2.Quality of recommendations - specific, comprehensive, and practical plans, recognition of implementation considerations.
Michelle_Michy
20201008183642externalcp26896_pcs1.pdf
1.
International Business
Stan Klatka
MKTG 560
Saint Xavier University
Table of Contents
Gowlings LLP: Canadian Legal Services Firm Going International..................................................5
Louis Vuitton in Japan....................................................................................................................15
Qualtrics: Rapid International Expansion........................................................................................35
Nora-Sakari: A Proposed JV in Malaysia (Revised).......................................................................47
Cameron Auto Parts: Joint Ventures, Licensing or Exporting.........................................................61
L’Oreal India: Where Beauty Meets Tradition.................................................................................69
Larson Inc. in Nigeria......................................................................................................................85
International Business MKTG 560
Stan Klatka Saint Xavier University
2.
9B16M190
GOWLINGS LLP: CANADIAN LEGAL SERVICES FIRM GOING INTERNATIONAL R. Chandrasekhar wrote this case under the supervision of Professor Brian Pinkham 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) [email protected]; www.iveycases.com. Copyright © 2016, Richard Ivey School of Business Foundation Version: 2016-11-10
In February 2014, at his office in downtown Toronto, Scott Jolliffe, chairman and chief executive officer (CEO) of Gowlings LLP (Gowlings), was weighing his options regarding the future of the firm’s international growth. Gowlings was the third-largest law firm in Canada by number of partners in 2013 (see Exhibit 1). It had already established offices in three locations outside Canada: Moscow, London, and Beijing. The company had been ranked as the number-one legal advisor based on deal volume for Canadian mergers and acquisitions (M&A) in both 2012 and 2013.1 It was also the advisor for more mid-market and small- cap2 M&A transactions worldwide than any other Canadian law firm in 2013.3 Gowlings was primed to build on these attributes and move to the next level in positioning itself as an international law firm. The firm had three main reasons for expanding beyond Canada into new markets. First, the legal business was becoming global. Globalization was particularly evident in practice areas like intellectual property (IP) and business law. A global law firm was loosely defined as one having 25 per cent or more of its lawyers outside its home market. However, for managers of a majority of law firms, going global generally meant finding the (often elusive) parity of power in the legal markets of the United States and the United Kingdom. Second, Gowlings’ corporate customers were pursuing new markets for their products and services. The firm was often required to follow their geographical footprints in order to serve them better at their new destinations. Third, foreign law firms were competing with Canadian law firms for Canadian business. As a leading domestic law firm, Gowlings had to strengthen its response to this competition. In identifying a new growth platform for Gowlings, Jolliffe was examining three attributes: a new global location, a new global partner, and a new organizational structure. Each attribute was interlinked, and each presented unique managerial dilemmas.
1 Gowling WLG, accessed December 15, 2015, www.gowlings.com/News/news.asp?newsID=850. 2 Mid-cap refers to a company with market capitalization of between $1 billion and $5 billion. Small cap refers to a company with market capitalization of less than a billion dollars. 3 Ibid.
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Page 2 9B16M190 Jolliffe explained:
As far as location is concerned, we are looking at the United States, the United Kingdom, and China. Which of them would give us a foot in the door for international expansion? As far as a new partner is concerned, we are beginning to narrow down our choice, and the question is, what are the synergies we should look for? As far as a new structure is concerned, the choice will be between a complete merger with the new partner, and an umbrella format in which the two firms would retain their independence. Which structure would best deliver our strategy for international expansion?
A chemical engineer from the University of Toronto, Jolliffe had worked briefly as an engineer in France before enrolling at the Queen’s University Faculty of Law. He had joined Gowlings as a summer student in 1975, and been called to the bar in 1978. Having worked with Gowlings in Ottawa for the first few years of his career, Jolliffe was asked to open an office in Toronto, where he began practice as an IP lawyer, focusing on patent, trademark, and copyright law. After heading the firm’s IP group in Toronto, he became a member of its executive committee in the early 1990s, and a managing partner of the firm in 1996. Jolliffe became the chair and CEO of Gowlings in 2008. He was scheduled to retire at the end of 2015, after two decades of leading the company. In this way, setting the stage for globalization was to be Jolliffe’s final contribution to the firm. THE LEGAL SERVICES INDUSTRY The legal services industry was estimated to generate $500 billion in revenue globally.4 The United States was the single largest market in the industry, valued at over $300 billion.5 However, the global market was fragmented. The largest firm, DLA Piper, had revenue of $2.4 billion in 2013, with 0.5 per cent of global market share.6 Revenue was a function of headcount. For example, DLA Piper also had the largest number of lawyers (4,036) on its payroll. The industry was affected by progress in the information and communication technologies (ICT) sector, which was disrupting trade and commerce in general worldwide. This disruption was evident in two ways. Computer-assisted review was replacing linear paper review in judicial processes, such as the process of unearthing documents relevant to a suit (which was known in legal parlance as “discovery”). Relative to a legal professional, e-discovery software could analyze documents in a fraction of the time for a fraction of the cost. For example, in a U.S. Department of Justice antitrust lawsuit in 1978, five television studios paid over $2.2 million for a legion of lawyers and paralegals, working for months at high hourly rates, to examine six million documents. In contrast, in 2011, the U.S. e-discovery firm Blackstone Discovery helped analyze 1.5 million documents for less than $100,000.7
4 All revenues are in U.S. dollars unless otherwise stated. 5 ”Despite the Massive Size of the Legal Industry ($300B), Venture Capital Funding to the Legal Tech Sector is Limping Along,” CB Insights—Blog, June 12, 2013, accessed December 10, 2015, www.cbinsights.com/blog/legal-tech-venture- capital. 6 “DLA Piper Tops ‘The Am Law 100’ as the World’s Largest Law Firm,” DLA Piper, April 29, 2013, assessed September 13, 2016, www.dlapiper.com/en/us/news/2013/04/dla-piper-tops-the-am-law-100-as-the-worlds-larg__. 7 John Markoff, “Armies of Expensive Lawyers, Replaced by Cheaper Software,” The New York Times, March 4, 2011, accessed December 10, 2015, www.nytimes.com/2011/03/05/science/05legal.html?pagewanted=all&_r=0.
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Page 3 9B16M190 Online dispute resolution (ODR) was rendering court appearances irrelevant.8 ODR surfaced originally in the late 1990s, to deal with disputes arising in cyberspace. Yet it quickly evolved into dealing with disputes arising offline as well. ODR was gaining popularity, not only because it was convenient, faster, and cost less but because it bypassed the issue of jurisdiction, which prevailed heavily in traditional mechanisms such as litigation.9 The disadvantages of ODR were that it dealt with a limited range of disputes, and carried the risk of lack of confidentiality. A global e-commerce platform, eBay Inc., was resolving 60 million disputes per annum among its users through ODR. The growing influence of information and communication technologies led to three other trends in the legal industry: disintermediation, commoditization, and unbundling. Disintermediation referred to consumers accessing a legal product or service by bypassing established players, including lawyers, in the value chain. For example, users could create contracts on their smartphones by tapping into pre-formatted templates, sign them electronically, and seal them as binding in a court of law.10 Commoditization happened in areas where work was so routine (as in discovery) that it reduced the need for even paralegal staff. Typically, this work consisted of tasks carrying fixed-fee pricing, and excluded complex files requiring a high degree of personal service. Unbundling was when a law firm passed some aspects of service to a third party, rather than provide a full bundle of legal services, while still taking responsibility for the overall project. The legal services industry was characterized by pricing imperfections. Users had little information about the value or cost of a particular legal service, and the choice of its competitive availability elsewhere. Firms used cost-plus pricing, wherein they aggregated input costs and added on a rate of return to arrive at the end price. The process was not transparent. While fixed fees prevailed in limited areas of practice like personal injury, class action, employment, immigration, and patent, billable hours were common in areas of practice like business law. One major trend was that businesses were unwilling to accept law firms as the sole arbiters of price. They were also uncomfortable with hourly billing rates, which they saw as a measure of cost to the law firm, rather than of value to the client. A primary drawback of what was called the “billable rate” model was that it did not limit the number of hours that a firm could bill; therefore, it provided no incentives for the firm to secure process efficiencies. Accordingly, businesses were seeking alternative fee arrangements to replace or supplement billable hours.11 This stance had brought firms under pressure to shift their internal performance metrics from billing as many hours as possible to achieving results in as few hours as possible. Law firms were still grappling with making the shift. Businesses were also asking their legal providers to find ways to reduce or eliminate costs through legal process outsourcing. In re-examining their operating processes and practices, these firms were on track to reinvent themselves. Although a majority of their costs were fixed, successful law firms were securing gross margins of 50 per cent of their revenue. With progressive increases in rent, salary, marketing, and technology infrastructure
8 Orna Rabinovich and Ethan Katsh, “Lessons from Online Dispute Resolution for Dispute Systems Design,” in Online Dispute Resolution: Theory and Practice, ed. Mohamed S. Abdel Wahab, Ethan Katsh, and Daniel Rainey (The Netherlands: Eleven International Publishing, 2012), accessed December 10, 2015, http://conferences.law.stanford.edu/codr2013/wp-content/uploads/sites/14/2013/03/Rabinovich-Eine-and-Katsh-ODR- Lessons-from-ODR-for-DRSD-Ch.3.pdf. 9 Joseph W. Goodman, “The Pros and Cons of Online Dispute Resolution: An Assessment of Cyber-Mediation Websites,” Duke Law & Technology Review 2 (2003): 9, accessed December 12, 2015, http://scholarship.law.duke.edu/dltr/vol2/iss1/2. 10 Glenn Manishin, “Disrupting the Legal Industry,” DisCo: Disruptive Competition Project, October 29, 2013, accessed December 10, 2015, www.project-disco.org/competition/102913-disrupting-the-legal-industry-2/#.VmtBkkorLIV. 11 Julius Melnitzer, “Pricing Legal Services: The Alternative Fee Arrangement Tipping Point,” accessed December 11, 2015, www.lexpert.ca/article/ pricing-legal-services-1.
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Page 4 9B16M190 costs, firms were working hard to keep expenses below the 60 per cent range.12 As might be expected, there was significant tension between equity partners and salaried associates, lawyers and non-lawyers, revenue generators and cost centres, and “rainmakers” (who brought in new business accounts) and regulars (who focused on the practice of law). The legal industry had low barriers to entry at the local level. Firms competed with one another on several levels: size of practice, area of practice, type of service, price, location, professional reputation, and experience. Size was an advantage because it enabled building scale. Smaller firms held their ground on the basis of niche positioning. At the global level, niches were built largely around domain expertise (e.g., in natural resources, and even further down into fossil fuels). Historically, the structure of a law firm was based on a general partnership model. Profits of the firm were distributed among the partners and not subject to entity-level tax but taxed as personal income of the individual partners. There were three ways in which a firm could compensate its partners. In the first, seniority was the main criterion; it promoted loyalty and team spirit, but put growth at risk by rewarding non-performers on par with performers. In the second, merit was the main criterion, which brought clarity to expectations and metrics of performance, but encouraged the rise of “lone wolves” and an overly competitive organizational culture. In the third pay structure, compensation was determined by a combination of subjective analysis and objective evaluation; the compensation decision was a collective decision made by a designated compensation committee, comprising three to four partners.13 A common legal form of general partnership that had become popular with law firms was the limited liability partnership (LLP). A low capital base was the major drawback of an LLP, because capital was limited to the contribution made by an incoming partner, and had no room for reinforcement from any other source. The bankruptcy of Dewey & LeBeouf LLP (the largest firm of its kind in the United States) in May 2012 was attributed to its partnership model. This bankruptcy led to calls for liberalization of law firms’ organizational structure to bring outside equity. The trend towards ownership of law firms by non- lawyers was catching on in countries like the United Kingdom. The Legal Services Industry in Canada The Canadian legal industry had its own unique characteristics. There was no non-lawyer ownership in Canadian law firms. The practice of law was restricted to licensed lawyers operating within a regulatory framework of codes of conduct, insurance, standards of admission, and grievance-handling tools. The median age for lawyers in Canada was 45.6, and the average age of retirement was 75. About two-thirds of Canadian lawyers were in private practice, and 20 per cent were in government organizations. Over 10 per cent were employed as in-house counsel. Some law firms were beginning to put up storefronts in the premises of discount retailers.14 Jolliffe described the Canadian legal landscape:
The legal profession faces serious issues of change management. Lawyers are not quick to move out of their comfort zones. They tend to hold on to traditional ways of problem solving and service delivery. Partly, they are in a state of denial about the disruption that technologies are
12 Stephen Mabey, “Client Focused Cost Controls,” Canadian Lawyer, September 15, 2014, accessed December 10, 2015, www.canadianlawyermag.com/5280/Client-focused-cost-controls.html. 13 Michael J. Anderson et al., “Partner Compensation Systems in Professional Firms,” accessed December 16, 2015, www.managingpartnerforum.org/mpf/index.cfm/Compensation/publication-details/?. 14 Drew Hasselback, “Hi! Welcome to Lawmart!” Financial Post, December 7, 2015.
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bringing about; partly, they don’t have clarity on solutions suited to their needs; and, partly, they don’t want to commit to investments in new systems, software, and people without witnessing returns that they could easily relate to. There is a general reluctance to take even routine activities, like documentation, out of the litigation process and treat [them] as distinct services by [themselves]. That is one of the reasons why [legal process outsourcing] is not catching on in Canada. What is common is “nearshoring,” wherein a firm in Toronto, for example, looks for low-cost providers in satellite towns, like Waterloo, with which they could communicate in real time.
GOWLINGS LLP: FIRM BACKGROUND Gowlings was the third-largest law firm in Canada in terms of headcount, with 707 lawyers in 2013. The firm had 285 owner-partners, and all major decisions had to be endorsed by a 75 per cent vote. Gowlings served clients from seven offices nationally (in Calgary, Hamilton, Montréal, Ottawa, Toronto, Vancouver, and the Waterloo Region) and three offices outside Canada (in Beijing, London, and Moscow). Its clients spanned 18 industries ranging from aerospace to academia. Gowlings generated 80 per cent of its $420 million consolidated annual revenues from Canadian clients; the rest was derived from U.S.-based clients doing business in Canada. Established as a two-person office in Ottawa in 1887, the firm grew as the Canadian economy grew, by building practices in then-fledgling areas like manufacturing, infrastructure, financial services, and government. By the 1980s, the company had acquired a core competency in IP law, which provided differentiation in a competitive environment. Gowlings strengthened its business technology practice when the Waterloo Region took off as an incubator of high-tech start-ups in 1995. IP and information technology (IT) professionals were becoming regular invitees at boardroom tables. Advanced technology was becoming the foundation of the “new economy.” The vanguards of the “old economy” (e.g., retailers and financial institutions) were also pursuing IT-driven initiatives, like e-commerce. Law firms saw an opportunity in serving a wide variety of these companies’ needs (corporate, financing, joint venture collaborations, distribution agreements, etc.). Gowlings saw the chance to leverage its IP practice in order to enter the highest level of corporate law. Its IP base was a draw for top-tier corporations (as clients) and for law firms with niche capabilities (as collaborators). By 2001, the convergence of IP, IT, and business law became central to the growth strategy of Gowlings in its bid to become a high-end corporate law firm. The company’s strategy was threefold: (1) attract both emerging clients in the new economy and established clients in the old economy for legal work related to managing high-tech enterprises in general; (2) merge with regional law firms with unique home-grown capabilities to build a critical mass; and (3) use national scale to attract top-tier work in corporate law. The firm used a structure that was based on a combination of what were referred to in legal circles as “quarterbacks” and “bench strength” to realize its strategy. “Quarterbacks” were front-end employees skilled at negotiating, structuring, and closing deals. “Bench strength” provided depth of knowledge which was essential to packaging the deals—in domains like taxation, securities, corporate finance, business restructuring, IP, and IT. This structure ensured that Gowlings was able to round out its practice; it meant that small and medium-sized clients starting with IP or IT work stayed on for legal advice on acquisitions and restructuring, and large clients signing up for specialized IP counsel stayed on for advice
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Page 6 9B16M190 on transactional law. Gowlings soon developed a reputation for business law independent of its reputation for IP law. In 2003, the firm launched an advertising campaign in the Canadian print media aimed at building the Gowlings brand among both present and potential clients. Carrying the tagline “the power of original thought,” the campaign sought to position the firm as a strategic thinker by aligning it with the world’s greatest innovators like Albert Einstein. This campaign was a novel initiative at a time when advertising and self-promotion were uncommon in the legal community. The focus on business law led the firm to shed some of its long-standing areas of practice, such as union- based labour relations. This shift was an indication that Gowlings was prepared to eliminate potential sources of conflict in legal practice in pursuit of its strategic goals. The firm deployed a legal project management module internally, called Gowlings Practical. Designed to help the company’s lawyers become more efficient, it was “a program that [brought] a simple yet effective project management approach to the way [Gowlings provided] legal services.” Gowlings Practical used data analytics to measure the cost of legal processes at a granular level. It was meant to provide value for clients through lower-cost service delivery, better cost predictability, and clearer client communication. INTERNATIONALIZATION Gowlings opened its first international office in Moscow in early 1990. The initiative was customer-led. Some of its Canadian customers were beginning to run test operations in the Soviet Union when the spirit of glasnost (meaning “openness” or “publicity” in Russian) was on the ascent. Gowlings followed its Canadian customers to provide legal support through approximately 12 Russian lawyers recruited in Moscow. Just as the firm was coping with the challenges typical of a start-up in a new location—such as managing the cost structure, lag time, and remoteness of the location—the Soviet regime collapsed. In early 1992, Gowlings’ Moscow office started catering to clients in the newly formed Commonwealth of Independent States with businesses in Belarus, Ukraine, Moldova, Armenia, Azerbaijan, Turkmenistan, Tajikistan, Uzbekistan, Kazakhstan, and Kyrgyzstan. It focused on “providing Western-style solutions to uniquely Russian issues” in trademark, copyright, and patent matters. In mid-2008, Gowlings ventured out of Canada again. It opened an office in London, which, apart from being a global financial centre, was one of the most competitive legal markets in the world. Although a shared language and common legal system were the two main attractions for the company, London was perceived by the firm as a gateway to Europe as well as the emerging markets in Africa and the Middle East. Staffed by 15 professionals, the London office offered services in four areas: capital markets; corporate finance and M&A; energy, infrastructure, and mining; and commercial dispute resolution. Gowlings’ subsequent international foray was in China, where it opened a representative office with three lawyers in Beijing in late 2011. The short-term objective of this office was to provide services for Chinese state-owned enterprises (SOEs) investing in Canada; the long-term goal was to attract SOEs’ work when they finally came to Canada with investments (which were anticipated to be massive). However, an imminent change in the Chinese investment landscape was leading to a rebound. The outbound investments from the SOEs were beginning to reach their upper limit. Most of the outbound investment from China was being done by the country’s new entrepreneurial class. The investment was of a smaller
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Page 7 9B16M190 magnitude, relative to SOEs, because it was privately financed. Gowlings therefore shifted its focus to inward foreign direct investment in China from its clients in the West. Canadian expertise in sectors such as oil and gas, mining, agriculture, and financial services was particularly valued in China. Jolliffe discussed the importance of a core competency in Gowlings’ global expansion:
We are exploring the potential to replicate globally the capabilities we have developed while working with our domestic clients. One example is in nuclear law. Given the demand for Canadian expertise in nuclear power in countries like China and India, and also that Gowlings has the know-how acquired locally, it is possible to build a global business around a single competence. Plans for new reactors need to be steered through regulatory approvals. The relationships between public and private entities, [and] contractors and subcontractors are complex, and need to be negotiated to preempt disputes. That is our competence.
THE DECISION Jolliffe would have to make decisions about three key issues going forward. Location Legal work outside a law firm’s home country was generally restricted to practice areas such as M&A and IP. Most of the work pertained to high-end, non-litigation services around financial assets. Because it moved in the direction of the flow of capital, the work was usually concentrated in traditional financial centres (i.e., New York and London). For the CEOs of law firms, going global largely meant finding their place in the U.S. and U.K. legal markets. China was beginning to emerge as another option for these firms because it was becoming a new source of global capital. Other cities in Continental Europe and Asia were also gaining attention. The United States was the largest legal market worldwide. It was also well served. Twenty per cent of Gowlings’ revenues (amounting to about $80 million) came from U.S. customers in Canada; these customers contributed indirectly to Canadian earnings through referrals as well. Retaining these firms was therefore crucial. Getting a foothold in the U.S. market by partnering with a U.S. firm would likely lead to losses in revenues because clients with potential conflicts of interest would walk away. In addition, such a partnership would upset the ongoing relationships with law firms in the United States, which would not only stop providing referrals to Gowlings, but might take a competitive stance against the firm. Further, it was important for Gowlings that its new non-U.S. partner would not simply use its association with Gowlings to enter the United States exclusively for its own gains. Gowlings had a representative office in Beijing; this office was inherently limited to being a liaison office that provided updates on the legal environment. Forging a relationship with a local firm was the way to enter the Chinese legal market, which had become liberal with China’s entry into the World Trade Organization in 2001. By the end of 2012, China’s legal industry had become competitive, with 174 international law firms (81 U.S. firms and 19 U.K. firms). Typically, each firm was an outpost, with a median size of 11 lawyers, responsible for less than 5 per cent of its parent firm’s global revenue.15 Most of these firms were struggling with integration because of differences in language, culture, and the process of building relationships.
15 Rachel E. Stern and Su Li, “The Outpost Office: How International Law Firms Approach the China Market,” Law & Social Inquiry—American Bar Foundation, Summer 2015.
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Page 8 9B16M190 The U.K. legal market was characterized by margin pressure. In FY2012/13, for example, the profits of the country’s top 50 law firms had fallen by 0.5 per cent in spite of a 6.9 per cent rise in revenues.16 There was increasing demand from clients for higher transparency and more value for the price. However, the market was conducive for entry, not only because of Commonwealth links with Canada, but because the United Kingdom was open to the entry of overseas legal firms. For example, it allowed non-lawyers to invest in legal businesses. It also provided licences for what it called alternative business structures for legal firms. Continental Europe did not appear attractive because its law firms focused more on domestic clients and issues. These firms did not have global aspirations—an important attribute that Gowlings was looking for in its partner, as Jolliffe emphasized:
From our experience in running three satellite offices so far, we know that language and culture are important in the choice of a global location. A major consideration is the availability of local talent. It should be multi-lingual. It should have the work ethic and an ambition to succeed in a competitive global environment. The location should enable us, in the long run, to provide a portfolio of services to clients, local and global. It should be a gateway to other global markets.
Partner Jolliffe was clear about the basic components of an ideal partnership for Gowlings: there should be cultural fit between the partners and there should be alignment in the areas of practice. He also wanted the process of sealing the partnership with the shortlisted firm to be inclusive at various levels in both firms from the start, rather than come as a surprise to the partners of each firm, without regard for their reactions or input. This preparation would largely take care of the cultural fit, in addition to reducing the time required for integration. Synergies in practice areas were equally necessary. While manufacturing companies looked at synergies in terms of improving operational efficiencies and reducing costs, law firms looked at them more in terms of generating revenue, because their costs were fixed. The practice areas of partners should be both supplementary and complementary so that they could be leveraged for growth and expansion into new geographical markets. For example, strengths in practice areas like natural resources, IP, and infrastructure could be supplementary, leading to scale. Gowlings’ strength in power generation could be supplemented by its partner’s strengths in power distribution, so that together, the firms could be better positioned to bid for power projects in South America, Asia, and the United States. Gowlings needed to be cautious about potential areas of conflict in practice areas. For example, the firm acted for, and not against, insurance companies, brand companies, and patent holders. The partner’s client base had to be compatible with its own client base, explained Jolliffe:
There are lots of different layers. We will not find the perfect fit in a single firm. We need to trade off. The bottom line is whether there is compatibility at a personal level. If you like a partner and get along, it can solve a lot of uncertainties. That is why we are looking only at firms we know, [which] we have done business with and are our good friends. The mergers that work well are also those . . . executed for the purpose of improving service to clients, rather than for increasing the profit pool for partners. A common vision is what we are looking for.
16 James Tsolakis, “A Perspective on the Legal Market,” Royal Bank of Scotland, April 2014, accessed December 12, 2015, www.rbs.com/content/dam/rbs/Documents/News/2014/03/perspective-on-the-legal-market.pdf.
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Page 9 9B16M190 Structure Gowlings did not want to simply play a small role within a legal conglomerate; it was looking for a merger of equals. The first alternative was to go for a complete merger involving full-scale integration. Such a merger would lead to scale economies, but it would require consolidation of accounts and greater compliance with regulatory oversight. Liabilities would become common with a merger. With partners sharing a common profit pool, it would be easier to encourage common behaviour across the firm. The second alternative was an umbrella structure, where the two firms would retain their identities. This structure would ensure that profits were generated locally and retained locally (while the firms shared common costs). Jolliffe felt that motivation levels would be high, but synergies would be under-exploited:
There is a general reluctance on the part of lawyers to give up the way they operate. They value the right to self-determination. If decision making is centred outside of them somewhere else, they see their ability to influence the decision being eroded. [Giving up the ability to make decisions] outweighs the strategic advantage of being associated with another brand with greater scope of legal work. It is an issue even at Gowlings, which has a flat structure. A change in the power equation, however marginal, is unsettling for partners. We need to keep that in mind while deciding on the structure of our new partnership.
