ent case

We are lifestyle entrepreneurs, not financial entrepreneurs, and we are trying to create a company where people like to come to work each day and we can achieve our personal goals.

— Nate Burstein, President, Elasto Therm

Nate and Julia Burstein were living their dream. The husband and wife team had found a way to acquire a manufacturing business, Elasto Therm, Inc. (ETI), and operate it in a way that met their personal lifestyle goals. “We have a theory,” Julia explained. “Our employees come first, the customer comes second, and we come next.” The pair believed that if they created a culture where employees had high levels of job satisfaction, then employees would take care of the customers, which would lead to solid business performance; and the latter would ultimately benefit customers, and the Bursteins.

The key enabler of their success was setting prices high enough to earn 30% gross margins— higher, they believed, than most competitors in the industry. The margins, in turn, enabled ETI to create a positive work environment and attract and retain employees with talent and skill levels also beyond industry norms.

In December 2012, the challenge the Bursteins faced was to figure out how to manage the business over the coming decade in a way that allowed them to continue to live their dream. The Bursteins and their top team had identified several possible growth options that fell into two categories: change how they worked with the external sales representatives who sold the company’s products, and/or acquire another company. Both options risked upsetting the existing culture that was the foundation of their current contentment.

ETI

Founded in 1967, ETI was a manufacturer of custom molded rubber and urethane parts for original equipment manufacturers (OEMs) in such industries as automotive, small engine, healthcare, and electronics. Typical products included bushings, gaskets, gears, roller wheels, O-rings, and trim pieces. Headquartered in Columbus, Ohio, the company specialized in selling low- to mid-volume quantities, mostly to small- and mid-sized businesses. ETI customers were located primarily east of the Mississippi River. The company employed 90 workers and managers, and had 2011 sales of $15 million. Sales for 2012 were expected to hit $16 million. (See Exhibit 1 for financial data.)

________________________________________________________________________________________________________________

Senior Lecturer Jim Sharpe and Senior Researcher James Weber, Global Research Group, prepared this case. Certain details have been disguised. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.

Copyright © 2013 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

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REV: SEPTEMBER 9, 2013

813-030 Elasto Therm: The Next Step

Rubber and Urethane

Rubber and urethane were different materials with different characteristics, competitors, and buyers. Nate estimated that the rubber industry was 100 times the size of the urethane industry in sales and that over 2,000 companies in the U.S. manufactured molded rubber parts using technologies similar to those of ETI, while perhaps only 200 companies made urethane parts. Nate estimated that ETI had less than 0.5% of the molded rubber business in the Midwest, excluding tires—in effect, he said, “we are nothing.” Rubber accounted for 60% of company sales, and urethane 40%. Nate explained the recruiting challenge: “Engineers coming out of college know metal and they might know plastic, but they don’t know rubber and they certainly don’t know urethane.”

Customers chose materials based on the desired properties of their finished product. These included flexibility, hardness, wear resistance, strength, electrical properties and costs. Rubber tended to be more flexible than urethane and performed better at high temperatures, whereas urethane had much higher wear resistance. By mixing chemicals in different concentrations, ETI’s engineers produced products with significantly different characteristics. Customers most often did not know when they needed urethane and relied on ETI to guide them. Urethane cost roughly $5/lb. while rubber cost $2/lb. (Commodity plastic cost $0.40/lb.)

Nate and Julia Burstein

Nate and Julia both had extensive backgrounds in manufacturing. The pair first met in a manufacturing leadership training program at General Electric (GE) after each had earned an undergraduate degree in engineering. At GE, Nate recalled learning that “cooperation was vital,” and he was always “seeking a balance between leadership and camaraderie,” but he did not like the “fear factor” that came with ranking people from top to bottom and then firing people at the bottom.

After about three years at GE, they both left to attend Harvard Business School where they earned their MBAs in 1995. After HBS, they both joined Detroit Diesel where Nate did worldwide purchasing and Julia managed half of an 800-employee factory. In his position, Nate frequently visited small manufacturing firms and observed “I could tell how a company was doing just by walking through its plant and seeing if the people were smiling and the lunch room was clean.”

