Provides a comprehensive and detailed Internal Resources & Capabilities Analysis which is linked to and supportive of the options presented.
1.
Summer 2020 Florence Tarrant
MGMT 4001 Dalhousie University
Table of Contents
EADS/Airbus: Vision 2020................................................................................................................5
OrganiGram: Navigating the Cannabis Industry with Grey Knowledge..........................................25
Big Boss Cement Inc.: Stirring Up Industry Competition in the Philippines....................................35
Strong Tie Ltd.................................................................................................................................45
Hillberg & Berk: Aiming to Sparkle in the Designer Jewellery Business.........................................51
Wooden Bakery: Should It Enter the U.S. Market?.........................................................................61
Product Portfolio Planning at Estonia's Saku Brewery...................................................................75
Brooks Sports: Competing against the Giants................................................................................97
Top Cloud-Agri Technology Co., Ltd.: Digital Business Model....................................................113
Summer 2020 MGMT 4001
Florence Tarrant Dalhousie University
2.
9B14M028
EADS/AIRBUS: VISION 20201
Rosi Ji, Thorsten Knauer, Momo Schäfer, Friedrich Sommer and Jil Wehlmann wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com. Copyright © 2014, Richard Ivey School of Business Foundation Version: 2014-05-02
On December 5, 2012, EADS announced to the media the upcoming changes to its shareholding structure and governance.2 But despite EADS’s success in reducing governmental influence on its management, the firm continued to face problems and challenges that needed further consideration. The planned merger with BAE Systems, which had failed only two months earlier, had delayed EADS’s goal of becoming the world’s biggest aerospace and defence company.3 Thus, the chief executive officer (CEO), Tom Enders, and the management team needed to determine the company’s next steps to pursue this goal of becoming the worldwide leader in air and space platforms and systems. In the course of pursuing this goal, EADS’s management had already worked out a program called Vision 2020, which defined the company’s challenges, responsibilities and strategic goals. But was this program still feasible? Would it be enough? Airbus played a critical role in EADS’s business.4 With its contribution of two-thirds of the company’s revenue in the past year, Airbus had functioned as EADS’s primary source of success. The firm’s high dependency on that revenue seemed to increase the impact that might result from the current production issues at Airbus.5 Additionally, Eurocopter had also been facing production and quality issues.6 As if these problems were not enough, Enders also needed to consider the current corruption investigation, which once again (as it did after the 2007 corruption scandal) was casting a shadow over the defence industry.7 ABOUT EADS N.V. Historical Background The idea of an integrated European aerospace company began in the 1990s and was intended as a response to the consolidation process taking place in the U.S. aerospace industry.8 European governments and defence-industry executives agreed that a fragmented European aerospace industry could no longer be competitive in the world market.9 The international merger plan started with the intention by the four “Airbus countries” — France, Germany, Spain and Great Britain — to form the integrated European Aerospace and Defence Company (EADC).10 The integration of Airbus’s production activities into one independent Airbus company was
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Page 2 9B14M028 seen as a first step toward the merger. However, when the individual countries focused on their national consolidation strategies, the goal of an international aerospace company was temporarily set aside. When the defence arm of General Electric Corporation in the United States was put up for sale in December 1998, British Aerospace plc (BAE) decided against a planned merger with German DaimlerChrysler Aerospace AG11 (DASA) and instead merged with the defence arm of General Electric Corporation to form BAE Systems in January 1999. Shortly afterward, representatives of Germany and France started the negotiations that led to the signing of an agreement to merge DASA and the French Aérospatiale-Matra in October 1999. The merger was joined by Spanish Construcciones Aeronáuticas S.A. (CASA) in December 1999, and the merger formation process continued until it was finalized in February 2000, with the official merger occurring July 10, 2000, launching the European Aeronautic Defence and Space Company (EADS). Since that time, EADS N.V.12 had become the world’s second largest aerospace company with revenues of €49.1 billion in 2011 and more than 130,000 employees in 47 countries around the world.13 Business Segments EADS united four major companies: Airbus, Astrium, Cassidian and Eurocopter, which enabled it to be active in the fields of aeronautics, space, defence and security.14 Airbus Airbus was founded in 1970 under the name Airbus Industries, as a temporary consortium of European aviation companies from Germany, France, Spain and Great Britain.15 The consortium was formed with the aim of competing with large U.S. aircraft manufacturers, such as Boeing and Lockheed Martin. Although Airbus Industries’ business situation improved after several difficult years, the situation continued to remain complicated. Aircraft development and manufacture was a money-consuming business; moreover, the involvement of different companies and countries and the resulting conflicts led to inefficiencies and delays in the company’s production process, making business even more costly. In the 1990s, the involved governments faced high unemployment rates and therefore needed to reduce their spending in the companies. Although the integration of the company’s production activities into one independent company failed in its first attempt, the situation was simplified by the formation of EADS, which merged three of the four partner Airbus Industries’ companies. After the merger, EADS owned 80 per cent of Airbus. The transfer of the production assets of BAE Systems in return for 20 per cent of shares led to the newly formed company, Airbus SAS — an EADS joint company with BAE Systems. After EADS bought BAE’s shares in July 2006 for €2.75 billion, Airbus became a fully owned EADS subsidiary. By 2012, Airbus was a leading manufacturer of commercial and military transport aircraft, and its revenues of €33.1 billion in 2011 made it EADS’s largest division. Airbus’s commercial planes varied from the 100-seat single-aisle A318 to the largest airplane worldwide, the more than 500-seat A380. At that time, Airbus covered almost half of all commercial aircraft orders worldwide. Airbus’s military division, with attributable revenue of €2.5billion in 2011, offered tanker, transport and mission aircraft.16 Although revenues and orders had both been high over the past few years, Airbus continued to face serious problems.17 The production of the A380 was delayed due to issues with the wiring inside the aircraft and with the software used by different production facilities.18 These problems had caused a two- year delay for delivery of the first aircraft, leading to a rapid decline in EADS’s share prices in June 2006. Additionally, production and development costs had grown to €11 billion from the planned €8.8 billion.
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Page 3 9B14M028 The problems, unfortunately, did not end with delivery of the A380. In January 2012, cracks were discovered on the wings of an A380, leading to a detailed visual inspection and repair costs of €105 million, which, it was announced, would be borne by Airbus.19 Astrium Astrium resulted in May 2000 from the fusion of the Franco-British company Matra-Marconi Space, DASA’s space division, Dornier Satellitensysteme GmbH,20 and the Space Infrastructure unit.21 It was a wholly owned subsidiary of EADS, with three main fields of activity: Astrium Space Transportation, Astrium Satellites and Astrium Services. In 2011, Astrium employed approximately 18,000 people in five countries and generated revenues of €5.0 billion, making it the leading European space company and number three worldwide. Astrium’s main growth drivers were services, export and institutional business. Its key profit drivers were services growth and cost efficiencies.22 Cassidian Cassidian was the defence and security division of EADS, offering solutions for armed forces and private securities under the mission statement: “We support the people whose mission is to protect the world.”23 In 2011, Cassidian achieved revenues of €5.8 billion and had approximately 28,000 employees in 23 countries.24 Cassidian’s most popular product was the Eurofighter, a twin-engine multi-role combat aircraft. It had been developed and produced by a consortium of EADS, BAE and Alenia Aermacchi (Italy), in which EADS held the greatest share (46 per cent), with Cassidian as the responsible division.25 The key growth drivers of the Cassidian division were its focus on profitable products and further cost- reduction measures. Eurocopter Eurocopter was the fourth division of EADS and the world’s leading helicopter manufacturer in the civil sector with a wide product range in civilian and military products.26 It was formed in 1992 through an international merger of the helicopter divisions of Aerospatiale-Matra (France) and DaimlerChrysler Aerospace (Germany).27 Through successive integration, Eurocopter had become Europe’s leading fully integrated aeronautical group.28 In 2011, the company achieved revenues of €5.4 billion and employed more than 20,000 people around the world.29 Although Eurocopter’s turnover had steadily grown over the past few years, the company had recently faced some problems.30 For example, shortly after the discovery of cracks in the wings of the Airbus A380, Eurocopter also discovered cracks in the rotors of its EC135 and the military version, EC635, in May 2012. In June 2012, six employees of Eurocopter died during a test flight of a new Cougar AS532 AL in the French Alps. In addition, Eurocopter had dealt with safety issues related to its civilian helicopter Puma EC225. After emergency landings in May, October and November 2012, the problem was located in the main gearbox vertical shaft, and fixing it took approximately three months.31 With the Puma being the most used helicopter for the supply to oil and gas platforms, Eurocopter also faced an image problem as a consequence. For Eurocopter, the key growth drivers were commercial demand and services; its key profit drivers were production ramp-up and services.32
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Page 4 9B14M028 Financials The 2009 economic and financial crisis hit EADS hard. Nevertheless, financial development was satisfactory in the following years because EADS recovered well, even overachieving its goals. The company’s past financial statements can be found in Exhibit 1. EADS management was satisfied that during the first nine months of 2012 the performance improvement trend was confirmed, and the targeted numbers were mainly achieved.33 In spite of such good reviews, however, management could not ignore that, in 2012, for the first time in 10 years, Boeing raced past Airbus in commercial performance.34 Revenues were especially influenced by Airbus, contributing around two-thirds of EADS’s total revenues, which left the group vulnerable to the fluctuations of the civil-aviation market (see financial development of EADS Group and the business segments in Exhibit 2). In line with the positive financial development and the market recovery, the ratings of EADS rose again (see Exhibit 3). BUSINESS ENVIRONMENT The Industry EADS benefited from an increased need for mobility resulting in annual growth rates of 5 per cent in air traffic. In 2011, the world was affected by a barrage of shocks, such as the Japanese earthquake and tsunami and the Eurozone’s financial turbulence. As a consequence, global economic growth, one of the key drivers for air traffic, slowed in 2011.35 The growth in global gross domestic product (GDP) was highly correlated with air traffic growth rates, measured in available seat kilometres. Additionally, air traffic had proven remarkably resilient to external shocks in the previous few decades. Despite the 9/11 attack, SARS,36 and the financial crisis, worldwide annual air traffic had increased by 53 per cent since 2000. In the long term, the highest growth potential for air traffic would exist in the emerging markets. In 2010, Brazil, Russia, India and China accounted for 69 per cent of the world’s population, and from 2011 to 2030, these countries were forecast to generate 56 per cent of the world’s economic growth.37 The National Intelligence Council (NIC) predicted that Brazil, Russia, India and China would collectively match the original G-7’s share of global GDP by 2040—2050.38 Similarly, defence spending grew in such regions as South America (+5.8 per cent), the Middle East (+2.5 per cent) and Oceania (+1.4 per cent), whereas defence expenditures had declined in the United States and Europe.39 Additionally, a gap was widening between the United States and Europe.40 The United States spent twice as much as Europe on military equipment and six times as much on its military research and development (R&D) in 2010, representing 43 per cent of the world’s defence spending. Emerging markets not only stimulated the economy but they could also lead to increased competition. As emerging countries built up their local industries, competition would increase in the fields of airlines and aircraft manufacturing. China, Brazil and Russia were nurturing aircraft manufacturing industries with additional developmental progress in such countries as India, South Korea and Turkey.41 Enders offered a prediction as to which nation would be able to produce a competitor for EADS: “The entry barriers to building large commercial aircraft are high, but if one country has the financial and industrial wherewithal to join the exclusive Airbus-Boeing club, it’s China.”42 Louis Gallois, the former CEO of EADS, predicted that manufacturers from China, Russia, Canada and Brazil would eventually break the large commercial aircraft manufacturing duopoly between Airbus and Boeing.43 Entry barriers to the commercial aircraft manufacturing industry primarily comprised capital intensiveness and essential technology.44 EADS’s biggest competitors were Boeing, Lockheed Martin, BAE Systems, Embraer and Bombardier (see Exhibit 4).
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Page 5 9B14M028 The commercial aircraft manufacturing market was dominated by Boeing and Airbus.45 All companies in this industry faced high fixed costs and high exit barriers.46 The airlines, which were the customers of aircraft manufacturers, were dependent on the aircraft manufacturers, as they had no other choice but to purchase commercial jets. As no viable substitute for air transportation existed, air transport was expected to remain the primary means of moving people over long distances.47 Because of the immense capital and production requirements and the necessary expertise in the military strike fighter aircraft market, the threat of new entrants was very low, whereas rivalry among competitors was extremely high. Indeed, governments were currently the only buyers, but, compared with the non- defence market, their relative bargaining power was reduced, mainly as a result of the aircraft sector’s political influence. Despite diminishing budgets in Europe and decreased spending in the United States, the global defence market was still expected to grow over the short term.48 Following the 2008 recession, order levels were rising again in the helicopter sector and were anticipated to grow strongly in the next couple of years.49 As relatively high energy prices were leading to exploration activity, the oil and gas sector was driving demand. Corporate and private helicopters served not only oil and gas exploration services but also offshore transport, emergency medical services and law enforcement operations. The United States and Europe accounted for 60 per cent of global demand in the commercial rotorcraft market, and China was expected to offer significant new opportunities, with the opening up of low-altitude airspace for civilian helicopter use.50 From 2011 to 2020, it was estimated that manufacturers would deliver 18,000 rotorcrafts worldwide, worth the equivalent of US$80 billion. The space industry was strongly driven by national interests and institutional activities. The European Space Agency (ESA) represented European interests. The European space industry generated 78 per cent of its revenues in Europe, whereas 22 per cent were generated through export. The industry had remained robust, despite increased competition in the launcher segment. Technological advances in satellite communications, satellite navigation and imaging had led to multiple innovations and new space-related service industries.51 Key Markets EADS’s market focus could be separated into three main geographical pillars: Europe, North America and the emerging markets. As a European company with its headquarters located in the Dutch city of Leiden, EADS generated 42 per cent of its revenues in Europe.52 As a result, EADS’s revenue was significantly supported both by European airlines, such as Lufthansa and Air France, which were two of Airbus’s major customers, and by Astrium’s and Cassidian’s strong market positions in the European countries. Immediately after recovering from the global economic crisis in 2011, the European economy was struck by the euro crisis, which led to a down-ranking of several European countries and thus, negatively affected growth predictions. Additionally, defence spending in Europe was declining, leading to a decrease in demand for defence products.53 The second key market for EADS was North America, home to Airbus’s biggest competitor, Boeing. Eurocopter was a leading supplier of civilian helicopters in the United States, and Airbus supplied several major U.S. airlines, leasing companies and private operators.54 Despite the economic crisis, the U.S. aerospace industry was able to increase its sales from US$209.9 billion to forecast sales of US$217.9 billion in 2012, demonstrating the strong market position of U.S. aerospace companies both within the United States and in its export business.55 Future development would be highly dependent on both fuel prices and the development of the U.S GDP. Additionally, growing competition as a result of aerospace
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Page 6 9B14M028 industry growth in emerging countries was expected to have a significant impact on future sales volumes.56 With its comparably high defence budgets, the U.S. market offered opportunities for defence suppliers worldwide, given their ability to enter U.S. markets through sufficient levels of trust and skill. The third geographical pillar of EADS’s market focus comprised the BRIC countries — Brazil, Russia, India and China. With their constantly growing economies, a rising demand for aircraft and helicopters and increases in defence spending, these emerging markets were growing in importance for EADS and other aerospace companies.57 India was of special strategic importance to EADS because of its booming domestic market for commercial aviation (in which Airbus had already claimed a 70 per cent market share), its significant market opportunities in the defence industry and its high standard of technological knowledge.58 Despite these opportunities, market entrants also needed to consider the extensive rules and conditions necessary for doing business in India. Because of China’s almost explosive growth, its aviation market had evolved into an important market not only for sales but also for production. China had an expected demand of 4,000 jetliners in the next 20 years and more than 1,000 civilian helicopters until 2018.59 Although the industry had been developing quickly in terms of production capacities and R&D, the Chinese market would be unable to meet this high demand on its own. Airbus used this knowledge when building its first assembly line outside of Europe in Tianjin, providing a significant number of jobs to Chinese workers. Brazil, as host of the upcoming Fédération Internationale de Football Association (International Federation of Football Association) (FIFA) World Cup in 2014 and the Olympic Games in 2016, would need to implement public safety programs, ensuring the availability of modern equipment for its state police force. In addition, the Brazilian aerospace industry offered several other market opportunities, such as further government programs in the security sector and an increasing demand for helicopters.60 The scientific tradition of Russia also had an impact on its aerospace industry. With Russia’s high focus on R&D, its aerospace industry was developing numerous new, state-of-the-art products.61 More information about EADS’s market presence in the BRIC countries is provided in Exhibit 5. Environment/Fuel Prices Companies in the aviation industry needed to contend not only with higher fuel prices but also with regulations on emissions, which were becoming stricter.62 Therefore, EADS’s innovative activity was focused on improving the fuel efficiency and environmental performance of its products and manufacturing plants. These improvements represented required conditions for EADS to stay competitive and to ensure its long-term growth in the aviation industry. Crude oil price volatility was airlines’ main challenge.63 During the second quarter of 2011, oil prices rose more than 25 per cent above January 2011’s prevailing levels. High fuel prices and regulations on emissions had driven demand for efficient new aircraft. In the medium term, fuel-efficient aircraft were expected to bring about the greatest improvement in eco-efficiency. In 2011, Airbus sold more than 1,200 new A320neo passenger planes, which could deliver up to 3,600 tons of carbon dioxide (CO2) savings annually per aircraft. An A380 double-decker with a consumption of less than three litres of fuel per passenger over 100 kilometres was planned for 2014. In 2011, Innovation Works, EADS’s innovation centre, presented two new advanced concepts for aircraft designs: Zehst and VoltAir.64 Zehst (Zero Emission High Speed Technology) was a future aircraft that was designed to fly through the stratosphere at 30 km above the ground, at a speed exceeding MACH 4. VoltAir was an all-electric aircraft technology concept combining a fuselage that
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Page 7 9B14M028 minimized drag with highly efficient, superconducting electric motors. This technology was expected to be up and running in 2014. From a baseline of 2006, EADS’s environmental-related targets represented an 80 per cent reduction in water discharge and a 50 per cent reduction in CO2, as well as reductions in volatile organic compound emissions, waste production and water consumption by 2020.65 In addition, EADS aimed to reduce energy consumption by 30 per cent and to generate 20 per cent of its energy through renewable energies. CURRENT DEVELOPMENTS Shareholding Structure The presence of governmental representatives at signings and ceremonies underscored, right from the beginning, the political dimension of the original merger forming EADS.66 In 2000, after EADS’s formation, 34.5 per cent of its stock was publicly traded on the stock markets, 30 per cent was held by Daimler AG, which also included the German government’s share and represented its interests, another 30 per cent was shared by Legardère Group and the French government and the final 5.5 per cent was held by Sociedad Estatal de Participaciones Industriale (SEPI), a large state-owned Spanish industrial holding company. At the end of September 2012, 50.2 per cent of the shares were publicly traded and 22.17 per cent were held by Société de gestion de l’aéronautique, de la défense et de l’espace (SOGEADE), which comprised the Legardère Group and the French state holding company Societé de Gestion de Participations Aéronautiques (SOGEPA). Another 22.17 per cent of shares were held by Daimler AG, and the last 5.4 per cent of the shares were held by SEPI.67 Although the governmental share of EADS was reduced over the years, the French and German governments clearly exerted a tremendous influence on EADS’ business. This relationship reached its climax when the German and French governments refused to reduce their shares in EADS during the course of the planned merger with BAE Systems. Therefore, one main management goal had been to reduce governmental influence on EADS, thereby simplifying EADS’s business and increasing its efficiency. This goal was reached on December 5, 2012, with the announcement of EADS’s new shareholder structure, which drastically reduced the shares held by governments to 12 per cent each for Germany and France and 4 per cent for Spain, while simultaneously increasing the publicly traded stock to more than 70 per cent (see Exhibit 6). Failed Merger In October 2012, merger talks were terminated between EADS and the British defence and aerospace firm BAE Systems. This failed merger marked the loss of a great opportunity for combining EADS with a major defence contractor that delivered and serviced military aircraft, ships, armaments and equipment, and ranked second in the global defence industry. Furthermore, BAE’s main client was the U.S. defence sector. The planned merger became public in September and would have created a defence and aerospace giant to rival Boeing. The deal was intended to combine BAE’s expertise in military and defence with EADS’s aerospace juggernaut Airbus, thereby generating both company growth and the necessary synergies to cut costs. Thus, the merger would have achieved Vision 2020’s major goals: the internationalization of EADS, the strengthening of the defence business and entry into the U.S. market.68 But, as in the shareholding structure already described, the German and French governments exerted a high degree of control over EADS, and the British government could veto any major decision through its ownership of a “golden share” in BAE.69 Therefore, governmental approval was necessary to implement the merger. After long
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Page 8 9B14M028 discussions, negotiations and proceedings, the parties concluded that the political objections could not be overcome, and governmental interests could not be adequately reconciled, both with one another and with the objectives that BAE Systems and EADS had set up for the merger. For BAE’s part, the British government expressed concerns about national security, job safety and a loss of engineering expertise. Even the United States, as its main client, expressed reservations regarding the protection of its national security interests. In terms of the role of EADS, both governments did not want to lose their influence on strategic decisions. Furthermore, concerns remained in terms of job safety and national security. Such strong resistance had not been expected from the German government, which was held mainly responsible for the failed the merger.70 BAE stated it would not reconsider the merger plans until the political climate changed.71 The failed merger had a major impact on the future of EADS, as it destroyed all plans for entering the U.S. market and a greater focus on the defence business.72 In particular, EADS needed a viable strategy for the defence market, as its business had suffered as a result of cost-cutting measures in Europe, leading to experts predicting the sector’s economic slowdown. It was obvious that the future of different governments’ defence procurement programs now needed to be closely monitored. Governments and EADS needed to quickly generate mutually beneficial solutions, as governments needed to maintain their ability to invest in this sector. Some firms even wanted to resell to, or renegotiate their orders with, other countries. Cassidian’s plans for cutting costs by implementing more efficient production and procurement means and an optimization of the management organization were intended to be steps in the right direction. Complicating matters, however, there were no orders in place after 2017 for Eurofighter, the aircraft that had generated Cassidian’s highest revenues.73 Allegations of Corruption Corruption was no rarity within the defence industry, and EADS was no exception. In 2006, the company had already faced allegations of corruption from Britain’s Serious Fraud Office, with BAE having brokered a deal for 72 fighters and other equipment between EADS’s Cassidian and Saudi Arabia.74 The inquiry ultimately was abandoned due to national security concerns. In August 2012, EADS was once again the subject of a fraud investigation in Britain, launched in response to bribery allegations. An EADS unit had allegedly paid bribes dating as far back as 2008 to secure and retain a ₤2 billion Saudi military communications project.75 In addition, the Austrian government claimed that bribery, money-laundering and fraud were also involved in the sale of 15 Eurofighters in 2007.76 Speculation had abounded concerning the deal between Cassidian and Austria because politicians opposing the deal had suddenly changed their opinions to come out in favour of it. Illegal payments of up to €180 million were purportedly also involved, but who had received the money remained unclear. Prosecutors were looking into a network of intermediaries and lobbyists and the trades of businesses common in the export of defence goods. Another possibility was that the payments had been bribes that allowed money from the big Eurofighter sale to flow back into the pockets of EADS’s executives. A publicly recognized scandal would have disastrous consequences for EADS. If the accusations were found to be true, the deal could be cancelled. In addition, such corruption scandals could not only add burdensome monetary consequences in the form of high penalties and investments for clarification but could also severely damage EADS’s reputation. Such a scandal could lead to problems, especially in the United States, the world’s biggest defence market, which EADS had been trying to enter for years. Personal consequences could also not be foreseen. In a similar scandal in Europe, taking place at German Siemens AG, supervisory board chairman Heinrich von Pierer had resigned, although no evidence
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Page 9 9B14M028 directly linked him to any illicit payments.77 Therefore, EADS claimed a zero-tolerance policy regarding fraudulent and unethical behaviour, which was communicated to its employees in an open letter.78 VISION 2020 Vision 2020 was a strategic roadmap that originated in January 2008, when the blueprint for EADS’s future was presented to the EADS board of directors. Since then it had been turned into a group-wide action plan for all EADS divisions. The primary goal for EADS was to become a world leader in air and space platforms and systems. EADS had strong European roots, but its playing field was the world. Europe accounted for 77 per cent of EADS’s sourcing and 97 per cent of its employees, although 57 per cent of EADS’s revenues derived from outside Europe. In addition, EADS exported 75 per cent of its products and services. Another aspect to be considered was the firm’s concentration on its core competencies and its focus on recognition by customers. Additionally, the service share needed to be raised from 10 per cent to 20 to 25 per cent (equalling €25 billion) by 2020 for the firm to become regarded by its customers as a critical service provider. Exhibit 8 provides an overview of the services provided by each business segment. Another of EADS’s important goals was to achieve a 50/50 balance between the Airbus revenue and other divisions’ revenues. Currently Airbus comprised 67 per cent of EADS’s revenues. As a consequence, EADS was highly dependent on the commercial aircraft cycles and carried the huge financial burden of aircraft programs. Environmental issues also played a significant role. As a global company, EADS needed to conduct its business ethically and with respect to its customers, burgeoning industries and local cultures. To become an eco-efficient company, EADS needed to set targets for its divisions. However, the environmental requirements were not just a challenge but also provided an opportunity for EADS to develop new products and technologies. Outlook After a major success had been achieved at EADS with the changes to the shareholder structure, the directions for EADS’s future needed to be determined. First, though, some answers were needed. Was Vision 2020 still feasible for EADS? What were the main challenges requiring solutions, and how should they be handled? What should be EADS’s future strategy, especially in terms of its high dependence on Airbus? And what would be the effect of the corruption investigation? How should EADS deal with the production issues at Airbus and Eurocopter? To sum up, the complete setup of the company could be questioned.
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EXHIBIT 1: EADS FINANCIAL STATEMENTS, 2010—2011 (IN € MILLIONS)
Balance Sheet
Assets 2011 2010 Goodwill 4,354 4,354 Financial fixed assets 9,802 7,960 Non-current securities 7,103 5,172 Total Fixed Assets 21,259 17,486 Receivables and other assets 6,362 4,874 Current securities 4,140 5,756 Cash and cash equivalents 3,394 3,199 Total non-fixed assets 13,896 13,829 Total assets 35,155 31,315
Liabilities and stockholders’ equity Issued and paid up capital 820 816 Share premium 7,519 7,645 Revaluation reserves (1,207) (989) Legal reserves 3,544 3,532 Treasury shares (113) (112) Retained earnings (2,746) (2,604) Result of the year 1,033 553 Stockholders’ equity 8,850 8,841 Financing liabilities 3,090 2,194 Non-current liabilities 3,090 2,194 Financing liabilities 0 29 Other current liabilities 23,215 20,251 Current liabilities 23,215 20,280 Total liabilities and stockholders’ equity 35,155 31,315
Cash Flow Statement 2011 2010 2009 Profit (loss) for the period attributable to equity owners of the parent (Net income (loss))
1,033 553 (763)
Profit for the period attributable to non-controlling interests 4 19 11 Adjustments to reconcile profit (loss) for the period to cash provided by operating activities:
Interest Income (377) (316) (356) Interest expense 364 415 503 Interest receives 417 332 382 Interest paid (307) (278) (331) Interest tax expense (income) 356 244 (220) Income taxes (paid) received (100) (140) 4 Depreciation and amortization 1,884 1,582 1,826 Valuation adjustments (408) (366) (254) Results on disposals of non-current assets (29) (75) (31) Results of companies accounted for by the equity method (164) (127) (115) Change in current and non-current provisions 230 (219) 1,594 Change in other operating assets and liabilities: 1,386 2,819 15 Cash provided by operating activities 4,289 4,443 2,265
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EXHIBIT 1 (CONTINUED)
Purchase of intangible assets, Property, plant and equipment (2,197) (2,250) (1,957) Proceeds from disposals of intangible assets, Property, plant and equipment
79 45 75
Acquisition of subsidiaries, joint ventures, businesses and non-controlling interests (net of cash)
(1,535) (38) (21)
Proceeds from disposals of subsidiaries (net of cash) 18 12 13 Payments for investments in associates, other investments and other long- term financial assets
(312) (190) (136)
Proceeds from disposals of associates, other investments and other long- term financial assets
77 91 43
Dividends paid by companies valued at equity 50 41 27 Dividends paid by companies valued at equity/ disposal groups classified as held for sale and liabilities directly associated with non-current assets classified as held for sale
0 0 103
Change in securities (378) (3,147) (821) Cash (used for) investing activities (4,198) (5,436) (2,674)
Increase in financing liabilities 813 99 1,114 Repayment of financing liabilities (399) (1,160) (208) Cash distribution to EADS N.V. shareholders (178) 0 (162) Dividends paid to non-controlling interests (5) (7) (4) Change in treasury shares (65) (48) 17 Cash provided by (used for) financing activities (1) (3) (5) Effect of foreign exchange rate changes and other valuation adjustments on cash and cash equivalents
165 (1,119) 752
Net increase (decrease) in cash and cash equivalents 254 (2,008) 293 Cash and cash equivalents at beginning of period 5,030 7,038 6,745 Cash and cash equivalents at end of period 5,284 5,030 7,038
Source: EADS Financial statements 2011, www.eads.com/dms/eads/int/en/investor-relations/documents/2012/events- reports/AGM-2012/Financial-Statements-2011-Complete-EN/Financial%20Statements%202011.pdf, accessed December 16, 2013, p. 108 and p. 9.
EXHIBIT 2: EADS GROUP AND ITS MAIN BUSINESS SEGMENTS, FINANCIAL METRICS, 2009— 2011
EADS Group 2009 2010 2011 Revenues (in € millions) 42,822 45,752 49,128 Self-financed R&D (in € millions) 2,825 2,939 3,152 EBIT (in € millions) (322) 1,231 1,696 Net Income (in € millions) (763) 553 1,033 Earnings per share (in €) (0,94) 0,68 1,27 Dividends per share (in €) N/A 0,22 0,45 Net cash position (in € millions) 9,797 11,918 11,681 Order intake (in € millions) 45,847 83,147 131,027 Order book (in € millions) 389,067 448,493 540,978 Employees 119,506 121,691 133,115
Note: R&D = research and development; EBIT = earnings before interest and taxes; N/A = not applicable. The sum of divisions’ numbers do not agree with the total due to minor business segments and headquarters.
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EXHIBIT 2 (CONTINUED)
Airbus 2008 (€ millions) 2009 (€ millions) 2010 (€ millions) 2011 (€ millions) Revenues 28,991 28,067 29,978 33,103 Self-financed R&D 2,306 2,321 2,482 EBIT 1,815 (1,371) 305 584 Order intake 85,493 23,904 68,223 117,874 Order book 357,824 339,722 400,400 495,513 Eurocopter Revenues 4,486 4,570 4,830 5,415 Self-financed R&D 169 189 235 EBIT 293 263 183 259 Order intake 4,855 5,810 4,316 4,679 Order book 13,824 15,064 14,550 13,814 Astrium Revenues 4,289 4,799 5,003 4,964 Self-financed R&D 74 85 109 EBIT 234 261 283 267 Order intake 3,294 8,285 6,037 3,514 Order book 11,035 14,653 15,760 14,666 Cassidian Revenues 5,668 5,363 5,933 5,803 Self-financed R&D 216 251 275 EBIT 408 449 457 331 Order intake 5,287 7,959 4,312 4,168 Order book 17,032 18,796 16,903 15,469
Note: R&D = research and development; EBIT = earnings before interest and taxes Source: www.eads.com/eads/int/en/investor-relations/financials-guidance/segment-information.html, accessed December 16, 2013.
EXHIBIT 3: EADS’S RATING HISTORY OF EADS
STANDARD & POOR’S RATING HISTORY
Short Term Long Term Outlook Rating Action A-1 A— Positive October 2, 2012 A-2 A— Positive September 20, 2011 A-2 A— Stable September 22, 2010 A-2 BBB+ Stable May 10, 2007 A-2 A— Negative watch October 11, 2006 A-1 A Negative watch October 3, 2006 A-1 A Negative June 14, 2006 A-1 A Stable April 30, 2004 A-1 A Negative September 3, 2003 A-1 A Negative watch March 18, 2003 A-1 A Stable January 8, 2001
MOODY’S RATING HISTORY
Short Term Long Term Outlook Rating Action NR A2 Stable December 6, 2012 NR A1 Stable March 9, 2007 NR A1 Negative watch September 22, 2006 NR A1 Stable June 23, 2005 NR A3 Stable March 15, 2002 NR A2 Negative watch September 27, 2001 NR A2 Stable March 8, 2001
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EXHIBIT 3 (CONTINUED)
FITCH RATING HISTORY
Short Term Long Term Outlook Rating Action F2 BBB+ Positive September 21, 2012 F2 BBB+ Stable February 8, 2008 F2 A— Negative March 15, 2007 F2 A— Negative watch October 10, 2006 F1 A Negative watch October 4, 2006 F1 A Negative June 14, 2006 F1 A Stable July 9, 2004
Source: www.eads.com/eads/int/en/investor-relations/Debt-and-access-to-funding/credit-ratings.html, accessed December 16, 2013.
EXHIBIT 4: COMPARISON OF EADS AND ITS COMPETITORS
Company Description Field of Activity Headquarters 2011
Revenues EBIT 2011
Employees
EADS Global leader in aerospace, defence and related services
Commercial and military aircraft, space programs, civil security, helicopters
Leiden, NL €49.1 billion
€1.7 billion
133,000
Boeing The world’s leading aerospace company and the largest manufacturer of commercial jetliners and military aircraft combined
Commercial airplanes, defence, space and security, research and technology
Chicago, IL US$ 68.7 billion
US$ 5.9 billion
170,000
Lockheed Martin
Global security and aerospace company
Aerospace and defence, information technology, space, emerging capabilities
Bethesda, MD US$46.5 billion
US $4 billion
120,000
BAE Systems
Global defence, aerospace and security company
Defence and security, electronics and systems integration, cyber and intelligence, military and technical services, information technology and information systems, consultancy services
London, UK £17.7 billion
£1.5 billion
93,500
Embraer Global aerospace company
Commercial aviation, executive aviation, defence and security
São José dos Campos, SA, Brazil
R$9.9 billion
R$5.2 billion
17,000
Bombardier World’s only manufacturer of both planes and trains
Business, commercial and amphibious aircraft, rail vehicles, transportation systems
Montréal, Canada
CDN$17.7 billion
CDN$1.1 billion
33,600
Note: EBIT = earnings before interest and taxes Source: Home pages and financial statements of the named companies.
Exchange rates At December 31, 2011 At December 31, 2012 €—US$ 1.2939 1.3194 €—£ 0.8353 0.8161 €—R$ 2.4159 2.7036
Source: European Central Bank exchange rates.
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EXHIBIT 5: EADS ACTIVITY IN BRIC COUNTRIES
Division Country Type of Activity
Airbus
Russia - Airbus engineering centre in Moscow - Production of Airbus aircraft components at Russian plants
India - Airbus engineering centre China - Assembly line for A320 family aircraft
- Joint venture between Airbus and a Chinese consortium of Tianjin Free Trade Zone (TJFTZ) and China Aviation Industry Corporation (AVIC)
Eurocopter
Brazil - Subsidiary: Helicópteros do Brasil (Helibras) providing 55 per cent of the civil market and 66 per cent of the military market
- Distribution of Eurocopter products and services India - Subsidiary for sales, support and service opened in 2012
- Industrial partnerships with Hindustan Aeronautics Ltd. (HAL) for sourcing China - Long-term partnership with China Aeronautics Industries Group Corp. (AVIC) for
development of helicopters - Market leader with 41 per cent market share
Astrium
Brazil - Shareholder of and collaboration with Equatorial Sistemas (EQSA) India - Main foreign partner for Indian Space Research Organization (ISRO) China - Joint venture with China Aerospace Science and Technology Corporation
(CASC) for cooperation with Chinese space industry
Cassidian
Brazil - Joint venture with Odebrecht: Brazilian based solutions for defence and security India - First defence-oriented engineering centre operated by a foreign company in
India - Leveraging of the vast pool of skilled engineers available in India and providing
consultancy and other services China - Several partnerships with Chinese companies: security provision for Olympic
Games 2008
EADS Russia - Russian Technology Office (RTO): cooperation with research and development
community
Note: BRIC = Brazil, Russia, India, China Source: Airbus Group, “Our Key Markets,” www.airbus-group.com/airbusgroup/int/en/our-company/key-markets.html, accessed April 10, 2014.
