(January 25, 1999), pp. 50–51.
4. Ibid.
5. Volcom, Inc.—Company Profile, Information, Business Descrip-
tion, History, Background Information on Volcom, Inc.,” Reference
22-18 SECTION D Industry Five—Clothing
for Business (June 25, 2009), http://www.referenceforbusiness
.com/hwastory2/3/Volcom-Inc.html.
6. “Investor Relations Overview—Profile,” Volcom (July 2, 2009),
http://www.volcom.com/investorRelations/index.asp?catId�1.
7. “History,” Volcom (July 2, 2009), http://www.volcom.com/
hwastory/index.asp.
8. “Volcom, Inc.—Company Profile, Information, Business Descrip-
tion, History, Background Information on Volcom, Inc.,” Reference
for Business (June 25, 2009), http://www.referenceforbusiness
.com/hwastory2/3/Volcom-Inc.html.
9. Volcom, Inc. 2005 Form 10-K.
10. “Volcom, Inc.—Company Profile, Information, Business Descrip-
tion, History, Background Information on Volcom, Inc.,” Reference
for Business (June 25, 2009), http://www.referenceforbusiness
.com/hwastory2/3/Volcom-Inc.html.
11. Ibid. This section was directly quoted, except for minor editing.
12. Ibid. This section was directly quoted, except for minor editing.
13. Ibid. This section was directly quoted, except for minor editing.
14. Ibid. This section was directly quoted, except for minor editing.
15. Ibid. This section was directly quoted, except for minor editing.
16. “Volcom IPO Makes Big Debut,” Los Angeles Business. BizJour-
nals (June 30, 2005), http://www.bizjournals.com/losangeles/
stories/2005/06/27/daily36.html. This section was directly
quoted, except for minor editing.
17. “Volcom, Inc.—Company Profile, Information, Business
Description, History, Background Information on Volcom,
Inc.,” Reference for Business (June 25, 2009), http://www
.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html.
18. Volcom, Inc., 2008 Form 10-K, p. 12.
19. Ibid., p. 30.
20. Ibid., p. 2. This section was directly quoted, except for minor
editing.
21. Ibid. This section was directly quoted, except for minor editing.
22. Ibid. This section was directly quoted, except for minor editing.
23. Ibid.
24. Ibid., p. 30.
25. Volcom, Inc., Proxy Statement (March 24, 2009), pp. 5–6. This
section was directly quoted, except for minor editing.
26. “Management,” Volcom (June 26, 2009), http://volcom.com/
investorRelations/management.asp?catId�7. This section was
directly quoted, except for minor editing.
27. “Volcom,” Facebook http://www.facebook.com/Volcom?v�
info, “Mission Statement,” Volcom http://www.volcom.com/
mwassionstatement1.asp (August 1, 2009).
28. “Volcom, Inc.—Company Profile, Information, Business
Description, History, Background Information on Volcom,
Inc.,” Reference for Business (June 25, 2009), http://www
.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html.
29. Karl Taro Greenfeld, “Killer Profits in Velcro Valley,” Time
(January 25, 1999), pp. 50–51.
30. “History,” Volcom (July 2, 2009), http://www.volcom.com/
hwastory/index.asp.
31. Ibid. This section was directly quoted, except for minor editing.
32. “Volcom, Inc.—Company Profile, Information, Business Descrip-
tion, History, Background Information on Volcom, Inc.,” Reference
for Business (June 25, 2009), http://www.referenceforbusiness
.com/hwastory2/3/Volcom-Inc.html.
33. Karl Taro Greenfeld, “Killer Profits in Velcro Valley,” Time
(January 25,1999), pp. 50–51.
34. Ibid.
35. Volcom, Inc., 2008 Form 10-K, pp. 2–4. This section was
directly quoted, except for minor editing.
36. Ibid., p. 4. This section was directly quoted, except for minor
editing.
37. Ibid., p. 11. This section was directly quoted, except for minor
editing.
38. Ibid., pp. 11–12.
39. Ibid., pp. 4–5. This section was directly quoted, except for minor
editing.
40. Ibid., pp. 6–7. This section was directly quoted, except for minor
editing.
41. Ibid., p. 7. This section was directly quoted, except for minor
editing.
42. Ibid., p. 12. This section was directly quoted, except for minor
editing.
43. Ibid., p. 11. This section was directly quoted, except for minor
editing.
44. Ibid., pp. 8–10. This section was directly quoted, except for mi-
nor editing.
45. Ibid., p. 11. This section was directly quoted, except for minor
editing.
46. Ibid., pp. 10–11. This section was directly quoted, except for mi-
nor editing.
47. Ibid., p. 12. This section was directly quoted, except for minor
editing.
48. “Bureau of Labor Statistics Data,” Databases, Tables & Calcula-
tors by Subject (October 18, 2009), http://data.bls.gov/
PDQ/servlet/SurveyOutputServlet?data_tool�latest_numbers&
series_id�LNS14000000.
49. Deloitte Touche Tohmatsu, Global Powers of Retailing 2009
(May 16, 2009), http://public.deloitte.com/media/0460/2009
GlobalPowersofRetail_FINAL2 .
50. “Bureau of Labor Statistics Data,” Databases, Tables & Calcu-
lators by Subject (October 18, 2009), http://data.bls.gov/
PDQ/servlet/SurveyOutputServlet?data_tool�latest_numbers&
series_id�LNS14000000.
51. Stephanie Rosenbloom, “After Weak Holiday Sales, Retailers
Prepare for Even Worse,” The New York Times (January 8, 2009),
http://www.nytimes.com/2009/01/09/business/economy/
09shop.html (October 18, 2009).
52. Ibid.
53. Ibid.
54. Deloitte Touche Tohmatsu, Global Powers of Retailing 2009
(May 16, 2009), http://public.deloitte.com/media/0460/
2009 GlobalPowersofRetail_FINAL2 , p. G44.
55. Ibid., p. G46.
56. Ibid., p. G44.
57. “Teen Spending Survey Points to Early Stages of a Discretionary
Recovery and Fashion Replenishment Cycle,” Business Wire,
Berkshire Hathaway (October 7, 2009), http://www.businesswire
.com/portal/site/google/?ndmViewId�news_view&newsId�
20091007005743&newsLang�en (October 18, 2009).
58. Ibid.
59. Ibid.
60. Volcom, Inc., 2008 Form 10-K, p. 13.
61. Robert F. Ohmes and Helena Tse, “Industry Overview: Apparel &
Footwear,” Bank of America, Merrill Lynch Research (June 4,
2009).
62. Ibid.
63. Ibid.
http://www.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html
http://www.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html
http://www.volcom.com/investorRelations/index.asp?catId=1
http://www.volcom.com/hwastory/index.asp
http://www.volcom.com/hwastory/index.asp
http://www.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html
http://www.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html
http://www.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html
http://www.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html
http://www.bizjournals.com/losangeles/stories/2005/06/27/daily36.html
http://www.bizjournals.com/losangeles/stories/2005/06/27/daily36.html
http://www.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html
http://www.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html
http://volcom.com/investorRelations/management.asp?catId=7
http://volcom.com/investorRelations/management.asp?catId=7
http://www.facebook.com/Volcom?v=info
http://www.volcom.com/mwassionstatement1.asp
http://www.volcom.com/mwassionstatement1.asp
http://www.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html
http://www.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html
http://www.volcom.com/hwastory/index.asp
http://www.volcom.com/hwastory/index.asp
http://www.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html
http://www.referenceforbusiness.com/hwastory2/3/Volcom-Inc.html
http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=LNS14000000
http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=LNS14000000
http://public.deloitte.com/media/0460/2009GlobalPowersofRetail_FINAL2
http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=LNS14000000
http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=LNS14000000
http://www.nytimes.com/2009/01/09/business/economy/09shop.html
http://www.nytimes.com/2009/01/09/business/economy/09shop.html
http://public.deloitte.com/media/0460/
http://www.businesswire.com/portal/site/google/?ndmViewId=news_view&newsId=20091007005743&newsLang=en
http://www.businesswire.com/portal/site/google/?ndmViewId=news_view&newsId=20091007005743&newsLang=en
http://www.facebook.com/Volcom?v=info
http://www.businesswire.com/portal/site/google/?ndmViewId=news_view&newsId=20091007005743&newsLang=en
http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=LNS14000000
http://public.deloitte.com/media/0460/2009GlobalPowersofRetail_FINAL2
http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=LNS14000000
CASE 22 Volcom Inc.: Riding the Wave 22-19
64. Ibid.
65. Karl Taro Greenfeld, “Killer Profits in Velcro Valley,” Time
(January 25, 1999), pp. 50–51.
66. Ibid.
67. Ibid.
68. Quiksilver, Inc., 2008 Form 10-K. This section was directly
quoted, except for minor editing.
69. Ibid., p. 9.
70. “Billabong,” http://www.billabongbiz.com/about-billabong.php.
71. Billabong, Full Financial Report 07-08, p. 57.
72. “The O’Neill Brand Was Acquired by Logo International BV,”
Surfesvillage (October 19, 2009), http://www.surfersvillage.
com/surfing/27873/news.htm.
73. Ibid.
74. Ibid.
75. “Back in the Day: Burton History,” Burton, http://demandware
.edgesuite.net/aadf_prd/on/demandware.static/Sites-Burton_
US-Site/Sites-Burton_US-Library/default/v1255721485198/
pdfs/BackintheDay .
76. Nathan Myers, “Burton Snowboards Acquires Channel Islands
Surfboards,” Surfing Magazine, http://www.surfingmagazine
.com/news/surfing-pulse/burton-merrick-interview/.
77. “Hurley,” K5 Board Shop (October 19, 2009), http://www
.k5.com/getbrand.asp?b�66&partnerid�31&utm_source�
Hurley�Site&utm_medium�banner&utm_campaign�
vendor_links.
78. Pacific Sunwear of California, Inc., 2008 Form 10-K. This sec-
tion was directly quoted, except for minor editing.
79. Ibid., p. 2.
80. Ibid., p. 20. This section was directly quoted, except for minor
editing.
81. Ibid.
82. Volcom, Inc., 2008 Form 10-K. This section was directly quoted,
except for minor editing, pp. 36–37.
83. Volcom, Inc., 2009 First Quarter Financial Results, p. 1.
http://www.billabongbiz.com/about-billabong.php
http://www.surfersvillage.com/surfing/27873/news.htm
http://www.surfersvillage.com/surfing/27873/news.htm
http://demandware.edgesuite.net/aadf_prd/on/demandware.static/Sites-Burton_US-Site/Sites-Burton_US-Library/default/v1255721485198/pdfs/BackintheDay
http://demandware.edgesuite.net/aadf_prd/on/demandware.static/Sites-Burton_US-Site/Sites-Burton_US-Library/default/v1255721485198/pdfs/BackintheDay
http://demandware.edgesuite.net/aadf_prd/on/demandware.static/Sites-Burton_US-Site/Sites-Burton_US-Library/default/v1255721485198/pdfs/BackintheDay
http://www.surfingmagazine.com/news/surfing-pulse/burton-merrick-interview/
http://www.surfingmagazine.com/news/surfing-pulse/burton-merrick-interview/
http://www.k5.com/getbrand.asp?b=66&partnerid=31&utm_source=Hurley+Site&utm_medium=banner&utm_campaign=vendor_links
http://www.k5.com/getbrand.asp?b=66&partnerid=31&utm_source=Hurley+Site&utm_medium=banner&utm_campaign=vendor_links
http://www.k5.com/getbrand.asp?b=66&partnerid=31&utm_source=Hurley+Site&utm_medium=banner&utm_campaign=vendor_links
http://www.k5.com/getbrand.asp?b=66&partnerid=31&utm_source=Hurley+Site&utm_medium=banner&utm_campaign=vendor_links
http://demandware.edgesuite.net/aadf_prd/on/demandware.static/Sites-Burton_US-Site/Sites-Burton_US-Library/default/v1255721485198/pdfs/BackintheDay
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23-1
C A S E 23
TOMS Shoes (Mini Case)
J. David Hunger
History
Blake Mycoskie started his entrepreneurial career by creating a college laundry service in 1997
when he was a student at Southern Methodist University. In his words, “After we expanded EZ
Laundry to four colleges, I sold my share. I moved to Nashville to start an outdoor media
company that Clear Channel scooped up three years later.” In 2002, Blake and his sister Paige
formed a team to compete on the CBS reality show The Amazing Race, coming in second. One
of the places that they visited during the filming was Argentina. Fascinated by South America,
FOUNDED IN 2006 BY BLAKE MYCOSKIE, TOMS Shoes was an American footwear company
based in Santa Monica, California. Although TOMS Shoes was a for-profit business, its mis-
sion was more like that of a not-for-profit organization. The firm’s reason for existence was
to donate to children in need one new pair of shoes for every pair of shoes sold. Blake My-
coskie referred to it as the company’s “One for One” business model.
While vacationing in Argentina during 2006, Mycoskie befriended children who had
no shoes to protect them during long walks to obtain food and water, as well as attend
school. Going barefoot was a common practice in rural farming regions of developing coun-
tries, where many subsistence farmers could not afford even a single pair of shoes. Mycoskie
learned that going barefoot could lead to some serious health problems. Podoconiosis was
one such disease in which feet and legs swelled, formed ulcers, emitted a foul smell, and
caused intense pain. It affected millions of people across 10 countries in tropical Africa, Cen-
tral America, and northern India. For millions, not wearing shoes could deepen the cycle of
poverty and ruin lives. Upset that such a simple need was being unmet, Mycoskie founded
TOMS Shoes in order to provide them the shoes they needed. “I was so overwhelmed by the
spirit of the South American people, especially those who had so little,” Mycoskie said. “I
was instantly struck with the desire—the responsibility—to do more.” The name of his new
venture was TOMS Shoes.
This case was prepared by Professor J. David Hunger, Iowa State University and St. John’s University. Copyright
©2010 by J. David Hunger. The copyright holder is solely responsible for case content. Reprint permission is solely
granted to the publisher, Prentice Hall, for Strategic Management and Business Policy, 13th Edition (and the inter-
national and electronic versions of this book) by the copyright holder, J. David Hunger. Any other publication of
the case (translation, any form of electronics or other media) or sale (any form of partnership) to another publisher
will be in violation of copyright law, unless J. David Hunger has granted an additional written permission.
Reprinted by permission.
Business Model
Realizing that a not-for-profit organization would be heavily dependent upon sponsors and
constant fundraising, Mycoskie chose to create an innovative for-profit business model to
achieve a charitable purpose. For every pair of shoes that the company sold, it would
donate one pair to a child in need. Mycoskie felt that this model would be more economically
sustainable than a charity because sales would be used to achieve the company’s mission. He
saw this to be a form of social entrepreneurship in which a new business venture acted to im-
prove society through product donations at the same time it lived off society through its sales.
Mycoskie believed that the firm’s One-for-One model would be self-sustaining because
the company could make and sell shoes at a price similar to other shoe companies, but with
lower costs. “Selling online (www.toms.com) has allowed us to grow pretty rapidly, but we’re
not going to make as much as another shoe company, and the margins are definitely lower,”
he admits. “But what we do helps us to get publicity. Lots of companies give a percentage of
their revenue to charity, but we can’t find anyone who matches one for one.”
23-2 SECTION D Industry Five—Clothing
Marketing and Distribution
TOMS Shoes kept expenses low by spending only minimally on marketing and promotion.
The company’s marketing was primarily composed of presentations by Blake Mycoskie, fan
word-of-mouth, and promotional events sponsored by the firm. The company won the 2007
Blake returned to Argentina in 2006 for a vacation. “On my visit I saw lots of kids with no shoes
who were suffering from injuries to their feet. I decided a business would be the most sustainable
way to help, so I founded TOMS, which is short for a ‘better tomorrow,’” explained Mycoskie.
While in Argentina, Mycoskie had taken to wearing alpargatas—resilient, light-weight,
slip-on shoes with a breathable canvas top and soft leather insole traditionally worn by
Argentine workers, but worn casually by most people in that country. Mycoskie spent two
months meeting with shoe and fabric makers in Argentina. Although he modeled his shoe
after the espadrille-like alpargata, he used brighter colors and different materials. “No one
looked twice at alpargatas, but I thought they had a really cool style,” said Mycoskie. “I’m a
fan of Vans, but they can be clunky and sweaty. These aren’t. They fit your foot like a glove
but are sturdy enough for a hike, the beach, or the city.”
Founding his new company that year in Santa Monica, California, the 30-year-old Blake
Mycoskie began his third entrepreneurial venture. With a staff of seven full-time employees
(including former Trovata clothing line designer John Whitledge), six sales representatives,
and eight interns, TOMS Shoes introduced 15 styles of men’s and women’s shoes plus
limited-edition artist versions in June 2006. The shoes were quickly selected for distribution
by stores like American Bag and Fred Segal in Los Angeles and Scoop in New York City. By
Fall 2006, the company had sold 10,000 pairs of shoes, averaging $38 each, online and
through 40 retail stores.
As promised, Mycoskie returned to Argentina in October 2006 with two dozen volunteers
to give away 10,000 pairs of shoes along 2,200 miles of countryside. Mycoskie wryly
explained what he learned from this experience. “I always thought that I’d spend the first half
of my life making money and the second half giving it away. I never thought I could do both
at the same time.” The next year, TOMS Shoes gave away 50,000 pairs of shoes in “shoe
drops” to children in Argentina plus shoe drops to South Africa. More countries were added
to the list over the next three years.
www.toms.com
CASE 23 TOMS Shoes (Mini Case) 23-3
Operations and Management
TOMS shoes were manufactured in Argentina, China, and Ethiopia. The company required
the factories to operate under sound labor conditions, pay fair wages, and follow local labor
standards. A code of conduct was signed by all factories. In addition to its production staff
routinely visiting the factories to ensure that they were maintaining good working standards,
third parties annually audited the factories. The company’s original line of alpargata shoes
was expanded to include children’s shoes, leather shoes, cordones youth shoes, botas, and
wedges. In January 2009, the company collaborated with Element Skateboards to create a line
of shoes, skate decks, and longboards. For each pair of TOMS Element shoes and/or skate-
board bought, one of the same was given to children at the Indigo Skate Camp in the village
of Isithumba in Durban, South Africa.
People’s Design Award at Cooper-Hewitt’s National Design Awards. Two years later,
Mycoskie and TOMS received the annual ACE award given by U.S. Secretary of State
Hillary Clinton. This award recognized companies’ commitment to corporate social respon-
sibility, innovation, exemplary practices, and democratic values worldwide. Mycoskie spoke
along with President Bill Clinton at the Opening Plenary session of the Second Annual
Clinton Global Initiative Conference in 2007. With other business leaders, he also met with
President Obama’s senior administration in March 2009 to present solutions and ideas to sup-
port small businesses. He was also featured in a CNBC segment titled “The Entrepreneurs,”
in which he and TOMS Shoes was profiled.
Mycoskie explained why he spent so much time speaking to others about TOMS Shoes.
“My goal is to inspire the next generation of entrepreneurs and company leaders to think
differently about how they incorporate giving into their business models. Plus, many of the
people who hear me speak eventually purchase a pair of Toms, share the story with others, or
support our campaigns like One Day Without Shoes, which has people go barefoot for one day
a year to raise awareness about the children we serve.”
Celebrities like Olivia Wilde, Karl Lagerfeld, and Scarlett Johansson loved the brand and
what it stood for. Actress Demi Moore promoted the 2010 One Day Without Shoes campaign
on The Tonight Show with Jay Leno. It didn’t hurt that Mycoskie’s fame was supported by his
Bill Clinton-like charisma, Hollywood good looks, and his living on a boat in Marina del Rey
with “TOMS” sails. Famed designer Ralph Lauren asked Mycoskie to work with him on a
few styles for his Rugby collection, the first time Lauren had collaborated with another brand.
TOMS Shoes and Blake Mycoskie were profiled in the LA Times, as well as Inc., People,
Forbes, Fortune, Fast Company, and Time magazines. Mycoskie pointed out that the 2009 LA
Times article, “TOMS Shoes the Model: Sell 1, Give 1,” resulted in 2,200 orders for shoes in
just 12 hours after the article appeared. In February 2010, FastCompany listed TOMS Shoes
as #6 on its list of “Top Ten Most Innovative Retail Companies.”
By early 2007, TOMS Shoes had orders from 300 retail stores, including Nordstrom’s,
Urban Outfitters, and Bloomingdale’s, for 41,000 pairs of shoes from its spring and summer
collections. The company introduced a line of children’s shoes called Tiny Toms in May 2007
and unveiled a pair of leather shoes in Fall of that year. By September 2010, the company
added Whole Foods to its distribution network and had given over 1,000,000 pairs of new
shoes to children in need living in more than 20 countries in the Americas (Argentina, El
Salvador, Guatemala, Haiti, Honduras, Nicaragua, and Peru), Africa (Burundi, Ethiopia,
Lesotho, Malawi, Mali, Niger, Rwanda, South Africa, Swaziland, Uganda, and Zambia),
Asia (Cambodia and Mongolia), and Eurasia (Armenia). The shoes were now selling for
$45 to $85 a pair.
23-4 SECTION D Industry Five—Clothing
Mission Accomplished: Next Steps?
When Blake Mycoskie originally proposed his One-for-One business model in 2006, few had
much confidence in his ability to succeed. He never generated a business plan or asked for
outside support. Mycoskie used the money he had earned from his earlier entrepreneurial
ventures to fund the new business. Looking back on those days, Mycoskie stated, “A lot of
people thought we were crazy. They never thought we could make a profit.” Much to every-
one’s surprise, TOMS Shoes had its first profitable year in 2008, only two years after being
founded! The company’s sales kept increasing throughout the “great recession” of 2008–2009
and continued being marginally profitable. Mycoskie admitted that the company would have
to sell about a million pairs of shoes annually to be really profitable. Nevertheless, TOMS
Shoes did not take on any outside investors and did not plan to do so.
In September 2010, Blake Mycoskie celebrated TOMS Shoes’ total sales of one million
pairs of shoes by returning to Argentina to give away the millionth pair. Looking forward to
returning to where it all began, Mycoskie mused: “To reach a milestone like this is really amaz-
ing. We have been so busy giving shoes that we don’t even think about the scope of what we’ve
created and what we’ve done.”
What should be next for TOMS Shoes? Blake Mycoskie invested a huge amount of his own
time, energy, and enthusiasm in the growth and success of TOMS Shoes. Was the company too
dependent upon its founder? How should it plan its future growth?
Blake Mycoskie was the company’s Chief Executive Officer and joked that he was also its
“Chief Shoe Giver.” He spent much of his time traveling the country to speak at universities and
companies about the TOMS Shoes’ business model. According to CEO Mycoskie in a June 2010
article in Inc., “The reason I can travel so much is that I’ve put together a strong team of about ten
people who pretty much lead the company while I am gone. Candice Wolfswinkel is my chief of
staff and the keeper of the culture. . . . I have an amazing CFO, Jeff Tyler, and I’ll check in with
him twice a week. I talk to my sales managers on a weekly basis. I also call my younger brother,
Tyler, a lot—he’s head of corporate sales.” The company had 85 employees plus interns and
volunteers. In 2009, more than 1,000 people applied for 15 summer internship positions.
The company depended upon many volunteers to promote the company and to distribute
its shoes to needy children. For example, Friends of TOMS was a registered nonprofit affili-
ate of TOMS Shoes that had been formed to coordinate volunteer activities and all shoe drops.
The company sponsored an annual “Vagabond Tour” to reach college campuses. Volunteers
were divided into five regional teams to reach campuses throughout the United States to spread
information about the One-for-One movement. To capture volunteer enthusiasm, the company
formed a network of college representatives at 200 schools to host events, screen a
documentary about the brand, or throw shoe decorating parties.
Mycoskie believed that a key to success for his company was his generation’s desire to
become involved in the world. “This generation is one that thrives off of action. We don’t
dream about change, we make it happen. We don’t imagine a way to incorporate giving into
our daily lives—we do it. TOMS has so many young supporters who are passionate about the
One for One movement, and who share the story and inspire others every day they wear their
TOMS. Seeing them support this business model is proof that this generation is ready and able
to create a better tomorrow.”
BEST BUY CO. INC., HEADQUARTERED IN RICHFIELD, MINNESOTA, was a specialty retailer of
consumer electronics. It operated over 1,100 stores in the United States, accounting for 19%
of the market. With approximately 155,000 employees, it also operated over 2,800 stores
in Canada, Mexico, China, and Turkey. The company’s subsidiaries included Geek Squad,
Magnolia Audio Video, and Pacific Sales. In Canada, Best Buy operated under both the
Best Buy and Future Shop labels.
Best Buy’s mission was to make technology deliver on its promises to customers. To ac-
complish this, Best Buy helped customers realize the benefits of technology and technological
changes so they could enrich their lives in a variety of ways through connectivity: “To make life
fun and easy,”1 as Best Buy put it. This was what drove the company to continually increase the
tools to support customers in the hope of providing end-to-end technology solutions.
As a public company, Best Buy’s top objectives were sustained growth and earnings. This was
accomplished in part by constantly reviewing its business model to ensure that it was satisfying cus-
tomer needs and desires as effectively and completely as possible. The company strived to have not
only extensive product offerings but also highly trained employees with extensive product knowl-
edge. The company encouraged its employees to go out of their way to help customers understand
what these products could do and how customers could get the most out of the products they pur-
chased. Employees recognized that each customer was unique and thus determined the best method
to help that customer achieve maximum enjoyment from the product(s) purchased.
24-1
C A S E 24
Best Buy Co. Inc.: Sustainable
Customer Centricity Model?
Alan N. Hoffman
This case was prepared by Professor Alan N. Hoffman, Bentley University and Erasmus University. Copyright ©2010
by Alan N. Hoffman. The copyright holder is solely responsible for case content. Reprint permission is solely granted
to the publisher, Prentice Hall, for Strategic Management and Business Policy, 13th Edition (and the international and
electronic versions of this book) by the copyright holder, Alan N. Hoffman. Any other publication of the case (transla-
tion, any form of electronics or other media) or sale (any form of partnership) to another publisher will be in violation
of copyright law, unless Alan N. Hoffman has granted an additional written permission. Reprinted by permission.
The author would like to thank MBA students Kevin Clark, Leonard D’Andrea, Amanda Genesky, Geoff Merritt, Chris
Mudarri, and Dan Fowler for their research. No part of this publication may be copied, stored, transmitted, reproduced,
or distributed in any form or medium whatsoever without the permission of the copyright owner, Alan N. Hoffman.
Industry Six—Specialty Retailing
From a strategic standpoint, Best Buy moved from being a discount retailer (a low price
strategy) to a service-oriented firm that relied on a differentiation strategy. In 1989, Best
Buy changed the compensation structure for sales associates from commission-based to non-
commissioned-based, which resulted in consumers having more control over the purchasing
process and in cost savings for the company (the number of sales associates was reduced). In 2005,
Best Buy took customer service a step further by moving from peddling gadgets to a customer-
centric operating model. It was now gearing up for another change to focus on store design and
providing products and services in line with customers’ desire for constant connectivity.
24-2 SECTION D Industry Six—Specialty Retailing
Company History2
From Sound of Music to Best Buy
Best Buy was originally known as Sound of Music. Incorporated in 1966, the company
started as a retailer of audio components and expanded to retailing video products in the early
1980s with the introduction of the videocassette recorder to its product line. In 1983, the com-
pany changed its name to Best Buy Co. Inc. (Best Buy). Shortly thereafter, Best Buy began
operating its existing stores under a “superstore” concept by expanding product offerings and
using mass marketing techniques to promote those products.
Best Buy dramatically altered the function of its sales staff in 1989. Previously, the sales
staff worked on a commission basis and was more proactive in assisting customers coming into
the stores as a result. Since 1989, however, the commission structure has been terminated and
sales associates have developed into educators that assist customers in learning about the prod-
ucts offered in the stores. The customer, to a large extent, took charge of the purchasing
process. The sales staff’s mission was to answer customer questions so that the customers
could decide which product(s) fit their needs. This differed greatly from their former mission
of simply generating sales.
In 2000, the company launched its online retail store: BestBuy.com. This allowed cus-
tomers a choice between visiting a physical store and purchasing products online, thus expand-
ing Best Buy’s reach among consumers.
Expansion Through Acquisitions
In 2000, Best Buy began a series of acquisitions to expand its offerings and enter international
markets:
2000: Best Buy acquired Magnolia Hi-Fi Inc., a high-end retailer of audio and video products
and services, which became Magnolia Audio Video in 2004. This acquisition allowed
Best Buy access to a set of upscale customers.
2001: Best Buy entered the international market with the acquisition of Future Shop Ltd, a
leading consumer electronics retailer in Canada. This helped Best Buy increase revenues,
gain market share, and leverage operational expertise. The same year, Best Buy also
opened its first Canadian store. In the same year, the company purchased Musicland, a
mall-centered music retailer throughout the United States (divested in 2003).
2002: Best Buy acquired Geek Squad, a computer repair service provider, to help develop a
technological support system for customers. The retailer began by incorporating in-store
Geek Squad centers in its 28 Minnesota stores and expanding nationally and then interna-
tionally in subsequent years.
2005: Best Buy opened the first Magnolia Home Theater “store-within-a-store” (located
within the Best Buy complex).
2006: Best Buy acquired Pacific Sales Kitchen and Bath Centers Inc. to develop a new cus-
tomer base: builders and remodelers. The same year, Best Buy also acquired a 75% stake
in Jiangsu Five Star Appliance Co., Ltd, a China-based appliance and consumer electron-
ics retailer. This enabled the company to access the Chinese retail market and led to the
opening of the first Best Buy China store on January 26, 2007.
2007: Best Buy acquired Speakeasy Inc., a provider of broadband, voice, data, and informa-
tion technology services, to further its offering of technological solutions for customers.
2008: Through a strategic alliance with the Carphone Warehouse Group, a UK-based provider
of mobile phones, accessories, and related services, Best Buy Mobile was developed.
After acquiring a 50% share in Best Buy Europe (with 2,414 stores) from the Carphone
Warehouse, Best Buy intended to open small-store formats across Europe in 2011.3 Best
Buy also acquired Napster, a digital download provider, through a merger to counter the
falling sales of compact discs. The first Best Buy Mexico store was opened.
2009: Best Buy acquired the remaining 25% of Jiangsu Five Star. Best Buy Mobile moved into
Canada.
CASE 24 Best Buy Co. Inc.: Sustainable Customer Centricity Model? 24-3
Industry Environment
Industry Overview
Despite the negative impact the financial crisis had on economies worldwide, in 2008 the con-
sumer electronics industry managed to grow to a record high of US$694 billion in sales—a
nearly 14% increase over 2007. In years immediately prior, the growth rate was similar: 14%
in 2007 and 17% in 2006. This momentum, however, did not last. Sales dropped 2% in 2009,
the first decline in 20 years for the electronics giant.
A few product segments, including televisions, gaming, mobile phones, and Blu-ray play-
ers, drove sales for the company. Television sales, specifically LCD units, which accounted for
77% of total television sales, were the main driver for Best Buy, as this segment alone ac-
counted for 15% of total industry revenues. The gaming segment continued to be a bright spot
for the industry as well, as sales were expected to have tremendous room for growth. Smart-
phones were another electronics industry segment predicted to have a high growth impact on
the entire industry.
The consumer electronics industry had significant potential for expansion into the global
marketplace. There were many untapped markets, especially newly developing countries.
These markets were experiencing the fastest economic growth while having the lowest own-
ership rate for gadgets.4 Despite the recent economic downturn, the future for this industry was
optimistic. A consumer electronics analyst for the European Market Research Institute pre-
dicted that the largest growth will be seen in China (22%), the Middle East (20%), Russia
(20%), and South America (17%).5
Barriers to Entry
As globalization spread and use of the Internet grew, barriers to entering the consumer elec-
tronics industry were diminished. When the industry was dominated by brick-and-mortar com-
panies, obtaining the large capital resources needed for entry into the market was a barrier for
those looking to gain any significant market share. Expanding a business meant purchasing or
24-4 SECTION D Industry Six—Specialty Retailing
Internal Environment
Finance
While Best Buy’s increase in revenue was encouraging (see Exhibit 1), recent growth had
been fueled largely by acquisition, especially Best Buy’s fiscal year 2009 revenue growth. At
the same time, net income and operating margins had been declining (see Exhibits 2 and 3).
Although this could be a function of increased costs, it was more likely due to pricing pres-
sure. Given the current adverse economic conditions, prices of many consumer electronic
products had been forced down by economic and competitive pressures. These lower prices
caused margins to decline, negatively affecting net income and operating margins.
$0
$5,000In
M
ill
io
ns
$10,000
$15,000
$20,000
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
2005
2006
2007
2008
2009
2010
EXHIBIT 1
Quarterly Sales,
Best Buy Co., Inc.
$0
$200
$400
In
M
ill
io
ns $600
$800
$1,000
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
2005
2006
2007
2008
2009
2010
EXHIBIT 2
Quarterly Net
Income,
Best Buy Co., Inc.
leasing large stores that incurred high initial and overhead costs. However, the Internet signif-
icantly reduced the capital requirements needed to enter the industry. Companies like Amazon.
com and Dell utilized the Internet to their advantage and gained valuable market share.
The shift toward Internet purchasing also negated another once strong barrier to entry: cus-
tomer loyalty. The trend was that consumers would research products online to determine which
one they intended to purchase and then shop around on the Internet for the lowest possible price.
Even though overall barriers were diminished, there were still a few left, which a company
like Best Buy used to its advantage. The first, and most significant, was economies of scale. With
over 1,000 locations, Best Buy used its scale to obtain cost advantages from suppliers due to high
quantity of orders. Another advantage was in advertising. Large firms had the ability to increase
advertising budgets to deter new entrants into the market. Smaller companies generally did not
have the marketing budgets for massive television campaigns, which were still one of the most
effective marketing strategies available to retailers. Although Internet sales were growing, the
industry was still dominated by brick-and-mortar stores. Most consumers looking for electronics—
especially major electronics—felt a need to actually see their prospective purchases in person.
Having the ability to spend heavily on advertising helped increase foot traffic to these stores.
SOURCE: Best Buy Co., Inc.
SOURCE: Best Buy Co., Inc.
CASE 24 Best Buy Co. Inc.: Sustainable Customer Centricity Model? 24-5
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
2005
2006
2007
2008
2009
2010
EXHIBIT 3
Operating Margin,
Best Buy Co., Inc.
$0
$500
$1,000
In
M
ill
io
ns
$1,500
$2,000
2005 2006 2007 2008 2009
Long term Debit
Cash
EXHIBIT 4
Long Term Debt
and Cash,
Best Buy Co., Inc.
SOURCE: Best Buy Co., Inc.
SOURCE: Best Buy Co., Inc.
Best Buy’s long-term debt increased substantially from fiscal 2008 to 2009 (see Exhibit 4),
which was primarily due to the acquisition of Napster and Best Buy Europe. The trend in avail-
able cash has been a mirror image of long-term debt. Available cash increased from fiscal 2005
to 2008 and then was substantially lower in 2009 for the same reason.
While the change in available cash and long-term debt were not desirable, the bright side
was that this situation was due to the acquisition of assets, which led to a significant increase
in revenue for the company. Ultimately, the decreased availability of cash would seem to be
temporary due to the circumstances. The more troubling concern was the decline in net income
and operating margins, which Best Buy needed to find a way to turn around. If the problems
with net income and operating margins were fixed, the trends in cash and long-term debt would
also begin to turn around.
At first blush, the increase in accounts receivable and inventory was not necessarily alarm-
ing since revenues were increasing during this same time period (see Exhibit 5). However,
$0
$1,000
$2,000
$3,000
$4,000
$5,000
2005 2006 2007 2008 2009
Inventory
Accounts receivable
EXHIBIT 5
Accounts Receivable
and Inventory,
Best Buy Co., Inc.
SOURCE: Best Buy Co., Inc.
24-6 SECTION D Industry Six—Specialty Retailing
Marketing
Best Buy’s marketing goals were four-fold: (1) to market various products based on the customer
centricity operating model, (2) to address the needs of customer lifestyle groups, (3) to be at the
forefront of technological advances, and (4) to meet customer needs with end-to-end solutions.
Best Buy prided itself on customer centricity that catered to specific customer needs and
behaviors. Over the years, the retailer created a portfolio of products and services that comple-
mented one another and added to the success of the business. These products included seven
distinct brands domestically, as well as other brands and stores internationally:
Best Buy: This brand offered a wide variety of consumer electronics, home office products,
entertainment software, appliances, and related services.
Best Buy Mobile: These stand-alone stores offered a wide selection of mobile phones, acces-
sories, and related e-services in small-format stores.
Geek Squad: This brand provided residential and commercial product repair, support, and in-
stallation services both in-store and on-site.
Magnolia Audio Video: This brand offered high-end audio and video products and related
services.
Napster: This brand was an online provider of digital music.
Pacific Sales: This brand offered high-end home improvement products primarily including
appliances, consumer electronics, and related services.
Speakeasy: This brand provided broadband, voice, data, and information technology services
to small businesses.
Starting in 2005, Best Buy initiated a strategic transition to a customer-centric operating model,
which was completed in 2007. Prior to 2005, the company focused on customer groups such as af-
fluent professional males, young entertainment enthusiasts, upscale suburban mothers, and techno-
logically advanced families.6 After the transition, Best Buy focused more on customer lifestyle
groups such as affluent suburban families, trendsetting urban dwellers, and the closely knit fami-
lies of Middle America.7 To target these various segments, Best Buy acquired firms with aligned
strategies, which were used as a competitive advantage against its strongest competition, such as
Circuit City and Wal-Mart. The acquisitions of Pacific Sales, Speakeasy, and Napster, along with
the development of Best Buy Mobile, created more product offerings, which led to more profits.
Marketing these different types of products and services was a difficult task. That was why
Best Buy’s employees had more training than competitors. This knowledge service was a value-
added competitive advantage. Since the sales employees no longer operated on a commission-based
pay structure, consumers could obtain knowledge from salespeople without being subjected to
high-pressure sales techniques. This was generally seen to enhance customer shopping satisfaction.
Operations
Best Buy’s operating goals included increasing revenues by growing its customer base, gain-
ing more market share internationally, successfully implementing marketing and sales strate-
gies in Europe, and having multiple brands for different customer lifestyles through M&A
(Merger and Acquisition).
Domestic Best Buy store operations were organized into eight territories, with each terri-
tory divided into districts. A retail field officer oversaw store performance through district
closer inspection revealed a 1% increase in inventory from fiscal 2008 to 2009 and a 12.5% in-
crease in revenue accompanied by a 240% increase in accounts receivable. This created a poten-
tial risk for losses due to bad debts. (For complete financial statements, see Exhibits 6 and 7.)
CASE 24 Best Buy Co. Inc.: Sustainable Customer Centricity Model? 24-7
Human Resources
The objectives of Best Buy’s human resources department were to provide consumers with
the right knowledge of products and services, to portray the company’s vision and strategy
on an everyday basis, and to educate employees on the ins and outs of new products and ser-
vices. Best Buy employees were required to be ethical and knowledgeable. This principle
started within the top management structure and filtered down from the retail field officer
through district managers, and through store managers to the employees on the floor. Every
employee must have the company’s vision embedded in their service and attitude.
Despite Best Buy’s efforts to train an ethical and knowledgeable employee force, there were
some allegations and controversy over Best Buy employees, which gave the company a bad black
eye in the public mind. One lawsuit claimed that Best Buy employees had misrepresented the
manufacturer’s warranty in order to sell its own product service and replacement plan. The law-
suit accused Best Buy of “entering into a corporate-wide scheme to institute high-pressure sales
techniques involving the extended warranties” and “using artificial barriers to discourage con-
sumers who purchased the ‘complete extended warranties’ from making legitimate claims.”10
In a more recent case (March 2009), the U.S. District Court granted Class Action certifi-
cation to allow plaintiffs to sue Best Buy for violating its “Price Match” policy. According to
the ruling, the plaintiffs alleged that Best Buy employees would aggressively deny consumers
the ability to apply the company’s “price match guarantee.”11 The suit also alleged that Best
Buy had an undisclosed “Anti-Price Matching Policy,” where the company told its employees
not to allow price matches and gave financial bonuses to employees who complied.
managers, who met with store employees on a regular basis to discuss operations strategies
such as loyalty programs, sales promotion, and new product introductions.8 Along with do-
mestic operations, Best Buy had an international operation segment, originally established in
connection with the acquisition of Canada-based Future Shop.9
In fiscal 2009, Best Buy opened up 285 new stores in addition to the European acquisi-
tion of 2,414 Best Buy Europe stores, relocated 34 stores, and closed 67 stores.
Competition
Brick-and-Mortar Competitors
Wal-Mart Stores Inc., the world’s largest retailer, with revenues over US$405 billion, oper-
ated worldwide and offered a diverse product mix with a focus on being a low-cost provider.
In recent years, Wal-Mart increased its focus on grabbing market share in the consumer elec-
tronics industry. In the wake of Circuit City’s liquidation,12 Wal-Mart was stepping up efforts
by striking deals with Nintendo and Apple that would allow each company to have their own
in-store displays. Wal-Mart also considered using Smartphones and laptop computers to drive
growth.13 It was refreshing 3,500 of its electronics departments and was beginning to offer a
wider and higher range of electronic products. These efforts should help Wal-Mart appeal to
the customer segment looking for high quality at the lowest possible price.14
GameStop Corp. was the leading video game retailer with sales of almost US$9 billion as
of January 2009, in a forecasted US$22 billion industry. GameStop operated over 6,000 stores
throughout the United States, Canada, Australia, and Europe, as a retailer of both new and used
video game products including hardware, software, and gaming accessories.15
The advantage GameStop had over Best Buy was the number of locations: 6,207
GameStop locations compared to 1,023 Best Buy locations. However, Best Buy seemed to
24-8 SECTION D Industry Six—Specialty Retailing
Online Competitors
Amazon.com Inc., since 1994, had grown into the United States’ largest online retailer with
revenues of over US$19 billion in 2008 by providing just about any product imaginable
through its popular website. Created as an online bookstore, Amazon soon ventured out into
various consumer electronic product categories including computers, televisions, software,
video games, and much more.18
Amazon.com gained an advantage over its supercenter competitors as Amazon was able to
maintain a lower cost structure compared to brick-and-mortar companies such as Best Buy. Ama-
zon was able to push those savings through to its product pricing and selection/diversification.
With an increasing trend in the consumer electronic industry to shop online, Amazon.com was
positioned perfectly to maintain strong market growth and potentially steal some market share
away from Best Buy.
Netflix Inc. was an online video rental service, offering selections of DVDs and Blu-ray
discs. Since its establishment in 1997, Netflix had grown into a US$1.4 billion company. With
over 100,000 titles in its collection, the company shipped for free to approximately 10 million
subscribers. Netflix began offering streaming downloads through its website, which elimi-
nated the need to wait for a DVD to arrive.
Netflix was quickly changing the DVD market, which had dramatically impacted brick-
and-mortar stores such as Blockbuster and Hollywood Video and retailers who offered DVDs
for sale. In a responsive move, Best Buy partnered with CinemaNow to enter the digital movie
distribution market and counter Netflix and other video rental providers.19
Core Competencies
Customer Centricity Model
Most players in the consumer electronics industry focused on delivering products at the low-
est cost (Wal-Mart—brick-and-mortar, Amazon—web-based). Best Buy, however, took a dif-
ferent approach by providing customers with highly trained sales associates who were
available to educate customers regarding product features. This allowed customers to make
informed buying decisions on big-ticket items. In addition, with the Geek Squad, Best Buy
was able to offer and provide installation services, product repair, and ongoing support. In
short, Best Buy provided an end-to-end solution for its customers.
have what it took to overcome this advantage—deep pockets. With significantly higher net in-
come, Best Buy could afford to take a hit to its margins and undercut GameStop prices.16
RadioShack Corp. was a retailer of consumer electronic goods and services including flat
panel televisions, telephones, computers, and consumer electronic accessories. Although the
company grossed revenues of over US$4 billion from 4,453 locations, RadioShack consis-
tently lost market share to Best Buy. Consumers had a preference for RadioShack for audio
and video components, yet preferred Best Buy for their big box purchases.17
Second tier competitors were rapidly increasing. Wholesale shopping units were becom-
ing more popular, and companies such as Costco and BJ’s had increased their piece of the con-
sumer electronics pie over the past few years. After Circuit City’s bankruptcy, mid-level
electronics retailers like HH Gregg and Ultimate Electronics were scrambling to grab Circuit
City’s lost market share. Ultimate Electronics, owned by Mark Wattles, who was a major in-
vestor in Circuit City, had a leg up on his competitors. Wattles was on Circuit City’s board of
executives and had firsthand access to profitable Circuit City stores. Ultimate Electronics
planned to expand its operations by at least 20 stores in the near future.
CASE 24 Best Buy Co. Inc.: Sustainable Customer Centricity Model? 24-9
Best Buy used its customer centricity model, which was built around a significant data-
base of customer information, to construct a diversified portfolio of product offerings. This al-
lowed the company to offer different products in different stores in a manner that matched
customer needs. This in turn helped keep costs lower by shipping the correct inventory to the
correct locations. Since Best Buy’s costs were increased by the high level of training needed
for sales associates and service professionals, it had been important that the company remain
vigilant in keeping costs down wherever it can without sacrificing customer experience.
The tremendous breadth of products and services Best Buy was able to provide allowed
customers to purchase all components for a particular need within the Best Buy family. For ex-
ample, if a customer wanted to set up a first-rate audio-visual room at home, he or she could
go to the Magnolia Home Theater store-within-a-store at any Best Buy location and use the
knowledge of the Magnolia or Best Buy associate in the television and audio areas to deter-
mine which television and surround sound theater system best fit their needs. The customer
could then employ a Geek Squad employee to install and set up the television and home the-
ater system. None of Best Buy’s competitors offered this extensive level of service.
Successful Acquisitions
Through its series of acquisitions, Best Buy had gained valuable experience in the process of
integrating companies under the Best Buy family. The ability to effectively determine where
to expand was important to the company’s ability to differentiate itself in the marketplace.
Additionally, Best Buy was also successfully integrating employees from acquired compa-
nies. Best Buy had a significant global presence, which was important because of the matur-
ing domestic market. This global presence provided the company with insights into
worldwide trends in the consumer electronics industry and afforded access to newly develop-
ing markets. Best Buy used this insight to test products in different markets in its constant ef-
fort to meet and anticipate customer needs.
Retaining Talent
Analyzing Circuit City’s demise, many experts concluded one of the major reasons for the
company’s downfall was that Circuit City let go of their most senior and well-trained sales
staff in order to cut costs. Best Buy, on the other hand, had a reputation for retaining talent
and was widely recognized for its superior service. Highly trained sales professionals had be-
come a unique resource in the consumer electronics industry, where technology was chang-
ing at an unprecedented rate, and was a significant source of competitive advantage.
Challenges Ahead
Economic Downturn
Electronics retailers like Best Buy sold products that could be described as “discretionary
items, rather than necessities.”20 During economic recessions, however, consumers had less
disposable income to spend. While there was optimism about a possible economic turnaround
in 2010 or 2011, if the economy continued to stumble, this could present a real threat to sell-
ers of discretionary products.
In order to increase sales revenues, many retailers, including Best Buy, offered customers
low interest financing through their private-label credit cards. These promotions were tremen-
dously successful for Best Buy. From 2007 to 2009, these private-label credit card purchases
24-10 SECTION D Industry Six—Specialty Retailing
Pricing and Debt Management
The current depressed economic conditions, technological advances, and increased competition
put a tremendous amount of pricing pressure on many consumer electronics products. This was a
concern for all companies in this industry. The fact that Best Buy did not compete strictly on price
structure alone made this an even bigger concern. Given the higher costs that Best Buy incurred
training employees, any pricing pressure that decreased margins put stress on Best Buy’s finan-
cial strength. In addition, the recent acquisition of Napster and the 50% stake in Best Buy Europe
significantly increased Best Buy’s debt and reduced available cash. Even in prosperous times, debt
management was a key factor in any company’s success, and it became even more important dur-
ing the economic downturn. (See Exhibits 6 and 7 for Best Buy’s financial statements.)
accounted for 16%–18% of Best Buy’s domestic revenue. Due to the credit crisis, however, the
Federal Reserve issued new regulations that could restrict companies from offering deferred
interest financing to customers. If Best Buy and other retailers were unable to extend these
credit lines, it could have a tremendous negative impact on future revenues.21
Products and Service
As technology improved, product life cycles, as well as prices, decreased. As a result, mar-
gins decreased. Under Best Buy’s service model, shorter product life cycles increased train-
ing costs. Employees were forced to learn new products with higher frequency. This was not
only costly but also increased the likelihood that employees would make mistakes, thereby
tarnishing Best Buy’s service record and potentially damaging one of its most important,
if not the most important, differentiators. In addition, more resources would be directed at
research of new products to make sure Best Buy continued to offer the products consumers
desire.
One social threat to the retail industry was the growing popularity of the online market-
place. Internet shoppers could browse sites searching for the best deals on specific products.
This technology allowed consumers to become more educated about their purchases, while
creating increased downward price pressure. Ambitious consumers could play the role of a
Best Buy associate themselves by doing product comparisons and information gathering with-
out a trip to the store. This emerging trend created a direct threat to companies like Best Buy,
which had 1,023 stores in its domestic market alone. One way Best Buy tried to continue the
demand for brick-and-mortar locations and counter the threat of Internet-based competition
was by providing value-added services in stores. Customer service, repairs, and interactive
product displays were just a few examples of these services.22
Leadership
The two former CEOs of Best Buy, Richard Shultze and Brad Anderson, were extremely suc-
cessful at making the correct strategic moves at the appropriate times. With Brad Anderson
stepping aside in June 2009, Brian Dunn replaced him as the new CEO. Although Dunn
worked for the company for 24 years and held the key positions of COO and President dur-
ing his tenure, the position of CEO brought him to a whole new level and presented new chal-
lenges, especially during the economic downturn. He was charged with leading Best Buy into
the world of increased connectivity. This required a revamping of products and store setups
to serve customers in realizing their connectivity needs. This was a daunting task for an ex-
perienced CEO, let alone a new CEO who had never held the position.
$ in millions, except per share and share amounts
February 28, 2009 March 1, 2008
ASSETS
Current Assets:
Cash and cash equivalents $498 $1,438
Short-term investments 11 64
Receivables 1,868 549
Merchandise inventories 4,753 4,708
Other current assets 1,062 583
Total current assets 8,192 7,342
Property and Equipment:
Land and buildings 755 732
Leasehold improvements 2,013 1,752
Fixtures and equipment 4,060 3,057
Property under capital lease 112 67
6,940 5,608
Less accumulated depreciation 2,766 2,302
Net property and equipment 4,174 3,306
Goodwill 2,203 1,088
Tradenames 173 97
Customer Relationships 322 5
Equity and Other Investments 395 605
Other Assets 367 315
Total Assets $15,826 $12,758
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable $4,997 $4,297
Unredeemed gift card liabilities 479 531
Accrued compensation and related expenses 459 373
Accrued liabilities 1,382 975
Accrued income taxes 281 404
Short-term debt 783 156
Current portion of long-term debt 54 33
Total current liabilities 8,435 6,769
Long-Term Liabilities 1,109 838
Long-Term Debt 1,126 627
Minority Interests 513 40
Shareholders’ Equity:
Preferred stock, $1.00 par value: Authorized — 400,000 shares; Issued
and outstanding — none
— —
Common stock, $0.10 par value: Authorized — 1.0 billion shares; Issued and
outstanding — 413,684,000 and 410,578,000 shares, respectively
41 41
Additional paid-in capital 205 8
Retained earnings 4,714 3,933
Accumulated other comprehensive (loss) income (317) 502
Total shareholders’ equity 4,643 4,484
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $15,826 $12,758
EXHIBIT 6 Consolidated Balance Sheets, Best Buy Co., Inc.
SOURCE: Best Buy Co., Inc. 2009 Form 10-K, p. 56.
24-11
24-12 SECTION D Industry Six—Specialty Retailing
$ in millions, except per share amounts
Fiscal Years Ended
February 28,
2009
March 1,
2008
March 3,
2007
Revenue $45,015 $40,023 $35,934
Cost of goods sold 34,017 30,477 27,165
Gross profit 10,998 9,546 8,769
Selling, general and administrative expenses 8,984 7,385 6,770
Restructuring charges 78 — —
Goodwill and tradename impairment 66 — —
Operating income 1,870 2,161 1,999
Other income (expense)
Investment income and other 35 129 162
Investment impairment (111) — —
Interest expense (94) (62) (31)
Earnings before income tax expense, minority
interests and equity in income (loss) of affiliates
1,700 2,228 2,130
Income tax expense 674 815 752
Minority interests in earnings (30) (3) (1)
Equity in income (loss) of affiliates 7 (3) —
Net earnings $1,003 $1,407 $1,377
Earnings per share
Basic $2.43 $3.20 $2.86
Diluted $2.39 $3.12 $2.79
Weighted-average common shares outstanding
(in millions)
Basic 412.5 439.9 482.1
Diluted 422.9 452.9 496.2
EXHIBIT 7 Consolidated Statements of Earnings, Best Buy Co., Inc.
SOURCE: Best Buy Co., Inc. 2009 Form 10-K, p. 57.
Wal-Mart
Best Buy saw its largest rival, Circuit City, go bankrupt. However, a new archrival, Wal-Mart,
was expanding into consumer electronics and stepping up competition in a price war Wal-Mart
hoped to win. Best Buy needed to face the competition not by lowering prices, but by coming
up with something really different. Best Buy had to determine the correct path to improve its
ability to differentiate itself from competitors, which was increasingly difficult given an
adverse economic climate and the company’s financial stress. How Best Buy could maintain
innovative products, top-notch employees, and superior customer service while facing in-
creased competition and operational costs was an open question.
CASE 24 Best Buy Co. Inc.: Sustainable Customer Centricity Model? 24-13
1. Best Buy Co. Inc., Form 10-K. Securities and Exchange Com-
mission, February 28, 2009.
2. Ibid.
3. Ibid.
4. Greg Keller, “Threat Grows by Ipod and Laptop,” The Colum-
bus Dispatch, May 18, 2009, http://www.dispatch.com/live/
content/business/stories/2009/05/18/greener_gadgets.
ART_ART_05-18-09_A9_TMDSJR8.html (July 10, 2009).
5. Larry Magid, “Consumer Electronics: The Future Looks
Bright,” CBSNews.com. May 2, 2008, http://www.cbsnews
.com/stories/2008/05/02/scitech/pcanswer/main4067008.shtml
(July 10, 2009).
6. Best Buy Co. Inc., Form 10-K, 2009.
7. Ibid.
8. Ibid.
9. Ibid.
10. Manhattan Institute for Policy Research, “They’re Making a Fed-
eral Case Out of It . . . in State Court,” Civil Justice Report 3. 2001,
http://www.manhattan-institute.org/html/cjr_3_part2.htm.
11. “Best Buy Bombshell,” HD Guru, March 21, 2009, http://
hdguru.com/best-buy-bombshell/400/.
12. Circuit City Stores Inc. was an American retailer in brand-name
consumer electronics, personal computers, entertainment soft-
ware, and (until 2000) large appliances. The company opened
its first store in 1949 and liquidated its final American retail
stores in 2009 following a bankruptcy filing and subsequent
failure to find a buyer. At the time of liquidation, Circuit City
was the second largest U.S. electronics retailer, after Best Buy.
13. Z. Bissonnette, “Wal-Mart Looks to Expand Electronics
Business,” Bloggingstocks.com, May 18, 2009, http://www
.bloggingstocks.com/2009/05/18/wal-mart-looks-to-expand
-electronics-business/.
14. N. Maestrie, “Wal-Mart Steps Up Consumer Electronics Push,”
Reuters, May 19, 2009, http://www.reuters.com/article/technology
News/idUSTRE54I4TR20090519.
15. Capital IQ, “GameStop Corp. Corporate Tearsheet,” Capital
IQ, 2009.
16. E. Sherman, “GameStop Faces Pain from Best Buy, download-
ing,” BNET Technology, June 24, 2009, http://industry
.bnet.com/technology/10002329/gamestop-faces-pain-from
-best-buy-downloading/.
17. T. Van Riper, “RadioShack Gets Slammed,” Forbes.com,
February 17, 2006, http://www.forbes.com/2006/02/17/
radioshack-edmondson-retail_cx_tr_0217radioshack.html.
18. Capital IQ, “Amazon.com Corporate Tearsheet,” Capital IQ,
2009.
19. T. Kee, “Netflix Beware: Best Buy Adds Digital Downloads
with CinemaNow Deal,” paidContent.org. June 5, 2009,
http://paidcontent.org/article/419-best-buy-adds-digital-movie-
downloads-with-cinemanow-deal/.
20. Best Buy Co., Inc., Form 10-K, 2009.
21. Ibid.
22. Ibid.
N O T E S
http://www.dispatch.com/live/content/business/stories/2009/05/18/greener_gadgetsART_ART_05-18-09_A9_TMDSJR8.html
http://www.dispatch.com/live/content/business/stories/2009/05/18/greener_gadgetsART_ART_05-18-09_A9_TMDSJR8.html
http://www.cbsnews.com/stories/2008/05/02/scitech/pcanswer/main4067008.shtml
http://www.cbsnews.com/stories/2008/05/02/scitech/pcanswer/main4067008.shtml
http://www.manhattan-institute.org/html/cjr_3_part2.htm
http://hdguru.com/best-buy-bombshell/400/
http://hdguru.com/best-buy-bombshell/400/
http://www.bloggingstocks.com/2009/05/18/wal-mart-looks-to-expand-electronics-business/
http://www.bloggingstocks.com/2009/05/18/wal-mart-looks-to-expand-electronics-business/
http://www.reuters.com/article/technologyNews/idUSTRE54I4TR20090519
http://industry.bnet.com/technology/10002329/gamestop-faces-pain-from-best-buy-downloading/
http://industry.bnet.com/technology/10002329/gamestop-faces-pain-from-best-buy-downloading/
http://www.forbes.com/2006/02/17/radioshack-edmondson-retail_cx_tr_0217radioshack.html
http://www.forbes.com/2006/02/17/radioshack-edmondson-retail_cx_tr_0217radioshack.html
http://paidcontent.org/article/419-best-buy-adds-digital-movie-downloads-with-cinemanow-deal/
http://paidcontent.org/article/419-best-buy-adds-digital-movie-downloads-with-cinemanow-deal/
http://www.bloggingstocks.com/2009/05/18/wal-mart-looks-to-expand-electronics-business/
http://www.reuters.com/article/technologyNews/idUSTRE54I4TR20090519
http://www.dispatch.com/live/content/business/stories/2009/05/18/greener_gadgetsART_ART_05-18-09_A9_TMDSJR8.html
http://industry.bnet.com/technology/10002329/gamestop-faces-pain-from-best-buy-downloading/
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GAP INC. WAS ONE OF THE LEADING INTERNATIONAL SPECIALTY RETAILERS OFFERING CLOTHING,
accessories and personal care products for men, women, children, and babies under the
Gap, Banana Republic, Old Navy, and Forth & Towne brand names. The company pri-
marily operated in North America. The company recorded revenues of $16.023 billion
during the fiscal year ended January 2006, a decrease of 1.5% over 2005. The operat-
ing profit of the company was $1.79 billion during fiscal year 2006, a decrease of
4.2% over 2005. The net profit was $1.113 billion, a decrease of 3.2% over 2005. Gap
was ranked 52nd (2005 ranking—40th) by the Business Week Interbrand survey conducted
in August 2006. It was valued at $6416 million ($8195 million in 2005). (See Exhibits 1
and 2 for Gap’s financial results.)
Paul Pressler (Pressler), who became Gap Inc.’s CEO in October 2002, had been heralded
for his cost-cutting strategies that had restored financial discipline in the company. But there
was a trade-off, analysts said. Pressler, who had little retail experience, did not steer Gap to-
ward its customers’ tastes. Realizing his mistakes, Pressler changed his strategy in mid-2004
to generate growth. Would he succeed in rejuvenating Gap Inc. and attracting customers once
again? (See Exhibit 3 for a brief SWOT analysis.)
This case was prepared by Mrs. Mrida Verma, ICFAI Center of Management Research (ICMR). This case cannot be
reproduced in any form without the written permission of the copyright holder, ICFAI Center of Management
Research (ICMR). Reprint permission is solely granted to the publisher, Prentice Hall, for the books Strategic Manage-
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25-1
C A S E 25
The Future of Gap Inc.
Mridu Verma
Gap Inc.’s heritage is based on connecting with people through great style and experiences—
and by making cultural connections along the way.
ROBERT FISHER, CHAIRMAN, GAP INC.1
25-2 SECTION D Industry Six—Specialty Retailing
EXHIBIT 1
Financial Results:
Gap Inc.
SOURCE: Gap Inc. Annual Report 2005.
Year Ending
January 28,
2006
January 29,
2005
January 31,
2004
Net Sales $16,023 $16,267 $15,854
Percentage change year-to-date (2%) 3% 10%
Earnings before income taxes $1,793 $1,872 $1,684
Percentage change year-to-date (4%) 11% 110%
Net Earnings $1,113 $1,150 $1,031
Percentage change year-to-date (3%) 12% 116%
Cash Flows
Net cash provided by operating activities $1,551 $1,597 $2,160
Net cash provided by (used for) investing
activites
286 183 (2,318)
Effect of exchange rate fluctations on cash (7) – 28
Net decrease in cash and equivalents (210) (16) (261)
Net cash provided by operating activities $1,551 $1,597 $2,160
Less: Net purchases of property and
equipment
(600) (419) (261)
Free cash flow $961 $1,176 $1,899
EXHIBIT 2
Select Financial
Results: Gap Inc.
SOURCE: Gap Inc. Annual Report 2005.
01
13.8
02
14.5
03
15.9
04
16.3
05
16.0
NET SALES
(in billions of dollars)
01 02 03 04 05
1,031
1,150
125
478
1,113
NET EARNINGS/LOSSES
(in millions of dollars)
01 02 03 04 05
(03)
0.54
1.09
1.21 1.24
EARNING (LOSS)
PER SHARE-DILUTED
(in dollars)
25 24
(1)
02
15
03 04 05
22
RETURN ON AVERAGE
SHAREHOLDERS’ EQUITY
(percent)
B. Financial Information:
Gap Inc.
A. Sales and Earnings:
Gap Inc.
CASE 25 The Future of Gap Inc. 25-3
EXHIBIT 3
SWOT Analysis:
Gap Inc.
SOURCE: Gap Inc. Annual Report 2005.
Strengths Weaknesses
Brand recognition Weak performance of Gap brand
Large network of physical stores Overdependence on North America
Low long-term debt Declining operating cash flows
Opportunities Threats
Launch of Forth & Towne Counterfeit products
Growth in online retail spending Slowdown in consumer spending
Markets in China and India Emergence of private labels
About Gap Inc.