In 1997, the couple had just had their first child when Julia’s father, owner of $30 million Plymouth Plastics, asked them to join the family business in Ohio. Nate became vice president of sales. Market issues led Julia’s father to sell the business to a larger firm, but only Nate stayed on before leaving in 2000. Based on their experience at Plymouth, they decided they wanted to own their company rather than work for someone else. They were not looking to make fast money by doing a turnaround or financial engineering. Rather, they hoped to find an enterprise they could work at for the rest of their careers. After conducting a yearlong search, and reviewing a number of possibilities, they purchased ETI in 2001.

Acquiring ETI

When the Bursteins identified ETI, it was being sold by a 74-year-old owner who had acquired the company in 1977. The Bursteins loved this man as soon as they met him, and it was evident that he cared for his company, his employees, and his customers. Nate recalled thinking, “I want to be him when I am 74.” When they toured the plant they found a clean, profitable, well-run operation with steady growth and $8 million in sales. Nate added, “You can also tell a lot about a company by

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Elasto Therm: The Next Step 813-030

looking at longevity: of customers, suppliers, employees, even banking relationships; ETI had all that too.” They eventually reached a deal with the seller who wanted to sell it to someone like them and not to a competing bidder: a lawyer who had offered a higher price. Ultimately, the Bursteins acquired ETI for $6 million plus $1.2 million for nine acres of land and the plant building. The Bursteins had $700,000 of their own money and borrowed the rest from a bank, from Julia’s father, and the seller, partly in the form of an employee stock ownership plan (ESOP).

The ESOP

The ESOP idea fit well into the Bursteins’ plan to create a company where people chose to work. Under the ESOP plan, the Bursteins’ would receive 63% of the shares of the company. The remaining 37% would be owned by the employees. The seller received cash for the 37%, but would not have to pay income taxes or capital gains on that portion of the sale. Beyond the financial implications, under ESOP plans, employees became owners, which gave them extra incentive to ensure the success of the company. Julia described her thinking about this:

The ESOP makes people feel like they are owners in the business, and we treat them that way. We do open-book management, and several times a year we teach them about margins, income statements, and balance sheets. I show the sales and that 30% margin is a lot of money. Where does it go? It goes to SG&A, capital spending, and then taxes. Then we make a distribution to all the shareholders, Nate and I, and the ESOP. Employees often think the owners make 10 times what they actually make, so I figure, why not just tell them?

Early Years at ETI

At ETI, Julia served as the company CEO while Nate was president; however, their job roles evolved over time. For the first three years after the acquisition, Nate worked at ETI and Julia mostly stayed home with first two and then three young children.

On the business front, their main priorities were to continue to grow the business and to spend very little on capital equipment so they could pay down the debt. Nate recalled, “We had borrowed as much as we could and made personal guarantees on it all; we had put in every dime we had, secured it against our 1996 minivan, lived in a small house, no cable, no cell phone, and took a 75% pay cut for three years to make it work.”

ETI’s top managers soon realized that there was no new team coming in. Nate recalled, “They saw that a 35-year-old guy with a wife who grew up nearby and had a few kids were probably in it for the long haul.” Nate and Julia quickly developed good working relations with almost everyone.

Nate worked closely with Bill Pezzella, ETI’s VP of sales and marketing who had joined the firm in the mid-1980s. Nate explained, “Bill was a great sales guy, and we had great reps working on our behalf. I was mostly just another warm body. I had been a buyer and in sales earlier in my career and was very comfortable outside these four walls.” Over time, Nate grew more comfortable with the business. He continued, “When we started, I treated every interaction and every decision like it would make or break the company. As I got to know the business more, and the people, it became clear that there were a lot of good things going on. Even we couldn’t screw this up!”

During this period, Julia spent little time at the company, a few half-days each month. At work, she mostly kept up with the business and walked around speaking with people. Nate observed, “I would say she is friendlier than I am, and people, especially the women, will connect with her in a

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813-030 Elasto Therm: The Next Step

way they might not with me.” Nate described the culture at that time as one that tended to avoid direct confrontation by talking around issues. “The people were patient,” he continued. “If it took years to resolve an issue, that was OK.” One challenge Nate faced during this period involved the plant manager—the only one who resisted what Nate was trying to do. Nate recalled:

The plant manager didn’t want to make decisions with data. He never knew how many people he should schedule for the next week. He went by gut feel, but his gut wasn’t very good. He had worked hard for 18 years, had only a high school degree, and had never worked anywhere else. I think I intimidated him, but he acted like I was some snot-nosed new kid. It took two years, but I eventually fired him and promoted someone from within.