EXHIBIT 6: SHAREHOLDING STRUCTURE OF EADS
September 30, 2012
50.20 per cent publicly traded
22.17 per cent Daimler AG (including the voting rights for private and public
investors)
22.17 per cent SOGEADE
5.40 per cent SEPI
0.06 per cent Shares held out of the contractual partnership by the French
government Note: SOGEADE = Société de gestion de l’aéronautique, de la défense et de l’espace SEPI = Sociedad Estatal de Participaciones Industriale
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EXHIBIT 6 (CONTINUED)
December 5, 2012: Target Structure
72 per cent Publicly traded
12 per cent Daimler AG (including the voting rights for private and public
investors)
12 per cent SOGEADE
4 per cent SEPI
Sources: Airbus Group, “Shareholding Structure,” www.eads.com/eads/int/en/investor-relations/share- information/shareholder-structure.html; www.eads.com/eads/int/en/news/-press.20121205_eads_governance.html, accessed December 16, 2013.
EXHIBIT 7: EADS’S MERGE AND ACQUISITION TARGETS IN THE UNITED STATES
Rockwell Collins
Focus on navigation, communications and aviation electronics Expertise in flight-deck avionics, cabin electronics, mission communications, information
management, simulation and training Global service and support network spanning 27 countries Services in maintenance and repair, spares and parts, training and database and software updates 20.000 employees worldwide at more than 60 locations
Advantages Disadvantages Good cash flow from operations Positive approach to cooperation and
partnerships Expectation of significant opportunities Balanced and integrated business model
Weaker government sales overshadowed stronger commercial revenue in the most recent two quarters
Reduced business in some defence segments Job reductions planned for 2013 Government system sales in 2012 reduced by
8 per cent
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EXHIBIT 7 (CONTINUED)
L-3 Communications Holdings Inc. Among the world’s top-ten defence contractors Defines success as the ability to meet customers’ needs C3ISR: Command, Control, Communications, Intelligence, Surveillance and Reconnaissance National security solutions: high-performance computing, cyber security, analytics, intelligence,
physical security and information technology (IT) services and solutions Aircraft Modernization and Maintenance (AM&M): logistic services for aircraft and military, upgrades
and sustainment Electronic systems: components, products, systems and subsystems and related services to
military and commercial customers 51.000 employees worldwide
Advantages Disadvantages Largely solid financial position with reasonable
debt levels Growth in earnings per share and notable
return on equity Key contract wins Should be a very quick and easy integration
Weak operating cash flow Declining revenues are expected for 2013
SAIC Inc. Scientific, engineering and technology applications company Solution of problems in national security, energy and environment, health and cyber security Provides engineering systems and anti-terrorism technologies to the U.S. Department of Defense,
the FBI and other U.S. government civil agencies 40.000 employees at locations worldwide Advantages Disadvantages
Comprehensive range of services Strong research and development activities
Most recent two years have been overshadowed by a contracting scandal, criminal persecution and a leadership shakeup
Limited liquidity Operational performance
ITT Exelis Aerospace, defence and information solutions company with strong positions in enduring and
emerging global markets Leader in networked communications, sensing and surveillance, electronic warfare, air-traffic
solutions and information systems Growing positions in cyber security, composite aerostructures, navigation, logistics and technical
services 20.000 employees
Advantages Disadvantages Diversified and top-tier global aerospace,
defence and information company Recent winner of several major orders Possibility of a high return on investment
Services differ from EADS’s services Difficult to integrate
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EXHIBIT 7 (CONTINUED)
Company Revenue
(US$ billion)
Operating Profit
(US$ billion)
Operating margin
(per cent)
Share Price (US$)
Market Capitalization (US$ billion)
2011 2010 2011 2010 2011 2010 2011 2010 2011 2010 L-3 Communication 15.2 15.7 1.6 1.8 10.5 11.2 66.7 70.5 6.7 8 SAIC 10.9 10.9 0.6 0.9 5.9 8.6 12.3 15.9 4.2 5.9 ITT Exelis 5.8 5.9 0.5 0.7 9.2 11.7 9 N/A 1.7 N/A Rockwell Collins 4.8 4.6 0.8 0.8 17.6 17.3 55.4 58.3 8.2 9.1
Note: N/A = not applicable Source: Deloitte Development LLC, 2011 Top 20 U.S. Aerospace and Defense Company Financial Analysis, 2012, www.deloitte.com/assets/Dcom-UnitedStates/Local%20Assets/Documents/AD/us_ad_ADPerformanceWrap- up_04032012.pdf, accessed December 16, 2013.
EXHIBIT 8: EADS SERVICES
Airbus International Network of support centres, training centres and spares stores - Engineering & Maintenance: recommendations for aircraft reliability improvements,
maintenance cost analysis and courses - E-Solutions: software services - Upgrade Services: enhancements and refinements to customers’ existing aircraft
Eurocopter Expansive Network of Customer Service Distributors, Service Centres and Training Centres - offer spare parts; technical assistance; maintenance, repair and operations (MRO)
services; trainings Astrium Mobile Satellite Services (MSS)
- Essential communications for mobile customers on air, at sea and on land - Troop welfare services: calls to their families and friends, connections to the Internet for
social media and other uses - Civil security services - Monitoring and intelligence services
Cassidian - Training Services: Air crews, operators, maintenance and management personnel - Fleet Services: Logistics and support activities - Managed Services: Obsolescence Management Services (to ensure sustainability of
installations and complex systems), Outsourced Operations Services (enables risk migration from the customer to Cassidian)
Source: Home pages of named companies.
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Page 18 9B14M028 ENDNOTES 1 This case has been written based on published sources only. Consequently, the interpretation and perspectives presented in the case are not necessarily those of EADS N.V. or any of its employees. The same applies to affiliated companies. 2 Airbus Group, “EADS Governance and Shareholding Structure Receives Far-Reaching Overhaul,” December 5, 2012, www.eads.com/eads/int/en/news/press.20121205_eads_governance.html, accessed December 16, 2013. 3 Airbus Group, “Announcement: BAE Systems plc and EADS N.V.,” October 10, 2012, www.eads.com/eads/int/en/news/press.20121010_eads_bae_announcement.html, accessed December 16. 2013; www.eads.com/eads/int/en/our-company/our-strategy/vision-2020.html, accessed December 16, 2013. 4 Ibid. 5 Nicola Clark, “EADS Offices Raided in Corruption Inquiry,” New York Times, November 7, 2012, www.nytimes.com/2012/11/08/business/global/eads-offices-raided-in-corruption-inquiry.html?_r=0, accessed December 16, 2013. 6 www.ftd.de/unternehmen/industrie/:nach-notwasserungen-sicherheitsproblem-quaelt-eurocopter/70122061.html, accessed January 25, 2013. 7 Nicola Clark, “The Airbus Saga: Crossed Wires and a Multibillion-euro Delay,” New York Times, December 11, 2006, www.nytimes.com/2006/12/11/business/worldbusiness/11iht-airbus.3860198.html?pagewanted=1&_r=3, accessed December 16, 2013. 8 Manfred Knappe, José Maria Palomino and Jean-Cosme Rivière, On the Wings of Time: A Chronology of EADS, Résidence-Verlag, Möhnesee, Germany, 2003, p. 282. 9 Andrea Rothman and Reed Landberg, “Europe Defense Firms Feel Pressure to Unite,” The Seattle Times, June 15, 2007, www.community.seattletimes.nwsource.com/archive/?date=19970615&slug=2544541, accessed December 16, 2013. 10 For historical background Manfred Knappe, José Maria Palomino and Jean-Cosme Rivière, op. cit. pp. 282—284. 11 Aktiengesellschaft (AG) is the German legal term comparable to a stock-listed corporation. 12 Naamloze Vennootschap (N.V.) is the Dutch legal term comparable to a stock-listed corporation. 13 www.eads.com/eads/int/en/our-company/where_we_operate.html, accessed December 16, 2013. 14 EADS Annual Report 2011, www.applications.eads.com/eads/investor-relations/int/annual-report2011, accessed December 16, 2013, p. III. 15 For historical data in this paragraph cf. Manfred Knappe, José Maria Palomino and Jean-Cosme Rivière, op. cit. 16 www.eads.com/eads/int/en/our-company/What-we-do/Airbus.html, accessed December 16, 2013. 17 Nicola Clark, “The Airbus Saga: Crossed Wires and a Multibillion-euro Delay,” op. cit. 18 Nicola Clark, “EADS Offices Raided in Corruption Inquiry,” op. cit. 19 “Airbus Faces €105m Compensation Bill for A380 Superjumbos’ Cracked Wings,” www.newsrt.co.uk/news/airbus-faces- 105m-compensation-bill-for-a380-superjumbos-cracked-wings-195002.html, accessed December 16, 2013. 20 Gesellschaft mit beschränkter Haftung (GmbH) is the German legal term comparable to private limited company. 21 Manfred Knappe, José Maria Palomino and Jean-Cosme Rivière, op. cit., p. 284. 22 Harald Wilhelm, Growth and the Bottom Line, 2012, www.eads.com/dms/eads/int/en/investor- relations/documents/2012/events-reports/GIF-2012/EADS_GIF- 2012_FINANCE_HW/EADS_GIF%202012_HW_FINANCE.pdf, accessed December 16, 2013. 23 Airbus, “Our Mission: What Does Cassidian Stand for?” www.cassidian.com/en_US/web/guest/mission, accessed December 16, 2013. 24 Ibid. 25 www.eads.com/eads/int/en/our-company/What-we-do/Cassidian/Eurofighter.html, accessed December 16, 2013. 26 Ibid. 27 Airbus, “Airbus Helicopters.” www.eurocopter.com/site/en/ref/Genealogy_346-87.html, accessed December 16, 2013. 28 Airbus Helicopters, “Who We Are,” www.eurocopter.com/site/en/ref/Shareholders_23-2.html, accessed December 16, 2013. 29 www.eads.com/eads/int/en/our-company/What-we-do/Eurocopter.html, accessed December 16, 2013. 30 www.ftd.de/unternehmen/industrie/:nach-notwasserungen-sicherheitsproblem-quaelt-eurocopter/70122061.html, accessed January 25, 2013. 31 Ibid. 32 Harald Wilhelm, Growth and the Bottom Line, op. cit. 33 Harald Wilhelm, 9m Results 2012, www.eads.com/dms/eads/int/en/investor-relations/documents/2012/events-reports/Q3- 2012/Q3-Earnings-2012/EADS%209m%202012%20Earnings%20presentation.pdf, accessed December 13, 2013. 34 Tim Hepher and Cyril Altmeyer, “Airbus Orders Surge in November but Lag Boeing,” Reuters, December 7, 2012, www.reuters.com/article/2012/12/07/uk-airbus-orders-idUSLNE8B602X20121207, accessed December 16, 2013. 35 For the company development in this section cf. EADS Annual Report 2011, p. 29. 36 Severe Acute Respiratory Syndrome (SARS) is an infectious disease first observed in Asia at the end of 2002. 37 EADS Annual Report 2011, p. 30. 38 Ibid., p. 29. 39 Ibid. 40 www.eads.com/eads/int/en/our-company/our-strategy/vision-2020.html, accessed January 25, 2013.
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Page 19 9B14M028 41 EADS Annual Report 2011, p. 31. 42 “EADS Boss Enders: Competition for Airbus and Boeing Can Only Come from China,” www.presseportal.de/pm/63073/2372964/eads-boss-enders-competition-for-airbus-and-boeing-can-only-come-from-china- for-more-investment-in, accessed January 8, 2013. 43 CAPA Center for Aviation, “Competition will Force Aircraft Manufacturers into Alliances: EADS,” www.centreforaviation.com/analysis/eads-competition-will-force-commercial-aircraft-manufacturers-to-enter-strategic- alliances-50774, accessed December 16, 2013. 44 Bijan Vasigh, Ken H. Fleming and Thomas Tacker, Introduction to Air Transport Economics, Ashgate Publishers, Aldershot, UK, 2008, p. 197. 45 Ibid., p. 212. 46 Ibid., p. 89, p. 211. 47 www.ukessays.co.uk/essays/business/commercial-aircraft-industry.php, accessed December 16, 2013. 48 The Industrial College of the Armed Forces, Spring 2011 Industry Study: Final Report — Aircraft Industry, National Defense University, Fort McNair, Washington DC, 2011, www.ndu.edu/icaf/programs/academic/industry/reports/2011/pdf/icaf-is-report-aircraft-2011.pdf, accessed December 16, 2013, p. 13-14. 49 EADS Annual Report 2011, p. 31. 50 Ibid. 51 Ibid., p. 33. 52 Ibid., p. xvii. 53 Ibid., p. 29. 54 www.eads.com/eads/int/en/our-company/key-markets/EADS-North-America.html, accessed December 16, 2013. 55 Aerospace Industries Association, 2012 Year-End Review and Forecast, www.aia- aerospace.org/assets/aia_yearender_web_2012.pdf, accessed December 16, 2013, p. 3. 56 EADS Annual Report 2011, p. 31. 57 Ibid, p. 26f., p. 29. 58 www.eads.com/eads/int/en/our-company/key-markets/India.html, accessed December 16, 2013. 59 Roger Cliff, Chad J. R. Ohlandt and David Yang, Ready for Takeoff: China’s Advancing Aerospace Industry, Rand Corporation, Santa Monica, CA, 2011. 60 www.eads.com/eads/int/en/our-company/key-markets/Brazil.html, accessed December 16, 2013. 61 www.eads.com/eads/int/en/our-company/key-markets/Russia.html, accessed December 16, 2013. 62 EADS Annual Report 2011, p. 59. 63 Ibid., p. 28. 64 Ibid., pp. 57-59. 65 Ibid., p. 36. 66 Manfred Knappe, José Maria Palomino and Jean-Cosme Rivière, op. cit., p. 282—284. 67 Airbus Group, “Shareholding Structure,” www.eads.com/eads/int/en/investor-relations/share-information/shareholder- structure.html, accessed July 12, 2013. 68 Information on alternative acquisition targets are provided in Exhibit 7. 69 A golden share can outvote the remaining shares of a company given specified circumstances. With this golden share, the British government was able to maintain a major impact on the most relevant business decisions at BAE. 70 Laurence Knight, “BAE Systems—EADS: The Rationale.” BBC News, www.bbc.co.uk/news/business-19783954, accessed December 16, 2013. 71 Tom McGhie, “BAE Boss Ian King Still Keen on EADS Merger,” This Is Money, www.thisismoney.co.uk/money/news/article-2217284/BAE-boss-Ian-King-keen-EADS-merger.html, accessed December 16, 2013. 72 Andrea Shalal-Esa and Soyoung Kim, “Analysis: BAE-EADS Merger Collapse Shifts Focus to Smaller Deals,” Reuters, October 10, 2012, www.reuters.com/article/2012/10/11/us-eads-bae-mergers-idUSBRE8991R220121011, accessed April 10, 2014. 73 J. Hartmann and A. Tauber, “Drohnen sind gefragt, Eurofighter wird Ladenhüter,” [“Drones Sell Like Hotcakes, Eurofighters Become Shelf Warmers”] Die Welt, www.welt.de/wirtschaft/article108952822/Drohnen-sind-gefragt-Eurofighter- wird-Ladenhueter.html, accessed December 16, 2013. 74 Nicola Clark, “EADS Offices Raided in Corruption Inquiry,” op. cit. 75 Christian Plumb, “UK Opens Probe into EADS Unit Saudi Defence Deal,” Reuters, August 9, 2012, www.uk.reuters.com/article/2012/08/09/uk-eads-bribery-idUKBRE8781A120120809, accessed December 16, 2013. 76 Matthias Kamp and Rüdiger Kiani-Kress, “EADS bereitete Korruption den Boden,” [“EADS Prepared the Ground for Corruption”], Wirtschafts Woche, www.wiwo.de/unternehmen/industrie/schmiergeld-skandal-eads-bereitete-korruption-den- boden/7397406.html, accessed December 16, 2013. 77 “Corruption Scandal: Investigation into Dubious EADS Austria Deal Intensifies,” Der Spiegel, November 12, 2012, www.spiegel.de/international/business/investigation-into-dubious-eads-austria-deal-intensifies-a-866646.html, accessed December 16, 2013. 78 Airbus Group, “Standards of Business Conduct,” www.eads.com/eads/germany/de/unser-unternehmen/ethics-and- compliance/Our-integrity-Principles/Standards-of-Business-Conduct.html, accessed December 16, 2013.
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3.
9B17M115
ORGANIGRAM: NAVIGATING THE CANNABIS INDUSTRY WITH “GREY KNOWLEDGE”
Opal Leung wrote this case solely to provide material for class discussion. The author does not intend to illustrate either effective or ineffective handling of a managerial situation. The author may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized, or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com. Copyright © 2017, Richard Ivey School of Business Foundation Version: 2017-08-09
From our strategic point of view, we are interested in jumping into the recreational marketplace just because of its size and breadth . . . we expect ourselves and most of the LPs [licensed
producers] will probably play on both sides of the fence, medicinal and recreational . . . assuming, and I’m sure that it will, that the medicinal marketplace will continue to thrive, even when the
recreational marketplace comes forward.
Larry Rogers, chief operating officer, OrganiGram On December 1, 2016, the Task Force on Cannabis Legalization and Regulation (the Task Force) released its final report.1 It was the result of a long process of consulting with many stakeholders, including patients, various levels of government, and experts across Canada and the United States. The Task Force was assembled in June 2016, soon after the Trudeau government announced (on April 20, 2016) that legislation to legalize recreational cannabis would be introduced in the spring of 2017 with the intention of having it become law in the spring of 2018. Several cannabis companies, including OrganiGram Holdings Inc., Canopy Growth Corporation, Aphria Medical Marijuana, Mettrum Ltd., and Aurora Cannabis Inc., had already been supplying medical cannabis to patients in Canada. The size of the recreational market was predicted to be approximately $5 billion2 and up to $22.6 billion if including the ancillary market (e.g., testing labs, security, and paraphernalia).3 With the potential to sell its product to this new market, the New Brunswick-based cannabis company OrganiGram had already begun to prepare for expansion into the recreational market, even before the government’s announcement was made.4 However, there were still several unknowns that made the cannabis industry’s environment ambiguous. What would the timeline for legalization be? Who would be allowed to grow cannabis and how much? Would there be any safety regulations to ensure that customers would receive safe recreational products? Would there be regulations for drivers who medicated with and drove under the influence of cannabis? Which part of the Task Force report recommendations would actually become a reality? From a marketing perspective, if the current cannabis companies were known as providers of pharmaceutical-grade cannabis, was it possible to adjust their brand to attract recreational users? If so, how would they do it? According to OrganiGram chief operating officer Larry Rogers, several
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Page 2 9B17M115 decisions had to be made based on “grey knowledge.” Even though the Task Force had released its report, it was still unclear which suggestions the federal government would adopt. CANNABIS REGULATIONS IN CANADA The Marihuana for Medical Purposes Regulations (MMPR) were enacted under the Controlled Drugs and Substances Act in July 2013. Before the MMPR, the Marihuana Medical Access Regulations, enacted in 2001 and repealed in 2013, allowed patients to grow their own cannabis plants or have someone grow the plants for them. The MMPR was an attempt to control the production and distribution of medical cannabis, with licensed producers (LPs) being the only companies authorized by Health Canada to cultivate and/or sell dried cannabis to patients who had prescriptions. The application process was very rigorous and, as a result, a low percentage of applicants were granted licences. As of August 1, 2016, 1,561 applications had been received, 253 had been refused, 419 were in progress, 54 had been withdrawn, and 801 were incomplete.5 As of December 28, 2016, only 37 licences had been issued, with most of them in Ontario (22) and British Columbia (8). Some companies had more than one licence, which meant that they had more than one site because each licence was location-specific. Patients could legally register and buy their medical cannabis at only one LP for each prescription. A subset of the LPs also had licences to produce and/or sell fresh cannabis seeds or cuttings and cannabis oil, with some companies holding more than one licence. Twenty-two licences for producing and/or selling cannabis oil were held by only 18 companies. The authorization to produce and sell oils and fresh plant material meant that companies could create and sell other products, such as cloned strains (clones) of cannabis (i.e., starter plants). LPs were required to keep detailed records of all cannabis received (including the name of the seller, the date and place of the transaction, and a full description of the product). In the Task Force report,6 one of the recommendations was to implement a seed-to-sale tracking system. The oils made by LPs were better for dosing than homemade oils because the amount of tetrahydrocannabinol (THC) and/or cannabidiol (CBD) could not be clearly determined in the latter. For example, when a patient smoked a joint made from dried cannabis, it was unclear how much THC was being inhaled. However, when using cannabis oil, the dosage was measured by volume. When the Access to Cannabis for Medical Purposes Regulations (ACMPR) was passed in August 2016, patients were once again allowed to grow their own cannabis plants. Some LPs started selling clones to patients.7 The ACMPR permitted companies to sell oil in a “capsule or similar dosage form” but not edibles— marijuana infused food products. OrganiGram was still in the research and development stage of capsule production. However, the ACMPR allowed patients to “alter the chemical or physical properties of the fresh or dried marihuana or cannabis oil,” meaning that patients could make their own edibles.8 OrganiGram patients received a copy of Aunt Sandy’s Medical Marijuana Cookbook9 as part of their client welcome kit. OrganiGram was the only LP on Canada’s east coast that had licences to cultivate (i.e., grow and process) dried cannabis, produce fresh cannabis and cannabis oil, and sell all of these products. The first few LP licences were granted in 2013.10 Its licences permitted it to produce up to 1,500 kilograms of dried cannabis and 500 kilograms of cannabis oil and sell up to 1,200 kilograms of dried cannabis and 500 kilograms of cannabis oil per year, within Canada.11 Also, medical cannabis plant cuttings and dried buds could be sold and shipped to other LPs on a wholesale basis. The only other LP in the Maritimes was Canada’s Island Garden Inc. (CIGI) in Prince Edward Island. However, CIGI had a licence only to cultivate dried cannabis.12 OrganiGram received its licence to cultivate dried cannabis on March 26, 2014, and received its oil licence on July 23, 2016. CIGI was licensed to
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Page 3 9B17M115 cultivate dried cannabis on June 16, 2016. The first licences to produce and sell cannabis oils were granted in the summer of 2015.13 ORGANIGRAM COMPANY BACKGROUND OrganiGram was founded in 2013 in Moncton, New Brunswick. In 2014, there were only approximately 17 staff members. The company employed 70 people as of December 2016, and it was looking forward to expanding its workforce up to about 170 staff in the next year or two to staff its new and expanding facilities. The organizational structure consisted of three levels: the C-suite (i.e., chief executive officer, chief operating officer, chief financial officer, and chief commercial officer), directors, and employees in various functions (e.g., garden workers and client support). Its facilities consisted of a main facility, a newly acquired building next to the main facility, and the adjoining 10-acre (4.1-hectare) property with a 136,000- square-foot (12,635-square-metre) industrial building. In addition to being the first medical cannabis company in the Maritimes to be licensed to grow and sell medical cannabis, it was a certified organic medical cannabis producer. This organic certification meant that it needed to follow more rules than most of its competitors. Canada had only three organic LPs.14 Organigram was the only Maritime cannabis company with licences to cultivate, produce, and sell cannabis products. In a Canadian Broadcasting Corporation report, it was announced that at the end of March 2016, the New Brunswick government awarded payroll rebates of up to $990,000 over three years to OrganiGram to help create up to 113 new jobs in the province.15 Chief executive officer Denis Arsenault stated, “We are from New Brunswick and we’re excited to invest at home, where the advantages of a well-educated work force, low power rates and a competitive cost of living make New Brunswick and Moncton a logical place for our future.”16 In the summer of 2016, OrganiGram purchased a new building in Moncton. In an interview published on October 25, 2016, chief commercial officer Ray Gracewood stated that much of the space in the new facility in Moncton would be for the manufacturing of edibles and extracts.17 To finance its expansion plans, OrganiGram announced the closing of a $40 million bought deal on December 7, 2016, to finance an expansion of its existing facility for an additional 32,000 square feet (2,973 square metres) of grow-room area and continue with its planned cannabis oil extracts and derivatives facility.18 In this bought deal, a group of investment firms (led by Dundee Securities Ltd.) offered $40,253,450 for 11,339,000 shares at a price of $3.55 per share to OrganiGram.19 THE PROCESS OF PRODUCING CANNABIS PRODUCTS The process of growing and processing cannabis started with purchasing and receiving materials such as soil and fertilizers. Cuttings taken from mother plants were started in the nursery to grow clones, which were put into pots of soil for the pre-vegetative (pre-veg) process. The process of growing plants from clones had two benefits: (1) it took less time than growing from seeds and (2) it ensured that the plants would have the same characteristics as the mother plant. The pre-veg process took several weeks, as did the vegetative process, which began when the plants were set into larger pots. Next, the plants were placed in grow rooms for the flowering stage, which took 56–72 days. After harvesting, the cannabis was trimmed, dried, cured, and packaged for mailing to patients. OrganiGram had produced and posted a YouTube video that described the growing process.20 According to Rogers, it could take over six months from starting the clones to packaging the final product. Under the ACMPR, LPs were permitted to sell cannabis products only to patients directly through mail order or to other LPs on a wholesale basis.
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Page 4 9B17M115 ORGANIGRAM’S EXISTING PRODUCT LINES OrganiGram differentiated itself by highlighting that some of its products were premium, 100 per cent organic, which meant that they were subject to audits, were grown in regulated soil, received organic fertilizers, and were free of certain disallowed pesticides. These standards were in addition to the Health Canada regulations. OrganiGram received its organic certification from ECOCERT on October 10, 2014.21 Many of OrganiGram’s strains had Maritime-themed names, such as Highlands, Rising Tides, and Lighthouse. The price of the dried cannabis ranged from $9.25 to $10.50 per gram. Daily dosages for patients ranged from 75 milligrams per day to 3.2 grams per day.22 According to the ACMPR, the possession limit was 30 times the daily dosage, or 150 grams, whichever was less. However, OrganiGram offered a 25 per cent discount to patients who were on social assistance or disability programs. Competitors also had compassionate-pricing programs. OrganiGram oils were all priced at $99 per 50 millilitres. The oils had different names from their dried plant strain names and were labelled with the amounts of THC and CBD in milligrams or millilitres. Depending on each patient’s needs, the choice would be made according to the amount of THC and/or CBD in the product. In addition to its cannabis products, OrganiGram sold vaporizers that ranged in price from $97.50 to $195. COMPETITORS In 2016, Canada’s largest publicly traded LPs were Canopy Growth, Mettrum, OrganiGram, Aphria, and Aurora Cannabis. The first four companies had licences to cultivate the dried plant, produce oils, and sell both products. Aurora had licences only to cultivate the dried plant and sell it. However, Aurora was enrolling new patients very quickly in a short period of time.23 In terms of licensed capacity and resources, Canopy Growth was the largest player and was the result of a merger of the companies Tweed and Bedrocan. Tweed had a branding partnership with Snoop Dogg.24 Canopy Growth was working on international expansion activities in Brazil, Australia, and Germany.25 Mettrum was very much a medically focused company that concentrated on building a physician’s network to increase its patient base. On December 1, 2016, it was announced that Mettrum would be acquired by Canopy Growth, pending shareholder approval.26 Many LPs were in the process of increasing the number of registered patients while expanding their operations. The prices for most dried cannabis strains tended to be between $6 and $12 per gram.27 Several companies, including OrganiGram, offered “compassionate pricing” (i.e., a discounted price) for those patients in need. Strains with higher percentages of THC often were able to garner higher prices. THE AMERICAN EXPERIENCE (WITH RECREATIONAL CANNABIS) Colorado and several other American states had already legalized recreational cannabis. Data from the cannabis data firm Headset Inc. Cannabis Intelligence provided sales data on the most popular recreational cannabis products in the United States.28 The dried flower was the most popular product (48 per cent of all transactions) but had the lowest profit margin (53.5 per cent on average). The second most popular product was edibles (13.1 per cent of all transactions), and some types had the highest profit margins (ranging from 53 per cent for soup to 65.5 per cent for brittle). Concentrates, beverages, and vapour products were also becoming more popular.
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Page 5 9B17M115 According to a 2016 report by the Rocky Mountain High Intensity Drug Trafficking Area on marijuana in Colorado, the established demand in 2014 was 121.4 metric tons for residents (aged 21 years and older) and the estimated demand was 8.9 metric tons for out-of-state visitors (aged 21 years and older). The same report noted 485,000 regular users of cannabis in Colorado. The total population of Colorado was 5.36 million.29 Based on data collected on approximately 40,000 legal (recreational) cannabis purchases, cannabis users spent an average of US$647 annually in Washington State.30 Thousands of jobs and millions of dollars collected in taxes were reported in Colorado.31 According to Rogers, Colorado “is like the gold standard for recreational marijuana in the world. It’s the only place of size that has had a recreational marketplace for more than a short period of time . . . at least they have some quantifiable data that you can try and use to project forward.” However, regulations were very different in the United States and varied from state to state. For example, the state law in Colorado permitted licensed retailers to sell only up to 30 per cent of their total “finished Retail Marijuana inventory” to other licensed establishments.32 Because marijuana was still illegal at the federal level, it was difficult for American cannabis businesses to open bank accounts and many used only cash transactions. CHALLENGES In September 2016, OrganiGram partnered with TGS International LLC,33 a firm in Colorado that had experience with manufacturing and selling edibles, which were not yet legal to sell in Canada. According to Rogers, the TGS partnership was meant to help OrganiGram “spin up” its edible-marijuana manufacturing facilities in Moncton quickly. Soon after, in a press release dated November 23, 2016, OrganiGram announced, “Trailer Park Boys Choose OrganiGram as Strategic Partner.”34 However, in mid- December 2016, the Task Force on Cannabis Legalization and Regulation completed and released its report, which included many recommendations.35 For the purpose of minimizing the harm of use, the Task Force recommended that the federal government “apply comprehensive restrictions to the advertising and promotion of cannabis and related merchandise by any means, including sponsorship, endorsements and branding, similar to the restrictions on promotion of tobacco products.”36 The Task Force also recommended that recreational products not be packaged in such a way that it would be appealing to children. With that in mind, what kinds of edibles would be permitted? The challenge was that OrganiGram was “deploying fairly substantive amounts of capital and not knowing exactly what the date is that that capital should be fully functioning,” according to Rogers. Other LPs, such as Canopy Growth and Aurora Cannabis, were also preparing for the recreational market by developing strategic partnerships and raising capital to expand their operational capacities. On the medical side, the total number of patients who could legally purchase medical marijuana was limited by the number of physicians who were willing and able to prescribe cannabis. Many of the cannabis clinics were in Ontario and Western Canada, where most of the LPs were located. However, some clinics had satellite offices in Atlantic Canada. According to Rogers, many physicians were uncomfortable with prescribing cannabis to their patients and had to refer them to cannabis clinics. However, the market data found on Health Canada’s website showed that the number of patients was increasing each quarter (see Exhibit 1). Even with these data and OrganiGram’s enterprise resource planning systems, it was difficult to make forecasts because one did not know which companies the patients would choose. NEXT STEPS The largest players (including OrganiGram) in the medical cannabis industry were in the midst of expanding their operations in anticipation of the introduction of the Trudeau government’s recreational cannabis
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Page 6 9B17M115 legislation in the spring of 2017. In addition to its domestic expansion activities, Canopy Growth, the largest publicly traded cannabis company in Canada, was already engaging in several international expansion activities in Brazil, Germany, and Australia. However, Rogers said that there was a shortage of product in Canada at that point in time and OrganiGram did not have any immediate plans to export cannabis. Its focus was on the current medical cannabis market and the anticipated recreational market in Canada. From Rogers’s perspective, it was unclear when the company could roll out new products, which products would be permitted, or who would be allowed to produce and/or sell recreational cannabis products. The challenge for OrganiGram was to work with the “grey knowledge” while creating a strategy for the anticipated recreational cannabis market and working on its medical cannabis sales. What kind of strategy should OrganiGram have for the recreational cannabis market? How should it organize the company to market both medical and recreational cannabis? Would the legalization of recreational cannabis lead to regulations that allowed for imported cannabis? With so many variables still unknown, what kinds of scenarios should OrganiGram prepare to face? Was it possible to create an implementation plan with a timeline, roll out schedule, and initial steps that would take into account the different scenarios?
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Page 7 9B17M115
EXHIBIT 1: MARKET DATA ON CANADA’S QUARTERLY SUPPLY OF CANNABIS FOR MEDICAL PURPOSES, APRIL 2015–SEPTEMBER 30, 2016
Apr. 1,
2015– June 30, 2015 (Q1)
July 1, 2015– Sep. 30, 2015 (Q2)
Oct. 1, 2015– Dec. 31, 2015 (Q3)
Jan. 1, 2016– Mar. 31, 2016 (Q4)
Apr. 1, 2016– June 30, 2016 (Q1)
July 1, 2016– Sep. 30, 2016 (Q2)
Dried Marijuana Amount sold to clients (in kg)
1,371 1,873 2,481 3,082 4,037 4,773
Amount produced
1,867 2,142 2,684 4,037 5,014 5,734
Amount in inventories of LPs at end of quarter (in kg)
5,445 7,312 9,729 10,695 11,788 13,246
Cannabis Oil Amount sold to clients (in kg)
N/A N/A 3 584 1,500 2,420
Amount produced
N/A 9 128 892 1,654 3,116
Amount in inventories of LPs at end of quarter (in kg)
N/A 7 208 1,421 2,038 3,330
Client Data Average amount authorized per client (g/day)
3.3 3 2.9 2.8 2.7 2.6
Average amount per client shipment (g/day)
1.08 1.12 1.12 1.03 0.96 0.89
Total number of registered clients at end of quarter
23,930 30,537 39,668 53,649 75,166 98,460
Note: Q = quarter; kg = kilogram; g = gram; LPs = licensed producers; N/A = not available Source: Government of Canada, “Market Data,” accessed December 28, 2016, www.canada.ca/en/health- canada/services/drugs-health-products/medical-use-marijuana/licensed-producers/market-data.html.
