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CASES

CASE 2 EDWARD MARSHALL BOEHM, INC.*

Edward Marshall Boehm—a farmer, veterinarian, and nature lover living near New York City—was convinced by his wife and friends to translate some of his clay animal sculptures into pieces for possible sale to the gift and art markets. Boehm recognized that porcelain was the best medium for portraying his creations because of its translucent beauty, permanence, and fidelity of color as well as form. But the finest of the porcelains, hard paste porcelain, was largely a secret art about which little technical literature existed. Boehm studied this art relentlessly, absorbing whatever knowledge artbooks, museums, and the few U.S. ceramic factories offered. Then, after months of experimentation in a dingy Trenton, New Jersey, basement, Boehm and some chemist friends developed a porcelain clay equal to the finest in the world.

Next Boehm had to master the complex art of porcelain manufacture. Each piece of porcelain sculpture is a technical as well as artistic challenge. A 52-step process is required to convert a plasticine sculpture into a completed porcelain piece. For example, one major creation took 509 mold sections to make 151 parts, and consumed 8 tons of plaster in the molds. Sculptural detail included 60,000 individually carved feather barbs. Each creation had to be kiln-fired to 2400° where heat could change a graceful detail into a twisted mass. Then it had to be painted, often in successive layers, and perhaps fired repeatedly to anneal delicate colors. No American had excelled in hard paste porcelains. And when Boehm’s creations first appeared, no one understood the quality of the porcelain or even believed it was hard paste porcelain.

But Boehm began to create in porcelain what he knew and loved best—nature, particularly the more delicate forms of animals, birds, and flowers. In his art Boehm tried “to capture that special moment and setting which conveys the character, charm, and loveliness of a bird or animal in its natural habitat.” After selling his early creations for several years during her lunch hours, his talented wife, Helen, left an outstanding opthalmic marketing career to “peddle” Boehm’s porcelains full time. Soon Mrs. Boehm’s extraordinary merchandising skills, promotional touch, and sense for the art market began to pay off. People liked Boehm’s horses and dogs, but bought his birds. And Boehm agreeably complied, striving for ever greater perfection on ever more exotic and natural bird creations.

* Republished with permission from H. Mintzberg and J. B. Quinn, The Strategy Process, Prentice Hall, New York, 1996.

By 1968 some Boehm porcelains (especially birds) had become recognized as collector’s items. An extremely complex piece like “Fondo Marino” might sell for $28,500 at retail, and might command much more upon resale. Edward Marshall Boehm, then 55—though flattered by his products’ commercial success—considered his art primarily an expression of his love for nature. He felt the ornithological importance of portraying vanishing species like U.S. prairie chickens with fidelity and traveled to remote areas to bring back live samples of rare tropical birds for study and later rendering into porcelain. A single company, Minton China, was the exclusive distributor of Boehm products to some 175 retail outlets in the United States. Boehm’s line included (1) its “Fledgling” series of smaller, somewhat simpler pieces, usually selling for less than $100, (2) its profitable middle series of complex sculptures like the “Snowy Owl” selling from $800 to $5,000, and (3) its special artistic pieces (like “Fondo Marino” or “Ivory Billed Woodpeckers”) which might sell initially for over $20,000.

Individual Boehm porcelains were increasingly being recognized as outstanding artistic creations and sought by some sophisticated collectors. Production of such designs might be sold out for years in advance, but it was difficult to anticipate which pieces might achieve this distinction. Many of the company’s past policies no longer seemed

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appropriate. And the Boehms wanted to further position the company for the long run. When asked what they wanted from the company, they would respond, “to make the world aware of Mr. Boehm’s artistic talent, to help world wildlife causes by creating appreciation and protection for threatened species, and to build a continuing business that could make them comfortably wealthy, perhaps millionaires.” No one goal had great precedence over the others.

CASES

CASE 3 AMERICAN INTERNATIONAL GROUP AND THE BONUS FIASCO*

After two decades of rapid growth and expansion in an environment of very little regulatory oversight and unbounded optimism about the power of the markets to create limitless wealth, the U.S. financial system came crashing down in the second half of 2008. What started as a sudden decline in housing prices after years of speculative growth very soon snowballed into a full-fledged financial crisis. Major banking companies such as Citicorp and Bank of America found their equity base wiped out by loan losses. Investment banking firms such as Merrill Lynch and Bear Stearns, which operate largely outside the regulatory framework of the Federal Reserve, were in even bigger trouble because they were highly leveraged. Fearing a complete financial meltdown, Henry Paulson, secretary of the Treasury in the Bush administration, announced a bailout package of $750 billion on September 16, 2008, to restore confidence in the banks and to jump-start the credit markets.

What exactly does the government do in a bailout? A bailout can take many forms. For example, the government can buy stock in a troubled institution, thus shoring up its equity base.

The very fact that the government has an equity stake may be taken as an implicit government guarantee by creditors, suppliers, and clients because concerns about solvency and ability to stay in business are assuaged. Alternatively, the government can extend a loan to the institution, to be paid back when the company becomes profitable again. Another approach is for the government to buy preferred stock in the company. In this case the government is entitled to a fair return on the investment. Finally, the government can buy distressed assets of the institution, thereby helping it to clean up its balance sheet. Irrespective of the form of the bailout, all bailouts represent a temporary or, in some cases, long- term commitment of public money to private companies.

As the economic crisis gathered momentum and the credit markets came to a standstill in the fall of 2008, it became clear that banks were not the only institutions in trouble. American International Group (AIG), one of the largest and most respected insurance companies in the world, found itself in even bigger financial distress in September 2008 when the rating agencies suddenly lowered its credit rating. Not only did this cause the cost of borrowing to go up for AIG, but it also triggered the requirement that the company post collateral with its counterparties. Unable to do so, AIG approached the government for a bailout. In the next few months, the government pumped an astounding $85 billion into AIG alone to prevent it from going bankrupt. Insurance companies are generally supposed to be risk-averse and prudent. How did AIG get into such a big mess?

* This case was prepared by Professor Abdul A. Rasheed of the University of Texas at Arlington, Graduate Student Brian Pinkham, and Professor Gregory G. Dess of the University of Texas at Dallas. This case was based solely on library research and was developed for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 2009 Abdul A. Rasheed and Gregory G. Dess.

The primary culprit for the problems of AIG was a somewhat exotic financial product called credit default swaps (CDSs). In simple terms, these swaps represented an insurance cover to holders of mortgage-backed securities: If the value of the securities went down, AIG would make good the losses suffered by the owners. In good times, when real estate prices were climbing steadily each year, the CDSs were pure profits for AIG. Emboldened by what it perceived as negligible risk and motivated by the prospect of ever-increasing profits, AIG sold hundreds of billions of dollars’ worth

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of these instruments. Although insurance is a business regulated by the states, these products were outside the range of regulation.

Right from the beginning, there was considerable controversy about whether the government should try to bail out any failing firm in a market economy. Even those who were not ideologically opposed to the bailout were skeptical whether the government efforts would be enough to save the company. There were also concerns about how the company would spend the bailout money.

Immediately after the first bailout was announced, AIG attracted considerable negative press when it was reported that AIG executives attended a lavish retreat in California that featured spa treatments, banquets, and golf outings. Total tab: $444,000. Immediately thereafter, AP reported that AIG executives spent $86,000 on a luxurious English hunting trip.1

This was only days after the Fed had extended a $37.8 billion loan on top of the $85 billion mentioned earlier. The company’s response: “We regret that this event was not canceled.”2

In March 2009, it was disclosed that AIG had paid $218 million in bonus payments to employees of the financial services division, the very division that was responsible for issuing the credit default swaps that got the firm into trouble. Overall, 418 managers were the beneficiaries of these “retention” bonuses, although 53 of them were no longer with the company! The highest bonus was $6.4 million. Six managers received more than $4 million each, and 51 people received between $ 1 million and $2 million.

The announcement of these bonuses sparked instant outrage among the public. President Barack Obama accused the company of “recklessness and greed.” Noting that AIG had “received substantial sums” of federal aid, the president announced that he was asking Treasury Secretary Timothy Geithner “to use that leverage and pursue every legal avenue to block these bonuses and make the American taxpayers whole.”3 Andrew Cuomo, New York State’s attorney general, threatened to subpoena the executives and engage in a “name and shame” campaign by making the list of bonus recipients public.4 The House even passed a bill that effectively imposed a punitive 90 percent tax on the bonuses.5

At the same time, there were others who felt that the payments represented contractual obligations and therefore populist sentiments should not be allowed to violate the sanctity of contracts. Many of the employees felt that they had every right to receive the payments they were promised and worked for. Their feelings were best expressed in the following resignation letter sent by Jake DeSantis, an executive vice president of the American International Group’s financial products unit, to Edward M. Liddy, the chief executive of AIG.

Dear Mr. Liddy: It is with deep regret that I submit my notice of resignation from A.I.G. Financial Products. I hope you take the time to read

this entire letter. Before describing the details of my decision, I want to offer some context: I am proud of everything I have done for the commodity and equity divisions of A.I.G.-F.P. I was in no way involved in—or

responsible for—the credit default swap transactions that have hamstrung A.I.G. Nor were more than a handful of the 400 current employees of A.I.G.-F.P. Most of those responsible have left the company and have conspicuously escaped the public outrage.

After 12 months of hard work dismantling the company—during which A.I.G. reassured us many times we would be rewarded in March 2009—we in the financial products unit have been betrayed by A.I.G. and are being unfairly persecuted by elected officials. In response to this, I will now leave the company and donate my entire post-tax retention payment to those suffering from the global economic downturn. My intent is to keep none of the money myself.

I take this action after 11 years of dedicated, honorable service to A.I.G. I can no longer effectively perform my duties in this dysfunctional environment, nor am I being paid to do so. Like you, I was asked to work for an annual salary of $1, and I agreed out of a sense of duty to the company and to the public officials who have come to its aid. Having now been let down by both, I can no longer justify spending 10, 12, 14 hours a day away from my family for the benefit of those who have let me down.

You and I have never met or spoken to each other, so I’d like to tell you about myself. I was raised by schoolteachers working multiple jobs in a world of closing steel mills. My hard work earned me acceptance to M.I.T., and the institute’s generous financial aid enabled me to attend. I had fulfilled my American dream.

I started at this company in 1998 as an equity trader, became the head of equity and commodity trading and, a couple of years before A.I.G.’s meltdown last September, was named the head of business development for commodities. Over this period the equity and commodity units were consistently profitable—in most years generating net profits of well over $100 million. Most recently, during the dismantling of A.I.G.-F.P., I was an integral player in the pending sale of its well-regarded commodity index business to UBS. As you know, business unit sales like this are crucial to A.I.G.’s effort to repay the American taxpayer.

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The profitability of the businesses with which I was associated clearly supported my compensation. I never received any pay resulting from the credit default swaps that are now losing so much money. I did, however, like many others here, lose a significant portion of my life savings in the form of deferred compensation invested in the capital of A.I.G.-F.P. because of those losses. In this way I have personally suffered from this controversial activity—directly as well as indirectly with the rest of the taxpayers.

I have the utmost respect for the civic duty that you are now performing at A.I.G. You are as blameless for these credit default swap losses as I am. You answered your country’s call and you are taking a tremendous beating for it.

But you also are aware that most of the employees of your financial products unit had nothing to do with the large losses. And I am disappointed and frustrated over your lack of support for us. I and many others in the unit feel betrayed that you failed to stand up for us in the face of untrue and unfair accusations from certain members of Congress last Wednesday and from the press over our retention payments, and that you didn’t defend us against the baseless and reckless comments made by the attorneys general of New York and Connecticut.

My guess is that in October, when you learned of these retention contracts, you realized that the employees of the financial products unit needed some incentive to stay and that the contracts, being both ethical and useful, should be left to stand. That’s probably why A.I.G. management assured us on three occasions during that month that the company would “live up to its commitment” to honor the contract guarantees.

That may be why you decided to accelerate by three months more than a quarter of the amounts due under the contracts. That action signified to us your support, and was hardly something that one would do if he truly found the contracts “distasteful.”

That may also be why you authorized the balance of the payments on March 13. At no time during the past six months that you have been leading A.I.G. did you ask us to revise, renegotiate or break these

contracts—until several hours before your appearance last week before Congress. I think your initial decision to honor the contracts was both ethical and financially astute, but it seems to have been politically

unwise. It’s now apparent that you either misunderstood the agreements that you had made—tacit or otherwise—with the Federal Reserve, the Treasury, various members of Congress and Attorney General Andrew Cuomo of New York, or were not strong enough to withstand the shifting political winds.

You’ve now asked the current employees of A.I.G.-F.P. to repay these earnings. As you can imagine, there has been a tremendous amount of serious thought and heated discussion about how we should respond to this breach of trust.

As most of us have done nothing wrong, guilt is not a motivation to surrender our earnings. We have worked 12 long months under these contracts and now deserve to be paid as promised. None of us should be cheated of our payments any more than a plumber should be cheated after he has fixed the pipes but a careless electrician causes a fire that burns down the house.

Many of the employees have, in the past six months, turned down job offers from more stable employers, based on A.I.G.’s assurances that the contracts would be honored. They are now angry about having been misled by A.I.G.’s promises and are not inclined to return the money as a favor to you.

The only real motivation that anyone at A.I.G.-F.P. now has is fear. Mr. Cuomo has threatened to “name and shame,” and his counterpart in Connecticut, Richard Blumenthal, has made similar threats—even though attorneys general are supposed to stand for due process, to conduct trials in courts and not the press.

So what am I to do? There’s no easy answer. I know that because of hard work I have benefited more than most during the economic boom and have saved enough that my family is unlikely to suffer devastating losses during the current bust. Some might argue that members of my profession have been overpaid, and I wouldn’t disagree.

That is why I have decided to donate 100 percent of the effective after-tax proceeds of my retention payment directly to organizations that are helping people who are suffering from the global downturn.

This is not a tax-deduction gimmick; I simply believe that I at least deserve to dictate how my earnings are spent, and do not want to see them disappear back into the obscurity of A.I.G.’s or the federal government’s budget. Our earnings have caused such a distraction for so many from the more pressing issues our country faces, and I would like to see my share of it benefit those truly in need.

On March 16 1 received a payment from A.I.G. amounting to $742,006.40, after taxes. In light of the uncertainty over the ultimate taxation and legal status of this payment, the actual amount I donate may be less—in fact, it may end up being far less if the recent House bill raising the tax on the retention payments to 90 percent stands. Once all the money is donated, you will immediately receive a list of all recipients.

This choice is right for me. I wish others at A.I.G.-F.P. luck finding peace with their difficult decision, and only hope their judgment is not clouded by fear.

Mr. Liddy, I wish you success in your commitment to return the money extended by the American government, and luck with the continued unwinding of the company’s diverse businesses—especially those remaining credit default swaps. I’ll continue over the short term to help make sure no balls are dropped, but after what’s happened this past week I can’t remain much

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longer—there is too much bad blood. I’m not sure how you will greet my resignation, but at least Attorney General Blumenthal should be relieved that I’ll leave under my own power and will not need to be “shoved out the door.”

Sincerely, Jake DeSantis

Liddy was clearly in an unwinnable situation. On the one hand, the politicians and the press were pillorying him for authorizing lavish bonuses while the company was essentially on welfare payments from the taxpayer. On the other hand, his own employees were upset at him that he was pandering to the politicians by describing these contractual payments as “distasteful.”

ENDNOTES 1. AIG executives spent thousands during hunting trip. Associated Press, October 17, 2008,

http://ap.google.com/article/ALeqM5g3InVeHoYnmXZnM2ACXSgjG0nlQD93R68VO0. 2. A. Taylor. AIG execs’ retreat after bailout angers lawmakers. Associated Press, October 11, 2008,

http://thecofJeedesk.com/news/index.php/archives/76kers. 3. T. Raum. Obama: AIG can’t justify “outrage” of exec bonuses with taxpayer money keeping company afloat. Associated Press, March 16,

2009, http://finance.yahoo.com/news/Frank-assails-bonuses-paid-to-apf-14646988.html. 4. Cuomo issues subpoena to AIG on credit derivatives data. March 27, 2009, www.rttnews.com/Content/BreakingNews.aspx?

Node=Bl&Id=895234%20&Category=Breaking%20News. 5. J. D. McKinnon and A. Jones. Laws may not hinder effort to tax AIG bonuses. Wall Street Journal, March 18, 2009,

http://online.wsj.com/article/SB123742691757579925.html.

CASES

CASE 4 PIXAR*

On the morning of January 10, 2013, everyone at Pixar Animated Studios was pleased to find that Brave had received an Academy Award nomination for best animated feature. After a continuous string of critically acclaimed films running through Toy Story, Finding Nemo, Ratatouille, Wall-E, and Up, the studio had failed to obtain a single nomination for Cars 2. This was a great setback for Pixar, which had already claimed five trophies, more than any other studio, since the category was added in 2001.

Although Cars 2 made about $560 million in theaters worldwide, matching the success of many of the studio’s other hits, the film did not win the critical acclaim that has been accorded to every other Pixar offering (see Exhibit 1). This led many industry observers to question whether the sequel had been developed as a result of pressure from the Walt Disney Company because of the opportunities that it would offer for sales of related merchandise. John Lasseter, Pixar’s chief creative officer and the director of Cars 2, denied that there was any such pressure: “It’s not true. It’s people who don’t know the facts, rushing to judge.”1

Pixar had been acquired by Disney in 2006 for the hefty sum of $7.4 billon. The deal had been finalized by the late Steve Jobs, the Apple Computer chief executive who had also served as the head of the computer animation firm. Jobs had previously developed a deal that had allowed Disney to distribute all of Pixar’s films and to split the profits. Disney CEO Bob Iger worked hard to eventually acquire Pixar, whose track record had made it one of the world’s most successful animation companies.

Both Jobs and Iger had been aware, however, that they must try and protect Pixar’s creative culture while they also tried to carry some of this over to Disney’s animation efforts. In order to ensure this, Disney has not only allowed Pixar to operate on its own, but also assigned some of the animation studio’s key talent to take over the combined activities of both Pixar and Disney. The creative team at Pixar has been trying to use elements of its lengthy process of playfully crafting a film to replace the standard production line approach that had been pursued by Disney. This contrast in culture is best reflected in the Oscars that the employees at Pixar have displayed proudly, but which have been painstakingly dressed in Barbie doll clothing.

Above all, everyone at Pixar remains committed to making films that are original in concept and execution, despite the risks involved. They make sequels only when they are able to come up with a compelling story that can make use of the old characters. Lasseter claims, however, that because everyone expects Pixar to stick with original films, any sequels that it makes are judged rather harshly. He compared his role as director of Cars 2 to that of a trapeze artist with a death wish. “Not only is there no net,” he said, “you’re doing it over spikes with poisoned ends.”2

* Case developed by Professor Jamal Shamsie, Michigan State University, with the assistance of Professor Alan B. Eisner, Pace University. Material has been drawn from published sources to be used for purposes of class discussion. Copyright © 2013 Jamal Shamsie and Alan B. Eisner.

EXHIBIT 1 Pixar Films

All of Pixar’s films released to date have ended up among the top animated films of all time based on worldwide box office revenue in millions of U.S. dollars.

Rank Title Year Revenue

1 Toy Story 3 2010 $1064

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2 Finding Nemo 2003 $906

3 Up 2009 $731

4 The Incredibles 2005 $631

5 Ratatouille 2007 $624

6 Cars 2 2011 $560

7 Brave 2012 $555

8 Monsters, Inc. 2002 $525

9 Wall-E 2009 $521

10 Toy Story 2 1999 $485

11 Cars 2006 $462

12 A Bug’s Life 1998 $363

13 Toy Story 1995 $362

Source: IMDb, Variety.

Pushing for Computer Animated Films The roots of Pixar stretch back to 1975 with the founding of a vocational school in Old Westbury, New York, called the New York Institute of Technology. It was there that Edwin E. Catmull, a straitlaced Mormon from Salt Lake City who loved animation but couldn’t draw, teamed up with the people who would later form the core of Pixar. “It was artists and technologists from the very start,” recalled Alvy Ray Smith, who worked with Catmull during those years. “It was like a fairy tale.”3

By 1979, Catmull and his team decided to join forces with famous Hollywood director George W. Lucas, Jr. They were hopeful that this would allow them to pursue their dream of making animated films. As part of Lucas’s filmmaking facility in San Rafael, California, Catmull’s group of aspiring animators was able to make substantial progress in the art of computer animation. But the unit was not able to generate any profits, and Lucas was not willing to let it grow beyond using computer animation for special effects.

Catmull finally turned in 1985 to Jobs, who had just been ousted from Apple. Jobs was reluctant to invest in a firm that wanted to make full-length feature films using computer animation. But a year later, Jobs did decide to buy Catmull’s unit for just $10 million, which represented a third of Lucas’s asking price. While the newly named Pixar Animation Studios tried to push the boundaries of computer animation over the next five years, Jobs ended up having to invest an additional $50 million—more than 25 percent of his total wealth at the time. “There were times that we all despaired, but fortunately not all at the same time,” said Jobs.4

Still, Catmull’s team did continue to make substantial breakthroughs in the development of computer-generated full- length feature films (see Exhibit 2). In 1991, Disney gave Pixar a three-film contract that started with Toy Story. When the movie was finally released in 1995, its success surprised everyone in the film industry. Rather than the nice little film Disney had expected, Toy Story became the sensation of 1995. It rose to the rank of the third highest grossing animated film of all time, earning $362 million in worldwide box office revenues.

Within days, Jobs decided to take Pixar public. When the shares, priced at $22, shot past $33, Jobs called his best friend, Oracle CEO Lawrence J. Ellison, to tell him he had company in the billionaire’s club. With Pixar’s sudden success, Jobs returned to strike a new deal with Disney. Early in 1996, at a lunch with Walt Disney chief Michael D. Eisner, Jobs made his demands: an equal share of the profits, equal billing on merchandise and on-screen credits, and guarantees that Disney would market Pixar films as they did its own.

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Boosting the Creative Component With the success of Toy Story, Jobs realized that he had hit something big. He had tapped into his Silicon Valley roots and, with Catmull’s team, used computers to forge a unique style of creative moviemaking. In each of their subsequent films, Pixar has continued to develop computer animation that has allowed for more lifelike backgrounds, texture, and movement than ever before. For example, because real leaves are translucent, Pixar’s engineers developed special software algorithms that both reflect and absorb light, creating luminous scenes among jungles of clover.

In spite of the significance of these advancements in computer animation, Jobs was well aware that successful feature films would require a strong creative spark. He understood that it would be the marriage of technology with creativity that would allow Pixar to rise above its competition. To get that, Jobs fostered a campuslike environment within the newly formed outfit, similar to the freewheeling, charged atmosphere in the early days of his beloved Apple (where he also returned as acting CEO). “It’s not simply the technology that makes Pixar,” said Dick Cook, former president of Walt Disney studios.5

Even though Jobs did play a crucial supportive role, it is Catmull, now elevated to the position of Pixar’s

EXHIBIT 2 Milestones

1986 Steve Jobs buys Lucas’s computer group and christens it Pixar. The firm completes a short film, Luxo Jr., which is nominated for an Oscar.

1988 Pixar adds computer-animated ads to its repertoire, making spots for Listerine, Lifesavers, and Tropicana. Another short, Tin Toy, wins an Oscar.

1991 Pixar signs a production agreement with Disney. Disney is to invest $26 million; Pixar is to deliver at least three full-length, computer-animated feature films.

1995 Pixar releases Toy Story, the first fully digital feature film, which becomes the top-grossing movie of the year and wins an Oscar. A week after release, the company goes public.

1997 Pixar and Disney negotiate a new agreement: a fifty-fifty split of development costs and profits of five feature- length movies. Short Gerl’s Game wins an Oscar.

1998 –99

A Bug’s Life and Toy Story 2 are released, together pulling in $1.3 billion in box office and video.

2001 –04

A string of hits from Pixar: Monsters, Inc.; Finding Nemo; and The Incredibles.

2006 Disney acquires Pixar and assigns responsibilities for its own animation unit to Pixar’s creative brass. Cars is released and becomes another box office hit.

2009 Wall-E becomes the fourth film from Pixar to receive the Oscar for a feature-length animated film.

2011 Toy Story 3 receives five Oscar nominations and wins two, including one for best animated film.

Source: Pixar,

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president, who has been mainly responsible for ensuring that the firm’s technological achievements help to pump up the firm’s creative efforts. He has been the keeper of the company’s unique innovative culture, which has blended Silicon Valley techies, Hollywood production honchos, and artsy animation experts. In the pursuit of Catmull’s vision, this eclectic group has transformed their office cubicles into tiki huts, circus tents, and cardboard castles, with bookshelves stuffed with toys and desks adorned with colorful iMac computers.

Catmull has also worked hard to build upon this pursuit of creative innovation by creating programs to develop the employees. Employees are encouraged to devote up to four hours a week, every week, to further their education at Pixar University. The in-house training program offers 110 different courses that cover subjects such as live improvisation, creative writing, painting, drawing, sculpting, and cinematography. For many years, the school’s dean was Randall E. Nelson, a former juggler who has been known to perform his act using chain saws so students in animation classes have something compelling to draw.

It is such an emphasis on the creative use of technology that has kept Pixar on the cutting edge. The firm has turned out ever more lifelike short films, including 1998’s Oscar-winning Geri’s Game, which used a technology called subdivision surfaces. This makes realistic simulation of human skin and clothing possible. “They’re absolute geniuses,” gushed Jules Roman, cofounder and CEO of rival Tippett Studio. “They’re the people who created computer animation really.”6

Becoming Accomplished Storytellers A considerable part of the creative energy goes into story development. Jobs had understood that a film works only if its story can move the hearts and minds of families around the world. His goal was to develop Pixar into an animated movie studio that becomes known for the quality of its storytelling above everything else: “We want to create some great stories and characters that endure with each generation.”7

For story development, Pixar has relied heavily on 43-year-old John Lasseter, who goes by the title of vice president of the creative. Known for his collection of 358 Hawaiian shirts and his irrepressible playfulness with toys, Lasseter has been the key to the appeal of all of Pixar’s films. Lasseter gets very passionate about developing great stories and then harnessing computers to tell these stories. Most of Pixar’s employees believe it is this passion that has ensured that each of the studio’s films has been a commercial hit. In fact, Lasseter is being regarded as the Walt Disney for the 21st century.

When it’s time to start a project, Lasseter isolates a group of eight or so writers and directs them to forget about the constraints of technology. The group bounces ideas off each other, taking collective responsibility for developing a story. While many studios try to rush from script to production, Lasseter takes up to two years just to work out all the details. Once the script has been developed, artists create story-boards that connect the various characters to the developing plot. “No amount of great animation is going to save a bad story,” he said. “That’s why we go so far to make it right.”8

Only after the basic story has been set does Lasseter begin to think about what he’ll need from Pixar’s technologists. And it’s always more than the computer animators expect. Lasseter, for example, demanded that the crowds of ants in A Bug’s Life not be a single mass of look-alike faces. To solve the problem, computer expert William T. Reeves developed software that randomly applied physical and emotional characteristics to each ant. In another instance, writers brought a model of a butterfly named Gypsy to researchers, asking them to write code so that when she rubs her antennae, you can see the hairs press down and pop back up.

At any stage during the process, Lasseter may go back to potential problems that he sees with the story. In A Bug’s Life, for example, the story was totally revamped after more than a year of work had been completed. Originally, it was about a troupe of circus bugs run by P.T. Flea that tries to rescue a colony of ants from marauding grasshoppers. But because of a flaw in the story—Why would the circus bugs risk their lives to save stranger ants?—codirector Andrew Stanton recast the story to be about Flik, the heroic ant who recruits Flea’s troupe to fight the grasshoppers. “You have to rework and rework it,” explained Lasseter. “It is not rare for a scene to be rewritten as much as 30 times.”9

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Pumping Out the Hits In spite of its formidable string of hits, Pixar has had difficulty in stepping up its pace of production. Although they may cost 30 percent less, computer-generated animated films do still take considerable time to develop. Furthermore, because of the emphasis on every single detail, Pixar used to complete most of the work on a film before moving on to the next one. Catmull and Lasseter have since decided to work on several projects at the same time, but the firm has not been able to release more than one movie in a year.

In order to push for an increase in production, Pixar has more than doubled its number of employees over the last decade. It is also turning to a stable of directors to oversee its movies. Lasseter, who directed Pixar’s first three films, is supervising other directors who are taking the helm of various films that the studio chooses to develop. Monsters, Inc., Finding Nemo, The Incredibles, Ratatouille, and Brave were directed by some of this new talent. But there are concerns about the number of directors that Pixar can rely upon to turn out high-quality animated films. Michael Savner of Bane of America Securities commented, “You can’t simply double production. There is a finite amount of talent.”10

To meet the faster production pace, Catmull has also added new divisions, including one to help with the development of new movies and one to oversee movie development shot by shot. The eight-person development team has helped to generate more ideas for new films. “Once more ideas are percolating, we have more options to choose

C10

from so no one artist is feeling the weight of the world on their shoulders,” said Sarah McArthur, who served as Pixar’s vice president of production.11

Finally, Catmull keeps pushing on technology in order to improve the quality of animation with no more than 100 animators working on each film. Toward this end, Catmull has been overseeing the development of new animation software, called Luxo, which has allowed him to use fewer people, who can focus on addressing various challenges that come up. During the production of Brave, for example, the animators had to make the curly hair of the main character appear to be natural. Claudia Chung, who worked on the film, talked about their reaction to various methods they kept trying: “We’d kind of roll our eyes and say, ‘I guess we can do that,’ but inside we were all excited, because it’s one more stretch we can do.”12

Catmull is well aware of the dangers of growth for a studio whose successes came out of a lean structure that wagered everything on each film. It remains to be seen whether Pixar can keep drawing on its talent to increase production without compromising the high standards that have been set by Catmull and Lasseter. Jobs was keen to maintain the quality of every one of Pixar’s films by ensuring that each one got the best efforts of the firm’s animators, storytellers, and technologists. “Quality is more important than quantity,” he emphasized. “One home run is better than two doubles.”13

In order to preserve Pixar’s high standards, Catmull has been working hard to retain the company’s commitment to quality even as it grows. He has been using Pixar University to encourage collaboration among all employees so that they can develop and retain the key values that are tied to their success. And he has helped devise ways to avoid collective burnout. A masseuse and a doctor now come by Pixar’s campus each week, and animators must get permission from their supervisors if they want to work more than 50 hours a week.

To Infinity and Beyond? The growth in emphasis on sequels has raised concerns about the ability of Pixar to keep turning out movies that generate both box office revenues and critical acclaim, given their reliance on a high degree of creativity. The studio will be releasing a sequel to Monsters, Inc. later this year and has a sequel to Finding Nemo in the works. At the same time, Lasseter is overseeing work on films with bold new ideas, such as Inside Out, based on a story told from the perspective of the emotions inside the mind of a little girl.

Despite the poor reviews that some critics gave to Cars 2, it is widely believed that Pixar will continue to maintain its creativity even while it is owned by Disney. In fact, Jobs was convinced that Pixar’s links with Disney would be mutually beneficial for both firms. In his own words, “Disney is the only company with animation in their DNA.”14 In fact, the acquisition of Pixar was viewed as an attempt by Disney to boost its own animation efforts by acquiring a group in which the talent of the individuals and the quality of the finished product are valued above everything else.

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In order to ensure this, Ed Catmull and John Lasseter have been in charge of the combined animation business of both Pixar and Disney. Tangled and Wreck-It Ralph, which were both commercial and critical successes, were Disney films that were completed under the supervision of these Pixar heads. For Lasseter, the new responsibilities for Disney have represented a return to his roots. He had been inspired by Disney films as a kid and started his career at Disney before being lured away to Pixar by Catmull. “For many of us at Pixar, it was the magic of Disney that influenced us to pursue our dreams of becoming animators, artists, storytellers and filmmakers,” Lasseter stated.15

But Catmull and Lasseter continue to face a challenging task. They must ensure that they keep developing hits for Pixar even as they try to turn things around at Disney. Furthermore, it is still too early to tell whether Pixar will be affected by the loss of Jobs, who passed away in 2011. He was an important sounding board for Lasseter, who often relied on the perspective of Jobs in supervising the films that Pixar was developing.