In 2003, Nate hired Debby Coyman to be ETI’s head of engineering, replacing someone who had left. Nate had worked with Coyman at Plymouth and the two were friends. Nate called her the “yin to my yang—she is detailed and I am not.” Coyman quickly became one of the key leaders at ETI, becoming the VP of technical services. With a degree in mechanical engineering and an MBA, she oversaw engineering, quality, the tool room, and chemistry.

A Change in Leadership

After about three years, Julia decided she wanted to return to work full time. Julia recalled:

Nate and I had talked about job sharing, but we were concerned that because everyone at ETI saw him as the company head they would treat me like I was the secretary. The same thing would happen at home—the school, the doctors, and the other parents would see me as still in charge and Nate as part time. So we decided to just switch. I came on to run the company and Nate went home and took care of the kids and the home full time.

The first few months caused tension between Nate and Julia. In the evenings they found themselves talking about their day, asking each other for advice, and, in some cases, micromanaging each other. Nate remembered, “Each of us was an expert in what the other was doing.” Over time, they let each other figure out their new roles.

Julia was more technically oriented than Nate, so where Nate enjoyed working externally with customers, Julia focused her time internally with engineering and production. Having Julia run the company raised challenges for Pezzella in sales. In most small companies, the top person often became involved with customers at critical times during the sales process. Julia did much less of this than Nate had; she was not a natural salesperson like Nate.

Not long after starting, Julia fired the plant manager, deciding that while this manager might be better than the one Nate had fired, he was still not strong enough. She decided to take on the plant manager responsibilities herself, figuring that ETI’s lead people in the plant were competent enough to not need a full-time plant manager.

The Bursteins lived in an upper-income suburban area. After Nate got settled in the home routine, he could see unfairness in the pressure that women like his wife faced. He explained:

Women can be hard on each other. If you’re a woman and you go to work, the stay-at-home moms might not tell you directly, but they are thinking, “How could you be so selfish that you would work instead of taking care of your kids?” If you stay home, the working women think “Women had fought for your right to work. You have a degree and are wasting it mushing

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peas for your kids.” For guys it is different. You are supposed to work and bring home the bacon. But if you stay home with the kids so your wife can go to work, you become a rock star.

Refocusing Engineering

Julia and Coyman decided that ETI needed to refocus its engineering group to improve customer service. They felt that ETI could differentiate itself from competitors by improving its technical capabilities and doing new product introductions better than anyone else. Julia explained, “It was a strategic decision that we bet the future of our business on.”

Many ETI products were ordered repeatedly for a number of years and required little ongoing engineering support. New products, however, required significant engineering, and getting this process right could improve the company’s reputation and increase sales. Nate explained: “When I bought for Detroit Diesel, I would hate it when told it would take 20 weeks for tooling and in week 19, find out it will be four weeks late. It sounds crazy, but that is still the norm for many OEM suppliers today.”

Each of the approximately 120 new products ETI made each year required new tooling. ETI would design a mold to conform to the dimensions and material properties the customer required, and then send the design to an outsourced mold maker who might take 12 weeks to deliver it. Upon arrival, the mold would be inspected and scheduled for a test run on a particular machine to minimize the impact on regular production runs. This process could break down in several places, causing delays.

The new system Coyman and Julia designed called for having a single individual be the “hub.” This engineer would deal with the customer, the mold maker, ETI’s material chemist, production scheduler, and manufacturing, and then communicate with each of the players in the system on a weekly basis, plus whenever something deviated from plan, so that there were fewer surprises. This new system soon led to personnel changes. Julia explained:

There are a lot of our engineers who want to be designing in front of a computer screen all day and never talk to anyone. We explained the system and what would be required of them to make this work. Since the overall job market was good, those who did not fit left to take positions elsewhere, and no one was fired.

Julia and Coyman took the opportunity to upgrade the skill level of the technical staff, replacing departing engineers with degreed engineers. At about the same time, ETI’s chemist, who did not have a degree, left and was replaced by one who did. Nate noted that this turnover was difficult, because “the people that left were part of ETI and were liked by their colleagues.”