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Page 8 9B17M115 ENDNOTES
1 The terms “cannabis,” “marijuana,” and “marihuana” all refer to various forms (dried or fresh) of the cannabis plant. Government of Canada, A Framework for the Legalization and Regulation of Cannabis in Canada: The Final Report of the Task Force on Cannabis Legalization and Regulation (November 30, 2016), accessed December 28, 2016, www.healthycanadians.gc.ca/task-force-marijuana-groupe-etude/framework-cadre/index-eng.php. 2 All currency amounts are in Canadian dollars unless otherwise specified. 3 Peter Koven, “Canada’s Budding Marijuana Industry Could Blossom into a $5-Billion Market If Liberals Make Recreational Pot Legal,” Financial Post, October 20, 2015, accessed December 28, 2016, http://business.financialpost.com/news/agriculture/ canadian-marijuana-stocks-jump-as-liberal-wins-signals-legalization-on-the-table; Robert Benzie, “Recreational Weed Could Be a $22.6B Industry: Study,” thestar.com, October 27, 2016, accessed December 28, 2016, https://www.thestar.com/news/queenspark/ 2016/10/27/recreational-weed-could-be-a-226b-industry-study.html. 4 “From the President’s Desk,” OrganiGram Holdings Inc., January 14, 2016, accessed June 13, 2017, https://www.organigram.ca/latest/from-the-presidents-desk. 5 Government of Canada, “Application Process: Becoming a Licensed Producer of Cannabis for Medical Purposes,” accessed October 6, 2016, www.canada.ca/en/health-canada/services/drugs-health-products/medical-use-marijuana/licensed- producers/application-process-becoming-licensed-producer.html. 6 Government of Canada, A Framework for the Legalization and Regulation of Cannabis in Canada: The Final Report of the Task Force on Cannabis Legalization and Regulation, op. cit. 7 THC BioMed was one of the companies to sell clones. “THC BioMed,” accessed July 12, 2017, http://thcbiomed.com. 8 Government of Canada, “Access to Cannabis for Medical Purposes Regulations (SOR/2016-230),” Justice Laws website, accessed December 28, 2016, http://laws.justice.gc.ca/eng/regulations/SOR-2016-230/page-10.html#h-16. 9 Sandy Moriarty, Aunt Sandy’s Medical Marijuana Cookbook (Piedmont, CA: Quick American Publishing, 2010). 10 Government of Canada, “Authorized Licensed Producers of Cannabis for Medical Purposes,” accessed May 1, 2017, www.canada.ca/en/health-canada/services/drugs-health-products/medical-use-marijuana/licensed-producers/authorized- licensed-producers-medical-purposes.html. 11 OrganiGram Holdings Inc., Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”): For the Year Ended August 31, 2016, accessed December 28, 2016, https://www.organigram.ca/assets/ financials/Organigram-Holdings-Inc-MDA-Aug-31-2016.pdf. 12 Government of Canada, “Authorized Licensed Producers of Cannabis for Medical Purposes,” op. cit. 13 Data shown in Exhibit 1 shows that cannabis oil production started in the summer of 2015. 14 OrganiGram Holdings Inc., op. cit. 15 “OrganiGram Gets $990k from New Brunswick Government,” CBC News, March 30, 2016, accessed December 28, 2016, www.cbc.ca/news/canada/new-brunswick/organigram-marijuana-funding-brunswick-1.3512416. 16 Ibid. 17 Cherise Letson, “New Brunswick’s OrganiGram Preparing to Light Up Recreational Market,” Huddle, October 25, 2016, accessed December 28, 2016, http://huddle.today/new-brunswicks-organigram-preparing-light-recreational-market. 18 “OrganiGram Announces Closing of $40M Bought Deal Financing,” Marketwired, December 7, 2016, accessed June 13, 2017, www.marketwired.com/press-release/organigram-announces-closing-of-40m-bought-deal-financing-tsx-venture-ogi-2181471.htm. 19 Ibid. 20 “Inside the Organigram Garden,” YouTube video, 2:38, posted by “Civilized,” July 26, 2016, accessed December 28, 2016, https://www.youtube.com/watch?v=Oh-62nDtJFM. 21 “OrganiGram Receives Organic Certification for Medical Marijuana Growing Process,” Marketwired, October 14, 2014, accessed June 13, 2017, www.marketwired.com/press-release/organigram-receives-organic-certification-for-medical- marijuana-growing-process-tsx-venture-ogi-1957140.htm. 22 Government of Canada, “Access to Cannabis for Medical Purposes Regulations—Daily Amount Fact Sheet (Dosage),” July 2016, accessed July 12, 2017, www.canada.ca/en/health-canada/services/drugs-health-products/medical-use- marijuana/information-medical-practitioners/marihuana-medical-purposes-regulations-daily-amount-fact-sheet-dosage.html. 23 “Operational Update: Aurora’s CanvasRx Subsidiary Surpasses 13,000 Patients Registered,” CNW, November 10, 2016, accessed June 13, 2017, www.newswire.ca/news-releases/operational-update-auroras-canvasrx-subsidiary-surpasses- 13000-patients-registered-600664531.html. 24 “Tweed Rolls Out Leafs by Snoop Cannabis Brand,” CBC News, October 6, 2016, accessed December 28, 2016, www.cbc.ca/news/canada/ottawa/tweed-leafs-by-snoop-brand-launch-1.3793667. 25 Canopy Growth Corporation, Annual Meeting of Shareholders, September 15, 2016, accessed December 28, 2016, https://cdn.shopify.com/s/files/1/0994/1238/files/160915_2016_Canopy_Growth_Corporation_AGM_Presentation_FINAL.pdf ?3923008218010883461. 26 Sunny Freeman, “Canopy Growth Corporation to Acquire Mettrum for $430M—Making a Mega-Company Serving Half Canada’s Medical Pot Users,” Financial Post, December 1, 2016, accessed December 28, 2016, http://business.financialpost.com/news/agriculture/canopy-grow-to-acquire-rival-mettrum-for-430-million-to-form-mega- company-serving-half-canadas-medical-pot-users. 27 Brad Martin, “The Cost of Medical Cannabis in Canada,” Lift News, August 4, 2016, accessed December 28, 2016, https://news.lift.co/the-cost-of-medical-cannabis-in-canada. 28 “What Are the Most Popular Cannabis Products?” Headset, June 29, 2016, accessed December 28, 2016, http://headset.io/blog/what-are-the-most-popular-cannabis-products.
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Page 9 9B17M115 29 Rocky Mountain High Intensity Drug Trafficking Area, The Legalization of Marijuana in Colorado: The Impact Vol. 4 (September 2016), accessed January 18, 2017, www.rmhidta.org/html/2016%20FINAL%20Legalization%20of%20 Marijuana%20in%20Colorado%20The%20Impact.pdf. 30 Polly Mosendz, “The Average Legal Pot User Spends $647 a Year on Weed,” Bloomberg, July 26, 2016, accessed December 28, 2016, www.bloomberg.com/news/articles/2016-07-26/the-average-legal-pot-user-spends-647-a-year-on-weed. 31 Joshua Miller, “In Colo., a Look at Life after Marijuana Legalization,” The Boston Globe, February 22, 2016, accessed December 28, 2016, https://www.bostonglobe.com/metro/2016/02/21/from-colorado-glimpse-life-after-marijuana-legalization/ rcccuzhMDWV74UC4IxXIYJ/story.html. 32 Code of Colorado Regulations, Retail Marijuana Rules, 1 CCR 212-2, 76, accessed December 28, 2016, https://www.colorado.gov/pacific/sites/default/files/Current%20Official%20Retail%20Marijuana%20Rules%20- %20Effective%2007012016.pdf. 33 “OrganiGram Enters Exclusive Partnership for Oils, Extracts and Edibles,” Marketwired, September 1, 2016, accessed December 28, 2016, www.marketwired.com/press-release/organigram-enters-exclusive-partnership-for-oils-extracts-and- edibles-tsx-venture-ogi-2154846.htm. 34 “Trailer Park Boys Choose OrganiGram as Strategic Partner,” Marketwired, November 23, 2016, accessed December 28, 2016, www.marketwired.com/press-release/trailer-park-boys-choose-organigram-as-strategic-partner-2178120.htm. 35 Government of Canada, A Framework for the Legalization and Regulation of Cannabis in Canada: The Final Report of the Task Force on Cannabis Legalization and Regulation, op. cit. 36 Ibid.
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4.
9B18A055
BIG BOSS CEMENT INC.: STIRRING UP INDUSTRY COMPETITION IN THE PHILIPPINES1
Shweta Pandey, Sandeep Puri, and Babak Hayati wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized, or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com. Copyright © 2018, Ivey Business School Foundation Version: 2018-08-30
In January 2018, the Philippine cement industry changed forever with the entry of a 100-per-cent Filipino- owned cement manufacturing company, Big Boss Cement Inc. (BBCI). When the company decided to set up shop with a cheaper, eco-friendly manufacturing process that promised less carbon emission,2 not only did the revolutionary move heat up competition, it also gave the National Ecolabelling Programme – Green Choice Philippines (NELP – GCP) initiative a big push. According to industry experts, in a scenario where the Philippine government planned to spend ₱3.6 trillion3 on infrastructure projects nationwide from 2018 to 2020, and where national demand for cement was expected to grow to 40 million metric tons by 2021,4 the entry of more players into the mix to meet this enormous requirement signalled the start of the “golden age of infrastructure” in the country.5 To ride this cement wave in the Philippines, the Consunji family-led conglomerate DMCI Holdings Inc. also intended to jump into the fray with a potential US$340-million investment to set up a plant in the province of Antique’s Semirara Island, which was famous for its large limestone reserves and where DMCI Holdings Inc. was already mining coal.6 Although BBCI’s eco-friendly manufacturing process was in line with the Philippine government directive of reducing greenhouse gas emissions by 70 per cent by 2030,7 BBCI was not the only company offering a green cement product. Of the industry’s four top players, which included Eagle Cement Corporation (Eagle Cement),8 three companies—CEMEX Holdings Philippines Inc. (CEMEX), Republic Cement Group (Republic Cement), and Holcim Philippines Inc. (Holcim),—had also rolled out green products. It was important for BBCI to analyze the macro-environmental and competitive forces relevant in the context of its entry into the cement industry. In an industry already exposed to green products, was it possible for BBCI to differentiate its product based solely on ecological appeal? Would its environmentally- friendly brand promise work? How could BBCI ascertain and counter potential obstacles to its success? BIG BOSS CEMENT INC. Henry “Big Boy” Sy Jr., the eldest son and namesake of the Philippines’ richest man, Henry Sy Sr., owned 95 per cent of BBCI, while another businessman, Anthony L. Almeda, was the other key shareholder with
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Page 2 9B18A055 a 4.88-per-cent stake. Sy Sr. had a net worth of US$12.7 billion as of 2017 and had been named the richest Filipino by Forbes for 10 consecutive years.9 Sy Jr. was the vice-chairperson of SM Investments Corporation and chairperson of both SM Prime Holdings Inc. and SM Development Corporation. SM Investments Corporation was the holding company of the SM Group of Companies and had three reportable operating segments (see Exhibit 1). According to BBCI officials, Sy Jr.’s investment in BBCI was in a personal capacity and independent of any affiliation to SM Investments Corporation.10 Sy Jr., who had graduated with a management degree, had top-level experience in companies engaged in banking, real estate development; construction; mall operation; food and rubber manufacturing; finance; and investment.11 Gilbert S. Cruz, an engineer who had worked in businesses situated in Zamboanga, Pampanga, Cavite, and Metropolitan Manila and had several bachelor degrees (chemistry, industrial engineering, and mechanical engineering), was named president of BBCI.12 Cruz had pioneered ultra-high-strength concrete and self- compacting/consolidating concrete in the Philippines.13 He had the experience of various concreting projects, such as Malaysia’s Petronas Towers in 1996, Taiwan’s high-speed rail project in 1997, China’s Three Gorges Dam project in 1999, and the Tokyo–Yokohama underwater tunnel project in 1999.14 Cement-Making Process The traditional method of cement production involved mining raw materials such as calcium carbonate, silica, alumina, and iron ore, which were extracted from limestone and clay, and crushing and stacking these into a stockpile for grinding. The mix was dried and ground again before cooking in a kiln fed with silica and/or clay, and underwent stages of preheating up to 1,500 degrees Celsius to produce clinker—a basic raw material needed for cement production. Clinker and a certain amount of gypsum were milled together to make cement. Additives gave cement specific properties such as permeability, resistance to sulphate, and higher quality.15 The process induced heavy carbon dioxide emissions, which led to the cement industry accounting for around 5 per cent of global carbon dioxide emissions. Government legislation was pushing cement manufacturers to focus on ways to lower carbon dioxide emissions. The combustion of fuels used to heat the kiln (fossil fuels such as coal and oil) accounted for 40 per cent of emissions, the calcination process (heating of limestone) for 50 per cent, and the electricity used to power additional plant machinery and final transportation accounted for 5–10 per cent of the industry’s emissions.16
Cement manufacturers were working on methods to use alternative fuels to lower fuel-combustion related emissions; for example, Holcim used alternative fuels such as industrial, agro, and residual waste (e.g., used tires and plastics) for its thermal-power requirements. Thermal energy generated from traditional fossil fuels such as coal represented 30–40 per cent of overall costs for the cement industry. The use of alternative fuels not only reduced manufacturing costs but also helped provide the government with a way to handle and dispose of hazardous waste and location waste. For example, when Republic Cement opted to use alternative fuels such as rice husks, saw dust, and refuse-derived fuel, substituting its fossil fuel requirements, the company not only managed to achieve a lower carbon footprint (an 18–25-per-cent emissions reduction), it also helped Metropolitan Manila address its solid waste disposal problem.17
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Page 3 9B18A055 Emissions Reduction Improving production-process efficiency (i.e., moving from wet to dry kilns) and replacing limestone-based clinker with materials such as coal fly ash and blast furnace slag used for blended cement helped reduce emissions.18 According to the Cement Sustainability Initiative, the percentage of clinker in the final cement product across the world had decreased from 83 per cent in 1990 to around 75 per cent in 2012, wherein 25 per cent of the cement was a non-clinker mineral with a lower energy requirement.19 Republic Cement had replaced clinker in its blended cement with carbon-neutral minerals or industrial by-products, as exemplified by its product Republic Portland Plus, which used fly ash, an industrial by-product of the power industry, and had a lower environmental impact, of around 25 per cent.20 Eagle Cement had built a waste- heat recovery system that generated up to 6.30 megawatts of power from the plant’s waste heat and allowed it to save up to 20 per cent of electricity costs in production—while conserving the renewable fuel supply and minimizing harmful gas emissions.21 Product The various products available in the market included Portland cement (made of clinker and gypsum) and blended cement (made of Portland cement clinker, gypsum, and pozzolan); however, local cement manufacturers promoted blended cement because of its durability, performance in severe weather conditions, sustainable construction (carbon dioxide emissions), and economics.22 BBCI had plans to roll out Portland cement Type 1B (blended cement that required less clinker) priced at ₱206 per bag, which was within the government price-control range of ₱205–215 per bag.23 Besides, the process used to produce the clinker did not require a kiln (costing around ₱3–5 billion) and hence required no burning.24 Clinker had to be imported from countries such as China, Vietnam, Indonesia, and Japan as the Philippines did not have enough capacity to crush and burn limestone into the raw material.25 According to a BBCI spokesperson, the company’s cement production process would make use of readily available pozzolanic raw materials such as lahar, and almost all types of soils and fillers.26 The company claimed that it could use any sand the government would allow for its raw material, including beach sand, as sand throughout the Philippines was 93 per cent the same, regardless of its source. BBCI claimed that its process would not only cater to the local cement industry but also decrease air pollution and environmental damage. Further, the company would only incur a cost of ₱2–4 billion, which was lower than the cost of a traditional cement plant (about ₱70 billion).27 However, the process failed to get an initial approval from the Philippine Board of Investment due to a lack of “proof of concept.”28 PHILIPPINE CEMENT INDUSTRY With a population of about 100 million as of 2015, which was growing at an average rate of 1.8–2.3 per cent annually, the Philippines’ need to improve infrastructure facilities and develop new residential areas had compounded.29 Foreseeing the massive requirements for doing so, the National Economic and Development Authority announced an increase in government spending on infrastructure from 5.32 per cent of gross domestic product (GDP) in 2017 (₱847.2 billion) to 7.3 per cent of GDP (₱1.84 trillion) by 2022.30 It earmarked 75 projects for prioritization, approval, and implementation until 2022. Of these, 18 projects, including the Malolos-Clark Airport–Green City Rail Project; New Centennial Water Source Project; Chico River Pump Irrigation Project; Phase 1 of the Mindanao Railway; the New Cebu International Container Port; and the Davao, Bohol, Laguindingan, Bacolod, and Iloilo airports, were approved by the National Economic and Development Authority’s board.31 The government had committed to investing US$23 billion in tourism infrastructure over six years under the National Tourism Development Plan.32
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Page 4 9B18A055 Industry reports estimated that the country’s residential market would account for 33.9 per cent of the construction industry’s total value in 2020, considering that the government intended to give financial aid to middle- and low-income families through various programs such as the Pag-IBIG Affordable Housing Program, Community Mortgage Program, Core Housing Program, and the Abot-Kaya Pabahay Fund Developmental Loan Program.33 However, a falling peso against the U.S. dollar was likely to lead to a rise in bank interest rates, resulting in higher interest on home loans and hence lower demand for housing.34 Despite this, the outlook for the construction industry was still positive. The Philippine government had launched a ₱10-billion reconstruction project for the City of Marawi, which had been destroyed in a state- versus-rebel group conflict.35 Apart from this, a rising expatriate population was fuelling demand for posh condominiums in the Philippines.36 Government focus on infrastructure investment, the urbanization of underprivileged rural areas, and housing projects for low- and middle-income groups had encouraged growth in the construction sector, which was expected to reach US$47 billion by 2020. The Asian Development Bank had upgraded the GDP forecast for 2018 from 6.7 per cent to 6.8 per cent, based on the assumption that the government’s infrastructure programs and investment would accelerate large projects.37 According to the Cement Manufacturers’ Association of the Philippines (CeMAP), cement sales, including those of imported cement, were rising (see Exhibit 2). By the end of 2016, sales had risen 6.6 per cent to 25.96 million metric tons, of which 1.59 million metric tons were imported.38 But cement importers needed to pay a minimum capitalization of ₱20 million and a post-surety bond of 10 per cent of the declared value of the imported cement.39 The gap between demand and local supply was the result of the lower-than-estimated effective capacity of most plants. These plants, which required refurbishments, were more than 20 years old and had a lower than 0.80 clinker-to-cement ratio. Moreover, to meet the Philippines’ growing needs, the cement industry was expected to grow “by an additional 11.5 million tons until 2025,” from its demand of 26.82 million metric tons in 2017.40 BBCI hoped to account for 3 per cent of the estimated 26.82 million metric tons, as existing players could only accommodate 20–22 million metric tons of the 2017 demand.41 No CeMAP report of the cement industry was available after 2016 because the association had halted the collection of sales data in August 2017 following an investigation into CeMAP, Holcim, and Republic Cement by the Philippine Competition Commission for alleged violations of competitive practices.42 As part of global initiatives to reduce emissions, the Philippine government, too, was promoting green products and had rolled out the NELP – GCP to veer consumers towards buying environmentally-friendly products by labelling and declaring products “green” on the basis of clean manufacturing practices.43 Besides this, the new companies BBCI, CEMEX, Republic Cement, and Holcim all had their products certified as “green” by the NELP – GCP. MAJOR PLAYERS As of 2016, the top four companies—Holcim, CEMEX, Republic Cement, and Eagle Cement—accounted for 80–82 per cent of total clinker and cement domestic production.44 Holcim was the market leader with the largest cement-production capacity— 8 million metric tons as of 2016 (see Exhibit 3). The competition was becoming more intense, with each of the four competitors rolling out initiatives and investments to increase production output by 2020 (see Exhibit 3). The Philippine cement industry’s production capacity was estimated at 28.63 million metric tons as of December 2016, based on nameplate capacities of integrated cement manufacturing and grinding plants.45 Industry reports placed the
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Page 5 9B18A055 number of cement plants in the country at 18 (16 integrated and two grinding plants), with the plants of the top four players spread across the Luzon, Visayas, and Mindanao regions (see Exhibit 4). Holcim Philippines Inc. Holcim was a member of the LafargeHolcim Ltd. group, a world leader in the construction materials industry, with a presence in 80 countries and over 80,000 employees.46 The company was formed in 2000 after the merger of three companies—Bacnotan Cement Corporation, Davao Union Cement Corporation, and Hi Cement Corporation—and the subsequent acquisition of the Alsons Cement Corporation in 2002.
Holcim manufactured, sold, and distributed cement, dry mix mortar products, and clinker. The company and its subsidiaries had four production facilities (see Exhibit 4), one grinding mill, three ports, and several storage and distribution points across the Philippines.47 Its investments in several sustainability initiatives, such as a continuous emissions monitoring system—to watch gaseous and dust emissions in real time— and being a founding member of the World Business Council for Sustainable Development, reflected the company’s commitment to reducing emissions by 20 per cent by 2010.48 CEMEX Holdings Philippines Inc. CEMEX, a subsidiary of CEMEX Asian South East Corporation, was a global building-materials company and had a presence across 50 countries. Its products included ordinary Portland cement, masonry or mortar cement, blended cement, and ready-mix concrete. As of March 31, 2016, the company and its subsidiaries owned two cement plants (see Exhibit 4), one ready-mix concrete plant, one admixtures facility, and several land distribution facilities and shipping terminals across the Philippines.49 Apart from developing green products, the company was also involved in several corporate social responsibility and skill-developing initiates. In 2014, it conducted a free 33-day masonry skills training program—Experto Ako!—where over 200 masons were taught about proper cement application and equipment, values formation, and teamwork.50 Besides this, CEMEX had partnered with the local government and non-profit organizations in the aftermath of Super Typhoon Yolanda to help rebuild and rehabilitate affected communities in the northern part of Cebu province.51 Republic Cement Group Republic Cement & Building Materials, Inc.; Republic Cement Iligan, Inc.; Republic Cement Mindanao, Inc.; and Republic Cement Services, Inc. comprised the Republic Cement Group, a joint venture between Ireland-based company CRH and local conglomerate Aboitiz Equity Ventures. CRH was a Fortune 500 building-materials company listed on the London Stock Exchange and the Irish Stock Exchange, and Aboitiz Equity Ventures, a public holding company of the Aboitiz Group, was a Filipino business group listed on the Philippine Stock Exchange. It had major investments in power, banking and financial services, food, infrastructure, and real estate. Republic Cement was involved in multiple sustainability initiatives; four of its key initiatives were for (1) people and communities (health, training, affordable housing, ethics, and compliance); (2) climate-change mitigation (reducing carbon dioxide emissions and the amount of clinker in cement, using alternative fuels, improving heat efficiency, and reforestation); (3) environmental responsibility (water conservation, bio-diversity, and particulate matter); and (4) blue innovation (discovering and promoting ecologically-sound solutions, processes, and products).52
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Page 6 9B18A055 Eagle Cement Corporation Eagle Cement was majority-owned and managed by Chinese Filipino businessman Ramon Ang, who was the president and chairman of San Miguel Corporation. He owned a hotel and over 100 acres of prime real estate.53 San Miguel Corporation was among the largest and most diversified conglomerates in the Philippines. It contributed about 5.1 per cent of the country’s GDP (as of 2015) through its operations in beverages, food, packaging, fuel and oil, power, and infrastructure.54 It manufactured, marketed, sold, and distributed cement products and by-products and had two wholly-owned subsidiaries—South Western Cement Corporation and KB Space Holdings Inc., a land holding company. While South Western Cement Corporation manufactured and sold cement and its by-products and owned mineral rights in Malabuyoc in the province of Cebu, KB Space Holdings Inc. owned several parcels of prime commercial land in Mandaluyong City.55 Eagle Cement had a cement production facility in Barangay Akle, Bulacan (see Exhibit 4), and a grinding and packaging facility in Limay, Bataan. THE WAY FORWARD BBCI operated a testing facility in Mandaluyong capable of a monthly production of 5,000 bags of cement.56 It was in the process of building a facility with an output capacity of 1.5 million bags of cement per month in Porac, Pampanga. Commercial operations were expected to start there in March 2018.57 BBCI planned to invest around ₱4 billion for two additional plants (both in Luzon) to increase its monthly capacity to 10 million bags of cement, and another plant was planned at Zambaonga Peninsula.58 Even as BBCI aimed for capacity expansions, it needed to identify and address potential obstacles to its success and decide how to manage them. Considering BBCI was not the only company to launch “green” cement to reduce emissions or to be involved in environmentally-friendly initiatives, it was necessary for the company to set itself apart from the others by its product’s eco appeal. It was also essential for BBCI to ensure that its segmentation, targeting, and positioning strategies were well aligned with its environmentally-friendly brand promise, for it to emerge as a market leader.
Shweta Pandey is Associate Professorial Lecturer at De La Salle University, Philippines; Sandeep Puri and Babak Hayati are Associate Professors at the Asian Institute of Management, Philippines.
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Page 7 9B18A055
EXHIBIT 1: SM INVESTMENTS CORPORATION OPERATING SEGMENTS
Area Subsidiaries (Category)
Retail The SM Store (non-food) SM Markets, WalterMart, Alfamart (food)
Property SM Prime Holdings Inc. (malls, residences)
Financial Services
BDO Unibank Inc. (investment banking, wealth management, credit cards, insurance, leasing, remittances) China Banking Corporation (serving small and medium-sized companies’ investment needs)
Sources: “Our Company,” SM Investments Corporation, accessed January 18, 2018, www.sminvestments.com/our-company; “Company Information: SM Investments Corporation,” PSE EDGE, accessed January 18, 2018, http://edge.pse.com.ph/companyInformation/form.do?cmpy_id=599.
EXHIBIT 2: CEMENT PRODUCTION, IMPORTS, AND DEMAND ('000 METRIC TONS), 2009–2016
Year Production Imports Demand (Local Sales +
Imports) Change (%)
2009 14,865 1 14,470 9.48 2010 15,900 1 15,450 6.77 2011 16,063 30 15,625 1.13 2012 18,907 0 18,395 17.73 2013 20,150 0 19,604 6.57 2014 21,305 4 21,305 8.68 2015 24,046 314 24,360 14.34 2016 24,370 1,590* 25,960* 6.57
Source: Cement Manufacturers’ Association of the Philippines Inc. (CeMAP), 2015 Annual Cement Industry Report, 2015, accessed January 25, 2018, http://cemap.org.ph/downloadables/PDF/cemap2015.pdf; *Philippines News Agency, “Cement Demand to Double by 2021 with Infra Boost,” The Manila Times, June 20, 2017, accessed January 18, 2018, www.manilatimes.net/cement-demand-double-2021-infra-boost/333791/.
EXHIBIT 3: PRODUCTION CAPACITY ('000 TONS) FOR KEY CEMENT MANUFACTURERS
Company 2016 2020 Holcim Philippines Inc. 8,000 12,000 Republic Cement Group 7,000 10,000 Cemex Holdings Philippines Inc. 5,700 7,200 Eagle Cement Corporation 5,100 9,100 Total 25,800 38,300
Source: Global Cement Staff, “Holcim Philippines to Bring on Extra 2Mt/yr through Debottlenecking,” Global Cement, May 26, 2017, accessed January 25, 2018, www.globalcement.com/news/item/6155-holcim-philippines-to-bring-on-extra-2mt-yr- through-debottlenecking; Danessa Rivera, “Republic Cement to Raise Capacity,” The Philippine Star, September 18, 2017, accessed January 25, 2017, www.philstar.com/business/2017/09/19/1740381/republic-cement-raise-capacity; Iris Gonzales, “Cemex Plans Additional Capacity in Philippines by 2019,” The Philippine Star, June 20, 2016, accessed January 25, 2018, www.philstar.com/business/2016/06/20/1594537/cemex-plans-additional-capacity-philippines-2019; Eagle Cement, “Eagle Cement Breaks Ground on its P12.5-B Integrated Cement Plant in Cebu,” November 22, 2017, accessed January 25, 2018, www.eaglecement.com.ph/article/eagle-cement-breaks-ground-on-its-p12-5-b-integrated-cement-plant-in-cebu/5.
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Page 8 9B18A055
EXHIBIT 4: REGION-WISE DISTRIBUTION OF KEY CEMENT PLANTS
Region Island Group
Regional Centre
Cement Plants
Ilocos (Region I) Luzon San Fernando
Holcim Philippines Inc.: La Union Plant, Bacnotan San Miguel Yamamura Packaging Corporation: Northern Cement Corporation Plant, Pangasinan Mabuhay Filcement Inc.: San Fernando
Central Luzon (Region III)
Luzon San Fernando
Eagle Cement Inc.: San Ildefanso, Bulacan Taiheyo Cement Corporation: San Feranando Republic Cement Group: Bulacan, Norgazaray Holcim Philippines Inc.: Bulacan BBCI:Porac, Pampanga
Calabarzon (Region IV-A)
Luzon Calamba
Republic Cement Group: Batangas Plant and Teresa Plant Cemex Holdings Philippines Inc.: Solid Cement Corporation at Rizal
Bicol (Region V) Luzon Legazpi Goodfound Cement Corp.: Albay
Central Visayas (Region VII)
Visayas Cebu City
Republic Cement: Danao Plant Cemex Holdings Philippines Inc. (APO Cement Corporation): Tina-an, Naga City, Cebu
Northern Mindanao (Region X)
Mindanao Cagayan de Oro
Republic Cement Group: Iligan Cement plant Holcim Philippines Inc.:Lugait Plant
Davao Region (Region XI)
Mindanao Davao City Holcim Philippines Inc.:Davao Plant
Zamboanga Peninsula (Region IX)
Mindanao Pagadian Big Boss Cement Inc.: Plant II (Planned), Zamboanga Peninsula
Source: “Cement Plants Located in Philippines,” CemNet.com, accessed January 30, 2018, www.cemnet.com/global-cement- report/country/philippines. F
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Page 9 9B18A055 ENDNOTES
1 This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives presented in this case are not necessarily those of Big Boss Cement Inc. or any of its employees. 2 Ted Cordero, “Henry Sy Jr. Goes into Cement Business,” GMA News Online, January 11, 2018, accessed January 18, 2018, www.gmanetwork.com/news/money/companies/639384/henry-sy-jr-goes-into-cement-business/story/. 3 ₱ = Philippine peso; All currency amounts are in ₱ unless otherwise specified; US$1= ₱51.41 on January 30, 2018. 4 Philippines News Agency, “Cement Demand to Double by 2021 with Infra Boost,” The Manila Times, June 20, 2017, accessed January 18, 2018, www.manilatimes.net/cement-demand-double-2021-infra-boost/333791/. 5 “Labor, Cement Shortages Threaten Infrastructure Momentum,” The Philippine Star, November 28, 2017, accessed January 20, 2018, www.philstar.com/business/2017/11/28/1763368/labor-cement-shortages-threaten-infrastructure-momentum. 6 Doris Dumlao-Abadilla, “DMCI to Enter Cement Business,” Inquirer.net, June 6, 2017, accessed January 12, 2018, http://business.inquirer.net/230853/dmci-enter-cement-business. 7 “PH Vows to Lower Carbon Emissions 70% by 2030,” Philippine Daily Inquirer, October 2, 2015, accessed January 21, 2018, http://newsinfo.inquirer.net/727316/ph-vows-to-lower-carbon-emissions-70-by-2030. 8 Richmond Mercurio, “Cement Makers Halt Sales Data Collection,” The Philippines Star, August 23, 2017, accessed January 20, 2018, www.philstar.com/business/2017/08/23/1731672/cement-makers-halt-sales-data-collection. 9 Bettina Faye V. Roc, “The Other Henry Sy,” SM Investments Corporation, July 26, 2013, accessed January 21, 2018, www.sminvestments.com/other-henry-sy#; Krista A. M. Montealegre, “Henry Sy, Jr. Forays into Cement Business,” BusinessWorld, January 12, 2018, accessed January 21 2018, http://bworldonline.com/henry-sy-jr-forays-cement-business/; Rosette Adel, “Forbes: Henry Sy World’s Richest Filipino for a Decade Now,” The Philippine Star, August 24, 2017, accessed January 22, 2018, www.philstar.com/business/2017/08/24/1732274/forbes-henry-sy-worlds-richest-filipino-decade-now. 10 Ted Cordero, op. cit. 11 “BBCI Executive Profile: Chairman – Henry Sy, Jr.,” Big Boss Cement, accessed January 22, 2018, http://bigbosscement.com/management-team/. 12 “BBCI Executive Profile: President – Engr. Gilbert S. Cruz,” Big Boss Cement, accessed January 22, 2018, http://bigbosscement.com/management-team/. 13 Ibid. 14 James Humarang, “Concrete Technologist Launches Greenest Cement Company in PH,” Tech and Lifestyle Journal, January 16, 2018, accessed January 22, 2018, http://techandlifestylejournal.com/big-boss-cement-initial-announcement/. 15 “Manufacturing Process,” Lafarge, accessed January 22, 2018, www.lafarge-na.com/wps/portal/na/en/2_2_1- Manufacturing_process. 16 Madeleine Rubenstein, “Emissions from the Cement Industry,” May 9, 2012, accessed January 22, 2018, http://blogs.ei.columbia.edu/2012/05/09/emissions-from-the-cement-industry/; Peter Edwards, “The Rise and Potential Peak of Cement Demand in the Urbanized World,” Cornerstone, accessed January 30, 2018, http://cornerstonemag.net/the-rise- and-potential-peak-of-cement-demand-in-the-urbanized-world/. 17 “Environmental Responsibility,” Holcim Philippines, accessed January 30, 2018, www.holcim.ph/sustainable- development/environmental-responsibility; Peter Edwards, op. cit.; “Climate Change Mitigation,” Republic Cement, accessed January 30, 2018, www.republiccement.com/our-advocacies/sustainable-development/climate-change-mitigation. 18 Madeleine Rubenstein, op. cit. 19 Peter Edwards, op. cit. 20 “Climate Change Mitigation,” op. cit. 21 “Taking Green to a Higher Level,” Eagle Cement, May 16, 2017, accessed January 30, 2017, www.eaglecement.com.ph/article/taking-green-to-a-higher-level/7. 22 “Blended Cement Is Next Generation Building Material,” The Philippine Star, February 6, 2011, accessed January 30, 2018, www.philstar.com/business/654393/blended-cement-next-generation-building-material. 23 Richmond Mercurio, “Price Cap on Construction Materials in Marawi Ordered,” The Philippine Star, November 23, 2017, accessed January 30, 2018, www.philstar.com/nation/2017/11/23/1761500/price-cap-construction-materials-marawi-ordered; James Humarang, op. cit. 24 Krista A. M. Montealegre, op. cit.; “Big Boss Cement to Prove Concept to Board of Investments,” CemNet.com, January 22, 2018, accessed February 7, 2018, www.cemnet.com/News/story/163270/big-boss-cement-to-prove-concept-to-board-of- investments.html. 25 Rose de la Cruz, “Cementing the Industry in an Environment-Friendly Way,” OpinYon, January 19, 2018, accessed January 30, 2018, www.opinyon.com.ph/index.php/3065-cementing-the-industry-in-an-environment-friendly-way. 26 VG Cabuag, “Cement Makers Jostle for Bigger Market Share,” Business Mirror, April 22, 2017, accessed January 21, 2018, https://businessmirror.com.ph/cement-makers-jostle-for-bigger-market-share/. 27 Rose de la Cruz, op. cit. 28 “Big Boss Cement to Prove Concept to Board of Investments,” op. cit. 29 Recto Mercene, “Infrastructure, Transport Projects Make Philippines Ripe for Investment,” Business Mirror, October 23, 2015, accessed January 24, 2018, https://businessmirror.com.ph/infrastructure-transport-projects-make-philippines-ripe-for- investment/. 30 “‘Build, Build, Build’ Is a Go,” Inquirer.net, December 18, 2017, accessed January 23, 2018, http://opinion.inquirer.net/109558/build-build-build-go.