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EXHIBIT 1: RANKING OF CANADIAN LAW FIRMS, 2013
Rank Name of firm Number of Partners Toronto Ottawa Vancouver Montreal Calgary Other Total
1 Borden Ladner Gervais LLP
272 98 129 147 115 10 771
2 Fasken Martineau DuMoulin LLP
225 22 136 173 29 170 755
3 Gowling LLP 211 157 61 84 96 98 707 4 Norton Rose
Fulbright Canada LLP
200 40 0 179 157 123 699
5 McCarthy Tétrault LLP
260 0 79 146 61 43 589
6 Blake Cassels & Graydon LLP
277 3 97 65 112 20 574
7 Dentons Canada LLP
149 27 64 90 101 90 523
8 Miller Thomson LLP
155 0 65 62 32 168 482
9 Stikeman Elliott LLP
201 13 41 153 44 23 475
10 Osler Hoskin & Harcourt LLP
275 24 0 61 62 22 444
Source: Created by authors using data from “Largest Law Firms in Canada*,” Law Times, September 2014, accessed September 6, 2016, www.lawtimesnews.com/images/stories/PDFs/2014/Largest%20law%20firms%202014.pdf.
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3.
9B10M067 LOUIS VUITTON IN JAPAN1
Justin Paul and Charlotte Feroul 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) [email protected]; www.iveycases.com. Copyright © 2010, Richard Ivey School of Business Foundation Version: 2017-02-21
In Japan, whether you are in Tokyo, Osaka or Nagoya, just turn your head and Louis Vuitton is everywhere. The celebration of the 30th anniversary of the presence of the illustrious, glittering French multinational in Japan took place in Aoyama, one of Tokyo’s fashionable districts. A unique vision of luxury took shape when Louis Vuitton opened yet another new store inside Comme des Garçons on September 4, 2008, in the heart of Japan’s capital. The pop-up store situated on the prestigious Omotesando Street was an illustration of Louis Vuitton’s attachment to the Japanese luxury market. Yves Carcelle, chairman and CEO of Louis Vuitton, said, “This project not only brings a new meaning to luxury, but also speaks volumes about how the know-how and heritage of Louis Vuitton have always been perceived in Japan, including by its foremost designers. We are very proud to have been able to help Rei Kawakubo2 relive her memories in such an original and creative way.”3 The Omotesando guerrilla marketing event reflected Louis Vuitton’s success in Japan. Louis Vuitton had been following an aggressive marketing strategy in the country, opening extravagant stores such as those in Ginza or Roppongi. Take a walk on Ginza’s main street, Chuo Dori, the centre of a paradise for shoppers, with long- established department stores, such as Mitsukoshi, Takashimaya and Matsuzakaya. Continue through the high-end fashion street Namiki-dori. Stop. There it is. You have reached the massive flagship Louis Vuitton store. When Louis Vuitton, the world’s biggest luxury-goods firm, inaugurated its huge shop in 2002 in the district of Omotesando, Tokyo, hundreds of people were queued outside. During the first few days, sales exceeded the initial estimations by ¥1 million.4 In the last decade, Japan had been Louis Vuitton’s most profitable market, representing almost half of its profits, but it seemed that with the 2008-2009 economic crisis, there might be the start of a decline in sales.
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 Louis Vuitton or any of its employees. 2 Rei Kawakubowas a famous Japanese fashion designer. She founded the fashion house Comme des Garçons Co. Ltd in 1973. The designer, known for her anti-fashion, austere and conceptual universe, was the guest designer of Louis Vuitton for one of its collections in 2008. 3 Lesley Scott, “Louis Vuitton at Comme des Garcons in Tokyo,” http://fashiontribes.typepad.com.Accessed July 11, 2008. 4 “Japan’s luxury-goods market — Losing its shine,” The Economist, September 18, 2008, www.economist.com. US$1 was equivalent to approximately ¥150 (yen) in 2002.
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Facing a weak economy and a shift in consumer preferences, Louis Vuitton started adapting its strategy in the Japanese market. The days of charging a high price for products with a proprietary logo seemed to be gone in Japan. The company had to launch relatively low-priced collections to boost sales. The firm had also been taking steps to open stores in other mid-size cities where the LV brand was not well-known. Louis Vuitton might be French, but Japan had become the land of Louis Vuitton lovers. Over the years, Japanese consumers had demonstrated fascination and passion for the iconic brand. What would be the key to Louis Vuitton’s continuing success in the Japanese market? LOUIS VUITTON —THE HISTORY The Foundation Louis Vuitton Malletier, often referred to as Louis Vuitton, was an international, well-established brand mostly famous for its craftwork leather bags and trunks. The firm was established in France in 1854 by Louis Vuitton and became known as one of the oldest French luxury fashion houses. Louis Vuitton, the company’s founder, was born in 1821 in Anchay, Jura, France. He became a Layetier in Paris and earned a reputation while working for the Empress Eugénie de Montijo, wife of Napoleon III. Learning from his work for the French aristocracy, he acquired personal “savoir-faire”5about leather luggage. In 1854, he founded the firm,” Louis Vuitton: Malletier à Paris.”6 The flat-bottom trunks of Louis Vuitton with trianon canvases represented a real revolution for travelling in those days as they combined lightness and storage capacity. In 1885, the firm opened its first overseas store in London, England, on Oxford Street. In 1888, Louis Vuitton developed the Canvas Damier Pattern in order to make the Louis Vuitton experience unique and recognizable by anybody. The logo “marque Louis Vuitton deposée,” meaning “mark Louis Vuitton deposited,” was also created. Following the death of Louis Vuitton in 1892, his son, Georges Vuitton, took over the leadership of the firm. He was ambitious about taking Louis Vuitton to the next step — building a global brand and setting up a multinational corporation.7 He participated in the Chicago World Fair in 1893, presenting the company’s product, and travelled all around the United States to promote the brand. In 1896, Georges Vuitton created the Monogram Canvas and attained worldwide trademarks on it to limit counterfeiting. The LV monogram was inspired by the Japanese and Oriental designs of the Victorian age. By 1914, the company opened the Louis Vuitton Building of the Champs-Elysées, now a symbol of the success and prestige of the company. Though World War I had begun, the firm initiated its global expansion strategy by opening stores in New York, Bombay, Washington, London, Alexandria and Buenos Aires. In 1936, Gaston-Louis Vuitton took over the direction of the company when his father, Georges Vuitton, passed away. The Modern Age of Louis Vuitton Gaston-Louis Vuitton guided the brand into its modern age. The company expanded its product line by applying the craftwork and design of its leather to small leather goods, such as purses and wallets, and to its whole luggage line. As a consequence, the Monogram Canvas was redesigned in 1959 to fit the new
5 “Know-how.” 6 “Louis Vuitton: Luggage maker in Paris.” 7 Official Louis Vuitton MySpace, www.myspace.com/louisvuittonmyspace, accessed June 25, 2010.
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range of products. The brand started its first advertising strategy by handing bags to Hollywood celebrity actresses. Audrey Hepburn carried a Louis Vuitton bag in 1963 in the film Charade, directed by Stanley Donan. In the mid 1970s, Louis Vuitton had become the world’s biggest luxury brand in terms of market share. The Vuitton-Racamier family,8 owner of the brand, had focused mainly on building a Japanese clientele. By 1977, the company owned two stores in Japan with annual profits of US$10 million. It further tapped into the Asian market in 1983, in Taipei, Taiwan and, in 1984, in Seoul, South Korea. The creation of Louis Vuitton Moët-Hennessy (LVMH) in 1987 established the largest luxury-goods conglomerate in the world. Moët et Chandon and Hennessy were the leading manufacturers of champagne and brandy. The merger resulted in an increase in profits for Louis Vuitton of 49 per cent in 1988 compared to 1987. By 1989, Louis Vuitton had entered into 130 countries across the world.9 In 1990, Yves Carcelles was nominated for president of Louis Vuitton. He carried on with an international expansion strategy, inaugurating the first Chinese store in the Palace Hotel in Beijing. The Monogram Canvas centennial was celebrated in 1996. Seven cities across the world held extravagant parties at stores and Louis Vuitton asked seven prestigious designers to imagine new products featuring the LV monogram. Azzedine Alaia, Manolo Blahnik, Romeo Gigli, Helmut Lang, Isaac Mizrahi, Syvilla and Vivienne Westwood created seven original and functional objects in a limited edition series.10 Louis Vuitton in the 21st Century In 1998, the American designer Marc Jacobs was appointed as Louis Vuitton’s art director. Jacobs was already a highly successful international designer, who became distinguished as the youngest fashion designer ever to be awarded the industry’s highest tribute, the Council of Fashion Designers of America (CFDA) award for New Fashion Talent. The challenge was huge, as Jacobs had to guide Vuitton’s first shoes and ready-to-wear collections. With this nomination, Louis Vuitton aimed at establishing the brand as a consistent trendsetter in high fashion. Since the late 1990s, creating limited-edition collections had become Louis Vuitton’s marketing strategy to capture consumers’ attention and reinvigorate the brand’s identity while boosting the bottom line. In 2001, Stephen Sprouse and Jacobs collaborated to design a limited edition series of Louis Vuitton bags. Sprouse was already a highly popular artist, as he had collaborated with the extravagant Andy Warhol and with contemporary artists and musicians, such as Debbie Harry and Duran Duran. In line with what The New York Times called Sprouse’s mix of “uptown sophistication in clothing with a downtown punk and pop sensibility,” the collaboration with Jacobs resulted in a limited edition that featured green and white graffiti written over the monogram pattern. All bags were made for Louis Vuitton’s VIP list and were meant to be collector’s items. In 2001, following the success of the Louis Vuitton limited edition, Jacobs designed Louis Vuitton’s first jewelry piece. In 2002, the Tambour watch collection was introduced. Pursuing its globalization strategy in the 21st century, Louis Vuitton opened one of its most famous stores on Fifth Avenue in New York City, then opened more stores in Sao Paulo, Brazil, Johannesburg, South Africa, and Shanghai, China. The brand reopened its store on the Champs-Elysées, which became the largest Louis Vuitton store in the world. Louis Vuitton celebrated world wide its 150th anniversary in
8 Henri Racamier married a descendant of Louis Vuitton. He was asked at the age of 65 by the family of his wife, Odile Vuitton, the great-granddaughter of Louis Vuitton, to run the family’s leather goods business. 9 Official Louis Vuitton MySpace, www.myspace.com/louisvuittonmyspace, accessed June 25, 2010. 10 Diana Prince, “Louis Vuitton: The history behind the purse,”www.associatedcontent.com, accessed July 26, 2008.
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2004. It had taken more than a century, starting with a family house, to build a timeless image of class, luxury and elegance. The industry-leading luxury conglomerate, LVMH, had been a major player in Louis Vuitton’s success; it had been setting the tone and practices of the brand. The LVMH group had divided itself into five business divisions: fashion and leather goods, selective retailing, wines and spirits, perfumes and cosmetics, and watches and jewelry. There were 50-plus luxury brands belonging to the group, which captured business in many countries. Louis Vuitton had been returning the favour to its parent company, as it represented the group’s best-performing brand due to continuous double-digit growth during the past years. Although LVMH did not disclose sales for Louis Vuitton alone, analysts reckoned that in 2003, sales had grown at least 16 per cent worldwide and had repeated that growth in 2004. Thanks to Louis Vuitton’s rapid growth, LVMH’s Paris-traded shares had almost doubled in price in 2004 to more than $75. Exhibits 1 to 4 show LVMH’s financial results for 2008, LVMH’s Fashion & Leather Goods Division’s 2008 financial statements and the division’s key figures.11 The LVMH group’s upward trend was said to be poised to continue as chairman Bernard Arnault’s expectations for the future were very optimistic. At that time, Louis Vuitton had already quintupled sales and increased margins six-fold since Bernard Arnault had bought the company in 1989, and the brand was said to have the greatest potential for growth of all luxury brands (see Exhibit 5). The Vuitton Machine: Inside the World’s Biggest Luxury Brand Thinking of Louis Vuitton, what would come to mind? It would certainly be top model celebrity ads in trendy fashion magazines, or fashionistas in new Louis Vuitton retail temples from the Champs Elysées to Tokyo’s high-end Omotesando shopping district. Behind the glamorous image of Louis Vuitton, one could see what made it unique, and what made it the most profitable luxury brand worldwide (see Exhibit 6). As Louis Vuitton had been progressing smoothly for the past years, Yves Carcelle, the charismatic textile executive who had been widely credited with masterminding Louis Vuitton’s ever-rising growth, had commented about the brand’s growth that “the sky’s the limit.” With $3.8 billion in annual sales, Louis Vuitton represented in 2004 about twice the size of its two main competitors, Prada and Gucci Group’s Gucci division. This fact was even more striking when LVMH announced a 30 per cent increase in Louis Vuitton’s earnings in 2003 due to a record operating margin at 45 per cent. The standard average margin in the luxury accessories business was 25 per cent.12 Efficient management practices Through the years, Louis Vuitton had established a strictly controlled distribution network thanks to an efficient structuring of the company that relied on continuously increasing productivity in design and manufacturing. Louis Vuitton owed much to its executives. Emmanuel Mathieu, who had headed Louis Vuitton’s industrial operations since 2000, had contributed to the boost in manufacturing productivity by five per cent a year, with more productivity, efficiency and teamwork. In 1999, the firm took 12 months to launch a new product; in 2004, the time was reduced to about six months. This continuous improvement had been the theme of Louis Vuitton’s industrial operations and was facilitated by manufacturing methods from auto makers and other industries that had been adopted to boost productivity.
11 The Louis Vuitton Company was part of the Fashion & Leathers Goods Division of LVMH. 12 Carol Matlack, “The Vuitton Money Machine,” Business Week, www.businessweek.com, accessed March 22, 2004.
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Managers such as Emmanuel Mathieu had helped transform the brand from a family business to a 21st century business.13 The manufacturing of Louis Vuitton products was still a labour-intensive process. Each team of 24 workers was responsible for producing about 120 handbags a day. Over a period of time, the brand seemed to have achieved perfect equilibrium between machines and labour. Quality products Louis Vuitton focused on constant improvement of quality and offered lifetime repair guarantees for its customers. The brand had been striving to increase both fidelity and endless desire in its consumers. Louis Vuitton based its strategy on the loyalty of its consumers and strove to attract more consumers to buy bags ranging from classic tan-and-brown monogrammed bags to newer lines, such as the Murakami line, which was priced at $1,000, and Suhali, a line of goatskin bags priced at more than $2,000. As they bought Louis Vuitton items, loyal shoppers stepped into the dream of the brand. The more the prices were raised, the more they would come back. When Jacobs joined Louis Vuitton, the New York designer had a challenge — attracting young buyers. However, Jacobs happened to be the perfect match, as the two product lines that he had launched (ready- to-wear and shoe lines) tapped into a market of younger consumers, even if those lines accounted for less than 15 per cent of the brand’s sales. The younger buyers were attracted by brand image and older clients by quality and lifetime free repairs. Production and quality control The efficiency of the manufacturing facilities and employees helped Louis Vuitton compensate for its decision to keep most manufacturing plants in France, one of the most expensive labour markets in the world. Eleven out of 13 factories that made Louis Vuitton bags were in France. The brand had never planned to manufacture its products in a location where labour was less expensive as the quality control standards in France were very high and customers expected “un savoir-faire à la Française,” meaning the famous refined French know-how. Quality control was conducted in the brand’s test laboratories. The leather raw material came from the hides of Northern European cattle. They were known for relatively few blemishes from insect bites. Despite high-quality leather, the quality of the bags was tested with mechanical arm hoists. The bags, loaded with weights, were lifted and dropped, again and again, as part of quality checking. Then, ultraviolet rays were projected on the handbags in order to determine their resistance to fading. Eventually, zippers were opened and shut 5,000 times. For other pieces, such as jewelry and bracelets, mechanized mannequin hands were strongly shaken to make sure none of the charms would fall off. In all Louis Vuitton factories, employees worked in teams of 20 to 30. Each team was responsible for one product at a time and were encouraged to suggest improvements in manufacturing. They were also briefed about the products, such as their price and how they were selling. The aim was to have autonomous and multi-skilled employees.
13 Ibid.
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The Boulogne Multicolor shoulder bag provided an example of how the whole production process worked. With the success of the Murakami line in 2003,14 the marketing executives thought that this line could be a source of further revenue. They questioned store managers and found out that customers wanted a Murakami shoulder bag. A prototype of this new Boulogne Multicolor bag went directly from the marketing department to top executives. Straight away, they approved it. The prototype went to the factory in Ducey on the Normandy coast of France. The teamwork efficiency of Louis Vuitton’s factory paid off. When some workers were asked to test it, they discovered that decorative studs were causing the zipper to bunch up. Following this discovery, managers were informed right away and technicians managed to place the studs a few millimetres away from the zipper in less than one or two days. The problem was solved.15 Advertising As Louis Vuitton had been going global, it had been able to develop a successful advertising strategy in line with its global expansion strategy. The advertising strategy of the company remained based on the idea that productivity would not sustain growth. Rather than cutting its ad budget like most luxury groups, the company increased ad spending by 20 per cent in 2003. This figure might have seemed very high, but in fact, it only represented five per cent of revenues, half the industry average.16 The company meticulously cultivated a celebrity culture and employed famous models and actresses, such as Jennifer Lopez and, more recently, Madonna, in its advertisement campaigns. However, in 2007, the firm implemented a change in its strategy and announced that former Soviet leader Mikhail Gorbachev would be featured in an advertisement campaign with sports stars Steffi Graf, Andre Agassi and Catherine Deneuve.17 The firm wanted a shift from hiring traditional top models. Louis Vuitton frequently used print ads in magazines and billboards in large cosmopolitan cities. The campaigns often involved famous stars like Gisele Bündchen, Eva Herzigova, Sean Connery, and Francis and Sofia Ford Coppola. Lots of customers were attracted to the mind-boggling 90-second commercial advertisement on television with the catchy question, “Where will life take you?” Translated into 13 different languages, it helped LV to build its brand. The media (communication) department was strategic in choosing the newspapers and magazines to reach out to the higher income group. Future challenges The most serious issue that would remain for years to come was the question of whether Louis Vuitton had reached its growth potential or not. One of its challenges would consist of reducing its risky dependence on the Japanese market. In 2004, 55 per cent of revenues came from Japanese consumers. To reduce dependence on this market, the brand aspired to continue building its sales in the United States, as well as tapping new emerging markets, mainly China and India. The second challenge would be to fight against worldwide counterfeiting. This was important because Louis Vuitton had been itself synonymous with status, convincing customers that they belonged to a privileged club.
14 In 2003, Takashi Murakami, in collaboration with Marc Jacobs, created the Monogram Multicolor canvas range of handbags and accessories. First designed for the Japanese market, the line was a worldwide success. 15 Carol Matlack, “The Vuitton Money Machine,” Business Week, www.businessweek.com, accessed March 22, 2004. 16 Carol Matlack, “The Vuitton Money Machine,” Business Week, www.businessweek.com, accessed March 22, 2004. 17 Official Louis Vuitton MySpace, www.myspace.com/louisvuittonmyspace, accessed June 25, 2010.
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In the future, Louis Vuitton would have to face a shift that all fashion houses feared, the possible departure of Jacobs. Yet, Jacobs had signed a contract as Louis Vuitton’s artistic director until 2018 and Marc Jacobs’s label18was one of the rising stars in LVMH’s portfolio. However, the biggest challenge was in keeping control of the multinational business. As brands went global, the temptation for many was to immediately find new outlets and new channels of distribution and to decide on the price in different countries. However, Louis Vuitton was highly disciplined and focused on quality. JAPAN —A KEY MARKET Overview of the Japanese Luxury Market Over the past few years, Japan had become the capital of luxury and a mass-market paradise for luxury brands. According to an estimate by HSBC in February 2009, it was the final destination of 45 per cent of luxury goods sold worldwide.19 According to some luxury analysts, the statistics were exaggerated. Indeed, Japan was considered the world’s largest market for luxury brands, but statistics said that Japan represented between 12 and 40 per cent of worldwide sales. The rate would vary according to the definition of the market. Claudia D’Arpizio upheld that, “Japan is the world’s largest market, and has the highest per capita spending for luxury goods.” She added, “Much of that volume is from Japanese purchases while on trips to Hawaii, the U.S. or Asia.”20 Competition Japan was the world’s most concentrated source of revenue for luxury brands. It represented the mass market and, consequently, the first source of profit for many international luxury brands. Exhibit 7 shows the percentages of several companies’ overall revenues generated in Japan. The CEO of Bulgari, Francesco Trapani, revealed, “Accounting for 26 per cent of total revenues, Japan is for Bulgari the first and most important market.” In 2006, Japan represented the biggest market for other luxury brands, such as Baccarat, Burberry, the Gucci Group, Louis Vuitton and Salvatore Ferragamo. In addition, Japan was the second biggest market for Coach and Tiffany & Co.21 Comparing Japan’s geography to the U.S. geography, the former was equivalent in size to the region of Montana. Within its tiny territory, Japan was sprinkled with 34 Bulgari stores, 37 Chanel stores, 115 Coach stores, 49 Gucci stores, 64 Salvatore Ferragamo boutiques, 50 Tiffany & Co. boutiques and 252 stores of the LVMH group, including leading brands such as Louis Vuitton, Donna Karan, Marc Jacobs, Berluti, Moet & Chandon, TAG Heuer and De Beers LV.22 18 Marc Jacob created his own label, Marc Jacobs Co. Ltd, in 1994. The company was part of LVMH. 19 Glenn Smith, “Luxury sector loses its recession-proof status,” Media, February 12, 2009,p. 19. 20 Ibid. 21 “Japan is the world’s most concentrated source of revenue for luxury brands,” Japan External Trade Organization, www.jetro.org, accessed May 8, 2006. 22 Louis Vuitton had settled an agreement for a joint venture with the diamond company De Beers for the Japanese market. “Japan is the world’s most concentrated source of revenue for luxury brands,” Japan External Trade Organization, www.jetro.org, accessed May 2006.
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Quality had always been a key factor for successful brands in the Japanese market, especially for smaller brands or niche brands that did not enjoy the same success as larger brands, such as Louis Vuitton. But new, foreign brands were trying to shake up the market share of existing luxury companies in Japan by offering high quality at competitive prices. The popular worldwide Swedish brand H&M tapped into the Japanese market in 2008 with its fast fashion concept. The entry of H&M into the market completely revolutionized it. As a consequence, the effectiveness of the business models of brands like Zara, H&M or Uniqlo enabled them to compete with quality brands amazingly quickly. Affordability was a new concept that was radically changing the mindset of Japanese customers, who were always eager to resemble top fashion models from famous catwalk shows. Consumer Behaviour in Japan Japan had been known for a group-oriented culture in which there was a real pressure to possess luxury status-driven brands. Successful brands, such as Prada, Hermès or Louis Vuitton, had made the Japanese luxury market the mass market. The Japanese way of consumption was different from the Western one. In Japan, young women were more beauty-conscious. The proportion of the urban population in Japan that possessed a famous, expensive luxury brand item was immense, reflecting a tendency not as deeply ingrained in other developed cities, such as New York, Sydney or even Paris, the high-end capital of luxury fashion. The Japanese way of consuming cosmetics and luxury brands seemed more like a compulsory form of social expression. According to Davide Sesia, the president of Prada Japan, Japanese women, to a much greater extent than Europeans, had a “psychological need to own something considered to be beautiful.”23 In Western societies, luxury shopaholics were not very well-perceived among society. However, the cultural and social homogeneity among Japanese society helped explain its attachment to luxury items. The existence of a large middle class and a high population density affected Japanese habits. Japanese people were used to spending more time out of their homes than people in any other culture. Japanese society could be described as an “impersonal” society in which looks were very important, and people were supposed to dress in a way that corresponded to their social position. Yet, times had changed and Japanese consumers were becoming less inclined to tolerate high prices that had formerly created desirability. Although young Japanese women would still be eager to save money for the “it” brands, they had become more aware of the value of money. The lower-priced accessories and small leather items, such as wallets, travellers or clutches, had reported a huge increase in sales in the recent past. Since 2000, luxury goods had held a different position in the consumer mindset. As the market had evolved towards more sophistication, luxury brands were no longer purchased as badges of membership in the new urban class. The norms of mature brand behaviour and consumer habits seen in the Western world were about to be reflected in the Japanese luxury market. Davide Sesia had advocated that, “The increased attitude of Japanese women in their 20s and 30s understanding themselves much better than in the past was a key phenomenon.”24 As a consequence, in the luxury market, the ready-to-wear segment had most incontestably been affected by the new trends in Japanese women’s choices.
23 “The State of Luxury in Japan,” Carter Associates, http://carterassociates.net/aboutJapan/view_04_Luxury.html, accessed February 12, 2008. 24 “The State of Luxury in Japan,” Carter Associates, http://carterassociates.net/aboutJapan/view_04_Luxury.html, accessed February 12, 2008.
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New Perspectives In response to the sluggish economy and appreciation of the Japanese yen, foreign luxury brands were lowering their prices. Louis Vuitton and Christian Dior had lowered their prices the week before Christmas in 2008. Louis Vuitton had made a seven per cent price reduction on leather goods, accessories, ready-to- wear, shoes, watches and jewelry. The decrease in prices was justified by “a policy of offering its products at appropriate prices.”25 This policy relied on the exchange rate fluctuation, manufacturing costs and quality considerations as the yen had strengthened against the euro in 2008.26 Although sales of luxury products had notably decreased due to the global financial crisis, which originated in the United States and spread all over the world during 2008-2009, a new, curious phenomenon had taken over — the rental of bags. Nonetheless, many luxury brands were aiming for the return of better days, like the luxury Belgian chocolatier Godiva, which was carrying on with plans to open two new cafés in Tokyo, or the luxury mobile phone company Vertu, which planned to open a shop in Ginza. Characteristics of the evolution of the ageing Japanese population, such as wealthier families and older women with increased purchasing power, represented new perspectives for the future of the Japanese luxury market. Though there was sustained slowdown in the demand for luxury goods in 2008 and 2009 due to the adverse consequences of the global recession, the Japanese luxury market would remain a healthy and growing industry. There had never been an annual sales decline and the growth for the next few years was still expected to be around six per cent.27 The Japanese market was defined as cyclical in the sense that there were periods of huge spending often followed by periods of slow growth and moderation. In order to compete, brands would have to rethink their decisions and strategies in a more complex way than in past years. Milton Pedraza, the chief executive officer of the Luxury Institute of New York, upheld that, “Luxury has to reinvent itself every few years, and I believe it will return to the traditional meaning of something unique and exclusive.”28 In the near future, prices of goods and lines of products would oscillate, but the average price would be considered the crucial issue in the luxury market. LOUIS VUITTON IN THE JAPANESE MARKET The year 1977 saw the opening of the first stores of Louis Vuitton in Japan in Tokyo and Osaka. In the 1980s, with the economic boom in Japan, there was “Vuittonmania” in Japan. Around 20 million Japanese women (out of a population of 127 million people in Japan) owned a bag of the brand and each year, Louis Vuitton sold more than five million units of “Keepal” and “Speedy,” the classic leather monogram bags.29 The famous Malletier made more than a third of its profit in Japan. What had been the key to its successful strategy?
