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Cases.pdf
1.
SCMT 403 Supply Chain Planning and Coordination Cheuk "Chuck" Law
SCMT 403 CC01/Fall 2018 MacEwan University
Table of Contents
Holt Renfrew.....................................................................................................................................5
Dabbawallahs of Mumbai (A)............................................................................................................9
Dabbawallahs of Mumbai (B)..........................................................................................................29
ECCO A/S - Global Value Chain Management...............................................................................33
Lego Group: An Outsourcing Journey............................................................................................55
Strategic Sourcing at Whirlpool China: Finding the Ideal Supplier.................................................71
Building Sustainable Distribution at Walmart Canada....................................................................79
Elizabeth Arden: Executing Global Supply Chain Re-engineering.................................................89
Apple Inc.: Managing a Global Supply Chain...............................................................................101
3M Canada: The Health Care Supply Chain.................................................................................123
Boeing: The Case for Supplier Diversity.......................................................................................133
Amazon Go: Venturing into Traditional Retail...............................................................................145
Crocs: Revolutionizing an Industry's Supply Chain Model for Competitive Advantage................157
McDonald's India: Optimizing the French Fries Supply Chain......................................................179
The North West Company (B): Supply Chain Management.........................................................195
Rosenbluth: Supply Chain Management in Services....................................................................203
SCMT 403 Supply Chain Planning and Coordination SCMT 403 CC01/Fall 2018
Cheuk "Chuck" Law MacEwan University
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9B04D011 DABBAWALLAHS OF MUMBAI (A) Ramasastry Chandrasekhar prepared this case under the supervision of Professor Larry Menor solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected]. Copyright © 2004, Ivey Management Services Version: (A) 2009-10-09 INTRODUCTION On November 7, 2003, Raghunath Medge, president of the Nutan Mumbai Tiffin Box Suppliers Charity Trust (the Trust), had just returned to his office in suburban Mumbai after meeting with Britain’s Prince Charles who was on an official visit to India’s commercial capital. The Trust was the managing organization of the dabbawallah meal delivery network (see Exhibit 1). The dabbawallahs’ service, often referred to as tiffinwallahs outside of Mumbai, was cited internationally by management scholars and industry executives as an exemplar of supply chain and service management. The service had acquired a reputation for its delivery reliability in Mumbai. International interest in the dabbawallahs was largely due to a 1998 article published in Forbes:1
Mumbai’s “tiffinwallahs” have achieved a level of service to which Western businesses can only aspire. “Efficient organization” is not the first thought that comes to mind in India, but when the profit motive is given free rein, anything is possible. To appreciate Indian efficiency at its best, watch the tiffinwallahs at work.
Documentaries on the dabbawallahs were produced by the BBC, MTV and ZEE TV, and their delivery performance earned them recognition in the Guinness Book of World Records and Ripley’s Believe It or Not! Medge, who had personally demonstrated to Prince Charles how the dabbawallah meal delivery system worked, was himself in the spotlight of late. He had recently been invited by the Confederation of Indian Industry to speak to its members at a leadership summit in a special module titled “Leading Without Suits and Ties.” He was also approached by human resource executives and asked to present seminars on team building. Additionally, he was asked by corporations, such as Siemens India, to make a presentation to their employees on the dabbawallahs’ working practices. Finally, he was also regularly sought by the print and television media within and outside of India. 1Subrata N. Chakravarty and Nazneen Karmali, “Fast Food,” Forbes Global, October 8, 1998.
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Page 2 9B04D011 Medge had begun to see a pattern in his interactions with these diverse audiences. The questions he was asked were, by and large, predictable. Typical queries revolved around the dabbawallahs’ workforce, customers and strategy: • How do the dabbawallahs find recruits? • How can an incentive system based on “equal pay for all” work? • Do the dabbawallahs know their clients? • How does the dabbawallah system ensure that the individual links in the delivery network do not break
down? • How is the Trust dealing with the issue of growth? • How is the Trust coping with dabbawallah competitors? • The world around you is changing but the dabbawallahs have not changed; why not? The question that Medge was asked most often — and which amused him the most — was: Is there a future for the dabbawallahs? Based on his own personal experience over the last three decades, Medge had developed a standard response to this particular question. HISTORY OF THE DABBAWALLAHS The dabbawallah service had begun informally in 1890 in Mumbai. According to Medge:
A Parsi banker working in Ballard Pier employed a young man, who came down from the Poona district to fetch his lunch every day. Business picked up through referrals and soon our pioneer dabba-carrying entrepreneur had to call for more helping hands from his village. Such was the origin of the dabbawallahs. However trivial the task may sound, it is of vital importance since havoc is caused if the client had to skip his home-cooked food or worse, carry the dabba himself in the ever so crowded Mumbai trains during the rush hour!
By the early 20th century, people from all parts of India were migrating to Mumbai in large numbers. Once they found a source of livelihood and settled down, they wanted home-cooked food at their workplaces. Home-cooked food had a comfort level for various reasons. First, the food was prepared in the ambience of a domestic kitchen, with recipes that were tried and tested, and that resulted in familiar fare. Second, home- cooked food was comparatively inexpensive. The dabbawallahs were initially charging two annas per month per dabba for their delivery service.2 Working independently and in small groups for decades, the dabbawallahs had united in 1954 to put together a rudimentary co-operative. This umbrella organization was officially registered in 1956 as a charitable trust under the name Nutan Mumbai Tiffin Box Suppliers Charity Trust. At that time, some of the dabbawallahs employed delivery boys to carry their dabbas and transport them along their routes on bicycles and pushcarts. These dabbawallahs would collect the fees from their clients every month and pay the boys whatever they could negotiate with them. This changed in 1983 when the Trust adopted an owner- partner system. Under this new system, the practice of subcontracting was dispensed with and dabbawallahs started to receive equal earnings. The delivery boys’ system was converted into an
216 annas comprised one rupee (Rs) at that time. The anna was replaced by the paise in 1960, and 100 paise comprised Rs1. As of November 2003, Cdn$ = Rs31.40.
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Page 3 9B04D011 apprenticeship system wherein new recruits were trained for at least two to three years on a fixed remuneration before they became full-time dabbawallahs. By 2003, more than 5,000 dabbawallahs worked under the aegis of the Trust. Together they delivered about 175,000 lunches daily in Mumbai (see Exhibit 2). They served a total area that covered approximately 75 kilometres (km) of public transport. The dabbawallah business generated approximately Rs380 million per annum. Given the two-way route for each dabba, the number of deliveries worked out to more than 350,000 per day. Despite the sheer number of daily deliveries, the failure rate reported by the media numbered one in two months, or one in every 15 million deliveries. The Nutan Mumbai Tiffin Box Suppliers Charity Trust The Trust was responsible for managing the overall meal delivery system. It worked in close co-ordination with the Mumbai Tiffin Box Suppliers’ Association, a forum that provided opportunities for social interactions among the dabbawallahs, and the Dakkhan Mavle Sahakari Patpedhi, a credit union that catered to the financial needs of individual dabbawallahs by providing personal loans. Given its charitable trust status, the Trust was also involved in community initiatives by providing free food and accommodation to low-income families at some pilgrimage centres. The Trust had a three-tier structure: Executive Committee, mukadams and dabbawallahs (see Exhibit 3). Under this structure, the basic operating unit was the team. Each team, which comprised between five and eight dabbawallahs, was headed by a mukadam. Having risen from the ranks of the dabbawallahs, a mukadam’s primary daily responsibility involved the sorting of the dabbas. However, as team leader, the mukadam performed several administrative tasks that included maintaining records of client payments, arbitrating disputes between dabbawallahs and customers, and apprentice training. The mukadam was also in charge of acquiring new clients for the team and managing customer satisfaction. New customers purchased their dabba from the dabbawallahs when service was commenced. Dabbas were typically replaced, at cost to the customer, once every two years. Seven to eight mukadams typically aggregated their efforts and constituted a profit centre; each profit centre was referred to as a “group.” There were about 120 groups in total. While each group was managed autonomously, its members stepped in without hesitation to help other groups in dealing with emergencies such as dabbawallah absenteeism. Monthly group maintenance costs totalled Rs35,000, covering the maintenance of the bicycles, pushcarts and wooden boxes the dabbawallahs used in their daily deliveries. The 13 members of the Executive Committee, which were elected by the general body every five years, co- ordinated the activities of the various groups. The Committee, which undertook all major decisions for the Trust and worked on the principles specified in the Co-operative Societies Act, met on the 15th of each month. Operational issues typically dominated each meeting’s agenda. Examples of such issues included disputes with the Mumbai city railways over dabbawallahs not carrying their monthly passes or the ID issued to them by the Trust, and with the city police when dabbawallahs parked their pushcarts or bicycles where parking was not permitted. Annually, there were few reports of lost or stolen dabbas. In such instances, clients were reimbursed by the individual dabbawallah or given a free dabba. F
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Page 4 9B04D011 Dabbawallah Profile The dabbawallahs were a homogenous group in many ways. Its members, traditionally male, hailed from the same geographical region — known as Mavla — located east of the Sahyadri (Western Ghats) near Pune, and they spoke the same language (Marathi). They shared similar customs and traditions, such as gathering together for a week every April for a festival in their hometown. They wore the same dress, a loose white dhoti shirt, cotton pajamas and their trademark white oval cap. All of these combined to form a distinct local identity for the dabbawallahs. They were easily recognized even in the busiest of locations. Pedestrians and commuters yielded to the dabbawallahs in order not to interfere with their service delivery. Seemingly always in a rush, the dabbawallahs were known for their reliability and work ethic. They ascribed to the traditional Indian belief that “work is worship.” Averaging 55 years in age, dabbawallahs were typically lean, agile, active and physically fit. While the minimum level of education of a dabbawallah was grade seven, most never got past grade eight schooling. Each dabbawallah earned a monthly income between Rs5,000 and Rs6,000. Out of this income, each dabbawallah was responsible for paying: 1. Rs120 for the monthly railway pass that allowed for unlimited access to Mumbai’s railways; 2. Rs60 for the maintenance of the bicycle or the pushcart (which were owned by the group or profit
centre); and 3. the compulsory monthly contribution of Rs15 to the Trust. “It is a good earning for a semi-literate by Indian standards,” observed Medge. Each new recruit would undergo an apprenticeship for two years on a fixed remuneration of Rs2,000 per month. Each apprentice was then required to purchase a delivery route before being admitted as a dabbawallah. The price for the route was fixed as a ratio of the average monthly earnings of the group at 1:7. For instance, most groups’ monthly earnings were approximately Rs140,000, so the apprentice was expected to deposit Rs20,000 for a delivery route. This money went to the Shared Capital of the Trust and would be returned to the dabbawallah upon retirement. Once admitted, the dabbawallah was guaranteed a monthly income and a job for life. DABBAWALLAH MEAL DISTRIBUTION NETWORK The dabbawallah meal distribution network was characterized by a combination of a “baton relay system” in which dabbas were handed off between dabbawallahs at various points in the delivery process and a “hub and spokes” system in which the sorting of dabbas was done at specific railway locations from where individual spokes branched out for distribution. There was no local historical model on which this distribution network was designed. All design decisions were driven by the singular purpose of delivering a dabba in time for the customer’s lunch. The delivery processes had largely remained unchanged since their inception even though the environment of service delivery had changed. For example, the delivery system did not rely on the use of computers. According to Medge:
If we were to use computers, we would be out of business. It is not because we do not know how to use computers but the system itself is not amenable to the use of technology in whatever form.
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Page 5 9B04D011 The only major change in the dabbawallahs’ delivery model was the fine-tuning of the coding system in 1966. The number of customers using the delivery service had continued to grow, and without some form of common identification that all dabbawallahs could follow, the sorting process at the hubs was likely to become overly time-consuming. Medge observed:
We decided to decentralize the coding at the level of groups and each group was free to develop its own coding system based on simple and easily identifiable numbers and signs. In time, each group gradually developed its own distinctive color code — from a spectrum of combinations of the seven primary colors — serving as the first line of identification for any dabbawallah.
The workday for a dabbawallah started with the first delivery pick-up at 8:30 a.m. (see Exhibit 4). Leaving their Mumbai home, most of the time by bicycle, the dabbawallahs arrived punctually to the minute at the doorstep of each collection point, although they might not be wearing a watch. The collection point would typically be the client’s home. Customers were aware of their responsibilities in the delivery process. Each knew that if the dabba was not ready for pick-up, the dabbawallah simply moved on; the dabbawallah did not wait. Each dabbawallah was personally responsible for the daily delivery of 30 to 35 dabbas. Dabbawallahs found that number to be usually manageable in terms of personal memory and physical handling capacity. As each dabba was picked up, it was hitched to the handle or the back-carrier of a bicycle. Sometimes it was placed on a wheeled wooden trolley pushcart. Once the pick-up route was covered and all the dabbas were finally collected, they were transported to the nearest of 68 suburban railway stations the dabbawallahs used. It was at this station that a second set of dabbawallahs, already positioned on the platforms, took over. They sorted the dabbas according to destinations and placed them in destination- specific wooden cartages. The cartages came in two standard sizes, accommodating 24 and 48 dabbas each. As the train arrived, at two-minute intervals, the cartages were placed in a specially designated cargo carriage on the train located next to the driver’s cabin. The loading had to be completed in 30 seconds, the time for which the train halted at each station. The cartages, accompanied by one or two dabbawallahs, were now ready to be transported to various hubs and destination terminals in Mumbai. The hub was essentially a mid-point station in the suburban railway network where trains converged before branching out to other parts of the city. Dadar, Bandra, Andheri and Kurla were the four major hubs for the dabbawallahs’ meal distribution network (see Exhibit 5). As epicentres that had to be passed through while moving from one end of the city to the other, the hubs were crucial links in the delivery system. They were also places where delivery errors could take place. That was why each of the hubs was actively managed by the mukadams, who stepped in to co-ordinate the sorting operation at each hub. As trains kept arriving in rapid succession, it became imperative to orchestrate three activities — sorting, loading and unloading — simultaneously. Doing so was a challenge during Mumbai’s rush hour when thousands of commuters were also getting on or off each train. Given the tight time schedule for Mumbai’s railways, the dabbawallahs had to complete their tasks quickly and precisely. From these hubs, the sorted dabbas spoked out to various destinations — including the terminal stations of the city railway — where a third set of dabbawallahs was waiting to take over. The dabbas were off-loaded at various terminals and re-sorted, depending now upon specific customer location information, such as the street, building and the floor. The dabbas were then handed over to the fourth set of handlers, individual dabbawallahs, who were assigned to specific delivery routes in Mumbai city. Placing the dabbas on pushcarts or bicycles, or in some cases carried by hand or in crates on top of their heads (a full crate of
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Page 6 9B04D011 dabbas could weigh up to 100 kilograms), the dabbawallahs delivered the home-cooked lunches to the designated recipient by 12:30 p.m. An hour or two later, the empty dabbas — dropped off by the satiated client at the same spot used for dabba pick-up — were collected to be routed backwards on their return journey. In short, each dabba was picked up at the source by one dabbawallah for transport to the railway terminal, sorted and loaded by a second dabbawallah, unloaded and re-sorted at the hub or destination station by a third dabbawallah and delivered by a fourth dabbawallah to the home from which the dabba was picked up earlier in the day. The exact combination of dabbawallahs used each day varied with the volume and density of traffic, but it remained the same on the return route. Since each dabba traveled through four sets of hands each day, it was important to identify and monitor the dabbas while in transit. This was done through a system of codes painted on the top of each dabba’s exterior (see Exhibit 6). The originating station and the destination station were the primary codes. They were crucial for the sorting operations that took place at each of the hubs, and they were normally identified by alphabets that any sorter could recognize. The other encoded data included the apartment, floor, building and street the dabba originated from and was to be delivered to. The codes included symbols (e.g. dashes, dots, etc.), alphabets, numbers and other forms of notation which likely made little sense outside of the dabbawallah community, but which the dabbawallahs recognized and understood instantly. The movement of the dabbas was monitored solely through these codes and client names were not utilized. Pulling one dabba aside, Medge explained:
The codes “K-BO-10-19/A/15” on top of this dabba mean the following: K was the dabbawallah who picked it up; BO meant Borivali, the area from where the dabba was collected; 10 referred to the Nariman Point area, the destination; 19/A/15 referred to the 19th building; A was the dabbawallah who delivered it; and 15 was the floor of the building where the customer’s workplace was located.
DABBAWALLAHS’ OPERATING ENVIRONMENT For many decades, the labor-intensive textile mills in Mumbai made the single largest contribution to the overall pool of dabbawallah customers. While the customer composition had recently changed to include school children, the basic customer profile had remained unchanged. The majority of dabbawallah customers comprised the Indian middle class of fixed income earners. Approximately 4,000 dabbawallahs daily served workforce clients. Given the larger geographic spread of these clients from their homes, dabbawallahs typically employed bicycles, pushcarts and the Mumbai railways to make these deliveries. Servicing school children, on the other hand, did not require the use of the railway system as most were located close to their residences. Despite the shorter distances for delivery, the dabbawallahs charged more for these deliveries since school lunch timings and their pick-ups varied. Dabbawallahs had three primary lunch competitors: fast-food chains, restaurants and roadside vendors. Kamat and Udupi were chains of both fast-food counters and restaurants located throughout Mumbai, catering to the lunch hour needs of their customers. These local chains were in direct competition with global chains, such as McDonalds, which entered the Mumbai market in 1997. Specialty food stalls, sans frills, serving local favorites provided another lunch option for Mumbai’s workforce, as did roadside vendors offering fast and efficient service and a varied lunch fare. Lastly, some Mumbai companies — for tax shelter purposes — offered their workers lunch coupons that were redeemable at select food outlets known as “Ticket Restaurants.” F
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Page 7 9B04D011 In Medge’s view, the growing presence of these lunch competitors did not meaningfully impact the dabbawallahs’ business. He observed:
Dabbawallahs have a niche of their own. We do not see any of them as competitors. They prepare food, but we are not in the business of preparing food. We do not manufacture; we only deliver. There is no other meal delivery service in Mumbai. We work in a unique operating space where we have a monopoly.
Several factors worked in the Trust’s favor. First, people in Mumbai, given a choice, seemed to prefer home-cooked food. Those who were already using the dabbawallah service were not inclined to switch to other providers as lunch hour routines were habit forming. Second, and perhaps most important, was the cost of home-cooked lunches. Home-cooked food delivered by a dabbawallah almost always cost far less than having lunch at a food counter or a restaurant. For instance, at Nariman Point, Mumbai’s central downtown location, a vegetarian lunch, served in a steel plate called a thali, purchased at a restaurant would cost Rs120. Further, a combination of snacks that passed off for lunch at a fast-food counter would cost about Rs30, while similar fare from a roadside vendor would cost Rs18. All these options required that customers leave their workplace to eat food whose quality was not assured. A lunch delivered by a dabbawallah from a catering establishment would cost an average of Rs20 (including Rs5 for delivery). A home-cooked lunch delivered by the dabbawallah would cost the home-owner about Rs8, with the majority of that cost paid for the dabbawallah delivery. Some of the smaller courier firms, known in Mumbai as angadias, were viewed in the local media as potential threats to the dabbawallahs in terms of their ability to develop a parallel delivery service. Medge was doubtful about this potential threat as “an angadia would require an army of couriers to handle the meal delivery business.” Mobilizing and motivating the requisite workforce would likely prove challenging for angadias, many of whom were mom-and-pop businesses that lacked the resources and skills to manage a substantially larger business demand. Larger courier firms operating in Mumbai, such as Blue Dart, DHL and FedEx, were not interested in pursuing a service similar to that offered by the dabbawallahs, given the unique requirements of this type of delivery and their concerns about the inability to extend this service beyond Mumbai. FOUNDATIONS FOR THE SUCCESS OF THE DABBAWALLAH SERVICE Observers generally agreed that there were five distinct reasons for the success of the dabbawallahs. Low-Cost Delivery Clients typically paid between Rs150 and Rs200 per month for delivery, depending upon the route and the geographical distance traveled by the dabbawallah. According to Medge:
If a courier company were to be involved in this business, it would be charging at least Rs20 per transaction for a box weighing 1.5 kilograms. But we charge far less — between Rs4 and Rs5 per transaction — even while ensuring that every dabbawallah makes enough money for a living.
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Page 8 9B04D011 The prices charged to the customer were fixed at the discretion of the group. There were two broad considerations in determining the price. First, the pick-up location was considered. For example, the delivery charges for large residential complexes and apartment buildings were lower because of the concentration of customers that allowed for delivery pick-up economies. Less populated areas typically meant fewer customers and longer pick-up/delivery times for the dabbawallahs, and therefore, the prices to service those areas were higher. The second consideration was time. For customers who could not deliver dabbas by the stipulated pick-up time, their charges were higher by up to 25 per cent. If the pick-up time was too close to the lunch hour, requiring an expedited delivery service, the charges were double. Medge observed:
We see future potential for revenue enhancement with such premium pricing. Indeed, customers with special needs and requests have gone up by 25 per cent, from about 20,000 to about 25,000, in 2002 alone.
Client service charges were generally increased across the board once every two years by about 15 per cent. This increase usually coincided with a major development, such as an increase in railway fares by the government. Delivery Reliability The service reliability of dabbawallahs was rooted in the following factors. First, dabbawallahs considered themselves as entrepreneurs, not employees. That explained why, for instance, they had never gone on strike. They worked six days a week, taking a break for five days in April every year to attend an annual village festival en masse. Second, they were not governed by a hierarchy that defined working relationships in terms of a boss and subordinates. Everyone worked as part of a team with a common goal that had to be achieved every working day: No customer should go without food. Third, they lived and worked in clans. All apprentices were recruited through referrals from relatives and friends migrating to Mumbai from the same geographical region. It ensured that there was no dilution of service culture or erosion of the basics. Fourth, each dabbawallah was solely responsible for the delivery for his 30 to 35 clients. While others may fill in occasionally, he generally maintained total control over his route. Decentralization The group structure allowed for independent operations. Each group maintained its own records of revenue and expenditure, serviced its own pool of customers, and managed its own system of billing, collection and expenditure allocation. Each group was also responsible for generating and distributing the monthly revenue among its members, resolving disputes on its own and acquiring new customers entirely independent of the Trust. In fact, the Trust had distanced itself completely from the day-to-day activities of each group. It had no centralized records of group clients or the dabbawallahs’ and mukadams’ incomes and expenses. The Trust’s Executive Committee dealt only with those matters that the mukadams deemed necessary for discussion at the monthly meeting. Decentralization had been instrumental to building cohesion within each group, and operational autonomy helped to provide focus on delivery effectiveness and improvement. Fo
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Page 9 9B04D011 Perceived Equality Given the design of the delivery service, not every dabbawallah was required to put in equal time and effort. Yet each dabbawallah in the group earned equal remuneration. As such, senior dabbawallahs earned the same monthly income as dabbawallahs with less experience and tenure. According to Medge:
The dabbawallah system has its own checks and balances because of the large component of physical labor which is integral to effective service delivery. For example, a senior dabbawallah undertook only those tasks, like sorting at a hub, which required co- ordination. Tasks involving legwork, like collection, loading, unloading and delivery, were done by the younger workforce. This system was a leveler. It helped forge equal relationships among the dabbawallahs.
Suburban Railway Network Mumbai’s longitudinal-based geography provided a great deal of latitude in logistics management because the movement of dabbas towards the various north to south destination points remained largely unhindered. This helped in reducing the amount of food spoilage during delivery. The dabbawallahs made extensive use of Mumbai’s suburban railway network. Indeed, one popular saying in Mumbai was: “If the local train is the lifeline of the city, then the dabbawallahs are the foodline.” It was only on days when the suburban railways grounded to a halt, such as the once or twice a year that monsoons flooded the tracks, that dabbas were not delivered. However, few recipients of the dabbas reached their workplaces when the railway system was not working. The railways provided the most convenient and economical mode of transport for the dabbas. On average, a dabbawallah covered 70 km to 80 km in two-and-a-half hours by train; on bicycle, dabbawallahs covered much less territory. RAGHUNATH MEDGE AND THE FUTURE OF THE DABBAWALLAHS Medge was an independent businessman in his own right, running a profitable operation known as the Tiffin Box Suppliers & School Bus Service. All dabbawallahs were allowed to pursue a business outside the delivery system as long as it did not interfere with their delivery activities. “But this is an exhausting and demanding job, and it is only after one becomes a mukadam that one has some free time,” said Medge. Medge, now in his late-40s, had worked his way through the Trust’s organizational structure and was currently serving his second three-year term as president. He also served as secretary of the Dakkhan Mavle Sahakari Patpedhi Credit Union. Medge’s father, himself a dabbawallah for four decades, also had served as a previous president of the Trust. Observers of the service generally cited three broad issues as potentially affecting the future of the dabbawallahs. Shrinking Customer Base and Customer Loyalty The number of dabbawallah clients peaked at around 275,000 in 1980. The closure of several textile mills during the 1980s explained much of the subsequent decline in customers as thousands of mill workers lost their jobs. The number of customers shrank gradually to less than half by the end of the decade, forcing
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Page 10 9B04D011 dabbawallahs to tap new customer segments, such as delivering to school children or delivering lunches produced by caterers. Targeting new customers was a task that was left to individual groups and the mukadams, as there was no co-ordinated effort at the level of the Trust aimed at new customer acquisition. According to Medge:
We have a great deal of decentralization in this business and each group is free to pursue new customers, depending upon its ability to mobilize resources and to cope with demands of servicing new customers. There is no interference from the Trust and no pressure of any kind on any of the dabbawallahs to get new customers. We do not want to stretch our human resources to a point where our delivery system faces the risk of a breakdown, leading to a loss of reputation built assiduously over decades.
The delivery system had built-in mechanisms that allowed for accommodating fluctuations in demand (e.g. customers going on annual vacations or schools being closed during summer). Clients were required to pay for the full month if a dabba was to be delivered for more than seven days in a month. Every customer paid on time, usually immediately upon being presented with the monthly invoice, and there was no credit for services not rendered (see Exhibit 7). More than 3,000 of the current dabbawallah clients had stayed with the service for more than two decades. Lifestyle Changes As double-income families became the norm in Mumbai and the demand for convenience foods rose, the time that might be spent cooking at home became a precious commodity for most. As a result, what constituted home-cooked or convenience food was likely to change over time, as new lunch items were becoming available on grocery shelves (e.g. microwavable food). In Medge’s view:
These changes are superficial and will not affect the core of our business, because at the end of the day, everyone prefers home-cooked food to all other foods. It is that innate preference that has been the basis of our survival so far. It will continue to be so in the future.
Workforce Management While each dabbawallah worked as an owner-entrepreneur, there were workforce management issues that currently needed to be addressed at the operational level. For example, some dabbawallahs had been in the business for more than four generations, and they were finding it difficult to get their children interested in following in their footsteps. Some of the dabbawallahs themselves seemed to prefer different careers for their children mainly because of the large component of physical labor involved in the job. To Medge, however:
For every current generation member of our families in Mumbai who fancies an office job, there are many others from our villages willing to join us as apprentices with hopes of becoming a mukadam.
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up pl
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10 , 2
01 8
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01 8.
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Page 11 9B04D011 While recognition of individual effort through monetary rewards was generally considered to have a positive and demonstrative impact on general work performance, the dabbawallah system had no provision for such individual rewards. Excellence was normally expected from every dabbawallah every day. There were three broad service expectations mukadams had for each dabbawallah: timely delivery to the client, courteous attitude and behavior towards the customer, and understanding the special needs, if any, of each customer. Dabbawallahs were expected to avoid drinking alcohol during business hours, to always wear their white cap on the job and to carry their identity cards. There were two measures of service performance actively monitored at the individual dabbawallah level: the number of customer complaints and the number of encounters with the authorities. There were no financial incentives for achieving excellence on either measure. For Medge:
Excellence is a state of mind that every dabbawallah automatically gets conditioned to, once he is part of the system. While we do not offer extra incentives, we offer little disincentives. In particular, we do not fire anyone.
CONCLUSION Medge was scheduled to address the faculty and students of the Indian Institute of Management in Lucknow in early January 2004 on how the dabbawallah meal distribution network worked. He was aware that this audience would be interested in the learning that the dabbawallahs could provide to improve supply chain — and service — design and execution. He was also aware that it was likely that most of the audience would have concerns about the future of the dabbawallahs. Since he anticipated being asked about that concern, Medge already knew what he was going to say in response:
The dabbawallah is a Mumbai institution that has survived for over a century now. It will survive for the next century and beyond. There will of course be a churning of customers. But children will continue to go to school, people will continue to go to work, everyone feels hungry at lunch hour and, if given a choice, everyone wants to have home-cooked food delivered personally to them. Dabbawallahs facilitate that choice. We will continue to be there as long as people exercise that choice. We will continue to be there because no one can provide the kind of error-free service that we provide.
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Page 12 9B04D011
Exhibit 1
DABBAWALLAHS OF MUMBAI
Dabba was a generic, colloquial term used explicitly in Mumbai to describe any cylindrical box. In the context of meal delivery service, a dabba was an aluminum box carried by its handle like a tin of paint. Each dabba housed three to four interlocking steel containers and was held together by a collapsible metallic wire handle. Each of these containers accommodated an individual food item found in a typical midday lunch.
Wallah was a label for a tradesperson in a particular profession. For example, a paperwallah was an individual who delivered newspapers. Taken together, a dabbawallah was a courier who picked up a lunch-full dabba from a client’s home in the morning, left it outside of the client’s workplace for pick-up, retrieved the empty dabba after the lunch was consumed and returned the empty dabba to the client’s home in the evening.
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Page 13 9B04D011
Exhibit 1 (continued)
This is a special pushcart that holds 150 dabbas. It takes between three to four dabbawallahs to maneuver this pushcart. Source: Company files.
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Page 14 9B04D011
Exhibit 2
DABBAWALLAHS AND CUSTOMERS
Year Number of Dabbawallahs Number of Customers
1900 58 1,445
1905 75 1,965
1910 142 4,120
1915 204 6,504
1920 321 9,675
1925 407 12,140
1930 695 22,865
1935 1,024 34,230
1940 1,206 42,340
1945 1,715 64,240
1950 2,106 82,000
1955 2,552 105,120
1960 3,216 140,000
1965 4,406 198,100
1970 4,605 176,040
1975 4,904 215,000
1980 5,511 275,075
1985 5,524 190,645
1990 5,102 130,860
1995 5,180 142,260
2000 5,164 165,670
2003 5,142 175,040 Source: R. Medge
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Page 15 9B04D011
Exhibit 3
THE NUTAN MAMBAI TIFFIN BOX SUPPLIERS CHARITY TRUST’S ORGANIZATIONAL STRUCTURE
President Raghunath D. Medge
Vice-president Sambhaji G. Medge
General Secretary Gangaram L. Talekar
Treasurer Damodar Pingle
Directors (9)
Mukadam1
Dabbawallah1 Dabbawallahn…
Mukadamm
Dabbawallah1 Dabbawallahn…
. . .
Group (120)
Executive Committee
President Raghunath D. Medge
Vice-president Sambhaji G. Medge
General Secretary Gangaram L. Talekar
Treasurer Damodar Pingle
Directors (9)
Mukadam1
Dabbawallah1 Dabbawallahn…
Mukadamm
Dabbawallah1 Dabbawallahn…
. . .
Group (120)
Executive Committee
Note: m # of mukadams in a group n # of dabbawallahs in a team Source: R. Medge
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up pl
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23
Page 16 9B04D011
Exhibit 4
SAMPLE MORNING JOURNEY OF A DABBA 8:25 a.m. The dabba is filled with lunch at the client’s kitchen and kept outside the door of the
residence. 8:30 a.m. The dabbawallah arrives, picks up the dabba and moves on knocking at the door only if the
dabba is not seen. Under normal circumstances there is no interaction with any member of the client’s household.
8:38 a.m. The dabba is placed on the bicycle or pushcart together with dabbas collected from other
customers. 9:20 a.m. Bicycles and pushcarts drawn by individual dabbawallahs arrive from various collection
centres to the suburban railway station. 9:30 a.m. The sorting operation begins with dabbas sorted according to destinations and placed in
cartages that are specific to each destination. The cartages come in two standard sizes, accommodating 24 and 48 dabbas each.
9:41 a.m. The suburban train arrives. The cartages, normally numbering five to six, are loaded into the
special compartment located next to the driver’s cabin. 10:21 a.m. The train arrives at one of the major hubs. The cartages are unloaded and bundled with
those arriving from other collection centres. They are resorted according to destinations. 11:05 a.m. Cartages are loaded into the suburban train for onward journey to the final destination
terminals. 11:45 a.m. The suburban train reaches the terminal station. Cartages are unloaded and dabbas are re-
sorted, now according to specific delivery routes. 12:10 p.m. Dabbas are placed in destination-specific cartages and hitched typically on to bicycles or
pushcarts for delivery to individual clients. 12:30 p.m. The dabba is delivered at the doorstep of the client’s workplace. The delivery process is reversed in the afternoon. The empty dabba is picked up between 1:15 p.m. and 2:00 p.m. for its return to the client’s home early that evening (e.g. by 5:30 p.m.).
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Page 17 9B04D011
Exhibit 5
MUMBAI CITY’S SUBURBAN RAIL NETWORK
Fo r
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25
Page 18 9B04D011
Exhibit 6
SAMPLE DABBAWALLAH DELIVERY CODES
Coding Key:* VP Code for the residential location (e.g. Vile Parle, a suburb of Mumbai) 9 VS 12 Code for dabbawallahs to use at the destination location where:
9 is the code for dabbawallahs at the destination station VS is the code for the building name 12 is the code for the floor number
E Code for dabbawallahs at the residential railway station 3 Code for destination railway station (e.g. Nariman Point) * Codes are painted on the top of each dabba in distinct group colors. Source: R. Medge
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Page 19 9B04D011
Exhibit 7
SAMPLE DABBAWALLAH INVOICE
The Marathi text at the top of the invoice specifies the name of the specific dabbawallah servicing the delivery route, the nine other dabbawallahs in his team and the mukadam overseeing this team’s efforts (e.g. Raghunath Medge in this instance). Source: R. Medge
F or
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27
4.
S w
9B04D013 DABBAWALLAHS OF MUMBAI (B) Ramasastry Chandrasekhar prepared this case under the supervision of Professor Larry Menor solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected]. Copyright © 2004, Ivey Management Services Version: (A) 2009-10-09 Even though Raghunath Medge, president of the Nutan Mumbai Tiffin Box Suppliers Charity Trust (the Trust), was confident that the dabbawallahs’ Mumbai service would continue to survive and prosper, he occasionally had to address issues that could affect the future of the business. For example, the Trust was now regularly approached by mass marketing companies who wished to use the meal-delivery network to sell their products. Medge’s response to these companies had been that their usage of the delivery network would be limited to only two activities: product sampling and distribution of flyers. Both activities would be conducted during a limited period of time from one or two weeks per year. For example, Dabur India Ltd, a manufacturer of Ayurvedic herbal products, had been allowed in mid- 1998 to distribute free samples of its digestives and antacids though the meal-delivery service. Star TV, a media channel, had been allowed to distribute a flyer, in late 2002, announcing the timing of a week-night program entitled “Kaun Banega Crorepati?” (a local version of “Who Wants to Be a Millionaire?”). ICICI Prudential, an insurance company, had been allowed in early 2004 to distribute promotional literature on its life insurance policies through the dabbawallahs. The Trust had charged a fixed fee of Rs10,0001 to each company. The money had become part of the capital of the Trust and had not been distributed as part of the monthly earnings to dabbawallahs. According to Medge:
We do not mind giving free product samples or distributing flyers. We can do it for a limited time and for a fixed fee, but we do not want to be perceived as a regular sales channel. The dabbawallahs cannot become salesmen for other companies as that would mean taking responsibility for billing and collection. Such a responsibility will complicate our main meal-delivery business. We want the delivery process to remain simple and hassle-free, as it has been for decades, so that we can concentrate on what we are good at.
1As of November 2003, Cdn$ = Rs31.40.
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Page 2 9B04D013 Another issue that Medge had often been asked to consider was the replication of the dabbawallahs’ service in other Indian metropolitan cities. For Medge, expansion to other cities provided substantially more challenges than distributing items for companies. Mumbai had several features that facilitated the operational success of the delivery system, such as the suburban railway network. Replicating the dabbawallahs’ Mumbai success elsewhere would likely depend, first and foremost, upon the ability of the dabbawallahs to deliver to all areas in a prospective city. Kolkata and Chennai were the only other major cities in India that already had working inner-city railway networks (see Exhibits 1 and 2). Delhi, on the other hand, only recently completed a portion of its new metro railway. Bangalore’s railway network was currently in its planning stages. Medge knew that in addition to the suburban railway network, two other factors were crucial to the success of the dabbawallahs’ meal-delivery service — the presence of a large working population and the preponderance of long commuting times. Many cities did not possess all three factors. Pune and Hyderabad, for example, were developing into major commercial and industrial centres, but they did not have a suburban railway network nor were they planning to construct one. The dabbawallahs’ service, however, had been present in Pune since 1997. The city was home to several Indian automotive, engineering and, of late, information technology companies and had a large workforce of about 2.7 million. However, the dabbawallahs’ service in Pune was currently confined to delivering to school children. The Pune operations were presently much smaller than those in Mumbai. Medge noted:
There are about 220 dabbawallahs who deliver in Pune. They come from the same villages in the Mavla region where we come from. Geographically, the villages are, in fact, closer to Pune than to Mumbai. Dabbawallahs in Pune transport dabbas mainly on bicycles. About 2,500 dabbas are being delivered to children in Pune schools every day from their homes.
Expanding operations to Pune offered several advantages for the dabbawallahs. Except for the issues of scale and the use of a railway, the Pune delivery system was an almost exact duplicate of Mumbai’s operations. Pune’s smaller scale did not warrant the use of the baton relay or the hub and spoke systems that had made the Mumbai system unique. A coding system was, however, in place, as was the use of mukadams and a decentralized organization structure with equality of pay. Networking prevailed to a limited extent because although a single dabbawallah carried the dabbas from collection to destination point and back, other dabbawallahs assisted only in emergency situations to ensure that the service was maintained without interruption. There were about 15 mukadams in Pune who were also dabbawallahs on a day-to-day basis. Medge observed:
A number of cities are developing their own Metro railways to service their inner-city transportation needs. Delhi and Bangalore, for example, will be among the first major cities to have such a system. Kolkata already has had one for almost two decades. We would be willing to put in place a meal-delivery system in these cities through employing local labor. We can teach the local labor the basics and provide overall supervision until their system becomes self-supporting. It will be like a franchising system. We can make it work, provided someone takes the initiative.
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Page 3 9B04D013
Exhibit 1
MAP OF INDIA
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Page 4 9B04D013
Exhibit 2
INDIA’S METRO RAILWAY NETWORKS PROJECTS
Mumbai Kolkata Chennai Delhi Population (in millions)
16 11 7.5 13
Metro railway launch year
1925 1984 1930 2002
Route length (in km) 80 17 30 21 Number of stations 68 17 18 18 Travel time (end to end in minutes)
105 35 40 25
Proposed expansion
• Upgrading existing stock
• Service improvements
Mass-transit electrified corridor
Gauge conversion
Phase 1: 88 km Phase 2: 76 km
Expected year of expansion completion
2007 2004 2004 Phase 1: 2005 Phase 2: 2010
Source: www.urbanrail.net
Delhi: A traffic target of 12 million commuter trips daily has been set for the Delhi Metro railway on completion of Phase 2 by 2010. The city’s population is expected to reach 15 million by then. When fully operational, the Delhi Metro would cover 60 kilometres (km) on elevated plane and 104 km on surface in addition to 31 km underground. The project is estimated to cost US$1 billion. It is being funded both through a loan by the Japan Bank of International Cooperation and through property development at highly lucrative sites around the Metro stations. Source: R C Acharya, “All set for Delhi Metro flag-off,’’ The Hindu Business Line, December 23, 2002. Mumbai: The suburban railway expansion is part of a comprehensive project known as the Mumbai Urban Transport Project. The expansion plan has three components: • Improving service efficiency (which includes additions to existing track capacity, conversion of DC to
AC and upgradating of signaling, electrical and telecommunication systems); • Acquiring new carriages and expanding network capacity; and • Conducting technical studies aimed at improving operations. The project is estimated to cost US$1.5 billion. The Mumbai suburban railway expansion is being funded to a large extent by the World Bank and it is slated for completion by 2007. Source: www.uktradeinvest.gov.uk/text/railways/india/ - 23k Referenced May 7, 2004.
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9B08M014 ECCO A/S — GLOBAL VALUE CHAIN MANAGEMENT Professor Bo Bernhard Nielsen, Professor Torben Pedersen and Management Consultant Jacob Pyndt 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 © 2008, Richard Ivey School of Business Foundation Version: 2017-05-10 Despite the summer, the weather was hazy on that day in May 2004 as the airplane took off from Hongqiao International Airport, Shanghai. The plane was likely to encounter some turbulence on its way to Copenhagen Airport in Denmark. The chief operations officer (COO) of the Danish shoe manufacturer ECCO A/S (ECCO), Mikael Thinghuus, did not particularly enjoy bumpy flights, but the rough flight could not overshadow the confidence and optimism he felt after his visit to Xiamen in southeast China. This was his third visit in three months. During 2003/2004, ECCO spent substantial resources on analyzing where to establish production facilities in China. On this trip, together with Flemming Brønd, the production director in China, Thinghuus had finalized negotiations with Novo Nordisk Engineering (NNE). NNE possessed valuable experience in building factories in China, experience gained through their work for Novozymes and Novo Nordisk. Now everything seemed to be in place. Construction was to begin in August, machines would be installed in January 2005, and the first pair of shoes would be leaving the factory by the end of March 2005 if all went well. The plan was to build five closely connected factories over the next four years with a total capacity of five million pairs of shoes per year, serving both export needs and the Chinese market, which was expected to grow in the future. Thinghuus felt relieved. He was confident that the massive investments in China would serve as a solid footstep on a fast growing market and provide a unique export platform to the global shoe market. However, he could not rest on his laurels. The massive investment in China was an integrated part of ECCO’s continuous attempt to optimize various activities in the value chain. Operating five distinct factories in Portugal, Slovakia, Indonesia, Thailand and shortly in China combined with a declared vision of integrating the global value chain, the task at hand was certainly complicated. Moreover, ECCO had one tannery located in the Netherlands and two located adjacent to shoe production facilities in Indonesia and Thailand. These tanneries enabled ECCO to maintain control of leather processing and ensure the quality of the leather utilized in ECCO’s shoe manufacturing.
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INTRODUCING ECCO It has always been our philosophy that quality is the only thing that endures. That is why we constantly work to create the perfect shoe — so good that you forget you are wearing it. It has to be light and solid, designed on the basis of the newest technology and knowledge about comfort and materials. ECCO have to be the world’s best shoes — shoes with internal values.
Karl Toosbuy, founder
With the simple slogan “A perfect fit — a simple idea,” Karl Toosbuy founded ECCO in Bredebro, Denmark in 1963. Inspired by the open and harsh landscape of southern Jutland, Toosbuy presented ECCO as a company with a passion for pleasant walking. Today, after more than 40 years of craftsmanship and dedication to uncompromised quality, ECCO remains extremely committed to comfort, design and a perfectly fitting shoe with the goal of constantly developing shoes that are pleasant to walk in, regardless of the weather conditions. The company’s vision is to be the “most wanted brand within innovation and comfort footwear — a position that only can be attained by constantly and courageously researching new paths, investing in employees, in our core competencies of product development and production technology.”1 ECCO aimed at producing the world’s most comfortable and modern footwear for work and leisure. Footwear for work, leisure and festive occasions had to be designed and constructed with uncompromising attention to customer comfort. Evidently, trends in the market in terms of fashion and elegance were important, but usability was ECCO’s highest design priority. As Søren Steffensen, executive vice- president, stated: “ECCO is not a fashion brand and it never will be. We do not sell shoes where the brand name is the most important and quality is a secondary consideration. Primarily, we sell high-quality shoes and that is where we seek recognition.”2 Products and Markets The ECCO group produces various types of shoes, including casual and outdoor shoes for men, ladies, and children, as well as semi-sport shoes, for two different seasons — spring/summer and autumn/winter. In 2004, the sales split between the different categories was children 11 per cent, ladies 47 per cent, men 30 per cent, and sport 12 per cent. The sport division produced outdoor, walking, running and golf shoes. ECCO’s golf shoes category had experienced particularly significant growth. ECCO’s development of golf shoes had started as a joke between Toosbuy and Dieter Kasprzak, chief executive officer (CEO), on the golf course 10 years ago. In 2004, the joke turned into 300,000 pairs sold, sponsorships of international golfers like Thomas Bjørn and Colin Montgomerie, and numerous endorsements in independent tests of golf equipment in the United States. Having tested ECCO’s golf shoes, Rankmark, an American company conducting objective tests and analyses of golf products, stated that “ECCO Golf Footwear was preferred by more than 90 per cent of golfers over their current brands.” In 2004, ECCO exported more than 90 per cent of its production, with the United States, Germany and Japan being the main markets. ECCO’s international profile was reflected in the workforce composition. In the same year, ECCO employed 9,657 employees, of which 553 were located in Denmark. The company worked constantly on creating new markets, particularly in Asia and Central and Eastern Europe. The 1 http://www.ecco.com/int/en/aboutus/index.jsp, accessed April 2005. 2 Berlingske News Magazine, March 7, 2004.
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North American market — the United States and Canada — was of great importance to ECCO. In 2004, the company’s American operations attained 17 per cent growth in sales when compared to 2003. That year, the American operations accounted for DKK 875 million in revenue, roughly 26 per cent of ECCO’s total sales.3 The American subsidiary had streamlined its vendorship, cutting the number from 1,200 in 2002 to 1,000 in 2004, yet the remaining dealers had purchased a higher volume. In addition, ECCO increased its number of partnerships by 18 to 34 in 2004. The American market was lucrative as shoes were selling at high prices. Men’s shoes typically cost between US$150 and US$450 and the highly successful golf shoes were sold for between US$200 and US$400. The majority of ECCO’s sales in North America went through exclusive department stores, such as Nordstrom’s and Dillard’s. FINANCE AND OWNERSHIP STRUCTURE During the period from 1999 to 2003, ECCO experienced stagnating productivity and declining operating margins (see Exhibit 1). For instance, the operating margin fell from 15 per cent in 2000 to five per cent in 2002. Moreover, company debts increased from DKK 1 billion to DKK 2 billion following investments in expansion and inventories. In response to these negative trends, ECCO launched strategic initiatives to streamline logistics, focus on more modern shoes and facilitate monitoring of the market. 2004 brought signs of improvement as the company achieved earnings of DKK 150 million and lifted its operating margin to eight per cent. The reduction of stock had a particularly notable effect on the 2004 result, further freeing up capital to finance ECCO’s ambitious growth plan. The company’s goal was to increase revenue to approximately DKK 8 billion to DKK 9 billion by 2013, selling 24 million pairs of shoes per year. Despite financial constraints in the beginning of the 21st century, which could have triggered an Initial public offering (IPO) to raise capital, ownership of the company was kept within the family. Prior to his death, Toosbuy passed on his shares to his daughter, Hanni Toosbuy, who was chairman of the supervisory board (see Exhibit 2). Commenting on the ownership structure of ECCO, Karl Toosbuy stated:
I do not believe that an IPO is in the best interest of the company. ECCO is stronger given the family ownership. The family can take higher risks. We are able to allocate. In many cases, we do not have the time to investigate things as profoundly as a listed company ought to do. Yet, we are sure that what we want is the right thing. Then we act instead of waiting.4
Organizational Developments Operating on a global scale required employees with international mindsets and good adaptability skills. Since its inception, ECCO had given high priority to the continuous education and training of its employees. The company invested aggressively in vocational training, career development, developmental conversations and expatriation. ECCO’s establishment of the Education and Conference Centre in 1994, the research centre Futura in 1996, and the ECCO Business Academy in 2001 served as signs of commitment to these issues. According to Karl Toosbuy, these investments were vital to allowing ECCO to recruit internally for management positions and, thereby, accomplish his strategy announced in 1991. This strategy stated that 80 per cent of the company’s leaders should come from inside ECCO. Twice during the 1990s, Toosbuy had stepped down as CEO only to reinstall himself some years later, underpinning the importance of knowing the company inside-out and adapting to ECCO’s culture. 3 Børsen, December 22, 2004. 4 Børsen, February 20, 1998.
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Despite the founder’s intention of internal recruitment for management positions, on two recent occasions this ambition could not be met. In 2001, ECCO hired Søren Steffensen in the position of sales and marketing director. Coming from a position of retail director in the Danish fashion clothing company, Carli Gry, had a reputation of knowing every shopping corner in Europe and was an efficient negotiator. In addition, Mikael Thinghuus took over the position of chief operating officer (COO) in 2003, having held positions at IBM and the East Asiatic Company. The third member of the executive committee was Jens Christian Meier, executive vice-president, who had spent most of his career within shoe manufacturing. He actually initiated his career at ECCO, continued at Clarks, and then moved on to Elefanten Shoes as managing director before returning to ECCO. His main responsibilities lay within the fields of logistics, sourcing and handling ECCO’s production facilities. When Karl Toosbuy died in June 2004, his son-in- law, Dieter Kasprzak, became CEO. Kasprzak had spent 23 years with ECCO, primarily as the director of design and product development. Whereas Toosbuy was known for his abilities to develop unique production techniques, Kasprzak was a designer by trade and was much more involved in product development and branding. The death of Toosbuy triggered considerations about future development becoming more market-oriented. Thinghuus commented: “Evidently, we may learn something from the marketing oriented firms [Nike, Reebok and Adidas]. We should aim at becoming better at telling what we stand for. We cannot expect that our unique production technology will last an eternity.”5 ECCO’S GLOBAL VALUE CHAIN ECCO maintained focus on the entire value chain, or from “cow to shoe” as the company liked to put it. ECCO bought raw hides and transformed them, into various kinds of leather usable in shoe manufacturing. Leather constituted the main material in shoe uppers, which were produced at ECCO’s production sites (see Exhibits 3 and 4). The company owned several tanneries in the Netherlands, Thailand (opened in 1999) and Indonesia, which supplied leather to ECCO’s factories all over the world. ECCO’s 2001 acquisition of the largest tannery in the Netherlands, followed by a tannery and leather research centre in 2002, made it possible to access leading expert knowledge about tanning. ECCO’s Dutch tannery manufactured around 3,500 rawhides a day, corresponding to approximately one million cows per year. Apart from providing ECCO’s factories with “wetblue” (see Exhibit 3), the development and research centre’s main task was to explore less polluting tanning methods and experiment with various kinds of leather for the coming generation of ECCO shoes. The centre employed 15 specialists who were also responsible for training employees from Thailand and Indonesia, allowing new technology and improved tannery methods to be disseminated. ECCO was among the five largest producers of leather worldwide. The majority of the rawhides originated from Germany, France, Denmark and Finland. Apart from supplying leather to its shoe factories around the world, it also sold leather to the auto and furniture industries. Explaining ECCO’s tanning activities, Toosbuy commented: “To us, it is a matter of the level of ambition. We make high demands on quality and lead times — higher than any of our suppliers have been able to accommodate. In essence, we really do not have an alternative to being self-sufficient.”6 In addition, the plan was to set up a tannery in conjunction with the factories in China. ECCO’s strategy was quite unique, as most of its competitors had phased out in-house production. Companies like Clarks and Timberland had followed Nike’s marketing-oriented business model by outsourcing the production to a large extent. These companies were described as branded marketers, i.e., manufacturers without factories, who only design and market their goods. While Timberland produced approximately 10 per cent of its shoes in-house, Clarks had completely outsourced its production. ECCO, by contrast, produced 80 per cent of its shoes in-house. The remaining 20 per cent were outsourced as these shoes (for instance, ladies’ shoes 5 Berlingske News Magazine, March 7, 2004. 6 Jyllands-Posten, May 22, 2002.