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Page 10 9B18A055 31 “Increased Infra Spending to Boost PH Economy – NEDA,” Republic of the Philippines, National Economic and Development Authority, September 8, 2017, accessed January 24, 2018, www.neda.gov.ph/2017/09/08/increased-infra-spending-to-boost- ph-economy-neda/. 32 Rey Gamboa, “Tourism Investment Gate Opens,” The Philippine Star, January 11, 2018, accessed January 24, 2018, www.philstar.com/business/2018/01/11/1776509/tourism-investment-gate-opens. 33 Richmond Mercurio, “Philippine Construction Works Seen Growing over 50% by 2020,” The Philippine Star, May 26, 2016, accessed January 24, 2018, www.philstar.com/business/2016/05/26/1586914/philippine-construction-works-seen-growing- over-50-2020. 34 Ditas B. Lopez and Y-Sing Liau, “Philippine Peso Predicted to be Asia’s Worst-performing Currency in 2018,” Bloomberg, December 21, 2017, accessed January 25, 2018, www.bloomberg.com/news/articles/2017-12-21/philippine-peso-seen-as- asia-s-laggard-for-2018-as-deficit-grows; Catherine Talavera, “Weaker Peso to Impact Property Market – JLL Analyst,” Manila Times, December 6, 2016, accessed January 25, 2018, www.manilatimes.net/weaker-peso-impact-property-market-jll- analyst/300252/. 35 Bernie Cahiles-Magkilat, “Cement Demand, Imports Seen Rising; Supply Enough for Projects,” Manila Bulletin, June 17, 2017, accessed January 23, 2018, https://business.mb.com.ph/2017/06/17/cement-demand-imports-seen-rising-supply- enough-for-projects/. 36 Tessa R. Salazar, “Expat Population Spurs Demand for Posh Condos,” Inquirer.net, June 15, 2012, accessed January 24, 2018, http://business.inquirer.net/65303/expat-population-spurs-demand-for-posh-condos. 37 Richmond Mercurio, “Philippine Construction Works Seen Growing over 50% by 2020,” op. cit.; Chris Schnabel, “ADB Upgrades Philippine GDP Growth Forecast for 2017, 2018,” Rappler, December 13, 2017, accessed January 30, 2018, www.rappler.com/business/191245-adb-upgrade-philippines-gdp-outlook-2017-2018. 38 ICR Newsroom, “Philippines Cement Sales Rise 6.6% in 2016,” CemNet.com, February 28, 2017, accessed January 27, 2018, www.cemnet.com/News/story/161205/philippines-cement-sales-rise-6-6-in-2016.html; Philippines News Agency, op. cit. 39 “DTI Issues New Requirements on Cement Importation,” Malaya Business Insight, March 1, 2017, accessed February 20, 2018, www.malaya.com.ph/business-news/business/dti-issues-new-requirements-cement-importation. 40 VG Cabaug, op. cit. 41 Krista A. M. Montealegre, op. cit. 42 Global Cement Staff, “Philippine Competition Commission Expects to Complete Investigation of Cement Industry by 2019,” Global Cement, August 3, 2017, accessed January 21, 2018, www.globalcement.com/news/item/6412-philippine-competition- commission-expects-to-complete-investigation-of-cement-industry-by-2019. 43 Ma. Elisa Osorio, “DTI Urges Consumers to Buy Products with Green Choice Seal,” The Philippine Star, August 28, 2011, accessed January 21, 2018, www.philstar.com/business/720829/dti-urges-consumers-buy-products-green-choice-seal. 44 Cabaug, op. cit. 45 Doris Dumlao-Abadilla, op. cit. 46 “About Us,” Holcim Philippines, accessed January 21, 2018, www.holcim.ph/about-us. 47 “Company Information: Holcim Philippines, Inc.,” PSE EDGE, accessed January 30, 2018, http://edge.pse.com.ph/companyInformation/form.do?cmpy_id=211. 48 “Environmental Responsibility,” op. cit. 49 “Company Information: Cemex Holdings Philippines, Inc.,” PSE Edge, accessed January 30, 2018, http://edge.pse.com.ph/companyInformation/form.do?cmpy_id=662. 50 “CEMEX Completes Experto Ako! Masonry Skills Training Program in Cebu,” CEMEX Holdings Philippines, October 10, 2014, accessed January 30, 2018, www.cemexholdingsphilippines.com/News20141010_2.aspx. 51 CEMEX, Integrated Strategy for a Better Future: 2016 Integrated Report, 2016, accessed January 30, 2018, www.cemex.cz/Userfiles/dokumenty/vyrocni-zpravy/IntegratedReport2016.pdf. 52 “About Us,” Republic Cement, accessed January 30, 2018, www.republiccement.com/about-us/profile; “Republic Cement Team Members Green the Coast,” Aboitiz Eyes, 2016 Issue 4, accessed January 30, 2018, http://aboitizeyes.aboitiz.com/republic-cement-team-members-green-coast/. 53 “Ramon Ang,” Forbes, accessed January 30, 2018, www.forbes.com/profile/ramon-ang/; Cabaug, op. cit. 54 “Our Company,” San Miguel Corporation, accessed January 30, 2018, www.sanmiguel.com.ph/page/our-company-inner. 55 “Eagle Cement Corporation,” PSE Edge, accessed January 30, 2018, http://edge.pse.com.ph/companyInformation/ form.do?cmpy_id=667. 56 Richmond Mercurio, “Henry Sy Jr. Ventures into Cement Business,” The Philippine Star, January 12, 2018, accessed January 22, 2018, http://webcache.googleusercontent.com/search?q=cache:Nux4ASxiLUYJ:old.philstar.com:8080/business/ 2018/01/12/1776833/henry-sy-jr.-ventures-cement-business+&cd=13&hl=en&ct=clnk&gl=ph. 57 James Humarang, op. cit. 58 “Henry Sy Jr.’s Big Boss Cement Eyes P4-B Investment for Expansion,” GMA News Online, January 20, 2018, accessed January 22, 2018, www.gmanetwork.com/news/money/companies/640380/henry-sy-jr-s-big-boss-cement-eyes-p4-b- investment-for-expansion/story/.
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9B11N021 STRONG TIE LTD.
Dan Thompson wrote this case solely to provide material for class discussion. The author does not intend to illustrate either effective or ineffective handling of a managerial situation. The author may have disguised certain names and other identifying information to protect confidentiality. Richard Ivey School of Business Foundation prohibits any form of reproduction, storage or transmission without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Richard Ivey School of Business Foundation, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail cases@ivey.uwo.ca. Copyright © 2012, Richard Ivey School of Business Foundation Version: 2012-02-03
In early January 2009, David Johnstone received the draft 2008 financial statements for Strong Tie and began to question the company’s performance when compared to previous years. How were profits holding up, given the intense price competition in the industry? Were attempts to lower costs through more automation paying off? Were the current problems in the U.S. housing market going to continue to reduce demand for connectors? How would lenders react to this poor performance? Was the company’s financing in danger? After discussing the matter with company accountant Audrey Johnstone, it was decided that an outside consultant should be hired to provide an independent analysis of the company’s recent performance and to provide suggestions for future action. COMPANY BACKGROUND Strong Tie Ltd., located in Winnipeg, Manitoba, designed and manufactured the standardized and customized structural connectors used to reinforce wood joints in the construction of decks, fences, houses and other structures. Strong Tie was a family-owned corporation founded in 1946 by Bill Johnstone to capitalize on the high demand for housing as returning World War II veterans married and began families. Bill Johnstone died in 1975 but passed the business on to his son David, who continued to operate the business along with his three daughters, Ellen, Elizabeth and Audrey. David served as CEO, while Ellen Johnstone, P.Eng, was responsible for product design and production; Elizabeth Johnstone, CSP, managed marketing, sales and distribution; and Audrey Johnstone, CA, managed the company’s finances. The Johnstone family was a pillar of the Winnipeg business community, making sizeable donations to local charities and sport teams. The standardized connectors were designed in Winnipeg based on input from architects, draftsmen and builders. The production process was highly automated with metal cutting, stamping and drilling machines completing most of the tasks. Human intervention was required to transfer work-in-process between stations, to feed machines and to pack, store and distribute the end products. This automation had allowed production to remain in Canada to date despite fierce competition from low-wage countries, particularly China. Customized connectors were produced based on specifications provided by the customer.
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Production of these units was more labour-intensive, but margins were still significantly higher as contractors were prepared to pay a premium to have their special needs met. Strong Tie prided itself on its product design capabilities. Designers in Winnipeg consistently generated an array of new standardized connectors that improved on existing products or addressed newly identified industry needs. These products were described in detail in terms of dimension, strength (load-bearing weights and steel gauge) and installation on the company’s website or in a paper catalogue located in stores — both were of very high quality. Strong Tie also had a reputation among construction professionals as providing innovative solutions to unique design requests and being able to produce customized products in a timely manner at a reasonable price. Standardized products were distributed through all national home improvement chains in North America including Home Depot, Lowe’s, Rona, Home Hardware, Eagle and Sears. Most local chains catering to contractors also carried the standardized products and accepted requests for customized connectors, which they then forwarded to Strong Tie. Strong Tie was estimated to have a 60 per cent market share, which had fallen from 70 per cent in recent years. Universal Connector, a U.S. firm based in Ohio, was estimated to have a 30 per cent and growing share; it offered a similar array of standardized products and customized design services. The remainder of the market was served by five Chinese producers whose market share had grown considerably in the last five years, although they had yet to enter the customized product segment. Universal Connector had closed a number of its U.S. manufacturing facilities in recent years and replaced them with new facilities in China, which put considerable downward pressure on industry prices. Currently, Strong Tie priced its products at a premium to its competitors because of its industry leadership. All sales were on terms Net 60. Large accounts such as Home Depot had a reputation of stretching their payments past the due date because of their buying power, while contractors frequently delayed payments due to cash flow problems. All purchases, which were primarily steel, were on terms 2/10, Net 60. Metal prices varied considerably, and the trend over 2006 to 2008 was for these prices to rise due to increasing demand from emerging market countries, particularly Brazil, Russia, India and China. Strong Tie had attempted to adopt just-in-time inventory practices to help reduce its raw material, work-in-process and finished goods inventory levels. The Johnstone family maintained excellent relations with its unionized workforce, which was represented by the United Steel Workers of America. They prided themselves on paying generous wages and providing their workers with excellent health care, disability and pension benefits. The company had never had a strike and was currently negotiating a new collective agreement to take effect in three months on April 1, 2009. In recent years, Strong Tie had been investing heavily in factory automation to improve its competitiveness. Automatic feeders and packaging equipment had been purchased to further reduce labour costs, and new computers and software had helped to speed up the design of high-margin customized connectors. A new, more automated warehouse had also been constructed. FINANCIAL STATEMENTS Exhibits 1 and 2 contain the income statements and balance sheets for Strong Tie for the last three years.
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FINANCIAL BENCHMARKS Reliable industry average information was not available for Strong Tie’s Chinese competitors, but comparable ratios were available for Universal Connector, a public company, in 2008. These ratios are contained in Exhibit 3. FINANCING Strong Tie had a $2,000,000, five-year, revolving credit agreement with the Bank of Nova Scotia, which was used to finance the company’s working capital requirements as well as a number of individual term loans to finance fixed assets. The revolving credit agreement was committed, so as long as the loan conditions were met, financing was guaranteed. The loan had to be secured 100 per cent by accounts receivable and inventory. The receivables were primarily with large retail chains that were in good financial health, so the Bank of Nova Scotia was prepared to lend 90 per cent of their value. They were also willing to lend 60 per cent of the value of the finished goods and work-in-process inventory because of a strong re-sale market and the short production process. The bank would only lend 40 per cent of the value of raw materials inventory due to general instability in the commodities market. The revolving credit agreement had to be paid down to zero at least once per year. All loans required that the company maintain a Current Ratio of 1.5 or higher, a Cash Flow Coverage Ratio of 1.0 or higher and a Long-term Debt to Total Capitalization Ratio of 40 per cent or less. Audited quarterly and annual financial statements also had to be provided to the bank each quarter. As the sole owner of the corporation, David Johnstone did not take a salary, but his three daughters received over $1,000,000 in salary and bonuses each year. Preferred dividends of $500,000 were paid out to Mr. Johnstone’s sister Katherine, who chose not to participate in the management of the business but was promised a regular income by her late father in lieu of receiving a share of the business. These dividends had to be paid unless the company entered bankruptcy.
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Exhibit 1
INCOME STATEMENTS
2006 2007 2008 Net Sales $16,200 $17,450 $16,500 Cost of Goods Sold 10,445 11,956 11,950 Gross Profit $5,755 $5,494 $4,550 Selling and Administration 3,054 3,130 3,379 Depreciation 396 720 756 Operating Income $2,305 $1,644 $415 Other Income Interest Income 21 10 2 Other Expense Interest Expense 246 291 407 Income Before Taxes $2,080 $1,363 $10 Income Taxes 624 409 3 Net income $1,456 $954 $7
Exhibit 2
BALANCE SHEETS
2006 2007 2008 Current Assets Cash $234 $122 $61 Temporary Investment 1,034 488 99 Accounts Receivable, Net 3,250 3,450 2,854 Raw Materials Inventory 1,025 1,350 1,395 WIP Inventory 200 138 42 Finished Goods Inventory 2,030 1,700 1,200 Prepaid Expenses 182 143 188 Total Current Assets $7,955 $7,391 $5,839 Fixed Assets Land , Plant, and Equipment $4,893 $7,076 9,590 Less: Accumulative Depreciation 1,380 2,100 2,856 Net Land, Plant, Equipment 3,513 4,976 6,734 Total Assets $11,468 $12,367 $12,573 Current Liabilities Accounts Payable $534 $543 500 Income Taxes Payable 54 35 23 Current Portion of Long-term Debt 1,000 1,145 1,340 Total Current Liabilities $1,588 $1,723 $1,863 Long-term Liabilities 3,190 3,500 4,059 Shareholders’ Equity Common Shares 1,350 1,350 1,350 Retained Earnings 5,340 5,794 5,301 Total Shareholders’ Equity $6,690 $7,144 $6,651 Total Liabilities and Shareholders’ Equity $11,468 $12,367 $12,573
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Exhibit 3
BENCHMARK RATIOS
Ratio Industry Average
Current Ratio 4 Cash Ratio .5 Raw Materials Turnover in Days 31 days WIP Turnover in Days 3 days Finished Goods Turnover in Days 51 days A/R Turnover in Days 63 days A/P Turnover in Days 11 days Cash Conversion Cycle 137 days Fixed Asset Turnover 4.1 Total Asset Turnover 1.7 Long-term Debt to Total Capitalization 35% Cash Flow Coverage 2 Gross Profit Margin 32% Operating Profit Margin 16% Net Profit Margin 10% ROA 17% ROE 28%
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9B17M040 HILLBERG & BERK: AIMING TO SPARKLE IN THE DESIGNER JEWELLERY BUSINESS Selena Shannon Pritchard wrote this case under the supervision of Professor W. Glenn Rowe solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized, or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com. Copyright © 2017, Richard Ivey School of Business Foundation Version: 2017-04-25 In September 2016, Rachel Mielke, chief executive officer (CEO) of Hillberg & Berk (H&B), was reviewing plans for H&B’s newly expanded flagship store and office building in Mielke’s hometown of Regina, Saskatchewan, Canada. In doing so, she reflected on the nine years since she had started H&B. In that time, H&B had grown tremendously (see Exhibit 1) and had established a recognized brand in the competitive designer jewellery landscape. At the top of Mielke’s mind was how to manage the company’s signature Sparkle Collection. Accounting for more than 70 per cent of sales, the collection had been a tremendous hit for the company. Now Mielke wondered how she could capitalize on the success of this product and build loyalty with the rest of the jewellery designed and offered by H&B. While H&B was no longer a small company, nor a large one, Mielke knew that how she managed her company’s strategy going forward would have significant implications for its ability to maintain sustainable growth. COMPANY INTRODUCTION Mielke founded H&B in 2007 out of a personal passion for jewellery design and entrepreneurship. Mielke’s goal for the company had been to create a world-class jewellery brand that empowered women and met them at every important life milestone. She aspired for the brand to align with her core beliefs and to remain authentic, which was evident in many elements of the company’s brand presence, including the name—the company was named for Mielke’s grandmother, Hilda Bergman, and Mielke’s dog, Berkley. The company had seen impressive growth as a result of building a loyal customer following. In her home province of Saskatchewan, Mielke had generated a lot of buzz and earned media for the brand, especially after her success on the Canadian Broadcasting Corporation’s television program Dragons’ Den and the company’s high-visibility partnerships with the Canadian Olympic team, the Canadian Football League, Tacori Diamonds, and Olympic gold medallist ice dancer Tessa Virtue. Dragons’ Den was a popular television show in Canada, wherein five successful Canadian business people (known as the “Dragons”) heard pitches from a variety of entrepreneurs. Mielke’s Dragons’ Den pitch was particularly helpful in getting the brand off the ground. In 2008, Mielke pitched the Dragons, asking for
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$200,0001 in exchange for 20 per cent of the company. Mielke impressively managed her time with the Dragons, noting how all the elements of her products were designed by H&B and had been featured in 2008 in a gifting lounge at the Oscar Awards in Los Angeles, California. At the time, H&B had $110,000 in annual revenue, which Mielke had generated while working part-time. For 2009, Mielke forecasted $420,000 in revenue. Brett Wilson, a Saskatchewan native and “Dragon,” bought into Mielke’s pitch and invested $200,000 in exchange for 30 per cent of the company. The deal went through, and Wilson became and remained a trusted coach for Mielke. By 2016, H&B had more than 120 employees and had delivered more than $10 million in annual revenue. H&B had also remained committed to its original goal of empowering women. By 2016 the company had contributed more than $600,000 to national and international women’s organizations. THE DESIGNER JEWELLERY INDUSTRY H&B operated in the affordable segment of the designer jewellery industry (defined by items that retailed for less than US$1,500). Within this segment, H&B viewed its closest group of competitors as Swarovski, PANDORA, Kendra Scott, and Alex and Ani (see Exhibits 2 and 3). The jewellery industry had grown at rates of between 5 and 6 per cent annually and was expected to total US$275 billion in global annual sales by 2020. Most companies in the industry were localized, with a few exceptions. However, brands had started to consolidate and drive international brand presence. It was expected, for example, that Swarovski would become one of the top global brands by 2020 (see Exhibit 3). In 2015, branded jewellery accounted for 20 per cent of overall jewellery sales; however, that number was expected to grow to 30–40 per cent of all sales by 2020.2 The greatest consumer growth in the industry had been in purchases of affordable, designer jewellery by three consumer groups: “new money” consumers who sought to display their newfound wealth, emerging market consumers who sought brands they trusted to represent their upgraded lifestyles, and finally, young consumers who viewed wearing certain brands as a preferred way to express themselves. Wholesale remained the key distribution method to consumers;3 however, brands were both expanding their e-commerce presence and opening bricks-and-mortar retail locations as an avenue for sharing their brand stories. For example, H&B competitor PANDORA had expanded from 200 locations in 2009 to more than 1,800 in 2016, and Swarovski had grown from only two stores in 1990 to more than 2,680 stores in 2016.4 While in the past the jewellery industry had comprised high- and low-end brands, a hybridization appeared to be occurring, resulting in brands offering products at a variety of price points in an effort to attract new consumers. At the same time, luxury brands such as Harry Winston and Cartier had doubled down on their exclusivity and high price point, maintaining a luxury brand image.5
1 All currency amounts are in Canadian dollars unless otherwise indicated. 2 Linda Dauriz, Nathalie Remy, and Thomas Tochtermann, “A Multi-Faceted Future: The Jewelry Industry in 2020,” McKinsey Insights, February 2014, accessed October 4, 2016, www.mckinsey.com/industries/retail/our-insights/a- multifaceted-future-the-jewelry-industry-in-2020. 3 Claudia D’Arpizio, Federica Levato, Daniele Zito, and Joëlle De Montgolfier, Luxury Goods Worldwide Market Study: A Time to Act; How Luxury Brands Can Rebuild to Win, fall–winter 2015, 2, accessed October 4, 2016, www.bain.com/Images/BAIN_REPORT_Global_Luxury_2015.pdf. 4 Dauriz, Remy, and Tochtermann, op. cit. 5 Ibid.
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EMPOWERING WOMEN
Through education, inspiration and opportunity, we are women empowering women—one sparkle at a time.
H&B Manifesto Empowering women was a clear goal for H&B. Mielke noted that most global jewellery collections were designed by men, for women. As the company founder, Mielke considered that having women running the company was vital: “I think that our company being run primarily by women and having a fresh perspective on jewellery, it’s unusual. Most of the major global players in the industry are run primarily by men, were started by men, and I don’t think there are a lot of amazing up and coming brands that are female-driven.” H&B had invested heavily in internal training and development to ensure that its workforce had the skills needed to grow with the company. Mielke noted that her focus was on the well-being of H&B’s workforce. H&B worked to empower employees by building collaborative, cross-functional teams. The company had also used innovative strategies to inspire creativity throughout its workforce. One program that was launched early at H&B was One of a Kind Friday, in which all employees, regardless of their position in the company, designed one-off pieces that would potentially be sold at H&B’s flagship retail store in Regina. Surprisingly, not just those who were experienced designers had products sell well, as one of the best-selling designers to emerge from One of a Kind Friday was H&B’s production manager. As H&B scaled, it continued this tradition, launching One of a Kind monthly runs that were sold both online and at its retail locations. These collections commanded a premium price, with necklaces being sold for up to $3,500. The company had made considerable effort to give back to local and international women’s organizations and had launched collaborations with charitable organizations, including the Canadian Breast Cancer Foundation, the Malala Fund, and Dizzy Feet Foundation. Mielke remarked: “I think that our focus on philanthropy and our passion about empowering women and finding ways that our brand can help make our community and make our country a better place by the success of our company also positions us as a very unique brand.” As Mielke contemplated H&B’s growth, maintaining a culture true to its core values was non-negotiable. Mielke’s focus was to ensure that H&B did not grow at the expense of its work culture and values that she and her senior leadership team had worked hard to establish. CUSTOMER SERVICE AND DISTRIBUTION When building H&B, Mielke had realized the critical importance of communicating the brand’s story. Like others in the industry, Mielke found the most effective way to do so was through bricks-and-mortar retail locations. Therefore, a key tactic in the company’s marketing strategy was building its physical retail presence. H&B prided itself on providing quality customer experiences. The company expected that every person who entered the stores would be treated like a guest in the brand’s home. The retail store teams were expected to immerse themselves in their local communities—building connections by attending events, organizing local charitable donations, developing meaningful relationships, and promoting H&B products. Employees were empowered to make decisions to provide the best possible experience and to “surprise and delight” customers when a connection was built. These
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gestures included gifting a soon-to-be bride with “something blue” earrings or larger efforts such as gifting Sparkle Ball earrings to mothers displaced by the disastrous 2016 fires in Fort McMurray, Alberta. H&B had invested heavily to build its e-commerce presence, recognizing the growth potential of the online market. However, Mielke noted that the online channel alone would not enable the company to scale: “We are seeing over and over again companies that are trying to start up as online only, switching to bricks and mortar because you just can’t tell your brand story well enough, you can’t scale online.” H&B had evolved its distribution strategy over time, selling through both boutique retailers and its own locations, including its online store; a street-front location housed in a character home in Regina; and mall locations in Edmonton, Alberta, and in Saskatoon, Saskatchewan that were either full-size stores or “Sparkle Bar” kiosks that had a smaller footprint (see Exhibit 4). H&B had found the best success in its full-size bricks-and-mortar locations. While the Sparkle Bar locations were popular, Mielke was concerned that these kiosk-like locations did not make it as easy to provide customers with a full brand experience. The cost of each additional full-size retail location was expected to be $1 million, comprising $500,000 for construction costs and $500,000 for marketing and start-up costs. H&B had also been selling through The Shopping Channel (TSC), with Mielke herself appearing on television and sharing the H&B story. These appearances proved to be popular and helped spread the word about H&B product throughout Canada. Mielke expected TSC to sell 15,000 pieces in 2016. When Mielke considered the company’s next steps, she knew an effective distribution strategy would be critical. As she considered expansion within Canada (see Exhibit 5), Mielke deliberated on which locations and tactics would best enable H&B to build a national and international brand presence without compromising on a quality service experience. THE SPARKLE COLLECTION Launched in spring 2011 with the Sparkle Ball earring, the Sparkle Collection had quickly become (and remained) a mainstay of the H&B brand, accounting for more than 70 per cent of the company’s total annual revenue. The collection had expanded to include necklaces, bracelets, charms, and earrings. Mielke noted, “Sparkle is the doorway into our brand, but we absolutely need to have product offerings beyond Sparkle and we need to develop more products like Sparkle.” Sparkle Ball earrings were available in three sizes and were priced from $50–$80, while items in the Sparkle Collection ranged from $50–$265. The Sparkle Ball had become an iconic product in the H&B brand. Mielke noted: “It’s also a beautiful product that you can wear every day and then it gets other people noticing the jewellery and commenting on it and then they talk about Hillberg & Berk.” The Sparkle Ball earring had proved a powerful tool for branding the company, and the earrings had been an official product of the Canadian Olympic team during the 2016 Rio Summer Olympic and Paralympic Games. Throughout the games, female athletes wore the earrings, both in competition and at notable events, including the opening ceremony. Sparkle Ball earrings were also part of an official partnership with the Canadian Football League (CFL) in that the company had designed custom coloured earrings that were worn by each CFL cheerleading team during games. H&B also ran complementary promotional activities during CFL games in Edmonton and Regina. While Mielke celebrated the success of the Sparkle Collection, she remained aware that having a hugely successful product led to a multitude of questions on how to proceed: “It’s a good opportunity because we know that we are on to a home-run product but, on the other hand, it’s a big liability or stress that our company has because so much of our growth and expansion is tied up in the success of one product.”
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THE PRODUCT Beyond the Sparkle Collection, H&B continued to grow and innovate its core collection and develop new lines. One such innovation was a line designed in collaboration with Canadian Olympic gold medallist ice dancer Tessa Virtue. The line was designed for and marketed to a younger, edgier audience and offered at a more affordable price point, with prices ranging from $65–$200. The line had seen success and had enabled H&B to connect with a wider consumer group. H&B also had a core collection of products that were released twice a year, one collection for spring– summer and one for autumn–winter. These collections offered a wide array of necklaces, earrings, rings, and bracelets. These products were made with high-quality materials such as semi-precious gemstones, Swarovski crystal, and sterling silver. The earrings in these lines typically ranged from $65 to $245, bracelets from $75 to $265, necklaces from $75 to $1,500, and rings from $65 to $140. The Tacori diamond collection was a departure from H&B’s other collections in that it was designed by Tacori but distributed by H&B. Tacori was a family-owned, luxury jewellery designer specializing in diamond jewellery. It was most known for its bridal and engagement lines. Tacori’s products were custom designed and handcrafted in California, and commanded a premium price. Most ring settings retailed for thousands of dollars before the addition of a centre stone. Tacori primarily retailed through partnerships, such as its collaboration with H&B. The partnership was chosen by Mielke to be able to better understand what it meant to sell diamonds and high-end engagement, wedding, and anniversary jewellery. Mielke saw value in this relationship in that it allowed H&B to offer diamond jewellery without yet committing to fine jewellery design and diamond inventory management. THE SUPPLY CHAIN With the rapid growth of the Sparkle Collection, H&B faced challenges with its supply chain. The company had sourced its Sparkle Balls from a single offshore supplier; however, there had been difficulties with consistent replenishment and quality. As this product represented a high proportion of the company’s sales, it was critical for H&B to find a way to improve this sourcing relationship. The company was also looking at ways to innovate its Sparkle Ball earrings to make them more durable and longer lasting. Mielke noted that the earring was like a fine garment and needed to be treated as such. However, H&B’s customers had a perception that the product could be worn more frequently and in a variety of conditions. Therefore, instead of trying to change customers’ behaviour, H&B launched an internal competition with the goal of designing a more robust Sparkle Ball. TALENT RESOURCES To date, H&B’s growth had been organic, and Mielke had built a loyal team that supported the company’s evolution. However, Mielke had one current consideration for sourcing talent:
Right now I am trying to figure out how we bring more experience into the company while still empowering the team within. So I would say—how do we find that experience within where we are located? If the people aren’t from Saskatchewan, how do we attract them to come to the province and want to live and have a family and have a career in our province?
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BRAND POWER
I am so passionate about the brand being authentic because people have become a lot more savvy on building a brand, but brands are built and die without any authenticity.
CEO, Rachel Mielke H&B’s success had largely been found in the company’s brand reputation. In H&B’s home province of Saskatchewan, the brand had high awareness and adoption. H&B had garnered unique opportunities to build its brand, including having been commissioned to design a broach for the Queen of England on behalf of the Saskatchewan government. The Queen had liked the broach so much that she had worn it on multiple occasions, including to a high-profile event at the Royal Ascot Racecourse. The company’s brand had also been greatly aided by earned media. Stories about the company being funded through Dragons’ Den, and its products being gifted at the Oscars and worn by Olympic athletes had been consistently shared through local and national news sources. Mielke had personally focused most of her attention on building the brand:
I would say that most of my focus over the years has gone into brand, even over other things, even over design of product or organizational structure or processes and procedures. So maybe a bit to my detriment some of those things aren’t where they should be, but I feel strongly that, at the core of the success of a company, has to be a truly authentic brand and brand experience, and that’s what I am extremely passionate about creating.
With the popularity of H&B’s signature Sparkle products had come copycat designs, from both large designers such as Swarovski and smaller jewellery producers in the company’s home market of Saskatchewan. Strong brand recognition, however, was one way that Mielke saw to overcome the replication of H&B’s signature product. Mielke now considered how to leverage the brand equity that she had built in an attempt to grow the company in a way that aligned with her goals of building a sustainable business and a healthy corporate culture. CONCLUSION As Mielke reflected on the importance of the Sparkle Collection she noted:
Sparkle is like the easy first purchase for people and it gets people, I think, interested and passionate about and addicted to our brand and then, eventually, hopefully that consumer comes back to buy a necklace or another pair of earrings or something in our collection. I am constantly thinking about diversification and how do we go from Sparkle to the next generation of Sparkle and how do we graduate that consumer from Sparkle into something else.
Mielke now faced a turning point in the H&B story, as she positioned the company for further growth. Mielke and her team considered the following questions: how would they manage their flagship Sparkle Collection, which currently accounted for more than 70 per cent of H&B’s sales? How would they manage supplier relationships that they were outgrowing? How would they leverage H&B’s brand presence to overcome copycat designs? How would H&B maintain its corporate culture while facing rapid growth?
The Ivey Business School gratefully acknowledges the generous support of the Ernst & Young Fund in the development of this case.
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EXHIBIT 1: HILLBERG & BERK’S FINANCIAL ANALYSIS, 2014–2017
April 30, 2014 April 30, 2015 April 30, 2016 April 30, 2017 Total Sales $2,647,228 $5,917,261 $10,323,513 $15,000,000 COGS (as a % of sales) 21.75 18.34 25.02 25 Gross Profit (as a % of sales) 78.25 81.66 74.98 75 Marketing (as a % of sales) 10.66 15.83 18.51 Payroll (as a % of sales) 28.86 25.75 29.23 Net Income (as a % of sales) 22.50 21.90 9.52
Note: COGS = cost of goods sold. The material in this exhibit has been disguised for reasons of confidentiality. Forecasted sales for 2017 were provided as of November 30, 2016. Source: Company files.
EXHIBIT 2: HILLBERG & BERK’S COMPETITOR PRODUCT ANALYSIS
Brand Earring Collection Range Swarovski CA$69–$345 Hillberg & Berk Sparkle Collection
CA$50–$115 Core Collection CA$65–$245 Tacori (available through H&B) CA$253–$1,089
PANDORA CA$20–$400 Kendra Scott US$45–$295 Alex and Ani US$25–$45
Source: Swarovski, www.swarovskigroup.com/S/home/index.en.html, accessed October 7, 2016; Hillberg & Berk, www.hillbergandberk.com, accessed October 7, 2016; PANDORA, http://pandoragroup.com, accessed October 7, 2016; Kendra Scott, www.kendrascott.com, accessed October 7, 2016; Alex and Ani, www.alexandani.com, accessed October 7, 2016.
Examples from the Sparkle Collection
Source: Company files.
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EXHIBIT 3: HILLBERG & BERK COMPETITOR ANALYSIS
Company Number of Stores Revenue Product Categories Comments Swarovski was a private company founded in Austria in 1895. The Crystal Group was the jewellery and collectible arm of the business. The company was a family-run company, and a fifth generation family member remained on the board.
2,680 stores worldwide, 1,380 operated by Swarovski, 1,300 operated by partners
€2.6 billion (Crystal Group only)
Necklaces, pendants, earrings, bracelets, rings, charms, men’s jewellery, activity-tracking jewellery, watches, bags, wallets, pens, crystal decorations, and sculptures
Swarovski also operated 12 subsidiaries. These businesses produced a wide range of products, most of which required cut lead glass; however, the company also produced high-fashion products, museums, and entertainment.
PANDORA was a publicly traded jewellery business founded in Denmark in 1982. The company had seen rapid growth based on the popularity of its charm bracelets.
More than 1,800 stores worldwide, the majority of which were franchised 9,300 other non-branded points of sale
DKK16.6 billion (approximately €2.2 billion)
Charms, bracelets, rings, earrings, necklaces, and pendants
Seven out of 10 women in PANDORA’s target demographic reportedly knew and recognized the PANDORA brand.
Kendra Scott was a private company based in Austin, Texas. The namesake founder had started the company from her house in 2002.
39 company-run stores
Reported to be US$150 million in 2015
Necklaces, earrings, bracelets, rings, charms, jewellery organizers, and “colour bar” custom items
The first Kendra Scott store opened in 2010. The company had been particularly successful by offering products from its “colour bar,” an in- store and online option where could customers pick coloured stones that were made into jewellery using a selection of standard designs, as customers watched.
Alex and Ani was a private company founded in 2004 in Cranston, Rhode Island. The company opened its first store in 2009.
65 company-owned stores as of 2015, and concession stands and partnerships with hundreds of stores and boutiques, including Nordstrom and Hudson’s Bay
Reported to be US$500 million in 2015
Bracelets, rings, earrings, necklaces, handbags, wallets, scarves, cuff links, blankets, and perfumed mists
Alex and Ani’s products were popular gifts, with the US$28 zodiac bracelet being a reported top seller.
Note: € = euro; US$1 = €0.878 on September 30, 2016. Source: PANDORA, “The PANDORA Story,” accessed October 4, 2016, http://pandoragroup.com/en/Media/Pandora_In_Brief/the-pandora-story; Swarovski, “About Swarovski: Corporate Facts,” accessed October 4, 2016, www.swarovskigroup.com/S/aboutus/Facts.en.html; Amy Anderson, “Meet Kendra Scott: Homemade Millionaire,” Success, March 7, 2016, accessed October 4, 2016, www.success.com/article/meet-kendra-scott- homemade-millionaire; Clare O’Connor, “Alex and Ani’s Carolyn Rafaelian Joins Self-Made List as Jewelry’s Richest Woman,” Forbes, June 3, 2016, accessed October 4, 2016, www.forbes.com/sites/clareoconnor/2016/06/03/alex-and-anis- carolyn-rafaelian-joins-self-made-list-as-jewelrys-richest-woman/#427fd5da2e93.
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EXHIBIT 4: HILLBERG & BERK STORE LOCATIONS
Store Name Location Store Type 1 Flagship Regina, Saskatchewan Standalone Store 2 Cornwall Regina, Saskatchewan Sparkle Bar 3 Midtown Saskatoon, Saskatchewan Standalone Store 4 Centre Saskatoon, Saskatchewan Pop-Up Standalone Store* 5 West Edmonton Mall Edmonton, Alberta Sparkle Bar 6 Kingsway Mall Edmonton, Alberta Sparkle Bar
*Expected to remain open until spring 2017 Source: Company files.
One of H&B’s Sparkle Bars
One of H&B’s Standalone Retail Stores
Source: Company files.