Gap Inc. was a specialty retailer operating retail and outlet stores selling casual apparel, ac-
cessories, and personal care products for men, women, and children under the Gap, Banana
Republic, Old Navy, and Forth & Towne brands. Gap division’s brands also included GapKids,
babyGap, and GapBody. In June 2006, the company operated 3,070 stores, including Gap,
Banana Republic, and Old Navy stores throughout the U.S., as well as in Canada, the UK,
France, and Japan. In addition, the company also marketed its products to its U.S. customers
through three Web sites: gap.com, bananarepublic.com, and oldnavy.com.
The company primarily conducted its business through four business divisions: Old
Navy, Gap, Banana Republic, and others. Old Navy targeted cost-conscious shoppers. Old
Navy stores offered selections of apparel, shoes, and accessories for adults, children, and
infants as well as other items, including personal care products. Old Navy also offered a
line of maternity and plus sizes in its stores. The Old Navy division recorded revenues of
$6.86 billion in fiscal year 2006, an increase of 1.6% over 2005. The Gap division offered
extensive selections of classically styled, casual apparel at moderate price points, usually
priced higher than Old Navy apparel. It also offered accessories and personal care prod-
ucts. The brand extensions of the Gap included GapKids, babyGap, and GapBody. During
the fiscal year 2006, the Gap division recorded revenues of $6.84 billion, a decrease of
5.6% over 2005.
The Banana Republic brand offered a more sophisticated dress-casual and tailored ap-
parel, shoes, and accessories for adults. Its products ranged from apparel, including intimate
apparel, to personal care products. The Banana Republic division recorded revenues of
$2.3 billion in fiscal year 2006, an increase of 1.4% over 2005. Other divisions included Forth
& Towne and direct, as well as international sales programmers. Forth & Towne was the com-
pany’s newest retail concept, principally targeting women over the age of 35. The “other” di-
vision recorded revenues of $29 million in fiscal year 2006, as compared to the revenues of
$11 million in fiscal 2005. The bulk of Gap Inc.’s sales came from Gap and Old Navy, with
Banana Republic and a new chain, Forth & Towne, representing less than 25% of its busi-
ness. North America, Gap’s largest geographical market, accounted for 90.9% of the total rev-
enues in the fiscal year 2006. Revenues from North America reached $14.56 billion in 2006,
a decrease of 1.4% over 2005. Europe accounted for 5.1% of the total revenues in the fiscal
year 2006.
25-4 SECTION D Industry Six—Specialty Retailing
Background Note
Gap
Gap was set up by Donald Fisher in 1969. After a pair of Levi’s jeans purchased by him
fell short of his size requirements, Fisher sensed a gap in the market. He decided to start
an only-jeans outlet that offered a wide range of sizes to the customers. With this inten-
tion, the first store was started in San Francisco. To reinforce the choices available at the
stores, Gap’s first advertisement carried the tag line “four tons of Levi’s.” The retail con-
cept was an instant hit. Gap’s “basics look” comprising signature (Levi’s) blue jeans and
white cotton shirts became a rage. Initially the goods were sold at Levi’s controlled prices,
allowing Fisher to earn hefty margins (in the region of 50%). A 1976 Federal Trade Commis-
sion (FTC) directive banned manufacturers from setting the retail price. With an increasing
number of retailers discounting their retail offerings, competition in the market heated up and
margins dried up. Fisher parted ways with Levi’s and shifted to high-margin private labels. By
1980, 200 Gap outlets in the U.S. offered 14 different private labels, such as Foxtails, Mon-
terey Bay, and Durango. As other retailers started taking the same private label route to bol-
ster their margins. Gap seemed to be getting lost in the crowd. It was at this juncture that
Fisher hired Millard “Mickey” Drexler (Drexler) to give a new direction to Gap.
When Drexler joined Gap in 1983, the company’s turnover was just $500 million. He
dumped the private-label brands and introduced Gap as a clothing brand. Soon, Gap controlled
everything from manufacturing to marketing to the distribution of its offerings. Gap took ad-
vantage of America’s casual-dress trend. Whenever growth appeared to slow, Drexler came up
with something new: GapKids, babyGap, and then discount stores. Gap led the corporate
dress-down revolution, and earnings grew at an average of 30% for the five years through
1999. In the mid-1990s, the Gap was so much a part of American pop culture that it warranted
its own skit on Saturday Night Live. Unfortunately, Gap’s khakis-and-blue-shirt formula
proved remarkably easy to replicate. The company soon found itself competing with discount
retailers such as Target and Wal-Mart.
When laid-off dot-commers stopped loading up on casual clothes, Gap took desperate
measures to lift sales, stocking trendy miniskirts and low-rise jeans to chase teenage shoppers.
Its purple shirts in extra large sizes did not find any buyers. Gap’s core 30-and-over clientele,
once Gap’s mainstay, fled to rivals such as value retailers Target and Kohl’s.
Banana Republic
Started by Mel and Patricia Ziegler in 1978, Banana Republic was positioned as an adven-
ture lifestyle store. It retailed bush jackets, travel trunks, travel books, fisherman hats, and
exotic maps with most of its sales coming through catalogues. Its ascent coincided with the
“safari fever”2 spreading across the U.S. in the early 1980s. When Banana Republic’s sales
touched the $10 million mark in 1983, its stores were bought by Gap.
Gap transformed Banana Republic from a catalog-based retailer to a physical retailer with
large stores across the country. The stores offered lifestyle apparels tailored to consumers
needs. By 1987, Banana Republic was a successful retail concept with sales revenue of
$191 million. With safaris going out of fashion, Banana Republic’s fortunes plunged. It re-
ported a loss of $10 million in 1988. Banana underwent a makeover and shed its safari-style
merchandise in favor of clothes for the dressed-down workplace, a strategy that sustained it
through the dot-com era. The emphasis was on a “modern casual lifestyle” look. Banana Repub-
lic was struggling to come up with a fashion mix that its 30-and-older customers, especially
men, felt more comfortable wearing.
CASE 25 The Future of Gap Inc. 25-5
Old Navy
Started in 1994, Old Navy targeted price-conscious customers. Old Navy apparels used dif-
ferent fabrics as compared to Gap and the stores were given a “fun” look.3 Using different
blends of fabric that helped keep its manufacturing costs low, Old Navy retailed basics for
the whole family at two-thirds Gap’s prices. It sold budget-priced jeans, T-shirts, and khaki
pants to kids, teens, and young adults. Thanks to a very successful season of fleece tops and
vests, Old Navy became the biggest contributor to the parent company’s overall growth in
2000, even when sales declined at the core Gap chain.
Encouraged by the sales, Drexler opened 282 Old Navy stores in the next three years. Old
Navy became the first-ever retail chain to reach $1 billion sales within four years. In 2004, Old
Navy accounted for 41% of Gap Inc.’s total sales. Though comparatively successful, Old Navy
had its own share of problems. Consumers complained that it was always bulging with mer-
chandise, with the floor often being permanently devoted to discounted goods to boost sales.
In 2000, Old Navy shifted its focus to teenagers. Initially, the brand was immensely popular
among teenagers, but soon the brand became a casualty of teenagers’ fickle preferences.
“Old Navy’s been a bit of a problem child for them recently. In some ways it became a
victim of its own success. The younger crowd went crazy for them and they met that demand,
but now they’re realizing that they need to appeal to a larger audience,” an analyst observed.4
Old Navy, whose merchandise mix was skewed too far toward teens in 2001, needed to win
back grownups. Old Navy also needed to restore a distinct identity to avoid drawing bargain-
hunting Gap shoppers.
Drexler acknowledged that each of the company’s three core brands—Gap, Banana
Republic, and Old Navy—had “come untethered from the tight rapport with consumers that
accounted for its earlier prosperity.” In the mid-1990s, Gap had embarked on an expansion
spree, increasing its retail square footage by more than 20% annually. Square footage at Gap’s
three chains doubled between 1999 and 2002 even as sales per square foot plunged from
$548 to $393 during the same period. In 2001, Gap posted a loss of $7.8 million on sales
of $13.8 billion.5 By March 2002, rating agencies had downgraded Gap Inc.’s debt from in-
vestment grade to junk. Heavy markdowns sliced Gap’s gross margins by 40%. In 2002, Gap
paid interest worth $145 million on the $2 billion debt it had raised to fund its expansion plans.
To make things worse, Gap’s per-store sales declined for 29 months straight as profits van-
ished. Drexler stepped down in September 2002. He was replaced by Paul Pressler (Pressler),
who had been running Disney’s consumer stores (which were later sold) and the Disneyland
theme park (where he expanded the souvenir shops and restaurants), and oversaw all Disney
parks and resorts, but had no previous fashion retail experience.
Pressler’s Turnaround Strategy
Initially, Pressler focused on cost cutting, consumer research, and more targeted marketing of
the three brands. Working with CFO Byron Pollitt (Pollitt), whom he had brought over from
Disney, Pressler shut down hundreds of stores, consolidated production among fewer suppli-
ers, and revamped inventory management. He reduced the inventory per square foot by 16%.
He attempted to increase margins by selling clothes closer to full price. To end panicky clear-
ance sales, Pressler ordered managers to rely increasingly on software that would tell them
when and by how much to mark down merchandise. Micro-management was replaced by
hands-off leadership. Pressler was not as interested in product details. He left specific color
and design decisions to Gap, Old Navy, and Banana Republic division heads. Pressler devoted
more attention to areas visible to the customer, including marketing and store atmosphere.
He hired what he called a “chief algorithm officer” to analyze the sales from every cash reg-
ister. It turned out that Gap had been sending the same size assortments to stores with different
25-6 SECTION D Industry Six—Specialty Retailing
The Decline
In July 2004 the turnaround hit a snag with each of the three chains’ sales heading southward,
pushing comparable sales down 5%. After initial success in distinguishing brands, Pressler’s
reliance on metrics prompted him to distinguish them even further, and the move backfired.
Old Navy, known for its specialty style at discounted prices, disappointed its faithful by stock-
ing commodity T-shirts and jeans similar to those sold at discount chains such as Target, in the
place of the trendy-but-cheap clothes it had stocked earlier. Banana Republic went over the
top, devoting too much of its space to embellished pieces unsuitable for the office. As for
the Gap brand, it started marketing outfits instead of individual staples like khakis and denim.
The Gap stores sported separate “going out” and “go to work” sections—making it harder
for the customers to navigate. Shoppers who had once considered Banana, Gap, and Old
Navy as default choices gravitated to fresher competitors like Abercrombie & Fitch, Urban
Outfitters, and J. Crew (rival clothing retailers).
An exodus of sorts was underway inside the company too. Soon after Drexler’s departure,
a stream of talented executives who had helped make Gap great in its heyday began to head
for the exits, from executive vice presidents to in-the-trenches designers (see Exhibit 4). Some
EXHIBIT 4
Employee Exodus:
Gap Inc. Employee Name
Year of
Departure
Name of the
Company Joined
Mickey Drexler
CEO
2002 J. Crew
Jeff Pfeifle
EVP, product and design, Old Navy
2002 J. Crew
Henry Stafford
Merchandiser, Old Navy men’s
2003 American Eagle Outfitters
Jerome Jessup
EVP, product development and design,
Gap brands
2003 Ann Taylor
Maureen Chiquet
President, Banana Republic
2003 Chanel
Neil Goldberg
President, Gap Inc. outlets
2003 The Children’s Place
Michael Tucci
EVP, Gap Inc. online division
2003 Coach
selling patterns. He initiated customized deliveries—for instance, sending more extra-larges to
places that needed them. Each chain also instituted “guardrails” that defined what portion of a
store’s inventory should go toward basic colors and styles regardless of how varied the floor dis-
plays were. All this served to cut the need for discounting, and profit margins improved.
When it came to the merchandise, Pressler also resorted to “numbers.” Consumer-insight re-
search showed that the three brands were losing market share. With the distinction between the
products of the three brands becoming hazy, each seemed to be eating into the other’s market
share. He decided to reposition all the three brands, giving each a distinctive identity. While Gap
stayed in the middle, Old Navy focused on lower prices and basic items, and Banana Republic
raised prices and experimented with runway-influenced designs. The strategy yielded results in
the early days. In 2003, the business bounced back after 29 straight months of same-store sales
declines under Drexler. Cash flow from operations went up and Gap’s credit rating rose.
CASE 25 The Future of Gap Inc. 25-7
SOURCE: Prepared from information provided in Julia Boorstin, “Fashion Victim,” Fortune, 4/17/2006, Vol. 153
Issue 7, p. 160–166.
John Goodman
SVP, Gap Inc. outlets
2003 Dockers
Jennifer Foyle
Divisional merchandising manager,
Gap brand, women’s
2003 J. Crew
Lynda Markoe
Senior director, Gap Inc. HR
2003 J. Crew
Todd Snyder
Senior director, Old Navy, men’s product design
2003 J. Crew
John Valdivia
VP, creative services, Old Navy
2003 J. Crew
Libby Wadle
Div. merchandising manager,
Banana Republic, women’s
2003 J. Crew
Roxane Al-Fayez
VP, operations, Gap Inc. online division
2003 Limited Brands
Thomas Cawley
CFO, Gap brand
2003 Peet’s Coffee & Tea
Patti Barkin-Camilli
SVP, Old Navy, women’s accessories
2003 Uniqlo
LeAnn NealzSVP, design, GapKids, babyGap
SVP, design, GapKids, babyGap
2004 American Eagle Outfitters
Barbara Wambach
EVP, Gap Body
2004 Bebe
Tara Poseley
SVP, merchandising, GapKids, babyGap
2004 Design Within Reach
Tracy Gardner
SVP, merchandising, Gap brand
2004 J. Crew
Mark Breitbard
SVP, merchandising, Gap Kids, babyGap
2005 Abercrombie & Fitch
Alan Marks
VP, corporate communications, Gap Inc.
2005 Nike
Pina Ferlisi
EVP, design, Gap brand
2005 Generra
Jeff Jones
EVP, marketing, Gap brand
2005 No announced destination
Felix Carbullido
VP and general manager, Gap.com
2006 Smith & Hawken
Alan Barocas
SVP, real estate, Gap Inc.
2006 No announced destination
Nick Cullen
EVP, chief supply chain officer, Gap Inc.
2006 No announced destination
Jyothi Rao
VP, merchandising, Forth & Towne
2006 No announced destination
Julie Rosen
VP, merchandising, Gap brand
2006 No announced destination
EXHIBIT 4
(Continued)
25-8 SECTION D Industry Six—Specialty Retailing
were fired, others left on their own. “From the day I got here, we’ve had to assess our tal-
ent,” mentioned Pressler,6 who called the turnover healthy and normal. But analysts and in-
dustry observers were not so sanguine, with some analysts downgrading the company.
Morgan Stanley analyst Michelle Clark opined that with other ex-Disney players such as
Gap-brand head Cynthia Harriss in key roles, the company’s lack of fashion expertise at the
top was being exacerbated by a drain of youthful morale and energy. Even company insiders
echoed her fears. “Ten of the best 15 executives in all retail were working for the company.
Now they’ve lost the creative people, almost all the merchandising and design leadership,” ob-
served a former head of one Gap division.7
By the time Pressler faced investors in Spring 2005, the momentum he had built up in his first
18 months was gone. He tried to shift Wall Street’s focus to the future, announcing that the com-
pany would introduce a new store chain, Forth & Towne, for women 35 and over. More privately,
he went back to the core brands, working with their respective presidents to analyze customer
surveys. The identity of each chain was recalibrated: Gap would offer high-quality basics with
style; Banana Republic would emphasize fashionable classics but avoid the cutting edge; Old
Navy would rededicate itself to low-priced trendy items. Pressler also cut the nine-month pro-
duction cycle on some Old Navy clothes to three months—so it could adapt to emerging trends
more readily—by moving designers from New York to its San Francisco headquarters, posi-
tioning some merchants closer to factories in Southeast Asia, and sourcing more items in North
America. Gap’s 2005 fall line featured its classic navy, gray, crisp white, and denim, plus some
richer materials—washed leather and cotton cashmere. Meanwhile, Banana Republic pulled
back from fashion extremes and was focusing on the classics. At Old Navy—to which Pressler
was looking for a big chunk of the company’s growth—product quality was improved noticeably.
Gap continued to face a perception problem—a struggle to recapture customers who had
abandoned it. Fiscally and operationally, Gap was a tighter, stronger business than it was in
2002. Pressler had hedged its fashion bets. Company-commissioned research was directing
brand presidents on how they could expand the chains into what Pressler called “lifestyle
brands,” with line extensions such as accessories and baby-wear. While creating the Forth &
Towne chain appeared a gamble, Pressler felt that the numbers pointed to an untapped market.
Industry observers, however, opined that no matter how carefully calibrated Gap’s fashion
choices were, the nature of the business required a certain degree of risk taking. No one knew
what consumers would actually buy until the goods were on the shelves.
Pressler also started investing more in the stores, where Gap’s minimalist look too often
appeared dated and shabby, replacing it with darker-wood fixtures (like Abercrombie), painted
walls (like J. Crew), and more dramatic window displays. A back wall dedicated to denim and
a colorful “T-shirt bar” highlighted Gap’s traditional expertise. New spotlighting, hand-drawn
chalk signs, and artful displays of intertwined jeans created a sense of theatricality. By year-
end 2005, 60 Gap stores had been redesigned, with another 220 of the chain’s 1,335 stores
scheduled to get the new look in 2006. The company expected to draw customers into the
stores, so that they would notice the better-designed, higher-quality products. In 2005, the
company opened 198 new stores and closed 139. In 2006, the company expected to open about
175 store locations, weighted toward the Old Navy brand, and close about 135 store locations,
weighted toward the Gap brand. Square footage was expected to increase between 1% and
2% for fiscal year 2006. (See Exhibit 5.)
All this came at a financial cost, pushing Gap’s capital expenditures to among the high-
est in specialty retail. It also meant operating margins would drop to between 10% and
10.5% in 2006. For the year 2005, Gap group posted sales of $16 billion, a 2% drop com-
pared with $16.3 billion for 2004. Comparative store sales for the year 2005 decreased by
5%, as against flat sales in 2004. Sales at the flagship Gap stores in the U.S. were essentially
flat at $1.2 billion year-over-year in 2005, but sales on the international front lost 5.6% to
$339 million from $359 million a year ago. By February 2006, customer traffic across the
CASE 25 The Future of Gap Inc. 25-9
EXHIBIT 5
Brand Information: Gap Inc.
SOURCE: Gap Inc. Annual Report 2005.
A. Brand-wise Financials: Gap Inc.
(Dollars in millions)
52 Weeks Ending January 28, 2006 Gap Old Navy
Banana
Republic Other Total
2004 Net Sales $7,240 $6,747 $2,269 $11 $16,267
Comparable store sales (302) (361) (104) – (767)
Noncomparable store sales (87) 409 130 15 467
Direct (online) (3) 32 – 3 32
Foreign exchange (11) 29 6 – 24
2005 Net Sales $6,837 $6,856 $2,301 $29 $16,023
B. Brand-wise Sales: Gap Inc.
(Dollars in millions)
52 Weeks Ending January 29, 2005 Gap Old Navy
Banana
Republic Other Total
2003 Net Sales $7,305 $6,456 $2,090 $3 $15,854
Comparable store sales (76) 25 109 – 58
Noncomparable store sales (155) 195 51 7 98
Direct (online) 16 47 14 – 77
Foreign exchange 150 24 5 1 180
2004 Net Sales $7,240 $6,747 $2,269 $11 $16,267
C. Brand-wise Store Details: Gap Inc.
Store count and square footage as follows:
January 28, 2006 January 29, 2005
Number of
Store Locations
Sq. Ft.
(in millions)
Number of
Store Locations
Sq. Ft.
(in millions)
Gap North America 1,335 12.6 1,396 13.0
Gap Europe 165 1.5 169 1.6
Gap Asia 91 1.0 78 0.8
Old Navy North America 959 18.4 889 17.3
Banana Republic North America 494 4.2 462 3.9
Banana Republic Asia 4 – – –
Forth & Towne 5 0.1 – –
Total 3,053 37.8 2,994 36.6
Increase (Decrease) 2% 3% (1%) 0%
Gap, Banana Republic, and Old Navy brands had decreased by 13% from the same point in
2005; same-store sales were down by 11%, and a few more key executives had left.
To fill the executive vacancies, Pressler generally tapped outsiders. Karyn Hillman, senior
vice president (SVP) of apparel merchandising for the Banana Republic division, had been pro-
moted to SVP of merchandising for the Gap Adult unit of the flagship Gap brand. Pressler also
hired Liz Claiborne veteran Denise Johnston to be president of Gap Adult, overseeing all aspects
of Gap’s women’s and men’s apparel and accessories. Pressler realized that fashion retail was not
strictly a numbers game, and the quantitative orientation that made Pressler so appealing as an
antidote to Drexler—and initially so successful—was ultimately coming back to haunt him. Run-
ning a Fortune 500 fashion retailer was a tricky balance between the art of conjuring styles and
25-10 SECTION D Industry Six—Specialty Retailing
Recovery Efforts
In the summer of 2006, Gap launched a new marketing campaign called Rock Color to spot-
light summer offerings. Inspired by the summer of 1969, the year the company was founded,
the promotion featured a pop-up store, which was actually a converted school bus from the
Sixties that would drive to summer resort spots on a mission to sell T-shirts, hoodies, flip-
flops, and beach hats. The campaign also involved in-store promotions, windows, print ads,
direct-mail, and outdoor ads and an online microsite offering customers the chance to win
concert tickets. Color was a key component of the campaign. Gap also introduced a contest
for customers in New York, Los Angeles, San Francisco, and Chicago to win tickets to con-
certs. Additionally, one grand-prize winner would receive a trip for two and backstage passes
to Gap’s private concert featuring John Legend.
Inspired by the success of Hennes & Mauritz,9 Gap entered into a partnership with British
designer Roland Mouret (Mouret) to launch a capsule collection of dresses in selected stores
of Europe and a handful of units in New York. The company hoped to increase traffic to its
stores through these initiatives. The move was lauded by analysts. Christine Chen, senior re-
search analyst at Pacific Growth Equities said, “Gap needs to rejuvenate their customer, whom
they have been disappointing for two years. Their problem has not been their merchandise,
which I think has improved drastically, it’s the stigma associated with the brand.”10 Gap had
been attempting to recast its image throughout 2006 summer and back-to-school season with
the return of television ads, its Audrey Hepburn campaign for the return of basic pants and,
most recently, product RED.
The Mouret collection was also a part of the Gap (RED) line and featured 10 dresses, rang-
ing in price from 45 pounds to 78 pounds, or about $85 to $148.11 Styles included belted shirt-
dresses; Courreges-inspired numbers and tunics with bib fronts or ruffled V-necks in charcoal,
silver-gray, navy, black, and red. The collection was seen by analysts as the next step in bring-
ing back old customers and getting new shoppers interested in the store. Mouret said he had
teamed up with Gap for a variety of reasons. “They came to me because they felt they weren’t
strong in the dress category. They wanted a new project that would take Gap dresses to a new
level. I have always been a fan of Gap—I like their laid-back attitude, and it was the right mix
of people to work with.”12
In April 2006, Pressler decided to concentrate on Southeast Asia to generate growth. He
entered into a franchise agreement with the leading retailers in Singapore, Kuala Lumpur,
Malaysia, and the Middle East to open Gap and Banana Republic stores there. This was the
first franchisee agreement entered into by the U.S.-based retailer that had always operated
company-owned stores. The main benefit of franchise partners was that they provided the lo-
cal knowledge and experience to allow the company to quickly tap new markets. The merchan-
dise in the new stores was a franchise-specific mix of products from the North American and
European collections as well as items not available in other markets. Prices were about 10 to
15% more in the new stores, mainly because of import costs and high rent.
Looking Ahead
In the third quarter of 2006, Gap Inc. reported a 10.8% decline in third-quarter earnings due
in part to sagging sales at Old Navy. Foot traffic to the chains was also on the decline. At Gap,
which was all but synonymous with the American mall, sales had fallen every month for the
the discipline of managing an enormous and far-flung operation. Pressler seemed much more
comfortable talking corporate strategy than clothing styles. He defined his task as “meeting
investor expectations, building platforms, and building a vision of where we want to go.”8
CASE 25 The Future of Gap Inc. 25-11
N O T E S
1. Chairman’s address Gap Inc’s Annual Report 2005.
2. Films such as Raiders of Lost Ark and Romancing the Stone
were at their peak during this period.
3. Old Navy had a practical décor, a lively ambiance, and concrete
floors unlike hardwood floors at Gap’s elite stores.
4. Lee, Louise, “Gap: Missing that Ol’ Micky Magic,” Business
Week, October 29, 2001 Issue 3755, p. 86.
5. Gap had posted a profit of $877 million in 2000.
6. Julia. Boorstin, “Fashion Victim,” Fortune, April 17, 2006, Vol.
153, Issue 7, pp. 160–166.
7. Ibid.
8. Julia Boorstin, “Fashion Victim,” Fortune, April 17, 2006,
Vol. 153, Issue 7, pp. 160–166.
9. While Gap executives downplayed the comparison, the link
with Mouret mirrored the strategy H&M had carried out over
the last few seasons by teaming up with designers, including
Karl Lagerfeld, Stella McCartney and, in 2006, with Viktor &
Rolf.
10. Moin, David, “Gap Brand Taps Hillman For Merchandising,”
Women’s Wear Daily, December 13, 2006, Vol. 192, Issue 124,
p. 11.
11. At December 2006 exchange rate.
12. Moin, David, “Gap Brand Taps Hillman for Merchandising
Post.” Women’s Wear Daily, December 13, 2006, Vol. 192,
Issue 124, p. 11.
year 2006, as executives experimented with a dizzying number of fashions and store layouts.
In the end, consumers appeared more confused than intrigued by the incessant changes. In the
fourth quarter, overall sales fell by 8%, led by Old Navy and to some extent the flagship brand
Gap. Interestingly, Banana Republic sales had rebounded. The comeback at Gap Inc. re-
mained a work in progress. A rotating cast of designers had tried to recreate the Gap brand—
with expensive handbags, bell-bottom jeans, and evening gowns—but the result was the same:
sales fell.
The overall decline in sales prompted the Gap Inc. board to hire Goldman Sachs (Goldman)
to explore strategies ranging from the sale of its 3,000 stores to spinning off a single division,
such as Banana Republic, which had become enticing to potential buyers. Goldman was expected
to conduct a full review of Gap’s business lines and then present a plan to directors.
Any decision about Gap’s future would be made by the company’s founding family, the
Fishers, who controlled more than 30% of its stock. A sale of Gap would be one of the largest
buyouts ever in the retail industry. The company’s prevailing market value in January 2007 was
$16.4 billion, and analysts expected that a buyer would have to pay more than $18 billion.
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Introduction
SITTING AT HIS DESK, ADMIRING THE COLORADO MOUNTAINS IN THE DISTANCE, Frank Crail was
counting his blessings at the success of Rocky Mountain Chocolate Factory Inc. (RMCF)
over the past 27 years. The company had not only allowed him and his wife to raise their chil-
dren in Durango, Colorado, but had also provided them a more-than-comfortable livelihood.
Crail knew that for his company to continue to grow and be successful, planning for the future was
necessary. How long would growth continue in the gourmet segment of the chocolate industry? Con-
sumer tastes were changing. Competition was heating up, with smaller companies being bought
by corporate giants who were eying the growth in the gourmet segment of the market. RMCF’s
business model had been effective, but should changes be considered? With one last glance at
the beginnings of springtime in the mountains, Crail left for RMCF’s annual planning meeting
and his management team waiting in the board room across the hall.
26-1
C A S E 26
Rocky Mountain Chocolate
Factory Inc. (2008):
RECIPE FOR SUCCESS?
Annie Phan and Joyce Vincelette
This case was prepared by Annie Phan, a student, and Professor Joyce Vincelette of the College of New Jersey. This
case cannot be reproduced in any form without the written permission of the copyright holder, Annie Phan and Pro-
fessor Joyce Vincelete. Reprint permission is solely granted to the publisher, Prentice Hall, for the book Strategic
Management and Business Policy-13th ed. (and the International and electronic versions of this book) by copyright
holders, Annie Phan and Professor Joyce Vincelete. This case was edited for SMBP-13th Edition. Copyright © 2008
by Annie Phan and Professor Joyce Vincelete. The copyright holders are solely responsible for the case content. Any
other publication of the case (translation, any form of electronics or other media), or sold (any form of partnership) to
another publisher will be in violation of copyright laws unless Annie Phan and Professor Joyce Vincelete have granted
an additional written reprint permission.
History1
Rocky Mountain Chocolate Factory (RMCF) was built around a location and a lifestyle. RMCF
began as Frank Crail’s dream to move his family from crowded and bustling Southern Califor-
nia, where he owned CNI Data Processing Inc., a company that produced billing software for the
26-2 SECTION D Industry Six—Specialty Retailing
Corporate Governance11
The biographical sketches for the executive officers and directors as of April 30, 2008, were
as follows:
Executive Officers
Franklin E. Crail (age 66) co-founded the first RMCF store in May 1981. Since the incorpora-
tion of the company in November 1982, he has served as its chief executive officer, president, and
a director. He was elected chairman of the board in March 1986. Prior to founding the company,
Mr. Crail was co-founder and president of CNI Data Processing Inc., a software firm that devel-
oped automated billing systems for the cable television industry.
cable TV industry, to a slower-paced and family-friendly environment. He and his wife chose the
small and quaint Victorian-era town of Durango, Colorado, and began surveying the town’s res-
idents and merchants for business opportunities. “It came down to either a car wash or a
chocolate shop,” recalls the father of seven. “I think I made the right choice.”2
Founded in 1981 by Crail and two partners and incorporated in Colorado in 1982, RMCF
was successful from the start. In addition to the opening of the Durango store, Crail’s partners
opened stores in Breckenridge and Boulder, Colorado. The first franchised stores were opened
in 1982 in Colorado Springs, and Park City, Utah. Crail later told ColoradoBiz that the “typi-
cal franchisee was a professional who wanted to set out on a second career in a small, family-
oriented town,”3 much as he himself had done. Crail’s two partners left the business in 1983.
Over the years, RMCF fine-tuned its chocolates and its strategy. In February 1986, Crail
took the company public, where it is now found on the NASDAQ under the symbol RMCF.
Chain Store Age pronounced RMCF founder Frank Crail one of its Entrepreneurs of the Year
for 1995. In the late 1990s most of the company-owned retail operations were closed or sold
to franchisees, allowing RMCF to focus on franchising and manufacturing.
In 2008, RMCF was an international franchiser and confectionary manufacturer. The origi-
nal shop “still stands on Main Street in Durango, with its sights and smells tempting tourists and
locals alike to experience a cornucopia of chocolaty treats before taking part in a scenic ride on
the Durango-Silverton Narrow Gauge Railroad or after a white water rafting trip through town.”4
As of March 31, 2008, there were five company-owned and 329 franchised RMCF stores
operating in 38 states (concentrated primarily on the west coast and in the Sun Belt), Canada,
and the United Arab Emirates,5 with total revenues of $31,878,183.6
Frank Crail believed he had created the recipe that had driven the company to success.
“The number one factor is the quality of the product,” said Crail. “Without that customers
aren’t going to stay around long.”7 “As a testament, Crail proudly points to a page from Money
magazine mounted on his office wall, which features Rocky Mountain Chocolate winning the
coveted 3-heart rating in a blind taste test. The candy maker’s chocolate beat out See’s Can-
dies, Perugina, Teuscher, Godiva, and Fanny May for the richest chocolate, with intense nat-
ural flavor.”8 In addition to product quality, taste, value, and variety having been key to
RMCF’s business strategy, the company also believed that its store atmosphere and ambiance,
its brand name recognition, its careful selection of sites for new stores and kiosks, its exper-
tise in the manufacture, merchandising and marketing of chocolate and other candy products,
and its commitment to customer service were keys to the accomplishment of its objective to
build on its position as a leading international franchiser and manufacturer of high quality
chocolate and other confectionary products.9
“A great deal has happened over the years,” recounts Crail with a twinkle in his eye. “I
never imagined that in my search for a place to raise a family things would turn out so sweet!”10
CASE 26 Rocky Mountain Chocolate Factory Inc. (2008) 26-3
Bryan J. Merryman (age 47) joined the company in December 1997 as vice president, Finance,
and chief financial officer. Since April 1999, Mr. Merryman has also served the company as chief
operating officer and as a director, and since January 2000 as its treasurer. Prior to joining the
company, Mr. Merryman was a principal in Knightsbridge Holdings Inc. (a leveraged buyout
firm) from January 1997 to December 1997. Mr. Merryman also served as chief financial offi-
cer of Super Shops Inc., a retailer and manufacturer of aftermarket auto parts from July 1996 to
November 1997, and was employed for more than eleven years by Deloitte and Touche LLP, most
recently as a senior manager.
Gregory L. Pope (age 41) became senior vice president of Franchise Development and Opera-
tions in May 2004. Since joining the company in October 1990, he has served in various posi-
tions, including store manager, new store opener, and franchise field consultant. In March 1996
he became director of Franchise Development and Support. In June 2001 he became vice pres-
ident of Franchise Development, a position he held until he was promoted to his present position.
Edward L. Dudley (age 44) joined the company in January 1997 to spearhead the company’s
newly formed Product Sales Development function as vice president, sales and Marketing, with
the goal of increasing the company’s factory and retail sales. He was promoted to senior vice
president in June 2001. During his 10-year career with Baxter Healthcare Corporation,
Mr. Dudley served in a number of senior marketing and sales management capacities, including
most recently that of director, Distribution Services from March 1996 to January 1997.
William K. Jobson (age 52) joined the company in July 1998 as director of information technol-
ogy. In June 2001, he was promoted to chief information officer, a position created to enhance
the company’s strategic focus on information and information technology. From 1995 to 1998,
Mr. Jobson worked for ADAC Laboratories in Durango, Colorado, a leading provider of diag-
nostic imaging and information systems solutions in the healthcare industry, as manager of tech-
nical services, and before that, regional manager.
Jay B. Haws (age 58) joined the company in August 1991 as vice president of Creative Services.
Since 1981, Mr. Haws had been closely associated with the company, both as a franchisee and
marketing/graphic design consultant. From 1986 to 1991 he operated two RMCF franchises lo-
cated in San Francisco. From 1983 to 1989 he served as vice president of Marketing for Image
Group Inc., a marketing communications firm based in Northern California. Concurrently,
Mr. Haws was co-owner of two other RMCF franchises located in Sacramento and Walnut
Creek, California. From 1973 to 1983 he was principal of Jay Haws and Associates, an adver-
tising and graphic design agency.
Virginia M. Perez (age 70) joined the company in June 1996 and has served as the company’s
corporate secretary since February, 1997. From 1992 until joining the company, she was em-
ployed by Huettig & Schromm Inc., a property management and development firm in Palo Alto,
California, as executive assistant to the president and owner. Huettig & Schromm developed,
owned, and managed over 1,000,000 square feet of office space in business parks and office
buildings on the San Francisco peninsula. Ms. Perez is a paralegal and has held various admin-
istrative positions during her career, including executive assistant to the chairman and owner of
Sunset Magazine & Books Inc.
Directors
The company bylaws provided for no fewer than three or more than nine directors. The board
had previously fixed the number of directors at six. Directors were elected for one-year terms.
Crail and Merryman were the only two internal board members. Directors of Rocky Moun-
tain Chocolate Factory who did not also serve as an executive officer were as follows:
Gerald A. Kien (age 75) became a director in August 1995. He retired in 1995 from his positions
as president and chief executive officer of Remote Sensing Technologies Inc., a subsidiary of En-
virotest Systems Inc., a company engaged in the development of instrumentation for vehicle
emissions testing located in Tucson, Arizona. Mr. Kien has served as a director and as chairman
26-4 SECTION D Industry Six—Specialty Retailing
Store Concept15
RMCF shops were a blend of traditional and contemporary styles. The company sought to es-
tablish a fun and inviting atmosphere in all of its locations. Unlike most other confectionary
stores, each RMCF shop prepared certain products, including fudge and caramel apples, in
the store. Customers could observe store personnel making fudge from start to finish, includ-
ing the mixing of ingredients in old-fashioned copper kettles and the cooling of the fudge on
large granite or marble tables, and were often invited to sample the store’s products. RMCF
of the Executive Committee of Sun Electric Corporation since 1980 and as chairman, president,
and chief executive officer of Sun Electric until retirement in 1993.
Lee N. Mortenson (age 71) has served on the board of directors of the company since 1987.
Mr. Mortenson has been engaged in consulting and investments activities since July 2000, and was
a managing director of Kensington Partners LLC (a private investment firm) from June 2001 to
April 2006. Mr. Mortenson has been president and chief executive officer of Newell Resources
LLC since 2002, providing management consulting and investment services. Mr. Mortenson
served as president, chief operating officer, and a director of Telco Capital Corporation of
Chicago, Illinois, from January 1984 to February 2000. Telco Capital Corporation was princi-
pally engaged in the manufacturing and real estate businesses. He was president, chief operat-
ing officer, and a director of Sunstates Corporation from December 1990 to February 2000.
Sunstates Corporation was a company primarily engaged in real estate development and man-
ufacturing. Mr. Mortenson was a director of Alba-Waldensian Inc. from 1984 to July 1999, and
served as its president, chief executive officer, and director from February 1997 to July 1999.
Alba was principally engaged in the manufacturing of apparel and medical products.
Fred M. Trainor (age 68) has served as a director of the company since August 1992.
Mr. Trainor is the founder, and since 1984 has served as chief executive officer and president of
AVCOR Health Care Products Inc., Fort Worth, Texas (a manufacturer and marketer of spe-
cialty dressings products). Prior to founding AVCOR Health Care Products Inc. in 1984,
Mr. Trainor was a founder, chief executive officer, and president of Tecnol Inc. of Fort Worth,
Texas (also a company involved with the health care industry). Before founding Tecnol Inc.,
Mr. Trainor was with American Hospital Supply Corporation (AHSC) for 13 years in a number
of management capacities.
Clyde W. Engle (age 64) has served as a director of the company since January 2000.
Mr. Engle is chairman of the board of directors and chief executive officer of sunstates cor-
poration and chairman of the board of directors., president and chief executive officer of Lin-
colnwood Bancorp, Inc. (formerly known as GSC Enterprises, Inc.), a one-bank holding
company, and chairman of the board and chief executive officer of its subsidiary, Bank of
Lincolnwood.
The Board of Directors had determined that Klein, Mortensen, Trainor, and Engle were “inde-
pendent directors” under Nasdaq Rule 4200. Mortenson, Trainor, and Kien served on the Au-
diting Committee, Compensation Committee, and the Nominating Committee of the
company’s board of directors.12
Directors of RMCF did not receive any compensation for serving on the board. Directors
received compensation for serving on board committees, chairing committees, and participat-
ing in meetings. Directors who are not also officers or employees of the company were enti-
tled to receive stock option awards.13
As of June 28, 2007, there were approximately 6,080,283 shares of common stock
outstanding and eligible to vote at the annual meeting. For each share of common stock
held, a shareholder was entitled to one vote on all matters voted on at the annual meeting
except the election of directors. Shareholders had cumulative voting rights in the election
of directors.14
CASE 26 Rocky Mountain Chocolate Factory Inc. (2008) 26-5
Outlet Centers
As of February 29, 2008, there were approximately 110 factory outlet centers in the United
States, and there were RMCF stores in approximately 67 (up from 65 in 2007) of these cen-
ters in more than 25 states.
believed the in-store preparation and aroma of its products enhanced store ambiance, was fun
and entertaining for customers, conveyed an image of freshness and homemade quality, and
encouraged additional impulse purchases by customers. According to Crail, “We have a great
marketing advantage with our unique in-store candy demonstrations. Customers can watch
the cook spin a skewered apple in hot caramel or watch fudge being made before their eyes.
Of course, everyone gets a sample!”16
RMCF stores opened prior to fiscal 2002 had a distinctive country Victorian décor. In fis-
cal 2002, the company launched its revised store concept, intended specifically for high foot
traffic regional shopping malls. This new store concept featured a sleeker and more contem-
porary design that continued to prominently feature in-store cooking while providing a more
up-to-date backdrop for newly redesigned upscale packaging and displays. The company re-
quired that all new stores incorporate the revised store design and also required that key ele-
ments of the revised concept be incorporated into existing store designs upon renewal of
franchise agreements or transfers in store ownership. Through March 31, 2008, 197 stores in-
corporating the new design had been opened.
The average store size was approximately 1,000 square feet, approximately 650 square
feet of which was selling space. Most stores were open seven days a week. Typical hours were
10 a.m. to 9 p.m., Monday through Saturday, and 12 noon to 6 p.m. on Sundays. Store hours
in tourist areas may have varied depending upon the tourist season.
RMCF believed that careful selection of store sites was critical to its success, and it
considered a number of factors in identifying suitable sites, including tenant mix, visibil-
ity, attractiveness, accessibility, level of foot traffic, and occupancy costs. The company be-
lieved that the experience of its management team in evaluating potential sites was one of
its competitive strengths, and all final site selection had to be approved by senior manage-
ment. RMCF had established business relationships with most of the major regional and
factory outlet center developers in the United States and believed these relationships pro-
vided it with the opportunity to take advantage of attractive sites in new and existing real
estate environments.
The company established RMCF stores in five primary environments: 1) regional centers,
2) tourist areas, 3) outlet centers, 4) street fronts, and 5) airports and other entertainment-
oriented shopping centers. Each of these environments had a number of attractive features,
including high levels of foot traffic. The company, over the last several years, has had a par-
ticular focus on regional center locations.
Tourist Areas, Street Fronts, and Other Entertainment-Oriented
Shopping Centers
As of February 29, 2008, there were approximately 40 (down from 45 in 2007) RMCF stores
in locations considered to be tourist areas, including Fisherman’s Wharf in San Francisco, and
the Riverwalk in San Antonio, Texas. RMCF believed that tourist areas offer high levels of
foot traffic, favorable customer spending characteristics, and increase its visibility and name
recognition. The company believed that significant opportunities existed to expand into ad-
ditional tourist areas.
26-6 SECTION D Industry Six—Specialty Retailing
Other1 7
RMCF believed there were a number of other environments that had the characteristics neces-
sary for the successful operation of successful stores, such as airports and sports arenas. In
February 2008, twelve (up from nine in 2007) franchised RMCF stores existed at airport locations:
two at both Denver and Atlanta international airports, one each at Charlotte, Minneapolis, Salt
Lake City, and Dallas/Fort Worth international airports, one at Phoenix Sky Harbor Airport, and
three in Canadian airports, including Edmonton, Toronto Pearson, and Vancouver international
airports.
On July 20, 2007, RMCF entered into an exclusive Airport Franchise Development
Agreement (which expires on July 20, 2009) with The Grove Inc. The company believed this
agreement would accelerate the opening of stores in high volume airport locations throughout
the United States. The Grove Inc. was a privately owned retailer of natural snacks and other
branded food products and, at the time of the agreement, owned and operated 65 food and bev-
erage units, including retail stores in 13 airports throughout the United States. Under the terms
of this agreement, The Grove Inc. had the exclusive right to open RMCF stores in all airports
in the United States where there were no stores currently operating or under development. The
Grove Inc., as of March 31, 2008, operated three stores under this agreement.
Kiosk Concept
In fiscal 2002, RMCF opened its first full-service retail kiosk to display and sell the com-
pany’s products. As of March 31, 2008, there were 18 (down from 24 in 2007) kiosks in op-
eration. Kiosks ranged from 150 to 250 square feet and incorporated the company’s
trademark cooking area where popular confections are prepared in front of customers. The
kiosk also included the company’s core product and gifting lines in order to provide the cus-
tomer with a full RMCF experience.
RMCF believed kiosks were a vehicle for retail environments where real estate is unavail-
able or building costs and/or rent factors do not meet the company’s financial criteria. The com-
pany also believed the kiosk concept enhanced its franchise opportunities by providing more
flexibility in support of existing franchisees’ expansion programs and allowed new franchisees
that otherwise would not qualify for a store location, an opportunity to join the RMCF system.
Franchising Program
The RMCF franchising philosophy was one of service and commitment to its franchise sys-
tem, and the company continuously sought to improve its franchise support services. The
company’s franchise concept had consistently been rated as an outstanding franchise oppor-
tunity and in January 2008, RMCF was rated the number one franchise opportunity in the
candy category by Entrepreneur magazine. As of March 31, 2008, there were 329 franchised
stores in the RMCF system.
Regional Centers
There were approximately 1,400 regional centers in the United States, and as of February 29,
2008, there were RMCF stores in approximately 95 (down from 100 in 2007) of these centers, in-
cluding locations in the Mall of America in Bloomington, Minnesota; and Fort Collins, Colorado.
Although often providing favorable levels of foot traffic, regional malls typically involved more
expensive rent structures and competing food and beverage concepts. The company’s new store
concept was designed to capitalize on the potential of the regional center environment.
CASE 26 Rocky Mountain Chocolate Factory Inc. (2008) 26-7
RMCF believed the visibility of its stores and the high foot traffic at many of its locations
had generated strong name recognition of and demand for its providers and franchises. RMCF
stores had historically been concentrated in the western and Rocky Mountain regions of the
United States, but new stores were gradually being opened in the eastern half of the country.
RMCF’s continued growth and success was dependent on both its ability to obtain suit-
able sites at reasonable occupancy costs for both franchised stores and kiosks and its ability to
attract, retain, and contract with qualified franchisees who were devoted to promoting and de-
veloping the RMCF store concept, reputation, and product quality. RMCF had established cri-
teria to evaluate prospective franchisees, which included the applicant’s net worth and
liquidity, together with an assessment of work ethic and personality compatibility with the
company’s operating philosophy. The majority of new franchises were awarded to persons re-
ferred by existing franchisees, to interested consumers who had visited RMCF stores, and to
existing franchisees. The company also advertised for new franchisees in national and regional
newspapers as suitable store locations were recognized.
Prior to store opening, each domestic franchise owner/operator and each store manager for
a domestic franchisee was required to complete a seven-day comprehensive training program in
store operations and management at its training center in Durango, Colorado, which included a
full-sized replica of a properly configured and merchandised RMCF store. Topics covered in the
training course included the company’s philosophy of store operation and management, cus-
tomer service, merchandising, pricing, cooking, inventory and cost control, quality standards,
record keeping, labor scheduling, and personnel management. Training was based on standard
operating policies and procedures contained in an operations manual provided to all franchisees,
which the franchisee was required to follow by terms of the franchise agreement. Additionally,
trainees were provided with a complete orientation to company operations by working in key fac-
tory operational areas and by meeting with members of the senior management.
Ongoing support was provided to franchisees through communications and regular site
visits by field consultants who audited performance, provided advice, and ensured that oper-
ations were running smoothly, effectively, and according to the standards set by the company.
The franchisee agreement required compliance with RMCF’s procedures of operation and
food quality specifications, permitted audits and inspections by the company, and required fran-
chisees to remodel stores to conform to established standards. RMCF had the right to terminate any
franchise agreement for non-compliance with operating standards. Franchisees were generally
granted exclusive territory with respect to the operation of RMCF stores only in the immediate
vicinity of their stores. Products sold at the stores and ingredients used in the preparation of prod-
ucts approved for on-site preparation were required to be purchased from the company or from ap-
proved suppliers. Franchise agreements could be terminated upon the failure of the franchisee to
comply with the conditions of the agreement or upon the occurrence of certain events, which in the
judgment of the company was likely to adversely affect the RMCF system. The agreements pro-
hibited the transfer or assignment of any interest in the franchise without the prior written consent
of the company and also gave RMCF the right of first refusal to purchase any interest in a franchise.
The term of each RMCF franchise agreement was 10 years, and franchisees had the right
to renew for one additional 10-year term. The company did not provide prospective fran-
chisees with financing for their stores, but had developed relationships with sources of fran-
chisee financing to which it would refer franchisees.
In fiscal 1992, the company entered into a franchise development agreement covering
Canada with Immaculate Confections Ltd. of Vancouver, BC. Under this agreement Immacu-
late Confections had exclusive rights to franchise and operate RMCF stores in Canada.
Immaculate Confections, as of March 31, 2008, operated 38 stores under this agreement.
In fiscal 2000, RMCF entered into a franchise development agreement covering the Gulf
Cooperation Council States of United Arab Emirates, Qatar, Bahrain, Saudi Arabia, Kuwait,
and Oman with Al Muhairy Group of United Arab Emirates. This agreement gave the
Al Muhairy Group the exclusive right to franchise and operate RMCF stores in the Gulf Co-
operation Council States. Al Muhairy Group, as of March 31, 2008, operated three stores un-
der this agreement.
Frank Crail gives credit for the success of RMCF to the more than 200 independent fran-
chise operators that bought into his concept. “They are the ones that really make this company
a success,”18 he remarked.
26-8 SECTION D Industry Six—Specialty Retailing
Company-Owned Stores
As of March 31, 2008, there were five company-owned RMCF stores. These stores provided
a training ground for company-owned store personnel and district managers and a controllable
testing ground for new products and promotions, operating, and training methods and mer-
chandising techniques, which might then be incorporated into the franchise store operations.
The cornerstone of RMCF’s growth strategy was to aggressively pursue unit growth op-
portunities in locations where the company had traditionally been successful, to pursue new
and developing real estate environments for franchisees that appeared promising based on
early sales results, and to improve and expand the retail store concept, such that previously un-
tapped and unfeasible environments (such as most regional centers) generated sufficient rev-
enue to support a successful RMCF location.19
Exhibit 1 shows the total number of RMCF stores in operation as well as those sold but
not open as of February 29, 2008.
Company-owned and franchised stores were subject to licensing and regulation by the
health, sanitation, safety, building, and fire agencies in the state or municipality where they
were located as well as various federal agencies that regulate the manufacturing, packaging,
and distribution of food products. RMCF was also subject to regulation by the Federal Trade
Commission and must comply with state laws governing the fair treatment of franchisees in-
cluding the offer, sale, and termination of franchises and the refusal to renew franchises.20
EXHIBIT 1
Rocky Mountain
Chocolate Factory
Stores as of
February 29, 2008
SOURCE: Rocky Mountain Chocolate Factory, Inc. 2008 Form 10-K, p. 34.
Sold, Not Yet Open Open Total
Company-Owned Stores 5 5
Franchise Stores—Domestic Stores 14 266 280
Franchise Stores—Domestic Kiosks 18 18
Franchised Stores—International 41 41
Products21
RMCF typically produced approximately 300 chocolate candies and other confectionery prod-
ucts at the company’s manufacturing facility, using premium ingredients and proprietary
recipes developed primarily by its Master Candy Maker. These products included many vari-
eties of nut clusters, caramels, butter creams, mints, and truffles. During the Christmas, Easter,
and Valentine’s Day holiday seasons, the company may have made as many as 100 additional
items, including many candies offered in packages specially designed for the holidays. RMCF
continually strove to create and offer new confectionery products in order to maintain the ex-
citement and appeal of its products and to encourage repeat business. RMCF developed a new
line of sugar-free and no-sugar-added candies. According to the company, “results have been
‘spectacular,’ filling a need for those with special dietary requirements.”22
In addition to RMCF’s traditional chocolates and candies, special treats were prepared in
each store. Besides the caramel-covered apples (some stores feature over 30 varieties), fudge
(more than fifteen varieties) was made fresh every day in each store using a marble slab to
literally suck the heat out of the confection while the cook shaped it with paddles into a gi-
ant 22-pound “loaf.” A variety of fruits, nuts, pretzels, and cookies were also dipped by hand
in pots of melted milk, dark, and even white chocolate.23
One of RMCF’s trademarks, big, chunky chocolate concoctions, were created somewhat
by accident. According to Crail, “In the early days, my partners and I did not know how to
make chocolate and had to literally learn on a ping pong table.” Crail recalls that “from the
start we made the candy centers too big, not compensating for the added size and weight when
coating the pieces in chocolate. And if they didn’t look quite right we would dip them again.
But the huge pieces instantly caught on and have remained the RMCF benchmark ever
since.”24 One of these large-sized specialties was a king-sized peanut butter cup dubbed the
Bucket™. Another signature piece, the Bear™ (turtles), was a paw-sized concoction of chewy
caramel, roasted nuts and a heavy coating of chocolate. The best-selling items were caramel
apples, followed by Bears.25
All products were produced consistent with the company’s philosophy of using only the
finest, highest quality ingredients with no artificial preservatives to achieve its marketing
motto of “the Peak of Perfection in Handmade Chocolates®.”26
RMCF believed that, on average, approximately 40 percent of the revenues of RMCF
stores were generated by products manufactured at the company’s factory, 50% by products
made in each store using company recipes and ingredients purchased from the company or ap-
proved suppliers, and the remaining 10% by products such as ice cream, coffee, and other sun-
dries purchased from approved suppliers. Franchisees sales of products manufactured by the
company’s factory generated higher revenue than sales of store-made or other products. A sig-
nificant decrease in the volume of products franchisees purchase from the company would ad-
versely affect total revenue and the results of operations. Such a decrease could result from
franchisees decisions to sell more store-made products or products purchased from third-party
suppliers.27
Chocolate candies manufactured by the company were sold at prices ranging from
$14.90 to $24.00 per pound, with an average price of $18.30 per pound. Franchisees were able
to set their own retail prices, though the company recommended prices for all of its products.28
CASE 26 Rocky Mountain Chocolate Factory Inc. (2008) 26-9
Packaging29
RMCF developed special packaging for the Christmas, Valentine’s Day, and Easter holidays
and customers could have their purchases packaged in decorative boxes and fancy tins
throughout the year.
In 2002, RMCF completed a project to completely redesign the packaging featured in its re-
tail stores. The new packaging was designed to be more contemporary and capture and convey
the freshness, fun, and excitement of the RMCF retail store experience. Sleek, new copper gift
boxes were designed to reinforce the association with copper cooking kettles. And the new logo
was meant to represent swirling chocolate.30 This new line of packaging won three National Pa-
perbox Association Gold Awards in 2002, representing the association’s highest honors.31
Marketing32
RMCF sought low-cost, high-return publicity opportunities through participation in local and
regional events, sponsorships, and charitable causes. The company had not historically and
did not intend to engage in national advertising. RMCF focused primarily on local in-store
marketing and promotional efforts by providing customizable marketing materials, including
26-10 SECTION D Industry Six—Specialty Retailing
Operations and Distribution36
Manufacturing
RMCF sought to ensure the freshness of products sold in its stores with frequent shipments to
distribution outlets from its 53,000-square-foot manufacturing facility in Durango, Colorado.
Franchisees were encouraged to order from the company only the quantities they could reason-
ably expect to sell within two to four weeks because most stores did not have storage space for
extra inventory.
RMCF believed that it should control the manufacturing of its own products in order to
better maintain its high product quality standards, offer unique proprietary products, manage
costs, control production and shipment schedules, and pursue new or underutilized distribu-
tion channels. The company believed its manufacturing expertise and reputation for quality
had facilitated the sale of selected products through new distribution channels, including
wholesaling, fundraising, corporate sales, mail order, and Internet sales.37
RMCF’s manufacturing process primarily involved cooking or preparing candy centers, in-
cluding nuts, caramel, peanut butter, creams and jellies, and then coating them with chocolate
or other toppings. All of these processes were conducted in carefully controlled temperature
ranges, employing strict quality control procedures at every stage of the manufacturing process.
RMCF used a combination of manual and automated processes at its factory. Although RMCF
believed that it was preferable to perform certain manufacturing processes, such as dipping
some large pieces by hand, automation increased the speed and efficiency of the manufacturing
process. The company had from time to time automated processes formerly performed by hand
where it had become cost-effective to do so without compromising product quality or appear-
ance. Efforts in the last several years had included the purchase of additional automated factory
equipment, implementation of a comprehensive advanced planning and scheduling system, and
installation of enhanced point-of-sales systems in all of its company-owned and 182 of its fran-
chised stores through March 31, 2008. These measures had improved the company’s ability to
deliver its products to the stores safely, quickly, and cost effectively.
Chocolate manufacturing had been a similar process for all companies within the
confectionary/chocolate industry up until 2005. In 2005, new chocolate manufacturing
technology was introduced. This new manufacturing process, called NETZSCH’s ChocoEasy™,
enabled chocolate makers of any size to cost-effectively manufacture all varieties of chocolate
from scratch. For the first time, smaller chocolate companies were no longer dependant on
large chocolate manufacturers and were now free to create their own chocolate recipes and to
develop their own proprietary chocolate brands.38
advertisements, coupons, flyers, and mail-order catalogs generated by its in-house Creative
Services Department, and point-of-purchase materials. The Creative Services Department
worked directly with franchisees to implement local store marketing programs. To cover its
corporate marketing expenses, each franchised store paid a monthly marketing and promo-
tions fee of 1 percent of its monthly gross sales.33
The trade name Rocky Mountain Chocolate Factory®, the phrases, The Peak of Perfection
in Handmade Chocolates, America’s Chocolatier®, The World’s Chocolatier®, as well as other
trademarks, service marks, symbols, slogans, emblems, logos, and designs used in the Rocky
Mountain Chocolate factory system, were proprietary rights of the company. The registration
for the trademark “Rocky Mountain Chocolate Factory” had been granted in the United States
and Canada. Applications had been filed to register the Rocky Mountain Chocolate Factory
trademark in certain foreign countries.34 The company had not attempted to obtain patent pro-
tection for the proprietary recipes developed by the company’s Master Candy Maker and was
relying upon its ability to maintain confidentiality of those recipes.35
CASE 26 Rocky Mountain Chocolate Factory Inc. (2008) 26-11
During fiscal 2008, the RMCF’s manufacturing facility produced approximately
2.84 million pounds of chocolate candies, an increase of 4% from the approximately 2.73 mil-
lion pounds produced in fiscal 2007. During fiscal 2008 the company conducted a study of
factory capacity. As a result of this study, RMCF believed its factory had the capacity to pro-
duce approximately 5.3 million pounds per year. In January 1998, the company acquired a
two-acre parcel adjacent to its factory to ensure the availability of adequate space to expand
the factory as volume demands.39
Ingredients40
RMCF maintained the taste and quality of its chocolate candies by using only the finest choco-
late and other ingredients. The principal ingredients used by RMCF are chocolate, nuts, sugar,
corn syrup, cream, and butter. Chocolate was purchased from the Guittard Chocolate company,
known for 130 years as providing the finest, most intensely flavored chocolate.41 The factory
received shipments of ingredients daily. To ensure the consistency of its products, ingredients
were bought from a limited number of reliable suppliers. The company had one or more alter-
native sources for all essential ingredients. RMCF also purchased small amounts of finished
candy from third parties on a private-label basis for sale in its stores.
Several of the principal ingredients used in RMCF’s candies, including chocolate and nuts,
were subject to significant price fluctuations. Although cocoa beans, the primary raw material
used in the production of chocolate, were grown commercially in Africa, Brazil, and several other
countries around the world, cocoa beans were traded in the commodities market, and their supply
and price were therefore subject to volatility. RMCF believed its principal chocolate supplier pur-
chased most of its beans at negotiated prices from African growers, often at a premium to com-
modity prices. RMCF purchased most of its nut meats from domestic suppliers who procured their
products from growers around the world. Although the price of chocolate and nut meats had been
relatively stable in recent years, the supply and price of nut meats and cocoa beans, and, in turn,
chocolate, were affected by many factors, including monetary fluctuations and economic, politi-
cal, and weather conditions in countries in which both nut meats and cocoa beans were grown.
The Ivory Coast (Cote d’Ivoire) was responsible for producing 40 percent of the world’s
cocoa beans that are necessary for the manufacturing of chocolate.42 In late 2006, there was a
five-day strike in which laborers refused to enter the factories because of unbearable working
conditions. These strikes led to an increase of 20 percent in the price of chocolate for most
companies within the industry.43 Forty-seven percent of the total U.S. imports of cocoa beans
came from the Ivory Coast.
RMCF did not engage in commodity futures trading or hedging activities. In order to as-
sure a continuous supply of chocolate and certain nuts, the company entered into purchase con-
tracts of between six to eighteen months for these products. These contracts permitted the
company to purchase the specified commodity at a fixed price on an as-needed basis during
the term of the contract.
Trucking Operations
Unable to find a suitable shipper, RMCF built its own fleet of brown and bronze semis.44 In
2008 RMCF operated eight refrigerated trucks and shipped a substantial portion of its prod-
ucts from its factory on its own fleet. The company’s trucking operations enabled it to deliver
its products to the stores quickly and cost-effectively. In addition, the company back-hauled
its own ingredients and supplies, as well as product from third parties to fill available space,
on return trips as a basis for increasing trucking program economics.45 The company’s truck-
ing operations are subject to various federal, state, and Canadian provincial regulations.46
26-12 SECTION D Industry Six—Specialty Retailing
Human Resources47
On February 29, 2008, RMCF employed approximately 190 people. Most employees, with
the exception of store, factory, and corporate management, were paid on an hourly basis.
RMCF also employed some people on a temporary basis during peak periods of store and fac-
tory operations. The company sought to assure that participatory management processes, mu-
tual respect and professionalism, and high performance expectations for the employee existed
throughout the organization.
RMCF believed that it provided working conditions, wages, and benefits that compared
favorably with those of its competitors. The company’s employees were not covered by a col-
lective bargaining agreement. The company considered its employee relations to be good.
Chocolate and Confectionary Industry
While people enjoy chocolate across cultures, there were certain cultures that value choco-
late sweets more than others. Per capita consumption of confectionary tended to be the high-
est in the established markets of Western Europe and North America, although these were
also the most mature.48
The sale of chocolate and confectionary products was affected by changes in consumer
tastes and eating habits, including views regarding the consumption of chocolate. In addition,
numerous other factors such as economic conditions, demographic trends, traffic patterns, and
weather conditions could influence the sale of confectionary products. Consumer confidence,
recessionary and inflationary trends, equity market levels, consumer credit availability, inter-
est rates, consumer disposable income and spending levels, energy prices, job growth, and un-
employment rates could impact the volume of customer traffic and level of chocolate and
confectionary sales.
According to the National Confectioners Association, the total U.S. candy market approx-
imated $29.1 billion of retail sales in 2007, up from $27.9 in 2005, with chocolate generating
sales of approximately $16.3 billion up from $15.7 billion in 2005. Per capita consumption of
chocolate in 2006 was approximately 14 pounds per person per year nationally, an increase of
1% when compared to 2005, according to Department of Commerce figures.49 The average
U.S. consumer spent $93.92 on confectionary products in 2006, $52.16 on chocolate.50
Exhibit 2 shows 2007 U.S. confectionary market sales.
In 2007 the United States was the strongest market for chocolate. According to a 2004 sur-
vey, the U.S. chocolate market was far from being saturated, and considerable opportunities for
growth remained, particularly in the gourmet, higher-priced premium segment.51 Consumers in
EXHIBIT 2
The 2007 U.S.
Confectionary
Market
SOURCE: National Confectionary Association 2007 Industry Review on the United States Confectionary Market,
January 2008, http://www.ecandy.com/ecandyfiles/2007_Annual_Review_Jan_08.ppt.