Coyman also began measuring “first-pass yield”—the percentage of new product introductions that ETI produced without any defects—and set an 80% target. Coyman noted, “We could set it higher, but some of what we do is very hard, and there will be mistakes. If we set the goal too high, people will feel like they were set up to fail. We conduct a root cause analysis for every failure so we can keep improving.” In the past, ETI’s first-pass yield averaged about 70%, while under the new system it improved to nearly 90%, making life easier for everyone, as Coyman explained:

We hear that our customers go to their buyers and say, “If we need a new mold, go to ETI.” They love that they get a weekly update and don’t have to wonder what is happening. They know that we recover well if there is a problem, and that we usually deliver when we say we will. It also helps us internally. Testing is lost time for the factory, but when the engineers get it

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813-030 Elasto Therm: The Next Step

right the first time, the manufacturing people don’t complain that the engineers are wasting their time. This reduces stress and helps everyone work better together.

Job Sharing

Julia ran ETI for about two years while Nate stayed home. Nate reflected, “We became a much more professionally run company because of those two years.” In 2006, however, Nate began to worry about how long he could remain out of the working world and still return with confidence and competence. Julia, who enjoyed working, also missed her time at home, so they decided to job share. Each worked three days per week with Wednesday as the overlap day. They hired a childcare provider to watch the kids when they both worked. Nate explained that it did not work well:

We are two different people and everyone knows that. Bill never went to Julia with a sales issue; he waited for me. Same for Debby; she went to Julia. I ran ETI for the first three years when money was tight, and if you came to me for a capital request, the answer was “No.” Julia was here when we had some money and so she would often say “Yes.” Even our children were good at playing this game at home.

The job-sharing arrangement also affected each of them differently, as Nate explained. “When we started job sharing, I felt like if I never worked another five-day week in my life, that would be great. I did the best I could at each and didn’t worry after that. Julia worried that she was not giving her best at either place—she was juggling, and balls were falling at home and at work.”

The job-sharing arrangement led to a significant cultural change at ETI. The culture had always been that people tended to talk around issues rather than address them head on. But this led to “rumormongering” when people talked and complained behind each other’s backs. With both owners in the office, they decided it was time for a change. Julia explained:

One person would get mad at a coworker for something. Rather than speak to the coworker directly or to a boss to solve the problem, they would complain to someone else, and that person would mention it to another person. Eventually we might hear about it, but we decided “no more.” We told people, “If you have a complaint about someone, tell them directly or go to someone in power. Otherwise keep quiet.” When it happened again, we met with the person privately and told them, “You do good work, but if you do that again, you will be fired.” Over the course of a year, we fired five people and the problem diminished.

The job-sharing arrangement lasted for about two years, ending in 2008. An exchange student from Yemen brought the Burstein household to six, so Julia cut back at ETI and worked on environmental issues and other projects that she could do alone and that were not time sensitive. She remained involved in ETI’s strategic planning and all major decisions such as the construction of a new building.

Managing during the Recession

In 2008, the economic recession led to a decline in sales. Initially, ETI made parts for customer orders sooner than normal, but it became apparent that the company needed to do more. The owners then decided that ETI would lay off everyone in the factory for a week, doing that several times if necessary. They were surprised, however, when the shift supervisors said “No.” Nate recalled:

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Elasto Therm: The Next Step 813-030

The lead people told us that we needed to cut some deadwood staff first. Julia and I didn’t think we had any deadwood, only great employees. They disagreed. We told them to each make a list of the 10 people they would let go. There was remarkable convergence on their lists on who should go. They just didn’t want to be the ones to fire them!

At the same time, Nate and Julia conducted a process known as zero-based budgeting. They questioned every expense item down to uniforms and floor cleaning. At zero sales, they would need no employees, but they would still lose money in fixed costs. Repeating the process at monthly sales of $100,000, roughly 10% of pre-recession levels, ETI would need only a handful of employees who Nate and Julia felt were most important to the organization. They repeated this process in 10% sales increments, adding specific new names each time and concluding that ETI could break even at 40% of sales.