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EXHIBIT 5: POPULATION STATISTICS, CANADA Saskatchewan’s Population According to Statistics Canada, Saskatchewan’s population was estimated to be 1,142,570, as of January 1, 2016. Gender Of the Saskatchewan Census population for 2011, 50.50 per cent was female while 49.50 per cent was male. The comparable values for the 2006 Census population were 50.91 per cent female and 49.09 per cent male. 2011 Census Populations by Province or Territory and Age Group
Age Group
0–14 % of Total 15–64 % of Total 65 and Over % of Total Canada 5,607,345 16.75 22,924,290 68.48 4,945,055 14.77 Newfoundland and Labrador 76,625 14.89 355,800 69.15 82,105 15.96 Prince Edward Island 23,060 16.45 94,360 67.30 22,785 16.25 Nova Scotia 138,215 15.00 630,140 68.37 153,370 16.64 New Brunswick 113,575 15.12 513,960 68.42 123,635 16.46 Quebec 1,258,625 15.93 5,386,695 68.16 1,257,685 15.91 Ontario 2,180,775 16.97 8,792,725 68.42 1,878,325 14.62 Manitoba 231,160 19.13 804,655 66.60 172,450 14.27 Saskatchewan 197,855 19.15 681,815 65.98 153,705 14.87 Alberta 684,790 18.79 2,554,745 70.08 405,720 11.13 British Columbia 677,365 15.39 3,033,980 68.95 688,715 15.65 Yukon Territory 5,865 17.30 24,940 73.57 3,095 9.13 Northwest Territories 9,010 21.73 30,055 72.48 2,400 5.79 Nunavut 10,425 42.67 20,420 63.99 1,060 3.32 Source: “Saskatchewan Population by Age and Sex Report: 2011 Census of Canada,” May 29, 2011, accessed October 7, 2016, www.stats.gov.sk.ca/stats/pop/2011AgeSex.pdf.
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9B16M128
WOODEN BAKERY: SHOULD IT ENTER THE U.S. MARKET?
Hagop Panossian and Dima Jamali wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized, or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com. Copyright © 2016, Richard Ivey School of Business Foundation Version: 2016-11-21
Wooden Bakery started in Lebanon in the early 1970s as a small traditional bakery and, over the course of four decades, went on to become one of the leading companies in the industry. The founder, Edward Bou Habib, had proudly witnessed every single phase of the business’s growth and expansion. His determination to succeed, his dedication, and his hard work had certainly paid off. In early 2015, in the company’s busy headquarters, which were situated 10 kilometres north of Beirut, the board of directors had to meet and vote on a major strategic decision that would determine Wooden Bakery’s future success or failure. A decision had to be made on whether the company was ready to pursue growth opportunities in North America and enter the U.S. market, with Chicago, Illinois, standing out as the potential location of choice. Prior to the board meeting, from the window of his office on the top floor of Wooden Bakery’s headquarters, Bou Habib looked down at the warm blue waters of the Mediterranean. He was remembering the important milestones that had revolutionized the production of traditional Lebanese bread. However, he never anticipated that the day would come when he would consider delivering Lebanese bread to the other side of the Atlantic. Bou Habib’s two sons, Assad and Ghassan Bou Habib, as well as the company’s general manager, Gilbert Hobeika, and all the board members seemed highly enthusiastic about the Chicago proposition. But was he? Bou Habib could clearly see further growth opportunities in Lebanon and the Arabian Gulf, where cultural differences were insignificant and resources were readily available. Bou Habib strongly believed that these were safer waters to navigate, and he wondered whether there was a real need to venture into unknown territories, stretching thin the resources of the company. But again, on his desk, in black and white, sat a handwritten quotation that had been sitting there for years, guiding his decision-making and his actions: “What counts more than success is the willingness to succeed.”
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Page 2 9B16M128 WOODEN BAKERY Modest Beginnings Wooden Bakery started as a small, traditional Lebanese bakery with a limited production capacity of 700 to 800 kilograms of flour per day. The production process was manual (labour-intensive) and primitive. It was virtually impossible to maintain the consistency of the quality of the bread in the absence of standardized processes and qualified labour. The bakery was called “Wooden Bakery” to indicate that the bread was baked the traditional way, as it had been in Lebanese villages in the old days. The original decision to enter the bread-making industry had not been a haphazard one. Lebanon was on the brink of a civil war in the early 1970s, and what could be a safer investment than a bakery during periods of political unrest and civil wars? One of the main assets of the bakery was its location. Situated on a main highway with a heavy traffic flow linking Beirut to the northern residential suburbs and north Lebanon, Wooden Bakery targeted and attracted people crossing this busy thoroughfare, whether on their way to or back home from work. Frustrated with the inefficiencies in production and the long hours of hard work from 3 a.m. until 10 p.m., Bou Habib soon realized that automation of the production process was the only way to grow his business. However, the European automated production lines, imported and tested by other bakeries, had failed to produce good-quality Lebanese bread. The only remaining option was to develop similar production lines in Lebanon and customize them to suit the production of traditional Lebanese pita bread. To that end, in the late 1970s, Bou Habib initiated the cooperation of a Lebanese bakery-equipment manufacturer called Saltek, and this partnership ultimately paid off. In 1980, the first automated pita bread production-line equipment was ready for use, and the first unit was reserved for Wooden Bakery. Garo Salkhanian, the general manager and owner of Saltek, clearly remembered his first meeting with Bou Habib: “One morning, Edward came to our factory with a bag full of cash, while we were working restlessly on designing and testing the prototype of the first automated pita bread production line. He wanted to buy it way before it was produced.” Just a few months later, thanks to Saltek, Wooden Bakery ushered in a new era of bread-making. Through his early insight, and taking action accordingly, Bou Habib managed to significantly increase Wooden Bakery’s production capacity (to 10 metric tons per day), and the consistency of the quality was secured. Growth through Bakery-Convenience Stores Another important growth spurt for Wooden Bakery started in 1996, when Bou Habib’s two sons took the initiative to plan, design, and introduce a new concept, thereby marking the beginning of yet another era of successful metamorphosis for Wooden Bakery. Three years later, in 1999, Wooden Bakery launched its first retail outlet, a bakery-convenience store, introducing a new and unique retail experience that met or even exceeded the expectations of Lebanese consumers. Situated in a prime location, just a few hundred metres away from the original bakery (i.e., on the same main highway) and open 24/7, the bakery-convenience store carried a wide-ranging inventory that consisted of an extensive variety of freshly baked Lebanese and French breads, different types of oriental and European sweets, and ka’ak (a Lebanese delicacy). A fine selection of dairy products, local and French cheeses, and Italian cold meats and charcuterie were also offered. In essence, the new store provided 70 to 80 of the same food items that were the most sought-after in supermarkets, but Wooden Bakery made them available through a one-stop shop. Moreover, in one of its corners, the 400- to 500-
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Page 3 9B16M128 square-metre store operated a traditional Lebanese oven, baking and serving Lebanese delicacies, such as mana’ish, pizzas, and sandwiches. The store also offered some basic seating arrangements next to the oven and a few tables on the mezzanine to accommodate customers who wanted to eat on-site. The new concept was immensely successful and went beyond all expectations, with the new bakery- convenience store gradually evolving into Wooden Bakery’s flagship store. In 2015, 16 years after its introduction, this location remained the most successful among Wooden Bakery’s 32 branches. It catered to approximately 4,000 customers per day. The company owned the real estate, and the store offered easily accessible parking space, which accommodated 3,000 cars per day. On average, customers spent between five to 10 minutes inside the store, unless they decided to have lunch or dinner on-site. This bakery-convenience store established Wooden Bakery as one of the big players in the bread industry in Lebanon and helped the company to position itself beyond Lebanon as one of the leaders in the regional industry (see Exhibits 1 and 2 for financial statements). Franchising and a New Factory In 2002, three years after the introduction of the first retail store, Wooden Bakery launched its first franchised operation in Lebanon, and two other franchised stores opened in 2003. Since that time, Wooden Bakery had been pursuing an aggressive growth strategy by opening, on average, two or three franchised branches per year. Its business development unit worked hard to grow a pool of potential franchisees from which it carefully selected the appropriate candidates and granted the franchising rights only to those investors who met and exceeded a stringent set of requirements (see Exhibit 3). Wooden Bakery was very successful in rolling out and adhering to those requirements across its 25 franchised stores. This franchising strategy marked another successful milestone for Wooden Bakery, given that a franchised store rarely failed, and the company remained ready to reacquire and manage any of the fledgling stores should the need arise. In 2007, to support its aggressive growth strategy, Wooden Bakery opened a large, central factory in Antelias, a northern suburb of Beirut, just a few kilometres away from the flagship store. This state-of- the-art factory processed 60 to 70 metric tons of flour per day (around 1,800 metric tons per month) and operated on three shifts a day. The factory also housed a central kitchen that supplied products to all the branches. This factory had acquired ISO 9001 quality management systems certification and had the capacity to cater to 10 additional branches. Moreover, the company was considering building a second factory in North Lebanon to strengthen its competitive positioning, increase volume, and alleviate logistics-related costs and problems. To sustain its rapid growth, Wooden Bakery also underwent a major restructuring and reorganizing process. A group of highly accomplished directors with strong academic and professional credentials was recruited to lead the newly created functional units. Operations were streamlined and professional management practices were adopted, enabling the family-owned firm to make significant headway in establishing the foundations of sound corporate governance. By 2015, Wooden Bakery had grown significantly, mobilizing 750 employees, a sales and distribution team of 60 employees, and a fleet of 100 vehicles and operating 32 branches scattered across Lebanon (seven company-owned and 25 franchised). Moreover, on a daily basis, the company distributed traditional Lebanese bread to 1,300 sales points (to supermarkets and mid-size and small grocery stores) spread across Lebanon, but with varying concentration in different geographical areas and a visibly heavy presence in one of Lebanon’s largest governorates, Mount Lebanon.
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Page 4 9B16M128 LEBANON AND THE BREAD INDUSTRY Lebanon was a very small country (10,452 square kilometres), and in 2014, its population was estimated to be around five million. Almost half the population lived in the capital city of Beirut and in its immediate suburbs, which were part of the Mount Lebanon governorate. Eighteen religious groups coexisted in Lebanon, made possible in part through the crafting of a unique political system based on proportional sectarian representation. Some geographic areas in the country had mixed populations, as in the capital city of Beirut, while others had heavy concentrations of a single religious group or sect. This population distribution resulted in regional and territorial strongholds for different companies, even in the bread industry. For example, Wooden Bakery’s stronghold was the Mount Lebanon governorate, where 25 of its 32 branches were located, while one of its main competitors, Chamsine, had a stronger presence in South Lebanon and the Beqaa Valley, two other large governorates. Lebanese pita bread was considered the dominant staple of the world-famous Lebanese cuisine. Pita bread was served as an accompaniment to various dishes; moreover, it was used to scoop sauces or dips, such as hummus and foul, and to wrap sandwiches like falafel, kebabs, or shawarma. The average consumption of a Lebanese family of four to five members was a pack of bread per day (the standard pack contained seven loaves, weighed 900 to 950 grams, and was sold at £1,5001). Bread was widely consumed across the country, regardless of residential area or income level. Since pita bread was an absolute necessity in the Lebanese diet, its production was regulated by the government. For example, the number of loaves in a pack, the weight, and the price of a pack were all fixed by the government. Government scrutiny and intervention were triggered by fluctuations in the market price of flour, which constituted 70 per cent of the production costs of bread. When the market price of a metric ton of flour exceeded £600,000 (US$400), the government stepped in and subsidized the cost by covering the difference, thus allowing bakeries to reduce the weight of a pack to 900 grams and the number of loaves to seven. When the price of flour dropped below £600,000, the government commanded bakeries to increase the weight to 950 or 1,000 grams and, accordingly, to increase the number of loaves in a pack. It was therefore not surprising that the price of a pack of bread had been kept constant at £1,500 for more than two decades. This stringent monitoring and the accompanying price ceiling were applicable only to traditional white pita bread. All bakeries offered a huge variety of healthy breads, such as brown, oat, full grain, and French breads, at market prices and with hefty profit margins. The introduction of automated bread-production processes in the 1980s vastly altered the structure of the Lebanese bread industry. A few bakeries grew fast enough to transform the industry at the expense of most of the small, traditional bakeries operating in every single neighbourhood and village in Lebanon. However, starting in 2012, with the influx of one million Syrian refugees who were fleeing the war and violence in their country, Lebanon’s bread consumption increased significantly, creating growth opportunities for most bakeries. In fact, the 2014–2015 monthly surge in bread production and consumption was gauged through the 17,000 metric tons of flour used by the industry. THE COMPETITION Aside from Wooden Bakery, a few other bakeries had also grown and become strongholds across different parts of the country, particularly the Chamsine Bakery, Moulin D’Or, and Pain D’Or.
1 £ = LBP = Lebanese pound; all dollar amounts are in U.S. dollars unless otherwise specified; US$1 = £1,500 as of April 2016.
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Page 5 9B16M128 Chamsine Bakery Chamsine Bakery was owned by the El Kaderi family and was the largest traditional pita bread producer in Lebanon (around 80 metric tons of flour used per day; 2,200 to 2,500 metric tons per month). Its primary focus concerned the production of traditional pita bread and ka’ak, which constituted the primary source of Chamsine Bakery’s competitive advantage, unlike its competitors, who had more-diversified product offerings. Chamsine Bakery had around 10 branches in Lebanon and a few thousand sales points. The flagship branch was located in the Khaldeh southern suburb of Beirut and served around 6,000 to 7,000 customers a day. The company had built a new factory in the Halat area to strengthen its competitive position in the governorates of North Lebanon and Mount Lebanon. Moreover, Chamsine Bakery had private-label agreements with companies in Canada and Australia, operated two branches in Syria, and had recently expanded into Turkey under the name Amaren (or, “two moons”). Moulin D’Or Moulin D’Or was founded in 1984. The owners were brothers: Antoine and Adel Seif. The business model and the growth story of Moulin D’Or were similar to Wooden Bakery’s, and for that reason, the company was one of Wooden Bakery’s major competitors. Moulin D’Or offered differentiated products (Lebanese and French bread, ka’ak, pastries, and catering services) and outstanding customer service. Its stronghold was the Kesrwen district in the Mount Lebanon governorate, which was Wooden Bakery’s stronghold as well. Moulin D’Or’s flagship store and factory were located in the Jeita area, but the company also maintained a strong presence in Beirut, El-Metn, Byblos, and North Lebanon. In 2015, Moulin D’Or operated eight franchises and two company-owned branches. It supplied McDonald’s Lebanon with burger buns, and it exported Kaa’ak to the United States. Pain D’Or Pain D’Or, founded in 1986, was part of a larger group called Malco, owned by the Koussa family. Its competitive strength was in the production of French bread, sweets, and pastries. In 1988, the company’s first retail shop was opened with a full-fledged pastry section. Pain D’Or produced a wide range of products (bread, French bread, pastry, doughnuts, viennoiseries, ice cream, and chocolate), had a catering department, and operated 18 branches spread across Lebanon. While Pain D’Or had been contemplating entering the Arabian Gulf market, its expansion plans in Saudi Arabia had been curtailed at some point due to tough competition triggered by its aggressive market entry strategy. Pain D’Or was preparing to enter the lucrative United Arab Emirates (UAE) market. Market Share Wooden Bakery and the above-mentioned competitors controlled around 40 per cent of the Lebanese bakery market. The remaining 60 per cent was controlled by other regional producers and small bakeries in villages and towns. Some of those companies were Farhat in South Lebanon; Al Wafaa in the southern suburbs of Beirut; Baydoun in Ashrafieh Beirut; and Green Lebanon in North Lebanon, Yammine, Keyrouz, Dagher, and Al Omara. The influx of refugees during the years leading up to 2015 had contributed to the rapid growth of some of these bakery chains.
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Page 6 9B16M128 REGIONAL EXPANSION IN THE ARABIAN GULF In 2009, Wooden Bakery started its regional expansion in the Arabian Gulf region through an area- development franchise agreement with a Saudi company that was owned by Abdel Mohsen Mohaisen. The related development was intended to cover the Riyadh area, and the development rights were initially granted for a period of 10 years, renewable for another 10 years after that. All partners had to be well- established companies with sufficient resources and remarkable industry-relevant knowledge and experience. The operational model that the Riyadh area-developing franchisee adopted was similar to the model Wooden Bakery had established in Lebanon, with a central factory catering to all the branches operating in a given area. The criteria and terms of the franchise agreement had been carefully thought through, with a requirement for the area-developing franchisee to initially pay Wooden Bakery a development fee equivalent to $1.5 million as well as royalty fees, which were described as “management service fees.” The royalty fees amounted to 4 per cent of branch-generated sales and 2 per cent of factory-generated sales. These royalty fees were slightly different than the royalty fees of 2.5 per cent applied in Lebanon (see Exhibit 3). In return, Wooden Bakery had to provide the franchisee with the right to use Wooden Bakery’s brand, trademarks, know-how, expertise, business operating systems, operation manuals, training methods, architectural services, design manuals, and whatever else was needed to ensure a smooth start to the new operations (see Exhibits 4 and 5). In 2015, six years after signing the first area-development agreement, Wooden Bakery had established a strong presence in the Riyadh area, with six franchised branches supported by a central factory. A second area-development agreement was signed in early 2015 with KAF Group–UAE. Operations were expected to start in 2016 and would cover major cities like Dubai and Abu Dhabi. Moreover, Wooden Bakery was expecting to sign a third agreement by the end of 2015 with a Qatari company, Al Tahouna Bakery, and was considering expanding to Oman and Kuwait as well. WHY CHICAGO? Chicago was considered to be the eighth richest city in the world and the third richest city in the United States, after New York and Los Angeles. It had a gross domestic product of around $600 billion and an estimated population of 2,722,389 (2014 estimates).2 The number of households in the city was 1,028,746, and the city was densely populated with 12,750 people per square mile (4,923 per square kilometre). The real median household income was $61,598, compared to a median American household income of $53,657 (all 2014 estimates). Moreover, Chicago had a relatively young population, with around 65 per cent of its residents between the ages of 18 and 65. All of these demographic factors were likely to work in Wooden Bakery’s favour (see Exhibits 6 and 7). Chicago, Illinois, and Detroit, in the neighbouring state of Michigan, had a high concentration of Americans of Arab and Lebanese descent. This factor represented an important consideration, although Wooden Bakery did not want to position itself as a bakery that provided pita bread primarily or exclusively to Middle Eastern communities; it wanted to position itself as a player in the food market serving almost everyone.
2 “Chicago Metro Area – GDP 2014,” Statista, accessed July 7, 2016, www.statista.com/statistics/183827/gdp-of-the- chicago-metro-area.
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Page 7 9B16M128 Other potential locations included New York and Los Angeles. While New York had its appeal, the running costs in New York were estimated to be significantly higher than those of the other cities under consideration. Los Angeles was also a potential option, with a notable immigrant population with Middle Eastern roots. However, managing the logistics of a growing start-up across a large geographic area, such as Los Angeles, was potentially more challenging. Chicago had long remained a culturally and ethnically diverse city, and this diversity was reflected in all facets of everyday life, especially food, and was believed to be conducive to the introduction of novel ideas and concepts. Moreover, Chicago was the home of 11 Fortune 500 companies, and the rest of the metropolitan area of Chicago hosted an additional 21 Fortune 500 companies. McDonald’s, Walgreens, and Mondelez International were just a few examples. Chicago was also a major world financial and trade centre, which implied that the minimum requisites of vibrancy and economic health were available to justify the differentiation food strategy that Wooden Bakery was considering (see Exhibits 6 and 7). Finally, Chicago had numerous supermarket chains, convenience stores, and bakeries; however, the way Wooden Bakery chose to define the industry and position itself would eventually determine the competitive arena and identify the company’s direct and indirect competition. Chains like Panera Bread, Mariano’s, and Corner Bakery Cafe would no doubt be among the potential competitors. The management of Wooden Bakery believed that capturing 7 to 10 per cent of the pita bread market in Chicago would be sufficient to break even, while anticipating that revenues from pita bread would constitute only 10 to 15 per cent of the company’s total revenues. THE DECISION AND LOOKING AHEAD On that sunny morning in early 2015, Wooden Bakery’s board of directors had to make a crucial strategic decision related to entering the U.S. market. The group’s great expectations of success were somehow overshadowed by the daunting prospect of the project’s immense risks and challenges. However, the decision-makers were well aware that a “No” vote would imply narrowing the horizons of Wooden Bakery’s growth opportunities to Lebanon and the region, while a “Yes” vote would mark the beginning of a new era and possibly the start of a metaphorical roller coaster ride, with the accompanying apprehensions and exhilaration. As Bou Habib contemplated the various options for Wooden Bakery’s future, he was fully cognizant that the family-owned company had managed over the span of a few decades not only to become a leading bakery chain, a powerful brand, and a fast-growing company in Lebanon and the surrounding region but also a professionally managed company with sound corporate governance and a competent management team. But in spite of all that operational excellence and Bou Habib’s unfailing entrepreneurial spirit, the days ahead were likely to be very challenging if the board approved the growth strategy in the United States. How should Wooden Bakery deploy its strengths and capabilities acquired in Lebanon in a totally new environment? How should Wooden Bakery go about entering the U.S. market? What would be the inevitable challenges of the new environment, and how would Wooden Bakery handle those challenges? What would be the key success factors? How should Wooden Bakery implement its growth strategy and secure and allocate the required resources? As Bou Habib gazed out his office window, all of these questions remained, as yet, unanswered.
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Page 8 9B16M128
EXHIBIT 1: WOODEN BAKERY INCOME STATEMENT (IN U.S. DOLLARS)
Year 2010 2011 2012 2013 2014 Sales 23,621,913 30,441,954 34,059,687 38,388,172 42,284,807 Cost of Goods Sold 15,855,426 20,749,239 22,130,943 25,820,124 26,585,504 Cost of Goods Sold as % of Sales 67.12 68.16 64.98 67.26 62.87 Labour Cost 2,590,465 3,254,925 3,911,624 4,161,776 4,647,823 Labour Cost as % of Sales 10.97 10.69 11.48 10.84 10.99 Operational & Overhead Costs 1,826,668 2,531,817 2,694,124 3,005,833 4,031,594 Operational & Overhead Costs as % of Sales 7.73 8.32 7.91 7.83 9.53 Depreciation 1,121,396 1,393,133 1,545,507 1,434,247 1,685,366 Depreciation as % of Sales 4.75 4.58 4.54 3.74 3.99 Net Profit 2,227,959 2,512,839 3,777,489 3,966,191 5,334,521 Net Profit as % of Sales 9.43 8.25 11.09 10.33 12.62
Source: Prepared by authors with company information.
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EXHIBIT 2: WOODEN BAKERY BALANCE SHEET (IN U.S. DOLLARS)
DESCRIPTION 2010 2011 2012 2013 2014 Assets Current Assets Cash 65,000 83,000 93,000 105,000 115,000 Banks 2,493,091 2,189,307 2,039,556 2,596,775 1,876,409 Deposits & Guarantees
90,000 100,000 115,000 120,000 130,000
Accounts Receivable
1,747,374 2,251,871 2,519,484 2,839,673 3,127,917
Total Current Assets
4,395,466 4,624,178 4,767,040 5,661,448 5,249,326
Fixed Assets Fixed Assets 15,500,000 16,275,000 17,414,250 18,981,533 19,361,163 Less Accumulated Depreciation
1,121,396 1,393,133 1,545,507 1,434,247 1,685,366
Net Fixed Assets
14,378,604 14,881,867 15,868,743 17,547,285 17,675,798
Total Assets 18,774,070 19,506,045 20,635,782 23,208,733 22,925,123 Liabilities Current Liabilities
Accounts Payable
1,954,779 2,558,125 2,728,472 3,183,303 3,277,665
Government Dues
145,000 152,250 175,088 196,098 229,435
Pre-Payments & Accruals
125,000 128,750 135,188 148,706 151,680
Salaries Due 215,872 271,244 325,969 346,815 387,319 Total Current Liabilities
2,440,651 3,110,369 3,364,716 3,874,922 4,046,098
Long-Term Loans
2,197,733 3,082,785 3,236,925 3,538,405 3,499,551
Total Liabilities 4,638,383 6,193,155 6,601,641 7,413,327 7,545,649 Shareholders’ Equity
Paid-In Capital 100,000 100,000 100,000 100,000 100,000 Retained Earnings
5,650,000 5,650,000 5,650,000 5,650,000 5,650,000
Partners’ Accounts
6,157,728 5,050,051 4,506,653 6,079,216 4,294,954
Yearly Net Results
2,227,959 2,512,839 3,777,489 3,966,191 5,334,521
Total Shareholders’ Equity
14,135,687 13,312,890 14,034,142 15,795,406 15,379,474
Total Equities 18,774,070 19,506,045 20,635,782 23,208,733 22,925,123
Source: Prepared by authors with company information. F
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EXHIBIT 3: WOODEN BAKERY’S BASIC FRANCHISING REQUIREMENTS IN LEBANON
Location
No franchise agreement is signed unless the location of a new store is available and approved; the location should have the potential to attract a minimum of 400 to 500 customers per day; the ideal choices for a prime location are
on a main highway to attract 3% of the cars crossing it; on a main road in a high-traffic area; on the central square of a town or village; and easily accessible and offering car-parking facilities.
Targeted Neighbourhoods
Wealthy and middle-class neighbourhoods Low-income areas have been avoided so far The average ticket per customer does not vary much between a high-income
residential area and a middle-class area Financial Resources and Obligations
The franchisee has to have the required financial resources ($350,000 to $800,000)
A due-diligence report should be done to ensure the reliability and the credit history of the franchisee
An initial fee of $50,000 to be paid upon signing the agreement Royalty fees are 2.5% of revenues
Management Experience
Basic retail management experience is required from the franchisee as a crucial factor of success
Threshold for Sales
To break even, daily sales should exceed 4.5 million Lebanese pounds ($3,000)
Development Process
It starts once a memorandum of understanding is signed. Wooden Bakery provides all the necessary resources (e.g., company-
approved architects, suppliers of capital goods, inputs). It usually takes six to 18 months to open a new branch after signing a
franchise agreement. Securing construction licences issued by the government can cause further
delays. Wooden Bakery also provides pre-opening training for a period of two to three
months to both owners and employees of a new franchise; a team of four area managers, one training manager, and one quality control officer is in charge of the training.
Routine visits and quality inspections are also part of the process after the new branch starts operating; the quality inspection officer visits the branches regularly to ensure that the quality standards are met and to provide his recommendations to the area manager who, in turn, implements the corrective measures in coordination with the branch manager and the owner of the franchise.
Source: Prepared by authors with company information.
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EXHIBIT 4: INVESTMENT REQUIREMENTS — AREA-DEVELOPMENT FRANCHISE — ARABIAN GULF (IN U.S. DOLLARS)
Estimated
Low Range Estimated
High Range When
Payable Method of Payment
Payment to
Area-Development Rights
Area-Development Fee 1 1,500,000 1,500,000 Upon
Execution Lump Sum Wooden Bakery
Subtotal 1,500,000 1,500,000 Franchise Package
Training & Opening Support 2 6,000 10,000 Upon
Execution Lump Sum Wooden Bakery
Subtotal 6,000 10,000 Establishment Costs (Outlet) Property Finding Fee 3 8,000 15,000 As Incurred As Billed Local Agent
Premises Lease 4 excl. excl. As Incurred As Billed Lawyer &
Landlord
Planning Applications 5 excl. excl. As Incurred As Billed Advisors &
Government Architectural Services 6 15,000 30,000 As Incurred As Billed Architect Building Work 7 in fit-out in fit-out As Incurred As Billed Contractors Store Fit-Out 8 350,000 1,000,000 As Incurred As Billed Contractors Initial Stock 9 50,000 150,000 As Incurred As Billed Suppliers Electronic Point of Sale (EPOS) Equipment
10 12,000 17,000 As Incurred As Billed
Suppliers
Other 11 35,000 100,000 As Incurred As Billed Suppliers Subtotal 470,000 1,312,000 As Incurred Establishment Costs (Factory) As Incurred Property Finding Fee 12 60,000 80,000 As Incurred As Billed Local Agent
Premises Lease 13 excl. excl. As Incurred As Billed Lawyer &
Landlord
Planning Applications 14 excl. excl. As Incurred As Billed Advisors &
Government Architectural Services 15 80,000 100,000 As Incurred As Billed Architect Building Work 16 in fit-out in fit-out As Incurred As Billed Contractors Store Fit-Out 17 4,500,000 7,000,000 As Incurred As Billed Contractors Initial Stock 18 200,000 350,000 As Incurred As Billed Suppliers
EPOS Equipment 19 200,000 350,000 As Incurred As Billed Advisors &
Government
Other 20 50,000 100,000 As Incurred As Billed Advisors &
Government Subtotal 5,090,000 7,980,000 Other Initial Costs Outlet
Legal & Accounting Fees 21 5,000 10,000 As Incurred As Billed Lawyer &
Accountant Health & Safety Advice 22 500 1,000 As Incurred As Billed H & S Advisor
Staff Recruitment & Training 23 25,000 200,000 As Incurred As Billed Supplier/
Employees Launch Promotion 24 20,000 100,000 As Incurred As Billed Suppliers Miscellaneous Costs 25 5,000 15,000 As Incurred As Billed Suppliers Other 26 As Incurred As Billed Suppliers Working Capital Provision 27 50,000 150,000 As Incurred As Billed Suppliers Factory As Incurred As Billed
Legal & Accounting Fees 28 25,000 30,000 As Incurred As Billed Lawyer &
Accountant Health & Safety Advice 29 in fit-out in fit-out As Incurred As Billed H & S advisor
Staff Recruitment & Training 30 400,000 400,000 As Incurred As Billed Suppliers/
Employees Working Capital Provision 31 1,000,000 2,000,000 As Incurred As Billed Suppliers Subtotal 1,530,500 2,906,000 Total investment 32 8,596,500 13,708,000
Source: Prepared by authors with company information.
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EXHIBIT 5: FINANCIAL STATEMENT, THEORETICAL PROFIT & LOSS ILLUSTRATIONS OF AN OUTLET FOR THE AREA DEVELOPER (IN U.S. DOLLARS)
Income
Traditional Outlet
Non- traditional
Outlet Sales
1
5,500,000
1,790,000 Gross Profit
2
2,035,000
662,000 Gross Profit (%) 37.00 37.00 Overheads Rent
3
150,000
86,667 Utilities
4
220,000
69,333 Insurance
5
4,000
2,667 Occupancy Costs 374,000 158,667 % of Turnover 6.87 8.86 Staff Numbers
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26 Staff Costs
6
765,000
220,000 Employment Costs
765,000
220,000 % of Turnover 13.91 12.29 Local Marketing at 2%
7
110,000
35,800 Marketing Costs
110,000
35,800 % of Turnover 2.00 2.00 Delivery Service
8
4,000
2,333 Sundries
9
55,000
17,333 Other Costs
59,000
19,666 % of Turnover 1.07 1.10 Management Service Fee @ 4%
220,000
71,600
Total Overheads
1,528,000
505,733
% of Turnover 28 28 Operating Profit
507,000
156,267 Operating Profit (%) 9 9 *All figures in U.S. dollars (US$)
Source: Prepared by authors with company information.
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EXHIBIT 6: CHICAGO INCOME (IN U.S. DOLLARS)
Real Per Capita Income 1 Year 3 Year U.S. $28,889 +0.85% +2.75% Illinois $30,417 +0.24% +3.64% Chicago $31,885 +0.22% +3.49%
Real Median Household Income 1 Year 3 Year
U.S. $53,657 +1.04% +0.93% Illinois $57,444 +0.55% +2.51% Chicago $61,598 +0.07% +2.18%
Real Median Family Income
1 Year 3 Year U.S. $65,910 +1.28% +1.88% Illinois $71,796 +1.56% +4.00% Chicago $75,522 +1.22% +3.07%
Source: Department of Numbers, accessed April 24, 2016, www.deptofnumbers.com/income/illinois/chicago.
EXHIBIT 7: CHICAGO DEMOGRAPHICS (2014)
Population 2,722,389 (2014 estimates - a growth of 1% since 2010) Density: 12,750.3 people per square mile (4,923.0/km²) Below 18: 23.1% Above 65: 10.3% Households in Chicago: 1,028,829 Average persons in household: 2.58 Visitors: 40 million/year
45.0% White (31.7% non-Hispanic whites)
32.9% Black or African-American
28.9% Hispanic or Latino (of any race)
13.4% from some other race
5.5% Asian (1.6% Chinese, 1.1% Indian, 1.1% Filipino, 0.4% Korean, 0.3% Pakistani, 0.3% Vietnamese, 0.2% Japanese, 0.1% Thai)
2.7% from two or more races
0.5% American Indian
Ethnic Groups Irish, German, Italian, Mexican, Assyrian, Armenian, Arab, Jewish,
English, Bosnian, Croatian, Bulgarian, Czech, Greek, Black, Korean, Chinese, Indian, Filipino, Vietnamese, Lithuanian, Macedonian, Albanian, Pakistani, Polish, Romanian, Russian, Serbian, Slovak, Swedish, Ukrainian, Dutch, Belgian, Cuban, and Puerto Rican.
Note: Chicago is a city with significant ethnic and cultural diversity. This diversity is a variable that cannot be ignored by players in the food industry.
Source: United States Census Bureau, accessed April 24, 2016, www.census.gov/quickfacts/table/PST045215/1714000.