$(in billions) % change
Retail Sales $29.1 3.5%
Manufacturer Shipments $16.9 3.0%
Domestic Manufacturer Shipments $17.5 2.7%
Imports $2.2 4.0%
Exports $0.9 13.1%
Profit margin is approximately 35% for the confectionary category.
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http://www.ecandy.com/ecandyfiles/2007_Annual_Review_Jan_08.ppt
CASE 26 Rocky Mountain Chocolate Factory Inc. (2008) 26-13
the United States were shifting away from mass-produced chocolates, of the type traditionally
manufactured by Hershey Foods and Mars Inc., to more expensive gourmet varieties free from
chemicals and preservatives. Hershey and Mars had recognized the trend and had been increas-
ing their interest in premium brands. Some industry observers have predicted that by 2011, pre-
mium chocolate will account for 25% of the U.S. market, generating sales of $4.5 billion.52
The European chocolate market had also remained lucrative for manufacturers, although
there had been some degree of slowdown over the past five years. Average annual per capita
chocolate consumption was cited as being about 8 kg in Europe, but this varied considerably
country by country.53 Chocolate was also used for other purposes (baking, snacks, etc.) that
differed considerably across ethnic, social, regional, or religious subcultures. Exhibit 3 shows
the leading countries for per capita consumption of chocolate and confectionary.
The leading manufacturers in the European market were Mars, Nestle, Cadbury, Ferrero,
and Lindt & Sprungli. These companies saw a bright future in Europe, particularly the mar-
kets of the newer members of the EU where consumers had significantly increased their
chocolate consumption since 2004. Some manufacturers also believed that Russia was a key
market for European growth because its rising affluence had driven a demand for premium
chocolate products.54
Confectionary manufacturers were also looking to break into new markets such as China
and India because of their growing affluence. These markets were dominated by traditional
sweets, but there was a growing demand for Western goods, including chocolate, with choco-
late consumption increasing at a rate of 25% a year in the Asia-Pacific region and 30% in
China.55 Many large chocolate and confectionary companies had undertaken marketing cam-
paigns in order to lure customers in China, India, and Japan away from traditional sweets to
chocolate.56 Exhibit 4 shows regional cocoa consumption.
EXHIBIT 3
Per Capita
Consumption of
Confectionary in
Leading Countries in
2002 (in kilograms)
SOURCE: Leatherheadfood International, The Global Confectionary Market—Trends and Innovations.
www.leatherheadfood.com/pdf/confectionary/pdf.
Chocolate Sugar Total
Denmark 8.6 8.0 16.6
Sweden 6.4 9.6 16.0
Ireland 8.8 6.0 14.8
Switzerland 10.7 3.3 14.0
UK 9.3 4.6 13.9
Norway 8.3 4.8 13.1
Germany 7.5 4.9 12.4
Finland 4.8 7.3 12.1
Belgium 8.0 3.5 11.5
Austria 8.2 3.2 11.4
EXHIBIT 4
Regional Cocoa
Consumption
SOURCE: Kermani, Faiz, Chocolate Challenges, Report Buyer, 2007, p. 4. www.reportbuyer.com.
Region Percentage of global total
Europe 42.8%
Americas 25.9%
Asia and Oceania 17.0%
Africa 14.3%
www.leatherheadfood.com/pdf/confectionary/pdf
www.reportbuyer.com
26-14 SECTION D Industry Six—Specialty Retailing
Consumer Tastes and Trends
The growth in the chocolate market was heavily dependent on manufacturers satisfying con-
sumer tastes and being aware of consumer trends in each market in which they operated. In
established markets, pressure was coming from consumers for lower-fat healthier snacks and
higher quality chocolate. In addition, consumers had been showing an interest in the health-
related benefits of chocolate. In emerging markets, chocolate manufacturers have had to com-
pete with traditional confectionary products. In addition, consumers were increasingly
becoming concerned with the exploitation of African workers and many were choosing not
to do business with “unethical” organizations that were not engaged in fair trade practices.
Gourmet Chocolate and Organic Chocolate
According to industry expert Michelle Moran, “Gourmet chocolate is expected to experience
delicious growth over the next four years. Indeed, it is expected to become a nearly $1.8 bil-
lion market. According to market analysts and manufacturers, consumers are seeking better-
quality chocolate at a variety of market levels. Further evidence of this trend is the recent
acquisitions of small artisan chocolatiers by large manufacturing powerhouses.”57 Customers
have been increasingly willing to pay higher prices for chocolates they felt were healthier;
products made with quality ingredients and free from chemicals and preservatives.
In addition to growth in the gourmet segment of the chocolate industry, organic chocolate
sales in the United States grew 65% to $120 million in 2006 according to Massachusetts-based
Organic Trade Association, with similar growth forecasted for 2007.58
Health Consciousness of Consumers
Throughout history many cultures had believed in the medicinal properties of cocoa. Most
historians agree that chocolate was first consumed in Central America and some evidence
suggest its use by the Mayan civilization as early 500 BCE.59 Following the Spanish conquest
of Mexico, chocolate found its way to Europe in the 1500s. A number of the original Euro-
pean chocolate manufacturers were apothecaries (early chemists) who wanted to take advan-
tage of the reported medicinal properties of cocoa. Dark chocolate is again being touted and
researched for its health benefits. Studies have been reported in medical and scientific jour-
nals linking chocolate derived antioxidant flavonols and other compounds with the reduction
in the risk of dementia, diabetes, heart-attacks, and strokes. In other studies, dark chocolate
has shown health benefits such as decreased blood pressure, lower cholesterol levels, and im-
proved sugar metabolism. Much additional research remains to be done before these health
benefits can be confirmed.
According to the National Confectioners Association, dark-chocolate sales were up 50% in
2007.60 Between 2002 and 2006, Hershey reported an 11.2% increase in the sale of dark choco-
late. As a result, Hershey had been concentrating almost half of its business in this area.61 Mars
Inc. was thought to be conducting research trying to substantiate the health benefits of chocolate
and had discussed partnerships with pharmaceutical companies to develop products from cocoa-
derived compounds.62 Other manufactures had been experimenting with low-fat, sugar-free
products and chocolates fortified with minerals, vitamins, antioxidants, and probiotics.
Ethical and Fair Trade Chocolate
Not only were consumers more health conscious and visibly consuming darker and more pre-
mium chocolates products, they were also showing concern for the exploitation of cocoa
CASE 26 Rocky Mountain Chocolate Factory Inc. (2008) 26-15
farmers in Western Africa, particularly the use of child labor and the prices that cocoa farm-
ers were able to charge for their crop.
Many consumers were choosing to support organizations and purchase products from com-
panies that supported both “ethical chocolates” as well as fair trade practices. These companies
had reported rising demand for their products as consumer interest in fair trade had grown.63
Competitors
The global market for chocolate was highly competitive. With consumer attitudes changing
and new markets offering opportunities for growth, chocolate manufacturers faced a number
of challenges in keeping ahead of their rivals.
RMCF and its franchisees competed with numerous businesses that offered confec-
tionery products, from large, publically held, global conglomerates to small, private, local
businesses. Many of the large competitors had greater name recognition, both domestically
and globally, and greater financial, marketing, and other resources than RMCF. In addition,
there was intense competition among retailers for prime locations, store personnel, and qual-
ified franchisees.
Large confectionary companies that had traditionally concentrated on mass-produced can-
dies, sought to make inroads into the premium market. For example, in 2005 Hershey Foods ac-
quired two medium-sized gourmet chocolate companies, Scharffen Berger and Joseph Schmidt,
for between $46.6 million and $61.1 million.64 Mars Inc. established its catalog/retail sub-
sidiary, Ethel M Chocolates, in 1981 when billionaire candy maker Forrest Mars developed a
chain of chocolate stores in the western U.S., specializing in liquor-filled candies. In 2005 Ethel
M’s launched an even more premium line of chocolates called ethel’s. Ethel’s chocolates were
available on-line and could be purchased at upscale department stores, including Nieman Mar-
cus, Macy’s, and Marshall Fields.65 Also in 2005, Ethel’s Chocolate Lounge was created as a
place where sweets lovers could linger on sofas and order hot cocoa and chocolate fondue.
Principal competitors of RMCF included Alpine Confections Inc., Godiva Chocolatier
Inc., See’s Candies Inc., Chocoladefabriken Lindt & Sprungli AG, Fannie May (a wholly
owned subsidiary of Alpine Confections), and Ethel M’s/ethel’s. These companies not only
manufactured chocolate but also had their own retail outlets. Exhibit 5 shows the number of
stores in operation for each of these competitors in 2006.
Godiva Chocolatier, the Belgian chocolate maker, with annual sales of approximately
$500 million, was one of the world’s leading premium chocolate businesses. Godiva sold its
products through company-owned and franchised retail stores, and wholesale distribution out-
lets, including specialty retailers and finer department stores and on the Internet. In January
2008, Campbell Soup company announced that it agreed to sell its Godiva Chocolatier unit to
Yildiz Holdings of Turkey for $850 million. Godiva was to become part of the Ulker Group,
which is owned by Yildiz. Ulker is the largest consumer goods company in the Turkish food
industry.66
Chocoladefabriken Lindt & Sprungli AG and its subsidiaries offered products under mul-
tiple brands names, including Lindt, Ghirardelli, Caffarel, Hofbauer, and Kufferle. The com-
pany was founded in 1845 and was based in Kilchberg, Switzerland, and had six production
sites in Europe, two in the United States, and distribution sites and sales companies on four
continents.67 Lindt & Sprungli was a recognized leader in the market for premium chocolate,
and offered a large selection of products in more than 80 countries around the world.68
See’s Candies, Ethel M’s/ethel’s, and Alpine Confections Inc. were privately held compa-
nies. Alpine Confections Inc. was based in Alpine, Utah, and had sales of approximately
$125 million in 2005. Alpine owned a number of candy companies, including Maxfield Candy
company, Kencraft Inc., and Harry London Candies Inc. Alpine acquired the Fanny Farmer
26-16 SECTION D Industry Six—Specialty Retailing
and Fannie May brands from bankrupt Archibald Candy Corporation in 2004. The company
also produced confections under license for Hallmark and Mrs. Fields. Alpine’s Canadian
brands included Dolce d’Or and Bottecelli, produced in British Columbia.69
See’s Candies was founded in 1921 and headquartered in San Francisco, and had manu-
facturing facilities in both Los Angeles and San Francisco. See’s Candies was purchased by
Berkshire Hathaway Inc. (Warren Buffett) in 1972. The company manufactured over 100 va-
rieties of candies and had over 200 retail candy shops throughout the western United States.70
A relatively new competitor founded in Oregon in 1993, acquired by Wayne Zink and
Randy Deer in 2005, and moved to Indianapolis, Indiana, was the Endangered Species Choco-
late Company. The company was the number-one seller of organic chocolate treats, with an-
nual sales of $16 million in 2007. Its products were stocked at natural-foods stores such as
Wild Oats and Whole Foods. Endangered Species Chocolate Co. was committed to making or-
ganic and healthy products that were easy on the environment, made with fair-traded ingredi-
ents, and with sustainable practices. One of Endangered Species main rivals, Oregon-based
Dagoba Chocolate, sold out to Hershey in 2007.71
EXHIBIT 5
Chocolate Retailers:
Number of Stores in
Operation 2006
SOURCE: Prepared by R.J. Falkner & Company Inc. on the company profile report for Rocky
Mountain Chocolate Factory, November 15, 2006.
0 50 100 150 200 250 300 350
RMCF
Godiva
See’s
Lindt
Fanny May
Ethel M’s
Financial Position72
In 2007 RMCF was ranked number 60 in Forbes annual listing of America’s 200 Best Small
Companies (up from number 124 in 2006). The list was compiled from publically traded
companies with sales between $5 million and $750 million. Qualifying candidates were
ranked according to return on equity, as well as sustained sales and earnings growth over
12-month and five-year periods.73 Exhibits 6 and 7 show the income statements and bal-
ance sheets for RMCF for the fiscal years ended 2004 through 2008.
RMCF’s revenues were derived from three principal sources: 1) sales to franchisees
and others of chocolates and other confectionery products manufactured by the company
(75-72-69-68%); 2) sales at company-owned stores of chocolates and other confectionery
products including product manufactured by the company (5-8-11-11%); and 3) the col-
lection of initial franchise fees and royalties from franchisees (20-20-20-21%). The figures
CASE 26 Rocky Mountain Chocolate Factory Inc. (2008) 26-17
EXHIBIT 6
Balance Sheets: Rocky Mountain Chocolate Factory Inc.
SOURCE: Rocky Mountain Chocolate Factory Inc., 2008 form 10-K, p. 30 and 2005 Form 10-K, p. 30.
Year ending February 28/29 2008 2007 2006 2005 2004
Assets
Current Assets
Cash & cash equivalents $675,642 $2,830,175 $3,489,750 $4,438,876 $4,552,283
Accounts receivable, less allowance for
doubtful accounts of $114,271, $187,519,
$46,929, $80,641, and $73,630 respectively
3,801,172 3,756,212 3,296,690 2,943,835 2,388,848
Notes receivable 22,435 50,600 116,997 451,845 313,200
Refundable income taxes 63,357 364,630
Inventories, less reserve for slow moving
inventory of $194,719, $147,700, $61,032,
$127,345, and $73,269 respectively
4,015,459 3,482,139 2,938,234 2,518,212 2,471,810
Deferred income taxes 117,846 272,871 117,715 156,623 149,304
Other current assets 267,184 367,420 481,091 250,886 353,733
Total current assets 8,963,095 10,759,417 10,440,477 11,124,907 10,229,178
Property and Equipment, Net 5,665,108 5,754,122 6,698,605 6,125,898 5,456,695
Other Assets
Notes receivable, gross 205,916 310,453 330,746 452,089 649,100
Less: Allowance 0 �52,005 �52,005 �47,005
Notes receivable, net 310,453 278,741 400,084 602,095
Goodwill, net 939,074 939,074 1,133,751 1,133,751 1,133,751
Intangible assets, net 276,247 349,358 402,469 426,827 498,885
Other assets 98,020 343,745 103,438 36,424 16,614
Total other assets 1,519,257 1,942,630 1,918,399 1,997,086 2,281,372
Total Assets 16,147,460 18,456,169 19,057,480 19,247,974 17,967,245
Liabilities and Stockholders’ Equity
Current Liabilities
Line of Credit 300,000
Current maturities of long-term debt – – 126,000 1,080,400
Accounts payable 1,710,380 898,794 1,145,410 1,088,476 952,542
Accrued salaries & wages 430,498 931,614 507,480 1,160,937 1,091,596
Other accrued expenses 467,543 585,402 750,733 324,215 474,906
Dividends payable 599,473 551,733 504,150 417,090 236,108
Deferred income 303,000 288,500 – – –
Total current liabilities 3,810,894 3,256,043 2,907,773 3,116,718 3,835,552
Long-term debt, less current maturities of
$126,000 and $1,080,400 respectively
1,539,084 1,986,174
Deferred Income Taxes 681,529 685,613 663,889 698,602 555,567
Stockholders’ Equity
Common stock, $.03 par value; 100,000,000
shares authorized; 100,000,000, 5,980,919,
6,418,905, 4,602,135 and 4,486,461 shares
issued and outstanding, respectively
179,428 192,567 188,458 138,064 134, 597
Additional paid-in capital 7,047,142 6,987,558 10,372,530 11,097,208 2,676,222
Retained earnings (accumulated deficit) 4,428,467 7,334,388 4,924,830 2,658,298 8,779,136
Total stockholders’ equity 11,655,037 14,514,513 15,485,818 13,893,570 11,589,952
Total liabilities and stockholders’ equity $16,147,460 $18,456,169 $19,057,481 $19,247,891 $17,967,245
26-18 SECTION D Industry Six—Specialty Retailing
EXHIBIT 7
Statements of Income: Rocky Mountain Chocolate Factory Inc.
SOURCE: Rocky Mountain Chocolate Factory Inc., 2008 Form 10-K, p. 31 and 2005 Form 10-K, p. 29.
Year Ending February 28/29 2008 2007 2006 2005 2004
Revenues
Sales $25,558,198 $25,335,739 $22,343,209 $19,380,861 $16,668,210
Franchise & royalty fees 6,319,985 6,237,594 5,730,403 5,142,758 4,464,618
Total revenues 31,878,183 31,573,333 28,073,612 24,523,619 21,132,828
Costs and Expenses
Cost of sales, exclusive of depreciation and
amortization expense of $389,273, $412,546,
$381,141, and $359,633, respectively
16,678,472 15,988,620 13,956,550 11,741,205 10,535,352
Franchise costs 1,498,709 1,570,026 1,466,322 1,411,901 1,135,686
Sales & marketing expenses 1,503,224 1,538,476 1,320,979 1,294,702 1,220,585
General & administrative expenses 2,505,676 2,538,667 2,239,109 2,497,718 2,235,499
Retail operating expenses 994,789 1,502,134 1,755,738 1,453,740 1,430,124
Depreciation & amortization 782,951 873,988 875,940 785,083 796,271
Total costs & expenses 23,963,821 24,011,911 21,614,638 19,184,349 17,353,517
Operating Income (loss) 7,914,362 7,561,422 6,458,974 5,339,270 3,779,311
Other Income (Expense)
Interest expense (1,566) (19,652) (99,988) (144,787)
Interest income 102,360 67,071 95,360 92,938 93,847
Total other income (expense), net 100,794 67,071 75,708 (7,050) (50,940)
Income before Income Taxes 8,015,156 7,628,493 6,534,682 5,332,220 3,728,371
Income Tax Expense 3,053,780 2,883,575 2,470,110 2,015,580 1,409,325
Net Income 4,961,376 4,744,918 4,064,572 3,316,640 2,319,046
Basic Earnings per Common Share 0.78 0.74 0.62 0.53 0.38
Diluted Earnings per Common Share 0.76 0.71 0.58 0.49 0.35
Weighted average common shares outstanding 6,341,286 6,432,123 6,581,612 6,307,227 6,146,764
Dilutive effect of employee stock options 159,386 227,350 427,780 498,223 472,205
Weighted average shares outstanding-diluted 6,500,672 6,659,473 7,009,392 6,805,450 6,618,969
Year end shares outstanding 5,980,919 6,418,905 6,596,016 6,442,989 6,281,045
Total number of employees 190 200 235 185 159
Number common of stockholders 400 400 409 420 420
Number of beneficiary stockholders 800 800 800 800 800
Total number of stockholders 1,200 1,200 1,209 1,220 1,220
in parentheses show the percentage of total revenues attributable to each source for fiscal
years ended February 28 (29), 2008, 2007, 2006, and 2005, respectively.74
Basic earnings per share increased 18.5% from fiscal 2006 to fiscal 2007 and from
$0.74 in fiscal 2007 to $0.78 in fiscal 2008, an increase of 5.4%. Revenues increased
12.5% from fiscal 2006 to fiscal 2007, and 1% from 2007 to fiscal 2008. Operating income in-
creased 17.1% from fiscal 2006 to fiscal 2007, and 4.7% (from $7.6 million in fiscal 2007 to
$7.9 million) in fiscal 2008. Net income increased 16.7% from fiscal 2006 to fiscal 2007, and
4.6% from $4.7 million in fiscal 2007 to $5.0 million in fiscal 2008. The increase in revenue,
earnings per share, operating income, and net income in fiscal 2008 compared to fiscal 2007
and 2006 was due primarily to the increased number of franchised stores in operation, the
CASE 26 Rocky Mountain Chocolate Factory Inc. (2008) 26-19
EXHIBIT 8
Rocky Mountain
Chocolate Factory
Sources of Revenue
2005–2008
(Revenues in
thousands of
dollars)
SOURCE: Rocky Mountain Chocolate Factory, Inc. 2007 Form 10-K, p. 23 and 2006 Form 10-K, p. 20 and 23.
2008 2007 2006 2005
Factory Sales $23,758.2 $22,709.0 $19,297.2 $16,654.4
Retail Sales 1,800.0 2,626.7 3,046.0 2,726.4
Royalty and Marketing Fees 5,696.0 5,603.8 5,047.9 4,577.5
Franchise Fees 623.1 633.8 682.5 565.3
Total $31,877.3 $31,573.3 $28,073.6 $24,523.6
increased sales to specialty markets, and the corresponding increases in revenue.75 Details can
be found in Exhibit 8.
Factory sales increased in fiscal 2008 compared to fiscal 2007 due to an increase of
28.8% in product shipments to specialty markets and growth in the average number of stores
in operation to 324 in fiscal 2008 from 310 in fiscal 2007. Same-store pounds purchased in fis-
cal 2008 were down 9% from fiscal 2007, more than offsetting the increase in the average
number of franchised stores in operation and mostly offsetting the increase in specialty mar-
ket sales. RMCF believed the decrease in same-store pounds purchased in fiscal 2008 was due
primarily to a product mix shift from factory products to products made in the stores and also
the softening in the retail sector of the economy.76
The decrease in retail sales resulted primarily from a decrease in the average number of
company-owned stores in operation from 8 in fiscal 2007 to 5 in fiscal 2008. Same-store sales
at company-owned stores increased 1.1% from fiscal 2007 to fiscal 2008 and 6.9% from fis-
cal 2006 to fiscal 2007.77
Under the domestic franchise agreement, franchisees paid the company 1) an initial fran-
chise fee; 2) a marketing and promotion fee equal to 1% of the monthly gross retail sales of
the franchised store; and 3) a royalty fee based on gross retail sales. RMCF modified its roy-
alty fee structure for any new franchised stores opening the third quarter of fiscal 2004 and
later. Under the new structure no royalty was charged on franchised stores’ retail sales of prod-
ucts purchased from the company and a 10% royalty was charged on all other sales of product
sold at franchised locations. For franchise stores opened prior to the third quarter of fiscal
2004, a 5% royalty fee was charged on franchise stores gross retail sales. Franchise fee rev-
enue was recognized upon opening of the franchise store.78
The increase in royalties and marketing fees resulted from growth in the average number
of domestic units in operation from 266 in fiscal 2007 to 281 in fiscal 2008 partially offset by
a decrease in same store sales of 0.09%. Franchise fee revenues decreased during the past two
fiscal years due to a decrease in the number of franchises sold during the same period the pre-
vious year.79
Cost of sales increased from fiscal 2007 to 2008 due primarily to increased costs and mix
of products sold. Company-store margin declined during the same period due primarily to a
change in mix of products sold associated with a decrease in the average number of company
stores in operation.80
As a percentage of total royalty and marketing fee revenue, franchised costs decreased to
23.7% in fiscal 2008, 25.2% in fiscal 2007, and 25.6% in fiscal 2006 due to lower incentive
compensation costs. During this same period, sales and marketing costs and general and ad-
ministrative costs also decreased due primarily to lower incentive compensation costs.81
In fiscal 2008 retail operating expenses decreased due primarily to a decrease in the aver-
age number of company-owned stores during fiscal 2008 versus fiscal 2007. Retail operating
expenses, as a percentage of retail sales, decreased from 57.6% in fiscal 2006, to 57.2% in fis-
cal 2007, to 55.3% in fiscal 2008 due to a larger decrease in costs relative to the decrease in
26-20 SECTION D Industry Six—Specialty Retailing
revenues associated with a decrease in the average number of company stores in operation dur-
ing each fiscal year.82
Depreciation and amortization of $783,000 in fiscal 2008 decreased 10.4% from the
$874,000 incurred in fiscal 2007 due to the sale or closure of four company-owned stores and
certain assets becoming fully depreciated. Depreciation and amortization of $874,000 in fis-
cal 2007 was essentially unchanged from the $876,000 incurred in fiscal 2006.83
Other, net of $101,000 realized in fiscal 2008 represented an increase of $34,000 from the
$67,000 realized in fiscal 2007, due primarily to higher average outstanding balances of in-
vested cash during fiscal 2008. Notes receivable balances and related interest income declined
in fiscal 2008 because of two notes maturing or being paid in full compared with fiscal 2007.
RMCF also incurred interest expense in fiscal 2008 related to use of an operating line of credit.
Other, net of $67,000 realized in fiscal 2007, represented a decrease of $9,000 from the
$76,000 realized in fiscal 2006, due primarily to lower interest income on lower average out-
standing balances of notes receivable and invested cash. RMCF paid its long-term debt in full
during the first quarter of fiscal 2006.84
RMCF’s effective income tax rate in fiscal 2008 was 38.1%, which was an increase of
0.3% compared to fiscal 2007. The increase in the effective tax rate was primarily due to in-
creased income in states with higher income tax rates.85
In early 2008 RMCF repurchased 391,600 shares of its common stock at an average price
of $11.94 because the company believed the stock was undervalued.86 During the past eight
years, the company had repurchased approximately 3,909,000 shares of its common stock (ad-
justed for stock splits and stock dividends), at an average price of $5.09 per share.87 As of
April 30, 2008, there were 5,980,919 shares of common stock outstanding.88
As of February 29, 2008, working capital was $5.2 million compared with $7.5 million as
of February 28, 2007. The change in working capital was due primarily to operating results
less the payment of $2.4 million in cash dividends and the repurchase and retirement of
$5.9 million of the company’s common stock.89
Cash and cash equivalent balances decreased from $2.8 million as of February 28, 2007,
to $676,000 as of February 29, 2008, as a result of cash flows generated by operating and in-
vesting activities being less than cash flows used in financing activities. RMCF had a $5.0 mil-
lion line of credit, of which $4.7 million was available as of February 29, 2008, that bears
interest at a variable rate. For fiscal 2009, the company anticipated making capital expendi-
tures of approximately $500,000, which would be used to maintain and improve existing fac-
tory and administrative infrastructure and update certain company-owned stores. The
company believed that cash flow from operations would be sufficient to fund capital expendi-
tures and working capital requirements for fiscal 2009. If necessary, the company had avail-
able bank lines of credit to help meet these requirements.90
RMCF revenues and profitability were subject to seasonal fluctuations in sales because of
the location of its franchisees, which had traditionally been located in resort or tourist loca-
tions. As the company had expanded its geographical diversity to include regional centers, it
had seen some moderation to its seasonal sales mix. Historically the strongest sales of the com-
pany’s products had occurred during the Christmas holiday and summer vacation seasons. Ad-
ditionally, quarterly results had been, and in the future are likely to be, affected by the timing
of new store openings and sales of franchises.91
The most important factors in continued growth in the RMCF’s earnings were ongoing
unit growth, increased same-store sales and increased same-store pounds purchased from the
factory. Historically, unit growth more than offset decreases in same-store sales and same-store
pounds purchased.92 RMCF’s ability to successfully achieve expansion of its franchise system
depended on many factors not within the company’s control, including the availability of suit-
able sites for new store establishment and the availability of qualified franchises to support
such expansion.93
CASE 26 Rocky Mountain Chocolate Factory Inc. (2008) 26-21
For the fiscal year ended February 29, 2008, same-store pounds purchased from the fac-
tory by franchised stores decreased 9.1% from the previous fiscal year.94 Fiscal 2007 showed
a similar trend with same-store pounds purchased by franchisees decreasing 2.6% from fiscal
2006.95 RMCF believed the decrease in same-store pounds purchased was due to a product mix
shift from factory-made products to products made in the store, such as caramel apples and
fudge.96 Company efforts to reverse the decline in same-store pounds purchased from the fac-
tory by franchised stores and to increase total factory sales depended on many factors, includ-
ing new store openings, competition, and the receptivity of the company’s franchise system to
new product introductions and promotional programs.
In addition to efforts to increase the purchases by franchisees of company manufactured
products, RMCF was also sought to increase profitability of its store system through increas-
ing overall sales at existing store locations. Changes in systemwide domestic same-store sales
can be found in Exhibit 9. The company believed that the negative trend in fiscal 2008 was due
to the overall weakening of the economy and retail environment.97
According to Bryan Merryman, COO and CFO, “Sales at most RMCF stores are greatly
influenced by the levels of ‘foot traffic’ in regional shopping malls and other retail environ-
ments where the stores are located, and widely reported declines in such traffic resulted in lower
revenues and earnings in the fourth quarter of our 2008 fiscal year. In light of the significant
uncertainties surrounding the U.S. economy and retail trends in coming months, combined with
decreasing same-store pounds purchased by franchisees, we do not feel comfortable providing
specific earnings guidance for fiscal 2009 at the present time. If recent economic and con-
sumer trends continue but do not deteriorate further, we are likely to report a modest decline in
earnings for the (2009) fiscal year. Fortunately, we believe we are in excellent financial posi-
tion and well able to withstand the recessionary forces currently buffeting the U.S. economy.”98
EXHIBIT 9
Changes in
Systemwide
Domestic
Same-Store Sales
SOURCE: Rocky Mountain Chocolate Fac-
tory, 2008 Form 10-K, p. 4, and 2007 Form
10-K, p. 4.
2003 (3.4%)
2004 (0.6%)
2005 4.8%
2006 2.4%
2007 0.3%
2008 (0.9%)
N O T E S
1. Rocky Mtn. Chocolate Profiles in Success, January 28, 2008,
p. 1, www.boj.com/success/Rocky/Rocky/htm, Rocky Moun-
tain Chocolate Factory Inc., 2008 Form 10-K, p. 3, and Rocky
Mountain Chocolate Factory, Inc., www.referenceforbusiness.
com//history/Qu-Ro/Rocky–Mountain-Chocolate-Factory,
January 28, 2008, pp. 1–6. These sections were directly quoted
with minor editing.
2. Rocky Mtn. Chocolate Profiles in Success, January 28, 2008,
p. 1, www.boj.com/success/Rocky/Rocky/htm.
3. Rocky Mountain Chocolate Factory, Inc., www.referencefor-
business.com//history/Qu-Ro/Rocky–Mountain-Chocolate-
Factory, January 28, 2008, p. 2.
4. Rocky Mtn. Chocolate Profiles in Success, January 28, 2008,
p. 1, www.boj.com/success/Rocky/Rocky/htm.
5. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K, p. 3.
6. Ibid., p. 30.
7. Rocky Mtn. Chocolate Profiles in Success, January 28, 2008,
p. 1, www.boj.com/success/Rocky/Rocky/htm.
8. Ibid.
9. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p. 10. This section was directly quoted with minor editing.
10. Rocky Mtn. Chocolate Profiles in Success, January 28, 2008,
p. 2, www.boj.com/success/Rocky/Rocky/htm. This section
was directly quoted with minor editing.
11. Rocky Mountain Chocolate Factory, Inc., Proxy Statement,
August 17, 2007, pp. 3–4, and Rocky Mountain Chocolate
Factory, Inc., 2008 Form 10-K, pp. 11–12. These sections were
directly quoted with minor editing.
www.boj.com/success/Rocky/Rocky/htm
www.referenceforbusiness.com//history/Qu-Ro/Rocky�Mountain-Chocolate-Factory
www.referenceforbusiness.com//history/Qu-Ro/Rocky�Mountain-Chocolate-Factory
www.boj.com/success/Rocky/Rocky/htm
www.referencefor-business.com//history/Qu-Ro/Rocky�Mountain-Chocolate-Factory
www.referencefor-business.com//history/Qu-Ro/Rocky�Mountain-Chocolate-Factory
www.referencefor-business.com//history/Qu-Ro/Rocky�Mountain-Chocolate-Factory
www.boj.com/success/Rocky/Rocky/htm
www.boj.com/success/Rocky/Rocky/htm
www.boj.com/success/Rocky/Rocky/htm
26-22 SECTION D Industry Six—Specialty Retailing
12. Rocky Mountain Chocolate Factory, Inc., Proxy Statement,
August 17, 2007, p. 11. This section was directly quoted with
minor editing.
13. Ibid., p. 20. This section was directly quoted with minor editing.
14. Ibid., p. 1. This section was directly quoted with minor editing.
15. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
pp. 4–9 and 2007 Form 10-K, pp. 5–7. These sections were di-
rectly quoted with minor editing.
16. Rocky Mtn. Chocolate Profiles in Success, January 28, 2008,
www.boj.com/success/Rocky/Rocky/htm, p.1. This section was
directly quoted with minor editing.
17. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
pp. 7–8 and Rocky Mountain Chocolate Factory, Inc., Press Re-
lease, August 1, 2007, p. 1. These sections were directly quoted
with minor editing.
18. Rocky Mtn. Chocolate Profiles in Success, January 28, 2008,
www.boj.com/success/Rocky/Rocky/htm, p. 1.
19. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p. 5. This section was directly quoted with minor editing.
20. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p.13. This section was directly quoted with minor editing.
21. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p. 6. This section was directly quoted with minor editing.
22. Rocky Mtn. Chocolate Profiles in Success, January 28, 2008,
www.boj.com/success/Rocky/Rocky/htm, p. 2.
23. Rocky Mtn. Chocolate Profiles in Success, January 28, 2008,
www.boj.com/success/Rocky/Rocky/htm, p. 2.
24. Ibid., p. 1. This section was directly quoted with minor editing.
25. Rocky Mountain Chocolate Factory, Inc., www
.referenceforbusiness.com//history/Qu-Ro/Rocky–Mountain-
Chocolate-Factory, January 28, 2008, p.3. This section was
directly quoted with minor editing.
26. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p. 9. This section was directly quoted with minor editing.
27. Ibid., p. 14. This section was directly quoted with minor
editing.
28. Ibid., p. 6. This section was directly quoted with minor editing.
29. Ibid., pp. 4, 6. This section was directly quoted with minor editing.
30. Rocky Mountain Chocolate Factory, Inc., www
.referenceforbusiness.com//history/Qu-Ro/Rocky–
Mountain-Chocolate-Factory, January 28, 2008, p. 1. This
section was directly quoted with minor editing.
31. Confectionary News.com, Rocky Mountain Chocolate Wins
Packaging Award, May 31, 2002, http://www.confectionarynews
.com/news/ng.asp?id�14118-rocky-mountain-chocolate.
32. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p. 10. This section was directly quoted with minor editing.
33. RJFaulkner & Company, Inc.-Company Profile, Research Re-
port, Rocky Mountain Chocolate Factory, Nov/Dec 2006, p. 5,
www.rjfalkner.com/page.cfm?pageid�2140.
34. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p. 10. This section was directly quoted with minor editing.
35. Ibid.
36. Ibid., pp. 9–10. This section was directly quoted with minor
editing.
37. Ibid., p. 3. This section was directly quoted with minor editing.
38. NETZSCH’S ChocoEasy™, “New Chocolate Manufacturing
Technology Offers Chocolatiers Independence, More Efficient
Production,” Press release, November 17, 2005, http://www
.foodprocessingtechnology.com/contractors/processing/
netzsch/press2.html.
39. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p. 15. This section was directly quoted with minor editing.
40. Ibid., pp. 9, 10, 13, 27, 38. These sections were directly quoted
with minor editing.
41. Rocky Mountain Chocolate Factory Corporate Site, Product Se-
lection, p. 1, www.rmcf.com/CO/Denver50122/products.asp?.
42. Chanthavon, Samlanchith, “Chocolate and Slavery: Child La-
bor in Cote d’Ivoire,” TED Case Studies, January 2001, http://
www.american.edu/ted/chocolate-slave.htm.
43. Bax, Pauline. “Chocolate Industry Watching Cocoa Strike,” The
Seattle Times. October 7, 2006, http://seattletimes.nwsource
.com/html/businesstechnology/2003308331_cocoa17.html.
44. Rocky Mountain Chocolate Factory, Inc., www
.referenceforbusiness.com//history/Qu-Ro/Rocky–
Mountain-Chocolate-Factory, January 28, 2008, p. 1. This section
was directly quoted with minor editing.
45. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p. 10. This section was directly quoted with minor editing.
46. Ibid., p. 12. This section was directly quoted with minor editing.
47. Ibid., p. 11. This section was directly quoted with minor editing.
48. Leatherhead Food International, The Global Confectionary
Market-Trends and Innovations, www.leatherheadfood.com/
pdf/confectionary/pdf.
49. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p. 3. This section was directly quoted with minor editing.
50. National Confectioners Association, United States Confec-
tionary Market, January 2008, Slide 5, http://www.ecandy
.com/ecandyfiles/2007_Annual_Review_Jan_08.ppt.
51. Kermani, Faiz, “Chocolate Challenges,” Report Buyer, 2007,
p. 3, www.reportbuyer.com. This section was directly quoted
with minor editing.
52. Ibid.
53. Ibid.
54. Ibid., pp. 3–4.
55. Ibid., pp. 5–6.
56. Ibid., p. 1.
57. Moran, Michelle, “Category Analysis: Chocolate: Quality Sat-
isfies American Sweet Tooth,” Gourmet Retailer Magazine,
June 1, 2006, http://www.gourmettretiiler.com/gourmetretailer/
search/article_display.jsp?vnu_content_id�1002650555.
58. Schoettle, Anthony, “Local Chocolate Firm Leads Organic
Pack,” Indianapolis Business Journal, December 17, 2007,
Vol. 28, Issue 42, p. 19.
59. Kermani, Faiz, “Chocolate Challenges,” Report Buyer, 2007,
p. 2, www.reportbuyer.com.
60. National Confectioners Association, United States Confec-
tionary Market, January 2008., Slide 26, http://www.ecandy
.com/ecandyfiles/2007_Annual_Review_Jan_08.ppt.
61. Kermani, Faiz, “Chocolate Challenges, Report Buyer,” 2007,
p. 7, www.reportbuyer.com.
62. Ibid., p. 7.
63. Ibid., p. 11.
64. Ibid., p. 3.
65. Young, Lauren, “Candy’s Getting Dandier,” Business Week,
February 13, 2006, Issue 3971, p. 88, and Fuller, Allisa C.,
“Ethel M Ready to Rule Chocolate Kingdom,” Las Vegas Busi-
ness Press, October 1986, Vol. 3, Issue 10, Section 1, p. 56.
66. Sorkin, Andrew Ross (ed.), “Campbell Soup Sells Godiva for
$850 million,” DealBook, New York Times Business, January 14,
2008, p. 1, http://dealbook.blogs.nytimes.com/2007/12/20/
campbell-soup-sells-godiva-fpr-850-million/.
www.boj.com/success/Rocky/Rocky/htm
www.boj.com/success/Rocky/Rocky/htm
www.boj.com/success/Rocky/Rocky/htm
www.boj.com/success/Rocky/Rocky/htm
www.referenceforbusiness.com//history/Qu-Ro/Rocky�Mountain-Chocolate-Factory
www.referenceforbusiness.com//history/Qu-Ro/Rocky�Mountain-Chocolate-Factory
www.referenceforbusiness.com//history/Qu-Ro/Rocky�Mountain-Chocolate-Factory
www.referenceforbusiness.com//history/Qu-Ro/Rocky-Mountain-Chocolate-Factory
www.referenceforbusiness.com//history/Qu-Ro/Rocky-Mountain-Chocolate-Factory
http://www.confectionarynews.com/news/ng.asp?id=14118-rocky-mountain-chocolate
http://www.confectionarynews.com/news/ng.asp?id=14118-rocky-mountain-chocolate
www.rjfalkner.com/page.cfm?pageid=2140
http://www.foodprocessingtechnology.com/contractors/processing/netzsch/press2.html
http://www.foodprocessingtechnology.com/contractors/processing/netzsch/press2.html
http://www.foodprocessingtechnology.com/contractors/processing/netzsch/press2.html
www.rmcf.com/CO/Denver50122/products.asp?
http://www.american.edu/ted/chocolate-slave.htm
http://www.american.edu/ted/chocolate-slave.htm
http://seattletimes.nwsource.com/html/businesstechnology/2003308331_cocoa17.html
http://seattletimes.nwsource.com/html/businesstechnology/2003308331_cocoa17.html
www.referenceforbusiness.com//history/Qu-Ro/Rocky-Mountain-Chocolate-Factory
www.referenceforbusiness.com//history/Qu-Ro/Rocky-Mountain-Chocolate-Factory
www.leatherheadfood.com/pdf/confectionary/pdf
www.leatherheadfood.com/pdf/confectionary/pdf
http://www.ecandy.com/ecandyfiles/2007_Annual_Review_Jan_08.ppt
http://www.ecandy.com/ecandyfiles/2007_Annual_Review_Jan_08.ppt
www.reportbuyer.com
http://www.gourmettretiiler.com/gourmetretailer/search/article_display.jsp?vnu_content_id=1002650555
http://www.gourmettretiiler.com/gourmetretailer/search/article_display.jsp?vnu_content_id=1002650555
www.reportbuyer.com
http://www.ecandy.com/ecandyfiles/2007_Annual_Review_Jan_08.ppt
http://www.ecandy.com/ecandyfiles/2007_Annual_Review_Jan_08.ppt
www.reportbuyer.com
http://dealbook.blogs.nytimes.com/2007/12/20/campbell-soup-sells-godiva-fpr-850-million/
http://dealbook.blogs.nytimes.com/2007/12/20/campbell-soup-sells-godiva-fpr-850-million/
www.referenceforbusiness.com//history/Qu-Ro/Rocky-Mountain-Chocolate-Factory
www.referenceforbusiness.com//history/Qu-Ro/Rocky-Mountain-Chocolate-Factory
CASE 26 Rocky Mountain Chocolate Factory Inc. (2008) 26-23
67. Business Week, Chocoladefabriken Lindt & Sprengli Ag, 2007,
http://investing.businessweek.com/research/stocks/snapshot
.asp?capID�876088.
68. Lindt Company Website, About Lindt, July 3, 2008,
http://investors.lindt.com/cgi-bin/show.ssp?id�5101&compa-
nyName�lindt&language�Engl.
69. Alpine Confections, Inc. Company History, http://www
.fundinguniverse.com/company-histories/
AlpineConfections-Inc-Company-Hist
70. See’s Candies Website, July 3, 2008, http://www.sees.com/
history.cfm and http://www.sees.com/about.cfm.
71. Schoettle, Anthony, “Local Chocolate Firm Leads Organic
Pack,” Indianapolis Business Journal, December 17, 2007,
Vol. 28, Issue 42, p. 19.
72. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K.
pp. 15–37 also 2007 and 2005 Form 10-K. This section was di-
rectly quoted with minor editing.
73. Rocky Mountain Chocolate Factory Press Release, October 24,
2007. This section was directly quoted with minor editing.
74. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K, p. 3
and 2007 form 10-K, p. 3. These sections were directly quoted
with minor editing.
75. Ibid., p. 20. These sections were directly quoted with minor editing.
76. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p. 21. This section was directly quoted with minor editing.
77. Ibid. This section was directly quoted with minor editing.
78. Ibid., p. 35. This section was directly quoted with minor editing.
79. Ibid., p. 21. This section was directly quoted with minor editing.
80. Ibid., p. 22.
81. Ibid., p. 22.
82. Ibid., p. 22.
83. Ibid., p. 22.
84. Ibid., p. 22.
85. Ibid., p. 22.
86. Ibid., p. 22. This section was directly quoted with minor editing.
87. Rocky Mountain Chocolate Factory. Inc. Board Authorizes
New Stock Repurchase Program, PR Newswire, February 19,
2008, p. 1, www.mergentonline.com/compdetail.asp?company.
88. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p. 1. This section was directly quoted with minor editing.
89. Ibid., p. 24. This section was directly quoted with minor editing.
90. Ibid., p. 24. This section was directly quoted with minor editing.
91. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p. 25. This section was directly quoted with minor editing.
92. Ibid., pp. 18–19. This section was directly quoted with minor
editing.
93. Ibid., p. 19. This section was directly quoted with minor editing.
94. Ibid., p. 19. This section was directly quoted with minor editing.
95. Rocky Mountain Chocolate Factory, Inc., 2007 Form 10-K,
p. 19. This section was directly quoted with minor editing.
96. Rocky Mountain Chocolate Factory, Inc., 2008 Form 10-K,
p. 4. This section was directly quoted with minor editing.
97. Ibid.
98. Rocky Mountain Chocolate Factory Reports Record FY2008
Revenues and Earnings, Press Release, May 8, 2008, pp. 1–2.
This section was directly quoted with minor editing.
http://investing.businessweek.com/research/stocks/snapshot.asp?capID=876088
http://investing.businessweek.com/research/stocks/snapshot.asp?capID=876088
http://investors.lindt.com/cgi-bin/show.ssp?id=5101&companyNamecompanyName=lindt&language=Engl
http://www.fundinguniverse.com/company-histories/AlpineConfections-Inc-Company-Hist
http://www.fundinguniverse.com/company-histories/AlpineConfections-Inc-Company-Hist
http://www.sees.com/history.cfm
http://www.sees.com/history.cfm
http://www.sees.com/about.cfm
www.mergentonline.com/compdetail.asp?company
http://investors.lindt.com/cgi-bin/show.ssp?id=5101&companyNamecompanyName=lindt&language=Engl
http://investors.lindt.com/cgi-bin/show.ssp?id=5101&companyNamecompanyName=lindt&language=Engl
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27-1
C A S E 27
Dollar General Corporation:
2011 Growth Expansion Plans
(Mini Case)
Kathryn E. Wheelen
Expansion Plan
On January 6, 2011, the management of Dollar General announced its 2011 expansion
plan for the company. Dollar General had plans to open 625 stores, add 6,000 employ-
ees, and open stores in three additional states—Connecticut, Nevada, and New Hamp-
shire. Recently, the company announced plans to open stores in Colorado. In addition,
the company intended to remodel or relocate 550 of its 9,200 stores in 35 states.
Each store averaged 6 to 10 employees, a combination of full-time and part-time
employees. Employees had the option of flex-time. Wages were competitive to the local
market wages. The company had 79,800 employees.1
Industry
The dollar discount store industry’s primary competitors were Dollar General, the largest
company, with revenues of $12.73 billion; Family Dollar Stores, with revenues of $8.04 billion;
Dollar Tree in third place with revenues of $5.71 billion. The industry’s total revenue was
$36.98 billion.2 See Exhibit 1 for information on each of the three major players in this indus-
try segment.
This case was prepared by Kathryn E. Wheelen. Copyright ©2010 by Kathryn E. Wheelen. The copyright holder is solely
responsible for the case content. This case was edited for Strategic Management and Business Policy, 13th edition.
Reprinted by permission only for the 13th edition of Strategic Management and Business Policy (including international
and electronic versions of the book). Any other publication of this case (translation, any form of electronic or media) or
sale (any form of partnership) to another publisher will be in violation of copyright law unless Kathryn E.. Wheelen has
granted additional written reprint permission.
27-2 SECTION D Industry Six—Specialty Retailing
Corporate Ownership
KKR (Koldberg Kravis Roberts & Co. L.P) owned 79.17% (7,898,796,886 shares) of the
company stock on September 30, 2010. On March 12, 2007, KKR acquired Dollar General
for $732 billion. KKR, a private equity company, paid a 31% premium for the stock at $16.78.
Goldman Sachs Group Inc. owned 17.17% (1,712,829,454 shares) of the company’s stock.
Combined, these two companies owned 96.37% of Dollar General’s stock.
Goldman Sachs was KKR’s advisor on this deal, while Lazard and Lehman Brothers were
Dollar General’s advisor on this deal.4
A. Dollar Discount Stores’ Competitive Information
Dollar General Family Dollar Dollar Tree
Net Sales (millions) $12,735 $8,041 $5,716
YoY Chg 8.00% 7.6% 13.0%
3-Year CAGR 10.3% 5.1% 10.3%
Comparable sales Chg 5.8% 5.9% 7.1%
Gross margin 32.0% 35.7% 35.3%
Operating margin 9.0% 7.3% 10.3%
Profit margin 3.9% 4.5% 6.5%
Operating income (millions) $1,145 $588 $590
YoY Chg (in bps) 27.6% 23.8% 7.1%
Net income (millions) $493 $365 $370
YoY Chg 47.4% 21.8% 27.2%
3-YR GAGR N/A 14.9% 21.9%
Diluted EPS $1.43 $2.72 $2.84
YoY Chg 36.2% 27.1% 33.1%
3-YR CAGR N/A 18.6% 27.6%
Store count 9,273 6,852 4,009
Retail selling Sq. Ft 66,270,000 48,721,000 34,400,000
Employees 79,800 50,000 54,480
B. Average Sales
Dollar General Family Dollar Dollar Tree
Avg. sales/selling sq. ft $198 $167 $172
Avg. sales/stores (1,000s) $1,408 $1,189 $1,464
Avg. sales/employee $155,758 $162,116 $172,671
EXHIBIT 1
Direct Competitors
of Dollar General
(Data is trading
12 months)
The discount variety store industry’s prime player was Wal-Mart with revenues of
$419.24 billion, 2,100,000 employees, and income of $15.11 billion. Wal-Mart operated
“803 discount stores, 2,747 supercenters, 158 neighborhood markets, and 596 Sam’s Clubs in
the United States; 43 units in Argentina, 434 in Brazil, 317 in Canada, 252 in Chile, 170 in
Costa Rica, 77 in El Salvador, 164 in Guatemala, 53 in Honduras, 1 in India, 371 in Japan,
1,469 in Mexico, 55 in Nicaragua, 56 in Puerto Rico, and 371 in the United Kingdom, as well
as 279 stores in the Peoples Republic of China.”
Target was in second place with revenues of $66.91 billion, 351,000 employees, and net
income of $2.82 billion. It operated 1,746 stores in 49 states. Other large discount store
companies were Costco Wholesale Corporation and Kmart Corporation.3
SOURCE: http://seekingalpha.com/article/245097-discount-retail-throwdown-a-closer-look-at-dollar-stores?
source�yahoo. Used by permission of the author, Josh Ramer of RetailSails.com
http://seekingalpha.com/article/245097-discount-retail-throwdown-a-closer-look-at-dollar-stores?source=yahoo
http://seekingalpha.com/article/245097-discount-retail-throwdown-a-closer-look-at-dollar-stores?source=yahoo
CASE 27 Dollar General Corporation: 2011 Growth Expansion Plans (Mini Case) 27-3
Management Perspective on Growth
Management’s stated position on growth as a strategy is cited as follows:
In 2008, management engaged Nielson to assist us in updating our proprietary customer re-
search in an effort to better understand our customers, their purchasing habits and prefer-
ences. The results of this study indicate that our highest frequency and highest spending
customers, comprising approximately 50% of our sales, are those for whom low prices and
value are critical to their everyday shopping decisions. In August of 2009, we updated this
study with a customer survey designed to give us insight into recent changes in our customer
base. The results of this survey indicate that, while the description of our core customer re-
mains the same, our stores are now attracting customers who had not shopped at our stores
previously because of their perception of image or quality. In addition, the percentage of
shoppers classified as one-stop shoppers has increased. We believe that recent additions to
our merchandise offering, improvements to store operations and expansion of operating
hours, along with our consistent value proposition, are resonating well with our existing cus-
tomers and have been critical to our success in attracting and retaining new customers.
Based on additional proprietary survey results, management believes that in excess of 95%
of our current customers expect to shop our stores with the same or greater frequency after
the economy improves.
Based on Nielson Homescan Panel’s estimate of Dollar General shoppers, only 41% of the
population in our trade area, defined as the countries in which we have stores, has shopped at
Dollar General in the past year. We believe that the remaining 59% represents an opportunity to
grow our customer base. We are striving to continue to improve on the quality, selection and pric-
ing of our merchandise and upgrade our stores’ standards in order to attract and retain increas-
ing numbers and demographics of customers.5
Analyst Views on Dollar General’s Expansion
An analyst said, “(this announced 2011 expansion) . . . is in the face of the street’s perception
lately that Dollar General and the other dollar stores have had their day. The Street’s view is
that Dollar General and the others will lose the middle income customers they’ve gained as
the economy continues to grow stronger.”6
The analyst further stated, “(third quarter) . . . declining growth rate is interpreted on the
Street as a trend that will continue. However, investors with a longer-term view might see the
same news with different eyes.”7
Another analyst said, “The dollar stores have included more national brands in their
merchandise in a move to retain the new higher income customer and keep them coming back
long after the recession has passed.” He further stated, “Also, in a development the (Wall)
Street dismissed, higher inflation on some of the dollar store merchandise is leading to . . .
(lower store margins).”8
Anthony Chukunba, BB&T analyst, said, “Even though the economy is starting to
recover, consumers will continue to look for ways to save money.” Management of Dollar
General would agree with this analyst. The management also feels the company’s enhanced
merchandise with more national brands at a lower cost was a strong magnet to draw customers
into their store.9
An analyst said the crucial factor in the present depressed economy was the hiring of
employees with wages to support a family, and not jobs at minimum wages and no health care.
If the former occurs, this plays into the customers who will shop at Dollar General.
According to the Federal Reserve Chairman, Ben S. Bernanke, wages in 2010 increased
only 1.7%. The country needed to add 230,000 jobs just to keep up with the growth in the
27-4 SECTION D Industry Six—Specialty Retailing
The Dollar General Store and Merchandise
The average Dollar General store had approximately 7,100 square feet of selling space and
was typically operated by a manager, an assistant manager, and three or more sales clerks.
Approximately 55% of the stores were in freestanding buildings, 43% in strip shopping
centers, and 2% in downtown buildings. Most of its customers lived within three miles, or a
10-minute drive, of the stores. The Dollar General store strategy featured low initial capital
expenditures, limited maintenance capital, low occupancy and operating costs, and a focused
merchandise offering within a broad range of categories, allowing the company to deliver
low retail prices while generating strong cash flows and investment returns. A typical new
store in 2009 required approximately $230,000 of equipment, fixtures, and initial inventory,
net of payables.
Dollar General generally had not encountered difficulty locating suitable store sites in the
past. Given the size of the communities that it was targeting, Dollar General believed that there
was ample opportunity for new store growth in existing and new markets. In addition, the
current real estate market was providing an opportunity for Dollar General to access higher
quality sites at lower rates than in recent years. Also, Dollar General believed it had signifi-
cant opportunities available for its relocation and remodel programs. Remodeled stores
required approximately $65,000 for equipment and fixtures while the cost of relocations was
approximately $110,000 for equipment, fixtures, and additional inventory, net of payables.
Dollar General has increased the combined number of remodeled and relocated stores to 450 in
2009 as compared to 404 in 2008 and 300 in 2007.11
The following chart shows the Dollar General’s four major categories of merchandise:12
Finance
Exhibit 2 shows the consolidated balance sheets and Exhibit 3 shows the consolidated state-
ments of income for Dollar General. The key financial metrics shown below were developed
by management for 2010.13
Management recognized that the company had substantial debt, which included a
$1.964 billion senior secured term loan facility which matures on July 6, 2014; $979.3 million
aggregate principal amount of 10.623% senior notes due 2015; and $450.7 million aggre-
gate principal amount of 11.875%/12.625% senior subordinated toggle notes due 2017. This
debt could have important negative consequences to the business, including:
� Same-store sales growth;
� Sales per square floor;
� Gross profit, as a percentage of sales;
2009 2008 2007
Consumables 70.8% 69.3% 66.5%
Seasonal 14.5% 14.6% 15.9%
Home products 7.4% 8.2% 9.2%
Apparel 7.3% 7.9% 8.4%
yearly population (college and high school graduates, etc.). If inflation returned to the
economy, wages must exceed the annual wage increase so consumers would have more
money to spend.
The U.S unemployment rate in January, 2011 was around 9.4%–9.6%. The actual total
unemployment rate was 16.6%.10
CASE 27 Dollar General Corporation: 2011 Growth Expansion Plans (Mini Case) 27-5
January 28,
2011
January 29,
2010
Assets
Current assets:
Cash and cash equivalents $ 497,446 $ 222,076
Merchandise inventories 1,765,433 1,519,578
Income taxes receivable – 7,543
Prepaid expenses and other current assets 104,946 96,252
Total current assets 2,367,825 1,845,449
Net property and equipment 1,524,575 1,328,386
Goodwill 4,338,589 4,338,589
Intangible assets, net 1,256,922 1,284,283
Other assets, net 58,311 66,812
Total assets $ 9,546,222 $ 8,863,519
Liabilities and Shareholders’ Equity
Current liabilities:
Current portion of long-term obligations $ 1,157 $ 3,671
Accounts payable 953,641 830,953
Accrued expenses and other 347,741 342,290
Income taxes payable 25,980 4,525
Deferred income taxes payable 36,854 25,061
Total current liabilities 1,365,373 1,206,500
Long-term obligations 3,287,070 3,399,715
Deferred income taxes payable 598,565 546,172
Other liabilities 231,582 302,348
Commitments and contingencies
Redeemable common stock 9,153 18,486
Shareholders’ equity:
Preferred stock, 1,000 shares authorized – –
Common stock; $0.875 par value, 1,000,000 shares
authorized, 341,507 and 340,586 shares issued and
outstanding at January 28, 2011 and January 29,
2010, respectively
298,819 298,013
Additional paid-in capital 2,945,024 2,293,377
Retained earnings 830,932 203,075
Accumulated other comprehensive loss (20,296) (34,167)
Total shareholders’ equity 4,054,479 3,390,298
Total liabilities and shareholders’ equity $ 9,546,222 $ 8,863,519
EXHIBIT 2
Dollar General
Corporation and
Subsidiaries
Consolidated
Balance Sheets (In
thousands, except
per share amounts)
SOURCE: Dollar General Corporation, 2010 Form 10-K, p. 64.
27-6 SECTION D Industry Six—Specialty Retailing
� Operating profit;
� Inventory turnover;
� Cash flow;
� Net income;
� Earnings per share;
� Earnings before interest, income taxes, depreciation, and amortization; and
� Return on invested capital.
Management’s position on the impact of debt on the company was stated below:
� Increasing the difficulty of our ability to make payments on our outstanding debt;
� Increasing our vulnerability to general economic and industry conditions because our
debt payment obligations may limit our ability to use our cash to respond to our cash
flow to fund our operations, capital expenditures, and future business opportunities or
pay dividends;
� Limiting our ability to obtain additional financing for working capital expenditures, debt
service requirements, acquisitions, and general corporate or other purposes;
� Placing us at a disadvantage compared to our competitors who are less highly leveraged
and may be better able to use their cash flow to fund competitive response to changing
industry, market, or economic conditions.14
For the Year Ended
January 28,
2011
January 29,
2010
January 30,
2009
Net sales $ 13,035,000 $ 11,796,380 $ 10,457,668
Cost of goods sold 8,858,444 8,106,509 7,396,571
Gross profit 4,176,556 3,689,871 3,061,097
Selling, general and administrative expenses 2,902,491 2,736,613 2,448,611
Litigation settlement and related costs, net — — 32,000
Operating profit 1,274,065 953,258 580,486
Interest income (220) (144) (3,061)
Interest expense 274,212 345,744 391,932
Other (income) expense 15,101 55,542 (2,788)
Income before income taxes 984,972 552,116 194,403
Income tax expense 357,115 212,674 86,221
Net income $ 627,857 $ 339,442 $ 108,182
Earnings per share:
Basic $ 1.84 $ 1.05 $ 0.34
Diluted $ 1.82 $ 1.04 $ 0.34
Weighted average shares:
Basic 341,047 322,778 317,024
Diluted 344,800 324,836 317,503
EXHIBIT 3
Dollar General
Corporation and
Subsidiaries
Consolidated
Statements of
Income (In
thousands, except
per share amounts)
SOURCE: Dollar General Corporation, 2010 Form 10-K, p. 65.
CASE 27 Dollar General Corporation: 2011 Growth Expansion Plans (Mini Case) 27-7
1. Greg Stushinisu, “Dollar General Forges Ahead,” January 20,
2011, and company announcement on January 6, 2011 and
company documents.
2. Yahoo–Finance–competitors of Dollar General.
3. Yahoo–Finance–for both Wal-Mart and Target.
4. Parla B. Kavilana, “Dollar General to Be Acquired by KKR,”
CNNMoney.com, March 12, 2007.
5. Dollar General Corporation, “SEC 10-K,” January 29, 2010,
p. 8. These two paragraphs are directly quoted.
6. Greg Stushinisu, “Dollar General Forges Ahead,” January 20,
2011 (posted).
7. Ibid.
8. Ibid.
9. Ibid.
10. CNN Finance and MSNBC—both had Chairman Bernanke on
the news.
11. Dollar General Corporation, “SEC 10-K,” January 29, 2010,
p.7. These two paragraphs are directly quoted.
12. Ibid.
13. Ibid., p. 11.
14. Ibid., p. 31.
N O T E S
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History
STANLEY WALSH BEGAN INNER-CITY PAINT CORPORATION IN A RUN-DOWN WAREHOUSE,
which he rented, on the fringe of Chicago’s “downtown” business area. The company is
still located at its original site.
Inner-City is a small company that manufactures wall paint. It does not compete with
giants such as Glidden and DuPont. There are small paint manufacturers in Chicago that sup-
ply the immediate area. The proliferation of paint manufacturers is due to the fact that the
weight of the product ( 521⁄2 pounds per 5-gallon container) makes the cost of shipping great
distances prohibitive. Inner-City’s chief product is flat white wall paint sold in 5-gallon plas-
tic cans. It also produces colors on request in 55-gallon containers.
The primary market of Inner-City is the small- to medium-sized decorating company.
Pricing must be competitive; until recently, Inner-City had shown steady growth in this mar-
ket. The slowdown in the housing market combined with a slowdown in the overall economy
caused financial difficulty for Inner-City Paint Corporation. Inner-City’s reputation had been
built on fast service: it frequently supplied paint to contractors within 24 hours. Speedy deliv-
ery to customers became difficult when Inner-City was required to pay cash on delivery
(C.O.D.) for its raw materials.
Inner-City had been operating without management controls or financial controls. It had
grown from a very small two-person company with sales of $60,000 annually five years ago,
to sales of $1,800,000 and 38 employees this year. Stanley Walsh realized that tighter controls
within his organization would be necessary if the company was to survive.
This case was prepared by Professor Donald F. Kuratko of the Kelley School of Business, Indiana University,
Bloomington, and Professor Norman J. Gierlasinski of Central Washington University. Copyright © 1994 by
Donald F. Kuratko and Norman J. Gierlasinski. The copyright holder is solely responsible for the case content.
Reprint permission is solely granted to the publisher, Prentice Hall, for SMBP–10th, 11th, 12th, and 13th Editions
(and the International and electronic versions of this book) by the copyright holder, Donald F. Kuratko and
Norman J. Gierlasinski. Any other publication of the case (translation, any form of electronic or other media) or
sale (any form of partnership) to another publisher will be in violation of copyright law, unless Donald F. Kuratko
and Norman J. Gierlasinski have granted additional written reprint permission. Reprinted by permission.
28-1
C A S E 28
Inner-City Paint
Corporation (Revised)
Donald F. Kuratko and Norman J. Gierlasinski
Industry Seven—Manufacturing
28-2 SECTION D Industry Seven—Manufacturing
EXHIBIT 1
Paint Cost Sheet:
Inner-City Paint
Corporation
Equipment
Five mixers are used in the manufacturing process. Three large mixers can produce a maxi-
mum of 400 gallons, per batch, per mixer. The two smaller mixers can produce a maximum
of 100 gallons, per batch, per mixer.
Two lift trucks are used for moving raw materials. The materials are packed in 100-pound
bags. The lift trucks also move finished goods, which are stacked on pallets.
A small testing lab ensures the quality of materials received and the consistent quality of
their finished product. The equipment in the lab is sufficient to handle the current volume of
product manufactured.