25 Miles Socha, “Vuitton, Dior to Lower Prices in Japan,” Women’s Wear Daily, February 12, 2008. 26 Miles Socha, “Vuitton, Dior to Lower Prices in Japan,” Women’s Wear Daily, February 12, 2008. 27 “The State of Luxury in Japan,” Carter Associates, http://carterassociates.net/aboutJapan/view_04_Luxury.html, accessed Feb 26 , 2008 28 Glenn Smith, “Luxury sector loses its recession-proof status,” Media, February 12, 2009, p. 19. 29 Phillipe Adam, “La passion japonaisede Louis Vuitton,” International Commerce, www.actu-cci.com, accessed July 9, 2007.
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The Entry into the Japanese Market Louis Vuitton was the first multinational luxury house to open its own shop-in-shops in Japan, without the help of a Japanese distributor. This strategy had become an efficient economic and commercial business model in the luxury market. In the 1970s and 1980s, foreign firms had manufactured and distributed their products by licensing. When Louis Vuitton decided to opt for a controversial strategy and to establish its own subsidiary, the company turned out to be a pioneer. It decided to export products from France to Japan. Kyojiro Hata had been the CEO of Louis Vuitton Japan for 28 years. Louis Vuitton’s headquarters’ management style meant strict control of the selective retail store network across the globe. Each subsidiary was, to a certain extent, extremely autonomous. The French headquarters had been relying on the Japanese business savoir-faire, believing Japanese managers to be more likely to make efficient market-driven decisions as they understood the local people. Louis Vuitton entered into the Japanese market at first through department stores with a single brand of its portfolio. The company offered its Japanese partners, like Seibu or Mitsukoshi, an interior design comparable to that found in its flagship stores in Paris. The purpose remained making a French luxury purchasing experience and controlling entirely the shop-in-shops (prices, products, sales teams, etc.). A few years later, in 1981, Louis Vuitton opened its first retail store in Namiki Dori, Ginza, in Tokyo. The company followed its expansion strategy and, by 2007, controlled 54 stores through a directly owned shop network in Japan.30 LVMH as a group had more than 250 stores in Japan. Some of them were stores opened as franchises during the last decade. New generations of shops opened in Nagoya, Osaka, Sapporo, Tokyo and elsewhere, revolutionizing the whole purchasing experience of luxury goods. The architecture of the stores had become part of the brand’s identity. A perfect illustration of this was the architecture of the Louis Vuitton building in Omotesando, Tokyo, built by Jun Aoki, which looked as if several trunks were piled up. Louis Vuitton had shifted towards a new approach in which the experience in a store would accord with the emotion brought out by the products. Louis Vuitton took advantage of the Japanese demand for high fashion. Japan had been, and remained, a source of creative ideas and trends. In a sense, Japan represented a fantastic laboratory to test new selling methods and to inaugurate innovative Louis Vuitton stores. Contrary to Europe, there were few rules and standards to follow in terms of urbanization and architecture. This enabled Louis Vuitton to design audacious and amazing stores like the ones in Ginza, Ometesando and Roppongi in Tokyo, or even one of the latest stores inaugurated in February 2007 in Nagoya’s Midland Square, just below the Toyota headquarters. The Japanese clientele were receptive to Louis Vuitton, as they were truly avid for new products and very demanding of the quality of products they bought. Strategic Approach Louis Vuitton had always been a trend-setting brand strategist in Japan, a country that revolved around tradition and culture. Since the designation of Jacobs as the artistic director of the brand, Louis Vuitton had successfully entered the Japanese ready-to-wear market. Jacobs had strived to combine his own artistic universe with the tradition and heritage of the brand. The designer had created a new energy and enthusiasm for each ready-to-wear runway collection, mixing tradition and innovation.
30 Phillipe Adam, “La passion japonaisede Louis Vuitton,” International Commerce, www.actu-cci.com, accessed July 9, 2007.
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Since 1995, the worldwide luxury market had been growing by 10 per cent each year.31 In 2002, the global economy faced a slowdown due to the recession caused by the September 11, 2001 terrorist attacks in the United States. The direct consequence was a decrease in sales, such as luxury shopping in duty free zones in international airports and prestigious luxury destinations like Tokyo’s Ginza Namiki Dori, the Place Vendôme in Paris and Madison Avenue in New York. The September 11th attacks had caused a major decline in tourist flows and in the luxury market. In Europe, foreign tourists accounted for 60 per cent of customers of luxury items.32 Louis Vuitton in Japan had to redefine its strategy because the sluggishness in the United States had an adverse impact on the purchasing power of the Japanese consumers as Japan was relying on export income from the United States. At that time, Louis Vuitton realized that it had to focus on local consumers rather than tourists. Luxury started to go local.33 Louis Vuitton reacted early to proceed with this major shift in strategy. The brand realized that for the past years it had been setting the trend as a brand leader, but that the guarantee of future growth would depend on adapting to and understanding local customers. To do so, the company tried to adjust its approach and products to reach local customers. A revelation came from the Japanese market. Limited editions: A new marketing strategy After Jacobs had seen an exhibition at the Fondation Cartier pour l’art contemporain in Paris by Takashi Murakami, Louis Vuitton decided to collaborate with the Japanese artist for its 2003 spring/summer collection. Takashi Murakami, who was known as the “Japanese Andy Warhol,” re-created a colourful pop version of Louis Vuitton’s monogram in 33 colours on a black and white background. In stores, Louis Vuitton’s handbags with smiling blossom designs became huge sellers in Japan. The strategy appeared to be a huge success for the leading luxury conglomerate LVMH, as the Murakami line increased Louis Vuitton’s profits by 10 per cent.34 The success was not only in the Japanese market but also in the European and American markets, which showed true admiration for Japanese culture. Following the massive success of the line, in 2003 and 2005 collaborations between Murakami and Jacobs resulted in the Monogram Cherry Blossom line, featuring a trendy motif inspired by the fruit of the cherry blossom — Japanese art wedded to Louis Vuitton’s perfection — and the Monogram Cerise line, with a new pattern that gave freshness and cheerfulness to the monogram. While announcing the exclusive Louis Vuitton store at the Murakami Exhibition in the Brooklyn Museum in April 2008, Jacobs had commented on their collaboration. “Our collaboration has produced a lot of work, and has been a huge influence and inspiration to many. It has been, and continues to be, a monumental marriage of art and commerce. The ultimate cross-over, one for both the fashion and art history books.”35 He had it spot on — it was indeed “commerce” and strategy, as Takashi Murakami had been the starting point of Louis Vuitton’s success in Japan.
31Claudia D’Arpizio, “Luxury goes local,” The Wall Street Journal Europe, www.bain.com/bainweb/home.asp, accessed May 1, 2004. 32 Ibid. 33 Ibid. 34 Ibid. 35 Sally Williams and Mona Sharf, “The Brooklyn Museum announces the inclusion of an exclusive Louis Vuitton store within the retrospective of Japanese artist Takashi Murakami,” www.brooklynmuseum.org, accessed March 21, 2008.
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The limits of limited editions For the past years, Louis Vuitton had boosted its sales with continuous limited editions in the Japanese market. Once again, in June 2008, Louis Vuitton had launched a major new accessory line called Monogram Ouflage, which combined the iconic brand’s monogram canvas with a new camouflage print designed by Takashi Murakami and Jacobs. It was unveiled at the pop-up Louis Vuitton shop opened at the Brooklyn Museum of Art. However, limited editions were under threat. The company had used them to market several lines of bags. In the end, the flood of mass-market interest would end up robbing the brand of some of its cachet and overdoing the profitable “limited edition” strategy would confuse consumers as they would no longer be able to differentiate between a real limited edition and a marketing ploy. Democratized luxury for all was good, but with precautions. Market dilution: A luxury brand is dead, a fashion brand is born How did the brand that had been synonymous with luxury and exclusivity grow while retaining its cachet? Though Louis Vuitton had been an enduring status symbol in Japan, it had to face a major challenge: brand dilution as it moved into offering new product lines. As a leader of the sector, the challenge was to continue growing in the Japanese market and still preserve the exclusivity and great quality the brand had always offered. There were two stages in luxury culture — the “show off” stage and the “fit in” stage — and Japan had already passed the two stages. The “fit in” stage was represented by Louis Vuitton. As an example, more than three-quarters of women in Tokyo of about twenty years of age possessed an item of the brand. This phenomenon was considered normal, as luxury goods symbolized membership of the “acceptable” group of society. Accordingly, mass expansion and mass distribution had become a real issue. In 2007, in the sulphurous book “Deluxe: How Luxury Lost Its Luster,” journalist Dana Thomas reported that 40 per cent of all Japanese owned a Louis Vuitton-monogrammed item. She compared Louis Vuitton’s expansive growth over the past decade to that of McDonald’s, suggesting that the “LV” logo had become almost as ubiquitous as the Golden Arches.36 These declarations damaged Louis Vuitton’s image. In addition, constant questioning over the origins of Louis Vuitton’s products and the repetition of limited editions over the past years had marked a new era for Louis Vuitton — an era characterized by disposable “it” bags with shelf lives of two fashion seasons at most. This climate seemed to be contrary to what was the essence of Louis Vuitton: tradition and longevity. Counterfeiting The LV-branded bags were priced high in Japan (see Exhibit 8) as in other countries. Therefore, the firm had to face challenges from fake bags. Louis Vuitton had been trying to battle against issues such as the falsification of the logo and market dilution. Since the end of the 1990s and the Asian Financial Crisis, there had been a flood of fake Louis Vuitton products coming from Seoul, Hong Kong, Tokyo and Los Angeles. Though China was the largest producer of Louis Vuitton counterfeited bags, South Korea was the largest producer in terms of high-quality bags. Most South Korean Louis Vuitton counterfeits were exported to Japan.
36 Dana Thomas, Deluxe: How Luxury Lost Its Luster, The Penguin Press, 2007.
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Louis Vuitton had been fighting this issue and remained optimistic. In 2001, at an International Herald Tribune conference in Paris, Christophe Girard, director of fashion strategy at LVMH, declared that when the economy is bad, consumers still wish to turn to luxury products, as their value is reliable and long- lasting. He added that “the quest for pleasure” did not fade away and “it even happens in war. People want to enjoy themselves.”37 This statement appeared to be accurate in Japan, which had been suffering from the Asian Financial Crisis and facing 10 years of economic slowdown, but in which women still had a “cult” for luxury brands. In 2000, Louis Vuitton sales in Japan had increased by 16 per cent, reaching ¥100 billion for the first time in the company’s history.38 However, Japanese consumers had been eager to buy Louis Vuitton bags at inexpensive prices. According to Hidehiko Sekizawa, the executive director of the Hakuhodo Institute of Life and Living in Tokyo, “Japanese shoppers have always been very fussy about quality. Now that the counterfeits are hard to distinguish from authentic products, they no longer mind buying fakes, even though they probably own a couple of authentic bags. They save the genuine articles for formal events like weddings and parties, and dinners and dates, and use counterfeits on rainy days, or to go to the supermarket for milk.”39 The Japanese laws regarding intellectual property had been modified in 1985 and had become similar to Western laws. These rules did not really diminish counterfeiting, which remained a gigantic issue in the following years. In 2008, a scandal went public. It was alleged that more than 90 per cent of the Louis Vuitton-branded products sold on the Japanese “Super Girls Auction” website (Girl-Oku) were counterfeit.40 The website, which targeted mobile phone users, was an auction site of Media Matrix Inc., a member company of the XAVEL group. Louis Vuitton reacted through the Union des Fabricants Tokyo (UDFT). A federal inspection was led in order to prove that the auction site had indeed broken the law. Following the investigation, there was a noticeable decline in sales due to Girl-Oku’s countermeasures, but the issue remained unsolved. Louis Vuitton’s Further Growth in Japan — Change in Management Even though there were doubts about future opportunities for Louis Vuitton in Japan, Kiyotaka Fujii, the new chief executive officer (CEO) of Louis Vuitton Japan, announced that this was not the case in December 2006. The designation of Fujii as the new CEO appeared to be the first change in the Japanese management team of the firm.41 Fujii, a 49-year-old businessman, had previous work experience in consulting and information technology. He had served as the director and an executive committee member of Quintiles Transnational Japan K.K., a leading pharmaceutical services organization providing professional services and information and partnering solutions to the pharmaceutical, biotechnology and healthcare industries. He had also worked at McKinsey & Co. at the New York headquarters. He had graduated from Tokyo University and had obtained an MBA from the Harvard Business School. His vision was to steer the Japanese subsidiary of Louis Vuitton to the next level, relying on the company’s long-term vision and high-quality business. When Yves Carcelles had revealed the appointment of the new CEO, he had pointed out that the person who was chosen as CEO had had to necessarily be Japanese with 37 Velisarios Kattoulas, “Counterfeiting bags of trouble,” Far Eastern Economic Review, March 21, 2002. 38 Ibid. 39 Ibid. 40 Kenji Toda, “Mobile-phone auction sites flooded with fake brand products,” Nikkei Business, August 20, 2008. 41 Koji Hirano, “Vuitton Sees Further Growth in Japan,” Women’s Wear Daily, December 6, 2006.
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a clear vision of Japanese culture. Fujii’s term of office was an absolute success. Among his remarkable acts, the creative collaboration with the Japanese architect Jun Aoki and the artist Takashi Murakami had resulted in smash hits, boosting Louis Vuitton’s sales in the market. He had also introduced Kabuki, or Japanese dance-drama, in Paris. Through the years, one of the strengths of the firm’s global strategy had been to take the best practices from certain cultures and implement them in selected markets. To continue to do so, Fujii would have to face the challenge of exporting the originality of Japanese artists and best practices internationally. Next steps for further growth After his designation as CEO of Louis Vuitton in Japan, Fujii announced that the priorities for the brand would be establishing an Internet business and expanding the range of Louis Vuitton’s products for children. Sales of smaller leather goods and other products, such as jewelry and eyewear had outstripped initial sales objectives. Fujii said that, “Ready-to-wear is another category to grow, and this communicates the message from Louis Vuitton to consumers and increases the brand value of Louis Vuitton. Business on the web is another possible approach to consumers.”42 The marketing strategy had been one of the key points of Louis Vuitton’s success in Japan. The brand was now expanding its strategy towards mid-size and smaller cities. By 2006, Louis Vuitton already had 52 stores and 40 shops-in-shops and was reconsidering its strategy in terms of adapting to Japanese demographic changes and rethinking the range of products offered. Despite changes in Japanese society, Louis Vuitton was still confident about its future. In 2006, an analyst from Mitsubishi UFJ Securities’ research division assessed that, “The Japanese market is not considered saturated yet; the strength of Louis Vuitton is its high recognition among people of wide generations, so opening more shops in middle-size cities makes sense. That’s the integrated power of the brand that includes product development and image management.”43 Louis Vuitton’s power was not about to fade away. CONCLUSION The after-shocks of the global recession were a threat to Louis Vuitton’s luxury business in Japan since its products were priced very high. There were signs that young Japanese women did not have the same vision as the previous generation. They were no longer eager to buy Louis Vuitton products. This represented a real change in the Japanese mindset and Louis Vuitton was already suffering the consequences. Japan had always been the luxury mass market symbol of Louis Vuitton’s golden age. Over the years, Louis Vuitton had been building its global strategy thanks to the experiences and lessons learned from Japan. In a gloomy economic context, the market was tending towards saturation, sales were declining, and competition was fiercer than ever. How could Louis Vuitton reinvent itself and regain what used to be its well-attested fame in Japan?
42 Koji Hirano, “Vuitton Sees Further Growth in Japan,” Women’s Wear Daily, December 6, 2006. 43 Ibid.
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Exhibit 1
LOUIS VUITTON MOËT-HENNESSY FINANCIAL HIGHLIGHTS (FINANCIAL YEAR 2008)
Key consolidated data
(EUR millions and percentage) 2008 2007 2006 Revenue 17,193 16,481 15,306 Profit from recurring operations 3,628 3,555 3,172 Net profit 2,318 2,331 2,160 Group share of net profit 2,026 2,025 1,879 Cash from operations before changes in working capital (1)
4,096 4,039 3,504
Operating investments 1,039 990 771 Total equity 13,887 12,528 11,594 Net financial debt (2) / Total equity ratio 28% 25% 29%
(1) Before income taxes and interest paid. (2) Net financial debt does not take into consideration the purchase commitments for minority interests included in other non-current liabilities.
Data per share
2008 2007 2006 Earnings per share (EUR) Basic group share of net profit 4.28
4.27 3.98
Diluted group share of net profit 4.26
4.22 3.94
Dividend per share Gross amount paid during the period (3) 1.60 1.60 1.40
(3) Excludes the impact of tax regulations applicable to the beneficiary. Source: Official Financial Report 2008, Louis Vuitton Moët-Hennessy website, published December 31, 2008, www.lvmh.com, accessed July 8, 2010.
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Exhibit 2
LOUIS VUITTON MOËT-HENNESSY, REVENUE BY BUSINESS GROUP (FINANCIAL YEAR 2008) (EUR MILLIONS)
Product Category 2008 2007 2006 Wines and spirits 3,126 3,226 2,994 Fashion and leather goods 6,010 5,628 5,222 Perfumes and cosmetics 2,868 2,731 2,519 Watches and jewellery 879 833 737 Selective retailing 4,376 4,164 3,877 Other activities and eliminations (66) (101) (43) Total 17,193 16,481 15,306
Source: Official Financial Report 2008, Louis Vuitton Moët-Hennessy website, www.lvmh.com,accessed July 8, 2009.
Exhibit 3
LOUIS VUITTON MOËT-HENNESSY, FASHION & LEATHER GOODS DIVISION 2008 FINANCIAL STATEMENTS
2008 2007 2006 Revenue (EUR millions) 6,010 5,628 5,222 Revenue by geographic region of delivery (%)
France 8 9 9 Europe (excluding France) 21 20 19 United States 19 20 21 Japan 20 22 26 Asia (excluding Japan) 25 23 20 Other markets 7 6 5 Total 100 100 100
Type of revenue as a percentage of total revenue (excluding Louis Vuitton)
Retail 47 49 50 Wholesale 44 38 36 Licenses 8 8 7 Other 1 5 7 Total 100 100 100
Profit from recurring operations (EUR millions)
1,927 1,829 1,633
Operating margin (%) 32.1 32.5 31.3
Number of stores Louis Vuitton 425 390 368 Fendi 180 160 135 Other brands 485 439 451 Operating investments (EUR millions)
311 246 319
Source: Official Financial Report 2008, Louis Vuitton Moët-Hennessy website, published December 31, 2008, www.lvmh.com, accessed July 8, 2009.
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Exhibit 4 LOUIS VUITTON MOËT-HENNESSY, FASHION & LEATHER GOODS DIVISION 2008 KEY FIGURES
Revenue and Profits from Recurring Operations
Millions of Euros
2006 2007 2008
Revenue 5,222 5,628 6,010 Profit from recurring
operations
1,633 1,829 1,927
Revenue by Geographical Region of Delivery in 2008
Investments in Millions of Euros
Fashion & Leather GoodsNumber of Stores
Source: Compiled using statistics from Louis Vuitton Moët-Hennessy website, www.lvmh.com, accessed December 31, 2008.
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Exhibit 5
LOUIS VUITTON SA — FINANCIAL DATA
Financial data are given in euros (millions)
12/2007 12/2006 % 12/2005 % 12/2004 % Number of months 12 12 12 12 Summarized Results 12/2007 12/2006 % 12/2005 % 12/2004 % Turnover 1,848 1,697 9 1,566 8 1,444 8 Export turnover 1,650 1,513 9 1,385 9 1,307 6
Wages and expenses 5 6 -17 5 20 5 0 Value added 688 676 2 618 9 578 7 Gross operating surplus 667 655 2 598 10 559 7 Operating income 637 659 -3 588 12 560 5 Financial result 491 456 8 462 -1 378 22 Exceptional result -5 -55 91 -8 -588 -50 84
Net income 866 819 6 815 0 650 25 Cash flow 919 892 3 841 6 706 19 Balance Sheet 12/2007 12/2006 % 12/2005 % 12/2004 % Net fixed assets 1,242 1,242 0 1,229 1 1,062 16 Net assets 1,297 1,315 -1 1,545 -15 1,495 3 Equity 2,187 2,197 -0 2,154 2 1,952 10
Long-term debt 1 3 -67 3 0 Current liabilities 286 291 -2 555 -48 513 8 Yearly investments 40 61 -34 46 Cash 12/2007 12/2006 % 12/2005 % 12/2004 % Net working capital 945 956 -1 927 3 889 4
Working capital requirements 946 957 -1 926 3 890 4 BFR overall turnover days 184 203 -9 213 -5 222 -4 Cash -1 -1 0 -1 Main Indicators (%) 12/2007 12/2006 % 12/2005 % 12/2004 % Profitability 46.89 48.25 -3 52.03 -7 45.03 16 Rate of value added 37.26 39.84 -6 39.43 1 40.01 -1 Solvency 286 291 -2 555 -48 513 8 Financial independence 86.14 85.96 0 77.66 11 76.32 2 Debt ratio 0.01 0.03 -67 0.15 -80 0.13 15
Source: Kompass International Neuenschwander SA website,www.kompass.fr/recherche.php?action=signin, accessed December 31, 2007. The original French version was translated into English.
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Exhibit 6
THE LEADING LUXURY BRANDS IN THE WORLD IN 2008
Rank Brand 2008 Brand Value in USD
(m.)
2008 Brand Value in Euros (m.)
Country of Origin
1 Louis Vuitton 21,602 16,718 France
2 Gucci 8,254 6,388 Italy
3 Chanel 6,355 4,918 France
4 Rolex 4,956 3,836 Switzerland
5 Hermès 4,575 3,541 France
6 Cartier 4,236 3,278 France
7 Tiffany & Co. 4,208 3,257 United States
8 Prada 3,585 2,775 Italy
9 Ferrari 3,527 2,730 Italy
10 Bulgari 3,330 2,577 Italy
11 Burberry 3,285 2,542 United Kingdom
12 Dior 2,038 1,578 France
13 Patek Philippe 1,105 855 Switzerland
14 Zegna 818 633 Italy
15 Ferragamo 722 559 Italy
Source: “2008 Leading Luxury Brands,” Interbrand, 2008, www.interbrand.com,accessed July 5, 2008.
Exhibit 7
TOP MULTINATIONAL LUXURY FASHION BRANDS — PERCENTAGE OF OVERALL REVENUE
FROM JAPAN IN TOTAL WORLD WIDE SALES (2005)
Baccarat 35%
Bulgari 26% Burberry 36% Coach 22% Hermes 25% Gucci Group 27% LVMH Group 15% Louis Vuitton(Fashion & Leather Goods) 30% Salvatore Ferragamo 27% Tiffany & Co. 20% Van Cleef and Arpels 33%
Source: “Japan is the world’s most concentrated source of revenue for luxury brands,” Japan External Trade Organization, May 2006,www.jetro.org/content/361 15, accessed February 18, 2008.
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Exhibit 8
LOUIS VUITTON BESTSELLING HANDBAGS IN JAPAN
Keepall 55 Speedy 35 The Alma Normande
The world’s most famous travel bag that dates back to the 1930s.
Price: $1,270.00
The LV Speedy is one of the most classic and easily recognizable LV bags.
Price: $725.00
Inspired by a shape invented by Gaston Vuitton in the 1930s, Alma is now a classic.
Price: $1,290.00 Keepall 55 Roses Multicolore Speedy Multicolore Tote Artist: Stephen Sprouse Year of Release: 2001 Price: $2,000.00
Artist: Takashi Murakami Year of Release: 2003 Price: $2,240.00
Artist: Takashi Murakami Year of Release: 2008 Price $1,200.00
Source: Nagoya franchisee of Louis Vuitton. Price has been converted at an exchange rate of ¥100 = US$1.
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4.