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9B05A028 PRODUCT PORTFOLIO PLANNING AT ESTONIA'S SAKU BREWERY Jordan Mitchell prepared this case under the supervision of Professor Michael Pearce solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail cases@ivey.uwo.ca. Copyright © 2005, Ivey Management Services Version: (A) 2010-02-18 INTRODUCTION In early 2004, Cardo Remmell, chief executive officer (CEO), and Karin Sepp, marketing director of Saku Õlletehase AS (Saku), were discussing their product portfolio plan. Located outside of Tallinn, Estonia, in the small town of Saku, the brewery had seen the domestic sales of its beer fall from the prior year and had experienced a two-year erosion (in value) from 48 per cent to 42.5 per cent of market share in its domestic beer brands. During the same period, the company had made gains with its other alcoholic beverages, such as long drinks and cider, and with its non-alcoholic beverages, such as bottled water and juices. Since late 2001, the company also had the rights to resell three well-known international beer brands — Guinness, Kilkenny and Carlsberg — as well as a previous agreement to sell two major soft drink brands — Pepsi and 7Up. While increases in the imported beer and long drinks were encouraging, Remmell and Sepp wondered what they could do to stem the decline of their flagship brand — Saku Originaal. Furthermore, they saw the opportunity to take advantage of the 3.5 million Finnish tourists that visited Estonia and who were familiar with the Saku name. Shipping Saku Originaal 100 kilometres north to Finnish shores would also be made easier by Estonia’s accession into the European Union (EU) in May 2004. However, Remmell and Sepp had to be careful to avoid cannibalizing sales to Finnish tourists on Estonian soil and had to be mindful of managing the growing product categories. ESTONIA Situated east of the Baltic Sea, south of Finland, west of Russia and north of Latvia, Estonia spanned 45,100 square kilometres and had a population of 1.4 million people. Throughout the country’s long history, it had seen several occupations by Germans, Danes, Swedes, Poles and Russians. The country was independent from 1918 to 1940, and in 1940, it became part of the Soviet Union as one of the 15 Soviet republics. During the Soviet occupation, all of the country’s enterprises were handed over to state control. In 1991, Estonia regained its independence, and the country quickly adopted liberal policies and transformed the nation to a democratic society. Many observers believed Estonia to be the quickest nation
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Page 2 9B05A028 of the former Soviet Union to integrate free-market mechanisms into the country’s economy. Former state- run enterprises were transformed to publicly traded companies on stock exchanges in Tallinn (the nation’s capital) and in other European countries. Estonia sought to adopt technology and was the first country in Europe to implement a virtual parliament with the government convening over a secure website. Technology was an important focus for the country, and by early 2004, it was not uncommon to pay for parking slots or coffees over mobile handsets. Exhibit 1 shows more facts about Estonia. THE ESTONIAN BEVERAGES MARKET Beer consumption in Estonia was estimated at about 67 litres per capita, with the total market staying flat at 95 million litres in 2003. One of the major changes in the Estonian beer market was the increase of imported beer market share moving from four million litres to 4.5 million litres in 2003. Beer (referred to as ‘õlu’ in Estonian) was predominantly sold in bottles (either plastic or glass) and cans, accounting for 91 per cent of the market, while draught beer made up the remainder. Industry observers believed that draught beer was declining, as the sale of bottled ciders and beers were becoming more popular in the hotels, restaurants and cafeterias (HORECA) sector. In addition, breweries were increasingly discounting the average price of cans by offering multi-packs of premium beer, which were largely aimed at tourist from Finland. Because the tax on beer in Finland was much higher, retail prices in Estonia were 40 per cent lower than in Finland. This price difference encouraged Finnish tourists to stock up during their visits. The beer market was divided between light pilsners and heavier stronger beers with higher alcohol content. Many of the other beverage segments in Estonia were experiencing growth: cider, long drinks, bottled water and soft drinks. The cider market had grown, year on year, more than 20 per cent since 2000. It amounted to 4.7 million litres with consumption estimated at three litres per capita, and growth for 2004 was estimated to be more than 20 per cent. Long drinks, which were bottled or canned mixed alcoholic beverages, had seen dynamic growth, soaring 30 per cent to seven million litres. Long drinks were expected to continue their strong growth pattern for the next year or two, before reaching a saturation point in the market. The bottled water segment climbed to 30 million litres, growing eight per cent with per capita consumption estimated at 25 litres while soft drinks grew five per cent accounting for 50 million litres and per capita consumption at 35 litres. Some industry observers felt that the bottled water segment was outpacing soft drinks, as consumers increasingly opted for water instead of soft drinks. The primary growth in the soft drink segment was from cheaper, local brands. To add to the pressure on the soft drink market, energy drinks with high doses of caffeine were becoming more widespread in the country, with an estimated 500 thousand litres being consumed and growth rates estimated at more than 30 per cent. BEER CONSUMERS IN ESTONIA While once considered an unsophisticated choice of beverage, Estonians’ attitude towards beer had changed significantly since the Soviet days. During the 1990s, Estonian beer manufacturers, led by Saku, slowly changed the image of beer by improving the quality and by targeting women in advertising campaigns — something unheard of a decade earlier. Once the quality had been improved sufficiently, Estonians became intently loyal to local brews. However, by early 2004, consumers were attracted by the onslaught of imported beer brands, such as Heineken and Carlsberg.
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Page 3 9B05A028 The largest consumer group was men aged 36 to 50 years old, followed by men 18 to 35 and women 18 to 35 years old. The high influx of Finnish tourists also swayed the market, as the low price of beer in Estonia compared to Finland prompted Finns to stock up when away on vacation. The ease of travel between Helsinki and Tallinn was aided by ferry services taking between one and two hours and costing between €15 and €40, depending on the time of day and speed of the ferry. Apart from connections between Finland and Estonia, frequent ferry crossings were available between Sweden and Estonia taking approximately eight hours. Often labeled as “beer rallies,” it was not an uncommon sight to see Finns and Swedes armed with boxes of alcohol to take home. Emor, an Estonian market research company, conducted a survey that found 78 per cent of Finnish tourist purchased alcohol to take back with them, with two-thirds of all Finnish tourists visiting Estonia at least every six months.1 The most common occasions for consuming beer included in a bar or public establishment (40 per cent of the time), during a festival (10 per cent), on a ferry between Estonia and Finland or Sweden (10 per cent) and at home (40 per cent). Apart from entertaining guests, watching television or accompanying a meal, beer at home was also consumed in the traditional Estonian sauna.2 SAKU’S HISTORY Although historians believed that brew kitchens had existed alongside the Kaala River in the small town of Saku for centuries, the Saku Brewery officially started producing beers in 1820, under the guardianship of Count Karl Friedrich von Rehibinder (see Exhibit 2 for historic photographs of company). Attracted by the clean flowing river, the Count built a manor beside the brewery. In 1849, the manor and brewery were purchased by the Baggo family, and by the 1870s, the Baggos had updated the brewery’s processes and beer quality by converting it to a modern industrial steam-fired brewery. Along with the production changes, the Baggos took the brewery from being a small-scale operation producing for the local town only to a company equipped to sell in Tallinn and the rest of the country. The brewery suffered a major setback during the war between Estonia and Russia and was later nationalized by the state in 1940, when Estonia came under Soviet rule. During Soviet times, Estonia played a key role providing foodstuffs and beverages for the entire union and served as the site for brewing experiments. In 1985, the Gorbachev government introduced a policy aimed at reducing alcohol consumption, which froze all future investments in the plant. By the late 1980s, the Soviet Union initiated a number of reforms allowing state-run enterprises greater flexibility in their operations. Cardo Remmell, who joined the company in 1983, as a construction manager, and was later promoted to managing director, recounted the late 1980s through to the privatization in 1991:
There were some of the first reforms around this time, and it allowed us to go to Finland and look at other breweries. And, we saw a lot of differences. We had about 10 purchasing managers and one salesperson and there they had it the other way around — one purchasing manager and 10 sales people. We had a lot of problems finding materials and locating suppliers within the system. We couldn’t get what we needed. So, we were looking for people to invest in us. The goal was to supply for Estonia. There were no real brands developed. There were the old Soviet brands, but the quality was just not acceptable.
1“The favorite products of Finnish cross-border shoppers are alcohol, sweets, clothes and tobacco products,” Emor, www.emor.ee, March 30, 2005, accessed April 17, 2005. 2Gatherings are common in saunas in Estonia, Finland, Sweden and Russia, taking place either in one’s home or at a cottage in the countryside.
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Page 4 9B05A028 In 1991, Estonia became an independent nation, and 60 per cent of Saku was sold to the Baltic Beverages Holding (BBH) group with the remaining 40 per cent control being retained by the newly formed Estonian government. BBH was controlled 50 per cent by the Swedish beverages company Prips and 50 per cent by the Finnish brewer Hartwall. In making the transition from a state-owned enterprise with a set production schedule to a private company that needed to supply to demand, Saku sought training and expertise from Prips and Hartwall. Remmell recalled:
First of all, our job was to reconstruct the brewery and turn out a quality product. It was a strange time, there were no rules. I didn’t know my authorization level. So, I got permission from the government afterwards. It was really just a big mess. With Hartwall and Prips, we got solid investment and marketing know-how. [To staff Saku] we looked for Estonians that had worked in other countries. Then, we found young people that we thought had the capability and trained them at a branding school in Norway and in Sweden. There was a lot of motivation to make it work. We had to find professionals to do the jobs and we had to make quick changes. It probably took two to three years to start to speak a common language.
Remmell and the rest of Saku’s management, along with the foreign investors, improved the product quality and took the results to a market research panel — the first of its type ever conducted in Estonia. The brewmasters were sent for training in Denmark, and the foreign investors updated the facilities to a modern brew facility. After selecting the beer on its taste and appropriate color and imaging, the name Saku Originaal was selected, with blue as the brand’s signature color. The company was on a mission to change the image of beer from Soviet times, as Estonians and Russians believed beer to be a low-quality beverage that lasted only seven days and had a deplorable smell over the preferred alcoholic drink of choice — vodka. Remmell reflected on the efforts to change the image of beer: “At first, we tried to promote beer to women. Because women didn’t drink beer too much in Soviet times. It had a really bad smell. So, with Saku, we improved the quality and then we opened the door to ladies.” Kristina Siemen, public relations manager for Saku, gave her rationale of how Estonia was able to quickly grasp consumer advertising, “Estonia is different. During Soviet times, we had Finnish television and we were actually troublemakers for the Soviets. We had the images of the West. We knew a bit about marketing and we knew what the image of a brand was.” By 1996, Saku had listed its shares on the Tallinn Stock Exchange, and the Estonian government sold its remaining share in the company. In 1999, Prips sold its share in the BBH group, and Carlsberg bought into BBH. BBH increased its ownership to 75 per cent and was the majority owner. Exhibit 3 shows some key facts about BBH. SAKU’S PRODUCTS Saku Originaal was the trademark brand of Saku’s stable of product offerings. It had been rated as Estonia’s best-known beer brand with unaided response of 60 per cent of the country’s adults. Approximately 65 per cent of all Estonian beer consumers had consumed Saku Originaal in the last six months. Saku’s complete portfolio of beer brands commanded 42.5 per cent market share. Saku Originaal’s most loyal consumers were middle-aged men. Consumers in this target audience like to think of themselves as being younger than their chronological age, so Saku Originaal’s advertising tended to feature consumers aged 18 to 35. Promotional activities centered around light-hearted and active images.
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Page 5 9B05A028 One consumer survey found that words such as, “tasty, quality, original, tradition, relaxation, ordinary, trust, reputation, snow, sauna and secure,”3 were associated with the Saku Originaal brand. Saku touted the tag line, “brewing for you!” and considered itself to be a “mood creator.” To foreigners, the brand Saku had become synonymous with the country so much so, some Finns endearingly referred to Estonia as “Saku Country.” Exhibit 4 shows some of Saku’s advertisements. Saku Originaal was priced at Kr204 (€1.28) per bottle, which was a mid-range price in the market place. For cans, Saku Originaal retailed at Kr16 (€1.02), and the packs of 12 cans sold for an average of Kr200 (€12.78). Prices at restaurants, bars and clubs ranged between Kr30 (€1.92) and Kr60 (€3.83). Exhibit 5 shows Saku’s financial highlights. More than half of Saku Originaal was sold in hotels, restaurants or cafeterias, with the remainder being distributed through supermarkets, kiosks and other stores. Exhibit 6 shows a breakdown of Saku’s distribution, sales and gross margin by division and product. Other Saku Beer Brands To appeal to other segments, Saku produced several other brands aimed at specific markets: Saku Rock, a beer aimed at younger consumers; Saku Tume, a dark beer popular in the winter; Saku Sorts, a bock-beer and Saku Valge, a premium wheat beer for distinguishing tastes. In 2003, the company launched two extra strong beers, Presidendi Pilsner and Presidendi 8, in plastic containers. The company was also the first in the country to launch a low-alcohol product, Saku Originaal Light. Saku promoted its stable of brands through sponsorship of music concerts, events and the Estonian gold medalist in cross-country skiing, Andrus Veerpalu. In preparation for the onslaught of increased tourism with Estonia’s accession into the European Union, Saku had licensed the Saku Rock name to a private company to build a state-of-the-art hotel in the harbor of Tallinn, directly in front of the ferry links. While the promotion for the hotel did not come out of Saku’s advertising budget, Saku had been doing additional promotions and advertising to take advantage of the increased exposure. Exhibit 7 shows pictures of the Saku Rock Hotel. Marketing Three World-Famous Brands: Carlsberg, Guinness and Kilkenny In October 2001, Saku had signed an agreement with Carlsberg and Guinness to act as the exclusive distributor of Carlsberg, Guinness and Kilkenny in Estonia. Initially, the company had high hopes, stating in the 2001 annual report, “In the long range we intend to increase the share of Carlsberg, Guinness and Kilkenny to 40 per cent of the Estonian imported beer market.”5 Saku wanted to take advantage of Estonians increasing desire to consume global brands. Remmell commented:
Eighty per cent of our revenue comes from domestic beer brands. Of course it’s attractive to introduce new brands and take well-known brands from other places. The key question
3Aile Lillepalu and Katri Pokats, "Evaluation of Branding Strategies among Selected Estonian Food and Beverages Producers," Stockholm School of Economics, Riga, August 2004, p.21. 4Kr12.5 = US$1. 5 Saku Annual Report, www.pruul.ee, p.6, December 31, 2001.
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is the market size. You have to evaluate the niche and ask what is the value of that niche? You can’t waste your money on your own brands or other owners. To launch something new, you need investments and we don’t have clear rules. Can it be successful? It takes a lot of human resources as well. So deciding about new products, you always have ambitions, but what if you’re not able to hit your targets?
In launching the three brands at once, Saku set a target of two per cent of the overall market for Carlsberg and one per cent for both Guinness and Kilkenny. The company supported the launch with out-of-home advertising, such as posters and giveaways in pubs and bars. Prices of Carlsberg were Kr30 (€1.92), in line with Heineken, and prices of Guinness and Kilkenny were at a premium of 20 per cent more than other imports. Carlsberg was available in all of the channels, whereas Guinness and Kilkenny were limited to HORECA distribution points. Alcoholic Beverages Outside of beer products, Saku marketed a cider line called Kiss, which was targeted towards young women in their early 20s, as an alternative to beer. Kiss had 24 per cent of the cider market in the country. The company also promoted a line of long drinks, such as vodka, pre-mixed gin and tonic and the newly inaugurated Ice Tequila drink. The popularity of long drinks had been growing, and Saku’s market share was estimated at 13 per cent in this segment. Remmell emphasized the importance of marketing responsible drinking in this high-alcohol segment and how the low price of vodka led to substitution:
Our issue is we are a beer country. There is cheap vodka, which is part of government policy and regulation. I think it’s too cheap. So low alcohol versus high alcohol and I think we need to make the prices to alcohol level equal. Alcohol is a problem. We need to show young people the difference between right and wrong. The alcohol policy is not well developed. We’ve tried to make a start through promoting self-regulation and understanding behavior. We want to say that beer can be a part of life, but we don’t want people to treat it just as alcohol . . . Beer is a topic that everyone wants to say something about right through from the prime minister to everyone else. Everybody likes to talk about beer. And, the alcohol policy is important for the government. The challenge is to separate . . . the heavy users and those that want to enjoy a social drink.
Non-Alcoholic Beverages In the water segment, Saku had licensed the name Vichy Classique in sparkling water and marketed still water under the name Montavit. The company had approximately 15 per cent of the segment. Approximately 75 per cent was sold through supermarkets and kiosks, and 25 per cent was sold through hotels, restaurants and cafeterias. Saku had the license for the registered trademarks, Pepsi, 7Up and Zingo, an orange-flavored soft drink. Estonia was dominated by Coca-Cola products, so even with Pepsi, Saku held about four per cent of the country’s overall soft drinks market. Sales on soft drinks were comparable to sales on water, with nearly 70 per cent being sold through supermarkets and 30 per cent being sold through hotels, restaurants and cafeterias.
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Page 7 9B05A028 COMPETITION In 1991, when Saku was privatized, two other Estonian beer-producing institutions were re-instated, including Tartu Õlletehas (Tartu) and Viru Õlu (Viru), which, as of 2004, held 35.4 per cent and 10.2 per cent of the beer market respectively. Other domestic breweries included Pärnu, Karksi, Viru-Nigula and Saaremaa, with a combined share of five per cent of the market. Exhibit 8 shows the market shares of major competitors by segment. A Le Coq (Tartu) The central competitive threat in the domestic beer domain was A Le Coq, a brand launched in 1999 by Tartu. The A Le Coq brand dated back to 1807, when a Belgian tradesman established a brewery in London, England. Tartu Brewery itself had history planted in Estonia since 1826, and like Saku, updated its simple brew kitchen to a modern facility in the 1870s. When Estonia became independent, Tartu looked to launch a product to compete with Saku. Olvi, another major Finnish brand, had purchased Tartu in the mid-1990s and worked on reconstructing the facility and developing a quality beer. A le Coq promoted its mission of, “A Le Coq makes you feel good,” and actively promoted Estonia’s national football and basketball teams. Besides the stable brand, A Le Coq premium, the company was the country’s sole distributor of Heineken (commanding three per cent share of the overall market). The brewery also offered a slew of other brands including Alexander, Buckler, Porter, Disel and Turbo Disel. In products outside of the beer market, Tartu marketed two gin-based long drink brands, Fizz ciders (a brand established by its parent Olvi), Aura non-alcoholic fruit juices, Aura bottled water, Arctic sports drinks, lemonade and other soft drinks. Remmell talked about his biggest domestic competitor:
When we launched in 1991, first was the quality. Tartu first tried to copy us on marketing but had not upgraded their quality. So, what happened? They had this big volume and then it dropped. Then, in 1999, they launched A Le Coq. Then, all of sudden, people had to choose between blue [Saku] and red [A Le Coq]. It’s one good learning point. We had a first mover advantage and what I learned is the chance to be alone and if you have it, it can be great. If you’re alone, you decide what to do and the consumers may not necessarily like it too much. Then, a competitor moves in and gives the consumers what they want. And, with A Le Coq, they use the brand in the same way, they analyzed our target group, found out what they liked and what they didn’t and started marketing to them.
Viru Viru was Saku’s other domestic competitor. Founded in 1975, Viru started as a collective farm by producing one sole brand — Ziguli beer — and during the 1980s, the company expanded into several other brands: Riia, Moskva and Kudne. In 1992, the Danish brewery Harboes Bryggeri A/S became the majority shareholder. As of 2004, Viru had a range of beer products, such as Bear Beer, under license from its parent, as well as Estonian brands, such as Toolse, Frederick, Palmse and Talveolu. The company produced and marketed a line of no-name soft drinks and non-alcoholic fruit drinks under the banner Kingsway, and a new line of energy drinks, called Hustler.
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Page 8 9B05A028 Imports Besides the imported brands under license, such as Hieneken by Tartu and Carlsberg by Saku, a number of other imported brands competed for market share. The imported segment was led by the Finnish company Koff, which commanded six per cent of the overall market and Olvi, which had three per cent. Some industry observers felt Koff’s market share had more to do with Koff’s advertising in Finland and its inexpensive prices in Estonia aimed at Finnish tourists. THE CHALLENGE: FORMING A PLAN Remmell and Sepp had helped to kickstart the transformation in the Estonian beer market in 1991. Thirteen years later, Saku was in a much different position. It had a complete portfolio of products in six different product categories. Recently, Saku had seen its market share drop, against strong domestic competitors, such as A Le Coq, and the onslaught of imported beer, such as Koff, Olvi and Heineken. While Saku was in a good position to compete in all segments of the beer market, Remmel and Sepp wondered how to plan the next few years. They were keen to take advantage of shipping Saku Originaal north to Finland, even though they were acutely aware of the difficulty in supporting an international expansion. As well, would they risk Saku’s domestic sales, since four million litres were purchased by Finns on holidays in Estonia? Remmell smiled as he thought about the latent opportunity with some of the nearby markets:
Our brand is a big opportunity, because the prices of Finnish beers are high. As well, Saku is a fairly common first name in Finnish. In fact, one day I remember walking in the town square, and I saw a Finnish tourist, and he had the jersey that said Saku Koivu, the famous hockey player, and he was holding a bottle of Saku beer in his hand. I smiled and thought it worked well together. But, to expand into other markets, that’s more difficult. See when putting a brand in another country you need to create a story for it. That is expensive for us. There’s a clear advantage to go into Finland for us, because we get so many Finnish tourists. However, we’re seeing many other people visit Estonia like the Swedish, and it’s much cheaper for us to introduce it to the tourist first. But, that’s just an idea right now. But the timing is not right. We need to focus on our domestic market. We don’t know what will happen with Russia and the taxes on exports. We were known in the old days for supplying all the food and beverages to the rest of the state.
CONSIDERATIONS TO THE PRODUCT PORTFOLIO Remmell, Sepp and the rest of their team had several considerations when planning their product portfolio. The company’s flagship brand was decreasing, and they were confident that exporting Saku to Finland would stem some of the decline. However, they were also worried that this action would cannibalize the domestic sales made to Finns while on holidays in Estonia. While growth in the cider and long drinks market had been unabated for the past two years, they were certain that growth rates would start to flatten out as the market reached a saturation point. What should be done with this line of products?
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Page 9 9B05A028 In the growing bottled water and soft drinks segment, Sepp and Remmell were disappointed with Saku’s performance against the rest of the market, considering it was currently occupying fifth place in bottled water and had a low market share in soft drinks. Siemen talked about the current opportunity with Saku’s portfolio of brands:
Our aim is to be the leader and innovator in the beer market. It’s a mature market and beer consumption is not increasing. So, we’re looking for new potential. For example, we launched the cider in 2000 and long drinks in 2001. With ciders, we have doubled sales over our expectations and with long drinks we’ve tripled sales. Water is also growing. This is really the start of a new era with more brands!
Remmell bridged the transformation in 1991 to current day:
[The transformation] was very exciting. If we didn’t change there wouldn’t be much hope. And, the main driving force was increasing the standard of living for everyone. We’re not there yet, but we’re certainly on the right road.
What would be the transformation for the future?
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Page 10 9B05A028
Exhibit 1
FACTS ABOUT ESTONIA
Population • 1,355,604 (2003 census) Age structure • 0-18 years: 24.5% (male 169,869; female 161,620) • 18-35 years: 21.0% (male 143,336; female 141,681)
• 36-50 years: 20.9% (male 134,847; female 148,447) • 51 years and over: 33.6% (male 176,644; female 279,160) Median age • Total: 38.8 years • Male: 35.1 years • Female: 42.1 years (2004 est.) Population growth rate • -0.66% (2004 est.) Sex ratio • At birth: 1.06 male(s)/female • Under 15 years: 1.06 male(s)/female • 15-64 years: 0.91 male(s)/female • 65 years and over: 0.49 male(s)/female • Total population: 0.85 male(s)/female (2004 est.) Ethnic groups • Estonian 65.3%, Russian 28.1%, Ukrainian 2.5%, Belarusian 1.5%, Finn
1%, other 1.6% (1998) Languages • Estonian (official), Russian, Ukrainian, Finnish, other GDP • Purchasing power parity - $17.35 billion (2004 est.) GDP - real growth rate • 4.7% (2004 est.) GDP - per capita • Purchasing power parity - $12,300 (2004 est.) GDP - composition by sector • Agriculture: 4.9%, Industry: 30.3%, Services: 64.8% Inflation rate (consumer prices) • 1.3% (2004 est.) Labor force • 654,000 (2004 est.) Labor force - by occupation • Agriculture 11%, industry 20%, services 69% (1999 est.) Unemployment rate • 10.1% (2004 est.) Industries • Engineering, electronics, wood and wood products, textile; information
technology, telecommunications Exports • $4.075 billion f.o.b. (2004 est.) Exports - commodities • Machinery and equipment 33%, wood and paper 15%, textiles 14%, food
products 8%, furniture 7%, metals, chemical products (2001) Exports - partners • Finland 21.9%, Sweden 12.5%, Russia 11.4%, Germany 8.4%, Latvia
7.4%, Lithuania 4% (2003) Imports • $5.535 billion f.o.b. (2003 est.) Imports - commodities • Machinery and equipment 33.5%, chemical products 11.6%, textiles 10.3%,
foodstuffs 9.4%, transportation equipment 8.9% (2001) Imports - partners • Finland 15.9%, Germany 11.1%, Russia 10.2%, Sweden 7.7%, Ukraine
4.3%, China 4.2%, Japan 4.1% (2003) Currency • Estonian kroon (Kr/EEK) Exchange rates • Krooni per U.S. dollar - 13.8564 (2003), 16.6118 (2002), 17.4781 (2001),
16.9686 (2000), 14.6776 (1999) Source: CIA World Fact Book, www.cia.gov, accessed January 15, 2005 and Statistics Estonia, http://pub.stat.ee/, accessed November 8, 2008.
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Page 11 9B05A028
Exhibit 2
SAKU’S FACILITIES
Drawing of Saku’s Factory, 1870s Exterior of Factory, Today
Saku Originaal Delivery Truck Saku Entrance
Kaala River, Saku
Source: Company files.
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Page 12 9B05A028
Exhibit 3
FACTS ABOUT BALTIC BEVERAGES HOLDING “Baltic Beverages Holding AB (BBH) is a 50:50 owned joint venture between Carlsberg Breweries A/S and Scottish & Newcastle plc. BBH operates 18 breweries in six countries in Eastern Europe, including Russia where it is the market leader with a 33 per cent market share.” 6
Russia Ukraine Baltics Kazakhstan Market Position 1 2 1 1 Market Share 33% 22% 43% EST 21%
43% LIT 45% LV
Key Brands Baltika Slavutich Saku Originaal Irbis Yarpivo Luiuske Rock Derbes
Nevskoye Baltika Aldaris Baltika Arsenalnoye Arsenal Utenos Alma-Ata
Uralskiy Master Suyturys Volga Don
Voronezhkoye
BBH 2003 2002 Personnel 15,000 14,000 Total sales volume, millions 3,135 2,911 Net Sales, € millions 1,161 1,237 EBITA, € millions 264 328
Source: BBH web site, www.bbh.sec, accessed January 15, 2005. Carlsberg — Carlsberg Breweries is the fifth biggest brewing group in the world, with nearly 29,000 employees, annual beer sales of 82 million hectolitres and operations at 103 sites in 49 countries. Carlsberg Breweries and Carlsberg A/S are headquartered in Copenhagen, Denmark. Carlsberg owns a strong portfolio of global, regional and national brands, including one of the world’s most international beer brands, Carlsberg.7 Scottish & Newcastle — Scottish & Newcastle has market-leader positions in 14 countries in Europe and Asia and exports beer to more than 60 countries around the world. In 2002/2003, S&N sold 4,790 million litres of beer. S&N employs 20,000 people and is headquartered in Edinburgh, U.K. S&N portfolio includes three of the top 10 beer brands in Europe: in addition to BBH’s leading brand Baltika, it embraces the French number-one beer Kronenbourg and the internationally popular Foster’s.8
6“BBH Results for Full Year,” www.scottish-newcastle.com, February 10, 2004, accessed January 15, 2005. 7BBH Website, www.bbh.se, accessed January 15, 2005. 8Ibid.
F o r
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Page 13 9B05A028
Exhibit 4
SAKU ADVERTISING AND BRAND IMAGES
Saku Originaal Advertisements and Images
Saku Rock Images
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Page 14 9B05A028
Exhibit 4 (continued)
Carlsberg Ads
Kiss Cider: Refreshingly Exotic Cider” Saku Gin: “Unusually Traditional”
Vichy Water Limps Soft Drink: “Catch the Sun” Source: Company files.
F o r
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Page 15 9B05A028
Exhibit 5
SAKU’S FINANCIAL HIGHLIGHTS (in € 000s)
2002 2003
Total Revenue 28,289 29,661 Expenses
Changes in inventories of WIP & Finished Goods 62 29 Materials, consumables and supplies used 10,505 11,830 Advertising 2,647 3,285 Other operating expenses 5,836 3,883 Personnel expenses 3,443 3,329 Depreciation and amortization expense 2,774 2,954 Other expenses 452 300
Total Expenses 25,719 25,610 Profit from Operations 2,570 4,051 Financial income and expenses (89) (60) Profit for the Period before Tax 2,481 3,991
Income Tax Expense 281 491 Net Profit for the Period 2,200 3,500
Basic EPS 0.28 0.44 Diluted EPS 0.28 0.44
Trade Receivables 1,857 2,256 Inventories 7,572 7,264 Total Assets 27,566 27,836 Trade Payable 1,277 782 Total Liabilities 5,112 4,438 Total Equity 22,454 23,398
Net Change in cash and cash equivalents (1,079) 1,197
Source: Saku Annual Report, pp. 11-15, December 31, 2003.
F o r
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Page 16 9B05A028
Exhibit 6
DISTRIBUTION AND SALES BY DIVISION
SALES 2002 % to Total 2003 % to Total
Saku beers 22,581 79.8% 23,563 79.4% Imported beers 688 2.4% 1,189 4.0% Saku mineral water 119 0.4% 105 0.4% Imported mineral water 1,281 4.5% 1,381 4.7% Other Saku alcoholic drinks 884 3.1% 2,007 6.8% Imported soft drinks 1,138 4.0% 1,110 3.7% TOTAL 26,691 94.4% 29,355 99.0% Other Revenues 1,598 5.6% 306 1.0% Total Revenues 28,289 100.0% 29,661 100.0%
GROSS MARGIN
2002 % to Sales 2003 % to Sales Saku beers 3,952 17.5% 4,241 18.0% Imported beers 144 21.0% 273 23.0% Saku mineral water 10 8.5% 8 8.0% Imported mineral water 192 15.0% 221 16.0% Other Saku alcoholic drinks 203 23.0% 502 25.0% Imported soft drinks 211 18.5% 211 19.0% TOTAL 4,712 17.7% 5,457 18.6%
Source: Saku Annual Report, p.29, December 31, 2003.
F o r
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Page 17 9B05A028
Exhibit 6 (continued)
SALES AND GROSS MARGIN BY PRODUCT
2002 % to Total 2003 % to Total 2002 GM % 2003 GM %
SAKU BEERS 22,581 23,563 Saku Originaal 18,607 82.4% 18,733 79.5% 3,238 17.4% 3,334 17.8% Saku Rock 1,739 7.7% 2,356 10.0% 306 17.6% 441 18.7% Saku Sorts 452 2.0% 353 1.5% 88 19.5% 67 19.0% Saku on Ice 294 1.3% 424 1.8% 53 18.0% 79 18.6% Saku Valge 632 2.8% 707 3.0% 127 20.1% 148 21.0% Saku Tume 248 1.1% 165 0.7% 45 18.2% 30 17.9% Saku Hele 158 0.7% 118 0.5% 30 19.1% 23 19.3% Saku Originaal Light 452 2.0% 589 2.5% 72 16.0% 97 16.5% Saku Presidendi - 0.0% 118 0.5% - 0.0% 22 18.3% TOTAL 22,581 100.0% 23,563 100.0% 3,959 17.5% 4,241 18.0%
IMPORTED BEERS 688 1,189 Carlsberg 468 68.0% 880 74.0% 95 20.3% 194 22.0% Guinness 186 27.0% 285 24.0% 43 23.0% 74 26.0% Kilkenny 34 5.0% 24 2.0% 7 20.0% 6 24.0% TOTAL 688 100.0% 1,189 100.0% 145 21.0% 273 23.0%
SAKU MINERAL WATER 119 105 Montavit Carbonized 67 56.0% 58 55.0% 6 8.4% 5 8.0% Montavit Still 52 44.0% 47 45.0% 5 8.7% 4 7.9% TOTAL 119 100.0% 105 100.0% 10 8.5% 8 8.0%
IMPORTED MINERAL WATE 1281 1,381 Vichy Classique Carbonized 666 52.0% 732 53.0% 100 15.0% 116 15.9% Vichy Classique Still 615 48.0% 649 47.0% 92 15.0% 105 16.2% TOTAL 1,281 100.0% 1,381 100.0% 192 15.0% 222 16.0%
OTHER SAKU ALCOHOLIC 884 2,007 Saku Gin 690 78.0% 963 48.0% 161 23.3% 231 24.0% Kiss Ciders 159 18.0% 943 47.0% 37 23.0% 252 26.7% Other 35 4.0% 100 5.0% 6 18.0% 19 19.0% TOTAL 884 100.0% 2,007 100.0% 204 23.0% 502 25.0%
IMPORTED SOFT DRINKS 1138 1,110 Pepsi 512 45.0% 344 31.0% 97 19.0% 66 19.3% 7Up 489 43.0% 244 22.0% 87 17.8% 44 17.9% Zingo 137 12.0% 333 30.0% 26 18.9% 64 19.2% Limps - 111 10.0% - 0.0% 22 19.8% Kali - 78 7.0% - 0.0% 15 19.7% TOTAL 1,138 100.0% 1,110 100.0% 210 18.5% 211 19.0%
TOTAL 26,691 29,355 4,720 5,457
SALES GROSS MARGIN
F
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Page 18 9B05A028
Exhibit 6 (continued)
ADVERTISING SPEND BY BRAND
2002 2003 % to Total % to Total
SAKU BEERS Saku Originaal 38.0% 34.0% Saku Rock 5.0% 7.0% Saku Sorts 1.0% 1.0% Saku on Ice 5.0% 4.0% Saku Valge 1.0% 1.0% Saku Tume 2.0% 2.0% Saku Hele 1.0% 1.0% Saku Originaal Light 3.0% 3.0% Saku Presidendi 0.5% 0.5% TOTAL 56.5% 53.5% IMPORTED BEERS Carlsberg 18.0% 20.0% Guinness 3.0% 3.0% Kilkenny 3.0% 1.5% TOTAL 24.0% 24.5% SAKU MINERAL WATER Montavit Carbonized 1.0% 1.0% Montavit Still 1.0% 1.0% TOTAL 2.0% 2.0% IMPORTED MINERAL WATER Vichy Classique Carbonized 1.0% 1.0% Vichy Classique Still 1.0% 1.0% TOTAL 2.0% 2.0% OTHER SAKU ALCOHOLIC Saku Gin 4.0% 5.0% Kiss Ciders 8.0% 9.0% Other 0.5% 0.5% TOTAL 12.5% 14.5% IMPORTED SOFT DRINKS Pepsi 1.0% 0.5% 7Up 1.0% 0.5% Zingo 1.0% 0.5% Limps 1.0% Kali 1.0% TOTAL 3.0% 3.5%
TOTAL 100.0% 100.0%
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Page 19 9B05A028
Exhibit 7
SAKU ROCK HOTEL
Saku Rock Hotel Exterior, Tallinn, Estonia
Saku Rock Hotel Interior
Saku Rock Bar Source: Case writer.
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Page 20 9B05A028
Exhibit 8
MARKET SHARES (IN VALUE) Source: Company files; Aile Lillepalu and Katri Pokats, “Evaluation of Branding Strategies among Selected Estonian Food and Beverages Producers,” Stockholm School of Economics, Riga, August 2004, p.21.
Long Drinks
13% 11%
76%
0% 10% 20% 30% 40%
50% 60% 70% 80%
Saku Tartu Others
Mineral Water
23%
15% 15%
47%
0% 5%
10% 15% 20% 25% 30% 35% 40% 45% 50%
Coca- Cola
Tartu Saku Others
Beer IMPORTS
40%
20% 18% 18%
4%
0% 5%
10% 15% 20% 25% 30% 35% 40% 45%
K of
f
O lv
i
H ei
ne ke
n
C al
sb er
g
O th
er s
Beer
43%
35%
11% 12%
0% 5%
10% 15% 20% 25% 30% 35% 40% 45%
Saku A Le Coq
(Tartu)
Viru Others
Cider
24% 20%
56%
0%
10%
20%
30%
40%
50%
60%
Saku Tartu Others
Soft Drinks
66%
16%
4% 14%
0% 10% 20% 30% 40% 50% 60% 70%
Coca- Cola
Tartu Saku Other
F o r
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Page 21 9B05A028
Exhibit 9
SELECTED BEER MARKETS Sales of Beer (based on 2003)
Finland Sweden Norway Russia
Volume (million liters) 407.1 483.3 231.0 8,084.1 Value (EUR millions) 2,311.8 1,737.8 1,715.1 8,270.8 Avg. value per liter (EUR) 5.68 3.60 7.42 1.02
Value Split Off-trade (Supermarkets, etc.) 51.7% 45.9% 56.3% 80.1% On-trade (Restaurants, Hotels, etc.) 48.3% 54.1% 43.7% 19.9% Total 100.0% 100.0% 100.0% 100.0%
Source: Euromonitor, Individual Country Reports, 2008-2009.
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9.