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with thin soles and certain types of sport shoes) contained specific features that would not benefit from ECCO’s “direct injected” technology. ECCO’s production process could be divided into five strategic roles or phases: full-scale, benchmarking, ramp-up, prototype and laboratory production. The objectives of full-scale production were to uphold demand, quality and operational reliability, and still produce high volumes. Benchmarking production, on the other hand, strove to retain knowledge and competencies in terms of opportunities for improvements and production cost structure. ECCO had full-scale production units in Portugal, Indonesia, Thailand, Slovakia and China (in operation from March 2005). A logical consequence of ECCO’s control of their value chain was that benchmarking served more to evaluate such aspects as the production unit in Portugal, vis-à-vis the plant in Slovakia, than to establish parameters upon which to evaluate external partners. The ramp-up process encompassed the set-up for the production system at large, such as running an assembly system based on new technology. While the newest technology came from Bredebro, Denmark, the actual establishment of the production system, including the streamlining of processes and the specific volumes of various kinds of materials, took place in ECCO’s foreign production units. The development of new products, prototypes and laboratory production technologies, was carried out at ECCO’s production site in Denmark. In particular, ECCO’s research centre, Futura in Tønder, Denmark, experimented with new materials, processes and technologies. Over the years, ECCO had seen a sharp division of tasks between Denmark and various foreign production sites. Earlier operations in Denmark had encompassed all design, prototype, ramp-up, quality control, branding, marketing and most research and development (R&D) aspects, while ECCO foreign plants performed volume production. For instance, ECCO had split up R&D activities, relocating many activities to the production sites, which evidently were more in touch with ECCO’s R&D efforts from a practical perspective. The R&D activities conducted at the production sites revolved around support for the production process and optimization of materials. ECCO’s full-scale production process involved both manual labor and capital-intensive machinery. Normally, the uppers were cut by hydraulic presses called clicking machines, although at times hand cutting was used in the manufacture of shoes made of fine leather (see Exhibit 5). The upper was then attached to the insole with adhesives, tacks, and staples. Applying advanced machinery, the uppers were then placed in an injection-molding machine where the shoe bottom, including the outsole and heel, was attached to the uppers under very high pressure. Lastly, each pair of shoes went through the finishing process using various operations, such as bottom securing and edge trimming, which improved the durability and appearance of the shoe. According to ECCO’s estimates, each pair of shoes comprised approximately 30 minutes of manual labor. ECCO’s tannery operations revolved around similar phases, including prototype, laboratory and ramp-up production of leather, which took place in the Netherlands. The full-scale processing of leather took place in tanneries in Indonesia and Thailand. ECCO’s maintaining ownership of the tannery operations not only reflected the company’s commitment to quality but also illustrated a high level of ambition and confidence. ECCO’s profound belief that “we cannot get the best quality if we do not do it ourselves,” as often stated by Toosbuy, still permeated the company’s business philosophy in 2005. Although design and product development processes were generally conducted by the head office in Bredebro, Denmark, at times the division between the different phases was not clear-cut. For instance, the design and development of shoe uppers happened with the strong involvement of the subsidiary in Indonesia in order to transform the design into high-quality, comfortable shoe uppers. Prior to beginning actual production for the next season, the subsidiary in Indonesia was required to make production samples. ECCO’s marketing team would screen the samples to forecast volumes and style of production. Based on the sales forecast, headquarters would allocate production orders among its network of Fo
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subsidiaries and licensees. The production of shoe uppers itself generally involved significant manual work. When the shoe uppers were completed they were shipped by sea to another group’s facilities for subsequent processing according to the allocation set by headquarters. Finished shoes were distributed via the group’s distribution centre and sales agents. ECCO’s distribution system was also vital to its business. ECCO had two main distribution centres; one in the United States and one in Tønder, Denmark. The latter was expanded in 2001 with four additional warehouses totaling 9,000 square meters, doubling the capacity from one million to two million pairs of shoes. The majority of ECCO’s shoe production went through Tønder, however, over the last years only between six and nine per cent of total production was actually sold on the Danish market. The consolidation of distribution in Tønder also involved the closure of ECCO’s distribution centre in Brøndby, Denmark and the warehouse in Bredebro, Denmark. The majority of shoe shipments arrived through the harbor of Aarhus, Denmark, but ECCO also utilized vans for transportation and freight planes in urgent cases. Through the use of a bar code system, the distribution centre was able to ship 60,000 pairs of shoes per day by lorry to 25 countries. Shoes for markets outside Europe were shipped by sea. Recent developments within the shoe business had resulted in retailers ordering a larger proportion of shoes in advance. Retailers typically ordered 75 to 80 per cent of ECCO’s production in advance of the season, while 20 to 25 per cent of orders aimed to fill up a retailer’s stock. These replenishment orders had to be delivered with only a few days notice. PRODUCTION TECHNOLOGY Since its foundation, ECCO emphasized production technology as a key asset to the company. The founder was, above all, known and recognized for his profound knowledge of inventing and fine-tuning cutting- edge production techniques. The core of ECCO’s product strategy was shoes based on “direct injection” technology. In simple terms, the shoe uppers were attached to the sole under very high pressure, utilizing very capital-intensive machinery. In contrast, both the sewing of uppers and the final finish before shoes left the factory were performed manually. Competitors had tried for a long time to apply the same techniques or to license ECCO’s production techniques, however, ECCO performed many small tasks differently throughout the process, which improved quality and made it hard to imitate. Of a total production of 12 million pairs of shoes in 2004, 80 per cent were based on the direct injection technology. The remaining pairs, mostly shoes with very thin soles, were outsourced as they would not benefit from ECCO’s core technology. Kasprzak’s vision was to make individually based shoes fine-tuned to each customer. As he stated: “Our strength is our technology and our ability to produce high-tech products. I believe that we can be the first in the world to produce individual shoes in terms of design and instant fit by applying the newest technology.”7 As a result of the importance of ECCO’s production methods and the fact that production was kept in- house, in 1980 ECCO began cooperating closely with Main Group, an Italian company specialized in injection machine molds and services for footwear. In 2002, Main Group started operations in China and ECCO expected to benefit from cheaper Main Group machines when initiating its production in China in spring 2005.
7 Berlingske Tidende, September 5, 2004.
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INTERNATIONALIZATION OF PRODUCTION Following a decade of tremendous growth, ECCO’s first steps towards globalization occurred through exports and the establishment of upper production in Brazil in 1974. Since then, the main forces driving ECCO’s internationalization have been i) establishment of a market presence, and ii) reduction of labor costs and increasing flexibility. ECCO was one of the offshoring pioneers in Danish manufacturing. Over a period of 25 years, ECCO established 26 sales subsidiaries covering the entire world and four international production units. The objective of these establishments, apart from achieving labor cost savings, was to spread risk. Initially, the various production sites were capable of producing the same types of shoes, indicating an insignificant degree of specialization in the production units. However, in recent years, ECCO had strived to narrow each unit and capitalize on its core competencies (see Exhibits 6 and 7). The early internationalization process affected the composition of employees — by 2004 only 553 worked in Denmark while 9,104 worked outside of Denmark (see Exhibit 8). Of these, 8,094 worked in production, while 1,010 worked in sales. Portugal ECCO’s first relocation of production occurred in 1984 with part of production being moved to Portugal. Although Portugal traditionally held a leading position in both the production of uppers and shoe assembly, ECCO then relocated some of these processes to production sites in Thailand and Indonesia in 1993 and 1991, respectively. Few uppers were produced in Portugal and the number of shoes leaving the factory decreased substantially from 2000 to 2004 (see Exhibit 7). In addition, in response to increasing labor costs, ECCO strove to make the Portuguese unit more high-tech, thereby decreasing the number of employees. While the Portuguese unit was more capital intensive, the focus on technology had transformed the plant into ECCO’s leading developer within laser-technology. Indonesia The Indonesian production unit, opened in 1991, specialized in producing shoe uppers for the ECCO group, while the finishing processes, such as attaching shoe uppers to soles, were undertaken in other facilities of the group. The production unit in Indonesia satisfied approximately 40 to 50 per cent of the group’s shoe upper demand. In shoe production, the main materials required were rawhides (procured locally as well as imported) that were processed into semi-finished and finished leather. Other materials required for production included reinforcement, yarn and accessories. Apart from the leather, the majority of the materials (70 to 80 per cent) were obtained from European suppliers, in particular granulate and Gore-Tex. Procurement of raw material took eight weeks from the placement of the order until materials were ready to be shipped, and another five weeks for sea shipment. Thailand ECCO’s production facility in Thailand, opened in 1993, encompassed both tannery and assembling facilities. In 2004, the site produced roughly 37 per cent of the uppers, primarily for shoe assembly in Thailand where 40 per cent of total unit volume was produced. ECCO’s production site in Thailand was rather successful in terms of output, employee satisfaction and size. Over the years, the number of employees increased substantially and annual employee turnover was less than seven per cent. Moreover, the Thais had a good eye for small details and were able to deliver first class workmanship. These Fo
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characteristics led ECCO to concentrate the production of its most complicated shoes in Thailand, including golf shoes and its advanced trekking boots. Slovakia Opened in 1998, ECCO’s production unit in Slovakia primarily assembled shoes and, to a lesser extent, uppers. The plant employed 824 people in 2004 and produced shoes primarily within the men’s segment. The underlying rationale for setting up production in Slovakia, apart from lower labor costs, was the country’s proximity to promising markets like Russia and Poland. Prior to entering Slovakia, Toosbuy stated: “We need bigger production capacity and quicker deliveries. Our goal is to increase production capacity by 15 per cent per year. One of our challenges associated with production in Asia is the three to four week transportation time.”8 Years later, ECCO’s executive production director, Flemming Brønd, added:
Shoe manufacturing is labor intensive, thus the wage level is of paramount importance. We already had a factory in Portugal, yet we were searching for an optimal location for a new plant in Europe as labor costs were raising in Portugal. We have the majority of our uppers flown in from Indonesia and India after which the shoes are assembled. Although we automated the assembly process by using robots, we still needed skilled labor to handle the machines.9
Having established production facilities in Slovakia, ECCO set up a production network in close proximity to the company’s major markets. This facility also provided some leeway in terms of driving up volume between plants, thereby alleviating the risks of an interruption in production due, for instance, to political unrest in Thailand. Despite ECCO’s global production facilities, the plant in Bredebro, Denmark still constituted ECCO’s primary model in terms of the development of cutting-edge production technology. China ECCO’s establishment of production facilities in China was by no means a spontaneous act. Toosbuy had, on various occasions, visited China to assess locations and the timing of entry. China’s recent membership of the World Trade Organization (WTO) allowed for 100 per cent foreign ownership of production sites. This, combined with the fact that approximately 50 per cent of the world’s shoe production took place in China, made the country too important to ignore. ECCO chose a site in Xiamen just north of the province of Guangdong, which Kasprzak described as “a smaller yet dynamic community where we have been very well received and provided good and competent service from the local authorities.” The plan was to build five factories over the next five years, as well as a very advanced tannery, including a beam house to convert rawhides. Total investment including tanneries would amount to approximately DKK 500 million. When realized, the Chinese production site would become ECCO’s largest worldwide, delivering some five million pairs of shoes annually. Although mostly targeted for export, one of the factories would serve the Chinese market exclusively. ECCO expected to employ around 3,000 people in China. Although low labor costs and taxes were considered, access to local manpower was the decisive factor when establishing operations in China. “Taxes are more or less the same in different zones, so it did not influence our location decision as such. On the other hand, it was important to us that Xiamen could 8 Berlingske Tidende, February 2, 1998. 9 Jyllands-Posten, December 12, 2003.
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provide local employees who we can train and keep for a longer period of time, which is definitely not the case in other places in China.”10 ECCO had high hopes for sales to the Chinese consumers as well. Over the next three years, the company hoped to double sales to 500,000 pairs. To realize this ambition, a formal sales subsidiary had been formed together with Aibu, ECCO’s long-standing partner in China. Over the last eight years, their partnership had evolved from one shop to selling approximately 250,000 pairs of shoes targeted at the segment for exclusive shoes. The plan was to strengthen collaborative ties even further through a combination of Aibu’s unique market knowledge and position in the Chinese market, together with ECCO’s strong brand and accumulated experiences with positioning shoes on a global scale. In fact, the experience from other Danish design icons operating in China suggested a network approach to gain the loyalty of the Chinese consumers. However, the approach was not without risks, as it involved being complaisant while at the same time keeping critical knowledge close to the chest until formal contracts had been signed. During 2003/2004, ECCO had been plagued by Chinese manufacturers copying the ECCO design. According to Søren Steffensen, executive vice-president of sales, every single case was pursued and handled by a special unit of attorneys at ECCO whose primary task was to protect the company’s brand and design. THE COMPETITIVE LANDSCAPE Generally, the market for lifestyle casual footwear was highly competitive and subject to changes in consumer preferences. Fierce competition had sparked investments in both cost optimization and new technologies. First, the quest for competitive pricing had driven the search for new ways of producing and assembling in order to lower costs and reduce time to market. Operations were streamlined and formerly manual processes were automated. Second, incumbents invested in new technology, improved customer service, and market knowledge. Traditionally, the footwear industry had been fragmented, yet in recent years, the distinction between athletic and lifestyle casual footwear blurred. Financially strong athletic shoe companies, like Nike and Reebok, competed directly with some of ECCO’s products. On the other hand, ECCO’s expansion into such new segments as golf shoes gave rise to new competitors. In addition, the industry felt increasing pressure from retailers that had established products under private labels. As a consequence of the fuzzy boundaries between different footwear product categories and geographical regions, pinpointing ECCO’s competitors was a challenge. However, ECCO itself regarded Geox, Clarks and Timberland as its main competitive threats worldwide (see Exhibit 9). Geox By all measures, the Italian shoemaker Geox constituted a competitive threat to ECCO’s operations in the casual lifestyle footwear segment. Founded in 1994 by the Italian entrepreneur Mario Moretti Polegato, Geox achieved impressive growth rates, increasing sales from €147.6 million in 2001 to €340.1 million in 2004, corresponding to a compound annual growth rate (CAGR) of 32 per cent. The success of Geox was based on perforated rubber soles in which a special waterproof and breathable membrane was inserted, allowing the vapor from perspiration to leave but still preventing water from entering the shoe — a technology protected by over 30 patents. Geox’s headquarters and R&D facilities were located in the centre of a large shoe-making area northwest of Venice — Montebelluna. Geox had its own production
10 Assistant General Manager, Morten Bay Jensen.
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facilities in Slovakia and Romania and outsourced to manufacturers in China, Vietnam and Indonesia. The entire production process and logistics were closely monitored in-house from headquarters in Italy. In terms of distribution, Geox operated with a business model similar to ECCO’s. The company’s shoes were sold in more than 60 countries through a worldwide distribution network of more than 230 single- brand Geox Shop stores and about 8,000 multibrand points of sale. Geox had global ambitions. The company still had a strong penetration in the Italian market, which generated approximately 55 per cent of sales. International sales were gaining momentum, however, comprising 45 per cent in 2004, with Germany, France, Iberia (Spain and Portugal) and the United States being the largest markets. Geox increased sales by 250 per cent from 2002 (US$4 million) to 2003 (US$14 million) in the very competitive American market. As a comparison, ECCO grew only 4.5 per cent in this market with sales of US$115 million in 2003 (see Exhibit 10). Although extremely successful, Geox planned to enter clothing in order to circumvent sudden shifts in consumer tastes. Clarks Clarks, the English shoemaker, was the biggest player within the casual lifestyle footwear segment, achieving global sales of US$1,534 million in 2003 (see Exhibit 9). Since its humble beginnings in 1825, Clarks had grown into a global shoemaker producing 35 million pairs and offering a wide product portfolio under the slogan “from career wear to weekend wear.” Clarks’ product portfolio included casual, dress casual, boots and sandals. Central to various categories were Clarks’ widely used technical features like “active air” (an air-cushioning technology) and “waterproof” (impermeable membrane sewn inside the boot), which sought to improve comfort, performance and versatility. Clarks, like other shoe manufacturers, had vigorously sought lower labor costs in response to fierce competition. The company once had 15 plants across the United Kingdom, but by 2005, only one small factory with 37 employees remained in Millom, Cumbria. The most recent closure occurred in early 2005 when the company shifted production to independent factories in Vietnam, Romania and China. According to company spokesman John Keery, this move was vital to ensuring that the business remained financially viable. As he stated: “The cost of manufacturing in the UK has increased over the last 20 years and we have been able to source our shoes cheaper in the Far East.”11 Based on cost considerations, availability of materials and capacity issues within individual countries, Clarks sourced shoes from 12 different manufacturers located primarily in Asia. Clarks kept less than one per cent of its production in-house. By using many independent manufacturers, Clarks was exposed to a variety of technologies, materials and shoemaking techniques and thus could access various types of expertise. However, monitoring material standard and product quality was an enormous task. Timberland Founded in Boston in 1918 by Nathan Swartz, Timberland designed, marketed and distributed under the Timberland® and Timberland PRO® brands. Their products included footwear and apparel and accessories products for men, women and children. Having introduced the waterproof boot based on injection-molding technology in 1973, Timberland’s primary strength resided within the outdoor boot category, which competed with ECCO’s outdoor and sport product categories. In 1978 and 1979, Timberland added casual and boat shoes to its line to become more than just a boot company. In the eighties, the company strived to be recognized as a lifestyle brand and entered Italy as the first international market. During the 1990s, 11 www.bbc.co.uk/somerset/content/articles/2005/01/10/clarks_feature.shtml, accessed March 2005.
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Timberland introduced kids’ footwear and launched the Timberland PRO® series designed for maximum surface contact and targeted at skilled tradesmen and working professionals. Timberland’s 2003 total revenue of US$1,328 million was comprised of footwear (76.7 per cent) and apparel and accessories (23.3 per cent), making Timberland twice the size of ECCO in terms of product sales. Despite the company’s late appearance in international markets, international sales comprised 38.5 per cent of total generated revenue — up from 29.5 per cent in 2001. Timberland’s products in the United States and internationally were sold through independent retailers, department stores, athletic stores, Timberland specialty stores and factory outlets dedicated exclusively to Timberland products. In Europe, products were sold mostly through franchised retail stores. In terms of manufacturing, Timberland operated production facilities in Puerto Rico and the Dominican Republic. Contrary to ECCO, which on average produced 80 per cent of its shoes in-house, Timberland manufactured only 10 per cent of total unit volume, with the remainder of the footwear production being performed by independent manufactures in China, Vietnam and Thailand. Timberland believed that attaining some internal manufacturing capabilities, such as refined production techniques, planning efficiencies and lead time reduction, might prove beneficial when collaborating with manufactures in Asia. To facilitate this collaboration, Timberland set up a quality management group to develop, review and update the company’s quality and production standards in Bangkok, Zhu Hai, Hong Kong and Ho Chi Minh City (Saigon). In terms of leather supplies, Timberland purchased from an independent web of 60 suppliers who were subject to rigid quality controls. This required substantial resources in order to scrutinize and monitor the supplier network. Analysts argued that Timberland was vulnerable to price increases on raw materials. Gross margins were negatively affected by increases in the cost of leather as selling prices did not increase proportionally. Shoe manufacturers like Timberland found it difficult to pass on the extra cost to the consumer. In order to diminish the effect of increasing prices for leather and other materials, Timberland was forced to closely monitor the market prices and interact closely with suppliers to achieve maximum price stability. By 2003, 10 suppliers provided approximately 80 per cent of Timberland’s leather purchases. As the plane approached Copenhagen Airport, Mikael Thinghuus recalled a management board meeting prior to his visit to China. Several viewpoints concerning ECCO’s future strategy had been presented and, while no one discredited ECCO’s unique production assets, there was a sentiment that advantages accruing from world-class production technologies could not be sustained forever. “We are not going to exist in 20 years time if we cannot excite and cast a spell over our customers,” one member of the committee commented. Another added: “We do not operate marketing budgets of the same magnitude as the big fashion brands. But our shoes are produced with an unconditional commitment to quality and our history is truly unique. We need to be better at telling that story.” Thinghuus was pondering:
“We need to be more concrete about the process towards market orientation. How can we relate better to our customers while at the same time being able to exploit efficiencies from a global value chain? Integrated or not. And what about entering new markets? The recent market expansion in China was just the beginning. Long-term outlook seemed favorable. Yet, was it feasible to invest in new markets, increase marketing efforts, and optimize a global value chain — all at the same time?”
Irrespective of the outcome of these thoughts, it was pivotal to consider how strategic initiatives would go hand in hand with ECCO’s philosophy of integrating the value chain from cow to shoe. Fo
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ECCO's operating margin and productivity 1999-2004
400
600
800
1000
1200
1400
1999 2000 2001 2002 2003 2004 Year
S ol
d sh
oe s
pe r
em pl
oy ee
0 2 4 6 8 10 12 14 16
O pe
ra tin
g m
ar gi
n
Exhibit 1
ECCO’S FINANCIAL HIGHLIGHTS 1999 TO 2004
Source: ECCO annual reports 1999-2004
ECCO’s consolidated financial highlights and key ratios 1999-2004 (DKK million) 1999 2000 2001 2002 2003 2004 Net revenue 2,552 2,836 3,216 3,360 3,169 3,394 Profit before amortization and depreciation
409 560 416 343 370 448
Amortization and -106 -143 -167 -187 -189 -181 Profit before financials 302 416 249 156 182 267 Net financials -25 -112 -93 -73 -61 -61 Profit before tax 277 305 156 82 120 206 Group profit 195 216 123 60 71 164 Profit for the year 185 208 115 51 62 151 Key ratios (%) Operating margin 11.9 14.7 7.8 4.6 5.7 7.9 Return on assets 11.7 10.6 5 2.8 4.3 7 ROIC 12.7 14.5 8.1 5.3 6.5 9.1 Investment ratio 3.3 2.2 1.5 1.2 1.2 1.2 Return on equity 28.9 25.7 12.4 5.3 6.5 15.2 Solvency ratio 30.9 31.1 31.4 33 34.1 35.1 Liquidity ratio 1.8 1.9 2.1 2 1.9 2 Pairs of shoes sold (millions) 9.160 9.603 10.14 10.65 11.22 12.04 Number of employees (2004) 8,290 8,853 9,087 8,839 9,388 9,657 Sold shoes per employee 1,104 1,084 1,116 1,205 1,195 1,247
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Exhibit 2
COMPOSITION OF MANAGEMENT BOARD AS OF 2004
Source: ECCO’s annual report 2004
Supervisory Board Hanni Toosbuy Kasprzak,
Chairman
Jens Christian
Meier Executive Vice-president,
Production
Dieter Kasprzak
Chief Executive Officer
Mikael Thinghuus Chief Operating Officer
Søren Steffensen
Executive Vice-president, Sales & Retail
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DistributionManufacturingTanningRaw Materials
Cattle Hides
Goat Skins
Goats
Sheeps SheepSkins
Heavy leather (Bovine)
Pickle, wet blue and crust
Light leather (Bovine)
Pickle, wet blue and crust
Light leather (Sheep and goats).
Pickle, wet blue and crust
Lining for shoes,
Shoe uppers &
Shoe assembling
Distribution Centre in the
US
Distribution Centre in Tønder
Operations performed in-house by ECCO
Va rio
us E
C C
O s
pe ci
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o ut
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a nd
m
ul tib
ra nd
st or
es
DistributionManufacturingTanningRaw Materials
Cattle Hides
Goat Skins
Goats
Sheeps SheepSkins
Heavy leather (Bovine)
Pickle, wet blue and crust
Light leather (Bovine)
Pickle, wet blue and crust
Light leather (Sheep and goats).
Pickle, wet blue and crust
Lining for shoes,
Shoe uppers &
Shoe assembling
Distribution Centre in the
US
Distribution Centre in Tønder
Operations performed in-house by ECCO
Va rio
us E
C C
O s
pe ci
al ty
o ut
le ts
a nd
m
ul tib
ra nd
st or
es
DistributionManufacturingTanningRaw Materials DistributionManufacturingTanningRaw Materials
Cattle Hides
Goat Skins
Goats
Sheeps SheepSkins
Heavy leather (Bovine)
Pickle, wet blue and crust
Light leather (Bovine)
Pickle, wet blue and crust
Light leather (Sheep and goats).
Pickle, wet blue and crust
Lining for shoes,
Shoe uppers &
Shoe assembling
Distribution Centre in the
US
Distribution Centre in Tønder
Operations performed in-house by ECCO
Va rio
us E
C C
O s
pe ci
al ty
o ut
le ts
a nd
m
ul tib
ra nd
st or
es
Exhibit 3
ECCO’S VALUE CHAIN AND EXPLANATION OF TANNERY OPERATION Explanations: Pickled: the stage of tanning where the hair is removed usually for sheepskins Wetblue: the next stage when lime is added to preserve skin Crust: the third stage when the remaining flesh and fat proteins are removed Finished: the final stage when the skin is dyed and finished using chrome sulphate and is converted to processed leather
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Exhibit 4
CONVERTING SKIN AND HIDES INTO LEATHER
Source: A Blueprint for the African Leather Industry — a development, investment and trade guide for the leather industry in Africa, UNIDO 2004, p. 17.
Steps in leather production The production of leather from hides and skins involves the treatment of raw materials, i.e., the conversion of the raw hide or skin, a putrecible material, into leather, a stable material. This material is obtained after passing through the different treatment and processing steps described in points 1 to 4. The production processes in a tannery can be divided into four main categories, though the processes employed in each of these categories may change, depending on the raw material used and the final goods that are to be produced. 1. Hides and Skins Storage and Beam-house Operations Upon delivery, hides and skins can be sorted, trimmed, cured (when the raw material cannot be processed immediately) and stored pending operations in the beam house. The following processes are typically carried out in the beam house of a tannery: soaking, de-haring, liming, fleshing (mechanical scraping off of the excessive organic material) and splitting (mechanically splitting regulates the thickness of hides and skins, splitting them horizontally into a grain layer, and, if the hide is thick enough, a flesh layer). 2. Tannery Operations Typically the following processes are carried out in the tannery: de-liming, bating, pickling and tanning. Once pickling has been carried out to reduce the pH of the pelt prior to tanning, pickled pelts, i.e., sheepskins can be traded. In the tanning process the collagen fibre is stabilized by the tanning agents so that the hide (the raw material) is no longer susceptible to putrefaction. The two main categories of tanning agents are minerals (trivalent chromium salts) and vegetable (quebracho and mimosa). The tanned hides and skins, once they have been converted to a non-putrescible material called leather, are tradable as intermediate products (wetblue). However, if leather is to be used to manufacture consumer products, it needs further processing and finishing. 3. Post-Tanning Operations Post-tanning operations generally involve washing out the acids that are still present in the leather following the tanning process. According to the desired leather type to be produced the leather is retanned (to improve the feel and handle of leathers), dyed with water-soluble dyestuffs (to produce even colours over the whole surface of each hide and skin), fat liquored (leathers must be lubricated to achieve product-specific characteristics and to re-establish the fat content lost in the previous procedures) and finally dried. After drying, the leather may be referred to as crust, which is a tradable intermediate product. Operations carried out in the beam house, the tannery, and the post-tanning areas are often referred to as wet processing, as they are performed in processing vessels filled with water to which the necessary chemicals are added to produce the desired reaction. After post-tanning the leather is dried and subsequent operations are referred to as dry processing. Typically, hides and skins are traded in the salted state, or, increasingly, as intermediate products, particularly in the wetblue condition for bovine hides and the pickled condition for ovine skins. 4. Finishing Operations The art of finishing is to give the leather as thin a finish as possible without harming the known characteristics of leather, such as its look and its ability to breathe. The aim of this process is to treat the upper (grain) surface to give it the desired final look. By grounding (applying a base coat to leather to block pores before applying the true finish coats), coating, seasoning, embossing (to create a raised design upon a leather surface by pressure from a heated engraved plate or roller) and ironing (to pass a heated iron over the grain surface of the leather to smooth it and/or to give it a glossy appearance) the leather will have, as desired by fashion, a shiny or matt, single or multi-coloured, smooth or clearly grained surface. The overall objective of finishing is to enhance the appearance of the leather and to provide the appropriate performance characteristics in terms of colour, gloss, and handling, among others.
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Exhibit 5
ILLUSTRATION OF DIFFERENT COMPONENTS IN THE CONSTRUCTION OF ECCO’S WALKATHON SHOE
Source: ECCO internal illustration F
or u
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Exhibit 6
ECCO’S PRODUCTION OUTPUT WORLDWIDE 2000-2004
Source: ECCO’s environmental report 2004
2004 2003 2002 2001 2000 Bredebro, Denmark (1963) Activity: Shoe factory. Development and preparation of new articles and prototype testing. No. of employees: 124 - Uppers produced (pairs) 3,805 3,720 4,482 5,281 - - Shoes produced (pairs) 20,577 38,000 211,413 478,674 800,605
Santa Maria da Feria, Portugal (1984) Activity: Shoe factory. Production of uppers and shoes. No. of employees: 720 - Uppers produced (pairs) 20,737 79,690 241,961 438,299 535,200 - Shoes produced (pairs) 2,649,178 2,442,395 2,590,327 3,769,754 4,150,000
Surabaya, Indonesia (1991) Activity: Tannery and shoe factory. Production of wetblue, crust, leather, uppers and shoes. No. of employees: 3554 - Wetblue produced (ft2) 18,249,560 15,970,001 15,338,582 8,432,162 11,134,743 - Leather produced (ft2) 15,098,971 14,062,152 12,048,197 15,566,070 15,104,307 - Uppers produced (pairs) 5,326,300 4,664,023 4,063,840 3,968,559 3,750,000 - Shoes produced (pairs) 246,018 29,119 - - 220,000
Ayudhthaya, Thailand (1993) Activity: Tannery and shoe factory. Production of crust, leather, uppers and shoes. No. of employees: 2775 - Leather produced (ft2) 10,095,425 9,138,590 8,046,037 8,291,589 5,800,000 - Uppers produced (pairs) 3,237,054 2,868,227 2,708,639 2,891,591 3,150,000 - Shoes produced (pairs) 3,910,382 3,319,623 3,264,747 3,102,710 3,200,000
Martin, Slovakia (1998) Activity: Shoe factory. Production of uppers and shoes. No. of employees: 824 - Uppers produced (pairs) 163,297 259,136 792,473 287,694 130,000 - Shoes produced (pairs) 2,771,025 2,265,312 1,974,408 1,657,498 1,500,000
Dongen, The Netherlands (2001) Activity: Tannery. Production of wetblue. Leather and development centre. Acquired by ECCO in 2001. No. of employees: 79 - Wetblue produced (ft2) 19,931,818 26,704,106 30,886,062 23,686,640
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Exhibit 7
ECCO’S PRODUCTION OUTPUT WORLDWIDE 2000-2004
Production of shoes (in pairs) 2000-2004
0 500,000
1,000,000 1,500,000 2,000,000 2,500,000 3,000,000 3,500,000 4,000,000 4,500,000
2000 2001 2002 2003 2004
Denmark Portugal Indonesia Thailand Slovakia
Production of leather and wetblue 2000-2004
0
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
2000 2001 2002 2003 2004
ft2
Wetblue (Indonesia) Leather (Indonesia) Leather (Thailand) Wetblue (the Netherlands)
Production of uppers 2000-2004 (in pairs)
0
1,000,000
2,000,000
3,000,000
4,000,000
5,000,000
6,000,000
2000 2001 2002 2003 2004 Denmark Portugal Indonesia Thailand Slovakia
Source: ECCO annual report, various issues F
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Exhibit 8
EMPLOYEE STATISTICS — GEOGRAPHICAL COMPOSITION 1980-2004
Composition of employees in ECCO by geography
0
2,000
4,000
6,000
8,000
10,000
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Employees in Denmark Employees outside Denmark
Source: various annual reports and internal documents
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Exhibit 9
GLOBAL SALES OF LIFESTYLE CASUAL FOOTWEAR BRAND SALES (IN US$ MILLION) 2002-2003
Rank Company 2002 2003 % change
1 Clarks 1,399 1,534 9.6% 29.2% 29.6% 2 ECCO 502 590 17.5% 10.5% 11.4% 3 Rockport 385 361 6.2% 8.0% 7.0% 4 Geox 208 329 58.2% 4.3% 6.3% 5 Birkenstock 270 300 11.1% 5.6% 5.8% 6 Bass 275 285 3.6% 5.7% 5.5% 7 Caterpillar 209 210 0.5% 4.4% 4.0% 8 Doc Martens 295 195 -34.0% 6.2% 3.8% Others 1,252 1,383 26.1% 26.7% Total $4,795 $5,187 8.2%
Note: Timberland is not included in the table. The company offers footwear across different categories including rugged footwear and athletic footwear as well as casual lifestyle footwear.
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Exhibit 10
U.S. SALES OF LIFESTYLE CASUAL FOOTWEAR BRAND SALES (IN US$ MILLION) 2002-2003
Source: JP Morgan — Apparel and Footwear Yearbook 2003
Rank Company 2002 2003 % change 1 Clarks 339 375 10.6% 18.8% 21.5%
2 Rockport 291 266 -8.6% 16.2% 15.2%
3 Bass 258 265 2.7% 14.3% 15.2%
4 Doc Martens 195 127 -34.9% 10.8% 7.3%
5 ECCO 110 115 4.5% 6.1% 6.6%
6 Birkenstock 110 80 -27.3% 6.1% 4.6%
7 Dansko 62 71 14.5% 3.4% 4.1%
8 Mephisto 55 55 0.0% 3.1% 3.1%
9 Sperry 49 53 8.2% 2.7% 3.0%
10 Josef Seibel 33 35 6.1% 1.8% 2.0%
11 Catterpillar 33 30 -9.1% 1.8% 1.7%
12 Sebago 20 16 -20.0% 1.1% 0.9%
13 Geox 4 14 250.0% 0.2% 0.8%
14 Stonefly 10 11 10.0% 0.6% 0.6%
14 FinnComfort 10 11 10.0% 0.6% 0.6% Others 220 224 12.2% 12.8% Total $1,799 $1,748 -2.8%
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9B10M094 LEGO GROUP: AN OUTSOURCING JOURNEY PhD Fellow Marcus Møller Larsen, Professor Torben Pedersen and Assistant Professor Dmitrij Slepniov 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. Richard Ivey School of Business Foundation prohibits any form of reproduction, storage or transmission without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Richard Ivey School of Business Foundation, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected]. Copyright © 2010, Richard Ivey School of Business Foundation Version: (A) 2017-05-10 PROLOGUE The last five years’ rather adventurous journey from 2004 to 2009 had taught the fifth-largest toy-maker in the world — the LEGO Group — the importance of managing the global supply chain effectively. In order to survive the largest internal financial crisis in the company’s roughly 70 years of existence, resulting in a deficit of DKK1.8 billion in 2004, the management had, among many initiatives, decided to offshore and outsource a major chunk of LEGO’s production to Flextronics, a large Singaporean electronics manufacturing services (EMS) provider. In this pursuit of rapid cost-cutting sourcing advantages, the LEGO Group planned to license out as much as 80 per cent of its production, besides closing down major parts of the production in high-cost countries. Confident with the prospects of the new partnership, the company signed a long-term contract with Flextronics. “It has been important for us to find the right partner,” argued Niels Duedahl, a LEGO vice-president, when announcing the outsourcing collaboration, “and Flextronics is a very professional player in the market with industry-leading plastics capabilities, the right capacity and resources in terms of molding, assembly, packaging and distribution. We know this from looking at the work Flextronics does for other global companies.”1 This decision would eventually prove to have been too hasty, however. Merely three years after the contracts were signed, LEGO management announced that it would phase out the entire sourcing collaboration with Flextronics. In July 2008, the executive vice-president for the global supply chain, Iqbal Padda, proclaimed in an official press release, “We have had an intensive and very valuable cooperation with Flextronics on the relocation of major parts of our production. As expected, this transition has been complicated, but throughout the process, we have maintained our high quality level. Jointly we have now come to the conclusion that it is more optimal for the LEGO Group to manage the global manufacturing setup ourselves. With this decision, the LEGO supply chain will be developed faster through going for the best, leanest and highest quality solution at all times.”2
1 LEGO press release, December 21, 2005. 2 LEGO press release, June 1, 2008.
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This sudden change in its sourcing strategy posed LEGO management with a number of caveats. Despite the bright forecasts, the collaboration did not fulfill the initial expectations, and the company needed to understand why this had happened. Secondly, what could LEGO management have done differently? Arguably, with little prior experience in outsourcing this large amount of production, the LEGO Group had had a limited knowledge base to draw on to manage a collaboration like this. Yet, with Flextronics’ size and experience with original equipment manufacturers (OEMs), this, in theory, should not have been a problem. Lastly, one could ponder whether the unsuccessful collaboration with Flextronics had been a necessary evil for the LEGO Group. LEGO management’s ability to handle its global production network after the Flextronics collaboration had surely changed, and aspects like standardization and documentation had, to a much larger extent, become valued. INTRODUCING THE LEGO GROUP: ONLY THE BEST IS GOOD ENOUGH The LEGO Group’s vision was to “inspire children to explore and challenge their own creative potential.” Its motto, “Only the Best is Good Enough,” had stuck with the company since 1932 when Ole Kirk Christiansen, a Danish carpenter, established the company in the small town of Billund in Jutland, Denmark, to manufacture his wooden toy designs. As the company itself said, “It is LEGO philosophy that ‘good play’ enriches a child’s life — and its subsequent adulthood. With this in mind, the LEGO Group has developed and marketed a wide range of products, all founded on the same basic philosophy of learning and developing — through play.”3 With this simple idea, the company, through its history, had grown into a major multinational corporation, and, by 2009, was the world’s fifth-largest manufacturer of toys in terms of sales. The same year, the LEGO Group earned DKK11.7 billion in revenues and DKK2.2 billion in profits, and had a workforce of approximately 7,000 employees around the world (see Exhibit 1). Its corporate management consisted, besides the chief executive officer and the chief financial officer, of four executive vice-presidents with respective business areas (markets and products; community, education and direct; corporate centre; and global supply chain) (see Exhibit 2). Products and Markets The LEGO brick was the company’s main product (see Exhibit 3). The iconic brick with the unique principle of interlocking tubes offering unlimited building possibilities was first introduced in 1958 and had basically remained unchanged ever since. The underlying philosophy of the brick was that it would stimulate creative and structured problem-solving, curiosity and imagination. In the company’s own words: “In the hands of children, the products inspire the unique form of LEGO play that is fun, creative, engaging, challenging — all at the same time . . . . We strive to accomplish this by offering a range of high quality and fun products centred around our building systems.”4 The simple yet multi-functional and combinational structure of the brick (there were as many as 915 million possible combinations to choose from with six eight-stud LEGO bricks of the same color) had, therefore, been core to the company’s history and success. In fact, the LEGO brick had been rewarded the “Toy of the Century” designation by both Fortune Magazine and the British Association of Toy Retailers. To segment the products, however, a number of categories had been created: First, “pre-school products” comprised products for the youngest children, who had yet to start school. The LEGO DUPLO products were examples of this category. Second, the “creative building” category targeted sets or buckets of traditional LEGO bricks without building instructions. Third, “play themes” products were the products 3 LEGO Annual Report, 2009. 4 Ibid.
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that had a particular story as their basis. This could be themes such as airports, hospitals and racing tracks. The classic LEGO City line and futuristic BIONICLE theme products were examples of this category. Fourth, and related to the play themes, were the “licensed products,” which were built up around movies or books that the LEGO Group had acquired the rights for, such as Harry Potter, Star Wars and Indiana Jones. Fifth, “MINDSTORM NXT” was a programmable robot kit, where consumers could construct and program robots to perform different tasks and operations. Sixth, “LEGO Education” comprised products that had been specifically developed for educational purposes. Last, in 2009 the LEGO Group made its first move into the board game category with the launch of the “LEGO Games” product line. The underlying logic of the entire product portfolio was to reflect the fact that children grow older and develop, and thus demand more challenging stimulation. LEGO products were sold in more than 130 countries. The largest single market was the United States, which in 2007 accounted for 30 per cent of the revenue in combination with Australia, New Zealand and the United Kingdom. Central and Southern Europe represented 27 per cent, while Scandinavia, Benelux, Eastern Europe and Asia represented 26.5 per cent. Dealing with a Crisis In 2004, radical changes took place within the LEGO organization as a consequence of a major internal crisis that drew the company near bankruptcy. The crisis, which could be traced back to the end of the 1990s, had accumulated with net losses worth DKK888 million and DKK1.8 billion in 2003 and 2004, respectively. Sales had fallen by 30 per cent in 2003 and 40 per cent in 2004. These results had been the most disappointing in the history of the company. On average, the toy maker had made economic losses equivalent to DKK2.2 million per day in the period from 1998 to 2004. The reasons for the crisis had been many. The immediate explanation was the company’s general loss of confidence in its core product — the LEGO brick. With an initiative to create new engines of growth and to address a decline in the traditional toy market, LEGO had sought, over the last decade, to broaden its portfolio into new, rather discrete areas, including computer games, television and clothing. This act of diversification had resulted in vast complexity and inefficiencies, as well as highly confused customers and employees. For instance, with the surge of licensed products like Harry Potter and Star Wars, the LEGO Group produced a range of unique bricks for each single new product. The LEGO Group had, at the time, roughly 11,000 suppliers — a number almost twice what Boeing used for its planes. Unfavorable developments in the global toy market as well as in the exchange rates of key currencies of important markets had not made matters easier. As former chief executive officer Kjeld Kirk Kristiansen argued, “We have been pursuing a strategy that was based on growth, increase in market shares and growth by focusing on totally new products. This strategy did not give the expected results.”5 Moreover, he noted that “we shifted the focus from our actual core product, which at the same time faced difficulties in a more competitive and dynamic market.”6 In October 2004, Jørgen Vig Knudstorp was appointed as Kristiansen’s successor. Kristiansen, who was the grandson of the founder, Ole Kirk Christiansen, had been the president and CEO of the LEGO Group since 1979. Knudstorp was only the second person outside the founding family who held the position of CEO, and his primary task was to steer the company back on track. “I don’t have any miracle cure,” he explained as to how he would put an end to the financial turmoil. “LEGO shall first and foremost drop its arrogance. We have been too sacred with our own virtues, not open enough, and not willing to listen to 5 LEGO press release, January 8, 2004. 6 LEGO Life, September 2007.
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what other people say. We shall now listen to customers and consumers; simply drop the sacredness. We must be aggressive in the market; work closely with retailers; and manage LEGO very tightly, also financially.”7 Accordingly, a strategy titled “Shared Vision” was soon implemented, and was defined around three core principles: “Be the best at creating value for our customers and sales channels.” “Refocus on the value we offer our customers.” “Increase operational excellence.” After divesting its theme parks and receiving an extraordinary loan from the founding family of 800 million DKK, the LEGO Group embarked on the comprehensive strategy of right-sizing its activities, its cost base and its many assets. In particular, careful scrutiny of the organization made the LEGO Group aware of the fact that its ineffective and inflexible supply chain was a key problem for the creation of a sound business platform. The degree of organizational complexity on multiple levels had basically undermined an otherwise sound business platform. According to Knudstorp: “From my perspective, the supply chain is a company’s circulation system. You have to fix it to keep the blood flowing.”8 LEARNING FROM OFFSHORE OUTSOURCING: A STORY IN THREE PARTS 1. Preparing for Outsourcing A key revelation of the comprehensive analysis that was initiated in 2004 was that urgent transformations in all major areas of the supply chain were needed. In the development function, the main focus was to simplify the LEGO sets, which over the years had grown highly elaborate. One LEGO senior director noted, “This excessive complexity of shapes and colors of LEGO elements that was coming from the development was badly hitting the supply chain.”9 A major challenge was to ensure that the right components were constantly in stock. Significant forecast errors and seasonal demand fluctuations coupled with customers’ expectations of short delivery times resulted in large stocks of many different components. The high numbers of components also required heavy investment in molds. The decision was therefore made to limit the growth in the number of product components and then to gradually reduce it. This was not only supposed to drive costs out of the supply chain, but was also to prepare the company for the new scenarios of the outsourced production set-up. In the area of distribution, the analysis uncovered the need for major changes in how the company approached its retailers. Describing the situation, a senior director was quoted as saying, “It was impossible to be efficient and manage the supply chain with the level of flexibility we had towards all retailers, including the smallest outlets. We clearly needed to put certain rules here.”10 To manage this, clearly defined service policies were established. The new policies distinguished explicitly between different approaches to the retailers and helped the company to focus more on the large retail chains that were increasingly gaining dominance in the toy market. This immediately helped to drive down the cost of distribution, provided a more reliable overview of demand and, along with reducing complexity, took some pressure away from the supply chain. Moreover, the company’s five European distribution facilities (Flensburg and Hohenwestedt in Germany, Billund in Denmark, and Lyon and Dunkerque in France) were all centralized in Jirny, 10 kilometres east of Prague, Czech Republic. Occupying 51,000 square metres,
7 Politiken, October 23, 2004. 8 s+b, Autumn 2007. 9 Interview with LEGO manager, August 27, 2007. 10 Ibid.
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the new European distribution centre was in full operation at the beginning of 2007 and handled customers in Europe and distribution centres throughout the world (except North America). The operation was outsourced to DHL Solutions. In addition, the distribution of LEGO products in the United States and Canada was outsourced to Exel Inc., a contract logistics provider operating in Alliance, Texas. However, no matter how significant the problems were in product development and distribution, sub- optimizing only those areas without improving various aspects of the actual production could hardly bring the company back on track. The LEGO Group’s production value chain was divided into the following steps: the development of the molding machine, molding, assembling, pre-packing and post-packing (see Exhibit 4). Assembling and post-packing were the most cost-intensive parts of the value chain. Prior to the crisis, the company owned and operated production plants in Denmark, the United States, Switzerland, the Czech Republic and South Korea. Allocation of roles and responsibilities to most of these factories followed a branding strategy in which one of the Swiss factories only produced DUPLO toys and another produced Technic products. Furthermore, the Danish factory only manufactured LEGO System products, while the U.S. facility predominately served American demands. The vast majority of the production took place in the Danish and U.S. sites, while roughly five to 10 per cent of the LEGO Group’s total production was outsourced to Chinese contract manufacturers. With the new strategic direction of achieving a lighter production portfolio, however, the company started to look for external partners to carry out a larger bulk of its production. There were two main strategic rationales for this. First of all, there was the cost-saving rationale. With the majority of the production in high-cost countries, the management saw major potential for cutting costs by relocating production to low- cost countries. “We were basically turning the 50 year old idea that Denmark and Switzerland were good countries for automatic production upside down,” recalled Duedahl, a LEGO vice-president. “The new mantra was: aggressive outsourcing to low-cost countries.”11 In spite of the fact that up to 95 per cent of global toy production was located in China, the LEGO Group decided to avoid relocating production facilities to Asia and instead emphasized proximity to its main markets in Europe and the United States. Based on the fact that the European market accounted for approximately 60 per cent of the company’s sales, the Czech Republic and Hungary, two low-cost Eastern European countries, fulfilled both the market proximity and cost-saving criteria. These countries were supposed to accommodate most of the capacity transferred from Denmark and Switzerland. In addition, the decision was made to move the company’s U.S. plant in Enfield to Mexico in order to supply the North American market, which constituted approximately 30 per cent of the LEGO Group’s sales. Secondly, with a production of approximately 24 billion bricks per year, the LEGO Group rationalized sourcing through potential economies of scale as well as the opportunity to drastically reduce production complexity by targeting large subcontractors. Thus, besides scaling down production in Denmark and closing sites in Switzerland and Korea, it was decided that production should be outsourced to a number of partners. These included Sonoco (a global manufacturer of consumer and industrial packaging products and provider of packaging services); Greiner (a global manufacturer of consumer and industrial packaging products); Weldenhammer (packaging products and services); 2B Pack (packaging products and services); and Flextronics (an electronics manufacturing services company). While the Technic and Bionicle product lines, to a large extent, were to be retained in-house, the Duplo and System lines (characterized by their high-volume production) were predominantly outsourced to Flextronics.
11 Ingenøren, October 24, 2008.
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Flextronics, a leading multinational electronics manufacturing services (EMS) provider based in Singapore, had a long history of offering services to original equipment manufacturers (OEMs), and was going to be the LEGO Group’s largest partner in terms of production undertaken. Flextronics was actually founded in 1969 in Silicon Valley, California, and became, in 1981, the first U.S. manufacturer to formally start offshoring production by establishing a manufacturing facility in Singapore. In 1990, however, the company moved its headquarters to Singapore, and had since succeeded in building a network of manufacturing facilities in 30 countries on four different continents. By 2009, Flextronics’ net sales were US$31 billion, and it had a workforce of approximately 160,000 employees (see Exhibit 5). Flextronics’ major clients included large multinational companies like Cisco Systems (consumer electronics products), Hewlett-Packard Company (inkjet printers and storage devices), Microsoft Corporation (computer peripherals and consumer electronics gaming products) and Sony-Ericsson (cellular phones). The company had focused its segments into six core areas — automotive, computing, industrial, infrastructure, medical, and mobile and consumer — and it operated with five business units that consisted of “strategic technologies and augmented services that are leveraged across all segments and customer product categories to create scalability and to add flexibility and speed to our segments.”12 The five business units were Multek (multi-layer printed and flexible circuit boards, interconnected technologies and complex display technologies); Vista Point Technologies (unique product solutions for camera modules); Global Services (logistics, reverse logistics and repair operations); FlexPower (design and manufacturing of semi- custom and custom power supplies and battery chargers); and Retail Technological Services (competitive and flexible field services for customer operations) (see Exhibit 6 for Flextronics’ service model). 2. A Troubled Marriage Following the decision to outsource major parts of production to Flextronics, a contract with Flextronics was finalized in June 2006. This was, according to the Danish company, a “brilliant idea,” as it locked the prices over a long period and thus eliminated the risk of production price fluctuations. In the period from 2004 to 2006, the following were outsourced to Flextronics: parts of the production facilities’ capacity in Denmark and Switzerland were relocated to Flextronics’ plants in Nyíregyháza and Sarvar, Hungary; the operating control of the LEGO Group’s Kladno site in the Czech Republic was handed over to Flextronics; and the Enfield plant in the United States was closed in favour of using Flextronics’ newly opened site in Juárez, Mexico. Throughout the transition phase, the LEGO Group was working intensely towards reducing its in-house production capacity from 90 to 95 per cent to the set target of approximately 20 per cent. Actually, the 20 per cent target had never been a strategic goal in itself. “It is very difficult to give such an estimate,” a LEGO vice-president explained. “Right from the beginning, the 80/20 per cent [outsourcing/in-house] ratio was more a communication way. What we have decided is that there are two competences that we need to keep in-house in Billund; that is, molding and packing competences. Whether it is 20 or 10 per cent of production it doesn’t matter; what matters is that in the future we will still be able to do what we are doing from the production point of view.”13 Flextronics had indeed been the LEGO Group’s preferred partner to undertake this task. Because of Flextronics’ long history and vast experience in standardizing and documenting work routines and processes to move business activities from site to site, LEGO management was convinced that Flextronics would excel in reducing the complexity of the LEGO production and organization in general. Knudtrup commented after ramping up the collaboration: “We have come to know Flextronics as a very professional partner in connection with the outsourcing of our DUPLO products, which has taken place over the past year. They understand and appreciate the unique values that LEGO products represent, not least the 12 Flextronics Annual Report, 2009. 13 Interview with LEGO manager, August 27, 2004.