At the same time, everyone at Pixar understands that a large part of their success can be attributed to the talent that the firm is able to recruit and train to work together. This leads to a continuous exchange of ideas and fosters a collective sense of responsibility on all their projects. “We created the studio we want to work in,” Lasseter remarked. “We have an environment that’s wacky. It’s a creative brain trust: It’s not a place where I make my movies—it’s a place where a group of people make movies.”16

ENDNOTES 1. Barnes, B. 2011. It wasn’t a wreck, not really. New York Times, October 18: C4. 2. Ibid.: C1. 3. Burrows, P., & Grover, G. 1998. Steve Jobs: Movie mogul. BusinessWeek, November 23: 150. 4. Ibid.: 150. 5. Ibid.: 146. 6. Ibid.: 146. 7. Graser, M. 1999. Pixar run by focused group. Variety, December 20: 74. 8. Barnes, op. cit.: C4. 9. Burrows & Grover, op. cit.: 146.

10. Bary, A. 2003. Coy story. Barron’s, October 13: 21. 11. Terdiman, D. 2012. Bravely going where Pixar animation tech has never gone. CNET News, June 16. 12. Tam, P.-W. 2001. Will quantity hurt Pixar’s quality? Wall Street Journal, February 15: B4. 13. Burrows, P., & Grover, G. 2006. Steve Jobs’ magic kingdom. BusinessWeek, February 6: 66. 14. Solomon, C. 2006. Pixar creative chief to seek to restore the Disney magic. New York Times, January 25: C6. 15. Ibid. 16. Bary, A. 2003. Coy story. Barron’s, October 13: 21.

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CASES

CASE 5 THE CASINO INDUSTRY*

On February 21, 2013, Revel, the only new casino built in Atlantic City in almost a decade, was preparing to file for bankruptcy. The $2.4 billion megaresort built on 20 acres of beachfront had opened only eight months earlier. “We will continue to improve customer service and roll out new amenities for our guests,” said Kevin DeSanctis, the casino’s chief executive officer.1 The fate of the Revel has reflected the effect of the recent economic crunch on casinos, particularly in places like Las Vegas and Atlantic City, as people have been forced to cut back on their spending.

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their travel plans and find some type of casino activity closer to where they live. As economic conditions improve, it is not clear how many of these patrons will return to these two major casino destinations. With some form of casino now allowed in over half of the states (see Exhibit 2), competition is developing all over

EXHIBIT 1 U.S. Casino Industry Gaming Revenues*

Billions of Dollars

2012† 36.71

2011 35.64

2010 34.60

2009 34.28

2008 36.22

2007 37.52

2006 35.27

2005 32.77

2004 31.17

2003 28.72

2002 28.07

* Gaming revenues include the amount of money won by casinos from various gaming activities such as slot machines, table games, and sports betting.

† 2012 figure is author estimate, based on recent industry trends. Source: State Gaming Regulatory Agencies * Case developed by Professor Jamal Shamsie, Michigan State University, with the assistance of Professor Alan B. Eisner, Pace University. Material has been drawn from published sources to be used for purposes of class discussion. Copyright © 2013 Jamal Shamsie and Alan B. Eisner.

EXHIBIT 2 Breakdown of Gaming Revenues by State, 2012

State Revenue (billions of dollars) Number and Type of Casinos

NEVADA 10.70* 256 land-based

NEW JERSEY 3.32† 11 land-based

INDIANA 2.72 1 land-based, 10 riverboats, 2 racetrack casinos

MISSISSIPPI 2.24 30 land-based dockside

LOUISANA 2.37 1 land-based, 13 riverboats, 4 racetrack casinos

PENNSYLVANIA 3.02 4 land-based, 6 racetrack casinos

MISSOURI 1.81 12 riverboats

ILLINOIS 1.48 10 riverboats

IOWA 1.42 7 land-based, 7 riverboats, 3 racetrack casinos

MICHIGAN‡ 1.42 3 land-based

NEW YORK 1.26 9 racetrack casinos

WEST VIRGINIA 0.96 4 racetrack casinos

COLORADO 0.75 40 land-based

DELAWARE 0.55 3 racetrack casinos

RHODE ISLAND 0.51 2 racetrack casinos

NEW MEXICO 0.25 5 racetrack casinos

FLORIDA 0.38 5 racetrack casinos

SOUTH DAKOTA§ 0.10 35 land-based (limited stakes)

OKLAHOMA 0.10 2 racetrack casinos

MAINE 0.06 1 racetrack casino

KANSAS 0.05 2 land-based

* $5.50 billion of this revenue comes from the Las Vegas strip.

† All of this revenue comes from Atlantic City. ‡ All of this revenue comes from Detroit. § All of this revenue comes from Deadwood.

Source: 2012 AGA Survey of Casino Entertainment.

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the country, led by riverboat casinos and Native American casinos (see Exhibit 3). Similar concerns are being raised about the growth of competition in various locations outside the United States. Over

the years, casinos have been developed in various parts of Europe and Asia, and these compete for the high rollers who have been frequent visitors to Las Vegas and Atlantic City in the past. In 2007, Macau replaced Las Vegas as the leading casino gambling center, after the opening of Sands Macao, Macau’s first Las Vegas-style casino, three years ago. Other Las Vegas-based casinos have also entered this market with lavish properties, such as MGM Macau and Wynn Macau.

EXHIBIT 3 States With Native American Casinos, 2012

State Number of Casinos

Alabama 3

Alaska 2

Arizona 25

California 70

Colorado 2

Connecticut 2

Florida 8

Idaho 8

Iowa 1

Kansas 4

Louisiana 3

Michigan 24

Minnesota 38

Mississippi 3

Missouri 1

Montana 13

Nebraska 6

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Nevada 3

New Mexico 22

New York 7

North Carolina 2

North Dakota 10

Oklahoma 114

Oregon 9

South Dakota 11

Texas 1

Washington 34

Wisconsin 29

Wyoming 4

Source: 2012 AGA Survey of Casino Entertainment.

For years, casinos in Las Vegas and Atlantic City have fought back by developing extravagant new properties. But it has been harder to obtain financing as the latest additions, such as the Revel in Atlantic City and the Palazzo in Las Vegas, have failed to draw enough clients. MGM Mirage had to search for new partners to push ahead with its ambitious City Center, which was completed in 2012, although work on one of the luxury hotel towers has been abandoned. Covering 67 acres, this $8.5 billion minicity includes luxury hotels, condominium units, a convention center, and retail space.

Most indicative of the downturn in Las Vegas is the half-completed Echelon Place, on which work has been suspended since 2009. At more than $4 billion, the 5,000-room hotel and retail complex was expected to be far more expensive than the previous record for a single casino, which was set when Steve Wynn built his $2.7 billion Wynn Las Vegas. “The last four or five years showed our dependence on the national economy. We always knew it, but this is the first time it really hit us,” said Billy Vassiliadis, the head of an advertising agency that represents the Las Vegas Convention and Visitors Authority.2

Riding the Growth Wave Although some form of gambling in the United States can been traced back to colonial times, the recent advent of casinos began with the legalization of gaming in Nevada in 1931. For many years, this was the only state in which casinos were allowed. As a result, Nevada still retains its status as the state with the highest revenues from casinos, with annual gambling revenues rising to over $10 billion by 2004. After New Jersey passed laws in 1976 to allow gambling in Atlantic City, the large population on the East Coast gained easier access to casinos. The further growth of casinos to other areas has occurred since 1988, as more and more states have legalized the operation of casinos because of their ability to help generate commercial activity and create jobs, in large part by increasing tourism.

The greatest growth has come in the form of waterborne casinos that have begun to operate in six states that have allowed casinos to develop at waterfronts such as rivers and lakes. By 2012, over 80 such casinos were generating about $10 billion in annual revenues. Several of the casinos along the Gulf Coast were destroyed or severely damaged by Hurricane Katrina. To encourage casinos to rebuild, Mississippi lawmakers passed a law in 2005 allowing casinos to operate up to 800 feet from the shore, allowing them to have a stronger foundation to withstand future hurricanes. Most of the damaged casinos in the area had reopened by early 2007.

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As casinos have spread to more states, there has also been a growing tendency to regard casino gambling as an acceptable form of entertainment for a night out. Although casinos have tended to draw players from all demographic segments, a recent national survey found that their median age was 47 and their median household income was around $50,000. On the whole, casino gamblers tended to be better educated and more affluent than those who bought lottery tickets. In fact, the bigger casinos attracted a high-roller segment, which could stake millions of dollars and included players from all over the world. Many of the casinos worked hard to obtain the business of this market segment, despite the risk that the sustained winning streak of a single player could significantly weaken the earnings for a particular quarter.

The growth of casino gambling has also been driven by the significantly better payouts that they give players compared with other forms of gambling. Based on industry estimates, casinos typically keep less than $5 of every $100 that is wagered. This compares favorably with racetrack betting, which holds back over $20 of every $100 that is wagered, and with state-run lotteries, which usually keep about $45 of every $100 that is spent on tickets. Such comparisons can be somewhat misleading, however, because winnings are put back into play in casinos much faster than they are in other forms of gaming. This provides a casino with more opportunities to win from a customer, largely offsetting its lower retention rate.

Finally, most of the growth in casino revenues has come from the growing popularity of slot machines. These coin- operated slot machines typically account for almost two-thirds of all casino gaming revenues (see Exhibit 4). A major reason for their popularity is that it is easier for prospective gamblers to feed a slot machine than to learn the nuances of various table games. Slot machines were also less labor intensive than table games. Major slot machine manufacturers, such as International Game Technology, have been making the transition to cashless or coin-free gaming by switching to the use of tickets. With the advent of new technology, server-based gaming will allow games on these machines to be changed or updated from a central system.

EXHIBIT 4 Top Five Favorite Casino Games, 2012

Game

Slot machines 53%

Blackjack 23%

Poker 7%

Roulette 3%

Craps 3%

Betting on a Few Locations Although casinos have spread across much of the country, two cities still dominate the casino business. Both Las Vegas and Atlantic City have seen a spectacular growth in casino gaming revenues over the years. Although Las Vegas has far more hotel casinos, each of the dozen casinos in Atlantic City typically generates much higher revenues. Over the last couple of decades, these two locations accounted for almost a third of the total revenues generated by all forms of casinos throughout the United States.

Las Vegas clearly acts as a magnet for the overnight casino gamblers, offering several high-end casino hotels with many choices for fine dining, great shopping, and top-notch entertainment. This allows the casinos to generate revenues from offering a wide selection of activities apart from gambling. At MGM Mirage, for example, revenue from nongaming activities has typically accounted for almost 60 percent of net revenue in recent years. Visitors find it easy to travel to Las Vegas, as it is linked by air to many major cities both in the United States and around the world.

During the 1990s, Las Vegas tried to become more receptive to families, with attractions such as circus performances, animal reserves, and pirate battles. But the city has been very successful with its recent return to its sinful roots, with a stronger focus on topless shows, hot night clubs, and other adult offerings that have been highlighted by the new advertising slogan: “What happens in Vegas, stays in Vegas.” Paul Cappelli, who creates advertising messages, believes

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that Las Vegas lost its way with the effort to become family friendly. “People don’t see Vegas as Jellystone Park. They don’t want to go there with a picnic basket,” he explained.3

For the most part, Las Vegas has continued to show a consistent pattern of growth in visitors. “We still compete with Orlando and New York,” said Terry Jicinsky, head of marketing for the Las Vegas Convention and Visitors Authority. “But based on overnight visitors, we’re the top destination in North America.”4 In order to accommodate this growth, several of the major resorts, such as Bellagio, Venetian, and Mandalay Bay, have added new wings. Even some of the older properties have been given expensive renovations, such as Caesars Palace, which was expanded to include a new Colosseum and a new Roman Plaza.

By comparison, Atlantic City cannot compete with Las Vegas in terms of the broad range of dining, shopping, and entertainment choices. It does, however, offer a beach and a boardwalk, along which its dozen large casino hotels are lined. Atlantic City attracts gamblers from various cities in the Northeast, many of whom arrive by charter bus and stay for less than a day. Atlantic City officials point out that one-quarter of the nation’s population lives sufficiently close so that they can drive there with just one tank of gas.

The opening of the much-ballyhooed Revel was part of a drive to try and make Atlantic City much more competitive with Las Vegas. But it failed to replicate the success of

C14

the Borgata Hotel Casino & Spa, which had been the last major new resort to open there, in 2003. “There’s no question that this is a Las Vegas-style mega-resort,” said Bob Boughner, the CEO of the Borgata.5

Raising the Stakes The gradual rise in the number of casinos, including those on riverboats, has led them to compete more heavily with each other to entice gamblers. Casinos have had to continuously strive to offer more in order to stand out and gain attention. This is most evident in Las Vegas and Atlantic City, the two destinations where the most and the largest casinos are located in close proximity. Potential gamblers have more choices when they visit either of these cities than they have anywhere else.

In Las Vegas, each of the casinos has tried to deal with this competition by differentiating itself in several different ways. A large number of them have tried to differentiate on the basis of a special theme that characterizes their casino, such as a medieval castle, a pirate ship, or a movie studio. Others have tried to incorporate the look and feel of specific foreign destinations into their casinos. Luxor’s, pyramids and columns evoke ancient Egypt, Mandalay Bay borrows looks from the Pacific Rim, and the Venetian’s plazas and canals re-create the Italian city.

Aside from ramping up the appeal of their particular properties, most casinos must also offer incentives to keep their customers from moving over to competing casinos. These incentives can be particularly helpful in retaining those high rollers who come often and spend large amounts of money. Casinos try to maintain their business by providing complimentary rooms, food, beverage, shows, and other perks each year that are worth billions of dollars. Gamblers can also earn various types of rewards through the loyalty programs that are offered by the casinos, with the specific rewards being tied to the amount that they bet on the slot machines and at the tables.

Some of the larger casinos in Las Vegas are also trying to fend off competition by growing through mergers and acquisitions. In 2004, Harrah’s announced that it was buying casino rival Caesars, allowing it to become the nation’s leading operator of casinos, with several properties in both Las Vegas and Atlantic City (see Exhibit 5). This deal came just a month after MGM Mirage had stated that it was buying the Mandalay Resort Group, allowing it to double the number of casinos it held on the Las Vegas strip. Firms that own several casinos can also pitch each of their properties to a different market and allow all of their customers to earn rewards on the firm’s loyalty program by gambling at any of these properties.

Such a trend toward consolidation, however, does not seem to make a serious dent in the business of smaller firms that operate just one or two resorts and focus on particular types of customers. Steve Wynn’s success with Wynn has led him to open Encore, another glitzy casino resort next to his original property. Similarly, the recently opened 455-room Palms Hotel Casino has already become one of the hottest and most profitable properties in Las Vegas. “There

EXHIBIT 5 Leading Casino Operators

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Caesars Entertainment

The largest casino operator in the world. Operates casinos across the U.S., including several in Las Vegas and Atlantic City. Runs several upscale casinos, such as Bellagio, Caesars Palace, Bally’s, Paris, Flamingo, Harrah’s, and Rio in Las Vegas. Also manages several Native American casinos.

MGM Resorts

Second largest operator of casinos, along with interests in real estate. Most of its casinos are located in Las Vegas and other parts of Nevada. Runs casinos under the name of MGM Grand, Bellagio, New York-New York, Mirage, Luxor, and Monte Carlo, all of which cater to the high end of the market. Developed the CityCenter project in Las Vegas. Also operates casinos on the Gulf Coast and in Illinois and Michigan, and has developed the MGM Macau.

Las Vegas Sands

Is a major player in the casino industry. Operates the Venetian and Palazzo in Las Vegas. Has also developed casinos in Macau, spearheaded by the Sands Macao and the Venetian Macao, and the Marina Bay Sands in Singapore.

Wynn Resorts

Operates the higher-end Wynn Las Vegas and Encore casinos, both in Las Vegas, and the Wynn Macau and Encore Macau.

Boyd Gaming

Operates casinos in various states around the U.S. Las Vegas properties that target the middle-income segment include Gold Coast, The Orleans, and Sam’s Town. Runs the Borgata in Atlantic City.

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will always be a market for a person who doesn’t feel comfortable in a big casino setting,” said George Maloof, a co- owner of the Palms Resort.6

Responding to Growing Threats The growth of Las Vegas and Atlantic City has been matched by the spread of casinos in many other parts of the United States. Among these, the largest volume of business is generated by the riverboats that have sprung up in Iowa, Illinois, Mississippi, Louisiana, Missouri, and Indiana. However, the growth of these casinos has not had much effect on the growth of visitors to Las Vegas and Atlantic City. Tom Graves, stock analyst at Standard & Poor’s, has expressed his confidence in the attractiveness of Las Vegas: “There’s a perception among gamblers that Las Vegas is still the foremost gaming market.”7

However, all of these casinos are facing growing competition from a variety of sources. Foremost among these is the rise in the number of Native American casinos. The Indian Gaming and Recreation Act of 1988 authorized Native Americans to offer gaming on tribal lands as a way to encourage their self-sufficiency. Of the approximately 550 Native American tribes in the U.S., more than 200 have negotiated agreements with states to allow gaming on tribal land. Native American casinos are exempt from federal regulations and are not required to pay any taxes on their revenues, but they generally pay a percentage of their winnings to the state in which they are located.

Over the past decade, a large share of the growth in U.S. gaming revenues has come from Native American casinos. The impact of these casinos on the traditional casino industry is likely to increase over the next few years. Several states are reaching agreements to allow the introduction or expansion of Native American casinos because of the additional revenues that they can provide. This has created fears that the growth of these Native American casinos is likely to draw away gamblers from the other types of casinos. In particular, the growth of these casinos in many states, such as California and Minnesota, may reduce the number of gamblers that make trips to the major gambling destinations, Las Vegas and Atlantic City.

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“racinos”—have being growing in popularity in the six states where they are currently allowed. According to the American Gaming Association, gaming activity at these racetracks has shown considerable growth over the last five years.

Finally, all casinos are closely observing the growth of gambling on the Internet. Although Internet gambling is not allowed under legislation in the United States, some 2,000 offshore sites generate about $15 billion in revenue. Electronic payment systems have made it possible for gamblers in the U.S. to make bets on these sites without cash, checks, or credit cards. Most casino operators believe that Internet gambling could represent both a threat and an opportunity for them. Placing bets through home computers offers convenience for prospective gamblers and a potentially low-cost business model for firms that already operate casinos. It is widely believed that gambling on the Internet might eventually be legalized, regulated, and taxed. “We frankly find attempts at prohibition to be very shortsighted,” said Alan Feldman, senior vice president of MGM Mirage in Las Vegas.8

Gambling on the Future The competitive pressures that forced many firms to build new casinos or to renovate existing ones made it difficult for them to deal with the drop in revenues that accompanied the recent economic downturn. In many cases, the heavy spending burdened casino operators with large amounts of debt that became harder to manage when demand for casino gambling began to decline. A few firms around the U.S., including some in Las Vegas and Atlantic City, ran into financial problems, forcing them to sell off some of their casinos and seek bankruptcy protection. Over the past few years, Trump Entertainment, Tropicana Entertainment, and Station Casinos have all filed for bankruptcy.

So far, such isolated failures have not dampened the enthusiasm of most of the firms that are continuing to invest heavily in casinos. Many of these gaming firms view the current economic conditions as a temporary setback that has forced them to place some of their plans for growth on hold. Since 2008, even as casino revenues dropped, 28 percent of the U.S. adult population still visited a casino, making this form of gaming second in popularity only to lotteries.

If the attraction of gaming continues to show the same level of growth that it has over the past decade, this should allow Las Vegas and Atlantic City to thrive even with the rise of new casinos in other locations. Some observers even believe that the spread of this form of gaming has created a bigger market for the casino resorts in Las Vegas and Atlantic City. As more and more people are drawn to casinos, they will be pulled to these centers of gaming. Few places, including Macau, can match Las Vegas or Atlantic City in terms of other forms of entertainment, such as shopping, fine dining, and theater shows.

Nevertheless, there are questions about the possible effect of the proliferation of casinos and the availability of Internet gambling on the revenue growth of gaming centers such as Las Vegas and Atlantic City. But many industry observers

C16

believe that these gaming centers will continue to thrive as people who gain a taste for gambling will eventually want to visit Las Vegas or Atlantic City in order to get a feel of the real thing. As Jan L. Jones, senior vice president for Harrah’s Entertainment, remarked, “Counting Las Vegas down and out, given the entrepreneurial spirit at work here, is just foolish.”9

ENDNOTES 1. Parmley, S. 2013. Another year of decline in 2012 for Atlantic City gaming. McClatchy-Tribune Business News, January 11. 2. Nagourney, A. 2013. Unfinished luxury tower is stark reminder of Las Vegas’s economic reversal. New York Times, January 23: All. 3. McCarthy, M. 2005. Vegas goes back to naughty roots; Ads trumpet return to adult playground. USA Today, April 11: B6. 4. Ibid.: B6. 5. Sloan, G. 2003. 2003. Atlantic City bets on glitz: Down-at-the-heels resort rolls the dice, wagering a cool $2 billion that it will one day rival

Las Vegas. USA Today, August 29: D1. 6. Palmeri, C. 2004. Little guys with big plans for Vegas. BusinessWeek, August 2: 49. 7. Woodyard, C., & Krantz, M. 2004. Latest Vegas marriage: Harrah’s, Caesars tie knot; $5 billion deal marks strategy to reach more gamblers.

USA Today, July 16: B1. 8. Woellert, L. 2004. Can online betting change its luck? BusinessWeek, December 20: 67. 9. Friess, S. 2009. Las Vegas sags as conventions cancel. New York Times, February 15: 20.

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C11

CASES

CASE 5 THE CASINO INDUSTRY*

Even as casinos struggle to show profits, there are growing concerns about the growth potential of places such as Las Vegas and Atlantic City over the longer term (see Exhibit 1). The economic slowdown forced potential visitors to put off their travel plans and find some type of casino activity closer to where they live. As economic conditions improve, it is not clear how many of these patrons will return to these two major casino destinations. With some form of casino now allowed in over half of the states (see Exhibit 2), competition is developing all over

EXHIBIT 1 U.S. Casino Industry Gaming Revenues*

Billions of Dollars

2012† 36.71

2011 35.64

2010 34.60

2009 34.28

2008 36.22

2007 37.52

2006 35.27

2005 32.77

2004 31.17

2003 28.72

2002 28.07

* Gaming revenues include the amount of money won by casinos from various gaming activities such as slot machines, table games, and sports betting.

EXHIBIT 2 Breakdown of Gaming Revenues by State, 2012

State Revenue (billions of dollars) Number and Type of Casinos

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NEVADA 10.70* 256 land-based

NEW JERSEY 3.32† 11 land-based

INDIANA 2.72 1 land-based, 10 riverboats, 2 racetrack casinos

MISSISSIPPI 2.24 30 land-based dockside

LOUISANA 2.37 1 land-based, 13 riverboats, 4 racetrack casinos

PENNSYLVANIA 3.02 4 land-based, 6 racetrack casinos

MISSOURI 1.81 12 riverboats

ILLINOIS 1.48 10 riverboats

IOWA 1.42 7 land-based, 7 riverboats, 3 racetrack casinos

MICHIGAN‡ 1.42 3 land-based

NEW YORK 1.26 9 racetrack casinos

WEST VIRGINIA 0.96 4 racetrack casinos

COLORADO 0.75 40 land-based

DELAWARE 0.55 3 racetrack casinos

RHODE ISLAND 0.51 2 racetrack casinos

NEW MEXICO 0.25 5 racetrack casinos

FLORIDA 0.38 5 racetrack casinos

SOUTH DAKOTA§ 0.10 35 land-based (limited stakes)

OKLAHOMA 0.10 2 racetrack casinos

MAINE 0.06 1 racetrack casino

KANSAS 0.05 2 land-based

* $5.50 billion of this revenue comes from the Las Vegas strip.

† All of this revenue comes from Atlantic City. ‡ All of this revenue comes from Detroit. § All of this revenue comes from Deadwood.

Source: 2012 AGA Survey of Casino Entertainment.

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EXHIBIT 3 States With Native American Casinos, 2012

State Number of Casinos

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Alabama 3

Alaska 2

Arizona 25

California 70

Colorado 2

Connecticut 2

Florida 8

Idaho 8

Iowa 1

Kansas 4

Louisiana 3

Michigan 24

Minnesota 38

Mississippi 3

Missouri 1

Montana 13

Nebraska 6

Nevada 3

New Mexico 22

New York 7

North Carolina 2

North Dakota 10

Oklahoma 114

Oregon 9

South Dakota 11

Texas 1

Washington 34

Wisconsin 29

Wyoming 4

Source: 2012 AGA Survey of Casino Entertainment.

first time it really hit us,” said Billy Vassiliadis, the head of an advertising agency that represents the Las Vegas Convention and Visitors Authority.2

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EXHIBIT 4 Top Five Favorite Casino Games, 2012

Game

Slot machines 53%

Blackjack 23%

Poker 7%

Roulette 3%

Craps 3%

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advertising slogan: “What happens in Vegas, stays in Vegas.” Paul Cappelli, who creates advertising messages, believes that Las Vegas lost its way with the effort to become family friendly. “People don’t see Vegas as Jellystone Park. They don’t want to go there with a picnic basket,” he explained.3

The opening of the much-ballyhooed Revel was part of a drive to try and make Atlantic City much more competitive with Las Vegas. But it failed to replicate the success of

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EXHIBIT 5 Leading Casino Operators

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Caesars Entertainment

MGM Resorts

Las Vegas Sands

Wynn Resorts

Operates the higher-end Wynn Las Vegas and Encore casinos, both in Las Vegas, and the Wynn Macau and Encore Macau.

Boyd Gaming

Operates casinos in various states around the U.S. Las Vegas properties that target the middle-income segment include Gold Coast, The Orleans, and Sam’s Town. Runs the Borgata in Atlantic City.

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will always be a market for a person who doesn’t feel comfortable in a big casino setting,” said George Maloof, a co- owner of the Palms Resort.6

The casino industry is also facing growing competition as a result of the move to introduce gaming machines at racetracks. Several states are passing legislation that would allow racetracks to raise their revenues by providing slot machines to their visitors. Racetracks where gaming machines have been installed—sometimes referred to as “racinos”—have being growing in popularity in the six states where they are currently allowed. According to the American Gaming Association, gaming activity at these racetracks has shown considerable growth over the last five years.

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forced them to place some of their plans for growth on hold. Since 2008, even as casino revenues dropped, 28 percent of the U.S. adult population still visited a casino, making this form of gaming second in popularity only to lotteries.

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CASES

CASE 6 APPLE INC.

Still Taking a Bite Out of the Competition?*

On January 25, 2013, just after Apple CEO Tim Cook presented the company’s first quarter earnings report, Apple’s stock price dropped below $440. For most other public companies, this stock price might seem something to celebrate, but for Apple it was bad news. 2012 had been a year of milestones. In September Apple stock had hit its all-time high of $702.10, making Apple the most valuable company in the world by market capitalization. September 2012 also marked Tim Cook’s first full year as CEO, and the first full year since the death of Apple’s visionary founder Steve Jobs. Although most Apple watchers mourned Steve Jobs’s death on October 5, 2011, most also realized that Jobs’s appointed successor, Tim Cook, came to the position as CEO with an impressive track record.

Cook had continued to grow the company, releasing the iPhone 5 and iPad Mini in September, and the 2012 year-end numbers had shown continued financial success across almost all product lines. However, expectations were still very high, and December 2012 rumors of a reduction in Asian supplier component orders for the iPhone for 2013 led investors to worry about a drop off in demand for the company’s flagship product. This worry led to a subsequent drop in Apple stock price of nearly 24 percent from its all-time high.1

In his first quarter 2013 conference call, CEO Cook attempted to defuse concerns over supply chain issues. That didn’t stop analysts and media watchers from writing headlines such as: “Is Apple Losing Its Brand Equity?” Listing issues such as Apple’s slipping online satisfaction scores, increasing competition, fewer repeat purchasers, and lower stock valuation, several writers wondered whether Apple was losing its luster.2 These headlines posed yet again the unavoidable question that now loomed large over 35-year-old Apple: What happens to a modern company whose innovations and inspirations are so closely tied to the vision of one leader when that leader’s influence is no longer present?3

Cook should have had every reason to be confident. In the 2013 first quarter, Apple had reported $54.5 billion in revenue, up 18 percent from a year before (see Exhibits 1 and 2).4 The results were excellent by most accounts, but investors were obviously looking for more. Despite Apple’s improving profit margins, higher cash reserves, and the first dividend payment to shareholders—plus the assumption of product plans for 2013 and beyond—some analysts believed that without Jobs’s stubbornness and obsession about process and product details, Apple would never be the same.

* This case was prepared by Professor Alan B. Eisner of Pace University and Associate Professor Pauline Assenza, Western Connecticut State University This case was based solely on library research and was developed for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 2013 Alan B. Eisner.

Apple, Fortune Magazine’s, “world’s most admired company” since 2008,5 had distinguished itself by excelling over the years not only in product innovation but also in revenue and margins (since 2006 Apple had consistently reported gross margins of over 30 percent). Founded as a computer company in 1976 and known early on for its intuitive adaptation of the “graphical user interface” or GUI (via the first mouse and the first on-screen “windows”),6 Apple had dropped the word computer from its corporate name in 2007. Apple Inc. in 2013 was known for having top-selling products not only in desktop (iMac) and notebook (MacBook) personal computers but also in portable digital music players (iPod), online music and “app” services (iTunes and App Store), mobile communication devices (iPhone), digital

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consumer entertainment (Apple TV), handheld devices able to download third-party applications, including games (iPod Touch via the App Store), and, recently, tablet computers (iPad) and online services (iCloud) (see Exhibit 3).

Although most of those innovations occurred after 1998, when Apple was under Steve Jobs’s leadership, there was a 12-year period in which Jobs was not in charge. The company’s ongoing stated strategy had been to leverage “its unique ability to design and develop its own operations systems, hardware, application software, and services to provide its customers new products and solutions with superior ease-of-use, seamless integration and innovative industrial design.”7

This strategy required not only product design and marketing expertise but also scrupulous attention to operational details. Given Apple’s global growth in multiple product categories, and the associated complexity in strategic execution, would the loss of one man be sufficient to prevent the company from sustaining its competitive advantage? Had Steve Jobs been essential to Apple’s success? Was Apple’s run of innovation and growth finally over? Could it still take a bite out of all competition, or was the competition catching up?

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EXHIBIT 1 Apple Sales

Go to library tab in Connect to access Case Financials.