9B18M022
QUALTRICS: RAPID INTERNATIONAL EXPANSION Esther Tippmann and Sinéad Monaghan 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) [email protected]; www.iveycases.com. Copyright © 2018, Ivey Business School Foundation Version: 2018-01-31
In May 2015, Qualtrics opened the new office for its Europe Middle East and Africa (EMEA) regional headquarters in the heart of Dublin, Ireland. It had capacity for up to 300 people, although at that time Qualtrics employed only about 60 people in Ireland.1 Plans for global expansion were aggressive—to grow the business by many multiples and to fill the office within three years. Ryan Smith, the chief executive officer (CEO) of Qualtrics, had travelled to Dublin for this event. During his visit, he sought to discuss the approach to quickly building Qualtrics’s EMEA operations with Dermot Costello, the recently hired managing director for Ireland. It was critical to decide on the company’s next steps. COMPANY BACKGROUND Thirteen years after it was launched, Qualtrics, a U.S. software-as-a-service (SaaS) firm based in Provo, Utah, was continuing to experience significant and exciting change. Established in 2002, Qualtrics initially focused on building sophisticated, user-friendly online survey tools. After years of operating the company on little capital and steady growth in revenue, and despite external economic effects including the U.S. financial crisis of 2007/08, Qualtrics’s expanded product offering experienced increasing traction in the market. At this time, many cash-tight companies started to replace their costly market research contracts with cost-effective, do-it-yourself online surveys. Seeing tremendous growth potential, the founders, brothers Ryan and Jared Smith, together with their father, Scott M. Smith, and family friend, Stuart Orgill, took on US$70 million2 in venture capital funding in 2012 to spur growth.3 Qualtrics, like many other digital platform companies, had recognized a multibillion-dollar global opportunity that the founders were keen to capture. As a result of its continued success, Qualtrics raised an additional $150 million in fall 2014 to accelerate growth, particularly in international markets.4 With the abundant opportunities that international markets presented, Qualtrics’s management was excited but equally concerned about balanced and sustained growth. On the one side, management was conscious of the economics of many software and online-service markets. In these markets, the mantra was to prioritize firm growth over margins and cost structure—to “grow fast or die slow.”5 However, the company was unwilling to accept that it needed to choose between aggressive growth and maintaining cash-flow positivity. Qualtrics was equally committed to both goals. At the same time, Ryan was aware of the dangers of overly aggressive expansion after the company lived through the dot-com tech bubble of the early 2000s:
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We’ve seen companies “fuel the jet.” They put the gas line in the jet [secure major funding from venture capitalists] and they’re paying for the gas and they let it fly. Hopefully, one day, it’ll fly on its own and you can pull the gas line out. But if they got to hold the line out before that thing is ready to fly, it all falls. We’ve seen that in the dot-com bubble.6
Indeed, Qualtrics needed to make some difficult and far-reaching decisions regarding its international expansion, especially in relation to its expansion in the EMEA region and the expansion of its regional headquarters in Dublin, Ireland. The company principals wanted to play their cards right by focusing on the most lucrative opportunities within the EMEA region. Also, management, including Costello, was aware of the immense task ahead to quickly develop its regional headquarters in Dublin, Ireland, from which most of its EMEA expansion would be driven and coordinated. INDUSTRY BACKGROUND The versatility and disruptive nature of online survey software, delivered as cloud-based software-as-a- service (SaaS), enabled firms to compete, and indeed, disrupt different markets. An industry born within the digital age, online survey software provided an electronic platform for survey development, use, and analysis for market research, product testing, and customer satisfaction.7 Qualtrics had chosen to focus on three markets: market research, customer experience, and employee insights (see Exhibit 1).8 The market research industry was fundamentally premised on enabling firms to acquire additional information and insights on their target market; consumer preferences for products or product innovations; and potential needs of firms’ existing, or future, customer base. On the other hand, customer experience management related to the process by which firms developed an understanding of consumers’ perception of their product and/or service to build a more extended relationship with their consumer base, including operationalizing responses to customer feedback. Finally, employee insights allowed firms to gauge the level of engagement among their employees, evaluate and review their performance, and acquire insights into potential opportunities for growth and development. These three markets showed evidence of strong growth as firms sought to become more data-driven in their decision making by integrating technological methods to gather, process, and analyze data in a more comprehensive and instantaneous manner. Online methods of collecting data facilitated the capture of a broader respondent base than was feasible with existing manual methods, especially as the digital revolution had led to a greater use of mobile devices to complete surveys online. Moreover, all of these markets could be disrupted by new technologies, as many of these tasks were traditionally performed by administrative functions or outsourced to expensive third-party providers. In this respect, Ryan estimated that companies spent $30 billion annually on outsourcing research projects to consulting firms.9 Depending on the market, Qualtrics faced different competitors. In one sense, Qualtrics had no direct competitors because no other company offered the full suite of products that could bring together insights from multiple internal functions to deliver holistic business insights that cut across market research, employee insights, and customer experience. In another sense, Qualtrics had many competitors because it was competing on three separate fronts: customer experience, employee insights, and market research. Although Qualtrics was aware of competitors, its leadership was clear that they did not pay much attention to them and remained focused on forging their own road.
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Page 3 9B18M022 GROWTH OF QUALTRICS The roots of Qualtrics dated back to the 1990s, when Scott M. Smith, then a professor of marketing at Brigham Young University, became passionate about using the Internet to speed up market research10 (see Exhibit 2). Ryan, in his early twenties at the time, started to work on developing his father’s idea in the basement of the family home.11 Their goal was simple: to make sophisticated research simple using an online survey product.12 In pursuit of this goal, they crammed racks of servers into closets of their home, resulting in frequent power outages, until eventually they bought a generator on eBay and located it in their garden. The current management imagined that many candidates, who were invited for an interview with Qualtrics in the early days of operation, never appeared, spooked by the odd-sounding instruction to walk around the house to the basement door. Despite their idiosyncratic office space, by 2006 Qualtrics was generating $1.3 million in revenue with 15 staff while still working from the basement of the Smith home.13 These early years and the experience of working with little capital embedded a deep sense of frugality and “scrappiness” in the company.14 The Qualtrics Product In terms of its product, the Qualtrics offering was renowned for its sophistication, ease of use, and functionality. Initially, Qualtrics focused on a niche market—universities—which, in many ways, was a result of Scott Smith’s personal experience. This target market allowed Qualtrics to build a top-notch online survey product by responding to the preferences and functionality requirements of demanding users— academic researchers. Although universities remained an important segment for Qualtrics, it now served the three markets outlined above: market research, customer experience, and employee insights. Its SaaS offering was positioned as an insights platform, built around value propositions that helped businesses gather data that would enable better business decisions. Most of Qualtrics’s revenues came from business customers, including such major companies as JetBlue, GE, Yahoo, and healthcare.gov.15 Ryan, the CEO of Qualtrics, emphasized that the advantage of the company’s offering related to it being an easy- to-use platform that didn’t require significant training or support, thereby enabling all users to gather valuable insights for their organizations. In addition, one of his favourite selling points was the product’s capacity to provide rapid-response insights or “fast data” to inform companies’ decision making, instead of an overreliance on backward-looking approaches such as “big data.”16 The strategy seemed to pay off. Qualtrics started to gain more traction in markets than its competitors and generated substantial growth in revenues.17 In 2015, Qualtrics had more than 7,000 clients running an average of more than 2 million surveys a day on the platform, and the company was cash-flow positive.18 Having focused primarily on its U.S. expansion, Qualtrics opened additional offices in Washington, DC (in 2014) and Dallas (in 2015). Qualtrics’s Organizational Culture Qualtrics management believed that it had created a special organization. Its unique characteristics included its customer orientation and sales culture.19 The goal was to have everyone focused on the customer. For example, during the early days of the company, if a customer called for assistance and had to wait longer than three rings for the phone to be answered, a red siren flashed and low-pitched bells rang in the office, alerting the entire company to drop what they were doing to pick up the phone and help a customer.20 The workplace also had a distinctly casual atmosphere, where employees wandered around in jeans and T-shirts,21 and employees described the organization as “fun,” “energizing,” and “stylishly nerdy.”22 At the same time, Qualtrics was extremely results-driven with a heads-down, hard-working approach.23
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Page 4 9B18M022 Ryan was a great believer in radical transparency, and ensured that vast information on critical decisions and day-to-day operations were accessible to everyone within the organization.24 This transparency included, for example, visibility of employee performance, allowing staff to approach top performers to learn from their expertise. On the Qualtrics intranet, available to any company employee, each team and department listed its quarterly goals; and each individual, from the CEO to the newest intern, listed their weekly activities and reported on how they had done the previous week.25 Hiring talented people with a tight person-organization fit was critical to Qualtrics management to ensure a high level of brainpower was available within the organization to work out any business challenge or problem.26 Although Ryan was not concerned about the culture of Qualtrics changing as the firm expanded, he wanted to ensure that every decision made within the company bettered the organization.27 Given the rapidness of change in the technology industry, Ryan also knew that Qualtrics needed to remain entrepreneurial and innovative: “We were successful in the basement, we built a profitable company that’s valued over a billion dollars. . . . But we know that none of that’s going to matter anymore. How are we going to compete in the future? Our business is really like many start-ups in a row.”28 As Qualtrics focused on international expansion, embedding entrepreneurship in its international offices to the same degree as it was part of the culture at the headquarters in Utah29 was integral to delivering on its long-term vision. Qualtrics’s Sales Model The heart of Qualtrics was its engineering and development department where new products were innovated. In addition, Qualtrics had developed a large, high-performing, and proactive sales organization that was responsible for much of the company’s progress thus far.30 Indeed, management believed that Qualtrics succeeded first and foremost because of a great product and an unparalleled sales force.31 Qualtrics largely used an inside-sales model, whereby salespeople located in the organization’s offices engaged remotely with the customers over the phone. This cost-effective approach originated out of necessity during the early years of Qualtrics when there were insufficient funds for travelling to meet with customers face to face.32 Although Qualtrics had an effective inside-sales machine and trained young, motivated graduates into their sales roles, the reliance on an inside-sales model could face limitations when dealing with large businesses for high-value and more complex enterprise deals, where personal interactions were critical to closing deals. Qualtrics management was also aware that many competitors invested in hiring seasoned field sales executives and that its inside-sales model might need adaptation when serving international markets on a larger scale and with greater geographic scope.33 Qualtrics Funding In 2006, Qualtrics moved into a more conventional office space in Provo. In light of steady revenue growth, Ryan convinced his brother Jared to join the company in 2009 to oversee the engineering and product efforts. It wasn’t an easy task, as it required Jared, acclaimed to be one of the elite engineers in Silicon Valley,34 to quit a senior high-powered job at Google where he had previously helped in setting up the Europe Middle East and Africa (EMEA) and Asia-Pacific (APAC) operations.35 Jared had, for example, worked for several years in Beijing to help run the Google China office.36 During this period, Ryan also warmed to the idea of seeking venture capital funding to support Qualtrics’s next growth phase. Pursuing venture capital funding was a far-reaching decision for the four founders, who had treated their equity as gold and strongly preferred to maintain their financial and operational independence.37 Moreover, as the company was not necessarily in need of cash, this decision altered its approach to seeking investment. In
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Page 5 9B18M022 fact, Qualtrics was in such a strong position that it had its choice of experienced investors who would act as a sounding board for major decisions.38 In 2012, Qualtrics signed a deal with Accel Partner’s Ryan Sweeney (whom Ryan Smith had known for three years), and Sequoia Capital’s Bryan Schreier (whom Jared had known for seven years and was part of the team that had set up and scaled Google’s EMEA operations).39 Both Ryan Sweeney and Schreier became Qualtrics board members. The two venture capital firms offered to invest $100 million, but Qualtrics ultimately decided to scale it back to $70 million. To further accelerate growth, Qualtrics raised an additional $150 million in fall 2014, led by Insight Venture Partners, Accel Partners, and Sequoia Capital. This deal valued Qualtrics at more than $1 billion. RAPID INTERNATIONAL EXPANSION Ryan had a strong vision of Qualtrics becoming a global firm.40 However, in 2013 only 3 per cent of revenues came from outside the United States, with 10 per cent of Qualtrics customers located in Europe.41 Before Qualtrics expanded to Europe, multilingual sales reps would work European hours in the Provo headquarters, starting their sales duties early in the morning to bridge the time zone differences between the United States and Europe. This model followed Qualtrics’s philosophy of “nail it, then scale it,” so when the decision was made to expand internationally, there was already a strong base group of customers and referrals ready to go. Initially, Qualtrics opened a small office in Dublin in fall 2013. Dublin was an attractive location for Qualtrics because of the city’s technology ecosystem, the availability of a multilingual and well-educated workforce, and its proven track record as an EMEA regional headquarters location for technology firms such as Google, Facebook, LinkedIn, and Twitter.42 Believing in the “nail it, then scale it” model, the Dublin office initially served as an experiment, with one person working from the cheapest office that Qualtrics could find to prove the potential in the EMEA market. Around this time, Costello, a seasoned executive experienced in developing regional operations for software firms, was hired to oversee this expansion. Similarly, John D’Agostino, an experienced executive in growing and leading international sales operations, was hired as executive vice president of Global Sales at headquarters. The Dublin office quickly grew, so much so that it ran out of space! In May 2015, about 20 months after first locating to Dublin, Qualtrics Dublin moved into a large office in a prime city centre location. 43 At this time, Qualtrics employed 700 people, most of them at the Provo headquarters,44 and had 60 people working in the Dublin offices. Both the Provo and Dublin offices were ready to scale up: wide expanses of open floor space were ready to be filled with new hires.45 The Dublin office had capacity for 300 employees.46 Although Dublin was, thus far, the only international Qualtrics office, Qualtrics management saw opportunities beyond the EMEA region. One of its next moves, for example, was to set up an office in Sydney, Australia.47 At this time, Ryan mentioned: “I feel we’re only 10% of where we can go”48 and it was his intention to “go big.”49 Qualtrics was in “hyper-growth mode”50 and ready to scale and grow aggressively internationally. Ryan and Costello weren’t interested in cautious and slow international growth, typical for many other firms. Rather, they wanted to capture the potential illustrated by the Dublin office and internationalize across the EMEA region at a highly accelerated pace. It was their target for EMEA to generate 30 per cent of total revenue in five years, which would require a yearly growth by many multiples. Ryan was committed to taking a “big bet.”51
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Page 6 9B18M022 THE NEXT STEPS It was now Costello’s task to deliver on these bullish targets for the EMEA region, and he knew that a clever approach was needed to achieve these goals. A couple of decisions had to be made. By May 2015, the Dublin office performed sales (mostly inside sales and field sales) and support activities, and it relied on the U.S. headquarters to supply the other value chain activities, such as product engineering, localization, marketing, and financial/legal undertakings. However, it seemed that the existing structure could quickly become inadequate. To support such a significant EMEA business, a largely self-sufficient European business would be required, whereby Dublin was the hub with satellite offices in selected countries across the region.52 This model raised the question of which value chain functions Costello should prioritize in developing and the optimal time for building out these functions. For example, although Qualtrics had started to localize its software for some European markets, as expansion broadened, more country-localized versions needed to be added. Doing so involved not only translation challenges but also technical adjustments. For example, within the online platform, tailoring the system to a European audience required specific additions, such as ensuring the appropriate punctuations for decimal-denominated numbers and Microsoft Excel integrations. Within the current model, such localization requests needed to be sent to headquarters, as was the case for marketing, legal, and finance support. Given the growth of the business in EMEA, these requests became more frequent. Dublin time was seven hours ahead of the time in Provo, Utah, thereby requiring extensive efforts to manage the time zone differences. Another activity was recruitment, which was currently handled by a local external provider. However, given the importance of recruiting the appropriate talent (and much of it in a short time period), questions arose about whether this hiring should be performed in-house. Yet, doing so would require significant investment and diverting resources from building out the sales team, which was ultimately the key driver for revenue generation. Questions also surrounded the scalability of an intense on-boarding program that often saw new hires spending some time in the Provo offices. Also, when setting up the EMEA headquarters, Qualtrics saw the value in experimenting with different country markets, using small-scale efforts initially to gauge the receptiveness of various country markets to its offering. Costello and his team also had a feeling that large markets and countries that were early adopters of technology would be high-potential opportunities. They noticed that the EMEA market was generally receptive; however, certain countries seemed to be easier to crack than others, and Qualtrics saw early wins from its initial efforts. In addition, certain countries were sensitive about data security and showed some reservation toward SaaS offerings, while customers in other countries were price-sensitive and hesitant to pay price premiums. To effectively allocate resources, a more selective approach was required that prioritized certain markets. This approach would allow Costello to focus resources and build sales and support teams for countries that showed the greatest potential. The issue was how to prioritize this approach to ensure the most lucrative markets were selected first (see Exhibit 3 for a list of some countries and indicators). Also, certain urban areas such as London (United Kingdom) seemed particularly attractive, given some significant customer wins and the presence of many large firms within a tight geographic radius. Decisions also needed to be made in relation to the company’s go-to-market approach. For example, in Eastern European markets, the Qualtrics pricing model, positioned in the middle to upper market, was perceived by many companies as uncompetitive, leading to questions of adaptation. Moreover, if Qualtrics envisioned larger and more complex deals with enterprise customers, would it be sufficient to rely mostly on a young, inside sales team, or would it be worthwhile to hire more seasoned sales reps and open offices across Europe to avoid time-consuming travel between Dublin and the European locations?
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Page 7 9B18M022 Last but not least, retaining the entrepreneurial culture was paramount, including, in particular, the entrepreneurial “scrappiness” and “self-service” culture that was at the heart of Qualtrics. Yet, transitioning toward a multinational corporation would increase not only the scale of the business but also its internal complexity, which could hamper the flexibility, nimbleness, and agility needed to continuously recognize and exploit opportunities. This internal complexity also raised the question of how these entrepreneurial cultural values could be deeply embedded within a rapidly growing EMEA business, where structures and processes needed to be developed to grow the business and integrate a considerable number of new hires. As Ryan and Costello celebrated the opening of their new office in Dublin, Costello was highly cognizant that he needed to quickly decide on and execute Qualtrics’s next steps to pave the way for delivering on the ambitious growth targets for the EMEA region.
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Page 8 9B18M022
EXHIBIT 1: QUALTRICS’S TARGET MARKETS
Source: “Customer Experience,” Qualtrics, 2016, accessed January 15, 2017, https://www.qualtrics.com/customer- experience/.
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EXHIBIT 2: QUALTRICS’S NATIONAL AND INTERNATIONAL EXPANSION
Source: Created by the case authors.
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EXHIBIT 3: COUNTRY INDICATORS FOR QUALTRICS’S EXPANSION PLANS (2014)
United Kingdom
DACH (Germany, Austria, Switzerland)
France Spain Italy Benelux (Belgium, Netherlands, Luxembourg)
Nordics (Sweden, Denmark, Norway)
Eastern Europe (Poland, Czech Republic, Slovak Republic)
MEA (South Africa, United Arab Emirates, Israel)
GDP (US$ trillions) 2.900 1.670 2.800 1.300 2.100 0.492 0.472 0.284 0.354 GDP growth rate (%) 3.07 1.41 0.64 1.36 0.09 0.02 0.02 0.03 0.03 Ease of doing business rank 10 26 38 52 65 41 9 56 33
Early traction (early adopter of Qualtrics offering)
Fast Slow Fast Average Average Fast Fast Slow Average
Attitude toward SaaS (especially in relation to data security)
Positive Sensitive on data security Positive Positive Sensitive on data security
Positive Positive Average Average
Price-sensitivity (willingness to pay a price premium)
Solid Solid Solid Solid Solid Solid Solid Price sensitive Price sensitive
European Union membership No
Switzerland is not an EU member
Yes Yes Yes Yes Yes Yes No
Euro currency No Switzerland does not use the Euro
Yes Yes Yes Yes No Only Slovak Republic
No
Typical flight time (Dublin – Capital)
1 hour, 5 mins
2 hours, 8 mins
1 hour, 28 mins
2 hours, 18 mins
2 hours, 51 mins
1 hour, 28 mins
2 hours, 32 mins
2 hours, 47 mins
7 hours, 52 mins
Note: GDP = gross domestic product; SaaS = software as a service; unless otherwise indicated, the information indicated for this sub-region refers to the average of the included countries. Source: Created by the authors using: “World Bank Databank,” The World Bank, 2017, accessed January 16, 2017, http://data.worldbank.org/indicator/NY.GDP.MKTP.CD; “World Bank Databank,” The World Bank, 2017, accessed January 16, 2017, http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG; Doing Business, Understanding Regulations for Small and Medium Enterprises (Washington, D.C.: World Bank), 2013, accessed January 15, 2017, www.doingbusiness.org/reports/global-reports/doing- business-2014; “Travel Math Calculator,” Travel Math, accessed January 15, 2017, www.travelmath.com/; information provided by Qualtrics management.
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Page 11 9B18M022 ENDNOTES
1 Ryan Smith, chief executive officer, Qualtrics, talk at office opening in Dublin, May 21, 2015. 2 All currency amounts are expressed in U.S. dollars. 3 “America’s Most Promising Companies,” Forbes, 2013, accessed July 18, 2016, www.forbes.com/companies/qualtrics/. 4 George Anders, “Qualtrics’ Ambitions Don’t Stop with $150 Million in Funding,” Forbes, September 24, 2014, accessed July 18, 2016, www.forbes.com/sites/georgeanders/2014/09/24/qualtrics-ambitions-dont-stop-with-150-million-in-funding /#583910047b34. 5 Eric Kutcher, James Manyika, Olivia Nottebohm, and Kara Sprague, Grow Fast or Die Slow: How Software and Online- Services Companies Become Billion-Dollar Giants, McKinsey & Company, February 2014. 6 Smith, op. cit. 7 IBIS World, Market Research in the US: Market Research Report, 2016. 8 “Welcome to the Qualtrics Insight Platform,” Qualtrics, 2016, accessed July 18, 2016, https://www.qualtrics.com/. 9 Smith, op. cit. 10 Victoria Barret, “Qualtrics: Tech’s Hidden Gem in Utah,” Forbes, May 15, 2012, accessed July 18, 2016, www.forbes.com/sites/victoriabarret/2012/05/15/qualtrics-techs-hidden-gem-in-utah/#28ca272b199e. 11 Ibid. 12 Smith, op. cit. 13 Barret, op. cit. 14 “Qualtrics Culture,” YouTube video, 2:24, posted by Qualtrics, July 29, 2013, accessed July 18, 2016, https://www.youtube.com/watch?v=jwyqR39D2cg; Smith, op. cit. 15 “Qualtrics Customers,” Qualtrics, 2017, accessed January 15, 2017, https://www.qualtrics.com/customers/. 16 Anders, op. cit. 17 Barret, op. cit. 18 Smith, op. cit. 19 “Qualtrics Culture,” op. cit. 20 Barret, op. cit. 21 Hamish McKenzie, “Why Provo’s Qualtrics Took $70m It Didn’t Even Want.” Pando, July 26, 2013, accessed July 18, 2016, https://pando.com/2013/07/26/why-provos-qualtrics-took-70m-it-didnt-even-want/. 22 “Qualtrics Culture,” op. cit. 23 McKenzie, op. cit. 24 “Qualtrics Culture,” op. cit. 25 Smith, op. cit. 26 Ibid. 27 Ibid. 28 Ibid. 29 “Qualtrics Culture,” op. cit. 30 Maryanna Quigless and Jonathan Levav, Qualtrics: Bootstrapping Growth (Stanford, CA: Stanford Graduate School of Business, 2014). Available from Ivey Publishing, product no. SM222. 31 McKenzie, op. cit. 32 James Lattin, Kirk Bowman, and Maryanna Quigless, Qualtrics: Scaling an Inside-Sales Organization (Stanford, CA: Stanford Graduate School of Business, 2014). Available from Ivey Publishing, product no. E503. 33 Ibid. 34 Derek Andersen, “The Story behind Qualtrics, the Next Generation Enterprise Co.,” TechCrunch.com, March 2, 2013, accessed July 18, 2016, https://techcrunch.com/2013/03/02/the-story-behind-qualtrics-the-next-great-enterprise-company/. 35 Barret, op. cit. 36 McKenzie, op. cit. 37 Quigless and Levav, op. cit. 38 McKenzie, op. cit. 39 Ibid. 40 Smith, op. cit. 41 Quigless and Levav, op. cit. 42 Smith, op. cit. 43 Ibid. 44 Ibid. 45 McKenzie, op. cit. 46 Smith, op. cit. 47 Anders, op. cit. 48 Ibid. 49 Barret, op. cit. 50 “Qualtrics Tour: Not Your Average Office,” YouTube video, 5:28, posted by Qualtrics, July 16, 2015, accessed July 18, 2016, https://youtu.be/5qYKKzuQds8. 51 Smith, op. cit. 52 Anders, op. cit.
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5.
9B15M085 NORA-SAKARI: A PROPOSED JV IN MALAYSIA (REVISED) R. Azimah Ainuddin wrote this case under the supervision of Professor Paul Beamish solely to provide material for class discussion. Revised (2015) with the assistance of Dwarka Chakravarty. 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) [email protected]; www.iveycases.com. Copyright © 2015, Richard Ivey School of Business Foundation Version: 2019-04-10 On Monday, March 11, 2013, Zainal Hashim, vice-chairman of Nora Holdings Sdn Bhd1 (Nora), was thinking about the Friday evening reception that he had hosted at his home in Kuala Lumpur (KL), Malaysia, for a team of negotiators from Sakari Oy2 (Sakari) of Finland. Nora was a leading supplier of telecommunications (telecom) equipment in Malaysia while Sakari, a Finnish conglomerate, was a leader in the manufacture and deployment of mobile broadband network infrastructure. The team from Sakari was in KL to negotiate with Nora the formation of a joint-venture (JV) between the two telecom companies. This final negotiation would determine whether a JV agreement would materialize. The negotiation had ended late Friday afternoon, having lasted for five consecutive days. The JV, if established, would be set up in Malaysia to manufacture and commission 4G (fourth generation) mobile network equipment to meet the needs of the telecom industry in Malaysia and in neighbouring countries, particularly Indonesia and Thailand. While Nora would benefit in terms of technology transfer, the venture would pave the way for Sakari to acquire knowledge and gain access to the markets of Southeast Asia. The opportunity emerged two and half years earlier when Peter Mattsson, president of Sakari’s Asian regional office in Singapore, approached Zainal3 to explore the possibility of forming a cooperative venture between Nora and Sakari. Mattsson said:
In the next five years, we expect over 100 per cent mobile network infrastructure growth in Asia, compared to worldwide growth of about 60 per cent a year. We expect mobile broadband (4G) to be the fastest growing segment in Asia, accounting for 40 per cent of all mobile network traffic by 2015. Mobile broadband network project revenues can range from a hundred million to several billion euros. In Malaysia, Thailand, Indonesia, and China, such projects are currently approaching contract stage. Thus it is imperative that Sakari establish its presence in this region to capture a share in the market.