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importance of quality and safety, which are fundamental to the good play experience.”14 In an equal manner, Matt Ryan, executive vice-president of Flextronics’ worldwide operations, stated that the relationship “is characterized by intense supply chain collaboration that provides strategic and efficient cost-savings to help improve the company’s competitive market positioning. We are excited to expand our partnership with the LEGO Group as this allows Flextronics further market diversification and enhanced plastic molding capabilities in low-cost regions.”15 A large part of Flextronics’ motivation for getting into business with the LEGO Group had thus been its interest in getting more competencies and knowledge about plastics, which constituted an important part of its electronics manufacturing activities. However, the collaboration did not last for long. Despite LEGO’s goal of optimizing its global supply chain, the outsourcing collaboration was cancelled after merely three years. As became evident, the result of attempting to manage and overcome the complexity of the production network by outsourcing it to external providers was actually only a more complex global manufacturing footprint. In particular, the collaboration with Flextronics presented the LEGO Group with some rather daunting and unexpected challenges. Considering the extreme pace of the transition, it eventually turned out problematic for LEGO to coordinate and control the increasingly global and complex network of production facilities as well as to ensure a reliable and seamless transfer of production knowledge between the two. For example, there was the challenge of aligning the LEGO products’ seasonal fluctuations and unpredictable demand with Flextronics’ business model. About 60 per cent of the LEGO production was made in the second half of the year, the product had an average lifespan of 16 to 18 months, and the demand uncertainty fluctuated with plus or minus 30 per cent. The LEGO Group’s need for flexible and market-responsive business solutions presented a strategic misfit with Flextronics’ more stable and predictable operations in which economies of scale was a key phrase. Divergence and misalignments between the two had, therefore, become the outcome. 3. A Bounded New Start In 2008, as the LEGO Group announced that it would phase out the cooperation with Flextronics, the process of sourcing back the production was initiated. This was embarked on by the LEGO Group taking over the control of the Kladno factory in the Czech Republic in February 2008. Flextronics was still in charge of molding LEGO products at two sites in Hungary (Sarvar and Nyíregyháza) and one site in Mexico (Juárez) until July 2008, when LEGO management affirmed that these would follow suit with the site in the Czech Republic. In Hungary, LEGO concentrated its activities at the Nyíregyháza facility by taking over the plant and its workforce. During the first quarter of 2009, the Juárez production moved to a new site fully owned by the LEGO Group in Monterrey in northeast Mexico, and the site was up and running in the second quarter of 2009. “We are not satisfied with the effectiveness in the outsourced facilities,” commented Knudstorp briefly after the decision to end the cooperation was made. “It takes more time to educate people than we had expected, and that means that we are still more effective in Billund.”16 Duedahl, however, argued that it might just as well have been the LEGO Group that had not been correct for Flextronics as the other way around: “All in all, we had to realize that our contract also made it difficult for Flextronics to carry out the responsibilities of the collaboration with LEGO in a sound manner. The supplier, like us, has the same need for a profitable business model.”17
14 LEGO press release, June 20, 2006. 15 Ibid. 16 JydskeVestkysten, July 1, 2008. 17 Ingenøren, October 24, 2008.
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Looking back, the attempt to cut costs and reduce complexity quickly had, in fact, complicated matters for the worse, and thus hindered a conducive foundation for creating profitable synergies. At a glance, the Flextronics adventure therefore looked like a failure. “We have learned that even though everything points at outsourcing, it might still not be the best solution,” said Duedahl.18 Still, however, the collaboration had brought along a number of positive externalities. The engagement had first of all helped LEGO to expand its global operations footprint despite its difficult financial situation. Prior to Flextronics, it was hardly possible to establish the new and needed operating bases in Mexico and Hungary. Flextronics had thus provided the Danish company with the necessary impetus for altering its global production network to serve important markets while saving costs. Perhaps more importantly, the collaboration had given the LEGO Group an indispensable lesson in understanding its own processes and structures. As Duedahl explained, “We have learned that we are more special than we expected to be.”19 In addition, Flextronics possessed valuable experience and knowledge in relation to the documentation and standardization of the production. Previously, the LEGO Group, to a large extent, had carried out its production processes without paying too much attention to the documentation of it. “We had had the pleasure of being in Billund for 40 years with many loyal colleagues,” said Thomas Nielsen, a LEGO manufacturing vice-president. “The downside to this, however, is that you become rather lazy on the documentation side, as everybody with many years of experience knows exactly what to do.”20 As the LEGO Group went from producing the absolute majority in-house to becoming highly dependent on external partners, changes were unavoidable. With the Flextronics collaboration, LEGO management came to realize not only the need, but also the value, of documenting work processes, communication lines and interfaces between activities and tasks in the production. “Production in another country — even within the same company — requires ten times more documentation than in the company that it is moved from,” rationalized Michael Vaag, a LEGO supply chain manager.21 The increased employment of process documentation had given the LEGO Group transparency and control, and thus ample room to manage challenges of complexity and to identify the stronger and weaker parts and links of the production network. In this respect, LEGO management had introduced, in 2005, a deliberate sales and operations planning (S&OP) process to monitor and coordinate the different production facilities’ roles, capacities and responsibilities in relation to the supply. This approach had stuck with the company also after the break-up with Flextronics and was considered “a strong fundament for the process.” Before being introduced in 2005 as a global process covering all LEGO in-house and outsourced sites, S&OP ran for a year at the company’s site in Enfield, United States, resulting in significant operations performance improvements. Michael Kehlet, a LEGO flow planning director, described S&OP as “a process gluing all operations’ work flows together.”22 The global S&OP process at LEGO was organized around three key areas: sales, production and product development. Monitoring and coordinating these areas took place through a multi- stage cycle, which started with data consolidation at the site level and concluded at a global executive S&OP meeting. The S&OP cycle took place every month, providing LEGO with a reliable and constantly updated overview of global operations for the following 12 months. Gradually, the S&OP process evolved into a rather critical tool for creating transparency and supporting management efforts in a relatively fragmented and globally distributed operations set-up, which involved numerous capacity groups and outsourcing partners.
18 Ibid. 19 Ibid. 20 Interview with Thomas Nielsen, October 7, 2009. 21 Ingenøren, March 14, 2008. 22 Interview with Michael Kehlet, September 13, 2008.
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Along with its surge in documenting business processes, the LEGO Group, through Flextronics, had also recognized the strength of standardizing its processes. Actually, standardizing the business processes had always been an integral part of the LEGO Group’s approach to production. With the production of around 24 billion bricks per year, a high degree of standardization was obviously imperative for the extreme accuracy required. The collaboration with Flextronics, however, had illuminated LEGO management’s perception of how standardization could be used more strategically in the firm. Chresten Bruun, a senior production director, explained how the virtues of standardization had been taken to new frontiers within the company. “We are standardizing on three levels,” he said, “the upper level: that is our way of thinking, our mindset, values, attitudes; on the mid level: how we operate our planning processes, follow-up processes, etc.; and the lower level: that is more the hardware part, the machines, lines and the layout in the production.”23 The total number of component portfolios had accordingly decreased from approximately 12,000 in 2004 to roughly half that number in 2008 (reaching levels that existed before 1996), with the final target being 5,500 for the year 2011. The LEGO mini figure policeman, for instance, was reduced from 16 different versions to only four. The standardization had implications throughout the whole value chain, starting with the design of new products — as every new product should contain at least 70 per cent “evergreen” bricks — i.e., bricks that could be used in more products. Reducing the more unique and product-specific bricks to only 30 per cent of all bricks allowed for a more flexible and smooth supply chain. Its international network of production facilities had also changed from mainly branding factories, where each facility had been responsible for one single product, to facilities that were more standardized, with their main purpose being to serve their respective markets. This gave the company considerable room to benchmark the factories, and thus optimize the total cost advantage of the production facilities in which the reaction time to market was a decisive parameter. In the aftermath of Flextronics, Michael Vaag, supply chain manager, summarized his success criteria for global production in four ways: “1) It is easy to move technology — it takes more time to build competences; 2) a clear plan for training and education shall be present; 3) there shall be local leaders who know the working culture in the country; and 4) there shall be a clear key figure structure, which ensures actual benchmarks/KPI between the factories.”24 In sum, the LEGO Group read the collaboration with Flextronics in three different stages — before, during and after — each stage with different challenges and opportunities (see Exhibit 7). What seemed to be the recurring theme throughout the entire process, however, was how LEGO management continuously increased its stock of knowledge concerning how to optimize its processes and organization to overcome and manage the multitude of complex issues deriving from having a global network of production. EPILOGUE The LEGO Group’s recent financial record showed that Knudstorp and his executive management had indeed been successful with the turnaround strategy: the profits for 2008 and 2009 of DKK1.85 billion and DKK2.2 billion, respectively, were the largest in the Group’s history. Commenting on this, Knudstorp said, “Our results for 2008 have been extraordinarily good. And this applies not only to the financial results. During 2008, we also took over two factories in the Czech Republic and Hungary, and we began the construction of a factory in Mexico. The successful change to [more in-house] production, combined with strong sales increases, is attributable to the impressive performance by all our employees.”25 The back- sourcing from Flextronics had played an inevitable part in achieving this. The new dominantly in-house
23 Interview Chresten Bruun, January 8, 2010. 24 Ingenøren, March 14, 2008. 25 LEGO press release, February 23, 2009.
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production network consisting of factories in Denmark, Hungary, the Czech Republic and Mexico seemingly gave the LEGO Group enough controllable flexibility to balance market demands with its network of offshoring activities. However, the LEGO executive management knew not to rest on its laurels. Although looking promising, the new production network was, in fact, a mere result of avoiding the emerging unexpected costs from having outsourced the production. A central question was therefore: What had the LEGO Group learned from the Flextronics collaboration and how could it use this knowledge constructively in the future?
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Exhibit 1
THE LEGO GROUP FINANCIAL FIGURES
mDKK 2009 2008 2007 2006 2005 HIGHLIGHTS Income statement Revenue 11,661 9,526 8,027 7,798 7,027 Expenses (8,659) (7,522) (6,556) (6,393) (6,605) Operating profit 3,002 2,002 1,471 1,405 423 Financial income and expenses (15) (248) (35) (44) (51) Profit before tax 2,887 1,852 1,414 1,281 329 Net profit for the year 2,204 1,352 1,028 1,290 214
Balance sheet Total assets 7,788 6,496 6,009 6,907 7,058 Equity 3,291 2,066 1,679 1,191 563 Liabilities 4,497 4,430 4,330 5,716 6,495
Cash flow statement Cash flow from operating activities 2,655 1,954 1,033 1,157 587 Investment in activities, plans and equipment 1,042 368 399 316 237 Investment in intangible assets 216 75 34 - - Cash flow from financing activities (906) (1,682) (467) 597 (656) Total cash flow 501 128 592 1,925 1,570
Employees Average number of employees 7,058 5,388 4,199 4,908 5,302
RATIO Financial ratios (in %) Gross margin 70.3 66.8 65.0 64.9 58.0 Operating margin (ROS) 24.9 22.0 18.1 17.0 5.4 Net profit margin 18.9 14.2 12.8 16.5 3.0 Return on equity (ROE) 82.3 72.2 71.6 147.1 44.2 Equity rate 42.3 31.8 27.9 17.2 8.0
Source: The LEGO Group Annual Report, 2009.
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Exhibit 3
THE LEGO BRICK
Source: www.lego.com.
Exhibit 4
PRODUCTION VALUE CHAIN
Source: Authors’ own creation.
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Exhibit 5
FLEXTRONICS IN BRIEF $31 billion in annual sales 160,000+ employees worldwide 120,000 employees in Asia (90,000 in China) Operating in 30 countries 27 million square feet of capacity (nine industrial parks) Large customers: Casio, Cisco Systems, Dell, Eastman Kodak, Ericsson, Hewlett-Packard, Microsoft,
Motorola, Research in Motion, Sony, Sony-Ericsson, Sun Microsystems, and Xerox.
Flextronics’ Market Segment Portfolio, 2007
Source: www.flextronics.com.
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69
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70
7.
Sw
9B12D012
STRATEGIC SOURCING AT WHIRLPOOL CHINA: FINDING THE IDEAL SUPPLIER Dr. Martin Lockstrom, Thomas E. Callarman and Shengrong Zhang 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. Richard Ivey School of Business Foundation prohibits any form of reproduction, storage or transmission without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Richard Ivey School of Business Foundation, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected]. Copyright © 2012, CEIBS Version: 2012-06-19
It was April 10, 2011, when Gianluca Castelletti, head of Whirlpool’s Asia International Procurement Office in Shanghai, was informed by his colleagues that the company was about to launch a new refrigerator model in just six months. With the current worldwide focus on energy saving, and as one of the biggest home appliances producers, Whirlpool China planned to introduce a new energy-efficient refrigerator. Castelletti immediately spotted a challenge in Whirlpool China’s plan to launch a new energy-efficient model within such a short period of time. Under the current global trend of energy-saving, consumers were demanding new energy-efficient products, which obviously would involve new kinds of technology. For the new refrigerator model, the basic difference was in the motor, since the current style of AC motor, which offered a low cost, would need to be replaced with DC motors, which offered much higher energy efficiency. Castelletti would have to find a suitable supplier of DC motors, and he had less than six months to do so. Delayed components would cause delays in the production of a new refrigerator, and thus, a later launch of new products. Within the home-appliance industry, the fierce level of competition meant that any delays in launching new products would result in a severe loss of sales for the stragglers. Castelletti now faced a tough challenge: How should he go about the process of finding a suitable supplier for the required DC motor parts? Should he explore the possibility of developing the company’s current supplier, or should he quickly engage an existing supplier of DC motors? Sourcing the right components was the first step in launching the new product. The pressure increased even further when Castelletti received call from his supervisor, inquiring about his planned strategy for sourcing the new motor for the energy-efficient refrigerator. Castelletti had to quickly decide where he could find the suitable suppliers in order to avoid delays in launching the new product. The question was “how”? Castelletti called together his team to develop a plan.
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71
Page 2 9B12D012 COMPANY BACKGROUND Whirlpool’s History Whirlpool Corporation was the world’s leading manufacturer of major home appliances. In 2010, the company had more than $18 billion revenues and net earnings of $619 million (see Exhibit 1). On a worldwide basis, Whirlpool had 68,000 employees working in 67 manufacturing and technology research centres. It produced all major categories of home appliances, including stoves, washers and dryers, dishwashers, refrigerators, garage organizers, and countertop appliances. Whirlpool produced and marketed Whirlpool, Maytag, KitchenAid, Jenn-Air, Amana, Gladiator Garage Works, Inglis, Estate, Brastemp, Bauknecht, Consul, and other major brand names to consumers in almost every country around the world . Whirlpool’s global headquarters were located in Benton Harbor, Michigan, with manufacturing facilities and sales outlets across North America, Latin America, Europe and Asia. In total, the company’s products were sold in more than 130 countries. Ironically, Whirlpool was founded on a business failure. In 1908, Lou Upton’s invested his savings in a venture that manufactured household equipment, but the business did not succeed. Upton retained one asset from the business that he hoped would be valuable: the patents on a hand-operated wringer washing machine that he thought could be converted to an electric model. In 1911, Upton joined forces with his uncle and his brother to launch the Upton Machine Company in St. Joseph, Michigan, which produced motor-driven wringer washers. After a quick business expansion, 1929 saw the company merge with the Nineteen Hundred Washer Company of New York. Twenty years later, the company’s name was changed to Whirlpool Corporation, and it soon earned the title of industry leader. After a series of other acquisitions, Whirlpool participated in an acquisition with the Maytag Corporation on March 31, 2006. This was a significant step for Whirlpool to become “the largest home appliance maker in the world,” a title that had previously been reserved for Electrolux. Whirlpool’s philosophy focused on customer loyalty. Its products were built to be reliable with long lifecycles, which meant substantial emphasis had to be paid to product quality. The company’s focus on quality was rooted at the conceptual stages and continued throughout the manufacturing process. The results of these quality efforts, combined with Whirlpool’s commitment to innovation and cost productivity, brought about a strong competitive advantage. Stiff competition from competitors such as Electrolux, General Electric, LG, etc. also created a competitive pricing environment, and hence, it was essential that Whirlpool concentrated on cost reduction, productivity initiatives, and innovation in order to offset high material costs and maintain its position in the market. Furthermore, lean manufacturing and operational excellence were the principles on which Whirlpool relied to ensure a continuous improvement of process and to meet its high standards of quality. China’s Household Electrical Appliance Market Aided by the rapid development of the Chinese economy and a rising GDP per capita, China’s household electrical appliances industry grew quickly in response to the government’s policy of stimulus in domestic F
or u
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72
Page 3 9B12D012 demand. According to China’s Household Electrical Appliances Industry Report, China had become the largest household electrical market in Asia Pacific area in recent years. According to the data from China Household Electrical Appliances Association, more than one-third of the household electrical appliances in the world were produced in China in 2007. Approximately 50 per cent of the world’s televisions were manufactured in China, along with 70 per cent of air conditioners and almost 100 per cent of the world’s microwave ovens. China stood out as one of the largest household appliance makers in the world, also boasting a large market share. Establishing a foothold in China had been a long and tedious process for Whirlpool since its entry into the market in 1995. At that time, Chinese regulations required foreign companies to work with local partners. The company’s chief executive officer (CEO) at that time announced a joint venture agreement after its investments of more than $100 million with local house appliances producers. The joint venture agreements gave Whirlpool a chance to produce the top four household appliance categories: washing machines, microwave ovens, refrigerators and air conditioners. Three short years, later Whirlpool was forced to pull out of two of the five joint ventures due to its unfamiliarity with and unclear positioning in the Chinese market. In 2001, China joined the World Trade Organization, and the resulting freer access to China’s market greatly improved conditions for Whirlpool. Furthermore, relocation of the company’s Asian headquarters to _Shanghai changes in the Chinese consumer mindset (i.e., Whirlpool’s offerings began to be accepted as a high-quality products) and incorporating learning from other multinationals all helped Whirlpool to compete more successfully in the Chinese market. By 2011, China accounted for approximately 3 per cent of the company’s global sales, including sales to other manufacturers. Whirlpool employed more than 2,500 people in China, and its microwave factory in Shunde produced more than two million units per year, most of which were shipped to North America and Europe. Washers and refrigerators were produced in factories that had been newly established in a joint venture with Hisense, one of the largest appliance producers in China. THE INTERNATIONAL PROCUREMENT OFFICE IN SHANGHAI Various factors could turn global sourcing into a tricky process: transportation delays, lack of technology and capacity of foreign resources, cultural and language differences, quality assurance, political and economic stability, and proper inventory management systems, to name just a few. For these reasons, Whirlpool set up an international procurement office in Shanghai to support its own manufacturing operations in Asia and to provide support for any other operation in the world that sourced components from Asia. In 2010, the Asian international procurement office sourced more than US$1 billion in China out of $8 billion global direct spend. Companies chose to source in China for many reasons, including reducing capital investment, gaining more market share, focusing on core competencies, and increasing the company’s flexibility in production. Although China may have shown a cost advantage when it came to raw materials, inconsistencies existed in the areas of quality and reliability. Other hindrances that companies often faced when operating in China stemmed from the fact that the country lacked capable service providers and suffered from shortcomings in the areas of transportation and IT infrastructure. At times, high rates of damage/loss in transit also caused a problem. For a supplier to be considered as a Whirlpool supplier, it had to match the following criteria: Fo
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Page 4 9B12D012 Whirlpool code of conduct and other requirements; Minimum quality audit score; Best total cost of ownership and manufacturing efficiency; Continuous innovation in design and manufacturing for best-in-class quality and technology; Structured project tracking, design reviews with management tollgates, utilizing design and process
FMEA, fault tree analysis, reverse engineering and other tools where applicable; and Access to UL, CSA, VDE and other agency approval. The following requirements were dependent on the commodity analyzed: Laboratory capability for engineering conformance and reliability testing. Prototype capabilities. Whirlpool required a very restricted supply quality system, namely the Whirlpool Supplier Quality System. The Whirlpool Supplier Quality System was developed based on the ISO 9001. The household appliance industry was broader than the ISO 9001 requirements, including process capabilities assessments (see Exhibit 2). Based on Castelletti’s experience, most suppliers in China, even those who supplied Whirlpool’s competitors, could not reach the minimum required score when audited as potential suppliers during the first round of Whirlpool’s selection of potential suppliers. With the minimum score required being 60/100, the first-round score among good, local suppliers was approximately 50. Elements were weighted separately to bring about the total score of 100. Since 1996, Whirlpool had followed a restricted Six Sigma program, and within the company, more than 1,500 Whirlpool employees possessed Six Sigma training. The training program included teaching the employees to use Lean and Six Sigma techniques. This system was intended to improve the quality and efficiency of Whirlpool’s manufacturing, technology, and business processes and products. When a supplier showed a distinct advantage on cost structure and could provide clear value, the SQE (Supplier Quality Engineer) and SDE (Supplier Development Engineer) team at Whirlpool’s international procurement office would provide resources to facilitate closing the gap within a certain time frame. The commodity team was also in charge of facilitating the supplier qualification process. The international procurement office had a special budget for the SQE team for supplier development, covering the travel costs of supplier visits and continuous training. The SQE members often travelled, moving from one supplier to another to conduct gap-closure development by providing training or by coaching the execution of given projects. The suppliers were not charged for the training they received from Whirlpool; however, they were expected to take some initiatives to acquire outside resources for self-improvement if their current situations were judged to be insufficient. For example, those local suppliers that did not have capable people in place would be pushed to hire the right people to enhance their quality process. FINDING THE RIGHT SUPPLIER To find a suitable supplier of DC motors for the new energy-efficient refrigerator model, Whirlpool used the Sourcing Strategy Development (SSD) process, which included four steps for sourcing the right suppliers: Step 1 - internal analysis; Step - 2 external analysis; Step 3 - Strategy development; and Step 4 - implementation. Even before Step 1, it was necessary to define the commodity and allocate F
or u
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Page 5 9B12D012 responsibilities and resources through co-ordination of global and regional activities. An internal analysis identified and prioritized the process-partner requirements, then evaluated the performance of the existing supply base, and reviewed the existing supply base. The SSD process should also identify the switching costs in Step 1. When the internal need was clear, then the process moved forward to Step 2, the external analysis, which included analyzing the supplier industry and competitors and evaluating competitor performance and strategies. The evaluation process made use of SWOT (Strength, Weakness, Opportunities, Threat) analysis and Best-in-Class performance analysis. From the results of the internal and external analysis, Step 3 was then used to develop the sourcing strategy. In this stage, Porter’s Five Forces Model was also adopted to analyze the competitiveness. After understanding the existing strategies, strategic options were formulated and their financial impact was analyzed. In developing a sourcing strategy, preliminary negotiations could be carried out, a suitable strategy and suppliers should be selected, and the critical path for implementation should be defined. Step 4 addressed the implementation stage, wherein the planned strategy was put into play, feedback was given to the chosen process partners and suppliers, and final negotiations were nailed down. In the implementation phase, if the goals had not been met, the strategy needed to be revised. With the complete SSD analysis, the sourcing strategy had put Whirlpool in a position to find suitable suppliers. THE CHALLENGES Acting as a supplier for one of the largest home-appliance makers in the world was not an easy job for suppliers. First, the suppliers had to agree to some aggressive payment terms. Whirlpool’s U.S. procurement team privileged the consignment stock process, which meant that any agreed-upon payment terms started when parts were withdrawn from Whirlpool’s components warehouse, located in every Whirlpool factory. The warehousing time and the transportation lead time, including sea and land transportation times, were consequently added to the agreed-upon payment terms but were not predetermined — or even pre-determinable. Many suppliers found it difficult to accept these challenging payment terms. Second, the suppliers had to endure a long sample-testing process When suppliers were deemed qualified (i.e., after passing the quality system audit) to move ahead for a particular project, Whirlpool still required them to provide samples that passed the sample tests and application tests (see Exhibit 3). Third, suppliers faced a continuous challenge in terms of cost and quality improvement, year on year, especially since Whirlpool placed a great deal of emphasis on both quality and cost. For the sourcing team, continuous improvement was expected in terms of each year’s sourcing performance. Whirlpool used a technology road map for its own corporate technology evolution; therefore, its suppliers were expected to meet that same requirement each year to ensure continuous progress. Whirlpool’s strict selection criteria made it difficult to find suppliers in China. To launch new products, Castelletti had to make full use of Whirlpool’s Asia International Procurement Office in Shanghai. Finding the right supplier for DC motors in less than six months was the key challenge in front of Castelletti. With the help of its Global Sourcing Strategy and its selection criteria, Castelletti had to decide how to find the optimal supplier.
F or
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Page 6 9B12D012
Exhibit 1
KEY FINANCIAL FIGURES
Consolidated Statements of income ( Millions of dollars, except per share data)
Year Ended December 31 2010 2009 2008 Net Sales $18,366 $17,099 $18,907 Expenses Cost of products sold 15,652 14,713 16,383
Gross margin 2,714 2,386 2,524
Selling, general and administrative 1604 1544 1798
Intangible amortization 28 28 28
Restructuring costs 74 126 149
Operating Profit 1,008 688 549 Other income (expense) Interest and sundry income ( expense) 197 175 100
Interest expense 225 219 203
Earnings before income and taxes and other items 586 294 246
Income tax benefit 64 61 201
Earnings before equity earnings 650 355 447
Equity loss of affiliated companies N/A 1 N/A
Net Earnings 650 354 447
Less : Net earnings available to non-controlling interests 31 26 29
Net earnings available to Whirlpool $619 $328 $418 Per share of common stock Basic net earnings available to Whirlpool $8.12 $4.39 $5.57
Diluted net earnings available to Whirlpool $7.97 $4.34 $5.50
Dividends $1.72 $1.72 $1.72 Weighted-average shares outstanding ( in millions) Basic net earnings available to Whirlpool 76.2 74.6 75.1
Diluted 77.6 75.6 76.0 Source: Internal resource provided by the company.
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76
Page 7 9B12D012
Exhibit 2
SUPPLIER EVALUATION MATRIX
Source: Internal resource provided by the company. F
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77
Page 8 9B12D012
Exhibit 3
SUPPLY CHAIN FLOW DIAGRAM
Source: Internal resource provided by company.
Shortlist suppliers based on stringent criteria
On site quality assessment: Minimum criteria of 60 required
Comparative benchmarking
Sampling process in China or in any other Engineering center in the world
Agreement of commercial conditions, including Payment terms
International Procurement Office works with suppliers to ensure min quality is met
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78
8.
9B13D010
BUILDING SUSTAINABLE DISTRIBUTION AT WALMART CANADA Asad Shafiq wrote this case under the supervision of Professors Robert D. Klassen and P. Fraser Johnson 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 © 2013, Richard Ivey School of Business Foundation Version: 2013-11-12 Spring was just beginning in Balzac, Alberta, and Virginia Garbutt, director of logistics at Walmart Canada, was planning for an upcoming meeting in two weeks with Andy Ellis, the senior vice-president of supply chain and logistics. As Garbutt reflected on the rapidly developing plans for the new distribution centre (DC) in western Canada, she recalled how only a few months earlier, Ellis had questioned:
If we are building a distribution centre, why not make this operation the most sustainable distribution centre in the world? We have this opportunity to be leaders in sustainability and, as far as I know, there is not a single sustainable distribution centre in other Walmart markets. So, why not be the first one, and make a sustainable distribution centre?
Yet, much remained unclear about how to translate Ellis’s challenge into specific actions. Walmart’s aspirational corporate sustainability goals were to be supplied 100 per cent by renewable energy, to create zero waste and to sell products that sustain people and the environment.1 Garbutt’s team was exploring at least three options that promised to make the Balzac DC significantly greener: hydrogen fuel cells for forklift trucks, low-wattage light emitting diode (LED) lighting and renewable energy generation from on-site wind turbines. However, any investment in sustainable technology had to make business sense. The new facility was rapidly taking shape and was expected to be fully operational in late 2010, about eight months away. Garbutt recognized that any decisions about design that would affect operations could dramatically impact the Balzac DC’s performance and operating costs. WALMART STORES, INC. Based in Bentonville, Arkansas and founded by the legendary Sam Walton, Walmart was the number one retailer in the world, with sales of US$419 billion last year, which in turn generated net income of US$16 billion from continuing operations. The firm employed over two million people in more than 10,000 stores across 28 countries, the result of a series of acquisitions over the past 20 years. Beginning with its “big box” discount store format in the 1960s, Walmart’s store formats around the world had expanded to
1 http://www.walmartstores.com/sustainability; accessed June 20, 2012. Fo
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Page 2 9B13D010 include supercentres (a larger version of a discount store with groceries), supermarkets, wholesale outlets, restaurants and apparel stores. Globally, it served about 200 million customers per week.2 Walmart’s strategy was to provide a broad assortment of quality merchandise and services at “everyday low prices” (EDLP), and the firm continued to be best known for its discount stores, which offered merchandise such as apparel, small appliances, housewares, electronics and hardware. SUSTAINABILITY AT WALMART STORES, INC. As noted above, Walmart’s corporate sustainability goals were simple and straightforward: to be supplied 100 per cent by renewable energy, to create zero waste and to sell products that sustain people and the environment. Based on this corporate direction, senior leadership in each country was encouraged to undertake initiatives that fit best with their local market and business conditions. This approach was popularly known as “freedom within a framework” throughout Walmart. Based on recent efforts to advance sustainability initiatives, the firm had won several awards including the Green Power Leadership Award from the U.S Environmental Protection Agency and inclusion in the U.K. Sunday Times list of Top 50 Best Green Companies.3 In early 2010, sustainability initiatives had received further high-level attention when CEO Mike Duke announced that Walmart would cut 20 million metric tons of greenhouse gas emissions from its global supply chain by 2015.4 Sustainability at Walmart Canada Headquartered in Mississauga, Ontario, Walmart Canada operated 379 retail outlets nationwide and served more than one million customers daily. The company's vision was to demonstrate environmental leadership by reducing the ecological impact of its operations through company-wide programs focused on waste, energy and products, as well as outreach programs that preserved and enhanced local environments. Just before the Vancouver Olympics, Walmart Canada hosted a Green Business Summit, gathering not only its own suppliers but also many competitors to share sustainability practices. Exhibit 1 summarizes several environmental key performance indicators for the past three years. A senior leader observed:
Walmart Canada’s specific initiatives to meet their sustainability goals in Canada are largely made-in-Canada solutions. We operate largely as an independent company within the global organization. While ideas like Walmart’s operating philosophy and values come to us from our parent company, most decisions that impact our business and our customers on a daily basis are made in Canada. 5
As a result, Walmart Canada had embarked on a range of its own initiatives that fit within the corporate sustainability strategy. For example, a zero-waste plan was implemented in its Canadian headquarters with such measures as a Styrofoam recycling program and designated chewing-gum composting bins. In an effort to try to broaden its sustainability efforts, a model test store was designed and built in
2 “WMT — 17th Annual Meeting for the Investment Community,” Thomson StreetEvents, October 13, 2010, accessed January 5, 2012.
3 http://www.walmartstores.com/sites/sustainabilityreport/2010/our_business_awards.aspx, accessed January 5, 2012. 4 http://www.greenbiz.com/news/2010/02/25/walmart-climate-commitment-eyes-supply-chain; accessed January 5, 2012. 5 Walmart Canada’s 2010 Corporate Social Sustainability Report.
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Page 3 9B13D010 Burlington, Ontario, in January 2009. Here, the emphasis was on energy efficiency and low-carbon footprint, and the store borrowed from earlier U.S. designs, as well as introducing new principles. For example, using a large number of skylights to provide natural light was borrowed from U.S. stores, whereas a geo-exchange system was introduced as a unique-to-Canada initiative. Collectively, these and other changes reduced the store’s energy consumption by approximately 60 per cent relative to stores of a similar footprint. However, these efforts did not always yield all of the expected benefits. While skylights provided important benefits during daytime hours, particularly in summer, these gains were offset to a major degree by greater energy consumption in winter with Ontario’s colder temperatures and shorter days. The ideas developed in the Burlington store and elsewhere were being transferred to other existing Canadian stores, with a target of improving energy efficiency by at least 20 per cent. However, efforts to expand sustainability were not focused only on the retail operations but also on Walmart’s supply chain and distribution centres. In 2010, the Balzac DC was one of the largest projects for the firm in Canada, and the goal was to save at least 1,000 metric tonnes annually (CO2 equivalent), relative to similar DCs elsewhere in Canada. DISTRIBUTION AT WALMART DCs are a vital part of the retail supply chain. Large retailers can carry several thousand stock keeping units (SKUs), but it would be impossible to efficiently ship all products directly from suppliers to stores. DCs permit consolidation of inventory, shipped from suppliers in bulk by truckload, railcar or intermodal shipping containers. Products are supplied from the DC to retail outlets as required. Common activities within a DC include receiving, break-bulk (e.g., splitting full cases and pallets into individual products), quality control, material handling (e.g., conveyors and forklift trucks), storage, packaging and shipping and transportation. Performance measurements of a DC typically include a combination of operational and financial metrics. The most common performance metrics include handling productivity (e.g., cost per unit), space utilization, accuracy (e.g., percentage of orders picked correctly), damage, service (e.g., fill rate, order cycle time) and inventory (e.g., turns). Walmart’s retail locations and supply chain directly supported its EDLP strategy. Stores were located in low-rent suburban areas close to major highways. In contrast, key competitors tended to be thinly spread across large geographic regions or located in prime urban areas. By the time the rest of the retail industry started to take notice of Walmart in the 1980s, it had built up the most efficient logistics network of any retailer. In the United States, Walmart’s 75,000-person logistics and information systems division included the largest private truck fleet of any firm: 6,600 trucks and 55,000 trailers, which delivered the majority of merchandise sold at stores.6 With 150 DCs located throughout the United States, over five billion cases of general merchandise, food and clothing were processed annually. Because all truck drivers were non-unionized, Walmart was able to assess and improve standard delivery procedures, coordinating and deploying the entire fleet as necessary. Uniform operating standards minimized potential miscommunication between traffic coordinators, truckers and store-level employees. As Johnnie Dobbs, executive vice president of logistics, remarked:
6 http://walmartprivatefleet.com/AboutUs/LeadershipProfiles.aspx, accessed January 2, 2012. Fo
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Page 4 9B13D010
Everyday low cost is the foundation for everyday low prices. So our focus across the organization is delivering products that our customers need in the most efficient method and process available. So, here’s an example of a sustained cost reduction in our transportation area. We have improved visibility and routing tools. We’ve reengineered processes that have decreased the number of empty miles and out-of-route miles that our drivers drive. Our merchants and our suppliers have improved packaging, and we’ve adjusted methods that we use to load our trailers, resulting in increased cases in cube in every trailer that we ship . . . [This year] we’ll ship 335 million more cases while we’ll drive 300 million fewer miles.7
In Canada, Walmart had a total of nine DCs that served 379 stores, including 211 supercentres that carried fresh and frozen foods. The trucking fleet clocked approximately 100 million kilometres per year as food and products moved through this distribution network, with an estimated 11 million kilometres related to the Balzac DC. The average distance from DC to stores was approximately 200 kilometres. Each of these DCs was arranged in a store-friendly manner, with similar products stacked together. Furthermore, merchandise purchased directly from offshore suppliers, such as from China or India, was processed at coastal DCs before shipment to retail stores. PLANNING FOR THE BALZAC DC The Balzac DC was being built to distribute fresh and frozen foods; it was essentially a giant refrigerator- freezer for fresh produce and deli meats. The DC was expected to deliver these products to Walmart Canada’s supercentres located in western Canada, ranging from Manitoba to British Columbia. Design called for 400,000 square feet of floor space, with 600 employees maintaining operations 24/7. Estimated capital costs were expected to be approximately $115 million. The project team was chaired by Garbutt and included Andrew Kornel, transportation vendor manager; Kevin Brant, director DC construction; and Andrew Telfer, sustainability lead. Challenged with building the “most sustainable distribution centre operation,” the project team began by first reviewing initiatives that had proven successful at other Walmart DCs located around the world. They soon realized significant geographic and operational differences necessitated adjustments at each location. For example, “rainwater harvesting” could be used to collect, filter and then store the rainwater that fell on a large DC roof. This rainwater could be used later to irrigate landscapes and plantings. However, while this system appeared simple in principle, substantial capital investment was required to store and pump the water. Furthermore, water was relatively inexpensive in Balzac and additional provincial and municipal permits would be needed to install such a system. As a result, rainwater harvesting was much more attractive in areas where water shortages or local laws encouraged these systems. Alternatively, to eliminate watering, shrubs, trees and grass could be changed to local drought resistant species. Another option, photovoltaic (PV) solar panels to generate electricity, also was considered as a source of renewable energy. This technology had been used at a number of other Walmart locations; however, government-guaranteed feed-in tariffs (FITs) and other incentives were essential to provide a reasonable financial return. In Alberta, these were not currently in place, and the payback was estimated at roughly
7 “WMT — 18th Annual Meeting for the Investment Community,” Thomson StreetEvents, Oct. 12, 2011, Investext, accessed January 12, 2012.
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Page 5 9B13D010 25 years. Instead, a solar thermal system could provide the majority of the domestic hot water for the facility. Third, permeable paving could improve storm water management. In essence, by carefully selecting and applying paving materials, water would pass through the paved surface to reduce runoff and increase soil infiltration, which, in turn, could reduce soil erosion, recharge underground aquifers and reduce the “heat island” effect. In places like California, this option was quite attractive, but the cold climate in Balzac presented problems, as the freezing of moisture underneath the paving likely would result in heaving. This effect is further exacerbated in locations with a high water table, such as Balzac. After reviewing various existing initiatives, the team identified several options that were viewed as better candidates. Each provided a clear step toward a more sustainable DC and also offered some potential financial return too. First, hydrogen fuel cells could be used to power the lift trucks that transferred food from inbound trucks arriving from suppliers, to warehouse storage, to outbound trucks headed for supercentres in western Canada. A second option was to use LED lighting to save energy. Finally, wind turbines could be installed on-site to generate renewable electricity. Garbutt and her team had already gathered some preliminary data on all three, but further work remained to understand how these might contribute to Walmart’s overarching sustainability objectives, as well as how they fit with the operational demands of the Balzac DC. Hydrogen Fuel Cells for Lift Trucks Hydrogen fuel cells had offered much promise for public transit and personal automobiles for many years. Yet, high costs and uncertain reliability continued to limit their application to a few high-profile test applications. Garbutt felt that this emerging technology might fit with Walmart’s need for more sustainable material handling equipment (MHE) in the DC. In particular, a large number of lift trucks were used to move fresh and frozen foods throughout the warehouse in a timely fashion, and there were potential advantages to using hydrogen as a source of fuel. Large distribution facilities depended on their lift truck fleets to keep operations going two or three shifts per day. In these settings, cost and efficiency had to be carefully managed, including employee labour costs, lift truck maintenance and refuelling cost and time. Historically, many warehouses used propane to fuel their lift trucks. Now, with the need to maintain cool conditions in a perishable food warehouse and pressure to improve indoor air quality, the industry now widely employed electric motors and rechargeable batteries in lift trucks. For a DC of Balzac’s size, the initial capital investment for batteries and chargers was estimated to be $1.89 million. Maintenance needs and long recharging times forced managers to purchase additional rechargeable battery packs in order to keep the perishable products moving and to improve employee and lift truck productivity. Spent lead-acid battery packs were swapped out of lift trucks to recharge for extended periods of time. The capital cost of this battery support area, including building, electrical, ventilation, lighting and battery handling equipment, was estimated to be $1.35 million. However, operating costs dwarfed any upfront capital investment. Projected operating costs over the next seven years included electrical energy to recharge, at $275,000 per year; battery maintenance, at $30,000 per year; and labour costs for servicing the battery room, as well as worker idle time, at $500,000 per year. The project team realized that hydrogen fuel cells might provide a clean source of energy for lift trucks. A hydrogen fuel cell can continuously draw hydrogen from an on-board storage tank to create electrical F
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Page 6 9B13D010 energy. But unlike rechargeable batteries, the storage tank can be quickly replenished without the handling, swapping and recharging of spent battery packs. Other advantages promised by hydrogen fuel cells included: • No emissions during operation, a critical factor when the operations' products or processes are
sensitive. • Delivering more consistent voltage than conventional battery packs, leading to lower power train
maintenance. • Hydrogen refuelling for the lift truck took much less time than exchanging the batteries, at roughly
two and 15 minutes, respectively. • Much longer life of the fuel cell. Lead-acid batteries lasted five years (roughly 1,500 recharge cycles),
on average. With technology improvements, the life span of fuel cells was expected to increase further.
• Maintenance, handling and disposal costs associated with batteries would be eliminated. While the promises of this technology were very exciting, much uncertainty remained. And the constraints of perishable products further ratcheted up the need for extremely high reliability. Because fuel cell technology was still evolving, large manufacturers of lift trucks did not build their own propulsion systems. (In contrast, rechargeable batteries were easily integrated into existing lift trucks.) Instead, manufacturers worked with any number of smaller firms that focused only on designing, developing and producing fuel cells. To begin, Garbutt’s team contacted several manufacturers of lift trucks, as well as producers of hydrogen fuel cells, to understand the state of the current technology. The news was not great: while prototypes were available and several firms offered experimental lift trucks, no other large DC (Walmart or its competitors) had adopted this technology. In essence, no one had yet proven it was reliable for full-scale deployment in a large facility. A rough estimate suggested that the capital cost would be approximately $3.93 million, including hydrogen storage and a refuelling station. But new products were quickly emerging, and several firms suggested that they could deliver a reliable technology. For example, Crown Equipment Corp (“Crown”), a large manufacturer of lift trucks with revenues of about $2 billion, had been working with a variety of fuel cell suppliers located in the United States, Germany and Canada. Substituting a hydrogen fuel cell for rechargeable batteries created complications for performance in terms of traction, lift rate and travel speeds. In turn, these factors were partly related to the weight distribution of a fuel cell relative to the much heavier rechargeable battery that it replaced. Furthermore, a typical fuel cell may enable the lift truck to travel too fast, requiring yet more modifications.8 Crown suggested that a newly developed fuel cell option could be tested in another Walmart DC. Once again, the test results were discouraging: the fuel cell could not keep up with the high number of pallet movements required in the warehouse. However, this testing did provide an opportunity to estimate operating costs over the next seven years, assuming the shortcomings could be successfully resolved: the cost of hydrogen, at $430,000 per year; fuel cell maintenance, at $105,000 per year; and labour costs including idle time, at $60,000 per year. The team realized that simply encouraging suppliers to deliver better performance was not sufficient. Instead, it was clear that Walmart would need to be more proactive, including dedicating engineering
8 www.forkliftaction.com/news/newsdisplay.aspx?nwid=8123, “Crown Puts Muscle into Fuel Cell Program,” February 9, 2010; accessed December 4, 2012.
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Page 7 9B13D010 resources and working jointly with one or more suppliers. Garbutt questioned whether this option was really worth investing additional time and resources, particularly given the uncertain outcome. Provided the team decided to proceed, how could potential suppliers be identified and motivated to engage in the project? Since efforts with traditional suppliers in the lift truck industry had failed to produce encouraging results, Garbutt wondered how a new supplier could be identified and developed. She and the team would need to ensure that any arrangement would ensure competitive pricing. LED Lighting Industrial incandescent bulbs typically converted only 5 to 10 per cent of electrical energy into light, with the rest being wasted as heat. Fluorescent lights were better, converting roughly 25 per cent of the energy into light. But LED promised even greater efficiency, converting up to 80 per cent of energy into light. New LED lighting technology used a solid-state lamp as an energy-efficient source of light that typically operated for at least 50,000 hours. Unlike fluorescent lights, LEDs contained no mercury, could be powered on instantly and their life expectancy was unaffected by cycling on and off. LEDs were particularly attractive for cool environments, where energy consumption dropped further and life expectancy extended to about 200,000 hours. Finally, LED lights were compact, which provided more flexibility in designing lighting fixtures and good control over the distribution of light with small reflectors or lenses.9 Further research pointed to at least two disadvantages. First, LED lights could change chemical composition over time, which, in turn, reduced the lamp’s brightness. While the light would continue to function, the brightness could fall below acceptable standards in a DC, prompting early replacement. This appeared to be more problematic with early systems or those made with less expensive materials. Suppliers of LED lamps assured the project team that any reduction in brightness now was comparable to conventional fluorescent lamps. Second, capital costs were significantly higher for LED lighting relative to fluorescent systems. Initial quotes for standard fluorescent lighting was $700,000 for warehouse lighting, $115,000 for exterior lighting, $50,000 for offices and $24,300 for dock lights. At current energy prices, this resulted in annual operating costs of $161,000 for the warehouse, $19,500 for exterior lights and $13,200 for office and dock lights combined. In contrast, the incremental capital cost for LED lights was $385,000 higher. However, in total, the operating cost for LED lighting was estimated to be $140,000 less annually. Wind Power The DC would consume a significant quantity of electrical energy to power the cooling and lighting systems in the building. Currently, electricity was priced at approximately 13¢ per kilowatt-hour (kWh) in southern Alberta and was expected to increase by 50 to 100 per cent over the next five to 10 years. Thus, a third and final option was the installation of two wind turbines on-site to generate electricity from a renewable source. Wind turbines drew upon the force of moving air to generate electricity by rotating propeller-like blades around a rotor. The motion of the rotor turned the drive shaft, which turned an electric generator. Small wind systems could be used independently of the electricity grid in what are called stand-alone or off-grid applications.
9 Moreno, I. et al., “Designing Light-emitting Diode Arrays for Uniform Near-field Irradiance,” Applied Optics 45.10, (2006) pp. 2265–2272.
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Page 8 9B13D010 Wind-derived energy appeared to be an attractive sustainability initiative from several perspectives. First, carbon dioxide emissions were eliminated, thus reducing Walmart’s impact on global warming. Second, wind energy was renewable. Third, the cost of energy produced was predictable and did not fluctuate with the price of non-renewable fossil fuels, like natural gas. As a result, wind power had been growing at an average rate of 25 per cent per year, making it the fastest growing source of energy in the world since 1990.10 As with the other options, the project team wanted to assess the attractiveness of harvesting wind energy. In southern Alberta, winds could peak at more than 80 kilometres per hour, providing excellent conditions for generating electricity. Although the wind in Balzac did not quite reach the same speed, wind generation looked viable for this facility. Two 30-metre wind turbines could be installed, and a single wind turbine operating at maximum speed could generate 30 kilowatts (kW) of power. Capital costs for this technology also had fallen dramatically in recent years and now averaged about $2,500 per kW.11 (In contrast, very large generators of 2,000 KW or more might cost less than half this per kW.) Moreover, current technology would allow the turbine to produce electricity with wind speeds of as little as 10 kilometres per hour, and the turbine might be expected to operate a decade or more. However, the actual energy generated varied significantly by time of day, season and location. An initial estimate suggested that the DC might be able to achieve roughly 30 per cent efficiency at this location, effectively generating an annual total of about 80,000 kWh of energy from each turbine. With two turbines, the site could generate enough energy to supply 40 average homes. Maintenance costs were related to the quantity of electricity produced and were expected to be 1¢ per kWh annually.11 Another option to support renewable energy at the DC was to purchase electricity from a renewable energy firm. For example, the Balzac DC could purchase green energy credits (GECs) from Bullfrog Power. The incremental cost of this was 2¢ per kWh in Alberta.12 MOVING FORWARD The three sustainability options identified by the team offered a range of opportunities and trade-offs. Garbutt wanted to meet Ellis’s challenge of building the most sustainable DC in the world, but she recognized that any investments in more sustainable technologies would have to be supported by an assessment of the business benefits and potential risks. She saw this project as an opportunity to set a new global standard for sustainability in Walmart’s distribution system, but she also recognized the importance of finding solutions that promised financial and operating benefits too. While these initiatives looked attractive, Garbutt also was willing to consider other opportunities to improve the sustainability performance of the Balzac DC. How would other options be identified, and what criteria should be applied in evaluating them? Moreover, Garbutt was uncertain to what extent these sustainability efforts at the Balzac DC should be promoted to Walmart’s customers. For example, should this facility be highlighted in the media, or should she consider some form of environmental certification? Construction plans were in the process of being finalized, and she needed to take specific recommendations forward to senior management.
10 http://www.eere.energy.gov/basics/renewable_energy.html; accessed June 20, 2012. 11 http://windustry.org/sites/windustry.org/files/Small_Wind_Calculator_2012.71.xls, accessed December 12, 2012. 12 https://www.bullfrogpower.com/home/abfaq.cfm#ab5a, accessed December 4, 2012.
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Page 9 9B13D010
Exhibit 1
WALMART CANADA SUSTAINABILITY KEY PERFORMANCE INDICATORS
2007 2008 2009
Environment Greenhouse Gas (GHG) emissions (tonnes, C02 -equivalent):
Direct 71,559 89,093 96,880 Indirect 195,234 206,028 207,443 Emission per retail sq. ft. 0.0078 0.0078 0.0077
Electricity intensity per sq. ft.13 19.41 kWh 19.34 kWh 18.65 kWh Total waste diversion (tonnes) 101,720 123,659 124,094 Waste diversion n/a 65% 80% Number of environmentally improved products 300+ 700+ 1000+ People Number of associates who received operational and leadership
training 1,507 2,383 5,300
Percentage of associates who received computer based training 100% 100% 100% Percentage of managers/senior managers who are women (senior managers)
45.9% (26.1%)
45.6% (26%)
47.4% (29.9%)
Number of associates promoted 9,400 9,900 6,600 Responsible Sourcing Factory audits
Direct imports by Walmart Canada (number of audits / factories)
1,077 / 735
814 / 551
539 / 465
Domestic imports by Canadian suppliers (number of audits / factories)
517 / 327
492 / 346
542 / 510
Unannounced audits 28% 15% 26% Factories disapproved 30 11 17 Suppliers and factory managers attending Ethical Standards training (globally)
10,000
14,297
2,940
Community Canadian suppliers and service providers 6,311 6,879 7,726 Payments to Canadian suppliers and service providers ($ billion) $11.2 $13.8 $17.8 New jobs created 4,961 5,083 1,714 New jobs created in the construction industry Community contributions
Raised through fundraising ($ million) $13 $14.6 $17.8 Donated by Walmart Canada ($ million) $6.9 $7.9 $7.7
Notes: 13Overall greenhouse gases have increased compared to 2008 due to the addition of new and expanded stores, however,
improvements in energy efficiency and design have mitigated in increase when measured on a square foot basis. n/a = not available. Source: Walmart Canada’s 2010 Corporate Social Sustainability Report, www.walmartcsr.ca; accessed November 30, 2012. Fo
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9.
9B13D017 ELIZABETH ARDEN: EXECUTING GLOBAL SUPPLY CHAIN RE- ENGINEERING Norman Gao wrote this case under the supervision of Professor David Wood 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. Richard Ivey School of Business Foundation prohibits any form of reproduction, storage or transmission without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Richard Ivey School of Business Foundation, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected]. Copyright © 2013, Richard Ivey School of Business Foundation Version: 2016-10-20 Pierre Pirard, senior vice-president of Global Supply Chain at Elizabeth Arden in New York City, was troubled with the challenges that lay before him. It was mid-2008 and less than a year after joining Elizabeth Arden, he had already made a significant impact in forecasting, inventory control and service performance. However, Pirard knew that the company would need much more. He was hired to make sweeping changes to how the company managed the supply chain and his next move would require a radical consolidation of suppliers, make dramatic changes to inventory management, have a far-reaching impact on product development and require major lead time reductions. Given such a disruptive move, could current suppliers be able to meet his expectations? Could Elizabeth Arden’s current employees keep up with the pace of change expected? And were significant results to shareholders really achievable? Pirard was determined to execute the re-engineering in a manner that would best address all these concerns. COSMETICS INDUSTRY “Cosmetics” are products used to enhance the appearance or odour of the human body. They are generally mixtures of chemical compounds, some derived from natural sources, many synthetic.1 The practice of caring, cleansing and decoration of the skin has been in existence for over a millennium. For instance, castor oil was used several thousand years ago in ancient Egypt as a protective balm. Galen of Pergamon (AD 129-199), a prominent Roman physician, surgeon and philosopher, developed one of the first precursors of modern skin creams from a mixture of beeswax, olive oil and rosewater (Aqua Rosae). Elizabeth Arden, Helena Rubinstein and Max Factor developed the modern cosmetics market in the United States during the 1910s. These firms were joined by Revlon just before World War II and Estée Lauder shortly after.2 In 2007, the worldwide cosmetics and perfume industry generated an estimated
1 Ullmann’s Encyclopedia of Industrial Chemistry, Wiley-VCH Verlag GmbH & Co. KGaA, Weinheim, Germany, 2012. 2 Company websites, www.revlon.ca/Revlon-Home/Revlon-Corporate/Corporate.aspx and www.esteelauder.com/cms/about/ index.tmpl, accessed July 15, 2013.