Transportation equipment consists of two 24-foot delivery trucks and two vans. This small
fleet is more than sufficient because many customers pick up their orders to save delivery costs.
Facilities
Inner-City performs all operations from one building consisting of 16,400 square feet. The ma-
jority of the space is devoted to manufacturing and storage; only 850 square feet is assigned as
office space. The building is 45 years old and in disrepair. It is being leased in three-year
increments. The current monthly rent on this lease is $2,700. The rent is low in considera-
tion of the poor condition of the building and its undesirable location in a run-down neigh-
borhood (south side of Chicago). These conditions are suitable to Inner-City because of the
dusty, dirty nature of the manufacturing process and the small contribution of the rent to
overhead costs.
Product
Flat white paint is made with pigment (titanium dioxide and silicates), vehicle (resin), and wa-
ter. The water makes up 72% of the contents of the product. To produce a color, the necessary
pigment is added to the flat white paint. The pigment used to produce the color has been previ-
ously tested in the lab to ensure consistent quality of texture. Essentially, the process is the mix-
ing of powders with water, then tapping off of the result into 5- or 55-gallon containers. Color
overruns are tapped off into 2-gallon containers.
Inventory records are not kept. The warehouse manager keeps a mental count of what is
in stock. He documents (on a lined yellow pad) what has been shipped for the day and to
whom. That list is given to the billing clerk at the end of each day.
The cost of the materials to produce flat white paint is $2.40 per gallon. The cost per
gallon for colors is approximately 40% to 50% higher. The 5-gallon covered plastic pails
cost Inner-City $1.72 each. The 55-gallon drums (with lids) are $8.35 each (see Exhibit 1).
5 Gallons 55 Gallons
Sales price $27.45 $182.75
Direct material (12.00) (132.00)
Pail and lid (1.72) (8.35)
Direct labor (2.50) (13.75)
Manufacturing overhead ($1/gallon) (5.00) (5.00)
Gross margin $6.23 $23.65
Gross profit ratio 22.7% 12.9%
CASE 28 Inner-City Paint Corporation (Revised) 28-3
Selling price varies with the quantity purchased. To the average customer, flat white sells
at $27.45 for 5 gallons and $182.75 for 55 gallons. Colors vary in selling price because of the
variety in pigment cost and quantity ordered. Customers purchase on credit and usually pay
their invoices in 30 to 60 days. Inner-City telephones the customer after 60 days of nonpay-
ment and inquires when payment will be made.
Management
The President and majority stockholder is Stanley Walsh. He began his career as a house
painter and advanced to become a painter for a large decorating company. Walsh painted
mostly walls in large commercial buildings and hospitals. Eventually, he came to believe
that he could produce a paint that was less expensive and of higher quality than what was
being used. A keen desire to open his own business resulted in the creation of Inner-City
Paint Corporation.
Walsh manages the corporation today in much the same way that he did when the busi-
ness began. He personally must open all the mail, approve all payments, and inspect all cus-
tomer billings before they are mailed. He has been unable to detach himself from any detail of
the operation and cannot properly delegate authority. As the company has grown, the time el-
ement alone has aggravated the situation. Frequently, these tasks are performed days after
transactions occur and mail is received.
The office is managed by Mary Walsh (Walsh’s mother). Two part-time clerks assist her,
and all records are processed manually.
The plant is managed by a man in his twenties, whom Walsh hired from one of his cus-
tomers. Walsh became acquainted with him when the man picked up paint from Inner-City for
his previous employer. Prior to the eight months he has been employed by Walsh as Plant Man-
ager, his only other experience has been that of a painter.
Employees
Thirty-five employees (20 workers are part-time) work in various phases of the manufactur-
ing process. The employees are nonunion, and most are unskilled laborers. They take turns
making paint and driving the delivery trucks.
Stanley Walsh does all of the sales work and public relations work. He spends approxi-
mately one half of every day making sales calls and answering complaints about defective
paint. He is the only salesman. Other salesmen had been employed in the past, but Walsh felt
that they “could not be trusted.”
Customer Perception
Customers view Inner-City as a company that provides fast service and negotiates on price
and payment out of desperation. Walsh is seen as a disorganized man who may not be able
to keep Inner-City afloat much longer. Paint contractors are reluctant to give Inner-City
large orders out of fear that the paint may not be ready on a continuous, reliable basis.
Larger orders usually go to larger companies that have demonstrated their reliability and
solvency.
Rumors abound that Inner-City is in difficult financial straits, that it is unable to pay sup-
pliers, and that it owes a considerable sum for payment on back taxes. All of the above con-
tribute to the customers’ serious lack of confidence in the corporation.
28-4 SECTION D Industry Seven—Manufacturing
Financial Structure
Exhibits 2 and 3 are the most current financial statements for Inner-City Paint Corporation.
They have been prepared by the company’s accounting service. No audit has been performed
because Walsh did not want to incur the expense it would have required.
EXHIBIT 2
Balance Sheet for
the Current Year
Ending June 30:
Inner-City Paint
Corporation
EXHIBIT 3
Income Statement
for the Current Year
Ending June 30:
Inner-City Paint
Corporation
Current assets
Cash $1,535
Accounts receivable (net of allowance for bad debts of $63,400) 242,320
Inventory 18,660
Total current assets $262,515
Machinery and transportation equipment 47,550
Less accumulated depreciation 15,500
Net fixed assets 32,050
Total assets $294,565
Current liabilities
Accounts payable $217,820
Salaries payable 22,480
Notes payable 6,220
Taxes payable 38,510
Total current liabilities $285,030
Long-term notes payable 15,000
Owners’ equity
Common stock, no par, 1,824 shares outstanding 12,400
Deficit (17,865)
Total liabilities and owners’ equity $294,565
Sales $1,784,080
Cost of goods sold 1,428,730
Gross margin $355,350
Selling expenses $72,460
Administrative expenses 67,280
President’s salary 132,000
Office Manager’s salary 66,000
Total expenses 337,740
Net income $17,610
Future
Stanley Walsh wishes to improve the financial situation and reputation of Inner-City Paint
Corporation. He is considering the purchase of a computer to organize the business and re-
duce needless paperwork. He has read about consultants who are able to quickly spot prob-
lems in businesses, but he will not spend more than $300 on such a consultant.
The solution that Walsh favors most is one that requires him to borrow money from the
bank, which he will then use to pay his current bills. He feels that as soon as business condi-
tions improve, he will be able to pay back the loans. He believes that the problems Inner-City
is experiencing are due to the overall poor economy and are only temporary.
THE GARDNER COMPANY WAS A RESPECTED NEW ENGLAND MANUFACTURER OF MACHINES and
machine tools purchased by furniture makers for use in their manufacturing process. As a
means of growing the firm, the Gardner Company acquired Carey Manufacturing three
years ago from James Carey for $3,500,000. Carey Manufacturing was a high quality
maker of specialized machine parts. Ralph Brown, Gardner’s Vice President of Finance,
had been the driving force behind the acquisition. Except for Andy Doyle and Rod Davis,
all of Gardner’s Vice Presidents (Exhibit 1) had been opposed to expansion through acqui-
sition. They preferred internal growth for Gardner because they felt that the company would
be more able to control both the rate and direction of its growth. Nevertheless, since both Peter
Finch, President, and R. C. Smith, Executive Vice President, agreed with Brown’s strong rec-
ommendation, Carey Manufacturing was acquired. Its primary asset was an aging manufactur-
ing plant located 400 miles away from the Gardner Company’s current headquarters and
manufacturing facility. The Gardner Company was known for its manufacturing competency.
Management hoped to add value to its new acquisition by transferring Gardner’s manufactur-
ing skills to the Carey Plant through significant process improvements.
James Carey, previous owner of Carey Manufacturing, agreed to continue serving as Plant
Manager of what was now called the Carey Plant. He reported directly to the Gardner Com-
pany Executive Vice President, R. C. Smith. All functional activities of Carey Manufacturing
had remained the same after the acquisition, except for sales activities being moved under
Andy Doyle, Gardner’s Vice President of Marketing. The five Carey Manufacturing salesmen
were retained and allowed to keep their same sales territories. They exclusively sold only prod-
ucts made in the Carey Plant. The other Carey Plant functional departments (Human Re-
sources, Engineering, Finance, Materials, Quality Assurance, and Operations) were
supervised by Managers who directly reported to the Carey Plant Manager. The Managers of
the Human Resources, Engineering, Materials, and Operations Departments also reported in-
directly (shown by dotted lines in Exhibit 1) to the Vice Presidents in charge of their respec-
tive function at Gardner Company headquarters.
This case was prepared by Professor Thomas L. Wheelen and J. David Hunger of Iowa State University. Names and
dates in the case have been disguised. An earlier version of this case was presented to the 2000 annual meeting of the
North American Case Research Association. This case may not be reproduced in any form without written permis-
sion of the two copyright holders, Thomas L. Wheelen and J. David Hunger. This case was edited for SMBP–9th,
10th, 11th, 12th, and 13th Editions. Copyright © 2001, 2005, and 2008 by Thomas L. Wheelen and J. David Hunger.
The copyright holders are solely responsible for case content. Any other publication of the case (translation any form
of electronic or other media) or sale (any form of partnership) to another publisher will be in violation of copyright
law, unless Thomas L. Wheelen and J. David Hunger have granted additional written reprint permission. Reprinted
by permission.
29-1
C A S E 29
The Carey Plant
Thomas L. Wheelen and J. David Hunger
29-2 SECTION D Industry Seven—Manufacturing
President
Peter Finch
(age 62)
Executive Vice President
R.C. Smith
(age 59)
Special Consultant
James Carey
(age 60)
Plant Manager
Carey Plant
Manager
Human Resources
Manager
Engineering
Manager
Finance
Manager
Materials
Manager
Quality Assurance
Manager
Operations
Assistant to
VP-Finance
Bill May
(age 29)
Vice President
Finance
Ralph Brown
(age 47)
Vice President
Materials
Ralph Foster
(age 60)
Vice President
Marketing
Andy Doyle
(age 47)
Vice President
Operations
Ted Williams
(age 55)
Operations Manager
First Shift
Ray Smith
(age 42)
Operations Manager
Second Shift
Bob Charles
(age 47)
Operations Manager
Third Shift
John Carson
(age 40)
Vice President
Quality Assurance
Rod Davis
(age 47)
Vice President
Engineering
Paul Harris
(age 59)
Vice President
Human Resources
Les Bean
(age 54)
EXHIBIT 1
Gardner Company Organization Chart
Note: Dotted lines show an indirect reporting relationship.
Until its acquisition, Carey Manufacturing (now the Carey Plant) had been a successful
firm with few problems. Following its purchase, however, the plant had been plagued by la-
bor problems, increasing costs, a leveling of sales, and a decline in profits (Exhibit 2). Two
years ago, the Carey Plant suffered a 10-week strike called by its union in response to demands
from the new management (Gardner Company) for increased production without a correspond-
ing increase in pay. (Although Gardner Company was also unionized, its employees were rep-
resented by a different union than were the Carey Plant employees.) Concerned by both the
strike and the poor performance of the Carey Plant since its purchase two years earlier, Ralph
Brown initiated a study last year to identify what was wrong. He discovered that the poor per-
formance of the Carey Plant resulted not only from its outdated and overcrowded manufactur-
ing facility, but also from James Carey’s passive role as Plant Manager. Gardner’s Executive
Committee (composed of the President and eight Vice Presidents) had been aware of the poor
condition of the Carey Plant when it had agreed to the acquisition. It had therefore initiated
plans to replace the aging plant. A new state-of-the-art manufacturing facility was being built
on available property adjacent to the current plant and should be completed within a few
months. The information regarding James Carey was, however, quite surprising to the Com-
mittee. Before Gardner’s purchase of Carey Manufacturing, James Carey had been actively in-
volved in every phase of his company’s operations. Since selling the company, however, Carey
had delegated the running of the plant to his staff, the Department Managers. One of his Man-
agers admitted that “He was the driving force of the company, but since he sold out, he has
withdrawn completely from the management of the plant.”
After hearing Brown’s report, the Executive Committee decided that the Carey Plant
needed a new Plant Manager. Consequently, James Carey was relieved of his duties as Plant
Manager in early January this year and appointed special consultant to the Executive Vice
President, R. C. Smith. The current staff of the Carey Plant was asked to continue operating
the plant until a new Plant Manager could be named. Vice Presidents Brown and Williams
were put in charge of finding a new Manager for the Carey Plant. They recommended several
internal candidates to the Executive Vice President, R. C. Smith.
CASE 29 The Carey Plant 29-3
EXHIBIT 2
Carey Plant: Recent
Sales and Profit
Figures
Year Sales Profits
5 Years Ago $12,430,002 $697,042
4 Years Ago 13,223,804 778,050
3 Years Ago 14,700,178 836,028
2 Years Ago 10,300,000 (220,000)1
Last Year 13,950,000 446,812
Note:
1. Ten-week strike during October, November, and December.
The Offer
On January 31 of this year, Smith offered the Plant Manager position of the Carey Plant to
Bill May, current Assistant to Ralph Brown. May had spent six years in various specialist ca-
pacities within Gardner’s Finance Department after being hired with an MBA. He had been
in his current position for the past two years. Brown supported the offer to May with praise
for his subordinate. “He has outstanding analytical abilities, drive, general administrative
skills and is cost conscious. He is the type of man we need at the Carey Plant.” The other ex-
ecutives viewed May not only as the company’s efficiency expert, but also as a person who
would see any job through to completion. Nevertheless, several of the Vice Presidents ex-
pressed opposition to placing a staff person in charge of the new plant. They felt the Plant
Manager should have a strong technical background and line management experience.
Brown, in contrast, stressed the necessity of a control-conscious person to get the new plant
underway. Smith agreed that Gardner needed a person with a strong finance background
heading the new plant.
Smith offered May the opportunity to visit the Carey Plant to have a private talk with each
of his future staff. Each of the six Department Managers had been with the Carey Plant for a
minimum of 18 years. They were frank in their discussions of past problems in the plant and
in its future prospects. They generally agreed that the plant’s labor problems should decline in
the new plant, even though it was going to employ the same 405 employees (half the size of
Gardner) with the same union. Four of them were concerned, however, with how they were
being supervised. Ever since the acquisition by the Gardner Company, the Managers of the
Operations, Materials, Human Resources, and Engineering Departments reported not only to
James Carey as Plant Manager, but also to their respective functional Vice Presidents and staff
at Gardner headquarters. Suggestions from the various Vice Presidents and staff assistants of-
ten conflicted with orders from the Plant Manager. When they confronted James Carey about
the situation, he had merely shrugged. Carey told them to expect this sort of thing after an ac-
quisition. “It’s important that you get along with your new bosses, since they are the ones who
will decide your future in this firm,” advised Carey.
Bill May then met in mid-February with Ralph Brown, his current supervisor, to discuss
the job offer over morning coffee. Turning to Brown, he said, “I’m worried about this Plant
Manager’s position. I will be in a whole new environment. I’m a complete stranger to those
Department Managers, except for the Finance Manager. I will be the first member of the Gard-
ner Company to be assigned to the Carey Plant. I will be functioning in a line position with-
out any previous experience and no technical background in machine operations. I also
honestly feel that several of the Vice Presidents would like to see me fail. I’m not sure if I
should accept the job. I have a lot of questions, but I don’t know where to get the answers.”
Looking over his coffee cup as he took a drink, Brown responded, “Bill, this is a great oppor-
tunity for you. What’s the problem?” Adjusting himself in his chair, May looked directly at his
mentor. “The specific details of the offer are very vague in terms of salary, responsibilities, and
authority. What is expected of me and when? Do I have to keep the current staff? Do I have to
hire future staff members from internal sources or can I go outside the company? Finally, I’m
concerned about the lack of an actual job description.” Brown was surprised by his protégé’s
many concerns. “Bill, I’m hoping that all of these questions, except for salary, will soon be an-
swered at a meeting Smith is scheduling for you tomorrow with the Vice Presidents. He wants
it to be an open forum.”
The Meeting
The next morning, May took the elevator to the third floor. As he walked down the hall to the
Gardner Company Executive Committee conference room, he bumped into Ted Williams,
Vice President of Manufacturing, who was just coming out of his office. Looking at Bill, Ted
offered, “I want to let you know that I’m behind you 100%. I wasn’t at first, but I do think
you may have what it takes to turn that place around. I don’t care what the others think.” As
the two of them entered the conference room, May looked at the eight Gardner Vice Presi-
dents. Some were sitting at the conference table and working on their laptops while others
were getting some coffee from the decanter in the corner. R. C. Smith was already seated at
the head of the table. Ralph Brown, sitting on one side of the table, motioned to May to come
sit in an empty chair beside him. “Want some coffee?” Brown asked. “Good idea,” responded
May as he walked over to the decanter. Pouring cream into his coffee, May wondered, “What
am I getting myself into?”
29-4 SECTION D Industry Seven—Manufacturing
30-1
C A S E 30
The Boston Beer Company:
BREWERS OF SAMUEL ADAMS BOSTON LAGER (Mini Case)
Alan N. Hoffman
Company History
The Boston Beer Company was founded by Jim Koch in 1984 after the discovery of his
great-great grandfather’s family microbrew recipe in the attic of his home in Cincinnati,
Ohio. In his kitchen, Jim Koch brewed the first batch of what is today known as Samuel
Adams® Boston Lager. Through use of the family recipe, Jim handcrafted a higher qual-
ity, more flavorful beer than what was currently available in the United States.
Samuel Adams® beers were known for their distinct taste and freshness. Although different
brewers had access to the rare, expensive Noble hops that Samuel Adams® used, its special ingre-
dients remained a secret and were what gave its brews their distinct flavor. Jim Koch refused to
compromise on the components that made up the full, rich flavorful taste of Samuel Adams® beer.
As his business began to grow, Jim moved his brewing operations into an old, abandoned
brewery in Pennsylvania. This was subsequently followed by the opening of the extremely
popular Boston Brewery in 1988. In the mid-1990s, Jim further expanded his business opera-
tions by purchasing the Hudepohl-Schoenling Brewery in his hometown of Cincinnati, Ohio.
In 1995 The Boston Beer Company Inc. went public.
Jim Koch was viewed as the pioneer of the American craft beer revolution. He founded
the largest craft brewery, brewing over 1 million barrels of 25 different styles of Boston Beer
products, employing 520 people. Nevertheless, Boston Beer was only the sixth-largest brewer
in the United States, producing less than 1% of the total U.S. beer market in 2010.
This case was prepared by Professor Alan N. Hoffman, Bentley University and Erasmus University. Copyright ©2010
by Alan N. Hoffman. The copyright holder is solely responsible for case content. Reprint permission is solely granted
to the publisher, Prentice Hall, for Strategic Management and Business Policy, 13th Edition (and the international and
electronic versions of this book) by the copyright holder, Alan N. Hoffman. Any other publication of the case (trans-
lation, any form of electronics or other media) or sale (any form of partnership) to another publisher will be in viola-
tion of copyright law, unless Alan N. Hoffman has granted an additional written permission. Reprinted by permission.
The author would like to thank MBA students Peter Egan, Marie Fortuna, Jason McAuliffe, Lauren McCarthy, and
Michael Pasquarello at Bentley University for their research.
No part of this publication may be copied, stored, transmitted, reproduced, or distributed in any form or medium
whatsoever without the permission of the copyright owner, Alan N. Hoffman.
Industry Eight—Food and Beverage
30-2 SECTION D Industry Eight—Food and Beverage
Corporate Mission and Vision
The mission of the Boston Beer Company was “to seek long term profitable growth by offer-
ing the highest quality products to the U.S. beer drinker.”1 As the largest craft brewer, the
Boston Beer Company had been successful for several reasons: (1) premium products pro-
duced from the highest quality ingredients; (2) an unwavering commitment to the freshness of
its beer; (3) constant creativity and innovation that resulted in the introduction of a new flavor
of beer every year; and (4) the passion and dedication of its employees.
The Boston Beer Company’s vision was “to become the leading brewer in the Better Beer
category by creating and offering high quality full-flavored beers.”2 The Better Beer category
was comprised of craft brewers, specialty beers, and a large majority of the imports. As of
2010, Samuel Adams® was the largest craft brewer and “the third largest brand in the Better
Beer category of the United States brewing industry, trailing only the imports Corona and
Heineken.”3
In 2007, the Boston Beer Company had revenues of $341 million with COGS of $152 million
and $22.5 million of net income. From 2007 to 2009, revenues grew by 22% to $415 million with
COGS of $201 million and $31.1 million in net income. Management expected sales to be
$430 million in 2010. The Boston Beer Company had no long-term debt and only 14 million shares
outstanding. In August 2010, the stock price was $67.
The Beer Industry
The domestic beer market in 2010 was facing many challenges. In 2010, domestic beer over-
all sales declined 1.2%. Industry analysts predicted inflation-adjusted growth to be only 0.8%
through 2012.4 Decreases in domestic beer sales as a whole were mainly due to decreased
alcohol consumption per person. U.S. consumers were drinking less beer because of health
concerns, increased awareness of the legal consequences of alcohol abuse, and an increase in
options for more flavorful wines and spirits.
To gain more market share in a highly competitive market, the industry was shifting to the
mass production of beers, leading to industry consolidation. There were two major players in
the brewing industry in the United States: AB InBev (Anheuser-Busch) and SABMiller PLC
(SABMiller). SABMiller PLC was a 2007 joint venture of SABMiller and Molson Coors.
Anheuser-Busch had been purchased in 2008 by Belgium producer InBev, the second largest
beer producer in the world.
The domestic beer industry also contained some opportunities. Although sales of
domestic beer were flat, the past decade showed increases in the domestic consumption of
light beer and the craft beer categories. The Better Beer category (comprised of craft, spe-
cialty, and import beers) was growing at an annual rate of 2.5% and comprised roughly 19%
of all U.S. sales. Beers were classified as “better beers” mainly because of higher quality,
taste, price, and image, compared to mass-produced domestic beers. The craft beer segment
grew an estimated 9% in 2010. In an industry dominated by male customers, females were
viewed as an opportunity. Research showed that women were most concerned about the
calories in beer. However, 28% of these same women answered that they were presently
drinking more wine.5
Since its inception, Jim Koch has had numerous offers from the large brewing companies
to buy him out, but he has consistently declined those offers. He wanted to remain independ-
ent and never compromise on the full, rich flavorful and fresh taste of Samuel Adams® beer.
Jim never altered his great-great grandfather’s original recipe created over a century ago.
CASE 30 The Boston Beer Company 30-3
Domestic Beers
Two major players in the U.S. domestic beer market—AB InBev and MillerCoors—accounted
for roughly 95% of all U.S. beer production and sales, minus imports.
MillerCoors LLC controlled roughly 30% of the U.S. beer market. MillerCoors recently
entered the Better Beer category by acquiring, in whole or in part, existing craft brewers and
by importing and distributing foreign brewers’ brands. In 2010, the company experienced
double-digit growth with its Blue Moon, Leinenkugel’s, and Peroni Nastro Azzurro brands.
AB Inbev was the number one brewer in the U.S. market in terms of both volume and rev-
enues. Its dominant position allowed it to exert significant influence over distributors, making
it difficult for smaller brewers to maintain their market presence or access new markets. Inbev
was created in the 2004 merger of the Belgian company Interbrew and the Brazilian brewer
AmBev and subsequently purchased Anheuser-Busch in 2008.
The growth in craft beer sales was good news for the Boston Beer Company, which posi-
tioned itself in this category and was the largest and most successful craft brewer in the United
States. It ranked third overall in the U.S. Better Beer category, trailing only two imports:
Corona from Mexico and Heineken from The Netherlands.
Craft Beer Segment
Sierra Nevada Brewing Company was the second largest craft beer maker in the United
States. Founded in Chico, California, in 1980, the company’s mission was to produce the
finest quality beers and ales, and believed that its mission could be accomplished “without
compromising its role as a good corporate citizen and environmental steward.” Its most
successful brands included the hop-flavored Pale Ale, as well as Porter, Stout, and wheat
varieties. Sierra Nevada, like Samuel Adams®, produced seasonal brews including Summer
Fest, Celebration, and Big Foot. Although Sierra Nevada beer had been distributed nationally
for some time, sales were still strongest on the West Coast.
New Belgium Brewing Company was founded in 1991 in Fort Collins, Colorado. Its
Fat Tire brand made up two-thirds of the company’s total sales.6 New Belgium currently had
nine total craft beer brands, in addition to seasonal and limited brands. Its products were
offered in 25 western and midwestern states. New Belgium, like Sierra Nevada, focused on
being eco-friendly and stressed employee ownership in its mission.
Imports
Grupo Modelo was founded in 1925 and was the market leader in Mexico. Its most success-
ful product, Corona Extra, was the United States’ number one beer import out of 450 imported
beers. AB Inbev held a 50% noncontrolling interest in Grupo Modelo.
Heineken, the third largest brewer by revenue, positioned itself as the world’s most
valuable international premium beer. Heineken had over 170 international, regional, and local
specialty beers and 115 breweries in 65 countries. It had the widest presence of all international
brewers due to the sales of Heineken and Amstel products.
Flavored Malt Beverage Category
Samuel Adams® also competed in the “flavored malt beverage” (FMB) category with Twisted
Tea. The FMB category accounted for roughly 2% of U.S. alcohol consumption. Twisted Tea
competed mainly with beverages such as Smirnoff Ice, Bacardi Silver, and Mike’s Hard
Lemonade. FMB products all targeted relatively the same consumers. Since pricing was
similar, these products relied heavily upon advertising and promotions.
30-4 SECTION D Industry Eight—Food and Beverage
Current Challenges
The Boston Beer Company had been growing revenues by 22% over the past two years, and
the craft beer industry as a whole continued to experience double-digit growth as well. How-
ever, there were some challenges ahead if the company was to successfully achieve its mission
and continue this level of growth.
1. Probably the most critical challenge was the increased level of competition in the craft
beer industry. “Volume sales within the craft beer industry increased 20% during
2002–2010 to 220 million cases,”7 and this astonishing growth attracted many players into
this market, especially imported beers such as Corona and Heineken, and the top two
brewers AB Inbev and MillerCoors.
2. Through mergers and acquisitions, the major competitors achieved cost savings and
greater leverage with suppliers and distributors and preferential shelf space and placement
with retailers.
3. A continuous increase in production costs of all basic beer ingredients, such as barley malt
and hops, as well as packaging materials like glass, cardboard, and aluminum continued
into 2010 with further increases in fuel and transportation costs. The global inventory of
the company’s “Noble” hops declined, and the harvest in recent years of its two key hops
suppliers in Germany did not meet the high standards of the Boston Beer Company. As a
result, Boston Beer received a lower quantity at a higher price than expected.
4. The company purchased a brewery in Breinigsville, Pennsylvania, in 2008 for $55 million.
Although this brewery was expected to increase capacity by 1.6 million barrels of beer
annually, it required significant renovations before it could produce quality beer.
United Airlines Dilemma
United Airlines recently approached the Boston Beer Company with an interesting opportu-
nity. United wanted to offer Samuel Adams® Boston Lager to fliers on all of its flights. This
would provide the Boston Beer Company increased national exposure and could result in a
significant increase in beer sales. However, United Airlines would only sell Samuel Adams®
Boston Lager in cans, not bottles.
The Boston Beer Company had never sold any of its beers in cans because management
believed that metal detracts from the flavor of the beer. Management felt that the “full-flavor”
of Samuel Adams® could only be realized using glass bottles. Should Boston Beer’s manage-
ment rethink its decision not to distribute its beer in cans to take advantage of this opportu-
nity? Many years ago, Jim Koch said that there would never be a “Sam Adams Light Beer,”
but he eventually reversed that decision and Sam Light became a huge success.
N O T E S
1. 2007 Annual Report, http://thomson.mobular.net/thomson/7/
2705/3248/.
2. 2007 Annual Report, http://thomson.mobular.net/thomson/7/
2705/3248/.
3. 2007 Annual Report, http://thomson.mobular.net/thomson/7/
2705/3248/.
4. Mintel—US–Domestic Beer December 2007.
5. Ibid.
6. http://www.rockymountainnews.com/news/2007/nov/24/
reuteman-colorado-rides-on-fat-tire-to-beer/.
7. Mintel Report, “Domestic Beer – US – December 2007 –
Executive Summary,” http://academic.mintel.com.ezp.bentley
.edu/sinatra/mintel/print/id�311747 (July 15, 2008).
http://thomson.mobular.net/thomson/7/2705/3248/
http://thomson.mobular.net/thomson/7/2705/3248/
http://thomson.mobular.net/thomson/7/2705/3248/
http://thomson.mobular.net/thomson/7/2705/3248/
http://thomson.mobular.net/thomson/7/2705/3248/
http://thomson.mobular.net/thomson/7/2705/3248/
http://www.rockymountainnews.com/news/2007/nov/24/reuteman-colorado-rides-on-fat-tire-to-beer/
http://www.rockymountainnews.com/news/2007/nov/24/reuteman-colorado-rides-on-fat-tire-to-beer/
http://academic.mintel.com.ezp.bentley.edu/sinatra/mintel/print/id=311747
http://academic.mintel.com.ezp.bentley.edu/sinatra/mintel/print/id=311747
PATRICK HUNN SAT AT HIS DESK WONDERING HOW COULD SUCH A GOOD DEAL BE VIEWED
NEGATIVELY? Patrick Hunn, team leader of Wal-Mart Sales, for Vlasic Foods International, had
made a record-breaking deal with Wal-Mart that resulted in selling more pickles than Vlasic
had ever sold to any one account. Wal-Mart was an important customer, accounting for 30%
of Vlasic Foods’ sales. By negotiating a deal with Wal-Mart to offer a gallon jar of Vla-
sic pickles for $2.97 at the front of the store, Hunn had given Wal-Mart its “customer stop-
per.” In addition, Hunn secured an agreement that Wal-Mart would continue to buy
grocery size pickles, relishes, and peppers with each order of the gallon jar. The gallon
jar of Vlasic pickles was available in over 3,000 Wal-Mart stores in the United States. It had
been the deal of a lifetime, he had thought at the time. Why did Marketing conclude that the
deal was an enormous mistake even though Vlasic sold more product to Wal-Mart than had
ever been sold into any account? Steve Young, vice president of Grocery Marketing for Vla-
sic Foods International, had approved the deal. Why was Young so convinced now that Vlasic
needed to get out as soon as they could?
Background
The Vlasic brand had a long heritage of being the number one pickle brand in America. The
founders of the product line were Polish immigrants who sold their pickles through a dairy and
food distributor in Detroit. From a creamery business to a full-scale manufacturing operation,
the Vlasic brand was built on product quality and strong advertising and promotion. An adver-
tising campaign developed in 1974 featured a stork delivering the message, “Vlasic is the best-
tasting pickle I ever heard!” This campaign helped give the brand a national identity.
31-1
C A S E 31
Wal-Mart and Vlasic Pickles
Karen A. Berger
This case was prepared by Professor Karen A. Berger of Lubin School of Business at Pace University. This case
cannot be reproduced in any form without the written permission of the copyright holder, Professor Karen Berger.
Reprint permission is solely granted to the publisher, Prentice Hall, for the book Strategic Management and
Business Policy—13th (and the International and electronic versions of this book) by copyright holder, Karen
Berger. This case was edited for SMBP—13th Edition. The copyright holders are solely responsible for the case
content. Any other publication of the case (translation, any form of electronics or other media), or sold (any form
of partnership) to another publisher will be in violation of copyright laws unless Professor Karen Berger has granted
an additional written reprint permission. This case was presented to and accepted by the Society for Case Research.
This case appeared in a 2007 issue of the Business Case Journal. This case was edited for SMBP-13th Edition.
Copyright © 2007 Professor Karen A. Berger. Reprinted by permission.
In 1978 the company was sold to the Campbell Soup Company. As part of Campbell, the
Vlasic brand prospered due to increased investment in both advertising expenditures and
R&D. The 1994 roll-out of the Vlasic Stackers line of pickle slices intended for sandwiches
continued to help build the brand into a major line of pickle products accounting for over a
third of the U.S. pickle market. By 2000 the brand boasted 95% consumer awareness and was
the only national pickle brand in America. However, the overall pickle market had been flat
for a few years and Vlasic had only achieved small gains in the nineties. As Campbell’s recon-
sidered its own agenda, its stock prices were sagging. Seeking to improve its profitability pic-
ture, Campbell reviewed its business units with an eye to weed out those businesses that did
not meet Campbell’s corporate benchmarks and objectives. Ultimately, the decision was made
to spin off several non-core businesses, including Vlasic pickles as well as Open Pit Barbecue
Sauce, Swanson foods, Armour meats in Argentina, and a mushroom farm business.
In March 1998 Campbell spun off a newly public company called Vlasic Foods Interna-
tional. This move was seen as essential to change Campbell’s strategic focus and improve its
long-term financial picture. The newly spun-off company, however, held debt of over $500
million along with an annual sales volume of $1.1 billion. The Vlasic line was its strongest
business, accounting for sales of over $251 million in 2000.
Patrick Hunn had a long-established relationship with Wal-Mart. First, he was a major li-
aison between Sam’s Club, a division of Wal-Mart, and Vlasic when it was part of Campbell’s.
His decade-long relationship with Wal-Mart made him essential to the newly formed company.
He was quickly promoted from team leader of Sam’s Clubs for Vlasic pickle brands to team
leader of Wal-Mart for all Vlasic brands and products.
Both Hunn and Young had access to the Retail Link database that Wal-Mart had made
available to its sixty-one thousand U.S. suppliers. From this database, first made accessible to
vendors in 1991, Young and other selected executives from Vlasic could look at their sales data
to help them understand the source and timing of their brands sold through Wal-Mart. This sys-
tem helped Vlasic and other companies service Wal-Mart in the way that Wal-Mart wanted,
with speed and care. In most stores, the system was connected at the individual store level al-
lowing a given supplier to receive reports of shelf movement via real-time satellite links that
update the system report each time a scan occurred at the point-of-purchase. Thus, the supplier
was able to adjust its manufacturing qualities in real-time. The accuracy and timeliness of this
type of system eliminated warehouse stock pile-ups, saving time and processing costs for the
supplier. A supplier that did not have this type of electronic data interchange throughout the
supply chain usually had higher costs and, therefore, would be likely to have difficulty meet-
ing Wal-Mart’s demands.
Like other Wal-Mart suppliers, Vlasic knew that Wal-Mart did not tolerate late orders or
out-of-stocks. Wal-Mart provided the seamlessness for suppliers to maximize the efficiency of
the supply chain and they expected their suppliers to respond. Vlasic had had no difficulties
meeting Wal-Mart’s volume requirements.
Bob Bernstock, president of the newly formed Vlasic Foods, knew that Wal-Mart was es-
sential to his company. By 1998 it was well-established—not just at Vlasic—that a contract
with Wal-Mart by definition was very important to a company’s growth and success. The scale
of business that Wal-Mart promised companies was unprecedented given the size of its orders
and distribution capabilities. Wal-Mart was able to go national with a new item in two weeks
as compared to two months in many other chains.
Hunn knew that his “charge” was to build volume for Vlasic brands and products through
Wal-Mart. He had successfully worked with Wal-Mart and saw this deal as just one more oppor-
tunity to do business with this important and well-respected client. While he was not sure that the
one gallon deal was a good idea at first, he had warmed up to the notion when he realized he could
tie the deal to the “grocery segment,” defined as pickles, relishes, and peppers 46 oz. and below.
31-2 SECTION D Industry Eight—Food and Beverage
Major deals and programs had to be approved by the president of Sales, Maurice Lane.
Both Steven Young, vice president for grocery sales, and Pat Hunn, team leader for the Wal-
Mart account, reported to the president of Sales.
By 1990 Wal-Mart was the number one retailer in the United States. By 1997 Wal-Mart had
already had its first $100 billion sales year with combined national and international sales total-
ing $105 billion. Wal-Mart had become an international company with stores in Canada, Ar-
gentina, Korea, China, and Germany.As team leader of Sales for such a large, important account,
Pat Hunn was an important player at Vlasic, controlling 30% of its largest line, Vlasic pickles.
The focus on the one-gallon jar of Vlasic pickles came into play when a Wal-Mart man-
ager came up with the idea to offer the one-gallon jar usually sold in the Food Service section
as a Memorial Day item at the promotion price of $2.97, instead of the everyday low price of
$3.47. The Food Service section, also known as the Institutional section, was an eight-foot sec-
tion near the rest of the grocery. The Food Service section contained items that small conces-
sion businesses and “Mom ’n Pop” grocery stores regularly bought. This section tended to not
be as frequently shopped as the end aisles and other more prominent areas of the store. The
Wal-Mart manager who wanted to do this promotion called the Bentonville headquarters, re-
questing promotional dollars for the one-gallon jar. Like other consumer packaged goods com-
panies, Vlasic regularly gave its customers allowance money, part of a Marketing Investment
Planning program (MIP fund for short). Once allowance money was paid, Vlasic customers
could utilize the funds as they wished. Wal-Mart was a centralized organization with promo-
tional funds controlled at the Wal-Mart headquarters. Thus, the manager of an individual store
had to get promotional funding from headquarters.
According to Hunn, the allowance permitted this one Wal-Mart store to price the gallon
jar at a price point of $2.97. The promotion ran over Memorial Day and “the gallon sold like
crazy. . . . surprising us all.”1 News of this success spread throughout the Wal-Mart district.
Soon many managers in the region wanted to duplicate this success in their stores.
In late 1998, one of the Wal-Mart grocery buyers, remembering the success of the Vlasic
gallon-jar promotion, brainstormed that the gallon jar could be a “customer stopper.” The over-
whelming success of this limited market promotion triggered more discussions between Hunn,
the Wal-Mart team leader at Vlasic, and the buying department at Wal-Mart. As team leader
of the Wal-Mart account, Hunn’s position required that he focus on building volume and mar-
ket share. Approval of the deal needed to also come from Steve Young, vice president of gro-
cery marketing. Both Hunn and Young were eager to build volume for their core brand.
CASE 31 Wal-Mart and Vlasic Pickles 31-3
The Deal
According to Hunn, this little promotion in a relatively low trafficked part of the store soon
blossomed into a major deal, because of the newly expanded scope of the promotion. Wal-
Mart executives were convinced that if consumers were enticed by a gallon of pickles at $2.97
in the Food Service section, then they would be even more enticed if the promotion was
moved to an end aisle. In fact, Wal-Mart buyers saw the one-gallon jar as the “customer stop-
per” they wanted. The product was to be a special feature that was showcased in end stacks
near or at the front of the stores. At the agreed upon price of $2.97, the jar would yield only
one or two cents per jar for Vlasic. At this lower cost, Wal-Mart could price the jar at $2.97,
leaving no more than a few cents profit per gallon jar for Wal-Mart as well. However, Hunn
secured the deal with one proviso—all gallon-jar orders would have to be tied to a corre-
sponding order of grocery sized items. As another control measure, the total number of cases
that Vlasic would sell to Wal-Mart was established at the start of the fiscal year as part of the
normal planning process.
31-4 SECTION D Industry Eight—Food and Beverage
The Results
The sales test proved right—the promotion was an enormous success for Wal-Mart. Vlasic’s
sales numbers skyrocketed, showing double-digit growth in the first few weeks. The gallon
jar was so successful that Wal-Mart was purportedly selling on average 80 jars per store per
week, or more than 240,000 gallons of pickles, just counting those sold in the gallon jars.
However, the production quantities necessary to serve Wal-Mart put a strain on the procure-
ment and production system. However, the product was selling and the Wal-Mart business
grew to more than 30% of Vlasic Food International’s business.2
Wal-Mart was very pleased with the success of the item. Wal-Mart continued to re-order
gallon jars as stock became low. Since there was no cap on the order volume except for the re-
quirement to also purchase the grocery size, the one-gallon jar was no longer a short-lived deal
item, but a regular deal. From the consumer’s point of view, the $2.97 deal was the Wal-Mart
Every Day Low Price.
However, sources at Vlasic reported that profit was down 25%–50%. Some blamed the
Wal-Mart deal for this decline. Production was pressed to provide quantities in record num-
bers and at times put a strain on the supply chain. Since the gallon jar used the same size and
generally same product quality cucumbers as the dills and spears, this at times affected the
availability of pickles for the jars of dills and spears. Since the jars of dills and spears consisted
of cut pickles, they carried higher margins than the whole pickles. In addition, the pickle cost
for the gallon jar could be reduced if less perfectly shaped pickles were added to the one gal-
lon jar. However, the expansion of the distribution of the gallon jar resulted in periodic substi-
tutions of the more perfect (and higher cost) pickles intended for the smaller but more
profitable jars of dills and spears. Thus, pickles that were needed for the jars of dills and spears
were sometimes in short supply and compromised the smooth flow of the supply chain. Mar-
keting reported that over time, the few cents that Vlasic was making on the promotion was
eroded, resulting in small losses per jar, given higher costs.
Supermarket sales, in non–Wal-Mart chains and independent stores, in 1999–2000 de-
clined significantly with many customers placing smaller orders than the previous year. Mar-
keting at Vlasic reported that predicted profits were eaten up by expenses associated with the
loss of business in the non–Wal-Mart grocery sector.
On the other hand, Wal-Mart business showed real, incremental growth in its stores, based
on analysis of organic growth from store expansion versus same-store growth. Not only was
Wal-Mart growing due to new stores, but its existing stores were growing and showing healthy
revenue and profit gains.
Through this promotion, volume of Vlasic pickles—all kinds—in Wal-Mart stores grew,
so that Wal-Mart accounted for 33% of the Vlasic business. According to Hunn, sales revenue
of Vlasic pickles was higher than before the gallon-jar “promotion.”
The Marketing Perspective
Steve sat at his desk. His hands were full of problems due to cash flow shortages at his com-
pany. Vlasic Foods International had been spun off from Campbell’s just months ago. The ef-
fect of the $500 million of debt that the spun-off company took with it was just becoming
known. While this deal was only one issue in a sea of financial challenges, Steve felt that he
should weigh in on the Wal-Mart part of the business given its effects on non–Wal-Mart gro-
cery accounts. He had pleaded with Hunn to dip into his equity with Wal-Mart and end this
promotion. Young was sure that this promotion had cannibalized the non–Wal-Mart business.
According to Young, they “saw consumers who used to buy the spears and the chips in
CASE 31 Wal-Mart and Vlasic Pickles 31-5
The Sales Perspective
Pat Hunn was surprised, if not disturbed, by the commentary from grocery marketing. Vlasic
had financial troubles that went way beyond the sale of pickles. Wal-Mart was a great
customer—sales with Wal-Mart now reached 33% of the Vlasic Foods business. On the rev-
enue side, Vlasic’s business was up with a dramatic shift upward in Wal-Mart sales. “Yes,
there have been some troubles with production, but that was their job. Wal-Mart has helped
build Vlasic’s name as a leader in the pickle business. . . . I simply do not see why so many
people are upset,” thought Hunn to himself. He sat at his desk, shrugged his shoulders, and
went back to work.
R E F E R E N C E S
Berman, Barry (1996), Marketing Channels. New York: John
Wiley & Sons. Brynwood Partners (2005), “Pinnacle
Foods,” www.brynwoodpartners.com/investment/
pinnacle. htm.
Dallas Business Journal (2003), “Hicks Muse Selling Pinnacle
Foods for $485 million,” www.bizjournals.ocm/dallas/
stories/2003/08/11/daily1.html.
Fishman, Charles (2003), “The Wal-Mart You Don’t Know,”
Fast Company, December 2003, p. 68, also available at
pf.fastcompany.com/magazine/77/walmart.html.
Freeman, Richard (2003), “Wal-Mart ‘Eats’ More U.S. Manu-
facturers,” Executive Intelligence Review, November 28.
Frontline (2004), “Interview with Cary Gereffi: Is Wal-Mart
Good for America?” posted Nov. 23, www.pbs.org/wgbh/
pages/frontline/shows/walmart/interviews/gereffi.html.
Gerard, Kim (2003), “How Levi’s Got Its Jeans Into Wal-
Mart,” CIO Magazine, July 15.
Hannaford, Steve (2004), “Wal-Mart’s oligonomy power,”
www.oligopolywatch.com, 10/04.
Hornblower, Sam (2004), “Wal-Mart & China: A Joint Venture:
Is Wal-Mart Good for America?,” Frontline, posted Nov.
23, www.pbs.org/wgbh/pages/frontline/shows/walmart/
secrets/wmchina.html.
Hunn, Patrick (2006), Phone interviews, conducted by K. A.
Berger, July 26, 2006, and August 4, 2006.
Koch, Christopher (2005), “Supply Chain and Wal-Mart,” “The
ABCs of Supply Chain Management,” CIO Magazine,
http://www.cio.com/research/scm/edit/012202_scm. html,
10/4/05.
Lauster, Steffen M., and J. Neely (2004), “The Core’s Compe-
tence: The Case for Recentralization in Consumer Prod-
ucts Companies,” strategy�Business Magazine,
Resilience Report, Booz Allen Hamilton.
Leis, Jorge (2005), transcript of radio interview, consulting ex-
pert Bain & Co., March 29, www.bain.com/bainweb.
Lewis, M. Christine, and Dogulas M. Lambert, “A Model of
Channel Member Performance, Dependence, and Satis-
faction,” Journal of Retailing, Vol. 67 (Summer 1991),
pp. 206–207.
Maich, Steve (2004), “Why Wal-Mart is Good,” Rogers Me-
dia Inc.
Porter (1991), “Know Your Place,” Inc. Boston, September,
Vol. 13, Iss. 9, pp. 90–93.
Porter (1980), Competitive Strategy Techniques for Analyzing
Industries and Competitors, New York: Free Press
(pp. 3–5, 24–29, 180–181).
Porter (1979), “How Competitive Forces Shape Strategy,”
Harvard Business Review.
Schooley, Tim (2001), “Heinz to Acquire Vlasic Pickles,”
Pittsburgh Business Times, Jan. 29.
Wal-Mart Website (2005), visited September 28, 2005,
www.walmartfacts.com/newsdesk/meet-our-partners.aspx.
Wal-Mart (2005), http://en.wikipedia.org/wiki/Wal-Mart.
supermarkets buying the Wal-Mart gallons. They’d eat a quarter of a jar and throw the thing
away when they got moldy. A family can’t eat them fast enough.”3
N O T E S
1. Fishman, 2003, p. 3 of pdf file from pf.fastcompany.com/
magazine/77/walmart.html).
2. Fishman, 2003, p. 4 of pdf file.
3. Fishman, 2003, p. 4 of pdf file.
www.brynwoodpartners.com/investment/pinnacle.htm
www.brynwoodpartners.com/investment/pinnacle.htm
www.bizjournals.ocm/dallas/stories/2003/08/11/daily1.html
www.bizjournals.ocm/dallas/stories/2003/08/11/daily1.html
www.pbs.org/wgbh/pages/frontline/shows/walmart/interviews/gereffi.html
www.pbs.org/wgbh/pages/frontline/shows/walmart/interviews/gereffi.html
www.oligopolywatch.com
www.pbs.org/wgbh/pages/frontline/shows/walmart/secrets/wmchina.html
www.pbs.org/wgbh/pages/frontline/shows/walmart/secrets/wmchina.html
http://www.cio.com/research/scm/edit/012202_scm.html
www.bain.com/bainweb
www.walmartfacts.com/newsdesk/meet-our-partners.aspx
http://en.wikipedia.org/wiki/Wal-Mart
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BREAD—ESSENTIAL AND BASIC, but nonetheless special—has transcended millennia. A master
baker combined simple ingredients to create what has been an integral part of society and cul-
ture for over 6,000 years. Sourdough bread, a uniquely American creation, was made from
a “culture” or “starter.” Sourdough starter contained natural yeasts, flour, and water and
was the medium that made bread rise. In order to survive, a starter had to be cultured, fed,
and tended to by attentive hands in the right environment. Without proper care and main-
tenance, the yeast, or the growth factor, would slow down and die. Without a strong starter,
bread would no longer rise.
Ronald Shaich, CEO and Chairman of Panera Bread Company, created the company’s
“starter.” Shaich, the master baker, combined the ingredients and cultivated the leavening agent
that catalyzed the company’s phenomenal growth. Under Shaich’s guidance, Panera’s total
systemwide (both company and franchisee) revenues rose from $350.8 million in 2000 to
$1,353.5 million in 2009, consisting of $1,153.3 million from company-owned bakery-café
sales, $78.4 million from franchise royalties and fees, and $121.9 million from fresh dough
sales to franchisees. Franchise-operated bakery-café sales, as reported by franchisees, were
$1,640.3 million in fiscal 2009.1 Panera shares have outperformed every major restaurant stock
over the last 10 years.2 Panera’s share price has risen over 1,600% from $3.88 a share on
December 31, 1999, to $67.95 a share on December 28, 2009.3 Along the way, Panera largely
led the evolution of what became known as the “fast casual” restaurant category.
Ronald Shaich had clearly nurtured the company’s “starter” and had been the vision and
driving force behind Panera’s success from the company’s beginnings until his resignation as
CEO and Chairman effective May 13, 2010. For Panera to continue to rise, the company’s new
CEO, William Moreton, would need to continue to feed and maintain Panera’s “starter.” In
addition to new unit growth, new strategies and initiatives must be folded into the mix.
This case was prepared by Ellie A. Fogarty, EdD, and Professor Joyce P. Vincelette of the College of New Jersey.
Copyright © 2010 by Ellie A. Fogarty and Joyce P. Vincelette. This case cannot be reproduced in any form without
the written permission of the copyright holders, Ellie A. Fogarty and Joyce P. Vincelette. Reprint permission is solely
granted by the publisher, Prentice Hall, for the book Strategic Management and Business Policy, 13th Edition (and
the international and electronic versions of this book) by the copyright holders, Ellie A. Fogarty and Joyce P.
Vincelette. This case was edited for SMBP 13th Edition. The copyright holders are solely responsible for case con-
tent. Any other publication of the case (translation, any form of electronic or other media) or sale (any form of part-
nership) to another publisher will be in violation of copyright law, unless Ellie A. Fogarty and Joyce P. Vincelette
have granted additional written reprint permission. Reprinted by permission.
32-1
C A S E 32
Panera Bread Company (2010):
Still Rising Fortunes?
Joyce P. Vincelette and Ellie A. Fogarty
32-2 SECTION D Industry Eight—Food and Beverage
History
Panera Bread grew out of the company that could be considered the grandfather of the fast
casual concept: Au Bon Pain. In 1976, French oven manufacturer Pavailler opened the first
Au Bon Pain (a French colloquialism for “where good bread is”) in Boston’s Faneuil Hall as
a demonstration bakery. Struck by its growth potential, Louis Kane, a veteran venture capi-
talist, purchased the business in 1978.4 Between 1978 and 1981, Au Bon Pain opened 13, and
subsequently closed 10, stores in the Boston area and piled up $3 million in debt.5 Kane was
ready to declare bankruptcy when he gained a new business partner in Ronald Shaich.6
Shortly after opening the Cookie Jar bakery in Cambridge, Massachusetts, in 1980,
Shaich, a recent Harvard Business graduate, befriended Louis Kane. Shaich was interested in
adding bread and croissants to his menu to stimulate morning sales. He recalled that “50,000
people a day were going past my store, and I had nothing to sell them in the morning.”7 In
February 1981, the two merged the Au Bon Pain bakeries and the cookie store to form one
business, Au Bon Pain Co. Inc. The two served as co-CEOs until Kane’s retirement in 1994.
They had a synergistic relationship that made Au Bon Pain successful: Shaich was the hard-
driving, analytical strategist focused on operations, and Kane was the seasoned businessperson
with a wealth of real estate and finance connections.8 Between 1981 and 1984, the team
expanded the business, worked to decrease the company’s debt, and centralized facilities for
dough production.9
In 1985, the partners added sandwiches to bolster daytime sales as they noticed a pattern
in customer behavior: “We had all of these customers coming and ordering a baguette cut in
half. Then they’d take out these lunch bags full of cold cuts and start making sandwiches. We
didn’t have to be marketing whizzes to know that there was an opportunity there,” recalled
Shaich.10 It was a “eureka” moment, and the birth of the fast casual restaurant category.11
According to Shaich, Au Bon Pain was the “first place that gave white collar folks a choice
between fast food and fine dining.”12 Au Bon Pain became a lunchtime alternative for urban
dwellers who were tired of burgers and fast food. Differentiated from other fast-food competi-
tors by its commitment to fresh, quality sandwiches, bread, and coffee, Au Bon Pain attracted
customers who were happy to pay more money ($5 per sandwich) than they would have paid
for fast food.13
In 1991, Kane and Shaich took the company public. By that time, the company had $68
million in sales and was a leader in the quick service bakery segment. By 1994, the company
had 200 stores and $183 million in sales, but that growth masked a problem. The company was
built on a limited growth concept, what Shaich called, “high density urban feeding.”14 The
main customers of the company were office workers in locations like New York, Boston, and
Washington DC. The real estate in such areas was expensive and hard to come by. This strate-
gic factor limited expansion possibilities.15
Au Bon Pain acquired the Saint Louis Bread Company in 1993 for $24 million. Shaich
saw this as the company’s “gateway into the suburban marketplace.”16 The acquired company,
founded in 1987 by Ken Rosenthal, consisted of a 19-store bakery-café chain located in the
Saint Louis, Missouri, area. The concept of the café was based on San Francisco sourdough
bread bakeries. The acquired company would eventually become the platform for what is now
Panera.
Au Bon Pain management spent two years studying Saint Louis Bread Co., looking for the
ideal concept that would unite Au Bon Pain’s operational abilities and quality food with the
broader suburban growth appeal of Saint Louis Bread. The management team understood that
a growing number of consumers wanted a unique expression of tastes and styles, and were tired
of the commoditization of fast-food service. Shaich and his team wrote a manifesto that spelled
out what Saint Louis Bread would be, from the type of food it would serve, to the kind of peo-
ple behind the counters, and to the look and feel of the physical space.17
Au Bon Pain began pouring capital into the chain when Shaich had another “eureka”
moment in 1995. He entered a Saint Louis Bread store and noticed a group of business people
meeting in a corner. The customers explained that they had no other place to talk.18 This expe-
rience helped Shaich realize that the potential of the neighborhood bakery-café concept was
greater than that of Au Bon Pain’s urban store concept. The bakery-café concept capitalized
on a confluence of current trends: the welcoming atmosphere of coffee shops, the food of sand-
wich shops, and the quick service of fast food.19
While Au Bon Pain was focusing on making Saint Louis Bread a viable national brand,
the company’s namesake unit was faltering. Rapid expansion of its urban outlets had resulted
in operational problems, bad real estate deals,20 debt over $65 million,21 and declining operat-
ing margins.22 Stiff competition from bagel shops and coffee chains such as Starbucks com-
pounded operational difficulties. Au Bon Pain’s fast-food ambiance was not appealing to
customers who wanted to sit and enjoy a meal or a cup of coffee. At the same time, the café
style atmosphere of Saint Louis Bread, known as Panera (Latin for “time for bread”) outside
the Saint Louis area, was proving to be successful. In 1996, comparable sales at Au Bon Pain
locations declined 3% while same-store sales of the Panera unit were up 10%.23
Lacking the capital to overhaul the ambiance of the Au Bon Pain segment, the company de-
cided to sell the unit. This allowed the company to strategically focus its time and resources on
the more successful Panera chain. Unlike Au Bon Pain, Panera was not confined to a small
urban niche and had greater growth potential. On May 16, 1999, Shaich sold the Au Bon Pain
unit to investment firm Bruckman, Sherrill, and Co. for $73 million. At the time of the divestiture,
the company changed its corporate name to Panera Bread Company. The sale left Panera Bread
Company debt-free, and the cash allowed for the immediate expansion of its bakery-café stores.24
Throughout the 2000s, Panera grew through franchise agreements, acquisitions (includ-
ing the purchase of Paradise Bakery & Café, Inc.), and new company-owned bakery-cafés.
By 2009, Panera had become a national bakery-café concept with 1,380 company-owned and
franchise-operated bakery-café locations in 40 states and in Ontario, Canada. Panera had
grown from serving approximately 60 customers a day at its first bakery-café to serving
nearly six million customers a week systemwide, becoming one of the largest food-service
companies in the United States. The company believed its success was rooted in its ability to
create long-term dining concept differentiation.25 The company operated under the Panera®,
Panera Bread®, Saint Louis Bread Co.®, Via Panera®, You Pick Two®, Mother Bread®, and
Paradise Bakery & Café® design trademark names registered in the United States. Others
were pending. Panera also had some of its marks registered in foreign countries.26
May 13, 2010, marked a significant change in the history of Panera Bread Company. After
28 years Ronald Shaich stepped down as CEO and Chairman effective immediately following the
Annual Stockholders Meeting, and William Moreton, previously the Executive Vice President and
co-Chief Operating Officer, assumed the role of CEO. Shaich planned to remain as the company’s
Executive Chairman. He announced that he expected to focus his time and energy within Panera
on a range of strategic and innovation projects and mentoring the senior team. In typical Panera
fashion, the transition had been planned for 1 1/2 years to ensure its success.
CASE 32 Panera Bread Company (2010): Still Rising Fortunes? 32-3
Concept and Strategy27
Concept
At the time when Panera was created, the fast-food industry was described as featuring low-
grade burgers, greasy fries, and sugared colas. Shaich decided to create a casual but comfort-
able place where customers could eat fresh-baked artisan breads and fresh sandwiches, soups,
and salads without worrying about whether it was nutritious.28
32-4 SECTION D Industry Eight—Food and Beverage
Strategy
Panera operated in three business segments: company-owned bakery-café operations,
franchise operations, and fresh dough operations. As of December 29, 2009, the company-
owned bakery-café segment consisted of 585 bakery-cafes, all located in the United States,
and the franchised operations segment consisted of 795 franchise-operated bakery-cafés,
located throughout the United States and in Ontario, Canada. The company anticipated 80 to
90 systemwide bakery-cafés opening in 2010 with average weekly sales for company-owned
new units of $36,000 to $38,000.36 Exhibit 1 shows the number and locations of all bakery-
cafés in 2009. Exhibit 2 shows the total number of systemwide bakery-cafés for the last five
years. As of December 29, 2009, the company’s fresh dough operations segment, which
supplied fresh dough items daily to most company-owned and franchise-operated bakery-
cafés, consisted of 23 fresh dough facilities. The locations and sizes of the fresh dough
facilities can be found in Exhibit 3. Company-owned bakery-café operations accounted
for 85.2% of revenues in 2009, up from 78% in 2005. Royalties and fees from franchise
operations made up 5.8% of revenues in 2009, down from 8.5% in 2005, and fresh dough op-
erations accounted for 9% of total revenues in 2009, down from 13.5% in 2005.37
Panera’s restaurant concept focused on the specialty bread/bakery-café category. Bread
was Panera’s platform and entry point to the Panera experience at its bakery-cafés. It was the
symbol of Panera quality and a reminder of “Panera Warmth,” the totality of the experience the
customer received and could take home to share with friends and family. The company
endeavored to offer a memorable experience with superior customer service. The company’s
associates were passionate about sharing their expertise and commitment with Panera cus-
tomers. The company strove to achieve what Shaich termed “Concept Essence,” Panera’s blue-
print for attracting targeted customers that the company believed differentiated it from
competitors. Concept Essence included a focus on artisan bread, quality products, and a warm,
friendly, and comfortable environment. It called for each of the company’s bakery-cafés to be
a place customers could trust to serve high-quality food. Panera’s mission statement was “a
loaf of Bread in every arm®.”29 Bread was Panera’s passion, soul, expertise, and the platform
that made all other of the company’s food items special.
The company’s bakery-cafés were principally located in suburban, strip mall, and regional
mall locations and featured relaxing décor and free Internet access. Panera’s bakery-cafés were
designed to visually reinforce the distinctive difference between its bakery-cafés and those of
its competititors.
Panera extended its strong values and concept of fresh food in an unpretentious, welcom-
ing atmosphere to the nonprofit community. The company’s bakery-cafés routinely donated
bread and baked goods to community organizations in need. Panera’s boldest step was the May
2010 opening of the Panera Cares bakery-café in Missouri, which had no set prices; instead,
customers were asked to pay what they wanted.30
Panera’s success in achieving its concept was often acknowledged through customer sur-
veys and awards from the press. From Advertising Age31 to Zagat,32 Panera was touted as one
of America’s hottest brands and most popular chain. Customers rated Panera fifth overall in the
restaurant industry in 2008 and highest among fast casual eateries in an annual customer satis-
faction and quality survey conducted by Dandelman & Associates, a restaurant market research
firm.33 In 2009, Panera also was named number one on the “Healthiest for Eating on the Go”
list by Health magazine for its variety of health menu options, whole grain breads, and half-
sized items. Numerous other national and local awards had been received each year for the com-
pany’s sandwiches, breads, lunches, soups, vegetarian offerings, cleanliness, Wi-Fi, community
responsibility, best places to work, and kids’ menu.34 Panera’s own consumer panel testing of
1,000 customers showed consistently high value perceptions of the company’s products.35
CASE 32 Panera Bread Company (2010): Still Rising Fortunes? 32-5
State
Company
Bakery-Cafés
Franchise-Operated
Bakery-Cafés
Total
Bakery-Cafés
Alabama 14 — 14
Arizona 30 5 35
Arkansas — 5 5
California 39 52 91
Colorado — 35 35
Connecticut 11 10 21
Delaware — 3 3
Florida 39 77 116
Georgia 14 18 32
Illinois 69 34 103
Indiana 32 6 38
Iowa 2 15 17
Kansas — 18 18
Kentucky 15 2 17
Maine — 4 4
Maryland — 42 42
Massachusetts 8 36 44
Michigan 47 15 62
Minnesota 23 3 26
Missouri 45 21 66
Nebraska 11 2 13
Nevada — 5 5
New Hampshire — 9 9
New Jersey — 48 48
New York 34 36 70
North Carolina 12 30 42
Ohio 9 89 98
Oklahoma — 17 17
Oregon 5 4 9
Pennsylvania 23 46 69
Rhode Island — 6 6
South Carolina 8 6 14
South Dakota 1 — 1
Tennessee 12 16 28
Texas 18 29 47
Utah — 6 6
Virginia 53 10 63
Washington 11 1 12
West Virginia — 7 7
Wisconsin — 24 24
Canada — 3 3
Totals 585 795 1,380
EXHIBIT 1
Year-End 2009
Company-Owned
and Franchise-
Operated
Bakery-Cafés:
Panera
Bread Co.
SOURCE: Panera Bread Company Inc., 2009 Form 10-K, p. 16.