9B16M150 BROOKS SPORTS: COMPETING AGAINST THE GIANTS1
Wiboon Kittilaksanawong and Andrew Jiro Poplawski wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized, or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com. Copyright © 2016, Richard Ivey School of Business Foundation Version: 2016-09-27
We knew a commitment to putting the runner first and creating both fantastic product and memorable experiences for them was a big idea—a billion dollar idea.2
Jim Weber, CEO Brooks Sports
With its company philosophy of “Run Happy,” Brooks Sports, Inc. (Brooks) strove to inspire and promote an active lifestyle through its innovative gear, enabling its customers to run longer, farther, and faster. The company began as a small shoe company in 1914 and had endured a number of growths and declines in its 100 years of operations.3 Nearly bankrupt at the turn of the century because of its attempt to compete with diversified athletic brands, and falling victim to a number of unsuccessful acquisitions, Brooks had finally found a strategy to compete in the sports market. Operating as an independent subsidiary of Berkshire Hathaway Inc., and under the direction of chief executive officer (CEO) Jim Weber, Brooks focused entirely on the niche running market, transforming from a brand that generated only US$65 million in sales in 2001,4 to one that generated over $500 million in 2014.5 In 2014, Brooks had set its sights on becoming a $1 billion brand by 2020.6 In the past, few companies focused on the small but growing running industry; however, with the running market becoming increasingly competitive, would Brooks’s runner-focused strategy carry the company to its $1 billion goal by 2020, or would Brooks be forced to shift to a diversified approach as the running market became more crowded? BROOKS SPORTS’ BEGINNINGS Founded by Morris Goldenberg in Philadelphia, Pennsylvania in 1914, Brooks began as a manufacturer of bathing shoes after acquiring the Quaker Shoe Company and quickly expanded its production to include athletic footwear after early success.7 In the 1920s, Brooks began producing baseball cleats, and in the 1930s, it expanded its production to include football cleats, ice skates, and boxing shoes. Brooks’s growth followed the popularity of sports throughout the United States; as market demand expanded, so did the company’s product lines. However, by continuing to expand its product range, Brooks went 60 years without distinguishing itself to customers until the 1970s.
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Page 2 9B16M150 Frank Shorter’s 1972 Olympic marathon gold medal and Bill Rodgers’ marathon victories inspired more than 25 million Americans to purchase their first running shoes and start long-distance running during a period referred to as “the first running boom.” 8 During this period, running shoe and apparel manufacturers grew rapidly, while marathons and other long-distance running events began appearing throughout the country and were completed by many new runners. Notably, these races were largely run by men, and few women ran at the time.9
Before the running boom, large sporting goods stores and mall retail stores carried a large range of athletic shoes at competitive prices, offering discounts and sales to attract customers. Yet these stores placed little emphasis on training employees and providing knowledge of running products, instead focusing on sales and profits. The running boom brought the introduction of specialty running stores (i.e., stores dedicated to solely running), which offered a number of advantages to consumers, including specialized customer service, running education from experienced athletes, local running community support, and shoes not available online or in national chain stores. Recognizing these advantages, runners began shifting their buying preferences, and running specialty stores became the “lifeblood of the running industry and sport, providing a sense of community and spreading the knowledge and passion to all levels of runners.” 10 During the running boom, Brooks introduced the Vantage, the first running shoe assisting runners with over-pronation to prevent injuries occurring from excessive inward rolling after landing. Led by this new product, Brooks soared to become one of the top three shoe brands by the 1970s, unaware that an upstart and rival company would soon grow to challenge it. CHASING NIKE Founded in 1964, Blue Ribbon Sports originally operated as a distributor for Japanese shoemaker Onitsuka Tiger.11 Under this partnership, Blue Ribbon Sports opened its first retail store in California and quickly expanded its retail and distribution to Massachusetts. In 1971, bearing the “Swoosh” logo, and acting independently under the name Nike, the company launched its first Nike athletic shoes. 12 By patenting its “Nike Waffle Trainer” and trademarking its Swoosh logo, Nike became a household name throughout the United States as it entered the same running market dominated by Onitsuka and other brands (including Adidas and Brooks) in the 1970s. Backed by high-profile endorsements and “Nike Air” technology, sales rose rapidly—from $10 million in 1970 to $270 million in 1980. By 1980, Nike held a 50 per cent market share in the U.S. athletic shoe market and opened itself up to an initial public offering.13 Reaching $1 billion in sales and diversifying into a wider range of athletic shoe fields, Nike was quickly becoming the envy of all athletic companies. As strong comparisons were made with Nike, Brooks began extending its operations to mirror those of Nike by branding products, endorsing athletes, and diversifying into new sports. 14 For nearly eight decades, Brooks had produced a variety of footwear to complement its running shoes, while also signing top athletes like Dan Marino and James Worthy for endorsements. However, what was highly successful for Nike devastated Brooks’s business. By the end of the 1970s, comparisons between the two companies had ended. Diversification led to an overextension into too many different sports, causing a rapid decline for Brooks’s identity and position in the athletic industry as a running company. Without steady success across all of its product lines, Brooks was left overexposed to the business downturn and its operations grew inefficient in production, leading to financial difficulties. Brooks began cutting costs by sacrificing quality, utilizing cheaper materials in the designing and manufacturing of its
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Page 3 9B16M150 footwear, lowering prices to regain customers, and distributing its products to discount chain stores with retail prices as low as $20—a significant decrease from its earlier $70 pricing point. Consequently, tarnished by inferior products and a poor business strategy, Brooks began losing credibility and received heavy criticism from customers. As the company shifted away from its core competency, running, it lost its position in the 1980s and faced the daunting challenge of winning back customers in the increasingly competitive niche market. MOVING IN DIFFERENT DIRECTIONS: NEW OWNERS, LEADERS, AND STRATEGIES Declining in the athletic industry, Brooks was acquired by Wolverine World Wide, Inc. (Wolverine) in 1982. With the goal of leveraging its Hush Puppies brand, Wolverine aimed to restore the declining image of Brooks’s shoes. However, Wolverine failed to allocate adequate resources to Brooks, instead focusing on growth from acquisitions and internal development by acquiring Town & Country, Viner Bros., and Kaepa in 1982, while also developing its own shoe line called Body Shoe.15 After a decade with little focus on Brooks’s failing shoes, Wolverine’s net income fell from $15.5 million in 1981 to $2.1 million in 1984, while Brooks experienced eight years of consecutive unprofitability and losses totalling $60 million in 1992.16 In 1993, a privately held Norwegian holdings company, the Rokke Group, became Brooks’s owner, purchasing the brand for $21 million.17 Looking to create a new identity for Brooks, the Rokke Group consolidated and relocated Brooks’s headquarters to the state of Washington. Despite ambitious goals to recover Brooks’s image in the athletics industry, the Rokke Group failed to integrate Brooks and develop synergies with its other brands. Instead, Brooks faced internal conflict over a direction for the company and continually delayed new shoe releases. Once one of the top three brands in the running shoe market, by 1993, Brooks had fallen to 25th, controlling only 0.4 per cent of the domestic market. The company began desperately searching for a new leader and strategy to turn it around. In 1994, Helen Rockey was selected as Brooks’s president by the Rokke Group, becoming the first female leader of a major athletic shoe company in the United States.18 Rockey had been selected because of her strong background in the sports industry and immense success at Nike. Following an analysis of Brooks’s operations, she began implementing changes to guide Brooks toward a unified vision for its stakeholders with the following goals:19 Increase sales and profits by 25 per cent in the next three to five years. Re-engineer Brooks’s products to focus exclusively on runners. Discontinue the production of all other sports categories. Stop retail store sales to concentrate on specialty running store distribution. By reverting back to its original runner-focused business model, Brooks aimed to shed its identity as a diversified athletic manufacturer, with Rockey stating, “Nike is in the entertainment business; we’re in the running business.” 20 Rockey began shifting attention to the design of Brooks’s footwear products, creating three objectives to instill confidence in Brooks’s new brand image: Promise new and revamped product excellence with a reduced defect rate. Emphasize operational efficiency with timely delivery. Provide sales support through marketing that incorporated individual retail stores. Regarding Brooks’s return to concentrating solely on runners, Rockey stated that “with a niche brand, you
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Page 4 9B16M150 have the opportunity to really target a focused segment of consumers and talk to them and service them.”21 Brooks sponsored runners and utilized the running community in its marketing strategy, looking to build closer bonds with retailers and the community while eliminating endorsements and only spending $750,000 a year on running publications and magazine advertisements. However, these marketing changes shifted the company’s target market. Brooks sacrificed the rising youth athletic market to target 35- to 54-year-old runners, the strongest niche of the running market at the time. With an increasing number of retail locations selling Brooks’s shoes, sales growth followed: Brooks recognized profitability in its first year under Rockey’s leadership.
In light of this growing success, Rockey believed the time was right to extend operations into running apparel. In 1997, Brooks released running and fitness apparel, creating a strong financial boost and second revenue source. Between 1995 and 1999, its sales increased an average of 30 per cent annually, orders from specialty running shops rose by 84 per cent, and its apparel accounted for 15 per cent of the company’s total sales. By the end of 1999, Brooks appeared to be revitalized and positioned for success in the new century. Despite the turnaround, the Rokke Group chose to focus more on the commercial fishing and real estate industries and, in 1998, sold Brooks to venture capital firm J.H. Whitney & Company for $40 million.22 Rockey left Brooks to join Just for Feet Inc., leaving Bruce Pettet, vice-president of sales and marketing, to run the company.23 Although he followed the same strategy as Rockey, Pettet was unable to lead Brooks to further success due to a lack of leadership, dedication, and commitment to the company. Upon leaving the company for a Colorado apparel, footwear and accessories company called Airwalk International LCC in 2000, Pettet was replaced by Eric Dreyer, former vice-president of Brooks’s footwear and apparel department.24 Like Rockey, Dreyer believed that the future of Brooks would be in the niche running segment, and he shifted the company’s positioning to target the high-end segment of the running industry.25 However, the running community was slow to adjust to the strategic shift, and it appeared Brooks would become bankrupt within the early 21st century. JIM WEBER AND THE SECOND RUNNING BOOM Surrounded by growing concerns for the declining company, Weber replaced Dreyer as Brooks’s CEO in 2001. As the company’s fifth CEO in nearly two years, he faced a number of challenges while pursuing the turnaround and revival of Brooks. 26 When Weber took over, Brooks was known for two high- performance stability running shoes that were introduced in the 1990s: the Beast and the Addiction.27 Weber referred to the shoes as “barbecue and lawn-mowing shoes” because its customers only wore the shoes for non-running, recreational activities. Yet the two products comprised over half of Brooks’s business. Weber’s initial thought after becoming CEO was, “Brooks was like every other athletic footwear company, only a lot smaller. [Brooks] didn’t have the marketing spend. Our brand was tired and running on fumes.”28 He knew the company would require something special to survive in the competitive athletic industry. Conveniently, at the same time that Brooks was seeking revival, a new running boom was growing in the 1990s, known as “the second running boom.”29 Unlike the first running boom, which focused almost entirely on competition among adult males, the second running boom centred on the social, health, and fashionable aspects of running, along with the sense of accomplishment. The aim was not to run for a record time but rather to run for charitable causes or take control of one’s life by losing weight and reducing stress.30 Through training programs, community events, and themed races, a new demographic of runners began to surface. Women also began putting on shoes and running, allowing companies to
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Page 5 9B16M150 expand their product lines to target female runners. From 1990 to 2012, every year but 2003 saw a new record in the number of finishers in U.S. running events (see Exhibits 1 and 2).31 Brooks decided to stop competing with its larger, established competitors, because, as Weber stated, the company was “everything to everybody and [consequently] . . . sixth, seventh, or eighth at everything.”32 Weber understood that “by doing one product, [Brooks] stopped confusing customer[s].”33 Accordingly, Brooks created a high-tech testing lab and an expanded shoe trail program and focused its design and development on technical running. As part of this new strategic intent, Brooks concentrated on its Beast and Addiction shoes while developing alternative running shoes, resulting in the creation of the Adrenaline GTS, geared toward runners with normal feet. Brooks aimed to be the exclusive running brand and expanded its product line to satisfy runners of all ages and styles. Rather than spending precious resources on advertising and hoping to attract customers, Brooks went straight to runners’ feet. By sending sales representatives to specialty running stores, the company built relationships with these stores and connected directly with its target consumers. Brooks also created a group of “gurus”—field marketing employees who promoted the brand and sold products at retail locations, run expositions, fun runs, and community events. Through its focused strategy, Brooks made developments that were impossible for larger brands competing in multiple athletic categories (i.e., beyond running) to replicate. Recognizing Brooks’s strong turnaround and growth in the running market, Russell Corporation (Russell) purchased the company for approximately $115 million in 2004.34 Brooks’s sales were estimated to be $95 million at the time, and sales were projected to equal the acquisition cost by 2005.35 Russell had started as an athletic uniform manufacturer in 1973, aiming to strengthen its position in the athletic market through acquisitions of established sporting brands. Once Brooks was acquired by Russell, Weber stated that “Russell understands the athletic industry and the specialty store environment, and [it believes] passionately in the Brooks brand, strategic vision, and plans for growth.”36 Russell planned to leverage its track business with high schools and colleges together with Brooks, while also expanding the company’s apparel line. However, the synergy between the two companies was never achieved, resulting in another sharp decline in Brooks’s positioning in the market. RUNNING IN THE RIGHT DIRECTION: THE BERKSHIRE HATHAWAY ACQUISITION In 2006, after further rapid decline, a merger agreement was completed for Berkshire Hathaway Inc. (Berkshire) to acquire Russell at a cost of nearly $600 million, which included the acquisition of Brooks.37 One of the world’s largest multinational holdings companies, Berkshire was founded in 1893 and was owned by Warren Buffett, who had grown the company’s revenue to nearly $200 billion in 2014.38 Berkshire owned over 70 companies and was a minority investor in a number of other companies, including clothing and shoes manufacturing companies. The acquisition allowed Berkshire to enter a new market, with Brooks competing at the premium end of the running segment. Buffet described the acquisition: “Brooks is doing what it should every day to provide a great product for people who are out there running, doing what they love, being healthy.”39 Under Berkshire’s ownership, Brooks gained no significant synergistic financial or operational benefits; instead, Brooks continued to make independent strategic moves, aspiring to shift its position to the top of the running market, with Berkshire expecting to see only its positive financial returns. As Brooks was only a small operationally independent part of the large Berkshire portfolio, it was unclear whether Brooks would finally achieve sustainable growth and profitability in the running market.
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Page 6 9B16M150 Under Berkshire, Brooks began utilizing a variety of unique marketing and promotional techniques that followed its “Run Happy” motto. In 2009, the company partnered with Competitor Group to connect with runners at Competitors’ Rock ‘n’ Roll Marathons, which had grown from 13 national races per year in 1988 to 24 national and six international events. The global races allowed Brooks to gain stronger brand recognition as the exclusive running company at the Competitor Group events. Additionally, the company travelled to hundreds of independent running events each year, bringing a double-decker British-style bus featuring “running-themed carnival games, an arcade of oddities, and the world’s biggest shoe.”40 Brooks also visited college campuses to create viral videos with students for social networking. Through these grassroots marketing strategies, Brooks connected with local runners and communities at a low cost, remaining consistent with its small marketing budget by avoiding high-cost strategies like television advertisements. One observer noted, “With limited marketing dollars, [Brooks gets] way more value than bigger companies.”41 Competing with Nike (which achieved $26 billion in sales in 201542) was a challenge, because “Nike [spent] more [in a morning] on marketing than [Brooks spent] in a whole year.”43 Running had traditionally been a very serious sport, with proponents following dedicated training schedules and striving to achieve weekly and monthly mileage goals. Brooks’s “Run Happy” motto turned that idea on its head by conveying a fun, light-hearted brand image, while also offering a superior running shoe for its customers. RUNNING TO NEW COMMUNITIES: GLOBAL EXPANSION In 2012, Brooks announced the opening of its first Asian subsidiary, Brooks Sports K. K. in Japan.44 Brooks entered Japan—which was home to the world’s second-largest running market—through a partnership with Custom Produce Inc. (CPI), a Japanese importer and retailer of foreign apparel, accessories, and athletic equipment.45 Although critics questioned Brooks’s choice of Japan to enter the Asian running market, Weber stated, “To reach our goal to be the leader in performance running by 2020, we need partners who share our passion for running and an appreciation for our Run Happy spirit . . . CPI is that partner for us in Japan.”46 Brooks Sports K. K. was the company’s first entry into the Asian market, but it was the second subsidiary for the company; Brooks’s first subsidiary had opened in Germany in 2002 and focused on Europe, the Middle East, and Africa. In 2013, the Tokyo Marathon became the sixth World Marathon Major, joining the United States and Europe as holders of the other five.47 The number of runners in Japanese marathons had increased by over 240 per cent over the past five years, and over 28 million runners had made long-distance running an integral part of their lifestyle in Japan. However, Japan was also home to Japanese athletic company ASICS. In a brand-loyal country, ASICS had grown from its split with Nike to become a significant force in the Japanese athletic market, producing footwear and equipment designed for a range of sports and generating nearly half of its income from the Japanese market. There were many differences between the Japanese retail channels that sold Brooks’s products and the specialty running stores Brooks relied on in its domestic market. While specialty running stores in the United States were completely focused on runners, Brooks’s shoes in Japan were sold through large athletic sporting stores that failed to provide the same level of service for runners looking to purchase specialized running shoes. In addition, many of Brooks’s direct competitors had a strong presence in these retail stores. Dependent upon retail stores, the competitive Japanese market was not an ideal environment to foster Brooks’s growth in Asian markets—especially since the company was focused only on the running segment. To compete with ASICS and other brands, it seemed that Brooks would have to replicate its successful focused strategy in Japan and other international markets.
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Page 7 9B16M150 A BRAND 100 YEARS IN THE MAKING Brooks celebrated its 100th anniversary in 2014, announcing that it had reached one of its major goals— $500 million in revenues—ahead of schedule. With products in more than 60 countries, Brooks was seeing global brand momentum. In 2011, its international business grew by 26 per cent, relative to 20 per cent in 2010. In specialty running stores, Brooks grew its number one market share position to 31 per cent.48 Additionally, Brooks’s Ghost 6 shoe maintained its foremost spot in the growing neutral footwear category at specialty running stores, while the Adrenaline GTS shoe remained the top choice for runners for the sixth straight year. Brooks also moved its headquarters just outside of Seattle to get closer to runners and the 27-mile Burke-Gilman Trail, with Weber stating that “the opportunity to be so close to our customers is amazing.”49 Brooks’s new headquarters also included the company’s first retail store, called Brooks Trailhead: “more than a store, it’s a place to gather with friends, start workouts and celebrate a good run,” ran the marketing.50 The retail store displayed Brooks’s history, and offered shoes, apparel, and accessories. Looking forward, Brooks had set its sights on becoming a $1 billion brand by 2020.51 In order to achieve these goals, would Brooks need to develop a different strategy to capture a stronger share of the running industry? THE RUNNING MARKET: OVERCROWDED WITH NEW ENTRANTS In 2004, only eight athletic brands competed in the U.S. running industry: Adidas, ASICS, Brooks, Mizuno, New Balance, Nike, Reebok, and Saucony; however, by 2014, there were over 34 brands (see Exhibit 3).52 For newer entrants, the low cost of production and high retail selling points were attractive for market entry, but newer companies were encountering resistance from specialty running stores operating with limited inventory space. In 2014, the sales from running-related retail in the United States was $7.5 billion (up from $7 billion in 2013 and $6 billion in 2006), while the international running market was expected to be $11 to $12 billion in running-related retail sales (see Exhibit 4).53 In addition, the number of female runners overtook the number of male runners in the United States, creating a growing target market for running brands (see Exhibit 5). Sales of running/jogging shoes totalled $3.09 billion in 2013 (up 2 per cent in total dollars from 2012), while units rose to a record 46.25 million (from 44.62 million in 2012) (see Exhibit 6).54 The market had rapidly expanded with trail, triathlon, and obstacle races like Tough Mudder and the Color Run. In 2013, there were over 23,000 timed races and 19 million people running at least twice a week in the United States. As the global running market was projected to reach $20 billion in 2015, international athletic brands were focusing more resources toward the niche running market. Facing the rise of new competitors and the diversity of running brands, one strategy for Brooks was to return to product diversification to increase its sales and profits in order to achieve its 2020 business goals. With successful diversification, Brooks would be able to increase its economy of scope when the new businesses were related. In the past, diversifying the Brooks brand had weakened the company’s strategic assets and led to its downfall. Yet with Brooks successfully focused on the running market, perhaps the company could leverage its past failure with its diversified experiences to become a successful diversifier. Would Brooks risk diversifying itself again to achieve its $1 billion goal by 2020? SPECIALTY RUNNING CHANNEL: A SALES DILEMMA Although Brooks took control of the multi-billion dollar specialty running-shoe market with a 29 per cent market share, the specialty-running channel only accounted for 10 to 20 per cent of the $20 billion running market. In 2014, there were just over 800 running specialty shops—a small number compared to
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Page 8 9B16M150 the amount of company-owned stores possessed by Brooks’s competitors (see Exhibit 7). Brooks owned only one retail store, relying on its local retail partnerships for growth, while companies like ASICS and Nike owned hundreds of company-owned retail stores globally, in addition to their presence in general retail and athletic stores. Furthermore, the specialty running stores that sold Brooks’s running products also sold those of its direct competitors. Brooks was facing the challenge of expanding distribution while remaining true to its core customers. In the past, specialty-running stores were useful for helping runners find the correct running shoe for their running style and feet. In 2014, runners already knew what they wanted in their running shoes. The Internet had become one of the strongest competitors for specialty-running stores because it offered the same products for a cheaper price (see Exhibit 8). Weber believed that “you can’t stop a runner from getting their second or third pair [online], but what we can manage is that they are full price and presented as a premium product.” Accordingly, Brooks stopped selling its inventory on Amazon and ended its relationships with another 50 Internet-only resellers from 2010 to 2014 (see Exhibit 9).55 As a niche company and against increasing competition, Brooks’s core dilemma was whether to grow through external or internal opportunities to achieve its $1 billion goal. A MARATHON OR A SPRINT TOWARD THE 2020 GOALS While competing at the premium end of the running market, a number of challenges stood between Brooks and its $1 billion 2020 goal. How would the company increase international sales? By diversifying into apparel, could Brooks leverage its past diversification failures to become a successful company in new athletic markets? Did the company possess the capability to manage a diversified business? Would the lack of Brooks’s retail stores hurt its global brand presence? Weber insisted that economic downswings did not change business for the company because “running has proven to be somewhat recession and economic pressure resistant . . . all you need is a pair of shoes, and you go out the door.”56 He believed that “as millions of people around the world make running a key part of their fit, healthy lifestyles . . . [Brooks’s] goal is to be their number one choice for gear.”57 For Brooks, the race to its $1 billion sales goal was becoming more of a marathon than a sprint.
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EXHIBIT 1: RUNNING-EVENT FINISHERS 1990–2012
Source: Adapted from “2013 State of the Sport—Part III: U.S. Race Trends,” Running USA, July 28, 2013, accessed June 6, 2016, www.runningusa.org/state-of-the-sport-race-trends.
EXHIBIT 2: U.S. RUNNING PARTICIPATION NUMBERS
Survey Category Total
Participants
2012–2013 Difference
(%) Sports & Fitness Industry Association (SFIA) Total Runners Run/jog at least once
54,188,000 5.3
SFIA Core Participants Run/jog 50+ days/year 29,843,000 1.2 SFIA Total Trail Runners Run on trails at least once 6,792,000 17.0 SFIA Total Adventure Racing Participated 1+ time 2,095,000 29.5 SFIA Casual Adventure Racing Participated 1 time 901,000 34.0 SFIA Core Adventure Racing Participated 2+ times 1,194,000 26.3 National Sporting Goods Association (NSGA) All Runners Run/jog 6+ days/year
41,996,000 4.9
NSGA Frequent Runners Run/jog 110+ days/year 9,944,000 7.8 NSGA Occasional Runners Run/jog 25–109 days/year 19,514,000 5.1 NSGA Infrequent Runners Run/jog 6–24 days/year 12,538,000 2.5
Source: Adapted from “2013 State of the Sport: 2013 US Race Trends,” Running USA, July 28, 2013, accessed June 6, 2016, www.runningusa.org/state-of-the-sport-race-trends.
25% 32% 42% 48%
53% 55% 56%
75%
68%
58% 52%
47% 45%
44%
0
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
14,000,000
16,000,000
18,000,000
1990 1995 2000 2005 2010 2011 2012
R U N N E R S
YEAR
Female Male
F o r
u se
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in t h e c
o u rs
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m e te
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a c
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o la
tio n .
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Page 10 9B16M150
EXHIBIT 3: RUNNING MARKET COMPETITORS Nike From its early years as a running shoe manufacturer and direct competitor of Brooks in the 1980s, Nike grew to become the company many imagined Brooks would be. Nike was recognized globally as the number one shoe and apparel company, designing, developing, and selling a variety of products and services. The company targeted every age demographic, from children to the elderly, and also sold through its subsidiaries, Converse and Hurley. Nike’s sales channels were over 850 company-owned retail stores around the world, independent distributors, licensees, retail accounts, and e-commerce websites. Nike’s success stemmed from its unique worldwide marketing campaigns, sponsoring, and advertising with some of the most famous athletes, sports teams, and collegiate programs in the world. In 2014, Nike generated $28 billion in total revenues and was the top athletic brand in many countries. Adidas Following a family feud between the brothers that founded Puma, Adidas was formed in 1949, when Adolf Dassler created a company to compete with his brother’s Puma brand. Adidas was a German multinational corporation, designing and manufacturing sports shoes, clothing, and accessories. With its iconic three-stripe logo, Adidas had become the second-largest sporting-goods manufacturer in the athletic industry behind Nike and focused on football, soccer, running, training gear, and apparel. The company acquired one of its competitors, Reebok, in 2005, for $3.8 billion. Adidas generated over $19.5 billion in revenue in 2014 and sold its products in 160 countries through 2,445 stores. ASICS From the end of its partnership with Nike, ASICS had grown significantly—not only in its domestic market (Japan) but also as a globally recognized brand. In 2014, ASICS’ sales were $3.2 billion. ASICS manufactured and marketed footwear, sportswear, and uniforms for a number of different sports. Its presence in Japan was heavy due to sponsorships and partnership with athletic teams in its domestic market. The company also sold fashion-oriented items under the Onitsuka Tiger brand. ASICS operated subsidiaries in Australia, China, Europe, and the United States, selling through 317 stores. Puma SE Globally recognized by its cat logo, Puma had grown into a major German multinational company that produced athletic and casual footwear and sportswear since its founding in 1924. A family dispute led to the company splitting into two companies: Adidas and Puma. While shoes were Puma’s core competency, its apparel had begun generating a growing portion of the company’s sales. In 2014, Puma generated $3.61 billion in revenue and had extended styles of athletic clothes for golfing, motorsports, and sailing, including other denim apparel. Puma distributed and sold its products in more than 120 countries. New Balance Originally known as the New Balance Arch Support Company in the first years after its founding in 1906, New Balance had grown to be a manufacturer of sports shoes for running, tennis, basketball, hiking, and golfing. The company was best known for its walking and cross-training shoes, and it achieved sales of $3.3 billion in 2014. In contrast to many of its competitors in the athletic industry, New Balance’s products were sometimes priced higher than its competitors; however, the company claimed to differentiate with technical features in its shoes, such as gel inserts, heel counters, and a diverse range of sizes and widths.
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t D
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Page 11 9B16M150
EXHIBIT 3 (CONTINUED) Saucony (Stride Rite) Founded in 1898, Saucony aimed to be the sole provider for athletes regardless of age. Like Brooks in the past, Saucony was a subsidiary of Wolverine World Wide, Inc. Best known for its running shoes, the company also sold shoes for walking, cross training, and hiking. Saucony became part of Stride Rite’s business in late 2005, when it was acquired for about $170 million in cash. The company sold its products through its parent company, Stride Rite’s wholesale segment; as a result, Saucony sold directly to customers in more than 80 countries around the world. Li-Ning One of the newer athletic companies, Li-Ning was founded in China in 1990 as a company that targeted athletics like running, basketball, football, tennis, and overall fitness. The company’s motto was translated to “Make the Change.” It had numerous partnerships with companies like France’s Aigle and Chicago’s Acquity Group to help expand its brand awareness and global presence. Despite the company’s quick rise in the athletic industry (with sales of over $1.1 billion in 2012), it had experienced losses in 2013. Li- Ning attempted to open retail stores in Portland, Oregon, the home of Nike, to directly compete against the established athletic giant. However, it faced strong backlash over its previous company logo, which caused it to switch in 2012. The company failed to understand the complexity of the Chinese athletic retail market. Li-Ning manufactured “affordable clothing” for lower-income Chinese customers but failed to recognize that wealthy Chinese customers also wanted higher quality. The company attempted to relaunch as a premium brand, but faced strong competition from Nike and Adidas, whose brand images were a strong purchasing point for customers in China. At the same time, Nike and Adidas had the largest market shares in China but did not enjoy the same profits and recognition as in their domestic market. Li- Ning was facing strong competition in China from local brands like Peak and 361 Degrees (361°), which sold at a low pricing point. With both the low- and high-cost segments crowded, Li-Ning had found it difficult to position itself in the Chinese athletic industry. Still, the company possessed 5,915 retail stores and continued to have a strong presence in both its domestic Chinese market and in the global market. Salomon (Amer Sports) Started by Francois Salomon and his family in 1947, the Salomon Group was a sports equipment manufacturing company from Annecy, France. In 1997, Adidas acquired Salomon; however, in 2005, the company sold the Salomon Group for $550 million to Amer Sports. Salomon manufactured products for a number of outdoor winter sports but also had a presence in the trail-running and climbing segments. The company sold through retail channels in over 40 countries on five continents. Source: Nike, Inc., 2014 Annual Report on Form 10-K, accessed August 17, 2016, http://s1.q4cdn.com/806093406/files/doc_financials/2014/docs/nike-2014-form-10K.pdf; Adidas Group, Annual Report 2014, accessed August 17, 2016, www.adidas-group.com/media/filer_public/2b/2f/2b2fd619-5444-4ee8-9c07- baa878d658c4/2014_gb_en.pdf; ASICS Corporation, Annual Report 2014, accessed August 17, 2016, http://assets.asics.com/page_types/2162/files/%E3%80%90HP%E6%8E%B2%E8%BC%89%E7%94%A8%E3%80%91asic sAR2014_140724%EF%BC%88%E9%87%8D%EF%BC%89_original.pdf?1406272299; “History,” PUMA, accessed August 17, 2016, http://about.puma.com/en/this-is-puma/history; “Sportswear/Sporting Goods Companies Ranked by Worldwide Revenue in 2015,” Statista, accessed August 17, 2016, www.statista.com/statistics/241885/sporting-goods--sportswear- companies-revenue-worldwide/; “Stride Rite Completes Saucony Purchase,” Boston Business Journal, September 16, 2005, accessed August 17, 2016, www.bizjournals.com/boston/stories/2005/09/12/daily67.html; Kathy Chu and Laurie Burkitt, “Li Ning Scaling Back After 2012 Loss,” Wall Street Journal, March 27, 2013, accessed August 17, 2016, www.wsj.com/news/articles/SB10001424127887324789504578383332158202140; CKGSB Knowledge, “Chinese Sportswear Brand Li-Ning's Long Road To Redemption,” Forbes, April 14, 2014, accessed August 17, 2016, www.forbes.com/sites/ckgsb/2014/04/14/chinese-sportswear-brand-li-nings-long-road-to-redemption/; “Amer Sports Acquires Salomon,” Amer Sports, May 2, 2005, accessed August 17, 2016, www.amersports.com/investors/stock-exchange- releases/2005/2013/11/07/amer-sports-acquires-salomon.
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EXHIBIT 4: RUNNING/JOGGING PARTICIPATION (MILLIONS)
Source: Adapted from “2013 State of the Sport—Part II: Running Industry Report,” Running USA, June 26, 2013, accessed June 6, 2016, www.runningusa.org/index.cfm?fuseaction=runningusawire.details&ArticleId=1755.
EXHIBIT 5: 2013 RUNNING/JOGGING PARTICIPATION BY AGE AND GENDER
Age 75+ 65–74 55–64 45–54 35–44 25–34 18–24 12–17 7–11 Female 70,000 278,000 1,056,000 1,993,000 4,066,000 5,640,000 4,391,000 2,431,000 1,829,000
Male 146,000 438,000 1,177,000 1,914,000 3,876,000 4,442,000 3,700,000 2,934,000 1,615,000
Source: Adapted from “2013 State of the Sport—Part II: Running Industry Report,” Running USA, June 26, 2013, accessed June 6, 2016, www.runningusa.org/index.cfm?fuseaction=runningusawire.details&ArticleId=1755.
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Total Participation 24.7 29.2 28.8 30.4 30.9 32.2 35.5 38.7 40 42
Male Participation 13.2 16.4 15 15.9 16.1 17.7 18.7 19.7 18.4 20.2
Female Participation 11.5 12.9 13.8 14.5 14.8 14.5 16.9 19 21.6 21.8
0 5
10 15 20 25 30 35 40 45
P a
ri c
ip a
n ts
( in
m il
li o
n s
)
Total Participation Male Participation Female Participation
0
1,000,000
2,000,000
3,000,000
4,000,000
5,000,000
6,000,000
75+ 65‐74 55‐64 45‐54 35‐44 25‐34 18‐24 12‐17 7‐11
P a rt ic ip a n ts ( in m
il li o n s)
Age
Female
Male
F o r
u se
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e rs
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F lo
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a n t fr
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1 1 , 2 0 2 0 t o J
u ly
0 3 , 2 0 2 0 .
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EXHIBIT 6: JOGGING & RUNNING SALES IN THE UNITED STATES (2010–2013)
2010 2011 2012 2013
Running Shoe Units 37.16 million 38.02 million 44.62 million 46.25 million
Running Shoe Dollars $2.32 billion $2.46 billion $3.04 billion $3.09 billion
Source: Adapted from “2013 State of the Sport—Part II: Running Industry Report,” Running USA, June 26, 2013, accessed June 6, 2016, www.runningusa.org/index.cfm?fuseaction=runningusawire.details&ArticleId=1755.
EXHIBIT 7: COMPETITOR TOTAL GLOBAL STORES (2014–15)
Company Asia Europe Americas Oceania Japan Total Global Stores Brooks 0 0 1 0 0 1 ASICS 87 67 25 6 132 317 Nike 858 Adidas 1,746 New Balance 200 Puma 540 Saucony 0 Li-Ning 5,915 Salomon 0
Source: Adapted from “2013 State of the Sport—Part II: Running Industry Report,” Running USA, June 26, 2013, accessed June 6, 2016, www.runningusa.org/index.cfm?fuseaction=runningusawire.details&ArticleId=1755.
EXHIBIT 8: SALES CHANNELS OF RUNNING SHOES (%)
Year 2010 2011 2012 2013 General Sporting Goods 22.5 23.3 22.4 22.6 Discount Stores 21.4 18.5 19.8 20.4 Online/Internet 12.2 12.5 17.5 18.1 Specialty Athletic Footwear 16.2 19.6 18.0 14.1 Department Stores 8.8 7.2 7.4 7.0 Family Footwear 6.3 6.4 4.1 6.7 Factory Outlet 7.7 5.7 1.9 4.9 Specialty Sports Shops 4.7 5.2 4.4 3.9 Other Outlets - - - 1.1 Mail Orders 1.4 0.4 1.1 0.8 Pro Shops - - 0.4 0.4
Source: Adapted from “2013 State of the Sport—Part II: Running Industry Report,” Running USA, June 26, 2013, accessed June 6, 2016, www.runningusa.org/index.cfm?fuseaction=runningusawire.details&ArticleId=1755.