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Page 2 9B13D017 annual turnover of $170 billion.3 Europe was the leading market, representing approximately $86 billion.4 In comparison, the U.S. cosmetics revenue for 2007 was $51.52 billion.5 Market volume information by product category for 2005 in the United States, Europe and Japan is available in Exhibit 1. The manufacture of cosmetics is currently dominated by a small number of multinational corporations that were founded in the early twentieth century, but the distribution and sale of cosmetics is spread among a wide range of different businesses. As of 2004, the top 100 cosmetics manufacturing firms worldwide had a combined market share of $124.5 billion of which the five largest—L’Oréal Group ($17.7 billion), Procter & Gamble Company ($16.5 billion), Unilever ($9.3 billion), Shiseido Company Limited ($5.9 billion) and Estée Lauder Companies, Inc. ($5.8 billion)6—accounted for 44 per cent or $55.2 billion. There were many worldwide distribution channels for cosmetics manufacturers to choose from, including department stores, mass merchandisers, drug stores, TV shopping networks, Internet retailers, distributors, supermarkets and salons. Due to a large portion of the cosmetics industry power being concentrated among a few large companies who all possess significant resources, competition among leading cosmetics manufacturers is fierce. A deep understanding of the drivers of consumer demand (fashion trends, demographics and consumer spending) is needed to build successful brand portfolios, engage positively with consumers and manage available inventory. To capture revenue and market share, cosmetics manufacturers must not only have a clear focus on offering products that are valuable to the eyes of the consumer but also strategically decide between numerous channels to deliver their products to these consumers in an effective manner. Since consumer perception heavily impacts revenue generation, it is common to see dominant cosmetics players enter into licensing agreements or conduct acquisitions in order to obtain brands or to gain access to preferred distribution channels. The structure of these agreements and acquisitions can have a direct effect on materials management. For example, in terms of obtaining brands, Elizabeth Arden acquired Liz Claiborne’s fragrance portfolio in 2008, structured as a long-term licensing deal whereby Elizabeth Arden acquired inventory and hard assets and would pay a royalty stream to Liz Claiborne. In terms of obtaining distribution, a U.S. fragrance manufacturer, Inter Parfums Inc., signed a four-year licensing agreement with the clothing company Gap for international distribution of personal care products through Gap and Banana Republic stores in the United States and abroad as well as in select specialty and department stores internationally.7 A ranking of the top 10 personal care brands and their respective brand value is available in Exhibit 2. Unlike cosmetics manufacturers, suppliers in the cosmetic industry are very fragmented. Cosmetics supplies must comply with the standards of the Food and Drug Administration (FDA), which defines and regulates the extremely broad category of cosmetics in the United States. Even when considering only the cosmetic chemicals market, hundreds of suppliers provide the broad array of organic and inorganic chemicals that are the essential ingredients of cosmetics and toiletries.8 To be competitive, suppliers focus on the ability to produce exciting and innovative products, to deliver on time and to integrate with their clients’ supply chain preferences. Also as a result of the abundance of competitors, successful suppliers
3 www.clickpress.com/releases/Detailed/82987005cp.shtml, Eurostaf, May 2007. 4 2007 average Euro to US$ = 1.37, www.oanda.com/currency/average, accessed June 20, 2013. All monetary amounts are in US dollars unless stated otherwise. 5 Inflation adjusted. “Cosmetic Industry,” Statista Dossier 2012; “Cosmetic & Beauty Products Manufacturing in the US,” 2011, IBISWorld, p. 31. 6 “The Beauty—Top 100,” WWD Beauty Report International, www.scribd.com/doc/3027409/Top-100-Cosmetic- Manufacturers, accessed July 8, 2013. 7 International Cosmetics News (ICN), June 1, 2008, p. 8. 8 www.ihs.com/products/chemical/planning/scup/cosmetic.aspx, accessed June 20, 2013.
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Page 3 9B13D017 often seek to secure long-term relationships and contracts. For instance, Swiss flavour and fragrance manufacturer Givaudan has signed a creative partnership deal with U.S. consumer goods group Colgate- Palmolive that will establish a dedicated team to work directly with Colgate’s internal perfumery resources on fragrance development across all categories. Givaudan is hoping the partnership will help it secure a spot on Colgate’s list of preferred suppliers.9 However, large cosmetics manufacturers may not necessarily favour long-term contracts due to the cost savings associated with lower prices when many suppliers compete for business. Given the fierce rivalry in cosmetics manufacturing as well as the abundance of both channels and suppliers, operational success in the international cosmetics industry is increasingly dependent upon the ability to handle complexity in addition to effective brand management. Not only must companies align their operations in a way that allows them to benefit from multiple upstream and downstream choices in the cosmetics value chain, they must be able to do so in a way that capitalizes on the fast-moving trends of the international cosmetics market. For instance, sales of prestige beauty products, primarily sold in department stores, dropped 3 per cent following a 15-year low in U.S. consumer confidence at the end of 2007.10 However, despite weaker than normal global market conditions, Brazil’s cosmetics and toiletries industry is second fastest growing market worldwide with a growth of nearly 14 per cent in 2007.11 ELIZABETH ARDEN INC. Elizabeth Arden established the modern concept of the U.S. beauty industry a century ago. Born Florence Nightingale Graham, she traveled from rural Canada to New York City, where she opened her company, initially named the “Red Door” salon, on Fifth Avenue in 1910. Her fundamental belief was that beauty should not be a veneer of makeup but an intelligent cooperation between science and nature in order to develop a woman’s finest natural assets. She lived by her mantra, “To be beautiful is the birthright of every woman.”12 She was largely responsible for establishing makeup as proper and appropriate, even necessary, for a ladylike image, when before it had often been associated with lower classes and such professions as prostitution. She targeted middle-aged and plain women for whom beauty products promised a youthful, beautiful image.13 Elizabeth Arden’s company grew from a small start-up to an international corporate success. It was acquired in the 1970s for $38 million by the pharmaceutical company Eli Lilly & Co. It changed hands twice more until 1990 when Unilever PLC purchased it. Unilever then sold it in 2001 to French Fragrances, Inc. (FFI), a perfume marketer that dealt in prestige as well as mass-market products. FFI paid approximately $190 million in cash for Elizabeth Arden, plus an exchange of stock that gave Unilever an approximately 18 per cent stake in the publicly owned company. Shortly after the acquisition, FFI changed its name to Elizabeth Arden, Inc.14 Since its inception, Elizabeth Arden had become one of the world’s leading makers of prestige perfumes and cosmetics, goods that were sold in over 90 countries worldwide, with major markets in the United States and Europe. Examples of brands included Elizabeth Taylor’s White Diamonds, White Shoulders, Red Door, 5th Avenue, Visible Difference and Millenium. However, sales were in decline by the turn of
9 International Cosmetics News (ICN), June 1, 2008. 10 www.marketoracle.co.uk/Article3859.html, accessed June 20, 2013. 11 www.klinegroup.com/news/speeches/cosmeceuticals-27jun08.pdf, accessed September 14, 2013. 12 corporate.elizabetharden.com/about-elizabeth-arden/, accessed June 20, 2013. 13 womenshistory.about.com/od/fashion20th/p/elizabeth_arden.htm, accessed June 20, 2013. 14 www.fundinguniverse.com/company-histories/elizabeth-arden-inc-history/, accessed June 20, 2013.
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Page 4 9B13D017 the century—annual sales were estimated at $890 million, well below the company’s peak in the early 1990s—and under new ownership, things were about to change. SITUATION IN 2007 Under the direction of Chairman and Chief Executive Officer (CEO) Scott Beattie, fiscal 2007 was a milestone for Elizabeth Arden as it surpassed $1 billion in net sales. Total net sales increased by 18.1 per cent to a record $1.127 billion, and reported earnings per diluted share grew 18.2 per cent to $1.30 from $1.10.15 Main contributions to this net sales were from North American fragrances (23 per cent), international businesses (12 per cent) and branded skin care and colour cosmetics (16 per cent). Select financial information can be found in Exhibit 3. This achievement was driven by the successful integration of two strategic acquisitions in the year, continued successful innovation on product offerings and further expansion and development of international markets. The company aimed to continue this progress and to grow from approximately $1.2 billion to $2 billion in the next three years. However, a top-line focus was not in itself sufficient; the company must drive operational results and increase value for its shareholders. As CEO Beattie stated in the 2007 annual report:
Our business strategy is to grow our brand portfolio by investing behind our core brands and to acquire control of and develop additional prestige brands through brand development, acquisitions and new licensing and distribution agreements […] We are also focused on improving our cash flow and operating margins, particularly through improving our extended supply chain and logistics functions, managing the advertising spend behind our new fragrance launches and leveraging our global overhead structure more efficiently.
Elizabeth Arden offered more than 400 prestige fragrance, skin care and cosmetic brands to retailers in the United States,16 including department stores such as Macy’s, Dillard’s Saks, JCPenney, Belk and Nordstroms; mass retailers such as Wal-Mart, Target, Sears, Kohl’s, Walgreens, Rite-Aid and CVS; and international retailers such as Sephora, Marionnaud, Hudson’s Bay, Shoppers Drug Mart, Myer and Douglas, as well as several travel outlets. It also sold online via e-commerce. In 2007, the 10 largest customers accounted for more than 39 per cent of net sales; the only customer that accounted for more than 10 per cent of net sales was Wal-Mart (Sam’s Club).17 See Exhibit 4 for categories of customers and their respective contribution to 2007 net sales. As was customary in the industry, Elizabeth Arden generally did not have long-term or exclusive contracts with retail customers but relied instead on purchase orders. The cosmetics industry competed primarily on brand strength, merchandise selection, reliable order fulfillment and delivery. Elizabeth Arden therefore focused on product recognition, quality, performance, price and providing value-added services to certain retailers (e.g., category management services).
15 Elizabeth Arden Annual Report 2007. 16 Of Elizabeth Arden’s distribution, 100 prestige brands were owned or licensed and 300 additional prestige fragrance brands were manufactured by other beauty companies. 17 Wal-Mart (including Sam’s Club) represented approximately 15 per cent of consolidated net sales and approximately 25 per cent of the North American fragrance segment net sales.
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Page 5 9B13D017 The Challenge of Translating Growth into Profit In 2007, the supply chain was performing sub-optimally compared to both industry benchmarks and internal aspirations.18 For instance, logistics costs (i.e., distribution, outbound freight) as well as supply chain overhead (i.e., demand and materials planning labour, purchasing labour) had been increasing as a percentage of net sales. The existing supply chain processes and infrastructure were determined to be manually intensive and inefficient and created an unnecessary amount of low value-added work. However, even though these processes were necessary for the business at the moment, focus would have to be on a fundamental shift in the operating model for the future. It was clear this change wasn’t just a supply chain initiative but rather a transformation of Elizabeth Arden, involving more pieces of the company. Since being hired a little less than a year earlier, Pirard had already completed improvements on production planning and sales forecasting. Forecasting and demand planning at Elizabeth Arden had been tedious and focused on the short term without extensive use of market intelligence and strategic account management. The company had been using a forecasting practice that enabled each division along a product delivery chain to add its own contingencies to forecasted numbers. This led to overestimation of necessary product as contingencies accumulated with only 33 per cent of the top 100 stock-keeping units (SKUs) in FY2006 forecasting “well” (within plus or minus 25 per cent error), resulting in a total accuracy of only 70.5 per cent. To improve the inventory accuracy and order fulfillment rate, Pirard utilized a single, more accurate forecast and sold off slow and obsolete products to make room for faster moving SKUs. Although progress was being made, Pirard knew that the internal process improvements conducted to date would not be sufficient for Elizabeth Arden to meet the expectation of CEO Beattie and the board. He believed that a complete re-engineering initiative would be necessary, centring on a “turnkey strategy.” In this new approach, Elizabeth Arden would seek to consolidate suppliers and the suppliers that remained would be given additional responsibility for undertaking the entire manufacturing process from materials procurement to product completion. Ideally, this would enable Elizabeth Arden to simplify procurement efforts. However, Pirard was concerned about the enormity of this change and wondered how to best approach the transformation. MANUFACTURING, SUPPLY CHAIN AND LOGISTICS Materials Management Elizabeth Arden used independent suppliers to obtain substantially all raw materials, components and packaging products and contract fillers to manufacture finished products relating to owned and licensed brands. As was customary in its industry, Elizabeth Arden also generally did not have long-term or exclusive agreements with contract manufacturers.19 Purchases were made through purchase orders, and Elizabeth Arden believed it maintained a good relationship with numerous manufacturers of brands and, although costly, could replace manufacturers should some become unavailable. Since individual purchase orders were made to many independent suppliers, Elizabeth Arden had to assume the responsibility of orchestrating a large portion of the product completion process. For instance, for a bottle of perfume, Elizabeth Arden bought the fragrance, pump, box, glass, cellophane wrap and
18 Company files. 19 Exception: Cosmetic Essence Inc. (third-party) manufacturing agreement ending January 31, 2010.
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Page 6 9B13D017 label separately from six independent suppliers and then had all these purchased materials shipped to a third-party manufacturer. After the third-party manufacturing was completed, Elizabeth Arden then arranged for the finished product to be shipped to either distribution centres around the world or directly to a customer. In an effort to minimize logistics complexity and reduce delivery time, “drop shipping” (sending product directly from source to customer) was used wherever possible. Although Elizabeth Arden hoped to be more flexible and have lower risk with a diversified independent supplier base, Pirard was concerned that the orchestration efforts detracted from the company’s strategic strengths. In 2007, material and indirect purchases of $350 million20 were converted into more than 9,000 items of finished goods SKUs. At a quick glance, 12 per cent of SKUs sold in 2006 made up 80 per cent of total sales (see Exhibit 5). A high level of complexity and customization in addition to the numerous SKUs put a burden on the fulfillment group, especially given that 12.2 million customized units represented only 17 per cent of total 2007 unit volume. In addition, Pirard was concerned that even though direct spend from purchasing was increasingly concentrated with the Top 10 suppliers21 (see Exhibit 6), it was not translating into volume benefits. In FY2007 the top 10 suppliers were estimated to represent 40 per cent of all items purchased. The high level of customization, slow moving SKUs and long lead times all led to extremely large inventory levels. Inventory days of supply (DOS) were 225 days, well above industry standard (approximately $340 million inventory investment). Finished goods alone accounted for 120 DOS. Inventory carrying costs were estimated to be 4.2 per cent of net sales and 7.2 per cent of cost of goods sold (COGS). As well, almost 30 per cent of unit volume forecast changes occurred within the supply lead time period, which drove logistic costs well above average. In 2007, Elizabeth Arden spent $3.2 million on airfreight costs and 0.3 per cent of sales on materials planning. Despite the high level of inventory and an increase in the expediting of finished goods, the current fill rate was only 85 per cent, 10 per cent below the industry. Although Pirard had already done some work to improve the fill rate by focusing on selling off some slow moving SKUs to make room for faster moving product, he was still very concerned with the very poor fill rate. He wondered how the re-engineering effort could not only further alleviate fill rate concerns but also help address the multitude of other materials management problems. How much impact could this re- engineering have on delivering bottom-line operational results? Organizational Design and Full-Time Equivalents (FTE) As of September 4, 2007, Elizabeth Arden had approximately 2,250 full-time employees and approximately 600 part-time employees in the United States and 17 foreign countries. Within the scope of the supply chain re-engineering, there were 217 full-time equivalents (FTEs) across 18 locations and six process areas (see Exhibit 7). Pirard was worried about the very manual and labour-intensive purchasing process—buyers spent most of their time on purchase order generation and expediting for both the individual components and finished goods, leaving limited time for strategic sourcing and value analysis. There was also no centralized management to perform strategic purchasing, resulting in a high direct material spend and an inability to consolidate spend across brands/commodities and utilize volume leverage to negotiate better pricing with
20 As of January 2008. 21 Top 10 suppliers, by volume order: Jackel, Matic Plast, IFF, Pochet, Givaudan, Arkay Packaging, Heinz, Rexam, Quest and Interasia.
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Page 7 9B13D017 suppliers. Pirard was concerned that this purchasing issue might only get worse as changes to the organization unfolded. Elizabeth Arden’s organizational design was functionally organized with employees interacting through hand-offs. For example, departments included demand planning, generic supply planning, confined supply planning and raw material planning (see Exhibit 8). In anticipation of the supply chain re- engineering effort, examples of transactional processes performed by employees can be found in Exhibit 9. It had already been determined that a more “customer oriented” approach to the organizational design might align more with a turnkey approach (e.g., in the Skin & Color Department). Pirard wondered if employees could handle the ambitious rapid re-engineering effort, and if so, what the best way of managing the workforce to deliver the expected results would be. MOVING FORWARD Beattie had hired Pirard because he knew he could make the changes necessary. The supply chain needed work, and there were many areas of proposed improvement that included, but were not limited to enhancing the effectiveness of demand management; developing a more collaborative, turn-key approach with key suppliers; simplifying material flows and collaborations with key accounts; utilizing strategic sourcing; and developing more cross-functional ability. However, many questions still remained unanswered with respect to Pirard’s task of carrying out the re-engineering and turning Elizabeth Arden’s tremendously successful growth into operating results. Pirard wondered which execution initiatives should be prioritized. Would the execution of the re-engineering vary by product type (e.g., glass sourcing versus fragrance sourcing)? As well, would the organizational design change, and if so, how much would it change and what would the end result look like? Would the savings be direct savings, indirect savings or both? Pirard knew that the supply chain re-engineering effort would be critical to the future success of Elizabeth Arden—more importantly, he knew that how he chose to execute the changes to the various components to the supply chain would directly affect the level of impact that the effort would have. He wanted to remain “results oriented” and therefore be able to tie the supply chain strategy to quantifiable outcomes. He turned his attention to three main questions in the turnkey strategy: how to effectively manage the consolidation of suppliers; how to execute the optimal organizational structure for this change; and lastly, how to maximize the monetary impact of the re-engineering for Elizabeth Arden and its shareholders. How much money would be saved; where would the savings come from; and when would they be realized?
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Page 8 9B13D017 EXHIBIT 1: MARKET FOR COSMETIC PRODUCTS IN THE UNITED STATES, JAPAN AND EUROPE
(2005)
Market for Cosmetic Products (2005) Product Market volume, (€B)
U.S. Japan Europe Skin and face 5.6 6.8 8.7
Body care 3.8 1 4.7 Hair treatment agents 5.5 4.2 6.2
Perfume 2.4 0.2 3.2 Decorative cosmetics 3.2 3.1 3.3
Other 2.6 1.4 4.1 Total 23.1 16.6 30.3
Source: Ullmann’s Encyclopedia of Industrial Chemistry 33, Section 15, Table 2.
EXHIBIT 2: TOP 10 PERSONAL CARE BRANDS (2008) IN BROAD CATEGORY OF “COSMETICS”
Top 10 Personal Care Brands (2008)
Rank Brand Parent Company Brand Value* ($B) Brand
Momentum**
1 Gillette Procter & Gamble 18 7.5 2 L’Oréal L’Oréal 12.3 6.5 3 Colgate Colgate-Palmolive 7.7 5 4 Avon Avon Products Inc. 6.6 5.5 5 Garnier L’Oréal 4.2 5 6 Nivea Beiersdorf 3.2 4.5 7 Lancôme L’Oréal 3.1 6.5 8 OralB Procter & Gamble 2.6 5.5 9 Crest Procter & Gamble 2.3 5.5
10 Olay Procter & Gamble 2.3 6 * Brand value is the sum of all earnings that a brand is expected to generate. ** Brand momentum is an index of a brand’s short-term (one-year) growth rate compared to the average short-term growth rate of all brands in the ranking. Source: Millward Brown Optimor (including data from Brandz, Datamonitor, Bloomberg), International Cosmetics News, June 1, 2008.
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Page 9 9B13D017
EXHIBIT 3: SELECT FINANCIAL DATA (IN $ THOUSANDS)
Years Ended June 30,
2007 2006 2005
Selected Statement of Income Data Net Sales* $1,127,476 $954,550 $920,538
Gross Profit $461,319 $404,072 $411,364 Income (loss) from operations $74,006 $68,257 $78,533 Debt extinguishment charges $– $758 $– Net income (loss) $37,334 $32,794 $37,604 Accretion and dividend on preferred stock $– $– $– Accelerated accretion on converted preferred stock $– $– $– Net income (loss) attributable to common shareholders $37,334 $32,794 $37,604
Selected Per Share Data Earnings (loss) per common share Basic $1.35 $1.15 $1.35
Diluted $1.30 $1.10 $1.25 Weighted average number of common shares
Basic 27,607 28,628 27,792 Diluted 28,826 29,818 30,025
Other Data EBITDA** $98,524 $89,608 $100,038
Net cash from operating activities $58,816 $65,276 $35,549 Net cash from investing activities $110,518 $24,335 $17,508 Net cash provided by (used in) financing activities $53,120 $(37,584) $(15,785)
Years Ended June 30,
2007 2006 2005
Selected Balance Sheet Data Cash $30,287 $28,466 $25,316 Inventories $380,232 $569,270 $273,343 Working capital $298,165 $280,942 $275,628 Total assets $939,175 $759,903 $719,897 Short-term Debt $97,640 $40,000 $47,700 Long -term-debt, including current portion $225,655 $225,951 $233,802 Convertible, redeemable preferred stock $- $- $- Shareholder’s equity $320,927 $277,847 $259,200
* Comparison of U.S. and international net sales = 63:37 (2007), 60:40 (2006), 62:38 (2005). ** EBITDA: earnings before interest, taxes, depreciation, and amortization Source: Company files.
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EXHIBIT 4: ELIZABETH ARDEN CUSTOMER BREAKDOWN BY SALES VOLUME (2007)
Region SBU* Total FY06 Sales ('000) No. of
Customers in SBU
No. of Customers Making up Top
80% of SBU Sales
Percent of Total
SBU
North America
Mass $483,647 361 17 5%
Prestige $182,065 82 23 28% Department Store Fragrance Group $59,593 127 4 3%
International All Other $317,073 2016 177 9% TOTAL $1,042,378 2586 242 9%
*SBU: strategic business unit Source: Company files.
EXHIBIT 5: ELIZABETH ARDEN TOP 40 SELLING BRANDS IN FY2006
1–10 11–20 21–30 31–40 CURIOUS PROVOCATIVE HALSTON Z14 IN CONTROL WHITE DIAMONDS TOMMY GIRL DESIGN LADIES RED DOOR REVEALED FANTASY DRAKKAR NOIR TRUE STAR OTHER CHEEK RED DOOR FIFTH AVENUE AFTER 5 BLOCKBUSTER ARDEN CORP/COFFRET SIGNATURE TOMMY BOY OTHER EYE ETERNITY LADIES CERAMIDE SKINCARE EIGHT HOUR MILLENIUM OTHER MAKEUP FOUNDATION SUNFLOWERS ARDENBEAUTY POLO SPORT MEN 5TH AVENUE PAUL SEBASTIAN COFFRET WOMEN A/ANAIS GREEN TEA LIPSTICK WHITE SHOULDERS ETERNITY MENS
PREVAGE PASSION WOMEN PROVOCATIVE INTERLUDE OSCAR LADIES
Source: Company files.
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EXHIBIT 6: PERCENTAGE OF TOTAL DIRECT SPEND IN THE TOP 10 SUPPLIERS (APRIL 2007)
FY2007 amount was a forecast based on the quarterly spend pattern of FY2006, materials and indirect purchases actually amounted to $350 million as of January 2008. Source: Company files.
EXHIBIT 7: FULL-TIME EQUIVALENTS (FTE) BREAKDOWN BY LOCATION AND PROCESS
FTE = Total dedicated staff + documented part-time staff contributions: 217 in-scope FTEs. Source: Company files.
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EXHIBIT 8: EXAMPLE OF MULTIPLE HAND-OFFS BETWEEN DEPARTMENTS
Source: Company files.
EXHIBIT 9: EXAMPLE OF EMPLOYEE PROCESSES (TRANSACTIONAL AND NON- TRANSACTIONAL)
General Accounting Procure to Pay Order to Cash
Human Resources
Information Technology
• General Ledger Accounting
• Journal Entry Processing
• Month/Year End Close
• Fixed Assets
• Financial Reporting
• Planning, Forecasting, Budgeting
• Requisitioning
• Procurement
• Accounts Payable
• Travel & Expense
• Disbursements
• Vendor Master Maintenance
• Sales Order Entry
• Sales Support/ Customer Service
• Cash Receipt
• Revenue Tracking
• Customer Master Maintenance
• Item Master Maintenance
• Payroll
• HR Administration
• Time Collection
• Benefits Administration
• Recruitment Administration
• Training
• Desktop
• LAN/WAN/ Network
• Data Center
• Disaster Recovery
• Print Services
• Hardware Support
• IT Procurement
Source: Company files.
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9B14D005
APPLE INC.: MANAGING A GLOBAL SUPPLY CHAIN1 Ken Mark wrote this case under the supervision of Professor P. Fraser Johnson 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 © 2014, Richard Ivey School of Business Foundation Version: 2017-03-13
INTRODUCTION Jessica Grant was an analyst with BXE Capital (BXE), a money management firm based in Toronto.2 It was February 28, 2014, and Grant was discussing her U.S. equity mandate with BXE’s vice-president, Phillip Duchene. Both Grant and Duchene were trying to identify what changes, if any, they should make to BXE’s portfolio. “Apple is investing in its next generation of products, potentially the first new major product lines since Tim Cook took over from Steve Jobs,” she said. Apple Inc., the world’s largest company by market capitalization, had introduced a series of consumer products during the past dozen years that had transformed it into the industry leader in consumer devices. Apple managed a global supply chain with creative development in the United States, outsourced manufacturing in Asia and components sourced from suppliers around the world. Apple was in the centre of a complex ecosystem that produced market-leading consumer devices. With $160 billion3 in cash in February 2014, the company was well-capitalized. Despite its commercial success, Apple’s stock was at $524.47 on February 28, 2014, 25 per cent below the $700 level it had reached in 2012. Cook reassured investors that the firm was focused on the future, and it had a solid pipeline of new products. This was his way of signalling to stakeholders that he would be able to run the firm following the death of Steve Jobs, one of Apple’s co-founders and the man responsible for rebuilding the firm. “We’re working on some things that are extensions of things you can see and some that you can't see,” Cook said at Apple’s annual shareholders' meeting on February 28, 2014.4 Industry observers were skeptical that the company could deliver new product successes:
It is unclear whether the spread-sheeting-loving, consensus-oriented, even-keeled Cook can successfully reshape the cult-like culture that Jobs built. Though Cook has deftly managed the iPhone and iPad product lines, which continue to deliver enormous profits, Apple has yet to launch a major new product under Cook; talk of watches and televisions remains just that . . . in the day- to-day at Apple, Cook has established a methodical, no-nonsense style, one that’s as different as could be from that of his predecessor. Job’s bi-monthly iPhone software meeting, in which he would go through every planned feature of the company’s flagship product, is gone. “That’s not Tim’s style at all,” said one person familiar with those meetings. ‘He delegates.’5 F
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Nevertheless, it was clear to Jessica that Apple’s product range would get more complex in the next few years. As part of her analysis of Apple’s stock, she wanted to take a look at the company’s supply chain to see if she could gain some insight into whether to continue with Apple as a key holding in BXE’s fund. APPLE INC. Apple Computer was founded on April 1, 1976, by Steve Jobs, Steve Wozniak and Mike Markkula to manufacture and distribute desktop computers. Both Jobs and Wozniak started tinkering with computing devices in a time when enthusiasts who wanted a fully functioning computer had to assemble the parts by themselves from individual components. They struck a deal to sell an initial order of 50 units of their “Apple I” computer to a local computer shop, and negotiated a 30-day credit term to pay for the parts, effectively using their suppliers to fund the startup. After selling 200 units of the Apple I, Wozniak improved the design and showcased the Apple II in April 1977. Needing capital for the next phase of their company, they brought on Markkula, a marketing manager at Intel who had retired after making millions on his stock options. The company became the largest private manufacturer of personal computers in the United States and held its initial public offering in December 1980, thereby creating 300 millionaires. Although it had a great product, the team at Apple soon found that IBM’s entry into the market in 1981 would change the industry. By 1983, IBM’s personal computer (PC) became the best-selling computer in the United States, heralding the beginning of its domination of the PC market. Even Apple’s popular 1984 Superbowl commercial,6 combined with a heavy marketing campaign, was not enough to stop IBM’s growth. Jobs left Apple in 1985. The company stumbled along for the next decade, and even though it launched a line of Macintosh computers, such as Quadra, Centris and Performa, it failed to gain traction in the marketplace. Worse, its retail partners, such as CompUSA and Sears, did not devote resources to displaying its products properly. Apple also suffered from a perception that its machines were more expensive than comparable Windows PCs. The company had poor operating controls and inventory management, failing to properly estimate demand for its products and leading to both stock-outs and excess inventory.7 Apple squandered its goodwill from the 1980s Macintosh era. In 1996, Microsoft was one year into the launch of Windows 95, which was turning out to be a very popular operating system. Apple’s sales of Macintosh computers fell dramatically and Apple, in an attempt to reverse the trend, began licensing the Mac operating systems to third-party manufacturers. From 1993 to 1996, Apple went through three CEOs: John Sculley, Michael Spindler and Gil Amelio.8 In 1996, Jobs returned to the company as CEO at a time when Apple’s future was in question. Apple’s market capitalization had fallen from $11.6 billion in 1987 to $3.1 billion at the end of 1996. In 1996, sales were $9.8 billion. In the early 1990s, Apple had begun licensing its Mac operating system to third-party manufacturers who would produce their own lines of devices powered by Mac’s operating system. Its licensing model was similar to that employed by Microsoft, allowing the operating system producer to earn additional revenues by selling copies to generic computer manufacturers. With the objective of reasserting control over its product, one of Jobs’ first decisions was to stop licensing Apple’s Mac operating system. This resulted in a fall in computer unit market share from 10 per cent to 3 per cent. Throughout this time, Apple continued to manufacture its own devices. In 1997, Jobs announced a partnership with Microsoft that would see the latter invest $150 million in Apple and release the dominant office software — Microsoft Office — for Macintosh. At the time of the announcement, Apple’s market capitalization had continued to fall to $2.5 billion. Fo
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Between 1998 and 2001, Apple launched iMac computers as a line of revamped PCs that focused on design. The computer body was made from bright colours, such as green, blue and purple. The line sold well and provided the spark for Apple’s return to prominence. In May 2001, Apple announced that it would be opening its own retail stores to enable it to educate consumers and to grow its market share. In October 2001, it introduced the iPod portable digital audio player. Supporting the iPod was the iTunes music store, which was stocked with downloadable songs. At a time when the biggest record labels were worried about pirated songs being downloaded to MP3 players, Apple negotiated a deal with the five largest labels to be part of iTunes. The success of the iPod helped to revitalize Apple’s prospects, building a strong financial base from which the firm could grow. By 2004, Apple was able to gain better control over its supply chain by working with new suppliers on proprietary parts for which Apple would provide upfront capital in return for volume commitments and a lower overall price per unit. Apple’s growing clout allowed it to work with its suppliers to launch a series of new products containing significant technological advancements, such as iPod Video, iPod Touch and, by 2007, the iPhone. Concurrently, Apple expanded its retail store base beyond the United States, opening its first Japanese store in 2003. From 2007 to 2013, Apple’s success with its music players allowed it to upgrade its iPhone and iPod line- up, introduce new Mac computers and other products such as Apple TV, and develop its application (app) store, where third party developers listed their apps for consumers to download. In April 2010, Apple reinvented the tablet computer market by launching its iPad. With its slim design, multi-touch screen and touch-sensitive keyboard, the iPad was an instant commercial success. For consumers, the iPad was a portable computer and entertainment device, allowing them to respond to emails, watch videos, play games, and browse the Internet, among other things. While Apple still used retail partners to distribute its products, it sold 70 per cent of its products and services directly to consumers and businesses (see Exhibit 1). Jessica had seen many reviews stating that Apple’s success was due to a combination of design, functionality, marketing and an ability to modify production to meet spikes in demand. She read an article about Apple’s launch of its iPhone 5 in September of 2012, including a demonstration of the new phone by the vice-president of marketing for Apple, Phil Shiller. Nine days away from that product’s official launch, Apple was confident enough in its just-in-time supply chain that it had not yet begun to ramp up production. The company had an aggressive schedule to meet as the iPhone 5 eventually sold at a rate of 3.7 million units per week for the first three months. In addition, it was available in 100 countries from 240 mobile phone carriers. 9 Intrigued by Apple’s ability to coordinate its supply chain on a real-time basis, Jessica started to dig further for details of the firm’s operations. She decided to focus on one product, the iPhone, and understand how Apple managed to bring that product to market. The iPhone’s Supply Chain Apple’s iPhone supply chain was global, tying together a research and development base in the United States, 156 suppliers, assembly operations in China and retail stores, some of which were its own Apple- branded stores. Jessica began to trace the path of Apple’s iPhone from inception to delivery to customer. Fo
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New Product Development Apple’s management team kept a short new product development cycle. Whereas a traditional product lifecycle – for a new car model, for example – might span four to five years, Apple’s iPhone lifecycle was closer to one year. Exhibit 2 provides a list of iPhone models since the first version was launched in June 2007, and Exhibit 3 shows iPhone unit sales by the quarter. The new product development department coordinated a wide variety of stakeholders, including internal groups, such as hardware, software and production. For example, the industrial design team headed by senior vice-president, Jony Ive, worked with the production team to ensure that products could be built in large volumes. Instead of outsourcing its manufacturing to third-party service providers — as in the case of Samsung10 — Apple preferred to control the entire supply chain internally. 11 Unlike other electronics manufacturers that might outsource the entire production — and management — of their supply chain to a third-party service provider, such as Solectron or Flextronics, Apple designers worked in close proximity with suppliers. Quite literally, the designers would often spend “months living out of hotel rooms in order to be close to suppliers and manufacturers, helping to tweak the industrial processes that translate prototypes into mass-produced devices.”12 Creative design and engineering was managed in California, where Apple developed new technologies, acquired licenses for intellectual property and made bolt-on acquisitions of technology firms whose products could be used in Apple’s ecosystem of products and services. Concurrently, Apple conducted market research and product-testing to refine the upgrade being considered. Cost data were put together, including a list of parts and suppliers, and an estimate of what it would cost to assemble the iPhone. Potential quality defects were identified and plans were drawn up to mitigate risk. In 2013, Apple continued to invest heavily in research and development (R&D) to ensure that it would have innovative products in its pipeline. R&D spending was $4.5 billion in 2013, up from $3.4 billion in 2012 and $2.4 billion in 2011. Apple’s devices — unlike Dell’s — were available in a limited number of configurations, a deliberate product strategy that allowed its supply chain processes to be streamlined. Apple’s technology competitors typically had separate R&D departments and separate profit and loss accountability for each product segment. In contrast, Apple was highly integrated, with centralized R&D and accounting for the entire company.13 Procurement Apple products contained key components that were often sourced from a single manufacturer. Because the different mobile phone firms often used the same components, key parts from a single, popular supplier were regularly out of stock due to overwhelming demand. To counteract this supply issue, part of Apple’s procurement strategy was to purchase suppliers’ production capacity in advance in order to ensure the steady supply of key parts (see Exhibits 4 and 5). In addition, Apple had a program that allowed it to buy capital equipment for suppliers in exchange for both supply assurance and achieving cost targets.14 As a percentage of the selling price of an iPhone, Apple captured approximately 60 per cent as gross margin, and suppliers such as LG and Samsung captured another 5 per cent to 7 per cent as revenues (see Exhibit 6 for a breakdown of the distribution of value from the sale of an iPhone). Product demand was forecast 150 days in advance and updates were continually sent to suppliers to allow adjustments in production schedules. Apple’s procurement team used sales targets to manage production ramp-up issues and place material purchase commitments, making pre-payments if necessary.15 It reacted to changes in sales
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forecasts by altering the orders, often at a moment’s notice. Depending on forecast demand, Foxconn was known to wake up its workers – even at midnight – to meet sudden spikes in orders from Apple:
One former executive described how the company relied upon a Chinese factory to revamp iPhone manufacturing just weeks before the device was due on shelves. Apple had redesigned the iPhone’s screen at the last minute, forcing an assembly line overhaul. New screens began arriving at the plant near midnight. A foreman immediately roused 8,000 workers inside the company’s dormitories, according to the executive. Each employee was given a biscuit and a cup of tea, guided to a workstation and within half an hour started a 12-hour shift fitting glass screens into beveled frames. Within 96 hours, the plant was producing over 10,000 iPhones a day. “The speed and flexibility is breathtaking,” the executive said. “There’s no American plant that can match that.”16
These alterations had an impact on both components and assembly labour requirements. Every quarter, for its current slate of products, Apple reviewed its inventory levels, adjusted its demand forecast, and monitored its cost of components. New products in the development pipeline were added to the review as well. An analyst estimated that the bill of materials for the iPhone 5 ranged from $199 to $230 for sub-models that retailed for $649 to $849 (see Exhibit 7). The production of the iPhone began with orders placed to 156 component suppliers around the world. It was normal for Apple to sign exclusivity agreements with key suppliers. For example, when Ive found a U.S. laser equipment supplier that made $250,000 machines to cut precision holes, an agreement was signed to secure hundreds of the machines for manufacturing Apple’s products. According to observers, maintaining control over suppliers was important. Apple’s decision to manage a “closed ecosystem” enabled it to negotiate large discounts on components. This gave the company access to flexible manufacturing volume in the event that demand was high, and savings on other supply chain costs, such as air-freight.17 Apple engineers worked closely with suppliers to update manufacturing processes and technology. For example, new tooling equipment was designed to cut the MacBook’s unibody shell. Apple’s insistence on exclusivity and its high volume of purchases meant that competitors often had to wait for key components, such as screens. “To manufacture the iPad 2,” for example, “Apple bought so many high-end drills to make the device’s internal casing that other companies’ wait time for the machines stretched from six weeks to six months, according to a manager at the drillmaker.”18 These delays had a material impact on competitors. In May 2005, news about Apple ordering DRAM chips sent Samsung’s stock price tumbling in one day, erasing a staggering $10 billion of the electronics giant’s market cap.19 For suppliers, Apple’s high-volume orders and offers to invest in capital equipment had both benefits and drawbacks. While suppliers enjoyed profits due to the high volumes ordered by Apple, the latter expected detailed breakdowns of suppliers’ costs for manufacturing labour, materials and even projected profit. Suppliers were also expected to keep two weeks of parts inventory in close proximity to assembly plants. In addition, the cost to carry parts was borne by suppliers as Apple stretched out its payables to as long as 90 days after the parts were used. 20 Apple’s offer to pay for machinery and its firm commitments to future supplier volume were not typical for the electronics industry, which traditionally preferred to negotiate the lowest possible combination of price and volume commitments per order. The following is an example of a deal negotiated by Apple with a key supplier:
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Apple struck a deal with GT Advanced Technologies Inc., a maker of furnace equipment that is used to produce sapphire materials that cover smartphone lenses and home buttons. Apple received an exclusivity agreement from GT Advanced for the furnaces in exchange for making a prepayment of $578 million. GT Advanced said it would pay Apple back over five years starting in 2015. The deal has “limited our ability to take additional” business, Thomas Gutierrez, GT Advanced’s CEO, said in a conference call with analysts. GT Advanced said in its announcement that revenue from the division that includes the kinds of machines Apple is buying will increase to 80 per cent of the company’s total business, predicted to be $600 million to $800 million, up from 31 per cent previously.21
To maintain their independence, some suppliers chose to decline Apple’s orders and capital, realizing that Apple’s negotiating tactics would leave them with slim profits. A major parts manufacturer declined to commit its manufacturing capacity to Apple’s products, even refusing a $1 billion upfront payment from Apple. The manufacturer was worried that Apple’s insistence on committed capacity and low prices would have an impact on sales to its other customers. 22 Product Assembly Final assembly of the iPhone 5 occurred in China, at Apple subcontractor Hon Hai Precision Industry Co., better known as Foxconn, at a cost to Apple of $8 per unit. Foxconn, founded in 1974, was an original design manufacturer for clients such as Apple, Sony, Nintendo, and BlackBerry. Based in Taiwan, it was the world’s largest electronics manufacturer with 1.23 million workers in 2012. In 2012, Foxconn generated $2.7 billion in net income from $4.2 billion in revenues. Foxconn had factories in Asia, Europe, Mexico and South America. Apple’s competitors, in contrast, tended to outsource production of their smartphones: In June 2011, it was reported that Nokia outsourced its Windows Phone handset production to Compal
Electronics.1 In December 2013, BlackBerry, in an attempt to turn around its business, outsourced its hardware
production to Foxconn,2 Even Samsung, a large conglomerate, announced in December 2013 that it would be outsourcing the
production of its low-end smartphones.3 Several iPhone components required labour-intensive assembly operations with complex quality control processes. For example, Apple had run each iPhone camera module through a battery of tests before it could be inserted into an iPhone. One of the key tasks for subcontractors was coordinating the sourcing and hiring of the temporary labour used in testing and assembling individual components. For example, for a group of 24 companies with 28 plants in Malaysia that were supplying assembly services to Apple’s component suppliers, receiving assembly orders meant that they had to focus efforts on hiring thousands of temporary workers. These firms looked to draw workers from developing Southeast Asian countries such as Indonesia, Cambodia, Mynamar, Vietnam and Nepal. When the iPhone 5 forecasts were developed, one of Apple’s top component manufacturers, Flextronics, put out a call for 1,500 additional temporary workers to assemble a camera component. Labour was hired 1 www.slashgear.com/nokia-outsources-windows-phone-production-to-compal-tip-insiders-24161238/; accessed June 4, 2014. 2 Will Connors, “At BlackBerry, Stock Jumps Despite Big Loss”, The Wall Street Journal Online, December 20, 2013, http://online.wsj.com/news/articles/SB10001424052702303773704579269901455159052; accessed June 4, 2014. 3 www.sammobile.com/2013/11/13/samsung-to-outsource-production-of-low-end-devices-focus-its-own-manufacturing- plants-on-premium-models/; accessed June 4, 2014.
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via a network of recruiters and subagents, all of which were tasked with finding people on short notice. For a job that paid approximately $178 per month, temporary workers paid as much as $1,000 in fees — to recruiters. Flextronics arranged for workers to board scheduled flights from their home countries to Malaysia, where they were transported to the company compound. Housing was provided, and workers were expected to work 12-hour shifts per day. Flextronics accounted for the fluctuations in orders by hiring or terminating temporary workers as needed. In the example cited above, 4,500 temporary workers began assembling iPhone 5 camera components in October 2012. But the workers were laid off in mid-January 2013, eliciting comments from the public that they had been unfairly treated. In response, Apple pointed to its supplier code of conduct, which had clear policies governing abusive practices such as harassment, involuntary labour and human trafficking.23 Due to Apple’s just-in-time supply chain, which placed significant responsibility on the shoulders of suppliers, component delays had an impact on Apple’s inventory projections. Sharp Corp, a supplier of iPhone displays, notified Apple that its output had fallen behind schedule as it struggled with high costs and debt servicing obligations.24 Finished components were consolidated at Foxconn’s China factories, where thousands of workers assembled the components into iPhones. Aside from the general labour required to test components and assemble devices, another critical advantage for Apple was that global suppliers provided engineers at a scale that its U.S. suppliers could not match. Apple’s executives had estimated that about 8,700 industrial engineers were needed to oversee and guide the 200,000 assembly-line workers eventually involved in manufacturing iPhones. The company’s analysts forecasted that it would take as long as nine months to find that many qualified engineers in the United States. In China, it took 15 days. On the assembly side, managing a huge workforce and keeping to tight schedules was difficult. A Foxconn factory was closed in Taiyuan, China in September 2012, following a riot among its 2,000 employees. In the summer of 2013, Foxconn began restricting workers to nine hours of overtime per week.25 To ensure that secrecy was maintained throughout the assembly process, Apple placed electronic monitors in select boxes of parts and followed the components remotely — from Cupertino — in case there were leaks. Logistics In 1997, Jobs’ return brought Apple a renewed focus on revamping its supply chain management capabilities. That year, Apple was facing a $1 billion backlog of orders that frustrated the management team. The firm looked at innovative ways to speed up the supply chain, even using expensive air-freight when most computer firms were relying exclusively on shipments by sea. In 1998, Jobs even pre-purchased all available holiday air-freight, paying $50 million to ensure that Apple’s new iMacs could be delivered to stores for the holiday sales rush. The move had the added benefit of shutting out rivals — such as Compaq Computer — from using air-freight as a transportation option. In fact, when it came time to ship its new iPod products in 2001, Apple discovered it was cheaper to ship them directly to consumers from its suppliers’ assembly plants in China. 26 Apple relied on intermediate warehouses at UPS and Fedex and had its own warehouses in Elk Grove, California. It had to ensure that its many sales outlets — online stores, retail stores, direct sales force, wholesalers and retail network — had the product stock they needed according to the demand forecast. In addition, the company had a reverse logistics system as well, encompassing the management of warranty claims, trade-ins and Apple’s recycle and reuse program. Managing reverse logistics effectively contributed Fo
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to Apple’s success, both on a cost level and on a customer service experience level. Traditionally, when a customer sought to return an electronic product, he or she would have to bring it back to the store with a receipt, and the store would take the item back, issue a refund, then hold the presumably defective item until it could be delivered back to the manufacturer. In contrast, Apple allowed consumers to enter data about the defect on the Apple website, adding the unit’s serial number to identify purchase details (including date of purchase, location and information about the customer). Within half a day, Apple would send the customer an email indicating if the product was still under warranty and providing details about how it would be returned. Within 48 hours, a pre-addressed, pre-stamped box would arrive at the customer’s door-step, sent by express parcel service. A shipping label and a receipt for the return were both included in the box, along with secure foam packaging and even packaging tape. By calling a central dispatch number, Apple’s assigned courier — UPS, FedEx or DHL — would come and pick up the item directly from the customer’s house or office.27 By providing rapid service through its reverse logistics function, Apple improved customer satisfaction, lowered the number of calls to its technical support services and eliminated the likelihood of customer error when processing a return (by using an incorrect address, for example). Getting the electronic product back into Apple’s service depots allowed them to diagnose and return the item to the customer rapidly, or fix the issue and sell the refurbished product as an “Apple Certified. Good as New” product in its Apple Store.28 Apple’s close management of its logistics system extended to packaging devices in plain boxes to “avoid detection,” and monitoring “every handoff point — loading dock, airport, truck depot and distribution center — to make sure each unit was accounted for.”29 Retail Experience Apple had 424 retail stores in 16 countries around the world. In addition, its online Apple Store was available in 39 countries. The company’s retail stores were typically located at high-traffic locations in quality shopping malls and urban shopping districts. By operating its own stores in desirable high-traffic locations, Apple was positioned to ensure a high-quality buying experience and attract new customers. The stores were designed to simplify and enhance the presentation and marketing of the company’s products and related solutions. The retail stores employed experienced and knowledgeable personnel who provided product advice, service and training and offered a wide selection of third-party hardware, software, other accessories and peripherals that complemented Apple’s products. Apple could monitor product sales by store by the hour and it relied on this information to tweak its production forecasts on a daily basis. According to one article: “If it becomes clear a given part will run out, teams are deployed and given approval to spend millions of dollars on extra equipment to get around the bottleneck.”30 The company also invested in programs to enhance reseller sales by placing high-quality Apple fixtures, merchandising materials and other resources within selected third-party reseller locations. Through the Apple Premium Reseller Program, certain third-party resellers focused on the Apple platform by providing a high level of product expertise, integration and support services. A side-by-side comparison of Apple’s iPhone 5 with devices from key competitors can be found in Exhibit 8.
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Looking Forward At the end of fiscal year 2013, Apple had $171 billion in sales, with market capitalization of $457 billion.31 There were rumours that Apple was going to announce a stock split, something it had only done three times in its history: on June 15, 1987, on June 21, 2000 and on February 28, 2005.32 Jessica noticed that Apple continued to invest in its supply chain. At the end of 2013, Apple was investing $10.5 billion in new technology — including assembly robots and milling machines — to ensure that its products could be made more quickly and more cost effectively. In fact, Apple’s supply chain was ranked number one in a list prepared by Gartner Group, an analytics firm (see Exhibit 9). Selected financial information from three competitors – Samsung, BlackBerry and Nokia - is shown in Exhibit 10. One observer noted that:
Apple is increasingly striking exclusive machinery deals . . . outspending peers on the tools that it then places in the factories of its suppliers, many of which are in Asia. ‘Their designs are so unique that you have to have a very unique manufacturing process to make it,’ said Muthuraman Ramasamy, an analyst with consulting firm Frost & Sullivan, who has studied the use of the machinery. ‘Apple has so much cash that they can invest in cutting-edge, world-class machinery that is typically used for aerospace and defense.’33
Finally, Jessica pored over financial information from 1996 to 2013, as well as important segment information (see Exhibits 11 and 12), before summarizing her notes on Apple’s supply chain. Then she started to prepare a one-page outline of the pros and cons for her presentation to Phillip Duchene.
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EXHIBIT 1: APPLE’S PRODUCTS iPhone The iPhone, with the iPhone 5s and 5c as the latest versions, combined a phone, photo and video camera, music player and Internet-accessible device. Apple’s iPhone segment generated $91.3 billion in sales in 2013, up 16 per cent from 2012. The iPhone had been launched as a high-end product and was available at a premium price. Apple’s iPhone 5c, however, was the first version of the iPhone targeted at the entry-level market. In 2013, Apple sold 150.3 million iPhones, up from 125 million units in 2012. iPad The iPad was Apple’s tablet computer, with the fifth generation iPad Air launched in October 2013. While many competitors had launched tablet computers in the past decade, Apple’s iPad, featuring a touch-screen interface, was the first tablet computer to gain traction in the market. Apple’s iPad segment generated $32 billion in sales in 2013, up 3 per cent from 2012. The number of iPad units sold rose 22 per cent from 58.3 million to 71 million, yet this segment’s revenues were stagnating due to Apple’s launch of smaller, less expensive iPad models over the years. Mac Apple’s Mac computers had Intel microprocessors and their own OS X operating system. Apple produced both desktop and laptop computers. Mac revenues fell 7 per cent to $21.5 billion in 2013. Unit sales fell 10 per cent to 16.3 million in 2013 from 18.2 million in 2012. iPod The firm’s portable digital music players combined a flash-memory player with features such as a photo and video camera, and allowed consumers to purchase content from its iTunes store. Sales of the iPod had been declining for the past few years, with segment revenues down 21 per cent in 2013 to $4.4 billion, and unit sales down 25 per cent to 26.4 million devices. iTunes and the iTunes Store Consumers could purchase and download apps, music and TV shows from the iTunes store. The iTunes store was integrated with Apple’s App Store and iBooks Store, which featured eBook downloads. The iTunes software and services segment generated revenues of $16.1 billion in 2013, up 25 per cent from 2012. By January 2013, Apple customers had downloaded 40 billion apps and Apple had made $7 billion in payments to third-party developers.34 Mac App Store and iCloud Computer users could download Mac apps from the Mac App store and iCloud was Apple’s cloud service, where users could keep their personal information online. Source: Apple annual reports and SEC filings.