32-6 SECTION D Industry Eight—Food and Beverage
For the Fiscal Year Ended
December 29,
2009
December 30,
2008
December 25,
2007
December 26,
2006
December 27,
2005
Number of Bakery-Cafés
Company-owned
Beginning of period 562 532 391 311 226
Bakery-cafés opened 30 35 89 70 66
Bakery-cafés closed (7) (5) (5) (3) (2)
Bakery-cafés acquired from
franchisees (1)
— — 36 13 21
Bakery-cafés acquired (2) — — 22 — —
Bakery-cafés sold
to a franchisees (3)
— — (1) — —
End of period 585 562 532 391 311
Franchise-operated
Beginning of period 763 698 636 566 515
Bakery-cafés opened 39 67 80 85 73
Bakery-cafés closed (7) (2) (5) (2) (1)
Bakery-cafés sold to
company (1)
— — (36) (13) (21)
Bakery-cafés acquired (2) — — 22 — —
Bakery-cafés purchased
from company (3)
— — 1 — —
End of period 795 763 698 636 566
Systemwide
Beginning of period 1,325 1,230 1,027 877 741
Bakery-cafés opened 69 102 169 155 139
Bakery-cafés closed (14) (7) (10) (5) (3)
Bakery-cafés acquired (2) — — 44 — —
End of period 1,380 1,325 1,230 1,027 877
Notes:
(1) In June 2007, Panera acquired 32 bakery-cafés and the area development rights from franchisees in certain markets in Illinois and
Minnesota. In February 2007, the company acquired four bakery-cafés, as well as two bakery-cafés still under construction, and the area
development rights from a franchisee in certain markets in California.
In October 2006, Panera acquired 13 bakery-cafés (one of which was under construction) and the area development rights from a
franchisee in certain markets in Iowa, Nebraska, and South Dakota. In September 2006, the company acquired one bakery-café in
Pennsylvania from a franchisee. In November 2005, Panera acquired 23 bakery-cafés (two of which were under construction) and the
area development rights from a franchisee in certain markets in Indiana.
(2) In February 2007, Panera acquired 51% of the outstanding capital stock of Paradise Bakery & Café Inc., which then owned and
operated 22 bakery-cafés and franchised 22 bakery-cafés, principally in certain markets in Arizona and Colorado.
(3) In June 2007, Panera sold one bakery-café and die area development rights for certain markets in Southern California to a new area
developer.
EXHIBIT 2 Company-Owned and Franchise-Operated Bakery-Cafés: Panera Bread Company
In addition to the dine-in and take-out business, the company offered Via Panera, a
nationwide catering service that provided breakfast assortments, sandwiches, salads, or soups
using the same high-quality ingredients offered in the company’s bakery-cafés. Via Panera
was supported by a national sales infrastructure. The company believed that Via Panera would
be a key component of long-term growth.
SOURCES: Panera Bread Company Inc., 2009 Form 10-K, p. 25 and 2006 Form 10-K, p. 20.
CASE 32 Panera Bread Company (2010): Still Rising Fortunes? 32-7
The key initiatives of Panera’s growth strategy focused on growing store profit, increasing
transactions and gross profit per transaction, using its capital smartly, and putting in place drivers
for concept differentiation and competitive advantage.38 The company paid careful attention to
the development of new markets and further penetration of existing markets by both company-
owned and franchised bakery-cafés, including the selection of sites that would achieve targeted
returns on invested capital.39 Panera’s strategy in 2009 was different from many of its competi-
tors. When many restaurant companies were focused on surviving the economic meltdown by
downsizing employees, discounting prices, and lowering quality, Panera chose to stay the course
and continued to execute its long-term strategy of investing in the business to benefit the cus-
tomer. The result, according to Shaich: “Panera zigged while others zagged.”40
During the economic downturn, Panera stuck to a simple recipe: Get more cash out of each
customer, rather than just more customers. While other recession-wracked restaurant chains
discounted and offered meals for as little as $5 to attract customers, Panera bucked conventional
industry wisdom by eschewing discounts and instead targeted customers who could afford to
shell out an average of about $8.50 for lunch. While many of its competitors offered less expen-
sive meals, Panera added a lobster sandwich for $16.99 at some of its locations. Panera was able
to persuade customers to pay premiums because it had been improving the quality of its food.41
“Most of the world seems to be focused on the Americans who are unemployed,” said CEO
Ronald Shaich. “We’re focused on the 90 percent that are still employed.”42
Panera’s positive financial results contrasted with those of many other casual dining chains,
which had posted negative same-store sales due partly to declining traffic and lower-priced
Facility Square Footage
Atlanta, GA 18,000
Beltsville, MD 26,800
Chicago, IL 30,900
Cincinnati, OH 22,300
Dallas, TX 12,900
Denver, CO 10,000
Detroit, MI 19,600
Fairfield, NJ 39,900
Franklin, MA (1) 40,300
Greensboro, NC 19,200
Kansas City, KS 17,000
Minneapolis, MN 10,300
Miramar, FL 15,100
Ontario, CA 27,800
Orlando, FL 16,500
Phoenix, AZ 9,100
Seattle, WA 16,600
St. Louis, MO 30,000
Stockton, CA 14,300
Warren, OH 16,300
Ontario, CAN (2) 300
Notes:
(1) Total square footage includes approximately 20,000 square feet utilized in tuna and cream cheese production.
(2) Company-owned limited production facility co-located with one of the franchised bakery-cafés in Ontario,
Canada, to support the franchise-operated bakery-cafés located in this market.
EXHIBIT 3
Year-End 2009 Fresh
Dough Facilities:
Panera Bread Co.
SOURCE: Panera Bread Company Inc., 2009 Form 10-K, p. 15.
32-8 SECTION D Industry Eight—Food and Beverage
food. Some chains found that discounting not only hurt margins but also failed to lure as many
customers as hoped. Shaich seemed to thrive on doing the opposite of his competition. During
2009, instead of slashing prices, he raised them twice, one on bagels and once on soup. “We’re
contrarians to the core,” said Shaich. “We don’t offer a lower-end strategy. In a world where
everyone is cutting back, we want to give more not less.”43 “This is the time to increase the food
experience,” insisted Shaich, “that is, when consumers least expect it.”44
Also crucial to Panera’s success in 2009 was the company’s approach to operations dur-
ing the recession. Over the years, many restaurant companies told investors they were able to
improve labor productivity while running negative comparable store sales. Panera believed
that reducing labor in a restaurant taxed the customer by creating longer waits, slower service,
and more frazzled team members. Panera took the approach of keeping labor consistent with
sales and continuing to invest in its employees as a way to better serve its customers.45
The results for 2009 showed that Panera’s strategy of zigging while others were zagging
paid off. Panera met or exceeded its earnings targets in each quarter of 2009. Panera delivered
25% earnings per share (EPS) growth in 2009 on top of 24% EPS growth in 2008. Panera’s
stock price increased 115% from December 31, 2007, to March 30, 2010.
Panera’s objectives for 2010 included a target of 17%–20% EPS growth through the
execution of its key initiatives. To further build transactions, Panera planned to focus on
differentiation through innovative salads utilizing new procedures to further improve quality.
Panera also planned to test a new way to make paninis using newly designed grills. The
company expected to roll out improved versions of several Panera classics while continuing to
focus on improving operations, speed of service, and accuracy.46
In early 2010, to increase gross profit per transaction and further improve margins while
still providing overall value to customers, Panera introduced an initiative called the Meal
Upgrade Program. With this program, a customer who ordered an entrée and a beverage was
offered the opportunity to purchase a baked good to complete their meal at a “special” price
point. Panera intended to test other impulse add-on initiatives, bulk baked goods, and bread
as a gift.47
“I worry about keeping the concept special,” said Shaich. “Is it worth walking across the
street to? It doesn’t matter how cheap it is. If it isn’t special, there’s no reason the business
needs to exist.”48
The Fast Casual Segment
Panera’s predecessor, Au Bon Pain, was a pioneer of the fast casual restaurant category.
Dining trends caused fast casual to emerge as a legitimate trend in the restaurant industry as
it bridged the gap between the burgers-and-fries fast-food industry and full service, sitdown,
casual dining restaurants.
Technomic Information Services, a food-service industry consultant, coined the term to
describe restaurants that offered the speed, efficiency, and inexpensiveness of fast food with the
hospitality, quality, and ambiance of a full-service restaurant. Technomic defined a fast casual
restaurant by whether or not the restaurant met the following four criteria: (1) The restaurant had
to offer a limited service or self-service format. (2) The average check had to be between $6 and
$9, whereas fast-food checks averaged less than $5. This pricing scheme placed fast casual
between fast food and casual dining. (3) The food had to be made-to-order, as consumers
perceived newly prepared, made-to-order foods as fresh. Fast casual menus usually also had more
robust and complex flavor profiles than the standard fare at fast-food restaurants. (4) The décor
had to be upscale or highly developed. Décor inspired a more enjoyable experience for the
customer as the environment of fast casual restaurants was more akin to a neighborhood bistro or
casual restaurant. The décor also created a generally higher perception of quality.49
CASE 32 Panera Bread Company (2010): Still Rising Fortunes? 32-9
The fast casual market was divided into three categories: bread-based chains, traditional
chains, and ethnic chains. According to a Mintel 2008 report, bread-based chains, such as Panera,
and ethnic chains, such as Chipotle Mexican Grill, had sales momentum and were predicted to
grow at the expense of traditional chains such as Steak n Shake, Boston Market, Fuddruckers, and
Fazoli’s, which were weighted down by older concepts. The report also suggested that bread-
based and ethnic chains had an edge with respect to consumer perceptions about food healthful-
ness.50 Most fast casual brands did not compete in all dayparts (breakfast, lunch, dinner,
late-night); rather, they focused on one or two. While almost all competitors in this segment had
a presence at lunch, many grappled with the question of whether and how to participate in other
dayparts.51 In addition, unlike fast-food restaurants that constructed stand-alone stores, fast casual
chains were typically located in strip malls, small town main streets, and pre-existing properties.
According to Technomic, by offering high-quality food with fast service, fast casual
chains had experienced increased traffic in 2009 as diners “traded-down” from casual dining
chains and “traded-up” from fast-food restaurants to lower priced but still higher-quality fresh
food.52 In other words, the desire to eat out did not diminish; only the destination changed.
Sales in 2009 for the top 100 fast casual chains reached $17.5 billion, a 4.5% increase over
2008; and units grew by 4.3% to 14,777 locations,53 compared to a 3.2% sales decline in the
overall restaurant industry.54 The growth in the fast casual segment was also due to the matu-
ration of two large segments of the U.S. population; baby boomers and their children. Both age
groups had little time for cooking and were tired of fast food.
Bakery-café/bagel remained the largest of the fast casual restaurant clusters and the largest
menu category, generating $4.8 billion in U.S. sales in 2009 and jumping from 17% to 21% of the
top 100 fast casual restaurants. In 2009, Mexican, with total sales of $3.8 billion, was the second
largest fast casual cluster of restaurants.55 Technomic’s 2009 Top 100 Fast-Casual Restaurant Re-
port noted that besides burgers (up 16.7%), the fastest growing menu categories reflected the grow-
ing interest of consumers in international flavors: Asian/noodle (up 6.4%) and Mexican (up 6.3%).56
According to Technomic, “Growth within the fast-casual segment reveals positive con-
sumer preferences for the service format, concept, and menu positioning, and price points but
competition is still fierce and dining-dollars are still minimal. Fast-casual operators will have to
continue being creative with value-oriented menu offerings, uniqueness in terms of flavor, prepa-
ration and quality, and new ways to bolster the bottom line.”57 This is in agreement with a state-
ment made by Panera’s Chief Concept Officer, Scott Davis, “The key thing to remember about
fast casual is this: customers don’t know what it is. To them, ‘fast casual’ just means ‘food.’That
insight can go a long way toward helping you refocus your energy where it counts most. Food
is what matters. It is the No. 1 way to differentiate your business from your competitors.”58
Exhibit 4 provides a list of the 20 largest fast casual franchises in 2010. Even though
Chipotle Mexican Grill was one of Panera’s key competitors, it was not included on this list
because it did not franchise. Exhibit 5 lists the nine largest bread-based fast casual chains.
Competition
Panera experienced competition from numerous sources in its trade areas. The company’s
bakery-cafés competed with specialty food, casual dining and quick service cafés, bakeries, and
restaurant retailers, including national, regional, and locally owned cafés, bakeries, and restau-
rants. The bakery-cafés competed in several segments of the restaurant business based on cus-
tomers’needs for breakfast, AM “chill,” lunch, PM “chill,” dinner, and take-home through both
on-premise sales and Via Panera catering. The competitive factors included location, environ-
ment, customer service, price, and quality of products. The company competed for leased space
in desirable locations and also for hourly employees. Certain competitors or potential competi-
tors had capital resources that exceeded those available to Panera.59
32-10 SECTION D Industry Eight—Food and Beverage
2009 United States Sales
1. Panera Bread $2,796,500
2. Zaxby’s 718,250
3. El Polio Loco 582,000
4. Boston Market 545,000
5. Jason’s Deli 475,870
6. Five Guys Burgers and Fries 453,500
7. Qdoba Mexican Grill 436,500
8. Einstein Bros. Bagels 378,444
9. Moe’s Southwestern Grill 358,000
10. McAlister’s Deli 351,960
11. Fuddruckers 320,500
12. Wingstop 306,606
13. Baja Fresh Mexican Grill 300,000
14. Schlotzky’s 248,000
15. Corner Bakery Café 235,029
16. Fazoli’s 235,000
17. Noodles & Company 230,000
18. Bruegger’s Bagel Bakery 196,000
19. Donatos Pizza 185,000
20. Cosi 168,500
Note:
(a) Not all key fast casual competitors are franchised restaurants.
EXHIBIT 4
2010’s Twenty
Largest Fast Casual
Franchises
Panera’s 2009 sales of nearly $2.8 billion ranked as the largest of the fast casual chains.
The company saw an increase in sales of 7.1% and an increase in units of 4.3% to 1,380 stores
over 2008. Chipotle Mexican Grill held on to the number two spot, growing U.S. sales 13.9%
to $1.5 billion, and units by 14.2% to 955 locations in 2009.60
Panera and Chipotle Mexican Grill, which together made up more than 25% of the fast
casual segment, posted double-digit percentage increases in first-quarter 2010 sales over the
same period in 2009, driven by opening new outlets and robust increases in same-store sales.
By contrast, United States revenues at McDonald’s suffered in 2009, and for the first five
2005 2007
Panera Bread/Saint Louis Bread Co. $1,508,000 $2,271,000
Jason’s Deli 275,000 427,000
Einstein Bros. Bagels 358,000 416,000
McAlister’s Deli 207,000 307,000
Au Bon Pain 271,000 265,000
Corner Bakery 173,000 230,000
Bruegger’s 155,000 182,000
Cosi 136,000 174,000
Atlanta Bread 181,000 155,000
EXHIBIT 5
United States
Systemwide Sales
of Top Bread-Based
Fast Casual Chains
SOURCE: Technomic’s 2010 Top 100 Fast-Casual Chain Restaurant Report, www.bluemaumau.cor/9057/2010’s-
top-twenty-largest-fastcausual-franchises.
SOURCE: Mintel Oxygen Report, August 2008.
www.bluemaumau.cor/9057/2010�s-top-twenty-largest-fastcausual-franchises
www.bluemaumau.cor/9057/2010�s-top-twenty-largest-fastcausual-franchises
CASE 32 Panera Bread Company (2010): Still Rising Fortunes? 32-11
months of 2010, same-store sales were up 3% over the same period in 2009. Burger King strug-
gled during the same period with revenues in the United States and Canada down 4% for the
first three months of 2010.61 Established restaurant chains were beginning to take notice of the
opportunities in the fast casual segment and considering options. For example, Subway started
testing an upscale design in the Washington, DC, market in 2008. New competitors, such as
Otarian, were also entering the fast casual segment testing new concepts, many having a health
and wellness or sustainability component to them.
Although Panera continued to learn from its competitors, none of its competitors had yet fig-
ured out the formula to Panera’s success. While McDonald’s had rival Burger King, and Applebee’s
had T.G.I. Friday’s, there was no direct national competitor that replicated Panera’s business model.
Like Panera, Chipotle sold high-quality food made with fine ingredients—but it was Mexican. Cosi
sold quality sandwiches and salads, but lacked pastries and gourmet coffees. Starbucks had fine cof-
fee and pastries but not Panera’s extensive food menu. According to Shaich, the reason is that “this
is hard to do, . . . what seems simple can be tough. It is not so easy to knock us off.”62
Corporate Governance
Panera was a Delaware corporation and its corporate headquarters were located in Saint
Louis, Missouri.
Board of Directors
Panera’s Board was divided into three classes of membership. The terms of service of the three
classes of directors were staggered so that only one class expired at each annual meeting. At the
time of the May 2010 annual meeting the Board consisted of six members. Class I consisted of
Ronald M. Shaich and Fred K. Foulkes, with terms expiring in 2011; Class II consisted of
Domenic Colasacco and Thomas E. Lynch, with terms expiring in 2012; and Class III consisted
of Larry J. Franklin and Charles J. Chapmann III, with terms ending in 2010. Mr. Franklin and
Mr. Chapman were both nominated for re-election with terms ending in 2013, if elected.63
The biographical sketches for the board members are shown below.64
Ronald M. Shaich: (age 56), was a Director since 1981, co-founder, Chairman of the Board
since May 1999, Co-Chairman of the Board from January 1988 to May 1999, Chief Ex-
ecutive Officer since May 1994, and Co-Chief Executive Officer from January 1988 to
May 1994. Shaich served as a Director of Lown Cardiovascular Research Foundation, as
a trustee of the nonprofit Rashi School, as Chairman of the Board of Trustees of Clark
University, and as Treasurer of the Massachusetts Democratic Party. He had a Bachelor
of Arts degree from Clark University and an MBA from Harvard Business School. Im-
mediately following the 2010 Annual Meeting, Mr. Shaich planned to resign as Chief Ex-
ecutive Officer and the Board intended to elect him as Executive Chairman of the Board.
Larry J. Franklin: (age 61), was a Director since June 2001. Franklin had been the President
and Chief Executive Officer of Franklin Sports Inc., a leading branded sporting goods
manufacturer and marketer, since 1986. Franklin joined Franklin Sports Inc. in 1970 and
served as its Executive Vice President from 1981 to 1986. Franklin served on the Board
of Directors of Bradford Soap International Inc. and the Sporting Goods Manufacturers
Association (Chairman of the Board and member of the Executive Committee).
Fred K. Foulkes: (age 68), was a Director since June 2003. Dr. Foulkes had been a Profes-
sor of Organizational Behavior and had been the Director (and founder) of the Human Re-
sources Policy Institute at Boston University School of Management since 1981. He had
32-12 SECTION D Industry Eight—Food and Beverage
Top Management
The biographical sketches for some of the key executive officers follow.67
Ronald Shaich: (age 56) planned to resign as Chief Executive Officer immediately following
the May 2010 Annual Meeting. The Board of Directors announced its intentions to elect
him as Executive Chairman of the Board at that time. The Board intended to appoint
William W. Moreton to succeed Mr. Shaich as Chief Executive Officer and President and
to elect him to the Board of Directors.68
William M. Moreton: (age 50) re-joined Panera in November 2008 as Executive Vice Pres-
ident and Co-Chief Operating Officer. He previously served as Executive Vice President
and Chief Financial Officer from 1998 to 2003. From 2005 to 2007, Moreton served as
President and Chief Financial Officer of Potbelly Sandwich Works, and from 2004–2005
as Executive Vice President-Subsidiary Brands, and Chief Executive Officer of Baja
Fresh, a subsidiary of Wendy’s International Inc. Immediately following the conclusion
taught courses in human resource management and strategic management at Boston
University since 1980. From 1968 to 1980, Foulkes had been a member of the Harvard
Business School faculty. Foulkes had written numerous books, articles, and case studies.
He had served on the Board of Directors of Bright Horizons Family Solutions and the So-
ciety for Human Resource Management Foundation.
Domenic Colasacco: (age 61), was a Director since March 2000, and Lead Independent Di-
rector since 2008. Colasacco had been President and Chief Executive Officer of Boston
Trust & Investment Management, a banking and trust company, since 1992. He also
served as Chairman of its Board of Directors. He joined Boston Trust in 1974 after begin-
ning his career in the research division of Merrill Lynch & Co. in New York City.
Charles J. Chapman III: (age 47), was a Director since 2008. Chapman had been the Chief
Operating Officer and a Director of the American Dairy Queen Corporation since
October 2005. From 2001 to October 2005, Chapman held a number of senior positions
at American Dairy Queen. Prior to joining American Dairy Queen, Chapman served as
Chief Operating Officer at Bruegger’s Bagel’s Inc. where he was also President and co-
owner of a franchise. He also held marketing and operations positions with Darden
Restaurants and served as a consultant with Bain & Company.
Thomas E. Lynch: (age 50), was a Director since March 2010 and previous Director from
2003–2006. Lynch served as Senior Managing Director of Mill Road Capital, a private eq-
uity firm, since 2005. From 2000 to 2004, Lynch served as Senior Managing Director of
Mill Road Associates, a financial advisory firm that he founded in 2000. From 1997
through 2000, Lynch was the founder and Managing Director of Lazard Capital Partners
From 1990 to 1997, Lynch was a Managing Director of the Blackstone Group, where he
was a senior investment professional for Blackstone Capital Partners. Prior to Blackstone,
Lynch was a senior consultant at the Monitor Company. He also had previously served on
the Board of Directors of Galaxy Nutritional Foods Inc.
The Board had established three standing committees, each of which operated under a
charter approved by the Board. The Compensation and Management Development Committee
included Foulkes (Chair), Franklin, and Colasacco. The Committee on Nominations and Cor-
porate Governance included Franklin (Chair), Chapman, and Foulkes. The Audit Committee
included Colasacco (Chair), Foulkes, and Franklin.65
The compensation package of non-employee directors consisted of cash payments and
stock and option awards. Total non-employee director compensation ranged from $29,724 to
$124,851 in fiscal 2009 depending on services rendered.66
CASE 32 Panera Bread Company (2010): Still Rising Fortunes? 32-13
of the 2010 Annual Meeting, upon the resignation of Mr. Shaich, the Board planned for
Mr. Moreton to succeed Mr. Shaich as Chief Executive Officer, and the Board intended to
appoint him as President and elect him to the Board.
John M. Maguire: (age 44) had been Chief Operating Officer and subsequently Co-Chief Op-
erating Officer since March 2008 and Executive Vice President since April 2006. He pre-
viously served as Senior Vice President, Chief Company, and Joint Venture Operations
Officer from August 2001 to April 2006. From April 2000 to July 2001, Maguire served
as Vice President, Bakery Operations and from November 1998 to March 2000, as Vice
President, Commissary Operations. Maguire joined the company in April 1993; from
1993 to October 1998, he was a Manager and Director of Au Bon Pain/Panera Bread/
Saint. Louis Bread.
Cedric J. Vanzura: (age 46) had been Executive Vice President and Co-Chief Operating Of-
ficer since November 2008 and Executive Vice President and Chief Administrative Offi-
cer from March to November 2008. Prior to joining the company, Vanzura held a variety
of roles at Borders International from 2003 to 2007.
Mark A. Borland: (age 57) had been Senior Vice President and Chief Supply Chain Officer
since August 2002. Borland joined the company in 1986 and held management positions
within Au Bon Pain and Panera Bread divisions until 2000, including Executive Vice Pres-
ident, Vice President of Retail Operations, Chief Operating Officer, and President of Man-
ufacturing Services. From 2000 to 2001, Borland served as Senior Vice President of
Operations at RetailDNA, and then rejoined Panera as a consultant in the summer of 2001.
Jeffrey W. Kip: (42) had been Senior Vice President and Chief Financial Officer since May
2006. He previously served as Vice President, Finance and Planning, and Vice Presi-
dent, Corporate Development, from 2003 to 2006. Prior to joining Panera, Mr. Kip was
an Associate Director and then Director at UBS from 2002 to 2003 and an Associate at
Goldman Sachs from 1999 to 2002.
Michael J. Nolan: (age 50) had been Senior Vice President and Chief Development Officer
since he joined the company in August 2001. From December 1997 to March 2001,
Nolan served as Executive Vice President and Director for John Harvard’s Brew House,
L.L.C., and Senior Vice President, Development, for American Hospitality Concepts Inc.
From March 1996 to December 1997, Nolan was Vice President of Real Estate and De-
velopment for Apple South Incorporated, a chain restaurant operator, and from July 1989
to March 1996, Nolan was Vice President of Real Estate and Development for Morrison
Restaurants Inc. Prior to 1989, Nolan served in various real estate and development ca-
pacities for Cardinal Industries Inc. and Nolan Development and Investment.
Other key Senior Vice Presidents included Scott Davis, Chief Concept Officer; Scott Blair,
Chief Legal Officer; Rebecca Fine, Chief People Officer; Thomas Kish, Chief Information Of-
ficer; Michael Kupstas, Chief Franchise Officer; Michael Simon, Chief Marketing Officer; and
William Simpson, Chief Company and Joint Venture Operations Officer. In 2009, the total
compensation for the top five highest paid executive officers ranged from $939,919 to
$3,354,708.69
At year-end 2009 there were two classes of stock: (1) Class Acommon stock with 30,491,278
shares outstanding and one vote per share, and (2) Class B common stock with 1,392,107 shares
outstanding and three votes per share.70 Class A common stock was traded on NASDAQ under
the symbol PNRA. As of March 15, 2010, all directors, director nominees, and executive officers
as a group (20 persons) held 1,994,642 shares or 6.22% of Class A common stock and 1,311,690
shares or 94.22% of Class B common stock with a combined voting percentage of 13.23%. Ronald
Shaich owned 5.5% of Class A common stock and 94.22% of Class B common stock for a com-
bined voting percentage of 12.42%.71 In November 2009, Panera’s Board of Directors approved
a three-year share repurchase program of up to $600 million of Class A common stock.72
32-14 SECTION D Industry Eight—Food and Beverage
Menu73
Panera’s value-oriented menu was designed to provide the company’s target customers with
affordably priced products built on the strength of the company’s bakery expertise. “We hit a
cord with people who understand and respond to food, but we also opened a door for people
who are on the verge of that,” said Scott Davis. “We run an idea through a Panera filter and
give it a twist that takes a flavor profile closer to what you’d find in a bistro than a fast-food
joint.”74 The Panera menu featured proprietary items prepared with high-quality fresh ingre-
dients as well as unique recipes and toppings. The key menu groups were fresh-baked goods,
including a variety of freshly baked bagels, breads, muffins, scones, rolls, and sweet goods;
made-to-order sandwiches; hearty and unique soups; hand-tossed salads; and café beverages
including custom-roasted coffees, hot or cold espresso, cappuccino drinks, and smoothies.
The company regularly reviewed and updated its menu offerings to satisfy changing cus-
tomer preferences, to improve its products, and to maintain customer interest. To give its cus-
tomers a reason to return, Panera had been rolling out new products with fresher ingredients
such as antibiotic-free chicken (Panera is the nation’s largest buyer75). The roots of most new
Panera dishes could be traced to its R&D team’s twice-yearly retreats to the Adirondacks,
where staffers took turns trying to out-do each other in the kitchen. “We start with: What do
we think tastes good,” said Scott Davis. “We’re food people, and if we’re not working on some-
thing that gets us really excited, it’s kind of not worth working on.”76 Panera did not have test
kitchens and instead tested all new menu items directly in its cafés. According to Davis, “You
can experiment all you want in the kitchen with a new product but you won’t really see a mea-
sure of its potential until you see it in a store.”77
Panera integrated new product rollouts into the company’s periodic or seasonal menu rota-
tions, referred to as “Celebrations.” Examples of products introduced in fiscal 2009 included the
Chopped Cobb Salad and Barbeque Chicken Chopped Salad, introduced during the 2009 sum-
mer salad celebration. Other menu changes in 2009 included a reformulated French baguette, a
new line of smoothies, new coffee, a new Napa Almond Chicken Salad sandwich, a new Straw-
berry Granola Parfait, the Breakfast Power Sandwich, and a new line of brownies and blondies.
Three new salmon options, five years in the making, were introduced in early 2010 along with
a new Low-Fat Garden Vegetable Soup and a new Asiago Bagel Breakfast Sandwich. New chili
offerings were in the planning stages. During this time Shaich had also been busy tweaking
things he wanted Panera to do better, such as improving the freshness of Panera’s lettuce by
cutting the time from field to plate in half. He also improved the freshness of the company’s
breads by opting to bake all day long and not just in the early morning hours. Panera’s changes
and improvements were all designed to build competitive advantage by strengthening value.
Value, according to the company, meant offering guests an even better “total experience.”
In 2008, Panera introduced the antithesis to the microwaved, processed breakfast sandwich.
“At Panera we believe customers deserve a breakfast that is made by bakers, not microwaves—
so we have developed a hand-crafted, made to order grilled breakfast sandwich that literally
breaks the mold,” said Shaich. “Our survey shows that 82% of consumers would prefer freshly
cooked eggs in their breakfast sandwiches and Panera is happy to oblige.”78 The new line of
breakfast sandwiches were made fresh daily with quality ingredients—a combination of all-
natural eggs, Vermont white cheddar cheese, Applewood-smoked bacon or all natural sausage,
grilled between two slices of fresh baked ciabatta. Many of the company’s competitors had also
moved to more protein-based breakfast sandwich offerings because of the growth opportunities
in this segment of the market. “To compete in this business, we believe we need to have offer-
ings that are worth getting out of your car for,”79 said Scott Davis.
Not all of Panera’s menu innovations had been successful with customers or had added
much to the bottom line. Panera redesigned its menu boards in 2009 to draw the customers’
eyes toward meals with higher margins, like the soup and salad combo, rather than pricier
CASE 32 Panera Bread Company (2010): Still Rising Fortunes? 32-15
items, like a strawberry poppy-seed salad, that did not bring as much to the bottom line. The
Crispani pizza was discontinued in 2008, after it failed to drive business during evening hours.
To improve margins, Panera was able to anticipate and react to changes in food and sup-
ply costs including, among other things, fuel, proteins, dairy, wheat, tuna, and cream cheese
costs through increased menu prices and to use its strength at purchasing to limit cost inflation
in efforts to drive gross profit per transaction.
“Panera’s always been ahead of the curve in the transparency of their food,”80 said Howard
Gordon, a former Cheesecake Factory executive and now restaurant industry consultant.
“Everyone said the antibiotic-free chicken was doomed to fail,” said Shaich. “They said it was
too expensive and too difficult for consumers to understand the value of paying more.
Wrong.”81 Panera chose to be ahead of the curve again when it announced in early 2010 that
it would post calorie information on all systemwide bakery-café menu boards by the end of
2010. Panera had for a number of years provided a nutritional calculator on its website so that
customers were able to find nutritional information for individual products or build a meal ac-
cording to their dietetic specifications. Recognizing the health risks associated with transfats,
Panera had completely removed all transfat from its menu by 2006.82 Panera also offered a
wide range of organic food products including cookies, milk, and yogurt, which were incor-
porated into the company’s childrens’ menu, Panera Kids, in 2006. Because of its healthy
choices, Panera was named “One of the 10 Best Fast-Casual Family Restaurants” by Parents
Magazine in its July 2009 issue.83
Site Selection and Company-Owned Bakery-Cafés84
As of December 29, 2009, the company-owned bakery-café segment consisted of 585 company-
owned bakery-cafés, all located in the United States. During 2009, Panera focused on using its
cash to build new high ROI bakery-cafés and executed a disciplined development process that took
advantage of the recession to drive down costs while selecting locations that delivered strong sales
volume. In 2009, Panera believed the best use of its capital was to invest in its core business, ei-
ther through the development of new bakery-cafés or through the acquisition of existing bakery-
cafés from franchisees or other similar restaurant or bakery-café concepts, such as the acquisition
of Paradise Bakery & Café Inc.
All company-owned bakery-cafés were in leased premises. Lease terms were typically
10 years with one, two, or three five-year renewal option periods thereafter. Leases typically
had charges for a proportionate share of building and common area operating expenses and
real estate taxes, and contingent percentage rent based on sales above a stipulated sales level.
Because Panera was considered desirable as a tenant due to its profitable balance sheet and
national reputation, the company enjoyed a favorable leasing environment in lease terms and
the availability of desirable locations.
The average size of a company-owned bakery-café was approximately 4,600 square feet
as of December 29, 2009. The average construction, equipment, furniture and fixtures, and
signage costs for the 30 company-owned bakery-cafés opened in fiscal 2009 was approxi-
mately $750,000 per bakery-café after landlord allowances and excluding capitalized develop-
ment overhead. The company expected that future bakery-cafés would require, on average, an
investment per bakery-café of approximately $850,000.
In evaluating potential new locations for both company-owned and franchised bakery-
cafés, Panera studied the surrounding trade area, demographic information within the most
recent year, and publicly available information on competitors. Based on this analysis and
utilizing predictive modeling techniques, Panera estimated projected sales and a targeted return
on investment. Panera also employed a disciplined capital expenditure process focused on
occupancy and development costs in relation to the market, designed to ensure the right-sized
32-16 SECTION D Industry Eight—Food and Beverage
bakery-café and costs in the right market. Panera’s methods had proven successful in choosing
a number of different types of locations, such as in-line or end-cap locations in strip or power
centers, regional malls, drive-through, and freestanding units.
Franchises85
Franchising was a key component of Panera’s growth strategy. Expansion through franchise
partners enabled the company to grow more rapidly as the franchisees contributed the re-
sources and capabilities necessary to implement the concepts and strategies developed by
Panera.
The company began a broad-based franchising program in 1996, when the company ac-
tively began seeking to extend its franchise relationships. As of December 29, 2009, there were
795 franchise-operated bakery-cafés open throughout the United States and in Ontario,
Canada, and commitments to open 240 additional franchise-operated bakery-cafés. At this
time, 57.6% of the company’s bakery-cafés were owned by franchises comprised of 48 fran-
chise groups. The company was selective in granting franchises, and applicants had to meet
specific criteria in order to gain consideration for a franchise. Generally, the franchisees had
to be well capitalized to open bakery-cafés, with a minimum net worth of $7.5 million and
meet liquidity requirements (liquid assets of $3 million),86 have the infrastructure and re-
sources to meet a negotiated development schedule, have a proven track record as multi-unit
restaurant operators, and have a commitment to the development of the Panera brand. A num-
ber of markets were still available for franchise development.
Panera did not sell single-unit franchises. Instead, they chose to develop by selling mar-
ket areas using Area Development Agreements, referred to as ADAs, which required the fran-
chise developer to open a number of units, typically 15 bakery-cafés, in a period of four to six
years. If franchisees failed to develop bakery-cafés on schedule or defaulted in complying with
the company’s operating or brand standards, the company had the right to terminate the ADA
and to develop company-owned locations or develop locations through new area developers in
that market.
The franchise agreement typically required the payment of an up-front franchise fee of
$35,000 (broken down into $5,000 at the signing of the area development agreement and
$30,000 at or before the bakery-café opens) and continued royalties of 4%–5% on sales from
each bakery-café. The company’s franchise-operated bakery-cafés followed the same protocol
for in-store operating standards, product quality, menu, site selection, and bakery-café con-
struction as did company-owned bakery-cafés. Generally, the franchisees were required to pur-
chase all of their dough products from sources approved by the company.
The company did not generally finance franchise construction or area development
agreement purchases. In addition, the company did not hold an equity interest in any of the
franchise-operated bakery-cafés. However, in fiscal 2008, to facilitate expansion into
Ontario, Canada, the company entered into a credit facility with the Canadian franchisee. By
March 2010, Panera had repurchased the three franchises in Toronto in order to be more
directly involved in the Canadian market. While the company thought the geographic market
represented a good growth opportunity, Panera decided to study and learn from other
U.S. firms that had expanded successfully in Canada.87
Bakery Supply Chain88
According to Ronald Shaich, “Panera has a commitment to doing the best bread in America.”89
Freshly baked bread made with fresh dough was integral to honoring this commitment.
System-wide bakery-cafés used fresh dough for sourdough and artisan breads and bagels.
CASE 32 Panera Bread Company (2010): Still Rising Fortunes? 32-17
Panera believed its fresh dough facility system and supply chain function provided com-
petitive advantage and helped to ensure consistent quality at its bakery-cafés. The company
had a unique supply-chain operation in which dough was supplied daily from one of the com-
pany’s regional fresh dough facilities to substantially all company-owned and franchise-
operated bakery-cafés. Panera bakers then worked through the night shaping, scoring, and
glazing the dough by hand to bring customers fresh-baked loaves every morning and through-
out the day. In 2009, the company began baking loaves later in the morning to ensure fresh-
ness throughout the day and altered the fermentation cycle of its baguettes to make them
sweeter.
As of December 29, 2009, Panera had 23 fresh dough facilities, 21 of which were
company-owned, including a limited production facility that was co-located with one of the
company’s franchised bakery-cafés in Ontario, Canada, to support the franchise-operated
bakery-cafés located in that market, and two of which were franchise operated. All fresh dough
facilities were leased. In fiscal 2009, there was an average of 62.5 bakery-cafés per fresh dough
facility compared to an average of 62.0 in fiscal 2008.90
Distribution of the fresh dough to bakery-cafés took place daily through a leased fleet of
184 temperature-controlled trucks driven by Panera employees. The optimal maximum distri-
bution range for each truck was approximately 300 miles; however, when necessary, the dis-
tribution ranges might be up to 500 miles. An average distribution route delivered dough to
seven bakery-cafés.
The company focused its expansion in areas served by the fresh dough facilities in order
to continue to gain efficiencies through leveraging the fixed cost of its fresh dough facility
structure. Panera expected to enter selectively new markets that required the construction of
additional facilities until a sufficient number of bakery-cafés could be opened that permitted
efficient distribution of the fresh dough.
In addition to its need for fresh dough, the company contracted externally for the manu-
facture of the remaining baked goods in the bakery-cafés, referred to as sweet goods. Sweet
goods products were completed at each bakery-café by professionally trained bakers. Comple-
tion included finishing with fresh toppings and other ingredients and baking to established ar-
tisan standards utilizing unique recipes.
With the exception of products supplied directly by the fresh dough facilities, virtually all
other food products and supplies for the bakery-cafés, including paper goods, coffee, and
smallwares, were contracted externally by the company and delivered by vendors to an inde-
pendent distributor for delivery to the bakery-cafés. In order to assure high-quality food and
supplies from reliable sources, Panera and its franchisees were required to select from a list of
approved suppliers and distributors. The company leveraged its size and scale to improve the
quality of its ingredients, effect better purchasing efficiency, and negotiate purchase agree-
ments with most approved suppliers to achieve cost reduction for both the company and its
customers. One company delivered the majority of Panera’s ingredients and other products to
the bakery-cafés two or three times weekly. In addition, company-owned bakery-cafés and
franchisees relied on a network of local and national suppliers for the delivery of fresh produce
(three to six times per week).
Marketing91
Panera focused on customer research to plan its marketing and brand-building initiatives.
According to Panera executives, “everything we do at Panera goes through the customer filter
first.”92 Panera’s target customers were between 25 and 50 years old, earned $40,000 to
$100,000 a year, and were seeking fresh ingredients and high quality choices.93 The company’s
customers spent an average of $8.50 per visit.94
32-18 SECTION D Industry Eight—Food and Beverage
Management Information Systems100
Each company-operated bakery-café had programmed point-of-sale registers to collect trans-
action data used to generate pertinent information, including transaction counts, product mix,
and average check. All company-owned bakery-café product prices were programmed into
the system from the company’s corporate headquarters. The company allowed franchisees to
have access to certain proprietary bakery-café systems and systems support. The fresh dough
facilities had information systems that accepted electronic orders from the bakery-cafés and
monitored delivery of the ordered product. The company also used proprietary online tools
such as eLearning to provide online training for retail associates and online baking instruc-
tions for its bakers.
Panera’s intranet site, The Harvest, allowed the company to monitor important analytics
and provide support to its bakery-cafés. For example, Panera used a weather application on its
Panera was committed to improving the customer experience in ways the company be-
lieved rare in the industry. The company leveraged its nationwide presence as part of a broader
marketing strategy of building name recognition and awareness. As much as possible, the com-
pany used its store locations to market its brand image. When choosing a location to open a
new store, Panera carefully selected the geographic area. Better locations needed less market-
ing, and the bakery-café concept relied on a substantial volume of repeat business.
In 2009, Panera executed a more aggressive marketing strategy than most of its competi-
tors. While many competitors discounted to lure customers back through 2009, Panera focused
on offering guests an even better “total experience.” Improvements to the “total experience”
included new coffee and breakfast items, new salads, new China, smoothies, and Mac and
Cheese. The company focused on improving store profit by increasing transactions as well as
increasing gross profit per transaction through the innovation and sales of higher gross profit
items. Panera also had a successful initiative to drive add-on sales through the Meal Upgrade
program.95
In 2010, Panera began modest increases in advertising and additional investments in its
marketing infrastructure because the company recognized the importance of marketing as a
driver of earnings and sales increases.96 In spite of these increases, Panera remained very cau-
tious about its marketing investments and focused on the appropriate mix for each market. Panera
primarily used radio and billboard advertising, with some television, social networking, and
in-store sampling days. Panera found that it benefited when other companies advertised
products that Panera also carried, such as McDonald’s early 2010 promotion of smoothies.
Panera was testing additional television advertising in 20 markets but considered any significant
growth in this medium to be a few years away.97
Panera’s franchise agreements required franchisees to pay the company advertising fees
based on a percentage of sales. In fiscal 2009, franchise-operated bakery-cafés contributed
0.7% of their sales to a company-run national advertising fund, paid a marketing administra-
tion fee of 0.4% of sales, and were required to spend 2.0% of their sales on advertising in their
respective local markets. The company contributed the same sales percentages from company-
owned bakery-cafés toward the national advertising fund and marketing administration fee.
For fiscal 2010, the company increased the contribution rate to the national advertising fund
to 1.1% of sales.98
Panera invested in cause-related marketing efforts and community activities through its
Operation Dough-Nation program. These programs included sponsoring runs and walks, help-
ing nonprofits raise funds, and the Day-End Dough-Nation program through which unsold
bakery products were packaged at the end of each day and donated to local food banks and
charities.99
CASE 32 Panera Bread Company (2010): Still Rising Fortunes? 32-19
Human Resources104
From the beginning, Panera realized that the key ingredients to the successful development
of the Panera brand ranged from the type of food it served to the kind of people behind the
counters. The company placed a priority on staffing its bakery-cafés, fresh dough facilities,
and support center operations with skilled associates and invested in training programs to
ensure the quality of its operations. As of December 29, 2009, the company employed
approximately 12,000 full-time associates (defined as associates who average 25 hours or
more per week), of whom approximately 600 were employed in general or administrative
functions, principally in the company’s support centers; approximately 1,200 were em-
ployed in the company’s fresh dough facility operations; and approximately 10,300 were
employed in the company’s bakery-café operations as bakers, managers, and associates. The
company also had approximately 13,200 part-time hourly associates at the bakery-cafés.
There were no collective bargaining agreements. The company considered its employee
relations to be good.
Panera believed that providing bakery-café operators the opportunity to participate in the
success of the bakery-cafés enabled the company to attract and retain experienced and highly
motivated personnel, which resulted in a better customer experience. Through a Joint Venture
Program, the company provided selected general managers and multi-unit managers with a
multi-year bonus program based upon a percentage of the cash flows of the bakery-café they
operated. The intent of the program’s five-year period was to create team stability, generally
resulting in a higher level of stability for that bakery-café and to lead to stronger associate
engagement and customer loyalty. In December 2009, approximately 50% of company-owned
bakery-café operators participated in the Joint Venture program.105
Finance
Panera reported a 48% increase in net income of $25,845 million, or $0.82 per diluted
share, during the first quarter of 2010, compared to $17,432 million, or $0.57 per diluted
share, during the first quarter of 2009. For this same period, Panera reported revenues of
$364,210 million, a 14% gain, over revenues of $320,709 for the same period in 2009.106
intranet that tied a bakery-café’s historic local weather to the store’s historic sales, allowing
managers to forecast sales based on weather for any given day. “That helps in staffing and how
you’re going to allocate labor and what you need in terms of materials,” said Greg Rhoades,
Panera’s senior manager in information services. He called The Harvest “our single source of
information.” Panera shared news with its employees about food safety and customer satis-
faction websites and provided information on daily sales, hourly sales, staffing, product sales,
labor costs, and ingredient costs.101
The company began offering Wi-Fi in its bakery-cafés in 2003. By 2010 most bakery-
cafés provided customers free Internet access through a managed Wi-Fi network. As a result,
Panera hosted one of the largest free public Wi-Fi networks in the country.102
In 2010, Panera began to pilot test a loyalty program, “My Panera,” in 23 stores. Rather
than just a food-discounting program, “My Panera” was intended to provide a deeper relation-
ship with the customer by including participants in events such as the food tasting of new prod-
ucts. The company expected to complete the pilot by year-end 2010 and hoped to begin
leveraging the data to better understand its high frequency customers and to “surprise and
delight” them in a way that was tailored to the customers’ buying habits.103
32-20 SECTION D Industry Eight—Food and Beverage
Company-owned comparable bakery-café sales in the first quarter of fiscal 2010 increased
10.0%, due to transaction growth of 3.5% and average check growth of 6.5% over the com-
parable period in 2009. Franchise-operated comparable bakery-café sales increased 9.2%
in the first quarter of 2010 compared to the same period in 2009. As a result, total compa-
rable bakery-café sales increased 9.5% in the first quarter of fiscal 2010 compared to the
comparable period in 2009.107 In addition, average weekly sales (AWS) for newly opened
company-owned bakery-cafés during the first quarter of 2010 were $56,111 compared to
$41,922 in the first quarter of 2009. During the first quarter of 2010, Panera and its fran-
chises opened eight new bakery-cafés systemwide. No bakery-cafés were closed during
this period.108
Exhibits 6 to 8 provide Panera’s consolidated statement of operations, common size
income statements, and consolidated balance sheets, respectively, for the company for the
fiscal years ended 2005 through 2009.
In fiscal 2009, during an uncertain economic environment, Panera bucked industry-wide
trends and increased performance on the following key metrics: (1) systemwide comparable
bakery-café sales growth of 0.5% (0.7% for company-owned bakery-cafés and 0.5% for
franchise-operated bakery-cafés); (2) systemwide average weekly sales increased 1.8% to
$39,926 ($39,050 for company-owned bakery-cafés and $40,566 for franchise-operated
bakery-cafés); and (3) 69 new bakery-cafés opened systemwide (7 company-owned bakery-
cafés and 39 franchise-operated bakery-cafés). In fiscal 2009, Panera earned $2.78 per diluted
share.109 In addition, average weekly sales (AWS) for newly opened company-owned bakery-
cafés in 2009 reached a six-year high for new units.110 Exhibit 9 provides 2005–2009 selected
financial information about Panera.
Total company revenue in fiscal 2009 increased 4.2% to $1,353.5 million from $1,298.9
million in fiscal 2008. This growth was primarily due to the opening of 69 new bakery-cafés
systemwide in fiscal 2009 (and the closure of 14 bakery-cafés) and, to a lesser extent, the 0.5%
increase in systemwide comparable bakery sales.
Company-owned bakery-café sales increased 4.2% in fiscal 2009 to $1,153.3 million
compared to $1,106.3 million in fiscal 2008. This increase was due to the opening of 30 new
company-owned bakery-cafés and to the 0.7% increase in comparable company-owned
bakery-café sales in 2009. Company-owned bakery-café sales as a percentage of revenue re-
mained consistent at 85.2% in both fiscal 2009 and fiscal 2008. In addition, the increase in av-
erage weekly sales for company-owned bakery-cafés in fiscal 2009 compared to the prior
fiscal year was primarily due to the average check growth that resulted from the company’s
initiative to drive add-on sales. Franchise royalties and fees in fiscal 2009 were up 4.8% to
$78.4 million, or 5.8% of total revenues, up from $74.8 million in 2008. Fresh dough sales
to franchises increased 3.5% in fiscal 2009 to $121.9 million compared to $117.8 million in
fiscal 2008.111
Panera believed that its primary capital resource was cash generated by operations. The
company’s principal requirements for cash have resulted from the company’s capital expendi-
tures for the development of new company-owned bakery-cafés; for maintaining or remodeling
existing company-owned bakery-cafés; for purchasing existing franchise-operated bakery-
cafés or ownership interests in other restaurant or bakery-café concepts; for developing, main-
taining, or remodeling fresh dough facilities; and for other capital needs such as enhancements
to information systems and infrastructure. The company had access to a $250 million credit fa-
cility which, as of December 29, 2009, had no borrowings outstanding. Panera believed its cash
flow from operations and available borrowings under its existing credit facility to be sufficient
to fund its capital requirements for the foreseeable future.112
According to Nicole Miller Regan, an analyst at Piper Jaffray, “the key to Panera’s suc-
cess during the recessionary period lies in what the company hasn’t done. . . . It hasn’t tried to
change.” 113 “For us, the recession has been the best of times,” said CEO Shaich.114
For the Fiscal Year Ended (1)
December 29,
2009
December 30,
2008
December 25,
2007
December 26,
2006
December 27,
2005
Revenues
Bakery-café sales $ 1,153,255 $ 1,106,295 $ 894,902 $ 666,141 $ 499,422
Franchise royalties and fees 78,367 74,800 67,188 61,531 54,309
Fresh dough sales to franchisee 121,872 117,758 104,601 101,299 86,544
Total revenue 1,353,494 1,298,853 1,066,691 828,971 640,275
Costs and Expenses
Bakery-café expenses
Cost of food and paper products $ 337,599 $ 332,697 $271,442 $ 196,849 $ 143,057
Labor 370,595 352,462 286,238 204,956 151,524
Occupancy 95,996 90,390 70,398 48,602 35,558
Other operating expenses 155,396 147,033 121,325 92,176 70,003
Total bakery-café expenses 959,586 922,582 749,403 542,583 400,142
Fresh dough cost of sales to franchisees 100,229 108,573 92,852 85,951 74,654
Depreciation and amortization 67,162 67,225 57,903 44,166 33,011
General and administrative expenses 83,169 84,393 68,966 59,306 46,301
Pre-opening expenses 2,451 3,374 8,289 6,173 5,072
Total costs and expenses 1,212,597 1,186,147 977,413 738,179 559,180
Operating profit 140,897 112,706 89,278 90,792 81,095
Interest expense 700 1,606 483 92 50
Other (income) expense, net 273 883 333 (1,976) (1,133)
Income before income taxes 139,924 110,217 88,462 92,676 82,178
Income taxes 53,073 41,272 31,434 33,827 29,995
Net income 86,851 68,945 57,028 58,849 52,183
Less: income (loss) attributable to
noncontrolling interest
801 1,509 (428)
Net income attributable to
Panera Bread
$ 86,050 $ 67,436 $ 57,456 $ 58,849 $ 52,183
Per Share Data
Earnings per common share
attributable to Panera Bread
Company
Basic $ 2.81 $ 2.24 $ 1.81 $ 1.88 $ 1.69
Diluted $ 2.78 $ 2.22 $ 1.79 $ 1.84 $ 1.65
Weighted average shares of common
and common equivalent shares
outstanding
Basic 30,667 30,059 31,708 31,313 30,871
Diluted 30,979 30,422 32,178 32,044 31,651
Notes:
(1) Fiscal 2008 was a 53-week year consisting of 371 days. All other fiscal years presented contained 52 weeks consisting of 364 days with
the exception of fiscal 2005. In fiscal 2005, the company’s fiscal week was changed to end on Tuesday rather than Saturday. As a result, the
2005 fiscal year ended on December 27, 2005, instead of December 31, 2005, and, therefore, consisted of 52 and a half weeks rather than the
53 week year that would have resulted without the calender change.
(Dollar amounts in thousands, except per share information)
EXHIBIT 6
Consolidated Statement of Operations: Panera Bread Company
SOURCE: Panera Bread Company Inc., 2009 Form 10-K, pp. 20–21. 32-21
32-22 SECTION D Industry Eight—Food and Beverage
(Percentages are in relation to total revenues except where otherwise indicated)
For the Fiscal Year Ended
December 29,
2009
December 30,
2008
December 25,
2007
December 26,
2006
December 27,
2005
Revenues
Bakery-café sales 85.2% 85.2% 83.9% 80.4% 78.0%
Franchise royalties and fees 5.8 5.8 6.3 7.4 8.5
Fresh dough sales to franchisee 9.0 9.1 9.8 12.2 13.5
Total revenue 100.0% 100.0% 100.0% 100.0% 100.0%
Costs and Expenses
Bakery-café expense (l)
Cost of food and paper products 29.3% 30.1% 30.3% 29.6% 28.6%
Labor 32.1 31.9 32.0 30.8 30.3
Occupancy 8.3 8.2 7.9 7.3 7.1
Other operating expenses 13.5 13.3 13.6 13.8 14.0
Total bakery-café expenses 83.2 83.4 83.7 81.5 80.0
Fresh dough cost of sales to
franchisees (2) 82.2 92.2 88.8 84.5 86.7
Depreciation and amortization 5.0 5.2 5.4 5.3 5.2
General and administrative
expenses 6.1 6.5 6.5 7.2 7.2
Pre-opening expenses 0.2 0.3 0.8 0.7 0.8
Total costs and expenses 89.6 91.3 91.6 89.0 87.3
Operating profit 10.4 8.7 8.4 11.0 12.7
Interest expense 0.1 0.1 0.1 — —
Other (income) expense, net — 0.1 — -0.2 -0.2
Income before income taxes 10.3 8.5 8.3 11.2 12.8
Income taxes 3.9 3.2 2.9 4.1 4.7
Net income 6.4 5.3 5.4 7.1 8.2
Less: net income attributable to
noncontrolling interest 0.1 0.1 — — —
Net income attributable to
Panera Bread Company 6.4% 5.2% 5.4% 7.1% 8.2%
Notes:
(1) As a percentage of bakery-café sales.
(2) As a percentage of fresh dough facility sales to franchisees.
EXHIBIT 7 Common Size Statement: Panera Bread Company
SOURCES: Panera Bread Company, Inc. 2009 Form 10-K, p. 24 and 2006 Form 10-K, p. 19.
CASE 32 Panera Bread Company (2010): Still Rising Fortunes? 32-23
(Dollar amounts in thousands, except share and per share information)
For the Fiscal Year Ended
December 29,
2009
December 30,
2008
December 25,
2007
December 26,
2006
December 27,
2005
Assets
Current assets
Cash and cash equivalents $ 246,400 $ 74,710 $ 68,242 $ 52,097 $ 24,451
Short-term investments — 2,400 23,198 20,025 36,200
Trade accounts receivable, net 17,317 15,198 25,122 19,041 18,229
Other accounts receivable 11,176 9,944 11,640 11,878 6,929
Inventories 12,295 11,959 11,394 8,714 7,358
Prepaid expenses 16,211 14,265 5,299 12,036 5,736
Deferred income taxes 18,685 9,937 7,199 3,827 3,871
Total current assets 322,084 138,413 152,124 127,618 102,774
Property and equipment, net 403,784 417,006 429,992 345,977 268,809
Other assets
Goodwill 87,481 87,334 87,092 57,192 48,540
Other intangible assets, net 19,195 20,475 21,827 6,604 3,219
Long-term investments — 1,726 — — 10,108
Deposits and other 4,621 8,963 7,717 5,218 4,217
Total other assets 111,297 118,498 116,636 69,014 66,084
Total assets $ 837,165 $ 673,917 $ 698.752 $ 542,609 $ 437,667
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable 6,417 4,036 6,326 5,800 4,422
Accrued expenses 135,842 109,978 121,440 102,718 81,559
Deferred revenue — — — 1,092 884
Total current liabilities 142,259 114,014 127,766 109,610 86,865
Long-term debt — — 75,000 — —
Deferred rent 43,371 39,780 33,569 27,684 23,935
Deferred income taxes 28,813 — — — 5,022
Other long-term liabilities 25,686 21,437 14,238 7,649 4,867
Total liabilities 240,129 175,231 250,573 144,943 120,689
Stockholders’ Equity
Common stock, $.0001 par value:
Class A, 75,000,000 shares authorized:
30,364,915 issued and 30,196,808
outstanding in 2009; 29,557,849 issued
and 29,421,877 outstanding in 2008;
30,213,869 issued and 30,098,275
outstanding in 2007.
3 3 3 3 3
Class B, 10,000,000 shares authorized;
1,392,107 issued and outstanding
in 2009; 1,398,242 in 2008;
1,398,588 in 2007; 1,400,031
in 2006 and 1,400,621 in 2005.
— — — — —
EXHIBIT 8 Consolidated Balance Sheets: Panera Bread Company
(continued )
32-24 SECTION D Industry Eight—Food and Beverage
(Dollar amounts in thousands)
A. Year to Year Comparable Sales Growth (not adjusted for differing number of weeks)
For the Fiscal Year Ended
December 29,
2009
(52 weeks)
December 30,
2008
(53 weeks)
December 25,
2007
(52 weeks)
December 26,
2006
(52 weeks)
December 27,
2005
(52-1/2 weeks)
Company-owned 0.7% 5.8% 1.9% 3.9% 7.4%
Franchise-operated 0.5% 5.3% 1.5% 4.1% 8.0%
Systemwide 0.5% 5.5% 1.6% 4.1% 7.8%
B. System Wide Average Weekly Sales
For the Fiscal Year Ended
December 29,
2009
December 30,
2008
December 25,
2007
December 26,
2006
December 27,
2005
Systemwide average
weekly sales $ 39,926 $ 39,239 $ 38,668 $ 39,150 $ 38,318
C. Company-owned Bakery-Café Average Weekly Sales
For the Fiscal Year Ended
December 29,
2009
December 30,
2008
December 25,
2007
December 26,
2006
December 27,
2005
Company-owned average
weekly sales 39,050 38,066 37,548 37,833 37,348
Company-owned number
of operating weeks
29,533 29,062 23,834 176,077 13,280
D. Franchise-owned Bakery-Café Average Weekly Sales
For the Fiscal Year Ended
December 29,
2009
December 30,
2008
December 25,
2007
December 26,
2006
December 27,
2005
Franchise average
weekly sales 40,566 40,126 39,433 39,894 38,777
Franchise number of
operating weeks 40,436 38,449 34,905 31,220 28,090
SOURCE: Panera Bread Company, Inc., 2009 Form 10-K, pp. 45; 2008 Form 10-K, p. 43; and 2006 Form 10-K, p.36.
Treasury stock, carried at cost; (3,928) (2,204) (1,188) (900) (900)
Additional paid-in capital 168,288 151,358 168,386 176,241 154,402
Accumulated other comprehensive income
(loss) 224 (394) — — —
Retained earnings 432,449 346,399 278,963 222,322 163,473
Total stockholders’ equity 597,036 495,162 446,164 397,666 316,978
Noncontrolling interest — 3,524 2,015 — —
Total equity $ 597,036 $ 498,686 $ 446,164 $ 397,666 $ 316,978
Total equity and liabilities $ 837,165 $ 673,917 $ 698,752 $ 542,609 $ 437,667
EXHIBIT 9 Selected Financial Information: Panera Bread Company
SOURCES: Panera Bread Company, Inc., 2009 Form 10-K, p. 26–30 and 2008 Form 10-K, p. 25–27 and 2006 Form 10-K, p. 20–23.
EXHIBIT 8 Consolidated Balance Sheets: Panera Bread Company (continued)
CASE 32 Panera Bread Company (2010): Still Rising Fortunes? 32-25
1. Panera Bread Company Inc., 2009 Form 10-K, pp. 1–2.
2. John Jannarone, “Panera Bread’s Strong Run,” Wall Street Jour-
nal (January 23, 2010).
3. Christopher Tritto, “Panera’s Rosenthal Cashes In,” St. Louis
Business Journal (January 5, 2010), http://stlouis.bizjournals
.com/stlouis/stories/2010/01/04/story2.html.
4. “Overview: Panera Bread Company,” Hoover’s Inc.
5. Linda Tischler, “Vote of Confidence,” Fast Company 65
(December 2002), pp. 102–112.
6. Peter O. Keegan, “Louis I. Kane & Ronald I. Shaich: Au Bon
Pain’s Own Dynamic Duo,” Nation’s Restaurant News 28
(September 19, 1994), p. 172.
7. Tischler, pp. 102–112.
8. Keegan, p. 172.
9. Robin Lee Allen, “Au Bon Pain’s Kane Dead at 69; Founded
Bakery Chain,” Nation’s Restaurant News 34 (June 26, 2000),
pp. 6–7.
10. Keegan, p. 172.
11. Tischler, pp. 102–112.
12. Ibid.
13. Powers Kemp, “Second Rising,” Forbes 166 (November 13,
2000), p. 290.
14. Tischler, pp. 102–112.
15. Ibid.
16. “Overview: Panera Bread Company,” Hoover’s Inc.
17. Robin Lee Allen, “Au Bon Pain Co. Pins Hopes on New President,
Image,” Nation’s Restaurant News 30 (December 2, 1996),
pp. 3–4.
18. Tischler, pp. 102–112.
19. Chern Yeh Kwok, “Bakery-Café Idea Smacked of Success from
the Very Beginning; Concept Gives Rise to Rapid Growth in
Stores, Stock Price,” St. Louis Dispatch (May 20, 2001), p. E1.
20. Allen (December 2, 1996), pp. 3–4.
21. Kemp, p. 290.
22. Richard L. Papiernik, “Au Bon Pain Mulls Remedies, Pares
Back Expansion Plans,” Nation’s Restaurant News 29 (August 28,
1995), pp. 3–4.
23. “Au Bon Pain Stock Drops 11% on News That Loss Is
Expected,” Wall Street Journal (October 7, 1996), p. B2.
24. Andrew Caffrey, “Heard in New England: Au Bon Pain’s Plan
to Reinvent Itself Sits Well with Many Pros,” Wall Street
Journal (March 10, 1999), p. NE.2.
25. Panera Bread Company Inc., 2009 Form 10-K, p. 1.
26. Ibid., pp. 6–7.
27. Panera Bread Company Inc., 2009 Form 10-K, pp. 1–2.
28. Bruce Horovitz, “Panera Bakes a Recipe for Success,” USA
Today (July 23, 2009), p. 1.
29. Panera Press Kit, p.1.
30. Christopher Leonard, “New Panera Location Says Pay What
You Want,” Associated Press (May 18, 2010).
31. Emily Bryson York. “Panera: An America’s Hottest Brands
Case Study,” Advertising Age (November 16, 2009), http://
adage.com/article?article_id=140482.
32. Zagat Survey, http://www.zagat.com/FASTFOOD.
33. Tritto.
34. Panera Company Overview, www.panerabread.com/about/
company/awards.php.
35. Panera Bread Company Inc., Second Quarter Earnings Conference
Call, July 28, 2010.
36. Panera Press Release (314-633-4282), Panera Bread Reports
Q1 EPS of $.82, up 44% Over Q1 2009, on a 10% Company-
owned Comparable Bakery-Café Sales Increase, pp. 1–10.
37. Ibid., p. 20.
38. Panera Bread Company Inc., Second Quarter Earnings Confer-
ence Call, July 28, 2010.
39. Ibid., p. 10.
40. Panera, April 12, 2010 Letter to Stockholders, p. 1.
41. Julie Jargon, “Slicing the Bread but Not the Prices,” Wall Street
Journal (August 18, 2009), B1.