1 Sdn Bhd is an abbreviation for Sendirian Berhad, which means private limited company in Malaysia. 2 Oy is an abbreviation for Osakeyhtiot, which means private limited company in Finland. 3 The first name is used because the Malay name does not carry a family name. The first and/or middle names belong to the individual and the last name is his/her father’s name.
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The large potential for mobile broadband networks was also evidenced in the low penetration rates for most Southeast Asian countries. In 2011, mobile broadband penetration rates for Indonesia, Thailand, Malaysia and the Philippines ranged from three to 30 connections per 100 people compared to the rates in Japan, Finland, United States and Sweden, which exceeded 75 connections per 100 people. THE TELECOM INDUSTRY IN MALAYSIA Telekom Malaysia Bhd (TMB), the national telecom company, was given the authority by the Malaysian government to develop the country’s telecom infrastructure. With a paid-up capital of RM2.4 billion,4 it was also given the mandate to provide telecom services that were on par with those available in developed countries. In 2013, Malaysia had one dominant fixed line operator — TMB and three major mobile operators — Maxis, Celcom, and DiGi, all three of whom had been awarded 1800 MHz (Mega Hertz) wireless 4G spectrum licenses by the government. Maxis was the first to launch its 4G LTE (Long Term Evolution) service in 2013, followed by Celcom, and DiGi. TMB was also looking to move into the wireless 4G LTE space in order to increase coverage and quality of its nationwide broadband service. It planned to use a block of 850 MHz spectrum that it had licensed in 1998 and aimed to have one million subscribers on its wireless LTE network by 2017. Use of the lower frequency 850 MHz band would improve geographic coverage, and entail reduced TMB investment in cell sites relative to the competition. As the nation’s largest telecom company, TMB’s operations were regulated through a 20-year license issued by the Ministry of Energy, Telecommunications and Posts. In line with the government’s Vision 2020 program, which targeted Malaysia to become a developed nation by the year 2020, there was a strong need for upgrading the telecom infrastructure in rural areas. In his statement in TMB’s 2013 Annual Report, the Group CEO said:
2014 will also see TM moving into the LTE space as the Group continues with its plan to expand its wireless broadband services, especially in under-served areas, and complementing TM’s existing suite of fixed broadband services. Providing mobility solutions to TM customers is a natural progression and is in line with the industry evolution towards true convergence, not just from a technology or device perspective, but more importantly from a customer experience point of view, in the delivery of end-to-end broadband and data services.
Although TMB had become a large national telecom company, it often lacked the expertise and technology to undertake massive infrastructure projects. In several cases, local telecom companies would be invited to submit their bids for a particular contract. It was also common for these local companies to form partnerships with large multinational corporations (MNCs), mainly for technological support. For example, Pernas-NEC, a JV company between Pernas Holdings and NEC, was one of the companies that had been successful in securing large telecom contracts from the Malaysian authorities. NORA’S SEARCH FOR A JV PARTNER In August 2012, TMB called for tenders to bid on a two-year project worth RM1 billion for building an LTE radio access network in various parts of the country. The project involved deploying cell sites (towers) comprising antennae, amplifiers, LTE base stations and switches, laying fiber optic cable to connect cell sites with the fixed broadband network, and implementing network planning and optimization software. See Exhibit 1 for a simplified representation of a 4G LTE (and mobile broadband) network.
4 RM is Ringgit Malaysia, the Malaysian currency. As at March 11, 2013, US$1 = RM3.11.
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With peak speeds of up to 300 Mbps (Megabits per second), 4G LTE networks were about five times faster than 3G networks. (See Exhibit 2 for a comparison of 1G, 2G, 3G, and 4G LTE mobile networks). Each LTE cell tower could potentially support twice as many simultaneous network users (64 to 128) as a 3G tower (32 to 64). Nora was interested in securing a share of the RM1 billion contract from TMB and more importantly, in acquiring the knowledge in LTE technology from its partnership with a telecom MNC. During the initial stages, when Nora first began to consider potential partners in the bid for this contract, MNCs such as Samsung and NEC seemed appropriate candidates. Nora also had the experience of long-term working relationships with Japanese partners, including a fiber optic joint venture with NEC, and a five-year technical assistance agreement with Samsung to manufacture telephone handsets. Alcatel-Lucent and Ericsson were not considered, as they were already involved with other local competitors. Subsequent to Zainal’s meeting with Mattsson, he decided to consider Sakari as a serious potential partner. He was briefed about Sakari’s SK4LTE, a 4G LTE platform that was based on an open IP (Internet Protocol) centric and technology neutral architecture, which enabled the use of standard components, standard software development tools, and standard software languages. The core of its platform — the SK10 base station—was an industry benchmark in size, spectrum flexibility, data capacity, and energy consumption. The system was modular, and its software could be upgraded to provide new services and applications and could interface easily with new network equipment, thus providing the assurance of “future proofing.” This was a very attractive feature of the SK4LTE as it would facilitate development and implementation of advanced wireless systems. Mattsson had also convinced Zainal and other Nora managers that although Sakari was a relatively large player in mobile broadband networks, these networks were easily adaptable, and could cater to densely populated urban areas as well as geographically dispersed rural needs. Nora was also concerned that Sakari would be less willing to provide custom-made products and would tend to offer standard products that, in some aspects, were not consistent with the needs of the customer. Apparently, despite Sakari’s larger size and global 4G LTE footprint, compared to that of some of the other MNCs, Sakari was prepared to work out customized products according to TMB and Nora’s needs. Mattson pointed to the mobile network equipment JV manufacturing facility that Sakari had established in Brazil to cater to the needs of the local market and other Latin American countries, as an exemplar of what could be done in Malaysia. Prior to the March 2013 meeting, 20 meetings had been held in KL or Helsinki to establish relationships between the two companies. Each side had invested no less than RM4 million in promoting the relationship. Mattsson and Ilkka Junttila, Sakari’s representative in KL, were the key people in bringing the companies together. (See Exhibits 3 and 4 for brief backgrounds on Malaysia and Finland respectively.) NORA HOLDINGS SDN BHD Nora was one of the leading companies in the telecom industry in Malaysia. It was established in 1975 with a paid-up capital of RM2 million. Last year, the company recorded a turnover of RM640 million. Nora Holdings consisted of 35 subsidiaries, including two publicly listed companies: Multiphone Bhd, and Nora Telecommunications Bhd. Nora had 5,545 employees, of which 923 were categorized as managerial (including 440 engineers) and 4,622 as non-managerial (including 484 engineers and technicians). Since the inception of the company, Nora had secured two cable-laying projects. For the latter project worth RM500 million, Nora formed a JV with two Japanese companies, Sumitomo Electric Industries Ltd.
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(held 10 per cent equity share) and Marubeni Corporation (held five per cent equity share). Nora also acquired a 63 per cent stake in a local cable-laying company, Selangor Cables Sdn Bhd. Nora had become a household name in Malaysia as a telephone manufacturer. It started in 1980 when the company obtained a contract to supply telephone sets to the government-owned Telecom authority, TMB. The RM130 million contract lasted for 15 years. In 1985 Nora secured licenses from Siemens and Nortel to manufacture telephone handsets and subsequently developed its own telephone sets — the N300S (single line), N300M (micro-computer controlled), and N300V (hands-free, voice-activated) models. Upon expiry of the contract as a supplier of telephone sets to TMB, Nora suffered a major setback when it lost a RM32 million contract to supply 600,000 N300S telephones. The contract was instead given to a Taiwanese manufacturer that quoted a lower price. Subsequently, Nora moved towards the high-end feature phone domestic market, selling about 6,000 high-end sets per month, in Malaysia. Nora had also ventured into the export market with its feature phones. The foreign markets were very competitive and many manufacturers already had well-established brands. With the rise in mobile telephone usage, sales of fixed-line phones were stagnating and Nora expected the business to slowly decline in the coming years. Nora had also secured a 15-year TMB contract to install, operate and maintain payphones in Malaysia. In 1997, Nora started to manufacture card payphones under a license from GEC Plessey Telecommunications (GPT) of the United Kingdom. The agreement also permitted Nora to sell the products to several countries in Southeast Asia. While payphone revenues were as high as RM120 million a year, profit margins were only about 10 per cent because of high investment and maintenance costs. With growing telephone ownership across Southeast Asia, particularly of mobile phones, growth in the payphone business had steadily declined since 2008. Demand for and installation of new payphones was largely confined to poor and/or rural areas. Payphone companies were going out of business in the developed nations and Nora was concerned about long-term viability. In 2011, Nora acquired S&B Telecom’s business for RM80 million, with the intent of securing a foothold into the fast growing and higher margin mobile network services business. S&B Telecom’s work involved installation, commissioning, and maintenance of mobile cell tower equipment, and laying fiber optic cables to connect the cell towers with fixed networks. Nora saw this line of business as crucial for winning the TMB 4G LTE contract and establishing a successful JV with a MNC network equipment provider. THE MANAGEMENT When Nora was established, its founder, Osman Jaafar, managed the company with his wife, Nora Asyikin Yusof, and seven employees. Osman was known as a conservative businessman who did not like to dabble in acquisitions and mergers to make quick capital gains. He was formerly an electrical engineer who was trained in the United Kingdom and had held several senior positions at the national Telecom Department in Malaysia. Osman subsequently recruited Zainal Hashim for the position of deputy managing director at Nora. Zainal held a master’s degree in microwave communications from a British university and had experience as a production engineer at Pernas-NEC Sdn Bhd, a manufacturer of transmission equipment. Zainal was later promoted to the position of managing director and six years later, the vice-chairman. Industry analysts observed that Nora’s success was attributed to the complementary roles, trust, and mutual understanding between Osman and Zainal. While Osman “likes to fight for new business opportunities,”
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Zainal preferred a low profile and concentrated on managing Nora’s operations. Industry observers also speculated that Osman, a former civil servant and an entrepreneur, was close to Malaysian politicians, notably the Prime Minister, while Zainal had been a close friend of the Finance Minister. Zainal disagreed with allegations that Nora had succeeded due to its close relationships with Malaysian politicians. However, he acknowledged that such perceptions in the industry had been beneficial to the company. Osman and Zainal had an obsession for high-tech and made the development of research and development (R&D) skills and resources a priority in the company. About two per cent of Nora’s earnings was reinvested into R&D activities. Although this amount was considered small by international standards, Nora planned to increase it gradually to 5 to 6 per cent over the next two to three years. Zainal said:
We believe in making improvements in small steps, similar to the Japanese kaizen principle. Over time, each small improvement could lead to a major creation. To be able to make improvements, we must learn from others. Thus, we would borrow a technology from others, but eventually, we must be able to develop our own to sustain our industry competitiveness.
To further enhance R&D activities at Nora, Nora Research Sdn Bhd (NRSB) formed a wholly owned subsidiary (WOS) with a staff of 60 technicians/engineers. NRSB operated as an independent company undertaking R&D activities for Nora as well as private clients in related fields. The company facilitated R&D activities with other companies as well as government organizations, research institutions, and universities. SAKARI OY Sakari was established in 1865 as a pulp and paper mill northwest of Helsinki. In the 1960s, Sakari started to expand into the rubber and cable industries when it merged with the Finnish Rubber Works and Finnish Cable Works. In 1975, Aatos Olkkola took over as Sakari’s president and led it into businesses such as computers, consumer electronics, and cellular phones via a series of acquisitions, mergers and alliances. In 1979, a JV between Sakari and Vantala, Sakari-Vantala, was set up to develop and manufacture mobile telephones. Sakari-Vantala had captured about 14 per cent of the world’s market share for mobile phones and held a 20 per cent market share in Europe for its mobile phone handsets. Outside Europe, a 50-50 JV was formed with Tandy Corporation, which had made significant sales in the United States, Malaysia and Thailand. Sakari first edged into the telecom market by selling switching systems licensed from France’s Alcatel and by developing the software and systems to suit the needs of small Finnish phone companies. Sakari avoided head-on competition with Siemens and Ericsson by not trying to enter the market for large telephone networks. Instead, Sakari concentrated on developing dedicated telecom networks for large private users, such as utility and railway companies. In Finland, Sakari held 40 per cent of the market for telecom infrastructure, versus Ericsson (34 per cent), Siemens (25 per cent), and Alcatel (1 per cent). In 1989 Mikko Koskinen took over as president of Sakari. He announced that telecommunications, computers, and consumer electronics would be maintained as Sakari’s core business, and that he would continue efforts in expanding the company overseas. To do so, he envisaged the setting up of several alliances, each designed for a specific purpose. He said, “Sakari has become an interesting partner with which to cooperate on an equal footing in the areas of R&D, manufacturing and marketing.”
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Due to the recession in Finland, which began in 1990, Sakari began divesting its less profitable companies within the basic industries (metal, rubber, and paper), as well as leaving the troubled European computer market with the sale of its computer subsidiary, Sakari Macro. The company’s new strategy was to focus on two main areas: telecom systems and mobile phones globally, and consumer electronic products in Europe. The company’s divestment strategy led to a reduction of Sakari’s employees from about 41,000 in 1989 to 29,000 in 1991. The Finnish economy went through a rapid revival in 1993, followed by a new period of intense growth. Since the mid-1990s the Finnish growth had been bolstered by intense growth in telecommunications equipment manufacturing as a result of an exploding global telecommunications market. Sakari capitalized on this opportunity and played a major role in the telecommunications equipment manufacturing sector. In 1998, despite having nearly $15 billion in telecom equipment sales, and being the world leader in mobile phones, Sakari was still a small company by international standards. There were six larger competitors headquartered respectively in the United States (2), Sweden, France, Canada and Germany. Sakari lacked a strong marketing capability and had to rely on JVs to enter the world market, particularly the United States. In its efforts to develop market position quickly, Sakari had to accept lower margins for its products, and often the Sakari name was not revealed on the product. In 2001, Sakari was Finland’s largest publicly-traded industrial company and derived the majority of its total sales from exports and overseas operations. The company had succeeded in globalizing and diversifying its operations to make the most of its high-tech capabilities. Sakari had also started marketing under its own name. As a result, Sakari emerged as a more influential player in international markets and had gained international brand recognition. In 2007, Sakari combined its telecoms infrastructure operations with those of Magma to form a JV named Sakari-Magma (SM). The plan was to reduce cost, identify product and service complementarities, and provide a superior market alternative to both Ericsson’s high-end offerings and Huawei’s low cost solutions. SM became a leading global provider of both wireless and landline telecom infrastructure equipment to telecom operators around the world. However, the JV struggled to support existing customers of Magma and work effectively with services partners. In 2011, SM announced that it would cut 17,000 jobs over the next two years and restructure its business to focus on mobile broadband solutions. By January 2013, SM had secured 75 LTE network infrastructure contracts worldwide and had an LTE contract share of 18 per cent behind Ericsson at 38 per cent and Huawei at 32 per cent. Its SK4LTE platform had sold well in developed nations such as Canada, Germany, and South Korea, as well as in developing countries such as China, Brazil, and India. In the first quarter of 2013, Sakari purchased Magma’s stake in SM for $2 billion, and announced the sale of its devices business to Oscorp for $7 billion. Sakari attributed its success in the telecom industry to R&D. Strong in-house R&D in core competence areas enabled the company to develop technology platforms, such as its SK4LTE system, that were reliable, flexible, widely compatible and economical. About 20 per cent of its annual sales revenue was invested into R&D and product development units in Finland, the United States, Germany, China, and India. Sakari’s current strategy entailed global operations in production and R&D. It planned to set up additional R&D centres in leading markets, as well as in Southeast Asia – a region where it had no business experience. THE NORA-SAKARI NEGOTIATION Nora and Sakari had discussed the potential of forming a JV in Malaysia for more than two years. Nora engineers went to Helsinki to assess SK4LTE technology in terms of its compatibility with Malaysian
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requirements, while Sakari managers travelled to KL to assess Nora’s capability in manufacturing and installing 4G LTE equipment and the feasibility of gaining access to the Malaysian market. In October 2012, Nora submitted its bid for TMB’s RM1 billion contract to supply and install 4G LTE equipment supporting 1200 cell sites. Assuming the Nora-Sakari JV would materialize, Nora based its bid on supplying Sakari’s 4G LTE technology. Nora competed with five other companies shortlisted by TMB, all offering their partners’ technology — Alcatel-Lucent, Ericsson, Huawei, NEC, and Samsung. In mid- January 2013, TMB announced three successful companies in the bid. They were companies using technology from Alcatel-Lucent, Ericsson, and Sakari. Each was awarded a one-third share of the RM1 billion contract and would be responsible for delivering 400 cell sites over a period of two years. Industry observers were critical of TMB’s decision to select Sakari and Ericsson, despite both being market leaders in 4G LTE products and services. Sakari’s SK4LTE platform was criticized for failing to make any impact in the United States, one of the world’s largest and most important mobile markets. Ericsson was criticized for lacking flexibility in adapting its solutions and delivery priorities to align with customer needs. The February 4 Meeting Following the successful bid and ignoring the criticisms against Sakari, Nora and Sakari held a major meeting in Helsinki on February 4 to finalize the formation of the JV. Zainal led Nora’s five-member negotiation team, which comprised Nora’s general manager for corporate planning division, an accountant, two engineers, and Marina Mohamed, a lawyer. One of the engineers was Salleh Lindstrom who was of Swedish origin, a Muslim and had worked for Nora for almost 10 years. Sakari’s team was led by Kuusisto, Sakari’s vice-president. His team comprised Junttila, Hussein Ghazi, Aziz Majid, three engineers, and Julia Ruola, a lawyer. Ghazi was Sakari’s senior manager who was of Egyptian origin and also a Muslim who had worked for Sakari for more than 20 years, while Aziz, a Malay, had been Sakari’s manager for more than 12 years. The meeting went on for several days. The main issue raised at the meeting was Nora’s capability in penetrating the Southeast Asian market. Other issues included Sakari’s concerns over the efficiency of Malaysian workers in manufacturing, maintaining product quality and ensuring prompt deliveries. Zainal said that this was the most difficult negotiation he had ever experienced. Zainal was Nora’s most experienced negotiator and had single-handedly represented Nora in several major negotiations for the past 10 years. In the negotiation with Sakari, Zainal admitted making the mistake of applying the approach he often used when negotiating with companies based in North America or the United Kingdom. He said:
Negotiators from the U.S. tend to be very open and often state their positions early and definitively. They are highly verbal and usually prepare well-planned presentations. They also often engage in small talk and ‘joke around’ with us at the end of a negotiation. In contrast, the Sakari negotiators are serious, reserved and ‘cold.’ They are also relatively less verbal and do not convey much through their facial expressions. As a result, it was difficult to determine whether they are really interested in the deal or not.
Zainal said that the negotiation on February 4 turned out to be particularly difficult when Sakari became interested in bidding on a recently-announced tender for a major telecom contract in the United Kingdom. Internal politics within Sakari led to the formation of two opposing “camps.” One “camp” held a strong belief that there would be very high growth in the Asia-Pacific region and that the JV in Malaysia was seen
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as a hub to enter these markets. Although the government had liberalized equity ownership restrictions and allowed the formation of WOS’s, JVs were still an efficient way to enter the Malaysian market for a company that lacked local knowledge. This group was represented mostly by Sakari’s managers positioned in Asia and engineers who had made several trips to Malaysia, which usually included visits to Nora’s facilities. It also had the support of Sakari’s vice-president, Kuusisto, who was involved in most of the meetings with Nora, particularly when Zainal was present. Kuusisto had also made efforts to be present at meetings held in KL. This group also argued that Nora had secured the contract in Malaysia whereas the chance of getting the United Kingdom contract was low in view of the intense competition prevailing in that market. The “camp” not in favour of the JV believed that Sakari should focus its resources on entering the United Kingdom, which could be used as a hub to penetrate the European Union (EU) market. There was also the belief that Europe was closer to home, making management easier, and that problems arising from cultural differences would be minimized. This group was also particularly concerned that Nora had the potential of copying Sakari’s technology and eventually becoming a strong regional competitor. Also, because the United Kingdom market was relatively “familiar” and Sakari had local knowledge, it could set up a WOS instead of a JV and avoid JV-related problems, such as joint control, joint profits, and technology leakage. Zainal felt that the lack of full support from Sakari’s management led to a difficult negotiation when new misgivings arose concerning Nora’s capability to deliver its part of the deal. It was apparent that the group in favour of the Nora-Sakari JV was under pressure to further justify its proposal and provide counterarguments against the United Kingdom proposal. A Sakari manager explained, “We are tempted to pursue both proposals, but our current resources are limited. Thus, a choice has to made, and soon.” The March 4 Meeting Another meeting to negotiate the JV agreement was scheduled for March 4. Sakari’s eight-member team arrived in KL on Sunday afternoon of March 3, and was met at the airport by the key Nora managers involved in the negotiation. Kuusisto did not accompany the Sakari team to this meeting. The negotiation started early Monday morning at Nora’s headquarters and continued for the next five days, with each day’s meeting ending late in the evening. Members of the Nora team were the same members who had attended the February 4 meeting in Finland, except Zainal, who did not participate. The Sakari team was also represented by the same members in attendance at the previous meeting plus a new member, Solail Pekkarinen, Sakari’s senior accountant. On the third day, the Nora team requested that Sakari ask Pekkarinen to leave the negotiation. He was perceived as extremely arrogant and insensitive to the local culture, which tended to value modesty and diplomacy. Pekkarinen left for Helsinki the following morning. Although Zainal had decided not to participate actively in the negotiations, he followed the process closely and was briefed by his negotiators regularly. Some of the issues that they complained were difficult to resolve had often led to heated arguments between the two negotiating teams. These included: 1. Equity Ownership In previous meetings, both companies agreed to form the JV with a paid-up capital of RM8 million. However, they disagreed on the equity share proposed by each side. Sakari proposed an equity split of 49 per cent for Sakari and 51 per cent for Nora. Nora, on the other hand, proposed a 30 per cent Sakari and 70 per cent Nora split. Nora’s proposal was based on the common practice in Malaysia as a result of historical
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foreign equity regulations set by the Malaysian government that allowed a maximum of 30 per cent foreign equity ownership unless the company would export a certain percentage of its products. Though these regulations were liberalized by the Malaysian government effective July 1998 and new regulations had replaced the old ones, the 30-70 foreign-Malaysian ownership divide was still commonly observed. Equity ownership became a major issue as it was associated with control. Sakari was concerned about its ability to control the accessibility of its technology to Nora and about decisions concerning the activities of the JV as a whole. The lack of control was perceived by Sakari as an obstacle to protecting its interests. Nora had concerns about its ability to exert control over the JV because it was intended as a key part of its long-term strategy to develop its own mobile broadband equipment and related high-tech products. 2. Technology Transfer Sakari proposed to provide the JV with the basic structure of the SK10 base station. The JV company would assemble the base stations at the JV plant and subsequently install the exchanges in designated locations identified by TMB. By offering Nora only the basic structure of the SK10, the core of Sakari’s 4G LTE platform would still be well-protected. On the other hand, Nora proposed that the basic structure of the SK10 base station be developed at the JV company. Based on Sakari’s proposal, Nora felt that only the technical aspects in assembling and installing the SK10 would be obtained. This was perceived as another “screw-driver” form of technology transfer while the core technology associated with making the base stations would still be unknown. 3. Royalty Payment Closely related to the issue of technology transfer was the payment of a royalty for the technology used in building the base stations. Sakari proposed a royalty payment of 5 per cent of the JV gross sales while Nora proposed a payment of 2 per cent of net sales. (Net sales were overall sales minus returns, allowances for damaged or missing goods, plus any discounts.) Nora considered the royalty rate of 5 per cent too high because it would affect Nora’s financial situation. Financial simulations prepared by Nora’s managers indicated that its return on investment would be less than the desired 10 per cent if royalty rates exceeded three per cent of net sales. This was because Nora had already agreed to make large additional investments in support of the JV. Nora would invest in a building to be rented to the JV company to accommodate an office and the base station plant. Nora would also invest in another plant to supply the JV with antennae and amplifiers required for the cell sites. An added argument raised by the Nora negotiators in support of a two per cent royalty was that Sakari would receive benefits from the JV’s access to Japanese technology used in manufacturing antennae and amplifiers. Apparently the Japanese technology was more advanced than Sakari’s present technology. 4. Expatriates’ Salaries and Perks To allay Sakari’s concerns over Nora’s level of efficiency, Nora suggested that Sakari provide the necessary training for the JV technical employees. Subsequently, Sakari had agreed to provide eight engineering experts for the JV company on two types of contracts, short-term and long-term. Experts employed on a short-term basis would be paid a daily rate of US$1640 plus travel/accommodation. The permanent experts would be paid a monthly salary of US$26,000. Three permanent experts would be
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attached to the JV and the number would gradually be reduced to one, after a year. Five experts would be available on a short-term basis of less than three months each year to provide specific training. The Nora negotiation team was appalled at the exorbitant amount proposed by the Sakari negotiators. They were surprised that the Sakari team had not surveyed the industry rates, as the Japanese and other western negotiators would normally have done. In response to Sakari’s proposal, Nora negotiators adopted an unusual “take-it or leave-it” stance. They deemed the following proposal reasonable in view of the comparisons made with other JVs that Nora had entered into with other foreign parties:
Permanent experts’ monthly salary ranges to be paid by the JV company were as follows: (1) Senior expert (seven to 10 years experience)…. RM32,800–RM37,700 (2) Expert (four to six years experience)…………. RM30,300–RM34,100 (3) Junior expert (two to three years experience)… RM27,900–RM31,600 (4) Any Malaysian income taxes payable would be added to the salaries. (5) A car for personal use. (6) Annual paid vacation of five weeks. (7) Return flight tickets to home country twice a year for singles and once a year for families. (8) Any expenses incurred during official travelling. Temporary experts invited by the JV for technical assistance would be paid the following fees: (1) Senior expert……………………...…………. RM1,800 per working day (2) Expert………………………………...……... RM1,600 per working day (3) The JV company would not reimburse the following:
• Flight tickets between Finland (or any other country) and Malaysia. • Hotel or any other form of accommodation. • Local transportation.