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EXHIBIT 2: IPHONE VERSIONS AND FEATURES
Source: Apple annual reports and SEC filings.
iPhone (1st generation) iPhone 3G iPhone 3GS iPhone 4 iPhone 4S iPhone 5 iPhone 5C iPhone 5S
iOS 4.0 (GSM) iOS 4.2.5 (CDMA)
In addition to prior, features a fingerprint- resistant oleophobic coating,[242] and 262,144-color (18-bit) TN LCD with hardware spatial dithering[9]
4, 8 or 16 GB 8 or 16 GB 8, 16, 32 or 64 GB 16, 32 or 64 GB 16 or 32 GB 16, 32 or 64 GB
833 MHz (underclocked to 600 MHz) ARM Cortex-A8[11][245]
Samsung S5PC100[11][246] (64 KB L1 + 256 KB L2) 256 MB LPDDR DRAM[11][245] (200 MHz)
1 GB LPDDR3 DRAM[260]
Back 3 MP photos, VGA (480p) video at 30 fps, macro focus
5 MP photos, f/2.8, 720p HD video (30 fps), Back- illuminated sensor, LED flash
8 MP photos, f/2.4, 1080p HD video (30 fps), Back-illuminated sensor, face detection, video stabilization, panorama
8 MP photos with 1.5µ pixels, f/2.2 aperture, 1080p HD video (30 fps) or 720 HD video slo-mo video at 120 fps, improved video stabilization, True Tone flash, Infrared cut-off filter, Back- illuminated sensor, face detection, panorama, ability to take photos while shooting videos and Burst mode
Front
1.2 MP photos with 1.75µ pixels, 720p HD video (30 fps), Back- illuminated sensor
4, 8 GB: June 29, 2007
16, 32 GB: June 19, 2009
16, 32 GB: June 24, 2010
16, 32, 64 GB: October 14, 2011
16 GB: February 5, 2008
8 GB black: June 24, 2010
CDMA: February 10, 2011
8 GB: September 20, 2013
White: April 28, 2011 8 GB: October 14, 2011
4 GB: September 5, 2007
16 GB: June 8, 2009
16, 32 GB: June 24, 2010
16, 32 GB: October 4, 2011
32, 64 GB: September 12, 2012
8, 16 GB: July 11, 2008
8 GB black: June 7, 2010
8 GB black: September 12, 2012
8 GB: September 10, 2013
16 GB: September 10, 2013 8 GB: In Production
Model
Initial operating system
iPhone OS 1.0 iPhone OS 2.0 iPhone OS 3.0 iOS 5.0
Storage 8, 16 or 32 GB
Processor 620 MHz (underclocked to 412 MHz) Samsung 32-bit RISC ARM (32 KB L1) 1176JZ(F)-S v1.0[243][244]
1 GHz (underclocked to 800 MHz) ARM Cortex-A8 Apple A4 (SoC)[247]
1 GHz (underclocked to 800 MHz) dual- core ARM Cortex- A9 Apple A5 (SoC)[248]
iOS 6.0 iOS 7.0
Display
3.5 in (89 mm), 3:2 aspect ratio, scratch-resistant[7] glossy glass covered screen, 262,144-color (18- bit) TN LCD, 480 × 320 px (HVGA) at 163 ppi, 200:1 contrast ratio
3.5 in (89 mm), 3:2 aspect ratio, aluminosilicate glass covered 16,777,216-color (24-bit) IPS LCD screen, 960 × 640 px at 326 ppi, 800:1 contrast ratio, 500 cd⁄m² max brightness
4 in (100 mm), 71:40 aspect ratio, 1136 x 640 px screen resolution at 326 ppi
1.3 GHz dual-core Apple-designed ARMv7s Apple A6[249]
1.3 GHz dual-core Apple-designed ARMv8-A 64-bit Apple A7 with M7 motion coprocessor[250]
Memory 128 MB LPDDR DRAM[252] (137 MHz) 512 MB LPDDR2 DRAM[253][254][255][256][257] (200 MHz)
1 GB LPDDR2 DRAM[258][259]
Cameras
2 MP f/2.8
8 MP photos with 1.4µ pixels, f/2.4, 1080p HD video (30 fps), Infrared cut-off filter, Back- illuminated sensor, face detection, video stabilization, panorama and ability to take photos while shooting videos
No VGA (0.3 MP) photos and videos (30 fps) 1.2 MP photos with 1.9µ pixels, 720p HD video (30 fps), Back- illuminated sensor
Materials Aluminum, glass, steel, and black plastic
Glass, plastic, and steel; black or white
(white not available for 8 GB models) Black or white aluminosilicate glass and stainless steel
Black with anodized aluminium "Slate" metal or white with
White, pink, yellow, blue or green polycarbonate
Silver (white front with "Silver" aluminium metal back), Space Gray (Black front with anodized aluminium
All models: September 20, 2013
Discontinued All models: September 10, 2013 In Production
Released All models: July 11, 2008 All models: September 21, 2012
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EXHIBIT 3: IPHONE SALES BY QUARTER
Source: Apple annual reports and SEC filings.
Global iPhone Sales by FY Quarter (in MMs)
Q3 2007 0.270 Q4 2007 1.190 Q1 2008 2.315 Q2 2008 1.703 Q3 2008 0.717 Q4 2008 6.890 Q1 2009 4.363 Q2 2009 3.793 Q3 2009 5.208 Q4 2009 7.367 Q1 2010 8.737 Q2 2010 8.752 Q3 2010 8.398 Q4 2010 14.102 Q1 2011 16.240 Q2 2011 18.650 Q3 2011 20.340 Q4 2011 17.070 Q1 2012 37.040 Q2 2012 35.100 Q3 2012 26.000 Q4 2012 26.900 Q1 2013 47.800 Q2 2013 37.400 Q3 2013 31.200 Q4 2013 33.800 Q1 2014 51.000
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EXHIBIT 4: IPHONE SUPPLIERS OF 97 PER CENT OF APPLE’S IPHONE PRODUCT MATERIALS
Source: Apple Inc., www.apple.com/supplier-responsibility/, accessed October 4, 2013.
Apple Suppliers 2011 1 AACTechnologies Holdings Inc. 53 Daishinku Corporation (KDS) 105 Interflex Co.,Ltd. 2 AcBel Polytech Inc. 54 Darfon Electronics Corporation 106 International Rectifier Corporation 3 Acument GlobalTechnologies 55 Delta Electronics Inc. 107 Intersil Corporation 4 Advanced Micro Devices,Inc. 56 Diodes Inc. 108 Inventec Appliances Corporation 5 AmperexTechnology Ltd. 57 Dynapack InternationalTechnology 109 Jabil Circuit,Inc. 6 Amphenol Corporation 58 Elpida Memory,Inc. 110 Japan Aviation Electronics Industry,Ltd. 7 Analog Devices,Inc. 59 Emerson Electric Co. 111 Jin Li Mould Manufacturing Pte Ltd. 8 Anjie Insulating Material Co.,Ltd. 60 ES Power Co.,Ltd. 112 Kaily Packaging Pte Ltd. 9 Asahi Kasei Corporation 61 Fairchild Semiconductor International 113 Kenseisha Sdn.Bhd.
10 AU Optronics Corporation 62 FasteningTechnology Pte Ltd. 114 Knowles Electronics 11 AustriaTechnologie & Systemtechnik AG 63 FLEXium Interconnect,Inc. 115 Kunshan Changyun Electronic Industry 12 austriamicrosystems 64 Flextronics International Ltd. 116 LairdTechnologies 13 AvagoTechnologies Ltd. 65 Fortune Grand Enterprise Co.,Ltd. 117 Lateral Solutions Pte Ltd. 14 Brady Corporation 66 Foster Electric Co.,Ltd. 118 Lens OneTechnology (Shenzhen) Co.,Ltd. 15 Brilliant International Group Ltd. 67 Fuji Crystal Manufactory Ltd. 119 Lg Chem,Ltd. 16 Broadcom Corporation 68 Fujikura Ltd. 120 Lg Display Co.,Ltd. 17 Broadway Industrial Group Ltd. 69 Grand UprightTechnology Ltd. 121 Lg Innotek Co.,Ltd. 18 Byd Company Ltd. 70 Gruppo Dani S.p.A. 122 LinearTechnology Corporation 19 CareerTechnology (MFG.) Co.,Ltd. 71 Gruppo Peretti 123 Lite-OnTechnology Corporation 20 CatcherTechnology Co.,Ltd. 72 Hama Naka Shoukin Industry Co.,Ltd. 124 Longwell Company 21 Cheng Loong Corporation 73 Hanson Metal Factory Ltd. 125 LSI Corporation 22 Cheng Uei Precision Industry Co.,Ltd.(Foxlink) 74 Heptagon Advanced Micro-Optics Pte Ltd. 126 Luen Fung Commercial Holdings Ltd. 23 Chimei Innolux Corporation 75 Hi-P International Ltd. 127 Macronix International Co.,Ltd. 24 Coilcraft,Inc. 76 Hitachi-LG Data Storage 128 Marian,Inc. 25 Compeq Manufacturing Co.,Ltd. 77 Hon Hai Precision Industry Co.,Ltd.(Foxconn) 129 MarvellTechnology Group Ltd. 26 Cosmosupplylab Ltd. 78 Hynix Semiconductor Inc. 130 Maxim Integrated Products,Inc. 27 CymMetrik (Shenzhen) Printing Co. 79 Ibiden Co.,Ltd. 131 Meiko Electronics Co.,Ltd. 28 Cyntec Co.,Ltd. 80 InfineonTechnologies AG 132 MicrochipTechnology Inc. 29 Cypress Semiconductor Corporation 81 Intel Corporation 133 MicronTechnology,Inc. 30 Mitsumi Electric Co.,Ltd. 82 Ri-Teng Computer Accessory Co.,Ltd. 134 Suzhou Panel Electronic Co.,Ltd. 31 Molex Inc. 83 ROHM Co.,Ltd. 135 Taiyi PrecisionTech Corporation 32 Multek Corporation 84 Rubycon Corporation 136 TaiyoYuden Co.,Ltd. 33 Multi-Fineline Electronix,Inc. 85 Samsung Electro-Mechanics Co.,Ltd. 137 TDK Corporation 34 Murata Manufacturing Co.,Ltd. 86 Samsung Electronics Co.,Ltd. 138 Texas Instruments Inc. 35 NanYa Printed Circuit Board Corporation 87 SanDisk Corporation 139 Tianjin Lishen Battery Joint-Stock Co.,Ltd. 36 NEC Corporation 88 SANYO Electric Co.,Ltd. 140 Toshiba Corporation 37 Nippon Mektron,Ltd. 89 SDI Corporation 141 Toshiba Mobile Display Co.,Ltd. 38 NishokuTechnology Inc. 90 SeagateTechnologies 142 Toyo Rikagaku Kenkyusho Co.,Ltd. 39 NVIDIA Corporation 91 Seiko Epson Corporation 143 TPK Holding Co.,Ltd. 40 NXP Semiconductor N.V. 92 Seiko Group 144 TripodTechnology Corporation 41 ON Semiconductor Corporation 93 Sharp Corporation 145 TriQuint Semiconductor 42 Optrex Corporation 94 Shimano Inc. 146 Triumph Lead ElectronicTech Co. 43 Oriental Printed Circuits Ltd. 95 Shin Zu Shing Co.,Ltd. 147 TXC Corporation 44 Panasonic Corporation 96 SilegoTechnology Inc. 148 Unimicron Corporation 45 PCH International 97 SimploTechnology Co.,Ltd. 149 UnisteelTechnology Ltd. 46 Pegatron Corporation 98 Skyworks Solutions Inc. 150 Universal Scientific Industrial Co.,Ltd. 47 Pioneer Material PrecisionTech 99 Sony Corporation 151 Vishay Intertechnology 48 Prent Corporation 100 Standard Microsystems Corporation 152 Volex plc 49 Primax Electronics Ltd. 101 STMicroelectronics 153 Western Digital Corporation 50 Qualcomm Incorporated 102 Sumida Corporation 154 Wintek Corporation 51 Quanta Computer Inc. 103 Sumitomo Electric Industries,Ltd. 155 Yageo Corporation 52 Renesas Electronics Corporation 104 SunrexTechnology Corporation 156 Zeniya Aluminum Engineering,Ltd.
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EXHIBIT 5: LIST OF APPLE’S KEY SUPPLIERS
Firm Location Part or service supplied Samsung Singapore CPU and Video Chips Infineon Singapore Baseband Communications Primax Electronics Taiwan Digital Camera Modules Foxconn International Taiwan Internal Circuitry Entery Industrial Taiwan Connectors Cambridge Silicon Taiwan Bluetooth Umicron Technology Taiwan Circuit Board Catcher Technology Taiwan Casings Broadcomm U.S. Touch Screen Controls Marvell U.S. 802.11 Specific Parts Foxconn China Assembly and Inventory
EXHIBIT 6: DISTRIBUTION OF VALUE FOR IPHONE, 2010
Source: Kenneth L. Kraemer, Greg Linden and Jason Dedrick, “Capturing Value in Global Networks: Apple’s iPad and iPhone”, July 2011, page 5. From “pcic.merage.uci.edu/papers/2011/Value_iPad_iPhone.pdf.” Note that “Apple Profits” are gross margins to Apple and suppliers’ “profits” are revenues to that supplier. Amounts do not add up to 100 per cent due to rounding.
Cost of inputs: China labor 1.8% Cost of inputs: Non-China labor 3.5% Cost of inputs: materials 21.9% Unidentified profits: 5.3% South Korea profits 4.7% Japan profits 0.5% Taiwan profits 0.5% E.U. profits 1.1% Non-Apple U.S. profits 2.4% Apple profits 58.5%
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EXHIBIT 7: IPHONE 5 – ESTIMATED BILL OF MATERIALS (2012)
Source: HIS iSuppli Research, September 2012. https://technology.ihs.com/410378/iphone-5-carries-199-bom-virtual- teardown-reveals, accessed January 3, 2014.
Components/Hardware Elements 16 GB 32 GB 64 GB Pricing without Contract 649$ 749$ 849$ Total Bill of Materials Cost 199$ 209$ 230$ Manufacturing Cost 8.00$ 8.00$ 8.00$ Bill of Materials and Manufacturing 207$ 217$ 238$ Major Cost Drivers Memory NAND Flash 10.40$ 20.80$ 41.60$ DRAM 10.45$ 10.45$ 10.45$ Display and Touchscreen 44.00$ 44.00$ 44.00$ Processor 17.50$ 17.50$ 17.50$ Camera(s) 18.00$ 18.00$ 18.00$ Wireless Section - BB/RF/PA 34.00$ 34.00$ 34.00$ User Interface and sensors 6.50$ 6.50$ 6.50$ Bluetooth/WLAN 5.00$ 5.00$ 5.00$ Power Management 8.50$ 8.50$ 8.50$ Battery 4.50$ 4.50$ 4.50$ Mechanical/Electro-Mechanical 33.00$ 33.00$ 33.00$ Box Contents 7.00$ 7.00$ 7.00$
iPhone 5 Model
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EXHIBIT 8: IPHONE AND COMPETITORS
Source: http://mashable.com/2012/09/12/iphone-5-compared/, accessed April 3, 2014.
iPhone 5 Samsung Galaxiy S III Droid RAZR
HD Nokia Lumia
920
Screen Size 4 inches 4.8 inches 4.7 inches 4.5 inches
Resolution 1,136 x 640 1,280 x 720 1,280 x 720 1,280 x 768
Weight 3.9 oz 4.7 oz 5.1 oz 6.5 oz
CPU Dual-core Apple A6
Dual-core 1.5GHz Snapdragon S4 (in the U.S.)
Dual-core 1.5GHz Snapdragon S4
Dual-core 1.5 GHz Snapdragon S4
Storage 16GB, 32GB or 64GB, no card slot
16GB, 32GB or 64GB +microSD slot
12GB+microSD slot
32GB, no card slot
Connectors Apple Lightning microUSB microUSB microUSB
Operating System iOS 6 Android 4.0.4 (Ice Cream Sandwich)
Android 4.0.4 (Ice Cream Sandwich)
Microsoft Windows Phone 8
Battery
225 hours standby, 8 hours talk time (3G)
790 hours standby, 11:40 hours talk time (3G)
TBA
300 hours standby, 10 hours talk time (3G)
Camera
8MP, 3264x2448 pixels, autofocus, LED flash
8MP, 3264x2448 pixels, autofocus, LED flash
8MP, 3264x2448 pixels, autofocus, LED flash
8MP, 3264x2448 pixels, optical image stabilization, autofocus, dual- LED flash
Networking Wi-Fi, 2G, 3G, 4G LTE Wi-Fi, 2G, 3G, 4G LTE
Wi-Fi, 2G, 3G, 4G LTE
Wi-Fi, 2G, 3G, 4G LTE
Price
$199 for 16GB, $299 for 32GB, $399 for 64GB; avail. Sept. 21
$199.99 + $35 carrier fee
$199 (estimated, launch end of 2012)
TBA, launch Q4 2012
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EXHIBIT 9: SUPPLY CHAIN RANKINGS BY GARTNER GROUP
Notes: 1. Gartner Opinion and Peer Opinion: Based on each panel's forced-rank ordering against the definition of “DDVN orchestrator” 2. ROA: ((2012 net income / 2012 total assets) × 50%) + ((2011 net income / 2011 total assets) × 30%) + ((2010 net income / 2010 total assets) × 20%) 3. Inventory Turns: 2012 cost of goods sold / 2012 quarterly average inventory 4. Revenue Growth: ((change in revenue 2012-2011) * 50%) + ((change in revenue 2011-2010) * 30%) + ((change in revenue 2010-2009) × 20%) 5. Composite Score: (Peer Opinion * 25%) + (Gartner Research Opinion * 25%) + (ROA * 25%) + (Inventory Turns × 15%) + (Revenue Growth × 10%) 6. 2012 data used where available. Where unavailable, latest available full-year data used. All raw data normalized to a 10- point scale prior to composite calculation. “Ranks” for tied composite scores are determined using next decimal point comparison. Source: Debra Hofman, Stan Aronow, Kimberly Niles, “The Gartner Supply Chain Top 25 for 2013”, The Gartner Group, 22 May 2013, pages 5-6.
Rank Company
Peer Opinion1
(172 voters) (25%)
Gartner Opinion1
(33 voters) (25%)
Three-Year Weighted
ROA2 (25%)
Inventory Turns3
(15%)
Three-Year Weighted Revenue
Growth4 (10%) Composite
Score5
1 Apple 3,203 470 22.3% 82.7 52.5% 9.51 2 McDonald's 1,197 353 15.8% 147.5 5.9% 5.87 3 Amazon.com 3,115 475 1.9% 9.3 33.6% 5.86 4 Unilever 1,469 522 10.5% 6.5 9.0% 5.04 5 Intel 756 515 15.6% 4.2 11.4% 4.97 6 P&G 1,901 493 8.6% 5.8 3.6% 4.91 7 Cisco Systems 1,167 517 8.5% 11.2 7.8% 4.67 8 Samsung Electronics 1,264 298 11.6% 18.5 15.7% 4.35 9 The Coca-Cola Co. 1,779 278 11.7% 5.5 14.0% 4.33
10 Colgate-Palmolive 794 324 18.9% 5.2 3.6% 4.27 11 Dell 1,409 342 6.2% 30.7 -0.6% 4.05 12 Inditex 745 221 18.0% 4.2 13.4% 3.85 13 Wal-Mart Stores 1,629 282 8.8% 8.1 4.9% 3.79 14 Nike 955 236 14.1% 4.2 10.6% 3.62 15 Starbucks 808 159 16.5% 4.8 11.5% 3.41 16 PepsiCo 810 314 8.6% 7.8 10.5% 3.41 17 H&M 399 41 28.2% 3.7 6.7% 3.22 18 Caterpillar 714 247 5.8% 2.8 23.4% 2.91 19 3M 999 105 13.3% 4.2 6.9% 2.87 20 Lenovo Group 397 211 2.5% 22.2 29.8% 2.75 21 Nestlé 679 112 13.3% 5.1 -0.6% 2.51 22 Ford Motor 552 231 5.7% 15.1 3.1% 2.51 23 Cummins 74 139 13.3% 5.3 13.5% 2.48 24 Qualcomm 122 45 12.7% 8.5 25.9% 2.37 25 Johnson & Johnson 730 144 9.6% 2.9 3.3% 2.35
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EXHIBIT 10: KEY COMPARATIVE INFORMATION FOR SAMSUNG, BLACKBERRY AND NOKIA
Source: Mergent Database; accessed April 3, 2014.
Samsung In U.S. dollars FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 Net sales 117,821 137,905 142,403 188,351 217,462 Cost of sales 81,756 91,562 96,785 118,621 130,934 Gross margin 36,065 46,343 45,618 69,730 86,528 Research & development expense 6,384 8,115 8,613 NA NA Net income (loss) 8,436 14,400 11,853 22,333 28,978 Total shareholders' equity 63,131 79,685 87,896 113,777 142,649
Accounts receivable, net 15,400 17,081 18,885 22,348 23,761 Accounts payable 7,117 957 884 1,092 1,002 Inventories 8,504 11,919 13,564 16,622 18,195 Land & buildings 37,648 47,236 53,546 64,142 71,789 Cash equivalents 19,336 22,759 25,979 39,972 57,751 Total assets 96,954 119,764 134,315 169,589 203,562
BlackBerry In U.S. dollars FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 Net sales 14,953 19,907 18,435 11,073 6,813 Cost of sales 8,369 11,082 11,856 7,639 6,856 Gross margin 6,584 8,825 6,579 3,434 (43) Research & development expense 965 1,351 1,559 1,509 1,286 Net income (loss) 2,457 3,411 1,164 (646) (5,873) Total shareholders' equity 7,603 8,938 10,100 9,460 3,625
Accounts receivable, net 2,594 3,955 3,062 2,353 972 Accounts payable 616 832 744 1,064 474 Inventories 622 618 1,027 603 244 Land & buildings 1,957 2,504 2,748 2,395 942 Cash equivalents 1,911 2,121 1,774 2,654 2,529 Total assets 10,204 12,875 13,731 13,165 7,552
Nokia In U.S. dollars FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 Net sales 59040 56809 50004 39773 17497 Cost of sales 39933 39655 35363 28715 10138 Gross margin 19107 17154 14641 11058 7359 Research & development expense 8512 7847 7259 6303 3606 Net income (loss) 375 1797 -1925 -4994 -1017 Total shareholders' equity 21247 21723 18000 12452 9169
Accounts receivable, net 11497 10131 9288 7316 3994 Accounts payable 7131 8165 7155 5792 2536 Inventories 2687 3377 3014 2027 1107 Land & buildings 2690 2615 2383 1886 779 Cash equivalents 1645 2611 2531 4618 5061 Total assets 51483 52361 46829 39474 34681
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EXHIBIT 11: APPLE’S HISTORICAL FINANCIAL INFORMATION (SELECTED)
Source: Mergent Database; accessed April 3, 2014.
FY 2013 FY 2012 FY 2011 FY 2010 FY 2009 FY 2008 FY 2007 FY 2006 FY 2005 9/28/2013 9/29/2012 9/24/2011 9/25/2010 9/26/2009 9/27/2008 9/29/2007 9/30/2006 9/24/2005
Net sales 170,910,000 156,508,000 108,249,000 65,225,000 36,537,000 32,479,000 24,006,000 19,315,000 13,931,000 Cost of sales 106,606,000 87,846,000 64,431,000 39,541,000 23,397,000 21,334,000 15,852,000 13,717,000 9,888,000 Gross margin 64,304,000 68,662,000 43,818,000 25,684,000 13,140,000 11,145,000 8,154,000 5,598,000 4,043,000 Research & development expense 4,475,000 3,381,000 2,429,000 1,782,000 1,333,000 1,109,000 782,000 712,000 534,000 Net income (loss) 37,037,000 41,733,000 25,922,000 14,013,000 5,704,000 4,834,000 3,496,000 1,989,000 1,335,000 Total shareholders' equity 123,549,000 118,210,000 76,615,000 47,791,000 27,832,000 21,030,000 14,532,000 9,984,000 7,466,000
Accounts receivable, net 13,102,000 10,930,000 5,369,000 5,510,000 3,361,000 2,422,000 1,637,000 1,252,000 895,000 Accounts payable 22,367,000 21,175,000 14,632,000 12,015,000 5,601,000 5,520,000 4,970,000 3,390,000 1,779,000 Inventories 1,764,000 791,000 776,000 1,051,000 455,000 509,000 346,000 270,000 165,000 Land & buildings 3,309,000 2,439,000 2,059,000 1,471,000 955,000 810,000 762,000 626,000 361,000 Cash equivalents 146,761,000 121,251,000 81,570,000 51,011,000 33,992,000 24,490,000 15,386,000 10,110,000 8,261,000 Total assets 207,000,000 176,064,000 116,371,000 75,183,000 53,851,000 39,572,000 25,347,000 17,205,000 11,551,000
Full-time employees 80,300 72,800 60,400 46,600 34,300 32,000 21,600 17,787 14,800
FY 2004 FY 2003 FY 2002 FY 2001 FY 2000 FY 1999 FY 1998 FY 1997 FY 1996 9/25/2004 9/27/2003 9/28/2002 9/29/2001 9/30/2000 9/25/1999 9/25/1998 9/26/1997 9/27/1996
Net sales 8,279,000 6,207,000 5,742,000 5,363,000 7,983,000 6,134,000 5,941,000 7,081,000 9,833,000 Cost of sales 6,020,000 4,499,000 4,139,000 4,128,000 5,817,000 4,438,000 4,462,000 5,713,000 8,865,000 Gross margin 2,259,000 1,708,000 1,603,000 1,235,000 2,166,000 1,696,000 1,479,000 1,368,000 968,000 Research & development expense 489,000 471,000 446,000 430,000 380,000 314,000 303,000 485,000 604,000 Net income (loss) 276,000 69,000 65,000 -25,000 786,000 601,000 309,000 -1,045,000 -816,000 Total shareholders' equity 5,076,000 4,223,000 4,095,000 3,920,000 4,107,000 3,104,000 1,642,000 1,200,000 2,058,000
Accounts receivable, net 774,000 766,000 565,000 466,000 953,000 681,000 955,000 1,035,000 1,496,000 Accounts payable 1,451,000 1,154,000 911,000 801,000 1,157,000 812,000 719,000 685,000 791,000 Inventories 101,000 56,000 45,000 11,000 33,000 20,000 78,000 437,000 662,000 Land & buildings 351,000 350,000 342,000 337,000 324,000 323,000 338,000 453,000 480,000 Cash equivalents 5,464,000 4,566,000 4,337,000 4,336,000 4,027,000 3,226,000 2,300,000 1,459,000 1,745,000 Total assets 8,050,000 6,815,000 6,298,000 6,021,000 6,803,000 5,161,000 4,289,000 4,233,000 5,364,000
Full-time employees 11,695 10,912 10,211 9,603 8,568 6,960 6,658 8,437 NA
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EXHIBIT 12: APPLE’S SEGMENT INFORMATION
Source: Apple 2013 10-K filing, page 27.
2013 Change 2012 Change 2011 Net Sales by Operating Segment: Americas $62,739 9% $57,512 50% $38,315 Europe 37,883 4% 36,323 31% 27,778 Greater China (a) 25,417 13% 22,533 78% 12,690 Japan 13,462 27% 10,571 94% 5,437 Rest of Asia Pacific 11,181 4% 10,741 8% 9,902 Retail 20,228 7% 18,828 33% 14,127 Total net sales $170,910 9% $156,508 45% $108,249
Net Sales by Product: iPhone (b) $91,279 16% $78,692 71% $45,998 iPad (b) 31,980 3% 30,945 61% 19,168 Mac (b) 21,483 -7% 23,221 7% 21,783 iPod (b) 4,411 -21% 5,615 -25% 7,453 iTunes, software and services (c) 16,051 25% 12,890 38% 9,373 Accessories (d) 5,706 11% 5,145 15% 4,474 Total net sales $170,910 9% $156,508 45% $108,249
Unit Sales by Product: iPhone 150,257 20% 125,046 73% 72,293 iPad 71,033 22% 58,310 80% 32,394 Mac 16,341 -10% 18,158 9% 16,735 iPod 26,379 -25% 35,165 -17% 42,620
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ENDNOTES
1 This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives presented in this case are not necessarily those of Apple Inc. or any of its employees. 2 http://blogs.vancouversun.com/2012/09/24/iphone-5-sold-out-apple-stores-have-stock-other-retailers-out-of-luck/, accessed April 3, 2014. 3 All currencies are in US$ unless otherwise stated. 4 www.reuters.com/article/2014/02/28/us-apple-tv-idUSBREA1R1O420140228, accessed April 3, 2014. 5 Poornima Gupta, Peter Henderson, “Apple CEO Tim Cook is slowly, quietly, burying Steve Jobs,” Reuters, August 22, 2013, accessed April 3, 2014. 6 www.youtube.com/watch?v=2zfqw8nhUwA, accessed May 16, 2014. 7 Stewart Alsop, “Apple of Sun’s Eve,” Time, February 5, 1996. 8 http://allaboutstevejobs.com/bio/longbio/longbio_08.php, accessed April 3, 2014. 9 Cam Simpson, “An iPhone Tester Caught in Apple’s Supply Chain,” Bloomberg Businessweek, November 7, 2013, accessed April 3, 2014. 10 www.unwiredview.com/2013/11/13/samsung-sees-advantages-in-outsourcing-smartphone-production-10-million-galaxy- trend-duos-units-already-made/; accessed January 3, 2014. Samsung had its own factories in China, Vietnam and India but was accelerating the outsourcing of the production of its smartphone devices. 11 Adam Satariano, “Apple’s $10.5 B on Robots to Lasers Shores up Supply Chain,” Bloomberg, November 13, 2013, accessed April 3, 2014. 12 Cam Simpson, op.cit. 13 http://webcache.googleusercontent.com/search?q=cache:oOEKIPnsaD0J:blog.smartadvantage.com/competit 14 www.slideshare.net/Xelal/apple-logistics; accessed April 3, 2014. 15 Apple 10-K report 2013, page 7. http://investor.apple.com/SECFilingNav.cfm?FilingID=1193125-13-416534&CIK, accessed April 3, 2014. 16 “How the U.S. Lost Out on iPhone Work,” www.nytimes.com/2012/01/22/business/apple-america-and-a-squeezed-middle- class.html?pagewanted=all&_r=0, accessed April 3, 2014. 17 Adam Satariano and Peter Burrows, “Apple’s Supply-Chain Secret? Hoard Lasers,” Businessweek, November 3, 2011. 18 Cam Simpson, op. cit. 19 www.webpronews.com/samsung-market-value-drops-10-billion-on-apple-news-2012-05, accessed April 3, 2014. 20 Cam Simpson, op. cit. 21 Adam Satariano, op. cit. 22 Cam Simpson, op. cit. 23 Poornima Gupta and Jennifer Saba, “Apple sells over 5 million iPhone 5, supply constraints loom,” Reuters, September 24, 2012, accessed April 3, 2014. 24 Ibid. 25 Paul Mozur, “Life Inside Foxconn’s Facility in Shenzhen,” China Realtime Report, The Wall Street Journal, December 19, 2012, accessed April 3, 2014. 26 Cam Simpson, op. cit. 27 www.scdigest.com/assets/newsViews/09-01-06-1.php?cid=2165, accessed April 3, 2014. 28 http://store.apple.com/ca/browse/home/specialdeals, accessed April 3, 2014. 29 Cam Simpson, op. cit. 30 Ibid. 31 www.macrumors.com/2013/10/28/apple-reports-q4-2013-year-end-results-7-5-billion-profit-on-37-5-billion-in-revenue/, accessed April 3, 2014. 32 http://investor.apple.com/faq.cfm?FaqSetID=2, accessed April 3, 2014. 33 Adam Satariano, op. cit. 34 Matthew Lynley, “Apple has paid out more than $7 billion to developers,” The Wall Street Journal, January 7, 2013, accessed April 3, 2014.
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11.
9B15D011
3M CANADA: THE HEALTH CARE SUPPLY CHAIN Professor P. Fraser Johnson 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 © 2015, Richard Ivey School of Business Foundation Version: 2016-12-09 On Monday January 12, 2015, Scott Davis, national manager of key accounts and channel markets, Medical Division at 3M Canada (3M) Health Care, was preparing for his meeting at the end of the month with Matt Pepe, vice president of 3M Canada’s Health Care Business Group. The Medical Division currently relied on value-added resellers (VARs) to distribute its products to Canadian hospitals. Recently, however, these customers were pressuring 3M to ship products directly to the hospitals as opposed to using VARs. Hospital strategic sourcing managers believed that major cost savings could be achieved in the supply chain through a “direct distribution” model. Matt had asked Scott to prepare an analysis of the Medical Division’s distribution system and to make recommendations by the end of the month regarding potential changes to its existing method of distributing products to Canadian hospitals. THE CANADIAN HEALTH CARE SYSTEM Health care services in Canada were government-funded and delivered through a variety of organizations such as Regional Health Authorities (RHAs), hospitals, physician practices and medical clinics. While the provinces held the primary responsibility for delivery of health care services, the federal government maintained regulatory authority through the Canada Health Act. In addition to providing hospital and physician services, provinces and territories delivered a range of additional health care support services including prescription drug plans, homecare, continuing care and long-term care. The nature and scope of these services could vary depending on the province and territory, and were influenced by changing health care demands and demographics. In 2015, the Canadian health care system was under significant financial strain as a result of a number of factors, including the aging baby boomer segment of the population, government fiscal constraints and rising costs. Total health care expenditures were estimated at $215 billion in 2014. Government spending on health care had more than doubled since 2000 and represented approximately 11 per cent of Canadian gross domestic product (GDP), compared to 7.0 per cent of GDP in 1975.1
1 Canadian Institute for Health Information, National Health Expenditure Trends, 1975 to 2014, CIHI October 2014, www.cihi.ca/en/nhex_2014_report_en.pdf, accessed December 15, 2014.
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The major categories of health care spending in Canada from 1975 to 2014 included hospitals, drugs and physicians. Hospitals had traditionally represented a prominent place in health care provision and the single largest cost in the system; however, the share of health care spending on specific categories had shifted during the past four decades. Spending on hospitals had declined from 47 per cent of the total in 1975 to 31 per cent in 2014, while spending on “other” health care costs (e.g., public health, nursing homes, residential care facilities and other health care professions) increased from 28 to 37 per cent during the same period. Drugs accounted for approximately 16 per cent of total health care spending, while physicians constituted approximately 16 per cent (see Exhibit 1).2 As a result of the fiscal pressures faced by government policy makers, a number of initiatives were introduced with the objective of changing business practices in order to improve speed and efficiency of service. One outcome was the closure of hospital beds and sites and the consolidation of hospital operations. As a result, hospital spending as a percentage of total government spending shrunk significantly, although spending on hospitals, in current dollars increased twelvefold between 1975 and 2014 (see Exhibit 1).3 In most provinces, RHAs were created with responsibility for organizing, delivering and coordinating public health programs, hospital services, community care and long-term or continuing care services. These efforts resulted in changes in the delivery of health care in Canada. For example, day surgeries were on the rise and fewer patients were staying overnight in hospital. Overall, out-of-hospital health care was increasing and health care professionals were developing innovative practices that allowed the aging population to stay in homecare rather than long-term care institutions or hospitals. Other cost reduction actions included the formation of larger centralized procurement organizations and the consolidation of hospital supply chain operations. New centralized strategic sourcing organizations targeted supplier price reductions and lower total costs of ownership through product and service standardization. Supply chain operations consolidation provided improved control of inventories, invoicing and product handling. Wherever possible, hospital procurement groups were attempting to reduce costs by negotiating contracts directly with manufacturers, as opposed to dealing with distributors. Most provinces had initiatives underway to restructure their health care supply chain organizations with the objective of reducing costs. One example was in British Columbia, where the Health Shared Services BC (HSSBC) was launched in February 2009 to provide services to the province’s six health authorities in the areas of accounts receivable, accounts payable, payroll services, employee records and benefits, technology services, and supply chain, which included purchasing and strategic sourcing, inventory management, warehousing and in-hospital replenishment.4 The supply chain group had approximately 1,000 employees located across six health authorities, and managed more than $1.9 billion in total annual spending. The hybrid organizational model balanced the needs of the local regions with the need for centralization by allowing each health authority to have a regional branch office that was responsible for that particular health authority’s requirements. HSSBC supply chain estimated that it had achieved more than $230 million in savings since its inception.5
2 CIHI, National Health Expenditure Trends, 1975 to 2014, Canadian Institute for Health Information, October 2014, www.cihi.ca/en/nhex_2014_report_en.pdf, accessed December 15, 2014. 3 Ibid. 4 Health Shared Services BC, “About Us—Health Shared Services BC,” HSSBC, www.hssbc.ca/AboutUs/default.htm, accessed December 15, 2014. 5 Health Shared Services BC, “Services—Supply Chain,” HSSBC, www.hssbc.ca/Services/Supply-Chain/default.htm, accessed December 15, 2014.
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3M COMPANY The Minnesota, Mining and Manufacturing Company, now called 3M, was founded in 1902. After an initial mining venture proved to be unsuccessful, the company established itself as a leading developer, manufacturer and distributor of consumer and industrial products. 3M was a Fortune 500 Company with revenues of $31.8 billion in fiscal 2014. The company had more than 30 business units organized into five business groups — consumer, safety and graphics, industrial, health care, and electronics and energy. Headquartered in St. Paul, Minnesota, the company had operations in more than 70 countries and served customers in more than 200 countries.6 Known for innovation and problem solving, 3M was a science and technology company with laboratories and manufacturing facilities in more than 38 countries. Its research and development (R&D) spending in 2014 was $1.8 billion, and in 2013, 3M’s CEO Inge Thulin committed to spending six per cent of the company’s sales on R&D aimed at helping the company achieve its targeted four to six per cent organic revenue growth over five years.7 Some of 3M’s most widely recognized brands included ScotchgardTM stain removal and fabric protection, FiltreteTM home filtration products, Post-itTM Notes, ThinsulateTM Insulation, and LittmannTM Stethoscopes. 3M had operated in Canada for more than 60 years from their head office in London, Ontario. 3M Canada was optimized for global alignment (with five business groups) as well as the ability to serve the priority markets relevant to the country’s business landscape — the Priority Markets Division focused on the construction, mining, oil and gas industries in Canada. While the business groups operated with autonomy, they also benefited from involvement in the marketing strategies of the more than 30 business units within these sectors globally. All local business units had their own technical, sales and marketing functions, along with full access to the experience, knowledge, manufacturing capabilities and other valuable assets of the global organization. The exchange was a two- way street, and many new 3M products carried the stamp of knowledge gained through 3M’s global operations, including 3M Canada. This internal synergy positioned 3M Canada as a vital component in the North American market. Unique centres of marketing, sales, administrative and manufacturing excellence within 3M Canada also served some of 3M’s North American customers. 3M CANADA MEDICAL DIVISION 3M Canada Health Care Group was committed to supplying innovative products and solutions for medical, oral care, health information management, drug delivery and food safety. Major product categories included skin and wound care, infection prevention, stethoscopes, medical devices, dental, orthodontics, drug delivery systems, veterinary and animal care, and health information systems (see Exhibit 2). The Medical Division focused on institutional customers, such as hospitals, long term care facilities and home care agencies.
6 3M, “About Us – Who We Are,” 3M, http://solutions.3m.com/wps/portal/3M/en_US/3M-Company/Information/AboutUs/ WhoWeAre/, accessed August 12, 2014. 7 3M, “Corporate Profile – 3M Performance,” 3M, http://solutions.3m.com/wps/portal/3M/en_US/3M-Company/Information/ Profile/Performance/, accessed August 12, 2014.
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The Medical Division was staffed with dedicated sales, marketing and technical personnel. Many of the sales and technical staff were health care professionals who had left the hospital system to work at 3M. Their highly specialized health care knowledge helped them gain credibility with customer user groups. Medical Division sales to Canadian hospitals were approximately $9 million per month, or 65 per cent of the Medical Division’s revenue, while the remainder went to the out of hospital market. Sales to hospitals were channeled through specialized distributors called value-added resellers (VARs). There were five VARs distributing 3M health care products to approximately 350 hospital customers in Canada. Only approximately 5 per cent of the Medical Division’s sales to hospitals were sold on a direct basis. The out-of-hospital market, which comprised approximately 5,000 organizations across the country, such as home care agencies, surgical centres, long-term care facilities, walk-in clinics and private physician offices, was serviced by both VARs and another distribution channel identified as the Professional Health Care Dealers (PHC). PHCs responded to the unique needs of the various sub-segments of the out-of- hospital market. 3M Canada Medical Division sales representatives spent almost all their efforts working with the hospital customers. The company’s sales strategy was to offer premium products with innovative features that improved the health and healing processes of the patients. The sales representatives and regional managers worked with clinicians and educated nurses and doctors of the superior benefits of 3M products. Their efforts were tailored to the needs of the local RHA and health care delivery model. Clinicians would be encouraged to specify 3M products to hospital strategic sourcing committees when making contracting decisions. Hospitals were free to choose their channels to purchase 3M products. The hospitals could elect to buy their goods directly from 3M (for full case shipments only) or through one of the VARs. In either case, the unit price for products remained the same; only the terms and conditions were negotiable. VARs received an agency fee, which averaged 8 per cent, based on sales to hospital customers for performing value-added services such as storage, transportation, product handling, transaction and order processing, credit management, billing, returns and inventory management. By contractual agreement, VARs could also be required to provide special services, such as EDI (electronic data interchange) for order processing and sales tracings, to 3M. Some VARs serviced only certain parts of Canada, such as a province or region, while others operated nationally. 3M Canada was usually indifferent as to which VAR serviced its hospital customers since contracts were between 3M and the hospitals, and the VAR acted as an intermediary or agent (see Exhibit 3). VARs competed for the award of 3M hospital contracts by providing value-added services to the hospital. For example, some VARs offered small lot shipment quantities and just-in-time (JIT) deliveries. Scott estimated that one in four hospital deliveries from VARs were full case shipments. Some VARs also accommodated hospital requirements for specific delivery windows that supported JIT delivery arrangements. Many VARs had invested in information systems that supported the billing preferences of the customers. Fo
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3M CANADA COMPANY LOGISTICS NETWORK Like all 3M Canada businesses, the Health Care Group drew its logistical support from the company’s shared services organization. Products were manufactured globally, and Canadian materials management staff ordered products that were shipped to 3M’s distribution centre (DC) in Milton, Ontario (approximately 50 kilometers west of Toronto) from 3M’s Forest City, Iowa DC. Approximately 7.5 per cent of the Milton DC capacity was dedicated to Medical Division products. A third party logistics company operated the Milton DC, which had monthly facility costs of approximately $250,000. The DC handled only full case shipments and current volumes for the Medical Division were approximately 76,000 cases per month. The associated monthly picking costs were approximately $12,000. The company targeted inventory turns of 12 times in all of its distribution centres, and the Milton DC maintained an average inventory level of approximately $5.5 million in Medical Division products. The distribution centre manager indicated to Scott that moving to subcarton picking to support direct distribution would require significant changes to the warehouse configuration and picking processes, which would be much more labour-intensive. He indicated that picking costs would increase by approximately tenfold under direct distribution. 3M Canada had a centralized materials management and customer service team based in London, Ontario. A team of customer service staff managed all orders that were received from 3M customers, including the Medical Division. The orders placed for the Medical Division differed from much of the other health care group orders in that orders were primarily received from the large VAR customers. Scott estimated that, of the approximately 500 orders 3M currently received each month, more than 80 per cent were electronic orders and the balance were manual orders. Moving to a direct-distribution model would result in a significant increase in the number of Medical Division orders processed each month and the percentage of manual orders was expected to increase dramatically because many hospitals did not have systems to support electronic orders. Scott estimated that the customer service team would need to add additional staff and resources to handle the increased workload at a total cost of approximately $550,000 per year. THE DIRECT-DISTRIBUTION ALTERNATIVE Matt Pepe expected Scott to evaluate the existing method of distribution for the Medical Division and to make appropriate recommendations. As part of this assignment, Scott decided to interview several directors of strategic sourcing at 3M’s largest hospital customers. These interviews indicated a strong perception that major cost savings could be achieved in the supply chain if hospitals bought product directly from 3M as opposed to using VARs. As part of initiatives to restructure provincial health care supply chain organizations, most hospitals were members of regional supply chain service organizations, such as HSSBC and Health Care Materials Management, located in London, Ontario. These organizations, although not a substitute for the VARs, provided some of the logistical services offered by the VARs, such as consolidation, inventory management, replenishment and small lot shipments. Contracts with VARs compensated hospitals for services by regional supply chain service organizations through reductions in the agency fee. Scott also investigated how direct distribution would affect supply chain costs in the areas of warehouse handling and transportation. Exhibit 4 summarizes the warehouse handling costs incurred by 3M Canada under the existing distribution model. Based on conversations with the manager of the Milton DC, Scott Fo
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expected that these costs would triple under direct distribution. He also estimated that inventories at the Milton DC would need to be increased by approximately 25 per cent to support a direct-distribution model. Working with the transportation manager, Scott had also been able to collect information from the VARs concerning their transportation costs. Exhibit 5 provides estimates of the additional transportation volumes and costs from the 3M Milton DC to hospital customers under direct distribution. PREPARING FOR THE MEETING WITH MATT PEPE Although direct distribution had several advantages, Scott was concerned about the ability of 3M to transition from a distribution network that relied on VARs to a direct-distribution model. If 3M Medical Division adopted the direct-distribution model, it would pull away from the existing distribution model that was used by most other 3M Canada businesses. As part of his report to Matt, Scott would have to identify the specific changes that 3M would have to make to its supply chain organization and the accompanying changes in areas such as sales and marketing, finance and accounting, sourcing and logistics. Scott identified five areas that he believed would have to be addressed in his assessment of direct distribution with respect to logistics: storage, fulfillment, customer service, transportation and warehouse handling. However, Scott was also acutely aware of perceptions by some customers of the existing distribution model. The Medical Division had recently participated in a benchmarking project managed by a third-party consulting firm. As part of the benchmarking process, the consultants collected data from hospital managers, including representatives from purchasing, finance and clinicians, in seven areas that included business relationship and support, manufacturer personnel, products, business education and support, contract administration, logistics and supply chain management, and customer service and support. Overall, the Medical Division ranked very high among the 15 health care companies that participated in the benchmarking project. However, its poorest rating was in the area of logistics and supply chain management, and each of the companies that ranked above the Medical Division in the benchmarking report used a direct distribution model. As Scott looked at his calendar and recognized that he had only three weeks to complete his analysis and develop recommendations for his meeting with Matt, he wondered what value the VARs provided to the hospitals, and whether the current distribution model provided the best value to the Medical Division and its customers. While 3M Canada was responsible for the entire product and pricing support, VARs were paid a commission in the form of an agency fee. Several VARs claimed there was not enough profit to support the services they provided. Other major competitors in Canada, such as Johnson & Johnson, maintained a direct distribution supply chain model, and Scott felt he should carefully evaluate the opportunities associated with such a system. He felt the direct-distribution model would be considered if variable expenses were less than the prevailing agency fee. Meanwhile, the staff in the 3M Canada logistics group warned Scott of major challenges that would be presented by changing to a direct distribution model. Scott wanted to make sure he had considered all possible ramifications and cost implications as part of his report to Matt.
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EXHIBIT 1: SHIFTING SHARES OF HEALTH CARE SPENDING IN CANADA 1975 – 2014
Source: Canadian Institute for Health Information, National Health Expenditure Trends, 1975 to 2014, CIHI October 2014, www.cihi.ca.
0%
5%
10%
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20%
25%
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19 75
19 77
19 79
19 81
19 83
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19 99
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Other
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Drugs
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EXHIBIT 2: 3M HEALTH CARE — SELECTED PRODUCT LINES
Dental • Adhesives • Cements • Composites • Curing Lights • Digital Materials and Equipment • Finishing and Polishing
• Glass Ionomer and Liner • Implants • Impression Materials and Equipment • Infection Control • Preventative Care • Provisional/Temporizing • Teeth Whitening
Infection Prevention • Diagnostics • Fabric Drapes • Hand Antiseptic • Hygiene Monitoring • Immobilization • Incise Drapes
• Masks and Respirators • Patient Monitoring • Skin Preparation • Staplers • Sterilization • Surgical Hair Removal • Surgical Scrub
Health Information Systems • Coding and Reimbursement • ICD-10 Solutions and Services • Medical Records Abstracting • Patient Care Planning • Classification and Grouping
• Clinical Documentation Improvement • Coding and Billing compliance • Consulting Services • Health Data Interoperability • Medical Dictation and Transcription
Medical Devices • In Vitro Diagnostic Components • Optical Laboratory Consumables
• Stick to Skin
Skin and Wound Care • Cleaners • Compression Systems • Dressings • Foam Padding • Hydrogel
• I.V. Site Dressings • Medical Tape • Moisture Barriers, Creams and Lotions • Self-Adherent Wraps • Skin Closures
Veterinary and Animal Care • Casting and Splinting • Diagnostic Imaging • Sterilization Assurance
• Stethoscopes and Accessories • Surgical Products • Wound Management
Source: http://solutions.3mcanada.ca/wps/portal/3M/en_CA/Products/ProdServ/Dir/HealthCare/, accessed August 12, 2014.
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EXHIBIT 3: 3M MEDICAL MARKET DISTRIBUTION STRATEGY
Acute Care/Institutional Markets 3M will conduct its business as required to meet customer expectations including the negotiations for pricing of products and terms. However, we will allow our customers alternatives to how the product is purchased, inventoried, delivered. Customers may select to receive goods directly from 3M or from a select list of value-added resellers. 3M encourages its customers to select a prime distributor to enable a tripartite optimization of the supply chain.
Non-acute Markets 3M will always allow its customers a choice of distributor but will endeavor to leave the setting of prices to the needs of the market and channel that delivers the product.
Intent 3M will seek other ways to control our brands, markets and relationships with customers without becoming a logistics company.
Source: Company records.
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EXHIBIT 4: MONTHLY WAREHOUSE HANDLING COSTS UNDER CURRENT MODEL
Receipts $ 3,732 Put away $ 2,343 Let down $ 919 Movement $ 340 Legislative labeling $ 28 Serial number $ 48 Lot number $ 19,664 Bill 101 relabel $ 41
Source: Company records.
EXHIBIT 5: ESTIMATED TRANSPORTATION COSTS — DIRECT DISTRIBUTION MODEL
Average transportation rate ($)*
Estimated number of shipments per year
Alberta 60.17 3,676 British Columbia 69.76 3,621
Manitoba 41.52 1,372 New Brunswick 58.51 1,097 Newfoundland 64.69 933
Nova Scotia 50.86 1,262 Northwest Territories 91.31 55
Ontario 26.76 33,302 Prince Edward Island 15.84 165
Quebec 31.64 8,559 Saskatchewan 26.61 768
Yukon Territory 114.68 55 * Transportation costs based on three-day standard ground transportation, except Ontario and Quebec — next-day
service and adjusted for typical shipment size (weight and volume). Source: Company records.
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12.
9B16C015
BOEING: THE CASE FOR SUPPLIER DIVERSITY Laurin Hodge wrote this case under the supervision of Professor Karen L. Proudford 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 © 2016, Richard Ivey School of Business Foundation Version: 2016-05-24
In 2013, Joan Robinson-Berry, vice-president of the Shared Services Group (SSG) Supplier Management organization for The Boeing Company (Boeing), sat at her desk, thinking about a recent interaction, during which the importance of supplier diversity had been questioned. Robinson-Berry asked herself, “Will there ever come a day when these questions are no longer asked?” More importantly, she wondered, “Did I respond appropriately?” The question regarding the importance of supplier diversity had come up during her presentation at an annual gathering of more than 300 members of Boeing’s SSG. Robinson-Berry had been leading a discussion about the year’s priorities when one of the buyers stood up and posed both a comment and a question: “We’re operating now in an environment where we have to do more for less. We have all of these targets we have to meet and yet our customers are driving us to do more. Can we still try to meet these cost reductions and use these diverse suppliers?” Robinson-Berry knew it was an important question, one that many buyers had considered but few would have had the courage to ask. At the same time, she struggled to understand a perspective that compartmentalized diversity from supply chain. She clearly saw the link between the two aspects of the business, and diversity was an integral part of Boeing’s corporate responsibility initiatives.1 Furthermore, supplier diversity was in alignment with real business priorities focused on accelerating productivity, reducing the cost structure, growing aggressively internationally, and executing flawlessly to satisfy customers.2 For example, Robinson-Berry knew that not one small or diverse business was on Boeing’s “no-fly” suppliers list — the group of suppliers that charged excessive margins, were non-responsive in terms of quality, and were not adept at managing risk. By contrast, Boeing had large-scale suppliers on the list. Even large, established businesses presented risks to Boeing, but few people outside the supply chain management organization recognized this.
1 Boeing, “Our Principles,” Boeing, accessed March 20, 2016, www.boeing.com/principles/. 2 Joan Robinson-Berry, “Shaping Our Success — Creating a Shared Vision,” presentation (Boeing, June 11, 2011).
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Page 2 9B16C015 BACKGROUND Joan Robinson-Berry was one of four functional leaders who shared responsibility for the company’s entire portfolio of supplier partners. She led the overall strategy, contracting, daily management, and development of the non-production goods and services supply chain for Boeing. Her role included developing, maintaining, and improving relationships between Boeing, the U.S. federal government, and small business subcontractors. Her task was to build bridges with partners in order to meet the ever-changing demands of the aerospace industry. Robinson-Berry was well positioned for this task: she held degrees in engineering, math, and business. In addition, as an African American woman, she had an understanding of the ways in which diversity influenced key areas, such as supplier diversity. It was no surprise then that Boeing, under Robinson-Berry’s guidance, was a national leader in supplier diversity. From Robinson-Berry’s informed perspective, supplier diversity had saved the company a great deal of money. In her answer to the question posed during the meeting, she had cited an example: “Our office supplies were being handled by a majority vendor, but we ended up giving the business to a minority vendor. Not only did we realize a cost reduction but that vendor is also flexible and able to adapt quickly to changing demands. As a result, we’ve expanded their portfolio.” To emphasize that Boeing’s work on diversity in the supply chain was an enduring facet of its business, she had continued:
Not only is supplier diversity a competitive advantage for the company, it is the law when you’re working on Department of Defense projects. Even on commercial programs, supplier diversity is a business imperative because corporate customers want to see who we’re doing business with. . . . they are interested in our global footprint as well — the ways in which we tie strategic work placement when trying to open new markets.