A B C D E F

1 Net Sales by Product

2 2012 (in millions)

% Change

2011 (in millions)

% Change

2010 (in millions)

3 Desktops $6,040 (6)% $ 6,439 4% $ 6,201

4 Portables 17,181 12% 15,344 (36)% 11,278

5 iPod 5,615 (25)% 7,453 (10)% 8,274

6 Music* 8,534 35% 6,314 28% 4,948

7 iPhone 80,477 71% 47,057 87% 25,179

8 iPad 32,424 59% 20,358 311% 4,958

9 Peripherals 2,778 19% 2,330 28% 1,814

10 Software, services 3,459 17% 2,954 15% 2,573

11 Total net sales S 156,508 45% $108,249 66% $ 65,225

12 Cost of sales 87,846 64,431 39,541

13 Gross margin S 68,662 $43,818 $ 25,684

14 Gross margin % 43.9% 40.5% 39.4%

15 Research and development $ 3,381 $ 2,429 $ 1,782

16 Percentage of net sales 2% 2% 2.7%

17 Selling, general, and administrative

$10,040 $ 7,599 $5,517

18 Percentage of net sales 6% 7% 8.5%

19 Total operating expenses $13,421 $10,028 $ 7,299

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20 Net income $ 41,733 $ 25,922 $14,013

A B C D E F

1 Net Sales by Region

2 2012 (in millions) % Change 2011 (in millions) % Change 2010 (in millions)

3 Americas $57,512 50% $38,315 56% $ 24,498

4 Europe 36,323 31% 27,778 49% 18,692

5 Japan 10,571 94% 5,437 37% 3,981

6 Asia-Pacific 33,274 47% 22,592 174% 8,256

7 Retail Net Sales 18,828 33% 14,127 44% 9,798

* Includes revenue from sales from the iTunes Store, App Store, and iBookstore in addition to sales of iPod services and Apple-branded and third-party iPod accessories.

Source: Apple 10K SEC filing, 2012.

EXHIBIT 2 Apple First Quarter 2013 Sales

Go to library tab in Connect to access Case Financials.

A B C F

1 Net Sales by Product

2 1st Quarter 2013 (in millions)

1st Quarter 2012 (in millions)

Percentage Change

3 iPhone* $ 30,660 $ 23,950 28%

4 iPad* 10,674 8,769 22%

5 Mac* 5,519 6,598 (16)%

6 iPod* 2,143 2,528 (15)%

7 iTunes, Software and Services†

3,687 3,020 22%

8 Accessories‡ 1,829 1,468 25%

9 Total net sales $ 54,512 $ 46,333 18%

A B C F

1 Net Sales by Region

2 1st Quarter 2013 (in millions) 1st Quarter 2012 (in millions) Percentage Change

3 Americas $ 20,341 $ 17,714 15%

4 Europe 12,464 11,256 11%

5 Greater China§ 6,830 4,080 67%

6 Japan 4,443 3,550 25%

7 Asia-Pacific 3,993 3,617 10%

8 Retail 6,441 6,116 5%

* Includes deferrals and amortization of related nonsoftware services and software upgrade rights.

† Includes revenue from sales on the iTunes Store, the App Store, the Mac App Store, and the iBookstore, and revenue from sales of AppleCare, licensing, and other services. ‡ Includes sales of hardware peripherals and Apple-branded and third-party accessories for iPhone, iPad, Mac, and iPod. § Greater China includes China, Hong Kong, and Taiwan.

Source: Apple 10Q SEC filing, 2013.

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EXHIBIT 3 Apple Innovation Time Line

Date Product Events

1976 Apple I Steve Jobs, Steve Wozniak, and Ronald Wayne found Apple Computer.

1977 Apple II Apple logo first used.

1979 Apple II+ Apple employs 250 people; the first personal computer spreadsheet software, VisiCalc, is written by Dan Bricklin on an Apple II.

1980 Apple III Apple goes public with 4.6 million shares; IBM personal computer announced.

1983 Lisa John Sculley becomes CEO.

1984 Mac 128K, Apple IIc Super Bowl ad introduces the Mac desktop computer.

1985 Jobs resigns and forms NeXT Software; Windows 1.01 released.

1986 Mac Plus Jobs establishes Pixar.

1987 Mac II, Mac SE Apple sues Microsoft over GUI.

1989 Mac Portable Apple sued by Xerox over GUI.

1990 Mac LC Apple listed on Tokyo Stock Exchange.

1991 PowerBook 100, System 7 System 7 operating-system upgrade released, the first Mac OS to support PowerPC-based computers.

1993 Newton Message Pad (one of the first PDAs)

Sculley resigns; Spindler becomes CEO; PowerBook sales reach 1 million units.

1996 Spindler is out; Amelio becomes CEO; Apple acquires NeXT Software, with Jobs as adviser.

1997 Amelio is out; Jobs returns as interim CEO; online retail Apple Store opened.

1998 iMac iMac colorful design introduced, including USB interface; Newton scrapped.

1999 iMovie, Final Cut Pro (video editing software)

iBook (part of PowerBook line) becomes best-selling retail notebook in October; Apple has 11 % share of notebook market.

2000 G4Cube Jobs becomes permanent CEO.

2001 iPod, OS X First retail store opens, in Virginia.

2002 iMac G4 Apple releases iLife software suite.

2003 iTunes Apple reaches 25 million iTunes downloads.

2004 iMac G5 Jobs undergoes successful surgery for pancreatic cancer.

2005 iPod Nano, iPod Shuffle, Mac Mini

First video iPod released; video downloads available from iTunes.

2006 MacBook Pro Apple computers use Intel’s Core Duo CPU and can run Windows software; iWork software competes with Microsoft Office.

2007 iPhone, Apple TV, iPod Touch Apple Computer changes name to Apple Inc.; Microsoft Vista released.

2008 iPhone 3G, MacBook Air, App Store

App Store launched for third-party applications for iPhone and iPod Touch and brings in $1 million in one day.

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2009 17-inch MacBook Pro, iLife, iWork ‘09

iTunes Plus provides DRM-free music, with variable pricing; Jobs takes medical leave.

2010 iPad, iPhone 4 iPhone 4 provides FaceTime feature; iTunes reaches 10 billion songs sold.

2011 iPad2, iPhone 4S, iCIoud iPhone available on Verizon Wireless; Jobs resigns as CEO, dies on October 5th. Tim Cook becomes CEO.

2012 iBook Author, iPhone5, iPad Mini

iBook supports textbook creation on iPad. Apple becomes world’s most valuable company (market cap).

Source: Apple.com: Fried, I. 2009. Celebrating three decades of Apple. CNET News, Special issue: Apple turns 30, March 28. news.cnet.com/2009-1041- 6053869.html; and Wikipedia. Apple Inc. en.wikipedia.org/wiki/Apple_inc.

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Company Background

Founder Steve Jobs Apple Computer was founded in Mountain View, California, on April 1, 1976, by Steve Jobs and Steve Wozniak. Jobs was the visionary and marketer, Wozniak was the technical genius, and A. C. “Mike” Markkula Jr., who had joined the team several months earlier, was the businessman. Jobs set the mission of empowering individuals, one person–one computer, and doing so with elegance of design and fierce attention to detail. In 1977 the first version of the Apple II became the first computer ordinary people could use right out of the box, and its instant success in the home market caused a computing revolution, essentially creating the personal computer industry. By 1980 Apple was the industry leader and went public in December of that year.

In 1983 Wozniak left the firm and Jobs hired John Sculley away from PepsiCo to take the role of CEO at Apple, citing the need for someone to spearhead marketing and operations while Jobs worked on technology. The result of Jobs’s creative focus on personal computing was the Macintosh. Introduced in 1984, with the now-famous Super Bowl television ad based on George Orwell’s novel Nineteen Eighty-Four,8, the Macintosh was a breakthrough in terms of elegant design and ease of use. Its ability to handle large graphic files quickly made it a favorite with graphic designers, but it had slow performance and limited compatible software was available. That meant the product as designed at the time was unable to significantly help Apple’s failing bottom line. In addition, Jobs had given Bill Gates at Microsoft some Macintosh prototypes to use to develop software, and in 1985 Microsoft subsequently came out with the Windows operating system, a version of GUI for use on IBM PCs.

Steve Jobs’s famous volatility led to his resignation from Apple in 1985. Jobs then founded NeXT Computer. The NeXT Cube computer proved too costly for the business to become commercially profitable, but its technological contributions could not be ignored. In 1997 then Apple CEO Gilbert Amelio bought out NeXT, hoping to use its Rhapsody, a version of the NeXTStep operating system, to jump-start the Mac OS development, and Jobs was brought back as a part-time adviser.

Under CEOs Sculley, Spindler, and Amelio John Sculley tried to take advantage of Apple’s unique capabilities. Because of this, Macintosh computers became easy to use, with seamless integration (the original plug-and-play) and reliable performance. This premium performance meant Apple could charge a premium price. However, with the price of IBM compatibles dropping, and Apple’s costs, especially R&D, way above industry averages (in 1990 Apple spent 9 percent of sales on R&D, compared to 5 percent at Compaq and 1 percent at many manufacturers of IBM clones),9 this was not a sustainable scenario.

Sculley’s innovative efforts were not enough to substantially improve Apple’s bottom line, and he was replaced as CEO in 1993 by company president Michael Spindler. Spindler continued the focus on innovation, producing the PowerMac, based on the PowerPC microprocessor, in 1994. Even though this combination produced a significant price- performance edge over both previous Macs and Intel-based machines, the IBM clones continued to undercut Apple’s

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prices. Spindler’s response was to allow other companies to manufacture Mac clones, a strategy that ultimately led to clones stealing 20 percent of Macintosh unit sales.

Gilbert Amelio, an Apple director and former semiconductor turnaround expert, was asked to reverse the company’s financial direction. Amelio intended to reposition Apple as a premium brand, but his extensive reorganizations and cost- cutting strategies couldn’t prevent Apple’s stock price from slipping to a new low. However, Amelio’s decision to stop work on a brand-new operating system and jump-start development by using NeXTStep brought Steve Jobs back to Apple in 1997.

Steve Jobs’s Return One of Jobs’s first strategies on his return was to strengthen Apple’s relationships with third-party software developers, including Microsoft. In 1997 Jobs announced an alliance with Microsoft that would allow for the creation of a Mac version of the popular Microsoft Office software. He also made a concerted effort to woo other developers, such as Adobe, to continue to produce Mac-compatible programs.

In late October 2001, Apple released its first major non-computer product, the iPod. This device was an MP3 music player that packed up to 1,000 CD-quality songs into an ultraportable, 6.5-ounce design: “With iPod, Apple has invented a whole new category of digital music player that lets you put your entire music collection in your pocket and listen to it wherever you go,” said Steve Jobs. “With iPod, listening to music will never be the same again.”10 This prediction became even truer in 2002, when Apple introduced an iPod that would download from Windows—its first product that didn’t require a Macintosh computer and thus opened up the Apple “magic” to everyone. In 2003 all iPod products were sold with a Windows version of iTunes, making it even easier to use the device regardless of computer platform.

In April 2003, Apple opened the online iTunes Music Store to everyone. This software, downloadable on any computer platform, sold individual songs through the iTunes application for 99 cents each. When announced, the iTunes Music Store already had the backing of five major record labels and a catalog of 200,000 songs. Later that year, the iTunes Music Store was selling roughly 500,000 songs a day. In 2003 the iPod was the only portable digital player that could play music purchased from iTunes, and this intended exclusivity helped both products become dominant.

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After 30 years of carving a niche for itself as the premier provider of technology solutions for graphic artists, Web designers, and educators, Apple appeared to be reinventing itself as a digital entertainment company, moving beyond the personal computer industry. The announcement in 2007 of the iPhone, a product incorporating a wireless phone, a music and video player, and a mobile Internet browsing device, meant Apple was also competing in the cell phone/smartphone industry.

Also introduced in 2007, the iPod Touch incorporated Wi-Fi connectivity, allowing users to purchase and download music directly from iTunes without a computer. Then, in 2008 Apple opened the App Store. Users could now purchase applications written by third-party developers specifically for the iPhone and iPod Touch. These applications included games, prompting analysts to wonder whether Apple was now becoming a competitor in the gaming market.

In 2010 Apple launched the large-screen touch-based tablet called the iPad and sold over 2 million of these devices in the first two months.11 That same year, Apple’s stock value increased to the extent that the company’s market cap exceeded Microsoft’s, making it the biggest tech company in the world.12 In 2011 Steve Jobs made his last product launch appearance to introduce iCloud, an online storage and syncing service. On October 4, 2011, Apple announced the iPhone 4S, which included “Siri,” the “intelligent software assistant.” The next day, on October 5, came the announcement that Steve Jobs had died.

Apple continued to innovate, however, and on September 21, 2012, Apple had its biggest iPhone launch ever, with the iPhone 5. Over 2 million preorders for this larger and more powerful phone pushed the delivery date back to late October.13 Later in the fall, Apple released the iPad Mini with a smaller screen. On September 19, 2012, Apple stock reached $702.10, its highest level to date, which made Apple the most valuable company in the world.

Apple had become a diversified digital entertainment corporation (see Exhibit 4). All the way back in 2005 analysts had believed Apple had “changed the rules of the game for three industries—PCs, consumer electronics, and music … and appears to have nothing to fear from major rivals.”14 On top of steady sales increases of its computers of the iPod, and of iTunes, the added categories of iPhone and iPad had shown substantial growth. Apple had taken bites out of the competition on all fronts (see Exhibit 4). However, by 2013, Samsung had outperformed Apple in worldwide smartphone sales,15 and Google’s Android had captured the largest market share of cell phone operating systems. At the same time, both the Amazon Kindle Fire HD and Microsoft’s Surface tablet were nipping at the iPad’s heels. Was this a warning of things to come?

Apple’s Operations Maintaining a competitive edge required more than innovative product design. Operational execution was also important. For instance, while trying to market its increasingly diverse product line, Apple believed that its own retail stores could serve customers better than could third-party retailers. By the end of 2012, Apple had 390 stores open, including 140 international locations, with average store revenue of about $51.5 million, and had received trademark protection for its retail stores’ “distinctive design and layout.”16

In further operational matters, regarding a head-to-head competition against Dell in the computer market, for instance, while Dell’s perceived early dominance might have been partly the result of its efficient supply-chain

EXHIBIT 4 Apple’s Product Lines and Major Competitors

Product Category Apple Products Major Competitors

Computers iMac, Mac Pro, Mac mini, MacBook, MacBook Pro, MacBook Air

HP, Dell, Toshiba in the laptop; Acer and Asus in the netbook/ultrabook form factor

Portable music/media players

iPod Shuffle, iPod Nano, iPod Classic, iPod Touch

Samsung, SanDisk Sansa, Archos, Microsoft Zune

Smartphones iPhone Nokia, RIM, Samsung, ZTE, LG, Google/Motorola, HTC

Music/media downloads

iTunes, the App Store Amazon, Google Android apps

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Handheld gaming devices

iPod Touch, iPhone Nintendo, Sony

Software* Safari web browser, QuickTime Microsoft IE, Mozilla Firefox, Google Chrome, Windows Media Player, RealNetworks

Home theater downloads

Apple TV Roku, possibly Tivo

Tablet computers iPad Samsung Galaxy Tab, Amazon Kindle Fire, Google Nexus, Windows Surface

* Includes only the software that is sold separately to use on either Windows or Mac computers.

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management, Apple had outperformed Dell in inventory and other metrics since 2001.17 To solidify its own supply chain, Apple entered into multiyear agreements with suppliers of key components. In addition, Apple had historically had the best margins, partly because of its simpler product line, leading to lower manufacturing costs.18 Also, Apple had been outsourcing manufacturing and final assembly of iMacs, iPods, and iPhones to partners in Asia, paying close attention to scheduling and quality issues.

Outsourcing to Asian manufacturers was not without its problems, however. In 2012, headlines worldwide accompanied the exposure of China’s Foxconn manufacturing facility for labor abuses that led to worker suicide threats. Apple, as well as most other technology companies, used Foxconn facilities to assemble products, including the iPad and iPhone. After the story broke, Apple CEO Tim Cook visited the Foxconn plant and reviewed an audit of working conditions that found violations in wages, overtime, and environmental standards. Apple stated that it remained “committed to the highest standards of social responsibility across our worldwide supply chain,”19 and Cook announced that Apple would be bringing some of the production of Mac computers back to the U.S., starting in 2013. They could do this possibly without affecting the company’s profitability, because of automation cost savings. As one supply chain expert said, “Apple’s product line is highly standardized, with a very small number of products and very few configurations, and that makes it much easier to do automation.”20

Supply chain and product design and manufacturing efficiencies were not the only measures of potential competitive superiority. Apple had also historically paid attention to research and development, increasing its R&D investment year after year. In 2012, Apple spent $952 million on R&D, an increase from $647 million in the previous year. Among its current rivals, Apple’s R&D investment was beaten only by Microsoft (number 1), Google, Hewlett-Packard, and Amazon.21

As one of Steve Jobs’s legacies, Apple had traditionally kept the specifics of its research and development a closely guarded secret and fiercely protected its innovative patents. A well-publicized series of lawsuits in 2012 highlighted rifts between Apple and Samsung, both a rival and supplier. Samsung smartphones had captured more market share than Apple’s iPhones in the beginning of 2012, and Apple argued that Samsung had succeeded with both its phones and tablets only by copying Apple’s designs. Samsung replied by claiming that Apple had infringed on Samsung’s patents.22

U.S. intellectual property courts found in favor of Apple, but Japanese courts found in favor of Samsung. The ongoing battle meant Apple needed to look for other suppliers of chips and displays. In September 2012, supply chain watchers pointed out that Apple had a major challenge ahead finding reliable suppliers for increasingly scarce components. This shortage endangered CEO Cook’s historical strategy of cutting tight deals with suppliers and meant Apple could see smaller profit margins ahead, especially for the previously lucrative iPhone.23

Status of Apple’s Business Units in 2013

The Apple Computer Business In the computer market, Apple had always refused to compete on price, relying instead on its reliability, design elegance, ease of use, and integrated features to win customers. From the beginning, some analysts had believed Apple had the opportunity to steal PC market share as long as its system was compatible, no longer proprietary, and offered upgrades at

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a reasonable cost.24 This opportunity for increased market share was realized when Apple began using Intel processors in the iMac desktop and the MacBook portables, which allowed them to run Microsoft Office and other business software.

Despite the continuing push to convert customers to the Macintosh computing products, Apple’s worldwide Mac computer sales during the first quarter of 2013 decreased almost 22 percent over the same quarter in the previous year, to $5.5 billion. Reportedly, this decline was partly because of supply constraints,25 but sales of desktop computers, especially, were slowing worldwide as the tablet and smartphone markets grew. This caused analysts to wonder if the high-margin Mac sales might be further cannibalized by the iPad, leading to a continued erosion of Apple profit margins.26 Sales of Apple computers in the United States during the fourth quarter of 2012 did see a decline over the previous year, but not as much as the domestic shipments of Dell (down 16.6 percent). According to market analysis done by IDC, the Mac’s domestic market share grew from 10.9 to 11.4 percent, putting it in third place overall in IDC’s survey of PC vendor units shipped in 4Q2012 (see Exhibit 5).27 This is up substantially from 2010, when Apple had only 7.4 percent of the U.S. market.28

Personal Digital Entertainment Devices: iPod Although many analysts at the time had felt the MP3 player market was oversaturated, Apple introduced the iPod Touch in 2007, intending it to be “an iPhone without the phone,” a portable media player and Wi-Fi Internet device without the AT&T phone bill.29 The iPod Touch borrowed most of its features from the iPhone, including the finger-touch interface, but it remained mainly an iPod, with a larger viewing area for videos. Apple released the fifth-generation iPod Touch in September 2012, with upgraded features like support for recording 1080p video and panoramic still photos, and support for Apple’s “Siri.”

Apple reported selling 12.7 million iPod units during the first quarter of 2013, a decline of 18 percent over the same period in the previous year.30 As with desktop computer sales, the MP3 player market was contracting overall as smartphone and tablet devices took over many music-related tasks. Even with the decline in iPod sales, Apple was

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still leading well over its rivals. According to NPD group, in 2012 the iPod had a 70 percent share of the MP3 player market in the United States.31 Apple rival Microsoft’s entry into this space, the Zune, was discontinued in October 2011. Its market share never exceeded 1 percent.32

EXHIBIT 5 Domestic PC Market Share, Fourth Quarter 2012, units in thousands

Company 4Q12 Shipments

4Q12 Market Share (%)

4Q11 Shipments

4Q11 Market Share (%)

4Q12–4Q11 Growth (%)

Hewlett- Packard

4,797 27.0 4,266 23.0 12.4%

Dell 3,475 19.6 4,166 22.4 –16.6

Apple 2,030 11.4 2,033 10.9 –0.2

Lenovo 1,504 8.5 1,348 7.3 11.6

Toshiba 1,256 7.1 1,900 10.2 –33.9

Others 4,685 26.4 4,862 26.2 –3.6

Total 17,747 100.0 18,575 100.0 6.6

Note: PCs include desktops, portables, mini notebooks, and workstations. It does not include handhelds, x86 servers, and tablets (i.e., iPad and Android-based tablets). Data for all vendors are reported for calendar periods. Source: IDC Worldwide Quarterly PC Tracker, January 10, 2013

Mobile Communication Devices: iPhone In 2007 further competition for the iPod came from the blurring of lines between digital music players and other consumer electronic devices. While others may have seen the computer as central to the future of digital music, telecom companies worked to make the mobile phone a center of the digital world. Apple’s entry, the iPhone, combined an Internet-enabled smartphone and video iPod. The iPhone allowed users to access all iPod content and play music and video content purchased from iTunes. More recent smartphone models increased the quality of the photo and video components to make even the digital camera or camcorder appear obsolete. The smartphone market in 2007 was estimated at 10 percent of all mobile phone sales, or 100 million devices a year. Steve Jobs had said he “would like to see the iPhone represent 1 percent of all mobile phone sales by the end of 2008.”33 This proved to be a conservative estimate, and by 2012 Apple had achieved 6.9 percent (see Exhibit 6).

Going into 2013, it appeared that the cell phone landscape was changing yet again, with smartphones becoming the device of choice for most manufacturers—smartphones were also often the electronic data consumers’ device of choice, with multiple features, including cameras and the ability to surf the Internet while being held in the hand, rather than taking up the space of a tablet or ultra-thin computer. However, the smartphone market was increasingly turning into a battle between mobile operating systems.

Apple’s iPhone, running on iOS, now had considerable competition from Samsung’s Galaxy smartphones, especially. And this was partly due to Samsung’s use of Google’s Android operating system. Historical worldwide leader Nokia had stumbled badly with its outdated Symbian operating system and was trying to regain a foothold by partnering with Microsoft, using the Windows Phone operating system. Research in Motion had had problems updating its BlackBerry line of phones, although RIM still had some long-term Blackberry fans awaiting the delayed release of BlackBerry 10. The market share by operating system map was now worth watching, with Android devices expected to continue to capture the majority of market share through 2016 (see Exhibit 7).34

EXHIBIT 6 Worldwide Market Share—Cell Phones, 2nd Quarter 2012

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Manufacturer Market Share 2Q2012 Market Share 2Q2011

Samsung 21.6% 16.3%

Nokia 19.9 22.8

Apple 6.9 4.6

ZTE 4.3 3.0

LG 3.4 5.7

Huawei 2.6 2.1

TLC 2.2 1.9

HTC 2.2 2.6

Motorola 2.2 2.4

Research in Motion 1.9 3.0

Others 32.8 35.7

Source: Gartner 2012.

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EXHIBIT 7 Top Smartphone Operating Systems, Forecast Market Share, and Compound Annual Growth Rate, 2012–2016

Smartphone OS Market Share 2012 Projected Market Share 2016 CAGR 2012-2016 (%)

Google Android 68.3% 63.8% 16.3%

Apple iOS 18.8 19.1 18.8

RIM BlackBerry OS 4.7 4.1 14.6

Microsoft Windows Phone 2.6 11.4 71.3

Linux 2.0 1.5 10.5

Others 3.6 0.1 –100.0

TOTAL 100.0 100.0 18.3%

Source: IDC. 2012. Worldwide mobile phone growth expected to drop to 1.4 % in 2012 despite continued growth of smartphones, according to IDC. IDC, December 4. www.idc.com/getdoc.jsp?containerld=prUS238l82l2#.UQSn-_J5V8E.

Apple’s growth was projected to continue to slow, partly because its high price relative to other smartphones made it cost prohibitive for some users in the emerging markets of China, India, and Russia. Even though Apple sold more than two million iPhone 5 units in China over the weekend launch in January 2013, a cheaper iPhone might position Apple even better in this developing market.35 However, this potential move by Apple to reduce prices would go against the company’s long-held stance that quality was worth the higher price tag.

Analysts were questioning this strategy, pointing out that “the iPhone and related revenue accounted for about 51% of Apple’s revenue in FY 12 and will grow to about 54% of revenue in FY 13.” Therefore, a strategy of “competing on the price-point” rather than competing by creating new technologies that blow the competitors away appeared “to be a sign

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of slowing innovation.”36 The lower price points would also reduce Apple’s profit margins, especially in this iPhone category, traditionally one of Apple’s more financially successful operating segments.

In addition, by 2013 it appeared some of the “cool” factor had disappeared from the iPhone. In Asian markets, especially, Apple’s shares of mobile devices had fallen sharply in 2012, losing considerable ground to Samsung and HTC smartphones. Younger users, the 20-something college students and fresh graduates, were looking for the next new thing, and that was increasingly an Android-driven device. A social media expert in Singapore noted, “Apple is still viewed as a prestigious brand, but there are just so many other cool smartphones out there now that the competition is just much stiffer.” This was a problem, because this Asian market was also where consumers were adopting very quickly, spending 78 percent more on smartphones in 2012 than they did in 2011.37 In addition, CEO Tim Cook’s visit to China in the fall of 2012, presumably to woo China Mobile’s chief executive into subsidizing the iPhone, didn’t have the expected result. China Mobile’s wireless network, the world’s largest, wouldn’t be adding the iPhone without better terms from Apple. Instead it would be offering its subscribers the Nokia Lumia Windows 8 phone.38 Given all these challenges, could Apple continue to ride the success of the iPhone to greater profits? Many were skeptical.

Tablet Computer: iPad In April 2010 Apple released the iPad, a tablet computer, as a platform for audio-visual media, including books, periodicals, movies, music, games, and web content. More than 300,000 iPads were scooped up by eager tech consumers during the device’s first day on store shelves. Weighing only 1.5 pounds, this lightweight, portable, and touch-screen device was seen as a gigantic iPod Touch.39

Considering that previous tablet computers had failed to catch on in the mass market, Apple made a bold move by introducing the iPad. Upon its release, some users criticized the iPad for a lack of features, such as a physical keyboard, a webcam, USB ports, and Flash support, and for its inability to multitask, share files, and print. However, features like the sleek design, touch screen, multiple apps, and fast and easy-to-navigate software made the iPad popular in business, education, and the entertainment industry. The iPad was selected by Time magazine as one of the 50 Best Inventions of the Year 2010.40

Up until September 2010, Apple iPads accounted for 95 percent of tablet computer sales, according to research firm Strategy Analytics.41 But by the end of 2012, that figure had fallen to 78.9 percent. The loss of share was due to the arrival of new tablet devices, such as Samsung’s Galaxy, based on Google’s open-source Android system. Other platforms and devices had also begun to appear, including Google’s Nexus, Amazon’s Kindle Fire HD, and Microsoft’s Windows 8 Surface tablet.42

In October 2012 Apple released the iPad Mini, a 7-inch version of the iPad, pitting it directly against Amazon’s popular Kindle Fire. Although analysts were worried that the Mini would cannibalize sales of the standard-size iPad, sales of the Mini over the holidays in 2012 were excellent, exceeding 5 million units.43 This easily beat the

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rate of Amazon’s sales after the Kindle Fire’s launch in 2011, causing one analyst to label the iPad Mini a “game changer” in the market share wars.44

The Software Market Although Apple has always created innovative hardware, software development was also an important goal. Software had increasingly becoming Apple’s core strength, especially in its computers, due to its reliability and resistance to virus infections and resulting crashes.45 The premier piece of Apple software was the operating system. The iOS allowed Apple to develop software applications such as Final Cut Pro, a video-editing program for professionals’ digital camcorders, and the simplified version for regular consumers, called iMovie. The iLife software package provided five integrated applications, allowing the computer to become a home studio: iMovie; iDVD, for recording photos, movies, and music onto DVDs; iPhoto, for touching up digital photos; GarageBand, for making and mixing personally created music; and the iTunes digital music jukebox. Also available was iWork, containing a PowerPoint-type program called Keynote and a word-processor/page-layout program called Pages. Both iLife and iWork underwent major upgrades in 2009, further increasing their respective abilities to compete with Microsoft applications.

Apple’s Web browser, Safari, was upgraded in 2009 to compete with Windows Internet Explorer, Mozilla Firefox, and the new entrant, Chrome from Google. Apple announced, “Safari 4 is the world’s fastest and most innovative browser,”46 but analysts were quick to point out that Google’s Chrome, which debuted six months earlier, was perhaps the first to take the browser interface in a new direction. One commentator called Chrome “a wake-up call for the Safari UI guys.… It’s not that any particular feature of Chrome is so wonderful, or even that the sum of those features puts Safari back on its heels in the browser wars. It’s the idea that someone other than Apple has taken such clear leadership in this area. Google Chrome makes Safari’s user interface look conservative; it makes Apple look timid. And when it comes to innovation, overall daring counts for a lot more than individual successes or failures on the long-term graph.”47

Reviews of Apple’s Safari upgrade noted, “Whether or not the individual features of Chrome inspired Apple, it’s clear that Apple isn’t going to let Google have the lead in browser innovation without a fight. And the more innovation that happens, the better it will be for users of Web browsers—which at this point is pretty much everybody with a computer!”48 Browser market share data at the end of 2012 showed Microsoft with the majority, but Safari was still in second place at around 20 percent, beating out Chrome, Firefox, Android, and others.49

In other software development areas, Apple had not been that successful. In 2012 Apple had stumbled badly with its Maps software. Released in iOS6, Apple Maps was meant to replace Google Maps on the iPhone, but instead produced distorted images and gave really bad directions. CEO Tim Cook had to apologize that Apple had fallen short of its commitment to making “world-class products,” and suggested customers go back to using its competitor’s mapping software.50

iTunes Arguably, Apple’s most innovative software product was iTunes, a free downloadable software program for consumers running on either Mac or Windows operating systems. It was bundled with all Mac computers and iPods and connected with the iTunes Music Store for purchasing digital music and movie files that could be downloaded and played by iPods, iPads, and the iPhone, and by iTunes on PCs.

Although the volume was there, iTunes had not necessarily been a profitable venture. Out of the 99 cents Apple charged for a song, about 65 cents went to the music label; 25 cents went for distribution costs, including credit card charges, servers, and bandwidth; and the balance went to marketing, promotion, and the amortized cost of developing the iTunes software.51 However, if not wildly profitable, iTunes was still considered a media giant, especially with its over 435 million accounts stored in its database as of 2013.52

Several competitors had tried to compete with the iTunes service. RealNetworks’s Rhapsody subscription service, Yahoo MusicMatch, and AOL music downloads all had tried to compete for the remaining market share, using the potentially buggy Microsoft Windows Media format, and all had subsequently failed.53 Even though one commentator had said in 2004 that “ultimately someone will build a piece of software that matches iTunes,”54 as of 2013 the only serious competition was from Amazon.

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At the start of 2013, iTunes accounted for over 60 percent of all digital music sales. In second place was Amazon’s MP3 store with 16 percent market share. Google Play, eMusic, Zune Music Pass, Rhapsody, and a few others each captured 5 percent or less of the remaining sales. Growth, however, was occurring in the streaming service market, especially with the rising popularity of online radio and Internet streaming provider Pandora. This caused market watchers to wonder whether Apple might be thinking of adding a streaming capability to iTunes.54

The App Store In March 2008, Apple announced that it was releasing the iPhone software development kit (SDK), allowing developers to create applications for the iPhone and iPod Touch and sell these third-party applications via the Apple App Store. The App Store was made available on iTunes, and it was directly available from the iPhone, iPad, and iPod Touch products. This opened the window for another group of Apple customers, the application developers, to collaborate with Apple. Developers could purchase the iPhone Developer Program from Apple for $99, create

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either free or commercial applications for the iPhone and iPod Touch, and then submit these applications to be sold in the App Store. Developers would be paid 70 percent of the download fee iPhone or iPod Touch customers paid to the App Store, and Apple would get 30 percent of the revenue. The applications ranged from simple audio files that were available for free (e.g., ringtones), to straightforward programs that sold for 99 cents (e.g., a program that turned the iPhone into a simple voice recorder), to full-featured applications that retailed for up to $69.99 (e.g., ForeFlight Mobile, which allowed pilots to get weather and airport information), and included complete games from top developers such as Zynga and Electronic Arts (EA).