Nate and Julia fired 15 individuals and implemented the financial plan. Julia described how she felt at an all-staff meeting:

This was not easy. Several of these people were the husband, brother, or daughter of other people who still work here. We didn’t cut out just new people, we decided on people based on their overall value to the company. Some of these people had been here a long time and we still loved them, but we did what was best for the company long term. I put the budgeting spreadsheets on the wall showing what happens at each level of sales and what next month’s production would be so everyone could see future layoffs. We put a chart up every month for about eight months until the economy improved.

A New Building

In 2008, Nate and Julia decided to build a new 25,000-square-foot building adjacent to ETI’s existing 30,000-square-foot plant at a cost of $2.2 million. The Bursteins had considered expanding their existing building or moving just down the street into a single 60,000-square-foot facility, but decided they preferred two separate buildings. With two buildings, ETI could use one for rubber and the other for urethane, which simplified production management.

Nate explained, “Too many people in one building is not good. It is a lot easier to feel part of a team when there are 30 people than if there are 100.” Nate estimated that it cost $500,000 more to go with two buildings than the single-building option. In 2012, reviewing the expansion decision, Nate recalled, “It was a big decision at the time, and I was reluctant to take on more debt, but it has turned into a real enabler. We could not have grown the business to this year’s level without it.” Despite the benefits, there were a few drawbacks. Nate continued, “The buildings are 100 yards apart, but we have a single address. We struggled with getting mail back and forth, having multiple loading docks—even finding someone is harder. And we’ve had to overcome a few ‘us’ versus ‘them’ issues.”

Overseas Sourcing

In addition to manufacturing products, ETI sourced products internationally for customers through an ETI service called “ET Source.” Some foreign manufacturers could produce parts at lower costs depending on quality and quantity parameters. When quoting some jobs, ETI might indicate one price for local manufacturing and a lower price for foreign manufacturing.

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813-030 Elasto Therm: The Next Step

Alternatively, ETI might not be interested in making the part at all, but would be willing to source it for the customer. Through ET Source, ETI identified appropriate manufacturers, provided engineering and technical support, received product shipments, and provided backup production capabilities. ETI’s ET Source sales had increased from $85,000 in 2004 to nearly $1.5 million in 2011. Margins for ET Source were similar to ETI’s locally made products. Nate explained, “We are providing a service for our customers for what they considered ’commodity’ products, and it prevents a competitor from getting their foot in the door.”

Employee Satisfaction

In 2012, one if its mid-level employees had nominated ETI for a best-employer award for the Columbus area, and the company had to allow an outside research organization to conduct a detailed employee survey. ETI received the top award for communication and came in second overall for a small business. Julia explained:

This was very cool. I told our workers that Nate and I had risked our careers and our financial future on the idea that if you treat your people well, say please and thank you, and create a place where people want to come to work, good things will happen. People always tell me they love working here, but they have to say that because I sign their paycheck—but now we know they really mean that.

The survey also provided ETI with data on employee satisfaction. Despite high scores overall, the data showed that people who had worked at ETI for less than four years were less satisfied than longer tenured staff. Nate explained, “When we bring someone in, we often find out they are not quite the person we thought, so either they leave or we fire them. It has been annoying. The problem was that we did not know how to do this better.” ETI had hired an HR professional to help with hiring, and Nate hoped that if the survey was repeated in another year’s time, ETI would do better.

Coyman commented on why she worked at ETI:

I live 100 miles away and people think I am crazy, but this is a great place to work. I have been at companies where you check your brain at the door, and ship the product, hoping QA doesn’t catch it before it gets out the door. To me those are lousy philosophies. Nate and Julia treat their people well, pay decent wages, and do things like remodel the bathroom to make it nicer for us. I could find a closer employer, but be worried about shareholder value at the end of the quarter and cap ex versus cash generated. That sort of thing is a stupid waste of time; it adds no value to the business and is all about looking good.

Manufacturing Representatives

ETI sold its products through manufacturing representatives (reps). Reps were not employees of ETI, but rather were independent sales agents working on commission, who also sold for other manufacturers. ETI used 30 reps at a dozen firms, each with their own geographic area. (See Exhibit 2 for estimate of sales from the reps in 2012.)