THE AEROSPACE INDUSTRY The aerospace industry included a diverse arrangement of companies and public agencies involved in the research, design, manufacturing, operating, and/or maintenance of vehicles moving through space and air. Organizations such as the federally funded National Aeronautics and Space Administration (NASA), Lockheed Martin, Northrop Grumman, and Boeing formed some of the major pillars of the American aerospace industry. Within the aerospace industry, a landscape of challenges had been created by a labour shortage of workers prepared to fill highly technical jobs, aging employees, volatile changes in economic markets, flat or declining customer budgets, and increasing regulation. To mitigate risk and meet both domestic and international demand, a targeted business approach was required. Specifically, Robinson-Berry and her colleagues at Boeing were striving to fill a very clear commercial market need, projected over the next 20 years to have the revenue potential of US$5.2 trillion,3 with airlines needing 36,700 new airplanes.4 Where there was potential reward, there was also potential risk. Driving progress in aerospace meant working within a dynamic industry. Political and economic power was shifting as economies were recovering from financial crisis, and the rise of both competing and partnering countries, such as China and India, presented interesting opportunities to reshape the industry globally. 3 US$1 = CA$0.978 (average during week of June 6–June 12, 2011). All currency denominated amounts are in U.S. dollars unless otherwise specified. 4 Boeing, “Current Market Outlook, 2014–2033,” 3, accessed December 17, 2015, www.boeing.com/assets/pdf/commercial/ cmo/pdf/Boeing_Current_Market_Outlook_2014.pdf.
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Page 3 9B16C015 China planned to build over 305,000 kilometres of rail lines, 218,000 kilometres of expressways, and 60 airports within the next 20 years. Likewise, the Chinese populace had become the world’s largest online population; the United States was 15th per capita in broadband penetration. India and China produced 12 times more engineers at the undergraduate level than U.S. colleges and universities.5 The aerospace industry, which relied on access to partners, customers, and infrastructure (see Exhibit 1), needed to recalibrate according to the growth of emerging markets, shifting power, and great uncertainty. Worldwide, $1.7 trillion was spent on research and development (R&D), but, globally, R&D expenses were expected to grow only 3.5 per cent (2011), which could translate into $1.2 trillion in new revenues for firms prepared to capitalize on the opportunity. Yet, any aerospace firm needed to work at diversifying its strategy as a means to remain competitive, especially given that China had overtaken Japan (and now trailed only the United States) in spending on R&D.6 THE BOEING COMPANY Boeing, the world’s largest aerospace company, had established a strong business presence domestically and internationally since its inception in 1916. Boeing had supplied Model Cs7 to the U.S. Navy throughout World War I, had manufactured B-17s and B-29 bombers for World War II, and had been a trusted supplier during both the Cold War and the Vietnam War. At the time of Robinson-Berry’s presentation, Boeing was aligning its four major units — Boeing Commercial Airplanes; Boeing Defense, Space, and Security; Boeing Engineering, Operations, and Technology; and Boeing Shared Services Group — to work as one unified organization in order to face the challenges and create opportunities in the aerospace industry. The motto of “One Boeing” spoke to a corporate initiative that emphasized technology development and market presence across its entire product line, competitive market pricing, and continuous attention to performance. With 21,000 suppliers around the world and a majority of its commercial airplane revenues coming from customers outside of the United States, Boeing was truly a global company. Realizing the company’s goal of mutual growth and prosperity required the meticulous management of manufacturing, service, and technology partnerships and the dedication of nearly 168,000 employees in more than 65 countries. Notwithstanding Boeing’s established positioning in the aerospace industry, strategic investments continued to be required to secure future leadership. The company’s supplier spend was approximately $60 billion, with an estimated $2 billion committed to more than 2,000 small and/or diverse businesses. This commitment to diversity in sourcing and partnerships was the result of Boeing’s leadership, including the dedicated efforts of Robinson-Berry. She constantly defined and redefined the supply chain architecture to maintain a focus on the global environment, while ensuring American businesses were afforded the opportunity to participate in domestic sourcing.
5 Vivek Wadhwa, Gary Gereffi, Ben Rissing, and Ryan Ong, “Where the Engineers Are,” Issues in Science and Technology 23, no. 3 (Spring 2007), accessed May 16, 2016, http://issues.org/23-3/wadhwa/. 6 Adapted from Robinson-Berry, op. cit. 7 The Boeing Model C was a fixed-wing aircraft, also called a seaplane or hydroplane. The Model C, which could take off and land on water, was the company’s first commercial and financial success.
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Page 4 9B16C015 BOEING’S SUPPLY CHAIN MANAGEMENT STRATEGY The practice of supply chain management had evolved over five decades. In the mid-1960s, American companies began “slicing up their supply chains in search of low-cost and capable suppliers offshore,” and during this time it became common practice to have “twin plants for production-sharing”; during the 1970s and 1980s, the American economy shifted from “‘producer-driven’ supply chains to ‘buyer-driven’ chains. The geography of these chains expanded from regional production-sharing arrangements to full-fledged global supply chains, with a growing emphasis on East Asia.”8 As the global economy continued to expand, multinational corporations and small businesses alike began building international relationships for finished goods, services, and R&D.9 The original shifts to global supply chains were often made for economic impact and as competitive differentiators. Using specialized supplier selection, development, and evaluation processes to properly manage internal and external chains, many corporations found greater potential for lean enterprises.10 While the need for greater integration required new and perhaps greater effort, the benefit was increased operational and financial performance. As Boeing considered the aerospace landscape of global strategic sourcing, Robinson-Berry was tasked with finding the right balance of efficiency, responsiveness, and reliability to lead her team toward meeting its defined corporate goals and 2016 vision. The theory behind her work was that “efficiency, responsiveness and reliability of supply chains are seen as key drivers of a firm’s profitability. . . . Hence their supply chains must perform according to four competitive priorities: speed, cost, quality and flexibility.”11 Accordingly, Boeing’s supply chain strategy was built on these principles: Supply chain and supplier strategies leveraged the buying power of Boeing, ensuring industry-best
costs, prices, operational performance, and access to key technologies and markets. Suppliers, as a condition of participation, needed to provide consistent superior performance across
Boeing and visibility into their extended supply chain’s capabilities and performance. An enterprise’s past performance was a key criterion in future source selections.
Competition would be used wherever possible, driving relative supplier margins to reflect risk and commercial value.
These principles drove a strategy that recognized the importance of interdependencies, skilled negotiation, and a thorough assessment of risk (see Exhibit 2). CORE ISSUES AND KEY OBSTACLES As multinationals grew, diverse supply chain opportunities flourished and new obstacles arose. The dynamic nature of partnerships, markets, and infrastructure undoubtedly created new challenges with greater reliance on suppliers.
8 Gary Gereffi and Joonkoo Lee, “Why the World Suddenly Cares About Global Supply Chains,” Journal of Supply Chain Management 48, no. 3 (2012): 25. 9 Ibid. 10 Gwendolyn Whitfield and Robert Landeros, “Supplier Diversity Effectiveness: Does Organizational Culture Really Matter?,” Journal of Supply Chain Management 42, no. 4 (2006): 16–28. 11 Bertie M. Greer and Peter Theuri, “Linking Supply Chain Management Superiority to Multifaceted Firm Financial Performance,” Journal of Supply Chain Management 48, no. 2 (2012): 99.
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Page 5 9B16C015 While organizations with strong supply chains outperformed their competitors, there were key obstacles that had to be managed if firms were to realize improvements in earnings per share, return on assets, and profit margins. One such obstacle was the recurring question of sustainability. Where could Boeing continue to find new frontiers in purchasing and supply management? Western firms were increasingly looking to source materials from emerging markets, yet “to avoid the risk of reputational damage to the buying company, [firms] must ensure that their international suppliers comply with their corporate codes of conduct and that environmental and social misconduct at supplier premises does not occur.”12 As supply chains became more complex, Boeing and its competitors reassessed the level of risk in the global environment, which included the need for system-level security to protect information and communication networks, the potential for significant failures in infrastructure, the need to address the high level of reliance on oil, and the inconsistent regulatory and legislative priorities around the world. The scale of these challenges required collaboration and a coordinated response from businesses and governments worldwide.13 Learning to “do more with less” provided new layers of uncertainty, giving greater rise to pre-emptive planning. Yet, how should companies plan for the future? One common idea was for multinationals such as Boeing to employ “strategies [that] help companies to proactively address the critical vulnerabilities that expose the organisation to risks that exceed its tolerance.”14 Resilience in the business model extended to areas of risk tolerance, corporate responsibility, socio-political influences, and technological infrastructure. For some firms, voluntary codes of conduct were one option for ensuring that suppliers — especially those that might work outside of the United States and have different norms for conducting business — were complying with corporate standards. In addition, as new standards evolved, there was often a short lead time. Internal compliance officers could be helpful in ensuring that changes were implemented rapidly across the entire supply chain. Corporate responsibility produced a stronger reliance on identifying suppliers who were “green” and socially compatible.15 Boeing’s commitment to providing a fuel-efficient family of airplanes and services to customers was the centrepiece of its environmental strategy.16 Accordingly, innovative solutions for reaching this goal extended to sourcing. New contracting provisions placed a greater emphasis on the impact on environmental ecosystems, and Boeing began to conduct regular environmental performance assessments of key suppliers, site visits, and Lean+ supplier sessions focused on improvements to the triple bottom line.17 Politically, Boeing’s supply chain needed to quickly adapt to the evolving industry governance impacting various stages of the supply chain.18 Conducting business within the aerospace industry required the ability to incorporate new standards into sourcing and supplier management processes so Boeing remained legally and socially responsible. This enormous challenge was based on “the frequent changes in the plethora of environmental and social standards issued by regulatory bodies and nongovernmental organizations
12 Carsten Reuter, Kai Foerstl, Evi Hartman, and Constantin Blome, “Sustainable Global Supplier Management: The Role of Dynamic Capabilities in Achieving Competitive Advantage,” Journal of Supply Chain Management 46, no. 2 (2010): 45–63. 13 Jonathan Wright and Daniella Datskovska, “New Perspectives on Global Risk,” Logistics Management 51, no. 5 (2012): 42–44. 14 Deloitte, Supply Chain & Operations: Leveraging the Backbone of Your Business as a Source of Competitive Advantage, 11, accessed April 11, 2016, www2.deloitte.com/content/dam/Deloitte/be/Documents/Operations/201411_SupplyChainOperations_2014.pdf. 15 Reuter et al., op. cit. 16 Boeing, 2014 Environment Report: Build a Better Planet, December 17, 2015, www.boeing.com/aboutus/environment/ environment_report_14/index.html. 17 Lean+ was a Boeing initiative aimed at eliminating inefficiencies in order to boost performance in key areas across the company. See Jennifer Cram, “The Power of Lean+: How Process Improvements Also Create Better Environmental and Workplace Safety Performance,” Boeing Frontiers (September 2009) accessed April 9, 2016, www.boeing.com/news/frontiers/archive/2009/september/ts_sf01.pdf. 18 Gereffi and Lee, op. cit.
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Page 6 9B16C015 (NGOs) [which caused] dynamic swings of stakeholder interests and continuous alterations in the type of pressure exerted. . . .”19 As if navigating these key obstacles was not challenging enough, Boeing could never lose sight of the technical aspect of conducting business in the modern environment. Domestic partnerships provided a common understanding of infrastructure, while conducting business in emerging markets often led to challenges with technology. As a competitive differentiator, Boeing had to acknowledge that
To participate in just-in-time and fragmented international supply chains, firms must be able to communicate and engage in cross-border financial transactions with supply-chain partners in a timely manner, usually via the Internet. Therefore, information and communications technology (ICT) networks and globally linked financial institutions are integral to today’s trade-facilitation research and policy analysis.20
Robinson-Berry and her team identified six cautionary tension points as a means to address the core issues of managing Boeing’s complex supply chain (see Exhibit 3). Boeing’s Supplier Diversity Strategy The Boeing supplier diversity strategy existed within a market and company context that shaped its success. The company’s global footprint was extensive: Europe: 450 suppliers; $5 billion India, Middle East, and Africa: 50 suppliers; $200 million North Asia: 90 suppliers; $5.7 billion Southeast Asia and Australia: 925 suppliers; $290 million North America (Non-U.S.):21 625 suppliers; $1.8 billion Historically, Boeing had relied on three focus areas in building this footprint: major initiatives procurement, implementation of supply chain strategy, and concentrated focus on distribution networks/logistics management. For the future, Boeing needed to address internal and external constraints (see Exhibit 4). As a result, the company took a more nuanced approach to its current focus. The most successful multinational firms had innovative supplier diversity programs and a world-class supply base that reflected their customer base. With a vision of an integrated team utilizing small and diverse suppliers providing innovative products, services, and solutions enriching the value chain, customers, and communities, Robinson-Berry and her team were working to maximize potential for all partners. While it might be easier professionally to work with the same trusted suppliers, Boeing acknowledged the intrinsic value of diversity (see Exhibit 5). The supply chain architecture was built on a corporate belief in the value of a vibrant, small, and diverse supplier community. Boeing’s diversity efforts were measured against five benchmarks: the identification and development of opportunities for each of the unique small business communities; assisting small businesses in becoming high-performance suppliers; educating and training the Boeing community about the benefits of diversity; participating in community outreach activities to generate the appropriate leads; 19 Reuter et al., op. cit., 46. 20 Catherine Mann, “Supply Chain Logistics, Trade Facilitation and International Trade: A Macroeconomic Policy View,” Journal of Supply Chain Management 48, no. 3 (2012): 8. 21 Non-U.S. North America referred to Canada and Mexico.
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Page 7 9B16C015 and supporting the mentor/protégé program because, through mentoring, resources and ideas were shared that strengthened the value chain, ensuring a pipeline for the future (see Exhibit 6). Domestically, successful firms understood that it was vital to develop inroads into communities that had limited representation. The business world realized the momentum of diversity, as minority-owned businesses became a fast-growing segment of the U.S. economy, growing from less than 7 per cent to 15 per cent in five years. In fact, 4 million minority-owned businesses in the United States generated $637 billion in sales revenue and employed 4.5 million people. When it came to sourcing for global supply chains, the changing demographics sparked specific supplier diversity initiatives because partnering with a diverse supply base provided access to new markets and innovative ideas — and with the growing number of minority- and women-owned businesses, it made “good business sense.”22 Boeing, like many multinational organizations, identified the need to adopt and implement diversity initiatives that were integrated throughout the organization. As a result, Boeing’s focus areas (see Exhibit 6) aligned with the ultimate aim of working with small businesses as a competitive differentiator. This integrated commitment to maintaining a diverse supply chain domestically positioned Boeing as an industry leader, with a spending level of more than $3.5 billion with Money Management Minority Business Enterprises and insurance agencies. Additionally, $89 million was committed to relevant U.S. non-profit organizations, with employees contributing $51 million to the Employee Community Fund. Although those recognitions were important, the true measure of an impactful supplier diversity program was the long-standing success of its supplier partners. Many former small businesses that had partnered with Boeing became large businesses. Of the 11 businesses designated by Boeing as “Suppliers of the Year” in 2006, five were small businesses. Boeing had also been inducted into the Billion Dollar Roundtable as a result of its $2 billion spend with Minority and Women Business Enterprises. Robinson-Berry was responsible for Boeing’s relationships with the U.S. federal government and small business subcontractors. She knew that many Boeing employees might still question whether the company’s diversity goals were in conflict with its business priorities. However, she did not understand compartmentalizing diversity from the supply chain. The connection to cost reduction was very clear to her. Obviously, supplier diversity fit with Boeing’s corporate responsibility initiatives, but it also supported real business priorities. No small or diverse businesses appeared among those suppliers who were damaging Boeing with excessive margins, poor quality, and bad risk management. By contrast, Boeing needed to pull product from a major avionics supplier because the company could not meet its requirements. The risks of working with large suppliers were not often recognized outside the supply chain management organization. Robinson-Berry knew that supplier diversity had reduced costs for the company. In one case, Boeing had saved money by shifting office supplies from a majority vendor to a more flexible minority vendor. Furthermore, supplier diversity was required to deal with the Department of Defense, and served as an advantage with corporate customers. THE ROAD AHEAD Boeing was committed to redefining its supply chain architecture in order to focus on the global environment, and to growing its international business. There were great opportunities for what authors
22 Whitfield and Landeros, op. cit., 17.
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Page 8 9B16C015 Bertie M. Greer and Peter Theuri called “strategic improvements” that happened “upstream and/or downstream as products, services, capital, and information [flowed] through the supply chain.”23 Indeed, intensified competition and increasingly demanding customers would require integrated services and advanced capabilities. The corporate advantage of creating links between purchasing and Boeing’s long-term objectives was undeniable, as the potential gain in market size ranged into trillions of dollars. Robinson-Berry could not afford to lose sight of the risks that were fundamental to outsourcing vital components of the organization’s business. The reputational risk for Boeing was significant; risk management and change management needed to be built into her supply chain design. Collaboration would be essential on the road ahead. Robinson-Berry had been effective at building alliances with the next generation of small and diverse businesses. She and her team viewed “commitment, communication and process integration (coordinating activities that relate to supplier diversity across functional areas) as key elements to supplier diversity. Continued growth in the minority population in the coming years will likely keep practitioner interest in supplier diversity high.”24 The diversity imperative ran parallel with Robinson-Berry’s business priority — to make Boeing competitive by providing effective services at an affordable cost (see Exhibit 7). Robinson-Berry once again thought about the question posed during her presentation, remembering how difficult it had been to capture all she had learned about supply chain and diversity in one brief answer.
23 Greer and Theuri, op. cit., 98. 24 Whitfield and Landeros, op. cit., 19.
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Page 9 9B16C015
EXHIBIT 1: SUSTAINING COMPETITIVE ADVANTAGE THROUGH PREFERRED PARTNERSHIPS
Source: Adapted from Joan Robinson-Berry, “Shaping Our Success — Creating a Shared Vision,” presentation (Boeing, June 11, 2011).
EXHIBIT 2: BOEING’S SUPPLIER MANAGEMENT STRATEGY
• Beginning with the market, value proposition, and control points. • Architecting the supply chain and sourcing strategy early. • Competing and preserving options to compete. • Negotiating from the levels position first — team later. • Understanding interdependencies in the supply chain. • Establishing clear, complete, and accurate requirements the first time and every time thereafter. • Managing the four corners of the contract: terms, price, risk, requirements. • Remembering suppliers did not get a better deal than the corporation could get from their customers.
Source: Adapted from Joan Robinson-Berry, “Shaping Our Success — Creating a Shared Vision,” presentation (Boeing, June 11, 2011).
Customers Access to the global market
Infrastructure Access to process and
tools
Partners Access to global
capabilities
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Page 10 9B16C015
EXHIBIT 3: INTERNAL AND EXTERNAL TENSIONS
Source: Adapted from Joan Robinson-Berry, “Supply Chain Management and University Relations,” presentation (Tuskegee, AL: Tuskegee University, November 30, 2011).
EXHIBIT 4: INTERNAL AND EXTERNAL CONSTRAINTS ON BOEING
INTERNAL CONSTRAINTS Previous strategy focused on domestic market
Preparing a workforce to support international goals Getting culture of buyers motivated to work with non-U.S. suppliers
Creating international-friendly buy-to packages
EXTERNAL CONSTRAINTS Changes in Middle East market related to local labour requirements
Navigating various international markets where the supply base might be run by larger entities Shrinking U.S. Department of Defense budgets
Commercial versus Department of Defense markets Source: Adapted from Joan Robinson-Berry, “Shaping Our Success — Creating a Shared Vision,” presentation (Boeing, June 11, 2011).
Schedule pressure versus
requirements quality
Skip over supply chain architecture:
lose strategic control
Single/sole source versus open competitions
Teaming then negotating: de facto source solutions
Supplier oversight versus insight:
boarding parties, work arounds
Increasing Boeing's risk exposure due to poor contract terms, flow downs
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Page 11 9B16C015
EXHIBIT 5: WHY IS SUPPLIER DIVERSITY IMPORTANT TO BOEING?
New perspectives and ideas are generated by a diverse supply base Small businesses make up a substantial proportion of the overall domestic supply base Our suppliers may also be our customers; they are diverse in ethnicity and gender The purchasing power of minorities is expected to climb Investing in communities we serve can be a strategic advantage
Source: Adapted from Joan Robinson-Berry, “Rules+Risks+Rewards: The Changing Outlook for Aerospace and Defense Contracting,” presentation at the Aerospace+Defense Contract Management Conference (Garden Grove, CA: National Contract Management Association, July 26–27, 2007).
EXHIBIT 6: BOEING SUPPLIER DIVERSITY FOCUS AREAS
HBCU/MI & SBIR Mentor Protégé Supplier Development Technology Roadmap Historically Underutilized Business Zone Small Disadvantaged Business/Minority Business Enterprises Small and Diverse Business Inreach/Outreach Veteran-Owned Small Business/Service Disabled Veterans Women-Owned Businesses Affiliations and Boards AbilityOne
Note: HBCU/MI = Historically Black Colleges and Universities & Minority Institutions; SBIR = Small Business Innovative Research Source: Adapted from Joan Robinson-Berry, “Supply Chain Management and University Relations,” presentation (Tuskegee, AL: Tuskegee University, November 30, 2011).
EXHIBIT 7: EXECUTIVE COMMITMENT TO SUPPLIER DIVERSITY
Involve small and diverse suppliers up front in the acquisition process Manage our supplier base to ensure a sufficient mix of diverse suppliers are qualified to achieve our goals Identify strategic opportunities where affordability can be improved through company leveraging contracts with small and diverse suppliers Develop and enhance the capabilities of high-performing small and diverse suppliers through mentoring relationships
Source: Adapted from Joan Robinson-Berry, “Rules+Risks+Rewards: The Changing Outlook for Aerospace and Defense Contracting,” presentation at the Aerospace+Defense Contract Management Conference (Garden Grove, CA: National Contract Management Association, July 26–27, 2007).
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13.
9B17M092
AMAZON GO: VENTURING INTO TRADITIONAL RETAIL1 Wiboon Kittilaksanawong and Aurélia Karp 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 © 2017, Richard Ivey School of Business Foundation Version: 2017-06-28
Amazon.com, Inc. (Amazon), one of the largest global online retailers, decided to enter the offline retail industry in December 2016 by launching its first Amazon Go store in Seattle, offering a technologically innovative way of shopping that allowed customers to make purchases without a cashier.2 The launch was the first time that Amazon really entered the traditional retail industry. Earlier, in May 2016, the company had entered food, diaper, and housekeeping product manufacturing with its Amazon Elements brand.3 Nevertheless, these products were only available online for American Prime Members. Founded in 1994 as an online bookstore, the company had become an e-commerce giant, leading digital sales of books and electronic products. It revolutionized the way consumers purchased products, while also becoming a trusted source of product information for potential buyers. However, the company was not profitable until 2001, while it was still experiencing some financial difficulties.4 As of the third quarter of 2016, it was the fourth most valuable public company in the United States.5 In 2015, it surpassed Wal-Mart Stores, Inc. (Walmart) as the most valuable online retail company in the United States. Could Amazon reproduce its online success in the traditional offline retail segment? Could its current competitive advantages be replicated in offline retailing? Did this diversification make sense, considering Amazon’s existing key resources and capabilities, the presence of established traditional retailers like Walmart, and the market trend that was increasingly moving toward online stores? HISTORY The Beginnings: 1994–1997 On July 5, 1994, Jeff Bezos, a 30-year-old engineer graduating from Princeton University, left his job as vice-president at D.E. Shaw & Co., a global investment firm based in New York, to create an online bookstore based in Seattle. He saw the future of selling products online and thus first sold books, videos, computer hardware and software, and compact discs. He chose to sell books because of the high worldwide demand, low price per piece, and high number of titles. His aim was to provide more varieties of books online than were available in a physical store. Amazon’s main competitors were Barnes & Noble Booksellers Inc., the largest retail bookseller, and other local booksellers in the United States. The company Fo
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Page 2 9B17M092 was named Amazon.com in the year after it was created. Through a partnership with Ingram Book Group LLC, Amazon could access books at wholesale prices and sell them online at cheaper prices than physical bookstores. Within its first two months, Amazon’s online sales covered more than 45 countries with sales revenue of US$20,0006 per week. In June 1997, it went public and entered the Nasdaq stock exchange at an initial price of $18 per share, raising $54 million. Global Expansion and Laborious Financial Results: 1998–2004 In 1998, Amazon began to expand internationally, first by entering the United Kingdom and Germany, and then moving to Europe and Asia, including France, Japan, and China. The company included different languages on its websites to serve these international markets. Bezos was not expecting to make any profits during the first four or five years of the business. Shareholders were not satisfied with the company because it was not profitable and not growing fast enough. However, this business model, with slow but efficient growth, saved Amazon from suffering too much from the 2001 dot-com bubble, and the company realized its first profits in 2001. Nevertheless, its profit was only $5 million from revenues of over $1 billion. Since 2001, the company had significantly diversified its products, from books to computers, electronics, clothes, and beauty products. Diversification, Early Steps in the Service Industry, and Own-Brand Products: 2005–2010 Amazon continued to extend its services through AmazonFresh, a grocery service, and Amazon Music, an online music store. The company increased its product offerings through the Fulfilment by Amazon program, where products were stored in Amazon’s fulfilment centres and then quickly picked, packed, and shipped to customers. It also created Amazon Prime to provide a two-day shipping service in the United States for only $79 a year. It launched Amazon Web Services Inc., which offered inexpensive, reliable, and scalable cloud computing services, including Amazon Mechanical Turk, a crowdsourcing Internet marketplace that enabled individuals and businesses to coordinate the use of human intelligence. This period also marked the beginning of Amazon’s own-brand products, including the 2007 launch of the Amazon Kindle, one of the very first e-books readers, three years before the launch of Apple Inc’s iBooks. Innovating and Diversifying at a Faster Pace: 2011–2017 The company kept innovating to improve its products and services. It launched Amazon Locker, a parcel delivery service that allowed buyers to pick up purchases at secure, self-service kiosks, and Amazon Prime Air, a cargo airline and drone-based delivery system. In February 2017, the company announced that it would invest $1.5 billion to build an air cargo hub to support the increasing size of its fleet.7 Amazon also entered new segments with its Kindle Fire and Fire HD, which competed with Apple’s iPad. Amazon acquired several companies, including GoodReads, an online social networking site for sharing books and reviews, and LoveFilm, a DVD-by-mail and streaming video-on-demand provider that competed with Netflix in Europe. It acquired Kiva Systems to develop robots that efficiently moved products in warehouses, thereby shortening delivery times. The company launched Amazon Video Direct to compete with YouTube,8 and it also developed and operated Amazon Video, an Internet video-on-demand service where customers could buy, rent, and instantly watch digital movies and TV shows. Amazon opened its first physical bookstore, Amazon Books, in Seattle, selling
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Page 3 9B17M092 products at the same prices as those available in the online stores. These strategic moves allowed Amazon to become a global online retail giant. By 2015, its market capitalization surpassed that of Walmart. AMAZON’S DEVELOPMENT Headquartered in Seattle, Amazon was one of the big four global digital companies: Google, Apple Inc., Facebook Inc., and Amazon. It had worldwide operations, with websites serving markets in 14 countries in North America, Europe, and Asia, and shipping services in 75 countries.9 Its business was expanding rapidly. The number of full-time and part-time Amazon employees increased 47 per cent in one year to reach 268,900 in 2016.10 This was 23 times more employees than its online competitor EBay and twice as many as Apple, but it was less than 12 per cent of the employees of its offline competitor Walmart. Amazon announced a plan to hire 100,000 full-time employees in the United States from January 2017 to mid-2018, potentially becoming one of the largest technology employers in the country.11 Amazon offered a wide range of products on its website, including books, apparel, and even food. As of February 2017, Amazon.com had 48 categories of products—both new and used—that were created and sold both by Amazon itself and by other companies. Most products were in the digital and multimedia sectors. The company had diversified a lot over the years but mainly within online businesses. The company’s revenues from online retail sales largely surpassed those of its competitors: in 2015, its online retail sales were 5.5 times greater than those of Walmart, making it the leader in the online retail market12 (see Exhibit 1). Amazon made $71.84 billion in online retail sales between November 2014 and November 2015. This was more than the combined online sales of Apple, Walmart, Sears, Roebuck & company, The Gap Inc., Costco Wholesale Coporation, Target Corporation, The Kohl’s Corporation, Best Buy Co., and The Home Depot Inc.13 In the second quarter of 2016, Amazon hit a record profit for the third straight quarter—$857 million ($1.78 per share) on revenue of $30.4 billion.14 This record far surpassed analysts’ estimates of profits per share of $1.11 and revenues of $29.5 billion. In 2016, its online retail sales accounted for half of all online retail sales in the United States.15 According to Amazon’s chief financial officer, Brian Olsavsky, these positive financial figures were a result of “working very hard on efficiency” and “benefits of operating at scale.”16 For years, as Amazon’s online retail sales and profits increased continually, the company kept on investing in research and development (R&D) to improve its offers and to develop new market sectors. In 2016, Amazon decided to enter food and consumable goods manufacturing through Amazon Elements, available only online for American Prime Members, and offline retailing through Amazon Go in Seattle, the first brick-and-mortar convenience food store that employed mobile e-commerce, machine learning, and computer vision to allow customers to make purchases without a cashier.17 However, Amazon’s performance in the third quarter of 2016, especially in terms of profits, was lower than expected, and this caused its stock price to decrease by 7 per cent. While its revenues were as expected, at $32.7 billion, its profits were $252 million, which was much lower than in the second quarter.18 Earnings per share were only $0.52—below the estimated $0.78. Still, as of the third quarter of 2016, Amazon was the fourth most valuable public company in the United States. This poorer performance resulted largely from increased investments in improving existing offers and developing new offers. Such investments were expected to increase as Amazon entered offline retail segments, which required at least buying physical stores. As Olsavsky said, “We are in a period of advancing up our investments in the second half of 2016, even more so than in prior years.”19 In May 2016, Fo
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Page 4 9B17M092 to raise more capital, Bezos sold over one million of his shares—the largest amount he had ever made—for $671 million. In August 2016, he sold another record one million shares for $756.7 million, reducing his shares in Amazon to 16.9 per cent (see Exhibit 2). AMAZON’S COMPETITIVE ADVANTAGES Amazon’s success was not only due to its first-mover advantage but also came from a combination of competitive advantages related to marketing, supply chain, innovation, and customer-centricity. Brand Awareness and Innovative Marketing Amazon’s marketing strategy relied on its strong brand awareness. As Bezos said, “Brand names are more important online than they are in the physical world.”20 In another interview, he noted the importance of communicating the story of Amazon’s brand: “You can have the best technology, you can have the best business model, but if the storytelling isn’t amazing, it won’t matter . . . Nobody will watch.”21 The company implemented innovative marketing to receive free press coverage and to increase good customer perception of its products and services. Its community banana stands gave away about 4,500 free bananas daily to Seattle inhabitants to create more links with customers and improve its brand image. Since bananas were also the most popular item sold by Amazon’s rival, Walmart, some analysts thought this campaign could be seen as a way of attacking Walmart by showing that Amazon also sold good-quality fresh items.22 Amazon chose to advertise its first unexpected offline retail venture, Amazon Go, through video teasing, which successfully created a buzz among the general public. Amazon did not really need to spend a lot of money to advertise this brand-new offline offer, as media outlets were already talking about this innovative retail marketing approach. Amazon’s competitors also started to react to the resulting widespread public awareness by creating their own videos, which generated even more visibility for Amazon Go. In 2015, Amazon spent $2.8 billion on digital marketing, an increase of 40 per cent from the year before.23 The company also established partnerships with digital celebrities to promote its products.24 However, these marketing activities were not the only reason for Amazon’s success, and Amazon focused less on offline advertising than digital brands like Apple and Samsung. As Bezos said, “In the old world, you devoted 30 per cent of your time to building a great service and 70 per cent of your time to shouting about it. In the new world, that inverts.”25 Efficient Supply Chain Management to Create a Convenient Shopping Experience As an online retailer, Amazon revolutionized the way customers shopped for products through its efficient supply chain management, which made a wider range of products available and delivered those products faster than its competitors. The company’s global presence and available worldwide shipments allowed customers to easily buy almost anything from any country from Amazon. Unlike Walmart, Amazon did not need a physical shop; it just needed a warehouse to store products. It also had products delivered directly from the producer to the customer. Its fast delivery came from the strategic location of its warehouses, the high levels of available product inventory, its fast order management, and its partnerships with delivery companies. For example, in Japan, Amazon partnered with Yamato Holdings Co., Ltd., allowing buyers to receive products within a day of their orders.26 This very efficient delivery also came from its investments in robotics. F
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Page 5 9B17M092 From the beginning of its business, Amazon sold many products at highly competitive prices, usually cheaper than those of offline competitors. Bezos even said, “There are two kinds of companies, those that work to try to charge more and those that work to charge less. We will be the second.”27 This ability to reduce prices came from the high economies of scale Amazon could generate on some products because of their high turnover. Unlike offline retailers, Amazon did not pay expensive rent for physical shops but efficiently managed warehouses at strategic locations to maximize its inventory turnover. Its strategy to sell more at a low price meant the company’s margins were usually lower than those of competitors, and this was one reason why it was not profitable for many years. Customer-Centricity and Innovation Bezos’s strategy had always been to focus on customer needs. He said, “We’ve had three big ideas at Amazon that we’ve stuck with for 18 years, and they’re the reason we’re successful: Put the customer first. Invent. And be patient.”28 Since the beginning of online business, Amazon kept innovating to create the best possible user experience. The company emphasized the ease of use of its websites. It also reduced product delivery time, proposing even same-day deliveries in some cities. This customer-centric approach allowed the company to be more innovative. As Bezos said, “If you’re competitor-focused, you have to wait until there is a competitor doing something. Being customer-focused allows you to be more pioneering.”29 The company increased the number of products it offered over the years to satisfy customer needs, particularly through partnerships with prominent players such as retailer Toys “R” Us Inc. AMAZON’S PRIVATE LABELS AND OFFLINE RETAIL OFFERS Amazon had already launched a bookstore in a university in Seattle, which offered over 6,000 book titles, and it planned to open a second one in San Diego. Although Amazon did not have much experience in the traditional manufacturing and retail business, it decided in 2016 to enter grocery product manufacturing and brick-and-mortar food retailing. This decision went against the general trend of business models followed by many competitors, which were increasingly moving from offline physical stores to online stores. However, Bezos did not see this decision as a risk. Instead, he saw it as a normal evolution of business, and said, “What’s dangerous is not to evolve.”30 New Brands After developing many electronic devices under its own brand, Amazon decided to enter the higher-margin grocery and household goods sectors. In May 2016, the company announced the launch of three brands available for purchase online on its websites: Happy Belly (which offered grocery products including milk, coffee, cereals, and pasta), Wickedly Prime (which offered ready-to-eat prepared foods), and Mama Bear (which offered baby products including baby food, cleaning wipes, and diapers).31 Amazon thus not only sold grocery and household products online but also produced them through private labels, allowing the company to have potentially higher margins.32 On its websites, the company explained that this move was driven by its customer-centric capabilities. 33 According to Amazon, the product offerings would be improved based on the clients’ feedback. It wanted to create and promote brands that would be seen by customers as more trustworthy than others. While Amazon Elements products had been available only in the United States and only to Amazon Prime members, a small segment of Amazon’s entire customer base, Amazon contracted with multiple manufacturers to produce this new range of products. These manufacturers included TreeHouse Foods Inc., F
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Page 6 9B17M092 which was also manufacturing similar goods for other retailers. This development could be seen as an attempt by Amazon to catch up and compete even more with other retailers such as Walmart and Target, which had had their own product brands for years. Because Amazon’s brand awareness was so high, it could develop these new offers easily without having to spend millions of dollars on advertising and other marketing activities. Amazon could adapt its product offers to meet consumer demands by utilizing its enormous customer databases. However, as Amazon had not been a traditional retailer before, this strategic move might be seen as risky. Indeed, this was not the first time that Amazon had tried to produce baby products. In 2014, the company had launched its own diapers on its websites, but removed them from Amazon.com only few weeks after the launch due to manufacturing defects and negative customer feedback.34 Nevertheless, Bezos was not the kind to give up easily after one failure. He said, “If you’re not stubborn, you’ll give up on experiments too soon. And if you’re not flexible, you’ll pound your head against the wall and you won’t see a different solution to a problem you’re trying to solve.”35 These new Amazon-branded products could also create tensions with suppliers who were currently presenting their products on Amazon.com, potentially putting Amazon in an even tougher position to negotiate with them.36 Should Amazon’s own brands be showcased on its websites while the company aimed to be a leader in the sale of its own-brand products? Should these own-brand products be marketed the same way as products available from other suppliers? Was the launch of its own-brand products considered unfair competition? Amazon Go Amazon’s business model was designed under the assumption that retail businesses were all growing and moving toward the online environment. However, with Amazon Go, the company clearly revised its business model to combine online and offline retailing. The company opened its first brick-and-mortar food store on December 5, 2016, near its headquarters in Seattle. It announced this new initiative only by posting a video about the Amazon Go concept that day.37 Immediately after the post, media outlets around the world wrote about it. The store was accessible only to the company’s employees for beta testing, while a public opening was planned for early 2017. It seemed that Amazon might be planning to extend Amazon Go to the United Kingdom. According to the Guardian, the company had registered a British trademark for the store concept in December 2016, on the same day it opened the Seattle store.38 The company refused to comment to the newspaper about this potential U.K. expansion. However, such an expansion would not be surprising given that the company had often before used the United Kingdom as its first non-U.S. market to test new offers. These strategic moves implied that Amazon might be thinking of developing the Amazon Go concept globally. The Amazon Go store, which sold staple foods, was 1,800 square feet (over 160 square metres) in area. Its uniqueness was its fast and convenient electronic payment system. Customers just entered the store, picked up the products they wanted, and left the store without having to queue to process payments.39 When customers took products from the store, sensors would concurrently transmit information about the purchases to its online processing system, which would debit the price of those products directly from the customers’ Amazon Prime accounts before the customers left the store.40 Amazon Go and Amazon.com had the same aim: to revolutionize the way people consumed in their everyday life and to offer the best possible customer experience. According to the company, this shopping technology was really not a new concept, as Amazon’s teams had already been working on it for four years.41 Fo
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Page 7 9B17M092 The automated grocery store raised significant concerns among Amazon’s employees due to the potential job cuts in Amazon stores. It was estimated that, through this technology, Amazon’s grocery stores might eliminate thousands of jobs in the long term.42 COMPETITION IN THE OFFLINE RETAIL MARKET Amazon Go and Amazon’s private labels, including Amazon Elements, targeted markets that were quite similar to those of its major grocery retail competitors, Walmart and Target. Over the years, Amazon had surpassed these large retailers in terms of online sales, but would the company be able to reproduce this online success in the offline markets? Though it might generate greater profit margins, the offline retail market was extremely competitive, requiring much larger investments. Importantly, Amazon had no solid experience in managing physical chain stores. Many competitors, particularly established grocery retailers, viewed such announcements with humour. Amazon was clearly a latecomer without sufficient knowledge of brick-and-mortar retail markets, while efficient delivery systems allowed more customers to shop for products online. Monoprix S.A., a major French retail chain located in key areas in city centres, made a parody of Amazon Go’s video, saying that Amazon should have better served its customers’ needs.43 This reaction was similar to the response to Amazon’s entrance into the online food market, in which it became a big player. By 2016, the Amazon Prime service had over 63 million users; these users could be potential users of Amazon Go and Amazon Elements as well.44 Amazon’s biggest competitor in the online retail market was Walmart, an American retailer operating in both offline and online markets through its own brick-and-mortar stores and websites. It was the largest offline retailer in the United States and the second online retailer after Amazon. Amazon and Walmart had been competing in the online market for years. Walmart had even sued Amazon in 1998 for hiring former Walmart executives and thus stealing its trade secrets.45 Doug McMillon, the president and chief executive officer of Walmart, commented that Walmart’s high number of stores gave it a competitive edge over purely online stores such as Amazon and that, by being in both offline and online markets, the company could do “quick last minute delivery that is free, cheaper, pushes cutoff shopping during holidays, and . . . brings people into stores.”46 The opening of Amazon Go stores and the development of Amazon’s own-brand grocery products could thus become a serious threat to Walmart. CONCLUSION The launch of Amazon Go and Amazon Elements, as well as other private labels, clearly demonstrated Amazon’s intention to move from being online only to becoming a mixed offline and online retail and manufacturing company. Amazon Go and Amazon Elements had several similarities: they were offline, were reserved only for Amazon Prime members, were in the grocery segment, and had the same competitors. These initiatives, which were seen as good opportunities for Amazon to generate higher profits, meanwhile put the company into a riskier position due to its lack of experience in traditional retailing. In online retail sales, Amazon’s performance had surpassed its mixed online and offline retail competitors over the years, demonstrating its strengths in marketing, supply chain, and customer-centricity in online segments. Could Amazon replicate the competitive advantage that contributed to its online success in the offline retail markets? Could the company leverage its existing online assets and capabilities in the offline segments? Given this diversification, how could Amazon manage the efficiency of its operations and the quality of its products in the long term? Did the company have capabilities to do so? Would Amazon Go change the way people bought and consumed as Amazon.com had done so successfully before? Would the company be
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Page 8 9B17M092 able to go against the trend of grocery shopping, which was increasingly moving toward online markets? Could the company develop these offline retail offers globally? Could competitors easily imitate this innovative shopping technology? Finally, given potential job cuts, would Amazon face resistance from store employees and unions?
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Page 9 9B17M092
EXHIBIT 1: DIGITAL SALES WORLDWIDE, BY RETAILER (IN $MILLIONS)
Amazon.com 71,844 Walmart 13,188 Apple 10,740 Macy’s 4,710 Home Depot 4,267 Best Buy 3,672 Costco 3,498 Nordstrom 2,620 Gap Inc. 2,505 Target 2,491 Williams-Sonoma 2,459 Kohl’s 2,282 Sears Holdings 2,084
Source: Phil Wahba, “This Chart Shows Just How Dominant Amazon Is,” Fortune, November 6, 2015, accessed April 16, 2017, http://fortune.com/2015/11/06/amazon-retailers-ecommerce/.
EXHIBIT 2: AMAZON’S YEAR END FINANCIAL RESULTS
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Revenues (million $) 14,835 19,166 24,509 34,204 48,077 61,093 74,452 88,988 107,006 135,987
Gross Margin (%) 22.6 22.3 22.6 22.3 22.4 24.8 27.2 29.5 33.0 35.1
Operating Income (million $)
655 842 1,129 1,406 862 676 745 178 2,233 4,186
Operating Margin (%) 4.4 4.4 4.6 4.1 1.8 1.1 1.0 0.2 2.1 3.1
Net Income (million $)
476 645 902 1,152 631 −39 274 -241 596 2,371
Earnings Per Share ($)
1.12 1.49 2.04 2.53 1.37 −0.09 0.59 −0.52 1.25 4.90
Source: “Amazon.com Inc. AMZN,” Morningstar, accessed April 16, 2017, http://financials.morningstar.com/ratios/r.html?t=AMZN.
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Page 10 9B17M092 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 Amazon.com, Inc. or any of its employees. 2 Andrew Melville, “Amazon Go Is about Payments, Not Grocery,” Forbes, January 20, 2017, accessed April 16, 2017, https://www.forbes.com/sites/groupthink/2017/01/20/amazon-go-is-about-payments-not-grocery/#41fd22df67e4. 3 Greg Bensinger, “Amazon to Expand Private-Label Offerings—From Food to Diapers,” Wall Street Journal, May 15, 2016, accessed April 16, 2017, https://www.wsj.com/articles/amazon-to-expand-private-label-offeringsfrom-food-to-diapers-1463346316. 4 “Amazon Posts a Profit,” CNN Money, January 22, 2002, accessed April 16, 2017, http://money.cnn.com/2002/01/22/technology/amazon/. 5 Tomi Kilgore, “Amazon Passes Exxon to Become 4th Most Valuable Company in the U.S.,” MarketWatch, August 2, 2016, accessed April 16, 2017, www.marketwatch.com/story/amazon-passes-exxon-to-become-4th-most-valuable-company-in-the- us-2016-08-01. 6 All currency amounts are in US$ unless otherwise specified. 7 Darrell Etherington, “Amazon Will Build Its Own 1.5 Billion Air Cargo Hub,” Techcrunch, Feb 1, 2017, accessed April 16, 2017, https://techcrunch.com/2017/02/01/amazon-will-build-its-own-1-5-billion-air-cargo-hub/. 8 Ron Amadeo, “‘Amazon Video Direct’ Takes Aim at the Professional Side of YouTube,” Ars Technica, November 5, 2016, accessed April 16, 2017, https://arstechnica.com/business/2016/05/amazon-video-direct-takes-aim-at-the-professional-side- of-youtube/. 9 “Amazon.com,” accessed April 16, 2017, https://www.amazon.com. 10 Nat Levy, “Amazon Reaches New High of 268,000 Employees—Skyrocketing 47% in Just One Year,” GeekWire, July 28, 2016, accessed April 16, 2017, www.geekwire.com/2016/amazon-employment-2nd-quarter/. 11 Don Reisinger, “Amazon Is Planning to Hire 100,000 Full-Time Employees,” Fortune, January 12, 2017, accessed April 16, 2017, http://fortune.com/2017/01/12/amazon-full-time-employees/. 12 Phil Wahba, “This Chart Shows Just How Dominant Amazon Is,” Fortune, November 6, 2015, accessed April 16, 2017, http://fortune.com/2015/11/06/amazon-retailers-ecommerce/. 13 “How Much Does Amazon Spend On Digital Marketing,” Spinutech, August 9, 2016, accessed April 16, 2017, https://www.spinutech.com/blog/digital-marketing/how-much-does-amazon-spend-on-digital-marketing/. 14 Jason Del Rey, “Amazon Just Posted a Record Profit for the Third Straight Quarter,” Recode, July 28, 2016, accessed April 16, 2017, https://www.recode.net/2016/7/28/12315690/amazon-earnings-q2-2016. 15 Jason Del Rey, “Amazon’s Complete Retail Domination in One Tiny Chart,” Recode, December 23, 2015, accessed April 16, 2017, https://www.recode.net/2015/12/23/11621690/amazons-complete-retail-domination-in-one-tiny-chart. 16 Eugene Kim, “Amazon CFO Had to Explain It’s Not a Bad Thing Amazon Had Its Highest Quarterly Profit Ever,” Business Insider, July 28, 2016, accessed April 16, 2017, www.businessinsider.com/amazon-cfo-defends-profit-on-conference-call- 2016-7. 17 David Jones, “Amazon’s Register-Free Grocery Shopping Could Disrupt Retail,” TechNewsWorld, December 6, 2016, accessed May 15, 2017, www.technewsworld.com/story/84141.html. 18 Eugene Kim, “Amazon Misses, Stock Falls,” Business Insider, October 27, 2016, accessed April 16, 2017, www.businessinsider.com/amazon-earnings-q3-2016-2016-10. 19 Ibid. 20 Bill Murphy, “‘Follow the Money’ and Other Lessons from Jeff Bezos,” Inc., August 6, 2013, accessed April 16, 2017, www.inc.com/bill-murphy-jr/follow-the-money-lessons-from-jeff-bezos.html. 21 Aly Weisman, “Here’s How Jeff Bezos Chooses Which Amazon Shows to Green-Light,” Business Insider, July 15, 2015, accessed April 16, 2017, www.businessinsider.com/what-jeff-bezos-wants-in-an-amazon-show-2015-7. 22 Jacob Demmitt, “Amazon Opens ‘Community Banana Stand’ at Seattle HQ to Give Away Free Fruits,” GeekWire, December 3, 2015, accessed January 6, 2017, www.geekwire.com/2015/amazon-opens-community-banana-stand-to-give- away-hundreds-of-free-snacks-at-seattle-hq/. 23 “Amazon Upped Its Digital Marketing Spend 40% Last Year to $2.8 Billion,” PR Newswire, January 27, 2015, accessed April 16, 2017, www.prnewswire.com/news-releases/amazon-upped-its-digital-marketing-spend-40-last-year-to-28-billion- 300026351.html. 24 Celine Mingot, “Mister V et Cyprien Choisis pour Promouvoir le Programme Amazon Premium Jeunes [Mister V and Cyprien Selected to Promote the Amazon Premium Youth Program],” Influenth, December 5, 2016, accessed April 16, 2017, www.influenth.com/mister-v-cyprien-choisis-promouvoir-programme-amazon-premium-jeune/. 25 Jessica Stillman, “7 Jeff Bezos Quotes That Outline the Secret to Success,” Inc., May 7, 2014, accessed April 16, 2017, www.inc.com/jessica-stillman/7-jeff-bezos-quotes-that-will-make-you-rethink-success.html. 26 Chris Cooper and Kiyotaka Matsuda, “Amazon Surge in Japan Lifts Yamato’s Express Deliveries Freight,” Bloomberg, August 15, 2014, accessed April 16, 2017, https://www.bloomberg.com/news/articles/2014-08-14/amazon-surge-in-japan- lifts-yamato-s-express-deliveries-freight. 27 George Anders, “Jeff Bezos’s Top 10 Leadership Lessons,” Forbes, April 4, 2012, accessed April 16, 2017, https://www.forbes.com/sites/georgeanders/2012/04/04/bezos-tips/#3dee7902fce4. 28 Paul Farhi, “Jeffrey Bezos, Washington Post’s Next Owner, Aims for a New ‘Golden Era’ at the Newspaper,” Washington Post, September 3, 2013, accessed April 16, 2017, https://www.washingtonpost.com/lifestyle/style/jeffrey-bezos-washington- posts-next-owner-aims-for-a-new-golden-era-at-the-newspaper/2013/09/02/30c00b60-13f6-11e3-b182- 1b3bb2eb474c_story.html.