As of January 2013, over 40 billion apps had been downloaded from Apple’s App Store, but Google Play, the app store for Android users, was gaining ground, indicating that Google might be attracting more top-tier developers and quality titles to its marketplace. However, downloads for both platforms had slowed in 2013, causing market watchers to wonder if a plateau might be coming. This might mean diminishing returns and a less prosperous business model for all concerned.56

The Future of Apple Although Steve Jobs had always been given credit for Apple’s ability to innovate and to appeal especially to a certain type of consumer (Jobs had originally estimated Apple’s market share in the creative-professional marketplace as over 50 percent),57 Jobs himself credited his people:

We hire people who want to make the best things in the world … our primary goal is to make the world’s best PCs—not to be the biggest or the richest. We have a second goal, which is to always make a profit—both to make some money but also so we can keep making those great products.… [Regarding the systemization of innovation,] the system is that there is no system. That doesn’t mean we don’t have process. Apple is a very disciplined company, and we have great processes. But that’s not what it’s about. Process makes you more efficient… but innovation … comes from saying no to 1,000 things to make sure we don’t get on the wrong track or try to do too much. We’re always thinking about new markets we could enter, but it’s only by saying no that you can concentrate on the things that are really important.58

Jobs, according to the portrait laid out in countless biographies and articles over the years, was a control freak with a compulsive attention to detail. He routinely sent products back to the lab, killed them in their crib, demanded new features, or euthanized old ones, all while keeping Apple’s attention narrowly focused on just a few products with the potential for high returns.59

With Jobs’s death, the question on everyone’s mind was obvious: Could Apple survive with Jobs gone? Most analysts were enthusiastic about the talents of Tim Cook. Cook was an operations genius, keen-minded, demanding, and adept at cutting costs while delivering complex products on time and coping with staggering growth targets. He was also monastic and incredibly devoted to Apple. He had been responsible for oversight of sales, customer support, and logistics—which meant much of the company had already reported to him. Cook had also ably run the company during Jobs’s medical absences, so when Jobs gave the CEO job to Cook in 2011, most were satisfied.

However, in the past, Jobs had still remained involved in all major strategic decisions, even throughout his illness. Critics noted that Cook had been a good temporary replacement, but feared he lacked the dynamism and creative vision

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to see Apple continue its innovative growth.60 Cook needed to demonstrate that the company’s values—true passion for innovation, design excellence, and almost unstoppable momentum around new product development—would continue in Jobs’s absence.61 Cook needed to create a management structure that didn’t depend on a single guiding genius like a Steve Jobs.

Since Jobs’s death, there has been attrition and restructuring in the top ranks. Ron Johnson, former head of Apple Retail, responsible for the success of Apple Stores, left to try his luck as head of J.C. Penney. This meant Philip Schiller, head of Apple’s worldwide marketing, had more on his plate. Scott Forstall, head of software design, was escorted out of the company in October 2012, presumably because of missteps and maverick moves, including the poorly researched Maps software.62 Jonathan Ive, Apple’s design chief, was asked to take on Forstall’s software role as well as hardware, a move applauded in some circles. Ive’s leadership in industrial design would become critical—with such a small product line, Apple could not afford a single misstep going forward. CEO Cook’s leadership and the depth of his upper management team were critical. As one technophile put it, “no other company in the industry puts so much control over product direction and design in the hands of such a tiny number of executives.”63

During Tim Cook’s first year as CEO, he had had to deal with a flat economy, supplier troubles, increasing competition, investor panic, and possibly unrealistic expectations, and yet the company still grew by 60 percent. Under Cook, Apple appeared to be transitioning itself “from being a hypergrowth company to being a premium, branded consumer company.” 64 It may be that Apple was becoming “simply a wildly profitable company that continues to be a major (or dominant) player in various product categories,” and was that so bad?65

ENDNOTES 1. Allsopp, A. 2012. Apple shares drop 6.4% on worst trading day in four years, analysts speculate why. MacWorld, December 6,

www.macworld.co.uk/digitallifestyle/news/?newsid=3415160. 2. Travlos, D. 2013. Is Apple losing its brand equity? Forbes, January 19, www.forbes.com/sites/darcytravlos/2013/01/19/is-apple-losing-its-

brand-equity/ 3. Stone, B., & Burrows, P. 2011. The essence of Apple. Bloomberg Businessweek, January 24-30.

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CASES

CASE 7 WEIGHT WATCHERS INTERNATIONAL INC.*

During 2013, Weight Watchers celebrated 50 years of weight loss success. To mark the occasion, Weight Watchers created the 360° program, which has been called the “Points Plus program with a 21st-century makeover.” By monitoring the amount of carbs, fats, fiber, and proteins in the food choices people make on a daily basis, and using current scientific research into why people eat what they eat, Weight Watchers could help guide members toward making healthier eating decisions in all sorts of situations.1 This 50-year celebration came after significant financial gain as well. In 2011 Weight Watchers hit a new revenue record of $1.8 billion.2 2012 saw a slight reduction in revenue but still beat all pre-2011 numbers.

Weight Watchers, while the undeniable industry standard, had lost some of its luster in recent years, as many potential consumers considered it the prior generation’s answer to weight loss or simply not the right weight-loss choice for them. Aware of this stigma, Weight Watchers had set out to reinvent itself. Originally started in 1963 by Jean Nidetch as a support group for women in her home, Weight Watchers International Inc. had grown into a multibillion-dollar weight- loss goliath in four decades’ time. In November 2010 Weight Watchers had introduced the new PointsPlus system. This replaced the old calorie-counting system by considering where the calories came from. Even though calories still counted, PointsPlus encouraged people to eat a wide variety of healthy foods—split between three meals plus snacks within an individualized calorie level. With a counting system based on dietary guidelines, dieters were encouraged to maximize their PointsPlus allowance by choosing more “Power Foods,” the healthiest, most filling foods, such as whole grains, lean meats, low-fat dairy, and unlimited quantities of fresh fruit and nonstarchy vegetables.

Although doctors and nutritionists gave the Points program (both the original and the subsequent Points Plus version) a thumbs up,3 Weight Watcher’s CEO David Kirchhoff felt it wasn’t enough. Citing evidence from behavioral scientists, in 2012 Kirchhoff said he “realized that Weight Watchers needed to take into account social, environmental and behavioral factors that led members to fail.”4 Weight Watchers had always believed in behavior change, encouraging people to be mindful of what they ate, but just counting calories, as the PointsPlus system did, was not enough. The 360° program added two new components to tracking caloric intake: “spaces,” which included tips for how to handle eating situations in the different environments members might encounter, and “routines,” which encouraged members to create new habits for themselves—for instance, changing just three small behaviors a day such as walking an extra five minutes, eating lunch at the same time, and drinking an additional glass of water. These 360° components—tracking, spaces, and routines—were even available as apps on the Weight Watcher website and Apple or Android mobile devices. By adding the mobile apps and other online social networking support to the direct face-to-face support of the weekly meeting, Kirchhoff believed Weight Watchers now had a program that tied everything together and that people would be willing to pay for it.5

* This case was developed by Professor Alan B. Eisner, Pace University; Professor Helaine J. Korn, Baruch College–City University of New York; and graduate student Jennifer M. DiChiara, Pace University. Material has been drawn from published sources to be used for class discussion. Copyright © 2013 Alan B. Eisner.

The market for weight-loss products was growing and obesity levels were on the rise in more and more parts of the world, which made weight management an attractive industry for firms, especially deeply entrenched firms such as Weight Watchers. However, faced with increased competition from other weight-loss programs such as Jenny Craig and the Biggest Loser franchise, Weight Watchers had to increase customer value and seek new target segments to preempt the competition and stay on top of its promising industry. In the highly competitive weight-management industry, Weight

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Watchers International Inc. was in a position where it had to remain cognizant of the major trends that had the potential to adversely affect industry and firm profitability and revenues. Those trends, as they related to Weight Watchers and the weight-loss industry, included the temporary emergence of fad diets, decreased effectiveness of marketing and advertising programs, the need for developing new and innovative products and services, the development of more favorably perceived or more effective weight management methods (such as pharmaceuticals and surgical options such as the Lap-Band), and the threat of impairment of the Weight Watchers brand and other intellectual property.6

The challenge for Weight Watchers was repositioning itself and creating a forward-focused diet plan for the 21st century while staying true to the mission initially established by Jean Nidetch, Weight Watchers’ founder. The brand needed to remain relevant and, at the same time, pursue additional medium- to long-term initiatives, such as reaching out to new market segments.7 How could

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Weight Watchers retain market leadership while staying hip, relevant, and preemptive? While Weight Watchers had made the effort to introduce new products for several years and had been in the process of shifting its strategic focus from narrow- to broad-based differentiation, the question still remained whether the company could stay true to its core values, mission, and models and, at the same time, embrace effective expansion.

History and Expansion Jean Nidetch began Weight Watchers in an unlikely, and unintended, way. The origins of Weight Watchers started when Jean invited six women into her home to help both herself and her neighbors and friends lose weight by communally discussing their weight-loss issues. Nidetch’s belief, which became the core of the Weight Watchers philosophy, was that anyone could be given a “diet” but the group and social setting of “talk therapy” was the true component not only to losing weight but also to keeping it off. She believed in fostering success through group support, and she created a simple reward system that included pins and tie bars to reward increments of weight loss. The idea was simple, yet very effective!8

The basic concept of the Weight Watchers plan consisted of two components. First, there was the Weight Watchers program, and second, there was the group support. The program was essentially a food plan and an activity plan. The food plan was intended to provide people with the educational tools they needed for weight loss as well as to provide control mechanisms so that individuals could find their way to healthier food choices. The company radically simplified the food selection process involved in dieting by assigning each food a corresponding point value, which eliminated the need to tally calories.9 In the past, Weight Watchers had been recognized more for its food plan, but by 2012 it was getting noticed for its activity and cause marketing plans as well. For instance, Weight Watchers underwrote a policy summit initiated by the Pentagon to address “the growing national security threat posed by a shrinking pool of Americans lean enough to serve in the military.”10

Nidetch had accomplished what she set out to do and much more. Weight Watchers, originally targeting primarily women, ages 25 to 55, experienced a rapid expansion. Of the behemoth that Weight Watchers came to be, Nidetch said, “My little group became an industry. I really didn’t mean it to—it was really just a club for me and my fat friends.” She continued by commenting on something a lecturer once said: “It’s a place where you walk in fat and hope nobody notices you, and four or five months later you walk out thin and hope that everyone sees you.” Nidetch believed that the love, information, companionship, and commiseration of fellow overweight individuals were the key components in an effective formula many people needed to succeed at weight loss. This idea had been perpetuated at Weight Watchers and had been translated into meeting leadership—all employees who lead meetings were formerly overweight individuals who were successful on the plan.11

What Weight Watchers evolved into was a globally branded company providing weight-management services worldwide. By 2013, approximately 1.3 million members attended almost 45,000 Weight Watchers meetings around the world each week. Expansion and the onset of the dot-com era had inevitably led to the creation of WeightWatchers.com, an Internet-based version of the Weight Watchers plan. Weight Watchers was selling a wide range of branded products and services, including meetings conducted by Weight Watchers International and its franchisees (and the products sold at the meetings), Internet subscriptions to WeightWatchers.com, licensed products sold by retailers, magazine subscriptions, and other publications.12 In addition, the company had put its name and point values on a variety of food

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products sold in supermarkets, such as Progresso soups,13 and it had created a separate Weight Watchers menu for Applebee’s restaurants, among other things.14

WeightWatchers.com In 2013 WeightWatchers.com was not only the leading subscription-based weight-loss site on the Internet but also the

official website for Weight Watchers International Inc. It offered information on the Weight Watchers plan, provided several paid and free weight-loss tools, and housed a series of fitness videos, blogs, and interesting links. Weight Watchers eTools, Weight Watchers Mobile, Weight Watchers At Work, and ActiveLink Activity Monitor, all of which could be accessed through the site, offered a variety of tools, including an integrated, multifeature food diary with a database of over 31,000 foods, along with their corresponding point values, a recipe database, a restaurant guide, and a personal weight tracker.

Industry and Competitive Environment Weight Watchers International Inc. had experienced stock price volatility in the past, as had the majority of its competitors, because of rival weight management options—such as the over-the-counter weight-loss drug Alii, launched by GlaxoSmithKline in June 2006, and the development of Allergan’s Lap-Band device. However, there had yet to be a widely supported “magic pill” or surgical option to weight management. In the absence of a safe and effective pharmaceutical or surgical alternative for weight loss, Weight Watchers and its competitors had faced a weight- management industry characterized by not only competition but great opportunity as well. Along with expanding waistlines had come an expanding market for weight-management companies, and the time had come for such companies to be creative and innovative in sustaining and increasing market positions. Only Weight Watchers had been able to consistently fare well for decades in an industry plagued with fad diets and “the next best thing.”

Obesity was on the rise in the developed countries, especially in North America, and Weight Watchers was

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well positioned to help consumers as they began their weight-loss battles. In 2011, weight loss, including the health and fitness industry, constituted a $60 billion-a-year industry in the United States alone,15 and projections in 2012 showed total healthcare spending would increase to as much as 19.6 percent of gross domestic product by 2021.16 Of course, dieting was discretionary spending, so there was no way to estimate how much of that business Weight Watchers would gain. However, the Boston Medical Center estimated 45 million Americans were on a diet each year.17 Particularly noteworthy was the rise of U.S. baby boomers as a significant proportion of the dieting population as they came to be more health conscious and proactive in their weight management than prior generations had been, and they were looking for new ways to gain control of their weight.18 The obesity problem was not confined to the United States, however, and this made geographic expansion a possibility for weight-loss firms. Worldwide, the World Health Organization predicted 2.3 billion people would be overweight by 2015 and more than 700 million would be obese.19 Overall, the statistics proved there were tremendous opportunities in the weight-loss industry, and these opportunities led many companies to compete for business in this area.

Weight Watchers was attempting to reinvent itself while still paying close attention to the moves of its weight-loss rivals. Competition for Weight Watchers International Inc. included both price competition and competition from self- help, pharmaceutical, surgical, dietary supplement, and meal-replacement products, as well as other weight-management brands, diets, programs, and products.20 The main competitors for Weight Watchers had traditionally included Jenny Craig, Slim-Fast, NutriSystem (Nasdaq: NTRI), The Zone, South Beach Diet, and Medifast, as well as programs from fitness gurus such as The Biggest Loser star Julian Michaels.21

CEO Kirchhoff believed that most competitors were essentially in a different business than Weight Watchers was. He said, “Most of the companies that are out there aggressively marketing are in the business of providing and delivering meals. Weight Watchers is in the business of helping people change behavior. So in that sense, we’re teaching people how to fish, and they are selling people fish.”22

Over the years, Weight Watchers had consistently earned the highest overall rating, according to various surveys, because of its nutritionally based diet, weekly meetings, and weigh-ins for behavioral support. According to Consumer Reports, Weight Watchers offered dieters the best staying power. Consumer Reports liked the fact that the plan did not exclude any food group and that its points system encouraged low-fat, high-fiber meals. In the 2013 survey, among the commercial plans, Weight Watchers was rated the top plan overall. Medifast came in second with its low-calorie meal replacements, followed by Jenny Craig. Nutrisystem came in last. Comments by survey participants were that almost 20 percent of them didn’t like the taste of the prepared foods delivered by these three competitors, and about one in five dieters said the cost was higher than they had been led to believe. In terms of weight lost, those on Weight Watchers lost more weight than those on any other diet except Medifast.23 Going into 2013, diets currently in people’s minds included the competitors listed in Exhibit 1.

Trends going into 2013 included a growing interest in vegetarianism and raw food, such as the “Flextarian” and Mediterranean plant-based diets, and the new “Paleolithic” diet that required cutting out all processed foods, eliminating any food that was not eaten before the industrial or agricultural revolution. Whatever the fad, nutritionists suggested that a diet that is easy to follow might be better overall, since “the more tedious a diet is and the more work it demands, the less likely you are to stick to it.”24 In the U.S. News & World Report survey, Weight Watchers was voted the easiest diet to follow and one of the best diets overall. Other diets that had followings in previous years included the Atkins, South Beach, Glycemic Index, and Zone diets. More recent research had failed to conclusively prove that these diets were actually good for heart health and diabetes control.25

One important factor in all these diets is the extent to which they are do-it-yourself efforts. Many of the successful diets, including the DASH and Mayo Clinic diets, required consistent self-control without any external support system. Obviously, Weight Watchers was different there, as were Jenny Craig and Nutrisystem.

Another differentiating factor was cost. The cost of plans where you buy your own food would depend, of course, on a person’s food choices. The cost of the commercial plans also varied widely. Weight Watchers’ cost depended on whether you chose to attend weekly in-person meetings or use the online tools only. A monthly pass to unlimited in-person meetings was $42.95, which also included access to eTools. Or you could pay per meeting; meetings were $12 to $15 per week, with a one-time $20 registration fee. To follow online only, a 3-month plan was $65. None of the costs included

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food. With Jenny Craig, the initial registration fee could exceed $400, and a week’s worth of Jenny’s Cuisine might cost at least $100. Nutrisystem, which had basically fallen off the survey charts due to complaints about costs and the poor taste of the food, had a 28-day Select Plan, which included 10 days of frozen meals and 18 days of pantry food, and generally cost between $300 and $340. Packaged diets such as Slim-Fast didn’t have a personal support system, but food supplements could be customized to achieve a “satisfied feeling” that reduced regular food intake. A 24-pack of shakes cost about $35 and 24 snack bars cost about $17. One major advantage Weight Watchers had was the extent of research done into its results. Two studies published in 2012 found Weight Watchers was just as good as clinical weight-loss programs under a physician’s control and that some Weight Watchers participants lost more than twice as much weight as those following clinical advice.26 A physician from the

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Mayo Clinic said, “It’s only natural that the weekly weighins and ‘group spirit’ of programs such as Weight Watchers would prove more effective than occasional guidance from a doctor or nurse, since research has shown that dieters are more likely to stick with weight-loss programs that stress accountability.”27

EXHIBIT 1 Competitors for Weight Watchers

I Diet Plan Diet Type Good for Ratings* Price Comments

Weight Watchers

Commercial diet Weight loss, heart health

First for weight loss; tied for third as best diet overall

Membership costs less than $40/mo.; buy-it- yourself food is extra

Rated easiest to follow

Jenny Craig Commercial diet Weight loss Second best at weight loss (tie)

Membership and food can run as high as $400/mo.

Customized meal plan plus weekly one- on-one counseling

Biggest Loser Diet

Commercial diet Weight loss, diabetes

Second best at weight loss (tie)

Need to buy the book, $22, plus buy-it- yourself food

Six-week program of self-directed food and exercise

Slim-Fast Diet Commercial diet Weight loss Fair rating $35 for 24 shakes Easy to follow

Nutrisystem Commercial diet Weight loss, not heart healthy

Fair rating Meals cost up to $340/mo.

Taste isn’t as good as Jenny Craig meals

Medifast Commercial diet Weight loss Good to poor rating; hard to stay on it

Meals cost up to $315/mo.

Need to supplement with your own food

The Mediterranean Diet

Developed by Harvard School of Public Health

Overall healthy eating

Third best diet overall

Buy-it-yourself food; fresh produce, olive oil, and nuts are expensive

Plant-based, do-it- yourself, easy to follow

The Ornish Diet Dr. Ornish developed for overall nutrition

Heart health, diabetes

Third for heart health and diabetes control

Buy-it-yourself food Plant-based, from book by Dean Ornish

The TLC Diet Developed by National Institutes of Health

Heart health One of the best do- it-yourself diets overall

Buy-it-yourself food Stands for Therapeutic Lifestyle Changes

The DASH Diet Government- developed suggested eating plan

Heart health, diabetes

First for heart health & diabetes control; best do-it- yourself

Buy-it-yourself food Stands for Dietary Approaches to Stop Hypertension

Mayo Clinic Diet Diabetes Buy-it-yourself food

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Nutritionist- developed, do-it- yourself

Third for diabetes control

Best for health, not necessarily weight control

The Vegan Diet Based on eating little to no meat

Heart health, diabetes

Overall rating is good if you eat correctly

Buy-it-yourself food Extremely restrictive; not for everyone

* Ratings are from both Consumer Reports and U.S. News & World Report: Consumer Reports. 2013. Lose weight your way: 9,000 readers rate 13 diet plans and tools. Consumer Reports, February, www.consumerreports.org/cro/magazine/2013/02/lose-weight-your-way/index.htm;, and Comarow, A. 2012. Best diets methodology: How we rated 25 eating plans. U.S. News, January 3, health.usnews.com/best-diet/articles/2012/01/03/best-diets-methodology-how-we-rated-25- eating-plans.

Business Model Revenues for Weight Watchers International Inc., as shown in Exhibit 2, were principally gained from meeting fees (members paid to attend weekly meetings), product sales (bars, cookbooks, and the like, sold as complements to weight- management plans), online revenues (from Internet subscription products), and revenues gained from licensing (the placement of the Weight Watchers logo on certain foods and other products) and franchising (franchisees typically paid a royalty fee of 10 percent of their meeting fee).28 The costs of running meetings were low, with part-time class instructors paid on a commission basis, and many meeting locations were rented hourly in inexpensive local facilities such as churches. This lean organizational structure allowed wide profit margins.29 Meeting fees were paid up front or at the time of the meeting by attendees, resulting in net negative working capital for Weight Watchers—an indication of cash-flow efficiency.30

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EXHIBIT 2

Weight Watchers’ Revenue Sources (in millions)

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A B C D E F G

1 Weight Watchers’ Revenue Sources (in millions)

2 2012 2011 2010 2009 2008 2007

3 Meeting fees $ 934.9 $ 990.3 $ 819.6 $ 817.5 $ 908.1 $ 880.7

4 Product sales 253.2 281.8 260.5 251.3 285.6 281.1

5 Online revenues 504.3 399.5 238.8 196.0 185.8 151.6

6 Licensing, franchise royalties, and other 134.4 147.6 133.1 134.1 156.3 153.8

7 Total $1,826.8 $1,819.2 $1,452.0 $1,398.9 $1,535.8 $1,467.2

Source: Weight Watchers 10K filings.

What was perhaps most important about Weight Watchers’ business model was its flexibility. The number of meetings could be adjusted according to demand and seasonal fluctuations. The business model’s reliance on a variable cost structure had enabled the company to maintain high margins even as the number of meetings over the same time period was expanded. When attendance growth outpaced meeting growth, the gross margins of Weight Watchers typically improved. Since fiscal year 2005, Weight Watchers International had maintained an annual gross margin in the operating segment of 50 percent or more.31 Weight Watchers’ business model yielded high profit margins and strong cash flow as a result of the company’s low variable expenses and low capital expenditure requirements.

By allowing its meetings to be held anywhere, Weight Watchers kept its capital costs low—unlike Jenny Craig, which maintained its own centers with food inventories. This model also allowed Weight Watchers to gain entry into the workplace at wellness-minded companies via its Weight Watchers at Work Program.32

UBS analyst Andrew McQuilling commented on Weight Watchers’ achievement of a near-perfect business model. McQuilling said, “There are three things we can always count on: death, taxes, and people’s tendency to overeat. Since 1977, sales [for Weight Watchers] have compounded at a 13 percent rate. It’s a profitable business that satisfies a growing market, so to speak. Weight Watchers is not just a fad. It’s a perfect business. It’s as if it sells air. The company has a 40 percent return on invested capital. People pay a fee to join and then pay to attend meetings.”33

Performance Despite high leverage, Weight Watchers’ financial health was considered “decent,” according to a statement by Morningstar analyst Kristan Rowland. Bank of America analyst Scott Mushkin agreed, touting Weight Watchers’ classroom-based approach as the only one with empirical evidence of success. The strong brand and doctor- recommended methods, it was expected, would help increase business for Weight Watchers as the fad diets faded out of fashion.34 Exhibits 3 to 5 show financial statements of the firm.

EXHIBIT 3 Income Statements (in $ thousands)

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Go to library tab in Connect to access Case Financials.

A B C D E F

1 Income Statements (in $ thousands)

2 2012 2011 2010 2009 2008

3 Total revenue 1,826,812 1,819,156 1,452,037 1,398,913 1,535,812

4 Cost of revenue 744,026 772,016 661,407 670,939 700,835

5 Gross profit 1,082,786 1,047,140 790,630 727,974 834,977

6 Operating expenses:

7 Selling, general, and administrative 571,980 500,812 400,285 371,324 409,930

8 Operating income or loss 510,805 546,328 390,345 354,650 425,047

9 Income from continuing operations:

10 Other income/expenses net (1,979) (3,386) (963) 228 1,969

11 Earnings before interest and taxes 508,826 542,942 389,382 356,878 427,016

12 Interest expense 90.5 59,850 76,204 66,722 92,667

13 Income before tax 417.0 483,092 313,178 290,156 334,349

14 Income tax expense 159.5 178,748 120,656 115,585 132,002

15 Minority interest 523 1,713 2,773 1,984

16 Net income from continuing ops 257.4 304,867 194,235 177,344 204,331

17 Net income 257.4 304,867 194,235 177,344 204,331

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EXHIBIT 4 Balance Sheets (In thousands)

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A B C D E F

1 Balance Sheets (in thousands)

2 Assets 2012 2011 2010 2009 2008

3 Current assets:

4 Cash and cash equivalents 70,215 47,469 40,534 46,137 47,322

5 Net receivables 136,605 71,787 63,522 57,864 70,181

6 Inventory 46,846 53,437 40,571 32,488 40,121

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7 Other current assets 35,699 41,833 45,815 63,462 67,417

8 Total current assets 217,967 214,526 190,442 199,951 225,041

9 Property plant and equipment 71,768 41,072 30,930 36,038 37,508

10 Goodwill 59,414 50,012 51,425 51,373 51,296

11 Intangible assets 839,487 801,487 795,826 790,250 777,103

12 Other assets 6,087 5,811 9,973 3,334 3,120

13 Deferred long-term asset charges 26,571 8,720 13,391 6,563 12,684

14 Total assets 1,218,607 1,121,628 1,091,987 1,087,509 1,106,752

16 Liabilities

17 Current liabilities:

18 Accounts payable 225,856 217,232 187,388 174,979 211,046

19 Short/current long-term debt 128,566 149,546 237,277 255,947 224,032

20 Other current liabilities 93,433 127,429 114,470 105,129 60,046

21 Total current liabilities 447,855 494,207 539,135 536,055 495,124

22 Long-term debt 2,291,669 926,868 1,167,561 1,238,000 1,485,000

23 Other liabilities 15,111 9,596 13,208 15,342 11,459

24 Deferred long-term liability charges 129,431 100,723 62,807 34,624 2,685

25 Monthly Interest – – 4,042 3,242 –

26 Total liabilities 2,884,066 1,531,394 1,782,753 1,824,021 1,994,268

27 Stockholders’ equity:

28 Retained earnings 1,603,513 1,378,616 1,103,817 1,260,349 1,131,080

29 Treasury stock (3,281,831) (1,793,983) (1,794,066) (1,684,323) (1,684,828)

30 Other stockholders’ equity 12,859 5,601 (4,517) (312,518) (333,768)

31 Total stockholders’ equity (1,665,459) (409,766) (694,766) (736,512) (887,516)

32 Net tangible assets (2,564,360) (1,261,265) (1,542,017) (1,578,135) (1,715,915)

EXHIBIT 5 Cash Flow Statements (in thousands)

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A B C D E F

1 Cash Flow Statements (in thousands)

2 2012 2011 2010 2009 2008

3 Net income 257,426 304,867 194,235 177,344 204,331

4 Depreciation 43,710 35,820 33,671 29,972 25,959

5 Adjustments to net income 48,927 53,112 41,493 55,648 29,769

6 Changes in accounts receivables 5,870 (3,482) (6,764) (1,322) (343)

7 Changes in liabilities (4,562) 34,020 22,225 (2,638) 7,408

8 Changes in inventories (1,341) (24,456) (15,490) 1,624 (7,469)

9 Changes in other operating activities (639) 2,531 14,027 7,651 (18,489)

10 Total cash flow from operating activities 349,391 401,889 281,484 265,506 241,166

11 Capital expenditures (48,807) (21,750) (9,137) (12,349) (16,281)

12 Other cash flows from investing activities (60,649) (23,460) (19,509) (11,278) (55,905)

13 Total cash flows from investing activities (109,456) (45,210) (28,646) (23,627) (72,186)

14 Dividends paid (51,961) (51,624) (53,409) (54,078) (55,045)

15 Sale/purchase of stock (1,491,501) 7,116 2,513 5,546 (107,898)

16 Net borrowings 1,354,564 (313,285) (205,916) (194,500) (625)

17 Other cash flows from financing activities – – – – 3,507

18 Total cash flows from financing activities (211,120) (351,962) (256,812) (246,964) (160,061)

19 Effect of exchange rate changes (11,799) 2,218 (1,629) 3,900 (1,420)

20 Change in cash and cash equivalents 17,016 6,935 (5,603) (1,185) 7,499

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Innovation Domestically and abroad, Weight Watchers was fortunate enough to build on a foundation of five decades of weight management expertise that had allowed the company to become one of the most recognized and trusted brand names among weight-conscious consumers worldwide.35 The innovation initiatives at Weight Watchers were focused on three main objectives: (1) rejuvenating the brand through more effective marketing, (2) providing more customer value by introducing new products, and (3) broadening the customer mix by targeting new customer segments.

The Brand With regard to its brand, Weight Watchers had been fortunate to have consumers consider its brand credible and effective. The company had needed to more adequately differentiate its lifestyle-based approach from the strictly dieting orientation utilized by many of its competitors. In a focus group for Weight Watchers, a woman who had considered joining expressed concern that her weight would be called out in public and that she would have to tell her whole weight- loss struggle as if she were at an Alcoholics Anonymous meeting. Thus, one of the primary challenges for Weight Watchers was to correct these types of misperceptions as to what Weight Watchers actually was.36 Weight Watchers had the challenge of dispelling concerns that the meeting experience would be something akin to a Biggest Loser weigh-in and competition.

The second thing that Weight Watchers was trying to do was to reenergize the brand with more effective and differentiated marketing. Of marketing, David Kirchhoff said, “I think we do a very good job of marketing to people who have been with us before, so-called rejoins, but I think we could do a much better job of marketing to people who have never been with us before.”37 Weight Watchers believed that its advertising needed to accomplish three basic tasks. First, it had to be noticed when it was seen. Second, on noticing it, people had to associate the advertising with the Weight Watchers brand. Third, it had to accomplish both the first and the second aims while communicating something new about Weight Watchers that would cause consumers to reconsider Weight Watchers as their solution—a plan at which they could be successful.38 Weight Watchers had to actively emphasize the innovative things that it was doing in order to overcome consumers’ preconceived notions. The company needed to show its consumers that it was different from the other diets out there to unleash the power that Weight Watchers believed had become a little dormant in its brand. Weight Watchers also had to consider the potential of marketing to relay relevant information that would appeal to a wider net of demographic groups.

The Program To increase customer value, Weight Watchers introduced three new programs that provided members with more flexibility and satisfaction. One innovation was a Monthly Pass payment option. When a member became a Monthly Pass subscriber, he or she participated in an eight-month recurring billing commitment in exchange for complete access to the full range of product offerings. So the underlying benefit was customization—members could utilize the different options as they saw fit in meeting their weight-loss needs. And it seemed to work. People on the Monthly Pass were losing 30 percent more weight since the pass’s implementation. Further, there was a higher attendance intensity for Monthly Pass holders than for those who paid per meeting.39 If a member canceled his Monthly Pass because he had reached his goal weight, and then later regained weight, he knew that he could always return to Weight Watchers because the plan had worked in the past.