ETI had instituted several practices designed to maximize the effort and attention that each rep devoted to selling for ETI. Even when a customer’s engineer might call one of ETI’s engineers, resulting in a direct sale, ETI would keep the rep in the loop and pay the resulting commission. Nate explained, “I don’t distract the reps with collections, and I pay them for anything in their geography

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Elasto Therm: The Next Step 813-030

because I am really paying for their shoe leather time to go get the next customer. That is what I need them to do.” Nate added that ETI had a variety of reps:

Reps come with different skills and interests. Some are very technical, and they also understand urethane and applications. The very best technical reps can find us more sales by walking through a customer’s plant and pointing out things that are made from metal that should be made in urethane. Other reps are really great at relationship management, and some of our customers need that. So reps run the gamut, and we are OK with that.

Margins and Pricing

When the Bursteins acquired ETI, they were attracted by its profitability, but they did not fully appreciate its importance at the time. Julia recalled, “I did not realize then that the margins would be the enabler for so much of what we do.” The high margins, for example, allowed their loans to be paid down faster, including the ESOP debt. Every January, ETI paid its factory workers a bonus if margins exceeded 26%, and typically paid the equivalent of two to three weeks’ extra pay. ETI also paid generous education benefits, and several employees had earned college degrees.

Because of its margins, ETI took more risks. As Nate observed, “When you’re making good money, you can take a chance on things and can be creative and screw things up a little bit every once in a while. At 20% gross you don’t have enough money left over to take chances. You’ve got to just keep doing what you've been doing.” Higher margins also enabled ETI to employ higher-level talent. Nate continued, “In addition to Julia and myself, there are four other key leaders here who have engineering degrees and MBAs and significant experience. Not many other companies of our size can afford that. It allows us to work a reasonable work week and take vacations without worrying that the place will fall apart.”

Nate reinforced this regularly with all the employees when he presented the company’s financial statements. At least two factors enabled ETI to earn higher margins. One was its unremitting effort to reduce costs and improve efficiencies in the plant. Coyman explained that as the skill level of its people improved, ETI got better at doing things right. For example, in recent years the company had cut its scrap rate in half. Coyman remarked:

Our cost of poor quality—scrap plus product returns—is low compared to our competitors. We don’t want put on a Band-Aid; we want to know the root cause and solve it by improving the processes and driving out variation. In the early years, we had weekly continuous improvement meetings, but the wrong people were in the room. Now we focus on how the processes and the equipment are failing the people, not on what people are doing wrong.

Pricing also played a significant role in ETI’s higher margins. ETI primarily sold products produced in low- and mid-volume quantities. Customers did not generally have their own expertise in materials, so they valued ETI’s engineers for technical support. The products tended to be very small and fairly low cost, and customers typically had bigger things to worry about—such as quality, on-time delivery, and responsive service—than a few pennies on a low-volume part. Nate provided an example: “We provide a set of parts that we sell for $1,000 to a customer that puts them onto a machine that it sells for $1.25 million. Do they care if our parts cost $1,000 versus $1,100? Yes, but not as much as we do. They fight us on price, but over time we can get our pricing through and stay under their radar screen.”

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813-030 Elasto Therm: The Next Step

An additional factor that contributed to ETI’s profits was its product, customer, and industry diversity: it made rubber and urethane parts, and had many small customers across a variety of industries. A downturn in any one area or the loss of a single customer had little impact. Nate observed, “If we push too hard on our pricing, we can afford to lose the customer. Many times customers come back because of our delivery, quality, and technical support. We like being in a less competitive niche and avoid ‘commodity’ parts or a customer who focuses solely on price.”

For both rubber and urethane products, the customer owned the mold, which ETI would return if the customer chose to switch suppliers. A complicating factor, however, was that ETI owned the material formulas. The OEM had a good idea of what chemicals were in a product, but small variations in the formula could make a big difference in the material properties. Also, some buyers were required by their OEM customers to run quality and reliability tests on products from new suppliers. These tests might cost significantly more than the price of the product, so their in-house engineering staffs did not want to be bothered running such tests. Often, customer engineers designed the product and then told the buyer to buy the part from ETI.

Nate explained that ETI focused constantly on margins and pricing:

We review pricing on a product every time a part is reordered. We set a higher price, and often the customer does not want to fight us, they just need the parts in four weeks. We also have this unwritten rule that if a customer has hired a new buyer, we revisit their pricing. The new buyer often does not know enough yet, and the old buyer is on the way out the door.