In defense of their proposed rates, Sakari’s negotiators argued that the rates presented by Nora were too low. Sakari suggested that Nora’s negotiators take into consideration the fact that Sakari would have to subsidize the difference between the experts’ present salaries and the amount paid by the JV company. A large difference would require that large amounts of subsidy payments be made to the affected employees. 5. Arbitration Another major issue discussed in the negotiation was related to arbitration. While both parties agreed to an arbitration process in the event of future disputes, they disagreed on the location for dispute resolution. Because Nora would be the majority stakeholder in the JV, Nora insisted that any arbitration should take place in KL. Sakari, however, insisted on Helsinki, following its commonly practised norm. At the end of the five-day negotiation, many issues could not be resolved. While Nora could agree on certain matters after consulting Zainal, the Sakari team had to refer contentious items to its board before making any decision. THE DECISION Zainal read through the minutes of the negotiation and was disappointed that an agreement had not yet been reached. He was concerned about the contractual commitment Nora had made to TMB. Nora would be expected to fulfill the contract soon but had yet to find a partner to provide the technology. Companies such as NEC and Samsung, which had failed in the bid, could still be potential partners. However, Zainal had also not rejected the possibility of a reconciliation with Sakari. He could start by contacting Kuusisto in Helsinki. But should he?
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EXHIBIT 1: HOW 4G LTE (AND MOBILE BROADBAND) WORKS: A SIMPLIFIED NETWORK REPRESENTATION
Source: Dwarka Chakravarty.
EXHIBIT 2: MOBILE NETWORKS: EVOLUTION AND COMPARISON
GENERATION 1G 2G 3G 4G LTE Introduced 1980s 1990s 2000s 2010s Peak Data Rate 2 Kbps 0.5 Mbps 63 Mbps 300 Mbps Services Voice Voice, Text Voice, Video, Data Voice, Video, Data Signal Analog Digital Digital Digital Network PSTN PSTN PSTN and Internet Internet
Note: Kbps/Mbps = Kilo/megabits per second; PSTN = Public Switched Telephone Network. Source: Qualcomm, “The Evolution of Mobile Technologies,” www.qualcomm.com/media/documents/files/the-evolution-of- mobile-technologies-1g-to-2g-to-3g-to-4g-lte.pdf, accessed June 16, 2015.
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EXHIBIT 3: MALAYSIA: BACKGROUND INFORMATION Malaysia is centrally located in Southeast Asia. It consists of Peninsular Malaysia, and the states of Sabah and Sarawak on the island of Borneo. Malaysia has a total land area of about 330,000 square kilometres, of which 80 per cent is covered with tropical rainforest. In 2013, Malaysia’s population was 30 million, with approximately 13 million in the labour force. The population was relatively young, with 40 per cent between the ages of 15 and 39. The average household size was four, but extended families were common. Kuala Lumpur had close to 1.5 million inhabitants. The population is multiracial; the largest ethnic group is the Bumiputeras (the Malays and other indigenous groups such as the Ibans in Sarawak and Kadazans in Sabah), followed by the Chinese and Indians. Bahasa Malaysia is the national language but English is widely used in business circles. Islam is the official religion but other religions (mainly Christianity, Buddhism and Hinduism) are widely practised. All Malays are Muslims, followers of the Islamic faith. During the period of British rule, secularism was introduced to the country, which led to the separation of the Islamic religion from daily life. In the late 1970s and 1980s, several groups of devout Muslims undertook efforts to reverse the process, emphasizing a dynamic and progressive approach to Islam. As a result, changes were made to meet daily religious needs. Islamic banking and insurance facilities were introduced and prayer rooms were provided in government offices, private companies, factories, and even in shopping complexes. Malaysia is a parliamentary democracy under a constitutional monarchy. In 2013, the Barisan Nasional, a coalition of several political parties representing various ethnic groups, was the ruling political party. Its predominance had contributed to political stability and economic progress in the last two decades. The recession of the mid 1980s led to structural changes in the Malaysian economy, which had been too dependent on primary commodities (rubber, tin, palm oil and timber) and had a very narrow export base. To promote the establishment of export-oriented industries, the government directed resources to the manufacturing sector, introduced generous incentives and relaxed foreign equity restrictions. Heavy investments were made to modernize the country’s infrastructure. This led to rapid economic growth in the late 1980s and early 1990s. The growth had been mostly driven by exports, particularly of electronics. From 2003 to 2008, Malaysia’s GDP grew at an average rate of 6.5% per year. Malaysia was severely affected by the global financial crisis of 2008-2009, given its economic exposure to the U.S. and Japan – top export destinations and key sources of foreign investment. In 2010, the government launched its New Economic Model (NEM) comprising a number of reforms to boost private sector driven, inclusive economic growth to enable Malaysia to achieve developed nation status by 2020. From 2011 to 2013, GDP grew at an average of 5% per year. Consumer price inflation averaged 2.3% and the unemployment rate was 3%. In 2013, the services sector accounted for over 50% of GDP, with manufacturing making up 25% of the economy. Malaysia had also succeeded in nearly eradicating poverty. Malaysia had a GDP per capita of US$10,500 and was ranked 18th among all countries in terms of ease of doing business by the World Bank. Sources: Ernst and Young, “Doing Business in Malaysia”, 1997, Ernst and Young International, New York. The World Bank, http://data.worldbank.org/indicator/, accessed April 29, 2015.
Other online sources.
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EXHIBIT 4: FINLAND: BACKGROUND INFORMATION Finland is situated in the north-east of Europe, sharing borders with Sweden, Norway and the former Soviet Union. About 65 per cent of its area of 338,000 square kilometres is covered with forest, about 15 per cent lakes and about 10 per cent arable land. Finland has a temperate climate with four distinct seasons. In 2013, Finland was one of the most sparsely populated countries in Europe with a population of 5.4 million, 80 per cent of whom lived in the urban areas. Helsinki had a population of about 590,000. Finland had a well-educated work force of about 2.7 million. About half of the work force was engaged in providing services, 25 per cent in manufacturing and construction, and four per cent in agricultural production. The small size of the population and an ageing demographic (33 per cent of the population above the age of 55 and only about 30% in the age group 15 to 39), led to scarce and expensive labour. Thus Finland had to compete by exploiting its lead in high-tech industries. Finland’s official languages are Finnish and Swedish, but only about five per cent of Finns speak Swedish. English is the most widely spoken foreign language. About 75 per cent of Finns are Lutheran Christians and about one per cent are Orthodox Christians. Finland has been an independent republic since 1917. A President and a 200-member single-chamber parliament are elected every six and four years, respectively. Since the mid-1990s, the Finnish growth has mainly been bolstered by intense growth in telecommunications equipment manufacturing. The Finnish economy grew at an average of nearly 5% per year from 1994 to 2000. Finland was one of the 11 countries that joined the Economic and Monetary Union (EMU) on January 1, 1999. Finland has been experiencing a rapidly increasing integration with Western Europe. Membership in the EMU provide the Finnish economy with an array of benefits, such as lower and stable interest rates, elimination of foreign currency risk within the Euro area, reduction of transaction costs of business and travel, and so forth. The EMU did pose structural risks in regard to monetary interconnectedness of stronger and weaker economies without a corresponding fiscal union. The IT sector slump in 2001 and 2002 had its impact on the Finnish economy, which for the years 2001 to 2003 registered an average growth of 2.1 per cent. The economy rebounded from 2004 onwards, achieving a growth of 5.2 per cent in 2007, but was hit hard by the global financial crisis of 2008-2009. A feeble recovery in 2010 and 2011 was stymied by the debt crisis and economic downturn in Europe and Finland’s economy declined in 2012 and 2013. The GDP in 2013 still languished at about 5 per cent below its 2008 level. In the period from 2011 to 2013, Finland’s average consumer price inflation and unemployment rate were 2.6 per cent and 7.9 per cent, respectively. Finland’s 2013 GDP per capita was US$39,000 and it was ranked 8th among all countries in terms of ease of doing business by the World Bank. Finland is a developed nation and its standard of living is among the highest in the world. The Finns have small families with an average household size of two. For long, the stable trading relationship with the former Soviet Union and other Scandinavian countries led to few interactions between the Finns and people in other parts of the world. The Finns are described as rather reserved, obstinate, and serious people. A Finn commented, “We do not engage easily in small talk with strangers. Furthermore, we have a strong love for nature and we have the tendency to be silent as we observe our surroundings. Unfortunately, others tend to view such behaviour as cold and serious.” Sources: Ernst and Young, “Doing Business in Finland”, 1997, Ernst and Young International, New York. The World Bank, http://data.worldbank.org/indicator/, accessed April 29, 2015.
Other online sources.
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9B16M044
CAMERON AUTO PARTS: JOINT VENTURES, LICENSING OR EXPORTING
Professor Paul Beamish revised this case (originally prepared by Professor Harold Crookell) 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) [email protected]; www.iveycases.com. Copyright © 2016, Richard Ivey School of Business Foundation Version: 2020-02-24
The spring of 2015 found Alex Cameron in Europe again visiting Sandy McTaggart, his U.K. licensee, and Pierre Michelard, an important French customer. Cameron Auto Parts had enjoyed remarkably rapid growth during 2013–2014, and this seemed to be accelerating into the first six months of 2015 (see Exhibits 1 and 2). During 2013, a major plant expansion was undertaken, adding 200,000 square feet to the company’s production capacity at a cost of $10 million.1 An additional $2 million was spent on equipment and tooling. Long-term debt of $8 million was raised in September 2014 at 7 per cent, and the bank loan was reduced. In spite of these expenditures occasioned by rapid growth, Cameron Auto Parts entered 2015 in a strong financial position because of its high overall profitability. Sales in 2014 reached $150 million, $65 million of which came from flexible couplings. Profits before tax were $20 million. As a result, Alex was feeling rather solvent and somewhat exhausted as he set foot in Europe for a well-earned month’s rest. McTaggart’s factory in Scotland was one of his first stops, and Sandy McTaggart, looking five years younger than he did in 2013, was there to greet him: Sandy: Come in, Alex. Come in! I have a surprise for you. A cheque for £100,000. Alex: Is this our royalty cheque for 2014? Sandy: Aye! A lot better than the £20,000 you got last year, don’t you think? And we’ve only scratched
the surface. You can look for £500,000 next year and maybe more. Alex: How on earth have you managed it, Sandy? You’re talking about sales of £4.5 million this year
and £24.5 million by next year. You don’t have the capacity to produce it. Sandy: We’ve been buying a little equipment here and there and hiding it away in this old museum of a
factory. We’ve lots of room yet. And we’ve almost doubled our sales force. My two boys are looking after that: one has the U.K. sales force and the other does foreign sales. They’re very
1 All currency in U.S. dollars unless specified otherwise.
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enthusiastic about your line of flexible couplings, now that we’ve got the price down to North American levels.
Alex: I didn’t know your sons were in the business. Sandy: Aye well! They weren’t very active until this last year. Tell me, what would you say to a joint
venture? Alex: (with obvious enthusiasm) What? Cameron buy out a piece of McTaggart? Well, of course, it
would depend on . . . Sandy: No, No, No. Not in McTaggart! With McTaggart, in Australia. Alex: Australia! You’ve got to be kidding. What do we know about Australia? Sandy: I don’t know about you, but we’ve been selling there for a number of years. Our man in
Australia knows the market well and feels it’s time to build an assembly plant there. He’s selling some flexible couplings now and a number of our other lines. With local assembly, he feels he could triple volume to around £10 million (about half flexible couplings, and half other products). It would take an investment of £2 million to make around £400,000 a year after Australian tax of 30 per cent.
Alex: Why build a plant in Australia at all? Why not just increase your shipments from here? Sandy: It’s the tariffs, Alex. The tariffs! It’s 5 per cent on the finished couplings and another 5 per cent
on the components. So we can have the finishing and assembly work done in Australia, lower our price a little, and put ourselves in a position to service the market more promptly. Of course, you wouldn’t charge us a royalty on unfinished parts shipped to Australia. What I’d suggest is a 60:40 joint venture with us in control and responsible for managing the venture.
Alex: Why couldn’t we go 50:50 on it? Is there any special virtue in 60:40? Sandy: Well, now, somebody’s got to manage it. Can you supply the management? Alex: At the moment, we are just run off our feet in the United States. We’ve been growing so fast.
The only way we could go in really is on a silent partner basis. In effect, you’re looking to us to put up £800,000, is that it?
Sandy: Aye! We have some used equipment here that’s just about exactly what they need. Then we
should reach some agreement about capitalizing our management input, and the rest of our share we’ll invest in cash. I think we can work out a mutually profitable arrangement.
Alex: Well, you seem to have thought this through pretty carefully. Are you fairly confident about
your profit estimate? Sandy: We’ve had a lot of experience in the Australian market. It’s pretty stable and we know the costs.
The venture will make at least £800,000. But we’d be better off to take it out in fees rather than dividends because the U.K. corporate tax rate of 21 per cent is lower than the 30 per cent Australian rate. In April 2015, the U.K. corporate tax rate will even fall to 20 per cent for profits
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above £300,000. What we’d propose is a management fee of four per cent on sales to us, and a royalty of two and a half per cent to you. Then if there’s any profit remaining, we’ll declare that as a dividend. What do you say?
Alex: You’re an old horse trader, Sandy. Let me think this one over. I’m on my way through Europe to
see Michelard, so I’ll drop in on the way back and let you know. Sandy: Well, while you’re thinking it over, keep in mind that Australia entered a free trade agreement
with New Zealand in 1983, which seems to have worked out rather well. We have a sales rep in New Zealand.
Alex: I have seen that in our U.S.-Canada agreement. I was hoping to get some insight into free trade
during my visit to Europe. Sandy: There’s a big difference between free trade and a European Union-style agreement. You
Americans don’t seem to know what’s going on outside your own borders. Alex: That may be true, but we learn fast when we visit. Sandy: What are you going to see Michelard about, anyway? You’re not going into business with a
Frenchman, surely! Alex: Oh no! He’s just a good customer of ours, that’s all. Always keep in touch with my good
customers. That’s how we got together in the first place. Sandy: That’s what I’m afraid of. We wouldn’t want you moving into Europe without us. Alex: As a matter of fact Sandy, I’m surprised to find you selling our flexible couplings in Europe and
Australia. Our license agreement specified the U.K. market only. Sandy: Aye! But that was for the production exclusivity clause. You gave us an exclusive license to
produce in the United Kingdom but did not specify that we were unable to sell on a non- exclusive basis anywhere we want. I should have thought you’d understood that.
Alex: I do now. I’m a fast learner. I can see this visit to Europe is going to be important. Sandy: Aye, well remember what I said! And think about the Australia proposition. Alex left the discussion with mixed feelings. Although Cameron Auto Parts was well able to afford the investment, he wondered whether Australia was the place to put it. On the other hand, he was conscious of how well McTaggart had done with the flexible coupling license agreement. His £100,000 royalty was little compared to what McTaggart must have made, and for this reason Alex felt that an equity investment would have paid off better than being a licensor. He didn’t want to lose the whole European market for a mere 2 per cent royalty, and this concern was in the forefront of his mind as he left for France. THE FRENCH PROPOSAL The welcome he received was somewhat unexpected. He was paged on arrival at the airport by a chauffeur from Michelard and then driven in an air-conditioned limousine to a small exclusive country estate. There
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he was greeted by Pierre Michelard, his brother Andre, and cousin Raymond, who together formed the entire ownership and management of Michelard & Cie., a long-established family-owned distributor organization. After a delightful, two and a half hour multi-course gourmet dinner, Pierre finally came to the point, albeit with a degree of sophisticated reluctance. Pierre: To sum up, we would like to undertake production of your flexible coupling in a small factory
we have just acquired near the Swiss border. However, we are not experienced as manufacturers and would require some assistance from you to get underway. We would like you to consider investing the sum of $5 million for a 40 per cent interest in our organization with a view to producing the flexible coupling here as quickly as possible.
Alex: This is quite a surprise. I’m flattered, of course. Are all three of you in agreement with such a
transaction? Pierre: Of course! No doubt you will want to see our financial statements covering the last few years.
Perhaps you could look them over tonight and we’ll talk about the matter tomorrow. There is a suite of rooms available to you here on the estate for as long as you care to stay.
THE FRENCH AGREEMENT After Alex had accustomed himself to his opulent surroundings, he sat down to review the financial statements of Michelard & Cie. (see Exhibits 3 and 4), and to draw up a set of questions for the meeting the following day. In the back of his mind was the prospect of using Michelard as a way of breaking into the continental European countries, Sandy McTaggart’s warning notwithstanding. As he perused the statements, however, three things worried him: 1. Michelard seemed short of cash; 2. the company’s administrative costs seemed very high; and 3. the company had no experience as a manufacturer. In reviewing his own records, Alex found that Cameron’s sales to Michelard over the previous two years were $30,000 (2013) and $85,000 (2014). Sales in the first four months of 2015 had amounted to $80,000, catching Cameron by surprise and resulting in some delays. Michelard’s policy had been to add 50 per cent to the landed cost (after freight and 5 per cent duty, and before 20 per cent VAT) in arriving at a selling price. The company also handled a number of other complementary lines of product which were sold to similar customers. By the following morning, Alex had reached a tentative decision subject to some clarification in the ensuing meeting. (His rough notes appear in Exhibit 5.) Alex: I’m generally in favor of a partnership, but not on the terms you have suggested. First, I feel the
capital input from me to purchase a 40 per cent interest in Michelard should not exceed $4 million. Second, Cameron should receive a royalty of 4 per cent on sales of all flexible couplings. And, third, the venture will start out as a finishing and assembly operation, importing components from America until it is able to absorb the total production technology.
Pierre: Will $4 million be sufficient to finance development of flexible coupling sales to the level we
require to get our costs down? Our hope is to sell about €9.6 million [euros] in flexible couplings by 2017 and reduce our selling price 25 per cent. I’m not sure we can do that on $4 million.
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Alex: I think we can if we manage things carefully and reinvest our profits for growth. We have developed this way in America. If the venture runs a little short, Cameron can always loan a small amount on a temporary basis.
Pierre: Perhaps you are right. I think we can agree to your financial terms provided our factory is
independent of imports within two years. Do you have any other questions you wish to raise? Alex: It may take three years but we’re willing to try for two. Now, there are a couple of points I’d like
to clear up. Your organization does not seem to be overly profitable, given its sales level, and the reason appears to be high overhead costs. Also, your sales in Germany and Holland are very sporadic.
Pierre: Our profit figures are perhaps misleading. In France, we find it better for tax reasons to take our
return as owners in the form of salary rather than dividends. By normal standards our profit would be much higher. In terms of foreign markets, we have never been able to deal properly with the Germans or the Dutch. The European Union gives a lot of opportunities, but at the moment it is difficult for our French sales representatives to penetrate the German and Dutch markets.
Alex: I suppose these changes all take time. I’d like to see our investment here service all of
continental Europe eventually. There’s no reason why sales could not exceed 16 million euros by 2018. With your distribution and management, and our technology we can do it together.
MCTAGGART’S REACTION Alex left Michelard with an unsigned agreement in principle, spent an abbreviated continental holiday, and then returned home via Scotland. McTaggart was furious when he heard the news of the proposed French joint venture, and Sandy and Alex had their first major row: Sandy: I thought you had your head screwed on better than this, Alex. You realize this makes us
competitors. Michelard of all people! They run that business in their spare time. You’ve made a damn fool of yourself over there.
Alex: There’s no need to get so irritated, Sandy. I’m getting a 4 per cent royalty out of Michelard, and
if I really had my head screwed on I’d have got a 4 per cent royalty out of you too. Sandy: You’ll never collect one quarter of the royalty from Michelard that you’ll get from me. They just
don’t have what it takes. My men will run rings round them everywhere but their home market. And I’ll tell you this too. As soon as we’ve figured a way around your process patents, we’re pulling out of the license agreement.
Alex: Well, you’d better do a good job of it, because if you don’t, we’ll sue you for a bundle. At the conclusion of this rather stormy meeting, Alex boarded a plane for Detroit. By the end of the six- hour flight, his stomach was still knotted-up over the prospect of a prolonged confrontation with Sandy McTaggart. In order to ease the situation, he decided to write to Sandy agreeing to the joint venture in Australia substantially along the lines of Sandy’s proposal but with a few changes.
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EXHIBIT 1: INCOME STATEMENTS (for years ended December 31, 2013 AND 2014, in $ millions)
Flexible
couplings 2013 auto
parts
TOTAL Flexible
couplings 2014 auto
parts
TOTAL TOTAL SALES 33.0 72.0 105.0 65.01 85.02 150.0 Manufacturing costs 24.0 61.0 85.0 38.5 74.0 112.5 Gross profit 9.0 11.0 20.0 26.5 11.0 37.5 Admin. and Selling expenses 4.0 4.0 8.0 8.0 4.5 12.5 Interest expense 0.5 0.5 1.0 1.0 0.8 1.8 Depreciation 1.5 1.5 3.0 1.6 1.6 3.2 Total Expenses 6.0 6.0 12.0 10.6 6.9 17.5 Net profit before tax 3.0 5.0 8.0 15.9 4.1 20.0 Income Tax 2.0 8.0 Net profit after tax 6.0 12.0
Note: Flexible couplings were estimated to account for $18 million of total assets in 2013 and $32 million in 2014 (disproportionately in the form of working capital investment).
1. 95 per cent to United States or Canada. 2. Entirely to the Big Three in United States or Canada.
Source: Company files.
EXHIBIT 2: BALANCE SHEETS (as at December 31, 2013 AND 2014, in $ millions)
2013 2014 Assets
Cash 0.3 2.8 Accounts receivable 15.0 23.5 Inventories 12.0 17.0
Total current assets 27.3 43.3
Property, plant & equipment (net) 23.0 22.0
Total Assets 50.3 65.3
Liabilities Accounts payable 15.0 21.0 Bank loan 8.0 5.0 Accrued items 2.0 3.0
Total current liabilities 25.0 29.0
Long-Term debt 8.0 7.0
Common stock 0.5 0.5 Retained earnings 16.8 28.8
Total equity 17.3 29.3
Total Liabilities 50.3 65.3 Source: Company files.
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EXHIBIT 3: SELECTED FINANCIAL DATA ON MICHELARD & CIE. (euros 000s)
2012 2013 2014 Sales 9,680 8,200 9,760 Cost of Sales 7,808 6,520 7,488 Gross margin 1,872 1,680 2,272 Selling expense 464 480 624 Administrative costs 1,344 1,152 1,520 Net profit 64 48 128 Cash 208 160 80 Accounts receivable 2,640 2,208 2,560 Inventory 2,320 1,968 2,240 Fixed assets (net) 1,024 1,184 2,944 Total assets 6,192 5,520 7,824 Accounts payable 1,040 960 1,216 Bank loan 640 Nil 1,920 Equity 4,512 4,560 4,688 Total liabilities 6,192 5,520 7,824
Note: One U.S. dollar equalled about 0.75 euros on average in 2014.
Source: Company files.
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EXHIBIT 4: MICHELARD & CIE. GEOGRAPHIC DISTRIBUTION OF SALES (euros 000s)
2012 2013 2014 France 4,160 4,400 5,248 Belgium 1,840 1,360 1,744 Switzerland 1,440 1,760 1,840 Italy 640 680 448 Germany 1,040 — 256 Holland 560 — 224 Total 9,680 8,200 9,760
Source: Company files.
EXHIBIT 5: ALEX CAMERON’S ROUGH NOTES Proposed investment $4 million = 3 million euros 2016 2017 2018 (million euros) (million euros) (million euros) Projected sales of flexible couplings 4.00 9.60 16.00 Expected incremental profit1 Nil 0.80 2.40 Share — 40% Nil 0.32 0.96 Royalty — 4% 0.16 0.38 0.64 Profit on component shipments (40% × ¼ sales)2 0.40 0.96 1.60 Total3 0.56 1.66 3.20 Notes: 1. Estimated profit on flexible coupling operations alone. 2. Component shipments expected to be the equivalent of one quarter of sales value at a marginal profit of 40 per cent to
Cameron. 3. Total estimated profit is before tax. Source: Company files.
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9B17M146
L’ORÉAL INDIA: WHERE BEAUTY MEETS TRADITION1
Prem Shamdasani 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) [email protected]; www.iveycases.com. Copyright © 2017, National University of Singapore and Richard Ivey School of Business Foundation Version: 2017-09-29
By the end of 2013, L’Oréal SA (L’Oréal) had become a global force to reckon with in both the professional and beauty segments. L’Oréal had spent more than 20 years studying its target consumers in India, and was constantly innovating through products that catered to those consumers’ specific needs. However, L’Oréal had realized that developing localized products was not the only criterion for success in a new market. Competition had made significant inroads and was intensifying as global and local players continued to thwart L’Oréal’s efforts to penetrate and dominate the hair-care, skincare, makeup, and professional hair- care segments in the value-conscious and largely unorganized but fast-growing beauty market in India. L’Oréal, known for its innovative marketing strategy, was yet to attain a market share lead in the majority of its product segment markets. What future strategy should L’Oréal adopt to become a market leader in India? THE L’ORÉAL GROUP Founded in 1909, L’Oréal, a French company, was more than 100 years old. It was the largest cosmetics manufacturer in the world as of 2012, with a presence in 35 countries and a market share of over 19 per cent worldwide (see Exhibit 1). It owed its success broadly to an overarching three-pronged strategy: 1) expansion into newer and emerging markets, 2) research and innovation, and 3) localized production. COMPANY DIVISIONS Consumer Products The consumer products division encompassed hair-care, skincare, makeup, and colourant products that were distributed through mass-market retail channels and catered to a large range of customers at competitive prices. Brands such as L’Oréal Paris, Garnier, and Maybelline fell under this division (see Exhibit 2).