The Monthly Pass commitment plan also represented an overall better and more effective way for members to approach weight loss. Monthly Pass allowed members to move away from a week-to-week focus in favor of a more holistic approach to incorporating Weight Watchers into their lives.40 In addition, Monthly Pass also benefited the company in that it gave Weight Watchers a salable proposition. Before the development of Monthly Pass, when potential customers called to make an inquiry, there was no way to sell them something at that moment to get them committed. With the development of Monthly Pass, the call center could now sell the product over the phone to consumers, in addition to the pass’s availability on the Weight Watchers website. However, Weight Watchers also wanted to continue to offer its conventional pay-as-you-go plan, because the company aimed to appeal to the widest variety of consumers with the most payment options available.

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PointsPlus, introduced at the end of 2010, was a revision of the traditional Points program. The revised program was designed to educate and encourage people to make choices that favored foods the body worked harder to convert into energy, resulting in fewer net calories absorbed. Users were encouraged to focus on foods that create a sense of fullness and satisfaction and are more healthful, nudged toward natural foods rather than foods with excess added sugars and fats, while still allowing flexibility for indulgences, special occasions, and eating out. While calorie-counting had been the foundation of many weight-loss programs, including the Weight Watchers original Points system, the new PointsPlus program went beyond just calories to help people make healthful and satisfying choices. It took into account the energy contained in each of the components that make up calories—protein, carbohydrates, fat, and fiber—and it also factored how hard the body worked to process them (conversion cost) as well their respective eating satisfaction (satiety).41

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The next program innovation, introduced in December 2012, was the 360° Plan. This plan built on the PointsPlus program, with members still encouraged to track their food intake with numbers based on the content of protein, fiber, carbohydrates, and fat. In addition, however, the program helped participants make better food-related decisions and did more to incorporate physical activity. For instance, an optional physical activity monitor, called Active Link, could track physical movements. This monitor, costing $40 plus a $5 monthly charge, measured all activity and converted it into PointsPlus values. Also, members were encouraged to use more of the Weight Watchers smartphone apps and website tools during the meetings, while participating in hands-on demonstrations such as learning to estimate portion sizes. Other new tips included teaching people to better manage food environments at home, at work, traveling, or at restaurants. According to Karen Miller-Kovach, chief scientific officer for the company, the emphasis on controlling food in the spaces where you live and work was based on research on “hedonic hunger—the desire to seek out high- sugar, high-fat foods that bring pleasure … you have to control your environment to avoid that drive.”42

The Customer Innovation at Weight Watchers also involved broadening the customer mix and targeting new customer segments. Weight Watchers had begun to actively consider expanding beyond its target consumer market of women, ages 25 to 55.43 In an attempt to appeal to other demographic groups, such as men and the Hispanic community in the United States, Weight Watchers retooled its offerings and approach to appear more relevant to weight-loss consumers who sought different methods of weight management.

In terms of the Hispanic community, the company worked to better serve the growing Hispanic population. For example, they improved their Spanish-language meeting materials and increased the number of Spanish meetings offered.44

Men, another attractive market segment, appeared to be more the self-help type and were not as much in favor of a group-support experience.45 Weight Watchers meetings had been attended mostly by women, with men making up only 5 percent of members. Morgan Stanley analyst Catherine Lewis said, “Weight Watchers has a pipeline of unpenetrated and underpenetrated markets” and, thus, was testing home weight-loss services for men.46 Atkins, the low-carbohydrate- focused diet plan, had held great appeal for men in the beginning of the new millennium.47 By 2011, Atkins was much less popular in the weight-conscious community, and there existed a void in weight-management services for men that Weight Watchers International was hoping to fill.

To do so, Weight Watchers Online, the step-by-step online guide to following the Weight Watchers plan, was intentionally customized for men and their unique set of weight-loss challenges.48 The WeightWatchers.com for Men customization was born of the realization that Weight Watchers should appear to be more culturally relevant to more groups of people who want different things.49 For instance, a research study showed that about 70 percent of men were overweight and about 30 percent of men were obese. Yet, according to the study, only 28 percent of men were actively engaged in weight loss. Weight Watchers sought to provide the weight-loss answer for men by applying its 40 years of experience to its customized Internet offerings for men.

While the fundamental concepts of weight loss—eat less and exercise more—were the same for both genders, the approach to weight loss for each gender was different. As Chief Scientific Officer Miller-Kovach noted, “Men and women are biologically and emotionally different, and multiple variables factor into how each loses weight.” However, the same underlying motivators for weight loss were shared between the genders: “appearance and health.”50 Thus, while the preferred means might be different, the desired end was the same. Weight Watchers Online for Men allowed men to

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follow the Weight Watchers plan and get food and fitness ideas and other content and resources tailored specifically to them. These products afforded Weight Watchers a new opportunity to appeal to a large market segment that might not have otherwise considered giving the program a try.51

The launch of Weight Watchers Online for Men was considered by company executives to be a “new product for a new market,” and the company focused on getting the product experience right, delivering on consumer expectations, and doing a good job. Once the company felt that it was delivering the product correctly, it planned to be more aggressive in marketing it. However, even before the active targeting to men, the percentage of men as a percentage of the Weight Watchers’ total market had been on the rise. Weight Watchers was pleased with the early results of the male- focused products and continued working to identify the proper levers for building that part of the business.52 One of those levers was spokesman–sports legend Charles Barkley, whose humorous approach was intended to appeal to the everyday man.

In the past, Weight Watchers had been recognized for its focus on consumers, a business-to-consumer model, but by 2013 it was expanding into a business-to-business model as well. Obesity had become a global phenomenon, and Weight Watchers was using its brand awareness and brand trust, the clinical evidence of its program success, its affordable business model, and now unique approach to behavior change to position itself as a partner with large, self-insured companies. In addition, Weight Watchers’ spokespeople, Academy Award–winning actress and Grammy Award –winning recording artist Jennifer Hudson, major pop star Jessica Simpson, and sports legend Charles Barkley were sharing their weight-loss stories,

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CASES

CASE 8 JAMBA JUICE*

On January 4, 2013, Jamba Juice CEO James D. White rang the opening bell at NASDAQ in New York City. Headlines announced “Jamba Juice Rings in the New Year With the Unveiling of Brand-New Jamba Kids™ Meals.” This new menu targeting Jamba’s newest and youngest customers involved smaller 9.5-ounce sizes of fruit smoothies—Strawberries Gone Bananas, Blueberry Strawberry Blastoff, Popp’in Peach Mango, and Berry Beet It—plus two new food items: a Pizza Swirl with Turkey and a Cheesy Stuffed Pretzel. The idea for this kid’s menu came from listening to customers, who had struggled to share the larger smoothie drinks with their young children. It also meshed with Jamba’s overall strategy: to create “good-for-you food that tastes good” and to continue to add more full-meal options to the menu for both kids and adults.1

The Jamba Juice Company had gradually expanded its product line since 1994 to offer Jamba products that pleased a broader palate. In addition, Jamba had been pursuing an aggressive expansion program, evolving from a made-to-order smoothie company into a healthy, active-lifestyle company, but was it biting off more than it could chew? After all, the continued menu expansion had put Jamba Juice in direct play against the likes of McDonald’s and Starbucks, and Jamba was just emerging from six straight years of net financial losses. Although CEO James White had worked to build Jamba’s position as a popular health-and-wellness brand, 2012 was the chain’s first year of profitability in six years as a public company. Going into 2013 White still had his work cut out for him.

In January 2009, just after his arrival as the new Jamba Juice CEO, White had instituted a new set of strategic priorities. Believing it was necessary to revitalize the company, White had outlined the following goals:2

• Transform the chain through refranchising existing stores.

• Initiate international growth.

• Build a retail presence with branded consumer packaged goods and licensing.

• Bring more food offerings to the menu across all dayparts—breakfast, lunch, afternoon, dinner.

• Implement a disciplined expense-reduction plan and improve comparable sales.

* This case was developed by Professor Alan B. Eisner, Pace University; Professor Jerome C. Kuperman, Minnesota State University–Moorhead; Professor James Gould, Pace University; and Associate Professor Pauline Assenza, Western Connecticut State University. Material has been drawn from published sources to be used for class discussion. Copyright ©2013 Alan B. Eisner.

Entering 2013, Jamba Juice pronounced this turnaround complete and began to focus on achieving a second phase of growth. In January 2012, CEO White called this next set of initiatives an accelerated growth BLEND Plan 2.0. This plan included the following:

• Become a top-of-mind brand by simplifying and sharpening Jamba’s healthy food and beverage marketing message to better clarify value and make the brand more relevant.

• Embody health by engaging company workers in programs that would allow them to embody healthful living and improve their knowledge of nutrition, and extend this lifestyle message broadly across the enterprise.

• Accelerate global retail growth through new and existing formats. Focus franchise growth on more nontraditional venues, such as airports, transportation hubs, grocery stores, big-box outlets, school cafeterias, and college campuses. Build a global consumer packaged-goods platform in Jamba-relevant categories.

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• Continue to reduce operational costs by using technology to drive store-level productivity and improve efficiency in the supply, sourcing, and distribution process.3

According to White, the above strategic priorities supported the company’s mission to “accelerate growth and development of Jamba as a premier healthy, active lifestyle brand.”4 White’s goal was to grow the brand to a value of $1 billion by 2015.5 Could Jamba Juice succeed with its strategic growth plans, especially now that McDonald’s, Starbucks, and even Burger King were selling smoothies?

Background Juice Club was founded by Kirk Perron and opened its first store in San Luis Obispo, California, in April 1990.6 While many small health-food stores had juice bars offering fresh carrot juice, wheat germ, and protein powder, dedicated juice and smoothie bars were sparse in 1990 and didn’t gain widespread popularity until the mid- to late 1990s.

Juice Club began with a franchise strategy and opened its second and third stores in northern and southern California in 1993. In 1994 management decided that an expansion strategy focusing on company stores would provide a greater degree of quality and operating control. In

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1995 the company changed its name to Jamba Juice Company to provide a point of differentiation as competitors began offering similar healthy juices and smoothies in the marketplace.

EXHIBIT 1

Income Statements

Go to library tab in Connect to access Case Financials.

A B C D

1 Fiscal Year Ended

2 Jan. 1,2013 Jan 3, 2012 Dec. 30, 2010

3 Revenue:

4 Company stores $215,125 $214,837 $254,491

5 Franchise and other revenue 13,664 11,597 8,162

6 Total revenue 228,789 226,434 262,653

7 Costs and operating expenses:

8 Cost of sales 50,215 49,503 61,307

9 Labor 63,086 67,868 85,189

10 Occupancy 29,473 31,092 38,561

11 Store operating 33,612 32,847 38,358

12 Depreciation and amortization 11,062 12,463 14,610

13 General and administrative 40,771 37,798 37,262

14 Store preopening 604 965 648

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15 Impairment of long-lived assets 711 1,291 2,778

16 Store lease termination and closure 421 721 4,255

Other operating (1,779) 210 (4,292)

18 Total costs and operating expenses 228,176 234,748 278,676

19 Loss from operations 613 (8,324) (16,023)

20 Other income (expense):

21 Interest income 61 159 73

22 Interest expense (217) (473) (547)

23 Total other income (expense) (156) (314) (474)

24 Income (loss) before income taxes 457 (8,638) (16,497)

25 Income tax benefit (expense) (155) 340 (159)

26 Net income (loss) S 302 $ (8,298) $ (16,656)

Source: Jamba 10-K reports.

In March 1999 Jamba Juice Company merged with Zuka Juice Inc., a smoothie retail chain with 98 smoothie retail units in the western United States. On March 13, 2006, Jamba Juice Company agreed to be acquired by Services Acquisition Corp. International (headed by Steven Berrard, former CEO of Blockbuster Inc.) for $265 million.7 The company went public in November 2006 as NASDAQ-traded JMBA. Jamba Juice stores were owned and franchised by Jamba Juice Company, which was a wholly owned subsidiary of Jamba Inc.

In August 2008 Jamba Juice faced significant leadership changes. Steven Berrard agreed to assume the responsibilities of interim CEO, replacing Paul E. Clayton.8 In December 2008 James White was named CEO and president, while Berrard remained chairman of the board of directors. Prior to joining Jamba Juice, White had been senior vice president of consumer brands at Safeway, a publicly traded Fortune 100 food and drug retailer. During what CEO White called the turnaround years from 2009 to 2011, he worked to eliminate short-term debt, innovate and expand the menu, and change the business model by refranchising stores, growing internationally, and commercializing product lines.

Going into 2013, Jamba Juice had 788 locations, consisting of 301 company-owned and operated stores and 454 franchise stores, with 33 licensed sites overseas. During fiscal year 2012, Jamba Inc. was able to

• deliver positive company-owned comparable store sales increases of 4 to 6 percent,

• produce adjusted operating profit margins of 20 to 23 percent,

• deliver consumer packaged-goods licensing revenue of approximately $3 million,

• and keep base general and administrative expenses flat, in dollars, with fiscal 2011 results.9

Overall, at year end, Jamba had over $228 million in revenue, a huge increase compared to the just over $22 million in revenue during fiscal year 2006. (see Exhibits 1 and 2).10

Top-Of-Mind Brand Marketing According to data presented by Jamba Inc. in late 2012, Jamba Juice was already the smoothie brand leader and the third leading top-of-mind healthy food and beverage brand, ahead of Healthy Choice, Lean Cuisine, Weight Watchers, and Panera Bread.11 Jamba also boasted over 1.5 million Facebook fans and had outlets in 30 U.S. states, with branded products available in all 50 states plus 33 international locations.

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EXHIBIT 2 Balance Sheets (in thousands of dollars)

Go to library tab in Connect to access Case Financials.

A B C D

1 Balance Sheets (in thousands of dollars)

2 2012 2011 2010

3 Assets

4 Current assets:

5 Cash and cash equivalents 31,691 20,959 30,644

6 Net receivables 11,327 13,040 6,377

7 Inventory 3,143 2,228 2,486

8 Other current assets 5,416 4,844 6,528

9 Total current assets 51,577 41,071 46,035

10 Property, plant, and equipment 38,442 44,760 49,215

11 Intangible assets 2,748 1,130 1,341

12 Other assets 846 1,332 3,423

13 Total assets 93,613 88,293 100,054

14 Liabilities and Stockholders’ Equity

15 Current liabilities:

16 Accounts payable 8,206 4,155 43,908

17 Accrued compensation/benefits/reserves 8,653 7,658 --

18 Accrued jambacard liability 33,634 33,256 --

19 Other current liabilities 9,728 9,961 12,622

20 Total current liabilities 60,221 55,030 56,530

21 Long-term debt -- 166

22 Deferred long-term liability charges 11,880 13,079 15,416

23 Total liabilities 72,101 68,109 72,112

24 Stockholders’ equity:

25 Redeemable preferred stock 7,916 17,880 20,554

26 Common stock 78 68 64

27 Retained earnings (366,489) (366,791) (358,493)

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28 Capital surplus 380,007 369,027 365,817

29 Total stockholders’ equity 13,596 2,304 7,388

Source: Jamba 10-K reports.

Menu Items One of the ways Jamba intended to grow “top-of-mind” was by creating innovative and “craveable” menu items they could offer throughout the day—for breakfast, lunch, afternoon, and dinner. Jamba Juice stores offered customers a range of fresh squeezed fruit juices, blended beverages, baked goods and meals, nutritional supplements, and healthy snacks. Jamba smoothie and juice options were made with real fruit and 100 percent fruit juices. Jamba smoothies were rich in vitamins, minerals, proteins, and fiber, were blended to order, and provided four to six servings of fruits and vegetables. In addition to the natural nutrients in Jamba smoothies, Jamba offered supplements in the form of Boosts and Shots. Boosts included 10 combinations of vitamins, minerals, proteins, and extracts designed to give the mind and body a nutritious boost. Shots included three combinations of wheatgrass, green tea, orange juice, and soymilk designed to give customers a natural concentrate of vitamins, minerals, and antioxidants.

As a complement to its smoothie and boost offerings, Jamba also offered baked goods and other meal items. Each of these items was made with natural ingredients and was high in protein or fiber. One popular item added was steel cut hot oatmeal with fruit, a low-calorie organic product that captured a “best of rating by nutritionists when compared against offerings from McDonald’s, Starbucks, Au Bon Pain, and Cosi.12 Jamba also offered a variety of grab-and-go wraps, sandwiches, and California flatbread food offerings.

In 2010 Jamba added an organic brew-by-the-cup coffee service and a line of Whirl’ns frozen yogurt and sorbet bar treats, with probiotic fruit and yogurt blends. In 2012 Jamba added to the hot beverage category by acquiring premium tea blender Talbott Teas. This acquisition was championed by ABC TV’s Shark Tank venture capitalists Kevin O’Leary, Daymond John, and Barbara Corcoran, who convinced Jamba CEO James White that this acquisition would be a good fit for Jamba’s strategy to “accelerate growth through the acquisition of specialty lifestyle brands that support the company’s expansion into new and relevant product categories.”13

In 2011 Jamba introduced its first line of fruit and vegetable smoothies with three offerings: the Berry UpBEET, combining strawberries and blueberries with the juices from carrots, beets, broccoli, and lettuce; the Apple ‘n Greens blend of apple and strawberry juice with the juice from dark leafy green vegetables, carrots, and lettuce, and adding spirulina (a microscopic blue-green algae used as a

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dietary supplement), peaches, mangos, and bananas; and the Orange Carrot Karma—a simple blend of carrot juice, orange juice, mangos, and bananas. The year 2012 saw the introduction of Fit ’N Fruitful smoothie offerings with 14 added vitamins and minerals, protein and fiber from Balance Boost, two or more servings of fruit, and the added benefit of a “Weight Burner Boost” made with conjugated linoleic acid, or CLA, to help manage weight “tastefully.”

In the summer of 2012, Jamba Juice launched a “Make It Light” option for its 10 classic smoothies, which cut calories, sugar, and carbohydrates by one-third. The Make It Light version replaced the nonfat frozen yogurt or sherbet used in classic smoothies with a lower-calorie dairy base sweetened with Splenda. A 16-ounce classic Banana Berry smoothie, for example, had 290 calories and 60 grams of sugar. The Make It Light version, however, had 170 calories and 32 grams of sugar.

Also in 2012 Jamba announced plans to “re-concept” existing stores in selected markets with a fresh-squeezed juice emphasis. This was planned to address competition from both Juice It Up! and Starbucks, who were expanding their premium juice bar businesses. But the big announcement was in 2013, when Jamba introduced its kids meals. This new menu was targeted toward children ages 4 to 8, with a complete meal—a smoothie plus a food item—containing fewer than 500 calories. The items included whole grains, 2.5 servings of fruit or vegetables, and no added sugar.

Proof that the expanded menu was working was evident in the 4th quarter of 2012. Jamba saw same-store sales growth in each part of the day as follows: breakfast sales, up 6.3 percent from 2011; lunch, up 7.3 percent; afternoon, up 7.2 percent; and dinner, up 5.6 percent.14

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Marketing Regarding its marketing efforts, historically, Jamba had not engaged in any mass-media promotional programs, relying instead on word of mouth and in-store promotions to increase customer awareness. However, Jamba was featured in stories appearing in the Wall Street Journal, the New York Times, USA Today, and a host of local newspapers and magazines, as well as profiled spots on TV news shows such as Good Morning America. Jamba also ran an “Ambassadors of WOW” contest nationwide, encouraging fans to nominate themselves or worthy friends or family members to be the new faces of Jamba Juice, creating “wow” through support and involvement within their communities. These ambassadors would have the opportunity to appear in Jamba Juice advertisements and promotional campaigns.15

Jamba also capitalized on the openings of new sites as opportunities to reach out to the media and secure live local television coverage, radio broadcasts, and articles in local print media. Openings were also frequently associated with a charitable event, thus serving to reinforce Jamba Juice Company’s strong commitment to its communities. In addition, Jamba aligned itself with “active living” spokespeople, such as tennis star Venus Williams, who partnered with Jamba to open two stores in the Maryland-Washington, D.C., area.16

One of the key objectives of Jamba’s growth strategy was to market itself in a way to increase sales year-round and significantly decrease weather and seasonal vulnerabilities. Seasonal issues were serious, since the traditional driver of Jamba’s revenue and profit was the sale of smoothies during hot weather. In southern states (e.g., California), where the weather remained warm year-round, Jamba experienced fairly steady sales. However, in the northern states (e.g., New York), where there was a cold and fairly lengthy winter season, Jamba experienced severe seasonal variability. To counter the seasonal slump, Jamba pushed to increase the presence of nontraditional stores inside existing venues.

Transition from Company-Owned to Franchise Stores and Nontraditional Formats Originally, Jamba Juice Company had followed a strategy of expanding its store locations in existing markets and only opening stores in select new markets. During 2007, Jamba began acquiring the assets of Jamba Juice franchised stores in an attempt to gain more control over growth direction. They acquired over 30 franchise stores during the first three quarters of 2007 and expected to continue making additional franchise acquisitions as part of its ongoing growth strategy. In 2006 approximately 33 percent of Jamba’s stores were franchised, but franchises accounted for only about 4 percent of its revenue.17 By April 2008, 71 percent of Jamba stores were company owned. In early 2008 a financial analyst predicted that Jamba’s widely recognized brand poised it to “expand in an under-penetrated and growing health food market.”18 However, the same analyst recognized that Jamba was experiencing declines in store traffic and store-level margins due to the subprime crisis and that Jamba therefore needed to slow its expansion until the economy had a chance to recover. In May 2008 Jamba announced its plans to close 10 underperforming company-owned stores by the end of the year and terminate signed leases for seven unbuilt locations.19 This coincided with Jamba Inc.’s fiscal 2007 financial loss of over $228 million and the need to carry a $25 million senior term note.

In August 2008 CEO Paul E. Clayton stepped down after eight years in the role and was ultimately replaced by James White in November 2008. White subsequently reversed the trajectory of the growth strategy, focusing on the acceleration of franchise and nontraditional store growth. The more heavily franchised business model tended to require less capital investment and reduced the volatility of cash flow performance over time. However, revenue sources then came more from royalties and franchise fees rather than retail sales. By 2011 franchisees outnumbered company-owned stores (see Exhibit 3).

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EXHIBIT 3 Store Types and Locations

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A B C D E F G

1 Store Types and Locations

2 Company- Owned Stores

Franchise Stores

International Stores

Total Stores

Nontraditional Stores*

CPG License Agreements

3 2012 301 473 35 809 44 SKUs**

4 2011 307 443 19 769 10

5 2010 351 391 1 743

6 2009 478 260 1 739 127

7 2008 511 218 729 119

8 2007 501 206 707 99

* Out of the Total Stores. Since 2009 all stores could be in nontraditional locations. ** n 2012, the CPG business model shifted from a third-party licensing structure to one that combined both licensing and direct selling. This allowed greater control over product development, production, distribution, sales, and profit.

International growth was also on the horizon. Starting with the first South Korean location in January 2011, Jamba Juice had grown to 30 stores internationally by 2013, with 20 outlets in South Korea, 7 in Canada, and 3 in the Philippines. The 30th store was located in the Mall of Asia, the largest integrated shopping, dining, and leisure destination in the Philippines.20 Jamba and its partners were poised to open more than 200 stores in South Korea and 40 more in the Philippines within the next 10 years. In addition, Jamba’s Canadian partner was projected to develop 80 Jamba Juice stores by 2022.

Starting in 2012, Jamba Inc. was also aggressively pursuing licensing agreements for commercialized product lines in the areas of Jamba-branded make-at-home frozen smoothie kits, frozen yogurt novelty bars, all natural energy drinks, coconut water fruit juice beverages, Brazilian super fruit shots, trail mixes, and fruit cups. The objective was to reinforce the Jamba better-for-you message with convenient and portable products available at multiple consumer locations. By the end of 2012, there were over 44 license agreements in place.

Nontraditional Locations Jamba had generally characterized its stores as either traditional or nontraditional. Traditional locations included suburban strip malls and various retail locations in urban centers. Traditional stores averaged approximately 1,400 square feet in size and were designed to be fun, friendly, energetic, and colorful to represent the active, healthy lifestyle that Jamba Juice promoted.

Nontraditional stores were considered those located in areas that allowed Jamba to generate awareness and try out new products to fuel the core business. Jamba’s nontraditional opportunities included store-within-a-store locations, airports, shopping malls, and colleges and universities.

Store-within-a-store: Jamba Juice Company was developing franchise partner relationships with major grocers and retailers to develop store-within-a-store concepts. The franchise partnerships provided it with the opportunity to reach new customers and enhance the brand without making significant capital investments.

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Airports: Jamba operated several airport locations and had the opportunity to develop stores in numerous additional airports. Jamba Juice Company’s highly portable product appealed to travelers on the go and provided them with an energizing boost.

Shopping malls: Jamba had opportunistically established stores in shopping malls that presented attractive expansion opportunities. In addition, as with the airport locations, the indoor setting helped to alleviate weather and seasonal vulnerabilities that challenged traditional locations.

Colleges and universities: The Jamba brand was believed to be extremely appealing to the average college student’s active, on-the-go lifestyle, and Jamba expected to continue to develop on-campus locations.

Other potential nontraditional store locations: Additional high-traffic, nontraditional locations existed for Jamba to explore. Many large health clubs included a juice and smoothie bar within their buildings. There was an opportunity for Jamba to partner with a major gym chain or individual private gyms with high membership rates. Another possibility was to partner with a large school district. Schools across the country were under increasing scrutiny to offer healthy alternatives to the traditional fat-, carbohydrate-, and preservative-rich foods served in cafeterias, especially as a growing number of states were prohibiting the sale of junk food on K–12 campuses.

In 2011 Jamba introduced self-service JambaGO automated drink stations in nontraditional locations, including schools. The move into schools was seen as a real growth opportunity—with Jamba products in front of a captive audience on a daily basis, “generations will grow up knowing the brand.”21 Taking roughly the space of a soda fountain beverage dispenser, the JambaGo format, which CEO White called a wellness center, included the chain’s branded packaged products, as well as the option of several preblended smoothies. The JambaGO concept was a way to reinforce Jamba as a healthy, active lifestyle brand

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that was also convenient and portable. This licensed concept represented no capital investment for Jamba and used the razor/razor blade net profit model. White was hoping Jamba would become “the go-to resource for healthy solutions for school foodservice directors.”22 During 2012, Jamba installed 239 units, with a projection to grow to 1,500 by the end of 2013.

Building a Global Consumer Packaged Goods Platform Jamba Juice Company’s strong association with premium, flavorful beverages translated well into ready-to-drink beverages available in a variety of retail locations. For instance, Jamba Juice had developed an agreement with Nestlé under which Nestlé would manufacture three flavors of Jamba’s juice and smoothie ready-to-drink products. Jamba All- Natural Energy Drinks were rolled out in multiple retail locations in the Northeast and in 600 Jamba Juice retail stores in March 2011.23 Kraft had had a similar deal with Starbucks to distribute its Frappuccino drinks, which Starbucks ended in 2010. The 90-calorie Jamba energy drinks contained no artificial preservatives, flavors, or colors, and were made with 70 percent real fruit juice and 80 mg of caffeine derived from natural sources. However, by April 2012, Jamba Juice had followed Starbucks’s lead and split with Nestlé. Jamba acquired the product formulation and intellectual property under a licensing agreement with Nestlé, explaining that Jamba wanted more control over the growth of its consumer packaged goods.24 In aggressive moves starting in 2010, Jamba had expanded licensing agreements to include a line of fruitinfused coconut water, to be distributed through the Pepsi Beverage Company, Brazilian super fruit shots, and all-natural fruit cups to be produced in partnership with Zola and Sundia Corporation. Other Jamba-branded consumer products included yogurt and sorbet frozen novelty items manufactured under license by Oregon Ice Cream LLC out of Eugene, Oregon, and Jamba-branded apparel, including cotton T-shirts, beanies, and a canvas tote bag, developed in partnership with licensee Headline Entertainment.

Engage Company Workers—Embody a Healthy, Active Lifestyle In order to meet the goal of a top-of-mind brand, Jamba Juice believed it also had to build a customer-first, operationally focused service culture. Attracting and developing team members who provided superior service was important to reinforcing Jamba’s brand image. Jamba sought to hire customer-service-oriented people and provided team members with extensive training, financial incentives, and opportunities for advancement when they fulfilled service expectations.

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Jamba participated in the Obama administration’s Summer Jobs Initiative in both 2011 and 2012, holding National Hiring Days in more than 70 stores to attract nearly 6,000 team members for the May–September busy summer season. Over 10 percent of those hires were subsequently retained for ongoing employment with Jamba. In addition, Jamba established partnerships with San Francisco–based Job Corps Culinary Arts Center and the Bay Area chapter of the United Way to develop internship programs in culinary skills. Job Corps interns were able to work side-by-side with Jamba’s product innovation team developing new menu concepts. This helped build product knowledge and encourage employee long-term loyalty to the brand.25

In May 2012, Jamba created a new Healthy Living Council of nutritionists and dietary experts to help the brand evolve with more healthful offerings, as well as to educate both employees and consumers and to work with schools on healthy living and antiobesity efforts. The timing of this effort coincided with New York Mayor Bloomberg’s ban on sugary drinks larger than 16 ounces. Jamba’s All Fruit smoothies were all under 250 calories at 16 ounces and offered multiple servings of fruit. According to Jamba’s Healthy Living Council member, dietician Elizabeth Ward, “When you use whole fruit and 100-percent pure fruit juice, you’re getting vitamins and minerals and fiber that you’re not getting from a smoothie base or blend that a lot of places [like McDonald’s] start with.… We want you to get away from drinks that are offering nothing for the calories. When you’re consuming 200 calories, you want to get vitamins and minerals and protein, [as you do with Jamba Juice drinks].”26 This information helped Jamba employees educate consumers about the Jamba difference.

Expense Reduction Plan As a major part of CEO White’s strategic initiative, and partly due to the weakness of consumer spending at the time, Jamba planned to increase operating margins by reducing store-level costs. This would be done over several years by reducing costs of goods sold, simplifying operations to reduce labor costs, better managing wages and benefits, implementing a labor-planning system, increasing occupancy savings, and improving management of controllable costs, store costs, and marketing expenditures. In addition, Jamba took several measures to reduce general and administrative costs. They were also looking for ways to better use technology to improve store-level productivity, for instance, testing a program with Google Wallet that allowed guests to pay and redeem coupons with their smartphones.27

Competition Jamba was the smoothie industry leader and had initially had several competitors with similar health and fitness focuses, such as Juice It Up!, Planet Smoothie, and Smoothie King, but by 2009 that had changed. Starbucks and Panera Bread had entered the smoothie market, and McDonald’s brought its marketing machine into the frozen drink category, launching its line of smoothies in the summer of 2010 with a value pitch. McDonald’s introduced

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a 12-ounce smoothie for $2.29, while, at the time, Jamba Juice’s berry smoothies started at $3.55 for 16 ounces. When asked about the McDonald’s push into its competitive space, Jamba Juice’s CEO White said, “We view the entry of McDonald’s into the smoothie category as an overall validation of the potential of smoothies. Their advertising will expand interest in the category.”

Burger King had entered the smoothie market as well in 2012, and Starbucks, with its smoothies in place since 2008, had acquired both Evolution Fresh, the premium juice bar operator, and Teavana Teas during 2012. This positioned Starbucks as a head- to-head competitor to Jamba Juice.

On the international market, Canadian-based Tim Hortons had been offering smoothies in its U.S. market since mid-2010 and in 2011 was beginning to sell berry smoothies in Canada. Analysts there believed the smoothie market was “hot,” growing 8 percent in 2010, with relatively small consumption.28 By 2012, Jamba Juice had expanded into Canada, with seven units, and planned additional franchise development of up to 80 locations by 2020.