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Page 11 9B17M092 29 David LaGesse, “America’s Best Leaders: Jeff Bezos, Amazon.com CEO,” U.S. News, November 19, 2008, accessed April 16, 2017, https://www.usnews.com/news/best-leaders/articles/2008/11/19/americas-best-leaders-jeff-bezos-amazoncom-ceo. 30 Michael Shick, “Jeff Bezos—What’s Dangerous Is Not to Evolve,” Fast Company, March 3, 2010, accessed April 16, 2017, https://www.fastcompany.com/1569357/jeff-bezos-whats-dangerous-not-evolve. 31 Greg Bensinger, op. cit.; Flore Fauconnier, “Amazon va Lancer sa Propre Marque Alimentaire [Amazon Launches Its Own Food Brand],” Journal du Net, May 29, 2015, accessed April 16, 2017, www.journaldunet.com/ebusiness/commerce/amazon- mdd-alimentaire-0515.shtml; “Amazon Vendra Sa Propre Nourriture [Amazon Will Sell Its Own Food],” Infopresse, May 16, 2016, www.infopresse.com/article/2016/5/16/amazon-vendra-sa-propre-nourriture. 32 “Amazon va Bientôt Vendre de la Nourriture et D’Autres Produits sous Sa Propre Marque [Amazon Will Soon Sell Food under Its Own Brand],” Kulture Geek, May 16, 2016, accessed April 16, 2017, http://kulturegeek.fr/news-84373/amazon- vendre-nourriture-dautres-produits-propre-marque. 33 “Amazon Elements,” Amazon.com Inc., accessed April 16, 2017, https://www.amazon.com/Amazon-Elements-Premium- products-Transparent- origins-Exclusive-to-Prime/b?ie=UTF8&node=10166275011. 34 Omar Belkaab, “Amazon Lance Ses Propres Marques D’Alimentation, de Détergents et de Couches Culottes [Amazon Launches Own Brand of Food, Detergents, and Coats],” Numerama, May 16, 2016, accessed April 16, 2017, www.numerama.com/business/170495-amazon-lance-propres-marques-dalimentation-de-detergent-de-couches- culottes.html. 35 John Greathouse, “5 Time-Tested Success Tips from Amazon Founder Jeff Bezos,” Forbes, April 30, 2013, accessed April 16, 2017, https://www.forbes.com/sites/johngreathouse/2013/04/30/5-time-tested-success-tips-from-amazon-founder- jeff-bezos/#384564c2370c. 36 Jason Del Rey, “Amazon Is Going to Sell Its Own Lines of Food, Detergent and Diapers, and It's Going to Be a Really Big Deal,” Recode, May 15, 2016, accessed April 16, 2017, https://www.recode.net/2016/5/15/11680080/amazon-happy-belly- mama-bear-private-label. 37 “Introducing Amazon Go and the World’s Most Advanced Shopping Technology,” YouTube video, 1:49, posted by Amazon, December 5, 2016, accessed April 16, 2017, https://www.youtube.com/watch?v=NrmMk1Myrxc. 38 Sean Farrell, “Amazon Go Checkout-Free Stores Look Set to Come to UK,” Guardian, December 9, 2016, accessed April 16, 2017, https://www.theguardian.com/business/2016/dec/09/amazon-go-stores-uk-trademark-us. 39 Andrew Melville, op. cit. 40 Sean Farrell, op. cit. 41 “Frequently Asked Questions,” Amazon.com, Inc., accessed April 16, 2017, https://www.amazon.com/b?node=16008589011. 42 Erik Sherman, “Amazon's Grocery Would Eliminate Thousands of Jobs,” Forbes, December 7, 2016, accessed April 16, 2017, https://www.forbes.com/sites/eriksherman/2016/12/07/amazons-grocery-would-eliminate-thousands-of-jobs/. 43 Nicolas Scheffer, “Monoprix Ironise à Propos D'Amazon Go [Monoprix Ridicules Amazon Go],” Les Echos, January 3, 2017, accessed April 16, 2017, https://business.lesechos.fr/directions-marketing/communication/communication- digitale/0211641428346-monoprix-ironise-a-propos-d-amazon-go-304014.php; Angela Natividad, “This Grocery Chain Just Mocked Amazon Go as a Latecomer With Snarky Remake of its Ad,” AdWeek, January 3, 2017, accessed April 16, 2017, www.adweek.com/creativity/grocery-chain-just-mocked-amazon-go-latecomer-snarky-remake-its-ad-175322/. 44 Audrey Shi, “Amazon Prime Members Now Outnumber Non-Prime Customers,” Fortune, July 11, 2016, accessed April 16, 2017, http://fortune.com/2016/07/11/amazon-prime-customers/. 45 “Wal-Mart Sues Amazon,” CNN Money, October 16, 1998, accessed April 16, 2017, http://money.cnn.com/1998/10/16/companies/walmart/. 46 Phil Wahba, op. cit.
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14.
CASE: GS-57
DATE: 06/18/07 (REV. 3/7/11)
David Hoyt and Amanda Silverman prepared this case under the supervision of Michael Marks and Professors Chuck Holloway and Hau Lee as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. The case was revised in March 2011 to include full year 2007 results. Copyright © 2011 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. To order copies or request permission to reproduce materials, e-mail the Case Writing Office at: [email protected] or write: Case Writing Office, Stanford Graduate School of Business, 518 Memorial Way, Stanford University, Stanford, CA 94305-5015. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means –– electronic, mechanical, photocopying, recording, or otherwise –– without the permission of the Stanford Graduate School of Business.
CROCS (A): REVOLUTIONIZING AN INDUSTRY’S SUPPLY CHAIN MODEL FOR COMPETITIVE ADVANTAGE
If the products sell extremely well, we will build more in season, and will be back on the shelves in a few weeks. And we’ll build even more, and even more, and even more, in that same season. We’re not going to wait with a hot new product until next year, when hopefully the same trend is alive.
—Ronald Snyder, CEO of Crocs, Inc.1
On May 3, 2007, Crocs, Inc. released its results for the first quarter of the year. The footwear company, which had sold its first shoes in 2003, reported revenues of $142 million for the quarter, more than three times its sales for the first quarter of 2006. Net income, at $0.61 per share was more than 17 percent of sales, nearly four times higher than the previous year.2 These results far exceeded market expectations, which had been for earnings of $0.49 per share on $114 million of revenue.3 As part of the earnings release, the company announced a two-for-one stock split. Immediately after the announcement, the stock price jumped 15 percent. The growth and profitability of Crocs, which made funky, brightly colored shoes using an extremely comfortable plastic material, had been astounding. Much of this growth had been made possible by a highly flexible supply chain which enabled the company to build additional product to fulfill new orders quickly within the selling season, allowing it to respond to unexpectedly high demand—a capability that was previously unheard of in the footwear industry. This ability to fulfill the needs of retailers also made the company a very popular supplier to shoe sellers.
1 Quotations are from interviews with the authors, unless otherwise specified. 2 Press Release, “Crocs, Inc. Reports Fiscal 2007 First Quarter Financial Results,” May 3, 2007. Online at http://www.crocs.com/consumer/press_details/688244 (accessed May 4, 2007). 3 Rick Munarriz, “Ugly Shoes, Pretty Profits,” The Motley Fool, May 4, 2007. Online at http://www.fool.com/investing/high-growth/2007/05/04/ugly-shoes-pretty-profits.aspx (accessed May 7, 2007).
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This success also raised questions about how the company should grow in the future. Should it vertically integrate or grow through product line extension? Should it grow organically or through acquisition? Would potential growth paths exploit Crocs’ core competencies or defocus them?
CROCS, INC.
In 2002, three friends from Boulder, Colorado went sailing in the Caribbean. One brought a pair of foam clog shoes that he had bought from a company in Canada. The clogs were made from a special material that did not slip on wet boat decks, was easy to wash, prevented odor, and was extremely comfortable. The three, Lyndon “Duke” Hanson, Scott Seamans, and George Boedecker, decided to start a business selling a new design of these Canadian shoes to sailing enthusiasts out of a leased warehouse in Florida, as Hanson said, “so we could work when we went on sailing trips there.”4 The founders wanted to name the shoes something that captured the amphibious nature of the product. Since “Alligator” had already been taken, they chose to name the shoes “Crocs.” The shoes were an immediate success, and word of mouth expanded the customer base to a wide range of people who spent much of their day standing, such as doctors and gardeners. In October 2003, as the business began to grow, they contacted Ronald Snyder, a college friend, to become a consultant for the company. Snyder had been an executive with Flextronics, a leading electronics contract manufacturer, heading up the company’s design division. He had extensive experience in manufacturing operations, mergers and acquisitions, and sales and marketing. When he first started consulting with Crocs, Snyder said, “I thought I would work a few hours a day. I thought it would be restful.”5 But seeing the rapid growth of the company based on word- of-mouth marketing, Snyder joined Crocs in June 2004 as its president, becoming CEO in January 2005. When Snyder joined the company it was headquartered in Colorado, but essentially distributing shoes made by the Canadian manufacturer Finproject NA. One of Snyder’s first moves was to purchase Finproject, which was renamed “Foam Creations.” Crocs now owned the formula for the proprietary resin “croslitetm” that gave the shoes their unique properties of extreme comfort and odor resistance. The company now also controlled manufacturing. Snyder encouraged the company to think big. He brought in a number of key executives from Flextronics, and built infrastructure in preparation for growth. (See Exhibit 1 for Crocs executives and directors.) He also launched the product worldwide. Snyder explained the rationale behind launching worldwide at an early point in the company’s life:
The plan was, we’re going to launch the world in order to get a brand out that would be a sustainable brand with this funky-looking, strange product. Other, larger shoe companies, or even larger apparel companies, could have knocked us off, and could have gone into Europe before we got there if they had infrastructure in Europe.
4 Diane Anderson, “When Crocs Attack,” Business 2.0, November 1, 2006. 5 Ibid.
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So, being Flextronics guys, and understanding that the world is flat, and you can get everywhere fairly quickly, we said, ‘We need to launch the world pretty much at once.’ We delayed a bit in South America, but now we’re there fairly strong, too. But we needed to launch everywhere in order to have us be the brand that had sustainability. That’s what we’ve been able to pull off at this point. We were in every country you can think of before anybody else had any real capability to ship product in other countries besides the U.S. Certainly, there are knock-offs in all those other places, but they are just known as knock-offs. They are not known as originals, which is what we were hoping to achieve.
Crocs started its sales efforts on a grass-roots basis in the U.S. The company participated in many trade shows in every industry that could benefit from the product, such as garden shows, boat shows, and pool supply shows. As stores began carrying the shoes, Crocs personnel worked closely with the stores. Snyder observed, “If you just put up a rack of funny-looking shoes, I don’t think they would have done anything. But we got in there with some of our own people, or our reps, and stood around and got people excited.” Crocs also went to a wide range of events, such as concerts, festivals, and sports tournaments, to talk to customers about the shoes. The company took a similar approach in other countries, but the momentum generated in the U.S. helped foreign adoption. The company initially used representatives and distributors in the U.S., but brought this function in-house in order to control costs. In other countries, Crocs had its own sales staff wherever possible, but as of mid-2007 had some third-party distributors in some locations. In addition to a popular product and a global strategy, Crocs developed a supply chain that provided a competitive advantage. Traditional industry practice was for retail distributors to place bulk orders for each season’s inventory many months in advance, with little ability to adjust to changes during the selling season. The Crocs model did not impose these limitations on retailers—the company could fill new orders within the season, quickly manufacturing and shipping new product to retail stores. (The traditional practice, and the Crocs supply chain will be described in detail below.) From 2003 through 2006 the company had phenomenal growth. Revenue in 2003 had been 1.2 million. By 2006, it was $355 million, with a net income of $64 million (18 percent of revenue). Crocs went public in February 2006, with an initial market capitalization of over $1 billion. After the Q1 2007 earnings release, the market cap passed $2.7 billion. Sales outside of North America grew from 5 percent of total revenue in 2005 to 25 percent in 2006. In its Q1 2007 earnings release, the company said that it expected 2007 revenue to be between $670 and $680 million. (The company had historically reported results that comfortably exceeded expectations.6) (See Exhibits 2 and 3 for company financial information.) Crocs’ financial performance was far superior in many respects to others in the footwear industry (Exhibit 4).
6 Munarriz, loc. cit.
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The Crocs Shoe
The original Crocs shoe was a clog design. Visually, its two most distinctive features were large ventilation holes and bold colors. The key to the shoe, however, was the croslite material. This proprietary closed-cell foam material molded to the shape of the wearer’s foot, providing an exceptionally comfortable shoe. It was extremely light, did not skid, was odor resistant, and did not mark surfaces. It could also be washed with water. Croslite could be produced in any color, and the company chose bold colors (described by some as “crayon” colors) which further enhanced the distinctive, funky look. Crocs shoes generally sold for about $30—which was not marked down, as retailers found they did not need to unload excess inventory through clearance sales at the end of a selling season. As Crocs grew, it added additional shoe designs. The two original models, Beach and Cayman, accounted for about 62 percent of footwear sales in 2006.7 These two models also formed the basis of some of the other Crocs models. By April 2007, the company had a wide range of shoes and other products. Its website showed 31 basic footwear models, ranging from sandals to children’s rain boots to shoes designed for professionals, such as nurses, who had to stand all day. Some of its shoes were made under a license agreement with Disney, and incorporated Disney characters. In addition, Crocs offered four models of shoes (CrocsRX) that were designed to meet the special needs of those with medical problems that affected the feet, such as diabetes. The company offered 17 models of collegiate models that were made in school colors, with the school logos. Universities such as USC, UCLA, Notre Dame, Cal, and Ohio State participated in the program. (By the start of the 2007/8 academic year, Crocs expected to include many other institutions in its catalog of university logo shoes.) Crocs sponsored the AVP Professional Beach Volleyball Tour, and offered two models with the AVP logo.8 (See Exhibit 5 for photos of selected Crocs products.) While shoes comprised 96 percent of company revenues in 2006,9 Crocs also branched out into other accessory products, such as caps, shirts, shorts, hats, socks, and backpacks. It had products such as kneepads and kneelers that utilized croslite to provide functionality. It also sold decorative inserts that could be put into the shoe ventilation holes, originally made by a family- owned company (Jibbitz) that Crocs purchased in December 2006. Crocs made other acquisitions in 2006 and early 2007 in the sports protection equipment and apparel market, and in action footwear. These acquisitions further broadened the company’s product line, and introduced products that incorporated conventional materials such as leather. (See Exhibit 6 for a list of Crocs acquisitions.)
Producing a Crocs Shoe
The raw materials for the croslite in Crocs shoes are a mixture of relatively inexpensive ingredients purchased in pellet form from a variety of suppliers. These ingredients are then combined in a process called “compounding,” in which they are converted into a slurry, mixed, 7 Crocs Form 10K for 2006, pp. 15-16. 8 Product links from Crocs homepage: http://www.crocs.com/home.jsp (accessed April 24, 2007). 9 Crocs Form 10K for 2006, p. F-27.
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and then reformed into new pellets. As part of the compounding process, color dyes are added. The compounded pellets are then ready to be molded into croslite products. Croslite components for Crocs products are made by injection molding. This requires an injection molding machine, and molds for each style and size. After the parts are molded, they must be assembled. This might involve gluing croslite parts together, or stitching, in the case of components made of leather, canvas, or other materials which had been added to the Crocs product line in late 2006 and early 2007. The finished products are then tagged and placed in boxes containing 24 pairs of shoes for distribution to retailers. Standard industry practice was for each pack of 24 to contain only one style and color. Crocs, however, would custom configure 24-packs to meet the needs of its smaller customers.
CROCS REVOLUTIONIZES THE FOOTWEAR SUPPLY CHAIN
The footwear industry was oriented around two seasons—spring and fall. The standard practice was for footwear companies preparing for the upcoming fall season to take their products to shows around the world in January. Buyers would book orders for fall delivery following these shows (“pre-books”). The fall orders that were received at the beginning of the year would be planned for delivery in August, September, October, and November. These scheduled shipments would drive the production plan. The manufacturers would add some excess to the build, typically about 20 percent of the pre-booked orders, to take advantage of potential additional orders. A very aggressive company might add 50 percent to the build, but all the product would be manufactured before the season began. Most shoes were produced in Asia (primarily China and Vietnam), with some manufactured in South America. This production and supply model had obvious limitations. Retailers had to estimate what their customers would want well in advance of the selling season. If they underestimated, they would have empty shelves and forego potential sales. If they overestimated, they would be stuck with unsold stock at the end of the season and be forced to have clearance sales in order to get rid of this excess stock at discounted prices. Making this even more difficult was the consideration that fashion was subject to trends that were difficult to predict—history was of only limited value, particularly with new products that incorporated novel design elements that might either become wildly popular or fall flat.
The Crocs Supply Chain
Crocs looked at the supply chain from a very different perspective than traditional shoe companies. Coming from their electronics contract manufacturing backgrounds, Snyder and other key Crocs executives were accustomed to producing what the customer needed, when it was needed, and responding rapidly to changes in demand. They decided to develop a model focused on customer needs—when a customer needed more product, they would get it. Snyder described the new model as follows: “If the products sell extremely well, we will build more in season, and will be back on the shelves in a few weeks. And we’ll build even more, and even more, and even more, in that same season. We’re not going to wait with a hot new product until next year, when hopefully the same trend is alive.” Fo
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Under the Crocs model, retailers would not need to take a big risk in January by placing large orders for their fall season—they could place smaller pre-booked orders, and order more when they saw how well the products sold. Traditionally, customers had to guess which products would be hot, and could not get more of a product that was in higher demand than they had guessed, rising losing potential sales. Conversely, overestimating demand when placing pre- booked orders would risk end-of-season sales to unload excess inventory at reduced prices. Crocs wanted customers to be able to get more of a product during the season in order to take advantage of unexpectedly high demand. To do that, Crocs would have to be able to make the products during the season, and ship them to customers quickly. One analyst remarked, “They’ve surprised everybody. Their replenishment system is unheard-of in the retail footwear space.”10 The positive relationship that Crocs developed with its retailers resulted in additional benefits. As Crocs became important to big retailers, they approached Crocs to suggest increasing the Crocs presence. Snyder described one large retailer who said: “Bring us new products, bring us apparel, accessories, T-shirts, socks, hats, Jibbitz [decorative accessories for Crocs shoes] and we’ll give you a whole area that will be dedicated to the current Crocs offerings and any new stuff you come out with.” Snyder observed, “Once you have retail space, it’s pretty valuable.”
Developing the Crocs Supply Chain
Phase One: Taking over Production As mentioned earlier, one of Snyder’s first moves was buying the manufacturer of Crocs shoes (Foam Creations) in June 2004 so that it could own the proprietary croslite resin and control manufacturing. At that point, Crocs purchased the raw material pellets from a variety of companies in Europe and the United States, and shipped them to a third-party compounding company in Italy. The Italian company had been part owner of Foam Creations, and had previously done the compounding, so continuing to use them for this function avoided supply chain interruptions. The compounded, colorized pellets were then shipped back to Foam Creations in Canada, where shoes were molded and assembled. The finished products were then shipped to a third-party distribution company in Denver that warehoused the shoes, and packaged and shipped them to customers.
Phase Two: Global Production Using Contract Manufacturers Crocs started production in China in early 2005, using a large contract manufacturer. The raw materials were still being sent to Italy for compounding, but the compounded pellets were now sent to both Canada and China. The shoes that were made in China were shipped to the Denver warehouse for packaging orders and distribution. Crocs began to enter the Asian and European markets in the spring of 2005. As described earlier, the company’s strategy was to launch worldwide, so it brought on manufacturing
10 Jim Duffy of Thomas Weisel Partners, quoted in Anderson, loc. cit.
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capacity to support this approach. It added capacity through contract manufacturers in Florida, Mexico, and Italy (due to the local presence of the compounding company). Coming from the contract manufacturing business, Snyder and his team expected that the benefits of contract manufacturing they had experienced in the electronics industry would also be present in this new business. Electronics contract manufacturers in all parts of the world were highly responsive to customer demands, and quick to increase or stop production as required. They soon found that this was not the case with footwear manufacturing. Snyder explained:
We realized very quickly that third party [manufacturers] with our new model weren’t going to work [outside of Asia]. Third parties in Asia are absolutely great. They are very flexible. They can be both flexible and high volume. They move very quickly. They [contract manufacturers] take risks with us, where they buy equipment. They invest in helping us grow the business. No [third party manufacturers in] other countries were willing to even entertain that. We’d have to give them long-term forecasts, long-term contracts, we’d have to sign away our next few kids. Nothing was good about using contractors in any other part of the world, to be honest…
[Third party manufacturers outside of Asia] would want to know what we’re shipping four months from now, not next week. We were telling them, ‘No, we actually need you to change tomorrow, and start shipping different stuff next week, if that’s what’s required, since that’s our model.’ [And they said,] ‘Oh no, no, we can’t do that!’
Phase Three: Bringing the Global Supply Chain In-House When Snyder realized that contractor manufacturers outside of Asia would not be able to adopt the company’s supply chain model, he developed company-owned manufacturing operations in Mexico, and Italy. Crocs set up a manufacturing operation in Brazil that was scheduled to open by the end of June 2007. It was also exploring potential manufacturing sites in India, and expected to start production there by the end of the year. Crocs had used a contract manufacturer in Romania to serve European customers, and considered several options to replace the contractor, including: buying the contractor, setting up a new facility in Romania, or looking elsewhere. They were approached by a company in Bosnia that seemed to understand the Crocs model. The two companies agreed to an arrangement whereby Crocs owned the molding equipment and molds, using the contract company’s personnel for labor. If this approach did not meet Crocs’ requirements for flexibility and rapid response to demand, it would move to an entirely company-owned manufacturing facility. The Chinese contract manufacturer, who could meet Crocs’ needs for flexibility and responsiveness, was maintained. (In 2006, 55 percent of Crocs’ unit volume was produced in China.11) Crocs also kept the Florida contract manufacturer, which was only making one high- volume product and could ship with a Made in USA label, and continued to manufacture in Canada. 11 Crocs Form 10K for 2006, p. 8.
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While manufacturing in each geographic region added both capacity and the ability to respond to local customers, having the compounding done in Italy led to supply chain inefficiencies. Compounded material had to be sent from Italy to each production site, in the correct amounts and colors. This resulted not only in inefficient shipping of materials around the world, but also reduced manufacturing flexibility in each location, since they could only process the colors that they had in stock. The raw materials were inexpensive, so centralizing compounding did not result in significant savings through inventory consolidation. In 2006, Crocs took control of the compounding activity, creating state-of-the-art compounding facilities in Canada, China, and Mexico. Crocs could now ship raw materials to each of these plants. The plants could compound material as need for production, delaying the colorizing decision until a specific color product was needed. Snyder described the results:
We can get an order now, and we don’t even have to make the compound and colorize it yet, and we can ship it in two weeks. So now the model is starting to really take shape, where we don’t have to take risks on even color compound at this point. Now we have that in place, which makes a huge difference.
Moving compounding in-house also provided IP protection for the croslite compound. Crocs also changed its warehousing model. The company had used a contract warehousing and distribution firm in Colorado to handle all its shipments. All production came to the contractor’s Colorado warehouse in bulk, where every shoe was removed and labeled, then warehoused. Customer orders were then filled from this central warehouse. This arrangement was inefficient, since bulk orders from large customers could have been shipped directly from the factory to the customers if warehousing and distribution had been located near each factory. To address these problems, the company added warehousing operations to each factory, including labeling and other value-added activities such as installing hand tags and putting products into bags or boxes. For customers that ordered large quantities, such as Nordstrom, Dillard’s, or Dick’s Sporting Goods, the orders could be shipped directly from the Chinese warehouse. The Chinese warehouse was owned by one of the Crocs suppliers, but run by Crocs’ personnel and Crocs’ systems. Other warehouses were owned by Crocs, or were being transitioned to Crocs ownership (as in the case of Japan). The intent was for Crocs to control order fulfillment activities in Asia. Crocs had a similar experience with warehousing contractors as it had with contract manufacturers. The company had tried using a number of third-party warehousers, in the U.S. and elsewhere. Crocs found that these companies did a good job for a short time, but soon lost interest. As Snyder noted, “We don’t lose interest in our own stuff,” leading to the decision to have the company take control of warehousing.
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Additional Considerations and Benefits of the Crocs Supply Chain Model
Small vs. Large Retail Customers Crocs’ early sales were to small retailers. These stores were willing to take more risk than the large chains, and work with a new, rapidly growing supplier—particularly one that provided a high level of support and rapid shipment of product. Small stores were willing to work with Crocs through problems such as stockouts and shipment delays—large retailers generally imposed financial penalties for such problems. Crocs saw the small retailers as important to building the brand, and providing a brand presence, even after the majority of sales went to large retailers. After Crocs’ initial success in small stores, large retailers approached the company. Since the large retailers had seen the market acceptance of the Crocs shoes, Crocs was in a much stronger negotiating position than it would have been earlier in its development—it could negotiate favorable terms, which did not include the financial penalties that would previously have been required. By mid-2007, about 75 percent of revenue came from large retailers, split approximately evenly between shoe stores, department stores, and sporting goods stores. The rest of the revenue came from a large number of small shops representing many different segments such as gift shops, bicycle retailers, specialty food retailers, health and beauty stores, surf shops, and kiosks. These small shops accounted for a much larger percentage of orders (although at much lower dollar levels) than the large retailers, requiring a different approach to distribution. To meet the needs of small customers, product would be shipped to the company-owned warehouse in Colorado, where the orders were configured and shipped. Snyder explained the company’s approach to fulfilling orders for these customers as follows:
We had to be able to service that customer base [small retailers], because it was a pretty big chunk of our business. Those guys could never take stuff direct from the factory. So, we felt we still needed to have a warehouse for quick shipments for the big guys and refills for the small independents that don’t have the warehousing capabilities that the larger guys would have. And almost none of them have distribution centers, of course—we ship direct to their shops. So, we still need the Denver operation which ships about half of our product now.
While these stores might send orders to Crocs by fax for small quantities to be delivered directly to their stores, the large retailers had an entirely different fulfillment model. These companies had their own distribution centers, and sent orders electronically. Their orders were packed and shipped from the Crocs factories to the customers’ distribution center. The customer would then ship it to the appropriate retail store.
Dealing with Explosive Growth The Crocs supply chain was able to support the company’s explosive growth, enabling the company to ride the wave of customer enthusiasm for its products. For instance, Snyder described a new flip-flop sandal that was introduced in 2006. This was Crocs’ first product in this segment, and the company did not know how many would be purchased. Since it was F
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unique and extremely comfortable, they decided to make 250,000 pairs—far more than they had pre-booked orders for, and perhaps as many as any model selling in that category in the world. Early in the selling season, there were indications that the new flip-flop was going to be even more popular than they expected, so Crocs made sure that it had excess injection molding machine capacity and molds available. It continued to get orders, and build more product to meet the new orders. By the end of the season in September, they had shipped nearly 2.5 million pairs—more than 10 times what they would have shipped if they had operated under the traditional model of making all of a season’s production prior to the season based on pre-booked orders. The primary requirements for adding capacity were having enough injection molding machines, and having enough molds for the desired product. Crocs purchased molding machines from two primary suppliers, who could initially deliver new machines in about three months. However, as the suppliers observed Crocs’ rapid growth, they managed to have new machines available sooner—by April 2007, the company could generally get them within six weeks. Molds generally started to arrive in about six weeks, but it would be about three months before Crocs would have a full set of all sizes. Crocs would move equipment from one location to another to better meet its production needs. Molding machines were not transferred often, but when they were, the company tried to have machines from just one vendor at each site. Molds, however, were frequently transferred between production locations. If they needed fast response to meet a growing demand in the U.S., they might move production to Mexico, which was closer to the customers.12 For products with lots of pre-booked orders, a relatively dependable forecast, and high volume, production might be shifted to China. As part of a licensing agreement with Disney, Crocs introduced a shoe with a Mickey Mouse head replacing a Crocs hole. The product was very popular, and the company decided it needed production flexibility, so it moved molds to Mexico to meet U.S. demand. However, product destined for Asian customers was made in China, and product going to European customers was made in Europe. In order to be able to respond immediately to increases in demand, Crocs kept total manufacturing capacity at about 1 million pairs per month beyond the actual production plan. This capacity could be turned on at a moment’s notice. The company also planned its infrastructure (both systems and people) slightly ahead of demand, so that it could respond quickly. In marketing, it spent according to what it could afford—when sales went up, it increased marketing spending. Consequently, it had ad campaigns ready to go within a week if the business took off enough to support added spending.
Shifting Production to Reduce Duty Payments The footwear industry was subject to considerable duties. For instance, the U.S. imposed duties on all Crocs shoes coming from China, with tariffs ranging from 3 to 37.5 percent depending on 12 If a style failed in the marketplace (which had not yet happened as of April 2007), molds could be reworked to make different styles.
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the materials in the shoe. Shoes that were entirely molded had a low tariff, while those which used leather or other materials would have a high tariff.13 On the other hand, under the North American Free Trade Agreement, Crocs paid no duty for products made in Mexico and shipped to the U.S. There were trade agreements between many countries that allowed duty-free shipments—for instance, there was no duty on Mexican shoes sold in Europe. The duty situation was considered from the early stages of new product development. The operations people would tell the designers what duty costs would be incurred based on the materials in the new product. They would also look at the processes needed to make the new shoes, and all this information would be included in the product strategy. If a Chinese- manufactured product had a high tariff, they would consider production in a low-tariff location. However, if it required production processes that were not yet available in the low-tariff country, those processes might be developed as part of the new product plan. Crocs might also make a high-tariff shoe in China at the start, with a plan to reduce costs later by moving the production. The Canadian manufacturing operation was retained in part because of duty considerations. For instance, Canada and Israel had a duty-free relationship. Crocs shoes were extremely popular in Israel, having sold more than one million pairs in the country in 2006. (The Canadian operation was also very helpful in selling within Canada, as the Made in Canada label provided an important marketing advantage.)
New, More Complicated Products In 2007, Crocs was expanding its product lines beyond croslite molded shoes. In part due to its February 2007 acquisition of Ocean Minded, it was starting to make shoes with uppers made of leather and other conventional footwear materials, with croslite used for the shoe soles. This introduced additional complication into the production process. Leather and other materials were also more expensive than croslite. Even with a more complicated production process, Crocs intended to apply the same fast- response model it had brought from Flextronics and had optimized for molded shoes. Snyder commented:
Now, it does become more complex—people could throw darts at this thing by saying, ‘But they only make injection molded shoes, so they have an advantage over other shoe manufacturers out there.’ Yes, we certainly did. But now we’ve got the same model going for more standard shoes, where it might have a croslite bottom, and it would have more standard uppers—it might have canvas, leather, suede, whatever. But we still are using the same model, where if something is popular, hot in the season, we are going to be able to make more. It may not be as much in the first year, as the extra 2 million we did of the sandal, but even the
13 The tariff classification was extremely difficult to determine. Crocs submitted models to the customs authorities for a ruling. If they believed that a product was put into a category with too high a tariff, they would appeal. To get a sense of the complicated nature of the tariff classifications, see: United States International Trade Commission, “Harmonized Tariff Schedule of the United States (2007)(Rev. 1) Section XII, Chapter 64,” http://hotdocs.usitc.gov/docs/tata/hts/bychapter/0701c64.pdf (May 7, 2007).
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sandal was a difficult process. It wasn’t just molding. It had gluing and everything involved. But the model is still there. We are not going to say “no” to a demand of a very popular new product. That’s going to be our model going forward, and we still have a lot of room to get better in our flexible manufacturing sites. We are continuing to do things in Mexico and Canada and in Europe to make those even more flexible to be able to get stuff to the market faster than the two, four, six weeks, whatever it would take now depending on the capacity or the demand at a given factory.
Introducing New Products In its first few years of sales, Crocs observed that all products sold equally well in each market around the world. This provided an attractive opportunity. A new shoe model could be tested in the spring/summer season in the southern hemisphere, and the results could be used to indicate how it might be accepted in the U.S. and Europe. If the product was a huge hit, production could be planned accordingly for the northern hemisphere launch. On the other hand, if the product sold slowly, those not bought in the southern hemisphere could be sold in the northern hemisphere for its spring/summer season. Snyder elaborated:
Now we’re in a situation where we can bring out new products that might have more complexity in the supply chain—more leather and more other types of materials, grommets, sewing machines, whatever is required. We can now launch those into half of the countries, still be aggressive with our build, still build much more than the pre-books, thinking that a given product is going to be hot. Suppose we launch a product in North America first. We’ve got other seasons coming along in other parts of the world, and we’ve got another 10-15,000 stores we can launch this particular new product into very quickly. So, we don’t take a huge risk by doing that. We don’t take a huge risk by ordering extra raw materials, and even building up extra shoe stock as we launch a new product. If it sells out in the U.S., we build more, and if all that sells out in the US, that’s OK— we’ll launch in Europe or Asia the next year.
Supply Chain Planning As of mid-2007, Crocs was using a home-grown database system for planning that had evolved over time. However, it was in the process of bringing up a commercial enterprise resource planning system. They had launched the inventory module, which allowed them a global view of inventory, and provided information for the planning system. The new planning system was being brought online. Crocs had planning people in the U.S., Asia, and Europe. Each country had to generate its own requirements plan, but there was also a global planning activity for each model type. The global planning personnel worked with the local staff on the requirements for each market.
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Product planning was based on pre-books for each model, as well as information on what retailers were picking up the model. Crocs analyzed the expected sales of each model, but built the actual product after it could see the actual demand to avoid ending up with unsold inventory. While Crocs did not build inventory in excess of expected orders, the company did acquire excess capacity (sometimes as much as two to three times the expected capacity) in the form of molds and molding machines so that it could quickly ramp capacity in case a product took off.
PROGRESS DURING 2007
The company continued its success throughout 2007. By the end of the year, Crocs seemed to be firing on all cylinders. It had developed a supply chain that was revolutionary in the industry and had been a critical factor in this success. Its products were very popular in the marketplace. It had positive relationships with its retail customers. Revenue for 2007 reached $847 million, EPS was $2.08, the stock had reached an all time high of $68 per share in October, and management was ecstatic. (See Exhibit 7 for stock prices.) In the company’s quarterly conference call, management made the following comments:14
Ron Snyder (CEO): We have become a global company. We now sell in over 90 countries through 19,000 doors outside of the U.S., up 1,000 doors since I reported the number a month ago, which represents an increase of 11,000 doors or 137 percent over this time a year ago. We’re very encouraged with our account growth and we expect to continue to grow doors significantly in 2008. As a result, our international revenues accelerated in 2007 and for the first time accounted for approximately half of our total business.
The growth we witnessed overseas in 2007, particularly in Western Europe and Asia, was very similar to what we saw in the U.S. the past few years as the Crocs brand achieved more mainstream notoriety and demand….
In emerging markets like China, India and Brazil we are gaining important traction and capturing key shelf space with our core products and establishing Crocs as a leader in affordable, casual footwear….
In August, we purchased Bite Footwear. Since that time, we have leveraged both companies’ core competencies to produce new sports sandals featuring Croslite and the first ever Crocs-branded golf shoe which will be on the shelf this spring. Additionally, we have doubled Bite’s distribution for spring to over 2,000 doors.
We have been busy organically growing our business. We launched YOU by Crocs, our line of fashion footwear for woman…. We developed new models for our CrocsRX line that have broadened our market both domestically and
14 Fair Disclosure Wire, “Q4 2007 Crocs, Inc. Earnings Conference Call – Final,” February 19, 2008. Slide numbers referenced by speakers deleted. Online at: https://goliath.ecnext.com/coms2/gi_0199-9760698/Q4-2007- Crocs-Inc-Earnings.html (accessed March 7, 2011).
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internationally. We partnered with world-renounced Chef Mario Batali on a signature Crocs at Work shoe ….
We have increased our current global production capacity by 80 percent and can make approximately 7.2 million pairs of shoes per month versus about 4 million this time a year ago….
John McCarvel (COO): To keep pace with this global demand we have continued to invest in global distribution infrastructure…. We’ve invested in 15 distribution centers worldwide to service our customers in these regions, thus positioning ourselves better for anticipated demand for the first half of 2008….
Russ Hammer (CFO): We ended 2007 with inventories of $248.4 million compared to $195.3 million at the end of Q3. We have historically chased demand since inception and we believe we are properly positioned on a forward-looking turns basis to meet our first half forecasted customer demand.
As John [McCarvel], mentioned, we also invested in inventory to better meet the demand in our multiple points of distribution in thousands of accounts around the world for our rapidly growing international customer base. In our high-growth business model, we calculate our required inventory levels on a forward-looking turns basis. We believe this represents a more accurate quantitative analysis of proper inventory levels. Based on our forward-looking analysis, we believe we are properly positioned to meet anticipated demand.
STUDY QUESTIONS
1. What are Croc’s core competencies? 2. How do they exploit these competencies in the future? Consider the following
alternatives: a. Further vertical integration into materials b. Growth by acquisition c. Growth by product extension
3. To what degree do the alternatives in Question 2 fit the company’s core competencies, and to what degree to they defocus the company away from its core competencies?
4. How should Crocs plan its production and inventory? How do the company’s gross margins affect this decision? What can go wrong?
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Exhibit 1 Crocs Executives and Directors
Executive Background Ronald Snyder, President, CEO, Director With Crocs since June 2004 (consultant since
October 2003). Senior executive with Flextronics. Founder of The Dii Group, which was acquired by Flextronics.
Peter Case, SVP, Finance, CFO, Treasurer With Crocs since April 2006. Previously EVP, CFO, and treasurer of a publicly held sports apparel and accessories company.
John McCarvel, SVP, Global Operations With Crocs since January 2005 (consultant beginning in 2004). Previously an executive with Flextronics and The Dii Group.
Michael Margolis, VP, Sales and Marketing With Crocs since January 2005. Led Crocs sales group as a consultant beginning in October 2003. Previously, was founder and executive with an apparel and merchandising company.
Director Background Raymond Croghan Board member since August 2004. Prior to
retirement in 1999, ran a healthcare information technology consulting firm. Also on the board of several privately held companies.
Ronald Frasch Board member since 2006. Vice chairman of Saks Fifth Avenue. Background in global retailing.
Michael Marks
Board member since August 2004. Member of Kohlberg Kravis Roberts & Co., a private equity firm, since January 1, 2006. Chairman of Flectronics. Previously, served as CEO and chairman of Flextronics from 1991-2005. Also a director of SanDisk Corporation and Schlumberger Limited.
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Directors, continued Marie Holman-Rao Board member since 2006. Background in the
apparel business, including Limited Brands, Inc., Gap, Inc., Banana Republic, and Ann Taylor.
Richard Sharp, Chairman Board chairman since April 2005. With Circuit City from 1982 to 2002, serving as president, CEO, and chairman. Also a board member of Flextronics (formerly chair) and of Carmax, Inc., the nation's largest specialty retailer of used cars and light trucks.
Thomas Smach Board member since April 2005. With Flextronics since 2000, as CFO, and SVP of finance. Previously SVP, CFO and treasurer of The Dii Group, Inc., which was acquired by Flextronics. Also serves on the board of ADVA AG Optical Networking.
Ronald Snyder President of Crocs. See background above under Executives.
Sources: Crocs website, “Board and Management Profiles,” http://www.crocs.com/company/Investor_Relations/Board_Management.jsp (April 23, 2007), Crocs Proxy, October 2006.
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Exhibit 2 Crocs’ Financial Performance Through 2007
All amounts in $ millions, except as noted. 2004 2005 2006 2007 Revenue 13.5 108.6 354.7 847.4 Cost of Goods Sold 7.2 47.8 154.2 349.7 Gross Profit 6.4 60.8 200.6 497.6 Gross Profit Margin 47.0% 56.0% 56.5% 58.8% SG&A Expense 7.2 30.6 97.2 259.9 Depreciation & Amortization 0.7 3.3 8.1 22.1 Operating Income (1.6) 26.9 95.3 237.8 Operating Margin - 24.8% 26.9% 28.1% Net Income after Taxes (1.5) 17.0 64.4 168.2 Net Profit Margin 15.6% 18.2% 19.8% Geographic Distribution of Revenue (% of total)
North America 13.5 (100%) 102.8 (95%) 265.5 (75%) 487.7 (69%) Asia -- 4.7 (4%) 54.4 (15%) 163.0 (19%) Europe -- 1.0 (1%) 30.3 (9%) 173.7 (21%) All Other -- 0.1 4.6 (1%) 22.9 (3%) Shoes as percent of total revenue
81% 94% 96% 90%
Selected Balance Sheet Items (Calendar year end, all values in $ millions) 2003 2004 2005 2006 2007 Cash 0.3 1.0 4.8 67.9 36.3 Net Receivables 0.2 3.3 20.0 69.3 152.9 Inventories 0.4 2.4 28.5 86.2 248.4 Net Fixed Assets 0.3 3.7 14.8 34.8 88.2 Accounts Payable 0.5 6.9 37.8 71.2 83.0 Short-term Debt - 1.0 8.5 0.5 7.1 Long-term Debt - 1.4 3.2 0.1 - Sources: Hoovers and company annual reports. Product and geographic distribution of revenue from Crocs Form 10K for 2007, p. F-28, F-29 and Form 10K for 2006, pp. F-27, 8.
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Exhibit 3 2007 Quarterly Financial Results
Crocs reported the following quarterly results for 2007 (dollar values in millions, except as otherwise stated): Q1 Q2 Q3 Q4 Revenues 142.0 224.3 256.3 224.8 Gross profit 84.4 131.9 155.4 125.8 Gross profit (% of sales) 59.4% 58.8% 60.6% 56.0% SG&A Expenses 47.3 63.5 77.2 71.9 Net income, after tax 24.9 48.5 56.5 38.3 Net income (% of sales) 17.5% 21.6% 22.4% 17.0% Net income per share, diluted $0.30 $0.58 $0.66 $0.45 Source: Company quarterly earnings statements.
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Exhibit 4 Industry Comparisons
Comparisons of Crocs with companies selected as “best of group” and industry median. Crocs Deckers
Outdoor Nike Timber-
land Industry Median
Annual Sales ($ million) 355 304 14,955 1,568 Market Capitalization ($ million) 2,102 897 10,065 1,306 Profitability Gross Profit Margin 56.5% 46.4% 43.7% 47.3% 24.5% Pre-Tax Profit Margin 27.2% 17.8% 13.1% 10.4% 3.2% Net Profit Margin 18.2% 10.4% 8.7% 6.8% 2.7% Return on Equity 56.7% 16.1% 21.6% 19.5% 15.5% Return on Assets 34.1% 13.7% 14.4% 13.0% 3.4% Return on Invested Capital 51.1% 15.9% 18.4% 19.0% 4.7% Operations Inventory Turnover 3.5 5.0 4.3 4.7 5.6 Receivables Turnover 8.0 6.0 6.5 7.4 6.6 Valuation Price/Sales Ratio 5.9 3.0 1.3 0.8 0.8 Price/Earnings Ratio 30.4 28.3 20.0 15.3 20.1 Price/Cash Flow Ratio 170.3 18.5 14.1 11.7 10.6 Growth 12 month Revenue Growth 227% 15% 8.8% 0.1% 7.5% 12 month Net Income Growth 280% (1.0%) 0.4% (35.3%) 53.2% 12 month EPS Growth 239% (2.3%) 2.9% (31.5%) 50.0% Source: Hoovers Online Competitive Landscape (April 27, 2007). Crocs growth numbers are for calendar years 2005 and 2006. Crocs inventory turns from Crocs.
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Exhibit 5 Selected Crocs Products
Beach was the company’s most popular model. Beach and Cayman accounted for 62 percent of 2006 shoe sales.
Beach and Cayman were the first two Crocs products, and formed the basis for some other shoe models.
Disney beach was a version of the Beach model produced under license from Disney.
Professional was intended for people such as nurses who spent all day working on their feet.
Jibbitz were used to customize Crocs shoes by filling the ventilation holes in the shoes.
Crocs produced items such as kneepads that took advantage of the properties of croslite.
Crocs offered branded accessories such as wristbands, caps, and socks.
Cloud was designed to meet the special needs of diabetic patients.
Crocs offered a range of shirts and shorts.
Source: Crocs website (www.crocs.com , accessed April 23, 2007). Images © Crocs, Inc., reprinted with permission.
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Exhibit 6 Crocs Acquisitions, 2004-2006
Acquisition Date Acquired Purchase Price
Description
Foam Creations (formerly Finproject NA) June 2004
Original manufacturer of Crocs products and owner of croslite intellectual property.
Fury (formerly 55 Hockey Products) October 2006 Note 1.
Manufacturer of hockey and lacrosse products. Develops protection gear based on croslite, which offers low weight, energy absorption, and microbial resistance.
EXO Italia October 2006 Note 1.
Designer of ethylene vinyl acetate (EVA) products, primarily for the footwear industry.
Jibbitz December 2006 $13.5 million
Family owned company specializing in colorful snap-on products designed as accessories for Crocs footwear.
Ocean Minded, LLC January 2007 $1.75 million plus potential earn-out of up to $3.75 million.
Designer and manufacturer of high quality leather and EVA based sandals for the beach, adventure, and action sports markets. Uses recycled and recyclable materials whenever possible. Products target young men and women who want high quality fashion sandals with an emphasis on style and comfort.
Notes
1. The aggregate purchase price for Fury and EXO Italia was $9.6 million. 2. Purchase prices include acquisition-related costs.
Source: Crocs Form 10K for the year ending December 31, 2006, pp. F-11, F-12, F-30.
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Exhibit 7 Stock Price from IPO through September 2007
The following graph shows Crocs’ stock price from IPO though September 2007.
Source: Nasdaq price quotations.
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15.
CASE: GS-79
DATE: 11/19/13 (REV’D 5/14/15)
Sonali Rammohan prepared this case under the supervision of Professor Hau Lee as the basis for class discussion
rather than to illustrate either effective or ineffective handling of an administrative situation.
Copyright © 2013 by the Board of Trustees of the Leland Stanford Junior University. Publically available cases are
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Center, 655 Knight Way, Stanford University, Stanford, CA 94305-5015.
MCDONALD’S INDIA:
OPTIMIZING THE FRENCH FRIES SUPPLY CHAIN
A potato is a complex animal.
—Tony VanLeersum, Former Corporate Vice President of Agriculture, McCain Foods Ltd. 1
Before opening its first store in India in 1996, McDonald’s spent six years building its supply
chain. 2 During those six years, the company worked to source as many ingredients as possible
from India, and their efforts were successful. However, MacFries, as McDonald’s french fries
were popularly known, were a particularly tough product to source locally—and importing fries
was undesirable for both cost and availability reasons. There were many complexities related to
growing the potato best suited for fries in India’s agricultural conditions. By 2007, 11 years after
opening its first restaurant, the MacFry was finally being produced in India. McDonald’s main
MacFry supplier was the Canadian company McCain, which established a potato processing
factory in the city of Ahmedabad, located in the state of Gujarat. McCain spent many years
working on potato agronomy and with farmers to build up supply in India. This was beginning
to pay off. From 2007 to 2011, local MacFry production increased from none to more than 80
percent, giving McDonald’s tremendous benefits in terms of cost savings, inventory reduction,
and assured supply (Exhibit 1).
Despite the strides made in recent years, by 2011 Abhijit Upadhye, McDonald’s then senior
director of Supply Chain India was still a worried man. Since September 2008, double-digit
food inflation in India had been adding huge cost pressures on the company. 3 In addition,
McDonald’s had aggressive growth plans for the coming years. The MacFry was the single
1 Cited during an interview with KS Narayanan, former managing director, McCain India.
2 McDonald’s India presentation, 2010 Stanford Responsible Supply Chains Conference by Abhijit Upadhye.
3 http://www.thehindubusinessline.com/industry-and-economy/economy/article2717938.ece?homepage=true
(February 13, 2012).
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largest procurement item, so having a 100 percent local supply was critical to avoiding high
import duties. The question that troubled him was: “Will I ever be able to eliminate imported
fries from my supply chain?” 4
ABOUT MCDONALD’S AND MCCAIN
McDonald’s
Founder Ray Kroc opened his first McDonald’s in 1955 in Des Plains, Illinois. 5 By 2011, 33,000
McDonald’s restaurants served more than 64 million customers in 119 countries every day. In
2010, the company had over $24 billion in revenues and $4.9 billion in net income. McDonald’s
had a long-standing belief in a local approach to doing business. Ray Kroc’s philosophy was to
work with suppliers who shared McDonald’s dream and concrete goals. In the U.S., around 80
percent of restaurants were franchised, allowing for local control of stores.
McDonald’s in India was created through joint ventures between McDonald’s Corp. and two
Indian businessmen, Amit Jatia and Vikram Bakshi. By 2011, McDonald’s India had 240
restaurants, and planned to grow this number to 500 restaurants by 2014. 6
McCain
Founded in 1957, McCain was the world’s largest producer of frozen french fries and potato
specialties. 7 The company produced many other frozen food items, such as pizza, veggie
burgers, peas, and juice concentrate. Headquartered in Florenceville, New Brunswick, Canada,
the company had three main divisions: McCain Foods, McCain Produce, and the Day & Gross
Transportation Group. McCain produced 33 percent of all french fries in the world, and was the
world’s third largest grower of potatoes. The company had 50 manufacturing facilities around
the world, 3,200 grower partners, and $6 billion in net sales. In India, McCain had a potato
processing facility in Ahmedabad, Gujarat which supplied french fries to McDonald’s. The
company also sold specialty products such as potato wedges, hash browns and potato patties to
hotels, service restaurants, and in retail. From India, McCain exported these products to
Pakistan, Sri Lanka, Bangladesh, China, South Africa and other markets. The company did not
export french fries, given the heavy Indian demand.
BUILDING A SUPPLY CHAIN FROM SCRATCH
Not All Potatoes Are Created Equal
While India was the third-largest producer of potatoes in the world, less than 1 percent were
process grade. 8 To qualify for french fry production, a potato must have high solids, low sugars,
4 Quotations are from interviews with the author, unless otherwise noted.
5 Data in this section from http://www.aboutmcdonalds.com/mcd/our_company/mcdonalds_history_timeline.html
(January 12, 2012) unless otherwise noted. 6 http://www.mcdonaldsindia.com/pdf/news/BS03-Dec-20-2011.pdf (January 12, 2012).
7 Data in this section from http://www.mccain.com/GoodBusiness/business/Pages/mccainfoods.aspx (January 12,
2012) and from interviews. 8 Source: McCain India.
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a large, oblong shape, disease resistance and a long dormancy. Ideally, a french fry potato needs
a growing season of 120 to 150 days, long daylight (14 to 16 hours) when photosynthesis takes
place, and cool nights, when potato bulking takes place. Sandy-loam soil is ideal, and the
potatoes grow better with controlled irrigation.
In India, ideal potato growing and storage conditions simply do not exist. The Indian climate
allows growth only in the winter versus the long summers in parts of the U.S. and Europe. The
growing season in India is between 90 to 100 days as opposed to 120 to 140 days during the
summers in the U.S. and Europe. This limited the number of days that potatoes could be
harvested. Outdated farming and irrigation practices limited yields as well. Typical Indian
potatoes have high sugars, low solids, and are small―not a good fit for long french fries. When
a normal Indian table potato is sliced into a french fry and put into oil, due to high moisture
levels, the result is an oily, soggy mass of potatoes rather than crispy golden fries. Storage was
also a problem. Potatoes need cold storage with special controls (for humidity and temperature)
to maximize their shelf life, and this type of storage was not available in India at the time.
McDonald’s India Demand and Supply in the 1990s
There were compelling reasons for McDonald’s to expand in India in the 1990s. The country
had the second-largest overall population in the world next to China. Early in the 1990s, then
Prime Minister PV Narasimha Rao and Finance Minister Manmohan Singh implemented
financial reforms which helped to open the Indian economy to trade. Prior to this period, an
elaborate set of licenses and regulations existed and these were required to set up and run
businesses in India after the country’s independence from the British in 1947. 9 The country had
a fast-growing middle class which now had more discretionary spending power.
To cater to the Indian consumer, McDonald’s worked on developing a completely new menu
geared to local tastes (Exhibit 3). It developed a vegetarian menu, and focused on fish and
chicken products since beef is not eaten by most Hindus, who represented around 80 percent of
the population, 10
and pork is not commonly eaten. Through India-based research and
development, the company built a menu that was 60 percent vegetarian. The company initially
reached out to upper-income consumers and some middle-income consumers. But Bakshi
believed that they had to eventually reach out to the burgeoning middle class that was growing at
a rapid pace.
When the first stores opened, the lowest-priced sandwich was approximately Rs. 13 (around
$.37) and an order of fries was about Rs. 20 (around $.57). 11
India had the second-largest acreage of arable land in the world and was the second-largest
producer of potatoes and other vegetables in the world. However, yields for cereals and
vegetables remained substantially lower than the world average in 2011. 12
In addition, 500
billion Indian rupees (approximately $10 billion) worth of fruits and vegetables were wasted
9 http://news.bbc.co.uk/2/hi/south_asia/55427.stm (January 12, 2012).
10 http://censusindia.gov.in/Ad_Campaign/drop_in_articles/04-Distribution_by_Religion.pdf (January 12, 2012).
11 http://www.tradingeconomics.com/india/currency (data about 1996 exchange rate accessed January 20, 2012).
12 http://www.rba.gov.au/publications/bulletin/2011/jun/pdf/bu-0611-3.pdf (January 30, 2012).
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every year due to supply chain inefficiencies such as poor cold storage, and poor warehousing
and distribution infrastructure. 13
Agriculture constituted 19 percent of GDP in India. 14
While things were rapidly changing in
many food sectors, agriculture practices were outdated compared to developed economies. The
Indian government encouraged small-scale farming, which caused landholdings to be very small.
This made it difficult to gain economies of scale. It was common to have 50 to 100 farms across
a 100-acre region, compared to the United States, where the average farm size was 418 acres in
2007. 15
In 1990, when McDonald’s began investigating entry into India, the company observed very
outdated farming and irrigation practices in the country. Water and electricity were wasted in the
farming process, and there were no facilities at the farm level to store post-harvest produce.
Most raw materials such as wheat flour, milk and potatoes did not meet McDonald’s target
specifications. Logistics and distribution were real challenges as well. Roads were extremely
poor, and a cold chain barely existed. There were only 200 refrigerated trucks in the entire
country. Temperature controlled warehouses for products like potatoes were not available. The
quality of food processing was quite low. McDonald’s could not buy processed chickens, as
India had mostly a live bird market. There was no deboning facility available. Vegetable
processing was very rare, as most Indians used fresh vegetables purchased at the local market. It
was clear that the company had a lot of work to do to develop the supply chain it needed to
deliver food to customers that met McDonald’s specifications. According to Upadhye,
“McDonald’s had to develop everything from scratch.” Keeping in line with its philosophy
around the world, and despite challenges with obtaining local supplies of ingredients, the
company planned to use local sources for ingredients to the fullest extent possible. Sourcing
from within the country was particularly important in India, given steep import duties.