F o r
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EXHIBIT 9: AVERAGE PRICE OF JOGGING/RUNNING SHOES, 2014 (US$)
Specialty Athletic Footwear 88.26 Mail Order 84.87 Specialty Sports 82.51 Online 73.01 Sporting Goods 70.24 Factory Outlet 66.05 Other Outlets 63.65 Family Footwear 56.10 Department Stores 57.62 Discount Stores 45.93
Source: Adapted from “2013 State of the Sport—Part II: Running Industry Report,” Running USA, June 26, 2013, accessed June 6, 2016, www.runningusa.org/index.cfm?fuseaction=runningusawire.details&ArticleId=1755.
F o r
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Page 15 9B16M150 ENDNOTES 1 This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives presented in this case are not necessarily those of Brooks Sports or any of its employees. 2 Brooks Sports, Inc., “Brooks Running Company Celebrates 100th Year Hitting Major Growth Milestone,” Brooks Running, May 16, 2014, accessed June 6, 2016, www.brooksrunning.com/en_us/05-16-2014.html. 3 Brooks Sports, Inc., “Brooks Running Company Kicks Off 2014 with Strong Business Momentum and Laser Focus on Defining the Next 100 Years of the Run,” Brooks Running, January 22, 2014, accessed June 6, 2016, www.brooksrunning.com/en_us/01-22-2014.html. 4 All currency amounts are in US$ unless otherwise specified. 5 Jonathan Stempel, “Brooks CEO Says His Shoes Fit Buffett Better,” Thomson Reuters, May 2, 2014, accessed June 6, 2016, www.reuters.com/article/2014/05/02/us-berkshire-annual-brooks-idUSBREA410RD20140502. 6 “2014 State of the Sport—Part II: Running Industry Report,” Running USA, June 15, 2014, accessed August 17, 2016, www.runningusa.org/2014-running-industry-report. 7 Rachel Weingarten, “How to Keep Your Corporate Branding Strategy on the Cutting-Edge,” January 5, 2015, accessed August 16, 2016, www.forbes.com/sites/sungardas/2015/01/05/how-to-keep-your-corporate-branding-strategy-on-the- cutting-edge/#177ac2671296 8 Allison Van Dusen, “Running High,” Forbes, November 3, 2006, accessed June 6, 2016, www.forbes.com/2006/11/03/marathon-running-trends-forbeslife-avd_1104run.html. 9 Linzay Logan, “Inside the Women's Running Explosion,” Competitor.com, February 8, 2013, accessed June 6, 2016, http://running.competitor.com/2013/02/features/inside-the-womens-running-explosion_65638. 10 Brian Metzler, “10 Reasons to Shop at Running Specialty Stores,” Competitor.com, May 23, 2014, accessed June 6, 2016, http://running.competitor.com/2014/05/photos/10-reasons-to-shop-at-specialty-running-stores_78898. 11 Lara O'Reilly, “11 Things Hardly Anyone Knows about Nike,” Business Insider, November 4, 2014, accessed June 6, 2014, www.businessinsider.com/history-of-nike-facts-about-its-50th-anniversary-2014-11. 12 Donald Katz, “Triumph of the Swoosh,” SI.com, August 16, 1993, accessed June 6, 2016, www.si.com/vault/1993/08/16/129105/triumph-of-the-swoosh-with-a-keen-sense-of-the-power-of-sports-and-a-genius-for- mythologizing-athletes-to-help-sell-sneakers-nike-bestrides-the-world-of-sport-like-a-marketing-colossus. 13 Lucien Rhodes, “Winning Is a State of Mind at Nike,” Inc.com, August 1, 1981, accessed June 6, 2016, www.inc.com/magazine/19810801/6547.html. 14 Kurt Badenhausen, “Brooks Running Shoes Hit Their Stride,” Forbes, May 20, 2013, accessed June 6, 2016, www.forbes.com/sites/kurtbadenhausen/2013/05/20/brooks-running-shoes-hit-their-stride/. 15 “Wolverine World Wide, Inc. History,” Funding Universe, 2004, accessed June 6, 2016, www.fundinguniverse.com/company-histories/wolverine-world-wide-inc-history/. 16 Ibid. 17 Himanee Gupta, “Brooks Sports Finds the Shoe Now Fits Here,” The Seattle Times, February 4, 1993, accessed June 6, 2016, http://community.seattletimes.nwsource.com/archive/?date=19930204&slug=1683678. 18 Pam Balcke, “Leading Ladies,” Runner's World, October 1, 2001, accessed June 6, 2016, www.runnersworld.com/leading-ladies. 19 Helen E. Jung, “Chief Wants to Run up Shoe Profits, Reputation,” The Seattle Times, January 31, 1994, accessed, June 6, 2016, http://community.seattletimes.nwsource.com/archive/?date=19940131&slug=1892716. 20 Leigh Gallager, “Runner's World,” Forbes, February 22, 1999, accessed June 6, 2016, www.forbes.com/global/1999/0222/0204052a.html. 21 Helen E. Jung, op. cit. 22 American City Business Journals, “Bruce Pettet Named President of Brooks Sports,” Puget Sound Business Journal, March 15, 1999, accessed June 6, 2016, www.bizjournals.com/seattle/stories/1999/03/15/daily3.html. 23 Seattle Times Staff, “Brooks Sports Acquired by Venture-Capital Firm,” The Seattle Times, October 26, 1998, accessed June 6, 2016, http://community.seattletimes.nwsource.com/archive/?date=19981026&slug=2779908. 24 “Eric Dreyer Named President of Brooks Sports,” Just Style, June 22, 2000, accessed June 6, 2016, www.just- style.com/news/eric-dreyer-named-president-of-brooks-sports_id76960.aspx. 25 “Brooks Sprints to High-End Niche,” Puget Sound Business Journal, March 11, 2001, accessed June 6, 2016, www.bizjournals.com/seattle/stories/2001/03/12/story5.html. 26 Jim Weber, “Ice Skates to Running Shoes,” The New York Times, November 10, 2012, accessed June 6, 2016, www.nytimes.com/2012/11/11/jobs/jim-weber-of-brooks-sports-and-the-path-to-running-shoes.html. 27 Abigail Tracy, “How Brooks Reinvented Its Brand,” Inc.com, April 24, 2014, accessed June 6, 2016, www.inc.com/abigail- tracy/how-brooks-running-became-an-industry-leader.html. 28 Ibid. 29 Duncan Larkin, “Is Another Running Boom Under Way?” Competitor.com, July 30, 2013, accessed June 6, 2016, http://running.competitor.com/2013/07/news/is-another-running-boom-underway_79364. 30 Jere Longman, “New Running Boom Is Much More Low Key,” The New York Times, May 28, 1997, accessed June 6, 2016, www.nytimes.com/1997/05/28/sports/new-running-boom-is-much-more-low-key.html?pagewanted=all. 31 “2013 State of the Sport—Part III: U.S. Race Trends,” Running USA, July 28, 2013, accessed August 16, 2016, www.runningusa.org/state-of-the-sport-race-trends. 32 Abigail Tracy, op. cit.
F o r
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Page 16 9B16M150 33 Jonathan Stempel, op. cit. 34 Russell Corporation, “Russell Announces Plans to Acquire Brooks Sports, Inc.,” US Securities and Exchange Commissions, December 14, 2004, accessed July 21, 2015, www.sec.gov/Archives/edgar/data/85812/000119312504216143/dex991.htm. 35 Dave Marino-Nachison, “Russell's a Good Sport,” The Motley Fool, December 15, 2004, accessed June 6, 2016, www.fool.com/investing/small-cap/2004/12/15/russells-a-good-sport.aspx. 36 Russell Corporation, op. cit. 37 Russell Corporation/Berkshire Hathaway, “Berkshire Hathaway to Acquire Russell Corporation,” Berkshire Hathaway Press Release, April 17, 2006, accessed June 6, 2016, www.berkshirehathaway.com/news/apr1706.pdf. 38 Dana Mattioli, Anupreeta Das, and Doug Cameron, “Warren Buffett Pins Berkshire’s Growth on Deals,” August 9, 2015, accessed August 16, 2016, www.wsj.com/articles/warren-buffett-pins-berkshires-growth-on-deals-1439167812. 39 Brooks Sports, Inc., “Brooks Running Company Celebrates 100th Year Hitting Major Growth Milestone,” op. cit. 40 Stuart Glascock, “A Light Step,” Seattle Business Magazine, January 2011, accessed June 6, 2016, http://seattlebusinessmag.com/article/light-step. 41 Ibid. 42 Mike Ozanian, “The Forbes Fab 40: The World's Most Valuable Sports Brands 2015,” Forbes, October 22, 2015, accessed August 17, 2016, www.forbes.com/sites/mikeozanian/2015/10/22/the-forbes-fab-40-the-most-valuable-brands-in- sports-2015/#3029b5de2e2a. 43 Kurt Badenhausen, “Brooks Running Shoes Hit Their Stride,” Forbes, May 20, 2013, accessed June 6, 2016, www.forbes.com/sites/kurtbadenhausen/2013/05/20/brooks-running-shoes-hit-their-stride/. 44 Brooks Sports, Inc., “Brooks Sports Brings Run Happy Spirit to World's Second Largest Running Market,” Brooks Running, February 2, 2012, accessed June 6, 2016, www.brooksrunning.com/en_us/02-02-2012.html. 45 Wash Bothell, “Brooks Sports Brings Run Happy Spirit to World’s Second Largest Running Market: Leading Running Brand Bolsters Global Presence with Japanese Subsidiary,” Brooks Running, February 2, 2012, accessed August 17, 2016, www.brooksrunning.com/en_us/02-02-2012.html. 46 Brooks Sports, Inc., “Brooks Sports Brings Run Happy Spirit to World's Second Largest Running Market,” op. cit. 47 Associated Press, “Tokyo Race Added to World Majors,” ESPN, November 2, 2012, accessed June 6, 2016, http://espn.go.com/olympics/trackandfield/story/_/id/8583403/tokyo-marathon-joins-world-marathon-majors-series. 48 Brooks Sports, Inc., “Brooks Breaks Tape on Momentous Year and Kicks Off 2015 with Clear Focus on Being No. 1 Choice for Runners Worldwide,” Brooks Running, January 20, 2015, accessed June 6, 2016, www.brooksrunning.com/en_us/01-20-2015.html. 49 Sarah Max, “Brooks Sports Moves New Home Closer to Trails,” The New York Times, July 29, 2014, accessed June 6, 2016, www.nytimes.com/2014/07/30/realestate/commercial/brooks-sports-moves-new-home-closer-to-trails.html. 50 Brooks Trailhead: Your Run Starts Here, accessed August 16, 2016, http://talk.brooksrunning.com/blog/2014/10/01/brooks-trailhead-your-run-starts-here/. 51 “2014 State of the Sport—Part II: Running Industry Report,” op. cit. 52 Brian Metzler, “Why Are There So Many Running Shoe Brands?” Competitor.com, August 12, 2015, accessed June 6, 2016, http://running.competitor.com/2015/08/shoes-and-gear/why-are-there-so-many-running-shoe-brands_133494. 53 Matt Powell, “Sneakernomics: Understanding the International Sneaker Market,” Forbes, July 29, 2014, accessed June 6, 2016, www.forbes.com/sites/mattpowell/2014/07/29/sneakernomics-understanding-the-international-sneaker-market/. 54 Ibid. 55 Abigail Tracy, op. cit. 56 Jonathan Stempel, op. cit. 57 Brooks Sports, Inc., “Brooks Breaks Tape on Momentous Year and Kicks Off 2015 with Clear Focus on Being No. 1 Choice for Runners Worldwide,” op. cit.
F o r
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10.
9B20M052
TOP CLOUD-AGRI TECHNOLOGY CO., LTD.: DIGITAL BUSINESS MODEL
Haifen Lin, Tingchen Qu, and Shaojie Han wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized, or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com. Our goal is to publish materials of the highest quality; submit any errata to publishcases@ivey.ca. i1v2e5y5pubs Copyright © 2020, Ivey Business School Foundation Version: 2020-03-30
Top Cloud-Agri Technology Co., Ltd. (TPYN), founded in 2008 in the province of Zhejiang, China, had become one of the most famous intelligent agricultural service providers in China. By implementing a digital business model, TPYN had successfully transformed from an agricultural instruments and meters1 supplier to a leader in the agricultural industry. Yuyang Chen, the chairman of TPYN, was satisfied with this achievement.
However, to further develop the digital business model, Chen put forward a new concept—“open, share, integrate, and win-win”—in March 2017. This concept indicated cross-industry and cross-domain integration requiring abundant resources, which could provide not only a new opportunity for TPYN but also a huge challenge. Considering the consumption of resources required to implement this digital business model, Chen was confronted with a new question: should TPYN continue to implement the new model by itself, or should it seek cooperation with the government or other larger platforms?
DIGITAL DEVELOPMENT OF THE CHINESE AGRICULTURAL INDUSTRY
The impact of demographics and the ecological environment on Chinese agriculture had first caused a transformation from traditional agriculture to modern agriculture (e.g., mechanization and automation), and then to intelligent agriculture2 (see Exhibit 1). During the process, digital technologies, such as the mobile Internet, the Internet of things, and cloud computing were used extensively, dramatically simplifying the agricultural planting process and improving efficiency.
The Development of Chinese Agriculture
Agriculture in China experienced four periods of development—traditional agriculture, agricultural mechanization, agricultural automation, and agricultural intellectualization. Traditional agriculture was characterized by the importance of manpower and animal labour, a small agricultural production scale, backward production technologies, and low capacity for resisting natural disasters. In the period of agricultural 1 Instruments and meters are used to detect, measure, observe, and calculate various physical quantities, material components, and physical parameters. Vacuum leak detectors, pressure gauges, length gauges, and microscopes are considered instruments and meters. Instruments and meters can be divided into two categories: general and professional. The instrumentation industry is a highly competitive market with great development potential. 2 “2016 China Artificial Intelligence Series White Paper—Intelligent Agriculture [in Chinese],” Chinese Association for Artificial Intelligence, September 2016, accessed September 2019, www.caai.cn/index.php?s=/home/article/detail/id/216.html.
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Page 2 9B20M052 mechanization, agricultural machinery and equipment were used as the main farming tools, which greatly improved agricultural productivity. During this period, attention focused on deepening the production process, enlarging industrial scale, improving the industrial chain, and realizing sound marketing strategies. In the period of agricultural automation, information technologies were extensively adopted into agricultural machinery and equipment, facilitating the digitalization, precision, and automated production of agriculture. In the present period of agricultural intellectualization, intelligent tools were used widely in the agricultural industry. When adopting technologies such as big data, cloud computing, the Internet, and sensors, intelligent agriculture reflected a self-controlled system with a full chain, an industry-wide scale, and a connected production process. All processes and links involved in this system were controllable and efficient.
Digital Economy and Digital Agriculture: Intelligent Agricultural Production
The digital economy referred to an economic system where widely used digital technologies3 brought about fundamental changes in the overall economic environment and economic activities. The digital economy was also a socio-political and economic system in which both information and business activities were digitized and primarily focused on the products and services that depended on digital technologies in production and marketing. These goods and services were widely available in the modern economy.
Digital agriculture, as its name implied, involved the application of digital technologies in agriculture and referred to real-time monitoring from the micro- to macro-scale. This application collected information about crop growth, development, pests, water, and fertilizer, and generated dynamic spatial information systems to better monitor crop growth and increase yield. Digital agriculture not only focused on connecting agricultural production links but also on improving the efficiency of the whole agricultural system. For example, the United States agricultural production system, in which the pre-production, mid-production, and post-production links were closely connected, consisted of production materials and technologies supply, the production process, storage, transportation, crops processing, and marketing. This closely linked system reduced resource waste, made the agricultural production system more efficient, and met the demand for higher work efficiency and lower costs.
In 2004, the Chinese government published Central Document No.1,4 which demanded increased agricultural information in China. By 2012, agricultural information had attracted the attention of the whole world. With the support of the central government, digital agricultural technologies were developed rapidly in China, accompanied by numerous breakthroughs in key technologies and the development of many digital agricultural technology products. In addition, a networked digital agricultural technology platform was established to integrate and further apply the data collected by those digital agricultural technology products.
By applying the Internet, the Internet of things, and “3S” technology,5 China made significant achievements in the development of digital agriculture and the intelligent production of agriculture. In 2015, the market of digital agriculture in China had reached US$13.8 billion.6 Moreover, benefitting from the benign operation of those digital agricultural technology products and platforms, China had been able to realize intelligent operation, such as real-time monitoring of crop growth, efficient data collection and analysis, and timely transmission of information within the agricultural industry. 3 “China’s Digital Economy Development White Paper (2017)” [in Chinese], China Academy of Information Communications Technology, July 2017, accessed September 2019, www.caict.ac.cn/kxyj/qwfb/bps/201804/t20180426_158452.htm. 4 Central Document No. 1 was originally referred to as the first document issued annually by the central government of the Communist Party of China; now the term describes the Chinese government’s view of the importance of rural issues. 5 3S technology includes remote sensing (RS), a geographic information system (GIS), and global positioning system (GPS). 3S technology is the core technology of digital agriculture. 6 Chen Qing, “Smart Agriculture: Solving Global Famine Is No Longer a Dream” [in Chinese], Huawei, October 26, 2017, accessed September 2019, www.huawei.com/cn/about-huawei/publications/winwin-magazine/plus-intelligence/feeding-the- world-connected-farming.
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Page 3 9B20M052 TOP CLOUD-AGRI TECHNOLOGY CO., LTD. (TPYN) Founded in April 2008 as an agricultural instruments supplier, TPYN specialized in offering digital agricultural services. Through more than 10 years of development, its main business had changed from developing instruments to providing integrative agricultural solutions based on new instruments with information technologies. Since 2012, the company had specifically implemented the digital business model and made great achievements. As more followers imitated its products and model, TPYN put forward the new concept of open, share, integrate, and win-win, and developed an “intelligent agricultural cloud platform” to further implement its digital business model. Before 2012, as an agricultural instruments supplier, TPYN had focused on developing and improving the technology of its products. However, even though its products were of higher quality than those of its competitors, its customers were not able to distinguish them; worse still, competitors and even newcomers to the industry frequently imitated TPYN’s products. Consequently, the competition in the agriculture instrument industry was increasingly fierce. To keep its position as a leader and find new development opportunities, TPYN transformed its business model from a traditional one to a digital business one by adopting and using information technologies. TPYN adopted Internet Plus thinking into its development system and focused on integrating Internet of things technology with traditional agricultural testing instruments. By adopting existing digital technologies, TPYN developed a series of new agricultural instruments, making agricultural production more automatic and intelligent. Based on this, TPYN could provide its customers with overall solutions related to agricultural production instead of only selling instruments. More specifically, TPYN depended on these digital agricultural instruments to collect and transmit basic data on the entire process of agricultural production. By analyzing these data, TPYN produced overall solutions for its customers. The company had successfully realized digitalization, precision, and automation in agricultural production. By implementing this digital business model, TPYN maintained its leading position in the agricultural industry and led industry development. The implementation of the digital business model brought changes in four main aspects: first, it changed the original farming mode of agricultural production from automatic agricultural production mode to preliminary intelligent agricultural production mode; second, it optimized the circulation channels of agricultural products; third, it effectively controlled the quality of agricultural products; and finally, it effectively improved the quality of agricultural services. TPYN not only promoted the evolution of the entire agricultural industry through digital transformation but also attracted many followers and newcomers that imitated its activities and model. EARLY IMPLIMENTATION OF TPYN DIGITAL BUSINESS MODEL The core of the digital transformation was replanting existing products or services with a new digital variant to simplify agricultural production processes, improve production efficiency, and intellectualize the process of agricultural service management. Chen realized that the development of agricultural digitalization, to which the Chinese government had attached great importance, could be an inevitable trend. Therefore, TPYN invested a great deal of money in research and development (R&D) every year. From 2015 to 2017, the investment in R&D accounted for more than 12 per cent of its operating revenue. The digital transformation of TPYN occurred in two phases: preliminary trial and further implementation. In the preliminary trial phase, TPYN focused on realizing precise agricultural production, improving the quality and safety of agricultural products, optimizing the distribution channel, and developing overall solutions to agricultural issues for agricultural producers.
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Page 4 9B20M052 Realizing Precise Agricultural Production TPYN changed its production mode by implementing a digital business model using two angles. The first angle involved TPYN introducing Internet of things technology7 in 2014 to develop a series of modern and precise agricultural instruments, including sensors of soil, meteorology, plant physiological, animal husbandry, and aquatic products etc. by cooperating with China Telecommunications Corporation (China Telecom).8 TPYN used these sensors to monitor the growth and environment of crops in real time and then offered targeted measures to improve the survival rate and quality of those crops. Compared with the traditional manual measurement and recording method, data collected by digital sensors were precise, and the measurement was more efficient. In the second angle, TPYN attempted to use the information from a second and third industry to better develop a primary industry.9 TPYN conducted targeted agricultural production according to accurate demand (i.e., data from customer demand) from a third industry, or the company could make good use of the combination of agricultural machinery and digital technology to improve the production of crops and the sales volume of by-products. Based on digital technologies like the Internet of things and big data, TPYN achieved the precise production of agriculture by developing digital instruments and using information from other industries. Improving the Quality and Safety of Agricultural Products In the past, customers only saw final agricultural products or by-products, or at most, the source of these products. Information about when these products were planted, raised, fertilized, or fed during the growth process and how they were circulated to customers was unavailable. Customers often bought agricultural products or by-products with high uncertainty. Therefore, the quality and safety of agricultural products required significant attention. TPYN developed a quality tracking system for agricultural products by using digital technologies (see Exhibit 2) during its digital transformation. Customers could scan the quick response10 (QR) code of a product to check all information about the planting, breeding, production (obtained through intelligent monitoring instruments), and circulation processes (obtained through the integrated service platform of the Internet of things). Thus, the quality and safety of agricultural products could be guaranteed. The system provided transparent product information to customers, and offered a lot of information about the agricultural industry, which could be used as a reference for the relevant government departments to regulate the industry and judge how much support should be given. Until October 2019, this system had been actively promoted and widely adopted by the government and industrial sectors of Xinjiang, Shanxi, Gansu, Zhejiang, and other provinces in China. 7 “Internet of Things White Paper (2011)” [in Chinese], CAICT, May 2011, accessed September 2019, www.caict.ac.cn/kxyj/qwfb/bps/201804/t20180426_158179.htm. 8 China Telecommunications Corporation (China Telecom), a large state-owned telecommunications enterprise, is a leading comprehensive intelligent information service operator that helps power the network and service the daily life of the people and residents; “About China Telecom: Group Overview” [in Chinese], China Telecom, accessed March 8, 2020, www.chinatelecom.com.cn/corp/01/index.html. 9 The first industry refers to agriculture; the second industry refers to industry; and the third industry refers to service. 10 QR codes stored more information and represented more data types than traditional bar codes. QR codes were scanned using mobile devices, such as mobile phones.
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Page 5 9B20M052 Optimizing the Distribution Channels of Agricultural Products As the leader in intelligent agriculture, TPYN promoted the digitization process of the agricultural industry not only in agricultural production and services but also in the circulation of agricultural products and by-products. In the past, the circulation of agricultural products consisted of many links from farmers to distributors and through to customers. This process of product circulation led to several problems, such as increased costs and decreased product freshness. By adopting digital technologies, TPYN created integrated production, supply, and marketing to connect and promote product production and sales. For example, the company used e-commerce to deliver agricultural products directly from a planting base to the dining table, addressing the problem of farmers having difficulty selling their products and people having difficulty buying what they needed. Offering Overall Agricultural Production Solutions To further improve the efficiency and output of agricultural production, in 2015, TPYN developed solutions related to six aspects of agricultural production (see Exhibit 3): facility agriculture, water and fertilizer integration, plant protection information, agricultural product quality and safety, intelligent animal husbandry, and aquaculture. Each focused on an agricultural issue and consisted of systems specific to those issues. For example, changes in water, fertilizer, and carbon dioxide in plants were monitored in greenhouses (see Exhibit 4). Each system was supported by a variety of digital sensors that collected and transmitted real-time plant and animal growth data to the system. The integrated data was then sent to the corresponding agricultural experts, so they could formulate targeted improvement plans for the farmers. The content of the plan usually included the current growth state of the crops and animals, existing problems, ways to solve these problems, and a method for optimizing the current growth state. Compared with the traditional, experience-based method of governance, this new service mode was more targeted, saving resources and satisfying not only society’s high requirements for labour efficiency but also customers’ demand for convenience and efficiency. This digital service, which matched the rapid development of the digital economy, brought high value- added output to customers and was particularly useful in activating the potential market demand. For example, agricultural users that could afford it used this digital service, because it reduced the complexity of the procedures required to obtain useful information. Consequently, this service had huge commercial potential. Chen regarded this solution service as one of TPYN’s core businesses and set up several professional and technical teams to focus on program planning, data analysis, and developing and designing special instruments and software. By 2017, the total number of R&D personnel in TPYN reached 120— 34.29 per cent of the company’s employees.
FURTHER DEVELOPMENT OF TPYN’S DIGITAL BUSINESS MODEL
By exploring the digital business model early, TPYN achieved precise production of agriculture and provided integrative agricultural solution services for customers, which indicated a transfer of automatic agriculture to intelligent agriculture. The digital business model achieved great success, and TPYN kept its position as the leader in intelligent agriculture. However, Chen also realized this was only the beginning and that the company needed to further develop the digital business model.
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Page 6 9B20M052 The Necessity for Further Development
TPYN made significant breakthroughs in the early trial phases of the digital business model. Though this model stimulated dramatic change in the whole agricultural industry, as model development progressed, new problems emerged.
First, institutions and regulations for the new business model had not been set up, which led to fierce and disorderly competition in the industry. The digitalization of the traditional agricultural industry, a new trend in China and around the world, needed the support of corresponding institutions, rules, and regulations. As this new model and relevant technologies developed and spread rapidly, newcomers swarmed to the industry, leading to a lower concentration and higher complexity of the industry.
Second, attracted by TPYN’s achievements related to implementing the digital model, many existing firms in the agricultural industry followed TPYN’s lead and imitated its activities, but received only a meagre profit (see Exhibit 5). TPYN had successfully applied digital technologies in agricultural production (selling and controlling), which indicated a change from traditional agriculture. As a result, many existing firms adopted a similar business model.
Finally, seasonal financial risks still existed. The company’s main customers were government agencies and large distributors that usually purchased products and services in the first half of the year but settled their accounts in the second half or even at the end of the year. This method of settlement left the company’s annual income concentrated mainly between June and December each year, resulting in seasonal financial challenges. The company’s operational expenditure was relatively balanced throughout the year, so TPYN always faced the risk of seasonal loss.
Platform Construction
Confronted with these development problems, Chen decided to take the digital business model further. He concluded that implementing the new model in the early stages focused on local agricultural operations, but the target was to simplify and accurately process agricultural production data. However, the fierce competition in the industry was a problem, so TPYN had to further adopt or develop new digital technologies for the model to set up a platform for deeper cooperation. By doing so, more firms involved in the industrial chain could benefit from the digital business model. Moreover, it might be a good way to combine the software and hardware within the industry chain. Chen decided to transform TPYN into a digital platform.
To do this, TPYN built an intelligent agricultural cloud platform to further develop its digital business model. This platform integrated and applied agricultural information from local agricultural Internet of things sensors. More specifically, this platform could collect, analyze, and transmit agricultural data, and could be run through the framework of “one platform + one centre + N applications,” namely “1 + 1 + N” (see Exhibit 6). “One platform” represented the system that delivered the data analysis results to customers; “one centre” referred to the big data centre; and “N applications” reflected a large number of tools for collecting useful data. Customers could then depend on this information and analysis to make their own decisions.
TPYN began constructing this platform system in 2016; the plan was to integrate agricultural resources at the provincial, municipal, and county levels; gather agricultural data; form a data centre; and build up an interconnected and shared digital information service system. By effectively operating this system, TPYN solved several existing problems, such as interest asymmetry; accelerated the construction of the entire agricultural industrial chain; and eased the disorderly competition in the industry.
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Page 7 9B20M052 The Concept of the Agricultural Ecosphere
Setting up the platform was only the first step in building a complete industrial ecosystem. In fact, an agricultural industry ecosystem11 required the vertical integration of multiple elements in Cloud+Network+End,12 covering all aspects of the industry. In March 2017, at the Internet and Modern Agriculture and the Intelligent Agriculture Summit held in Hangzhou, Zhejiang province, China, Chen put forward the concept of open, share, integrate, and win-win. Chen believed that sharing the digital business model broke the constraints of the industry, built up an industry ecosphere, and fully integrated resources. Only by doing so could digital information flow smoothly through the whole industrial chain. This cross-industry and cross-disciplinary cooperation was necessary to break the existing thinking and mode of many industries. Therefore, practising the concept of open, share, integrate, and win-win was important. Chen believed that only by constructing an agricultural ecosystem could the disorderly competition in the industry be fixed.
FUTURE CHALLENGE
To further develop the digital business model, Chen advocated setting up the intelligent agricultural cloud platform and practising the concept of open, share, integrate, and win-win, which indicated the core concept of sharing. However, constructing an agricultural ecosystem by practising this concept required greater efforts, especially in new technology development and financial support. Though TPYN created the digital business model five years ago and achieved some success, Chen knew further development would be more challenging and would include cross-industry and cross-field digital development. The question remained: Could TPYN further develop its business model by itself as it had five years ago? Or, should the company seek support from the government or a larger platform to enhance the transition and development of TPYN—and the whole agricultural industry?
11 “Internet of Things White Paper (2016)” [in Chinese], CAICT, December 2016, accessed September 2019, www.caict.ac.cn/kxyj/qwfb/bps/201804/t20180426_158398.htm. 12 “Cloud + Network + End” is the basic structure of all fields in “Internet + Traditional Industry.” Cloud refers to cloud computing and the infrastructure and basic resources to support cloud computing. Network usually refers to the Internet. End contains hardware terminals and software terminals. The cloud, network, and end are not separated but are integrated with each other. From the perspective of development, the first is the end, and then the end is connected to the network; finally, the network brews the cloud.
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Page 8 9B20M052
EXHIBIT 1: THE DEVELOPMENT STAGE OF THE AGRICULTURAL INDUSTRY IN CHINA
Source: Created by the case authors using information from Yuyang Chen, chairman, Top Cloud-Agri Technology Co., Ltd.; Wang Dong, Chen Yuanquan, Li Daoliang, Zhu Wanbin, Tan Weiming, Du Taisheng, Tian Jianhui, and Kang Shaozhong, “Foresight of Disruptive Technologies in Agricultural Engineering,” Strategic Study of Chinese Academy of Engineering 20, no. 6 (2018): 57–63, accessed March 7, 2020, www.engineering.org.cn/en/10.15302/J-SSCAE-2018.06.009.
EXHIBIT 2: THE PROCESS OF CONTROLLING AGRICULTURAL PRODUCT QUALITY
Source: Created by the case authors using information from Yuyang Chen, chairman, Top Cloud-Agri Technology Co., Ltd.
Agriculture 1.0
Automatic Agriculture Traditional Agriculture Mechanical Agriculture Intelligent Agriculture
Agriculture 3.0 Agriculture 4.0 Agriculture 2.0
Modern Agriculture
Scanning
Cold chain transportation
information
Seed information
Planting information
Inspection information
Consumer terminals
Seed purchase
Quality inspection
Plant growth environment
Packaging processing
Warehouse delivery
Packaging information
Supermarket information
QR code
Bar code
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Page 9 9B20M052
EXHIBIT 3: SIX MODULES OF A TPYN INTEGRATIVE AGRICULTURAL SOLUTION
Source: Created by the case authors using information from Yuyang Chen, chairman, Top Cloud-Agri Technology Co., Ltd.
EXHIBIT 4: THE GREENHOUSE MONITORING SYSTEM
Source: Created by the case authors using information from Yuyang Chen, chairman, Top Cloud-Agri Technology Co., Ltd.
Modules Systems Corresponding Agricultural Field
Facility Agriculture
Intelligent monitoring system for agriculture facility; intelligent management system for edible fungus cultivation; management system for precious medicinal materials cultivation; monitoring and early warning management system for agricultural product storage.
The Storage of Agricultural Products
Water and Fertilizer Integration
Integrated automatic control system for water and fertilizer; soil moisture monitoring system.
The Agricultural Production Environment
Plant Protection Informatization
Plant protection information monitoring and early warning system; forest fire prevention monitoring and early warning system; agriculture (agriculture and forestry) “four emotions” monitoring system; digital monitoring and early warning system for major pests and crop diseases; intelligent management system for tea planting; intelligent management system for rice field planting.
Plant Protection
Quality and Safety of Agricultural Products
Tracking system for the agricultural industry chain; e-commerce management system for agricultural products.
Tracking the Quality of Agricultural Products
Intelligent Animal Husbandry
Intelligent livestock management system; livestock and poultry breeding monitoring system; animal and animal product distribution traceability system.
Livestock Breeding
Aquaculture Aquaculture management system. Aquaculture
Temperature Sensors
Humidity Sensors
A c q u i s i t i o n C o n t r o l l e r
Temperature: XX Humidity: XXX Illumination: XX
Light Sensors
Draught Fan
Wet Curtain
Fill Light
Nutrient Solution
Intelligent control and
management of greenhouse production using technology
platform.
Plant image information acquisition
Intelligent Monitoring Equipment
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EXHIBIT 5: THE ANNUAL OPERATING INCOME OF TPYN AFTER IMPLEMENTING A DIGITAL BUSINESS MODEL
Note: CNY = Chinese yuan/renminbi; 1USD = 7.0099 CNY on December 23, 2019. Source: Created by the case authors using data from Yuyang Chen, chairman, Top Cloud-Agri Technology Co., Ltd.
2,937.65 3,174.42
1,819.92 2,228.54
3,429.55
0
500
1,000
1,500
2,000
2,500
3,000
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4,000
2013 2014 2015 2016 2017
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Page 11 9B20M052
EXHIBIT 6: “1 + 1 + N” MODE OF INTELLIGENT AGRICULTURE CLOUD PLATFORM
Source: Created by the case authors using information from Yuyang Chen, chairman, Top Cloud-Agri Technology Co., Ltd.
Security System
Data standard specification
system
Platform operation and maintenance guarantee system
Information collection
and monitoring system
N applications
Data Collection
Intelligent equipment collect + report
Historical data import
System data
migration
System data sharing
Internet data capture +
Service Objective
Government agency
Rural grassroots
Agriculture- related unit
Agricultural practitioner
Business entity
Social public
Service Carrier
PC computer
Tablet computer
Intelligent phone
Command big screen
We Chat
Internet +
Agriculture +
Platform
Leisure agriculture
Government service portal
Agricultural Internet of things
Seed QR code traceability
Agricultural machinery scheduling
Supervision of input goods
Agricultural resources
supervision system
Public health supervision
Agricultural product quality
and safety traceability
system
Agricultural product quality
safety
Yunnong Mall
……
One smart agricultural
cloud platform
+
Big Data Centre
Agricultural production
data
Agricultural resource data
Agricultural management
data
Farmers getting rich
data
……
Agricultural product quality
data
Agricultural market data
Rural construction
data
Agricultural ecological data
A big data centre
F o r
u se
o n ly
in t h e c
o u rs
e S
tr a te
g y
A n a ly
si s
& F
o rm
u la
tio n a
t D
a lh
o u si
e U
n iv
e rs
ity t a u g h t b y
F lo
re n ce
T a rr
a n t fr
o m
M a y
1 1 , 2 0 2 0 t o J
u ly
0 3 , 2 0 2 0 .
U se
o u ts
id e t h e se
p a ra
m e te
rs is
a c
o p yr
ig h t vi
o la
tio n .
123
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