Can Jamba Grow without Losing Its “Healthy Alternatives” Brand Identity? Jamba Juice Company’s desire to grow by expanding its selection of nonjuice menu items seemed to follow the Starbucks model. Although originally just a coffeehouse, by 2012 most Starbucks stores offered a variety of muffins, fruit plates, sandwiches, quiches, and desserts. And with the 2012 acquisition of juice bar operator Evolution Fresh and premium loose tea purveyor Teavana, Starbucks was pushing boundaries even further. This menu expansion helped Starbucks attract customers who were looking for a light meal or dessert to go with their coffee and also attracted noncoffee drinkers who just came in for the food, tea, and juice beverages. Offering iced coffees, teas, and juices helped Starbucks overcome some of its seasonal variability, giving customers a cool-drink offering during hot-weather months. Offering ready-to-go-drinks in grocery and convenience stores also enabled Starbucks to get its products to a wider customer base.

Likewise, Jamba had set out to strengthen its customer reach by offering ready-to-drink products, hot food and drink items to attract customers during the cold-weather months, and a range of breakfast and lunch food items to complement its juice-based offerings and satisfy customer desires all day and all year-round. Could Jamba follow Starbucks’s path of broadening its menu base but still maintaining its brand identity?

One of the issues with growth is how to manage the pace of innovation—by choosing a direction that capitalizes on the organization’s core competencies and then validating new ideas by testing them in the marketplace—and then to make sure the financial and human assets are available to invest in sustaining needed operational components. Consultant Robert Sher advises CEOs of mid-market companies who are trying to plan for growth. He pointed to Jamba CEO James White as one who seemed to get it, explaining that White’s team uses “a well-disciplined ‘stage-gate’ process to de-risk each idea, from conception through testing.” As an example, Sher pointed to Jamba’s launch of its steel-cut oatmeal, a product that took two years of field testing but ended up a winner.29

With White at the helm, the Jamba turnaround seemed to be on track. However, even with no debt and increased margins going into 2013, there was still speculation about whether Jamba could sustain itself as a brand well-recognized enough to compete with the likes of Starbucks and McDonald’s. With Burger King also entering the smoothie category, the drive-through chains might be able to slash prices on their smoothies and use them as loss leaders. And Starbucks, with its move into the juice bar business, might be able to attract the family dollar as well as its traditional adult customer.30

However, going into 2013, Jamba CEO White believed his company might actually benefit from these increased entries into the juice market, reminding the market that Jamba had been offering healthy alternatives for 22 years, and “the bigger players that have entered the fresh juice and smoothie market have done nothing but elevate the importance of healthier on-the-go solutions.”31 At the time, the investment community seemed to agree. In October 2012 shares of Jamba jumped 3.5 percent in one day when analyst Lloyd Khaner said he saw Jamba Juice as a fantastic value opportunity going into a second growth phase. Khaner argued that investors shouldn’t lose sight of Jamba’s core competencies.32 It’s likely Jamba’s competitors weren’t losing sight of Jamba either. There was still speculation about whether Starbucks, McDonald’s, or even Monster Beverage might see Jamba as an increasingly attractive acquisition target.33 After a 2012 year-to-date stock return of 71 percent, one analyst said, “With a valuable brand at an attractive price, it’ll be interesting to see if Jamba remains independent throughout the coming year.”34

ENDNOTES 1. Dostal, E. 2013. Jamba Juice introduces kids’ meals. Nation’s Restaurant News, January 4, nrn.com/latest-headlines/jamba-juice-introduces-kids-meals. 2. Jamba Inc. 2010. Jamba Inc. Form 10K annual report, for period ending December 29, 2009. Available at ir.jambajuice.com/phoenix.zhtml?

c=192409&p=irol-sec 3. Jamba Inc. 2011. Jamba Inc. Form 10K annual report, for period ending January 3, 2012. Available at http://ir.jambajuice.com/phoenix.zhtml?

c=192409&p=IROL- secToc&TOC=aHROcDovL2FwaS50ZW5rd216YXJkLmNvbS9vdXRsaW51LnhtbD9yZXBvPXRlbmsmaXBhZ2U9ODEyNzg4OQ%3d%3d&ListAll=l&sXBRL=1

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4. Ibid. 5. Jamba Inc. 2012. JMBA analyst November 2012 presentation. December 17, ir.jambajuice.com/phoenix.zhtml?c=192409&p=irol-presentations. 6. FundingUniverse.com.n.d. Jamba Juice Company (company history). www.fundinguniverse.com/company-histories/Jamba-Juice-Company-Company-

History.html.

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7. Jamba Juice Company. 2006. Jamba Juice Company and Services Acquisition Corp. International announce merger. March 13, www.sec.gov/Archives/edgar/data/1316898/000110465906015960/a06-6826_1ex99dl.htm.

8. Jamba Inc. 2008. Jamba, Inc. announces changes to its senior management team. Business Wire, August 6, ir.jambajuice.com/phoenix.zhtml? c=192409&p=irol-newsArticle&ID=1189166.

9. Jamba Inc. 2013. Jamba, Inc. Announces Fourth Quarter 2012 and Fiscal Year 2012 Financial Results. Business Wire, March 5. http://ir.jambajuice.com/phoenix.zhtml?c=192409&p=irol-newsArticle&ID=1792488&highlight=

10. Jamba Inc. 2012. Jamba Inc. Form 10K annual report, for period ending March 3, 2013. http://ir.jambajuice.com/phoenix.zhtml?c=192409&p=irol-sec 11. Jamba Inc. 2012. JMBA analyst November 2012 presentation. December 17. Citing research by Ipsos/Synovate eNation Onmibus unaided awareness,

September 2012, n = 1,907. ir.jambajuice.com/phoenix.zhtml?c=192409&p=irol-presentations. 12. Jamba Inc. 2011. Jamba Juice oatmeal favorite pick on Good Morning America today. ABC News, February 8, ir.jambajuice.com/phoenix.zhtml?

c=192409&p=irol-news&nyo=0; video clip available at abenews.go.com/GMA/video/fast-food-oatmeal-how-healthy-is-it-12865436. 13. QSR Magazine. 2012. Jamba Juice acquires premium tea company, Talbott Teas. QSR Magazine, February 21, www.qsrmagazine.com/news/jamba-juice-

acquires-premium-tea-company-talbott-teas. 14. Jamba Inc. 2012. JMBA analyst November 2012 presentation. 15. Jamba Inc. 2011. Jamba Juice announces two new “Ambassadors of WOW.” PRNewswire, May 9, ir.jambajuice.com/phoenix.Zhtml?c=192409&p=irol-

newsArticle&id=1561602. 16. Jamba Inc. 2012. Jamba Juice growth continues: New stores open in Washington D.C. with tennis-great Venus Williams. Business Wire, July 9,

ir.jambajuice.com/phoenix.zhtml?c=1924O9&p=irol-newsArticle&ID=1712664 17. Lee, L. 2007. A smoothie you can chew on: To appeal to diners as well as drinkers, Jamba Juice is adding heft to its concoctions. BusinessWeek, June 11:

64. 18. Zacks Investment Research. 2008. Zacks analyst blog highlights: Jamba Juice, Krispy Kreme, Starbucks and PeopleSupport. January 10,

news.moneycentral.msn.com/ticker/article.aspx?symbol=US:JMBA&feed=BW&date=20080110&id=8018383. 19. Jamba Inc. 2008. Jamba announces organizational changes and store development reductions. Business Wire, May 15, ir.jambajuice.com/phoenix.zhtml?

c=192409&p=irol-newsArticle&ID=1189172. 20. Jamba Inc. 2012. Jamba announces significant progress in international expansion. Business Wire, July 17, ir.jambajuice.com/phoenix.zhtml?

c=192409&p=irol-newsArticle&ID=1715180. 21. Jennings, L. 2011. Jamba Juice on growth, JambaGO. Nation’s Restaurant News, December 9, nrn.com/archive/jamba-juice-growth-jambago. 22. Jennings, L. 2012. Jamba Juice launches next phase of growth. Nation’s Restaurant News, January 10, nrn.com/archive/jamba-juice-launches-next-phase-

growth. 23. Drinks Business Review. 2011. Nestle Jamba All-Natural Energy Drinks to land at 600 Jamba Juice stores in U.S. March 11, energysportsdrinks.drinks-

business-review.com/news/nestl-jamba-all-natural-energy-drinks-to-land-at-600-jamb a-juice-stores-in-us-110311. 24. QSR Magazine. 2012. Jamba Juice offers CPG energy drinks. QSR Magazine, April 23, www.qsrmagazine.com/news/jamba-juice-offers-cpg-energy-

drinks. 25. QSR Magazine. 2012. Jamba Juice unveils summer hiring campaign results. QSR Magazine, October 9, www.qsrmagazine.com/news/jamba-juice-unveils-

summer-hiring-campaign-results. 26. Jennings, L. 2012. Jamba Juice works to make smoothies more healthful. Nation’s Restaurant News, June 19, nrn.com/latest-headlines/jamba-juice-works-

make-smoothies-more-healthful. 27. Matteson, S. 2012. Google Wallet: Where it’s been and where it’s going. TechRepublic, November 30, www.techrepublic.com/blog/google-in-the-

enterprise/google-wallet-where-its-been-and-where-its-going/1672. 28. QSRweb.com. 2011. Tim Hortons rolling out smoothies in Canada. March 4, www.qsrweb.com/article/179756/Tim-Hortons-rolling-out-smoothies-in-

Canada. 29. Sher, R. 2012. Google can survive too much innovation. You can’t. Forbes, May 15, www.forbes.com/sites/forbesleadershipforum/2012/05/15/google-

can-survive-too-much-innovation-you-cant/. 30. Munarriz, R. A. 2012. Is a smoothie war breaking out? Motley Fool, September 4, www.fool.com/investing/general/2012/09/04/is-a-smoothie-war-

breaking-out.aspx. 31. CNBC. 2013. Jamba Juice CEO on increasing competition. CNBC interview, Video.CNBC.com, January 4, video.cnbc.com/gallery/?video=3000139247. 32. South, J. 2012. Why Jamba Juice jumped. Motley Fool, October 2, www.fool.com/investing/general/2012/10/02/why-jamba-juice-jumped.aspx. 33. Munarriz, R. A. 2012. Is Jamba the next Teavana? Motley Fool, November 15, http://www.fool.com/investing/general/2012/ll/15/is-jamba-the-next-

teavana.aspx. 34. Caplinger, D. 2012. How Jamba juiced investors’ 2012 returns. Motley Fool, December 21, www.fool.com/investing/general/2012/12/21/how-jamba-

juiced-investors-2012-returns.aspx.

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CASES

CASE 9 ANN TAYLOR

Survival in Specialty Retail* ANN Inc., specialty retailer of women’s apparel sold under its Ann Taylor or LOFT brands, was one of the few darlings of the retail sector stock analysts at the end of 2012. Fourth quarter revenues for ANN were up almost 9 percent from the previous year, making it one of only a handful of retailers to show real growth. Going into 2013, specialty retailers were beginning to recover from four years of dismal performance. The economic troubles of 2008 had lasted through 2009, producing one of the worst retail seasons in recent memory. 2010 had been an uphill battle, but at least some retailers had seen improvement, especially the luxury vendors such as Neiman Marcus and Nordstrom. The feeling during 2011 was that customers had shown “a clear preference for select high-end apparel brands such as Gucci,” and were “willing to pay a premium on something that delivers on luxury.” At the same time, shoppers were also “hunting down designer brands at steep discounts” at stores such as T.J. Maxx or Target, causing one businessman to label this the “barbell effect”: “high-end brands are holding ground among consumers, while spending at value- oriented stores has also been pretty stable. [But] it’s a tough place for mid-tier right now,” namely, those retailers such as Gap, Chico’s, and Ann Taylor.1

By 2012, luxury fashion spending may have been up, but the mid-market specialty apparel retailers continued to struggle. Customers were looking for value, but also fashion—if a store had the right product, with the right price point, it could be a winner. Quality could beat quantity, but the quest for this “right” balance had many retailers resorting to discounting month after month in order to drive sales or recover from bad guesses and poor inventory management.2 The firm with the right “mix” could stand out, and analysts were pointing to ANN’s strong results. Ann Taylor was starting to look good.

However, Ann Taylor had had its own set of problems, mainly with its two divisions: the legacy Ann Taylor store for upscale professional women versus the LOFT’s more casual fashion. Analysts had long worried that LOFT stores would cannibalize sales “as traditional Ann Taylor shoppers sought more relaxed, lower-priced merchandise, particularly during the recession.” Ann Taylor would be 59 years old in 2013 and needed to make sure it wouldn’t become a victim of a midlife crisis.3 Kay Krill, ANN’s CEO, had been reflecting on these issues for some time.

* This case was prepared by Associate Professor Pauline Assenza, Western Connecticut State University, Professor Alan B. Eisner of Pace University, and Professor Jerome C. Kuperman of Minnesota State University–Moorhead. This case is solely based on library research and was developed for class discussion of strategies rather than to illustrate either effective or ineffective handling of the situation. An earlier version of this case was published in The CASE Journal 5, no. 2 (Spring 2009). Copyright © 2009 The CASE Association. Current copyright © 2013 Pauline Assenza and Alan B. Eisner.

Krill had been appointed president of Ann Taylor Stores Corporation (ANN) in late 2004, and she succeeded to president/CEO in late 2005 when J. Patrick Spainhour retired after eight years as CEO. Even back then, there was concern among commentators and customers that the Ann Taylor look was getting “stodgy,” and the question was how to “reestablish Ann Taylor as the preeminent brand for beautiful, elegant, and sophisticated occasion dressing.”4

Krill’s challenge was based on the ANN legacy as a women’s specialty clothing retailer. Since 1954, Ann Taylor had been the wardrobe source for busy, socially upscale women, and the classic basic black dress and woman’s power suit with pearls were Ann Taylor staples. The Ann Taylor client base consisted of fashion-conscious women from age 25 to 55. The overall Ann Taylor concept was designed to appeal to professional women who had limited time to shop and who were attracted to Ann Taylor stores by their total wardrobing strategy, personalized client service, efficient store layouts, and continual flow of new merchandise.

ANN had two branded divisions focused on different segments of this customer base:

• Ann Taylor (AT), the company’s original brand, provided sophisticated, versatile, and high-quality updated classics.

• Ann Taylor LOFT (LOFT) was a newer brand concept that appealed to women who had a more relaxed lifestyle and work environment and who appreciated the more casual LOFT style and compelling value. Certain clients of Ann Taylor and LOFT cross-shopped both brands.

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customers expected to find Ann Taylor and other major-label bargains. Both brands were also increasingly retailed online, on their respective websites.

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ANN had regularly appeared in the Women’s Wear Daily Top 10 list of firms selling dresses, suits, and evening wear and the Top 20 list of publicly traded women’s specialty retailers. These listings recognized the total company, that is, the combined results of both divisions. Since 2005, the LOFT division, with more square footage per store, had outsold the flagship Ann Taylor (AT) division stores.9 Since its emergence as a distinctly competitive entity, LOFT had been such a success for the company that some analysts credited the division for “keeping the entire ANN corporation afloat.”5 Financial data from 2009 to 2013 show the performance of LOFT compared to AT. (See Exhibit 1.)

Krill acknowledged the ongoing challenge: “To be successful in meeting the changing needs of our clients, we must continually evolve and elevate our brands to ensure they remain compelling—from our product, to our marketing, to our in-store environment.”6

Although Krill believed that, overall, Ann Taylor still had its historic appeal, the question remained whether that appeal could be sustained indefinitely in the risky and uncertain specialty retail environment, where success depended on the “ability to predict accurately client fashion preferences.”7

Ann Taylor Background Ann Taylor was founded in 1954 as a wardrobe source for busy, socially upscale women. Starting out in New Haven, Connecticut, Ann Taylor founder Robert Liebeskind established a stand-alone clothing store. When Liebeskind’s father, Richard Liebeskind Sr., a designer, as a good-luck gesture, gave his son exclusive rights to one of his best-selling dresses, “Ann Taylor,” the company name was established. Ann Taylor was never a real person, but her persona lived on in the profile of the consumer.

Ann Taylor went public on the New York Stock Exchange in 1991 under the symbol ANN. In 1994 the

EXHIBIT 1 AT versus LOFT Financial Performance, FY 2009–2013

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A B C D E F

1 AT versus LOFT Financial Performance, FY 2009–2013

2 Fiscal Year Ending

3 Feb. 2,2013 Jan. 28,2012

Jan. 29,2011

Jan. 30,2010

Jan. 31,2009

4 Net Sales (in millions)

5 Ann Taylor stores $ 644.5 $ 494.0 $ 503.1 $ 462.0 $ 694.8

6 Ann Taylor e-commerce Included in above

124.4 92.6 61.4 70.2

7 Ann Taylor Factory Outlet 300.7 289.4 268.0 248.0 254.9

8 Total Ann Taylor brand 945.2 907.9 863.7 771.3 1,019.9

9 LOFT stores 1,202.2 991.0 943.3 947.8 1,098.2

10 LOFT e-commerce Included in above

123.9 96.9 60.2 61.8

11 LOFT Outlet 228.0 189.7 76.3 49.3 14.7

12 Total LOFT brand 1,430.3 1,304.6 1,116.5 1,057.2 1,174.7

13 Total company $2,375.5 $2,212.5 $1,980.2 $1,828.5 $2,194.6

14 Comparable-Store Sales Percentage, increase or (decrease)

15 Ann Taylor 1.1 5.2 18.7 (23.8) (17.0)

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16 LOFT 4.8 8.0 5.0 (11.9) (10.2)

17 Total company 3.3% 6.8% 10.7% (17.4%) (13.4%)

18 Fiscal Year Ending

19 Feb 2,2013 Jan. 28,2012

Jan. 29,2011

Jan. 30,2010

Jan. 31,2009

20 Net sales 100.0% 100.0% 100.0% 100.0% 100.0%

21 Cost of sales % 45.2 45.4 44.2 45.6 51.9

22 Gross margin % 54.8 54.6 55.8 54.4 48.1

23 Selling, general, and administrative expenses %

47.8 48 49.4 52.9 47.8

Restructuring, asset, goodwill impairment % – – 0.3 2.8 17.2

25 Operating income (loss) % 7.0 6.6 6.1 (1.3) (16.9)

26 Interest income % – – – 0.1 0.1

27 Interest expense % – (0.1) (0.1) 0.2 0.1

28 Income before tax % 7.0 6.5 6.0 (1.4) (16.9)

29 Income tax provision % 2.7 2.6 2.3 (0.4) (1.7)

30 Net income % 4.3% 3.9% 3.7% (1.0%) (15.2%)

31 Percentage change from prior period:

32 Net sales 7.4% 11.7% 8.3% (16.7%) (8.4%)

33 Operating income 14.6 21.5 600.1 (93.6) (339.2)

34 Net income 18.5 17.9 503.1 (94.5) (443.3)

Source: ANN Inc. 10K filings.

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company added a mail-order catalog business, a fragrance line, and free-standing shoe stores positioned to supplement the Ann Taylor (AT) stores. The mail-order catalog attempt ended in 1995, and the lower-priced apparel concept, Ann Taylor LOFT, was launched. LOFT was meant to appeal to a younger, more casual and cost-conscious, but still professional, consumer. CEO Sally Kasaks incorporated more casual clothing, petite sizes, and accessories in an attempt to create a one-stop shopping environment to “widen market appeal and fuel growth.”8 Following losses in fiscal 1996 that could be attributed to a fashion misstep—cropped T-shirts didn’t fit in with the workplace attire—Kasaks left the company. New ANN CEO Patrick Spainhour, who had been chief financial officer at Donna Karan and also had previous experience at Gap, shelved the fragrance line and closed the shoe stores in 1997.

Originally, the LOFT stores were found only in outlet centers, but in 1998 the LOFT stores in the discount outlet malls were replaced by a third concept, Ann Taylor Factory (Factory). The Factory carried clothes from the Ann Taylor (AT) line. This “outlet” concept offered customers direct access to the AT designer items “off the rack” without elaborate promotion and with prices regularly 25 to 30 percent less than at the high-end Ann Taylor stores. The LOFT concept was revamped, and stores were opened in more prestigious regional malls and shopping centers. By 1999 LOFT clothes were a distinct line of “more casual, yet business- tailored, fun, and feminine” attire, and they were about 30 percent less expensive than the merchandise at the flagship Ann Taylor division’s stores.9 At that time, the LOFT was under the direction of Kay Krill, who had been promoted to the position of executive vice president of the LOFT division.

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promoted from executive vice president to president of LOFT. In 2004 Krill was made president of the entire ANN corporation, bringing both Ann Taylor and LOFT under her control.

In February 2005 Kay Krill announced that LOFT had reached $1 billion in sales; and in June 2005 ANN completed a move to new corporate headquarters in Times Square Tower in New York City.10 In the fall of 2005 chairman and CEO J. Patrick Spainhour retired and President Kay Krill was elevated to the CEO position. In a conference call following her promotion, Krill stated her goals as “improving profitability while enhancing both brands … restoring performance at the Ann Taylor division and restoring the momentum at LOFT.”11

Krill felt that the outlook for fiscal year 2006 was cautiously positive, and she announced continued plans for expansion and related capital expenditures. The stock responded with new highs, moving to a peak of over $40 in late 2006. At that time, analysts were mainly supportive, citing “confidence in the retailer’s strong management team, improving store products, and conservative inventory management.”12 ANN’s stock price subsequently retreated in 2007 and 2008, along with the rest of the retailing sector.

Challenges in the macroeconomic climate prompted Krill to announce a restructuring plan in 2008.13 However, after a posted loss of $333.9 million in 2008 and the continuing economic uncertainty going into 2009, ANN was reluctant to give any profit forecast for the coming quarters. At the end of 2009 net sales had reached the lowest point since 2005 and in 2010 had still not rebounded enough to surpass 2007 figures. (See Exhibit 2.) At the end of 2011, sales had jumped over 11 percent from 2010, and although gross margins fell to 54.6 percent from 55.8 percent a year earlier, earnings per share had gone from $–5.82 in 2008 to $1.66 in 2011. Signaling a more focused strategy moving forward, Krill announced a name change for the company:

I am pleased to announce today that, in order to better reflect the multi-channel focus we have on our business, we have decided to change our corporate name from Ann Taylor Stores Corporation to ANN INC. Today, our Company is far more than a traditional “store-based” retailer. We have two distinct brands—Ann Taylor and LOFT—each of which operates across three channels and enables us to reach our client whether she is making her purchases at our stores, online or at our factory outlet locations.14

Going into 2013, things had improved once again, with total company comparable sales for the full year of fiscal 2012 increasing 3.3 percent. (See Exhibits 3, 4, and 5.) This made the stockholders happy, but, as an analyst once said, to really fire up shareholders, “you need to forecast future results that are higher than hoped.”15 The concern going forward was how to keep profit margins up when the overall shopping forecast was lukewarm—and had forced retailers, including ANN, to discount prices heavily in order to reach sales targets.

EXHIBIT 2 ANN Net Sales (in $ billions)

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EXHIBIT 3 Income Statements (In $ thousands)

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A B C D

1 Income Statements (in $ thousands)

2 Period Ending

3 Feb. 2, 2013 Jan. 28, 2012 Jan. 29, 2011

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4 Total Revenue 2,375,509 2,212,493 1,980,195

5 Cost of Revenue 1,073,167 1,004,350 876,201

6 Gross Profit 1,302,342 1,208,143 1,103,994

7 Operating Expenses

8 Sellinq, General, and Administrative 1,135,551 1,062,644 978,580

9 Nonrecurring ________ ________ 5,624

10 Operating Income or Loss 166,791 145,499 119,790

11 Income from Continuing Operations

12 Total Other Income/Expenses Net (189) – –

13 Earninqs before Interest and Taxes 166,602 145,499 119,790

14 Interest Expense 1,051 (1,052) (668)

15 Income before Tax 167,653 144,447 119,122

16 Income Tax Expense 65,068 57,881 45,725

17 Net Income 102,585 86,566 73,397

EXHIBIT 4 Balance Sheets (in thousands of dollars)

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A B C D

1 Balance Sheets (in thousands of dollars)

2 Period Ending

3 Feb. 2,2013 Jan. 28, 2012 Jan. 29, 2011

4 Assets

5 Current Assets:

6 Cash and Cash Equivalents 167,011 150,208 226,644

7 Short-Term Investments – – –

8 Net Receivables 57,454 62,555 72,277

9 Inventory 216,848 213,447 193,625

10 Other Current Assets 64,716 49,107 57,367

11 Total Current Assets 506,029 475,317 549,913

12 Property Plant and Equipment 409,703 360,890 332,489

13 Other Assets 18,632 12,340 12,523

14 Deferred LonG-Term Asset Charqes 7,841 39,134 31,895

15 Total Assets 942,205 887,681 926,820

16 Liabilities

17 Current Liabilities:

18 Accounts Payable 105,691 235,147 232,805

19 Period Ending

20 Feb. 2,2013 Jan. 28, 2012 Jan. 29, 2011

21 Liabilities

22 Short/Current Long-Term Debt – – –

23 Other Current Liabilities 231,063 50,750 49,103

24 Total Current Liabilities 336,754 285,897 281,908

25 Long-Term Debt –

26 Other Liabilities 31,125 35,030 22,997

27 Deferred Long-Term Liability Charges 189,216 202,877 198,470

28 Total Liabilities 557,095 523,804 503,375

29 Stockholders’ Equity

30 Common Stock 561 561 561

31 Retained Earninqs 676,842 574,527 487,691

32 Treasury Stock (1,056,011) (1,017,330) (863,569)

33 Capital Surplus 768,215 811,707 801,140

34 Other Stockholder Equity (4,497) (5,318) (2,378)

35 Total Stockholder Equity 385,110 363,877 423,445

36 Net Tangible Assets 385,110 363,877 423,445

Source: ANN Inc. 10K filings.

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EXHIBIT 5 Statement of Annual Cash Flows

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A B C D

1 Statement of Annual Cash Flows

2 Period Ending

3 Feb. 2,2013 Jan. 28, 2012 Jan. 29, 2011

4 Net Income 102,585 86,566 73,397

5 Operating Activities, Cash Flows Provided by or Used in

6 Depreciation 97,829 94,187 95,523

7 Adjustments to Net Income 64,442 38,149 26,526

8 Changes in Accounts Receivables 1,324 (2,060) 5,130

9 Changes in Liabilities (7,573) (24,649) (7,680)

10 Changes in Inventories (3,401) (19,822) (25,919)

11 Changes in Other Operating Activities 3,703 35,457 (2,666)

12 Total Cash Flow From Operating Activities 258,909 207,828 164,311

13 Period Ending

14 Feb. 3, 2013 Jan. 28, 2012 Jan. 29, 2011

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15 Investing Activities, Cash Flows Provided by or Used in

16 Capital Expenditures (147,286) (118,918) (61,213)

17 Investments (1,977) (1,288) 5,322

18 Other Cash Flows from Investing Activities (649) (250) (1,331)

19 Total Cash Flows from Investing Activities (149,912) (120,456) (57,222)

20 Financing Activities, Cash Flows Provided by or Used in

21 Sale/Purchase of Stock (94,823) (169,736) (97,094)

22 Net Borrowings (2,801) (1,511) 1,622

23 Other Cash Flows from Financing Activities 5,449 (188) 3,377

24 Total Cash Flows from Financing Activities (92,175) (163,808) (84,936)

25 Change in Cash and Cash Equivalents 16,803 (76,436) 22,153

Source: ANN Inc. 10K filings.

The Apparel Retail Industry

Industry Sectors To better appreciate Ann Taylor’s issues, it’s helpful to understand the apparel retail industry. Industry publications such as the Daily News Record (DNR—reporting on men’s fashion news and business strategies) and Women’s Wear Daily (WWD—reporting on women’s fashions and the apparel business) as well as industry associations such as the National Retail Federation (NRF) report data within the clothing sector. Practically speaking, industry watchers tend to recognize three categories of clothing retailers:

• Discount mass merchandisers: Chains such as Target, Walmart, TJX (T.J. Maxx, Marshall’s, HomeGoods), and Costco.

• Multitier department stores: Those offering a large variety of goods, including clothing (e.g., Macy’s and JCPenney), and the more luxury-goods-focused stores (e.g., Nordstrom and Neiman Marcus).

• Specialty store chains: Those catering to a certain type of customer or carrying a certain type of goods, for example, Abercrombie & Fitch for casual apparel.

More specifically in the case of specialty retail, many broadly recognized primary categories exist, such as women’s, men’s, and children’s clothing stores (e.g., Victoria’s Secret for women’s undergarments,16 Men’s Wearhouse for men’s suits, Abercrombie Kids for children ages 7 to 1417). Women’s specialty stores are “establishments primarily engaged in retailing a specialized line of women’s, juniors’ and misses’ clothing.”18

Specialty Retailer Growth: Branding Challenges Unlike department stores that sell many different types of products for many types of customers, specialty retailers focus on one type of product item and offer many varieties of that item. However, this single-product focus increases risk, as lost sales in one area cannot be recouped by a shift of interest to another, entirely different product area. Therefore, many specialty retailers constantly seek new market segments (i.e., niches) that they can serve. However, this strategy creates potential problems for branding.19

Gap Inc. is an example of a specialty retailer that added several brand extensions to appeal to different customer segments. In addition to the original Gap line of casual clothing, the company offered the following: Old Navy with casual fashions at low prices, Banana Republic for more high-end casual items, Athleta performance apparel and gear for active women, and Piperlime, an online shoe store. In 2005 Gap spent $40 million to open a chain for upscale women’s clothing called Forth & Towne, which closed after only 18 months. The store was supposed to appeal to upscale women over 35—the baby-boomer or “misses” segment—but, instead, the designers seemed “too focused on reproducing youthful fashions with a more

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generous cut” instead of finding an “interesting, affordable way” for middle-aged women to “dress like themselves.”20

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Mexican folk art boutique, Chico’s was originally a stand-alone brand. Starting in late 2003, Chico’s FAS decided to promote two new brands: White House/Black Market (WH/BM) and Soma by Chico’s (Soma). Chico’s WH/BM brand was based on the acquisition of an existing store chain, and it focused on women age 25 and older, offering fashion and merchandise in black-and- white and related shades. Soma was a newly developed brand offering intimate apparel, sleep-wear, and active wear. Each brand had its own storefront, mainly in shopping malls, and was augmented by both mail-order catalog and Internet sales. The idea was that the loyal Chico’s customer would be drawn to shop at these other concept stores, expecting the same level of quality, service, and targeted offerings that had pleased her in the past. In 2011 Chico acquired Boston Proper, a brand that sold women’s high-end apparel and accessories focusing on women between 35 and 55 years old only through catalogs and online. Boston Proper’s intention was to create “a daring, modern style with a sensual feel designed for today’s independent, confident and active woman.”21

Although Chico’s had been a solid performer during the decade, surpassing most other women’s clothing retailers in sales growth, a downturn in 2006 caused Chico’s shares to fall more than 50 percent when the company reported sales and earnings below analysts’ expectations. Chico’s had seen increasing competition for its baby-boomer customers, and it said it had lost momentum, partly because of “fashion missteps” and lack of sufficiently new product designs. The company’s response was to create brand presidents for the three divisions to hopefully create more “excitement and differentiation.”22

In an attempt to better manage the proliferation of brands, many firms, similar to Chico’s, created an organizational structure in which brands had their own dedicated managers, with titles such as executive vice president (EVP), general merchandise manager, chief merchandising officer, or outright “brand president.”23 With each brand supposedly unique, companies felt the person responsible for a brand’s creative vision should be unique as well.