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Page 2 9B17M146 L’Oréal Luxe The luxe division included premium skincare, makeup, and fragrance products that were sold at stores dedicated to the individual brands, in department stores and travel retail stores, and by e-commerce. Some of these “prestige” brands, as L’Oréal called them, included the cosmetics brands Lancôme, Shu Uemura, and Cacharel; the skincare brands Biotherm and Kiehl’s; and the fragrances Guy Laroche, Paloma Picasso, and Yves Saint Laurent. Professional Products Hair colourants and hair-care products for professional use by hairdressers and sold in salons and through some mass-market retail channels fell under the category of professional products. Some of the best-known brands were L’Oréal Professionnel Paris, Kérastase Paris, Redken, and Matrix. Active Cosmetics Dermo-cosmetics healthcare brands such as Vichy and La Roche-Posay, which were sold through pharmacies and specialist drugstores, were part of the active cosmetics division. THE COSMETICS AND BEAUTY MARKET IN INDIA The Indian economy and environment, in a little more than two decades following economic liberalization, had become increasingly conducive to the growth of consumer product businesses. For markets other than North America and Western Europe, India’s contribution to cosmetics sales steadily increased from 2001 to 2013 (see Exhibit 3 and 4). As the Indian economy grew and developed, a new, more financially stable middle-class had begun to arise, monopolizing the mass-market segment of the Indian population. Their needs and desires had evolved to become more in tune with global trends, prompting a multitude of multinational companies to enter the market in a series of waves, making the markets increasingly competitive. Beauty and skincare was one such market that had grown larger and denser. In 2011, the value of the Indian cosmetics market was ₹100 billion2 according to ASSOCHAM.3 By the end of 2013, the Indian cosmetics market had grown to ₹290 billion ($4.5 billion).4 More Women in the Workforce India’s female workforce in urban areas grew by 19.74 per cent from 22.8 million on January 1, 2010, to 27.3 million on January 1, 2012.5 In a country such as India where women were not given as much priority for education, and the majority who worked before marriage became homemakers after marriage, this was a notable rise in a small amount of time. More women in urban centres were starting to work, whether full- time or part-time.6 Increasing Salaries In addition to the increasing number of women in the workforce, salaries had been steadily rising. In 2001, the average annual salary of an Indian woman was ₹4,492, which grew to ₹9,457 in 2010. Women’s
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Page 3 9B17M146 consumption preferences were evolving, as women had more discretionary funds to spend on cosmetics. These middle-class women no longer had any reason to compromise on their beauty products.7 Globalization and Increasing Westernization As India had risen and continued to rise, a mall culture had flooded urban cities and international media, and other entertainment had piqued local interests. In addition, the Internet had made the world more compact, with the average Indian city dweller more aware of global trends and international culture than before. This made middle-class society more aspirational and keen to be a part of this culture. With the rise of department stores and malls, international companies had found the ideal avenue and environment in which to showcase their brands and demonstrate the value of their products through trials, testing, and education.8 Another segment of Indian society, women in rural areas, aspired to look like fashion-conscious women in urban areas. This opened up a whole other market for extremely low-cost beauty products that were locally manufactured. This market was a huge challenge, with massive rewards waiting to be reaped. L’ORÉAL’S INITIAL FAILED ENTRY INTO INDIA As part of its global expansion strategy, L’Oréal entered India in 1992 with its Garnier Ultra Doux range of shampoos.9 L’Oréal set up a company in partnership with the MJ Group for the distribution of its products because at that time, foreign companies were not permitted to operate in wholly owned subsidiaries or own majority stakes in their Indian operations.10 In 1994, L’Oréal established a wholly owned subsidiary in India.11 L’Oréal’s Ultra Doux range of shampoos contained natural ingredients such as lemon, wheat germ, rose oil, and eucalyptus. In India, the use of natural ingredients for beauty purposes had been customary for generations. For example, women used sandalwood paste on their face for fairer skin, as well as herbs such as henna on their hair for colour and conditioning. For this reason, L’Oréal believed Ultra Doux would appeal to women in India. The company’s entry strategy targeted the lower middle classes, which made up a large segment of the market, positioning Ultra Doux as an affordable shampoo and pricing it at the bottom range to make it affordable. To sell it at a lower price, the company altered the formula by removing certain molecular compounds that nourished the hair.12 However Ultra Doux was not easily noticed amid prevailing shampoo brands such as Sunsilk, Clinic Plus, and Clinic All Clear from established global giant Hindustan Unilever, and local brands such as Chik and Ayur. Ultra Doux had no unique selling proposition to differentiate it, and it was largely unsuccessful.13 Also, after India’s economic liberalization in 1991, a host of other multinational companies entered India with their shampoo brands, making Ultra Doux’s offering even more insignificant. Despite there being immense scope for growth in the shampoo market, Ultra Doux attracted little attention among all these brands. In 1995, L’Oréal tried bringing a second product to India. In an attempt to create a new market, the company introduced an anti-aging product: Garnier Synergie’s Wrinkle Lift cream, the first of its kind in India. It was sold at between ₹130 and ₹240.14 The product did not meet success with Indian consumers. In developed countries, where women of all age groups had spending power, anti-aging was becoming a trend around this time. However, this was not the case at all in India. Women with newly acquired spending
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Page 4 9B17M146 power belonged to the younger age groups and were more excited by other cosmetics and beauty products that they previously did not have access to. L’Oréal had picked a product that was highly successful in markets that faced completely different dynamics, and tried to sell it in India. This did not yield the desired results. L’Oréal needed to understand Indian society and lifestyles, including the different classes and their respective needs, and the changes taking place, in order to have successful product offerings. Simple customized versions of its already available products were not making headway. L’Oréal needed to innovate specifically for India in order to succeed in India. L’ORÉAL’S SECOND ATTEMPT AT INDIA Hair Colour In 1996, L’Oréal, for the first time, undertook a project to understand the real needs of Indian consumers. With regard to hair-care issues, what came out of this research was highly valuable for a company that dealt so extensively with hair colour. The research found that many young women, even those in their twenties, were starting to get grey hair. In 1996, the only products available to them to hide grey hair were the natural herb henna and ammonia-based hair dyes. Henna was traditionally used in India to dye and condition hair, but it was not long-lasting, and the chemicals in the other dyes dried out hair. The home hair-colouring kits that were widely used in Europe and the United States at the time were not available in India. This was a huge gap in the hair-care segment, and L’Oréal immediately capitalized on this opportunity. Considering that these women—who were conscious of their hair colour and dryness— belonged to the rising middle-class segment, L’Oréal brought in a product for them, steering away from the mass-market segments that it had initially targeted with Ultra Doux. It introduced L’Oréal Excellence Crème, a relatively expensive hair dye that came in a cream form that was gentler on the hair than liquid dyes. In Europe, this was a luxury product, and it was introduced in India at a similar price point, selling at the then rupee equivalent of $9. Right from 1997, with the introduction of L’Oréal Excellence, the company localized its advertising strategy by hiring famous Indian women to represent the brand in print and television. The first famous Indian woman to represent L’Oréal was Diana Hayden, Miss World 1997, after which L’Oréal hired Miss World 1994, the Bollywood actress Aishwarya Rai. L’Oréal hired more over the years, from Bollywood actress Sonam Kapoor to Indian model and Hollywood actress Freida Pinto. Although L’Oréal’s localized advertising for different countries cost a lot more money, the strategy enabled the targeted audiences to better identify with the brand. In those years, the majority of the retailing of consumer products happened through small stores run by individuals, called kirana stores. Chain department stores and supermarkets were rare at the time, so L’Oréal had to reach out to thousands of these little stores to stock its products and develop its distribution. Considering that its initial products did not sell well, shopkeepers were left with lots of unsold inventory and were not convinced to keep new L’Oréal products. At this point, L’Oréal had to reflect deeply and get to the basics of understanding what would make these Indian shopkeepers stock its products. In essence, L’Oréal had to localize its business-to-business (B2B) marketing and sales strategy in India. First, it hired employees to educate shopkeepers about the benefits of a cream-based dye as compared to the liquid and powder dyes that had largely been offered by Indian companies such as Godrej and Vasmol for more than 40 years before L’Oréal came in. Second, the sales
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Page 5 9B17M146 teams offered to clean these small shops in exchange for allowing the installation of cardboard display cases of Excellence Crème. With this strategy, in the first year, 2,500 shops agreed to stock the product.15 As L’Oréal Excellence Crème became more successful, the company developed mass-market versions of the product, such as small packets of hair dye costing the rupee equivalent of $2.70, which was much more affordable than purchasing an entire bottle. L’Oréal also developed Excellence Shampoo packets costing $1. L’Oréal Excellence products were still considered to be on the pricier side in India.16 In 2002, L’Oréal introduced Garnier Color Naturals, a cream-based hair colourant developed specially for Indian consumers. This was developed by keeping in mind Indian women’s hairstyles and length. Because women wore their hair parted, grey roots were more visible and women needed to touch up these roots with colour more regularly than they needed to colour all of their hair. In regard to length, Indian women had mostly kept their hair long. Thus, the small packets of hair colour manufactured for Westerners with shorter hair were not suitable for the Indian consumer, and could be quite expensive. Garnier Color Naturals was developed so that it could be stored after opening, could be conveniently used for multiple applications, and was suitable for touch-ups. It was offered in colours matching the shades of Indian hair, such as a range of blacks and browns, and was priced lower, targeting the lower-income strata of Indians. The hair-colouring kit, costing ₹99, was less than one-fifth the selling price of L’Oréal Excellence Crème. Color Naturals was in a higher price bracket than that of Godrej Dyes, which was the market leader in the middle-market hair dye segment, offering powder dye packets for ₹7. However, L’Oréal aggressively marketed and promoted Color Naturals through multiple channels. To teach consumers about the product and the benefits of its features, L’Oréal promoted it to all levels of hairdressers, from salons in big metropolitan areas to barbershops in small towns. Once again, L’Oréal used its tried, tested, and successful strategy of educating these entities about hair dyes and this particular product’s benefits.17 In 2003, L’Oréal opened its first factory in India at Pune to localize production. Being based in India, among Indian consumers, L’Oréal was more easily able to innovate in its products and packaging formats. Production capacity was doubled around 2011. The Pune factory played a vital role in producing many hair-care products specifically for Indian consumers. L’Oréal Professionnel The company realized that the Indian salon sector was a highly unpenetrated and largely unorganized market. There were no formal salon-training programs in the country, and most salons either used products developed by small local companies or extremely expensive foreign brands.18 L’Oréal saw an opportunity in this and, in 1997, launched its professional products division to target this sector with its salon brands. L’Oréal adopted a long-term marketing and industry-building plan and was the first to directly target and comprehensively penetrate this huge market of small beauty parlours across the country. L’Oréal invested in educating and training small and big parlours alike about L’Oréal Professionnel Paris and Kérastase Paris products and how to use them, while convincing them to stock these in their salons. L’Oréal opened five regional training centres, beginning a program to train salon owners and stylists to use its products.19 In its B2B marketing process in India, L’Oréal helped many smaller salons transition to better-quality products and assisted in upgrading salons, turning some into chains. The company was very committed to these salons, and had a lot of interaction with the owners of salon businesses all across the country.20 By
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Page 6 9B17M146 2005, L’Oréal was training 20,000 hairdressers a year.21 Thanks to its strong network, within less than a year after L'Oréal launched its Matrix brand with a range of colourants, the company had partnered with almost 5,000 hair salons in Mumbai, Delhi, and Kolkata.22 L’Oréal continued on its educational path. In 2006, it started a hairdressing academy in Mumbai that offered training in cutting, styling, colouring, and straightening.23 In 2010, the professional hair-care market was growing at 16 per cent.24 Among already competing brands such as Lakmé, Henkel’s Schwarzkopf, and Shahnaz Husain, Procter & Gamble (P&G) brought Wella Koleston, and local company CavinKare introduced Raaga Professional.25 Two years later, in 2012, Henkel launched a second professional brand, Indola, in the low end of the segment, priced at 35 per cent less than Schwarzkopf, its premium brand. This brand was in direct competition with L’Oréal’s Matrix, and by 2013, Indola had a presence in 7,000 salons in India.26 L’Oréal Professionnel Paris, Kérastase Paris, and Matrix had by this time established their brands through L’Oréal’s consistent opening of training centres. The company’s most successful professional hair-care brand in India was Matrix, which targeted the lowest-end salons. Matrix assisted L’Oréal in collecting salon surveys, recruiting, training sales representatives and staff, and developing quarterly performance reports. By 2011, Matrix had reached almost 29,681 salons and 38,419 hairdressers.27 While strengthening its training and distribution reach, L’Oréal focused on innovation as well, and developed Matrix Biolage Oil Therapie in 2011 for the Indian market, where oil was commonly used to nourish hair.28 After 16 years of dedication to its localized B2B sales and marketing strategy, in 2013, L’Oréal became India’s bestselling brand in the ₹120 billion India professional hair-care market, with P&G following in second place. L’Oréal had a reach of more than 40,000 parlours in India and was training more than 100,000 hairdressers each year.29 Hair Care In the hair-care space, L’Oréal was innovating through products with specific formulations to address Indian traditions and needs. In 2009, L’Oréal introduced Garnier Fructis Shampoo + Oil 2 in 1. Regular use of hair oil to condition hair was commonplace in India. A revolutionary product that L’Oréal developed for India was the Garnier Easy Rinse shampoo. In the rural parts of India, and even among the masses in urban India, water availability was a regular problem. Showers were uncommon in the homes of the lower middle class; instead, they bathed using buckets of water. The Easy Rinse shampoo was developed to rinse out with just two mugs of water, enabling those without showers to conveniently incorporate the shampoo into their lifestyles. Additionally, it was sold in sachets rather than large, expensive bottles. Many people used these sachets for two or three washes, depending on the size of the sachet.30 Garnier shampoos and conditioners were available in ₹3 and ₹4 sachets and were a huge success in India.31 Skincare and Fairness Market L’Oréal entered the skincare market with its Wrinkle Lift Anti-Ageing Cream in 1995, which was unsuccessful in a market that had not yet been primed for basic skincare and was not interested in anti- aging skincare. Since that product, Garnier had introduced moisturizers, sun-protection creams, face wash, and other anti-aging products, all within the skincare market.
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Page 7 9B17M146 In 2004, it launched Light Ultra by Garnier Skin Naturals, its first anti-blemish cream product in India, which combined a sun filter, an exfoliate, and anti-oxidants. It also offered Light Eye Roll-On to brighten eye contours. The latter became the bestselling product in the market in the skincare segment.32 By 2012, while Hindustan Unilever had 58 per cent of the skincare market, L’Oréal was second, with 13 per cent, P&G was at 10 per cent, and Emami was at 9 per cent.33 Despite entering the market around 40 years after skincare giants such as Nivea, Pond’s, and Lakmé, L’Oréal had the second-largest market share in the skincare segment. Veering into the fairness market, Hindustan Unilever’s Fair & Lovely, launched in 1978, was the first fairness cream in India. In 2013, it had close to a 55 per cent share of the fairness market.34 In a country where lighter skin colour was seen as a virtue, not just women but even men were conscious of skin colour. Emami launched Fair and Handsome in 2005 to capitalize on the growing use of Fair & Lovely by men in India. A few years later, in 2009, L’Oréal launched its own men’s skincare line. Garnier Men PowerLight cream, a non-greasy lightening cream with a fairness scale to measure the result, became extremely popular in India. Famous model and actor John Abraham promoted this brand, which did tremendously well in just a few months, and became the number-two men’s skincare brand in India.35 With the Garnier shampoo and conditioner sachets being a huge success, L’Oréal developed and introduced a 7.5-millilitre sachet of Garnier Light Fairness Moisturiser for ₹12. L’Oréal’s Garnier hired Bollywood actresses Priyanka Chopra, Deepika Padukone, Alia Bhatt, and Chitrangada Singh, among others, to endorse its products and attract the attention of Indian consumers. However, being a brand for the middle classes, it also used non-celebrities in its advertisements in order to identify itself as a product for anyone, and not neglect mass-market consumers. Makeup In 1998, L’Oréal launched Maybelline New York, a mass-market cosmetics brand, tapping into the young female segment in India. Lakmé, since 1952, had catered to mass-market consumers, offering products at prices within their reach. The Indian cosmetics market was led by Lakmé, with a 17.7 per cent share in 2012, followed by L’Oréal India, Modi Revlon, and Oriflame.36 Maybelline was the only brand competing directly with Lakmé in catering to the more budget-sensitive market. All the other cosmetics brands of L’Oréal, such as Lancôme, and other company brands such as Revlon and Chambor, were premium, targeting luxury consumers at the upper end of the spectrum.37 Innovating for the Indian market, in 2011, Maybelline launched Colossal Kajal, a kohl pencil developed for Indian consumers. In just one year, by 2012, it had become L’Oréal India’s bestselling makeup product.38 GOING FORWARD L’Oréal, globally and through its India division, continued to proactively research and develop newer products for the market, aggressively market its products, and build up its manufacturing units in India. In early 2013, L’Oréal India opened research and innovation laboratories in Mumbai and Bangalore for researchers and scientists to work together to develop new India-centric products.39 It had also launched a phytochemistry laboratory in Bangalore for research on herbal and Ayurvedic ingredients and how they could be used to develop new products and categories for India.40
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Page 8 9B17M146 L’Oréal India was making all the right moves. However, concurrently, its competitors were also finding success (see Exhibit 5). The beauty “arms race” continued, and all these companies struggled in never- ending competition. Those that were not intuitive or reactive enough lagged behind and were surpassed. Companies within the beauty market that had been hitherto focusing on one segment were moving into newer segments. Among all these various initiatives by companies competing with L’Oréal in all the different areas of the beauty market, would the company continue to reap success in India? What did L’Oréal need to do to further develop its market and brands in India? How could it stay ahead of others in the hair-care, skincare, makeup, and professional product markets in India? How could L’Oréal grow and strengthen its distribution network and loyalty in India and beat competitors such as Hindustan Unilever Limited (HUL) and P&G who were now entering the professional hair-care market?
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Page 9 9B17M146
EXHIBIT 1: WORLDWIDE DISTRIBUTION OF L’ORÉAL’S OPERATIONS
Research and Evaluation Centres
L'Oréal Production Sites
Country Number Country Number
France 12 United States 7
United States 3 France 10
Brazil 1 Canada 2
China 1 Spain 1
Japan 2 Mexico 1
India 1 Germany 1
Indonesia 1 Poland 1
Sweden 1 Belgium 1
Brazil 1
Israel 1
Japan 1
Indonesia 1
India 1
China 2
Russia 1
Turkey 1
South Africa 1
Sweden 1
Source: L’Oréal, Registration Document 2012: Annual Financial Report, accessed August 5, 2016, www.loreal- finance.com/_docs/pdf/rapport-annuel/2012/LOREAL_Document-de-Reference-2012_GB.pdf.
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EXHIBIT 2: L’ORÉAL’S BUSINESS GLOBALLY AND IN INDIA
Source: L’Oréal, accessed July 7, 2016, www.loreal.com; L’Oréal India, accessed July 7, 2016, www.loreal.co.in.
Cosmetics The Body Shop Dermatology
Professional Consumer L'Oréal Active
The L'Oréal Group
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EXHIBIT 3: BREAKDOWN OF COSMETICS SALES BY REGION
Note: IFRS = International Financial Reporting Standards Source: L’Oréal, Annual Report 2016, accessed January 5, 2017, www.loreal-finance.com/en/annual-report-2016/key-figures; L’Oréal, “2006 Financial Highlights,” accessed January 5, 2017, www.loreal- finance.com/_docs/rapport/2006/us/2006_Financial_highlights.pdf; L’Oréal, “Financial Highlights 2004,” accessed January 5, 2017, www.loreal-finance.com/_docs/rapport/2004/us/Financial_highlights.pdf; L’Oréal, “Financial Highlights 2002,” accessed January 5, 2017, www.loreal-finance.com/_docs/rapport/2002/us/04_FINANCIAL_HIGHLIGHTS.pdf.
EXHIBIT 4: MARKET SHARE—FMCG MARKET IN INDIA, MARCH 2013
Market share of companies in a few FMCG categories
Hair Oil Marico (42%) Dabur (15%) Bajaj (8%) Emami (5%)
Shampoo HUL (46%) P&G (24%) CavinKare (10%) Dabur (6%)
Skincare HUL (59%) Dabur (7%) Emami (7%) L’Oréal (6%) Note: FMCG = fast-moving consumer goods. Source: AFS Action, Research Report: Indian FMCG Industry (July 30, 2013), accessed July 7, 2016, http://reports.dionglobal.in/Actionfinadmin/Reports/FDR0108201343.pdf.
0%
20%
40%
60%
80%
100%
Rest of the World
North America
Western Europe
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EXHIBIT 5: L’ORÉAL’S COMPETITION IN INDIA
MULTINATIONAL COMPANIES
COMPANY ENTRY INTO INDIA
Hindustan Unilever
Unilever set up its first Indian subsidiary in 1931, and over the years developed a presence in the entire gamut of consumer products. It became Hindustan Unilever (HUL) in 1956, with the merger of Hindustan Vanaspati Manufacturing Company, Lever Brothers India Limited, and United Traders Limited. It owned skincare brand Pond’s, which had been in India since 1947, and local brand Lakmé, established in 1952, and leading what was estimated to be a ₹25 billion cosmetics market as of 2014 with a 30 per cent share. HUL had a long presence in these markets. In 1978, it launched Fair & Lovely, the first fairness cream in India. Its hair-care brands Sunsilk, Clear, Clinic Plus, and Dove, which were introduced in India in 1964, 1972, 1988, and 1993, respectively, together claimed a 50 per cent share of the ₹40 billion shampoo market as of 2013.
Nivea Nivea, an affiliate company of Germany’s Beiersdorf, had been in India since the 1930s and sold skincare products such as creams, moisturizers, face wash, deodorant, lip balms, and bath-care products. In 2014, the company was still importing almost 60 per cent of its products to India, which prevented it from offering more affordable products to reach out to the masses. To increase its competitiveness in India, the company was setting up a factory and R&D centre in the region. The brand was branching out into the anti-aging, sun-care, and men’s care products as well, aiming to grab more market share in India, and thus becoming a direct competitor to many of L’Oréal’s brands.
Procter & Gamble
P&G entered India in 1964 with a range of consumer products, and competed against L’Oréal in the shampoo, skincare, and professional hair-care and hair-colour markets. Pantene and Head & Shoulders, launched in India in 1995 and 1997, respectively, together held a 30 per cent share of the ₹40 billion shampoo market in 2013.
Revlon Revlon entered India in 1995 and competed in the cosmetics, nail-paint, perfumes, hair-colour, and shampoo markets, competing most directly with L’Oréal in the cosmetics segment, with a 14 per cent market share as of 2014.
Oriflame India
The Swedish direct-sales company Oriflame Cosmetics set up operations in India in 1995, and sold skincare, colour cosmetics, hair-care, and health and wellness products through its sales representatives, which numbered 250,000 in 2013. It was the largest direct-selling cosmetics company in India.
Henkel Cosmetics
Henkel introduced professional hair-care brand Schwarzkopf Professional to India in 2003 and by 2013 had tie-ups with almost 5,000 salons, capturing an 18 per cent share in the professional hair-care market.
Estée Lauder
Estée Lauder entered India in 2005 with its premium cosmetics brands Estée Lauder, Clinique, and MAC. In 2008, aware of the growing interest in products with natural ingredients, it acquired a 20 per cent stake in the Indian luxury Ayurveda brand Forest Essentials.
Avon Avon, one of the largest direct-selling companies in the world, marketing and selling its products through sales representatives, had a range of products in India, ranging from cosmetics and skincare products for men and women, to body soap, fragrances, and hair-care products.
Chambor Cosmetics and skincare products had been distributed and marketed by Baccarose in India since 1993 and 2006, respectively.
Shiseido The Japanese premium brand Shiseido had been in India since 2001. In 2013, it established a wholly owned subsidiary in India to have closer contact with the market and to sell a new makeup and skincare brand, Za, targeted toward aspirational middle-income consumers—the fastest-growing segment in the market.
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EXHIBIT 5 (CONTINUED)
HOMEGROWN COMPANIES
COMPANY ENTRY INTO INDIA
Dabur
Set up in 1884 to develop Ayurveda-based health products, Dabur entered the hair-care market in 1940 with its Dabur Amla Hair Oil. Its Vatika shampoo range and hair oils, and its Uveda and Gulabari skincare products, were based on herbal and Ayurveda formulas that were traditional to India.
Godrej
The Godrej Liquid and Powder Hair Dyes were launched in the 1970s and 1981, respectively. Godrej, a local Indian company, dominated the Indian hair-colour market with its leading brand, Godrej Expert, which had evolved out of its initial hair dyes. This was an ammonia-free hair- colour range offered in cream or powder form and with conditioners and herbal ingredients such as henna and amla. Godrej Expert Powder Hair Dye was the bestselling hair dye in the world, available in a sachet format that the company pioneered in 1995, and selling for one- tenth the price of L’Oréal’s cream hair product, thus meeting the needs of low-income customers. The cream form, offered in a sachet as well, was developed in 2012. Renew was another Godrej brand that offered fashion hair colours and Nupur was a henna hair-colour brand.