42. Ibid.
43. Horovitz, p. 1.
44. Ibid.
45. Panera, April 12, 2010 Letter to Stockholders.
46. Ibid.
47. Ibid.
48. Sean Gregory, “How Panera Bread Defies the Recession,” Time
(December 23, 2009), p. 2, www.time.com/time/printout/
0,8816,1949371,00.html.
49. G. LaVecchia, “Fast Casual Enters the Fast Lane,” Restaurant
Hospitality 87 (February 2003), pp. 43–47.
50. MINTEL 2008.
51. Ibid.
52. Paul Ziobro, “Panera Looks to Bake Up Profit,” Wall Street
Journal (August 13, 2008), p. B3C.
53. “Fast-Casual Chains Thriving During Tough Economy”
(June 24, 2010), www.foodproductdesign.com/news/2010/
06/fast-casual-chains-thriving-during-tough-economy.aspx.
54. Lauren Shephard, “Convenience Key to Driving Fast-Casual
Sales,” Nations Restaurant News (June 16, 2010).
55. “Fast-Casual Chains Thriving. . . .”
56. Bob Vosburgh, “The Future of Fast Casual Restaurants” (June
24, 2010), whrefresh.com/2010/06/24/the-future-of fast-casual-
restaurants/.
57. “Fast-Casual Chains Thriving. . . .”
58. Megan Conniff, “Food Should Be King at Fast-Casual Restau-
rants” (May 25, 2010), smartblogs.com.restaurants/2010/05/
25/Food-should be-king at fast-casual-restaurants.
59. Panera Bread Company Inc., 2009 Form 10-K, p. 8.
60. “Fast-Casual Chains Thriving. . . .”
61. Greg Farrell, “Appetite Grows for US ‘Fast Casual Food,’”
Financial Times (June 18, 2010), www.ft.com/cms/s/0f452038-
7b06-11df-8935-00144feabdc0.html.
62. Horovitz, p. 1.
63. Panera Bread Company Inc. Notice of Annual Stockholders
Meeting, April 12, 2010, pp. 4–5.
64. Ibid., pp. 5–8.
65. Ibid., pp. 10–12.
66. Ibid., p. 37.
67. Ibid., pp. 14–16.
68. Ibid., p. 5.
69. Ibid., p. 29.
70. Ibid., p. 3.
71. Ibid., p. 40.
72. Ibid., p. 1.
73. Panera Bread Company Inc., 2009 Form 10-K, p. 4.
74. Kate Rockwood, “Rising Dough: Why Panera Bread Is on a
Roll,” Fastcompany.Com (October 1, 2009), www.fastcompany
.com//magazine/139/rising-dough.html.
N O T E S
http://stlouis.bizjournals.com/stlouis/stories/2010/01/04/story2.html
http://stlouis.bizjournals.com/stlouis/stories/2010/01/04/story2.html
http://adage.com/article?article_id=140482
http://adage.com/article?article_id=140482
http://www.zagat.com/FASTFOOD
www.panerabread.com/about/company/awards.php
www.panerabread.com/about/company/awards.php
www.time.com/time/printout/0,8816,1949371,00.html
www.time.com/time/printout/0,8816,1949371,00.html
www.foodproductdesign.com/news/2010/06/fast-casual-chains-thriving-during-tough-economy.aspx
www.foodproductdesign.com/news/2010/06/fast-casual-chains-thriving-during-tough-economy.aspx
www.ft.com/cms/s/0f452038-7b06-11df-8935-00144feabdc0.html
www.ft.com/cms/s/0f452038-7b06-11df-8935-00144feabdc0.html
www.fastcompany.com//magazine/139/rising-dough.html
www.fastcompany.com//magazine/139/rising-dough.html
75. Ibid.
76. Ibid.
77. Conniff.
78. Panera Press Release, April 1, 2008, p. 1.
79. Stephen Shuck, “Breakfast Proteins,” The Breakfast Journal,
A Special Edition from Nation’s Restaurant News (August 11,
2008), p. 4.
80. Ibid.
81. Ibid.
82. www.Datamonitor.com (December 15, 2008), p. 8.
83. www.panerabread.com/menu/cafe/kids.php.
84. Panera Bread Company Inc., 2009 Form 10-K, pp. 5–6.
85. Panera Bread Company Inc., 2009 Form 10-K, p. 7.
86. Panera Bread Franchise Information, www.panerabread.com/
about/franchise/, pp. 1–8.
87. Panera Bread Company Inc., Second Quarter Earnings Con-
ference Call, July 28, 2010.
88. Panera Bread Company Inc., 2009 Form 10-K, p. 7.
89. Tischler, p. 102–112.
90. Panera Bread Company Inc., 2009 Form 10-K, p. 28.
91. Panera Bread Company Inc., 2009 Form 10-K, pp. 3–4.
92. Panera Bread Company Inc., Second Quarter Earnings Con-
ference Call, July 28, 2010.
93. Jargon, p. B1.
94. Ibid.
95. Panera, April 12, 2010 Letter to Stockholders.
96. Panera Bread Company Inc., Second Quarter Earnings Con-
ference Call, July 28, 2010.
97. Ibid.
98. Panera Bread Company Inc., 2009 Form 10-K, p. 3.
99. Panera Bread Company Inc. http://www.panerabread.com/
about/community/.
100. Panera Bread Company Inc., 2009 Form 10-K, p. 6.
101. Gregg Cebrzynski, “Panera Bread Managers ‘Harvest’Key Sales
Data via Intranet to Support Internal Marketing Goals,” Nation’s
Restaurant News (November 3, 2008), www.nrn.com/article/
panera-bread-managers-%E2%80%98harvest%E2%80%99-
key-sales-data-intranet-support-internal-marketing-goals.
102. Panera, 2009 Form 10-K, p. 6.
103. Panera Bread Company Inc., Second Quarter Earnings Con-
ference Call, July 28, 2010.
104. Panera Bread Company Inc., 2009 Form 10-K, p. 8.
105. Ibid. p. 5.
106. Panera Press Release (314-633-4282), Panera Bread Reports
Q1 EPS of $.82, up 44% Over Q1 2009, on a 10.0% Company-
owned Comparable Bakery-Café Sales Increase, pp. 1–10.
107. Ibid., pp. 1–2.
108. Ibid., p. 2.
109. Panera Bread Company Inc., 2009 Form 10-K, p. 23.
110. Panera Bread Company Inc., 2009 Form 10-K, Annual Letter to
Stockholders, p. 2.
111. Panera Bread Company Inc., 2009 Form 10-K, pp. 26–28.
112. Panera Bread Company Inc., 2009 Form 10-K, pp. 4 and 32–33.
113. Sean Gregory, “How Panera Bread Defies the Recession,” Time
(December 23, 2009), pp. 1–2, www.time.com/time/printout/
0,8816,1949371,00.html.
114. Ibid., p. 1.
32-26 SECTION D Industry Eight—Food and Beverage
www.Datamonitor.com
www.panerabread.com/menu/cafe/kids.php
www.panerabread.com/about/franchise/
www.panerabread.com/about/franchise/
http://www.panerabread.com/about/community/
http://www.panerabread.com/about/community/
www.nrn.com/article/panera-bread-managers-%E2%80%98harvest%E2%80%99-key-sales-data-intranet-support-internal-marketing-goals
www.nrn.com/article/panera-bread-managers-%E2%80%98harvest%E2%80%99-key-sales-data-intranet-support-internal-marketing-goals
www.nrn.com/article/panera-bread-managers-%E2%80%98harvest%E2%80%99-key-sales-data-intranet-support-internal-marketing-goals
www.time.com/time/printout/0,8816,1949371,00.html
www.time.com/time/printout/0,8816,1949371,00.html
33-1
C A S E 33
Whole Foods Market 2010:
How to Grow in an Increasingly
Competitive Market? (Mini Case)
Patricia Harasta and Alan N. Hoffman
REFLECTING BACK OVER HIS THREE DECADES OF EXPERIENCE IN THE GROCERY BUSINESS, John Mackey
smiled to himself over his previous successes. His entrepreneurial history began with a sin-
gle store which he has now grown into the nation’s leading natural food chain. Whole
Foods is not just a food retailer but instead represents a healthy, socially responsible
lifestyle that customers can identify with. The company has differentiated itself from
competitors by focusing on quality as excellence and innovation that allows it to charge a
premium price for premium products. While proud of the past, John had concerns about the
future direction Whole Foods should head.
Company Background
Whole Foods carries both natural and organic food, offering customers a wide variety of
products. “Natural” refers to food that is free of growth hormones or antibiotics, whereas
“certificated organic” food conforms to the standards, as defined by the U.S. Department
of Agriculture (USDA) in October 2002. Whole Foods Market® is the world’s leading
This case was prepared by Patricia Harasta and Professor Alan N. Hoffman, Bentley University and Erasmus University.
Copyright ©2010 by Alan N. Hoffman. The copyright holder is solely responsible for case content. Reprint permission is
solely granted to the publisher, Prentice Hall, for Strategic Management and Business Policy, 13th Edition (and the interna-
tional and electronic versions of this book) by the copyright holder, Alan N. Hoffman. Any other publication of the case
(translation, any form of electronics or other media) or sale (any form of partnership) to another publisher will be in viola-
tion of copyright law, unless Alan N. Hoffman has granted an additional written permission. Reprinted by permission. The
authors would like to thank Will Hoffman, Christopher Ferrari, Robert Marshall, Julie Giles, Jennifer Powers, and Gretchen
Alper for their research and contributions to this case. No part of this publication may be copied, stored, transmitted, repro-
duced, or distributed in any form or medium whatsoever without the permission of the copyright owner, Alan N. Hoffman.
33-2 SECTION D Industry Eight—Food and Beverage
Whole Foods Market’s Philosophy
Whole Foods Market’s corporate website defines the company philosophy as follows:
Whole Foods Market’s vision of a sustainable future means our children and grandchildren will be
living in a world that values human creativity, diversity, and individual choice. Businesses will har-
ness human and material resources without devaluing the integrity of the individual or the planet’s
ecosystems. Companies, governments, and institutions will be held accountable for their actions.
While Whole Foods recognizes it is only a supermarket, management is working toward
fulfilling their vision within the context of the industry. In addition to leading by example, they
strive to conduct business in a manner consistent with their mission and vision. By offering
minimally processed, high-quality food, engaging in ethical business practices, and providing
a motivational, respectful work environment, the company believes it is on the path to a
sustainable future.
Whole Foods incorporates the best practices of each location back into the chain. This can
be seen in the company’s store product expansion from dry goods to perishable produce,
including meats, fish, and prepared foods. The lessons learned at one location are absorbed by
all, enabling the chain to maximize effectiveness and efficiency while offering a product line
customers love. Whole Foods carries only natural and organic products. The best tasting and
most nutritious food available is found in its purest state—unadulterated by artificial additives,
sweeteners, colorings, and preservatives.
Employee and Customer Relations
Whole Foods encourages a team-based environment allowing each store to make indepen-
dent decisions regarding its operations. Teams consist of up to 11 employees and a team leader.
The team leaders typically head up one department or another. Each store employs anywhere
from 72 to 391 team members. The manager is referred to as the “store team leader.”
retailer of natural and organic foods, with 193 stores in 31 states, Canada, and the United
Kingdom.
According to the company, Whole Foods Market is highly selective about what it sells,
dedicated to stringent quality standards, and committed to sustainable agriculture. It believes
in a virtuous circle entwining the food chain, human beings and Mother Earth: each is reliant
upon the others through a beautiful and delicate symbiosis. The message of preservation and
sustainability are followed while providing high-quality goods to customers and high profits
to investors.
Whole Foods has grown over the years through mergers, acquisitions, and new store open-
ings. The $565 million acquisition of its lead competitor, Wild Oats, in 2007 firmly set Whole
Foods as the leader in the natural and organic food market and led to 70 new stores. The U.S.
Federal Trade Commission (FTC) focused its attention on the merger on antitrust grounds. The
dispute was settled in 2009, with Whole Foods closing 32 Wild Oats stores and agreeing to sell
the Wild Oats Markets brand.
Although the majority of Whole Foods’ locations are in the United States, European
expansion provides enormous potential growth due to the large population and it holds a more
sophisticated organic-foods market than the U.S. in terms of suppliers and acceptance by the
public. Whole Foods targets its locations specifically by an area’s demographics. The company
targets locations where 40% or more of the residents have a college degree as they are more
likely to be aware of nutritional issues.
CASE 33 Whole Foods Market 2010: How to Grow in an Increasingly Competitive Market? 33-3
The “store team leader” is compensated by an Economic Value Added (EVA) bonus and is
also eligible to receive stock options.
Whole Foods tries to instill a sense of purpose among its employees and has been named
for 13 consecutive years as one of the “100 Best Companies to Work For” in America by
Fortune magazine. In employee surveys, 90% of its team members stated that they always or
frequently enjoy their job.
The company strives to take care of its customers, realizing they are the “lifeblood of our
business,” and the two are “interdependent on each other.” Whole Foods’primary objective goes
beyond 100% customer satisfaction with the goal to “delight” customers in every interaction.
Competitive Environment
At the time of Whole Foods’ inception, there was almost no competition with less than six
other natural food stores in the United States. Today, the organic foods industry is growing
and Whole Foods finds itself competing hard to maintain its elite presence.
Whole Foods competes with all supermarkets. With more U.S. consumers focused on
healthful eating, environmental sustainability, and the green movement, the demand for
organic and natural foods has increased. More traditional supermarkets are now introducing
“lifestyle” stores and departments to compete directly with Whole Foods. This can be seen in
the Wild Harvest section of Shaw’s, or the “Lifestyle” stores opened by conventional grocery
chain Safeway.
Whole Foods’competitors now include big box and discount retailers who have made a foray
into the grocery business. Currently, the United States’ largest grocer is Wal-Mart. Not only does
Wal-Mart compete in the standard supermarket industry, but it has even begun offering natural
and organic products in its supercenter stores. Other discount retailers now competing in the su-
permarket industry include Target, Sam’s Club, and Costco. All of these retailers offer grocery
products, generally at a lower price than what one would find at Whole Foods.
Another of Whole Foods’ key competitors is Los Angeles-based Trader Joe’s, a premium
natural and organic food market. By expanding its presence and product offerings while main-
taining high quality at low prices, Trader Joe’s has found its competitive niche. It has 215 stores,
primarily on the west and east coasts of the United States, offering upscale grocery fare such as
health foods, prepared meals, organic produce, and nutritional supplements. A low cost struc-
ture allows Trader Joe’s to offer competitive prices while still maintaining its margins. Trader
Joe’s stores have no service department and average just 10,000 square feet in store size.
A Different Shopping Experience
The setup of the organic grocery store is a key component to Whole Foods’ success. The
store’s setup and its products are carefully researched to ensure that they are meeting the
demands of the local community. Locations are primarily in cities and are chosen for their
large space and heavy foot traffic. According to Whole Foods’ 10-K, “approximately 88% of
our existing stores are located in the top 50 statistical metropolitan areas.” The company uses
a specific formula to choose store sites that is based upon several metrics, which include but
are not limited to income levels, education, and population density.
Upon entering a Whole Foods supermarket, it becomes clear that the company attempts
to sell the consumer on the entire experience. Team members (employees) are well trained and
the stores themselves are immaculate. There are in-store chefs to help with recipes, wine
tasting, and food sampling. There are “Take Action food centers” where customers can access
33-4 SECTION D Industry Eight—Food and Beverage
The Green Movement
Whole Foods exists in a time where customers equate going green and being environmentally
friendly with enthusiasm and respect. In recent years, people began to learn about food and the
processes completed by many to produce it. Most of what they have discovered is disturbing.
Whole Foods launched a nationwide effort to trigger awareness and action to remedy the prob-
lems facing the U.S. food system. It has decided to host 150 screenings of a 12 film series called
“Let’s Retake Our Plates,” hoping to inspire change by encouraging and educating consumers
to take charge of their food choices. Jumping on the bandwagon of the “go green” movement,
Whole Foods is trying to show its customers that it is dedicated to not only all natural foods, but
to a green world and healthy people. As more and more people become educated, the company
hopes to capitalize on them as new customers.1
Beyond the green movement, Whole Foods has been able to tap into a demographic that
appreciates the “trendy” theme of organic foods and all natural products. Since the store is
associated with a type of affluence, many customers shop there to show they fit into this category
of upscale, educated, new age people.
The Economic Recession of 2008
The uncertainty of today’s market is a threat to Whole Foods. The expenditure income is low
and “all natural foods” are automatically deemed as expensive. Because of people being laid
off, having their salaries cut, or simply not being able to find a job, they now have to be more
selective when purchasing things. While Whole Foods has been able to maintain profitability,
it’s questionable how long this will last if the recession continues or worsens. The reputation of
organic products being costly may be enough to motivate people to not ever enter through the
doors of Whole Foods. In California, the chain is frequently dubbed “Whole Paycheck.”2
However, management understood that it must change a few things if the company was to
survive the decrease in sales felt because customers were not willing to spend their money
so easily. They have been working to correct this “pricey” image by expanding offerings of
private-label products through their “365 Everyday Value” and “365 Organic” product lines.
Private-label sales accounted for 11% of Whole Foods’ total sales in 2009, up from 10%
in 2008. They have also instituted a policy that their 365 product lines must match prices of
similar products at Trader Joe’s.3
information on the issues that affect their food such as legislation and environmental factors.
Some stores offer extra services such as home delivery, cooking classes, massages, and valet
parking. Whole Foods goes out of its way to appeal to the above-average income earner.
Whole Foods uses price as a marketing tool in a few select areas, as demonstrated by the
365 Whole Foods brand name products priced less than similar organic products that are
carried within the store. However, the company does not use price to differentiate itself from
competitors. Rather, Whole Foods focuses on quality and service as a means of standing out
from the competition.
Whole Foods spends much less than other supermarkets on advertising, approximately
0.4% of total sales in the fiscal year 2009. It relies heavily on word-of-mouth advertising from
its customers to help market itself in the local community. The company advertises in several
health conscious magazines, and each store budgets for in-store advertising each fiscal year.
Whole Foods also gains recognition via its charitable contributions and the awareness that
they bring to the treatment of animals. The company donates 5% of its after-tax profits to not-
for-profit charities. It is also very active in establishing systems to make sure that the animals
used in their products are treated humanely.
CASE 33 Whole Foods Market 2010: How to Grow in an Increasingly Competitive Market? 33-5
Organic Foods as a Commodity
When Whole Foods first started in the natural foods industry in 1980 it was a relatively new
concept. Over its first decade, Whole Foods enjoyed the benefits of offering a unique value
proposition to consumers wanting to purchase high-quality natural foods from a trusted
retailer. Over the last few years, however, the natural and organic foods industry has attracted
the attention of general food retailers that have started to offer foods labeled as natural or
organic at reasonable prices.
By 2007, the global demand for organic and natural foods far exceeded the supply. This
is becoming a huge issue for Whole Foods, as more traditional supermarkets with higher
purchasing power enter the premium natural and organic foods market. The supply of organic
food has been significantly impacted by the entrance of Wal-Mart into the competitive arena.
Due to the limited resources within the United States, Wal-Mart began importing natural and
organic foods from China and Brazil, which led to it coming under scrutiny for passing off
non-natural or organic products as the “real thing.” Additionally, the quality of natural and
organic foods throughout the entire market has been decreased due to constant pressure from
Wal-Mart.
The distinction between what is truly organic and natural is difficult for the consumer to
decipher as general supermarkets have taken to using terms such as “all natural,” “free-range,”
and “hormone free,” confusing customers. Truly organic food sold in the United States bears
the “USDA Organic” label and needs to have at least 95% of the ingredients organic before it
can get this distinction.4
In May 2003 Whole Foods became America’s first Certified Organic grocer by a feder-
ally recognized independent third-party certification organization. In July 2009, California
Certified Organic Growers (CCOF), one of the oldest and largest USDA-accredited third-party
organic certifiers, individually certified each store in the United States, complying with stricter
guidance on federal regulations. This voluntary certification tells customers that Whole Foods
has gone the extra mile by not only following the USDA’s Organic Rule, but opening its stores
up to third-party inspectors and following a strict set of operating procedures designed to
ensure that the products sold and labeled as organic are indeed organic—procedures that are
not specifically required by the Organic Rule. This certification verifies the handling of
organic goods according to stringent national guidelines, from receipt through repacking to
final sale to customers. To receive certification, retailers must agree to adhere to a strict set of
standards set forth by the USDA, submit documentation, and open their facilities to on-site
inspections—all designed to assure customers that the chain of organic integrity is preserved.
Struggling to Grow in an Increasingly Competitive Market
Whole Foods has historically grown by opening new stores or acquiring stores in affluent neigh-
borhoods targeting the wealthier and more educated consumers. This strategy has worked in the
past; however, the continued focus on growth has been impacting existing store sales. Average
weekly sales per store have decreased over the last number of years despite the fact that overall
sales have been increasing. It is likely that this trend will continue unless Whole Foods starts to
focus on growing sales within the stores it has and not just looking to increase overall sales by
opening new stores. It is also increasingly difficult to find appropriate locations for new
stores that are first and foremost in an area where there is limited competition and also to have
the store in a location that is easily accessible by both consumers and the distribution network.
Originally Whole Foods had forecast to open 29 new stores in 2010 but this has since been
revised downward to 17.
33-6 SECTION D Industry Eight—Food and Beverage
N O T E S
1. “Whole Foods Market; Whole Foods Market Challenge: Let’s
Retake Our Plates!” Food Business Week (April 15, 2010).
2. “Eating Too Fast At Whole Foods,” Business Week (2005).
3. Katy McLaughlin, “As Sales Slip, Whole Foods Tries Health
Push,” Wall Street Journal (August 15, 2009).
4. “Whole Foods Markets Organic China California Blend,”
http://www.youtube.com/watch?v=JQ31Ljd9T_Y (April 10, 2010).
5. Organic Trade Association, http://www.organicnewsroom.com/
2010/04/us_organic_product_sales_reach_1.html.
Opening up new stores or the acquisition of existing stores is also costly. The average cost
to open a new store ranges from $2 to $3 million, and it takes on average 8 to 12 months. A lot
of this can be explained by the fact that Whole Foods custom builds the stores, which reduces
the efficiencies that can be gained from the experience of having opened up many new stores
previously. Opening new stores requires the company to adapt its distribution network, infor-
mation management, supply, and inventory management, and adequately supply the new
stores in a timely manner without impacting the supply to the existing stores. As the company
expands, this task increases in complexity and magnitude.
The organic and natural foods industry overall has become a more concentrated market
with few larger competitors having emerged from a more fragmented market composed of a
large number of smaller companies. Future acquisitions will be more difficult for Whole Foods
as the FTC will be monitoring the company closely to ensure that it does not violate any fed-
eral antitrust laws through the elimination of any substantial competition within this market.
Over the last number of years there has been an increasing demand by consumers for
natural and organic foods. Sales of organic foods increased by 5.1% in 2009 despite the fact
that U.S. food sales overall only grew by 1.6%.5 This increase in demand and high margin
availability on premium organic products led to an increasing number of competitors moving
into the organic foods industry. Conventional grocery chains such as Safeway have remodeled
stores at a rapid pace and have attempted to narrow the gap with premium grocers like Whole
Foods in terms of shopping experience, product quality, and selection of takeout foods. This
increase in competition can lead to the introduction of price wars where profits are eroded for
both existing competitors and new entrants alike.
Unlike low-price leaders such as Wal-Mart, Whole Foods dominates because of its brand
image, which is trickier to manage and less impervious to competitive threats. As competitors
start to focus on emphasizing organic and natural foods within their own stores, the power of
the Whole Foods brand will gradually decline over time as it becomes more difficult for
consumers to differentiate Whole Foods’ value proposition from that of its competitors.
http://www.organicnewsroom.com/2010/04/us_organic_product_sales_reach_1.html
http://www.organicnewsroom.com/2010/04/us_organic_product_sales_reach_1.html
ORIGINALLY CALLED INSTA-BURGER KING, the company was founded in Florida in 1953 by
Keith Kramer and Matthew Burns. Their Insta-Broiler oven was so successful at cooking
hamburgers that they required all of their franchised restaurants to use the oven. After the
chain ran into financial difficulties, it was purchased by its Miami-based franchisees,
James McLamore and David Edgerton, in 1955. The new owners renamed the company
Burger King. The restaurant chain introduced the first Whopper sandwich in 1957.
Expanding to over 250 locations in the United States, the company was sold in 1967 to
Pillsbury Corporation.
The company successfully differentiated itself from McDonald’s, its primary rival, when
it launched the Have It Your Way advertising campaign in 1974. Unlike McDonald’s, which
had made it difficult and time-consuming for customers to special-order standard items (such
as a plain hamburger), Burger King restaurants allowed people to change the way a food item
was prepared without a long wait.
Pillsbury (including Burger King) was purchased in 1989 by Grand Metropolitan, which
in turn merged with Guinness to form Diageo, a British spirits company. Diageo’s manage-
ment neglected the Burger King business, leading to poor operating performance. Burger King
was damaged to the point that major franchises went out of business and the total value of the
34-1
C A S E 34
Burger King (Mini Case)
J. David Hunger
This case was prepared by Professor J. David Hunger, Iowa State University and St. John’s University. Copyright ©2010
by J. David Hunger. The copyright holder is solely responsible for case content. Reprint permission is solely granted to
the publisher, Prentice Hall, for Strategic Management and Business Policy, 13th Edition (and the international and
electronic versions of this book) by the copyright holder, J. David Hunger. Any other publication of the case (transla-
tion, any form of electronics or other media) or sale (any form of partnership) to another publisher will be in violation
of copyright law, unless J. David Hunger has granted an additional written permission. Reprinted by permission.
34-2 SECTION D Industry Eight—Food and Beverage
firm declined. Diageo’s management decided to divest the money-losing chain by selling it to
a partnership private equity firm led by TPG Capital in 2002.
The investment group hired a new advertising agency to create (1) a series of new ad
campaigns, (2) a changed menu to focus on male consumers, (3) a series of programs designed
to revamp individual stores, and (4) a new concept called the BK Whopper Bar. These changes
led to profitable quarters and re-energized the chain. In May 2006, the investment group took
Burger King public by issuing an Initial Public Offering (IPO). The investment group continued
to own 31% of the outstanding common stock.
Business Model
Burger King was the second largest fast-food hamburger restaurant chain in the world as
measured by the total number of restaurants and systemwide sales. As of June 30, 2010, the
company owned or franchised 12,174 restaurants in 76 countries and U.S. territories, of
which 1,387 were company-owned and 10,787 were owned by franchisees. Of Burger King’s
restaurant total, 7,258 or 60% were located in the United States. The restaurants featured
flame-broiled hamburgers, chicken and other specialty sandwiches, french fries, soft drinks,
and other low-priced food items.
According to management, the company generated revenues from three sources: (1) retail
sales at company-owned restaurants; (2) royalty payments on sales and franchise fees paid by
franchisees; and (3) property income from restaurants leased to franchisees. Approximately
90% of Burger King restaurants were franchised, a higher percentage than other competitors
in the fast-food hamburger category. Although such a high percentage of franchisees meant
lower capital requirements compared to competitors, it also meant that management had lim-
ited control over franchisees. Franchisees in the United States and Canada paid an average of
3.9% of sales to the company in 2010. In addition, these franchisees contributed 4% of gross
sales per month to the advertising fund. Franchisees were required to purchase food, packag-
ing, and equipment from company-approved suppliers.
Restaurant Services Inc. (RSI) was a purchasing cooperative formed in 1992 to act as
purchasing agent for the Burger King system in the United States. As of June 30, 2010, RSI
was the distribution manager for 94% of the company’s U.S. restaurants, with four distrib-
utors servicing approximately 85% of the U.S. system. Burger King had long-term exclu-
sive contracts with Coca Cola and with Dr. Pepper/Seven-Up to purchase soft drinks for its
restaurants.
Management touted its business strategy as growing the brand, running great restaurants,
investing wisely, and focusing on its people. Specifically, management planned to accelerate
growth between 2010 and 2015 so that international restaurants would comprise 50% of the
total number. The focus in international expansion was to be in (1) countries with growth
potential where Burger King was already established, such as Spain, Brazil, and Turkey;
(2) countries with potential where the firm had a small presence, such as Argentina,
Colombia, China, Japan, Indonesia, and Italy; and (3) attractive new markets in the Middle
East, Eastern Europe, and Asia.
Management was also working to update the restaurants by implementing its new
20/20 design and complementary Whopper Bar design introduced in 2008. By 2010, more than
200 Burger King restaurants had adopted the new 20/20 design that evoked the industrial look
of corrugated metal, brick, wood, and concrete. The new design was to be introduced in
95 company-owned restaurants during fiscal 2011.
Management was using a “barbell” menu strategy to introduce new products at both the
premium and low-priced ends of the product continuum. As part of this strategy, the company
introduced in 2010 the premium Steakhouse XT burger line and BK Fire-Grilled Ribs, the first
bone-in pork ribs sold at a national fast-food hamburger restaurant chain. At the other end of
the menu, the company introduced in 2010 the 1⁄4 pound Double Cheeseburger, the Buck Dou-
ble, and the $1 BK Breakfast Muffin Sandwich.
Management continued to look for ways to reduce costs and boost efficiency. By
June 30, 2010, point-of-sale cash register systems had been installed in all company-owned,
and 57% of franchise-owned, restaurants. It had also installed a flexible batch broiler to max-
imize cooking flexibility and facilitate a broader menu selection while reducing energy
costs. By June 30, 2010, the flexible broiler was in 89% of company-owned restaurants and
68% of franchise restaurants.
Industry
The fast-food hamburger category operated within the quick service restaurant (QSR) seg-
ment of the restaurant industry. QSR sales had grown at an annual rate of 3% over the past
10 years and were projected to continue increasing at 3% from 2010 to 2015. The fast-food
hamburger restaurant (FFHR) category represented 27% of total QSR sales. FFHR sales were
projected to grow 5% annually during this same time period. Burger King accounted for
around 14% of total FFHR sales in the United States.
The company competed against market-leading McDonald’s, Wendy’s, and Hardee’s
restaurants in this category and against regional competitors, such as Carl’s Jr., Jack in the Box,
and Sonic. It also competed indirectly against a multitude of competitors in the QSR restau-
rant segment, including Taco Bell, Arby’s, and KFC, among others. As the North American
market became saturated, mergers occurred. For example, Taco Bell, KFC, and Pizza Hut were
now part of Yum! Brands. Wendy’s and Arby’s merged in 2008. Although the restaurant in-
dustry as a whole had few barriers to entry, marketing and operating economies of scale made
it difficult for a new entrant to challenge established U.S. chains in the FFHR category.
The quick service restaurant market segment appeared to be less vulnerable to a recession
than other businesses. For example, during the quarter ended May 2010, both QSR and FFHR
sales decreased 0.5%, compared to a 3% decline at both casual dining chains and family dining
chains. The U.S. restaurant category as a whole declined 1% during the same time period.
America’s increasing concern with health and fitness was putting pressure on restau-
rants to offer healthier menu items. Given its emphasis on fried food and saturated fat, the
quick service restaurant market segment was an obvious target for likely legislation. For
example, Burger King’s recently introduced Pizza Burger was a 2,530-calorie item that
included four hamburger patties, pepperoni, mozzarella, and Tuscan sauce on a sesame seed
bun. Although the Pizza Burger may be the largest hamburger produced by a fast-food chain,
the foot-long cheeseburgers of Hardee’s and Carl’s Jr. were similar entries. A health reform
bill passed by the U.S. Congress in 2010 required restaurant chains with 20 or more outlets
to list the calorie content of menu items. A study by the National Bureau of Economic
Research found that a similar posting law in New York City caused the average calorie count
per transaction to fall 6%, and revenue increased 3% at Starbucks stores where a Dunkin
Donuts outlet was nearby. One county in California attempted to ban McDonald’s from
including toys in its high-calorie “Happy Meal” because legislators believed that toys
attracted children to unhealthy food.
Issues
Even though Burger King was the second largest hamburger chain in the world, it lagged far
behind McDonald’s, which had a total of 32,466 restaurants worldwide. McDonald’s averaged
about twice the sales volume per U.S. restaurant and was more profitable than Burger King.
CASE 34 Burger King (Mini Case) 34-3
34-4 SECTION D Industry Eight—Food and Beverage
New Owners: Time for a Strategic Change?
On September 2, 2010, 3G Capital, an investment group dominated by three Brazilian
millionaires, offered $4 billion to purchase Burger King Holdings Inc. At $24 a share, the
offer represented a 46% premium over Burger King’s August 31 closing price. According to
John Chidsey, Burger King’s Charman and CEO, “It was a call out of the blue.” Both the
board of directors and the investment firms owning 31% of the shares supported acceptance
of the offer. New ownership should bring a new board of directors and a change in top
management. What should new management propose to ensure the survival and long-term
success of Burger King?
McDonald’s was respected as a well-managed company. During fiscal year 2009 (ending
December 31), McDonald’s earned $4.6 billion on revenues of $22.7 billion. Although its
total revenues had dropped from $23.5 billion in 2008, net income had actually increased from
$4.3 billion in 2008. In contrast to most corporations, McDonald’s common stock price had
risen during the 2008–2010 recession, reaching an all-time high in August 2010.
In contrast, Burger King was perceived by industry analysts as having significant prob-
lems. As a result, Burger King’s share price had fallen by half from 2008 to 2010. During
fiscal year 2010 (ending June 30), Burger King earned $186.8 million on revenues of
$2.50 billion. Although its total revenues had dropped only slightly from $2.54 billion in
fiscal 2009 and increased from $2.45 billion in 2008, net income fell from $200.1 million
in 2009 and $189.6 million in 2008. Even though same-store sales stayed positive for
McDonald’s during the recession, they dropped 2.3% for Burger King from fiscal 2009 to
2010. In addition, some analysts were concerned that expenses were high at Burger King’s
company-owned restaurants. Expenses as a percentage of total company-owned restaurant
revenues were 87.8% in fiscal 2010 for Burger King compared to only 81.8% for
McDonald’s in fiscal 2009.
McDonald’s had always emphasized marketing to families. The company significantly
outperformed Burger King in both “warmth” and “competence” in consumers’ minds. When
McDonald’s recently put more emphasis on women and older people by offering relatively
healthy salads and upgraded its already good coffee, Burger King continued to market to
young men by (according to one analyst) offering high-calorie burgers and ads featuring danc-
ing chickens and a “creepy-looking” king. These young men were the very group who had
been hit especially hard by the recession. According to Steve Lewis, who operated 36 Burger
King franchises in the Philadelphia area, “overall menu development has been horrible. . . . We
disregarded kids, we disregarded families, we disregarded moms.” For example, sales of new,
premium-priced menu items like the Steakhouse XT burger declined once they were no longer
being advertised. One analyst stated that the company had “put a lot of energy into gimmicky
advertising” at the expense of products and service. In addition, analysts commented that fran-
chisees had also disregarded their aging restaurants.
Some analysts felt that Burger King may have cannibalized its existing sales by putting
too much emphasis on value meals. For example, Burger King franchisees sued the company
in 2009 over the firm’s double-cheeseburger promotion, claiming that it was unfair for them
to be required to sell these cheeseburgers for only $1 when they cost $1.10. Even though the
price was subsequently raised to $1.29, the items on Burger King’s “value menu” accounted
for 20% of all sales in 2010, up from 12% in 2009.
“A DECADE AGO, CHURCH & DWIGHT WAS A LARGELY HOUSEHOLD DOMESTIC PRODUCTS COMPANY
with one iconic brand, delivering less than $1 billion in annual sales. Today, the company
has been transformed into a diversified packaged goods company with a well-balanced
portfolio of leading household and personal care brands delivering over $2.5 in annual
sales worldwide.”1 Now, after a decade of rapid growth fueled by a string of acquisitions,
the top management team is faced with a new challenge. It must now rationalize the firm’s
expanded consumer products portfolio of 80 brands into the existing corporate structure
while continuing to scout for new avenues of growth. This is no easy task as it competes for
market share with such formidable consumer products powerhouses as Colgate-Palmolive,
Clorox, and Procter & Gamble, commanding combined sales of over $100 billion. Future
decisions will determine if the company can compete successfully with these other well-
known giants in the consumer products arena or remain in their shadows.
35-1
C A S E 35
Church & Dwight:
Time to Rethink the Portfolio?
Roy A. Cook
This case was prepared by RoyA. Cook of Fort Lewis College. Copyright © 2010 by RoyA. Cook. The copyright holder
is solely responsible for case content. Reprint permission is solely granted to the publisher, Prentice Hall, for the book
Strategic Management Business Policy, 13th Edition (and the international and electronic versions of this book) by the
copyright holder, Roy A. Cook. Any other publication of the case (translation, any form of electronics or other media) or
sale (any form of partnership) to another publisher will be in violation of copyright law, unless Roy A. Cook has granted
an additional written permission. This case was revised and edited for SMBP, 13th Edition. Reprinted by permission.
Background
For over 160 years, Church & Dwight Co. Inc. has been working to build market share on a
brand name that is rarely associated with the company. When consumers are asked, “Are you
familiar with Church & Dwight products?” the answer is typically “No.” Yet, Church &
35-2 SECTION D Industry Eight—Food and Beverage
Management
The historically slow but steady course Church & Dwight has traveled over the decades
reflected stability in the chief executive office and a steady focus on long-term goals. The
ability to remain focused may be attributable to the fact that about 25% of the outstanding
shares of common stock were owned by descendants of the company’s co-founders. Dwight
C. Minton, a direct descendant of Austin Church, actively directed the company as CEO from
1969 through 1995 and remained on the board as Chairman Emeritus. He passed on the du-
ties of CEO to the first non-family member in the company’s history, Robert A. Davies III, in
1995 and leadership at the top has remained a stable hallmark of the company.
Many companies with strong brand names in the consumer products field have been
susceptible to leveraged buy-outs and hostile takeovers. However, a series of calculated actions
has spared Church & Dwight’s board and management from having to make last-minute deci-
sions to ward off unwelcome suitors. Besides maintaining majority control of the outstanding
common stock, the board amended the company’s charter, giving current shareholders four
votes per share. However, they required future shareholders to buy and hold shares for four
years before receiving the same privilege. The board of directors was also structured into three
classes with four directors in each class serving staggered three-year terms. According to
Minton, the objective of these moves was to “[give] the board control so as to provide the best
results for shareholders.”5
Dwight products can be found among a variety of consumer products in 95% of all U.S.
households. As the world’s largest producer and marketer of sodium bicarbonate-based prod-
ucts, Church & Dwight has achieved fairly consistent growth in both sales and earnings as
new and expanded uses were found for its core sodium bicarbonate products. Although
Church & Dwight may not be a household name, many of its core products bearing the ARM &
HAMMER name are easily recognized.
Shortly after its introduction in 1878, ARM & HAMMER Baking Soda became a funda-
mental item on the pantry shelf as homemakers found many uses for it other than baking, such
as cleaning and deodorizing. The ingredients that can be found in that ubiquitous yellow box
of baking soda can also be used as a dentrifice, a chemical agent to absorb or neutralize odors
and acidity, a kidney dialysis element, a blast media, an environmentally friendly cleaning
agent, a swimming pool pH stabilizer, and a pollution-control agent.
Finding expanded uses for sodium bicarbonate and achieving orderly growth have been
consistent targets for the company. Over the past 30 years, average company sales have increased
10%–15% annually. While top-line sales growth has historically been a focal point for the
company, a shift may have occurred in management’s thinking, as more emphasis seems to have
been placed on bottom-line profitability growth. Since President and Chief Executive Officer
James R. Cragie took over the helm of Church & Dwight from RobertA. Davies III in July of 2004,
he has remained focused on “building a portfolio of strong brands with sustainable competitive
advantages.”2 At that time, he proposed a strategy of reshaping the company through acquisitions
and organic growth and he continues to state that “Our long-term objective is to maintain the
company’s track record of delivering outstanding TSR (Total Shareholder Return) relative to that
of the S&P 500. Our long-term business model for delivering this sustained earnings growth is
based on annual organic growth of 3–4%, gross margin expansion, tight management of overhead
costs and operating margin improvement of 60–70 basis points resulting in sustained earnings
growth of 10–12% excluding acquisitions.”3 In addition, Cragie noted that “. . . [W]e have added
$1 billion in sales in the past five years, a 72% increase, while reducing our total headcount by 5%,
resulting in higher revenue per employee than all of our major competitors.”4 The results of these
efforts can be seen in the financial statements shown in Exhibits 1, 2, and 3.
CASE 35 Church & Dwight: Time to Rethink the Portfolio? 35-3
Year Ending December 31 2009 2008 2007
Net Sales $ 2,520,922 $ 2,422,398 $ 2,220,940
Cost of sales 1,419,932 1,450,680 1,353,042
Gross Profit 1,100,990 971,718 867,898
Marketing expenses 353,588 294,130 256,743
Selling, general, and administrative expenses 354,510 337,256 306,121
Patent litigation settlement, net (20,000) — —
Income from Operations 412,892 340,332 305,034
Equity in earnings of affiliates 12,050 11,334 8,236
Investment earnings 1,325 6,747 8,084
Other income (expense), net 1,537 (3,208) 2,469
Interest expense (35,568) (46,945) (58,892)
Income before Income Taxes 392,236 308,260 264,931
Income taxes 148,715 113,078 95,900
Net income 243,521 195,182 169,031
Non-controlling interest (12) 8 6
Net Income $ 243,533 $ 195,174 $ 169,025
Weighted average shares outstanding—Basic 70,379 67,870 65,840
Weighted average shares outstanding—
Diluted
71,477 71,116 70,312
Net income per share—Basic $ 3.46 $ 2.88 $ 2.57
Net income per share—Diluted $ 3.41 $ 2.78 $ 2.46
Cash dividends per share $ 0.46 $ 0.34 $ 0.30
EXHIBIT 1
Consolidated
Statements of
Income: Church &
Dwight Co. Inc.
(Dollars in
thousands, except
per share data)
SOURCE: Church & Dwight Co. Inc., 2009 Annual Report, p. 43.
As a further deterrent to would-be suitors or unwelcome advances, the company entered
into an employee severance agreement with key officials. This agreement provided severance
pay of up to two times (three times for Mr. Cragie) the individual’s highest annual salary and
bonus plus benefits for two years (three years for Mr. Cragie) if the individual was terminated
within one year after a change in control of the company. Change of control was defined as the
acquisition by a person or group of 50% or more of company common stock; a change in
the majority of the board of directors not approved by the pre-change board of directors; or the
approval by the stockholders of the company of a merger, consolidation, liquidation, dissolu-
tion, or sale of all the assets of the company.6
As Church & Dwight pushed aggressively into consumer products outside of sodium
bicarbonate-related products and into the international arena in the early 2000s, numerous
changes were made in key personnel. These changes can be seen by reviewing Exhibit 4
and noting the original date of hire for these key decision-makers. Many of the new mem-
bers of the top management team brought extensive marketing and international experience
from organizations such as Spalding Sports Worldwide, Johnson & Johnson, FMC, and
Carter-Wallace.
In addition to the many changes that have taken place in key management positions,
changes have also been made in the composition of the board of directors. Four members of the
10-member board have served for 10 years or more, whereas the other six members have served
for five years or less. Two women serve on the board and ages of members range from 50 to 74,
with six members being younger than 60. All but one of the newer additions to the board
Year Ending December 31 2009 2008 2007
Assets
Current assets
Cash and cash equivalents $ 447,143 $ 197,999 $ 249,809
Accounts receivable, less allowances of $5,782 and $5,427 222,158 211,194 247,898
Inventories 216,870 198,893 213,651
Deferred income taxes 20,432 15,107 13,508
Prepaid expenses 11,444 10,234 9,224
Other current assets 10,218 31,694 1,263
Total current assets 928,265 665,121 735,353
Property, plant, and equipment, net 455,636 384,519 350,853
Notes receivable — — 3,670
Equity investment in affiliates 12,815 10,061 10,324
Long-term supply contracts — — 2,519
Tradenames and other intangibles 794,891 810,173 665,168
Goodwill 838,078 845,230 688,842
Other assets 88,761 86,334 75,761
Total assets $ 3,118,446 $ 2,801,438 $ 2,532,490
Liabilities and Stockholders’ Equity
Current liabilities
Short-term borrowings $ 34,895 $ 3,248 $ 115,000
Accounts payable and accrued expenses 332,450 310,622 303,071
Current portion of long-term debt 184,054 71,491 33,706
Income taxes payable 15,633 1,760 6,012
Total current liabilities 567,032 387,121 457,789
Long-term debt 597,347 781,402 707,311
Deferred income taxes 201,256 171,981 162,746
Deferred and other long-term liabilities 112,440 93,430 87,769
Pension, postretirement, and postemployment benefits 38,599 35,799 36, 416
Minority interest — — 194
Total liabilities 1,516,674 1,469,733 1,452,225
Commitments and contingencies stockholders’ equity
Preferred stock–$1.00 par value
Authorized 2,500,000 shares, none issued — — —
Common stock–$1.00 par value
Authorized 300,000,000 shares, issued 73,213,775 shares 73,214 73,214 69,991
Additional paid-in capital 276,099 252,129 121,902
Retained earnings 1,275,117 1,063,928 891,868
Accumulated other comprehensive income (loss) 10,078 (20,454) 39,128
Common stock in treasury, at cost:
2,664,312 shares in 2009 and 3,140,931 shares in 2008 (32,925) (37,304) (42,624)
Total Church & Dwight Co. Inc. stockholders’ equity 1,601,583 1,331,513 —
Noncontrolling interest 189 192 —
Total stockholders’ equity 1,601,772 1,331,705 1,080,265
Total Liabilities and Stockholders’ Equity $ 3,118,446 $ 2,801,438 $ 2,532,490
EXHIBIT 2
Consolidated Balance Sheets: Church & Dwight Co. Inc. (Dollars in thousands, except share and per share data)
SOURCE: Church & Dwight Co. Inc., 2009 Annual Report, p. 44.
35-4
CASE 35 Church & Dwight: Time to Rethink the Portfolio? 35-5
Consumer
Domestic
Consumer
International
Specialty
Products Corporate Total
Net Sales
2009 $1,881,748 $393,696 $245,478 $ — $2,520,922
2008 1,716,801 420,192 285,405 — 2,422,398
2007 1,563,895 398,521 258,524 — 2,220,940
Income Before
Income Taxes
2009 $325,633 $38,562 $15,991 $12,050 $392,236
2008 236,956 34,635 25,335 11,334 308,260
2007 205,688 34,656 16,351 8,236 264,931
EXHIBIT 3
Business Segment
Results: Church &
Dwight Co. Inc.
Name Age Position
Anniversary
Date
James R. Cragie 56 President & Chief Executive Officer 2004
Jacquelin J. Brova 56 Executive Vice President, Human Resources 2002
Mark G. Conish 57 Executive Vice President, Global Operations 1975
Steven P. Cugine 47 Executive Vice President, Global New Products
Innovation
1999
Matthew T. Farrell 53 Executive Vice President Finance and Chief Financial
Officer
2006
Bruce F. Fleming 52 Executive Vice President and Chief Marketing Officer 2006
Susan E. Goldy 55 Executive Vice President, General Counsel and Secretary 2003
Adrian J. Huns 61 Executive Vice President, President International
Consumer Products
2004
Joseph A. Sipia Jr. 61 Executive Vice President, President, and Chief
Operating Officer, Specialty Products Division
2002
Paul A. Siracusa 53 Executive Vice President, Global Research and
Development
2005
Louis H. Tursi 49 Executive Vice President, Domestic Consumer Sales 2004
Steven J. Katz 52 Vice President, Controller and Chief Accounting Officer 1986
EXHIBIT 4
Key Officers:
Management
Positions and Tenure
with Church &
Dwight Co. Inc.
SOURCE: Church & Dwight Co. Inc., 2009 Annual Report, p. 30.
SOURCE: Notice of Annual Meeting of Stockholders and Proxy Statement, Church & Dwight Co. Inc., 2009, pages 11–12.
brought significant consumer products and service industry insights from their ties with com-
panies such as Revlon, ARAMARK, VF Corporation, Welch Foods, and H. J. Heinz. Although
in a less active role as Chairman Emeritus, Dwight Church Minton, who became a board mem-
ber in 1965, continued to provide leadership and a long legacy of “corporate memory.”
Changing Directions
Entering the 21st century, “. . . [m]anagement recognized a major challenge to overcome . . .
was the company’s small size compared to its competitors in basic product lines of household
and personal care. They also recognized the value of a major asset, the company’s pristine
balance sheet, and made the decision to grow.”7 According to Cragie, “Church & Dwight has
35-6 SECTION D Industry Eight—Food and Beverage
Consumer Products
Prior to its acquisition spree, the company’s growth strategy had been based on finding new
uses for sodium bicarbonate. Using an overall family branding strategy to penetrate the
consumer products market in the United States and Canada, Church & Dwight introduced
additional products displaying the ARM & HAMMER logo. This logoed footprint remained
significant as the ARM & HAMMER brand controlled a commanding 85% of the baking soda
market. By capitalizing on its easily recognizable brand name, logo, and established market-
ing channels, Church & Dwight moved into such related products as laundry detergent, carpet
cleaners and deodorizers, air deodorizers, toothpaste, and deodorant/antiperspirants. This
strategy worked well, allowing the company to promote multiple products using only one
brand name, but it limited growth opportunities “. . . in highly competitive consumer product
markets, in which cost efficiency, new product offering and innovation are critical to success.”9
From the company’s founding until 1970, it produced and sold only two consumer
products: ARM & HAMMER Baking Soda and a laundry product marketed under the name
Super Washing Soda. In 1970, under Minton, Church & Dwight began testing the consumer
products market by introducing a phosphate-free, powdered laundry detergent. Several other
products, including a liquid laundry detergent, fabric softener sheets, an all-fabric bleach, tooth
powder and toothpaste, baking soda chewing gum, deodorant/antiperspirants, deodorizers
(carpet, room, and pet), and clumping cat litter have been added to the expanding list of ARM
& HAMMER brands. However, simply relying on baking soda extensions and focusing on
niche markets to avoid a head-on attack from competitors with more financial resources and
marketing clout limited growth opportunities.
So, in the late 1990s, the company departed from its previous strategy of developing new
product offerings in-house and bought several established consumer brands such as BRILLO,
undergone a substantial transformation in the past decade largely as a result of three major
acquisitions which doubled the size of the total company, created a well balanced portfolio
of household and personal care businesses, and established a much larger international
business.”8 The MENTADENT, PEPSODENT, AIM, and CLOSE-UP brands of toothpaste
products were purchased from Unilever in October of 2003; the purchase of the remaining
50% of Armkel, the acquisition vehicle that had been used to purchase Carter-Wallace’s
consumer brands such as TROJAN, was completed in May of 2004; and SPINBRUSH was
purchased from Procter & Gamble in October of 2005.
Five years later, another major acquisition was finalized when the stable of Orange Glow
International products, including the well-known OXICLEAN brand, were added to the
portfolio. The acquisitions didn’t stop as Del Pharmaceutical’s ORAGEL brands were added
in 2008. What impact has this string of acquisitions made? The numbers speak for themselves
as revenues have been pumped up from less than $500 million in 1995 to over $1 billion in
2001, then to $1.7 billion in 2005, and finally topping $2.5 billion in 2009.
Explosive growth through acquisitions transformed this once small company focused on a
few consumer and specialty products into a much larger competitor, not only across a broader
range of products, but also geographic territory. Consumer products now encompassed a broad
array of personal care, deodorizing and cleaning, and laundry products while specialty products
offerings were expanded to specialty chemicals, animal nutrition, and specialty cleaners. Inter-
national consumer product sales, which were an insignificant portion of total revenue at the turn
of the century, now accounted for 16% of sales. In the face of consumer products behemoths
such as Clorox, Colgate-Palmolive, and Procter & Gamble, Church & Dwight had been able to
carve out a respectable position with several leading brands. Regardless, the firm was not a
major market force and needed to evaluate its portfolio of 80 different consumer brands.
CASE 35 Church & Dwight: Time to Rethink the Portfolio? 35-7
Brand Name Market Position
ARM & HAMMER In 9 out of 10 households in America
TROJAN #1 condom brand
OXICLEAN #1 laundry additive brand
SPINBRUSH #1 battery-powered toothbrush brand
FIRST RESPONSE #1 branded pregnancy kit
NAIR #1 depilatory brand
ORAJEL #1 oral care pain relief brand
XTRA Leading deep value laundry detergent
EXHIBIT 5
Market Position of
Key Church &
Dwight Co. Inc.
Brands
PARSONS Ammonia, CAMEO Aluminum & Stainless Steel Cleaner, RAIN DROPS water
softener, SNO BOWL toilet bowl cleaner, and TOSS ’N SOFT dryer sheets from one of its
competitors, the Dial Corporation. An even broader consumer product assortment including
TROJAN, NAIR, and FIRST RESPONSE was added to the company’s mix of offerings with
the acquisition of the consumer products business of Carter-Wallace in partnership with the
private equity group, Armkel. The list of well-known brands was further enhanced with the
acquisition of Crest’s SPINBRUSH, Coty’s line of ORAJEL products, and OXICLEAN, as
well as other brands from Orange Glow International. In fact, acquisitions have been so
important that seven of the company’s eight brands are the result of these moves. The com-
pany has achieved significant success in the consumer products arena, as can be seen in
Exhibit 5.
Church & Dwight faced the same dilemma as other competitors in mature domestic and
international markets for consumer products. New consumer products had to muscle their way
into markets by taking market share from larger competitors’ current offerings. With the major-
ity of company sales concentrated in the United States and Canada where sales were funneled
through mass merchandisers, such as Wal-Mart (accounting for 22% of sales), supermarkets,
wholesale clubs, and drugstores, it was well-equipped to gain market share with its low-cost
strategy. In the international arena where growth was more product driven and less marketing
sensitive, the company was less experienced. To compensate for this weakness, Church &
Dwight relied on acquisitions and management changes to improve its international footprint
and reach.
With its new stable of products and expanded laundry detergent offerings, Church &
Dwight found itself competing head-on with both domestic and international consumer prod-
uct giants such as Clorox, Colgate-Palmolive, Procter & Gamble, and Unilever. The breadth
of its expanded consumer product offerings, composed of 60% premium and 40% value brand
names, can be seen in Exhibit 6.
According to Minton, as the company grew, “We have made every effort to keep costs
under control and manage frugally.”10 A good example of this approach to doing business can
be seen in the Armkel partnership. “Armkel borrowed money on a non-recourse basis so a
failure would have no impact on Church & Dwight, taking any risk away from shareholders.”11
As mentioned previously, the remaining interest in Armkel was purchased in 2005. This
important move cleared the way to increase marketing efforts behind TROJAN, a brand which
controlled 71% of the market.12
As more and more products were added to the consumer line-up, Church & Dwight
brought many of its marketing tasks in-house as well as stepping out with groundbreaking and
often controversial marketing campaigns. The first major in-house marketing project was in
SOURCE: Church & Dwight Co. Inc., 2009 Annual Report, p. 1.
35-8 SECTION D Industry Eight—Food and Beverage
Type of Product Key Brand Names
Household ARM & HAMMER Pure Baking Soda
ARM & HAMMER Carpet & Room Deodorizers
ARM & HAMMER Cat Litter Deodorizer
ARM & HAMMER Clumping Cat Litters
BRILLO Soap Pads
SCRUB FREE Bathroom Cleaners
CLEAN SHOWER Daily Shower Cleaner
CAMEO Aluminum & Stainless Steel Cleaner
SNO BOWL Toilet Bowl Cleaner
ARM & HAMMER and XTRA Powder and Liquid Laundry Detergents
XTRA and NICE ‘N FLUFFY Fabric Softeners
ARM & HAMMER FRESH ‘N SOFT Fabric Softeners
DELICARE Fine Fabric Wash
ARM & HAMMER Super Washing Soda
OXICLEAN Detergent and Cleaning Solution
KABOOM Cleaning Products
ORANGE GLO Cleaning Products
Personal Care ARM & HAMMER Toothpastes
SPINBRUSH Battery-operated Toothbrushes
MENTADENT Toothpaste, Toothbrushes
AIM Toothpaste
PEPSODENT Toothpaste
CLOSE-UP Toothpaste
PEARL DROPS Toothpolish and Toothpaste
RIGIDENT Denture Adhesive
ARM & HAMMER Deodorants & Antiperspirants
ARRID Antiperspirants
LADY’S CHOICE Antiperspirants
TROJAN Condoms
NATURALAMB Condoms
CLASS ACT Condoms
FIRST RESPONSE Home Pregnancy and Ovulation Test Kits
ANSWER Home Pregnancy and Ovulation Test Kits
NAIR Depilatories, Lotions, Creams, and Waxes
CARTERS LITTLE PILLS Laxative
ORAJEL Oral Analgesics
EXHIBIT 6
Key Church &
Dwight Co. Inc.
Brand Names
dental care. Although it entered a crowded field of specialty dental products, Church &
Dwight rode the crest of increasing interest by both dentists and hygienists in baking soda for
maintaining dental health—enabling it to sneak up on the industry giants. The company
moved rapidly from the position of a niche player in the toothpaste market to that of a major
competitor.
In a groundbreaking marketing campaign that some considered controversial, the com-
pany aired commercials for condoms on prime-time television. “Church & Dwight executives
said their new campaign was designed to shake people up, particularly those who don’t think
they need to use condoms. Attempts were made to shock them out of complacency and grab
SOURCE: Form 10-K, 2009, pages 2–3.
CASE 35 Church & Dwight: Time to Rethink the Portfolio? 35-9
their attention.”13 Other campaigns, such as when the Trojan brand advertised its own stimulus
package at the same time as the federal stimulus package was enacted, stated, “because we be-
lieve we should ride out these hard times together.”14 A Valentine’s Day ad featuring condoms
in place of candy in a heart-shaped box of chocolates continued to highlight the shock theme.15
The company’s increasing marketing strength caught the attention of potential partners as
is evidenced by its partnership with Quidel Corporation, a provider of point-of-care diagnostic
tests, to meet women’s health and wellness needs. “The partnership combined Church &
Dwight’s strength in the marketing, distribution and sales of consumer products with Quidel’s
strength in the development and manufacture of rapid diagnostic tests.”16 Other product tie-ins,
especially with ARM & HAMMER Baking Soda, have been created with air filter, paint, and
vacuum cleaner bag brands.
For the most part, Church & Dwight’s acquired products and entries into the consumer
products market have met with success. However, potential marketing problems may be loom-
ing on the horizon for its ARM & HAMMER line of consumer products. The company could
be falling into the precarious line-extension snare. Placing a well-known brand name on a wide
variety of products could cloud the brand’s image, leading to consumer confusion and loss of
marketing pull. In addition, competition in the company’s core laundry detergent market con-
tinues to heat up as the market matures and sales fall with major retailers such as Wal-Mart and
Target wringing price concessions from all producers.17 Will the addition of such well-known
brand names as ORAJEL, OXICLEAN, and SPINBRUSH continue the momentum gained
from the XTRA, NAIR, TROJAN, and FIRST RESPONSE additions? Where would new
avenues for consumer products’ growth come from?
Specialty Products
In addition to a large and growing stable of consumer products, Church & Dwight also has a
very solid core of specialty products. The Specialty Products Division basically consists of
the manufacture and sale of sodium bicarbonate for three distinct market segments: specialty
chemicals, animal nutrition products, and specialty cleaners. Manufacturers utilize sodium
bicarbonate performance products as a leavening agent for commercial baked goods; an
antacid in pharmaceuticals; a chemical in kidney dialysis; a carbon dioxide release agent in
fire extinguishers; and an alkaline in swimming pool chemicals, detergents, and various
textile and tanning applications. Animal feed producers use sodium bicarbonate nutritional
products predominantly as a buffer, or antacid, for dairy cattle feeds and make a nutritional
supplement that enhances milk production of dairy cattle. Sodium bicarbonate has also been
used as an additive to poultry feeds to enhance feed efficiency.
“Church & Dwight has long maintained its leadership position in the industry through a
strategy of sodium bicarbonate product differentiation, which hinges on the development of
special grades for specific end users.”18 Management’s apparent increased focus on consumer
products has only recently impacted the significance of specialty products in the overall
corporate mix of revenues, as is shown in Exhibit 7.
Church & Dwight was in an enviable position to profit from its dominant niche in the sodium
bicarbonate products market since it controlled the primary raw material used in its production.
The primary ingredient in sodium bicarbonate is produced from the mineral trona, which is
extracted from the company’s mines in southwestern Wyoming. The other ingredient, carbon
dioxide, is a readily available chemical which can be obtained from a variety of sources. Produc-
tion of the final product, sodium bicarbonate, for both consumer and specialty products is com-
pleted at one of the two company plants located in Green River, Wyoming, and Old Fort, Ohio.
The company maintained a dominant position in the production of the required raw
materials for both its consumer and industrial products. It manufactures almost two-thirds
35-10 SECTION D Industry Eight—Food and Beverage
2009 2008 2007 2006 2005 2004
Consumer domestic
Household 47 45 45 43 41 47
Personal care 27 26 26 29 29 27
Consumer international 16 17 17 17 17 12
Specialty products 10 12 12 11 13 14
Total 100 100 100 100 100 100
EXHIBIT 7
Revenues by Product
Category as a
Percent of Net Sales:
Church & Dwight
Co. Inc.
of the sodium bicarbonate sold in the United States and, until recently, was the only
U.S. producer of ammonium bicarbonate and potassium carbonate. The company has the
largest share (approximately 75%) of the sodium bicarbonate capacity in the United States
and is the largest consumer of baking soda as it fills its own needs for company-produced
consumer and industrial products.19
The Specialty Products Division focused on developing new uses for the company’s core
product, sodium bicarbonate. Additional opportunities continue to be explored for ARMEX
Blast Media. This is a sodium bicarbonate-based product used as a paint-stripping compound.
It gained widespread recognition when it was utilized successfully for the delicate task of strip-
ping the accumulation of years of paint and tar from the interior of the Statue of Liberty without
damaging the fragile copper skin. It is now being considered for other specialized applications
in the transportation and electronics industries and in industrial cleaning because of its apparent
environmental safety. ARMEX also has been introduced into international markets.
Specialty cleaning products are found in blasting (similar to sand blasting applications) as
well as many emerging aqueous-based cleaning technologies such as automotive parts cleaning
and circuit board cleaning. Safety-Kleen and Church & Dwight teamed up through a 50-50 joint
venture, ARMAKLEEN, to meet the parts cleaning needs of automotive repair shops. Safety-
Kleen’s 2,800 strong sales and service team markets Church & Dwight’s aqueous-based clean-
ers as an environmentally friendly alternative to traditional solvent-based cleaners.20
The company’sARMAKLEEN product is also used for cleaning printed circuit boards. This
nonsolvent-based product may have an enormous potential market because it may be able to
replace chlorofluorocarbon-based cleaning systems. Sodium bicarbonate also has been used to
remove lead from drinking water and, when added to water supplies, coats the inside of pipes and
prevents lead from leaching into the water. This market could grow in significance with additions
to the Clean Water Bill. The search for new uses of sodium bicarbonate from pharmaceutical to
environmental protection continues in both the consumer and industrial products divisions.