An alternative to brand extension was the divestiture of brands. In 1988 Limited Brands acquired Abercrombie and Fitch (A&F) and rebuilt A&F to represent the “preppy” lifestyle of teenagers and college students ages 18 to 22. In 1996 Limited Brands spun A&F off as a separate public company. Limited Brands continued divesting brands: teenage clothing and accessories brand The Limited TOO in 1999, plus-size women’s clothing brand Lane Bryant in 2001, professional women’s clothing brand Lerner New York in 2002, and in 2007 the casual women’s clothing brands Express and The Limited. Paring down in order to focus mostly on its key brands, Victoria’s Secret and Bath & Body Works, the corporation made it clear that it had made a strategic decision to limit its exposure to changing clothing trends.24

Women’s Specialty Retail: Competitors and the “Misses” Segment The National Retail Federation, a trade group based in Washington, DC, reported in 2007 that the retail niches showing the greatest growth were department stores, stores catering to the teenage children of baby boomers, and apparel chains aimed at women over 35.25 The four major women’s specialty retailers that had tried to target older upscale shoppers were Ann Taylor, Chico’s FAS, Coldwater Creek, and Talbots. Ann Taylor was the only one of these with a significant brand extension for the younger professional, but all four had pursued a shopping environment and merchandise that were clearly focused on women over 35. (See Exhibit 6.)

This group of “older” women was part of the baby-boomer demographic, born between 1946 and 1964, and the purchasing power of these women had not gone unnoticed.26 Historically, this “misses” market had been challenging to define, and therefore the category had been slow to innovate. These women were diverse, ranging from “traditional types who prefer flat shoes and ankle- length skirts to women who resembled characters from Desperate Housewives.”27

Talbots subsequently decided to sell off this division in 2009, in the wake of retailing’s “abysmal holiday season.” Analysts were not surprised, because Talbots had never made an acquisition before and had encountered problems integrating the two businesses.29

Going into 2011, Talbots was struggling with merchandise that was perceived as too “mature,” with stores that looked old- fashioned, and with vacancies in key upper management positions. CEO Trudy Sullivan had been named one of the “worst CEOs of 2012” for her inability to turn the company around,30 and by 2013 Talbots had shut dozens of stores and been bought out by a private equity firm for less than $3 per share.31

Coldwater Creek, with its large jewelry, accessory, and gift assortment in addition to apparel, described itself as “the fashion informed advocate for the 50 year old woman.”32 The company began by appealing with a Northwest/Southwest lifestyle approach that had included a group of spa locations. Coldwater Creek had created a common brand identity for its three distribution channels:

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catalog, Internet, and in-store shopping, but it too was having trouble finding the right mix of merchandise and presenting items properly in the stores. It also had experienced key gaps in upper management. The company had suffered since the economic downturn of 2008, with the stock crashing from over $100 in 2006 to less than $2 in 2012, and it had decided to close stores and reconsider merchandise targeted directly at its core demographic, rather than trying to bring in the younger shopper. Going into 2013 Coldwater Creek had new management and a strategy to return to its northwestern roots. Analysts were starting to call the

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stock a possible turnaround.33 The stories of Talbots and Coldwater Creek illustrate how hard it can be for retailers to refine their fashion message and try to appeal to new, often younger customers “without alienating shoppers who have long been loyal fans.”34

EXHIBIT 6 Selected Retail Performers: Descriptions

Company Ticker Symbol

Number of Stores

Locations Served

Merchandise Market Served Comments

Ann Taylor: ANN

981 46 states plus Puerto Rico and Canada

Specialty women’s—private-label “total wardrobing strategy” to achieve the “Ann Taylor look” in suits, separates, footwear, and accessories

Brands are Ann Taylor for updated professional classics; LOFT for lower- priced, more casual wear; and Ann Taylor Factory & LOFT Outlet for outlet-priced items.

Talbots (bought out by private equity in 2012)

516 46 states plus Canada

Specialty women’s—apparel, shoes, and accessories via store, catalog, and Internet

Brands are Talbots and Modern Classics for women. Brands target high-income, college-educated professionals over 35 years old.

Chico’s FAS: CHS

1,190 48 states plus U.S. Virgin Islands and Puerto Rico

Specialty women’s—privately branded clothing, intimate garments, and gifts for fashion-conscious women with moderate to high income via stores, catalog, Internet

Brands are Chico’s for women over 30, White House/Black Market for women over 25, Soma intimates, and Boston Proper online & catalog (modern style, sensual feel).

Coldwater Creek Inc.: CWTR

350 48 states Specialty women’s—apparel, accessories, jewelry, and gifts via store, catalog, Internet.

Offers Coldwater Creek brand of clothing and jewelry, cosmetics, and personal care products to women over 35 with income in excess of $75,000; socially responsible.

Source: Mergent Online; company reports.

Chico’s FAS was one of the first to introduce the concept of apparel designed for the lifestyle of dynamic mature women who were at the higher-age end of the boomer demographic.35 Chico’s had always been aware of the need to focus its branding on the older women’s segment. As a result of this focus, Chico’s had ended the difficult 2008 year with “strong brand equity,” one of the few specialty retailers with “staying power.”36 In 2011, of the four retailers focused on the “mature women” segment, Chico’s was the only one focused on inventory control, supply-chain management, and moving away from relying on China’s manufacturing power. Analysts therefore saw Chico’s as having good prospects for maintaining positive margins going forward. By 2013, Chico’s had not only rediscovered what its customers wanted, but had also cut back on margin-squeezing discounting practices, and therefore was considered the winner of the group.37 In fact, based on 2012 results, Chico’s and Ann Taylor were both among the top five in the specialty apparel retail industry, as ranked by margin.38 (See Exhibit 7.)

In August 2007 Kay Krill announced that ANN would be creating a new chain of stores, expected to launch sometime in 2008 or 2009, targeting this “older-women” segment. Some analysts wondered about this move into an overlooked but risky market that had “tripped up several competitors.” They pointed out that although ANN’s clothes were expected to be more fashionable, the company still faced stiff competition, made even tougher given the uneven performance of AT and LOFT.39 In 2008, as a result of the overall economic conditions, Krill announced that this new concept offering would have to be delayed at least until 2009,40 and by 2010 there was no more mention of this initiative. Instead, Krill announced that the “boomer” terminology was outdated: “We never called ourselves ‘misses.’ We’re timeless, modern and ageless, and we had to adjust and become more relevant to what

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modern consumers want today. It’s been an evolution. I feel like we are on the right track.”41 ANN’s goal was to sell clothes to more affluent women in general, regardless of age range. However, at the end of 2012 ANN had nearly twice as many LOFT stores as Ann Taylor stores, and the LOFT customer was normally a younger woman.

EXHIBIT 7 Selected Retail Performers: Financial Results

Company Name* Total Revenue (millions)

Net Income (millions)

Inventory Turnover

Revenue per Employee($)

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Abercrombie & Fitch (ANF) 4,158.1 127.7 3.43 46,328

ANN Inc. (ANN) 2, 212.5 86.6 4.93 111,486

Ascena Retail Group Inc. (ASNA)†

3,353.3 162.2 3.28 73,098

Chico’s FAS Inc. (CHS) 2,196.4 140.9 5.48 111,232

Coldwater Creek Inc. (CWTR)

773.0 (99.7) 3.77 112,340

Limited Brands Inc. (LTD) 10,364.0 850.0 6.22 107,139

Talbots Inc. (TLB)‡ 1,141.3 (111.9) 5.00 130,981

ROA% ROE % ROI % (Operating)

EBITDA Margin %

Abercrombie & Fitch 4.27 6.82 9.82 9.01

Ann Taylor Stores Corp. 9.57 22.05 36.17 10.83

Ascena Retail Group Inc. 7.00 13.02 20.77 11.51

Chico’s FAS Inc. 9.94 13.62 21.50 14.65

Coldwater Creek Inc. (21.74) (64.62) (52.98) (5.04)

Limited Brands Inc. 13.57 105.68 29.51 17.95

Talbots Inc. (17.09) (112.44) (60.24) (4.20)

* AU results are stated in U.S. dollars, using the most recent filings as of FY2011. † Ascena Retail Group is a national specialty retailer of apparel for women and tween girls. It operates through the following brands: Justice, apparel for girls ages 7–14; Lane Bryant, plus-size fashion; Maurices, fashion for 17- to 34-year-old women; Dressbarn, clothing for women from the mid-30s to mid-50s; and Catherines, plus-size and extended-size apparel. As of July 28, 2012, the company operated 3,828 stores. ‡ Talbots went private in 2012.

Source: Mergent Online.

Krill was also moving toward what was being called a “multichannel” sales approach: using full-price stores mixed with factory outlets and online options for each brand. ANN’s e-commerce business had more than doubled since 2010, and between 2011 and 2012 e-commerce comparable sales grew over 37 percent for the Ann Taylor brand and 29 percent for LOFT. ANN also planned to accelerate its outlet-store growth plans, opening up to 50 new factory stores in 2012. These stores offered merchandise for 25 to 30 percent less than the cost at the AT or LOFT regular stores. In addition, the LOFT stores were slated for an overhaul, adding warmth and creating a less “lofty” look, and the Ann Taylor stores were being downsized to a more productive, smaller store format. Testing the international market, ANN opened its first Ann Taylor “boutique” store in Toronto, Canada, during 2012, with two more added soon after.42

ANN Operational Information At the end of fiscal year 2012, ANN had 984 stores in 46 states, the District of Columbia, and Puerto Rico, with flagship locations in New York and Chicago, and an international presence with three stores in Canada. (See Exhibit 8.) The company had also had an online presence since 2000, transacting sales at www.anntaylor.com and www.LOFT.com. This “very profitable” Internet channel was considered “a meaningful and effective marketing vehicle for both brands” and was a way for ANN to reach out to the international market.43 To help with this, in March 2013 ANN announced international shipping was available for products sold on its two e-commerce sites. For the first time, international customers could shop in the currency of their choice and see competitive shipping costs and delivery times to their international location. So, basically, anyplace with Internet and shipping.44

As part of a corporate restructuring plan, ANN began to reconfigure its brick-and-mortar retail footprint. The plan included closing unprofitable stores, adding more factory outlets, and reducing the square footage per outlet

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format, approximately 30–0 percent smaller than the old stores, resulting in higher productivity and a more intimate, contemporary environment, decorated to make the shopper feel at home.45

EXHIBIT 8 Stores’ Operational Data

FY2012 FY2011 FY2010 FY2009

Employees, total 19,600 19,900 19,400 18,800

Inventory turns* 5.0 4.9 4.8 4.9

Net sales (revenue) per employee $121,199 $111,486 $102,352 $97,529

Number of Stores/Square Footage:†

Ann Taylor Stores 275/1,389 280/1,460 266/1,453 291/1,581

Ann Taylor Factory 101/696 99/700 92/668 92/668

LOFT Stores 512/2,950 500/2,904 502/2,930 506/2,976

LOFT Outlet 96/650 74/520 36/233 18/123

Total Company 984/5,685 953/5,584 896/5,284 907/5,348

Net Sales/Avg. Gross Square Foot‡ $418 $416 $464 $421

* Inventory turns can be calculated differently, depending on whether yearly average or year-end inventory values are used. † Square footage in thousands. ‡ Net sales per average gross square foot is determined by dividing net sales for the period by the average monthly gross square footage for the period. Unless otherwise indicated, references herein to square feet are to gross square feet, rather than net selling space. Online sales are excluded from the net sales per average gross square foot calculations.

Source: ANN Inc. 10K filings; Mergent Online.

Substantially all merchandise offered in ANN’s stores was exclusively developed for the company by its in-house product design and development teams. ANN sourced merchandise from approximately 138 manufacturers and vendors, none of whom accounted for more than 10 percent of the company’s merchandise purchases in fiscal 2012. Merchandise was manufactured in over 19 countries, including China (42 percent of purchases, 48 percent of total merchandise cost), the Philippines, Indonesia, India, and Vietnam. North American distribution was handled through a primary warehouse in Louisville, Kentucky, and online orders were handled by a third-party fulfillment center in Bolingbrook, Illinois.

Ann Taylor’s Historic Issues: Brand Identity and Management Turnover As with other specialty retailers, ANN had struggled with erratic performance in one division or the other and had suffered from excessive turnover in top management ranks. When ANN went public in 1991, the Ann Taylor brand, with its historically loyal following, was a candidate for brand extension. At one point in its history, the company had five separate store concepts: Ann Taylor (AT), Ann Taylor’s Studio Shoes, Ann Taylor LOFT, Ann Taylor Petites (clothing for women 5 feet 4 inches and under), and Ann Taylor Factory. In addition, ANN’s management had experimented with a makeup line and with children’s clothes. By 2005, the company had closed the shoe stores, reduced the accessories inventory that stores carried, and eliminated the makeup line.

Since 1999 analysts had warned that ANN needed to be wary of cannibalization within the brands. The analysts speculated that customers might turn away from AT in order to buy at LOFT. ANN had always tried to respond to the customer with “wardrobing,” a philosophy of “outfitting from head to toe,” combining relaxed everyday wear with more dressy pieces.46 Because LOFT sold more-relaxed but still tailored items at a lower price than AT, the concern was that some of AT’s customers might shop at LOFT for things that they previously would have bought at AT.

Therefore, in 2005 Krill asked her staff to spend time with ANN customers and develop “brand books,” or profiles, of the typical Ann Taylor (AT) and LOFT clients.47 The “Ann” (AT) marketing profile was of a married 36-year-old working mother with two children and a household income of $150,000. She would lead a busy, sophisticated life. When giving a presentation to a client, she’d wear a formal suit with a blouse, not a camisole, underneath, and her idea of dressing down at work might be a velvet jacket with jeans.

In contrast, the typical LOFT client was in her 30s and married, with children, worked in a laid-back, less corporate environment, and had a household income between

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$75,000 and $100,000. She would call her style “casual chic” and might wear pants and a floral top with ruffled sleeves to work, while on the weekend she would wear a printed shoulder-baring halter top with cropped jeans.

Also in 2005, Krill tried to reconfigure ANN’s top management, creating three positions that reported directly to her—COO, executive vice president (EVP) of planning and allocation, and EVP/chief marketing officer. These three additional positions provided specific expertise while still allowing Krill to “lead both divisions [AT and LOFT] in a more hands-on-way.” Krill could then focus on merchandising and marketing, especially brand differentiation.48 AT and LOFT continued to have separate EVPs for merchandising and design and separate senior vice presidents for divisional marketing, design, sourcing, and store direction.

In 2006 Krill lost her recently hired COO, Laura Weil, who left abruptly after only a few months on the job. Weil’s many responsibilities at ANN had included merchandise planning; information systems; all supply chain operations, including sourcing, logistics, and distribution; real estate; construction and facilities; and purchasing; as well as finance, accounting, and investor relations.49 Krill decided not to replace Weil and eliminated the position on the organizational chart. Krill also assumed leadership of LOFT again. Krill commented, “I believe that building a winning team is critical to fully realizing our company’s full potential.”50

However, it appeared that creating that “winning team” was taking longer than anticipated. One source wondered about the pressure on Krill, especially because she didn’t have a strong operating partner to help with merchandising and other creative decisions.51

Even though Krill had made differentiation between AT and LOFT a top priority, analysts continued to challenge Krill’s efforts, noting that it had been hard to get both divisions moving forward simultaneously. As one analyst said, “It just seems like it’s a struggle to get both of these divisions firing on all cylinders at the same time.”52 Krill responded to the comment that consistency had been a problem: “The notion that Ann Taylor got soft because I was supporting the LOFT team is really a completely inaccurate comment. As CEO of the company I have to spend my time on many things, and if one of our businesses is softening in any way I will focus extra time on it.”53 At the end of 2008, Krill had finally filled the AT and LOFT divisional president positions, and these individuals had remained in place, at least into 2011. However, the Ann Taylor division did see a change in brand president in 2012.

Future Initiatives? Since 2008 Krill had been acknowledging that differentiating LOFT from Ann Taylor had been a challenge. In 2010, Krill had believed the transition to a “world-class multi-channel retailer” would allow Ann Inc. to serve “two distinct segments of the market with two differentiated brands” across three channels—in the full-price store, in the factory store, or online.54 And in 2011 she believed that “we have evolved both brands to be highly differentiated and distinct. Absolutely, the number-one challenge is to sustain the momentum of both brands and all channels.”55 Going into 2013, that challenge still remained.

ENDNOTES 1. Dickler, J. 2011. Consumers: We want Gucci or Target. Forget the Gap. Shoppers are once again showing a preference for high-end brands. CNN Money,

March 9. money.cnn.com/2011/03/09/pf/consumers_prefer_luxury/. 2. Mahashwari, S. 2012. Retailers respond as millennials seek quality: Public “exhausted” by fast fashion; well-priced apparel now more appealing. Chicago

Tribune, November 16, articles.chicagotribune.com/2012-11-16/business/ct-biz-1116-bf-fast-fashion-20121116_1_american-apparel-apparel-retailers- higher-prices; Berk, C. C. 2013. Dour December may not spell retail disaster this year. CNBC, January 2, www.cnbc.com/id/100349579; Steigrad, A. 2013. Holiday’s aftermath: Squeeze on profits. Women’s Wear Daily 502, no. 3 (January 4): 1.

3. Jones, S. M. 2012. Ann Taylor tailors new Mag Mile store to fit modern shoppers, improve sales. Chicago Tribune, March 1, articles.chicagotribune.com/2012-03-01/business/ct-biz-0302-ann-taylor-20120229_1_ann-taylor-kay-krill-modern-shoppers.

4. Warner, B., director, corporate communications, Ann Taylor Stores Corporation. 2007. ANN representatives noted that there was no apparent cause-and- effect relationship between AT sales decline and the growth of LOFT. Personal communication, July.

5. Tucker, R. 2004. LOFT continues to pace Ann Taylor. Women’s Wear Daily, August 12: 12. 6. Ann Taylor Stores Corporation. 2007. Letter to shareholders. Ann Taylor Stores Corporation 2007 Annual Report, investor.anntaylor.com/phoenix.zhtml?

c=78l67&p = irol-reportsAnnual. 7. Ann Taylor Stores Corporation. 2008. Q1 2008 Ann Taylor Stores earnings conference call. SeekingAlpha.com, May 22, seekingalpha.com/article/78473-

ann-taylor-stores-corp-ql-2008-earnings-call-transcript. 8. Wilson, M. 1995. Reinventing Ann Taylor. Chain Store Age Executive with Shopping Center Age, January: 26. 9. Summers, M. 1999. New outfit. Forbes, December 27: 88.

10. Ann Taylor Stores Corporation. 2005. Ann Taylor announces LOFT division reaches $1 billion in sales. Investor.AnnTaylor.com, February 12, investor.anntaylor.com/news/20060213-187405.cfm?t=n.

11. Krill, K. 2005. As quoted in “Q3 2005 Ann Taylor Stores earnings conference call.” 12. Associated Press. 2006. Ann Taylor Stores jumps on strong earnings. MoneyCentral.MSN.com, March 10, news.moneycentral.msn.com/ticker/article.asp?

Feed=AP&Date=20060310MD=5570346&Symbol=US:ANN 13. Ann Taylor Stores Corporation. 2007. Letter to shareholders. 14. Ann Taylor Stores Corporation. 2011. Ann Taylor reports substantially higher sales and earnings for fourth quarter and fiscal 2010.

Investor.AnnTaylor.com, March 11, investor.anntaylor.com/phoenix.zhtml?c=78l67&p=irol-newsArticle&ID=1538446. 15. Koppenheffer, M. 2011. Ann Taylor shares popped: What you need to know. Motley Fool, March 11, www.fool.com/investing/general/2011/03/11/ann-

taylor-shares-popped-what-you-need-to-know.aspx.

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16. Victoria’s Secret is a division of Limited Brands, which also operates Pink (a subbrand of Victoria’s Secret focused on sleepwear and intimate apparel for high school and college students), Bath & Body Works, CO. Bigelow (personal beauty, body, and hair products), The White Barn Candle Co. (candles and home fragrances), Henri Bendel (high-fashion women’s clothing), and La Senza (lingerie sold in Canada and worldwide).

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17. Abercrombie & Fitch, as of 2013, had three brand divisions in addition to the flagship Abercrombie & Fitch stores: abercrombie (the brand name is purposely lowercase) for kids ages 7 to 14; Hollister Co. for southern California surf-lifestyle teens; and Gilly Hicks: Sydney, launched in 2008, specializing in women’s intimate apparel. RUEHL No. 925, launched in 2004 with more sophisticated apparel for ages 22 to 35, closed in 2010.

18. U.S. Census Bureau. Monthly Retail Trade and Food Services NAICS Codes, Titles, and Descriptions. www.census.gov/svsd/www/artsnaics.html 19. According to the American Marketing Association (AMA), a brand is a “‘name, term, sign, symbol or design, or a combination of them intended to

identify the goods and services of one seller or group of sellers and to differentiate them from those of other sellers.’ … Branding is not about getting your target market to choose you over the competition, but it is about getting your prospects to see you as the only one that provides a solution to their problem.” A good brand will communicate this message clearly and with credibility, motivating the buyer by eliciting some emotion that inspires future loyalty. From marketing.about.com/cs/brandmktg/a/whatisbranding.htm.

20. Turner, J. 2007. Go forth and go out of business. Slate, February 26, www.slate.com/id/2160668. 21. Chico’s FAS. Corporate profile, www.chicosfas.com/phoenixxhtml?c=72638&p=irol-homeProfile. 22. Lee, G. 2007. Chico’s outlines plan to improve results. Women’s Wear Daily, March 8: 5. 23. The responsibilities of these positions include “creative vision” for the brand: marketing materials, store design, and overall merchandising (developing

product, ensuring production efficiency, monitoring store inventory turnover, and adjusting price points as needed). 24. Columbus Business First. 2007. Limited Brands cutting 530 jobs. June 22, columbus.bizjournals.com/columbus/stories/2007/06/18/daily26.html. 25. Jones, S. M. 2007. Sweetest spots in retail. Knight Ridder Tribune Business News, July 31: 1. 26. See, for instance, the website www.aginghipsters.com, a “source for trends, research, comment and discussion” about this group. 27. Agins, T. 2007. The boomer balancing act: Retailers say new looks for middle-age women are both youthful and mature. Wall Street Journal (Eastern

edition), November 3: W3; and Moin, D. 2010. Scoring some hits: Misses’ market sees marked turnaround. WWD, March 31: 1. 28. Talbots Inc. 2006. Talbots completes the acquisition of the J.Jill Group. Business Wire, May 3, phx.corporate-ir.net/phoenix.zhtml?c=65681&p=irol-

newsArticle&ID=851481. 29. Abelson, J. 2008. Talbots is seeking a buyer for J.Jill. Boston Globe, November 7,

www.boston.com/business/articles/2008/11/07/talbots_is_seeking_a_buyer_for_j_jill. 30. Williams, S. 2012. Huge CEO gaffes: Talbots. Motley Fool, July 6, www.fool.com/investing/general/2012/07/06/huge-ceo-gaffes-talbots.aspx. 31. Protess. B. 2012. After rejecting higher offers, Talbots agrees to $369 million buyout. New York Times Dealbook, May 31,

dealbook.nytimes.com/2012/05/31/after-rejecting-higher-offer-talbots-agrees-to-369-million-buyout/. 32. Lomax, A. 2013. Chilly post-holiday news from Coldwater Creek. Motley Fool, January 15, www.fool.com/investing/general/2013/01/15/chilly-post-

holiday-news-from-coldwater-creek.aspx. 33. Dutton, A. 2013. Can Idaho’s Coldwater Creek hang on? Idaho Statesman, January 15, www.idahostatesman.com/2013/01/15/2412566/coldwater-

creek.html. 34. Lutz, A. 2011. How Talbots grew—and lost—its customers. Bloomberg Businessweek, June 16,

www.businessweek.com/magazine/content/11_26/b4234025390837.htm. 35. Some marketers believe that the boomers are a bifurcated demographic. Although the boomer market encompasses those born from 1946 to 1964, boomers

born between 1946 and 1954 have slightly different life experiences than those born between 1955 and 1964 have. 36. Wall Street Transcript Online. 2009. Investor interest in specialty apparel companies examined in Wall Street transcript specialty retail report. March

25.finance.yahoo.com/new s/Investor-Interest-in-twst-14741666.html. 37. Caplinger, D. 2012. Was 2012 Coldwater Creek’s turning point? Motley Fool, December 14, www.fool.com/investing/general/2012/12/24/was-coldwater-

creeks-2012-turning-point.aspx; Caplinger, D. 2013. Can Coldwater Creek stay hot in 2013? Motley Fool, January 7, www.fool.com/investing/general/2013/01/07/can-coldwater-creek-stay-hot-in.aspx; Lomax, A. 2013. Chilly post-holiday news from Coldwater Creek. Motley Fool, January 15, www.fool.com/investing/general/2013/01/15/chilly-post-holiday-news-from-coldwater-creek.aspx.

38. Cardona, M. 2012. Are these clothing stores a good fit now? MotleyFool, April 26, www.fool.com/investing/general/2012/04/26/are-these-clothing-stores- a-good-fit-now.aspx.

39. Kingsbury, K., & Moore, A. 2007. Ann Taylor tries for a better fit. Wall Street Journal (Eastern edition), August 25: B6. 40. Barbaro, M. 2007. Ann Taylor said to plan boomer unit. New York Times, August 13: C3. 41. Moin. 2010. Scoring some hits. 42. Cariaga, V. 2012. Ann Taylor apparel sales up as new strategy pays off. Investor’s Business Daily, January 8, news.investors.com/print/business-the-new-

america/010813-639740-ann-taylor-clothing-retail-sales-fashion-gap.aspx. 43. Information in this section comes from Ann Taylor Stores Corporation 10K filing as of FY2012. 44. PRNewswire. 2013. ANN INC. launches international shipping for Ann Taylor and LOFT. PRNewswire, March 8, investor.anninc.com/phoenix.zhtml?

c=78167&p=irol-newsArticle&ID=1794016; multimedia assets at www.multivu.com/mnr/60584-ann-inc-launches-international-shipping-for-ann-taylor- and-loft.

45. Jones, S. M. 2012. Op. cit. 46. Kennedy, K. 2000. This is not your momma’s clothing store—not by a longshot. Apparel Industry Magazine (Altanta), December: 22-25. 47. Merrick, A. 2006. Boss talk: Asking “What would Ann do?” In turning around Ann Taylor, CEO Kay Krill got to know her customers, “Ann” and “Loft.”

Wall Street Journal (Eastern edition), September 15: B1. 48. Moin, D. 2005. Ann Taylor Stores taps two to fill out executive ranks. Women’s Wear Daily, March3. 49. Moin, D. 2006. Laura Weil exits Ann Taylor. Women’s Wear Daily, May 5: 2. 50. Ann Taylor Stores Corporation. 2006. Ann Taylor Stores 2005 Annual Report, investor.anntaylor.com/phoenix.zhtml?c=78l67&p=irol-reportsAnnual. 51. Moin, D. 2006. Rebound at Ann Taylor: CEO Kay Krill fashions retailer’s new career. Women’s Wear Daily, June 26: 1.

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52. Ann Taylor Stores Corporation. 2008. Q4 2007 Ann Taylor Stores earnings conference call. SeekingAlpha.com, March 14, seekingalpha.com/article/68606-ann-taylor-stores-corporation-Q4-2007-earnings-call-transcript?page=8.

53. Ann Taylor Stores Corporation. 2008. Q1 2008 Ann Taylor Stores earnings conference call. 54. Ann Taylor Stores Corporation. 2011. Ann Taylor Stores’ CEO discusses Q4 2010 results—earnings call transcript. SeekingAlpha.com, March 11,

seekingalpha.com/article/257806-anntaylor-stores-ceo-discusses-q4-2010-results-earnings-call-transcript. 55. Moin. 2011. Growing Ann Taylor gets a new moniker.

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CASES

CASE 9 ANN TAYLOR

Survival in Specialty Retail* ANN Inc., specialty retailer of women’s apparel sold under its Ann Taylor or LOFT brands, was one of the few darlings of the retail sector stock analysts at the end of 2012. Fourth quarter revenues for ANN were up almost 9 percent from the previous year, making it one of only a handful of retailers to show real growth. Going into 2013, specialty retailers were beginning to recover from four years of dismal performance. The economic troubles of 2008 had lasted through 2009, producing one of the worst retail seasons in recent memory. 2010 had been an uphill battle, but at least some retailers had seen improvement, especially the luxury vendors such as Neiman Marcus and Nordstrom. The feeling during 2011 was that customers had shown “a clear preference for select high-end apparel brands such as Gucci,” and were “willing to pay a premium on something that delivers on luxury.” At the same time, shoppers were also “hunting down designer brands at steep discounts” at stores such as T.J. Maxx or Target, causing one businessman to label this the “barbell effect”: “high-end brands are holding ground among consumers, while spending at value-oriented stores has also been pretty stable. [But] it’s a tough place for mid-tier right now,” namely, those retailers such as Gap, Chico’s, and Ann Taylor.1

ANN had two branded divisions focused on different segments of this customer base:

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• Ann Taylor (AT), the company’s original brand, provided sophisticated, versatile, and high-quality updated classics.

ANN also carried both brands in factory outlet stores. The merchandise in each branded division’s store was specifically designed to carry the brand label. The stores featured the previous years’ top fashions and were located in outlet malls, where customers expected to find Ann Taylor and other major-label bargains. Both brands were also increasingly retailed online, on their respective websites.

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Financial data from 2009 to 2013 show the performance of LOFT compared to AT. (See Exhibit 1.) Krill acknowledged the ongoing challenge: “To be successful in meeting the changing needs of our clients, we must

continually evolve and elevate our brands to ensure they remain compelling—from our product, to our marketing, to our in-store environment.”6 Although Krill believed that, overall, Ann Taylor still had its historic appeal, the question remained whether that appeal could be sustained indefinitely in the risky and uncertain specialty retail environment, where success depended on the “ability to predict accurately client fashion preferences.”7

Ann Taylor went public on the New York Stock Exchange in 1991 under the symbol ANN. In 1994 the

EXHIBIT 1 AT versus LOFT Financial Performance, FY 2009–2013

Go to library tab in Connect to access Case Financials.

A B C D E F

1 AT versus LOFT Financial Performance, FY 2009–2013

2 Fiscal Year Ending

3 Feb. 2,2013 Jan. 28,2012

Jan. 29,2011

Jan. 30,2010

Jan. 31,2009

4 Net Sales (in millions)

5 Ann Taylor stores $ 644.5 $ 494.0 $ 503.1 $ 462.0 $ 694.8

6 Ann Taylor e-commerce Included in above

124.4 92.6 61.4 70.2

7 Ann Taylor Factory Outlet 300.7 289.4 268.0 248.0 254.9

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8 Total Ann Taylor brand 945.2 907.9 863.7 771.3 1,019.9

9 LOFT stores 1,202.2 991.0 943.3 947.8 1,098.2

10 LOFT e-commerce Included in above

123.9 96.9 60.2 61.8

11 LOFT Outlet 228.0 189.7 76.3 49.3 14.7

12 Total LOFT brand 1,430.3 1,304.6 1,116.5 1,057.2 1,174.7

13 Total company $2,375.5 $2,212.5 $1,980.2 $1,828.5 $2,194.6

14 Comparable-Store Sales Percentage, increase or (decrease)

15 Ann Taylor 1.1 5.2 18.7 (23.8) (17.0)

16 LOFT 4.8 8.0 5.0 (11.9) (10.2)

17 Total company 3.3% 6.8% 10.7% (17.4%) (13.4%)

18 Fiscal Year Ending

19 Feb 2,2013 Jan. 28,2012

Jan. 29,2011

Jan. 30,2010

Jan. 31,2009

20 Net sales 100.0% 100.0% 100.0% 100.0% 100.0%

21 Cost of sales % 45.2 45.4 44.2 45.6 51.9

22 Gross margin % 54.8 54.6 55.8 54.4 48.1

23 Selling, general, and administrative expenses %

47.8 48 49.4 52.9 47.8

Restructuring, asset, goodwill impairment %

– – 0.3 2.8 17.2

25 Operating income (loss) % 7.0 6.6 6.1 (1.3) (16.9)

26 Interest income % – – – 0.1 0.1

27 Interest expense % – (0.1) (0.1) 0.2 0.1

28 Income before tax % 7.0 6.5 6.0 (1.4) (16.9)

29 Income tax provision % 2.7 2.6 2.3 (0.4) (1.7)

30 Net income % 4.3% 3.9% 3.7% (1.0%) (15.2%)

31 Percentage change from prior period:

32 Net sales 7.4% 11.7% 8.3% (16.7%) (8.4%)

33 Operating income 14.6 21.5 600.1 (93.6) (339.2)

34 Net income 18.5 17.9 503.1 (94.5) (443.3)

Source: ANN Inc. 10K filings.