The Building Blocks of a Local Approach
McDonald’s local approach to doing business shaped its entry into India. The company wanted
to have partners that understood Indian operating conditions and Indian consumers. The
company also wanted to build a local supply chain in order to drive agricultural growth, generate
employment and show the Indian government the company’s commitment to development. With
the India supply chain, the company used a mix of international suppliers, local supplies and
joint ventures. Jatia and Bakshi, McDonald’s joint venture partners, provided intimate
knowledge of the Indian market. Jatia was responsible for the west and south, and Bakshi was
responsible for the north and east. This was critical since all the elements, from the menu, cost
structure and overall economics were very different from their counterparts in the U.S. The joint
venture model, where McDonald’s corporate partnered with local entities, was typical of how
McDonald’s operated in many international markets. In certain cases, after the business was on
a solid footing, local partners could be given a developmental license, which meant the business
was 100 percent locally owned.
13
http://www.isb.edu/faculty/Working_Papers_pdfs/Can_India_be_the_Food_Basket_for_the_World.pdf (January
30, 2012). 14
https://www.cia.gov/library/publications/the-world-factbook/fields/2012.html (January 12, 2012). 15
http://www.ers.usda.gov/StateFacts/US.htm (January 12, 2012).
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In the early 1990s, the company developed joint ventures between Indian partners and
international suppliers. Many items, from sandwich sauces, chicken and vegetable patties to
distribution center services were developed through joint ventures between local suppliers and an
international McDonald’s supplier. In some cases, McDonald’s could rely on 100 percent
domestic sources, such as with fish patties, dairy mixes and buns. Where local sources or
partnerships could not satisfy McDonald’s needs, the company resorted to imports. This was the
case with oil, toys used in Happy Meals, and for many years, MacFries.
McDonald’s opened its first two Indian restaurants, in Delhi and Mumbai, in 1996, only after
years of developing the supply chain and knowledge of the Indian market. The company focused
on four key principles: quality, service, cleanliness and value (QSC and V). In the Indian market
in the 1990s, the quality of ingredients was the big challenge. According to Jatia, “The challenge
was not really about volume; it was more about getting everything right.” Most agricultural
products were grown for home consumption, so they did not conform to standards required for
processing. Therefore McDonald’s looked at each of the components required to service all of
its products and started creating backwards linkages all the way to the farm level. The company
spent over $100 million to develop the supply chain before stores were opened. And yet, they
would need to build restaurants one store at a time. During these early years, the company had to
absorb the supply chain costs until they could earn revenues from opening up many restaurants.
After years of setting up the basic foundation to open its first store in 1996, McDonald’s turned
its focus to building food, safety and quality standards, meeting service standards, and clearing
bottlenecks in the supply chain. Growth accelerated from 2003 to 2007, when compounded
annual growth was around 31 percent. From 2007 to 2011, compounded growth was around 35
percent. McDonald’s began to focus more attention on fulfilling capacity needs, adjusting
supply and service models, and further localizing its products.
POTATO AND FARMER MATTERS
French fries were very popular with Indian customers, and the supply of MacFries was critical to
the company’s success in India. According to Jatia, “French fries are something that our
consumers absolutely love at McDonald’s, and for us to not be able to bring it at an affordable
price was not acceptable.”
In order to supply french fries to India, in the early 1990s McDonald’s helped create a joint
venture between international french fry supplier Lamb Weston and India-based Tarai Foods.
The joint venture invested 10 million dollars to set up the first french fry line in the country.
This money was invested in land, plant and machinery. Given the challenges around raw
material quality and storage conditions, the joint venture focused on identifying and growing a
suitable variety of potato for making MacFries. New storage facilities were created to help store
potatoes in the right conditions. While McDonald's knew the specifications it needed to produce
MacFries, the joint venture’s agricultural techniques were not successful in developing a potato
that contained the ideal amount of solids and the desired size. When the potatoes developed by
the venture were used on the processing line, they produced fries which were oily and limp. The
huge investment of time and money that went into producing a MacFry had failed because the
company could not grow the right variety of potato. McDonald's could not open its first store F or
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without MacFries on the menu, so it had to react quickly to develop another plan. At this point,
the company realized that importing frozen fries was the best option to get fries quickly.
After failing to develop a local potato supply, Lamb Weston petitioned the Indian government to
allow imports of fries into India. The process for obtaining an import license was complex and
time consuming. First, a case had to be presented for allowing the import of an item which was
in a restricted category. The case had to make clear why the import was initially required for
starting and establishing a market. At the same time, the company had to explicate its plan to set
up the required agriculture and plant so that it could ultimately produce local fries. The entire
process for approval took almost six months. In 1996, for the first time, frozen french fries were
introduced into the customs classification so that Lamb Weston could import fries. The Indian
government allowed the imports, but under a restricted category, so import quantities were
limited to 800 metric tons of french fries. In addition, import duties were 56 percent. The lead
time for importing fries from the U.S. to India was around 60 days; 40 days of shipping plus time
for handling and customs clearance. It was becoming clear that imports would not be a long-
term solution to satisfy the demand for MacFries.
Given McDonald’s aggressive growth plans and limitations on import quantities under one
license, McDonald’s invited another one of its international suppliers, McCain, to augment the
import supply. McCain was also allowed to import 800 metric tons of frozen french fries, which
it sourced from its plants in the U.S., New Zealand and Europe. Both Lamb Weston and McCain
were then helping import french fries to serve the growing demand for McDonald’s in India. By
1999, the quantity restriction was removed by the government. However, the steep import duties
and unfavorable exchange rate meant that fries would continue to be an expensive item unless
localized. Relying on imports was not a tenable strategy.
Making a Structural Change
Though the initial attempt to localize french fries had failed, McDonald’s decided to try again in
1998 with McCain. As Jaideep Mukherji, McCain India’s first managing director said, “We
needed to discard bleak predictions.” McCain understood that growing the right potato was the
key. As Harrison McCain, founder and chairman of McCain Foods said, “If you don’t get the
agronomy right nothing else matters in this business.” McCain India’s first employee was an
agronomist and its second was a supply chain manager. McCain began to work on potato
agronomy―a branch of agriculture dealing with field crop production and soil management.
This way, they could develop the right variety of potato so that potatoes could be grown and
produced into french fries within India.
In India, the government strictly controls certain imports, and raw potatoes were not allowed to
be imported. So McCain had to bring in the potato germplasm (a collection of genetic resources
that could be used to grow potatoes more suitable for french fry production). The local supply
strategy was an exercise in risk management. If Indian licensing requirements changed in the
future, McDonald’s could be in a position where they did not have a license to import fries. And
even if imports were not restricted, in order to retain its low cost structure, McDonald’s needed
to ultimately figure out a way to avoid high import duties on MacFries.
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From McCain’s perspective, it was important to localize production to the extent possible
wherever the company operated around the world. Given import duties levied on foreign
agricultural products in many countries, McCain believed that having a local strategy was often
an advantage.
The first big focus would have to be cultivating the appropriate variety of potato where other
suppliers had failed. McCain learned that cultivating potato seeds in high elevations was ideal
because seeds grown at high altitude had high vigor, enabling a commercial crop planted with
those seeds to have higher yield and larger-sized potatoes. So it instituted a Shepody potato seed
multiplication program in the 13,000-foot high Lahaul Spiti Valley, part of the Himalayan
mountain range in Northern India. Seeds were sown in May, and harvested in September. Given
the heavy snows in the region, they were transported down from the mountains by donkeys.
Second, farmers would need to grow the full potatoes in a suitable, more accessible location than
the Himalayas. At the same time, McCain had to test its production capabilities in India.
Vista Foods, which supplied McDonald’s with patties, puffs and pies, had some excess capacity
in India. True to its supplier partnership philosophy, McDonald’s helped McCain get access to
this excess capacity without a huge investment. McCain had to bring in equipment in order to
produce potato wedges and patties (potato products that were easier to provide in India due to the
less stringent raw material requirements compared to fries), while the rest of the infrastructure
was provided by Vista Foods. This gave McCain enough potato product volume to build up
some business with local farmers. If McCain had not been given production capability to test the
Indian potatoes, farmers would have been reluctant to try something new. So with wedges,
McCain was able to test the Indian market and develop confidence that it was a market worth
pursuing. This proved to be a win-win-win arrangement in Jatia’s eyes. The patty supplier
Vista’s excess capacity was utilized, McCain was able to test the Indian market with small-scale
production, and McDonald’s had found a route to developing a local supply of french fries.
Knowing that they would have McDonald’s commitment to buy fries, McCain then decided to
build a $25 million (Canadian) manufacturing facility dedicated to processing french fries. The
plant had the capacity to process 40,000 tons of potatoes per year. Seeds were planted in Gujarat
farms in September and October, and potatoes were harvested in February and March.
Once they were processed, fries were frozen and sent to third-party logistics storage facilities or
to McDonald’s distribution centers. From here, they were shipped to restaurants.
Partnering with Farmers to Improve Quality and Build Quantity: a Win-Win
McCain conducted regional trials to locate the ideal growing area, and experimented with 13
types of potatoes to pinpoint the right variety. They also conducted management trials to
identify the best combination of growing practices, and storage trials to figure out the best
protocol for storing potatoes. From this experimentation, McCain zeroed in on the central Indian
state Gujarat as the prime growing area. Three varieties were identified that could work.
McCain established a one-acre demonstration farm near Ahmedabad in Gujarat for farmers to
learn how to grow this new crop. As Narayanan put it, “Seeing is believing.” McCain showed
farmers the seeds to use, how to improve yields through better sowing, drip irrigation, and better
harvesting techniques. The new drip irrigation techniques used 33 percent less water than F or
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traditional flood irrigation. By 2011, around 100,000 acres were under drip or sprinkler
irrigation, compared with just 67 acres in 2002. The company transformed storage practices by
applying a potato sprout suppressant in combination with using controlled temperature storage.
This helped to avoid deterioration in potato quality during storage. The local Gujarat
government had a scheme to subsidize farmers’ drip/sprinkler irrigation system purchases.
Meanwhile, after gaining confidence that the market for fries was solid and the production
capability available, McCain invested 25 million dollars in a manufacturing facility capable of
producing fries, coated wedges, hash browns, mashed products and coated formed products.
Exhibit 4 shows the potato farms in Gujarat.
Key agricultural breakthroughs were demonstrated to farmers growing potatoes for McCain.
These included shifting from traditional row planting to mechanical field preparation, shifting
from hand picking of potatoes to mechanical picking, and planting in double rows to utilize
space better and reduce water consumption. Since Indian potatoes were an annual crop, making
improvements to growing practices and then assessing the impact took many years. McCain
needed to demonstrate to farmers that the improved yields they were seeing were sustainable
over time and were not just a one-time occurrence. There were many variables which affected
potatoes: the type of seed used, temperature, rainfall, irrigation techniques, fertilizers, pesticides,
and more. The company conducted management trials and only put techniques into practice
after they had been seen to work for three years. As Narayanan said “… [A]t the end of the day,
the farmer is also an entrepreneur. He’s putting in a lot of his effort, his land, his resources at
play, and on top of that, you need something that is really sustainable.” Given that it took six
months to pass government quarantine clearance followed by three to four years to develop the
right seed and then three years to test it in the fields, it took between six and seven years to
develop a commercial variety of potato. According to McCain’s Gujarat plant manager Rajeev
Chauhan, “The seed pipeline is the most critical to ensure future supply.” Enough seeds needed
to be planted to meet demand many years in the future.
In 2007, after many years of refinements to agronomy and developing farmer partnerships,
McCain was finally able to produce fries that met McCain and McDonald’s specifications. Jatia
gave McCain credit for doing what everyone said was not possible. Most potato-growing
experts McDonald’s had consulted in the past said that India could never grow the type of potato
needed to make a MacFry. But against all odds, and after years of effort, McCain made this
happen. By 2008, 30 percent of McDonald’s India’s supply was being manufactured locally. By
2010, that number had grown to 75 percent. McCain’s efforts were in line with McDonald’s
approach with other farmers. For iceberg lettuce (another key ingredient in McDonald’s menu),
the farmers were taken by McDonald’s to various countries like Australia and China to give
them exposure to different growing techniques and farming practices.
The benefits to McDonald’s from using local fries were a 30 percent lower cost structure and no
exposure to the fluctuating exchange rate. In the second half of 2011, for example, the Indian
rupee exchange rate had gone from 44.5 INR to 53 INR per U.S. dollar. This meant that local
fries were saving an additional 19 percent in import costs. With local fries, inventory levels were
reduced from an average holding of 15 days for imported fries to 6 days for local fries. The
reduction in shipping time (60 days from the U.S. to less than a day for getting local product)
also had a significant benefit for risk management and contingency planning.
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In addition, McCain’s close relationships with farmers helped ensure a secure supply. While
collaborating with so many different farmers had its complexities, Bakshi also saw the diverse
supply base as a positive to securing supply: “Even if one or two farmers are not able to work
with you, it doesn’t really change the model … it’s the best insurance for yourself.”
There were benefits to farmers as well. Traditionally, farmers sold produce at the local “mandi,”
or village market. When potatoes were traditionally harvested in February and March, they were
at the mercy of the mandi, where prices could be manipulated. Mandi sales and prices could
fluctuate dramatically. The benefits to farmers of doing business with McCain were: guaranteed
sales of farm output, an increase in yields of 30-40 percent compared with “regular” potatoes,
reduction in operating costs, increased and predictable farm income, and reduction in
consumption of natural resources like water. Another benefit was trust. One farmer said, “Our
money is safe with them [McCain]. We can’t trust the brokers [middlemen].”
By avoiding selling to a middle man at the mandi, many farmers reported making more money.
Farmer Hitesh C. Patel used to grow cotton, corn and other items and switched to french fry
potatoes. After switching products, he reported getting higher prices, yields and quality
production, which enabled him to purchase a Honda City car after using a bicycle for many
years. He said, “My lifestyle has changed, my personality has changed. Farmers today are being
treated as first class, not fourth class.” Many farmers reported seeing an increase in yields after
receiving guidance and training from McCain, and ultimately their profits rose. Farmer Amrit B.
Patel reported seeing an increase in income. In his opinion, the risk in doing business with
McCain was zero, since the price he and other farmers received was fixed. He reported that, of
all the companies he knew of, McCain was the only one that worked directly with farmers rather
than going through brokers. Bakshi observed, “They [farmers] are eager to learn, they’re eager
to change; they’re eager to innovate so they can have a better life.” The Gujarat government also
supported farmers by providing subsidies for drip irrigation equipment, submersible pumps, and
other items which helped farmers to improve yields.
While collaboration with source suppliers had yielded many benefits, parties always had to
balance the needs of everyone involved. According to Jatia, “We say it’s about the end
customer, and we expect our suppliers and the whole system to do whatever it takes to meet the
needs of the end customer because that’s what is important. And sometimes in that bargain there
are conflicts that are thrown up, and resolving those conflicts in terms of pricing protocols, in
terms of adding capacity and who retains what margin, becomes challenging.”
After more and more french fries began to be processed locally, McDonald’s fries costs declined,
which helped the company launch Extra Value meals. These were designed to provide an entrée,
drink and fries at everyday low prices. Jatia said this decision to launch extra value meals helped
McDonald’s improve its position as an affordable meal destination, thereby increasing customer
visits and average spend per visit.
OPTIMIZING THE SUPPLY CHAIN NETWORK
While McDonald’s and McCain had made great strides in growing the local MacFry supply,
McDonald’s still faced many challenges looking ahead. F or
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The first challenge revolved around quantity and quality. How could the company deal with
volume increases while still getting the quality product it required? In 2011, the company had
about 240 restaurants. The goal was to grow this number to 500 by 2014 and reach out even
more to the growing middle class of over 250 million people. How was the company going to
source better, cheaper and faster than the competition? Quality food processing suppliers were
still in relatively short supply—assuring a sufficient supply of product was management’s most
serious concern. There were other supply chain challenges that exacerbated the problem, such as
poor roads from farms to highways, and a lack of quality warehousing space. Management was
also concerned about product costs. But constraints on the physical product or manufacturing
capacity would be a severe barrier to growth.
To meet rapidly growing demand, rather than simply focus on its own supply chain, McDonald’s
had begun to focus on its suppliers’ supply chains. With the MacFry, since only 75 percent of
fries were being processed locally, the challenge would be meeting ever-growing demand while
increasing the portion of fries processed in India. Bakshi had a long-term vision to even become
a net exporter of fries to other countries within the McDonald’s system.
The second challenge had to do with costs, since everyday value to the customer was such a key
aspect of McDonald’s business proposition. Although McCain, the potato farmers and
McDonald’s had come a long way from conditions in the 1990s, inflation continued to hover in
the double digits in India, making it all the more important that McDonald’s manage its supply
chain costs (Exhibit 5). Jatia and Bakshi wanted to grow productivity and manage costs rather
than increase prices, since consumers’ discretionary spending was being threatened by inflation.
One benefit of McCain working directly with farmers was that, with the middlemen out of the
picture, farmers retained more profits. So even if inflation was high, farmers would experience a
modest increase in their income since they no longer had to give some profits to the middleman.
With french fries being the largest volume purchase item, its costs mattered. How could
McDonald’s get to 100 percent local fries? The Indian climate allowed growth only in the
winters versus the long summers in the U.S. and Europe. The growing season in India was 90 to
100 days, as opposed to 120 to 140 days during summers in the U.S. and Europe. In India, the
window for harvesting a full year’s crop was about 15 to 30 days, whereas it was 60 to 90 days
in the U.S. and Europe.
In addition, limitations existed in the type of cold storage technology available, so potatoes could
not be stored for more than six to eight months. With these limitations, the McCain
manufacturing line would only be used for fries six to eight months in the year. McDonald’s still
faced importing some fries at a high cost. McCain wanted to stretch the shelf life of potatoes to
10 to 11 months, which would enable them to produce fries 365 days a year. In terms of
production costs, local fries cost about 70 percent of imported fries. Inventory holding for
imported fries was 275 metric tons, compared to 110 metric tons for local fries. With cold
storage available, McDonald’s could explore multiple ways to get potatoes from farmers (see
Exhibit 6).
A third related challenge involved keeping up with production needs without increasing supply
chain costs. For example, if McCain eventually would have to consider adding an entirely new
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plant to manage growing demand, the cost structure would again be mismatched with restaurant
revenues, as was the case in the late 1990s. This would make it challenging to deliver affordable
product and value to the customer.
A fourth challenge the company faced was competition for supply from other international food
companies. Companies like PepsiCo had the same quality standards as McDonald’s, and would
be looking at the same suppliers and many of the same farms for supply. An advantage
McDonald’s had was in volume. Even during an economic downturn such as the one in 2011,
McDonald’s volume was relatively stable—suppliers were still able to cover their fixed costs.
Due to this and the long-standing relationships it had built with nearly 1,000 farmers, company
management felt confident that they could continue to depend on their suppliers.
McDonald’s India and McCain India had come a long way and had discovered that close
collaboration with farmers was essential to their collective success. They have been successful
in sourcing locally for their demands (see Exhibit 7). Given the pressure of food inflation,
reducing reliance on imports was becoming even more critical. There were several avenues
McCain could take to better optimize the supply chain network. The company’s close
collaboration with farmers over many years would help them address the current challenge of
cost control. But the question remained: Could McDonald’s ever achieve 100 percent local
supply and stay there amidst growing demand?
STUDY QUESTIONS
1. What were the pitfalls of the initial attempts by McDonald’s India to create its french fry supply chain? What were the critical factors that enabled McCain’s success?
2. Under McCain’s management, the MacFry supply chain has been effective. What are the risks of this model? How can McDonald’s address the competitive threats from other
firms moving in and capitalizing on the large investments of time and money that
McDonald’s has made?
3. What are the options McDonald’s India can pursue to meet the huge growth in demand that has been predicted in India?
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Source: McDonald’s India (with permission).
Exhibit 2
Selected Financial Data
The Contribution of McDonald’s French Fries to Costs and Revenues
As a percentage of total purchase 10%
As a percentage of total revenue Approximately 15%
Capital Costs for French Fry Manufacturing
Lamb Weston/Tarai Foods joint venture $10 million
McCain India $40 million *
Source: McDonald’s India (with permission).
* Note: 25 million Canadian dollars were invested in the facility. The US dollar estimate was made based on
USD/Canadian dollar exchange rate in 2002, http://www.tradingeconomics.com/canada/currency (accessed January
30, 2012).
Exhibit 1
McDonald’s India - Imported versus Local Fries
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Exhibit 3
McDonald’s India Menu Board with Fries
Source: McDonald’s India (with permission).
Exhibit 4
French Fries Potato Farms – Gujarat, India
Source: McDonald’s India (with permission). F or
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191
McDonald’s India: Optimizing the French Fries Supply Chain: GS-79
p. 14
Exhibit 5
Indian Inflation Rate (Annual Change of Consumer Price Index)
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
3.72% 3.78% 5.57% 6.53% 5.51% 9.70% 14.97% 9.47% 6.49% 11.17%
Source: Inflation.eu, http://tinyurl.com/7ga23aa (accessed November 19, 2013)
Exhibit 6
Multi-Channel Potato Value Chain in India
Source: McDonald’s India (with permission).
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McDonald’s India: Optimizing the French Fries Supply Chain: GS-79
p. 15
Exhibit 7
Sourcing for McDonald’s India
Source: McDonald’s India (with permission).
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9B07D008 THE NORTH WEST COMPANY (B): SUPPLY CHAIN MANAGEMENT Ken Mark wrote this case under the supervision of Professors P. Fraser Johnson and Steve Foerster solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected]. Copyright © 2007, Ivey Management Services Version: (A) 2010-02-09 INTRODUCTION It was Thursday March 27, 2003, and Barry McLeod, director of procurement and marketing for The North West Company (North West), was considering North West’s proposed move to a “pull” merchandise replenishment strategy — also known as localization. Currently, North West employed a “push” strategy in which category managers at North West’s Winnipeg headquarters analysed trends, placed orders and allocated products to stores. At North West, the shift towards localization promised to tap into the local knowledge that resided with store managers, allowing them to better tailor product quantities to preferences in their communities. Under localization, product assortment decisions, which had been previously made at the category manager’s level at Winnipeg headquarters, would become the responsibility of North West’s 147 store managers. As McLeod wondered about the challenges and opportunities of moving to a “pull” strategy, Ken Claudel, vice-president of logistics and supply chain, e-mailed to request a Monday morning meeting to review three items: the benefits and costs of localization, the potential risks of localization and the implementation plan. NORTH WEST COMPANY’S CURRENT SUPPLY CHAIN STRATEGY Forecasting and Procurement Similar to other large retailers, North West category managers analysed sales and markdown trends, worked with suppliers to determine which new products to stock and submitted purchase orders at least four months in advance of popular selling periods, such as the back-to-school season (mainly August and September) and the Christmas shopping season (mainly November and December). Forecasting the next year’s demand was a blend of science and art. Typically, category managers worked with store managers to review the previous year’s lineup, orders and actual sales. Using historical averages and the next year’s forecast growth rate, category managers estimated demand for products at a company level. Category Fo
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managers met frequently with suppliers to review the product lineup for the upcoming year, which often differed from year to year. North West’s buyers would also visit trade shows in Canada, the United States and China to assess potential new products. Lead times ranged from three to six months for purchases of general merchandise (largely from China), which was longer than the lead time for purchases from local and regional manufacturers. At North West, the general merchandise category encompassed all non-food items and included home furnishings, housewares, apparel, footwear, outerwear, luggage and transportation. Product Receiving and Shipping Approximately two months before a selling period, suppliers’ products started arriving at North West’s distribution center in Winnipeg, Manitoba. The distribution center was 340,000 square feet: 290,000 square feet of production space and 50,000 square feet of office space. In 2002, inventories at the distribution center averaged $21.5 million: food ($12.5 million), general merchandise destined for stores ($3 million) and merchandise for the Selections Catalogue ($6 million). North West’s distribution center had two levels: On the ground floor, merchandise was received, neatly stored, then selected and shipped to stores on a regular basis. On the top floor, seasonal merchandise was temporarily stocked separately from regular merchandise. Small but high-value items were stored in the center of the distribution center, on two floors, where they could be efficiently picked for orders from North West’s Selections Catalogue. In general, space was optimized since product receiving and shipping followed a tightly managed schedule. In this supply chain, slow-moving or excess merchandise that was pushed to stores was eventually (and temporarily) housed in a store’s warehouse before being discounted or discarded. For a high-level look at a sample supply chain for the Back to School selling period, see Exhibit 1. Merchandising and Selling Stores started receiving shipments of a product about four to six weeks before its selling season. As soon as the merchandise was received, all of it was put on display. Thus, although the back-to-school season ran mostly from August to September, selected back-to-school products were being displayed as early as late June. From late June to September, stores would receive shipments of different back-to-school products, in order to keep the product assortment fresh. Unlike other large retailers, North West’s 147 stores were spread thinly across Canada: product could take anywhere from a few days to four weeks to deliver, using a variety of transportation modes, including truck, boat, airplane and rail. Shipping product to remote regions was always a calculated risk on the part of the category manager: if it were a popular item, it would often sell out the day it arrived. If excess stock were shipped, there would be markdowns according to a set schedule. When markdowns reached the 75 per cent level, product was shipped to North West’s clearance outlet in Winnipeg, Manitoba. If particular items were not immediately available, Northern customers were often known to either shop at competitors’ stores or purchase substitute items. Markdowns Eight to 10 weeks after product first arrived at the store, store managers began their product price markdown program, which involved a series of escalating discounts of the original retail price. Markdown
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programs were key to inventory management at all retailers: aging inventory was sold to generate cash and to make way for fresher stock. For the current markdown schedule, see Exhibit 2. EVALUATING THE LOCALIZATION STRATEGY For the past six years, North West’s inventory turns had been in the 2.2 times range, below its annual target of 3.0 times. At the store level, aging inventory was building up, as can be seen in Exhibit 3. Exhibit 4 provides inventory turns for other retailers. Inspired by Giant Tiger’s example of a “pull” system in action, North West management was considering giving store managers more control over their inventory ordering. Forecasting and procurement would continue to be managed centrally; however, store managers would be able to customize their stores’ product assortments by choosing from a menu of products. Store managers would become the local market experts, determining which stock-keeping units (SKUs) to carry and in what quantities, and incentive plans would be changed to reflect these new responsibilities. For example, a greater percentage of a store manager’s pay would become variable, linked to the store’s operating margin. A store manager could decide to expand the store’s fresh food assortment, the store’s toys and gifts section could be tailored to meet different festive periods, or double the standard allotment of oak furniture and closets could be ordered if a new road works project was expected to pump additional funds into the community in the coming months. The key limiting factor for store managers was their “open-to-buy” (OTB) dollars. For a description of how OTB worked, see Exhibit 5. North West would need to invest less than $10 million1 to develop a computer-based Advanced Ordering System (the appropriate computer hardware and software) to support the OTB process. The OTB process would spur store managers to clear out aging inventory in order to free up dollars to purchase new inventory. McLeod developed a simple model to illustrate the effect of aging inventory on profitability (see Exhibit 6). From an operations perspective, there were several implications with regard to localization. McLeod observed:
We will have 147 different store managers making decisions on the quantity of product shipped to store. Store managers, even if they are given the same set of information, might make different decisions, based on his or her preferences, experiences and biases.
Localization seemed like a great way to enable store managers to take advantage of their knowledge of the community in which they lived. McLeod summarized the situation:
Currently, we have not been able to increase our inventory turns over 2.2 times. I expect that with localization, we could achieve inventory turns in the 3.0 or 3.5 range. However, there are risks involved. Our supply chain processes will have to change. We’ll have to invest in information systems and technology. For store managers to operate effectively, they’ll have to be trained and coached. Localization is a large project with organization- wide impacts.
1 Case writers’ estimates.
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McLeod wondered where he should start and how long implementation would take. He knew that Claudel expected him to assess the localization initiative on three levels: the potential benefits and costs, the risks and the implementation plan:
I first need to identify where localization makes sense for the company. Do we implement localization for all of our food and general merchandise categories or for only a selected number of categories and or SKUs? With respect to rolling this out, I will need to decide whether to start implementation by category or the store level. For example, should we identify all or most of the localization categories at the outset and implement on a store-by-store basis, or should we start with a limited number of categories and let all the store managers participate from the outset? Obviously our store managers would need training and we would have to support localization with appropriate management information systems. I can see a lot of upfront costs and I’m concerned about the return on investment on this project. I want to understand the economics of localization before we proceed. In will need to explain to Ken where the potential costs and opportunities are if we proceed with localization. Finally, North West has approximately $130 million invested in inventory and I see localization as one of several potential opportunities to improve our margins and return on investment. Consequently, if we decide not to proceed with localization Ken will expect me to show how and where we can make improvements under our current supply chain model of direct distribution.
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Exhibit 2
THE NORTH WEST COMPANY’S MARKDOWN SCHEDULE (2002) (showing percentage off retail price)
Weeks 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Large Store 0 0 0 0 0 0 0 25 25 25 50 50 50 50 50 75 75 75 75 Small Store 0 0 0 0 0 0 0 0 0 25 25 25 50 50 50 50 50 75 75 75 75
Source: The North West Company.
Exhibit 3
THE NORTH WEST COMPANY’S AGE OF INVENTORY REPORT (FISCAL YEAR 2002)
Age of Inventory (in weeks) 0-6 7-12 13-18 19-24 25-30 31-36 37+ Value of Inventory (%) 67.0 11.9 11.5 4.8 2.0 1.2 1.6 100.0
Source: The North West Company.
Exhibit 4
INVENTORY TURNS FOR OTHER RETAILERS (2002)
Source: The North West Company.
Company Inventory Turns Costco Wholesale Corp. 11.5 Wal-Mart Stores 7.5 Target Corp. 6.0 Walgreen Co. 5.7 Sears Holding Corp. 3.9 The North West Company 2.2
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Exhibit 5
THE NORTH WEST COMPANY’S OPEN TO BUY (OTB) DESCRIPTION
Budget − Forecast = OTB $1,200 − 900 = $300 Beginning $ Inventory $1,000 − Need For Sales (500) + On Order 400
= Forecast Ending $ 900 Forecast Inventory $
Budget End of period $ 1,200 OTB $300
Source: The North West Company.
Exhibit 6
THE NORTH WEST COMPANY’S INVENTORY AGE AND PROFITABILITY (2002)
Cost of item (including freight) $ 100.00 Retail of item $ 230.00 Margin % 56.52% Inventory holding cost (per month) 1.83%
Inventory Age Cost of Item
(including inventory holding cost)
Margin Profit (if sold at
full retail price) 1 month or less $100.00 56.52% $130.00 6 months $111.49 51.52% $118.51 1 year $124.39 45.95% $105.69 2 years $154.53 32.81% $75.47 3 years $192.10 16.48% $37.90
Source: The North West Company.
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9A95D021 ROSENBLUTH: SUPPLY CHAIN MANAGEMENT IN SERVICES Sara Allan prepared this case under the supervision of Professor John Kamauff solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. This material is not covered under authorization from CanCopy or any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected]. Copyright © 1995, Ivey Management Services Version: (A) 2008-10-23 On October 1993, Mike McCormick, Director of Industry Relations for Rosenbluth International, an international travel services company based in Philadelphia, Pennsylvania, was preparing a series of negotiations with one of Rosenbluth’s “preferred” airline suppliers. Ever since a new manager had taken over travel agency relations one year ago at this airline, the relationship with this supplier had deteriorated. As a result, Rosenbluth had been directing fewer of its corporate clients to the airline. McCormick wondered what he should do about the relationship. Should Rosenbluth continue to consider the airline a preferred supplier, or should it focus on other suppliers with whom the relationship was stronger and more cooperative? His primary obligation was, after all, to the needs of Rosenbluth’s clients. Mike had to determine the best way to manage Rosenbluth’s suppliers to satisfy those needs. ROSENBLUTH INTERNATIONAL Rosenbluth International was a worldwide travel management company with annual revenues of $1.5 billion. Started by 1892 by Marcus Rosenbluth as a steamship ticket office, the Rosenbluth family continued to own and manage it throughout its 100-year history. President and CEO Hal Rosenbluth started his career with Rosenbluth in 1974. In 1992, Rosenbluth had 550 locations in 335 cities and had established international alliances with 34 affiliates around the Fo r
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globe. Since 1992, annual revenues had grown from $40 million to $1.5 billion. Rosenbluth operated in three lines of business: leisure travel, meeting and motivation management, and corporate travel (which represented 90 per cent of the company’s revenues). According to industry observers, Rosenbluth’s ability to exploit the opportunities offered by the deregulation of the airline industry in 1978 had fuelled its growth. The advent of deregulation meant that airlines could change fares and schedules any time they wished. This resulted in a massive increase in the number of available routes and fares, and the information became very volatile, as changes were made constantly. The printed medium was no longer an efficient way to conduct business for travel agencies, and a different approach was needed to keep up with tariffs and schedules. Computerized Reservation Systems (CRSs), provided by the large airlines, became a permanent fixture in the airline/travel agency distribution system. The CRS gave immediate access in a real-time environment to air tariff information, the availability of specific seats, and a sense of what discount opportunities were available. Changes in schedules, etc. were immediately reflected in the CRS system. Deregulation had a profound impact on the travel industry and some experts predicted the demise of the travel agency as a factor in the industry. Hal Rosenbluth and his colleagues reacted differently.
What did deregulation mean? We weren’t sure we knew. But if all the bets were off, the company that could gather information faster and turn it into knowledge would win.
Rosenbluth was able to recognize early the impact that this information explosion would have on corporate travel expenses, and positioned itself to become an expert in managing corporate travel information. The corporate market wanted excellent service, coupled with a need for quick access to information that would allow any feasible cost savings to be realized. Information technology was the only mechanism for cost effectively managing the complexity that emerged in the industry following deregulation. Therefore, Rosenbluth set out to create an information systems infrastructure that would allow it to gather, track and report information on all of its clients’ travel activity (Exhibit 1). It began by downloading information from the CRS and modifying the data locally to produce customized reports for corporate clients. In 1983, Rosenbluth introduced READOUT, a product that turned the flight selection process around, listing flights by fare instead of by time of departure. The CRS would display available flights by time of departure only; thus in order to find out the cost of a flight, the agent would have to switch back and forth between fare screen and the list of flights. In contrast, READOUT would display the flights for a particular city-pair in order of increasing fare, so that the cost implications of a particular flight selection were immediately apparent at the point of sale. Fo r
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In 1985, Rosenbluth took another important step toward becoming a technology leader by developing systems that would allow it to operate in the back office independently from the CRS. The CRS was essential in performing the travel agency functions, and the CRS providers had leveraged this into control over virtually all aspects of the business. All hardware and software were closed systems with fixed functionality, including the “back-end” processing for accounting and travel management reporting, and the system was subsidized by the CRS provider, usually an airline. For Hal Rosenbluth, the primary issue was control over back-end processing. Overall, the CRSs were not sufficiently responsive to corporate clients’ needs for reporting and control. The CRS subsidy further impinged on the agency’s independence. As Hal Rosenbluth said:
Knowledge is in the back office. If you are dependent on a CRS provider for your back office, you can’t fully utilize the knowledge. How can you ask United Airlines’ APOLLO to help you shift a client’s business to American?
Rosenbluth developed its own back office system, VISION, in 1986, thus liberating itself from the control of the airlines who owned or operated the CRSs. The CRSs were still used for booking a reservation, but a record of the transaction always went into VISION also. The resulting VISION database provided complete and accurate information and gave considerable flexibility in reporting and analysis. Not only did VISION allow Rosenbluth to provide extensive reporting for corporate clients, it also allowed the agency to track its market share and volumes with the service providers. Rosenbluth was now able to identify opportunities for negotiating price and rebates with the airlines, based on historical fact. Exhibit 2 shows the categories included in a sample VISION report. TRAVEL INDUSTRY — SUPPLIER RELATIONS The use of negotiated fares and rates was an important trend to appear in the travel industry in the 1980s. As early as 1982, about one-half of firms surveyed with in- house travel departments were negotiating rates directly with hotels and car rental agencies. These special prices were primarily corporate-wide discounts and special group prices for specific meetings and events. In the mid-1980s, a new frontier in price negotiation opened. By having access to detailed data on their corporate travel down to the city-pair, firms were able to identify their high- volume routes and negotiate with suppliers for preferential fares on a route-by- route basis. Maximizing the opportunities for negotiated prices required consolidating travel information over an entire organization to lever purchasing power fully. The organization had to be able to demonstrate to the air supplier that the increase in the volume from a fare program would more than offset the lower fares. Using a Fo r
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single agency facilitated this consolidation of information. Moreover, the purchasing power of the travel agency itself could be an important factor in negotiations, creating a benefit for consolidating travel through fewer agencies. The ability of an agency to move market share dictated negotiated prices which required being able to demonstrate the effects of the program and to monitor compliance. Travel agencies were in a good position to encourage compliance with the firm’s negotiated agreement at the time the reservation was made. Rosenbluth was a pioneer in the industry in the use of negotiated route-by-route fares, thereby taking advantage of the trend towards consolidating travel accounts through a single agency. The VISION system was truly innovative in the industry at the time and allowed Rosenbluth to provide the detailed analysis required to its clients and to negotiate with travel suppliers on their behalf. Negotiated route-by- route programs led to a significant change in the way that Rosenbluth approached the corporate travel market. Corporate travel was sold almost exclusively by agency commission sharing. Travel agents would typically rebate to clients 15 per cent of their commissions. Rosenbluth adopted a more cooperative approach based on service and partnership. Instead of rebates, Rosenbluth offered guaranteed savings through lower airfares. Rosenbluth maintained that it could reduce overall travel costs for the client while still earning its standard 10 per cent commission. This claim could be backed up by reports from the VISION system, comparing prices paid to the lowest available fare. Hal Rosenbluth described the Rosenbluth approach as follows:
Rebating doesn’t help anyone involved. When a service company gives away its commissions, it doesn’t leave much to pay its people and to invest in the future. In the end it hurts the company and its clients. We try to hold firm to a position that makes everyone win. We might guarantee a client with a $20 million budget a $1 million reduction in travel costs through consolidated purchasing, specially negotiated fares and the manipulation of travel patterns toward less expensive alternatives. In effect we are saying, “Why assume you have to keep spending that $20 million?”
Rosenbluth formed an Industry Relations department to manage supplier negotiations on behalf of clients. This allowed all negotiations to be undertaken centrally, sending a consistent message to clients. Industry Relations personnel developed close ties with the relationship managers at the supplier companies. In 1991, Mike McCormick was appointed Director of Industry Relations. Mike joined the department in 1986 as a data analyst and in 1988 had been promoted to Manager of Industry Relations. As manager, he had been responsible for expanding the department to include a supplier relations management team. This team worked to improve and enhance Rosenbluth’s preferred supplier Fo r
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relationships, by creating business and marketing plans, guiding Rosenbluth’s business units in their supplier relationships, and ensuring that valuable supplier products and services were available for clients. Mike described the process the department undertakes as follows:
We have positioned our department as a yield management group. As a travel company our clients are expecting us to manage their travel budgets. Once you have done that to satisfy the client’s need to the lowest cost, you need to take a macro bundling of all of our accounts to maximize our margins and to achieve overrides above the standard 10 per cent . . . Contracts are usually a year, but that’s only a formality. With our primary suppliers, we start by setting joint objectives and then we back into how we are going to measure that to ensure that we jointly meet our goals. The negotiations are clearly different from a yearly sit down to hammer out costs. It is more like an on-going set of negotiations as we continually iron out details. The weekly and monthly management reports are used to help us manage our activities. We share all of our info with the airlines.
To provide the motivation for successful negotiations, Rosenbluth employed techniques such as taking inventory positions to secure the most economical routes for clients. Rosenbluth studied travel patterns, and suppliers were guaranteed a certain level of business based on historical data. The company shared information both with clients and suppliers. Rosenbluth’s systems allowed the company to demonstrate exactly how much it cost a client to travel between two points on any given time of day, day of the week or week of the year. This information could then be used by the client to shift travel patterns to those times during which travel was more economical. Rosenbluth would then show clients how to shift business to the carrier that offered the best rates and services. Exhibit 3 shows a sample of an airfare activity report that would typically be used in negotiations. Exhibit 4 similarly depicts a typical travel pattern analysis that would be used to describe travel patterns, airline market shares and the impact of negotiated airfare programs. As Hal Rosenbluth described it, “The suppliers who participate get more business; our clients get significant savings, and we share in those savings.” Partnering with airlines allowed Rosenbluth to define clearly its role in the travel process. Negotiated agreements with clients and travel agencies assured the airlines of brand loyalty. According to David Miller, Director of MIS at Rosenbluth:
Developing brand loyalty is a real problem for airlines. For them, we are creating a mechanism that takes care of those facets of travel that they cannot handle. The ideal situation for airlines would be to Fo
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have travel agency dealerships. We use this to our advantage by partnering with appropriate airlines to reinforce the relationship with the customer at a lower cost than the airlines can.
Hal Rosenbluth believed strongly in the benefits of forming close partnerships with both clients and suppliers. He said:
Companies can’t overlook the importance of supplier relationships in helping to meet their client’s needs. In our case, we rely on airline, hotel and car rental suppliers to provide the end product — the travel itself. We need to make sure that our suppliers are performing for our clients. We need to work in concert with our clients and suppliers in strategic partnerships. The way we see it, all three parties need to know exactly what to expect.
Rosenbluth’s strategy was to appeal simultaneously to the airlines for lower costs and better services and to the customer for preferences. Hal felt that more could be accomplished when clients and suppliers worked together like true partners in a venture than in a typical adversarial relationship. Supplier selection was predicated to a great extent on trust. Hal described the process of forming preferred supplier relationships as follows:
Regarding the airlines, we went in with those executives who we thought would be respectful of a partnership. It had a three-way win. Any one of the three parties could destroy it. Trust and respect, the viability of the supplier, and geographical overlaps and linkages were key. We focused on the thought processes of their senior executives. One of the major issues was that we did not try to build long-term relationships with potentially competing companies, which was the game that most travel agencies tried to play.
According to Mike McCormick:
We don’t have these relationships with all airlines. We had to make decisions about aligning with preferred suppliers. Our ability to direct business is the lifeblood of our industry. The number of preferred suppliers has narrowed over the years and will continue to narrow. You can only give your true support to so many, both statistically and in terms of developing and sustaining ethical relationships. We have taken the high road here by making tough decisions often resulting in short-term sacrifices, but over the long term we have engendered open and trusting relationships . . . which is not necessarily indicative of our industry. Fo
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Rosenbluth was committed to maintaining open, trusting relationships. The company strived to be known as the ethical player in the industry. According to Mike Melvagh, Manager of Rosenbluth’s Canadian operations:
We will tell a client that we can’t do something if it jeopardizes our relationship with a supplier. Our Industry Relations department has worked very hard to build Rosenbluth’s reputation and image. Why would we want to risk damaging it?
Added Hal:
One of the things we have always done, and we’ve made it very clear to our existing and prospective clients, is that we’re going to be very straight with our suppliers in negotiating with them. We won’t promise to deliver something that we don’t know we can deliver.
This policy of openness and trust was entrenched throughout the company, as well as with its clients and suppliers. Hal Rosenbluth had endeavored to shape a culture based on team work and employee empowerment at Rosenbluth. His success was recognized when Rosenbluth was ranked among the top 10 in the book The 100 Best Companies to Work for in America (Exhibit 5). Hal’s philosophy was that there was no reason to hide anything from clients:
The more you try to hide something the more curious people become. We found that openness is reciprocal. The more candid we are with our clients and suppliers, the more candid they are with us. The level of trust we build is reciprocal.
Hal also insisted that Rosenbluth use its clients’ products whenever feasible. Hal gave this example of the importance of this policy:
Because the James River Corporation is our client, we use only their paper products. Each time we visit the rest room, we’re reminded of how important our clients’ products are.
Hal’s vision of partnership extended past the traditional client-supplier relationship.
The definite level in partnership is the idea of a “corporate marriage.” This would be a form of interchange that takes place in an environment of complete trust. An exchange of people.
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Hal felt that this level of partnership provided insight into the needs of clients that could not be attained any other way. As Hal put it:
The benefits are reciprocal. Our clients who participate in this degree of partnership come to understand the objectives we must achieve as a business and the challenges we face. A walk in each other’s shoes builds the platform for true teamwork.
Achieving “corporate marriages” with key clients would truly entrench Rosenbluth’s relationships. According to Hal:
The only thing that puts the relationships at risk is new management in the partners. If they differ in their beliefs, it can lead to catastrophic break-ups. It would take us less than a night to adapt to a change but only with the participation and understanding of our clients.
THE CURRENT SITUATION A change in management at Global Airways was what had precipitated Mike McCormick’s current troubles. Rosenbluth had first developed a preferred supplier relationship with Global five years earlier. Together with several of its largest national accounts, Rosenbluth had successfully negotiated route-by-route overrides with Global for many important domestic city-pairs, which represented very high volume routes for Rosenbluth. Global was one of the three largest airlines in the United States and had established itself as a leader in the industry in providing quality in-flight services for corporate travellers. The U.S. airline industry, including Global, had faced serious financial difficulties during the period 1990 to 1992. (See Exhibits 6 and 7 for airline industry aggregate data for the years 1982 to 1992). However, Global appeared to be recovering better than most U.S. airlines, following a restructuring and a significant cost-cutting effort in early 1992. As part of the restructuring, many top managers were let go, including the management of the Corporate Relations department. Rosenbluth had enjoyed a very strong relationship with the former Vice-President of Corporate Relations, Rick Chadwick. Chadwick had supported Rosenbluth’s approach to building corporate loyalty and moving share through negotiated fares. He recognized the importance of partnering with travel agencies to provide the travel management function that the airlines could not cost effectively perform for large corporate clients.
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The restructuring had resulted in a significant downsizing of the Corporate Relations department at Global. The remaining staff now reported to the Vice President of Operations, Bill Whitherspoon. Whitherspoon had been hired in 1992, and had previously worked at one of the largest telecommunications companies in the United States. He had no previous experience in the travel or transportation industries. Whitherspoon’s background was as a comptroller, and he had a reputation as a “real bean-counter”. Mike had scheduled a meeting with Whitherspoon immediately following his appointment. The meeting had been a disappointment. Whitherspoon announced that negotiated airfares on high volume routes were going to be seriously curtailed with all corporate clients. This would translate into a large increase in travel costs for Rosenbluth’s clients that flew these routes, much to their dissatisfaction. Rosenbluth and its clients were starting to look around for possible discounts at other airlines. Mike felt that the options were fairly limited. The two other large carriers that flew these routes were both struggling with large operating losses and very high debt loads. Their future viability was not assured. The service levels on these airlines had also deteriorated with the decline in profitability, as they attempted to control costs. In addition, one of the airlines owned a minority interest in one of Rosenbluth’s largest competitors. However, both airlines were showing willingness to negotiate on price, especially if the travel agency could demonstrate the ability to move market share away from the airlines’ competitors. Alternatively, Mike could try to salvage the relationship with Global. Although the clients in question were unhappy about fare increases, they all had very strong relationships with Rosenbluth and were extensive users of Rosenbluth’s travel management products. Their combined travel accounts amounted to over $150 million. Perhaps working together to lobby Global for better service could sway Whitherspoon. Whatever the solution was, Mike would have to be creative. Whitherspoon, although unyielding, appeared to be fair and possess integrity. Rosenbluth had been successful in demonstrating the benefits of the relationship to Global in the past. Now Mike had to determine how to demonstrate what benefits there might be in future co-operation, if he wanted to preserve the relationship.
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Exhibit 1
ROSENBLUTH TRAVEL: DOMESTIC TECHNOLOGY INFRASTRUCTURE
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Exhibit 2
AIRFARE COST PER MILE — DETAIL BY TIME OF DAY This report provides useful cost per air mile information by city-pair and carrier flown. By analyzing this report, a travel manager can either direct travellers towards a particular carrier or flight or be better equipped when negotiating with airlines. A report is also available by day or week, which determines the company’s most popular travel day and time. Either non-directional or directional travel can be analysed. 1. DATE RANGE: Time period analysed on report based upon date of travel. 2. CITY-PAIR: Point-to-point arrival and destination cities for each segment
flown. 3. CARRIER: Airline flown for corresponding city-pair. 4. NO. OF TRIPS: Number of segments flown within the corresponding city-pair. 5. FLIGHT NUMBER: Airline assigned flight number 6. DEPARTURE Time slots analyzed. Shown in military time. TIMES: 7. CLASS OF TRAVEL: Categories applicable to class of service flown. 8. TOTAL FARE PAID: Total value of all segments within corresponding city-pair. 9. AVERAGE FARE PAID: Calculated by dividing total no. of segments into total fare paid. 10. CITY-PAIR MILEAGE: Air miles involved within corresponding city-pair. A consistent
source is used to generate these figures. 11. AVERAGE COST Calculated by multiplying the total no. of PER MILE: segments and the city-pair mileage and dividing that figure into
the total fare paid. 12. SUBTOTAL: Totals for each report field for each carrier flown or the selected
sort field.
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Exhibit 3
AIRFARE ACTIVITY ANALYSIS
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Exhibit 3 (continued)
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Exhibit 3 (continued)
Figure 5 -
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Exhibit 4 Travel Pattern Analysis This section discusses travel patterns, airline market shares, and the impact of negotiated airfare programs. Comparative average ticket prices in your company’s most frequently travelled markets and in total are also provided. Impact Analysis of Negotiated Airfare Programs The table below depicts your company’s top 10 most frequently travelled markets, the actual number of one-way segments flown in each market, the actual share in each market, and a comparative airfare spending analysis. The spending analysis is projected from selected fare categories, representing the highest and lowest non-premium fares that were available to your travellers. The airfares employed in this analysis were compiled over the past quarter and do not take into consideration seat availability nor what was actually confirmed on behalf of your travellers.
This analysis is designed to assess travel patterns from quarter to quarter and to demonstrate the potential savings impact of negotiated programs. It is also useful for identifying new opportunities for negotiated airfare programs. 1Market values shown are derived by multiplying the actual number of segments flown in each market by the airfares noted in each category 2 Coach represents the full coach fare. 3 L.U.F represents the published “ Lowest Usable Fare” as defined by your corporate travel policy 4 NEG represents non-published airfares that were specifically negotiated for your company.
City Pairs Segments Coach2 LUF3 NEG4/LUF Coach LUF NEG/LUF Airline Share
IAH SFO 2,579 700$ 420$ 319$ 1,805,300$ 1,083,180$ 822,701$ CO 87.1% UA 8.5% LAX OAK 813 69 69 69 56,097 56,097 56,097 UA 61.5% WN 38.5% IAH OAK 772 700 239 239 540,400 184,508 184,508 UA 44.2% HP 40.3% IAH MSY 754 360 139 139 271,440 104,806 104,806 CO 100% HOU MSY 629 89 89 89 55,981 55,981 55,981 WN 100% LAX SFO 462 337 124 124 155,694 57,288 57,288 UA 69.2% US 18.5% OAK ONT 393 69 69 69 27,117 27,117 27,117 WN 100% SFO MSY 380 750 450 342 285,000 171,000 129,960 CO 48.8% UA 33.9% SFO IAD 290 920 500 380 266,800 145,000 110,200 UA 96.9% CO 2.1% OAK PHX 288 99 99 99 28,512 28,512 28,512 HP 69.8% WN 29.5%
3,492,341$ 1,913,489$ 1,577,170$ Potential Savings (%) 45.21% 54.84% Potential Savings ($) 1,578,852$ 1,915,171$
Negotiated Airfare Analysis Top 10 City Pairs Market Value1
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Exhibit 5
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Exhibit 6
U.S. AIRLINE INDUSTRY OPERATING PROFIT AND NET INCOME
Source: DOT Form 41 data
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Exhibit 7
U.S. CARRIERS’ OPERATING PROFIT/LOSS FOR INTERNATIONAL PASSENGER OPERATIONS
Source: DOT RSPA Form 41 Data
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220
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