International Operations
Church & Dwight has traditionally enjoyed a great deal of success in North American markets
and is attempting to gain footholds in international markets through acquisitions. The com-
pany’s first major attempt to expand its presence in the international consumer products mar-
ket was with the acquisition of DeWitt International Corporation, which manufactured and
marketed personal care products including toothpaste. The DeWitt acquisition not only pro-
vided the company with increased international exposure but also with much-needed tooth-
paste production facilities and technology. However, until the 2001 acquisition of the
Carter-Wallace line of products, only about 10% of sales were outside the United States.
SOURCE: Company records.
CASE 35 Church & Dwight: Time to Rethink the Portfolio? 35-11
EXHIBIT 8
International
Markets for Church
& Dwight Co. Inc.
Products
Canada France United Kingdom
(36% of International Sales) (20% of International Sales) (16% of International Sales)
Antiperspirants Baby Care Antiperspirants
Baking Soda Depilatories Baking Soda
Bathroom Cleaners Diagnostics Depilatories
Carpet & Room Deodorizer Feminine Hygiene Feminine Hygiene
Condoms OTC Products Pregnancy Kits
Depilatories Skin Care Skin Care
Gum Toothpaste Toothpaste
OTC Products Toothpolish
Pregnancy Kits
Toothpaste
Mexico Middle East Australia
Baking Soda Baking Soda Baby Care
Brillo Bathroom Cleaners Depilatories
Condoms Brillo OTC Products
Depilatories Carpet & Room Deodorizer Pregnancy Kits
Gum Fabric Softener Toothpolish
OTC Products Gum
Pregnancy Kits Toothpaste
Toothpaste
Toothpolish
Korea Eastern Europe Germany
Baking Soda Antiperspirant Pregnancy Kits
Gum Baking Soda Toothpolish
Pet Care Toothpaste
Toothpaste
Spain Japan
Depilatories Baking Soda
Skin Care
By 2009, 19% of revenue was derived from sales outside the United States. Most of the growth
in international markets was being fueled by consumer products, as shown in Exhibit 8.
As the company cautiously moved into the international arena of consumer products, it also
continued to pursue expansion of its specialty products into international markets. Attempts to
enter international markets have met with limited success, probably for two reasons: (1) lack of
name recognition and (2) transportation costs. Although ARM & HAMMER was one of the
most recognized brand names in the United States (in the top 10), it did not enjoy the same name
recognition elsewhere. In addition, on an historic basis, international transportation costs were
at least four times as much as domestic transportation costs. However, export opportunities con-
tinued to present themselves as 10% of all U.S. production of sodium bicarbonate was exported.
While Church & Dwight dominated the United States sodium bicarbonate market, Solvay
Chemicals was the largest producer in Europe and Ashi Glass was the largest producer in Asia.
Although demand was particularly strong in Asia, “. . . little of the chemical produced in North
America and Europe is exported to Asia because of prohibitive transportation costs.”21
SOURCE: http://www.churchdwight.com/company/international.asp, retrieved 6/1/2010.
http://www.churchdwight.com/company/international.asp
35-12 SECTION D Industry Eight—Food and Beverage
N O T E S
1. Church & Dwight Co. Inc. Annual Report, 2009, p. 2.
2. Church & Dwight Co. Inc. Annual Report, 2005, p. 3.
3. Church & Dwight Co. Inc. Annual Report, 2009, p. 5.
4. Ibid.
5. Minton, Dwight Church, personal interview, October 2, 2002.
6. 8-K, 2006.
7. Church & Dwight Co. Inc. Proxy Statement, 2004.
8. Church & Dwight Co. Inc. Annual Report, 2006, p. 3.
9. 10-k, 2006, p. 20.
10. Minton, Dwight Church, personal interview, October 2, 2002.
11. Ibid.
12. Jack Neff, “Trojan,” Advertising Age 76 (November 7, 2005).
13. Mary Ann Liebert, “Condom Maker Wants to Go Prime Time,”
in Drug Development and STD News. AIDS Patient Care and
STDs 19 (2005), p. 470.
14. “BEST of BRANDFREAK 2010,” Brandweek 50 (December 14,
2009), p. 58.
15. Stuart Elliot, “This Campaign Is Wet (and Wild),” The New York
Times on the Web (February 9, 2010), Business/Financial Desk;
CAMPAIGN SPOTLIGHT.
16. Press Release, 2006, p.1.
17. Doris de Guzman, “Household Products Struggle,” Chemical
Market Reporter 269 (2006).
18. Church & Dwight Co. Inc. Annual Report, 2000, p. 17.
19. Lisa Jarvis, “Church & Dwight Builds Sales Through Strength
in Bicarbonate,” Chemical Market Report 257 (April 10, 2002).
20. Helena Harvilicz, “C&D’s Industrial Cleaning Business Contin-
ues to Grow,” Chemical Market Reporter 257 (May 15, 2000).
21. Gordon Graff, “Sodium Bicarb Supply Strong, Tags Level with
Producer Costs,” Purchasing (April 6, 2006), p. 28C1.
22. Kerri Walsh, “Stocking Up on Innovation,” Chemical Week
(January 18–25, 2010), p. 19.
Streamlining
Two significant projects were completed in 2009. One was the completion and start-up of a
major new manufacturing facility and the other was the disposition of some non-core assets.
With the completion of a 1.1 million square foot manufacturing plant for laundry deter-
gent, the company consolidated into one facility the functions that had previously been com-
pleted in five separate facilities with room to grow. This move took place in an industry facing
slowing growth. Global laundry detergent sales had grown by 8% between 2003 and 2008, but
were only forecast to grow by 3% between 2008 and 2013.22
Although the company had made some minor asset sales in the past, the disposition in
2009 of five domestic and international consumer product brands acquired during the 2008 Del
Laboratories transaction marked the first major jettisoning of non-core assets for the company.
This was followed by the disposition of the Lambert Kay pet supplies line; then the BRILLO
brand in March of 2010. These changes were just the beginning. To remain competitive in a
volatile retail market with major competitors jockeying for shelf space and retailers seeking to
rationalize their breadth of product offerings, more changes may be considered.
The core business and foundation on which the company was built remained the same
after more than 160 years. However, as management looks to the future, can it successfully
achieve a balancing act based on finding growth through expanded uses of sodium bicarbon-
ate while assimilating a divergent group of consumer products into an expanding international
footprint? Will the current portfolio of products continue to deliver the same results in the face
of competitors who, unlike consumers, know the company and must react to its strategic and
tactical moves?
Andean Community A South American
free-trade alliance composed of Columbia,
Ecuador, Peru, Bolivia, and Chili.
Annual report A document published each
year by a company to show its financial con-
dition and products.
Assessment center An approach to evaluat-
ing the suitability of a person for a position by
simulating key parts of the job.
Assimilation A strategy that involves the dom-
ination of one corporate culture over another.
Association of South East Asian Nations
(ASEAN) A regional trade association com-
posed of Asian countries of Brunei Darus-
salam, Cambodia, Indonesia, Laos, Malaysia,
Myanmar, Philippines, Singapore, Thailand,
and Vietnam. ASEA+3 includes China,
Japan, and South Korea.
Autonomous (self-managing) work teams
A group of people who work together without
a supervisor to plan, coordinate, and evaluate
their own work.
Backward integration Assuming a function
previously provided by a supplier.
Balanced scorecard Combines financial
measures with operational measures on cus-
tomer satisfaction, internal processes, and
the corporation’s innovation and improve-
ment activities.
Bankruptcy A retrenchment strategy that
forfeits management of the firm to the courts
in return for some settlement of the corpora-
tion’s obligations.
Basic R&D Research and development that
is conducted by scientists in well-equipped
laboratories where the focus is on theoretical
problem areas.
BCG (Boston Consulting Group) Growth-
Share Matrix A simple way to portray a cor-
poration’s portfolio of products or divisions
in terms of growth and cash flow.
Behavior control A control that specifies
how something is to be done through policies,
rules, standard operating procedures, and or-
ders from a superior.
Behavior substitution A phenomenon that
occurs when people substitute activities that
do not lead to goal accomplishment for ac-
tivities that do lead to goal accomplishment
because the wrong activities are being
rewarded.
Benchmarking The process of measuring
products, services, and practices against
those of competitors or companies recog-
nized as industry leaders.
Best practice A procedure that is followed by
successful companies.
Blind spot analysis An approach to analyz-
ing a competitor by identifying its perceptual
biases.
Board of director responsibilities
Commonly agreed obligations of directors,
which include: setting corporate strategy,
overall direction, mission or vision; hiring
and firing the CEO and top management;
controlling, monitoring, or supervising top
management; reviewing and approving the
use of resources; and caring for shareholder
interest.
Board of directors’ continuum A range of
the possible degree of involvement by the
board of directors (from low to high) in the
strategic management process.
BOT (build-operate-transfer) concept A
type of international entry option for a com-
pany. After building a facility, the company
operates the facility for a fixed period of time
during which it earns back its investment,
plus a profit.
Brainstorming The process of proposing
ideas in a group without first mentally screen-
ing them.
Brand A name that identifies a particular
company’s product in the mind of the
consumer.
Budget A statement of a corporation’s pro-
grams in terms of money required.
Business model The mix of activities a com-
pany performs to earn a profit.
Business plan A written strategic plan for a
new entrepreneurial venture.
Business policy A previous name for strate-
gic management. It has a general manage-
ment orientation and tends to look inward
with primary concern for integrating the cor-
poration’s many functional activities.
Business strategy Competitive and coopera-
tive strategies that emphasize improvement of
the competitive position of a corporation’s
products or services in a specific industry or
market segment.
Cannibalize To replace popular products be-
fore they reach the end of their life cycle.
Cap-and-trade A government-imposed ceil-
ing (cap) on the amount of allowed green-
house gas emissions combined with a system
allowing a firm to sell (trade) its emission
reductions to another firm whose emissions
exceed the allowed cap.
Capability A corporation’s ability to exploit
its resources.
Capital budgeting The process of analyzing
and ranking possible investments in terms of
the additional outlays and additional receipts
that will result from each investment.
10-K form An SEC form containing income
statements, balance sheets, cash flow state-
ments, and information not usually available in
an annual report.
10-Q form An SEC form containing quar-
terly financial reports.
14-A form An SEC form containing proxy
statements and information on a company’s
board of directors.
360-degree performance appraisal An
evaluation technique in which input is gath-
ered from multiple sources.
80/20 rule A rule of thumb stating that one
should monitor those 20% of the factors that
determine 80% of the results.
Absorptive capacity A firm’s ability to
value, assimilate, and utilize new external
knowledge.
Acquisition The purchase of a company that
is completely absorbed by the acquiring
corporation.
Action plan A plan that states what actions
are going to be taken, by whom, during
what time frame, and with what expected
results.
Activity ratios Financial ratios that indi-
cate how well a corporation is managing its
operations.
Activity-based costing (ABC) An account-
ing method for allocating indirect and fixed
costs to individual products or product lines
based on the value-added activities going
into that product.
Adaptive mode A decision-making mode
characterized by reactive solutions to existing
problems, rather than a proactive search for
new opportunities.
Advisory board A group of external business
people who voluntarily meet periodically
with the owners/managers of the firm to dis-
cuss strategic and other issues.
Affiliated directors Directors who, though
not really employed by the corporation, han-
dle the legal or insurance work for the com-
pany or are important suppliers.
Agency theory A theory stating that prob-
lems arise in corporations because the agents
(top management) are not willing to bear re-
sponsibility for their decisions unless they
own a substantial amount of stock in the
corporation.
Altman’s Bankruptcy Formula A formula
used to estimate how close a company is to
declaring bankruptcy.
Analytical portfolio manager A type of gen-
eral manager needed to execute a diversifica-
tion strategy.
GLOSSARY
G-1
G-2 GLOSSARY
Captive company strategy Dedicating a
firm’s productive capacity as primary supplier
to another company in exchange for a long-
term contract.
Carbon footprint The amount of greenhouse
gases being created by an entity and released
into the air.
Cash cow A product that brings in far more
money than is needed to maintain its market
share.
Categorical imperatives Kant’s two princi-
ples to guide actions: A person’s action is ethi-
cal only if that person is willing for that same
action to be taken by everyone who is in a sim-
ilar situation, and a person should never treat
another human being simply as a means but al-
ways as an end.
Cautious profit planner The type of leader
needed for a corporation choosing to follow a
stability strategy.
Cellular/modular organization structure A
structure composed of cells (self-managing
teams, autonomous business units, etc.) that
can operate alone but can interact with other
cells to produce a more potent and competent
business mechanism.
Center of excellence A designated area in
which a company has a core or distinctive
competence.
Center of gravity The part of the industry
value chain that is most important to the com-
pany and the point where the company’s
greatest expertise and capabilities lay.
Central American Free Trade Agreement
(CAFTA) A regional trade association com-
posed of El Salvador, Guatemala, Nicaragua,
Honduras, Costa Rica, the United States,
and the Dominican Republic.
Clusters Geographic concentrations of inter-
connected companies and industries.
Code of ethics A code that specifies how an
organization expects its employees to behave
while on the job.
Codetermination The inclusion of a corpo-
ration’s workers on its board of directors.
Collusion The active cooperation of firms
within an industry to reduce output and raise
prices in order to get around the normal eco-
nomic law of supply and demand. This practice
is usually illegal.
Commodity A product whose characteristics
are the same regardless of who sells it.
Common-size statements Income state-
ments and balance sheets in which the dol-
lar figures have been converted into
percentages.
Competency A cross-functional integration
and coordination of capabilities.
Competitive intelligence A formal program
of gathering information about a company’s
competitors.
Cooperative strategies Strategies that in-
volve working with other firms to gain com-
petitive advantage within an industry.
Co-opetition A term used to describe si-
multaneous competition and cooperation
among firms.
Core competency A collection of corporate
capabilities that cross divisional borders and
are widespread within a corporation, and is
something that a corporation can do exceed-
ingly well.
Core rigidity/deficiency A core competency
of a firm that over time matures and becomes
a weakness.
Corporate brand A type of brand in which
the company’s name serves as the brand
name.
Corporate capabilities See capability.
Corporate culture A collection of beliefs,
expectations, and values learned and shared
by a corporation’s members and transmitted
from one generation of employees to
another.
Corporate culture pressure A force from
existing corporate culture against the imple-
mentation of a new strategy.
Corporate entrepreneurship Also called
intrapreneurship, the creation of a new busi-
ness within an existing organization.
Corporate governance The relationship
among the board of directors, top manage-
ment, and shareholders in determining the di-
rection and performance of a corporation.
Corporate parenting A corporate strategy
that evaluates the corporation’s business
units in terms of resources and capabilities
that can be used to build business unit value
as well as generate synergies across business
units.
Corporate reputation A widely held percep-
tion of a company by the general public.
Corporate scenario Pro forma balance
sheets and income statements that forecast
the effect that each alternative strategy will
likely have on return on investment.
Corporate stakeholders Groups that affect
or are affected by the achievement of a firm’s
objectives.
Corporate strategy A strategy that states a
company’s overall direction in terms of its
general attitude toward growth and the man-
agement of its various business and product
lines.
Corporation A mechanism legally estab-
lished to allow different parties to contribute
capital, expertise, and labor for their mutual
benefit.
Cost focus A low-cost competitive strategy
that concentrates on a particular buyer group
or geographic market and attempts to serve
only that niche.
Competitive scope The breadth of a com-
pany’s or a business unit’s target market.
Competitive strategy A strategy that states
how a company or a business unit will com-
pete in an industry.
Competitors The companies that offer the
same products or services as the subject
company.
Complementor A company or an industry
whose product(s) works well with another
industry’s or firm’s product and without
which that product would lose much of its
value.
Concentration A corporate growth strategy
that concentrates a corporation’s resources on
competing in one industry.
Concentric diversification A diversification
growth strategy in which a firm uses its cur-
rent strengths to diversify into related prod-
ucts in another industry.
Concurrent engineering A process in which
specialists from various functional areas
work side by side rather than sequentially in
an effort to design new products.
Conglomerate diversification A diversifica-
tion growth strategy that involves a move into
another industry to provide products unre-
lated to its current products.
Conglomerate structure An assemblage of
legally independent firms (subsidiaries) op-
erating under one corporate umbrella but
controlled through the subsidiaries’ boards
of directors.
Connected line batch flow A part of a cor-
poration’s manufacturing strategy in which
components are standardized and each ma-
chine functions like a job shop but is posi-
tioned in the same order as the parts are
processed.
Consensus A situation in which all parties
agree to one alternative.
Consolidated industry An industry in which
a few large companies dominate.
Consolidation The second phase of a turn-
around strategy that implements a program to
stabilize the corporation.
Constant dollars Dollars adjusted for inflation.
Continuous improvement A system devel-
oped by Japanese firms in which teams
strive constantly to improve manufacturing
processes.
Continuous systems Production organized
in lines on which products can be continu-
ously assembled or processed.
Continuum of sustainability A representa-
tion that indicates how durable and imitable
an organization’s resources and capabilities
are.
Contraction The first phase of a turnaround
strategy that includes a general across-the-
board cutback in size and costs.
GLOSSARY G-3
particular buyer group, product line segment,
or geographic market.
Differentiation strategy See differentiation.
Dimensions of national culture A set of five
dimensions by which each nation’s unique
culture can be identified.
Directional strategy A plan that is composed
of three general orientations: growth, stabil-
ity, and retrenchment.
Distinctive competencies A firm’s compe-
tencies that are superior to those of competi-
tors.
Diversification A corporate growth strategy
that expands product lines by moving into an-
other industry.
Divestment A retrenchment strategy in
which a division of a corporation with low
growth potential is sold.
Divisional structure An organizational
structure in which employees tend to be
functional specialists organized according to
product/market distinctions.
Downsizing Planned elimination of positions
or jobs.
Due care The obligation of board mem-
bers to closely monitor and evaluate top
management.
Durability The rate at which a firm’s under-
lying resources and capabilities depreciate or
become obsolete.
Dynamic industry expert A leader with a
great deal of experience in a particular indus-
try appropriate for executing a concentration
strategy.
Dynamic capabilities Capabilities that are
continually being changed and reconfigured
to make them more adaptive to an uncertain
environment.
Dynamic pricing A marketing practice in
which different customers pay different
prices for the same product or service.
Earnings per share (EPS) A calculation that
is determined by dividing net earnings by the
number of shares of common stock issued.
Economic value added (EVA) A shareholder
value method of measuring corporate and di-
visional performance. Measures after-tax op-
erating income minus the total annual cost of
capital.
Economies of scale A process in which unit
costs are reduced by making large numbers of
the same product.
Economies of scope A process in which unit
costs are reduced when the value chains of
two separate products or services share activ-
ities, such as the same marketing channels or
manufacturing facilities.
EFAS (External Factor Analysis Sum-
mary) table A table that organizes external
factors into opportunities and threats and how
well management is responding to these spe-
cific factors.
Electronic commerce The use of the Internet
to conduct business transactions.
Engineering (or process) R&D R&D con-
centrating on quality control and the develop-
ment of design specifications and improved
production equipment.
Enterprise resource planning (ERP) soft-
ware Software that unites all of a company’s
major business activities, from order pro-
cessing to production, within a single family
of software modules.
Enterprise risk management (ERM) A
corporatewide, integrated process to manage
the uncertainties that could negatively or
positively influence the achievement of the
corporation’s objectives.
Enterprise strategy A strategy that explic-
itly articulates a firm’s ethical relationship
with its stakeholders.
Entrepreneur A person who initiates and
manages a business undertaking and who
assumes risk for the sake of a profit.
Entrepreneurial characteristics Traits of
an entrepreneur that lead to a new venture’s
success.
Entrepreneurial mode A strategy made by
one powerful individual in which the focus
is on opportunities, and problems are
secondary.
Entrepreneurial venture Any new business
whose primary goals are profitability and
growth and that can be characterized by inno-
vative strategic practices.
Entry barrier An obstruction that makes it
difficult for a company to enter an industry.
Environmental scanning The monitoring,
evaluation, and dissemination of information
from the external and internal environments
to key people within the corporation.
Environmental sustainability The use of
business practices to reduce a company’s
impact upon the natural, physical environ-
ment.
Environmental uncertainty The degree of
complexity plus the degree of change existing
in an organization’s external environment.
Ethics The consensually accepted stan-
dards of behavior for an occupation, trade,
or profession.
European Union (EU) A regional trade
association composed of 27 European
countries.
Evaluation and control A process in which
corporate activities and performance results
are monitored so that actual performance can
be compared with desired performance.
Executive leadership The directing of activ-
ities toward the accomplishment of corporate
objectives.
Cost leadership A low-cost competitive
strategy that aims at the broad mass market.
Cost proximity A process that involves keep-
ing the higher price a company charges for
higher quality close enough to that of the
competition so that customers will see the ex-
tra quality as being worth the extra cost.
Crisis of autonomy A time when people
managing diversified product lines need more
decision-making freedom than top manage-
ment is willing to delegate to them.
Crisis of control A time when business units
act to optimize their own sales and profits
without regard to the overall corporation. See
also suboptimization.
Crisis of leadership A time when an entre-
preneur is personally unable to manage a
growing company.
Cross-functional work teams A work team
composed of people from multiple functions.
Cultural integration The extent to which
units throughout an organization share a com-
mon culture.
Cultural intensity The degree to which
members of an organizational unit accept the
norms, values, or other culture content asso-
ciated with the unit.
Deculturation The disintegration of one
company’s culture resulting from unwanted
and extreme pressure from another to impose
its culture and practices.
Dedicated transfer line A highly automated
assembly line making one mass-produced
product using little human labor.
Defensive centralization A process in which
top management of a not-for-profit retains all
decision-making authority so that lower-level
managers cannot take any actions to which
the sponsors may object.
Defensive tactic A tactic in which a company
defends its current market.
Delphi technique A forecasting technique in
which experts independently assess the prob-
abilities of specified events. These assess-
ments are combined and sent back to each
expert for fine-tuning until agreement is
reached.
Devil’s advocate An individual or a group
assigned to identify the potential pitfalls and
problems of a proposal.
Dialectical inquiry A decision-making
technique that requires that two proposals
using different assumptions be generated for
consideration.
Differentiation A competitive strategy that is
aimed at the broad mass market and that in-
volves the creation of a product or service that
is perceived throughout its industry as
unique.
Differentiation focus A differentiation
competitive strategy that concentrates on a
G-4 GLOSSARY
Executive succession The process of groom-
ing and replacing a key top manager.
Executive type An individual with a particu-
lar mix of skills and experiences.
Exit barrier An obstruction that keeps a
company from leaving an industry.
Expense center A business unit that uses
money but contributes to revenues only
indirectly.
Experience curve A conceptual framework
that states that unit production costs decline
by some fixed percentage each time the to-
tal accumulated volume of production in
units doubles.
Expert opinion A nonquantitative forecast-
ing technique in which authorities in a
particular area attempt to forecast likely
developments.
Explicit knowledge Knowledge that can be
easily articulated and communicated.
Exporting Shipping goods produced in a
company’s home country to other coun-
tries for marketing.
External environment Forces outside an or-
ganization that are not typically within the
short-run control of top management.
External strategic factor Environmental
trend with both high probability of
occurrence and high probability of impact on
the corporation.
Externality Costs of doing business that are
not included in a firm’s accounting system,
but felt by others.
Extranet An information network within an
organization that is available to key suppliers
and customers.
Extrapolation A form of forecasting that ex-
tends present trends into the future.
Family business A company that is either
owned or dominated by relatives.
Family directors Board members who are
descendants of the founder and own signifi-
cant blocks of stock.
Financial leverage The ratio of total debt to
total assets.
Financial strategy A functional strategy to
make the best use of corporate monetary
assets.
First mover The first company to manufac-
ture and sell a new product or service.
Flexible manufacturing A type of manu-
facturing that permits the low-volume out-
put of custom-tailored products at relatively
low unit costs through economies of scope.
Follow-the-sun-management A manage-
ment technique in which modern communi-
cation enables project team members living
in one country to pass their work to team
members in another time zone so that the
project is continually being advanced.
of another company that is listed on the ac-
quiring company’s balance sheet.
Grand strategy Another name for direc-
tional strategy.
Green-field development An international
entry option to build a company’s manufac-
turing plant and distribution system in an-
other country.
Greenwash A derogatory term referring to a
company’s promoting its environmental sus-
tainability efforts with very little action to-
ward improving its measurable environmental
performance.
Gross domestic product (GDP) A measure
of the total output of goods and services
within a country’s borders.
Growth strategies A directional strategy that
expands a company’s current activities.
Hierarchy of strategy A nesting of strategies
by level from corporate to business to func-
tional, so that they complement and support
one another.
Horizontal growth A corporate growth
concentration strategy that involves expand-
ing the firm’s products into other geographic
locations and/or increasing the range of
products and services offered to current
markets.
Horizontal integration The degree to which
a firm operates in multiple geographic loca-
tions at the same point in an industry’s value
chain.
Horizontal strategy A corporate parenting
strategy that cuts across business unit bound-
aries to build synergy across business units
and to improve the competitive position of
one or more business units.
House of quality A method of managing new
product development to help project teams
make important design decisions by getting
them to think about what users want and how
to get it to them most effectively.
Human resource management (HRM)
strategy A functional strategy that makes the
best use of corporate human assets.
Human diversity A mix of people from dif-
ferent races, cultures, and backgrounds in the
workplace.
Hypercompetition An industry situation
in which the frequency, boldness, and ag-
gressiveness of dynamic movement by the
players accelerates to create a condition of
constant disequilibrium and change.
Idea A concept that could be the foundation
of an entrepreneurial venture if the concept
is feasible.
IFAS (Internal Factor Analysis Summary)
table A table that organizes internal factors
into strengths and weaknesses and how well
management is responding to these specific
factors.
Forward integration Assuming a function
previously provided by a distributor.
Four-corner exercise An approach to ana-
lyzing a competitor in terms of its future
goals, current strategy, assumptions, and
capabilities, in order to develop a competi-
tor’s response profile.
Fragmented industry An industry in
which no firm has large market share and
each firm serves only a small piece of the to-
tal market.
Franchising An international entry strategy
in which a firm grants rights to another
company/individual to open a retail store
using the franchiser’s name and operating
system.
Free cash flow The amount of money a new
owner can take out of a firm without harming
the business.
Full vertical integration A growth strategy
under which a firm makes 100% of its key
supplies internally and completely controls
its distributors.
Functional strategy An approach taken by a
functional area to achieve corporate and busi-
ness unit objectives and strategies by maxi-
mizing resource productivity.
Functional structure An organizational
structure in which employees tend to be spe-
cialists in the business functions important to
that industry, such as manufacturing, sales, or
finance.
GE Business Screen A portfolio analysis
matrix developed by General Electric, with
the assistance of the McKinsey & Company
consulting firm.
Geographic-area structure A structure that
allows a multinational corporation to tailor
products to regional differences and to
achieve regional coordination.
Global industry An industry in which a com-
pany manufactures and sells the same prod-
ucts, with only minor adjustments for
individual countries around the world.
Globalization The internationalization of
markets and corporations.
Global warming A gradual increase in the
Earth’s temperature leading to changes in the
planet’s climate.
Goal displacement Confusion of means with
ends, which occurs when activities originally
intended to help managers attain corporate
objectives become ends in themselves or are
adapted to meet ends other than those for
which they were intended.
Goal An open-ended statement of what one
wants to accomplish, with no quantification
of what is to be achieved and no time criteria
for completion.
Good will An accounting term describing the
premium paid by one company in its purchase
GLOSSARY G-5
protected by a patent, copyright, trademark,
or trade secret.
Interlocking directorate A condition that
occurs when two firms share a director or
when an executive of one firm sits on the
board of a second firm.
Intermittent system A method of manufac-
turing in which an item is normally processed
sequentially, but the work and the sequence of
the processes vary.
Internal environment Variables within the
organization not usually within the short-run
control of top management.
Internal strategic factors Strengths (core
competencies) and weaknesses that are likely
to determine whether a firm will be able take
advantage of opportunities while avoiding
threats.
International transfer pricing A method of
minimizing taxes by declaring high profits in
a subsidiary located in a country with a low
tax rate and small profits in a subsidiary lo-
cated in a country with a high tax rate.
Intranet An information network within an or-
ganization that also has access to the Internet.
Investment center A unit in which perfor-
mance is measured in terms of the difference
between the unit’s resources and its services
or products.
ISO 9000 Standards Series An internationally
accepted way of objectively documenting a
company’s high level of quality operations.
ISO 14000 Standards Series An internation-
ally accepted way to document a company’s
impact on the environment.
Issues priority matrix A chart that ranks the
probability of occurrence versus the probable
impact on the corporation of developments in
the external environment.
Job characteristics model An approach to
job design that is based on the belief that tasks
can be described in terms of certain objective
characteristics and that those characteristics
affect employee motivation.
Job design The design of individual tasks in
an attempt to make them more relevant to the
company and more motivating to the
employee.
Job enlargement Combining tasks to give a
worker more of the same type of duties to
perform.
Job enrichment Altering jobs by giving the
worker more autonomy and control over
activities.
Job rotation Moving workers through sev-
eral jobs to increase variety.
Job shop One-of-a-kind production using
skilled labor.
Joint venture An independent business en-
tity created by two or more companies in a
strategic alliance.
Justice approach An ethical approach that
proposes that decision makers be equitable,
fair, and impartial in the distribution of costs
and benefits.
Just-In-Time A purchasing concept in which
parts arrive at the plant just when they are
needed rather than being kept in inventories.
Key performance measures Essential
measures for achieving a desired strategic
option—used in the balanced scorecard.
Key success factors Variables that signifi-
cantly affect the overall competitive position
of a company within a particular industry.
Late movers Companies that enter a new mar-
ket only after other companies have done so.
Law A formal code that permits or forbids
certain behaviors.
Lead director An outside director who calls
meetings of the outside board members and
coordinates the annual evaluation of the CEO.
Lead user A customer who is ahead of mar-
ket trends and has needs that go beyond those
of the average user.
Leading Providing direction to employees
to use their abilities and skills most effec-
tively and efficiently to achieve organiza-
tional objectives.
Lean Six Sigma A program incorporating the
statistical approach of Six Sigma with the lean
manufacturing program developed by Toyota.
Learning organization An organization that
is skilled at creating, acquiring, and transfer-
ring knowledge and at modifying its behavior
to reflect new knowledge and insights.
Levels of moral development Kohlberg pro-
posed three levels of moral development: pre-
conventional, conventional, and principled.
Leverage ratio An evaluation of how effec-
tively a company utilizes its resources to gen-
erate revenues.
Leveraged buy-out An acquisition in which
a company is acquired in a transaction fi-
nanced largely by debt—usually obtained
from a third party, such as an insurance com-
pany or an investment banker.
Licensing arrangement An agreement in
which the licensing firm grants rights to an-
other firm in another country or market to
produce and/or sell a branded product.
Lifestyle company A small business in
which the firm is purely an extension of the
owner’s lifestyle.
Line extension Using a successful brand
name on additional products, such as Arm
& Hammer brand first on baking soda, then
on laundry detergents, toothpaste, and de-
odorants.
Linkage The connection between the way
one value activity (for example, marketing) is
performed and the cost of performance of an-
other activity (for example, quality control).
Imitability The rate at which a firm’s under-
lying resources and capabilities can be dupli-
cated by others.
Index of R&D effectiveness An index that is
calculated by dividing the percentage of total
revenue spent on research and development
into new product profitability.
Index of sustainable growth A calculation
that shows how much of the growth rate of
sales can be sustained by internally generated
funds.
Individual rights approach An ethics be-
havior guideline that proposes that human
beings have certain fundamental rights that
should be respected in all decisions.
Individualism-collectivism (IC) The extent
to which a society values individual freedom
and independence of action compared with a
tight social framework and loyalty to the
group.
Industry A group of firms producing a simi-
lar product or service.
Industry analysis An in-depth examination
of key factors within a corporation’s task
environment.
Industry matrix A chart that summarizes
the key success factors within a particular
industry.
Industry scenario A forecasted description
of an industry’s likely future.
Information technology strategy A func-
tional strategy that uses information systems
technology to provide competitive advantage.
Input control A control that specifies re-
sources, such as knowledge, skills, abilities,
values, and motives of employees.
Inside director An officer or executive em-
ployed by a corporation who serves on that
company’s board of directors; also called
management director.
Institution theory A concept of organiza-
tional adaptation that proposes that organ-
izations can and do adapt to changing
conditions by imitating other successful
organizations.
Institutional advantage A competitive bene-
fit for a not-for-profit organization when it
performs its tasks more effectively than other
comparable organizations.
Integration A process that involves a rela-
tively balanced give-and-take of cultural and
managerial practices between merger part-
ners, with no strong imposition of cultural
change on either company.
Integration manager A person in charge of
taking an acquired company through
the process of integrating its people and
processes with those of the acquiring company.
Intellectual property Special knowledge
used in a new product or process developed
by a company for its own use and is usually
G-6 GLOSSARY
Liquidation The termination of a firm in
which all its assets are sold.
Liquidity ratio The percentage showing to
what degree a company can cover its current
liabilities with its current assets.
Logical incrementalism A decision-making
mode that is a synthesis of the planning, adap-
tive, and entrepreneurial modes.
Logistics strategy A functional strategy that
deals with the flow of products into and out
of the manufacturing process.
Long-term contract Agreements between
two separate firms to provide agreed-upon
goods and services to each other for a speci-
fied period of time.
Long-term evaluation method A method in
which managers are compensated for achiev-
ing objectives set over a multiyear period.
Long-term orientation (LT) The extent to
which society is oriented toward the long
term versus the short term.
Lower cost strategy A strategy in which a
company or business unit designs, produces,
and markets a comparable product more effi-
ciently than its competitors.
Management audit A technique used to
evaluate corporate activities.
Management By Objectives (MBO) An
organization-wide approach ensuring pur-
poseful action toward mutually agreed-
upon objectives.
Management contract Agreements through
which a corporation uses some of its person-
nel to assist a firm in another country for a
specified fee and period of time.
Market development A marketing functional
strategy in which a company or business unit
captures a larger share of an existing market for
current products through market penetration
or develops new markets for current products.
Market location tactics Tactics that deter-
mine where a company or business unit will
compete.
Market position Refers to the selection of
specific areas for marketing concentration
and can be expressed in terms of market,
product, and geographical locations.
Market research A means of obtaining new
product ideas by surveying current or potential
users regarding what they would like in a new
product.
Market segmentation The division of a mar-
ket into segments to identify available niches.
Market value added (MVA) The difference
between the market value of a corporation and
the capital contributed by shareholders and
lenders.
Marketing mix The particular combination
of key variables (product, place, promotion,
and price) that can be used to affect demand
and to gain competitive advantage.
Multinational corporation (MNC) A com-
pany that has significant assets and activities
in multiple countries.
Multiple sourcing A purchasing strategy in
which a company orders a particular part
from several vendors.
Multipoint competition A rivalry in which a
large multibusiness corporation competes
against other large multibusiness firms in a
number of markets.
Mutual service consortium A partnership of
similar companies in similar industries that
pool their resources to gain a benefit that is
too expensive to develop alone.
Natural environment That part of the ex-
ternal environment that includes physical
resources, wildlife, and climate that are an
inherent part of existence on Earth.
Net present value (NPV) A calculation of
the value of a project that is made by pre-
dicting the project’s payouts, adjusting them
for risk, and subtracting the amount
invested.
Network structure An organization (vir-
tual organization) that outsources most of
its business functions.
New entrants Businesses entering an indus-
try that typically bring new capacity to an in-
dustry, a desire to gain market share, and
substantial resources.
New product experimentation A method of
test marketing the potential of innovative
ideas by developing products, probing poten-
tial markets with early versions of the prod-
ucts, learning from the probes, and probing
again.
No-change strategy A decision to do noth-
ing new; to continue current operations and
policies for the foreseeable future.
North American Free Trade Agreement
(NAFTA) Regional free trade agreement
between Canada, the United States, and
Mexico.
Not-for-profit organization Private non-
profit corporations and public governmental
units or agencies.
Objectives The end result of planned activity
stating what is to be accomplished by when,
and quantified if possible.
Offensive tactic A tactic that calls for com-
peting in an established competitor’s current
market location.
Offshoring The outsourcing of an activity or
function to a provider in another country.
Open innovation A new approach to R&D in
which a firm uses alliances and connections
with corporate, government, and academic
labs to learn about new developments.
Operating budget A budget for a business
unit that is approved by top management dur-
ing strategy formulation and implementation.
Marketing strategy A functional strategy
that deals with pricing, selling, and distribut-
ing a product.
Masculinity-femininity (MF) The extent to
which society is oriented toward money and
things.
Mass customization The low-cost produc-
tion of individually customized goods and
services.
Mass production A system in which em-
ployees work on narrowly defined, repetitive
tasks under close supervision in a bureau-
cratic and hierarchical structure to produce a
large amount of low-cost, standard goods and
services.
Matrix of change A chart that compares tar-
get practices (new programs) with existing
practices (current activities).
Matrix structure A structure in which func-
tional and product forms are combined
simultaneously at the same level of the orga-
nization.
Mercosur/Mercosul South American free-
trade area including Argentina, Brazil,
Uruguay, and Paraguay.
Merger A transaction in which two or more
corporations exchange stock, but from which
only one corporation survives.
Mission The purpose or reason for an organi-
zation’s existence.
Mission statement The definition of the
fundamental, unique purpose that sets an
organization apart from other firms of its type
and identifies the scope or domain of the
organization’s operations in terms of products
(including services) offered and markets
served.
Modular manufacturing A system in which
preassembled subassemblies are delivered as
they are needed to a company’s assembly-line
workers who quickly piece the modules to-
gether into finished products.
Moore’s law An observation of Gordon
Moore, co-founder of Intel, that microproces-
sors double in complexity every 18 months.
Moral relativism A theory that proposes that
morality is relative to some personal, social,
or cultural standard, and that there is no
method for deciding whether one decision is
better than another.
Morality Precepts of personal behavior that
are based on religious or philosophical
grounds.
Most favored nation A policy of the World
Trade Organization stating that a member
country cannot grant one trading partner
lower customs duties without granting them to
all WTO member nations.
Multidomestic industry An industry in
which companies tailor their products to the
specific needs of consumers in a particular
country.
GLOSSARY G-7
Penetration pricing A marketing pricing
strategy to obtain dominant market share by
using low price.
Performance The end result of activities, ac-
tual outcomes of a strategic management
process.
Performance appraisal system A system to
systematically evaluate employee perfor-
mance and promotion potential.
Performance gap A performance gap exists
when performance does not meet expecta-
tions.
Periodic statistical report Reports summa-
rizing data on key factors such as the number
of new customer contracts, volume of re-
ceived orders, and productivity figures.
Phases of strategic management A set
of four levels of development through which
a firm generally evolves into strategic
management.
Piracy The making and selling counterfeit
copies of well-known name-brand products,
especially software.
Planning mode A decision-making mode
that involves the systematic gathering of ap-
propriate information for situation analysis,
the generation of feasible alternative strate-
gies, and the rational selection of the most
appropriate strategy.
Policy A broad guideline for decision making
that links the formulation of strategy with its
implementation.
Political strategy A strategy to influence a
corporation’s stakeholders.
Population ecology A theory that proposes
that once an organization is successfully es-
tablished in a particular environmental
niche, it is unable to adapt to changing
conditions.
Portfolio analysis An approach to corporate
strategy in which top management views its
product lines and business units as a series of
investments from which it expects a prof-
itable return.
Power distance (PD) The extent to which
a society accepts an unequal distribution of
influence in organizations.
Prediction markets A forecasting technique
in which people make bets on the likelihood
of a particular event taking place.
Pressure-cooker crisis A situation that exists
when employees in collaborative organiza-
tions eventually grow emotionally and physi-
cally exhausted from the intensity of
teamwork and the heavy pressure for innova-
tive solutions.
Primary activity A manufacturing firm’s
corporate value chain, including inbound
logistics, operations process, outbound lo-
gistics, marketing and sales, and service.
Primary stakeholders A high priority
group that affects or is affected by the
achievement of a firm’s objectives.
Prime interest rate The rate of interest banks
charge on their lowest-risk loans.
Private nonprofit corporation A non-
governmental not-for-profit organization.
Privatization The selling of state-owned
enterprises to private individuals. Also the
hiring of a private business to provide serv-
ices previously offered by a state agency.
Procedures A list of sequential steps that
describe in detail how a particular task or job
is to be done.
Process innovation Improvement to the
making and selling of current products.
Product champion A person who generates
a new idea and supports it through many or-
ganizational obstacles.
Product development A marketing strategy
in which a company or unit develops new
products for existing markets or develops new
products for new markets.
Product innovation The development of a
new product or the improvement of an exist-
ing product’s performance.
Product life cycle A graph showing time
plotted against sales of a product as it moves
from introduction through growth and matu-
rity to decline.
Product R&D Research and development
concerned with product or product-packaging
improvements.
Product/market evolution matrix A chart
depicting products in terms of their competi-
tive positions and their stages of product/
market evolution.
Product-group structure A structure of a
multinational corporation that enables the
company to introduce and manage a similar
line of products around the world.
Production sharing The process of combin-
ing the higher labor skills and technology
available in developed countries with the
lower-cost labor available in developing
countries.
Professional liquidator An individual called
on by a bankruptcy court to close a firm and
sell its assets.
Profit center A unit’s performance, mea-
sured in terms of the difference between rev-
enues and expenditures.
Profit strategy A strategy that artificially
supports profits by reducing investment and
short-term discretionary expenditures.
Profitability ratios Ratios evaluating a com-
pany’s ability to make money over a period
of time.
Profit-making firm A firm depending on
revenues obtained from the sale of its goods
Operating cash flow The amount of money
generated by a company before the costs of
financing and taxes are figured.
Operating leverage The impact of a specific
change in sales volume on net operating
income.
Operations strategy A functional strategy
that determines how and where a product
or service is to be manufactured, the level
of vertical integration in the production
process, and the deployment of physical
resources.
Opportunity A strategic factor considered
when using the SWOT analysis.
Orchestrator A top manager who articulates
the need for innovation, provides funding for
innovating activities, creates incentives for
middle managers to sponsor new ideas, and
protects idea/product champions from suspi-
cious or jealous executives.
Organization slack Unused resources within
an organization.
Organizational analysis Internal scanning
concerned with identifying an organization’s
strengths and weaknesses.
Organizational learning theory A theory
proposing that an organization adjusts to
changes in the environment through the learn-
ing of its employees.
Organizational life cycle How organizations
grow, develop, and eventually decline.
Organizational structure The formal setup
of a business corporation’s value chain com-
ponents in terms of work flow, communica-
tion channels, and hierarchy.
Output control A control that specifies what
is to be accomplished by focusing on the end
result of the behaviors through the use of ob-
jectives and performance targets.
Outside directors Members of a board
of directors who are not employees of
the board’s corporation; also called
non–management directors.
Outsourcing A process in which resources
are purchased from others through long-term
contracts instead of being made within the
company.
Parallel sourcing A process in which two
suppliers are the sole suppliers of two differ-
ent parts, but they are also backup suppliers
for each other’s parts.
Pattern of influence A concept stating that
influence in strategic management derives
from a not-for-profit organization’s sources
of revenue.
Pause/proceed with caution strategy A
corporate strategy in which nothing new
is attempted; an opportunity to rest before
continuing a growth or retrenchment
strategy.
G-8 GLOSSARY
and services to customers, who typically pay
for the costs and expenses of providing the
product or service plus a profit.
Program A statement of the activities or
steps needed to accomplish a single-use plan
in strategy implementation.
Propitious niche A portion of a market that
is so well suited to a firm’s internal and exter-
nal environment that other corporations are
not likely to challenge or dislodge it.
Public governmental unit or agency A kind
of not-for-profit organization that is estab-
lished by government or governmental agen-
cies (such as welfare departments, prisons,
and state universities).
Public or collective good Goods that are
freely available to all in a society.
Pull strategy A marketing strategy in which
advertising pulls the products through the
distribution channels.
Punctuated equilibrium A point at which a
corporation makes a major change in its strat-
egy after evolving slowly through a long
period of stability.
Purchasing power parity (PPP) A measure
of the cost, in dollars, of the U.S.-produced
equivalent volume of goods that another na-
tion’s economy produces.
Purchasing strategy A functional strategy
that deals with obtaining the raw materials,
parts, and supplies needed to perform the
operations functions.
Push strategy A marketing strategy in which
a large amount of money is spent on trade
promotion in order to gain or hold shelf space
in retail outlets.
Quality of work life A concept that empha-
sizes improving the human dimension of
work to improve employee satisfaction and
union relations.
Quasi-integration A type of vertical growth/
integration in which a company does not
make any of its key supplies but purchases
most of its requirements from outside suppli-
ers that are under its partial control.
Question marks New products that have
potential for success and need a lot of cash for
development.
RFID A technology in which radio frequency
identification tags containing product infor-
mation is used to track goods through inven-
tory and distribution channels.
R&D intensity A company’s spending on
research and development as a percentage of
sales revenue.
R&D mix The balance of basic, product, and
process research and development.
R&D strategy A functional strategy that
deals with product and process innovation.
Ratio analysis The calculation of ratios from
data in financial statements to identify possi-
ble strengths or weaknesses.
Sarbanes-Oxley Act Legislation passed by
the U.S. Congress in 2002 to promote and
formalize greater board independence and
oversight.
Scenario box A tool for developing corpo-
rate scenarios in which historical data are
used to make projections for generating pro
forma financial statements.
Scenario writing A forecasting technique in
which focused descriptions of different likely
futures are presented in a narrative fashion.
Secondary stakeholders Lower-priority
groups that affect or are affected by the
achievement of a firm’s objectives.
Sell-out strategy A retrenchment option
used when a company has a weak competitive
position resulting in poor performance.
Separation A method of managing the cul-
ture of an acquired firm in which the two
companies are structurally divided, without
cultural exchange.
SFAS (Strategic Factors Analysis Sum-
mary) matrix A chart that summarizes an or-
ganization’s strategic factors by combining
the external factors from an EFAS table with
the internal factors from an IFAS table.
Shareholder value The present value of the
anticipated future stream of cash flows from
a business plus the value of the company if it
were liquidated.
Short-term orientation The tendency of
managers to consider only current tactical or
operational issues and ignore strategic ones.
Simple structure A structure for new entre-
preneurial firms in which the employees tend
to be generalists and jacks-of-all-trades.
Six Sigma A statistically-based program
developed to identify and improve a poorly
performing process.
Skim pricing A marketing strategy in which
a company charges a high price while a prod-
uct is novel and competitors are few.
Small-business firm An independently
owned and operated business that is not dom-
inant in its field and that does not engage in
innovative practices.
SO, ST, WO, WT strategies A series of pos-
sible business approaches based on combi-
nations of opportunities, threats, strengths,
and weaknesses.
Social capital The goodwill of key stake-
holders, which can be used for competitive
advantage.
Social entrepreneurship A business in
which a not-for-profit organization starts a
new venture to achieve social goals.
Social responsibility The ethical and discre-
tionary responsibilities a corporation owes its
stakeholders.
Societal environment Economic, technolog-
ical, political-legal, and sociocultural envi-
ronmental forces that do not directly touch on
Real options approach An approach to new
project investment when the future is highly
uncertain.
Red flag An indication of a serious underly-
ing problem.
Red tape crisis A crisis that occurs when a
corporation has grown too large and complex
to be managed through formal programs.
Reengineering The radical redesign of busi-
ness processes to achieve major gains in cost,
service, or time.
Regional industry An industry in which
multinational corporations primarily coordi-
nate their activities within specific geo-
graphic areas of the world.
Relationship-based governance A govern-
ment system perceived to be less transparent
and have a higher degree of corruption.
Repatriation of profits The transfer of prof-
its from a foreign subsidiary to a corpora-
tion’s headquarters.
Replicability The ability of competitors to du-
plicate resources and imitate another firm’s
success.
Resources A company’s physical, human,
and organizational assets that serve as the
building blocks of a corporation.
Responsibility center A unit that is isolated
so that it can be evaluated separately from the
rest of the corporation.
Retired executive directors Past leaders of a
company kept on the board of directors after
leaving the company.
Retrenchment strategy Corporate strategies
to reduce a company’s level of activities and
to return it to profitability.
Return on equity (ROE) A measure of per-
formance that is calculated by dividing net in-
come by total equity.
Return on investment (ROI) A measure of
performance that is calculated by dividing net
income before taxes by total assets.
Revenue center A responsibility center in
which production, usually in terms of unit or
dollar sales, is measured without considera-
tion of resource costs.
Reverse engineering Taking apart a competi-
tor’s product in order to find out how it works.
Reverse stock split A stock split in which an
investor’s shares are reduced for the same to-
tal amount of money.
Risk A measure of the probability that one
strategy will be effective, the amount of assets
the corporation must allocate to that strategy,
and the length of time the assets will be
unavailable.
Rule-based governance A governance
system based on clearly stated rules and
procedures.
Rules of thumb Approximations based
not on research, but on years of practical
experience.
the short-run activities of an organization but
influence its long-run decisions.
Sole sourcing Relying on only one supplier
for a particular part.
Sources of innovation Drucker’s proposed
seven sources of new ideas that should be
monitored by those interested in starting en-
trepreneurial ventures.
Sponsor A department manager who recog-
nizes the value of a new idea, helps obtain
funding to develop the innovation, and facili-
tates the implementation of the innovation.
Stability strategy Corporate strategies to
make no change to the company’s current
direction or activities.
Staffing Human resource management pri-
orities and use of personnel.
Stages of corporate development A pattern
of structural development that corporations
follow as they grow and expand.
Stages of international development The
stages through which international corpora-
tions evolve in their relationships with widely
dispersed geographic markets and the manner
in which they structure their operations and
programs.
Stages of new product development The
stages of getting a new innovation into the
marketplace.
Stage-gate process A method of managing
new product development to increase the
likelihood of launching new products quickly
and successfully. The process is a series of
steps to move products through the six stages
of new product development.
Staggered board A board on which directors
serve terms of more than one year so that only
a portion of the board of directors stands for
election each year.
Stakeholder analysis The identification and
evaluation of corporate stakeholders.
Stakeholder measure A method of keeping
track of stakeholder concerns.
Stakeholder priority matrix A chart that
categorizes stakeholders in terms of their
interest in a corporation’s activities and
their relative power to influence the corpo-
ration’s activities.
Stall point A point at which a company’s
growth in sales and profits suddenly stops and
becomes negative.
Standard cost center A responsibility center
that is primarily used to evaluate the perfor-
mance of manufacturing facilities.
Standard operating procedures Plans that
detail the various activities that must be carried
out to complete a corporation’s programs.
Star Market leader that is able to generate
enough cash to maintain its high market share.
Statistical modeling A quantitative tech-
nique that attempts to discover causal or
Strategic piggybacking The development of
a new activity for a not-for-profit organiza-
tion that would generate the funds needed to
make up the difference between revenues and
expenses.
Strategic planning staff A group of people
charged with supporting both top manage-
ment and business units in the strategic
planning process.
Strategic R&D alliance A coalition
through which a firm coordinates its re-
search and development with another firm(s)
to offset the huge costs of developing new
technology.
Strategic rollup A means of consolidating a
fragmented industry in which an entrepreneur
acquires hundreds of owner-operated small
businesses resulting in a large firm with eco-
nomies of scale.
Strategic sweet spot A market niche in
which a company is able to satisfy customers’
needs in a way that competitors cannot.
Strategic type A category of firms based on
a common strategic orientation and a combi-
nation of structure, culture, and processes that
are consistent with that strategy.
Strategic vision A description of what the
company is capable of becoming.
Strategic window A unique market opportu-
nity that is available only for a particular
time.
Strategic-funds method An evaluation
method that encourages executives to look at
development expenses as being different from
expenses required for current operations.
Strategies to avoid Strategies sometimes fol-
lowed by managers who have made a poor
analysis or lack creativity.
Strategy A comprehensive plan that states
how a corporation will achieve its mission
and objectives.
Strategy formulation Development of long-
range plans for the effective management of
environmental opportunities and threats in
light of corporate strengths and weaknesses.
Strategy implementation A process by
which strategies and policies are put into ac-
tion through the development of programs,
budgets, and procedures.
Strategy-culture compatibility The match
between existing corporate culture and a new
strategy to be implemented.
Structure follows strategy The process through
which changes in corporate strategy normally
lead to changes in organizational structure.
Stuck in the middle A situation in which a
company or business unit has not achieved a
generic competitive strategy and has no com-
petitive advantage.
Suboptimization A phenomenon in which a
unit optimizes its goal accomplishment to the
detriment of the organization as a whole.
explanatory factors that link two or more time
series together.
STEEP analysis An approach to scanning the
societal environment that examines socio-
cultural, technological, economic, ecological,
and political-legal forces. Also called PESTEL
analysis.
Steering control Measures of variables that
influence future profitability.
Stewardship theory A theory proposing that
executives tend to be more motivated to act in
the best interests of the corporation than in
their own self-interests.
Strategic alliance A partnership of two or
more corporations or business units to
achieve strategically significant objectives
that are mutually beneficial.
Strategic audit A checklist of questions by
area or issue that enables a systematic analy-
sis of various corporate functions and activi-
ties. It’s a type a management audit.
Strategic audit worksheet A tool used to an-
alyze a case.
Strategic business unit (SBU) A division or
group of divisions composed of independent
product-market segments that are given pri-
mary authority for the management of their
own functions.
Strategic choice The evaluation of strategies
and selection of the best alternative.
Strategic choice perspective A theory that
proposes that organizations adapt to a changing
environment and have the opportunity and
power to reshape their environment.
Strategic decision-making process An
eight-step process that improves strategic de-
cision making.
Strategic decisions Decisions that deal with
the long-run future of an entire organization
and are rare, consequential, and directive.
Strategic factors External and internal factors
that determine the future of a corporation.
Strategic flexibility The ability to shift from
one dominant strategy to another.
Strategic group A set of business units or
firms that pursue similar strategies and have
similar resources.
Strategic inflection point The period in an
organization’s life in which a major change
takes place in its environment and creates a
new basis for competitive advantage.
Strategic management A set of managerial
decisions and actions that determine the long-
run performance of a corporation.
Strategic management model A rational,
prescriptive planning model of the strategic
management process including environmen-
tal scanning, strategy formulation, strategy
implementation, and evaluation and control.
Strategic myopia The willingness to reject
unfamiliar as well as negative information.
GLOSSARY G-9
Tipping point The point at which a slowly
changing situation goes through a massive,
rapid change.
Top management responsibilities Leadership
tasks that involve getting things accomplished
through and with others in order to meet the
corporate objectives.
Total Quality Management (TQM) An
operational philosophy that is committed
to customer satisfaction and continuous
improvement.
TOWS matrix A matrix that illustrates how
external opportunities and threats facing
a particular company can be matched with
that company’s internal strengths and
weaknesses to result in four sets of strategic
alternatives.
Transaction cost economics A theory that
proposes that vertical integration is more
efficient than contracting for goods and serv-
ices in the marketplace when the transaction
costs of buying goods on the open market be-
come too great.
Transfer price A practice in which one
unit can charge a transfer price for each
product it sells to a different unit within a
company.
Transferability The ability of competitors to
gather the resources and capabilities neces-
sary to support a competitive challenge.
Transformational leader A leader who
causes change and movement in an organiza-
tion by providing a strategic vision.
Transparent The speed with which other
firms can understand the relationship of re-
sources and capabilities supporting a success-
ful firm’s strategy.
Trends in governance Current developments
in corporate governance.
Trigger point The point at which a country
has developed economically so that demand
for a particular product or service is increas-
ing rapidly.
Triggering event Something that acts as a
stimulus for a change in strategy.
Turnaround specialist A manager who is
brought into a weak company to salvage that
company in a relatively attractive industry.
Turnaround strategy A plan that empha-
sizes the improvement of operational effi-
ciency when a corporation’s problems are
pervasive but not yet critical.
Turnkey operation Contracts for the con-
struction of operating facilities in exchange
for a fee.
Turnover A term used by European firms to
refer to sales revenue. It also refers to the
amount of time needed to sell inventory.
Uncertainty avoidance (UA) The extent to
which a society feels threatened by uncertain
and ambiguous situations.
Union of South American Nations An orga-
nization formed in 2008 to unite Mercosur
and the Andean Community.
Utilitarian approach A theory that proposes
that actions and plans should be judged by
their consequences.
Value chain A linked set of value-creating
activities that begins with basic raw materials
coming from suppliers and ends with distrib-
utors getting the final goods into the hands of
the ultimate consumer.
Value-chain partnership A strategic al-
liance in which one company or unit forms a
long-term arrangement with a key supplier or
distributor for mutual advantage.
Value disciplines An approach to evaluating a
competitor in terms of product leadership, op-
erational excellence, and customer intimacy.
Vertical growth A corporate growth strategy
in which a firm takes over a function previ-
ously provided by a supplier or distributor.
Vertical integration The degree to which a
firm operates in multiple locations on an in-
dustry’s value chain from extracting raw ma-
terials to retailing.
Virtual organization An organizational struc-
ture that is composed of a series of project
groups or collaborations linked by changing
nonhierarchical, cobweb-like networks.
Virtual team A group of geographically
and/or organizationally dispersed coworkers
that are assembled using a combination of
telecommunications and information tech-
nologies to accomplish an organizational task.
Vision A view of what management thinks an
organization should become.
VRIO framework Barney’s proposed analysis
to evaluate a firm’s key resources in terms of
value, rareness, imitability, and organization.
Web 2.0 A term used to describe the evolu-
tion of the Internet into wikis, blogs, RSS,
social networks, podcasts, and mash-ups.
Weighted-factor method A method that is
appropriate for measuring and rewarding
the performance of top SBU managers and
group-level executives when performance
factors and their importance vary from one
SBU to another.
Whistle-blower An individual who reports to
authorities incidents of questionable organi-
zational practices.
World Trade Organization A forum for
governments to negotiate trade agreements
and settle trade disputes.
Z-value A formula that combines five ratios
by weighting them according to their impor-
tance to a corporation’s financial strength to
predict the likelihood of bankruptcy.
NOTE: This glossary contains terms used in
the twelve chapters of this textbook plus the
three additional chapters provided on the
publisher’s Web site to buyers of this book.
Substages of small business development A
set of five levels through which new ventures
often develop.
Substitute products Products that appear to
be different but can satisfy the same need as
other products.
Supply-chain management The formation of
networks for sourcing raw materials, manufac-
turing products or creating services, storing
and distributing goods, and delivering goods or
services to customers and consumers.
Support activity An activity that ensures that
primary value-chain activities operate effec-
tively and efficiently.
SWOT analysis Identification of strengths,
weaknesses, opportunities, and threats that
may be strategic factors for a specific
company.
Synergy A concept that states that the whole is
greater than the sum of its parts; that two units
will achieve more together than they could
separately.
Tacit knowledge Knowledge that is not eas-
ily communicated because it is deeply rooted
in employee experience or in a corporation’s
culture.
Tactic A short-term operating plan detailing
how a strategy is to be implemented.
Takeover A hostile acquisition in which one
firm purchases a majority interest in another
firm’s stock.
Taper integration A type of vertical integra-
tion in which a firm internally produces less
than half of its own requirements and buys the
rest from outside suppliers.
Task environment The part of the business
environment that includes the elements or
groups that directly affect the corporation
and, in turn, are affected by it.
Technological competence A corporation’s
proficiency in managing research personnel
and integrating their innovations into its day-
to-day operations.
Technological discontinuity The displace-
ment of one technology by another.
Technological follower A company that imi-
tates the products of competitors.
Technological leader A company that pioneers
an innovation.
Technology sourcing A make-or-buy deci-
sion that can be important in a firm’s R&D
strategy.
Technology transfer The process of taking a
new technology from the laboratory to the
marketplace.
Time to market The time from inception to
profitability of a new product.
Timing tactics Tactics that determines when
a business will enter a market with a new
product.