All these factors gave ETI confidence to establish higher prices. The company did not set excessively high prices, however, which might lead customers to quickly go elsewhere. Rather it set prices a bit higher than what the customer might expect to pay elsewhere and it let its good service and quality prevent the customer from switching. Nate noted, “Where the average manufacturer makes a 20% margin, we might make 22% to 23% because we are a bit more efficient. We are able to get that additional 7% to get to 30% margin because of our ability to price for value.”

Options for Growth

Between 2001 and 2012, ETI had approximately doubled in size. Julia explained:

We have had good, steady growth. There’s no rocket science behind that, and I found that if you take care of employees and customers, good things happen. In manufacturing, you must always improve productivity. That means that you need fewer people to do the same work. How can I ask people to become more productive if I don’t also grow the business so they don’t worry about losing their jobs? We are trying to create a company that people are attracted to work for, and that is why growth is important to us.

As they thought about growth, Nate, Julia, and their top team also considered the challenges and opportunities that different options for growth brought to ETI. These options fell into two categories: changing how they used reps, and acquiring other small companies.

Changing How ETI Used Manufacturing Reps

ETI targeted low-volume sales because at higher volumes, customers had greater incentive to buy on price. ETI reps earned a 5% commission on all sales in their geography. A rep would rather sell one high-volume job for $50,000 than 10 low-volume jobs for $5,000—they made the same in

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Elasto Therm: The Next Step 813-030

commissions, but the single sale took less time. New reps generally brought in low-volume jobs because they had yet to develop the ability to find many high-volume jobs. But many of ETI’s experienced reps had access to high-volume jobs. Additionally, each new machine that ETI installed in its plant was more efficient than older machines and made more high-volume jobs possible. Since the reps were one of the critical elements of ETI’s strategy, it was important to be sensitive to their objectives too.

Changing commissions ETI could change its commission structure. It could simply pay a lower commission rate for high-volume jobs. Alternately, ETI could continue to price high-volume quotes to earn sufficient margin, likely winning less of this business. Either case could upset the reps.

Hiring technical specialists Another option would be for ETI to hire a few urethane specialists as employees. Since almost all urethane business was low-volume, expanding the company’s urethane business would help maintain diversity in the customer base. ETI’s existing reps were less capable at selling urethane than they were at selling rubber, and the urethane market was smaller, so this option would let them focus on what they did best. However, the reps would be nervous that ETI was starting to develop its own sales capabilities and would eventually not need them. ETI could counter this concern by modifying the contract it had with the reps to protect commissions from their geography for two years instead of 30 days.

Hire sales employees A third option for ETI was to hire a few of its own sales employees and send them to new areas that the existing reps did not cover. This might prove costly, since the lead time for a new component to get into production might be two to three years. Also, existing reps would learn of this practice and become concerned.

Expanding the rep base A fourth option was for ETI to identify areas where it did not have sales coverage and contract with new reps for those areas. This option would accomplish two objectives. First, because industries tended to cluster geographically, any new region that ETI entered would likely include new industries, thus increasing its diversity. Second, new reps primarily sold low-volume jobs. Under this option, ETI could let its existing reps continue with business as usual, perhaps taking a harder look at coverage in their assigned territories.

Potential Acquisition Targets

ETI could achieve growth, and access to new markets, by acquiring another company. Finding the right fit with ETI could prove difficult and time consuming, and Nate had heard horror stories about the distraction of integrating an acquisition into an ongoing operation. In 2012, members of the top team had visited two possible targets.

Plastics company The first target was a plastics company located in the same region as ETI. It had $10 million in sales and did low- to mid-volume plastic injection molding with modern equipment, but was nearing capacity at its current facility. This prospect brought two benefits: product diversity and new customers. Entering the plastics business would add a “third leg” to ETI’s stool when combined with rubber and urethane. Nate believed that some of this company’s customers bought their rubber from ETI competitors and could be convinced to buy from ETI.

One hurdle, however, was that many ETI reps already represented a plastics company. The reps would have to choose which plastics company to represent. For those who did not choose ETI, Nate could find another rep to just sell plastic in that geography and thus have one rep for rubber and urethane and another for plastic. The plastics company’s rep network was much smaller than ETI’s, and Nate saw that as an opportunity to better utilize the ETI reps.