Shahnaz Herbals Group
Launched in 1970, this company developed Ayurveda beauty and care products such as face masks, hair lotions, hair oil, skin creams, cosmetics, sun-care creams, and fairness creams, as well as men’s shaving, hair, and face products.
Emami
Emami, established in 1974, manufactured health, personal, and beauty products based on Ayurveda formulations. It competed with L’Oréal in the hair oil market with Emami and Navratna. It led the men’s fairness market with its Fair and Handsome cream, launched in 2005.
CavinKare
CavinKare started in 1983 with the Chik brand of shampoo, selling in small sachets, a form of packaging introduced for the first time in India at the time. CavinKare quickly amassed the rural market for which shampoo had previously been mostly out of reach and too pricey. It was the first company to develop a product for this entirely unpenetrated market. In 2012, 87 per cent of the shampoos sold in India were in sachet packaging and CavinKare had around a 30 per cent share of this. Over the years, the company had launched other hair-care brands such as Meera shampoo in 1991, Nyle shampoo in 1993, and Karthika shampoo in 2007. The company forayed into the fairness market with Fairever in 1998 and into the hair-colour market with Indica in 1998, and opened two salon chains called Limelite and Green Trends. It launched a professional hair product brand called Raaga Professional in 2010. In 2012, CavinKare had a 5 per cent share of the Indian skincare market and an 11 per cent share of the shampoo market.
Ayur Since its inception in 1984, it had been innovating hair and skin products strictly formulated from natural herbal ingredients.
Marico
Marico was born out of the company Bombay Oil Industries in 1990, with its already established hair oil brand Parachute. It forayed into diverse and multiple markets, including skincare through the Parachute brand, and hair care, establishing Nihar Naturals in 2003 and Hair & Care for hair oils in 2005.
Biotique Founded in 1992, the company combined ancient Ayurveda-based formulas made 100 per cent from natural botanicals (with no chemicals, preservatives, or animal testing) with new-age biotechnology, to develop skincare, hair, body, makeup, baby, and men’s beauty products.
Lotus Herbals
Set up in 1993, Lotus Herbals was an herbal cosmetics and skincare manufacturing company that spent a large portion of its resources on research and development. Its bestselling brand, Whiteglow, a skin-whitening cream launched in 2011, had the highest growth among premium fairness creams in India, surpassing Olay, Pond’s, and Garnier, with a 12 per cent market share in this segment. In the sun-protection category, Lotus was the second-largest brand, following Lakmé.
Colorbar Cosmetics
Founded in 2004 in India, Colorbar differentiated itself by becoming the first home-grown brand to offer the same excellent buyer experience for premium-range makeup products as that of international brands.
Note: R&D = Research and Development. Source: Public sources.41
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Page 14 9B17M146 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 L’Oréal or any of its employees. 2 ₹ = INR = Indian rupee; all currency amounts are in Indian rupees or U.S. dollars unless otherwise specified; US$ = ₹63.18 on December 31, 2014. 3 Simon Pitman, “India Market for Cosmetics Could Double in Value by 2014,” CosmeticsDesign-Asia.com, December 7, 2011, accessed July 7, 2016, www.cosmeticsdesign-asia.com/Market-Trends/India-market-for-cosmetics-could-double-in-value-by- 2014. 4 Natalia Ningthoujam, “Indian Cosmetics Market Booming; Spells Profits for Global Brands (2013 in Retrospect),” Business Standard, December 26, 2013, accessed August 9, 2016, www.business-standard.com/article/news-ians/indian-cosmetics- market-booming-spells-profits-for-global-brands-2013-in-retrospect-113122600358_1.html. 5 National Sample Survey Office, Ministry of Statistics and Programme Implementation, Government of India, Key Indicators of Employment and Unemployment in India, 2009–2010 (June 30, 2011), accessed August 9, 2016, http://mail.mospi.gov.in/index.php/catalog/143/download/1637. 6 Ratna Bhushan, “Modi Revlon’s New Brand to Target Mass Market, Take on Rivals Like Lakme, L’Oréal,” The Economic Times, March 17, 2014, accessed August 9, 2016, http://articles.economictimes.indiatimes.com/2014-03- 17/news/48297545_1_modi-revlon-colour-cosmetics-shiseido. 7 Ibid. 8 Ibid. 9 Sayantani Kar, “Garn(i)ering Volumes,” Business Standard, October 18, 2010, accessed August 21, 2016, www.business- standard.com/article/management/garn-i-ering-volumes-110101800034_1.html. 10 Ruchita Saxena, “L’Oréal India’s Beauty Grows with Time,” Business Standard, March 24, 2008, accessed August 21, 2016, www.business-standard.com/article/companies/l-oreal-india-s-beauty-grows-with-time-108032401075_1.html. 11 Kar, op. cit. 12 Christina Passariello, “Behind L’Oréal’s Makeover in India: Going Upscale,” Wall Street Journal, July 13, 2007, accessed August 21, 2016, www.wsj.com/articles/SB118427165113365012. 13 Ibid. 14 Bindu D. Menon, “When Age Cannot Wither,” Business Line, November 21, 2013, accessed August 21, 2016, www.thehindubusinessline.com/features/weekend-life/when-age-cannot-wither/article5372501.ece. 15 Passariello, op. cit. 16 Ibid. 17 Viveat Susan Pinto, “L’Oréal Refurbishes Shampoo Range to Take on HUL, P&G,” Business Standard, September 21, 2013, accessed August 21, 2016, www.business-standard.com/article/companies/L’Oréal-refurbishes-shampoo-range-takes- on-hul-p-g-113091700826_1.html. 18 Rama Bijapurkar, A Never-Before World (India: Penguin Books, 2013). 19 Mrinalini Reddy, “Indo-vation: Tapping the Indian Market,” INSEAD Knowledge, November 25, 2010, accessed September 1, 2016, https://knowledge.insead.edu/business-finance/marketing/indo-vation-tapping-the-indian-market-797. 20 Viveat Susan Pinto, “Our Turnover Will Cross Rs 2,000 cr by Year-End: Jean-Christophe Letellier,” Business Standard, June 30, 2014, accessed September 1, 2016, www.business-standard.com/article/companies/our-turnover-will-cross-rs-2- 000-cr-by-year-end-jean-christophe-letellier-114063000048_1.html. 21 Passariello, op. cit. 22 L’Oréal, Annual Report 2005, accessed September 1, 2016, www.LOreal-finance.com/eng/annual-report-2005. 23 Reddy, op. cit. 24 L’Oréal, Annual Report 2011, accessed September 1, 2016, www.loreal-finance.com/eng/annual-report-2011. 25 “P&G India Brands,” P&G, accessed September 1, 2016, https://www.pg.com/en_IN/brands/pg_india_brands.shtml. 26 Purvita Chatterjee, “Henkel Cosmetics to Double Schwarzkopf Professional Salons,” Business Line, January 16, 2013, accessed September 3, 2016, www.thehindubusinessline.com/marketing/henkel-cosmetics-to-double-schwarzkopf- professional-salons/article4313211.ece. 27 “Developing the Hair Salon Industry in India,” L’Oréal.com, accessed September 3, 2016, www.loreal.com/beauty-in- india/LOreal-in-india/developing-the-hair-salon-industry-in-india.aspx. 28 L’Oréal, Annual Report 2011, op. cit. 29 Sapna Agarwal, “L’Oréal India Plans to Take Mass Market Route in Growth Efforts,” Live Mint, December 3, 2013, accessed September 3, 2016, www.livemint.com/Companies/pPi8sRESJKWJ1NyMvJIOqI/L’Oréal-India-plans-to-take-mass-market- route-in-growth-effo.html. 30 Preeti Khicha, “Consumers Lead the Way,” Business Standard, September 21, 2011, accessed September 3, 2016, www.business-standard.com/article/management/consumers-lead-the-way-111092100046_1.html. 31 Bindu D. Menon, “L’Oréal Takes to Sachets,” Business Line, April 30, 2009, accessed September 3, 2016, www.thehindubusinessline.com/todays-paper/tp-marketing/L’Oréal-takes-to-sachets/article1050435.ece. 32 L’Oréal, Annual Report 2009, accessed September 3, 2016, www.loreal-finance.com/eng/annual-report-2009. 33 Sangeetha Kandavel, “Can CavinKare Rediscover Growth in FMCG Space?” The Economic Times, May 6, 2012, accessed September 3, 2016, http://articles.economictimes.indiatimes.com/2012-05-06/news/31588235_1_cavinkare-shampoo- market-fmcg-sector.
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Page 15 9B17M146 34 Viveat Susan Pinto, “Worry Lines Appear on F&L,” Business Standard, August 1, 2013, accessed September 3, 2016, www.business-standard.com/article/management/worry-lines-appear-on-f-l-113080100035_1.html. 35 L’Oréal, Annual Report 2009, op. cit. 36 Pia Heikkila, “A Makeover for India’s Cosmetics Industry,” The National, April 22, 2012, accessed September 3, 2016, www.thenational.ae/business/industry-insights/retail/a-makeover-for-indias-cosmetics-industry#page2. 37 Pinto, “Our Turnover Will Cross Rs 2,000 cr by Year-End,” op, cit. 38 Rashmi K. Pratap, “The Eyes Have It,” Outlook Business, July 7, 2012, accessed September 3, 2016, www.outlookbusiness.com/specials/youth-inc/the-eyes-have-it-1148. 39 Avantika Chilkoti, “L’Oréal, India & Aishwarya Rai,” Financial Times, January 14, 2013, accessed September 10, 2016, http://blogs.ft.com/beyond-brics/2013/01/14/loreal-india-aishwarya-rai. 40 Pinto, “Our Turnover Will Cross Rs 2,000 cr by Year-End,” op. cit. 41 “Our Brands,” Hindustan Unilever Limited, accessed September 10, 2016, https://www.hul.co.in/brands/?brand=413664- 41003; Prince Mathews Thomas, “The Rise of ColorBar,” Forbes India, January 15, 2014, accessed September 10, 2016, http://forbesindia.com/article/boardroom/the-rise-of-colorbar/36895/1; Pinto, “L’Oréal Refurbishes Shampoo Range to Take on HUL, P&G,” op. cit.; “Nivea to Set up First Plant in India at Sanand,” The Economic Times, June 23, 2014, accessed September 10, 2016, http://articles.economictimes.indiatimes.com/2014-06-23/news/50798379_1_nivea-india-rd-center- rakshit-hargave; “Modi-Revlon to Open 100 Stores in India in Three Years,” Economic Times, March 21, 2014, accessed October 21, 2016, http://economictimes.indiatimes.com/industry/cons-products/fashion-/-cosmetics-/-jewellery/modi-revlon- to-open-100-stores-in-india-in-three-years/articleshow/32432620.cms; Shinmin Bali, “Oriflame India Sees ‘Great Opportunity’ in Men’s Products,” Campaign India, August 4, 2014, accessed October 21, 2016, www.campaignindia.in/Article/389654,oriflame-india-sees-8216great-opportunity8217-in-men8217s-products.aspx; “Oriflame Aims to Double India Revenues by 2016,” Economic Times, June 2, 2013, accessed October 21, 2016, http://articles.economictimes.indiatimes.com/2013-06-02/news/39691031_1_oriflame-india-indian-market-hair-care; Chatterjee, op. cit.; “About Us,” Baccarose.com, accessed October 21, 2016, http://baccarose.com/chambor/index.html; Italian Trade Commission, The Cosmetic & Personal Care Sector in India (2008), accessed October 21, 2016, http://italiaindia.com/images/uploads/pdf/cosmetics-personal-care%20-2008.pdf; Shantanu Jain, “Shiseido Celebrates Official Establishment of Shiseido India Pvt. Ltd,” Everything Experiential, March 26, 2014, accessed October 21, 2016, http://everythingexperiential.businessworld.in/article/Shiseido-celebrates-official-establishment-of-Shiseido-India-Pvt-Ltd-/26- 03-2014-101839; “One of the Best Ayurvedic Company—Dabur Corporate Profile,” Dabur, accessed October 21, 2016, www.dabur.com/in/en-us/about/aboutus/dabur-ayurvedic-company; Jonathan Moules, “The Godrej Group: Good-Quality Products Can Be Made for Low Earners,” Financial Times, June 10, 2013, accessed October 21, 2016, www.ft.com/intl/cms/s/0/62a453e2-b704-11e2-841e-00144feabdc0.html#axzz3SHH3cago; “Nupur,” Godrej Consumer Products, accessed October 21, 2016, www.godrejcp.com/exports/brands/hair-care/nupur-2.aspx; Kandavel, op. cit.; T. E. Narasimhan, “Low-Cost Warrior CavinKare Reboots for Better Profits,” Business Standard, June 10, 2013, accessed October 21, 2016, www.business-standard.com/article/companies/low-cost-warrior-cavinkare-reboots-for-better-profits- 113061001048_1.html; Ratna Bhushan, “Lotus Herbals Doesn’t Need Any Funding: Scion Nitin Passi,” Economic Times, October 17, 2014, accessed October 21, 2016, http://articles.economictimes.indiatimes.com/2014-10- 17/news/55148411_1_india-equity-partners-lotus-herbals-private-equity-funding.
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9B15M047
LARSON INC. IN NIGERIA Professor Paul W. Beamish revised this case (originally prepared by Professor I.A. Litvak) 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) [email protected]; www.iveycases.com. Copyright © 2015, Richard Ivey School of Business Foundation Version: 2015-04-09
David Larson, vice-president of international operations for Larson Inc., was mulling over the decisions he was required to make regarding the company’s Nigerian operation. He was disturbed by the negative tone of the report sent to him on January 04, 2015, by the chief executive officer (CEO) of the Nigerian affiliate, George Ridley (see Exhibit 1). Larson believed the future prospects for Nigeria were excellent and was concerned about what action he should take. COMPANY BACKGROUND Larson Inc. was a New York-based multinational corporation in the wire and cable business. Wholly- owned subsidiaries were located in Canada and the United Kingdom, while Mexico, Venezuela, Australia, and Nigeria were the sites of joint ventures. Other countries around the world were serviced through exports from the parent or one of its subsidiaries. The parent company was established in 1925 by David Larson’s grandfather. Ownership and management of the company remained in the hands of the Larson family and was highly centralized. The annual sales volume for the corporation worldwide approximated $936 million in 2014. Revenue was primarily generated from the sale of power, communication, construction and control cables. Technical service was an important part of Larson Inc.’s product package; therefore, the company maintained a large force of engineers to consult with customers and occasionally supervise installation. As a consequence, licensing was really not a viable method of serving foreign markets. BACKGROUND ON NIGERIA Nigeria is located in the west-central part of the African continent. With 178.5 million people in 2014, it was the most populous country in Africa and the seventh most populous nation in the world. Population growth was estimated at 2.8 per cent annually. About 44 per cent of the population was under 15 years of age. A majority of the labor force in Nigeria worked in agriculture but there was a trend of more people moving to urban centres. The gross domestic product in 2014 was about $510 billion, making it the largest economy in Africa. While per capita GDP was about $3000, on a purchasing power parity basis it was substantially higher at
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Page 2 9B15M047 $ 5676. GDP had grown from 2005 to 2014 at about six per cent annually. This increase was fueled in part by growth in services and the export sales of Nigeria’s oil reserves. During the 2005 to 2014 period, Nigeria’s average annual inflation rate had been 10.3 per cent. This high level had contributed to the change in the value of the naira from about 132 to the U.S. dollar in 2005 to about 165 to the U.S. dollar in 2014. THE NIGERIAN OPERATION Larson Inc. established a joint venture in Nigeria in 2005 with a local partner who held 25 per cent of the joint venture’s equity. Sales revenue for the Nigerian firm totalled $45 million in 2014. Of this revenue, $39.4 million was realized in Nigeria, while $5.6 million was from exports. About 40 per cent of the firm’s Nigerian sales ($16 million) were made to various enterprises and departments of the government of Nigeria. The company was making a reasonable profit of 10 per cent of revenue, but with a little bit of luck and increased efficiency, it was believed it could make a profit of 20 per cent. The Nigerian operation had become less attractive for Larson Inc. in recent months. Although it was widely believed that Nigeria would continue to be one of the key economic players in Africa in the years to come and that the demand for Larson’s products would remain very strong there, doing business in Nigeria was becoming more costly. Furthermore, Larson Inc. had become increasingly unhappy with its local partner in Nigeria, a lawyer who was solely concerned with quick “paybacks” at the expense of reinvestment and long-term growth prospects. David Larson recognized that having the right partner in a joint venture was of paramount importance. The company expected the partner or partners to be actively engaged in the business, “not business people interested in investing money alone.” The partner was also expected to hold a substantial equity in the venture. In the early years of the joint venture, additional funding was often required and it was necessary for the foreign partner to be in a strong financial position. The disillusionment of George Ridley, the Nigerian firm’s chief executive officer (CEO), had been increasing since his early days in that position. He was an expatriate from the United Kingdom who, due to his background as a military officer, placed a high value upon order and control. The chaotic situation in Nigeria proved very trying for him. His problems were further complicated by his inability to attract good, local employees in Nigeria, while his best expatriate staff requested transfers to New York or Larson Inc.’s other foreign operations soon after their arrival in Nigeria. On a number of occasions, Ridley was prompted to suggest to head office that it reconsider its Nigerian commitment. THE DECISION David Larson reflected on the situation. He remained convinced that Larson Inc. should maintain its operations in Nigeria. Larson also wondered what should be done about Ridley. On the one hand, Ridley had been with the company for many years and knew the business intimately; on the other hand, Larson felt that Ridley’s attitude was contributing to the poor morale in the Nigerian firm and wondered if Ridley had lost his sense of adaptability. Larson knew Ridley had to be replaced, but he was unsure about the timing and the method to use, since Ridley was only two years away from retirement. Larson had to come to some conclusions fairly quickly. He had been requested to prepare an action plan for the Nigerian operation for consideration by the board of directors of Larson Inc. in a month’s time. He thought he should start by identifying the key questions, whom he should contact, and how he should handle Ridley in the meantime.
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EXHIBIT 1: THE RIDLEY REPORT In response to the request from head office for a detailed overview of the Nigerian situation and its implications for Larson Inc., Ridley prepared the following report in December, 2014. It attempts to itemize the factors in the Nigerian environment that have contributed to the problems experienced by Larson’s joint venture in Nigeria. Repatriation of Capital 1. While the Nigerian Investment Promotions Commission (NIPC) has removed time constraints and ceilings on
repatriation, the divesting firm still has to submit evidence of valuation. In most cases the valuation is unrealistically low. This has represented substantial real-capital asset losses to the overseas companies concerned.
Remittance 2. A problem regarding remittances has arisen as a result of the 2003 Nigerian Insurance Act, section 67, under
which cargoes due for import to Nigeria have to be insured with a Nigerian-registered insurance company. For cargoes imported without confirmed letters of credit, claims related to cargo loss and damage are paid in Nigeria; however, foreign exchange for remittance to pay the overseas suppliers is not being granted on the grounds that the goods have not arrived.
Problems Affecting Liquidity and Cash Flow 3. A number of problems have arisen during the last two years that are having a serious effect upon liquidity and
cash flow, with the result that the local expenses can be met only by increasing bank borrowing, which is not only an additional cost but also becoming more difficult to obtain.
a) Serious delays exist in obtaining payment from federal and state government departments for supplies and
services provided, even in instances where payment terms are clearly written into the contract concerned. This is particularly true for state governments where payment of many accounts is 12 months or more in arrears. Even after payment, further delays and exchange-rate losses are experienced in obtaining foreign currency for the part that is remittable abroad. This deterioration in cash flow from government clients had, in turn, permeated through to the private clients.
b) There is a requirement that a 100 per cent deposit be made on application for foreign currency to cover letters of credit.
c) In order to clear the cargo as soon as possible and to avoid possible loss at the wharf, importers normally pay their customs duty before a ship arrives.
F
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EXHIBIT 1 (CONTINUED)
d) Most company profits are taxed at a flat rate of 30 per cent. Firms operating in Nigeria must contend with a number of arbitrary levies and taxes, imposed mainly by state governments eager to augment their extremely thin revenue bases. The federal government attempted to put a halt to such practices by specifying which taxes all three (federal, state and local) tiers of government can collect, but it has not been entirely successful in enforcing compliance. Tax authorities are constantly trying to “trip up” companies in the course of inspections or audits, through their “interpretation” of the tax legislation. Consequently, net earnings after tax are insufficient to cover increased working capital requirements.
Incomes and Prices Policy Guidelines 4. Many of the guidelines issued by the Productivity, Prices and Incomes Board are of direct discouragement, as
they make operations in Nigeria increasingly less attractive in comparison with other areas in the world. Although these guidelines were removed, increases for wage, salary, fees for professional services and auditing are still subject to final government approval.
Offshore Technical and Management Services 5. Restrictions on the reimbursement of expenses to the parent company for offshore management and technical
services are a cause of great concern, since such services are costly to provide. Professional Fees 6. The whole position regarding fees for professional services provided from overseas is most unsatisfactory. Not
only are the federal government scales substantially lower than those in most other countries, but also the basis of the project cost applied in Nigeria is out of keeping with normally accepted international practice. The arbitrary restriction on the percentage of fees that may be remitted is a further disincentive to attracting professional services. Moreover, payment of professional fees in themselves produces cash flow problems exacerbated by long delays in payments and remittance approvals.
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EXHIBIT 1 (CONTINUED) Royalties and Trademarks 7. The National Office of Technology Acquisition and Promotion (NOTAP) restricts the payment of royalties for
the use of trademarks for a period of 10 years, which is out of keeping with the generally accepted international practice. This can be extended only under special cases. Limits for licensing and technical service fees are between one per cent to five per cent of net sales. Management fees are chargeable at two per cent to five per cent of a company’s profit before tax (or one per cent to two per cent of net sales when no profits are anticipated during the early years). The maximum foreign share of consulting fees is five per cent. Such applications, however, are only granted for advanced technology projects for which indigenous technology is not available. Further, service agreements for such projects have to include a schedule of training for Nigerian personnel for eventual takeover and Nigerian professionals are required to be involved in the project from inception.
Quotas, Work Permits, and Entry Visas 8. It must be recognized that expatriate expertise is a very important element for this business, but expatriate staff
is very costly. Unfortunately, at the present time there are a number of difficulties and frustrations, such as the arbitrary cuts in expatriate quotas, the delays in approving quota renewal, and in some cases, the refusal of entry visas and work permits for individuals required for work in Nigeria. Expatriate quotas are usually granted for two to three years subject to renewal.
Expatriate Staff 9. In general, the conditions of employment and life in Nigeria are regarded as unattractive when compared with
conditions in many other countries competing for the same expertise. These differences are due to: the general deterioration of law and order; the rising security threats from the Boko Haram insurgency; the restrictions on salary increase and home remittance; the difficulties in buying air tickets; the poor standard of health care; the unsatisfactory state of public utilities such as electricity and water; the harassment from the police, airport authorities and other government officials; the general frustrations related to visas and work permits mentioned above. The situation has now reached a stage where not only is recruitment of suitably qualified, skilled experts becoming increasingly difficult, but we are also faced with resignations and refusals to renew contracts even by individuals who have worked and lived here for some years. Furthermore, the uncertainty over the length of time for which employment in Nigeria will be available (due to doubts whether the necessary expatriate quotas will continue to be available to the employer) is most unsettling to existing staff. This and the restriction of contracts to as little as two years are important factors in deterring the more highly qualified applicants from considering posts in Nigeria. These factors are resulting in a decline in the quality of expatriate staff it is possible to recruit.
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2 4 , 2 0 2 0 t o D
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EXHIBIT 1 (CONTINUED) Local Staff 10. Nigeria has one of the strongest national unions in Africa — the Nigeria Labour Congress (NLC). It is almost
impossible to discipline a worker without attracting confrontation with the union. On certain occasions, some union members can be very militant. The union is also continuously attacking the employment of expatriates and trying to replace them with Nigerian staff.
11. Inadequate local technical training leads to low quality workers who tend to be lazy and not quality conscious. 12. The desirability of maintaining a tribal balance in the work force limits the options in recruiting the best
workers. 13. Nigerian companies suffer heavily from pilferage, which normally accounts for two per cent of sales. Public Utilities 14. The constant interruption in public utility services not only affects the morale of all employees but also has a
very serious impact upon the operation of the business itself. Unless reasonable and continuing supplies of electricity, water, and petroleum products can be assured, and the highway adequately maintained, the costs related to setting up and operating escalate.
Continuity of Operating Conditions 15. The general and growing feeling of uncertainty about the continuity of operating conditions is a matter of
considerable concern. It would seem that this uncertainty is engendered by a whole range of matters related to: short notice changes (sometimes even retrospective) in legislation and regulations; imprecise definition of legislation and regulations, which leads to long periods of negotiation and uncertainty; delays between public announcement of measures and promulgation of how they are to be implemented; and sometimes inconsistent interpretation of legislation and regulations by Nigerian officials.
Government Officials 16. Foreign partners have to rely on their Nigerian counterpart to handle the government officials. But it is
impossible to measure its performance nor to control its expense in these activities. In addition, carefully cultivated relationships with officials could disappear, as they are transferred frequently.
Bribery 17. Surrounding many of the problems previously listed is the pervasive practice of bribery, known locally as the
dash. Without such a payment it is very difficult to complete business or government transactions with native Nigerians.
Terrorism 18. Since 2009, Boko Haram’s activities have caused a significant threat to our operation and to the security of our
employees, especially expatriates. The militancy and strength of the terrorist group have been on a steady rise and foreign companies and nationals have traditionally been its main targets.
F o r
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90
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