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Originally, the LOFT stores were found only in outlet centers, but in 1998 the LOFT stores in the discount outlet malls were replaced by a third concept, Ann Taylor Factory (Factory). The Factory carried clothes from the Ann Taylor (AT) line. This “outlet” concept offered customers direct access to the AT designer items “off the rack” without elaborate promotion and with prices regularly 25 to 30 percent less than at the high-end Ann Taylor stores. The LOFT concept was revamped, and stores were opened in more prestigious regional malls and shopping centers. By 1999 LOFT clothes were a distinct line of “more casual, yet business-tailored, fun, and feminine” attire, and they were about 30 percent less expensive than the merchandise at the flagship Ann Taylor division’s stores.9 At that time, the LOFT was under the direction of Kay Krill, who had been promoted to the position of executive vice president of the LOFT division.

Ann Taylor attempted a cosmetics line in 2000, which it discontinued in 2001. In 2000 the online store at www.anntaylor.com was launched, only to be cut back in late 2001 when projected cash-flow goals were not met. In early 2001 Spainhour restructured management reporting relationships, creating new president positions for both the AT and LOFT divisions, and Kay Krill was promoted from executive vice president to president of LOFT. In 2004 Krill was made president of the entire ANN corporation, bringing both Ann Taylor and LOFT under her control.

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EXHIBIT 2 ANN Net Sales (in $ billions)

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EXHIBIT 3 Income Statements (In $ thousands)

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A B C D

1 Income Statements (in $ thousands)

2 Period Ending

3 Feb. 2, 2013 Jan. 28, 2012 Jan. 29, 2011

4 Total Revenue 2,375,509 2,212,493 1,980,195

5 Cost of Revenue 1,073,167 1,004,350 876,201

6 Gross Profit 1,302,342 1,208,143 1,103,994

7 Operating Expenses

8 Sellinq, General, and Administrative 1,135,551 1,062,644 978,580

9 Nonrecurring ________ ________ 5,624

10 Operating Income or Loss 166,791 145,499 119,790

11 Income from Continuing Operations

12 Total Other Income/Expenses Net (189) – –

13 Earninqs before Interest and Taxes 166,602 145,499 119,790

14 Interest Expense 1,051 (1,052) (668)

15 Income before Tax 167,653 144,447 119,122

16 Income Tax Expense 65,068 57,881 45,725

17 Net Income 102,585 86,566 73,397

EXHIBIT 4 Balance Sheets (in thousands of dollars)

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A B C D

1 Balance Sheets (in thousands of dollars)

2 Period Ending

3 Feb. 2,2013 Jan. 28, 2012 Jan. 29, 2011

4 Assets

5 Current Assets:

6 Cash and Cash Equivalents 167,011 150,208 226,644

7 Short-Term Investments – – –

8 Net Receivables 57,454 62,555 72,277

9 Inventory 216,848 213,447 193,625

10 Other Current Assets 64,716 49,107 57,367

11 Total Current Assets 506,029 475,317 549,913

12 Property Plant and Equipment 409,703 360,890 332,489

13 Other Assets 18,632 12,340 12,523

14 Deferred LonG-Term Asset Charqes 7,841 39,134 31,895

15 Total Assets 942,205 887,681 926,820

16 Liabilities

17 Current Liabilities:

18 Accounts Payable 105,691 235,147 232,805

19 Period Ending

20 Feb. 2,2013 Jan. 28, 2012 Jan. 29, 2011

21 Liabilities

22 Short/Current Long-Term Debt – – –

23 Other Current Liabilities 231,063 50,750 49,103

24 Total Current Liabilities 336,754 285,897 281,908

25 Long-Term Debt –

26 Other Liabilities 31,125 35,030 22,997

27 Deferred Long-Term Liability Charges 189,216 202,877 198,470

28 Total Liabilities 557,095 523,804 503,375

29 Stockholders’ Equity

30 Common Stock 561 561 561

31 Retained Earninqs 676,842 574,527 487,691

32 Treasury Stock (1,056,011) (1,017,330) (863,569)

33 Capital Surplus 768,215 811,707 801,140

34 Other Stockholder Equity (4,497) (5,318) (2,378)

35 Total Stockholder Equity 385,110 363,877 423,445

36 Net Tangible Assets 385,110 363,877 423,445

Source: ANN Inc. 10K filings.

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EXHIBIT 5 Statement of Annual Cash Flows

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A B C D

1 Statement of Annual Cash Flows

2 Period Ending

3 Feb. 2,2013 Jan. 28, 2012 Jan. 29, 2011

4 Net Income 102,585 86,566 73,397

5 Operating Activities, Cash Flows Provided by or Used in

6 Depreciation 97,829 94,187 95,523

7 Adjustments to Net Income 64,442 38,149 26,526

8 Changes in Accounts Receivables 1,324 (2,060) 5,130

9 Changes in Liabilities (7,573) (24,649) (7,680)

10 Changes in Inventories (3,401) (19,822) (25,919)

11 Changes in Other Operating Activities 3,703 35,457 (2,666)

12 Total Cash Flow From Operating Activities 258,909 207,828 164,311

13 Period Ending

14 Feb. 3, 2013 Jan. 28, 2012 Jan. 29, 2011

15 Investing Activities, Cash Flows Provided by or Used in

16 Capital Expenditures (147,286) (118,918) (61,213)

17 Investments (1,977) (1,288) 5,322

18 Other Cash Flows from Investing Activities (649) (250) (1,331)

19 Total Cash Flows from Investing Activities (149,912) (120,456) (57,222)

20 Financing Activities, Cash Flows Provided by or Used in

21 Sale/Purchase of Stock (94,823) (169,736) (97,094)

22 Net Borrowings (2,801) (1,511) 1,622

23 Other Cash Flows from Financing Activities 5,449 (188) 3,377

24 Total Cash Flows from Financing Activities (92,175) (163,808) (84,936)

25 Change in Cash and Cash Equivalents 16,803 (76,436) 22,153

Source: ANN Inc. 10K filings.

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The Apparel Retail Industry

• Discount mass merchandisers: Chains such as Target, Walmart, TJX (T.J. Maxx, Marshall’s, HomeGoods), and Costco.

• Specialty store chains: Those catering to a certain type of customer or carrying a certain type of goods, for example, Abercrombie & Fitch for casual apparel.

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generous cut” instead of finding an “interesting, affordable way” for middle-aged women to “dress like themselves.”20

Chico’s FAS Inc. was another specialty retailer that tried brand expansions. Chico’s focused on private-label, casual- to-dressy clothing for women age 35 and older, with relaxed, figure-flattering styles constructed out of easy-care fabrics. An outgrowth of a Mexican folk art boutique, Chico’s was originally a stand-alone brand. Starting in late 2003, Chico’s FAS decided to promote two new brands: White House/Black Market (WH/BM) and Soma by Chico’s (Soma). Chico’s WH/BM brand was based on the acquisition of an existing store chain, and it focused on women age 25 and older, offering fashion and merchandise in black-and-white and related shades. Soma was a newly developed brand offering intimate apparel, sleep-wear, and active wear. Each brand had its own storefront, mainly in shopping malls, and was augmented by both mail-order catalog and Internet sales. The idea was that the loyal Chico’s customer would be drawn to shop at these other concept stores, expecting the same level of quality, service, and targeted offerings that had pleased her in the past. In 2011 Chico acquired Boston Proper, a brand that sold women’s high-end apparel and accessories focusing on women between 35 and 55 years old only through catalogs and online. Boston Proper’s intention was to create “a daring, modern style with a sensual feel designed for today’s independent, confident and active woman.”21

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and earnings below analysts’ expectations. Chico’s had seen increasing competition for its baby-boomer customers, and it said it had lost momentum, partly because of “fashion missteps” and lack of sufficiently new product designs. The company’s response was to create brand presidents for the three divisions to hopefully create more “excitement and differentiation.”22

This group of “older” women was part of the baby-boomer demographic, born between 1946 and 1964, and the purchasing power of these women had not gone unnoticed.26 Historically, this “misses” market had been challenging to define, and therefore the category had been slow to innovate. These women were diverse, ranging from “traditional types who prefer flat shoes and ankle-length skirts to women who resembled characters from Desperate Housewives.”27

To respond to this diversity in the marketplace, women’s specialty retailer Talbots Inc. acquired catalog and mail- order company J.Jill Group in 2006. J.Jill was a women’s clothing specialty retailer offering casual fashion through multichannel mail-order, Internet, and in-store venues. J.Jill targeted women ages 35 to 55, while Talbots focused on the 45 to 65 age group. Although the acquisition had supposedly positioned Talbots as a “leading apparel retailer for the highly coveted age 35+ female population,”28 Talbots subsequently decided to sell off this division in 2009, in the wake of retailing’s “abysmal holiday season.” Analysts were not surprised, because Talbots had never made an acquisition before and had encountered problems integrating the two businesses.29 Going into 2011, Talbots was struggling with merchandise that was perceived as too “mature,” with stores that looked old-fashioned, and with vacancies in key upper management positions. CEO Trudy Sullivan had been named one of the “worst CEOs of 2012” for her inability to turn the company around,30 and by 2013 Talbots had shut dozens of stores and been bought out by a private equity firm for less than $3 per share.31

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EXHIBIT 6 Selected Retail Performers: Descriptions

Company Ticker Symbol

Number of Stores

Locations Served

Merchandise Market Served Comments

Ann Taylor: ANN

981 46 states plus Puerto Rico and Canada

Specialty women’s—private-label “total wardrobing strategy” to achieve the “Ann Taylor look” in suits, separates, footwear, and accessories

Brands are Ann Taylor for updated professional classics; LOFT for lower-priced, more casual wear; and Ann Taylor Factory & LOFT Outlet for outlet- priced items.

Talbots (bought out by private equity in 2012)

516 46 states plus Canada

Specialty women’s—apparel, shoes, and accessories via store, catalog, and Internet

Brands are Talbots and Modern Classics for women. Brands target high-income, college- educated professionals over 35 years old.

Chico’s FAS: CHS

1,190 48 states plus U.S. Virgin Islands and Puerto Rico

Specialty women’s—privately branded clothing, intimate garments, and gifts for fashion-conscious women with moderate to high income via stores, catalog, Internet

Brands are Chico’s for women over 30, White House/Black Market for women over 25, Soma intimates, and Boston Proper online & catalog (modern style, sensual feel).

Coldwater Creek Inc.: CWTR

350 48 states Specialty women’s—apparel, accessories, jewelry, and gifts via store, catalog, Internet.

Offers Coldwater Creek brand of clothing and jewelry, cosmetics, and personal care products to women over 35 with income in excess of $75,000; socially responsible.

Source: Mergent Online; company reports.

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winner of the group.37 In fact, based on 2012 results, Chico’s and Ann Taylor were both among the top five in the specialty apparel retail industry, as ranked by margin.38 (See Exhibit 7.)

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EXHIBIT 7 Selected Retail Performers: Financial Results

Company Name* Total Revenue (millions)

Net Income (millions)

Inventory Turnover

Revenue per Employee($)

Abercrombie & Fitch (ANF)

4,158.1 127.7 3.43 46,328

ANN Inc. (ANN) 2, 212.5 86.6 4.93 111,486

Ascena Retail Group Inc. (ASNA)†

3,353.3 162.2 3.28 73,098

Chico’s FAS Inc. (CHS) 2,196.4 140.9 5.48 111,232

Coldwater Creek Inc. (CWTR)

773.0 (99.7) 3.77 112,340

Limited Brands Inc. (LTD) 10,364.0 850.0 6.22 107,139

Talbots Inc. (TLB)‡ 1,141.3 (111.9) 5.00 130,981

ROA% ROE % ROI % (Operating)

EBITDA Margin %

Abercrombie & Fitch 4.27 6.82 9.82 9.01

Ann Taylor Stores Corp. 9.57 22.05 36.17 10.83

Ascena Retail Group Inc. 7.00 13.02 20.77 11.51

Chico’s FAS Inc. 9.94 13.62 21.50 14.65

Coldwater Creek Inc. (21.74) (64.62) (52.98) (5.04)

Limited Brands Inc. 13.57 105.68 29.51 17.95

Talbots Inc. (17.09) (112.44) (60.24) (4.20)

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Source: Mergent Online.

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store. ANN’s stores typically had approximately 25 percent of their total square footage allocated to stockroom and other nonselling space. Also, the Ann Taylor stores, in many cases, had outdated floor plans and physical assets. The redesign involved a smaller format, approximately 30–0 percent smaller than the old stores, resulting in higher productivity and a more intimate, contemporary environment, decorated to make the shopper feel at home.45

EXHIBIT 8 Stores’ Operational Data

FY2012 FY2011 FY2010 FY2009

Employees, total 19,600 19,900 19,400 18,800

Inventory turns* 5.0 4.9 4.8 4.9

Net sales (revenue) per employee $121,199 $111,486 $102,352 $97,529

Number of Stores/Square Footage:†

Ann Taylor Stores 275/1,389 280/1,460 266/1,453 291/1,581

Ann Taylor Factory 101/696 99/700 92/668 92/668

LOFT Stores 512/2,950 500/2,904 502/2,930 506/2,976

LOFT Outlet 96/650 74/520 36/233 18/123

Total Company 984/5,685 953/5,584 896/5,284 907/5,348

Net Sales/Avg. Gross Square Foot‡ $418 $416 $464 $421

Source: ANN Inc. 10K filings; Mergent Online.

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customer with “wardrobing,” a philosophy of “outfitting from head to toe,” combining relaxed everyday wear with more dressy pieces.46 Because LOFT sold more-relaxed but still tailored items at a lower price than AT, the concern was that some of AT’s customers might shop at LOFT for things that they previously would have bought at AT.

In contrast, the typical LOFT client was in her 30s and married, with children, worked in a laid-back, less corporate environment, and had a household income between

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ENDNOTES 1. Dickler, J. 2011. Consumers: We want Gucci or Target. Forget the Gap. Shoppers are once again showing a preference for high-end brands.

CNN Money, March 9. money.cnn.com/2011/03/09/pf/consumers_prefer_luxury/. 2. Mahashwari, S. 2012. Retailers respond as millennials seek quality: Public “exhausted” by fast fashion; well-priced apparel now more

appealing. Chicago Tribune, November 16, articles.chicagotribune.com/2012-11-16/business/ct-biz-1116-bf-fast-fashion- 20121116_1_american-apparel-apparel-retailers-higher-prices; Berk, C. C. 2013. Dour December may not spell retail disaster this year.

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CNBC, January 2, www.cnbc.com/id/100349579; Steigrad, A. 2013. Holiday’s aftermath: Squeeze on profits. Women’s Wear Daily 502, no. 3 (January 4): 1.

4. Warner, B., director, corporate communications, Ann Taylor Stores Corporation. 2007. ANN representatives noted that there was no apparent cause-and-effect relationship between AT sales decline and the growth of LOFT. Personal communication, July.

investor.anntaylor.com/phoenix.zhtml?c=78l67&p = irol-reportsAnnual. 7. Ann Taylor Stores Corporation. 2008. Q1 2008 Ann Taylor Stores earnings conference call. SeekingAlpha.com, May 22,

seekingalpha.com/article/78473-ann-taylor-stores-corp-ql-2008-earnings-call-transcript. 8. Wilson, M. 1995. Reinventing Ann Taylor. Chain Store Age Executive with Shopping Center Age, January: 26. 9. Summers, M. 1999. New outfit. Forbes, December 27: 88.

10. Ann Taylor Stores Corporation. 2005. Ann Taylor announces LOFT division reaches $1 billion in sales. Investor.AnnTaylor.com, February 12, investor.anntaylor.com/news/20060213-187405.cfm?t=n.

11. Krill, K. 2005. As quoted in “Q3 2005 Ann Taylor Stores earnings conference call.” 12. Associated Press. 2006. Ann Taylor Stores jumps on strong earnings. MoneyCentral.MSN.com, March 10,

news.moneycentral.msn.com/ticker/article.asp?Feed=AP&Date=20060310MD=5570346&Symbol=US:ANN 13. Ann Taylor Stores Corporation. 2007. Letter to shareholders. 14. Ann Taylor Stores Corporation. 2011. Ann Taylor reports substantially higher sales and earnings for fourth quarter and fiscal 2010.

www.fool.com/investing/general/2011/03/11/ann-taylor-shares-popped-what-you-need-to-know.aspx. 16. Victoria’s Secret is a division of Limited Brands, which also operates Pink (a subbrand of Victoria’s Secret focused on sleepwear and

intimate apparel for high school and college students), Bath & Body Works, CO. Bigelow (personal beauty, body, and hair products), The White Barn Candle Co. (candles and home fragrances), Henri Bendel (high-fashion women’s clothing), and La Senza (lingerie sold in Canada and worldwide).

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C58

CASES

CASE 10 HEINEKEN*

At the start of 2013, Dutch brewer Heineken had strengthened its position as the world’s third largest brewer by securing a stronger foothold in the lucrative Asian beer market. It had recently paid over $6 billion to secure control of Asian Pacific Breweries, the owner of Tiger beer, Bintang lager, and other popular Asian brands. Listed in Singapore, Asia Pacific Breweries operates 30 breweries across the region, with operations in Cambodia, China, Indonesia, Malaysia, New Zealand, Singapore, Thailand, and Vietnam. CEO Francois van Boxmeer stated that the firm had wanted to make “a bold move in the region, which will be a growth market for decades to come.”1

The move came on the heels of acquisitions and capacity investments that Heineken has been making in other developing markets. In 2011, it purchased five breweries in Nigeria to increase its presence in Africa, which is becoming one of the world’s fastest-growing beer markets. The previous year, it had acquired Mexican brewer FEMSA Cervesa, producer of Dos Equis, Sol, and Tecate beers, to become a stronger, more competitive player in Latin America. With its purchase of Asia Pacific Breweries, Heineken expects that around 55 percent of its operating profits will come from such high-growth markets.

At the same time, Heineken has maintained its leading position across Europe. It made a high-profile acquisition of Scottish-based brewer Scottish & Newcastle, the brewer of well-known brands such as Newcastle Brown Ale and Kronenbourg 1664. Although the purchase had been made in partnership with Carlsberg, Heineken was able to gain control of Scottish & Newcastle’s operations in several crucial European markets, such as the United Kingdom, Ireland, Portugal, Finland, and Belgium.

These decisions to acquire brewers that operate in different parts of the world have been a part of a series of changes that the Dutch brewer has been making to raise its stature in the various markets and to respond to changes that are occurring in the global market for beer. Beer consumption has been declining in the U.S. and Europe as a result of tougher drunk-driving laws and a growing appreciation for wine. At the same time, the beer industry has become ever more competitive, as the largest brewers have been expanding across the globe through acquisitions of smaller regional and national players (see Exhibits 1 and 2).

EXHIBIT 1 Income Statements*

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A B C D E F G

1 Income Statements*

2 2012 2011 2010 2009 2008 2007

3 Revenue 18,383 17,123 16,133 14,701 14,319 12,564

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4 EBIT 3,904 2,455 2,476 1,757 1,080 1,528

5 Net Profit 2,949 1,430 1,436 1,018 347 807

* Figures in millions of Euros.

Source: Heineken.

EXHIBIT 2 Balance Sheets*

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A B C D E F G

1 Balance Sheets*

2 2012 2011 2010 2009 2008 2007

3 Assets 35,979 27,127 26,549 20,180 20,563 12,968

4 Liabilities 23,217 17,035 16,321 14,533 15,811 7,022

5 Equity 12,762 10,092 10,228 5,647 4,752 5,946

* Figures in millions of Euros.

Source: Heineken.

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The need for change was clearly reflected in the appointment in October 2005 of Jean-Francois van Boxmeer as Heineken’s first non-Dutch CEO. He was brought in to replace Thorny Ruys, who had decided to resign 18 months ahead of schedule because of his failure to significantly improve Heineken’s performance. Prior to the appointment of Ruys in 2002, Heineken had been run by three generations of Heineken ancestors, whose portraits still adorn the dark- paneled office of the CEO in its Amsterdam headquarters. Like Ruys, van Boxmeer faces the challenge of preserving the firm’s family-driven traditions, while trying to deal with threats that have never been faced before.

Confronting a Globalizing Industry Heineken was one of the pioneers of an international strategy, using cross-border deals to expand its distribution of its Heineken, Amstel, and about 250 other beer brands in more than 175 countries around the globe. For years, it has been picking up small brewers from several countries to add more brands and to get better access to new markets. From its roots on the outskirts of Amsterdam, the firm has evolved into one of the world’s largest brewers, operating more than 125 breweries in over 70 countries in the world, claiming about 10 percent of the global market for beer (see Exhibits 3 and 4).

EXHIBIT 3 Geographical Breakdown of Sales*

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A B C D E E F

1 Balance Sheets*

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2 2012 2011 2010 2009 2008 2007

3 Western Europe 7,785 7,752 7,894 8,432 7,661 5,450

4 Central & Eastern Europe 3,280 3,229 3,143 3,200 3,687 3,686

5 Africa & Middle East 2,639 2,223 1,988 1,541 1,566 2,043

6 Americas 4,523 4,029 3,296 1,817 1,774 1,416

7 Asia Pacific 527 216 206 305 279 597

* Figures in millions of Euros

Source: Heineken.

EXHIBIT 4 Significant Heineken Brands in Various Markets

Country Brands

U.S. Heineken, Amstel Light, Paulaner* Moretti

Netherlands Heineken, Amstel, Lingen’s Blond, Murphy’s Irish Red

France Heineken, Amstel, Buckler,† Desperados‡

Italy Heineken, Amstel, Birra Moretti

Spain Heineken, Amstel, Cruzcampo, Buckler

Poland Heineken, Krolewskie, Kujawiak, Zywiec

China Heineken, Tiger, Reeb§

Singapore Heineken, Tiger, Anchor, Baron’s

India Heineken, Arlem, Kingfisher

Indonesia Heineken, Bintang, Guinness

Kazakhstan Heineken, Amstel, Tian Shan

Egypt Heineken, Birell, Meister, Fayrouz†

Israel Heineken, Maccabee, Gold Star§

Nigeria Heineken, Amstel Malta, Maltina, Gulder

South Africa Heineken, Amstel, Windhoek, Strongbow

Panama Heineken, Soberana, Crystal, Panama

Chile Heineken, Cristal, Escudo, Royal

* Wheat beer. † Nonalcoholic beer. † Tequila-flavored beer. § Minority interest.

Source: Heineken.

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In fact, the firm’s flagship Heineken brand ranked second only to Budweiser in a global brand survey jointly undertaken by BusinessWeek and Interbrand a couple of years ago. The premier brand has achieved worldwide recognition according to Kevin Baker, director of alcoholic beverages at British market researcher Canadean Ltd. A U.S. wholesaler recently asked a group of marketing students to identify an assortment of beer bottles that had been stripped of their labels. The stubby green Heineken container was the only one that incited instant recognition among the group

But the beer industry has been undergoing significant change due to a furious wave of consolidation. Most of the bigger brewers have begun to acquire or merge with their competitors in foreign markets in order to become global players. Over the past decade, South African Breweries Plc acquired U.S.-based Miller Brewing and then Fosters, the largest Australian brewer, to become a major global brewer. U.S.-based Coors linked with Canada-based Molson in 2005, with their combined operations allowing it to rise to a leading position among the world’s biggest brewers. More recently, Belguim’s Interbrew, Brazil’s AmBev, and U.S.-based Anheuser-Busch merged to become the largest global brewer with operations across most of the continents (see Exhibit 5).

Many brewers have also expanded their operations without the use of such acquisitions. For example, Anheuser- Busch had brought equity stakes in and struck partnership deals with Mexico’s Grupo Modelo, China’s Tsingtao, and Chile’s CCU. Such cross-border deals have provided significant benefits to the brewing giants. To begin with, it has given them ownership of local brands that has propelled them into a dominant position in various markets around the world. Beyond this, acquisitions of and partnerships with foreign brewers can provide the firm with the manufacturing and distribution capabilities that they could use to develop a few global brands. “The era of global brands is coming,” said Alan Clark, Budapest-based managing director of SABMiller Europe.2

Since its acquisition of Anheuser-Busch, InBev is planning to include Budweiser in its existing efforts to develop Stella Artois, Brahma, and Becks as global flagship brands. Each of these brands originated in different locations, with Budweiser coming from the U.S., Stella Artois from Belgium, Brahma from Brazil, and Becks from Germany. Similarly, the newly formed SAB Miller has been attempting to develop the Czech brand Pilsner Urquell into a global brand. Exports of this pilsner have doubled since SAB acquired it in 1999. John Brock, the CEO of InBev, commented: “Global brands sell at significantly higher prices, and the margins are much better than with local beers.”3

Wrestling with Change Although the management of Heineken has moved away from the family for the first time, they are certainly aware of the long-standing and well-established family traditions that would be difficult to change. Even with the appointment of non- family members to manage the firm, a little over half of the shares of Heineken are still owned by a holding company controlled by the family. With the death of Freddy Heineken, the last family member to head the Dutch brewer, control passed to his only child and heir, Charlene de Carvalho, who has insisted on having a say in all of the major decisions.

And the family members were behind some of changes that were announced at the time of van Boxmeer’s appointment, changes to support its next phase of growth as a global organization. As part of the plan, dubbed Fit 2 Fight, the executive board was cut down from five members to three, all of whom are relatively young. Along with van Boxmeer, the board is made up of the firm’s chief operating officer and chief financial officer. Later, this board was further cut down to two members. The change is expected to assist the firm in thinking about the steps that it needs to take to win over younger customers across different markets whose tastes are still developing.

Heineken has also created management positions that would be responsible for five different operating regions and nine different functional areas. These positions were created to more clearly define different spheres of responsibility. Van Boxmeer argues that the new structure also provides incentives for people to be accountable for their performance: “There is more pressure for results, for

EXHIBIT 5 Leading Brewers

Brewer 2012 Market Share*

1. Anheuser-Busch InBev, Leuven, Belgium 20%

2. SAB Miller, London, UK 12%

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3. Heineken, Amsterdam, Netherlands 10%

4. Carlsberg, Copenhagen, Denmark 6%

5. Molson Coors Brewing, Denver, USA 4%

* Market share based on annual sales, in US dollars.

Source: Beverage World.

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achievement.”4 He claims the new structure has already encouraged more risk taking and boosted the level of energy within the firm.

The executive committee of Heineken was also cut down from 36 to 13 members in order to speed up the decision- making process. Besides the two members of the executive board, this management group consists of the managers who are responsible for the five different operating regions and six of the key functional areas. Van Boxmeer hopes that the reduction in the size of this group will allow the firm to combat the cumbersome consensus culture that has made it difficult for Heineken to respond swiftly to various challenges even as its industry has been experiencing considerable change.

Finally, all of the activities of Heineken have been overseen by a supervisory board, which currently consists of 10 members. Individuals that make up this board are drawn from different countries and cover a wide range of expertise and experience. They set up policies for the firm to use in making major decisions in its overall operations. Members of the supervisory board are rotated on a regular basis.

Maintaining a Premium Position For decades, Heineken has been able to rely upon the success of its flagship Heineken brand, which has enjoyed a leading position among premium beers in many markets around the world. It had been the best-selling imported beer in the U.S. for several decades, giving it a steady source of revenues and profits from the world’s biggest market. But by the late 1990s, Heineken had lost its 65-year-old leadership among imported beers in the U.S. to Group Modelo’s Corona. The Mexican beer has been able to reach out to the growing population of Hispanic Americans, who represent one of the fastest-growing segments of beer drinkers.

Furthermore, the firm was also concerned that Heineken was being perceived as an obsolete brand by many young drinkers. John A. Quelch, a professor at Harvard Business School who has studied the beer industry, said of Heineken: “It’s in danger of becoming a tired, reliable, but unexciting brand.”5 The firm has therefore been working hard to increase awareness of their flagship brand among younger drinkers. It has been running commercials on websites such as YouTube and Facebook. Two recent videos showed a young man on a wild date and a man’s show-stopping arrival at a wild party. Through such efforts, the firm has managed to reduce the average age of the Heineken drinker from about 40 years old in the mid-1990s to about 30 years old.

Heineken recently introduced a light beer, Heineken Premium Light, to target the growing market for such beers in the U.S. It has also rolled out a new design for the Heineken bottle that will be used across all of the countries where it is sold. The firm has also introduced Heineken in other new forms of packaging. It has achieved some success with a portable draught beer system called Draught-Keg. About 20 glasses of beer can be dispensed from this mini keg. A BeerTender system, which keeps kegs fresh for several weeks once they have been tapped, also continues to grow in sales.

At the same time, Heineken has also been pushing on other brands that would reduce its reliance on its core Heineken brand. It has already achieved considerable success with Amstel Light, which has become the leading imported light beer in the U.S. and has been selling well in many other countries. But many of the other brands that it carries are strong local brands that it has added through its string of acquisitions of smaller breweries around the globe. It has managed to develop a relatively small but loyal base of consumers by promoting some of these as specialty brands, such as Murphy’s Irish Red and Moretti.

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Finally, Heineken has been stepping up its efforts to target Hispanics, who account for one-quarter of U.S. sales. Besides developing specific marketing campaigns for them, it added popular Mexican beers such as Tecate and Dos Equis to its line of offerings. For years, these had been marketed and distributed by Heineken in the U.S. under a license from FEMSA Cervesa. In 2010, Heineken decided to acquire the two firms, giving them full control over all of their brands. Benj Steinman, publisher and editor of Beer Marketer’s Insight newsletter, believes their relationship with FEMSA has been quite beneficial: “This gives Heineken a commanding share of the U.S. import business and … gives them a bigger presence in the Southwest… and better access to Hispanic consumers.”6

Above all, Heineken wants to maintain its leadership in the premium beer category, which represents the most profitable segment of the beer business. In this category, the firm’s brands face competition in the U.S. from domestic beers such as Anheuser’s Budweiser Select and imported beers such as InBev’s Stella Artois. Although premium brews often have slightly higher alcohol content than standard beers, they are developed through a more exclusive positioning of the brand. This allows the firm to charge a higher price for these brands. A six-pack of Heineken, for example, costs $10, versus around $7 for a six-pack of Budweiser. Furthermore, Just-drinks.com, a London-based online research service, estimates that the market for premium beer will continue to expand over the next decade.

Building a Global Presence Van Boxmeer is well aware of the need for Heineken to use its brands to build upon its existing stature across global markets. In spite of its formidable presence in markets around the world, Heineken has failed to match the recent moves of formidable competitors such as Belgium’s InBev and U.K.’s SABMiller, which have grown significantly through mega-acquisitions. Many industry watchers assume that the firm has been reluctant to make such acquisitions in large part because of the dilution of family control.

For many years, Heineken had limited itself to snapping up small national brewers such as Italy’s Moretti and Spain’s Cruzcampo, which have provided it with small, but profitable avenues for growth. In 1996, for example,

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