G-10 GLOSSARY
I-1
Applebee’s, 304
Apria Healthcare, 47
Arcelor, 278
Archer Daniels Midland (ADM), 195
Arctic Cat, 279, 280
Arctic Council, 96
Aristotle, 257
Arm & Hammer, 180, 238
Arthur D. Little Inc., 115
Asea Brown Boveri (ABB), 290, 294
Ashridge Strategic Management Centre, 18
Association of Southeast Asian Nations
(ASEAN), 8, 9, 113
Astra Zenica, 188
AT&T, 240, 307, 316
Automotive Resources, 346
Avis, 300
Avnet, Inc., 123
Avon Co., 27, 121, 138, 247
Baan, 162, 347
Baby Fresh Organic Baby Foods, 287
Badaracco, J., 86
Bain & Co., 7, 217, 248, 306, 340, 344
Bajal Auto, 142
Baldor Electric Company, 242
Baldwin Locomotive, 98
Baldwin-United, 284
Ballmer, S., 60
Banadex, 90
Banbury, C., 296
Banerjee, P., 361
Bank of America, 11
Bank of Montreal, 47
Bank One, 270
Bankers Trust of New York, 306, 309
Banking Act of 1933, 52
Barclays, 370
Barnevik, P., 150
Barney, J. B., 195
Baxter Healthcare, 134
Bechtel Group Inc., 27
Beijing Olympics, 22
Bell South, 240, 341
Ben & Jerry’s Ice Cream, 75
Benetton, 287
Bennigan’s Grill & Tavern, 220
Berkshire Hathaway, 215, 355
Berle, A. A., 50
Bert, A., 272
Best Buy, 119, 144, 209, 270
Best Western, 47
Bezos, J., 26, 61
Bharti Enterprises, 213
Bharti-Mart, 213
Bice, A., 79
Big Idea Group, 242
Bill of Rights, 85
Birkinshaw, J. M., 228
Bisquick, 225
Black & Decker, 198
Black, J. S., 310
Blank, A., 42
Bloom, R., 160
BMW, 21, 149, 152, 158, 187, 213, 355
Body Shop, 59, 60
Boeing Company, 21, 111, 159, 170, 214,
248, 316
Bombardier, 214, 215, 288
Borders, 230
Bosch Appliances, 229
Bosch-Siemens, 191
Bose Corporation, 244
Boston Consulting Group, 5, 221
Boston University, 360
Boveri AG, 150
BP Amoco, 145
Brabeck-Letmathe, P., 295
Brady Bunch, 105
Branson, R., 60
Brastemp, 243
Brigham, L., 94
Bristol-Myers Squibb, 210, 306
British Aerospace, 197
British Airways, 8, 19, 125
British Petroleum (BP), 13, 145, 209, 371
Brynjolfsson, E., 274
Budweiser, 196, 212, 346
Buffet, W., 215
Burger King, 116
Burns, L., 222
Busch Gardens, 104
Business Environment Risk Index, 115
Business Roundtable Institute for Corporate
Ethics, 83
Business Software Alliance, 246
Business Week, 11, 42, 63, 302
Byron, W., 72
Cadbury Cocoa Partnership, 276
Cadbury Report, 56
Cadbury Schweppes, 18, 19, 276
Cadillac, 22
CAFTA, 8
Calhoun, D., 4
Callaway, 346
Campbell, A., 18, 226, 227, 278
Canadair, 214
Canary Wharf, 370
CANENA, 345
Canon, 84, 211
Carbon Trust, 11, 340
Carbonrally.com, 100
Carrefour, 211, 213
3Com, 240
3M, 21, 47, 125, 270, 290, 294, 333, 355
60 Minutes, 346
A&W, 198
A. C. Nielsen Co., 121
Abbott Laboratories, 312
Accenture, 360
Ace Hardware, 246
Addidas, 111
Adelphia Communications, 55
Admiral, 315
Adobe, 354
Aerospatiale, 197
AES, 370
AFL-CIO, 58
AIM Global, 348
Airbus Industrie, 111, 170, 197, 214, 254
Ajax Continental, 316
Alamo, 186
Albertson’s, 188
Alcatel-Alsthorn NV, 150
Alcoa, 322
Aldi, 186
Alexander, M., 226, 227
All-China Federation of Trade Unions, 105
Allen, J., 204
Allied Corp. 207
Allied Signal, 208, 290, 306
Allport-Vernon-Lindzey Study of Values, 80
Altman, E.I., 371
Amazon.com, 26, 61, 143, 230
America West, 211
America’s Most Admired Companies, 355
American Airlines, 8, 19, 332
American Customer Satisfaction Index
(ACSI), 44, 332
American Cyanamid, 294, 295
American Express, 240, 355
American Family Association (AFA), 78
American Hospital Supply (AHS), 162
American Management Assoc., 248, 333
American Productivity & Quality Center
(APQC), 344
American Society for Industrial
Security, 121
American Society of Training and
Development, 303
Americans for Balanced Energy Choices, 322
Amgen, 25
Amnesty International, 59
Amoco, 145
Andean Community, 8, 9
Anheuser-Busch, 53, 143, 153, 194, 196,
212, 213, 245, 343
Aossey, B., 174
Apple, 60, 109, 112, 139, 187, 194, 230,
239, 270, 283, 343, 347, 355
NAME INDEX
I-2 NAME INDEX
Carroll, A., 72, 73
Carroll’s Foods, 208, 209
Case, 102
Casey’s General Store, 258
Castaño, C., 90
Caterpillar, 152, 165, 229, 270, 289, 322
Cavanagh, G. F., 85
Celta, 243
Census of Manufacturing, 318
Center for Energy & Economic Develop-
ment (CEED), 322
Center for Financial Research & Analysis
(DFRA), 364
Central American Free Trade Agreement
(CAFTA), 9
Certified Emissions Reducer (CER), 370
Chandler, A., 14, 279, 283
Chang, S., 294
Charan, R., 341
Charmin, 188
Checkers Restaurants, 364
Cheerios, 70, 111
Chevrolet Volt, 222
Chevron, 254
Chiquita Brands International Inc., 90
Chiscos, 346
Chouinard, Y., 187
Chow, D., 346
Christensen, C. M., 156
Chrysler Corp., 52, 159, 196, 241, 244, 259,
322, 334
Chung, W., 8
Church & Dwight Co., 180, 236, 238
Circuit City, 144, 220
Cisco Systems, 21, 55, 73, 122, 208, 331,
346, 355
Citibank, 370
Citicorp, 306
Citigroup, 11
Claussen, E., 9
Clayton Act, 52
Clinton, H., 125
Clorox Company, 195, 198
Coca-Cola, 11, 18, 152, 161, 194, 245, 338,
339, 347
Colgate-Palmolive, 236, 238
Colt’s Manufacturing, 284
Combined Code of Conduct, 56
Comcast, 57
Compaq, 112, 216, 360, 361
ConAgra, 257
Cone, Inc., 74
Conference Board, 74
ConocoPhillips, 10
Construcciones Aeronáuticas, 197
Converse, 111
Cooper & Lybrand, 196
Cooper, C. 80
Corning, Inc., 291, 303
Corporate Library, 53, 56
Cosby Show, 105
Eastman Kodak, 98, 284, 308
Eaton Corporation, 352
eBay, 143, 260, 348
Echeverria, J. 11
Eckberg, J., 321
Eco-Management and Audit Regulations, 59
Economic Espionage Act in 1996, 122
Economist, 122
Economist Intelligence Unit, 74, 115, 197
Ecopods, 86
Eisner, M., 62
Electrolux, 51, 125, 191, 310, 371
Electronic Data Systems (EDS), 360
Eli Lilly, 125
Elion Chemical, 245
Elliot, J. R., 104
Ellison, L., 207, 280, 281
Emerson Electric, 53
Encyclopaedia Britannica Inc., 26
Energy Star, 229
Enhanced Tracker, 342
Enron, 44, 45, 55, 79, 80, 82
Ensign, P.C., 228
Enterprise Rent-A-Car, 300
Environics, 10
Environmental Protection Agency, 100
Equitable Life, 46
Erhardt, W., 302
Ericsson, 211
Eskew, M., 125
Estée Lauder, 104
Ethics Resource Center, 79
European Aeronautic & Space Co.
(EADS), 170
European Union (EU), 8, 9, 10, 104, 113,
119, 370
Excel, 111, 251
Exxon, 21
Facebook, 162
Fairfax, 121
Fazio, L., 79
Federated Department Stores, 278
FedEx, 4, 22, 138, 162, 208, 247, 342,
348, 355
Ferari, M., 144
Fiat, 213, 214
Fiat Group, 296
Findex, 121
Finsbury Data Services, 121
Fiorina, C., 62, 360
First Boston, 240
Folgers, 198
Footprint Chronicles, 187
Forbes 100, 6
Ford Motor Co., 78, 136, 144, 145, 160,
244, 248, 274, 283, 290,
308, 333
Ford, H, 144, 208, 283
Fortune, 70, 355
Foster, R., 155
Costco Wholesale, 270, 355
Craigslist, 260
Cramer, J., 23
Crane, A., 75
Credit Suisse, 370
Crest, 211
Crest Whitestrips, 227
Cromme Commission, 56
CSX Corp., 216
Cummins, Inc., 229
CVS, 270
D’Aveni, R., 13, 118, 191, 192
Daft, D., 161
Daimler-Benz Aerospace, 197, 270
DaimlerChrysler, 314
Daksh eServices Ltd., 248
Dale, K., 244
Danone, 245
Dashboard software, 332
Davis, S. M., 286
Dean Foods Co., 241
Dean, H., 241
Deere and Co., 188, 274, 338
Defining Moments, 86
Degeorge, 82
Delawder, T., 333
Delay, T., 340
Dell Computer, 23, 105, 110, 112, 133, 141,
143, 163, 186, 191, 217, 244,
248, 355, 360
Dell, M., 23, 141, 217
Deloitte & Touche Consulting Group, 107
Delphi Corp., 220, 243
Delta Airlines, 211, 219, 278
Delta Small Car Program, 150
Deming, W. E., 244
DHL, 200
Diligence Inc., 121
Disney, W., 143
Dixon, L., 244
Dodge Viper, 259
Doha Round, 103
Dole Food, 348
Donahoe, J., 260
Dow Chemical, 290
Dow Corning, 134
Dow Jones & Company, 75, 76
Dow Jones Sustainability Index (DJSI),
11, 76
Dr. Pepper/Snapple, 19
Draghi Law of l998, 56
Drauch, D., 222
Dreamliner, 248
Duke Energy, 322
DuPont, 63, 143, 223, 279, 280,
282, 333
Durant, W., 283
Eastern Airlines, 250, 284
Eastman Chemical Co., 341
NAME INDEX I-3
Greiner, L. E., 280, 283
Gretzky, W., 127
Grey-Wheelright, 323
Group Danone, 295
Grove, A., 24, 77, 113, 254
Hambrick, D., 29, 30
Hamilton Beach, 198
Hamilton, R. D., 333
Hammer, M., 289
Hardee’s, 116
Harley-Davidson, 290, 309
Harper Collins, 230
Harrigan, K. R., 209
Harris Interactive, 70
Harris Poll, 75
Hay Group, 355
Hayes Microcomputer Products, 285
Hayes, D., 285
HCL Technologies, 246
Head & Shoulders, 211, 346
Healthy Choice, 257
Heartland Institute, 322
Hegel, 257
Heilmeier, G., 156
Heineken, 163, 181
Herd, T., 272
Hershey Foods, 19, 308, 347
Hertz, 300
Hesse, D., 109
Hewitt Associates, 314
Hewlett, W., 360
Hewlett-Packard, 13, 62, 84, 134, 143, 149,
158, 191, 206, 211, 216, 246,
284, 333, 260, 361
Hofstede, G., 319, 320
Home Café, 198
Home Depot, 22, 42, 200, 239, 277, 285,
312, 314, 347
Homecoming Financial, 79
Honda, 139, 189, 213
Honeywell, 244
Hoover, 219
Hoover, R., 291, 303
Hoover’s Online, 12, 121
Hovis, J., 123
HSBC, 370
Huggies, 193
Hurricane Katrina, 11
Hurt, M., 360
Hypercompetition, 13, 191
IBM, 8, 26, 27, 107, 112, 115, 117, 133,
142, 58, 197, 213, 223, 242,
244, 247, 250, 280, 307, 310,
354, 255, 360
ImClone, 210
Immelt, J., 2, 308
Impacts of a Warming Arctic, 94
In Search of Excellence, 352
In the Garden, 391
InBev, 213
Indian Auto Show, 136
Infrasource Services, 57
Ingersoll-Rand, 244
Innovator’s Dilemma, 156
Institutional Shareholder Services (ISS), 56
Intel, 21, 77, 113, 140, 152, 224, 241,
254, 339
Intercontinental Hotels, 251
Intergovernmental Panel on Climate Change
(IPCC), 12
International Accounting Standards
Board, 345
International Electrotechnical Commission
(IEC), 345
International Energy Agency, 10
International Harvester, 284, 347
International House of Pancakes (IHOP), 304
International Monetary Fund, 101
International Organization for Standardiza-
tion (ISO), 345
International Panel on Climate Change, 128
International Paper, 212
International Standards Assoc., 333
Internet Explorer, 143, 193
Interstate Bakeries, 104
Intrade.com, 125
Investor Responsibility Research
Center, 57
Iowa State University, 274
ISDC, 346
Iverson, K., 328
Ivory, 152
J. D. Edwards, 162, 347
J. P. Morgan Chase & Co., 249
Jaguar, 136, 219
JetBlue, 170
Jewel, 188
Jobs, S., 60, 230, 283
John Deere, 102, 239
Johns-Manville, 284
Johnson & Johnson (J&J), 78, 84, 133, 228,
259, 355
Johnson, L., 274
Jones Surplus, 316
Jones, M., 277
Joyce, W., 7
JPMorgan Chase, 11
Jung, C., 323
Kant, I. 85
Kaplan, R. S., 339
KappaWest, 134
Kearney, A. T., 272
Kellogg Co., 239
Kenworth, 187
KeraVision, Inc., 341
KFC, 174, 198
Kimberly Clark, 134, 193, 228, 240
King, S., 230
Frank J. Zamboni & Co., 179
Fredrickson, J., 29, 30
Freeman, K., 322
Freightliner, 187
Friedman, M., 72, 73, 74
Friedman, T., 8
Friends of the Earth, 59
Frost, T. S., 115, 228
Fujitsu Ltd., 250
Fuld-Gilad-Herring Academy of Competi-
tive Intelligence, 108
Galbraith, 145
Gap International, 84
Gartner Group, 159
Gaskell, J., 144
Gates, W., 60, 118
Gateway, 105, 112
GE Capital International Services, 248
GE Energy Financial Services, 370
Genentech, 25, 55, 354
General Agreement on Tariffs and Trade
(GATT), 103
General Electric (GE), 2, 5, 6, 8, 21, 22, 27,
47, 98, 125, 138, 152, 159,
196, 211, 215, 219, 223, 227,
245, 247, 248, 258, 282, 290,
304, 306, 307, 308, 322, 339,
343, 354, 355, 370
General Foods, 148
General Mills, 70, 72, 111, 121, 225
General Motors (GM), 22, 60, 98, 142, 150,
196, 219, 222, 243, 248, 257,
260, 279, 280, 282, 283, 285,
308, 310, 311, 313, 322, 333,
339, 349, 360
George Washington University, 102
Georgetown University’s Environmental
Law & Policy Institute, 11
Georgia-Pacific, 246
Gerstner, L., 26, 60
Ghosn, C., 315
Gilad, 123, 133
Gillette, 26, 133, 140, 141, 142, 151, 193,
208, 278, 341
Glass, Lewis & Co., 55
Global Crossing, 45, 55
Goizueta, R., 338
Goldman Sachs Group, 11, 355
Goodyear Tire & Rubber, 160, 243
Google, 17, 57, 125, 143, 149, 355
Goold, M., 226, 227, 278
Graduate Management Admission
Council, 79
Graduate Management Admission Test
(GMAT), 79
Grant, R. M., 27
Grantham, C., 159
Green Book, 59
Greenpeace, 59, 77
Gregersen, H. B., 310
I-4 NAME INDEX
Kinko’s 208
Kirin, 196
KLD Broad Market Social Index, 11
Kleenex, 152
Kleiner Perkins, 52
K-Mart, 189, 284
Knight, P., 60
Kohlberg, L., 83
Korn/Ferry International, 51, 341
Koutsky, J., 274
Kraft Foods,18, 19, 295, 364
Kramer, M. R., 74
Kroger, 270
Kroll, Inc., 121
Krups, 198
Kugler, R., 24
Kurtzman Group, 81
Kvinnsland, S., 321
Kyoto Protocol, 10, 370
L. L. Bean, 344
L’Oreal, 59
Labatt, 196
Lada, 214
Lafley, A., 242
Land, E., 283
Land Rover, 136, 219
Langone, K., 42
Larsen, R., 259
Lawrence, P. R., 286
Lay, K., 80
Leadership Development Center, 307
Lear, 243
Learjet, 214
Leder, M., 365
LEGO, 163
Lehman Brothers, 370
Lemon Fresh Comet, 195
Lenovo Group, 223
Levi Strauss & Co., 75, 84, 125, 270
Levinson, A., 25
Lewis, J., 316
LexisNexis, 121
Lincoln Electric, 117
Linebarger, T., 229
Linux, 242,
Livingston, R., 247
Loarie, T., 341
Lockheed Martin, 134, 247
Loewen Group, 190
Logitech, 294
Long John Silver’s, 198
Long Range Planning, 18
Lorange, P., 198
Lorsch, J., 57
Lovins, A., 161
Lutz, B., 60, 222, 259
MacDonald, T., 272
Macy’s Department Stores, 278, 284
Mad Money, 23
Morgan Stanley, 370
Morningstar, 56
Mossville Engine Center, 289
Motorola, 84, 141, 159, 211, 303
Movie Gallery, 102
MphasiS, 360
Mr. Coffee, 198
Mr. Donut, 238
MS-DOS, 111
Mullen, D., 348
Mulva, J., 10
Muralidharan, R., 333
Myers-Briggs, 323
MySpace, 162
NAFTA, 8, 113
Nardelli, R., 42, 277, 314
NASDAQ, 49, 55, 57
National Association of Corporate
Directors, 45
National Car Rental, 300
National Nanotechnology Infrastructure
Network, 242
National Research Center, 332
Nature Conservancy, 100
NCR Corp., 159, 316, 360
Nestlé, 18, 151, 245, 294, 295
Netscape, 143, 193
Netsuite, 332
New Balance, 111
New York Stock Exchange, 49, 55, 57
Newman’s Own, 84
Newport News Shipbuilding, 17
News Corp, 370
Nickelodeon, 188
Nike, 8, 86, 111, 187, 204, 241, 287, 306
Nissan Motor Company, 142, 213,
278, 315
Nohria, N., 7
Nokia, 152
Noorda, R., 200
Nordstrom, 149, 258, 355
North America Index, 76
Northern Telecom, 159
Northwest Airlines, 52, 211, 219, 278
Norton, D. P., 339
Novartis, 25
Novell, 200
Nucor Corporation, 149, 328
NutraSweet, 112
Nutt, P., 257
O’Reilly, T., 230
Obama, B., 125
Ocean Spray, 238
Ocean Tomo, 241
Office Depot, 332
Ohio State University, 346
Olay, 211
Olive Garden, 116
Olivetti, 223
Magic Chef, 20
Malik, O., 230
Malmendier, U., 61
Management Tools and Trends, 7
Manco, Inc., 344
Marchionne, S., 296
Marcus, B., 42
Margolis, J. D., 74
Market Research.com, 121
Marlboro, 346
Marriott, 246
Marsh Center for Risk Insights, 245
Mary Kay Corp., 121
Mary Poppins, 143
Maslow, A., 83
Matsushita Electric Industrial Corporation
(MEI), 150
Matsushita, K., 150
Mattel, 242, 247
Matten, D., 75
MaxiShips, 247
May Company, 278
Maybelline, 104
Maytag Corp., 76, 127, 139, 165, 177, 183,
191, 197, 213, 219, 241, 315,
373, 376, 383
McCain, J., 125
McDonald’s, 74, 104, 116, 152, 174, 186,
190, 246, 247, 277, 306
McDonnell Douglas, 170, 316
McKesson, 322
McKinsey & Co., 6, 8, 46, 47, 57, 74, 120,
155, 162, 176, 216, 220, 223,
256, 306, 314, 340, 375
McLeodUSA, 195
McNealy, S., 283
Mead Corporation, 47
Means, G. C., 50
Medtronic, 47, 84
Mercedes Benz, 152
Mercer Delta Consulting, 56
Merck, 188
Mercosur (Mercosul), 8, 9, 112
Merrill Lynch, 348
Mesa Airlines, 211
Microsoft, 8, 20, 60, 111, 118, 121, 125,
143, 152, 180, 193, 194, 207,
242, 306, 335, 339, 347, 355
Midamar Corp., 174, 188
Miles, R. E., 117, 288
Miller Brewing Co., 8, 181
Millstone, 198
Mintzberg, H., 23, 26, 259
Mission Point Capital Partners, 370
MIT, 248
Mitsubishi Motors, 314
Mittal Steel, 278
Modelo, 196
Montgomery Ward, Inc., 284, 304
Moody’s, 56
Morgan Motor Car Co., 188
NAME INDEX I-5
242, 278, 280, 287, 305, 306,
347, 355
Project Fusion, 278
Project GLOBE, 320
Quaker Oats, 370
Quinn, J. B., 26
Qwest, 45, 55, 195
Radio Shack, 341
RAND Corp., 124
Random House, 230
Raytheon, 341
RCA Labs, 156
RE/MAX A-1 Best Realtors, 79
Reebok, 8, 111, 204, 287
Reinemund, S., 60
Reinhardt, F. L., 10
Renault, 142, 214, 278, 315
Renshaw, A. A., 274
Rensi, E., 247
Rent.com, 260
RHR International, 307
Richardson, B., 158
Riding the Bullet, 230
Rituxan, 25
River Rouge plant, 208
Rivers, R., 24
RJR Nabisco, 339
Roadway Logistics, 246
Roberson, B., 7
Roberts, B., 57
Rockwell Aerospace, 170
Rockwell Collins, 154
Rocky Mountain Institute, 161
Roddick, A., 59, 60
Roj, Y, 56
Rolm and Haas, 47
Roman Catholic Church, 257
Romanos, J., 230
Rosenkrans, W., 133
Ross, D., 302
Royal Dutch Shell, 125, 209
RSD, 197
Rubbermaid, 117, 344
Rumelt, R., 214
Ryall, M. D., 120
S. C. Johnson, 84
Safeguard, 346
Safeway, 188, 270
SAM (Sustainable Asset Management AG)
Research, 76
SAM (Sustainable Asset Management
Group, 11
SAP AG, 162, 207, 347
Sarason, Y., 296
Sarbanes-Oxley Act, 55, 56, 84
Saturn, 313
Savage, R., 352
SBC Communications, 53
Schilit, H., 364
Schlitz Brewing Co., 51
Schroeder, K., 100
Scientific-Atlanta Inc., 208
ScoreTop.com, 79
Scott Paper, 228
Sears Manufacturing Co., 274
Sears Roebuck and Co., 105, 119, 279, 295,
307, 350
Securities and Exchange Commission
(lSEC), 49, 55, 57, 58
Security Outsources Solutions, 121
Seidenberg, I., 61
Service Corporation International, 47, 190
ShareNet, 13
Shea, C., 70
Sherwin-Williams Co., 209
Shopping.com, 260
Shorebank, 84
Siemens, 13, 150, 211
Signal Companies, 207
Simon & Schuster, 210
Simpson Industries, 219
Singer-Loomis, 323
Skoll, J., 260
Skype, 260
Sloan, A. P., 257, 279
SmartyPig, 143, 144
Smith & Wesson, 238
Smithfield Foods, 208, 209
Smucker, 84
Snow, C. C. 117, 288
Society of Competitive Intelligence Profes-
sionals (SCIP), 122, 133
Sony Corp., 84, 143, 194, 197, 218
South African Breweries (SAB), 8, 181
Southwest Airlines, 21, 143, 170, 186, 195,
332, 355
Sparks, 81
Sprint Nextel, 109
SSA, 347
Stanberry, T., 144
Standard & Poor’s (S&P), 56
Standard Oil, 279, 307
Stanley Works, 347
Staples, 19, 190
Starbucks, 75, 212, 308, 355
Steak & Ale, 220
Steinway, 194
Stern Stewart & Co., 338
Stewart Enterprises, 190
Stewart, J., 304
Stringer, H., 218
Structured Query Language (SQL), 280
Stuart, L. S., 306
Stuart, S., 51
StubHub, 260
Stumbleupon, 260
Sullivan, J., 115, 160
Sun Microsystems, 283
Sunbeam, 364
Olson, M., 270, 272
Omidyar, P., 260
Open Compliance and Ethics Group, 84
Open Standards Benchmarking
Collaborative, 344
Oppenheimer, P., 239
Oracle Corp., 121, 162, 207, 278, 280,
282, 347
Orbitz, 57
Orion Pictures, 284
Orphagenix, 188
Owens-Corning, 347
P. F. Chang’s, 190
Pacar Inc., 187
Pacific Gas and Electricity, 125
Packard, D., 360
Palm, 194
Pampers, 193, 211
Pan Am Building, 251
Pan American Airlines, 250, 251, 284
Panasonic, 150, 223
Panda Restaurant Group, 190
Pascal, 11
Patagonia, 84, 187
Patel, 82
PayPal, 260
Pelino, D., 307
People’s Car, 136, 142
PeopleShareNet, 13
PeopleSoft, 162, 207, 347
PepsiCo., 18, 60, 152, 306, 344, 370
Perez, A., 284
Perot, R., 360, 361
Peterbilt, 187
Peters, T. J., 352
Pew Center on Global Climate Change, 9
Pfizer, 47, 282, 306
Pharmacia AB, 281, 321
Pharmacia Upjohn, 154
Philips, 139, 294
Pitney Bowes, 55
Pizza Hut, 174, 190, 198, 314
Plato, 257
PlayStation 3, 197
Pohang Iron & Steel Co. Ltd. (POSCO), 56
Polaroid Corporation, 250, 283
Porter, M.E., 10, 74, 99, 110, 112, 113, 114,
123, 133, 134, 140, 146, 189,
192, 194
Potlach Corporation, 187
PowerShip, 247
Prahalad, C. K., 294
Preda Code of Conduct, 56
PriceWaterhouseCoopers, 121, 341, 360
PRISM software, 348
Prius, 222
Procter & Gamble (P&G), 20, 24, 75, 107,
111, 117, 121, 141, 145, 161,
163, 168, 163, 193, 195, 198,
208, 211, 227, 228, 236, 238,
I-6 NAME INDEX
Super Size Me, 74
Surowiecki, J., 124
Sustainability Yearbook, 11
SWD. Inc., 333
Swiss Re, 10
Taco Bell, 314
Taisei Corp., 27
Target, 27, 47, 189, 270, 341, 355
Tata Consultancy Services, 360
Tata Group, 255
Tata Motors, 136, 142, 219
Tate, G., 61
Taxin, G., 55
Taylor, A., 399
Technic, 150
Tennessee Valley Authority, 254
Tesco, 211, 213, 348
Tesla Motors, 10
Texas Gas Resources, 216
Texas Instruments, 47
Textron, 354
TIAA-CREF, 51
Tide, 111, 211, 346
Tilt, 81
Timberland, 200
Time, 127
Timex, 186
Toman Corp., 225
Toro, 215
Toshiba, 197, 211
Tower Records, 102
Toyota Motor, 152, 163, 189, 213,
222, 290, 355
Toys “R” Us, 270
Trading Process Network, 247
Trans World Airlines (TWA), 250
Treacy, M. 123, 133, 135
Trend Micro, 294
Tricon Global Restaurants, 314
Trident Group, 121
Tyco, 45, 55, 79, 80
U.S. Airways, 211
U.S. Airways Express, 211
U.S. Arctic Research Commission, 94
U.S. Climate Action Partnership
(USCAP), 322
U.S. Constitution, 85
U.S. Department of Defense, 348
Walt Disney Co., 62, 152, 187, 251, 283
Warner-Lambert, 27, 282
Waterman, R. H., 352
Watkins, S., 80, 82
Web 2.0, 230
WebFountain, 107
Welch, J., 227, 258, 290, 308
West Bank, 144
Westinghouse, 196
Weyerhauser, 145
Wheaties, 70
Wheeling-Pittsburgh Steel, 52, 284
Whirlpool Corp., 47, 127, 139, 177, 191,
219, 240, 243, 247, 315, 347
Whisper, 211
Whitman, M., 260, 348
Who Wants to Be a Millionaire?, 251
Wiersema, F., 123, 33, 135
Wiersema, M., 62
Wilburn, N., 287
Wilburn, R., 287
Williamson, O. E., 210
Windows, 111, 118, 193
Wisdom of Crowds, 124
Woods, T., 204
Word, 111
Work Design Collaborative, 159
World Bank, 101
World Custom Organization, 346
World Index, 76
World is Flat, 8
World Knowledge, 230
World Political Risk Forecasts, 115
World Trade Organization (WTO),
103, 112
WorldCom, 44, 45, 55, 79, 80
Wrigley, 18
Xerox, 139, 274, 290, 307, 308, 309, 344
Yahoo!, 370
Yamaha, 194
Yankelovich Partners, 366
Young, S., 310
Yum! Brands, 198, 212, 314
Zabriskie, 321
Zamboni, F., 179
Zimmer Holdings, 104
Zook, C. 204
U.S. Department of Energy (DOE), 245
U.S. Environmental Protection Agency, 260
U.S. False Claims Act, 84
U.S. Internal Revenue Service, 345
U.S. Securities and Exchange Commission
(SEC), 48, 122
U.S. Steel, 56
U.S. West, 195
Unilever, 24, 236, 238, 245, 295, 310
Union Carbide, 246
Union of South American Nations, 9
United Airlines (UAL), 52, 211, 250
United Auto Workers, 160
United Distillers, 125
United Express, 211
United Parcel Service (UPS), 19, 22, 125,
160, 200, 247, 355
United Self Defense Forces of Columbia
(AUC), 90
United States Chamber of Commerce, 121
United States Index, 76
United Steel Workers, 160
University of Michigan, 294
University of Southern California, 56
University of the Arctic, 97
Upjohn Pharmaceuticals, 321
Urschel Laboratories, 239
Van Alstyne, M. 274
Van Bever, D., 270, 272
Van Der Linde, B., 334
VCA Antech, 190
Venktraman, N. V., 360
Verizon Communications, 61
Verry, S., 270, 272
Vidal Sassoon, 346
Virgin, 60
Volkswagen, 347
Volvo, 270
W&T Offshore, 57
Wagoner, R., 222
Wake Forest University, 322
Walgreen Co., 104, 270
Wall Street Journal, 70
Wal-Mart, 11, 143, 1613, 186, 189, 211,
212, 213, 218, 242, 258, 270,
344, 347, 348, 355
Walsh, J. P., 74
Walsh K., 370
I-7
Brainstorming, 124
Brand management, 287
Brand, 152
Brand, corporate, 152
BRIC countries, 101
Budget, 22, 276
Budget analysis, 344
Business ethics, 79
Business intelligence, 120
Business model, 142
Business policy, 5
Business strategy, 19, 183
Buyers, bargaining power, 112
Bypass attack, 194
CAD/CAM, 158, 242
Capabilities, 138
Capabilities, dynamic, 138, 191
Cap-and-trade, 370
Capital budgeting, 153
Capital, social, 74
Captive company, 211
Captive company strategy, 219
Carbon footprint, 99, 100
Carbon trading, 370
Case analysis methodology, 380
Case method, 365
Cash cows, 23
Categorical imperatives, 85
Cautious profit planner, 304
Cellular organization, 288
Cellular structure, 288
Center of excellence, 228
Center of gravity, 145
Centralization, 294
Chairman of the Board, 54
Chief Risk Officer, 335
Chief Strategy Officer, 62
Choice, criteria, 258
Choice, strategic, 267
Cloud computing, 102
Co-creation, 163
Code of ethics, 83
Codetermination, 52
Collusion, 195
Commodity, 112
Common-size statements, 371
Common thread, 182
Communication, 314
Competency, core, 138
Competency, distinctive, 138
Competition, multipoint, 228
Competitive advantage, 139
Competitive analysis techniques, 133
Competitive intelligence, 120
Competitive intelligence, sources, 121
Competitive scope, 185
Competitive strategy, 183
Competitive tactics, 192
Complementor, 113
Concentration strategy, 208
Concentric diversification, 214, 215
Concurrent engineering, 159
Conglomerate diversification, 215
Conglomerate structure, 148
Connected line batch flow, 242
Consensus, 257
Consolidated industry, 114
Consolidation, 218
Constant dollars, 372
Consumer Price Index (CPI), 372
Continuous improvement, 243, 318
Continuous systems, 157
Continuum of sustainability, 141
Continuum, board of directors, 46
Continuum, vertical integration, 209
Contraction, 218
Control, guidelines, 351
Controls, behavior, 332
Controls, input, 333
Controls, output, 332
Cooperative strategies, 195
Co-opetition, 200
Core competency, 138
Core rigidity/deficiency, 138, 284
Corporate brand, 152
Corporate culture, 149, 255
Corporate culture, managing, 311
Corporate culture, pressures
from, 255
Corporate governance, 45, 56
Corporate governance, trends, 57
Corporate parenting, 226, 227
Corporate reputation, 152
Corporate scenarios, 251
Corporate stakeholders, 75
Corporate strategy, 19, 206
Corporate valuation, 340
Corporate value-chain analysis, 146
Corporation, 45
Cost focus, 187
Cost leadership, 186
Cost proximity, 188
Costing, activity-based, 334
Counterfeit goods, 346
Crisis of autonomy, 282
Crisis of control, 282
Crisis of leadership, 280
Critical mass, 207
Cross-functional work teams, 159
Cultural integration, 149
Cultural intensity, 149
Culture of fear, 42
Culture, corporate, 149, 255, 311
10-K form, 366
10-Q form, 366
14-A form, 366
360-degree appraisal, 246
80/20 rule, 351
Accounting, forensic, 364
Acquisition, 208, 213
Action plan, 316, 317
Activity-based costing (ABC), 334
Activity ratios, 366
Adaptive mode, 26
Advanced Manufacturing Technology
(AMT), 242
Affiliated directors, 49
Agency theory, 48, 50
AIDS, 104
Analysis, financial, 366
Analysis, industry, 110
Analysis, organizational, 138
Analysis, portfolio, 220
Analytical portfolio manager, 304
Analyzers, 117
Annual report, 366
Appraisal system, 307
Arms race, 250
Assessment centers, 307
Assets, 138
Assimilation, 315
Assumptions, 123
Autonomous (self-managing) work
teams, 159
Backward integration, 208
Bad service excuses, 277
Balanced scorecard, 339
Bankruptcy formula, 371
Bankruptcy, 219
Bargaining power of buyers, 112
Bargaining power of suppliers, 113
Barrier, entry, 111
Basic R&D, 154
Behavior controls, 332
Behavior substitution, 350
Benchmarking, 344
Blind spot analysis, 133
Board of directors, 45
Board of directors, committees, 54
Board of directors, continuum, 46, 47
Board of directors, election, 53
Board of directors, evaluation of, 341
Board of directors, members, 48
Board of directors, nomination, 53
Board of directors, organization, 54
Board of directors, responsibilities, 45
Board of directors, staggered, 53
Books, electronic, 230
BOT concept (Build Operate Transfer), 214
SUBJECT INDEX
I-8 SUBJECT INDEX
Customer satisfaction, 318
Cycle of decline, 220
Decentralization, 294
Decision making, ethical, 79
Decision making modes, 25
Decision making, strategic, 25
Deculturation, 316
Dedicated transfer lines, 242
Defenders, 117
Defensive tactics, 194
Delphi technique, 124
Devil’s advocate, 257
Dialectical inquiry, 257
Differentiation, 186
Differentiation focus, 188
Differentiation strategy, 185
Dimensions of quality, 189
Directional strategy, 206, 207
Director of Corporate Development, 62
Director, lead, 54
Directors, affiliated, 49
Directors, family, 51
Directors, inside, 48
Directors, outside, 48
Directors, retired executive, 49
Discretionary responsibilities 73
Disk operating system (DOS), 180
Distinctive competencies, 138
Diverse workforce, 246
Diversification, concentric, 214
Diversification, conglomerate, 215
Diversification, related, 214
Diversification strategy, 208, 214
Diversification, unrelated, 215
Diversity, human, 161
Divestment, 219
Divisional structure, 147, 279, 282
Do everything strategy, 250
Dogs, 223
Downsizing, 308
Due care, 46
Durability, 140
Dynamic capabilities, 138, 191
Dynamic industry expert, 304
Dynamic pricing, 239
Earnings guidance, 349
Earnings per share (EPS), 332, 335
e-books, 230
Ecomagination, 2
Economic forces, 101
Economic responsibilities, 73
Economic Value Added (EVA), 338
Economics, transaction cost, 109
Economies of scale, 158
Economies of scope, 147, 158
EFAS (External Factors Analysis Summary)
Table, 126
Election of board members, 53
Flexible manufacturing, 158
Flexible manufacturing systems, 242
Follow the leader, 250
Follow-the-sun management, 247
Forecasting, 123
Forecasting techniques, 124
Forensic accounting, 364
Form 10-K, 366
Form 10-Q, 366
Form 14-A, 366
Formulation of strategy, 17
Forward integration, 208
Four-corner exercise, 133, 134
Fragmented industry, 114
Franchising, 212
Frankenfood, 104
Free cash flow, 336
Free-market capitalism, 80
Frogs in boiling water, 82
Frontal assault, 193
Full integration, 209
Functional strategy, 20, 236
Functional structure, 147, 281
GE business screen, 223
Generally Accepted Accounting Principles
(GAAP), 345, 371
Geographic-area structure, 295
Global industries, 115
Global MNC, 346
Global warming, 12, 340
Globalization, 8
Goal, 18
Goal displacement, 350
Golden rule, 85
Good will, 370
Governance system, 80, 81
Governance, corporate, 45, 56
Green-field development, 213
Greenwash, 4
Gross domestic product (GDP), 373
Group, strategic, 115
Growth, external, 216
Growth, horizontal, 211
Growth, internal, 216
Growth strategies, 207
Growth strategies, controversies, 216
Growth, vertical, 208
Guerrilla warfare, 194
Guideline for decision making, 21
Guidelines for control, 351
Halal foods, 174
Hierarchy of strategy, 20
Historical comparisons, 344
Hit another home run, 250
Horizontal growth, 211
Horizontal integration, 211
Horizontal strategy, 228
Hubris, 61
Electric car, 222
Electronic books, 230
Employee stock ownership plans
(ESOP), 52
Encirclement, 194
Engineering (or process) R&D, 154
Enterprise Resource Planning (ERP), 347
Enterprise Risk Management (ERM), 335
Enterprise strategy, 76
Entrepreneurial mode, 26
Entry barrier, 111
Environment, natural, 99
Environment, societal, 100
Environment, task, 107
Environmental scanning, 16, 98
Environmental sustainability, 8, 75
Environmental uncertainty, 98
Environmental variables, 16
EPS (earnings per share), 349
Equilibrium, punctuated, 23
Ethical decision making, 79
Ethical responsibilities, 73
Ethics, 84
Ethics code, 83
Evaluating board of directors, 341
Evaluating top management, 341
Evaluation and control, 22
Evaluation and control process, 320
Evolution, industry, 114
Exclusive contract, 210
Excuses for bad service, 277
Executive leadership, 60
Executive succession, 305
Executive type, 304
Exit barriers, 112
Expatriate, 310
Expatriates, stealth, 311
Expense centers, 343
Experience curve, 157
Expert opinion, 124
Explicit knowledge, 141
Exporting, 211
External environment, 16
External growth, 216
External strategic factors, 109
Externalities, 99
Extranet, 162
Extrapolation, 124
Eyeballs, 336
Family directors, 51
Financial analysis, 366, 369
Financial expert, 55
Financial issues, 153
Financial leverage, 153
Financial measures, 335
Financial statements, 369
Financial strategy, 239
First mover, 193
Flanking maneuver, 194
SUBJECT INDEX I-9
Islamic law (sharia), 105
ISO 9000 Standards Series, 333
ISO 14000 Standards Series, 333
Issues priority matrix, 109
Job characteristics model, 291
Job design, 290
Job enlargement, 290
Job enrichment, 290
Job rotation, 290, 307
Job shop, 156, 242
Joint venture, 197, 212
Justice approach, 85
Just-In-Time (JIT), 243, 244
Keiretsu, 52
Keirsey Temperament Sorter, 323
Key performance measures, 339
Key success factors, 118
KFC, 31
Knowledge, explicit, 141
Knowledge, tacit, 141
Laissez-faire, 72
Late movers, 193
Law, 84
Lead director, 54
Leaders, transformational, 60
Leadership, executive, 60
Leading, 311
Leading, international, 319
Lean Six Sigma, 274, 290
Learning organization, 13
Legal responsibilities, 73
Levels of moral development, 83
Leverage ratios, 366
Leverage, financial, 153
Leverage, operating, 157
Leveraged buyout, 240
Licensing, 212
Licensing arrangement, 198
Line extensions, 236
Liquidation, 220
Liquidity ratios, 366
Logical incrementalism, 26
Logistics strategy, 246
Long-range plans, 17
Long-term contracts, 210
Long-term evaluation method, 352
Long-term orientation (LT), 320
Losing hand, 251
Lower cost strategy, 185
Management audits, 341
Management Buy Outs, 240
Management By Objectives (MBO),
318, 320
Management contracts, 214
Management directors, 48
Management tool, 7
Manual typewriters, 223
Manufacturing, flexible, 158
Market development, 236
Market development strategy, 236
Market location tactic, 193
Market position, 151
Market segmentation, 151
Market Value Added (MVA), 338
Marketing issues, 151
Marketing mix, 151
Marketing strategy, 236
Masculinity-femininity (M-F), 320
Mass customization, 158, 244
Mass production, 242
Matrix, BCG growth share, 221
Matrix, industry, 119
Matrix of change, 274, 275, 276
Matrix, SFAS, 176
Matrix structure, 285, 286
Matrix, TOWS, 182
Measurement problems, 348
Measures of corporate performance, 335
Measures of divisional and functional
performance, 342
Measures, financial, 335
Measures, international, 344
Measures, key performance, 339
Measures, stakeholder, 337
Measuring performance, 332
Merger, 207
Mindshare, 336
Mission, 17, 181
Mission statement, 17, 18
MNC, global, 346
MNC, multidomestic, 346
Model, business, 142
Modes of strategic decision making, 25
Modular manufacturing, 243
Modular structure, 288
Moore’s Law, 155
Moral development levels, 83
Moral relativism, 82
Morality, 84
Most favored nation, 103
Muddling through, 26
Multidomestic industries, 114
Multidomestic MNC, 345, 346
Multinational Corporation (MNC), 105, 291
Multinational corporation, global, 292
Multinational corporation,
multidomestic, 292
Multiple sourcing, 244
Multipoint competition, 228
Mutual service consortium, 197
MUUs (monthly unique users), 336
Natural environment, 99
Net present value (NPV), 254
Network structure, 287
New entrants, 111
Human assets, 138
Human diversity, 161
Human resource issues, 158
Human Resource Management (HRM)
strategy, 246
Hurdle rate, 22, 153
Hypercompetition, 117, 191
IFAS (Internal Factor Analysis Summary)
Table, 164
Imitability, 140
Implementation of strategy, 21
Incentives, strategic, 352
Index of sustainable growth, 372
Individual rights approach, 85
Individualism-collectivism (I-C), 319
Industries, global
Industries, multidomestic
Industries, regional, 115
Industry, 109
Industry analysis, 99, 110
Industry evolution, 114
Industry matrix, 119
Industry scenario, 125, 252
Industry value-chain analysis, 145
Information systems, strategic, 347
Information technology issues, 162
Information technology strategy, 247
Input controls, 333
Inside directors, 48
Institution theory, 13
Institutional investors, 57
Intangible assets, 138
Integration, 315
Integration, backward, 208
Integration, forward, 208
Integration, full, 209
Integration, horizontal, 211
Integration manager, 303
Integration, quasi, 209
Integration, taper, 209
Integration, vertical, 208
Intelligence, competitive, 120
Interlocking directorate, 52
Interlocking directorate, direct, 52
Interlocking directorate, indirect, 52
Intermittent systems, 156
Internal environment, 16
Internal growth, 216
International entry options, 211
International Financial Reporting
Standards(IFRS), 345
International measurement, 344
International societal considerations, 105
International strategic alliances, 292
International transfer pricing, 345
Intranet, 162
Inventory turnover ratio, 332
Investment centers, 343
Investors, institutional, 57
I-10 SUBJECT INDEX
Niche, propitious, 177
No-change strategy, 217
Nomination of board members, 53
Non-management directors, 48
Northern Sea Route, 96
Northwest Passage, 94
Objectives, 18, 181
Offensive tactics, 193
Offshoring, 248
Open innovation, 241
Operating budgets, 342
Operating cash flow, 336
Operating leverage, 157
Operational planning, 21
Operations issues, 156
Operations strategy, 242
Organization slack, 208
Organizational learning theory, 13
Organizational life cycle, 283
Organizational structures, 147, 285
Other stakeholders, 113
Output controls, 332
Outside directors, 48
Outsourcing, 211, 213, 247
Outsourcing matrix, 250
Parallel sourcing, 245
Parenting, corporate, 226
Parenting strategy, 206
Pascal’s wager, 11
Pause/proceed-with-caution strategy, 217
Penetration pricing, 239
PepsiCo, 314
Performance, 22, 332
Performance appraisal system, 307
Performance, corporate, 335
Performance, divisional, 342
Performance evaluations, 341
Performance, functional, 342
Performance gap, 24
Performance, key measures, 339
Periodic statistical reports, 342
PESTEL analysis, 101
Phases of strategic management, 5
Pioneer, 193
Pirated software, 346
Planning mode, 26
Planning, operational, 21
Plans, long-range, 17
Policies, 21, 258
Policy, 21
Political-legal forces, 102
Political strategy, 255
Pooling method, 370
Population ecology, 12, 13
Portfolio analysis, 206, 220
Portfolio analysis, advantages/
disadvantages, 225
Portfolio analysis, strategic alliances, 225
Retaliation, 195
Retired executive directors, 49
Retrenchment, 308
Retrenchment strategies, 207, 218
Return On Equity (ROE), 336
Return On Investment (ROI), 332, 335, 336,
343, 344, 345, 349
Revenue centers, 343
Reverse engineering, 140
Reverse logistics, 166
Reverse stock splits, 240
Revival phase, 284
Rightsizing, 308
Risk, 253
Risks in competitive strategies, 188
Rivalry, 111
Rivalry among existing firms, 111
ROE (Return on Equity), 336
ROI (Return on Investment), 335
Role of the board of directors, 46
Rules of thumb, 351
Sarbanes-Oxley Act, 55
SBUs, 282, 352
Scenario analysis, 335
Scenario box, 252
Scenario, industry, 125
Scenario writing, 125
Scorecard, balanced, 339
SEC 10-K form, 366
SEC 10-Q forms, 366
SEC 14-A forms, 366
Self-managing work teams, 246
Sell-out strategy, 219
Separation, 316
SFAS (Strategic Factors Analysis Summary)
Matrix, 176
Shareholder, 45
Shareholder value, 337
Short-term orientation, 349
Simple structure, 147, 280
Situational analysis, 176
Six Sigma, 4, 274, 289
Skim pricing, 239
Social capital, 74
Social responsibility, 72
Societal environment, 99, 100, 101
Societal environment, international, 105
Sociocultural forces, 103
Sole sourcing, 244
Sourcing, 247
Stability strategies, 207, 217
Staff, strategic planning, 62
Staffing, 302
Staffing follows strategy, 303
Staffing, international, 309
Stages of corporate development, 280
Stages of international development, 293
Staggered board, 53
Stakeholder analysis 75
Power distance (PD), 319
Prediction markets, 124
Pressure-cooker crisis, 283
Pricing, dynamic, 239
Pricing, penetration, 239
Pricing, skim, 239
Prime interest rate, 372
Problem children, 222
Procedures, 22, 276
Product development, 236
Product development strategy, 236
Product life cycle, 152
Product R&D, 154
Product-group structure, 295
Production sharing, 213
Professional liquidator, 304
Profit centers, 343
Profit strategy, 218
Profitability ratios, 366
Profits, repatriation of, 345
Program, 21, 274
Propitious niche, 177, 181
Prospectors, 117
Pull strategy, 239
Punctuated equilibrium, 23
Purchasing power parity (PPP), 107
Push strategy, 239
Quality circles, 320
Quality dimensions, 189
Quality of Work, 160
Quasi-integration, 209
Question marks, 222
R&D intensity, 154
R&D issues, 154
R&D mix, 154
R&D strategy, 241
Radio frequency identification (RFID),
163, 348
Ratio analysis, 366
Reactors, 117
Real-options approach, 254
Red flag, 364
Red tape crisis, 282
Reengineering, 288
Regional industries, 115
Related diversification, 214
Relativism, moral, 82
Repatriation of profits, 100, 345
Replicability, 141
Report, annual, 366
Reputation, corporate, 152
Resizing, 308
Resource-based approach, 138
Resources, 138
Resources for Case Research, 377
Responsibilities, boards of directors, 45
Responsibilities of a business, 72, 73
Responsibilities, top management, 58
SUBJECT INDEX I-11
Strategy-culture compatibility, 312
Strategy, diversification, 214
Strategy, enterprise, 76
Strategy formulation, 17, 176
Strategy, functional, 20
Strategy, hierarchy, 20
Strategy, horizontal, 228
Strategy implementation, 221, 72, 274
Strategy, political, 255
Structural barriers, 194
Structure, cellular, 288
Structure, divisional, 282
Structure follows strategy, 279
Structure, functional, 281
Structure, geographic-area, 295
Structure, matrix, 285
Structure, modular, 288
Structure, network, 287
Structure, product-group, 295
Structure, simple, 280
Structures, organizational, 147, 285
Stuck in the middle, 189, 266
Suboptimization, 350
Substitute product, 112
Suppliers, bargaining power, 113
Supply chain management, 163
Sustainability continuum, 141
Sustainability, 75, 140
Sustainability, environmental, 8, 75
Sustainability index, 76
Sustainable growth, index of, 371
Sweet spot, strategic, 177
Switching costs, 111
SWOT analysis, 16, 176
Synergy, 214, 278
Synergy Game, 296
Tacit knowledge, 141
Tactic, 192
Tactics, timing, 193
Tactics, competitive, 192
Tactics, defensive, 194
Tactics, market location, 193
Tactics, offensive, 193
Take rate, 348
Takeovers, 208
Tangible assets, 138
Taper integration, 209
Task environment, 99, 107
Teams, 158, 159
Technological competence, 154
Technological discontinuity, 155
Technological follower, 241
Technological forces, 102
Technological leader, 241
Technology scouts, 242
Technology transfer, 154
Temporary/part-time workers, 159
Theories of organizational adaptation, 12
Threat of new entrants, 111
Threat of substitutes 112
Timing tactic, 193
Top management, 45
Top management responsibilities, 58
Top management, evaluation of, 341
Total Quality Management (TQM), 318, 320
TOWS Matrix, 182
Trade associations, 9
Transaction cost economics, 209, 210
Transfer pricing, 343
Transfer pricing, international, 345
Transferability, 140
Transformational leaders, 60
Transparency, 140
Trends in corporate governance, 57
Trigger point, 106, 107
Triggering event, 24
Turnaround specialist, 304
Turnaround strategy, 218
Turnkey operations, 213
Turnover, 371
Types, strategic, 117
Typewriters, manual, 223
Uncertainty avoidance (UA), 319
Union relations, 159
Unrelated diversification, 215
Utilitarian approach, 85
Valuation, corporate, 340
Value Added, economic, 338
Value added, market, 338
Value chain, 143
Value discipline triad, 135
Value disciplines, 133
Value, shareholder, 337
Value-chain analysis, 143
Value-chain, corporate, 146
Value-chain, industry, 145
Value-chain partnership, 198
Values statement, 17
Vertical growth 210
Vertical growth strategy, 208
Vertical integration, 145, 208, 210
Virtual organization, 287
Virtual teams, 159
Vision, 17
Vision, strategic, 60
VRIO framework, 138
War game, 134
Web 2.0, 162, 230
Weighted-factor method, 352
Whistleblowers, 55, 84
Wildcats, 222
Z-Value Bankruptcy Formula, 371
Stakeholder measures, 337
Stakeholder priority matrix, 255
Stakeholder, primary, 77
Stakeholder, secondary, 77
Stakeholders, 75
Stall point, 270
Standard cost centers, 342
Standard Operating Procedure (SOP),
22, 276
Star employee, 322
Stars, 222
Statistical modeling, 124
Stealth expatriates, 311
STEEP analysis, 100, 101
Steering controls, 332
Stewardship theory, 49, 50
Stickiness, 336
Strategic alliance portfolio, 225
Strategic alliance, 196
Strategic alliances, international, 292
Strategic audit, 28, 34, 125, 163, 342, 373
Strategic audit, student-written, 383
Strategic audit worksheet, 373, 374
Strategic business units (SBUs), 148
Strategic choice, 257
Strategic choice perspective, 13
Strategic decision making, 25
Strategic decision-making process, 27, 28
Strategic decisions, 25
Strategic factors, 16, 109, 177
Strategic flexibility, 13
Strategic-funds method, 353
Strategic group, 115
Strategic incentive management, 352
Strategic inflection point, 24
Strategic information systems, 347
Strategic management benefits, 6
Strategic management model, 15
Strategic management phases, 5
Strategic management process, 15
Strategic management, 5
Strategic myopia, 108
Strategic planning process, 61
Strategic planning staff, 62
Strategic posture, 34
Strategic rollup, 190
Strategic sweet spot, 177, 180
Strategic type, 117
Strategic vision, 60
Strategic window, 179
Strategies to avoid, 250
Strategies, growth, 207
Strategies, retrenchment, 218
Strategies, stability, 217
Strategy, 19
Strategy, business, 19, 183
Strategy, competitive, 183
Strategy, concentration, 208
Strategy, cooperative, 195
Strategy, corporate, 19
Cover
Half-Title Page
Title Page
Copyright Page
Dedication Page
Brief Contents
Contents
Preface
About the Contributors
Acknowledgments
PART ONE: Introduction to Strategic Management and Business Policy
CHAPTER 1 Basic Concepts of Strategic Management
1.1 The Study of Strategic Management
1.2 Globalization and Environmental Sustainability: Challenges to Strategic Management
Global Issue: REGIONAL TRADE ASSOCIATIONS REPLACE NATIONAL TRADE BARRIERS
Environmental Sustainability Issue: PROJECTED EFFECTS OF CLIMATE CHANGE
1.3 Theories of Organizational Adaptation
1.4 Creating a Learning Organization
1.5 Basic Model of Strategic Management
Strategy Highlight 1.1: DO YOU HAVE A GOOD MISSION STATEMENT?
1.6 Initiation of Strategy: Triggering Events
Strategy Highlight 1.2: TRIGGERING EVENT AT UNILEVER
1.7 Strategic Decision Making
1.8 The Strategic Audit: Aid to Strategic Decision-Making
1.9 End of Chapter Summary
APPENDIX 1.A: Strategic Audit of a Corporation
CHAPTER 2 Corporate Governance
2.1 Role of the Board of Directors
Strategy Highlight 2.1: AGENCY THEORY VERSUS STEWARDSHIP THEORY IN CORPORATE GOVERNANCE
Global Issue: CORPORATE GOVERNANCE IMPROVEMENTS THROUGHOUT THE WORLD
2.2 The Role of Top Management
Environmental Sustainability Issue: CONFLICT AT THE BODY SHOP
2.3 End of Chapter Summary
CHAPTER 3 Social Responsibility and Ethics in Strategic Management
3.1 Social Responsibilities of Strategic Decision Makers
Environmental Sustainability Issue: THE DOW JONES SUSTAINABILITY INDEX
Strategy Highlight 3.1: JOHNSON & JOHNSON CREDO
3.2 Ethical Decision Making
Strategy Highlight 3.2: UNETHICAL PRACTICES AT ENRON AND WORLDCOM EXPOSED BY “WHISTLE-BLOWERS”
Global Issue: HOW RULE-BASED AND RELATIONSHIP-BASED GOVERNANCE SYSTEMS AFFECT ETHICAL BEHAVIOR
3.3 End of Chapter Summary
Ending Case for Part One: BLOOD BANANAS
PART TWO: Scanning the Environment
CHAPTER 4 Environmental Scanning and Industry Analysis
4.1 Environmental Scanning
Environmental Sustainability Issue: MEASURING AND SHRINKING YOUR PERSONAL CARBON FOOTPRINT
Global Issue: IDENTIFYING POTENTIAL MARKETS IN DEVELOPING NATIONS
4.2 Industry Analysis: Analyzing the Task Environment
Strategy Highlight 4.1: MICROSOFT IN A HYPERCOMPETITIVE INDUSTRY
4.3 Competitive Intelligence
Strategy Highlight 4.2: EVALUATING COMPETITIVE INTELLIGENCE
4.4 Forecasting
4.5 The Strategic Audit: A Checklist for Environmental Scanning
4.6 Synthesis of External Factors—EFAS
4.7 End of Chapter Summary
APPENDIX 4.A: Competitive Analysis Techniques
CHAPTER 5 Internal Scanning: Organizational Analysis
5.1 A Resource-Based Approach to Organizational Analysis
5.2 Business Models
5.3 Value-Chain Analysis
Strategy Highlight 5.1: A NEW BUSINESS MODEL AT SMARTYPIG
5.4 Scanning Functional Resources and Capabilities
Global Issue: MANAGING CORPORATE CULTURE FOR GLOBAL COMPETITIVE ADVANTAGE: ABB VERSUS MATSUSHITA
Environmental Sustainability Issue: USING ENERGY EFFICIENCY FOR COMPETITIVE ADVANTAGE AND QUALITY OF WORK LIFE
5.5 The Strategic Audit: A Checklist for Organizational Analysis
5.6 Synthesis of Internal Factors
5.7 End of Chapter Summary
Ending Case for Part Two: BOEING BETS THE COMPANY
PART THREE: Strategy Formulation
CHAPTER 6 Strategy Formulation: Situation Analysis and Business Strategy
6.1 Situation Analysis: SWOT Analysis
Global Issue: SAB DEFENDS ITS PROPITIOUS NICHE
6.2 Review of Mission and Objectives
6.3 Generating Alternative Strategies by Using a TOWS Matrix
6.4 Business Strategies
Environmental Sustainability Issue: PATAGONIA USES SUSTAINABILITY AS DIFFERENTIATION COMPETITIVE STRATEGY
6.5 End of Chapter Summary
CHAPTER 7 Strategy Formulation: Corporate Strategy
7.1 Corporate Strategy
7.2 Directional Strategy
Strategy Highlight 7.1: TRANSACTION COST ECONOMICS ANALYZES VERTICAL GROWTH STRATEGY
Global Issue: COMPANIES
Strategy Highlight 7.2: SCREENING CRITERIA FOR CONCENTRIC DIVERSIFICATION
7.3 Portfolio Analysis
Environmental Sustainability Issue: GENERAL MOTORS AND THE ELECTRIC CAR
7.4 Corporate Parenting
7.5 End of Chapter Summary
CHAPTER 8 Strategy Formulation: Functional Strategy and Strategic Choice
8.1 Functional Strategy
Global Issue: INTERNATIONAL DIFFERENCES ALTER WHIRLPOOL’S OPERATIONS STRATEGY
Environmental Sustainability Issue: OPERATIONS NEED FRESH WATER AND LOTS OF IT!
8.2 The Sourcing Decision: Location of Functions
8.3 Strategies to Avoid
8.4 Strategic Choice: Selecting the Best Strategy
8.5 Developing Policies
8.6 End of Chapter Summary
Ending Case for Part Three: KMART AND SEARS: STILL STUCK IN THE MIDDLE?
PART FOUR: Strategy Implementation and Control
CHAPTER 9 Strategy Implementation: Organizing for Action
9.1 Strategy Implementation
9.2 Who Implements Strategy?
9.3 What Must Be Done?
Environmental Sustainability Issue: FORD’S SOYBEAN SEAT FOAM PROGRAM
Strategy Highlight 9.1: THE TOP TEN EXCUSES FOR BAD SERVICE
9.4 How Is Strategy to Be Implemented? Organizing for Action
Strategy Highlight 9.2: DESIGNING JOBS WITH THE JOB CHARACTERISTICS MODEL
9.5 International Issues in Strategy Implementation
Global Issue: MULTIPLE HEADQUARTERS: A SIXTH STAGE OF INTERNATIONAL DEVELOPMENT?
9.6 End of Chapter Summary
CHAPTER 10 Strategy Implementation: Staffing and Directing
10.1 Staffing
Strategy Highlight 10.1: HOW HEWLETT-PACKARD IDENTIFIES POTENTIAL EXECUTIVES
10.2 Leading
Environmental Sustainability Issue: ABBOTT LABORATORIES’ NEW PROCEDURES FOR GREENER COMPANY CARS
Global Issue: CULTURAL DIFFERENCES CREATE IMPLEMENTATION PROBLEMS IN MERGER
10.3 End of Chapter Summary
CHAPTER 11 Evaluation and Control
11.1 Evaluation and Control in Strategic Management
11.2 Measuring Performance
Environmental Sustainability Issue: HOW GLOBAL WARMING COULD AFFECT CORPORATE VALUATION
Global Issue: COUNTERFEIT GOODS AND PIRATED SOFTWARE: A GLOBAL PROBLEM
11.3 Strategic Information Systems
11.4 Problems in Measuring Performance
11.5 Guidelines for Proper Control
Strategy Highlight 11.1: SOME RULES OF THUMB IN STRATEGY
11.6 Strategic Incentive Management
11.7 End of Chapter Summary
Ending Case for Part Four: HEWLETT-PACKARD BUYS EDS
PART FIVE: Introduction to Case Analysis
CHAPTER 12 Suggestions for Case Analysis
12.1 The Case Method
12.2 Researching the Case Situation
12.3 Financial Analysis: A Place to Begin
Environmental Sustainability Issue: IMPACT OF CARBON TRADING
Global Issue: FINANCIAL STATEMENTS OF MULTINATIONAL CORPORATIONS: NOT ALWAYS WHAT THEY SEEM
12.4 Format for Case Analysis: The Strategic Audit
12.5 End of Chapter Summary
APPENDIX 12.A: Resources for Case Research
APPENDIX 12.B: Suggested Case Analysis Methodology Using the Strategic Audit
APPENDIX 12.C: Example of a Student-Written Strategic Audit
Ending Case for Part Five: IN THE GARDEN
GLOSSARY
A
B
C
D
E
F
G
H
I
J
K
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NAME INDEX
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SUBJECT INDEX
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PART SEVEN: Cases in Strategic Management
SECTION A: Corporate Governance and Social Responsibility: Executive Leadership
CASE 1 The Recalcitrant Director at Byte Products Inc.: Corporate Legality versus Corporate Responsibility
CASE 2 The Wallace Group
SECTION B: Business Ethics
CASE 3 Everyone Does It
CASE 4 The Audit
SECTION C: International Issues in Strategic Management
CASE 5 Starbucks’ Coffee Company: The Indian Dilemma
CASE 6 Guajilote Cooperativo Forestal: Honduras
SECTION D: General Issues in Strategic Management
INDUSTRY ONE: Information Technology
CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy
CASE 8 iRobot: Finding the Right Market Mix?
CASE 9 Dell Inc.: Changing the Business Model (Mini Case)
CASE 10 Rosetta Stone Inc.: Changing the Way People Learn Languages
CASE 11 Logitech (Mini Case)
INDUSTRY TWO: INTERNET COMPANIES
CASE 12 Google Inc. (2010): The Future of the Internet Search Engine
CASE 13 Reorganizing Yahoo!
INDUSTRY THREE: ENTERTAINMENT AND LEISURE
CASE 14 TiVo Inc.: TiVo vs. Cable and Satellite DVR: Can TiVo survive?
CASE 15 Marvel Entertainment Inc.
CASE 16 Carnival Corporation and plc (2010)
INDUSTRY FOUR: TRANSPORTATION
CASE 17 Chrysler in Trouble
CASE 18 Tesla Motors Inc. (Mini Case)
CASE 19 Harley-Davidson Inc. 2008: Thriving through a Recession
CASE 20 JetBlue Airways: Growing Pains?
CASE 21 TomTom: New Competition Everywhere!
INDUSTRY FIVE: CLOTHING
CASE 22 Volcom Inc.: Riding the Wave
CASE 23 TOMS Shoes (Mini Case)
INDUSTRY SIX : SPECIALTY RETAILING
CASE 24 Best Buy Co. Inc.: Sustainable Customer Centricity Model?
CASE 25 The Future of Gap Inc.
CASE 26 Rocky Mountain Chocolate Factory Inc. (2008)
CASE 27 Dollar General Corporation (Mini Case)
INDUSTRY SEVEN: MANUFACTURING
CASE 28 Inner-City Paint Corporation (Revised)
CASE 29 The Carey Plant
INDUSTRY EIGHT: FOOD AND BEVERAGE
CASE 30 The Boston Beer Company: Brewers of Samuel Adams Boston Lager (Mini Case)
CASE 31 Wal-Mart and Vlasic Pickles
CASE 32 Panera Bread Company (2010): Still Rising Fortunes?
CASE 33 Whole Foods Market (2010): How to Grow in an Increasingly Competitive Market? (Mini Case)
CASE 34 Burger King (Mini Case)
CASE 35 Church & Dwight: Time to Rethink the Portfolio?
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