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813-030 Elasto Therm: The Next Step

The acquisition would also allow for employee development opportunities. Nate believed that the plastics company’s engineering function was not on par with that of ETI, and that ETI had an engineer on staff who could be promoted to run the acquired engineering function.

However, ETI faced a significant challenge with this acquisition: barely 20% margins. Nate declared, “Since it has low-volume orders, we think it should command a higher margin like we do, but they don’t, and we don’t know why.” The team wondered whether ETI’s engineering and technical systems, plus its relentless focus on efficiency gains and price, would carry over. The plastics industry, additionally, was much more competitive than the rubber industry—more companies, fewer barriers to entry, and non-proprietary formulas—all of which might prevent higher margins.

Rubber company The second target was a rubber molding company with $10 million in sales and similar production methods as ETI. One customer accounted for over 200 parts—70% of the company’s business. ETI also sold to this customer and would welcome selling more. If it acquired this company, ETI would have over 30% with the one customer—far more than any other and significantly over its targeted 10% to maintain customer diversity. Again, there was concern about whether ETI could maintain its 30% margins.

Nate, who knew the current owner, understood that the company was having financial difficulties: it was not current with its creditors and was technically in default on some loan covenants. Nate figured that he could acquire the business for a very favorable price, but was concerned that the business was unprofitable. The company had two years left on its plant lease. If ETI acquired this company, Nate would not renew the lease, bringing some of the work to ETI’s plant, and getting rid of the rest. ETI could then spread its own fixed costs across higher sales levels. Nate realized, “We could also simply sit tight and cherry pick their customers when they go out of business.”

The Next Step

Nate and Julia had reached many of the goals they set out to achieve when they had acquired ETI and sought to create a company where people felt good about coming to work every day. The financial and operational outlook for ETI looked good, but Nate and Julia also strove for continuous improvement, and believed that the company needed to maintain momentum to remain successful in the long term.

Each of them was also considering where they might have an impact in their own community. They knew that as their children approached high school age, they would be pulled away from the business. Expanding the business through an acquisition would require stepped-up engagement by both of them, as they remembered so well from their early days at ETI. Additionally, their ESOP structure caused them to consider whether they should be taking on the risks associated with more volume instead of focusing on extracting additional profits from their existing niche. As they thought about what they had created, they wondered which of their options made the most sense for ETI and for themselves.

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Exhibit 1 Financial Data

813-030 -13-

2011

7,866,802 5,177,651 1,484,219

716,715 15,245,387

2,266,066 380,000 2,646,066

262,504 8,667,000

2004

2005

6,521,545 4,332,206 194,772 494,183 11,542,706

1,428,542 312,621 1,741,163

2,743,243 5,380,000

2006

6,776,767 4,420,550 278,353 689,262 12,164,932

1,286,445 259,075 1,545,520

2,128,491 6,260,000

2007

7,096,482 4,950,654 542,050 766,268 13,355,454

1,550,070 241,656 1,791,726

1,753,049 6,730,000

2008

6,592,955 5,104,087 651,983 788,746 13,137,771

1,296,646 253,581 1,550,227

1,450,826 6,130,000

2009

5,228,211 3,727,131 619,898 440,259 10,015,499

760,579

380,800 1,141,379

721,275 5,673,000

2010

6,520,920 4,551,423 1,449,927

538,564 13,060,834

1,687,536 345,000 2,032,536

343,435 6,618,000

Sales Rubber 6,349,749 Urethane 4,043,695

ET Source

T ooling Total Sales

85,385 627,829 11,106,658

EBIT 1,462,049 Depreciation 291,479 EBITDA 1,753,528

Debt Outstanding 3,511,328 Corporate Value 3,950,000

Source: Company document.

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813-030

Elasto Therm: The Next Step

Exhibit 2 Territory

D A J C E B L

2012 Sales by Product Line for Manufacturer Reps

Rubber

25% 15% 10% 17% 20%

3%

Urethane ET Source Total

29% 44% 28% 15% 21% 16% 26% 2% 14%

3% 10% 12%

0% 3% 12% 12% 8% 6% 2% 8% 3% 6% 0% 2% 4% 0% 2% 1% 0% 2% 1% 2% 1% 1% 0% 1% 0% 0% 0%

K M G H F

Source:

2% 2% 1% 1% 0%

Company document.

3% I 1%

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